Monday, April 30, 2012

Food price index rose 5X faster than global per capita GDP since 2000: The real factor that caused the failure of the financial economy.



            It is never easy to approach this subject.  When one wants to point out a problem with global food sustainability prospects, the automatic reply comes in the form of accusations of one holding Malthusian and alarmist views, which have been proven wrong, and will always be wrong.  Presentation of counterfactual evidence is no longer necessary when one has such an impressively effective tool to suppress an argument.  The need for suppression of this issue is found in many social quarters.  Economic interests are in expansion, and that includes the expansion of the consumer base.  Population growth is therefore seen as important.  Religious groups are interested in suppressing this issue, because the idea of promoting Planned Parenthood contrasts with the teachings these establishments inherited from an era which is no longer recognizable to us in terms of lifestyle and circumstances.  Finally, we have our political elites, who simply hope they can continue to stick their heads in the sand and ignore this increasingly hard to ignore problem.  There are no easy answers to this problem; there are no quick fix and therefore politically convenient solutions.  So we lack the mechanism to organize a human response to this already evident and coming humanitarian catastrophe.

A widening gap between food price and economic growth:

            According to the UN’s food and agriculture organization, between 2000 and 2012, the price of food has gone up by 150%, as measured by their global food price index.  This long term structural rise in food prices is unprecedented in history.  There was never a global rise in food prices that we know of in our past.  All previous price spikes were regional, triggered by temporary disruptions in agriculture.  Real global GDP growth during this same period has been a relatively more moderate 50% gain.  On a per capita basis, real GDP growth was about 35% for this period, because we had an increase in the world’s population of about 16%.  In contrast, before the year 2000, in most decades, per capita GDP growth tended to outpace the rise in food prices.

Causes:

It is tempting to sweep this problem under the carpet.  We could blame this problem on speculators and excessive money printing by central banks.  The benefit of doing so is peace of mind.  The cost is failure to tackle the problem.

The real reasons for this increase in the price of food are as follows:

-An increase in the price of inputs, such as oil, which also rose in price by about 500% over this twelve year period.  Other inputs such as potash also rose in price.

-Farmland is becoming more scarce, due to factors such as degradation due to misuse, loss of water supply for irrigation, changing weather patterns (climate change), and encroachment by other uses for the land, such as building residential neighborhoods, use of land by other industries such as mining, or oil and gas extraction, as well as building infrastructure such as rail lines and highways.

-We also have food contamination, and pollution that can cause a drop in food yields.  Such is the case with wild fisheries, which are impacted by contamination, as is the case at Fukushima and in the Gulf of Mexico.  Pollution in the form of agricultural runoff is causing dead zones in oceans.  Overfishing is also causing fisheries to collapse.

-The rate of increase in cereal yields per unit of land has declined in recent decades from 2.5% per year to about 1.5% per year.  So, not only do we have less farmland available, but yields are not advancing as fast as they used to, for reasons such as land degradation, unstable weather patterns, as well as an approach to the limit of what yield enhancing techniques can do for us, such as the use of irrigation, hormones, GM seeds, and the application of fertilizers and pesticides.

-Aside from supply side issues, we have demand side issues to contend with.  The already mentioned increase in the price of oil caused the popularity of bio-fuels to rise, which means that we are now shifting our food supply from feeding people to feeding our transport system.  Effectively, we are pitting gas tanks against people’s stomachs.

-On the demand side, we also have a continuing rise in the world’s population, as well as a rise in the world’s middle class ranks, who demand more animal protein that takes far more land and resources per caloric unit produced than cereals do.

-If speculators are indeed a cause of the rise in food prices, I would put them right where I just did; at the bottom of the list.


Current dangers and dangers ahead:

            The non-food economy rose by only about 25% per capita in the past twelve years, or about 2% per year.  If we were to exclude other commodities such as oil, coal and metals, which also rose in price considerably, the non-commodity advance of the world’s economy has been rather flimsy.

The market economy, as well as the political decision making apparatus, reacts to triggers, such as a change in prices of certain goods in accordance with their natural design.  It has been so far very unfashionable to acknowledge this, but the unwise growth in the supply of credit that we witnessed before the collapse of 2008, was in large part a move to compensate for the rise in commodity prices, which interestingly started at the same time, and took an increasing chunk out of the non-commodity economy.  I know that many want to believe that it was the other way around and the increase in credit and money supply led to a jump in prices, but these people tend to ignore the fact that natural resources production, with a few exceptions, became harder to expand during this period.  Not even the huge surge in prices was enough to accelerate production rates.  At most, as is the case with oil, the rise in prices only led to the prevention of complete stagnation, or even decline in production rates.

            The rise in the supply of credit was not a permanent solution to countering the surge in commodity prices, such as food. The 2008 crash was proof of it.  In the long-run, the continued rise in food prices and other commodities can only lead to global growth rates slowing or even stagnating.  Ironically, this stagnation can lead to a further decline in agricultural product availability, because at this point farmers around the world are increasingly dependent on regular subsidies and disaster relief from governments. Governments are increasingly strapped for cash however, so a collapse in farm subsidies and disaster aid can lead to a further increase in food prices, which then will of course create a further drag on the global economy.  The impending cuts in farm subsidies are already being debated and there will be no other choice but to implement.   The vicious cycle effect can then continue with a further deterioration of our financial abilities to undertake certain projects for extracting commodities that the farm industry is dependent on for achieving current yields, such as potash, phosphate rock and oil.  Let us not forget that commodity extracting companies depend on credit lines to undertake new projects, or expand existing ones.  In the absence of the financial economy being able to provide this credit, extracting companies will scale back.

            At this point, it does not matter if as an individual is politically left or right leaning.  It does not matter if one is living in a democracy or dictatorship.  The one thing that we can all commonly say about our elites is that they failed us.  The missing ingredient that would have made it possible to continue down our current path would have been a global mechanism to keep us from loosing sustainability.  The market economy has often proved itself to be efficient and resilient, but it never contained a mechanism to price in sustainability as an output cost.  As a result we did not get sustainability, we only received market solutions, such as product substitution, which made it seem like our human ingenuity coupled with the invisible hand of the market can conquer all our challenges.  We lost track of the fact that opportunities for substitution are also finite.  The only response we got from the market doubters thus far was to encourage local administrative entities, such as municipalities, countries, or as is the case of the EU, a group of countries to engage in unilateral sustainability projects, which in the absence of global action only serves to endanger a region’s economic sustainability as we can now see with the EU and California.

            There is no telling how bad the situation we are currently in can get.  At the present time, the UN estimates that there are 1 billion people on this planet who are facing outright starvation.  In reality, more than half the world’s population is suffering from a more or less severe form of malnutrition.  Many may get the necessary caloric intake, but not the necessary nutritional intake, due to the higher cost of many ingredients.  In the absence of many inputs such as irrigation, or oil, which we are engaging currently in increasingly complex and expensive projects in order to provide to the global market, we can easily see the current global food output drop by half or even more.  If I am correct, and the rise in the price of food and other commodities is causing the continued long term degradation of the financial economy, in the absence of urgent action, in the form of a global solution, along the lines that I proposed in the form of the sustainability tariff, we are currently marching towards the edge of the cliff, and there will be nothing to stop us from going over it.

Monday, April 23, 2012

Has China’s oil production peaked? What are the implications?


            In the past decade, perhaps the most prominent story in regards to oil was the rise of Chinese consumption.  They went from consuming 4.8 mb/d in 2000, to 9.4 mb/d in 2010.  Their increase was equivalent to half of all extra global demand added in the past decade  Oil imports made up the bulk of the supply increase during this period, but a rise from 3.3 mb/d to 4.4 mb/d in Chinese production, helped dampen the demand for imports.  So while consumption rose by 5 mb/d, imports rose by 4 mb/d.  Many people believe that in the current decade, China’s rate of growth in oil consumption will decrease. I believe they are right, in fact I believe that consumption growth might be less than many anticipate.

Consensus is that demand growth should average about .4 mb/d per year. 

I believe average demand from China during this period will not exceed .3 mb/d, giving us an approximate consumption rate of about 12.5 mb/d by 2020.

This should be good news for the strained global oil industry, except that as the graph below shows, there is a chance that Chinese demand for oil imports will be pushed up not only due to increasing consumer demand, but also because of declining supplies.

Data source:  EIA


            The EIA projected that this year, Chinese oil production will average 4.5 mb/d.  They did not release their data for the first month of this year yet, but in December of 2011, average daily production was about 4.2 mb/d.  Given that the year will start off with a weak number, the full year average will most likely leave those hopping for a robust continuation of growth disappointed.  I do believe that Chinese oil production peaked in the fourth quarter of 2010.  To clarify what I mean by peaked; we are unlikely to ever see production that will be substantially higher than the average we had during that quarter.   We might however see it go down by a few hundred thousand barrels by 2020.

Implications:

            As I said, I expect Chinese demand to be dampened somewhat, compared to the past decade as well as compared with most projections out there.  If demand growth will be about .3 mb/d per year, while instead of the average 100,000 b/d increase per year we had during the past decade, we will have a 50,000 b/d yearly decline, the drop in demand growth for imports from China will not be very substantial, compared to the last decade.  While growth in demand will be .3 mb/d less than during the previous decade, the drop in demand for imports will be a less substantial decline of .15 mb/d.

            This is highly problematic in today’s world.  Demand increase for petroleum consumption coming from the world’s main exporting region, the Middle East can be as much as 3 mb/d by 2020.  This means that export capacity growth from this vital region will be limited, if any.  Production in Africa is set to increase, but so is demand, so export growth from this region will be dampened as well.  Same can be said about Latin America.  Russia is an important oil exporter, but there is a good chance that Russian oil production will also start declining during the current decade.  That, combined with a slight increase in internal oil demand means that Russian exports will likely decline.

            The only bright spot is North America, where unconventional projects should increase overall production, while demand is relatively stagnant.  This means that demand for imported oil from outside the region will likely decline.  This decline however will most likely only make up for production declines we expect to see from the North Sea region.  

            Bottom line is that China and its Asian neighbors will continue to drive demand for oil imports, while there are fewer opportunities to find new net exporters, who will not have their capacity swallowed up by their own consumption or that of their immediate neighbors.  If indeed China’s production has peaked, the task of supplying the global economy with the needed fuel has just become a little bit more challenging.

Need for acknowledgement of the situation:

            The mainstream media has lately been very much gripped by a wave of optimism on fuel.  Shale gas, oil shale, oil sands, apparently solved all our challenges for many, many decades, so we should stop worrying and go on with our lives.  The not long ago increasing awareness of the reality of the peak in conventional oil production, which is likely something we are living through right now, has faded away now, and the new story line is all about hundreds of years worth of unconventional fossil fuels, which magically made our fuel problem disappear.  Yet, the reality is not as rosy as the mainstream media tries to make it.  The 2011 downgrade of the Marcellus shale by the USGS, which was also accepted by the EIA as a fact, never made it on the radar screen of mainstream cable and newspaper outlets.  Overnight, 80% of the gas we thought we had in the largest US shale gas play, disappeared.  There is evidence that the other plays were also overhyped.  I never saw acknowledgement in the mainstream media of it.  We are bombarded with claims of oil reserves that are currently not technically feasible, like the Powder River kerogen deposits that do contain more “oil” than Saudi Arabia ever did, but none of it has ever been shown to be commercially viable, no matter what the price of oil, because it is a net energy sinkhole.  In other words, it takes more energy to produce it than we can get out of it.

            Reality is that in the absence of demand dampening economic events, the oil story will continue to be one of very tight supplies, despite all the hype about unconventional sources.  In North America, there is an especially strong trend towards leaning towards the optimistic storyline when it comes to energy, because thanks to the fracking revolution, natural gas prices have plummeted to levels not seen in over a decade.

It is unfortunate that people have such a short memory.  It was just over a decade ago that the “experts” were worried that there was so much new supply of crude coming online that, they will have a hard time sustaining the price over $10 a barrel for perhaps decades.  Now, reaching such a low price is unthinkable, because most fields cost substantially more to produce than that.  In the absence of recessionary pressures, we are actually having a hard time keeping the price bellow $100 for very long.  When It comes to the North American gas market, I don’t expect prices to skyrocket in the very near term, but as new demand is created to soak up the extra supply of gas, it will eventually become inevitable for prices to rise, because supply will eventually fail to keep up with demand, and there will be nothing else to substitute as a replacement for the gas.  It is very important to understand that it does not take much of a glut or shortage to make the price of such an inelastic commodity make very big moves in price.  So what may seem like a market swimming in natural gas, can very quickly become a market facing shortages.

The possible peak in Chinese production is yet another one of those negative stories on energy that the mainstream media seems to have become allergic to reporting.  We have instead people like Sarah Palin, and Larry Kudlow tell us stories of trillions of barrels in reserves that only await our will to pay a small environmental price to harness their benefits, which as I stated in regards to these so called reserves such as kerogen, are nothing more than a very old story that once in a while resurfaces for political purposes.  These are stories based on citations of reports prepared by organizations that are less than what one might call reputable and impartial, but the citations are given legitimacy due to the mainstream status of the above mentioned messengers, so enough people believe it.  As a result, the average consumer, investor, even policy maker is left to suffer from one of the most basic causes of market failure, which is the lack of reliable information to base decisions on.  The much needed relief that the global economy needs in order to have a chance of re-emerging out of the current stagnation and disfunctionality, will not come in the form of lower oil prices.  We need therefore to start thinking of new ways of redressing the situation urgently.   

Monday, April 16, 2012

Larry Kudlow, Sarah Palin, President Obama, oil prices & failed communist dictators, promising progress: More in common than you think.



            I decided to write this article a few weeks ago, as I watched Mr. Larry Kudlow on CNBC, tell the viewer that there is so much petroleum in the US, that Americans can unilaterally change the global oil market in a positive way, driving prices at the pump much lower.  This could only happen if the political will wasn’t lacking, of course.  Last Friday, I also watched a similar show, hosted by Sarah Palin, on FOX news, called “paying at the pump”.  The barrage of distorted information is just incredible.  The last time, I experienced such an intensive barrage of public misinformation was as a child, when Eastern Europe’s communist dictators were desperately trying to convince the masses that all was well, even as the system was failing miserably.  People never believed it of course, so they took to the streets, ending their failed policies.  Unfortunately, people in the west tend to be more gullible, due to their firm belief in the validity of their elites.    

Kudlow’s claim:

            US president Obama stated that the US only has 2% of the world’s proven reserves.  That is in part technically correct.  The EIA, and IEA both agree that the US has about 22 billion barrels of proven reserves, while the world has about 1.3 trillion barrels.  This of course does not mean that 22 billion barrels is all there is that will ever be recovered.  New discoveries, technological innovation meant to improve recovery rates, and price incentives can all potentially add to that number substantially.  Mr. Kudlow and Sarah Palin took issue with it, counterclaiming that president Obama is using outdated methods of assessing the situation, and we in fact have over sixty times more oil that is technically recoverable than president Obama claims.  The US therefore could drill its way to lower gasoline prices, and to energy independence.  To back his claims, Mr.Kudlow cited the Institute for Energy Research; a non profit organization, funded by energy company donations, which is run by a former Enron employee.


Keeping Kudlow and Palin honest:  (not easy)

The categories of oil can be divided into conventional fields, including offshore and deep offshore, in other words, the stuff we usually think of when someone mentions oil.  There are the oil sands, which currently are mainly produced in Canada, but the US also has some resources.  There is the shale oil (tight oil), which recently became responsible for most of the 10% or so increase in US oil production that we got in the past few years, thanks to fracking technology that initially was used to produce shale gas.  There is also the oil shale, which periodically makes it in the news as a potential future source of oil, but in reality, it never made it as a commercially viable source of energy thus far, and there is no indication that it ever will.

Conventional Fields:

- (Total oil in place 5-600 billion barrels x .5 optimistic recovery rate) – 180 billion barrels already produced = maximum 120 billion barrels still left to be produced.

            -Note:  Current recovery rates according to most geologists working in the field is under 40%.  I used 50% to account for future innovations, yet to happen.

US Shale Oil: (tight oil)

Total oil in place, up to a trillion barrels, out of which the US department of energy estimates that up to 4 billion barrels are recoverable in the Bakken formation, while another 3.5 billion can be recovered from the Eagle Ford formation.  A few smaller formations also can potentially add a billion barrels or so.

Rounding it out to about 10 billion barrels that can be recovered, according to US department of energy and the United States Geological Survey (USGS), gives us a recovery rate of oil in place for this resource of about 1%.  We can choose to be optimistic, and assume that new, yet to be developed and perfected fracking techniques can increase this number five fold, giving us a potential reserve of 50 billion barrels.

Oil Shale: (not the same resource category as above)

The green river formation contains kerogen, which is not quite oil.  It is a solid form of hydrocarbon, which would need to be cooked to become oil.  There are to date no commercial operations of great significance anywhere on this planet.  Only small pilot projects were attempted as experiments, which thus far have been largely unsuccessful.  The US does have about 2 trillion barrels equivalent of this resource, but thus far, we cannot count even one of those barrels as reserves.  I think there is some potential for this resource to be mined and used directly in power plants, similar to what we do with coal.

Oilsands:

According to the US department of energy, there may be up to 80 billion barrels in, place, from which as much as 11 billion barrels may be recoverable.  One issue is that due to different technical challenges than what the industry encountered in Canada, new techniques have to be developed, which have not yet been developed, so in fact the technology does not yet exist.  In this particular case, we can assume that the technical challenges can be overcome, so a rounded up total of 10 billion barrels of potential reserves is appropriate to consider.

Total:

120 billion barrels conventional + 50 billion barrels of tight oil + 10 billion barrels of oil sands = 180 billion barrels potentially still left to be produced.  This is my own approximation.  The US department of the interior, estimates that aside from the 22 billion barrels in proven reserves, there is an additional 134 billion barrels in conventional and unconventional fields that can potentially be extracted, giving us a total of 156 billion barrels.  I should point out however that the word “potential” implies that it is by no means a done deal, so we can only count on the currently proven reserves as a resource that we can know for sure that it will be there with 100% certainty.

To add some perspective to the numbers above, the US currently consumes about 7 billion barrels per year, while the entire world consumes about 31 billion.

One thing that the ultra optimist voices may still be right about is that this potential resource, if it will ever be produced, is more that the Saudis may have left, because the 260 billion barrels that they claim to have in reserve, is now widely believed to be more hype than volume.  So the US may indeed have more oil than Saudi Arabia, but that is not necessarily great news for the global oil market.

Kudlow & Palin versus Obama:

            As we can see, even though president Obama chooses to refer to the more conservative estimate of actual proven reserves, he is a lot closer to reality with his 22 billion barrels than Mr. Kudlow is with his 1.4 trillion barrels.

            President Obama is also right to claim that we cannot drill our way to long term low prices, because we should not forget that the oil and the finished refined products market is a largely open, international market.  Mr. Kudlow should know this by now, since he is after all in finance.  In effect, a surge in production in the US may only serve to dampen prices temporarily, until demand catches up to supply.

            There is also the issue of the more expensive supplies being produced currently around the world, which would cease production in the event that US would be able to push prices down significantly, so in reality, given that we are now dependent on many sources of expensive to extract oil, we cannot expect to be able to drive prices down significantly.  This is also a basic of supply and demand economics which Mr. Kudlow seems to prefer to ignore.

            Since the very basic theories in economics are being so carelessly ignored in this conversation, I decided to add a very basic supply/demand model, showing how price and quantity interact with each other.


                As you can see, the effect that increasing supply of a product has, is to move the supply demand balance from point a, to point b.  This in reality would cause many oil sources that depend on the current price in order to at least break even to cease production.  Deepwater sources come to mind.  So, in the long-run, a ramp up in US production, which itself would come from sources that are on the expensive side, would not affect the current balance all that much.  The balance might move back to point a in a relatively short period of time.  As you may have noticed, I did not include a second line for demand, to deal with the expected increase in global consumption, in the absence of recessionary pressures, but we should not forget that a ramp up in US production of this finite resource can only have the effect of delaying the current high cost by a few years at best.  It most definitely cannot create a new permanent balance point.



The first symptoms of a failing society, led by elites with no answers to counter increasingly grave problems.

            The communist system I was born into had many structural problems.  The base it was founded on was flawed, because Marx envisioned a utopian society, devoid of desire to accumulate more than others in terms of goods, prestige and power.  Nor did he acknowledge the benefit of harnessing the individual drive towards prosperity.   With some reforms, the system might have survived for a while longer, and people would have been spared decades of hardship.  Reforms were not possible, because the elites never admitted to the problems.  The rotten foundation was never recognized, and neither were the many mistakes that the elites made, which took their toll with a cumulative, and eventually disastrous effect.

            Now here we are!  Our problems are dismissed by one faction, which chooses to make more and more outrageous claims. The problems are assumed to be resolvable by the other faction, by implementing flawed solutions, in the form of local sustainability initiatives, which do not allow us to survive in the long run, because they are causing economic disadvantages in the short run.  In effect, the solution they recommend to counter our sustainability problem is not sustainable economically.  The fact that sustainability is a global public good, and should be treated as such, continues to be ignored. 

We the people are left in the middle, confused, indoctrinated into believing into one faction’s rhetoric or the other’s, mainly through a barrage of false and distorted information, like the above mentioned examples I gave.  We as a society that is shaped in a way that requires the elites to court our blessings for their actions are unfortunately highly over-tolerant of being fed false information, in order for us to be convinced into giving our blessing.  The problems are accumulating in the meantime, because we are not tackling them.  The damage will at some point become more than our institutional cohesion can bear, at which time there is nothing left but painful failure.  

Monday, April 9, 2012

Rio + 20 part three: Eastern Europe versus Asia.



            As I promised in my first article on the upcoming earth summit in June, which I wrote in February, I intend to write a piece on the subject every month leading up to the summit, and one last article in July to reflect on the final outcome.  My first two articles concentrated on the main problem that seems to be completely ignored, which is that global sustainability put into economic terms, is a public good.  In other words we will only have it if we go about it the same way as we do when we reach partial consensus on building sidewalks or public parks.  The partial consensus is needed to support the policy, and mechanisms meant to ensure that everyone, including those who dissent, pays for the project, are needed in order to make it happen.  In the absence of such an approach, we will always be left disappointed and eventually suffering the consequences, as the historical record can tell us.

            In my previous articles, I mainly compared mature developed economies, such as from Western Europe, which took it upon themselves to go it alone in the quest for sustainability, with developing nations, such as China, which is currently benefitting not only from lower wages, but also from fewer regulations and enforcement of environmental and worker protection rules.  Some may be tempted to argue that the stagnation of Europe is happening because they are developed nations which already accumulated as much capital as they can, while the developing nations are in the middle of accumulating it.  On a graph drawn on a piece of paper it looks great, but in reality it can be shown that it simply is not the case, because we do have the East European countries, which still qualify as developing nations which should be in convergence mode, but are not. 

            I hope I will not be misunderstood as a result of writing this article.  I do not want to take away from the argument that some of these countries are suffering from self inflicted wounds, due to cultural failure to adapt to a post communist world.  Some East European nations were able to adapt better than others, as the table below can testify to.  When we put them up for comparison with other developing nations from Asia, of various developmental stages, we can see clearly that the self inflicted damage argument, which sometimes conveniently takes all the blame for the situation in Eastern Europe, cannot explain away the huge disparity that exists in growth rates that the two regions are experiencing.

Eastern Europe economic indicators versus Asian Competitors.


Country
Freedom
Corruption
Literacy
GDP/capita
GDP/rate
Hungary
Free
54’th
16’th
$19,600
145’th
Poland
Free
41’th
18’th
$20,100
100’th
Czech. R
Free
57’th
26’th
$25,900
144’th
Romania
Free
75’th
57’th
$12,300
156’th
South Korea
Free
43’th
36’th
$31,700
97’th
China
Not Free
32’th
68’th
$8,400
6’th
India
Free
95’th
137’th
$3,700
13’th


            If we look at the table I prepared, we see that all countries I picked for comparison, except for China are considered to be free.  In other words we can expect innovation to flourish, because there are few barriers to information and private capital flowing freely.

            In the corruption category, it is hard to argue that Eastern Europe is plagued by more corruption than Asian countries.  China seems to have an edge on the face of things, but in this case we have to take the result of the findings with some skepticism.  All indications are that local governors and lower level officials may be more corrupt than what one may expect to encounter in any of the above mentioned East European countries.  For some reason, it does not seem to show up in their corruption rankings, but I have it on reliable witness description of the situation there, that it is quite bad.  Other than that, as we can see, There is little difference between South Korea and all East European countries, except for Romania, while by far the most corrupt place from this bunch is India.  So corruption cannot be the differentiating factor.

            If we are to judge the level of worker competence by literacy rates, the above chart clearly shows that Eastern Europe has an advantage in this category.   South Korea is the only place that can be considered to be equally competitive.  There are of course many other measures on education that we can refer to, and some of them may yield somewhat different results.  One thing that neither of those comparisons can ever claim is that Asian developing nations have a great advantage in comparison with Eastern Europe in terms of worker skills, so this cannot be a differentiating factor either.

            When it comes to per capita GDP, the poorest country from this group is from Asia as well as the richest.  There is therefore not such a strong argument to be made for two different regions that are at different stages in capital accumulation.  Yet, if we look at the chart, there is actually no overlap whatsoever between East European nations and Asian countries when it comes to recent growth rates.  If we were to broaden the chart to include all developing nations from Europe and Asia, we would get some overlap, but not a significant amount.  The only EU members that grew at a comparatively competitive pace in 2011 are the Baltic States.  Estonia for instance achieved a rate of over 6%, which places them in the 31’Th place globally.  I should point out however that if we were to average out the growth rate in the Baltic region over a decade, and compare it with the Asian region, we would similarly see a significant disparity.  The Baltic States saw double digit recessions during the recent crisis, while Asia continued expanding.

            If we compare the general trend of the two regions, and project their most likely economic outcomes, we get a picture of two regions with very different future outlooks.  Asia is set to become the most important economic region on the planet.  Eastern Europe is looking more and more like a sad case of failure, despite all the ingredients for competitiveness being there.  A few decades from now, we may in fact witness the  complete collapse of a few of these states.  At the moment, from all the above mentioned examples, only the Czechs seem to be immune from the danger of complete failure.

The real differentiating factor:

            Given that we have two regions that on balance should be roughly equally competitive, and yet one region clearly outshines the other, there has to be another factor that makes all the difference.  The difference is that Eastern Europe was drafted into Western Europe’s crusade of unilateral global goodwill, and model behavior, through being conditioned to do this as a prerequisite of joining the EU family.  This means that the cost of doing business in Eastern Europe is automatically higher, due to more stringent environmental regulations, as well as laws protecting people from overexploitation.  So in other words, they are handicapped economically, exactly because they agreed to follow the path of the first Rio summit, and the path that is also being proposed at Rio + 20, by the UN and its 56 recommendations. 

There is an additional burden on the regional economy as a result of having to forego certain opportunities to develop the economy.  For instance, Poland and Hungary have significant coal reserves, yet they both had to forego the opportunity to exploit the resource, in favor of increasing cleaner burning natural gas imports from Russia.  To put it into perspective, Hungary has on a per capita basis, four times more coal than China does, which is currently responsible for almost half of the world’s coal production and consumption.  If Hungary was to exploit its coal reserves at a similar rate per capita, and additionally adjust for its higher reserves per capita, it would have to increase its current production of coal almost tenfold from current levels.   This means that tens of thousands of jobs in mining disappeared, in the last decades, or were never created, which actually means that hundreds of thousands of jobs were lost, due to the amplified effect of loosing additional jobs that the original economic activity would have supported within the community.  The balance of trade is also affected, due to having to increase natural gas imports.  Over time, this resulted in lower yearly GDP growth and a higher debt to GDP ratio.  A rough estimate I can give for the difference that this path had made to Hungary’s development is that it’s debt to GDP ratio would likely be somewhere near 60% of GDP, instead of the 80% that it currently struggles with.  Unemployment rate would be about 3-5% lower, so instead of 11% currently, it would be about 6-8%.  Because of the additional jobs retained and even created directly and indirectly thanks to the positive effects of using local coal, instead of expensive imported Russian gas, Hungary would have been able to retain some of the population that migrated away in the last two decades.  Together with a steady influx of ethnic Hungarians migrating to Hungary from neighboring states, would have meant that they would have been one of the few states that would have been relatively unaffected by the coming demographic catastrophe, which will become evident in the Eastern Europe region in about two decades.  This assessment, compared to the UN report which claims that their recommendations only carry limited economic downsides for volunteering countries, is the big elephant in the room, which everyone wants to ignore.

This is the last article that concentrates on the failure of the approach to global sustainability that is already evident after the initial twenty years post Rio 1, and is still the approach that is favored as the top recommendation for Rio + 20, coming up in June.  The Europeans hoped that if they would create a working example of a region that can flourish even if they sacrifice in the name of the common good, and even remain competitive, then everyone else will follow.  It is somewhat easy to explain away the current economic failure of the EU as just a side effect of being a mature economy, which is just too far ahead in wages to be able to remain competitive in the face of the surging East.  It is harder however to explain the lack of economic progress that the eastern part of the EU is faced with, despite being a still developing region which should be converging, and yet it is not.  I am sure that other developing nations are also tuned in to this situation, and I doubt they will be willing to voluntarily do this to themselves in the name of the common good.  Similarly, developed nations such as the US, which still shows some vitality will also turn its back on the UN proposals, because at this point, given the tougher global environment, it is an issue of survival, which is looking less and less certain for the good Samaritan Europeans, who thought naively that they will singlehandedly, and unilaterally save the world.

The first step towards sustainability was a step in the wrong direction, which already cost the world two decades.  The sooner we admit to it, the sooner we can take the step back, and re-direct towards the right path.  The first step that needs to be taken towards identifying the right path is to finally admit that sustainability is a public good and it needs to be treated as such.  Unfortunately it seems that no one in higher circles is willing to spell this out thus far.  As things stand now, the UN will recommend taking further steps towards disaster for both those who will follow their recommendations, and those who do not.  There are two months left to avoid the loss of another precious two decades, which might be two decades we cannot afford to loose, because if we do, there is nothing left but irreversible disaster.  A Rio + 40 will probably never happen, so it is either now, or prepare for individual survival, because the common good will not be achieved. 

 
           

Monday, April 2, 2012

Disposable cars


            In the argument for our future wellbeing, we are told we can rely on the market and human ingenuity to conquer our problems. We are increasingly presented with a vision of a future of electric, hybrid, bio-fuel, and even hydrogen powered cars as the way of the future, so no worries about our unsustainable path right?  Wrong!!!

            It is now proven by history that the market if left to its own, will not push for these wonder products.  Government subsidies are often needed to support the dispersal of the above mentioned technologies, and even so, they do not stand a chance against the products coming down the pipeline of the motor industry.

            Most are unaware of this, because it is not heavily advertised, but the large automakers are increasingly invested in the true “way of the future”, and it is not electric cars.  If left unguided, the market will do the same with cars as it did with furniture, shoes, stereos, televisions, vacuum cleaners, and a host of other products, which are no longer repaired when they break, but discarded and forgotten.

The demand side:

            In my book, I used shoes as an example of why it is that we are naturally predisposed to moving towards the disposable product economy as long as the market has free global reign.  Basically, the main aspect of market economics we need to understand the trend, is that for the market to operate perfectly as it does in theoretical economic models, we have to avoid market failures.  One market failure is the lack of perfect information.  For instance when I buy a pair of shoes, I have no way of knowing whether I am in fact getting my money’s worth.  I for instance purchased a pair of shoes for about $25, which lasted me only one weekend, because the synthetic material the inside lining was made from became so smelly that it was beyond tolerance.  I hardly expected those shoes to last me only a weekend. If I would have known, I would have refrained from buying them, because they we not worth 25 dollars.  It is at this point that we naturally gravitate towards the disposable economy, because we similarly have no way of knowing whether purchasing a pair of $100 shoes will make us feel we got what we paid for.  If we purchase cheap shoes however, there is always the possibility that one may be pleasantly surprised, which is also something I experienced in my quest for shoes.  I hope the example of my stinky shoes will suffice to promote a basic understanding of market failure due to our inability to function based on perfect information, which will never be available.

            When in the market for cars, currently one does expect to get a higher quality product when purchasing a Mercedes, as opposed to a Chevrolet Cavalier.  The difference is enough to claim that it is worth the extra money, not only in terms of quality and performance, but also due to the social status that comes with owning such a visible status symbol.  In my younger years, a good friend of mine purchased a Ford Mustang, which did indeed bring him attention from the opposite sex for a little while.  The car ran out of its original warranty way before he was done making payments on it however, and the status symbol had to eventually be abandoned, because just a month after the warranty ran out, the car started breaking down, and it required very pricy additional investments to keep it on the road, which my friend was not able to afford.  Given that it was a pricy purchase, there was only room to be unpleasantly surprised, while cheaper cars can either live up to their low expectations, or yield a positive surprise.  So this is one of the main reasons why there is a market for cheaper and less durable cars.

            There are also other forces at work, which I believe to be factors in making our current time, a ripe occasion for the market to be inundated with much cheaper, less durable cars.  We should remember that since about 2007, people in the US lost about $7 trillion in equity as a result of the bursting of the housing bubble.  Many also lost money as a result of the stock market.  In addition, unemployment rates are higher all over the western world, making one income families more common.  Fuel prices are also on average much higher.  Western households have to find ways to compensate for these factors in the long run, so it makes sense to expect a high level of demand for small, cheap, and fuel efficient cars.  It may even be enough to override our desire to drive in a larger car that offers the benefit of the visible status symbol, we instinctively desire to have.

The supply side:

            Some may be tempted to credit this to the magic of the market, but I believe it is a coincidence of two trends of supply and demand coming together, from different parts of the world.  It just so happens that due to the rise of Asia as a driver of the global economy, we already have a lineup of cheap affordable cars coming through the pipeline, and all indications are that they are ready to take on the western markets now, after spending a few years maturing in the Asian markets.

            Perhaps the most famous of these cheap, near disposable cars is the Nano, made by India’s Tata Motors.  It sells for under $3,000, which means that there is little room to be unpleasantly surprised by its quality and durability derived satisfaction.  To put it into perspective, my first car cost me $2,600, it had no warranty, and it broke down almost every month during the three year period I owned it.  Given the choice, I would have definitely considered purchasing a new car for roughly the same price.

            Renault-Nissan is also starting production of a new car in India, which they claim will sell at a base price of under $3,000.  Renault’s CEO Carlos Chosn made it clear that he wants to export these cars to the developed world.  They will likely cost a lot more than the $3,000 they will sell them for in India, because they have to adjust for western tastes, but if they will manage to get them on the market at a base price of $5,000, it will together with a few other like minded firms change the nature of the car industry forever.

            There are also other efforts worth mentioning of trying to move towards the disposable car market.  A Chinese company named Great Wall Motors will assemble cars in Bulgaria starting this year, which they want to sell for $11,000, which is just outside the magic range.  Renault tried already a few years back to do the same by producing the Dacia Logan in Romania, but they failed to keep the price at the magic 5,000 euro level (about $8,000), because the cheapest base model available for sale is 5,900 Euros ($9,500).  Cars made in these two poor EU countries are not at the disposable point just yet, but we are getting very close.

Economic and environmental effects:

            It goes without saying that cars that will retail in the $3-10,000 range will not be built in Western Europe, or North America.  At the most, they will be assembled here, out of exclusively imported finished components.  The cars that will still be built here, will face downward price pressures as well, because they will not only have to compete in sales with these new cars, but the re-sale value will drop, because when new cars will be sold in the above mentioned price range, old used cars will automatically fall out of favor.  The only alternative will be to actually improve on durability, and offer more generous warranty.  That of course means that they will have to cut back on wages and benefits for their employees drastically, in order to be able to still earn a profit. 

            For such a low price, the cars will be built to last about half as long on the roads as the current fleet does, and as such, warranty will still be offered, but it will be more limited in terms of duration and mileage.  Under these circumstances, people will be reluctant to fix the cars once the warranty runs out.  A car that sells for $5,000 brand new, will not have much value left five years later, so if the fix is pricy, it will not get done.  People will opt to buy new ones instead.  This means that the mechanic will go the way of the TV and vacuum cleaner repair people.  The only mechanic shops which will survive will be the dealership shops, which will also deal with warranty claims.

            Tire retailers and a host of other specialty services, geared towards car upkeep will also go bust, because these cars will likely never have to have their tires changed for the duration of their time on the road, nor will other intervention be worth it, especially after a few years of owning such a vehicle.  Used cars lots will disappear, or specialize in selling the new cheap cars.

            Overall, the only field which might see an increase in employment will be car salespeople, who will work for increasingly pathetic commissions.  The overall effect will be disastrous for the western world, because the wage gap is just too high to be able to compete in manufacturing these cheap vehicles.  The loss of countless businesses and employment opportunities in the local shops will be felt throughout society.

            The effect on sustainability will be a net loss to our efforts to achieve a sustainable path.  On one hand, the cars will be smaller and more fuel efficient.  On the other hand, supply and demand laws dictate that as the price of a product drops, demand will rise, because many more people, throughout the world will be priced into the market, who up to recently were priced out.  So even though many of these cars will have similar fuel efficiency as the average hybrid or even better, the overall effect will be one of increased demand for transport fuels.

            The increased rate of production stemming from an increase in car ownership demand, as well as the increase due to the lower durability of the cars will have the effect of adding to the strain on our resources and environment.  Some components will likely end up being recycled, but recycling car parts can be very energy and labor intensive, so there is the possibility that we may just end up abandoning the carcass after the car is no longer roadworthy. 

            The availability of cheap affordable cars will have one positive economic effect, which is that many families will have an opportunity to cut their transport costs, helping with the deleveraging process that the western consumer needs to undergo to regain some health.  In the process of this deleveraging, it is more than likely that we will see the middle class eroded even further.  The massive loss of jobs in the manufacturing, repair and parts retail car sector will play a big role in that impoverishment.

            Unless a global mechanism meant to provide an incentive for the durable economy to be resurrected will be implemented very soon, this is the future we are looking at, as far as the car as well as many other industries are concerned.  It is not the future envisioned by people on the right, who want to make us believe that we will continue driving in large SUV’s and Trucks, while they make sure that gas stays cheap.  Reality is that they cannot provide cheap gas anymore, no matter how much they drill.  Those days are gone; it is just that it is so darn hard to accept it for some, that they prefer to buy into these cheap gimmicks.  Our future is equally unlikely to be the one being dreamt of by the left.  We will not be driving around in hybrid, electric and hydrogen cars.  We will be driving cheap, fuel efficient cars, made in the developing world.  There will be a many fold increase of motor vehicles worldwide, due to the cheap price.  The world will also get trashed because of the low durability of these cars, which will require an increase in the intensity of our exploitation of resources.  This trend cannot be stopped by grants in R & D, or by subsidies for electric vehicles, because the market in the current environment it operates in, is much stronger than the effect of these incentives.  That is why I continue to insist that we have to change the environment the market operates in.

            I will continue to insist for this change, as long as people are willing to listen.  I am pleasantly surprised by the size of the audience my articles have attracted so far, since I started writing at the beginning of the year.  I want to thank the readers for their interest.  I will do my best to continue to make it worthwhile for people to continue to visit.