The Limits of Conventional Economics in Dealing with Sustainability

The dominant paradigm in economics at the moment (the "conventional", "mainstream", or "neoclassical" paradigm) is based on some assumptions about the world which, while very useful in dealing with the problems of efficient allocation of resources in the short-term, are less accurate and useful in dealing with the longer-term, broader, and more difficult problems of sustainable development. Sustainable development involves three hierarchially interrelated problems. These are maintaining:

1. a sustainable scale of the economy relative to its ecological life support system;
2. a fair distribution of resources and opportunities, not only between the current generation of humans, but also between present and future generations and between humans and other species, and
3. an efficient allocation of resources over time that adequately accounts for natural capital (Daly 1990).

The problem of distribution is thought by most conventional economists to be best left to the political process, and the scale problem is thought not even to exist as a problem due to infinitite substitution possibilities and technological change. As Bishop (1993) has pointed out, it is not so much that these broader issues are "inconceivable" within the conventional paradigm, but rather that they have not been recognized as being as important as they have now become, and their implications have not been fully "internalized."

Primary among these implications is that the scale and distribution problems cannot be solved inside the market allocation mechanism, even if markets are "perfect" in the sense of all external costs internalized. Rather, the scale and distribution problems must be solved outside the market an d the market can then be utilized as an efficient instrument to implement the solutions. Institutions that recognize the need for an ecologically sustainable economic development are needed to provide the proper framework for the market to act within.

Consider the analogy of a ship. The allocation problem has to do with how the load is allocated to different containers on the deck, the distribution problem has to do with the initial distribution and size of the containers, and the scale problem has to do with the size of the total aggregate load. Obviously the first problem in order of priority is to make sure the total load can be carried by the ship (the scale or carrying capacity problem), otherwise it's irrelevant how the load is arranged. The second problem in order of priority is the distribution of the containers - should all the continers be of relatively equal size or should some be much bigger than the rest and how should they be arranged on the deck. Only after these two problems have be en solved does the third problem of allocation of the load among containers come into play, and it is important to recognize that every distribution has its own unique efficient allocation (Bishop 1993).

The conventional paradigm largely ignores the scale and distribution problems as being "outside the domain" of economics. It views economics as being limited to solving the technical issues surrounding the efficient allocation problem. Going back to the ship analogy, it would be like optimally alloca ting the load on the ship until it capsizes from maldistribution or sinks from overloading. The problem is that optimal allocation does not guarentee sustainability. As Bishop (1993) points out:

"The goal of environmental economics has been to manage natural resources so as to come as close as possible to an idealized, highly efficient time path for the economy, but as we have seen, there are an infinite number of such time paths, each associated with a different allocation of endowments. The time pa th that mainstream environmental economics is taking as the ideal for purposes of analysis may not be sustainable. Better integration of environmental concerns, including those associated with poential extinction of species, into economic efficiency anal yses may benefit present and future generations, but it may not be sufficient to attain sustainability."

If economics is defined more broadly as the "management of the household" as the Greek root of the word implies, then it must address all the proble ms attendant on that management, including the scale and distribution problems, even if those problems do not submit to the mathematical models and prescriptions that have been used to solve the allocation problem.

As we point out below, ecological econo mics is an attempt to extend the domain of economics to cover the broader issues of scale and distribution, while integrating these problems with the allocation problem and extending the allocation problem to adequately internalize "natural capital." Some of the basic assumptions and conclusions of the conventional paradigm will continue to be useful in solving the allocation problem within this broader context, but some will have to be reconsidered and reformulated.

Fixed Tastes and Preferences and Consumer Sovereignty

The conventional paradigm assumes tastes and preferences are fixed and given and that the economic problem consists of optimally satisfying those preferences. In the short run (ie. 1-4 yrs) this assumption makes some sense. Tast es and preferences don't change that fast. But they do change and in fact there is an entire industry (advertising) devoted to changing them. Sustainability is an inherently long-run problem and in the long-run it doesn't make sense to assume tastes and preferences are fixed. This is a very disturbing prospect for economists because it takes away the easy definition of what is "optimal." If tastes and preferences are fixed and given then we can adopt a stance of "consumer sovereignty" and just give t he people what they want. We don't have to know or care why they want what they want, we just have to satisfy their preferences as efficiently as possible. But if preferences are allowed to change over time and under the influence of education, advertiz ing etc. we need a different criteria for what is "optimal" and we have to figure out how preferences change, how they relate to this new criteria, and how they can or should be changed to satisfy the new criteria.

One alternative for this new criteri a is sustainability itself, or more completely sustainable scale, fair distribution, and efficient allocation. This criteria implies coming to a social consensus on a sustainable scale and fair distribution and then using both the market and other instit utions like education and advertizing in order to implement these social decisions. This might be called "community sovereignty" as opposed to "consumer sovereignty." It makes most conventional economists very uncomfortable to stray from consumer sovere ignty because it eliminates the tidy view of economics as simply optimally satisfying a fixed set of preferences and it opens a Pandora's box of possibilities for "totalatarian" governance. If tastes and preferences can change, then who is going to decid e how to change them? Two points need to be kept in mind: (1) preferences are already being manipulated every day; and (2) we can just as easily apply open democratic principles to the problem as hidden or totalatarian principles in deciding how to mani pulate preferences. So the question becomes: do we want preferences to be manipulated unconsciously, either by a dictatorial government or by big business acting through advertizing. Or do we want to manipulate them consciously based on social dialogue and consensus with a higher goal in mind? Either way, this is an issue that can no longer be avoided, and one which we believe can best be handled using open democratic principles and innovative thinking.

Unlimited Substitutability and Technological Change

A second major assumption of the conventional paradigm is that natural and human-made capital are near perfect substitutes and that technological change will eliminate any resource constraints to unlimited growth. In the words of Nordhaus and Tobin (1972):

"The prevailing standard model of growth assumes that there are no limits on the feasibility of expanding the supplies of non-human agents of production. It is basically a two-factor model in which production depends only on labor and reproduc ible capital. Land and resources, the third member of the classical triad, have generally been dropped...the tacit justification has been that reproducible capital is a near perfect substitute for land and other exhaustible resources."

The mathematical form assumed for the production function can also imply more substitutability than is there in reality. For example, even if natural capital is explicitly included in the production function, it makes little difference as long as the production functio n is a form (such as the Cobb-Douglas function) in which natural resources can approach zero with output remaining constant, as long as reproduceable (manufactured) capital or labor (human capital) are increased by a compensatory amount. In more technica l terms, the elasticity of substitution of human-made for natural capital was assumed to be constant and high.

This assumption of near perfect substitutability (high constant elasticity of substitution) has little support in logic or in fact. It was moti vated more by mathematical convenience than anything else, except perhaps the hubris-driven technological dream of being independent of nature. Consider the following list of objections to the tenet of near perfect substitutibility of human-made for natural capital :

1. If human-made capital were a perfect substitute for natural capital, then natural capital would also be a perfect substitute for human-made capital. But if the latter were the case there would be no reason to develop and accumulate human -made capital in the first place! Why does one need human-made capital if one already has an abundance of a near perfect substitute? Historically we developed human-made capital as a complement to natural capital, not as a substitute. It should be obvio us that the human-made capital of fishing nets, refineries, saw mills and the human capital skill to run them does not substitute for, and would in fact be worthless without, the natural capital of fish populations, petroleum deposits, and forests.
2. Manufactured capital is itself made out of natural resources, with the help of human capital (which also consumes natural resources). Creation of the "substitute" requires the very thing that it is supposed to substitute for, and sometimes even more!
3. A physical analysis of "production" reveals that it is really a transformation process---a flow of natural resource inputs is transformed into a flow of product outputs, by two agents of transformation, the stock of laborers (human capital) and the stock of manufactured capital at their disposal. Natural resources are that which is being transformed into a product (the material cause of production); manufactured and human capital are that which is effecting the transformation (the efficient cause of production). The relationship is overwhelmingly one of complementarity, not substitutibility. The overwhelming reason for increasing the stock of human-made capital is to process a larger flow of natural capital, not to make possible a reduced flow. It is poss ible to reduce the waste of materials in process by investing capital in the recycling of prompt scrap, but this is marginal and limited.

The point being made is that the substitution of human-made physical capital for natural capital in the production of a given good is very limited, and that on the whole natural capital and human-made capital are complements in the production of any given good. There may remain considerable substitutibility between human and manufactured capital (the two agents), or a mong various particular forms of natural capital (aluminium for copper, glass for aluminium) or even between nonrenewable natural capital and renewable natural capital. That is not in dispute. Nor are we disputing the possibility of substituting a technically superior product that requires less energy and materials to render the same human service (eg. cars that get more miles per gallon and light bulbs that give more lumens per watt). The latter is efficiency-increasing technical progress (development) as opposed to throughput-increasing technical progress (growth). But for any given product embodying any given level of technical knowledge, human-made capital and natural capital are, in general, complements, not substitutes.

Historical Continuity and No Threshold Effects

A third assumption of conventional thinking at the macro level is that the future will basically be a continuation of past trends and that there will be no major thresholds or discontinuities to disturb this pattern. This view stems from the relative stability of growth trends in western economies in recent history, but it is totally inconsistent with most of the research on the behavior of complex systems in general (Costanza et al. 1993; Holling 1994) and with the behavior of civilizations over a more extended period of history (Tainter 1988; Yoffee and Cowgill 1988; Ponting 1991). Because complex systems (including human societies) frequently exhibit threshold effects, discontinuties, and nonlinear and sometimes chaotic dynami cs, the assumption of historical continuity is a very dangerous one. The past is not necessarily a good guide to the future in these cases. So what do we do? The consequence is to accept a much higher level of uncertainty in planning for the future and designing institutions that are flexible, adaptable, and resilient...

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