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Commentary

Future GDP growth is likely to be lower

20 Nov 2012 by Jim Fickett.

Jeremy Grantham's latest quarterly letter is out. The main point of a 16-page analysis is that the growth rate of US GDP is likely to drop to about 1%/year, and stay there. A large number of factors is considered; the two biggest are: (1) the working age population is growing much more slowly than before, and (2) natural resources will absorb a much larger fraction of total spending than before.

The main analysis is for the US but, obviously, these factors apply in many other nations as well.

I admire Grantham for attempting a quantitative approach to such a big-picture topic. At the same time, he recognizes that much of the analysis depends on fairly arbitrary assumptions. So I think the takeaway is not so much an exact level as that the GDP growth rate is likely to be permanently lower, as the planet's sustainable population reaches its limits and resources become scarcer and more expensive to retrieve.

As when Grantham wrote before about a paradigm shift in resource costs, I think he may be right but early, due to underestimating the effect of the China bubble. He counters the idea that high prices could be due to a bubble in demand by saying that mining costs have risen enormously. True, and part of that is, indeed, due to increased scarcity. But demand bubbles themselves drive up costs, as mining companies compete for scarce talent and equipment.

There are a couple of other points from the letter worth mentioning. One is that the definition of GDP leads to some odd artifacts, so that GDP does not always represent the value of output, as we tend to think it does. To me the clearest example is that destroying something and rebuilding it contributes nothing to well-being, but does contribute to GDP. So one often hears economists celebrating that a major disaster won't hit GDP too badly because of the reconstruction efforts. Joseph Stiglitz, someone I admire, on the whole, recently said,

The bubble broke, and now real estate investment is half of what it was. No way that that’s going to recover soon. The only good news is that the houses were shoddily constructed—and in maybe 5 or 10 years we’ll have to reconstruct them.

“good news”? It is true that rebuilding something that has fallen down contributes to GDP. But this is a limitation of GDP; the necessity to rebuild is never a net positive in the real world.

Jeremy Grantham points out a very similar distortion for resource costs:

But nothing shows the deficiencies of GDP measurement as clearly as the topic of a resource squeeze. Take oil. Today we are constantly pumping those wonderfully cheap, irreplaceable barrels of Saudi oil from their great oil fields (the likes of which have never been discovered since the 1970s or, one could argue, the 1950s) that begged to leap out of the ground with a lifting cost of a handful of dollars. In their place, to maintain oil production, we are preparing to deliver oil from deep and dangerous offshore Brazil. One-day daily flights of 300 miles, outside the range of current helicopters, will have to be made to supply rigs of incredible size, anchored to the ocean bed two miles below and drilling another two miles below that. They will need vast quantities of steel and other increasingly expensive commodities as well as large inputs of brains from the best Schlumberger types the industry can offer. The “good” that comes out is the same good that came out of the Saudi field – one barrel of nearly identical oil – but instead of a $10 lifting cost it will have costs of $120-$170 and counting, all of which will be accounted for as Brazilian GDP! So the more you torture the planet to produce oil, digging up tar sands and baking the oil to dribble out, the higher the GDP. Similarly, if when one day, not too far off, we are reduced to digging a thousand tons of copper ore to get a ton of pure copper, chewing up 10 times the energy of 50 years ago at 3 or 4 times the cost of energy (or 30 to 40 times the total energy cost), the higher the GDP will seem. The greater our collective pain, the greater the apparent pleasure will be. So you see the problem: we are trying to measure future growth and one of the bigger and least recognized negative factors is plugged in with the reverse sign!

So he attempts to estimate the effects on the non-resource part of the economy – the oil companies will do well, but everyone else's budgets will be stretched.

He also has a beautifully (and terrifyingly) simple take on fossil fuels, climate change, and politics:

Carbon Math Made Simple

1) Our emissions of greenhouse gasses have increased global temperature by 0.8 ̊C since 1850.

2) A 2.0 ̊C increase is the limit that gives us even a modest hope of avoiding very serious climate damage.

3) We can calculate how much CO2 it would take to incur that incremental 1.2 ̊C: 565 gigatons.

4) We can also calculate how many gigatons would be produced by the proven reserves of the hydrocarbon industry: approximately 2,800 gigatons, 5 times our target allowance. (Behind the “proven” are terrifyingly larger “probable” and “possible” reserves.)

5) Thus, we know that to be even a little safe we need 80% of these proven reserves to be left in the ground. The market value of oil companies is about equal to the perceived value of their reserves. The odds of the energy companies being enthusiastic about having 80% of their value left in the ground: nil.