Mainstream macroeconomic theories tend to leave out environmental issues in their basic calculations. Despite increasing awareness of alternative macroeconomic models among academics, students today continue to be exposed to conventional theories that treat the environmental consequences of economic activity as ‘externalities’. Green National Accounting attempts to include environmental protection as a value in its alternate, and more comprehensive, macroeconomic model. Although difficult, GNA offers a macroeconomic decision-making tool that begins to account for the environment. Recognizing that universities are drivers of change, there needs to be wide-spread reforms to the teaching of “green” macroeconomics at the introductory level of college education.
Pfly, Don’t Litre!, 2007
Certains droits réservés.
Economic prosperity and environmental protection are often placed in opposition to each other, as decision-makers (such as corporate managers, government officials or individuals), consciously or not, often choose to promote one and neglect the other. Mainstream economic doctrines equate human welfare with growing economic activity, and have little regard for ecological impacts (1). However, as economist Michael Wright of Stanford University has remarked: “In modern society, we seem to have lost touch of the fundamental dependence we have on conserving nature […] it is critical to show how humans benefit from nature by calculating the real economic value of those benefits.(2)” Only recently has economic thought undergone significant remodeling and come to incorporate environmental values into economic theory. Familiarity with the origins of macroeconomic theory is needed to understand the current situation.
The Birth of Neoclassical Economics
Neoclassical economic theory was born in the second half of the nineteenth century. It focused on profit maximization via monetary values assigned as the balance between supply and demand. Since the Industrial Revolution, the natural resources, such as forests, minerals, cattle, land and water, have been commodified at an increasing rate (3). Efforts to care for the environment through the traditional concept of stewardship existed. However, as the earth seemed immensely vast, the consequences of over-extraction of natural ‘resources’ were unclear and it seemed that “nature would absorb all things and continue to grow” (4). Clearly, neoclassical economic theories were not developed with environmental crisis and global climate change in mind.
Macroeconomic Assumptions:
The Gross Domestic Product and the Standard of LivingBefore we proceed, we will briefly review the place of macroeconomics within neo-classical economics. In the 1930s, economic analysis developed separate branches of enquiry into individual (household, business enterprises) and aggregate (national) economic behavior. The latter became known as macroeconomics. Macroeconomics addresses large-scale economic aggregates, such as total output and total employment at the national level. One important concept within macroeconomics is the formula for a nation’s Gross Domestic Product, or GDP. GDP is the sum, in monetary terms, of all the goods and services produced in a domestic economy in a given year. Accordingly, GDP is the sum of Consumption (of domestically-produced goods and services) plus Government spending (on the same) plus Gross Investment (in domestic plants, equipment and housing) plus Net exports (calculated as the value of national products exported minus the value of foreign products imported). In other words, a nation’s GDP rises with growth in consumption, government spending, gross investment and/or exports; and it falls with increases in imports (5).
Economists often use the GDP to make rough assessments of the standards of living in different countries (6). Standard of living is partly evaluated through annual income per capita, which is often crudely equated to the GDP per capita. In economic terms, the national standard of living is supposed to indicate the well-being of a nation’s population. Given the logic of the GDP, the method for evaluating the Standard of living assumes that increased domestic production leads to higher employment rates, which increases a population’s ability to spend and consume goods. If one recalls the formula for GDP, this neoclassical macroeconomic model suggests that increasing the GDP will directly lead to an improvement in the national standard of living.
The Economics of Happiness
However, this calculation of a “standard of living” is clearly not the same as an actual measure of people’s well-being or quality of life (7). Nonetheless, in an issue of the journal The Economist in 2006 entitled “Happiness and Economics” market growth and human happiness were linked. The message conveyed is that happiness correlates to a higher standard of living. Unfortunately, many university students today, and potential leaders of tomorrow, may come to regard this mistaken equation as the only valid macroeconomic model. Fortunately, many others are challenging these pervasive economic ideas, such as Robert E. Lane in his study, The Loss of Happiness in Market Democracies. Lane shows that benefiting from an above average income and consuming beyond need may actually lower a person’s sense of fulfillment (8). The mainstream macroeconomics assumption, that human welfare increases with economic growth, should not go unchallenged.
With regards to prevailing economic models, John McMurtry ironically notes in his article, “Myths of the Global Market,” that “the great myth is that all commodities are ‘goods’ never ‘bads’. Just sum up the sales of the ‘goods’ and you have the sum of society’s happiness and well-being” (9). Hence, the depletion of forests and fish stocks resulting directly or indirectly from increases in commodity production is not deducted from the GDP, even though, arguably, it impoverishes human well-being. As trees are chopped down and replaced by roads, the world loses carbon sinks and natural beauty. In a cascading effect, communities dependent on fish or forest for their livelihood may actually be less well-off even as the GDP grows. Thus, the argument for increased production crumbles, as does many of the societal justifications behind the application of mainstream macroeconomic theory.
Further examples that illustrate how conventional calculations of GDP neglect the negative environmental effects of blind production are abundant. For instance, public expenditure on gasoline is added to the GDP even though the damage done to the environment and people’s health is not taken into account. Similarly, burning coal to produce electricity increases the GDP, whereas the resulting acid rain and the sulfur dioxide produced is not deducted. Ironically, the medical cost of treating respiratory difficulties caused by environmental pollution actually increases the GDP. The negative impacts of production processes on the quality of life are not accounted for in current calculations of GDP. Indeed, as noted by McMurtry, the “production of junk food, violent video games, and fossil-fuel leisure machines all count as much in the National Accounts as organic foods, clean water or solar-powered electricity.(10)”
Counting Better: Comprehensive National Accounting
Contemporary macroeconomics has developed a new way to account for the environmental impacts of economic activity. In the 1990s, “Comprehensive National Accounting” gained wide acceptance among economists. This newer model tries to estimate the value of off-market goods and services (e.g. under the table transactions) and non-monetary transactions (e.g. the exchange of goods for other goods) that have been neglected in previous models.
As part of Comprehensive National Accounting, “Green National Accounting,” was formulated to account for the environment in its calculation of the GDP (11). This evolution in macroeconomics takes into consideration the depletion of natural resources, ecological damages, and environmental pollution by attempting to determine how much society values avoiding these scenarios.
There are inherent difficulties in this method and the values obtained are far from precise. Since there is no clear monetary value for many negative environmental impacts, economists employ two hypothetical concepts: “Willingness to Pay” and “Willingness to Accept (monetary) Compensation.” For instance, halting the development of community parklands would likely provoke varying degrees of “Willingness to Pay” and “Willingness to Accept Compensation” within the community. Furthermore, the methods used to survey these two parameters may suffer from incomplete information and even cause reactions that affect survey results, therefore diminishing the credibility of the values obtained. As noted by Sjak Smulders, while neoclassical macroeconomics may effectively measure the volume of market activities, they do not adequately evaluate the impact of market activities on other aspects of society and the environment (12). Yet, conventional macroeconomic models continue to be widely taught at universities as an introductory course to students (13).
Internalizing Pollution
In neoclassical macroeconomics, the blanket term “externality” encompasses all negative (or positive) effects of a production process on society. For instance, when a factory emits pollution into the environment, the reduction in the health of humans and the ecosystem are labeled “externalities” because they were external to the considerations of the decision-maker involved in production. Although they do not enter into neoclassical calculations, Green National Accounting tries to evaluate and internalize these “externalities.” For instance, those responsible for polluting could be economically penalized – charged, fined or taxed. A difficult task is faced by the Green economist, who must internalize the social and environmental costs of pollution. Determining these values can be very difficult and imprecise. Green National Accounting proposes that if the most “accurate” socio-environmental costs are charged to the polluter then the polluting process will become less economically viable. In an extreme situation, this form of accounting could completely halt a polluting activity, reduce negative impacts on the environment but also incur losses to employment and other economic activities. Green National Accounting treats protection of the environment as an essential part of economic calculations.
Conclusion
Economic theory and the environment are closely linked. Policies like “Polluters Pay,” government taxation, and the European Union’s Cap-and-Trade policies regarding carbon dioxide emissions are among the many efforts being used to attenuate climate change. In addition, investments in green technologies are rising. International investments in renewable power-generation, biofuels and low-carbon technologies rose from $28 billion USD in 2004 to $71 billion USD in 2006 (14). In short, factors of production that used to be considered external to decision-makers are now integrated into all economic operations. This makes one wonder why neoclassical macroeconomic theories that do not take environmental impacts into account are still being taught to many undergraduate students in universities worldwide when more comprehensive theories are available.
It is with these issues in mind that the Gund Institute for Ecological Economics at the University of Vermont aims to “shift the world’s economics away from their present emphasis on infinite growth and towards a focus on sustainable human well-being” (15). Two notable efforts in this direction include the already cited Gund Institute and the Natural Capital Project (launched in Washington, DC, with a partnership between Stanford University, The Nature Conservancy, and the World Wildlife Fund). Both of these initiatives intend to investigate how economists could better assess the economic value of the natural environment. According to proponents of the Natural Capital Project, current neoclassical macroeconomic practices “consistently omit the trillions of dollars of benefits that nature provides, and on which our lives depend” (16).
Students throughout the world need to understand the problematic calculations of GDP and economic prosperity in conventional macroeconomic theories. Efforts to introduce the concepts of Green National Accounting ought to be made at the undergraduate level as it affects the widest range of students. The future generation must be given the tools to understand how economy and ecology are intimately linked, and, most importantly, how our conception of economy deeply affects the quality of the environment and the future of human life in this fragile planetary ecology.
References
(1) It is worth noting that “economy” and “ecology” share the same idea of “dwelling” or “home” through “eco-” (derived from the Greek word “oikos”). Economy indicates the law or order (Greek “nomos”) of dwelling. Ecology means the science (“-ology”) of dwelling – where we live.
(2) Wright, Michael. “Natural Capital Project: Aligning economic forces with conservation.” Stanford University, World Wildlife Fund, The Nature Conservancy. [on-line] < http://www.naturalcapitalproject.org/hawaii_prim.html>. 15/08/07.
(3) Wright, Gavin (2006). “Natural Resource Industries: Forest Areas of the United States. Historical Statistics of the United States Millennium Edition. Vol.4, Part D, Economic Sectors, Cambridge University Press, New York, NY. 4-280. For example, total forest cover in the United States fell staggeringly from 558 million acres to 328 million acres between 1880 and 1920 (estimated original forest cover is 900 million acres). A great deal of this deforestation can be attributed to domestic and international commercial sales by the newly formed United States timber industry. This industry and many others established themselves (in a chicken or egg fashion) alongside economic theory regarding profit maximization, and certainly not conservation.
(4) McDonough, William and Michael Braungart. Cradle to Cradle: remaking the way we make things. New York: North Point Press, 2002. 25.
(5) Ragan, Christopher T.S. and Richard G. Lipsey. Macroeconomics, 11th Ed. Toronto, Ontario: Pearson Addison Wesley, 2005. 508. Note that GDP differs from Net Domestic Product (NDP). NDP is calculated as GDP minus depreciation, or the loss of value of capital from one year to the next. It is an indicator of how well the economy is producing income for the inhabitants of a country. However, like GDP, NDP leaves out non-marketed goods and services, non-monetary transactions and other goods and services that have value but no specified price, like the environment.
(6) More specifically, Net National Product (NNP), a value of Gross Domestic Product (GDP) adjusted for yearly depreciation of capital is actually used to compare Standards of Living as it provides a more accurate measure of income.
(7) A more sophisticated measure of a population’s well-being is proposed by the Human Development Index (HDI) authored jointly by Indian Nobel prize winner Amartya Sen and Pakistani economist Mahbub ul Haq, with help from Gustav Ranis of Yale University and Lord Meghnad Desai of the London School of Economics. The HDI was developed in 1990 and has since been used in the annual Human Development Report issued by the United Nations Development Programme.
(8) Lane, Robert E. The Loss of Happiness in Market Democracies. New Haven, Connecticut: Yale University Press, 2000. 185-186.
(9) McMurtry, J. “Myths of the Global Market.” New Internationalist. June (2007): 34.
(10) McMurtry, J. “Myths of the Global Market.” New Internationalist. June (2007): 34.
(11) Smulders, Sjak. “Green National Accounting.” The New Palgrave: Dictionary of Economics. Second edition. Eds. John Eatwell, Murray Milgate, Peter Newman. New York: Macmillan Press, 2006.
(12) Smulders, Sjak. “Green National Accounting.” The New Palgrave: Dictionary of Economics. Second edition. Eds. John Eatwell, Murray Milgate, Peter Newman. New York: Macmillan Press, 2006.
(13) Outside of the field of economics, other university programs that require students to understand basic microeconomic and macroeconomic theory include: International Development Studies, Environmental Studies, Accounting, Management, and Finance, to name but a few.
(14)Duncan, Emma. “Cleaning up: How business is starting to tackle climate change and how governments need to help”. The Economist. June 2-8 (2007): 13.
(15) Gund Institute for Ecological Economics. University of Vermont. [on line] < http://www.uvm.edu/giee/?Page=default.html>. 14/08/07.
(16) Wright, Michael. “Natural Capital Project: Aligning economic forces with conservation.” Stanford University, World Wildlife Fund, The Nature Conservancy. [on line]<http://www.naturalcapitalproject.org/hawaii_prim.html>. 15/08/07.