We can't divorce the economy from the environment

In case you haven't noticed, a lot of economists are very concerned about Tony Abbott's choice of target for the reduction in greenhouse gas emissions by 2030, to be taken to the international climate change conference at Paris in December.

But if you think that means they believe Abbott's target is too tough and will do too much damage to the economy, you've got the wrong end of the stick.

Most would be likely to believe the target should be more ambitious, and few would be concerned that such a target would do significant economic harm. Conventional economic modelling almost invariably shows the loss of economic growth would be surprisingly small, almost trivial.

They'd be more concerned to ensure the instruments used to achieve the target were those likely to do so at the lowest cost in terms of economic growth forgone. That's why few would have approved of Abbott's decision to abandon Julia Gillard's hybrid carbon tax/emissions trading scheme and replace it with "direct action" payments from the budget.

I'm not claiming every economist thinks this way, of course; just the great majority. There are a few exceptions, naturally, just as you can find the odd scientist who disagrees with the overwhelming majority view that global warming is real and caused by humans.

If you hadn't noticed, consider the leading part played by economists in urging that Australia be at the forefront of international efforts to reduce emissions. First, the various reports by Professor Ross Garnaut​, then the chairman of the independent Climate Change Authority, Bernie Fraser – former Reserve Bank governor and former secretary of the Treasury – then leading non-government experts such as Professor Frank Jotzo​ and Professor Warwick McKibbin, both of the Australian National University.

Note, too, the role of Dr Martin Parkinson, who worked first on John Howard's emissions trading scheme, then on Labor's as the first head of the Department of Climate Change. When Parkinson moved on to become head of Treasury, he was succeeded by another Treasury chap, Blair Comley​.

In fact, there were so many senior Treasury people at the top of the Climate Change department, it was a virtual outpost of Treasury. Both Parkinson and Comley were sacked as one of Abbott's first acts on becoming Prime Minister. Presumably, they were punished for caring too much about global warming.

Remember too that, internationally, both the emissions trading scheme and the carbon and other pollution taxes are inventions of economists. A trading scheme was used with great effect by the Americans in their efforts to reduce acid rain.

Two characteristics of economists stand out when it comes to climate change. First, they accept what the scientists are telling us without argument. Unlike some, they're not disposed to explain to the experts where they're getting it wrong.

Second, they don't believe we can go on thinking "the economy" can be kept in a separate box to "the environment". There are major interactions between the two that can't be ignored.

But, as a journalist, I'm not a member of the economists' union, so to speak, so let me stop describing their majority views and give you mine. My thinking has been influenced by the more radical opinions of yet another economist, Professor Herman Daly, of the University of Maryland.

In defending his latest target, Abbott pledged he'd never put the environment ahead of the economy and jobs. This separate-box thinking is like saying you'd never put staying alive ahead of going to work. Lose your life and whether you get to work or not hardly matters.

Daly says the economy is a "wholly owned subsidiary of the environment". Whether at a national or global level, the economy exists inside the environment – the ecosystem. It's a box inside a circle, if you like.

The point is, all human activity – all our producing and consuming – depends directly on the natural environment. The air we breathe, the water we drink, the food we eat, the clothes we wear, the shelters we build and the energy we use all come from the ecosystem that surrounds us.

Much of our economic activity involves misusing, overusing and abusing the natural environment. We've done great damage to our soil, rivers and aquifers, we've destroyed much habitat and many species, and now the world's overuse of fossil fuels is playing havoc with the climate.

We can be divided into those who want to do what we can to stop the destruction and start on the clean-up, and those who want to put it out of mind and keep on as we are, leaving the bill to be picked up by the next generation.

The latter group will always justify their insouciance by claiming to be putting jobs first. Yeah, sure. For the next few years, at least.

Let me be honest with you. I don't believe those modelling exercises seeming to prove that the economic costs of acting to reduce greenhouse gas emissions will be minor. Such results are a product of the assumptions built into all conventional economic models that, whatever shock the economy is hit by, after 20 years or so, everything will be back to where it would have been.

So, the cost in terms of growth and jobs forgone might be greater than we're being told. But of one thing I'm sure: the longer we leave it, the higher those costs will be.

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All we should be doing to protect land and water

You get the feeling Tony Abbott doesn't lie awake at night worrying about what our economic activity is doing to our natural environment.

In which case, those of us who do care about ecological sustainability – including many Coalition voters and, in all probability, Abbott's successor, whether Liberal or Labor – will have a lot of catching up to do.

This looks like being true of our excessive contribution to global greenhouse gas emissions. But it also applies to the more mundane problems of protecting and restoring our degraded land, water systems and native flora and fauna.

So what should we be doing, even if we aren't yet? The Wentworth Group of Concerned Scientists have produced a paper on Using Markets to Conserve Natural Capital. As the name implies, it has economists' fingerprints all over it.

In many cases the adverse environmental consequences of economic activity aren't reflected in the costs faced by producers and their customers, a classic instance of "market failure" – where the operation of market forces does not produce satisfactory outcomes for the community.

For instance, industries will continue to emit excessive greenhouse gases if there's no market value placed on retaining a stable climate system. And farming may cause land degradation if there's no market value placed on preserving the services the ecosystem provides to society by allowing us to grow food and fibre.

All this is a way of saying that the economy and the environment are inextricably linked but, left to its own devices, the market isn't capable of ensuring we don't stuff the environment and thereby stuff the economy.

Most economists accept this truth, but argue that the least economically costly way to fix the problem is to intervene in markets in ways that harness market forces to the service of the environment.

Often this can be done by getting the social (community-wide) costs of environmental damage incorporated into the private costs borne by producers and consumers. This was the rationale for the Gillard government's policy of using a hybrid carbon tax/emissions trading scheme to put a price on emissions of carbon dioxide and other greenhouse gases.

The concerned scientists accept this logic and propose four market-oriented interventions to reduce future damage to the nation's "environmental assets" and to fix past damage.

Their first proposal is to change the law to impose on all landowners, public or private, a "duty of care" to prevent further damage to their land and water resources. Developing codes of practice would give landowners greater certainty about their obligations.

This reflects the principle that the community's right to a clean and sustainable environment overrides the rights of individuals to unrestricted use of their private property.

Actions of great environmental value that go beyond the standard of care required – such as fixing damage done in the past – could be purchased by governments from private owners using programs that use market-based instruments, such as Victoria's BushTender​ program.

The scientists' second proposal is for the federal government to supplement our efforts to reduce carbon emissions by paying farmers, Indigenous communities and other landowners to engage in "carbon farming" – doing things that improve the rate at which carbon dioxide is removed from the atmosphere and converted to plant material or soil organic matter, where it stays.

If you do this right, it can also be used to restore degraded land. But it involves having a price on carbon so farmers can be rewarded with valuable "carbon offset" certificates.

However, there are risks if the market for carbon offsets isn't properly regulated. "Without complementary land-use controls and water accounting arrangements in place, carbon forests could take over large areas of high quality agricultural land and affect water availability," the paper warns.

"This could create adverse impacts on food and fibre production, and affect regional jobs that are dependent on these industries."

The scientists' third proposal is that we reform the tax system to make it one that doesn't encourage unsustainable practices, but rather encourages the conservation and repair of the natural environment.

"Subsidising or providing economic incentives for fossil fuels makes no sense because it results in increased costs to the environment, costs we will all have to bear sooner or later," the paper says.

It particularly makes no sense when at the same time we're using a tax on carbon to discourage the use of fossil fuels or, as now, spending taxpayers' money to pay for "direct action" to reduce emissions.

And yet our miners and farmers are exempt from paying petrol excise on fuel used off-road. It's the obvious tax break to get rid of – and save the government money.

The paper also recommends establishing a broad-based land tax to provide long-term, equitable funding for paying farmers, Indigenous communities and other land holders to restore and maintain environmental assets in a healthy condition.

Finally, the scientists propose government action to encourage sustainable farming practices. They say farmers need to receive a financial reward for managing their farms sustainably and suppliers, retailers and consumers need to have confidence that their products satisfy rigorous standards.

A farm is sustainable when environmental assets located on the farm are being maintained in a condition that contributes to the overall health and resilience of its surrounding region.

Environmental assets – not all of which will be on farms – include soil, native vegetation, native fauna, water resources (rivers, aquifers, wetlands, estuaries) and carbon.

The financial reward doesn't have to come from the government. Consumers will pay a premium for food that has been grown sustainably, provided they have some assurance this is so.

The government's role is to support the development of voluntary, industry-based sustainable certification of farms and to ensure such schemes are trustworthy. The government should also be active in the development of international sustainability standards so our exporting farmers can participate and benefit.

All very sensible stuff. Now we just need a sensible government.

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Greenery has magic properties

I've just got to get through extended Christmas festivities - and subsequent mopping up - and I'll be off on my hols. What am I doing this year? Same as most years: heading for the bush. This time, we're going to the mountains.

As a denizen of the inner city, I've long had a great desire to get out into the country whenever possible. Get into the grass and trees, where the air is clean and the sleeping seems better.

There's a place we rent not far up the coast that backs on to a national park. I call it Lyrebird Lodge. And even when we go overseas, I often find the country towns beat the big cities.

In recent times, I've been singing the praises of big cities: how efficient they are and how they promote creativity and productivity, particularly in the era of the information economy.

But cities have their dark side and insufficient grass and trees is it. That's more than just a personal preference. Environmental psychologists and others have been gathering impressive evidence of the health-giving properties of greenery.

It's evidence to support the US biologist E. O. Wilson's "biophilia" hypothesis: because humans evolved in natural environments and have lived separate from nature only relatively recently in their evolutionary history, people possess an innate need to affiliate with other living things.

Research published last year found that people who live in urban areas with more green space tend to report greater well-being - less mental distress and higher life satisfaction - than city dwellers who do not have parks, gardens or other green space nearby.

Mathew White and colleagues at the University of Exeter Medical School used a national longitudinal survey of households in Britain to track the experience of more than 10,000 people for 17 years to 2008.

They found that, on average, the positive effect on well-being was equivalent to about one-third of the difference between being married rather than unmarried and a 10th of the effect of being employed rather than unemployed.

A different study followed the experience of more than 1000 people over five years, in which time some moved to greener urban areas and some to less green areas. The results showed that, on average, people who moved to greener areas felt an immediate improvement in their mental health. This boost could still be measured three years later.

"These findings are important for urban planners thinking about introducing new green spaces to towns and cities, suggesting they could provide long term and sustained benefits for local communities," the lead author of the study said.

A study from Canada began by summarising all the various benefits from contact with nature that other research had found: it can restore people's ability to pay attention, improve concentration in children with attention-deficit hyperactivity disorder, and speed recovery from illness. It might even reduce the risk of dying.

Yet another study notes that the first hospitals in Europe were infirmaries in monastic communities where a garden was considered an essential part of the environment in that it supported the healing process.

This study of studies, from Norway, says: "In most cultures, both present and past, one can observe behaviour reflecting a fondness for nature. For example, tomb painting from ancient Egypt, as well as remains found in the ruins of Pompeii, substantiate that people brought plants into their houses and gardens more than 2000 years ago."

Many studies find health benefits from contact with nature. The Norwegian paper says a key element in this may be nature's stress-reducing effect. Stress plays a role in the causes and development of cardiovascular diseases, anxiety disorders and depression.

Contact with nature may help "simply by being consciously or unconsciously pleasing to the eye".

Office employees seem to compensate for lack of a window view by introducing indoor plants or even just pictures of nature. One study found that having a view to plants from the work station decreased the amount of self-reported sick leave.

One of my favourite blog sites, PsyBlog, conducted by the British psychologist Dr Jeremy Dean, notes research estimating that people now spend 25 per cent less time in nature than they did 20 years ago. Instead, recreational time is often spent surfing the internet, playing video games and watching movies.

But this is more up my line: Dean reports a study finding that taking group walks in nature is associated with better mental well-being and lower stress and depression.

The study evaluated a British program called Walking for Health, and involved nearly 2000 participants, divided into two matched groups of those who took part in the walks and those who did not.

The walks, which extended over three months, combined three elements, each of which you'd expect to make people feel better: walking, being in nature and being with other people.

Those who seemed to benefit most were those who had been through a recent stressful life event, such as divorce, bereavement or a serious illness.

"Our findings suggest that something as simple as joining an outdoor walking group may not only improve someone's daily positive emotions, but may also contribute a non-pharmacological approach to serious conditions like depression," one of the study's authors said.

You beaut. When I get to the mountains, I'm hoping to do a lot of bush walking.

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Don't forget our other environmental problems

There's a hidden danger in the ascendancy of climate-change denialism in Canberra. It won't last - denials of reality can never last - but while it does it's an enormous distraction.

The obvious cost is that the longer we leave it to get serious about playing our part in reducing global greenhouse gas emissions, the more expensive and disruptive our efforts will need to be.

But there's also a hidden cost. The more time we spend arguing about climate change, the more our attention is distracted from the many other threats to the economy and our way of life coming from other environmental problems.

We've been conscious of the many other ways economic activity has been degrading our natural environment for decades. We've been working to reduce that degradation for decades, and the need for action has been clear to people on all sides of politics.

What's more, as the Wentworth Group of Concerned Scientists acknowledges in a report published last Thursday, we've made progress in some areas. Air pollution controls have given us much improved air quality in our cities and water pollution controls have created cleaner waterways and restored the health of coastal estuaries.

Controls over land clearing, the creation of additional national parks and investments to manage fire and restore native vegetation on private land have given greater protection to our biodiversity.

New farming practices, such as "minimum till" and landcare, have improved soil structure, increased vegetation and reduced soil erosion.

Overused water resources, such as the Great Artesian Basin, have started to recover following the agreement in 2004 laying the foundation for long-term sustainable management of our freshwater resources.

And incentives to generate renewable energy are driving the transformation of energy markets.

But despite these improvements, the Wentworth Group reminds us that the most recent official survey, the State of the Environment report, in 2011, found other environmental assets are still in poor condition or are getting worse.

Despite all we've done and spent to repair the damage to our land, for instance, the report found the trends for many indicators remain adverse.

On rivers, wetlands and estuaries, many catchments remain in a degraded condition. Within many drainage basins, river condition is still affected by inadequate environmental flows, pollution and changes in ecological processes.

"In Australia's food bowl, the Murray-Darling Basin, 20 of the 23 river systems are in a poor or very poor condition," the group says. And despite the Howard government's appropriation of $10 billion in 2008, the Gillard government's basin plan in 2011 won't restore these rivers to a healthy condition.

The first State of the Environment report in 1996 described the loss of Australia's biodiversity as "perhaps our most serious environmental problem". Since then, the rate of land clearing, a primary driver of species extinction, has slowed.

Even so, land clearing for agriculture, mining, coal seam gas and urban development is continuing to fragment and degrade native vegetation. In the decade to 2010, clearing of native vegetation across Australia still averaged a million hectares a year.

"Clearing of native vegetation, when combined with pollution and over-extraction from waterways, the introduction of weeds and feral animals, and unsustainable fire practices, has resulted in the listing of over 1600 species of native plants and animals as threatened with extinction," the group says.

The condition of the Great Barrier Reef has declined over the past two decades. Since 1986, on average across the reef, hard coral cover has declined by half.

It's surely not saying anything new or controversial that our economy - and our way of life - depend on our preserving a healthy natural environment. Healthy waterways are needed for swimming, fishing, drinking and irrigation, and to allow us to recover from floods and droughts.

Healthy soils store carbon and nutrients, support production of food, fibre and raw materials, store and filter water, and host rich biodiversity.

Healthy native vegetation protects river corridors, filters water, stores carbon, provides wood, protects against erosion, gives people access to nature, manages salinity and provides habitat for plants and animals.

Healthy coasts, estuaries and beaches provide habitat, buffer the effects of storms and give people a place to enjoy nature. Healthy oceans provide food, recreation and habitat for marine plants and animals.

So there's no either/or. If we want the economy to stay healthy we must restore the health of the environment. Should we continue degrading the environment it will rebound on the economy, causing great loss and disruption.

We need to modify our economic activity to reverse the damage we're doing to the environment. This will involve some cost and some frustration for business people who want to be free to make a buck however they please and let others worry about the eventual environmental costs.

But the good news from the Wentworth Group is that if we introduce the right policies the economic cost need not be great. It offers a five-point "blueprint for a healthy environment and a productive economy" on which it will elaborate next year.

The trick is that productivity - how much we make relative to how much we use - is the key to long-term economic growth and a pillar of ecological sustainability. People can create greater value while using less materials and energy, with less impact on the environment.

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Many reasons for the impossible: power demand falling

We know the two great certainties in life are death and taxes, but many thought there was a third: the inexorable rise in consumption of electricity. As the population grew and each of us got a little more prosperous each year, we'd use more power. The mighty electricity industry was built on that certainty.

Except that electricity consumption has been falling for the past four years. To say this has taken the industry by surprise is an understatement. For well over a century – even during the Great Depression – the quantity of electricity used in Australia each year was greater than the year before.

It took the industry and its regulators two or three years to accept the trend was more than just a hiccup on the ever-upward path, which delay probably added to the decline.

There are few aspects of the economy – global or national – where change is more significant, more diverse or more interesting than energy supply and demand – where energy covers coal, gas (conventional and unconventional), petroleum, wind, solar and other renewables. Expect to hear more from me on the topic.

But there are few questions more interesting than exactly why the unthinkable, a fall in electricity consumption, has come about. Short answer: a surprisingly large combination of reasons, although Tony Abbott's crusading against the carbon tax must get some of the credit.

The best attempt to quantify the various factors involved comes from a report prepared by Dr Hugh Saddler, an energy expert with the Pitt and Sherry consultancy, for the Australia Institute. Saddler's modelling covers the years to 2012-13, but we know from reporting this week by Origin Energy and AGL that the fall continued in 2013-14.

Saddler focuses on energy produced and consumed from the National Energy Market, which covers the five eastern states and the ACT, but the decline is occurring also in Western Australia. After peaking in 2008-09, consumption from the national market in 2012-13 was down by almost 8 terawatt hours, or 4.3 per cent.

But that's only half the story. Just as important as why demand has fallen is why it hasn't continued growing, as continued growth in the population and the economy would lead us to expect. Saddler estimates that had demand continued growing from 2004 at its average rate of growth over the previous 20 years (2.5 per cent a year) it would have been 37 terawatt hours more than it actually was in 2012-13.

This shortfall is equal to the output of almost 5000 megawatts of coal-fired generation capacity, the combined capacity of the Bayswater and Eraring power stations in NSW, or Loy Yang A and B and Hazelwood in Victoria.

"All of the decline in consumption has been at the expense of coal-fired generators, with the result that many are now barely profitable," Saddler says.

Greenhouse gas emissions fell by 9.2 megatonnes of carbon dioxide equivalent, about 2 per cent of Australians total annual emissions.

So what has caused our power consumption to fall rather than rise? The biggest single reason is the introduction from the late 1990s of regulations to increase the energy efficiency of refrigerators, freezers and many other residential and commercial appliances, and to increase the energy efficiency of new buildings.

Saddler estimates this explains 37 per cent of the 37 terawatt-hour shortfall from what might have been.

The next biggest part of the explanation is structural change in the economy away from electricity-intensive industries. Over the year to September 2012, three major NSW industrial power users – Port Kembla steelworks, Kurri Kurri aluminium smelter and the Clyde oil refinery – were partly or completely shut down. This explains 10 per cent of the 37 terawatt-hour shortfall.

The evidence also suggests that power consumption by other major industrial users has been little changed over the three years to 2012-13. Saddler estimates that this failure to grow explains a further 14 per cent of the shortfall, taking the total contribution from structural change to almost a quarter.

The next most important part of the explanation is the response of electricity users, particularly residential users, to the higher prices they were being charged. Saddler finds that after 2010 there was "an abrupt change in consumer responsiveness to higher prices".

This was the time when the possible effect of a carbon tax on electricity became a major political issue thanks to the efforts of Abbott and his "sceptic" mates. At the time, retail electricity prices were rising spectacularly, mainly because of a huge increase in spending on upgrading the transmission and distribution networks (poles and wires) to cope with an expected ever-rising peak demand on hot summer afternoons.

Saddler finds evidence to support his argument that all this carbon-tax-related fuss about the high cost of electricity caused many households to be a lot more conscious of what was happening to their power bills and to respond by finding ways to cut their usage – to the extent that they "have managed to completely offset the effect of higher prices on their household budgets by reducing consumption".

This highly unusual jump in the short-run "price elasticity" of electricity explains 19 per cent of the shortfall, he estimates.

He further calculates that the growth in output from rooftop photovoltaic solar and other small, distributed generators accounts for about 13 per cent of the shortfall. This, of course, is a fall in the demand for electricity supplied by the major, mainly coal-fired generators, not a fall in the use of electricity as such.

Saddler notes that for the past three years the annual peak demand has been falling, not increasing, despite the huge investment to cope with ever-rising peaks. When will this additional capacity, which is now built and for which all electricity consumers are paying – and will continue to pay for some years to come – be required, if ever, he asks.

Good question.

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Ignoring climate change will cost the economy

Sometimes I fear Australia has decided to go backwards just as the rest of the world has decided to go forwards. Take climate change. If the repeal of the carbon tax gets through the Senate this week there will probably be celebrations in the boardrooms of all the business groups that lobbied so hard for its removal.

But if they imagine the lifting of this supposedly great burden on them and the economy will mean it's back to business as usual, they'll soon find out differently.

They may have rolled back the economic cost of doing something about climate change, but now they'll face the increasing cost of not doing something about it. As Martijn Wilder, an environmental lawyer with the Baker & McKenzie law firm, finds in a new report for the Committee for Economic Development of Australia, we're going to be hit from all sides.

There are the costly physical effects of climate change we've already started experiencing, there are the consequences for us of measures our trading partners are starting to take to limit their emissions, there's the growing reluctance of foreign institutions to fund new coalmines and power stations and there's the threat to our fossil fuel industries from ever-cheaper renewable energy.

In case anyone's forgotten, Wilder reminds us that the physical effects of climate change include a rise in the sea level, acidification of the ocean, change in rainfall patterns and an increase in the frequency of natural disasters, including droughts. Extreme weather may lead to more bushfires, while heavy rainfall and cyclones may lead to flooding.

Do you think all that generates no costs to business, no disruption to the economy? Take the Queensland floods in 2011, Wilder says. They not only hit insurance company earnings, they also halted production at various coalmines. This forced up world coal prices, with adverse effects for industries reliant on coal.

Since we've always had cyclones and floods, no one can say climate change caused this particular disaster. But the scientists tell us events such as these will become more frequent. And the insurance industry's records tell us the number of catastrophic weather events is already increasing, with the economic losses associated with weather rising.

As for the idea there's no hurry in preparing for problems that may not become acute until later this century, consider this. Had a levee to protect Roma, in Queensland, been built in 2005, it would have cost $20 million. Since it wasn't built, $100 million has been paid out in insurance claims since 2008 and a repair bill of more than $500 million incurred by the public and private sectors since 2005.

This sort of thing is happening in other countries, too. Hurricane Sandy, in October 2012, caused widespread damage in New York, crippling electricity infrastructure and leaving downtown Manhattan without power for four days. The record-breaking storm surge alone cost the local electricity company $500 million and New York businesses $6 billion.

Perhaps such events explain why many other countries are moving forwards rather than backwards in their efforts to combat climate change. Australia's coal and natural gas industries won't escape being affected by tougher regulation of the use of fossil fuels in the countries to which they export.

While Europe has had a weak emissions trading scheme since 2005, the Chinese are trialling such schemes in six provinces. South Korea, one of our main trading partners, is to introduce a scheme next year. The US is taking direct action to cut power station emissions.

China is moving to limit coal to 65 per cent of energy consumption by next year and has banned new coal power generation in Beijing, Shanghai and Guangzhou. Wilder says this will cut demand from the largest importer of Australian coal and thus affect the value of big mining and loading assets in Australia.

The more the rest of the world seeks to reduce its use of coal and other fossil fuels, the more Australian businesses need to contemplate the possibility of their mines becoming "stranded assets" - assets that suddenly become unprofitable and so lose their value.

Until recently, foreign investors and financiers haven't taken climate-change risk into account. Now they're starting to worry not just about the morality of emitting more greenhouse gas, but the risk that investments in new mines and power stations will lose their value before they reach the end of their useful lives. The change started with international agencies such as the World Bank, but is spreading to pension-fund investors.

Then there's the threat from the rise of renewable energy. China's goal of becoming a world leader in renewable energy has made it the world's largest maker of renewable energy equipment and the single largest destination for investment in renewables.

Wilder says renewables are reaching a "point of disruption" and will displace coal and gas power stations in many parts of the world. In Australia, the sharply rising price of gas is increasing the cost-competitiveness of renewables.

"Unlike natural gas and coal, the input for renewable energy is not subject to the volatility of global energy markets and with renewable costs continuing to decline, renewable generation represents a safer long-term investment," he says.

I know, let's get the government to put the kybosh on renewables. That would be a smart move.

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Botched reform causes higher power prices

There's no subject more likely to stir people up than rising electricity bills. With prices roughly doubling since 2007, that's hardly surprising. But why have prices risen so fast? And will they keep rising?

It has suited various business lobbies and Coalition politicians - federal and state - to leave people with the impression the main reason is the carbon tax and the renewable energy target, which requires that 20 per cent of Australia's electricity come from renewable energy sources by 2020.

In truth, the price rises started well before these measures took effect and they explain only a small part of the increase. Which suggests the politicians will suffer yet another loss of credibility when eventually (and stupidly) the carbon tax is abolished and the renewables target is dropped, as seems on the cards, but power prices don't seem to fall by much.

The more important reasons were given by Professor Ross Garnaut, of the University of Melbourne, in a recent speech. Here's my version of his explanation.

One part of the reason is that more people have been using renewable energy and this reduced their demand for conventional electricity from the grid, which is produced mainly by coal-fired generators, of course.

Apart from all the wind turbines, governments - federal and state, Coalition and Labor - have offered incentives to people to incur the significant expense of installing rooftop solar power systems.

The most generous of these incentive schemes have been abandoned but, at the same time, the cost of photovoltaic systems has been falling rapidly, partly because of advances in technology, partly because more purchasers mean greater economies of scale.

The most important economic characteristic of renewable energy is that once you've incurred the high "fixed cost" of installing a system, the "variable cost" of using the system to produce more energy is negligible. Sunshine is free. So once you've got a system, you use it.

A second important part of the reason for rising power prices is that many businesses and households have reacted to the rising price by being more economical - less wasteful - in their use of electricity.

Another factor (one many economists tend to ignore) is that all the talk about the need to reduce emissions of carbon dioxide to stop climate change, and all the talk about how much power we waste, has made more firms and householders waste-conscious. Some people are being careful in their use of electricity as a self-interested response to its rising price, while others - including businesses - are doing it from a sense of duty to society.

By now, I trust, a big red light is flashing in your head. If people are using less power from the grid because more of them are collecting their own and more are reducing their wastage of electricity, doesn't that mean demand for conventional power is falling?

Indeed it does. According to figures from the Grattan Institute, since late 2009 electricity demand in eastern Australia has fallen by about 7 per cent.

But hang on, is this guy saying the price of electricity has gone up because demand for it has gone down? Isn't it supposed to be the other way round? Isn't a fall in demand supposed to lead to a fall in the price?

Well, assuming no change in supply, yes it is. So you're right to be to be puzzled. The relationship I've described between price and demand is, as an economist would say, "perverse".

But why? Because, as Garnaut explains, we've stuffed up the deregulation of the electricity market. (Moral: as we're being reminded by the plan to "deregulate" university fees, if you deregulate or privatise without knowing what you're doing you can make things worse rather than better.)

Before the reform process began, each state had its own, government-owned electricity monopoly, with little trade between the states. From the late 1980s it was decided to break the integrated state monopolies into their component parts - generation, transmission, distribution and retailing - and form one big eastern Australian electricity market with as much competition and as little monopoly as possible.

The power stations were separated into individual businesses - some of which were privatised, particularly in Victoria - and made to compete in a highly sophisticated "national" wholesale market for electricity. Garnaut says this has worked well, with competition keeping the wholesale price low in response to the reduced demand.

But transmission (high-voltage power lines) and distribution (local poles and wires to the premises) are natural monopolies. That is, it's not economic to have more than one network. So whether these businesses are publicly or privately owned, the prices they charge have to be regulated to prevent them overcharging.

Trouble is, Garnaut says, we've done this by fixing the maximum rate of return the businesses are allowed to earn on the capital they have invested. Economists have known for 60 years that this always causes problems because it's so hard to pick the right rate of return.

If it's too low it leads to underinvestment in the physical network, causing blackouts. If it's too high, however, it leads to overinvestment in the network at the expense of business and household customers.

But as well, when monopoly businesses that are guaranteed a certain rate of return suffer a loss of demand, the regulator has to allow them to restore their profitability by raising their prices.

Another red light flashing? Surely if you keep responding to a fall in demand by raising prices, this will lead to a further fall in demand (particularly as the cost of renewable energy keeps falling) and the whole thing will keep going round and round and getting worse and worse.

Just so. People in the know call it a "death spiral". One day soon the regulators of the regulators - aka federal and state governments - will have to step in and call the madness to a halt. Until then, prices will keep rising.

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Our econocrats' vision is too narrow

Part of my job is making sure readers are kept fully informed about the messages our top econocrats are trying to get across to the public. They're usually much franker and clearer than the spin we get from our political leaders.

But just because I report their views faithfully doesn't mean I always agree with them.

As it related to the outlook for the economy, the message in the speech Treasury secretary Dr Martin Parkinson delivered last week fitted well with the messages we've been getting from Glenn Stevens and Dr Philip Lowe, of the Reserve Bank.

It's a warning that, between the slowdown in our rate of productivity improvement, the expected continuing fallback in mineral export prices and the reversal of the "demographic dividend" delivered by the baby boomers, "we face a significant challenge in maintaining the rate of growth in living standards that Australians have come to expect".

Specifically, Parkinson projected that, even if we assume labour productivity grows at its long-term average, the other two factors would cause real income per person to grow by just 0.7 per cent a year over the decade to 2023-24, rather than the 2.3 per cent "to which Australians have become accustomed".

So over 10 years our present annual real income of $63,600 per person would grow only to $69,000, rather than $82,000, leaving us only $5400 a year better off, rather than the $18,400 a year to which we've become accustomed.

To keep average incomes growing as fast as we've come to expect will require us to double our present rate of productivity improvement to 3 per cent a year.

Sorry, but I very much doubt we'll be willing to make the many controversial reforms needed to achieve such a transformation. More to the point, I'm not convinced we should.

The admonitions we get from our econocrats are far too relentlessly materialist and, hence, mono-dimensional. Whatever their professed "wellbeing framework", when the chips are down their advice is to make maintaining the rate at which our material standard of living is rising our highest priority, if not our only priority.

We're always being reminded of the pecuniary price to be paid for worrying about foreign ownership, or saving family farming or preserving the weekend. But the warnings never run the other way: the greater personal stress or relational problems or loss of leisure or greater social disharmony that could accompany going all out to maximise economic growth.

No one knows better than I do that you can't say everything you want to say in the time allotted for a speech or the space allotted for a column. But, even so, some obvious caveats and qualifications almost never rate a mention.

The most obvious is the environment. What reason is there to believe acting to maintain our rate of growth won't do significant further damage, even unacceptable damage to the ecosystem? How do we know continuing climate change - a problem about which we've decided not to make a genuine contribution to international efforts to combat - won't negate our productivity-raising efforts?

How can we talk about capturing a big share of the growth in Asia's demand for Western foodstuffs without mentioning climate change?

To be fair, their present political masters are so down on the environment that our econocrats aren't free to speak on the subject. Parkinson is facing the sack for having been chief designer of the emissions trading scheme (including the Howard government's version) and his successor - an outstanding Treasury officer - has already had the chop. It's a wonder Professor Ross Garnaut isn't behind bars - or at least had his office raided by ASIO.

Another obvious but never-mentioned caveat is the distribution of all this increased income. It's all very well to talk about increasing the average income, implicitly assuming the extra income will be shared in line with the existing distribution. Our experience of income growth over the past 30 years is that a disproportionate share ends up in the hands of the people at the top.

Why no mention of this when ordinary workers are being asked to support reforms that could cost them their jobs?

More basically, how do the econocrats know we'd find a slower rate of growth in our affluence bitterly disappointing? They don't. Their confident claims that we would are based on their faith in materialism, not evidence.

Most of us are condemned to spend 40 years of our lives working 40 hours a week. Why do econocrats never wonder whether making that work more satisfying would do more for our "wellbeing" than making extracting more productivity from our labour the only priority?

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What if growth slowed to a trickle and no one cared?

It is the professed belief of almost every economist, business person and politician that Australians require governments to achieve maximum improvement in their material standard of living. I'm not sure that's true - but we're about to find out.

Of late the econocrats have been warning that, unless we undertake major reform, national income will grow a lot more slowly in the coming decade than it did in the past one. According to Dr David Gruen, of Treasury, gross national income per person grew at an annual rate of 2.3 per cent over the past 13 years, but may grow by only about 0.9 per cent over the coming 10 years.

This projected slowdown is explained mainly by the switch from rising to falling prices for our mineral exports - that is, it focuses on income rather than production. It implies only a small slowdown in the underlying rate of growth in gross domestic product (GDP) per person, being based on the assumption that we maintain our long-run rate of improvement in the productivity of labour - an assumption some may question.

Reserve Bank deputy governor Philip Lowe says that, if we don't achieve a substantial improvement in productivity, "we will need to adjust to some combination of slower growth in real wages, slower growth in profits, smaller gains in asset prices and slower growth in government revenues and services".

So far, these supposedly dire warnings have met with a giant yawn from the public. And, assuming the slowdown comes to pass, I'm not convinced the public will notice it, let alone care. I doubt that we will retain the national resolve to implement the reforms economists say we need to keep incomes growing strongly, nor am I sure the economists' favourite prescription would work. As for myself, I think slower growth could be a good thing.

Would the punters notice? Maybe not. Despite a decade of above-average growth in real income per person, most people would swear that, whoever had been benefiting from the resources boom, not a cent of it had come their way.

For at least seven years, the popular perception has been that people are struggling to keep up with the cost of living - that is, living standards are slipping. And get this: politicians on both sides, who profess to believe that rising living standards are governments' raison d'etre, have fallen over themselves to agree - contrary to all the objective evidence - that times are tough.

Clearly, they believe failing to agree that times are tough is more likely to get them tossed out than falsely confessing to have failed in their supposedly sacred duty to keep living standards rising.

You may object that the punters' failure to perceive that their living standards have been rising may not stop them correctly perceiving that living standards are now rising only slowly. But consider the United States, where real median household income has been flat to down for the past 30 years because almost all the real income growth has been appropriated by the top few per cent.

Have decades of failure to enjoy rising material comfort caused the American electorate to rise up in revolt? Not a bit of it.

It's significant that the advocates of eternal growth never promote it in terms of rising affluence, but always in terms of the need to create jobs. Barring recession, there's no suggestion production won't be growing fast enough to hold unemployment at about 5 per cent over the decade.

Of course, a recession that led to rapidly rising joblessness would undoubtedly cause great voter disaffection, but that's not what we're talking about.

While it may be possible for the economic, business and political elite to agree their precious materialism has sprung a leak and that something must be done, that doesn't mean they could agree on major reform; it's more likely to lead to continued rent-seeking at the expense of other interest groups. If my share of the pie is bigger, what's the problem?

Economists have no evidence to support their fond belief that the burst of productivity improvement in the second half of the 1990s was caused by micro-economic reform. But even if you share their faith, it's a dismal record: if you undertake sweeping reform of almost every facet of the economy then, 10 to 15 years later, you get no more than five years of above-average improvement. What's more, all the big reform has already been done.

With the global ecosystem already malfunctioning under the weight of so much economic activity, it's time the age of hyper-materialism came to an end and we switched attention from quantity to quality.

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How we lost our way on climate change - sorry, kids

I don't have grandchildren but I'm hoping for some, someday, so this column is for them. I want you to know that although, in the mid-teens of this century, Australians elected a government that wasn't genuine in its commitment to combating the effects of climate change, and that even abolished the main instrument economists invented for that purpose, I never accepted this complacency.

Partly because that government's predecessors had done such a poor job of introducing effective measures - and even a party known as the Greens played its cards all wrong - the nation lost its resolve and allowed its original bipartisan commitment to decisive action to be lost.

The minority of people who doubted the scientists' advice that the globe was warming combined with libertarians - who, as a matter of principle, oppose almost all arguments for intervention by government - to persuade the Liberals to break with bipartisanship.

If the Liberals under their new leader, Tony Abbott, had opposed action against climate change outright, Liberal voters who accepted the need for action would have been forced to choose between the party and their beliefs.

Instead, Abbott focused his opposition on the Labor government's main instrument for gradually bringing about a reduction in emissions of carbon dioxide and other greenhouse gasses, an emissions trading scheme whose price would be fixed by the government for the first year or two.

Abbott insisted the Coalition remained committed to Australia's international undertaking to reduce emissions by at least 5 per cent below 2000 levels by 2020, and by 15 per cent or 25 per cent provided other countries were taking comparable action.

The big difference was that, rather than using Labor's "carbon tax" to achieve the target, the Coalition would rely on "direct action", such as offering monetary incentives to farmers and others to reduce emissions.
This left Abbott free to run an almighty scare campaign about how Labor's "great big new tax on everything" would greatly increase the cost of living for ordinary Australian families and impose big costs on Australian businesses, which would impair their ability to compete.

Abbott associated with outright climate-change deniers and said things that seemed to brand him as one of them, while always adding, sotto voce, that he accepted human-caused climate change and the need to do something about it.

Apart from attracting voters away from Labor and its frightening carbon tax, the result of making climate change an issue of party dispute was to give Liberal supporters a licence to stop worrying about climate change - if the leaders of my party aren't worrying, why should I? - while providing a fig leaf for those Liberals who retained their concern.

The business lobby groups' initial position had been: if it's inevitable we do something, let's get on with it and make future arrangements as certain as possible. But with their side of politics inviting them to put their short-term interests ahead of the economy's long-term health, most business people found it too tempting to resist.

To be fair, some businesses stuck with their schemes to reduce their own emissions and some pressed on with repositioning their business for a world where the use of fossil fuels had become prohibitively expensive as well as socially disapproved of.

You will find this hard to believe, but in the mid-teens, it was still common to think about "the economy" in isolation from the natural environment which sustained it. Economists, business people and politicians had gone for two centuries largely ignoring the damage economic activity did to the environment.

The idea that, eventually, the environment would hit back and do great damage to the economy was one most people preferred not to think about. At the time, it was fashionable to bewail the lack of action to increase the economy's productivity. Few people joined dots to realise the climate was in the process of dealing a blow to our productivity, one that would significantly reduce the next generation's living standards.

At the time, we rationalised our selfishness - our willingness to avoid a tiny drop in our standard of living at the expense of a big drop in our offspring's - by telling ourselves half-truths and untruths about the global nature of climate change.

We told ourselves there was nothing Australia could do by itself to affect climate change (true), that at the Copenhagen conference in 2009, countries had failed to reach a binding agreement on action to reduce emissions (true) and that the world's two biggest polluters, China and the US, were doing nothing much to reduce their emissions.

We had no excuse for not knowing this was untrue because successive government reports told us the contrary. One we got just before the carbon tax was abolished, from the Climate Change Authority, said the two superpowers were stepping up their actions to reduce emissions. "These measures could have a significant impact on global emissions reductions," it concluded.

I recount this history to explain how my generation's dereliction occurred, not to defend or justify it. We knew what we should have done; we chose not to do it. I never fell for any of these spurious arguments.
Did I ever doubt that climate change represented by far the greatest threat to Australia's future economic prosperity? Never. Should I have said this more often, rather than chasing a thousand economic will-o'-the-wisps? Yes.

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Death of man who inspired the emissions trading scheme

The man who first thought that governments should auction off rather give away the rights to such things as broadcast spectrum or taxi licences, and who started the thinking that led to the invention of emission trading schemes, died last week at the age of 102.

He also inspired the joke economists tell each other as a warning against reading too much into statistics: "If you torture the data long enough, it will confess."

He was British-American economist Ronald Coase (rhymes with rose), of the University of Chicago, who in 1991 was awarded the Nobel prize for his trouble.

The first of his discoveries came in 1937 and launched a whole sub-field of economics, but now seems pathetically obvious. He asked why firms exist. Why do capitalists employ people to make or do lots of things for them, when most of those things could be bought from the market?

Why are many of the things produced by a "market economy" actually produced inside firms - some of them employing many thousands of people - where employees have to do as they're told by the boss and the rules of the market don't apply?

His answer was that buying things from others in the marketplace involved hidden costs, which he dubbed "transaction costs" - the cost of finding the best deal, checking quality, negotiating a price, writing a watertight contract and then, if necessary, enforcing that contract.

Business people would do things "in house" whenever this was cheaper than incurring all the transaction costs involved in buying from the market. (But once you start thinking like that, it eventually occurs to you that there will be times when it's cheaper to "outsource" the provision of services you formerly provided in-house.)

In a paper on the US Federal Communications Commission, written in 1959, Coase argued that the transaction costs faced by the commission in deciding which of the many applicants for a broadcast licence would make the greatest contribution to the economy were impossibly high.

But this did not justify the commission continuing to give away licences to whomever it saw fit. It would be better to replicate market conditions by auctioning the licence to the highest bidder. This way, the licence would go to the firm most likely to put the licence to its "highest-valued use".

Do you see how this led to the invention of the tradeable permit? Say the government is trying to limit to a certain level the catching of a particular type of fish, or limit emissions that cause acid rain, or those that cause climate change.

It issues permits for firms to catch or emit up to that level. Because this level is lower than the market would otherwise produce, it has thereby increased the item's "scarcity value", allowing firms with permits to get away with charging a higher price.

If it gives the permits away to firms, it's effectively allowing them to levy a tax on their customers. If it auctions the permits, it's ensuring the proceeds of the disguised tax are collected by the taxman.

The firms that get the licences by bidding highest can be expected to pay no more than allows them to continue profitably producing whatever it is. They'll also have a monetary incentive to find ways to continue producing their product while generating fewer emissions.

And by allowing firms to trade their permits - say, to sell any they discover they don't need - you increase their incentive to find ways to reduce their emissions, as well as ensuring the burden of reducing emissions is shifted to those firms that can do so at the lowest cost.

But Coase's greatest claim to fame came from a paper he wrote in 1960, The Problem of Social Cost, which became the all-time most cited paper by other academic economists and made him the darling of libertarians and free-market conservatives.

Social costs - also known as "negative externalities" - are costs imposed on third parties by transactions between people in the marketplace. Say I run a factory that imposes a lot of noise on my neighbours, emits fumes and puts gunk into the local river. Since this polluting costs me nothing it represents costs borne by the community, not by me and my customers. It's a cost that's "external" to the market.

What should governments do about this problem? The traditional answer was for them to protect the victims of this action by imposing restrictions or obligations on the perpetrator.

But Coase argued that, simply by clarifying the property rights involved, governments could leave it to the affected parties to negotiate a satisfactory solution. Again, the solution could be left to the market.

What's more, this ability to reach a privately negotiated solution meant it didn't matter to which side the government awarded the property rights. The libertarians loved this so much they called it the "Coase theorem".

What they liked was that it appeared to justify a greatly reduced role for governments in solving environmental problems. That it would also favour the rich and powerful was, of course, purely coincidental.

Over the years, however, Coase made it clear the libertarians had taken him out of context. For one thing, he'd argued that to whom you awarded the property rights made no difference from the perspective of economic efficiency. Obviously, it made a big difference from an equity or fairness perspective.

And his theorem had been based on the explicit assumption that the transaction costs involved in negotiating a solution were negligible. Not surprisingly, the man who had discovered transaction costs thought that, in the real world, transaction costs would be significant and often prohibitive.

Is it easy for all the people affected by a factory's pollution to get together and negotiate a satisfactory solution with a rich factory owner? Sounds to me like a case for government intervention.

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Forest logging propped up by conservationists

Everyone knows the environment and the economy are in conflict; that any effort we make to protect the environment comes at the expense of profit and jobs.

So, for instance, everyone knows that if the community wants to see restrictions on the logging of native forests in Tasmania, it's only reasonable for the government to compensate the industry and its workers for their loss of livelihood.

And this is precisely what the federal government has been doing for years. As long ago as 1989, the Tasmanian forestry sector received $42 million under the Helsham agreement. Under the Tasmanian regional forestry agreement of 1997, it got $110 million and under the Tasmanian community forest agreement of 2005, it got $203 million.

Under the Tasmanian forestry agreement - negotiated by the industry, unions and conservation groups, and finalised earlier this year - it will get another $300 million. Two weeks ago, as the battle for Tasmanian votes hotted up, Labor announced that the release of some of this money would no longer be conditional on the preservation of certain forests.

The national native forest industry has been doing it tough in recent years. Over the period from 2009 to 2011, removals of "roundwood" (logs) were 30 per cent below the average of the previous 18 years. And woodchip exports fell by a third between 2008 and last year.

The fall in production and exports has bankrupted the native hardwood industry's largest producer, Gunns Limited, and led to the closure of numerous processing facilities around the country.

State forest authorities have also recorded substantial losses. Forestry Tasmania recorded a net loss before tax and other items of $64 million over the four years to last year, an average of $16 million a year. The Forests Corporation of NSW recorded a total loss of $85 million over the same period, an average of $21 million a year.

The way the industry likes to tell it, it was hit by the banning of logging in certain forest areas and the tightening up of forest management practices. But while it was recovering from this blow, it was hit first by the global financial crisis and then by the high dollar (which has reduced earnings from exports and reduced the price of the imported forest products it competes against).

Talk about bad luck. Clearly, the industry just needs a bit of government help to keep it on track until things get back to normal.

And, indeed, all of the parties to the latest Tasmanian forestry agreement believe it will deliver "an ongoing, vibrant forestry industry in Tasmania based on native forests and, increasingly in the future, plantation".

There's just one problem: this is wishful thinking. The industry's story uses the environment as a convenient whipping-boy to draw attention away from its long-term structural decline - and probably demise.

The chequered story of the native forest industry and the way it has sucked ever-growing subsidies from governments can be deduced (as I have done) from a report prepared earlier this year by Andrew Macintosh, of the Australian National University, for the Australia Institute, The Australian Native Forest Sector: Causes of the decline and prospects for the future.

It's true the industry has been adversely affected by conservation measures, the global financial crisis and the high dollar. But they're secondary to its underlying problem of declining demand for its products and increasing competition both from other products and other, overseas producers of its products.

When you look at it, you see that the logging of hardwood native forests is under pressure from every direction.

To the extent that people still want hardwood, they increasingly prefer it from plantations, not native forests. But demand for hardwood itself is declining in favour of softwood, most of which comes from plantations.

Demand for wood is being reduced by demand for other products such as steel, by engineered wood (where thin bits of wood are glued together in different ways) and by wood-saving innovations.

And all that's before you get to increased competition from wood producers in other countries - competing in our domestic market and competing in our export markets.

The supply and future supply of plantation wood has been greatly expanded by another government subsidy, managed investment schemes, in which misguided punters overinvested in crazy pursuit of tax breaks.

Where the native forest sector can't sell its logs for use in building construction - as increasingly it can't - it sells them to be chopped into woodchips for papermaking. Naturally, woodchips are worth less. But even the native forest woodchip market is facing reduced demand and increased competition.

Macintosh concludes that "with sluggish demand in many key markets, strong competition from Asian, South American and African producers, and a distinct market preference for plantation-sourced products" and "in the absence of additional government assistance, the sector is likely to continue to decline and, in some areas, it could collapse entirely".

See what's happening? Our perception that protecting the environment is always in conflict with the economy and jobs is being used by the industry, its unions and the politicians as a cover for continued handouts to the industry, handouts that will do nothing but delay the inevitable.

And the conservation groups, having been convinced the industry's problems are all their fault, are running cover for an industry that doesn't want to face the truth and politicians trying to buy Tasmanian votes.

The result is that taxpayers are paying to allow an industry that probably would have collapsed to continue doing damage to native forests. It's getting help other industries wouldn't get, partly because it's doing something most other industries don't do: destroying the environment.

This makes sense?

If the conservationists had more sense they'd joint the economic rationalists in urging governments to stop giving subsidies - explicit and hidden - to an industry trying to defy market realities.

Environmentalists would do more good if more of them knew a bit of economics.

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Sorry, productivity isn't almost everything

To be frank, I don't lay awake at nights worrying about how Australia is going to lift its rate of productivity improvement back to 2 per cent a year. Contrary to the impression Kevin Rudd is trying to convey with his seven-point productivity plan, higher productivity would do little to help us make the transition to the post-resources boom world.

The biggest risk in the potential hiatus between the waning of the boom and the return to healthy growth in the non-mining economy is an unacceptable rise in unemployment, and higher productivity won't fix that.

For one thing, the threat to employment is immediate and relatively short term, requiring deft management of the macro-economic levers, not the longer-term measures needed to enhance our productivity performance.

More fundamentally, improved productivity is about increasing our material standard of living - real income per person - not about increasing employment (which, in any case, shouldn't be more than a temporary problem).

I worry a lot more about whether our existing high material standard of living is compatible with the preservation of a healthy natural environment - including one that avoids excessive global warming - than about how we can drive our consumption levels even higher. The origins of the very resources boom we're struggling to adjust to - and our hand-rubbing contemplation of Asia's rapidly growing middle class - ought to be making us wonder whether the globe's natural resources and ecosystem will be able to cope with so much affluence.

So if we fail to get productivity improving at the rate of 2 per cent a year rather than 1.6 per cent, I won't be shedding too many tears. Apart from ecological sustainability, I give improving our non-material quality of life a much higher priority than increasing the number of cars, TV sets and gadgets per home.

But for all the business people, economists and politicians who profess to care so deeply about accelerating our rate of consumption let me offer some advice: you won't get far until you can see past your sectional interests and ideological hang-ups. If the hyper-materialists were genuine in their drive for faster productivity improvement they'd be ascertaining those measures likely to do most to enhance productivity and resolving to pay whatever price was necessary to bring them about.

But that's not what they're doing. Rather than asking which measures would be most effective, they're asking which measures they'd be most comfortable with. Whether the most comfortable measures would be particularly effective doesn't seem to worry them. Take the business lobbies. They're proceeding on the theory that anything making life easier for business must surely be good for productivity. So top of their list is a return to individual bargaining in industrial relations, followed by measures that reduce the tax burden on business and increase it for everyone else. As for the economists, they're really only interested in measures that fit their model's built-in presumption against government intervention in the economy.

So their preference is for measures that reduce intervention - micro-economic reform - and do little to add to government spending and taxation. The first problem with this approach is that it's generally unpopular with the electorate and invokes fierce opposition from vested interests, mainly business interests.

Successive governments have been reluctant to undertake further micro reform for well over a decade. So if more micro reform is the key to faster productivity improvement don't expect to see much improvement.

The second problem with the economists' approach is it means they have little enthusiasm for productivity enhancing measures that involve significantly increasing government spending.

Trouble is, this includes the two areas where big productivity gains are most likely to be found: greater investment in education, training and research to increase human capital, and greater investment in public infrastructure to improve the conditions in which our businesses operate.

It shouldn't be assumed that all we need to improve education and infrastructure is a lot more spending. But nor should it be assumed - as many economists do - that all that's needed is reformed government intervention in these areas. In truth, both better intervention and a lot more spending are needed. The first part is tricky, the second is ideologically unfashionable (as well as requiring higher taxes).

To be sure, the Labor government is already spending a lot more on education and training, and this should favourably affect productivity in due course. Ideological blinkers have prevented many people from seeing that the Gonski reforms to direct greater funding to disadvantaged students should have a productivity pay-off - as should the national disability insurance scheme.

My guess is any improvement we see in our productivity performance will happen more in spite of all the speech-making on the topic than because of it.

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Adding the environment to the national accounts

Over the eight years to 2010-11, gross domestic product increased by 28 per cent, whereas Australia's net energy use increased by 18 per cent. So our "energy intensity" - energy used per $1 of GDP - is falling at the rate of 1 per cent a year.


In 2010-11 we produced 89 per cent of our total energy supply domestically, with the remaining 11 per cent being mainly imported oil. This took our total annual supply of energy to almost 19,000 petajoules. Of this we exported 71 per cent - mainly coal, uranium and natural gas.

Turning from energy to water, the price charged to households rose by 17 per cent in 2010-11, while the amount of water consumed by households fell by 8 per cent. On average, households were paying $2.44 a kilolitre. Of total water consumption of more than 13,000 gigalitres, 54 per cent went to agriculture and 33 per cent to the rest of industry, leaving just 13 per cent going to households.

Turning from water to land, Victoria's 23 million hectares of rateable land are valued at more than $1 trillion. Residential land accounts for 83 per cent of this total value, even though it accounts for only 5 per cent of the state's total area.

How do I know all this? Because I've been reading the "energy account", the "water account" and the "land account (Victoria, experimental estimates)", each published by the Bureau of Statistics in the past few weeks.

You may think from the examples I've given that the sort of information contained in these "accounts" is mildly interesting. But this exercise is really important and, to those of us who worry about the ecological sustainability of economic activity, even exciting.

You've seen me bang on before about the need for us to stop thinking of the economy being in one box and the environment in a completely separate box. The economy can't sensibly be separated from the environment because it exists within the natural environment - the ecosystem, if you prefer.

The economy depends on the ecosystem for its continued existence. It draws renewable and non-renewable natural resources and "ecosystem services" (such as photosynthesis and other natural processes) from the natural environment, then pumps all manner of pollution and waste back into the ecosystem.

It's clear that if our neglect of the ecosystem as we run the economy causes damage or depletion to the ecosystem, a point could be reached where the malfunctioning of the ecosystem inflicts damage and loss back on the economy. We could get into an adverse feedback loop between the economy and the environment.

This, of course, is exactly what's worrying us about climate change. The extensive burning of fossil fuels is causing emissions of carbon dioxide and other gasses which, partly because the clearing of land has reduced the role of forests as carbon sinks, are building up in the atmosphere, trapping in heat and interfering with the world's climate.

I fear climate change is just the first and most pressing instance of adverse feedback between the economy and the environment. If so, we need to become a lot more conscious of the interaction between the two.

But how did we get into the habit of thinking of the economy in isolation from the environment? The rest of us fell into the habit because that's the way the economists have always thought of it.

In the second half of the 19th century, when economists were setting in concrete their way of conceptualising the economy and analysing its workings, it made sense for them to conclude the environment could be excluded from the model without any great loss of relevance.

At the time, global economic activity was quite small relative to the vastness of the natural world. They couldn't know how hugely economic activity would grow, with a rapidly multiplying global population and an ever-rising worldwide average material standard of living.

Nor could they know how damming rivers, irrigating crops and sinking bores would interfere with the water cycle, how clearing land, running farm animals and growing crops would interfere with soil quality, or how ever-improving fishing technology would almost denude our oceans of fish.

Another problem was that their model was built on the role of market prices in co-ordinating economic activity. Many aspects of the natural environment, vital though they were to the functioning of the economy, weren't privately owned and didn't have a market price, so were "external" to the model.

Yet another part of the reason we've fallen into the habit of ignoring the environment when we think about the economy is that this is the way we've constructed our economic indicators - our gauges of how it's travelling. The chief gauge is the "national accounts" with their bottom line, gross domestic product.

We've taken to sharing the macro-economists' obsession with GDP, a measure of market production of goods and services during a period and the income generated by that production. It's a good indicator of employment prospects, but it takes no account of the using up of natural resources, nor of the cost of the damage economic activity is doing to the ecosystem.

But though economists may be stuck in their ways, the world's national statisticians aren't so hidebound. The concepts, classifications and accounting rules needed to calculate the national accounts in member countries have long been set down by the United Nations Statistical Commission. Earlier this year the commission decided to introduce a system of integrated environmental and economic accounting. This will involve developing environmental accounts on a comparable basis to the existing economic accounts, so they can be combined to give a more comprehensive picture of how the economy is affecting the environment and the environment is affecting the economy.

This "system of environmental-economic accounting" - SEEA - is a huge project, involving the measurement of various environmental dimensions not presently measured and the conversion of physical measures - such as petajoules and gigalitres - into dollar values.

Our Bureau of Statistics is at the forefront of this international development. Its recently published energy, water and land accounts are stepping stones in this great advance.

Publishing integrated economic and environmental accounts won't magically solve all our environmental problems, but it will make it much harder to forget these two aspects of our existence are inextricably joined.

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Wellbeing index gives better picture of mining boom

DON'T believe the doomsayers.This week's national accounts indicate the economy is slowing to something a bit below trend but the critics of the great god gross domestic product are right: it is a quite inadequate and often misleading measure of the nation's progress.

This is why, for more than a year, the Herald has commissioned Dr Nicholas Gruen, principal of Lateral Economics, to calculate a broader index of wellbeing, which we have published within a few days of the release of the Bureau of Statistics' quarterly national accounts, with GDP as their centrepiece.

Our purpose has been to supplement rather than supplant the official figures, which have valid - if narrower - uses and were never intended to be treated as the nation's all-encompassing bottom line.

The Herald-Lateral Economics wellbeing index uses the national accounts to produce a modified version of GDP called "net national disposable income". This adjustment takes account of the annual depreciation (using up) of man-made capital and of the income earned within Australia which isn't owned by Australians.

It also shifts the focus from the value of the nation's production to how much disposable income the nation's households have available to spend on consumption or save, in the process allowing for the change in the prices of our exports relative to the prices of imports.

To this figure the index adds adjustments for the value of the net depletion of natural resources (after allowing for new discoveries), the estimated cost of future climate change, all levels of education and training, changes in income inequality, various measures of the nation's health and employment-related satisfaction.

All this means the index is well placed to help answer a question on many people's minds: what will we have to show for the resources boom?

Unlike GDP, the wellbeing index takes account of the loss of the minerals dug up and sent overseas, not just the export income earned from doing so. It also takes account of the loss of real income we have suffered from the end of the first stage of the boom: the marked decline in the world prices of coal and iron ore during the three months to the end of September.

This was the main factor that converted the growth of 0.5 per cent in GDP during the quarter - a measure of the quantity of goods and services produced in the economy - to a fall of 0.7 per cent in our net national disposable income.

But the accounts confirm that Australian households are continuing to save the high proportion of their disposable incomes. So that is proof we have been saving rather than spending some of our windfall gain from the boom.

But the broader index shows we have also increased our investment in the education and training of our workforce. So much so that, despite the fall in export prices, the index rose by 0.2 per cent during the quarter.

We should be using our good fortune to raise the value of workers' labour and improve their lives in the years ahead - and the wellbeing index shows we are.

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Climatic adjustment limits our farmers' Asia boom

The first thing to realise about the rise of Asia is that our farmers are about to join our miners in the winners' circle. The second is that climate change and other environmental problems may greatly limit our farmers' ability to exploit this opportunity. The third is that what we see as a looming bonanza, the rest of the world sees as a global disaster.

According to the government's white paper on the Asian century (which, be warned, shares economists' heroic assumption that there are no physical limits to consumption of the world's natural resources), continuing population growth and rising living standards in Asia will cause global food production to grow 35 per cent by 2025, and 70 per cent by 2050.

Rising affluence is expected to change the nature of Asia's food consumption, with greater demand for higher quality produce and protein-rich foods such as meat and dairy products. This will also increase the requirement for animal feed, such as grains. There'll also be demand for a wider range of processed foods and convenience foods, and for beverages, including wine.

But environmental and other problems will prevent the Asians from producing much of the extra food they'll be demanding. Unlike in the past, Asia is likely to become a major importer of food. And, of course, any delay in increasing food production to meet the increasing demand will raise the prices being charged.

You little beauty. "Australia's diverse climate systems and quality of agricultural practices position us well to service strong demand for high-quality food in Asia," the white paper says. After all, Australia is one of the world's top four exporters of wheat, beef, dairy products, sheep, meat and wool.

"As a result, agriculture's share of the Australian economy is expected to rise over the decade to 2025," we're told, something that hasn't happened for many, many decades.

So, a new age of growth and prosperity for Aussie farmers? Don't be too sure. The environmental constraints the white paper expects to bedevil Asian farmers will also limit our farmers' ability to cash in on Asia's growing affluence.

Also published last week was a determinedly positive but franker assessment of our agricultural prospects, Farming Smarter, Not Harder, from the Centre for Policy Development.

It says "winners of the food boom will be countries with less fossil fuel-intensive agriculture, more reliable production and access to healthy land and soils". That's not a good description of us.

The first question is climate change - the problem so many Australians have been persuaded isn't one. Although other countries - including China - are doing more to combat climate change than the punters have been led to believe, we don't yet know how successful global efforts to limit its extent will be.

What we do know is we're already seeing the adverse effects - hurricane Sandy, for instance - and can expect to see a lot more, even if global co-operation is ultimately successful in drawing a line. At present we're focused on efforts to prevent further change; before long we'll need to focus on how we adapt to the change that's unavoidable.

This non-government report says climate change is projected to hit agricultural production harder in the developing world than the developed world - "with the exception of Australia".

"Rainfall is forecast to increase in the tropics and higher latitudes, and decrease in the semi-arid to arid mid-latitudes, as well as the interior of large continents," the report says. "Droughts and floods are expected to become more severe and frequent. More intense rainfall is expected with longer dry periods between extremely wet seasons. The intensity of tropical cyclones is expected to increase."

So, without action to reduce or manage climate risks, Australia's rural production could decline by 13 per cent to 19 per cent by 2050, it says.

And it's not just climate change. "One of the biggest challenges for Australian agriculture is that our soils are low in nutrients and are particularly vulnerable to degradation ... every year we continue to lose soil faster than it can be replaced."

The productivity of broadacre farming used to grow by 2.2 per cent a year; since the early 1990s it's averaged just 0.4 per cent. Australian farmers use a lot of fertilisers and fuel, the cost of which is also likely to rise strongly. And that's not to mention problems with water.

Meanwhile, those who worry about how the world's poor will feed themselves - or about the political instability we know sharp rises in food prices can cause - don't share our hand-rubbing glee at the prospect of Asia's greatly increased demand for food.

Almost as bad as high food prices are highly volatile prices. The three world price spikes in the past five years each coincided with droughts and floods in major food supply regions. Extreme weather events are likely to become even more frequent. (The growing diversion of grain to produce biofuels is another contributor to higher food prices.)

After the food price spike in 2008, 80 million people were pushed into hunger. But the growing concern with "food security" is often a euphemism for resort to beggar-thy-neighbour policies: countries that could export their food surplus to other, more needy countries decide to hang on to it, just in case.

The Asians' attempts to continue their (perfectly understandable) pursuit of Western standards of living are likely to be a lot more problem-strewn than the authors of the white paper are willing to acknowledge.

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Asia white paper assumes away environment

The most glaring weakness in the Prime Minister' s white paper on the Asian century is its failure to factor in the high likelihood that mounting environmental problems will stop Asia continuing to grow so rapidly as well as limit our ability to take advantage of what growth there is.

To be fair, most of the environmental problems that could trip up Asia s economies and ours do rate a mention in the bowels of the 300-page document.

But it doesn t join the dots. Asia s environmental problems are dismissed merely as among the various challenges to be overcome bumps along the road. As for our own environmental problems, the government s existing policies have them well in hand.

And it would be unfair to single out the Gillard government as unwilling to face up to the seriousness of our problems with the natural environment and start integrating them into its forecasts and projections.

That s just as true of almost all economists and business people. While most economists (and some business people) are prepared to acknowledge particular environmental problems climate change, water, soil, fish stocks, biodiversity they re not prepared to see them as symptoms of a much bigger problem: we may be reaching the physical limits to continued growth in natural resource use.

So, just like the white paper, they continue to put worries about environmental problems in a box marked environment , which they keep separate from the box marked economy , where they do their forecasts and longer-term projections of economic growth.

It s an uncontroversial statement that the global economy the production, consumption and other economic activities of humans exists within, and depends on, the natural environment, the global ecosystem.

And it s obvious to anyone with eyes that certain economic activities are doing damage to the ecosystem, which is already rebounding on the economy in the form of costs and disruption (hurricane Sandy, for instance). It s not hard to believe these costs and disruptions are likely to multiply unless we start organising the economy very differently.

It thus makes all the sense in the world for economists to integrate the environment and the economy when thinking about what the future holds. So why don t they? Because they never have, and find the idea pretty frightening.

Economists standard way of thinking about the economy effectively assumes away the environment. That s because their conventional model which has changed little in the past 100 years is built around the prices charged in markets, whereas most environmental assets clean air, clean water, good soil, reasonably reliable weather can t be bought and sold in markets.

Thus most of the costs and benefits generated by the ecosystem are external to the model and so liable to be overlooked. Schemes such as the carbon tax are attempts to put a price on greenhouse gas emissions and so get them into the price mechanism (and the model).

So you can bolt bits of the environment onto the model, but you have to do it case-by-case, which is hardly satisfactory. As Professor Herman Daly has said, if the survival of your society is external to your model, you probably need a new model .

The funny thing is, if you re still not sure why so many scientists doubt it will be physically possible for Asia to grow as big as economists project, the clues are all there in the white paper. To put things in context, at present the developed world accounts for just 15 per cent of the world s population, but 51 per cent of gross world product.

The 19 per cent of the world s population living in China has a standard of living equivalent to 20 per cent of America s. The white paper expects that to reach 40 per cent in just 13 years.

For India and Indonesia, accounting for a further 21 per cent of the world s population, their standard of living could also double, from 10 per cent to almost 20 per cent. And, of course, living standards in other parts of Asia are also supposed to be rising rapidly, meaning more than half the world s population is applying to join the profligate rich club.

Have you any idea what that would mean in additional use of the world s energy and other natural resources?

The white paper advises that, in the 19 years to 2009, Asia s energy consumption more than doubled and its share of world energy consumption jumped from 25 per cent to 38 per cent. China is now the world s biggest energy consumer.

Having gone from consuming less than half as much energy as the US in 2000, China now consumes slightly more. It accounts for almost half the world s coal consumption. It s the world s largest consumer of steel, aluminium and copper, accounting for about 40 per cent of global consumption for each. It s predicted to be 90 per cent dependent on imported oil by 2050.

In 2009, fossil fuels accounted for about 82 per cent of Asia s energy mix. Asia accounts for about 40 per cent of global greenhouse gas emissions up from 31 per cent in 2001. China recently overtook the US as the world s largest emitter.

The white paper happily assumes effective global action to limit climate change will be forthcoming, so makes no allowance for it in its projections.

It s not the done thing for economists to imagine we could ever run out of natural resources. Prices may rise a bit, but this will merely call forth the solution to the problem, whereupon prices will fall back. And every textbook leaves you thinking this process happens seamlessly.

So, no need to worry. Our faith in unending growth remains unshaken.

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IS A ‘STEADY-STATE’ ECONOMY FEASIBLE?

Walter Westman Lecture on Science, Humanity and the Environment International House, University of Sydney, Wednesday, August 8, 2012

I was pleased to attend the first of these Walter Westman lectures, in 2008, given by my friend Steve Hatfield-Dodds, and I’m honoured to deliver this year’s lecture. I want to talk about economic growth - a topic of concern to many people who think deeply about science, humanity and the environment - and specifically about whether it would be feasible for us to move to a ‘steady-state’ economy.

Virtually all our business people, economists and politicians believe it to be not just possible but desirable for the economy to continue growing forever - and the faster the better. They regard the achievement of growth as one of the most important objectives of government, and they have no doubt this is in accord with the wishes of almost everyone in the electorate.

Why do they regard economic growth as such a good thing? Because when the economy’s generation of income - and its production of goods and services, which is the same thing, and is conventionally measured by the growth in real gross domestic product - grows faster than the population is growing, income per person is rising, meaning that, on average, our material standard of living is rising. Doesn’t that sound good to you?

But the advocates of growth believe it brings with it many other advantages. They argue that the richer we get, the more easily we can afford to spend money on fixing the environment. They argue that rising real incomes should also directly benefit the poor and, as well, that when incomes are rising it’s easier to get agreement to redistributing income in favour of the poor. They further argue that growth in the economy is necessary to create the additional jobs needed to provide employment for a growing population of working age.

So why do an increasing minority of people oppose continuing economic growth? Because of their belief that unending economic growth is ecologically unsustainable and, indeed, physically impossible. They see the global economy as a sub-system of the global ecosystem, which is of fixed size. If the ecosystem can’t grow, then there must be a limit to the extent to which the economy can grow within it. They look at all the damage economic activity has done and is doing to the natural environment - the damage to soil, forests, waterways and fish stocks, the destruction of species and, most obvious and pressing, the emission of greenhouse gases - and they conclude we must be close to the ‘limits to growth’. To press up to those limits or even exceed them must surely damage the natural environment to such an extent that huge, possibly irreparable damage is done to the economy, not just the environment.

That’s the most fundamental, pressing reason for wanting to call a halt to growth, but there’s a supporting reason from the ‘science of happiness’. Psychologists and a few economists studying what they prefer to call ‘subjective wellbeing’ have concluded that once people’s incomes reach a certain fairly modest level, further increases do little or nothing to raise the ‘aggregate happiness’ of the people in a country. This is because we so quickly adapt to any change in our material circumstances, with improvements soon being taken for granted as we aspire to something bigger and better.

But it’s also because, as studies show, what makes everyone but the poor happier as individuals is not an increase in our income along with everyone else’s, but an increase in our income relative to everyone else’s. It’s this that would feed our desire to feel superior to others and also permit us to demonstrate that superiority to the world by means of our superior possessions. The trouble with such aspirations, however, is that they involve a zero-sum game: I can advance my position in the pecking order only at the expense of the positions of all the people I pass. Such status competition - such consumption competitions - is socially wasteful: it uses up a host of scarce economic resources without making any net addition to total happiness. For the managers of the economy, this creates two problems. First, all they can ever do is raise incomes overall; there’s nothing they can do to raise the relative incomes of everyone in the economy. So their growth-favouring policies do little or nothing to increase the community’s subjective wellbeing - which must surely be the justification for their efforts. Second, it means that, for an affluent economy such as ours, most of the annual increase in our real incomes that the economic managers have laboured to produce is dissipated on the socially wasteful purchase of ‘positional goods’ - goods and services whose purpose is to demonstrate to others our superior position in the social order. For me, this is a powerful reason for not being too dismayed by ecologists’ insistence that we can no longer afford economic growth: if so, we won’t be giving up all that much.

This brings me directly to my topic: is a steady-state economy - and economy that doesn’t grow - feasible? First I’ll examine the reasons people argue it isn’t feasible, then I’ll examine what we’d need to do to make it feasible.

The growth imperative is so deeply ingrained in our thinking, so much an assumption underlying so much of what we say - even what I say - that many people imagine the economy is like a bicycle: if you stop going forward you lose your balance and fall off. Fortunately, the analogy isn’t apt. Though many people would have to adjust their thinking in a steady-state economy, it wouldn’t collapse just because it wasn’t growing. What would cause deep problems, however, is if the economy was steadily shrinking, particularly if prices were falling.

There’s obvious truth to the argument that when incomes are growing it’s easier to afford to repair the environment. But that argument becomes dubious when we reach the point where the growth itself is adding to the environmental damage. We have to destroy the environment to afford to save it? It’s hard to imagine how the environment could end up ahead on that deal.

There’s more truth to the argument that when incomes are growing it’s easier to give the poor a better deal, including by redistributing income from the better-off to the less well-off. It’s factually correct - in Australia, though not in America - that real growth in national income over the years has led to real growth in the incomes of households at the bottom of the distribution, as well as in the middle and at the top. What’s also true, however, is that incomes at the very top have been growing much faster than all other incomes. I think advocates of a steady-state economy have to accept that, yes, the absence of growth would increase the political resistance to greater redistribution in favour of those at the bottom. But just because growth makes greater redistribution easier doesn’t necessarily mean redistribution happens. It hasn’t happened sufficiently to prevent the gap between rich and poor widening significantly over the past 30 years or so, notwithstanding all the growth we’ve enjoyed.

The strongest anti-steady-state argument is that we need economic growth to provide employment for our growing population of working age. It’s pretty much the only argument I get from the ecologically aware economists I talk to. But I don’t think it’s insurmountable. The first reservation is that, were it not for immigration, our working-age population wouldn’t be growing (as is the case for most of the advanced economies and will soon be the case for China). We could adjust our net migration to keep the working-age population steady. The second reservation is that, even if our working-age population was growing, we could respond to the problem by job-sharing. Here I’m not only referring to the idea of two or more part-time workers sharing the one full-time job, but to the more fundamental solution that rather than continuing to take the continuing improvement in the productivity of labour in the form of ever-higher real wages, we could do what the futurists of the 1960s and 70s expected we’d do and take it in the form of shorter working hours.

Before I turn to the more positive question of how we’d go about achieving a steady-state economy, we should clarify an issue I probably should have raised much earlier. In all that follows I’ll be leaning heavily on the leading thinker in the area of steady-state economics, Professor Herman Daly of the University of Maryland. There’s enormous terminological confusion between scientists and economists on what exactly they mean by the word ‘growth’. Scientists take it to mean something very different from what economists do, which means much of what little debate passes between them flies over the heads of the other side. I’m sure the ground of disagreement between them would be greatly reduced if only this terminological confusion could be ended.

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

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

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

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

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

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

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

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

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

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

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

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

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