There are two dogmas that neoclassical economists must never publicly doubt lest they be defrocked by their professional priesthood: first, that growth in GDP is always good and is the solution to most problems; second, that free international trade is mutually beneficial thanks to the growth-promoting principle of comparative advantage. These two cracked pillars “support” nearly all the policy advice given by mainstream economists to governments.
Even such a clear thinker as Paul Krugman never allows his usually admirable New York Times column to question these most sacred of all tenets. And yet in less than 1,000 words the two dogmas can easily be shown to be wrong by just looking at observable facts and the first principles of classical economics. Pause, and calmly consider the following:(1) Growth in all micro-economic units (firms and households) is subject to the “when to stop rule” of optimization, namely stop when rising marginal cost equals declining marginal benefit. Why does this not also apply to growth of the matter-energy throughput that sustains the macro-economy, the aggregate of all firms and households? And since real GDP is the best statistical index we have of aggregate throughput, why does it not roughly hold for growth in GDP? It must be because economists see the economy as the whole system, growing into the void — not as a subsystem of the finite and non-growing ecosphere from which the economy draws resources (depletion) and to which it returns wastes (pollution). When the economy grows in terms of throughput, or real GDP, it gets bigger relative to the ecosystem and displaces ever more vital ecosystem functions. Why do economists assume that it can never be too big, that such aggregate growth can never at the margin result in more illth than wealth? Perhaps illth is invisible because it has no market price. Yet, as a joint product of wealth, illth is everywhere: nuclear wastes, the dead zone in the Gulf of Mexico, gyres of plastic trash in the oceans, the ozone hole, biodiversity loss, climate change from excess carbon in the atmosphere, depleted mines, eroded topsoil, dry wells, exhausting and dangerous labor, exploding debt, etc. Economists claim that the solution to poverty is more growth — without ever asking if growth still makes us richer, as it did back when the world was empty, or if it has begun to make us poorer in a world that is now too full of us and our stuff. This is a threatening question, because if growth has become uneconomic then the solution to poverty becomes sharing now, not growth in the future. Sharing is now called “class warfare.”(2) Countries whose growth has pushed their ecological footprint beyond their geographic boundaries into the ecosystems of other countries are urged by mainline economists to continue to do so under the flag of free trade and specialization according to comparative advantage. Let the rest of the world export resources to us, and we will pay with exports of capital, patented technology, copyrighted entertainment, and financial services. Comparative advantage guarantees that we will all be better off (and grow more) if everyone specializes in producing and exporting only what they are relatively better at, and importing everything else. The logic of comparative advantage is impeccable, given its premises. However, one of its premises is that capital, while mobile within nations, does not flow between nations. But in today’s world capital is even more mobile between countries than goods, so it is absolute, not comparative advantage that really governs specialization and trade. Absolute advantage still yields gains from specialization and trade, but they need not be mutual as under comparative advantage — i.e., one country can lose while the other gains. “Free trade” really means “deregulated international commerce” — similar to deregulated finance in justification and effect. Furthermore, specialization, if carried too far, means that trade becomes a necessity. If a country specializes in producing only a few things then it must trade for everything else. Trade is no longer voluntary. If trade is not voluntary then there is no reason to expect it to be mutually beneficial, and another premise of free trade falls. If economists want to keep the world safe for free trade and comparative advantage they must limit capital mobility internationally; if they want to keep international capital mobility they must back away from comparative advantage and free trade. Which do they do? Neither. They seem to believe that if free trade in goods is beneficial, then by extension free trade in capital (and other factors) must be even more beneficial. And if voluntary trade is mutually beneficial, then what is the harm in making it obligatory? How does one argue with people who use the conclusion of an argument to deny the argument’s premises? Their illogic is invincible!Like people who can’t see certain colors, maybe neoclassical economists are just blind to growth-induced illth and to destruction of national community by global integration via free trade and free capital mobility. But how can an “empirical science” miss two red elephants in the same room? And how can economic theorists, who make a fetish of advanced mathematics, persist in such elementary logical errors?If there is something wrong with these criticisms then some neoclassical colleague ought to straighten me out. Instead they lamely avoid the issue with attacks on nameless straw men who supposedly advocate poverty and isolationism. Of course rich is better than poor — the question is, does growth any longer make us richer, or have we passed the optimum scale at which it begins to make us poorer? Of course trade is better than isolation and autarky. But deregulated trade and capital mobility lead away from reasonable interdependence among many separate national economies that mutually benefit from voluntary trade, to the stifling specialization of a world economy so tightly integrated by global corporations that trade becomes, “an offer you can’t refuse.”Will standard economists ever pull the plug on brain-dead dogmas?Herman Daly is a professor emeritus in economics at the University of Maryland, School of Public Policy. He is a member of Center for the Advancement of the Steady State Economy (CASSE). Visit the Daly News for more essays by Professor Daly and CASSE staff.
In his February 10th essay, New York Times columnist Joe Nocera asked a simple question: “Can a person support the Keystone XL oil pipeline and still believe that global warming poses a serious threat?”
Joe answers “yes,” with the logic that this one pipeline alone will not bring about a global warming apocalypse, which is ultimately caused by “deeply ingrained human habits.” He was on the defensive as a result of his prior column “Poisoned Politics of Keystone XL,” in which he defends Canada’s decision to court China as an alternative market for its Tar Sands oil in the face of Obama’s refusal to approve the XL Pipeline under political duress. “At least one country in North America understands where its national interests lie. Too bad it’s not us.”
Joe is a balanced and thoughtful observer of business and Wall Street, but I disagree with him on XL.
If one believes as I do that global warming poses a “serious threat,” i.e., a threat of potentially and even likely catastrophic consequences, then the XL pipeline provides a useful and timely “line in the sand” that can be used to call the question, and alter the course of the global economy before it is too late.
Let’s review the two issues that are the focus of Joe’s second column. The first is whether Tar Sands oil is all that bad, and whether it alone will doom the planet as leading climate science authority Jim Hanson suggests. I don’t know whether tar sands oil emits only 6 percent more greenhouse gases than other oil as the IHS Cera study Joe sights suggests or 17-20 percent more as I heard from environmental leader Bill McKibben. The point is the absolute volume of carbon in this massive reserve, the equivalent of 150 parts per million in the atmosphere, when added to existing “proved” reserves, will undoubtedly doom life as we know it on the planet if it’s all produced and burned.
Marginal differences in quality and efficiency do not alter the hard boundaries of absolute scale limits. When faced with absolute limits, it only makes sense to prioritize high quality (low carbon) fuels, focus on efficiency, and find alternatives fast. Efficiency of energy source or use will never solve the scale limit issue. That's the big deal.
The stunning truth points to a far more difficult challenge that the politicians, economists, and columnists are failing to see. Unless we solve the technical challenge of carbon sequestration, a feat that appears to be fading from the imagination of even the technology optimists, then even before the expansion of Tar Sands production, the world already has proven reserves in the process of coming out of the ground in the decades ahead that exceed our carbon budget by a factor of 5 times.
In other words, as I have described in “The Big Choice,” we can choose to burn the fossil fuels we already have and likely cause irreparable damage to the planet by blowing through the 2 degree Celsius warming limit that climate scientists tell us is the tipping point, or we can choose to abandon 80 percent of the global fossil fuels already discovered and find alternative means to power our restructured and less energy-intensive economy. I call this our “big choice” because at current market value, that 80 percent of what would become “stranded assets” is worth about $20 Trillion. No wonder the fossil fuel interests will stop at nothing to promote denial.
So where to start? I can think of no better place for America to lead than in our own backyard on a project whose scale matters. Tar Sands. There’s no easy way down folks, so we simply need to decide whether to engage in the serious decisions in front of us. Greece failed to do so with their unsustainable fiscal path. We see the results. Our energy/carbon path represents a “bio-capacity deficit” that makes the the consequences of the present financial crisis cascading across Europe appear modest in comparison.
Joe’s second issue relates to trade. One argument against the XL Pipeline is that the oil would cross America on its way to Gulf Coast refineries, and then head to Europe, doing nothing for our “national security” interest of sourcing oil from friendly allies as pipeline supporters claim. Here, Joe rightly points out that the trade flows of this oil will probably not deviate much from existing patterns. But this is missing the point.
The oil market is now a global market. Global supply and demand is what sets world prices, plus or minus a transportation charge, subject to temporary logistical constraints. So whether tar sands oil goes to the US or China, the price we all pay over time will not vary by a significant degree.
However, the future will likely look quite different than the past. This is the vital message of running into limits on an unsustainable path. We will choose to take one of two paths, either actively or passively:
Business as usual: Global energy demand will continue to grow. We will fail to materially curb our burning of fossil fuels. We will set in motion irreversible climate change that will impact the lives of our children for sure and likely ourselves (most would suggest this is already the case). Oil will become scarce and the global “free market” will function no longer. Having access to Canadian oil will be seen as a US asset, ensuring us vital supply either by negotiation or by annexation. But it will be clear to all that the world is on a frightening path, and our “non-negotiable” SUV lifestyle will be the furthest thing from our minds.
Smart path: We will understand, as our military and security establishment now does (another essay on that here), that our unsustainable economic system poses the greatest threat to our national (and global) security. We will start making hard decisions in line with a vision of a sustainable future, one important decision at a time. Deciding not to expand Tar Sands production when the challenge is how to decide which existing resources to strand in the ground, and how to share the consequent financial and social burdens, will be one of the easier of these decisions.
So my question back to Joe Nocera is, what do you mean by “a serious threat”?
Co-authored by Peter Malik, Director of Center for Market Innovation at the NRDC
Generation Investment Management’s recently released white paper calls for a “paradigm shift” to Sustainable Capitalism. It is an admirable and important contribution to the discussion about how to make individual firms more sustainable. Building on this foundation, we need the sustainable business community to join the ongoing systems level conversation implicit in Generation’s paper about how to make the whole global economy truly sustainable, not merely less unsustainable. Without such a systemic shift, the sum of individual firm sustainability efforts will not translate into sustainable capitalism.
In the spirit of contemporary Chinese artist Ai Weiwei’s belief--quoted in Sustainable Capitalism-- that “liberty is about the right to question everything,” we offer five questions as a beginning to this critical dialogue:
1. Can we find the answers to economic unsustainability within conventional economics?
The profound ramifications of climate change (and other such market failures) impact not only firms and their financial value, they impact our economic, social, political, and ecological systems. To recognize this reality, conventional economists would have us price (“internalize”) the effects of this externality. But the compounding interconnections between global temperature rise, sea level rise, soil degradation, biodiversity loss, etc., make accurate pricing impractical, while some risks such as climate change have consequences that simply cannot be priced. Furthermore, the discount function embedded in conventional financial analysis all but ensures that the costs to be borne by our grandchildren tomorrow are not valued today.
We have therefore concluded that looking at the sustainability challenge through the lens of conventional economics and finance reinforces the error that got us into our current difficulties. As Einstein famously said: “We can't solve problems by using the same kind of thinking we used when we created them.”
Instead, we should look to natural systems science to understand sustainability because it is by definition sustainable--unlike our modern global economy. Leading new economy thinkers from the sciences like Janine Benyus, author of Biomimicry, are already working on this new way of thinking.
2. What does nature teach us about sustainable capitalism?
If we look to nature as the model and measure for sustainability, we find that nature does not maximize the goals of its parts. Rather, nature limits the goals of each species to that which can benefit the system without drawing down on its future viability. A “framework that seeks to maximize long-term [firm-level] economic value creation”—the definition offered for sustainable capitalism—must first be constrained by the need for the economy writ large to carry on.
Innovative models, such as the Evergreen Cooperatives in Cleveland, are sprouting up all over the country. Inspired by the $20 billion Mondragon Cooperatives in Spain, Evergreen has, for example, established an umbrella organization to provide a source of continuity for all of its cooperative enterprises. All cooperatives are expected to support a fellow co-op in distress, absorbing its excess labor capacity. Rather than reinvest or distribute all its profits, each co-op contributes to a fund that a distressed co-op can tap and that helps finance the next generation of cooperative businesses.
3. Can we live within our ecological means?
A natural system cannot continue to exist if it depletes the resources it depends on or ruins the capacity of its host to recycle its wastes. Sustainable Capitalism begins and ends with quotes from two leading thinkers on this issue, Herman Daly and Tim Jackson, but it fails to address the core challenge they have put to economics, mainstream finance and capitalism: how can an economic system that depends upon finite natural resources continue to grow exponentially? Resource constraints and limits to growth must be addressed in any credible discussion of the future of capitalism (see Jeremy Grantham).
A paper by Johan Rockström published in Nature in 2009 detailed what he and his team call the “safe operating space for humanity.” To stay within the safe operating space requires that we not cross any of nine planetary boundaries, including three we have already crossed—atmospheric carbon (climate change), runaway biodiversity loss, and nitrogen cycle disruption.
The goal of perpetuating the healthy function of the ecosystem must trump the profit-maximization goal of individual firms. This means we must design, as the Mondragon and Evergreen Cooperatives have attempted in more regional ways, a governance system that can set the priorities and enforce naturally defined limits on the global economy.
4. How long-term must “long-term thinking” be?
Lester Brown defines a sustainable society as one that “satisfies its needs without diminishing the prospects of future generations.” Short-termism is certainly a problem throughout society, and nowhere worse than in finance, as Sustainable Capitalism points out. However, the real issue is not the difference between hyper intra-second trading (destructive as that can be), quarterly earnings guidance, annual bonus cycles, and three-year performance metrics. Markets are wonderful human tools that work best in short timeframes, but they offer no protection against long-term resource depletion threats, as we have learned from our forests and fisheries and now climate change. We must not expect even better structured markets, with more transparent information, to perform tasks they are not designed for. Instead, we need markets designed and governed by something like the “7th generation” decision-making process of the Iroquois. We need what E.F. Schumacher called an “economics of permanence.”
5. How can we go beyond sustainability?
Generations’ Sustainable Capitalism says “sustainability does not involve a trade-off between profitability and improving the environment.” We believe the authors meant “harming or using the environment less,” not “improving the environment.” Discussions of sustainable business often confuse the two, and fail to take up the hard choices. If we are to achieve the sustainability of natural systems, we should be searching for a regenerative capitalism that rebuilds, rather than breaks down, the social and ecological support systems we depend on, promoting true prosperity in the process.
With their path-breaking approach to integrated value investing that seeks to break free from the myopic reductionism of conventional financial analysis, Generation Investment Management has made a courageous and valuable contribution to addressing the “wicked challenge” of our lifetime: unsustainability.
To move forward, we can think of no better metaphor than the “fresh canvas” the authors of Sustainable Capitalism call for. The canvas forces constraints on the artist. Like our planet, its boundaries are fixed. Within that constraint, the artist’s discipline and creativity flourish. So too will human resourcefulness, innovation, and colaboration be stimulated by the discipline of operating the economy within the earth’s physical boundaries.
It is our great challenge, at this time, to transform the global economic system. Let us look to nature’s wisdom as our guide, rather than be confined by the limitations of conventional economic and financial theory. There is no more urgent task for a genuinely sustainable capitalism than to envision, define, and negotiate how to share and enforce the human economy’s “safe operating space” in an equitable way. The hard work lies ahead.