Different Economic Approaches To Sustainable Development Economics Essay

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The society that we live in today can be described in many ways. It is developed, prosperous, dynamic, and driven by mankind's synergistic and almost obsessive relationship with technology and 'progress' to simplify life. It is also flawed in many ways, with our 'progress' and heightening demands often triggering consequences of regress and complication. Over the years, this has raised concerns over whether human demand on the earth's ecosystems is bearing an ecological footprint that is too large for the earth to handle.

According to Hussen (2004), the economy depends on the natural environment for three distinct purposes; to extract nonrenewable resources and to harvest renewable resources to be used as factors of production; to dispose of and assimilate of wastes; and to utilize environmental amenities for personal use and pleasure. These points emphasize the fact that natural resources are essential factors of production, of which a certain amount are needed to fuel the production process and the economy as a whole. Yet, since the earth is finite, this effectively places an upper limit on the amount of resources that can be extracted and harvested.

It is this biophysical limit that brings about the somewhat controversial question of whether man-kind can sustain this production process and development

"Without compromising the ability of the future generations to meet their own needs." (WCED, 1987: 43)

"In neoclassical economics, price is an indicator of resource scarcity." (Hussen, 2004. p3) This fundamental concept implies that the more scarce a resource becomes, the greater the price. An increase in the resource price effectively reduces the quantity demanded, and thus conserves more of the resource for future consumption. Accordingly, increasing prices in the production and consumption sectors send a factor substitution signal to the market. This signal encourages more money to be invested in a suitable man-made or natural substitute in order to replace the scarce resource, either partially or fully. In this way, technological advances augment the scarcity of natural resources, and moves towards generating an efficient allocation over time, and thus achieving a sense of sustainability. (Hussen, 2004. p3)

This demonstrates the neoclassical school's faith in the market mechanism to achieve an efficient equilibrium, and maximize welfare over time, hence relying heavily on the guidance of the invisible hand. (Smith, 1776) Consequently, sustainability, from a neoclassical perspective, can be defined as the maximization of welfare over time, or more specifically, the maximization of utility derived from consumption. (Harris, 2003. p2)

However, a number of distortions create great inefficiencies in the markets. Pollution is an example of a negative externality that creates an inefficiency which consequently causes the total social cost of production to exceed consumers' value. Similarly, the full cost of using open-access resources are not recognized by consumers, which results in the resource being depleted too quickly. Thus, from an environmental perspective, "Perfectly functioning, self-regulating markets are the exception, rather than the rule." (Fullerton et al, 1998)=

As a result, economic efficiency is not seen as a sufficient condition for sustainable development. Hanley states that "Achieving sustainable development involves achieving both intra-generational and intergenerational equity." (Hanley et al, 1997. p425) In order to achieve such a goal, economists must first recognize the distinction between efficiency and equity. As has been proven, these two concepts can mean very different things, when analyzing issues related to long-term economic progress and the natural environment." (Pezzey et al, 2002. p24) In-fact, this is one of the major precedents that divides neoclassical and ecological theorists.

In 1963, Barnett and Morse conducted a study that strongly questioned many of the basic foundations of resource limits and the pessimistic views of the Malthusian population trap. Their results revealed some evidence against these premises, with constant or falling prices for agriculture and minerals. Thus, in sharp contrast to Malthusian perspective, they concluded that technological progress and increased income per capita provided solutions for both environmental problems and population growth. (Tahvonen, 2000. p3)

Trends in natural resource prices relative to other prices in United States 1879-1957

Source: Barnett and Morse (1963)

In his model, Stiglitz (1974) re-emphasized that technical progress is indeed one way to compensate for declining resource reserves. He concluded that if the rate of exogenous technical progress is considerable enough, the production process is sustainable, and effects of depletion are thus equalized. (Pezzey et al, 2002. p7)

Stiglitz' theorem draws a parallel to the constant capital rule of non-declining aggregate capital, or the Hartwick rule, a well-known tenet derived from the work of Hartwick (1977) and Solow (1986). The rule states that as long as enough of the Hotelling rent from non-renewable resources is re-invested in reproducible capital to offset the decline in the resource, consumption of the good may remain constant. (Harris, 2003. p3) However, for this condition to hold, an assumption is made that man-made capital and natural capital are perfect substitutes, with an elasticity of substitution equal to one. Moreover, Hartwick assumes that the maintenance of natural capital is not required, and therefore, resources are considered to have no intrinsic value, and the process is rather one of an anthropocentric nature. (Harris, 2003. p3) Solow went on to endorse this theory when he said "If it is very easy to substitute other factors for natural resources, then there is in principal no problem." (Daly, 1991. Ch8)

Due to the idea of perfect substitutability discussed above, Julian Simon believes that the key constraint is not the finite amount of resources on the earth's surface, but rather "Human imagination and the exercise of educated skills." (Simon, 1980. p1435) He further explains that the quantity of future resources cannot possibly be calculated due to factors such as more efficient mining methods, better production, less waste, unknown reserves, new lodes and variation in grades. (Hussen, 2004. p3)

However, in contrast, to argue that the amount of resources available is not a constraint, and to believe that "The world can in effect get along without natural resources, but through continually substituting them for man-made resources, is to ignore the difference between the actual world and the garden of Eden." (Daly, 1991. Ch8) Man-kind could only have developed such a 'sophisticated' lifestyle through the use of the resources at our disposal, thus it is logical to say that the declining amount of resources does definitely act as a constraint.

That is to say, for example, if the government chooses to cut down a forest and replace it with a factory, the welfare of society improves, provided that the economic value of the new factory exceeds that of the depleted forestry. (Harris, 2003. p3) In this way, the neoclassical standpoint limits the forest to its financial use value, a value much lower than its true worth (Arrow et al, 1996) The notion of welfare needs to be humanized and should include everything that influences the situation in which people live, not merely material consumption. (Asheim, 2010) Thus, if natural capital has any exclusive significance at all, this added value will be lost and the neoclassical economic efficiency will prove to be unsustainable. (Harris, 2003. p3)

Therefore, realistically, man-made and natural capital are considered to be fundamental complements and only marginal substitutes, a viewpoint adopted by those from the ecological school of thought. (Daly, 1994, p.25).

Considering the fact that substitution possibilities are limited, future consumption per capita in the long run must effectively fall to zero. (Tahvonen, 2000. p6) It's simply impossible to remain completely sustainable with ever-depleting resource quantities. According to the laws of thermodynamics, no amount of substitution or technological progress can overcome this gloomy outcome. (Krautkamer, 2005. p37)

The first law states that energy cannot be created, only transferred, thus referring to the fact that we cannot create more resources. The second law is the entropy law, where raw materials enter the production process with low entropy (high amount of energy), and leave the system as high entropy waste, with dissipated energy that is irrecoverable. (Daly, 1991. Ch8) Accordingly, "the complete recycling of matter is impossible in a closed system." (Krautkamer, 2005. p37) "Therefore, it is argued that even continuous technological change (that does not violate physical laws) will not change the pessimistic outcome." (Toman et al.1995) Thus, Hartwick's rule of re-investment has come to be known as a 'weak sustainability approach.'

Despite this, Hartwick's rule is one of the more popular sustainability policies used today, with many governments and institutions having used it whether consciously or not. (Pezzey et al, 2002. p8) Announcing the importance of investing rents from natural resource depletion and creating incentives for this using taxation or other methods is certainly a clear and legitimate starting point for economies to adopt. (Pezzey et al, 2002. p8) However, it is uncertain as to "How much should be invested, or how much should be invested by the private sector versus some public trust fund for future generations." (Pezzey et al, 2002. p8)

"If one takes the view that market investment behavior is driven by a conventional PV objective, then Hartwick's investment rule in effect requires massive government intervention in capital markets." (Tahvonen, 2000. p6) Norwegian policies regarding their choices of oil-income reinvestment as opposed to consuming the resource, somewhat resembles the Hartwick policy. Yet, from what has been observed, a much higher savings rate will be required for any sort of sustainability to be achieved. (Tahvonen, 2000. p6)

Another concept primary to neoclassical economists is the "endogenous growth theory." This concept, founded by the likes of Solow and Stiglitz, considers technological enhancement and development to be a continuous process that is driven by re-investment and the motivation of firms to gain competitive advantage. Firms invest huge amounts into research and development, whilst governments try to speed up the process by investing further in R&D projects and in general education. (Barro et al, 1995). However, according to growth models, an increase in investment will increase consumption, driving economic growth, and in turn generating more pollution through waste in an ever expanding production process. Yet, neoclassical theorists argue that "Significant improvements in environmental quality are fully compatible with economic growth." (Hussen, p230) A higher per capita income, will increase the demand for improved environmental quality, which will result in increased expenditure on environmental cleanup operations." (Hussen, 2004. p230) Perhaps with more growth, 'cleaner' pollution technologies will evolve, so that although there is more pollution, it is somewhat refined, compared to the 'dirty,' more harmful pollution that we see coming from low-income countries today.

Daly, the founder of the 'strong sustainability' viewpoint, mentions that the "Neoclassical paradigm is that the economy is the total system, and that nature is merely a sector of the economy (ie. The extractive sector)." (Daly, 2000. p65) Nature is not seen as the force that is sustaining the economy, but rather as a sector with various products, just as any other. If the products or services of the extractive sector should become scarce, the economy will "grow around" that particular scarcity either through substitution, or new technologies. (Daly, 2000. p65) This is exactly what is highlighted above in the pollution scenario. If increased production produces a larger amount of pollution, increased demand for environmental quality, will simply stimulate the economy to "Grow around" the problem.

From a macroeconomic perspective, these increased environmental costs are rarely weighed against the production benefits, or taken seriously. There is no cost or benefit function for economic growth and therefore, no impression of how large economic growth should be. The adopted rule worldwide is the higher the better, without accounting for external constraints and costs.

Daly makes a point that perhaps at some instance, uneconomic growth will be realized, occurring at the optimal GNP point where rising marginal costs equal to falling marginal benefits. (Daly, 2000. p65) Although this equilibrium is completely theoretical, with the costs of depletion, pollution and an abundance of other factors being impossible to calculate, his concept of optimal scale does provide some 'food for thought' for governments.

In an era characterized by rapid extraction of a finite number of resources, and market prices that are too low, depicting the increasing technological dependence rather than the non-scarcity, uneconomic growth is looming over the future of man-kind. (Daly, 2000. p74) Unfortunately, the negative stigma involved is still not fully acknowledged, and if I were to use human nature as a predictor, a reaction to the inevitable problem that faces us, will probably only occur once we can see the physical consequences for ourselves. As the ecological footprint presses firmer, so the externalities will be revealed. Whilst, 'greening' the BOP accounts, and including user costs when evaluating projects are indeed solutions to incorporating these external costs, a broader consideration of optimal scale will need to be enforced somehow, although it is not very apparent how. (Daly, 1991. Ch6)

This above "neoclassical evidence for the unimportance of nature," is further augmented by the fact that Solow failed to include a 'Resource variable' in his production models, thus implying that resources are abundant and that increased production will have no significant effect on natural resources or the natural environment. (Daly, 1991. ch8,)

A few year's later, the 'resource variable' was included in a much criticized Cobb-Douglas function (Q = K*R*L). The implications of this model suggest that the resource quantity can be infinitely small, provided that capital is sufficiently large, whereas in actuality, the increase of capital implies additional depletion of resources. (Daly, 1991. ch8) So this, along with the concept that capital and natural resources are not perfectly substitutable, rendered the Cobb-Douglas function void from an ecological perspective.

So what are the solutions from an ecological point of view? Daly gives four prescriptions to foster environmentally sustainable development.

The first is to "Stop counting the consumption of natural capital as income." This prescription has already been touched on. It comprises of incorporating user costs in project evaluation, because if user costs are not accounted for, net benefits are boosted and bias investment allocation is biased towards these projects. (Daly, 1991. Ch6) Moreover, a portion of depleted natural capital used for exports, must be accounted for in the capital account of the Balance of payments. (Daly, 1991. Ch6)

The second of Daly's prescriptions is to "tax labour and income less, and resource throughput more." (Daly, 1991. Ch6, p5) In the past, subsidizing resource throughputs such as fertilizers to stimulate growth has been a regular occurrence for governments. Alternatively, pigouvian taxes should be charged to account for the presence of externalities and correct the market outcome, instead of taxing labour. Shifting the tax base would induce greater efficiency and internalize the externalities from depletion and pollution. (Daly, 1991. Ch6)

The third is to "Maximize short run productivity of natural capital, and invest in increasing its long run supply." (Daly, 1991. Ch6) This refers back to Hartwick's rule of re-investing proceeds from non-renewables into renewable natural capital. This allows for the development of substitutes such that when the resource runs out, the substitute can allow similar consumption possibilities. (Daly, 1991. Ch6) For renewables, resource consumption should be limited to sustainable growth rates. This means that the harvest rates should be less than the growth rates. Moreover, waste for degradable pollutants should be kept below the assimilative capacity levels.

The final and most abstract of Daly's prescriptions is a recommendation to move away from the ideology of globalization and free trade, and to orientate the focus towards a more nationalist approach, seeking domestic development with internal markets as first choice, unless more efficient otherwise. He prescribes this due to the loss of control within a country's borders associated with such globalism. With the loss of control, Daly could not foresee proper law and policy enforcement.

Daly is thus "An important architect of the "strong sustainability" view that capital-resource substitutability is very limited, so the sustenance of specific resource sectors is very important." (Pezzey et al, 2002. p11)

However, his 'strong approach' has been criticized for being rather formless and impractical, since it is often more theoretical and biophysical, making some of his philosophies difficult to apply. An example of this is his theory of optimal scale.

To add to Daly's prescriptions and the ecological school of thought in general, I'd like to refer to a formula presented by Bill Gates during his speech at TED this year. This has come to be known as the Gates' climate equation.

Source: (Steffen, 2010)

For zero emissions to result, one of these variables has to equal zero. Over the years, population growth has proven to be a difficult factor to control. Even though it has slowed it's still increasing, which will increase the demand for natural resources. Moreover, "The desire for a higher living standard in the developing world, places additional demands on technological progress to prevent increasing scarcity of natural resource commodities." (Krautkamer, 2005. p40) Developments in energy efficiency have also been lacking, so it is therefore logical to focus on the last element of the equation, the carbon emissions of energy. Thus, if we are able to create energy that is carbon-neutral, emissions will equal to zero.

Yet, this idea of zero emissions is difficult to fathom, and it's hard to imagine life improving with this goal in mind. However, as humans, "We are capable of re-inventing and re-evaluating the meaning of prosperity, and in so doing, reducing the ecological demands of that prosperity." (Steffen, 2010)

According to a study, "Even if we were to maximize energy efficiency and limit the impact of population size, we'd still be emitting 13 billion tons of carbon annually from energy production." So what are the solutions? (Asla, 2010)

"Cities are creatures of habit. Habits are cemented into the bureaucracies and politics that make and maintain our urban habitats." This goes for humans as well. A particular way of life becomes fixated in our brains and it is difficult to change this. The question is whether services and institutions that are designed for 'Another day at the office,' will be able to respond when the 'unusual comes to town.' (Aylett, 2009)

In this way, the solution to excessive automobile emissions, perhaps isn't designing a more efficient, carbon friendly car, but it might be designing a better city, that is transport friendly for all modes of transport, and attempting to encourage the use of modes that are less detrimental to the environment. Likewise, if we change our relationship to products and 'stuff' in general, we may be able to reduce consumption. The answer to the problem of overconsumption may not be recycling after all. (Steffen, 2010)

A more hands on and actualized solution is a venture that Bill Gates' has invested millions in. His proposal is to first begin by slowly fading out the use of coal and natural gas, and to change the focus to technologies such as carbon capture, nuclear, wind, and solar power. In particular, Gates spoke about his new investment, a company called Terra-Power who are developing new nuclear technologies. (Asla, 2010)

"The idea of TerraPower is that, instead of burning a part of uranium, the one percent, which is the U235, we decided let's burn the 99 percent, the U238. In terms of fuel, this really solves the problem.  You actually burn up the waste, and you can use all the leftover waste as fuel from today's reactors. This would power the U.S. for hundreds of years." (Flores, 2010)

Whilst Gates' researches alternatives, others believe that the concentration should be on deploying technology as opposed to R&D. Supporters of this line of attack have been searching for policy interventions to raise the price of high-carbon, and thus harmful energy, whilst concurrently subsidizing low-carbon energy sources, to give the market a push in the right direction, and speed up the movement along the learning curve (Asla, 2010)

Thus, after an in-depth look at both schools of thought, the flaws, strengths and possible solutions, a middle-ground is needed to be found by economists, however one that is more biased towards the ecological approach. The neoclassical approach proved to be far too narrow with too many unrealistic assumptions, such as perfect substitution between man-made and natural capital, unlimited use of resource and growth, faith in the market mechanism to allocate resources effectively, the exclusion of social costs in pricing, and the ethically questionable use of discounting. The ecological school of thought is much more realistic from a substitution, resource allocation and growth perspective, yet although it provides some greater food for thought and theory, it falls slightly short with some unrealistic and impractical solutions.

Despite this, new solutions and developments have been put forward. The obvious focus would be to move towards renewable energies as Gates' mentioned, and to investigate methods of nuclear energy that will ensure safety, because sooner or later, the benefits will most probably outweigh the costs. Other practical solutions, are green accounting, the shifting of the tax base towards resource throughput, and of course re-investing natural resource rents. Moreover, changing peoples' mindsets through education and awareness can make a big difference to lowering consumption levels. It all starts off with something small, like saving electricity and recycling. Then, with the help of incentivized policies from Governments, hopefully man-kind can push for sustainability on a larger scale.