The Economist's Response to Ecological Issues 2

THE ENVIRONMENTAL-MACRO ECONOMICS OF OPTIMAL SCALE T

Just as the micro unit of the economy (firm or household) operates as part of a larger system (the aggregate or macroeconomy), so the aggregate economy is likewise a part of a larger system, the natural ecosystem. The macroeconomy is an open subsystem of the ecosystem and is totally dependent upon it, both as a source for inputs of low-entropy matter-energy and as a sink for outputs of high-entropy matter-energy. The physical exchanges crossing the boundary between the total ecological system and the economic subsystem constitute the subject matter of environmental macroeconomics. These flows are considered in terms of their scale or total volume relative to the ecosystem, not in terms of the price of one component of the total flow relative to another. Just as standard macroeconomics focuses on the volume of transactions rather than the relative prices of different items traded, so environmental macroeconomics focuses on the volume of exchanges that cross the boundary between system and subsystem, rather than the pricing and allocation of each part of the total flow within the human economy or even within the nonhuman part of the ecosystem.

The term "scale" is shorthand for "the physical scale or size of the human presence in the ecosystem, as measured by population times per capital resource use." Optimal allocation of a given scale of resource flow within the economy is one thing (a microeconomic problem). Optimal scale of the whole economy relative to the ecosystem is an entirely different problem (a macro-macro problem). The micro allocation problem is analogous to allocating optimally a given amount of weight in a boat. But once the best relative location of weight has been determined, there is still the question of the absolute amount of weight the boat should carry. This absolute optimal scale of load is recognized in the maritime institution of the Plimsoll line. When the watermark hits the Plimsoll line the boat is full, it has reached its safe carrying capacity. Of course, if the weight is badly allocated, the water line will touch the Plimsoll mark sooner. But eventually as the absolute load is increased, the watermark will reach the Plimsoll line even for a boat whose load is optimally allocated. Optimally loaded boats will sink under too much weight -- even though they may sink optimally! It should be clear that optimal allocation and optimal scale are quite distinct problems. The major task of environmental macroeconomics is to design an economic institution analogous to the Plimsoll mark -- to keep the weight, the absolute scale, of the economy from sinking our biospheric ark. [N.B. Any analogy has its limits, and the Plimsoll line is used here mainly to clarify the difference between optimal allocation and optimal scale. But the analogy might be pressed just a bit more regarding the obvious difficulty of determining just where to draw the analogous line for the economy. Drawing the line on a ship's bow seems comparatively easy, and indeed it is. But carping academic relativists can point out that there would be different Plimsoll lines for fresh and salt water; that the line is not just a physical measurement but involves some social judgment of acceptable risk; that the technical design of the ship will influence the position of the line, etc. Yet in spite of all these difficulties we do manage to draw a reasonable line somewhere to the immense benefit of generations of seafarers. Likewise for the economy, it is more important that a limit be placed somewhere than that the limit be accurate.]

The market, of course, functions only within the economic subsystem, where it does only one thing: it solves the allocation problem by providing the necessary information and incentive. It does that one thing very well. What it does not do is solve the problem of optimal scale and of optimal distribution. The market's inability to solve the problem of just distribution is widely recognized, but its similar inability to solve the problem of optimal or even sustainable scale is not as widely appreciated. [N.B. This can be illustrated in terms of the familiar microeconomic tool of the Edgeworth box. Moving to the contract curve is an improvement in efficiency of allocation. Moving along the contract curve is a change in distribution which may be deemed just or unjust on ethical grounds. The scale is represented by the dimensions of the box, which are taken as given. Consequently, the issue of optimal scale of the box itself escapes the limits of the analytical tool. A microeconomic tool cannot be expected to answer a macroeconomic question. But, so far, macroeconomics has not answered the question either -- indeed has not even asked it. The tacit answer to the implicit question seems to be that a bigger Edgeworth box is always better than a smaller one!]

An example of the confusion that can result from the nonrecognition of the independence of the scale issue from the question of allocation is provided by the following dilemma. [See, for example, David Pearce et al. 1989, p. 135.] Which puts more pressure on the environment, a high or a low discount rate? The usual answer is that a high discount rate is worse for the environment because it speeds the rate of depletion of nonrenewable resources and shortens the turnover and fallow periods in the exploitation of renewables. It shifts the allocation of capital and labor towards projects that exploit natural resources more intensively but it restricts the total number of projects undertaken. A low discount rate will permit more projects to be undertaken even while encouraging less intensive resource use for each project. The allocation effect of a high discount rate is to increase throughput, but the scale effect is to lower throughput. Which effect is stronger is hard to say, although one suspects that over the long run the scale effect will dominate. The resolution to the dilemma is to recognize that two independent policy goals require two independent policy instruments. We cannot serve both optimal scale and optimal allocation with the single policy instrument of the discount rate (Tinbergen 1952). The discount rate should be allowed to solve the allocation problem, within the confines of a solution to the scale problem provided by a presently nonexistent policy instrument that we may for now call an "economic Plimsoll line" that limits the scale of the throughput.

Economists have recognized the independence of the goals of efficient allocation and just distribution and are in general agreement that it is better to let prices serve efficiency, and to serve equity with income redistribution policies. Proper scale is a third independent policy goal and requires a third policy instrument. This latter point has not yet been accepted by economists, but its logic is parallel to the logic underlying the separation of allocation and distribution. In pricing factors of production and distributing profits the market does, of course, influence the distribution of income. Providing incentive requires some ability to alter the distribution of income in the interests of efficiency. The point is that the market's criterion of distributing income is to provide an incentive or efficient allocation, not to attain justice. And in any case, historical conditions of property ownership are major determinants of income distribution and have little to do with either efficiency or justice. These two values can conflict, and the market does not automatically resolve this conflict. The point to be added is that there are not just two, but three, values in conflict: allocation (efficiency), distribution (justice), and scale (sustainability).

Microeconomics has not discovered in the price system any built-in tendency to grow only up to the scale of aggregate resource use that is optimal (or even merely sustainable) in its demands on the biosphere. Optimal scale, like distributive justice, full employment or price level stability, is a macroeconomic goal. And it is a goal that is likely to conflict with the other macroeconomic goals. The traditional solution to unemployment is growth in production, which means a larger scale. Frequently the solution to inflation is also thought to be growth in real output, and a larger scale. And most of all, the issue of distributive justice is "finessed" by the claim that aggregate growth will do more for the poor than redistributive measures. Conventional macroeconomic goals tend to conflict, and certainly optimal scale will conflict with any goal that requires further growth once the optimum has been reached.

Return to top of section Return to beginning of Daly article

HOW BIG IS THE ECONOMY?

In the past, it has not been customary to consider the macroeconomy as a subsystem of a larger ecosystem. As long as the human economy was infinitesimal relative to the natural world, then sources and sinks could be considered infinite, and therefore not scarce. And if they are not scarce then they are safely abstracted from economics. There was no need to consider the larger system since it imposed no scarcities. This was a reasonable view at one time, but no longer. As Kenneth Boulding says, when something grows it gets bigger! The economy has gotten bigger, the ecosystem has not. How big has the economy become relative to the ecosystem?

Probably the best index of the scale of the human economy as part of the biosphere is the percentage of human appropriation of the total world product of photosynthesis. Net primary production (NPP) is the amount of solar energy captured in photosynthesis by primary producers, less the energy used in their own growth and reproduction. NPP is thus the basic food resource for everything on earth not capable of photosynthesis. Vitousek, et al. (1986) calculate that 25% of potential global (terrestrial and aquatic) NPP is now appropriated by human beings. [N.B. The definition of human appropriation underlying the figures quoted includes direct use by human beings (food, fuel, fiber, timber), plus the reduction from the potential due to ecosystem degradation caused by humans. t he latter reflects deforestation, desertification, paving over, and human conversion to less productive systems (such as agriculture).]

If only terrestrial NPP is considered, the fraction rises to 40%. Taking the 25% figure for the entire world, it is apparent that two more doublings of the human scale will give 100%. Since this would mean zero energy left for all nonhuman and nondomesticated species, and since humans cannot survive without the services of ecosystems (which are made up of other species), it is clear that two more doublings of the human scale is an ecological impossibility, although arithmetically possible. Furthermore, the terrestrial figure of 40% is probably more relevant since we are unlikely to increase our take from the oceans very much. Total appropriation of the terrestrial NPP can occur in only a bit over one doubling time. Perhaps it is theoretically possible to increase the earth's total photosynthetic capacity somewhat but the actual trend of past economic growth is decidedly in the opposite direction.

Assuming a constant level of per capita resource consumption, the doubling time of the human scale would be equal to the doubling time of population, which is on the order of 40 years. Of course economic growth currently aims to increase the average per capita resource consumption and consequently to reduce the doubling time of the scale of the human presence below that implicit in the demographic rate of growth. The greenhouse effect, ozone layer depletion, and acid rain all constitute evidence that we have already gone beyond a prudent Plimsoll line for the scale of the macroeconomy.

Daly Page 1 - 2 - 3 - 4 - 5

	Abstract		A glittering anomaly
	Introduction		Steps already taken in environmental macroeconomics
	The environmental-macro economics of optimal scale		Carrying capacity as a tool of environmental macroeconomics
	How big is the economy?		Policy Implications