Economic growth and economic crisis

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					Economic growth and economic crisis

This moment –despite its dangers - provides a wonderful opportunity to remake our economic system,
which is so clearly failing. The era of deregulated capitalism is at an end. This is not to say that
capitalism itself is about to be overthrown, but we are in a situation where the nearest historical
parallel is the emergence of Keynesianism and the New Deal in the 1930s. We are, in other words, on
our way to a new form of regulated capitalism, and so it is essential to discuss now what types of new
regulations there should be.

In order to generate ideas about a new framework of this sort, there needs to be a wide-ranging
analysis of what has caused the current financial and economic crisis. There are two key elements,
which interact. One of these is essentially ecological: the market is responding to rising consumer
demand and falling availability of resources by putting prices up, hence the recent increases in the
prices of oil, food, and other commodities. The other is financial: the market is responding to the abuse
by the banks and other financial institutions of their power to create credit, by bursting the credit
bubble and bringing us all back down to earth.

In this crisis we can see at work both the strengths and the weaknesses of the market, and we can see
a lot of weaknesses and really no strengths at all in the deregulatory policies which have been pursued
by governments of many different parties in many different countries, but above all in the USA.

It is the combination of ecological and financial factors which is particularly problematic for the
economy, because the two interact. The financial practices of the banks and other institutions only
make sense in an ever-expanding growth economy. Since, because of the ecological side of the
problem, we don’t have such an economy, the practices of the financial sector become less and less
appropriate. We have now got to the point where that mismatch is very visible, and brings with it the
continuing potential for repeated financial crises if the problem is not addressed at a fundamental level.

This article is an attempt to set out the anatomy of the factors which underly the current crisis. It starts
from the most basic hypothesis of green economics. This is that there is a collision taking place, on a
world scale, between economy and ecology. Moving on from that starting-point, I will then outline
what the theoretical consequences of such a collision would be in a world economy organised primarily
as a market, and then compare this with recent developments, including the interaction between the
ecological factors and the practices of the financial sector. On this basis, I will set out some conclusions
for future policy.

(1) The collision between economy and ecology

The inescapable starting-point for a realistic understanding of the economy is that all economies depend
on the natural world, both for resources such as oil and metals, and for the capacities of the
environment, such as the capability to absorb carbon dioxide or to keep the water cycle functioning.

It follows from this, that economies which are not organised in a way which takes this dependence on
“the environment” fully into account are going to suffer adverse consequences – a “feedback” or


“backlash” from the natural world. We can see this as a collision between the consequences of the
(non-ecologically-managed) economy and the requirements of ecology.

Despite economic production and its many environmental impacts having steadily increased over a long
period of time, particularly since the industrial revolution, the capacities of the natural world have
remained essentially the same.

This produces a fundamental problem of imbalance and tension between the two. There are many
ways in which this situation has been responded to, in order to continue to push outwards the
possibilities for production. These include increased technological efficiency, more wide-ranging
exploration for oil and other resources, greater inventiveness in substituting one material for another,
increased skills and knowledge in the labour force, and so on.

There has been a great deal of scope in these and other approaches, and the combination of them
basically accounts for the considerable economic achievements of the past 200 years. They do not,
however, change the fundamental situation, which is a long-run imbalance between ecology and

However this reasoning leaves completely open the question of timescale. Are we still at a stage
where economic growth is nowhere near touching the limits of what the planet can sustain, or are we
at or now beyond those limits?

In order to answer that question, it is useful to conduct a “thought experiment” about what reaching a
collision between economy and ecology would look like in a world economy organised principally as a
market. In particular, how would such a collision be expressed through the forces of supply, demand,
and the price mechanism?

(2) The price mechanism in a time of ecological crisis

In thinking through the implications of something as fundamental as the collision between economy
and ecology, the simplest and most basic tools of economic analysis have an important role to play.
How would such a collision express itself in terms of supply, demand, and price?

The standard diagram which speaks most clearly to this situation is Ricardo’s diagram of how rent is
determined by the supply and demand for land. Land, according to David Ricardo, is essentially fixed in
supply. Whatever happens on the demand side, we can’t make more of it (although there is a sense in
which European colonialism was an attempt to do exactly that). Fundamentally, land is unlike almost
everything else that is bought and sold in the economy. Producers of products, and suppliers of labour,
can generally be persuaded to increase supply if the price has increased as a result of increased
demand. In the case of land, however, we are stuck with the amount we have already got.

A collision between economy and ecology means that more and more resources will take on this key
characteristic of land. If there are environmental limits to production, the closer we come to those
limits, then the closer we are coming to a situation of fixed supply of resources and environmental

The consequence of this is that increases in demand will more and more often result in increases in
price instead of increases in supply. The prices of resources will be bid up as a result of competition

between a great many consumers, firms and governments, wanting to buy the resources, or products
made from them.

At the same time as the limitations on supply, increases in demand are also part of the “collision” of
economy and ecology, principally because of increased population and rising aspirations. So long as the
purchasing power is available for that demand to be effective (which depends principally on the fruits
of past production), demand will then rise at the same time as supply is coming closer and closer to
being fixed.

The outcome, predictably, is higher prices. This is inflation of a cost-push, not demand-pull, form.
Demand-pull inflation, which is the outcome of too much money being in circulation, tends to create an
inflationary spiral in which incomes go up broadly in line with price increases, and levels of material
consumption do not generally fall.

Cost-push inflation, however, tends to create stagflation, i.e. stagnation plus inflation. This occurred in
the UK twice in the 1970s, as a result of greatly increased oil prices in 1973 and 1979. Increased oil
prices led to increased prices more generally. Firms could not afford to buy so many materials, and
hence output levels stagnated, and then in fact fell. This combination was “stagflation” – two short
periods of a “no growth economy”, brought about by increased prices, led by the price of oil.

It is therefore possible to see how a collision between economy and ecology – expressed through the
market as relatively fixed supply combined with increasing demand – would result in higher prices and
produce lower growth or stagnation. Next it will be useful to compare this theoretical situation with
recent developments in the world economy.

(3) Recent developments in the world market

By the time these words are read, any figures given here for the prices of oil, metals, food and other
commodities will be out-of-date. Commodity prices are moving fast, mainly upwards but also
sometimes down. The figures quoted here are simply snapshots from a period in the recent past when
commodity prices were rising particularly fast. The picture has become complicated more recently,
however, because the long-term factors pushing up commodity prices have been counteracted by
downward pressures created by the current financial crisis. Before considering that complication,
however, it is important first to look at the larger underlying trends.

Oil prices are important, even though not as important as they were for most economies in the 1970s.
There is a great deal of evidence of “peak oil”, principally because the time-lag between discovery and
production makes it possible to roughly predict levels of production from data about discovery. In
addition, opinion in the market can be gauged from the prices of five-year oil futures (where people are
paying now for delivery five years later). In April 2008, oil futures dated for 2013 were at 108 dollars a
barrel, indicating the expectation that even if current oil price levels are not maintained, figures in
excess of 100 dollars are here to stay.

UK oil production has fallen 43% in the past eight years. Mexico’s output has dropped 9% in the past
two years. Norway’s output has dropped 25% since its peak in 2001. [“International Herald Tribune”
29.4.08] Russian oil output is now also thought to have passed its peak. [“Financial Times” 15.4.08]


Largely as a result of peak oil, combined with rising demand, oil prices have been rising fast. This trend
has been exacerbated by speculation, but speculation by itself rarely creates a sustained trend. It simply
represents betting on a trend being continued, exaggerating the trend but not creating it.

On 2nd April 2008, the price of medium-grade rice on the world market was more than two and a half
times the price a year earlier. There has been a general increase in rice prices, as land for growing rice
and other basic forms of food is increasingly converted over to use for manufacturing industry,
buildings, biofuels, transport infrastructure, and more expensive forms of food, such as meat production.
Prices on the world market have been further increased as a result of restrictions on exports, in order to
feed the home populations of rice producing countries, causing increased difficulties for poor importing
countries where not much rice is produced, such as some countries in Africa. [“Time” 28.4.08]

There have also been price increases on the world markets for metals and other commodities.

(4) Market responses to ecological crisis

It is easy to see how these recent developments compare with what would be expected from the
“collision” model. They are exactly what would be expected, as the collision between the world
economy and what the resources and environment of the planet can provide gets expressed through
the market in terms of supply, demand, and price.

Despite all its many faults as a way of organising the world economy, the market is at least functioning
as a mechanism that is telling us about the limits to growth. Whilst a great deal of discussion about the
environment and economics, particularly within conventional environmental economics (as distinct from
ecological economics and green economics), has been about the design of policies which can make use
of market forces, such as for example carbon emissions permits trading schemes, it is important not to
lose sight of the fact that the market mechanisms which already exist, such as the market for oil,
already communicate and respond to many environmental and resources pressures even at present,
particularly to limits on supply. This train of thought will be pursued later. Here, however, it is
necessary to add in briefly some complexities about the current situation.

The first complexity is the financial crisis, which has centred on problems with American “subprime”
mortgages. This will be discussed in a later section, in the context of the workings of the financial
system, and how these interact with ecological factors.

There are also complexities created by the knock-on consequences of the basic trends in supply and
demand. One is that greater efforts will be made to mobilise resources in order to increase their
supply. For example, oil is being sought from sources where production is expensive and particularly
damaging environmentally, such as in Alaska. A perverse consequence of global climate change is that
new areas of the Arctic are now accessible for the exploration of oil and gas, which when extracted and
used will contribute further to climate change. This is all part of the economy/ecology collision.

The economy should also be expected to respond to price signals such as the increased price of oil
through greater efforts to develop newer energy sources, develop technologies which are more energy
and resource efficient, and substitute more plentiful resources in place of rarer and more expensive
ones. These trends generally serve to soften and postpone, and potentially even reverse, the collision.


Another major source of complexity is that the consequence of stagflation will tend eventually to be
stagnation in real incomes as well as in output. This will tend to reduce the pressures of increasing
demand, and thereby slow down price rises (although these will still take place because of limitations
in supply). By then, however, a general state of stagnation will have taken hold throughout the
economy, affecting output, income, and expenditure.

(5) The current crisis for growth

The current economic crisis is therefore at root a result of the ecological crisis, as the economy finds it
more and more difficult to get hold of all the resources it demands. Markets tend to go in cycles, and
so the current crisis is not going to continue indefinitely. However, in the long run, the forces which
have created it will continue to exist and have an impact, amounting to a fundamental historic collision
between economy and ecology on a world scale.

The current recession exhibits symptoms of this long-term underlying “collision”, but that is not to say
that these symptoms cannot be outweighed in the near future in the short run by the forces which
normally come into play when recessions are being recovered from, such as technological innovation
and low prices stimulating an increase in production.

That may be a comforting conclusion, but there are three additional conclusions to be drawn which are
less comforting.

(1) The long-term collision is more fundamental than any short-term economic cycles, and so can be
expected to eventually predominate. The history of the 21st Century may well turn out to be the history
of this gradually being brought about. This is essentially a race between technology and ecology: either
could win, but the increasing pressures on the environment are so severe that a fall in the long-run rate
of growth must be expected.

(2) Although the current recession is unlikely to be permanent, the mechanisms which are in operation
now, and the ways in which they are operating, provide a very good indication of the ways in which the
long-term collision, expressed through market forces, is likely to eventually bring the growth economy
to a halt. These are principally the simple mechanisms of supply, demand, and price, with the bidding
up of prices leading to a situation of stagflation.

(3) Adjustment to the planet’s limits is currently being brought about more effectively through markets
than through political systems. Supply and demand do at least reflect some realities, certainly not
perfectly and not without externalities. Politicians, and the citizens and voters acting to influence them,
however, often choose to ignore realities almost entirely.

Despite the fact that green politics is weak by comparison with many other political forces, and despite
the largely tokenistic nature of most measures taken so far by most governments and ”green
consumers”, in fact the mechanisms already exist to bring a halt to the growth economy, and those
mechanisms are market mechanisms.

Far from the market always acting as a pressure for economic growth, as both its advocates and its eco-
socialist critics argue, the market currently provides a means for ending economic growth. Price rises

are likely to be much more effective and widespread in their impact in limiting consumption than
voluntary simplicity or “sustainable behaviours” are. The market for oil has pushed prices way beyond
what any elected government would have been prepared to contemplate bringing about through

However, where political systems operate well – on the basis of citizens who are well-informed and
institutions which look to the long-term as well as the immediate future – they can do better than this,
through overcoming the haphazard, unco-ordinated, conflict creating and socially unjust nature of most
market responses to economic difficulties. A great deal of what is currently important in politics today
is about efforts to improve political systems so that they can respond to the ecological crisis more
effectively than markets are doing currently.

(6) The financial element

Six months ago (in Spring 2008), the economic crisis was primarily a crisis of rising commodity prices
creating stagflation. This has been followed more recently by a crisis of the financial system, centred in
difficulties in America. Is there a connection between these two forms of economic crisis?

The key to the financial sector of the economy is the creation of credit not 100% backed by assets, so
that banks lend out more money than has been deposited with them. Opinions differ as to the
relationship between credit creation and economic growth. Some people see the creation of credit by
the banks as the key driver of economic growth, because this creation of additional demand stimulates
the creation of additional supply. According to a green version of Social Credit theory, the way to put
an end to economic growth is by preventing the creation of credit (or allowing only a small amount of
credit creation, by governments and not by banks).

However there are good reasons for seeing this as implausible. Additional demand stimulating
additional supply is only possible if the additional supply can in fact be created, and created over the
long run. The means by which it is created are the real driving forces for economic growth – and these
basically consist, in a capitalist economy, of a combination of a motive to produce the additional supply
(the profit motive) with a powerful means of providing it (technological development). Without
inventions such as the steam engine and the computer, the creation of credit by itself would merely
have created inflation, not economic growth.

The real relationship between credit and growth is, I suggest, the opposite to that in the “green Social
Credit” theory. In other words, it is not credit which creates growth, but the prospect of future growth
which makes the creation of credit possible. Seeing it this way round provides an explanation of the
current financial crisis which the opposite view does not, because on that view, there should be no
recession so long as credit is still being created.

The creation of credit depends on an expectation by the banks which create it that they will get their
money back, plus interest. Interest can only be paid if the borrower has more money in the future than
he or she has at the time of borrowing. Across the whole economy, this can only be the case if there is
economic growth. Essentially people and companies borrow at interest because of their expectation of
economic growth, and banks only lend because they share that same expectation.


Similarly, a great deal of investment is funded by borrowing. Lehman Brothers, shortly before their
collapse, had debts about 35 times their own capital (according to “Time” magazine 29.9.08). They
were only able to operate on that basis because the returns from their investment were sufficiently
large to enable them to repay their debts plus interest.

And similarly too, whilst the housing market was going up, the value of the houses provided sufficient
guarantees to lenders that if homeowners defaulted on their mortgage payments, they could simply
retake the house and sell it at a profit. There was therefore, from their point of view, essentially no risk
involved in lending to even the riskiest clients.

But what happens when house prices stop going up, the returns from investment are not enough to pay
the interest, and economic growth fails to provide the money to repay debts? What happens is what
we have just seen: crisis in the financial sector, bursting the credit bubble, and bringing the economy
down with a bump, in line with the reality of faltering economic growth. The market is said to be
providing a “correction”.

The pressure for this correction derived from an imbalance between the “real economy” – suffering
stagflation as a result of limited supply and rising worldwide demand – and the financial sector, which
has continued to be geared to ever-expanding growth. The current financial crisis cannot therefore be
separated from the underlying ecological crisis which is its root cause.

However market corrections are generally fast, disorganised, un-planned-for, and unfair in their
distribution of who gets to bear the costs and who gets away with the benefits, and can often be
overdone, creating a downward spiral of disaster (as in the unravelling which followed the 1929 Wall
Street Crash) rather than simply a realistic adjustment. It would be far better to have economic
arrangements which prevented credit bubbles and bursts from happening in the first place.

This is where there is a need for some changes in policy and regulation.

(7) Some policy conclusions

(1) Stricter requirements on banks and other lending institutions to increase the amounts of assets they
have to hold, relative to the amount they lend out, in order to reduce the risk to those banks and
institutions, and through them to the economy as a whole. Without necessarily requiring a ratio of 1:1,
the Lehman ratio of 35:1 was ridiculous.

(2) A general increase in regulation of the financial sector – and a shift in the detail of regulation, so
that it is updated to match the current complex nature of financial markets. This will probably need to
involve increased regulatory powers at the EU level, and should include a more thorough system for
getting the financial sector to contribute to tax revenues, rather than being allowed to shift their tax
liabilities into “havens”. This is especially necessary if these firms expect to draw on tax revenues to
support them when they get into difficulties.

(3) A deliberate effort, by governments and people generally, to build up financial institutions which
are not subject to global financial markets through the buying and selling of shares, but are mutually
owned, community-based, and founded on real assets. This was the basic idea in the creation of co-
operatives and building societies, and it is time to renew it.


(4) Much more stringent social and environmental responsibility requirements should be placed on
companies which want the financial protection which is provided to them through having “limited
liability” status.

(5) The tax system should be redesigned on a forward-looking, “long-termist” basis, so that it
encourages increased energy and resource efficiency, and gives a boost to the whole sustainable
consumption and production agenda.

(6) Greater flexibility for employees in the labour market, enabling people to go part-time or take
career breaks without being penalised in terms of job security, wage rates, promotion and training
opportunities, etc.

(7) An end to planning and economic policies which increase the UK’s (and especially London’s)
dependence on the riskier parts of the financial services sector.

(8) At the same time, however, there is considerable scope for the expansion of the insurance industry,
both because of environmental risk (e.g. flooding) and the need for a legislative requirement on the
financial sector to take out insurance in order to fund any future “bail-outs”. This proposal was put
forward by Republicans in recent US Congressional negotiations – but it is more practical as a
requirement for the future than as an immediate response to crisis.

(9) The drawing up of the National Policy Statements envisaged in the Planning Bill should be on the
basis of sustainable development principles rather than on simple assumptions about growth.

(10) An end to Government mixed messages about carbon emissions – for example, through scrapping
Heathrow expansion and putting serious investment into Carbon Capture & Storage.

Victor Anderson      30.9.08