Ominous portent of the omitted variable: the urgent need to understand energy's role in productivity growth

Abstract

The consequences of a global economic recovery that does not reduce carbon dependency are profoundly concerning, yet some economic recovery agendas have unsettling overtones of 'business-as-usual'. In Australia, for example, restoring 'productivity growth' is firmly on the agenda. 'Productivity growth' is commonly understood to mean either higher labour productivity - an increase in value-added (or GDP) per hours worked by labour - or an increase in 'total factor productivity', otherwise known as technological change. Either way, as ecological economists have shown, the remarkable pace of technological change and the impressive increases in labour productivity achieved over the last century have markedly raised the level of material and energy throughput into the economy - yet it is this 'resource productivity' that must be improved in order to achieve 'green mileage' and greater sustainability. The question arises then: can an economy pursue a recovery based on increases in labour productivity, total factor productivity and resource productivity simultaneously? The fact that the question is not being asked in policy circles appears to be because natural resources, and energy in particular, are often omitted altogether from the aggregate production functions used to measure productivity increases, creating somewhat of a 'blind spot'. Even if energy is included as a factor of production, methodology consistent with the assumptions of the neoclassical theory underpinning conventional productivity measurement undervalues it by weighting it at its GDP 'factor cost share'. Drawing on ecological economics research, this paper puts the case as to why energy should be included as a factor of production; why weighting energy by its 'factor cost share' when it is included, is wrong; how this commits a type of 'water versus diamonds' valuation error; and why this matters so much at this point in time.