The Rise and Fall of the Middle Class

 

10/06/2011

The industrial revolution introduced the world to a new prosperity never seen before. New sources of energy enabled mechanized and automated industrial processes to increase per capita output and free up labor to participate in value-added activities. Energy from coal and oil substituted manual labor many times over, leading to faster transportation, faster construction, greater agricultural production, cheaper materials (i.e. plastics), and more. With a barrel of oil reportedly replacing 25,000 man hours of work effort and costing very little to obtain (prior to 2005), the ROI on energy created a world of plenty.

A world of plenty can suddenly afford kitchen appliances, cars, bigger houses, post secondary education, entertainment, health care, social security, and more. Furthermore, a world of plenty can afford to structure it’s consumption economy using a credit-based model, because economic surpluses from future ROI on energy can be used to repay or service consumer loans made today.

I don’t think a higher being sat back and designed the economy to take advantage of the high returns on energy. The economic relationship between energy and economic growth was more likely an organic evolution led by consumers and innovative businesses that found ways to take advantage of an inexpensive resource. As the innovations became more pervasive, so too did economic dependence on the resource. After a couple centuries of high energy ROI (first from coal, then from oil) most people today don’t think twice about how much of our societal success is dependance on cheap energy. The truth is, we may owe much of what we’ve accomplished in bridging the gap between the bourgeoisie and proletariat, namely the growth of the middle class, to the surpluses generated by a high return on energy.

To clarify, return on energy, not the availability of energy, determines how energy use impacts an economy. If it costs less than a barrel of oil to extract a barrel of oil, energy is a net contributor to our lives. The less energy it takes to extract energy, the greater the economic influence – the world economy has benefited greatly because, for a long time, it took very little energy to obtain more energy. However, as the difficulty of extraction rises, it takes more energy to extract a barrel of oil and the economic benefits shrink. Eventually, when it takes 1+ units of energy to extract 1 unit of energy, the energy form is a sink and is no longer a viable source of economic or societal benefit.

Over the past decade energy prices have been rising as the difficulty to extract new sources rose. The days of sticking a straw in the ground and watching the oil gush out have been replaced by deep water drilling, shale oil and arctic exploration. Not coincidentally, the economies of the western world appear to have reached their limits. Real economic life has been replaced by the last gasps of a credit-based system. What little growth we’ve seen over the past 10 years was fueled easy money rather than real economic growth and the middle class today appears to be falling apart.

I believe the middle class may unfortunately be a fleeting phenomenon in the economic history of the world. With the availability of cheap energy, mankind stumbled upon a windfall gain that lasted a couple-hundred years, and democratic societies chose to spread the new wealth across all its members, creating a moderate, well-off majority that strengthened domestic stability. As this windfall gain begins to dwindle (because energy is harder to obtain), societies are caught between paying the over-promises of the past and watching domestic stability disintegrate.

As they are over-levered to consumption growth in a world where consumption growth is shrinking, developed market economies are highly vulnerable to a shrinking energy ROI. This vulnerability is bubbling to the surface, as the middle class in the western world has struggled over the past decade and real economic activity in developed energy consuming nations has disappointed. Crash after crash, recession after recession, we could be witnessing the beginning of the slow demise of the middle class. The devolution of the middle class could take generations to play out, just as it took generations for a meaningful middle class population to form. Nevertheless, unless we discover a way to raise energy ROI to previous levels, the middle class might vanish.

planbeconomics.com

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