Ecological Economics and Sustainable Business Joshua Farley, PhD University of Vermont Community Development and Applied Economics & Gund Institute for Ecological Economics

Introductions  Background  What do you hope to get out of this course?  What is the unsustainable activity described in your newspaper article?

What is Economics?  The allocation of scarce (available) resources among alternative desirable ends  Alternative: How people transform nature to meet their needs

Sequence of 3 questions:  What are the desirable ends?  What are the scarce resources?  How do we allocate? What else do we need to know before we can decide how to allocate? What else do we need to know before we can decide how to allocate?

Today’s Goal  Provide brief general answers to the three questions, from perspectives of: Neoclassical economics Neoclassical economics Ecological economics Ecological economics This group This group  Examine the role and limitations of business in allocating resources towards those ends.

Where do you Stand?

Desirable Ends  The desirable ends for our economic system is continuous growth (i.e. growth in GNP).  The purpose of business is to make money  In my professional life, the most important desirable end for me is salary

Desirable Ends  Growth Is this the dominant economic goal in the world today? Is this the dominant economic goal in the world today? Should it be? Should it be? Are people insatiable? Are people insatiable? Can capitalism survive an end to growth? Can capitalism survive an end to growth? What are the drawbacks to this goal? What are the drawbacks to this goal? How big should the economy be? How big should the economy be?  Profit Is this the dominant goal in your business? Is growth? Is this the dominant goal in your business? Is growth? Contrast this to assumptions of neoclassical economics Contrast this to assumptions of neoclassical economics  Salary What about working conditions? Status? What about working conditions? Status? Most desirable job: operating a hedge fund Most desirable job: operating a hedge fund Goal for college students: 1975 “develop a meaningful philosophy of life” to 2005 “make a lot of money” Goal for college students: 1975 “develop a meaningful philosophy of life” to 2005 “make a lot of money”

Scarce Resources  Technology and ingenuity will solve all our environmental problems What resources are required for economic production? What resources are required for economic production? What drives solutions? Profits? If not, where will the resources come from? What drives solutions? Profits? If not, where will the resources come from?

Allocation  The private sector is almost always more efficient than the public sector.  “Few trends could so thoroughly undermine the very foundation of our free society as the acceptance by corporate officials of a social responsibility other than to make as much money for their stockholders as possible” Nobel laureate Milton Friedman

Allocation  There is a fundamental conflict between economic growth and environmental quality

What is Ecological Economics?

Same basic questions…  What are the desirable ends?  What are the scarce resources?  How do we allocate?

…with changing answers: Coevolutionary economics  Hunter-gatherer economics Accumulation = death Accumulation = death  Economics of early agricultural societies Depended on technological advance Depended on technological advance Advent of property rights Advent of property rights  Industrial market economics Use of non-renewable resources: FOSSIL FUELS Use of non-renewable resources: FOSSIL FUELS  Ecological economics Driven by the growing scarcity of natural capital Driven by the growing scarcity of natural capital

What are the Desirable Ends? “If you don’t know where you’re going, you might end up somewhere else”

Desirable Ends  A high quality of life for this and future generations.

Where are we going? What ends does our society currently pursue?  Endless economic growth, more material consumption Why has the US failed to sign on to the Kyoto Protocol? Why has the US failed to sign on to the Kyoto Protocol? Why can’t women and children eat fish from Vermont? Why can’t women and children eat fish from Vermont?  We consume more than we produce  How long does it take to double consumption?

Subjective Well Being: What makes people happy/satisfied?  Money? (Not very, and only relative wealth once basic needs are met) (Not very, and only relative wealth once basic needs are met)  Friends  Desiring less  Marriage  Religion/community  Helping others

The Smile Factor  Are Americans the happiest/most satisfied people in the world?  Are Americans getting happier over time?  If we’re not deliriously happy, what’s the justification for consuming 25% of the Earth’s resources?

What makes people unhappy?  Pursuit of material gain “young adults who focus on money, image and fame tend to be more depressed, have less enthusiasm for life and suffer more physical symptoms such as headaches and sore throats than others.”  Comparing yourself with others Status is a never-ending tread-mill Status is a never-ending tread-mill

Quality of life = fulfillment of human needs  Much more than consumption  Market goods only one of many human needs  Satiation occurs pseudosatisfiers pseudosatisfiers  Needs the same across time and culture, how we satisfy them differs

Where does our current vision of the desirable ends come from?

Three necessary intermediate ends, in order of importance:  Ecologically sustainable scale  Socially just distribution of resources within and between generations  Economically efficient allocation

What are the scarce resources?

First law of thermodynamics  Matter energy cannot be created or destroyed We cannot create something from nothing, nor nothing from something We cannot create something from nothing, nor nothing from something All economic production requires raw materials provided by nature All economic production requires raw materials provided by nature Continuous physical growth of the economy is impossible Continuous physical growth of the economy is impossible

Second law of thermodynamics  Entropy never decreases in an isolated system Things fall apart, wear out, become useless Things fall apart, wear out, become useless All economic activity generates waste All economic activity generates waste  It is impossible to do work or recycle waste without low-entropy energy: no economic production without energy There is only a finite stock of accumulated low entropy matter/energy There is only a finite stock of accumulated low entropy matter/energy There is only a finite flow of solar energy There is only a finite flow of solar energy  The ultimate limit to the physical size of the economic system is our ability to capture low entropy provided by solar energy

Three Specific Scarce Resources  Energy  Ecosystem goods  Ecosystem services

Energy  Patent on steam engine 1769 Wealth Nations 1776  Finite stock of fossil fuels (finite flow of solar energy, which is a service)  Use = depletion; completely non-renewable  Use = pollution  1 barrel of oil = 20,000-25,000 hours of human labor  Substitution very difficult  What’s the state of the stock?

The Hubbert curve-discovery

The Hubbert curve-production

Unconventional Fossil Fuels  Alberta tar sands  Orinoco heavy crude  Shale oil  Liquid coal  Energy return on energy invested very low  Waste emissions extremely high

Waste Emissions

What Level of CO2 Reductions are Required?  Kyoto  Schwarzenegger  Germany’s G8 proposal  Stern Report

Ecosystem Goods: Biotic Raw Materials  We can use them up as fast as we like  If I use it, you can't Competition for use Competition for use  Private property rights common  Market goods  Scarcity  price increase  innovation of substitutes  Ecosystem structure, building blocks of ecosystems

Ecosystem Services  Structure generates function, ecosystem functions of value to humans=ecosystem services  Climate regulation, water regulation, disturbance regulation, etc.  Waste absorption capacity  Capacity for ecosystem structure to reproduce itself  Habitat for biodiversity, nutrient cycling, without which other services cannot exist.  Essential to human survival

Ecosystem Services  Provided at a given rate over time  If I use it, you still can (except waste absorption) Cooperative in use Cooperative in use  Can't be owned: no property rights (except waste absorption)  Non-market goods—no price signal  Scarcity  price increase  innovation

The Special Case of Waste Absorption Capacity  Competitive in use E.g. If the global climate absorbs US CO 2 emissions, it can no longer absorb China’s E.g. If the global climate absorbs US CO 2 emissions, it can no longer absorb China’s  Can be assigned property rights Government level regulations determine supply and ownership Government level regulations determine supply and ownership We’ve done it in the US for SO 2 emissions We’ve done it in the US for SO 2 emissions Kyoto seeks to do this for CO 2 Kyoto seeks to do this for CO 2  Can be made into a market good through regulation

The Laws of Ecology The raw materials converted into economic products are elements of ecosystem structure The raw materials converted into economic products are elements of ecosystem structure Ecosystem services are provided by a special configuration of ecosystem structure Ecosystem services are provided by a special configuration of ecosystem structure

Ecosystem Services, uncertainty and Ignorance  We often don't know what services are until they're gone  The ozone layer  Sardines and global climate change  Time lags: the passenger pigeon  Sample size of one: uncertainty is unavoidable  How much risk do we accept with life support functions?

What does this mean for the economy?

The Economic Problem  Micro-allocation : how do we allocate resources provided by nature among different economic products? Markets are favored approach Markets are favored approach  Macro-allocation: How do we allocate ecosystem structure between: Economic production, essential to our survival Economic production, essential to our survival Planetary life support functions, essential to our survival Planetary life support functions, essential to our survival  Life support functions have no price; markets alone cannot solve this allocation problem

Current Status

Currents status

Human made capital has grown more abundant, and natural capital more scarce How big should the economy be?

Earth, Inc.  If the Earth were a business, how well would you assess the performance of its CEOs?  We are disinvesting in natural capital How do you feel about this as a shareholder in Earth, Inc.? How do you feel about this as a shareholder in Earth, Inc.?  Can a business survive if it continually disinvests in essential capital?  Can an economy?

What caused the problems in your newspaper articles?  Government?  Business?  Individuals?  Nature?

Supply Chain  Y=f (K, L)  Trace the chain of production from means to ends  Ultimate means  product  By-products What are the relevant inputs? What are the relevant inputs?  Product  desirable ends  Does the firm pay the full cost of production? Does the consumer?  Y=f (K, L, N; r) + w

 Pencil -Timber -Rubber -Metal -Graphite - Coal -Sunlight -CO2 -Depleted forest services -Mine tailings -Mining jobs -Logging jobs -Soil -Landfill waste -Dirty water -Dirty air -Water -Paint -Chemistry jobs -Pencil making jobs -Mining machinery -Saws and sawmills - Minerals Oil -Garbage trucks -Landfill land -Watershed degradation -Subsidies -Communication -Roads -Ships -Knowledge -Agriculture -Rubber trees -Managerial skills - Pencil making machinery

Sustainability, Justice and Efficiency

What Resources are Critical to Sustainability?  Must be essential with no good substitutes  Water  Energy  Food  Ecosystem services (which includes the ability for ecosystem goods to reproduce)  Information

What are the Rules for Sustainability?  Cannot deplete critical natural capital Must maintain life support functions Must maintain life support functions Must retain ability to renew itself Must retain ability to renew itself  Cannot use up renewable resources faster than they can renew themselves  Cannot spew waste into the environment faster than it can be absorbed  Cannot use up critical non-renewable resources faster than we develop renewable substitutes

What are the Principles of a Just Distribution?  Each person is entitled to the products of their own labor  No one is entitled to take something away from someone else against their will  Values created by nature or by society as a whole belong to society as a whole  Whoever takes values created by nature or society should compensate society  What about future generations?

Why is the value of Natural Capital Increasing? The laws of economics

What are the limiting factors ?  Of production? If we want more seafood, do we need more boats and factories, or larger wild stocks? If we want more seafood, do we need more boats and factories, or larger wild stocks? If we want more timber, do we need more chainsaws or more forests? If we want more timber, do we need more chainsaws or more forests?  For human well-being? Material consumption doubles every generation. Material consumption doubles every generation. Do you want your grand-kids to have more air- conditioning or more ozone layer? Do you want your grand-kids to have more air- conditioning or more ozone layer? More cars or more climate stability? More cars or more climate stability? More consumer goods or more ecosystem services? More consumer goods or more ecosystem services?  We need to invest in the limiting factors

The Demand Curve for Natural Capital (and other Essential, Non-substitutable Resources) Valuable: elastic demand Critical: Perfectly inelastic demand Important: inelastic demand Natural Capital stocks Marginal value Demand curve for natural capital

The Total Value of Natural Capital Valuable: elastic demand Important: inelastic demand Natural Capital stocks Marginal value Demand curve for natural capital Critical: Perfectly inelastic demand

Conventional Economists: Missing the point….  Schelling (Nobel Memorial Prize in 2005): “Agriculture and Forestry are less than 3% of total output, and little else is much affected. Even if agricultural productivity declined by a third over the next half century, the per capita GNP we might have achieved by 2050 we would still achieve in 2051.”

Market relevant characteristics of resources

Excludability  Excludable resource regime One person/group can prevent another from using the resource One person/group can prevent another from using the resource Necessary for markets to exist Necessary for markets to exist Ecosystem goods can generally be made excludable Ecosystem goods can generally be made excludable Patents make information excludable Patents make information excludable  Non-excludable No enforceable property rights No enforceable property rights Can’t charge for use Can’t charge for use Some resources non-excludable by nature, including most ecosystem services Some resources non-excludable by nature, including most ecosystem services  Policy variable

Rivalness  Rival resources My use leaves less for you to use My use leaves less for you to use All ecosystem goods are rival All ecosystem goods are rival  Non-rival My use does not leave less for you to use My use does not leave less for you to use Inefficient to ration through prices; leads to under-consumption Inefficient to ration through prices; leads to under-consumption Most ecosystem services are non-rival Most ecosystem services are non-rival Information is perfectly non-rival Information is perfectly non-rival  Non-rival but congestible

Public Goods Game  Part of class grade  Each of you begins with 60 points (a D-). Points are rival and excludable.  Can be donated to public good, made non-rival and non-excludable  N = number of students  Conversion rate of private good:public good = 1.5/N:1  If everyone donates all their points, you each get a 90 (B+)

 Round 1: Write down the number of points you want to donate. The remainder are yours. No one will know what you do but me.  Round 2: Write down the number of points you want to donate. Everyone will know.  Round 3: Same as round two, but you can also donate points to punish those who contribute less than average. Conversion rate of private good:punishment = 1:N/3 (punishment is also private good)

Lessons?  Does greedy self interest generate the greatest good for the greatest number?  Bell curve of pro-social behavior  Role of altruistic punishment

How do We Allocate?

Allocation Matrix Rival Non-rival ExcludableNon-Excludable Market Good: Ecosystem structure, Fossil fuels, Waste absorption capacity (e.g. SO 2 ) Tragedy of the non- commons: patented information, e.g. Tamiflu, ozone safe refrigerants Pure Public Good: Street lights, national defense, most ecosystem services, non-patented information Open Access Regime: Unowned ecosystem structure, waste absorption capacity (e.g. CO 2 ) Non-rival, congestible Club or Toll Good

Supply Chain and the Allocation Matrix  Where does each part of the supply chain fit into the matrix?  stock flow resources such as ecosystem goods: Use = depletion Use = depletion We control rate of use, can be stockpiled We control rate of use, can be stockpiled Transformed into what it produces Transformed into what it produces  Fund service resources such as ecosystem services Particular configuration of stock flows Particular configuration of stock flows Not transformed through use Not transformed through use Can’t be stockpiled Can’t be stockpiled We don’t control rate of use We don’t control rate of use

Open access regimes  Businesses/individuals gain all benefits from over-exploitation, share costs with everyone  Leads to lower yields and higher costs for most species  Generally unsustainable, unfair and inefficient

Fish: “Tragedy of the commons”

Pollution: “Tragedy of the commons”

Public Goods  View sunset, $10  Non-excludable so markets don’t provide (underproduction)  Non-rival so markets shouldn’t provide (underconsumption)  What are options?

Information: The Tragedy of the Non-commons  Production How do we produce the right things? Eflornithine How do we produce the right things? Eflornithine How do we produce them efficiently? Medicine, ‘anti-commons’ How do we produce them efficiently? Medicine, ‘anti-commons’  Consumption How do we ensure people consume the appropriate amount? How do we ensure people consume the appropriate amount? Alternatives to ozone depleting compounds, carbon based fuels Alternatives to ozone depleting compounds, carbon based fuels Avian flu, HIV drugs Avian flu, HIV drugs

Are patents just?  Samuel Slater, “Father of American Industry”  Developed countries own 97% of all patents  Raises costs for research that meets the needs of the poor  “Standing on the shoulders of giants”

Efficient Allocation: The Role of Business and Government

How are we addressing macro-allocation?  For better or worse, government regulation is the main mechanism Limits to waste emissions Limits to waste emissions Limits to resource extraction (mostly fisheries so far) Limits to resource extraction (mostly fisheries so far)  Voluntary personal measures: negligible  Voluntary business measures Often done to pre-empt regulations, or get a jump on competition Often done to pre-empt regulations, or get a jump on competition e.g. Wal-Mart e.g. Wal-Mart

What do you Think of Wall-Marts efforts?  What was their motivation?  How will they contribute to sustainability?  Is it enough?

What is the impact of regulations and other government interventions on Business?

Sinks  Regulation of waste sector creates markets  No regulation  no waste industry  More regulation  growth in waste industry E.g. carbon markets: converting methane to energy could give triple dividend E.g. carbon markets: converting methane to energy could give triple dividend Benefits those who anticipate it, may harm those who don’t Benefits those who anticipate it, may harm those who don’t But also compensation for damages But also compensation for damages  Yet more regulation  no-waste industry Closing the loops Closing the loops Waste outputs from one industry become resource inputs into another Waste outputs from one industry become resource inputs into another

Future of Business: Sinks  Emphasis must shift from managing waste outflows to handling materials  Landfills become source, not sink  Industrial ecology and closed loop systems  Increased reliance on ecosystem services Living machines, bacterial digesters, nutrient cycling Living machines, bacterial digesters, nutrient cycling  Increased reliance on renewable energy Ecological processes are solar powered Ecological processes are solar powered Energy from waste Energy from waste

Energy Energy  Regulations to curb global warming  Subsidies for alternative fuels  Mandated efficiency  Rationing? California vs. Brazil California vs. Brazil  Claims for just distribution, e.g. Louisiana, Alaska

Future of Business: Energy  Can’t do work without energy  Skyrocketing prices  Efficiency  Markets for new technologies? Is this good? Is this good?  Return to the local  Economic instability?

Sources  Limits to extraction: biotic  Limits to extraction: abiotic  Mandated compensation for damages

Future of Business: sources  Limits to extraction: biotic Leads to increase in output, reduced costs of harvest Leads to increase in output, reduced costs of harvest Changing terms of trade (ag) Changing terms of trade (ag)  Limits to extraction: abiotic Efficiency Efficiency Markets for substitutes? Markets for substitutes?  Compensation for damages Internalizing costs of externalities Internalizing costs of externalities  Terms of trade: Agriculture

Market Mechanisms  Taxes  Cap, distribute and trade  Payments for ecosystem services  Financial assurance bonds

Common Asset Trusts  Democratic decision-making, informed by scientific expertise and precautionary principle  Sustainable quotas  Easier on sources, but possibly more feasible for sinks

Information?

 What is role of business in solving the problems described in your newspaper articles?  Will your business take these steps voluntary, from fear of regulation, or after regulation?

Conclusions  Natural capital has become the limiting factor in economic production  Economy must move towards less waste and greater regulation of waste emissions to protect natural capital  Less resource extraction  Greater investments in knowledge

Conclusions  Threat and Opportunity  Reactive Regulations forced upon you, no control. Regulations forced upon you, no control. Tough to catch up with the leaders. Other countries well ahead of us. Tough to catch up with the leaders. Other countries well ahead of us.  Proactive Can become leaders in a booming sector Can become leaders in a booming sector regulations modeled on industry’s innovations regulations modeled on industry’s innovations