Frontier Issues in Ecological Economics

Frontier Issues in Ecological Economics In loving memory of my mother, Lesley Mayfield Lawn (April 17, 1939 to January...

Author: Philip A. Lawn

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Frontier Issues in Ecological Economics

In loving memory of my mother, Lesley Mayfield Lawn (April 17, 1939 to January 13, 2002)

Frontier Issues in Ecological Economics Philip Lawn Flinders University, Adelaide

Edward Elgar Cheltenham, UK • Northampton, MA, USA

© Philip Lawn 2007 All rights reserved. No part of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical or photocopying, recording, or otherwise without the prior permission of the publisher. Published by Edward Elgar Publishing Limited Glensanda House Montpellier Parade Cheltenham Glos GL50 1UA UK Edward Elgar Publishing, Inc. William Pratt House 9 Dewey Court Northampton Massachusetts 01060 USA A catalogue record for this book is available from the British Library Library of Congress Cataloguing in Publication Data Lawn, Philip A. Frontier issues in ecological economics / Philip Lawn. p. cm. Includes bibliographical references and index. 1. Environmental economics. 2. Sustainable development. I. Title. HC79.E5L385 2007 333.7—dc22 2006013237

ISBN 978 1 84542 840 2 Printed and bound in Great Britain by MPG Books Ltd, Bodmin, Cornwall

Contents vii viii

About the author Acknowledgements PART I AN INTRODUCTION TO ECOLOGICAL ECONOMICS, SUSTAINABLE DEVELOPMENT AND THE STEADY-STATE ECONOMY 1 2

Introduction What is sustainable development?

3 10

PART II SUSTAINABLE DEVELOPMENT AND NATURAL CAPITAL 3 4 5

Is human-made capital an adequate long-run substitute for natural capital? The potential conflict between sustainability and welfare maximisation Natural resource prices and natural resource scarcity

PART III 6 7 8 9

41 62 81

SUSTAINABLE DEVELOPMENT INDICATORS

An introduction to sustainable development indicators An assessment of various measures of sustainable economic welfare Using a Fisherian measure of income to guide a nation’s transition to a steady-state economy Eco-efficiency indicators: theory and practice

107 123 147 166

PART IV SUSTAINABLE DEVELOPMENT: THEORETICAL AND POLICY ISSUES 10 11

On the independence of the sustainability, distribution and efficiency goals Ecological tax reform: why and in what form? v

193 200

vi

12 13 14

Contents

Does the Environmental Kuznets Curve exist? A theoretical perspective IS-LM-EE: incorporating an environmental equilibrium curve into the IS-LM model Reconciling the policy goals of full employment and ecological sustainability

217 245 270

PART V SUSTAINABLE DEVELOPMENT AND THE INTERNATIONAL DIMENSION 15 16

17

Keynes, international governance arrangements and globalisation Increasing sustainable national income by restoring comparative advantage as the principle governing international trade The 2002 World Summit on Sustainable Development: another opportunity to address the scale and globalisation issues gone begging

PART VI 18

293

314

326

CONCLUSION

Is a steady-state economy compatible with a democratic-capitalist system?

Bibliography Index

335 344 363

The author Philip Lawn received his Bachelor of Economics in 1991 from Flinders University, Australia. After working for a short time as an economics tutor, Philip embarked on postgraduate studies at Griffith University in Brisbane, Australia. In 1998, Philip received his PhD in ecological economics and, in the same year, returned to Flinders University to take on a position as a lecturer in environmental and ecological economics. In recent years, Philip has published a number of articles in the field of ecological economics. He also has three other books to his name – Toward Sustainable Development (Lewis Publishers, 2000), Sustainable Development Indicators in Ecological Economics (ed.) (Edward Elgar, 2006), and Measuring Genuine Progress (co-authored with Matthew Clarke) (Nova Science Publishers, 2006). Philip is currently the editor of an Inderscience journal entitled The International Journal of Environment, Workplace, and Employment which serves as a forum for examining ways to reconcile the ecological sustainability and full employment objectives. Philip is a member of the International Society for Ecological Economics (ISEE) and is on the executive board of the Australia and New Zealand branch (ANZSEE).

vii

Acknowledgements This book is the latest product of an intellectual journey that is 20 years long and far from complete. Throughout this journey, I have been fortunate enough to receive the wonderful support of family and friends as well as a wealth of intellectual guidance and assistance from teachers, colleagues, collaborators, and students. Of these, I would like to single out and thank Ralph Shlomowitz (Flinders University), Matthew Clarke (RMIT University, Melbourne), Stewart Fraser (past teacher and now occasional mentor), and the members of the International Society of Ecological Economics (ISEE). Through regular contact and feedback with ISEE colleagues at both international and regional conferences, my knowledge and understanding of ecological economics has grown immensely. I have no doubt that this infusion of knowledge is a major reason why a book of such depth exists in front of you. Whilst on the infusion of knowledge, I cannot go by, as with any major work of mine, without thanking Herman Daly – a man whose shoulders must be painfully bruised from having me stand on them for the last decade. Those with an intimate knowledge of Daly’s work will have little difficulty identifying the extent of Daly’s impact on this book and the intellectual debt I clearly owe him (despite having not met Daly to date). To a lesser degree, I could say the same about Kenneth Boulding, Nicholas GeorgescuRoegen, and Richard Norgaard. As always, my greatest debt is owed to my parents Graham and Lesley Lawn. Whilst my mother sadly passed away some four years ago, without her love and support throughout my first 37 years of life, along with the continuing support of my father, this book would not exist at all. Philip Lawn

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PART I

An introduction to ecological economics, sustainable development and the steady-state economy ‘As I see it, the maintenance of ecological integrity and of equity in an efficient way defines the heart of ecological economics.’ M. Young, 1997 ‘Lack of a precise definition of the term “sustainable development” is not all bad. [. . . .] But the term is now in danger of becoming an empty shibboleth. [. . . .] Even though we must not expect analytical precision in reasoning with dialectical concepts, it is nevertheless possible and very necessary to clarify the notion of sustainability and to offer the first few principles of sustainable development.’ H. Daly, 1991a, pp. 248–9

1.

Introduction

THE AIM OF THE BOOK Ecological economics is a transdisciplinary paradigm that extends and integrates the study and management of nature’s household (the ecosphere) and humankind’s household (the macroeconomy). As a relatively new paradigm, ecological economics has largely emerged in response to the failure of mainstream economic paradigms to deal adequately with the coevolutionary interdependence of social, economic and ecological systems. Thus, in many ways, the development of an ecological economic paradigm can best be described as a concerted attempt to overhaul the standard neoclassical approach by bringing the false pre-analytical visions underpinning its assumptions into line with biophysical and existential realities (Lawn, 2002). Because of its broad, transdisciplinary nature, ecological economics has brought to many people’s attention a large number of critical issues, most of which centre on how human beings can live more sustainably, peacefully and less wastefully. The aim of this book is to deal with these matters, in particular, the frontier issues that have emerged in recent years and those that have long been a source of disagreement and debate. Not for one moment am I pretending that this book serves as a definitive and comprehensive treatment of all major ecological economic issues and the theory that underpins them. Furthermore, the book is not pitched as a text in ecological economics. For that, I urge all readers to consult the brilliantly constructed works of Common and Stagl (2005) and Daly and Farley (2004). But I do believe the book covers the key areas that reflect the character of ecological economics and which set it so distinctly apart from other economic disciplines. More importantly, I’m modestly confident that this book will broaden people’s knowledge and understanding of ecological economics and contribute, if only in a very small way, to a more sustainable, just and efficient future for all.

THE STRUCTURE OF THE BOOK To achieve its aims, this book is divided into six sections of which the chapters contained in Parts II, III, IV, and V share a common theme. Part I, as 3

4

Ecological economics, sustainable development and the steady-state

the introductory section, begins with the current chapter. In Chapter 2, the concept of sustainable development is discussed and eventually defined. This leads to some very important questions concerning economic growth, the desirable size of macroeconomic systems, and the steady-state economy. Chapter 2 concludes by describing the characteristic features of the steady-state economy, the purpose of which is to provide a macroeconomic template for the remainder of the book. Part II, containing three chapters, focuses on the role of natural capital in achieving sustainable development. In Chapter 3, the long-running debate as to whether human-made capital can adequately substitute for declining natural capital is revisited. Upon demonstrating that mainstream production functions cannot be used to make substitutability assessments, a Bergstrom production function is put forward and manipulated to unveil the range and direction of change in the elasticity of substitution between the two forms of capital. The manipulation exercise reveals the existence of a complementarity relationship which, it is argued, has far-reaching implications for resource policy and national income accounting. The following chapter (Chapter 4) incorporates a time dimension into the Bergstrom production function to better appreciate the long-run production possibilities of an economic system. The revised function is then used to conduct a range of simulation exercises, including one revealing a potential conflict between present value welfare maximisation and the need to keep natural capital intact to achieve ecological sustainability. It is then shown that the prevailing social discount rate may influence a society’s choice of a sustainable or unsustainable pathway. Given the possibility that the conditions of ecological sustainability and intertemporal efficiency may fail to coincide, Chapter 5 involves an investigation into the relationship between natural resource prices and natural resource scarcity. Following an extension of a typology of resource scarcity originally outlined by Hall and Hall (1984), it is shown that resource prices generated by conventional resource markets are unable to reflect the absolute scarcity of the total resource stock and its constituent types. This leads to the conclusion that caution should be taken when using natural resource prices to ascertain whether the stocks of particular resources are in decline and/or as a basis for determining the sustainable rate of resource use. Furthermore, it suggests that ecological sustainability will require quantitative restrictions on the rate of resource throughput that must be determined on the basis of ecological rather than economic criteria. Part III moves onto sustainable development indicators and begins, in Chapter 6, with a survey of some of the popular indicators employed by ecological economists to measure sustainable income and sustainable economic welfare at the national level. In Chapter 7, three perceived weaknesses of

Introduction

5

recently devised indicators of sustainable economic welfare, such as the Genuine Progress Indicator (GPI), are addressed. They include: (a) the supposed lack of a theoretical foundation to support them; (b) the shortcomings associated with the valuation methods used in their construction; and (c) the questionable interpretation of the final results. By focusing on the individual items which make up these indicators, it is shown that they are soundly based on Fisher’s (1906) distinction between income and capital. In addition, whilst the criticisms relating to (b) and (c) are in some sense valid, it is argued that these alternative indicators are more reliable measures of sustainable economic welfare than mainstream macroeconomic indicators, such as Gross Domestic Product (GDP). Finally, it is stressed that a more consistent and robust set of valuation methods must be established. Without them, alternative indicators of sustainable economic welfare, such as the GPI, are unlikely to enjoy mainstream acceptance. With the conclusions of Chapter 7 in mind, Chapter 8 involves the use of a Fisherian-based measure of income to assist a nation in its transition to a steady-state economy. After explaining the distinction between Fisherian and Hicksian income, Australia’s Fisherian national income is calculated for the period 1967–97. The empirical evidence suggests that Australia surpassed its optimal macroeconomic scale in the mid-1970s. Despite a deceleration in Australia’s rate of macroeconomic growth between the mid-1970s and mid-1990s, it is shown that Australia chose not to make the full transition to a steady-state economy thereafter. Instead, Australia appears to have reverted to a high-growth policy. The chapter concludes with some suggestions regarding the likely impact of this policy stance on the future trend in Australia’s sustainable economic welfare. As useful as indicators of sustainable economic welfare might be, they do not reveal the fundamental cause for any decline in a nation’s genuine progress. For example, it is impossible to know, from these indicators alone, whether a fall in sustainable economic welfare is the result of decreasing efficiency or, if efficiency is rising, whether its rate of increase is being exceeded by the rate of macroeconomic expansion (the Jevons’ Paradox). To deal with this dilemma, a number of eco-efficiency indicators are established in Chapter 9 on the basis of various coevolutionary principles and understandings. The eco-efficiency indicators are then calculated for Australia for the period 1966–67 to 1994–95. The results suggest that much of Australia’s technological progress in recent times has been of the throughput-increasing rather than efficiency-increasing variety. Indeed, it is argued that more should be done to reduce Australia’s reliance on non-renewable resources, to reinvest non-renewable resource depletion profits into renewable resource substitutes, and to reduce the rate of native

6


vegetation clearance. Given the recent rapid rise in psychic costs, it is also suggested that a greater proportion of Australia’s incoming resource should be allocated to satisfy emerging higher-order needs. In view of the stark messages presented in Part III, Part IV of the book deals with a range of emerging theoretical and policy issues. In Chapter 10, the issue of sustainability versus efficiency is broadened to include the goal of distributional equity. Support is then given to Herman Daly’s decade-old thesis that the three policy goals of allocative efficiency, distributional equity and ecological sustainability require the imposition of a separate policy instrument (Daly, 1992). Furthermore, since markets are unable to sense a sustainable rate of resource throughput and a just distribution of income and wealth, it is argued that the policy goals of ecological sustainability and distributional equity must be resolved prior to the efficiency goal. Chapter 11 builds on the conclusions drawn in Chapter 10 to design an ecological tax reform (ETR) package to facilitate the sustainable development process. To assist in this regard, five key organisation modes are put forward. It is then explained why conventional ETR prescriptions – which rely erroneously on the manipulation of market prices to achieve ecological sustainability – lead to just two of the five organisational modes being attained. Following an outline and justification of an ETR package incorporating assurance bonds and tradeable resource use permits, the final section of the chapter deals with some of the criticisms levelled at this alternative ETR approach. In the early 1990s, a number of economists believed they discovered sufficient empirical evidence to support the view that environmental quality would at first deteriorate but later improve as a nation’s per capita real GDP rose over time. Given a similar posited relationship between per capita real GDP and income inequality in the 1950s (Kuznets, 1955), this theory soon became known as the ‘Environmental Kuznets Curve’ (EKC) hypothesis. The policy implications of this hypothesis cannot be overstated since, if shown to be correct, the solution to environmental degradation is the continued growth of a nation’s real GDP, not its curtailment. In Chapter 12, a theoretical model developed by Munasinghe (1999) is extended and employed to determine if the EKC curve exists. It is shown that the EKC does not resemble the purported concave relationship between environmental degradation and per capita real GDP, but a thirddegree polynomial where, eventually, environmental degradation must increase in the presence of continued macroeconomic growth. This conclusion raises a number of policy-related issues, in particular, whether a so-called ‘pollution haven hypothesis’ serves as a possible explanation for the favourable circumstances empirically evident in wealthy Northern nations. These issues are discussed in the closing sections of the chapter.

Introduction

7

Chapter 13 involves the incorporation of an ‘environmental equilibrium’ or EE curve into the IS-LM model that has long served as the foundation of modern macroeconomics (Heyes, 2000). The EE curve represents an explicit environmental constraint on macroeconomic systems that might, for example, follow the introduction of assurance bonds and tradeable resource use permits of the type revealed in Chapter 11. Although little more than a pedagogical device, it is shown how the IS-LM-EE framework can be used to examine the potential impact of expansionary fiscal and monetary policies on both national income and sustainable economic welfare. It is also revealed that the impacts can be quite marked with significant implications for future macroeconomic policy. Much of this book concerns the ecological economic position that the growth of macroeconomies must eventually cease in order to achieve ecological sustainability. Since many observers believe that a growth rate of two to three per cent is necessary to negate steep rises in unemployment, Chapter 14 deals with a seemingly obvious question: how can full employment be generated in the presence of a low-growth or steady-state economy? A number of suitable policies are surveyed and discussed, including measures to sever the GDP-employment link, changes in industrial relations to augment labour productivity, ecological tax reform, and expansionary demand-side policies. To assess the possible impact of these policy initiatives the IS-LM-EE model from Chapter 13 is invoked. As it turns out, the model suggests there are severe restrictions on the capacity of central governments to employ demand-side policies to reconcile the full employment and ecological sustainability objectives. Consequently, a combined employer-of-last-resort program (Job Guarantee) and universal Basic Income is recommended to complement the above suggested measures. While the former ensures a ‘loose’ form of full employment, it is argued that the latter can trigger a real labour supply withdrawal to reduce the full employment level of income to an ecologically sustainable level. Part V of the book addresses the international dimension of sustainable development, perhaps the most crucial of all areas of concern. In the first of three chapters in this section, Chapter 15 begins by distinguishing between globalisation and internationalisation. It is then argued that the eventual demise of the Bretton Woods system created a vacuum that allowed the globalisation phenomenon to thrive. Following an hypothesised link between the rise of globalisation and the fall in sustainable economic welfare (as measured by the GPI), an IMPEX (Import-Export) system of foreign exchange management is put forward as a way of restoring comparative advantage as the principle governing international trade. Combined with modifications in the way the World Bank, International Monetary Fund (IMF), and World Trade Organization (WTO) operate, it

8


is explained how economic entanglement of the internationalist kind can be installed and the rising tide of globalisation overturned. In Chapter 16, the IMPEX system of foreign exchange management is theoretically supported by way of an extension of the IS-LM-EE model revealed in Chapter 13. The chapter begins with the inclusion of a ‘balance of payments’ or BP curve into the IS-LM-EE framework. The extended model is then used to analyse the relationship between international trade and sustainable national income where: (a) international capital flows are highly mobile (the status quo position), and (b) where the international mobility of capital is restricted by an IMPEX system of foreign exchange management (the Lawn position). With the use of two hypothetical policy examples, it is shown that sustainable income is higher with an IMPEX system in place (the Lawn position). Finally, in Chapter 17, an assessment is made of the 2002 World Summit on Sustainable Development held in Johannesburg. Whilst recognising that a number of positive initiatives emerged from the Summit, it is argued that it failed to address two critical areas of concern – namely, the scale and globalisation issues. The chapter begins by emphasising the need for developed nations to reduce the scale of per capita resource consumption and for poorer countries to reduce the scale of population growth. By highlighting the problem areas raised during the Summit and the policy measures recommended to alleviate them, it is shown that the scale issue was virtually ignored. Stressed instead was the need for continued growth but with improved environmental management, changing consumption patterns, and a fallacious decoupling of macroeconomic growth and environmental damage. Whilst globalisation received some attention, it was regarded at the Summit as an irreversible force that ought to be accelerated. The chapter concludes with a pleading message for all future summits to deal appropriately with the scale and globalisation issues if sustainable development is to in any way be achieved. The aim of the final chapter of the book, Chapter 18, is to convince the reader that a steady-state economy is compatible with a democraticcapitalist system. To achieve its aims, the chapter starts with an investigative look at the likely impact of a steady-state economy on profits, incentive and investment. It is argued that these capitalist imperatives would not be stifled by the presence of a non-growing but qualitatively improving macroeconomy. It is then explained how, from a political economic perspective, a would-be government wishing to introduce a steady-state economy is potentially electable in a representative democracy. Overall, it appears there is no reason why a steady-state economy could not be gradually installed in a manner consistent with the principles of sustainable development and with a minimum amount of institutional disruption.

Introduction

9

In view of the empirical evidence that will be revealed in Part III of the book, let us hope that the transition to a steady-state economy begins sooner rather than later. Let us also hope that there is enough ‘ecological’ space for impoverished countries to enjoy a short spurt of clean, equitable and efficient growth and that they too make the transition to a steady-state economy when the time is appropriate. For there is probably little time left to begin the transition before the impacts of ecological and existential limits impose themselves in rather catastrophic and irrecoverable ways.

2.

What is sustainable development?

DEFINING SUSTAINABLE DEVELOPMENT Sustainable development is a concept that first gained notoriety following the release of the Brundtland Report by the World Commission on Environment and Development in 1987. However, it was not until the 1992 Earth Summit in Rio de Janeiro and the widespread promotion of the United Nations’ Agenda 21 that sustainable development was firmly established as a desirable policy objective. Between these two events, ecological economics was formally established as a new transdisciplinary science. Perhaps it is not surprising that an edited book to emerge from an early ecological economics workshop was given the title Ecological Economics: The Science and Management of Sustainability (Costanza, 1991). A relatively short time later, a highly influential book on ecological economics was written by Herman Daly, arguably the world’s leading ecological economist. It was titled Beyond Growth: The Economics of Sustainable Development (Daly, 1996). The titles of these two books suggest that the sustainable development concept is at the core of the ecological economics movement. There are two good reasons for this. In the first instance, development conjures up an image of ‘betterment’ in what is a far from perfect world in urgent need of remediation. Development, however, is meaningless if not impossible to experience unless it can be ecologically sustained. If nothing else, the sustainable development concept is intuitively desirable. Second, most ecological economists believe that the sustainable development concept is ill-conceived and, as such, the policy measures being introduced by most national governments to achieve sustainability are at odds with sustainability requirements. Since the very nature of ecological economics reflects the above-mentioned book titles, it seems quite logical that sustainable development would constitute a foundation concept upon which ecological economists can gain a better understanding of the critical issues at hand, of the policies needed, and of the performance indicators required to avoid past policy failings. Quite naturally, this raises the question as to what exactly is implied by sustainable development. At all times, sustainable development will mean different things to different people. There are many reasons for this. First, 10


11

the concept of sustainable development is used in many locations and contexts, by people from varying cultural backgrounds and disciplinary schools of thought, and for different purposes. Second, the sustainable development concept has evolved rapidly and over a relatively short period of time. Finally, debates about sustainable development have been influenced by a wide range of underlying views regarding the relationship between human beings, economic systems, and the natural environment of which they are a part. As such, there are various opinions as to how sustainable development should be measured and what is required to move toward the sustainable development goal. To accommodate the various interpretations of sustainable development, it is necessary to define sustainable development in broad terms. Unfortunately, this makes the task of measuring sustainable development a very difficult one. Thus the concept of sustainable development used to assess a nation’s sustainable development performance is likely to differ from the one used to describe the sustainable development process generally. The former is likely to be defined in considerably narrower terms in order to establish operational rules of thumb to serve as the basis for a congruent set of sustainable development indicators. Of course, when defining sustainable development more narrowly, there is the inherent danger of losing sight of both its broader meaning and the need to accommodate the diverse cultural interpretations of the sustainable development process. Clearly, an appropriate balance between inclusiveness and specificity needs to be struck. This is an issue taken up in more detail in Chapter 6. For now, however, our focus is on the establishment of a suitable broad definition of sustainable development. The definition will thenceforth serve as a foundational concept for the remainder of the book. The Coevolutionary Worldview as a Concrete Representation of the Socio-economic Process The quest for a broad definition of sustainable development must begin within the context of a concrete representation of the socio-economic process. Unfortunately, a number of past interpretations of sustainable development have been falsely premised on the view that ecological, social, and economic spheres of influence are independent systems. The circular flow model of the macroeconomy that forms the centrepiece of the mainstream economic view of the sustainable development process is a case in point. The inadequacy of this approach has led many observers to introduce linkages between the three major systems to represent the transfer of material, energy and informational flows between them (see Lawn, 2006a, Figure 2.1). While this is an improvement on isolationist models, such an

12


approach remains deficient because the ecological, social and economic spheres are invariably presented as independently demarcated systems. As such, this approach continues to reflect an atomistic-mechanistic view of the world and thus fails to recognise the coevolutionary nature of economic, social and ecological change (Mulder and van den Bergh, 2001). Coevolution is a term used to describe the evolving relationships and feedback responses typically associated with two or more interdependent systems. Coevolution takes place when at least one feedback loop is altered by within-system activity that, in turn, initiates an ongoing and reciprocal process of change (Norgaard, 1985). A coevolutionary worldview provides a more realistic and concrete understanding of the many critical relationships that bind together the various systems that make up the global system. There are a number of basic features of the coevolutionary worldview worthy of elaboration. First, the coevolutionary paradigm begins from the premise that the Earth is a system comprised of closely interacting and interdependent subsystems. Second, it recognises the Earth and its constituent systems as dissipative structures1 – that is, the Earth as a dissipative structure open with respect to energy (a solar gradient); and the Earth’s constituent subsystems as dissipative structures open with respect to energy, matter and information.2 Third, since each system is connected to and dependent on all others, everything evolves together over time. Even the rules governing the relationships between systems are in a constant state of flux. Fourth, coevolution is characterised by path-dependency – a proclivity of systems to be inextricably related to their past characteristics and to thus exhibit structural inertia (David, 1985; Arthur, 1989). Fifth, given its complexity, the global system is envisaged as one that is far greater and richer than the sum of its parts. Sixth, the coevolutionary worldview regards disequilibria and change as the rule rather than the exception. For many people accustomed to atomistic-mechanistic paradigms, this sounds at best unsettling, and at worst debilitating. But this need not be the case. As Norgaard (1985) has pointed out, disequilibria and change should be seen as an ongoing process offering a plethora of opportunities for humankind to engage in positive coevolution which, for the purposes of this chapter and the remainder of the book, can be construed as a coevolutionary process commensurate with the sustainable development objective. Finally, the coevolutionary worldview is based on a principle of system embeddedness that is sometimes referred to as the logos of nature. Metaphorically, logos is a term used as a principal concept embracing the natural order of the universe. By acknowledging the logos of the global system, the coevolutionary worldview recognises, first, that the world is characterised by self-organisation (Capra, 1982). Second, it recognises that systems exist at varying levels of complexity and, as such, are

13


ECOSPHERE (Natural capital)

Heat loss (–)

SOCIOSPHERE (Institutions)

MACROECONOMY (Human-made capital)

Solar flux (+) SUN

Figure 2.1 A coevolutionary depiction of the interdependent relationship between the economy, sociosphere and ecosphere characteristically stratified and multi-levelled (Laszlo, 1972). The logos of the global system and the embedded relationship between the three major spheres of influence – the macroeconomy, sociosphere and ecosphere – are illustrated by way of Figure 2.1. In Figure 2.1, the three major spheres of influence represent different systems at varying degrees of complexity. Each can be considered a holon insofar as they manifest the independent and autonomous properties of wholes and the dependent properties of parts.3 Thus each sphere consists of smaller parts while simultaneously acting as the part of a larger whole (i.e., the macroeconomy serves as a component of the sociosphere while the sociosphere serves as a component of the ecosphere). In a sense, Figure 2.1 represents the sociosphere as the interfacial system between the macroeconomy and the larger ecosphere, thereby highlighting the crucial role played by institutions and social capital in promoting stable human behaviour in the face of indeterminacy, novelty and surprise (Capra, 1982; Hodgson, 1988; Faber et al., 1992). The Linear Throughput Representation of the Socio-economic Process In order to diagrammatically convey the coevolutionary worldview in greater detail, consider the linear throughput representation of the socio-economic

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Ecological economics, sustainable development and the steady-state 4. Natural capital (ECOSPHERE) (sole provider of source, sink and life-support services) SOCIOSPHERE 1. Net psychic income

Heat loss (–)

2. Human-made capital (MACROECONOMY) non-renewable source resources in (production)

Solar flux (+)

SUN

3. Throughput

waste out (consumption)

sink

renewable source

recycling

5. Lost natural capital services

= low entropy resource flow 1. Net psychic income 4. Natural capital = high entropy waste flow 2. Human-made capital 5. Lost natural capital services = psychic (non-physical) flows 3. Throughput

Figure 2.2

Linear throughput depiction of the socio-economic process

process in Figure 2.2. In keeping with the coevolutionary paradigm, the linear throughput model: (a) depicts the macroeconomy as a subsystem of the sociosphere that, in turn, is depicted as a subsystem of the ecosphere; (b) recognises the ongoing exchange of matter, energy and information between the three major spheres of influence and all constituent subsystems; and (c) acknowledges the evolving relationships and feedback responses typically associated with coevolutionary change. Although the dynamics of the linear throughput model involve a multitude of elements, each element can be conveniently classified into five broad elemental categories. The first elemental category, natural capital, constitutes the original source of all human endeavours. This is because natural capital is the only source of low entropy resources; it is the ultimate waste assimilating sink; and it is the sole provider of the life-support services that maintain the habitability of the Earth.4 The second elemental category is the throughput of matter-energy – that is, the input into the macroeconomy of low entropy resources and the subsequent output of high entropy wastes. The throughput flow is the physical intermediary connecting natural and human-made capital. Human-made capital is the third elemental category and is needed for human welfare to be greater than it would otherwise be if the socio-economic


15

process did not take place. Conventionally, human-made capital is confined to producer goods such as plant, machinery and equipment. From a Fisherian perspective, capital is interpreted as all physical objects subject to ownership that are capable of directly or indirectly satisfying human needs and wants (Fisher, 1906). Hence human-made capital best refers to durable consumer goods as well as producer goods. Although not subject to ownership (other than by the individual who possesses productive knowledge and skills), labour can also be included as part of the stock of human-made capital. The fourth important elemental category is a psychic rather than physical category. Contrary to some opinions, human well-being depends not on the rate of production and consumption, but on the psychic enjoyment of life (Boulding, 1966; Georgescu-Roegen, 1971; Daly, 1996). Fisher (1906) referred to such a flux as ‘psychic income’. Most economists refer to the psychic enjoyment of life as utility satisfaction. Psychic income is the true benefit of all socio-economic activity and has four main sources. The first source of psychic income comes from the consumption and use (wearing out) of human-made capital. The second source of psychic income is derived from being directly engaged in production activities (e.g., the enjoyment and self-worth obtained from work). A third source of psychic income comes from non-economic pursuits such as time spent with family and friends, volunteer work and leisure activities. The final source of psychic income flows from the natural environment in terms of its aesthetic and recreational qualities. It is true that this final source of psychic income does not come directly from socio-economic activity. If anything, such activity tends to destroy rather than enhance such values. It is therefore better that these values be taken as a given and their subsequent destruction be counted as an opportunity cost of the socioeconomic process. This last point reminds us that not all socio-economic activity enhances the psychic enjoyment of life. Consumption of some portion of humanmade capital can reduce the psychic enjoyment of life if consumers make bad choices or if needs and wants have been inappropriately ranked. In addition, while benefits can be enjoyed by individuals engaged in production activities, for most people production activities are unpleasant. Unpleasant things that lower one’s psychic enjoyment of life (e.g., noise pollution and commuting to work) represent the ‘psychic outgo’ of economic activity. It is the subtraction of psychic outgo from psychic income that leads to a measure of net psychic income – the fourth elemental category. Net psychic income is, in effect, the ‘uncancelled benefit’ of socio-economic activity (Daly, 1979). Why is this so? Imagine tracing the socio-economic

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process from natural capital to its final psychic conclusion. Every intermediate transaction involves the cancelling out of a receipt and expenditure of the same magnitude (i.e., the seller receives what the buyer pays). Once a physical good is in the possession of the final consumer, there is no further exchange and no further cancelling out of transactions. Apart from the good itself, what remains at the end of the process is the uncancelled exchange value of the psychic income that the ultimate consumer expects to gain from the good plus any psychic disbenefits and other costs associated with the good’s production. Note, therefore, that if the costs are subtracted from the good’s final selling price, the difference constitutes the ‘use value’ added to low entropy matter-energy during the production process. Presumably the difference is positive otherwise the socio-economic process is a pointless exercise. The fifth and final elemental category is the cost of lost natural capital services and arises because, in obtaining the throughput to produce and maintain human-made capital, natural capital must be manipulated and exploited both as a source of low entropy and as a high entropy waste absorbing sink. Perrings has shown that no matter how benignly human beings conduct their exploitative activities, the resultant disarrangement of matter-energy and inevitable coevolutionary feedback responses has deleterious impacts on the natural environment (Perrings, 1987). Consequently, human beings must accept some loss of the free source, sink and lifesupport services provided by natural capital as some portion of the low entropy it provides is transformed into physical goods and returns, once they have been consumed, as high entropy waste. In a similar way to net psychic income, lost natural capital services constitute the ‘uncancelled cost’ of socio-economic activity (Lawn and Sanders, 1999). Why? Imagine tracing the socio-economic process from its psychic conclusion back to natural capital. Once again, all transactions cancel out. What remains on this occasion is the opportunity cost of resource use or, more definitively, the uncancelled exchange value of any natural capital services sacrificed in obtaining the throughput of matterenergy to fuel the socio-economic process.5 In sum, the linear throughput model illustrates the following. Natural capital provides the throughput of matter-energy that is needed to produce and maintain the stock of human-made capital. Human-made capital is needed to enjoy a level of net psychic income greater than what would otherwise be experienced if the socio-economic process did not take place. Finally, in manipulating and exploiting natural capital for the throughput of matter-energy, the three instrumental services that natural capital provides are, to some degree, unavoidably sacrificed.


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ASPECTS FUNDAMENTAL TO UNDERSTANDING WHAT IS REQUIRED TO ACHIEVE SUSTAINABLE DEVELOPMENT The above discussion now places us in a more advantageous position to reflect on the aspects central to both defining and achieving sustainable development. These aspects can be categorised as ecological/biophysical, psychological, economic and social/cultural. Ecological and Biophysical Factors As previously mentioned, the throughput of matter-energy is the physical intermediary connecting natural and human-made capital. It was also pointed out that natural capital constitutes the tap-root of the socioeconomic process because natural capital is the only source of low entropy resources; it is the ultimate waste assimilating sink; and it is a critical generator of the life-support services that maintain the human habitability of the planet. Given the obvious importance of natural capital in achieving ecological sustainability, one must ask the following questions: ● ●

How much natural capital is required to ensure the ecological sustainability objective is not recklessly put at risk? Should natural capital maintenance be a necessary sustainability tenet, what rules of thumb should human beings adhere to in order to prevent the wholesale decline in both the quantity and quality of natural capital stocks?

I will endeavour to answer the first question by beginning with a consideration of production possibilities. Ever since Hicks (1946) defined income as the maximum amount that can be produced and consumed in the present without compromising the ability to produce and consume the same amount in the future, it has been widely recognised that sustaining the production of a particular quantity of physical goods requires the maintenance of income-generating capital. Where debate has raged is in relation to what form the capital should take. While some observers believe natural and human-made capital should be individually maintained, others believe it is only necessary to maintain an appropriately combined stock of both forms of capital. In order to differentiate between the two schools of thought, the former is now commonly referred to as the ‘strong sustainability’ approach to capital maintenance. The latter is labelled as the ‘weak sustainability’ approach. Which of the two approaches stands as the most appropriate form of action depends critically upon whether human-made

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capital and the technology embodied within it is able to serve as an adequate substitute for the low entropy matter-energy that only natural capital can provide. Should it fail to do so, the requisite capital maintenance policy is that advocated by the strong sustainability proponents. It is undeniably true that advances in the technology embodied in human-made capital can, for some time at least, reduce the incoming resource flow required from natural capital to produce a given physical quantity of goods. However, for three related reasons, this does not amount to substitution (Lawn, 1999). First, technological progress only reduces the high entropy waste generated in the transformation of natural capital to human-made capital. It does not allow human-made capital to ‘take the place of’ natural capital. Second, because of the first and second laws of thermodynamics, there is a limit to how much production waste can be reduced by technological progress. This is because 100 per cent production efficiency is physically impossible; there can never be 100 per cent recycling of matter; and there is no way to recycle energy at all.6 Third, a value of one or more for the elasticity of substitution between human-made and natural capital is necessary to demonstrate the adequate long-run substitutability of the former for the latter. It has recently been shown that the value of the elasticity of substitution derived from a production function obeying the first and second laws of thermodynamics is always less than one (Lawn, 2003; and Chapter 3). Thus the production of a given quantity of humanmade capital requires a minimum incoming resource flow and, therefore, a minimum amount of resource-providing natural capital (Meadows et al., 1972; Pearce et al., 1989; Costanza et al., 1991; Folke et al., 1994; Daly, 1996; Lawn, 2003). It is for this reason that some observers believe the strong sustainability approach to capital maintenance is necessary to achieve sustainability of the socio-economic process. But before one can give a satisfactory answer to the first of the above questions, it is still necessary to consider what constitutes the minimum amount of natural capital that needs to be kept intact to ensure ecological sustainability. It is at this point that we must go beyond production possibilities and turn our attention to the life-support function of natural capital. The ability of natural capital or the ecosphere to support life exists because, as a far-from-thermodynamic-equilibrium system characterised by a range of biogeochemical clocks and essential feedback mechanisms, it has developed the self-organisational capacity to regulate the temperature and composition of the Earth’s surface and atmosphere.7 There has, unfortunately, been a growing tendency for human beings to take for granted the conditions for life – a consequence of technological optimism and the growing detachment most people have from the vagaries of the natural


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world. In particular, two falsely held beliefs have emerged. The first is a widely held belief that the Earth’s current uniqueness for life was preordained. This is not so since, as Blum (1962) explains, had the Earth been a little smaller, or a little hotter, or had any one of an infinite number of past events occurred only marginally differently, the evolution of living organisms on Earth might never have eventuated. Moreover, the coevolutionary process need not have included the participation of human beings. Second, it is widely believed that organic evolution is confined to living organisms responding to exogenously determined environmental factors. However, it is now transparently clear that ‘fitness’ is a byproduct of the coevolutionary relationship that exists between the ecosphere and its constituent species. Indeed, the ecosphere is as uniquely suited to existing species as are the latter to the ambient characteristics of the ecosphere. Hence, according to Blum (1962, p. 61), it is ‘impossible to treat the environment as a separable aspect of the problem of organic evolution; it becomes an integral part thereof’. Unequivocally, just as current environmental conditions were not preordained, nor are the environmental conditions of the future. They will always be influenced by the evolution of constituent species and, in particular, the actions of recalcitrant species. An awareness of the above brings to bear a critical point. While human intervention can never ensure the Earth remains eternally fit for human habitability, humankind does have the capacity to bring about a premature change in its prevailing comfortable state. Many people believe that global warming, ozone depletion, and acid rain are already the first signs of a radical change in the planet’s comfortable conditions. Nonetheless, there are some observers who argue that these events, if they are occurring at all, are of no great concern since they are little more than symptoms of a benign coevolutionary adjustment brought on by the eccentricities of humankind. That is, any malady caused by human activity is short-lived because whatever may threaten the human habitability of the planet induces the evolution of a new and more comfortable environmental state. For such observers, humankind is potentially immune from the consequences of its own actions. Nothing, however, could be further from the truth. The quasi-immortality of the ecosphere prevails only because of the informal association that exists between the global system and its constituent species. But quasi-immortality in no way extends to any particular species. Indeed, historical evidence indicates a tendency for the global system to correct ecological imbalances in ways that are invariably unpleasant for incumbent species. Hence, while the Earth has revealed itself to be immune to the emergence of wayward species (e.g., oxygen bearers in the past), individual species – including human beings – are in no way immune from the consequences of their own collective

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folly. We can therefore conclude that the minimum amount of natural capital required to ensure ecological sustainability may greatly exceed the quantity necessary for production purposes alone. Of course, this still leaves the first of the above questions unanswered. Deeper insight into the minimum required natural capital can be gained by considering what bestows natural capital with the unique capacity to support life. Is it the quantity of natural capital or is it some particular aspect of it? Lovelock leaves us in no doubt by emphasising that a minimum number and complexity of species are required to establish, develop, and maintain the Earth’s biogeochemical clocks and essential feedback mechanisms. To wit: The presence of a sufficient array of living organisms on a planet is needed for the regulation of the environment. Where there is incomplete occupation, the ineluctable forces of physical or chemical evolution soon render it uninhabitable. (Lovelock, 1988, p. 63)

It is, therefore, a combination of the convoluted interactions and interdependencies between the various species, the diversity of species, and the complexity of ecological systems – in all, the biodiversity present in natural capital – that underpins its life-supporting function. That is not to say that the quantity of natural capital is unimportant. It is important if only because the biodiversity needed to maintain the Earth’s habitable status requires a full, not partial, occupation by living organisms. But the quantity of natural capital, itself, should never be equated with biodiversity. If the sheer magnitude of natural capital is an inadequate indication of the effectiveness with which it can foreseeably support life, what is the minimum level of biodiversity needed to maintain the ecosphere’s lifesupport function? Unfortunately, this is not known, although there is general agreement that some semblance of a biodiversity threshold does exist. What we do know about biodiversity is that in the same way biodiversity begets greater biodiversity, so diminutions beget further diminutions.8 It is also known that the present rate of species extinction is far exceeding the rate of speciation – indeed, so much so that biodiversity has, on any relevant time scale, become a non-renewable resource (Daily and Ehrlich, 1992). Given that a rise in the global rate of extinction will unquestionably increase the vulnerability of human beings to its own extinction, a sensible risk-averse strategy for humankind to adopt is a rigid adherence to a biodiversity ‘line in the sand’. Ehrlich (1993, p. IX) provides a hint as to where this line should be drawn by pointing out that humankind knows enough about the value of biodiversity to operate on the principle that ‘all


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reductions in biodiversity should be avoided because of the potential threats to ecosystem functioning and its life-support role’. As a corollary of Ehrlich’s dictum, humankind should draw a line at the currently existing level of biodiversity. Conscious efforts should also be made to preserve remnant vegetation and important ecosystems.9 In all, a systematic decline in both a nation’s natural capital stocks and the biodiversity contained within should be viewed as a failure on the part of government policy to achieve ecological sustainability. We are now in a position to answer the second of our above questions – that is, what sustainability precepts must we follow to prevent the decline in both the quantity and quality of natural capital stocks? While there are many possible precepts, the four fundamental rules of thumb requiring adherence are: 1. 2.

3. 4.

The rate of renewable resource extraction should not exceed the regeneration rate of renewable resource stocks; The depletion of non-renewable resources should be offset by using some of the depletion proceeds to cultivate renewable resource substitutes; The rate of high entropy waste generation should not exceed the ecosphere’s waste assimilative capacity; Native vegetation and critical ecosystems must be preserved, rehabilitated, and/or restored. In addition, future exploitation of natural capital should be confined to areas already strongly modified by previous human activities.

As we shall see soon, these sustainability precepts can be used to ascertain our broad definition of sustainable development. Moreover, and provided the rate of resource use, the regeneration rates of renewable resource stocks, and the ecosphere’s waste assimilative capacity can be reliably measured, the above precepts can also serve as a useful means for establishing sustainability indicators. This will be more obvious in Part II of the book when attention is given to indicators of a nation’s sustainable development performance. Psychological Factors It has already been explained that human well-being depends critically on the psychic enjoyment of life. Despite having a good sense of what contributes directly towards net psychic income – the fourth elemental category of the linear throughput model – it is important to consider the extent to which each of the contributing factors is likely to advance the human

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Higher-order needs Self-actualisation needs

Esteem needs

Need for belongingness and love

Safety needs

Physiological needs Lower-order needs Figure 2.3

Maslow’s (1954) needs hierarchy

condition. Although this will differ from culture to culture, and between each individual in any particular society, a greater understanding can be arrived at by contemplating Maslow’s (1954) hierarchy of human needs as depicted in Figure 2.3. Beginning with the lowest form of human needs, the hierarchy is classified below in accordance with Maslow’s ranking of lower- to higherorder needs.10 ● ●

Physiological needs – this category of need includes one’s basic requirement for food, clothing and shelter. Safety needs – this includes the need for physical and mental security; freedom from fear, anxiety and chaos; and the need for stability, dependency and protection. It also includes the need for a comprehensive and overarching philosophy that organises one’s view of the universe into a satisfactory, coherent and meaningful whole. Satisfying safety needs necessitates such things as: (a) a minimum level of income and an appropriate welfare safety net – overall, a strict adherence to the principle of intragenerational equity and


●

●

●

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justice; (b) the establishment of institutions based around the need for social coherence and stability; and (c) ecological sustainability and the continuation of the evolutionary process to ensure physiological needs are safely sustained in the future. The need for belongingness and love – this includes the need for affectionate relationships with people in general; the hunger for contact and intimacy; the desire for a sense of place in one’s group, family and society; and the urgent need to overcome or avoid the pangs of loneliness, of ostracism, of rejection and of rootlessness. A true and fully encompassing sense of belongingness and love also necessitates a strong sense of identity with posterity. Hence satisfying the need for belongingness and love demands a corresponding adherence to the principle of intergenerational equity and justice. The need for esteem – this includes the need for a stable and high evaluation of oneself, for self-respect and the esteem of others. It essentially involves: (a) the desire for strength, achievement, adequacy, mastery and competence; (b) the need for independence and freedom; (c) the desire for recognition, attention, importance, dignity and appreciation; and (d) a sense of personal contribution to society at large. Self-actualisation needs – the need for self actualisation relates to an individual’s ultimate desire for self-fulfilment, that is, one’s desire to become fully actualised in what he or she is capable of becoming. At the pinnacle of the hierarchy of human needs, Maslow (1954) regards self-actualisation needs as the most ‘creative and rewarding phase of the human development process’.

By organising human needs into a hierarchy of relative prepotency, Maslow’s needs hierarchy not only reflects the multidimensionality of the human existence, it paints a picture of the human personality as an integrated whole in which every part, level and dimension is interdependent. Most importantly, however, the needs hierarchy indicates that once basic physiological needs have been satisfied, desires originating from a higher level of existence begin to emerge. As they do, an individual’s desires are no longer dominated by the need for food, clothing and shelter, but by the need to satisfy emerging psychological needs. It is at this point that a healthy human existence requires the emerging higher-order needs to be satisfied along with basic physiological needs – what Weisskopf (1973) refers to as a healthy existential balance. It is important to recognise that should the lower-order needs of the majority of a nation’s citizens be satisfied, the socio-economic process need not operate in a manner consistent with the adequate satisfaction of

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emerging higher-order needs. In other words, it is possible for the socioeconomic process to continue its emphasis on physiological need satisfaction at the expense of psychological need satisfaction. Why might this be so when it perceptibly results in many people experiencing an unhealthy existential imbalance? A couple of points need to be made here. First, unlike psychological need satisfaction, physiological need satisfaction (such as being well fed) has no enduring qualities. Hence satisfying lower-order needs requires one to frequently engage in what is required to satisfy them (such as eating often). Second, if higher-order or psychological needs are being inadequately satisfied, an equilibrium – albeit an unhealthy one – can be obtained by engaging in more physiological need-satisfying activities (such as increased production and consumption). Because physiological need satisfaction quickly evaporates, the desire for more production and consumption significantly reduces one’s ability and the time available to fully satisfy higher-order needs. In doing so, it further increases the desire for higher rates of production and consumption that usually manifests itself in the form of a physical expansion of the macroeconomic subsystem. Consequently, an illusionary need for continued growth has the potential to become self-perpetuating. In a coevolutionary world characterised by path-dependency, a growth addiction can arise even though it may be contrary to the betterment of the human condition. This growth addiction is commonly referred to as ‘consumerism’ or the ‘treadmill of production’ (Schnaiberg, 1980). What does this all mean in terms of the human developmental process? To begin with, it is self-evident that need satisfaction aimed continuously at increasing the supply of means along one level that neglects needs on a different level is likely to disturb the balance of human existence (Kenny, 1999).11 Since human development or the improvement in the total quality of life demands a balanced system of need satisfaction, the accumulation of human-made capital should only continue if, having largely satisfied lower-order needs, it does not come at the expense of satisfying higherorder needs. Finally, it would seem that human development demands, at the very least, a deep respect for the continuation of the evolutionary process plus as a widespread concern for posterity and intragenerational inequities and injustices. Clearly, this entails having to invoke and uphold various universal rights and privileges, one of which should be the eradication of absolute poverty. Not only does poverty alleviation ensure the satisfaction of basic physiological needs, it constitutes a prerequisite for the attainment of the higher-order needs necessary for a balanced and healthy human existence.


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Economic Factors Many of the economic factors central to both defining and achieving sustainable development also emanate from Maslow’s needs hierarchy. Basic physiological needs at the lower end of the needs hierarchy are, as previously explained, satisfied by way of the consumption and use of humanmade capital. Therefore, just as natural capital maintenance is required to ensure ecological sustainability, so must human-made capital remain intact once its accumulation reaches a ‘sufficient’ quantity. The stock of humanmade capital must also be equitably distributed and, in order to both maximise the benefits it yields and reduce the throughput required to keep it intact, must be efficiently produced. Unemployment is an economic factor that has long been a weakness of contemporary socio-economic processes. While unemployed people in countries with a social security safety net are rarely deprived of their ability to satisfy basic lower-order needs, they are often deprived of the capacity to satisfy their safety and esteem needs. In almost all instances, they are starved of their potential to satisfy self-actualisation needs. Indeed, for many long-term unemployed people, self-actualisation needs are grotesquely suppressed. This often leads to disillusionment, depression and an increased likelihood of committing a serious crime.12 Unemployment also results in a major loss of valuable skills and the subsequent depreciation of a nation’s productive capacity (Mitchell, 2001a). Indisputably, the impact of unemployment and underemployment should be counted as a welfarereducing cost. In addition, full employment must be viewed as an obligatory macroeconomic objective for any nation wanting to achieve a comprehensive form of sustainable development. There is, however, the potential for the full employment and ecological sustainability objectives to conflict (see Chapter 14). Under the institutional arrangements currently existing in most countries, there is a wellestablished link between Gross Domestic Product (GDP) and employment. This link compels such countries to continually expand the macroeconomic subsystem to prevent unemployment from rising. Compounding the fact that growth can eventually be existentially undesirable, it is unquestionably unsustainable. It is therefore critical to discover ways and means to sever the GDP–employment link so that full employment can be achieved without the perceived need for continued growth. It is unfortunate that many beneficial economic factors are ignored because they fail to be assigned a market price. Unpaid household work and other forms of voluntary work yield enormous benefits in terms of both the economic goods and services they provide and the psychological need satisfaction obtained by those who engage in such work. Clearly, any

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worthwhile indicator of sustainable development must, where possible, include the value of unpaid as well as paid forms of employment. Finally, debt is an economic factor all too often overlooked when both the concept of sustainable development is discussed and when indicators of sustainable development are constructed. Of particular significance is overseas debt. In most instances, the increase in a nation’s foreign debt reduces its long-term capacity to sustain current levels of economic welfare. While it is true that a net borrower can use the inflowing funds to both augment its stock of human-made capital and improve the technology embodied within it, productive capacity is ultimately limited by the stock of natural capital. Unfortunately, many countries with burgeoning foreign debts are forced to liquidate their natural capital assets in order to service their debt repayments. This has the disastrous effect of eroding their sustainable productive capacity. Worse still, heavily indebted Third World countries are increasingly required to accept loans from the International Monetary Fund (IMF) that, as a consequence of their attached conditions, compel respective governments to rein in spending on the provision of vital public services (Pitt, 1976; George, 1988; Daly and Cobb, 1989). Social/Cultural Factors Critical social and cultural factors are to be found and expressed in a society’s institutions. By institutions I mean norms, customs, habits, support networks, and various non-price rules embodied in a range of formal and informal structures and arrangements. There has been a tendency in recent times to downplay the importance of institutions, particularly with regard to the relationship between institutions and the market place. Many free-marketeers, for example, view institutions as constraints or impediments to the free and effective operation of markets. Some observers have gone so far as to say that a nation’s well-being can be deleteriously affected by a condition referred to as ‘institutional sclerosis’ (Olson, 1982). While one should never doubt the likely existence of ill-conceived institutions or institutional arrangements that become obsolete over time, the economic value of the majority of institutions lie in their capacity to serve as a cognitive framework for both interpreting reality and understanding the sense data upon which choices and exchanges are made (Hodgson, 1988). Furthermore, institutions act as an informational guideline without which a complex economic environment would be largely devoid of meaningful and purposeful action (McLeod and Chaffee, 1972). Hence it is only through a culturally-defined institutional framework – society’s moral capital – that market-based arrangements between buyers and sellers can


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be of a qualitative nature sufficient to facilitate mutually advantageous exchange (Boulding, 1970; O’Connor, 1989). From a non-economic perspective, social and moral capital constitute much of the foundation upon which many higher-order needs, such as a sense of belongingness, contribution and social inclusion, are ultimately satisfied. The importance of moral capital helps explain why market economies, once they became widely established, were so successful in advancing the human condition. Either by good luck or good design, the moral capital presupposed by a market economy was largely in place at the time when markets first emerged as prominent institutional mechanisms – a legacy of a pre-capitalist past when morality played a critical role in the establishment of built-in restraints on individual self-motivated behaviour. This ensured that market outcomes were beneficially influenced by shared morals, religion, custom and education (Daly, 1987). However, there is increasing evidence to suggest that the individualistic ethos that has since become an integral part of modern capitalism is slowly undermining the market’s moral capital foundations (Hirsch, 1976). It is for this reason that some observers believe that markets do not accumulate moral capital, they have a tendency to deplete it. As a consequence, the continued success of any market economy, in particular, its ability to achieve sustainable development, could well depend on society’s capacity to regenerate moral capital, just as it relies on the ecosphere to regenerate natural capital (Daly and Cobb, 1989; Lawn, 2000). The importance of moral capital has one other important implication for the sustainable development process. It has already been argued that human development involves having to invoke and uphold various universal rights and privileges. Exactly what these rights and privileges entail is, again, a cultural-specific issue. Nonetheless, very few would argue against the principle that while the needs of posterity should take priority over the extravagant desires of the present, they should always remain subordinate to the latter’s basic needs. There is a good reason for this. People currently alive can experience the pain of severe deprivation. People yet to exist cannot. Whether we like it or not, sentience unambiguously serves as a means for determining what rights accrue to whom and when. But, of course, human beings are not the only sentient creatures on the planet. To overlook the moral concerns and rights of sentient non-human creatures simply because they are incapable of expressing preferences in the same way as human beings is entirely unjustifiable (Pearce, 1987). Indeed, as Johnson (1991) stresses, the genuine interests of sentient non-human beings must carry at least some moral weight otherwise human interests carry no moral weight at all. The consequent need to recognise the ‘intrinsic value’ of sentient non-human beings visibly warrants the limited rights of subhuman

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species to be included in the general domain of human rights. Although the rights of sentient non-human beings would in no way equal the rights of humans, one would expect an extended principle of justice to include the dignified and, where plausible, cruelty-free treatment of sentient nonhuman beings. This leads to an important question: Is it possible that a moral obligation to include the rights of subhuman species in the general domain of human rights – a so-called biocentric view of the world – could limit humankind’s capacity to exploit natural capital for its own instrumental purposes? The answer is a probable yes, since the application of an extended principle of justice would, in some way, restrict the ability of humankind to augment the regenerative and waste assimilative capacities of the natural capital stock. For example, the prohibition of inhumane means of incarceration, transportation and exploitation of livestock would greatly limit the capacity to augment the maximum sustainable yields of meat, dairy and poultry products. And while certain logging practices do not threaten sustainable timber yields, they can result in unacceptable losses of wildlife and old growth forests (e.g., the replacement of slow growing native forests with rapidly growing exotic timber plantations). Any subsequent banning of such logging practices would significantly reduce sustainable timber yields. In both instances, the regulation of human exploitative activities on biocentric grounds could dramatically restrict the sustainable rate of resource extraction from the supporting ecosphere. One of the difficulties associated with a biocentric view of the sustainable development process is that is difficult to devise a general rule of thumb to uphold the limited rights of sentient non-human beings. Pearce (1987) suggests that natural capital intactness and biodiversity preservation and restoration – essentially an adherence to the four previously listed sustainability precepts – are sufficient to continue the evolutionary process and protect the habitats of sentient non-human creatures. Hence, according to Pearce, there is no need to make allowances above what is already required to maintain the source, sink and life-support functions of natural capital. Unfortunately, this advice does not prevent the unwarranted removal of sentient non-humans from their habitats nor any ill-treatment that may arise out of their subsequent exploitation. A strict adoption of a biocentric stance obviously demands more than mere natural capital intactness. However, from a measurement perspective – which is important when pondering the value of sustainable development indicators – Pearce’s recommendation probably suffices. Without doubt, it is more amenable to measurement. Furthermore, in view of the atrocious record that most countries have in terms of natural capital maintenance, designing policy on evidence revealed by indicators that account for changes in the quantity


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and quality of natural capital constitutes an enormous step towards protecting the rights of sentient non-human creatures. If social and moral capital is fundamentally important to achieving sustainable development, how do we go about measuring it? There have been a number of attempts at measuring social capital but all are in the embryonic stage of development (Spellerberg, 1997; World Bank, 1998; Kreuter et al., 1999; Lochner et al., 1999; Stone, 2001). It is probably more constructive at this stage to measure the impact of its deterioration, particularly given that it can be more readily observed in the form of such undesirables as high unemployment, reduced volunteer labour, and increasing rates of crime and family breakdown. Notably, the cost of many of these undesirables have already been estimated and employed in the calculation of alternative measures of economic welfare, such as the Index of Sustainable Economic Welfare and Genuine Progress Indicator (see Chapters 6 and 7). Unfortunately, these costs are excluded from measurements of GDP or, if incorporated, are perversely counted as benefits. Defining Sustainable Development in Broad Terms Taking account of the aforementioned, I propose the following as a very broad definition of sustainable development: A nation is achieving sustainable development if it undergoes a pattern of development that improves the total quality of life of every citizen, both now and into the future, while ensuring its rate of resource use does not exceed the regenerative and waste assimilative capacities of the natural environment. It is also a nation that ensures the survival of the biosphere and all its evolving processes while recognising, to some extent, the intrinsic value of sentient non-human beings. As indicated at the beginning of the chapter, such a broad definition of sustainable development may not, by itself, be conducive to the establishment of sustainable development indicators. But it is a useful definition for a number of reasons. First, by equating human development with an improvement in the total quality of life, it reminds us of how important it is to satisfy the full spectrum of human needs. Second, by referring to every citizen, both now and into the future, it obliges the current generation to adhere to the principles of intra- and intergenerational equity. Third, it captures the two main aspects relating to the sustainability imperative – namely, the fundamental need to operate within the limits imposed by the ecosphere’s source and sink functions, and the importance of preserving biodiversity and critical ecosystems. Fourth, it reminds us that rights accrue to creatures other than ourselves that, if upheld, limit humankind’s share of the planet. Finally, it serves as an important basis for defining sustainable

30


development in narrower terms insofar as any subsequent focus on a particular sustainable development aspect (e.g., ecological sustainability) must conform to the relevant sustainable development principle (natural capital maintenance) while eschewing violation of all remaining principles (e.g., avoid leaving a section of society grossly disadvantaged).

SUSTAINABLE DEVELOPMENT, ECONOMIC GROWTH AND SUSTAINABLE ECONOMIC WELFARE Economic and Uneconomic Growth In view of the above definition of sustainable development and the linear throughput model from which it has emerged, one is naturally drawn to the following questions: how big can the macroeconomic subsystem grow before the throughput of matter-energy required to maintain it can no longer be ecologically sustained? Moreover, how big should the macroeconomic subsystem grow before the economic welfare it generates begins to decline such that growth, itself, becomes uneconomic? I believe the latter question is as important as the first if only because an economic limit to growth is likely to be arrived at sooner than an ecological limit and, in the case of many industrialised countries, has probably been reached (MaxNeef, 1995). To answer the above questions, the two elemental categories of net psychic income (uncancelled benefits) and lost natural capital services (uncancelled costs) can be diagrammatically presented to demonstrate the impact of a growing macroeconomy. Consider Figure 2.4 where, for the moment, it is assumed that there is no technological progress. The uncancelled benefit (UB) curve in Panel 2.4a represents the net psychic income generated as a national economy expands. The characteristic shape of the UB curve is attributable to the law of diminishing marginal benefits which, barring technological improvements, is equally applicable to the total stock of wealth as it is to individual items. The cost of a growing macroeconomy is represented in Panel 2.4a by way of an uncancelled cost (UC) curve. It represents the natural capital services lost in the process of transforming natural capital and the low entropy it provides into human-made capital. The shape of the UC curve is attributable to the law of increasing marginal costs. Why does this law apply to a macroeconomic system? First, it is customary to extract the more readily available and higher quality resources first and be left with the more complicated task of having to extract lower quality

31

What is sustainable development? Panel 2.4a

UC

Uncancelled Benefits (UB) Uncancelled Costs (UC) and Sustainable Economic Welfare (SEW)

UB SEW*

0

S*

SS

Physical scale of macroeconomy

SS


Panel 2.4b Sustainable Economic Welfare (SEW)

SEW

SEW*

0

S*

Figure 2.4 The sustainable economic welfare generated by a growing macroeconomy resources later. Second, the cost of the undesirable ecological feedbacks associated with each incremental disruption of natural capital increases as the macroeconomy expands relative to a finite natural environment. Note that the UC curve is vertical at a physical economic scale of SS. This is because SS denotes the maximum sustainable scale – what is, for given levels of human know-how, the largest macroeconomic scale that a nation can physically sustain while still adhering to the four sustainability precepts. Since economic welfare is the difference between the benefits and costs of the socio-economic process, the vertical distance between the UB and UC curves represents the sustainable economic welfare applicable to various macroeconomic scales. Sustainable economic welfare is also illustrated by way of the SEW curve in Panel 2.4b. In this particular case, a nation’s sustainable economic welfare is maximised by operating at the macroeconomic scale of S* (i.e., where sustainable economic welfare equals SEW*). For this reason, S* constitutes the optimal macroeconomic scale although, in a coevolutionary world characterised by disequilibria, such a point would not precisely exist nor be precisely attained. Nonetheless, it is a moving macroeconomic target considerably more worthy of aiming for than a directionless higher level of real GDP, as will be revealed later in the book.

32


Importantly, when technological progress is assumed to be fixed – that is, when the UB and UC curves are stationary – growth is only desirable or ‘economic’ in the early stages of a nation’s developmental process. Continued physical expansion of the economic subsystem beyond the optimal or sufficient scale is antithetic to the sustainable development goal because it eventually leads to a decline in sustainable economic welfare. In other words, growth beyond the optimal scale is ‘uneconomic’. This suggests that a nation’s macroeconomy should, at some point, be maintained at a particular physical scale. It is also on this basis that some observers believe that sustainable development can only continue if a nation makes the eventual transition to a steady-state economy (Daly, 1973, 1991a, 1996). Technological Progress and Sustainable Economic Welfare One cannot ignore the role played by technology and its impact on sustainable economic welfare. Advances in efficiency-increasing technological progress are able to beneficially shift the UB curve upwards and the UC curve downwards and to the right. For example, superior product design, a more equitable distribution of income and wealth (Robinson, 1962), a greater focus on non-consumption activities, and the improved organisation of human beings in production-related activities (thereby reducing the cost of commuting, crime and unemployment) can enhance the net psychic income associated with a particular macroeconomic scale. By shifting the UB curve upwards and increasing the vertical distance between it and the UC curve, efficiency-increasing technological progress can augment the sustainable economic welfare enjoyed by a nation’s citizens. Better still, it can achieve this without the need for macroeconomic expansion. Unquestionably, a nongrowing economy need not, as some believe, preclude human development. The UC curve can be shifted downwards and to the right by way of increased rates of recycling, greater product durability, reduced production waste, boosting the productivity of natural capital, and decreasing the ecological impact of natural capital exploitation. Again, beneficial shifts of the UC curve can increase a nation’s sustainable economic welfare. Moreover, and unlike shifts in the UB curve, technological advances that shift the UC curve increase a nation’s maximum sustainable scale. That is, they allow a larger macroeconomy to be sustained by a rate of throughput consistent with the ecosphere’s regenerative and waste assimilative capacities. Thus small growth spurts are ecologically permissible provided the macroeconomy is no larger than its maximum sustainable scale. Unfortunately, few countries appear to be in such an advantageous position. Evidence provided by Wackernagel et al. (1999) suggests that the ecological footprint of most nations has exceeded their biocapacity. The majority of the world’s


33

macroeconomies already appear to have surpassed the equivalent of Ss in Figure 2.4. Interestingly, not all technological progress will beneficially shift the UB and/or UC curves. Some forms of technological progress simply allow more natural capital to be exploited which, in turn, permits the matterenergy passing through the macroeconomic subsystem to be increased. Technological progress of this kind can be called throughput-increasing technological progress. Examples include the development of a novel resource exploration method that leads to the discovery of a new oil deposit, a new resource extraction technique that allows a previously inaccessible mineral deposit to be exploited, and the development of a new use for a previously unwanted resource. The application of throughput-increasing technological progress brings to bear, at least in the short run, a larger physical scale of a nation’s macroeconomy. Unlike efficiency-increasing technological progress (technological progress that shifts the UB and/or UC curves), the throughput-increasing variety is not always desirable. This is because the application of throughput-increasing technology brings about a movement along the UB and UC curves which, as Figure 2.4 shows, is only desirable in the early phase of a nation’s developmental process. Eventually, its continued application leads to a decline in sustainable economic welfare and a macroeconomic scale in excess of the optimum. Limits to the Beneficial Shift of the UB and UC Curves Many would point to efficiency-increasing technological progress as a gateway to perpetual growth and an associated rise in sustainable economic welfare. Nothing, however, could be further from the truth. The scope for technological advances that beneficially shift the UC curve is considerably limited. For example, the first and second laws of thermodynamics not only forbid 100 per cent production efficiency, but also the 100 per cent recycling rate of waste materials and the recycling of energy altogether. The Entropy Law also ensures that nothing is eternally durable. Second, it is impossible to indefinitely increase the productivity of natural capital. Regardless of how well natural capital is managed, the productivity of a one hectare area of land could never, for example, be increased to meet the eating and waste assimilating requirements of a million people. Third, at least some of the ecosphere’s instrumental functions are always lost as a consequence of its exploitation (Perrings, 1986). In view of these limitations which, according to some ecological economists, are fast approaching (e.g., Ayres and Ayres, 1999), it is clear that an upper limit exists on the maximum sustainable scale of

34


macroeconomic systems. In other words, there is an inevitable biophysical limit to growth. What about limits to beneficial shifts of the UB curve? This is a more complex issue because service, as a psychic rather than physical magnitude, can theoretically grow forever. Having said this, there are two things worthy of consideration. First, there is a probable limit on humankind’s capacity to experience service – a person can, after all, only be so happy.13 Second, service does not exist independently of physical goods. For example, accounting services cannot be provided by an imaginary accountant working in an imaginary office typing away at an imaginary desk on an imaginary computer. It is therefore wrong to believe that services can be augmented by shifting the socio-economic process away from traditional manufacturing industries to the tourism, financial and information technology industries. Quite simply, manufacturing industries are required to maintain the human-made capital from which services can be enjoyed. In all, the belief that natural resource reliance can be reduced by making the transition towards so-called ‘service industries’ is a fallacy (see Chapter 3 and Lawn, 2001a). For argument’s sake, let’s assume that the UB curve can be shifted upwards indefinitely. In view of the fast approaching limits to beneficial shifts of the UC curve, a nation’s progress will depend entirely upon whether it is able to shift its policy focus towards qualitative improvement (development) and away from quantitative expansion (growth). For this reason, the steady-state economy not only constitutes a long-run biophysical necessity, it eventually serves as a macroeconomic prerequisite for continuing national development. Issues surrounding the shifts of the UB and UC curves and their implications for sustainable economic welfare are taken up in considerable detail in a later chapter on eco-efficiency indicators (Chapter 9).

CONCLUDING REMARKS It has been argued in this chapter that a movement towards sustainable development can only proceed once a broad and workable definition of sustainable development has been established. In my view, such a definition is best derived within the context of a concrete representation of the socioeconomic process. Of course, there are many ways that the socio-economic process can be appropriately represented and I did not wish to claim that the linear throughput model used to define sustainable development in this chapter is the superior approach. However, the circular flow model of the macroeconomy is anything but appropriate because it fails to reflect the


35

now widely accepted coevolutionary worldview. The linear throughput model, on the other hand, is consistent with the coevolutionary paradigm while it also acknowledges the biophysical, psychological, economic and social/cultural factors central to achieving sustainable development. The broad definition of sustainable development arrived at in this chapter specifically focuses on: (a) human development as a process involving satisfaction of the full spectrum of human needs; (b) the importance of upholding the principles of intra- and intergenerational justice; and (c) the fundamental need for macroeconomic systems to operate within the limits imposed by the ecosphere’s source and sink functions. Both the broad definition of sustainable development and the linear throughput model from which it has emerged draws attention to the physical scale of the macroeconomy – in particular, at what point does further physical expansion of the macroeconomy violate the sustainable development goal (i.e., causes sustainable economic welfare to decline)? Subsequent investigation leads us to the conclusion that macroeconomic systems should never grow beyond their maximum sustainable scale and should ideally cease to expand once their optimal or sufficient physical scale has been reached. In other words, to achieve sustainable development, a nation must ultimately make the transition to a non-growing or steady-state economy. Although the steady-state economy was mentioned throughout this chapter, it was at no stage described in any great detail. Since, for the purposes of this book, the steady-state economy will serve as the macroeconomic foundation upon which sustainable development can be achieved, it is worth outlining its basic characteristics. First, a steady-state economy is comprised of a constant magnitude of physical goods (human-made capital) maintained by a resource flow consistent with the regenerative and waste assimilative capacities of the natural environment.14 Also constant in a steady-state economy is the population of human beings. For obvious reasons, the steady-state economy is designed to be ecologically sustainable. Second, despite the incorporation of novel institutions to be outlined in future chapters, the steady-state economy retains a number of institutional mechanisms common to the growth economy. One of these is the market mechanism, although the role of many steady-state institutions is to confine the market domain to its rightful allocative function. The marketlimiting as well as market-enabling role of steady-state institutions are taken up in varying degrees of elaboration in Chapters 10, 11 and 12. The third major feature of the steady-state economy is that it need not be static, dull or stultifying. Through improvements in product design and a variation in the market allocation of the incoming resource flow over time, a steady-state economy can be exceedingly dynamic. Moreover,

36


qualitative improvement or development can be achieved provided all consumed or worn out goods are replaced by new goods exhibiting higher benefit-yielding qualities. An increase in time devoted to leisure activities and a greater sense of purpose can also advance the development process in a steady-state economy and thus contribute to the transition towards something approximating an optimal macroeconomic scale. Exactly how might the transition to a steady-state economy best be initiated? Furthermore, to what extent is the steady-state economy compatible with a democratic-capitalist system that many believe to be the preferred socio-political framework within which to operate? These questions will not be discussed here. They will, however, be the focus of a number of chapters throughout the book and be revisited in considerable detail in Chapters 8 and 18.

NOTES 1.

2. 3. 4. 5.

6.

7. 8.

Dissipative structures are dynamic systems that draw in low entropy matter-energy from their parent system. In doing so, they exploit their capacity to change their physical form, to grow, and, potentially at least, to develop. Provided a dissipative structure is fulfilling its thermodynamic potential, it will tend toward a state of increasing order. But it can do so only at the expense of a much greater degree of increasing disorder of the parent system upon which it depends. In the natural world, information exists as genetic information coded in the DNA molecule. In the anthropocentric world, information exists as knowledge encoded in various institutions and organisations. A holon is a term made popular by Arthur Koestler. See Capra (1982, p. 303). The first and second laws of thermodynamics are explained in detail in Chapter 3. There are two things worthy of note here. First, uncancelled costs are often undervalued because many natural capital values escape market valuation. Second, uncancelled costs should reflect the highest of two classes of opportunity costs. The first is the cost of transforming an extracted unit of low entropy into physical goods in terms of alternative goods forgone. For example, if an extracted unit of low entropy resource X is used to produce good A, it cannot be used to produce goods B, C, or D, and so on. The second class of opportunity cost involves any reduced capacity of natural capital to provide a future flow of low entropy resources that is required to produce physical goods in the future. For example, if the extraction of a unit of low entropy resource X reduces the capacity of natural capital to provide a continuous flow of a unit of X over time, a unit of X will be unavailable to produce goods of any type in the future. Once weighed up, it is the larger of these two classes of opportunity costs that should be used to value the uncancelled costs of the socio-economic process. The technical efficiency of production (E) can be written as the ratio of energy-matter embodied in physical goods (Q) to the energy-matter embodied in the low entropy resources used to produce them (R) – that is, E = Q/R. While the value of E can be reduced by technological progress, E must be something less than a value of one. It is the self-organisational capacity of the Earth to maintain the conditions fit for life that has led Lovelock to develop his ‘Gaian hypothesis’ – an hypothesis based on the notion that the Earth, or Gaia, behaves like an immense quasi-organism. See Lovelock (1988). It has been estimated that for every one plant species lost, approximately fifteen animal species will follow. See Norton (1986, p. 117).

What is sustainable development? 9.

10.

11. 12. 13. 14.

37

Of course, the mere preservation or ‘locking up’ of large and small ecosystems will not, by itself, ensure biodiversity maintenance. Given the interdependent relationships between systems of all types, individual ecosystems are not entirely self-supporting (Lovelock, 1988). Their continued existence and the well-being of the biodiversity they contain is conditional upon the exchanges of both matter-energy with and between neighbouring and far-distant systems. This applies to systems of all kinds, whether they be relatively pristine, moderately disturbed or totally refined. Above all else, maintaining biodiversity requires the exploitation of natural capital to be conducted on the principle of respecting the holistic integrity of geographical land and water resource units. It should be pointed out that Max-Neef, while agreeing with Maslow’s notion that all human needs are interrelated, does not believe in the existence of a needs hierarchy. Except for basic subsistence needs, Max-Neef (1991) believes in the presence of a horizontal spectrum rather than vertical hierarchy of human needs. Kenny provides ample evidence to show that once a certain ‘standard of living’ is attained, the relationship between growth and happiness breaks down. Evidence provided by the Australian Bureau of Statistics shows an alarmingly high rate of mental disorders amongst unemployed people relative to the remaining population. See Australian Bureau of Statistics (1997). Even mainstream economists recognise this fact with the notion of a consumer’s ‘bliss point’. There will naturally be some minor fluctuations either side of the steady physical quantity of goods but the average quantity will effectively remained unchanged.

PART II

Sustainable development and natural capital ‘The economy is a wholly owned subsidiary of the natural environment’. Gaylord Nelson

3.

Is human-made capital an adequate long-run substitute for natural capital?

INTRODUCTION Consideration of the critical role played by natural capital is not a recent phenomenon. Concern about impending resource scarcity was expressed as far back as 1798 by Thomas Malthus (Malthus, 1798 [1926]). Since then, the economic importance of natural capital has been revisited many times. Perhaps the first large-scale empirical analysis was undertaken by Barnett and Morse (1963). Using the unit cost of extractive resource output as a principal measure of resource scarcity, Barnett and Morse concluded that natural resources generally became more plentiful in the USA over the period 1870 to 1957.1 Without trying to deny the significance of Barnett and Morse’s contribution, Smith (1978) later revealed the theoretical and empirical limitations of their approach. Similar criticism emerged elsewhere raising serious doubts about the use of resource prices and unit extraction costs as resource scarcity indexes (e.g., Daly, 1979 and 1996; Brown and Field, 1979; V.K. Smith, 1979; Slade, 1982; Hall and Hall, 1984; Norgaard, 1990; Bishop, 1993; Lawn, 2000). Following the ‘limits to growth’ concerns in the late 1960s and early 1970s, two alternative approaches were undertaken to reassess the importance of natural capital in sustaining real output – one by Meadows et al. (1972) and another by Nordhaus and Tobin (1972). In what is often referred to as the Club of Rome Report, Meadows et al. employed ‘doomsday models’ to investigate the ecological limits to growth and the potential for technological change to remove such limits. They concluded that, left unchecked, humankind would soon deplete the world’s stocks of critical natural resources. Consequently, Meadows et al. called for a halt to the growth of real output. The Club of Rome Report did not escape criticism. Many economists rejected the Report’s findings because it overlooked the supposed ability of resource prices to signal any impending resource scarcity that, in turn, would induce the substitution towards more abundant resources 41

42

Sustainable development and natural capital

as well as accelerate the development of resource-saving technological progress. With criticism of this kind in mind, Nordhaus and Tobin (1972) employed a constant elasticity of substitution (CES) production function to determine the elasticity of substitution of human-made capital for natural capital. By showing that the elasticity of substitution was approximately equal to two for the United States over the period 1909 to 1958, Nordhaus and Tobin concluded that declining resource stocks had not been a drag on America’s real output.2 Implicit support for Nordhaus and Tobin came from Solow (1974) during the delivery of his Robert T. Ely Lecture at the 1974 American Economics Association meeting. During this lecture, Solow referred to what he considered the ease with which humanmade capital could be substituted for natural capital. Solow also spelt out how resource rents could be invested to ensure a sustainable consumption stream. A similar ‘sustainability prescription’ was put forward by Stiglitz (1974) in a paper dealing with the optimal depletion rate of exhaustible resources. The Solow/Stiglitz sustainability prescription was later embraced by Hartwick in his development of an elegant mathematical rule for reinvesting natural resource rents (Hartwick, 1977 and 1978). A variation of Hartwick’s rule emerged in 1989 when El Serafy, in stressing the need to base income measurements on a Hicksian definition of income, arrived at an ingenious formula to calculate the income and user cost components of resource depletion profits (El Serafy, 1989). Criticism of the Nordhaus and Tobin study and the Solow/Stiglitz sustainability prescription surfaced in 1979 when Daly and Georgescu-Roegen both revealed the inability of CES production functions to assess the substitutability of human-made capital for natural capital. Daly and Georgescu-Roegen’s criticism was based on the fact that production is a physical transformation process yet CES production functions disobey the first and second laws of thermodynamics. The continued use of CES and translog production functions to determine the elasticity of substitution between natural capital and human-made capital (e.g., Berndt and Wood, 1975; Atkinson and Halvorsen, 1976; Griffin and Gregory, 1976; Fuss, 1977; Halvorsen and Ford, 1978; Fisher, 1981), plus further criticism of the deployment of neoclassical production functions (e.g., Cabeza Gutes, 1996), saw the natural/human-made capital substitutability debate resurface in 1997 when virtually an entire issue of Ecological Economics (volume 22, number 3, 1997) was devoted to the debate. The aim of this chapter is to show that Daly and Georgescu-Roegen are correct – natural capital and human-made capital are complementary forms of capital, not substitutes, and the ecological sustainability of economic activity requires natural capital maintenance. To achieve its aim, the

Is human-made capital a substitute for natural capital?

43

chapter is structured as follows. First, the relationship between physical production possibilities and the first and second laws of thermodynamics is explained. Second, the necessary properties of a production function describing feasible production possibilities are outlined. Third, it is shown why a CES production function – which is a representative of mainstream production functions – cannot be used to assess the substitutability of human-made capital for natural capital. Fourth, a Bergstrom production function (BPF) is put forward as an alternative to the CES production function. Fifth, the BPF is manipulated to reveal the range and direction of change in the elasticity of substitution between natural capital and humanmade capital. Finally, the implications of complementarity on resource policy and national income accounting are briefly discussed.

PHYSICAL PRODUCTION POSSIBILITIES AND THE FIRST AND SECOND LAWS OF THERMODYNAMICS Although the output of physical goods and the so-called inputs of natural resources, labour and human-made capital (producer goods) are typically measured in monetary units, the basic essence of a production function is to mathematically describe a range of physically feasible production possibilities. As a technical production recipe, a production function must adhere to the basic physical laws governing physical transformation processes in the same way a mathematical description of flight possibilities must adhere to the law of gravity. The two natural laws governing physical transformation processes are the first and second laws of thermodynamics, the relevance of which to economics was first outlined by Soddy (1922) and later by Boulding (1966), Ayres and Kneese (1969), Georgescu-Roegen (1971), Daly (1973), Perrings (1987), and Lawn (2000). The first law of thermodynamics is the law of conservation of energy and matter. It declares that energy and matter can never be created or destroyed. The first law thus imposes a condition of finitude. The second law is the so-called Entropy Law. It declares that whenever energy is used in physical transformation processes, the amount of usable or ‘available’ energy always declines. While the first law ensures the maintenance of a given quantity of energy and matter for the purpose of production and ecosystem functioning, the Entropy Law determines that which is usable. This is critical since, from a physical viewpoint, it is not the total quantity of matter-energy that is of primary concern, but the amount that exists in a readily available form. The best way to illustrate the relevance of these two laws is to provide a simple example. Consider a piece of coal. When it is burned, the

44


matter-energy embodied within the coal is transformed into heat and ash. While the first law ensures the total amount of matter-energy in the heat and ashes equals that previously embodied in the piece of coal, the second law ensures the usable quantity of matter-energy does not. In other words, the dispersed heat and ashes can no longer be used in a way similar to the original piece of coal. To make matters worse, any attempt to reconcentrate the dispersed matter-energy, which requires the input of additional energy, results in more usable energy being expended than that reconcentrated. Hence all physical transformation processes involve an irrevocable loss of available energy or what is sometimes referred to as a ‘net entropy deficit’. This enables one to understand the use of the term low entropy and to distinguish it from high entropy. Low entropy refers to a highly ordered physical structure embodying energy and matter in a readily available form, such as a piece of coal. Conversely, high entropy refers to a highly disordered physical structure embodying energy and matter that is, by itself, in an unusable form, such as heat and ash. By definition, any matter-energy used in the economic processes can be considered a low entropy resource whereas unusable by-products can be considered high entropy wastes. What do the first and second laws of thermodynamics mean in terms of physical production possibilities? First, the quantity of matter-energy embodied in final goods must be something less than the matter-energy embodied in the resources used in their production. That is, at least some of the low entropy matter-energy embodied in the resources used in the production process immediately becomes high entropy production waste.3 As such, 100 per cent production efficiency can never be achieved. Exactly what quantity of low entropy matter-energy is immediately wasted depends on the efficiency of the resource allocation process and, more importantly, the state of production technology at a given point in time. Presumably, as advances are made in production technology, a smaller percentage of the matter-energy embodied in resources becomes high entropy production waste, whilst a larger percentage finds itself embodied in final goods. This means that, until the thermodynamic limit is reached, more goods can potentially be produced from the same quantity of resource input. Second, 100 per cent recycling is impossible. This is an important point because some observers have confined their analysis of the substitution/ complementarity debate to the first law of thermodynamics in the false belief that advances in recycling technology can offset the impact of an ever-diminishing stock of low entropy resources. After all, why would the quantity of low entropy resources be of concern if matter-energy can be 100 per cent recycled at a velocity of circulation deemed necessary to sustain real output? Third, once the thermodynamic limit is reached, real output is entirely dependent on the available quantity of low entropy resources and, therefore,


45

on the existence of resource-providing natural capital. While it may be true that the thermodynamic limit is a long way off in terms of the transformation of most resource types into final goods, it is also true that, as the thermodynamic limit is approached, each additional technological advance becomes more difficult and increasingly costly to attain. Moreover, the gains in terms of reduced high entropy production waste become progressively smaller. It may not, as a consequence, be necessary to reach thermodynamic limits for the maintenance of a given output level to be highly dependent on the available stock of resource-providing natural capital. Finally, low entropy matter-energy is, in effect, the only true input of the economic process – that is, the ‘ultimate’ resource as described by Ayres and Miller (1980, p. 361). Despite their essential nature in production, labour and human-made capital are merely resource-transforming agents that, themselves, require low entropy resources to be produced and maintained. Furthermore, high entropy wastes are the true outputs of the economic process. This doesn’t mean that final goods are not outputs. Nevertheless, they constitute the output of the production phase of the economic process (along with any immediate high entropy waste produced) and inputs into the consumption phase. The output of the consumption phase returns to the natural environment as high entropy waste (ultimate outputs).

NECESSARY PROPERTIES OF A FEASIBLE PRODUCTION FUNCTION In order to employ a production function to examine substitution possibilities, a number of necessary properties must be incorporated into the function. Three properties stand out: one to ensure adherence to the first and second laws of thermodynamics; another to incorporate the role played by technological progress in reducing the quantity of high entropy production waste (and to thus increase the real output producible from a given incoming resource flow); and a final property to recognise low entropy resources as the true input of the production process. To consider how the first basic property can be incorporated into a production function, imagine that the technical efficiency of the production process (E) is measured by the ratio of real output (Q) to resource inputs (R).4 That is: E QR

(3.1)

where Q real output measured in terms of the matter-energy (available work) embodied in the output produced; and Rlow entropy resource

46


input measured in terms of the matter-energy (available work) embodied in the resources used to produce Q. Irrespective of the quantity of resource input and human-made capital used in the production process, a production function must be formulated to ensure E is less than a value of one (E 1). As for the second necessary property, a production function must be designed to capture the increase in E brought about by advances in production technology. Finally, to recognise low entropy resources as the true input of the production process, real output (Q) must be a multiple of R, as implied by (3.1). In view of the necessary properties of a production function, Figure 3.1 illustrates both a feasible isoquant (I1) and a non-feasible isoquant (I2) where K represents the stock of human-made capital (resource-transforming agents). For the benefit of readers unfamiliar with isoquants, an isoquant is a curve representing the different combinations of low entropy resource inputs and resource-transforming agents that generate the same quantity of output. The higher is the output associated with a particular isoquant, the further that isoquant is from the origin. Included in Figure 3.1 is a resource asymptote at Rmin to represent the minimum resource quantity required to produce a real output level of Q0. I1 is a feasible isoquant in the sense that all the resource/human-made capital K I2

I1

Q0 0

Rmin

Source: Lawn (2003) with permission from Inderscience Enterprises Ltd.

Figure 3.1

A physically feasible and non-feasible isoquant

R

47


combinations lying along it are to the right of the resource asymptote. It therefore satisfies the first and second laws of thermodynamics. I2 is a nonfeasible isoquant in that some of the resource/human-made capital combinations along its locus include resource input quantities less than the minimum requirement (i.e., those to the left of the resource asymptote at Rmin). Figure 3.2 includes three feasible isoquants to demonstrate what happens when technological advances are made. At any point in time, the minimum resource requirement depends on the state of production technology. As technological progress is made, the resource asymptote shifts leftward from Rmin1 to Rmin2 to Rmin. In this hypothetical example, Rmin represents the thermodynamic limit of E1. Once the thermodynamic limit has been reached, no further resource-saving progress is possible and, as such, the resource asymptote cannot be shifted any further left. Note that as the resource asymptote shifts leftward, so too does the isoquant representing the feasible resource/human-made capital combinations to produce Q0. That is, the isoquant shifts from I1 to I2 to I3. Once Rmin and I3 are reached, a real output level of Q0 can only be sustained if the stock of resource-providing natural capital is kept intact. Furthermore, increases in real output become entirely dependent on the expansion of natural capital and/or the augmentation of its regenerative and waste assimilative capacities.

K

E=1 I3

I2

I1

Q0 0

Rmin

Rmin2

Rmin1

R


Figure 3.2

Physically feasible isoquants and technological progress

48


AN EXAMINATION OF THE CES PRODUCTION FUNCTION How well does the CES production function meet the necessary properties outlined above and to what extent can it be used to examine substitution possibilities?5 Consider the following CES production function that is typically employed to investigate the elasticity of substitution between humanmade and natural capital: Q(K, R) [ · R (1 ) · K ] 1

(3.2)

where Q real output measured in terms of the matter-energy (available work) embodied in the output produced; K human-made capital and includes labour as well as producer goods such as plant, machinery and equipment; Rlow entropy resource input measured in terms of the matter-energy (available work) embodied in the resources used to produce Q; the efficiency parameter indicating the state of production technology; the output elasticity of low entropy resource input; (1) the output elasticity of human-made capital; and the substitution parameter. For the above CES production function, the elasticity of substitution between natural capital and human-made capital is: 1(1 )

(3.3)

Alternatively, (3.3) can be written as: ( 1)

(3.4)

Substituting (3.4) into (3.2) yields: Q(K, R) [ · R(1) (1 ) · K(1) ] (1)

(3.5)

Rearranging (3.5) one obtains: · R(1) (Q) (1) (1 ) · K(1)

(3.6)

Equation (3.6) allows us to consider the thermodynamic feasibility of the following polar elasticity cases: (a) where K is increased over time and the elasticity of substitution is less than one, implying inadequate long-run substitutability ( 1 and 1/ 0); and (b) where K is increased over


49

time and the elasticity of substitution is greater than one, implying adequate long-run substitutability ( 1 and 1/ 0). Consider the former case. As K is increased and tends to infinity, the K term in (3.6) tends to zero. What remains is the quantity of R that determines the position of the resource asymptote as depicted in Figure 3.2, which is: Rmin

Q (1)

(3.7)

Now consider the second case. As K tends to infinity, the K term in (3.6) also tends to infinity. For a given quantity of real output, R tends toward zero. What does this mean? It means that a value of 1 denoting the adequate long-run substitutability between natural capital and human-made capital is potentially derivable even as the quantity of low entropy resource input is declining towards zero. This constitutes a flagrant violation of the first and second laws of thermodynamics. More importantly, it is possible to generate a value of 1 despite the increase in human-made capital being incapable, in the long run, of sustaining real output as natural capital declines. Thus, as Dasgupta and Heal (1979) have warned, past and present evidence, including that provided by CES and other similar production functions, may be a totally misleading guide for judging long-run substitution possibilities. Of course, it could be argued that the use of a CES production function is perfectly valid if Q in equation (3.2) is a measure of the service or welfare derived from the consumption of final goods. In this case, an increase in the welfare-yielding qualities of final goods can reduce the output needed to sustain the same level of welfare over time. This, in turn, reduces the need for resource input and the economy’s reliance on resource-providing natural capital. A few things need to be said in reply. First, the emphasis in this chapter is on the physical quantity of output, not welfare, for the reason that advocates of traditional production functions have employed the CES production function to explain how physical output can rise as resource input declines. As legitimate as a shift in emphasis to welfare might be, one cannot employ a production function for a particular set of circumstances (output as the quantity of final goods produced) by justifying its use under different circumstances (output as the welfare generated by the production process). Second, while a change in Q to a measure of the service or welfare derived from the consumption of final goods permits Q R and E 1, the CES production function does not explicitly separate the physical and welfare-related aspects of the production process. This presents a number

50


of potential problems. To begin with, it is often argued that the resource intensity of the economic process can be greatly reduced by shifting the focus of economic activity away from the production of goods (e.g., manufacturing industries) and towards the provision of services (e.g., the information technology and tourism industries). This is a fallacy (Lawn, 2001a). Goods are the physical objects that yield the service. Service is the welfare that flows from goods as they are either consumed (e.g., food and petrol) or worn out through use (e.g., clothes and consumer durables). As much as goods and services are distinct magnitudes, they are in no way independent magnitudes. While some economic activities are less resource intensive than others, thereby providing a higher level of service per unit of matter-energy expended, Costanza (1980) and Ayres and Ayres (1999) have shown with the use of embodied energy studies that there is very little difference in resource use intensity across industries. As explained in the previous chapter, this disparity virtually disappears if one attributes to the so-called ‘service industries’ the resources required to produce the humanmade capital necessary for such industries to function.6 Hence there is no reason to believe that the resource intensity per unit of welfare can be reduced by shifting the emphasis of economic activity towards specific industries. In view of the physical foundation upon which all service or welfare is derived, a production function with output measured in terms of welfare must recognise the thermodynamic limits governing the physical aspect of the production process. If not, the production function permits the welfare per unit of resource input to rise indefinitely via unlimited increases in either the quantity or the service-yielding qualities of the final goods produced. Only the latter aspect may be permitted, not the former, and so the physical aspect of the economic process must still be constrained.7 The CES production function fails in this regard. Finally, the welfare ‘default’ position taken by the advocates of traditional production functions is undermined by a recognition of the critical waste assimilative and life-support services provided by natural capital. Even if it was possible to generate the same level of economic welfare from an ever-declining input of low entropy resources, the depletion of natural capital is likely to result in declining non-economic welfare. If the latter overtakes the former, total welfare declines. Estimates of the Index of Sustainable Economic Welfare and Genuine Progress Indicator to be discussed in Chapters 6 and 7 suggest that this is already occurring for a range of industrialised countries (see Daly and Cobb, 1989; Diefenbacher, 1994; Moffat and Wilson, 1994; Max-Neef, 1995; Redefining Progress, 1995; Rosenberg and Oegema, 1995; Jackson and Stymne, 1996; Jackson et al., 1997; Guenno and Tiezzi, 1998; Lawn and Sanders, 1999).


51

Returning to the question posed at the beginning of this section: How well does the CES production function meet the necessary properties of a feasible production function? While a CES production function may be of use to estimate the minimum resource requirement when 1, it is inadequate as a means of determining the potential substitutability of human-made capital for natural capital. The CES production function fails to meet the necessary properties of a production function for the simple reason that it ‘. . . involves parameters that have no physical interpretation and no foundations in commonly accepted thermodynamic principles’ (Marsden et al., 1974, p. 137).

THE BERGSTROM PRODUCTION FUNCTION To assess the potential substitutability of human-made capital for natural capital, it is necessary to employ a non-traditional production function. One such function is the Bergstrom production function (BPF) as outlined by Ayres and Miller (1980).8 In its most basic form, the BPF is represented by the following: Q(, K, R) [1 exp( · KR)]R

(3.8)

where Q, K and R are the same as they were for the CES production function, and the technology parameter. It can be easily shown that the BPF satisfies all three necessary properties of a production function. To recall, the first property of a production function is the need for the technical efficiency of the production process (E) to be less than a value of one. In the case of the BPF, the technical efficiency of the production process is given by: E [1 exp( · KR)]

(3.9)

where E ratio of the matter-energy embodied in real output (Q) to the matter-energy embodied in resource inputs (R). Regardless of the value of or the human-made capital/resource input ratio (KR) , E is always less than one. Hence the BPF satisfies the first necessary property of a production function. In addition, as K/R increases over time, the technical efficiency of the production process rises asymptotically to the thermodynamic limit of E 1. This ensures the BPF incorporates the second necessary property of a production function. The third necessary property of a production function – namely, the need to recognise low entropy resources as the true input of the production process – is satisfied by denoting real output as a multiple of R.

52


The BPF also includes two additional features. By confining human-made capital to the technical efficiency component of the function, the BPF correctly treats human-made capital as a resource-transforming agent of the production process, not as a direct input. Furthermore, by including in the technical efficiency component of the BPF a ratio of human-made capital to resource input ( K/R), the BPF treats human-made capital as a resourcedependent variable. As such, any increase in the quantity of human-made capital is only possible if there has been a prior increase in resource input. Unfortunately, traditional production functions treat human-made capital as an exogenous variable. This falsely implies that human-made capital can be augmented without any additional expenditure of low entropy resources and, if the regenerative capacity of renewable resources has not been exceeded, without the consequent depletion of natural capital. Figure 3.3 is an isoquant map generated by a BPF. Included in Figure 3.3 are four isoquants (I1 through to I4) representing the different resource/ human-made capital combinations required to produce four different output levels (Q1 through to Q4). For each isoquant and output level there is a unique resource asymptote representing the minimum low entropy resource requirement (Rmin1 through to Rmin4). Unlike the CES production function, an isoquant map generated by a BPF precludes all thermodynamically ·K/R

0

I1(Q1)

Rmin1

I2(Q2)

Rmin2

I3(Q3)

Rmin3

I4(Q4)

Rmin4

R


Figure 3.3

Isoquant map generated by the Bergstrom production function


53

infeasible resource/human-made capital combinations (i.e., combinations that lie to the left of the relevant resource asymptote). The aim now is to derive the elasticity of substitution () from the BPF in order to gain greater insight into the range of feasible substitution possibilities. If we let Z K (a composite human-made capital factor) and substitute it into (3.8) we obtain: Q(Z, R) [1 exp(ZR)]R

(3.10)

The elasticity of substitution is given by the following:

MRTS d(ZR) · ZR RZ d(MRTSRZ )

(3.11)

where MRTSRZ denotes the marginal rate of technical substitution between low entropy resource input and the human-made capital/technology factor, and is: MRTSRZ QR QZ

(3.12)

where QR the marginal product of low entropy resource input, and QZ the marginal product of the human-made capital/technology factor. To continue, it is necessary to derive QR and QZ. They are respectively: QR Q R 1 (1 ZR)eZR

(3.13)

and QZ Q Z eZR

(3.14)

By substituting (3.14) and (3.13) into (3.12) one obtains: MRTSRZ

1 (1 ZR)eZR e ZR

(3.15)

or MRTSRZ eZR 1 ZR

(3.16)

54


If, for simplification, we let ZR, then: MRTSRZ e 1

∴

d(MRTSRZ ) e 1 d(ZR)

(3.17) (3.18)

and d(ZR) 1 d(MRTSRZ ) e 1

(3.19)

Substituting (3.17) and (3.19) into (3.11) yields:

e 1 (e 1) ·

(3.20)

where, for 108, is less than one. Furthermore: lim → 0 →

(3.21)

Both (3.20) and (3.21) convey some important information. Not only does a complementary relationship exist between natural and human-made capital for all relevant values of , the degree of complementarity between the two forms of capital increases as the human-made capital/resource ratio rises (i.e., → 0).9 Does this suggest that, in the presence of declining natural capital technological advances cannot ensure a sustained real output level? Eventually, yes, since an elasticity of substitution of less than one implies an inadequate long-run substitutability of human-made capital for natural capital. In the short run, however, and until the thermodynamic limit of E 1 has effectively been reached, the answer is no. Nevertheless, it is a mistake to believe that the short-run potential for additional humanmade capital to sustain real output is an example of substitution of one for the other. It is what I have elsewhere referred to as ‘implicit substitution’ – the illusion of substitutability that is created when improved human knowhow embodied in human-made capital reduces the high entropy waste generated during the production process (Lawn, 1999). At no stage does this constitute human-made capital substituting or ‘taking the place of’ natural capital. Figure 3.4 illustrates why there is an increase over time in the degree of complementarity between human-made and natural capital as the

55

Is human-made capital a substitute for natural capital? I1(Q1) I2(Q2)

I3(Q3)

Z

Z3

C

Z2

B

A

Z1

0 Rmin1

Rmin2 R2 Rmin3 R1

R


Figure 3.4 Increasing complementarity between natural and human-made capital human-made capital/resource ratio rises. Initially, the economy is situated at point A, where Q1 of output is being produced by a human-made capital/ resource combination of (Z1, R1). Point A lies on the isoquant I1. As the low entropy resource input declines to R2 (due to natural capital depletion), the human-made capital factor must be increased to Z2 to sustain the output of Q1. That is, the economy is forced to move to point B on the isoquant I1 (Z2, R2). Critically, in moving from point A to B, the economy is positioned closer to the resource asymptote of Rmin1. This simply reflects that there is less room for further reductions in high entropy waste and that the economy is a step closer to perfect complementarity. Having moved to point B, a future technological breakthrough reduces the high entropy waste generated in the production process and, in so doing, augments the human-made capital factor to Z3. As a consequence, the economy is promoted to a higher isoquant of I2. The economy now moves to point C and is able to produce Q2 of output by employing a human-made capital/resource combination of (Z3, R2). Note that despite the promotion to a higher isoquant, the economy moves closer to the new resource asymptote (i.e., C is closer to the new resource asymptote of Rmin2

56


than B is to the original asymptote of Rmin1). This illustrates why, as the human-made capital/resource ratio rises, the elasticity of substitution tends toward zero. Of course, the analysis so far has focused exclusively on the resourceproviding role of natural capital. If one also acknowledges that natural capital provides critical life-support and waste assimilative services that human-made capital cannot replicate, it is clear that human-made capital and natural capital must be considered complements not substitutes. Indeed, the inability of human-made capital to replicate the life-support and waste assimilative services generated by natural capital may prove to be a more stringent constraint on real output than resource availability. One does not have to think long and hard to recognise that the most pressing environmental concerns relate to ecosystem destruction, biodiversity loss, and pollutioninduced problems such as global warming, acid raid and ozone depletion.

HUMAN-MADE CAPITAL AND NATURAL CAPITAL AS COMPLEMENTS – IMPLICATIONS FOR NATURAL RESOURCE POLICY Does the complementary relationship between human-made and natural capital have any implications for natural resource policy? This question arises if only because an economic system could be moving either very quickly or slowly towards the aggregate resource constraint of Rmin depicted in Figure 3.2. If it is the latter, and thermodynamic constraints have the potential to take thousands of years to come into effect, should we be concerned about declining natural capital stocks? The answer is yes for a number of good reasons. First, as just explained, natural capital provides a range of indispensable services that human-made capital cannot replicate. What’s more, the natural capital required to ensure these services are sustained is likely to far exceed the quantity required to sustain Rmin. Second, we are unlikely to know how far away the resource constraint is. This is because the ecosphere is a highly complex system with the potential to undergo catastrophic changes that cannot be a priori known – in particular, changes brought about by the destruction of critical feedback mechanisms that are a function of prevailing natural capital and biodiversity levels (Lovelock, 1979; Capra, 1982; and Faber and Proops, 1990). As such, it is possible for a decline in natural capital to trigger drastic changes in the ecosphere that could rapidly promote the timing of an aggregate resource constraint. Third, in view of the complementary relationship between human-made and natural capital, we have a moral obligation to ensure natural capital


57

exists in sufficient quantities for future generations. This is important because although the propensity to discount future values may render the depletion of natural capital irrelevant to the present generation, it must be asked whether the subjective desires of the present should outweigh the need for future generations to possess adequate quantities of natural capital. Very few people would argue against the notion that present needs should outweigh future needs. However, fewer people would favour the relegation of future needs to the subjective desires of currently existing people. Issues to Consider When Adopting a Strong Sustainability Stance to Resource Use If only for precautionary reasons, there is a clear case for keeping natural capital intact. A resources policy aimed at achieving natural capital maintenance is commonly referred to as a ‘strong sustainability’ stance to resource use. It is a policy direction that stands in stark contrast to the weak sustainability position of only having to maintain a combined stock of natural and human-made capital (the latter stance being the product of the substitutability supposition). Unfortunately, the adoption of a strong sustainability position is an exercise more easily said than done. There are a number of issues that must be considered. To begin with, a natural capital constraint at the global level does not, at face value, amount to a similar constraint at the national level. For example, a country could seemingly deplete its natural capital and rely upon an imported resource flow to sustain Rmin. In reality, of course, this is not a viable solution since, at best, the notion of importing sustainability holds only in relation to resource availability, not in terms of the lifesupport role of natural capital. In addition, natural capital exporters are also limited in terms of the quantity of resources they can provide for natural capital importers. Furthermore, it would be irresponsible for a nation’s policy makers to permit the depletion of the sole provider and assimilator of the ultimate inputs and outputs of its own socio-economic process and be subsequently reliant on the natural capital of other nations. Second, what does one really mean by natural capital maintenance? Does it mean that a given quantity of natural capital must be kept intact? What about natural capital quality? For example, imagine that the quantity of a nation’s natural capital remained intact but a major component of it – for example, slow-growing native forests – was converted to fast-growing timber plantations. Although the resource-providing role of natural capital would increase, the life-support function would diminish. Does the augmentation of one function simply compensate for the decline in the other? The answer is probably no since the life-support services provided by native forests

58


becomes increasingly more valuable at the margin than the additional source function provided by timber plantations as more of the former is converted to the latter. Consequently, it may be necessary to categorise the major components of a nation’s natural capital, including the various services they provide, and seek to maintain them both quantitatively and qualitatively. A final consideration is the non-renewable resource component of natural capital. By its very nature it cannot be kept intact. While resource discoveries can offset the depletion of known reserves, the decline in nonrenewable resource assets, particularly if resource demands continue to increase, must eventually outweigh the magnitude of new resource discoveries. To keep the overall stock of natural capital intact, additional renewable resource assets must be cultivated and/or the productivity of existing renewable resources must be increased to offset the eventual decline in nonrenewable resources. Of course, this doesn’t resolve the dilemma completely since a number of non-renewable resources have no renewable resource substitutes (e.g., copper). Common sense dictates that resources of this kind should be used conservatively with the aim of overcoming reliance upon them well short of their complete exhaustion. Implementing a Strong Sustainability Stance to Resource Policy and National Accounting What can policy makers do to ensure natural capital maintenance? Economic logic suggests that policy makers should seek to maximise the productivity of a limiting factor in the short run and invest in the augmentation of its supply in the long run (Daly, 1996). Given that natural capital is fast becoming the limiting production factor, not human-made capital, policy makers should be encouraging greater investment in natural capital. How can this best be achieved? A policy being widely promoted is that of ecological tax reform (ETR). ETR involves a reduction in the tax rate on such ‘goods’ as income, profits and labour and an increase in the tax rate on such ‘bads’ as resource depletion and pollution. While the former encourages value adding and an emphasis on qualitative improvement rather than quantitative expansion (growth), the latter increases resource use efficiency. There is, however, a vigorous debate concerning whether ETR, in its popular form, will satisfy the strong sustainability requirement. A number of ecological economists (e.g., Norgaard, 1990; Bishop, 1993; Daly, 1996; and Lawn, 2000) have argued that while Pigouvian taxes can reduce the resource intensity per unit of output (increase E), they cannot guarantee natural capital maintenance. This, they stress, is a consequence of Pigouvian taxes being unable to ensure that the percentage increase in production efficiency induced is not exceeded by a larger percentage increase


59

in real output – the latter resulting from a desire to consume more goods over time.10 If this occurs (often referred to as the Jevons’ Paradox), resource inputs must rise and, as such, stocks of natural capital must inevitably decline. For this reason, ecological economists have argued in favour of an ETR package that incorporates tradeable resource use permits. A limit on the number of permits keeps natural capital intact by restricting the throughput of resources to a rate that is within the regenerative and waste assimilative capacities of natural capital. Meanwhile, the premium paid for permits acts as a throughput tax to facilitate the efficient allocation of the incoming resource flow. The value of ETR and the debate surrounding its implementation is taken up in more detail in Chapter 11. A second policy initiative is now emerging from a group of economists disillusioned by the failure of resource depletors to replace non-renewable resources with appropriate income-generating assets. One such economist belonging to this group is Salah El Serafy who has developed a formula for calculating the income and set-aside (user cost) components of resource depletion profits (El Serafy, 1989). The aim of the formula is to determine the percentage of resource extraction profits required to establish a replacement asset capable of generating a perpetual income stream. The formula is as follows: X 1

1 (1 ) n 1

(3.22)

where Xtrue income, total net receipts (gross receipts less extraction costs), the discount rate, nthe number of periods over which the resource is to be liquidated, and X the user cost or the amount of total net receipts that must be set aside to establish a replacement asset to ensure a perpetual income stream. When using the formula to determine the set-aside component of resource depletion profits, El Serafy argues that the chosen discount or interest rate should reflect prudent behaviour on the part of a resource liquidator. That is, it should reflect the rate of return on the eventual replacement asset. This, however, leaves the option open for weak sustainability advocates to use the rate of return or interest rate generated by nonsubstitute assets, such as human-made capital. In view of the need to keep natural capital intact, the most appropriate discount rate is the interest rate yielded by the renewable resource asset being cultivated to ensure natural capital maintenance (Lawn, 1998). This happens to be its natural regeneration rate. Thus, putting the strong sustainability approach into practice requires the discount rate in equation (3.22) to be replaced by the regeneration rate of renewable resource substitutes.

60


In terms of national income accounting, there have been a number of attempts in the past to calculate a ‘green’ measure of national income by subtracting the cost of natural resource depletion from GDP estimates (Repetto et al., 1989; Young, 1990; Van Tongeren et al., 1993; Hill and Hill, 1999; Akita and Nakamura, 2000; Skanberg, 2001; DGBAS, 2002; and ABS, 2002). The results of these adjustments have been quite marked, not only on national income itself, but in terms of the comparative rates of change in green national income relative to the standard GDP figures. If one adopts the strong sustainability position and further subtracts the setaside amount using the El Serafy formula, the disparity in the rates of change is greater still. In the case of the Indonesian study by Repetto et al. (1989), it is enough to bring about negative rates of national income growth. Adopting the strong sustainability position is also likely to have a significant impact on the current account of the many countries relying heavily on the export of non-renewable resources for export income. By lowering the true value of export income, the persistent current account deficit problem faced by many countries would be greatly accentuated by a strong sustainability stance to national income accounting. In due course, one would expect the national income ramifications outlined above to feed back into the policy domain and lead to a more judicious natural resource use policy. This is because an entirely new picture would be conveyed of national economic performance, both absolute and relative, with obvious consequential impacts on investment decisions. There is, however, the possibility that countries imprudently exploiting their resource assets might simply resist the adoption of a strong sustainability stance. If so, this would amount to nothing more than a small shortterm gain at the expense of a disastrous long-term cost.

CONCLUDING REMARKS In view of the inability of CES production functions to assess the substitutability of human-made capital for declining natural capital, a Bergstrom production function has been put forward as a viable alternative. Use of this production function shows that, where relevant, the elasticity of substitution between natural capital and human-made capital is less than one. Furthermore, the elasticity of substitution moves closer to zero as the stock of human-made capital is augmented in response to natural capital depletion. Given the range of other critical services provided by natural capital, both it and human-made capital must be classed as complements, not substitutes. The complementary relationship between natural and humanmade capital implies the need to keep the former intact. This demands


61

greater urgency on the part of policy makers to encourage natural capital investment and to require non-renewable resource liquidators to cultivate renewable resource substitutes. It also suggests that a strong sustainability stance should be taken when measuring national income since current accounting practices convey inaccurate information about the economic performance of recalcitrant nations.

NOTES 1. 2.

3. 4. 5. 6.

7.

8. 9. 10.

In a later study to extend the analysis beyond 1957, Barnett (1979) concluded that there was no sign of increasing resource scarcity in the USA between 1957 and 1970. A value of one for the elasticity of substitution implies that increases in human-made capital can offset the decline in natural capital sufficiently to sustain real output at the current level. Should the elasticity of substitution be greater than one, increases in human-made capital can, even in the presence of declining natural capital, lead to a higher quantity of future output. When the elasticity of substitution is less than one, no amount of additional human-made capital can offset the decline in natural capital enough to sustain real output in the long run. In this instance, a continuing decline in natural capital means less real output. Eventually all low entropy used in production becomes high entropy waste since final goods are either directly consumed (non-durables) or worn out through use (durables). This efficiency ratio (E) is referred to as a ‘second law’ energy efficiency measure (Ayres, 1978). It can be estimated by using an energy accounting model based on Leontief’s (1970) input-output analysis. This section owes a lot to the work of Dasgupta and Heal (1979). As such, the service sector is not ‘goods free’ and, in fact, the direct inputs of the service sector are invariably the outputs of the goods sector. This means that the matter-energy used to produce the goods required for the service sector to function is effectively an indirect input of the service sector. Even an unlimited increase in the welfare-yielding qualities of physical goods is improbable. To begin with, there is a likely limit on the capacity of human beings to in fact experience the welfare-yielding qualities of physical goods. Second, there is almost certainly a limit as to how much welfare a particular good can yield. Surely no one believes that the utilisation of the energy and matter contained in a tonne of iron ore could render a city of one million inhabitants deliriously happy? – and then still happier? Perhaps this is taking things a bit far, but it does highlight the obvious existence of limits on the welfare side of the economic process. For other examples see Marsden et al. (1974) and Ruth (1995a). Given that the issue of substitutability/complementarity arises only as a consequence of declining resource availability, the potential for the elasticity of substitution to be greater than one for values of 108 is of little relevance. Ecological economists believe that resource prices are good at reflecting relative scarcities but not the absolute scarcity of low entropy matter-energy. The former explains why prices are good at facilitating a more efficient use of resources but inadequate at ensuring a sustainable rate of resource use. Efficiency does not guarantee sustainability in the same way it does not guarantee distributional equity. This issue is explored in Chapters 5 and 10.

4.

The potential conflict between sustainability and welfare maximisation

INTRODUCTION The previous chapter showed that the long-run output potential of the economic process has been overstated as a consequence of the mainstream use of aggregate production functions that violate the first and second laws of thermodynamics. A Bergstrom production function (BPF) was subsequently put forward as an alternative means of describing production or resource-transforming possibilities. Use of the BPF revealed that natural and human-made capital are effectively complementary rather than substitutable forms of capital. Unfortunately, the BPF, alone, is unable to indicate the likely pattern of natural capital depletion should a society wish to continuously increase its level of production and consumption over time. In order to fully appreciate the long-run production possibilities of an economic system, a time dimension must be incorporated into the BPF. In addition, assumptions must be made about the nature of both natural and human-made capital and the technology embodied within the latter. This is precisely what is undertaken in this chapter. Furthermore, the revised BPF is employed to conduct a range of simulation exercises. The simulation exercises reveal a number of important results and conclusions, none more so than: (a) the potential conflict that can arise between maximising present value welfare and the need to maintain natural capital for future generations, and (b) the critical role played in this conflict by the prevailing discount rate. Why might discounting conflict with natural capital maintenance and the ecological sustainability goal? An efficient allocation of the incoming resource flow requires human needs and wants to be best served by the allocation process. Should this be achieved, the social surplus or economic welfare generated from the allocation of the incoming resource flow is maximised. Since most nations rely upon the market as the principal resource allocation mechanism, efficiency will depend very much on interacting demand and supply forces and the accuracy with which market 62

Conflict between sustainability and welfare maximisation

63

prices reflect the full benefits and costs of resource use. Because of the potential for markets to ‘fail’, government intervention is often justified as a means of improving the efficiency of the resource allocation process. The last point aside, the demand-side forces in any market are largely a function of the tastes and preferences that individuals have for particular goods and the various resources required to produce them. Rightfully so, economists take people’s tastes and preferences very seriously. But tastes and preferences are not confined to an individual’s ranking of available consumption goods. Tastes and preferences also relate to when people prefer to receive the benefits of the allocation process. Most people, if given the opportunity to consume something now or in the future, will prefer consumption now. This tendency to discount future values applies to both benefits and costs. That is, people prefer to realise benefits sooner rather than later, while they prefer to incur costs later rather than sooner. It is the intensity with which an individual prefers the present over the future that determines his or her discount rate. For example, a discount rate of 5 per cent per annum implies that a person would need to receive 5 per cent more of something in a year’s time (e.g., $105) to be equally satisfied with receiving $100 today. Thus, given the choice between $100 today or $105 in one year’s time, a person with a 5 per cent discount rate would be indifferent between the two. However, they would prefer to wait if $110 was offered in a year’s time because the present value of the future payment is $110/1.05 or $104.76 which is greater than the $100 received today. Conversely, if the promised future payment was $102, they would accept $100 today because the present value of the future payment is $102/1.05 or $97.14, which is less than the $100 received today. If a society believes an efficient allocation of the incoming resource flow is desirable and, to achieve it, people’s tastes and preferences should be attended to as best as possible, there is no reason to ignore the rate of time preference any more than the preferences people have for different goods and the services they yield.1 Hence, from an efficiency perspective, the discounting of future benefits and costs cannot be overlooked when people undeniably prefer the present to the future. Moreover, since decisions pertaining to the current allocation of resources must be made today, the discounting of future benefits and costs must be based on our present rate of time preference. Unfortunately, discounting has potential ramifications for the natural environment. This is because the cost of lost natural capital services invariably manifests itself long after a benefit-yielding activity has taken place. In addition, the benefits of environmental rehabilitation flow well after the initial cost-incurring restoration work has occurred. Should discounting be applied when making economic assessments, it is common for the monetary

64


value of future environmental benefits and costs to be overwhelmingly marginalised.2 This increases the likelihood that the present value of the net benefits emanating from pro-environmental actions will be discouragingly low or negative. Discounting is therefore decidedly biased towards environmentally destructive activities. As we shall see in this chapter, high discount rates can predispose the decision making process towards natural capital depletion and set in place pathways that are distinctly unsustainable. This potential conflict between present value welfare maximisation and ecological sustainability poses an obvious dilemma. It compels us to consider whether there is any moral obligation on the part of the current generation to subordinate allocative efficiency to the sustainability goal and, if so, to determine whether the efficiency goal can still be accommodated in a way that maximises present value welfare (and facilitates a macroeconomic adjustment to the optimal scale as per Figure 2.4 in Chapter 2). For now, however, we shall return to the BPF and conduct a range of simulation exercises in order to establish a suitable context from which these issues can be considered in greater detail.

A SIMULATION EXERCISE INVOLVING A REVISED BERGSTROM PRODUCTION FUNCTION The simulation model employed in this chapter involves a revision of the BPF as described by equation (3.8) in Chapter 3. The primary modification of the BPF is the incorporation of a time dimension whereby production possibilities become a function of past and present values of natural and human-made capital. We begin with the following revised BPF: Qt (t1, Kt1, Rt ) [1 exp(t1 · Kt1 Rt )]Rt

(4.1)

where Qt real output produced in the current time period (t); Kt1 quantity of human-made capital existing at the conclusion of the previous time period (t 1) that is subsequently available for production purposes in the current time period (t); t1 technology embodied in the humanmade capital existing at the end of previous time period (t 1); Rt low entropy resource input extracted for production purposes in the current time period (t); and ta time period of any particular length, be it a year, decade or century. A number of things require elaboration at this point. First, for simplification, the simulation exercise deals with the sustainability of the economic process from the point of view of resource availability only. The importance of the life-support and waste assimilative services provided by


65

natural capital are, for the moment, ignored. Second, the physical goods produced in the current time period (Qt) are distributed for consumption (QCt) and investment purposes (QINVt), whereby the latter corresponds to the producer goods manufactured to ensure the availability of a desired quantity of human-made capital in the next time period (t 1). Third, human-made capital depreciates at the rate of d% per time period. Hence the quantity of human-made capital existing at the end of the previous time period (t 1) that is subsequently available for production in the current time period (t) is: Kt (1 d) · Kt1 QINVt1

(4.2)

Fourth, and again for simplification, natural capital (N) exists in a renewable form only. It regenerates or grows at the rate of r% per time period. Consequently, the total amount of low entropy matter-energy available for production in the current time period (t) is equal to stock of low entropy matter-energy existing at the end of the previous time period (Nt1) plus the amount by which it grows in the present. Allowing for the extraction of low entropy matter-energy in the current time period for production purposes (Rt), the natural capital existing at the end of the current time period (t) is: Nt (1 r)Nt1 Rt

(4.3)

Fifth, it will be assumed that the initial objective is to sustain, for as long as is physically possible, a particular consumption stream. This stream may consist of either a constant quantity of goods per time period or a quantity that increases at a specified rate. It will also be assumed that both and K increase at a specified rate per time period. Once the values of d and r have been specified, as well as the initial values of QC, , K, N plus the rate of increase in the former three, one can compute: (a) the output required for consumption and investment purposes in each time period (i.e., consumer goods plus producer goods); (b) the amount of resource input required to produce the total output of consumer and producer goods in each time period; and (c) the impact on natural capital of extracting the required resource input. Should natural capital decline to zero, the quantity of low entropy resources available for production ceases. So, too, does the stream of consumption and producer goods. For the first simulation exercise, the following is assumed: ●

QC, the desired consumption level, is 1000 units for each time period that output can be physically sustained. QC is measured in terms of the matter-energy embodied in the final goods produced;

66

Sustainable development and natural capital ● ● ● ● ●

K is initially 1000 units (at time t 1). The stock of human-made capital accumulates at a rate of 2.5% per time period; is initially 1.90 (at time t 1) and rises at a rate of 2.5% per time period; d0.2 or 20%; r 0.02 or 2%; N is initially 20 000 units (at time t 1) and is measured in terms of the matter-energy embodied in the resources of which it is comprised.

Figure 4.1 reveals what happens to each of the main variables over time. Panel 4.1a shows that the goods produced for consumption purposes (QC) remain constant over the time in which the economic process takes place – a consequence of the first assumption above. However, the total output (Q) increases because QINV rises to accommodate the desire to augment the stock of human-made capital (K) at a rate of 2.5 per cent per time period. In addition 20 per cent of the stock of human-made capital existing at any point in time must be replaced. Despite the rise in total output, the quantity of resource input (R) falls over the entire period (Panels 4.1a and 4.1b). Why is this so? It can be seen from Panel 4.1b that the combined human-made capital/technology factor ( K) constantly rises. This leads to an increase in the technical efficiency of production (E) (Panel 4.1c). Because the resourcesaving impact of the rise in E outweighs the resource-demanding impact of the increase in Q, the total resource input requirement in each successive time period falls. Nevertheless, the resource input requirement for each time period (R) continues to exceed the quantity of low entropy matter-energy regenerated by the remaining stock of natural capital (i.e., r N in Panel 4.1b). As a consequence, natural capital (N) declines (Panel 4.1b). The eventual depletion of natural capital brings the economic process to a halt in the fifteenth time period (t14). Panel 4.1c also reveals what happens to the elasticity of substitution, the technical efficiency of production, and the marginal products of each production factor as the human-made capital/resource input ratio ( K/R) rises. In line with the conclusions drawn in Chapter 3, the elasticity of substitution is less than one and constantly falling. Conversely, the technical efficiency of production rises asymptotically towards a value of one. As for the marginal products of both the human-made capital/technology factor and low entropy resource input, the former declines and the latter increases. This follows from the fact that as the technical efficiency of the production process (E) approaches a value of one, an expansion in real output becomes increasingly dependent on the rise in resource input.3 In other words, the capacity of an expanding stock of human-made capital to increase real output diminishes.

67

Conflict between sustainability and welfare maximisation Panel 4.1a 2,000.00 1,800 .00 1,600 .00

Units of embodied energy

1,400 .00 1,200 .00 1,000 .00 800 .00

Qc

Q

600 .00

QInv

K

R

400 .00 200 .00 0.0 0 t–1

t0 (now )

t1

t2

t3

t4

t5

t6

t7

t8

t9

t10

t11

t12

t13

t14

Time periods

Panel 4.1b 20 ,000 .00 Z (K + technol og y) R N r.N


15 ,000 .00

10 ,000 .00

5,00 0.00

0.00 t–1

t0 (now )

t1

t2

t3

t4

t5

t6

t7

t8

t9

t10

t11

t12

t13

t14

Time periods –5,000.00 Panel 4.1c 3.00 Z/R MP of Z (K + te chno logy ) MP of resource input E = Q/ R < 1 Elastic ity of substitution

2.50

Unit value

2.00

1.50

1.00

0.50

0.00 t–1

t0 (now )

t1

t2

t3

t4

t5

t6

t7

t8

t9

t10

t11

t12

t13

t14

Time periods

Figure 4.1 Simulation 1 – Standard model parameters with a Bergstrom production function

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Figure 4.2 illustrates the change in the time it takes for natural capital to be fully exhausted and for the economic process to cease as the five main parameters are varied (simulation 2). In Panel 4.2a, all the parameters of the model are held constant except for the depreciation rate of humanmade capital (d). The depreciation rate is varied in 5% intervals from 0.05 to 0.25 (original value for d is 0.20). As can be seen from Panel 4.2a, natural capital is exhausted more rapidly the higher is the depreciation rate of human-made capital. A higher depreciation rate requires more producer goods to be manufactured to augment the stock of human-made capital at the desired rate of 2.5% per time period. This increases the demand for low entropy resource input which subsequently leads to a more rapid rate of natural capital depletion. In Panel 4.2b, it is the accumulation rate of human-made capital that is varied (1.25%, 2.5%, 5%, 10% and 20% per time period). The result is an interesting one in that there are two opposing forces at work. The first is the increase in output required in each time period to more rapidly augment the stock of human-made capital. This, of course, leads to greater depletion pressure on natural capital. The second is the increase in the technical efficiency of production (E) as the human-made capital/resource input ratio ( K/R) rises. This reduces the depletion pressure on natural capital. As the accumulation rate of human-made capital increases beyond the original 2.5% per time period, the increase in the depletion factor exceeds the resource-conserving factor. Natural capital is exhausted much sooner. This is an important conclusion since it completely overturns the conventional belief that rapidly accumulating stocks of human-made capital can offset the decline in natural capital. Note, however, that a decline in the accumulation rate of human-made capital to 1.25% per time period results in the rate of change in both factors effectively cancelling each other out. There is, as a consequence, little change in the time it takes to fully exhaust the stock of natural capital. Panel 4.2c illustrates the impact of a variation in the rate of the technological progress embodied in human-made capital (1.25%, 2.5%, 5%, 10% and 20% per time period). As is clearly evidenced in Panel 4.2c, a faster rate of technological progress means a greater increase in the technical efficiency of production (E) and a lengthening of the time it takes to fully exhaust the stock of resource-providing natural capital. In the final example, the desired consumption level of QC is varied. Originally, the desired consumption level was held constant at 1000 units per time period. It is now increased at rates of 1.25%, 2.5%, 5% and 10% per time period. Panel 4.2d reveals that a higher desired consumption level demands a higher level of output and a greater input of low entropy resources. This leads to a more rapid depletion of natural capital.

Units of embodied energy in available natural capital

0.00

5,000.00

10,000.00

15,000.00

20,000.00

Figure 4.2

–5,000.00

Units of embodied energy in available natural capital

d = 0.05 d = 0.10 d = 0.15 d = 0.20 d = 0.25

Time periods

Beta increases by 1.25% p.a. Beta increases by 2.5% p.a. Beta increases by 5% p.a. Beta increases by 10% p.a. Beta increases by 20% p.a.

Panel 4.2c: Variation in rate of technological progress

0.00 ) 1 2 3 4 5 6 7 8 9 0 1 2 3 5 6 7 8 9 1 t– (now t t t t t t t t t t1 t1 t1 t1 t14 t1 t1 t1 t1 t1 Time periods 0 t –5,000.00

5,000.00

10,000.00

15,000.00

K increases by 1.25% p.a. K increases by 2.5% p.a. K increases by 5% p.a. K increases by 10% p.a. K increases by 20% p.a.

Panel 4.2b: Variation in accumulation of human-made capital

0.00

5,000.00

10,000.00

15,000.00

20,000.00

–5,000.00

Constant Qc Qc increases by 1.25% p.a. Qc increases by 2.5% p.a. Qc increases by 5% p.a. Qc increases by 10% p.a.

Panel 4.2d: Variation in the consumption level

0.00 ) 1 2 3 4 5 6 7 8 9 0 1 1 3 t– now t t t t t t t t t t1 t1 t12 t1 t14 ( Time periods –5,000.00 t0

5,000.00

10,000.00

15,000.00

20,000.00

Time periods

Simulation 2 – Difference in time to deplete natural capital (variations in the model parameters)

t0 t–1 (n o w ) t1 t2 t3 t4 t5 t6 t7 t8 t9 t 1 0 t1 1 t1 2 t 1 3 t1 4 t1 5 t1 6 t1 7

Units of embodied energy in available natural capital Units of embodied energy in available natural capital

Panel 4.2a: Variation in depreciation rate of human-made capital

t t0 –1 no w)

20,000.00

t1 t2 t3 t4 t5 t6 t7 t8 t9 t 1 0 t1 1 t1 2 t1 3 t1 4

69

70


A SIMULATION EXERCISE INVOLVING THE SUSTAINABLE OPERATION OF THE ECONOMY In the next simulation exercise (simulation 3), the aim is twofold: (a) to ensure the economic process is sustained, which requires natural capital to be kept intact; and (b) to consume the maximum sustainable quantity of output in view of the various system parameters and the desire to accumulate humanmade capital at a particular rate. This simulation exercise differs from the first set of exercises (simulations 1 and 2) in that the quantity of consumption goods producible in any given time period is subject to a natural capital maintenance requirement. In the two former instances, a desired consumption level was maintained which, as a consequence of having to make available the necessary quantity of low entropy resources for production purposes, resulted in the eventual exhaustion of natural capital. Hence unlike the first set of exercises, this exercise is a constrained maximisation problem – that is, the objective is to maximise consumption subject to keeping natural capital intact. For this particular exercise, the following is assumed: ●

● ● ● ● ●

K is initially 1000 units (at time t 1). The stock of human-made capital accumulates at a rate of 2.5% per time period and continues to do so even after the technical efficiency of the production process effectively reaches the thermodynamic limit of E → 1; is initially 1.90 (at time t 1) and rises at a rate of 5% per time period; d0.2 or 20%; r 0.04 or 4%; N remains at 20 000 units and is measured in terms of the matterenergy embodied in the resources of which it is comprised; the quantity of low entropy resource input (R) is constant at 800 units of matter-energy per time period (that is, Rr N0.04 20 000).

In this instance, the desired consumption level (QC) depends on the rate of technological progress and the desired rate of human-made capital accumulation. Figure 4.3 reveals what happens to the main variables over time. Panel 4.3a shows that, initially, the total output (Q) increases as the technical efficiency of the production process (E) rises. However, as E approaches a value of one (Panel 4.3c), Q stabilises at a quantity near 800 units per time period. The quantity of goods produced for consumption purposes (QC) initially rises but then declines to zero. This is because a greater proportion of the total output is required over time to augment human-made capital at the desired rate of 2.5% per time period. Eventually all output is devoted to the production of producer goods (i.e., Q QINVt in Panel 4.3a).

Conflict between sustainability and welfare maximisation Panel 4.3a

4,000.00


3,500.00 3,000.00

Qc Q QInv K

2,500.00 2,000.00 1,500.00 1,000.00 500.00 t0 t– (n 1 ow ) t1 t3 t5 t7 t9 t1 1 t1 3 t1 5 t1 7 t1 9 t2 1 t2 3 t2 5 t2 7 t2 9 t3 1 t3 3 t3 5 t3 7 t3 9 t4 1 t4 3 t4 5 t4 7 t4 9 t5 1

0.00 Time periods Panel 4.3b 100,000.00


90,000.00 80,000.00 70,000.00

Z (K + technology) R Constant N

60,000.00 50,000.00 40,000.00 30,000.00 20,000.00 10,000.00 t0 t (n –1 ow ) t1 t3 t5 t7 t9 t1 1 t1 3 t1 5 t1 7 t1 9 t2 1 t2 3 t2 5 t2 7 t2 9 t3 1 t3 3 t3 5 t3 7 t3 9 t4 1 t4 3 t4 5 t4 7 t4 9 t5 1

0.00 Time periods Panel 4.3c 1.20 1.00

Unit value

0.80 0.60

MP of Z (K + technology) MP of resource input E = Q/R < 1 Elasticity of substitution

0.40 0.20

t0 t– (n 1 ow ) t1 t3 t5 t7 t9 t1 1 t1 3 t1 5 t1 7 t1 9 t2 1 t2 3 t2 5 t2 7 t2 9 t3 1 t3 3 t3 5 t3 7 t3 9 t4 1 t4 3 t4 5 t4 7 t4 9 t5 1

0.00 Time periods

Figure 4.3 Simulation 3 – Constant natural capital (continuing accumulation of human-made capital)

71

72


In view of the assumptions, N remains constant at 20 000 units and R at 800 units (Panel 4.3b). Panel 4.3c shows that the elasticity of substitution is less than a value of one and falls continuously towards a value of zero. While the marginal product of the human-made capital/technology factor falls rapidly towards zero, the marginal product of low entropy resource input rises towards a value of one. This simply demonstrates, again, that an increase in output is entirely dependent upon a rise in the quantity of low entropy resource input once the thermodynamic limit of E → 1 is effectively reached. There is, however, a notable shortcoming of the exercise just described. It was assumed that the stock of human-made capital would continue to be accumulated despite the technical efficiency of the production process nearing the thermodynamic limit of E → 1 (and the marginal product of the human-made capital/technology factor approaching zero). This is a pointless exercise since it needlessly reduces the quantity of goods available for consumption. Hence, in the next simulation exercise (simulation 4), the assumptions remain unchanged except the stock of human-made capital now ceases to grow once E nears the thermodynamic limit. This doesn’t mean that all newly produced goods can be henceforth distributed for consumption purposes. The production of new producer goods is still required because, in each time period, 20% of the stock of human-made capital requires replacement. Figure 4.4 reveals the outcome of the new simulation exercise. Like Panel 4.3a in the previous example, Panel 4.4a shows the total output (Q) increasing slightly and then stabilising as E asymptotically approaches the thermodynamic limit of one. In the initial stages, the quantity of goods produced for consumption purposes (QC) increases. It then declines slightly before rising sharply in time period t13. QC stabilises at the t13 quantity. It does not decline towards zero as in the previous exercise. Why does it follow this pattern? Although more producer goods are manufactured in the initial stages, the increase in the technical efficiency of production (E) is sufficiently large to allow the quantity of consumer goods produced to be increased. That is, the increase in total output exceeds what is required to accumulate producer goods at the desired rate. However, this no longer occurs once E approaches a value of one. A smaller quantity of the total output produced is subsequently distributed for consumption purposes. QC stabilises once there is no further need to augment the stock of human-made capital. As for the production of new producer goods (QINV), this quantity initially rises to ensure the stock of human-made capital accumulates at the rate of 2.5% per time period. Because E effectively reaches the thermodynamic limit of one in time period t12, there is no need for the further accumulation of human-made capital. From time period t13 onwards, the

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Conflict between sustainability and welfare maximisation Panel 4.4a 1,400.00 Qc Q QInv K


1,200.00 1,000.00 800.00 600.00 400.00 200.00 0.00

1 ) t– ow (n t0

t2

t4

t6

0

t8

2

t1

4

t1

6

t1

8

t1

0

t1

2

t2

4

t2

6

t2

8

t2

t2

Time periods Panel 4.4b

24,000.00


20,000.00

16,000.00

Z (K + technology) R Constant N

12,000.00

8,000.00

4,000.00

0.00

1 ) t– ow (n

t2

t4

t6

t8

0

t1

2

t1

t0

4

t1

6

t1

8

t1

0

t2

2

t2

6

4

8

t2

t2

t2

Time periods Panel 4.4c

1.20

1.00

Unit value

0.80 MPz MPr

0.60

E = Q/R < 1 0.40

Elasticity of substitution

0.20

t0

t6

t8

0

t1

2

t1

4

t1

6

t1

8

t1

0 t2

2

t2

4

t2

6

t2

8

t4

t2

–

t2

t (n 1 ow )

0.00

Time periods

Figure 4.4 Simulation 4 – Constant natural capital (human-made capital ceasing to accumulate once E → 1

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production of new producer goods is sufficient to keep the stock of humanmade capital intact. Consequently QINV stabilises at the t13 quantity. It is also during this time period that QC stabilises. Once again, N remains constant at 20 000 units and R at 800 units (Panel 4.4b). Panel 4.4c is much the same as Panel 4.3c in the previous exercise. Despite consumption being sustained indefinitely in this final case, the actual quantity of goods consumed in each time period is considerably less than that briefly enjoyed in the very first simulation exercise (simulation 1). For instance, QC ranges from 500 to 531 units per time period compared to the 1000 units enjoyed per time period over 15 time periods in simulation 1. Clearly, ecological sustainability is likely to come at the expense of a much lower consumption level per period – although, of course, the consumption stream is one that can be permanently sustained.

SHOULD WE OPERATE SUSTAINABLY OR UNSUSTAINABLY? This chapter has so far examined hypothetical situations where, firstly, a desired consumption level is generated until the total depletion of natural capital results in the cessation of the economic process (simulations 1 and 2), and secondly, where sustaining the economic process is a principal objective (simulations 3 and 4). It has been shown that ecological sustainability has the potential to come at the expense of a much lower consumption level per period when compared to the unsustainable case. Ignoring costs of various types (e.g., social and environmental costs), let’s assume that economic welfare is entirely a function of the quantity of final goods available for consumption purposes. What, then, is the most desirable pathway of the economic system? From a strictly utilitarian perspective, the answer to this question depends on the rate at which future consumption is discounted. To demonstrate why, consider the following simulation exercise involving six different scenarios. For each scenario the following is assumed: ● ● ● ●

K is initially 1000 units (at time t 1). The stock of human-made capital accumulates at a rate of 2.5% per time period; is initially 1.90 (at time t1) and rises at a rate of 5% per time period; d0.2 or 20%; r 0.04 or 4%.

The various scenarios differ in the following way. Scenarios 1 and 2 are ecologically sustainable cases – in fact, they are the same as the previous

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Conflict between sustainability and welfare maximisation 1,800.00 1,600.00 Scenario 1 Scenario 2 Scenario 3 Scenario 4 Scenario 5 Scenario 6


1,400.00 1,200.00 1,000.00 800.00 600.00 400.00 200.00

t0 (n ow ) t1 t3 t5 t7 t9 t1 1 t1 3 t1 5 t1 7 t1 9 t2 1 t2 3 t2 5 t2 7 t2 9 t3 1 t3 3 t3 5 t3 7 t3 9 t4 1 t4 3 t4 5 t4 7 t4 9 t5 1 t5 3 t5 5 t5 7 t5 9

0.00 t–1

Time periods

Figure 4.5

Undiscounted welfare under various hypothetical scenarios

Table 4.1 Present value sum of welfare stream under different discount rates Discount rate (%)

1.25%

2.5%

5%

10%

Scenario 1 Scenario 2 Scenario 3 Scenario 4 Scenario 5 Scenario 6

14 216.92 42 789.58 17 819.31 17 000.00 16 368.29 14 772.93

11 682.29 21 563.51 15 978.89 15 438.41 15 000.00 13 748.10

8 407.74 10 967.81 13 085.32 12 911.17 12 740.44 12 000.00

5 244.41 5 693.27 9 364.92 9 499.41 9 581.57 9 411.27

two simulation exercises (simulations 3 and 4). Scenarios 3 to 6 are unsustainable cases. They differ insofar as QC in Scenario 3 remains constant at 1000 units; QC in Scenario 4 begins at 1000 units and rises at a rate of 1.25% per time period; QC in Scenario 5 rises at a rate of 2.5% per time period; and QC in Scenario 6 rises at a rate of 5% per time period. Figure 4.5 reveals the undiscounted welfare enjoyed in each time period for the six different scenarios. Table 4.1 reveals the present value (discounted) sum of welfare enjoyed for each scenario at four different discount rates (1.25%, 2.5%, 5% and 10%). Highlighted in Table 4.1 is the preferred scenario for each of the four discount rates. At discount rates of 1.25% and 2.5%, Scenario 2 is the most preferred long-run path. At discount rates of 5% and 10%, Scenario 3 and Scenario 5 are respectively the preferred options. Significantly, between a discount rate of 2.5% and 5%,

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the preferred scenario switches from a sustainable to an unsustainable pathway. This suggests there is likely to be, for any particular set of circumstances, a ‘threshold’ discount rate above which ecological unsustainability is, from a strictly utilitarian perspective, the preferred long-run path of the present generation. The threshold discount rate is not derived here but is the subject of future research. Of course, welfare is not necessarily a direct function of the quantity of goods consumed. There are many other welfare benefits and costs associated with the economic process (Daly, 1996; Lawn, 2000). This having been said, the temper of public policy is, in most instances, firmly focused on increasing real GDP. Since real GDP is very much a physical index of production and, to a lesser extent, consumption, policy makers are implicitly assuming a direct link between the quantity of goods consumed and a nation’s welfare. While there is talk of the importance of environmental factors, there is little evidence to indicate a genuine shift towards ecological sustainability. Indeed, as mentioned in Chapter 2, the ecological footprint of most nations has exceeded domestic biocapacity and, as such, the majority of the world’s macroeconomies appear to have surpassed their maximum sustainable scale (Wackernagel et al., 1999). It might well be argued, therefore, that the social discount rate in these countries is sufficiently high for ecological unsustainability to be the preferred long-run path. Assuming this to be the case, the following questions arise: Should output decisions and their long-run impact on natural capital be determined solely on the basis of what maximises the present value welfare of the current generation? Do people already in existence have a moral obligation to ensure natural capital maintenance for the benefit of future generations? That is, do moral considerations outweigh utilitarian considerations to the extent that currently existing people must forego welfare benefits to meet their obligations toward future generations? If so, what does it mean in terms of natural resource policy and output decisions? To the first two questions, it is generally agreed that the needs of presently existing people outweigh the needs of people yet to come into existence. However the needs of future people should always take moral precedence over the subjective wants and desires of the present generation.4 Given that the majority of consumption goods are produced to serve wants rather than needs, the desire to continuously increase the quantity of goods for consumption purposes seems morally unjustified. No doubt some observers would argue that the growth in human population numbers increases the aggregate needs of the present generation and, in doing so, its right to the planet’s resources. Many, such as myself, would disagree by suggesting this highlights the urgency with which population growth needs to be controlled (Boulding, 1964; Ehrlich and Ehrlich, 1990;


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Daly, 1996; Lawn, 2000). In fact, since a larger population reduces the capacity of future generations to meet their own needs, the present generation is in many ways morally obligated to introduce policies to control population growth. As for the third question, some observers believe that currently existing people should not have to forego welfare benefits if future generations are likely to be better off (Beckerman, 1992). But will future generations necessarily enjoy a higher level of welfare? It has already been demonstrated in this chapter that increasing levels of production and consumption are inevitably unsustainable irrespective of any technological progress and/or accumulation of human-made capital. Thus the degree to which future generations might be made better off will undoubtedly be short lived if higher future welfare depends on rising levels of consumption. There is, however, more damning evidence to consider. Recently developed indicators of economic welfare (e.g., the Index of Sustainable Economic Welfare and Genuine Progress Indicator) suggest that an increasing scale of economic activity has rendered the average person worse off in most developed countries since the 1970s. In other words, the current growth in the physical scale of macroeconomic systems is already having a negative impact on economic welfare (see Daly and Cobb, 1989; Diefenbacher, 1994; Moffat and Wilson, 1994; Max-Neef, 1995; Redefining Progress, 1995; Rosenberg and Oegema, 1995; Jackson and Stymne, 1996; Jackson et al., 1997; Guenno and Tiezzi, 1998; Castaneda, 1999; Lawn and Sanders, 1999; Clarke and Islam, 2005; Chapters 6 and 7). Why should we expect the welfare of future generations to be higher than it is at present? Continuing growth at the expense of qualitative improvement (development) is only likely to lower welfare in the future. Unquestionably, the moral obligation to operate sustainably plus the apparent growth-induced decline in current welfare means that a nation’s natural resource policy should be based on natural capital maintenance (strong sustainability). Population control measures also need to be introduced.5 Meanwhile, the focus of economic activities should be diverted away from quantitative expansion and reoriented towards qualitative improvement. That is, all but impoverished nations should immediately initiate the transition towards a steady-state economy to achieve sustainable development. The final set of simulation exercises suggests something else of importance. Strictly speaking, each of the preferred long-run paths under the four different social discount rates was intertemporally efficient (Table 4.1). Yet only two of them were ecologically sustainable. This clearly reveals what ecological economists have long been arguing – intertemporal efficiency does not necessarily equate with ecological sustainability (intergenerational

78


equity). If ecological sustainability is a more fundamental goal than intertemporal efficiency, as some believe it is, should we subordinate the efficiency goal to the sustainability goal in circumstances where the social discount rate contributes to an unsustainable long-run path? Oddly enough, the answer is both yes and no. It is yes in the sense that if efficiency threatens sustainability, and society desires the latter (i.e., considers ecological sustainability to have objective value that ought not to be violated), it will be necessary to install the required institutions to ensure natural capital maintenance (Page, 1977; Common and Perrings, 1992). At the same time, the answer is no in the sense that subordinating efficiency to sustainability need not threaten the resolution of the former goal (Daly, 1991a; Lawn, 2000). Efficiency, after all, is equivalent to making the best of a given set of circumstances and, in theory, Pareto efficiency is achievable under any circumstances. What the initial set of circumstances ultimately determines is the quality of any ensuing Pareto optimal outcome. Provided the market mechanism is able to perform its rightful allocation function, and this is a critical factor, market prices can still grind out an efficient or near welfare-maximising outcome. Thus, in the case where natural capitalmaintaining institutions have been collectively established, the market can be called upon to generate the most desirable outcome from a sustainable incoming resource flow, irrespective of the social discount rate.6 This will differ markedly from the best possible outcome being generated from a resource flow that, depending on the social rate of discount, is unsustainable. Only in the former instance is it possible to guarantee a macroeconomic adjustment towards the optimal scale (S* in Figure 2.4). Having said this, attaining a macroeconomic scale somewhere near the optimum will depend upon how well the market can still perform its allocation function. This, in turn, will depend upon the nature of the natural capital-maintaining institutions installed – that is, the extent to which any imposed limitations on resource rights remain transferable, and how well resource prices continue to accurately reflect the relative scarcity of each resource type. As will be argued in later chapters, this is best achieved through the implementation of tradeable resource use permits. Details about the permit system will be outlined and explained in greater detail in Chapter 11 when the focus of attention switches to ecological tax reform as a means of initiating the transition to a steady-state economy.

CONCLUDING REMARKS In this chapter, a time dimension was incorporated into the Bergstrom production function to better appreciate the long-run production possibilities


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of an economic system. The results of the subsequent simulation exercises indicate that a society must choose between a sustainable or unsustainable pathway where, if the latter is chosen, a higher level of consumption can be enjoyed but only in the short or medium term. From a strictly utilitarian perspective, the choice of pathway will depend largely on the rate at which the present generation discounts future consumption. Moreover, it would appear that a threshold discount rate exists above which ecological unsustainability is, from a strictly utilitarian perspective, the preferred long-run path of the present generation. On the other hand, if a nation or society considers ecological sustainability to have objective value that should not be violated, it will have little option but to keep natural capital intact and introduce policies to control population growth. It will also have to determine the means by which it can simultaneously resolve the sustainability, equity and efficiency goals. Market prices are widely interpreted as indicators of impending scarcity. Since it has been shown that ecological sustainability and intertemporal efficiency do not necessarily coincide, an investigation into how well natural resource prices reflect the absolute scarcity of natural resources is warranted. Should it be demonstrated that market prices have the capacity to reflect the relative scarcity of different resource types but not their absolute scarcity (the former being an important allocative instrument only), it would be safe to conclude that natural resource prices are inadequate sustainability signals. We simply wouldn’t be able to rely on resource prices to indicate whether the stocks of particular resources are in decline, or as a means of determining the sustainable rate of resource use. It is with this in mind that an investigation into natural resource prices and its relationship with natural resource scarcity is undertaken in the next chapter.

NOTES 1. One can argue that the welfare benefits of the allocation process depend very much upon the appropriate ranking of tastes and preferences. That is, preferences (intermediate ends) must be ranked in relation to a well-conceived Ultimate End and the modern consumerist ethic is probably reflective of an Ultimate End gone horribly wrong. This is arguably true; however, an ill-conceived Ultimate End is unlikely to be reflective of the allocation process per se. Nor is it likely that tastes and preferences ranked in accordance with an appropriate Ultimate End – however the latter may be defined – would result in the general public having a non-positive rate of time preference (i.e., negative discount rate). 2. It should be noted that discounting reduces the benefits and costs in monetary terms not biophysical terms. 3. For a derivation of the marginal products of both the human-made capital/technology factor and low entropy resource input, see Lawn (2003).

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4. This doesn’t mean that present wants should not be met. It simply means that the needs of future generations should take precedence over whatever present wants, if satisfied, jeopardise future needs. 5. For a discussion on how to control population growth and to ensure natural capital maintenance, see Daly (1996) and Lawn (2000). 6. Since intragenerational equity is also a critical element in achieving sustainable development, it is also necessary to have appropriate distributional institutions installed.

5.

Natural resource prices and natural resource scarcity

INTRODUCTION Over the last 30 years there has been considerable debate as to what constitutes the most appropriate indicator of natural resource scarcity. The debate is not only the consequence of incomplete and imperfect data (Brown and Field, 1979; Cleveland and Stern, 2001), it is the upshot of a continuing disagreement about what is meant by resource scarcity and what its potential implications are for human well-being (Barnett, 1979; Smith and Krutilla, 1979; Smith, 1980; Slade, 1982; Hall and Hall, 1984; Mueller and Gorin, 1985; Cairns, 1990; Cleveland, 1991; Farzin, 1995; Ruth, 1995b). Ecological economists believe that much of the debate has been complicated by the lack of understanding of a number of key aspects. These include: (a) the physical properties of natural resources; (b) the role played by natural resources in the economic process; and (c) the difference between the efficient allocation of natural resources and the sustainable rate of natural resource use. While the debates surrounding the first two aspects are well known to most economists, although not always properly understood, the debate surrounding the latter is not. The reason for this stems from the general belief that the sustainability problem can be adequately resolved by dealing with the allocation problem alone. ‘Get the prices right’, most economists say, and a sustainable rate of resource use is achieved along with allocative efficiency. Ecological economists strongly refute this in the same way most economists refute the suggestion that allocative efficiency ensures distributional equity (Howarth and Norgaard, 1990; Daly, 1992 and 1996; Lawn, 2000). According to ecological economists, it is because of this third factor that mainstream economists make an erroneous assertion – namely, that a shadow is automatically cast in the form of a higher market price whenever a resource becomes increasingly scarce. Furthermore, it is this supposed tendency for the market price of a scarce resource to rise that induces the substitution towards more abundant resources and the development of resource-saving technological progress. Thus it is generally claimed that resource prices always provide the necessary signals to trigger whatever 81

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human action is needed to ward off the potential welfare-declining impact of increasing resource scarcity. So ingrained among some economists is their belief in the ability of resource prices to respond to increasing scarcity, it formed the basis for the attacks on the ‘limits to growth’ thesis put forward by Meadows et al. (1972) in the Club of Rome report. Consider the following: [T]hey (the Club of Rome) give precious little attention to the economic negative feedbacks that would upset their whole system. By this I mean the incentives to new exploration, recycling, and the use of substitutes that would be occurring gradually as the increasing scarcity of any product led to an upward trend in its price (parentheses added) (Beckerman, 1972, p. 357).

In direct contrast to the mainstream position, an increasing number of ecological economists are of the view that while resource prices are reasonably adept at reflecting the relative scarcity of various resource types (e.g., how scarce oil is relative to coal), the same cannot be said for their ability to reflect the absolute scarcity of both a particular resource type and the entire stock of all resources (Norgaard, 1990; Bishop, 1993; Daly, 1996; Lawn, 2000). Hence many ecological economists believe that actual resource prices provide no guidance as to whether the stocks of particular resources are in decline, or as a means of determining the sustainable rate of resource use.1 To date, the arguments put forward by this growing number of ecological economists have been verbally based. The aim of this chapter is to provide theoretical support for their emerging position. To achieve its aim, the chapter is organised as follows. First, the concept of resource scarcity is discussed and defined. Also explained is the difference between the notions of relative and absolute scarcity. Second, the verbal argument put forward by ecological economists is outlined. Third, a typology of resource scarcity is introduced in order to: (a) detail the various resource scarcities applicable under different assumptions and conditions, and (b) to ascertain the most relevant of these resource scarcities and, therefore, the most applicable scarcity indexes. Fourth, theoretical support is provided for the ecological economic position by way of a welfare-maximising resource depletion model. Finally, the simulation results of the model are outlined and discussed.

A DEFINITION OF RESOURCE SCARCITY When economists refer to natural resource scarcity, what do they really mean? For some observers, increasing resource scarcity means fewer resource stocks while, for others, it refers to the economic impact of


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declining resource availability. Since the economic factor cannot be ignored, a definition of natural resource scarcity must take account of the relationship between quantities and qualities of natural resource stocks, technological progress as it relates to the extraction of natural resources and their transformation into physical goods, and the overall impact of resource availability on human well-being – including the waste assimilative and life-support functions played by natural capital. Cleveland and Stern (2001) define resource scarcity as the extent to which human well-being is affected by the quality, availability or productivity of natural resource stocks. On this basis, relative scarcity can be considered the extent to which the quality, availability or productivity of a particular resource type impacts upon human well-being relative to the quality, availability or productivity of other resource types. Thus, if the availability of a particular resource declines relative to other resources, then, ceteris paribus, its positive contribution to human well-being comparatively declines and, as such, its relative scarcity increases. There are two aspects related to absolute scarcity. The first aspect concerns the absolute scarcity of a particular resource type – that is, the extent to which the quality, availability or productivity of a specific resource type impacts on human well-being irrespective of any relative comparison with the quality, availability or productivity of other resources. The second aspect concerns the quality, availability or productivity of the entire stock of all resources. A distinction between the two aspects is important because an increase in the absolute scarcity of a particular resource type can be mitigated by the substitution of one resource type for another, although this should not be confused with the substitution of human-made capital for declining natural capital. I should point out that it is possible for the absolute and relative scarcity of a particular resource to move in opposite directions. For example, if the absolute scarcity of a particular resource rises at a much lesser rate than all other resources, its relative scarcity decreases. Similarly, the absolute scarcity of a particular resource can fall and its relative scarcity can increase if the decline in its absolute scarcity is less than the rate of decline in the absolute scarcity of all other resources. Ecological economists believe that the difference between relative and absolute scarcity is a critical one. As I pointed out in the introduction, many ecological economists believe that resource prices are able to reflect relative scarcities with some degree of accuracy but not the absolute scarcity of all resources. While the relative scarcity information provided by resource prices is very useful in terms of how best to allocate various resources to alternative product uses, sustainability is a question of the absolute scarcity of the non-substitutable low entropy matter-energy that sustains the

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economic process, not the relative scarcity of its constituent types. To achieve ecological sustainability, ecological economists believe it is necessary to establish a separate institutional mechanism based on ecological criteria in the same way intragenerational equity requires a separate institutional mechanism based on ethical criteria (Daly, 1992 and 1996; Lawn, 2000).

THE ECOLOGICAL ECONOMIC ARGUMENT REGARDING RESOURCE PRICES AND RESOURCE SCARCITY On what basis do ecological economists believe resource prices are unable to reflect the absolute scarcity of resources? Their verbal argument can be summarised by the following. First, relative prices are generated by interacting market demand and supply forces that are essentially flow-based forces. By flow-based forces I mean the inflowing quantity of low entropy resources demanded at various prices by resource buyers and, on the supply-side, the inflowing quantity of the various types and grades of low entropy resources supplied at various prices by resource sellers. Second, while the stock of a particular resource has some bearing over the inflowing quantity being supplied, the supply of a particular incoming flow at any point in time is much less restricted than the supply of the same incoming flow over time. For example, if timber suppliers opted to double the quantity of timber supplied to a particular timber market, they could do so for some limited period even if the rate of supply exceeded the capacity of forests/timber plantations to supply the same quantity of timber over time. As for the suppliers of a non-renewable resource, any quantity supplied at a particular point in time cannot be continued indefinitely. However, until the stock of the resource is close to exhaustion, it is still possible for its short-term supply to be increased. Third, in the short term when a larger, yet unsustainable, quantity of a particular resource is being supplied, it is possible, at least during the initial depletion phase of the resource, for the price-influencing effect of flowbased forces to dominate the stock effect. Should this be occurring, the relative price of the dwindling resource will fall, not rise – as one would expect of the short-run price for crude oil if, for example, OPEC countries immediately increased oil production. Would this fall in price be a reflection of its declining absolute scarcity? No. It would be a reflection of a higher inflowing quantity (declining relative scarcity) at a time when the remaining stock was shrinking (increasing absolute scarcity). It is true that the stock effect on resource prices must eventually outweigh the flow effect since, on the supply-side, resource prices are also influenced


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by the cost of extraction/harvesting. This cost is likely to rise sharply as it becomes increasingly difficult to sustain the same inflowing quantity from an ever-diminishing stock. Clearly, resource prices must eventually reflect an increase in the absolute scarcity of low entropy matter-energy. But there are three main reasons why the conveyance of this information in markets is likely to be delayed or not be properly conveyed at all. First, resources themselves are required to extract/harvest resources. If the prices of the resources used to extract/harvest new resources are understated, so is the cost of extraction. This, in turn, understates the cost of future extraction, and so on. Second, futures markets are imperfect at best and nonexistent at worst. Third, where futures markets exist, they are designed to capture the stock effect on the future supplies of particular resources. For example, if the stock of a particular resource is severely limited, so are future supplies. One would expect the price of a rapidly dwindling resource in a futures contract to be very high to reflect the shortage of future supplies. While the price might well be higher, it is unlikely to be sufficiently high because people have the tendency to discount future values, including the cost to future generations of having smaller resource stocks. Furthermore, future generations, the very people most likely to be adversely affected by increasing resource scarcity, have no way of bidding in the present for the future availability of resources. Taken together, these factors may or may not threaten the intergenerational efficiency of resource use. However, as demonstrated in the previous chapter, intergenerational efficiency does not guarantee intergenerational equity (sustainability) in the same way intragenerational efficiency need not coincide with intragenerational equity (Howarth and Norgaard, 1990; Daly, 1992). In all, the price signals generated by resource markets, including futures markets, may prove ineffective at ensuring natural capital maintenance and a sustainable resource flow. Since ecological sustainability is a resource throughput problem, not a resource allocation problem, ecological economists believe the achievement of the former requires the incoming resource flow to be quantitatively restricted to a rate that is within the regenerative and waste assimilative capacities of the natural environment – for example, by way of auctioning off a limited number of tradeable resource use permits (see Lawn, 2000; and Chapters 10 and 11). The absolute scarcity factor is incorporated into resource prices because the quantitative restriction on the incoming resource flow limits flow-based (supply-side) market forces to a magnitude consistent with the regenerative and waste assimilative capacities of the natural envionment. In other words, ecological limits, not just costs, are internalised into resource prices which ensures that the price effect of lower stocks is not overwhelmed by short-term flow-based forces. This leaves the relative scarcity

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factor to be determined by demand-side forces plus whatever it costs to supply an ecologically sustainable quantity of a particular resource. Of course, the aforementioned might apply to renewable resources. What about non-renewable resources that, by their very nature, cannot be exploited sustainably? Given that non-renewable resources are the main focus of this chapter, a detailed explanation will be given soon. Suffice to say now, some of the proceeds from non-renewable resource depletion must be diverted towards the cultivation of a renewable resource substitute and/or the augmentation of the regeneration rate of renewable natural capital.2 Provided the replacement asset is able to sustain the same resource flow as the exhausted non-renewable resource asset, the flow-based (supplyside) market forces remain compatible with an augmented sustainable flow of renewable resources. This, in turn, ensures the absolute scarcity factor is incorporated into non-renewable resource prices.

A TYPOLOGY OF RESOURCE SCARCITY The notion of resource scarcity is far more complex than that indicated by a simple dichotomy between relative and absolute scarcity. Resource scarcity also depends on the assumptions made about the magnitude of resource stocks, the physical properties of matter and energy, and the ability, if it exists, of human-made capital and the technology embodied within it to ‘substitute’ for natural capital. In searching for a broader typology of resource scarcity, it is worth considering what Fisher (1979) has said about scarcity indexes. Fisher believes a measure of resource scarcity requires one essential property – it must reflect the direct and indirect sacrifices made to obtain a unit of the resource. Interestingly, since the sacrifices made to obtain a unit of a particular resource determine the extent to which the quality, availability and productivity of natural resource stocks affects human well-being, Fisher’s view on scarcity indexes corresponds closely with Cleveland and Stern’s (2001) definition of resource scarcity. In applying Fisher’s criterion, Hall and Hall (1984) argue that an appropriate measure of resource scarcity depends critically upon the nature of the scarcity perceived to be of relevance. This is because alternative definitions of scarcity involve a different assortment of sacrifices and, thus, the need for a different scarcity index. An important question now emerges: Under what circumstances and conditions are the various scarcity indexes able to adequately guide resource liquidators/users and policy makers? This question arises because it is clearly necessary to understand the applicability of the


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different definitions of resource scarcity in order to recognise the usefulness and shortcomings of the various scarcity indexes. Hall and Hall (1984) have attempted to answer a similar question by establishing a fourfold scarcity typology based on the Malthusian and Ricardian views on resources – the former that resources are limited in an absolute sense; the latter that there is only a decline in the quality of resources, not a limit on the total available resource stock. The four definitions of scarcity put forward by Hall and Hall are Ricardian Flow Scarcity (RFS), Ricardian Stock Scarcity (RSS), Malthusian Flow Scarcity (MFS) and Malthusian Stock Scarcity (MSS). I would like to put forward a five-fold scarcity typology similar to Hall and Hall’s typology except that it includes two Malthusian stock scarcities – Weak Malthusian Stock Scarcity (WMSS) and Strong Malthusian Stock Scarcity (SMSS). The two Malthusian stock scarcities account for the emerging ‘weak’ and ‘strong’ notions of sustainability. As will soon be demonstrated, the five-fold scarcity typology is also designed to relate the two flow scarcities (RFS and MFS) to the relative scarcity of particular resources, and the three stock scarcities (RSS, WMSS and SMSS) to the absolute scarcity of the total resource stock. Ricardian Flow Scarcity (RFS) Advocates of the RFS position believe the importance of varying resource quality diminishes as technological advances are made – indeed, so much so, it is possible to sustain a continued flow of resources of equal or superior quality over time. An example of the RFS position is that of Barnett and Morse (1963, p. 11): Advances in fundamental science make it possible to take advantage of the uniformity of matter-energy – a uniformity that makes it feasible, without preassignable limit, to escape the quantitative constraints imposed by the character of the earth’s crust . . . Science, by making the resource base more homogeneous, erases the restrictions once thought to reside in the lack of homogeneity. In a neo-Ricardian world, it seems, the particular resources with which one starts increasingly become a matter of indifference.

In theory, a rise in RFS would occur if the rate at which science ‘homogenised’ the resource base was insufficient to offset the decline in the availability of high quality resources. This is because the sacrifices required to supply a unit of a particular resource would increase and, in doing so, reduce human well-being. In these circumstances, an increase in RFS would be reflected by a rise in the price of a non-renewable resource that, itself, would reflect the marginal cost of its extraction:3

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RFS: P MC

(5.1)

where P price and MCthe marginal cost of resource extraction. It is worth noting that, under RFS conditions, the in situ price or royalty of a non-renewable resource is assumed to be zero. Malthusian Flow Scarcity (MFS) MFS differs to RFS insofar as the Malthusian assumption of a fixed quantity of resources reduces humankind’s ability to continually supply a unit of a particular resource. Having said this, the MFS position accepts that resource extraction progress can, to some extent, reduce the impact of a fixed quantity of resources on human well-being. In recognition of the absolute scarcity effect of a fixed quantity of resources, the MFS position accounts for what the RFS approach overlooks – namely, the opportunity cost of resource extraction in terms of lower future stocks. In this sense, the price of a resource under MFS conditions should, in theory, better reflect the absolute scarcity of a resource than the price under RFS conditions. However, for reasons soon to be outlined, many ecological economists believe that the price of a resource under MFS conditions still inadequately reflects the absolute scarcity of a resource. It is this claim that is examined more closely in the upcoming simulation exercises. The opportunity cost of a resource accounted for under MFS conditions constitutes the in situ price or royalty of a non-renewable resource that must grow at the rate of interest to ensure resource extraction in each time period. As such, an increase in MFS is reflected by a rise in the sum of the marginal cost of resource extraction and the opportunity cost of lower resource stocks: MFS:

PMC OC

(5.2)

where OC the opportunity cost of lower resource stocks. Equation (5.2) constitutes the basis for the Hotelling (1931) price rule on non-renewable resources. Ricardian Stock Scarcity (RSS) Both RSS and MSS go much further than the above flow scarcities by recognising the contribution resources play in sustaining the economic process. Some time ago, Hicks (1946) pointed out that ‘true’ income is the maximum amount that can be produced and consumed today without undermining the capacity to do likewise in the future. In a practical sense,


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the ability to sustain Hicksian income depends upon the maintenance of income-generating capital. Both the RFS and MFS positions ignore this aspect which, according to many ecological economists, goes a long way towards explaining the inadequacies of RFS and MFS based indexes. Because RSS is based on the proposition that resources are not fixed in an absolute sense – they merely decline in quality – sustaining Hicksian income requires no more than the non-declining productivity of incomegenerating capital. Of course, if it is assumed that the non-renewable resources of highest quality are exhausted first, it is not possible for the quality of non-renewable resources to remain unchanged – unless, as per the RFS position, science is able to sufficiently homogenise the resource base to offset the decline in the availability of high quality resources. The RSS position refutes the ability of science to accomplish this feat on the basis that resource homogenisation stands in stark contrast to the first and second laws of thermodynamics. Because of these two physical laws, it is not the uniformity of matter-energy that makes something useful. To the contrary, ‘usefulness’ is possible because of the difference in the concentration and temperature of matter and energy (Georgescu-Roegen, 1971; Daly, 1991a). Indeed, if all matter-energy was uniformly distributed in thermodynamic equilibrium, there would be a total absence of potential for any physical process to occur – sometimes referred to as a ‘heat death’. In view of the unavoidable decline in resource quality under the RSS position, non-renewable resource extraction involves a ‘user cost’. The user cost represents the sacrifices that would need to be made to ensure, over time, an equally productive stock of income-generating capital. An important consideration now is: How does one calculate the user cost of non-renewable resource extraction? There are several suggestions. The first was posited long ago by John Ise (1925). Ise believed it was prudent to price non-renewable resources at the cost of their nearest substitute. In this sense, the user cost constitutes the difference between the cost of resource extraction and the price of the nearest substitute asset. A second and more practical approach has been put forward by Salah El Serafy (1989). As explained in Chapter 3, El Serafy has developed a formula for calculating the income and set-aside (user cost) components of resource depletion profits (see equation 3.22). To recall, the formula enables a resource liquidator to determine the percentage of resource extraction profits that must be set aside to establish a replacement asset capable of generating a sustainable income stream. But, to ensure sustainability, the discount rate must approximate the interest rate (i) earned from the best alternative replacement asset. El Serafy makes no stipulation as to what form the replacement asset should take – that is, whether it is a human-made capital or natural capital asset. As we shall soon see, this may prove to be of particular importance.

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Since Ricardian scarcity denies the existence of a fixed quantity or absolute scarcity of resources, a measure of RSS makes no allowance for the opportunity cost of lower resource stocks. Thus, as per the RFS position, the in situ price of a non-renewable resource is again assumed to be zero. Given the aforementioned, an increase in RSS is reflected by a rise in the sum of the marginal cost of resource extraction and the user cost reflecting the decline in resource quality over time: RSS:

P MC UC(i)

(5.3)

where UC the user cost of non-renewable resource depletion and i the interest rate generated by the replacement asset, whether it be a humanmade or natural capital asset. Weak Malthusian Stock Scarcity (WMSS) The distinction between Malthusian and Ricardian Stock Scarcity becomes a fairly obvious one. Since the former assumes that the quantity of resources is limited in an absolute sense, sustaining Hicksian income requires more than a non-negative change in the productivity of income-generating capital. It also requires that the physical quantity of income-generating capital be kept intact since a constantly productive albeit diminishing capital stock is unable to sustain Hicksian income. A key issue requiring consideration at this point is whether it is necessary to keep a combined stock of human-made and natural capital intact or a constant stock of both forms of capital. This depends on whether the two forms of capital are substitutes or complements. Should human-made capital be a substitute for natural capital, there is only a need to keep a combined stock of human-made and natural capital intact. This is often referred to as the ‘weak’ sustainability position (Pearce and Turner, 1990). Advocates of weak sustainability believe it matters little if a replacement asset is the form of human-made capital or natural capital – one simply invests the necessary portion of depletion profits, as per the El Serafy formula, into the best available replacement asset. Unlike the RSS stance, the assumed existence of a fixed quantity of nonrenewable resources under the WMSS position ensures the opportunity cost of lower non-renewable resource stocks remains. An increase in WMSS is thus reflected by a rise in the sum of the marginal cost of resource extraction, the opportunity cost of lower resource stocks, and the user cost reflecting a decline in the combined stock of income-generating capital: WMSS: PMC OC UC(i)

(5.4)


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Two things are worth noting at this point. First, should the price of a nonrenewable resource accurately reflect WMSS, the difference between the in situ price and the price of an extracted unit is much greater than under MFS assumptions. Second, and because of the first point, the optimal depletion time is lengthened under WMSS conditions (Lawn, 2005). Strong Malthusian Stock Scarcity (SMSS) Ecological economists are of the view that human-made and natural capital are complementary forms of capital. While it is true that the technological progress embodied in human-made capital can reduce the natural capital required to sustain Hicksian income, for a number of reasons, this does not amount to substitution in the sense of human-made capital ‘taking the place’ of natural capital (Lawn, 1999). First, technological progress only reduces the high entropy waste generated in the transformation of natural capital to physical goods. Second, because of the first and second laws of thermodynamics, there is a limit to how much production waste can be reduced by technological progress – there can be no 100 per cent production efficiency; there can never be 100 per cent recycling of matter; and there is no way to recycle energy at all (Georgescu-Roegen, 1971). Thus the production of a given quantity of goods always requires a minimum resource flow and, therefore, a minimum amount of resource-providing natural capital (Pearce et al., 1989; Costanza et al., 1991; Folke et al., 1994; Daly, 1996).4 Third, human-made capital itself requires natural capital for it to exist and be maintained. Finally, natural capital provides a range of life-support services that human-made capital cannot replicate. The natural capital required to ensure these services are sustained is likely to far exceed the quantity required to sustain the production of physical goods alone. Thus, for precautionary reasons, ecological economists believe it is necessary to keep the stock of natural capital intact – what is referred to as the strong sustainability position. In rejecting the WMSS position, ecological economists have stressed that some portion of the profits obtained from the depletion of nonrenewable resources must be invested into renewable resource substitutes. This has considerable implications for the user cost of non-renewable resource depletion. As explained in Chapter 3, the discount rate in the El Serafy formula must approximate the interest rate generated by the cultivated renewable resource assets (Lawn, 1998). This interest rate is effectively equal to the regeneration rate of renewable resources (r) and may be lower than the interest rate generated by human-made capital (i). If so, the user cost will be higher in the strong sustainability case than in

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the weak sustainability case, which would: (a) lead to a greater disparity between the in situ price and the extracted unit price of a non-renewable resource, and (b) further lengthen the optimal depletion time of a nonrenewable resource. However, should r i, WMSS is subsumed by SMSS since the most viable investment option is the cultivation of a renewable resource asset. Overall, an increase in SMSS is reflected by a rise in the sum of the marginal cost of resource extraction, the opportunity cost of lower resource stocks, and the user cost reflecting the decline in the stock of natural capital: SMSS:

P MC OC UC(r)

(5.5)

where r the regeneration rate of the natural capital asset being cultivated to replace the soon-to-be exhausted non-renewable resource asset.

AN ECOLOGICAL ECONOMIC PERSPECTIVE OF THE RESOURCE SCARCITY INDEXES Table 5.1 summarises the five-fold scarcity typology. From an ecological economic perspective, the shortcomings of the two flow scarcities plus the need for natural capital maintenance means an adequate reflection of both relative and absolute scarcities can only be served by an index measuring SMSS. The RFS index fails in both regards while an MFS index reflects relative resource scarcities only. Although the WMSS index incorporates the constant capital stock requirement, it is based on the false assumption that human-made capital can substitute for natural capital. It therefore only reflects both relative and absolute resource scarcities in circumstances where r i. If ecological economists are correct in what they say, what should the price path of a non-renewable resource look like? Ideally, an increase in its absolute scarcity ought to be mirrored by a rise in its market price. Moreover, an increase in its relative scarcity should be accompanied by a growing disparity between the price of it and other resources. Finally, an increase in the absolute scarcity of the full range of resource types should lead to a rise in the market price of all resources. In circumstances where the absolute scarcity of a particular resource falls at a lesser rate than all other resources – in which case its relative scarcity increases – one ought to expect the price of the resource in question to decline but by a lesser percentage than the price of other resources. Thus, its relative price should be higher.

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SMSS is preferred scarcity type with most appropriate scarcity index

P MC OC UC(r) • •

Strong Malthusian • absolute stock constraint Stock Scarcity • technology cannot homogenise matter-energy (SMSS) • must keep quantity of natural capital intact • human-made and natural capital are complements

Source:

wrongly assumes that human-made and natural capital are substitutes

P MC OC UC(i) • •

• absolute stock constraint • technology cannot homogenise matter-energy • must keep quantity of income-generating capital intact • human-made and natural capital are substitutes

Weak Malthusian Stock Scarcity (WMSS)

Lawn (2004a) with permission from Inderscience Enterprises Ltd.

• • • • • •

P MC UC(i)

• no absolute stock constraint • decline in resource quality only • technology cannot homogenise matter-energy • must keep quality of income-generating capital intact to sustain Hicksian income • human-made and natural capital are substitutes

Ricardian Stock Scarcity (RSS)

• • •

P MC OC

• absolute stock constraint • technology cannot homogenise matter-energy

by focussing on quality of incomegenerating capital, RSS overlooks need to keep quantity of income-generating capital intact to sustain Hicksian income wrongly assumes that human-made and natural capital are substitutes

overlooks need to keep stock of income-generating capital intact to sustain Hicksian income

wrongly assumes no absolute stock constraint wrongly assumes technology has capacity to homogenise matter-energy

• • • •

P MC

Malthusian Flow Scarcity (MFS)

no absolute stock constraint decline in resource quality only technology can homogenise matter-energy

• • •

Ricardian Flow Scarcity (RFS)

Ecological economic perspective

Scarcity index

Assumptions

Scarcity type

Table 5.1 Summary of the five-fold scarcity typology

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Simulation Exercises to Support the Ecological Economic Position To provide theoretical support for the ecological economic stance on resource scarcity, the Hotelling model will now be applied to a hypothetical non-renewable resource. The aim of the upcoming simulation exercises is to highlight both the inadequacies of the MFS position and to demonstrate that market prices are unable to reflect the absolute scarcity of a particular resource type. Conclusions regarding the WMSS and SMSS positions and support for the ecological economic stance on the latter are the subject of future work. It is important, at this point, to explain why the Hotelling model has been chosen to conduct the simulation exercises. As it turns out, it is not so much that the Hotelling model is able to capture the MFS position. Indeed, as we shall soon see, it will reveal the MFS position to be a false one. The Hotelling model has been chosen because it is a standard welfare-maximising model that supposedly generates a price path reflecting the relative and absolute scarcity of a particular resource type. Should the Hotelling model succeed in this regard, the MFS position is validated. If not, then at least the first part of the emerging ecological economic argument is theoretically sound even if there is not universal support for the SMSS position. The Hotelling model used to conduct the various simulation exercises initially begins with the following assumptions: ● ●

● ● ● ● ●

the initial gross price (P0) of the non-renewable resource (at time t0) $17.76 per tonne (1000 kg); the final gross price (PT) equals the choke price (J) of the nonrenewable resource$36.65, (that is, the price of the resource that, when reached, results in the resource no longer being demanded); the marginal cost of resource extraction$10.00 and remains constant over time; the interest rate on alternative assets, which is assumed to be the same as the discount rate, is 2.5%; the initial quantity of the non-renewable resource (S) is 2000 tonnes; the price elasticity of demand for the resource 0.01;5 to maximise social welfare, two conditions must be satisfied: (a) the resource must be fully depleted, and (b) the price of the resource must equal the choke price as the final tonne of the resource is extracted.

There are three important equations fundamental to the Hotelling model. These equations describe the demand for the resource (equation 5.6), the optimal gross price at any point in time during the resource depletion process (equation 5.7), and the optimal extraction quantity for each time

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period (equation 5.8). See Lawn (2004a) for the full derivation of equations (5.6), (5.7) and (5.8). The three equations are: Demand: Pt JeaRt

(5.6)

where Pt the gross price of the resource at a particular point in time; J the choke price of the resource; athe price elasticity of demand for the resource; and Rt the quantity of the resource extracted at a particular point in time. Extraction quantity:

Rt

ln J ln[(PT MC) (1 ) (Tt) MC] a (5.7)

where PT the gross price of the resource at the terminal time period – that is, the point in time when the entire stock of the resource is exhausted; MC marginal cost of resource extraction; and the discount rate. Gross resource price: Pt J exp([ln J ln[(PT MC)(1 ) (Tt) MC]])

(5.8)

It will also be assumed that any changes in the parameters of the model are a priori unknown by the resource liquidators and that any knowledge of resource discoveries or resource extraction technological progress occurs at the very end of each time period. For this reason, decisions altering the optimal extraction rate and the optimal resource price occur at the beginning of the following time period. This, in a sense, renders the model one of a discrete time variety as opposed to Slade’s (1982) continuous time model. However, the advantage of this model is that it includes: (a) the possibility of resource discoveries; (b) the potential for technological progress to lower the marginal cost of resource extraction; and (c) the impact of past resource prices on the present gross price. In the first simulation, it is assumed that the parameters of the model remain constant over the time it takes to fully deplete the resource. That is, there is no resource extraction technological progress, there are no new resource discoveries, and the discount rate remains unchanged. In addition, the present gross price is unaffected by past resource prices. Figure 5.1 reveals the optimal price pattern/path for the non-renewable resource in question. With the parameters of the model remaining constant over time, the gross price rises as the stock of the resource diminishes. The initial net price or the in situ price of the resource (P0 MC) increases at the rate of interest. It takes 50 years (51 time periods) to fully deplete the

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0 t0

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t30

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Source: Lawn (2004a) with permission from Inderscience Enterprises Ltd.

Figure 5.1 Optimal resource price and size of resource stock – Simulation 1 (unchanged parameters) resource. The optimal price path revealed in Figure 5.1 is that expected as per the Hotelling price rule on non-renewable resources (with positive extraction costs). So long as there are no changes in the conditions associated with the extraction of the resource, the increase in the gross price of the resource accurately reflects the rise in its absolute scarcity. Undoubtedly, the conditions associated with the extraction of any resource will vary over time. So, therefore, will its optimal price path. The question that arises is this: Should the absolute scarcity of the resource increase, will the price path of the resource continue to reflect its changing relative and absolute scarcity? In the second simulation, it is assumed that resource discoveries occur for the first 25 time periods following t0 at the rate of 3.25 per cent of the remaining resource stock. It is also assumed that technological progress reduces the marginal cost of resource extraction at the rate of 1 (0.05t 1) per time period. Finally, it is also assumed that resource liquidators believe that, following any decline in the marginal cost of extraction, the marginal cost will remain constant until the resource has been fully exhausted or until there has been further technological progress which they cannot predict. A few things need to be said about these assumptions. First, they are quite realistic – there is a finite quantity of each non-renewable resource and discoveries of substantially meaningful quantities must eventually cease. In addition, there are thermodynamic limits to advances in resource extraction technology (Peet, 1992). Hence the marginal cost of resource


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extraction is always positive, while reductions in marginal cost via technological progress become increasingly more difficult to achieve. Second, the rates at which both new discoveries are made and the marginal cost of resource extraction declines have been deliberately chosen so that the stock of the resource falls over time. This is to ensure there is a continual increase in the absolute scarcity of the hypothetical resource. Finally, while the assumption regarding the lack of predictability of future resource extraction progress is somewhat dubious, it is designed to facilitate model simplification. For example, predictability would require the MC in equations (5.7) and (5.8) to be functions themselves, rather than constants, thereby seriously complicating the model. Furthermore, one would have to make an assumption about the degree of predictability. In any case, the incorporation of a predicted downward trend in the marginal cost of extraction would result in greater downward pressure on the simulated resource price path. Omitting the predictability of resource extraction progress is therefore unfavourable to the ecological economic position on absolute scarcity. There is, in my opinion, no bias on my part to generate a result to support the arguments put forward by most ecological economists. The third simulation is designed to show that resource prices can adequately reflect the relative scarcity of different resource types. In this case, a second hypothetical resource will also be exhausted. To simplify matters, everything associated with this second resource is exactly the same as the first resource – that is, it has the same starting price ($17.76), same initial quantity (2000 tonnes), same initial marginal cost of extraction ($10.00), and the same rate of resource extraction progress. The only difference between the two simulations is that there are no additional discoveries of the second resource. This ensures that the second resource is depleted much sooner than the first. In doing so, the relative scarcity of the second resource will increase while, conversely, it will decline in the case of the first resource. Figure 5.2 reveals the new optimal price pattern/path for the two nonrenewable resources (Simulations 2 and 3). Because there is a change in at least one of the model’s parameters at the end of each time period, the optimal price paths in Figure 5.2 constitute the locus of all the initial resource prices following the adjustments made over time by the liquidators of the two hypothetical resources (i.e., the initial prices for each new optimal price path at the beginning of each successive time period). As can be seen from Figure 5.2, the gross price of the first resource falls from its initial starting value of $17.76 per tonne to $16.75 per tonne by time t13. This occurs despite a considerable diminution of the resource stock. The first resource is fully exhausted in time period t62. In line with the verbal argument put forward by ecological economists, the dominating influence

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20 $17.76 $17.74

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10

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Marginal Cost 0 t0

t5

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Figure 5.2 Optimal resource price and size of resource stock – Simulation 2 (fall in MC of extraction; resource discoveries at the rate of 3.25% of remaining stock) and Simulation 3 (fall in MC of extraction; no resource discoveries) of flow-based demand and supply forces plus the discounted future welfare impact of lower resource stocks causes the resource price to fall in the initial stages. Following time t13, the gross resource price rapidly rises as a consequence of the eventual domination of the stock effect. If it is acknowledged that human welfare is dependent upon natural capital stock maintenance (the SMSS position), it is quite clear that the gross price of the resource may, for some time, fail to reflect the resource’s increasing absolute scarcity. The same can be said of the gross price of the second resource. Despite a continuing decline in the resource stock, the gross price falls marginally from its initial starting value of $17.76 per tonne to $17.74 per tonne and is fully exhausted in time period t45. Note that although the increasing absolute scarcity of both resources is not initially reflected by a rise in their gross price, there is a growing disparity between the price of both resources. This demonstrates that resource prices do successfully reflect the relative scarcity of both resources – that is, the gross price of the second resource is increasingly higher than the gross price of the first resource, despite the former’s initial decline, thereby reflecting the increasing relative scarcity of the second hypothetical resource. The fourth simulation relates to the non-renewable resource discussed in the second simulation exercise. It is in every way the same as the second

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Natural resource prices and natural resource scarcity $ 40

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0 t0

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Figure 5.3 Comparison of optimal resource price and size of resource stock – Simulation 2 (as previous) and Simulations 4 and 5 (gross price is a varied function of past prices) simulation except it is now assumed that the current gross price of the resource is a function of its previous price. The impact of past prices is incorporated by assuming that previous prices affect the marginal cost of resource extraction. In all, it is assumed that the marginal cost of resource extraction alters by the amount: MCt

P Pt2 1 · 1 t1P (0.05t 1) t2

(5.9)

where Pt1 and Pt2 denote the gross resource price in the previous two periods. In the fifth simulation, the alteration in the marginal cost of extraction is denoted by: MCt

P Pt2 1 · 1 0.5 t1P (0.05t 1) t2

(5.10)

The difference between the fourth and fifth simulation is that, in the former case, it is assumed that the percentage change in resource prices over the previous two time periods impacts fully on the marginal cost of extraction. In the latter case, it is assumed that half of the percentage change in resource prices impacts on the marginal cost. Figure 5.3 compares the

100 $


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Res. Stock – simul. 6 Res. Stock – simul. 5

Res. Stock – simul. 7 0 t0

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Figure 5.4 Comparison of optimal resource price and size of resource stock – Simulations 5, 6 and 7 (gross price is a function of price over previous two periods; discount rate2.5%, 5% and 10%) results of simulations 2, 4 and 5. Consistent with the argument presented by a growing number of ecological economists, Figure 5.3 shows that when the current resource price is a function of past prices, the gross price falls more dramatically in the initial stages than when it does not. Moreover, the larger of the three declines in the gross price accompanies the most rapid rate of extraction – a seemingly perverse result in that the lowest gross price is associated with the highest degree of absolute scarcity. In the final set of simulations it is assumed, firstly, that half of the percentage change in resource prices impacts on the marginal cost of extraction (as per simulation 5). What differs on this occasion is that a 5% and 10% discount rate is chosen to accompany the already used 2.5%. Figure 5.4 compares simulations 5, 6 and 7 (2.5%, 5% and 10%). It shows that when the future welfare impact of lower resource stocks is more heavily discounted, there is, initially, a more dramatic decline in the gross price of the resource. Once again, this occurs in unison with the more rapid exhaustion of the resource stock. An important point needs to be made. The above simulations are based on a social welfare-maximising model under supposed MFS conditions. However, not all resource extraction decisions are designed to maximise human well-being, even in an intergenerational efficiency sense. Many are motivated by political factors whereby governments often subsidise and encourage excessive rates of resource extraction to stimulate the growth of


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real GDP – the latter not always leading to increased human welfare (Lawn, 2000; Redefining Progress, 1995). Hence, the decline in resource prices that initially accompanies an increase in absolute scarcity could be far more severe and protracted than that indicated by the simulation model used in this chapter. The most alarming aspect regarding the simulation exercises is the revelation that conventional resource markets cannot be relied upon to ensure a sustainable rate of resource use. This being the case, what must we do to achieve sustainability and, in so doing, prevent macroeconomic systems from exceeding their maximum sustainable scale? The answer is quite clear. Just as we step outside the market domain and employ various redistribution mechanisms to achieve distributional equity, we must do likewise and impose, among other things, quantitative restrictions on the rate of resource throughput to achieve ecological sustainability. Whereas an ethical criterion is used to determine a just and equitable distribution of income and wealth, ecological criteria must be invoked to determine the appropriate rate of resource throughput. As we shall see, the market can then be employed to allocate the sustainable incoming resource flow efficiently. This allows the welfare generated from each unit of low entropy matter-energy to be maximised, thereby facilitating a macroeconomic adjustment towards the optimal scale. But the market should only be engaged following the institutionalisation of the sustainable rate of resource throughput, not before.

CONCLUDING REMARKS The standard welfare-maximising model employed in this chapter reveals that the price of a resource may not always rise to reflect the impact of increasing absolute scarcity on human well-being. Indeed, for a considerable length of time, the price of a resource can fall even as the stock of the resource declines. Furthermore, the extent of the fall in price is greater when a higher discount rate is applied and the marginal cost of resource extraction is assumed to be a function of past resource prices. Thus, the belief amongst many ecological economists that resource prices generated by conventional resource markets are unable to reflect the absolute scarcity of resource stocks appears to have strong theoretical support. As such, one must be cautious when using resource prices to ascertain whether the stocks of particular resources are in decline and/or as a basis for determining the sustainable rate of resource use. Of course, one could argue that the welfare-maximising model used to test the MFS position discussed in this chapter is itself inadequate and that

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an alternative model could yet validate the MFS position. I therefore invite those who support the MFS position to develop such a model. One could also argue that resource prices are of little value in reflecting the relative as well as the absolute scarcity of resources. I tend to believe, like a growing number of ecological economists, that resource prices serve as reasonably good indicators of relative scarcity (e.g., simulation 2 versus simulation 3) but fail miserably in terms of reflecting the absolute scarcity of individual resource types and the stock of all resources (e.g., simulations 2 and 4 through to 7). Whether resource prices based on the SMSS position can overcome this shortcoming – which requires the incorporation of an additional user cost factor in keeping with the need to keep natural capital intact (equation 5.5) – has not been ascertained. Needless to say, if the incorporation of the user cost as per the SMSS position is able to generate resource prices to reflect the absolute scarcity of each resource type, it should be possible to demonstrate that ecological limits can be internalised into resource prices. But it will, nonetheless, necessitate quantitative restrictions on the rate of resource throughput that must at all times be based on ecological rather than economic criteria.

NOTES 1. Having said this, there is a debate amongst some resource economists as to whether the in situ price of resource deposits (resource rents) rise over time as a resource becomes increasingly scarce. Heal (1976) and Farzin (1992), for example, have argued that as a stock of a particular resource nears exhaustion, resource rents may, contrary to popular opinion, fall monotonically to zero. Despite differing assumptions about extraction costs, Hanson (1980) comes up with the same conclusion. 2. The need to divert some of the proceeds towards the cultivation of a replacement resource asset can also apply to the harvesting of a renewable resource if it is being exploited unsustainably. 3. The RFS represented by equation (5.1) differs to that used by Barnett and Morse (1963). Barnett and Morse took the meaning of resource scarcity to be an increase in the extent to which nature resists the efforts of humankind to produce resource commodities. Given this, Barnett and Morse chose to measure resource scarcity in terms of ‘unit costs’ or, equivalently, the cost of labour and human-made capital required to obtain a unit of a particular resource. The unit cost formula used by Barnett and Morse was as follows:

UCt

Lt Kt Qt

where: UCt unit cost of extraction at time t; Qt output of resource at time t; Lt labour measured as number of persons employed in extractive activities; , weights; Kt human-made capital cost measured as net fixed stock of human-made capital.


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4. It has been shown that when a production function obeying the first and second laws of thermodynamics is used to estimate the elasticity of substitution between human-made and natural capital, the value is always less than one for all relevant values of the humanmade capital/natural capital ratio. A value of at least one is required for adequate longrun substitutability. See Lawn (2003) and Chapter 3. 5. The low coefficient of a 0.01 is based on the assumption that the demand for a necessary non-renewable resource is very price inelastic.

PART III

Sustainable development indicators ‘But is not even the poorest approximation to the correct concept always better than an accurate approximation to an irrelevant or erroneous concept?’ H.E. Daly, 1996

6.

An introduction to sustainable development indicators

INTRODUCTION Since the late 1980s and, in particular, the 1992 Earth Summit in Rio de Janeiro, many national governments have introduced a range of policy measures in an attempt to steer their economies along a more sustainable path. On the surface, at least, this appears to be a positive trend. But should we be scratching the surface and asking whether nations have been successful in moving toward the sustainable development goal? Is it possible that we have focused too heavily on policy measures and have forgotten to supplement the means to achieving sustainable development with a suitable range of indicators to assess a nation’s sustainable development performance? Or, alternatively, do we now have appropriate sustainable development indicators at our disposal but the policies implemented to achieve sustainable development have been horrendously conceived and/or inadequately implemented? Either way, we could be aimlessly moving along a catastrophic pathway or, as Costanza (1987) describes it, be caught in a ‘social trap’ because of our reliance on misleading signals or our failure to heed the warning signs revealed by recently established indicators. Given the questions asked above, it is important that we think more seriously about the potential value and shortcomings of sustainable development indicators already in use as well as what can be done to improve upon them. If successful, we should be better informed about the impact of past policies and what is required to avoid past failings. In Chapter 2, a broad definition of sustainable development was established to serve as a foundational concept for the book. At the same time, it was also pointed out that a broad definition may not be conducive to the establishment of sustainable development indicators. That is, it may be necessary to define sustainable development more narrowly in order to establish operational rules of thumb to serve as the basis for a congruent set of sustainable development indicators. With this in mind, narrower definitions of sustainable development are outlined in this chapter to introduce the reader to some of the popular indicators employed by ecological economists. In the remaining chapters in Part III, attention switches to 107

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Sustainable development indicators

specific sustainable development indicators as a means of dealing with the criticisms directed towards them and to demonstrate how they can guide a nation’s transition to a steady-state economy.

DEFINING SUSTAINABLE DEVELOPMENT NARROWLY TO FACILITATE THE EMERGENCE OF SUSTAINABLE DEVELOPMENT INDICATORS Sustainable Development as Increasing Hicksian Income – Sustainable Net Domestic Product (SNDP) In seeking narrower definitions of sustainable development to facilitate its measurement, it is worth beginning with a reconsideration of the Hicksian definition of income. To recall, Hicks (1946) defined income as the maximum amount that can be produced and consumed in the present without compromising the ability to do likewise in the future. Whether a nation should specifically aim to continue the production and consumption of a given quantity of physical goods is, of course, a debatable issue. But there is one aspect of Hicksian income that cannot be denied – it automatically subsumes the sustainability principle. Combined with the fact that the consumption of physical goods relates in some positive way to human well-being, the first of our narrower definitions of sustainable development can thus be: sustainable development is a case of increasing Hicksian income. In view of the widespread use of real GDP as a measure of income at the national level, it is instructive to consider how well it does or does not reflect Hicksian income. GDP is a monetary measure of the goods and services annually produced by domestically located factors of production (i.e., by the natural and human-made capital located in a particular country). The best way to determine whether GDP constitutes Hicksian income is to ask the following question: Can a nation consume its entire GDP without it undermining its ability to produce and consume the same GDP in the future? For a number of reasons, the answer is an obvious no. First, some of the annual GDP must be set aside to replace worn out human-made capital. Second, production and consumption involve activities that are, in many cases, ecologically destructive. Consequently, a portion of the annual GDP – namely, some of the profits generated from the depletion of natural capital – must be invested to restore the stock of income-generating capital. Finally, many economic activities are designed, not with consumption in mind, but for rehabilitative purposes (e.g., medical procedures and vehicle accident repairs). Others are conducted with the specific intention of


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defending a nation’s citizens from the side effects of past and present human endeavours (e.g., flood mitigation projects and crime prevention measures). Clearly, GDP overstates Hicksian national income. In all, a better measure of Hicksian income or what is variously referred to as Sustainable Net Domestic Product (SNDP) or ‘green’ Net Domestic Product (gNDP) can be calculated by adhering to the following formula (Daly, 1996):1 SNDP GDP DHK DNK DRE

(6.1)

where SNDPSustainable Net Domestic Product, GDPGross Domestic Product, DHKdepreciation of human-made capital (producer goods plus labour), DNKdepletion of natural capital, and DREdefensive and rehabilitative expenditures. Exactly what measure of SNDP one obtains when using equation (6.1) depends on the deduction one makes with regards to the depletion of natural capital. As I have previously explained, El Serafy’s (1989) user cost formula can be used to calculate the portion of resource depletion profits that must be set aside to establish a replacement capital asset (equation 3.22). The set-aside component of depletion profits constitutes the user cost or replacement cost of resource depletion. It is this amount that should be deducted to ascertain a nation’s SNDP. But, of course, the user cost will differ depending on whether one adopts the weak sustainability or strong sustainability approach to capital maintenance. To recall, the discount rate in the user cost formula should reflect the interest rate generated by the replacement asset. If a weak sustainability approach is adopted, whereby substitutability between human-made and natural capital is assumed, it is highly probable that a human-made capital asset will be established. Present value calculations associated with human-made capital assets commonly involve the use of a 6 or 7 per cent interest rate. This contrasts significantly with the interest rate or natural regeneration rate of a cultivated substitute resource which is usually in the order of 2 to 3 per cent. Hence the discount rate used in the El Serafy formula is likely to be much lower if a natural capital asset is established as per the strong sustainability approach.2 Consider, then, a non-renewable resource with a mine life of 30 years. At a discount rate of 2 per cent, the user cost constitutes 54% of depletion profits (46% constitutes income in the Hicksian sense). However, at a discount rate of 7 per cent, the user cost constitutes just 12% of depletion profits (88% constitutes income). Clearly, the user cost deducted in the calculation of SNDP will be much higher when the strong sustainability stance is embraced. SNDP will be correspondingly lower.

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Sustainable Development as Non-Declining Capital (Weak Sustainability) – Genuine Savings (GS) While SNDP provides a better measure of Hicksian income than GDP, some observers have questioned whether it serves as an adequate indicator of long-run sustainability. This is an important consideration because one of the main reasons for establishing green national accounts is to determine whether a nation’s economy is operating on a sustainable pathway and, should it not be, what it means in terms of both future consumption and welfare. We have seen that the main premise behind Hicksian income and SNDP is the need to keep income-generating capital intact. Let’s assume that national accounting adjustments have been made as per equation (6.1) and the final measure of SNDP for a particular year is lower than GDP. Does the final figure for SNDP indicate a level of output that can be produced and consumed indefinitely? Not necessarily. If a nation continues down the same unsustainable path by consuming its capital assets, it is unlikely that the SNDP calculated for a particular year will be consumable at some point in the future.3 So what does SNDP actually indicate? In the end, SNDP merely approximates the output that would currently be available for consumption if appropriate steps have been taken over the previous year to move the economy onto a sustainable pathway (i.e., had the necessary stocks of capital been maintained). Whether this level of output can be consumed in the long run depends upon a nation actually taking the appropriate action. Despite this, SNDP is still a very useful statistic, although I agree with Hamilton (1994) that SNDP does not readily translate into a policy signal about the long-run sustainability of a nation’s economy. Consequently, SNDP cannot, by itself, be used to develop a national sustainability policy. There is a way to deal with this measurement problem. Since Hicksian income is based on the notion of keeping income-generating capital intact, we can focus on the stock of capital rather than the total quantity of goods produced. So long as income-generating capital does not diminish, the socio-economic process can be considered sustainable. Thus we arrive at our second narrow definition of sustainable development: sustainable development is a case of non-declining capital. To accommodate the concerns raised by Victor (1991) over the long-run effect of declining capital stocks, Pearce and Atkinson (1993) put forward a savings rule as a potential indicator of sustainable development. Based on earlier work by Hartwick (1977) and Solow (1986), the original savings rule has continually undergone a rigorous refining process. It is now commonly referred to as Genuine Savings (GS) following the work of Hamilton (1994).


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In summary, GS measures the stock of income-generating capital by comparing the depreciation of a nation’s capital stock with its investment in all forms of capital. The use of the term ‘genuine’ was coined by Hamilton to reflect the fact that an appropriate savings rule must include changes to natural capital, not simply human-made capital. There are many equations available to calculate GS (Pearce and Atkinson, 1993; Hamilton, 1994; Pearce et al., 1996; and Dietz and Neumayer, 2006). For the purposes of this chapter, GS is given by the following: GS INV NFB DHK DNK q · EHI

(6.2)

where GS Genuine Savings, INVinvestment in human-made capital (producer goods), NFBnet foreign borrowing, DHKdepreciation of human-made capital (producer goods plus labour), DNK depletion of the ecosphere’s source and sink functions, and q EHI value of the ecosphere’s augmented/diminished life-support function – qmarginal value of ecosystem health; EHI change in the ecosystem health index (Costanza, 1992). Sustainability is denoted by a non-negative measure of GS. As with Hicksian income, the value of GS depends on whether one adopts the weak or strong sustainability approach to capital maintenance. Because the user cost of resource depletion is much higher when the strong sustainability stance is taken, GS is lower. There is, therefore, a greater likelihood of GS being negative and the socio-economic process, as a whole, appearing to be unsustainable under the strong sustainability approach. Sustainable Development as Non-Declining Natural Capital (Strong Sustainability) Not unlike Hicksian income, GS has a number of deficiencies. First, using optimisation principles, it has been shown that a positive value for genuine savings is a necessary but insufficient condition for achieving sustainability (Asheim, 1994; Pezzey and Withagen, 1998). Second, Dietz and Neumayer (2006) have revealed a range of theoretical weaknesses associated with GS. I will not go into details here except to say that these deficiencies relate to the impact on the GS model of exogenous shocks such as technological progress, terms of trade, and a non-constant discount rate over time. Finally, despite the strong sustainability approach involving a more austere estimation of the user cost of natural capital depletion, it is still possible for natural capital to decline – which denotes unsustainability – and for GS to be positive.4 For example, assume that the strong sustainability based user cost method is employed to calculate GS. Assume, also,

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that the stock of human-made capital has increased while the stock of natural capital has declined. Should the value of the former exceed the value of the latter, GS will be positive. However, since the maintenance of both human-made and natural capital is necessary to achieve sustainability under strong sustainability conditions, the positive value for GS is misleading. In the end, a measure of GS simply measures the value of the combined stock of capital if steps had been taken to keep both human-made and natural capital intact. But, like a measure of SNDP, a positive value for GS does not indicate long-term sustainability if a nation fails to introduce the necessary policy measures to ensure appropriate capital maintenance. Hence, regardless of what stance is taken in relation to the user cost calculation of resource depletion, a positive value for GS is only meaningful in the weak sustainability sense. Alarmingly, an increase in GS in the presence of declining natural capital also points to an excessive rate of conversion of natural to human-made capital since, along with the output generated, neither can be sustained into the future. Economic logic dictates that a nation should maximise the productivity of the limiting factor of production and invest in its increase (Daly, 1996). The limiting factor of production was previously human-made capital while natural capital was once super-abundant. As Table 6.1 will soon show, the imbalance now appears to have been reversed. Indeed, any increase in GS despite a decline in natural resource assets amounts to an erroneous investment strategy on the part of policy makers. With all this in mind, advocates of the strong sustainability approach might therefore call for the following as a third narrow definition of sustainable development: sustainable development is a case of non-declining natural capital. From an indicator perspective, this definition leads us to the problem of how to measure natural capital. One solution is to compile a natural capital account. Ideally, this account would exist as an inventory of: (a) the two major forms of low entropy providing natural capital – namely, renewable and non-renewable resources; (b) waste absorbing sinks; and (c) important ecosystems. The greatest difficulty associated with the construction of a natural capital account is determining the means by which its various elements should be measured. Does one use monetary values or physical estimates of the quantity of natural capital? Unfortunately, neither bears any precise relationship to the capacity of natural capital to sustain its source, sink and life-support functions. In response, a number of observers believe it is more pertinent to identify the specific aspects of the natural environment that perform critical and irreplaceable functions – what might be called ‘critical’ natural capital.5


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There is one last weakness of GS that requires mentioning. While a measure of GS indicates something about the capital stock, it doesn’t tell us if what we wish to sustain is rising or falling. Despite the logical desirability of a constant or rising stock of capital, one is still left asking: is the total quality of life improving? Sustainable Development as Increasing Economic Welfare – Index of Sustainable Economic Welfare (ISEW) and Genuine Progress Indicator (GPI) The last weakness of GS brings us to the second deficiency of Hicksian income and, therefore, of SNDP – namely, it is not a particularly good way to conceptualise income. Very early on in the consideration of national income, Fisher (1906) argued that the annual national dividend does not strictly consist of the physical goods produced over a particular year. As explained in relation to the linear throughput model in Chapter 2, Fisher believed the annual dividend was equivalent to the services enjoyed by the ultimate consumers of physical goods which, after subtracting the psychic costs of irksome activities, could be regarded as the net psychic income generated by the socio-economic process. For additional reasons given in Chapter 2, net psychic income can effectively be thought of as the uncancelled benefit of socio-economic activity. The implications of adopting Fisher’s distinction between income and capital are significant. To begin with, any durable producer or consumer good manufactured during the current year is not part of this year’s income. It simply constitutes an addition to the stock of human-made capital. Only the services rendered by the non-durable goods consumed in the current year and the durable goods manufactured in previous years that have depreciated through use over the current year are part of this year’s income. Unfortunately, since the calculation of SNDP counts all additions to humanmade capital as current income, it wrongly conflates the services rendered by capital (income) with the capital that renders them. While it is true that psychic income cannot be experienced without the existence of physical goods, it is certainly not determined by the rate at which goods are produced and consumed. It is, in part, determined by the quantity of human-made capital (at least up to a certain amount), the quality of the stock, and its ownership distribution – all of which can be favourably adjusted without the need for an increased rate of production and consumption. It is interesting to note that one of the forefathers of national income accounting, A.C. Pigou (1932), believed Fisher’s approach was both mathematically attractive and logically correct. Pigou opted not to follow Fisher’s approach because he believed its use of non-conventional language involved

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disadvantages that outweighed the benefits of logical clarity. Given that this observation was made at a time when the rise in production benefits clearly exceeded the rise in production costs, one can hardly be critical of Pigou. However, emerging evidence suggests the latter are now surpassing the former and so the great weight of disadvantage rests with the maintenance of the present system of national income accounting (Max-Neef, 1995). Fisher’s distinction between income and capital has one further implication. By keeping the two separate, it forces one to recognise that since the stock of human-made capital depreciates and wears out through use, its continual maintenance is a cost not a benefit. It constitutes a cost because the maintenance of human-made capital requires the production of new goods that, as the linear throughput model revealed, can only occur if there is an ongoing throughput of matter-energy (the input of low entropy resources and the output of high entropy wastes). This, of course, results in the inevitable loss of some of the source, sink and life-support services provided by natural capital – the uncancelled cost of the socio-economic process. As equation (6.1) showed, the calculation of SNDP requires the cost of natural capital depletion to be subtracted. Nevertheless, because Fisher’s distinction between income and capital treats the production of replacement goods as the cost of keeping human-made capital intact, SNDP effectively stands as an index of sustainable cost. While an index of sustainable cost is preferable to an index of unsustainable cost, such as GDP, it scarcely serves as a quality of life indicator. To recall from Chapter 2, two of the five elemental categories of the linear throughput model – namely, net psychic income (uncancelled benefits) and lost natural capital services (uncancelled costs) – were diagrammatically presented to demonstrate the possible impact of a growing macroeconomy on sustainable economic welfare (Figure 2.4). Sustainable economic welfare was represented by the vertical distance between the UB and UC curves. It was also shown in this figure that growth is only desirable in the early stages of a nation’s developmental process. Continued physical expansion of the economic subsystem beyond the optimal macroeconomic scale (that is, where sustainable economic welfare is maximised) is antithetic to the sustainable development goal because it reduces a nation’s sustainable economic welfare. This subsequently brings us to our fourth narrow definition of sustainable development: sustainable development is a case of increasing economic welfare and occurs only while the macroeconomy is growing between the physical scales of zero and the optimal macroeconomic scale (S*). Economic welfare at the national level is now conveniently revealed by the Index of Sustainable Welfare (ISEW) and Genuine Progress Indicator (GPI). Both indicators involve the estimation of a range of economic,

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social and environmental benefits and costs deemed applicable to the socioeconomic process (see Chapter 7 for a list of the benefit and cost items used). The costs are subtracted from the benefits to obtain an index number equivalent to the vertical difference between the UB and UC curves in Figure 2.4. As such, the ISEW and GPI conform to the Fisherian definition of income rather than Hicksian income.6 Why are there two indicators of sustainable economic welfare? Essentially both indicators differ in name only – the latter name adopted in the mid 1990s to increase the indicator’s appeal – although there are slight variations in some of the valuation methods used to estimate the benefit and cost items that make up the indexes (Neumayer, 1999). It should be noted that a third index, a Sustainable Net Benefit Index (SNBI), has recently been developed to highlight the Fisherian foundation underlying these new measures of economic welfare. In this example, the various items are organised into separate ‘uncancelled benefit’ and ‘uncancelled cost’ accounts (Lawn and Sanders, 1999). The sum total of the cost account is subtracted from the sum total of the benefit account to obtain the final index value. Figures 6.1 and 6.2 reveal the SNBI for Australia and the ISEW for the USA and a number of European countries. In each case the alternative index begins to decline once the growth of the macroeconomy reaches what amounts to a ‘threshold’ level of GDP (Max-Neef, 1995). Thus the macroeconomies of each of these countries appear to have exceeded their optimal scale. $25000

$ at 1989/90 prices

$20000

$15000

$10000

Per capita SNBI Per capita real GDP

$5000

Figure 6.1 Per capita SNBI and per capita real GDP for Australia, 1966/67 to 1994/95

94/95

90/91

86/87

82/83

78/79

74/75

70/71

66/67

$0

116

Sustainable development indicators US

Germany 400

300

1950 = 100

200 100

300 200 100

400

300

300

200 100

92

86

19

80

92

86

19

80

19

74

19

68

19

62

19

19

56 19

50 19

92

86

19

80

19

19

74 19

68

62

19

19

56 19

Sweden

300

300

1950 = 100

400

200 100

200 100

0

92

86

19

80

19

74

19

68

62

19

19

56

19

19

50

92

86

19

80

19

19

74 19

68

62

19

19

19

56

0

19

50 19

0

The Netherlands

1950 = 100

19

100

400

50

74

200

0

19

19

68

Austria

400 1950 = 100

1950 = 100

UK

19

62

19

19

50 19

92

86

19

80

19

74

19

68

19

62

19

56

19

19

50 19

56

0

0

19

1950 = 100

400

GDP ISEW

Source: Jackson and Stymne (1996).

Figure 6.2 The GDP and ISEW for the US and a range of European countries (Index: 1950 100) There have been a number of criticisms levelled at the ISEW, GPI and SNBI. Some of these criticisms are dealt with in Chapter 7. At this point, I shall bring to the reader’s attention one important weakness. While the ISEW, GPI and SNBI count the cost of resource depletion and environmental degradation, the final index figures do not indicate whether the economic welfare being enjoyed is sustainable in the long run. This is because environmental costs, whether reflected by the market or estimated by way of shadow prices, do not automatically become infinite once the macroeconomy exceeds


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the maximum sustainable scale (as per the UC curve at SS in Figure 2.4). Thus it is difficult to tell if a declining index figure means: (a) a nation has surpassed its optimal scale; (b) a nation is operating inefficiently and therefore experiencing a narrowing of its UB and UC curves; and/or (c) a nation’s UB and UC curves are widening but at a lesser rate than the rate of macroeconomic expansion. Sustainable Development as Increasing Eco-efficiency The need to distinguish between the possibility of excess growth and shifts in the UB and UC curves would indicate a need to gain a greater understanding of the impact of both technological progress – which can shift the UB and UC curves – and the efficiency with which natural capital is transformed into human-made capital. The latter is commonly referred to as ‘eco-efficiency’. In view of the desirability of improving the efficiency of the transformation process, a fifth narrow definition of sustainable development emerges, namely: sustainable development is an example of increasing eco-efficiency. To examine the eco-efficiency concept in more detail, the two elemental categories of net psychic income and lost natural capital services can be alternatively arranged to arrive at a measure of ecological economic efficiency (EEE).7 Consider the following EEE ratio (Daly, 1996, p. 84): EEE

net psychic income lost natural capital services

(6.3)

For a given physical scale of the macroeconomy, an increase in the EEE ratio indicates an improvement in the efficiency with which natural capital and the low entropy resources it provides is transformed into benefit-yielding human-made capital. A multitude of factors can be shown to contribute to an increase in the EEE ratio. To demonstrate how, the EEE ratio is decomposed to reveal four eco-efficiency ratios. The EEE ratio thus becomes the following identity: Ratio 1

Ratio 2

Ratio 3

Ratio 4

NPY NPY HMK RT NK EEE LNCS HMK RT NK LNCS (6.4) where EEEecological economic efficiency, NPYnet psychic income, LNCS lost natural capital services, HMKhuman-made capital, RT resource throughput, NK natural capital.

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Starting from Ratio 1 and progressing through to Ratio 4, each ecoefficiency ratio cancels the ensuing ratio out. This leaves the basic EEE ratio on the left-hand side. The order in which the four eco-efficiency ratios are presented is in keeping with the conclusions drawn from the linear throughput representation of the socio-economic process: net psychic income is enjoyed as a consequence of human-made capital (Ratio 1); human-made capital requires the continued throughput of matter-energy (Ratio 2); the throughput of matter-energy is made possible thanks to the three instrumental services provided by natural capital (Ratio 3); and, in exploiting natural capital, the three instrumental services provided by natural capital are, to some degree, sacrificed (Ratio 4). Each eco-efficiency ratio represents a different form of efficiency pertaining to a particular sub-problem of the larger ecological economic problem of sustainable development. The four eco-efficiency ratios are discussed in considerable detail and calculated for Australia in Chapter 9. Also provided in that chapter is an explanation of how increases in the eco-efficiency ratios can beneficially shift the UB and UC curves shown in Figure 2.4 and increase sustainable economic welfare. Sustainable Development as Overshoot Avoided – Ecological Footprint Not to Exceed Biocapacity As with any indicator, eco-efficiency ratios have their inherent weaknesses. I will endeavour to focus on one crucial weakness. Not unlike SNDP and Fisherian measures of income, eco-efficiency indicators are unable to reveal whether a nation’s macroeconomy has exceeded its maximum sustainable scale. While eco-efficiency ratios can indicate the effectiveness with which natural capital is transformed into human-made capital, they say nothing about the long-run capacity of natural capital to sustain the socio-economic process. This, of course, comes as no surprise to observers who have long argued that efficiency does not guarantee ecological sustainability (Norgaard, 1990; Bishop, 1993; Daly, 1996). The need for an indicator to reveal whether the macroeconomy is nearing or has surpassed the maximum sustainable scale has led many observers to call for the compilation of a natural capital account (Jansson et al., 1994). Unfortunately, natural capital accounting is an exercise easier said than done. Because it is impossible to add heterogeneous physical quantities, difficulties arise when measuring the total stock of any form of capital. For instance, how does one add timber, oil, fish stocks, wetlands and ecosystem services to obtain a single, well-behaved physical index of natural capital? One possible way of getting around this problem is to aggregate the individual components of natural capital into a single quantitative index expressed in real monetary values. However, in what is known as the


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‘Cambridge controversy’, some observers question whether an index of this kind can adequately represent the physical and qualitative aspects of capital (England, 1998). Because of the potential problems associated with compiling a natural capital account, it is has been suggested that an alternative means of ascertaining whether the macroeconomy has overshot its maximum sustainable scale should be established (Catton, 1980). One such approach is the comparison of a nation’s ecological footprint with its available biocapacity. A country’s ecological footprint is the equivalent area of land required to both generate the renewable resources and absorb the high entropy wastes needed to sustain economic activity at the current level (Wackernagel and Rees, 1996). Biocapacity refers to the amount of available land a nation has to generate an ongoing supply of renewable resources and absorb its own and other nation’s spillover wastes. Unsustainability occurs if a nation’s ecological footprint exceeds its biocapacity. This leads us to the next of our narrow definitions of sustainable development: sustainable development is a case of overshoot avoided. Table 6.1 reveals that most of the world’s nations have an ecological footprint in excess of their biocapacity (i.e., have an ecological deficit). This is of great concern because it suggests that most national economies have exceeded their maximum sustainable scale. Although trade has been mooted as a possible means of enabling surplus countries to export ecological capacity to deficit countries, Table 6.1 indicates that the world, as a whole, is in ecological deficit to the tune of 0.7 hectares per person (average global footprint of 2.8 hectares per person compared to the average global biocapacity of 2.1 hectares per person). There have been a number of criticisms levelled at the methodology used to calculate the ecological footprint (van den Bergh and Verbruggen, 1999; Ayres, 2000; Moffatt, 2000; Opschoor, 2000; van Kooten and Bulte, 2000; van Vuuren and Smeets, 2000). While methodological issues related to the ecological footprint are far from resolved, some of the criticisms have been addressed via the development of more credible valuation approaches (Lenzen and Murray, 2001). This has significantly increased the worthiness of ecological footprint estimates. Having said this, some observers believe that ecological footprint assessments reveal only half of the sustainability story. As Rapport (2000) stresses, human survivability depends on more than the ability of the planet to meet the resource demands of socio-economic activity. It also depends upon the maintenance and restoration of ecosystem health – that is, the lifesupport function of natural capital (Vitousek et al., 1997; Rapport et al., 1998). Since ecological footprint studies reveal little more than humankind’s demand for resources, an indication as to whether humankind has overshot

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Table 6.1


The ecological footprint of 52 nations as at 1997

Argentina Australia Austria Bangladesh Belgium Brazil Canada Chile China Colombia Costa Rica Czech Republic Denmark Egypt Ethiopia Finland France Germany Greece Hong Kong Hungary Iceland India Indonesia Ireland Israel Italy Japan Jordan Korean Republic Malaysia Mexico Netherlands New Zealand Nigeria Norway Pakistan Peru Philippines

Ecological footprint (hectare/capita)

Available biocapacity (hectare/capita)

Ecological surplus ( ) or deficit (–)

3.9 9.0 4.1 0.5 5.0 3.1 7.7 2.5 1.2 2.0 2.5 4.5 5.9 1.2 0.8 6.0 4.1 5.3 4.1 5.1 3.1 7.4 0.8 1.4 5.9 3.4 4.2 4.3 1.9 3.4 3.3 2.6 5.3 7.6 1.5 6.2 0.8 1.6 1.5

4.6 14.0 3.1 0.3 1.2 6.7 9.6 3.2 0.8 4.1 2.5 4.0 5.2 0.2 0.5 8.6 4.2 1.9 1.5 0.0 2.1 21.7 0.5 2.6 6.5 0.3 1.3 0.9 0.1 0.5 3.7 1.4 1.7 20.4 0.6 6.3 0.5 7.7 0.9

0.7 5.0 1.0 0.2 3.8 3.6 1.9 0.7 0.4 2.1 0.0 0.5 0.7 1.0 0.3 2.6 0.1 3.4 2.6 5.1 1.0 14.3 0.3 1.2 0.6 3.1 2.9 3.4 1.8 2.9 0.4 1.2 3.6 12.8 0.9 0.1 0.3 6.1 0.6

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Table 6.1

(continued)

Poland Portugal Russian Federation Singapore South Africa Spain Sweden Switzerland Thailand Turkey United Kingdom United States of America Venezuela World

Ecological footprint (hectare/capita)

Available biocapacity (hectare/capita)

Ecological surplus ( ) or deficit (–)

4.1 3.8 6.0 6.9 3.2 3.8 5.9 5.0 2.8 2.1 5.2

2.0 2.9 3.7 0.1 1.3 2.2 7.0 1.8 1.2 1.3 1.7

2.1 0.9 2.3 6.8 1.9 1.6 1.1 3.2 1.6 0.8 3.5

10.3 3.8

6.7 2.7

3.6 1.1

2.1

0.7

2.8 2.8 2.1 1.3 Earths

Note: Hectares per capita expressed in terms of world average yield in 1993. Source: Wackernagel et al. (1999), pp. 386–7.

the Earth’s sustainable carrying capacity requires footprint estimates to be complemented by diagnostic assessments of the health of the Earth’s ecosystems. As important as they no doubt are, ecological footprint and ecosystem health assessments suffer a similar fate as the natural capital account – they do not tell us whether the quality of the human condition is improving. Clearly, ecological footprint/biocapacity comparisons plus ecosystem health assessments serve only as a potential indicator of ecological sustainability.

THE POLICY GUIDING VALUE OF SUSTAINABLE DEVELOPMENT INDICATORS One doesn’t have to think long and hard to acknowledge a fundamental weakness characterising all the indicators so far presented – they either reveal something about the sustainability of the socio-economic process or

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something about the quality of life it generates. No single indicator is able to adequately reflect both sides of the sustainable development coin. Regardless of what indicators are ultimately devised, inherent deficiencies always exist that, in some way, diminish their policy-guiding value. Despite this, each indicator has the potential to provide policy makers with important information about past and present activities. This, in turn, can assist them to introduce the policies most likely to move a nation towards the sustainable development goal. The policy guiding value of sustainable development indicators can be further increased by examining them collectively rather than individually. For example, the ISEW, when combined with ecological footprint/biocapacity comparisons, can provide policy makers with substantial insight as to whether a country is approaching or has exceeded its optimal macroeconomic scale or, more crucially, its maximum sustainable scale. Hence, although the indicators revealed in this chapter are unable to reflect concrete reality with great precision, the message they convey can warn policy makers of impending socio-economic decline or ecological catastrophe. This, alone, makes the quest for sustainable development indicators worthwhile. But the advocates of the various sustainable development indicators must never become complacent. There is always room for improvement or, if need be, the eventual rejection of an unworthy indicator. I hope the following chapters in Part III of this book enhance our capacity to do just that.

NOTES 1. Equation (6.1) is just one of a number of varieties of Hicksian income equations. 2. Interestingly, a strong sustainability advocate would argue that the rate of return on natural capital is generally higher than it is for human-made capital because, under strong sustainability assumptions, the return on a human-made capital asset is entirely dependent on the availability of natural capital, but not vice versa. 3. This is likely to be the case even if SNDP continues to increase over a lengthy period since it is possible, for some time at least, for positive real output additions made to equation (6.1) to exceed the subtractions made for natural capital depletion. 4. This is due largely to the fact that the GS equation exists in a purely additive/subtractive form. The GS equation therefore implies potential substitutability of one element in the equation for another. The equation requires a ‘subject to’ condition which, in the strong sustainability case, is the need for a non-negative change in natural capital. 5. See the special section on ‘Identifying critical natural capital’ in Volume 44 (2–3) of Ecological Economics (2003). 6. For example, SNDP, as a measure of Hicksian income, starts with GDP as its base value – see equation (6.1). Conversely, the ISEW and GPI start with consumption expenditure as the base value – because it is the major psychic income item – and avoid adding any net additions to the capital stock. 7. It should be pointed out that this is just one way of defining and measuring eco-efficiency.

7.

An assessment of various measures of sustainable economic welfare

INTRODUCTION Ecological economists have long believed that the continued growth of macroeconomic systems is both ecologically unsustainable and existentially undesirable. Consistent with this belief, ecological economists have put forward a ‘threshold hypothesis’ – the notion that when macroeconomic systems expand beyond a certain size, the additional benefits of growth are exceeded by the attendant costs (Max-Neef, 1995). In order to support their belief, ecological economists have developed a number of indexes to measure and compare the benefits and costs of growth. The first of them, the Index of Sustainable Economic Welfare (ISEW), was originally calculated for the USA by Daly and Cobb (1989). It has since been calculated for the UK, most western European and Scandinavian countries, Canada, Australia, Chile, Japan and Thailand. Over this time, many of the methods used to calculate the index have been revised. As pointed out in Chapter 6, the ISEW has also been given a variety of different names – for example, a Genuine Progress Indicator or GPI (Redefining Progress, 1995) and a Sustainable Net Benefit Index or SNBI (Lawn and Sanders, 1999; Lawn, 2000). While there has been a variation in the disparity between GDP and the chosen index calculated for different countries, the trend movement in the ISEW, GPI and SNBI is very consistent. That is, up to a point, the growth of macroeconomic systems seems to be beneficial to human well-being. Beyond this point, growth appears to have a detrimental impact. On the surface at least, the ISEW, GPI and SNBI offer solid support for the threshold hypothesis and the need for countries to eventually abandon the growth objective and focus on, among other things, qualitative improvement to achieve sustainable development. Some recent articles (e.g., G. Atkinson, 1995; Neumayer, 1999 and 2000) have called into question the methods used to calculate the ISEW, GPI and SNBI. They also cast doubt over whether such indexes substantiate the threshold hypothesis (e.g., Neumayer, 2000). These are very timely contributions since they challenge ecological economists to consider whether their results reflect a genuine trend or a subconscious desire to design an 123

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index to vindicate their own threshold hypothesis. Since, as an advocate of these alternative indexes, this challenge extends to me, I will assess the ISEW and other related welfare measures to determine the extent to which they reflect concrete reality or the prejudices of ecological economists. To do this, three main areas require close attention. They are: (a) the theoretical foundation underlying the indexes; (b) the valuation methods used to construct and calculate the indexes; and (c) the interpretation of the results. I shall deal with each of these separately. Beforehand, I will briefly mention something about each of the relevant indexes. Gross Domestic Product (GDP) As explained in Chapter 6, GDP is a monetary measure of the goods and services annually produced by domestically located factors of production (i.e., by the natural and human-made capital located in a particular country). GDP can be measured in nominal or real values. If GDP is measured in nominal values, it is measured in terms of the prices of all goods at the time of production. On the other hand, if GDP is measured in real values, it is measured in terms of the prices of all goods in a particular year – often referred to as the base year. Consequently, annual changes in real GDP reflect the differences in the quantity of goods and services produced from year to year. It is for this reason that, in conventional terms, real GDP is preferred to nominal GDP as a measure of national income. Most readers will have come across Gross National Product (GNP). GNP is much the same as GDP except that it measures the monetary value of the goods and services annually produced by domestically owned rather than domestically located factors of production (i.e., by the natural and human-made capital owned by the citizens of a particular country). Index of Sustainable Economic Welfare (ISEW) and Genuine Progress Indicator (GPI) The ISEW and GPI are indicators designed to approximate the sustainable economic welfare or true progress of a nation’s citizens. The calculation of both indexes involves the extraction from the national accounts of the various transactions deemed relevant to human well-being (Redefining Progress, 1995). Further adjustments are made to account for aspects of economic activity that GDP ignores. The ISEW and GPI include a number of social and environmental benefits and costs that invariably escape market valuation. Table 7.1 provides a list of the typical items used in the calculation of the ISEW and GPI.

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Measures of sustainable economic welfare

Table 7.1

Items used to calculate the GPI for USA from 1950 to 1995

Item Private consumption expenditure Index of distributional inequality Weighted personal consumption expenditure Cost of consumer durables Services yielded by consumer durables Services yielded by roads and highways Services provided by volunteer work Services provided by non-paid household work Public expenditure on health and education counted as consumption Cost of noise pollution Cost of crime Cost of commuting Cost of underemployment Cost of lost leisure time Cost of household pollution abatement Cost of vehicle accidents Cost of family breakdown Net capital investment Net foreign lending/borrowing Loss of farmland Cost of resource depletion Cost of ozone depletion Cost of air pollution Cost of water pollution Cost of long-term environmental damage Loss of wetlands Loss of old-growth forests GPI (valued in dollars) positive and negative items

Benefit/Cost ( /) / / /

Source: Redefining Progress (1995).

Table 7.1 includes a range of positive and negative items that are summed to obtain a final index number. All items are valued in monetary terms, as are the ISEW and GPI. The final index number is usually calculated in real rather than nominal values. The ISEW and GPI basically differ in name only. It is becoming increasingly common for updated calculations to be referred to as the GPI. If one compares the original ISEW with recent calculations of the GPI, the list of items used to arrive at the final index number has varied over time, as have some of the valuation methods. One

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also finds a difference in the valuation methods used to calculate the ISEW and GPI for different countries (see, for instance, Diefenbacher, 1994; Moffatt and Wilson, 1994; Rosenberg and Oegema, 1995; Jackson and Stymne, 1996; Jackson et al., 1997; Stockhammer et al., 1997; Guenno and Tiezzi, 1998; Castaneda, 1999; Hamilton, 1999). The reasons for these differences are usually related to the availability of data and the preference researchers have for specific valuation methods. Sustainable Net Benefit Index (SNBI) As indicated in Chapter 6, the SNBI is much the same as the ISEW and GPI. Where the SNBI differs is in the explanation of the rationale for an alternative index and the presentation of the items used in its calculation. The welfare related items are sorted into separate ‘uncancelled benefit’ and ‘uncancelled cost’ accounts (see Table 7.2). The total of the uncancelled cost account is subtracted from the uncancelled benefit account to obtain the SNBI. This approach has the advantage of presenting the results in a manner consistent with Fisher’s (1906) distinction between income and capital. It also allows one to compare the benefits and costs of a growing macroeconomy. In so doing, it strengthens its own case as well as the case for the ISEW and GPI.

THE THEORETICAL FOUNDATION OF THE ISEW AND GPI While the development of the ISEW and GPI has been motivated by the inability of GDP to serve as a measure of sustainable economic welfare, surprisingly little effort has been devoted towards the establishment of a theoretical foundation to support them.1 This is why a colleague and I put forward the SNBI (Lawn and Sanders, 1999). Apart from wanting to find out whether Australia had exceeded the welfare-increasing threshold of continuing growth, we wanted to highlight the theoretical foundation underlying the existing ISEW and GPI. In order to demonstrate that the ISEW and GPI have a sound theoretical foundation, I will begin by reiterating the inadequacies of GDP and Sustainable Net Domestic Product (SNDP). I will then show how and in what way the ISEW and GPI are consistent with Fisher’s distinction between income and capital. In Chapter 6, it was explained that GDP is a deficient indicator of national income because it fails to measure the maximum amount that a nation can produce and consume over a given period without undermining its capacity to do likewise in the future. To overcome this inadequacy,


127

various subtractions were made from GDP to obtain a measure of SNDP – see equation (6.1). There are, of course, a number of weaknesses associated with SNDP. First, there is the issue of whether the SNDP is an appropriate measure of national income. The questionable nature of SNDP arises because, as Fisher (1906) persuasively argued, the annual national dividend does not constitute the physical goods produced in a particular year, but the services or psychic income enjoyed by the consumers and/or users of the stock of all existing human-made goods. Conceived in this way, this year’s income should not include the full exchange value of the durable producer and consumer goods manufactured during the current year. Instead, their depreciation value should enter future income calculations to reflect the services generated from their eventual use. Since the calculation of the SNDP counts all additions to human-made capital as current income, it falsely conflates the services rendered by capital (income) with the value of the capital that renders them. Second, since the stock of human-made capital depreciates and wears out through use, its continual maintenance requires the production of new goods that can only occur if there is a continual input of low entropy resources and output of high entropy wastes. This so-called throughput of matter-energy constitutes a cost not a benefit, which is measured in terms of the natural capital services sacrificed in order to keep the stock of humanmade capital intact. Thus, as was pointed out in Chapter 6, SNDP is equivalent to an index of sustainable cost, not sustainable economic welfare. Finally, from a human well-being perspective, SNDP overlooks many welfare related aspects associated with the socio-economic process. These include the cost of reduced leisure time, the cost of commuting, the cost of crime and family breakdown, the value of volunteer and non-paid household work, and the welfare effect of a change in the distribution of income. Often overlooked, the redistribution of income from the low marginal benefit uses of the rich to the higher marginal benefit uses of the poor can lead to an overall increase in the economic welfare enjoyed by society as a whole (Robinson, 1962; Easterlin, 1974; Abramowitz, 1979). Hence, while the SNDP of a nation can increase over time, it will not accurately reflect the increase in a nation’s economic welfare if the rise in the SNDP is accompanied by a growing income disparity between the rich and the poor.

THE THEORETICAL SUPERIORITY OF THE ISEW AND GPI Contrary to some opinions, the ISEW and GPI do not lack a theoretical foundation. The ISEW and GPI serve as very good indicators of both

128

X X X X X X X X X X X

• • • • • • • • • • •

( ) positive item; ()negative item; ( /) item that may be either positive or negative

Total psychic income psychic income items XXXX

private consumption expenditure ( ) index of distributional inequality ( /) weighted private consumption expenditure ( ) services yielded by consumer durables ( ) services yielded by public dwellings ( ) services yielded by roads and highways ( ) non-paid household and volunteer work ( ) public consumption expenditure on health and education ( ) imputed value of leisure time ( ) net producer goods growth ( /) net foreign lending/ borrowing) ( /)

$

Psychic income items

Item value

Items used to calculate the SNBI for Australia from 1966/67 to 1994/95

Uncancelled benefit account

Table 7.2

XXXX

$

Account subtotal

$

Account total

$

SNBI

129

X X X X X X X X X X

• • • • • • • • • •


Net psychic income psychic income less psychic outgo XXXX XXX AAA

Total psychic outgo psychic outgo items XXX

XXX

$

$

Psychic outgo items

cost of consumer durables () defensive private health and education expenditure () cost of private vehicle accidents () cost of noise pollution () disamenity cost of air pollution () cost of commuting () cost of crime () cost of family breakdown () cost of underemployment () cost of unemployment ()

Account subtotal

Item value

Uncancelled benefit account (continued)

AAA

$

Account total

$

SNBI

130

cost of cost of cost of cost of

water pollution () air pollution () solid waste pollution () ozone depletion ()

cost of long-term environmental damage () Ecosystem health index ( /)

Y Y

Y Y Y Y

Y Y Y Y Y


SNBI net psychic income lost natural capital services AAA BBBZZZ

Lost natural capital services YY YY YY BBB

Lost sink function lost sink function items YY

• •

Lost life-support services function items

lost sink function lost sink function items YY

• • • •

Lost sink function items

Lost source function lost source function items YY

user cost of non-renewable resource depletion () loss of agricultural land () net change in timber stocks (/ ) net change in fishery stocks (/ ) cost of degraded wetlands, mangroves, saltmarshes ()

YY

YY

YY

$

$

Lost source function items

• • • • •

Account subtotal

Item value

(continued)

Uncancelled cost account

Table 7.2

BBB

$

Account total

ZZZ

$

SNBI


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income and sustainable economic welfare precisely because they are consistent with Fisher’s distinction between income and capital. The best way of demonstrating this is to focus on the individual items used to construct the ISEW and GPI. Private Consumption Expenditure Unlike the SNDP, which starts with GDP as its initial reference point, the ISEW and GPI begin with private consumption expenditure. This is important because it provides an approximate estimate of what Fisher described as the services or psychic income enjoyed by the ultimate consumers of human-made goods. Using consumption expenditure as the initial reference point does not imply that consumption is itself good – a theoretical failing of the SNDP. It implies that consumption is a ‘necessary evil’. That is, it is necessary to consume goods to gain the services they yield. Of course, if the same level of service can be enjoyed from less consumption, this would constitute a societal gain because less production would be required to keep the stock of human-made capital intact. Such a gain, if it were made, would not be reflected in this particular item but would be reflected in other items due to a smaller cost of pollution or resource depletion or both. Thus, if a given level of service from consumption was accompanied by a reduction in the rate of production (due, for example, to an increase in the durability of human-made capital), this would lead to a rise in the ISEW and GPI. However, it would lower the SNDP. Index of Distributional Inequality/Weighting of Private Consumption Expenditure As I mentioned earlier, the distribution of income can have a significant impact on a nation’s economic welfare. If private consumption expenditure does not change from one year to the next but the distribution of income deteriorates, the economic welfare enjoyed by society as a whole is likely to fall because the marginal benefit uses of the rich is less than the marginal benefit uses of the poor. Unless private consumption expenditure is weighted according to changes in the distribution of income, it will inaccurately reflect its true contribution to a nation’s economic welfare. This adjustment is made in the calculation of the ISEW and GPI but not so in the case of the SNDP. The Cost of Consumer Durables Included in private consumption expenditure is the amount paid in the current year on consumer durables such as cars, refrigerators and household

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furniture. This amount constitutes an addition to the stock of human-made capital. It does not constitute current income in the Fisherian sense. In the calculation of the ISEW and GPI, the cost of consumer durables is subtracted from weighted private consumption expenditure. It is not done so in the calculation of the SNDP. Services Yielded by Existing Consumer Durables Not included in private consumption expenditure is the value of the services annually yielded by previously purchased consumer durables. As Fisher argued, these services constitute current income. In the calculation of the ISEW and GPI, the annual value of these services is added to the running total. It is overlooked in the calculation of the SNDP. The service value is usually calculated as a percentage of the total value of the entire stock of consumer durables. Ideally, the percentage rate chosen should reflect the estimated depreciation rate or ‘rate of consumption’ of consumer durables. Services Yielded by Publicly Provided Human-made Capital Consumer durables are not the only form of human-made capital that yields services. Publicly provided human-made capital such as libraries, museums, roads and highways do likewise. To be consistent with the Fisherian concept of income and capital, these services are treated as income and added in the calculation of the ISEW and GPI. They are again overlooked in the calculation of the SNDP. The service value is usually calculated in the same way as it is for consumer durables; that is, as a percentage of the total value of the existing stock of publicly provided human-made capital. Consistent with the Fisherian concept of income and capital, current expenditure by governments on human-made capital is not included because it merely constitutes a current addition to the existing stock. Services Provided by Volunteer and Non-paid Household Work Not all benefit yielding services are provided by market-based economic activity. The initial reference item of private consumption expenditure overlooks the services provided by volunteer and non-paid household work. To obtain a better indicator of the psychic income enjoyed by a nation’s citizens, the ISEW and GPI include these services. The SNDP does not.


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Disservices Generated by Economic Activity The items so far discussed make a positive contribution to the psychic income of a nation. However, the socio-economic process involves a range of irksome activities while it also generates many undesirable side effects. To extend the concept of psychic income to that of ‘net psychic income’, the cost of irksome and psychic outgo related aspects must also be included. The ISEW and GPI do this by deducting the following: ● ● ● ● ● ●

the cost of noise pollution the cost of commuting the cost of crime the cost of underemployment in some cases, the cost of unemployment the cost of lost leisure time.

Defensive and Rehabilitative Expenditures A large portion of the human-made capital produced each year does not contribute to the psychic income of a nation. It is produced to prevent or minimise the extent to which the undesirable side effects of the socioeconomic process reduce the psychic income enjoyed in the future. In calculating the ISEW and GPI, the following defensive and rehabilitative expenditures are subtracted from the running total: ● ● ● ●

the cost of household pollution abatement the cost of vehicle accidents the cost of family breakdown in some cases, a certain percentage of private health expenditure assumed to constitute a form of defensive expenditure.

Net Capital Investment The inclusion of this particular item is contentious. One of the key implications of the Fisherian concept of income and capital is that additions to the stock of human-made capital should not be counted as income. The ISEW and GPI go a long way towards ensuring this by subtracting current expenditure on consumer durables and by not adding current government expenditure on human-made capital. However, the calculation of the ISEW and GPI includes the net investment in the stock of producer goods (plant, machinery and equipment). If the calculation of this item was based on an estimate of the net increase in the total stock of producer

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goods, as it is in the calculation of SNDP, the inclusion of this item would be inconsistent with Fisher’s distinction between income and capital. It is not, however, calculated in this manner. Rather, net capital investment is calculated as the increase in the stock of producer goods above the amount required to keep the quantity of producer goods per worker intact. As contentious as this item is, there is some justification for its inclusion. In Chapter 2 and Part II it was argued that human-made capital cannot replicate the critical instrumental services provided by natural capital. As such, natural capital and its human-made counterpart are complementary forms of capital. Both natural and human-made capital must be individually maintained to achieve sustainability. In terms of the stock of humanmade capital, complementarity implies that the quantity of producer goods per worker must not fall. Should the stock of producer goods exceed this requirement, the difference constitutes an increase in a nation’s productive capacity. This, of course, is a clear benefit and is appropriately added when calculating the ISEW and GPI. Net Foreign Lending/Borrowing This item is included because a nation’s long-term capacity to sustain the psychic income generated by the socio-economic process depends very much on whether natural and human-made capital is domestically or foreign owned. Evidence clearly indicates that many countries with large foreign debts have difficulty maintaining the investment levels needed to keep their stock of human-made capital intact (e.g., Argentina in recent times). Furthermore, they are often forced to liquidate natural capital stocks to repay debt (George, 1988). Cost of Sacrificed Natural Capital Services As I explained earlier, one of the major implications of Fisher’s distinction between income and capital is its recognition that the continual maintenance of human-made capital is a cost. The cost emerges by way of the natural capital services lost in obtaining the throughput required to keep the stock of human-made capital intact. To be consistent with the Fisherian concept of income and capital, it is necessary to deduct the cost of the lost source, sink and life-support services provided by natural capital. The ISEW and GPI do this by deducting the following: ●

the loss of farmland and the cost of resource depletion (lost source services of natural capital)

Measures of sustainable economic welfare ● ●

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the cost of ozone depletion and air and water pollution (lost sink services of natural capital) the cost of long-term environmental damage and the loss of wetlands and old-growth forests (lost life-support services of natural capital).

In conclusion, the ISEW and GPI have a sound theoretical foundation based on Fisher’s distinction between income and capital. This makes the ISEW and GPI far superior indicators of both income and sustainable economic welfare than GDP and the SNDP. Moreover, provided the benefits and costs of the socio-economic process can be measured with some degree of accuracy, it is reasonable to believe that the ISEW and GPI can serve as a valuable means of assessing whether, at the national level, the additional benefits of growth are being exceeded by the additional costs. There is, as explained in Chapter 6, a theoretical weakness associated with the ISEW and GPI that also extends to the SNBI. All three indexes merely count the cost of lost natural capital services. Whilst it is important to obtain a better measure of economic welfare by subtracting the cost of environmental damage, it is equally important to know if a nation’s stock of natural capital has declined to such an extent that the economic welfare it currently enjoys cannot be sustained in the future. The ISEW, GPI and SNBI do not provide this information. As such, they serve only as a means to ascertain whether a nation’s macroeconomy has surpassed its optimal scale. Since natural capital maintenance is required to achieve sustainability, it is advisable to undertake biophysical assessments of a nation’s resource stocks and critical ecosystems and present the information in something akin to a natural capital account. Only then will it be possible to ascertain whether a nation’s macroeconomy has also exceeded its maximum sustainable scale.

ASSUMPTIONS AND VALUATION METHODS USED TO CALCULATE THE ISEW AND GPI I believe the validity of the criticism levelled at the ISEW, GPI and SNBI is greatest in relation to the valuation methods used for their calculation (see Maler, 1991; G. Atkinson, 1995; Hamilton, 1994 and 1996; Neumayer, 1999 and 2000). To assess the valuation methods and assumptions used, I will focus on the more contentious methods. The majority of criticism has been levelled at the valuation of the following items listed in Table 7.1 – private consumption expenditure; the index of distributional inequality and the subsequent weighting of private consumption expenditure; defensive and rehabilitative expenditures; the cost of resource depletion; and,

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finally, the tendency to deduct the cumulative cost of ozone depletion, longterm environmental damage, and lost old-growth forests. Private Consumption Expenditure The monetary value of private consumption expenditure is extracted directly from the national income accounts. The criticism here is levelled at the assumption that all private consumption expenditure contributes to human well-being. Since this item includes the consumption of such things as junk food, tobacco products, alcohol and guns, it is unlikely that all consumption expenditure advances the psychic income of a nation’s citizens. In response, it may be a valuable exercise to determine which elements of private consumption expenditure should be omitted from the final estimation of the ISEW and GPI. Of course, this requires the researcher to make subjective judgments about the service yielding qualities of physical goods which, in the end, may lead to greater criticism. Not surprisingly, the issue has been largely avoided by ISEW and GPI advocates. Another way of dealing with this problem is to conduct a sensitivity analysis by selectively excluding some of the components of private consumption expenditure. For example, private consumption expenditure includes a category for ‘cigarettes and tobacco’ and another for ‘alcoholic drinks’. The full amount of the former could be omitted and half of the latter. There might also be a justification for excluding a small percentage of expenditure on ‘food’ – say 20 per cent. Given the magnitude of the consumption expenditure item, omissions of this nature could lead to a small variation in the overall index which would then allow analysts to make their own conclusions regarding its impact on sustainable economic welfare. Conversely, one could argue that junk food and tobacco products should not be omitted given that the ISEW and GPI already include specific items to capture some of the costs of undesirable forms of consumption (e.g., higher health costs and reduced productivity). There is, therefore, the potential to double count some costs by omitting a certain percentage of all consumption expenditures on the assumption that they provide few if any benefits. Clearly, there is a need for further debate on this issue. There is another important consideration regarding private consumption expenditure that warrants closer examination (Lawn, 2000). Private consumption expenditure is measured in real rather than nominal money values in order to capture the change in the physical quantity of goods consumed over time. For two reasons, an increase in real private consumption expenditure cannot be directly equated with a proportionate increase in psychic income. The first is due to the law of diminishing marginal utility which suggests that as one increases their consumption of physical goods,


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the service one enjoys increases at a diminishing rate. The second is due to the fact that an increase in the rate at which some individual goods are consumed may not increase the service one enjoys at all. Consider, for example, the lighting of a room by a single light bulb. Is more service experienced if three light bulbs are worn out or ‘consumed’ over one year compared to just one light bulb because the latter is more durable? No, because the total service provided by the three fragile light bulbs is the same as that provided by the more durable light bulb. Despite this, real private consumption expenditure may still prove the best available reference point in the estimation of economic welfare. Why? It is generally recognised that people will pay a higher price for a good embodying superior service yielding qualities. Consequently, a measure of psychic income can be approximated with the use of market prices. For instance, the rental value of a car, a house, a TV or a refrigerator – that is, the amount paid to rent durable goods for a one-year period – can be used as a proxy measure of the annual services they yield. In addition, the service yielded by the goods consumed entirely during the accounting period in which they are purchased (non-durables) can be valued at their actual market prices (Daly, 1991a). It has to be said that variations in the market prices and rental values of physical goods occur for reasons other than changes in their service yielding qualities. The price of a good can also be affected by: (a) the relative prices of the different forms of resources available to produce it; (b) the actual quantity or supply of the good itself; and (c) changes in taxes, the nominal money supply and the opportunity cost of holding money. Clearly, for prices to remain a proxy indicator of psychic income, it is necessary to eliminate all price influencing factors other than those related to a good’s service yielding qualities. Given that this is a near impossible task, there are two choices available. The first option is to leave prices as they are; that is, to rely on current prices. The second is to deflate the nominal annual value of private consumption expenditure by an aggregate price index, such as the Consumer Price Index (CPI). If the former option is chosen, the nominal value of private consumption expenditure will embody unwanted price influences over and above any use-value related influences. If the latter is chosen, one obtains a real value of private consumption expenditure. But, in so doing, one also eliminates the price influencing effect of a variation in use values – the very influence that one wants to maintain in order for prices to be used as an approximate measure of psychic income. The most desirable option, and the option chosen by ISEW, GPI and SNBI advocates, is to follow the lead of Daly and Cobb (1989) and use, as a reference point, the real value of private consumption expenditure. This second option is desirable for the following reason. While the law of

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diminishing marginal utility suggests that an increase in psychic income will be proportionately less than any increase in the quantity of physical goods consumed, the law is based on the assumption that there is no change in their service yielding qualities. It is reasonable to assume that, through technological progress, the service yielding qualities of most goods will continue to increase for some time to come. If so, this will largely offset the effect of the law of diminishing marginal utility. To what extent it does so, one cannot ascertain; however, it should be sufficient to ensure that any positive impact on psychic income over time is closely approximated by changes in real private consumption expenditure. Index of Distributional Inequality/Weighting of Private Consumption Expenditure In general, the method of adjusting consumption expenditure involves the use of an index of distributional inequality that is constructed from the Gini coefficient of income distribution. The index of distributional inequality is assigned a value of 100 for the first year of the study period and adjusted in accordance with changes over time in the Gini coefficient. Private consumption expenditure is then divided by the index value and multiplied by 100. An improvement/deterioration in the distribution of a nation’s income results in the upward/downward weighting of private consumption expenditure. There are two main criticisms of this approach. First, following evidence on the link between income distribution and environmental quality, it has been suggested that a more equal distribution of income can lead to a greater rate of environmental damage. If so, a more equal distribution of income would presumably lower the ISEW and GPI as much as it might increase it. This suggests that no weighting should be applied to private consumption expenditure. I disagree with this criticism for three reasons. In the first instance, let’s assume that a more equal distribution of income increases the present welfare contribution made by private consumption expenditure and also results in deteriorating environmental quality. This does not alter the welfare related justification for the adjustment to private consumption expenditure since any increase in resource depletion and environmental degradation should be captured by other items used to calculate the ISEW and GPI (e.g., the environmental cost items). Next, the argument put forward linking income distribution and environmental damage is unconvincing. The argument is based on the view that sustainability is positively correlated with current savings, whereby the latter can fall as a consequence of redistributing income from the rich (who have a high marginal propensity to save) to


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the poor (with a low marginal propensity to save). The overall fall in savings presumably contributes to growing environmental damage. As true as the savings impact of income redistribution might be, it is equally true that a less equal distribution of income leads to environmental deterioration because the poor, usually subsistence farmers in many Third World countries, are forced to live beyond the carrying capacity of their local environments in order to survive. In addition, much of the savings undertaken in industrialised countries takes the form of human-made capital accumulation. This invariably occurs at the expense of natural capital depletion, as evidenced by national measures of genuine savings that include the depreciation of natural as well as human-made capital (Pearce, 1993). Last but not least, the alternative policy option to redistribution – namely, further growth of macroeconomic systems – appears to be the principal factor contributing to environmental damage. The second criticism lies in the use of the Gini coefficient to establish an index of distributional inequality. Neumayer (2000) claims this technique is very subjective and ad hoc. Neumayer believes the Atkinson index of distributional inequality (Atkinson, 1970) is less subjective because it makes explicit the researcher’s assumption regarding a society’s aversion to income inequality. I disagree; indeed, I believe it is the converse. By starting with an index value of 100 the Gini coefficient method makes no subjective assumption about the desirability of the distribution of income at the beginning of the study period. It is only assumed that an improvement/deterioration in the distribution of income has a positive/negative impact on the overall welfare of a nation’s citizens. This is hardly subjective since, as already mentioned, the welfare impact of a changing distribution of income has empirical support (Easterlin, 1974; Abramowitz, 1979). On the other hand, the Atkinson index approach requires the researcher to make an explicit choice as to what is society’s aversion to income inequality at the beginning of the study period. This seems to be far more open to subjectivity. One final point: Stockhammer et al. (1997) go much further than most and use the index of distributional inequality to weight the final or raw ISEW value. Whether this is justified is debatable. There is certainly good reason for weighting the services provided by consumer durables along with private consumption expenditure. However, while it could be successfully argued that the cost of environmental damage, crime and family breakdown is disproportionately borne by the poor, it could also be argued that the poor benefit most from public consumption expenditures. Given what appears to be a clear case of inconsistency and the potential for different methodologies to significantly alter the ISEW, GPI and SNBI, further debate on this issue is required.

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Defensive and Rehabilitative Expenditures The subtraction of defensive expenditures has been widely criticised (Maler, 1991; United Nations, 1993; Hamilton, 1994 and 1996; Neumayer, 1999). It has been suggested that the concept of defensive expenditure is very dubious because it is impossible to draw the line between what does and does not constitute a defensive form of expenditure. For example, as Neumayer (1999, p. 83) argues: ‘If health expenditures are defensive expenditures against illness, why should food and drinking expenditures not count as defensive expenditures against hunger and thirst? Are holiday and entertainment expenditures defensive expenditures against boredom? Should they all be subtracted from private consumption expenditures?’ Furthermore, a United Nations review of national accounting has argued that when the concept of defensive expenditures is pushed to its logical conclusion, scarcely any consumption expenditure contributes to an improvement in human welfare. There is some degree of truth in the above criticism. Certainly some percentage of food and drinking expenditure is defensive, as is spending on clothes and housing. However, there is a fundamental difference between necessary expenditure on such things as food and drink, and expenditures people feel increasingly required to make to protect themselves against the unwanted side effects of the socio-economic process. It is safe to say that the latter are defensive in nature and the majority of the former are not. In addition, if private consumption expenditure was confined to defensive measures only, a lot less spending would take place since, for example, expenditure on cosmetic surgery would not occur. Nor would there be any spending on gourmet food at a restaurant. Perhaps there is some justification for counting only half of all money spent on food and drink as welfare enhancing? As it is, where calculations of the ISEW, GPI and SNBI involve deductions for defensive expenditures (e.g., private health and education expenditure), only a percentage of the total expenditure is deducted. Whilst not directly criticising the subtraction of defensive expenditures, some observers have stressed the need to attribute the cost of such expenditures to the year in which the injurious activities took place (e.g., Leipert, 1986). As is quite rightly argued, a failure to address this issue will result in the overstatement of the economic welfare of earlier years. Except for the ISEW calculated for Austria by Stockhammer et al. (1997), little has been done in this regard. The lack of any action is due largely to the difficulty in assigning the present cost of defensive expenditures to the years in which the damaging activities took place. To date, the overall impact on the ISEW, GPI and SNBI of subtracting defensive expenditures has been less


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significant than other costs. This may not, however, continue to be the case. Hence, in order for future calculations of the ISEW, GPI and SNBI to better approximate the economic welfare generated in a given year, it will be necessary for the present cost of damaging activities to be imputed and attributed to past years. Cost of Sacrificed Natural Capital Services Perhaps the greatest criticism of the ISEW and GPI has been levelled at the methods used to calculate the cost of resource depletion plus the tendency of researchers to deduct the cumulative cost of ozone depletion, long-term environmental damage and lost old-growth forests. In terms of the cost of non-renewable resource depletion, there is, again, little if any consistency in the methods used by the ISEW and GPI proponents. This has attracted criticism in itself. As for the methods used, Neumayer (2000) is particularly critical of the rationale behind the use of a replacement cost approach. Neumayer believes a resource rent approach should be used. This has been done in a number of ISEW and GPI calculations; however, the typical resource rent approach involves a deduction of the total cost of non-renewable resource depletion. In most instances, it also involves the assumption of escalating non-renewable resource prices. Neumayer argues against the deduction of the total cost of non-renewable resource depletion by claiming that El Serafy’s (1989) ‘user cost’ formula is the correct means of calculating resource rents. The significance of El Serafy’s user cost formula is that only a portion of the total cost of resource depletion is deducted. I agree entirely with Neumayer regarding the El Serafy user cost formula, although the interest rate used in the formula (see equation 3.22 in Chapter 3) should be replaced by the regeneration rate of the renewable resource that must be cultivated to keep the total stock of natural capital intact (Lawn, 1998).2 However, I disagree with Neumayer’s argument against the use of a replacement cost approach. Neumayer dislikes the replacement cost approach because he believes there is no reason why non-renewable resources have to be fully replaced in the present when there are adequate reserves available for many years to come. If there is no current requirement to fully replace non-renewable resources, then, according to Neumayer, it is wrong to use a replacement cost approach to calculate the cost of depletion. I disagree with Neumayer because the ISEW and related measures are interested in the sustainability of, as well as the economic welfare generated by, economic activity. While the present quantity of resources being extracted from non-renewable resource stocks can be sustained for some time without having to find or establish a renewable resource replacement, this doesn’t

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mean that it can be sustained indefinitely. And while it may not be necessary to think about a replacement resource for some time, for proper accounting purposes, the actual cost of establishing a renewable resource substitute must be attributed to the point in time when the depletion took place. Indeed, this is the basis behind the El Serafy user cost method. It might be argued that I am being inconsistent here – after all, I am arguing in favour of the replacement cost approach while also promoting the use of El Serafy’s user cost formula. The El Serafy user cost formula is regarded as just one of many ways to execute the resource rent approach. However, the beauty of the El Serafy user cost formula is that it can be used to calculate resource rents and replacement costs, and so it is not entirely correct to say it is exclusively a resource rent method. For example, reconsider the El Serafy user cost formula (equation 3.22 in Chapter 3). This user cost approach is a resource rent method in that the portion of the proceeds from resource extraction that does not constitute a user cost is a genuine resource rent. It is also a replacement cost method in that the portion of the proceeds from resource extraction which does constitute a user cost is, in fact, the genuine cost of resource asset replacement. Since it is the user cost that ought to be deducted when calculating the ISEW, GPI and SNBI, the El Serafy formula serves its purpose as a replacement cost means of estimating the cost of resource depletion. As for the assumed escalation of non-renewable resource prices over time, Neumayer’s (2000) observation that most commodity prices have not increased in real terms is entirely correct. Nevertheless, in view of the expected life of many non-renewable resources and the projected rates of depletion, the price of non-renewable resources should be rising to reflect their impending absolute scarcity. That they have not simply reflects the fact that markets, while very good at signalling relative scarcities (e.g., the scarcity of oil relative to coal), are woefully inadequate at signalling the absolute scarcity of the total quantity of all low entropy resources available for current and future production (Howarth and Norgaard, 1990; Norgaard, 1990; Bishop, 1993; Daly, 1996; and Chapter 5). Should one use the actual market prices of non-renewable resources to assist in the calculation of the ISEW, GPI and SNBI if they fail to reflect their increasing absolute scarcity? I think not. To get an accurate picture of sustainable economic welfare, one should use the best estimate of rising non-renewable resource prices. Many studies have used a 3 per cent escalation factor. In the calculation of the SNBI (Lawn and Sanders, 1999; Lawn, 2000) a 2 per cent escalation factor was assumed. In conclusion, an assumed escalation of non-renewable resource prices seems justified. Another highly contentious issue is whether the deduction term for the cost of ozone depletion, long-term environmental damage and lost


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old-growth forests should, in each case, be a cumulative total. By cumulative I mean that the amount deducted for each year is equal to contribution made to the cost for the year in question plus the accumulated cost from previous years. Neumayer (2000) believes this is wrong since it involves double counting. He believes that only the present cost should be deducted. Neumayer has a very good point here and unless accumulation of past costs can be adequately justified, it should be abandoned. However, I believe that cost accumulation can be justified because the ISEW, GPI and SNBI are calculated to approximate the sustainable economic welfare being experienced by a nation’s citizens over the course of a particular year. In the case of ozone depletion, long-term environmental damage and lost old-growth forests, the impact on the sustainable economic welfare in any given year depends very much on what has happened in the past. Hence, the total cost in any given year must reflect the amount required to compensate a nation’s citizens in that year – in a sense, a compensatory fund – for the cumulative impact of past and present economic activities on the natural environment.

THE NEED FOR A MORE ROBUST AND CONSISTENT SET OF VALUATION METHODS There is little doubt that the establishment of more robust means of valuation should strengthen the ISEW, GPI and SNBI as well as increase the policy guiding value they currently possess. However, the most urgently needed refinement concerns the establishment of a consistent set of valuation methods. To date, there have been as many as five different approaches to the calculation of some of the items that make up these alternative indexes. The inconsistency problem also extends to the choice of items. For example, in some studies, the imputed value of leisure time is added (Lawn and Sanders, 1999; Lawn, 2000); in others, the value of lost leisure time is deducted (Redefining Progress, 1995); and in others, there is no inclusion of leisure at all (Daly and Cobb, 1989; Stockhammer et al., 1997). Furthermore, the inconsistency problem is compounded by the existence of three different names for essentially the same index. Most people are aware of the United Nations System of National Accounts (SNA). The SNA sets out the standardised methods by which GDP and other conventional macroeconomic indicators are calculated. A consistent set of valuation methods and procedures, as well as an agreed name, is also required for the ISEW, GPI and SNBI. While it is unlikely that many governments would initially acknowledge and certify the new index, professional and academic organisations and societies are much

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more likely to do so. This is critically important. The eventual acceptance of a new welfare index – including its eventual use as a policy guiding barometer – is likely to depend heavily upon its recognition by large reputable organisations. A Suitable Name for an Alternative Welfare Index Given the likely benefit of having just one name for an alternative welfare index, which of the three that currently exist is the most appropriate? Alternatively, is there a superior name that has yet to be suggested? It would seem to me that a number of factors should be taken into account when determining an agreed name. First, the name must be relatively short and simple. Second, the name must describe, in a non-technical fashion, what is being measured. Third, the name must avoid alienation. People from whatever background or position in society must feel, from the name alone, that they are an integral, living element of the index – that the index reflects the welfare of the nation in which they live and participate. For these reasons, I lean towards the Genuine Progress Indicator as the best name so far devised. A Standardised Set of Items and Valuation Methods to Calculate the Indexes Any move towards the standardisation of items and valuation methods must take into account the availability of the data required to calculate the individual items. After all, if the aim of standardisation is to eliminate inconsistency and facilitate inter country comparisons, there is little point agreeing on the items if the data needed to calculate certain items is not available in many countries. From my own experience in calculating the SNBI for Australia – a country possessing a wealth of statistical information – I am acutely aware of the difficulty obtaining appropriate data. Data availability will undoubtedly be a more pressing problem in many Third World countries. If, in trying to establish a standardised welfare index, the lack of available data leads to an index with so few items as to render it superfluous, it may be expedient to have two indexes – a more comprehensive index for countries with extensive data sets; an abridged version that can be calculated for all nations to permit inter country comparisons. Second, the choice of valuation technique for each particular item should be aimed at minimising the subjectivity required on the part of the researcher. By subjectivity, I mean the extent to which one is left to make his or her own assumptions in order to calculate the individual item in question. Maximising researcher objectivity lends itself to consensus and


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consensus is clearly necessary for an alternative welfare index to be broadly accepted by reputable organisations and the wider community.

INTERPRETING THE RESULTS OF PAST STUDIES To what extent do the ISEW, GPI and SNBI serve as reliable measures of sustainable economic welfare and as empirical support for the threshold hypothesis? Considerably more, it would seem, than GDP or any other macroeconomic indicator. Having said this, a number of things must be kept in mind. First, there is the already discussed issue of whether current valuation methods are sufficiently robust to ensure the final index values are suitably accurate. Second, the ISEW, GPI and SNBI must be supplemented by a satellite account of natural capital to determine whether the changing level of economic welfare is ecologically sustainable. Third, the list of items used to calculate the ISEW, GPI and SNBI is not exhaustive – there are many welfare related factors unaccounted for (e.g., the disutility of certain forms of work and the existence values of natural capital). Fourth, as Neumayer (1999) has pointed out, some items dominate others such that it is possible for a small variation in dominant items to overwhelm large variations in the remainder. Overcoming this problem may require the decomposition of the dominant items into a number of smaller items and a sensitivity analysis to assess their individual impact on the final index value. Fifth, while the ISEW, GPI and SNBI convey useful information about the current manifestations and immediate effects of past and present activities, they reveal much less about the future impact of current activities. In line with suggestions put forward by Asheim (1994 and 1996), Pezzey (1993) and Pezzey and Withagen (1998), it may be expedient to employ forecasting techniques that would allow researchers to incorporate into the ISEW, GPI and SNBI the probable benefits and costs of current actions. This, in turn, would strengthen the policy guiding relevance of these alternative indexes. Sixth, it is universally recognised that a single index cannot tell us everything about sustainable development although the consistent trend revealed by the ISEW, GPI and SNBI is enough to suggest that the costs of continuing growth are, for many countries, already exceeding the additional benefits. Finally, since monetary based indicators are far from perfect, the value of the ISEW, GPI and SNBI would be greatly enhanced if the indexes were supplemented by non-monetary welfare and sustainability indicators – for example, a comparison between a nation’s ever-changing ecological footprint and biocapacity (Wackernagel et al., 1999).

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CONCLUDING REMARKS As imperfect as the ISEW, GPI and SNBI are, I believe the illumination of a sound theoretical foundation and the evolution of more robust valuation methods will unquestionably strengthen the case for these alternative indexes. It should also lead to wider acceptance of the threshold hypothesis and agreement over which countries have exceeded their optimal macroeconomic scale. Above all, the quest for more appropriate indicators of sustainable economic welfare must remain a high priority for ecological economists at a time when all but the world’s poorest nations urgently need to make the transition away from growth to that of sustainable qualitative improvement, better known as sustainable development.

NOTES 1. Perhaps the one exception is Stockhammer et al. (1997). 2. This is because the regeneration rate of a renewable resource is effectively its interest rate.

8.

Using a Fisherian measure of income to guide a nation’s transition to a steady-state economy

INTRODUCTION In a relatively recent News and Review article in the journal, Ecological Economics, William Mates (2004) outlined two basic accounting identities for Hicksian and Fisherian national income. The identities were devised following a paper I wrote highlighting the theoretical foundation underlying the Index of Sustainable Economic Welfare (ISEW) and the Genuine Progress Indicator (GPI). In a response to Mates’ paper (Lawn, 2004b), I extended Mates’ accounting identities to include the cost of lost natural capital services. I also introduced a means by which the physical scale of a nation’s macroeconomy could be measured and tracked. This, I argued, would enable one to calculate the economic welfare associated with a nation’s prevailing growth strategy and aid its inevitable transition to a steady-state economy. In this chapter, I go one step further and measure the Hicksian and Fisherian national income of Australia for the period 1967–97. In view of the superiority of the latter indicator, I also contrast Australia’s per capita Fisherian income with the growth trend of the Australian economy to reveal whether Australia should have already initiated a transition to a steady-state economy and, if so, when the transition might best have begun. Before revealing the results of the study, I will briefly say something about the steady-state economy and reiterate the difference between Hicksian and Fisherian national income. Second, I will introduce the basic equations for Hicksian and Fisherian national income revealed in my response to Mates’ paper (Lawn, 2004b). Third, since both equations are limited in terms of their informational content, they are modified to give them greater policy guiding value. Fourth, it is explained what constitutes, quantitatively, the difference between a rapid growth, high growth, low growth, and steady-state strategy. Fifth, Hicksian and Fisherian income are calculated for Australia for the period 1967–97. In the final section of the 147

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chapter, conclusions are drawn regarding the desirability of Australia’s past and present growth strategies.

HICKSIAN INCOME, FISHERIAN INCOME AND THE STEADY-STATE ECONOMY The Steady-State Economy To recall from Chapter 2, a steady-state economy is a physically nongrowing economy that, ideally, is maintained by a resource flow consistent with the regenerative and waste assimilative capacities of the natural environment. The transition to a steady-state economy is necessary for two reasons. First, a continually expanding economy is ecologically unsustainable because the economy, as a dependent subsystem of the larger ecosphere, cannot outgrow its host. Hence a steady-state economy is necessary to ensure the economy does not exceed its maximum sustainable scale (SS in Figure 2.4). Given the complex nature of economy-environment interactions and the uncertainty as to how large the maximum sustainable scale might be, the ‘safe’ maximum is probably a lot smaller than the estimated maximum (e.g., 75 per cent of the estimated maximum sustainable scale). Second, well before the macroeconomy reaches its maximum sustainable scale, the additional benefits of a growing macroeconomy are eventually outweighed by the additional costs – a corollary of the principles of diminishing marginal benefits and increasing marginal costs. If a nation wishes to achieve sustainable development, not just ecological sustainability, the growth of the macroeconomy must come to rest at the point where the marginal benefits and marginal costs of growth are equal – that is, where economic welfare is maximised (S* in Figure 2.4). Thus, a steady-state economy is necessary to operate at the optimal macroeconomic scale, although growth up to the optimum is both ecologically sustainable and welfare-increasing. Of these two scales just mentioned, a steady-state economy is most desirably operated at the optimal macroeconomic scale. Clearly, an optimal steady-state economy will be considerably smaller in size than the maximum sustainable steady-state economy. Indeed, the latter is something a nation should seek to avoid altogether. In Chapter 2, it was also highlighted that continued development (increasing economic welfare) is still possible in the presence of a steadystate economy. Better product design and a variation in the market allocation of the incoming resource flow over time can facilitate qualitative

Fisherian income and the steady-state economy

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improvements such as the replacement of worn out goods by new goods exhibiting higher benefit-yielding qualities. An increase in time devoted to leisure activities and a greater sense of purpose can also contribute to the development process in a steady-state economy. In order to determine whether a nation should begin the transition to a steady-state economy, it is necessary to know: 1. 2.

Is the nation’s economy physically growing and, if so, at what rate? Is economic welfare rising or falling?

It is true that a fall in economic welfare accompanying a physical expansion of a nation’s macroeconomy does not conclusively indicate an immediate need to abandon the growth objective. Declining economic welfare in the presence of a growing macroeconomy can also be the result of a grossly inefficient allocation of the incoming resource flow and/or a woefully inequitable distribution of income and wealth. If either or both are to blame, an immediate transition to a steady-state economy could prove to be a premature course of action. However, apart from impoverished nations, it is fairly safe to assume that a decline in economic welfare can be largely attributable to the macroeconomy having surpassed its optimal scale. Hicksian and Fisherian National Income An answer to the second question above can be obtained by employing a more appropriate means of measuring national income. At various stages in this book, income has been defined in the Hicksian sense as the maximum amount that can be produced and consumed in the present without compromising the ability to do likewise in the future. The appealing aspect of Hicksian income was its recognition that sustaining the production of a particular quantity of physical goods requires the maintenance of incomegenerating capital. To ascertain a measure of Hicksian national income, it was suggested that various deductions be made to Gross Domestic Product (GDP) – see equation (6.1). This, in turn, led to a measure of Hicksian national income often referred to as Sustainable Net Domestic Product (SNDP). However, it was also argued that Hicksian national income possessed an inherent weakness. The weakness lay not with the failure of SNDP to capture the capital maintenance requirement (although potential problems do exist in this regard), but with the fact that SNDP includes all additions to human-made capital as current income. In doing so, Hicksian national income conflates the services rendered by capital (income) with the capital that renders them. Moreover, since the monetary value of the physical

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goods produced in a given year is effectively the cost of keeping humanmade capital intact, Hicksian national income stands as an index of sustainable cost rather than an index of sustainable economic welfare. Fisherian national income overcomes the inherent deficiency of Hicksian national income by attempting to measure the annual services or net psychic income enjoyed by a nation’s citizens. It does this by confining consumption benefits to both the services rendered by the non-durable goods consumed in the current year and the durable goods used over the current year that have been manufactured and accumulated in previous years. Unlike SNDP, it does not include this year’s additions to the stock of human-made capital as current income. Fisherian national income, as with Hicksian income, also takes account of the natural capital services lost in providing the throughput of matter-energy needed to keep the stock of human-made capital intact. All in all, Fisherian national income is much closer to a measure of sustainable economic welfare than Hicksian national income. In their most basic form, Hicksian and Fisherian national income can be denoted by the following simple identities: Hicksian national income:

YH CON INV DEP LNCS (8.1)

Fisherian national income:

YF CON DEP LNCS

(8.2)

where CONprivate public consumption expenditure, INVgross fixed investment in human-made capital (producer goods), DEPdepreciation of human-made capital (producer goods), and LNCSlost natural capital services. The merit of equations (8.1) and (8.2) lies in the simplicity with which they reveal the logical superiority of the Fisherian concept of national income. For example, while Hicksian national income as defined in equation (8.1) correctly includes current consumption as income, it wrongly counts as current income all newly produced human-made capital (i.e., that which has been produced now in order to provide welfare benefits in the future). Furthermore, Hicksian income erroneously subtracts the depreciation or ‘consumption’ of previously accumulated human-made capital (that is, welfare benefits currently being enjoyed as a consequence of past production). Measuring national income as per equation (8.1) is tantamount to saying that investing rather than consuming now involves no sacrifice in the present and that sacrifices in the past yield no current benefits. Fisherian income as defined in equation (8.2) overcomes this perversity.


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INCREASING THE POLICY GUIDING VALUE OF HICKSIAN AND FISHERIAN MEASURES OF NATIONAL INCOME Being examples of Hicksian and Fisherian national income in their most basic algebraic form, equations (8.1) and (8.2) are limited in terms of their informational content. Both equations require modifications to bestow them with greater policy guiding value. Let us begin the modification process with a more thorough examination of Hicksian national income. First, equation (8.1) differs from equation (6.1) in Chapter 6 in the sense that it does not include the deduction of defensive and rehabilitative expenditures (e.g., the cost of vehicle repairs, family breakdown, and a certain percentage of health and education expenditure). These expenditures should, of course, be subtracted to obtain a better estimate of a nation’s sustainable productive capacity. Given that we wish to keep the equation for Hicksian national income as simple as possible, an uncomplicated adjustment to equation (8.1) is required. For the purposes of this chapter, it is assumed that 10 per cent of all private and public consumption expenditure constitutes spending of a defensive and/or rehabilitative kind. As such, only 90 per cent of private and public consumption expenditure is assumed to be making a contribution to a nation’s Hicksian income. Compared to studies conducted elsewhere, this is a very conservative downward adjustment. Some readers will have noticed that equation (8.1) starts with consumption expenditure as the base item whereas equation (6.1) begins with GDP. Is this a case of being inconsistent? Not entirely, since two of the main items of GDP are: (a) private and public consumption, and (b) investment expenditure. The addition of consumption and investment expenditure in equation (8.1) therefore accounts for all domestic related components of GDP. Of course, equation (8.1) still leaves out the third major component of GDP – namely, net exports (exports less imports). A more comprehensive measure of Hicksian national income must include the addition of net exports in equation (8.1). As for Fisherian national income, a number of basic adjustments to equation (8.2) are necessary. To begin with, private consumption expenditure includes current spending on consumer durables (ECD). Because this expenditure constitutes an addition to the stock of human-made capital, albeit consumer goods, it must be subtracted from equation (8.2). To be consistent with Fisher’s distinction between income and capital, the depreciation of previously accumulated consumer durables must be added to reflect the service they yield in the current year (SCD). Second, equation (8.2), just like equation (8.1), does not include the deduction of defensive and rehabilitative expenditures. As such, these

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expenditures need to be deducted in much the same way as they should when modifying Hicksian national income. But there is a need to go somewhat further in relation to Fisherian national income. Why? Deductions in relation to Hicksian national income are confined to whatever part of the annual product must be set aside to maintain a nation’s sustainable productive capacity – that is, its ability to keep producing the same quantity of goods over time. But Fisherian income is concerned with more than sustaining a nation’s productive capacity. It is also concerned with the net psychic income enjoyed by a nation’s citizens, and the latter need not equate to the former. There is little doubt that the consumption of many items that make up private and public consumption expenditure do not contribute to a nation’s net psychic income even though it may have little detrimental impact on its productive capacity (e.g., tobacco products and excessive quantities of junk food and alcohol).1 Consequently, a further adjustment to equation (8.2) is required that does not need to be made to equation (8.1). For the purposes of this chapter, an additional 10 per cent of all private and public consumption expenditure is assumed to be non-welfare enhancing. This means that only 80 per cent of private and public consumption expenditure (net of recommended ECD and SCD adjustments) is assumed to be making a contribution to a nation’s Fisherian income. This, again, is a very conservative adjustment when compared to similar studies. Third, it has been shown that a redistribution of income from the low marginal service uses of the rich to the higher marginal service uses of the poor can increase the net psychic income enjoyed by society as a whole. Clearly, a welfare adjustment must be made to equation (8.2) to account for changes over time in the distribution of income. Again, an adjustment of this nature need not be made to equation (8.1) because a change in the distribution of income is unlikely to have a significant impact on a nation’s sustainable productive capacity.2 For the purpose of this chapter, the welfare contribution made by the previously adjusted value of private and public consumption expenditure (i.e., CONF 0.8(CON – ECD SCD)) is weighted by an index of distributional inequality. The weighting approach is the one commonly used in the calculation of the ISEW and the GPI. As explained in Chapter 7, this method involves the use of an index of distributional inequality based on the Gini coefficient of income distribution. The index of distributional inequality is assigned a value of 100 for the first year of the study period and is then varied in accordance with changes over time in the Gini coefficient. The adjusted value of private and public consumption expenditure is divided by the index value and multiplied by 100. An


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improvement/deterioration in the distribution of a nation’s income results in the upward/downward weighting of the welfare contribution made by consumption expenditure. Fourth, the cost of lost natural capital services subtracted from equations (8.1) and (8.2) must include the full range of source, sink and lifesupport functions sacrificed in supplying the throughput of matter-energy needed to keep the stock of human-made capital intact. Whilst it is a relatively simple exercise to estimate the cost of sacrificed source and sink functions (e.g., the cost of resource depletion and pollution), it is much more difficult to estimate the cost of losing some of the life-support services provided by critical ecosystems. To assist in this regard, the sum total of the cost of lost natural capital services is weighted in line with changes in an ecosystem health index. The rationale for this adjustment is simple. The impact of most resource extraction and pollution activities is not confined to the erosion of the ecosphere’s source and sink functions. It also extends to ecosystem degradation. A good example is strip mining – a resource extraction practice requiring the initial removal of terrestrial fauna and flora. Another is agriculture – again, an activity first requiring the clearance of native vegetation. To account for the loss of the ecosphere’s life-support function, an ecosystem health index is calculated on the premise that remnant vegetation loss constitutes the ‘greatest threat to biodiversity’ and, therefore, to ecosystem functioning (Biodiversity Unit, 1995). A base index value of 100 is assigned to the first year of the study period and is adjusted in line with the annual changes in the area of relatively undisturbed land. The annual cost of lost natural capital services is then divided by the index value and multiplied by 100. A decrease/increase in the area of relatively undisturbed land results in an upward/downward weighting of lost natural capital services. Finally, while net exports need to be added to equation (8.1) to obtain a more comprehensive measure of Hicksian national income, they must not be added to equation (8.2). Why? Both consumption and investment expenditure includes current spending on imported consumer and producer goods. Not included are, for obvious reasons, the exported consumer and producer goods purchased by foreigners. It is because exports but not imports help in the determination of a country’s productive capacity that net exports have to be added when calculating Hicksian national income. But, again, Fisherian national income is not about sustainable productive capacity. It’s about net psychic income or sustainable economic welfare, and the goods that a nation exports do not contribute directly to a nation’s net psychic income. Exports are not counted in equation (8.2) to begin with and, appropriately, are not added.

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Conversely, the goods that a nation imports do make a direct contribution to its citizens’ net psychic income. Some of these goods make their positive contribution now (e.g., imported non-durable consumer goods plus the imported durable goods accumulated in the past), while some make their contribution later (e.g., imported durable goods currently being added to the existing stock). Since equation (8.2) already includes current import expenditure on both non-durable and durable consumer goods, it is necessary to retain the import expenditure on all non-durable consumer goods but subtract the import expenditure on consumer durables. Provided that the first of the recommended modifications to Fisherian income has been followed, this deduction will have already been made. In view of the aforementioned, and without compromising the relative simplicity afforded by equations (8.1) and (8.2), the following identities and sub-equations will henceforth be used to conduct an empirical analysis of Australia’s growth strategy: Hicksian national income YH CONH INV DEP NX LNCS (weighted)

(8.3)

and Fisherian national income YF CONF DEP LNCS (weighted)

(8.4)

CONH 0.9CON

(8.5)

CONF [0.8(CON ECD SCD)](weighted)

(8.6)

where

and where CONH private public consumption expenditure adjusted as per the Hicksian income concept; CONF private public consumption expenditure adjusted as per the Fisherian income concept and then weighted in accordance with changes in the distribution of income; INV gross fixed investment in human-made capital (producer goods); DEP depreciation of human-made capital (producer goods); NXnet exports (exports less imports); LNCS (weighted)lost natural capital services weighted in accordance with changes in the ecosystem health index; ECD current expenditure on consumer durables; and SCDservice yielded by the accumulated stock of consumer durables. In light of what I said earlier regarding net psychic income and the need to account for the psychic costs of economic activity, a measure of Fisherian income might also include such items as the value of volunteer and household labour, the value of leisure time, the cost of unemployment,


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noise pollution, commuting, crime, and family breakdown, and the change in a nation’s foreign debt position.3 As important as these items can be, they have been omitted to avoid overcomplicating the calculation of Fisherian national income and to permit more meaningful comparisons with Hicksian national income. One last point: Fisherian national income provides an indication of where a nation stands in relation to its optimal macroeconomic scale. It does not tell us whether a nation’s economy has surpassed its maximum sustainable scale. For this to be revealed, it is necessary to undertake biophysical assessments of resource stocks and critical ecosystems and present the information in something akin to a natural capital account. Diminution of natural capital over time would indicate that a nation’s economic welfare is becoming increasingly unsustainable. As a back-up to the natural capital account, a comparison between a nation’s ever-changing ecological footprint and biocapacity could also be provided (see Wackernagel et al., 1999). In this instance, the surpassing of the latter by the former would also indicate the unsustainable nature of economic activity.4

MAKING A QUANTITATIVE DISTINCTION BETWEEN THE VARIOUS RATES OF GROWTH OF A NATIONAL MACROECONOMY Net Capital Investment and a Nation’s Rate of Macroeconomic Growth Earlier on in the chapter, I indicated that knowing whether a nation should initiate the transition to a steady-state economy requires some understanding of the growth rate of a nation’s macroeconomy. To determine whether the stock of human-made capital is growing, the values for gross fixed investment in human-made capital (INV) and the depreciation of human-made capital (DEP) used in the calculation of Hicksian and Fisherian income can again be of assistance. It should be noted that, on this occasion, the values for INV and DEP are employed for a different and unrelated purpose. Given that INV represents newly produced human-made capital while DEP represents the diminution of existing human-made capital, the former minus the latter constitutes a net addition to the stock of human-made capital. This net addition is commonly referred to as net capital investment (NCI INVDEP). It follows that a level of investment in excess of depreciation (NCI 0) implies a physical expansion of the human-made capital of which the macroeconomy is comprised. In doing so, it indicates that a nation’s macroeconomy has physically grown.

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With this in mind, consider the following growth strategies: ● ● ● ● ●

INV 2DEP (NCI/DEP 1.0) 2DEP INV1.5DEP (1.0 NCI/DEP0.5) 1.5 DEP INV DEP (0.5 NCI/DEP 0) INV DEP (NCI 0) INV DEP (NCI 0).

The first can be loosely regarded as a ‘rapid growth’ strategy since the current addition of human-made capital provides for more than two years’ worth of current-year depreciation. In this instance, the ratio of net capital investment to depreciation is 1.0. The second can be regarded as a ‘high growth’ strategy since the stock of human-made capital continues to expand but at a lower rate than the first strategy. With a high growth investment policy in place, the ratio of net capital investment to depreciation lies somewhere between 0.5 and 1.0. The third is a ‘low growth’ strategy whereby the current addition of human-made capital is sufficient to marginally exceed one year’s worth of current-year depreciation. On this occasion, the ratio of net capital investment to depreciation lies somewhere between 0.0 and 0.5. The fourth is a ‘steady-state’ strategy where, quite obviously, the current addition of human-made capital is sufficient only to keep the stock of human-made capital intact. The final strategy is a ‘negative growth’ or contractionary strategy and may be required should a nation’s economy have already exceeded its optimal scale.5 Adopting the Appropriate Growth Strategy What growth strategy should a nation adopt at a particular point in its development process? A rapid growth strategy is desirable if a nation’s macroeconomy is well short of the optimal scale. This is because the marginal benefits of growth are presumably large while the marginal costs are small. As such, a rapid rate of growth will increase Fisherian national income. Countries in this position will invariably be poor and in desperate need of a period of rapid growth. It is unlikely, however, that a rapid growth strategy would be desirable for wealthy nations, particularly countries having recently completed a long phase of industrialisation. Not only would a rich country adopting such a strategy quickly surpass its optimal scale – in which case Fisherian national income would fall – it would risk exceeding its maximum sustainable scale. The transition from a rapid growth to a high growth strategy is desirable for a developing country once the expansion of its macroeconomy begins to impinge more heavily on the supporting ecosphere. This is because the


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marginal costs of a rapid growth policy, should such a policy continue, will eventually exceed the marginal benefits it generates. As such, Fisherian national income will at some stage begin to decline. Should the macroeconomy of a developing country be growing as per the high growth strategy, it will eventually enter the category of a newly industrialised country. Since it is now the continuation of a high rate of growth that lowers Fisherian income, it is desirable to shift to a low growth strategy. At this stage of the development process, continued growth – albeit at a much lower rate – will eventually lead to a metamorphic change from a newly industrialised country into one with a well-established industrial base. Because the macroeconomy ought now to be nearing its optimal scale, a transition to a steady-state strategy will need to be initiated. This can be achieved by gradually restricting the throughput of matter-energy until the rate is consistent with the ecosphere’s regenerative and waste assimilative capacities. In a steady-state milieu, Fisherian national income can be increased by qualitatively advancing the stock of human-made capital, improving the manner in which production activities are organised and conducted, and encouraging people to substitute towards pursuits that increasingly satisfy their high-order needs.

SHOULD AUSTRALIA BE MAKING THE TRANSITION TO A STEADY-STATE ECONOMY? Calculating Australia’s Hicksian and Fisherian National Income The calculation of Australia’s Hicksian and Fisherian national income for the period 1967–97 is provided in Table 8.1. Constructed on the basis of equations (8.3) to (8.6), Table 8.1 reveals the annual value of each of the principal indicators and the items used in their calculation. All monetary values are based on 1989/90 prices. The most important columns are columns x, y, aa, bb, and cc which respectively disclose the ratio of net capital investment to depreciation (NCI/DEP); Australia’s prevailing growth strategy; per capita Hicksian income; per capita Fisherian income; and per capita real GDP. Most of the data used to compile Table 8.1 was sourced directly from various publications produced by the Australian Bureau of Statistics (Catalogue Nos 5241.0, 6523.0 and 1301.0). There are, however, a few exceptions. First, the data used to list the annual value of the stock of consumer durables (column d) was sourced from the Commonwealth Treasury of Australia (various). Second, the ecosystem health index (column q) was calculated from data generated by two landcover disturbance surveys

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1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997

Year

117.3 124.9 130.3 137.5 143.2 149.0 156.7 165.8 173.0 180.2 184.9 188.9 195.7 200.7 209.1 216.2 219.6 226.0 235.0 244.3 247.8 257.3 267.4 278.4 282.2 290.3 297.8 305.0 319.5 333.2 341.0

a

105.6 112.4 117.2 123.8 128.9 134.1 141.0 149.2 155.7 162.2 166.5 170.1 176.2 180.6 188.2 194.6 197.6 203.4 211.5 219.9 223.0 231.6 240.7 250.6 254.0 261.2 268.1 274.5 287.5 299.9 306.9

CONH ($) (a 0.9) b

8.9 9.4 9.9 10.4 10.8 11.4 12.3 14.1 15.2 16.1 16.1 15.3 15.0 15.0 15.8 16.4 16.2 16.9 17.4 18.0 18.1 18.8 19.2 19.7 19.0 19.5 19.9 20.5 21.2 21.5 21.8

c

ECD ($)

43.9 45.6 47.6 49.7 51.1 53.0 55.2 58.3 62.1 64.9 67.5 68.4 67.0 67.8 68.9 71.2 71.9 72.0 73.9 79.1 82.0 81.9 82.6 83.9 84.5 85.3 87.2 90.5 93.8 95.5 95.6

d

Consumer durables ($)

4.4 4.6 4.8 5.0 5.1 5.3 5.5 5.8 6.2 6.5 6.8 6.8 6.7 6.8 6.9 7.1 7.2 7.2 7.4 7.9 8.2 8.2 8.3 8.4 8.5 8.5 8.7 9.1 9.4 9.6 9.6

SCD ($) (d 0.1) e 112.8 120.0 125.2 132.1 137.6 142.9 149.9 157.5 164.0 170.6 175.6 180.5 187.4 192.5 200.2 206.9 210.5 216.3 225.0 234.2 237.9 246.7 256.5 267.1 271.7 279.4 286.6 293.5 307.7 321.2 328.8

Unadjusted CONF ($) (a c e) f 90.3 96.0 100.1 105.7 110.0 114.3 119.9 126.0 131.2 136.5 140.5 144.4 150.0 154.0 160.1 165.5 168.4 173.0 180.0 187.4 190.4 197.4 205.2 213.7 217.3 223.5 229.3 234.8 246.2 257.0 263.0

Adj. CONF ($) (f 0.8) g

Per capita Hicksian income, Fisherian income and real GDP for Australia, 1967–97

CON ($)

Table 8.1

100.0 100.0 100.0 98.8 97.6 96.4 95.2 93.9 98.8 103.6 108.5 113.3 118.2 119.1 120.3 121.2 122.1 122.7 123.6 124.2 125.8 127.3 128.8 130.3 131.5 132.7 133.9 135.2 136.4 134.5 136.7

Distribution index 1967 100.0 h

90.3 96.0 100.1 107.0 112.7 118.6 126.0 134.2 132.8 131.7 129.5 127.4 126.9 129.3 133.1 136.6 137.9 141.0 145.6 150.9 151.3 155.1 159.3 164.0 165.3 168.4 171.2 173.7 180.5 191.1 192.4

Weighted CONF ($) (g/h) 100 j

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1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997

Year

21.0 22.4 24.1 25.8 27.5 29.0 30.5 31.6 33.9 35.1 36.3 37.6 39.2 41.0 42.5 44.2 46.0 47.4 48.9 50.3 51.3 52.8 54.1 55.9 57.8 59.7 60.9 62.2 64.9 66.9 68.4

m

k

42.3 44.7 48.6 51.1 54.0 55.8 56.5 58.3 55.4 58.2 59.3 58.6 62.7 63.0 69.4 73.9 65.5 67.7 73.9 77.5 76.7 81.5 89.9 89.5 80.4 76.8 79.4 83.4 92.7 94.6 102.1

DEP ($)

INV ($) p 43.4 48.8 52.7 56.3 59.6 62.8 66.5 70.6 72.9 77.5 77.9 80.2 81.4 83.4 83.9 86.9 85.1 87.9 90.7 92.5 94.3 98.8 101.7 104.8 102.5 103.7 106.3 107.7 111.0 114.3 116.0

3.5 4.7 4.3 3.0 0.5 2.2 2.5 7.2 5.4 2.3 3.6 1.2 1.5 1.0 4.3 7.9 4.1 3.5 4.1 2.6 5.4 5.2 6.4 6.6 3.8 7.6 7.0 9.4 1.2 4.3 5.3

LNCS ($)

n

NX ($)

100.0 99.5 98.9 98.4 97.8 97.3 96.7 96.2 95.7 95.1 94.6 94.0 93.5 93.0 92.4 91.9 91.7 91.6 91.5 91.3 91.2 91.0 90.9 90.7 90.6 90.4 90.3 90.1 90.0 89.9 89.8

Ecosystem health index 1967 100.0 q 43.4 49.0 53.3 57.2 60.9 64.5 68.8 73.4 76.2 81.5 82.4 85.3 87.1 89.7 90.8 94.5 92.8 95.9 99.1 101.3 103.4 108.5 111.9 115.6 113.2 114.7 117.7 119.5 123.4 127.2 129.1

LNCS (weighted) ($) (p/q) 100 r 80.1 80.9 84.1 88.9 93.9 98.5 100.8 95.3 95.6 101.5 103.5 104.5 111.1 113.9 120.0 121.8 120.2 124.3 133.3 143.2 150.5 156.9 158.1 162.0 167.2 171.3 175.9 185.5 190.8 204.7 216.7

YH ($) (b k m n r) s 67.9 69.4 70.9 75.5 79.4 83.1 87.6 92.3 90.5 85.4 83.4 79.8 79.0 80.6 84.8 86.2 91.0 92.4 95.5 99.8 99.2 99.3 101.5 104.3 109.9 113.4 114.5 116.3 122.0 130.8 131.6

YF ($) (j m r) t

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21.3 22.3 24.5 25.4 26.5 26.8 26.1 26.7 21.5 23.1 23.0 21.0 23.5 22.0 26.9 29.7 19.5 20.3 25.0 27.3 25.4 28.7 35.7 33.6 22.6 17.1 18.5 21.2 27.8 27.7 33.7

NCI ($) (k m) w 1.02 0.99 1.02 0.98 0.96 0.92 0.86 0.85 0.63 0.66 0.63 0.56 0.60 0.54 0.63 0.67 0.43 0.43 0.51 0.54 0.50 0.54 0.66 0.60 0.39 0.29 0.30 0.34 0.43 0.41 0.49

NCI/DEP (ratio) (w/m) x rapid/high rapid/high rapid/high rapid/high high high high high high high high high high high/low high high low low high/low high/low high/low high/low high high low low low low low low low/high

Growth strategy y 11799 12009 12263 12507 13067 13304 13505 13723 13893 14033 14192 14359 14516 14695 14923 15184 15394 15579 15788 16018 16264 16532 16814 17065 17284 17489 17656 17838 18054 18311 18518

Aust. Pop. (thousands) z 6789 6739 6857 7112 7185 7407 7465 6946 6884 7232 7292 7278 7653 7753 8041 8022 7809 7978 8445 8943 9253 9492 9402 9493 9675 9797 9964 10399 10567 11179 11705

Per capita YH ($) (s/z) aa

All values are in billions of 1989/90 dollars except columns aa, bb, cc, and dd, and where indicated.

158.8 164.7 179.2 189.2 198.3 207.9 215.9 225.9 230.2 236.9 243.8 246.3 260.0 265.4 274.8 281.0 276.2 293.0 307.8 319.9 328.2 345.3 360.0 371.1 366.7 357.8 379.4 396.6 414.8 432.4 448.6

1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997

Note:

Real GDP ($) u

(continued)

Year

Table 8.1

5754 5782 5785 6038 6073 6244 6490 6726 6514 6082 5876 5554 5442 5484 5683 5678 5914 5933 6049 6232 6100 6008 6038 6114 6357 6486 6486 6520 6757 7143 7109

Per capita YF ($) (t/z) bb

13455 13713 14610 15128 15174 15625 15984 16461 16567 16884 17178 17153 17913 18062 18413 18509 17944 18808 19499 19973 20180 20885 21413 21743 21214 20459 21486 22232 22974 23614 24226

Per capita GDP ($) (u/z) cc


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(Biodiversity Unit, 1995; Graetz et al., 1995). Finally, a GPI study by the Australia Institute was used to calculate the cost of lost natural capital services (column p) (Hamilton and Denniss, 2000). The value of column q is the sum of the following environmental costs: ● ● ● ● ● ● ● ●

cost of cost of cost of cost of cost of cost of cost of cost of

land degradation depleted energy resources lost native forests irrigation water use air pollution urban water pollution climate change ozone depletion.

A Descriptive Analysis of the Empirical Evidence In Figure 8.1 Australia’s per capita Hicksian income and per capita Fisherian income are compared for each year over the study period (taken from columns aa and bb in Table 8.1). There are a few things worthy of interest. First, over the entire study period per capita Hicksian income remained higher than per capita Fisherian income. Second, per capita Hicksian income increased in almost every year during the study period. Small decreases were confined to the recessionary years of the mid1970s and early 1980s (when per capita real GDP decreased). Third, while

$12 000 Per capita YH

$ at 1989/90 prices

$10 000

Per capita YF

$8 000 $6 000 $4 000

$0

1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997

$2 000

Figure 8.1 Per capita Hicksian income and Fisherian income for Australia, 1967–97

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per capita Fisherian income rose continuously between 1967 and 1974, it declined in every year to 1979. It rose only marginally in 1980 and 1981, but declined both in 1982 and in the period of 1986 to 1988. Per capita Fisherian income increased in every year after 1988 with modest gains obtained in 1991 and 1995. Fourth, in the years that per capita Fisherian income rose, the increases were considerably more moderate than the increases in per capita Hicksian income. Since Hicksian national income is akin to an index of sustainable cost, it is clear that the rise in sustainable cost did not translate effectively into a rise in sustainable economic welfare. In other words, the sustainable cost incurred during most of the study period was largely squandered since it did little to increase the sustainable economic welfare enjoyed by the average Australian citizen. The lack of effective translation from cost to welfare is also reflected by the lengthy periods that per capita Hicksian income and per capita Fisherian income ran contrary to each other (1973–80 and 1986–90). Fifth, per capita Fisherian income was only slightly higher in 1997 than it was in 1967 ($7109 compared to $5754). Furthermore, the 1997 figure was not much higher than the 1974 within-period peak of $6726. Overall, per capita Fisherian income increased by 23.5% while per capita Hicksian income rose by a much larger 71.1%. This, again, reflects the lack of effective translation of sustainable cost to sustainable economic welfare – presumably the result of excessive growth and an insufficient focus on such qualitative factors as value-adding in production, increased resource use efficiency, distributional equity and natural capital maintenance. What about the change in Australia’s growth strategy over the study period? To consider this, refer to columns x and y in Table 8.1. From 1967 to 1970 Australia was initially engaged in a rapid/high growth strategy (average NCI/DEP1.01). Why might Australia have been carrying out a rapid/high growth policy at this time? Despite Australia’s considerable wealth in the 1960s, it had historically relied on the export of agricultural and resource commodities until the 1950s. The rapid/high growth strategy conducted in the late 1960s doubtless reflects Australia’s desire at the time to establish an industrial base upon which its development could proceed in the 1970s and beyond. Although Australia maintained a high growth strategy between 1971 and 1982 (average NCI/DEP 0.71), its rate of growth clearly decelerated during this period. By 1983, Australia had moved to what appears to have been a low growth strategy (NCI/DEP 0.43). This strategy did not, however, endure for any length of time. Indeed, Australia’s rate of growth increased between 1985 and 1990 and occasionally edged back into high growth territory (average NCI/DEP 0.56). But at no stage did

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Australia’s growth rate return to the levels experienced early on in the study period. One can probably conclude that the lower growth rate of 1983 and 1984 had more to do with the early 1980s recession than a deliberate policy to lower the overall rate of growth. Having said this, Australia appears to have made the transition to a low growth strategy in the period of 1991 to 1996 (average NCI/DEP0.36). In 1997, the final year of the study period, Australia’s growth rate rose to something just short of the high growth mark (NCI/DEP of 0.46 in 1997). Interestingly, if one goes beyond 1997, Australia’s growth rate returned to the high growth mode by the year 2000 (NCI/DEP of 0.50, 0.52, and 0.53 in 1998, 1999, and 2000). Assessing Australia’s Growth Policy for the Period 1967–97 An assessment of Australia’s various growth strategies can be made by juxtaposing per capita Fisherian income with the growth trend of the Australian macroeconomy. Consider, therefore, Table 8.1 and Figure 8.2. It can be seen that the rapid growth and high growth policies of the late 1960s and early 1970s had a positive effect on per capita Fisherian income. However, the continuation of a high growth policy beyond the mid-1970s led to its eventual decline. $8000

1.20

Ratio of NCI/DEP

$6000 0.80

NCI/DEP Per capita YF

0.60

$5000 $4000 $3000

0.40

$2000 0.20

$1000 $0 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997

0.00

YF valued in dollars at 1989/90 prices

$7000

1.00

Figure 8.2 Per capita Fisherian income and ratio of net capital investment to human-made capital depreciation for Australia, 1967–97

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Given the spike in per capita Fisherian income in 1974, there is good reason to believe that the Australian macroeconomy reached its optimal scale around this time. Whether by luck, circumstance, or design, the transition to a low growth rate by 1984 had a positive impact on Australia’s per capita Fisherian income. Nevertheless, the return to a high growth policy in the mid- to late 1980s caused per capita Fisherian income to again fall. The upturn in Australia’s per capita Fisherian income after 1991 was again precipitated by a return to a low growth policy, although the higher rate of growth experienced in the last year of the study period severely dampened the trend rise in per capita Fisherian income. What can we conclude from all of this? First, apart from the period 1967 to 1974, high rates of growth were unambiguously associated with a decline in Australia’s per capita Fisherian income. Conversely, per capita Fisherian income recovered on both occasions that Australia made the transition to a lower growth rate (1979–84 and 1991–96). This suggests two things: (a) Australia probably reached its optimal macroeconomic scale in the mid1970s and should have initiated the transition to a steady-state economy at this time, and (b) since the rise in Fisherian income twice corresponded with a low rate of growth, a high growth rate is not, as some people believe, a sustainable development prerequisite. Second, although per capita Fisherian income was higher in 1997 than it was in 1974, one cannot conclude that the economy of 1997 was preferable in scale to that of the mid-1970s. As it is, one would have expected advances in efficiency-increasing technological progress to have taken place between 1974 and 1997. This ought to have increased the per capita Fisherian income associated with whatever physical scale the Australian economy was in 1997. But if the beneficial impact of efficiency-increasing technology happened to be matched by the detrimental scale effects of continuing macroeconomic growth, it is entirely conceivable that Australia’s per capita Fisherian income would have been higher in 1997 had it possessed an economy of similar physical scale to that of the mid-1970s (i.e., if a steadystate strategy had been put in place at this time). This cannot be conclusively drawn from this study; however, the possibility is quite strong given that Australia’s per capita Fisherian income was only 7% higher in 1997 than in 1974. Finally, if Australia has reverted to a high growth strategy (1998 onwards), one can surmise that its failure to make the transition to a steady-state economy will lead to future declines in per capita Fisherian income. Furthermore, if a high growth strategy is continued for too long, the Australian macroeconomy could soon exceed its maximum sustainable scale. In this case, the economic welfare of the average Australian would not only diminish, it would cease to be ecologically sustainable.


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CONCLUDING REMARKS This chapter has demonstrated how a measure of Fisherian national income can be used to monitor the impact of a growing economy and, in the process, guide a nation’s transition to a steady-state economy. When applied to Australia for the period 1967–97 the empirical evidence suggests that Australia probably surpassed its optimal macroeconomic scale during the mid-1970s. From this time on, Australia’s rate of growth began to decelerate. The transition to a lower growth rate appears to have arrested the decline in Australia’s per capita Fisherian income. However, Australia reverted to a high growth policy in the late 1990s. By electing not to move towards a steady-state economy, Australia has chartered itself on a future course that could well see it having to endure a decline in sustainable economic welfare or, worse still, a macroeconomy in excess of its maximum sustainable scale. Only time will tell if Australia has opted for the wrong growth strategy in its quest to achieve sustainable development.

NOTES 1. Should it in fact do so, it is reflected by a reduced level of future consumption. This is already captured by private and public consumption expenditure (CON) that is common to both Hicksian and Fisherian incomes measures. 2. It is reasonable to suggest that, should the distribution of a nation’s income be so unequal as to leave a measurable proportion of the population physically and mentally degraded, the productive capacity of such a country would be significantly impaired. I would subscribe totally to such a view, however, it is the impact of a change in the distribution of a nation’s income over a given study period that must matter if we are also to make an adjustment to Hicksian national income. The total impact and the change in impact over time are two entirely different things. If the magnitude of the total impact is considerable in country A but not in country B, one would expect, all things being equal, for the disparity to be reflected by a reduced level of production over the entire study period in country A relative to country B. 3. As revealed in Chapter 7, the values of many of these items are used in the calculation of the Index of Sustainable Economic Welfare (ISEW) and the Genuine Progress Indicator (GPI). 4. Having said all that, a decline in economic welfare over some considerable period of time as reflected by a fall in Fisherian national income is probably a good indication that a nation’s economy is nearing or has exceeded its maximum sustainable scale. 5. The distinction I have drawn here between a high growth and low growth investment strategy is a purely arbitrary one. However, as we shall see, the distinction becomes quite useful when comparing a nation’s per capita Fisherian income with changes in the physical scale of its economy.

9.

Eco-efficiency indicators: theory and practice

INTRODUCTION Broadly speaking, eco-efficiency is measure of the efficiency or effectiveness with which natural capital is transformed into human-made capital. As explained in Chapter 6, the need for eco-efficiency indicators arises because, in the event that the ISEW, GPI or SNBI is falling, it is difficult to know if the fundamental cause is declining efficiency or, if the opposite is the case, whether the rate of increase in resource use efficiency is less than the rate of macroeconomic expansion (i.e., the Jevons’ Paradox). This dilemma was borne out to some degree in the previous chapter – that is, Australia’s Fisherian income merely suggested that the Australian macroeconomy as at 1974 was preferable in physical scale to that of 1997. But it did not provide a definitive answer. To obtain something much closer to that, a measure of eco-efficiency is required. Given the conclusions drawn from the coevolutionary paradigm in Chapter 2, it is clear that eco-efficiency indicators must be developed on the basis of various understandings. While many such understandings exist, the number can be reduced to the following shortlist: (a) natural capital and human-made capital are complements, not substitutes; (b) humankind cannot overcome its dependence on the natural environment by ‘dematerialising’ economic activity; and (c) since humankind cannot control the evolutionary pathway of the global system, eco-efficiency solutions must be in keeping with a coevolutionary worldview. It will be argued in this chapter that the eco-efficiency ratios outlined in Chapter 6 are commensurate with these understandings. The eco-efficiency indicators are then calculated for Australia to reveal the extent to which Australia’s use of its natural capital assets has progressed since the mid-1960s. By enabling one to identify where Australia has made particular gains and losses, it is shown that eco-efficiency indicators can provide valuable information for policy makers.

166

167

Eco-efficiency indicators: theory and practice

ECO-EFFICIENCY, TECHNOLOGICAL PROGRESS AND SUSTAINABLE ECONOMIC WELFARE In Chapter 6, the two elemental categories of net psychic income and lost natural capital services were arranged to arrive at a measure of ecological economic efficiency (EEE). The EEE ratio was then decomposed to reveal the following four eco-efficiency ratios: Ratio 1

Ratio 2

Ratio 3

Ratio 4

NPY NPY HMK RT NK EEE LNCS HMK RT NK LNCS (9.1) where EEE ecological economic efficiency, NPYnet psychic income, LNCSlost natural capital services, HMKhuman-made capital, RT resource throughput, NK natural capital. To recall, the order in which the four eco-efficiency ratios are presented is in keeping with the conclusions drawn from the linear throughput representation of the socio-economic process. As such, each eco-efficiency ratio represents a different form of efficiency pertaining to a particular subproblem of the larger ecological economic problem of sustainable development. The four eco-efficiency ratios will now, along with their implications, be individually explained and discussed. The Service Efficiency of Human-made Capital Ratio 1 is a measure of the service efficiency of human-made capital. It increases whenever a given amount of human-made capital yields a higher level of net psychic income. An increase in Ratio 1 causes the uncancelled benefit (UB) curve in Figure 2.4 to shift upwards. This can be achieved by improving the technical design of newly produced goods and by advancing the means by which human beings organise themselves in the course of producing and maintaining the stock of human-made capital (thereby reducing such things as the disutility of labour and the cost of commuting and unemployment). A beneficial shift in the UB curve can also be achieved by redistributing income from the low marginal service or psychic income uses of the rich to the higher marginal service uses of the poor (Robinson, 1962). There is, however, a limit on the capacity for redistribution to increase Ratio 1 because an excessive approach to redistribution adversely dilutes the incentive structure built into a market based system.

168

Sustainable development indicators UC

Uncancelled benefits (UB), uncancelled costs (UC) and sustainable economic welfare (SEW)

UB1 UB SEW*

0

S*

SEW*1

S*1

SS Physical scale of macroeconomy

Figure 9.1 A change in sustainable economic welfare brought about by an increase in the service efficiency of human-made capital (Ratio 1) Figure 9.1 illustrates what happens to sustainable economic welfare when the UB curve shifts upwards. Because an increase in Ratio 1 augments the net psychic income yielded by a given amount of human-made capital, the UB curve shifts up to UB1. The uncancelled cost (UC) curve does not move since the opportunity cost of creating and maintaining a given stock of human-made capital remains unchanged. Moreover, the maximum sustainable scale remains at SS. However, sustainable economic welfare is no longer maximised at the prevailing macroeconomic scale of S*. It is now desirable to expand the physical scale of the macroeconomy to the new optimal scale of S*1 where sustainable economic welfare now equals SEW*1. Maintenance, Growth and Exploitative Efficiencies Changes in Ratios 2, 3 and 4 cause the UC curve to shift. Ratio 2 is a measure of the maintenance efficiency of human-made capital. It increases whenever a given physical magnitude of human-made capital can be maintained by a lower rate of resource throughput. This can be achieved by developing new technologies that reduce the resource input requirement either through: (a) the more efficient use of resources in production; (b) increased rates of product recycling; (c) greater product durability; or


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(d) improved operational efficiency. An increase in Ratio 2 causes the UC to shift downwards and to the right for the following reasons. First, it enables any given macroeconomic scale to be sustained by a reduced rate of resource throughput. Second, a lower rate of throughput means that less natural capital requires exploitation which, in turn, means fewer lost natural capital services. Ratio 3 is a measure of the growth efficiency or productivity of natural capital. This form of efficiency is increased whenever a given amount of natural capital can sustainably yield more low entropy resources and assimilate a greater quantity of high entropy wastes. Better management of natural resource systems and the preservation of critical ecosystems can lead to a more productive stock of natural capital. How does an increase in Ratio 3 lead to a downward and rightward shift of the UC curve? An increase in the productivity of natural capital reduces the quantity of natural capital that must be exploited for the throughput of matter-energy needed to sustain the macroeconomy at a given physical scale. This allows a macroeconomy to be sustained at the expense of fewer natural capital services. Ratio 4 is a measure of the exploitative efficiency of natural capital. If Ratio 4 increases, fewer natural capital services are lost in exploiting a given quantity of natural capital. This, again, allows a macroeconomy of a given physical scale to be sustained at the expense of fewer natural capital services. In doing so, it leads to a downward and rightward shift of the UC curve. Increases in Ratio 4 can be obtained through the development and execution of more ecologically sensitive extractive techniques, such as the use of underground rather than open-cut or strip mining practices. Figure 9.2 illustrates what happens to sustainable economic welfare when there is a beneficial shift of the UC curve. Because an increase in Ratios 2, 3 and 4 reduces the uncancelled cost of producing and maintaining a given macroeconomic scale, the UC curve shifts down and out to UC1. However, the UB curve remains stationary since an increase in Ratios 2, 3 and 4 does not augment the net psychic income generated by a given stock of human-made capital. Unlike a shift in the UB curve, a shift in the UC curve results in an increase in the maximum sustainable macroeconomic scale (SS to SS2). The logic behind this is quite simple. If there are now fewer natural capital services being sacrificed to maintain what was previously the maximum sustainable macroeconomic scale, a larger macroeconomic subsystem can now be sustained from the same loss of natural capital services. Figure 9.2 shows that, prior to increases in the maintenance efficiency of humanmade capital and/or the growth and exploitative efficiencies of natural capital, sustainable economic welfare is maximised by operating at a

170

Sustainable development indicators UC UC1

Uncancelled benefits (UB), uncancelled costs (UC) and sustainable economic welfare (SEW)

SEW*2

SEW*

UB

0

S*

S*2

SS

2

SS


Figure 9.2 A change in sustainable economic welfare brought about by increases in the maintenance efficiency of human-made capital (Ratio 2), and the growth and exploitative efficiencies of natural capital (Ratios 3 and 4) macroeconomic scale of S*. Upon increases in Ratios 2, 3, and/or 4, it is desirable to expand the physical scale of the macroeconomy to the new optimal scale of S*2 where, on this occasion, sustainable economic welfare increases to SEW*2. Limits to Efficiency-increasing Technological Progress There is considerable debate surrounding how much and for how long human beings can rely on efficiency-increasing technological progress to reduce the uncancelled costs of the socio-economic process. The ecological economic position, however, is quite clear on this issue. Because of biophysical constraints outlined in Chapter 2, humankind’s ability to increase Ratios 2, 3 and 4 is ultimately limited (Georgescu-Roegen, 1971; Pearce and Turner, 1990; Costanza et al., 1991; Folke et al., 1994; Daly, 1996; Lawn, 2000). Ratio 2, for instance, is limited by the first and second laws of thermodynamics (e.g., matter and energy cannot be created, nothing is eternally durable, and recycling and production technology can never be 100 per cent efficient). Ratio 3 is limited by the inability to indefinitely increase the productivity of natural capital, while Ratio 4 is limited by the fact that at least some of the ecosphere’s instrumental functions are lost as a consequence of its exploitation (Perrings, 1986).


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Conclusions regarding limits to increases in Ratio 1 are harder to draw because service, as a psychic rather than physical magnitude, is not subject to the same physical laws as the goods that yield the service. Having said this, there is a probable limit on humankind’s capacity to experience service (i.e., a point of satiation exists for everyone). Indeed, economists have a term for such a condition. It is commonly referred to as a ‘bliss point’. Thus, regardless of how well physical goods are designed, a given quantity of human-made capital is unlikely to yield ever-increasing levels of net psychic income.

THEORETICAL SUPPORT FOR THE ECO-EFFICIENCY INDICATORS In this section, it is shown that the eco-efficiency indicators revealed in equation (9.1) are commensurate with the coevolutionary understandings outlined in the introduction of the chapter. Eco-efficiency and the Complementary Relationship between Natural and Human-made Capital By keeping natural and human-made capital sharply distinct and having a separate magnitude for each, the eco-efficiency indicators recognise the unique nature of the two forms of capital. Moreover, natural and humanmade capital are shown to be coupled in terms of the throughput of matterenergy that can only be provided by the stock of natural capital. As such, the eco-efficiency indicators explicitly recognise the entropic connection between the two forms of capital. In doing so, they are commensurate with the strong sustainability notion that natural and human-made capital are strictly complements, not substitutes. To cast off any lingering doubts, consider the indicator effect of augmenting the stock of human-made capital at the expense of natural capital depletion. Because it does not involve an increase in efficiency-increasing technological progress, since this would allow human-made capital to be increased without having to liquidate natural capital, such an exercise would not be reflected by increases in either Ratios 2 or 3.1 However, it would presumably lower Ratio 4 – a reflection of the increased opportunity cost of each additional disruption of natural capital. This would reduce the EEE ratio and, since it would shift the UC curve upwards, lead to a decline in sustainable economic welfare. Many standard eco-efficiency exercises falsely reveal increases in the effectiveness with which natural capital is transformed into human-made capital in circumstances such as these.

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Eco-efficiency and Humankind’s Dependence on the Ecosphere There is a growing view among many observers and some organisations that humankind can significantly overcome its dependence on the natural environment by dematerialising economic activity (Schmidheiny and Zoraquin, 1996; WCED, 1987; United Nations, 1999; WBCSD, 2000). In particular, it is believed that eco-efficiency gains can be made by shifting the emphasis of economic activity away from the production of goods towards the provision of services. As explained in Chapter 3, this is a fallacy. Because goods are the physical objects that yield the service, and service is the welfare that flows from goods as they are either consumed or worn out through use, ‘goods’ and ‘services’ are effectively two faces of the same coin. What’s more, the direct inputs of the service sector (e.g., office furniture and equipment) are invariably the outputs of the goods sector (e.g., desks, chairs, computers and fax machines). This means that the matter-energy used to produce the goods required for the service sector to function effectively constitutes an indirect input of the service sector. Evidence based on embodied energy studies suggests that the combined direct and indirect inputs of the service sector are much the same as the goods sector (Costanza, 1980; Ayres and Ayres, 1999). As such, the service sector is just as limited as the goods sector in terms of the capacity to reduce the throughput per unit of net psychic income enjoyed – which, as elucidated above, is very limited indeed. In all, there is no reason to believe that the resource intensity per unit of welfare can be reduced by shifting the emphasis of economic activity towards specific industries. The eco-efficiency ratios outlined in equation (9.1) prevent the fallacious emergence of eco-efficiency improvements because, again, they keep natural and human-made capital separate and distinct. This ensures that the overall level of service or net psychic income can only rise if: (a) the quantity of human-made capital has increased, or (b) there has been an increase in the service-yielding qualities of human-made capital. The former, however, does not constitute an eco-efficiency improvement. Critically, it does not lead to a rise in any one of the four eco-efficiency ratios. Only (b) amounts to an eco-efficiency improvement which, importantly, is reflected by a rise in Ratio 1. Of course, it is true that more service can be generated from a given resource flow if technological progress increases the rate of recycling and/or the degree of production efficiency. This is because a larger stock of human-made capital can be produced and maintained from a given rate of throughput which, ceteris paribus, leads to a higher overall level of service experienced. Importantly, it is correctly reflected by a rise in Ratio 2. However, Ratio 2 can only rise so far because, as previously explained, an


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increase in the maintenance efficiency of human-made capital is limited by the first and second laws of thermodynamics. Given that increases in Ratios 3 and 4 are also biophysically limited, the dematerialisation of the socioeconomic process, if actively pursued, is ultimately revealed by the four ecoefficiency ratios as a cornucopian pipedream. So, too, is the notion that humankind can overcome its dependence on the natural environment. Eco-efficiency Solutions and the Coevolutionary Paradigm The need for eco-efficiency indicators to be commensurate with the coevolutionary worldview is perhaps the greatest source of concern among their detractors. Critics (e.g., Hukkinen, 2001) are consistent in their antagonism towards a particular theme underlying most eco-efficiency concepts – namely, that humankind can significantly augment the effectiveness with which it transforms natural capital into human-made capital by increasing its control over the global system. The notion of control of any sort is at odds with the coevolutionary worldview. Most eco-efficiency critics therefore argue that the majority of the claims made about potential ecoefficiency improvements are unrealistic. Furthermore, they believe such claims lead to the development of inappropriate, if not hazardous, policy prescriptions. To explain why, we need to examine an important implication of the coevolutionary worldview in greater depth. A critical aspect of the coevolutionary paradigm not outlined in Chapter 2 is the concept of surprise. Surprising events occur because there is always a disparity between what humankind expects ex ante and what it experiences ex post – a consequence of the evolving relationships and feedback responses typically associated with two or more interdependent systems. The notion of surprise has been given implicit attention by economists ever since the groundbreaking work of Knight (1921). Unfortunately, the treatment of surprise has been confined to the distinction between risk and uncertainty. As Faber and Proops point out (1990), a coevolutionary paradigm requires a third category of surprise; namely, human ignorance. Since the existence of surprising events restricts humankind’s ability to predict future outcomes, then, for two good reasons, it is necessary to gain a better understanding of their source. To begin with, the precise nature and source of a surprising event determines the degree to which humankind can make valid predictions regarding future events. Second, without a comprehensive knowledge of the sources of surprise, humankind’s ability to positively influence the evolutionary pathway of the global system is greatly reduced. To deal with surprise, Figure 9.3 serves as a diagrammatic representation of its various sources. Also included is a simple taxonomy of ignorance.

174

Sustainable development indicators Sources of Surprise

Range of possible outcomes all known

Probabilities all known – Risk (Predictable in principle)

Range of outcomes unknown (Ignorance)

Probabilities not all known – Uncertainty (Predictable in broad terms)

Open Ignorance

Irreducible Ignorance

Closed Ignorance

Reducible Ignorance (Predictable in principle or in broad terms)

Novelty Complexity (Unpredictable in principle) (Unpredictable in principle) Source: Adapted from Faber, Manstetten and Proops (1992, p. 84).

Figure 9.3 Sources of surprise and a taxonomy of ignorance Risk and uncertainty Figure 9.3 depicts two kinds of surprising events experienced by humankind. The first includes events where the range of all possible outcomes is a priori known. Humankind’s understanding of the dynamic processes involved is sufficient to make useful, if limited, predictions about the likely emergence of particular outcomes and events. Exactly how restricted humankind’s predictive capacities are depends on its knowledge of the respective probabilities of each outcome emerging. Should all probabilities be known (e.g., it is known that there is a 60%, 30% and 10% chance of X, Y or Z respectively occurring), future outcomes are predictable ‘in principle’ (Faber et al., 1992). In these circumstances, one is dealing with risk since, if X is the desired outcome, there is a 40% chance of it not occurring. When the probabilities of a range of outcomes are not all known (e.g., it is known that X, Y or Z may occur, but the probability of each emerging is not), one is dealing with uncertainty. On this occasion, future outcomes are only predictable ‘in broad terms’ (Faber et al., 1992). Thus humankind is restricted to saying little more than something about the probable future


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behaviour of a system and the range of future events and outcomes that might ensue (e.g., worst and best case scenarios). Clearly, when confronted with uncertainty, humankind’s predictive powers are considerably weaker than in circumstances involving risk. Closed and open ignorance The second category of surprising events involves those where the range of all possible outcomes are not known. It is here where humankind suffers from ignorance (Faber et al., 1992). As the taxonomy of ignorance in the right-hand side of Figure 9.3 shows, ignorance comes in two forms – closed and open ignorance. When a society deliberately overlooks its ignorance, that is, it chooses to believe what has not yet been proven to be true, it is in a state of closed ignorance. Closed ignorance, particularly if it exists in the form of assumed omniscience (e.g., believing in the dematerialisation of the socio-economic process), constitutes a significant barrier to humankind’s capacity to positively influence the evolutionary pathway of the global system. In the event that a society is aware of its ignorance and, furthermore, chooses not to believe something until proven true, it is in a state of open ignorance. Only in a state of open ignorance is it possible for a society to fully experience novel and surprising events. Figure 9.3 indicates that open ignorance can be dichotomised into two forms – reducible and irreducible ignorance. Reducible ignorance is ignorance that can be partially or fully overcome through learning and the application of the scientific method. Reducible ignorance exists because the stock of a society’s knowledge is, at any moment in time, incapable of explaining and predicting the broadly explainable and predictable. Appropriate research eventually makes it possible to explain an event that has already taken place and/or to predict a greater range of future events. The second form of open ignorance – irreducible ignorance – is never amenable to scientific tools of learning and research. In this instance, outcomes have the potential to emerge that can never be a priori envisaged. As a consequence, irreducible ignorance involves a class of future events which are ‘unpredictable in principle’. That is, humankind is unable to make even tentative predictions about the likely range of all possible outcomes. Not surprisingly, irreducible ignorance severely restricts humankind’s capacity to positively influence the evolutionary pathway of the global system. Ignorance of the irreducible variety exists because of two ever-present factors. The first factor is complexity (Dyke, 1988). Here an outcome is unexpected because the complex nature of the processes underlying certain dynamic systems precludes the possibility of gaining a comprehensive

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understanding of them. In the second instance, irreducible ignorance stems from the emergence of novelty. Novelty arises because the parameters of dynamic systems are forever evolving. This leads to adaptive and somatic change in the short- and medium-term, and genotypic change (bifurcation) in the long-term (Capra, 1982). Novelty gives rise to irreducible ignorance because, in not knowing the initial boundary conditions governing the global system’s evolutionary pathway, one cannot predict the future pathway of the global system either in principle or in broad terms. The inevitability of surprise, in all its above described forms, obliges humankind to take note of the following. First, it cannot ‘control’ the evolutionary pathway of the global system. The increasing ability of humankind to manipulate the ecosphere does not translate to an equivalent increase in its ability to control the destiny of ecological and natural resource systems. Indeed, humankind can only hope to marginally increase its knowledge of the long-term impact that its own manipulative endeavours are having on the global system. For this reason, humankind is strictly confined to positively ‘influencing’ the pathway of the global system which, moreover, it can only do in circumstances where predictions can be made about the implications of its endeavours in principle and in broad terms. Second, since the logos of the global system is characterised by uncontrollable coevolutionary processes decidedly more so than by human teleology, humankind must obey the logos of the global system. As Laszlo (1972, p. 75) puts it: ‘There is freedom in choosing one’s path of progress, yet this freedom is always bounded by the limits of compatibility with the dynamic structure of the whole (or global) system’ (parentheses added). It would appear, therefore, that only insofar as humankind learns to respect and obey the logos of the global system can it, in Boulding’s words, ‘move away from the slavery of evolution to the freedom of teleology’ (Boulding, 1970, p. 18). Clearly, for humankind to maximise its limited capacity to positively influence the global system’s pathway, it must recognise the circumstances under which it is a slave to the ‘rules’ governing coevolutionary processes (as opposed to being a slave to the process itself), and where its actions are most likely to bring to bear catastrophic future macrostates of the global system (i.e., where the impact of its own actions are unpredictable in principle). Implications for the eco-efficiency ratios Just how well do the four eco-efficiency ratios stack up against the coevolutionary worldview? Very well, it would seem. Because the eco-efficiency ratios emerge from the decomposition of the larger EEE ratio and reflect


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the conclusions drawn from the linear throughput model – itself a product of the coevolutionary paradigm – there is an implicit recognition that each sub-problem is an integral part of the larger ecological economic problem of sustainable development. That is, each eco-efficiency ratio takes account of the possible impact that a particular activity can have on the global system. As such, there is a strong sense of interdependence between the four eco-efficiency ratios. To demonstrate how, consider the following example. A new production technique enhances the strength of certain metals that, in turn, increases the durability of many newly produced goods. This augments the maintenance efficiency of human-made capital (increases Ratio 2). However, the production technique involves the use of a new chemical that, when released into the natural environment, impacts deleteriously on a range of ecosystems and the organisms contained within. This ultimately reduces the productivity of natural capital and leads to the degradation of certain natural resource assets. As a consequence, Ratios 3 and 4 will decline – perhaps enough to cause the EEE ratio to fall. If so, sustainable economic welfare would more than likely fall or, worse still, the macroeconomy would move closer to, if not surpass, its maximum sustainable scale. Clearly, genuine eco-efficiency improvements as reflected by Ratios 1–4 will only be possible if the logos of nature is duly recognised. This, as we have seen, is a fundamental coevolutionary imperative that humankind must adhere to if it is to positively influence the coevolutionary pathway of the global system – that is, increase the sustainable economic welfare generated by the socio-economic process.

CALCULATING THE ECO-EFFICIENCY INDICATORS FOR AUSTRALIA Having provided theoretical support for the eco-efficiency indicators outlined in equation (9.1), they are now calculated for Australia. To do this, it is first necessary to obtain an index value for the five elemental categories of the linear throughput model. This can be achieved by compiling uncancelled benefit, uncancelled cost, human-made capital, natural capital, and throughput accounts. Four of these five accounts have been compiled for Australia for the period 1966/67 to 1994/95. Because the compilation of a throughput account was a profoundly difficult exercise, the annual consumption of energy was used as a proxy measure of resource throughput. Due to a lack of space and the extensive and unique nature of the study, a full explanation of the individual accounts, the

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items they comprise, data sources, and the methods of calculation can be found in Lawn (2000). Australia’s Ecological Economic Efficiency (EEE) Ratio The EEE ratio is the ratio of uncancelled benefits (net psychic income) to uncancelled costs (lost natural capital services). It indicates, at the macro level, the advances a nation has made in terms of the efficiency with which it transforms natural capital and the low entropy resources it provides into service-yielding human-made capital. The EEE ratio for Australia over the period 1966/67 to 1994/95 is indicated by Figure 9.4 and column f in Table 9.1. Both show that the EEE ratio increased from 2.41 in 1966/67 to a peak in 1973/74 of 2.85. The EEE ratio then declined to 1.86 in 1992/93 before rising slightly to 1.94 by 1994/95. By the end of the study period, the EEE ratio was much lower than its initial value (1.94 compared to 2.41). Interestingly, the trend movement of the EEE ratio closely follows that of the Sustainable Net Benefit Index (SNBI) that was revealed in Chapter 6 (see Figure 6.1). This would indicate that the general decline in Australia’s SNBI after 1973/74 was due as much to the inefficient allocation of resources as it was to the depletion of natural capital and the inequitable distribution of income. In what ways inefficiencies contributed to the decline in the SNBI is not altogether clear from the EEE ratio. This information is better revealed by the four eco-efficiency ratios that make up the larger ecological economic problem. It is towards these efficiency ratios that we now direct our attention. 3.50 3.00

EEE ratio

2.50 2.00 1.50 1.00 0.50 0.00 66/67

70/71

74/75

78/79

82/83

86/87

90/91

94/95

Figure 9.4 Ecological economic efficiency (EEE) ratio for Australia, 1966/67 to 1994/95

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Australia’s Service Efficiency Ratio (Ratio 1) A nation’s service efficiency ratio is a measure of how well the total stock of human-made capital contributes to the net psychic income of its citizens (Ratio 1). Figure 9.5 and column g in Table 9.1 reveal the service efficiency of Australia’s human-made capital. Both show that Australia’s service efficiency began at a value of 0.126 in 1966/67 (equivalent to an imputed service rate of 12.6%). It then increased to a peak of 0.133 (13.3%) by 1972/73. Apart from a small rise between 1979/80 and 1981/82, Australia’s service efficiency ratio effectively declined thereafter. By the end of the study period (1994/95), the service efficiency ratio had fallen to 0.102 (10.2%). Given that technological progress has undoubtedly increased the ability of human-made capital to directly yield service (e.g., televisions now provide colour images, microwave ovens cook food in a fraction of the time of conventional ovens, and cars are less noisy and considerably more comfortable than those gone by), why would the service efficiency of humanmade capital have declined over much of the study period? Although the uncancelled benefit account is not provided in this chapter (see Lawn, 2000, Table 14.1), it shows that Australia’s psychic income increased at a much slower rate than its psychic outgo (e.g., the cost of such things as commuting, noise pollution, unemployment, and so on). In other words, the stock of human-made capital was able to generate more psychic benefits but it came at the expense of considerably higher psychic disbenefits. Clearly, the incoming resource flow is being predominantly allocated to meet the 16.0 14.0

Service efficiency (%)

12.0 10.0 8.0 6.0 4.0 2.0 0.0 66/67

70/71

74/75

78/79

82/83

86/87

90/91

94/95

Figure 9.5 Service efficiency ratio (Ratio 1) for Australia, 1966/67 to 1994/95

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1966/67 1967/68 1968/69 1969/70 1970/71 1971/72 1972/73 1973/74 1974/75 1975/76 1976/77 1977/78 1978/79 1979/80 1980/81 1981/82 1982/83 1983/84 1984/85 1985/86 1986/87 1987/88 1988/89 1989/90 1990/91 1991/92 1992/93 1993/94 1994/95

Year

Table 9.1

262,606 282,956 294,981 306,639 332,281 347,843 375,789 401,192 398,862 405,100 394,768 391,465 386,852 367,096 402,592 412,625 392,483 406,404 406,801 415,492 431,925 457,233 454,252 447,247 435,961 448,485 445,182 455,611 479,328

Uncancelled benefits ($m at 1989/90 prices) a 2,084,135 2,225,354 2,333,700 2,434,665 2,601,301 2,707,916 2,821,276 2,995,896 3,083,698 3,153,572 3,244,952 3,319,701 3,366,208 3,416,009 3,535,944 3,532,734 3,588,416 3,682,232 3,781,370 3,825,766 3,946,069 4,071,717 4,130,657 4,224,225 4,325,592 4,384,474 4,439,785 4,585,704 4,712,174

Human-made capital (HMK) ($m at 1989/90 prices) b 1,805.8 1,898.9 2,025.9 2,137.6 2,210.3 2,331.2 2,447.8 2,615.1 2,694.5 2,730.6 2,905.6 2,982.7 3,050.9 3,130.2 3,146.1 3,236.5 3,122.9 3,220.4 3,369.6 3,403.0 3,514.8 3,622.3 3,832.1 3,945.2 3,946.6 4,003.2 4,079.2 4,176.6 4,366.0

Resource throughput (energy consump) (P/joules) c

Eco-efficiency ratios for Australia, 1966/67 to 1994/95

780,448 777,952 775,057 772,290 771,314 769,665 766,550 762,221 758,384 754,000 746,602 739,869 733,361 727,961 721,292 714,341 706,361 700,039 692,692 681,766 674,395 666,835 658,973 651,192 642,862 634,924 625,177 618,259 608,912

Natural capital (NK) ($m at 1989/90 prices) d

108,941 112,830 117,306 122,265 126,338 130,902 135,338 140,820 146,047 150,430 155,479 159,814 166,103 171,962 176,748 182,239 186,395 190,907 197,236 202,215 206,729 211,570 216,289 224,187 228,905 233,111 239,809 243,097 247,534

Uncancelled costs ($m at 1989/90 prices) e

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Note:

1966/67 1967/68 1968/69 1969/70 1970/71 1971/72 1972/73 1973/74 1974/75 1975/76 1976/77 1977/78 1978/79 1979/80 1980/81 1981/82 1982/83 1983/84 1984/85 1985/86 1986/87 1987/88 1988/89 1989/90 1990/91 1991/92 1992/93 1993/94 1994/95

Year

0.126 0.127 0.126 0.126 0.128 0.128 0.133 0.134 0.129 0.128 0.122 0.118 0.115 0.107 0.114 0.117 0.109 0.110 0.108 0.109 0.109 0.112 0.110 0.106 0.101 0.102 0.100 0.099 0.102

Service efficiency of HMK (Ratio 1) (a/b) g 1,154.1 1,171.9 1,151.9 1,139.0 1,176.9 1,161.6 1,152.6 1,145.6 1,144.4 1,154.9 1,116.8 1,113.0 1,103.3 1,091.3 1,123.9 1,091.5 1,149.1 1,143.4 1,122.2 1,124.2 1,122.7 1,124.1 1,077.9 1,070.7 1,096.0 1,095.2 1,088.4 1,098.0 1,079.3

Maintenance efficiency of HMK (Ratio 2) (b/c) h

Column j is based on terajoules of energy consumption (1 petajoule 1000 terajoules).

2.41 2.51 2.51 2.51 2.63 2.66 2.78 2.85 2.73 2.69 2.54 2.45 2.33 2.13 2.28 2.26 2.11 2.13 2.06 2.05 2.09 2.16 2.10 1.99 1.90 1.92 1.86 1.87 1.94

Ecological economic efficiency (EEE) (a/e) f 2.31 2.44 2.61 2.77 2.87 3.03 3.19 3.43 3.55 3.62 3.89 4.03 4.16 4.30 4.36 4.53 4.42 4.60 4.86 4.99 5.21 5.43 5.82 6.06 6.14 6.31 6.52 6.76 7.17

Growth efficiency of NK (Ratio 3) (c/d 1,000) j 7.16 6.89 6.61 6.32 6.11 5.88 5.66 5.41 5.19 5.01 4.80 4.63 4.42 4.23 4.08 3.92 3.79 3.67 3.51 3.37 3.26 3.15 3.05 2.90 2.81 2.72 2.61 2.54 2.46

Exploitative efficiency of NK (Ratio 4) (d/e) k

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already satisfied lower-order needs of most Australians. An insufficient proportion of the total resource flow is being allocated to satisfy emerging higher-order needs. Australia’s Maintenance Efficiency Ratio (Ratio 2) As defined earlier in the chapter, the maintenance efficiency ratio is a measure of the throughput of matter-energy required to keep a given quantity of human-made capital intact (Ratio 2). For the purposes of this study, the maintenance efficiency ratio indicates the quantity of human-made capital maintained by Australia per petajoule of energy consumed. Figure 9.6 and column h in Table 9.1 show that, in 1966/67, a petajoule of energy maintained $1154.1 million of human-made capital. This increased to a maximum of $1176.9 million by 1970/71. The quantity of human-made capital maintained per petajoule of energy consumed then declined very gradually to a low of $1070.8 million in 1989/90. By 1994/95, it had marginally recovered to $1079.3 million – still considerably lower than the initial 1966/67 figure. The overall fall in Ratio 2 is particularly interesting because many studies on the energy efficiency of economic activity have indicated a steady improvement over recent decades (e.g., Reddy and Goldemberg, 1990; OECD, 1998; Weiszacker et al., 1998). In my opinion, the misleading nature of these studies arises largely because they are based on GDP/energy ratios instead of human-made capital/energy ratios, as has been calculated here. The problem with GDP/energy ratios is that a measure of GDP includes the cost of energy use. As such, energy consumption appears in both the

Maintenance efficiency ($ of HMK per petajoule)

1,400.0 1,200.0 1,000.0 800.0 600.0 400.0 200.0 0.0 66/67

70/71

74/75

78/79

82/83

86/87

90/91

94/95

Figure 9.6 Maintenance efficiency ratio (Ratio 2) for Australia, 1966/67 to 1994/95

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numerator and the denominator of the ratio. What’s more, GDP is often regarded as a useful if not imprecise indicator of the rate of a nation’s resource throughput. Consequently, a GDP/energy ratio involves the division of two flows when an appropriate eco-efficiency indicator demands the division between a stock magnitude (in this case human-made capital) and a flow magnitude (energy consumption). Australia’s Growth Efficiency Ratio (Ratio 3) The growth efficiency ratio is a measure of the productivity of natural capital (Ratio 3). As presented in this study, Australia’s growth efficiency ratio represents the terajoules of energy entering the Australian macroeconomy relative to each unit of natural capital it has available for exploitation (note that one petajoule equals 1000 terajoules). Australia’s growth efficiency ratio is revealed by Figure 9.7 and column j in Table 9.1. The ratio increased over the study period in all but the financial year of 1982/83. The ratio began from a low of 2.31 in 1966/67 and increased to a high of 7.17 by 1994/95. The increase in Ratio 3 over the study period suggests that Australia’s natural capital became progressively more productive – that is, it is increasingly able to generate a flow of low entropy resources and assimilate high entropy waste. This is misleading. Closer examination of Australia’s natural capital account and the sources of its energy use (see Lawn, 2000, Tables 14.5 and 14.6) reveal that the continued rise in Australia’s energy consumption was only made possible by Australia’s increased depletion rate of non-renewable energy stocks. 8.00

Natural capital growth efficiency (terajoules per $ of NK)

7.00 6.00 5.00 4.00 3.00 2.00 1.00 0.00 66/67

70/71

74/75

78/79

82/83

86/87

90/91

94/95

Figure 9.7 Natural capital growth efficiency ratio (Ratio 3) for Australia, 1966/67 to 1994/95

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Sustainable development indicators 1.60

Renewable nat. cap. growth efficiency

1.40 1.20 1.00 0.80 0.60 0.40 0.20 0.00 66/67

70/71

74/75

78/79

82/83

86/87

90/91

94/95

Figure 9.8 Renewable natural capital growth efficiency ratio for Australia, 1966/67 to 1994/95 Given that a nation is ultimately dependent on renewable energy, a renewable natural capital growth efficiency ratio constitutes a more cogent eco-efficiency indicator than one based on a stock that includes a nonrenewable resource component. This ratio can be easily calculated by excluding all non-renewable resources from the stock variable (denominator), and the consumption of non-renewable energy from the flow variable (numerator). Australia’s renewable natural capital growth efficiency ratio for the period 1966/67 to 1993/94 is revealed in Figure 9.8 (terajoules of renewable energy consumed per $ millions of renewable natural capital). It shows that the renewable natural capital growth efficiency ratio changed marginally between the period 1966/67 and 1983/84 (1.24 in 1966/67 and 1.22 in 1983/84). However, by 1993/94, the ratio had increased to a value of 1.52. To a great extent, this increase reflects the impact of stricter pollution standards. It is also a lagged response to the oil price shocks of 1973 and 1979. While an increase in the ratio is an encouraging development, it must be seen in the context of Australia’s continuing reliance on non-renewable energy sources. One would be hard-pressed to conclude that the capacity of Australia’s natural capital to provide a sustainable flow of energy has in any way significantly increased when so little of it is presently sourced from renewable resource stocks. Australia’s Exploitative Efficiency Ratio (Ratio 4) A nation’s exploitative efficiency ratio is a measure of the opportunity cost of natural capital services foregone relative to the stock of natural capital

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Eco-efficiency indicators: theory and practice 8.0

Natural capital exploitative efficiency

7.0 6.0 5.0 4.0 3.0 2.0 1.0 0.0 66/67

70/71

74/75

78/79

82/83

86/87

90/91

94/95

Figure 9.9 Natural capital exploitative efficiency ratio (Ratio 4) for Australia, 1966/67 to 1994/95 available for exploitation. A nation’s exploitative efficiency ratio is calculated by dividing the estimated monetary value of its natural capital by the uncancelled cost of its economic activity. The larger/smaller is the ratio, the smaller/larger is the opportunity cost of natural capital services sacrificed per dollar of available natural capital. Australia’s exploitative efficiency ratio is indicated by Figure 9.9 and column k of Table 9.1. Both reveal that the exploitative efficiency ratio declined in every year between 1966/67 and 1994/95. This result suggests that the opportunity cost of exploiting natural capital for the throughput of matter-energy increased continually over the study period. The decline in the exploitative efficiency ratio was considerable. The ratio began at a value of 7.16 in 1966/67 and declined to a value of 2.46 by 1994/95. Whilst this result probably overstates the opportunity cost of Australia’s natural capital exploitation, it does reflect Australia’s heavy reliance on non-renewable resources, its lack of reinvestment into renewable resource substitutes, and its poor record of land management, in particular, the high rates of native vegetation clearance in the states of Queensland and New South Wales.

THE POLICY RELEVANCE OF ECO-EFFICIENCY INDICATORS Much has already been revealed in Chapters 6 and 7 about the accuracy of various indicators and the implications for policy making. Most of this

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discussion can also be directed at the eco-efficiency indicators estimated in this chapter. For example, the calculation of certain items that make up the uncancelled cost account involves assumptions and valuation methods heavily criticised by Neumayer (1999 and 2000). In addition, the natural capital account is potentially beset with problems and weaknesses highlighted by England (1998). Moreover, the ‘Cambridge controversy’ raises serious issues regarding the compilation of a human-made capital account. Finally, one can also call into question the legitimacy of establishing a single index value for each of the elemental categories used to calculate the eco-efficiency ratios. Many of these issues were dealt with in Chapter 7, although they were far from completely resolved. While these concerns reduce the certainty of the conclusions drawn from the eco-efficiency indicators presented in this chapter, they do not necessarily extinguish their policy guiding value. For as Daly (1996, p. 115) reminds us, even the poorest approximation of a correct and highly desirable concept is always better than an accurate approximation of an irrelevant or erroneous concept. While most mainstream performance indicators (e.g., GDP and GDP/energy ratios) are often accurate approximations of various phenomena, they constitute poor if not entirely misleading indicators of a nation’s sustainable development performance. Conversely, the eco-efficiency indicators revealed in this chapter appear to provide a transparent overall picture of Australia’s management and use of its natural capital assets. The question that needs to be answered is this: To what extent can a general outlook of natural capital management be used to inform a nation’s policy makers? Perhaps it should first be stressed that it does not enable policy makers to make policy decisions regarding, for example, the management of a specific river basin, a regional electricity market, or a particular city’s transport network. What it does do, however, is enable policy makers to identify general policy shortcomings and establish appropriate policy goals. The latter can then be used to facilitate the emergence and subsequent implementation of more specific public policies. For example, in Australia’s case, the decline in the service efficiency ratio (Ratio 1) in most years since the early 1970s indicates that although the lower-order needs of most Australians are being adequately satisfied, the continuing growth in the stock of human-made capital is coming at the expense of higher-order need satisfaction. Rather than Australia’s uncancelled benefit (UB) curve shifting up as desired (see Figure 9.1), it has probably been shifting down over the last 20 years, thereby contributing to the decline in Australia’s sustainable economic welfare. This evidence sends a signal to policy makers that there is an urgent need to focus on qualitative improvement, not quantitative growth. Moreover,


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since the fall in Ratio 1 can be largely attributed to the increased cost of unemployment, commuting, noise pollution, crime, and a widening gap between the rich and poor, Australian policy makers need to concentrate their policy attention on the social factors discussed in Chapter 2. Too much of the incoming resource flow is being allocated to produce more goods with little attention given to the indirect and mounting costs associated with Australia’s persistent drive for growth. Clearly, current incentives and disincentives – caused by such market distortions as the failure to publicly remunerate non-paid household work – are restricting the options available to Australians and forcing them, on occasions, to make choices that are not in their welfare interests. In addition, the Australian taxation system is discouraging value-adding in production (qualitative improvement) by excessively taxing such ‘goods’ as income, wages and profit. More also needs to be done by Australian policy makers to reduce unemployment. The continuing acceptance of high unemployment rates is not only morally unjustified, it is unnecessary (Wray, 1998; Mitchell and Watts, 2002; Tcherneva, 2003). Finally, Australian policy makers need to overturn the growing imbalance between rich and poor. The public remuneration of non-paid work and a greater commitment to full employment would assist enormously in this regard. As for the maintenance efficiency ratio (Ratio 2), which was lower at the end of the study period than the beginning, distorted incentives again appear to be the culprit. Coupled with a large increase in Australia’s total energy consumption between 1966/67 and 1994/95, the fall in Ratio 2 indicates that most of Australia’s recent technological innovation has been of the throughput-increasing variety. To recall, throughput-increasing technology augments the resource flow passing through a nation’s macroeconomy. Unlike efficiency-increasing technology, the throughput-increasing variety leads to a movement along the UB and UC curves rather than a beneficial shift of both curves. As figure 2.4 illustrated, a movement along the UB and UC curves eventually results in a decline in sustainable economic welfare as the macroeconomy expands beyond the optimal scale. Disconcertingly, little progress seems to have been made in terms of maintenance efficiency-increasing innovation. More therefore needs to be done by Australian policy makers to encourage greater production efficiency, more durable goods, and higher rates of material recycling. At the very minimum, taxes should be imposed to discourage such ‘bads’ as resource depletion and pollution. Indeed, if Australian policy makers were to combine depletion and pollution taxes with a reduction in taxes on income, wages and profit, they would come very close to instituting what is now popularly termed ‘ecological tax reform’ (Lawn, 2000). The issue of ecological tax reform is revisited in greater detail in Chapter 11.

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The policy related message provided by Australia’s growth efficiency ratio (Ratio 3) is somewhat less definitive because the rise in this ratio was the consequence of Australia’s increasing rate of non-renewable resource depletion. In view of the decline in Australia’s natural capital stock, it should be clear to policy makers that Australia has failed to invest enough of the proceeds from its depletion of non-renewable resources into the cultivation of renewable resource substitutes. Without a policy overhaul in this area, it is unlikely that Australia could self-sustain its current rate of energy consumption into the future. It has been pointed out several times that a ‘user cost’ formula has been devised by El Serafy (1989) to calculate the portion of depletion profits that must be set aside to establish a replacement capital asset. This socalled El Serafy Rule can be operationalised by compelling resource liquidators to establish a ‘capital replacement’ account in the same way it is necessary for most business managers to establish a superannuation fund for employees (Lawn, 1998). This could be done through changes in accounting legislation. On a positive note, the rise in Australia’s renewable natural capital growth ratio since the early 1980s appears to have been induced, in part, by stringent pollution standards introduced at the national and state levels during the 1970s and early 1980s. However, since this rise can also be attributed to the oil price shocks of 1973 and 1979, a tax imposed on depletion and pollution activities – by increasing the throughput cost of production – would boost the incentive of Australian producers to develop greener production techniques. This would bring about a much larger rise in the renewable natural capital growth ratio than that experienced in the 1980s and 1990s. Furthermore, by asserting greater downward pressure on the uncancelled cost (UC) curve, such a policy would assist in increasing Australia’s economic welfare. Finally, attention turns to the evidential decline in Australia’s exploitative efficiency ratio (Ratio 4). Again, the fall in Ratio 4 has much to do with Australia’s reliance on non-renewable resources and its lack of suitable asset replacement. However, the largest contributing factor appears to be Australia’s excessive rate of native vegetation clearance. While in some states of Australia vegetation clearance is strictly controlled, in other states it is not. A sensible policy response requires the establishment of coordinated clearance controls at the national level where, importantly, the Federal government is better positioned to compensate affected landowners than State governments. Compensation is not only necessary for equity reasons, but to encourage landowners to conserve and manage protected vegetation.


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CONCLUDING REMARKS Contrary to some opinions, eco-efficiency indicators can be developed in a manner consistent with both the coevolutionary paradigm and the conclusions drawn from the linear throughput representation of the socio-economic process. Despite some possible inaccuracies, appropriately developed eco-efficiency indicators can provide valuable information for policy makers. The eco-efficiency exercise conducted for Australia demonstrates this point. What’s more, the development and application of more robust valuation methods should only improve their policy guiding value. Indeed, if just some of the policies suggested in this chapter were implemented by Australian policy makers, much could be accomplished, I’m sure, to overcome the welfare-declining impact of failing to embrace the notions of qualitative improvement, distributional equity and natural capital maintenance.

NOTE 1. In the case of renewable natural capital, it would involve the use of a resource flow in keeping with its regenerative capacities. In the case of non-renewable natural capital that does not regenerate, it would involve the cultivation of a renewable resource substitute to replace the declining non-renewable resource. This would keep the combined stock of natural capital intact.

PART IV

Sustainable development: theoretical and policy issues ‘Increasing awareness that our global ecological life support system is endangered is forcing us to realise that decisions made on the basis of local, narrow, short-term criteria can produce disastrous results globally and in the long run. We are also beginning to realise that traditional economic and ecological models and concepts fall short in their ability to deal with global ecological problems.’ R. Costanza, 1991

10.

On the independence of the sustainability, distribution and efficiency goals

INTRODUCTION Having now considered the critical role of natural capital and the importance of sustainable development indicators in guiding a nation’s transition towards a steady-state economy, Part IV deals with a number of additional theoretical and policy issues central to achieving sustainable development. The first of these issues relates to the hot debate that has raged amongst some ecological economists over the independence or otherwise of the three policy goals of allocative efficiency, distributional equity and ecological sustainability. The debate has simmered since Daly’s 1992 thesis entitled ‘Allocation, distribution, and scale: towards an economics that is efficient, just, and sustainable’. While these policy goals are not strictly independent as originally claimed, I believe they are sufficiently distinct for their simultaneous resolution to require, as Daly has argued, each of the policy goals to be addressed by the imposition of a separate policy instrument. As such, the aim of this chapter is to provide support for Daly’s sustainable development thesis. It does this by focusing attention on Daly’s 1992 paper, the 1999 reply by Daly to Stewen’s 1998 criticism of Daly’s thesis, and Stewen’s (1999) subsequent response to Daly’s reply.

HERMAN DALY’S ORIGINAL THESIS AND THE SUBSEQUENT RESPONSES In 1992, Daly argued that the policy goals of allocative efficiency, distributional equity and ecological sustainability are independent. In keeping with a policy absolutism discovered by Tinbergen (1952), Daly pointed out that, for the three policy goals to be satisfactorily resolved, each must be addressed via the institutionalisation of a separate policy instrument. The instruments Daly had in mind were: 193

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quantitative restrictions on the rate of resource throughput to achieve ecological sustainability; taxes and transfer payments to achieve a just distribution of income and wealth; relative prices determined by market supply and demand forces to achieve allocative efficiency.

Daly also argued that the policy goals of ecological sustainability and distributional equity should be resolved prior to the efficiency goal. According to Daly, an approach of this type internalises ecological and distributive limits, not just costs, and paves the way for markets to facilitate a macroeconomic adjustment towards an optimal scale (that is, a scale that is not only sustainable and just, but one where economic welfare – the difference between the benefits and costs of economic activity – is maximised). Stewen (1998) and Prakash and Gupta (1994) have questioned the independence of the three policy goals by correctly pointing out that all things in a coevolutionary world reflect and are impacted upon by everything else. While Daly has acknowledged coevolutionary interconnectedness in both his 1994 and 1999 replies (Daly, 1994 and 1999a), Stewen (1999) remains critical of Daly’s justification of his independence thesis on the grounds that each policy goal is akin to a simultaneous equation. Stewen makes the point that allocative, distributive and scale (throughput) decisions are mixed together in political processes and, as such, are not made in a sequence of mathematical equations. As valid as Stewen’s point is, I believe this is a clear case of confusing the complexities of the political process with a policy absolutism. It is this confusion that lies at the heart of the problem that Daly has highlighted. To demonstrate my point, consider the problem from a different perspective. A house has been damaged in a storm. Needing repair is the tiled roof, the drainpipes and a number of broken windows. The house is uninsured. The owners must decide how much to outlay for repairs in the knowledge that the more they spend, the more they forego alternative benefits. The damaged items can be replaced with high or low quality fittings. Choice of the latter means less is spent to repair the house and fewer alternative benefits are foregone. The process by which a financial decision must be made is not altogether complex but neither is it straightforward. If nothing else, the decision regarding how much to spend on each of the damaged items will be mixed together in the overall decision making process. Does this alter the fact that a roof tiler is required to repair the damaged roof, a plumber is required to fix the damaged drain pipes, and a glazier is required to replace the broken windows? No it doesn’t. Of course, the owners could pay the glazier to fix the roof as well the windows, just as mainstream economists would like to use

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relative prices to simultaneously resolve the sustainability and efficiency goals. But if the glazier is not trained in roof repairs in the same way that relative prices are incapable of sensing the absolute scarcity of low entropy matter-energy (Norgaard, 1990; Bishop, 1993; Chapter 5) the expeditious nature of the decision making process is of little value. Just as one could not guarantee the restoration of the house roof in line with minimum building standards, one could not guarantee a sustainable rate of resource throughput and, thus, a sustainable macroeconomic scale. This, I believe, is the point Daly tried to make – not whether political processes, as important as they no doubt are, can react ‘in the sense deciders hope’. If this still leaves open the question of whether the three policy goals are genuinely independent, perhaps it would be truer to say they are ‘distinct’ policy goals and it is their distinctiveness that demands the application of a separate policy instrument. Some observers will be quick to point out that this ignores the fact that a decision made with respect to one problem will undoubtedly influence the outcomes related to all remaining problems. For example, the greater is the restriction on the rate of resource throughput required to achieve ecological sustainability, the higher are resource prices and, initially at least, the smaller is the physical quantity of goods produced. Throughput restrictions will clearly alter the allocation of resources and the distribution of income and wealth. Nevertheless, provided a system of taxes and transfers ensures an equitable distribution of whatever goods are available for consumption, and relative prices ensure an efficient allocation of whatever the incoming resource flow happens to be, we end up with a different distributionally just and allocatively efficient outcome. But the changed outcome need not be less just or less efficient even if the economic welfare generated does not immediately equate to the level enjoyed prior to the imposition of the tighter throughput constraint. Indeed, if the level of economic welfare is lower, as was the case in the simulation exercise conducted in Chapter 4, it might simply mean that the economic welfare previously enjoyed was, for prevailing levels of human know-how, ecologically unsustainable. Should we despair at the prospect of an immediate cut in economic welfare? No we should not since higher resource prices ought to induce both greater rates of resource saving technological progress and the impartation of increasingly higher use value to each unit of low entropy matterenergy used in production. As such, we can expect greater levels of economic welfare to be experienced in the long run. More importantly, with the incoming resource flow restricted to the maximum sustainable rate, it would now be ecologically sustainable. If inequities and inefficiencies emerge, the problem lies with the transfer system and/or the ineffectiveness

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of prevailing markets, not with the decision to quantitatively restrict the incoming resource flow to the maximum sustainable rate.

MORE CRITICISM OF DALY AND FURTHER RESPONSES Stewen’s 1999 criticism of Daly extends well beyond the independence thesis. Stewen is also critical of the manner in which Daly deals with the issue of scale. In his reply to Stewen’s 1998 paper, Daly (1999a, p. 2) indicates that the reduction in the scale of the macroeconomy means a ‘proportional reduction’ in the same way a one-tenth scale model of a house is a ‘factor ten proportional reduction in all dimensions of the house’. Further, Daly suggests that the allocation (proportional balance) remains the same as the scale is reduced. Stewen (1999, p. 2), in reply, believes that such a reduction is a ‘too simplistic hope’. For two reasons, I agree with Stewen.1 First, setting out to achieve, for example, a direct factor ten reduction of a macroeconomy is not the best way to reduce the scale of economic activity. It is best achieved by imposing factor reductions on the rate of resource throughput (low entropy matter-energy) – the very stuff required to fuel the economic process. Second, if throughput constraints are imposed on the market, one is unlikely to witness a factor ten proportional reduction in all dimensions of the macroeconomy. This is because throughput constraints would, as previously explained, raise resource prices and, in so doing, induce a more efficient use of the incoming resource flow. Higher resource prices would also facilitate the development of resource saving technological progress. One would therefore see a less-than-ten factor reduction in the physical scale of the macroeconomy. Moreover, since resources would be reallocated to resource extensive and/or high value-adding industries, the macroeconomy would not be a scaled down version of a macroeconomy that previously existed. As Stewen (1999, p. 3) stresses, ‘materially intensive sectors will wither, others will prosper and grow’. Referring back to the house example, a factor ten reduction in the rate of throughput is likely to result in something resembling a factor eight or nine reduction of a completely different house – for example, one that is more durable, better insulated and, although smaller, allows for better practical use of living space. The aforementioned suggests there is a probable flaw in the Plimsoll line analogy used by Daly in his 1992 paper. It’s a very useful analogy insofar as it demonstrates how the optimal realisation of one goal (the even loading of cargo on a ship) does not guarantee, without a Plimsoll line, the optimal


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realisation of another goal (ensuring the cargo weight does not exceed the ship’s carrying capacity). Unfortunately, the allocation of the cargo on a ship is more akin to distribution. What’s more, the Plimsoll line analogy gives the impression that a reduction in scale of a macroeconomy is equivalent to a proportional reduction in all its dimensions. The analogy also misleads people into thinking that, in order to undergo a scale adjustment, the final outcome must be a priori prescribed. This latter intimation, I’m sure, is not what Daly had in mind. Interestingly, Stewen makes two points that implicitly support the need for separate policy instruments. In the first instance Stewen (1999, p. 3) suggests it is ‘neither socio-politically, nor economically, nor ecologically desirable to prescribe in detail how individuals ought to reduce scale. The overall result is what is important’ (Stewen’s emphasis). This, I believe, is exactly what Daly was alluding to. Like Stewen, Daly’s uppermost concern is the overall result – that of an efficient, just and sustainable macroeconomy to achieve sustainable development. Daly is simply at pains to point out that a desirable overall result is unlikely to be achieved unless each policy goal is addressed by way of a separate policy instrument. Merely ‘getting the prices right’ or relying on a single policy instrument to resolve two or more of the policy goals will not suffice. In the second instance, Stewen (1999, p. 3) says ‘it is not clear from the outset in which areas of production the greatest material savings are to be expected’. The question that immediately arises is: does it really matter?2 So long as the necessary throughput constraints are in place and distributional considerations have been taken into account, the market is left to determine where the sustainable incoming resource flow should be allocated – presumably to the resource extensive and/or high value-adding industries. And what if the market fails? We are left with an ecologically sustainable, distributionally just, yet inefficient macroeconomy. Would such an outcome justify rejection of Daly’s thesis? No, with two of three policy goals resolved, it would simply indicate that there is an urgent need to tinker with the market mechanism to improve allocative efficiency. The last point is very important insofar as it demonstrates why, as Daly has emphasised, there is a logical sequence of policy setting. It makes no sense whatsoever to resolve the allocation problem first and then make the necessary adjustments to ensure the incoming resource flow is both ecologically sustainable and distributionally just. Since allocation involves the relative division, through exchange, of the incoming resource flow among alternative product uses, it is too late to adjust the physical volume of the resource flow should it be unsustainable (Lawn, 2001b). Furthermore, since an individual’s command over the allocation of the incoming resource flow depends on his/her ability to pay for the means to the satisfaction of needs and wants, it

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is too late to adjust the distribution of the incoming resource flow among alternative people, following its allocation, should it be inequitable. Having said this, an initial distribution that is just does not ensure a just distribution at the conclusion of the allocation process. There is, as a consequence, always a need for some further redistribution. But redistribution, following allocation, is much less disruptive and market distorting if the distribution of the incoming resource flow is equitable to begin with. Above all, the policy goals of ecological sustainability and distributional equity must be resolved prior to the efficiency goal. This, of course, begs the question as to how this logical sequence of policy setting might be achieved? One such example is a system of tradeable resource use permits. A restriction on the number of permits auctioned by a government authority limits the throughput of matter-energy to a rate consistent with the regenerative and waste assimilative capacities of the natural environment. This resolves the sustainability goal. The revenue raised from the sale of the permits can be redistributed to the poor and those directly harmed by depletion/pollution activities. This resolves the equity goal. Finally, the premium paid by resource buyers for the limited number of permits – which is determined by demand and constrained supply forces in the various resource markets – serves as a throughput or absolute scarcity tax to facilitate the efficient allocation of the incoming resource flow.3 Finally, Stewen (1999) argues that dealing with the scale issue separately may, in the end, frustrate attempts to achieve the sustainability goal. Stewen (1999, p. 2) points to the ‘substantial social effects’ of a reduction in scale – for example, the impact on income distribution – and the disincentives arising out of the potential paralysation of factor and goods markets. I agree with Stewen insofar as opposition towards the steps required to achieve sustainability is often the consequence of the unwillingness of the present generation to bear any short-term pain for the long-term benefits that might only be enjoyed by future generations. Nevertheless, it is equally unrealistic to believe that the desire for growth can also continue without substantial social effects. The pertinent question is: which has the greatest social impact? In view of recent calculations of the Index of Sustainable Economic Welfare (ISEW) and other similar indexes which suggest that the extra benefits of growth are already being exceeded by the additional costs (Max-Neef, 1995; Chapters 6 and 8), I believe it to be the latter, even if the imposition of throughput constraints would inflict some considerable short-term pain. Why do we not see political pressure to move toward a sustainable scale? Coevolution not only leads to interdependencies, it also results in the path-dependence of systems – a proclivity of systems to exhibit structural inertia as they continue to be tied to their past characteristics (David, 1985; Arthur, 1989). It is because of path-dependencies that the cost of


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immediate or rapid adjustment to an ecologically sustainable pathway invariably outweighs the discounted sum of future net benefits (see Chapter 4). It is not surprising, therefore, that an addiction to growth has become a global phenomenon with little evidence emerging of any genuine political will to achieve sustainability. Where does this leave us? Short of convincing people of their moral obligation to preserve natural capital for future generations, we may have to be content with the initial levying of throughput taxes – a deficient sustainability instrument – to prepare macroeconomic systems, and ourselves, for the eventual imposition of direct throughput constraints (Lawn, 2000).

CONCLUDING REMARKS It is clearly important to overcome the political obstacles standing in the way of a sustainable, just and efficient macroeconomy. As such, ecological economists should be thankful to Stewen for reminding them of the role played by political and institutional forces in the sustainable development process. However, political factors, alone, do not alter the fact that the three policy goals of allocative efficiency, distributional equity and ecological sustainability are sufficiently distinct to warrant the imposition of separate policy instruments. Indeed, by augmenting humankind’s stock of knowledge, the widespread understanding of Daly’s thesis is considerably more likely to accelerate the transition towards sustainable development than a better understanding of political processes (Boulding, 1991). Better still, it is with Daly’s thesis in mind that we can direct our attention in the next chapter to ecological tax reform and how a reform package ought to be designed to maximise the prospects of achieving sustainable development.

NOTES 1. This is not to say that I disagree with Daly since this is more about a point of clarification. 2. One might argue that it matters a lot if people employed in a declining, resource intensive industry lose their jobs. But presumably a macroeconomic system that ensures distributional equity would have in place institutional mechanisms to adequately deal with affected persons (for example, a welfare safety net, publicly funded retraining programs, and financial compensation for all displaced workers). 3. It is the constrained supply forces that ensure ecological limits are internalised into resource prices.

11.

Ecological tax reform: why and in what form?

INTRODUCTION Ecological tax reform (ETR) is a policy initiative that has recently been put forward to facilitate the sustainable development process. In almost all prescribed cases, ETR involves a policy mix of reduced taxes on income and labour and the imposition of Pigouvian taxes on resource use and pollution emissions (e.g., see O’Riordan, 1997; Roodman, 1998). The reasons for this course of action are well understood. First, the value-adding encouraged by a reduction in income taxes leads to a qualitative improvement in the stock of human-made capital. Second, the substitution towards labour encouraged by a reduction in labour taxes ensures that any subsequent decline in production does not contribute to growing unemployment. Finally, the reduction in resource throughput encouraged by the imposition of throughput taxes helps to reduce the pressure of economic activity on the natural environment. What isn’t well understood about ETR is that it relies exclusively on the manipulation of market prices – an allocation instrument – when ecological sustainability is, as explained in Chapter 10, a throughput problem that requires an entirely separate policy instrument to be adequately resolved. In addition, market prices (and this includes adjusted prices) are greatly influenced by the present value maximisation decisions made by currently existing people. If market prices are to assist in facilitating ecological sustainability, it will be necessary to bring forward potential future costs into the present decision making domain. As I will soon explain, typical ETR prescriptions fail in this regard. To assess the expediency of conventional ETR prescriptions, the following is proposed. First, the conclusions drawn from the linear throughput model revealed in Chapter 2 will be used to outline five organisational modes to facilitate the movement toward sustainable development. Next, I will explain why conventional ETR prescriptions lead to just two of the five organisational modes being attained and how an ETR package incorporating assurance bonds and tradeable resource use permits can bring about the attainment of all five organisational modes. In the final section 200


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of the chapter, I deal with some of the criticisms levelled at this alternative ETR approach.

FIVE ORGANISATIONAL MODES TO ACHIEVE SUSTAINABLE DEVELOPMENT In order to arrive at the five organisational modes required to achieve sustainable development, let us reconsider some of the conclusions drawn from the linear throughput model. In the first instance, it was shown that only natural capital provides the throughput of matter-energy needed to produce and maintain the stock of human-made capital (i.e., natural capital → throughput → human-made capital). Second, humanmade capital is needed to experience a level of net psychic income greater than what would otherwise be experienced if the socio-economic process never took place (i.e., human-made capital → net psychic income). Finally, by exploiting natural capital for the throughput of matter-energy, some of the three instrumental services that natural capital provides are unavoidably sacrificed (i.e., lost natural capital services → natural capital → throughput → human-made capital → net psychic income). The linear throughput model also revealed that natural and humanmade capital are complementary forms of capital which, furthermore, was supported by the exercise conducted in Chapter 3. By arranging the various elemental magnitudes of the linear throughput model in conformity with the conclusions drawn from it, we were able to arrive at a measure of ecological economic efficiency (equation 6.3) as well as four component ecoefficiency ratios (equation 6.4). From this and the diagrammatical representation of the two elemental categories of net psychic income (uncancelled benefits) and lost natural capital services (uncancelled costs), it was further concluded that there is an inevitable limit to the maximum sustainable scale of macroeconomic systems. More importantly, however, it was shown that an economic limit to growth exists at an even smaller macroeconomic scale – namely, the optimal macroeconomic scale – which, as revealed in Chapter 6, had already been exceeded in the case of a number of developed nations. Whilst it was demonstrated that efficiency-increasing technological progress can increase sustainable economic welfare, thereby permitting development in the presence of a steady-state economy, it was also explained that technology is subject to various biophysical and existential limits. This is particularly so with regards to the capacity to beneficially shift the uncancelled cost (UC) curve (e.g., Figure 9.2).

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Given the aforementioned, the movement toward sustainable development can be summarised and encapsulated by the following five organisational modes. 1.

Accumulate a stock of human-made capital until it reaches a sufficient physical magnitude. A sufficient magnitude of human-made capital (the steady-state economy) is best defined in terms of a quantity beyond which any further growth leads to a decline in sustainable economic welfare. The best indicator of a sufficient stock of human-made capital is ether the Index of Sustainable Economic Welfare (ISEW) or the Genuine Progress Indicator (GPI). 2. Maximise the psychic enjoyment of life (net psychic income) subject to the sufficient accumulation and equitable distribution of human-made capital. This involves the maximisation of the service efficiency of human-made capital (Ratio 1 from equation 6.4). Attainment of organisational mode 2 requires a qualitative improvement in the stock of human-made capital over time, not its continual physical expansion. 3. Minimise the throughput of matter-energy required to maintain the sufficient magnitude of human-made capital intact. This requires the maximisation of the maintenance efficiency of human-made capital (Ratio 2 from equation 6.4). 4. Maintain natural capital intact and, where feasible, maximise its productivity; that is, maximise its ability to generate a flow of renewable low entropy resources and assimilate high entropy wastes. While the former demands that the rate of resource throughput does not exceed the regenerative and waste assimilative capacities of the natural environment, the latter involves the maximisation of the growth efficiency of natural capital (Ratio 3 from equation 6.4). 5. Minimise the natural capital services lost in the process of obtaining the throughput of matter-energy required to fuel the socio-economic process. This requires the maximisation of the exploitative efficiency of natural capital (Ratio 4 from equation 6.4). To ascertain how well a nation is ‘organising’ itself, a number of things are required. First, it is necessary to compile accounts for each of the five key magnitudes emerging from the linear throughput model. Second, it is necessary to use the information provided by each account to calculate a measure of sustainable economic welfare (equal to the uncancelled benefits of economic activity less the uncancelled costs) as well as the four ecoefficiency ratios. The results of such an exercise have already been revealed for Australia in previous chapters – namely, the measure of Fisherian national income


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in Chapter 8 and the eco-efficiency ratios in Chapter 9. By relating this empirical evidence to the five organisational modes, the following judgements can be made about Australia’s sustainable development performance.1 ●

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Australia has accumulated a stock of human-made capital that appears to have surpassed the sufficient level. That is, in almost every year between 1973/74 and 1994/95, Australia’s sustainable economic welfare fell even though real GDP continued to rise. Since Australia would have been better served by the transition towards a steadystate economy in the mid-1970s, Australia appears to have violated organisational mode 1. While the service efficiency of Australia’s human-made capital (Ratio 1) increased over the period 1966/67 to 1972/73, it remained relatively steady up to 1981/82, and effectively declined thereafter. By 1994/95, the service efficiency ratio was less than what it was at 1966/67. Australia is therefore failing to attain organisational mode 2. Why is this the case? Quite simply, the increase in the quantity and quality of human-made capital has been offset by sharp increases in such psychic disbenefits as unemployment, commuting costs, noise pollution, crime and a widening gap between the rich and poor. Australia’s maintenance efficiency ratio (Ratio 2) rose from 1966/67 to a peak in 1970/71. It then declined very gradually to a low in 1989/90. By 1994/95, Australia’s maintenance efficiency ratio had marginally recovered; however, it was still lower than the initial 1966/67 figure. This evidence plus the large overall increase in total energy consumption between 1966/67 and 1994/95 indicates that most technological innovation in Australia over the last 30 years has probably been of the throughput increasing rather than efficiencyincreasing variety. Above all, it indicates that Australia is violating organisational mode 3. Australia’s natural capital declined between 1966/67 and 1994/95. While Australia’s stocks of renewable natural capital increased slightly, its augmentation was insufficient to offset the diminution of non-renewable resource stocks. This suggests that little if any of the proceeds earned from the sale of non-renewable resource depletion was set aside to cultivate renewable resource substitutes. As for the productivity of Australia’s natural capital (Ratio 3), the ratio of resource throughput to natural capital increased between 1966/67 and 1994/95. While this suggests that Australia’s natural capital is more productive, the increase in the ratio was largely the consequence

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of Australia’s increased depletion rate of non-renewable resource stocks. This is an unsustainable practice that reflects Australia’s failure to attain organisational mode 4. Australia’s exploitative efficiency ratio (Ratio 4) declined in every year between 1966/67 and 1994/95. This result suggests that the opportunity cost of exploiting natural capital for the throughput of matter-energy increased continuously over the study period. As such, it would appear that Australia is violating organisational mode 5. While the result probably overstates the true increase in the opportunity cost of natural capital exploitation, it reflects Australia’s poor record in preserving remnant vegetation, its heavy reliance on nonrenewable resources, and its lack of reinvestment into renewable resource substitutes.

In summary, Australia has failed to attain the five organisational modes required to achieve sustainable development. This is probably not surprising given Australia’s continued preoccupation with growth and its failure to undertake anything that remotely resembles ETR. Notwithstanding this, with recent cuts in income taxes in Australia and the introduction of a goods and services tax (GST), some people are suggesting that the change in the structure of Australia’s taxation system may have a positive sustainable development impact (Abelson, 1998). For two reasons, this is unlikely to be the case. First, a GST is a value-added tax and the disincentive it generates may well offset any increase in value-adding brought about by a lowering of income taxes. Second, a GST is not a throughput tax – it does not penalise the profligate use of natural resources. Indeed, because the newly adopted tax system in Australia offers tax credits to producers as compensation for the higher cost of intermediate inputs, it subsidises natural resource use.

THE FAILURE OF THE CONVENTIONAL ECOLOGICAL TAX REFORM APPROACH Isolating appropriate organisational modes also provides an important insight into why conventional ETR prescriptions are unlikely to facilitate sustainable development. To recall, a major element of any conventional ETR package is the imposition of throughput taxes. As previously explained, throughput is the physical intermediary that connects natural and human-made capital (i.e., natural capital → throughput → humanmade capital). Given that a throughput tax is applied to the incoming resource flow already extracted from natural capital, a throughput tax


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merely influences the way the resource flow is utilised to produce humanmade capital. By increasing the cost of acquiring a portion of the incoming resource flow, a throughput tax encourages resource users to minimise the throughput required to produce and maintain a given quantity of humanmade capital. Hence, a throughput tax should increase the maintenance efficiency of human-made capital (Ratio 2) and the attainment of organisational mode 3. Presumably, an increase in Ratio 2 would also lead to a decline in the incoming resource flow as well as a reduction in the quantity of natural capital requiring exploitation. By reducing the uncancelled cost of economic activity, this should shift the UC curve downwards and to the right and increase a nation’s sustainable economic welfare (e.g., Figure 9.2). But what if the total quantity of human-made capital being produced and maintained rises? Furthermore, what if the percentage increase in the quantity of newly produced goods exceeds the percentage increase in the maintenance efficiency of human-made capital? The rate of resource throughput would instead increase (the Jevons’ Paradox). This would result in the diminution of natural capital and a failure to attain the first part of organisational mode 4. Moreover, in view of the law of diminishing marginal benefits and the law of increasing marginal costs, a rise in the total rate of resource throughput would lead to the additional benefits of a larger macroeconomic scale being exceeded by the additional costs and, thus, to a decline in sustainable economic welfare. Indeed, it would be possible for a nation’s macroeconomy to now exceed its maximum sustainable scale. This would amount to a failure to attain organisational mode 1. Unfortunately, with the conventional ETR approach there is no additional mechanism in existence to prevent this from occurring (i.e., an institution to impose quantitative restrictions on the incoming resource flow). Thus, while throughput taxes influence the micro behaviour of individuals, they do not necessarily influence macro behaviour because they are only applied following the extraction of low entropy resources. What about organisational modes 2 and 5 and the second part of organisational mode 4? Conventional ETR prescriptions can be expected to facilitate the attainment of organisational mode 2 – the maximisation of net psychic income per unit of human-made capital – because throughput taxes and a reduced income tax rate provide an additional incentive to increase the service-yielding qualities of human-made capital. Unfortunately, conventional ETR prescriptions are unable to facilitate the attainment of organisational mode 5 and the second part of organisational mode 4. Consider the latter – the maximisation of the productivity of natural capital (i.e., its ability to generate a flow of low entropy resources

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and assimilate high entropy wastes). While a reduction in income taxes may, to some degree, encourage resource owners to improve the management of renewable resource stocks (since the increase in after-tax profits could now exceed the cost of improved management), throughput taxes will not. Why? Irrespective of whether natural capital is more or less productive, each unit of the now higher incoming resource flow is taxed at the same rate, as is the now higher outgoing waste flow. There are, therefore, no pecuniary rewards to be gained from increasing the productivity of natural capital in addition to what resource owners could earn prior to the introduction of a throughput tax. Hence, a throughput tax does not provide an additional incentive for resource owners to increase the productivity of natural capital. The same also applies to organisational mode 5 – the minimisation of the loss of natural capital services per unit of natural capital exploited. Even if a resource owner could adopt more ecologically benign exploitative techniques, a throughput tax would not increase their incentive to do so. The fact that throughput taxes fail to achieve ecological sustainability underscores a critical point emphasised in the previous chapter. Throughput taxes involve the manipulation of market prices but relative prices assist only in the efficient allocation of the incoming resource flow. It is because of the latter that conventional ETR measures are able to facilitate the attainment of organisational modes 2 and 3 – both modes are satisfied by better allocating the incoming resource flow to alternative product uses. But the efficient allocation of the incoming resource flow does not guarantee an ecologically sustainable rate of resource throughput.2 Nor does it guarantee an equitable distribution of income and wealth, although this is generally well accepted by mainstream as well as ecological economists. Since ecological sustainability is a throughput problem, not an allocation problem, achieving it requires the imposition of quantitative restrictions on the incoming resource flow. There is no need to place similar restrictions on the outgoing waste flow because the first law of thermodynamics ensures the quantity of matter-energy entering a macroeconomic system equals the quantity eventually exiting it. However, because of the Entropy Law, a quantitative restriction on the incoming resource flow has no influence on the qualitative nature of outgoing waste. Achieving ecological sustainability therefore requires an additional institutional mechanism to deter producers from generating ecologically destructive substances. This aside, the deleterious nature of some high entropy wastes may require the generation of particular substances to be prohibited or at least the quantity produced severely limited.


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AN ECOLOGICAL TAX REFORM PACKAGE TO ACHIEVE SUSTAINABLE DEVELOPMENT The inability of conventional ETR prescriptions to facilitate sustainable development does not mean that ETR should be abandoned. What is required of an ETR package is: (a) a policy instrument to quantitatively restrict the incoming resource flow to one that is within the regenerative and waste assimilative capacities of natural capital; (b) a policy instrument to qualitatively control the high entropy wastes generated by the transformation of the incoming resource flow into human-made capital; (c) a policy instrument to ensure the efficient allocation of the incoming resource flow among alternative product uses; and (d) a policy instrument to compensate injured parties and to assist in correcting inequitable imbalances between the rich and poor. Because a conventional ETR package includes a throughput tax and a lowering of tax rates on income and labour it already includes policy instrument (c). Moreover, since the revenue raised by a throughput tax can be used for compensation and redistribution purposes, a conventional ETR package also includes policy instrument (d). However, its failure to include policy instruments (a) and (b) means a comprehensive ETR package should still include the lowering of taxes on income and labour but, rather than having an explicit tax on resource throughput, incorporate the use of tradeable resource use permits and assurance bonds.3 Tradeable Resource Use Permits A system of tradeable resource use permits has been briefly outlined in Chapters 3 and 10. The following is a more detailed description of how the system might operate. Upon estimating the maximum sustainable rate of resource throughput, a purpose-designed government authority would be empowered to auction off a limited number of resource use permits to the highest bidding resource buyers. A permit would grant the possessor the right to purchase a portion of the permissible resource flow from resource sellers – for example, a cubic metre of unprocessed timber. If a resource buyer requires ten cubic metres of raw timber, they must acquire ten permits. As each cubic metre of timber is purchased, the resource buyer must surrender a permit. Importantly, the limit on the initial number of permits sold ensures the existence of policy instrument (a). The auctioning process would be undertaken each year to allow the authority to vary the number of permits in line with novel changes in the ecosphere’s regenerative and waste assimilative capacities. This would mean that a permit would expire at the end of each year even if the permit was

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unused. To maintain competitive markets, there would be a limit on the number of permits any single individual or firm could purchase. Since anyone would be entitled to engage in the initial auctioning process, individuals and/or environmental groups could purchase some of the permits and opt not to use them in order to restrict the incoming resource flow to something less than the maximum sustainable rate. This would allow the optimal macroeconomic scale to be of a biocentric rather than egocentric kind. All non-expired permits could be resold (exchanged) to another individual or firm so long as the new buyer was not already in possession of the maximum permissible quota of permits. Because a prospective resource buyer is required to purchase resource use permits, they inevitably pay a higher price for each unit of the incoming resource flow. As per normal, they pay the price charged by resource sellers for supplying the resource. However, they now pay an additional amount to secure resource use permits. This so-called ‘premium’ is equivalent to a throughput tax or, more accurately, an absolute scarcity rent that reflects the market internalisation of ecological limits, not simply ecological costs (Daly, 1979). Because the premium encourages the more efficient use of the incoming resource flow and induces the development and application of efficiency-increasing technology, it ensures the existence of policy instrument (c). Note, therefore, that there is no need for a government authority to calculate and impose a throughput tax – the tax rate is determined by the interaction of the demand and artificially constrained supply forces in the resource use permit market. One might be tempted to ask whether this system gives existing people the freedom to discount the future implications of whatever they plan to do with their portion of the incoming resource flow. The answer would, of course, be yes. However, it would not allow presently existing people, in aggregate, to lay claim to an incoming resource flow in excess of the maximum sustainable rate. Indeed, prevailing discount rates would merely determine the proportion of the incoming resource flow consumed in the present and that which is invested to generate future consumption. That is, high discount rates would mean more current consumption and less future consumption. But it would not lead to an unsustainable rate of resource use nor, therefore, a pattern of consumption that is intergenerationally unjust. As a consequence, a system of tradeable resource use permits would avert the potential conflict revealed and outlined in Chapter 4 between ecological sustainability and present value welfare maximisation. Last but not least, the revenue raised by the sale of resource use permits can be redistributed to the poor and/or be used to compensate people affected by the negative spillover effects of other people’s actions. As we shall see in Chapter 14, some of this revenue can also be used to


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part-finance a Job Guarantee program to attain full employment in a low growth or steady-state economy. This ensures the existence of policy instrument (d). In order to maximise the effectiveness of tradeable resource use permits, the system should be designed so that a specific arrangement exists for each renewable resource type and for different geographical/jurisdictional locations.4 The first aspect is self-explanatory – different resource types have different regeneration rates. Although less obvious, the regional aspect is important because particular resource types (e.g., timber species) grow at different rates depending on their geographical location. In addition, a failure to consider regional effects could see an entire quota of a particular timber or fish species being sourced from one location, thereby resulting in the decimation of a local fish population or forest reserve. Finally, since ecological sustainability requires the maintenance of critical ecosystems (e.g., biodiversity integrity), all future exploitation of natural capital is probably best confined to locations already strongly modified by previous human activities. Permit systems can clearly help to reduce or prohibit resource exploitation from sensitive and/or hitherto low-impacted areas. There is, nonetheless, a potential weakness with the system of tradeable resource use permits just described. While it ensures the sustainability of renewable resource use, it cannot do the same with non-renewables. The solution to the sustainability dilemma with respect to non-renewable resources has, in part, been explained in Chapters 3 and 5. To recall, natural capital intactness requires some of the proceeds from the depletion of nonrenewables to be used to establish renewable resource substitutes. This is best achieved by compelling resource liquidators to establish a ‘capital replacement’ account in the same way business managers are required in some countries to establish a superannuation fund for employees. This could be mandated through changes in accounting legislation. Ideally, the legislative changes would include a strict schedule of discount rates and average mine lives to apply when using equation (3.22) to calculate the set-aside component for each non-renewable resource type. As such, the set-aside component would constitute a ‘user cost’ tax. The capital replacement accounts would be held by government-approved resource management companies whose task it would be to cultivate renewable replacement assets on behalf of the non-renewable resource liquidators. Unfortunately, a potential problem still exists with non-renewable resources insofar as some varieties do not have a known renewable resource substitute. Do we therefore consume these resources rapidly in the belief that this is justifiable so long as we do everything to keep the remaining stock of natural capital intact, in particular, the preservation of critical ecosystems? I think not and believe it is fair, from an intergenerational

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perspective, that we deplete these resources very slowly by extending their availability across as many generations as possible. It is here where a system of tradeable resource use permits can again be of use – this time to lengthen the intergenerational availability of nonrenewable resources with no known substitutes. The number of permits auctioned each year to purchase these resources would be determined on the basis of estimated stock levels – including projected discoveries – as well as the period over which their continued availability was deemed intergenerationally fair. Given the likelihood of severe restrictions being placed on the annual consumption of non-substitutable resources, it is reasonable to believe that their prices would rise considerably relative to the prices of renewable and substitutable non-renewable resources. In doing so, a permit system would assist in weaning a nation’s macroeconomy off nonsubstitutable resources well short of their complete exhaustion. Assurance Bonds As I mentioned earlier, the first law of thermodynamics dictates that the quantity of matter-energy entering a macroeconomy in the form of low entropy resources must inevitably equal the quantity of matter-energy exiting as high entropy waste.5 Thus, with tradeable resource use permits in place, there is no need for pollution permits to quantitatively restrict the outgoing waste flow. This aside, it is possible, in some instances, for the paucity of environmental sink capacity to be a more binding sustainability constraint than the lack of resource availability – particularly at the local or regional level. In circumstances such as these, the number of resource use permits auctioned off each year should be conditioned in terms of waste limits. It was also pointed out that, as a consequence of the Entropy Law, a quantitative restriction on the incoming resource flow has no influence on the qualitative nature of outgoing waste. For this reason, a system of tradeable resource use permits does not ensure the existence of policy instrument (b). What about pollution taxes to control the qualitative nature of outgoing waste? The problem here is that although pollution taxes make polluting more expensive, the worst effect of pollution often takes some considerable time to manifest itself. This means polluters will only pay for the cost of their pollutive activities at some stage in the future. Because people discount future values, the prospect of having to pay much later for the cost of pollution is less of a disincentive to pollute than having to pay upfront. This is where assurance bonds can play a part in reducing the toxic and intractable nature of high entropy waste (Costanza and Perrings, 1990). With assurance bonds, a polluting firm pays a bond equal to the cost of the


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worst case pollution scenario. In this sense, the assurance bond serves as a ‘provisional’ tax. Should the owners of a bond-paying firm demonstrate that the pollution they subsequently generated has had no deleterious impact on the natural environment, they receive the bond back in full plus any interest accrued over the period in which the bond has been held by a government authority. If the pollution has had an undesirable impact on the natural environment, the bond is confiscated either in full (where pollution damage equals the worst case scenario) or in part (where pollution damage is something less than the worst case scenario). If the worst case scenario is unacceptably risky (i.e., it involves highly toxic substances), the generation of the substances in question may require prohibition or generation under strictly controlled conditions. Not unlike the premiums paid for resource use permits, confiscated bond money can be used for redistribution purposes and environmental rehabilitation projects. It would not, however, be necessary for all firms to pay an assurance bond. Ideally, a government authority would identify ‘low risk’ and ‘high risk’ industries and confine bond payments to firms operating in the latter category. The high risk category might also be divided into two subcategories – for example, ‘high risk A’ and ‘high risk B’ – whereby the former sub-category would include industries generating highly dangerous substances. As just mentioned, the firms operating in these industries would need to be rigorously controlled and monitored to avoid irrecoverable environmental damage. In all, by bringing into the present decision making domain the potential cost of ecological damage caused by highly toxic and intractable wastes, assurance bonds eliminate the usual discounting of future costs and encourage polluters to minimise their impact on the natural environment. Barring illegal or corrupt activities, this ensures the incorporation of policy instrument (b) into an ETR package.

A RESPONSE TO TYPICAL CRITICISMS OF THE ALTERNATIVE ECOLOGICAL TAX REFORM APPROACH In this final part of the chapter I would like to deal with a number of criticisms of this alternative ETR approach. Throughput Taxes are Simpler than Tradeable Resource Permits It is often claimed that the imposition of a throughput tax is much simpler than a system of tradeable resource use permits. In a logistical sense, this is

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probably true since there is no need to establish a government authority to conduct the auctioning of permits. However, in both cases, it is necessary to police resource buyers and sellers to prevent abuse of the system. From a practical sense, I believe a system of tradeable resource use permits is simpler for a reason already given above – it is only necessary to estimate the maximum sustainable rate of resource throughput. There is no need to calculate and impose the correct throughput price/tax since this is determined by interacting demand and supply forces in the resource use permit market. If a throughput tax is imposed, it is still necessary to estimate the maximum sustainable rate of resource throughput in order to estimate the correct throughput tax. Even if the former can be correctly estimated, why should anyone believe that a bureaucrat can determine the throughput price/tax more accurately than a market in which the quantity of resource use permits has already been limited to one that forbids a throughput flow in excess of the maximum sustainable rate? Trying to control the incoming resource flow with throughput taxes simply doubles the probability of bureaucratic error. Throughput Taxes Guarantee Ecological Sustainability So Long as the Throughput Tax is Set High Enough I pointed out above that a throughput tax will not lead to a lessened throughput rate if the percentage increase in newly produced goods (which a throughput tax cannot directly control) is greater than the percentage increase in the maintenance efficiency of human-made capital. As some people have urged, why not set the throughput tax high enough to ensure the total rate of resource throughput falls to one that is within the regenerative and waste assimilative capacities of natural capital? There are a few points that need to be made here. First, how high is high enough? With a tradeable resource use permit scheme this is not an issue. One simply limits the number of permits to the maximum sustainable rate and lets the market indicate what is high enough. Second, what if, in making sure the rate of resource throughput is reduced to a sustainable level, the tax rate imposed is too high? While it will guarantee sustainability (at least for the time being), it will hinder the efficient allocation of the incoming resource flow. To some people who believe ecological sustainability is of greater concern than a minor resource allocation problem, this does not represent a major cause for concern. I also happen to believe that ecological sustainability is more important than Pareto efficiency. But why not have a system of tradeable resource use permits and achieve the former while also being as close as possible to achieving the latter?


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Finally, what if the throughput tax to ensure ecological sustainability is high enough today but too low tomorrow? The ecosphere is a complex system subject to novel changes that cannot be a priori known. As such, the maximum sustainable rate of throughput will fluctuate over time. In addition, since people’s tastes, preferences, and discount rates are also in a state of flux, the disincentive effect of a throughput tax set at a particular rate will vary over time. To ensure ecological sustainability, a throughput tax will have to be continually adjusted. This only adds to the difficulties already faced by the tax setter. What if the Maximum Sustainable Rate of Throughput is Incorrectly Estimated? A tradeable resource use permit scheme is not infallible. Whether it assists in achieving ecological sustainability depends largely on how accurately the maximum sustainable rate of throughput is estimated. If an overestimation is made and too many permits are auctioned off, the incoming resource flow will exceed the maximum sustainable rate. Should a throughput tax be preferred, any overestimation of the maximum sustainable rate of throughput will result in an insufficient tax rate. Hence the possibility of error does not amount to an argument against tradeable resource use permits. To avoid any problems that might emerge from incorrectly estimating the maximum sustainable rate of throughput, it would be wise to adopt a ‘precautionary’ approach and limit the incoming resource flow and the number of permits sold to, say, 75% of the estimated maximum sustainable rate.6 If the Ecological Tax Reform Package Succeeds in Reducing Throughput, Won’t Tax Revenues Decline? It is often claimed that if the rate of resource throughput is reduced to a trickle and few if any assurance bonds are confiscated, the tax revenue of the government will decline. As such, the revenue neutral nature of ETR will be jeopardised.7 This is not necessarily the case. Presumably, at the same time, the reduction in income taxes included in an ETR package is increasing the rate of value-adding. This, in turn, boosts profits, wages and income. Assuming that the revenue raised from permit sales and confiscated assurance bonds is likely to fall, why wouldn’t we expect the revenue raised from income taxes to rise? Furthermore, there is no reason to believe that the increase in the latter would not offset the decline in the former so that, overall, the government’s budget position would not deteriorate. In fact, given that limits to increases in the eco-efficiency Ratios 2, 3 and 4 are likely to be reached much sooner than Ratio 1, there is every chance that

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the revenue raised from income taxes will continue to rise long after the decline in the revenue from permit sales and confiscated assurance bonds has ceased. In all, tax revenues are likely to rise not fall.

CONCLUDING REMARKS In its present popular form, ETR is a vast improvement on current tax systems, as evidenced by Australia’s current failure to attain the five organisational modes required to achieve sustainable development. But it is still an inadequate means of achieving sustainable development because it principally relies on the manipulation of market prices when ecological sustainability is a throughput problem requiring a separate policy instrument to be adequately resolved. Indeed conventional ETR prescriptions are likely to lead to just two of the five organisational modes being attained. For sustainable development to be achieved, an ETR package must incorporate, among other things, a policy instrument to restrict the incoming resource flow to a rate that is within the regenerative and waste assimilative capacities of the natural environment, and another to qualitatively control the high entropy wastes generated by the transformation of the incoming resource flow into human-made capital. Given the distinctiveness of the sustainability, equity and efficiency goals and its implications for policy instruments, I believe an ETR package should include something like the following. ●

●

As per conventional ETR prescriptions, a reduction in tax rates on income, profits and the employment of labour (e.g., payroll taxes).8 The levying of lower tax rates on income and profits encourages value-adding in production, while lower taxes on labour helps to maintain or boost employment levels. Unlike conventional ETR prescriptions, a system of tradeable resource use permits. ⇒ In the case of renewable resources, the limited number of permits auctioned off by a government authority provides the necessary policy instrument to ensure the rate of renewable resource use remains within the regenerative and waste assimilative capacities of renewable resource stocks. In some instances, a specific arrangement needs to be designed to meet local or regional peculiarities. The premium paid by resource buyers for permits serves as a throughput or absolute scarcity tax to: (a) facilitate the efficient allocation of the incoming resource flow,


●

●

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and (b) to induce, where feasible, efficiency-increasing technological progress. ⇒ As for non-renewable resources, tradeable resource use permits can be used in circumstances where a particular non-renewable resource has no known renewable resource substitute. By extending the availability of non-substitutable resources, permits ensure their rate of exhaustion is intergenerationally just. Moreover, permits assist in weaning a nation off non-substitutable resources prior to their complete exhaustion. The introduction of a user cost tax to deal with the depletion of all non-renewable resources identified as having a renewable resource substitute. As a means of operationalising the El Serafy user cost rule, the user cost tax should be sunk into capital replacement accounts to facilitate the cultivation of substitute renewable resource assets. This, in turn, would keep the total stock of natural capital intact. The payment of assurance bonds by polluting firms operating in ‘high risk’ industries. As a form of provisional tax, assurance bonds bring forward the cost of potential ecological damage caused by toxic wastes. In doing so, they encourage polluters to minimise their impact on the natural environment.

I might also point out that an ETR package could include two other policies not discussed in this chapter. They are: (a) a system of transferable birth licences to control human population numbers (Boulding, 1964), and (b) an IMPEX (Import-Export) system of foreign exchange management to eliminate foreign debts and to reinstate comparative advantage as the principle governing international trade (Iggulden, 1996). The reason for their possible inclusion is that most of the ETR initiatives described in this chapter are examples of a macro-control/microflexibility approach to policy (Lawn, 2006b). Both the system of transferable birth licences and an IMPEX system of foreign exchange management fall into this policy category. While the former policy measure is not discussed in this book, the latter is outlined in considerable detail in Chapter 15.9 It would, of course, be naive of me to move on without admitting that the ETR measures recommended in this chapter are a drastic leap from the present policy environments in most countries. As such, they are unlikely to be immediately implemented. For this reason, conventional ETR prescriptions may well be an ideal, if not the only, means of beginning the transition toward sustainable development. But they should always be recognised as such and never the ultimate solution.

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NOTES 1. I should remind the reader that the study period for the analysis on Australia was 1966/67 to 1994/95. 2. The imposition of a carbon tax in Sweden, for instance, has had little impact on aggregate carbon emission levels (see Harrison and Kriström, 1999). 3. Since sustainability also requires a sustainable human population, a comprehensive ETR package might also include tradeable birth licences (see Lawn, 2000). 4. In an ideal world, the boundaries of legal and political jurisdictions within nations would closely resemble geographical or biophysical regions, such as a particular river basin. Many environmental problems are accentuated by the legal and political complexities arising from multiple jurisdictions existing within a well-defined geographical or biophysical region. The Murray-Darling Basin in Australia involving the states of Queensland, New South Wales, Victoria and South Australia is a case in point. 5. Because matter-energy is temporarily ‘frozen’ in human-made capital and only dissipates in the form of high entropy waste as human-made capital depreciates over time, the quantity of matter-energy entering and exiting a macroeconomic system need not be equal at a given point in time. 6. The advantage of a permit system is quite clear – it guarantees a certain rate of resource use, even if it turns out to be the incorrect quantity, which is of little concern if a precautionary approach has been adopted. 7. Revenue neutrality is seen by some as a positive political selling point of ETR. 8. Having said this, there may be very good reasons for introducing a 100% income tax rate on very high incomes to maintain a socially acceptable gap between the rich and poor (Daly, 1992 and 1996; Lawn, 2000). Some people would argue that a 100% tax rate would blunt the incentive to achieve and potentially offset the value-adding benefit of setting lower tax rates for incomes below the maximum permissible level. A few things need to be said in reply. First, the 100% tax rate would only apply to a small percentage of the population. Second, the maximum permissible income would rise as the minimum income increased. Third, economists have long pointed out the probable existence of a backward-bending labour supply curve for people on high incomes. That is, as the wages of the rich increase, they eventually opt for more leisure time and less work – the consequence of the income effect of a higher wage exceeding the substitution effect. If this is the case, higher wages already act as a natural disincentive for the rich to increase effort levels. A maximum limit on income should therefore serve its desired equity function at little or no cost at all to society. Finally, one must question whether people on exorbitantly high incomes are earning economic rents – that is, an income that exceeds the minimum amount required for an individual to supply their labour in its current manner. If the answer is yes, as I believe it is for incomes that exceed the minimum acceptable income level by an order of magnitude of 10 or more, a 100% tax rate does not alter the labour supply decisions of the very rich. 9. A system of transferable birth licences is discussed in Heer (1975), Daly (1992), and Lawn (2000).

12.

Does the Environmental Kuznets Curve exist? A theoretical perspective

INTRODUCTION Because endorsement for a steady-state economy rests entirely on the presence of ecological and existential limits to growth, ecological economists must always be prepared to investigate new concepts that appear, on the surface at least, to endorse the pro-growth position. One very prominent pro-growth concept that has gathered steam since its popularisation in the 1992 World Development Report (IBRD, 1992) is the so-called Environmental Kuznets Curve (EKC). Not surprisingly, the likely existence and policy implications of the EKC have become a hot topic of debate over the past decade. The EKC emerged following the belief that the relationship between per capita real GDP and environmental quality could behave in a manner similar to the relationship between per capita real GDP and income inequality postulated in the mid-1950s by Simon Kuznets (1955). That is, environmental quality would at first deteriorate but later improve as a nation’s per capita real GDP rose in accordance with its rate of economic advancement. Should the EKC exist, its policy implications are significant. While a nation should always aim to minimise the environmental impact per unit of economic activity, the environmental impact of growth should not be of concern since, as real GDP rises over time, environmental quality eventually and increasingly improves. Hence the solution to environmental degradation is the continued growth of a nation’s real GDP, not its curtailment. Many studies have been undertaken to determine the level of truth underlying the EKC hypothesis (Shafik and Banyopadhyay, 1992; Seldon and Song, 1994; Grossman and Krueger, 1995; Cole et al., 1997; Panayotou, 1997; de Bruyn et al., 1998; Kaufmann et al., 1998; Suri and Chapman, 1998; Torras and Boyce, 1998; Unruth and Moomaw, 1998; Stern, 2002). Empirically, there appears to be no conclusive evidence either way (Arrow et al., 1995; Ekins, 1997; McConnell, 1997; Rothman and de 217

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Bruyn, 1998). The aim of this chapter is to determine whether, from a strictly theoretical perspective, the relationship between real GDP and environmental quality, as depicted by the EKC, can exist in the long run. Despite the value of empirical analyses, theoretical investigations can be useful for two reasons. First, empirical studies can bring forth misleading evidence of a particular relationship due to specification faults or the use of inaccurate or inappropriate data. Indeed, some observers believe this to be precisely the case with the EKC (e.g., Stern, 2002). Second, by adopting realistic assumptions, theoretical analyses can be used to explore impossibilities and, by corollary, potentialities. Theoretical models do not reveal the actual state of play, however, they can indicate what is possible and what the relationship between per capita GDP and environmental degradation is likely to be under certain circumstances.1 To achieve its aims, the chapter is structured as follows. First, a theoretical model developed by Munasinghe (1999) is extended and employed to determine the level of truth underlying the EKC hypothesis. As it turns out, the revised model indicates that the EKC resembles a third-degree polynomial – what I instead refer to as an Environment-Income Curve (EIC) – not the concave or inverted U-shaped relationship that is presumed to exist between environmental degradation and per capita real GDP. Second, various aspects relating to the EIC are discussed. These include: (a) Pareto optimal versus Pareto sub-optimal pathways; (b) safe ecological limits; and (c) the ‘pollution haven hypothesis’ as a possible explanation for the favourable circumstances empirically evident in wealthy countries. Third, issues in need of future research work are briefly outlined and discussed. Finally, some conclusions are drawn as to what is needed to achieve both improved environmental quality and continued human development.

A MODEL FOR ANALYSING THE BENEFITS AND COSTS OF ENVIRONMENTAL IMPROVEMENTS In an important and valuable paper, Munasinghe (1999) has developed a basic model to demonstrate how the standard EKC might emerge as per capita real GDP rises. While the same model is employed in this chapter, additional assumptions are included and some of the existing assumptions are varied to account for thermodynamic and biophysical realities. As will soon be revealed, it is by incorporating real world phenomena that the EIC – a third-degree polynomial – is shown to emerge rather than the inverted U-shaped EKC.

Does the Environmental Kuznets Curve exist?

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The EKC model outlined by Munasinghe (1999) is premised on two basic underlying assumptions: 1.

2.

The benefits and costs of achieving environmental improvements depend on per capita real GDP, technology and the prevailing state of the environment; The goal of economic agents is to obtain the combination of per capita real GDP and environmental quality that maximises net benefits.

The goal in assumption 2 can be written as: Max NB B(D,Y) C(D,Y)

(12.1)

where NB represents the net benefits to be maximised; B and C are the benefits and costs of environmental improvements and are functions of D and Y; D the level of environmental degradation; and Yper capita real GDP. At any given level of per capita real GDP (say, YY0), the corresponding level of environmental quality is determined by equating the marginal benefits and costs of environmental improvements (i.e., where the net benefits of environmental improvements are maximised). Hence the first order marginality condition derived from equation (12.1) is: MB MC 0

(12.2)

where MB B D and MC C D. In order to examine the impact of a change in per capita real GDP around an equilibrium point of (D, Y0), equation (12.2) can be written as:

¯

(MBY MCY ) dY (MBD MCD ) dD 0

(12.3)

where, for i Y, D, it follows that MBi B i and MCi C i. Alternatively, equation (12.3) can be written in the form: dD dY(MBY MCY )(MCD MBD )

(12.4)

dD bdY

(12.5)

b [dDdY] DD (MBY MCY )(MCD MBD )

(12.6)

or

where

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According to equation (12.6), if b 0, environmental degradation increases as per capita real GDP rises. If b0, a rise in per capita real GDP is accompanied by environmental improvements. For the purposes of this chapter, it is important to consider the circumstances under which the coefficient b is likely to be positive or negative. Consider the denominator in the right-hand side of equation (12.6). One can safely assume that, for any given Y and degree of technological progress, improvements in environmental quality will be increasingly costly to achieve (i.e., MCD 0). Hence the marginal cost curve for reducing environmental degradation is downward sloping. Next, it is not unreasonable to believe that, for any given Y and preference for environmental quality, each successive decrease in environmental degradation (D) will be valued less than the previous incremental reduction (i.e., MBD 0). For this reason, the willingness to pay for environmental improvements can be represented by an upward sloping marginal benefit curve. Given MCD 0 and MBD 0, the denominator of equation (12.6) must be negative (i.e., MCD MBD 0). Hence the sign of the coefficient b will be strictly opposite to the sign of the numerator (MBY MCY). The Marginal Cost or MC (Y) Curve Before it is possible to understand the likely changes to the numerator in equation (12.6), it is necessary to examine the nature of the marginal cost and marginal benefit curves and their probable shifts as per capita real GDP rises. Let’s begin with the marginal cost or MC(Y) curve where, for the purposes of this exercise, it is assumed that: (a) the economy is closed to international transactions, and (b) population numbers are constant. Figure 12.1 depicts the MC(Y) curve for a per capita real income of Y0. The intersection of the MC(Y0) curve with the horizontal axis at Dmax (Y0) represents the use of the dirtiest and least efficient production and resource extraction techniques from the range of available techniques. Figure 12.1 also includes two asymptotes, neither of which appear in Munasinghe’s (1999) paper. The asymptote on the left, Dmin(Y0), represents the highest level of environmental quality that can, under any circumstances, accompany the continuing production of Y0. This asymptote exists because of: (a) thermodynamic limits to resource use efficiency and resource extraction technology (Georgescu-Roegen, 1971; Daly, 1992; Peet, 1992; Lawn, 2003), and (b) biophysical limits to the exploitative efficiencies of natural capital (Ehrlich and Holdren, 1973; Capra, 1982; Perrings, 1986; Lawn, 2000). Why do thermodynamic and biophysical realities mean that a minimum level of environmental degradation must be associated with a given per capita real GDP? To begin with, and since real GDP is effectively a

Does the Environmental Kuznets Curve exist? Dmin (Y0)

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Dmin (Y0)

MC(Y)

MC(Y0)

Dmax (Y0)

Figure 12.1

Env. degn

The MC(Y) curve

physical index of production, the first and second laws of thermodynamics dictate that a minimum irreducible quantity of low entropy matter-energy is required to sustain a particular output level.2 In addition, the first and second laws of thermodynamics also apply to the quantity of energy required to make increasingly lower grade resources available for production. That is, the poorer is the average grade of remaining non-renewable resource deposits, the more energy is required to make available a given quantity and quality of non-renewable resources (Peet, 1992). Thus, as non-renewable resources dwindle and their quality declines, more not less high entropy energy (waste energy) will be generated. Finally, biophysical factors limit the ability of human beings to continually increase the regenerative and waste assimilative capacities of renewable natural capital over time. This is important because the constrained regenerative capacity of renewable natural capital limits the potential substitutability of renewable resources for declining non-renewable resources, while the constrained assimilative capacity limits the sustainable quantity of all wastes generated from the use of both renewable and non-renewable resources. Returning to Figure 12.1, the asymptote on the right, Dmin(Y0), represents the highest achievable level of environmental quality given the current state of technology. As will soon be illustrated, technological progress has the capacity to shift this asymptote and the MC(Y0) curve leftward but only as far as the Dmin(Y0) asymptote. A movement up and along the MC(Y0)

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Theoretical and policy issues Dmin Dmin Dmin Dmin (Y0 ) (Y1) (Y0 ) (Y1)

MC(Y)

MC(Y1)

MC(Y0 )

Dmax (Y0 )

Dmax (Y1) Env. degn

Figure 12.2 Shift of the MC(Y) curve – due to increase in Y from Y0 to Y1 (efficiency-increasing technological progress is fixed) curve results from the use of cleaner extraction/production techniques from the range of available techniques. This may occur following the introduction of depletion/pollution taxes or the internalisation of environmental spillover costs by other means (e.g., tradeable depletion and assurance bonds). Figures 12.2 and 12.3 illustrate single shifts of the MC(Y0) curve. In Figure 12.2, the rightward shift of the MC(Y0) curve to MC(Y1) is the result of an increase in per capita real GDP from Y0 to Y1. At this point, efficiency-increasing technological progress is assumed to be fixed.3 This does not, however, rule out advances in throughput-increasing technological progress that may be the principal cause for the rise in Y – for example, technology that makes available previously inaccessible resource deposits. Because an increase in per capita real GDP magnifies the ‘scale effect’ of economic activity, the two asymptotes and the Dmax intersection point shift rightward (i.e., Dmin(Y0) to Dmin(Y1); Dmin(Y0) to Dmin(Y1); and Dmax(Y0) to Dmax(Y1)). In Figure 12.3, the leftward rotation of the MC(Y0) curve to MC1(Y0) is the result of efficiency-increasing technological progress. Per capita real GDP is constant at Y0. In this case, the Dmin asymptote shifts leftward from Dmin(Y0) to Dmin1(Y0) and, in doing so, moves closer to the absolute

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Does the Environmental Kuznets Curve exist? Dmin Dmin1 Dmin (Y0 ) (Y0 ) (Y0 ) MC(Y)

MC(Y0 ) MC1(Y0 )

Dmax (Y0 ) Env. degn

Figure 12.3 Shift of the MC(Y) curve – due to efficiency-increasing technological progress (Y fixed at Y0) asymptote of Dmin(Y0). The MC(Y) curve rotates around the intersection point Dmax(Y0) because the availability of cleaner techniques does not eliminate the pre-existing dirtiest and least efficient techniques. Nor does it preclude economic agents from continuing with their use. Figures 12.4 and 12.5 illustrate successive shifts of the MC(Y) curve. The rightward shifts of the MC(Y) curve in Figure 12.4 are the result of equal increments in Y (i.e., Y0 Y1 Y2 Y3 Y4). With efficiency-increasing technological progress assumed to be fixed, it is reasonable to believe that the scale effect of economic activity will, with every incremental change in Y, increase at an escalating rate. For example, the environmental impact of a particular logging intensity is greater if the land area in question is already subject to considerable land clearance. For this reason, the magnitude of each successive shift of the MC(Y) curve is greater than the previous shift. In Figure 12.5, the continuing leftward rotation of the MC(Y0) curve around the intersection point Dmax(Y0) is the consequence of incremental changes in efficiency-increasing technology. Because each technological breakthrough moves a nation closer to the thermodynamic and biophysical limits of both resource use and resource extraction efficiency, the MC(Y0) curve moves closer to the Dmin(Y0) asymptote. Clearly, each technological breakthrough becomes more difficult to achieve and less effective

224

MC(Y)

Theoretical and policy issues MC(Y0) MC(Y1) MC(Y2) MC(Y3) MC(Y4)

Env. degn

Figure 12.4 Successive shifts of the MC(Y) curve – due to increases in Y (efficiency-increasing technological progress is fixed) Dmin (Y0) MC(Y) MC5(Y0) MC4(Y0) MC3(Y0)

MC2(Y0)

MC1(Y0)


Figure 12.5 Successive shifts of the MC(Y) curve – due to efficiencyincreasing technological progress

225

Does the Environmental Kuznets Curve exist? Immature phase

Adolescent phase

Mature phase

MC(Y) MC(Y7) MC(Y6) MC(Y5) MC(Y4) MC(Y3) MC(Y2) MC(Y1)

MC(Y0) Env. degn

Figure 12.6 Successive shifts of the MC(Y) curve – due to increases in both Y and efficiency-increasing technological progress in reducing the environmental degradation associated with the continuing production of Y0. As such, the magnitude of each leftward rotation of the MC(Y0) curve is smaller than the previous rotation. Figure 12.6 merges the conclusions drawn from Figures 12.4 and 12.5 to ascertain the probable shifts of the MC(Y) curve over the course of a nation’s development process. It is assumed that Y increases incrementally from Y0 to Y7 as a nation develops.4 The magnitude of the rightward shifts of the MC(Y) curve can be explained by the following. First, in the immature phase of the development process, per capita real GDP is small but increasing; so, therefore, is the scale effect of economic activity. Because the major emphasis is on growth, most technological progress is of the throughput increasing rather than efficiency increasing kind. The scale effect of an increasing Y not only exceeds the tempering effect of any small advances in efficiency-increasing progress, the difference between the two effects magnifies. As a consequence, the MC(Y) curve shifts rightward at an increasing rate (i.e., MCY 0; MCYY 0). During the adolescent phase of a nation’s development process, the scale effect of economic activity is much larger than in the immature phase and also increasing. However, with almost all resource frontiers now exploited, a much greater proportion of all technological breakthroughs are of the

226


efficiency increasing kind. The scale effect continues to exceed the tempering effect of increasing efficiency, however, the disparity between the two diminishes. For this reason, the MC(Y) curve shifts rightward at a decreasing rate (i.e., MCY 0; MCYY 0). Once a nation reaches the mature phase of its development process, the scale effect of economic activity is significantly large. Importantly, efficiencyincreasing technological progress approaches thermodynamic and biophysical limits and, as such, becomes less effective at reducing environmental degradation. Unlike the adolescent phase, there is now a growing disparity between the scale effect and the offsetting impact of increasing efficiency. The MC(Y) curve again shifts rightward at an increasing rate (i.e., MCY 0; MCYY 0). Furthermore, because of the extent of the scale effect at higher levels of Y, shifts of the MC(Y) curve are much larger than shifts experienced during the immature phase of the development process. The Marginal Benefit or MB(Y) Curve In contrast to the MC(Y) curve, the behaviour of the marginal benefit or MB(Y) curve is much simpler to predict. Figure 12.7 depicts the MB(Y) curve for a per capita real GDP of Y0. There are two endpoints of the MB(Y0) curve – one at the Dmin(Y0) asymptote; the other at the Dmax(Y0) level of environmental degradation. The first endpoint of the MB(Y0) curve exists because it is unlikely anyone will pay for a level of environmental quality that cannot be achieved (i.e., DDmin(Y0)). The second endpoint arises because people will not pay to prevent a level of environmental degradation that never eventuates (i.e., D Dmax(Y0)). A movement left and along the MB(Y0) curve transpires if, without any change in the preference for environmental quality, people are induced to pay for the use of cleaner extraction/production techniques from the range of available techniques. This may occur following the introduction of higher municipal waste charges or deposit schemes on bottles, cartons, and so on. Single shifts of the MB(Y0) curve are illustrated in Figures 12.8 and 12.9. The upward shift of the MB(Y0) curve to MB(Y1) in Figure 12.8 is the result of an increase in per capita real GDP from Y0 to Y1. It is assumed, at this point, that the preference for environmental quality at any particular level of income is fixed. Why, then, would the MB(Y0) curve shift up? At any given level of environmental quality, people’s willingness to pay for environmental improvements rises in line with increases in Y. That is, a higher per capita real GDP enables people to pay for environmental improvements without having to forego alternative benefits. Given the nature of the shifts in the Dmin asymptote and the Dmax level of environmental degradation, the two endpoints of the marginal benefit curve shift rightward as well as upward.

227

Does the Environmental Kuznets Curve exist? Dmin (Y0)

Dmin (Y0)

MB(Y)

MB(Y0)

Dmax (Y0 )

Figure 12.7

Env. degn

The MB(Y) curve Dmin Dmin Dmin Dmin (Y1) (Y1) (Y0 ) (Y1)

MB(Y)

MB(Y1)

MB(Y0)

Dmax (Y0 )

Dmax (Y1) Env. degn

Figure 12.8 Shift of the MB(Y) curve – due to increase in Y from Y0 to Y1 (preferences fixed)

228

MB(Y)

Theoretical and policy issues Dmin Dmin (Y0) (Y0)

MB1(Y0)

MB(Y0)


Figure 12.9 Shift of the MB(Y) curve – due to increased preference for environmental quality (Y fixed at Y0) In Figure 12.9, the upward shift of the MB(Y0) curve to MB1(Y0) is the result of an increased preference for environmental quality. A shift of this kind may occur following information revealing the profound welfare benefits of improved environmental quality (e.g., advertising campaigns run by environmental groups). Because there is no change in the positions of the Dmin asymptote and the Dmax level of environmental degradation, the endpoints of the marginal benefit curve merely shift up. The probable shifts of the MB(Y) curve over the course of a nation’s development process are illustrated in Figure 12.10. Once again, Y increases incrementally from Y0 to Y7 as a nation’s development process takes place. To explain the shifts in the MB(Y) curve, it is first assumed that the willingness of economic agents to pay for environmental improvements will continue to rise as per capita real GDP increases. Hence the ongoing rise in Y leads to successive upward shifts of the MB(Y) curve (i.e., MBY 0). Because growth is the major economic objective during the immature phase of the development process, the shifts in the MB(Y) curve are small. Nevertheless, each subsequent shift increases in magnitude in line with people’s augmented capacity to pay for environmental improvements and their growing appreciation of the benefits of environmental

229

Does the Environmental Kuznets Curve exist? Mature phase

Adolescent phase

Immature phase

MB(Y) MB(Y7)

MB(Y6) MB(Y5) MB(Y4)

MB(Y3) MB(Y2) MB(Y1)

MB(Y0)

Env. degn

Figure 12.10 Successive shifts of the MB(Y) curve – due to increases in both Y and preference for environmental quality quality (i.e., MBYY 0). This trend continues into the adolescent phase of the development process. At some point, people become increasingly less willing to pay for improvements in environmental quality despite their rising capacity to do so. This is because diminishing returns are likely to beset the increasing benefits of an ever-improving environment. When could we expect diminishing returns to set in? This is open to conjecture, however, it is likely occur in the latter part of the adolescent phase of a nation’s development process and continue on into the mature phase. As a consequence the magnitude of each successive shift of the MB(Y) curve will now decline (i.e., MBYY 0).

DERIVING THE ENVIRONMENT-INCOME CURVE (EIC) There is now sufficient information to derive the EIC and determine whether it corresponds with the mainstream EKC position. The information is summarised in Table 12.1. The left-hand column of Table 12.1 indicates the different phases of a nation’s development process. All three development phases described above are further dichotomised into an ‘early’ and ‘later’ stage. The key columns in Table 12.1 are the three on the right-hand side.

230

later (Y2 to Y3)

later (Y4 to Y5)

ii)

later (Y6 to Y7 →)

Mature phase i) early (Y5 to Y6)

ii)

Adolescent phase i) early (Y3 to Y4)

ii)

Immature phase i) early (Y0 to Y2)

Phase of the development process

•

•

•

•

•

•

•

•

•

•

•

•

•

•

•

•

•

•

positive small falling positive very small falling

positive large rising positive large constant

positive very small rising positive small rising

MBY

•

•

•

•

•

•

negative

negative

zero

positive

positive

positive

MBYY

•

•

•

•

•

•

•

•

•

•

•

•

•

•

•

•

•

•

positive small constant positive large rising

positive large constant positive small falling

positive small rising positive large rising

MCY

•

•

•

•

•

•

positive

zero

negative

zero

positive

positive

MCYY

•

•

•

•

•

•

( ) ( ) 0

( ) ( ) 0

( ) ( ) 0

( ) ( ) 0

( ) ( ) 0

( ) ( ) 0

MBY MCY

•

•

•

•

•

•

positive

zero

negative

zero

positive

positive

•

•

•

•

•

•

upward

approx. flat

downward

approx. flat

upward

upward

➤

➤

➤

➤

➤

➤

Coefficient b Slope of the EIC

Table 12.1 Shift of the MB(Y) and MC(Y) curves and the corresponding slope of the Environment-Income Curve (EIC) as Y rises


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They respectively indicate the sign of the numerator in equation (12.6), the sign of the coefficient b, and the nature of the slope of the EIC. A diagrammatical derivation of the EIC is presented in Figure 12.11. Throughout the immature phase of a nation’s development process (Y0 to Y3), the magnitude of the shifts in both the MB(Y) and MC(Y) curves increases (MBYY 0, and MCYY 0). Since the latter exceeds the former, the numerator in equation (12.6) is negative. This means that the coefficient b is positive and the EIC is upward sloping. Such a conclusion corresponds with the mainstream EKC position. In the early stage of the adolescent phase (Y3 to Y4), the magnitude of the shift in the MB(Y) curve continues to increase (MBYY 0). However, this is no longer the case with the MC(Y) curve – a consequence of a heightened emphasis on efficiency-increasing technological progress (MCYY 0). With MBY and MCY now of a similar value, the numerator in equation (12.6) is approximately zero. With the coefficient b also around zero, the EIC momentarily peaks. In the later stage of the adolescent phase (Y4 to Y5), technological progress is dominated by the efficiency-increasing variety. The magnitude of the shift in the MC(Y) curve begins to diminish (MCYY 0). At the same time, diminishing returns start to set in with respect to the value of an everimproving environment. Consequently, the magnitude of the shift in the MB(Y) curve is relatively constant (MBYY 0). Despite this, MBY now exceeds MCY and the numerator of equation (12.6) is positive. With the coefficient b negative, the EIC is downward sloping. Such a conclusion also corresponds with the mainstream EKC position. As a nation enters the mature phase of its development process (Y5 to Y7), efficiency-increasing technological progress approaches thermodynamic and biophysical limits. Early on in this phase, the magnitude of the shift in the MC(Y) curve is relatively constant (MCYY 0). However, it rapidly increases as a nation’s development process fully matures (MCYY 0). At the same time, diminishing returns with respect to the value of an ever-improving environment become firmly established. The magnitude of the shifts in the MB(Y) curve now decreases and does so indefinitely (MBYY 0). Altogether, MBY and MCY are of a similar value in the early part of the mature phase such that the coefficient b is approximately zero. Momentarily, the EIC bottoms out. From this point on, MCY exceeds MBY, the coefficient b is increasingly positive, and the EIC slopes upward indefinitely. Unlike most conclusions, this does not accord with the mainstream EKC position. It does, however, correlate with the positions taken by Pezzey (1989) and Opschoor (1990). Of course, the EIC is unlikely to appear as smooth as the curve depicted in Figure 12.11. Fluctuations in the business cycle during the earlier phases of

232

Theoretical and policy issues MC(Y7)

MB(Y) MC(Y)

MB(Y7)

MC(Y6)

MB(Y6)

MC(Y5)

MB(Y5)

MC(Y4) MB(Y4) MC(Y3) MB(Y3) MC(Y2) MB(Y2) MB(Y1)

MC(Y1) MC(Y0)

MB(Y0)

0

Environmental degradation Y0 Immature phase

Y1

Y2

Y3

Y4

Adolescent phase

Y5

Y6

Mature phase

Y7 Per capita Y

Figure 12.11

EIC

Deriving the Environment-Income Curve (EIC)


233

a nation’s economic development process are likely to result in a particular trend movement of the EIC being momentarily overturned or prolonged. In addition, exogenous factors will impact on the per capita output levels at which the EIC changes its course, while improved environmental management is likely to extend the period of time that the EIC slopes downwards and/or the per capita output level at which the EIC inevitably slopes upwards. Furthermore, changes in the shift magnitudes of the MB(Y) and MC(Y) curves over the course of a nation’s development process are unlikely to coincide as neatly as outlined in this section. For example, it is possible that the change in emphasis from throughput-increasing to efficiency-increasing technological progress could continue into the later stage of a nation’s adolescent phase or the thermodynamic limits to efficiency improvements might not emerge until well into the mature phase. As for the preference for environmental quality as per capita real GDP rises, one cannot predict exactly when this will alter over time. Indeed, for cultural reasons, the shift in preference for greater environmental quality could occur at either quite low or very high per capita income levels. Nevertheless, there is one thing for certain – both thermodynamic limits to efficiency-increasing technological progress and diminishing returns with respect to the value of an ever-improving environment are inevitable in the long run. As such, and despite the appearance of the EIC in the immature and adolescent phases of a nation’s development process, the coefficient b must become increasingly positive in the final mature phase.5 Therefore, the EIC must eventually slope upward indefinitely.

IMPLICATIONS OF THE ENVIRONMENT-INCOME CURVE (EIC) The Pareto Optimal EIC Versus the Sub-Optimal EIC As just explained, whether the relationship between a nation’s per capita real GDP and environmental degradation resembles the one represented by Figure 12.11 depends on many factors, many of which are beyond the control of government policy. This having been said, government policy can play an important role in facilitating the efficient allocation of natural resources. In particular, governments can intervene to ensure that the worst effects of market failure are ameliorated. Should this be accomplished, something approaching a Pareto optimal EIC is achievable. Figure 12.11 was derived on the premise that the prevailing combination of per capita real GDP and environmental quality always maximised a nation’s net benefits. Figure 12.11 therefore resembles a Pareto optimal

234


EIC. Unfortunately, governments rarely deal adequately with instances of market failure and, in some cases, accentuate them by subsidising excessive rates of resource use in the quest for higher levels of real GDP. As such, a nation’s EIC is likely to be of the sub-optimal kind. The notion of a Pareto optimal EIC is contrasted with a sub-optimal EIC in Figure 12.12 (EIC1 versus EIC2). The latter curve is drawn on the expectation that, firstly, the environmental degradation associated with each per capita level of real GDP is higher than the Pareto optimal case, and secondly, the disparity in environmental degradation is likely to grow as per capita real GDP rises. An important aspect concerning the Pareto optimal EIC depicted in Figure 12.12 is that allocative efficiency does not enable a nation to circumvent ecological limits. No matter how efficiently a nation allocates its annual resource flow, the scale effect of rising levels of real GDP eventually overwhelms any efficiency benefits. Consequently, the detrimental impact of continuing growth on the natural environment (i.e., depletion of natural capital) cannot be avoided. This has long been stressed by Daly with the use of his Plimsoll line analogy (Daly, 1992) and has been further highlighted elsewhere (e.g., Howarth and Norgaard, 1990; Norgaard, 1990; Bishop, 1993; Chapter 10). What is even clearer from Figure 12.12 is that it is erroneous to equate a Pareto optimal EIC with an optimal development pathway. Apart from sustainability concerns, it is highly probable that, as real GDP continues to rise, the net benefits being maximised in equation (12.1) will eventually decline.

Environmental degradation

EIC2

EIC1

Per capita GDP

Figure 12.12 Pareto optimal EIC (EIC1) versus sub-optimal EIC (EIC2)


235

How can this be? It has already been concluded that the marginal cost of a growing real GDP for a nation in the latter part of its mature development phase will be both large and increasing (i.e., MCYY 0). The marginal benefit, on the other hand, will be both small and decreasing (i.e., MBYY 0). Thus, as real GDP continues to grow, net benefits will fall. In a sense a nation will be making the best of a worsening set of circumstances (that is, maximising net benefits at each point in time but reducing future development potential). This is an important point because many observers presume that the achievement of Pareto optimality over time automatically implies everincreasing levels of economic welfare (increasing net benefits). But this need not be the case and, if the evidence provided by alternative national accounting indicators is anything to go by, it appears that the economic welfare of many industrialised countries has declined or stalled over the past 20 to 30 years despite real GDP continuing to grow (Daly and Cobb, 1989; Cobb and Cobb, 1994; Max-Neef, 1995; Chapter 6).6 What, then, would constitute an optimal development pathway? It would be a pathway characterised by a sustained period of growth throughout the immature and adolescent phases of a nation’s development process. During this time (Y0 to Y5 in Figure 12.11), economic welfare could be expected to increase as net benefits were maximised. While the rate of environmental degradation would rise during the immature phase (Y0 to Y3), it would not presumably be too excessive nor undermine critical forms of natural capital. As such, a nation’s development would continue to be ecologically sustainable. However, it would be expected that environmental degradation would decline during the adolescent phase (Y3 to Y5) – that is, a nation would now operate on the downward-sloping section of the EIC. As a nation entered the mature phase of its development process (Y

Y5), it would initiate a transition to a steady-state (non-growing) economy by introducing policy measures to slow the rate of growth in real GDP. In other words, it would endeavour to keep its remaining stocks of natural capital intact by avoiding a prolonged movement along the upward-sloping section of the EIC. This could be achieved by imposing quantitative restrictions on the rate of resource throughput (see Chapter 11). The policy measures would also include initiatives to promote value-adding in production and a more equitable distribution of income and wealth. As a nation entered the final phase of its development process – in other words, as it moved ever closer to the thermodynamic and biophysical limits of both resource use and resource extraction efficiency – the quantitative restriction on the rate of resource throughput would result in the economy slowing to the point where it effectively became a steady-state economy (i.e., approximately at Y6 in Figure 12.11). Development in the sense of increasing economic welfare or rising net benefits would still be possible via

236


qualitative improvements in production, increased distributional equity, and a greater sense of purpose (i.e., the shifting up of the uncancelled benefits curve in Figure 9.1). The key difference between adopting a steady-state policy as opposed to a growth policy is that, unlike the latter, the steady-state policy does not compromise future development potential. Thus, by maintaining real GDP at something approximating Y6 and focusing on qualitative improvement, a nation avoids surpassing its optimal macroeconomic scale – that is, a physical scale beyond which further growth leads to a decline in economic welfare even if resources continue to be allocated in a Pareto optimal manner. Clearly, the crucial stage in terms of a nation remaining on an optimal development pathway is the interface of the adolescent and mature development phases. At this point, a nation should impose quantitative throughput constraints to prevent the economy from exceeding its optimal scale and to thus avoid any continuing movement along the upward-sloping section of the EIC. That is, it should initiate a transition to a steady-state economy, preferably with the introduction, among other things, of an ecological tax reform package outlined in the previous chapter. Safe Ecological Limits In his 1999 paper on the EKC, Munasinghe refers to the concept of safe ecological limits and the possibility of devising Pareto-increasing policies to ensure the continued growth in per capita real GDP does not result in irreversible forms of environmental damage. Munasinghe describes this course of action as ‘tunnelling’ underneath the safe ecological limit by ensuring the downturn in the EKC occurs before the safe limit is reached (see Munasinghe, 1999, Figure 3). The problem with Munasinghe’s scenario is that it is only possible if the standard EKC relationship exists. Should the EIC exist, the level of environmental degradation must eventually exceed the prevailing safe ecological limit. The concept of safe ecological limits does, however, remain a crucial one even in an EIC environment. Consider the two EIC curves in Figure 12.13. The top curve (EIC2) is an example of a sub-optimal EIC, whereas the lower curve (EIC1) is an EIC of the Pareto optimal variety. Assuming that Y* is the level of per capita real GDP that corresponds to an optimal macroeconomic scale, it is quite evident that the growth in per capita real GDP between Y0 and Y1 will result in the safe ecological limit of SL being exceeded if resources are allocated inefficiently. On the other hand, should resources be efficiently allocated (EIC1), the level of environmental degradation always remains within the safe ecological limit. The real output level of Y* is therefore easily attained.

237



EIC2

EIC1

SL

Safe ecological limit

Y0

Figure 12.13

Y1

Y*

Per capita GDP

Safe ecological limits

Although, in the sub-optimal EIC case, the level of environmental degradation falls below the safe ecological limit for some levels of per capita income between Y1 and Y*, the situation is much graver if exceeding SL causes ecological breakdown and a subsequent decline in the safe ecological limit. Consider Figure 12.14. Once more, the Pareto optimal EIC (EIC1) remains within the safe ecological limit of SL and Y* is comfortably attained. As for the sub-optimal EIC (EIC2), a per capita income level of Y0 results in the safe ecological limit being exceeded. This causes the safe limit to fall from SL to SL1. Should per capita real GDP rise to Y1, the lower ecological limit is again exceeded. Furthermore, as per capita real GDP rises to Y2, Y3, and eventually to Y*, the safe ecological limit falls to SL2, SL3, and SL4. At no stage does the level of environmental degradation fall below the ever-declining safe ecological limit. Thus, while allocative efficiency cannot circumvent ecological limits, it clearly plays a crucial role in terms of: (a) how much economic welfare is experienced at a given level of per capita real GDP, and (b) whether the relatively high levels of per capita real GDP that characterise a nation in the mature phase of its development process, such as Y6 in Figure 12.11, can be ecologically sustained. Indeed, as Figure 12.14 demonstrates, inefficient growth is potentially unsustainable early on in a nation’s development process. This is certainly of concern given the tendency of many governments to ignore the amelioration of market failures in the belief that growth, regardless of what form it takes, is a more critical development concern.

238

Theoretical and policy issues EIC2

Environmental degradation EIC1

SL SL1 SL2 SL3 SL4

Y0

Y1

Y2

Y3

Y*

Per capita GDP

Figure 12.14 Safe ecological limits – decline if safe ecological limit (SL) is exceeded International Trade and the Pollution Haven Hypothesis One of the assumptions of the model used to derive the EIC was the closure of an economic system to international transactions. If we relax this assumption, it may be possible to benefit from the trade in both goods and environmental services which may permit larger per capita levels of real GDP to be enjoyed at lower levels of environmental degradation. Consider, for example, a nation that is: (a) well endowed with hard and softwood timbers, and (b) because of the nature of the ecosystems from which the two timber varieties are extracted, softwood harvesting has a greater impact on domestic biodiversity levels than the harvesting of hardwoods. Assume, initially, that the nation’s timber requirements are confined to its own domestic sources and the environmental degradation from having to meet its annual timber demands is equal to ‘X’. Theoretically, impact X can be significantly reduced if the nation in question specialises in hardwood timber harvesting and exchanges the surplus hardwood with softwoods from another country. Furthermore, just as some nations are better suited to growing cereal crops and others tropical fruits, so are nations likely to be better suited to assimilating certain kinds and quantities of waste. Hence the usual restriction that a nation’s natural capital places on its ability to assimilate the waste byproducts of economic activity can be partially overcome by exporting difficultto-assimilate wastes to a nation better able to absorb them. Some countries may even become waste assimilating ‘specialists’, although such countries


239

would need to set aside some of their waste assimilative capacity to absorb the imported wastes of other nations, thereby reducing the quantity of waste they could sustainably generate themselves. There are two further aspects of international trade worthy of note. First, while international trade may permit the enjoyment of larger per capita levels of real GDP at lower levels of environmental degradation, there are limits to such benefits. There are, after all, a limited number of countries a nation can trade with and, in the same way that a national economy is constrained by a nation’s natural capital stocks, so is the global economy ultimately constrained by the finitude of the global ecosystem. Hence, once all the potential benefits of international trade are exhausted, the relationship between per capita real GDP and environmental degradation must again correlate with the EIC and not the EKC. However, so long as benefits are to be had from international trade, it is possible for the EIC of a particular country to be lower than it would otherwise be if its economy was closed to international transactions. In such a situation, the difference between an EIC(trade) and an EIC(no trade) would look something similar to the difference between the Pareto optimal and sub-optimal EICs depicted in Figure 12.12. Irrespective of how efficiently resources are being allocated within the domestic economy, the value of international trade is particularly crucial when combined with the conclusions drawn earlier from Figure 12.14. The lower EIC brought about by international trade has the potential to constitute the difference between certain countries operating above or below their safe ecological limit at relatively high levels of per capita real GDP. Countries in this category include those with a large existing population (e.g., India and China) and those with a small resource base (e.g., Japan, The Netherlands and Singapore). The second important aspect of international trade is the contentious ‘pollution haven hypothesis’. The pollution haven hypothesis is based on the view that, since international trade is now governed by the principle of absolute advantage – a consequence of the free international mobility of capital (Daly and Cobb, 1989; Daly, 1996; Lawn, 2000) – many producers operating in countries with stringent social and environmental standards are unable to compete with foreign operators subject to much weaker standards. As a consequence, ‘dirty’ or low skill-related production in rich Northern counties is often relocated to more profitable, low cost countries in the poorer South. This, it is believed, has had two major implications. First, in the South, it has generated small income benefits to the urban working classes, it has benefited the rich most, it has failed rural communities dismally, and has led to excessive rates of resource depletion and industrial pollution. Second, in the rich North, the working classes have disproportionately

240


borne the cost of high unemployment rates that appear to have arisen since the globalisation phenomenon began in the early 1970s. To what extent is the pollution haven hypothesis credible? A number of studies have been undertaken to verify or repudiate the theory that capital moves to locations with weaker social and environmental standards. The majority of these studies support the position that differences in labour costs account for at least some industrial flight (Leonard, 1988; Hodge, 1995; Garrod, 1998; Ratnayake and Wydeveld, 1998). However, almost all the studies lead to the conclusion that environmental stringency has virtually no impact on the choice of production location (Dean, 1992; Pearce and Warford, 1993; Jaffe et al., 1995; Garrod, 1998). The reason for this, it seems, is that the cost of adjusting to environmental standards is small for all but a few highly pollutive industries and avoiding such costs through relocation is almost always absorbed by the cost of relocation itself (Leonard, 1988; Stevens, 1993). For some observers, however, the lack of conclusive statistical evidence means the verdict is still out on whether variations in environmental standards cause industrial flight (Hodge, 1995; Field, 1998; Ratnayake and Wydeveld, 1998). As I see it, the weakest aspect of the empirical studies so far undertaken is that they only concentrate on the relocation of existing firms and industries from the North to the South. They have not considered three other potential manifestations of industrial flight, namely: (a) how many new industries have emerged in the South where, if not for the disparities in standards between the North and South, most would have emerged in the North?; (b) to what extent is the low adjustment cost to strict environmental standards due to standards in the North falling short of what is required to meet sustainability requirements, in which case if standards were suitably tightened, the cost differential would be significant enough to induce the relocation of capital?; and (c) how much has the threat of offshore relocation served to prevent the introduction of more exacting environmental standards in the North, or worse still, has led to the watering down of existing standards? Until these questions have been suitably answered, the apparent lack of any mass relocation of existing industries from North to South cannot be used to disclaim the pollution haven hypothesis. Assuming the pollution haven hypothesis is credible, it is highly possible that the rich Northern countries could be benefiting from international trade at the expense of their Southern trading partners (Arrow et al., 1995; Stern et al., 1996; Suri and Chapman, 1998). Figure 12.15 illustrates what could result if the pattern of international trade and the location of dirty and lowwage production activities are in line with the pollution haven hypothesis. Panel 12.15a reveals the EIC of the global economy (EICG). In Panel 12.15b, the EIC of a typical rich nation is lowered by engaging in

241

Does the Environmental Kuznets Curve exist? Panel 12.15a World economy

Environmental degradation EICG

Global safe ecological limit

Per capita GDP Panel 12.15b Rich nations (aggregate)


EICR1

EICR2 SLRich

Per capita GDP Panel 12.15c Poor nations (aggregate) EICP2


EICP1

SLPoor

Per capita GDP

Figure 12.15

North versus South (international trade)

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international trade in a globalised world economy (EICR2 versus EICR1). Furthermore, international trade enables rich countries to remain below their safe ecological limit. On the other hand, in Panel 12.15c, the disproportionate amount of dirty and low-wage production in poor countries results in a much higher EIC (EICP2 versus EICP1). Worse still, the EIC of the poorer countries now exceeds the safe ecological limit at much lower levels of per capita GDP. The EICs also exhibit a shorter period of declining environmental degradation. Should the divide between the North and the South resemble Figure 12.15, there would be every reason to be concerned about the ecological impact of globalisation given the widespread belief that the relationship between environmental degradation and per capita real GDP in rich countries will eventually be mimicked by the poorer Southern countries. In fact, should environmental deterioration in the South exceed the environmental gains in the North, the EIC of the global economy would be less desirable in appearance than that depicted in Panel 12.15a. It is therefore instructive to note that the few instances where the Index of Sustainable Economic Welfare (ISEW) and Genuine Progress Indicator (GPI) have been calculated for developing countries – namely, Chile and Thailand (Castaneda, 1999; Clarke and Islam, 2005) – the index appears to be stalling at per capita income levels much lower than that experienced by industrialised countries. Furthermore, the predominant cause appears to be the growing cost of environmental degradation. What is the solution to the pollution haven hypothesis? It is certainly not the abandonment of international trade. What is required is the abandonment of globalisation in favour of internationalisation – the latter being a form of economic entanglement where national economies exist as separate and autonomous entities tied together in recognition of the importance of international trade, treaties and alliances (Daly, 1999b). Also requiring restoration is the governing of international trade by the principle of comparative advantage. Internationalisation and the return of comparative advantage are not dealt with in this chapter but are thoroughly addressed in Part V of the book.

FUTURE EMPIRICAL RESEARCH Even if it is broadly accepted that the EIC relationship exists, what are we to make of any strong empirical evidence indicating that growing levels of per capita real GDP are leading to: (a) improved environmental outcomes in rich nations, and (b) growing environmental degradation in poor nations? Are we to simply conclude that rich nations are on the downward-sloping


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section of their EIC, while poor nations are on the initial upward-sloping section of theirs? And can we conclude that, so long as this pattern continues, growth in per capita real GDP in both rich and poor countries is of no environmental concern? No, we cannot, for it is impossible to know the genuine level of per capita real GDP at which environmental quality ceases to improve without an empirical estimation of the factors affecting the relationship between per capita real GDP and environmental degradation both within a particular nation and between nations. Hence future empirical research must focus at least as much on the underlying factors affecting the income-environment relationship as it should on its trend movement. Given the potential for a globalised world economy to distort the respective income-environment relationships in the rich North and the poor South, international trade would appear to be a factor most in need of investigation. In particular, the pollution haven hypothesis requires a more thorough empirical examination whereby all the potential manifestations of industrial flight listed above demand full consideration. Also of value would be an empirical examination of the incomeenvironment relationship at the global level. By this I mean a statistical analysis to determine the relationship between global per capita income and global environmental quality. Sustainability is, after all, a global phenomenon and an analysis at the global level would provide clearer evidence as to the aggregate impact of a globalised world economy on the global environment.

CONCLUDING REMARKS The theoretical model outlined in this chapter has shown that an inverted U-shaped relationship between environmental degradation and per capita real GDP, as supposedly depicted by the standard Environmental Kuznets Curve, cannot exist. What is likely to exist is a third-degree polynomial revealing that continuing growth in real GDP must eventually lead to worsening environmental quality. This will be the case even if a nation’s government is able to implement policies to maximise the efficiency of resource use and make the best of whatever gains can be had from international trade – a consequence of the scale effect of rising levels of real GDP eventually overwhelming the diminishing efficiency benefits. It seems clear, therefore, that yet another pro-growth argument is fatally flawed. What’s more, the consequences of this refutation are obvious. While an optimal development pathway is likely to involve a sustained period of growth throughout the immature and adolescent phases of a nation’s development process, a transition to a steady-state economy is inevitably

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required. In addition, the macroeconomic models used by economists to predict various outcomes and offer advice on macroeconomic policy settings must, at the very least, incorporate the limits imposed by the natural environment. There is little doubt that the failure to do this in the past has led to a continuous array of false conclusions, such as those now circulating with respect to the EKC hypothesis. With this last thought in mind, the next chapter provides a possible means by which mainstream macroeconomic models can be revised to satisfy the alternative views raised by ecological economists. As we shall see, the potential implications of stimulatory fiscal and/or monetary policies on both Hicksian income and sustainable economic welfare are quite marked. These implications cannot be ignored, even by ecological economists, because they dramatically reduce the capacity of policy makers to simultaneously achieve the objectives of ecological sustainability and full employment – a topic that is taken up in greater detail in Chapter 14.

NOTES 1. A good example of the value of theoretical investigations can be found in relation to the purported substitutabilities between human-made capital and natural capital. Early empirical studies suggested a high degree of substitutability of human-made capital for declining natural capital – that is, an elasticity of substitution greater than one (Nordhaus and Tobin, 1972; Griffin and Gregory, 1976; Halverson and Ford, 1978; Stiglitz, 1979). However, theoretical investigations of the production functions used in these studies revealed that they violated the first and second laws of thermodynamics (Georgescu-Roegen, 1979; Daly, 1996; Lawn, 2003). This, in turn, enabled values for the elasticity of substitution to be obtained that, in reality, could not exist (Lawn, 2003). Thus, conclusions drawn from empirical studies that increasing resource scarcity was not a cause for concern were totally unsupported. 2. Despite real GDP being measured in monetary units, it is effectively a physical index of production because the price level is kept constant over time. 3. Technological progress can be either of the efficiency increasing or throughput increasing variety. The former involves technological progress that, for example, reduces the resource input (R) required to produce a given level of real output (Q) – at least up to the thermodynamic limit of E Q/R 1. Throughput increasing technological progress might include the development of a novel resource exploration method that leads to the discovery of a new oil deposit; a new resource extraction technique that allows a previously inaccessible mineral deposit to be exploited; or the development of a new use for a previously unwanted resource. Because the application of throughput-increasing technological progress facilitates increases in the quantity of resources used in production, it results in a higher level of output being produced. Of course, whether the larger output level can be sustained in the long run depends on whether the higher rate of throughput remains within the regenerative and waste assimilative capacities of the ecosphere. 4. It will later be shown that the increase in Y during the mature phase could be undesirable. 5. The existence of thermodynamic limits to efficiency-increasing technological progress is all that is required to ensure the coefficient b becomes increasingly positive. There is no escaping this inevitability. 6. The alternative indicators I’m referring to here are the Genuine Progress Indicator (GPI) and the Index of Sustainable Economic Welfare (ISEW).

13.

IS-LM-EE: incorporating an environmental equilibrium curve into the IS-LM model

INTRODUCTION It is more than a decade since Daly (1991b) urged the incorporation of environmental concerns into the macroeconomic models used to conduct policy analysis. Until recently, Daly’s plea was ignored. Of course, it would be erroneous of me to overlook the many attempts to integrate environmental factors into macro policy issues. The expanding literature on green national accounting and ecological tax reform is ample evidence of the extent to which environment-economy relations have made their way into policy analysis. Furthermore, considerable work has been undertaken to answer the following questions put forward by Daly at the time he was urging the development of an environmental macroeconomics: (a) How big can a macroeconomy grow before the throughput of matter-energy required to sustain the macroeconomy exceeds the regenerative and waste assimilative capacities of the natural environment?; and (b) How big can a macroeconomy grow before the additional benefits of growth are exceeded by the additional costs – that is, before the economic welfare generated by a growing macroeconomy begins to decline? As far as Daly is concerned, the failure of macroeconomists to deal with the second question is at odds with microeconomic theory. Microeconomics is based largely on the concept of optimal scale. Whether it is the output of a firm or the number of hours an individual spends at work, the customary microeconomic rule is to increase the scale of an activity while the marginal benefits continue to exceed the marginal costs. However, once marginal benefits and costs equate, the expansion in scale should cease since, in effect, the optimal scale has been reached. Yet, strangely, at a time when the micro foundations of macroeconomics are gaining prominence, macroeconomics totally overlooks the concept of optimal scale. The questions posed by Daly have not been altogether ignored. In response to the first question, ecological footprint measures have been calculated at the national level to ascertain the physical scale of a nation’s 245

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economic activity. As explained in Chapter 6, these have been compared with the available biocapacity of a nation to determine whether macroeconomic systems have exceeded their maximum sustainable scale. The second of Daly’s questions has been addressed by ecological economists who have sought to identify, measure and compare the benefits and costs of economic activity at the national level. Exercises of this nature have resulted in the calculation of the Index of Sustainable Economic Welfare (ISEW) and the Genuine Progress Indicator (GPI). Despite the value of ecological footprint studies and measures of sustainable economic welfare, neither involve the explicit incorporation of environmental concerns into standard macroeconomic models. Clearly, they do not constitute a satisfactory response to Daly’s plea for an environmental macroeconomics. This has all changed thanks to a recent proposal by Heyes (2000) to include an ‘environmental equilibrium’ or EE curve into the standard IS-LM framework. The new curve, which aims to incorporate an environmental constraint into the IS-LM model, has considerable implications for fiscal and monetary policy. Indeed, as I will soon show, the implications go much further than Heyes has indicated in his paper. To consider the deeper implications of Heyes’ proposal, this chapter is structured as follows. First, the IS-LM-EE model is briefly outlined as is the rationale for the EE curve and the factors affecting its slope and position. Being an environmental constraint, the EE curve is only of value if appropriate institutional arrangements are in place to ensure the macroeconomy adjusts back to the curve should there be forces pushing the macroeconomy beyond it. It is therefore explained in the second section of the chapter how the system of tradeable resource use permits and assurance bonds outlined in Chapter 11 can assist in this regard. The third section includes a demonstration of the difference between the effect of expansionary fiscal and monetary policies on real output in circumstances where, firstly, the separate policy instruments have been instituted (the Lawn position), and secondly, where they have not (the Heyes position).1 In the final section, the IS-LM-EE framework is extended to show how considerations of the maximum sustainable scale and the optimal scale of macroeconomic systems determine the desirability or otherwise of an expansionary monetary policy under the Heyes and Lawn positions.

THE IS-LM-EE MODEL The IS-LM-EE framework used in this chapter is an extension of an IS-LM model first expounded by Blanchard (1981). It is the same IS-LM model employed by Heyes (2000). Although this flexible-price model is not the

An environmental equilibrium curve into IS-LM

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most sophisticated in existence, it has been chosen for the same two reasons given by Heyes. First, it is the mainstay of modern macroeconomics (Blanchard and Fischer, 1989). Second, it deals with the major deficiencies of the fixed-priced IS-LM model.2 The IS-LM-EE framework includes the following notation: ● ● ● ● ● ● ● ● ● ● ● ● ● ●

● ● ●

Y real output (real GDP) A aggregate spending on all goods long-term real interest rate short-term real interest rate i short-term nominal interest rate *expected inflation rate G autonomous government expenditure Ldemand for nominal money balances Msupply of nominal money balances Pprice level ttime R total throughput of matter-energy (input of low entropy resources and output of high entropy wastes) Etechnical efficiency of production (0E1) institutional parameter capturing the extent to which spillover depletion and pollution costs are borne by the resource user and polluter (0 1) technological parameter capturing the state of resource-saving and pollution-reducing technological progress (01) r regeneration rate of natural capital N physical stock of natural capital.

The IS Curve It is assumed that household expenditure on consumer goods and investment spending on producer goods are influenced by the long-term real interest rate . It will also be assumed that real output adjustments to changes in aggregate spending are sluggish. By denoting the aggregate spending on all goods as A(, Y, G), adjustments in real output can be written as: dY [A(, Y, G) Y] dt

(13.1)

dY (, Y, G) dt

(13.2)

or

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where 0, Y 0 and G 0. Because equilibrium in the goods market requires A Y, equation (13.2) defines the IS curve in (, Y) space when dY/dt0. The slope of the IS curve is Y , which is negative. An increase in G, which implies an expansionary fiscal policy, activates a rightward shift of the IS curve. The LM Curve To derive the LM curve, it is assumed that agents have rational expectations and are risk-neutral. It is also assumed that asset holders equalise the rates of return on short-term nominal bonds and real consols such that: ddt

(13.3)

ddt i *

(13.4)

Since i – * then:

Money market equilibrium requires the demand for money to equal the supply of real money balances. This is where: MP L(i, Y)

(13.5)

By rearranging equation (13.4) and substituting for i in equation (13.5), one obtains the following equilibrium equation for the money market:

M L ddt *, Y P

(13.6)

Equation (13.6) defines the LM curve in (,Y) space when ddt 0. The slope of the LM curve is positive. An expansionary monetary policy, which involves an increase in the nominal money supply M, leads to a rightward shift of the LM curve. Macroeconomic equilibrium occurs where the IS and LM curves intersect, that is, at an (,Y) combination where both the goods and money markets are in equilibrium. The EE Curve To explain the rationale for the EE curve, imagine a fixed state of technological progress. Imagine, also, that the throughput of matter-energy required to produce the equilibrium output level exceeds the regenerative


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and waste assimilative capacities of the natural environment. This would render the output level unsustainable in the sense that natural capital stocks would diminish and therefore be incapable of providing the required rate of throughput in the long run. As we know, technology is not fixed and improvements in the range of all production techniques enable a given level of output to be sustained by a lessened rate of throughput.3 However, given the existence of thermodynamic limits to increases in the technical efficiency of production and the complementary relationship between natural and human-made capital, sustainability requires, at the very least, that both forms of capital be maintained. The need for natural capital intactness implies that a macroenvironmental constraint should be incorporated into the standard IS-LM framework. It is the EE curve that constitutes the necessary constraint. In doing so, the EE curve serves as the ecological Plimsoll line referred to in Chapter 10. To construct the EE curve, let E be the technical efficiency of resource use in production, where (Ayres, 1978): E

available energy embodied in real output produced (Y) (13.7) available energy embodied in resource throughput (R)

Because of the complementarity of natural and human-made capital, E is always less than one (see Chapter 3). At equilibrium, E is determined by the aggregate choice of production techniques. The more resource intensive and/or highly pollutive are the techniques used by producers, the lower is E. It will be assumed that E is a function of , , and ; that is, EE(,,). While the impact of and on the technical efficiency of production is fairly obvious, the impact of the real interest rate () is not. In short, the marginal cost of employing a given production technique increases as the real interest rate rises. Conversely, the real interest rate does not affect the marginal benefit of employing a particular production technique in terms of resource input costs and/or pollution charges. Thus, as the real interest rate rises, the marginal benefit and marginal cost of production equate at a much dirtier and inefficient set of production techniques. In the light of this, it follows that low values of and high values of induce the adoption of cleaner production techniques from the range of available techniques. In addition, an increase in avails producers with more advanced resource-saving and pollution-reducing techniques. Increases in also make it easier and therefore less costly to produce at a given technical efficiency level. Hence E 0, E 0 and E 0. Unlike Heyes, I do not believe that the freedom to choose among the range of available techniques amounts to an assumption that natural and

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human-made capital are substitutes. Yes, producers can opt for dirty techniques; however, because the total rate of throughput must not exceed the long-term carrying capacity of the natural environment, dirtier techniques mean a reduction in the maximum permissible output level. If natural and human-made capital were substitutes then, presumably, the permissible output level could remain unchanged because a higher rate of throughput and a subsequent diminution of natural capital could simply be offset by a larger stock of human-made capital. Yet, since Heyes’ construction of the EE curve is based on the need to keep natural capital intact, his model forbids what the substitutability condition supposedly permits. By rearranging equation (13.7), the total throughput of matter-energy used in the economic process can be denoted by R YE , where RY 0 and RE 0. As such, the total throughput of matter-energy used in production can be written as: R

Y E(, , )

(13.8)

Let Nt denote the physical stock of natural capital at time t. Assume, also, that natural capital regenerates at a rate equal to r Nt. It follows, therefore, that the net rate of natural capital enhancement/depletion is:

dN R r · N dt

Y ∴ dN r · N dt E(, , )

(13.9)

(13.10)

Since environmental equilibrium requires natural capital intactness, equation (13.10) defines the EE curve in (,Y) space when dN/dt 0. Differentiation of equation (13.10) implies that the EE curve has the following slope: d | EE·Y dY| dNdt0

(13.11)

Because the numerator of (13.11) is positive and E 0, the slope of the EE curve is negative. However, the magnitude of the slope will change over the length of its locus. Indeed, it will be steep whenever the technical efficiency of production is insensitive to changes in . As Figure 13.1 demonstrates, this will increasingly be the case as the maximum permissible

251


output level is approached (Ymax). The reason for this is straightforward. As real output approaches Ymax, the marginal cost of pollution abatement becomes progressively higher. So, therefore, does the marginal cost of employing cleaner production techniques. Consequently, an increasingly larger decline in the real rate of interest is necessary to render a switch to a cleaner production technique profitable. Once Ymax is reached, and the cleanest available technique is employed, further resource savings and reductions in pollution are no longer possible through a switch in production technique alone. It is at this point that the EE curve is effectively vertical (i.e., E → 0 and the slope → ). Figure 13.1 also shows how the EE curve is incorporated into the standard IS-LM diagram. With all three curves intersecting at the same point, Figure 13.1 depicts an environmental-macroeconomic equilibrium whereby the interest rate/output combination of (0, Y0) leads to environmental equilibrium as well as equilibrium in both the goods and money markets. Like Heyes, Figure 13.1 is presented so that the intersection point is where the EE curve is steeper than the IS curve. This need not be the case, but will be assumed in order to simplify later comparisons with Heyes’ paper. To explain the position of an EE curve and the factors that cause it to shift, consider Figure 13.2. The first curve is EE0 where 1 and 1. In EE (dN/dt = 0) LM (d /dt = 0)

0

IS (dY/dt = 0)

Y0

Figure 13.1

Ymax

Environmental-macroeconomic equilibrium

real Y

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EE2 ( = 1, = 1) EE1 ( = 1, < 1) EE0 ( < 1, < 1)

Ym

Figure 13.2

Ymax

YS

real Y

Position and shift of the EE curve

this instance, not all spillover costs are borne by resource users and polluters. Furthermore, should the cleanest available production technique be employed, the technical efficiency of production is less than the thermodynamic limit of E→1. EE0 is near vertical at Ym to denote the maximum permissible output level. Now consider EE1 where 1 and is the same as for EE0. The only difference between EE0 and EE1 is that spillover depletion and pollution costs are now entirely borne by resource users and polluters. The increase in causes the EE curve to shift rightward. It also leads to an increase in the maximum permissible output level from Ym to Ymax. The reason for this is obvious. As increases to a value of one, and the environmental spillover costs of economic activity are fully internalised, the cost of dirty forms of production increases relative to cleaner alternatives. This results in resources being allocated towards cleaner production techniques and, thus, to an increase in the sustainable output level. Once 1, a rightward shift of the EE curve can only be secured via increases in . Consider, in Figure 13.2, the shift of the EE curve from EE1 to EE2, where 1 and 1. In this particular instance, the maximum permissible output level increases from Ymax to YS. YS differs from Ymax in that it is no longer institutionally or technologically possible to increase


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output without exceeding the natural environment’s long-term carrying capacity. Hence, the EE curve can no longer shift rightward of EE2. Furthermore, YS stands as the maximum sustainable output level. How does my EE curve differ from that of Heyes? They are in many ways the same except the EE curve I am proposing includes the technological parameter . The reason for incorporating this shift parameter will become obvious later in the chapter. Like Heyes, I will ignore the fact that both r and N can serve as additional shift parameters. Increases in both variables lead to a rightward shift in the EE curve. I have decided to overlook this because, firstly, there is insufficient space to incorporate it into the analysis. Second, while increases in r and N can augment the maximum sustainable rate of throughput, any such increases can only be achieved very slowly (Norgaard, 1984). Interestingly, as Heyes pointed out, the EE curve can shift leftward if the total throughput used to produce a given level of output exceeds the carrying capacity of the natural environment. This is because an excessive output level degrades the natural environment and diminishes its future capacity to provide low entropy resources and absorb high entropy wastes. Again, for simplification and lack of space, environmental feedback effects of this sort will be ignored.

ENSURING THE MACROECONOMY ADJUSTS TOWARDS THE EE CURVE As I pointed out in the introduction, incorporating an environmental constraint into the IS-LM model is of little value if the macroeconomy is unable to adjust back to an interest rate/output combination existing on the EE curve. Natural forces already exist to ensure the macroeconomy adjusts towards the IS and LM curves. In my opinion, there are no natural forces to ensure a macroeconomic adjustment towards the EE curve. To explain why, assume that the macroeconomy is operating at an interest rate/output combination to the right of the EE curve (where R r N). For the macroeconomy to move back onto the EE curve, resource markets must reduce the throughput of matter-energy to a rate equal to the regenerative and waste assimilative capacities of the natural environment. Unfortunately, for reasons given in Chapters 5 and 10, markets are unlikely to accomplish this, even if all spillover costs have been fully internalised. Since ecological sustainability is a throughput problem, not an allocation problem, getting the macroeconomy to operate on an EE curve requires the same two policy instruments that are needed to implement an appropriate ecological tax reform (ETR) package – namely, one to restrict the incoming

254


resource flow to an ecologically sustainable rate; another to ensure the incoming resource flow is efficiently allocated. For this reason, operating on an EE curve demands the introduction of assurance bonds and a system of tradeable resource use permits. This policy approach will henceforth be referred to as the Lawn position. Another way of getting the macroeconomy to operate on the EE curve is to shift the IS and/or LM curves so that the intersection of both curves lies on an EE curve. This can be done with the use of fiscal and monetary policy settings. Since this was the approach adopted by Heyes (2000), it will henceforth be referred to as the Heyes position. There is, however, a major problem with this approach. The policy setter must know what variations in policy settings are required to shift the IS and/or LM curves sufficiently to move the macroeconomy back to the EE curve. In addition, the policy setter must be fully cognisant of the impact on the position of the IS and LM curves of any changes in exogenous variables. This, however, is a near impossible task. The same problem does not arise with a resource use permit system because, first and foremost, the permissible incoming resource flow is restricted to the maximum sustainable rate. This ensures the macroeconomy adjusts back to the EE curve. Furthermore, with the premium paid for permits facilitating the more efficient allocation of the incoming resource flow, a resource use permit system can also induce beneficial shifts of the EE curve. This does not occur when fiscal and monetary policy settings are used to move the macroeconomy back onto the EE curve.

FISCAL AND MONETARY POLICY WITHIN THE IS-LM-EE FRAMEWORK Fiscal and monetary policy settings can be used to achieve any one of a number of macroeconomic objectives. In this section of the chapter, consideration is given to the likely impact of expansionary fiscal and monetary policies on the equilibrium output level. To demonstrate the full effect of both policies, the following is assumed: ●

● ●

the policy setter is omniscient with respect to what is required to ensure the intersection of the IS and LM curves lies on an EE curve; all spillover costs are borne by the resource user and polluter ( 1); prior to any expansionary fiscal or monetary policy, the technological parameter capturing the state of resource-saving and pollutionreducing technological progress is less than one (1). This allows

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●

for technological progress following an expansionary fiscal or monetary policy and, thus, a rightward shift of the EE curve; if the rate of throughput exceeds the regenerative and waste assimilative capacities of the natural environment, resource prices will only rise to fully reflect ecological limits, not just spillover costs, if the incoming resource flow has been explicitly restricted to the maximum sustainable rate (i.e., if a resource use permit system has been introduced).4

An Expansionary Fiscal Policy Figures 13.3 and 13.4 illustrate the impact of an expansionary fiscal policy on the equilibrium output for a different set of underlying conditions. Figure 13.3 is the impact under the Heyes position, where macro policy settings are used to ensure the intersection of the IS and LM curves lies on the EE curve. Figure 13.4, on the other hand, is the impact under the Lawn position, where assurance bonds and a resource use permit scheme have been instituted. In Figure 13.3, the macroeconomy is initially at the equilibrium point a where the equilibrium interest rate/output combination is (0,Y0 ) . Due

LM1 LM0 EE

1

c b a

0

IS1 IS0

Y1

Y0

1

Y0

Ymax

YS

real Y

Figure 13.3 Expansionary fiscal policy (no tradeable resource use permits)

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to an increase in G, the IS curve shifts rightward to IS1. A new macroeconomic equilibrium is established at point b where, if no environmental constraint is imposed, the equilibrium output level increases to Y01. However, the new macroeconomic equilibrium is inconsistent with environmental equilibrium (R r N). To keep natural capital intact, the fiscal expansion must be accompanied by a monetary contraction – that is, a leftward shift of the LM curve to LM1. This moves the macroeconomy to a new environmental-macroeconomic equilibrium at point c. The interest rate/output combination at the new equilibrium position is (1,Y1 ) . Overall, the real interest rate has increased while real output has fallen. Figure 13.4 is the same as Figure 13.3 from point a to point b. However, on this occasion, the excess demand for low entropy matter-energy leads to a rise in resource prices as resource buyers bid up the price of the limited number of resource use permits. This increases the resource input cost of the production process. Exactly how much of this transfers into higher goods prices depends on the extent of any resource-saving technological progress induced by the higher resource costs. If there is no subsequent technological progress (i.e., remains unchanged), two things will happen.

LM2

LM1 EE2

EE3

LM0

EE0 EE1 LM3 c1

c2 b c3

a

0

IS1 IS0

Y1

Y2 Y0

Y 01

Y3

YS real Y

Figure 13.4 Expansionary fiscal policy (tradeable resource use permit system imposed)


257

First, the EE curve will maintain its present position at EE0. Second, higher resource input costs will flow on into higher goods prices such that the LM curve will shift leftward to LM1. The LM curve shifts because higher goods prices reduce the supply of real money balances (i.e., M/P falls). With a new environmental-macroeconomic equilibrium at point c1, real output falls to Y1 as it did in Figure 13.3. What, however, if the higher resource costs lead to the development of resource-saving technological progress? The EE curve will shift rightward. The shifts from EE0 to EE1, EE2, and EE3 represent different degrees of technological progress, whereby the shift to EE3 represents the highest rate of progress. The movement of the LM curve also depends on the extent of any technological progress. Consider the shift of the EE curve to EE1 and the accompanying shift of the LM curve to LM2. In this particular instance, there has been a small increase in resource-saving progress. While, to some extent, this nullifies the impact of higher resource input costs, it is insufficient to prevent goods prices from rising. Nevertheless, the rise in goods prices is less than the case of no technological progress. Consequently, the LM curve does not shift as far leftward, however, it shifts sufficiently enough to restore environmentalmacroeconomic equilibrium, this time at point c2. Overall, real output falls slightly to Y2. The shift of the EE curve to EE2 is the result of a much larger increase in technological progress. On this occasion, there is no rise in goods prices and, therefore, no shift of the LM curve. The new environmental-macroeconomic equilibrium moves to point b and, overall, real output increases to Y01 – the same output level when no environmental constraint is imposed. Where the EE curve shifts to EE3, the extent of the resource-saving technological progress is sufficient to cause goods prices to fall. This leads to a rightward shift of the LM curve to LM3, a new environmental-macroeconomic equilibrium at point c3, and an increase in real output to Y3. Note the benefit of having in place a resource use permit scheme to restrict the incoming resource flow to the maximum sustainable rate. The LM curve automatically shifts to ensure the IS and LM curves intersect at a point lying on the newly positioned EE curve. In addition, the induced technological progress leads to a beneficial shift of the EE curve and the potential to sustain a higher output level. An Expansionary Monetary Policy Figures 13.5 and 13.6 illustrate the comparative impact of an expansionary monetary policy. Figure 13.5 is the impact under the Heyes position, while Figure 13.6 is the impact under the Lawn position. In Figure 13.5,

258


LM0 EE LM1

0

a b c

1

IS0 IS1

Y0

Y1

Y 01

Ymax

YS

real Y

Figure 13.5 Expansionary monetary policy (no tradeable resource use permits) the macroeconomy is initially at the equilibrium point a where the equilibrium interest rate/output combination is (0,Y0 ) . Because of an increase in M, the LM curve shifts rightward to LM1. A new macroeconomic equilibrium is established at point b where, if no environmental constraint is imposed, the equilibrium output level increases to Y01. Again, the new macroeconomic equilibrium is inconsistent with an environmental equilibrium. To keep natural capital intact, the monetary expansion must be accompanied by a fiscal contraction – that is, a leftward shift of the IS curve to IS1. This moves the macroeconomy to point c. The interest rate/output combination at the new environmentalmacroeconomic equilibrium is (1,Y1 ) . Overall, the real interest rate has declined while real output has increased, although the extent of the increase in output is less than a situation where no environmental constraint has been imposed (i.e., Y1 Y01). Figure 13.6 is again the same as Figure 13.5 from point a to point b. Once more, the excess demand for low entropy matter-energy leads to a rise in resource prices and an increase in the resource input cost of the production process. If the increase in resource input costs fails to induce any technological progress, the EE curve maintains its present position at EE0. In

259


LM0 LM2 EE0

EE1 EE2 EE3 LM1 LM3

0

a c1

b c2 IS

Y0

Y1

Y 01

Y2

YS real Y

Figure 13.6 Expansionary monetary policy (with tradeable resource use permits) addition, the higher resource input costs flow on into higher goods prices such that the LM curve shifts back to its original position. Overall, the new environmental-macroeconomic equilibrium is back at point a. In addition, real output remains unchanged at Y0. The shifts from EE0 to EE1, EE2 or EE3 represent different degrees of technological progress. Once again, the movement of the LM curve depends on the extent of any technological progress. The greater is the degree of technological progress, the larger is the new equilibrium output level. A combined shift of the EE curve to EE1 and the LM curve to LM2 (minimal technological progress) brings about a new environmental-macroeconomic equilibrium at point c1 and an increase in real output to Y1; a shift of the EE curve to EE2 and no accompanying shift of the LM curve (larger increase in technological progress) generates a new equilibrium at point b and a rise in real output to Y01; while a combined shift of the EE curve to EE3 and the LM curve to LM3 (considerable technological progress) produces a new equilibrium at point c2 and an increase in real output to Y2. In this latter case, real output increases beyond the level achieved when no environmental constraint is imposed (i.e., Y2 Y01).

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MAXIMUM SUSTAINABLE SCALE AND OPTIMAL SCALE Given the above, is an expansionary fiscal policy to be preferred or an expansionary monetary policy? This will depend on a number of things. First, it will depend on the relative slopes of the IS, LM and EE curves. Figures 13.3–13.6 confine the analysis to circumstances where the EE curve is steeper than the IS curve. Second, it will depend on whether the prevailing conditions are consistent with the Heyes or Lawn position. Based on Figures 13.3 and 13.5 (the Heyes position), an expansionary monetary policy leads to an increase in the sustainable equilibrium output level, while an expansionary fiscal policy causes it to fall. This suggests that an expansionary monetary policy is preferred. As for Figures 13.4 and 13.6 (the Lawn position), determining the impact of expansionary fiscal and monetary policies is not as clear-cut. This is because the overall impact depends on the extent of any resource-saving technological progress. There is, however, a third factor to consider. Since the well-being of a nation depends on the sustainable economic welfare of economic activity (Daly, 1996; Lawn, 2000), ascertaining the impact of expansionary fiscal and monetary policies requires a comparison of production benefits and production costs. If the latter are increasing faster than the former, a policy that leads to an increase in output will lower sustainable economic welfare. Hence an evaluation of fiscal and monetary policies cannot be made simply by observing the impact on the equilibrium output level. To incorporate the impact on sustainable economic welfare, consider Figure 13.7. It will again be assumed that 1 and 1. Panel 13.7a depicts an environmental-macroeconomic equilibrium condition. The equilibrium interest rate/output combination is (*, Y*). Panel 13.7b is a 45 degree line to allow the real output level in Panel 13.7a to be extended to Panel 13.7c. The vertical axis in Panel 13.7b indicates that real output is the sustainable production level when the macroeconomy is operating on the EE curve. Moreover, Ymax indicates the maximum permissible production level at the prevailing state of technological progress. YS, on the other hand, indicates the maximum sustainable production level once technical efficiency reaches the thermodynamic limit of E→1 (i.e., once 1). Panel 13.7c depicts a consumption line where the consumption level (C) is equivalent to the physical depreciation rate (d) of the total stock of human-made capital (S). That is, Cd S. The stock of human-made capital, which indicates the physical scale of the macroeconomy, expands if production exceeds consumption. Naturally, the scale of the macroeconomy stabilises once the two equate. For an equilibrium output level of Y*, the physical scale of the macroeconomy is S*. At the prevailing state


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of technological progress, the maximum sustainable scale of the macroeconomy is Smax SS indicates the maximum sustainable scale once 1. Panel 13.7d is essentially the same figure as Panel 2.4a. The uncancelled benefits (UB) curve represents the net psychic income yielded by a growing macroeconomy. The cost of increasing the physical scale of the macroeconomy is represented by the uncancelled cost (UC) curve. The UC curve is vertical at Smax to indicate that the uncancelled cost of economic activity is infinite once the incoming resource flow exceeds the carrying capacity of the natural environment. For any given macroeconomic scale, sustainable economic welfare is measured by the vertical distance between the UB and UC curves. Sustainable economic welfare is maximised at a macroeconomic scale of S* (i.e., where sustainable economic welfare SEW*). Thus, S* denotes the optimal macroeconomic scale. Overall, Figure 13.7 has been drawn so the optimal macroeconomic scale is consistent with the prevailing environmental-macroeconomic equilibrium. Now consider Figure 13.8 where an expansionary fiscal policy is enacted under the Heyes position (no tradeable resource use permits). Prior to the fiscal expansion, the initial environmental-macroeconomic equilibrium at point a is such that the sustainable economic welfare of economic activity is being maximised. Due to an increase in G, the IS curve shifts rightward to IS1. Since the new equilibrium at point b is inconsistent with an environmental equilibrium, the fiscal expansion must be accompanied by a monetary contraction – that is, a leftward shift of the LM curve to LM1. This moves the macroeconomy to a new environmental-macroeconomic equilibrium at point c. Because the equilibrium output level falls to Y1, the physical scale of the macroeconomy reduces to S1. At S1, the sustainable economic welfare of economic activity declines to SEW1. Clearly, under these conditions, an expansionary fiscal policy is inimical to national well-being. Naturally a conclusion of this sort will differ if, prior to the introduction of an expansionary fiscal policy, the macroeconomy has already surpassed its optimal scale (i.e., at a scale larger than S*). In this situation, a reduction in the scale of the macroeconomy would increase the sustainable economic welfare of economic activity. Indeed, it is conceivable that an expansionary fiscal policy could move the macroeconomy back to its optimal scale. Figure 13.9 illustrates the impact of an expansionary monetary policy under the Heyes position. Prior to the monetary expansion, the initial environmental-macroeconomic equilibrium at point a is again consistent with the macroeconomy operating at the optimal scale. Because of an increase in M, the LM curve shifts rightward to LM1. Once again, the new equilibrium at point b is inconsistent with an environmental equilibrium. To keep natural capital intact, the monetary expansion must be

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Ymax

YS real Y

Figure 13.7

S*

S*

UC

Smax

Smax

Panel 13.7c

SEW*

Panel 13.7d

IS-LM-EE and sustainable economic welfare (optimal macroeconomic scale)

Y*

Y*

Ymax

Ymax

Ymax

Y*

YS

Y=Y

YS real Y

YS

Panel 13.7b

Y*

IS

LM

Uncancelled benefits (UB) and uncancelled costs

real Y (Production)

45º

EE

Panel 13.7a

real Y (Production)

*

SS

SS

Macro scale

C = d.S

Macro scale

UB

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b

Ymax

Figure 13.8

S1

S1

SEW1 SEW*

S*

Smax

Smax

UC

Panel 13.8d

Panel 13.8c

S*

Expansionary fiscal policy with no tradeable resource use permits

YS real Y

Y* Y1

real Y (Production)

Y* Y1

Ymax

IS

Y=Y

YS real Y

IS

1

Ymax

Y*

Panel 13.8b

Y*

a


Ymax

Y1

Y1

c

LM

YS

45º

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LM1

YS

real Y (Production)

*

Panel 13.8a

SS

SS

Macro scale

C = d.S

Macro scale

UB

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Y1 Ymax

c

b

real Y (Production)

Figure 13.9

SEW*

Expansionary monetary policy with no tradeable resource use permits

Y1 Y*

Y=Y

Y1 Y*

YS real Y

YS real Y

YS

Y1 Ymax

IS IS1

LM1

Ymax

Y*

Panel 13.9b

Y*

a

LM

YS

45º

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Ymax

real Y (Production)

*

Panel 13.9a

S*

S*

S1

Smax

UC

Smax

Panel 13.9c

S1

SEW1

Panel 13.9d

SS

SS

Macro scale

C = d.S

Macro scale

UB


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accompanied by a fiscal contraction – that is, a leftward shift of the IS curve to IS1. This moves the macroeconomy to point c. Because the equilibrium output level rises to Y1, the scale of the macroeconomy increases to S1. At a larger macroeconomic scale, the sustainable economic welfare of economic activity declines to SEW1. Despite an expansionary monetary policy having the opposite impact of an expansionary fiscal policy on real output and the macroeconomic scale, it too reduces national well-being. Again, this conclusion can differ if the macroeconomy is initially smaller than its optimal scale, as it may well be for many impoverished nations. Figures 13.10 and 13.11 will now illustrate the impact on sustainable economic welfare of an expansionary monetary policy under the Lawn position (where a resource use permit scheme is in place). Figure 13.10 is the same as Figure 13.9 from point a to point b. However, the excess demand for low entropy matter-energy leads to a rise in both resource prices and the resource input cost of the production process. In this particular instance, higher resource input costs fail to induce any technological progress. Consequently, the EE curve maintains its present position at EE. The higher resource input costs flow on into higher goods prices so that the LM curve shifts back to its original position. Because the equilibrium output level remains at Y*, the macroeconomy continues to operate at the prevailing optimal scale of S*. Now consider Figure 13.11. Everything is the same as Figure 13.10 except, on this occasion, higher resource input costs bring about an increase in resource-saving technological progress. This not only shifts the EE curve rightward to EE1, it also causes a downward/rightward shift of the UC curve in Panel 13.11d to UC1. The rightward movement of the UC curve is due to the fact that an increase in the maximum permissible output level to Ymax1 corresponds to an increase in the maximum sustainable scale to Smax1. The downward movement of the UC curve comes about because an increase in resource-saving technological progress reduces the source, sink and lifesupport services lost in the process of maintaining a given macroeconomic scale. This, in turn, reduces the uncancelled cost of economic activity. Because the increase in technological progress is insufficient to prevent goods prices from rising, the LM curve shifts leftward to LM1. This brings about a new environmental-macroeconomic equilibrium at point c. The increase in equilibrium output to Y1 corresponds to a larger macroeconomic scale of S*1. Unlike an expansionary monetary policy under the Heyes position, the increase in output and macroeconomic scale does not lower sustainable economic welfare. Indeed, on this occasion, the expansion of the macroeconomy leads to an increase in sustainable economic welfare to SEW*1. Hence there is a beneficial expansion from one optimal macroeconomic scale to another.

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Ymax

b

YS real Y

Figure 13.10

S*

S*

Smax

Smax Panel 13.10c

SEW*

UC

Panel 13.10d

SS

SS

Expansionary monetary policy with tradeable resource use permits no technological progress

Y*

real Y (Production)

Y*

Y=Y

YS

Ymax

YS real Y

IS

LM1


Ymax

Y*

Panel 13.10b

Y*

a

LM

YS

45º

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Ymax

real Y (Production)

*

Panel 13.10a

Macro scale

C = d.S

Macro scale

UB

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b IS

Panel 13.11b Y=Y

Y1 Ymax Ymax1 YS real Y

c

real Y (Production)

Figure 13.11

S *1

S*

S *1

UC UC1

Smax Smax1

Smax Smax1

SEW*1

Panel 13.11c

S*

SEW*

Panel 13.11d

SS

Macro scale

Macro scale

C = d.S

SS

UB

Expansionary monetary policy with tradeable resource use permits small technological progress

Y1 Ymax Ymax1 YS real Y

Y*

Y1

Y*

Y*

a

LM LM2 LM1

Y1 Y*

EE1

YS Ymax1 Ymax

45º

EE

Uncancelled benefits (UB) and uncancelled costs (UC)

YS Ymax1 Ymax

real Y (Production)

*

Panel 13.11a

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CONCLUDING REMARKS Given the importance now placed on the sustainability of economic activity, mainstream economists can no longer ignore the need to incorporate environmental constraints into macroeconomic models. Thanks to Heyes, any excuse that economists may have had in the past has vanished. Nevertheless, Heyes’ initial IS-LM-EE proposal is far from complete. Hence I have endeavoured to demonstrate the far-reaching implications that an extended IS-LM-EE model can have for fiscal and monetary policy. In all, these implications depend largely on four key aspects: (a) the means by which the macroeconomy is manipulated to ensure it operates on an EE curve; (b) the extent of any resource-saving and/or pollution-reducing technological progress; (c) the impact on the sustainable economic welfare of economic activity, not just the impact on real output; and (d) whether a nation is initially operating at an optimal macroeconomic scale. Assuming the macroeconomy is operating at the optimal scale, this chapter has shown that an expansionary fiscal policy, when accompanied by a monetary contraction to keep the macroeconomy on the EE curve, lowers the sustainable economic welfare of economic activity. The same also occurs when an expansionary monetary policy is accompanied by a fiscal contraction. In both cases, the macroeconomy moves to a suboptimal scale. The story is much different if assurance bonds and a resource use permit scheme have been instituted. For example, when an expansionary monetary policy is adopted, sustainable economic welfare remains unchanged if there has been no technological progress, but increases if some degree of technological progress has taken place. While, in the former instance, the macroeconomy continues to operate at the prevailing optimal scale, in the latter case, it expands from one optimal scale to another. It is very true that the extended IS-LM-EE model used in this chapter is also far from complete. To begin with, the model assumes a macroeconomy that is closed to international transactions. This deficiency can, as Heyes pointed out, be dealt with by including a ‘balance of payments’ or BP curve. It can also be addressed by permitting the international trade in resources and wastes, both of which allow for a potential rightward shift of the EE curve. A wealth of other factors can also be included at the researcher’s discretion to strengthen the validity of the model’s findings. These include such customary additions as adaptive expectations, bond-financed government deficits, or policy announcement effects. Other additions include the feedback effect of a degraded natural environment, incentive-based initiatives to shift the UB curve upwards (e.g., reduced rates of tax on labour and income), or an increase in the durability of all newly produced goods. Whatever the case, it does not alter the fact that environmental concerns


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should not remain the exclusive domain of microeconomic analysis. They should also be incorporated into macroeconomic models, thereby opening the door to a whole new branch of macroeconomics.

NOTES 1. To be fair to Heyes, his effort was very much an introductory essay and so this chapter is more of an extension of analysis than a critique. 2. The major deficiencies of the fixed-priced IS-LM model are: (a) the assumption that the aggregate supply curve for goods is perfectly elastic, and (b) the lack of suitable micro foundations underpinning the IS and LM curves – for example, aversions of risk and expectations of changing macroeconomic variables. 3. Technological progress of this kind would be equivalent to an increase in the maintenance efficiency of human-made capital (Ratio 2 of the four eco-efficiency ratios in equation (6.4)). 4. This assumes that resource prices in resource markets will not, by themselves, rise to reflect an increase in the absolute scarcity of low entropy matter-energy. I could instead assume that resource prices will rise to some degree, however, my aim is to show the implications if they do not fully reflect ecological limits. For ease of exposition, it is better to assume that resource prices will not rise at all.

14.

Reconciling the policy goals of full employment and ecological sustainability

INTRODUCTION As we have seen in this book, ecological economists believe that the growth of macroeconomic systems must be curtailed to achieve ecological sustainability. Impoverished nations aside, ecological economists are strongly urging governments to commence a rapid transition towards a steady-state economy. Naturally, this demands that restrictions be placed on the rate of resource throughput which, as was demonstrated in the previous chapter, severely limits the growth in real Gross Domestic Product (GDP). The problem confronting ecological economists is that, under the institutional arrangements of most countries, a growth rate of around two to three per cent is required to prevent unemployment from escalating. This raises a very important question: How can low rates of unemployment or, preferably, full employment be achieved in a low growth or steady-state economy? Ecological economists have been largely silent on this issue. I believe their failure to adequately respond to this question significantly harms their cause. To answer the above question, the fundamental factors underlying the conflict between the sustainability and full employment goals are sketched. It is then argued that a critical step towards achieving full employment is the severing of the GDP-employment link. Following this, the various means to achieving full employment in a low growth or steady-state economy are surveyed and discussed. At this point, the IS-LM-EE framework is invoked as a means of assessing the use of expansionary demandside policies in circumstances where the incoming resource flow is limited to an ecologically sustainable rate. Also analysed in the context of the IS-LM-EE framework is a Job Guarantee scheme being promoted by Mitchell and Watts (1997 and 2001). The final section of the chapter includes a brief appraisal of a universal form of unconditional income to encourage workers to reduce their work hours and/or exit the labour force.

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Full employment and sustainability

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ECOLOGICAL SUSTAINABILITY, THE STEADYSTATE ECONOMY AND FULL EMPLOYMENT In Chapter 2, it was revealed that sustainable development requires, among other things, the realisation of the full employment objective since, without it, it is inconceivable that the higher- and lower-order needs of each and every citizen could be adequately satisfied. Furthermore, full employment has been shown to be an essential part of realising the goal of distributional equity. Given what was said above regarding the supposed link between growth and employment, two of the critical means to achieving sustainable development – namely, full employment and an impending cessation to growth – appear utterly incompatible with each other. Why exactly is this so? More importantly, is it possible for policy and/or institutional changes to bring about their eventual congruence? An answer to the first question can be found by perusing any undergraduate textbook or popular macroeconomics journal. With little difficulty, references to the terms ‘full employment level of output’ and ‘potential output’ are common. Both terms mean the same thing and can be considered the level at which national output or real GDP would be if all resources were fully employed (Fischer et al., 1988). Although mainstream economists do not specify what is meant by fully employed resources, it essentially implies the full utilisation of the incoming resource flow (the material cause of production) plus the full employment of the labour and producer goods component of the stock of human-made capital (the efficient or value-adding cause of production). Interestingly, mainstream economists never spell out what is meant by a fully employed unit of labour. Is it a person engaged for 30, 35, 40 or 50 hours per week in a paid form of employment? Perhaps more, perhaps less? This is an important question because someone working 35 hours in a week may be deemed underemployed if the answer is 40 hours, but fully employed if it is 35 hours. Unfortunately, this issue has yet to be adequately addressed. The above aside, it is a fact of life that unemployment is in some way related to real GDP. For example, if the current level of real GDP is insufficient to generate full employment (i.e., the prevailing level of real GDP is less than potential real GDP), full employment can only be obtained if, ceteris paribus, real GDP is increased sufficiently to bridge what is commonly referred to as the ‘unemployment gap’. However, there are many factors other than real GDP that affect unemployment. Thus, when one is referring to potential real GDP, one is implying a level of real GDP that ensures full employment under a particular set of circumstances. This fact is not altogether ignored by mainstream economists who frequently

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state that any particular full employment level of real GDP is specific to a given quantity of human-made capital embodying a particular level of technology. What mainstream economists tend to overlook is the fact that it is also policy- and institution-specific. It goes without saying that mainstream economists routinely ignore the limits that the rate of resource throughput places on the full employment level of output. Once it is recognised that the full employment level of real GDP is as policy- and institution-specific as the prevailing level of real GDP, it becomes abundantly clear that closing the unemployment gap no longer requires efforts directed exclusively towards increasing real GDP. Thoughts immediately arise to the possibilities of bringing the full employment level of output back towards the prevailing level of real GDP or, if the optimal macroeconomic scale has been exceeded, something lower again. It is, therefore, the failure of mainstream economists to fully acknowledge the policy- and institution-specific nature of the full employment level of output that goes a long way towards explaining the perceived incompatibility of the steady-state economy and the full employment objective. Mainstream economists simply haven’t given much if any thought to lowering the full employment level of output which, as a consequence, leads to one very false conclusion – growth in real GDP is necessary to obtain full employment.

FULL EMPLOYMENT IN A LOW GROWTH OR STEADY-STATE ECONOMY Severing the GDP-Employment Link The second of the initial questions raised above referred to the possibility of implementing policy measures to reconcile the steady-state economy and the full employment objective. One way of resolving this dilemma is to sever the current institutional link between real GDP and the employment level. This can be accomplished by minimising the need for paid forms of employment which, in turn, can be achieved by focusing economic activity on improving the quality of all newly produced goods and reducing the rate at which the stock of human-made capital wears out and must be replaced (i.e., by increasing the service and maintenance efficiencies of human-made capital). Both courses of action minimise the need for employment because, ceteris paribus, more durable goods with higher use values command higher selling prices. This translates to higher profits and wages, the latter of which can reduce the need for work and increase the potential for job-sharing.


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Having said this, there are three main obstacles preventing most people from reducing their work hours. The first is the unequal distribution of wealth. The distribution of wealth is critical because wealth provides the owner a flow of income without the need for excessively laborious work. Since the majority of a nation’s citizens possess little income-generating wealth, they are compelled to work long hours to obtain a share of the annual output of newly produced goods. Without wanting to downplay the significance of relative income shares across the total population, not enough attention has been given to the distribution of wealth which, by the way, is often more unequal than the distribution of income (ABS, Catalogue No. 6523.0; EPAC, 1995; Davy, 1996). Policies therefore need to be introduced to bring about a more equitable distribution of wealth. The second major obstacle is the degenerative influence that an unfettered global market with highly mobile capital flows has on the wages and conditions of employment (Daly, 1993; Røpke, 1994; Lawn, 2000). So long as the international trading environment continues to apply standards-lowering pressure on national economies, it will be difficult to bring about the increase in hourly wages required to reduce the need for work and to share the workload across the entire labour force. While more will be revealed in Chapters 15 and 16, I will take this opportunity to highlight again a socalled IMPEX (Import-Export) system of foreign exchange management to deal with the standards-lowering pressure of globalisation. As an alternative pro-trade arrangement, the IMPEX system permits exchange rate flexibility and internalises the cost of domestic environmental and social standards into the price of foreign-made goods (Lawn, 2000). Provided increases in wages and conditions of employment reflect rises in labour productivity, the IMPEX system allows domestic standards to be raised without reducing the international competitiveness of domestic producers. It therefore promotes an economic climate conducive to job-sharing. The third major obstacle is the inflexibility of labour markets. Caused mainly by archaic industrial relations systems, labour market inflexibility forces many people to work excessive hours at a time when some people are underemployed while others cannot find work at all. Although labour market rigidities have been lessened in many countries over the last decade, the rapid rise in casual employment is a measure of the inappropriate reform of most industrial relations systems (Cowling et al., 2006). Moreover, there have been many instances where modifications to industrial relations systems have led to the erosion of workers’ wages and conditions of employment. Clearly, policy makers need to install a form of labour market flexibility that both protects workers’ pay and conditions and increases their options beyond the current restrictive choice of either too many hours in a full-time occupation or a more appropriate number of

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hours in a casual job. Only then will the potential for job-sharing truly emerge. Supply-side Solutions Supply-side solutions to the unemployment problem involve the implementation of incomes policies, labour market programs, and initiatives designed to increase the flexibility of labour markets. While I have already talked about labour market flexibility as a means to facilitate job-sharing, labour market flexibility can also increase the productivity of labour. Furthermore, productivity rises can be enhanced if policies are juxtaposed with an industrial relations system that promotes harmonious workplace relationships, horizontal decision making structures, and incentive-based means of remuneration. Rises in labour productivity increase the four ecoefficiency ratios referred to in Chapter 9. This applies upward pressure on the real hourly wage that, again, lessens the need to work. Interestingly, studies by Weitzman (1984), Estrin (1986), and Blandy and Brummitt (1990) report that productivity benefits are greatest when employment conditions are based on collective enterprise arrangements rather than individually negotiated contracts. Regrettably, the latter are becoming part and parcel of the industrial relations landscape of most countries.1 What is the recent employment record of many industrial relations systems? Although the changes typically introduced in most countries have helped to reduce unemployment rates, they have not brought about full employment. In addition, the increase in casual employment and the number of people working longer hours suggests that the benefits of lower unemployment are coming at the expense of higher psychic costs and a growing gap between rich and poor. Also, the increase in productivity over the past decade, which is measured in terms of output per unit of labour, may be illusionary if, as revealed in Chapter 9, the fall in three of Australia’s four eco-efficiency ratios is a superior guide to labour productivity and representative of productivity movements in most countries. As for labour market programs, most involve some form of training and skills development plus the introduction of incentives to encourage employers to take on more employees (Dawkins and Freebairn, 1997). Despite the success of a limited number of well targeted labour market programs in Australia, evidence suggests they are not very cost effective. In addition, many labour market programs appear to have done little more than shuffle existing unemployment queues. Few have increased employment levels to any great extent (Miller, 1994; Webster, 1997). Finally, an incomes policy is designed to directly control aggregate wage outcomes as well as wage relativities between different occupations. Usually


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implemented at the national level, an incomes policy involves the adjustment of wages in response to price changes and advances in labour productivity. Ideally, wage adjustments are regulated to prevent the erosion of real wages and to ensure wage rises are commensurate with productivity gains. While some would argue that the setting of a real wage floor can act as a stumbling block to unemployment reduction, others claim that the lowering of real wages at the bottom end of the wage scale encourages firms to adopt low-skilled job hiring strategies at the expense of capital investment, employee training, and research and development (Hancock, 1987; Harrison and Bluestone, 1990; Buchanan and Callus, 1993). Thus, by guarding against lower real award rates, an incomes policy can promote the type of investment needed to increase labour productivity, boost real wages and sustain employment growth (Watts and Burgess, 2000). On the down side of the ledger, an incomes policy reduces labour market flexibility and relies on bureaucrats rather than the market to alter wage relativities in response to productivity changes across different occupations. Apart from the negative impact of inflexible labour markets already outlined, this prevents labour markets from responding adequately to a nation’s current and future labour requirements. An incomes policy can therefore lead to an undesirable imbalance between the demand and supply of certain forms of labour. Should an incomes policy be totally abandoned? Probably not. There will always be a good case for having real wages maintained at the lower end of the relative wage scale to ensure a society’s poorest workers are able to live decently. Bottom-end real wages can be adjusted by an independent authority such as the Industrial Relations Commission that presently exists in Australia (now Australian Fair Pay Commission). All in all, supply-side solutions are vitally important insofar as effective policies can boost labour productivity, increase real wages and lower unemployment. Having said this, any suggestion that all unemployment is supply-side related and/or the result of voluntary labour withdrawal is patently untrue. To some extent, persistent unemployment continues to be the manifestation of deficient aggregate demand (Modigliani, 2000; Mitchell, 2001b). Unfortunately, the need to make a transition towards as steady-state economy places severe constraints on the use of demand-side policies to achieve full employment – as will now be demonstrated. Demand-side Solutions Demand-side solutions involve the stimulation of aggregate demand to boost real output that, in turn, creates more employment opportunities. Demand-side policies essentially take the form of either a fiscal or monetary

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expansion. Expansionary fiscal policy involves the increase in government spending and/or the decrease in income taxes to augment the spending power of consumers. For some time now, expansionary fiscal policy has been out of favour with governments and policy makers alike. There are a couple of reasons for this. First, it is feared that increased government spending can lead to higher interest rates that can crowd out private investment and consumer spending. Mitchell and Watts (2001) refute this assertion by arguing that the role of government debt is not to finance an increase in government spending but to maintain reserve balances in the short-term money market in order to defend the overnight cash rate. Lack of support by the central bank leads to a decline on the overnight cash rate, not a rise as conventionally understood. Thus, according to Mitchell and Watts, the notion of financial crowding out being caused by the deficit spending of governments, as opposed to the crowding out effect of inflation, is meaningless. Second, governments are increasingly concerned about the possibility of expansionary fiscal policies leading to high inflation and a long-run unemployment crisis. Mitchell and Watts (1997) again refute such a suggestion. They argue, firstly, that inflationary pressure exists only when the macroeconomy is operating at the full employment level of national income. If unemployment exists as a consequence of deficient demand, the macroeconomy can safely respond to nominal impulses by expanding real output. Second, if an employer-of-last-resort program (e.g., Job Guarantee) is made the centrepiece of a stimulatory policy, the payment of a minimum award wage to the Job Guarantee employees ensures price stability by defining the private sector wage structure. While I agree with Mitchell and Watts on this aspect, I believe there is the potential for inflationary pressure to emerge from a different source – namely, from the rise in the price of low entropy resources as the macroeconomy approaches ecological limits. More on this soon. Doubts surrounding the use of expansionary fiscal policies have led many governments to rely on expansionary monetary policies to stimulate investment and consumer spending. Nevertheless, loose monetary policy has only been used to stimulate the macroeconomy when in recession and never to the extent needed to achieve full employment. The failure to do this is again related to fears that an expansion of such magnitude leads to an unacceptable level of inflation that eventually results in an unemployment rate higher than the one existing prior to the policy’s implementation. Let’s assume, for the moment, that the standard fears concerning the long-term inflationary and crowding out effects of expansionary fiscal and monetary policies are unfounded. Since both involve the stimulation of the macroeconomy, to what extent can they be used if ecological sustainability necessitates the cessation of a high growth policy? To analyse the

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possibilities, we shall revisit the IS-LM-EE framework outlined in the previous chapter. To assist in this regard, we shall assume that assurance bonds and a system of tradeable resource use permits described in Chapter 10 have been instituted to ensure the macroeconomy operates at all times on an environmental equilibrium or EE curve. To be consistent with Mitchell and Watts, the LM curve is assumed to be horizontal. An expansionary fiscal policy Figure 14.1 illustrates the impact of an expansionary fiscal policy on equilibrium output. Initially, the macroeconomy is situated at the equilibrium point a where the equilibrium interest rate/output combination is (0, Y0). For the purposes of this section of the chapter, we shall ignore the possibility of reducing the full employment output level back to the prevailing output level of Y0 and assume it exists at Y01. Hence, (Y01 Y0 ) represents an unemployment gap. By increasing government spending (G), the central government shifts the IS curve rightward to IS1. If no environmental constraint was imposed,

EE0

EE1 EE2

EE3

c1

LM1 c2

LM2 b

0

LM0

a

IS1 IS0

Y1

Y0

Y2

Y 01 (f/e)

YS

real Y

u/e gap

Figure 14.1 Expansionary fiscal policy (assurance bonds and tradeable resource use permits imposed)

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a new environmental-macroeconomic equilibrium would be restored at point b. Furthermore, the equilibrium output level would increase to Y01 and the unemployment gap would be bridged. However, full employment would be temporary since Y01 is ecologically unsustainable. Conversely, with assurance bonds and a permit system in place to serve as a macro-environmental constraint, point b is unobtainable. What’s more, an excess demand for low entropy resources would ensue. This would lead to a rise in resource prices and an increase in the input costs of production. To what extent higher resource prices translate into higher goods prices depends on the extent of any resource-saving technological progress induced by the higher resource costs. The shifts from EE0 to EE1, EE2 and EE3 represent three different degrees of technological progress. The shift to EE1 represents the lowest rate of progress whereas the shift to EE3 represents the highest. Because a change in goods prices affects the quantity of real money balances (M/P), the LM curve shifts upward, downward, or not at all depending on the rate of resource-saving technological progress. Consider the shift of the EE curve to EE1 and the accompanying shift of the LM curve to LM1. In this particular instance, a low rate of resource-saving technological progress results in the inflated resource costs translating significantly into higher goods prices. As a consequence, the upward shift of the LM curve is very pronounced. A new environmental-macroeconomic equilibrium is restored at point c1. Overall, at Y1, real output has fallen slightly compared to its initial level of Y0 (i.e., Y1 Y0). Not only is the unemployment gap not bridged, it is magnified by the increase in G. In the second instance, the shift of the EE curve to EE2 is the consequence of a much larger increase in technological progress. Because the rise in goods prices is smaller than the previous case, the LM curve shifts only as far as LM2. On this occasion, a new environmental-macroeconomic equilibrium is restored at point c2. Unlike the previous instance, the real output level of Y2 is slightly higher than its initial level of Y0 but is still less than Y01 (i.e., Y0 Y2 Y01). The unemployment gap is therefore only partially bridged. In the final case, the degree of resource-saving technological progress is exactly sufficient to prevent a rise in goods prices. As such, there is no shift of the LM curve. Because the real interest rate remains unchanged, private sector spending is unaffected. The new environmental-macroeconomic equilibrium moves to point b, as intended, and real output increases to the full employment level of Y01. Of course, there is every possibility that the amount of resource-saving technological progress required to sustainably produce an output level of Y01 would be well beyond the capacity of any nation to achieve in the short or medium term. If this is the case, it is unlikely that full employment would

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follow a fiscal expansion. It is also worth considering that even if the necessary technological progress was obtainable in the long run, many factors would change over this time – not the least of which would be the size of the labour force. Clearly, with the potential for real output to fall immediately following a fiscal expansion, the imposition of a macroenvironmental constraint severely limits a nation’s capacity to employ an expansionary fiscal policy to achieve full employment. An expansionary monetary policy The impact of an expansionary monetary policy is illustrated by Figure 14.2. Once again, the macroeconomy is initially at the equilibrium point a where the equilibrium interest rate/output combination is (0, Y0) and (Y01 Y0 ) represents the unemployment gap. An increase in M leads to a system-wide surplus in the banking sector and downward pressure on the overnight cash rate. The LM curve therefore shifts downward to LM1. A new macroeconomic equilibrium is established at point b where, if no environmental constraint was imposed, the equilibrium output level would increase to Y01. Not unlike an expansionary fiscal policy, the excess demand for low entropy resources leads to a rise in resource prices and an increase in EE0

0

EE1 EE2

EE3

a

LM0 LM2

c1 b

LM1 LM3

c2 IS

Y0

Y1

Y 01

Y2

YS

real Y

(f/e) u/e gap

Figure 14.2 Expansionary monetary policy (assurance bonds and tradeable resource use permits imposed)

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producers’ input costs. If the increase in resource input costs fails to induce any technological progress, the EE curve maintains its present position at EE0. In addition, the higher resource input costs flow on into higher goods prices such that the LM curve shifts back to its original position. Overall, the new environmental-macroeconomic equilibrium returns to point a. In addition, real output remains at its original level of Y0. Different degrees of resource-saving technological progress induced by higher resource prices are represented by the shift in the EE curve from EE0 to EE1, EE2 and EE3. Once again, the movement of the LM curve also depends on the extent of any technological progress. The greater is the degree of technological progress, the larger is the new equilibrium output level. A combined shift of the EE curve to EE1 and the LM curve to LM2 (minimal technological progress) brings about a new environmentalmacroeconomic equilibrium at point c1 and an increase in real output to Y1 (although Y1 Y01); a shift of the EE curve to EE2 and no accompanying shift of the LM curve (larger increase in technological progress) produces a new equilibrium at point b and a rise in real output to Y01; while a combined shift of the EE curve to EE3 and the LM curve to LM3 (considerable technological progress) brings about a new equilibrium at point c2 and an increase in real output to Y2. In this latter case, real output increases beyond the level required to achieve full employment (i.e., Y2 Y01 ) . It is here where demand-pull inflation of the type referred to by Mitchell and Watts (1997) has the potential to emerge. In view of the time it takes for technological progress to take place, the full employment output level of Y01 is again likely to be beyond the immediate capacity of a nation to achieve. Whilst a preference for fiscal or monetary expansion will again depend on the relative slopes of the various curves, the IS-LM-EE model demonstrates that the use of either fiscal or monetary policies to achieve full employment is severely constrained. In fact, full employment is just as unlikely to occur following an expansionary monetary policy as it is following a fiscal expansion. Clearly, in a low growth or steady-state economy, it is highly doubtful whether demand-side policies could be relied upon, alone, to achieve the full employment objective.

SPECIFIC POLICY INITIATIVES TO ACHIEVE ECOLOGICAL SUSTAINABILITY AND FULL EMPLOYMENT In this particular section of the chapter, a number of specific policy initiatives will be analysed and discussed. Some fall under the banner of supplyside solutions and others demand-side solutions. The last of these


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initiatives discussed – the remuneration of non-paid work – is an explicit attempt at lowering the full employment level of income to overcome the current predicament of having to boost real GDP to meet the full employment objective. Ecological Tax Reform As described in Chapter 11, ecological tax reform (ETR) involves a combination of tax cuts on ‘goods’ such as labour, income, wages and profits, and tax impositions on such ‘bads’ as resource depletion and pollution. Ecological economists argue that the former encourages value-adding in production which boosts, among other things, real wages. This allows workers located on the backward-bending section of their labour supply curve to reduce their working hours and increase their welfare. Hence ETR goes a long way towards severing the GDP-employment link. Another key element of an ETR package is that it alters the cost structure of commercial operations. By rendering resource use more expensive and reducing the cost of hiring labour, employers will, as much as possible, substitute the latter for the former, although it must be said that in view of the considerable degree of complementarity between resource input and human-made capital (which includes labour), the scope for substitution is small. But whatever scope there is, more people and fewer resources are likely to be employed to produce a given level of real output. Finally, the increase in taxes and charges on depletion and pollution – best achieved by way of tradeable resource use permits and assurance bonds – encourages technological progress that further reduces the resource intensity of economic activity. In doing so, it lessens the throughput of resources required to keep the stock of human-made capital intact (that is, increases the maintenance efficiency of human-made capital). This shifts the EE curve to the right and increases a nation’s sustainable income. Overall, a well targeted ETR package can promote the transition towards a steady-state economy while simultaneously reducing, though not entirely alleviating, the unemployment problem. Indeed, ETR can facilitate employment growth even while real GDP is falling. The question that still remains is this: Is a well targeted ETR package enough to guarantee full employment? The answer is probably not, and so there is a need for additional policy responses – including the use of demand-side measures. The Job Guarantee The Job Guarantee is a demand-side policy which involves the government acting as an employer-of-last-resort to continually absorb unemployed

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labour displaced by the private sector (Mitchell and Watts, 1997 and 2001). Job Guarantee employees are paid a minimum award wage to ensure they live decently and to establish a wage floor for the entire macroeconomy.2 Spending by the government on the Job Guarantee increases (decreases) as jobs are lost (gained) in the private sector. In doing so, the Job Guarantee achieves ‘loose’ full employment. But does it ensure price stability? Certainly, by paying ‘buffer stock’ employees a minimum award wage, the Job Guarantee stifles the emergence of wage-related inflation (Mitchell, 2000). However, there is another source of cost-push inflationary pressure to consider. It comes in the form of rising low entropy resource prices as the macroeconomy approaches ecological limits. As was demonstrated from the IS-LM-EE analysis above, a fiscal expansion is likely to lead to higher prices as the excess demand for low entropy resources forces resource buyers to bid up the price of the limited number of resource use permits. This increases the real interest rate, crowds out private investment, and results in a lower equilibrium output level. We might therefore expect, in the short run, private sector employment to fall and the number of Job Guarantee employees to rise beyond the previous unemployment level. The cost-push pressure exerted by higher resource prices also has some implications for Mitchell’s use of the Job Guarantee to control inflation. Mitchell is entirely correct to reject the popular NAIRU approach to inflation control since, although it succeeds on the inflation front, it results in unacceptable levels of involuntary unemployment.3 In response, Mitchell (2000) and Mitchell and Watts (2001) have put forward an alternative inflation control mechanism. They have referred to it as the NAIBER – the notion of a ‘non-accelerating inflation buffer employment ratio’. It works in the following manner. First, assume that a NAIRU policy is being employed and exists at a 6% unemployment rate. The Job Guarantee is now introduced to eliminate all but frictional unemployment. For argument sake, assume inflationary pressures now emerge. The government dampens private sector activity by, for example, increasing the corporate tax rate. A smaller percentage of the labour force will now be employed in the private sector while more will become Job Guarantee employees. Assuming an appropriate increase in the corporate tax rate, the ratio of Job Guarantee workers to private sector employees rises until the inflation rate is again stabilised. In other words, the NAIBER is achieved. Both inflation control and full employment are simultaneously resolved. Given the above, the NAIBER is likely to be higher than the NAIRU in the short run. For some observers, this will be undesirable since an increasing number of people will be paid the lower Job Guarantee wage. This is undoubtedly true, however, consider the fact that, unlike unemployed labour, Job Guarantee workers will retain and acquire new and existing


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skills. This will achieve a number of objectives. First, it will maintain the productivity and self-esteem of the entire labour force. This will facilitate increases, over time, in the floor wage. Second, Job Guarantee workers will constitute a more credible threat to private sector employees than unemployed labour. Presumably the NAIBER will serve as a more effective inflation control mechanism than the NAIRU (Mitchell, 2000). Third, because the combined labour force will be more productive, the NAIBER is likely to be considerably lower than the NAIRU in the long run. Nonetheless, this all changes once the inflationary impact of higher resource prices emerges. Assuming that the macroeconomy is operating at the ecological precipice – something that most macroeconomies appear to have reached – the introduction of the Job Guarantee will push the macroeconomy beyond the sustainability threshold and, in doing so, increase the real interest rate, crowd out private investment, and result in a lower equilibrium output level. We might therefore expect, in the short run, private sector employment to fall even further and the number of Job Guarantee employees to rise beyond the previous NAIBER level. Consequently, what I would call an ‘ecologically sustainable non-accelerating inflation buffer employment ratio’ – the ESNAIBER – is likely to be higher than the standard NAIBER in the short run. What about the long run? The much higher price for low entropy resources brought about by the introduction of tradeable resource use permits should induce a much greater rate of technological progress and shift the EE curve more rapidly. This will not only allow higher levels of real GDP to be obtained from the maximum sustainable rate of resource throughput, it should reduce any inflationary pressure that a Job Guarantee scheme would generate. This, in turn, would keep interest rates low and encourage producers to adopt the best available ‘green’ technologies. Because of this, the ESNAIBER is likely to be lower than the NAIBER in the long run that, as already explained, should be lower than the NAIRU. Consequently, there is likely to be fewer people employed by the Job Guarantee scheme under a ESNAIBER policy than there would be unemployed people under a NAIRU policy – a desirable outcome in itself. The importance of combining the Job Guarantee scheme with an ETR package produces two further positive spin-offs. First, the higher price paid for resource use permits serves to deflate the macroeconomy by the precise amount needed to bring about the ESNAIBER. There is no need to adjust tax rates, as in the NAIBER situation, since the resource use permit market fulfils this role as the demand for resource use permits fluctuates relative to their limited supply. Second, it was shown in Chapter 2 that the macroeconomy need not be approaching ecological limits in order for its physical expansion to result in

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the decline in sustainable economic welfare (see Figure 2.4). Assume, for a moment, that the introduction of the Job Guarantee scheme leads to a larger macroeconomy. By encouraging the development and use of efficiency-increasing technology, a well designed ETR package ensures that any growth is largely the consequence of positive shifts in the uncancelled benefit (UB) and uncancelled cost (UC) curves, not because of any movement along the two curves (see Figures 9.1 and 9.2). This ensures that full employment is obtained without a nation having to experience a decline in economic welfare. There is one final aspect of the Job Guarantee requiring attention. To be successful, the Job Guarantee must ultimately meet the preferences of the labour force. To do this, it is necessary for a Job Guarantee program to include a range of fractional jobs – all with the benefits and privileges of full-time employment (e.g., annual and sick leave entitlements). Given that the average full-time job in most countries involves approximately 37.5 hours of work per week, or 7.5 hours daily, fractional positions should be established to allow individuals to work 7.5 hours (one day), 15.0 hours (two days), 22.5 hours (three days), 30.0 hours (four days), and 37.5 hours (five days) per week. Better still, a flexible Job Guarantee program should include the possibility of people working half-days (3.75 hours per day) for, say, a minimum of two half-days per week. Not unlike the disciplining effect of a minimum or floor wage, the flexibility of fractional employment would force the hand of the private sector to do likewise, thus helping to facilitate a ‘standards-guaranteeing’ form of labour market flexibility. Greening the Job Guarantee It has been suggested that the inflationary pressure caused by ecological limits to macroeconomic expansion can be avoided if Job Guarantee jobs are sufficiently ‘green’ (i.e., involve environmental rehabilitation and/or low resource-intensive activities). Unfortunately, if the macroeconomy already exists at the ecological precipice, inflationary pressure cannot be averted because all activities, no matter how sensitive they are to the natural environment, must involve the use of additional resources. Since the intensity of resource use varies minimally across different industries and across different activities (Costanza, 1980; Ayres and Ayres, 1999), the introduction of a Job Guarantee scheme unavoidably results in resource demands exceeding the maximum sustainable resource supply – at least until efficiency gains have been made across the entire macroeconomy. It is because of this that the ESNAIBER will be higher than the NAIBER in the short run.


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Despite the aforementioned, a Job Guarantee scheme can still be designed in such a way as to generate long-term environmental benefits. For example, Job Guarantee employees engaged in reafforestation and other environmental rehabilitation activities can assist in the augmentation of both the stock of natural capital and its productivity. This can go a long way towards raising the growth and exploitative efficiencies of natural capital (i.e., eco-efficiency ratios 3 and 4). But such a process is rather slow and subject to eventual biophysical limits (Norgaard, 1984). This having been said, the process can be accelerated if the Job Guarantee scheme is complemented by an ETR package that includes tradeable resource use permits and assurance bonds. To sum up, a Job Guarantee scheme introduced to eliminate unemployment will result in a decline in the number of private sector employees in the short run should the nation’s macroeconomy already exist at its maximum sustainable scale. Such a scheme immediately consumes resources while any ecological ‘breathing space’ provided by increases in the growth and exploitative efficiencies of natural capital – both of which permit more resources to be sustainably exploited from the stock of natural capital – takes considerable time to emerge. A Guaranteed Basic Income Although rarely motivated by the full employment objective, some observers have long advocated a Basic Income to overcome the income insecurity associated with unemployment (Baetz, 1972; Van Parijs, 1991 and 2000; Atkinson, 1995; Clark and Kavanagh, 1996). The Basic Income is usually proposed in the form of an unconditional and universal transfer payment financed by increased tax rates or a widening of the tax base. Set above the absolute poverty line, the Basic Income replaces existing forms of public assistance – for example, unemployment benefits, disability allowances and old-age pensions (Clark and Kavanagh, 1996). The aims of the Basic Income are many, but the primary objective is to ensure that each and every citizen is provided with a basic living wage irrespective of their contribution to society or their physical and mental capacity to make a contribution. By avoiding a link between the transfer payment and work, advocates of the Basic Income claim that individuals are afforded ‘real freedom’ in the sense that financial restraints on behaviour and the means by which a person can realise their genuine aims and desires are removed (Gintis, 1997). One of the other potential benefits of the Basic Income is that it can reduce people’s need and/or incentive to work and can thus precipitate a labour supply withdrawal. This, in turn, can reduce the full employment level of income, thereby limiting

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the need to undertake expansionary demand-side measures to reduce unemployment. Critics of the Basic Income claim, first and foremost, that it does not guarantee full employment (Cowling et al., 2006; Saunders, 2002). Indeed, while the Basic Income provides a liveable wage for people who choose not to work, it does not guarantee work for those who still seek it. This is of great significance if employment itself serves a critical welfare function (Elster, 1988; Sen, 1997). Unfortunately, high unemployment is likely to persist because the Basic Income cannot, without the discipline of unemployment, attenuate emerging wage-price or price-price pressures (Cowling et al., 2006). Thus, like the NAIRU approach to inflation control, the Basic Income is non-inflationary only if there is a sufficiently large pool of unemployed labour. Second, critics of the Basic Income point out that the level of national output required to support the Basic Income requires enough people to continue in paid forms of employment. In many ways, those who remain engaged in paid employment ‘pay’ for the non-work of those who exit the labour market. As such, the freedom from work exigency that the Basic Income affords one person becomes the source of another worker’s alienation (Cowling et al., 2006). Third, the Basic Income constitutes an indiscriminate form of Keynesian expansion. Like any indiscriminate demand-side approach, the Basic Income has the potential to trigger periodic phases of demandpull and induced cost-push inflation at low rates of unemployment, only to be followed by contractionary fiscal policy and high rates of unemployment. Ecological limits aside, the Job Guarantee avoids this dilemma by providing the minimum demand expansion necessary to achieve full employment. Finally, critics argue that the objective of the Basic Income to reduce unemployment is flawed because, apart from the potential problems outlined above, it encourages an artificial labour supply withdrawal (Cowling et al., 2006). Of course, the legitimacy of this criticism depends very much on what is meant by ‘artificial’ since, as we have seen, inducing an exodus of labour can be of great value in reducing unemployment should the macroeconomy be teetering on an ecological precipice. One can identify three main sources of a genuine or ‘real’ labour supply withdrawal. Two of these have already been outlined and discussed but are worth repeating. They include: 1.

Increased labour market flexibility. As explained earlier in the chapter, flexible labour markets enable people who would like to reduce their work hours, but presently cannot, to in fact do so.


2.

3.

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Increased labour productivity. Improvements in labour productivity lead to higher real wages that allow people to reduce the number of hours they work. Government cash payments to reflect the contribution that non-paid work makes to the social product (e.g., non-paid household work, child rearing and volunteer work).

Why is the last an example of a real labour supply withdrawal? Because the cash payment not only reflects the contribution one makes to a nation’s real income, thereby ensuring that any withdrawn labour is precisely matched by a real demand-side outcome, but it overcomes the subsidisation by those who continue to work for the non-work of those who do not. Of these three sources of genuine labour supply withdrawal, it is the last that is most relevant to the Basic Income. To what extent the Basic Income induces a real or artificial labour supply withdrawal depends on how much the Basic Income exceeds the level of remuneration approximating the nonpaid work contribution made by the average citizen towards the social product.4 I refer to the average citizen because it would be far too complex to determine the exact non-paid work contribution made by each person and remunerate them accordingly. It is also administratively simpler to provide the Basic Income on a universal basis. Clearly, a Basic Income set at the basic living wage – as most Basic Income proponents advocate – would far exceed the average person’s nonpaid work contribution and precipitate a large artificial withdrawal of labour. However, a Basic Income set, for example, equal to the unemployment benefit paid in most developed countries (about 30–40% of the minimum wage) would be close to the mark. Whilst a Basic Income of this sort would significantly and desirably reduce the number of people engaged in the labour market, it would induce little in the way of an artificial labour supply withdrawal. Moreover, whatever potential exists for an artificial labour supply withdrawal, it would be minimised by making available a range of fractional job positions under the Job Guarantee program that, over time, would compel the private sector to offer a similar range of fractional job opportunities. There are, however, two additional reasons for providing a Basic Income at the level proposed above. First, Cowling et al. (2006) have argued that any policy initiative aimed at contributing to the full employment objective must not violate social attitudes towards work and non-work. If the dominant social view is that no one should receive ‘something for nothing’ (such as a Basic Income at the living wage), then it is utterly inconsistent for people to receive ‘nothing for something’. The Basic Income, in the form proposed above, would go a long way towards the rightful receipt of

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‘something for something’, even if it was, as I have recommended, administered in a very blunt and universal manner. Also, business concerns about the incentive effects of a Basic Income can also be alleviated if: (a) the combined payment of the Basic Income plus a full-time Job Guarantee position equals the minimum income level, and (b) the Basic Income is deficit-financed.5 This is because the minimum hourly Job Guarantee wage rate would be lower than the rate paid if the Job Guarantee existed alone (i.e., where 100% of a Job Guarantee employee’s minimum income was derived from the Job Guarantee scheme compared to approximately 30% and 70% respectively by a combined Basic Income and Job Guarantee). Assuming that the private sector can attract labour by paying an hourly wage for low-skilled jobs equal to that of a Job Guarantee job, the minimum hourly wage paid by the private sector would fall. In fact, a deficit-financed Basic Income would serve as a private sector subsidy on the employment of labour, thereby further assisting in the implementation of ecological tax reform. Second, the failure of most governments to remunerate non-paid work distorts worker incentives. In stark contrast to the fears that a Basic Income would induce an artificial withdrawal of labour, the non-payment of household and volunteer work has long induced an artificial influx of reluctant workers into conventional labour markets. Regrettably, this has placed enormous pressure on families and other critical institutions, norms and customs. The Basic Income proposed in this chapter would correct this destructive labour market distortion. It is true that one would prefer to see traditional non-paid work remain unpaid on the basis that it constitutes an integral part of a nation’s social capital (i.e., people undertake such work because they feel morally obligated to do so). But if market forces have the propensity to deplete social capital (Hirsch, 1976; Daly and Cobb, 1989), and its preservation and replenishment requires non-pecuniary assets to be valued in the same way as other assets, the case for a limited Basic Income is further enhanced.

CONCLUDING REMARKS The immediate need for lower rates of growth and the eventual desirability of a steady-state economy places considerable constraints on the ability of policy makers to achieve full employment at a time when unemployment coincides with high rates of growth. But lower unemployment levels can still be achieved if the GDP-employment link is severed and a great deal more is done to successfully facilitate genuine increases in productivity,


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resource-saving technological progress, and qualitative improvements in the stock of human-made capital. Nevertheless, full employment will require these initiatives to be supplemented by a range of well crafted policy measures. These include a buffer stock employment program, such as the Job Guarantee; an ecological tax reform package incorporating tradeable resource use permits and assurance bonds; and a universal Basic Income that, by remunerating people for their non-paid contribution towards the social product, can induce a real labour supply withdrawal and thus reduce the full employment level of income to something more ecologically manageable.

NOTES 1. Collective arrangements also point to the need for corporate law reform. Existing laws entrench the division between owners (stockholders), managers and employees. They have played a significant role in the development and evolution of industrial relations systems that are, in a strict Hegelian sense, dialectical in nature. Dialectical systems hinder rather than advance the knowledge-building process (Boulding, 1970). One might ask the question as to why has so much attention been given to labour market reform and yet so little to corporate reform? See Lawn (2000) on how corporate reform might be conducted. 2. One of the other benefits of a Job Guarantee scheme is that it allows a government to indirectly implement a progressive industrial relations policy. For example, a government could introduce post-industrial workplace practices (that is, greater participatory democracy through the devolution of power in the workplace) that would give people the choice between a potentially demeaning but higher-paid job in the private sector or a selfactualising but lower-paid Job Guarantee job. In the same way the Job Guarantee wage acts as a disincentive for the private sector to pay very low wages, so the Job Guarantee scheme can act as a disincentive for the private sector to generate demeaning jobs and/or introduce draconian workplace practices. 3. The need for a pool of unemployed labour is a defining condition of the NAIRU – a ‘nonaccelerating inflation rate of unemployment’. 4. Virtually all people contribute to the social product by way of some form of non-paid work. Even ‘drop outs’ and people who would exit the labour market in the presence of a Basic Income must engage in the generation of surplus value to survive or live comfortably. Note, also, that in so-called primitive societies, everyone had a crucial role to play and was not ‘paid’ for their work. They contributed to the social product and were then distributed their entitlement. While modern societies differ greatly, there remains some requirement on the part of each citizen to generate surplus value. The Basic Income, as I am proposing here, would merely acknowledge this contribution. 5. If the government’s aim is for the Basic Income to be budget-neutral, tax rates must be raised. To attract labour, the private sector would have to offer a higher pre-tax wage. If the tax rises are imposed on capital, the desire to invest will weaken. Neither would appease business interests and concerns.

PART V

Sustainable development and the international dimension ‘I sympathise, therefore, with those who would minimise rather than those who would maximise economic entanglement between nations. Ideas, knowledge, art, hospitality, travel – these are the things which should of their nature be international. But let goods be homespun whenever it is reasonably and conveniently possible; and, above all, let finance be primarily national.’ J.M. Keynes, 1933

15.

Keynes, international governance arrangements and globalisation

INTRODUCTION This book has so far dealt with the sustainable development issue from a domestic or national perspective. Apart from a reference to the pollution haven hypothesis as a potential cause for the different Environmental Kuznets Curves of the rich North and poor South (Chapter 12), and another brief reference to the employment consequences of globalisation (Chapter 14), the international dimension has been largely overlooked. One cannot, however, continue in this vein. Indeed, the international dimension may prove to be the most crucial of all areas of concern. Part V of this book explores the international dimension of sustainable development by focusing on the role played by the international mobility of financial capital, the effectiveness or otherwise of major intergovernmental development conferences, and the influence of key institutions such as the World Bank, the World Trade Organization, and the International Monetary Fund. The importance of these three institutions provides a convenient opportunity to explore the international dimension from a somewhat novel perspective – that is, by surmising what John Maynard Keynes, if he was alive today, would make of the rising globalisation phenomenon. Why Keynes? Keynes was an economist who had a profound influence on economic policy and the formation of international governance arrangements in the twentieth century. During the thirty years following World War II, economic policy was based almost entirely on the macroeconomic theory that Keynes developed in response to the 1930s Great Depression. Moreover, it was largely because of Keynes’ intellectual leadership that the World Bank, the International Monetary Fund, and the General Agreement on Tariffs and Trade (now the World Trade Organization) emerged from the 1944 Bretton Woods conference. Being an economist, many would logically think that Keynes would be a supporter of globalisation in its present form. After all, most observers believe that all economists are in favour of globalisation. While most economists are, many are not. The central aim of this chapter is to demonstrate 293

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The international dimension

that John Maynard Keynes would distance himself from the current globalisation phenomenon. This chapter also aims to reveal the extent to which the global economy departs from Keynes’ vision of economic entanglement and how a shift in emphasis towards an internationalist arrangement would increase the sustainable economic welfare of countries worldwide. Before moving on, an important point needs to be made. While this chapter involves an economic rather than socio-political examination of the globalisation issue, this does not mean that socio-political factors are peripheral to the rise and fallout of the globalisation phenomenon. Nevertheless, it is important to deal with the issue of globalisation from an economic perspective because it provides an insight into the economic misgivings of the globalisation movement. More importantly, it points the way towards a viable economic alternative and the practical means to achieving it.

GLOBALISATION VERSUS INTERNATIONALISATION Globalisation means different things to different people. From an economic perspective, globalisation refers to the integration of many national economies into one single global economy through free trade and free capital mobility (Daly, 1999b). As such, globalisation involves the erasure of national boundaries and the bypassing of many institutions and laws existing within the nation state for economic purposes. In a globalised world, the fundamental unit of concern is the corporation and the individual consumer. Moreover, international trade is governed not by the economic principle of comparative advantage, but by the principle of absolute advantage (Daly and Cobb, 1989; Ekins et al., 1994; Røpke, 1994; Daly, 1996; Lawn, 2000). Internationalisation refers to a global economic environment within which national economies exist as separate and autonomous entities tied together in recognition of the importance of international trade, treaties and alliances. In an internationalist world, the many institutions and laws existing within the nation state impinge on economic activities for the purposes for which they were intended – that is, to facilitate an efficient economy, a sustainable rate of resource use, and a just and equitable distribution of income and wealth. Accordingly, the fundamental unit of concern is the nation state. In addition, the people residing within each nation are viewed as a community of citizens rather than a collection of individual consumers. Unlike a globalised world, international trade is governed by the more desirable economic principle of comparative advantage.

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The difference in the fundamental unit of concern is of great importance in terms of the international system of governance. In an internationalist world, international institutions serve the interests of their members, which are nation states. In a globalised world, international institutions serve the interests of transnational corporations in the belief they will increase the welfare of people across the globe. As I will soon explain, the trend towards globalisation has had a profound influence on the evolution of the Bretton Woods institutions, in particular, the evolution of the General Agreement on Tariffs and Trade (GATT) and its eventual transition to the World Trade Organization (WTO).

THE BRETTON WOODS SYSTEM The Bretton Woods system emerged in response to the collapse of international financial markets and the sharp decline in international trade that accompanied the ravages of World War II and the economic ruin of the 1930s Great Depression. In order to reconstruct international goods and capital markets, representatives from 45 countries convened in Bretton Woods, New Hampshire, in July 1944. Under the intellectual leadership of Keynes, a cooperative governance arrangement was established that led to the formation of the International Monetary Fund (IMF), the World Bank, and a system for regulating the exchange rates of national currencies. An attempt was also made to establish an international institution to reduce protectionist tariffs and other barriers to international trade. Although not successful at the time, the initial discussions led to the eventual formation of the GATT in 1947. The Bretton Woods System of Exchange Rate Management Prior to the introduction of the Bretton Woods system, national currencies were valued in terms of the gold standard – a system of fixed exchange rates whereby each currency was valued in terms of a given quantity of gold. Many economists, including Keynes, were severe critics of the gold standard. Thus, under the Bretton Woods arrangement, gold was established as a ‘dual monarch’ along with the United States dollar. Instead of gold being the only international currency, each country was required to peg the value of its currency relative to the US dollar, which remained directly convertible into gold at $35 per ounce. Because each currency’s parity was valued in terms of the US dollar, a set of exchange rates for different currencies was fixed by international agreement. National governments undertook to maintain their actual exchange

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rates within one percentage point of their predetermined par values (Samuelson et al., 1992). The Bretton Woods system successfully maintained fixed exchange rates for virtually the entire period between 1945 and 1971. There were, however, occasions when the parity of a particular currency would be adjusted if it was deemed to be grossly inconsistent with its fundamental value. For example, the German Deutschmark was revalued several times, while the British pound was devalued in 1967. By establishing a fixed yet adjustable system of exchange rate management, the designers of the Bretton Woods system were able to maintain the stability of the international financial system that, for the most part, was successful in facilitating international trade. What they also managed to secure was exchange rate flexibility to minimise the number of painful deflation and high unemployment episodes frequently experienced under the gold standard. The International Monetary Fund The IMF was created during the Bretton Woods conference to administer the international monetary system, to oversee the newly established system of exchange rate management, and to serve as a central bank for the central banks of member countries. Since the demise of the Bretton Woods system in 1971, the role of the IMF has changed considerably. Initially, the great majority of the IMF’s resources were used to maintain the value of national currencies and to assist countries suffering balance of payments difficulties. The ensuing shift to a floating system of exchange rates, coupled with a rapid growth in the volume of international trade, saw the IMF become the central institution responsible for the expansion of international liquidity. The IMF fulfilled such a role by creating and allocating a new international currency called ‘special drawing rights’ (SDRs). The primary function of this new international medium of exchange was to overcome the financial constraints that countries would often face in times of a shortage of international reserves of gold and US dollars. This, it was hoped, would facilitate trade in circumstances where it would otherwise be financially infeasible. The new responsibility of the IMF enabled the volume of international trade to remain buoyant during the 1970s despite the combined effect of a world recession, high oil prices, and the very large balance of payments deficits of less-developed countries. Perhaps the most significant change in IMF policy over the last thirty years relates to the ‘conditionality’ of IMF loans. During the IMF’s first quarter of a century, stipulations were confined to the exchange rate conduct of recipient countries. Following the demise of the Bretton Woods system, conditionality was extended to the economic policies of debtor


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nations. As a consequence, the direct involvement of the IMF in the economic affairs of developing countries exceeded the role originally assigned to it at the Bretton Woods conference. The IMF’s involvement further intensified following the introduction of ‘financing packages’ that, for the first time, included private commercial bank funding (Garritsen de Vries, 1986). Financing packages now typically involve the private sector matching of each dollar lent by the IMF, thereby enabling the IMF to supervise a greater range of resources than its budget would have previously permitted. What’s more, the financing packages have allowed commercial banks to engage in the economic policies of Third World countries. The World Bank Whereas the IMF was assigned a supervisory role over the international financial system created at the Bretton Woods conference, the World Bank was created to finance Third World development and the internal reconstruction of war-torn Japan and Europe. To achieve its aim, the World Bank was assigned the task of investing the capital contributed by more than 140 member countries into development projects that would raise the productive capacity of needy nations. The World Bank was considered necessary because it was feared there was an insufficient quantity of private capital to finance economically viable projects in the period immediately following World War II. To further promote self-sustaining development, the World Bank was also assigned the task of providing technical assistance for: (a) the expansion of domestic and international markets; (b) the construction of national infrastructure; and (c) the establishment of development oriented institutional arrangements (Todaro, 1994). Not unlike the IMF, the institutional framework of the World Bank has undergone considerable changes since its inception. Initially, the World Bank’s principal concern was the rebuilding of economies destroyed during World War II. It was for this reason that all lending passed through a branch of the World Bank known as the International Bank for Reconstruction and Development (IBRD). While the structure of IBRD lending has changed little over the years, the nature of the projects it finances has altered dramatically. One of the main reasons for this was the speed with which the European and Japanese economies recovered after World War II. Thus, by the end of the 1950s, the World Bank began to focus its attention on the development of Third World countries. The shift in the emphasis of World Bank investment was reflected by the establishment in 1960 of the International Development Association (IDA). Although the responsibilities of the IDA are similar to those of the

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IBRD, its lending policies are different insofar as it specifically lends funds to countries with critically low per capita incomes. In addition, the funds are offered on concessional terms in recognition of the inability of such countries to readily service the debts incurred. The loans are typically interest-free, while the periods between repayments are many times longer than standard IBRD loans. An interesting development in the 1950s was the establishment of the International Finance Corporation (IFC) in 1956. The complementary role of the IFC involved the investment in development projects that the World Bank was restricted from financing under the Bretton Woods arrangement. Unlike the World Bank, the IFC was given the green light to directly lend to the private sector. By having the capacity to underwrite or hold equity in the projects it financed, the IFC successfully secured a direct stake in the financial interests of loan recipients (World Bank, 1983). This has greatly increased the number of new and existing private sector activities benefiting from World Bank funded projects. It is also important to recognise the extent to which the role of the World Bank has evolved in line with its structural changes. While the objectives of the World Bank are essentially macroeconomic in nature – for example, to increase a country’s GDP – the character of World Bank funding has altered markedly. Until the early 1970s, World Bank funding was primarily targeted at the microeconomic level (e.g., for infrastructural and industrial development purposes). Hence, to begin with, World Bank funding reflected the belief held by the Bretton Woods participants that desirable macroeconomic objectives should be achieved by injecting funds at the sectoral and industry levels. Following the demise of the Bretton Woods system and the rise of the IFC, there has been a significant increase in the proportion of funds used for structural adjustment purposes – that is, for the restructuring of a nation’s economy and its economic institutions to ameliorate chronic trade and government budget deficits. Thus, World Bank funding is now increasingly aimed directly at the macroeconomic level, often without regard to its sectoral implications. The General Agreement on Tariffs and Trade As previously mentioned, the GATT emerged in response to a strong desire, initially expressed by the Bretton Woods participants, to rid the international economy of unfair import restrictions and the protection of inefficient industries (Fischer et al., 1988). This, it was hoped, would further accelerate the development process and increase economic welfare worldwide. The main principles underlying the GATT were:

Keynes, international governance and globalisation ● ● ●

●

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countries should cooperate, wherever possible, to lower barriers to trade; all trade barriers should be applied on a non-discriminatory basis (i.e., no country should be awarded preferential treatment over another); should a country increase its tariffs above agreed-upon levels, it is required to compensate its trading partners for the economic injury suffered; trade conflicts should be settled via consultation and international arbitration.

Since the inception of the GATT, signatory countries have met every few years to identify troublesome trade barriers and to negotiate their removal. Although significant trade barriers continue to exist, many observers consider the history of trade and tariff negotiations to be one of the major successes in international cooperation. Not everyone agrees with this view, despite the fact that tariff levels and import quotas have been substantially reduced. Indeed, fewer observers hold such a view since the GATT became the World Trade Organization in 1995. However, this cannot be considered a failure of the Bretton Woods system but, as we shall see, a consequence of the transition to globalisation. The Bretton Woods System as an Example of Internationalisation Despite its shortcomings and imperfections, there is little doubt that the Bretton Woods institutions and system of exchange rate management was of the internationalist mould. We know this because the Keynesian model upon which the Bretton Woods institutions emerged was based on an international federation of national communities cooperating to solve global economic dilemmas under a governance principle of subsidiarity (Daly, 1996). In addition, the World Bank and the IMF were initially conceived to serve the interests of its members – nation states – not powerful elites and transnational corporations. The same can be said of GATT. While GATT was initially designed to increase the volume of international trade, its policy of negotiating tariff reductions and promoting greater access to markets was aimed at overturning the existence of unfair import restrictions and the widespread practice of protecting inefficient industries to the detriment of both the domestic country and its potential trading partners. Although a great number of transnational corporations have since benefited from this policy, many inefficient operators that previously hid behind protectionist trade barriers have not.

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THE DEMISE OF THE BRETTON WOODS SYSTEM AND THE RISE OF GLOBALISATION During the quarter of a century following World War II, the world economy thrived under the Bretton Woods arrangements. Why, then, did the Bretton Woods system collapse? Despite its success, it was a far from perfect system. More importantly, the Bretton Woods system was never devised with the intention of continuing indefinitely (Harrod, 1951). It was a cooperative arrangement designed to meet international needs and concerns at the time. Thus, like any system with a limited lifespan, its success contained the seeds of its own destruction. The Demise of the Bretton Woods System To understand precisely why the Bretton Woods system collapsed, it is necessary to recall that exchange rate parities were previously set in US dollar terms. Furthermore, since most international transactions were conducted in US dollars, both government and private reserves of liquidity were primarily kept in US dollar balances. While these two factors did not, by themselves, bring down the Bretton Woods system, they constituted a noose around the system’s neck. All that was required was the emergence of an executioner. The executioner eventually arrived in the form of President Nixon following a massive accumulation of US dollars outside the United States during the 1960s that continued on into the early 1970s.1 There were three main reasons why this accumulation process took place. First, Japan and Germany had developed large trade surpluses and thus possessed huge liquid reserves of US dollars. Second, a much larger than expected level of spending was conducted abroad by the US on external military campaigns (e.g., the Vietnam War). Third, there was an increasing amount of overseas investment by American corporations during the 1960s. By 1971, the amount of liquid US dollar balances had magnified to the point where it was difficult for governments around the world to maintain official currency parities. With the US also experiencing a large balance of payments deficit, confidence in the US dollar collapsed. This greatly lowered the barriers to international capital flows. Billions of US dollars could now be easily transferred around the world at short notice. In the presence of such immense quantities of highly mobile financial capital, governments across the world found it impossible to maintain fixed exchange rates. Meanwhile, pressure began to mount on the US Treasury. So much did this pressure become, it was soon evident that the United States could no longer: (a) automatically convert US dollars into other assets; (b) trade US dollars for gold at $35 per ounce; and (c) set an official parity of the US


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dollar relative to other national currencies and, furthermore, defend the exchange rates at all costs (Samuelson et al., 1992). Consequently, in August 1971, President Nixon brought the curtain down on the Bretton Woods system by formally severing the link between gold and the US dollar. As such, the global economy entered a new era of floating exchange rates. It also ushered in the rise of globalisation. The Rise of Globalisation The formal demise of the Bretton Woods system left behind a vacuum that somehow needed to be filled. There was, however, no Bretton Woods type conference organised to render in a new system of exchange rate management. Consequently, the opportunity to maintain economic entanglement of the internationalist kind – that is, one designed to serve the interests of all nation states – was missed. With enormous pools of financial capital rapidly circulating the global economy and no international governance arrangement to regulate the flow of capital and its impact on exchange rates, the globalisation phenomenon began in earnest.2 Globalisation was further boosted by various rounds of GATT negotiations that increasingly forced signatory nations to comply with international trade rules that favoured powerful elites and transnational corporations at the expense of the capacity of national governments to introduce and enforce more stringent social and environmental standards, including efficient policies of cost internalisation.3 This trend has accelerated since the transition of the GATT to the WTO in 1995.4 Another important development in the late 1970s and 1980s was the relaxation of corporate merger constraints within countries. Due to the expansion of many individual operations during the post-WWII period, many corporations reached a scale that bestowed them with considerable market power by the 1960s. To prevent these or future corporations from engaging in anticompetitive practices, merger applications in many developed countries were often denied by the appropriate authorities. However, an explicit policy turnaround occurred in the late 1970s and early 1980s. This about-face was the result of two main factors. First, it was at this point in time that government regulation and intervention were increasingly viewed with suspicion and blamed for the 1970s episode of stagflation. Consequently, many beneficial forms of regulation were abandoned without due consideration of their long-term impact (i.e., in this case, the need for intranational competition in order for national markets to operate efficiently). Second, corporate heavyweights successfully argued for the loosening of merger constraints on the grounds that economic success in a competitive global economy required the operation of corporations to be both

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diversified and large-scale (Daly and Cobb, 1989). The licence to merge into large conglomerates provided corporations with the economies of scope and the huge sources of capital to operate offshore with a degree of ease never before experienced. This further accelerated the globalisation of international capital. It is worth pausing at this point to consider the following question: Should not the continuing survival of the Bretton Woods institutions have tempered the globalisation phenomenon? The answer would probably be yes, if not for the fact that the Bretton Woods institutions tacitly evolved in a manner inconsistent with the charter upon which they were originally conceived. As I mentioned earlier, the role of the IMF changed from being the chief arbiter and preserver of the value of national currencies and assistant to countries with balance of payments problems, to the central institution responsible for the expansion of international liquidity. The IMF was, therefore, partly responsible for the increase in international capital flows and the lack of an international arrangement to reduce the impact of currency dealings on exchange rates. In addition, the changing conditionality of IMF loans has often led to economic policies that promote the interests of commercial banks – increasingly involved in the design of debt financing packages – ahead of the interests of debt-inflicted countries and the needs of their citizens (George, 1976). As for the World Bank, its change in focus to the economic restructuring of national economies plus its investment in development projects not previously permitted under the original Bretton Woods arrangement has also resulted in undesirable outcomes for many of its constituents (Pitt, 1976; George, 1988; Daly and Cobb, 1989). In all, the collective shift in the global economic order, the evolutionary change in the Bretton Woods institutions, and the Articles under which the WTO now operates depart considerably from Keynes’ vision of a global economic environment whereby national economies exist as separate entities tied together in recognition of the value of fair and genuinely beneficial forms of international trade. There is little doubt that a gradual transition has occurred from economic entanglement of the internationalist variety – as desired by Keynes – to that of the globalisation kind.

WHAT DOES GLOBALISATION MEAN IN TERMS OF INTERNATIONAL TRADE AND SUSTAINABLE ECONOMIC WELFARE? While it is clear that the global economy currently fits the globalisation mould, is it a cause for concern? Could it be that Keynes’ vision of economic entanglement is undesirable or simply inappropriate for the


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twenty-first century? The answers to these questions depend very much on empirical evidence. There is little doubt that the ease with which international capital can be transferred around the global economy combined with the massive increase in the volume of international trade have played a significant role in boosting not only the global gross product, but the real per capita GDP of most nations worldwide (UN, 2002a). Furthermore, the percentage of the population living below the absolute poverty level in most developing countries appears to be declining (29% to 23% during the 1990s) although, with rapid population growth occurring in many of these countries, the total number of people in this category continues to rise (World Bank, 2001 and 2002).5 While material standards of living have increased quite measurably in South-East Asia over the last thirty years, it is also clear that income inequality has risen in many countries in both the less-developed South and the developed North (Cobb et al., 1995). It would therefore appear that the major beneficiaries of globalisation have been the Southern and Northern rich. Small gains have no doubt accrued to the Southern poor – indeed, as I indicated in Chapter 12, a growing middle class has emerged in South-East Asia – however, these have largely been offset by rural underdevelopment, urban overpopulation, and the loss and destruction of once self-reliant communities. The poor in the North also appear to have suffered, either in the form of low minimum wages, longer working days, and an inadequate system of social insurance (e.g., the USA), or high unemployment (e.g., Europe). But perhaps the most damning evidence of the impact of globalisation is revealed by the Index of Sustainable Economic Welfare (ISEW) and the Genuine Progress Indicator (GPI). As already explained in previous chapters, the ISEW and GPI indicate that most people are no better off than they were 20 or 30 years ago. Furthermore, the growth in economic activity facilitated by globalisation has depleted natural capital, as evidenced by the gradual rise in the world’s ecological footprint and the now apparent global ecological deficit of 0.7 hectares per person (Wackernagel et al., 1999). Critically, the downward trend in sustainable economic welfare and the emerging ecological deficit commenced not long after the global economy began its transition from internationalisation to globalisation. One might argue that the corresponding episodes of globalisation and declining economic welfare are purely coincidental. Indeed some believe the problem does not so much lie with globalisation itself, but with its obstruction by antagonists. Impedance, it is argued, has denied the great majority of people the benefits of globalisation (Beckerman, 1992; Bhagwati, 1993). Certainly more must be done if one is to apportion significant blame to the globalisation phenomenon.

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There is, however, one indisputable fact. The massive increase in, and mobility of, international capital facilitated by economic globalisation has resulted in international trade being predominantly governed by the economic principle of absolute advantage.6 Absolute advantage is where the terms of international trade are dictated by absolute rather than relative profitability. Under these circumstances, the choice of production location and corporate investment decisions are primarily based on where the absolute cost of production is lowest. This differs entirely from a situation where international trade is governed by the economic principle of comparative advantage. It has long been argued that international trade, when governed by the principle of comparative advantage, offers the potential for countries to enjoy a higher standard of living than that provided by domestic production alone. Very few people refute this assertion. However, it is rarely considered how international trade can impact negatively on welfare when it is governed by the principle of absolute advantage. To understand how this latter phenomenon might occur, one must go back to a basic premise underlying the rationale for international trade. Early in the nineteenth century, David Ricardo (1817) pointed out that the comparative advantage argument for free trade rests entirely on the immobility of capital. For instance, the principle of comparative advantage can never operate within the confines of a national economy because capital is always free to move to locations offering the most profitable investment opportunities – that is, where goods can be produced at the lowest absolute cost. Hence, at the intranational level, investment and the allocation of resources are always governed by absolute rather than relative profitability. Ricardo promoted free trade because, in 1817, the international mobility of capital was severely limited. As has been outlined above, this is not the case in a globalised economy. Should it matter that international trade is now governed by a different principle? After all, no national economy has been brought to ruin because intranational trade is governed by the principle of absolute advantage. For a number of good reasons, yes. First, intranationally, all production and exchange activities are subject to basically the same non-price rules, including any efficient national policy of cost internalisation. Consequently, no one producer can gain an unfair advantage by paying an equivalent form of work a significantly lower wage, by polluting when and where another producer cannot, or by paying a much lower rate of tax.7 To gain a competitive advantage, a producer must be genuinely more efficient than his or her nearest competitors. The same, however, cannot be said of the international market. This is because the international market is not a formally instituted market in the sense of it being a collective set of social and cultural institutions within which a large number of commodity exchanges


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between buyer and seller take place (Hodgson, 1988). Indeed, because social and cultural institutions rarely exist beyond national boundaries, commodity exchanges between international buyers and sellers take place in a domain largely free of institutional constraints. Consequently, the ‘price-determining parameters’ of national markets within which domestic production takes place are, for many countries, grossly incommensurate with those of the global market.8 To some extent, this is not a bad thing. On the positive side, it is desirable for price signals to reflect variations in economic efficiency. If a domestic producer is inefficient because a foreign producer is better at producing a similar commodity, the variation in prices should ensure the survival of the latter and the demise of the former. On the negative side, it is undesirable to have domestic producers closing down because of an inability to compete with a foreign operator subject to much weaker social and environmental standards. Yet industrial flight is precisely what an unfettered globalised market promotes because the free mobility of capital allows nationally instituted non-price rules and a policy of cost internalisation to be avoided by transnational corporations (Daly, 1993). Furthermore, the competitive pressure to lower the cost of production leads, not always to increased efficiency, but often to the erosion of environmental and social standards at the national level as the price-determining parameters of the global market come to rest at the lowest common denominator (Daly and Cobb, 1989). This so-called ‘race to the bottom’ has been exacerbated by WTO Articles that render governments somewhat powerless to introduce compensating tariffs that might otherwise offset any cost advantage possessed by foreign-made goods subject to weaker production-related standards. Recent calls in Australia to reduce the minimum wage, to allow mineral exploration in National Parks, to lower tax rates in line with taxation regimes of its nearest Asian neighbours, and to slash public funding to hospitals, schools and universities, are symptomatic of the degenerative impact of a global free trade environment governed by the law of absolute advantage. Second, since highly mobile capital will generally flow to locations with an absolute advantage in production, the potential for large trade imbalances to emerge is significantly high. The same does not occur when capital is effectively immobile because the level of international lending and borrowing required to run up large foreign debts is precluded. The growth in unserviceable foreign debts has not only forced many poor nations to deplete their natural capital assets in order to augment export income, it has often led to an IMF enforced restructuring of their economies. This invariably brings to bear significant hardship to the economically disadvantaged of such countries.9

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Finally, there are many who believe that globalisation encourages Southern nations to earn additional export income that can be used to invest in advanced capital goods and technology. This investment, it is argued, allows Southern nations to establish the necessary productive capacity to catch up with the North. In view of what has been said so far, the benefits of increased productive capacity are of little value if its achievement requires absurdly low wages and poor working conditions and/or comes at the expense of environmental degradation. Yet it is the eroding bedrock of any beneficial increase in productive capacity – namely, adequate social and environmental standards – that is fast becoming an undesirable by-product of globalisation itself. Globalisation, it seems, facilitates the emergence of opposing rather than complementary forces. But there are other long-term problems associated with export oriented globalisation. These have convinced internationalists that all nations, not simply those in the South, should focus on import replacement policies. An import replacement policy is not, as some believe, ‘anti-trade’. Nor does it require the imposition of tariffs and quotas to protect inefficient and underperforming industries. Import replacement is where a country increases the efficiency of production to such an extent that it is able to produce a variety of goods at a lower cost than it previously cost to import them. Thus, instead of earning an additional $1 billion from the production and exportation of more wheat, a country might reduce import spending on cars by $1 billion by becoming more efficient at automobile production. While it is true that an extra dollar of export income has the same effect on the balance of trade as one less dollar spent on imported goods, a successful import replacement policy leaves a country producing a greater variety of goods. This not only increases a country’s self-sufficiency, it reduces its exposure to volatile global market forces.10 In addition, overspecialisation in the quest for higher export income – that is, the production of a greater quantity of a reduced range of goods – renders a country more reliant on exports as a source of income that, in turn, renders it ‘less free not to trade’.

REINSTATING ECONOMIC ENTANGLEMENT OF THE INTERNATIONALIST KIND The aforementioned suggests that a system of exchange rate management should be installed to limit the mobility of international capital flows. Not only would this restore comparative advantage as the principle governing international trade, it would go a long way towards reinstating economic


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entanglement of the internationalist kind. In doing so, it would allow the most to be gained from international trade. An IMPEX System of Foreign Exchange Management The principle of comparative advantage can be restored by reducing the incentive of transnational corporations to locate where absolute profitability is highest internationally. This can be achieved by restricting the international mobility of financial capital. A restriction of this kind reduces industrial flight insofar as the mobility of financial capital is necessary to gain from the international movement of human-made capital (i.e., of plant, machinery and equipment). If one cannot easily move the profits generated elsewhere back to one’s home country, there is a reduced incentive to locate operations overseas. As a consequence, a restriction in the international mobility of financial capital shifts the focus of the capitalist’s concern to where production can be best located domestically – a choice dictated by the principle of absolute advantage at home – but by the principle of comparative advantage internationally. Unfortunately, a direct macro constraint on the international flow of financial capital impedes the beneficial adjustment of exchange rates. With this in mind, a practical means of restoring the principle of comparative advantage is to introduce a so-called IMPEX (Import-Export) system of foreign exchange management (Iggulden, 1996).11 To operate the system at a national level, an IMPEX facility would be formally established by a national government. Ideally, the IMPEX facility would come under the supervision of a country’s central bank. Unlike the present system, the IMPEX system would operate under five critical rules. 1. 2. 3. 4.

5.

Every international transaction must pass through the IMPEX facility. All foreign currency must be exchanged for IMPEX dollars ($IMP). The purchase of foreign currency requires the possession of IMPEX dollars. No spending on imports is permitted unless there is sufficient ‘earned’ foreign exchange available on the day (held in the form of IMPEX dollars) and only if importers are willing to pay the price being asked by the possessors of IMPEX dollars. The buying and selling of the IMPEX dollars of any particular country is only open to the citizens of that country.

The exchange process would operate as follows. When foreign currency enters a country, the earner receives IMPEX dollars based on the exchange rate between the domestic currency and the foreign currency earned. For

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instance, if an Australian exporter earns $US100 and the going exchange rate between an Australian and American dollar is $US1.00 = $Aus1.20, the Australian receives $IMP120 from the IMPEX facility. The possessor of the $IMP120 is free to purchase another foreign currency to import foreign goods or, if they have no importing intentions, to sell the IMPEX dollars to an Australian who does. The Australian could not sell the IMPEX dollars to a foreign national. Should the Australian exporter want immediate conversion of American to Australian dollars, the earned IMPEX dollars would still be available for purchase by potential Australian importers, however, they would be held by the IMPEX facility. In the day-to-day buying and selling of IMPEX dollars, an IMPEX rate establishes itself relative to the domestic currency. For example, assume that the demand for IMPEX dollars exceeds its supply such that $Aus140 is required to purchase $IMP100. The going IMPEX rate would be 1.40. Should the amount of IMPEX dollars demanded by Australians for import purposes increase relative to the IMPEX dollars earned, the IMPEX rate would appreciate (go higher than 1.40). On the other hand, if the demand for IMPEX dollars fell relative to its supply, the IMPEX rate would depreciate (go lower than 1.40). What, then, would an Australian have to do if they required $US100 to import American goods? Unless they were already in possession of IMPEX dollars, they would firstly be required to purchase $IMP120 as per the going exchange rate between the Australian and American dollar of $US1.00 = $Aus1.20. Second, to purchase $IMP120, they would be required to part with $Aus168 as per the going IMPEX rate of 1.40 (i.e., $US100 1.20 1.40). Thus, in order for an Australian to import $US100 worth of American goods, it would cost $Aus168, not $Aus120 as per usual. Clearly, there would be two currency markets in place. One is the traditional foreign exchange market. The other is a domestic IMPEX market. In the international foreign exchange market, exchange rates fluctuate as per normal because although the IMPEX system ensures a nation’s overall trade is balanced, it still allows a country to have trade imbalances with individual countries. For example, Australians may choose to import more American goods and fewer Japanese goods, thereby leading to deterioration in the terms of trade with the US but an improvement with Japan. Since Australians would demand more $US and fewer Japanese yen then, ceteris paribus, the $Aus should depreciate relative to the $US and appreciate relative to Japanese yen. Operated along these lines, the IMPEX system delivers two important benefits. To begin with, it ensures a balance of payments equilibrium and the absence of unserviceably large foreign debts. Second, it internalises domestic environmental and social standards into the price of foreign


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goods. By doing so, the IMPEX system restores the principle of comparative advantage by eradicating the absolute disadvantage that domestic goods normally suffer whenever strict environmental and social standards increase the cost of domestic production. How does the IMPEX system do this? Let’s say that a national government introduces stricter environmental and social standards which increases the cost of domestic production and thus causes the price of all domestic goods to rise relative to foreign goods. One would expect a decrease in exports, a fall in the amount of earned foreign exchange, and a subsequent decline in available IMPEX dollars. On the import side, an increase in the demand for imports would be expected as well as a corresponding rise in the demand for IMPEX dollars. Both factors push up the price of IMPEX dollars and, by increasing the cost of imports, largely offset the price advantage originally enjoyed by foreign goods. As will be formally demonstrated in the next chapter, it is this internalisation of domestic standards into the prices of foreign goods which generates an international trading environment that can facilitate increases in sustainable national income. I should also add that an IMPEX system of foreign exchange management need not be as rigid as suggested here. It is possible for the IMPEX facility to make available for purchase a small amount of ‘unearned’ IMPEX dollars. This would permit small trade imbalances, allow for overseas borrowing/lending that could be of particular value to poorer nations requiring an injection of overseas investment funds, and incorporate some degree of flexibility into the system. Flexibility is required in the event that other countries introduce the IMPEX system. For example, the IMPEX system prohibits import spending until such time as there is foreign currency earned from exports held in the form of IMPEX dollars. However, the latter cannot occur unless there is a willing importer. If the potential importer also has an IMPEX system in place, but has yet to export goods of its own, the import spending would be prohibited. Clearly, a stalemate between the two countries would ensue that could only be overcome if a small amount of unearned IMPEX dollars was made available by an IMPEX facility operating in the importing country. Of course, given the potential for foreign debt to be economically and ecologically unserviceable, there is a need for strict controls on the amount of unearned IMPEX dollars issued by an IMPEX facility. Ideally, unearned IMPEX dollars would cease to be issued once the accumulated foreign debt reached a small fraction of a nation’s sustainable income – for example, 2 or 3% of Sustainable Net Domestic Product.12 A similar restriction would also have to be placed on the amount of unearned IMPEX dollars purchasable by overseas investors who, with some flexibility

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incorporated into the IMPEX system, would be free to buy and sell foreign IMPEX dollars up to a pre-assigned limit. This would prevent interest payments to overseas investors exceeding a nation’s maximum serviceable capacity. I would just like to conclude this section by allaying any fears that an IMPEX system of foreign exchange management is simply another protectionist policy designed to maintain the wealth of rich countries by keeping the Third World poor. When asked during an internet seminar on his 1996 book, Beyond Growth, about the possible implications of internalising social and environmental standards into the prices of imported Third World goods, Herman Daly had this to say: Granted this makes it harder for poor countries to export – so does a decent minimum wage and the existence of free labour unions and the outlawing of child labour within the poor country. In my view it is not all bad to make it harder for poor countries to export to the US. It means that instead of planting all their land in bananas or fancy fruits and flowers for export, the poor country might have to plant more rice and beans for its own citizens. And to sell the rice and beans to its own citizens, it will have to worry about their purchasing power – about domestic jobs and decent wages, and the distribution of income within their country. And they might worry a bit less about cutting wages and social benefits in order to be more competitive in the global market, as they must do in the export-led model of development to which the IMF and WTO are so totally committed. Admittedly, less export revenue will be available to buy expensive toys for the elite, but even that might not be all bad. Maybe they will begin to invest some of their surplus in their own country. (http://csf.colorado.edu/ seminars/daly97/proceedings)

Bringing the Bretton Woods Institutions into Line with Internationalist Requirements In order to reinforce the IMPEX system of foreign exchange management, it is necessary to reverse the changes to the Bretton Woods institutions so they again operate in line with the charter upon which they were originally conceived. This requires the IMF to greatly reduce both the creation and allocation of special drawing rights that would significantly limit the expansion of international liquidity. More importantly, the IMF should alter the conditionality of its loans to assist developing countries to service their foreign debts in ways that do not cause short-term hardship (e.g., reduced national expenditure on welfare, health and education) and long-term impoverishment (e.g., the depletion of natural capital stocks that inevitably leads to a decline in a nation’s sustainable productive capacity). Given that the IMF was originally created to administer the international monetary system, it could also play an important role as the


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overseer of a widely introduced IMPEX system of foreign exchange management. For example, the IMF could, along with the central banks of each participating country, monitor the issuing of IMPEX dollars within nations and ensure the trade in IMPEX dollars complied with the five critical rules listed above. As for the World Bank, a greater proportion of the investment capital contributed by its member countries should be used to redistribute capital goods and technology from developed to developing countries. Not only would this raise the productive capacity of needy nations – a primary reason for the World Bank’s creation – it would facilitate the narrowing of the technology and income gaps between the North and South. As it presently stands, many World Bank projects fail in this regard because growing private sector funding has resulted in the great majority of the benefits flowing back to transnational corporations and their wealthy shareholders. Invariably, only a small percentage of the profits are reinvested in the South. Bridging the technology gap would enable developing countries to better compete with the North in terms of the production and sale of high value-added goods without the need for low wages, poor working conditions and weak environmental standards. With more of the profits being domestically generated and owned, a higher level of Southern reinvestment is also likely to ensue. I pointed out that the IMPEX system has the capacity to eradicate the absolute disadvantage that domestic goods often endure whenever strict environmental and social standards increase the cost of domestic production. There is, however, a good reason why the introduction of an IMPEX system is unlikely to lead to the full internalisation of domestic environmental and social standards into the price of foreign-made goods. Markets are not perfect – they have a propensity to fail. This aside, the failure of markets rarely justifies their wholesale abandonment. Except for extreme cases, the usual solution is some form of collective intervention that improves the effective operation of markets. The IMPEX system of foreign exchange management is no exception. Its probable failure to fully internalise the cost of environmental and social standards into the price of foreign-made goods justifies the imposition of ‘green’ tariffs – that is, a tax charged by a government on an imported good to internalise whatever cost remains externalised by the IMPEX system. As previously explained, current WTO Articles often prohibit such action. There is a potential problem associated with green tariffs. It is possible for a tariff war to rage should some countries take the opportunity to impose tariffs for protectionist reasons (i.e., to protect an inefficient domestic industry from overseas competition). Internationalists believe it is the WTO’s legitimate role to resolve rather than complicate the green tariff issue. They

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are of the opinion that the WTO is the ideal institution to oversee and sanction green tariffs that genuinely reflect the internalisation of domestic standards into the price of foreign-made goods. Internationalists also believe the WTO is ideally positioned to forbid illegitimate tariffs. Were this to happen, the WTO’s fundamental unit of concern would shift from the corporation to the nation state as originally intended by the instigators of the Bretton Woods system. Of equal importance, the current trend of standards-lowering competition would also be averted.

CONCLUDING REMARKS Globalisation, as I have defined it in this chapter, is a destructive force that has failed to generate the welfare benefits claimed by its advocates. The decline in sustainable economic welfare being experienced worldwide supports the internationalist position held by John Maynard Keynes and his vision of economic entanglement that facilitates beneficial forms of international trade, allows national economies to exist as separate and autonomous entities, and enables democratically elected governments to introduce laws that impinge on economic activities for the purposes for which they were intended. One can safely conclude that Keynes, if he was alive today, would not think kindly of globalisation as it exists at the beginning of the twenty-first century. Whether Keynes would endorse the practical measures offered in this chapter to achieve internationalisation is another matter. Nonetheless, it is high time that Keynes’ vision was again embraced and the means to its realisation was widely debated and discussed.

NOTES 1. 2. 3.

4.

By the early 1970s, holdings of US dollars abroad had grown from virtually nothing to $50 billion (Samuelson et al., 1992). Indeed, institutional changes were brought into being to increase rather than control the international mobility of financial capital. By cost internalisation I mean policies that seek, usually through depletion and/or pollution taxes, to internalise the spillover cost of environmentally damaging activities into the price of the goods produced as a consequence of such activities. Cost internalisation policies can also be facilitated through the introduction of tradeable resource use permits and assurance bonds of the like described in Chapter 11. Cost internalisation deliberately favours goods produced with a lower environmental impact. It is true that a country has the ability under WTO rules to impose a tariff on an imported good produced by foreign firms subject to weaker workplace and environmental standards (the aim of which is to eliminate the cost advantage foreign producers gain by producing in such locations). However, the right to impose such a tariff is conditional upon


5.

6.

7. 8.

9.

10. 11. 12.

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an identical tax being imposed on domestic producers. The problem with this is that, in most cases, taxes are not used to penalise ‘dirty’ domestic producers. More often than not, a regulation in the form of a legislative requirement is used to compel domestic producers to meet acceptable social and environmental standards. The difficulty with this lies in the fact that such regulations increase the cost of dirty production but, since the increase in cost is due to regulations rather than the imposition of explicit taxes and charges, the cost disadvantage to domestic producers cannot be offset by a tariff. Only the latter and not the former constitutes a legitimate basis for tariff impositions. It is problematic whether the fall in the percentage of people in developing countries living under the absolute poverty line was as large as that reported by the World Bank. The poverty income threshold arbitrarily chosen by the World Bank was a mere $1 per day. Many would argue that a much larger daily income is required for someone to be classed as living beyond the absolute poverty level. Where the principle of absolute advantage does not hold sway is in relation to tourism, agriculture, and the resource extractive industries because, unlike factory production, an abundance of natural scenery, desirable growing conditions, and natural resource stocks cannot be relocated from one country to another. While there are often disparities between the non-price rules of different states or provinces in a given country, they are usually much smaller in magnitude than the disparities between different nations. Price-determining parameters are the various economic, social and environmental factors which form the institutional context of any particular market. As such, they influence or ‘determine’ the market price for different goods and services. Examples include natural capital services, human know-how, cultural norms and beliefs, as well as individual tastes and preferences (d’Arge, 1994). There are, however, a number of countries with very large foreign debts that appear quite serviceable. According to Pitchford (1990), most foreign debts are of little concern since many accumulated debts are the result of numerous rational arrangements established between domestic borrowers and foreign lenders. While this may be so, one must be careful not to fall victim to the fallacy of composition. Micro rationality can still lead to macro irrationality if transactions between individuals and entities across international borders are incommensurate with the social and environmental standards of the countries in which they reside. Self-sufficiency was recently promoted as a desirable national goal in the United Nations Report on the World Summit on Sustainable Development that was held in Johannesburg (United Nations, 2002b). The term IMPEX is merely a convenient amalgamation of IMP and EX, which are short for imports and exports. A 2 or 3% rate is consistent with the regeneration rate of most renewable resources – in effect, the interest rate generated by the natural capital that all nations are ultimately reliant upon.

16.

Increasing sustainable national income by restoring comparative advantage as the principle governing international trade

INTRODUCTION In the previous chapter, three important claims being made by ecological economists were outlined. The first was that, in a world characterised by highly mobile capital flows, international trade is governed by the principle of absolute advantage, not by the principle of comparative advantage. The second was that international trade can undermine the efforts of national governments to introduce more stringent environmental and social standards because, when capital flows are highly mobile, transnational corporations can readily relocate production activities to avoid nationally instituted non-price rules and cost internalisation policies. Finally, it was claimed that the potential for capital to flow to locations enjoying an absolute advantage in production can lead to the emergence of large trade imbalances that cannot be serviced in an ecologically sustainable manner. To deal with these claims – in particular, the need to restore comparative advantage as the principle governing international trade – an IMPEX system of foreign exchange management was posited. The aim of this chapter is to provide theoretical support for the IMPEX system. To do this, the IS-LM-EE model revealed in Chapter 13 is expanded to include a ‘balance of payments’ or BP curve. The more extensive IS-LMEE-BP model is employed to analyse the relationship between international trade and sustainable national income under a different set of international trading conditions – one where capital is highly mobile (the status quo position); another where the international mobility of capital is restricted by the IMPEX system of foreign exchange management (the Lawn position).1

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Restoring comparative advantage

315

THE IS-LM-EE-BP MODEL Because this chapter focuses on sustainable national income rather than real GDP, sustainable income will be defined, as it was in Chapters 6 and 8, as the maximum quantity of goods a nation can consume in the present without undermining its capacity to consume the same quantity of goods in the future. In this sense, a nation’s sustainable income will be equivalent to Sustainable Net Domestic Product (SNDP) as represented by equation (6.1). Since it will also be assumed that natural and human-made capital are complements, not substitutes, the SNDP in question will be of the strong sustainability variety. That is, the two forms of capital must be individually kept intact. As it turns out, by having an environmental equilibrium (EE) curve explicitly incorporated into the IS-LM-EE-BP model, the national income level corresponding to an environmentalmacroeconomic equilibrium (i.e., where the IS, LM, EE, and BP curves intersect) is automatically equal to SNDP of the strong sustainability kind. The notation used in the IS-LM-EE-BP model is the same as that used in Chapter 13. However, the following is included to deal with the addition of an external sector: ● ● ● ● ● ● ● ●

BPbalance of payments NX net exports (exports minus imports) CFnet inflow of financial capital Yf foreign national income e nominal exchange rate er real exchange rate (where er e P/Pf) Pf foreign price level if foreign short-term nominal interest rate.

The IS Curve The LM and EE curves in this extended framework do not differ from the IS-LM-EE model. However, with international trade now taken into account, the same cannot be said of the IS curve. If we again assume that real output adjustments to changes in aggregate spending are sluggish, aggregate spending on all goods will now be denoted by A(, Y, G, Yf , er), whereby the net exports component is NX(Y, Yf , er). This means that adjustments in real output can be written as: dY [A(, Y, G, Y , e ) Y] f r dt or

(16.1)

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dY (, Y, G, Y , e ) f r dt

(16.2)

Because equilibrium in the goods market still requires A Y, equation (16.2) defines the IS curve in (, Y) space when dYdt 0. The slope of the IS curve is Y , which is again negative. Along with variations in G as per the government’s fiscal policy stance, other factors with the potential to shift the IS curve are changes in foreign income and an appreciation/depreciation of the real exchange rate. The Balance of Payments or BP Curve To derive the BP curve, it will be assumed that a disparity between the domestic and foreign interest rate induces a domestic inflow/outflow of financial capital. By also assuming that the balance of payments is equal to net exports plus the net inflow of financial capital, the balance of payments can be written as: BP NX(Y, Yf , ef ) CF

ddt * if

(16.3)

Equation (16.3) defines the BP curve in (,Y) space when BP 0 and ddt 0. The slope of the BP curve is non-negative and depends on the mobility of financial capital. For example, the more mobile are financial capital flows, the flatter is the BP curve. If financial capital flows are perfectly mobile, the BP curve is horizontal. A vertical BP curve arises when financial capital is unable to flow across international borders in response to interest rate differentials. This is effectively the situation that arises when an IMPEX system of foreign exchange management is in place.2 Moreover, the IMPEX system ensures the BP curve automatically shifts to the point where the IS and LM curves intersect. Why is this so? Assume, for a moment, that there is a rightward shift of either the IS or LM curve that brings about an intersection of the two curves somewhere to the right of the BP curve. The resultant increase in real income will lead to a rise in imports and a subsequent decline in net exports. Because the IMPEX system restricts the mobility of capital, an offsetting inflow of financial capital is not forthcoming. Hence there will be a balance of payments deficit (BP 0). Normally, in these circumstances, the eradication of the balance of payments deficit requires central bank intervention in the foreign exchange market – for example, the selling off of the domestic currency to induce a real exchange rate depreciation that, in turn, increases net exports. Such a

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move is unnecessary with an IMPEX system in place because the initial increase in the demand for imports leads to an increase in the demand for a given supply of IMPEX dollars. The supply of available IMPEX dollars will, in a sense, be fixed because the increase in supply is contingent upon an increase in the foreign exchange earned from exports. The increase in demand for IMPEX dollars relative to its fixed supply forces up the price of available IMPEX dollars. By increasing the cost of importing foreign goods, net exports decline until a balance of payments equilibrium is restored. That is, the initial increase in imports induced by the higher national income is offset by lower imports arising from the increase in the price of IMPEX dollars. Thus, regardless of how much and in what direction real income fluctuates in response to shifts in the IS and LM curves, the IMPEX system is able to induce a shift of the BP curve in order to maintain a balance of payments equilibrium. Figure 16.1 depicts an environmental-macroeconomic equilibrium for an open economy where the interest rate/income combination of (0, Y0) leads, simultaneously, to environmental equilibrium, a balance of payments equilibrium, and equilibrium in both the goods and money markets. Again, for simplification, Figure 16.1 is presented in the same way as EE (dN/dt = 0) LM (dR/dt = 0)

BP (d␭/dt = 0; BP = 0)

0

IS (dY/dt = 0)

Y0

Ymax

real Y

Figure 16.1 Environmental-macroeconomic equilibrium (IS-LM-EE-BP model)

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Figure 13.1 with the EE curve steeper than the IS curve at their point of intersection. Figure 16.1 also presents a status quo position where the BP curve is both upward sloping and flatter than the LM curve. In view of the highly mobile nature of financial capital, this is an entirely reasonable assumption.

SUSTAINABLE NATIONAL INCOME AND INTERNATIONAL TRADE In what follows, the impact of policy changes on sustainable income will be considered within the context of two different sets of international trading conditions – one where capital is highly mobile (the status quo position); another where the international mobility of capital is restricted by an IMPEX system of foreign exchange management (the Lawn position). To do this, the following will be assumed: ● ● ● ●

A floating exchange rate regime is in place; Domestically all spillover or external costs are borne by resource users and polluters (1); There is no international trade in low entropy resources and high entropy wastes, only goods;3 The technological parameter capturing the state of resource-saving and pollution-reducing technological progress is less than one ( 1). This allows for technological progress and a rightward shift of the EE curve.

Hypothetical Policy Initiative No. 1: Introduction of a Macro-environmental Constraint The first hypothetical case is represented by Figure 16.2. Panel 16.2a depicts a situation where an IMPEX system of foreign exchange management is in place (vertical BP curve), while Panel 16.2b depicts a status quo situation where international financial capital is highly mobile (upward sloping BP curve). In both figures, it is assumed that, to begin with, there is no macro-environmental constraint on the scale of economic activity. It is also assumed that a macroeconomic equilibrium initially exists at point a where the interest rate/output combination is (0, Y0). Because of the lack of a macro-environmental constraint, the prevailing income level at point a is ecologically unsustainable (R r N). The government now adopts a ‘sustainability’ stance and subsequently imposes a macro-environmental constraint. It does this with the introduction

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Restoring comparative advantage Panel 16.2a

BP1 BP2 BP0 EE0 EE1 EE2

1 IMP 0

LM1 LM2 LM0

b c a IS

Y1 YIMP Y0

YS real Y

Panel 16.2b

EE0 EE1

LM 1

LM 0

BP1 BP0

HMC 0

b

a

IS1

YHMC YIMP Y0

IS0

YS real Y

Figure 16.2 Sustainable national income following the introduction of a macro-environmental constraint (IMPEX system versus highly mobile capital)

320


of a system of tradeable resource use permits and assurance bonds as described in Chapter 11. By ensuring the macroeconomy operates on an EE curve, the government policy guarantees that any future income level will ultimately be sustainable. The question is, will the sustainable income level be greater with highly mobile capital flows or with capital flows restricted by an IMPEX system of foreign exchange management? Consider Panel 16.2a where an IMPEX system of foreign exchange management is in place. With the throughput of resources now restricted to the maximum sustainable rate, and the macroeconomy initially forced to operate on the EE0 curve, resource prices rise to fully reflect ecological limits, not just spillover costs, as resource buyers bid up the price of the newly introduced resource use permits. This increases the resource input cost of production. Let’s assume that an increase in resource-saving technological progress is induced by the higher cost of natural resource use (i.e., increases and the EE curve shifts rightward from EE0 to EE1). Let’s also assume that the extent of the technological progress is insufficient to prevent a rise in goods prices. With an increase in P, two things happen. First, the LM curve shifts left to LM1 as the stock of real money balances declines (i.e., M/P falls). Second, the real exchange rate rises. This leads to a fall in the foreign demand for domestic goods and an increase in the domestic demand for foreign goods. Do net exports fall? No, because as explained in the previous chapter, the price advantage enjoyed by foreign goods is offset by an increase in the price of IMPEX dollars. Hence, domestic producers are not disadvantaged by the increase in the domestic cost of production. Furthermore, the offshore relocation of domestic producer goods is discouraged. As a consequence, the BP curve shifts left to BP1 while the IS curve remains stationary. Overall, a new macroeconomic equilibrium is established at point b where the interest rate/output combination is (1, Y1). Since point b is to the right of the new EE curve, Y1 is still unsustainable. Resource prices therefore increase further as does the resource input cost of production. Assuming another induced rise in resource-saving technological progress, the EE curve shifts rightward to EE2. With point b now to the left of EE2, goods prices fall. The LM curve shifts rightward somewhat to LM2 as does the BP curve to BP2. The equilibrium at point c is now an environmental-macroeconomic equilibrium where the interest rate/output combination is (IMP, YIMP). While national income has fallen from its original level at point a, it is now ecologically sustainable. In Panel 16.2b, where capital is highly mobile, everything is the same as Panel 16.2a, except, in this case, the rise in the real exchange rate leads to a decline in net exports. Because international trade is governed by the


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principle of absolute advantage, domestic producers are disadvantaged by the increase in the domestic cost of production. Depending on the cost of relocation, there is also likely to be some degree of industrial flight. Since net exports decline, the BP curve shifts up to BP1 while the IS curve shifts down to IS1. Overall, a new environmental-macroeconomic equilibrium is established at point b where the interest rate/output combination is (HMC, YHMC). Again, national income is lower than at point a but is now ecologically sustainable. If one compares the sustainable national income in Panels 16.2a and 16.2b, it is higher with an IMPEX system of foreign exchange management in place (i.e., YIMP YHMC in Panel 16.2b). Why would this be the case? Quite simply, when capital is highly mobile and is able to escape the cost disadvantage of a macro-environmental constraint, the perceived need to develop resource-saving technological progress and/or adopt cleaner production techniques is considerably reduced. Consequently, with comparably dirtier production techniques employed, the sustainable income level is much lower. From a policy perspective, prior knowledge by a government of a possible reduction in national income could be enough to deter it from introducing the macro-environmental constraint in the first place, in which case national income would initially be higher at Y0, but would be ecologically unsustainable. In a worst case scenario, a government could go much further and, in order to increase national income in the short run, dilute existing environmental and social standards. Hypothetical Policy Initiative No. 2: An Expansionary Monetary Policy In the second hypothetical case, it is assumed that a macro-environmental constraint has already been instituted. It is also assumed that the initial equilibrium at point a, where the interest rate/output combination is (0, Y0), is an environmental-macroeconomic equilibrium (R r N). Because of a high unemployment rate, the government introduces an expansionary monetary policy to increase the sustainable income level. The question again is, under which set of international trading conditions will the resultant sustainable income level be highest? Consider Panel 16.3a of Figure 16.3 where an IMPEX system of foreign exchange management is in place. Because of a shift rightward of the LM curve to LM1, a new macroeconomic equilibrium is established at point b where the interest rate/output combination is (1, Y1). Two things are worthy of note at this point. First, the rise in the demand for resource throughput now exceeds the available resource supply (R

r N). This increases resource prices. In doing so, it induces resource-saving

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The international dimension Panel 16.3a

BP0 BP2 BP1 EE0 EE1

LM0 LM2 LM1

0 IMP 1

a

c b IS

Y0 YIMP Y1

YS

real Y

Panel 16.3b

LM0

EE0 EE 1

LM2

LM1 BP0 BP1

0 = HMC 1

c a b IS0 IS1

Y0YHMCYIMP Y1

YS

real Y

Figure 16.3 Sustainable national income following an expansionary monetary policy with macro-environmental constraint already in place(IMPEX system versus highly mobile capital)


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technological progress that shifts the EE curve rightward to EE1. Second, since the amount of technological progress is insufficient to prevent the increased cost of resources flowing to some extent onto goods prices, P rises. This shifts the LM curve leftward to LM2 while also appreciating the real exchange rate. The latter increases the domestic demand for foreign goods but decreases the foreign demand for domestic goods. The domestic demand for foreign goods is also boosted by the rise in national income. With an IMPEX system in place, the price of an IMPEX dollar increases in response to both the rise in their demand, and the fall in their supply. This causes the BP curve to shift rightward to BP2. Overall, a new environmental-macroeconomic equilibrium is established at point c where the sustainable income level is YIMP. Now consider Panel 16.3b where the mobility of capital is high. The same occurs as per Panel 16.3a, however, the rise in the real exchange rate now leads to a balance of payments deficit. Why is this so? The increase in national income to Y1 causes imports to rise while the fall in the real interest rate to 1 results in an outflow of capital. As a consequence, three forces are exerted on the real exchange rate. In the first instance, the outflow of capital reduces the demand for the domestic currency and thus exerts downward pressure on the real exchange rate. Second, the rise in imports does likewise by increasing the supply of the domestic currency on the foreign exchange market. Finally, the increase in the price of domestic goods exerts upward pressure on the real exchange rate. Since the first two forces, combined, are likely to exceed the latter, one would expect an overall depreciation of the real exchange rate. This increases net exports and causes the IS curve to shift upwards to IS1 and the BP curve to shift downwards to BP1. With the LM curve shifting leftward somewhat to LM2 (in response to the increase in goods prices), a new environmental equilibrium is established at point c where the sustainable income level is YHMC. A comparison of Panels 16.3a and 16.3b shows that sustainable income is again higher when an IMPEX system of foreign exchange management is in place (i.e., YIMP YHMC in Panel 16.3b). Why? When capital mobility is high the increase in net exports brought on by the depreciation of the real exchange rate puts greater pressure on the real interest rate (i.e., HMC in Panel 16.3b IMP in Panel 16.3a). This leads to the use of dirtier production techniques vis-à-vis the IMPEX system and a lower sustainable income level. Once again, this may induce a weakening of existing environmental and social standards and/or force a government to remove the existing macro-environmental constraint with obvious detrimental implications for future levels of national income.

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CONCLUDING REMARKS Because of the high mobility of capital, international trade is presently governed by the less desirable principle of absolute advantage. In keeping with the ecological economic preference for a macro control-micro flexibility approach to policy setting, an IMPEX system of foreign exchange management has been presented as a way to restrict the mobility of capital and to restore comparative advantage as the principle governing international trade. To offer theoretical support for the IMPEX system, an IS-LM-EE-BP model was introduced to analyse the relationship between international trade and sustainable income. In the two hypothetical policy initiatives presented in this chapter, (a) where a macro-environmental constraint was imposed on the scale of economic activity, and (b) where an already existing macro-environmental constraint was accompanied by an expansionary monetary policy, the sustainable income level was shown to be higher under an IMPEX system compared to the present situation where international capital flows are highly mobile. Exactly what the prospects might be for any introduction of the IMPEX system is, of course, a moot point. Given the predilection that the WTO and IMF have for free market solutions, it is possible that such a system would be inconsistent with the current membership requirements of both organisations. This would render any attempt to introduce an IMPEX system exceptionally difficult. Political economic barriers aside, the IMPEX system of foreign exchange management is in no way anti-trade; it minimises the likelihood of international financial crises by preventing the emergence of unserviceable foreign debts; it is still very much a market based system in that it permits exchange rate flexibility while automatically internalising domestic environmental and social standards into the price of foreign-made goods; and, by facilitating higher levels of sustainable national income, it promotes trading patterns considerably more in keeping with the three desirable goals of ecological sustainability, allocative efficiency and distributional equity. With all due respect to the organisations in question, perhaps it is time for the WTO, IMF and the World Bank to again function in the spirit of the Bretton Woods charter from which they were originally created – that is, to serve the genuine long-term interests of member states – and provide a climate congenial to the establishment of more desirable trading arrangements, including such institutional mechanisms as an IMPEX system of foreign exchange management.


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NOTES 1. While the aim of the IMPEX system is to protect both environmental and social standards from the degenerative impact of free trade, the IS-LM-EE-BP model deals only with environmental factors. 2. If the IMPEX facility makes available to potential overseas investors a limited amount of ‘unearned’ IMPEX dollars, it is possible for the BP curve to be upward sloping rather than strictly vertical. However, the limit on the amount of IMPEX dollars purchasable by overseas investors means the BP curve will have a very steep slope. 3. It is true that trade in resources and wastes can shift the EE curve rightward and, in doing so, augment a nation’s ecological carrying capacity. However, this must come at the expense of a leftward shift of the EE curve for the exporter of resources and/or the importer of wastes. Trade of this nature can be sustainable so long as the exporter of resources and/or the importer of wastes have sufficient capacity to remain within their own ecological limits. Despite this, trade in resources and wastes have been ignored for simplicity and because there is an eventual limit to how much one nation can import ‘sustainability’ from ecologically well endowed countries.

17. The 2002 World Summit on Sustainable Development: another opportunity to address the scale and globalisation issues gone begging INTRODUCTION There is much to commend the 2002 World Summit on Sustainable Development (WSSD). Despite conflicting definitions, sustainable development was again confirmed as a central element of the international political agenda. Also stressed was the importance of civil society in achieving desirable goals and the crucial link between poverty and the environment. The positive elements aside, the Summit can best be described as another missed opportunity. What is it that continues to be unresolved? Above all else, it is the issue of scale – the scale of economic activity relative to the natural environment that sustains it; the scale of present and future population numbers in developing countries; and the scale of per capita consumption in the industrialised North that, for obvious reasons, is aspired to in the South. Globalisation is also an important issue that was inadequately addressed at the Summit. Indeed, the United Nations Report on the Johannesburg Summit was replete with policies to achieve sustainable development that are at odds with globalisation forces and international trading rules that increasingly favour powerful elites and transnational corporations at the expense of nation states (United Nations, 2002a). In the remainder of this brief chapter, I will reiterate the critical nature of the scale and globalisation issues, in what way the Summit participants failed to address them, and what needs to be done to increase sustainable economic welfare worldwide.

THE ISSUE OF SCALE Since the release of the Brundtland Report in 1987 (WCED, 1987), there have been many attempts at defining sustainable development, most of which emphasise the role of social and political factors in providing the 326

The 2002 World Summit on Sustainable Development

327

institutional bedrock upon which sustainable development can proceed. As we have seen in this book, ecological economists regard sustainable development as a process whereby: (a) the scale of economic activity is ecologically sustainable, and (b) the difference between the per capita benefits and costs of economic activity – economic welfare – is non-declining. To ensure the scale of economic activity is ecologically sustainable, the rate of resource throughput fuelling an economic system must, of course, remain within the regenerative and waste assimilative capacities of the natural environment. Should this rate be exceeded, an economic system has effectively overshot its maximum sustainable scale (Catton, 1980). Is it desirable for economic systems to operate at their maximum sustainable scale? For two reasons, no. First, the complexity of ecological systems and the coevolutionary nature of economic and ecological change render a precise understanding of the maximum sustainable scale impossible. For precautionary reasons, the scale of economic systems should be limited to something much smaller than their estimated maximum. This is why I recommended in Chapter 11 that the incoming resource flow should be limited to approximately 75% of the estimated maximum sustainable rate. Second, as the maximum sustainable scale is approached, the additional cost of an increase in scale is very large (the law of increasing marginal costs). Conversely, the additional benefits of the same increase in scale are very small (the law of decreasing marginal benefits). Thus, at this point, a further increase in the scale of an economic system leads to the extra costs of growth exceeding the extra benefits. This results in a decline in sustainable economic welfare and a failure to achieve sustainable development. With this in mind, nations should operate their economies at a scale that comes closest to maximising sustainable economic welfare – what we now know as the optimal scale (S* in Figure 2.4). Once the optimal scale has effectively been obtained, a nation can continue to experience sustainable development by focusing its efforts on qualitative improvement. By qualitative improvement I mean producing better rather than more goods; substituting towards non-economic activities as the production of better goods reduces the need for more consumption; using resources more efficiently in production, which reduces a nation’s resource demand; increasing the durability of goods; increasing the rate of materials recycling; investing in natural capital; discovering more benign means of exploiting natural capital stocks; and controlling population growth (most relevant in the developing South). Does this mean that growth – a euphemism for increasing scale – is always undesirable? No, but growth only contributes to sustainable development in the early stages of a nation’s development process. This is why rich Northern

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countries need to limit the increase in the scale of their economies. Many have already exceeded their optimal scale and a significant number appear to have surpassed their maximum sustainable scale. Naturally enough, since impoverished Southern countries are well short of their optimal scale, many require a good dose of economic growth (albeit growth that is clean, efficient and equitably distributed). Having said this, the benefits of growth in the South are likely to be negated by the increase in population numbers projected by the United Nations (United Nations, 2002b). Clearly, there is a need for population growth control policies in the developing world. Furthermore, since the planet’s ecosystems are already highly stressed as evidenced by the world’s ecological deficit of 0.7 hectares per person, the need for Southern growth demands a reduction in per capita resource consumption in the rich North. The transfer of technology and a North to South redistribution of wealth are also urgently required. Given the clear importance of scale related issues, what actions and policies were recommended during the Johannesburg Summit? While there was an emphasis on increased efficiency, better environmental management and changing consumption habits, there was a very strong focus on the need for continued growth (United Nations, 2002a). At no stage were we given an indication as to how much growth is desirable and, most importantly, at what stage we should consider alternatives to growth. The importance attached to growth is exemplified by a foreword statement by Nitin Desai, the Secretary-General of the WSSD. Desai refers to sustainable development as a paradigm that integrates ‘economic growth, social development, and environmental protection as interdependently and mutually supportive elements of long-term development’ (italics added) (United Nations, 2002b). Consistent with previous summits, economic growth was assumed to be a sustainable development prerequisite. What was not therefore considered at the Summit was whether there are multidimensional limits to growth and, moreover, if economic growth is, as I explained above, the major cause of declining economic welfare and environmental degradation. Interestingly, if one surveys a report published by the United Nations just prior to the Johannesburg Summit entitled Global Challenge, Global Opportunity, almost all the problems mentioned within it are scale related. Consider the following examples, some of which were section headings: ●

‘The world will eventually need to feed, house, and support about 5 billion additional people. This increased population, combined with higher standards of living, particularly in the developing countries, will pose enormous strains on land, water, energy, and other natural resources.’ (United Nations, 2002a, p. 4);

The 2002 World Summit on Sustainable Development ●

● ● ●

●

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‘With population growth and almost no additional land available for agricultural expansion, arable land per capita will continue to decline.’ (United Nations, 2002a, p. 4); ‘The potential to expand crop production is limited’ and: ‘Agricultural expansion threatens other ecosystems.’ (United Nations, 2002a, p. 9); ‘Nearly half the world’s people will experience water shortages by 2025.’ (United Nations, 2002a, p. 11); ‘The world’s forested area continues to decline’ and: ‘Agricultural expansion is the main cause of deforestation.’ (United Nations, 2002a, p. 12); ‘Fossil fuel consumption and CO2 emissions continue to grow’ (United Nations, 2002a, p. 16).

Despite this evidence, never once was a reduction in scale seen as a potential solution to scale related problems. Even the most obvious and urgently needed policy of population growth control in the South was overlooked. We are instead given an optimistic picture of the world population stabilising, without the use of population policies, at around 10.5 to 11.0 billion people in the latter half of this century (United Nations, 2002a, p. 4). The participants of the Summit also avoided the issue of scale by stressing the need to ‘delink economic growth and environmental degradation’ (United Nations, 2002b, p. 13). If economic growth is defined as a quantitative increase in the scale of economic activity, the dematerialisation approach advocated in the United Nations Report is biophysically and thermodynamically unobtainable (Lawn, 2001a; Chapter 2). If, instead, economic growth is defined as an increase in the welfare generated by economic activity, it is possible, to a limited degree, to reduce a nation’s natural resource reliance. However, this is no longer a case of the quantitative growth promoted at the Johannesburg Summit, but an example of qualitative improvement – the very process I have recommended throughout this book to deal with the problem of excessive scale.

THE ISSUE OF GLOBALISATION When considering ways to achieve sustainable development (such as the resource use permit system described in Chapter 11), governments are increasingly forced to contend with the external forces of globalisation. As mentioned in the previous chapter, the ‘race to the bottom’ being exacerbated by current international trading rules and governance arrangements is placing considerable pressure on governments to lower environmental and

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social standards to allow domestic producers to compete with foreign-made goods subject to much weaker production related standards. Globalisation, as I have also argued, compels many countries to overspecialise in the production of goods. This reduces a country’s selfsufficiency, increases its exposure to volatile global market forces, and renders it more reliant on exports as a source of income. Furthermore, despite increases in the material standard of living in South-East Asia over the last thirty years, it is also clear that globalisation has increased the income gap within countries and led to the emergence of serious pockets of high unemployment in the developed North. In view of the detrimental effects of globalisation, how did the participants respond to globalisation at the Johannesburg Summit? Unlike the issue of scale, the globalisation phenomenon was given considerable attention. However, globalisation was ostensibly viewed as an irreversible force offering challenges and opportunities that nations should do their best to exploit (United Nations, 2002b, p. 3 and pp. 37–8). There was no suggestion that the entities most able to exploit globalisation are transnational corporations. Nor was consideration given to the possibility that globalisation might make it difficult for governments to introduce some of the policies the participants themselves recommended – namely, initiatives to encourage the diversification of production; the removal of market distortions and the internalisation of environmental costs into the price of natural resources; the promotion of sustainable land management practices; and the eradication of poverty by way of livable wages and access to reliable public services (United Nations, 2002b, pp. 10, 15, 17 and 30). In fact, the Summit participants were keen to increase the openness of global markets and the mobility of financial capital (United Nations, 2002a, pp. 37–9). This would merely intensify the forces of globalisation and their negative impact on economic welfare. Contrary to the position taken at the Johannesburg Summit, globalisation is reversible. As outlined in Chapter 15, economic entanglement of the kind where national economies exist as separate and autonomous entities tied together in recognition of the importance of international trade, treaties and alliances can be reinstated. Also restorable is the principle of comparative advantage which, as I have shown, would increase sustainable national income. Moreover, if there was sufficient political will expressed by the world’s powerful nations, the Bretton Woods institutions of the World Bank, the IMF, and the now WTO could again operate in conformity with the charter upon which they were conceived (see Chapter 15). In all, a modification of international governance arrangements based on the internationalist model would be of benefit to both the developing South and the developed North.

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CONCLUDING REMARKS Despite many positive initiatives emerging from the Johannesburg Summit, another wonderful opportunity to begin the transition to sustainable development was missed. Unless there is a concerted effort to control population growth and shift the economic focus from quantitative growth to qualitative improvement, the benefits of improved environmental management, increased efficiency and changing consumption patterns will be overwhelmed. It is also necessary to modify the Bretton Woods institutions and restrict the international mobility of capital in order to halt the rise of globalisation that increasingly rewards dirty and low-wage production and weakens the capacity of governments to introduce sustainable development policies of their own. One hopes that the issues of scale and globalisation will receive the attention they deserve at future summits. With the sustainable economic welfare of many nations in decline and the world’s ecological deficit growing by the minute, it must happen decisively and soon if we are to witness any genuine movement toward sustainable development.

PART VI

Conclusion ‘However more scientific our socio-economic method may seem by comparison, its omission of a political dimension is nonetheless crippling, even fatal, for a comprehension of the human prospect.’ R.L. Heilbroner, 1974

18.

Is a steady-state economy compatible with a democraticcapitalist system?

INTRODUCTION This book has focused heavily on the belief that achieving sustainable development requires the eventual transition to a steady-state economy. While a number of observers have revealed themselves to be sympathetic to this ecological economic position, many question the capacity of a democratic-capitalist system to achieve such a goal (Olson, 1973; Heilbroner, 1974; Thurow, 1980; O’Connor, 1994; Luban, 1998). There are, however, a great number of commentators who have been far less kind to ecological economists. These commentators openly refute the suggestion that growth needs to be curtailed (e.g., Beckerman, 1992). Doubts about the ecological economic position rest on the back of three generally held beliefs: first, continued growth is desirable and can be sustained provided there is adequate substitution and resource-saving technological progress; second, both a low growth economy and a steady-state economy are inconsistent with the imperatives of a market based capitalist system; and third, only an authoritarian regime could impose and maintain the macro-environmental constraints advocated by ecological economists. I believe that Parts I and II have already debunked the first of these beliefs. With the support of arguments expressed throughout the book, my aim in this chapter is to successfully deal with the second and third beliefs. To do this, I will argue that a steady-state economy is very much compatible with a democratic-capitalist system. On the surface, this may seem little more than an interesting albeit extravagant exercise. For two good reasons, I believe it is a critical issue and one that ecological economists have unfortunately failed to deal with. First, unless the steady-state economy is compatible with a democratic-capitalist system, it is unlikely that any transition to a steady-state economy would be smooth, pleasant or peaceful. Second, until such time as a society is convinced of a viable alternative to growth based macroeconomies (such as the steady-state economy), the probability of it sanctioning such a transition is 335

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virtually nil. It is for these two reasons that, in my opinion, this chapter serves as an appropriate conclusion to the book. To achieve the central aim of this chapter, a number of key questions must be specifically addressed. ●

● ● ●

●

Since the profit motive is central to a capitalist system, can profits (as well as high wages and income) be sustained in the presence of a steady-state economy? Will private incentive and the desire to invest be stultified by a steadystate economy? Is full employment an achievable macroeconomic objective in a steady-state economy? Since a macro-environmental constraint on the rate of resource throughput is a likely steady-state requirement, is there a possibility of it being imposed by a democratically elected government, or is it only possible in the presence of an authoritarian regime? Is a national transition to a steady-state economy possible in a globalised world economy?

PROFITS, INCENTIVE AND INVESTMENT IN A STEADY-STATE ECONOMY The answers to two of the five questions above have already been given in Chapters 14 (the full employment dilemma) and Part V (the international dimension). I need therefore say no more than to mention the following. First, with appropriate policy measures in place (e.g., ecological tax reform, pertinent industrial relations reform and employer-of-last-resort programs), full employment can successfully accompany a steady-state economy. Second, a nation clearly cannot achieve sustainable development alone. As such, the move to an internationalist arrangement must be given central prominence when communicating the desirability of the steadystate economy and the urgency with which the high growth objective must be abandoned. As for the future of capitalism in a steady-state economy, there are a number of things we know about capitalism that are necessary for it to endure and succeed. To begin with, the rate of profit must increase in order to sustain investment levels (Heilbroner, 1974). Second, a capitalist system requires an incentive structure that rewards effort, thrift and innovation. Third, capitalism must be responsive to changing consumer demands. It is this reason why capitalism and markets largely go hand in hand. Fourth, a capitalist system must be supported by a cultural commitment to expressive

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individuality (Luban, 1998). Without it, capitalism is retarded in terms of its ability to initiate and respond to change. Finally, a key element of capitalism is an ethos of economic advancement (Heilbroner, 1974). This is an interesting requirement in the sense that an economic system based on an ethos of economic advancement need not guarantee advancement in the future. Moreover, should the economic system fail to do as required of it and by it, it may ultimately collapse. It has already been pointed out in previous chapters that many capitalist countries appear to be experiencing a decline in sustainable economic welfare (e.g., Figure 6.2). For all we know, the growth which has served capitalism well in the past, and which many observers believe to be a capitalist imperative, could prove to be capitalism’s Achilles heel. In view of these capitalist imperatives, where does the steady-state economy stand in relation to them? Heilbroner (1974) has argued that a low growth or, more particularly, a stationary capitalist system is subject to a falling rate of profit because of the inevitable evaporation of investment opportunities. Thus, in the absence of an expansionary frontier, a deflationary spiral of incomes and mass unemployment would beset a steady-state economy. O’Connor (1994) provides implicit support for Heilbroner by arguing that an insufficient level of profits would be generated by an economic system involving little more than maintenance of the status quo. Furthermore, since profit in a capitalist system functions as an incentive to expand, both profit and growth constitute the means and ends to one another. It is this reason, according to O’Connor, why various and often opposing macroeconomic theories all have one thing in common – they presuppose a capitalism that cannot stand still. Capitalism must either expand or contract and any prolonged failure to achieve the former leads to the system’s demise. While I agree with the mechanics of what Heilbroner and O’Connor say, the weakness in their argument lies in the belief that a steady-state economy is a static system. Both observers appear to arrive at this view by falling into the same trap as Olson (1973) – that a steady-state policy involves freezing the composition of output which, as Luban (1998) adds, results in the loss of occupational mobility and choice. But, as I have demonstrated many times throughout this book, a steady-state economy need not be a stationary economy devoid of development potential. I would even go so far as to take exception to the idea that the rate of profit would decline in a non-improving steady-state economy. After all, humanmade capital has to be replaced as it is either directly consumed or worn out through use. Thus, at the very least, the rate of profit should safely remain constant. If this is not enough to sustain a capitalist system, something as basic as the more efficient maintenance of a given stock of human-made

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capital ought to go somewhere towards serving this function since a continual reduction in the maintenance cost of human-made capital would presumably increase the profit margins of producers (at least until the limits of Ratio 2 from equation (6.4) were reached). The need to replace less efficient with more efficient producer goods would act as a spur for continuing investment. Of course, we can do much more than increase the maintenance efficiency of human-made capital. We can also improve both the quality of goods produced and the manner in which we organise ourselves in the course of producing them (i.e., increase Ratio 1 of equation (6.4)). Apart from enabling humankind to realise its development aspirations in the presence of a constant physical quantity of human-made capital (see Figure 9.1), this would allow profits to rise which, in turn, would expand the opportunities for investment. In doing so, the potential for higher incomes and wages would be maintained as well as the prospects for economic advancement, occupational mobility and choice. Clearly, profits, incentive and investment would not be jeopardised by a long-run transition to a steady-state economy. Indeed, I believe profits and investment opportunities would be higher in a steady-state economy because, at present, growth is bringing about a decline in sustainable economic welfare in many countries as macroeconomies exceed their optimal scale. Unwittingly, a growing proportion of the incoming resource flow is now being allocated towards preventative and rehabilitative measures rather than welfare-enhancing activities (Lawn, 2000; Chapters 6 and 7). In addition, the depreciation of natural capital is increasing throughput costs. It is highly likely, therefore, that growth will limit rather than advance future investment opportunities.

IS THE STEADY-STATE ECONOMY COMPATIBLE WITH DEMOCRACY? It has already been shown that initiating the transition to a steady-state economy is likely to require the imposition of a quantitative throughput constraint. There are a number of other macro constraints that ecological economists believe are necessary but will not be discussed in this chapter (e.g., population growth control measures). Like the tradeable resource use system outlined in Chapter 11, they all essentially involve a policy approach based on macro control and micro flexibility (Daly, 1991a; Costanza et al., 1997; Lawn, 2000). Given the lack of macro controls at present, ecological economists must consider whether any society is capable of imposing appropriate macro constraints through the conscious


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intervention of the electorate rather than by convulsive changes forced upon it. For a variety of reasons, many observers believe not. Luban (1998), for example, argues that the notion of a steady-state economy stands in stark contrast to the view of every democratic politician that national economies must grow robustly and that low or no growth is political suicide. Moreover, Luban, following Olson (1965), suggests that interest groups benefiting most from a high rate of growth would strenuously lobby against a proposed transition to steady-state economy. In doing so, they would constitute an insurmountable hurdle in a democratic system. Luban therefore concludes that the transition to a steady-state economy is impossible for all but an authoritarian government to manage. Heilbroner’s (1974) views concur almost entirely with those of Luban. Heilbroner is convinced that only socialism could administer the adaptation of an industrial society to a steady-state economy. Heilbroner comes to this conclusion on the basis that no would-be government in a liberal democracy would entertain the idea of limiting its citizens to the well-being obtainable from its present volume of output. Heilbroner makes another interesting observation – the present momentum of the high growth economy is so great that the transformation to a steady-state economy would be prohibitively costly, particularly in terms of lost jobs. Thus, the capacity of any democratic system to initiate a shift to a steady-state economy is exceeded in the sense that no substantial voluntary diminution of growth is remotely conceivable at this point in time. Certainly, while both interest group obstruction and the impact of structural adjustment is cause for trepidation, other concerns are based on falsehoods. As revealed throughout this book, the transition to steady-state economy does not involve putting a ceiling on material output and its composition; a constant stock of human-made capital does not imply a limit to the well-being of a nation’s citizens; and, despite claims that a 2–3% rate of growth is necessary to prevent unemployment from rising, high unemployment need not accompany a steady-state economy. To recall, the transition to ecological sustainability requires the selfimposition of a resource constraint which, depending on the proximity of the limits to Ratios 2–4, induces a natural transition from a high growth economy to a low growth economy and eventually to a steady-state economy. In other words, a macro constraint is imposed at the input end of the economic process, not the output end. Facilitated by a variation in the market allocation of the incoming resource flow, growth is permitted for some time along with a change (improvement) in the composition of output. An attempt to impose a macro constraint at the output end, which is both unnecessary and undesirable, is virtually impossible by means other

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than the firm fist of an authoritarian regime. It is no wonder that, to some observers, democracy appears incompatible with a steady-state economy. The aforementioned does not, however, confirm that democracy and a steady-state economy are compatible. To consider this issue in more detail, we need to briefly examine the relationship between the political dimension and human nature. This is important because, as Heilbroner (1974) has correctly pointed out, coercive political power is only successful if it is accepted by those over whom it will be exercised. One cannot have coercive political power without political obedience. A central feature of human existence is the shaping of one’s adult personality by the period of dependence and development in early life. Traces of the conditioning process that occurs as a child passes from infancy to adolescence can be clearly found in the traits of obedience and one’s capacity for identification. Of particular interest to us is the role played by the political function in providing a sense of psychological security – something made possible by recreating the subordination to which peoples’ extended period of dependency has accustomed them (Heilbroner, 1974). Thus, in times of great anxiety or predicament, we can expect the pressure of political movements to push in the direction of authority, not away from it. In view of this, there are a number of things we need to take into consideration. They include: (a) since acquiescence to greater authority is only likely to accompany a sense of crisis, to what extent are humankind’s current circumstances perceived as perilous?; (b) given that a steady-state economy embraces the notion of identity towards human beings of all races, religions and generations, to what extent can we expect a sense of identification to extend beyond its current primitive boundaries?; and (c) since an excessive level of superordination would render democracy and the steady-state economy incompatible, what form would the political authority required to initiate a transition to a steady-state economy most likely take? According to Heilbroner (1974), the myopia that confines the vision of the present generation to the short term does not augur well in terms of convincing people of the dilemma we currently face and the urgency with which we need to act. Nor does it promise much in terms of identification with the needy and posterity. To wit (Heilbroner, 1974, p. 143): ‘When men (sic) can generally acquiesce in, even relish, the destruction of their living contemporaries, when they can regard with indifference or irritation the fate of those who live in slums, rot in prison, or starve in lands that have meaning only insofar as they are vacation resorts, why should they be expected to take the painful actions needed to prevent the destruction of future generations whose faces they will never live to see? Worse yet, will they not curse these future generations whose claims to life can be honoured only by sacrificing present


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enjoyments; and will they not, if it comes to a choice, condemn them to nonexistence by choosing the present over the future?’

Convinced that a transition to a steady-state economy is only possible following a long-travelled route down a self-destructive path, Heilbroner holds out little hope of appropriate macro constraints being imposed by a democratically elected government. Without wanting to deny the possible eventuation of Heilbroner’s conclusion, I am somewhat more optimistic. Why? To begin with, much of the present myopia is based on the erroneous belief that, should a crisis transpire, its deleterious impact will not be felt for some time to come. Yet, if the empirical evidence of an existing decline in sustainable economic welfare is reasonably accurate, the negative consequences of excessive or ‘uneconomic’ growth are already upon us. The lack of widespread understanding of a viable alternative to growth – namely, a qualitatively improving steady-state economy – is also a contributing factor. Clearly, greater knowledge of both the true current picture and the welfare benefits of making the transition now to a steady-state economy, not in the future, would go a long way towards overturning the myopia obstacle. As for the lack of identity most people have with posterity and many of their living contemporaries at home and abroad, a further ray of hope exists. Ironically, it comes from Heilbroner (1974) himself. Heilbroner believes a sense of identification can extend beyond its current modest domain so long as self-preservation becomes a primary human goal. This can become a possibility by again communicating the alarming empirical evidence and the existence of a viable steady-state alternative. Also required is a broad understanding of the complex interrelations between countries – for example, the ecological impact that one nation’s activities can have on other countries, and that achieving sustainable development requires as much tolerance and cooperation as it does intranational and international competition. One cannot ignore, at this point, the probable role played in the democratic process by the interest groups benefiting most from a high rate of growth. They would undoubtedly thwart attempts to move to a steady-state economy. But they would not necessarily have everything their own way. The logic of interest group formation can, in principle, be counteracted (Taylor, 1987). For instance, it has been shown that a shared and mutually transparent commitment to a particular cause, no matter how drastic the means to achieving it might seem, can lead to the formation of organised groups with the capacity to counteract special interest groups whose sole aim is to protect their distributive share of wealth and/or power. Should the urgency with which the transition to a steady-state economy is required

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become apparent, there is no reason why growth oriented interests could not be overpowered. This certainly wouldn’t be a simple or straightforward task in a growth-obsessed world, but democracies have survived very difficult transitions and circumstances in the past (Luban, 1998). In addition, we are quite possibly talking about self-preservation and the forces it would generate cannot be underestimated. We now come to the last of the questions raised in this section of the chapter – that is, what form would the political authority required to bring about a steady-state economy most likely take? While it would clearly entail coercion in the form of currently non-existent macro constraints imposed and policed by relevant government authorities, it would continue to preserve much of the current institutional and legal framework that serves to protect individual self-expression, the right to private ownership, and the market mechanism. Polemically, it is my belief that there would be fewer legislative constraints in a steady-state economy because a policy approach based on macro control and micro flexibility would rid us of the increasing pervasiveness and number of growth induced or ‘scale related’ externalities. The rise of small, issue based political parties in many democratic countries since the 1970s is an indicator of how much political action is now devoted to internalising the many scale related externalities that, following a transition to a steady-state economy, would rapidly vanish. In sum, a would-be government wishing to initiate the transition away from a high growth economy is democratically electable provided enough people can be convinced of the crisis we already face, the desirability of a steady-state economy, and the likely preservation of currently enjoyed freedoms.

CONCLUDING REMARKS The need to make the transition to a steady-state economy should not pose a threat to continuing human development. To the contrary, it should arrest the current decline in sustainable economic welfare that appears to be the result of macroeconomic growth beyond the optimal scale. Although the transition to a steady-state economy requires the imposition of painful macro constraints, I’m certain that the structural changes needed would not be as difficult nor as disruptive as most people believe. Indeed, given the potential for continuing high profit rates and investment plus the preservation of individual self-expression, private ownership and the market mechanism, I am convinced that the steady-state economy and a democratic-capitalist system are entirely compatible. In fact, the greatest threat to democracy, capitalism and international peace may prove to be humankind’s ‘addiction’ to growth.1


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If I have convinced you of the perils of continued growth in this book then, unless you are a citizen of a poor nation, you will cringe every time you hear someone singing the graces of growth or celebrating the latest rise in real GDP. As any reformed drug addict will tell you, detoxification only succeeds if the addict can first be convinced of his or her genuine plight. With the evidential impact of excessive growth more stark than ever, it is time to do more than issue warnings to the general populace. An alternative to growthmania needs to be urgently communicated (e.g., the steady-state economy), yet this requires a thorough understanding of the issues involved and how human progress can be achieved without the need for continued growth. Only this will convince society (the growth addicted) that the long-term benefits of a steady-state economy are worth the shortterm pain of the necessary structural changes that must be endured (the withdrawal symptoms).

NOTE 1. By humankind’s addiction to growth, I don’t mean that each single person is necessarily addicted to the growth in production and consumption. What I am essentially referring to here is the addiction to growth of society as a whole.

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Index absolute advantage 313, 314, 324 accounting practices, current 61 accumulation of human-made capital 202 acid rain 19, 56 agricultural expansion and deforestation 329 agriculture 153 air pollution 135, 161 allocation process 62, 79, 81 allocative efficiency 6, 199, 324 assurance bonds 7, 200, 210–11, 215 Atkinson index 139 atomistic-mechanistic paradigms 12 Australia eco-efficiency indicators 177–88 efficiency-increasing 5 throughput-increasing 5 growth policy 163–4 Hicksian national income 147 national income 157–61 native vegetation clearance 5 natural capital assets 166 steady-state economy 157–64 sustainable development 203 Sustainable Net Benefit Index 128–30 authoritarian government 335, 336, 339, 340 balance of payments (BP) curve 315, 316–18 balance of payments equilibrium 308 and IMPEX system 317 Basic Income 285–8 belongingness and love 23 benefit, uncancelled 30–32, 114 Australia 128–30 benefit-yielding services 132 benefits and costs 63, 64 Bergstrom production function (BPF) 4, 43, 51–60, 62 simulation 64–9

biocapacity 118–21 biocentric view 28 biodiversity 20, 21, 29 loss 21, 56 biogeochemical clocks 18 biophysical factors 17–21 biophysical limit to growth 34 birth licences, transferable 215 Blum, H. 19 Bretton Woods system 7, 295–9, 324 demise 300–302 internationalisation and 299 Brundtland Report, 1987 10, 326 ‘Cambridge controversy’ 119 capital (income) 149, 150 depreciation of 139 human-made 14–15, 41–61, 90, 150 defensive 133 depreciation 127 income-generating 17, 110, 111 mobility and immobility of 304, 314 natural 14–18, 28–32, 41–61, 90–91, 111–13, 201 complementarity with humanmade 171 declining and non-declining 56–7, 110–13 depletion 62, 108–9, 303 exploitative efficiency 16, 32, 169 for future generations 62 greater investment in 58, 327 maintenance 30, 57, 70 matter-energy and 17, 18 minimum required 20 resource-providing 18 renewable 65, 203 services 135, 141–3, 153 sustainability 134 capital investment, net 133–4 capitalism in a steady-state economy 336 363

364

Index

capital maintenance 18 capital stock requirement 92 carbon tax in Sweden 216 cash payments for non-paid work 287, 288 catastrophe 9 climate change 161 clothes expenditure 140 clothing need 22 Club of Rome report 41–2, 82 coal burning 42–4 coercion 342 coevolutionary paradigm 11, 12, 173–4 commuting costs 133, 155 comparative advantage 304, 307, 314–25 for landowners 188 compensation of injured parties 207 complementarity relationship 4 complexity of systems 12–13, 175–6 conditionality 296 conservation of energy and matter, law of 43–4 constant elasticity of substitution (CES) 42 production function 48–51, 60 constant natural capital, simulation 71, 73 consumer durables, cost of 131–2 consumer goods 15, 247 consumerism 24 Consumer Price Index (CPI) 137 consumption choices and 15, 25 economy and 108 expenditure 131, 132, 151, 152 levels, increase 70, 77 patterns 8 per capita 326 undesirable forms 136–7 continuing growth, costs 145 ‘control’ of evolutionary pathway 176 corporate law reform 289 corporate merger constraints 301 cost accumulation 143 cost and benefit accounts, uncancelled 126 Costanza, R. 10 cost internalisation 301, 304, 305, 312 costs 124

benefits and 123 increased 187 uncancelled 30–32, 114 crime costs 133 serious 25 crime prevention measures 109 crime rates, increasing 29 crisis, sense of 340, 342 crop production, expansion 329 cruelty-free treatment 28 dairy products 28 Daly, Herman 10, 310 on sustainable development 193–6 data availability 144 debt, as economic factor 26 defensive expenditures 140–41 demand-side forces, market 63 demand-side solutions 275–7 democracy and steady-state economy 338–42 democratic-capitalist system 8, 335 depletion of non-renewable resources 21 Australia 204 profits 90 time, optimum 91 depreciation rate, human-made capital 68 destruction of contemporaries (Heilbroner) 340 of future generations (Heilbroner) 340 developing countries, population 326 development potential, future 236 diminution of species 20 ‘dirty’ domestic producers and taxes 313 disability allowance 285 discount rate 62, 63, 64, 89 disequilibria 12 dissipative structures 36 distributional equity 6, 193–9, 324 distributional inequality 131, 138–9, 152 Atkinson index 139 diversification of production 330 dividend, annual 113 DNA molecule 36

Index dollars, US 296, 300–301 domestic and foreign goods 309 dominant items 145 ‘doomsday models’ 41 durability of goods 187 increase in 327 durable goods 272 earth 12 atmosphere, temperature regulation 18 as dissipative structure 12 human habitability and 14, 19 Earth Summit, Rio de Janeiro 10, 107 ecoefficiency 171–3 increasing 117–18 indicators 5, 166–89 ecological criteria 83 ecological deficit 119, 303 ecological economics 10 perspective 92–101 ecological factors 17–21 ecological footprint 118–21 excessive 76 of nations 32 of world 303 ecological limits 9 safe 236–8 ecological sustainability 7, 74-8, 324 conflict with welfare maximisation 64 full employment and 270–89 human need 23, 324 policy 280–88 policy goal 62, 193–9 ecological systems, complexity 20 ecological tax reform (ETR) 6, 58, 59, 187, 200–216, 281 ecological tax reform (policy goal) 199 economic activity dematerialisation 172 disservices 133 scale of 326 economic advancement 337 economic factors 25–6 economic growth 30–4 environmental degradation and 329 economic systems and sustainability 327 economic welfare 74–7, 298, 327

365

cuts 195 increasing 114 sustainable 5, 30–34, 115, 126, 131, 168 economy 13 non-growing 32 ecosphere 3, 13, 32 drastic changes in 56 humankind’s dependence on 172–3 life support and 18 species and 19 ecosystem 21 degradation 56, 153 health 119–21 preservation 29 efficiency goal 64, 78, 193–9 efficiency-increasing technology 222, 224–6, 233 Ehrlich, P. 20–21 elasticity of substitution 4, 60, 61, 66 electorate, constraints by 339 El Sarafy, Salah user cost rule 59–60, 89–91, 109, 141–2, 215 employment, full 7, 270–89, 336 energy 12, 221 consumption, Australia 187, 188 cost of depleted resources 161 flows 11 loss 44 recycling 33, 91 energy-matter in physical goods 36 entropy, high and low 16, 44, 45, 46, 127 Entropy Law 33, 43, 206 environmental benefits 124 and Job Guarantee 284–5 environmental damage 8 long-term 135, 142, 143 environmental degradation 6, 138, 237, 306 cost of 242 environmental equilibrium (EE) curve 7, 245–69 environmental improvement 218–29 Environment-Income Curve (EIC) 229–42 relationship 242–3 Environmental Kuznets Curve (EKC) 6, 217–44, 293 environmental macroeconomics 245

366

Index

environmental management 8 environmental quality 138 and real GDP 217 environmental rehabilitation 63 environmental sink capacity 210 environmental standards, weaker 305 equity, intragenerational 29 esteem, need for 22 ethical criteria 83 evolution of living organisms 19 evolutionary process 24, 28 exchange rate management 295–6, 299, 301, 306 exchange rates, fixed 300–301 existential limits 9 expansionary fiscal policy 276 –9 expenditures, rehabilitative and defensive 140–41 exploitation of livestock, inhumane 28 exploitative efficiency ratio, Australia 184–5, 188 export income 60, 306 extinction, global rate 20 family breakdown 29 cost of 133, 155 farmland, loss of 134 fauna and flora removal 153 feasible production function 45–7 feedback mechanisms 18 financial capital, mobility 293 financing packages 297 finitude 43 fiscal policy 254–9 expansionary 255–7, 260, 276 –9 Fisherian measure of income 5, 15, 147–65 Fisherian National Income 149–55, 202–3 flood mitigation projects 109 flow-based forces 84 food and drinking expenditure 140 food need 22 forecasting techniques 145 foreign borrowing, net 134 foreign currency 307–10 foreign debt 26, 15, 310, 313 of nation 155 unserviceable 305, 324

foreign exchange management BP curve and 316–8 IMPEX system 8, 307–11, 320, 324 macro-control policy 215 mobility of capital 324 standards lowering pressure 273 foreign lending, net 134 forested areas, decline of 329 forests, old growth, loss of 28, 135–6, 143 forests, slow-growing, native 57 forests/timber plantations 84 fossil fuel consumption 329 free trade 294, 304 future generations 76, 77 futures markets 85 Gaian hypothesis 36 General Agreement on Tariffs and Trade (GATT) trade barriers and 298–9 World Trade Organization and 295 genetic information 36 Genuine Progress Indicator (GPI) 5, 77, 127, 131–48 in developing countries 242 estimation of benefits and costs 113–17 globalisation and 303 growth objective and 123–6 human-made capital and 202 theoretical superiority 127, 131–35 USA calculations 125 costs and benefits 125 valuation methods 135–43 genuine savings (GS) 110–12 geographical locations, different 209 Gini coefficient 138, 139, 152 global economy 240 globalisation 7, 8, 293–313 byproducts 306 destructive force 312, 329–30 rise of 300–302 versus internationalisation 242, 294–5 World Summit and 326 globalisation’s negative impact 330 global market, unfettered 273

Index global system ‘control’ of 173, 176 constituent species of 19 global warming 19, 56 gold standard 295, 300–301 goods consumption 65, 66 durable and non-durable 113, 150 imported 154 market prices 137 price of 124 quality of 338 goods and services 50, 61, 172 tax (GST) Australia 204 government debt 276 Great Depression 1930s 293 ‘green’ employment under Job Guarantee 284–5 Gross Domestic Product (GDP) 6, 126, 149 growth 270 employment link 25, 272–4, 281 measurement 124 Gross National Product (GNP) 124 growth alternative to 341 drive for, in Australia 187 economic and uneconomic 30–32 excessive 340, 342, 343 limits to 328 low 339 voluntary diminution of 339 growth efficiency 169, 183–4 growth policy 236 growth strategies 156–7 guns 136 habitat protection 28 Hartwick, J. 42 ‘heat death’ 89 heat loss 13 Heilbroner, R. 339, 340, 341 Hicksian income 5, 89–91, 108–10, 162 Hicksian national income 147–65 high entropy waste 16, 55, 91, 119, 202, 210 high growth strategy in Australia 5, 162–3 Hotelling model 94

367

household expenditure 247 household pollution abatement, cost 133 household work, non-paid 25, 26, 132 housing expenditure 140 human development 24, 342 and human needs 35 human ignorance 173 humankind, and supposed immunity 19 human-made capital (plant, machinery and equipment) 307 human-made capital 14–18, 25, 34, 201 depreciation 155 efficient maintenance 337–8 investment in 111 matter-energy and 17, 18 natural and 109, 244 psychic income and 15 resource input and 52, 54, 55, 68 service efficiency 167–8 stock 200 ‘sufficient quantity’ 25 sustainability 134 technology of 18 human population 35, 215 human survivability 119 human well-being 15, 100, 101 costs 127 private consumption and 136 identification with needy 340 identification with posterity 340, 341 ignorance, closed and open 175–6 ignorance and surprise 173, 174 ill-treatment of non-human creatures 28 IMPEX dollars 307–10, 317, 325 IMPEX (Import-Export) system 8, 215, 273, 314, 324 mobility of capital and 316 Import-Export system 273, 307–10 import and export of natural capital 57 import replacement policies 306 import restrictions 298, 299 impoverishment, long-term 310 incarceration of livestock, inhumane 28 incentive in a steady-state economy 336–8

368

Index

income guaranteed 285–8 Hicksian definition 108, 109 psychic 113, 114, 127 Australia 128 reduced taxes on 200 income and capital 113 Fisherian 132, 133, 134 income inequality 139 incomes policy 275 income tax on high income earners 216 income and wealth distribution 32, 138 inconsistency problem 143 Index of Sustainable Economic Welfare (ISEW) 123–48 in developing countries 242 economic welfare indicator 77, 113–17 globalisation and 303 human-made capital stock 202 theoretical superiority 127, 131–35 valuation methods 135–43 individualism of modern capitalism 26 industrial pollution 239 industrial relations policy 289, 336 industrial relocation 240 industries, inefficient 299 inflation 276 inflation control by Job Guarantee 282 informal structures of society 26–7 information technology industries 50 informational flows 11 innovation 336 institutions and the market place 26 integration of national economies 294 interest-free loans 298 interest rate 89 intergenerational equity 29, 85 International Bank for Reconstruction and Development (IBRD) 297 international capital 303, 306 International Development Association (IDA) 297–8 International Finance Corporation (IFC) 298 international governance 293–313 international liquidity 302, 310 international market 304–5 International Monetary Fund (IMF) 293, 295–7, 310

loans 26, 302 international trade 8, 238–42, 294, 314–25 absolute advantage and 304 globalisation and 302–6 North versus South 239–43 sustainable national income and 318–24 internationalisation 7 internationalist requirements and Bretton Woods 310–12 interrelations between countries 341 intertemporal efficiency 4, 77, 78 intranational competition 301 investment in human-made capital 155 in steady-state economy 336–8 investment expenditure 151, 247 investment opportunities 337, 338 irrigation 161 IS Curve 315–16 IS-LM model 245–69 IS-LM-EE model 246–53 IS-LM-EE-BP model 315–18 isolationist models 11 isoquant map 46, 47, 52 Jevons’ Paradox 5, 59, 205 Job Guarantee 276, 281–4 and ‘green’ jobs 284–5 program 209, 270, 289 job losses 339 job-sharing 272, 274 Johannesburg Summit 328 junk food 136 justice 23 Keynes, John Maynard 293–313 Keynesian expansion 286 Koestler, Arthur, on holon 36 labour, reduced taxes on 200 labour force preferences 284 labour market flexibility and inflexibility 273, 286 labour market programs 274 labour productivity 7 increased 287 labour supply withdrawal 7, 287, 288 land available 119

Index land degradation, cost of 161 land management practices 330 law of absolute advantage 305 laws of thermodynamics 43–5 leisure time imputed value 143 lost 133 liberal democracy 339 life-support function 18, 56 of forests 57–8 of natural capital 135 services 14, 91 light bulbs, durability 137 linear throughput 13, 14, 201 liquidity 300 international 296 living organisms Earth and 19 sufficient array 20 LM curve 248 loans 26 logging methods 28 logos of nature 12, 13 love, need for 22 Lovelock, J. 20 low and high entropy wastes 169 low entropy matter-energy 65, 101 scarcity 85 resource 17, 36, 84, 202 Luban, D. 339 macro constraints 339–42 macronomic equilibrium 257–8 macroeconomic subsystem 24, 25 macroeconomic systems 7, 77, 101, 123, 169 and ecosphere’s limits 35 growth 6, 8, 155–7, 270 macroeconomic targets 31 macroeconomic theory 293 macroeconomics, growth rate 7 macroeconomy 14, 258 Australia 148–9 EE curve and 253–4 scale reduction in 196 sustainable economic welfare 32, 33, 114, 118–19 macro-environment constraint 318–21 mainstream production functions 4

369

maintenance efficiency 168 Australia 182–3, 203 Malthusian Flow Scarcity (MFS) 87, 88 Malthusian Stock Scarcity (MSS) 87 Malthus, Thomas 41 manufacturing industries 34, 50 marginal benefit 226–9 marginal cost MC (Y) curve 220–26 market failure 311 market price manipulation 200 market prices 25, 79, 81, 92, 137, 142 and absolute scarcity 94 market supply and demand 194 market valuation 124 markets 26–7, 62–3, 197 Maslow’s needs hierarchy 22 material flows 11 materials recycling 187 increasing rate of 327 matter 12, 14 matter-energy resource 44 matter-energy throughput 14, 16, 198, 202 matter-energy uniformity 87, 89 Max-Neef, M. 37 MB (Y) curve 226–9 meat products 28 mental disorders among unemployed 37 microeconomics 245 mineral exploration in Australian National Parks 305 minimum resource requirements 47 minimum wage 282 mobility of capital, international 318, 324 monetary-based indicators 145 monetary policy 254–9 expansionary 257–67, 279–80, 321–3 money, revaluation and devaluation 296 moral capital of society 26–7 moral considerations 76 moral obligation to future generations 56–7, 199 moral rights of non-human creatures 27–8 morality 26

370

Index

multiple jurisdictions of regions 216 Munasinghe, M. 6, 218–20, 236 nation state 294, 295, 326 national income 126 accounting 3, 58–60, 114 ‘green’ measure 60 native forests, lost 161 native vegetation clearance, Australia 188 natural capital see capital natural environment 326 deleterious effects 16 economic systems and 11 finite 31–2 qualities 15 natural and human-made capital, complementarity 171 natural order of universe 12 natural resources 83 depletion 60 policy 77 prices 4, 81–103 scarcity 4, 41, 81–103 natural world, detachment from 18–19 need for growth, illusionary 24 need satisfaction, balanced system 24 needs of future generations 76 hierarchy 37 human 22 versus desires 27, 76 negative consequences 341 net capital investment 155–7 net entropy deficit 44, 45 net exports 315, 316 Neumayer, E. 135, 139, 140–43, 145 noise pollution 155 costs 133 non-consumption activities 32 non-human creatures, sentient 27–8 removal or displacement of 28 rights of 29 value of 29 non-paid work, public remuneration 187, 281 non-renewable resource 109, 209, 221 depletion 188 Norgaard, R. 12

North–South divide 239–43 redistribution of wealth 327–8 novelty and ignorance 176 occupation, incomplete 20 occupational mobility 338 oil price shocks, 1973 188 oil production 84 old-age pensions 285 optimal development pathway 235 optimal scale of economies 327 optimal scale of expansion 32 optimism, technological 18 organic evolution 19 overshoot and sustainable development 119 ozone depletion19, 56, 136, 142, 143, 161 cost 135 Pareto efficiency 78 Pareto optimal EIC 233–6 path-dependencies 12, 198 payment for improvements 229 per capita real GDP 217, 218 permits from government-authority 198 philosophy of life, need for 22 physical production possibilities 43–5 physical quantity of output 49 physiological needs 22, 24 Pigou, A.C. 113–14 Pigouvian taxes 58, 200 plant and animal losses 36 plant and machinery 133 Plimsoll line analogy 196–7 policy goals 193–9 policy guiding value of Fisherian measures 151–5 of Hicksian measures 151–5 policy instruments 207 policy setting 197–8 policy and sustainable development 122 political authority for steady-state economy 342 political power, coercive 340 political pressure 198 political will for sustainability 199 pollution 131

Index pollution haven hypothesis 6, 238–42, 293 pollution-induced problems 56 pollution taxes and permits 200, 210, 211 population control policies 76, 77, 80, 327, 328 growth 303, 326, 329 reduction 8 positive coevolution 12 posterity, needs of 27 poultry products 28 poverty in developing countries 303 poverty and environment 326 poverty eradication 24, 330 powerful elites 326 predictability of resource extraction progress 97 predictive capacities of humankind 174–5 preservation of ecosystems 21 price in situ, and extracted 91 price-determination parameters 313 prices 94–6 of goods 137 relative 194 private consumption expenditure 136–9 private incentive 336 private ownership, right to 342 producer goods 133, 134, 247 product design 148–9 product durability 32 product recycling 168 production costs 305 function 45, 46 rate of 131 production levels, increase 77 production waste 18, 32, 91 productive capacity 26 of nation 152 productivity rises 274 profit and growth 337, 338 profit motive 336 profits 108 in a steady-state economy 336–8 pro-growth 217 protectionist trade barriers 299 psychic costs of economic activity 154

371

psychic enjoyment of life (psychic income) 15, 21 of citizens 150 net 16, 30, 32, 133, 153–4, 201, 202 psychological factors 21–5 public assistance 285 public consumption expenditure 139 qualitative improvement 77, 186, 327 quality of natural capital 57 quantitative expansion 77 quantitative growth 186 quantitative restrictions 194 quasi-immortality 19 ‘race to the bottom’ 305, 329 reafforestation 285 real GDP 217, 218, 242, 243 real output 61 recycling 14, 18, 32–3, 44, 91, 187, 327 regenerative capacities 327 relationships with people 23 renewable energy 184 replacement asset 89 replacement cost approach 141, 142 researcher activity 144 resource base, homogenisation 89 resource demand excessive 239 non-renewable 89, 91, 92 scarcity in US 61 user cost 109 resource markets, conventional 101 resource policy 3, 58–60 resource prices optimal 98, 99, 100, 101, 269 resource rent approach 141, 142 resource scarcity definition 82–4, 97 indexes 92–101 typology of 86–92 resource throughput 4, 85, 270 resource use intensity 50 permits 283 taxes on 200 resource-transforming agent 46, 52 resources allocation mechanism 4, 62 availability 57, 64, 66 consumption 8

372

Index

depletion 131,134, 138, 141 cost of 135 profits of 59 extraction 85, 100, 153 fixed quantity 88 input, reduction 168 more efficient use 327 natural 3 non-renewable 58, 84, 89, 142 renewable 21 scarcity 102 trade in 7, 325 revenue neutrality 216 revenue from sale of permits 198 Ricardian Flow Scarcity (RFS) 87 Ricardian Stock Scarcity (RSS) 87–90 Ricardo, David 304 rich and poor imbalance 187, 207 Rio de Janeiro, Earth Summit 10, 107 risk and uncertainty 173–5 safety needs 22 satiation, point of 171 savings 139 scale and globalisation issues 331 scale issue 7, 326–9 scale reduction 8 scarcities 142 scarcity indexes 86, 87 relative and absolute 82, 83 resources 101, 102 scarcity typology, five-fold 93 science and resource base 89 self-actualisation need 22, 23, 25 self-destructive path 341 self-organisation 12 self-preservation, human goal 341, 342 self-respect 23 self-sufficiency 313 sentience 27–8 service efficiency 167–8 Australia 179, 182, 203 service sector and goods sector 172 service yielding qualities of goods 137–8 set-aside component 59–60 shelter need 22 simulation exercises 4, 62 sink 14

services, lost 135 waste absorbing 16, 17 skills, loss of 25 social benefits 124 social capital 13, 29, 288 social/cultural factors 26–9 social discount rate 4 social factors of policy, Australia 187 social insurance in USA 303 social security 25 social standards, weaker 305 socialism 339 socio-economic process 11–16, 23–4, 113 and resources 119–21 sociosphere 13, 14 solar flux 13, 14 source services 14 South-East Asia 303 special interest groups and growth 341 species diversity 20 species extinction, rate of 20 and speciation 20 steady-state alternative 341 steady-state economy 32, 147–65, 335 Australia 5, 148–9 biophysical necessity, long-run 34 defined 35–6 for sustainable development 77 transition to 8, 9, 32, 270 steady-state policy 236 steady-state strategy 157 Stewen, M. 193–9 stock effect and flow effect 84 stocks of resources 101 strip mining 153 Strong Malthusian Stock Scarcity (SSMS) 91–2, 94 subjectivity 144 sub-optimal EIC 233–6 substitutability assessments 4 subsystems, interdependent 12 sun 13, 14 supply-side solutions 274–5 surprise 176 concept of, in global system 173 sustainability 62–80, 141–2 long-run 110, 111 versus efficiency 6 sustainable cost 114

Index sustainable development 1, 7, 10–37, 114, 201 indicators 107–22 thesis 193–6 sustainable economic welfare, measures 123– 46 sustainable national income 314–25 Sustainable Net Benefit Index (SNBI) 115–17, 123–6, 145–6 Sustainable Net Domestic Product (SNDP) 108–12, 126, 132, 315 Hicksian 149 weaknesses 127 sustainable operation of economy 70–74 system embeddeness 12 tariff reductions 299 tariffs on imported goods 312 tastes and preferences 63 tax credits as compensation, Australia 204 taxation system, Australia 187 tax reform approach 204–7 ecological 6, 7, 58, 187, 281, 336 taxes on pollution and depletion 187 reduced, on income 200 transfer payments and 194, 195 technological progress 87, 167–71, 244 Australia 5 efficiency-increasing 170 fixed state 248–9 in human-made capital 18, 91 production waste and 45, 47 resource-saving 335 sustainable ecological welfare 32–3 throughput-increasing 33 technology gap 311 technology transfer, North to South 328 temperature regulation, Earth’s surface 18 thermodynamic equilibrium 89 thermodynamics, first and second laws 33, 221 CES production functions and 42 isoquants and 47 limits to technological progress 170

373

matter-energy and 210 violation of 49, 62 Third World countries 139, 144 in debt 26 financing packages 297 ‘threshold hypothesis’ 123 thrift 336 throughput constraints 196 throughput-increasing technology 222, 233 throughput taxes 199, 206, 211–14 timber harvesting 28, 238 timber plantations, fast-growing 57, 58 time dimension 4, 62 tobacco products 136 totals cumulative 142–3 tourism industries 50 toxic wastes 215 trade, international 238–42 trade barriers 299 trade conflicts 299 trade and ecological capacity 119 trade imbalances, large 305 tradeable resource use permits 200, 207–14 description of 198, expansionary fiscal policy and 256 transnational corporations 305, 307, 326 exploitation by 330 transportation of livestock, inhumane 28 UB curves 33 UC curves 33 Ultimate End 79 uncancelled costs 36 see also costs underemployment costs 133 unemployment 25, 29, 133, 339 cost of 154 high, in Europe 303 mental disorder and 36 paid 272 real GDP and 270, 271 reduction of 187 unemployment benefits 285 unemployment rates, high 187 ‘unit costs’ 102 United Nations report on scale 328

374 United Nations System of National Accounts (SNA) 143 urban overpopulation 303 urban water pollution, costs 161 urgency to act 340 US dollars 296, 300–301 ‘user cost’ formula (El Serafy) 109, 188 definition 89 resource rents calculation 141–2 user-cost tax and 215 user-cost component 59–60 valuation technique 144, 145 consistent 143–5 more robust 143–5 vegetation clearance of native 5–6 loss 153 preservation of 21 vehicle accidents, cost 133 voluntary work, value of 25, 26 volunteer work 29, 132 vulnerability of human beings 20 wages 274–5, 289, 306, 330 wants versus needs 76 waste 221 assimilation 56, 85, 238–9, 327 trade in 325 waste flow 206 waste generation, high entropy 18, 21

Index waste materials recycling 33 water pollution 135 water shortages 329 water use 161 Weak Malthusian Stock Scarcity (WMSS) 90–91 wealth, unequal distribution 273 welfare economic and non-economic 50 welfare aspects of socio-economic process 127 welfare benefits 77, 79 welfare index, name for 144 welfare maximisation 4, 62–80 welfare-reducing cost 25 welfare-yielding qualities 61 wetlands, loss 135 wholes and parts 13 wildlife loss 28 work part-time 284 self-worth and 15 working conditions, poor 306 World Bank 293, 297–8, 311 World Commission on Environment and Development, 1987 10 world poverty 313 World Summit on Sustainable Development, 2002 9, 326–31 World Trade Organization (WTO) (formerly GATT) 293, 295 green tariffs 312

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A Survey of Ecological Economics

Ecological Economics: An Introduction (2005)

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Ecological Economics and Sustainable Development: Selected Essays of Herman Daly (Advances in Ecological Economics)

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Handbook of Ecological Economics

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Contemporary Issues in Development Economics

Post Keynesian and Ecological Economics: Confronting Environmental Issues

Rationality in Economics: Constructivist and Ecological Forms

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Rationality in Economics: Constructivist and Ecological Forms

A Survey of Ecological Economics

Ecological Economics: An Introduction (2005)

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Ecological Economics: Principles And Applications

Ecological Economics and Sustainable Development: Selected Essays of Herman Daly (Advances in Ecological Economics)

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