Monday, May 27, 2013


Talk to Master of Sustainability students, University of Sydney

Tony Masters has invited me to talk to you about sustainability from an economist’s perspective, which I’m happy to do, though I must warn you that my perspective is very different from the majority position among economists who, though they’re happy to use the word, attach a very different meaning to it than the one I do, and that many of you may.

As I’m sure you’ve realised, ‘sustainability’ means different things to different people. This is partly because it’s a very fashionable to talk about sustainability - everybody’s doing it, the sustainable adjective or adverb can be slapped on the front or the back of almost every noun: our Treasury talks about ‘fiscal sustainability’, I read about sustainable agriculture, business sustainability, even sustainable culture. The word gets used a lot because it’s something no one can disagree with: who could say they’re opposed to sustainability? Who could admit they want to keep doing something even though it’s un-sustainable? After all, as the US economist Herb Stein famously said, ‘if something cannot go on forever, it will stop’. Or ‘trends that can’t continue, won’t’.

But, because it’s a word no one could oppose, we need to keep its meaning vague so it doesn’t involve something we don’t fancy, having to stop doing things we would prefer to keep doing. The term ecological sustainability ought to be pretty unambiguous, but this may be why the UN Bruntland Commission in 1987 settled on the less specific term ‘sustainable development’. And this lack of specificity may be why the report started the sustainability craze. The report did define sustainable development to mean development that meets the needs of the present without sacrificing the ability of the future to meet its needs.

That might sound good, but it leaves a loophole for economists to jump through. The secretary to the Treasury, Dr Martin Parkinson, gave a speech in 2011 he called ‘sustainable wellbeing’. He said ‘sustainable wellbeing requires that at least the current level of wellbeing be maintained for future generations’. This required that each generation bequeath a stock of capital that is at least as large as the stock it inherited. This should include all forms of capital: man-made capital, human capital, natural capital and social capital. ‘Note, though,’ he goes on, ‘that drawing down any one part of the capital base may be reasonable as long as the economy’s aggregate productive base is not eroded. For example, reducing our natural resource base and using the proceeds to build human capital or infrastructure may offer prospects of higher future wellbeing.’

See the loophole? The implicit assumption is that all the different forms of capital are good substitutes for each other. It’s saying that, provided we leave the next generation with a sufficiently high level of education and a sufficient quantity of man-made capital, it may not matter than we wrecked the natural environment in the process. You can see this mentality in the way many economists, business people and lobby groups approach environmental problems: yes of course the environment matters, but so do a lot of other things, and the objective must be to find the best trade-off between all our many conflicting, but equally desirable, objectives. In this process, the environment will get better treatment, but it won’t get all it wants. Don’t be greedy, be reasonable. The trouble is, you can’t ask a dying river system to be reasonable, to put up with more degradation because many people’s livelihoods depend on that degradation continuing. You can’t bargain with nature, you can either sustain it or continue with unsustainable practices.

Why can’t economists, business people and politicians see that? Because they don’t want to see it. Because they’re committed to unending economic growth and so don’t want to accept there may be physical limits to growth, that the economy is a sub-system of the natural environment - the ecosystem - and so, because the size of the ecosystem is fixed, there must be physical limits to how much the economic sub-system can grow.

My guide in this area is Herman Daly, a professor of economics at the University of Maryland, and a founder of the school of economic thought known as ‘ecological economics’ (not to be confused with the far more conventional ‘environmental economics’). His definition of sustainable development is much tighter: development without growth beyond environmental carrying capacity, where development means qualitative improvement and growth means quantitative increase.

When it comes to economists (and business people and politicians), the big area of conflict with ecologists and people in the physical sciences, the big stumbling block, the big reason they want to interpret ‘sustainability’ their own way, is the question of growth. The economists want it to continue forever; the scientists say it must stop. But the first point I want to make is that there’s enormous terminological confusion between scientists and economists on what exactly they mean by the word ‘growth’. Scientists take it to mean something very different from what economists do, which means much of what little debate passes between them flies over the heads of the other side. I’m sure the ground of disagreement between them would be greatly reduced if only this terminological confusion could be ended.

What ecologists want is an end to growth in the ‘throughput’ of natural resources. If you think of the economy as a machine, we put inputs in one end of the machine, and take outputs out of the other end. To an ecologist, the inputs of concern to them are natural resources and ‘ecosystem services’; the outputs of concern to them are an equivalent amount of waste - in the form of landfill, sewage and all the many types of pollution, including greenhouse gases. In conformity with the laws of thermodynamics, the ecologists worry as much about the emission of waste - and the ecosystem’s ability to absorb that waste - as they do about the using up of natural resources. This is why what they seek is an end to growth in the throughput of such resources. I think many of them imagine this would be achieved if GDP ceased to grow.

But the economists conceptualise things very differently. To them, the inputs to the economic machine aren’t just natural resources, but also the other economic resources: labour and capital - physical capital in the form of machines, structures and infrastructure. (The input from ecosystem services is ignored.) To their eyes, the output from the economic machine isn’t waste (it gets ignored) but all manner of goods and services. What real GDP measures is the growth in the output of goods and services over time. (Since those of us who work earn our income from our contribution to the output of goods and services, real GDP also measures the growth in real income.)

So what is it that causes GDP - output of goods and services - to grow? Two things. First, any increase in the throughput of economic resources: natural resources, but also labour and capital. But, second - and this is the bit that goes straight over the heads of most ecologists - any increase in the efficiency of the economic machine at turning inputs into outputs. Economists call this ‘productivity’, which they define as output per unit of input. The productivity of the economic machine increases almost continuously each year, and has done since the start of the industrial revolution. What causes ‘multi-factor’ productivity to improve is the continuing pursuit of economies of scale, the increasing specialisation of labour, the rising knowledge and skill of the workforce, and technological advance: the invention of better machines and better ways of doing things. Now get this: over the long term, productivity improvement accounts for the lion’s share of our rising real income per person and our rising material standard of living.

The point is that when economists hear people say they want an end to growth, they assume that means they want an end to productivity improvement. They find this prospect appalling. But this is not what ecologists want. All they want to stop is growth in the throughput of natural resources - which isn’t something most economists would relish, but isn’t nearly as frightening. And this means GDP could still increase, provided that increase came from improved productivity, not increased use of natural resources.

Clearing up this misunderstanding allows us to envisage more clearly what a steady-state economy would look like - that is, an economy that conformed to Daly’s definition of sustainable development. It would be an economy that didn’t get bigger in its impact on the environment - that was ecologically sustainable - but did get better, in terms of the quality of our lives. It would be an economy that didn’t grow, but it wouldn’t be an economy that was stagnant, that never changed. It wouldn’t be an economy where people had to stop striving - to build a better mousetrap, write a symphony or find the cure for cancer. Many economists instinctively fear a steady-state economy would stifle the incentive to innovate. But that fear’s not justified. Indeed, you could argue that, with the quantitative route to improvement blocked off, the qualitative route would gain more attention. Herman Daly’s way of making the distinction is to say economic growth (pushing more resources through a physically larger economy) is bad, but economic development (squeezing more welfare from the same throughput of resources) is fine.

But how would we go about reorganising the economy so that we no longer increased the throughput of natural resources? It wouldn’t be easy, but nor would it be terrifically hard. It actually represents nothing more than a design problem - one the economics profession is well-equipped to solve, should the community decide to give it that task. We’d still have a capitalist, market economy where market forces continued to determine economic outcomes and to drive the push for greater efficiency in resource use, within the framework set by government. The big difference would be the government adding a new constraint to the operation of market forces: a limit on the consumption of natural resources.

How would we achieve that limit? By using the same ‘economic instrument’ we’ve already begun using to limit the burning of fossil fuels: a system of tradable permits. You impose a cap on the total quantity of a certain class of natural resource permitted to be consumed in a year, and auction to producers permits to use the resource up to the cap. The more efficient firms are at doing what they want to do while using fewer natural resources to do it, the less they have to spend on permits - thus harnessing market forces to help reduce the use of those resources. Firms that discover they have more permits than they need are able to trade them for money to firms that discover they need more permits than they have. By such means the burden of limiting resource use to the cap is transferred to those firms able to reduce their resource use most cheaply, thereby limiting the loss of income to the community involved in achieving the limit on resource use. As firms became more efficient at reducing their natural resource use - including by the invention of new technological solutions to the problem - it would possible, if desired, to lower the cap and, hence, the quantity of resources used, at no increased cost to the community.

The purpose of such a cap-and-trade scheme would be, of course, to raise the price of natural resources - and the prices of goods with a high natural-resource component - relative to the prices of all other goods and services. In line with the most orthodox economics, it’s this change in relative prices which would motivate producers and consumers to reduce their resource use, and do so with minimum loss of economic efficiency. Economists believe changes in relative prices are very effective in bringing about changes in the behaviour of producers and consumers.

This process would, of course, lead to a once-off increase in the general level of consumer prices, which might be quite a significant increase. Many of you would be concerned about the effect on the cost of living, particularly for pensioners and low income-earners. But, as with our present carbon tax, once the cap-and-trade scheme had brought about the desire changed in relative prices, the proceeds from the sale of permits - analogous to the proceeds from a carbon tax - are available for use to reduce the rates of other taxes - the obvious one being income tax - and increase the rates of pensions and benefits such as the family allowance, thereby compensating households for the increase in their cost of living. So I don’t see a reason to be concerned about the effect of the move on the welfare of low income-earners. Such a re-jig of the tax system would be a classic example of what environmental economists mean when they call for the burden of tax collection to be shifted from taxing ‘goods’ (such as labour and capital) to taxing ‘bads’ (such as greenhouse gas emissions and the consumption of natural resources). You raise the same amount of total tax revenue but, in the process, you discourage activities you want to discourage rather than activities you don’t want to discourage.

Raising the prices of natural resources relative to the prices of other resources - labour and capital - could be expected to have various desirable side-effects. First, it would increase the economic incentive for people to recycle natural resources and repair rather than replace appliances with a high materials-component.

Second, changing the relative prices of economic resources could be expected to change the focus of the private sector’s continuing search for greater efficiency - economising, if you like - in the use of economic resources and, hence, improved productivity. For all the time since the Industrial Revolution, most of the economising effort - including most technological advance - has been, quite logically, directed towards economising in the use of the most expensive resource: labour. But if we were to make natural resources more expensive than labour - particularly if the scheme involved a fall in the main tax on labour, income tax, thereby lowering its effective cost - this should mean a lot more entrepreneurial effort would be directed towards reducing the economy’s despoiling of the natural environment.

There are many more implications of a steady-state economy I could explore, but that’s enough to be going on with. Is a steady-state economy feasible? Yes it is.