Insights from a rare self-reflective economist

I find economics an annoyingly smug discipline. Despite the contestable nature of much core economic theory, any critical analysis is quickly dismissed as heterodox and filed away under an appropriate sub discipline by the Serious economists. Because of this, whenever an academic economist takes a jibe at economics as a discipline, chances are their research is going to be pretty interesting.

This is what drew my attention to ecological economist John Gowdy, who begins this short talk on preferences and valuation by admitting that many of the most exciting developments in contemporary economics – such as the recognition that humans are part of social systems – are rather obvious to non-economists. 

If you have a spare 15 minutes I can recommend watching the video but, if not, here’s a quick summary.

Following his initial statement, Gowdy looks at these recent developments in a bit more detail explaining that research in behavioural economics is challenging some of the fundamental assumptions of textbook microeconomics. Microeconomics is the study of decision making at the individual or firm level and, therefore, these assumptions are often referred to collectively as the model of ‘economic man’: an individual who is purely selfish, perfectly rational and makes decisions based on a set of intrinsic preferences. Gowdy highlights research that contradicts the last of these assumptions by arguing that preferences are not constant or based on what is ‘best’ for an individual, but are influenced by a range of factors such as the opinions of respected figures.

Because individual preferences are not, therefore, innate Gowdy argues that conventional environmental valuation techniques that rely on the model of economic man are too simplistic. It may be possible to use individual preferences to derive monetary values for unpriced goods and services, but if these preferences are liable to change there is no guarantee that the calculated value is consistent with the most socially desirable outcomes.

Observing collective decision-making in rural Nigeria, he suggests that a more appropriate approach to environmental valuation would involve deliberation rather than algebra. While I agree in principle, I’m skeptical about the practicality of such deliberative valuation. Extended discussion to reach consensus may be an appropriate way to solve problems in a small rural community, but it’s not clear to me how such an approach would work when trying to establish values that are used to guide national-level decision-making.

Throughout the course of this blog I’ve noticed that this tradeoff between accuracy and practicality is a frequent problem in environmental economics. As I wrote earlier, I agree that environmental valuation is desirable in principle, as a way to highlight the social and economic importance of the environment to policy makers. However, in light of the practical issues I’ve examined I now find myself questioning the use of environmental valuation and wondering whether it threatens to do more harm than good. I’m still mulling this over so make sure you check back sometime in 2014 for my concluding thoughts. 

Until then, hope you’re all enjoying the Christmas break and Happy New Year!

Thresholds: better safe than valued

The US Dust Bowl in the 1930s – recorded so evocatively by the music of Woody Guthrie – is another instance where 

 the erosion of natural resilience by human activity had catastrophic consequences. 

Avid readers may remember this earlier post in which I introduced the concept of environmental wealth and described the collapse of southern Mesopotamian civilisation to show the severe consequences that result when environmental resilience is not adequately valued. However, if resilience is to be incorporated into comprehensive wealth accounting, simply stating that environmental resilience is ‘valuable’ is not enough as accounting frameworks require that all inputs are allocated an exact monetary value. This interesting paper by Walker et al (2010) attempts to address this considerable practical challenge, estimating a monetary value of agricultural resilience in the Goulburn-Broken Catchment to variation in the water table.

Walker et al define ecological resilience using Holling’s (1973) seminal interpretation that conceptualises resilience as the capacity of a system to remain in a particular state or ‘regime' despite temporary shocks. Holling argued that ecological systems move into alternate ‘regimes’ when a critical point is crossed and therefore resilience is primarily determined by the proximity of a given system to such a threshold. Anderies et al’s analysis of the Goulburn-Broken Catchment in South East Australia (Anderies et al 2006) found that when the region’s water table rose to 2m below the surface, natural processes drew saline groundwater upwards resulting in land salinisation and, therefore, Walker et al take this 2m level as a natural threshold.

By examining historical data on rainfall variability in the basin, Walker et al are able to estimate the probability that the 2m threshold will be exceeded, given any level of the water table in the previous period. This allows the authors to establish the level of resilience for a particular groundwater depth. The authors then use agricultural land value figures from Whish-Wilson and Shafron (1997) to attach a monetary value to the saline and non-saline states that, in turn, allows monetary values to be calculated for each resilience level. Applying their methodology, Walker et al find that between 1991 and 2001 unusually dry climate conditions caused the water table to fall from 3m to 3.5m achieving an increase in resilience worth roughly $23 million, which is equivalent to about 7% of the region’s conventional wealth.

This may seem a bit technical and abstract, but Walker et al’s experimental research is important. It’s all very well saying that environmental services should be included in national accounts but for this to be possible, methods of valuing these services need to be developed. However, I think that Walker et al’s paper also highlights a fundamental problem with resilience valuation.

The author’s entire valuation exercise relies on the knowledge of a precise environmental threshold – in this case the 2m water table level – and therefore application of their valuation methodology in other contexts is only possible if significant environmental thresholds can be identified. Environmental complexity means many different types of interdependent environmental resilience exist at a range of scales. For example, the population resilience of freshwater species influences the resilience of a freshwater body to nutrient enrichment and vice versa. This means that natural thresholds are numerous and extremely hard to determine, suggesting that the perfect knowledge required for resilience valuation is highly unrealistic. 

Because the resilience of ecosystems is such a complex and contingent phenomenon, I believe that resilience valuation is unfeasible, rendering the concept of environmental resilience incompatible with comprehensive wealth accounting. Rather than using wealth indicators to inform policy intervention, an alternative way of avoiding critical thresholds would be to establish ‘safe minimum standard’ policy targets for a series of environmental parameters. Although this doesn’t overcome the problem of threshold identification entirely – as determining a ‘safe minimum standard’ inevitably requires some knowledge of what is ‘unsafe’ – exact knowledge of thresholds isn’t necessary.

Attaching monetary values to environmental resilience may offer the empirical precision so beloved by contemporary economists, but the complexities of the real world make such an approach impractical. When it comes to incorporating environmental resilience into policy decisions, therefore, I reckon it’s better to be safe than valued.

Looking glass modelling

'Mitigation tomorrow and mitigation yesterday - but never mitigation today'
Alice and the White Queen, John Tenniel, 1865.

Utility maximization, perfect competition, consumer rationality – when reading economic modelling literature, it doesn’t take long to come across some pretty absurd statements. Because of the complexity of real-world economic processes, simplification is recognised to be a fundamental tenet of economic modelling that is necessary in order to establish and examine specific economic relationships. Such simplification is achieved by making various assumptions when constructing the model and it is here that the absurdities start cropping up. It’s important to recognise that economic models shouldn’t be automatically dismissed because of these outlandish assumptions. In particular, I believe that abstract models are useful for producing benchmark results that can be compared with the real world. For example, examining model predictions that don’t hold in reality and asking why different outcomes are observed can highlight particularly important aspects of economic systems. However, economic models aren’t used solely for academic purposes and often inform policy decisions, which is when extreme assumptions start to be problematic.

Integrated assessment models (IAMs) are a particular type of environment-economy model that are often used when assessing the economic costs of climate change and mitigation policies[1]. Although specific models vary, the general framework combines an economic model of production with a simple general circulation model. Production is assumed to have a positive effect on ‘utility’ or wellbeing, as it enables consumption, but also incurs economic costs or damages by generating greenhouse gas emissions that cause atmospheric temperature increases. Mitigation is incorporated by assuming that decision makers can invest in either production or abatement technology, which has the effect of reducing the level of emissions per unit of output. Policy makers, therefore, face an inter-temporal problem: investing in abatement today is beneficial, as it causes future climate change costs to be avoided, but also undesirable, as it reduces present-day consumption and hence wellbeing. 

From this, it’s pretty clear that IAMs are gross simplifications of reality, but are these simplifications problematic? This excellent paper by Ackerman et al (2009) argues they are, outlining three issues with the IAM framework related to the practice of discounting, speculative valuation methods and the modelling of mitigation. Although the first two of these points are significant, I’m going to focus here on the third, as discounting and valuation are already highly debated topics and I believe Ackerman et al’s critique of mitigation modelling relates to topics I have discussed previously.

A popular use of IAMs is to determine an ‘optimal’ path of mitigation that achieves particular emission reduction targets while minimising the adverse wellbeing impacts of abatement investment and Ackerman et al observe that such modelling exercises often conclude the ‘optimal’ policy involves backloading investment. This observation is supported by a review of IAMs that found ‘perhaps the most surprising result is the consensus that… modest controls are generally optimal’ (Kelly and Kolstad 1999, pg 19), which directly contradicts statements made by the scientific community that argue immediate action against climate change is imperative.

Ackerman et al argue that this result occurs because the way technological change is modeled in IAMs is inadequate and causes the costs of mitigation to be overstated. While IAMs acknowledge that abatement technology will become increasingly efficient over time (meaning that a given amount of investment in abatement will achieve a greater reduction in emissions), this technological change is assumed to occur at a constant rate that can be determined from past data. As the authors state, this awesome simplification makes the optimality of backloading unsurprising:

‘Because climate change is a long term crisis, and predictable, inexorable technological change will make it easier and cheaper to reduce emissions in the future, it seems better to wait before addressing the problem of climate change’, (Ackerman et al 2009, pg 308).

Such a blithe treatment of efficiency overlooks a significant and rich literature on innovation that emphasises technological change is often path dependent and, as I have written about before, can be positively influenced by public policy. If politicians are presented with the result that the ‘optimal’ policy is to do nothing – or very little – now, the potential benefits of targeted public investment are unlikely to be realised.

Although there have been recent attempts to ‘endogenise’ technological progress, which means efficiency is no longer taken as a constant but is determined within the model, these progressive developments haven’t been applied to all IAMs. Furthermore, it is often very hard to establish what assumptions are being made in any particular model as these are often buried in technical annexes rather than explicitly stated in the main body of reports and research papers. As long as economists continue to use IAMs that treat technological change as given and discuss underlying assumptions evasively, I worry that climate policy will remain an unfulfilled promise reminiscent of the White Queen’s policy of ‘jam tomorrow’ that Alice found so frustrating in her adventures through the looking glass…

"The rule is, jam to-morrow and jam yesterday – but never jam to-day." 
"It must come sometimes to 'jam to-day'," Alice objected."No, it can't," said the Queen. "It's jam every other day: to-day isn't any other day, you know."  (Carroll 1897).

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[1] Just to give you an idea of their significance, the whole Stern Review was based on the PAGE2002 IAM (Hope 2006, Dietz et al 2007)

Hungry for social policy

At the beginning of this blog I explained the concept of a ‘green transition’ referred to two distinct changes: reducing the environmental intensity of economic activity and improving the resilience of socio-economic systems to changes in climate. My previous posts have all addressed the former topic and so today I’m going to focus on the latter and examine how experiences of past climate change can inform present efforts to increase such societal resilience.

Records of the Great Famine that spread across Northern Europe during 1315-17 exemplify the severe social effects that changes in climate can cause. While historians have been aware of the catastrophic event for centuries, thanks to the harrowing accounts recorded by medieval chroniclers, more recent analyses have reconstructed climatic conditions during the period in order to examine the causes of the crisis. The tree-ring and GISP2 ice core analyses (undertaken by Lyons in Crawford (ed) 1989 (Ch. 2) and Dawson et al 2007 respectively), conclude that Northern Europe experienced significant increases in rainfall during 1315-16 that occurred alongside an increase in Northern Atlantic sea surface temperature. This supports numerous accounts recorded during the famine period that describe prolonged downpours from 1314-1316 that decimated crops and caused severe flooding (Jordan 1996). Although the rains subsided in 1317, the agricultural crisis persisted as widespread outbreaks of livestock murrain, caused by inundated pastures, continued to disrupt agricultural markets. Jordan argues that this caused the crisis period to continue for a further 5 years with food prices returning to pre-1315 levels only after 1322.

While the climatic cause of the famine is uncontested there is evidence that the severity of the crisis was increased by socio-economic factors. Crop failures caused substantial increases in agricultural market prices causing food to become unaffordable for large sectors of the population. Within this group it was the landless poor who experienced the most prolonged and severe impacts as, unable to undertake subsistence agriculture, they were dependent on agricultural markets and therefore endured food scarcity over the entire 1315-1322 period.

By analysing historical records, Kershaw (1973) has identified two factors that caused increases in this particularly vulnerable group during the famine period:

1. Increases in the unemployed landless – Outbreaks of livestock murrain and increased pressures on manorial finances caused large landowners to considerably reduce the number of people they employed resulting an increase in unemployment among landless individuals and, hence, an increase in the landless poor.

2. Reduction in peasant population – Peasants (individuals who undertook subsistence agriculture on small plots of land they owned) were vulnerable to climate variations as they didn’t maintain stores of produce. Following the initial crop failures, these individuals were forced to sell their smallholdings to wealthier households securing a temporary increase in income but removing their capacity to cultivate subsistence crops when the torrential rains ended in 1317. 

The factors highlighted by Kershaw indicate that economic responses can exacerbate the social effects of climate change implying that resilience to future climate change could be increased by policies that inhibit the repeat of these responses:

1. Improving climate-resilience of smallholders – It is clear that measures designed to increase the resilience of agricultural production to climate change are critical to the improvement of broader social resilience.  In particular, policies that seek to ensure that smallholder subsistence agriculturalists are prepared to withstand future climate change and climate variability could minimise a recurrence of the most severe social impacts observed during 1315-22. Reports such as CGIAR (2012) have identified which crops are most suited to increasing food security in poorer countries while also enhancing resilience to future climate and therefore policies that attempt to increase uptake of these crops among smallholders, such as seed subsidies, could be valuable methods of increasing social resilience.

2. Rural employment guarantees – The Great Famine also shows that resilience to climate variations could be improved by reducing the sensitivity of employment to climate change. In the present context, rural workforces dependent on agriculture are most vulnerable to climate variations and therefore, policies to guarantee rural employment could mitigate the social impact of harvest failure. Economist Jean Dreze is a prominent advocate of such policies and in this interview he explains his position and defends India’s rural employment guarantee scheme.

Although it’s necessary to treat precedents from the past with some caution, as their relevance is inevitably constrained by their historical context, an understanding of the factors that have increased vulnerability to climate in the past can be insightful. The experience of the Great Famine exemplifies how economic responses can exacerbate the social impacts of climate events and emphasises that economic policies will be essential in mitigating the severe social consequences threatened by a changing and increasingly variable climate. 

Public investment please

What with financialisation and a taste for fossil fuels, it seems that the private sector is incapable of financing a green transition. But what can the government do to compensate for this?

While economic theory tends to view the public sector as a cumbersome barrier to business, with blundering government intervention likely to result in cronyism and ‘government failure’, economist Marianna Mazzucato, is out to challenge this caricature. Contrary to conventional economic wisdom, which sees the correct role of government as (at most) fixing flaws in markets leaving the dynamic private sector to get on with innovation, she argues that state investment has underpinned some of the most revolutionary technological developments of the last few decades (Mazzucato 2011). In the video below she explains her thesis and examines the iphone to reveal the many ways in which public investment enabled the creation of one of Silicon Valley’s most iconic products.

These examples are much more than just fun facts as Mazzucato argues that they show government acting as an ‘entrepreneurial state’ willing to take the biggest investment risks that scare the comparatively timid and impatient private sector. In particular, she highlights how the Defense Advanced Research Projects Agency has acted as a technology pioneer overseeing the early stages of the internet among many other important developments. Trenzel et al (2012) provide another interesting example, examining how government intervention facilitated the shale gas revolution in the US.

Listening to contemporary politicians with their mantra of ‘getting the deficit down’, you might be inclined to dismiss Mazzucato’s argument as interesting but irrelevant: government might have been able to can get things done in the past but in the wake of the financial crisis it simply doesn’t have the financial resources to take the big investment risks any more. Mazzucato also addresses this issue of financing, stating that governments in the past have been far too reluctant to reap the rewards of their investments. If the public sector stopped being so modest about its entrepreneurial role and started demanding remuneration from the companies that profit from publicly funded innovations, government investment could be self-financing. Furthermore, figures recently published by the Overseas Development Institute (Whitley 2013) show that government subsidies offered to the coal, oil and gas industries amount to £2.6bn a year, making Britain the fifth largest fossil fuel subsidiser in the world.

Mazzucato believes that the next sector waiting to benefit from public sector innovation is green tech and I agree. Britain, however, is falling behind countries like the US and South Korea where publicly-funded green initiatives have already been developed:

Taken from 'The Green Investment Gap' (PIRC 2011)

The UK government should stop subsidising fossil fuels and start an active programme of green investment. A green-investment bank simply won’t be enough as history shows that only after government has taken the biggest investment risks will the private sector start loosening its purse strings.

Peatland and modelling

Have CSERGE developed Earth's very own Deep Thought?

Peatlands are important. It is estimated that Northern peatlands store more than 455Pg of carbon (Gorham 1991), which, according to my calculations, is roughly twice as much as the carbon stored in the world’s tropical rainforests[1]. So yeah, these soggy, waterlogged landscapes are pretty important.

The large swathes of peatland that now exist in the circum-arctic region are believed to have developed during the late Pleistocene and early Holocene as ice sheets retreated and the climate became warmer and wetter. The hypothesis that climate has been the prime driver of peat formation is supported by Macdonald et al (2006) who use radiocarbon dating to establish the timing of peat development across northern Europe. They find that peatland expansion across all continents occurred in a pattern that reflects fluctuations in global temperatures with initial expansion during the Bølling-Allerød warm period (c.14.7–14.5 ka bp) slowing during the colder conditions of the Younger Dryas (c.12.65–11.5 ka bp) before rapidly increasing after the end of the Younger Dryas at around 11.5 ka bp.

Evidence from the UK, however, indicates anthropogenic impacts have also been important causes of peatland formation. For example, Oldfield (in Walker and West (eds) 1970) has shown that Blelham Bog in the Lake District was artificially established in the early 19^th century as a result of human flooding of former peat cuttings with subsequent stream diversion throughout the 19^th century encouraging further silt deposition and, hence, peat formation.

While the contribution of humans to peatland therefore appears variable, it is clear that anthropogenic impacts are the overwhelming drivers of contemporary peatland destruction. In Europe alone, it is estimated that out of a total mire and peatland area of 617.000km2, 52% has been converted over last century with the main areas of conversion including agriculture (50%), forestry (30%) and peat extraction (10%) (Byrne et al 2004). It's clear that future land-use decisions should preserve this significant carbon sink, but how can we ensure that such decisions are made?

Here I believe that recent developments in environment-economy modelling can, again, be instructive. Work is being undertaken at The Centre for Social and Economic Research on the Global Environment to develop integrated land-use models that will allow decision-makers to measure the impacts of land-use changes not only in terms of changes in market-priced commodities, such as agricultural output and timber, but also non-market benefits such as the recreational services of forests and, importantly, the carbon sequestration benefits of peatland.

Bateman et al (2013) provides an example of how such modelling developments can promote pro-peat land-use decisions. The authors use a series of decision models to explore how land use patterns change under various scenarios defined in terms of the magnitude of climate change and the strength of environmental regulations. Valuation models are then used to determine the magnitude of changes in market and non-market benefits that are the result of land use in each scenario. The images below show the results from the ‘world markets’ scenario in which environmental regulation and policy are weakened unless they coincide with improved agricultural production. Looking at the maps, the difference between market (agricultural) and non-market (ghg emissions and recreation) outcomes is explicit. Chopping down trees and converting peatland to agriculture would be expected to increase agricultural output but the maps below show how this also causes increased carbon emissions and losses in recreational benefits (going for a walk in a field of potatoes isn’t quite the same as going for a walk in an ancient forest).

Images from Bateman et al (2013)

These maps might look nice but what’s the point of this? Bateman et al (2013) show that basing land-use decisions solely on market values will have considerable detrimental effects and, while this result is pretty unsurprising, the model developed by CSERGE makes the point impossible to ignore.

I do, however, have some reservations. The novel aspect of Bateman et al’s modelling approach is the combination of a land-use decision model with a valuation model. This allows all the impacts of land use changes to be expressed in terms of a single monetary unit (note that the maps above are all in terms of £/ha/yr). To me, there seem to be two issues with such an approach. The first is that this means that modelling results are inevitably going to depend on the monetary values that are placed on non-market benefits such as the carbon sequestration services of peatland. I’ve written before about the importance of such environmental valuation but it’s important to recognise that the model’s conclusions will always be contingent on the valuation methods used.

While I believe that environmental valuation has many benefits, my second, and more significant, concern is that policy makers place too much emphasis on such modelling exercises. I worry that politicians are far too keen to hold up the results of such models as facts that make further deliberation redundant, ignoring that the results are actually contingent on subjective valuation method decisions.

So yes, environment-economy models such as that developed by CSERGE can aid pro-peatland decision-making but it’s vitally important to use them correctly as tools to inform further debate rather than infallible oracles that always produce The Truth.

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[1] To put the peatland figure in context I used NASA’s estimate of the total carbon stored in tropical forests (247 billion tons) and used this converter to express the figure in petagrams. I am pretty ignorant about comparative carbon storage estimates so if this appears way off to anyone please let me know!  

A brief note on Kraken

no, not that Kraken...

A while ago I wrote about the effect that financialisation is having on private sector investment. The recent approval of EnQuest’s development of the Kraken oil field, however, suggests that the private sector is willing to invest – just in the wrong type of energy! Compared to the £5.55bn that was invested in renewables in the UK in 2012 (Frankfurt School UNEP Centre and BNEF 2013), EnQuest’s £4bn project is startling: how can a single fossil fuel project amount to over 70% of total renewable investment?

The Kraken news story reminded me of a report published earlier this year that highlights the magnitude of the financial resources that are being devoted to fossil fuel exploitation (Leaton et al 2013). The report emphasises that burning already known fossil fuels reserves would generate carbon emissions large enough to warm the planet by more than the 2°C that the Copenhagen Accord states should be the upper bound of climate policy targets. The authors argue that further investment in fossil fuels is therefore a waste of scarce financial resources but estimate that, despite this, the top 200 global oil, gas and coal mining companies spent $674bn in 2012 to find and develop new fossil fuel sources. Ironically, this figure is approximately 1% of global GDP, which what the Stern Review (2006) concluded would be necessary to stable atmospheric carbon dioxide levels at 500-550ppm by 2050.

Because of the private sector’s apparent aversion to green investment, it seems that the public sector will have to step up as the national green financier. I’ll be posting  later this week about whether it’s possible for government to spearhead a surge in green investment, so make sure you check it out. Until then, how about some music that seems to reflect the private-sector attitude…

Climate change and conservation

Evidence about the extinction of megafauna, such as the giant sloth,
can be used to challenge climate-species fatalism

If the planet is already locked into significant climate change, as is widely recognised, then what is the point of conservation? In the past, the earth has undergone considerable changes that have been accompanied by species extinctions and so aren’t contemporary conservation efforts just wasting resources by attempting to preserve species that are maladapted to the present climate?

The above statement is an example of what I like to call ‘climate-species fatalism’, which argues that human efforts will be unable to overcome the pressures placed on endangered species by climate change therefore rendering conservation pointless. While economists may be notorious for holding controversial opinions, I’m just trying to provoke a response here and don’t actually believe this. Although climate-species fatalism may appeal to politicians looking for an excuse to avoid action, I would argue that evidence from past extinction events implies that, even in the present context, conservation can still prove effective.

The wave of late Pleistocene megafauna extinctions is a good case in point. 50 ka BP the planet was home to over 150 genera of megafauna (animals >44kg) but by 10 ka BP at least 97 of these had become extinct. The causes of this significant extinction event are debated and there is a rich academic literature that attempts to solve the megafauna mystery. Was it the arrival of trigger-happy human populations who hunted easy-to-catch larger species to extinction or are shifts in climate to blame? While proof of the latter of these causes would support the position of climate-species fatalists, Barnosky et al (2004) have undertaken a comprehensive summary and analysis of a range of studies that indicates that both factors were significant. Observing that the global wave of extinctions occurred in a pattern of regional pulses, the authors assess both paleoecological evidence about major regional climate shifts and archaeological evidence about the date of human population arrival to suggest that regional extinctions peaked when both adverse human and climatic pressures were present.

These findings have present day relevance as they imply that, even as unavoidable climate change places increased pressure on species, addressing anthropogenic impacts that are adversely affecting threatened species can mitigate extinction risks.

So if conservation remains important, what sort of policies should conservationists be pushing for? I have previously discussed the development of integrated environment-economy models and believe that they can offer an insight here. In particular, Lenzen et al (2012) have developed a particular economic-environment model that analyses the impact of trade on global biodiversity. By evaluating the species impact of supply chains and combining this with an analysis of international trade patterns, the authors have been able to show how the impacts that consumers have on biodiversity often extend well beyond national borders. For example, the study finds that UK imports threaten 285 species abroad owing to the high volumes of environmentally harmful crops such as tea, coffee and palm oil demanded by UK consumers.

This shows that a national approach to conservation, which focuses exclusively on domestic biodiversity impacts, will be inadequate to preserve global biodiversity. Lenzen et al (2012) emphasise that their findings show how local biodiversity threats are driven by global trade systems and argue that this international dimension demands similarly international conservation policies. For example they argue that policies to address production practices with damaging impacts on local biodiversity should acknowledge the role of international traders and consumers as well as local producers themselves. This gives support to initiatives such as the Roundatable for Sustainable Palm Oil which seeks to increase the sustainability of palm oil production through engagement with stakeholders across the commodity’s geographically dispersed supply chain.

    

While climate-species fatalism is challenged by historical evidence I fear that, unless further conservation efforts are made at an international level, conservation policy will be inadequate to mitigate the extinction threats posed by climate change and the climate-species fatalists will be proved right.

A brief comment on carbon taxation

Last week I wrote about the importance of environmental economics and in particular the topic of environmental valuation. A significant and debated subject within this field is carbon taxation and there is a considerable literature that analyses different schemes around the world and tries to establish the correct ‘shadow price’ of carbon (a price that reflects the negative effects of carbon emissions), in order to determine the ‘optimal’ rate of taxation. Carbon taxation is such a large topic that an entire blog could be devoted to the subject – as dull as that may be – and so I will not attempt a summary here but instead want to explain my opinion on the subject.

The logic of carbon taxation is simple and comes straight from economics 101. Carbon emissions cause negative effects on parties other than the emitter but are un-priced and therefore occur at a level above that which maximises social wellbeing. To redress this, carbon taxes are necessary to increase the private costs of emitting so that they align with the social costs of emissions. Simply put, if you levy a tax on something people (should) do it less and therefore harmful things, like smoking and carbon emissions, should be taxed. Although this – like most economics – is a simplification, I believe that the basic principle makes sense and I therefore support economic taxation as a way to reduce carbon emissions.

Despite this endorsement, I fear that there is too much emphasis, both within academic economics and policy making, on this one policy tool. This is probably because carbon taxation requires relatively little public intervention when compared to other schemes such as cap-and-trade systems and therefore appeals to politicians who are wary of large administrative costs and accusations of being against the free market (an apparently indefensible position in contemporary politics).

I worry that carbon taxation is becoming a token green policy that politicians can flag up as proof of their environmental credentials detracting attention from the overall inadequacy of environmental policy. Statements such as this made by the OECD are increasing the problem as they suggest that governments should only engage in the most ‘cost-effective’ environmental policies instead of employing a range of tools to achieve ambitious policy aims. With organisations such as the committee on climate change stating that global carbon emissions need to peak by 2020 and then be halved by 2050 in order to avoid severe climate change, it is obvious that carbon taxation alone does not constitute adequate environmental policy.

To achieve a green transition, environmental policy needs to move beyond laissez-faire market tinkering and become more imaginative and ambitious. While carbon taxation is undoubtedly an important policy tool, academic and policy work should give up the holy-grail-like quest for the ‘optimal’ level of taxation and instead focus on developing an environmental policy arsenal capable of mitigating and tackling the considerable threats posed by climate change.  

Can you get to that? - the wisdom of funk and history

When you base your love on credit and your loving days are done,
the cheques you signed with love and kisses later come back signed insufficient funds 

- Can you get to that, Funkadelic

What reason can I possibly have for introducing this post with some 70s funk? To me, the song’s lyrics make the point that the accumulation of debt, which is the equivalent to the erosion of wealth, has implications. Although the concept of ‘wealth’ is often viewed from a solely monetary perspective (as the assets that an individual owns such as savings and housing), some economists argue that this narrow definition needs to be extended to include the natural and social forms of wealth that sustain human wellbeing (such as environmental processes and education). This concept of ‘comprehensive wealth’ means that ‘environmental debt’ can be defined as actions that reduce the ability of the natural environment to sustain human wellbeing, which brings us back to Funkadelic’s lyrics:

Well, I read an old quotation in a book just yesterday
,Said "Gonna reap just what you sow,
The debts you make you have to pay."

The collapse of ancient civilisations in southern Mesopotamia exemplifies the catastrophic impacts that the accumulation of excessive ‘environmental debt’ can have on human societies. Irrigated agriculture was essential to the development of early Sumerian societies around 5300 BC as it enabled high crop yields that were able to sustain sedentary, urban populations (Leick 2003). Between 2350 and 1700 BC, however, crop yields declined considerably owing to an increase in salinity that impeded the cultivation of wheat and, although populations were able to adapt by shifting to the more salt-tolerant crop of barley, yields continued to remain below 50% of previous levels (Chew 2001). Thompson (2004) argues that these dramatic declines in food production drove depopulation in Southern Mesopotamia causing a northward shift in regional power that ended the dominance of Southern civilisations. 

The extent to which human activities caused this disastrous increase in salinity is debated. Jacobsen and Adams (1958) suggest that population pressures necessitated the construction of large irrigation channels resulting in progressive salinisation as over-irrigation caused ground water levels to rise. An alternative explanation that emphasises the impact of climatic change is presented by Issar (1995), who argues that variations in climate diminished the flow of the Tigris and Euphrates rivers, reducing the amounts of water available to flush salts from irrigated land. I believe that the most adequate explanation of south Mesopotamian decline, however, is a synthesis of these alternative hypotheses as articulated by Chew (2001) who states that climatological changes undermined an agricultural system that had been pushed to it’s ecological limits as a result of intense cultivation practices.

The critical point here is that the Mesopotamian populations did not recognise that their intensive farming practices were reducing environmental resilience and thereby undermining the capacity of the natural environment to sustain their civilisation. In other words, they were running up environmental debt with inadequate consideration of the consequences. 

So what can be done to avoid a repeat of the Mesopotamian experience?

It is inevitable that the efforts needed to ensure contemporary human civilisation is not undermining the natural wealth upon which it depends are numerous and diverse. In order to increase the effectiveness of such efforts, and discourage actions with deleterious environmental effects, it is vital that methods of monitoring and quantifying natural wealth are developed. While this may seem like blue-skies thinking, several governments – including the UK Treasury – are currently attempting to incorporate environmental variables into the national accounting frameworks that are the basis of standard economic indicators such as GDP. If you can get past the crippling dullness of the video below (it is produced by the Office for National Statistics after all), it provides a pretty good explanation of what’s being done in the UK. 

By providing an objective environmental monitoring framework with which politicians could be held to account these methodological developments could promote a green transition by increasing political motives to preserve – and perhaps even enhance – environmental wealth. However, despite the potential of environmental accounting, I’m pretty skeptical that it will actually achieve anything. To date, very few environmental variables have been considered and negligible public awareness of the concept means it is unlikely to displace GDP as the raison d'être of politicians. In the face of current political priorities I fear that valuable lessons, both from funk and from the past, are going to continue to be ignored and that the accumulation of environmental debt will continue until the consequences start to manifest themselves in pretty severe ways. 

The industrial revolution, Malthusian constraints and modelling

A view of Machester from Kersal Moor, Willian Wylde (1852)

The industrial revolution that occurred in Britain during the mid to late 18^th century initiated an unprecedented increase in material living standards that continues today. Before the mid-18^th century, income per capita was stable and relatively equal across the world with the emergence of global inequality occurring concurrent with the industrial revolution (see below). 

Gross domestic product per capita depicting data from Maddison (2007)

This has led to the period being known as ‘the great divergence’. As the historian P.H.H. Vries writes:

‘The great divergence in the end, by definition, must boil down to the fact that during its industrialisation Britain escaped from the Malthusian constraints and Smithian limits that characterised (advanced) organic economies’. (Vries 2001 p 423).

This escape from ‘Malthusian constraints’ described by Vries indicates how the industrial revolution caused a considerable change in the relationship between economic activity and the natural environment: from being limited by a dependence on the natural environment, production was now able to accelerate considerably through mineral and fossil fuel exploitation (Thomas 1985). However, although the industrial revolution changed the nature of the production-environment relationship, it did not terminate it; contemporary economic activity remains dependent on the environment. The present-day dependence of production on the natural environment might seem obvious to some, but I believe that the relational shift caused by the industrial revolution has led to a chronic neglect of environmental considerations within mainstream academic economics.

This is particularly apparent within the esoteric subject of economic modeling. Whenever you hear that the IMF or some similar institution has produced an economic forecast, it’s not just the outcome of a bunch of suits sat in a room gazing at crystal balls. These forecasts are produced using mathematical models of that consist of thousands of equations intended to describe the significant relationships within an economic system[1]. Establishing these relationships is a considerable task and therefore a degree of simplification is necessary and, because the natural environment does not overtly limit contemporary economic production, there has been a tendency to ‘simplify’ away environmental factors. Although major commodity prices such as oil and grain are usually included, there is no consideration of soil fertility, water quality, climate or any similar ‘uneconomic’ environmental variables. 

Such oversight is dangerous. As previously stated, economic activity is still dependent on and impacts the environment. If models are unable to capture how these environmental impacts change in response to economic variation and how these changes feedback into economic systems, the environment is going to remain inadequately considered by policy makers and economies are going to become increasingly vulnerable to external environmental impacts. Thankfully, the environment-shaped hole in contemporary models is being addressed by several projects that are attempting to create new models capturing interactions between economic activity and the environment (for example see Tukker et al 2009 and Peters et al 2011).

Although the particular environment-economy relationships included in these new models differ between projects and are often estimated from past data, which risks overlooking threshold effects, their development can only be seen as a good thing as they are challenging orthodox models in which the economy is represented as a self-contained system unbound from the ‘malthusian constraints’ of the environment.  

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[1] (sadly more tangible and entertaining models such as the Phillip’s model are no longer used). 

Standing up for environmental economics

I feel sorry for environmental economics. As a discipline it is too often viewed as ‘quasi-economics’ by more orthodox practitioners and is often treated with extreme suspicion by environmentalists. Despite this, the subject has managed to flourish within state bureaucracies and today’s conservation rhetoric is guided by the concept of ‘ecosystem services’, which smacks of the influence of economists. I was therefore surprised to read this short piece by environmental economist Zara Phang who reports that reference to the subject was almost completely absent during the launch of the Malaysian chapter of the UN’s Sustainable Development Solutions Network.

Zara’s piece also effectively makes the point that there needs to be a change in the way ‘sustainability’ is perceived. For environmentally beneficial initiatives to gain traction within governments across the world, it is vital that the economic benefits of sustainable initiatives – namely in the form of avoided future costs – are properly recognised so that ‘sustainability’ ceases to be viewed solely as an economic burden. An example of this is the work of TEEB that looks at valuing the benefits of biodiversity:

Through developing ways of valuing the economic benefits of the environment, environmental economists are making contributions to the pro-sustainability debate the importance of which, I believe, should be better recognised.  

A brief comment on the energy price debate

Over the past few weeks, a barrage of double-digit energy price increases announced by major providers has attracted condemnation from politicians and the media. Price increases put pressure on the real value of wages and threaten to increase levels of fuel poverty incurring significant social costs in the form of adverse effects on physical and mental health. These problems also raise concerns about equality as the pinch of rising energy prices is often felt most severely by society’s most vulnerable. For these reasons, energy affordability is high on the political agenda – and rightly so – but to me, the present fixation on low energy prices is problematic.

Although recent price rises have been met with a sense of indignation, the UK enjoys energy prices that are well below the EU average (see below). From an economic perspective, low energy prices reduce incentives to improve energy efficiency and invest in substitute technologies such as renewables – both measures that are integral to the process of green transition. Low prices also constrain energy company profits that are essential to financing much-needed investment to improve the UK's energy infrastructure.

It appears that present political efforts to secure fuel affordability are set on tackling fuel prices but I would argue that this approach is unimaginative and will impede progress toward achieving a green transition. Rather than seeking to keep prices low, an alternative approach to ensuring fuel affordability would attempt to increase low incomes. As well as general macroeconomic and industrial policy to encourage the creation of skilled manual jobs (the sort of employment that provides middle-income salaries), more specific measures would include fuel energy subsidy payments to the low-waged and un-waged. Such an alternative approach would allow energy prices to rise, providing the incentives that any green transition will need, while mitigating the most significant social costs.

To further address the social discontent that energy price increases with inevitably cause, politicians could also take steps to ensure that energy company profits are also being used to fund socially beneficial investment. Despite enjoying considerable profits, energy firms are investing less in new assets to improve the UK energy system than the value of depreciation of existing assets. If this trend continues then a furore over future price hikes would be justified. It would be far more constructive, however, to act now and use the regulatory system of the UK energy market to demand energy companies increase levels of investment.

Fuel affordability and securing a green transition are both undoubtedly important issues, but the present political emphasis on energy prices imposes an artificial trade-off between the two. Although this trade-off can be overcome through the pursuit of more imaginative and ambitious energy-affordability policies such as those discussed above, the problem with such alternatives is that they are more complex and harder to achieve than a seductively simple energy price freeze. In order to achieve a socially and environmentally sound energy market it is vital that British politicians don’t let fear of complexity compromise the quality of policy.

  

'Shareholder value', short-sighted stock markets and green transition financing

'Chicago, Board of Trade II' – Andreas Gursky (1999)

While estimates of the cost of moving to a green economy vary, one thing is clear: achieving a green transition is not going to be cheap. To move to a green economic model, substantial increases in research and development in areas such as energy efficiency are necessary alongside considerable investment to replace old technologies with newer, cleaner substitutes. Such measures have large financial requirements with the UN Environment Programme estimating that 2% of global GDP (currently US$1.3 trillion per year) will be needed to finance the transition to a green economy by 2050. When confronted with such a hefty figure, the question of how to finance a green transition becomes significant and is one subject that I hope to address over the course of this blog.

Following the financial crisis, governments have found themselves facing tight budget constraints and, as aging populations continue to place upward pressure on social security expenditures, public financial resources devoted to green investments are unlikely to increase. In these circumstances, the private sector is critical to financing a green transition with some studies estimating that as much as 80% of the capital needed to address climate change issues in future decades will come from the private sector. However, despite the clear importance of private sector financing, international organisations acknowledge that there is a fundamental conflict between the long-term nature of much green investment and the increasingly shortsighted behaviour of corporations (for example see pg. 623 here and pg. 29 here). If the private sector is going to fund a green transition, this considerable barrier must be addressed.

While the causes of such corporate myopia are complex, Lazonick and O’Sullivan (2000) explain how changes in corporate governance ideologies that emerged in the 1970s and 1980s have had a major impact. The ‘shareholder value’ hypothesis argued that misaligned incentives between the owners of corporations (shareholders) and corporate decision-makers (managers) had led to falling profit rates in the US and that, in order to redress this, incentives should be aligned by tying managerial pay to stock price performance.

This practice, which has proliferated over the subsequent decades, wouldn’t in itself disincentivise green investment if stock markets were far-sighted and stock prices reflected predicted corporate profits over periods of, say, 10-25 years. The problem is that they don’t. Share prices tend to respond significantly to current period profit results indicating that contemporary stock markets are extremely short-sighted. The combination of ‘shareholder value’ corporate models and myopic stock markets has led to what has been termed ‘quarterly capitalism’: a situation in which managers are incentivised to do whatever it takes to ensure good quarterly or annual profit performance in order achieve high stock values and by consequence a nice heavy pay packet. Several studies evidence such corporate short-termism (for a summary see pg. 3-4 of Haldane 2011) with Graham et al (2005), for example, finding that 78% of a sample of executives wouldn’t invest in a project that lowered earnings below quarterly expectations even if, beyond this, it yielded increased profit.

In contrast to the short time horizons of contemporary corporations, green investments only tend to be profitable in the long run as large up-front costs are offset by efficiency gains over extended periods. In a system of ‘quarterly capitalism’, managers balk at the high upfront costs of such projects owing to the reduction in current profits they would cause. In these circumstances, substantial green investment by the private sector is unlikely.

It appears, therefore, that financing a green transition is at an impasse: private sector investment is essential but current management practices mean it is unforthcoming. Reluctance of governments and regulators to exercise their influence over the operation of financial markets makes fatalism here easy: the increasing short-termism of stock markets and managers appears as an unfortunate but inevitable development. But this belief is wrong. Haldane (2011) emphasises, there are a number of measures through which the myopia of the private sector can be redressed including, for example, making managerial pay dependent on performance over an extended period rather than annual stock prices.

Achieving a green transition is a long-term game that demands substantial financial resources. While the magnitude of these financial requirements is beyond the capabilities of the public purse, it should be recognised that action by governments is necessary in order to address the current system of ‘quarterly capitalism’. Without these measures, private institutions will continue to shun long-term investments and the green transition will remain unaffordable.