Energy’s Place in Economic Theory

I recently started studying for the second (in a series of three) CFA® examinations (I passed the first one last June.)  The CFA charter is a credential often used by stock analysts and money managers.  In addition to an industry work requirement, there are 3 tests, which are administered once a year, covering a curriculum including Statistics, Economics, Financial Theory, Ethical standards, markets and the like.    

I expect to study about 200 hours for the exam, which is in June. By the way, if there is anyone reading this in Denver who also is studying for the Level II exam, I’d be interested in getting together to work through some of the problems and share study materials.

I just finished a reading on theories of economic growth, a chapter from Economics by Michael Parkin, which is probably one of the best basic Economics text books out there.  It’s been a long time since I took an Economics course, and so I had forgotten how economic growth theory is taught.   

I was disappointed. 

Why?  Because the role of energy use in labor productivity is almost completely ignored. (Labor productivity is simply the sum of all economic activity divided by the number of hours worked.  Since the number of hours worked is relatively easy to measure, growth in labor productivity is the key factor which needs to be understood in order to understand economic growth.)  All three theories covered attempt to explain labor productivity through the interaction of two factors: the ratio of capital to labor employed, and technological change.  As a short aside, the role of energy use is given a slight nod, because the drop in productivity growth in the United States in the 1970s is attributed to the Energy Price Shocks of ’73-4 and ’79-80, in addition to a diversion of effort for coping with environmental problems.  To me, that sounds eerily familiar.  Those are precisely the same problems I expect the world will be trying to cope with for the next decade and beyond.   It’s not that economists as a whole fail to recognize the role of energy use in keeping our economy going.  For example, the effects of the recent rise in energy prices have been widely discussed, and many pessimists (myself among them) have been surprised at how little effect rising energy prices have had on the economy.   The explanation for the lesser effect on economic growth is that our economy has become (partly as the result of the ‘70s price shocks) much more efficient, requiring less energy per unit of GDP. What bothers me is that energy is dealt with as an aside, not as one of the major factors in determining economic growth.  For most of the 20th century, we were blessed with energy supplies which we could increase at will to meet increasing demand, so supply constraints were seldom a factor in determining the growth rate.  In a sense, economist theory is like military strategy: there is too much emphasis on figuring out how to win yesterday’s battles, not tomorrow’s.  Tomorrow’s economic battles, as I see them, will be learning to cope with diminishing supplies of fossil fuels.  Economists, who are the ones who will be helping society plan those battles, should be taught the role of energy in economic growth as part of their framework of understanding, not as an aside or afterthought.  This brings to mind the other aside in the chapter: The other cause given for the slowing of productivity growth in the 1970s was due to the expansion of laws and resources devoted to protecting the environment.  This is perhaps a graver weakness of economic dogma than the minor role for energy.  Because we measure only economic growth, and do not count natural resources like clean air and water among our assets, destruction of those assets is much more likely to be overlooked or minimized by policy makers than it would be otherwise.   This concept is known as Green GDP, and is still very much a fringe theory in economics, in large part because it is fiendishly tricky to measure accurately.  Unfortunately, what isn’t measured is usually ignored, and, like the unmeasured risk of terrorists flying airplanes in to skyscrapers, is likely to come back to haunt us in time.

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5 Comments

  1. Bayu Gunawan said

    Dear Tom,

    Let me introduce my self first. I work for MedcoEnergi, which is the biggest private oil&gas company in Indonesia as corporate&financial planning analyst. The company shares listed both in Jakarta stock exchange & Luxemburg.

    In this opportunity, I would like to have some discussion with you in regard to the preparation of CFA examination. I took the level-1 exam in December 2006. But unfortunately I failed. I only could give much less than 200 hours of preparation time for the exam. And I plan to take this June 2007 exam with committment of spending appropriate effort & time for it.

    I’ve tried to analyze from the past exam result about my strength & weakness areas. My performance ranges from 50%-70% for all topics and only 2 topics that >70%. And I need your advise on this.

    I really appreciate if you could share to me what kind of specific strategy that you did in order to pass the level-1 exam. And how about your past result, would you share it also, so I can figure out how much point that I have to make in order to pass the exam for each topic.

    I got my Bsc in engineering & just graduated for MBA program in december 2006. Since I have lots of exposures in oil&gas industry in which you seem interest with, I think we could also share about this topic.

    Please mail me directly for sharing files or others

    Best regards

    Bayu

    TK: I don’t know how much I can help you. I found the videos from some of the prep courses useful, but basically I had 2 advantages: I didn’t have to learn the statistics, because my PhD is in math (most people think this is the hardest part), and I spent the full study time. My results are here. These are hard exams. If you want to pass, you’re going to have to put in the full study time, and maybe more. As far as I know, there are no shortcuts.

    My strategy was simply to read all the books, watch all the Schweiser study videos I borrowed from a friend, and the take practice exams until I was getting 90% and doing it in the allotted time.

  2. Bayu Gunawan said

    Tom

    Thanks for your explanation. It help me to identify my mistakes and clear the next steps I have to take. I also used the schweiser study book materials but not its video. And I agree with you these are hard exams.

  3. bayu gunawan said

    Dear Tom,

    I just passed my level-1 exam. The result for level-1 had been available since last week (july 25th, 2007). I think for level-2 will be ready shortly. And I hope you will pass your level-2.

    Now, I will start preparing my level-2 exam. Could you share a little bit about level-2 examination? Is it more difficult than level-1 and did you have a specific strategy to deal with it? I just bought the study notes from schweser for the preparation purpose. And hope it’ll help me to reduce the preparation hours. But I still agree with you that we should read the first hand explanations in the original text book for several difficult topics.

    Best regards,

    Bayu

  4. Tom said

    Congratulations on passing level 1!

    I believe I passed level 2, but do not yet have the results. (Type “CFA” into the search box to see other articles I’ve written about it.) I would not recommend my method of studying for level 2… I got overconfident because of my high scores on level 1, and did very little studying until mid-April. For the next 6 weeks, I studied about 8 hours a day, seven days a week. I think I passed in the end, but it was a painful experience. I plan to be much more disciplined for level 3.

    Because I was trying to pack so much studying in to so little time, I did some things I had not done in level one. For one, I took two of the CFAI practice tests, which I found to be both overpriced and not very helpful… they were much harder than the questions that I actually saw on the exam, and I think the whole exercise was counterproductive. I suggest using the Schweser practice exams instead of the official CFAI exams. The questions at the end of the chapters in the CFAI notes were also a lot more useful than the practice exams.

    Again, I used the Schweser study videos, and I also bought the 2005 audio notes. I found those a good complement to the CFAI official study notes, that I read cover to cover. I did not buy the Schweser paper study notes, and so I cannot comment on them. (The 2005 audio study notes and 2006 videos are for sale if anyone is interested… if no one contacts me looking to buy before then, I’ll probably sell them on ebay in January, when I expect demand will be highest.)

    Overall, I thought level I and level II were about the same difficulty, just different material. If you learn the material, they are manageable, but don’t try to cut corners.

  5. ruhi said

    Hi Tom,

    I came across your blog while searching for someone who blogs about CFA. I passed Level- I this June and am now an “official” Level II candidate. You say that CFA online exams were not helpful. Is this applicable only to Level II? I found them to be very helpful for L-I prep. Do you mean to say that we can give it a skip for Level II?

    Since I also got the curriculum during the time of registration, I’m planning to use it for reading purposes and complementing it with 2007 Schweser notes, which I got for free. After CFAI issued statements against the prep providers, I feel that studying only from Schweser might put me in a tight spot next year.

    Also, could you tell me if you used the Schweser Qbank? I’m thinking of buying it in Nov-Dec to get some extra practice as I read from the Curriculum.

    Thank you for all your help,

    Ruhi

    p.s- I have discussed my strategy in details at http://cfaleveltwo.wordpress.com. If you find time, could you take a look at my “Game Plan” page and see if it looks alright? Like you, I really want to get done with this beat ASAP! :) Thanks once again.

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