The second article of the concrete methodology for building social capital
SEOUL, KOREA - Economic policies influence our lives profoundly. To be sound, they should be based on a thorough understanding of the economic system. Consisting of people, machines, and natural resources, the economy is arguably one of the most complex systems.
Adam Smith’s The Wealth of Nations founded capitalist economics in 1776 – the same year as the first steam engines of James Watt were installed in commercial enterprises. Thus, living within the notions of agrarian society, Adam Smith could not help but consider capital, labor, and land as the only factors of production. In his time capital consisted essentially of tools, agricultural implements, and means of transportation, all powered by human and animal muscle power, partially in combination with wind and water. Labor handled them. And land, bearing photosynthesizing plants, provided food and firewood, without anybody realizing that the two have “energy” in common.
When Karl Marx published the first volume of Das Kapital in 1867, he was concerned with the physical origin and the distribution of wealth. He justly worried about the workers’ miserable living conditions. The working day had 14–16 hours, and people died early. Marx reasoned that all capital and consumer goods are ultimately produced by labor, and that therefore they should belong to the working masses, and that private property could only be accumulated by the exploitation of workers. If he had realized the completely new production mechanism that had emerged with the coal-powered steam engine, he would have understood that in the sphere of industrial production value added can also be produced by the exploitation of energy sources without exploiting people.
Wealth is created on three levels of an economy’s productive physical basis. The fundamental level, which is absolutely indispensable for the physical existence of humans, is that of agriculture. The middle level, without whose products modern people can hardly imagine living, is that of goods-producing industry. On top is the level of human interactions in the services-producing sectors. Thanks to creative energy utilization it has been possible to produce so much of the vital goods on the two lower levels that their prices, which, as a rule, measure scarcity, are low in the industrially advanced countries. Therefore, the economic importance of a level of wealth creation is seemingly smaller the greater its importance is for life.
The figure below depicts the prior vision of wealth creation in the productive physical basis of modern economies. We consider capital, labor, and energy as the fundamental physical factors of production and creativity as a non-quantifiable input from human ingenuity, whose economic impact can only be detected ex post facto. Space contains natural resources, accommodates the production system, and absorbs its emissions. Introducing energy as a third factor of production on an equal footing with capital and labor has been motivated by the observation that long-term economic growth in industrialized countries has been accompanied by considerable capital deepening, i.e., increase of the capital/labor quotient, without a significant increase of the capital coefficient, which is the capital/output quotient. This would contradict one of the most famous laws of economics, the law of diminishing returns, if standard economics did not call “technological progress” to the rescue.
The energy-converting and information-processing machines with their energetic inputs are open thermodynamic systems, subject to the laws of nature when they produce the output. The output is the sum of all goods and services produced within an economic system. Its measure is the GDP, or parts thereof. The natural environment, in which all economic systems are embedded, serves as the reservoir of temperature and pressure for the heat engines, transistors, and all other energy conversion devices of the capital stock. It also contains the energetic and material resources.
Everybody is striving for wealth. Societies with preferences for laissez-faire usually have lower taxes and levies and higher income inequalities than social market economies. These facts are summarized by: “Wealth is allocated on markets, and the legal framework determines the outcome,” which includes the engineering mechanisms of production in the realm of the productive physical basis. This will lead to the law: “Energy conversion and entropy production determine the growth of wealth.”
The cost-share theorem of standard economics is not valid in modern industrial economies, where capital, labor, and energy are the main factors of production. Maximization of profit or overall welfare subject to the technological constraints “limits to automation” and “limits to capacity utilization” yields new conditions for economic equilibrium. According to them, output elasticities, which measure the factors’ economic weights and indicate their productive powers, are equal not to the factors’ cost shares but rather to “shadowed” cost shares, where shadow prices due to the constraints add to factor prices.