An Economic System in Collision with the Earth’s Environmental System
Our planet is not growing to take into account population and economic growth. The resources that the world contains are not increasing to satisfy our continual desire for expansion. Our current economic system does not see the value of decreasing consumption. Sustained and widespread drops in spending can cause economic recessions and are linked to undesired increases in bankruptcy and unemployment rates. It appears that our economic system is in conflict with our environmental system.
One method towards restoring balance, which recognizes the connection and interdependence of both systems looks at assessing and internalising externalities in order for the whole environmental and social cost to be reflected in the price of goods and services. The externality of an economic transaction is the consequential impact on another party not directly implicated in the transaction. In this instance, the price of the transaction does not include the whole costs or benefits in the production or consumption of the product or service cost. For example, the tar sand operations in Canada generate vast quantities of contaminated water but do not currently compensate for the environmental and health impacts on nearby communities. Would tar sand investments continue if they were required to pay for the present and future environmental and health damage created? The difficulty lies in valuing the cost of current and future impacts. For instance, the impact of the Bhopal spill disaster in 1984 is still unfolding on today’s generation as they continue to get sick from associated cancer and birth defects. Predicting and quantifying environmental and social costs is complex. In the case of climate change, Lord Stern of Brentwood was the first economist to value the whole cost of carbon. The Stern Review published in 2006 suggests that each tonne of CO2e emitted causes damages estimated at least US$85. However one tonne of CO2e is currently trading at US$24.60. The financial markets are currently not valuing the whole cost of carbon.
Neither the market nor individuals can be solely relied upon to prevent the inefficiencies caused by economic externalities. Consequently, the government must intervene and oblige companies to internalise the costs of environmental and social impacts. This implies that if business pollution generates expenses such as medical bills from sickness, then the government will require the company to pay that cost. Consequently businesses would incorporate the whole and long-term costs and decide if the activity is cost-effective. This creates a decision-making process that supports the optimal economic, social and environmental choices.
A recent example of this is the Carbon Reduction Commitment Energy Efficiency Scheme (CRC). The CRC launched on April 1st 2010, is a mandatory scheme designed to promote energy efficiency and reduce carbon emissions in the UK. It requires businesses to monitor their emissions, report these emissions annually, and buy and surrender allowances that correspond to their emissions. As a result the carbon cost of products will gradually be reflected in the price to consumers and low carbon technologies will be implemented, prioritised and become profitable for businesses. A recent report commissioned by the UK Government confirms the rising worldwide demand for low carbon goods and services. The report estimates that the global sector for Low Carbon and Environmental Goods and Services (LCEGS) is valued at £3 trillion, and is expected to increase by 4% per annum in the next five years.
Similarly, DEFRA calculates that the carbon footprint of reuse and recycling is less than manufacturing new goods. Internalising externalities such carbon into the cost of products creates financial incentives to promote reuse and recycling versus extracting new raw materials. As a result businesses can take advantage and focus on re-manufacturing and still generate employment – simply different types of employment based upon service repairs and reuse or recycling to extend the life span of goods. The Institute for Self-Reliance also conducted a study that supports the economic case for reuse and recycling.
Right now, a business can choose to be proactive and start calculating the whole cost of its business activities along its supply chain. This involves looking at impacts generated from the extraction of raw materials, manufacturing and transportation before considering usage and eventual disposal of products. Whole costing and transforming business activities towards low carbon and low resource-use activities can provide competitive advantage and ability to hedge the risk of legislation exposing externalities.
This solution starts to enable economic and environmental systems to align and prosper together.
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Like I’ve always said. Many economists have known and/or know what the problem is. The solutions are where people disagree although some ideas have more support than others.
The problem is often in the application of solutions. Take, for instance, the idea of individual economic agents applying the concept of a “triple bottom line” (income + aggregate net impact of externalities).
For the sake of brevity, consider this only at the corporate level. Not only would there have to be agreement over the value of the environmental/social impact externality when translated in less “multi-dimensional” financial terms but, moreover, there would have to be some way to enforce its proper application. This would easily require expanding the role of governments or quasi-government agencies staffed by technocrats able to perform an oversight role (science-trained? un-corrupt?). It would also require someone to police both the corporations and the technocrats themselves. One can easily envisage a situation where this requires a wholesale revisit of our political and economic system on a national and global scale with the end result being, perhaps, something a bit closer to that of a centrally-planned economy.
Unfortunately, in the West (and now most of the rest of the world), the mere mention of that considered almost unthinkable (even “evil” by some). Just look at Obama’s situation. He can’t even fix a few small problems and his approval rating already indicates he will lose congressional support in November, rendering him a lame duck president barely two years into his mandate. Why? Because he’s a “dirty communist” (i.e. healthcare bill). It’s ridiculous. And this was a man who galvanized practically everyone around him at the start….
Valuing economic goods seems to be done well enough by the market, why not valuing environmental and social goods (and bads)?
As a civilisation we haven’t needed to create a vast, centrally-planned bureaucracy to define the value of, say, gold or celebrity ringtones. The market for modern art is not wildly volatile despite the huge difference between how much it’s valued by Charles Saatchi vs the bloke in the pub.
So I can’t see why Anonymous believes it’s not possible for governments or NGOs to help build a set of market prices to drive the economic internalisation of externalities, without scary state control.
The EU with its Emissions Trading Scheme, the UK with its CRC Energy Efficiency Scheme, or the US with its Greenhouse Gas Reporting Rule, or NGOs like the Fairtrade Foundation, Transfair USA etc with fairly traded goods, or Marine Stewardship Council with its sustainable fish are all creating “technocratic” valuations of social/environmental goods and bads. They are also policing the trade in these goods/bads. And marginal costs are going down over time.
So is this a problem of real bureaucratic deadweight or is it just one of perception?
Industrial civilisation has grown out of, primarily, European roots and is still organised on an assumption that was in the book of Genesis; that man has dominion over the planet and everything in it. When Italian accountants invented double-entry book-keeping with the concept of balance at its heart, they revolutionised how people could think about business but clearly didn’t have any need to upset that assumption. Indeed, had our global population remained in the tens or low hundreds of millions, we might have got away with it for a long time. Instead we have an economic system that tells ordinary people that with the decisions they make in their everyday life it is ok to trash the future. Worse, it is “rational” behaviour because it is the “cheapest” way to do things.
We need an urgent and radical re-think both on how we account for our economic activity and how we organise it so that we are rewarded for living with the planet, not destroying it.