An Introduction to Ecological Economics: Chapter 3

Published: September 17, 2008, 6:05 pm

Updated: October 27, 2010, 9:52 am

Topics:

Ecological Economics (main)

Problems and Principles of Ecological Economics

As described in the previous chapter, ecological economics is the product of an evolutionary historical development. It is not a static set of answers. It is a dynamic, constantly changing set of questions. It also advocates a fundamentally different, transdisciplinary vision of the scientific endeavor that emphasizes dialogue and cooperative problem solving. It tries to transcend the definition and protection of intellectual turf that plagues the current disciplinary structure of science. This transdisciplinary vision was the rule in earlier times, but has been replaced by a more rigid disciplinary vision in recent times.

Figure 3.1 illustrates how this transdisciplinary vision differs from the now standard disciplinary vision. In the upper panel, the standard disciplinary vision is depicted as one that leads to the defining and protecting of disciplinary territories on the intellectual landscape. Sharp boundaries between disciplines, different languages and cultures within disciplines, and lack of any overarching view makes problems which cross disciplinary boundaries or which fall in the empty spaces between the territories very difficult, if not impossible, to deal with. There are also large gaps in the landscape that are not covered by any discipline. Within this vision of how to organize the scientific endeavor, one might think that the main role of ecological economics would be to fill in the empty space between economics and ecology, while maintaining sharp boundaries between what is economics, what is ecology, and what is ecological economics. But this is not really the vision of ecological economics.

Figure 3.1. Disciplinary vs. transdisciplinary views. A. Standard disciplinary view of the problem as “intellectual turf.” Sharp boundaries between disciplines, different languages and cultures within disciplines, and lack of any overarching view makes problems which cross-disciplinary boundaries very difficult to deal with. B. Interdisciplinary view where disciplines expand and overlap to fill in the empty spaces in the intellectual landscape. C. Transdisciplinary approach views the problem as a whole, rather than as intellectual turf to be divided up, and views the boundaries of the intellectual landscape as porous and changing. (Source: Authors)

The middle panel in Figure 3.1 illustrates an interdisciplinary vision of the problem. In this vision the disciplines expand and overlap to fill in the empty spaces in the intellectual landscape, but maintain their core territories. There is dialogue and interaction in the overlaps between territories, but the picture begins to look jumbled and incoherent. This vision is movement in the direction toward the transdisciplinary ecological economics vision, but it is still not quite there.

The bottom panel of Figure 3.1 illustrates the ecological economics vision, where the boundaries between disciplines have been completely eliminated and the problems and questions are seen as a seamless whole in an intellectual landscape that is also changing and growing. This vision coexists and interacts with the conventional disciplinary structure, which is a necessary and useful way to address many problems. The transdisciplinary view provides an overarching coherence that can tie disciplinary knowledge together and address the increasingly important problems that cannot be addressed within the disciplinary structure. In this sense ecological economics is not an alternative to any of the existing disciplines. Rather it is a new way of looking at the problem that can add value to the existing approaches and address some of the deficiencies of the disciplinary approach. It is not a question of “conventional economics” versus “ecological economics”; it is rather conventional economics as one input (among many) to a broader transdisciplinary synthesis.

We believe that this transdisciplinary way of looking at the world is essential if we are to achieve the three interdependent goals of ecological economics discussed below: sustainable scale, fair distribution, and efficient allocation. This requires the integration of three elements: (1) a practical, shared vision of both the way the world works and of the sustainable society we wish to achieve; (2) methods of analysis and modeling that are relevant to the new questions and problems this vision embodies; and (3) new institutions and instruments that can effectively use the analyses to adequately implement the vision.

The importance of the integration of these three components cannot be overstated. Too often when discussing practical applications we focus only on the implementation element, forgetting that an adequate vision of the world and our goals is often the most practical device to achieving the vision, and that without appropriate methods of analysis even the best vision can be blinded. The importance of communication and education concerning all three elements can also not be overstated.

The basic points of consensus in the ecological economics vision are:

1. the vision of the earth as a thermodynamically closed and nonmaterially growing system, with the human economy as a subsystem of the global ecosystem. This implies that there are limits to biophysical throughput of resources from the ecosystem, through the economic subsystem, and back to the ecosystem as wastes;
2. the future vision of a sustainable planet with a high quality of life for all its citizens (both humans and other species) within the material constraints imposed by 1;
3. the recognition that in the analysis of complex systems like the earth at all space and time scales, fundamental uncertainty is large and irreducible and certain processes are irreversible, requiring a fundamentally precautionary stance; and
4. that institutions and management should be proactive rather than reactive and should result in simple, adaptive, and implementable policies based on a sophisticated understanding of the underlying systems which fully acknowledges the underlying uncertainties. This forms the basis for policy implementation which is itself sustainable.

Sustainable Scale, Fair Distribution, and Efficient Allocation

A complementary way of characterizing ecological economics is to list the basic problems and questions it addresses. We see three basic problems: allocation, distribution, and scale. Neoclassical economics deals extensively with allocation, secondarily with distribution, and not at all with scale. Ecological economics deals with all these, and accepts much of neoclassical theory regarding allocation. Our emphasis on the scale question is made necessary by its neglect in standard economics. Inclusion of scale is the biggest difference between ecological economics and neoclassical economics.

Allocation refers to the relative division of the resource flow among alternative product uses—how much goes to production of cars, to shoes, to plows, to teapots, and so on. A good allocation is one that is efficient, that is, that allocates resources among product end-uses in conformity with individual preferences as weighted by the ability of the individual to pay. The policy instrument that brings about an efficient allocation is relative prices determined by supply and demand in competitive markets.

Distribution refers to the relative division of the resource flow, as embodied in final goods and services, among alternative people. How much goes to you, to me, to others, to future generations. A good distribution is one that is just or fair, or at least one in which the degree of inequality is limited within some acceptable range. The policy instrument for bringing about a more just distribution is transfers, such as taxes and welfare payments.

Scale refers to the physical volume of the throughput, the flow of matter–energy from the environment as low-entropy raw materials and back to the environment as high-entropy wastes (see Figure 1.1). It may be thought of as the product of population times per capita resource use. It is measured in absolute physical units, but its significance is relative to the natural capacities of the ecosystem to regenerate the inputs and absorb the waste outputs on a sustainable basis. Perhaps the best index of scale of throughput is real GNP. Although measured in value units (P x Q, where P is price and Q is quantity), real GNP is an index of change in Q. National income accountants go to great lengths to remove the influence of changes in price, both relative prices and the price level. For some purposes the scale of throughput might better be measured in terms of embodied energy^[7]. The economy is viewed as an open subsystem of the larger, but finite, closed, and nongrowing ecosystem. Its scale is significant relative to the fixed size of the ecosystem. A good scale is one that is at least sustainable, that does not erode environmental carrying capacity over time. In other words, future environmental carrying capacity should not be discounted as done in present value calculations. An optimal scale is at least sustainable, but beyond that it is a scale at which we have not yet sacrificed ecosystem services that are at present worth more at the margin than the production benefits derived from the growth in the scale of resource use.

Scale in this context is not to be confused with the concept of “economies of scale,” which refers to the way efficiency changes with the scale or size of production within a firm or industry. Here we are using scale to refer to the overall scale or size of the total macroeconomy and throughput.

Priority of Problems. The problems of efficient allocation, fair distribution, and sustainable scale are highly interrelated but distinct; they are most effectively solved in a particular priority order, and they are best solved with independent policy instruments^[8]. There are an infinite number of efficient allocations, but only one for each distribution and scale. Allocative efficiency does not guarantee sustainability^[9]. It is clear that scale should not be determined by prices, but by a social decision reflecting ecological limits. Distribution should not be determined by prices, but by a social decision reflecting a just distribution of assets. Subject to these social decisions, individualistic trading in the market is then able to allocate the scarce rights efficiently.

Distribution and scale involve relationships with the poor, future generations, and other species that are fundamentally social in nature rather than individual. Homo economicus, as the self-contained atom of methodological individualism or as the pure social being of collectivist theory, is a severe abstraction. Our concrete experience is that of “persons in community.” We are individual persons, but our very individual identity is defined by the quality of our social relations. Our relations are not just external, they are also internal—that is, the nature of the related entities (ourselves in this case) changes when relations among them change. We are related not only by a nexus of individual willingnesses-to-pay for different things, but also by relations of trusteeship for the poor, future generations, and other species. The attempt to abstract from these concrete relations of trusteeship and reduce everything to a question of individual willingness-to-pay is a distortion of our concrete experience as persons in community—an example of what A. N. Whitehead called “the fallacy of misplaced concreteness”^[10].

The prices that measure the opportunity costs of reallocation are unrelated to measures of the opportunity costs of redistribution or of a change in scale. Any trade-off among the three goals (e.g., an improvement in distribution in exchange for a worsening in scale or allocation, or more unequal distribution in exchange for sharper incentives seen as instrumental to more efficient allocation), involves an ethical judgment about the quality of our social relations rather than a willingness-to-pay calculation. The contrary view, that this choice among basic social goals and the quality of social relations that help to define us as persons should be made on the basis of individual willingness-to-pay, just as the trade-off between chewing gum and shoelaces is made, seems to be dominant in economics today, and is part of the retrograde modern reduction of all ethical choice to the level of personal tastes weighted by income.

It is instructive to consider the historical attempt of the scholastic economists to subsume distribution under allocation (or more likely they were subsuming allocation under distribution—at any rate they did not make the distinction). This was the famous “just price” doctrine of the Middle Ages which has been totally rejected in economic theory, although it stubbornly survives in the politics of minimum wages, farm price supports, water and electric power subsidies, etc. However, we do not as a general rule try to internalize the external cost of distributive injustice into market prices. We reject the attempt to correct market prices for their unwanted effects on income distribution. Economists nowadays keep allocation and distribution quite separate and argue for letting prices serve only efficiency, while serving justice with the separate policy of transfers. This follows Tinbergen’s dictum of equality of policy goals and instruments: one instrument for each policy. The point is that just as we cannot subsume distribution under allocation, neither can we subsume scale under allocation.

It seems clear, then, that we need to address the problems in the following order: first, establish the ecological limits of sustainable scale and establish policies that assure that the throughput of the economy stays within these limits. Second, establish a fair and just distribution of resources using systems of property rights and transfers. These property rights systems can cover the full spectrum from individual to government ownership, but intermediate systems of common ownership and systems for dividing the ownership of resources into ownership of particular services need much more attention^[11]. Third, once the scale and distribution problems are solved, market-based mechanisms can be used to allocate resources efficiently. This involves extending the existing market to internalize the many environmental goods and services that are currently outside the market. Policy instruments to achieve the three goals of sustainable scale, fair distribution, and efficient allocation are discussed in detail in Section 2.4. First we delve a little more deeply into the scale and distribution problems.

From Empty-World Economics to Full-World Economics

Ecological economics argues that the evolution of the human economy has passed from an era in which human-made capital was the limiting factor in economic development to an era in which remaining natural capital has become the limiting factor. Economic logic tells us that we should maximize the productivity of the scarcest (limiting) factor, as well as try to increase its supply. This means that economic policy should be designed to increase the productivity of natural capital and its total amount, rather than to increase the productivity of human-made capital and its accumulation, as was appropriate in the past when it was the limiting factor. It remains to give some reasons for believing this “new era” thesis, and to consider some of the far-reaching policy changes that it would entail, both for development in general and for particular institutions.

Reasons the Turning Point Has Not Been Noticed

Why has this transformation from a world relatively empty of human beings and human-made capital to a world relatively full of these not been noticed by economists? If such a fundamental change in the pattern of scarcity is real, as we think it is, then how could it be overlooked by economists whose job is to pay attention to the pattern of scarcity? Some economists, including Boulding^[12] and Georgescu-Roegen^[13] have indeed signaled the change, but their voices have been largely unheeded.

One reason is the deceptive acceleration of exponential growth. With a constant rate of growth the world will go from half full to totally full in one doubling period—the same amount of time that it took to go from 1% full to 2% full. Of course the doubling time itself has shortened, compounding the deceptive acceleration. If we return to the example of the percent appropriation by human beings of the net product of land-based photosynthesis as an index of how full the world is of humans and their furniture, then we can say that it is 40% full because we use, directly and indirectly, about 40% of the net primary product of land-based photosynthesis^[14]. Taking 40 years as the doubling time of the human scale (i.e., population times per capita resource use) and calculating backwards, we go from the present 40% to only 10% full in just two doubling times or 80 years, which is about an average U.S. lifetime. Also, “full” here is taken as 100% human appropriation of the net product of photosynthesis which is [[ecological]ly] unlikely and socially undesirable (only the most recalcitrant species would remain wild; all others would be managed for human benefit). In other words, effective fullness occurs at less than 100% human preemption of net photosynthetic product, and there is much evidence that long-run human carrying capacity is reached at less than the existing 40% (see chapter 1). The world has rapidly gone from relatively empty (10% full) to relatively full (40% full). Although 40% is less than half full, it makes sense to consider it as relative fullness because it is only one doubling time away from 80%, a figure which represents excessive fullness. This change has been faster than the speed with which fundamental economic paradigms shift.

According to physicist Max Planck, a new scientific paradigm triumphs not by convincing the majority of its opponents, but because its opponents eventually die. There has not yet been time for the empty-world economists to die, and meanwhile they have been cloning themselves faster than they are dying by maintaining tight control over their guild. The disciplinary structure of knowledge in modern economics is far tighter than that of the turn-of-the-century physics that was Planck’s model. Full-world economics is not yet accepted as academically legitimate, but it is beginning to be seen as a challenge. This book, based on full-world economics, challenges the empty-world economics prevailing today.

Complementarity vs. Substitutability

A major reason for failing to note the major change in the pattern of scarcity is that in order to speak of a limiting factor, the factors must be thought of as complementary. If factors are good substitutes, then a shortage of one does not significantly limit the productivity of the other. A standard assumption of neoclassical economics has been that factors of production are highly substitutable. Although other models of production have considered factors as not at all substitutable (e.g., the total complementarity of the Leontief model), the substitutability assumption has dominated. Consequently, the very idea of a limiting factor was pushed into the background. If factors are substitutes rather than complements, then there can be no limiting factor and hence no new era based on a change of the limiting role from one factor to another. It is therefore important to be very clear on the issue of complementarity versus substitutability.

The productivity of human-made capital is more and more limited by the decreasing supply of complementary natural capital. Of course in the past when the scale of the human presence in the biosphere was low, human-made capital played the limiting role. The switch from human-made to natural capital as the limiting factor is thus a function of the increasing scale and impact of the human presence. Natural capital is the stock that yields the flow of natural resources—the forest that yields the flow of cut timber; the petroleum deposits that yield the flow of pumped crude oil; the fish populations in the sea that yield the flow of caught fish. The complementary nature of natural and human-made capital is made obvious by asking: what good is a sawmill without a forest? A refinery without petroleum deposits? A fishing boat without populations of fish? Beyond some point in the accumulation of human-made capital it is clear that the limiting factor on production will be remaining natural capital. For example, the limiting factor determining the fish catch is the reproductive capacity of fish populations, not the number of fishing boats; for gasoline the limiting factor is petroleum deposits, not refinery capacity; and for many types of wood it is remaining forests, not sawmill capacity. Costa Rica and Peninsular Malaysia, for example, now must import logs to keep their sawmills employed. One country can accumulate human-made capital and deplete natural capital to a greater extent only if another country does it to a lesser extent—for example, Costa Rica must import logs from somewhere. The demands of complementarity between human-made and natural capital can be evaded within a nation only if they are respected between nations.

Of course multiplying specific examples of complementarity between natural and human-made capital will never suffice to prove the general case. But the examples given above at least serve to add concreteness to the more general arguments for the complementarity hypothesis given later (Section 3.3).

Because of the complementary relation between human-made and natural capital, the very accumulation of human-made capital puts pressure on natural capital stocks to supply an increasing flow of natural resources. When that flow reaches a size that can no longer be maintained, there is a big temptation to supply the annual flow unsustainably by liquidation of natural capital stocks, thus postponing the collapse in the value of the complementary human-made capital. Indeed in the era of empty-world economics natural resources and natural capital were considered free goods (except for extraction or harvest costs). Consequently, the value of human-made capital was under no threat from scarcity of a complementary factor. In the era of full-world economics, this threat is real and is met by liquidating stocks of natural capital to temporarily keep up the flows of natural resources that support the value of human-made capital. Hence the problem of sustainability.

Policy Implications of the Turning Point

In this new full-world era, investment must shift from human-made capital accumulation toward natural capital preservation and restoration. Also, technology should be aimed at increasing the productivity of natural capital more than human-made capital. If these two things do not happen then we will be behaving uneconomically, in the most orthodox sense of the word. That is, the emphasis should shift from technologies that increase the productivity of labor and human-made capital to those that increase the productivity of natural capital. This would occur by market forces if the price of natural capital were to rise as it became more scarce. What keeps the price from rising? In most cases natural capital is unowned and consequently nonmarketed. Therefore it has no explicit price and is exploited as if its price was zero. Even where prices exist on natural capital, the market tends to be myopic and excessively discounts the costs of future scarcity, especially when under the influence of economists who teach that accumulating capital is a near-perfect substitute for depleting natural resources!

Natural capital productivity is increased by: (1) increasing the flow (net growth) of natural resources per unit of natural stock (limited by biological growth rates); (2) increasing product output per unit of resource input (limited by mass balance); and especially by (3) increasing the end-use efficiency with which the resulting product yields services to the final user (limited by technology). We have already argued that complementarity severely limits what we should expect from (2), and complex ecological interrelations and the law of conservation of matter–energy limits the increase from (1). Therefore the ecological economics focus should be mainly on (3).

The above factors limit productivity from the supply side. From the demand side, tastes may limit the economic productivity of natural capital in a way more stringent than the limit of biological productivity. For example, game ranching and fruit and nut gathering in a natural tropical forest may, in terms of biomass, be more productive than cattle ranching. But undeveloped tastes for game meat and tropical fruit may make this use less profitable than the biologically less productive use of cattle ranching. In this case a change in tastes can increase the biological productivity with which the land is used.

Since human-made capital is owned by the capitalist we can expect that it will be maintained with an interest to increasing its productivity. Labor power, which is a stock that yields the useful services of labor, can be treated in the same way as human-made capital. Labor power is human-made and owned by the laborer who has an interest in maintaining it and enhancing its productivity. But nonmarketed natural capital (the water cycle, the ozone layer, the atmosphere, etc.) is not subject to ownership, and no self-interested social class can be relied upon to protect it from overexploitation.

If the thesis argued above were accepted by development economists, what policy implications would follow? The role of economic development banks in the new era would be increasingly to make investments that replenish the stock and that increase the productivity of natural capital. In the past, development investments have largely aimed at increasing the stock and productivity of human-made capital. Instead of investing mainly in sawmills, fishing boats, and refineries, development should now focus on reforestation, restocking of fish populations, and renewable substitutes for dwindling reserves of petroleum. The latter should include investment in energy efficiency, since it is impossible to restock petroleum deposits. Since natural capacity to absorb wastes is also vital, resource investments that preserve that capacity (e.g., pollution reduction) also increase in priority. For marketed natural capital this will not represent a revolutionary change. For nonmarketed natural capital it will be more difficult, but even here economic development can focus on complementary public goods such as education, legal systems, public infrastructure, and population prudence. Investments in limiting the rate of growth of the human population are of the greatest importance in managing a world that has become relatively full. Like human-made capital, human-made labor power is also complementary with natural resources and its growth can increase demand for natural resources beyond the capacity of natural capital to supply sustainably.

The clearest policy implication of the full-world thesis is that the level of per capita resource use of the rich countries cannot be generalized to the poor, given the current world population. Present total resource use levels are already unsustainable, and multiplying them by a factor of 5 to 10 as envisaged in the Brundtland Report, albeit with considerable qualification, is ecologically impossible. As a policy of growth becomes less possible, the importance of redistribution and population prudence as measures to combat poverty increases correspondingly. In a full world both human numbers and per capita resource use must be constrained. Poor countries cannot cut per capita resource use; indeed they must increase it to reach a sufficiency, so their focus must be mainly on population control. Rich countries can cut both, and for those that have already reached demographic equilibrium the focus would be more on limiting per capita consumption to make resources available for transfer to help bring the poor up to sufficiency. Investments in the areas of population control and redistribution therefore increase in priority for development.

Investing in natural capital (nonmarketed) is essentially an infrastructure investment on a grand scale and in the most fundamental sense of infrastructure—that is, the biophysical infrastructure of the entire human niche, not just the within-niche public investments that support the productivity of the private investments. Rather, we are now talking about investments in biophysical infrastructure (“infra-infrastructure”) to maintain the productivity of all previous economic investments in human-made capital, be they public or private, by investing in rebuilding the remaining natural capital stocks that have come to be limiting. Since our ability actually to re-create natural capital is very limited, such investments will have to be indirect—that is, they must conserve the remaining natural capital and encourage its natural growth by reducing our level of current exploitation. Investments in waiting (e.g., fallow) have been respectable and accepted since Alfred Marshall in 1890. This includes investing in projects that relieve the pressure on these natural capital stocks by expanding cultivated natural capital (plantation forests to relieve pressure on natural forests), and by increasing end-use efficiency of products.

The difficulty with infrastructure investments is that their productivity shows up in the enhanced return on other investments, and is therefore difficult both to calculate and to collect for loan repayment. Also, in the present context these ecological infrastructure investments are defensive and restorative in nature—that is, they will protect existing rates of return from falling more rapidly than otherwise, rather than raising their rate of return to a higher level. This circumstance will dampen the political enthusiasm for such investments but will not alter the economic logic favoring them. Past high rates of return to human-made capital were possible only with unsustainable rates of use of natural resources and consequent (uncounted) liquidation of natural capital. We are now learning to deduct natural capital liquidation from our measure of national income^[15]. The new era of sustainable development will not permit natural capital liquidation to count as an income, and will consequently require that we become accustomed to lower rates of return on human-made capital—rates on the order of magnitude of the biological growth rates of natural capital, since that will be the limiting factor.

Once investments in natural capital have resulted in equilibrium stocks that are maintained but not expanded (yielding a constant total resource flow), then all further increases in economic welfare would have to come from increases in pure efficiency resulting from improvements in technology and clarification of priorities. Certainly investments are made in increasing biological growth rates, and the advent of genetic engineering may add greatly to this thrust. However, experience to date (e.g., the green revolution) indicates that higher biological yield rates usually require the sacrifice of some other useful quality (disease resistance, flavor, strength of stalk). In any case, the law of conservation of matter–energy cannot be evaded by genetics: more food from a plant or animal implies either more inputs or less matter–energy going to the non-food structures and functions of the organism^[16]. To carry the arguments for infrastructure investments into the area of biophysical/environmental infrastructure or natural capital replenishment will require new thinking by development economists. Since much natural capital is not only public but also globally public in nature, the United Nations seems to be the appropriate agency for a leadership role.

Consider some specific cases of biospheric infrastructure investments and the difficulties they present.

1. A largely deforested country will need reforestation to keep the complementary human-made capital of sawmills (carpentry, cabinetry skills, etc.) from losing their value. Of course the deforested country could for a time resort to importing logs. To protect the human-made capital of dams from silting up the reservoirs behind them, the water catchment areas feeding the lakes must be reforested or original forests must be protected to prevent erosion and sedimentation. Agricultural investments depending on irrigation can become worthless without forested water catchment areas that recharge aquifers.
2. At a global level enormous stocks of human-made capital and natural capital are threatened by depletion of the ozone layer, although the exact consequences are too uncertain to be predicted.
3. The greenhouse effect is a threat to the value of all coastally located and climatically dependent capital (such as agriculture), be it human-made (port cities, wharves, beach resorts) or natural (estuarine breeding grounds for fish and shrimp). And if the natural capital of fish populations diminishes due to loss of breeding grounds, then the value of the human-made capital of fishing boats and canneries will also be diminished in value, as will the labor power (specialized human capital) devoted to fishing, canning, and so on.

We have begun to adjust national accounts for the liquidation of natural capital, but have not yet recognized that the value of complementary human-made capital must also be written down as the natural capital that it was designed to exploit disappears. Eventually the market will automatically lower the valuation of fishing boats as fish disappear, so perhaps no accounting adjustments are called for. But ex ante policy adjustments aimed at avoiding the ex post writing down of complementary human-made capital, whether by market or accountant, is certainly overdue.

Initial Policy Response to the Historical Turning Point

Although there is as yet no indication of the degree to which development economists would agree with the fundamental thesis argued here, three UN agencies (World Bank, UNEP, and UNDP) have nevertheless embarked on a project, however exploratory and modest, of biospheric infrastructure investment known as the Global Environmental Facility. The Facility provides concessional funding for programs investing in the preservation or enhancement of four classes of biospheric infrastructure or nonmarketed natural capital. These are: protection of the ozone layer, reduction of greenhouse gas emissions, protection of international water resources, and protection of biodiversity. If the thesis argued here is correct, then investments of this type should eventually become very important in development economics. It would seem that the “new era” thesis merits serious discussion, especially since it appears that our practical policy response to the reality of the new era has already outrun our theoretical understanding of it. We need a much deeper understanding of natural capital and the ecosystem services it provides. The current status of this understanding is discussed below.

Ecosystems, Biodiversity, and Ecological Services

An ecosystem consists of plants, animals, and microorganisms that live in biological communities and that interact with each other, with the physical and chemical environment, with adjacent [[ecosystem]s] and with the atmosphere. The structure and functioning of an ecosystem is sustained by synergistic feedbacks between organisms and their environment. For example, the physical environment puts constraints on the growth and development of biological subsystems that, in turn, modify their physical environment.

Solar energy is the driving force of ecosystems, enabling the cyclic use of materials and compounds required for system organization and maintenance. Ecosystems capture solar energy through photosynthesis by plants. This is necessary for the conversion, cycling, and transfer to other systems of materials and critical chemicals that affect growth and production, i.e., biogeochemical cycling. Energy flow and biogeochemical cycling set an upper limit on the quantity and number of organisms, and on the number of trophic levels that can exist in an ecosystem^[17].

Holling^[18] has described ecosystem behavior as the dynamic sequential interaction between four basic system functions: exploitation, conservation, release, and reorganization. The first two are similar to traditional ecological succession. Exploitation is represented by those ecosystem processes that are responsible for rapid colonization of disturbed [[ecosystem]s] during which organisms capture easily accessible resources. Conservation occurs when the slow resource accumulation builds and stores increasingly complex structures. Connectedness and stability increase during the slow sequence from exploitation to conservation and a “capital” of biomass is slowly accumulated. Release or creative destruction takes place when the conservation phase has built elaborate and tightly bound structures that have become “overconnected,” so that a rapid change is triggered. The system has become brittle. The stored capital is then suddenly released and the tight organization is lost. The abrupt destruction is created internally but caused by an external disturbance such as fire, disease, or grazing pressure. This process of change both destroys and releases opportunity for the fourth stage, reorganization, during which released materials are mobilized to become available for the next exploitative phase.

The stability and productivity of the system is determined by the slow exploitation and conservation sequence. Resilience, the system’s capacity to recover after disturbance or its capacity to absorb stress, is determined by the effectiveness of the last two system functions. The self-organizing ability of the system, or more particularly the resilience of that self-organization, determines its capacity to respond to the stresses and shocks imposed by predation or pollution from external sources.

Some natural disturbances, such as fire, wind, and herbivores, are an inherent part of the internal dynamics of [[ecosystem]s] and in many cases set the timing of successional cycles^[19]. Natural perturbations are parts of ecosystem development and evolution and seem to be crucial for ecosystem resilience and integrity. If they are not allowed to enter the ecosystem, it will become even more brittle and thereby even larger perturbations will occur, with the risk of massive and widespread destruction. For example, small fires in a forest ecosystem release nutrients stored in the trees and support a spurt of new growth without destroying all the old growth. Subsystems in the forest are affected, but the forest remains. If small fires are blocked from a forest ecosystem, forest biomass will build up to high levels, and when the fire does come it will wipe out the whole forest. Such events may flip the system to a totally new state that will not generate the same level of ecological functions and services as before^[20]. These sorts of flips may occur in many ecosystems. For example, savanna ecosystems^[21], coral reef systems^[22], and shallow lakes^[23] all can exhibit this kind of behavior. The flip from one state to another is often induced by human activity; for example, cattle ranching in savanna systems can lead to completely different grass species assemblages; nutrient enrichment and physical disturbance around coral reefs can lead to replacement with algae-dominated systems; and nutrient additions can lead to eutrophication of lakes.

Natural ecosystems, including human-dominated systems, have been called “complex adaptive systems.” Because these systems are evolutionary rather than mechanistic, they exhibit a limited degree of predictability. Understanding the problems and constraints these evolutionary dynamics pose for [[ecosystem]s] is a key component in managing them sustainably^[24].

Biodiversity and Ecosystems

Species diversity appears to have two major roles in the self-organization of large-scale [[ecosystem]s]. First, it provides the units through which energy and materials flow, giving the system its functional properties. There is some experimental evidence^[25] that species diversity increases the productivity of ecosystems by utilizing more of the possible pathways for energy flow and nutrient cycling. Second, diversity provides the ecosystem with the resilience to respond to unpredictable surprises^[26].

“Keystone process” species are those that control the system during the exploitation and conservation phases. The species that keep the system resilient in the sense of absorbing perturbation are those that are important in the release and reorganization phases. The latter group can be thought of as a form of ecosystem “insurance”^[27]. The insurance aspect includes the reservoirs of genetic material necessary for the evolution of microbial, plant, animal, and human life. Genes preserve information about what works and what worked in the past. Genes thereby constrain the self-organization process to those options that have a higher probability of success. They are the record of successful self-organization^[28]. Günther and Folke^[29] distinguish between working and latent information in terms of the function of genes. Similarly, the organisms or groups of organisms that are controlling the ecosystem during the exploitation and conservation phases could be looked upon as working information; those with the ability to take over the system during the release and reorganization phases, that is, those who keep the system resilient, as latent information. Both are part of functional diversity.

Hence, it is the number of organisms involved in the structuring set of processes during the different stages of ecosystem development, and at different spatial and temporal scales, that determines functional diversity. This number is not necessarily the same as the number of all organisms in the system^[30]. Therefore, it is not simply the diversity of species that is important; it is how that diversity is organized into a coherent whole system. The degree of organization of a system is contained in the network of interactions between the component parts^[31], and it is this organization, along with system resilience and productivity (or vigor), which jointly determine the overall health of the system^[32].

Ecosystems and Ecological Services

Ecological systems play a fundamental role in supporting life on earth at all hierarchical scales. They form the life-support system without which economic activity would not be possible. They are essential in global material cycles such as the carbon (Carbon cycle) and [[water cycle]s]. Ecosystems produce renewable resources and ecological services. For example, a fish in the sea is produced by several other “ecological sectors” in the food web of the sea. The fish is a part of the ecological system in which it is produced, and the interactions that produce and sustain the fish are inherently complex.

Ecological services are those ecosystem functions that are currently perceived to support and protect human activities or affect human well-being^[33]. They include maintenance of the composition of the atmosphere, amelioration and stability of climate, flood controls and drinking water supply, waste assimilation, recycling of nutrients, generation of soils, pollination of crops, provision of food, maintenance of species and a vast genetic library, and also maintenance of the scenery of the landscape, recreational sites, aesthetic and amenity values^[34]. Biodiversity at genetic, species, population, and ecosystem levels all contribute in maintaining these functions and services. Cairns and Pratt^[35] argue that if a society was highly environmentally literate, it would probably accept the assertion that most, if not all, ecosystem functions are, in the long term, beneficial to society.

Ecosystem services are seldom reflected in resource prices or taken into account by existing institutions in industrial societies. Many current societies employ social norms and rules, which: (1) bank on future technological fixes and assume that it is possible to find technical substitutes for the loss of ecosystem goods and services; (2) use narrow indicators of welfare; and (3) employ worldviews that alienate people from their dependence on healthy ecosystems. But as the scale of human activity continues to increase, environmental damage begins to occur not only in local ecosystems, but regionally and globally as well. Humanity now faces a novel situation of jointly determined ecological and economic systems. This means that as economies grow relative to their life-supporting ecosystems, the dynamics of both become more tightly connected. In addition, the joint system dynamics can become increasingly discontinuous the closer the economic systems get to the carrying capacity of ecosystems^[36].

The support capacity of ecosystems in producing renewable resources and ecological services has only recently begun to receive attention, despite the fact that this “factor of production” has always been a prerequisite for economic development. In the long run a healthy economy can only exist in symbiosis with a healthy ecology. The two are so interdependent that isolating them for academic purposes has led to distortions and poor management.

Defining and Predicting Sustainability in Ecological Terms

Defining sustainability is actually quite easy: “a sustainable system is one which survives or persists”^[37].

Biologically, this means avoiding extinction and living to survive and reproduce. Economically, it means avoiding major disruptions and collapses, hedging against instabilities and discontinuities. Sustainability, at its base, always concerns temporality and, in particular, longevity.

The problem with the above definition is that, like “fitness” in evolutionary biology, determinations can only be made after the fact. An organism alive right now is fit to the extent that its progeny survive and contribute to the gene pool of future generations. The assessment of fitness today must wait until tomorrow. The assessment of sustainability must also wait until after the fact.

What often pass as definitions of sustainability are therefore usually predictions of actions taken today that one hopes will lead to sustainability. For example, keeping harvest rates of a resource system below rates of natural renewal should, one could argue, lead to a sustainable extraction system—but that is a prediction, not a definition. It is, in fact, the foundation of MSY-theory (maximum sustainable yield), for many years the basis for management of exploited wildlife and fisheries populations^[38]. As learned in these fields, a system can only be known to be sustainable after there has been time to observe if the prediction holds true. Usually there is so much uncertainty in estimating natural rates of renewal, and observing and regulating harvest rates, that a simple prediction such as this, as Ludwig, Hilborn, and Walters^[39] correctly observe, is always highly suspect, especially if it is erroneously thought of as a definition.

Figure 3.2. Sustainability as scale (time and space) dependent concepts. (Source: Costanza and Patten 1995^[1])

The second problem is that when one says a system has achieved sustainability, one does not mean an infinite life span, but rather a life span that is consistent with its time and space scale. Figure 3.2 indicates this relationship by plotting a hypothetical curve of system life expectancy on the y-axis versus time and space scale on the x-axis.

We expect a cell in an organism to have a relatively short life span, the organism to have a longer life span, the species to have an even longer life span, and the planet to have a longer life span. But no system (even the universe itself in the extreme case) is expected to have an infinite life span. A sustainable system in this context is thus one that attains its full expected life span.

Individual humans are sustainable in this context if they achieve their “normal” maximum life span. At the population level, average life expectancy is often used as an indicator of health and well-being of the population, but the population itself is expected to have a much longer life span than any individual, and would not be considered to be sustainable if it were to crash prematurely, even if all the individuals in the population were living out their full “sustainable” life spans.

Since [[ecosystem]s] experience succession as a result of changing climatic conditions and internal developments, they have a limited (albeit fairly long) life span. The key is differentiating between changes due to normal life span limits and changes that cut short the life span of the system. Things that cut short the life span of humans are obviously contributors to poor health. Cancer, AIDS, and a host of other ailments do just this. Human-induced eutrophication in aquatic ecosystems causes a radical change in the nature of the system (ending the life span of the more oligotrophic system while beginning the life span of a more eutrophic system). We would have to call this process “unsustainable” using the above definitions since the life span of the first system was cut “unnaturally” short. It may have gone eutrophic eventually, but the anthropogenic stress caused this transition to occur “too soon.”

More formally, this aspect of sustainability can be thought of in terms of the longevity of the system and its component parts:

• A system is sustainable if and only if it persists in nominal behavioral states as long as or longer than its expected natural longevity or existence time; and
• Neither component- nor system-level sustainability, as assessed by the longevity criterion, confers sustainability to the other level.

Within this context, one can begin to see the subtle balance between longevity and evolutionary adaptation across a range of scales that is necessary for overall sustainability. Evolution cannot occur unless there is limited longevity of the component parts so that new alternatives can be selected. And this longevity has to be increasing hierarchically with scale as shown schematically in Figure 3.2. Larger systems can attain longer life spans because their component parts have shorter life spans and can adapt to changing conditions. Systems with an improper balance of longevity across scales can become either “brittle” when their parts last too long and they cannot adapt fast enough^[40] or “unsustainable” when their parts do not last long enough and the higher level system’s longevity is cut unnecessarily short.

Ecosystems as Sustainable Systems

Ecological systems are our best current models of sustainable systems. Better understanding of ecological systems and how they function and maintain themselves can thus yield insights into designing and managing sustainable economic systems. For example, in mature [[ecosystem]s] all waste and by-products are recycled and used somewhere in the system or are fully dissipated. This implies that a characteristic of sustainable economic systems should be a similar “closing the cycle” by finding productive uses and recycling currently discarded material, rather than simply storing it, diluting it, or changing its state, and allowing it to disrupt other existing ecosystems and economic systems that cannot effectively use it.

Ecosystems have had countless eons of trial and error to evolve these closed loops of recycling of organic matter, nutrients, and other materials. A general characteristic of closing the loops and building organized non-polluting natural systems is that the process can take a significant amount of time. The connections, or feedback mechanisms, in the system must evolve and there are characteristics of systems that enhance and retard evolutionary change. Humans have the special ability to perceive this process and potentially to enhance and accelerate it. The economic system should reinvent the decomposer function of ecological systems.

The first by-product, or pollutant, of the activity of one part of the system that had a disruptive effect on another part of the system was probably oxygen, an unintentional by-product of photosynthesis that was very disruptive to anaerobic respiration. There was so much of this “pollution” that the earth’s atmosphere eventually became saturated with it, and new species evolved that could use this by-product as a productive input in aerobic respiration. The current biosphere represents a balance between these processes that have evolved over millions of years to ensure that the formerly unintentional by-product is now an absolutely integral component process in the system.

Eutrophication and toxic stress are two current forms of by-products that result from the inability of the affected systems to evolve fast enough to convert the “pollution” into useful products and processes. Eutrophication is the introduction of high levels of nutrients into formerly lower nutrient systems. The species of primary producers (and the assemblages of animals that depend on them) that were adapted to the lower nutrient conditions are outcompeted by faster growing species adapted to the higher nutrient conditions. But the shift in nutrient regime is so sudden that only the primary producers are changed, and the result is a disorganized collection of species with much internal disruption (i.e., plankton blooms, fish kills), which can rightly be called pollution. The introduction of high levels of nutrients into a system not adapted to them causes pollution (called eutrophication in this case), whereas the introduction of the same nutrients into a system that is adapted to them (i.e., marshes and swamps) would be a positive input. We can minimize the effects of such by-products by finding the places in the ecosystem where they represent a positive input and placing them there. In many cases, what we think of as waste are resources in the wrong place.

Toxic chemicals represent a form of pollution because there are no existing natural systems that have ever experienced them and so there are no existing systems to which they represent a positive input. The places where toxic chemicals can most readily find a productive use are probably in other industrial processes, not in natural ecosystems. The solution in this case is to encourage the evolution of industrial processes that can use toxic wastes as productive inputs or to encourage alternative production processes that do not produce the wastes in the first place.

Substitutability vs. Complementarity of Natural, Human, and Manufactured Capital

The upshot of these considerations is that natural capital (natural resources) and human-made capital are complements rather than substitutes. The neoclassical assumption of near perfect substitutability between natural resources and human-made capital is a serious distortion of reality, the excuse of “analytical convenience” notwithstanding. To see how serious this is, just imagine that in fact human-made capital was indeed a perfect substitute for natural resources. Then it would also be the case that natural resources would be a perfect substitute for human-made capital. Yet if that were so, then we would have had no reason whatsoever to accumulate human-made capital since we were already endowed by nature with a perfect substitute! Historically, of course, we did accumulate human-made capital long before natural capital was depleted, precisely because we needed human-made capital to make effective use of the natural capital (complementarity!). It is amazing that the substitutability dogma should be held with such tenacity in the face of such an easy reductio ad absurdum. Add to that the fact that capital itself requires natural resources for its production—i.e., the substitute itself requires the very input being substituted for—and it is quite clear that human-made capital and natural resources are fundamentally complements, not substitutes. Substitutability of capital for resources is limited to reducing waste of materials in process, for example, collecting sawdust and using a press (capital) to make particleboard. And no amount of substitution of capital for resources can ever reduce the mass of material resource inputs below the mass of the outputs, given the law of conservation of matter–energy.

Substitutability of capital for resources in aggregate production functions reflects largely a change in the total product mix from resource-intensive to different capital-intensive products. It is an artifact of product aggregation, not factor substitution (i.e., along a given product isoquant). It is important to emphasize that it is this latter meaning of substitution that is under attack here—producing a given physical product with fewer natural resources and more capital. No one denies that it is possible to produce a different product or a different product mix with fewer resources. Indeed new products may be designed to provide the same or better service while using fewer resources, and sometimes less labor and less capital as well. This is technical improvement, not substitution of capital for resources. Light bulbs that give more lumens per watt represent technical progress, qualitative improvement in the state of the art, not the substitution of a quantity of capital for a quantity of natural resource in the production of a given quantity of a product.

It may be that economists are speaking loosely and metaphorically when they claim that capital is a near perfect substitute for natural resources. Perhaps they are counting as “capital” all improvements in knowledge, technology, managerial skill, and so on—in short anything that would increase the efficiency with which resources are used. If this is the usage, then “capital” and resources would by definition be substitutes in the same sense that more efficient use of a resource is a substitute for using more of the resource. But to define capital as efficiency would make a mockery of the neoclassical theory of production, where efficiency is a ratio of output to input, and capital is a quantity of input.

The productivity of human-made capital is more and more limited by the decreasing supply of complementary natural capital. Of course in the past when the scale of the human presence in the biosphere was low, human-made capital played the limiting role. The switch from human-made to natural capital as the limiting factor is thus a function of the increasing scale of the human presence.

Growth vs. Development

Improvement in human welfare can come about by pushing more matter–energy through the economy, or by squeezing more human want satisfaction out of each unit of matter–energy that passes through. These two processes are so different in their effect on the environment that we must stop conflating them. Better to refer to throughput increase as growth, and efficiency increase as development^[41]. Growth is destructive of natural capital and beyond some point will cost us more than it is worth—that is, sacrificed natural capital will be worth more than the extra man-made capital whose production necessitated the sacrifice. At this point growth has become anti-economic, impoverishing rather than enriching. Development, or qualitative improvement, is not at the expense of natural capital. There are clear economic limits to growth, but not to development. This is not to assert that there are no limits to development, only that they are not so clear as the limits to growth, and consequently there is room for a wide range of opinion on how far we can go in increasing human welfare without increasing resource throughput. How far can development substitute for growth? This is the relevant question, not how far can human-made capital substitute for natural capital, the answer to which, as we have seen, is “hardly at all.”

Some people believe that there are truly enormous possibilities for development without growth. Energy efficiency, they argue, can be vastly increased^[42]. Likewise for the efficiency of water use. Other materials are not so clear. Others^[43] believe that the bond between growth and energy use is not so loose. This issue arises in the Brundtland Commission’s Report^[44] where on the one hand there is a recognition that the scale of the human economy is already unsustainable in the sense that it requires the consumption of natural capital, and yet on the other hand there is a call for further economic expansion by a factor of 5 to 10 in order to improve the lot of the poor without having to appeal too much to the “politically impossible” alternatives of serious population control and redistribution of wealth. The big question is: how much of this called for expansion can come from development, and how much must come from growth? This question is not addressed by the Commission. But statements from the secretary of the WCED, Jim MacNeil^[45] that “The link between growth and its impact on the environment has also been severed”, and “the maxim for sustainable development is not ‘limits to growth’; it is “the growth of limits,” indicate that WCED expects the lion’s share of that factor of 5 to 10 to come from development, not growth. They confusingly use the word “growth” to refer to both cases, saying that future growth must be qualitatively very different from past growth. When things are qualitatively different it is best to call them by different names, hence our distinction between growth and development. Our own view is that WCED is too optimistic—that a factor of 5 to 10 increase cannot come from development alone, and that if it comes mainly from growth it will be devastatingly unsustainable. Therefore the welfare of the poor, and indeed of the rich as well, depends much more on population control, consumption control, and redistribution than on the technical fix of a 5- to 10-fold increase in total factor productivity.

We acknowledge, however, that there is a vast uncertainty on this critical issue of the scope for economic development from increasing efficiency. We have therefore devised a policy that should be sustainable regardless of who is right in this debate. We save its full description for the final section. For now we mention only the basic logic: protect the pessimists against their worst fears and encourage the optimists to pursue their dreams by the same policy; namely, limit throughput. First some general principles of sustainable development.

More on Complementarity vs. Substitutability

The main issue is the relation between natural capital, which yields a flow of natural resources and services that enter the process of production, and the human-made capital that serves as an agent in the process for transforming the resource inflow into a product outflow. Is the flow of natural resources (and the stock of natural capital that yields that flow) substitutable by human-made capital? Clearly one resource can substitute for another—we can transform aluminum instead of copper into electric wire. We can also substitute labor for capital, or capital for labor, to a significant degree even though the characteristic of complementarity is also important. For example, we can have fewer carpenters and more power saws, or fewer power saws and more carpenters and still build the same house. In other words one resource can substitute for another, albeit imperfectly, because both play the same qualitative role in production: both are raw materials undergoing transformation into a product. Likewise capital and labor are substitutable to a significant degree because both play the role of agent of transformation of resource inputs into product outputs. However, when we come to substitution across the roles of transforming agent and material undergoing transformation (efficient cause and material cause), the possibilities of substitution become very limited and the characteristic of complementarity is dominant. For example, we cannot make the same house with half the lumber no matter how many extra power saws or carpenters we try to substitute. Of course we might substitute brick for lumber, but then we face the analogous limitation—we cannot substitute masons and trowels for bricks.

More on Natural Capital

Thinking of the natural environment as “natural capital” is in some ways unsatisfactory, but useful within limits. We may define capital broadly as a stock of something that yields a flow of useful goods or services. Traditionally capital was defined as produced means of production, which we call here human-made capital, as distinct from natural capital which, though not made by man, is nevertheless functionally a stock that yields a flow of useful goods and services. We can distinguish renewable from nonrenewable natural capital, and marketed from nonmarketed natural capital, giving four cross-categories. Pricing natural capital, especially nonmarketable natural capital, is so far an intractable problem, but one that need not be faced here. All that need be recognized for the argument at hand is that natural capital consists of physical stocks that are complementary to human-made capital. We have learned to use the concept of human capital (i.e., skills, education, etc.) which departs even more fundamentally from the standard definition of capital. Human capital cannot be bought and sold, although it can be rented. Although it can be accumulated it cannot be inherited without effort by bequest as can ordinary human-made capital, but must be re-learned anew by each generation. Natural capital, however, is more like traditional human-made capital in that it can be bequeathed. Overall the concept of natural capital is less a departure from the traditional definition of capital than is the commonly used notion of human capital.

There is a large subcategory of marketed natural capital that is intermediate between natural and human-made, which we might refer to as “cultivated natural capital.” This consists of such things as plantation forests, herds of livestock, agricultural crops, fish bred in ponds, and so on. Cultivated natural capital supplies the raw material input complementary to human-made capital, but does not provide the wide range of natural ecological services characteristic of natural capital proper (e.g., eucalyptus plantations supply timber to the sawmill, and may even reduce erosion, but do not provide a wildlife habitat or conserve biodiversity). Investment in the cultivated natural capital of a plantation forest, however, is useful not only for the lumber, but as a way of easing the pressure of lumber interests on the remaining true natural capital of natural forests.

Marketed natural capital can, subject to the important social corrections for common property and myopic discounting, be left to the market. Nonmarketed natural capital, both renewable and nonrenewable, will be the most troublesome category. Remaining natural forests should in many cases be treated as nonmarketed natural capital, and only replanted areas treated as marketed natural capital. In neoclassical terms, the external benefits of remaining natural forests might be considered “infinite” thus removing them from market competition with other (inferior) uses. Most neoclassical economists, however, have a strong aversion to any imputation of an “infinite” or prohibitive price to anything.

Sustainability and Maintaining Natural Capital

Solutions to the problems of sustainability will only be robust and effective if they are fair and equitable. Philosopher John Rawls^[46] has argued that policies that represent an overlapping consensus of the interest groups involved in a problem will most likely be fair, effective, and resilient. The normal political process tends to accentuate conflict, and majority voting often sidetracks efforts to find overlapping consensus. The policies resulting from majority voting often are unfair to the minority and are not resilient since the minority spends all of its time fighting the decision and trying to build a new majority to overthrow the previous majority. In addition, interest groups important to global, long-run decisions (like future generations and other species) are given little if any representation in the process.

There is, however, a growing, global, overlapping consensus that attempts to acknowledge the interests of future generations and other species. The consensus is that the appropriate long-term social goal is sustainability^[47]. Consensus on exactly what is meant by sustainability is still emerging^[48], but we interpret this as healthy disagreement over the means, not the ends. The goal is a system that will survive indefinitely and in good shape, and one can only be sure one has achieved that goal in retrospect. In prospect, there is disagreement over which current policies will achieve the goal and, as discussed above, we need to be especially cognizant of the inherent uncertainty of our ability to predict the future. The “precautionary principle” is beginning to achieve a degree of consensus as the basic approach to uncertainty^[49]. For this reason the focus should be on policies that are aimed at assuring sustainability over as wide a range of future conditions as possible.

For example, a sustainable system is one with “sustainable income,” defined in a Hicksian sense as the amount of consumption that can be sustained indefinitely without degrading capital stocks, including “natural capital” stocks^[50]. Since “capital” is traditionally defined as produced (manufactured) means of production, the term “natural capital” needs explanation. It is based on a more functional definition of capital as “a stock that yields a flow of valuable goods or services into the future.” What is functionally important is the relation of a stock yielding a flow; whether the stock is manufactured or natural is in this view a distinction between kinds of capital and not a defining characteristic of capital itself. For example, a stock or population of trees or fish provides a flow or annual yield of new trees or fish (along with other services), a flow which can be sustainable year after year. The sustainable flow is “natural income,” the stock that yields the sustainable flow is “natural capital.” Natural capital may also provide services like recycling waste materials or water catchment and erosion control, which are also counted as natural income. Since the flow of services from ecosystems requires that they function essentially as whole systems, the structure and biodiversity of the ecosystem is a critical component in natural capital.

To achieve sustainability, we must therefore incorporate natural capital, and the ecosystem goods and services that it provides, into our economic and social accounting as well as our systems of social choice. In estimating these values, we must consider how much of our ecological life support systems we can afford to lose. To what extent can we substitute manufactured for natural capital, and how much of our natural capital is irreplaceable? For example, could we replace the radiation screening services of the ozone layer if it were destroyed?

Daly^[51] has developed three basic criteria for the maintenance of natural capital and ecological sustainability:

1. For renewable resources, the rate of harvest should not exceed the rate of regeneration (sustainable yield);
2. The rates of waste generation from projects should not exceed the assimilative capacity of the environment (sustainable waste disposal); and
3. For nonrenewable resources the depletion of the nonrenewable resources should require comparable development of renewable substitutes for that resource.

Population and Carrying Capacity

A primary question is: Are there limits to the carrying capacity of the earth system for human populations? Ecological economics gives an unequivocal yes. Where doubt sets in is on the precise number of people that can be supported, about the standard of living of the population, and about the way in which food production will reach the limit imposed by the carrying capacity. These issues must be the priority research topics for the next decades.

Various estimates of global carrying capacity of the earth for people have appeared in the literature ranging from 7.5 billion^[52] to 12 billion^[53], 40 billion^[54], and 50 billion^[55]. However, many authors are skeptical about the criteria—amount of food, or kilocalories—used as a basis for these estimates. “For humans, a physical definition of needs may be irrelevant. Human needs and aspirations are culturally determined: they can and do grow so as to encompass an increasing amount of ‘goods,’ well beyond what is necessary for mere survival”^[56]. For a long and careful, if somewhat inconclusive, discussion of the population issue see Cohen^[57].

Cultural evolution has a profound effect on human impacts on the environment. By changing the learned behavior of humans and incorporating tools and artifacts, it allows individual human resource requirements and their impacts on their resident [[ecosystem]s] to vary over several orders of magnitude. Thus it does not make sense to talk about the “carrying capacity” of humans in the same way as the “carrying capacity” of other species^[58] since, in terms of their carrying capacity, humans are many subspecies. Each subspecies would have to be culturally defined to determine levels of resource use and carrying capacity. For example, the global carrying capacity for Homo americanus would be much lower than the carrying capacity for Homo indus, because each American consumes much more than each Indian does. And the speed of cultural adaptation makes thinking of species (which are inherently slow changing) misleading anyway. Homo americanus could change its resource consumption patterns drastically in only a few years, while Homo sapiens remains relatively unchanged. We think it best to follow the lead of Daly^[59] in this and speak of the product of population and per capita resource use as the total impact of the human population. It is this total impact that the earth has a capacity to carry, and it is up to society to decide how to divide it between numbers of people and per capita resource use. This complicates population policy enormously, since one cannot simply state a maximum population, but rather must state a maximum number of impact units. How many impact units the earth can sustain and how to distribute these impact units over the population is a dicey problem indeed, but one that must be the focus of research in this area.

Many case studies indicate that “there is no linear relation between growing population and density, and such pressures towards land degradation and desertification”^[60]. In fact, one study found that land degradation can occur under rising pressure of population on resources (PPR), under declining PPR, and without PPR^[61]. Therefore, the scientific agenda must look toward more complex, systemic models where the effects of population pressures can be analyzed in their relationships with other factors. This would allow us to differentiate population as a “proximate” cause of environmental degradation from the concatenation of effects of population with other factors as the “ultimate” cause of such degradation.

Research can begin by exploring methods for more precisely estimating the total impact of population times per capita resource use. For example, the “Ehrlich identity” (Pollution/Area = People/Area x Economic Production/People x Pollution/Economic Production) can be operationalized as (CO₂ Emissions/Km = Population/Km x GNP/Population x CO₂ Emissions/GNP). Thus no single factor dominates the changing patterns of total impact across time. This points to the need for local studies of causal relations among specific combinations of populations, consumption, and production, noting that these local studies need to aim for a general theory that will account for the great variety of local experience.

Another research priority is to look at the effect adding a new person has on resources, according to consumption levels and the effect that efficiency has on rising levels of consumption. Decreasing energy consumption in developed countries could dramatically decrease CO₂ emissions globally. It is only under a scenario of severe constraints on emissions in the developed countries that population (Population growth rate) growth in less developed ones plays a major global role in emissions growth. If energy efficiency could be improved in the latter as well as the former, then population increase would play a much smaller role.

Research priority should also look at situations where demand (either subsistence or commercial) becomes large relative to the maximum sustainable yield of the resource, where the regenerative capacity of the resource is relatively low, or where the incentives and restraints facing the exploiters of the resource are such as to induce them to value present gains much more highly than future gains.

Some authors single out a high rate of population growth as a root cause of environmental degradation and overload of the planet’s carrying capacity. Consequently, the policy instrument is obviously population control. Ehrlich and his colleagues maintain “There is no time to be lost in moving toward population shrinkage as rapidly as is humanly possible”^[62]. But, as Ehrlich himself fully recognizes, the policy of focusing solely on population control is known to be insufficient. It has repeatedly been shown that it is not easily achieved in and of itself, and that in addition important social and economic transformations must accompany it, such as the reduction of poverty. Even in those cases where population growth has been relatively successfully controlled, as in China, the welfare of the people has not necessarily improved and the environment is not necessarily exposed to lower rates of hazard.

The opposite position is taken by those who see high rates of population growth as stimulating economic development through inducing technological and organizational changes^[63] or as a phenomenon that can be solved through technological change^[64].

Such positions, however, ignore the dangers of environmental depletion implicit in unchecked economic growth: consumption increases, and rapidly growing populations can put a very real burden upon the resources of the earth and bring about social and political strife for control of such resources. This position also assumes that technological creativity will have the same outcomes in the future as in the past, and in the South as in the North, a questionable assumption. In particular, it assumes that new technology solves old problems without creating new ones that may be even worse. Finally, it heavily discounts the importance of the loss of biodiversity—a loss that is irreversible and whose human consequences are as yet unknown.

According to a World Bank study of 64 countries, when the income of the poor rises by 1%, general fertility rates drop by 3%^[65]. In contrast, other authors state that “population is not a relevant variable” in terms of resource depletion and stress that resource consumption, particularly overconsumption by the affluent, is the key factor^[66]. OECD countries represent only 16% of the world’s population and 24% of land areas, but their economies account for about 72% of the world gross product, 78% of road vehicles, and 50% of global energy use. They generate about 76% of world trade, 73% of chemical products exports, and 73% of forest product imports^[67]. The main policy instrument in this case, in the short term, is reducing consumption, and this can be most easily achieved in those areas where consumption per capita is highest.

Thus a new framework should expand the definitions of issues: focus not only on population size, density, rate of increase, age distribution, and sex ratios, but also on access to resources, livelihoods, social dimensions of gender, and structures of power. New models have to be explored in which population control is not simply a question of family planning but of economic, ecological, social, and political planning; in which the wasteful use of resources is not simply a question of finding new substitutes but of reshaping affluent lifestyles; and in which sustainability is seen not only as a global aggregate process but also as one having to do with sustainable livelihoods for a majority of local peoples.

Measuring Welfare and Well-Being

Getting a better handle on how to measure the well-being and health of both ecological and economic systems, and the welfare of humans within them, is critical. This section looks at the conventional macroeconomic measures of welfare (GNP and related measures) with an eye toward how to improve them to better reflect natural capital and sustainability.

The GNP and Its Political Importance

Economists want the market to perform well. They are deeply convinced that when the market performs well, people in general benefit. Most of their research is geared accordingly in one way or another to understanding what makes the market function well.

Although many of their theories about healthy market functioning are deductive, economists are also interested in measurement of market success, both in particular sectors of the market and for the market as a whole. The single most important measure in most countries is the gross national product. Most economists view growth in GNP, or GNP per capita, as a sign of a healthy market, which means for them a healthy economy.

With respect to some aspects of economic teaching, such as opposition to government intervention in the labor market, economists are regularly overruled by the public, acting through its elected representatives. But with respect to growth as measured by GNP, there has been no major public dissent. All political parties are committed to economic growth, and that means an increased GNP. When alarm is expressed about the difficulty of stimulating adequate growth today, the meaning is that the policies adopted have not sufficiently increased the GNP. The general public also accepts this view of economic health and is more likely to keep a party in power when it believes the economy—and that means chiefly the GNP—is growing.

Other countries also measure their national products. Although complete standardization has not been attained and difficulties in intercountry comparisons are recognized, the GNP measurements are also used by international financial agencies to measure the comparative success of development programs. Both the World Bank and the International Monetary Fund shape their policies by this indicator. Successful economic development means that the rate of increase of per capita GNP is satisfactory.

Humanitarians also often cite GNP figures. Their object is to arouse sympathy for people whose income is very low. They usually imply that the countries with high per capita GNP should find means of transferring some of their wealth to countries with low per capita GNP. In short, GNP as the standard measure of economic success is widely accepted by economists, politicians, financiers, humanitarians, and the general public. It is enormously important. This merits closer examination.

All groups assume that GNP measures something of importance to the economy and most assume that this is closely bound up with human welfare. It is recognized, of course, that human welfare has dimensions other than the economic one. But it is rightly held that the economic element in welfare is very important, and that the stronger the economy the greater the contribution to human welfare. It is also often thought that the economy is the major area of welfare subject to political influence. In any case, there is little consensus on any other measure, so that none of the others that have been proposed exert even a remotely comparable influence on public policy.

The tendency to forget that the GNP measures only some aspects of welfare and to treat it as a general index of national well-being is, of course, a typical instance of the fallacy of misplaced concreteness, as devastatingly shown by Daly and Cobb^[68]. It is obvious and need not detain us. It can be countered by giving increasing visibility to social indicators, such as the Physical Quality of Life Index, which measures literacy, infant mortality, and life expectancy at age one. Indicators of ecological health should also be developed and publicized^[69]. Although not stated in the form of statistical indexes, Lester Brown’s annual State of the World^[70] volumes and the annual Vital Signs^[71] scorecards help in this regard.

The assumption that economic welfare as measured by GNP can simply be added to other elements of welfare reflects the reductionist view of reality generally. The whole is found by putting together the parts into which it was divided for study. That assumes that the parts are in fact unchanged by their abstraction from the whole, which is clearly not true. Hence the first question to ask is whether [[growth] in the economy] as measured by GNP actually contributes to the total well-being of people.

Until recently this question was hardly raised, and even today it is not taken seriously in most economic and political circles. Nevertheless, the question is now before the world. There is a mounting chorus of critics who point out how high the cost of growth of GNP has been in psychological, sociological, and ecological terms^[72]. The relation of GNP to total human welfare requires further discussion.

But there is also a question about the relation of GNP to economic welfare itself. This question is familiar to economists. Indeed, no knowledgeable economist supposes that the GNP is a perfect measure of welfare. Most recognize both that the market activity that GNP measures has social costs, which it ignores, and that it counts positively market activity devoted to countering these same social costs. Obviously GNP overstates welfare! There are other weaknesses that make it vulnerable to ridicule, but there is a widespread assumption that these are minor weaknesses and that what the GNP measures comes close enough to economic welfare that it can be used without further ado in a whole range of practical contexts.

When economists or political leaders forget that what is measured by GNP is quite distinct from economic welfare, and when they then draw conclusions from the GNP about economic welfare, the fallacy of misplaced concreteness appears again. Although economists quickly acknowledge this, they also quickly deny its importance. Our task will be to examine more closely the discussion of GNP and economic welfare to determine whether this wide consensus among economists is justified or whether the fallacy, in this instance, is more important than they suppose. We will discuss three moves away from GNP. First we consider a move toward a conceptually more correct concept of income (Hicksian income). The issue here is not to measure economic welfare at all, but simply to do a better job of measuring income. Of course there is a relation between income and welfare, and a better measure of income is likely to be a better index of welfare also, but Hicksian income does not directly address the relation to economic welfare in general. The second move away from GNP is toward a measure of economic welfare, component by component. The third is a move toward a more comprehensive measure of total human welfare, in which economic welfare is only one component.

GNP: Concepts and Measurement

The definition of GNP has remained fairly consistent over the years. This is one of its appeals. There is a long historical record. Sherman^[73] defines GNP as follows:

The gross national product (GNP) may be calculated in two different ways, corresponding to the money flow from households to business or the equal money flow from business to households. In the first way, we examine the aggregate money demand for all products. This is the flow of money spending on consumer goods, investment goods, government expenditure, and net export spending.

The second way is to add up the money paid out by businesses for all of its costs of production. Most of these costs of production constitute flows of money income to households. These incomes include wages paid for services of labor, rent for the use of land, interest for the use of borrowed capital, and profit for capital invested^[74].

The text notes that depreciation and excise taxes must be added to the second way. When this is done, the first and second ways must attain identical results. Equality between the spending and income streams is guaranteed by the residual nature of profit. Any difference between the two streams appears as either profit or loss, which when added to the income stream guarantees the equality of the two flows.

Sherman goes on to show that by subtracting depreciation from GNP one arrives at net national product: by subtracting retained corporate profits, corporate income taxes, and contributions for social insurance and adding government transfer payments at net interest paid by government, one arrives at personal income; and by subtracting personal income taxes from this, one arrives at disposable personal income.

If Sherman were asked directly whether GNP is a measure of economic welfare, we are not sure what he would answer. But that he regards it as such for practical purposes and communicates this regard to his readers there can be no doubt. After having cautioned that each industry’s contribution to the national product is only the value added rather than the total value of its output, Sherman^[75] writes:

A second qualification is necessary if we wish to measure accurately the year-to-year improvement in national welfare…. We must always deflate the changes in the money value of the national product by the price changes to find the real amount of change in the national product.

Lastly, we may not be interested in the total national product but in the national product per person of the population…. Therefore, if we wish to measure the improvement in individual welfare, we must always deflate the increase in our total national product by the increase in our population.

One would expect from this textbook account that the actual measure of the GNP in the National Income Accounts was a straight measure of market activity only. There are those who would find this limitation beneficial in their work^[76]. However, this has never been the case.

The reason that GNP has never been based on market activity alone is that this would distort the actual economic situation drastically. From the beginning of the accounts, two major additions to market activity have been the food and fuel produced and consumed by farm families and the rental value of owner-occupied dwellings. The reasons for including these is obvious. Consider a scenario: suppose someone lives in a home he rents from someone else while owning a house elsewhere that he rents out to another party. Both rentals constitute market activity. If, he then moves into his own home, market activity is reduced, and if only market activity is counted then the GNP is reduced. Yet intuitively, no one feels that the economy has been damaged. (Also imputed have been the value of food and clothing provided to the military as well as banking services rendered to depositors without payment^[77].)

Our point is that from the beginning there has been a tension in the consideration of what it is that GNP measures. The tension is visible in the textbook accounts. On the one hand the emphasis is on market activity. On the other hand, there is a concern to make judgments about improvement in welfare. The GNP has emphasized the market but has made modest adjustments in the direction of welfare by imputing a rental value for owner-occupied housing. But the same logic that justifies the inclusion of these items would justify the inclusion of many others. Accordingly, many proposals have been advanced to impute additional values in computing the GNP. Thus far, none have been adopted. As Otto Eckstein comments,

NIPA (National Income and Product Accounts) has many purposes; to gauge economic performance, compare economic welfare over time and across countries, measure the mix of resources used between private and public sectors and between consumption and investment, and to identify the functional distribution of income and of the tax burden. Inevitably, these purposes clash and the accounts must be a compromise^[78].

A compromise cannot be completely satisfactory to anyone. Our concern, however, is not whether as a result of the compromise comparisons of “economic welfare over time and across countries” are slightly warped, but whether the GNP, which remains primarily a measure of market activity, is in general a useful measure of economic welfare at all. Might it not be better to have a measure of market activity that would work well for the more technical purposes to which the GNP is put and which made no adjustments whatever in the direction of measuring welfare? Then the question of how much correlation there is between increasing market activity and the economic welfare of the people could be asked more clearly and neutrally.

There is a second respect in which the GNP fails to be a pure measure of market activity. At some points it also concerns itself with wealth; specifically, capital. This is apparent where depreciation is included as a part of the cost of doing business. This operates in a rather odd way. The greater the depreciation of capital assets of business in a given year, the greater the GNP (all other things being equal). The decline in the value of a factory and its equipment increases the GNP. That this decline is not a contribution to economic welfare is recognized by the deletion of this figure in calculating the net national product and the national income. But we must remember that it is GNP rather than these other figures that functions in most comparative studies of economic welfare.

These comments indicate that although depreciation of capital assets does enter into GNP figures, it does so in a way that is opposite to its relation to national wealth. Some of the figures in the GNP do indicate a positive relation to the increase in national wealth; others are neutral in this respect and some, as we have seen, are negative. It is possible to ask whether measures of national wealth might not correlate more highly with national economic welfare than does either market activity or GNP. In fact, one great economist, Irving Fisher, argued strongly that this is the case^[79]. In Fisher’s view nearly all consumer goods are classed as capital or as wealth, and their consumption represents depreciation. For Fisher, welfare is the service (the psychic sense of want satisfaction) rendered by this capital, and for the most part would have to be imputed. For example, the value of the annual service of your overcoat is what it would cost you to rent it, which is the same imputation as with owner-occupied houses only more difficult since we have no rental markets for overcoats. But the logic is the same. It is at least essential that no one suppose that GNP measures national wealth or has any necessary correlation with its increase or decrease.

None of these comments are intended to imply that the National Income and Product Accounts of the U.S. government or similar accounts in other countries are of no use. Our concern here is with one particular use: namely, their use as a measure of economic welfare. Until we understand exactly what GNP does and does not measure, we cannot make reasonable judgments on this questions.

Like most of what happens in the world, the explanation of why the GNP measures what it does is historical rather than systematic. The Commerce Department began reporting statistics on the net product of the national economy in 1934. But it has been noted that

it was the mobilization for World War II and the consequent demand for data relating to the economy as a whole that was primarily responsible for shaping the accounts. The central questions posed by the war were how much defense output could be produced and what impact defense production would have upon the economy as a whole^[80].

Similar developments were occurring in other countries, and the United States compared its approach with those of the British and Canadians during 1944. The next year the League of Nations convened a meeting on national income accounting. So, by 1947, the United States was ready to publish its newly developed national accounting system. Although this was supplemented in various ways in later years and revised in 1958 and 1965, with respect to our concerns it has remained basically unchanged.

There have, however, been critical discussions of the National Income Accounts that raised questions relevant to our concerns. This was especially true of the 1971 Conference on Income and Wealth, which did concern itself with welfare questions. It became clear that:

Many users considered that the present emphasis of the national income and product accounts on market transactions led to a perspective that was too narrow for the measurement of economic and social performance. It was cogently argued that additional information was required on non-market activity, on the services of consumer and government durables and intangible investment, and on environmental costs and benefits^[81].

There was some discussion of the evaluation of leisure. But such considerations involved large imputation that would render the accounts less useful to “Those who used the national accounts for the analysis of economic activity in the short run, with a focus on inflation, the business cycle, and fiscal policy”^[82]. For this reason the concerns of those interested in measuring long-term economic and social performance have not been dealt with in the accounts.

On the other hand, BEA (Bureau of Economic Analysis) has established a new program to develop measures of nonmarket activity within the framework of GNP accounts. In part this work is a response to the emphasis put on this topic at the 1971 Conference on Income and Wealth, but it also reflects the strong interest in environmental studies within the Department of Commerce. The federal government’s concern with the measurement of the costs of pollution control and environmental damage has stimulated work in this area. BEA’s current program, however, includes not only environmental questions but also (1) time spent in nonmarket work and leisure, (2) the services of consumer durables, and (3) the services of government capital. The close relationship to the national income accounting system in this work is stressed, but as yet it has not been formally integrated^[83].

The tension we have noted between a measure of market activity and a measure of economic welfare is clearly being felt by those responsible for National Income Accounts. The problem seems to be insoluble as long as the effort is to have a single summary figure, such as GNP.

Richard Ruggles^[84], whose historical account we have been following, concludes:

There is no well-defined universe of nonmarket activities and imputations to be covered. The set of all possible imputations is unbounded. The only criterion that can be employed is whether the imputations are considered to be useful and necessary for the particular purpose at hand….

For all these reasons, an explicit separation of market transactions from imputations in the national accounts would seem highly desirable.... It would be recognized, however, that imputations alone cannot meet the information needs for measuring economic and social performance.... No amount of imputation can convert a one-dimensional summary measure such as the GNP into an adequate or appropriate measure of social welfare.

From GNP to Hicksian Income and Sustainable Development

Not only is GNP a poor measure of welfare, it is also a poor measure of income. In subsequent sections we discuss the effort to move from GNP toward a measure of welfare. This is a very difficult task involving many controversial issues. In this section, the focus is on the less controversial issue of converting GNP into a better measure of income. Unlike welfare, the concept of income has a fairly clear theoretical definition, although there are big problems in making that definition operational. In measuring welfare one cannot avoid-- to a large extent-- implicitly defining the concept by one’s very measure of it. With income, we have an explicit independent definition to which our measurements may to a greater or lesser degree correspond. With welfare, we have no such independent theoretical definition. It is therefore useful to keep these two departures from GNP quite separate.

The central criterion for defining the concept of income has been well stated by Sir John Hicks in Value and Capital^[85]:

The purpose of income calculations in practical affairs is to give people an indication of the amount which they can consume without impoverishing themselves. Following out this idea, it would seem that we ought to define a man’s income as the maximum value which he can consume during a week, and still expect to be as well off at the end of the week as he was at the beginning. Thus when a person saves he plans to be better off in the future; when he lives beyond his income he plans to be worse off. Remembering that the practical purpose of income is to serve as a guide for prudent conduct, I think it is fairly clear that this is what the central meaning must be.

The same basic idea of income holds at the national level and for annual time periods. Income is not a precise theoretical concept but rather a practical rule-of-thumb guide to the maximum amount that can be consumed by a nation without eventual impoverishment. We all know that we cannot consume the entire GNP without eventually impoverishing ourselves, so we subtract depreciation to get net national product (NNP), which is usually taken as income in Hicks’s sense. Note that the central defining characteristic of income is sustainability. The term “sustainable income” ought therefore to be considered a redundancy. The fact that it is not is a measure of how far we have strayed from the central meaning of income, and consequently of the need for correction.

But could we really consume even NNP year after year without impoverishing ourselves? No, we could not, for two reasons: first, because the production of NNP at the present scale requires supporting biophysical transformations (environmental extractions and insertions) that are not ecologically sustainable; and second, because NNP overestimates net product available for consumption by counting many defensive expenditures (expenditures necessary to defend ourselves from the unwanted side effects of production) as final products rather than as intermediate costs of production. Consequently, NNP increasingly fails as a guide to prudent conduct by nations.

For example, a developing country may obtain 6% of its GNP from timber exports. Perhaps 2% is based on sustained yield exploitation and the remaining 4% is based on deforestation (Land-use and land-cover change). The maximum sustainable consumption has been overestimated by 4%, not even counting the loss of unpriced natural services of the forest. That may sound small, but in an economy whose conventional GNP was growing at 3%, a 4% reduction is the difference between growth and decline, which makes a very big qualitative difference in a nation’s perception of itself and its policies, and indeed, of its leaders. The last difference is one reason for resistance to this change in income accounting. No politician wants to be known as the minister under whom the country went from growth to decline in one year! Yet there is an opportunity for someone to be known as the leader who finally introduced the income accounting system that saved the nation from eventual impoverishment.

Two adjustments to NNP are necessary to arrive at a good approximation to Hicksian income and a better guide to prudent behavior. One adjustment is a straightforward extension of the principle of depreciation to cover consumption of natural capital stocks depleted as a consequence of production. The other is to subtract (regrettably necessary) defensive expenditures made to defend ourselves from the unwanted side effects of growing aggregate production and consumption. Defensive expenditures are of the nature of intermediate goods; that is, they are costs of production rather than final products available for consumption. Defensive expenditures include policing, door locks, window bars, increased frequency of painting property to prevent damage from acid rain corrosion, and so on. To correct for having counted defensive expenditures in NNP, their magnitude must be estimated and subtracted in order to arrive at an estimate of sustainable consumption or true income.

To summarize, let us define our corrected income concept, Hicksian income (HI), as net national product (NNP) minus both defensive expenditures (DE) and depreciation of natural capital (DNC). Thus,

HI = NNP – DE – DNC.
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No interference whatsoever with the current national accounts (or loss of historical continuity or comparability) is entailed in this suggestion. Two additional adjustment accounts are introduced, not for frivolous or trendy reasons, but simply to gain a better approximation to the central and well-established meaning of income. Since these two adjustment accounts are also relevant to our attempt to measure welfare, they will be discussed in that context and are not further considered here.

What deserves some mention in this context is the recent surge of interest in “sustainable growth” or “sustainable development” within development agencies and Third World countries following the publication of the Brundtland Report^[86]. Although the two terms are used synonymously, we suggest a distinction. As discussed earlier, “growth” should refer to quantitative expansion in the scale of the physical dimensions of the economic system, whereas “development” should refer to the qualitative change of a physically nongrowing economic system in dynamic equilibrium with the environment. By this definition, the earth is not growing but is developing. Any physical subsystem of a finite and nongrowing earth must itself also eventually become nongrowing. Therefore growth will become unsustainable eventually and the term “sustainable growth” would then be self-contradictory. But sustainable development does not become self-contradictory. Now that these terms have become buzzwords among the development agencies, it is important to make this distinction and even more important to define sustainable development in operational terms. If we had defined development operationally as an increase in Hicksian income rather than as an increase in GNP, then sustainability would have been guaranteed, as we have seen.

The main operational implication of Hicksian income is to keep capital intact. Our problem is that the category of capital we have endeavored to maintain intact is only humanly created capital. The category “natural capital” is left out, as is human capital such as the skills, education, and health of workers. Indeed it is left out by definition as long as one defines capital as “(humanly) produced means of production.” We suggest a functional definition of capital as a stock that yields a flow of goods or services. As we have discussed before, there are then two categories of capital: natural and human-made. Natural capital is the nonproduced means of producing a flow of natural resources and services. Only human-made capital has been maintained intact, along with some natural capital stocks that are privately owned (herds of cattle, plantation forests).

Another approach that is relevant both to making GNP a better measure of income and to operationalizing the definition of sustainable development has been advanced by Salah El Serafy^[87]. El Serafy tackles the difficult issue of how to treat receipts from nonrenewable resources in defining income. Or, what comes to the same thing, how can a community avoid the absurdity of leaving its nonrenewable resources forever in the ground doing no one any good, yet not allow their exploitation to deflect the community from the path of sustainable development? He argues that receipts from a nonrenewable resource can be divided into an income and a capital component. The income component is that portion of the receipts that could be consumed annually in perpetuity on the assumption that the remainder of the receipts were invested in renewable assets. The return on the renewable assets and the amount invested each year are such that when the nonrenewable resource is exhausted, the new renewable assets will be yielding an amount equal to the income component of the receipts.

The basic logic underlying El Serafy’s method is that

the finite series of earnings from the resource, say a 10-year series of annual extraction leading to the extinction of the resource, has to be converted to an infinite series of true income such that the capitalized value of the two series are equal. From the annual earnings from sale, an income portion has to be identified, capable of being spent on consumption, the remainder, the capital element, being set aside year after year to be invested in order to create a perpetual stream of income that would sustain the same level of “true” income, both during the life of the resource as well as after the resource had been exhausted.

To make the separation into income and capital components, it turns out that one need know only the rate of discount (which must ultimately be related to the rate of growth of renewable resources and the rate of growth of factor productivity, although this relation is not discussed by El Serafy) and the life expectancy of the nonrenewable resource (total reserve stock divided by the annual extraction rate). Social choices or assumptions about these magnitudes will allow the calculation of the percentage of the nonrenewable resource receipts that should be counted as income. For example, if the life expectancy of a nonrenewable resource is 10 years and the discount rate is 5%, then it can be shown that 42% of current receipts is income and the remaining 58% is the capital content that must be reinvested. Alternatively, if the discount rate were 10% and the life expectancy remained at 10 years, the income component would be 65%. A discount rate of 10% and a life expectancy of 50 years would result in a 99% income component.

El Serafy’s method is elegant and parsimonious in terms of its information requirements. The effect of rising costs of extraction can be taken into account as a reduction of reserves. The whole calculation can be redone on the assumption of rising relative price of resources, rather than the assumption of constant prices used for simplicity. As a correction of GNP, El Serafy’s method is more radical than the subtraction of depletion of natural capital from NNP, because it would change the very calculation of GNP itself. Instead of keeping the present overestimate of Hicksian income and then subtracting an adjustment figure, El Serafy’s method would avoid the overestimate from the beginning by calculating GNP differently. While this is logically neater, it is politically more difficult to convince national income accountants to do this because it sacrifices historical continuity in the way accounts are kept. But even if the estimation of a natural capital depreciation adjustment account were favored for this reason, El Serafy’s method would still be useful in calculating natural resource depreciation, which would still be receipts in excess of the income component, assuming this amount was being consumed rather than invested.

If a development bank or agency takes sustainable development as its guiding principle, then, ideally, each of the projects it finances should be sustainable. Whenever this is not possible, as with the exploitation of a nonrenewable resource, there should be a complementary project that would ensure sustainability for the two taken together. The receipts from the nonrenewable extraction should be divided into an income and capital component as discussed above, with the capital component invested each year in the renewable complement (long-run replacement). Furthermore if projects or combinations of projects must be sustainable, then it is inappropriate to calculate the net benefits of a project or policy alternative by comparing it with an unsustainable option—that is, by using a discount rate that reflects rates of return on alternative uses of capital that are themselves unsustainable. For example, if a sustainably managed forest can yield 4% and is judged an uneconomic use of land on the basis of a 6% discount rate, which on closer inspection turns out to be based on unsustainable uses of resources, including perhaps the unsustainable clearing of that same forest, then clearly the decision simply boils down to sustainable versus unsustainable use. If we have already adopted a policy of sustainable development, then of course we choose the sustainable alternative, and the fact that it has a negative present value when calculated at a nonsustainable discount rate is simply irrelevant. The present value criterion itself is not irrelevant because we are still interested in efficiency—in choosing the best sustainable alternative. But the discount rate must then reflect only sustainable alternative uses of capital. The allocation rule for attaining a goal efficiently (maximize present value) cannot be allowed to subvert the very goal of sustainable development that it is supposed to be serving! Use of an unsustainable discount rate would do just that. We suspect that discount rates in excess of 5% often reflect unsustainable alternatives. At least one should be required to give, say, five concrete examples of sustainable projects that yield 10% before one uses that figure as a discount rate.

Given acceptance of the goal of sustainable development, there still remains the question of the level of community at which to seek this goal. International trade allows one country to draw on the ecological carrying capacity of another country and thus be unsustainable in isolation, even though sustainable as part of a larger trading bloc. The trade issue raises again the question of complementarity versus substitutability of natural and human-made capital. If we follow the path of strong sustainability then this complementarity must be respected either at the national or international level. A single country may substitute human-made for natural capital to a high degree if it can import the products of natural capital (the flow of natural resources and services) from other countries that have retained their natural capital to a greater degree. In other words, the demands of complementarity can be evaded at the national level, but only if they are respected at the international level. One country’s ability to substitute human-made for natural capital to a high degree depends on some other country’s making the opposite (complementary) choice.

One reason for the unanimity of support given to the phrase “sustainable development” is precisely that it has been left rather vague—development is not distinguished from growth in the Brundtland Report, nor is there any distinction between strong and weak sustainability. Politically this was wise on the part of the authors. They managed to put high on the international agenda a concept whose unstated implications were too radical for consensus at that time. But in so doing they have guaranteed eventual discussion of these radical implications. Consider, for example, two questions immediately raised by any attempt to operationalize the definition of sustainable development as development that “meets the needs of the present without compromising the ability of future generations to meet their own needs.” First there is the question of distinguishing “needs” from extravagant luxuries or impossible desires. If “needs” includes an automobile for each of a billion Chinese, then sustainable development is impossible. The whole issue of sufficiency can no longer be avoided. Second, the question of not compromising “the ability of future generations to meet their own needs” requires an estimate of that ability. It may be estimated on the basis of either strong or weak sustainability, depending on assumptions about substitutability between natural and humanly created capital. This will force deeper discussion of the substitutability issue, which lies near the heart of present economic theory.

We are very grateful to the Brundtland Commission for its fine work on this critical issue and suspect that it was not unaware of the difficulties we have raised, but rather thought wisely not to try to go too far too fast. In legitimating the concept of sustainable development they have made it easier for others to press the issue further. We hope that economists and development agencies will not abandon the ideal of sustainable development when its radical implications are realized. However, we hope they will abandon the oxymoron “sustainable growth,” which now functions as a thought-stopping slogan.

From GNP to a Measure of Economic Welfare

Without claiming to devise a comprehensive measure of social welfare, it may still be possible to develop a convincing measure of the positive contribution of the economy to social welfare. This was the goal of Nordhaus and Tobin^[88] in their construction of a Measure of Economic Welfare (MEW). However, this goal was for them a means to another goal, namely, the demonstration that the consensus among economists is correct, and that the existing GNP correlates sufficiently well with economic welfare to make it unnecessary to use the instrument they devise! This is their clear conclusion despite their early statement that “maximization of GNP is not a proper objective of policy”^[89]. We will ignore this puzzling contradiction and describe their careful work on a new indicator of the MEW—in which they “attempt to allow for the more obvious discrepancies between GNP and economic welfare”^[90].

Nordhaus and Tobin begin with the GNP and make three types of adjustments: “Reclassification of GNP expenditures as consumption, investment, and intermediate; imputation for the services of consumer capital, for leisure, and for the product of household work; correction for some of the disamenities of urbanization”^[91]. With the exception of environmental costs and benefits they covered all the questions raised in the 1971 Conference on Income and Wealth mentioned above. We will follow their argument in summary.

GNP is a measure of production, not consumption, whereas economic welfare is a matter of consumption. Hence, the first task is to separate consumption from investment and intermediate expenditures. This entails the deletion of depreciation, as is already accomplished in the NNP. Beyond this, Nordhaus and Tobin consider the effects of treating all durables as capital goods but find that this has little effect. More important is the result of allowing for government capital and reclassifying education and health expenditures as capital investments.

An especially interesting adjustment follows from the recognition that welfare correlates with per capita consumption rather than with gross consumption. To sustain per capita consumption for a population (Population growth rate), some portion of the NNP must be reinvested. Nordhaus and Tobin^[92] accordingly subtract from NNP for this purpose to gain a “sustainable” per capita consumption figure. We will quote only these sustainable MEW figures.

The authors also note that some expenditures are regrettable necessities rather than contributions to welfare. In this category they place the costs of commuting to work, police services, sanitation services, road maintenance, and national defense. The assumption is that when more people spend longer periods driving to work, the increase in the GNP does not mean that more human wants are satisfied. And so with the others. These figures are, accordingly, subtracted.

The second task is to make appropriate imputations for capital services, leisure, and nonmarket work. The latter two have a very large effect on the statistics, and there is no one indisputable method for valuing them. Nordhaus and Tobin propose three methods. The question is whether leisure and nonmarket activity are affected by technological progress. The authors prefer the measure that leaves the value of leisure unaffected by technical progress even though nonmarket productive activity is so affected. We will report only the statistics generated by this choice.

The third task is to consider urban disamenities. Nordhaus and Tobin recognize that there are negative “externalities” connected with economic growth and suggest that these are most apparent in urban life. “Some portion of the higher earnings of urban residents may be simply compensation for the disamenities of urban life and work. If so we should not count as a sign of welfare the full increments of NNP that result from moving a man from farm or small town to city” ^[93].

We now have before us the full range of adjustments made by Nordhaus and Tobin. One or another may appear inappropriate to some. For example, it may be argued that police protection is a contribution to welfare, and that it should not be deleted. The counterargument, however, is convincing if our purpose is to compare welfare over time. The increasing cost of police protection does not imply that we are less vulnerable to crime than we were in the past. Should the social situation change so that much less protection was needed, this should not be regarded as a reduction of economic welfare.

The real question is whether the list of regrettable necessities is sufficiently inclusive. As Nordhaus and Tobin^[94] recognize,

the line between final and instrumental outlays is very hard to draw. For example, the philosophical problems raised by the malleability of consumer wants are too deep to be resolved in economic accounting. Consumers are susceptible to efforts of producers. Maybe all our wants are just regrettable necessities; maybe productive activity does no better than to satisfy the wants which it generates; maybe our net welfare product is tautologically zero.

Having said this, they ignore the problem. The same problem has been briefly considered and dismissed by Denison and Jaszi, who believe that regrettables or defensive expenditures should be counted as final consumption, as is currently the case^[95]. All expenditures, they argue, are basically defensive: thus food expenditures are a defense against hunger, clothing and housing expenditures defend against the cold and rain, and so forth—and even expenditures on churches defend against the devil! Clever though this riposte may be, it misses the point: namely, that “defensive” means a defense against the unwanted side effects of other production, not a defense against normal baseline environmental conditions of cold, rain, and so on. It is not the case that “our net welfare product is tautologically zero”^[96]. Defensive expenditures are only those that were “regrettably made necessary” by other acts of production and consequently should be counted as costs of that other production; that is to say, counted as intermediate rather than final goods.

We are now ready to consider the results of Nordhaus and Tobin’s new MEW. What is of special interest to us is how it correlates with GNP, since the question of whether growth of GNP indicates improved economic welfare motivated the whole study. First, we will quote the conclusion of Nordhaus and Tobin^[97], and then we will examine the figures on the basis of which they make their judgment:

Although the numbers presented here are very tentative, they do suggest the following observations. First, MEW is quite different from conventional output measures. Some consumption items omitted from GNP are of substantial quantitative importance. Second, our preferred variant of per capita MEW has been growing more slowly than per capita NNP (1.1% for MEW as against 1.7% for NNP, at annual rates over the period (1929–1965). Yet MEW has been growing. The progress indicated by conventional national accounts is not just a myth that evaporates when a welfare-oriented measure is substituted^[98].

When their findings are more carefully examined for time frames other than the full period from 1929–1965, the relatively close association between growth of per capita GNP and MEW disappears^[99]. For example, between 1945 and 1947, per capita GNP fell about 15% (from $2,528 to $2,142) while per capita sustainable MEW rose by over 16% (from $5,098 to $5,934). Of course, this is the period of demobilization after World War II, so no conclusions should be drawn from this short-term negative relationship. Yet the presumption that the growth of GNP could be used as a reasonable proxy for MEW growth does not find confirmation in other periods either. From 1935 to 1945, per capita GNP rose almost 90% (from $1,332 to $2,528), while per capita sustainable MEW rose only about 13% (from $4,504 to $5,098). More significantly, during the postwar period 1947–1965, when neither depression nor war nor recovery had a major impact on growth rates, per capita GNP rose about six times as fast as per capita sustainable MEW^[100] (per capita GNP grew by 48% or about 2.2% per year, while per capita sustainable MEW grew by 7.5% or about 0.4% per year).

Moreover, if we assume, as Nordhaus and Tobin^[101] did in one of their options, that the productivity of housework has not increased at the same rate as the productivity of market activities, then per capita sustainable MEW actually registers a decline of 2% during the period 1947–1965. Alternatively, we might consider the growth of per capita sustainable MEW in the absence of any imputation for leisure or household production because, as Nordhaus and Tobin admit, “Imputation of the consumption value of leisure and nonmarket work presents severe conceptual and statistical problems. Since the magnitudes are large, differences in resolution of these problems make big differences in overall MEW estimates”^[102]. If that imputation is omitted, per capita sustainable MEW grows by 2% from 1947 to 1965. In any case, whether the appropriate figure for the change during that period in per capita sustainable MEW is 7.5%, 2%, or -2%, each of these results suggest that in fact “the progress indicated by conventional national accounts is ... just a myth that evaporates when a welfare-oriented measure is substituted”^[103]. With their own figures, Nordhaus and Tobin have shed doubt on the thesis that national income accounts serve as a good proxy measure of economic welfare.

Nordhaus reflected again on the significance of his work with Tobin five years later. His interpretation of the results was unchanged: “Although GNP and other national income aggregates are imperfect measures of the economic standard of living, the broad picture of secular progress that they convey remains after correction for their most obvious deficiencies”^[104].

He had still failed to remark upon the lack of similarity between the growth of MEW and GNP during the last 18 years of the period that he and Tobin had reviewed.

The Index of Sustainable Economic Welfare

We have shown that the national product, whether gross or net, is not identical with true national income and that subtracting indirect business taxes from NNP, as is done in the National Income Accounts to arrive at “national income,” still does not give us a true measure of national income. True income is sustainable, and to calculate this Hicksian income would require a quite different approach.

We have also shown that there is a marked difference between what the GNP measures and economic welfare, and that the latter has been growing much more slowly than the former as measured by the two proposals that have been made for judging the U.S. economy. A defender of the continuing use of GNP as a guide to policy could argue that, even so, economic welfare has advanced along with GNP. If any advance in the welfare measure is truly a gain, it is still desirable to increase GNP. The recognition that it takes a great deal of increase in GNP to achieve a small improvement in real economic welfare could be used to argue that ever greater efforts are needed for the increase of GNP.

To counter such a claim two points need to be made. First, there are social and ecological indicators that seem to be adversely affected by growth of GNP. Not all of these are dealt with in any of the welfare measures. This is especially true of many of the pervasive externalities.

Second, the major reason that the welfare measures show some growth as GNP grows is that they incorporate the largest element of the GNP as part of their own statistics. That is private consumption. These welfare measures assume that the more goods and services that are consumed by the public, the better. For example, excessive consumption of tobacco, alcohol, and fatty foods are all counted positively. Few suppose that these actually add to welfare, but the task of sorting out approved and disapproved expenses would be formidable indeed. Furthermore, economists generally regard any effort to make such distinctions as elitism of a sort they reject. However a person spending money in the market is assumed to be in the interest of satisfying that person’s wants, and no further consideration of value is possible. We are not arguing against the necessity of assuming for these statistical purposes that consumption in general must be positively appraised. But we do think it well to point out that it is this inability or unwillingness to make judgments of this sort that allows welfare measures to advance even a little as GNP advances a lot. The small advance in welfare held to accompany the larger advance in GNP might well disappear if the most questionable items were deleted from the private consumption column.

This survey does not suffice to establish a way of measuring economic welfare. Closer examination of decisions that must be made in any such index shows how large the arbitrary element is. Any measure would abstract from many features of actual economic welfare and its use would lead to ignoring the degree of abstraction involved. The very existence of a measure invites the fallacy of misplaced concreteness. But whether a new measure should be devised and used, or whether measured welfare is a will-o’-the-wisp that should be abandoned, the results make clear that GNP does not come close enough to measuring economic welfare to warrant its continued use for that purpose. To use it as if it were a significant indicator of economic well-being—much worse of well-being in general—is an egregious instance of the fallacy of misplaced concreteness.

Figure 3.3. Comparisons of indices of GNP per capita and ISEW per capita for five OECD countries. (Source: Max-Neef 1995^[2])

In an effort to address these issues (while remaining mindful of the pitfalls) Daly and Cobb^[105] developed an Index of Sustainable Economic Welfare (ISEW). The ISEW takes the MEW of Nordhaus and Tobin and the Economic Aspects of Welfare (EAW) of Zoltas^[106] as starting points, but incorporates the sustainability issues that EAW ignores and the environmental issues that MEW ignores. Rather than revising and bringing up to date the existing measures, they decided to create a new one that includes some of the elements not dealt with by any of the three indices already discussed, as well as fresh ways of treating topics that were included in them. To summarize these changes, ISEW:

1. Factors in income distribution on the assumption that an additional dollar’s worth of income adds more to the welfare of a poor family than a rich one.
2. Considerably alters what Nordhaus and Tobin^[107] did in the calculation of changes in net capital stock. Specifically, it includes only changes in the stock of fixed reproducible capital and excludes land and human capital in this calculation.
3. Updates Zoltas’s^[108] estimates using more recent data for air and water pollution and adds an estimate of noise pollution.
4. Includes estimates of costs of the loss of wetlands and farmlands, depletion of nonrenewable resources, commuting, urbanization, auto accidents, advertising, and long-term environmental damage.
5. Omits any imputation of the value of leisure.
6. Includes imputed values for the value of unpaid household labor.

Figure 3.3 (cont.) Comparisons of indices of GNP per capita and ISEW per capita for five OECD countries. (Source: Max-Neef 1995^[3].

Figure 3.3 (cont.) Comparisons of indices of GNP per capita and ISEW per capita for five OECD countries. (Source: Max-Neef 1995^[4])

Daly and Cobb^[109] calculated ISEW for the U.S. economy from 1950 to 1986. Since then, ISEW has been updated for the U.S. and calculated for several other countries. These results are shown in Figure 3.3. While GNP per capita continued to rise over the entire interval for the countries shown, ISEW per capita paralleled GNP per capita during the initial period, but then leveled off and in some cases began to decline. When exactly this leveling occurred varies by country, but it has occurred in all the countries studied so far. Max-Neef^[110] has postulated that this is evidence for the “threshold hypothesis,” that economic growth increases welfare only until a threshold is reached where the costs of additional growth begin to outweigh the benefits. ISEW, by doing a better job of including both the costs and benefits of growth can clearly show when this threshold has been passed. In the U.S. it was around 1970. In the U.K. it was around 1975, and in the other cases (Germany, Netherlands, Austria) around 1980. In the U.S. ISEW per capita continues to increase as GNP/capita increases until GNP per capita reaches about US$5,500 (in constant 1972 dollars per person), after which ISEW per capita declines with increasing GNP per capita. For the U.K. this relationship is very striking, with a very sharp peak at around £4700 (in constant 1985 pounds per person).

Toward a Measure of Total Human Welfare

While the ISEW goes a long way toward providing a better measure of economic welfare, it is certainly not a perfect measure of economic welfare and it falls far short of measuring total welfare. ISEW is still based on measuring how much is produced and consumed, with the tacit assumption that more consumption leads to more welfare. ISEW at least adjusts for the sustainability of this consumption, its negative impacts on natural capital, its distribution across income classes, and other reasonable adjustments. This is a huge improvement over GNP and one that tells a very different story about recent changes in aggregate economic welfare.

A completely different approach, however, would be to look directly at the actual well-being that is achieved—to separate the means (consumption) from the ends (well-being) without assuming that one is correlated with the other. Some authors have begun to look at the problem from this perspective. For example, Manfred Max-Neef^[111] has developed a matrix of human needs and has attempted to address well-being from this alternative perspective. While human needs can be classified according to many criteria, Max-Neef organized them into two categories: existential and axiological, which he arranges as a matrix. He lists nine categories of axiological human needs which must be satisfied in order to achieve well-being: (1) subsistence, (2) protection, (3) affection, (4) understanding, (5) participation, (6) leisure, (7) creation, (8) identity, and (9) freedom. These are arrayed against the existential needs of (1) having, as in consuming; (2) being, as in being a passive part of without necessarily having; (3) doing, as in actively participating in the work process; and (4) relating, as in interacting in social and organizational structures. The key idea here is that humans do not have primary needs for the products of the economy. The economy is only a means to an end. The end is the satisfaction of primary human needs. Food and shelter are ways of satisfying the need for subsistence. Insurance systems are ways to meet the need for protection. Religion is a way to meet the need for identity. And so on. Max-Neef summarizes as:

Having established a difference between the concepts of needs and satisfiers it is possible to state two postulates: first, fundamental human needs are finite, few and classifiable; second, fundamental human needs (such as those contained in the system proposed) are the same in all cultures and in all historical periods. What changes, both over time and through cultures, is the way or the means by which the needs are satisfied^[112].

This is a very different conceptual framework from conventional economics, which assumes that human desires are infinite and that, all else being equal, more is always better. According to this alternative conceptual framework, we should be measuring how well basic human needs are being satisfied if we want to assess well-being, not how much we are consuming, since the two are not necessarily correlated.

Alternative Models of Wealth and Utility

Figure 3.4. Alternative models of economic activity. (Source: Ekins 1992^[5])

We can summarize the foregoing discussion with reference to two alternative models of wealth and utility, based loosely on the ideas of Paul Ekins^[113]. Figure 3.4 shows these relationships diagramatically. Model 1 shows the conventional economic view of the process. The primary factors of land, labor, and capital combine in the economic process to produce goods and services (GNP) which is divided into consumption (which is the sole contributor to individual utility and welfare) and investment (which goes into maintaining and increasing the capital stocks). Preferences are fixed. In this model the primary factors are perfect substitutes for each other so land has been downplayed, and the lines between all the forms of capital are fuzzy. Property rights are usually simplified to either private or public and their distribution is usually taken as fixed and given.

Model 2 shows the alternative ecological economics view of the process. Notice that the key elements of the conventional view are still present, but more has been added and some priorities have changed. There is limited substitutability between the three basic forms of capital in this model: natural, human, and manufactured, and property rights regimes are complex and flexible, spanning the range from individual to common to public property. Natural capital captures solar energy and behaves as an autonomous complex system. Both economic goods and services and ecological services and amenities are produced and both contribute in different ways to satisfying basic human needs and creating both individual and community well-being. There is also waste production by the economic process which contributes negatively to well-being and has a negative impact on capital and ecological services. Preferences are adapting and changing but basic human needs are constant.

As Ekins^[114] points out:

It must be stressed that that the complexities and feedbacks of model 2 are not simply glosses on model 1’s simpler portrayal of reality. They fundamentally alter the perceived nature of that reality and in ignoring them conventional analysis produces serious errors....

In the remaining sections we elaborate the various implications of these distinctions.

Valuation, Choice, and Uncertainty

While there may be no “right” way to value a forest or a river, there is a wrong way, which is to give it no value at all.
—Paul Hawken in the forward to Prugh et al.^[115]

This section looks at the difficult and controversial issues of valuation, choice, and uncertainty. Conventional economic analysis usually assumes that individual human preferences are given and fixed, that the role of economics is to satisfy those preferences in the most efficient way possible, and that uncertainty can be handled in a fairly straightforward way by equating it to risk (uncertain events with known probabilities). As we will show, when one is concerned with sustainability, which is an inherently long-run problem, preferences cannot be considered to be fixed and given. Economics must then have a different and broader role, and we must acknowledge and deal with true uncertainty and indeterminacy, where probabilities are unknown and even the possibilities are often unknown.

Fixed Tastes and Preferences and Consumer Sovereignty

The conventional paradigm assumes tastes and preferences are fixed and given and that the economic problem consists of optimally satisfying those preferences. Tastes and preferences usually do not change rapidly and, in the short run (i.e., 1–4 yrs), this assumption makes sense. But preferences do change over longer time frames and in fact there is an entire industry (advertising) devoted to changing them. Sustainability is an inherently long-run problem, and in the long run it does not make sense to assume tastes and preferences are fixed. This is a very disturbing prospect for economists because it takes away the easy definition of what is “optimal.” If tastes and preferences are fixed and given, then we can adopt a stance of “consumer sovereignty” and just give the people what they want. We do not have to know or care why they want what they want, we just have to satisfy their preferences as efficiently as possible. But if preferences are expected to change over time and under the influence of education, advertising, changing cultural assumptions, and so on, we need a different criterion for what is “optimal” and we have to figure out how preferences change, how they relate to this new criterion, and how they can or should be changed to satisfy the new criterion.

One alternative for this new criterion is sustainability itself or more completely, sustainable scale, fair distribution, and efficient allocation. This criterion implies a two-tiered decision process^[116] of first coming to a social consensus on a sustainable scale and fair distribution and, second, using both the market and other institutions like education and advertising in order to implement these social decisions. This might be called “community sovereignty” as opposed to “consumer sovereignty.” It makes most conventional economists very uncomfortable to stray from consumer sovereignty because it eliminates the tidy view of economics as simply optimally satisfying a fixed set of preferences and it opens a Pandora’s box of possibilities for manipulating preferences. If tastes and preferences can change, then who is going to decide how to change them? There is a real danger that a “totalitarian” government might be employed to manipulate preferences to conform to the desires of a select elite rather than the society as a whole.

Two points need to be kept in mind: (1) preferences are already manipulated every day; and (2) we can just as easily apply open democratic principles (as opposed to hidden or totalitarian principles) to the problem in deciding how to manipulate preferences. So the question becomes: do we want preferences to be manipulated unconsciously, either by a dictatorial government or by big business acting through advertising, or do we want to formulate them consciously based on social dialogue and consensus with a higher goal in mind? Ethics is the ordering and revising of our existing preferences in the light of a higher goal. Taking preferences as given would mean that the ethical problem has been solved once and for all. Either way, this is an issue that can no longer be avoided, and one which we believe can best be handled using open democratic principles and innovative thinking.

Valuation of Ecosystems and Preferences

The issue of valuation is inseparable from the choices and decisions we have to make about ecological systems. Some argue that valuation of [[ecosystem]s] is either impossible or unwise. For example, some argue that we cannot place a value on such “intangibles” as human life, environmental aesthetics, or long-term ecological benefits. But, in fact, we do so every day. When we set construction standards for highways, bridges, and the like, we value human life—acknowledged or not—because spending more money on construction would save lives. Another often-made argument is that we should protect ecosystems for purely moral or aesthetic reasons, and we do not need valuations of ecosystems for this purpose. But there are equally compelling moral arguments that may be in direct conflict with the moral argument to protect ecosystems. For example, the moral argument that no one should go hungry. All we have done is to translate the valuation and decision problem into a new set of dimensions and a new language of discourse, one that in some senses makes the valuation and choice problem more difficult and less explicit.

So, while ecosystem valuation is certainly difficult, one choice we do not have is whether or not to do it. Rather, the decisions we make, as a society, about ecosystems imply valuations. We can choose to make these valuations explicit or not; we can undertake them using the best available ecological science and understanding or not; we can do them with an explicit acknowledgment of the huge uncertainties involved or not; but as long as we are forced to make choices we are doing valuation. The valuations are simply the relative weights we give to the various aspects of the decision problem.

We believe that society can make better choices about [[ecosystem]s] if the valuation process is made as explicit and participatory as possible. This means taking advantage of the best information we can muster and making uncertainties about valuations explicit too. It also means developing new and better ways to make good decisions in the face of these uncertainties. Ultimately, it means stating explicitly our goals as a society, both in the short term and in the long term.

This leads back to the role of individual preferences in determining value. If individual preferences change (in response to education, advertising, peer pressure, etc.) then value cannot completely originate with preferences. We need to distinguish at least two kinds of value within this context: (1) short-term or current value based on current individual preferences; and (2) long-term or sustainable value based on the preferences needed to assure long-term sustainability (sustainable scale, fair distribution, and efficient allocation). Instead of being merely an expression of current individual preferences, sustainable value (at least in the mid to long term) becomes a system characteristic related to the item’s evolutionary contribution to the survival of the linked ecological economic system.

Current value is the expression of individual preferences in the short term and locally, while sustainable value is the expression of community preferences in the long term and globally. Section 7.6 elaborates on these ideas.

Uncertainty, Science, and Environmental Policy

One of the primary reasons for the problems with current methods of environmental management is the issue of scientific uncertainty—not just its existence, but the radically different expectations and modes of operation that science and policy have developed to deal with it. If we are to solve this problem, we must understand and expose these differences about the nature of uncertainty and design better methods to incorporate it into the policy-making and management process.

To understand the scope of the problem, it is necessary to differentiate between risk (which is an event with a known probability, sometimes referred to as statistical uncertainty) and true uncertainty (which is an event with an unknown probability, sometimes referred to as indeterminacy). Every time you drive your car you run the risk of having an accident, because the probability of car accidents is known with very high certainty. We know the risk involved in driving because, unfortunately, there have been many car accidents on which to base the probabilities. These probabilities are known with enough certainty that they are used by insurance companies to set rates that will assure those companies of a certain profit. There is little uncertainty about the risk of car accidents. If you live near the disposal site of some newly synthesized toxic chemical you may be in danger as well, but no one knows to what extent. No one knows even the probability of your getting cancer or some other disease from this exposure, so there is true uncertainty. Most important environmental problems suffer from true uncertainty, not merely risk.

One can think of a continuum of uncertainty ranging from zero for certain information to intermediate levels for information with statistical uncertainty and known probabilities (risk) to high levels for information with true uncertainty or indeterminacy. Risk assessment has become the central guiding principle at the U.S. EPA^[117] and other environmental management agencies, but true uncertainty has yet to be adequately incorporated into environmental protection strategy.

Science treats uncertainty as a given, a characteristic of all information that must be honestly acknowledged and communicated. Over the years scientists have developed increasingly sophisticated methods to measure and communicate uncertainty arising from various causes. It is important to note that the progress of science has, in general, uncovered more uncertainty rather that leading to the absolute precision that the lay public often mistakenly associates with “scientific” results. The scientific method can only set boundaries on the limits of our knowledge. It can define the edges of the envelope of what is known, but often this envelope is very large and the shape of its interior can be a complete mystery. Science can tell us the range of uncertainty about global warming and toxic chemicals, and maybe something about the relative probabilities of different outcomes, but in most important cases it cannot tell us which of the possible outcomes will occur with any degree of accuracy.

Our current approaches to environmental management and policy making, on the other hand, abhor uncertainty and gravitate to the edges of the scientific envelope. The reasons for this are clear. The goal of policy is making unambiguous, defensible decisions, often codified in the form of laws and regulations. While legislative language is often open to interpretation, regulations are much easier to write and enforce if they are stated in clear, black and white, absolutely certain terms. For most of criminal law this works reasonably well. Either Mr. Cain killed his brother or he didn’t; the only question is whether there is enough evidence to demonstrate guilt beyond a reasonable doubt (i.e., with essentially zero uncertainty). Since the burden of proof is on the prosecution, it does little good to conclude that there was 80% chance that Mr. Cain killed his brother. But many scientific studies come to just these kinds of conclusions, because that is the nature of the phenomenon. Science defines the envelope while the policy process gravitates to its edges—generally the edge that best advances the policy maker’s political agenda. We need to deal with the whole envelope and all its implications if we are to use science rationally to make policy.

The problem is most severe in the environmental area. Building on the legal traditions of criminal law, policy makers and environmental regulators desire absolute, certain information when designing environmental regulations. But much of environmental policy is based upon scientific studies of the likely health, safety and ecological consequences of human actions. Information gained from these studies is therefore only certain within their epistemological and methodological limits^[118]. Particularly with the recent shift in environmental concerns from visible, known pollution to more subtle threats, like radon, regulators are confronted with decision making outside the limits of scientific certainty with increasing frequency^[119].

Problems arise when regulators ask scientists for answers to unanswerable questions. For example, the law may mandate that the regulatory agency come up with safety standards for all known toxins when little or no information is available on the impacts of these chemicals. When trying to enforce the regulations after they are drafted, the problem of true uncertainty about the impacts remains. It is not possible to determine with any certainty if the local chemical company contributed to the death of some of the people in the vicinity of their toxic waste dump. One cannot prove the smoking/lung cancer connection in any direct, causal way (i.e., in the courtroom sense), only as a statistical relationship. Global warming may or may not happen after all.

As they are currently set up, most environmental regulations, particularly in the United States, demand certainty, and when scientists are pressured to supply this nonexistent commodity there is not only frustration and poor communication but mixed messages in the media as well. Because of uncertainty, environmental issues can often be manipulated by political and economic interest groups. Uncertainty about global warming is perhaps the most visible current example of this effect.

The “precautionary principle” is one way the environmental regulatory community has begun to deal with the problem of true uncertainty. The principle states that rather than await certainty, regulators should act in anticipation of any potential environmental harm in order to prevent it. The precautionary principle is so frequently invoked in international environmental resolutions that it has come to be seen by some as a basic normative principle of international environmental law^[120]. But the principle offers no guidance as to what precautionary measures should be taken. It “implies the commitment of resources now to safeguard against the potentially adverse future outcomes of some decision”^[121], but does not tell us how many resources or which adverse future outcomes are most important.

Figure 3.5. Three kinds of science. (Source: Funtowicz and Ravetz 1991^[6])

This aspect of the “size of the stakes” is a primary determinant of how uncertainty is dealt with in the political arena. The situation can be summarized as shown in Figure 3.5, with uncertainty plotted against decision stakes. It is only the area near the origin with low uncertainty and low stakes that is the domain of “normal applied science.” Higher uncertainty or higher stakes result in a much more politicized environment. Moderate values of either correspond to “applied engineering” or “professional consultancy,” which allows a good measure of judgment and opinion to deal with risk. On the other hand, current methods are not in place to deal with high values of either stakes or uncertainty, which require a new approach; what might be called “post-normal” or “second-order science”^[122]. This “new” science is really just the application of the essence of the scientific method to new territory. The scientific method does not, in its basic form, imply anything about the precision of the results achieved. It does imply a forum of open and free inquiry without preconceived answers or agendas aimed at determining the envelope of our knowledge and the magnitude of our ignorance.

Implementing this view of science requires a new approach to environmental protection that acknowledges the existence of true uncertainty rather than denying it and that includes mechanisms to safeguard against its potentially harmful effects while at the same time encouraging development of lower impact technologies and the reduction of uncertainty about impacts. The precautionary principle sets the stage for this approach, but the real challenge is to develop scientific methods to determine the potential costs of uncertainty, and to adjust incentives so that the appropriate parties pay this cost of uncertainty and have appropriate incentives to reduce its detrimental effects. Without this adjustment, the full costs of environmental damage will continue to be left out of the accounting^[123], and the hidden subsidies from society to those who profit from environmental degradation will continue to provide strong incentives to degrade the environment beyond [[sustainable] levels].

Technological Optimism vs. Prudent Skepticism

Current economic policies are all based on the underlying assumption of continuing and unlimited material economic growth. This assumption allows problems of intergenerational, intragenerational, and interspecies equity and sustainability to be ignored (or at least postponed), since they are seen to be most easily solved by additional growth. Indeed, most conventional economists define “health” in an economy as a stable and high rate of growth. Energy, resource, and pollution limits to growth, according to these paradigms, will be eliminated as they arise by clever development and deployment of new technology. This line of thinking is often called “technological optimism.”

An opposing line of thought (often called “technological skepticism”) assumes that technology will not be able to circumvent fundamental energy and resource constraints and that eventually material economic growth will stop. It has usually been ecologists or other life scientists that take this point of view (notable exceptions among economists are J. S. Mill, Georgescu-Roegen, Boulding, and Daly), largely because they study natural systems that invariably do stop growing when they reach fundamental resource constraints. A healthy ecosystem is one that maintains a stable level. Unlimited growth eventually becomes cancerous, not healthy, under this view.

The technological optimists argue that human systems are fundamentally different from other natural systems because of human intelligence. History has shown that resource constraints can be circumvented by new ideas. Technological optimists claim that Malthus’ dire predictions about population pressures have not come to pass and the “energy crisis” of the late 1970s is behind us.

The technological skeptics argue that many natural systems also have “intelligence” in that they can evolve new behaviors and organisms (including humans themselves). Humans are therefore a part of nature, not apart from it. Just because we have circumvented local and artificial resource constraints in the past does not mean we can circumvent the fundamental ones that we will eventually face. Malthus’ predictions have not come to pass yet for the entire world, the pessimists would argue, but many parts of the world are in a Malthusian trap now, and other parts may well fall into it. Also those countries not in the Malthusian trap have avoided it precisely by heeding Malthus’ advice to limit fertility.

This debate has gone on for many decades now. It was given an impulse by Barnett and Morse’s^[124] Scarcity and Growth, the publication of The Limits to Growth by Meadows et al.^[125], and the Arab oil embargo in 1973. There have been thousands of studies on various aspects of our energy and resource future and different points of view have waxed and waned. But the bottom line is that there is still an enormous amount of uncertainty about the impacts of energy and resource constraints. In the next 20–30 years we may begin to hit real oil supply limits and CO₂ emission limits. Will fusion energy or solar energy or conservation or some as yet unthought of energy source step in to save the day and keep economies growing? The technological optimists say yes; the technological skeptics say no. Ultimately, no one knows. Both sides argue as if they were certain but the most insidious form of ignorance is misplaced certainty.

Whatever turns out to be the case, a more ecological approach to economics and a more economic approach to ecology will be beneficial in order to maintain our life-support systems and the aesthetic qualities of the environment. But there are vast differences in the specific economic and environmental policies we should pursue today, depending on whether the technological optimists or pessimists are right.

Figure 3.6. Payoff matrix for technological optimism vs. skepticism. (Source: Authors)

We can cast this optimist/skeptic choice in a classic (and admittedly oversimplified) game theoretic format using the “payoff matrix” shown in Figure 3.6. Here the alternative policies that we can pursue today (technologically optimistic or skeptical) are listed on the left and the real states of the world are listed on the top. The intersections are labeled with the results of the combinations of policies and states of the world. For example, if we pursue the optimistic policy and the world really does turn out to conform to the optimistic assumptions then the payoffs would be high. This high potential payoff is very tempting and this strategy has paid off in the past. It is not surprising that so many would like to believe that the world conforms to the optimist’s assumptions. If, however, we pursue the optimistic policy and the world turns out to conform more closely to the skeptical technological assumptions then the result would be “Disaster.” The disaster would come because irreversible damage to [[ecosystem]s] would have occurred and technological fixes would no longer be possible.

If we pursue the skeptical policy and the optimists are right then the results are only “Moderate.” But if the pessimists are right and we have pursued the pessimistic policy then the results are within the framework of game theory; this simplified game has a fairly simple “optimal” strategy. Given that we only get to play this game once, and we therefore cannot assign probabilities to the various outcomes, and that society as a whole should be risk averse in this situation, then we should choose the policy that is the maximum of the minimum outcomes (i.e., the MaxiMin strategy in game theory jargon). In other words, we analyze each policy in turn, look for the worst thing (minimum) that could happen if we pursue that policy, and pick the policy with the largest (maximum) minimum. In the case stated above we should pursue the skeptical policy because the worst possible result under that policy (“Sustainable”) is a preferable outcome to the worst outcome under the optimist policy (“Disaster”).

In other words, given our high level of uncertainty about this issue, and the enormous size of the stakes, it is irrational to bank on technology’s ability to remove resource constraints. If we guess wrong then the result is disastrous; there will be irreversible destruction of our resource base and civilization itself. We should at least for the time being assume that technology will not be able to remove resource constraints. If it does, we can be pleasantly surprised. If it does not, we are still left with a sustainable system. Ecological economics assumes this prudently skeptical stance on technical progress.

Social Traps

No complex system can be managed effectively without clear goals, and appropriate mechanisms for achieving them. In managing the earth, we are faced with a nested hierarchy of goals that span a wide range of time and space scales. In any rational system of management, global ecological and economic health and sustainability should be “higher” goals than local, short-term national economic growth or private interests. Economic growth can only be supported as a policy goal in this context to the extent that it is consistent with long-term global sustainability.

Unfortunately, most of our current institutions and incentive structures deal only with relatively short-term, local goals and incentives^[126]. This would not be a problem if the local and short-term goals and incentives simply added up to (or in other words were consistent with) appropriate behavior in the global long run, as many assume they do. Unfortunately, this goal and incentive consistency is frequently not the case. Individuals (or firms, or countries) pursuing their own private self-interests in the absence of mechanisms to account for community and global interests frequently run afoul of these larger goals and can often drive themselves to their own demise.

These goal and incentive inconsistencies have been characterized and generalized in many ways, beginning with Hardin’s^[127] classic paper on the tragedy of the commons (more accurately the tragedy of open-access resources) and continuing through more recent work on “social traps”^[128]. Social traps occur when local, individual incentives that guide behavior are inconsistent with the overall goals of the system. Examples include cigarette and drug addiction, overuse of pesticides, economic boom and bust cycles, and a host of others. For example, overfishing in an open-access fishery is a social trap because by following the short-run economic road signs, fishermen are led to exploit the resource to the point of collapse.

Social traps are also amenable to experimental research to observe how individuals behave in trap-like situations and how to best avoid and escape from social traps^[129]. The bottom line emerging from this research is that in cases where social traps exist the system is not inherently sustainable, and special steps must be taken to harmonize goals and incentives over the hierarchy of time and space scales involved. In economic jargon private costs and benefits must somehow be made to reflect social costs and benefits. Explicit, special steps must be taken to make the global and long-term goals incumbent on and consistent with the local and short-term goals and incentives.

This is in contrast to natural systems, which are forced to adopt a long-term perspective by the constraints of genetic evolution. This is not to say that individual species are immune to evolutionary traps set by adaptation to local conditions. But the system as a whole selects against these species in the long run. In natural systems, long-run “survival” generally equates to sustainability of the species as part of a larger ecosystem, and natural selection tends to find sustainable systems in the long run. Humans have broken the bonds of genetic evolution by the expanded use of learned behavior our large brain allows and by extending our physical capabilities with tools. The price we pay for this rapid adaptation is a misleading temporary partial isolation from long-term constraints and a susceptibility to social traps.

Another general result of social trap research is that the relative effectiveness of alternative corrective steps is not easy to predict from simple “rational” models of human behavior prevalent in conventional economic thinking. The experimental facts indicate the need to develop more realistic models of human behavior under uncertainty which acknowledge the complexity of most real-world decisions, and our species’ limited information processing capabilities^[130].

Escaping Social Traps

The elimination of social traps requires intervention: the modification of the reinforcement system. Indeed, it can be argued that the proper role of a democratic government is to eliminate social traps (no more and no less) while maintaining as much individual freedom as possible. Cross and Guyer^[131] list four broad methods by which traps can be avoided or escaped from. These are education (about the long-term, distributed impacts); insurance; superordinate authority (i.e., legal systems, government, religion); and converting the trap to a trade-off.

Education can be used to warn people of long-term impacts. Examples are the warning labels now required on cigarette packages and the warnings of environmentalists about future hazardous waste problems. People can ignore warnings, however, particularly if the path seems otherwise enticing. For example, warning labels on cigarette packages have had a partial but limited effect on the number of smokers.

The main problem with education as a general method of avoiding and escaping from traps is that it requires a significant time commitment on the part of individuals to learn the details of each situation. Our current society is so large and complex that we cannot expect even professionals, much less the general public, to know the details of all the extant traps. In addition, for education to be effective in avoiding traps involving many individuals, all the participants must be educated, and this is usually not possible.

Governments can, of course, forbid or regulate certain actions that have been deemed socially inappropriate (e.g., the smuggling of CFCs from developing countries into the U.S.).The problem with this direct, command-and-control approach is that it must be rigidly monitored and enforced, and the strong short-term incentive for individuals to try to ignore or avoid the regulations remains. A police force and legal system are very expensive to maintain, and increasing their chances of catching violators increases their costs exponentially (both the costs of maintaining a larger, better-equipped force and the cost of the loss of individual privacy and freedom).

Religion and social customs can be seen as much less expensive ways to avoid certain social traps. If a moral code of action and a belief in an ultimate payment for transgressions can be deeply instilled in a person, the probability of that person falling into the “sins” (traps) covered by the code will be greatly reduced, and with very little enforcement cost. On the other hand, using religion and social customs as means to avoid social traps is problematic because the moral code must be relatively static to allow beliefs learned early in life to remain in force later, and it requires a relatively homogeneous community of like-minded individuals to be truly effective. This system works well in culturally homogeneous societies that are changing very slowly. In modern, heterogeneous, rapidly changing societies, religion and social customs cannot handle all the newly evolving situations, nor the conflict between radically different cultures and belief systems.

Many trap theorists believe that the most effective method for avoiding and escaping from social traps is to turn the trap into a trade-off. This method does not run counter to our normal tendency to follow the road signs; it merely corrects the signs’ inaccuracies by adding compensatory positive or negative reinforcements. A simple example illustrates how effective this method can be. Playing slot machines is a social trap because the long-term costs and benefits are inconsistent with the short-term costs and benefits. People play the machines because they expect a large short-term jackpot, while the machines are in fact programmed to pay off, say, $0.80 on the dollar in the long term. People may “win” hundreds of dollars playing the slots (in the short run), but if they play long enough they will certainly lose $0.20 for every dollar played. To change this trap to a trade-off, one could simply reprogram the machines so that every time a dollar was put in $0.80 would come out. This way the short-term reinforcements ($0.80 on the dollar) are made consistent with the long-term reinforcements ($0.80 on the dollar), and only the dedicated aficionados of spinning wheels with fruit painted on them would continue to play. Requiring the true odds to be posted would also be helpful but not as effective.

In the context of social traps, the most effective way to make global and long-term goals consistent with local, private, short-term goals is to somehow modify the local, private, short-term incentives. These incentives are any combination of the reinforcements that are important at the local level, including economic, social, and cultural incentives. We must design the social and economic instruments and institutions to bridge the gulf between the present and future, between the private and social, between the local and global, between the ecological and economic parts of the system. Some instruments for accomplishing these goals are discussed in later sections.

The Dollar Auction Game

The “dollar auction game”^[132] is a simple but enlightening model useful in showing the difference between local and global costs and benefits. This game is a social trap that was designed specifically to simulate the conflict escalation process. The dollar auction is just like a normal auction except that both the highest and the second-highest bidder have to pay the auctioneer their bid at the end of the game, but only the highest bidder gets the prize. You can try playing this game with a group or class. Simply offer a dollar bill for bid with the following rules: (1) both the highest bidder and the second-highest bidder pay; and (2) the minimum bid is $.05 over the current high bid (this just keeps the game moving).

This game usually results in some very unexpected behavior. Players in the dollar auction game frequently bid much more than $1 for a $1 prize—an irrational result that is the product of a series of “rational” decisions by the bidders. This happens because the structure of reinforcements in this game is a trap. Initially, it looks very appealing to bid $.05 on a $1 prize, but as the bidding escalates past $.50 it becomes clear that even though the winning bidder might make out, the auctioneer is now standing to make money on the auction (the two bids of more than $.50 minus the $1 prize). But the bidding usually does not stop at $.50, because the second-highest bidder (at say $.45) would loose his bid if he dropped out, and so usually raises to at least $.55. It continues under this logic up to the $1 level, where it is clear that even the highest bidder will lose money by bidding more than $1 for a $1 prize. Even when the bidding reaches the $1 point, it usually continues because of the structure of the incentives. For example, if player A had bid $1 and player B had the second-highest bid at $.95, player B reasons that if he drops out he loses $.95 while if he raises to $1.05 he only loses $.05 (assuming he wins the $1 prize). So he usually raises, and this pattern of “rational” escalation (beyond the point where the overall outcome is rational) continues quite often to well beyond the $1 point. Individual and group behavior in the dollar auction game has been extensively studied by Teger^[133] who showed that almost all groups, from students to faculty to businessmen to clergy, are susceptible to being trapped in this game, and often bid as much as $5 or more for a $1 prize.

The dollar auction game can be converted to a trade-off by adding a “bidding tax” large enough to make dropping out rational in both the short run and the long run^[134]. For example, if when player B was at $.95 he was told that it would now cost $2 to enter a bid of $1.05 (a $.95 bidding tax) he would reason that if he drops out he loses $.95 but if he raises he loses $1 even if he wins the prize! So the chances are increased that he would drop out and escape the trap. This method has proven to be effective in experiments using the dollar-auction game^[135].

Trade and Community

During the 1980s, the international development, lending, and monetary agencies adopted the stance that development can best be achieved through opening up economies to international trade. During the 1990s, the North American Free Trade Agreement (NAFTA) and the Uruguay Round of the General Agreement on Tariffs and Trade were approved. These two agreements lowered tariffs and greatly facilitated the movement of financial capital between countries. The Uruguay Round established the World Trade Organization to monitor trade and adjudicate disputes. During this significant transformation in the international economic structure, economists took the position, based in the logic of exchange, that trade produced net benefits for both parties, hence freer trade was always better. Their position was consistent with 200 years of economic prescription. Environmentalists worried about national sovereignty with respect to environmental management, the likelihood that increased trade would lead to increased growth and environmental problems, and the difficulties of resolving environmental problems internationally. Labor unions in the industrialized nations were concerned that capital would move to the less developed nations both because wages were lower and environmental, health, and safety standards were lower. The economics profession had not considered how the expansion of trade relates to environmental management before the debate on international reorganization was well underway. Environmental economists took the position that trade can be good but that international environmental institutions would be needed to standardize regulations to keep nations from competing for industrial capital through lowering their environmental standards.

From the broader perspective of ecological economics, trading more goods across more national boundaries and freeing capital to move internationally raises many more issues than were acknowledged by conventional economists^[136]. The issue of community in particular was never formally addressed. For 200 years, economists have used the logic of exchange to promote individual choice and disempower communities. Ecological economists, on the other hand, acknowledge the role of communities in forming individual preferences, affecting human well-being, and facilitating environmental management. Each of these will be discussed in turn. First we consider whether the logic of exchange supports the general prescription of free trade.

Free Trade?

The logic of exchange, Adam Smith’s great discovery, has been used to promote free trade for two centuries. The logic is simply that when two parties who are free to choose actually choose to enter into an exchange, it is because the exchange makes each party better off. Based on this impeccable logic, economists have long intoned that governments should not restrict opportunities for people to make themselves better off through trade. Indeed, the political agenda of economics for 200 years to empower individuals and corporations and restrain governments and other forms of collective action has been bolstered, if not driven, by the logic of exchange. The logic is faultless under the assumption of informed, utility-maximizing parties and no effects beyond the two parties. Economists assume that the burden of proof as to whether any particular case does not meet the assumptions and is detrimental to society should be assumed by those who question free trade.

The political agenda of free trade for individuals and corporations, unfettered by taxes or other trade controls imposed through collective choice, however, does not logically follow from the logic of exchange. The problem, quite simply, is that the logic of exchange remains true regardless of how you define the parties entering into the exchange. It is true whether the parties are individuals, communities, bioregions, or nations. If it is true for nations, why should nations not be “free to choose” or be free to choose to affect the choices of individuals and corporations through taxes, quotas, or other controls? Economists have assumed that the parties should be individuals, in part because economics has followed the particular tradition in the social sciences that started with Hobbes and Locke assuming that societies are the sum of their individuals. But this is simply a convention in the dominant line of social science thought. Criteria beyond the logic of exchange are needed to determine which parties should be free to choose under different circumstances.

While economists and the majority of politicians today presume that the logic of exchange provides a sound basis for preferring individual choice over collective choice, the fundamental problem of political economy remains one of deciding when individuals, groups, communities, or the state should be entrusted with decision-making authority. This has been the central dilemma of social organization and politics for millennia; we have only been fooling ourselves for the past two centuries.

Had the atomistic premise of natural philosophy not been so readily translated to “individualism” in the dominant line of Western social thought, we might today presume that communities, bioregions, nations, or even spatially overlapping cultural groups should be free to choose. The difference between individual and community interest, of course, is intimately tied to the systemic character of environmental systems. Nature cannot readily be divided up and assigned to individuals. For this reason, collective management or collective limitations on individual choice are frequently appropriate. But the fact that the logic of exchange is indeterminate with respect to how we define the parties also tells us that commons institutions do not have to be justified on the grounds that individual behavior imposes costs on others. People may simply prefer to work together in common and share the fruits of their efforts in common. We do not need the failure of the logic of exchange to justify common activity since the logic of exchange is equally applicable to groups.

Community and Individual Well-Being

Economics is founded on self interest. But this self that interests us so much is in reality not an isolated atom, but is constituted by its relations in community with others—the very identity of the self is social rather than atomistic. If the very self is constituted by relations of community, then self-interest can no longer be atomistically self-contained or defined independently of the community interest. Some knowledge is individualistically diffuse and ephemeral, and while it is a great virtue of the market that it can tap that knowledge, other knowledge is quite public, universal, and fairly permanent: the laws of thermodynamics, for example, or the knowledge that murder and theft are wrong. To insist that everything is reducible to atomistic selfish individuals acting to maximize their gain on the basis of diffuse, piecemeal knowledge locked in their separate sealed heads is to treat an abstraction as more real than the concrete experience from which it has been abstracted.

Distribution and scale involve relationships with the poor, future generations, and other species that are more social than individual in nature. Homo economicus, whether the self-contained atom of methodological individualism or the pure social automaton of collectivist ideology, is in either case a severe abstraction. Our concrete experience is that of “persons in community.” We are individual persons, but our very individual identity is defined by the quality of our social relations. Our relations to each other are not just external, they are also internal; that is, the nature of the related entities (ourselves in this case) changes when relations among them change. We are related not only by the external nexus of individual willingnesses-to-pay for different things, but also by relations of kinship, friendship, citizenship, and trusteeship for the poor, future generations, and for other species, not to mention our physical dependence on the same ecological life-support system, and our common heritage of language and culture. The attempt to abstract from all these relationships an atomistic Homo economicus whose identity is constituted only by individualistic willingness-to-pay, is a severe distortion of our concrete experience as persons in community, another example of Whitehead’s “fallacy of misplaced concreteness”^[137].

In ecological economics we consider maintenance of the capacity of the earth to support life as an objective, shared value that is constitutive of our identity as persons in community. We do not derive this fundamental value from subjective preferences of currently living individuals, weighted by their incomes.

Community, Environmental Management, and Sustainability

Some things can be conveyed better, at least initially, with a parable, a story selected or designed to illustrate a point. Imagine a society of near-subsistence farmers with rights to land. Parents can improve the quality of the land by planting trees. Trees also provide other goods and services at various stages of their lives. The parents might choose to reduce their consumption in their youth to invest in trees in order to have more consumption in their older age. When one’s objective is to redistribute rewards over time for oneself, we think of the activity as an investment. One could also both invest in trees for oneself and accumulate them for transfer to one’s children. Some of the returns from planting trees are enjoyed by the parents, while others go to their children. The extent to which current consumption is forgone and trees are planted to increase the parents’ welfare or to meet the parents’ “responsibility” to transfer assets to their children would be difficult to determine. Wealth, of course, does not simply accumulate linearly. Some parents choose to cut more wood for timber or firewood than grew during the period they enjoyed the land, transferring less to their children than they had themselves received from their own parents. Natural disasters and war set the process back periodically just as a string of good years might make greedy parents look like misers. And the total amount that can be accumulated at any given time is limited by the cultural knowledge, technologies, and the nature of cooperation in the society.

Responsibility is within quotation marks above to emphasize that this is a key piece of the story. The Iroquois of what is now the northeastern United States are said to have been conscious of seven generations when they made decisions affecting their future. Such a consciousness and whatever institutions maintained and implemented it are so different from modern consciousness and institutions that the very term “seven generations” symbolizes the unsustainability, both environmentally and culturally, of modern life. A central argument of this book is that over centuries of believing that progress will take care of our progeny, modern peoples lost their sense of responsibility for their offspring and the institutions needed to assure appropriate transfers of assets. Let’s consider the institutional aspects that complemented and maintained responsibility.

Protecting the well-being of future generations cannot be accomplished by individuals acting out of self-interest alone. It must be a common responsibility because one’s great-great-grandchildren have seven sets of other great-great-grandparents in approximately one’s own generation besides oneself and one’s spouse. One never knows, however, who these other fourteen people are likely to be^[138]. Furthermore, even if one could enter into an agreement with the other great-great-grandparents, there are numerous relatives in between who must carry out the agreement over time. Thus it is very difficult to assure the well-being of one’s offspring beyond one’s own immediate children unless the entire community throughout time is playing by a set of rules to achieve the desired outcome^[139]. Patrilineal, matrilineal, and other rules of inheritance, the awarding of dowries, responsibilities to train youth, and diverse other practices and obligations can be interpreted as intergenerational commons institutions that have facilitated the transfer of assets to the next generation. The social concerns, consciousness, and institutions that promote individual responsibility are coevolved elements that are critical to the conservation of resources and their transfer to the next generation.

An additional element needs to be introduced into the parable. Indeed, economists would be very concerned if human-produced capital were not integral to the episode. Parents might save in order to acquire human-produced capital, for example, more saws, or perhaps a bigger or better type of saw with which they could more easily harvest their trees. The role of saws as capital is different from trees. Our stylized parents know that saws provide a return by reducing [[natural] tree capital] but not vice versa. Note that the existence of two types of assets, both trees and saws, considerably complicates the problem of collecting and processing information. It is the mix of trees and saws that is important. The next generation would not be very well off if it receives all trees and no saws and would be in dire straits indeed if it receives all saws and no trees. Assets need to be transferred from one generation to the next in the right proportions. Fortunately, in a small, relatively self-sufficient community, the proportion of trees and saws can be readily observed. Furthermore, members of the community can readily monitor the effects of their choices on their cumulative assets and adjust the mix accordingly.

To extend the parable, imagine that our once nearly isolated and relatively self-sufficient community becomes connected to a larger community by the clearing of trails and expansion of markets. While nothing else changes directly, the improvement in travel and introduction of markets open up new opportunities which, by exercising them, affect the community in a myriad of indirect ways. Some people, for example, might specialize by selling their trees and investing in the production of saws while others might invest more heavily in trees. As the community increasingly connects to markets, such decisions would be made in response to price signals from factor, commodity, and financial markets. The community institutions that had maintained a balance between trees and saws and heretofore sustained the community over time would fall into disuse and no longer be maintained.

The dynamics from here could be perverse. There may be an expanding market for saws precisely because, as communities were drawn into the market economy, people were choosing to cut trees, driving tree prices down, while the increased demand for saws would drive saw prices up, justifying greater investment in saws. If the market economy our community has joined has a way of assessing the overall mix of trees and saws within its area, informing everyone, and perhaps enforcing a proper mix, then disaster could be averted. Given the expanded area over which decisions are now interlinked, ultimately new intergenerational commons institutions will be needed to facilitate the appropriate transfer of assets over time. And yet the formation of commons institutions becomes more difficult the larger the community, and now multiple smaller communities are combined into a larger community. One can imagine some efforts initially being made to establish commons institutions on a larger scale, but with the process of market expansion ongoing, such efforts are partially successful at best.

Eventually our community finds itself fully a part of modern society and a still globalizing economy. Though transfers of real assets in terms of land, housing, and factories from one generation to the next still constitute a significant portion of total transfers, parents are increasingly trying to meet their investment and intergenerational transfer objectives through financial claims to assets, through the education of their offspring and the cohorts they might marry, or through legislation at the state and national, and now even global, levels. In a complexly interconnected, globalizing economy with many types of interrelated assets such as we have today, comparable information on the mix of assets, let alone the complementarity of the mix, is much harder to assess.

Let’s consider markets. Individual investors in financial markets only see interest rates, not the stocks of trees and saws, let alone the stocks of the myriad natural and human-produced capital supporting modern economies. But let’s address the global issue first, the complexity issue second. Economists will argue that the value of a corporation’s assets would decline if it cut all of its trees, but corporations can and do move on to other forests. Economic models assume good information. But who is keeping track of the whole picture? While most developed countries have fairly sophisticated monitoring institutions, even many of those nations do not make their data available to the public. Environmental monitoring in less developed countries is improving rapidly at the end of the twentieth century, but our increasing awareness of the importance of biodiversity, among other things, has increased the demand for monitoring far faster than the supply. But even if all investors individually realize they are investing in saws which are deforesting on net, they may continue to do so if there is not an enforcement institution. They have no alternative but to hope that the returns from an investment dependent on a rapidly depleting resource can be reinvested again in some other sector to the benefit of their children even if they can see that all in the further future are losing on net. This is the nature of a common pool problem unmatched by commons institutions.

The problem, however, is not simply one of monitoring and enforcement, but one of interpreting as well. With just trees and saws, contemplating the appropriate mix and deciding when there are too few of one or the other is relatively difficult. One must consider the age and species distribution of the trees as well as of the saws, the multiple uses of the trees, the likely future needs for tree services, and how these factors interact. Real economies, especially modern economies, depend on many more environmental resources and their services and the interactions greatly compound interpretation. Note that economic theory requires that decision makers be informed, not simply have access to great mounds of raw data. This means that global models of the physical interdependencies of the economy are necessary to produce the information required by economically rational investors as we go from relatively self-sufficient communities, where resource monitoring and assessment can be done informally, to global economies, where sophisticated monitoring and assessment systems are necessary.

With respect to trying to achieve our asset transfer objectives through education or the state, the situation is equally bleak. We have given little thought to which types of education complement trees or saws, or which substitute for them, let alone tried to affect the mix of education with the objective of sustainability in mind. Nor have we begun to analyze how modern institutions such as “pay-as-you-go” social security affect asset accumulation and transfers, let alone design new intergenerational commons institutions to facilitate appropriate individual behavior in a global economy.

The parable, of course, is highly stylized and too simple, but the point remains that people historically were closer to the resources they used and in a better position to monitor the overall set of assets on which they depended. Global agencies currently trying to oversee the whole picture with respect to resources and economic processes are very weak, short on conceptual justification, and an anathema to current market ideology. Ironically, the logic of markets in fact justifies information institutions at a minimum. The parable is about the interplay between community, environmental management, asset transfers, sustainability, and how they have been lost in the process of globalization.

Globalization, Transaction Costs, and Environmental Externalities

Economists have long argued that trade is good, more of it is even better, and governments should not intervene to constrain market transactions. Based on the logic of exchange, economists have provided strong justification for and generally favored the globalization of the world’s economies through the expansion of the institution of the market.

At the same time, economists recognize that market exchanges entail transaction costs: the costs of perceiving a potential gain, contracting with other parties, and enforcing a contract. For individual goods traded in markets, transaction costs are relatively low and sufficiently overcome by the transactors to complete an exchange. To some extent in the markets for all goods, however, there are some benefits and costs associated with the exchange that are external to the transacting parties and fall on external parties. Where transaction costs are sufficiently low for the external parties, they can become internal parties and influence the exchange. The problem of market failure exists when these transaction costs are prohibitively high and those external parties experiencing benefits or costs from the exchange remain external and do not affect the exchange. Similarly, for commons institutions, it is the transaction costs of communicating and agreeing between individuals and enforcing agreements which ultimately determine whether commons institutions arise and are sustained for the management of environmental resources and the attainment of other collective goals.

While it is well recognized that high transaction costs prevent the success of commons institutions and the internalization of externalities, why there are transaction costs and what makes them change are rarely discussed by economists. Economists systematically address the symptom of externalities but do not ask from whence externalities come. Ironically the arguments for trade and the development of externalities are closely interrelated. Understanding transaction costs or the distances associated with trade identifies these connections.

The term “distance” helps us understand the interrelationships between trade and transactions costs^[140]. Distance can be physical, social, or both. The subsistence community at the beginning of our parable could easily observe the effects of their interactions with nature, easily interpret the nature of problems, and easily communicate with each other and agree on a collective action. Their number, cultural homogeneity, geographic scope, and the relative character of the technologies they had available to them kept everything “close” and transaction costs low. The geographic expansion of exchange increases physical distance. With greater distance, it is more difficult for people to see the consequences of their actions. Those who see the consequences are in one place, those who can do something about it are in another, and the distance between them makes communicating and agreeing on a collective solution difficult.

Specialization, which goes along with increased trade, increases social distancing by reducing shared experiences and ways of seeing the world. The parable started with a world of generalist farmers and ended with a world of academics distanced by their disciplines, bankers with amazing international camaraderie, communications specialists who care little about the substance of their message, doctors and dentists with specialties of their own, engineers who think physics can and should be used to override ecological and sociological problems, and so on through the alphabet. Specialization not only makes communication difficult, specialization makes it difficult to perceive problems that defy specialties^[141]. And as trade expands, existing national and cultural borders are crossed, further compounding the difficulties.

The likelihood that adequate intergenerational commons institutions evolve is a function of the size of the community. The difficulties of negotiating an agreement among individuals are a function, in part, of the number of connections between individuals. Two people have one connection, three people have three, four people have six, and five people have ten, thus increasing geometrically. To the extent that groups already exist and have appropriate communication hierarchies, then the costs of transacting individually can be lowered. But the appropriateness of a communication hierarchy depends on whether the groups’ prior ordering of interests and knowledge to be communicated fits the new problem. In any case, the [[geographic]al] expansion of trade increases the number of individuals in the area over which commons institutions are now needed, but, with a greater number of people, forming and maintaining commons are more difficult.

As trade expands, it creates new problems and challenges the communication systems of existing groups. Existing commons institutions become obsolete as the geographic scope of effects beyond the market that they managed expands beyond their existing boundaries. Thus, communities that have some autonomy, that are not constantly being challenged by strong external forces but rather are evolving largely through internal dynamics, are more likely to develop and sustain viable institutions to encourage individuals to transfer appropriate levels of assets. Such autonomy has not been a characteristic of the past few centuries of globalization. Thus there is good reason to be concerned that the rise of trade and geographic expansion of economic activity has broken down the institutions of many separate communities that facilitated asset transfer. This globalization has also worsened the conditions for new institutions to arise as the expanding number of people who must come to terms geometrically increases the cost of coming to a new agreement.

In summary, the increased material consumption of current generations attributed to the gains from trade may well have been facilitated by the breakdown of commons, which facilitated the transfer of assets to future generations and the absence of their replacement on a larger scale. While economists’ promotion of exchange and specialization advances the markets for particular goods, it increases transaction costs and promotes the conditions for externalization of other goods through the failure of existing commons institutions and through a net increase in the externalization of environmental and other goods. Economics, by not using its own understanding of transaction costs more fully and acknowledging the problem of distancing, has unwittingly promoted two inextricably linked phenomena, both of which lead to more consumption in the present, but one of which results in less consumption in the future. There no doubt are gains from specialization and expansion of the market for the particular goods traded. At the same time, both specialization and geographic expansion increase the transaction costs for effects associated with exchange but prevented from being included in determining the exchange by the very same increased transaction costs.

The negotiations to “free” trade in North America were prolonged by the difficulties of making new international agreements to cover the expanded context of environmental and social problems. To the extent that externality-resolving institutions have not expanded in scope and adjusted as fast as have trading patterns, the gains from trade are less than expected, perhaps even negative, because the economy is working less efficiently than presumed. Equally important, however, is the absence of discussions concerning intergenerational equity and institutions to facilitate transfers of assets to future generations. The term “environmental externality” is now very much a part of the vocabulary of international discourse, though the international institutions designed to deal with externalities are far too weak^[142]. The concepts of intergenerational commons and the transfer of assets to future generations are not even a part of trade negotiations.

Policy Implications

A country’s external policies should complement its internal policies; that is, policies adopted with respect to foreigners should not contradict or undercut policies adopted with respect to the country’s own citizens. Such contradictions would disrupt national community. We view international community as a federation—as a community of communities—not as one world cosmopolitan aggregation of individuals resulting from a “world without borders.” National policies for national community are primary. The difficulty is that international free trade conflicts sharply with the basic national policies of: (a) getting prices right, (b) moving toward a more just distribution, (c) fostering community, (d) controlling the macroeconomy, and (e) keeping scale within ecological limits. Each conflict is discussed in turn.

(a) Getting prices right. If one nation internalizes environmental and social costs to a high degree, following the dictates of adjustment, and then enters into free trade with a country that does not force its producers to internalize those costs, then the result will be that the firms in the second country will have lower prices and will drive the competing firms in the first country out of business. If the trading entities were nations rather than individual firms trading across national boundaries, then the cost-internalizing nation could limit its volume and composition of trade to an amount that did not ruin its domestic producers, and thereby actually take advantage of the opportunity to acquire goods at prices that were below full costs. The country that sells at less than full-cost prices only hurts itself as long as other countries restrict their trade with that country to a volume that does not ruin their own producers. That, of course, would not be free trade. There is clearly a conflict between free trade and a national policy of internalization of external costs. External costs are now so important that the latter goal should take precedence. In this case there is a clear argument for tariffs to protect not an inefficient industry, but an efficient national policy of internalizing external costs into prices.

Of course, if all trading nations agreed to common rules for defining, evaluating, and internalizing external costs, then this objection would disappear and the standard arguments for free trade could again be made in the new context. But how likely is such agreement? Even the small expert technical fraternity of national income accountants cannot agree on how to measure environmental costs in the system of national accounts, let alone on rules for internalizing these costs into prices at the firm level. Politicians are not likely to do better. Some economists will argue against uniform cost internalization on the grounds that different countries have different tastes for environmental services and amenities, and that these differences should be reflected in prices as legitimate reasons for profitable trade. Certainly agreement on uniform principles, and proper extent of departure from uniformity in their application, will not be easy. Nevertheless, suppose that this difficulty is overcome so that all countries internalize external costs, using the same rules applied in each case to the appropriate degree in the light of differing tastes and levels of income.

(b) Just distribution. Wage levels vary enormously between countries and are largely determined by the supply of labor, which in turn depends on population size and growth rates. Overpopulated countries are naturally low-wage countries, and if population growth is rapid they will remain low-wage countries. This is especially so because the demographic rate of increase of the lower class (labor) is frequently twice or more that of the upper class (capital). For most traded goods, labor is still the largest item of cost and consequently the major determinant of price. Cheap labor means low prices and a competitive advantage in trade. (The theoretical possibility that low wages reflect a taste for poverty and therefore a legitimate reason for cost differences is not taken seriously here.) But adjustment economists do not worry about that because economists have proved that free trade between high-wage and low-wage countries can be mutually advantageous thanks to comparative advantage.

The doctrine of comparative advantage is quite correct given the assumptions on which it rests, but unfortunately one of those assumptions is that capital is immobile internationally. The theory is supposed to work as follows: when in international competition the relatively inefficient activities lose out and jobs are eliminated, at the same time the relatively efficient activities (those with the comparative advantage) expand, absorbing both the labor and capital that were disemployed in activities with a comparative disadvantage. Capital and labor are reallocated within the country, specializing according to that country’s comparative advantage. However, when both capital and goods are mobile internationally, then capital will follow absolute advantage to the low-wage country rather than reallocate itself according to comparative advantage within its home country. It will follow the highest absolute profit, which is usually determined by the lowest absolute wage.

Of course, further inducements to absolute profits such as low social insurance charges or a low degree of internalization of environmental, social, health, and safety costs also attract capital, usually toward the very same low-wage countries. But we have assumed that all countries have internalized costs to the same degree in order to focus on the wage issue. Once capital is mobile then the entire doctrine of comparative advantage and all its comforting demonstrations become irrelevant. The consequence of capital mobility would be similar to that of international labor mobility—a strong tendency to equalize wages throughout the world.

Given the existing overpopulation and high demographic growth of the Third World, it is clear that the equalization will be downward, as it has indeed been during the last decade in the U.S. Of course, returns to capital will also be equalized by free trade and capital mobility, but the level at which equalization will occur will be higher than at present. U.S. capital will benefit from cheap labor abroad followed by cheap labor at home, at least until checked by a crisis of insufficient demand due to a lack of worker purchasing power resulting from low wages. But that can be forestalled by efficient reallocation to serve the new pattern of effective demand resulting from the greater concentration of income. More luxury goods will be produced and fewer basic wage goods. Efficiency is attained, but distributive equity is sacrificed.

The standard neoclassical adjustment view argues that wages will eventually be equalized worldwide at high levels, thanks to the enormous increase in production made possible by free trade. This increase in production presumably will trigger the automatic demographic transition to lower birth rates—a doctrine that might be considered a part of the adjustment package in so far as any attention at all is paid to population. Such a thought can only be entertained by those who ignore the issue of scale, as neoclassicists traditionally do. For all 5.7 billion people presently alive to consume resources and absorptive capacities at the same per capita rate as Americans or Europeans is ecologically impossible. Much less is it possible to extend that level of consumption to future generations. Development as it currently is understood on the U.S. model is only possible for a minority of the world’s population over a few generations—that is, it is neither just nor sustainable. The goal of sustainable development is, by changes in allocation, distribution, and scale, to move the world toward a state in which “development,” whatever it concretely comes to mean, will be for all people in all generations. This is certainly not achievable by more finely tuned “adjustment” to the standard growth model, which is largely responsible for having created the present impasse in the first place.

Of course, if somehow all countries decided to control their populations and to adopt distributive and scale limiting measures such that wages could be equalized worldwide at an acceptably high level, then this problem would disappear and the standard arguments for free trade could again be evoked in the new context. Although the likelihood of that context seems infinitesimal, we might for purposes of a fortiori argument consider a major problem with free trade that would still remain.

(c) Fostering community. Even with uniformly high wages, made possible by universal population control and redistribution, and with uniform internalization of external costs, free trade and free capital mobility still increase the separation of ownership and control and the forced mobility of labor, which are so inimical to community. Community economic life can be disrupted not only by fellow citizens who, though living in another part of your country, might at least share some tenuous bonds of community with you, but by someone on the other side of the world with whom you have no community of language, history, culture, law, and so on. These foreigners may be wonderful people; that is not the point. The point is that they are very far removed from the life of the community that is affected significantly by their decisions. Your life and your community can be disrupted by decisions and events over which you have no control, no vote, no voice.

Specialization and integration of a local community into the world economy does offer a quick fix to problems of local unemployment (Employment, unemployment, and well-being), and one must admit that carrying community self-sufficiency to extremes can certainly be impoverishing. But short supply lines and relatively local control over the livelihood of the community remain obvious prudential measures which require some restraint on free trade if they are to be effective. Libertarian economists look at Homo economicus as a self-contained individual who is infinitely mobile and equally at home anywhere. But real people live in communities, and in communities of communities. Their very individual identity is constituted by their relations in community. To regard community as a disposable aggregate of individuals in temporary proximity only for as long as it serves the interests of mobile capital is bad enough when capital stays within the nation. But when capital moves internationally it becomes much worse.

When the capitalist class in the U.S. in effect tells the laboring class, “sorry, you have to compete with the poor of the world for jobs and wages. The fact that we are fellow citizens of the same country creates no obligations on my part,” then admittedly not much community remains, and it is not hard to understand why a U.S. worker would be indifferent to the nationality of his or her employer. Indeed, if local community is more respected by the foreign company than by the displaced American counterpart, then the interests of community could conceivably be furthered by foreign ownership in some specific cases. But this could not be counted as the rule, and serves only to show that the extent of pathological disregard for community in the U.S. has not yet been equaled by others. In any event the further undercutting of local and national communities (which are real) in the name of a cosmopolitan world “community” which does not exist, is a poor trade, even if we call it free trade. The true road to international community is that of a federation of communities and communities of communities—not the destruction of local and national communities in the service of a single cosmopolitan world of footloose money managers who constitute, not a community, but merely an interdependent, mutually vulnerable, unstable coalition of short-term interests.

(d) Controlling the macroeconomy. Free trade and free capital mobility have interfered with macroeconomic stability by permitting huge international payments imbalances and capital transfers resulting in debts that are not repayable in many cases and excessive in others. Efforts to service these debts can lead to unsustainable rates of exploitation of exportable resources, and to an eagerness to make new loans to get the foreign exchange with which to pay old loans, with a consequent disincentive to take a hard look at the real productivity of the project for which the new loan is being made. Efforts to pay back loans and still meet domestic obligations lead to government budget deficits and monetary creation with resulting inflation. Inflation, plus the need to export to pay off loans, leads to currency devaluations, giving rise to foreign exchange speculation, capital flight, and hot money movements, disrupting the macroeconomic stability that adjustment was supposed to foster.

To summarize so far: free trade sins against allocative efficiency by making it hard for nations to internalize external costs; it sins against distributive justice by widening the disparity between labor and capital in high-wage countries; it sins against community by demanding more mobility and by further separating ownership and control; and it sins against macroeconomic stability. Finally, it also sins against the criterion of sustainable scale in a more subtle manner that will now be considered.

(e) Keeping scale manageable. It has already been mentioned in passing that part of the free trade dogma of adjustment thinking is based on the assumption that the whole world and all future generations can consume resources at the levels current in today’s high-wage countries without inducing ecological collapse. So in this way free trade sins against the criterion of sustainable scale. But, in its physical dimensions, the economy really is an open subsystem of a materially closed, nongrowing, and finite ecosystem with a limited throughput of solar energy. The proper scale of the economic subsystem relative to the finite total system really is a very important question. Free trade has obscured the scale limit in the following way.

Sustainable development means living within environmental constraints of absorptive and regenerative capacities. These constraints are both global (e.g., climate change, ozone shield damage) and local (e.g., soil erosion, deforestation (Land-use and land-cover change)). Trade between nations or regions offers a way of loosening local constraints by importing environmental services (including waste absorption) from elsewhere. Within limits this can be quite reasonable and justifiable, but carried to extremes in the name of free trade it becomes destructive. It leads to a situation in which each country is trying to live beyond its own absorptive and regenerative capacities by importing these capacities from elsewhere. Of course environmental capacity-importing countries pay for the capacities they import, and all is well as long as other countries have made the complementary decision—namely, to keep their own scale well below their own national carrying capacity in order to be able to export some of their environmental services. In other words, the apparent escape from scale constraints enjoyed by some countries via trade depends on other countries’ willingness and ability to adopt the very discipline of limiting scale that the importing country is seeking to avoid. What nations have actually made this complementary choice? All countries now aim to grow in scale, and it is merely the fact that some have not yet reached their limits that allows other nations to import carrying capacity. Free trade does not remove carrying capacity constraints; it just guarantees that nations will hit that constraint more or less simultaneously rather than sequentially. It converts differing local constraints into an aggregated global constraint. It converts a set of problems, some of which are manageable, into one big unmanageable problem. Evidence that this is not understood is provided by the countless occasions when someone who really should know better points to The Netherlands or Hong Kong as both examples to be emulated, and as evidence that all countries could become as densely populated as these two. How it would be possible for all countries to be net exporters of goods and net importers of carrying capacity is not explained.

Of course the drive to grow beyond carrying capacity has roots other and deeper than the free trade dogma. The point is that free trade makes it very hard to deal with these root causes at a national level, which is the only level at which effective social controls over the economy exist. Standard economists will argue that free trade is just a natural extension of price adjustment across international boundaries, and that “right prices” must reflect global scarcities and preferences. But if the unit of community is the nation, the unit in which there are institutions and traditions of collective action, responsibility, and mutual help, the unit in which government tries to carry out policy for the good of its citizens, then “right prices” should not reflect the preferences and scarcities of other nations. Right prices should differ between national communities. Such differences traditionally have provided the whole reason for international trade in goods—trade that can continue if balanced, that is, if not accompanied by the free mobility of capital (and labor) that homogenizes preferences and scarcities globally, while reducing national economic policy to ineffectiveness unless agreed upon by all freely trading nations.

It is admitted by [[neoclassical] economists] that externalities resulting from overpopulation can spill over to other nations, and thus provide a legitimate reason against free immigration, however uncongenial to liberal sentiments^[143][144]. But externalities of overpopulation in the form of cheap labor can spill over into other countries through free migration of capital toward abundant labor, just as much as through free migration of labor toward abundant capital. The legitimate case for restrictions on labor immigration are therefore easily extended to restrictions on capital emigration for any country not wanting to suffer the consequences of another country’s overpopulation^[145].

The nation state certainly has many historical sins to atone for, but it is where community exists in the sense that it is the main unit in which policies are taken for the common good. To say that national boundaries are just lines on the map, and that we should all be environmental earth citizens is nice rhetoric, but not very realistic. Given the urgency of action, and the reality of transnational corporate power eager to take over, we have no alternative but to work within the existing institution of the nation state. Certainly population and per capita consumption will not be controlled at a global level. It will be done by nations. But the nations will have to cooperate and make binding international agreements.

For example, while all countries must worry about both population and per capita consumption, it is evident that the South needs to focus more on population, and the North more on per capita consumption. This fact will likely play a major role in all North/South treaties and discussions. Why should the South control its population if the resources saved thereby are merely gobbled up by Northern overconsumption? Why should the North control its overconsumption if the saved resources will merely allow a larger number of poor people to subsist at the same level of misery? Global problems are indeed global, but their solutions require national policies supported by international treaties. Nations have to be able to enact and enforce national policies agreed to in international treaties. If a nation’s borders are porous to the flow of goods and services, capital, and labor then that country is in a poor position to carry out any national policy, including those it agreed to in international treaties.

Related Links

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Notes This is a chapter from An Introduction to Ecological Economics (e-book). Previous: The Historical Development of Economics and Ecology (An Introduction to Ecological Economics: Chapter 3) |Table of Contents (An Introduction to Ecological Economics: Chapter 3)|Next: Policies, Institutions, and Instruments

Citation

Costanza, R., Norgaard, R., Daly, H., Goodland, R., & Cumberland, J. (2010). An Introduction to Ecological Economics: Chapter 3. Retrieved from http://editors.eol.org/eoearth/wiki/An_Introduction_to_Ecological_Economics:_Chapter_3