[R-G] [BillTottenWeblog] Brother, Can You Spare Me a Planet?

[Bill Totten]

Mainstream Economics and the Environmental Crisis

by Robert Nadeau

Scientific American Magazine (March 19 2008)

The causes of the environmental crisis may be hugely complex, but the
most effective way to deal with it in economic terms seems rather
obvious. We must use our best scientific understanding of how
environmental problems can be resolved as the basis for implementing
scientifically viable economic policies and solutions. If this could be
accomplished within the framework of the economic theory that we now use
to coordinate economic activities in the global market system -
neoclassical economics - there would be no cause for concern. But as
this discussion will demonstrate, there is a large problem here that
should be cause for great concern: Neoclassical economic theory is
predicated on unscientific assumptions that massively frustrate or
effectively undermine efforts to implement scientifically viable
economic policies and solutions.

These assumptions were first articulated by 18th-century moral
philosophers (Adam Smith, Thomas Malthus and David Ricardo) who embraced
a new understanding of God known as deism that resulted from attempts to
understand the metaphysical implications of Newtonian physics. Because
this physics assumes that the laws of gravity completely determine the
future state of physical systems, the deists concluded that the universe
does not require, or even permit, active intervention by God after the
first moment of creation. They then imaged God as a clock maker and the
universe as a clockwork regulated and maintained after its creation by
physical laws. {1}

Smith, Malthus and Ricardo believed that the clock maker created a
second set of laws to govern the workings of the clockwork - the natural
laws of economics. Smith imaged the collective action of the forces
associated with these laws as an "invisible hand", and this construct
became the central legitimating principle in mainstream economic theory.
Smith claimed that the invisible hand is analogous to the invisible
force that causes a pendulum to oscillate around its center and move
toward equilibrium or a liquid to flow between connecting chambers and
find its own level. Given that Smith's invisible hand has no physical
content and is an emblem for something postulated but completely
unproved and unknown, why did he believe that it actually exists? The
answer is that Smith was a deist and his belief in the existence of the
invisible hand was an article of faith.

The Origins of Neoclassical Economic Theory

In economics textbooks, the 19th-century creators of the economic theory
now used by mainstream economists (Stanley Jevons, Leon Walras, Maria
Edgeworth and Vilfredo Pareto) are credited with transforming the study
of economics into a rigorously mathematical scientific discipline. There
are, however, no mentions in these textbooks, or in all but a few books
on the history of economic thought, of a rather salient fact: The
progenitors of neoclassical economics, all of whom were trained as
engineers, developed their theories by substituting economic variables
derived from classical economics for physical variables in the equations
of a soon-to-be outmoded mid-19th century theory in physics. {2}

The physics that the economists used as the template for their theories
was developed from the 1840s to the 1860s. During this period,
physicists responded to the inability of Newtonian mechanics to account
for the phenomena of heat, light and electricity with a profusion of
hypotheses about matter and forces. In 1847 Hermann-Ludwig Ferdinand von
Helmholtz, one of the best known and most widely respected physicists at
this time, posited the existence of a field of energy that could unify
these phenomena. This proposal served as a catalyst for a movement
called "energetics" in which physicists attempted to explain very
diverse physical phenomena in terms of a vaguely defined protean field
of energy that fills all space.

The strategy used by the creators of neoclassical economics was as
simple as it was absurd - the economists copied the physics equations
and changed the names of the variables. In the resulting mathematical
formalism, utility becomes synonymous with the amorphous field of energy
described in the equations taken from the physics, and the sum of
utility and expenditure, like the sum of potential and kinetic energy in
the physical equations, is conserved. Forces associated with the field
of utility (or, in physics, energy) allegedly determine prices, and
spatial coordinates correspond with quantities of goods. Because the
physical system described in the equations of the theory in physics is
closed, the economists were obliged to assume that the market system
described in their theory is also closed. And because the sum of energy
in the equations that describe the physical system is conserved, the
economists were also obliged to assume that the sum of utility in a
market system is also conserved.

In the mathematical formalism that resulted from these substitutions,
economic actors allegedly operate within a field of force identified, in
both figurative and literal terms, with energy. The natural laws of
economics are assumed to operate within this field and to legislate over
the decisions made by the economic actors. Because utility-energy in
this mathematical formalism is conserved, the creators of neoclassical
economic theory concluded that production and consumption are physically
neutral processes that do not alter the sum of utility. And this
conclusion became the basis for the claim that capital circulates in a
closed loop from production and consumption and that the value of any
good, commodity or service can only be determined by decisions made by
economic actors. The creators of neoclassical economic theory also
failed to realize or chose to ignore the fact that market systems are
not closed and the conservation principle is quite meaningless in any
real economic process. Nevertheless, these assumptions are now used to
legitimate the existence of the invisible hand in its current form in
the neoclassical economic paradigm - constrained maximization in general
equilibrium theory.

Several well-known mid-19th century scientists told the economists that
there was no basis for substituting economic variables for physical
variables in the equations of the theory in physics. But the economists
did not appreciate how devastating this criticism was and proceeded to
claim that they had transformed the study of economics into a scientific
discipline comparable to physics. In what is surely one of the strangest
chapters in the history of Western thought, the origins of neoclassical
economics were forgotten, the claim that neoclassical economic theory is
scientific was almost universally accepted, and subsequent generations
of economists disguised the existence of the unscientific axiomatic
assumptions in this theory under an increasingly complex maze of
mathematical formalism.

This misalliance between economic thought and a 19th-century physical
theory explains why the neoclassical economic paradigm is predicated on
the following unscientific assumptions:

* Market systems exist in a domain of reality separate and distinct from
other domains.

* Capital circulates in these systems in a closed circular flow between
production and consumption with no inlets or outlets.

* The lawful dynamics of closed-market systems legislate over the
behavior of economic actors, and the actors obey fixed decision-making
rules.

* The dynamics that operate within closed market systems, if they are
not interfered with by the external or exogenous agencies such as
government, will necessarily result in the growth and expansion of these
systems.

* Market forces will resolve environmental problems via price
mechanisms, along with more efficient technologies and production processes.

* The resources of nature are largely inexhaustible, and those that are
not can be replaced by other resources or by technologies that minimize
the use of the exhaustible resources or rely on other resources.

* The environmental costs of economic activities can only be determined
by pricing mechanisms that operate within closed market systems.

* There are no biological or physical limits to the growth and expansion
of market systems.

One does not have to a scientist to realize that these assumptions make
no sense at all in scientific terms. In these terms, markets are open
systems that exist in embedded and interactive relationship with
environmental systems. Natural resources are clearly exhaustible, and
our over-reliance on some of these resources, particularly fossil fuels,
could soon result in irreversible large-scale changes in the global
climate system. The natural environment is not separate from economic
processes, and wastes and pollutants from these processes are already at
levels that threaten the stability and sustainability of virtually all
environmental subsystems.  Last but not least, the limits to the growth
of the global economy in biophysical terms are real and inescapable, and
the assumption that market systems can perpetually expand and consume
more scarce and nonrenewable natural resources is utterly false. {3}

A Green Thumb on the Invisible Hand

When mainstream economists are confronted with the charge that there is
no basis in neoclassical economic theory for realistically assessing the
environmental costs of economic activities and internalizing these costs
in pricing systems, they typically deny that this is the case by
appealing to the work done by environmental economists. This orthodox
approach to resolving environmental problems is taught in universities
and practiced in government agencies and development banks, and the
solutions are almost invariably embedded in the mathematical formalism
of general equilibrium theory.

When environmental economists calculate the environmental costs of
economic activities, they assume that the relative price of each bundle
of an environmental good, service, or amenity reveals the "real marginal
values" of the consumer. The creators of neoclassical economics
conceived of the construct of marginal values after substituting utility
for energy in the equations borrowed from the theory in physics. In the
resulting formalism, a marginal value essentially represents how much
more a consumer is willing to pay to acquire incrementally larger
amounts of a good, service or commodity. Note what the writers of a
textbook on environmental economics have to say about the dynamics of
this process:

"The power of a perfectly functioning market rests in its decentralized
process of decision making and exchange; no omnipotent planner is needed
to allocate resources. Rather, prices ration resources to those that
value them the most and, in doing so, individuals are swept along by
Adam Smith's invisible hand to achieve what is best for society as a
collective. Optimal private decisions based on mutually advantageous
exchange lead to optimal social outcomes." {4}

In environmental economics, the presumption that optimal private
decisions "based on mutually advantageous exchange" lead to optimal
social outcomes for the state of the environment is a primary article of
faith. The environmental economists also assume that the mechanisms of
the market system will resolve environmental problems when "prices are
right". The right price in neoclassical economic theory is a function of
the prices that economic actors have paid, or are willing to pay, to
realize some marginal benefits of environmental goods and services.

Environmental economists often use cost-benefit analyses to place a
value on environmental externalities, or environmental goods and
services that are "external" to market systems in the sense that they
are presumed to exist outside of the closed market system. The problem
that these accounting procedures are intended to resolve is that "real
marginal values" can only be determined by dynamics that operate within
closed market systems. Given that the vast majority of the damage done
to the natural environment by economic activities cannot be valued in
these terms, environmental economists have developed indirect methods
designed to estimate the "use-value" of these resources. {5}

For example, contingent valuation methods are used to assess the
economic value of recreation, scenic beauty, air quality, water quality,
species preservation, bequests to future generations and other nonmarket
environmental resources. The methods are intended to assess the
willingness-to-pay function of economic actors who would prefer to
preserve natural environments (preservation or existence values),
maintain the option of using natural resources (option values), and
bequeath natural resources to future generations (bequest values). {6}
Most contingent valuation surveys seek to determine the maximal amount
that individuals are willing to pay for an increase in the quality of an
environmental resource and the minimal amount they are willing to accept
as compensation to forgo this increase.

For the sake of argument, let us assume that contingent valuation
studies are capable of revealing maximal social outcomes of
environmental policy decisions. Are we then to believe, as one such
study showed, that reduction in chemical contaminants in drinking water
was not important in economic terms because the value of a statistical
life associated with a reduction in risk of death in thirty years was
only $181,000? {7}  Is $26 a measure of the real marginal costs of
pollution because this is the average price that a household is willing
to pay annually for a ten percent improvement of visibility in eastern
US cities? {8}  Is the value of a whooping crane the $22-per-year
average that one set of households was willing to pay to preserve this
species {9} and that of the bald eagle the $11-per-year average that
another set of households would spend to preserve this apparently less
valuable species? {10}

Mainstream Economics and International Treaties

One reason why the international community has not been successful in
forging agreements that could resolve the environmental crisis is that
countries involved in the process of negotiating these agreements
routinely invoke the legal principle of state sovereignty to protect
their economic interests. There is, however, another major reason why
these agreements have not been effective. The economic interests that
the representatives of nation-states are seeking to protect are based on
unscientific assumptions about the dynamics of market systems in
neoclassical economic theory. Another related problem is that these
assumptions are embedded in the mathematical theories that serve as the
basis for making cost-benefit analyses and the results of these analyses
almost invariably indicate that the costs of implementing scientifically
viable economic policies and solutions are greater than the benefits.
The unfortunate result is that the scientifically viable economic
policies and solutions are typically nothing more than distant memories
when the terms of a final agreement are approved.

This explains why the United Nations Framework Convention on Climate
Change (1992) failed to protect the climate system, why the Convention
on Biological Diversity (1992) did not even begun to reduce losses in
biodiversity, and why the UN Convention to Combat Desertification (1994)
did not slow, much less reverse, this process. The UN Convention on the
Law of the Sea (1982) and a host of other international agreements
intended to reduce ocean pollution, prevent overfishing and protect
endangered species failed to meet any of these objectives. Nonbinding
principles that would promote more sustainable management of forests
were agreed to at the UN's Earth Summit (1992) but negotiations broke
down prior to the point where a general framework convention could be
articulated. A UN Convention on the Non-Navigable Uses of International
Watercourses has been negotiated, but it has not gone into effect
because some sovereign nation-states perceived this agreement as a
threat to their economic interests. {11}

Scientific evidence may play a supportive and enabling role in some
negotiations, but only as a minimum condition for serious consideration
of an environmental issue. But what is not widely known is that these
agreements made a mockery of the scientifically based solutions. In the
vast majority of negotiations on a great range of issues, such as
commercial whaling, hazardous waste trade, loss of biodiversity,
conditions in the Antarctic, and ocean dumping of radioactive waste, the
scientific evidence was not given serious consideration. When this
evidence was perceived as a direct threat to the perceived economic
interests of particular nation-states, it was either systematically
ignored or explicitly rejected by the representatives of these states. {12}

Recent Developments in Mainstream Economic Theory

A fair number of economists over the past two decades, including such
luminaries as Kenneth J Arrow, have expressed doubts about the efficacy
of neoclassical economic theory. However, the most direct challenges to
axiomatic assumptions in this theory have been made by the game
theorists. For example, these theorists have challenged the assumption
that economic actors are supremely rational, obey fixed decision-making
rules and are incapable of making bad decisions. In conventional
neoclassical economic theory, the natural laws of economics allegedly
determine the optimal outcome of an economic process and economic actors
are devoid of all distinctly human characteristics. This theory also
assumes that the realm of the economy is stable and unchanging and that
economic actors are supremely rational entities who do not talk back. In
opening the box of human subjectivity, the game theorists have been
obliged to posit an increasing number of ad hoc variables to account for
the decision-making of individual economic actors. And this explains why
the history of game theory is marked by a continual regression into the
staggering complexities of language and culture. As the economist R
Sugden puts it:

"There was a time, not long ago, when the foundations of rational-choice
theory appeared firm, and when the job of the economic theorist seemed
to be one of drawing out the often complex implications of a fairly
simple and uncontroversial system of axioms. But it is increasingly
becoming clear that these foundations are less secure than we thought,
and that they need to be examined and perhaps rebuilt. Economic
theorists may have to become as much philosophers as mathematicians." {13}

These criticisms and revisions of assumptions in neoclassical economic
theory do not mean, however, that mainstream economists are in the
process of developing a new theory predicated on a different set of
assumptions. Virtually all of the advanced theoretical work in this
discipline is premised on the assumptions that market systems are
closed, self-correcting and self-sustaining. And the primary impulse in
these theories is to disclose the hidden dynamics that move market
systems toward optimal states of equilibria with the use of increasingly
more sophisticated mathematical techniques.

The Two-Culture Problem

In my view the greatest obstacle to implementing scientifically viable
economic solutions for global warming and other menacing environmental
problems is not the claim that neoclassical economic theory is
scientific. It is the two-culture problem famously described by British
physicist and novelist C P Snow in 1959. Snow was concerned that the
single intellectual culture that existed prior to World War Two was
splitting into two cultures with social scientists on one side of the
divide and scientists on the other. As it turned out, the two-culture
problem was not resolved; each culture's members became increasingly
isolated from the other's, and the divide eventually became a yawning chasm.

The schism between the two cultures of mainstream economists and
environmental scientists is painfully apparent in the institutional
frameworks and processes we now use to develop and implement economic
solutions for environmental problems. The members of these cultures
perform very different tasks and have virtually no contact with each
other. This problem is further complicated by the fact that the language
used on one side of the divide is virtually incomprehensible to those on
the other, and the cultural differences are large. These differences
range from alternate worldviews to disparate research methodologies and
rules for gathering evidence.

The most expedient way to deal with this two-culture problem is also the
most efficient way to begin the process of developing an environmentally
responsible economic theory. The solution is to create institutional
frameworks and processes for developing scientifically viable economic
policies and solutions for environmental problems that require
mainstream economists and environmental scientists to work closely
together during every stage of the process. This idea is not as radical
as it may first appear and there has already been some movement in this
direction.

After Nicolas Stern, an internationally known development economist and
former chief economist at the World Bank, was asked by the British
government to prepare a report on the economics of climate change, he
did something that no other mainstream economist with a similar
reputation had ever done. He crossed over the divide and took an
extended course on the science of global warming from environmental
scientists at the Hadley Center in London. The 700-page report that
resulted from this collaboration contained the first realistic
assessment of the costs of reducing global emissions of greenhouse gases
to levels where the most disastrous consequences of global warming are
unlikely to occur.

But in order to make this assessment, Stern and the other economists who
worked on the report were obliged to use methodologies that violate
foundational assumptions in neoclassical economic theory. In a lecture
that Stern gave to a group of economists a few months before the "Stern
Review on the Economics of Climate Change" was released on October 30
2006, {14} he explained why it was necessary to violate these
assumptions. Stern began this lecture with a brief overview of the
science of global warming with particular emphasis on the fact that the
interactions between human and environmental systems are nonlinear and
cannot be represented or described in the linear equations used by
mainstream economists.

Stern then explained why global warming is not "a standard externality"
problem and must be viewed as "international collective action problem".
He also explained why the methodologies used by mainstream economists to
evaluate the costs of economic activities are incapable of realistically
assessing these costs. During the course of this lecture, Stern
repeatedly told his fellow economists that any viable economic solutions
for the problem of global warming must be predicated on our best
scientific understanding of how this problem can be resolved. Equally
remarkable, he also said that the resolution of this problem will
require the very active involvement of governments and that the ethical
dimensions of this problems extend well beyond the framework of any
economic theory. {15}

If we do manage to create the institutional frameworks and processes
required to develop an environmentally responsible economic theory, many
mainstream economists and environmental scientists may be reluctant to
cross over the two-culture divide and work on this project. But this
resistance could be overcome if they realized that this is a
once-in-all-human-lifetimes opportunity. The opportunity is to protect
the lives of the 6.6 billion members of the extended human family and
the future existence of their descendents by resolving the crisis in the
global environment. If the opportunity to work on this project is
understood in these terms, perhaps mainstream economists and
environmental scientists will realize that there is no other work they
could possibly do in their lifetimes that serves a greater good or
answers to a higher calling.

Notes

(1) Bruno Ingrao and Georgio Israel, The Invisible Hand: Economic
Equilibrium in the History of Science, tranlated by Ian MacGilvray (MIT
Press, 1990).

(2) Philip Mirowski, Against Mechanism: Protecting Economics From
Science (Rowan and Littlefield, 1988); Mirowski, More Heat Than Light
(Cambridge University Press, 2003); Robert L Nadeau, The Wealth of
Nature: How Mainstream Economics Has Failed the Environment (Columbia
University Press, 2002); Nadeau, The Environmental Endgame: Mainstream
Economics, Ecological Disaster, and Human Survival (Rutgers University
Press, 2006).

(3) Robert Nadeau, The Environmental Endgame; pages 81-145.

(4) Nick Hanley, Jason E Schrogren, and Ben White, Environmental
Economics in Theory and Practice (Oxford University Press, 1997); page 358.

(5) W Michael Hanneman, "Valuing the Environment through Contingent
Value", Journal of Economic Perspectives 8 (Fall 1994); page 19.

(6) Mark Sagoff, "Some Problems with Environmental Economics",
Environmental Ethics 10 (Spring 1988); page 55.

(7) Robert C Mitchell and Richard T Carson, "Valuing Drinking Water Risk
Reduction Using Contingent Evaluation Methods", paper prepared for
Resources for the Future (US Government Printing Office, 1986).

(8 ) George Tolley et al, "Establishing and Valuing the Effects of
Improved Visibility in the Eastern United States", paper presented for
Environmental Protection Agency (Washington, DC, 1986).

(9) James Bowker and John R Stoll, "Use of Dichotomous Choice Nonmarket
Methods to Value the Whooping Crane Resource", American Journal of
Agricultural Economy 23, No 5 (1987); pages 943-950.

(10) Kevin J Boyle and Richard C Bishop, "Valuing Wildlife in
Benefit-Cost Analyses: A Case Study for Endangered Species", Water
Resources Research 23, No 5 (1987); pages 943-950.

(11) James Gustave Speth, Red Sky at Morning: America and the Crisis in
the Global Environment (Yale University Press, 2004); pages 77-98.

(12) Gareth Porter, Janet Welsh Brown, and Pamela S Chasek, Global
Environmental Politics, 3rd edition (Westview Press, 2000).

(13) R Sugden, "Rational Choice: A Survey of Contributions from
Economics and Philosophy", Economic Journal 101 (1991); page 783.

(14) "Stern Review on the Economics of Climate Change",
www.sternreview.org.uk

(15)
www.wbcsd.org/plugins/DocSearch/details.asp?MenuId=MTY5&ClickMenu=LeftMenu&doOpen=1&type=DocDet&ObjectId=MTgyNDE
_____

Robert Nadeau is a professor at George Mason University. His most
recently published books are The Wealth of Nature (Columbia University
Press, 2003) and The Environmental Endgame (Rutgers University Press, 2006).

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