1 Economics for Sustainable Development David Ervin Professor of Environmental Studies Portland State University June 20, 2007

© 2007 Portland State University 2

3 Outline F Macro economics and micro economics F Clarifying ‘free market’ economics F Why economic viability is key, but what form? F Weak and strong sustainability F Moving to sustainable macroeconomics F Moving to sustainable microeconomics F Public and private approaches to implement economics for sustainable development F A Columbia River illustration F Key lessons for sustainability economics

© 2007 Portland State University 4 What is economics? F Economics is about more than money & finance! F Microeconomics – how people spend and invest their time, money, and other resources to gain satisfaction; how firms decide which products to make and how much, the inputs and production methods to use, and the marketing strategies. F Macroeconomics – the study of the behavior of the national economy as a whole, e.g., consumption, production, interest rates, and investment patterns. F As with ecology, sustainability requires micro and macro scales because we must understand the consumer and business behaviors at both levels.

© 2007 Portland State University 5 Why economics is so powerful! F Most people display strong economic motivations, e.g., they like more goods and services than less. F Markets are a cost-effective way to transfer information to producers and consumers that guides resource use along the supply chain and across industries. F Most developed countries use ‘mixed capitalism’ systems of private markets with some government intervention for social and environmental objectives. F So, we must find ways that our economic system will achieve progress on sustainable development, rather than work against it.

© 2007 Portland State University 6 Clarifying what ‘free market’ economics means F ‘Free market’ means markets that operate without ‘excessive’ government intervention. F However, all markets are manmade institutions to achieve social objectives, and governed by a nation’s political system, legal system and cultural norms. F That is, the economic system depends on (or lies within) our social system. F Moreover, our social and economic systems depend fundamentally on the condition of our natural environment, e.g., climate change.

© 2007 Portland State University 7 Why economic viability is key F Sustainable development requires building & maintaining a stock of natural, social (human), manmade and other forms of capital to give future generations the opportunity to have at least the same standard of living (opportunities) as today – This is an investment problem! F Unless firms are profitable, people will not have jobs and pay taxes to government so that it can perform essential functions, such as environmental protection. F Long run economic growth is integral to resolving many equity problems, especially in developing countries, such as low standards of living. F Is our economic system up to advancing SD?

© 2007 Portland State University 8 Economic theories of sustainable development Western economists split into two camps on sustainability – ‘weak’ and ‘strong’ versions that depend on differing assumptions about the substitutability or ‘replaceability’ of natural capital with man-made or social capital. Weak sustainability assumes there is essentially no difference between natural capital and the other forms. Thus, the same depletion/use rules should apply to both. Maintaining and enhancing the total stock of capital alone is sufficient to attain sustainability.

© 2007 Portland State University 9 Economic theories of sustainable development cont’d Strong sustainability argues that man- made/physical and human capital cannot substitute for all environmental resources comprising the natural capital stock. Thus, maintaining or increasing the value of the total capital stock over time requires keeping the non-substitutable and essential (‘critical’) components of natural capital constant over time. Can you give examples of critical natural capital?

© 2007 Portland State University 10 Environmental Kuznets Curve F Hypothesizes that as per capita income grows that total pollution first increases at an increasing rate, then at a decreasing rate, and then levels off and decreases at some turning point. F Reasons: –Changes in economic structure, e.g., less manufacturing and more service industries

© 2007 Portland State University 11 Environmental Kuznets Curve F Reasons continued –As income increases, the demand for environmental quality also increases –Certain types of environmental or ecological processes behave that way F Limitations of the theory –Lacks systems approach –Applies to local but not to global pollution –Implies that lower income countries must experience higher pollution first before improving environmental quality.

© 2007 Portland State University 12 Conventional macroeconomics F Accepts the current property rights and income distribution as socially ‘correct’ or desirable. F Counts ‘nonmarket’ social and environmental costs in Gross Domestic Product (GDP), –crime avoidance and pollution control expenses F Omits ‘nonmarket’ social & environmental benefits in GDP, –family childcare & forest pollution filtering F Does not subtract depreciation of many forms of natural capital, e.g., ozone layer F Overstates the ‘discount rate’ used to evaluate investments, making future benefits and costs smaller (i.e., less valuable than current values).

© 2007 Portland State University 13 Issues with conventional macroeconomics F Problem: We decide national development questions based on market prices, interest rates and political power, all of which reflect the current income distribution, incomplete social & environmental accounting, & govt. policy failures. F Consequences: This system reinforces income inequities; under-invests in ‘nonmarket’ social and environmental resources, e.g., gene pools for biodiversity, and; hinders progress toward sustainable development.

© 2007 Portland State University 14 Sustainable macroeconomics F Ideal -- integrate the economy with the ecological and social systems. F Net National Welfare (NNW) = GNP + non-market environmental benefits + non-market social benefits - externality costs of growth - pollution abatement and cleanup costs - depreciation on manmade capital -depreciation on natural capital + change in social/human capital + future value of technology improvements

© 2007 Portland State University 15 Sustainable macroeconomics: first steps F Intragenerational and intergenerational inequities are addressed through open democratic processes. F The interest (discount) rate for evaluating investments that provide future goods and services, e.g., natural capital, is the growth rate of NNW, approximately 2-3%, not the market interest rate. F For example, if the discount rate is 2-3 % instead of 10%, investments that provide longer term net benefits will be more attractive.

© 2007 Portland State University 16 Sustainable macroeconomics: further steps F ‘Critical’ natural capital stocks, e.g., gene pools for ecosystem resilience, for which manmade and social capital cannot readily substitute are identified and preserved. F Precautionary principle of ‘no depletion’ invoked to protect critical natural capital stocks, unless acceptable substitutes are discovered. F Critical ecosystem cycles, e.g., carbon, are maintained. F Same actions are applied to ‘critical’ social capital

© 2007 Portland State University 17 Current microeconomics F Firms & individuals do not count ‘nonmarket’ social and environmental benefits and costs, unless government policies, e.g., pollution regulations, or other pressures, e.g., NGOs, cause them to do so. F Therefore, firms and individuals will underinvest in these types of social and environmental (natural) capital, such as forests and wetlands for air and water pollution control. F Firms and individuals address intragenerational and intergenerational inequities based on their values and private and public pressures.

© 2007 Portland State University 18 Sustainable microeconomics F Firms & individuals make decisions based on prices, interest rates, and government policies that include adjustments to GDP, protections of critical capital stocks, and adjustments for equity. F Government policy failures are corrected, e.g., agricultural production subsidies. F Public and private investment decisions are based on the social discount rate, i.e., growth rate of NNW.

© 2007 Portland State University 19 Public approaches to foster a more sustainable economy F Common law remedies F Regulations F Incentive (subsidy) programs F Emissions trading schemes F University education and research programs F Public-private collaborations to address ‘missing markets,’ e.g., ecosystem services F Etc?

© 2007 Portland State University 20 Motivations for firms to adopt more sustainable models F Reduce cost (waste) and improve productivity F Mitigate/preempt govt. environmental programs F Receive financial and/or technical assistance F Serve emerging green markets more effectively F Control risks (financial or other) F Achieve positive relationships with stakeholders F Manage competitors F Meet CEO personal or business objectives

© 2007 Portland State University 21 Columbia River habitat: conventional economics F Evaluates the economic effects project by project, not as an integrated system. F Uses market prices that reflect the current income distribution and policy failures. F Includes some nonmarket values, e.g., boating recreation, but not all. F Uses market-based discount rate to evaluate power/transport/habitat tradeoffs F Complies with social and court regulations, e.g., Native American claims

© 2007 Portland State University 22 Columbia River habitat: sustainability economics F Develops systems model of upper and lower Columbia River reaches to evaluate habitat options and linkages F Determines ‘critical’ habitats that cannot be traded off to maintain system resilience F Fulfills social (democratic) process requirements F Satisfies equity constraints F Includes all market and nonmarket values to max net benefits within ecological and social constraints. F Uses social discount rate

© 2007 Portland State University 23 Economics for Sustainability: Key Lessons 1. Environmental, social and economic systems must work in complementary ways, not at odds. 2. Assure that all stakeholders have a voice in deciding targets for (critical and non-critical) natural, social and manmade capital stocks, or their values are counted. 3. Reduce or eliminate government policy failures, such as subsidies that promote unsustainable agricultural production methods.

© 2007 Portland State University 24 Economics for Sustainability: Key Lessons (cont’d) 4. Assure that prices and costs include non-market environmental and social effects, e.g., global warming pollutants and family child care, to the extent technically and economically feasible. 5. Pursuing sustainability is a continuing process, not an end state. 6. Uncertainty in science and politics pervades the process. 7. ‘Learning by doing’ and adaptive management are necessary.

© 2007 Portland State University 25 References F Pearce, D. and E. Barbier Blueprint for a Sustainable Economy, Earthscan. F Goodstein, E Economics and the Environment, Wiley. F Harris, J Environmental and Resource Economics, Houghton Mifflin.