Thursday, January 15, 2009

The U.S. Economy: Increasingly Marginal Returns

"Marginal returns" refers to ever greater inputs being required to boost output. It also describes the way in which the U.S. economy is investing ever greater resources in regulatory and paperwork structures which have little or no measurable value.

The concept of "marginal returns" is intuitive. We all know the feeling of working ever harder on something just to keep it going. (That's the way I feel about this blog, actually...) Measurable increases in output require ever-larger inputs of energy, time and effort, eventually exhausting the resources available.

Author/thinker Jeremy Rifkin describes this mechanism extremely well in his fascinating book The Hydrogen Economy .. He illustrates the concept on a global scale by using the Roman Empire as an example.

Rome's early conquests yielded huge returns on "investment": large tracts of fertile cropland, significant treasure, productive populaces, etc.

But as time progressed, more and more of the Empires' wealth flowed to the citizenry of Rome, and conquests of distant lands such as Britain yielded less and less return; garrisoning these distant territories began costing more than they produced.

Eventually even holding onto the now-exhausted croplands and restive populations exceeded Rome's dwindling wealth, and the Empire collapsed. There are many ways of accounting for empire-collapse, be it Roman or Mayan, but certainly "marginal returns" describes one element.

Here is how Rifkin applies the concept to U.S. farming practices:

"The pesticides also destroy the remaining soil. The soil contains millions of microscopic bacteria, fungi, algae, and protozoa, as well as worms and anthropods. These organisms maintain the fertility and structure of the soil. Pesticides destroy these organisms and their complex habitats, hastening the process of soil depletion and erosion.

American farms lose more than four billion tons of topsoil annually, much of it because of the high-tech farming practices introduced over the past half century. By the 1970s, the U.S. had lost more than one-third of its agricultural topsoil. The depletion and erosion, in turn, have required the use of ever-increasing amounts of petrochemical fertilizers to maintain agricultural output. Marginal returns have set in. More and more energy inputs are required to produce smaller gains in net energy yield..."

My friend A.G. uses the steam locomotive as an example of the same idea. Toward the end of the steam locomotive's era of dominance, manufacturers were expending ever greater sums on ever smaller refinements to a system whose top efficiency was very low.

When the diesel-electric locomotive came on the scene with efficiencies far higher than the old steam behemoths could ever achieve, the entire steam locomotive industry faded away as quickly as the buggy whip. The steam-based manufacturers were so focued on squeezing an ever smaller marginal return out of their antiquated technology that they completely missed the advent of a far-superior technology.

Here is an example of diminishing /marginal returns run amok. A friend is currently engaged in a huge renovation of a two-story hillside home, the key feature of which is a new concrete foundation. The city required him to hire a special private-industry inspector during the concrete pours to ensure that the concrete was being laid down in such a fashion that it would reach the specified strength (3000 psi, etc.).

Now this makes sense when you're constructing a 20-story building, but a wood-frame two-story house is a comparatively lightweight structure. The concrete and reinforcing bar (rebar) in this foundation was massively over-engineered (i.e. easily enough to support a 4-5 floor structure), so the question arises: what benefit accrued from the hundreds of dollars spent to hire this inspector?

One way to answer this is to ask:

1. how many two-story wood-frame dwellings collapsed in the past two major earthquakes due to catastrophic failure of their concrete foundations or retaining walls due to failure of the actual concrete? (i.e. not if the walls did not have enough rebar due to faulty engineering.)

Answer: zero.

2. how many residents were killed by the failure of foundations beneath two-story wood-frame dwellings in the past 100 years? How many were injured?

Answer: zero and zero.

So exactly what benefit results when the problem supposedly "solved"--loss of life due to collapsing foundations of two-story wood-frame homes due to failure of the concrete to reach specified strength--does not even exist?

This "overkill" is endemic to governmental regulations which have no feedback mechanism, either price (price is no object because the government isn't paying) or utility (we say this over-engineering is a good thing because it "lowers risk", even when we can't quantify the risk, because it's "free" for government to specify it).

I submit that this feedback-free mechanism of marginal returns has burrowed into the very heart of the American economy and government. Blinders (the steam locomotive analogy) work in private industry (let's spend $70 per barrel extracting shale oil, and then $80, $90 and $100/barrel in ever more marginal oil exploration/production) while price/utility-feedback-free government loads every remaining industry in the U.S. down with ever-more extensive and confusing, overlapping regulations until either that industry is driven out of business or becomes uncompetitive with non-U.S. suppliers.

Correspondent Michael Goodfellow provided an example with this comment:

Interesting reading. Everyone gripes about foreign competition and low salaries in places like China. Sometimes they add "and they have no environmental laws." But I don't think people really realize what American regulation has come to.
Clark foam/surfboards closes its doors.

Think this is extreme? Think again. A recent story here in town described a resident who was fined $3,000 for erecting a greenhouse on his roof without obtaining a proper permit. OK, fair enough; life safety issues are legitimate concerns. But then the city demanded a $4,000 non-refundable fee to review his permit application, all for a 12-foot square greenhouse which cost far less than the non-refundable deposit--which is not the actual permit fee, of course, just a review fee the city keeps even if they don't issue a permit.

All this needs to be a completely All-American story is a couple of lawsuits which cost ten or twenty times the value of the offending greenhouse--lawsuits which completely miss the irony of the "green" intent of the owner.

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