Unit 2

Sustainable Development and Ecological Economic Efficiency

Preview

‘So much of the good juice of utility is allowed to evaporate out of commodities by distributing them unequally’.

Joan Robinson (1962) Economic Philosophy, London: C.A. Watts.

What is to be ‘sustained’ in sustainable development?

Now we have defined the concept of sustainable development and established its theoretical foundation within ecological economics, we are a little closer to the position where we can debate how an economy might move toward sustainable development in policy terms. However, we’re not quite there yet and we need to add a few more items to our ‘analytical tool kit’.

In Unit 3 we focus on the microeconomics of sustainable development and how the market might be harnessed to bring about the appropriate resource allocation. Before this, however, we need to consider the macroeconomic context within which these market transactions take place.

Specifically, given the fine balance between economy and environment, it is important to develop some notion of optimal scale; that is, the scale of the aggregate economy relative to the ecosystem. Curiously, as Daly (1992) points out, while defining the optimal scale of production or consumption is a primary focus of mainstream microeconomics, this fundamental concept is totally absent from macroeconomics.

Introduction

The main aim of this unit is to learn about ecological economic efficiency (EEE). This term, first coined by Herman Daly (1991), focuses on throughput use. Specifically, it’s about the efficiency with which capital (both natural and man made) is used to provide life support and life-enhancing services (Daly 1996, p. 83).

Professor Herman Daly

Image source: steadystate.org

On ecological economic efficiency:

‘Think of the world initially consisting of only natural capital – our initial dowry. We convert some of it into man-made capital in order to better serve our wants. The extent to which we should continue this conversion is economically limited. The efficiency with which we use the world to satisfy our wants depends on two things: the amount of service we get per unit of man-made capital, and the amount we sacrifice per unit of natural capital lost as a result of its conversion into man-made capital.’

Daly (1996, pp. 83-84)

Learning objectives

By the time you have completed this unit you should be able to:

  • Clearly define what is meant by ecological economic efficiency (and its four dimensions); and
  • Explain how ecological economic efficiency impacts upon optimal macroeconomic scale

2.1:      Defining ecological economic efficiency

Image source: climateark.org

EEE may be expressed in terms of the following ratio:

MMK services gained

——————————-

 NK services sacrificed

where MMK is man-made capital and NK is natural capital. This expression is the concise version of a more elaborate identity that reveals the four different dimensions of EEE. These dimensions are explored in the Reading 2.1 below.

Activity: Reading 2.1

Refer now to Reading 2.1 by Herman Daly (1992), entitled ‘Steady-State Economics: Concepts, Questions, and Policies’. This paper, the 1992 Schumacher Lecture, was one of the first public statements by Daly on ecological economic efficiency (the first appearing in Daly (1991). The paper itself has been reworked since and parts of it appear in Daly (1996).

Your main objective in reading this article is to familiarise yourself with the four components of the ecological efficiency ratio: service efficiency, maintenance efficiency, growth efficiency and ecosystem efficiency. Think of examples of each, and discuss their practical application with your classmates in the blog.

2.1.1 Neoclassical economics and optimal macroeconomic scale

  • Why is optimal macroeconomic scale ignored?

As Lawn (2001, p. 78) observes, mainstream economics pays virtually no attention to the notion of optimal macroeconomic scale. The merit of continued expansion of the macro-economy is beyond dispute, so long as it involves an increase in per capita output. To support his point, Lawn makes reference to a leading principles of economics textbook which includes the following passage:

The growth of total output relative to population means a higher standard of living because an expanding real output means greater material abundance and implies a more satisfactory answer to the economising problem.

Jackson, McIver and McConnell (1994, p. 414)

It is a great mystery why, in microeconomics, economists go to great lengths to separate benefits and costs, yet in the macroeconomic sphere it appears to be a non-issue.  Cast your minds back, for example, to your introductory micro classes, and recall the profit maximisation condition, ‘MC=MR’; viz. it is rational for a firm to increase output up to the point where marginal cost (MC) of production is equal to the marginal revenue (MR) received for that output. Any output beyond the point where MC=MR will be adding more to a firm’s cost than to its revenues. There are countless other examples.

How, then, does one go about identifying optimal macroeconomic scale? To what extent should NK continue to be converted into MMK to expand the physical scale of the macro-economy?

2.1.2 The uncancelled benefits of economic activity

As it was noted in Unit 1, how well the stock of MMK is able to bring about qualitative improvement in the human condition depends upon how effectively it serves an appropriately conceived hierarchy of intermediate ends – the ultimate end. The capacity to serve the ultimate end depends upon the service-yielding qualities of these physical commodities. Unlike MMK itself, though, the service yielded by the stock is a ‘psychic flux’ (Daly 1979) with no physical dimensions which means, of course, it is not something that can be accumulated. As Lawn (2001, p. 80) points out, as a flux rather than a stock or a flow, service closely corresponds with the notion of ‘psychic income’ as defined by Fisher (1906).

Psychic income can be viewed as the full benefit of economic activity, and it emanates from three main sources. The following excerpt from Lawn (2001, pp. 80-81) elaborates on these sources and explains how one needs to consider net psychic income, or what he calls uncancelled benefits of economic activity.

‘The first source of psychic income is that which arises from the consumption or wearing out of human-made capital. The second source emerges from being directly engaged in production activities (e.g., the enjoyment and the personal sense of contribution and self-worth obtained from work). The third source is the psychic income yielded directly from natural capital in terms of its existence values and its aesthetic and recreational qualities. Obviously, this final source of psychic income does not come from economic activity. Indeed, if anything, economic activity tends to destroy rather than enhance such values. It is, therefore, better that such values be taken as “givens” and their subsequent destruction be counted as an opportunity cost of economic activity.

This last point is a reminder that not all economic activity enhances the psychic enjoyment of life. The production and subsequent consumption of some portion of human-made capital can reduce the psychic enjoyment of life if consumers make bad choices or if needs and wants have been inappropriately ranked. In addition, while benefits can be enjoyed by individuals engaged in production activities, for most people, production activities are unpleasant. Unpleasant things that lower one’s psychic enjoyment of life (which can also include noise pollution and commuting to work) represent the “psychic outgo” of economic activity. It is the cancelling out of psychic outgo from psychic income that enables one to obtain a measure of net psychic income – the final or “uncancelled benefit” of economic activity. …

… Perceiving the final benefit of economic activity in this manner means one should never directly identify the quantity of human-made capital with benefit itself. The stock of human-made capital should always be construed as a benefit-yielding physical magnitude because there is no necessary correlation between the magnitude itself and the net psychic income it yields (Daly, 1979). It has been the direct identification of the quantity of commodities consumed with the intensity of net psychic income enjoyed that has led many observers to erroneously believe that consumption is a “good”.

Certainly, in the case of some items, service can only be derived through their direct consumption (e.g., food, drink, and petrol). Nevertheless, on the whole, service is not directly derived from the act of consumption because very few people derive much satisfaction from seeing the paint on their house crack, from viewing a deteriorating TV image as the picture tube nears the end of its useful life, or from wearing a shirt that has long begun to perish and fade. Clearly, while it is necessary to consume human-made capital to enjoy the net psychic income it yields, consumption should be viewed as a “necessary evil” and something to be minimised (Boulding, 1966). Only the service-yielding qualities of human-made capital, not the rate at which human-made capital is consumed, should be maximised.’

2.1.3 The uncancelled costs of economic activity

The benefit of producing and maintaining a stock of MMK is one side of the equation.  The cost of this production and maintenance must be considered in terms of NK services foregone. To this end, we noted in Unit 1 that, to do this, requires a continuous entropic throughput of matter and energy. We also noted that this would inevitably have some deleterious impact on the ecosystem.

Lawn (2001, p. 81) continues:

‘Consequently, human beings have no option but to acknowledge and accept some loss of the free source, sink, and life-support services provided by the ecosphere as they manipulate, refine, and directly transform natural capital and the low entropy it provides into human-made capital.

Because natural capital is the original source of all human activity, the loss of natural capital services is the final or uncancelled cost of economic activity just as net psychic income is the uncancelled benefit. … Thus, in the same way human-made capital should not be directly identified with benefit, so the throughput of matter-energy should not be directly identified with cost. For, unlike the loss of natural capital services, the throughput constitutes nothing more than a cost-inducing physical flow that is necessary to keep the stock of human-made capital intact (Daly, 1979).

One final but very important point. Although, from an accounting point of view, lost natural capital services constitute the uncancelled costs of economic activity, of greater concern is whether the combined loss of natural capital services renders the current level of economic activity ecologically unsustainable. Should this be the case, it follows that the prevailing macroeconomic scale is, by definition, suboptimal. Clearly, it is necessary to limit the throughput of matter-energy resulting in the loss of natural capital services to a level that can be ecologically sustained.’

2.1.4 Sustainable net benefits and an optimal macroeconomic scale

From the preceding analysis, we can now define sustainable net benefit in terms of the following equation:

Sustainable net benefits = net psychic income – lost natural capital services

It follows that, to be sustainable, a nation should only increase the physical scale of the macro-economy if this expansion leads to an increase in net benefits. In the event that net benefits do not increase, then the expansion in the physical scale of the macro-economy becomes ‘uneconomic’.

2.2:      The methodological forerunners of ecological economics

While the likes of Daly and Costanza have been influential in the establishment of ecological economics, their thinking will have been influenced by a number of individuals who probably never referred to themselves as ecological economists. Among the classical economists, the Reverend Thomas Robert Malthus obviously deserves a mention (see Unit 1). So too, does John Stuart Mill (1806-1873) who wrote about the ‘stationary state’ in The Principles of Political Economy (1848). In more recent times, the names of Nicholas Georgescu-Roegen and Kenneth Boulding figure very prominently.

John Stuart Mill

‘If the earth must lose that great portion of its pleasantness which it owes to things that the unlimited increase of wealth and population would extirpate from it, for the mere purpose of enabling it to support a larger, but not a better or a happier population, I sincerely hope, for the sake of posterity, that they will be content to be stationary, long before necessity compel them to it.’

The Principles of Political Economy (1848)

Image source: users.ox.ac.uk

2.2.1 Nicholas Georgescu-Roegen

Herman Daly, arguably the most prominent of commentators in the world today on sustainable development, pays special tribute to his mentor, Nicholas Georgescu-Roegen (whose work he describes as ‘magisterial’) in Chapter 13 of Beyond Growth: The Economics of Sustainable Development (Daly 1996). Indeed, there is widespread agreement among ecological economists that a key text in facilitating understanding of the economic aspect of sustainability is Georgescu-Roegen’s The Entropy Law and The Economic Process (1971).

Writing long before the term ‘sustainability’ came into common usage, Georgescu-Roegen essentially equates ‘entropic’ with ‘sustainable’. He explains how mainstream economics is a non-entropic paradigm, largely based on the work of the 19th century neoclassical economists, Leon Walras and Stanley Jevons. Their ‘arithmomorphic’ (mathematical/ mechanistic) approach is a process of production/consumption completely divorced from the physical world according to Georgescu-Roegen.

Image source: unige.ch

2.2.2    The entropy hourglass

The essence of Georgescu-Roegen’s work can be summed up with reference to his entropy hourglass metaphor.

Figure 2.2 The entropy hourglass

Image source: powerofculture.nl

Industrial societies have come to depend on finite stocks of low entropy

Daly (1996, pp. 29-30) describes the entropy hourglass metaphor thus:

‘First, the hourglass is an isolated system: no sand enters, no sand exits.

Second, within the glass there is neither creation nor destruction of sand, the amount of sand in the glass is constant. This, of course, is the analogue of the first law of thermodynamics – conservation of matter/energy.

Third, there is a continuing running down of sand in the top chamber, and an accumulation of sand in the bottom chamber. Sand in the bottom chamber has used up its potential to fall and thereby do work, it is high-entropy or unavailable (used-up) matter/energy. Sand in the top chamber still has potential to fall – it is low entropy or available (still useful) matter/energy. This is the second law of thermodynamics: entropy (or “used-up-ness”) increases in an isolated system. The hourglass analogy is particularly apt since entropy is time’s arrow in the physical world.

The analogy can be extended by considering the sand in the upper chamber to be the stock of low-entropy energy in the sun. Solar energy arrives to earth as a flow whose amount is governed by the constricted middle of the hourglass, which limits the rate at which sand falls, the rate at which solar energy flows to earth. Suppose that over ancient geologic ages some of the falling sand had gotten stuck against the inner surface of the bottom chamber, but at the top of the bottom chamber, before it had fallen all the way.

This becomes a terrestrial dowry of low-entropy matter/energy, a stock that we can use up at a rate of our own choosing. We use it by drilling holes into its surface through which the trapped sand can fall to the bottom of the lower chamber. This terrestrial source of low-entropy matter/energy can be used at a rate of our own choosing, unlike the energy of the sun, which arrives at a fixed flow rate. We cannot “mine” the sun to use tomorrow’s sunlight today, but we can mine terrestrial deposits and, in a sense, use up tomorrow’s petroleum today.

There is thus an important asymmetry between our two sources of low entropy. The solar source is stock-abundant, but flow-limited. The terrestrial source is stock-limited, but flow-abundant (temporarily). Peasant societies lived off the abundant solar flow; industrial societies have come to depend on enormous supplements from the limited terrestrial stocks. …

… One more thing. Unlike a real hourglass, this one cannot be turned upside down! Its central feature is what Georgescu-Roegen called the “metabolic flow”, the entropic throughput of matter/energy by which the economy depends on its environment. This dependence is completely abstracted from in the neoclassical economist’s starting point, the circular flow of exchange value.’

2.2.3    Cowboys and spaceships

Kenneth Boulding is generally regarded as something of a maverick. Although a prolific writer, and a man of considerable intellect, it’s probably fair to say that he remained on the fringes of the economics academe. This is not unusual for someone who challenges the orthodoxy (as we shall see in Unit 4), and the same might be said of Nicholas Georgescu-Roegen and Herman Daly.

It is sometimes suggested that Boulding’s forays into interdisciplinary studies, peripheral to the central developments within his discipline, were responsible for the lack of broad acceptance of his work. Perhaps, in time, his ecological and evolutionary approach to economics will become more widely acknowledged. Meanwhile, within the ecological economics fraternity his position of eminence has never been in doubt. Of particular note is his 1966 work, entitled ‘The Economics of the Coming Spaceship Earth’. This article is regarded as something of a classic and effectively set the stage for ecological economics with its description of the transition from the ‘frontier economics’ of the past to the ‘spaceship economics’ of the future.

Kenneth Boulding (1910-1993)

Image source: ecoplan.org

Daly (1996, p. 58) summarises the essence of the piece in a section that he gives the heading: ‘Cowboy, spaceman or bull in the china shop?’

‘If one starts from the vision of the economic process as an open subsystem of a closed finite total system, then the question of how big the subsystem should be relative to the total system is hard to avoid. How then have we managed to avoid it?

In two ways: first, by viewing the economic subsystem as infinitesimally small relative to the total system, so that scale becomes irrelevant because it is negligible; second, by viewing the economy as coextensive with the total system. If the economy includes everything, then the issue of scale relative to a total system simply does not arise.

These polar extremes correspond to Boulding’s colourful distinction between the “cowboy economy” and the “spaceman economy”. The cowboy of the infinite plains lives off of a linear throughput from source to sink, with no need to recycle anything. The spaceman in a small capsule lives off of tight material cycles and immediate feedbacks, all under total control and subservient to his needs. For the cowboy, scale is negligible; for the spaceman, scale is total. There is no material environment relative to which scale must be determined; there is no ecosystem, only economy. In each of these polar cases, the only problem is allocation. Scale is irrelevant.

It is only in the middle ground between the cowboy and the space- man that the issue of scale does not get conflated with allocation. But, as Boulding realised, the middle ground happens to be where we are. Between the cowboy and spaceman economies is a whole range of larger and smaller “bull-in-the-china-shop economies” where scale is a major concern. We are not cowboys because the existing scale of the economy is far from negligible compared to the environment. But neither are we spacemen, because most of the matter/energy transformations of the ecosystem are not subject to human control either by prices or by central planning.’

Activity: Cowboy economy vs Spaceship economy

Refer now to Reading 1.2 by Kenneth Boulding (1966) that first appeared in Jarrett, H. (ed.) (1966), Environmental Quality in a Growing Economy, Johns Hopkins University Press, Baltimore.

Discuss the relevance (or otherwise) of ‘The Economics of the Coming Spaceship Earth’ to current environmental problems and policies.

2.3:      Embracing the concept of throughput

Professor Herman Daly was the World Bank’s senior environmental economist from 1988 to 1994, but resigned after becoming frustrated with the institution’s bureaucracy and outdated policies. In his farewell speech to his World Bank colleagues, Daly advised that they take “a few antacids and laxatives to cure the combination of managerial flatulence and organizational constipation”, and prescribed “new glasses and a hearing aid” for the World Bank in dealing with the outside world.

In April 2002, Daly went back to the World Bank and gave an oft-cited speech (an excerpt appears below) as part of the ‘Environmentally and Socially Sustainable Development Month Distinguished Speaker Series’. This speech was important in that it puts forward the case for focusing on throughput rather than utility (You may want to read the full transcript of the speech which runs to 13 pages).

“Exactly what is it that is supposed to be sustained in ‘sustainable’ development? Two broad answers have been given:

First, utility should be sustained; that is, the utility of future generations is to be non-declining. The future should be at least as well off as the present in terms of its utility or happiness as experienced by itself. Utility here refers to average per capita utility of members of a generation.

Second, physical throughput should be sustained, that is, the entropic physical flow from nature’s sources through the economy and back to nature’s sinks, is to be non-declining. More exactly, the capacity of the ecosystem to sustain those flows is not to be run down. Natural capital is to be kept intact. The future will be at least as well off as the present in terms of its access to biophysical resources and services supplied by the ecosystem. Throughput here refers to total throughput flow for the community over some time period (i.e., the product of per capita throughput and population).

These are two totally different concepts of sustainability. Utility is a basic concept in standard economics. Throughput is not, in spite of the efforts of Kenneth Boulding and Nicholas Georgescu-Roegen to introduce it. So it is not surprising that the utility definition has been dominant.

Nevertheless, I adopt the throughput definition and reject the utility definition, for two reasons. First, utility is non-measurable. Second, and more importantly, even if utility were measurable it is still not something that we can bequeath to the future. Utility is an experience, not a thing. We cannot bequeath utility or happiness to future generations. We can leave them things, and to a lesser degree knowledge. Whether future generations make themselves happy or miserable with these gifts is simply not under our control. To define sustainability as a non declining intergenerational bequest of something that can neither be measured nor bequeathed strikes me as a nonstarter.”

Daly (2002, pp. 1-2)

Activity: The ends-means spectrum

Watch Herman Daly on YouTube talk about the ends-means spectrum (10 minutes), on why it is important to preserve sources of low entropy as the ultimate means. The ultimate ends, he says, is a much more difficult an issue to ponder. What, in your view, is the ultimate ends? Discuss this issue with your classmates.

Summary

The main objective of this unit was to extend our initial theoretical analysis of the sustainable development concept by defining ecological economic efficiency. In doing so, this further highlighted the interdependency of sustainability and development, and the notion of an optimal macroeconomic scale – something completely overlooked by neo-classical economics.

The likes of Georgescu-Roegen and Boulding were early critics of this shortcoming within mainstream economics. Herman Daly and others have since taken up the cudgel, Daly arguing for sustainability of throughput instead of utility.

Key concepts

Ecological economic efficiency (EEE); throughput; service efficiency; maintenance efficiency; growth efficiency; ecosystem efficiency; optimal macroeconomic scale; uncancelled benefits of economic activity; uncancelled costs of economic activity; net sustainable benefits; net psychic income; lost natural capital services; the entropy hourglass.

References and further reading

Boulding, K. (1966). ‘The economics of the coming spaceship earth’, in Jarrett, H. (ed.) Environmental Quality in a Growing Economy, Johns Hopkins University Press, Baltimore.

Daly, Herman E. (1979). ‘Entropy, growth and the political economy of scarcity’, in Scarcity and Growth Reconsidered, Smith, V.K., (ed.) Johns Hopkins University Press, Baltimore.

Daly, Herman E. (1991). Steady-State Economics, (2nd edn.), Washington D.C.: Island Press.

Daly, Herman E. (1992). ‘Steady-state economics: Concepts, questions, policies’. Bristol (UK) Schumacher Lectures on Re-visioning Society – Linking Economics, Ecology and Spiritual Values, October.

Daly, Herman E. (1996). Beyond Growth: The Economics of Sustainable Development. Boston: Beacon Press.

Daly, Herman E. (2002). ‘Sustainable Development: Definitions, Principles, Policies’. Invited Address, Environmentally and Socially Sustainable Development Month Distinguished Speaker Series, World Bank, April 30, 2002, Washington, DC.

Jackson, J., McIver, R. and McConnell, C. (1994). Economics, (4th edn.), Sydney: McGraw-Hill.

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