We're adding the environment to the national accounts

How do you get economists and business people to take the environment and its relationship with the economy seriously? Change its name to one that resonates with commercial values. What's a word that denotes great value, preciousness to a capitalist? I know - "capital".

You've heard of physical capital (machines, buildings and other structures), financial capital (securities such as shares and bonds), human capital (an educated and skilled workforce) and social capital (the shared values and norms of behaviour that enable mutually advantageous cooperation).

So why don't we rename the environment "natural capital"? It wasn't me who thought of it, however.

It doesn't sound like a lot of progress has been made at the Rio+20 summit on sustainable development. But one thing giving me hope is the "natural capital declaration" made by banks and big businesses, including our National Australia Bank, represented by its chief executive, Cameron Clyne.

"Natural capital," it says, "comprises Earth's natural assets (soil, air, water, flora and fauna) and the ecosystem services resulting from them, which make human life possible. Ecosystem goods and services from natural capital are worth trillions of US dollars per year and constitute food, fibre, water, health, energy, climate security and other essential services for everyone.

"Neither these services, nor the stock of natural capital that provides them, are adequately valued compared to social and financial capital. Despite being fundamental to our wellbeing, their daily use remains almost undetected within our economic system.

"Using natural capital this way is not sustainable. The private sector, governments, all of us, must increasingly understand and account for our use of natural capital and recognise the true cost of economic growth and sustaining human wellbeing today and into the future," the declaration says.

It goes on to say that "because natural capital is a part of the 'global commons' and is treated largely as a 'free good', governments must act to create a framework regulating and incentivising the private sector - including the financial sector - to operate responsibly regarding its sustainable use.

"We therefore call upon governments to develop clear, credible and long-term policy frameworks that support and incentivise organisations - including financial institutions - to value and report on their use of natural capital and thereby working towards internalising environmental costs."

Lovely. Great stuff. Most enlightened. But if you think we're just at the earliest stages of realising we need to measure our impact on the environment and incorporate it into our decision making, I have good news. At the level of national accounting, we're a lot further advanced than you realise.

You often see me banging on about the "national accounts", from which key economic indicators such as gross domestic product emerge. You've also seen me pointing to the limitations of GDP as a measure of wellbeing or progress, particularly its failure to take account of the costs economic activity is imposing on the environment and of the environment's present state of repair.

The "system of national accounts" we use is laid down by the United Nations Statistical Commission for use in all countries. It's an accounting framework that measures economic activity and organises a wide range of economic data into a structured set of accounts. It defines the concepts, classifications and accounting rules needed to do this.

So here's the news: earlier this year the UN Statistical Commission adopted as a new international statistical standard with equal status to the system of national accounts, the "system of environmental-economic accounting" - SEEA.

Our Bureau of Statistics has been at the forefront in the development of SEEA. Last month, it published a document, Completing the Picture: Environmental Accounting in Practice, explaining what SEEA is. I'm drawing on this document.

SEEA is another accounting framework that records as completely as possible the stocks and flows relevant to the analysis of environmental and economic issues. So SEEA is different from the various present independent sets of statistics because it demands coherence and consistency with a core set of definitions and treatments.

Get it? An accounting framework allows you to add a lot of different things together, making sure they fit together logically and there's no double-counting. SEEA puts information about changes in the environment on the same basis as the existing information about changes in the economy, so they can be combined and give us an integrated picture of how the environment and the economy are affecting each other.

Just a small problem, however. The existing national accounts measure economic activity in money terms. To achieve this, they stick almost wholly to measuring transactions in the market, since these reveal market valuations.

But the very reason economists and business people have been taking too little notice of the environment for the past centuries is that, for the most part, it's outside the market system - a "free good". There's not one price for clean air and another for dirty. Photosynthesis, pollination and precipitation are ecosystem services to the economy that aren't paid for, so it's hard to put a figure on what they're worth.

Despite this, SEEA extends the national accounts by recording environmental data that are usually available in physical or quantitative terms in coherence with the economic data in monetary terms. Maybe one day we'll discover a way to value natural capital so we can add it all together.

There are three main types of account in the SEEA framework that are added to the existing monetary flow (the change in something over a period) and stock (the position at a point in time) accounts of the national accounts.

First are physical flow accounts that record flows of natural inputs from the environment to the economy, flows of products within the economy and flows of "residuals" (various forms of waste) generated by the economy. These flows include water and energy used in production and waste flows to the environment, such as solid waste to landfill.

Second are functional accounts for environmental transactions between different economic sectors (such as industries, households, governments). Such transactions include investing in technologies designed to prevent or reduce pollution, restoring the environment after it has been polluted, recycling, conservation and resource management.

Finally, asset accounts in physical and money terms measure the stocks of natural resources available and changes in the amount available. There'd be accounts for minerals and energy, timber, fish, soil, water and land.

The bureau is beavering away to produce more of these accounts. It's making progress in turning SEEA into an Australian reality.

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Environmental accounting: completing the picture

Dinner Talk to ABS Conference on Environmental Accounting, Melbourne, Thursday, May 14, 2012

Ross Gittins, Economics Editor, The Sydney Morning Herald

I’m pleased to be invited to speak to this dinner of a conference convened by the nation’s official bean-counters. I don’t use that term disparagingly. Some people may think they’re far too talented or too important to waste time counting the beans, but I’m not one of them. If outputs and outcomes are important, then measuring them must be too. I’ve had two careers so far, and both have involved bean-counting. The first was as a chartered accountant, and the accountant in me meant that when I switched to economic journalism, I devoted considerable time to making sure I understood how the key indicators of the economy’s health ticked - the labour force survey, the CPI, the balance of payments, the national accounts and so on. I agree with the quote from the Stiglitz-Sen commission, which could almost be the public statisticians’ mission statement: ‘What we measure affects what we do; and if our measurements are flawed, decisions may be distorted’.

I’m also pleased to be speaking at a conference devoted to a subject so close to my heart: how we can establish a system of environmental accounts capable of being integrated with the economic accounts, to eventually produce a bottom-line figure for ‘green GDP’. It may be a sign of old age, but as the years have gone by I’ve become increasingly concerned about the interrelationship between the market economy - as we define it and measure it - and the natural environment - the ecosystem - in which it sits and on which it depends for its continued survival.

It’s clear we need to know a lot more about, and take a lot more notice of how the natural environment is changing over time, mainly as a result of human activity. That is, we need to be doing a lot more measuring of the environment, in its own right. We must keep track of what’s happening to be sure we’re not caught out by developments we didn’t quite notice before they became acute.

And, turning to the economy, the way we manage it - and the way we measure it, because measurements inform managers - needs to change over time to keep up with change in the economy and its environment, and also with developments in the scientific understanding of the way economic activity impinges on the social and natural environment in which the economy operates. Economists and statisticians have been slow to recognise the need for change in the way we define and measure ‘the economy’, but now, thankfully, real progress is being made - as witness the SEEA (system of environmental and economic accounting) and, indeed, this conference.

When you think about it, however, it’s not surprising that, at the time in the 19th century when our way of conceptualising the economy was being laid down by Alfred Marshall and the other neoclassical economists, it was considered possible to think of ‘the economy’ in splendid isolation from what then, I guess, would have been thought of as Nature, but we today have been schooled by natural scientists to think of as the ecosystem.

A hundred and fifty to 200 years ago, global economic activity was puny compared to the vastness of the global ecosystem - the vast oceans, endless forests, the geographical barriers between continents and countries, the perishingly cold winters and, in faraway climes, the intolerable heat. With humankind so puny and nature so vast as to seem almost infinite, it made all the sense in the world to view ecosystem services and environmental assets - air and water and fish and sunlight - as so infinitely available they could be treated as ‘free goods’, goods that had no price and so didn’t need to be taken into account. There was pollution, of course - factories that made loud noises, belched smoke, emitted waste material into the river and maybe left the hillside scarred - but these things were limited and local. They were unpleasant, but they weren’t something to worry too much about.

Two things have changed since those days. The first is the unbelievable growth in economic activity across the globe. Advances in public health and personal healthcare, and advances in economic production techniques, have seen the world’s population increase by a factor of seven since the dawn of the 19th century from 1 billion to 7 billion today. And advances in production techniques on their own have seen the average material standard of living across the world increase by a factor of six over the same period. Put the two together and economic activity, as measured, has increased by a factor of at least 42. Suddenly, global economic activity isn’t looking so puny and the global ecosystem isn’t looking so vast.

The second thing that’s changed since the industrial revolution is the depth of scientific understanding of the way the natural world works and the effects human activities are having on the way it works. First among these discoveries is the first law of thermodynamics which, for our purposes, tells us that economic activity can’t increase or reduce the quantity of anything, just change its form. So what the economy does from a physicist’s perspective is take natural resources and turn them into various forms of waste. Any system of environmental accounts - and any attempt to integrate environmental and economic accounts - has to take account not only of the natural inputs to the economic system but also the output of waste from the system.
Scientists have also made us aware of the way farming practices have affected river systems and underground water systems, the effects of commercial fishing, the limitations to fish farming, the extent of the destruction of species and, of course, the way the burning of fossil fuels and clearing of forests is changing the climate.

If I didn’t know I wasn’t allowed even to think it, I’d be tempted to say the extraordinary growth in global economic activity relative to the eternally fixed size of the ecosystem must surely be taking us close to the limits to economic growth - at least as we presently define growth and pursue it. Surely that’s precisely what the climate science is telling us. We’ve reached the limit to our ability go on burning fossil fuels and destroying natural carbon sinks in forests and so forth. We’re perilously close to natural tipping points - points from which there can be no return to the way things used to be. When the definition of the problem is limited to climate change, many, probably most, economists are willing to accept that things can’t continue the way they have been. But I can’t believe the environmental problem is limited to climate change; that we don’t face similar major threats to the status quo from farming practices, water and land degradation, overfishing and species destruction. I don’t believe we can go on indefinitely increasing our throughput of natural resources and our interference with the operation of ecosystem services.

This is not to say the end of the world is nigh, or even the end of economic activity. But it may well presage the end of global population growth and that part of economic growth that’s based on growth in the use of natural resources. What we don’t have to give up is the other part of economic growth, which comes from productivity improvement and technological advance. It may well be, however, that the objective of productivity improvement needs to change from economising in the use of labour to economising in the use of natural resources. Markets will always economise in the use of the most expensive resource, which in developed economies is labour. We need to turn that around, partly by ensuring natural resources are properly priced to reflect their true social costs and partly by shifting the tax system away from its present heavy reliance on taxing ‘goods’ such as labour to taxing ‘bads’ such as the use of natural resources.

When scientists talk about the limits to growth, economists always accuse them of failing to understand the ability of the price mechanism to solve or work around the seemingly looming end to the availability of particular natural resources, including the price mechanism’s ability to call forth technological solutions to the problem. To this the scientists always retort that economists are hopelessly unrealistic ‘technological optimists’.

I think the truth’s in the middle. In the economists’ mind, the price mechanism solves problems in a way that’s simple and reasonably smooth. They tend to think in comparative statics - the economy snaps from one equilibrium to another - without giving much thought to the dynamics of the adjustment process and the possibility of path dependency, of being knocked off course before you reach the expected equilibrium. I’m not confident of the ability of global commodity prices to adequately foresee emerging shortages around the corner and thereby send a clear enough, and early enough, signal to innovators to get on with finding their technological solution to the problem. If huge price increases occur with little warning and there’s a delay of some years before technological solutions emerge, considerable economic damage can be done in the interim, with unexpected flow-on effects and less-than-efficient policy responses by governments. And all because of economists’ naive faith that the real world will adjust in textbook fashion.

I was interested to see that highly orthodox institution, The Economist magazine, seriously entertaining the possibility of Peak Oil in a recent article (Buttonwood column, Feeling Peaky, April 21, 2012). It noted that global output of crude oil (as opposed to alternatives such as biofuels and liquids made from gas) has been flat since 2005. You can argue the world is ‘awash with energy’ thanks to the exploitation of American shale gas, but The Economist counters that oil is still the main fuel powering the globe’s fleet of cars and trucks. You could convert them all to liquid gas, but you can’t do it without considerable expense and delay, with the prospect of pretty bad things happening in the interim. You could find more oil - in the Arctic or in tar sands - but you couldn’t do that without a considerable increase in the price of petrol. Remember, too, that some potential alternatives to conventional oil - including biofuels and tar sands - are highly ‘energy inefficient’ - you have to expend a lot of energy to produce them. And the fact remains that, just as the industrial revolution was built on coal, so the post-war economy has been built on cheap oil. If oil and its substitutes are now to be very much more expensive, this spells significant cost, economic disruption, social hardship and weaker growth.

But I’ve provoked you enough with the threatening thought that there may be limits to growth after all. Now I want to view the case for measuring change in the environment - and for combining it with the measurement of the economy - from a different perspective. As you know, the overriding goal of microeconomics is to help the community deal with ‘the problem of scarcity’ - the fact that the physical resources available to us are finite, whereas our wants are infinite. There’s any amount of goods and services we’d like to consume, but the wherewithal to produce those goods and services is strictly limited.

But Avner Offer, a professor of economic history at Oxford, and others have advanced an interesting proposition: that the developed market economies’ attack on the problem of scarcity over the time since the industrial revolution has been so remarkably successful that we’ve actually defeated scarcity and replaced it with a different problem, the problem of abundance. Now, technically, for an economist to say that a resource is scarce is merely to say that it can only be obtained by paying a price, that it’s not so abundantly available as to be free. Clearly, in that technical sense, the problem of scarcity is still with us.

But, in the broader sense, it’s hard to deny that the citizens of the developed world live lives of great abundance. As we’ve seen, our material standard of living has multiplied many times over since the start of the industrial revolution. No one in the developed world is fighting for subsistence; even the relatively poor among us are doing well compared with the poor of Asia or Africa; we satisfied our basic needs for food, clothing and shelter a mighty long time ago; our real incomes grow by a percent or two almost every year, and each year we move a little higher on the hog. Our greater affluence can be seen in our ability to limit the size of our families, in the growth in the size and opulence of our homes, the fancy foreign cars we drive, our clothes, the private schools we send our children to, the restaurants we eat in and the plasma TVs, DVDs, video recorders, personal computers, mobile phones, stereo systems, movie cameras, play stations and myriad other gadgets our homes teem with.

How has this unprecedented and widespread affluence come about? It’s the product of the success of the market system. But above all it’s the product of all the technological advance - the invention and innovation - the capitalist system is so good at encouraging. Malthus’s dismal prediction in the late 1700s that the growth in the population would outrun the growth in food production was soon disproved.
It’s therefore reasonable to say that, when we look around us, what we see is not scarcity but abundance. This is something to be celebrated. But, as with everything in life, no blessing is unalloyed. Every good thing has its drawbacks and difficulties. As we’ve seen, the first and most obvious problem with abundance is the damage the huge expansion in economic activity is doing to the natural environment.

The next but less obvious problem with abundance is that it exacerbates humankind’s difficulty achieving self-control. Notwithstanding the economists’ assumption of rationality, humans have a big problem with self-control. It’s ubiquitous to daily life: the temptations to eat too much, get too little exercise, smoke, drink too much, watch too much television, gamble too much, shop too much, save too little and put too much on your credit card, to work too much at the expense of your family and other relationships.

The more stuff we have - the fewer among us whose main problem remains satisfying our basic needs - the more problems of self-control emerge as our dominant concern. But there’s a deeper point: humans have never been good at self-control, but as long as we were poor and resources were scarce, our self-control problem was held in check. It’s when things become abundant, when we can afford to indulge so many more of our whims, when we have a huge range of things or activities to choose from, that self-control problems become more prevalent and we have trouble making ourselves choose those options that are best for us in the longer term, not just immediately gratifying.

The topical problem of obesity provides an excellent example of the way the move from scarcity to abundance has exacerbated self-control problems. Humans evolved in conditions where nutrition was scarce. Our brains are therefore hardwired to eat everything that comes our way while we’ve got the chance, and they’re surprisingly poor at signalling to us when we’ve had enough. For as long as food remained scarce - that is, relatively expensive - and work remained highly physical, there wasn’t a problem. But as we triumphed over scarcity the former balance was lost. Technological advances in the growing, transport, storage, preservation and cooking of food greatly reduced its cost to consumers. As humans have become more time-poor, we’ve seen an explosion in inexpensive fast food, all of it cunningly laced with those three ingredients our brains were evolved to crave: fat, sugar and salt. Then, on the output side, we’ve seen technological advance strip the physical labour first out of work and then out of leisure. We don’t play sport, we watch it being played and these days we don’t even go to the effort of travelling to the grounds.

There’s a third aspect to the problem of abundance: the increased resources devoted to the socially pointless pursuit of social status through consumption. When we have long passed the point where our basic needs for food, clothing and shelter are being satisfied, but our real incomes continue to grow by a couple of percent a year, we have to find something to do with the extra money. Partly, we spend it on ‘superior goods’ - goods you want more of as you get richer - such as health and education. That’s fine. But a fair bit of the extra income is spent on ‘positional goods’ - goods whose purchase is designed to demonstrate to the world our superior position in the pecking order. The point here is that, from the viewpoint of the community rather than the individual, the pursuit of status is a zero-sum game: the gains of those individuals who manage to advance themselves in the pecking order are offset by the loss of status suffered by those they pass. From the perspective of society, a lot of resources are simply being wasted.

So that’s the case for believing that, at this late stage in our development, the problem of scarcity has been superseded by the problem abundance. It has obvious implications for the environment and the need to integrate environmental and economic measurement. I like the example of commercial fishing. Two hundred years ago the constraint was the scarcity of human capital: not enough boats to haul in all the fish available. Today, after so much technological advance in the fishing industry, the scarcity problem is reversed: far too many boats chasing far fewer fish.

You don’t need to think for long about the SEEA exercise before you realise the paucity of measurement of the many dimensions of the environment and the changes in them over time. You realise how much of the bureau’s efforts are devoted to the myriad measurements needed to support the economic accounts. Our management of the environment should be much better informed just by the more comprehensive measurement of environmental indicators in physical values. When you covert those physical values to dollars and integrate them with the economic accounts you are (to quote one of the bureau’s documents) enabling analysis of the impact of economic policies on the environment and the impact of environmental policies on the economy.

For as long as we’ve been worrying about the economy’s effect on the environment the great bugbear has been the environment’s status as an ‘externality’ to the market economy and the price mechanism. The environment isn’t part of the system and it takes a lot of alertness and effort to incorporate it into the system, case by case. My dream is that, though environmental assets will continue to go unpriced until we find a way to price them, we may be able to short-circuit the process by incorporating environmental money values into the GDP bottom line.

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ENERGY POLICY: A MARKETPLACE OR A GOVERNMENT’S PLACE?

Debate at The Sydney Globalist launch, Sydney University, Wednesday, March 21, 2012

I'm happy to be speaking in favour of govt intervention in the energy market and against a 'free' market. I’ll be giving an orthodox, economic response to the question and my colleague John Mikler will give a more radical, political response. He’s meant to be channelling Bob Carr - who cancelled his appearance here tonight when he got a better offer from someone called Julie/Julia - but I’m not sure John’s voice is deep enough.

The question we’re debating - a marketplace or a government’s place - is a clever play on words, but really, it makes no sense. It presents a false dichotomy. In the real world - as opposed to the world of economics textbooks - there are no markets that exist without government intervention and, since the fall of communism, no economies that governments attempt to regulate with no role for market forces. Even the most extreme libertarian - and we’ll be hearing from some extreme ones tonight - wants the government to intervene in the market to protect property rights and enforce contracts etc. Markets as we understand them are, in fact, the creation of governments. So the choice we face is not between the extremes of no government or no market, but what degree of intervention we judge to be appropriate - ie we're searching for - and arguing over - the right combination of intervention and market forces.

I prefer to make these judgments fairly pragmatically rather than based on ideology, and so make them case-by-case, or market-by-market. Only a fool denies the powerfulness of market forces, or their general efficiency in allocating resources. But, equally, only a fool imagines markets are perfect - infallible.

The overwhelming weight of scientific opinion tells us the burning of fossil fuels over the past 200 years or so has led to an excessive build up of greenhouse gases in the atmosphere, which has probably already begun to alter the world’s climate in damaging ways. Should this build-up continue, we’re told, there’ll be significant disruption to the climate, leading to significant disruption to the economy and a significant decline in our material standard of living.

If the scientists are right and we do have a problem, it would be idle to expect that market forces would, without assistance, act to correct the problem. That is, this is a clear case of ‘market failure’. The actions of the private producers and consumers of fossil fuels impose costs on the community, but those costs are not reflected in the market prices at which fossil fuels are exchanged. If we could find a way to get those costs incorporated into market prices - if we could, in economists’ jargon, ‘internalise the externality’ - then we could expect the operation of market forces to help discourage the use of fossil fuels, encourage people to turn to alternative forms of energy and create a monetary incentive for people to search for technological solutions to the problem.

If all this sounds like terribly standard economics, it is. The argument I’ve just given you is accepted by the great majority of economists. I need to remind you that the emissions trading scheme - and its close cousin, the carbon tax - are ‘economic instruments’ that were invented by economic rationalists as the best way of dealing with the threat of climate change with minimum loss to our material standard of living. Many economists would leave it there, but many others would add that there could well be a role for supplementing the price on carbon with more direct interventions such the imposition of emissions standards for new motor vehicles or building codes requiring better insulation. I’m a belt-and-braces man myself.

Under the urging of economists, many governments have used trading schemes or pollution taxes to solve more localised environmental problems, such as over-fishing. In contrast, climate change presents a far more daunting challenge - in Professor Ross Garnaut’s words, a diabolical challenge - because greenhouse gas emissions are a global issue than can be dealt with only with concerted action by all the major countries. This feature of the problem presents considerable scope for free-riding (why doesn’t my country bludge on the efforts of other countries) and Mexican standoffs (I’ll do something only after you’ve done something).

So far it’s proved hard to get agreement between the major countries on binding commitments to reduce emissions, which is not to say most of them are making no effort. There are problems with organising watertight schemes for the trading of emissions permits between countries, and real but hugely exaggerated problems with the potential for ‘carbon leakage’ (the risk of losing industries to those countries with lower emissions standards than ours).

I’m sure we’ll be hearing about these problems at length - mainly from people who, with their superior scientific expertise, deny we’ve got a problem with climate change in the first place. My response to these difficulties is simple: Australia has enough at stake for us to want to be part of the effort to break the Mexican standoff by putting our contribution on the table and getting on will implementing it. Assuming nothing can be done is the best way to ensure nothing is done, with all the economic destruction that would bring.

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Endless growth and a healthy planet don't compute

Do you ever wonder how the environment - the global ecosystem - will cope with the continuing growth in the world population plus the rapid economic development of China, India and various other "emerging economies"? I do. And it's not a comforting thought.

But now that reputable and highly orthodox outfit the Organisation for Economic Co-operation and Development has attempted to think it through systematically. In its report Environmental Outlook to 2050, it projects existing socio-economic trends for 40 years, assuming no new policies to counter environmental problems.

It's not possible to know what the future holds, of course, and such modelling - economic or scientific - is a highly imperfect way of making predictions. Even so, some idea is better than no idea. It's possible the organisation's projections are unduly pessimistic, but it's just as likely they understate the problem because they don't adequately capture the way various problems could interact and compound.

Then there's the problem of "tipping points". We know natural systems have tipping points, beyond which damaging change becomes irreversible. There are likely to be tipping points in climate change, species loss, groundwater depletion and land degradation.

"However, these thresholds are in many cases not yet fully understood, nor are the environmental, social and economic consequences of crossing them," the report admits. In which case, they're not allowed for in the projections.

Over the past four decades, human endeavour has unleashed unprecedented economic growth in the pursuit of higher living standards. While the world's population has increased by more than 3 billion people since 1970, the size of the world economy has more than tripled.

Although this growth has pulled millions out of poverty, it has been unevenly distributed and has incurred significant cost to the environment. Natural assets continue to be depleted, with the services those assets deliver already compromised by environmental pollution.

The United Nations is projecting further population growth of 2 billion by 2050. Cities are likely to absorb this growth. By 2050, nearly 70 per cent of the world population is projected to be living in urban areas.

"This will magnify challenges such as air pollution, transport congestion, and the management of waste and water in slums, with serious consequences for human health," it says.

The report asks whether the planet's resource base could support ever-increasing demands for energy, food, water and other natural resources, and at the same time absorb our waste streams. Or will the growth process undermine itself?

With all the understatement of a government report we're told that providing for all these extra people and improving the living standards of all will "challenge our ability to manage and restore those natural assets on which all life depends".

"Failure to do so will have serious consequences, especially for the poor, and ultimately undermine the growth and human development of future generations." Oh. That all?

Without policy action, the world economy in 2050 is projected to be four times bigger than it is today, using about 80 per cent more energy. At the global level the energy mix would be little different from what it is today, with fossil fuels accounting for about 85 per cent, renewables 10 per cent and nuclear 5 per cent.

The emerging economies of Brazil, Russia, India, Indonesia, China and South Africa (the BRIICS) would become major users of fossil fuels. To feed a growing population with changing dietary preferences, agricultural land is projected to expand, leading to a substantial increase in competition for land.

Global emissions of greenhouse gases are projected to increase by half, with most of that coming from energy use. The atmospheric concentration of greenhouse gases could reach almost 685 parts per million, with the global average temperature increasing by 3 to 6 degrees by the end of the century.

"A temperature increase of more than 2 degrees would alter precipitation patterns, increase glacier and permafrost melt, drive sea-level rise, worsen the intensity and frequency of extreme weather events such as heat waves, floods and hurricanes, and become the greatest driver of biodiversity loss," the report says.

Loss of biodiversity would continue, especially in Asia, Europe and southern Africa. Native forests would shrink in area by 13 per cent. Commercial forestry would reduce diversity, as would the growing of crops for fuel.

More than 40 per cent of the world's population would be living in water-stressed areas. Environmental flows would be contested, putting ecosystems at risk, and groundwater depletion may become the greatest threat to agriculture and urban water supplies. About 1.4 billion people are projected to still be without basic sanitation.

Urban air pollution would become the top environmental cause of premature death. With growing transport and industrial air emissions, the number of premature deaths linked to airborne particulate matter would more than double to 3.6 million a year, mainly in China and India.

With no policy change, continued degradation and erosion of natural environmental capital could be expected, "with the risk of irreversible changes that could endanger two centuries of rising living standards". For openers, the cost of inaction on climate change could lead to a permanent loss of more than 14 per cent in average world consumption per person.

The purpose of reports like this is to motivate rather than depress, of course. The report's implicit assumption is there are policies we could pursue that made population growth and rising material living standards compatible with environmental sustainability.

I hae me doots about that. We're not yet at the point where the sources of official orthodoxy are ready to concede there are limits to economic growth. But this report comes mighty close.

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Sustainable well-being

What does federal Treasury believe? What are the values that underlie the strong line it takes in its advice to governments? A lot of people think they know, but this week its newish boss, Dr Martin Parkinson, spelt it out in an important speech.

And some of the people who think they know all about the ''Treasury line'' may be surprised. Parkinson's title was ''Sustainable well-being'' .

What does he mean by well-being? It's ''what we in the Treasury think of primarily as a person's substantive freedom to lead a life they have reason to value'', he says.

What does he mean by sustainability? ''Sustainable well-being requires that at least the current level of well-being be maintained for future generations.

''In this regard, we can consider sustainability as requiring, relative to their populations, that each generation bequeath a stock of capital - the productive base for well-being - that is at least as large as the stock it inherited.''

But because well-being is a multi-dimensional concept, he says, going well beyond material living standards - and even the environment - we can see that the stock of capital should include all forms of capital, of which there are four.

First, physical and financial capital: the value of fixed assets such as plant and equipment and financial assets and liabilities.

Second, human capital: the productive wealth embodied in our labour, skills and knowledge, and in an individual's health.

Third, environmental capital: our natural resources and the ecosystems, which include water, productive soil, forest cover, the atmosphere, minerals, ores and fossil fuels.

Fourth, social capital: which includes factors such as the openness and competitiveness of the economy, institutional arrangements, secure property rights, honesty, interpersonal networks and the sense of community, as well as individual rights and freedoms.

Running down the stock of capital in aggregate diminishes the opportunities for future generations, Parkinson says. In one way or another, eroding the productive base will lead to lower future well-being. ''Note, though,'' he adds, ''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 well-being.

''A necessary, but not sufficient, condition for this to be the case is that those resources are priced appropriately and that the returns are invested sensibly.''

When you think about well-being rather than gross domestic product, he says, it quickly becomes apparent that society doesn't get an adequate return on many environmental goods. For example, water and carbon are not yet priced appropriately.

In the case of minerals and energy, arguably society is not sharing sufficiently in the returns from their exploitation, with the vast bulk of the benefits accruing to the shareholders of the firms doing the mining. As such, society is not getting the resources it would need to build up other parts of its capital stock.

''Unsustainable growth cannot continue indefinitely - if we reduce the aggregate capital stock in the long run, future generations will be made worse off. The problem is that we can be on an unsustainable path for a long period - and by the time we recognise and change, it could be too late.''

Our economy faces a number of pressures on environmental sustainability, including: climate change, salinity and resource depletion, in addition to water availability and pressures on biodiversity. Climate change policy - both in relation to reducing emissions and adapting to climate changes - is not just an environmental issue, Parkinson says. ''It is more fundamentally an economic and social challenge.''

The impact of decisions today will be felt in decades to come, and the progression of climate change impacts is unlikely to be linear (occurring at a steady rate of change). ''There are significant risks and uncertainties arising from our imperfect knowledge of the climate system. It is possible that climate impacts could suddenly accelerate. In fact, certain impacts to the climate system may lead to a tipping point where sudden, irreversible changes arise.''

Parkinson says Treasury, to do its job, needs ''an understanding of well-being that recognises that well-being is broader than just GDP, that sustainability is more than an environmental issue''.

''A focus on well-being and sustainability continue to be important parts of Treasury's culture and identity: they assist in providing context and high level direction for our policy advice; and they facilitate internal and external engagement and communication.

''Almost a decade ago we attempted to put more structure around the issue by writing down a well-being framework to provide greater guidance to staff on our mission.'' The framework is based on five dimensions.

First, the set of opportunities available to people. This includes not only the level of goods and services that can be consumed, but good health and environmental amenity, leisure and intangibles such as personal and social activities, community participation and political rights and freedoms.

Second, the distribution of those opportunities across the Australian people. In particular, that all Australians have the opportunity to lead a fulfilling life and participate meaningfully in society.

Third, the sustainability of those opportunities available over time. In particular, consideration of whether the aforementioned productive capital base needed to generate opportunities is maintained or enhanced for current and future generations.

Fourth, the overall level and allocation of risk borne by individuals and the community. This includes a concern for the ability, and inability, of individuals to manage the level and nature of the risks they face.

Fifth, the complexity of the choices facing individuals and the community. Treasury's concerns include the costs of dealing with unwanted complexity, the transparency of government and the ability of individuals and the community to make choices and trade-offs that better match their preferences.

These five dimensions ''reinforce our convictions that trade-offs matter deeply - trade-offs both between and within dimensions'', Parkinson says.

Well, that's what he thinks.

What do I think? I think Treasury has come a long way and is at its point of greatest enlightenment. But it has further to go - in principle as well as in practice.

In particular, I doubt how much trading off is possible when it comes to the environment.

Ensuring our kids are richer than we are, while destroying the natural environment because we refuse to accept the physical limits to economic growth, doesn't sound sustainable to me.

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A reality check at last on what we take for granted

A recurring theme in my writing this year has been to point out the limitations of gross domestic product as a measure of wellbeing, particularly as related to the environment. But today I have good news: something is being done about it. Economists and statisticians long ago developed a "system of national accounts" to measure developments in the economy, based on Keynesian theory about how economies work.

Although these accounts give much detail about income, production, spending and saving during a period and, these days, a balance sheet outlining the values of the nation's assets and liabilities to the rest of the world on the last day of the period, we tend to focus on a single bottom line: the change in the real value of goods and services produced during the period, otherwise known as GDP.

A United Nations commission sets down an international standard for all countries to follow in preparing their national accounts, using the same theory, concepts and definitions so each country's figures are comparable and can be added together to give gross world product. But as we've become more aware of the problems economic activity is creating for the natural environment - degradation of rivers and soil, depletion of non-renewable resources, use of renewable resources faster than their ability to renew themselves, destruction of species and generation of waste and pollution, including greenhouse gases - we've realised that little of this cost is taken into account in measuring the change in our income.

It's as though we've been thinking of and measuring "the economy" - the production and consumption of goods and services - in total isolation from the natural environment in which the economic activity occurs.

The environment provides the economy with many "ecosystem services", which a leading ecological economist, Professor Robert Constanza, of Portland State University, defines as "the benefits provided to humans through the transformations of resources (or environmental assets, including land, water, vegetation and atmosphere) into a flow of essential goods and services,

for example clean air, water and food".

These ecosystem services are treated as though they're "free goods" - goods in such abundant supply they have no value or cost - while, as we've seen, most of the damage economic activity does to the ecosystem is also ignored.

The main reason for these limitations is that, with some exceptions, the national accounts and GDP don't actually measure "the economy" but rather market transactions within the economy. So, for instance, it ignores all the production and consumption that occurs within households without money changing hands. It measures professional sport, but not amateur sport.

It's clear we can't go on effectively ignoring the relationship between the economy and the environment. The damage economic activity does to the environment diminishes our wellbeing, as well as rebounding on the economy and damaging it. We can go on ignoring the damage excessive irrigation is doing to the Murray-Darling so as to avoid disrupting the livelihoods of the irrigators, but if we eventually turn the river into a drain, irrigation will be no more.

We need to recognise and measure the interrelationship between the economy and the environment because we don't want to give ourselves a false impression of the progress we're making, even in a narrow, material sense. Measurement is important because "what we measure affects what we do; and if our measurements are flawed, decisions may be distorted".

To this end the UN commission and its member national statistical agencies have agreed on a "system of integrated environmental and economic accounting", which will become an international standard in 2012. This brings environmental and economic information together within a common framework, meaning information from each side is on a comparable basis and can thus be combined.

Well that's great. But our longstanding focus on purely economic measurement means we don't yet collect all the data we would need to produce environmental accounts that could be integrated with the economic accounts to give us a more balanced picture of the progress we're making (although, of course, this says nothing about other dimensions of progress, such as the quality of our health, extent of our education, inequality in the distribution of income and treatment of minorities).

It turns out the efforts of our Bureau of Statistics have been concentrated heavily on collecting the reams of statistical information needed to produce the quarterly national accounts.

So that's the first stumbling block. The second is that, with the environment, you have to start with physical measures (millilitres, petajoules, hectares or tonnes) then see if you can convert them to dollar values - as they must be if they're to be combined with the economic accounts. (That's the problem with non-market activities, of course. When something is bought or sold, you know its dollar value.)

The bureau of stats has issued a paper describing its progress in moving Towards an Integrated Environmental-Economic Account for Australia. It needs to produce six accounts that will add up to the environmental side.

A water account (released a few weeks ago and now to be produced annually) includes the physical flows of water supplied to, and used by, the economy, and water returns to the environment. It includes monetary supply and use tables and indicators of the water productivity of industries.

An energy account (to be produced annually from mid next year) includes physical and monetary supply and use tables for various energy products, by industry. A land account (to be produced annually from early next year) includes physical and monetary land use by industry, land cover by industry and changes in land cover over time.

An "environmental protection expenditure" account (to be produced annually from late 2012) gathers together protective spending already included in GDP for things such as waste water treatment. A waste account (to be produced three-yearly from late 2012) covers physical generation and disposal of waste by industry, type of waste and destination.

It would be nice if, having done all this measurement, we could produce from the integrated environmental-economic accounts a single, bottom-line figure for "green GDP", that we could watch as closely as we watch the present brown GDP. As yet, however, the world's statistical agencies haven't agreed on a definition of green GDP, nor agreed on how to convert all physical quantities into dollar values. But there will be enough information to allow outfits or academics to calculate their own versions of green GDP using their own assumptions. And it should be possible to produce a figure for GDP after adjustment for environmental depletion and degradation.

That will be a big step forward.

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REGULATING FOR SUSTAINABILITY

Talk to forum on Evidence-Based Regulatory Reform
Monash University Law Chambers, December 6, 2010

Some of the most important ideas are deceptively simple. Who, for instance, could dispute that the practice of medicine, the making of government policy or the reform of government regulation should be ‘evidence-based’? I have a mate who’s an academic neurologist and when we’re at our holiday homes and getting our daily exercise toiling up and down a mountain he often tells me about the advent of evidence-based medicine. I was surprised to learn that many of the cures prescribed by doctors often aren’t chosen on the basis of hard, scientific evidence, but rather on the doctor’s habits, on what he was taught at med school, on the doctor’s impression of what other doctors do, on years of casual observation as to what works and what doesn’t, on what might minimise the doctor’s ‘medico-legal’ risk, on what the doctor remembers reading in a medical journal, or even what the doctor was told recently by a visiting drug company rep. In place of this, the medical profession is slowly and painstakingly assessing what it knows from high-quality empirical studies about the efficacy of particular treatments, with treatments and tests graded, starting with the ‘gold standard’ and working down. Doctors who follow these guidelines can expect to avoid much criticism should things go amiss. The role of professional judgment is reduced, but the effectiveness of treatment is greatly enhanced.

Now, who among us could doubt that making medicine more ‘evidence-based’ is a great step forward? I was pondering the idea of writing a radical column advocating that economists and econocrats follow the doctors’ example and make their policy recommendations more evidence-based - less reliance on theory, more on empirics - when I was amazed to see the chairman of the Productivity Commission had given a long speech advocating ‘evidence-based policy-making’. The boss of the most notoriously theoretically pure economic institution is preaching sermons about the need to take more notice of the actual evidence? And I have no doubt that, in his own mind, his commitment to taking more notice of evidence was completely genuine.

The point I want to make is that, while no one could disagree with the proposition that everything we do ought to be more evidence-based - perhaps even choosing our spouse - in practice it ain’t that simple. What I regard as evidence may not be what you regard as evidence. And the conclusions I draw from the evidence may not be those you draw from the same evidence. It may transpire that your response to the evidence was sound and mine wasn’t. But both of us will be able to claim our decisions were evidence-based. So making evidence-based decisions may improve the quality of those decisions on average, but it offers no guarantee that decisions are correct. And even the expectation that paying more attention to evidence will generally improve the quality of decisions should itself be subject to evaluation once we have more evidence about the effectiveness of evidence-based decision-making.

‘Evidence’ is a word with a wonderful air of certainty and assurance. Who could doubt the evidence? Who could argue with the evidence? Yet we know from watching telly that this is just what barristers are paid to do: argue about different interpretations of the evidence. And far more lowly paid juries have the last word on what the evidence proves. We need to think more clearly about what evidence is. I think it’s just facts. In the case of economic questions it’s often statistical facts - the statistical composition of some population; the movement in some variable over time. Maybe the movement in two variables over time, the degree of correlation between them and whether we can be sure that one caused the other, or whether both are caused by some third variable.

But the world abounds with facts, far more than we can assimilate. Some facts (and some statistics) are relevant to the question at hand and some are irrelevant. How do we decide which facts are pertinent and which aren’t? We apply our judgment. The judgment of a professional has been schooled by her professional education; she’s been trained to think along certain lines, her thinking is guided by a ‘model’. A model - which can just as easily be called a theory - is an attempt to understand a complex reality by simplifying that reality: excluding all those factors considered to be of little importance so as to focus on those factors believed to be most important in explaining how things work. All models pick and choose between the facts, all professions rely on models, and each profession’s model tends to be quite different from the others, so that, for example, a lawyer and an economist can draw quite different conclusions from the same set of facts, the same evidence. How successful each profession’s model is at explaining and predicting the way the world works depends on whether it has avoided excluding from its model factors that end up being important in explaining behaviour. In practice, all professions suffer from what I call ‘model blindness’ - a tendency to underrate factors that aren’t in their model, but turn out to be important explanators. I doubt if more emphasis on evidence will overcome the endemic problem of model blindness.

Let me make a quite different point. One reason policy-makers don’t make more use of evidence is that the evidence - particularly statistical evidence - doesn’t exist. And often it doesn’t exist because evidence is expensive to collect. So any genuine push to make decision-making more evidence-based would involve spending a lot more taxpayers’ money on collecting evidence. And collecting more evidence would annoy lots of people. Much valuable potential evidence is possessed by government agencies, but they’re often quite resistant to requests to make it available, lest they provide outsiders with a stick to beat them. Other evidence has to be collected by government agencies from business, but business greatly resents having to fill in forms for the government. It’s likely that, in the mind of business, a fair bit of the push for ‘evidence-based regulatory reform’ involves getting rid of ‘red tape’ otherwise known as evidence.

But I’m supposed to be talking about regulating for sustainability, so let me take a case study and consider the extent to which evidence could throw light on the regulatory decisions to be made. Most of us are agreed that we need to greatly reduce our emissions of greenhouse gases in the next few decades. Economists are agreed that the least-cost way to achieve this is not by prohibiting certain undesirable behaviour or by subsidising certain desirable behaviour, but by ‘putting a price on carbon’. Is this judgment evidence-based? Probably not. It’s such a new area that there isn’t a lot of evidence available, and what evidence there is would be mixed. No, this conclusion comes straight from the economists’ conventional model, which assumes that prices are always the main influence over people’s economic behaviour and that changing prices is always the least-cost way to achieve policy objectives.

But as you probably realise, there are two different ways we could put a price on carbon. We could take the cap-and-trade, emissions trading scheme approach of the Rudd government’s carbon pollution reduction scheme, and limit the quantity of carbon dioxide permitted to be emitted, thus forcing up the price of emissions. Or we could impose a tax on emissions, thus increasing their price and thereby encouraging businesses and households to reduce the quantity of their emissions. As you can see, the two approaches are essentially mirror-image and, in theory, either way should achieve the same result. From about the time the Rudd government committed itself to the trading-scheme approach, the balance of opinion among economists swung in favour of the carbon tax approach. And now with the abandonment of the Rudd scheme, but the recommitment to putting a price on carbon, the nation is facing the choice.

Was the swing in economists’ opinion in favour of a tax evidence-based? I doubt it. Could it have been? Not really; as I say, there isn’t a lot of evidence available. It does seem clear the European Union’s trading scheme has not worked well - but it’s easy to say we can see what the Europeans did wrong and will make sure we avoid making the same mistakes. So on what basis do economists divide between supporting a trading scheme and supporting a carbon tax? Because the model says they’re essentially equivalent, I think it boils down to differing judgments about their political and administrative feasibility.

We should gather more evidence and take more notice of the evidence we have, but don’t imagine this will greatly reduce the role of subjective judgment in the way governments regulate the economy.

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Don't think you can keep on neglecting me, Darling

Sustainability is a dangerous word, but one to which politicians are irresistibly attracted. It has a wonderful ring to it and drips with virtue. Can you think of anyone who would admit to supporting anything that wasn't sustainable?

And Julia Gillard has brought sustainability back into its own. Kevin Rudd appointed Tony Burke our first Minister for Population, but one of Gillard's first acts was to change his title to Minister for Sustainable Population.

These days Burke is Minister for Sustainability, Environment, Water, Population and Communities. Phew. Anything else you'd like me to fix while I'm at it?

One of his tasks is to soothe the anguished and outraged response of irrigators to the Murray-Darling Basin Authority's "guide to a plan" to restore the river system's environmental flows by reducing water allocations by 27 to 37 per cent.

Apparently, the bureaucrats at the authority have no idea of the devastation they'd cause, wiping out whole river towns and causing horrendous unemployment, while prompting a huge leap in the price of food, ending the nation's food security and prompting a surge in food imports.

Clearly, there is a requirement for commonsense to prevail and for the needs of people, their livelihoods and their communities to be put ahead of worries about the environment.

Just one problem: that dangerous notion, sustainability. The authority's guide says many of the challenges and risks faced by the basin and its communities are the direct result of the actions of successive governments over the history of the basin. "In retrospect, many of these decisions failed to strike a long-term balance between meeting the needs of the environment and those of a growing economy and population," the guide says.

"The amount of surface water diverted for consumptive use such as [in] towns, industry and irrigation has increased from about 2000 gigalitres per year in 1920 to entitlements of approximately 11,000 gigalitres per year in the 1990s. However, the impact of drought over the past decade has seen actual diversions drop significantly.

"The combination of drought and historic diversions means there have been no significant flows through the Murray mouth since 2002."

It is clear the impacts of the necessary adjustments would fall on the current generation of farmers and irrigators, industries and communities. So effective transitional arrangements would be needed to help people.

But it is also clear the environment has not had sufficient water for decades. This has led to serious environmental decline. "Twenty out of 23 catchments in the basin are in 'poor' to 'very poor' ecosystem health," the guide says. "The past decade has seen increasing water quality problems and more frequent outbreaks of blue-green algae blooms.

"The real possibility of environmental failure now threatens the long-term economic and social viability of many industries and the economic, social and cultural strength of many communities."

Over the past few decades, the focus has swung primarily to looking at the economics of the basin and what it can produce, such that the role of the environment in underpinning that economic development has been "somewhat overlooked".

But that can't continue. "If the focus does not swing back towards considering water required for the environment, then the nation risks irretrievably damaging the attributes of the basin that enable it to be so productive," the guide says.

See what this is saying? The sustainability of the ecosystem is, in the end, non-negotiable. It's not a question of being reasonable, of politicians splitting it down the middle and everyone going away grumpily satisfied. It's not even a question of imagining we can put the interests of flesh and blood ahead of mere inanimate objects.

The natural environment is utterly unreasonable and unforgiving. For years we have been able to abuse it - knowingly and unknowingly - confident in the belief it would recover from that abuse or some new technology would pop up to solve any problems.

But now it is clear to our scientists we are reaching the tipping point. Keep flogging the horse and the horse will die and leave us in the lurch. You can't negotiate with the environment, asking it to remember how many people's livelihoods are depending on it. And no amount of abuse of ignorant, city-living greenies will make the problem go away.

If what we are doing to the Murray-Darling is ecologically unsustainable it won't be - can't be - sustained. Sooner or later, it will come to an end. The only choice we face is whether to take the pain now in the hope of saving something for the future or do what all our predecessors have done and close our eyes to the problem, take a few token steps to confound our consciences and hope to be dead before the final devastation.

But politics as usual - create such a fuss the pollies back off - remains dominant. And the standard tactic is to hugely exaggerate the amount of pain that would be suffered. The authority's guide says its plan could lead to long-term job losses of 800. Just one irrigation lobby has "modelling" showing that 17,000 jobs will be lost in NSW alone.

A tip: worry about the decline of country towns if you wish - that would really happen - but don't worry about job losses. Why not? Because our economy's problem is just the opposite: we are already close to full employment, where we don't have workers to fill all the (mainly city) vacancies. That's why our interest rates are already so much higher than other countries' and why they're set to go higher. That's why economists and business people are clamouring for higher immigration.

And to country people who fear the change the authority's suggested cuts would impose on them, I'd say just keep carrying on the way you are. This is a weak federal government without a majority, opposed by a Coalition wedded to populist obstruction.

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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".

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Getting richer as we mess up our world

I guess you've heard the good news: the devastation of the Christchurch earthquake will be a godsend to New Zealand's gross domestic product, giving it an almighty and much-needed boost.

So maybe it's a pity earthquakes don't happen more often. Perhaps we could do the Kiwis a favour and send our air force bombers over there to use a few cities for target practice.

If you think this sounds stupid, you're right. To anyone in their right mind, an earthquake that destroys many buildings, roads, bridges and vehicles - and disrupts many people's lives - can't possibly be a good thing.

But it will boost gross domestic product. GDP measures market production (and the income that production generates). So as the South Islanders spend a couple of billion repairing and rebuilding their main city, much extra production will occur and many additional jobs will be created.

But what about the loss of all the valuable assets destroyed by the quake - doesn't that count? Short answer: no. GDP is a sum that's all pluses and no minuses. It counts the benefits, but ignores the costs.

It doesn't count the destruction caused by natural disasters, nor the depletion of renewable and non-renewable resources. Production involves the emission of many forms of pollution, but this cost too is ignored.

If the clearing of land to build a town involves destroying the habitat of animals, perhaps leading to their extinction, the cost of the clearing and the building counts as a plus, but the loss of habitat or species doesn't count as a minus.

So, does that make GDP a giant con job? Yes and no. Economists will tell you GDP is an accurate measure of what it's intended to measure: market production and national income; it's not, and was never intended to be, a measure of the nation's well-being.

But this is disingenuous. Economists don't understand it's possible to know things without that knowledge being reflected in our behaviour. And though all economists know GDP is not a measure of well-being, they still treat it as though it is, obsessing over it, ignoring other indicators and encouraging us to do the same.

If GDP is so defective as a measure of well-being or social progress, why doesn't someone try to fix it? Well, many people have tried, but they've had little success. Trouble is, many of the factors affecting our well-being can't be measured in dollars, so they can't be included in the sum that is GDP.

This is the conclusion our own Bureau of Statistics soon came to when it set out to answer the question: is life in Australia getting better? To answer that you need to look at a diverse range of indicators and it's not possible to convert those indicators to a common basis so they can be added up to give a single, summary indicator.

Instead, each year the bureau produces Measures of Australia's Progress. It collects 17 indicators, gathered under three headings - economy, society and environment - trying to judge whether we've progressed or regressed on each indicator over the past 10 years.

Its latest issue was released this week to coincide with its NatStats conference on the topic, "Measuring What Counts: economic development, well-being and progress in 21st century Australia".

It shouldn't surprise you we've made progress on most of the economic indicators. Real net national disposable income (about the most meaningful derivative of GDP) increased from $35,000 a year per person in 1999 to $45,300 in 2009. It grew at an average rate of 2.6 per cent a year, well up on 1.5 per cent annual growth for the previous decade.

The nation's real net worth (assets minus liabilities) grew at the average rate of 0.9 per cent a year over the decade to reach $314,000 per person.

But not all the key economic indicators are good. The affordability of rent by low-income households - that is, housing costs as a proportion of gross income for low-income renters - has stayed constant at 27 per cent over the decade.

And the level of "multifactor productivity" - a measure of the efficiency with which the economy transforms inputs into outputs - has been relatively flat throughout most of the decade. So our economic growth came more from using additional inputs than from using inputs more efficiently.

With that mixed picture on the economy, let's move on to the key social indicators. Over the past decade, life expectancy at birth has increased by 2.2 years for girls and 3.3 years for boys. Over the same period, the proportion of people aged 25 to 64 who have a vocational or higher education qualification has risen from 49 per cent to 63 per cent. And the annual average rate of unemployment fell from 6.9 per cent to 5.6 per cent.

On crime, 6.3 per cent of all Australians aged 15 and over say they were victims of at least one assault in 2008-09. On family, community and social cohesion, there's no summary measure that captures the story. But the proportion of children living without an employed parent has fallen from 18 per cent to 13 per cent; the proportion of adults doing voluntary work during a year has risen by half to 34 per cent, and suicide rates have fallen for both sexes.

Turning to the environment, the past decade has seen the number of threatened fauna species increase from 312 to 427. In that time our net greenhouse gas emissions per year have increased by 16 per cent.

We have no summary indicator on our use of land, but the amount of annual land-clearing has fallen by a third, whereas the area of native forest remaining has fallen by 10 per cent. There's no summary indicator of our use and abuse of inland waters, oceans and estuaries. The volume of waste generated in Australia has nearly doubled.

We're entitled to draw two conclusions. First, when you drill down you find the general impression of ever-increasing well-being given to us by politicians, business people and economists is misleading. GDP might be growing rapidly, and the available social indicators may be all right, but we're going backwards on most environmental indicators.

Second, it's clear that, historically, much of the bureau's effort has gone into measuring the components of GDP, with too little effort being devoted to measuring the other, social and environmental dimensions of our well-being. Until that imbalance is corrected, the bureau's output will continue to mislead us.

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ONLY CAPITALISM CAN SAVE THE PLANET

IQ2 Debate, Sydney City Recital Hall
Tuesday, August 10,2010

The older I get, the more I worry about saving the planet. The past 200 years have seen a phenomenal expansion in economic activity around the world. In that time, the world’s population has exploded from one billion to 6½ billion. Over the same period, the average standard of living of all the people in the world has increased sixfold. Multiply the two together and you see the amount of economic activity in the world has increased by a factor of 45.

I fear that this huge expansion of human activity over just the past 200 years has reached a point where it’s starting to do significant damage to the natural environment - the ecosystem. The trouble is that, while the economy grows exponentially (that is, at a reasonably steady percentage rate) - the ecosystem doesn’t. It’s fixed in size. This says there must be natural limits to growth, and I suspect we’re close to those limits. That certainly seems to be the case with global warming: 200 years of growing use of fossil fuels have caused a build-up of carbon dioxide and other greenhouse gasses in the atmosphere that exceeds the earth’s capacity to absorb it, and this is starting to interfere with the climate in ways that are soon likely to do great damage to the economy. And the threat to the planet isn’t just from global warming. We also have big problems with water, soil, fish stocks and the destruction of species. As I say, I fear we’re reaching the limits to growth in our use of natural resources.

And yet I have no hesitation in supporting the motion that ‘Only capitalism can save the planet’. Why? Because, as Maggie Thatcher used to say: TINA - there is no alternative. And because capitalism is malleable. It’s changed a lot over the past 200 years as circumstances have changed, and it can change further as our needs dictate.

If you doubt that, it’s because you’re reacting to a comicbook definition of capitalism. Capitalism is just a pejorative term for a market economy - an economy where the means of production are largely privately owned and decisions about supply and demand are made in markets, with those markets receiving a greater or lesser degree of guidance from government. The world’s experiments with alternatives to market economies - central planning as in the former communist countries or heavily regulated socialist economies (such as pre-reform India) have failed and been abandoned. Those economies that retain vestiges central control are generally moving closer to a market model.

Don’t fall for either criticism or praise of The Free Market. Free markets don’t exist - never have, never will. In all real world economies freedom is constrained by government intervention to a greater or lesser extent. That’s really the point: the choice we face is not between markets that are totally unregulated or markets that are so tightly regulated they cease to be markets. The answer to our problems will never be found at one extreme or the other; it will always be found somewhere in the middle. Finding the optimal degree of regulation isn’t easy, particularly because regulating markets is much harder than it looks. It’s terribly easy to get reactions you weren’t expecting. So there’s plenty of scope for debate about where the line should be drawn.

Clearly, with the global financial crisis, the line in America was drawn too far in the direction of deregulation, great damage ensued, and now it’s clear the line needs to be redraw further in the direction of regulating. Note that we didn’t have any significant problem with our banks. So does that mean the Americans had a capitalist economy and we didn’t? Of course not. It just means we drew the regulatory line in a better spot than the Yanks did.

If the other side wants to argue that market economies are far from perfect, they won’t get any argument from me. Of course markets are far from perfect. That’s particularly true in the case of the environment, where many scarce natural resources don’t have prices and so don’t get into the market process. They’re external to the market system and so don’t benefit from the market’s usual ability to ensure those resources aren’t wasted or used to excess. But that just means governments have to find ways to get prices on them and thus get them into the market system.

Guess what? The planet is in danger and making the appropriate modifications to the capitalism system offers the best chance we have of saving it.

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Green jobs just muddy the climate-change waters

A cartoon by Jon Kudelka shows Julia Gillard ticking off items on her to-do list: first, appease billionaires; second, appease xenophobes; third, appease climate sceptics. Too true ... although, actually, when she has finished appeasing those who live in fear of boat people her last bit of pre-election deck-clearing will be to appease those who regret the government's decision to walk away from its emissions trading scheme by announcing a program of government subsidies to induce people to reduce their emissions directly.

Amazing though it may seem, the climate-change-denying opposition has a post-trading scheme policy to encourage "direct action", whereas the government - which still protests its acceptance of human-caused climate change - doesn't.

It's a fair bet that when we see Gillard's direct-action policy it will come complete with boasts about how many "green jobs" it will create.

Creating green jobs is all the rage. About a year ago Kevin Rudd promised to create 50,000 of them. Tony Abbott has plans for a standing army of 15,000 green workers who could be deployed across the country. And every environmental group or renewable energy lobby group wants to tell us how many "green-collar jobs" could be generated if only we'd do as they say.

It seems the notion of green jobs arose as a response to the claims of the opponents of climate policy that moving to a low-carbon economy would destroy lots of jobs. No it wouldn't, environmentalists cried, it would create lots of jobs. What's more, they would be green jobs.

But as the Australia Institute warns in a policy brief to be released today, there's a lot of woolly thinking about green jobs. It seems to be little more than a propaganda tool.

For a start, there has been little attempt to define what constitutes a green job. If, for instance, a job maintaining a wind turbine is a green job, what about a job in the business that makes the turbines?

And if it's green to manufacture steel turbines, what about the jobs of the people who mine the iron ore and coking coal needed to make the steel? But if it's not green to be a miner, would it be better for us to import all the turbines we need so the sin of being non-green was on someone else's head?

Should people who work in industries with a low environmental impact be regarded as having green jobs? If so, a significant proportion of all our existing jobs - particularly those in health, education and community services - are green.

But what about jobs in industries that have reduced their ecological footprint, even though it remains substantial? Are these jobs more green or less green than jobs in industries whose footprint has always been small?

As a general rule, industries that are capital-intensive are likely to have a bigger footprint than industries that are labour-intensive, such as service industries. Does this mean we could make the economy greener by abandoning our age-old quest to use machines to replace workers wherever possible?

Do workers whose job is to return a mine site to nature after it has been worked out qualify as green-collar workers? If so, what about workers who clean up after oil spills?

And what about jobs that make the natural environment more accessible to people? If, for instance, you employ some young people to improve the signs on a bush-walking track (for which I'm always grateful) are these green jobs? The advocates of such projects seem to think so.

Visiting the great outdoors may make people more environmentally conscious. But what if the greater accessibility attracts more people and thus adds to the degradation of the area? Would the green jobs then turn brown?

If I were to drive all around the state - or fly all around the world - educating people about the damage the use of fossil fuels does to the climate, would that make me a green-collar worker?

Give up? I reckon it's virtually impossible to come up with a watertight definition of green jobs. But I don't think that matters. As the Australia Institute's report argues, focusing on green jobs is at best a distraction and at worse a snare and a delusion. The object of the climate change exercise is to move to an economy where little of our energy needs are met by burning fossil fuels, thereby making us a "low-carbon economy" and greatly reducing our emissions of greenhouse gases.

Focus on that and the jobs will look after themselves. What seems to be missing from the preoccupation with green jobs is an understanding that all economic activity creates jobs. Moving to a low-carbon economy may well involve reducing jobs in industries that produce fossil fuels, but it will also create them in renewable-energy industries. And even should producing a quantity of energy from solar, wind or whatever involve fewer jobs than producing the same quantity from coal, that's not a problem either. This greater productivity of labour would leave income to be spent elsewhere in the economy - probably the services sector - where it would create jobs.

Our businesses have been using "labour-saving equipment" to replace workers for 200 years and it hasn't cause mass unemployment yet. (It's true, however, that the workers displaced from fossil-fuel industries may not be well placed to take the jobs created in the renewable industries or elsewhere, but that problem - which does need to be dealt with - is common to all the changes in the structure of the economy that continuous technological advance has caused over the centuries.)

It's OK for governments to spend money for the dominant purpose of creating jobs when they're fighting to urgently reduce the impact of recession. Apart from that, however, the money they spend should be aimed at achieving its nominal purpose. The number of jobs this spending creates should be incidental.

If we continue our muddled thinking about green jobs, we risk having politicians trying to curry our favour by wasting money on schemes that will do little to combat climate change.

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Prosperity cannot be paid forever by maxing out our green credit

The most thought-provoking comment I've seen on the budget came from Senator Christine Milne of the Greens. ''Every Australian knows,'' she said, ''that if you have two credit cards, it is very bad management to pay off your debt on one of them by racking it up on the other.'' The budget ''pulled down the national economic debt, but it continued the process of racking up our ecological debt''.

Sadly, it's true. The budget formally records Kevin Rudd's failure of leadership with his cowardly and illogical decision to shelve his emissions trading scheme.

It shows he took steps to avoid being accused of using the abandonment of the scheme to hasten the budget's return to surplus by using the net cash saving involved - $653 million - to increase spending on renewable energy.

The reversal did make it possible for the Government to meet its commitment to limit the real growth in its spending to 2 per cent a year.

And it did mean it was abandoning a ''great big new tax on everything'' in favour of a great big new tax on the mining companies, with the proceeds to be used to buy votes with a range of tax cuts and concessions - surely a net political gain.

Even so, if the government wants to insist it was motivated more by lack of political courage than by budgetary expediency, I accept its protestation.

No, that's not the point. It's that the budget continues our practice of worrying intensely about what we're doing to the economy while ignoring what we're doing to the environment. We just took a decision to take our chances on global warming - to do nothing to prepare for global action on climate change and nothing to set an example others might follow - but nowhere does that show up as a cost or liability.

It's not in the budget, nor in gross domestic product. It's invisible. We carefully measure and hugely publicise any increase in government debt or setback in economic growth, but what our actions and inactions are doing to the environment is largely out of sight.

When we run down our non-renewable resources (as we're hoping to do at a much faster rate with the return of the resources boom), nowhere does this show up as a cost or reduction of our assets. When we continue to deplete renewable resources at a rate much faster than they can renew themselves, nowhere does this show up as any kind of negative.

When we continue pumping our waste back into the environment - including greenhouse gases, but also other air and water pollution, garbage and human waste - at a faster rate than it can absorb, nowhere is this recorded as a cost.

GDP, our great de facto measure of progress, counts the short-term benefits from all this exploitation, but ignores its long-term costs. So Milne is right: we have been paying off our economic credit card by racking up debt on our environmental credit card.

But as the still-unfolding global financial crisis reminds us, you can get away with racking up debt only for so long. And with the environment the day of reckoning has already started to dawn. Lift your head from the economic statistics and you see rising average temperatures, the clearing of native forests, the destruction of habitat, the decline in fish stocks, the damage we've done to the Murray-Darling and other river systems and the degrading of our soil.

So far we've managed to keep the economy separate from the environment, but we won't get away with that much longer. Why not? Because, in the words of a former US senator, ''the economy is a wholly owned subsidiary of the environment''.

The economy exists within the natural environment and is dependent on it. Logically, you could have the natural world without an economy - that is, without human activity - but you couldn't have an economy without a natural world.

We can go for a period running our economy at the expense of the environment - plundering its natural resources on one hand, pumping out our waste on the other - but eventually we start to get feedback. The despoiled and depleted ecosystem begins to malfunction, with serious consequences for the continued functioning of our economy.

We get a lot more extreme (and thus expensive) weather events, a rising sea level forces us to move back from the coast, we start running out of native forests and some mineral resources and fossil fuels (making energy and fertiliser a lot dearer), we see the destruction of international tourist attractions such as the Great Barrier Reef,

we have to move agriculture north to where the rain is, but the elimination of fish stocks and degradation of soil makes food production a lot harder and more expensive the world over.

How did we get into the mindset that allowed us to take the environment for granted? Well, mainly it's because economic activity is simply more visible than the environment. And because, until relatively recently, we could plunder the natural world with impunity.

But also because we're wedded to a way of thinking about (and measuring) the economy that, because it has changed little in the past 150 years, simply ignores the environment. Because at the time global economic activity was so small relative to the huge natural world, it made sense for the early economists to treat the environment as a ''free good'' - something so plentiful it comes without cost.

But with the human population having more than trebled since 1927 and the global standard of living also having risen considerably, it's no longer sensible to treat the environment as an ''externality''.

We need a new economic model - and a new way of measuring progress - that recognises the centrality of the environment to our wellbeing and keeps recording and reminding us when we charge things up on our environmental credit card, as Rudd has just done.

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ENVIRONMENTAL ECONOMICS

July 24, 2007

The environment and economic activity

Mankind's economic activity - the production and consumption of goods and services - adversely affects the natural environment in many ways. It causes pollution, the using up of natural resources and the endangering of species. Linked with mankind's economic activity as a cause of environmental damage is the growth in the human population. More people mean more disturbance to the natural environment.

Economic activity will have a damaging effect on the environment no matter what system is used to organise that economic activity, whether it be a market system, command system or traditional system. However, since our economy is organised using the market system, we will focus on the way a market system affects the environment.

Economic arguments for preservation of the environment

There are four main economic arguments in favour of the preservation of the natural environment:
1) environmental assets. Environmental assets (such as clean air, clean water, attractive views, native species and fish in the sea) are just as much economic resources as the resources on which economics traditionally focuses: land, labour, capital and enterprise. Environmental assets are used in the process of production and consumption and are scarce (in limited supply). They are not 'free goods' because they can be used up. (Note: air can't be used up, but clean air can be.) If environmental resources can be used up, they should not be used wastefully, but used with economy ie allocated to their most efficient use. The main difference between traditional economic resources and environmental assets is that traditional economic resources have clearly defined private property rights, whereas environmental assets are common property. The price mechanism (and economic analysis) has difficulty coping with resources that are common property (ie market failure), but this isn't a reason to ignore environmental assets.

2) satisfaction of wants. The goal of economics is to maximise the satisfaction of the community's wants. It's clear that, as well as its material wants (more goods and services), the community has environmental wants (eg clean air and water, attractive views and the preservation of species). If economics ignores environmental wants because the market mechanism finds it hard to cope with them, it will not help maximise the community's satisfaction. It seems that, as the community's material standard of living rises, the value it places on environmental wants ('quality of life') increases.

3) environmental feedback. Much economic activity depends on the preservation of the environment eg effect of environmental damage on tourism; effect of land degradation on farming; effect of water quality on commercial fishing; over-harvesting of fish. As well, some environmental damage generates private costs eg double-glazing of windows to reduce noise pollution.

4) inter-generational equity. Much environmental damage is irreversible (eg clearing of land, building dams, destruction of native forests and extinction of species) and some resources are non-renewable. Current economic activity has implications for the environmental inheritance of future generations.

Economic arguments against preservation of the environment

There are three main economic arguments against preservation of the environment:
1) opportunity cost. Just as some material wants may only be satisfied at the expense of others, so some environmental wants may only be satisfied at the expense of some material wants. This is the correct way to express alleged economic arguments against environmental protection eg banning the logging of native forests will 'destroy jobs'; banning mining in national parks will 'harm the balance of payments'. A higher 'quality of life' may well involve a lower material standard of living. This is not a problem as long as the community understands the consequences of the choices it makes.

2) distributional implications. The costs and benefits of environmental protection may not be shared equally across the community. eg the people who gain most satisfaction from protecting native forests may not be the same people who lose their jobs.

3) the value of labour. Economists seek to make the most economical use of all resources, including man-made capital and labour. But environmentalists are concerned to make the most economical use (or even minimum use) of only natural resources, including energy. Implicitly, they attach little value to capital and labour. Because of the high cost of capital and labour, the market (and market-based intervention) will not produce as much recycling and avoidance of waste of raw materials as environmentalists desire.

Conflict between economic growth and environmental protection

The mainstream economists' view is that there is a conflict between man's desire to increase his material standard of living (ie produce more goods and services) and his desire to preserve the environment. The conflict arises because resources are scarce but wants are infinite. The opportunity cost of faster economic growth is more damage to the environment; the opportunity cost of less damage to the environment is slower economic growth.

There is, however, an exception to this general proposition: instances of government failure. Underpricing of publicly owned resources (eg forests, minerals) and underpricing of publicly provided services (eg electricity and water) can cause misallocation of resources and faster depletion of natural resources or unwarranted environmental damage (eg land degradation through irrigation; need to build more dams).

This is not to say that we face a mutually exclusive choice between either economic growth or environmental protection. It means the community must decide what trade-off it wants to make, what balance it wishes to strike, between these two valid, but conflicting, objectives. Economists are very familiar with trade-offs between conflicting objectives - which is why they developed the concept of opportunity cost.

Normally, the community determines the trade-off it desires between conflicting objectives in the market place via the price mechanism. It votes with its dollars. However, in the case of the conflict between economic growth and environmental protection, the market mechanism is not very effective in providing the community with the trade-off it desires. This is because environmental assets are common property rather than private property. Economic activity generates environmental externalities for third parties which those third parties lack the property rights to do anything about. This market failure means governments have to intervene in the market to ensure that the community's desired trade-off between economic growth and environmental protection is achieved. However, the political process by which governments seek to implement the community's preferences is an imperfect one where the true opportunity costs of choices may not be understood by the community.

Government policies to preserve the environment

Government policies to preserve the environment can be divided into two broad classes: command and control measures and economic instruments.

Command and control. In practice, most environmental intervention takes the form of legislation to prohibit or limit undesirable emissions and other activities. Local government zoning regulations limit polluting activities to certain areas, generally away from residential areas. State environment protection agencies set emission standards and rules for the disposal of waste and prosecute firms which fail to comply.

To the public, politicians and many environmentalists, regulation is the obvious way to respond to environmental problems. Regulation deals with the problem directly.
However, while economists accept that regulation and prohibition may be the only practical responses in some circumstances, they believe that, generally, regulation will not produce the best trade-off between SoL and environmental protection. This is because regulations impose costs without always creating incentives to find cheaper ways of reducing environmental damage.

Economic instruments. In our efforts to preserve the environment, economists favour the use of instruments which harness market forces to the service of the environment, believing that this will achieve the government's environmental objectives with minimum loss of economic growth. Economic instruments aim to 'internalise' externalities and, in the process, create incentives to meet environmental standards in ways that allocate resources efficiently.

Tradable permits. Governments may set an environmental standard which determines an acceptable level of emission, then award (or auction) permits to emit pollution up to the standard. Producers with low costs of controlling pollution have an incentive to do so, so they can sell part of their pollution rights to producers who face high costs of controlling pollution. The effect is to reduce the industry's overall cost of compliance with the standard. Tradable permits have an advantage over pollution taxes because the rate of emission is certain and the price of the permits uncertain, whereas with pollution taxes the rate of tax is certain and its effect on the level of emission is uncertain. Tradable permits can be used for other environmental protection, such as minimising the economic costs of limits on irrigation or fishing catches.

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