The Forgotten Assumption: Economics and the Environment

By Todd Olive, GLOBUS Editor-in-Chief

Nearly twelve months ago, this correspondent set out to answer the question ‘has economics failed?’ (Olive et al, 2018) in a prior editorial for this publication. The conclusion?

“Modern economics, with its – albeit slow – growing grasp and integration into interdisciplinary methodologies, is therefore by no means a failure: if anything, as time goes by while this correspondent writes, it is becoming less of one.”

Olive, 2018

Since then, by participating in a small degree of climate activism, this correspondent has grown increasingly concerned that, as an academic discipline and in its ‘real’ form in our world, economics is failing to address an assumption fundamental to its functioning: that everything in it relies on the environment as a basis for transactions and decisions. Provoked by a ‘climate emergency’ conference, at which economics in its 21st century form was soundly rejected by delegates, this correspondent would now like to examine this potential failing in two parts – specifically, to question the accuracy of the common definition of economics as ‘the study of the allocation of scarce resources’.

In order to do so – and as a concept to be used in the remainder of this series – we must consider ‘economics’ to refer to two disparate but highly related systems. Firstly, economic theory, the theoretical frameworks used by economists to interpret and analyse the world around us. Secondly, the ‘economy’: the intricate, invisible system that exists around and inside our lives, governing everything from the distribution of global wealth to the food on our tables. The former is purportedly an academic ‘textbook’, derived from observations of human and corporate interactions, that explains decision and transactions made in the latter – and as such, for the purposes of this series, this correspondent will consider the two as ‘one’.

The Assumption: Economics in a Natural World

The pre-requisite for identifying the assumption is in understanding that economics is fundamentally based on the environment: one of Marx’s many theories stated that economic activity is always about the conversion of so-called ‘environmental resources’.

Consider, for the sake of argument, the simplistic example of a restaurant. In this imaginary restaurant, you will find a number of broad categories of ‘things’: ingredients, furniture, tableware, utensils, and so on – not forgetting the building itself.

Food is derived, in one way or another, from nature – a straightforward point. Consider furniture, tableware, and utensils, however – aren’t these made from materials derived from our environment, too? Tables are made of wood; cutlery and utensils from metals mined from the ground; bricks or concrete, even, from some composition of clay-bearing soil, sand, lime, and so on: all of these materials are derived on the environment, or nature.

The reason that this correspondent has selected a restaurant as the scene for this explanation is because it demonstrates all three types of economic activity: primary, secondary, and tertiary. Primary constitutes anything and everything to do with resource extraction, from mining to agriculture; secondary involves the transformation of primary resources into goods, usually by manufacturing; tertiary is any form of service-based activity. In our restaurant, primary activity provides materials and ingredients, secondary activity (construction) provides the venue, and tertiary activity (cooking and table service) provides the actual meal.

Conventional economics and business defines four so-called ‘factors of production’ as critical to every economic activity: land, labour, capital (equipment) and enterprise (the entrepreneur’s ‘vision’). As this ‘theory of environmental economics’ extends, in ways that are perhaps sometimes difficult to conceive, to all corners of the economy, it could perhaps be said that the environment is the fifth (or, indeed, only) of these ‘factors of production’.

This theory extends, in ways that are perhaps sometimes difficult to conceive, to all corners of the economy. Economics is sited in a world that is fundamentally natural: everything in it relies on the environment as the single most important foundation of transactions and decisions.

The Flaw: The Economics of Pollution

In and of itself, the fact that economics is grounded in the distribution of environmental resources is, perhaps, not a problem: neither is the fact that this assumption is largely unacknowledged in economic literature and analysis. Rather, that this assumption goes unacknowledged allows economic processes to degrade and destroy the environment through overconsumption.

All economic activity, in some way, is responsible for environmental impacts, through the direct degradation of ‘environmental resources’ – either by consuming them or polluting them: land-based resources, including green spaces, may be “consumed” by mining or agriculture, while industrial water or air pollution degrades quantities of clean water or clean (from toxins or greenhouse gases) air.

Conventional economics fails to account for this in cost pricing, as these effects are considered ‘external’ to the transactions involved: their impacts are on resources not “owned” by any identifiable and finite individual or group, or may be in forms that are difficult (or impossible) to assign values to. As such, for example, if the cost of carbon emissions is not factored into a mechanised manufacturing process, each individual unit will have a lower cost: assuming that goods are produced to traditional profit maximising conditions (i.e. in a competitive market, produce until the cost of the next unit of production equals the price that the next consumer is willing to pay), more units will therefore be produced – culminating in a level of output that is above the ‘optimum’ level.

Economics attempts to capture this through the concept of valuable ‘externalities’, such as the enhanced greenhouse impact of carbon dioxide emissions, which transforms private (i.e. traditional) prices into social prices. Some might argue, as a result, that economics has, in fact, dealt with this particular aspect of its failing: the devil, however, is as ever in the detail. While this form of analysis does indeed exist, this correspondent has yet to see it employed in a core conventional theory that does not explicitly address externalities; effectively, it is seen as an ‘extra’, ‘taped on’ to some analyses depending on context. The assumption therefore remains implicit and unacknowledged: the vast majority of conventional analysis focuses solely on private prices. In the real world, economics can only realistically implement social costs by forcing economic agents to pay social prices: either by taxing polluting or degrading activity directly, or creating some kind of ‘market’ that restricts the total amount of degradation, forcing individual actors to pay escalating prices for the privilege. An example of the latter is found in the form of the European Union’s Emissions Trading Scheme.

Above and beyond this, however, the greatest conceptual and material threat of this degradation is derived from the difficult-to-imagine principle that all natural environmental systems are interconnected in a complex web of physical, chemical, and behavioural relationships.

While too complex to document in depth in this piece, an update by Steffan et al (2015) of the ‘planetary boundaries’ framework conceived in 2009 by Rockström et al provides a relevant lens, stating that climate change and ‘biosphere integrity’ are “highly integrated, emergent system-level phenomena that are connected to all of the other [planetary boundaries]”: essentially, that all of the environmental systems critical for life, particularly human life, on Earth, are fundamentally interconnected – particularly to climate and the biosphere.

The most important takeaway from this is that, as these so-called ‘Earth systems’ are highly interconnected, linear changes to input of pollution or extraction of environmental resources can lead to non-linear impacts on environmental systems – not to mention feedback loops inside individual systems that can cause non-linear changes internally, before impacts on other Earth systems are considered.

While, in theory, externality analysis could be adapted to account for these non-linear impacts – by, for example, introducing a progressive tax rate on carbon emissions that increases with quantity of emissions – economics in its current form, both theoretical and real, entirely fails to account for this. ‘General equilibrium’ models, in theory intended to address macroeconomic, market-wide impacts, ignore the environment; by and large, economic agents are allowed relatively uncontrolled access to resources, and are unfettered in their pursuit of greater sales and higher profit margins.

It is important to note, here, that economics education has much to answer for here. Conventional economic teaching – particularly that practiced by and large at the University of Warwick – is based on a set of ‘universal first principles’, underpinned by a vast set of simplifying assumptions, that students are asked to take at face value, internalise, and be able to regurgitate at a moment’s notice. All of this is supposedly to provide a ‘foundation’ for future learning – if a student so wishes, in the field of practical, real-world economics. As a consequence, however, many are left stuck inside a broadly neoclassical, neoliberal-esque world of economic theory – a situation that stifles creative thought, and holds back the entire profession from developing true solutions to problems such as the environmental assumption.

In conclusion?

Economics is sited in a world that is fundamentally natural: everything in it relies on the environment as the single most important foundation of transactions and decisions. As this correspondent has intended to demonstrate, however, this is an assumption that goes unrecognised, leaving humanity to run rampant over our only home.

As ‘the study of the allocation of scarce resources’, therefore, has economics failed?

Given the environment is a scarce, finite resource, given that economics, by its nature, consumes and degrades it, and given that it fundamentally fails to recognise that this is the case, this correspondent would like to change his previous conclusion: yes, economics has failed.

Does it have any saving graces? Is there any way that we can salvage the discipline, perhaps co-opting it into supporting sustainable outcomes? This correspondent will consider these questions, and more, in the remainder of this series.

Header Image: Photo by NeONBRAND on Unsplash

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