Methodological Overview - Economics and Ecology: United for a Sustainable World - page 10

The Energy-Inflation Connection
In the heat of the initial inquiries during the onset of Oil Shock, and dur-
ing the height of the stagflation experienced in 1974 to 1975, U.S. President
Gerald Ford requested economists to estimate the proportion of the double-
digit inflation that was energy based. Because empirical evidence revealed
that direct purchases of energy averaged 8 percent of the total costs to or
expenditures by U.S. firms, that figure (about one-twelfth of the perceived
inflation) was initially hypothesized to be the answer. After all, it was rea-
soned that the other 92 percent of nonenergy expenditures would tend to
shield a given producer from energy-related inflation.
The rate of inflation had moved from 4 percent in 1971 to as high as 12 per-
cent during 1974. By applying this methodology to explain the increases, the
indication was that only two-thirds of one percentage point could be ascribed
to energy, which means that in the absence of energy price increases, we
would still have experienced inflation of about 11.3 percent.
Subsequently, however, the tool of input-output analysis was employed
to address this question in a different manner. Input-output is a more
systemic analytical tool than most typical economic techniques and has
the ability to recognize cumulative effects as materials move through an
economy. It addresses how raw materials become intermediate goods and
services and then final products by flowing from primary or raw-resource
suppliers, to intermediate producers, and ultimately to final producers of
goods and services. In short, it can follow the process of transformation
of materials from extraction through final use. At each stage, value of the
intermediate good is increased through the application of additional pro-
ductive inputs, whether human labor, energy (solar or otherwise), recycled
chemicals, or something else.
The estimated relationships between economic sectors (e.g., coal and steel,
steel and automobiles, and so on) are determined by the state of technology
and the underlying structure of the economy. As such, those relationships
represent the percentages of all purchases by or sales by a particular eco-
nomic sector going from or to any other sector.
In simpler terms, input-output analysis would recognize that the purchase
of an intermediate good represents the purchase of previously expended
energy, which the value added to the intermediate good represents. The logic
is much like that supporting the original labor theory of value, as first devel-
oped by Adam Smith, David Ricardo, and Thomas Malthus. According to
these Classical-School economists, the source of all value was labor, because
human effort is indispensable in bringing forth the production of anything
useful to humankind, and labor is therefore inherently represented in the
purchase of any goods or services. Consequently, according to classical rea-
soning, the pricing of any good relies primarily on what it takes to recoup
the monetary value of the energy expended in the production of the good—
from beginning to end, human labor included.