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Did Peak Oil Cause the Financialization of the US Economy?
Pi-r8
Registered User regular
Registered User regular
(spoiler alert- it did!)
This is a long and somewhat complicated OP, so please bear with me. If you want the TL:DR version, skip to the graph at the end.
First, a definition. By "Peak Oil" I don't mean any sudden disappearance of all oil- I mean a gradual slowdown and peak in production. In particular, the oil consumption per capita (of conventional crude oil) is what interests me here.
Many, many progressives have lamented the "financialization" of the economy which started in the 80's- that is, letting the finance sector take over a greater and great share of our economy, especially as opposed to manufacturing. There's no question that it happened, or that's it's been a disaster for the average worker. See for example the following graphs, which have been widely circulated around progressive blogs:
There was a quote I remember from an investment book- I don't remember where- saying something like "if you want to beat the market average, the only way is to take money away from others who are earning less than average". That's pretty much what the richest Americans have been doing since 1976.
But the important question is- what caused this financialization? And how do we stop it? Should we, like many have suggested, move backwards to a manufacturing-based economy once again? If it was all a result of repealing regulations during the Reagan years, can we fix the problem by simply re-instituting those same regulations?
As a rule, I dislike conspiracy theories, by which I mean any story that tries to explain massive world events through the secret action of a small group of Great Men. Mostly I just don't think the Great Men are smart enough to pull it off- they don't know what to do, and even if they did they wouldn't be able to keep it secret. Some people have suggested that this change in the economy was caused by a small group of wealthy elites, working behind the scenes. It's not that I don't think they wouldn't try to do something like that, but I just don't think they're smart enough to pull it off. Peak Oil suggests a different story- one which is much more materialist and determinist, and basically independent of any particular human decisions. The Great Men just happened to be in the right place at the right time to take advantage of it. Compare this graph that I stole from Do the Math with the earlier graph of financialization:
Notice how the production curve followed an exponential growth curve until about 1975, and then leveled off hard (with small but noticeable dips from the Arab Oil embargo in 1973, and the Iranian revolution in 1979). And the most important number, oil consumption per person, peaked in 1980. This is reflected in the oil price history: the price stayed flat at roughly $15 per barrel (2009 dollars) up until the mid 70's, but then spiked with the turmoil in the middle east, and never came down to the earlier low prices ever again.
It made me suspicious that so many things seemed to change around 1975. This isn't proof of course- maybe just a coincidence, or merely one factor among many. But it's not just a random graph match-up- there's a strong logical reason to believe that these graphs are connected. The story here is that, until about 1975, we enjoyed a booming manufacturing-led economy fueled by cheap oil. We had unlimited potential to profitably expand the economy by simply burning more oil. But once the oil started getting more expensive, manufacturing lost its profitability. Meanwhile, the financial elites had an immense amount of capital saved up from the manufacturing boom, and they demanded a strong return on investment just like they'd always had before, so there was no place else for it to go but into finance. An industry driven by paper rather than energy has unlimited potential for growth, but only for the wealthy few, and it carries with it unlimited risk. At the same time, advances in technology made it much easier to offshore manufacturing to third-world countries that could use cheap labor instead of oil. We've been able to somewhat make up the difference by burning more "unconventional" oil and natural gas, but that's much less energy efficient and less profitable than conventional oil.
I decided to investigate further. First, I had to find the data on median income over time. It was surprisingly difficult to find this info- most sites just give either the mean income, or the median household income. I needed the median, because the mean is skewed so much by the massive increase at the top, so the median is much more representative of what an "average worker" is earning. Looking at the median incomes makes it clear how much our income has been stagnant since the mid 70's.
Then, I separated it into men's and women's income. I'm particularly interested in the trend of the men's income over time, because I think that is more representative of the "average worker" during the past. The change in women's income has been driven more by social than by economic factors. I got the income data from the US census.
Then, I needed data on US oil consumption per capita. This, again, was somewhat hard to find. I couldn't find any published source of oil consumption per capita going back to 1950. So, I took total consumption data from Earth Policy, and divided it by the population data from the US census in each year. The result is this graph:
There is a .88 Pearson R correlation between American men's median income, and American per capita oil consumption. There are, of course, other factors that influence short-term changes, but this is a remarkably high degree of correlation. It gives a p value of less than .0001 (meaning, there is less than a 0.01% chance that this correlation is just random chance). The women's median income is much less strongly correlated (r = .51) but still highly significant. Especially since I did all this with excel and just a couple hours of internet sleuthing. I'm sure that a real economist could produce a much better statistical fit.
What I would like to do is to test this correlation for other countries. Unfortunately, it's not so easy to find this data, especially for third-world nations like China. But if anyone has suggestions on where I can find more data on oil consumption per capita, or median income, I'd appreciate it. My hypothesis is that first-world countries like the UK and Canada will follow basically the same pattern as the US, while third-world countries like China and India would be the exact opposite (stagnant until the 70's, then a steep increase as they began to industrialize and burn more oil).
Unfortunately, if this is true, it also means that the financialization and stagnant growth of the U.S. economy will be very difficult to change. It's not enough to just add some extra finance regulations or raise the minimum wage- cheap oil is gone, and it's never coming back. The tech boom of the 90's led to a small increase, but that has now been completely wiped out by the recession. We need to fundamentally change the way the economy works.
This is a long and somewhat complicated OP, so please bear with me. If you want the TL:DR version, skip to the graph at the end.
First, a definition. By "Peak Oil" I don't mean any sudden disappearance of all oil- I mean a gradual slowdown and peak in production. In particular, the oil consumption per capita (of conventional crude oil) is what interests me here.
Many, many progressives have lamented the "financialization" of the economy which started in the 80's- that is, letting the finance sector take over a greater and great share of our economy, especially as opposed to manufacturing. There's no question that it happened, or that's it's been a disaster for the average worker. See for example the following graphs, which have been widely circulated around progressive blogs:
There was a quote I remember from an investment book- I don't remember where- saying something like "if you want to beat the market average, the only way is to take money away from others who are earning less than average". That's pretty much what the richest Americans have been doing since 1976.
But the important question is- what caused this financialization? And how do we stop it? Should we, like many have suggested, move backwards to a manufacturing-based economy once again? If it was all a result of repealing regulations during the Reagan years, can we fix the problem by simply re-instituting those same regulations?
As a rule, I dislike conspiracy theories, by which I mean any story that tries to explain massive world events through the secret action of a small group of Great Men. Mostly I just don't think the Great Men are smart enough to pull it off- they don't know what to do, and even if they did they wouldn't be able to keep it secret. Some people have suggested that this change in the economy was caused by a small group of wealthy elites, working behind the scenes. It's not that I don't think they wouldn't try to do something like that, but I just don't think they're smart enough to pull it off. Peak Oil suggests a different story- one which is much more materialist and determinist, and basically independent of any particular human decisions. The Great Men just happened to be in the right place at the right time to take advantage of it. Compare this graph that I stole from Do the Math with the earlier graph of financialization:
Notice how the production curve followed an exponential growth curve until about 1975, and then leveled off hard (with small but noticeable dips from the Arab Oil embargo in 1973, and the Iranian revolution in 1979). And the most important number, oil consumption per person, peaked in 1980. This is reflected in the oil price history: the price stayed flat at roughly $15 per barrel (2009 dollars) up until the mid 70's, but then spiked with the turmoil in the middle east, and never came down to the earlier low prices ever again.
It made me suspicious that so many things seemed to change around 1975. This isn't proof of course- maybe just a coincidence, or merely one factor among many. But it's not just a random graph match-up- there's a strong logical reason to believe that these graphs are connected. The story here is that, until about 1975, we enjoyed a booming manufacturing-led economy fueled by cheap oil. We had unlimited potential to profitably expand the economy by simply burning more oil. But once the oil started getting more expensive, manufacturing lost its profitability. Meanwhile, the financial elites had an immense amount of capital saved up from the manufacturing boom, and they demanded a strong return on investment just like they'd always had before, so there was no place else for it to go but into finance. An industry driven by paper rather than energy has unlimited potential for growth, but only for the wealthy few, and it carries with it unlimited risk. At the same time, advances in technology made it much easier to offshore manufacturing to third-world countries that could use cheap labor instead of oil. We've been able to somewhat make up the difference by burning more "unconventional" oil and natural gas, but that's much less energy efficient and less profitable than conventional oil.
I decided to investigate further. First, I had to find the data on median income over time. It was surprisingly difficult to find this info- most sites just give either the mean income, or the median household income. I needed the median, because the mean is skewed so much by the massive increase at the top, so the median is much more representative of what an "average worker" is earning. Looking at the median incomes makes it clear how much our income has been stagnant since the mid 70's.
Then, I separated it into men's and women's income. I'm particularly interested in the trend of the men's income over time, because I think that is more representative of the "average worker" during the past. The change in women's income has been driven more by social than by economic factors. I got the income data from the US census.
Then, I needed data on US oil consumption per capita. This, again, was somewhat hard to find. I couldn't find any published source of oil consumption per capita going back to 1950. So, I took total consumption data from Earth Policy, and divided it by the population data from the US census in each year. The result is this graph:
There is a .88 Pearson R correlation between American men's median income, and American per capita oil consumption. There are, of course, other factors that influence short-term changes, but this is a remarkably high degree of correlation. It gives a p value of less than .0001 (meaning, there is less than a 0.01% chance that this correlation is just random chance). The women's median income is much less strongly correlated (r = .51) but still highly significant. Especially since I did all this with excel and just a couple hours of internet sleuthing. I'm sure that a real economist could produce a much better statistical fit.
What I would like to do is to test this correlation for other countries. Unfortunately, it's not so easy to find this data, especially for third-world nations like China. But if anyone has suggestions on where I can find more data on oil consumption per capita, or median income, I'd appreciate it. My hypothesis is that first-world countries like the UK and Canada will follow basically the same pattern as the US, while third-world countries like China and India would be the exact opposite (stagnant until the 70's, then a steep increase as they began to industrialize and burn more oil).
Unfortunately, if this is true, it also means that the financialization and stagnant growth of the U.S. economy will be very difficult to change. It's not enough to just add some extra finance regulations or raise the minimum wage- cheap oil is gone, and it's never coming back. The tech boom of the 90's led to a small increase, but that has now been completely wiped out by the recession. We need to fundamentally change the way the economy works.
Pi-r8 on
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For decades following WW2 the U.S. economy had tons of structural advantages over the rest of the world: abundant domestic natural resources, a modern western government, and infrastructure (mostly) unscathed by wars and colonialism, and a military that could step into the void left by the old european powers. Expecting those advantages and their attendant positive outcomes for the "average" american to continue into perpetuity was always a pipe dream, and the rising price of oil is only one symptom (the rest of the world had to industrialize sometime, after all.)
"Financialization" of the economy is something that probably would've happened anyway. It's not as though people didn't like huge profits in the 60s, but the data management (computers) necessary to have all these specialized financial instruments didn't really exist until the 80s.
that's why we call it the struggle, you're supposed to sweat
Besides, if I'm completed wrong, how do you explain such strong correlation between oil and income?
It seems reasonable to me that oil consumption would correlate with income; the more income we have, the more willing we are to spend it on things, and "spending money on things" basically means consuming oil somewhere in the process (probably multiple times.)
that's why we call it the struggle, you're supposed to sweat
Income inequality seems easily explained by the fact that globalization creates opportunity for people at the top to expand their empires and forces people at the bottom to compete with people with far lower standards of living.
The beauty of this is, if the infinite growth model is viable, everybody wins. The expansion of labor markets (like China) is a recent shock and should smooth out in a few decades. At that point in time the standard of living for the poorest of the poor should be much better than it is now. If the energy input model is true and we can't increase energy production, then the rich will build walls around their compounds and the poor will die or live like slaves.
― Marcus Aurelius
Path of Exile: themightypuck
What do you suggest?
― Marcus Aurelius
Path of Exile: themightypuck
http://www.stat.columbia.edu/~gelman/research/unpublished/econanova.pdf
Edit: ok I'll try. I'm not an expert on stats, though.
There's a correlation but it's not as strong as you seem to be indicating, look at your charts (and find some more detailed ones), during the ~decade after the oil crash of the late 70s income exceeded the previous level long before oil usage did, and while oil usage dropped by over a quarter income only dropped by a few percent. It was actually a great opportunity for our government to move away from subsidizing oil, if we had our usage would probably be a quarter less than what it is today.
The next recession is either going to be from oil or finance (again), almost certainly. The only reason gas isn't $5 or higher right now is because of the housing bubble collapsing and demand being hit in the jewels. Regardless, we hit peak oil (as it is commonly understood) some time ago, a lot of what you put in your tank wasn't considered oil 15 years ago - the peak of cheap oil happened and is going to continue to be a growing problem.
Well of course it's not a perfect matchup. Wages are sticky, and it takes time for them to change. I wouldn't expect then to exactly change with a sudden shock like the Arab oil embargo.
I'm more interested in the long term trend- why did wages stop improving right when our oil consumption peaked?
Everyone knew that cheating and irresponsibility was happening, but everyone was trying to stay on as long as possible to make the most money before they got out. Then the music stopped and there were no chairs at all.
Now peak oil really didn't cause the financialization of the economy. It was simply a natural progression of integration and technology. That isn't to say oil didn't have an effect. Oil commodities are a very common way to hedge on oil prices (I think they are the most commonly traded commodity), but there are several other ways to hedge against fuel prices that are about as good. Now the back and forth nature of commodities is kind of getting away from the real purpose commodities trading which is to provide an easy way to protect the pricing of an item, and to buy huge quantities of stuff on the open market at a favorable price.
At the bottom of the issue, banking deregulation allowed commercial banks and mortgage lenders to get involved in financial services. Because credit default swaps made it possible for banks to make immediate profits on mortgage backed bonds regardless of the rating of the bonds (i.e. regardless of how likely they were to pay out), banks had incentive to issue as many mortgages as they could. This is where the subprime lending craze came from, and ultimately why tranche manipulation became a thing (to get more bonds to sell CDSes on, you need more bonds you can sell.)
that's why we call it the struggle, you're supposed to sweat
Case in point. There are factors in the world that have reduced the number and prevelance of pirates in the world. And there are factors in the world that have increased the global temperature. But pirates aren't the cause or in any way related to global temperatures.
When one source of cheap energy dries-up, you're going to go looking for others.
Labor has been more expensive here for a long time, though. This is just armchair bullshitting on my part, but I could imagine Nike deciding at first to simply offset the high cost of labor with cheap energy. When that was no longer a viable option, they would've just reversed the formula by moving the manufactuing base overseas (energy is expensive, but now you're more than making-up the difference in labor cost).
Actual data would tell a more accurate tale, of course.
Cheap energy is what allows off-shoring though. The rise in oil prices has actually moved manufacturing back to the US as shipping becomes too expensive.
Basically, to hit on the thread's topic directly, expensive oil discourages fianacialization, not the other way around.
I don't think I agree with you: the idea of peak oil is a psychological one. We have declared to have reached peak oil for over a century now. Back when the first fields were beginning to dry up in Pennsylvania there were already analysts declaring the end of the age of oil. Then they discovered the fields of Texas and later Russia and eventually Saudi Arabia. What is happening now is that the oil-producing countries throttling oil production. If they wanted to, they could produce as much oil as they did in the 70s, but it is far more worthwhile to not flood the market. There is also the very real possibility that the natural resources under the North Pole will blow the Arabic Peninsula out of the water. If the effect of oil on this planet interests you, there's a huge book by Daniel Yergin: The Prize. He does not pay enough attention to the negative effects of oil, but it is a great book regardless. It really puts some developments in a context you probably hadn't considered yet.
However, everyone agrees that fossil fuels are a finite resource and that synthetic fuel will never allow for an economic boom like oil has caused. In the past waves of society-wide development have been caused by discoveries that have fundamentally changed the way we did everything. For more on this subject I would like to refer you to the Kondatriev waves. When we're talking about the US in particular I think it is more relevant to look at the World-systems theory as described by Immanuel Wallerstein. For a more concise write-up I can recommend Political Geography: World-economy, Nation-state and Locality by Colin Flint & Peter Taylor.
Eh. There was going to be some coincidence.
When we do statistics with the eye for correlation making any sense we must in all cases start with a theory of how the thing we think effected the other effected the other. Correlation can and does occur randomly and when you start thinking "financialization has happened and so has peak oil" you're basically doing a hueristic on all the random things and aligning those up which had the randomness you're looking for.
When you just look at random correlation based on thinking about two things that have gone in the same or opposite directions you're taking the randomness out of it. You make the p-value (and r value) meaningless because the probability that you will can choose two events that are highly correlated approaches one when the sample set increases in size and your choice mechanism is looking for things that are highly correlated.
Anyway. The end of oil independence in the US is not the only event that occurred in the 70s (not, I note, the 80s). Also important was the rise of foreign competition from other countries that had recovered from World War II, most popularly known of which is Japan. Prior to this, the postwar record had strongly suggested that US companies were astonishingly immune to competitive pressure and change, which had led JK Galbraith to argue that managerial capitalism had permanently supplanted price competition. Of course the timing of this hypothesis was unfortunate in retrospect.
Second, the 70s coincided with the end of the Bretton Woods system; this had at least three effects that seem obviously important (casually speaking - I'm not putting that much thought into this post...). First, the US government could not casually run deficits as large has it had been before, so the Great Society died before it was implemented. The impact on inequality here is obvious; no need to invoke oil. Second, the need for the US itself to acquire funding from the open market made finance much more attractive. Third, the end of Bretton Woods both caused OPEC countries to organize to defend their own oil interests and introduce the institutional arrangements for aggressively pricing their oil exports (since the US had abdicated somewhat-benevolently doing so at its own expense), which would then lead to these new arrangements being additionally used as a political weapon during the Yom Kippur war, and also made it exceptionally difficult for the West to formulate a policy response to the oil crisis. It would not be until the 90s that Western central banks could assert enough control on a regular basis to create the Great Moderation period.
I think another component to the off shoring phenomenon (in manufacturing especially) is the improvement in information technology. It is much, much, much easier to deal with design changes now than it would be in 1980. Before rapid transmission of pictures or files was possible this kind of thing would have to be routed through physical delivery which was also much more costly in that period. The IT development side is obviously the reason why phone banks didn't move until the 90's.
Though oil prices are starting to push things back towards us there are other reasons why we hold on to what we do. Raw materials are somewhat, uh, freeform in China and in some areas that can cripple a product. I know one local company thrives in large part because of their relative ease of access to odd varieties of steel for the making of gears.
I disagree with most of the criticism in the Wiki, besides being poorly cited, it mostly refers to doubts about the "set in stone" nature of the waves. As any sensible social scientist (and yes, that includes economists) will tell you: there are no laws in the social sciences. Kondratiev is useful in so far as that it provides a plausible explanation for certain periods of economic growth in the developed world (ie: western Europe and USA and later Canada, Australia, New Zealand, Japan) over the past century (ie: Industrial Revolution up till the post-war years) and provides tools to make a slightly better educated guess about when the next economic high tide will be and what kind of developments one should look out for in that case.
or: what about standard Keynesian or Keynesian-flavored dynamics is insufficiently plausible. Kondratieff waves suggest that either policy is ineffective or the political business cycle reigns supreme, neither of which is plausible
There is nothing, I repeat nothing in Schumpeter's K-waves that suggests any theoretical basis for their existence; their sole claim to fame is in the observed empirical reality, a claim which has failed to stand up to closer scrutiny and postwar data. So why cling on to them? It provides no tools to make educated guesses over the next economic high tide.