The Economy and the Environment

Environmental economics developed as a discipline following the realization that economic theorizing needs to consider the greater system which affects human beings. Being greatly influenced by systems thinking, the need was felt for a paradigm shift in the whole perspective within which economic theory was placed. The genesis of the subject can also be traced to the widespread social and ecological movements of the sixties and seventies which brought environmental issues to the fore.

There is an indispensible nexus between the economy and the environment – changes in one have implications on the other. The economy being a subset of the ecosystem, economy-environment interactions require one to account for both adaptation and feedback within and between systems. There exist a multitude of roles for the environment with respect to the economy, as a supplier of resources, sink for waste products, supplier of amenities and provider of global life support services. This article is an attempt to highlight the interconnection and feedback mechanism which characterizes the linkages between the economy and the wider environment, within the context of debates on economic growth.

The 1972 MIT study on The Limits to Growth, which highlighted the environmental and resource problems that economic growth had brought in its wake, sparked off a major debate between the mainstream neoclassical economists and ecological economists. While the former were optimistic on the future growth prospects, based on an extrapolation from the past, the latter drew attention to the limits to economic growth posed by nature.

These limits as identified by the ecological economists include the biophysical and ethico-social limits the economic world confronts. Biophysical limits are backed by three important conditions – finitude, entropy and complex interdependence. The first two are backed by the laws of thermodynamics and when examined together with the complex interdependence (visible and invisible) of all the factors, provide a convincing argument to the existence of biophysical limits. On the other hand, ethico-social limits are fundamentally normative and thus are dependent on the context and social fabric of nations.

“Growth is widely thought to be the panacea for all the major economic ills of the modern world” (Daly, 2005). This is the stance of the optimists who believe that all problems including poverty, unemployment, overpopulation and environmental degradation, can be solved by increasing economic growth. With specific reference to the costs imposed on the environment, the argument advanced in favour of growth is that higher growth will enable us to tackle environmental concerns, through newer resource discoveries and control of pollution.

In this context, it is worth examining the Environmental Kuznets curve which presents an inverse U shaped relation between an environmental impact indicator like pollution and income per capita. Though in the early stages of economic growth, environmental degradation increases, after a certain threshold level in income per capita the trend reverses. We must exercise caution when we use the Kuznets curve, for though this relation holds for many urban pollutants, it fails to hold true for natural resource use and biodiversity conservation. Also, this implicitly assumes that environmental damage has a certain character of reversibility, when in reality we would not be able to restore the environment to its original state in many situations.

As strong advocates of the ‘rebound effect’, the growth optimists believe that technological progress will lead to systematic behavioural responses – new technology will lead to improved efficiency levels, bringing down costs and prices, boosting demand and thereby increasing investment and supply. This in turn leads to further cost reductions, thus maintaining the growth momentum of the past. However, this engine of growth was sustained largely by the natural resources it drew from the environment. Now, when we consider the possibility of exhaustion of these natural resources, we note that one of the most important constituents in the feedback cycle gets derailed – the element of cost. As raw materials become scarce, they become increasingly expensive, posing a threat to the belief in unending growth.

In this neo-classical framework, the economy is seen as a closed system without any links to the outside world. Technology is seen as a key driver of growth – to overcome resource limitations, aid in the discovery of new resources and play a key role in solving major environmental problems. This position comes under attack from those sceptical of indefinite exponential growth, recognizing the finite carrying capacity of earth. They draw attention to the whole host of environmental problems the growth mania has brought with it, which raise concerns on the sustainability of future growth. This environmental degradation can be seen as an iatrogenic disease (Daly, 1992), the resultant prescription of unlimited growth.  The ecological economists note that the issue at hand is not merely absolute limits on the availability of resources but also the environmental implications of increased resource discovery. In their view, technology is not always a problem solver.

A country’s Gross Domestic Product (GDP) is seen by the optimists to be the ultimate measure of well being. However, mainstream economists need to keep in mind that GDP is only a measure of overall economic activity, and not well being. GDP ignores problems of growing inequality, poverty, social unrest and justice. Besides, GDP not only fails to consider the environmental degradation and the depreciation of man-made capital but also ironically includes – rather than exclude – expenses which we incur to protect ourselves from negative externalities like pollution. This hyper-growth mania (Daly, 1992) underscores the fact that GDP is a misleading indicator of economic growth.

Further, happiness studies reveal that increased growth as measured in terms of increased GDP doesn’t translate into happiness and well being. The correlation between absolute growth and happiness holds only up to a certain threshold, beyond which only relative changes in income bear significance. Thus, being a zero-sum game, these relative changes do not alter the economy’s aggregate well being.

The classic economic argument that economic growth will make everyone better off in the long run, does not hold good any longer. The trickle-down effect advocated by the growth optimists does not work towards ameliorating poverty. Poverty exists despite economic growth because what grows is the reinvested surplus, and the benefits of growth go to the owners of the surplus who are definitely not poor. GDP growth and welfare are, thus, not synonymous – the argument that economic welfare leads to total welfare is a fallacy.

Acknowledging the limitations of GDP as a measure of well being, an alternative indicator like wealth per capita has been advocated by Partha Dasgupta. Understanding wealth as encompassing an economy’s entire productive base, institutional structure, knowledge and skills, wealth per capita is a better indicator of economic development.

Akin to a saturation point, Daly’s innovative concept of uneconomic growth describes the situation of an undesirable balance of utility and disutility (Daly, 2005). The point of balance between marginal utility and marginal disutility gives rise to the optimal scale of consumption and any increase beyond this point sets in a phase of uneconomic growth, when marginal disutility exceeds marginal utility.

The era of uneconomic growth reaches its futility limit as marginal utility converges to zero, with no additional utility to be gained from increased consumption. Society eventually faces an ecological catastrophe as marginal disutility continues to increase. Daly’s steady state economy, with zero economic growth poses an alternative to the conventional ever growing economy which faces the threat of reaching its futility limit.

Though mainstream economists dismiss sustainability as a fad, the concept of sustainability shifts the path of progress from growth, as defined in mere quantitative terms to development which signifies the qualitative improvements in well being. Sustainable economies signify an indefinite development trajectory, with a finite growth horizon. This transition from a growth economy to a steady state economy is quintessential to achieve sustainable development.

References:

(1) Ayres, Robert U. Turning point: The end of exponential growth? Technological Forecasting & Social Change. Vol 73, 2006. pp. 1188–1203.

(2) Daly, Herman. The Economic Growth Debate. Journal of Environmental Economics and Management. Vol 14, 1987. pp. 323-336.

(3) — “A Catechism of Growth Fallacies,” Chap. 5 in Steady-State Economics: Second Edition with New Essays, Washington: Island Press, 1991.

(4) — Economics in a Full World. Scientific American. September 2005.

(5) Hanley, N., J. Shogren, and B. White. Chap. 1 in Environmental Economics in Theory and Practice, Palgrave, London: 2007.

(6) Harris, Jonathan M. Chap. 1 and 2 in Environmental and Natural Resource Economics: A Contemporary Approach, 2006.

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