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Why have GDP Growth and Energy Growth Separated?

By Dave Cohen | Mon, 11 February 2013 23:01 | 0

On Friday I put up the following chart, and invited readers to comment on what's wrong with it.

Energy Consumption v GDP
From Bloomberg's Sustainable Energy In America 2013 Factbook. Due to the massive government stimulus of 2009, both GDP and energy consumption grew together in 2009-2010. As the stimulus petered out, energy consumption fell off dramatically but GDP continued to grow (black circle). Click to enlarge.

For your convenience, I have circled the suspicious anomaly—economic growth has radically departed from growth in energy consumption since 2010. That trend flies in the face of everything we know about economic expansion and energy consumption—they are inseparable, at least on a global scale. I am going to assume you have read and understood my descriptions of Tim Garrett's work, which I most recently explained in Is Global Economic Growth Persistent?

The Bloomberg report chalks the divergence up to great energy efficiency in the United States. That's a happy story, but the evidence which supports it ranges from thin to imaginary. I will not argue today that the weak efficiency story is false. (I'll comment on that later this week.) Instead, it behoves us to explain the divergence in another, more satisfactory way.

In Garrett's work, the consistent relationship between economic expansion and the increasing energy consumption which supports that expansion hold on the global scale. We might expect there to be some small local exceptions to the rule in places like British Columbia or Sweden, but the sheer size of the United States economy suggests that the constant relationship between the two trends should hold (more or less) in America as well. (We have to consider trends like the offshoring of manufacturing to energing markets, which effectively moves energy consumption to other countries.)

If we look at the long chart, we see that there has been a GDP-energy dependency since 1845.

US Consumption by Source
Note the contraction in both GDP and energy consumption during the Great Depression (condensed scale on the left). Click to enlarge. Source

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Thus we see that the divergence between GDP and energy over the last few years is unprecedented in the United States. That departure strongly suggests that GDP is artificially inflated. And we don't have far to look to see how this has been accomplished. Consider the next two graphs.

Federal Government Spending as % of GDP
From Mike Shedlock's Government Spending as Percentage of GDP (August 28, 2012). Chart by Doug Short of Adviser Perspectives

Federal Consumption and Gross Investment
From the Washington Post's A scary graph from Goldman Sachs, Ezra Klein, the WonkBlog (February 5, 2013).

Both graphs illustrate the simple, uncontroversial conclusion that the American economy (and thus the GDP measurement) has remained highly dependent on extravagant deficit spending, even after the American Recovery and Reinvestment Act (2009) ran its course. This suggests that GDP growth in the absence of growth in energy consumption is largely a monetary phenomenon, for the government basically (outside of some defense spending)writes checks, which they make good with borrowed money. The Federal goverment does not manufacture things, it typically does not distribute goods, it does very little which is physical, as opposed to monetary. By contrast, there was a large physical ("shovel ready") component in the 2009 stimulus.

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You might read my recent post Look At The GDP Fraud! We might go so far as to say that every GDP print in the last 2 years has been fraudulent in the sense described.

If government spending follows the dashed line in the Goldman Sachs graph—this is called "the sequester"—then we can reasonably expect GDP to follow energy consumption, as it has every year since 1845. GDP would thus decline in a most alarming way. I'll quote from Ezra Klein's post, the source of the 4th graph above—

“This is a large decline in historical context, but it is not without precedent,” [Alec] Phillips [of Goldman Sachs] continues. “This would mark the third decline in the last 50 years; the first occurred around 1970, after Vietnam War spending had peaked, followed by another around 1990 as military spending declined following the end of the Cold War and multiple rounds of spending caps were enacted.”

Even if there’s precedent for this kind of a drop, there are at least three reasons to be particularly concerned about it happening now. First, the previous periods of austerity that Phillips mentions were primarily driven by the end of major wars. That meant that a lot of that spending was not directly raising living standards in the United States, and so its absence didn’t have the kinds of consequences of, say, the sequester.

Second, this graph misses the significant tax-side austerity we’re engaged in, with the expiration of the payroll tax cut and the high-income tax increases from the fiscal cliff deal serving as an additional drag on growth. And third, the economy remains unusually weak by historical standards, and this kind of fiscal drag is going to make it that much harder to recover.

Indeed, if we look at energy consumption (in quadrillions of BTUs), we see just how weak the private American economy truly is.  It is total nonsense to use an "improved efficiency" argument to legitimize the disconnect between GDP and energy consumption in the United States. And if the arguments I've made today are correct, and the spending cuts are put in place, we can reasonably expect GDP to track energy consumption in the future, all other things being equal, just as it did during the Great Depression. In short, we can expect GDP to decline, just as those who fear "the sequester" say it will, unless a miracle occurs.

I shall comment further on "efficiency" and declining energy consumption later this week.

By. Dave Cohen

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