Lecture 12

1. Lecture 12 Ecological Economics

2. Ecological economics movement Laws of thermodynamics Principles of ecology Ecological Economics Herman Daly

3. Ecological Economics One way ecological economics differs from neoclassical economics is its consideration of environmental limits. “Ecological economics distinguishes itself from mainstream economics in its preanalytic vision of the economic system as a subsystem of the sustaining and containing global ecosystem.”

4. Neo classical Vs Ecological Economics Why it is important? If the economy is the whole then it can expand without limit and it doesnot displace anything and therefore incurs no opportunity cost . Nothing is given up as a result of physical expansion of the macroeconomy into unoccupied space

5. But if the macro economy is a part, then its physical growth encroaches on the other parts of the finite and non growing whole – an opportunity cost , as economist would call it. • In this case, if we choose to expand the economy, the most important natural space or function sacrificed as result of that expansion is the opportunity cost Ecosystems Economy

6. Growth has a cost, it is not free as it would be if we were expanding in void. • The Earth Ecosystem is not a void, it is our sustaining, life supporting envelope. • It is therefore quite conceivable that at some point the further growth of the macro economy could cost us more than it is worth. • Such growth is known as ‘uneconomic growth’ • Hence growth can be economic as well as uneconomic – there is an optimal scale

7. Natural Capital Pollutants Natural Capital Heat Ecological Economy

8. Natural Capital Pollutants Natural Capital Heat Ecological Economy

9. Ecological Economicskey assumptions…. • Markets do not reveal all of our desires. • Markets do not distribute resources justly. • Markets do not recognize optimal scale.

10. Three Economic Terms Growth: measurable increase in size, or increase in throughput. Throughput: the flow of natural resources from the environment, through the economy, and back to the environment as waste. Development: Increase in human wellbeing without changing throughput. The advancement of political and social freedoms1. The increase in quality of goods and services, as defined by their ability to increase human well-being. 1. Sen, A. 1999. Development as Freedom.New York: Alfred A. Knopf, Inc.

11. Growth vs Development While growth measures an increase in throughput, development measures the increase of prosperity, freedom, and health. Development can occur independent of economic growth. At what point will unending growth (increase of throughput) defy ecological restraints? Because there is such a growth boundary, how should the economy adapt. Sustainable Development is development without growth

12. Micro vs. Macro Economics • Microeconomics: efficient allocation of resources to maximize utility • Macroeconomics: focuses on promoting economic growth, employment, and inflation.

13. Themes and Leaders ScaleDistributionAllocation (Sustainability) (Justice) (Efficiency) Daly Martinez-Alier Costanza

14. Three themes in Ecological Economics Scale - The relationship between the size of an economy and ecosystem that supports it. How close are we to ‘carrying capacity’ Distribution - The apportionment of resources between different individuals (in space and time). Intergenerational equity? Should there be a middle class? Allocation - The apportionment of resources to different goods and services. Guns or Butter?

15. Coevolutionary Economics Economic, social, and political systems adapt to changes in the environment and also respond to and provoke environmental change. As Technology advances many of these changes accelerate. Hunters & gathers – agriculture – industrial revolution

16. Open/ Closed/Isolated System • Open system – Economy ( imports and exports both energy and matter) • Closed system – ( Earth) imports and exports energy only, matter circulates within the system but doesnot flow through it • Isolated system – (Universe) neither matter nor energy enters or exists Opportunity cost is the cost of any activity measured in terms of the value of the next best alternative foregone (that is not chosen)

17. Optimal Scale • Nothing new as a concept – it is very basic to micro economics • Recall marginal cost and marginal benefit discussion , where MC > MB (stop production)- optimal scale is MC=MB • So MC =MB is the ‘when to stop rule’ under micro economics • But interestingly there is no such rule for the macro economy – when the economy as a whole should stop growing , infact the default rule is grow forever • Why not grow for ever if there is no opportunity cost of growth ?

18. Optimal Scale Optimal scale is not strange to microeconomics. Question: At what level of production does one stop making widgets? When Marginal Costs = Marginal Benefits The ‘When to stop rule’. Strangely, there is no such rule in the Macroeconomic world view. Why? Because there are no opportunity costs for growth when the ECONOMY is viewed as an isolated system. This world view ‘works’ in an empty world. However, in a full world the opportunity costs of growth become so large that we have uneconomic growth in which welfare actually goes down. Welfare is a psychic entity. Matter and Energy are physical entities. “Neglecting the biophysical basis of economics gives a false picture. But neglecting the psychic basis gives a meaningless picture.”

19. Empty world to Full world

20. Diminishing Marginal Returns and Uneconomic Growth • As economy grows, natural capital is physically transformed into manmade capital • More and more manmade capital results in greater flow of services from that source • Reduced natural capital results in a greater flow of services from the source • Moreover as the growth of the economy continues the services from the economy grow at a decreasing rate.

21. As rational beings we satisfy our most pressing wants first, hence the law of diminishing utility • As the economy encroaches more and more on the ecosystem, we must give up some ecosystem services. • As rational being we presumably sequence our encroachments so that we sacrifice the least important ecosystem services first. • This the best case – the goal

22. In actuality, we fall short of it because we donot understand how the ecosystem works and have only recently begun to think of ecosystems services are scarce (need interdisciplinary perspective too) • Consequence is law of increasing marginal cost – for each further unit of economic expansion, beyond some threshhold, we must give up a important ecosystem service • Marginal cost increases and marginal benefit decreases

23. Diminishing Marginal Returns and Uneconomic Growth The preanalytic vision of Ecological Economics is expressed in the figure to the right. Stanley Jevons asked the question: ‘When does the effort of working begin to exceed the value of the wage to the worker?’ An Ecol Econ analogous question: ‘When does the cost to all of us displacing the Earth’s ecosystems begin to exceed the value of the extra wealth produced?’ ‘b’ – where we want to be ‘e’ – grim life at carrying capacity ‘d’ – the end of the world as we know it and we feel fine. 

24. A Paradigm Shift Why do Neoclassical economists not see the problems associated with ideas of the ‘Full World’, diminishing marginal returns, and uneconomic growth? They believe we are still in the ‘Empty World’ thus, MU is still very large relative to MDU. Technology will save the day preventing MDU from ever becoming too large relative to MU. The Paradigm problem – The Economy is simply not seen as a subsystem of a larger ecosystem. The Economy is an isolated system that can grow indefinitely. Where conventional economics espouses growth forever, ecological economics envisions a steady-state economy at optimal scale. Each is logical within its own preanalytic vision, and each is absurd from the viewpoint of the other. The difference could not be more basic, more elementary, or more irreconcilable.