SUSTAINABLE ECONOMICS

Posted by & filed under .

Pages 171~195 of the pdf book titled “The Ethics of Sustainability”

Charles J. Kibert
Leslie Thiele
Anna Peterson
Martha Monroe

Downloadable pdf book at:

http://www.google.co.jp/url?sa=t&rct=j&q=The%2Bsystem%2B(Capitalist%252Fprofit%252Fmonetary)%2Bitself%2Bis%2Bbased%2Bon%2Bcompetition%2Bwhich%2Bimmediately%2Bdestroys%2Bthe%2Bpossibility%2Bof%2Blarge-scale%2Bcollaborations%2Bfor%2Bthe%2Bcommon%2Bgood%252C%2Bhence%2Bparalysing%2Bany%2Battempt%2Bat%2Btrue%2Bglobal%2Bsustainability.&source=web&cd=26&ved=0CNkBEBYwGQ&url=http%3A%2F%2Fwww.cce.ufl.edu%2Fcurrent%2Fethics%2FEthics%2520of%2520Sustainability%2520Textbook.pdf&ei=Hh2oTs7bDczumAXrv_GkDw&usg=AFQjCNGNv4FlSG2_cnccfNM_K0nWNXA9pQ&sig2=hzCoC23GIA_1jMCaN8GxlQ

 

P.171

SUSTAINABLE ECONOMICS

A new economic theory, ecological economics, is evolving to support sustainability and
plays such a key role that it is sometimes referred to as the science of sustainability.1

Ecological economics emerged in the late 1980’s after two decades of gestation as an
economic theory whose principles support sustainability.2

Capitalism, the dominant economic system in the world, clashes with the concept of sustainability over several
issues, but especially over the role of the global ecosystem in the economy. Consequently
the contemporary economic theory underpinning capitalism, neoclassical economics, is
deficient when sustainability is being used as the guiding framework for shifting to a state
in which the economy produces goods and services, yet also protects and nurtures natural
and social systems.

The contemporary economic system is dominated by capitalism.  Capitalism is a
relatively simple concept – it is based on private ownership of capital, assets that can be
used to produce yet more assets.  Capital has several forms: financial capital or money;
physical capital such as buildings or machinery; human, social, and cultural capital,
assets that include knowledge, cooperation and collaboration, and the important artifacts
of society that may include art, music, architecture and traditions; and natural capital,
which may be thought of as nature, the environment, and ecosystems.  Capitalism focuses
principally on the first two types of capital: financial and physical. Sustainability, while
considering all forms of capital, maintains that natural capital must not be degraded.
Where ecological economics values nature as one of the key factors in the quality of life
for future generations, capitalism treats nature as simply a factor of production.
Neoclassical economics models the production system as a black box with inputs and
outputs. It considers nature and natural resources to be unbounded and infinite while
ecological economics understands the Earth to be finite with limited resources and fragile
ecological systems that are critical for the survival of all forms of life.  Neoclassical
economics assumes the Earth has infinite capacity for absorbing the waste generated from
production and consumption; ecological economics considers that nature has a limited
capacity to absorb some types of waste while others are unacceptable because they pose a
threat to life.

The focus of ecological economics is on the important role that nature and natural
systems play in the economy.  In a paper by Robert Costanza and his colleagues in 1997,
they estimated the economic value of the world’s ecosystems.  Published in Nature, the
article estimated this value as $33 trillion, with a range from $16 trillion to $54 trillion at
a time when the total global Gross Domestic Product was $27 trillion.3  This result meant
that the value of the world’s ecosystems at that time was 1.8 times greater than global
economic output.  A wide range of ecosystem services are free and would have to be
replaced with high cost technology if the ecosystem were damaged to the point where
these services were compromised.  For example, the pollination of wine grapes by bees in
Europe was estimated as a free service worth $2 billion because that would be the labor
cost of manually pollinating the flowers.

In comparing ecological and neoclassical economics, the major differences are:
1.  Ecological economics views human society as a subset of the sustaining global
ecosystem.  Neoclassical economics ignores both systems and focuses only on human
production and consumption.

2.  Ecological economics acknowledges that the global ecosystem, including humans,
obeys the physical laws of thermodynamics (which physicists refer to as the supreme
laws of nature) as well as the laws of ecology.  Neoclassical economics is silent on
physics and ecology but does make extensive use of mathematical models which treat the
economy as a black box of inputs and outputs.

3.  Ecological economics recognizes that the global ecological-economic system is highly
complex, non-linear and continually evolving and that simple answers or models to
difficult questions rarely exist.  Neoclassical economics does not address the role of the
ecological system in the economy.

4.  Ecological economics requires a systems approach to economic theory and decision
making in order to address modern economic challenges and opportunities.  Neoclassical
economics is fairly simplistic, focusing on one issue, business.   Milton Friedman, an
American winner of the Nobel Memorial Prize in Economics in 1976, clearly articulated
its relatively simple outlook when he said, “The business of business is business.”

This chapter will define and describe ecological economics, its history, the key
principles, and its current state, and its role as in supporting sustainability. The
emergence of Corporate Social Responsibility is also described because it dovetails with
the intent of sustainability and the principles of ecological economics.

FROM CLASSICAL ECONOMICS TO ECOLOGICAL ECONOMICS
Economics emerged in the latter half of the 18th century during a time of great social
change and scientific discoveries. Science brought with it the potential for new
technologies and improved quality of life, particularly in a material sense.  And the result
was a conflict between larger social goals and the ability of individuals to gain material
security.  The first questions addressed by economics were moral questions regarding the
rights of the individual to material gains versus the greater social good.  Thus the notion
of the “invisible hand,” by which markets guide individual behavior to achieve the
common good, emerged.  Economics was one of the first examples of transdisciplinary
scholarship in which social science and scientific progress were examined together to
gain a better understanding of the functioning of the system of exchanging goods and
services. Ecological economics has its roots in classical economic theory but did not
emerge as a separate discipline until the late 20th century when the development of
ecological theory flourished.4 The work of Thomas Malthus and David Ricardo, both of
whom suggested limited resources and limited quality agricultural land would set limits
on the human population, mark the beginning of an alternative view of economics which
eventually evolved into ecological economics.  In the mid-19th Century John Stuart Mill
argued that the economy had to be based on rules or property use and a sense of social
responsibility that favored the common good.  Karl Marx added to the debate by

criticizing capitalism for the accumulation of land and capital by a small fraction of the
population.  W. Stanley Jevons was one of the first economists to recognize the role of
energy in the economy.  Also in the later 19th Century, the science of ecology emerged
with Ernst Haeckel providing the first definition in 1870. Ecology emerged as a practical
science in the first two decades of the 20th Century.  Both ecological systems and the
interaction of humans with ecological systems were addressed, particularly the
interaction of the economy with nature.  In the 1920s Alfred Lotka was the first to
integrate ecology and economics in a scientific manner, arguing that nothing could be
understood without understanding the entire system of biotic and abiotic components,
including those produced by humans. Based on the work of Lotka and others, Arthur C.
Pigou articulated the concept of externalities, forces that are external to markets and do
not affect how they operate, but have impacts on society and nature.   The logic of
exploitation of resources was explained by Howard Hotelling and the conditions under
which conservation or depletion would occur.  The following paragraphs provide a more
detailed explanation of the work of these key figures in the history of ecological
economics, along with brief description of the work of key contemporary figures in the
evolution of ecological economics such as Kenneth Boulding, Herman Daly, and Robert
Costanza.

The Advent of Economics: Adam Smith (1723-1790)
Adam Smith, who was a moral philosopher, is generally considered to be the founder of
modern economics and was the originator of the “invisible hand” metaphor about how
markets function.  The key ethical question he attempted to address was whether or not
individual greed could be in the best interest of society.  He reasoned that if two
individuals making a transaction were fully informed of the consequences of their
decisions, then both would be better off because both were achieving a desired outcome.
Thus the “invisible hand” was posited to be in the background, an extension of the
Almighty, guiding the economic system for the good of society. Although Adam Smith
was a moral philosopher, his concept of economics made morality less important as
individuals were free to pursue their greed.  An improved materials well-being had an
important negative effect, the detachment of individuals from their supporting
communities. Prior to this era the individual depended on community and their
relationships with others in the community for their survival.  With the advent of
essentially unbridled pursuit of individual well-being and quality of life, community
relationships were less important.  And with the breakdown of these relationships came
the breakdown of humanity’s relationship with nature because the pursuit of wealth
permitted the exploitation of everything needed to increase wealth and material benefit.
At the start of the 21st Century the sustainability framework is still striving to reinstate
nature and community as vital links to quality of life and community.

Carrying Capacity: Thomas R. Malthus (1766-1834)
Another important figure in early economic thinking was Thomas R. Malthus who for the
first time suggested that famine and war were not the result of Divine providence, but
could instead be traced to human behavior and thinking.  His basic argument was that
human population could not continue to increase at an exponential rate because food and
other items needed for human survival would quickly prove to be inadequate to support a

large and rapidly growing human population.  Even though he assumed that the food
supply could be expanded somewhat, he suggested that due to technological advances,
the supply could only grow arithmetically, unable to keep up with the exponential
expansion of human numbers.  The end result would be wars over food and other
resources and the human population would be forced to shrink until it could be supported
by available resources.  Malthus’ model has never been fully demonstrated on a global
basis but there have been several regional examples where population outstripped the
resource base and went through a period of decline.  The Great Hunger in Ireland in the
1840s and the civil war in Rwanda in the late 1980s were at least in part due to
overpopulation and local food shortages.  His model influenced the development of
economic theory – for example, John Maynard Keynes used it to explain the rise and fall
of the business cycle and the control of product inventories.  Malthus’ model is important
from a sustainability perspective because it emphasizes the finite size of the earth, its
limited resources, and the impacts of population and consumption on the planet’s health.
It also introduced the concept of carrying capacity for the first time, still an important
concept that is central to the sustainability concept.

Resource Quality: David Ricardo (1772-1823)
David Ricardo introduced another model of economic system behavior that related to the
environment.  His model was an attempt to justify how landowners received a ‘rent’ or
income from land ownership due to the value of the crops grown on the land.  He
modeled how the more fertile and valuable land would be farmed first and receive a
higher rent because it could produce the most output for the least labor input.  Less
productive land that would be farmed later as valuable land was depleted would require
far more labor and there would be less of a margin between the rent and the value of the
crops.  The model showed how increasing population would force people to farm in less
favorable areas, and how previously undisturbed land would be eventually farmed. It also
provided insights into how technology such as pesticides and fertilizers would eventually
be needed to maintain production to justify the rents.  His work showed how changes in
food prices could lead to new farms, farm failures, and the farming of marginal land.  It
also described the interplay between population growth and food prices, and the role of
ecological systems in human survival.  Ricardo’s work also foreshadowed the conflict
between neoclassical economics, which largely ignored the role of ecological systems in
the economic system, and ecological economics for which nature and the environment
are central to a healthy economy.  It also set up the battle between the unlimited
economic growth mindset of conventional economic thinkers and the finite planet and
resource assumptions built into ecological economics.  While Malthus suggested the
concept of carrying capacity, Ricardo carried this thinking a step further by suggesting
that the next available resources would be of lower quality.  The result of their joint work
was the labeling of economics as the “dismal science.”

The Steady State: John Stuart Mill (1806-1873)
The son of social philosopher James Mill, John Stuart Mill was one of the early
economists.  His notion was that the common good was of the utmost importance and that
the economy had to be based on rules of property use and social responsibility.  He also
believed that material prosperity should not be an end in itself and that continuous growth

in material well-being was impossible.  He understood that natural capital had to be
protected and that humans had to mindful about converting natural capital into financial
or manufactured capital.  He also argued for the protection of biodiversity and suggested
that a steady-state economy was possible in which the economy stopped growing and the
extraction of natural capital was maintained at a level consistent with the ability of nature
to provide renewable resources.  The notion of a steady-state economy was later
elaborated by Herman Daly in the 1980s.  Mill was also concerned with the social ills of
the time, particularly the subjugation of women, considering it to be both immoral and an
enormous waste of talent.  His work and thinking foreshadowed the current concept of
sustainability as the balancing of Earth’s natural, social and economic systems.

Ownership of Resources: Karl Marx (1818-1883)
Karl Marx is best known for his many critiques of capitalism and one of the issues he
addressed in these critiques was resource ownership and resource distribution.   Marx
suggested that the concentration of capital in the hands of the few was not sustainable and
would have consequences, the ultimate consequence being the decay of capitalism.   One
of his major contributions to economic theory was the Labor Theory of Value in which he
argued that the value of commodities was tied to the value of the labor needed to produce
them.  Contrary to popular belief he did not believe that labor was the only value.  Marx
noted that nature was also an important source of value: “Labor is not the source of all
wealth. Nature is just as much a source of use values (and it is surely of such that material
wealth consists!) as labor which is itself only the manifestation of a force of nature,
human labor power.”5  He wrote that one of the consequences of misdistribution of
resources would be poor farmers working the property of rich land owners, without any
motivation to tend to the long term health of the land because it was not theirs.  The
landowner would then have to invest considerable resources to monitor the farmer, either
expending their own time or diverting management resources to ensure the productivity
of the property is maintained.  Marx maintained that for there to be social justice, the
equitable distribution of resources must be considered to be very important, both initially
and in the allocation of resources over time.

Resource Scarcity: W. Stanley Jevons (1835-1882)
W. Stanley Jevons is an important figure in the emergence of ecological economics
because of his recognition of the critical importance of energy in the economy. In 1865
Jevons wrote the The Coal Question which drew attention to the gradual exhaustion of
Britain’s energy supplies in the form of coal. It was in this work that he coined the phrase
Jevons’ Paradox (also called the Jevons Effect). England’s increased consumption of coal
after the introduction of James Watt’s more efficient coal-fired steam engine led to an
increase (rather than a decrease) in the rate of consumption of coal. In effect, the Paradox
called attention to the counter-intuitive result that increasing the efficiency of resource
use can lead to its accelerated depletion.  This phenomenon is now called the rebound
effect and it has been observed in the increased consumption of gasoline due to the
introduction of highly fuel efficient hybrid cars.6  Some research indicates that one of the
forces driving the increase in the size of the American home has been improvements in
heating, cooling, and lighting technologies which permit the operation of a larger house
at relatively low cost.  Although Jevons’ Paradox and the rebound effect have been

applied to energy resources, it is though that the general effect also governs
improvements in the efficient use of resources in general.

The Emergence of Ecology: Ernst Haeckel (1834-1919)
Ernst Haeckel is credited with coining and defining the concept of ecology in 1866: “By
ecology we mean the body of knowledge concerning the economy of nature—the
investigation of the total relations of the animal both to its inorganic and to its organic
environment including above all, its friendly and inimical relations with those animals
and plants with which it comes directly or indirectly into contact—in a word, ecology is
the study of all those complex interrelations referred to by Darwin as the conditions of
the struggle for existence.” Haeckel noted that ecology is the study of the economy of
nature, while economics was the study of the ecology of humans. Various definitions of
ecology evolved over time, with the eventual focus being on the relationships of
organisms to their environment. Haeckel, a trained physician who abandoned his practice
in 1859 and later became a professor of comparative anatomy in 1862, was also famous
for having discovered, described, and named thousands of new species, mapping a
genealogical tree relating all life forms, and coining many popular terms in biology still
in use today.

Systems Thinking: Alfred Lotka (1880-1949)
Alfred Lotka had a broad range of interests including chemistry, physics, biology and
economics and is primarily known today for formulating the Lotka-Volterra equations of
population dynamics, also known as the predator-prey equations.7  These equations, a
pair of first-order, non-linear, differential equations, were introduced by Lotka in order to
describe the dynamics of biological systems in which two species interact. He was the
first of his time to attempt to integrate ecological and economic systems in quantitative
and mathematical terms.  His view of the world as biotic and abiotic components acting
as a system, where everything was linked together and nothing could be understood
without an understanding of the whole system, influenced both ecologists and economists
of his time. Lotka is also well known for his development of systems criteria to drive
evolution, also called Lotka’s energy principle or Lotka’s power principle, stating that
systems survive by maximizing their energy flow. According to Lotka, “The principle of
natural selection reveals itself as capable of yielding information which the first and
second laws of thermodynamics are not competent to furnish. The two fundamental laws
of thermodynamics are, of course, insufficient to determine the course of events in a
physical system. They tell us that certain things cannot happen, but they do not tell us
what does happen.”  Howard T. Odum, a systems ecologist, used Lotka’s work to
develop The Maximum Power Principle which Odum and others claimed was essentially
the Fourth Law of Thermodynamics.  Lotka’s energy principle foreshadowed the
development of general systems theory as well as the later reintegration of ecology and
economics.

Market Failure: A.C. Pigou  (1877-1959)
A.C. Pigou is best known for his work with welfare economics. His Wealth and Welfare,
published in 1912, drew attention to welfare economics and conveyed his perception that
governments could internalize externalities through implementing a combination of taxes

and subsidies in order to correct market failures. Pigou’s work is described below in the
section, Shifting the Burden: Internalizing the Externalities.

The Efficient Use of Resources over Time: Harold Hotelling (1895-1973)
Harold Hotelling was a mathematical statistician who developed a model that examined
and described the conditions governing resource conservation or depletion.  He was
particularly interested in what he called exhaustible or non-renewable resources.
Hotelling described a situation where an owner of land containing mineral resources
could choose either to mine the resource or to leave it in the ground to be mined in the
future.   For a rational owner, the decision of when to mine is a function of the bank
interest rate versus the appreciation of the resource.  If the perceived appreciation in the
value of the resource is greater than the interest rate, the prudent owner would choose to
leave the resource in the ground.  Similarly if the interest rate was thought to be greater
than the forecasted appreciation rate, the owner would likely mine the resource and put
the money in the bank.   For renewable resources Hotelling’s model describes a similar
scenario.  For low interest rates, owners of a renewable resource such as trees in a forest
would increase the rate of harvest as the interest rate increases.  At some point the rate of
harvest, driven by increasing interest rates, will exceed the regeneration rate of the forest,
resulting in its decline. Clearly the expected interest rate and expected future price of a
resource are crucial in deciphering how biological resources should be managed. High
interest rates may lead to depletion and the loss of biodiversity while low interest rates
favor a conservation strategy.  According to Hotelling’s model, a species that is not
generating a flow of services at a rate greater than the rate of interest “should” be
depleted. This raised questions among many economists as the concept of extinction is
certainly a highly controversial outcome.  The debate over the impact of capital market
strategies on resource depletion continues as does the role of discount rates in decisions
about resource conservation versus harvesting.

Energetics and Systems: Georgescu-Roegen (1906-1994)
Georgescu-Roegen is best known for his contribution to ecological economics through
his magnum opus, The Entropy Law and the Economic Process (1971). Georgescu-
Roegen claimed, based on the Second Law of Thermodynamics, that the economy faces
limits to growth, an assault on one of the key tenets of neoclassical economics.  By
subjecting the economy to the constraints posed by the Second Law, he challenged the
assumption of unlimited economic growth, deeming it impossible based on the laws of
physics.  His insights gave birth to a new discipline called evolutionary economics, a
school of thought inspired by evolutionary biology, which stressed complex
interdependencies and resource constraints.

Spaceship Earth: Kenneth Boulding
The Economics of the Coming Spaceship Earth (1966) by Kenneth Boulding described a
shift in thinking about human welfare.8  In this paper Boulding contrasted the “cowboy
economy” which views the economy as existing in an open and unlimited system, to the
starker reality of a “spaceman economy” in which the economy resides in a closed
system, similar to a spaceship.  In the cowboy economy, consumption and production are
good, resources are unlimited, and success is measured by throughput, that is, the greater

the rate of consumption and production, the more successful the approach.  In the cowboy
economy, the concept of Gross Domestic Product (GDP) measures throughput, unable to
discern the consequences of resource depletion and waste generation. For example, the
Exxon Valdez disaster in March 1989 resulted in an oil spill of 11 million gallons which
contaminated 1,300 miles of coastline.  The cleanup cost of $1.3 billion increased GDP
by that amount. In the spaceship model, the planet is finite, resources are limited, and the
waste resulting from production and consumption affects life and health.  In the latter
metaphor the Earth is likened to a spaceship with humanity as the crew, the only
resources are those onboard, and any waste will affect the occupants unless recycled into
useful products. Boulding’s thinking which emphasizes an economy powered by
renewable energy, materials from renewable resources and recycling, and the careful
consideration of the impacts of waste, has become an important aspect of ecological
economics

Emergence of Ecological Economics: Herman Daly (1938 – )
Perhaps Herman Daly’s most recognized contribution to ecological economics is his
Steady State Economics (1973) which acknowledged that the earth is materially finite and
the economy is a subset of this finite system. Daly also further expanded the transition in
the concept of economics by discussing economics as a life science rather than a physical
science. This fundamental change in the perception of what economics entails led to a
new perspective regarding resource conservation and biological conservation.
Valuing Nature: Robert Costanza (1950 – )
Robert Costanza is well known in the field of ecological economics for his work focusing
on the interface between ecological and economic systems. His research expands on this
interface at larger temporal and spatial scale and includes landscape level spatial
simulation modeling, analysis of energy and material flows through economic and
ecological systems, valuation of ecosystem services, biodiversity, and natural capital, and
analysis of dysfunctional incentive systems and ways to correct them. Throughout his
publications Costanza discussed the local politics of global sustainability and outlined
goals, agenda and policy recommendations for ecological economics. One of his main
efforts has been to encourage the integration of the natural and social sciences among
decision makers.

THEORY AND PRINCIPLES
Ecological economics is a transdisciplinary field that draws from neoclassical economics,
ecology, and physics.  Consequently the still emerging theory of ecological economics
reflects the influence of these fields.  Unlike neoclassical economics which treats the
environment as an external factor of production, with unlimited resources and infinite
waste assimilation capacity, ecological economics makes natural systems the central
issue of economics, with particular emphasis on the limits to nature’s productivity and its
ability to absorb the debris from human production and consumption.  It addresses the
value of nature to the economy by virtue of the wide range of essentially free services
provided by nature.  It also examines the connections of environment and economy to
carrying capacity, health, biodiversity, poverty, population, and quality of life, to name
but a few.  The following paragraphs describe the theory and major principles that are part of the fabric of ecological economics.

The Global Ecosystem and the Economic System
A good starting point for rethinking economic theory to align it with sustainability, is the
reality that the economy does not exist as an independent, open system just with
production inputs and product outputs.    The economy resides in a system, the Earth,
which is largely closed except for solar energy and some incoming matter in the form of
meteors and other space debris.  All of the matter and most of the energy that are inputs
to the neoclassical black box model of the economy come from the global ecosystem and
even the workforce factor of production is totally dependent on the health and
productivity of nature.  The depletion of resources and generation of waste from
extraction of resources, disposal of waste and end of life products, energy and chemical
intensive agriculture, and the emissions from power production and factories all degrade
natural capital.  The main activity of the economy is the transformation of the earth and
natural production by its inputs and outputs.  And as currently operated the economy is
not capable of preserving intact the productivity of nature.  Degradation of natural capital
can only lead to higher costs for capitalism and reduced profits.  The economy’s
degradation of its own means of production is clearly a contradiction because it cannot
grow forever while destroying key inputs.  In his book, The Enemy of Nature: The End of
Capitalism or the End of the World?, Joel Kovel describes an ecological crisis resulting
from the economy’s degradation of its own conditions of production at an ever increasing
scale.   He notes that, “This degradation will have a contradictory effect on profitability
itself…either directly, by so fouling the natural ground of production that it breaks down,
or indirectly, through the reinternalization of  the costs that had been expelled into the
environment.”9

Herman Daly describes this contradiction by contrasting the Empty World versus the Full
World model. In the Empty World, the economy is relatively small and it resides in the
global ecosystem with relatively small effects, creating what economists call welfare or
quality of life for people.  As the economy grows it occupies more and more of the global
ecosystem until it reaches the physical limits of resources and waste disposal, the result
being that production drops off and welfare decreases.  The problem posed by ecological
economics is how to determine the scale of the economy relative to the global ecosystem
such that welfare is maximized.10

Natural Capital and Substitutability
In neoclassical economics, capital is one of several factors of production, the others being
labor, land, organization, and management.  Capital is not just money but also factories,
machinery and infrastructure.  In the past several decades the notion of capital has
evolved to include human capital, social capital, and cultural capital.  Ecological
economics adds a form of capital to economics that was not previously considered,
namely natural capital.  Natural capital can be defined as any stock of natural resources or
environmental assets, such as oceans, forests or agricultural land, that yields a flow of
useful goods and services now and in the future.  One of the problems for the concept of
natural capital is that, unlike the other forms of capital used in production, it has no
monetary value.  As noted earlier, in 1997, a group led by Robert Costanza attempted a
valuation of the global ecosystem and concluded that the value of the services provided

by natural systems was about $33 trillion.  Half of the value went to nutrient cycling. The
open oceans, continental shelves, and estuaries had the highest total value, and the
highest per-hectare values went to estuaries, swamps/floodplains, and seagrass/algae
beds.

Clearly natural capital does have value but the question of how much of this critical asset
must be maintained is a difficult and unresolved question.   In addressing this issue, there
are two extreme points of view.  At one pole is Weak Sustainability, the province of
neoclassical economics, whose adherents suggest there are substitutes for natural capital
and that what is important is to maintain the combined total stock of human-made and
natural capital.  At the other pole is Strong Sustainability whose proponents argue that
other forms of capital cannot replace natural capital and that, even more importantly,
some forms of natural capital are critical and truly irreplaceable.  The ozone layer
protecting the Earth from ultraviolet light is an example of what may be called critical
natural capital.  Consequently proponents of Strong Sustainability advocate that the stock
of natural capital must be maintained and must not be degraded.

The issue of substitutability of physical capital for natural capital is an important issue
ecological economics.  Neoclassical economics suggests that the substitution of one form
of capital for another is doable, for example natural resource assets can be replaced with
produced assets, such as human and physical capital, on a dollar for dollar basis.
However natural capital is not only a factor of production in an economic sense, it also is
often the very basis of societies and the well-being of the society.  The loss of natural
capital, for example an entire ecosystem, surely cannot be made up with an increase in
physical capital.  Agriculturally productive prime farmland displaced by development
and covered with buildings and infrastructure has no real substitutes that are not
extremely costly and energy intensive. Some forms of natural capital are indeed critical
and it would be prudent for society to hedge its bets by implementing policies that are
very protective of all natural systems.  As Robert Costanza and Herman Daly noted, “A
minimum necessary condition for sustainability is the maintenance of the total natural
capital stock at or above the current level. While a lower stock of natural capital may be
sustainable, society can allow no further decline in natural capital given the large
uncertainty and the dire consequences of guessing wrong. This ‘constancy of total
natural capital’ rule can thus be seen as a prudent minimal condition for assuring
sustainability, to be relaxed only when solid evidence can be offered that it is safe to do
so.”11

The Scale of the Economy and Carrying Capacity
The size of the economy directly affects the global environment and ecosystems because
virtually all the materials and energy resources needed for economic production have
their origins in nature or in geologic structures which underlie and support natural
systems.  In general, the rate of destruction of natural systems and structures is directly
proportional to the scale of the economy, the larger scale, the greater the mass of
materials movement.  Determining the upper boundary of the size of the economy is an
important issue for ecological economics because at some point the natural systems
which support life may be so severely impacted that the delivery of important services

such as clean air, potable water, and food may be compromised.  When the scale of the
economy is being addressed, the scale of the human population is also an important issue
because more people place more demand on resources.  The Earth’s human population
carrying capacity, first addressed by Thomas Malthus, is a central concern of ecological
economics because, by definition, exceeding this limit indicates the onset of severe
destruction of natural systems, not to mention severe consequences for humanity.

A good index of the scale of human impact on nature is the percentage of photosynthetic
production that has been appropriated for human use.  The term, net primary production
(NPP), can be used to help determine the scale of these impacts.  NPP is the amount of
solar energy captured by primary producers, less that used in their growth and
reproduction.  According to a 1986 study led by Peter Vitousek, humans were
appropriating about 25% of total NPP (includes both terrestrial and aquatic production).12
Of the terrestrial NPP, humans were appropriating about 40% of the total production.
Since the appropriation of NPP is likely proportional to population, with one doubling of
the then human population of 4.9 billion, almost all the terrestrial NPP would be used by
one species, humans.13 When world population reaches 7.0 billion the likely human
appropriation of terrestrial NPP will be about 60%.  The problem of course is that no one
can predict the consequences of this cooption on global ecosystems.  However, it is likely
that the diversion of terrestrial and aquatic resources for human use is contributing to the
widespread extinction of species and genetically distinct populations, and the genetic
impoverishment of many others.  It should be noted that NPP appropriation is
proportional to per capita income, with richer countries consuming far more NPP per
capita than poorer countries.

Humans are also appropriating enormous quantities of the natural flow of water on the
planet for their uses, much of it connected to the economy.  In 1996, a research project
led by Sandra Postel found that total sustainable potable water available to the earth’s
land mass was about 110,000 km3, comprised of 70,000 km3 of evapotranspiration (ET)
by plants and 40,000 km3 of runoff (R).  Of the R portion, only 12,500 km3 is actually
available (AR)  for human use due to temporal and geographic factors.  At the time of the
research it was found that humans were appropriating 26% of ET and 54% of AR for
their own uses, or about 30% of all the potable water powered by the natural water cycle.
Because water consumption is roughly proportional to population it is likely that at
present 40% of ET and 60% of AR are being used to meet human needs.14

Non-renewable resources are key ingredients of the human economy, from fossil fuels
such as coal, oil, and natural gas to metals such as iron, copper, and aluminum.  Some
non-renewables are indeed being regenerated, but at a rate so slow that for all practical
purposes the regeneration rate is zero.  Fossil fuels are an example of this latter case.
Non-renewable resources are all dwindling and as the rich deposits are depleted, ever
more energy is required to remove more dilute, lower concentrated, and distant deposits.
The extraction of iron ore, for example, requires the removal of overburden and the
extraction of the rock containing the iron ore.  As the rich deposits of iron ore are
exploited, the remaining sources have lower concentrations of ore, requiring even more
overburden and rock removal.  A concentration of 0.1% iron ore requires 10 times more

materials movement than a deposit with a concentration of 1.0% iron ore.  Thus the
combination of economic growth and the exhaustion of high concentration deposits
results in an exponential rise in materials movement and natural system destruction.   The
phenomenon of mass materials movement to extract non-renewable resources is
sometimes referred to as the ecological rucksack.  The ecological rucksack of a material
is defined as the total mass of materials movement required to obtain a unit mass of the
material.  For example, the ecological rucksack of aluminum is 85 because 85 kilograms
of materials must be extracted and processed to produce 1 kilogram of aluminum. In
comparison the ecological rucksack of recycled aluminum is 3.5 while that of gold
extracted from ores is 350,000.15

Renewable resources are also inputs to the economy and the desired utilization of these
resources to maintain a sustainable economy is to extract them at a rate that is equal to
the regeneration rate of the resource.   Sustainable forestry, for example, relies on good
management practices in which wood is extracted from the forest not only at its
regeneration rate, but also in a manner that will not cause damage to the ecosystems of
which the forest is a part.  Sir John Hicks, a winner of the Nobel Prize in economics,
defined sustainable income, sometimes referred to as Hicksian Income, as the maximum
amount that can be produced and consumed in the present without comprising the ability
to do likewise in the future. He specifically defined sustainable income as the maximum
amount that a person or a nation could consume over some time period and still be as
well off at the end of the period as they were at the beginning.16  When applied to
renewable resources this could be interpreted as using the surplus or interest of the
natural system, rather than consuming the core of the natural system itself.

Of course the economy consumes both renewable and non-renewable resources and by
definition non-renewable resources are being depleted while renewable resources, with
sustainable management can be consumed indefinitely.  In the context of sustainability,
there are practical and ethical questions about the consumption of non-renewable
resources in the sense that, once consumed, they are unavailable for future generations.
Even with aggressive recycling programs, non-renewable resources are lost in each cycle
of recycling, dissipating into the environment at their background concentration.  J.
Hartwick  suggested that some of the income from the sale of non-renewable resources
should be invested in the expansion of renewable resources.17  This is commonly refer
For example, a country such as Saudi Arabia with large deposits of oil, could invest some
of the income from its sale into the education of its citizens, thus creating a renewable
resource, an educated population that can develop a diverse economy to substitute for one
based on a finite resource.

Shifting the Burden: Internalizing the Externalities
Production produces pollution and waste, almost always with negative and often
unintended and initially unknown consequences for people and the environment.  Air,
water, and solid emissions affect health and contribute to the degradation of ecosystems.
Neoclassical economics presumes that the global ‘commons’ are free with respect to
emissions and waste and thus they are not factored into the cost of production. In
ecological economics these emissions are often referred to as externalities or negative

impacts of an activity on a third-party without compensating them.  In a broader sense
externalities can impact ecosystems as well, for example the degradation of forests by
acid rain.  Until relatively recently, companies were unconcerned about their discharges,
their waste disposal, or the consequences on communities or ecosystems.  Human history
is littered with examples of this pattern of behavior, from the Love Canal in New York
where 21,000 tons of buried toxic chemicals which were discovered in the late 1970s, to
the Bhopal accident in which 6,000 people were killed in India in the 1980s, the Exxon
Valdez accident of 1989 which caused untold damage to the ecosystems of Prince
William Sound in Alaska, not to mention past episodes with DDT, PCBs, and a wide
variety of other toxic chemicals.  And of course there is the continuing problem of routine
emissions of sulphur dioxide, particulates, and nitrous oxides from coal-burning power
plants, radioactive waste from nuclear power plants, and chemicals from factories,
wastewater treatment plants, metal plating operations, steel mills, paper pulp plants, and a
host of other sources.

The problem with externalities is how to compensate those negatively impacted by
emissions.  The problem of how to quantify all the social costs of the externalities of an
activity such as a petrochemical plant is a difficult one as is how to compensate those
affected.   Research on emissions provides some insight into determining health costs,
damage to infrastructure and buildings, forests, and other systems affected by the
emissions.  The problem of determining the level of compensation for people affected by
externalities can at least to some degree be quantified and the costs of a unit of emissions
can be determined.  Converted into a tax or fee, the externalities can internalized, that is,
included in the cost of production.18  Taxes that attempt to internalize externalities are
sometimes referred to as Pigouvian Taxes, after A.C. Pigou. He defined an externality as
a phenomenon that is external to markets and hence does not affect how markets operate
when in fact it should. Pigou suggested that by internalizing previously external costs,
that is, making them affect how the markets operate, the external costs could be
compensated for.  For example, in the case of a coal-fired power plant, its emissions
could be taxed and the resulting revenue could be used to restore damaged forests and
compensate those whose health has been affected.  Pigou also suggested that the value of
biodiversity could be protected since it is not included in the market signals that guide the
economic decisions of producers and consumers. One proposal regarding how to protect
the value of critical natural resources has been to designate responsibility and rights of
these resources to private parties. The potential problem with this suggestion is that in
some circumstances it may encourage individuals to charge consumers higher prices in
order to generate  money that would be directed to the conservation of the resource.  In
other circumstances charging too little would result in inadequate for protecting the
resource. This could then actually ccelerate the deterioration or even extinction of certain
resources rather than the conservation of them unless other controls are placed on
resource use. Furthermore, because there is no negative reinforcement in the form of
taxes of penalties for the depletion of a resource or species, there is no disincentive for
consumption. By placing an economic value on species and affecting current market
signals, the loss in biodiversity could be decreased. Valuation of ecosystems and
biodiversity could prove to be a beneficial tool in encouraging people to protect these
natural assets by assessing the costs and benefits of development.
The Polluter Pays Principle
The Polluter Pays Principle (PPP) is simple in concept and squarely addresses the
problem of how to internalize externalities by requiring that the costs of pollution be
borne by those who cause it. PPP was originally aimed at determining how the costs of
pollution prevention and control should be allocated based on the concept that those
causing the impacts should pay to compensate those impacted by their activities.  Its
immediate goal is internalizing the environmental externalities of economic activities and
ensuring the prices of goods and services fully reflect the costs of production. Bugge
(1996) identified four different interpretations of the PPP:

1. the PPP as an economic principle; a principle of efficiency;
2. the PPP as a legal principle; a principle of just distribution of costs;
3. the PPP as a principle of international harmonization of national
environmental policy; and
4. the PPP as principle of allocation of costs between states.

In its interpretation as an economic principle, the purpose of the PPP is to reduce
pollution by internalizing its social costs. The pollution charges could also be seen in the
context of the PPP as a legal principle in which the costs of pollution are efficiently and
justly allocated among those causing the pollution and redistributed to those affected by
it.

The scope of the PPP has evolved over time to include accidental pollution, control and
clean-up costs, in what is referred to as the extended Polluter Pays Principle.  Today the
PPP is a generally recognized principle of International Environmental Law, and it is a
fundamental principle of environmental policy of both the Organisation for Economic
Co-operation and Development (OECD) and the European Union.

The PPP is generally implemented through command-and-control and market-based
approaches. Command-and-control approaches include performance and technology
standards that set maximum pollution levels for various activities. In the case of a power
plant, government regulations requiring scrubbers and other technologies to be installed
in the plant to limit emissions to maximum levels is an example of a command and
control approach.   Market-based instruments include pollution taxes, tradable pollution
permits and product labeling. Cap and trade schemes in which carbon dioxide is allocated
and traded on a carbon exchange are examples of a market-based instruments.  The
elimination of subsidies is also an important part of the application of the PPP.   At the
international level the Kyoto Protocol is an example of the application of the PPP.
Signatories to the Protocol agreed that they have an obligation to reduce their greenhouse
gas emissions and must bear the costs of reducing, through prevention and control, their
carbon dioxide emissions.

Beneficiary Pays Principle

Cost sharing is the application of the beneficiary pays principle (BPP) to the solution of
the problem of externalities. The basic concept is that each entity that is likely to benefit
from solving a problem contributes to the costs of solving the problem in proportion to
his/her gains. For example, the rapid destruction of Amazonian rainforest in Brazil
together with the recognition that the loss of this rich store of biodiversity would be an
international tragedy has resulted in suggestions to Brazil that they not only stop but also
reverse its destruction.  However protecting and restoring the rainforest means that Brazil
would not only forgo the extraction of resources and development of agriculture, but also
have to make a sizable investment in regenerating the destroyed ecosystems.  Because the
international community stands to benefit from the restoration of the rainforest and as a
result will benefit from not only the preservation of biodiversity but also from the
sequestration of carbon, Brazil should be compensated for the loss of economic
development and the funds invested in the rainforest.  Another application of the BPP is
requiring industrialized countries to compensate resource-poor farmers in tropical
countries for adopting soil carbon management practices.

In each case the contribution of the beneficiary is based on their perceived benefits.
Another example is the cooperation of ranchers by making efforts, including forgoing
production, to help maintain highly valued landscapes as diverse as alpine meadows, the
Hell’s Canyon in Oregon and African savannahs.   In the case of Hell’s Canyon the threat
to landscape and biodiversity was the proposed development of hydroelectric power
installation.  Those who benefit from the recreational opportunities provided by these
protected landscapes should compensate the ranchers for the ongoing costs of landscape
maintenance. For example, the opportunity cost of wildlife conservation in protected
areas of Kenya, measured in terms of forgone livestock and agricultural production, has
been estimated to be around $203 million per year, or 2.8 percent of total GDP, while
revenues from wildlife tourism and forestry contribute only around $42 million per year
to the national economy (Norton-Griffiths and Southey, 1995). The authors argue that,
given the global nature of the benefits of Kenya’s conservation efforts, it is quite
appropriate that the international community bear some of the costs of conservation.

The BCP applies to a wide variety of situations where it is appropriate for those
foregoing economic opportunities for environmental benefit:

1.  Carbon sequestration and storage, for example a German electricity company paying
farmers in the tropics for planting and maintaining additional tree;

2.  Biodiversity protection where conservation donors pay local people for setting aside
natural areas.

3.  The restoration of natural areas to create a biological corridor, paid for by
communities that were built in a manner which resulted in the removal of the corridor.

4. Watershed protection where downstream water users pay upstream farmers for
adopting land uses that limit deforestation, soil erosion, and flooding risks.

5. Protecting landscape beauty, for example a tourism operator paying a local community
not to hunt in a forest being used for tourists’ wildlife viewing.

Extended Producer Responsibility
The concept of Extended Producer Responsibility (EPR) was first formally introduced in
Sweden by Thomas Lindhqvist in a 1990 report to the Swedish Ministry of the
Environment.  The formal definition of EPR is that it is an environmental protection
strategy designed to decrease the total environmental impact of a product by making the
manufacturer responsible for the entire life-cycle of the product and especially for the
take-back, recycling and final disposal of the product.  EPR initiatives include product
take-back programs, deposit refund systems, product fees and taxes, and minimum
recycled-content laws. EPR puts the onus upon the manufacturer and to many, represents
a mandatory approach.

Extended Producer Responsibility (EPR) uses political means to hold producers liable for
the costs of managing their products at the end of life. This tactic attempts to make the
transition from traditional end-of-pipe waste ‘diversion’ programs (funded by local
government and therefore the public, and of no responsibility to the producer) to ‘cradle
to cradle’ recycling systems designed, financed, and managed by the producers
themselves. EPR promotes that producers (usually brand owners) have the greatest
control over product design and marketing and therefore have the greatest ability and
responsibility to reduce toxicity and waste.

The major impetus for EPR came from northern European countries in the late 1980s and
early 1990s, as they were facing severe landfill shortages. EPR is generally applied to
post-consumer wastes which place increasing physical and financial demands on
municipal waste management.  EPR is based on the PPP, making manufacturers
responsible for the entire lifecycle of the products and packaging they produce. One aim
of EPR policies is to internalize the environmental costs of products into their price.
Another is to shift the economic burden of managing products that have reached the end
of their useful life from local government and taxpayers to product producers and
consumers.  In Germany, EPR is being implemented via government policy, and has
reduced packaging waste about 4% per year for several years after its implementation in
1991. The European Union has legislated that automobile manufacturers must provide
free take-back locations for waste automobiles, referred to as End-of-Life Vehicles or
ELVs, and must recycle a minimum of 80% of the mass of the vehicle.19

A related approach, Product Stewardship, is gaining in popularity because of its less
regulatory nature and its recognition that other parties have a role to play.  Product
Stewardship means that all parties – designers, suppliers, manufacturers, distributors,
retailers, consumers, recyclers, and disposers – involved in producing, selling, or using a
product take responsibility for the full environmental and economic impacts of that
product.  An example of Product Stewardship is a program in Oregon in which the
manufacturers of paint sold in Oregon, or a stewardship organization representing
manufacturers, are required to set up and run a convenient, statewide system for the
collection of post-consumer architectural paint.

Full Cost Accounting, Full Cost Pricing, and Life Cycle Costing
Another terminology related to internalization is full cost accounting (FCA).20   FCA
includes not only the internalized costs of the externalities produced by production but
also includes the life cycle costs of the product or activity. FCA applies to a wide range
of accounting systems, from national to business or government.  At national level, FCA
requires a modification to Gross Domestic Product (GDP) as a measure of performance
to include other societal and environmental impacts. This adjustment results in what are
sometimes referred to as Alternative Measures of Welfare which modify GDP to account
for environmental impacts, such as pollution, and social costs of, for example, prisons
and people not covered by health insurance.

For enterprise or government accounting systems, the US EPA developed a four tier
system for management to use to account for the environmental costs portion of FCA:21

Tier 0: Conventional Capital and Operating Costs
These are the normal costs of a project and include capital expenditures such as
buildings, equipment utilities, and supplies plus operating and maintenance expenses
such as materials, labor, training, insurance, and permitting.

Tier 1. Hidden Costs
There are a number of environmental costs that may not be accounted for as such as
monitoring, paperwork and reporting requirements. These include upfront environmental
costs, regulatory or voluntary environmental costs, and backend environmental costs (see
Table 1). Upfront costs are incurred prior to the operation of the process or facility and
related to the siting of facilities, qualification of suppliers, evaluation of alternative
pollution control equipment etc. Regulatory and voluntary environmental costs include
items such as environmental insurance, permitting costs, environmental monitoring and
testing, recordkeeping, voluntary audits, remediation, recycling activities etc. These costs
are often assigned to overhead accounts rather than allocated to departments of products
directly. Backend environmental costs are usually also ignored in current decision
making as they are not incurred at the present time. Such costs include the future costs of
decommissioning a laboratory, or product take-back requirements.

Tier 2. Contingent Costs
Contingent costs are costs that may or may not be incurred at some point in the future and
include penalties, fines, and future liabilities. They can only be estimated in probabilistic
terms – their expected value, or the probability of their occurrence. Examples are personal
injury claims related to product use, future remediation costs, and fines or penalties.

Tier 3. Less tangible Costs
These are the difficult to estimate costs associated with maintaining corporate image,
good relationships with investors, employees, and customers etc. These costs would
include the costs of environmental outreach activities (annual community cleanup days or
tree planting days for example), and publication of environmental reports, to name a few.
The ultimate goal of FCA is actually what might be called Full Cost Pricing in which the
full social and environmental costs of a product are included in the price paid by the
consumer.  The consumer is then making a decision based on a price for which these
costs have been paid.

ALTERNATIVE MEASURES OF WELFARE
Indicators for measuring the well-being and standard of living are important for assessing
changes in the quality of life of a nation.  In this section we describe standard macro-
economic indicators such as GDP that are used as an indicator of a society’s welfare and
other so-called alternative measures of welfare that are designed to provide a more
accurate assessment of the health of a society.

The Problem with Gross Domestic Product (GDP)
The most well recognized macro-economic indicator is GDP which was developed by
Simon Kuznets.   GDP is widely used by economists and policymakers for assessing a
nation’s economic performance and is defined as the market value of all final goods and
services made within the borders of a nation in a year.  Its purpose is to provide a
measure of the economic production and growth for a given nation and allows some level
of comparison between countries.

There are two approaches used for calculating GDP, the income and expenditure
methods. The income method includes total compensation to employees, gross profits for
incorporated and non-incorporated firms, and taxes less subsidies.  The expenditure
method calculates GDP by totaling consumption, gross investment, government spending,
and net exports. Either approach should yield approximately the same value. Today’s
economists divide consumption into the two categories of private consumption and public
sector spending. In order to make comparisons of annual economic performance more
convenient, GDP is reported in both current dollar and constant dollar forms. The
constant dollar method involves converting current economic data into some standard era
dollar, such as 1997 dollars. It is important to note that GDP does not take into account
goods and services produced by a nation’s companies operating in foreign countries.
Gross National Product (GNP) is an indicator which includes both the domestic and
foreign activities of a nation’s companies.

GDP is the most commonly used indicator of an economy’s economic performance.
Thought to be a direct indicator of an economy’s health, some relate the concept of GDP
to the nation’s standard of living or welfare. Although changes in this indicator are often
simultaneous with changes in profit margins, stock prices, unemployment, and wage
changes, is not actually a good gauge of a nation’s standard of living or welfare because
there are several other tangible and intangible factors that are not accounted for in the
calculation of GDP which affect individual welfare. There are many problems associated
with linking GDP and welfare but perhaps the greatest fallacy is thinking that when a
market performs well, people benefit and this contributes to the greater welfare of a
nation. GDP was not originally intended to measure well-being but rather economic
productivity. National income is not necessarily a measurement of welfare. Some critics
even argue that growth of GDP has been costly in psychological, sociological and
ecological terms. However there has been no real consensus an alternative to GDP as a
measure of welfare and thus it continues to be used for this purpose.  And some would
argue that if GDP does ignore social costs, then by definition it tends to overestimate
welfare.

GDP does not take into account the underground economy and has also been criticized
because it does take into account government spending that could be the result of natural
disaster damage mitigation, prisons supporting more criminals, a society burdened with
more health care costs due to unhealthy citizens, acts of terrorism, other accidents or
corporate fraud. While each of these costs contributes to spending, it seems
counterintuitive to link these costs with an increased quality of life or welfare, yet using
GDP as an indicator of welfare does just that. After 9/11, billions of dollars were spent in
rescue, cleanup and related costs alone covering only the short-term impacts of this
tragedy. Should this spending be included in the calculation of an indicator measuring
welfare? Another example of spending that is included in the calculation of GDP but
perhaps should not be is the cost of the depletion of natural resources. The more oil we
pump the more depletion of a key natural resource, yet GDP increases. GDP also
excludes the entire sector of volunteer services including activities such as mentoring,
child and elder care, and many other activities that actually do enhance welfare. GDP has
also been criticized for being extremely insensitive to the distribution of income within
nations. Countries with very different percentages of poverty could have similar GDPs
based on a combination of other differing factors.

Another important note to make regarding GDP is its reliance on imports. As a
community becomes more independent and self reliant, thus decreasing its imports and
increasing local commerce, GDP decreases.

Measure of Economic Welfare (MEW)
William Nordhaus and James Tobin proposed the Measure of Economic Welfare (MEW)
in 1972, as an alternative measure of welfare to GDP.  MEW adjusts total national output
and includes only the consumption and investment items that contribute directly to
economic well-being. This indicator is calculated making additions to GNP such as the
value of leisure time and the underground economy as well as deductions such as
environmental damage. The adjustments to GDP to determine MEW have three
categories: 1) reclassification of GNP expenditures as consumption, investment, and
intermediate, 2) imputation for the services of consumer capital, for leisure, and for the
product of household work, 3) correction for some of the disamenities of urbanization,
such as the loss of productive farmland.22

The most significant issue addressed by MEW is the recognition that GNP is a measure
of production, while economic welfare is a measure of consumption. Nordhaus later
commented on the comparison of GNP versus MEW data, suggesting that both indicators
are inaccurate and even after adjusting for the main issues concerning GNP, MEW is just
as deficient.

Index of Sustainable Economic Welfare (ISEW)
Another of the best known alternative measures of welfare is the Index of Sustainable
Economic Welfare (ISEW), created in 1989 by Herman Daly and John Cobb based on
Nordhaus and Tobin’s concept of MEW with the intention to develop a more
sophisticated indicator of welfare. The ISEW balanced consumer expenditure with
factors such as income distribution and costs associated with pollution and other forms of
environmental degradation. ISEW can be calculated by adding personal consumption,
public non-defensive expenditures, capital formation and services from domestic labor
and subtracting private defensive expenditures, costs of environmental degradation and
depreciation of natural capital.23

When developing ISEW, Daly and Cobb took into account major factors such as net
capital growth, foreign versus domestic capital, natural resource depletion, environmental
damage, the value of leisure and the value of unpaid household labor. One of the major
differences of this index compared to others is that its base is derived from personal
consumption rather than production. Although some believe this is a more effective
indication of welfare than production, its interpretation has limitations. There has also
been criticism regarding the relationship between economic welfare and happiness as
well as the relationship between absolute wealth or consumption versus the relationship
between relative wealth or consumption.

Other limitations to this index include the exclusion of many categories of additions and
deductions such as income from the underground economy, changes in working
conditions and certain expenditures questionable in their contribution to economic
welfare. As is the case when developing any index, certain assumptions were made, in
this case regarding the estimation of quantities that are inherently immeasurable, such as
the cost of natural resource depletion and long-term environmental damage.

Genuine Progress Indicator (GPI)
The concept of ISEW led to the idea of the Genuine Progress Indicator (GPI), created by
Redefining Progress in 1995.24 This concept, perhaps the most progressive indicator
developed to date, is based on green and welfare economics and attempts to measure
economic progress while distinguishing between worthwhile growth and economic
growth that causes a decline in the quality of life. GPI was designed to indicate whether a
country’s growth and the increased production of goods and expanding services have
actually yielded a greater well-being or not. Unlike other alternative measures of welfare,
the calculation of GPI does not begin with GDP as its base but rather with the extraction
from the national accounts of the transactions deemed directly relevant to human well-
being.

The calculation of GPI includes the addition of the following items: 1) personal
consumption expenditure, 2) services yielded by consumer durables, 3) services yielded
by roads and highways, 4)services provided by volunteer work, 5) services provided by
non-paid household work, as well the subtraction of the following items: 1)cost of
consumer durables, 2) cost of noise pollution, 3) cost of commuting, 4) cost of crime, 5)
cost of underemployment, 6) cost of lost leisure time, 7) the cost of household pollution
abatement, 8) the cost of vehicle accidents, 9) the cost of family breakdown, 10) loss of
farmland, 11) cost of resource depletion, 12) cost of ozone depletion, 13) cost of air
pollution, 14) cost of water pollution, 15) cost of long-term environmental damage, 16)
loss of wetlands, 17) loss of old-growth forests. The following items are subtracted from
the GPI: 1) index of distributional inequality, 2) net capital investment, 3) net foreign
lending/borrowing. When comparing the calculation of ISEW versus GPI, the items used
to arrive at the final index could be exactly the same depending on when the indexes were
calculated and how each index has been updated and perfected over time.

When comparing data reflecting GDP and GPI calculations from 1950 through 2004, the
trend in GDP shows a fairly steady increase in growth throughout the years, while the
trend in GPI shows a peak somewhere in the 1970s with virtually no growth since. Some
believe the data found using GPI is perhaps more indicative of our nation’s economic
state today versus in the 1970s than the data found using GDP.

Human Development Index (HDI)
Mahbub ul Haq’s Human Development Index (HDI), an important alternative to GDP,
consists of standard of living (GDP per capita), life expectancy at birth and knowledge (a
composite measure of education, literacy and school enrollment).25 This index is used to
measure a nation’s human development, which is considered to be indicative of the
expansion of opportunities for people regarding education, health care, income and
employment. HDI is published on an annual basis in the Human Development Reports
(HDRs) through the United Nations Development Programme (UNDP).

The calculation of the knowledge component of this formula is devised by measuring
adult literacy, with two-thirds weighting, and the gross enrollment rate, with one-third
weighting. The standard of living component is measured using the natural logarithm of
GDP per capita.

HDI has been the center of much scrutiny, mostly regarding its exclusion of any
ecological factors. HDI focuses primarily on national performance and is perhaps just
another index similar to GDP in that it faces much of the same criticism and issues as
many others. The UN annually ranks its members and these rankings are often used to
highlight national insufficiencies. Whether or not this index has actually progressed
towards a model more indicative of social welfare remains to be seen but the impact of
economic policies on quality of life is evident. This index has also been criticized for its
focus solely on national performance rather than global development as well.

Other Measures of Welfare
Another alternative measure of welfare is Tim Jackson’s Measure of Domestic Progress
(MDP), which adjusts previous theories accounting for climate change and resource
depletion. The quality-of-life index (PQLI), constructed by Morris David Morris in the
mid 1970s, is computed by averaging basic literacy rate, infant mortality rate and life
expectancy at age one (all equally weighted). Still other indexes, such as the Human
Poverty Index which focuses explicitly on poverty, and the Happy Planet Index which
consists of indicators such as life satisfaction, life expectancy, happy life years and ecological footprint, serve as more accurate indicators for certain countries.
SUMMARY
Ecological economics is a key discipline in what might be called the science of
sustainability.  Neoclassical economics is the antithetical to sustainability because it treats
nature only as a factor of production and does not account for the broader role of nature
in supporting life in general and quality of life for humanity.  Additionally it does not
acknowledge that economic growth is ultimately limited in scale and this limitation is due
to the scale of the global ecosystem in which the economy is contained.   Finally
neoclassical economics prefers to ignore the laws of physics, particularly the Second Law
of Thermodynamics, which also limits the scale of the economy.  Ecological economics
recognizes that the scale of the economy is a function of natural system productivity and
that economic growth must have limits because of the finite size of the Earth and its
ecosystems.  In ecological economics, natural capital has equal importance with other
forms of capital, and some natural capital is critical and must not be destroyed.
Substitutability of other forms of capital for natural capital is limited and the scale of the
economy is limited because some scale of natural capital must be protected to maintain
the services provided by natural systems. Ecological economics requires that externalities
be internalized, and that externalities be reduced to the absolute minimum.  The Polluter
Pays Principle is an implementation of internalization and fixes the responsibility for the
parties responsible for the impacts of emissions. Similarly other principles such as the
Beneficiary Pays Principle, Extended Producer Responsibility, Full Cost Accounting, and
life cycle costing, provide a framework for internalization and decision making.
Ecological economics also fosters alternative ways of assessing how well a country’s
economy is performing though the use of alternative measures of welfare such as the
Happy Planet Index, GPI, and the HDI.

REFERENCES
Brodsky, D. and D. Rodrik.  1981. “Indicators of Development and Data Availability:
The Case of the PQLI”, World Development, 9(7), pp. 695-699.

Costanza, Robert, Ed. 1991. Ecological Economics: The Science and Management of
Sustainability. New York: Columbia University Press.

Costanza, Robert,  et al. 1997. “The value of the world’s ecosystem services and natural
capital,” Nature 387, pp. 253-260.

Costanza, Robert, John. H. Cumberland, Herman Daly, Robert Goodland, Richard B.
Norgaard. 1997. An Introduction to Ecological Economics, St. Lucie Press.

Costanza, R. and Daly, H.E. 1992. “Natural capital and sustainable development,”
Conservation Biology 6(1), pp. 37-46.

Daly, Herman E. and J. Cobb, 1989. For the Common Good: Redirecting the Economy
toward Community, the Environment, and a Sustainable Future. Beacon Press, Boston.

Daly, Herman E.   . The Steady State Economy.

Daly, Herman E. 1999. “Uneconomic Growth and the Built Environment: In Theory and
In Fact,” in Reshaping the Built Environment, Charles J. Kibert, Ed., Washington, D.C.:
Island Press.

Daly, Herman E. and Joshua Farley. 2004. Ecological Economics: Principles and
Applications.

Hartwick, J.  1977. “Intergenerational equity and the investing of rents from exhaustible
resources,” American Economic Review 66, pp. 972-74

Kovel, Joel. 2002 .   The Enemy of Nature: The End of Capitalism or the End of the
World. Second Edition. London: Zed Books, Limited.
Lawn, P. 2003. “A theoretical foundation to support the Index of Sustainable Economic
Welfare (ISEW), Genuine Progress Indicator (GPI), and other related indexes”,
Ecological Economics 44(1), February, pp.105-118.

Nordhaus, Willliam and James Tobin. 1972. Is Growth Obsolete? Columbia University
Press, New York.

Marx, Karl. 1863. Critique of the Gotha Programme.

Norton-Griffiths, Michael and Clive Southey. 1995. “The opportunity costs of
biodiversity conservation in Kenya,” Ecological Economics 12(2), February, pp. 125-
139.

Postel, Sandar, Gretchen C. Dailey and Paul Ehrlich. 1996. “Human Appropriation of
Renewable Fresh Water,” Science 271, pp. 785-788.

Røpke, Inge. 2004. “The Early History of Modern Ecological Economics,” Ecological
Economics 50, pp. 293-314.

Sagar, A. and Najam, A. 1998. “The human development index: a critical review”,
Ecological Economics 25(3), June, pp. 249-264..

Vitousek, Peter, Paul Ehrlich, Anne H. Ehrlich, and Pamela A. Matson, 1986. “Human
Appropriation of the Products of Photosynthesis,” BioScience 34(6), pp. 363-373.

ENDNOTES

1
Robert Costanza calls ecological economics the science of sustainability in a volume he edited on the
subject: Ecological Economics: The Science and Management of Sustainability (1991).

2
Ecological economics could be said to have been founded in 1988 with the appearance of the Journal of
Ecological Economics.  A paper by Inge Røpke (2004) describes the early history of ecological economics
and the influences of ecologists, economists,  environmentalists, and others on its evolution.

3
As described in a paper by Costanza et al  (1997).

4
The development of economics and the emergence of ecological economics are derived from an excellent
book on ecological economics, An Introduction to Ecological Economics,  by Robert Costanza (1997) and
several colleagues, including Herman Daly, one of the key figures in the development of ecological
economics.

5
Karl Marx clarified his thinking on the value of nature  in Critique of the Gotha Programme (1863).

6
A discussion of the rebound effect relative to the Jevons Paradox can be found at

http://www.treehugger.com/files/2008/05/beating-energy-efficiency-paradox.php

7
These equations were first described in his book in his 1925 book,  Elements of Physical Biology.

8
This famous paper was presented at the Sixth Resources for the Future Forum on Environmental Quality
in a Growing Economy in Washington, D.C. on March 8,1966.

9
From The Enemy of Nature: The End of Capitalism or the End of the World? by Kovel (2002).

10
The Empty World versus Full World models are described by Daly (1999).

11
As stated in “Natural capital and sustainable development” by Robert Costanza and Herman  Daly
(1992).

12
Human appropriation includes direct use of  NPP for food, fuel, fiber, and timber plus reduction in
potential due to ecosystem degradation caused by humans.

13
From “Human Appropriation of the Products of Photosynthesis,” by Vitousek et al. (1986).

14
Summarized from “Human Appropriation of Available Fresh Water” by Sandra Postel, Gretchen Dailey,
and Paul Ehrlich (1996).

15
The ecological rucksack was invented by Friedrich Schmidt-Bleek of the Wuppertal Institute in Germany
in the mid-1990s.

16
An excellent description of the broader concepts associated with Hicksian Income can be found in An
Introduction to Ecological Economics by Costanza et al (1997).

17
As described in “Intergenerational equity and the investing of rents from exhaustible resources” by J.
Hartwick (1997).

18
In economics, externalities can have positive or negative benefits.  For example, an automobile can have
the positive externality of mobility for people, making them more efficient and improving their quality of
life. Automobiles also have the externality of air pollution which has negative social impacts.  In ecological
economics,  externality refers exclusively to negative impacts.

19
European Union Directive 2000/53/EC spells out the requirements for ELV recovery and recycling.  The
80% recycling rate increases to 90% in 2015.

20
True cost accounting  (TCA) is a terminology sometimes used as an alternative to full cost accounting.

21
The EPA’s full cost accounting process is described at www.epa.gov/waste/conserve/tools/fca/index.htm

22
The rationale for the MEW is covered in Nordhaus and Tobin  (1972).

23
The design of the ISEW is described in For the Common Good by Daly and Cobb (1989).

24
Lawn (2003) describes the theoretical basis for GPI and ISEW in “A theoretical foundation to support the
Index of Sustainable Economic Welfare (ISEW), Genuine Progress Indicator (GPI), and other related
indexes.”

25
The HDI is described by A Sagar and A. Najam (1998) in “The human development index: a critical
review.”

 

One Response to “SUSTAINABLE ECONOMICS”

  1. Vance

    This is GREAT stuff!! Have you heard of the Zeitgeist Movement and something called a Resource Based Economy, essentially what they refer as Ecological Economics.