From part-1 it is clear that, since human economy is a subsystem of the larger ecological system, the long term sustainability of an economy depends on whether the economic system takes into account two important factors: (a) How is the sourcing of resources from the earth system affecting the health of earth system ? (b) How is the waste output from the economy back into the earth system affecting its health ? Let us see how our current economic models fare in this regard.
By and large, we have market oriented economies across the world. In a market economy, the price of labor and goods, is determined by an ‘invisible hand’, depending on supply – demand push-pull forces (for the most part, excluding the cases where there is intervention from governments etc). The final price of any product is a very important signal in a market economy, as it drives the demand for that product vis-a-vis alternative options.
What does the price of any product, typically include ? It includes cost of labor, raw materials and capital. Add profits and taxes, and we get the final sales price. The idea is that the costs of the factors of production should be included in the price of the product. And this obviously includes the cost of the capital directly employed in producing the good or service. For example, the cost of machinery used to produce a car. That’s capital directly employed in producing the good. The price of the car includes (its share of) the cost of capital used to produce it.
The interesting thing is, the process of producing or using a product, may be affecting valuable earth system services. This is called an ‘externality’ in economics jargon. Example: Use of oil affects the climate service. The production of metals, first involves mining the ore from sensitive ecosystems which provide ecosystem services. The production of paper or timber, may first involve cutting forests which provide anti-flooding, carbon-sink and innumerable other services. All these natural services provided by nature may be considered as ‘natural capital’. So, the process of producing or using a product, may be depreciating ‘natural capital’. Obviously, the price of the product should include the capital depreciation cost it incurs, so that it presents a true picture of the costs of producing or using that product.
The crux of the matter is, we are not doing that. In other words, the prices of our products do not include costs of environmental externalities. Because price is the most important variable in a market economy, we have extremely distorted use of resources — An overuse of polluting resources such as oil because of cheap price, which also creates a disincentive for investing in and adopting cleaner technologies. Excess demand for products such as metals or timber or paper or plastics, without regard to environmental costs.
In Plan B 2.0, Lester Brown sums it up:
The central challenge, the key to building the new economy, is getting the market to tell the ecological truth. The dysfunctional global economy of today has been shaped by distorted market prices that do not incorporate environmental costs. Many of our environmental travails are the result of severe market distortions. (…)
Faulty corporate accounting systems that leave costs off the books have driven some of the world’s largest corporations into bankruptcy, costing millions of people their lifetime savings, retirement incomes, and jobs. Distorted world market prices that do not incorporate major costs in the production of various products and the provision of services could be even costlier. They could lead to global bankruptcy and economic decline.
Why do the market distortions occur ? Its because “The market” by itself, is blind to externalities. The market is like a super computer into which we feed costs of everything, and it turns out an optimal allocation. The costs of labor, raw materials, and man-made capital, are all automatically fed into this machine by humans who have a stake in getting their products & services valued. But nature unfortunately does not speak. The climate, the forests, the wetlands and the bees, do not demand a return on their services. When costs of critical services are not fed into the market-machine, the market does throw out faulty resource allocations. Garbage-in Garbage-out. In short, the market system hasn’t failed. We failed the free-market idea by unleashing it without plugging in the right numbers.
Thus the only way to remove market distortions is to pro actively feed environmental costs into the market-machine. This may be in the form of taxation on use of some resources. For example, carbon tax on the use of fossil energy. Or it may be outright ban of disruptive economic activity in sensitive ecosystems (thus associating an infinite value to that particular ecosystem).
Tools such as eco-taxation are just that. Tools. At the core, the decision to apply these tools is a political decision our societies have to make. The “market” or some “invisible hand” cannot apply these tools or incorporate environmental costs automatically.
(To be continued. This is part-2 of a series)
