Economy

Abstract

Capital and labor have been traditionally considered the factors that produce the wealth of nations, which is measured by the gross domestic product (GDP). After the oil price shocks of the 1970s and 1980s, energy was occasionally taken into account as a third factor of production. But mainstream economics has the problem that it can explain only about half, or less, of the observed economic growth of industrialized countries by the growth of the production factors. The other half, or more, is attributed to technological progress. This is just a word for what is not understood and is also called Manna from Heaven. The cause of the problem is the cost-share theorem, according to which the share of a factor in total factor cost should be equal to the factor’s productive power. The latter is called output elasticity in economics. Roughly speaking, it indicates by what fraction of 1% the output of an economy, i.e. the GDP, changes if the production factor changes by 1% while all other factors stay constant. On the average, the cost shares have been about 25% for capital, 70% for labor, and 5% for energy in industrialized economies. Thus, energy plays hardly any role in orthodox theories of production and growth. However, the cost-share theorem can be disproved by including technological constraints on capital, labor, and energy in the derivation of the (equilibrium) state in which an economy is supposed to operate. This is shown for the state of maximum profit, and for the state of maximum overall welfare as well. Consequently, a new method of computing output from the inputs of capital, labor and energy is needed and developed. It reproduces economic growth in Germany, Japan and the USA in good agreement with the empirical data and yields productive powers that are much larger for energy and much smaller for labor than their cost shares. In fact energy, and its conversion into physical work, accounts for most of the growth that mainstream economics attributes to technological progress and related concepts. As energy conversion is inevitably coupled to entropy production, the resulting emissions threaten environmental stability and impair economic evolution. In other words, future growth strategies must observe the Second Law of Economics: Energy conversion and entropy production determine the growth of wealth. This complements the First Law of Economics: Wealth is allocated on markets, and the legal framework determines the outcome. The distribution of wealth, the accumulation of debts, discounting of the future, and perspectives on growth are discussed.