Saturday, October 9, 2010

Do not let the environment go to waste

I sympathise with the calls from ecologists and others for an end to economic growth. But that doesn't mean I'd like to see no further increase in gross domestic product.

Huh? Let me explain. There's a lot of confusion between scientists and economists on exactly what is meant by "economic growth". Each side uses the words to mean something different.

As Professor Herman Daly, of the University of Maryland, a founder of ecological (as opposed to environmental) economics, has explained, what many ecologists want an end to is growth in the use of natural resources.

Actually, he says an end to the "throughput" of natural resources. This is a reference to the first law of thermodynamics, which says matter and energy can't be destroyed, just have their form changed.

So when we use natural resources as an input to the economic machine, so to speak, what comes out the other end (apart from the goods and services we sought to create) is various forms of waste - sewage, landfill, polluted air and waterways, not to mention greenhouse gases.

Thus from a scientific perspective, what economic activity does is convert natural resources into waste. Daly's point is that we have to worry about both ends of the process: not just the exhaustion of non-renewable resources and the over-exploitation of renewable resources, but also the unending stream of waste we're pumping into the environment.

The scientists are saying that, since the global economy (human activity of an economic nature, which is most of it) exists within the global ecosystem and the ecosystem is of a fixed size, it's simply not physically possible for the economy to grow at an "exponential" (a reasonably steady percentage) rate forever.

They're also saying we must be close to the ecological limits to growth in our throughput of natural resources, as is clearly the case with greenhouse gas emissions. Hence the calls for an end to "growth".

Most economists - particularly older economists who've known nothing but the promotion of endless growth throughout their careers - find this a pretty shocking notion. But it's not as bad as they fear.

Why not? Because the "growth" the scientists have in mind is not the same as the growth the economists have in mind. The economists' idea of growth is growth in (real) GDP - that is, growth in the economy's output of goods and services.

And the growth in the output from the economic machine comes from two different sources: from increased inputs of all resources (labour, man-made capital and "land", which includes natural resources), but also from the increased efficiency with which those resources are combined - otherwise known as improved "productivity" (output per unit of input).

So improved productivity means achieving more output of goods and services from an unchanged quantity of inputs. This increased production is achieved mainly by technological advance: the invention of better machines, the discovery of better ways to manage the production process (increased "know-how") and the exploitation of economies of scale, though increases in human capital (the skill of the workforce) also help.

It turns out that, over the decades, improved productivity is actually the main source of growth in GDP. Economists are mainly concerned with organising the economy in a way that creates the incentives for people to achieve greater efficiency in the use of all types of resources and thus improved productivity.

And though they usually don't realise it, the scientists aren't saying they have any objection to the pursuit of efficiency and improved productivity. Indeed, implicit in what they're saying is that they'd love to see us become more efficient in the use of natural resources if this allowed us to use fewer of them.

So the expertise economists contribute to society - their understanding of how to promote efficiency in the allocation of resources - wouldn't be under threat from moving to a "steady-state economy" in which the goal was no further growth in the throughput of natural resources.

Indeed, our move to such an economy couldn't be achieved without the expertise of economists. They understand how economies work and scientists don't.

Economists see what they do as helping people to "optimise under constraints", the main constraint being the scarcity of all resources. What the ecologists are calling for is simply the imposition on the economy of one specific constraint: no further increase in the throughput of natural resources. How would that be achieved? By using an "economic instrument" invented by economic rationalists, the cap-and-trade system. Just as an emissions trading scheme caps the amount of greenhouse gases allowed to be emitted, so you'd impose a cap on the use of natural resources.

Proceeds from auctioning permits to use natural resources would constitute "a great big new tax on everything", so you'd use those proceeds to finance cuts in other taxes, particularly those on income and consumption. You'd rejig the tax system so more revenue came from taxing environmental "bads" and less from taxing economic "goods".

You'd be significantly changing relative prices in the economy, so goods and services with a high natural-resources component became a lot dearer, whereas those with a low natural-resources component became a lot cheaper.

Market forces would adapt to the change in relative prices, achieving the cap in the use of natural resources with least disruption to the economy. The point of the cap is to stop market forces doing what they otherwise would: flowing the benefit of increased efficiency in the use of natural resources on to customers in the form of lower prices, which would then defeat the object of the exercise by encouraging greater demand for natural-resource-intensive goods and services.

Under the present constraints, market forces focus on economising in the use of the most expensive resource, labour (which is made more so by the high taxes on labour - income and consumption taxes). Often, this involves waste in the use of cheaper, natural resources because it's not economic to do more recycling and to repair rather than replace appliances.

The point is, even if you achieved an end to "growth" in the throughput of natural resources, you'd still be getting "growth" in real GDP arising from increased productivity in the use of all resources. The main difference is that the market's effort would go into raising the productivity of natural resources rather than the productivity of labour. Daly's way of trying to end the terminological confusion is to say that in a steady-state economy there'd be no "quantitative growth" but there'd still be "qualitative development".