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Environmental Sustainability and Economic Growth

I am now using Friday’s blog space to provide draft versions of the Modern Monetary Theory textbook that I am writing with my colleague and friend Randy Wray. We expect to publish the text sometime early in 2014. Comments are always welcome. Remember this is a textbook aimed at undergraduate students and so the writing will be different from my usual blog free-for-all. Note also that the text I post is just the work I am doing by way of the first draft so the material posted will not represent the complete text. Further it will change once the two of us have edited it.

Today, I am continuing to add the sections in Chapter 25. So far we have done 25.1 and 25.2. I am jumping to 25.5 today.

Chapter 25 Recent Policy Debates

In this Chapter we consider the following policy debates:

  • 25.1: Ageing, Social Security, and the Intergenerational Debate
  • 25.2: Twin Deficits and Sustainability Of Budget Deficits
  • 25.3: Fixed Versus Flexible Exchange Rates: Optimal Currency Areas, the Bancor, or Floating Rates?
  • 25.4: Economic Growth: Demand or Supply Constrained?
  • 25.5: Environmental Sustainability and Economic Growth

25.5 Environmental Sustainability and Economic Growth

We started our course in macroeconomics by noting that the main macroeconomic policy goals are full employment and price stability.

A central idea in economics whether it be microeconomics or macroeconomics is efficiency – getting the best out of what you have available. At the macroeconomic level, the “efficiency frontier” is normally summarised in terms of full employment – where all available labour resources are being productively deployed.

We have learned that the concept of full employment is hotly contested among different schools of thought in macroeconomics but this does not negate the fact that the attainment of full employment – using our macroeconomic resources to the limit – remains a central focus of macroeconomic theory and policy. The debate is about what that limit actually is.

However, this debate is framed by economists in terms of the extent to which there are structural impediments which might mean our conception of full employment is associated with higher rates of unemployment than otherwise. We considered those issues in Chapter 14.

We learned that capitalist monetary economies are prone to deliver mass involuntary unemployment as a result of a lack of effective demand.

The solution to involuntary unemployment involves increasing the level of effective demand so that it is consistent with the level that is required to employ all those willing and able to work is filled with public net spending.

This can be achieved by increased government spending to ensure that the shortfall in non-government spending relative to the full employment level of demand is filled.

In addition, the government can also stimulate non-government spending in a number of ways including tax cuts, interest rate cuts, and investment and export incentive schemes.

This suggests that sustaining the economically and socially desirable goal of full employment requires continuous growth in aggregate demand and real GDP as populations expand.

In Chapter 3, we learned that the conventional market-based measures of national income as indicators of well-being are flawed in a number of ways. First, many activities that nurture well-being (for example, homeduties, caring for our children) are not counted as economic activity, unless a payment for service is made.

Further, any production that is sold in the market place will add to the conventional measures of GDP. So a society is considered to be “growing” and doing better if it produces increasing quantities of military weapons, which then wreak havoc during times of conflict.

Similarly, a major environmental disaster, such as the 2010 Deepwater Horizon oil spill in the Gulf of Mexico, boosts economic growth as a result of the clean-up operation, even though the event devastates the local marine environment.

We also learned that national income measures of well-being largely ignore distributional issues. How might we feel about two economies which are recording the same growth rates, but where in one, the vast majority of the income growth is secured by a small minority and the rest of the population live in poverty, whereas in the other, the population broadly shares in the increased real income?

Conventional real GDP measures also ignore the costs of increasing depletion rates of non-renewable natural resources. The mining or forestry activity, for example, boosts economic growth but the environmental damage that is left behind is not considered because the firms involved do not count the damage as a cost of production.

Industrial production growth will be “good” for real GDP growth but the associated pollution of the land, water and air that results from the activity might be damaging for our health and, ultimately, undermine the capacity of the economy to produce as the natural systems die. There is growing evidence that unsustainable farming practices are reducing the amount of available productive land and destroying waterways but still count $-for-$ in our measures of economic growth.

It is clear that the capitalist system not only is prone to creating mass unemployment but it also grows on the back of environmental degradation which is destroying our natural capital. This would appear to require a shift in our “growth-at-all-costs” approach to economic policy making.

Mat Forstater (2001: 386) wrote that:

Environmental degradation in the form of unsustainable rates of natural resource depletion and excessive pollution of land, air, and water is characteristic of modern capitalist economies. Humanity now faces significant challenges in the form of both local ecological crises and global environmental problems, such as ozone depletion, global climate change, biodiversity loss, soil erosion, and deforestation …

The question that arises is whether the desire to maintain full employment and the requisite growth that is associated with that policy goal is consistent with environmental sustainability, given the increasing evidence that anthropogenic global warming and resource depletion is endangering the health of the natural environment upon which our economic and social settlements depend.

While full employment appears to be a necessary social and economic goal, can we reconcile it with the obvious need to ensure our natural environment is also sustained?

Thus, even if it were possible to expand aggregate demand enough to promote growth sufficient to keep pace with labour force growth and productivity growth and mop up the huge stocks of long-term unemployment, how could the natural ecosystems, already under great strain, cope?

While the full treatment of what constitutes environmental sustainability is beyond the scope of this textbook some useful observations can be made. For further discussion of what constitutes environmental sustainability see Lawn (2001) and Forstater (2001).

What we will learn is that growth is not necessarily good or bad per se. We can certainly improve our measures of growth to reflect the shortcomings noted above.

At a minimum this requires us to include all the costs of production in our measures of economic activity. Our revised net measures of economic growth will then ensure that we understand whether the changing scale of economic activity is advancing our overall well-being or not. It is entirely possible that the conventional measure of real GDP might show a slowdown in growth (which we would currently interpret as a problem) while new improved measures of real GDP (net of costs) would show an improvement in sustainable growth.

But we can also engender growth that will be sufficient to ensure that all those who want work can find a job at decent pay and conditions and still satisfy the requirements of environmental sustainability.

Clearly, this suggests that it will be necessary to change the composition of final output toward environmentally sustainable activities. It is not increased aggregate demand per se that will be necessary to sustain full employment, but increased aggregate demand in certain areas of activity.

Policy makers intent on eliminating the waste of human potential need to ally that aim with the broader aim of preserving our natural capital and minimising the waste that arises from resource extraction.

That is, our notion of a “macroeconomic efficiency frontier” thus has an extra constraint on it – the need to protect our natural capital.

Phillip Lawn (2001: PAGE NO) defines this in terms of an “optimal macroeconomic scale” which is:

… where the physical scale of a nation’s macroeconomy and the qualitative nature of the goods with which it is comprised maximises the sustainable economic welfare enjoyed by its citizens. The notion of optimal macroeconomic scale is a crucial one because it enables one to understand how the nation can achieve SD without the perceived need for continued growth.

Several elements are present in the concept of an “optimal macroeconomic scale”. First, what are the benefits of creating and maintaining wealth derived from economic activity. Second, what does this cost in terms of depleting the available environmental services.

Natural capital is identified by Lawn (2001: PAGE NO) as “the original source of all economic activity” because it “is the sole source of low entropy matter-energy and the ultimate repository of all high entropy wastes”. Economic activity generates real income (which is the satisfaction derived from consuming goods and services produced) but also imposes social costs on those who produce these goods and services.

Lawn (2001: PAGE NO) notes we have to endure personal costs such as the disutility of work and the stress of commuting as part of the process of generating these economic benefits and the calculation of what he calls “net psychic income” reflects the human costs and benefits of economic activity.

While calculating the human costs of economic activity, we also have to take into account the costs of depleting the available environmental services. Extracting these services (the low entropy matter-energy) creates waste (high entropy matter-energy) which has no further use. This waste depletes our natural capital and is the ultimate resource cost of economic activity.

Trying to define the costs of natural resource depletion is fraught because the biosystem is a living entity and economists are unable to define the use point beyond which it dies.

Sustainable net benefits are the difference between the net psychic income and the environmental costs of economic activity. The maximum macroeconomic scale for a nation occurs when the sustainable net benefits are zero. Beyond this physical scale of production, the environmental costs exceed the net psychic income derived from economic activity.

However, this point is likely to be well beyond the point where the economy maximises its sustainable net benefits for any given technology. The maximum sustainable net benefits is the optimal macroeconomic scale because the difference between the net psychic benefits and the environmental costs are at their greatest.

The macroeconomic efficiency frontier thus is defined by the juxtaposition between the net human benefits and the environmental costs required to create those net human benefits.

The full employment goal then needs to be expressed not just in terms of the total number of jobs required but also the type of jobs and the activities these jobs will be engaged in.

Growth is necessary for employment as the population grows but it cannot be unfettered and left to the market. It has to be a carefully guided growth with new tools not normally used by economists to help governments decide on what their contribution should be and how they should regulate the contribution of the non-government sector.

Consideration of that will lead to a rather dramatic reshaping of our conception of productive work, which is current narrowly defined in terms of “gainful” paid endeavour in pursuit of (private) profit.

Conclusion

WE WILL CONTINUE NEXT WEEK! THE COMPLETE FIRST DRAFT IS NEARING COMPLETION AND I WILL START POSTING REVISED DRAFTS SEQUENTIALLY IN THE COMING WEEKS.

References

Forstater, M. (2003) ‘Public employment and environmental sustainability’, Journal of Post Keynesian Economics, Spring, 25(3), 385-406 – PDF download.

Lawn, P.A. (2001) Toward Sustainable Development: an ecological economics approach, CRC Press, Boca Raton, Florida.

Tcherneva, P.R. (2009) ‘Evaluating the economic environment viability of Basic Income and Job Guarantees’, in Lawn, P.A. (ed.) Environment and Employment: A Reconciliation, Routledge, London, 184-205.

Thought for the Week

Lars Ulrich, on band longevity (Source):

Somewhere along the line we learnt to get along, and somewhere along the line, we learnt that we would rather be in Metallica than not be in Metallica.

Saturday Quiz

The Saturday Quiz will be back again tomorrow. It will be of an appropriate order of difficulty (-:

That is enough for today!

(c) Copyright 2013 Bill Mitchell. All Rights Reserved.

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    This Post Has 8 Comments
    1. Good stuff Bill

      Just a note to the ‘anti-growth’ camp – or the ‘economic growth is unsustainable’ – It all depends what type of economic growth we are talking about. It does not have to mean consuming more stuff and more physical resources, or increasing burden on the natural environment.

      So, yes if we mean endless growth in airline travel with concomitant increases in pollution and use of finite fuel resources. But no, if for instance we mean ever more sophisticated and value-added skilled craft production of musical instruments sourced from sustainable timber. Same for culture and arts production – if Bill’s points above are addressed. My sense is that the ‘design’ proportion of goods is increasing (as a percentage of the value of the raw materials involved) – and some of that design value is explicitly about using less resources. Such production represent a sustainable growth path in GDP terms and in human capital for the economy. So it depends on the type of growth we want and indeed the type of society we want.

    2. Sounds like a very well-balanced and sensible view. Just to pick up on:

      ‘At a minimum this requires us to include all the costs of production in our measures of economic activity. Our revised net measures of economic growth will then ensure that we understand whether the changing scale of economic activity is advancing our overall well-being or not.’

      Maybe not an argument you have much time for in your book, but there are some philosophical issues with this kind of environmental accounting. See:

      http://www.monbiot.com/2011/06/06/an-answer-to-the-meaning-of-life/

    3. Bill
      you write “Growth is necessary for employment as the population grows”.
      My question is: is growth necessary for employment if the population is stable?

    4. Jan,
      I would add to that comment: is growth necessary for employment if the retirement age is lowered or the work week shortened (with the same pay)?

    5. There are many aspects to a stable economic system and Bill has touched on just a few in this article. The concept is a study in itself.

      One important aspect in the Australian context is population growth being driven by a very large immigration intake.Population is at the base of all our environmental and many of our social problems.
      Stop increasing population then allow it to reduce gradually to a sustainable level.

      There has been some reduction in that idiot idea of Costello,the Baby Bonus.More effectively,Australia needs an immediate moratorium on immigration.

    6. QUOTE – Natural capital is identified by Lawn (2001: PAGE NO) as “the original source of all economic activity” because it “is the sole source of low entropy matter-energy and the ultimate repository of all high entropy wastes”. – UNQUOTE.

      It is excellent to see these words in an economic text. This grounds economics in physical and thermodynamic reality.

      QUOTE – Sustainable net benefits are the difference between the net psychic income and the environmental costs of economic activity. The maximum macroeconomic scale for a nation occurs when the sustainable net benefits are zero. Beyond this physical scale of production, the environmental costs exceed the net psychic income derived from economic activity.

      However, this point is likely to be well beyond the point where the economy maximises its sustainable net benefits for any given technology. The maximum sustainable net benefits is the optimal macroeconomic scale because the difference between the net psychic benefits and the environmental costs are at their greatest.

      The macroeconomic efficiency frontier thus is defined by the juxtaposition between the net human benefits and the environmental costs required to create those net human benefits. – UNQUOTE.

      I am struggling to understand more than the general drift of this passage. Maybe this reflects my poor comprehension skills, maybe it reflects the fact that lecturers and tutors will have to spend some time on clarifying this area or maybe it means it needs to be re-written to be a bit clearer. Maybe it means all three, as the concepts are not easy to assimilate. One (unavoidable) problem is that two different systems of values are being compared; human values and natural values. Human values are always socially determined (by interaction, negotiation, force and so on) be they moral or money values.

      The issue of natural values immediately raises a possible duality. Natural values may be considered as intrinsic and existing independently without humans as agents to assign value or natural values may be considered as existent by being assigned by humans. Both conditions may indeed be considered to exist together. Nature may be considered to have both an intrinsic value set and a value set assigned by man. I favour this latter view. The question is which value set or sets do we appeal to for (a) moral force in our argument and (b) some form of economic quantification and comparison. The answer may be the intrinsic value set for (a) and the human value set for (b) but philosphically the value set (a) is difficult but necessary to argue for IMO.

    7. A few words about ‘growth in real GDP’, ‘economic growth’, ‘value growth’, and ‘producing more goods with fewer natural resource inputs’.

      GDP = price x Q. Real GDP involves holding the price level constant. Hence real GDP is effectively a monetary measure of the physical quantity of goods and services produced over time.

      Growth in real GDP should not automatically be labelled ‘economic growth’. Economic growth is where, as a consequence of increasing the quantity of goods and services produced, the additional benefits exceed the additional costs. If additional costs exceed aditional benefits, then the increase in real goods and services produced amounts to ‘uneconomic growth’. Measures of real GDP cannot distinguish ‘economic’ from ‘uneconomic’ growth, in the same way that an increase in a firm’s output does not indicate whether the firm’s profit is rising or falling. A new indicator called a Genuine Progress Indicator (GPI) aims to separate the benefits and costs of economic activity. GPI studies of high-GDP countries indicate that growth is lowering economic welfare because the additional production benefits are now being exceeded by the additional social and environmental costs – the former subject to the principle of diminishing marginal benefits; the latter two subject to the principle of increasing marginal costs (in particular, the second category of costs).

      A national economy should grow up to the point where the marginal benefits of growth equal the marginal costs of growth (the optimal macroeconomic scale). Economic welfare can still be increased at the optimal scale but only by producing better not more goods, improving the distribution of income and wealth, reducing social costs (e.g., unemployment), and reducing the resource/pollution intensity of production/consumption. This would amount to ‘value growth’ but this is not the same as real GDP growth.

      Because of the first and second laws of thermodynamics, the technical efficiency of production must be less than one. That is, if E denotes ‘technical eficiency’; Q denotes the matter-energy embodied in all physical goods produced; R denotes the matter-energy embodied in the natural resources used to produce these goods; and E = Q/R, then E < 1. This means that a given quantity of real output requires a minimum quantity of natural resources to produce. It is impossible to keep producing more real output from fewer natural resource inputs. Since natural resources emanate from natural capital, the sustainability of real output depends on keeping natural capital intact, which means extracting resources no faster than natural capital can regenerate them and generating pollution no faster than natural capital can safely assimilate it. Above all, it means there is an ecological limit to the growth in real output – hence an ecological limit to the growth of real GDP.

      Some people point to the shift towards services as a way out of the ecological limits problem. Strictly speaking, service is the 'utility' enjoyed from the consumption or use of physical goods. Services do not come from nowhere. I've never heard of a person getting a hair cut from an imaginery barber in an imaginery barber shop. For good reasons, the 'services' sector is referred to as the tertiary sector and 'manufacturing' is referred to as the secondary sector (agriculture and resource extractive industries are referred to as the primary sector). The output of the secondary sector is the input of the tertiary sector in the same way as the output of the primary sector is the input of the secondary sector. There is no such thing as shifting to services and away from goods. If we produce better goods, then it is possible to enjoy more 'service' from a given quantity of goods. But that's not substituting one for the other. The increased percentage of services in the real GDP of many rich countries merely reflects the fact that they have de-industrialised and now import most of their physical goods from low-wage, low-environmental standards countries. However, whilst services have increased as a percentage of real GDP, so has per capita energy consumption and per capita GHG emissions. So any notion that shifting to services can reduce environmental stress is nonsense. We can reduce environmental stress by increasing the services yielded by physical goods. This would increase the GPI but it may or may not increase real GDP.

      Policies to increase real GDP in order to achieve full employment are fine so long as the growth is 'economic'. If it is not, then we must somehow achieve full employment without increasing a nation's real output. I believe Bill's (Bill Mitchell) Job Guarantee can achieve full employment in both cases. In the first case (i.e., where GDP growth is 'economic'), govt spending expands in the form of the JG to absorb unemployed workers and economic welfare increases. In other words, real GDP rises to the full employment level of income. In the second case (i.e., where GDP growth is 'uneconomic'), the JG rations real GDP as people move from private sector employment to JG employment. Economic welfare rises, not because there are more goods (in fact, more goods would lower economic welfare), but because there is a more equitable distribution of income and because the social costs associated with unemployment are alleviated. In other words, the full employment level of income falls to the prevailing real GDP. May I say, in the second case, if we taxed the absurd economic rents earned by the very rich, I have no doubt that there would be much less need to have people moving from higher paid private sector jobs to JG jobs. There is more than enough real GDP to fully employ all people wanting work at decent wage levels. The real issue is redistribution.

    8. Phil Lawn says; “The increased percentage of services in the real GDP of many rich countries merely reflects the fact that they have de-industrialised.”

      I agree with this but it probably goes much further. It also means that they have financialised the economy and moved rewards away from workers who actually make things and to what I call the FIRE ‘EM sector (finance, insurance, real estate, embezzlers and managers).

      Of course in the long run, a country that does not make things is in dire trouble. If the US continues to de-industrialise and to allow much industrial capacity to shift to China then the bottom line is that the US could no longer support and supply a sophisticated military but China could. Allowing de-industrialisation is a geostrategic mistake. But I am sure the Chinese fully understand both Napoleon and Sun Tzu.

      “Never interrupt your enemy when he is making a mistake.” – Napoleon.

      “Victorious warriors win first and then go to war, while defeated warriors go to war first and then seek to win.” – Sun Tzu.

      China is “winning first” by de-industrialising the West. Of course, there are also greater forces at work which might put the “kibosh” on China too in the long run. China will suffer from resource depletion as much as the West. China will suffer grievously from climate change. Its deserts are extending enormously. That said, China will follow its millenia old strategy of incremental expansion around its borders at the points of least resistance.

      Possibly I am out of order mentioning geostrategy in an economics blog. However, I think it’s always a mistake to do economics and forget physics and natural forces on the one hand and geopolitics on the other.

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