Lecture EEcological & Environmental

Economics

Overview• Terminology• Conflicting views of the economy’s relationship to nature• No-Limits versus Limits to the economy views• Problems with current economic theory & reality• Changing signals to the economy and internalization• Economy behaving like an ecosystem• Alternatives to measuring welfare by GDP• Globalization• Dow Jones Sustainability Index• Summary and Conclusions

Economics Terminology• Economics: the study of the allocation of scarce means among

competing ends. (Daly)• Capital: wealth of property that is used or invested to produce

more wealth; the money with which an enterprise is started. Set of all physical things capable of satisfying human wants and subject to ownership. Fisher (1906)– natural, human, manmade, critical natural

• Wealth: Riches, possession of these.• Riches: a great quantity of money or property or valuable

possessions.• Money: portable pieces that can be used as a medium of

exchange. Banknotes or coins.

More...• Technology: mechanical arts and applied

sciences.• Growth: increasing in size by accretion or

assimilation of material. A quantitative increase in physical dimensions or size.

• Economic Growth: rising aggregate consumption (C) or output (Q).

• Development: bring to a fuller, greater, or better state.

Empty World View – Herman Daly

Full World View

Physical Limits to Economy

• Malthus: absolute limits or scarcity

• Ricardo: relative limits

• Marx: limits due to social and political unrest

Malthus Diagram

Closed Economic System

Capital TechnologyStock Stock

Production Labor

OutputConsumption Households

Capital Investment

Technology Investment

Source: Pezzey

Economy with Environmental Considerations Environmental

Productivity Natural Resource StocksRenewable Non- Pollution

Capital Technology Resources Renewable StockStock Stock Resources

Production Labor

Output Waste FlowsHouseholds

Capital Investment ConsumptionUtility Environmental Amenity

Technology Investment

Clean Up Expenditure

Environmental Quality

Source: Pezzey

Prevailing Economic System

• Private ownership of material resources

• Public ownership of “sinks”

• Perfect functioning of the market

• Infinite subsitutability of resources

• Subsidized disposal, energy, water

Mainstream economics FALLACIES

• Marie Antoinette Economicslet agriculture fall, consume other 97% of GNP

• Technological cavalry will save uswe can substitute for soil, air, water, forests...

• “Not Beating the Wife As Much As Before” false complacency for partial success

Source: Davidson, E.A., You can’t eat GNP, Perseus, Cambridge MA 2000.

Main problems with current economic theory

Externalities

- costs not borne by those who create them

Badly defined property rights

- environmental goods perceived as commons

The environment is not subject of rights

- the environment’s interests are not legally represented in the economic system

Externalities- Are equal to expenses on the elimination of a

problem.

- Distort the economic rationality by influencing decisions on the allocation of means.

- Are reflected in the revenues of the whole social or consumer groups (e.g. by making other economic actors pay for the pollution caused by them, some companies are ‘subsidized by those who incur those costs)

- May lead to exploitation of some geographical regions by others when regional distribution of labor is taken into account (e.g. migration of polluting industries)

Problems with Current Economic Theory

• Assumes market prices reflect consumer willingness to pay.

• Assumes that consumers are the best judge of value and that community considerations are irrelevant.

• Assumes consumers understand the value of ecological resources provided by many biological resources. Assumes consumer, aided by the market place, knows which species are unnecessary for ecosystem maintenance.

• Assessment of economic value ignores many equity and moral considerations.

• General failure to recognize that market prices are highly distorted.

M.D. Young, Sustainable Investment and Resource Use, Parthenon Publishing Group, 1992, 24-25.

Socialism collapsed because it did not

allow prices to tell the economic truth.

Capitalism may collapse because it

does not allow prices to tell the

ecological truth.

Source: Dahle, 2001.

Worth of Ecosystem

• Costanza et al 1997, “The value of the world’s ecosytem goods and services,” Nature, 387:253-260.– Pollination, Raw Materials Production, Water Supply,

Waste Recycling & Pollution Control, Recreation & Education, Climate and Atmosphere Regulation, Soil Formation and Erosion Control, Control of Pests & Diseases

• Value of services: US$16 to $US54 trillion• World GNP: US$18 trillion• Ecosystem-to-GNP ratio 1.8

Changing the Signals to the Economy

• Currently taxes are applied to positive aspects of behavior: wages, productivity, profit

• It would be better to tax aspects that are negative: waste, inefficiency, pollution

• Possible mechanisms:– Pollution taxes– Tradable pollution permits– Deposit fees

• Shifting impacts of production to producers is called “internalization”

Internalization• Benefits of Internalization Processes

• Transparency

• Across All Sectors

• Flexibility

• Stimulates Innovation

• Polluter Pays

• Caveat: must be transnational

• Cooperation between sectors

• Another example of interconnectedness

Government Use of Internalization Processes

Regulations Performance Standards Manufacturer Responsibility Subsidies Permits Taxes : “Tax pollution, not production” -Pollution,

excise, severance, tax credits Alternative National Accounting Systems Government as Purchaser and Facilitator (Recycled

Content Products/EPA Green Lights

Tax Base Examples Effects How CommonProductiveActivities

Taxes on sales,income,payroll,corporateprofits

Distortionary: Discourageswhat it taxes, reducingemployment and earnings

Very common - thesource of most revenuein industrial countries

Excess Profitsfrom NaturalResource Use

Taxes onlogging invirgin forests,fishing

Neutral: Shares with society theexcess profits that are generatedby rising prices from naturalresources, which are caused byglobal demand and dwindlingsupplies. Neither encourages ordiscourages what it taxes, sinceresource users still earn a fairprofit.

Rare

EnvironmentalDestruction

Taxes onwater and airpollutantssuch asfertilizer run-off and lead

Corrective: Makes pollutersexperience the full costs of whatthey do, encouraging them toreduce the economic toll on thisand future generations.

Becoming morecommon, but exceptfor energy taxes notmajor revenue sources.

Table 2 Global taxing priorities (Roodman 1995)

Tax shifts from work & investment to environmental damage

Country, year initiated Taxes Cut On Taxes Raised On

Revenue Shifted (%)

Sweden, 1991 Personal Income Carbon and Sulfur Emissions

1.9

Denmark, 1994 Personal Income Motor fuel, coal, electricity, water sales

2.5

Spain, 1995 Wages Motor fuel sales 0.2

Denmark, 1996 Wages,

agricultrual property

Carbon emissions; pesticide, chlorinated solvents, battery sales

0.5

Netherlands, 1996 Personal income & wages

Natural gas and electricity sales

0.8

United Kingdom, 1996-7

Wages Landfilling 0.2

Finland, 1996-7 Personal income & wages

Energy sales; landfilling 0.5

Sustainable Economic System

• Understands primary role of natural systems in the economy

• Integrates functions of industrial and natural “ecologies”

• Accounts for true costs of waste and disposal

• Cradle-to-Grave responsibility for products

• Penalizes waste, rewards efficiency

• Provides for fair, just, meaningful, and fulfilling employment of human resources

Ecological Economics

• A new transdisciplinary field addressing the relationship between ecosystems and economic systems in the broadest sense.

• Uses the tools of conventional economics and ecology as appropriate.

• Need to establish institutions that take the long term view, a la biology.

• Economics as an ecological system.

R. Costanza, Ed. Ecological Economics, The Science and Management of Sustainability,

Columbia University Press, 1991, 3-7.

Relationships of Economic Schools

Some Ecological & Environmental EconomicsTerms

• Hicksian Income: income that does not forego future opportunities for others; living off nature’s interest not its capital

• Pigou’s Externalities a Pigouvian Tax is on paid by polluters equal to the marginal external cost borne by the pollutees. The polluter is thus informed about the full social costs of his operations and the victims can be fairly reimbursed (1920).

• Solow Criterion: Solow stated that substitutability would allow man to get along without natural resources (1974).

• The Hartwick-Solow Rule: Manufactured capital can substitute for natural capital

Hicksian Income...income that can be consumed without reducing future consumption possiblities

Hartwick-Solow Rule

Value of savings >= Value of Manufactured Capital

Deterioration + Value of natural Capital

Depletion/Degradation

The amount a society must save and reinvest to maintaincapital intact. The total capital stock (natural plus manufactured must be nondeclining.

D. Pearce et al. The Economics of Sustainable Development, Ann. Rev. of Energy Environ. 1994. 19: 457-474.

The Ecological Economists

• Kenneth Boulding (1910-1992): The Economics of the Coming Spaceship Earth (1966)

• Nicholas Georgescu-Roegen (1906-1994): The Entropy Law and Economic Progress- the economy is not a reversible mechanical systems but subject to the 2nd Law

• Herman Daly: student of N. G-R., steady state economy

Gowdy, J. and Sabine O’Hara, Economic Theory for Environmentalists, St Lucie Press, 1995, 129-132.

Biological Basis for the Economy

• A.J. Lotka: “The Earth Machine” or the “Mill Wheel of Life”

• J.A. Hobson : organic test as the test of welfare

• N. Georgescu-Roegen: thermodynamic limits, biophysical foundations of the economy

• M.K. Hubbert: biophysical constraints to economic growth

• H.T. Odum: economy as an ecosystem

• G. Hardin: institutional conditions for overexploitation

• M. Rothschild: Bionomics - genetic material of the economy is technology

Economy like ecosystem?

• Eugene Odum:

– young ecosystems: production, growth, quantity

– mature ecosystems: protection, stability, quality

• Today’s economy is like a young ecosystem

• How do we create an economy that is like a mature ecosystem?

The metabolic analogy

Useful matter

Useful Energy

Useful matter

Useful Energy

Metabolism

Economics

Time

Distribution

Distribution

Degraded matter

Degradedenergy

Totallydegraded matter

Totallydegradedenergy

Anabolism Catabolism

Anabolism Catabolism

Bionomics

• The economy behaves like a biological system

• Behavior of biological systems applied to economics

• Excellent forecasting tool (e.g. AT&T demand for telephone service)

Alternative Measures of Welfare

(Examples)

• Index of Sustainable Economic Welfare (ISEW)

• Genuine Progress Indicator (GPI)

• Human Development Index (HDI)

Human Development Index

• Created by the United Nations Development Program (UNDP)

• A composite of three indicators

– Longevity: life expectancy

– Knowledge: literacy, years of schooling

– Standard of Living: purchasing power based on GDP/capita

Genuine Progress Indicator• Developed by non-profit: Redefining Progress• Starts with real personal consumption, adjusts for income distribution• Subtracts:

– Crime & Divorce– Resource depletion– Environmental Damage– Income Distribution– Pollution– Lifespan of durable goods & public infrastructure– Dependence on foreign assets

• Adds:– Value of household work and parenting– Value of volunteer work

INDEX OF SUSTAINABLE ECONOMIC WELFARE – U.S., 1990 (Constant billion $ of 1972

Personal income adjusted for income distribution

$1,164

+services for household labor +520

+services of consumer durable goods +225

+services of highways and streets +18

+consumption public spending on health/education

+45

-consumer spending on durable goods -225

-defensive private spending on health and education

-63

-cost of commuting and auto accidents -67

-cost of personal pollution control -5

-cost of air, water, and noise pollution -39

-lost of wetlands and farmland -58

-depletion of natural resources -313

-long term damage from nuclear wastes, ozone depletion, and greenhouse gases

-371

+net capital growth +29

+/- net international investment position -34

INDEX OF SUSTAINABLE ECONOMIC WELFARE

$818

Globalization• The World Trade Organization (WTO) (1995)• Established by final act of Uruguay Round of Multilateral Trade Negotiations

in Marrakech in April 1994– Goal is to remove all obstacles to trade

• How a product is made• By whom• What happens when it is made

– Result: Countries and regions cannot set standards, express values, or determine what they do or do not support

– Outcomes: Child labor, prison labor, forced labor, substandard working conditions and wages, environmental destruction, habitat loss, toxic waste production, synthetic hormones, genetically engineered materials

• Membership: 135 countries (but no plebiscite was held!)• Violates Agenda 21 and the Universal Declaration of Human Rights

Case Study: Chiquita Brands International• Chiquita Brands International is a $2 billion company• Main product is bananas from Central America• History of labor abuses, heavy pesticide use

(dichloropropane), resulting in birth defects and infertility

• European countries biased import policy for bananas to small family farmers using fewer chemicals

• U.S. sued and in WTO arbitrated case and won, forcing European countries to eliminate their bias

• Other cases: Countries must allow McDonald’s, Blockbuster, Pizza Hut, etc. to operate within their borders

Dow Jones Sustainability Index

Dow Jones Trend

Dow Jones Sustainability Index vs S&P 500

Leading DJ Sustainability Firms

• Consumer– BMW AG, Germany– Fuji Photo, Japan– Unilever Plc., Netherlands– Bristol-Myers Squibb, US

• Energy– Suncor Energy, Canada– Enbridge Inc., Canada

• Utilities– Deutsche Telekom AG,

Germany– TransAlta Corp., Canada

• Financial– Credit Suisse Group,

CH– Skandia Forsakrings

AB, SW

• Industrial– Honeywell Inc., US– Tomra Systems ASA,

Norway

• Technology– Fugitsu Ltd., Japan– ST Microelectronics,

France

BP: Sustainable profits?

World’s largest supplier of solar modules

$200 million/yr $1 billion/yr by 2007 Solar-powered H2O

electrolysis: hydrogen buses

WBCSD, US Members• 3M Company• Alcoa• AT&T• Arthur D. Little• The Boston Consulting Group• Cargill Incorporated• CEMEX• CH2M Hill• Conoco• Dow Chemical Company• DuPont• Eastman Kodak Company• Ford Motor Company• General Motors Corporation• Interface• International Paper

Monsanto Company

Johnson & Johnson

Phelps Dodge

Procter & Gamble Company

Rohm and Haas

S.C. Johnson & Son

Suncor Energy Inc

Texaco

Time Warner

Unocal

Westvaco Corporation

Weyerhaeuser Company

Xerox Corporation

Main Points• Everything is connected

• The result is there are feedback loops between all elements of the system

• Maldistribution of wealth is prevalent but not sustainable

• GDP and GNP do not really represent ‘welfare’ just economic throughput

• The economy responds to signals it is sent– Cheap waste disposal

– Low costs for emissions (air, water, land)

– Low cost for environmental impacts

– Cheap and subsidized resources

– Tax benefits for resource depletion

• How do you change the signals to the economy?

Summary and Conclusions• The current economic system is not sustainable

– Depends on the scale of material/energy throughput– Subsidizes resource extraction and pollution– Taxes productive activities– Does not measure ‘welfare’

• A system based on Ecological Economics would:– Shift taxes to waste, inefficiency, and pollution, away from

wages, profits, productivity, and investment– Focus on dematerialization, deenergization, decarbonization, and

detoxification– Measure welfare instead of absolute monetary transactions– Support an EcoIndustrial revolution