Top Economist: The Unthinkable is About to Happen To Energy

0:00 The next time Iran attacks this country,

0:02 go in and grab one of their big oil installations.

0:05 Every bridge in Iran will be decimated.

0:08 Every power plant in Iran will be out of business,

0:12 burning, exploding, and never to be used again.

0:16 Meet Steve Keen, the economist who warned us before the 2008 crash.

0:20 What if this crisis isn't just about geopolitics, but energy itself?

0:25 As tensions rise in the Strait of Hormuz,

0:27 the world could be underestimating the real danger.

0:30 If we lose 10% of the energy of the planet

0:32 courtesy of what's happening in the Strait of Hormuz,

0:35 then we're going to get a 10% fall in GDP.

0:38 But the neoclassicals say, "Don't worry, be happy.

0:41 If you don't have energy, you can substitute labor." It's nonsense.

0:45 You can't substitute one input for another.

0:47 One of the reasons we're being completely taken by surprise by the scale

0:51 of what's happening in the Strait of Hormuz and the impact

0:53 it's having upon the global economy is that conventional economic theory

0:58 pretty much ignores the physical world of how it talks about production.

1:02 So, the standard model that economists

1:03 use is called the Cobb-Douglas production function,

1:06 and that shows output being produced by combining what they call technology,

1:10 labor, and capital, and they leave energy out completely.

1:13 But when they do include energy, they tack it on in exactly the same

1:17 way that they talk about labor and capital themselves.

1:20 The amount of capital multiplied by the amount

1:22 of labor multiplied by the amount of energy,

1:25 and they then each of those are raised to the power of an exponent,

1:28 which is based upon the share that each

1:30 of these so-called factors of production have in the economy.

1:34 So, for labor, the share that labor gets is roughly 70% of GDP,

1:40 so the figure they use for them is 0.7.

1:42 Leaving out the energy sector, they say the capitalists get about 25% of GDP,

1:47 so the component they exponent they use for capital is 0.25.

1:51 And then when they do include energy, they say, "Well,

1:54 energy is the another 5% of GDP, as I've got in this example,

1:59 and therefore the component exponent for capital is

2:01 0.05." when you vary any of the inputs,

2:05 it's the production function enables you to substitute capital

2:11 for labor and substitute labor for energy and so on.

2:14 And therefore, the actual impact of a fall in energy is given by the exponent,

2:20 which is in this case 5%.

2:22 So, what it's saying that a 10% increase

2:25 in the amount of energy available would increase

2:27 GDP by half of 1% and equally a 10% fall would reduce GDP by half of 1%.

2:35 Now, the alternative model,

2:36 which is the model that my school of economic thought,

2:39 the post-Keynesians in general,

2:41 use, came out of empirical work by Wassily Leontief,

2:45 great Russian stroke American mathematical economist.

2:49 And he looked at data on income and capital all

2:53 around the world and said that however you measure them,

2:56 so long as you the two ways

2:57 of measuring income and capital are reasonably consistent,

3:00 you find there's a constant relationship between the two, roughly speaking.

3:04 So, if you have capital worth 300, you'll have output worth 100.

3:08 If capital worth 600, you'll have output worth 200.

3:12 He didn't have an explanation for it,

3:14 but it was so much of regularity that he said,

3:16 "This tells you the amount of output that will

3:19 produced will be equal to that amount of capital

3:21 divided by what he called the capital to output

3:24 ratio." And that was generally a figure of about three.

3:27 Now, also what came out of of the empirical examination of production

3:32 by Leontief was that capital and labor and energy are not substitutes.

3:36 You need them in the right proportion, and if you don't have any of one of them,

3:40 your output is going to be constrained

3:42 by what your available level of output is.

3:45 So, I've done a very simple rendition of that here in this Ravel model,

3:51 and what I'm showing is the the way

3:52 the neoclassicals think that production is created.

3:55 So, you have capital raised to the power of 0.25 multiplied by labor multiplied

4:01 raised to the power of 0.7 multiplied by energy raised to the power of 0.05.

4:06 And this effectively says, "Well,

4:08 that's where the rabbit sat to have a realistic approach

4:10 to economics." Then join me and learn realistic economics through stevekeen.com.

4:14 You can use my Ravel software that you've seen me using in this video.

4:18 You can talk to me and ask me questions.

4:20 There's a free book bundle that's available just this week.

4:22 To apply, go to stevekeen.com or scan the QR code.

4:25 Because you're multiplying them together, you can substitute one for the other.

4:30 So, if there's a fall in energy,

4:31 you get a smaller impact than you have a fall in capital,

4:35 and a smaller impact again than if you have a fall in labor.

4:38 The Leontief approach basically says, "Well,

4:41 whatever you don't have enough of, that's the constraint

4:44 upon your capacity to produce output." And in this case,

4:48 setting up with all the amounts of capital

4:51 and labor and energy at maximum level,

4:54 I'm now going to see what happens according to both theories if

4:57 I reduce the amount of each of those inputs that are available.

5:01 So, I've got energy up here.

5:03 Available energy is 100,

5:04 then going to be graphed on the bottom of the chart down here,

5:08 where the vertical shows what is the theoretical prediction

5:12 for the impact of that loss of energy on output.

5:15 You're going to get a neoclassical prediction

5:17 and a prediction I'm calling the Keen prediction,

5:19 but it comes from Leontief idea there.

5:21 So, let's run this model,

5:23 and then if I now say let's say let's say there's a a 1% fall in energy,

5:28 then that is the neoclassical prediction of the impact that's going to have.

5:33 That's that 0.05% impact.

5:36 Down here, it's a 1% impact according to the Leontief

5:39 model that that I use and that all post-Keynesians use.

5:43 Keep on going, and if you have a 10% fall in energy,

5:47 and that's about the scale we're looking at for what's

5:49 happening in the Strait of Hormuz right now,

5:51 at least a 10% fall in global energy supplies will come out of that.

5:55 The neoclassicals predict that's going to cause

5:57 a half of 1% fall in GDP up there.

6:00 The post-Keynesian prediction is it'll cause a 10% fall in total GDP.

6:06 That's the gap between neoclassical theory and empirical reality.

6:11 We're going to find out the hard way

6:12 that this one is correct and this one is a fantasy.

6:15 One of the thing that this approach to thinking about production says it argues

6:20 is it says that it's losing capital has a bigger impact than losing energy.

6:25 So, if I now do the same thing now,

6:27 but I've got falling amount of capital, you'll notice it's lower.

6:30 A prediction of more damage for the neoclassical model coming

6:33 out of this as I reduce the amount of capital,

6:36 but the prediction for the post-Keynesian is exactly the same.

6:40 And the reason is labor and capital and energy are not substitutes.

6:44 They are factors that work together to produce output.

6:47 So, if you have a fall in the availability of one of the resources,

6:50 it'll affect your capacity to use the other resources as well.

6:53 You can't add more energy with less less labor.

6:56 You've got to have more of both.

6:58 The same for the machinery.

6:59 So, as I reduce the capital,

7:02 the prediction for the neoclassical model that that would

7:04 cause if you had a 10% fall in capital,

7:07 that might cause a 3% fall in GDP or 2.5% fall in GDP.

7:13 Down here, it's saying now it's going to be 10%.

7:15 And then if we now go back and restore the capital

7:19 to the index value of 100 and now reduce the labor,

7:22 the prediction from the neoclassical theory is reducing labor is going

7:26 to have a bigger impact than reducing energy or reducing capital on outputs.

7:31 So, if I reduce that amount now, you see that the Cobb-Douglas prediction

7:36 is closer to the post-Keynesian prediction, but this is still realistic.

7:41 Because you can't substitute energy for machinery

7:45 and you can't substitute labor for capital,

7:48 then you do not get the substitution effect

7:51 that minimizes the damages that the neoclassicals talk about here.

7:55 You get the fact you simply haven't got the inputs.

7:57 If you don't have the machines, you can't put the energy into the machines.

8:01 If you don't have the energy, you can't fire up the machines.

8:04 If we lose 10% of the energy of the planet courtesy of what's happening

8:08 in the Strait of Hormuz or what's not happening in the Strait of Hormuz,

8:12 then we're going to get a 10% fall in GDP.

8:15 Now, that's the attitude that non-orthodox

8:17 economists like myself have towards this situation.

8:21 Some people who are experts in energy analysis have the same sort of argument.

8:25 Ed Conway would make the same basic case.

8:28 But the neoclassicals say, "Don't worry, be happy.

8:31 If you don't have energy, you can substitute labor." So,

8:34 you don't have the the fuel you need to put into that petrol tank of yours?

8:37 That's fine.

8:38 Just put the service station attendant in there instead,

8:41 and you'll get the same level of output.

8:42 It's nonsense.

8:44 You can't substitute one input for another.

8:46 This is just at the very aggregate level as well, of course.

8:49 What we're looking at in the case of losing the Strait of Hormuz is

8:53 that there are very specific types of energy that come out of that region.

8:58 Equally, there are things like fertilizer that come out of that region.

9:01 If you don't have the fertilizer,

9:03 you can't substitute that by spreading workers across your production fields.

9:07 You're going to have less food output.

9:09 So, all these the neoclassical arguments trivialize the impact of losing

9:14 inputs by saying we can substitute one input for another.

9:17 The Leontief argument, which is the one that my school of economic thought uses,

9:22 the post-Keynesian school of economic thought,

9:24 it says that if you lose one of those inputs,

9:27 you can't substitute for the others.

9:29 Your level of production is going to go down.

9:31 And so, we're about to find the very

9:33 hard way that mainstream economics misleads us,

9:36 whereas the non-orthodox stuff that I'm part of gives us an accurate idea

9:40 of what's likely to happen out of a crisis like the Strait of Hormuz.