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Scale, prices, and biophysical assessments
Ecological Economics 38 (2001) 369– 382 www.elsevier.com/locate/ecolecon
ANALYSIS
Scale, prices, and biophysical assessments Philip A. Lawn * School of Economics, Flinders Uni6ersity of South Australia, GPO Box 2100, Adelaide 5001, Australia Received 14 August 2000; received in revised form 8 February 2001; accepted 9 February 2001
Abstract In a recent forum on biophysical assessments, a number of ecological economists expressed serious reservations about the use of prices to assess the appropriate scale of macroeconomic systems. While such reservations are warranted, the preference for biophysical assessments over prices indicates that many ecological economists are focussing on one notion of scale and neglecting another altogether. There are two notions of scale that are critical to achieving sustainable development (SD). One is the maximum sustainable macroeconomic scale; the other is the optimal macroeconomic scale. The maximum sustainable scale is the largest macroeconomic scale that can be sustained by a throughput of matter-energy that is within the ecosphere’s regenerative and waste assimilative capacities. The optimal scale is a preferable macroeconomic scale and is one that is not only sustainable, but one that maximises the net benefits of economic activity. Biophysical assessments are needed to determine the maximum sustainable scale because ecological sustainability is a biophysical problem, not an economic problem. Thus, it is through biophysical assessments that the necessary restrictions on the incoming resource flow can be calculated and imposed. However, since the achievement of an optimal macroeconomic scale is an economic problem — albeit a constrained economic problem — relative prices are required to efficiently allocate the sustainable resource flow so the macroeconomy can adjust to the optimum. Failure to recognise the two notions of scale and the most appropriate means of their assessment is likely to thwart rather than advance the movement toward SD. © 2001 Elsevier Science B.V. All rights reserved. Keywords: Maximum sustainable scale; Optimal scale; Biophysical assessments; Prices; Sustainable development
1. Introduction For some time now, ecological economists have been pointing out that while prices are good at facilitating the efficient allocation of resources, they are unable to ensure that the incoming resource flow fuelling the economic process is * Tel.: +61-8-82012838; fax: +61-8-82015071. E-mail address: [email protected] (P.A. Lawn).
ecologically sustainable (Howarth and Norgaard, 1990; Norgaard, 1990; Daly, 1991, 1996; Bishop, 1993). So critical do ecological economists believe the limitations of prices to be, virtually an entire issue of Ecological Economics (vol. 29, no. 1) was devoted to a forum focussing on the importance of biophysical assessments in sustainability analyses. Unfortunately, by almost unanimously ruling out the usefulness of prices when it comes to scale-related issues (e.g. Røpke, 1998), the partici-
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pants of the forum failed to indicate what is the most desirable macroeconomic scale. In doing so, they gave implicit approval for nations to operate their macroeconomies somewhere approaching the maximum sustainable scale. While this is preferable to operating unsustainably, it is by no means desirable. Indeed, the most desirable scale from a sustainable development (SD) perspective is the optimal macroeconomic scale which, interestingly, was never mentioned in the forum. Of course, the fact that many countries appear to have already exceeded their maximum sustainable scale (Wackernagel et al., 1999) suggests the movement towards an optimal scale is of little current importance. I beg to differ since by explaining what constitutes an optimal macroeconomic scale one can offer a viable alternative to ‘growthmania’. This increases the likely introduction of the policies required to achieve SD.
2. Maximum sustainable scale, optimal scale, and sustainable development SD is probably best described as a process of sustainable qualitative improvement. To achieve SD, essentially two things are required. First, the economic process must be ecologically sustainable — that is, the rate at which resources are used and wastes are generated must not exceed the ecosphere’s regenerative and waste assimilative capacities. Should the throughput of matter-energy required to maintain a macroeconomic system at a particular physical scale be ecologically unsustainable, the macroeconomy will have exceeded its maximum sustainable scale. Second, the net benefits of economic activity must be non-decreasing. Should the net benefits of a growing macroeconomic system be increasing, growth of the macroeconomy is desirable. Conversely, should net benefits be falling then, even if the rate of throughput is ecologically sustainable, growth of the macroeconomy is undesirable. Indeed, in such circumstances the macroeconomic system will have exceeded its optimal scale. Fig. 1 can be used to better understand the notions of optimal scale and maximum sustainable scale. It can also shed light on what is required to
bring about an optimal macroeconomic scale and to facilitate the transition toward SD. Fig. 1 is a linear throughput representation of the economic process that, unlike the conventional circular model, depicts the macroeconomy as a subsystem of the natural environment. By tracing economic activity from its original source to its ultimate conclusion, the linear throughput model reveals five macro magnitudes applicable to the economic process. The first of these is natural capital. Natural capital constitutes the original source of all economic activity since it provides a source of low entropy resources; it acts as a sink to assimilate high entropy wastes, and it provides a range of life-support services necessary to maintain the habitability of planet Earth. The second macro magnitude is the throughput of matter-energy — that is, the input into the macroeconomy of low entropy resources and the subsequent output of high entropy wastes. The throughput flow is the physical intermediary connecting natural and human-made capital. Human-made capital is the third macro magnitude and is needed for human welfare to be greater than it would otherwise be if the economic process did not take place. Conventionally, human-made capital is confined to producer goods such as plant, machinery, and equipment. From an ecological economic perspective, capital is interpreted in the Irving Fisher sense as all physical objects subject to ownership that are capable of directly or indirectly satisfying human needs and wants (Fisher, 1906). Hence, human-made capital refers to consumer goods as well as producer goods. Although not subject to ownership (other than by the individual who possesses productive knowledge and skills), labour can also be included as part of the stock of human-made capital. The next important magnitude is a psychic rather than physical magnitude. Contrary to some opinions, human welfare depends not on the rate of production and consumption, but on the psychic enjoyment of life (Boulding, 1966; GeorgescueRoegen, 1971; Daly, 1996; Lawn, 1999). Fisher (1906) referred to such a flux as ‘psychic income’. Most economists refer to the psychic enjoyment of life as utility satisfaction. Psychic income is the true benefit of all economic activity and has three main sources. The first source of psychic income comes from the consumption of human-made capital. The
P.A. Lawn / Ecological Economics 38 (2001) 369–382 Fig. 1. The linear throughput representation of the macroeconomy (1) net psychic income; (2) human-made capital; (3) throughput (low entropy input high entropy flows); (4) natural capital; (5) lost natural capital services. N-RKn, non-renewable natural capital; RKn, renewable natural capital; E, energy; M, matter; h, harvest rate; r, natural regeneration rate; W, waste; A, waste assimilative capacity; , low entropy flows; , high entropy output; , psychic flows.
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second source emerges as a consequence of being directly engaged in production activities (e.g. the enjoyment and self-worth obtained from work). A third source of psychic income flows from the natural environment in terms of its aesthetic and recreational qualities. It is true that this final source of psychic income does not come from economic activity. If anything, economic activity tends to destroy rather than enhance such values. It is, therefore, better that these values be taken as a given and their subsequent destruction be counted as an opportunity cost of economic activity. This last point reminds us that not all economic activity enhances the psychic enjoyment of life. 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 (e.g. noise pollution and commuting to work) represent the ‘psychic outgo’ of economic activity. It is the subtraction of psychic outgo from psychic income that leads to a measure of net psychic income — the fourth important macro magnitude. Net psychic income is, in effect, the ‘uncancelled benefit’ of economic activity. Why? Imagine tracing the economic process from natural capital to its final psychic conclusion. Every intermediate transaction involves the cancelling out of a receipt and expenditure of the same magnitude (i.e. the seller receives what the buyer pays). Only once a physical good is in the possession of the final consumer is there no further exchange and, thus, no further cancelling out of transactions. Apart from the good itself, what remains at the end of the process is the uncancelled exchange value of the psychic income that the ultimate consumer expects to gain from the good plus any psychic disbenefits and other costs associated with the good’s production. Note, therefore, that if the costs are subtracted from the good’s final selling price, the difference constitutes the ‘use value’ added to low entropy matter-energy during the production process. Presumably the difference is positive, otherwise the economic process is a pointless exercise.
The fifth macro magnitude is the cost of lost natural capital ser6ices and arises because, in obtaining the throughput to produce and maintain human-made capital, some of the services provided by natural capital are inevitably lost (Perrings, 1986). In a similar way to net psychic income, lost natural capital services constitute the ‘uncancelled cost’ (UC) of economic activity (Daly, 1996; Lawn, 2000a; Lawn and Sanders, 1999). Imagine tracing the economic process from its psychic conclusion back to natural capital. Once again, all transactions cancel out. However, on this occasion, what remains is the uncancelled exchange value of any natural capital services sacrificed in obtaining the throughput of matter-energy to fuel the economic process. In sum, the linear throughput model illustrates the following. Natural capital provides the throughput of matter-energy that is needed to produce and maintain the stock of human-made capital. Human-made capital is required to enjoy a level of net psychic income greater than what would otherwise be experienced if the economic process did not take place. Finally, in exploiting natural capital for the throughput of matter-energy, the three instrumental services that natural capital provides are, to some degree, unavoidably sacrificed. The linear throughput model also shows that natural and human-made capital are complementary forms of capital. Although technological progress embodied in human-made capital can reduce the resource flow required from natural capital to produce physical goods, for two related reasons this does not amount to substitution (Lawn, 1999). First, technological progress merely reduces the high entropy waste generated in the transformation of natural to human-made capital. Second, because of the first and second laws of thermodynamics, there is a limit to how much production waste can be reduced by technological progress — there can be no 100% production efficiency; there can never be 100% recycling of matter; and there is no way to recycle energy at all. Thus, the production of a given quantity of human-made capital will always require a minimum resource flow and, therefore, a minimum amount of resource-providing natural capital.
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Fig. 2. The changing sustainable net benefits of a growing macroeconomy (adapted partly from Daly, 1991).
3. Economic and uneconomic growth A great advantage of the linear throughput model over the circular flow model is that it forces one to consider how big the macroeconomic subsystem can grow before the throughput of matterenergy required to maintain it can no longer be ecologically sustained. Moreover, it also leads one to consider how big the macroeconomic subsystem should grow before the net benefits of growth start declining and growth itself becomes uneconomic. Barring technological progress, Fig. 2 indicates the eventual undesirability of growth as the physical scale of the macroeconomic subsystem expands. The uncancelled benefits (UB) curve in Panel 2a represents the net psychic income yielded by a growing macroeconomy. The characteristic shape of the UB curve is attributable to the law of diminishing marginal utility which, barring technological improvements, is equally applicable to the total stock of wealth as it is to individual items. The cost of increasing the physical scale of the macroeconomy is represented in Panel 2a by the UC curve.
It represents the source, sink, and life-support functions lost in the process of transforming natural capital into human-made capital. The shape and nature of the UC curve is attributable to the law of increasing marginal costs — a reflection of the increase in costs arising from the macroeconomy growing relative to a finite natural environment. The UC curve is vertical at SS to denote the maximum sustainable scale. For any given macroeconomic scale, sustainable net benefits are measured by the difference between UB and costs and, hence, the vertical distance between the UB and UC curves. Sustainable net benefits are represented by the SNB curve in Panel 2b and are maximised at a macroeconomic scale of S*. Thus S* denotes the optimal macroeconomic scale. Fig. 2 demonstrates a number of important points. First, growth is only economic in the early stages of the development process. Continued physical expansion of the macroeconomic subsystem, which is equivalent to moving along the UB and UC curves, leads to a decline in sustainable net
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benefits (renders a nation poorer rather than richer). Second, the maximum sustainable scale need not be the desirable or optimal macroeconomic scale. Indeed, while ecological sustainability is a necessary condition for achieving the optimum, it is by no means a sufficient condition. Finally, an economic limit to growth is likely to precede any biophysical limit to growth and, as studies of many countries have shown, has in most cases been exceeded (Max-Neef, 1995; Jackson and Stymne, 1996; Lawn, 2000a; Lawn and Sanders, 1999).
4. Technology and sustainable net benefits One cannot ignore the role played by advances in technology. Technological progress can increase the net psychic income gained and decrease the natural capital services sacrificed in maintaining a given macroeconomic scale. This is because technological progress can beneficially shift the UB curve upwards and the UC curve downwards and to the right. Furthermore, technological progress can also increase the maximum sustainable scale. To explain how the two curves can be positively shifted, two of the five key magnitudes of the linear throughput model can be arranged to represent a measure of ecological economic efficiency (EEE). The ratio is as follows (Daly, 1996): EEE =
net psychic income lost natural capital services
(1)
For a given physical scale of the macroeconomy, an increase in the EEE ratio indicates an improvement in the efficiency with which natural capital is transformed into benefit-yielding human-made capital. A multitude of factors can increase the EEE ratio. To demonstrate how, the EEE ratio can be expanded to reveal four component ratios. The EEE ratio thus becomes the following identity:
EEE=
net psychic income = lost natural capital services
Starting from Ratio 1 and progressing through to Ratio 4, each component ratio cancels the ensuing ratio out. This leaves the basic EEE ratio on the left-hand side. The order in which the four component ratios are presented is in keeping with the conclusions drawn from the linear throughput representation of the macroeconomy — i.e. the net psychic income from economic activity is enjoyed because of the existence of human-made capital (Ratio 1); human-made capital exists as a consequence of the throughput of matter-energy (Ratio 2); the throughput of matter-energy is made possible because of the existence of natural capital (Ratio 3); and, in exploiting natural capital, the three instrumental services provided by natural capital are, to some degree, sacrificed (Ratio 4). Each component ratio represents a different form of efficiency and will now be individually explained and discussed. Ratio 1 is a measure of the ser6ice efficiency of human-made capital. It increases whenever a given physical magnitude of human-made capital yields a higher level of net psychic income. An increase in Ratio 1 causes the UB curve to shift upwards and can be achieved by improving the technical design of newly produced commodities. It can also be achieved by improving the manner in which human beings organise themselves in the course of producing and maintaining the stock of human-made capital, thereby reducing such things as the disutility of labour and the cost of commuting and unemployment. A beneficial upward shift in the UB curve can also be achieved by distributing the stock of human-made capital more equitably. Often overlooked, the redistribution of income from the low marginal service or psychic income uses of the rich to the higher marginal service uses of the poor can lead to an overall increase in the net psychic income enjoyed by society as a whole (Robinson, 1962). There is, however, a limit on the capacity for redistribution
Ratio 1
Ratio 2
Ratio 3
Ratio 4
net psychic income × human-made capital
human-made captial × throughput
throughput × natural capital
natural capital lost natural capital services
(2)
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Fig. 3. A change in sustainable net benefits brought about by an increase in the service efficiency of human-made capital (Ratio 1).
to increase Ratio 1 because an excessive approach to redistribution adversely dilutes the incentive structure built into a market-based system. Fig. 3 illustrates what happens to sustainable net benefits when the UB curve shifts upwards. Because an increase in Ratio 1 augments the net psychic income yielded by a given magnitude of human-made capital, the UB curve shifts up to UB1. The UC curve does not move since the uncancelled opportunity cost of creating and maintaining a given stock of wealth remains unchanged. Moreover, the maximum sustainable macroeconomic scale remains at SS. Prior to the increase in the service efficiency of human-made capital, sustainable net benefits are maximised by operating at a macroeconomic scale of S* — i.e. where sustainable net benefits equal SNB*. Following an increase in the service efficiency of human-made capital, sustainable net benefits are no longer maximised at the prevailing macroeconomic scale. Instead, they are maximised at the scale S*1 where sustainable net benefits equal SNB1. It is now desirable to expand the physical scale of the macroeconomy to S*1.
Changes in Ratios 2–4 cause the UC curve to shift. Ratio 2 is a measure of the maintenance efficiency of human-made capital. It increases whenever a given physical magnitude of humanmade capital can be maintained by a lessened rate of throughput. This can be achieved by developing new technologies that reduce the requirement for resource input either through, (a) the more efficient use of resources in production; (b) increased rates of product recycling; (c) greater product durability, and/or (d) improved operational efficiency. An increase in Ratio 2 causes the UC to shift downwards and to the right for the following reasons. First, it enables any given macroeconomic scale to be sustained by a reduced rate of throughput. Second, a lower rate of throughput means not having to exploit as much natural capital which means fewer lost natural capital services. Ratio 3 is a measure of the growth efficiency or productivity of natural capital. This form of efficiency is increased whenever a given amount of natural capital is able to sustainably yield a
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Fig. 4. A change in sustainable net benefits brought about by increases in the maintenance efficiency of human-made capital (Ratio 2), and the growth and exploitative efficiencies of natural capital (Ratios 3 and 4).
greater quantity of low entropy resources and assimilate more of the high entropy waste that economic activity generates. Better management of natural resource systems and the preservation of critical ecosystems can lead to a more productive stock of natural capital. How does an increase in Ratio 3 lead to a downward and rightward shift of the UC curve? An increase in the productivity of natural capital reduces the quantity of natural capital that must be exploited to sustain the macroeconomy at a given physical scale. This, in turn, means a macroeconomy of a given physical scale can be sustained at the expense of fewer natural capital services. Ratio 4 is a measure of the exploitati6e efficiency of natural capital. If Ratio 4 increases, fewer natural capital services are lost in exploiting a given quantity of natural capital. This, again, allows a macroeconomy of a given physical scale to be sustained at the expense of fewer natural capital services and, thus, to a downward and rightward shift of the UC curve. Increases in Ratio 4 can be obtained through the development and execution of more ecologically sensitive extractive techniques such as the use of underground rather than open-cut or strip mining practices.
Fig. 4 illustrates what happens to sustainable net benefits when there is a shift of the UC curve. Because an increase in Ratios 2–4 reduces the UC of producing and maintaining a given macroeconomic scale, the UC curve shifts down and out to UC1. However, the UB curve remains stationary since an increase in Ratios 2–4 does not augment the net psychic income yielded by a given stock of human-made capital. Unlike a shift in the UB curve, a shift in the UC curve results in an increase in the maximum sustainable macroeconomic scale (SS –S1S). The logic behind this is quite simple. If there are now fewer natural capital services sacrificed in maintaining what was previously the maximum sustainable macroeconomic scale, a larger macroeconomic subsystem can now be ecologically sustained from the same loss of natural capital services. Prior to further increases in either the maintenance efficiency of human-made capital and/or the growth and exploitative efficiency of natural capital, sustainable net benefits are maximised by operating at a macroeconomic scale of S* — i.e. where sustainable net benefits equal SNB*. Upon an increase in Ratios 2, 3, and/or 4, sustainable net benefits are maximised at the scale S*1 where they now equal SNB1. It is now desirable to
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expand the physical scale of the macroeconomy to S*1. 5. Limits to the beneficial shift of the UB and UC curves There is considerable debate surrounding how much and for how long human beings can rely on technological progress to increase these four efficiency ratios and thus shift the UB and UC curves. Ecological economists believe the limits to technological progress with respect to decreasing UCs (increases to Ratios 2– 4) are inevitable and probably not that far away. Conclusions regarding limits to increases in the service efficiency of human-made capital (Ratio 1) are harder to draw because net psychic income is a psychic rather than physical magnitude. Nevertheless, it is difficult to believe that a given physical magnitude of human-made capital could yield ever-increasing levels of net psychic income. Given the existence of these limits, particularly in relation to the capacity to positively shift the UC curve, a few of things are irrefutably clear. First, there is an inevitable limit to the maximum sustainable scale of the macroeconomic subsystem. Second, while the physical expansion of the macroeconomic subsystem is able to promote economic development in the early stages of a nation’s SD process, the growth objective must give way to a qualitative improvement of human-made capital and a reduction in the psychic disbenefits associated with maintaining the stock intact. Finally, provided the throughput of matter-energy required to maintain the improving human-made capital is within the regenerative and assimilative capacities of natural capital, a nation is able to achieve SD without the assumed need for continued growth.
6. Achieving an optimal macroeconomic scale Having argued that nations should aim to operate at the optimal macroeconomic scale, how is it attained? First, it is necessary to know the following.
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What is the physical scale of a nation’s macroeconomy? Are the sustainable net benefits of economic activity non-decreasing and, should they be falling, does this mean a nation’s macroeconomy has exceeded its optimal scale? Is a nation improving the efficiency with which it transforms natural capital into benefit-yielding human-made capital? In other words, is the EEE ratio increasing or decreasing? In view of the complementarity of natural and human-made capital, what is happening both quantitatively and qualitatively to a nation’s stock of natural capital? If natural capital is in decline, has a nation’s macroeconomy exceeded its maximum sustainable scale? To find the answers to these questions, the system of national accounts ought to be designed to measure the five key magnitudes fundamental to the economic process. This requires a separate account for UB (net psychic income), UCs (lost natural capital services), human-made capital, natural capital, and the throughput of matter-energy (the input of resources and the output of wastes). Interestingly, for Australia, for which I have compiled individual accounts for four of the five magnitudes for the period 1966– 1967 to 1994–1995, I obtained the following answers to the above questions (Lawn, 2000a).1 The stock of human-made capital increased in all but one financial year from 1966– 1967 to 1994–1995 ($2084 billion in 1966–1967 to $4712 billion by 1994–1995). In effect, the Australian macroeconomy grew over the study period at an average rate of 2.9% per annum. Furthermore, Australia’s population increased from 11.8 to 18.1 million. Per capita sustainable net benefits (UB less UCs) increased in every year between 1966– 1967 and 1973–1974 ($13 023 per Australian in 1
The items in each account were measured in 1989 – 1990 dollars. Because of the difficulty associated with the compilation of a throughput account, Australia’s total energy consumption was used as a proxy measure of resource throughput. The methods used to calculate the dollar values of the items in each account and a discussion of the potential valuation problems can be found in Lawn (2000a,b).
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Fig. 5. Per capita sustainable economic welfare and per capita real GDP for Australia, 1966 – 67 to 1994 – 95.
1966–1967 compared with $18 977 per Australian in 1973–1974). In most years thereafter, per capita sustainable net benefits declined. By 1994–1995, per capita sustainable net benefits were lower than in 1966–1967 ($12 852 per Australian in 1994– 1995). See Fig. 5 where a comparison is drawn between per capita sustainable net benefits and per capita GDP. From a quantitative perspective, Australia’s stock of natural capital decreased over the study period. While there were very small increases in the stock of renewable natural capital, this was considerably outweighed by the diminution of non-renewable natural capital. As for the quality of Australia’s natural capital, the growth efficiency ratio (Ratio 3) increased over the study period suggesting Australia’s natural capital became more productive. This is misleading since the continued rise in Australia’s energy consumption was only made possible by an increase in the depletion rate of non-renewable energy stocks. Clearly, Australia’s current rate of energy consumption cannot be sustained. In addition, an
ecosystem health index that was used to weight the UCs of economic activity declined in every year over the study period.2 The ecosystem health index, which was based on changes in native vegetation cover, fell from an index value of 100.0 in 1966–1967 to 90.0 in 1994– 1995. The trend movement in Australia’s EEE ratio was similar to the change in sustainable net benefits. That is, the EEE ratio rose between 1966–1967 and 1973–1974 (2.41–2.85), but fell in most financial years thereafter (1.94 by 1994–1995). This indicates that the general decline in sustainable net benefits after 1973– 1974 was due as much to the inefficient allocation of resources as it was to the depletion of natural capital.
2 The UCs were weighted by an ecosystem health indicator because the items used to measure the lost source and sink functions of natural capital did not account for impacts on the ecosphere’s life-support services. For example, mining not only reduces the source function of natural capital but, by degrading ecosystems, also reduces its life-support function.
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In view of the general downturn in the sustainable net benefits of economic activity, the Australian macroeconomy appears to have exceeded its optimal scale (Lawn and Sanders, 1999). It is more difficult to determine whether the maximum sustainable scale has been surpassed. This is because a measure of sustainable net benefits does not, by itself, indicate whether a nation is operating sustainably (Lawn, 2000b). However, the following should be considered. A recent study by Wackernagel et al. (1999) reveals that Australia’s ecological footprint is considerably less than its biocapacity (9.0 ha per Australian compared with an available biocapacity of 14.0 ha per Australian). The same study also indicates that the world’s biocapacity is just 2.1 ha per person. Approximately four-and-a-half Earths would, therefore, be required for everyone to enjoy the same per capita rate of resource consumption as the average Australian. Since ecological sustainability is ultimately a global issue, Australia will undoubtedly be pressured in the future to reduce its ecological footprint and share its surplus biocapacity with less fortunate nations. Exactly how far Australia might be expected to reduce its ecological footprint is anyone’s guess, nevertheless, it may be enough to render the current physical scale of the Australian macroeconomy unsustainable. Finally, as previously mentioned, Australia’s natural capital stocks have declined while the cost of lost natural capital services has steadily increased. In all, the Australian macroeconomy would, at the very least, appear to be fast approaching its maximum sustainable scale. What about designing policies and institutional mechanisms to facilitate the transition towards an optimal macroeconomic scale? Since ecological sustainability is a necessary condition for achieving the optimum, the first policy goal is to ensure the throughput of matter-energy is within the ecosphere’s regenerative and waste assimilative capacities. The second policy goal is to ensure the sustainable incoming resource flow is distributed equitably. Distributional equity is not only a moral imperative but, as explained earlier, a fairer and more just distribution of income and wealth can increase the sustainable net benefits accruing to a nation’s citizens. The third main policy goal
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is allocative efficiency, which is necessary to ensure the equitably distributed and sustainable incoming resource flow is allocated to different product uses in conformity with consumer preferences as weighted by the ability of each individual to pay for the means to their satisfaction. It also ensures that the appropriate signals and incentives are in place to facilitate increases in the service and maintenance efficiency of human-made capital (Ratios 1 and 2). Of course, the three goals of ecological sustainability, distributional equity, and allocative efficiency are not entirely independent of each other (Prakash and Gupta, 1994). Contestable markets, for example, not only improve the efficiency of resource allocation but, by keeping profits at the normal economic level, act as a useful redistribution mechanism. In addition, Pigouvian taxes reduce the pressure of each unit of output on natural capital as well as increase the efficiency of resource use. This aside, the three policy goals are sufficiently independent to be classified as separate or distinct policy goals requiring a separate policy instrument to be adequately resolved (Tinbergen, 1952; Daly, 1991, 1996). The first major policy goal, ecological sustainability, cannot be achieved through the use of prices/markets because relative price signals only provide information regarding the scarcity of one thing relative to another — for instance, the scarcity of one type of resource (oil) relative to another (coal). It is because the market is very effective at revealing relati6e scarcities that it constitutes an effective allocative mechanism. But sustainability is a question of the absolute scarcity of the non-substitutable low entropy that sustains the economic process and no amount of relative scarcity information can render the market effective at ensuring a sustainable resource flow (Howarth and Norgaard, 1990; Norgaard, 1990; Bishop, 1993; Daly, 1996). This is why there is a need for biophysical assessments. In the first instance, they can indicate the extent to which economic activity has impacted on natural capital. Second, they can be used to calculate the maximum sustainable rate of resource throughput. This can then serve as a benchmark for quantitatively restricting the incoming resource flow. Dis-
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tributional equity requires the use of redistribution mechanisms such as taxes, transfers, and universal rights and privileges. Since the third major policy goal — allocative efficiency — requires the use of relative price signals, it is here where biophysical assessments are of lessened value. Biophysical assessments are still of some value since they can be used to compute the spillover costs of pollution and ecosystem degradation. However, they cannot be used to prevent the macroeconomy from exceeding its optimal scale. Does it matter in what order the three policy goals are addressed? Yes, it does (Costanza et al., 1997; Lawn, 2000a). For instance, should we resolve the allocation problem first and then make the necessary adjustments to ensure the incoming resource flow is ecologically sustainable and distributionally just? The answer is no. Since allocation involves the relative division of the incoming resource flow among alternative product uses, it is too late to adjust the physical volume of the resource flow should it be unsustainable. Furthermore, since an individual’s command over the allocation of the incoming resource flow depends on the ability to pay for the means to need and want satisfaction, it is too late to adjust the distribution of the incoming resource flow among alternative people, following its allocation, should it be inequitable. Clearly, the policy goals of ecological sustainability and distributional equity must be resolved first. This internalises ecological and distributive limits, not just costs, and paves the way for markets to facilitate a macroeconomic adjustment towards the optimum. Resolving the three policy goals in this fashion also allows a nation to avoid the so-called Jevons’ Paradox. The Jevons’ Paradox is a situation where increasing resource use efficiency reduces production costs and, in so doing, encourages an excessively large increase in the rate of production. This leads to growing rather than diminishing pressure on the ecosphere. While the above-mentioned policy approach does not prevent an increase in production rates, it does ensure that any increase is ecologically sustainable. Moreover, by internalising ecological and distributive limits, it increases the possibility that any
subsequent change in the physical scale of a nation’s macroeconomy will lead to a rise in sustainable net benefits. How can this policy approach be instituted? One way is to introduce an ecological tax reform package incorporating resource use permits and assurance bonds (Lawn, forthcoming).3 The generally accepted approach to ecological tax reform is a reduction in taxes on income and labour and the imposition of Pigouvian taxes on resource use and pollution emissions. The aim of the tax cuts on income and labour is to encourage valueadding in production, since this leads to a qualitative improvement in the stock of human-made capital, as well as to encourage the substitution towards labour. The aim of the Pigouvian taxes is to reduce the pressure of economic activity on the ecosphere. This latter aim is misguided because it relies on the manipulation of market prices to achieve ecological sustainability. As an alternative to Pigouvian taxes, a government authority can auction off a limited number of resource use permits. A limit on the number of permits institutes a quantitative restriction on the incoming resource flow. Furthermore, because of the first law of thermodynamics, it also imposes a quantitative limit on the rate of waste generation. The revenue raised from the initial sale of the permits can be redistributed to the needy in order to narrow the gap between rich and poor. In addition, the premium paid for the permit acts as a throughput tax to facilitate the efficient allocation of the sustainable resource flow. Assurance bonds should also be incorporated into an ecological tax reform package because tradeable resource use permits have no influence on the qualitative nature of outgoing waste. Could not pollution taxes be used to resolve this problem? Although pollution taxes make polluting more expensive, often the cost of pollution takes considerable time to emerge. This means polluters only pay for the cost of their pollutive activities at some stage in the future. Because people discount future values, the prospect of 3
Since ecological sustainability also requires a sustainable human population, a comprehensive ecological tax reform package might also include transferable birth licences.
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having to pay much later is less of a disincentive to pollute than having to pay upfront. This is where assurance bonds play their part (Costanza and Perrings, 1990). With assurance bonds, a polluting firm pays upfront a bond equal to the cost of the worst-case pollution scenario. Should the owners of the firm be able to demonstrate that the pollution generated has had no deleterious impact on the natural environment, they receive the bond back in full plus any interest accrued over the period in which the bond has been held by a government authority. If the pollution has had an undesirable impact on the natural environment, the bond is confiscated either in full (where pollution damage equals the worst case scenario) or in part (where pollution damage is something less than the worst case scenario). If the worst case scenario is unacceptably risky (i.e. it involves highly toxic substances), the generation of the substances in question may require prohibition or generation under very strictly controlled conditions. In all, by bringing into the present decisionmaking domain the potential ecological damage caused by highly toxic and intractable wastes, assurance bonds eliminate the usual discounting of future costs and encourage polluters to minimise their impact on the ecosphere.
7. Conclusion In the forum I referred to at the beginning of the paper, Herendeen (1998) points out that if ecological economists abandon scale questions, ‘ecological economics sounds no different to conventional economics’. However, if ecological economists ignore the notion of optimal scale and the important role that prices play in facilitating a macroeconomic adjustment towards the optimum, ecological economics sounds no different to conventional ecology. Thus, while Herendeen’s statement is a reminder of the perils of ‘economic imperialism’, the second statement is a reminder of the perils of ‘biophysical reductionism’. Biophysical assessments undoubtedly have their place in any attempt to achieve SD since they are an essential means to ensuring a nation’s macroeconomy does not exceed its maximum sustainable
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scale. But relative prices and markets are also necessary to ensure the sustainable incoming resource flow is efficiently allocated to alternative product uses. The inability of relative price signals to ensure a sustainable resource flow should never be seen as a reason for excluding prices when it comes to scale-related issues. Indeed, knowing the benefits of biophysical assessments and the role that relative prices play in facilitating the transition towards an optimal macroeconomic scale is one of the keys to achieving SD. Acknowledgements I would like to thank Mathis Wackernagel and Charles Hall for their very constructive comments. The responsibility for any errors rests solely with the author. References Bishop, R., 1993. Economic efficiency, sustainability, and biodiversity. Ambio 1993, 69 – 73. Boulding, K., 1966. The economics of the coming spaceship Earth. In: Jarrett, H. (Ed.), Environmental Quality in a Growing Economy. John Hopkins University Press, Baltimore, pp. 3 – 14. Costanza, R., Perrings, C., 1990. A flexible assurance bonding system for improved environmental management. Ecol. Econ. 2, 57– 76. Costanza, R., Cumberland, J., Daly, H., Goodland, R., Norgaard, R., 1997. An Introduction to Ecological Economics. St. Lucie Press, Boca Raton. Daly, H., 1991. Steady-State Economics, second ed. Island Press, Washington, DC. Daly, H., 1996. Beyond Growth. Beacon Press, Boston. Fisher, I., 1906. The Nature of Capital and Income. Kelly, New York. Georgescue-Roegen, N., 1971. The Entropy Law and the Economic Process. Harvard University Press, Cambridge. Herendeen, R., 1998. Should sustainability analyses include biophysical assessments. Ecol. Econ. 29, 17 – 18. Howarth, R., Norgaard, R., 1990. Intergenerational resource rights, efficiency, and social optimality. Land Econ. 66, 1 – 11. Jackson, T., Stymne, S., 1996. Sustainable Economic Welfare in Sweden: A Pilot Index 1950 – 1992. Stockholm Environment Institute, The New Economics Foundation. Lawn, P., 1999. On Georgescu – Roegen’s contribution to ecological economics. Ecol. Econ. 29, 5 – 8. Lawn, P., 2000a. Toward Sustainable Development: An Ecological Economics Approach. Lewis Publishers, Boca Raton.
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Lawn, P., 2000b. A reassessment of the index of sustainable economic welfare, genuine progress indicator, and other related measures. Paper presented at the Energy and Resources Group Colloquium, University of California at Berkeley, August 30, 2000. Lawn, P., Ecological tax reform: many know why but few know how. Environ. Dev. Sustain. (forthcoming). Lawn, P., and Sanders, R., 1999. Has Australia surpassed its optimal macroeconomic scale? Finding out with the aid of benefit and cost accounts and sustainable net benefit index. Ecological Economics 28, 213 –229. Max-Neef, M., 1995. Economic growth and quality of life: a threshold hypothesis. Ecol. Econ. 15, 115 – 118. Norgaard, R., 1990. Economic indicators of resource scarcity: a critical essay. J. Environ. Econ. Manage. 19, 19 –25.
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Perrings, C., 1986. Conservation of mass and instability in a dynamic economy – environment system. J. Environ. Econ. Manage. 13, 199 – 211. Prakash, A., Gupta, A., 1994. Are efficiency, equity, and scale independent. Ecol. Econ. 10, 89 – 91. Robinson, J., 1962. Economic Philosophy. Watts, London. Røpke, I., 1998. Prices are not worth much. Ecol. Econ. 29, 45 – 46. Tinbergen, J., 1952. On the Theory of Economic Policy. North-Holland, Amsterdam. Wackernagel, M., Onisto, L., Bello, P., Callejas Linares, A., Susana Lo´ pez Falfa´ n, S., Me´ ndez Garcı´a, J., Sua´ rez Guerrero, A.I., Sua´ rez Guerrero, M.G., 1999. National natural capital accounting with the ecological footprint concept. Ecol. Econ. 29, 375 – 390.
ANALYSIS
Scale, prices, and biophysical assessments Philip A. Lawn * School of Economics, Flinders Uni6ersity of South Australia, GPO Box 2100, Adelaide 5001, Australia Received 14 August 2000; received in revised form 8 February 2001; accepted 9 February 2001
Abstract In a recent forum on biophysical assessments, a number of ecological economists expressed serious reservations about the use of prices to assess the appropriate scale of macroeconomic systems. While such reservations are warranted, the preference for biophysical assessments over prices indicates that many ecological economists are focussing on one notion of scale and neglecting another altogether. There are two notions of scale that are critical to achieving sustainable development (SD). One is the maximum sustainable macroeconomic scale; the other is the optimal macroeconomic scale. The maximum sustainable scale is the largest macroeconomic scale that can be sustained by a throughput of matter-energy that is within the ecosphere’s regenerative and waste assimilative capacities. The optimal scale is a preferable macroeconomic scale and is one that is not only sustainable, but one that maximises the net benefits of economic activity. Biophysical assessments are needed to determine the maximum sustainable scale because ecological sustainability is a biophysical problem, not an economic problem. Thus, it is through biophysical assessments that the necessary restrictions on the incoming resource flow can be calculated and imposed. However, since the achievement of an optimal macroeconomic scale is an economic problem — albeit a constrained economic problem — relative prices are required to efficiently allocate the sustainable resource flow so the macroeconomy can adjust to the optimum. Failure to recognise the two notions of scale and the most appropriate means of their assessment is likely to thwart rather than advance the movement toward SD. © 2001 Elsevier Science B.V. All rights reserved. Keywords: Maximum sustainable scale; Optimal scale; Biophysical assessments; Prices; Sustainable development
1. Introduction For some time now, ecological economists have been pointing out that while prices are good at facilitating the efficient allocation of resources, they are unable to ensure that the incoming resource flow fuelling the economic process is * Tel.: +61-8-82012838; fax: +61-8-82015071. E-mail address: [email protected] (P.A. Lawn).
ecologically sustainable (Howarth and Norgaard, 1990; Norgaard, 1990; Daly, 1991, 1996; Bishop, 1993). So critical do ecological economists believe the limitations of prices to be, virtually an entire issue of Ecological Economics (vol. 29, no. 1) was devoted to a forum focussing on the importance of biophysical assessments in sustainability analyses. Unfortunately, by almost unanimously ruling out the usefulness of prices when it comes to scale-related issues (e.g. Røpke, 1998), the partici-
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pants of the forum failed to indicate what is the most desirable macroeconomic scale. In doing so, they gave implicit approval for nations to operate their macroeconomies somewhere approaching the maximum sustainable scale. While this is preferable to operating unsustainably, it is by no means desirable. Indeed, the most desirable scale from a sustainable development (SD) perspective is the optimal macroeconomic scale which, interestingly, was never mentioned in the forum. Of course, the fact that many countries appear to have already exceeded their maximum sustainable scale (Wackernagel et al., 1999) suggests the movement towards an optimal scale is of little current importance. I beg to differ since by explaining what constitutes an optimal macroeconomic scale one can offer a viable alternative to ‘growthmania’. This increases the likely introduction of the policies required to achieve SD.
2. Maximum sustainable scale, optimal scale, and sustainable development SD is probably best described as a process of sustainable qualitative improvement. To achieve SD, essentially two things are required. First, the economic process must be ecologically sustainable — that is, the rate at which resources are used and wastes are generated must not exceed the ecosphere’s regenerative and waste assimilative capacities. Should the throughput of matter-energy required to maintain a macroeconomic system at a particular physical scale be ecologically unsustainable, the macroeconomy will have exceeded its maximum sustainable scale. Second, the net benefits of economic activity must be non-decreasing. Should the net benefits of a growing macroeconomic system be increasing, growth of the macroeconomy is desirable. Conversely, should net benefits be falling then, even if the rate of throughput is ecologically sustainable, growth of the macroeconomy is undesirable. Indeed, in such circumstances the macroeconomic system will have exceeded its optimal scale. Fig. 1 can be used to better understand the notions of optimal scale and maximum sustainable scale. It can also shed light on what is required to
bring about an optimal macroeconomic scale and to facilitate the transition toward SD. Fig. 1 is a linear throughput representation of the economic process that, unlike the conventional circular model, depicts the macroeconomy as a subsystem of the natural environment. By tracing economic activity from its original source to its ultimate conclusion, the linear throughput model reveals five macro magnitudes applicable to the economic process. The first of these is natural capital. Natural capital constitutes the original source of all economic activity since it provides a source of low entropy resources; it acts as a sink to assimilate high entropy wastes, and it provides a range of life-support services necessary to maintain the habitability of planet Earth. The second macro magnitude is the throughput of matter-energy — that is, the input into the macroeconomy of low entropy resources and the subsequent output of high entropy wastes. The throughput flow is the physical intermediary connecting natural and human-made capital. Human-made capital is the third macro magnitude and is needed for human welfare to be greater than it would otherwise be if the economic process did not take place. Conventionally, human-made capital is confined to producer goods such as plant, machinery, and equipment. From an ecological economic perspective, capital is interpreted in the Irving Fisher sense as all physical objects subject to ownership that are capable of directly or indirectly satisfying human needs and wants (Fisher, 1906). Hence, human-made capital refers to consumer goods as well as producer goods. Although not subject to ownership (other than by the individual who possesses productive knowledge and skills), labour can also be included as part of the stock of human-made capital. The next important magnitude is a psychic rather than physical magnitude. Contrary to some opinions, human welfare depends not on the rate of production and consumption, but on the psychic enjoyment of life (Boulding, 1966; GeorgescueRoegen, 1971; Daly, 1996; Lawn, 1999). Fisher (1906) referred to such a flux as ‘psychic income’. Most economists refer to the psychic enjoyment of life as utility satisfaction. Psychic income is the true benefit of all economic activity and has three main sources. The first source of psychic income comes from the consumption of human-made capital. The
P.A. Lawn / Ecological Economics 38 (2001) 369–382 Fig. 1. The linear throughput representation of the macroeconomy (1) net psychic income; (2) human-made capital; (3) throughput (low entropy input high entropy flows); (4) natural capital; (5) lost natural capital services. N-RKn, non-renewable natural capital; RKn, renewable natural capital; E, energy; M, matter; h, harvest rate; r, natural regeneration rate; W, waste; A, waste assimilative capacity; , low entropy flows; , high entropy output; , psychic flows.
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second source emerges as a consequence of being directly engaged in production activities (e.g. the enjoyment and self-worth obtained from work). A third source of psychic income flows from the natural environment in terms of its aesthetic and recreational qualities. It is true that this final source of psychic income does not come from economic activity. If anything, economic activity tends to destroy rather than enhance such values. It is, therefore, better that these values be taken as a given and their subsequent destruction be counted as an opportunity cost of economic activity. This last point reminds us that not all economic activity enhances the psychic enjoyment of life. 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 (e.g. noise pollution and commuting to work) represent the ‘psychic outgo’ of economic activity. It is the subtraction of psychic outgo from psychic income that leads to a measure of net psychic income — the fourth important macro magnitude. Net psychic income is, in effect, the ‘uncancelled benefit’ of economic activity. Why? Imagine tracing the economic process from natural capital to its final psychic conclusion. Every intermediate transaction involves the cancelling out of a receipt and expenditure of the same magnitude (i.e. the seller receives what the buyer pays). Only once a physical good is in the possession of the final consumer is there no further exchange and, thus, no further cancelling out of transactions. Apart from the good itself, what remains at the end of the process is the uncancelled exchange value of the psychic income that the ultimate consumer expects to gain from the good plus any psychic disbenefits and other costs associated with the good’s production. Note, therefore, that if the costs are subtracted from the good’s final selling price, the difference constitutes the ‘use value’ added to low entropy matter-energy during the production process. Presumably the difference is positive, otherwise the economic process is a pointless exercise.
The fifth macro magnitude is the cost of lost natural capital ser6ices and arises because, in obtaining the throughput to produce and maintain human-made capital, some of the services provided by natural capital are inevitably lost (Perrings, 1986). In a similar way to net psychic income, lost natural capital services constitute the ‘uncancelled cost’ (UC) of economic activity (Daly, 1996; Lawn, 2000a; Lawn and Sanders, 1999). Imagine tracing the economic process from its psychic conclusion back to natural capital. Once again, all transactions cancel out. However, on this occasion, what remains is the uncancelled exchange value of any natural capital services sacrificed in obtaining the throughput of matter-energy to fuel the economic process. In sum, the linear throughput model illustrates the following. Natural capital provides the throughput of matter-energy that is needed to produce and maintain the stock of human-made capital. Human-made capital is required to enjoy a level of net psychic income greater than what would otherwise be experienced if the economic process did not take place. Finally, in exploiting natural capital for the throughput of matter-energy, the three instrumental services that natural capital provides are, to some degree, unavoidably sacrificed. The linear throughput model also shows that natural and human-made capital are complementary forms of capital. Although technological progress embodied in human-made capital can reduce the resource flow required from natural capital to produce physical goods, for two related reasons this does not amount to substitution (Lawn, 1999). First, technological progress merely reduces the high entropy waste generated in the transformation of natural to human-made capital. Second, because of the first and second laws of thermodynamics, there is a limit to how much production waste can be reduced by technological progress — there can be no 100% production efficiency; there can never be 100% recycling of matter; and there is no way to recycle energy at all. Thus, the production of a given quantity of human-made capital will always require a minimum resource flow and, therefore, a minimum amount of resource-providing natural capital.
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Fig. 2. The changing sustainable net benefits of a growing macroeconomy (adapted partly from Daly, 1991).
3. Economic and uneconomic growth A great advantage of the linear throughput model over the circular flow model is that it forces one to consider how big the macroeconomic subsystem can grow before the throughput of matterenergy required to maintain it can no longer be ecologically sustained. Moreover, it also leads one to consider how big the macroeconomic subsystem should grow before the net benefits of growth start declining and growth itself becomes uneconomic. Barring technological progress, Fig. 2 indicates the eventual undesirability of growth as the physical scale of the macroeconomic subsystem expands. The uncancelled benefits (UB) curve in Panel 2a represents the net psychic income yielded by a growing macroeconomy. The characteristic shape of the UB curve is attributable to the law of diminishing marginal utility which, barring technological improvements, is equally applicable to the total stock of wealth as it is to individual items. The cost of increasing the physical scale of the macroeconomy is represented in Panel 2a by the UC curve.
It represents the source, sink, and life-support functions lost in the process of transforming natural capital into human-made capital. The shape and nature of the UC curve is attributable to the law of increasing marginal costs — a reflection of the increase in costs arising from the macroeconomy growing relative to a finite natural environment. The UC curve is vertical at SS to denote the maximum sustainable scale. For any given macroeconomic scale, sustainable net benefits are measured by the difference between UB and costs and, hence, the vertical distance between the UB and UC curves. Sustainable net benefits are represented by the SNB curve in Panel 2b and are maximised at a macroeconomic scale of S*. Thus S* denotes the optimal macroeconomic scale. Fig. 2 demonstrates a number of important points. First, growth is only economic in the early stages of the development process. Continued physical expansion of the macroeconomic subsystem, which is equivalent to moving along the UB and UC curves, leads to a decline in sustainable net
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benefits (renders a nation poorer rather than richer). Second, the maximum sustainable scale need not be the desirable or optimal macroeconomic scale. Indeed, while ecological sustainability is a necessary condition for achieving the optimum, it is by no means a sufficient condition. Finally, an economic limit to growth is likely to precede any biophysical limit to growth and, as studies of many countries have shown, has in most cases been exceeded (Max-Neef, 1995; Jackson and Stymne, 1996; Lawn, 2000a; Lawn and Sanders, 1999).
4. Technology and sustainable net benefits One cannot ignore the role played by advances in technology. Technological progress can increase the net psychic income gained and decrease the natural capital services sacrificed in maintaining a given macroeconomic scale. This is because technological progress can beneficially shift the UB curve upwards and the UC curve downwards and to the right. Furthermore, technological progress can also increase the maximum sustainable scale. To explain how the two curves can be positively shifted, two of the five key magnitudes of the linear throughput model can be arranged to represent a measure of ecological economic efficiency (EEE). The ratio is as follows (Daly, 1996): EEE =
net psychic income lost natural capital services
(1)
For a given physical scale of the macroeconomy, an increase in the EEE ratio indicates an improvement in the efficiency with which natural capital is transformed into benefit-yielding human-made capital. A multitude of factors can increase the EEE ratio. To demonstrate how, the EEE ratio can be expanded to reveal four component ratios. The EEE ratio thus becomes the following identity:
EEE=
net psychic income = lost natural capital services
Starting from Ratio 1 and progressing through to Ratio 4, each component ratio cancels the ensuing ratio out. This leaves the basic EEE ratio on the left-hand side. The order in which the four component ratios are presented is in keeping with the conclusions drawn from the linear throughput representation of the macroeconomy — i.e. the net psychic income from economic activity is enjoyed because of the existence of human-made capital (Ratio 1); human-made capital exists as a consequence of the throughput of matter-energy (Ratio 2); the throughput of matter-energy is made possible because of the existence of natural capital (Ratio 3); and, in exploiting natural capital, the three instrumental services provided by natural capital are, to some degree, sacrificed (Ratio 4). Each component ratio represents a different form of efficiency and will now be individually explained and discussed. Ratio 1 is a measure of the ser6ice efficiency of human-made capital. It increases whenever a given physical magnitude of human-made capital yields a higher level of net psychic income. An increase in Ratio 1 causes the UB curve to shift upwards and can be achieved by improving the technical design of newly produced commodities. It can also be achieved by improving the manner in which human beings organise themselves in the course of producing and maintaining the stock of human-made capital, thereby reducing such things as the disutility of labour and the cost of commuting and unemployment. A beneficial upward shift in the UB curve can also be achieved by distributing the stock of human-made capital more equitably. Often overlooked, the redistribution of income from the low marginal service or psychic income uses of the rich to the higher marginal service uses of the poor can lead to an overall increase in the net psychic income enjoyed by society as a whole (Robinson, 1962). There is, however, a limit on the capacity for redistribution
Ratio 1
Ratio 2
Ratio 3
Ratio 4
net psychic income × human-made capital
human-made captial × throughput
throughput × natural capital
natural capital lost natural capital services
(2)
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Fig. 3. A change in sustainable net benefits brought about by an increase in the service efficiency of human-made capital (Ratio 1).
to increase Ratio 1 because an excessive approach to redistribution adversely dilutes the incentive structure built into a market-based system. Fig. 3 illustrates what happens to sustainable net benefits when the UB curve shifts upwards. Because an increase in Ratio 1 augments the net psychic income yielded by a given magnitude of human-made capital, the UB curve shifts up to UB1. The UC curve does not move since the uncancelled opportunity cost of creating and maintaining a given stock of wealth remains unchanged. Moreover, the maximum sustainable macroeconomic scale remains at SS. Prior to the increase in the service efficiency of human-made capital, sustainable net benefits are maximised by operating at a macroeconomic scale of S* — i.e. where sustainable net benefits equal SNB*. Following an increase in the service efficiency of human-made capital, sustainable net benefits are no longer maximised at the prevailing macroeconomic scale. Instead, they are maximised at the scale S*1 where sustainable net benefits equal SNB1. It is now desirable to expand the physical scale of the macroeconomy to S*1.
Changes in Ratios 2–4 cause the UC curve to shift. Ratio 2 is a measure of the maintenance efficiency of human-made capital. It increases whenever a given physical magnitude of humanmade capital can be maintained by a lessened rate of throughput. This can be achieved by developing new technologies that reduce the requirement for resource input either through, (a) the more efficient use of resources in production; (b) increased rates of product recycling; (c) greater product durability, and/or (d) improved operational efficiency. An increase in Ratio 2 causes the UC to shift downwards and to the right for the following reasons. First, it enables any given macroeconomic scale to be sustained by a reduced rate of throughput. Second, a lower rate of throughput means not having to exploit as much natural capital which means fewer lost natural capital services. Ratio 3 is a measure of the growth efficiency or productivity of natural capital. This form of efficiency is increased whenever a given amount of natural capital is able to sustainably yield a
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Fig. 4. A change in sustainable net benefits brought about by increases in the maintenance efficiency of human-made capital (Ratio 2), and the growth and exploitative efficiencies of natural capital (Ratios 3 and 4).
greater quantity of low entropy resources and assimilate more of the high entropy waste that economic activity generates. Better management of natural resource systems and the preservation of critical ecosystems can lead to a more productive stock of natural capital. How does an increase in Ratio 3 lead to a downward and rightward shift of the UC curve? An increase in the productivity of natural capital reduces the quantity of natural capital that must be exploited to sustain the macroeconomy at a given physical scale. This, in turn, means a macroeconomy of a given physical scale can be sustained at the expense of fewer natural capital services. Ratio 4 is a measure of the exploitati6e efficiency of natural capital. If Ratio 4 increases, fewer natural capital services are lost in exploiting a given quantity of natural capital. This, again, allows a macroeconomy of a given physical scale to be sustained at the expense of fewer natural capital services and, thus, to a downward and rightward shift of the UC curve. Increases in Ratio 4 can be obtained through the development and execution of more ecologically sensitive extractive techniques such as the use of underground rather than open-cut or strip mining practices.
Fig. 4 illustrates what happens to sustainable net benefits when there is a shift of the UC curve. Because an increase in Ratios 2–4 reduces the UC of producing and maintaining a given macroeconomic scale, the UC curve shifts down and out to UC1. However, the UB curve remains stationary since an increase in Ratios 2–4 does not augment the net psychic income yielded by a given stock of human-made capital. Unlike a shift in the UB curve, a shift in the UC curve results in an increase in the maximum sustainable macroeconomic scale (SS –S1S). The logic behind this is quite simple. If there are now fewer natural capital services sacrificed in maintaining what was previously the maximum sustainable macroeconomic scale, a larger macroeconomic subsystem can now be ecologically sustained from the same loss of natural capital services. Prior to further increases in either the maintenance efficiency of human-made capital and/or the growth and exploitative efficiency of natural capital, sustainable net benefits are maximised by operating at a macroeconomic scale of S* — i.e. where sustainable net benefits equal SNB*. Upon an increase in Ratios 2, 3, and/or 4, sustainable net benefits are maximised at the scale S*1 where they now equal SNB1. It is now desirable to
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expand the physical scale of the macroeconomy to S*1. 5. Limits to the beneficial shift of the UB and UC curves There is considerable debate surrounding how much and for how long human beings can rely on technological progress to increase these four efficiency ratios and thus shift the UB and UC curves. Ecological economists believe the limits to technological progress with respect to decreasing UCs (increases to Ratios 2– 4) are inevitable and probably not that far away. Conclusions regarding limits to increases in the service efficiency of human-made capital (Ratio 1) are harder to draw because net psychic income is a psychic rather than physical magnitude. Nevertheless, it is difficult to believe that a given physical magnitude of human-made capital could yield ever-increasing levels of net psychic income. Given the existence of these limits, particularly in relation to the capacity to positively shift the UC curve, a few of things are irrefutably clear. First, there is an inevitable limit to the maximum sustainable scale of the macroeconomic subsystem. Second, while the physical expansion of the macroeconomic subsystem is able to promote economic development in the early stages of a nation’s SD process, the growth objective must give way to a qualitative improvement of human-made capital and a reduction in the psychic disbenefits associated with maintaining the stock intact. Finally, provided the throughput of matter-energy required to maintain the improving human-made capital is within the regenerative and assimilative capacities of natural capital, a nation is able to achieve SD without the assumed need for continued growth.
6. Achieving an optimal macroeconomic scale Having argued that nations should aim to operate at the optimal macroeconomic scale, how is it attained? First, it is necessary to know the following.
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What is the physical scale of a nation’s macroeconomy? Are the sustainable net benefits of economic activity non-decreasing and, should they be falling, does this mean a nation’s macroeconomy has exceeded its optimal scale? Is a nation improving the efficiency with which it transforms natural capital into benefit-yielding human-made capital? In other words, is the EEE ratio increasing or decreasing? In view of the complementarity of natural and human-made capital, what is happening both quantitatively and qualitatively to a nation’s stock of natural capital? If natural capital is in decline, has a nation’s macroeconomy exceeded its maximum sustainable scale? To find the answers to these questions, the system of national accounts ought to be designed to measure the five key magnitudes fundamental to the economic process. This requires a separate account for UB (net psychic income), UCs (lost natural capital services), human-made capital, natural capital, and the throughput of matter-energy (the input of resources and the output of wastes). Interestingly, for Australia, for which I have compiled individual accounts for four of the five magnitudes for the period 1966– 1967 to 1994–1995, I obtained the following answers to the above questions (Lawn, 2000a).1 The stock of human-made capital increased in all but one financial year from 1966– 1967 to 1994–1995 ($2084 billion in 1966–1967 to $4712 billion by 1994–1995). In effect, the Australian macroeconomy grew over the study period at an average rate of 2.9% per annum. Furthermore, Australia’s population increased from 11.8 to 18.1 million. Per capita sustainable net benefits (UB less UCs) increased in every year between 1966– 1967 and 1973–1974 ($13 023 per Australian in 1
The items in each account were measured in 1989 – 1990 dollars. Because of the difficulty associated with the compilation of a throughput account, Australia’s total energy consumption was used as a proxy measure of resource throughput. The methods used to calculate the dollar values of the items in each account and a discussion of the potential valuation problems can be found in Lawn (2000a,b).
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Fig. 5. Per capita sustainable economic welfare and per capita real GDP for Australia, 1966 – 67 to 1994 – 95.
1966–1967 compared with $18 977 per Australian in 1973–1974). In most years thereafter, per capita sustainable net benefits declined. By 1994–1995, per capita sustainable net benefits were lower than in 1966–1967 ($12 852 per Australian in 1994– 1995). See Fig. 5 where a comparison is drawn between per capita sustainable net benefits and per capita GDP. From a quantitative perspective, Australia’s stock of natural capital decreased over the study period. While there were very small increases in the stock of renewable natural capital, this was considerably outweighed by the diminution of non-renewable natural capital. As for the quality of Australia’s natural capital, the growth efficiency ratio (Ratio 3) increased over the study period suggesting Australia’s natural capital became more productive. This is misleading since the continued rise in Australia’s energy consumption was only made possible by an increase in the depletion rate of non-renewable energy stocks. Clearly, Australia’s current rate of energy consumption cannot be sustained. In addition, an
ecosystem health index that was used to weight the UCs of economic activity declined in every year over the study period.2 The ecosystem health index, which was based on changes in native vegetation cover, fell from an index value of 100.0 in 1966–1967 to 90.0 in 1994– 1995. The trend movement in Australia’s EEE ratio was similar to the change in sustainable net benefits. That is, the EEE ratio rose between 1966–1967 and 1973–1974 (2.41–2.85), but fell in most financial years thereafter (1.94 by 1994–1995). This indicates that the general decline in sustainable net benefits after 1973– 1974 was due as much to the inefficient allocation of resources as it was to the depletion of natural capital.
2 The UCs were weighted by an ecosystem health indicator because the items used to measure the lost source and sink functions of natural capital did not account for impacts on the ecosphere’s life-support services. For example, mining not only reduces the source function of natural capital but, by degrading ecosystems, also reduces its life-support function.
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In view of the general downturn in the sustainable net benefits of economic activity, the Australian macroeconomy appears to have exceeded its optimal scale (Lawn and Sanders, 1999). It is more difficult to determine whether the maximum sustainable scale has been surpassed. This is because a measure of sustainable net benefits does not, by itself, indicate whether a nation is operating sustainably (Lawn, 2000b). However, the following should be considered. A recent study by Wackernagel et al. (1999) reveals that Australia’s ecological footprint is considerably less than its biocapacity (9.0 ha per Australian compared with an available biocapacity of 14.0 ha per Australian). The same study also indicates that the world’s biocapacity is just 2.1 ha per person. Approximately four-and-a-half Earths would, therefore, be required for everyone to enjoy the same per capita rate of resource consumption as the average Australian. Since ecological sustainability is ultimately a global issue, Australia will undoubtedly be pressured in the future to reduce its ecological footprint and share its surplus biocapacity with less fortunate nations. Exactly how far Australia might be expected to reduce its ecological footprint is anyone’s guess, nevertheless, it may be enough to render the current physical scale of the Australian macroeconomy unsustainable. Finally, as previously mentioned, Australia’s natural capital stocks have declined while the cost of lost natural capital services has steadily increased. In all, the Australian macroeconomy would, at the very least, appear to be fast approaching its maximum sustainable scale. What about designing policies and institutional mechanisms to facilitate the transition towards an optimal macroeconomic scale? Since ecological sustainability is a necessary condition for achieving the optimum, the first policy goal is to ensure the throughput of matter-energy is within the ecosphere’s regenerative and waste assimilative capacities. The second policy goal is to ensure the sustainable incoming resource flow is distributed equitably. Distributional equity is not only a moral imperative but, as explained earlier, a fairer and more just distribution of income and wealth can increase the sustainable net benefits accruing to a nation’s citizens. The third main policy goal
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is allocative efficiency, which is necessary to ensure the equitably distributed and sustainable incoming resource flow is allocated to different product uses in conformity with consumer preferences as weighted by the ability of each individual to pay for the means to their satisfaction. It also ensures that the appropriate signals and incentives are in place to facilitate increases in the service and maintenance efficiency of human-made capital (Ratios 1 and 2). Of course, the three goals of ecological sustainability, distributional equity, and allocative efficiency are not entirely independent of each other (Prakash and Gupta, 1994). Contestable markets, for example, not only improve the efficiency of resource allocation but, by keeping profits at the normal economic level, act as a useful redistribution mechanism. In addition, Pigouvian taxes reduce the pressure of each unit of output on natural capital as well as increase the efficiency of resource use. This aside, the three policy goals are sufficiently independent to be classified as separate or distinct policy goals requiring a separate policy instrument to be adequately resolved (Tinbergen, 1952; Daly, 1991, 1996). The first major policy goal, ecological sustainability, cannot be achieved through the use of prices/markets because relative price signals only provide information regarding the scarcity of one thing relative to another — for instance, the scarcity of one type of resource (oil) relative to another (coal). It is because the market is very effective at revealing relati6e scarcities that it constitutes an effective allocative mechanism. But sustainability is a question of the absolute scarcity of the non-substitutable low entropy that sustains the economic process and no amount of relative scarcity information can render the market effective at ensuring a sustainable resource flow (Howarth and Norgaard, 1990; Norgaard, 1990; Bishop, 1993; Daly, 1996). This is why there is a need for biophysical assessments. In the first instance, they can indicate the extent to which economic activity has impacted on natural capital. Second, they can be used to calculate the maximum sustainable rate of resource throughput. This can then serve as a benchmark for quantitatively restricting the incoming resource flow. Dis-
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tributional equity requires the use of redistribution mechanisms such as taxes, transfers, and universal rights and privileges. Since the third major policy goal — allocative efficiency — requires the use of relative price signals, it is here where biophysical assessments are of lessened value. Biophysical assessments are still of some value since they can be used to compute the spillover costs of pollution and ecosystem degradation. However, they cannot be used to prevent the macroeconomy from exceeding its optimal scale. Does it matter in what order the three policy goals are addressed? Yes, it does (Costanza et al., 1997; Lawn, 2000a). For instance, should we resolve the allocation problem first and then make the necessary adjustments to ensure the incoming resource flow is ecologically sustainable and distributionally just? The answer is no. Since allocation involves the relative division of the incoming resource flow among alternative product uses, it is too late to adjust the physical volume of the resource flow should it be unsustainable. Furthermore, since an individual’s command over the allocation of the incoming resource flow depends on the ability to pay for the means to need and want satisfaction, it is too late to adjust the distribution of the incoming resource flow among alternative people, following its allocation, should it be inequitable. Clearly, the policy goals of ecological sustainability and distributional equity must be resolved first. This internalises ecological and distributive limits, not just costs, and paves the way for markets to facilitate a macroeconomic adjustment towards the optimum. Resolving the three policy goals in this fashion also allows a nation to avoid the so-called Jevons’ Paradox. The Jevons’ Paradox is a situation where increasing resource use efficiency reduces production costs and, in so doing, encourages an excessively large increase in the rate of production. This leads to growing rather than diminishing pressure on the ecosphere. While the above-mentioned policy approach does not prevent an increase in production rates, it does ensure that any increase is ecologically sustainable. Moreover, by internalising ecological and distributive limits, it increases the possibility that any
subsequent change in the physical scale of a nation’s macroeconomy will lead to a rise in sustainable net benefits. How can this policy approach be instituted? One way is to introduce an ecological tax reform package incorporating resource use permits and assurance bonds (Lawn, forthcoming).3 The generally accepted approach to ecological tax reform is a reduction in taxes on income and labour and the imposition of Pigouvian taxes on resource use and pollution emissions. The aim of the tax cuts on income and labour is to encourage valueadding in production, since this leads to a qualitative improvement in the stock of human-made capital, as well as to encourage the substitution towards labour. The aim of the Pigouvian taxes is to reduce the pressure of economic activity on the ecosphere. This latter aim is misguided because it relies on the manipulation of market prices to achieve ecological sustainability. As an alternative to Pigouvian taxes, a government authority can auction off a limited number of resource use permits. A limit on the number of permits institutes a quantitative restriction on the incoming resource flow. Furthermore, because of the first law of thermodynamics, it also imposes a quantitative limit on the rate of waste generation. The revenue raised from the initial sale of the permits can be redistributed to the needy in order to narrow the gap between rich and poor. In addition, the premium paid for the permit acts as a throughput tax to facilitate the efficient allocation of the sustainable resource flow. Assurance bonds should also be incorporated into an ecological tax reform package because tradeable resource use permits have no influence on the qualitative nature of outgoing waste. Could not pollution taxes be used to resolve this problem? Although pollution taxes make polluting more expensive, often the cost of pollution takes considerable time to emerge. This means polluters only pay for the cost of their pollutive activities at some stage in the future. Because people discount future values, the prospect of 3
Since ecological sustainability also requires a sustainable human population, a comprehensive ecological tax reform package might also include transferable birth licences.
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having to pay much later is less of a disincentive to pollute than having to pay upfront. This is where assurance bonds play their part (Costanza and Perrings, 1990). With assurance bonds, a polluting firm pays upfront a bond equal to the cost of the worst-case pollution scenario. Should the owners of the firm be able to demonstrate that the pollution generated has had no deleterious impact on the natural environment, they receive the bond back in full plus any interest accrued over the period in which the bond has been held by a government authority. If the pollution has had an undesirable impact on the natural environment, the bond is confiscated either in full (where pollution damage equals the worst case scenario) or in part (where pollution damage is something less than the worst case scenario). If the worst case scenario is unacceptably risky (i.e. it involves highly toxic substances), the generation of the substances in question may require prohibition or generation under very strictly controlled conditions. In all, by bringing into the present decisionmaking domain the potential ecological damage caused by highly toxic and intractable wastes, assurance bonds eliminate the usual discounting of future costs and encourage polluters to minimise their impact on the ecosphere.
7. Conclusion In the forum I referred to at the beginning of the paper, Herendeen (1998) points out that if ecological economists abandon scale questions, ‘ecological economics sounds no different to conventional economics’. However, if ecological economists ignore the notion of optimal scale and the important role that prices play in facilitating a macroeconomic adjustment towards the optimum, ecological economics sounds no different to conventional ecology. Thus, while Herendeen’s statement is a reminder of the perils of ‘economic imperialism’, the second statement is a reminder of the perils of ‘biophysical reductionism’. Biophysical assessments undoubtedly have their place in any attempt to achieve SD since they are an essential means to ensuring a nation’s macroeconomy does not exceed its maximum sustainable
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scale. But relative prices and markets are also necessary to ensure the sustainable incoming resource flow is efficiently allocated to alternative product uses. The inability of relative price signals to ensure a sustainable resource flow should never be seen as a reason for excluding prices when it comes to scale-related issues. Indeed, knowing the benefits of biophysical assessments and the role that relative prices play in facilitating the transition towards an optimal macroeconomic scale is one of the keys to achieving SD. Acknowledgements I would like to thank Mathis Wackernagel and Charles Hall for their very constructive comments. The responsibility for any errors rests solely with the author. References Bishop, R., 1993. Economic efficiency, sustainability, and biodiversity. Ambio 1993, 69 – 73. Boulding, K., 1966. The economics of the coming spaceship Earth. In: Jarrett, H. (Ed.), Environmental Quality in a Growing Economy. John Hopkins University Press, Baltimore, pp. 3 – 14. Costanza, R., Perrings, C., 1990. A flexible assurance bonding system for improved environmental management. Ecol. Econ. 2, 57– 76. Costanza, R., Cumberland, J., Daly, H., Goodland, R., Norgaard, R., 1997. An Introduction to Ecological Economics. St. Lucie Press, Boca Raton. Daly, H., 1991. Steady-State Economics, second ed. Island Press, Washington, DC. Daly, H., 1996. Beyond Growth. Beacon Press, Boston. Fisher, I., 1906. The Nature of Capital and Income. Kelly, New York. Georgescue-Roegen, N., 1971. The Entropy Law and the Economic Process. Harvard University Press, Cambridge. Herendeen, R., 1998. Should sustainability analyses include biophysical assessments. Ecol. Econ. 29, 17 – 18. Howarth, R., Norgaard, R., 1990. Intergenerational resource rights, efficiency, and social optimality. Land Econ. 66, 1 – 11. Jackson, T., Stymne, S., 1996. Sustainable Economic Welfare in Sweden: A Pilot Index 1950 – 1992. Stockholm Environment Institute, The New Economics Foundation. Lawn, P., 1999. On Georgescu – Roegen’s contribution to ecological economics. Ecol. Econ. 29, 5 – 8. Lawn, P., 2000a. Toward Sustainable Development: An Ecological Economics Approach. Lewis Publishers, Boca Raton.
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