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An eternal optimist's humble riposte to Professor Krugman

Iqbal Latif - 4/24/2008

Living with hope and buoyancy is far better than gloom and kismet. We are all inherently dull creatures; we steal our moments of happiness from sorrows around us. We need to live every instant with the greatest of relish, this is what life is all about. Give it your best shot silly - GIYBSS is my motto.

There is no shortage of prophets of doom. Paul R. Ehrlich, author of The Population Bomb (1968), furnishes a recent example of this. (Ehrlich predicted, in the late 1960s, that hundreds of millions would die from a coming overpopulation crisis in the 1970s, and that by 1980 inhabitants of the United States would have a life-expectancy of only 42 years). Add to it other names like Club of Rome, Global 2000 and latest "Neo-Malthusianism" rampant on intellectual cycles in a benign manner. Limits to Growth predicted oil running out in 1992 among other natural resources. Authors inadvertently load their case by letting some things grow exponentially and others not. Selectivity of information by the intellectuals is the prevalent rampant offense.

I was reading an article by Professor Krugman in NYT under the title Limits to growth and related stuff, by Paul Krugman. Paul Krugman explains why he is not as optimistic as the others in the opinion that "human ingenuity and technological progress will solve all our problems."

Being an eternal optimist and strongly believing that we humans have done very well, as we are net constructors not destructors, this line caught my attention: “You might say that this is my answer to those who cheerfully assert that human ingenuity and technological progress will solve all our problems. For the last 35 years, progress on energy technologies has consistently fallen below expectations.” He adds further that “as we learned in the 1980s, the long-run price elasticity of demand for oil is much higher than the short run elasticity, because in the long run you can switch to less gas-guzzling cars and stuff. But my point remains: alternatives to conventional oil have consistently proved harder to work than people expected.”

US petrol prices breached $3 a gallon at the wholesale level for the first time on Monday. Nymex May RBOB unleaded gasoline rose 2 cents to $2.9996 a gallon yesterday, just short of Monday's record of $3.0040. Oil is priced in $, so a cheaper $ should mirror relatively cheaper oil prices in countries whose currencies have appreciated. Actually in UK, petrol prices are nearly 4.2£ a gallon, equivalent to 8 dollars plus change; in Europe it may be a little more, although £ and Euro have both appreciated against a falling $, from £/$1.68 to nearly 2 and Euro/$ 1.15 to 1.60. The logic of cheap $ dictates that petrol should be cheaper in Europe than USA, but it is not the case; it is a highly taxed commodity, as the Saudi Oil minister keeps demanding: give me your tax revenue and take the oil revenue.

This differential of high petrol prices has always been there in Europe as well as Asia; in India, petrol is around 6.5$ a gallon. If UK and European or Indian economies are not in recession as a result of higher petrol prices, why should the USA be impacted adversely? I think these prices are weaning people away from gas guzzlers; Europeans drive far smaller cars and have mass transit systems so that resources are optimally utilized. Let 'petrol' find its own level, let the pattern of demand change; car pooling in England and Europe is a must. In America it has not even caught up. Innovation will come in human relationships if prices dictate a change; the first lesson of free markets is that living on freebies for far too long is not good anyway.

Maybe this realistic realignment of petrol in USA will help taper the demand. As free marketeers, why should liberal 'Economists' like Prof. Krugman worry about cheap oil or alternatives? Why can't US citizens pay the same price of petrol as others do? The problem with the Americans is that, as 2% of the world's population, they have been consuming 25% of the world's oil. Sensationalism, as a part of research, has become the norm for all major economic pundits. In Europe the truth story is that oil, if adjusted for inflation, efficiency (today 1.8 barrel of oil produces 1m US$ of GDP against 4 barrels of oil produced 1 m US$ GDP) and currency translation, in £ and Euro terms, we are not very far from embargo level prices. Higher oil prices are helping new economies of scale and efficiencies. If this was not so, oil at 119 $ plus MZM growing at 10% should have resulted in Weimar republic kind of hyperinflation. PPI numbers, whichever way one can interpret, are benign numbers if one reads how much commodities have gone through the roof in the last few months.

Higher oil prices cannot be detached from new global demand of consumers in India, China and the BRICS countries; the global standards of living are going higher. You can't put 2 billion as new consumers and wait for demand to stay calm and docile as if nothing happened, can you?

On oil, when everyone is pretty much on one side of the trade, that becomes frightening. Who can chart greed when oil makes a new high every day irrespective of low consumer confidence? Oil goes high, economy will go into dumps, that is what logic is built on that is unsustainable logic; economic slowdown will definitely impact oil prices and vice versa. One must not disregard the weight of the hedge funds on oil futures. Amaranth Advisors LLC hedge fund managing US$9 billion in assets in September 2006, collapsed after losing roughly US$6 billion in a single week on natural gas futures. The failure was the largest hedge fund collapse in history. Like natural gas that went up to $15 per unit until Amaranth Advisors LLC hedge fund blew up. Yesterday Crude oil for May delivery advanced $1.69, or 1.4 percent, to $119.17 a barrel at the 2:30 p.m. close of floor trading on the New York Mercantile Exchange. Futures reached $119.90 today; the highest since trading began in 1983. Prices are up 88 percent from a year ago.

Still there are a lot of people like me who think that the rally in Oil is, like currency speculation, based on demand as well as word; there is no reason for 1 billion barrels of oil being traded every day versus actual demand of 87 million barrels a day. Overshooting is part of the trading and we are seeing these parabolic prices but, on the other hand, an economy that can still deliver at 120$ oil would do very well at 90$. And once this bubble bursts, we will see that soon. It is not luck that global market capitalisation is on a tear and the bull has never ever died, even with a 7 trillion wipe off from the .com bubble.

When Professor Krugman says, 'I'd actually suggest that this is true not just for energy but for our ability to manipulate the physical world in general: 2001 didn't look much like 2001, and in general material life has been relatively static.' (How do the changes in the way we live between 1958 and 2008 compare with the changes between 1908 and 1958? I think the answer is obvious). He is actually being very US-centric and blinkered. It is loading the case with generalities and feelings, e.g., 'in general material life has been relatively static.' Anyone who sincerely believes this, when the pace of advancement has been so phenomenal in the last ten decades, is deliberately missing the plot. For an economist to ignore new consumer centres in China, India, Brazil is so shocking. The lifting of all boats has changed the life of billions; the shift of capital to a 'Mao-infested pauper land' and transformation of China to 1.5 trillion $ reserve land in the last decade is the greatest change in the annals of economic human history. The transformation of India from Gandhian self-reliance and Nehruvian socialism has changed the future of a continent and along with it half of the human race. Is life stagnant with these changes?

I am perplexed with the mediocrity of the argument that “My grandparents lived through much more earth-shaking transformations than I have. The Internet is a big deal, but does it compare to the telephone, electric light, airplanes, penicillin?” Maybe the 'Internet' is a far smaller a step in relation to the discovery of wireless and telephone, however, internet has killed the distance between brains; the idea of 'free communication' is the greatest innovation mankind has ever seen. Yes, telephonic costs and deflation pricing of technology represent far greater opportunities; but it is sophistication and ability of mass usage of technology that has changed the frontiers of global economy. The way ideas flow through the world is akin to discovery of human ability to speak. If humans were unable to speak, we would not have evolved much better than chimps; positioning of trachea, vocal chords have helped us with our ability to sing and articulate against grunts of a chimp; no speaking, no writing; no thinking, on a smaller scale technology in the last decade has propelled us into a new stratosphere of ideas, i.e., connection of minds on an unprecedented scale – that is a revolution no less than the human ability to speak; the exponential growth from this cannot be ascertained by limited minds of ours.

Prof Krugman benevolently dismisses 'Limits to Growth stuff.' He writes that: “anyway, while the Limits to Growth stuff of the 1970s was a mess, the history of energy technology doesn't support extreme optimism, either.” Limits to Growth attracted controversy as soon as it was published. Yale economist Henry C. Wallich characterized the book as "a piece of irresponsible nonsense" in a Newsweek editorial dated March 13, 1972. That is not at all the case. The Skeptical Environmentalist (page 121) states: "Limits to Growth showed us that we would have run out of oil before 1992." What Limits to Growth actually has is the above table which has the current reserves (that is no new sources of oil are found) for oil running out in 1992 assuming constant exponential growth. The static reserve numbers assume that the usage is constant, and the exponential reserve assumes that the growth rate is constant. For petroleum, neither assumption was correct in the years that followed due to the OPEC's oil embargo, followed by a return to increasing production.

The problem between optimists and pessimists is that the latter are always well received and receive the enormous chunk of exposure; anything damning attracts far more attention. How can news that 6 billion people of earth had good food be any kind of news? It has to be the 100s that died of malnutrition that should make news. How many of us remember Robert M. Solow from MIT, Dr. Allen Kneese and Dr. Ronald Riker of Resources for the Future (RFF) who rejected and complained about the weak base of data on which Limits to Growth's predictions were made (Newsweek, March 13, 1972, page 103):

"The authors load their case by letting some things grow exponentially and others not. Population, capital and pollution grow exponentially in all models, but technologies for expanding resources and controlling pollution are permitted to grow, if at all, only in discrete increments."

Why do we need to incorporate optimism as a strategy for human behavior, because there are no shortages of forecasters of disaster? We tend to take premonitions of tragedy far more seriously. Just tracking Malthusian prophecies have troubled many a continent and have impacted many a life. According to 'Wikipedia,' Malthusian theory also influenced British policies in Ireland during the 1840s: the government neglected relief-measures during the Irish Potato Famine (1845-1849), seeing mass starvation as a natural and inevitable consequence of the island’s supposed over-population. Malthus's position as professor at the British East India Company training college, which he held until his death in 1834, gave his theories substantial sway over Britain's administration of India that even continued under the Raj in 1858. The authorities regarded the famines as necessary to keep the "excess" population in check. In some cases administrators even banned private efforts to transport food into famine-stricken areas. "Malthusian" mentality can be very negative; those policies neglected the enormous economic damage done through loss of human capital, collapse of credit structures and financial institutions, and the destruction of physical capital (especially in the form of livestock), social infrastructure and commercial relationships. As a (presumably unintended) consequence, production often did not recover to pre-famine levels in the affected areas for a decade or more after each disaster, well after the replacement of the lost population.

The earth shaking transformations had totally by-passed the other 2/3rd of the global population. They are just discovering basic necessities of life - people used to die because of the lack of basic needs. The world as was expected by the free marketers is lifting all boats. USA today is nearly 25% of the global GDP of 55 trillion $'s; it is 25% of a far bigger cake. (IBM, Google, Yahoo, Caterpillar and McDonald earnings are testimony of that global reach). USA owns 7 of the top 10 world brands, as such, will continue to flourish. New global prosperity means new opportunities for USA; a huge new base for customers is being totally neglected in the doom and gloom of oil prices. Oil prices are not doom or gloom scenario, the best thing happened to the world is that those stuck in the lowest rung of the ladder have broken free; it is demand coming from those corners that are creating bottlenecks. Nations are smart; 70% of French electricity comes from nuclear power, Brazil gets 40% of its electrical requirements from hydro power, oil prices are expediting changes that are being adopted, like Indians utilizing canal flows for generating power.

Innovation at subatomic levels is seeing the biggest change; it is changing the landscape of the world. Maybe life looks stagnant for someone living with a per capita income of 45K$, but for those at 4K$, life and opportunities are immense. Those who suffered malnutrition and hunger are on a higher calorie intake today, so it is not a Malthusian crisis of scarcity, it is all about rising demand and rising expectations. Malthus proposed the idea that population, if unchecked, increases at a geometric rate (i.e. 1, 2, 4, 8, 16, etc.), whereas the food-supply grows at an arithmetic rate (i.e. 1, 2, 3, 4, 5 etc.). One needs to expand his horizons beyond the shores of Atlantic and Pacific to appreciate the greatness that western innovations have bestowed on mankind at large.