Dinner Talk to ABS Conference on Environmental Accounting, Melbourne, Thursday, May 14, 2012
Ross Gittins, Economics Editor, The Sydney Morning Herald
I’m pleased to be invited to speak to this dinner of a conference convened by the nation’s official bean-counters. I don’t use that term disparagingly. Some people may think they’re far too talented or too important to waste time counting the beans, but I’m not one of them. If outputs and outcomes are important, then measuring them must be too. I’ve had two careers so far, and both have involved bean-counting. The first was as a chartered accountant, and the accountant in me meant that when I switched to economic journalism, I devoted considerable time to making sure I understood how the key indicators of the economy’s health ticked - the labour force survey, the CPI, the balance of payments, the national accounts and so on. I agree with the quote from the Stiglitz-Sen commission, which could almost be the public statisticians’ mission statement: ‘What we measure affects what we do; and if our measurements are flawed, decisions may be distorted’.
I’m also pleased to be speaking at a conference devoted to a subject so close to my heart: how we can establish a system of environmental accounts capable of being integrated with the economic accounts, to eventually produce a bottom-line figure for ‘green GDP’. It may be a sign of old age, but as the years have gone by I’ve become increasingly concerned about the interrelationship between the market economy - as we define it and measure it - and the natural environment - the ecosystem - in which it sits and on which it depends for its continued survival.
It’s clear we need to know a lot more about, and take a lot more notice of how the natural environment is changing over time, mainly as a result of human activity. That is, we need to be doing a lot more measuring of the environment, in its own right. We must keep track of what’s happening to be sure we’re not caught out by developments we didn’t quite notice before they became acute.
And, turning to the economy, the way we manage it - and the way we measure it, because measurements inform managers - needs to change over time to keep up with change in the economy and its environment, and also with developments in the scientific understanding of the way economic activity impinges on the social and natural environment in which the economy operates. Economists and statisticians have been slow to recognise the need for change in the way we define and measure ‘the economy’, but now, thankfully, real progress is being made - as witness the SEEA (system of environmental and economic accounting) and, indeed, this conference.
When you think about it, however, it’s not surprising that, at the time in the 19th century when our way of conceptualising the economy was being laid down by Alfred Marshall and the other neoclassical economists, it was considered possible to think of ‘the economy’ in splendid isolation from what then, I guess, would have been thought of as Nature, but we today have been schooled by natural scientists to think of as the ecosystem.
A hundred and fifty to 200 years ago, global economic activity was puny compared to the vastness of the global ecosystem - the vast oceans, endless forests, the geographical barriers between continents and countries, the perishingly cold winters and, in faraway climes, the intolerable heat. With humankind so puny and nature so vast as to seem almost infinite, it made all the sense in the world to view ecosystem services and environmental assets - air and water and fish and sunlight - as so infinitely available they could be treated as ‘free goods’, goods that had no price and so didn’t need to be taken into account. There was pollution, of course - factories that made loud noises, belched smoke, emitted waste material into the river and maybe left the hillside scarred - but these things were limited and local. They were unpleasant, but they weren’t something to worry too much about.
Two things have changed since those days. The first is the unbelievable growth in economic activity across the globe. Advances in public health and personal healthcare, and advances in economic production techniques, have seen the world’s population increase by a factor of seven since the dawn of the 19th century from 1 billion to 7 billion today. And advances in production techniques on their own have seen the average material standard of living across the world increase by a factor of six over the same period. Put the two together and economic activity, as measured, has increased by a factor of at least 42. Suddenly, global economic activity isn’t looking so puny and the global ecosystem isn’t looking so vast.
The second thing that’s changed since the industrial revolution is the depth of scientific understanding of the way the natural world works and the effects human activities are having on the way it works. First among these discoveries is the first law of thermodynamics which, for our purposes, tells us that economic activity can’t increase or reduce the quantity of anything, just change its form. So what the economy does from a physicist’s perspective is take natural resources and turn them into various forms of waste. Any system of environmental accounts - and any attempt to integrate environmental and economic accounts - has to take account not only of the natural inputs to the economic system but also the output of waste from the system.
Scientists have also made us aware of the way farming practices have affected river systems and underground water systems, the effects of commercial fishing, the limitations to fish farming, the extent of the destruction of species and, of course, the way the burning of fossil fuels and clearing of forests is changing the climate.
If I didn’t know I wasn’t allowed even to think it, I’d be tempted to say the extraordinary growth in global economic activity relative to the eternally fixed size of the ecosystem must surely be taking us close to the limits to economic growth - at least as we presently define growth and pursue it. Surely that’s precisely what the climate science is telling us. We’ve reached the limit to our ability go on burning fossil fuels and destroying natural carbon sinks in forests and so forth. We’re perilously close to natural tipping points - points from which there can be no return to the way things used to be. When the definition of the problem is limited to climate change, many, probably most, economists are willing to accept that things can’t continue the way they have been. But I can’t believe the environmental problem is limited to climate change; that we don’t face similar major threats to the status quo from farming practices, water and land degradation, overfishing and species destruction. I don’t believe we can go on indefinitely increasing our throughput of natural resources and our interference with the operation of ecosystem services.
This is not to say the end of the world is nigh, or even the end of economic activity. But it may well presage the end of global population growth and that part of economic growth that’s based on growth in the use of natural resources. What we don’t have to give up is the other part of economic growth, which comes from productivity improvement and technological advance. It may well be, however, that the objective of productivity improvement needs to change from economising in the use of labour to economising in the use of natural resources. Markets will always economise in the use of the most expensive resource, which in developed economies is labour. We need to turn that around, partly by ensuring natural resources are properly priced to reflect their true social costs and partly by shifting the tax system away from its present heavy reliance on taxing ‘goods’ such as labour to taxing ‘bads’ such as the use of natural resources.
When scientists talk about the limits to growth, economists always accuse them of failing to understand the ability of the price mechanism to solve or work around the seemingly looming end to the availability of particular natural resources, including the price mechanism’s ability to call forth technological solutions to the problem. To this the scientists always retort that economists are hopelessly unrealistic ‘technological optimists’.
I think the truth’s in the middle. In the economists’ mind, the price mechanism solves problems in a way that’s simple and reasonably smooth. They tend to think in comparative statics - the economy snaps from one equilibrium to another - without giving much thought to the dynamics of the adjustment process and the possibility of path dependency, of being knocked off course before you reach the expected equilibrium. I’m not confident of the ability of global commodity prices to adequately foresee emerging shortages around the corner and thereby send a clear enough, and early enough, signal to innovators to get on with finding their technological solution to the problem. If huge price increases occur with little warning and there’s a delay of some years before technological solutions emerge, considerable economic damage can be done in the interim, with unexpected flow-on effects and less-than-efficient policy responses by governments. And all because of economists’ naive faith that the real world will adjust in textbook fashion.
I was interested to see that highly orthodox institution, The Economist magazine, seriously entertaining the possibility of Peak Oil in a recent article (Buttonwood column, Feeling Peaky, April 21, 2012). It noted that global output of crude oil (as opposed to alternatives such as biofuels and liquids made from gas) has been flat since 2005. You can argue the world is ‘awash with energy’ thanks to the exploitation of American shale gas, but The Economist counters that oil is still the main fuel powering the globe’s fleet of cars and trucks. You could convert them all to liquid gas, but you can’t do it without considerable expense and delay, with the prospect of pretty bad things happening in the interim. You could find more oil - in the Arctic or in tar sands - but you couldn’t do that without a considerable increase in the price of petrol. Remember, too, that some potential alternatives to conventional oil - including biofuels and tar sands - are highly ‘energy inefficient’ - you have to expend a lot of energy to produce them. And the fact remains that, just as the industrial revolution was built on coal, so the post-war economy has been built on cheap oil. If oil and its substitutes are now to be very much more expensive, this spells significant cost, economic disruption, social hardship and weaker growth.
But I’ve provoked you enough with the threatening thought that there may be limits to growth after all. Now I want to view the case for measuring change in the environment - and for combining it with the measurement of the economy - from a different perspective. As you know, the overriding goal of microeconomics is to help the community deal with ‘the problem of scarcity’ - the fact that the physical resources available to us are finite, whereas our wants are infinite. There’s any amount of goods and services we’d like to consume, but the wherewithal to produce those goods and services is strictly limited.
But Avner Offer, a professor of economic history at Oxford, and others have advanced an interesting proposition: that the developed market economies’ attack on the problem of scarcity over the time since the industrial revolution has been so remarkably successful that we’ve actually defeated scarcity and replaced it with a different problem, the problem of abundance. Now, technically, for an economist to say that a resource is scarce is merely to say that it can only be obtained by paying a price, that it’s not so abundantly available as to be free. Clearly, in that technical sense, the problem of scarcity is still with us.
But, in the broader sense, it’s hard to deny that the citizens of the developed world live lives of great abundance. As we’ve seen, our material standard of living has multiplied many times over since the start of the industrial revolution. No one in the developed world is fighting for subsistence; even the relatively poor among us are doing well compared with the poor of Asia or Africa; we satisfied our basic needs for food, clothing and shelter a mighty long time ago; our real incomes grow by a percent or two almost every year, and each year we move a little higher on the hog. Our greater affluence can be seen in our ability to limit the size of our families, in the growth in the size and opulence of our homes, the fancy foreign cars we drive, our clothes, the private schools we send our children to, the restaurants we eat in and the plasma TVs, DVDs, video recorders, personal computers, mobile phones, stereo systems, movie cameras, play stations and myriad other gadgets our homes teem with.
How has this unprecedented and widespread affluence come about? It’s the product of the success of the market system. But above all it’s the product of all the technological advance - the invention and innovation - the capitalist system is so good at encouraging. Malthus’s dismal prediction in the late 1700s that the growth in the population would outrun the growth in food production was soon disproved.
It’s therefore reasonable to say that, when we look around us, what we see is not scarcity but abundance. This is something to be celebrated. But, as with everything in life, no blessing is unalloyed. Every good thing has its drawbacks and difficulties. As we’ve seen, the first and most obvious problem with abundance is the damage the huge expansion in economic activity is doing to the natural environment.
The next but less obvious problem with abundance is that it exacerbates humankind’s difficulty achieving self-control. Notwithstanding the economists’ assumption of rationality, humans have a big problem with self-control. It’s ubiquitous to daily life: the temptations to eat too much, get too little exercise, smoke, drink too much, watch too much television, gamble too much, shop too much, save too little and put too much on your credit card, to work too much at the expense of your family and other relationships.
The more stuff we have - the fewer among us whose main problem remains satisfying our basic needs - the more problems of self-control emerge as our dominant concern. But there’s a deeper point: humans have never been good at self-control, but as long as we were poor and resources were scarce, our self-control problem was held in check. It’s when things become abundant, when we can afford to indulge so many more of our whims, when we have a huge range of things or activities to choose from, that self-control problems become more prevalent and we have trouble making ourselves choose those options that are best for us in the longer term, not just immediately gratifying.
The topical problem of obesity provides an excellent example of the way the move from scarcity to abundance has exacerbated self-control problems. Humans evolved in conditions where nutrition was scarce. Our brains are therefore hardwired to eat everything that comes our way while we’ve got the chance, and they’re surprisingly poor at signalling to us when we’ve had enough. For as long as food remained scarce - that is, relatively expensive - and work remained highly physical, there wasn’t a problem. But as we triumphed over scarcity the former balance was lost. Technological advances in the growing, transport, storage, preservation and cooking of food greatly reduced its cost to consumers. As humans have become more time-poor, we’ve seen an explosion in inexpensive fast food, all of it cunningly laced with those three ingredients our brains were evolved to crave: fat, sugar and salt. Then, on the output side, we’ve seen technological advance strip the physical labour first out of work and then out of leisure. We don’t play sport, we watch it being played and these days we don’t even go to the effort of travelling to the grounds.
There’s a third aspect to the problem of abundance: the increased resources devoted to the socially pointless pursuit of social status through consumption. When we have long passed the point where our basic needs for food, clothing and shelter are being satisfied, but our real incomes continue to grow by a couple of percent a year, we have to find something to do with the extra money. Partly, we spend it on ‘superior goods’ - goods you want more of as you get richer - such as health and education. That’s fine. But a fair bit of the extra income is spent on ‘positional goods’ - goods whose purchase is designed to demonstrate to the world our superior position in the pecking order. The point here is that, from the viewpoint of the community rather than the individual, the pursuit of status is a zero-sum game: the gains of those individuals who manage to advance themselves in the pecking order are offset by the loss of status suffered by those they pass. From the perspective of society, a lot of resources are simply being wasted.
So that’s the case for believing that, at this late stage in our development, the problem of scarcity has been superseded by the problem abundance. It has obvious implications for the environment and the need to integrate environmental and economic measurement. I like the example of commercial fishing. Two hundred years ago the constraint was the scarcity of human capital: not enough boats to haul in all the fish available. Today, after so much technological advance in the fishing industry, the scarcity problem is reversed: far too many boats chasing far fewer fish.
You don’t need to think for long about the SEEA exercise before you realise the paucity of measurement of the many dimensions of the environment and the changes in them over time. You realise how much of the bureau’s efforts are devoted to the myriad measurements needed to support the economic accounts. Our management of the environment should be much better informed just by the more comprehensive measurement of environmental indicators in physical values. When you covert those physical values to dollars and integrate them with the economic accounts you are (to quote one of the bureau’s documents) enabling analysis of the impact of economic policies on the environment and the impact of environmental policies on the economy.
For as long as we’ve been worrying about the economy’s effect on the environment the great bugbear has been the environment’s status as an ‘externality’ to the market economy and the price mechanism. The environment isn’t part of the system and it takes a lot of alertness and effort to incorporate it into the system, case by case. My dream is that, though environmental assets will continue to go unpriced until we find a way to price them, we may be able to short-circuit the process by incorporating environmental money values into the GDP bottom line.
