Thursday, November 11, 2010

importance of Liebig's law of the minimum

Recently Paul Krugman showed in his blog a graph of commodity costs: Big spike in 2008 and back to normal levels. But of course commodity prices as a whole are suppressed in this ongoing financial mess. He is failing to take into account Liebig's Law.

Liebig's Law applies in its original form to plants. Let's just consider the 3 standard ingredients: NPK. A particular type of plant will need a particular ratio. The growth of a particular plant in a particular location will be constrained by whichever is in shortest supply (taking the preferred ration into account). There will then be unused amounts of the other 2. Now we can imagine that the plants of that type in that area will be evolving towards making more balanced use of the resources available there. However long before much progress is made in that direction the area is likely to be overrun by a different species that is already better adapted to the NPK ratio there.

We need to understand the corresponding situation in economics. Global production requires resources. The key resource is the one in short supply. Naturally there is an excess availability of the ones that aren't in short supply, and their price is driven down. There is only so much that society can spend on resources as a whole, so not surprisingly the total cost of resources stays steady. The key is the one in short supply. Currently, and for the next decade, that is oil.

There is pressure on us to evolve: to use oil more efficiently and to use other things where possible. However our current technology mix is the wrong "plant" for the new environment. The correct answer is to switch to an electric instead of an oil economy.

Getting back to Krugman's post. The key commodity for global production is the one in short supply, where the substitutability is almost used up. That's oil. Total/average commodity costs are not the important thing.

P.S. On previous occasions I've misspelt this Lieberg.