The Economic Approach to Environmental and Natural Resources, 3e

Further Topics Part IV

Introduction • There are reasons to be optimistic about the environment. • Conventional air and water pollutants have been regulated and birth rates have declined to the point where zero population growth will be realized in the near future. • The ozone depletion problem has been addressed, the global warming problem is being recognized, and moving to a sustainable economy is being discussed. • There are reasons to be pessimistic about the situation in developing countries. • Population growth is far from being under control.

Introduction • Environmental degradation is taking place at a massive and unprecedented rate, which is leading to the loss of much of the world's renewable resources. • The economic conditions in much of the world's developing countries prevent the people from having a long-term perspective. • This, combined with a lack of understanding of the long-term economic importance of maintaining the environmental quality, implies that many developing nations have not recognized the need to take immediate steps to preserve the environment. • This chapter will attempt to summarize some of the debate on prospects for the future.

Absolute Scarcity • The concept of absolute scarcity originated in the work of Malthus, who argued that since there was a fixed amount of land, scarcity was inevitable because of the law of diminishing marginal returns. • As pointed out in the previous chapter, Malthus failed to consider technological innovations which would change the relationship between population and land. • The idea of absolute scarcity has been revisited in modern times, as world population exploded, pollution intensified, hunger increased, and shortages of energy and other resources materialized. • Many scholars, citing the finite nature of the world and its resources, argued that scarcity was inescapable.

Entropy and Economics • Nicholas Georgescu-Roegen has argued that entropy is the source of ultimate scarcity. • Entropy refers to the amount of disorder in a system: the higher the entropy, the higher the state of disorder; the lower the entropy, the greater the order. • The third law of thermodynamics (the entropy law) states that the universe (or a subsystem of the universe) is in a constant state of entropic degradation. • A simpler way of phrasing this is that as time and the physical forces of the universe progress, energy and materials tend to dissipate and become more difficult to access.

Entropy and Economics • The relevance of the entropy law of economic activity and prospects for the future is that useful goods and resources tend to be low entropy, and the economic process increases their entropy. • For example, a fossil fuel, such as coal or oil, is characterized by low entropy. • Coal is a relatively homogenous substance, with a much higher concentration of carbon than the environment as a whole. • When the coal is burned in the economic process, the carbon is scattered though the atmosphere. • The process of using the coal increases its entropy and reduces its usefulness. • Since the amount of low entropy on earth is fixed, and since entropic degradation is irreversible, it will be the ultimate constraint on the human species. • Georgescu-Roegen argues that entropic degradation implies that the time span of human existence is limited because we will eventually run out of low entropy matter to support life.

Entropy and Economics • There are two basic criticisms of the work of Georgescu-Roegen. • Since we do not really know the initial stock of low entropy matter, we do not know if our rate of consumption is high relative to the stock. • In addition, we receive constant infusions of energy from the sun, and this energy can be used to slow the process of entropic degradation. • The policy implications of the relationship between entropy and the economic processes are that activities should be encouraged that are less degrading of low entropy, as these impose less costs on the future. • Conserving low entropy is conceptually equivalent to saying that we should minimize the use of inputs and minimize waste.

Doomsday Models • The Limits to Growth model of Meadows and Meadows and similar models attempted to predict the future based on assumptions regarding resource quantities and production techniques. • The first step is to specify initial conditions (of population, wealth, arable land, capital, natural resources, etc.) and then allow these variables to grow. • The implications of growth are computed (that is, more output implies more pollution, more output implies faster resource depletion, and more people mean more food cultivation and more soil erosion). • What these models found was that in a rather short period of time (20-50 years), some sort of constraint interfered with the ability of the economic system to support population and the system collapsed.

Doomsday Models • These models caused considerable excitement for two reasons. • Society was just beginning to become aware of the problems of environmental degradation and population growth through books such as Rachel Carson's Silent Spring and Paul Ehrlichs' Population Time Bomb. • And the public was enthralled by (and did not really understand the nature of) computers and computer models. • Many people felt that if a computer predicted the collapse of humankind, this must be taken seriously.

Doomsday Models • There are two criticisms of these doomsday models. • They are tremendously sensitive to the assumed rates of exponential growth. • If population is assumed to increase at 2 percent per year, it will double in 35 years. However, if population is assumed to increase at 3 percent per year, it will double every 23 years. • These models have no endogeniety or positive feedback in the model, including the effect of scarcity on prices and prices on scarcity. • There is no mechanism for increasing scarcity, pollution, or population to affect behavior in these models. In other words, even as we are forced to wear gas masks because of hideous pollution, we take no steps to reduce the level of pollution.

Doomsday Models • The most important drawback to these models is the failure to represent market prices in the model. • As scarcity increases, price will increase which will trigger a full set of market responses that tend to lessen the scarcity problem. • The importance of the neo-Malthusian models is that a new intellectual paradigm was created to address the role of scarcity and the long-term prospects for humankind.

Price, Scarcity, and Neo-Classical Economics • The work of Hotelling (who identified user cost as the mechanism that makes price reflect scarcity) forms the basis of the neoclassical (modem economic) approach to scarcity. • Barnett and Morse, who investigated the scarcity question in the 1960s, discussed the mechanisms through which price mitigates scarcity. • If oil becomes more scarce, the price will rise. • The higher price generates added incentives for exploration for new sources of oil and makes it more profitable to remove oil from more difficult places. • The higher price gives added incentive for research and development into new technologies for finding, extracting, and utilizing oil and discourages current consumption of oil. • Finally, higher prices encourage the development of substitutes for oil.

Price, Scarcity, and Neo-Classical Economics • Barnett and Morse also examined Malthus’ hypothesis that the law of diminishing returns implies that as labor increases, the marginal product of labor must decline. • They found that while this hypothesis held in an economy where the only inputs were labor and land, it did not hold in an economy with more than 2 inputs. • If land is held constant in an economy with labor and capital, it is possible to see quantity or quality changes in capital that will increase the productivity of labor. • The authors felt that the question of scarcity was an empirical one that could only be answered by looking at real world phenomenon. • The authors stress that it is important to examine scarcity of individual resources and scarcity of resources in general. • It is important to examine resources in general, because as particular resources become scarcer, other resources could be substituted for it.

Price, Scarcity, and Neo-Classical Economics • Barnett and Morse developed two hypotheses on which to build an empirical test. • Both hypotheses are based on the supposition that if resources become more scarce, their opportunity cost should rise. • Their strong scarcity hypothesis looks at whether the cost of extracting resources (labor and capital costs) has been increasing over time. • Their weak scarcity hypothesis looks at whether the price of extractive materials has been rising relative to the price of other goods. • Both of these hypotheses were tested using historical data and their general conclusion is that scarcity is not increasing.

Price, Scarcity, and Neo-Classical Economics • There are two major criticisms of the above conclusion. • It is difficult to make predictions into the future by looking at past trends and this is particularly true when the forces underlying the trends are not included in the analysis. • The authors examine the changes in extraction costs over time, but do not look at the factors that affect extraction cost, such as the characteristics of resource reserves, technological innovation, and the availability of cheap energy, and so on. • In addition, Barnett and Morse choose a monotonic specification for their empirical tests. • A monotonic function is one that is always increasing or decreasing. If one fits a monotonic function through a long time series of data, recent changes in the data will not be reflected in the sign of the slope of the function. • Slade (1982) has re-estimated some of these functions for selected minerals with a quadratic (u-shaped) function and found that we are now on the upward sloping part of the "u".

Price, Scarcity, and Neo-Classical Economics • An additional argument against the findings in the Barnett and Morse study is that the measure employed by the authors might not be the best indicator of scarcity. • For the purpose of this chapter, the most important missing dimension is that these measures do not include the full social cost of removing extractive resources, as they exclude environmental costs. • The cost of labor and capital could be falling while the environmental costs are rising. • The increase in environmental costs is likely to come about for three reasons. • As lower grades of ore are extracted, the amount of waste material increases. As lower grade ore and deeper deposits are extracted, the use of more energy is required. As environmental degradation increases (from both extractive and non-extractive activities) the marginal social damages of degradation may be increasing.

Price, Scarcity, and Neo-Classical Economics • One might argue that if the price of the extractive good includes its environmental cost, then price would still serve as a good signal of resource scarcity. • It has been argued that the current environmental regulations in the United States fully internalized the environmental cost of goods. • There has been insufficient time since the implementation of this legislation to allowing time series testing of this argument.

System-wide Change and Sustainability • Authors such as Meadows and Meadows and Gore and Brown argue that the current methods of economic production are not sustainable in that they generate a system-wide change which interferes with the long-term ability of the planet to support human population. • These changes include global warming, acid rain, ozone depletion, deforestation, soil loss, water availability, and quality problems. • Since environmental resources and the state of the environment are fundamental to the production process, system-wide decline could lead to a great future loss of productive capability and severely limit the prospects of future generations.

System-wide Change and Sustainability • Disagreement over whether or not system-wide change exists leads to an extremely important policy question and one that had not been adequately addressed. • This question is: “What level of proof is required before one acts?” • The scientific method requires rigorous proof before claiming that a result holds. • Typically, 95 percent or 99 percent confidence is required before rejecting a null hypothesis. • A null hypothesis is the supposition that the researcher attempts to disprove, in order to accept the alternative hypothesis.

System-wide Change and Sustainability • In the global climate change area, the null hypothesis is that CO2 emissions are not causing global warming. • A 95 percent confidence can be interpreted to mean that we are 95 percent sure that there will be global warming as a result of carbon dioxide emissions. • A risk adverse posture would be to begin to take actions now to limit system-wide change in the future. • According to the criterion of sustainability, we do not need to prohibit economic growth. • We need to constrain growth and pursue growth paths that are sustainable, where the change that the economic activity engenders does not undermine the ability to engage in that activity or alternative economic activities in the future.

System-wide Change and Sustainability • The concept of sustainable development implies that some growth paths are possible, while Malthusian concepts say that growth is fundamentally limited. • Some of the most noted neo-Malthusians have backed away from their prediction of societal collapse and become advocates of sustainability. • The relationship between sustainability and the past work in traditional economics, which shows that price can limit scarcity, can be found in John Krutilla's 1967 call to reconsider the concept of conservation. • Krutilla argued that we need to refocus our old concern with the conservation of extractive resources and be more concerned with the conservation of unique natural environments.

System-wide Change and Sustainability • A current extension of Krutilla's reconsideration argument would be to extend the concern with conservation to the viability and sustainability of entire environmental systems. • People who argue for movement towards a theory of sustainable economics argue that system-wide environmental degradation will not be incorporated into market prices, so public policy is necessary. • The advocacy of sustainable economics is also not inconsistent with cost/benefit analysis. • However, costs and benefits are treated differently in the sustainability paradigm. • Future costs and benefits are not necessarily converted to present values. As a result, these costs may be more fully incorporated into decision making.

System-wide Change and Sustainability • Many scholars have developed plans to move the global economy onto a sustainable path. These plans share many elements, including operating goals and attitudinal goals. • Advocates of sustainable growth argue that sustainability will not occur unless values change. • This would include a move to be more concerned with equity, both intratemporal and intertemporal, and to be more willing to accept short term sacrifice for long term gain. • Since these attitudes are not synchronized with the way political systems have developed, political systems will have to change to be more future-oriented.

System-wide Change and Sustainability • Meadows et al. speak of this change as the next in a series of revolutions that transform economic systems. • The first of these was the agricultural revolution, as people moved from hunting/ gathering to domesticated agriculture. • The second revolution that dramatically changed human existence was the Industrial Revolution. • Meadows et al. argue that it is time for a new economic revolution and that is a sustainability revolution.

System-wide Change and Sustainability • Although each author has suggested a different set of operation goals that must be met for sustainability to occur, there are common threads. Sustainability requires that countries: • control population growth, • eliminate the reliance on fossil fuels, • reduce pollution emissions and waste, • eliminate the pressing Third World poverty that is the source of so much degradation, • slow deforestation, desertification, soil erosion and other assaults on our renewable resource base, • eliminate military conflict and the devotion of resources to military hardware and • develop new "appropriate" technology that is capable of meeting economic needs at minimal environmental costs, particularly in developing countries.

Summary • Severe problems have been identified in this text, and often little has been done to rectify them. • Pollution, environmental degradation, global warming, loss of biodiversity and other problems have been shown to have the potential to drastically affect the quality of life in the future. • However, the future is not already determined; the future is a choice and our actions today will determine the future. • Through an understanding of scientific relationships, social institutions, and economic principles, we can understand the forces that govern environmental change and choose a set of policies that move us toward a sustainable future.

The Economic Approach to Environmental and Natural Resources, 3e