152. WHY EXACTLY IS GROWTH NECESSARY?

It is true that our economic system requires growth to function, and will breakdown without growth. The exact reasons why this is true aren't often discussed, so let's describe two of them.

1) Over the long-term, a non-growing real economy cannot service a positive real interest rate.

There are two kinds of interest -- nominal interest and real interest -- and to understand the phenomenon of interest, it is critical to distinguish them clearly in your mind. If you put your money in a savings account paying 4% a year, that 4% is called the nominal interest rate. How much that interest is worth in the real world, however, is determined by the rate of inflation. If the inflation rate happens to be 4%, then your savings account paying 4%, will yield you no net return in terms of purchasing power. If you put $1.00 in the account, you will have $1.04 a year later, but in the meantime, the price of eggs (for instance) will have risen from $1.00 to $1.04, so you are just spinning your tires. You don't get any net value. The following formula gives a good approximation of real interest which is accurate for practical purposes:

Real interest = Nominal interest - Inflation rate

So how does this apply to peak oil? Well, first of all, it is clear that a growing economy is not necessary to pay off interest (i.e. nominal interest) as Heinberg claims:

Currently, most money is loaned into existence by banks and is thus based on debt and implies a commitment to pay interest on that debt. If the economy does not grow, new money will not be created to pay interest on existing loans; those loans will thus be defaulted upon, and a crash will occur.Source

Heinberg is wrong because all interest is payable in money, and money is a human construct which is not limited in any physical way. All outstanding debts in the economy, plus interest, could be paid off tomorrow simply by the government printing up the necessary money. Therefore the economy does not have to grow to pay off interest (i.e. nominal interest). The only thing that has to grow is the money supply, and there is no genuine limit on that.

Nominal interest is, in some sense, just a deceptive illusion and a red herring, so it is always best -- when discussing these issues -- to focus in on the heart of the matter: real interest.

The only time a non-growing economy has a problem is when it has to continually pay real interest (i.e. interest over and above the inflation rate). If the borrower pays compounding real interest, there will come a time (which may take quite a while coming) when interest payments cannot be made because the economy is not producing enough real stuff.

So, if growth goes negative, the real interest rate will eventually have to follow it. This will cause flight out of the bond market, because bondholders are very inflation sensitive, and don't like the idea of negative real interest rates. The government can try to fight this by keeping the real interest rate on bonds positive. But it can't work. Saying you will pay a real interest rate is equivalent to an agreement to pay your lender in physical barrels of oil. You can't keep it up because the interest is increasing, while the available barrels of oil are decreasing. Eventually, the government would have to: a) default, or b)acquiesce to inflation and start printing money instead of borrowing it with bonds.

This is a deep threat to the current economic system, but it can be massaged. One approach would be to to eliminate the institution of risk-free real interest, as in the Islamic banking system. Such a change would not really be that significant. Citibank already has sophisticated Islamic (non-interest) banking operations Source. Essentially, this would be a retrofitted economy where investment occurs exclusively through risky equities, rather than risk-free bonds and savings accounts.

2) If productivity and/or population is increasing, growth is necessary to prevent unemployment.

This situation can be described with the following equation:

G/P = E

Where:
G=GDP
P=Productivity (GDP/total man-years to produce GDP),
E=Number of employed persons (i.e. total number of man-years needed to produce GDP)

In simple terms, we can describe the situation like this. If productivity is increasing at your company, that means they need fewer employees to produce a unit of output. So they lay off the excess people. In order for those people to return to work, growth must occur. Either the old company must have sales growth to justify hiring the workers back, or a new business (which adds new sales to the GDP) must be started up.

Now, look at the equation again. If GDP is decreasing, and productivity is increasing, the total number of employed people must go down. Increasing population will amplify this negative effect on employment. So the other direct effect of decreasing GDP is increasing unemployment.

This problem could be massaged in different ways. If GDP is constant, a constant employment rate could be ensured by freezing the population, and stopping productivity improvements. The employment rate could be raised by reducing the population, and reversing productivity gains (i.e. doing farming by hand instead of with labor-saving machines).

We can also look to working examples of modern economic systems which have functioned while eliminating unemployment (i.e. the planned economy of the Soviet Union, or capitalist equivalents like work-fare).

It's interesting to note that even a cornucopian like Marshall (Peak Oil will be a Non-Event) Brain is very concerned about about about increasing unemployment due to increasing productivity. See his page Robotic Nation.

On this point, it looks like we're all in the same boat -- doomers, cornucopians and moderates. The problem of unemployment is going to require some heroic creative thinking, no matter what happens.

-- by JD