Energy Efficiency

The key to the economic model

EXERGY  COMPLETES THE ADAM SMITH ECONOMIC MODEL

From Classical to Modern Economic Growth model

The traditional economic model, rooted in Adam Smith’s classical economics, explains growth mainly through two factors of production:

  1. Capital (machines, buildings, financial resources)
  2. Labor (human work and skills)

While this framework was foundational, it became increasingly clear that it does not fully explain the complexity of modern economic growth.


Solow’s Contribution

In the 1950s, Robert M. Solow developed the neoclassical growth model, which earned him the Nobel Prize in Economics in 1987.

  • His model showed that capital and labour together explain only about 14% of long-term economic growth.
  • The remaining 86% comes from what he called "technological progress", or broadly speaking, improvements in knowledge, efficiency, and productivity.
  • Solow famously referred to this as a “measure of our ignorance” — because we could not fully identify or quantify what was driving most of the growth.


The Limits of the Classical Model

Modern economics traces its origins to Adam Smith, who described production as the result of two key factors: capital (machines, infrastructure, finance) and labour (human work and skills). This framework shaped economic thought for centuries, but struggles to explain real-world growth patterns


Introducing Energy into Economics

Two researchers, Robert U. Ayres and Benjamin Warr, sought to address this gap. They argued that economics had overlooked a fundamental reality: production is a physical process governed by the laws of thermodynamics.

Ayres and Warr introduced a third factor of production: exergy, the portion of energy that can be converted into useful work (unlike raw “energy,” which includes unusable forms such as waste heat). In their model, output is a function of capital, labour, and exergy.



Why "Exergy" matters

Exergy highlights the crucial role of energy quality and usability. For example, one barrel of oil and the same amount of low-temperature heat may contain equal energy, but only the oil can power vehicles or industry. Without sufficient exergy flows, both labour and capital remain idle — a factory without electricity or workers without fuel cannot produce.


Empirical Validation

Ayres and Warr tested their thermodynamic growth model with historical data:

  • United States (1900–2000): While Solow-type models explained only a small fraction of GDP growth, the inclusion of exergy allowed the model to account for nearly 100% of growth trends.
  • Europe and Japan: Similar studies confirmed that economic expansion correlated strongly with both exergy consumption and improvements in exergy efficiency — the ability to do more with the same usable energy.


Energy Efficiency Implications for the future economy

The thermodynamic approach reframes growth as an energy-driven process. Technology, in this light, is largely about improving exergy efficiency. This perspective directly links economics with ecological limits, resource depletion, and sustainability challenges.

By embedding thermodynamics into economic theory, Ayres and Warr provide not just an explanation for Solow’s “residual,” but also a framework for understanding how growth, energy, and the environment are inseparably connected.

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