Nafziger Economic Development (4th ed)

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policy, in which carbon and emissions prices are set (through a carbon tax) to equate marginal damage and marginal abatement cost (a shadow price of carbon), and in which emission permits are allocated equal to each country’s equilibrium carbon tax. Nordhaus and Boyer oppose an “environmental pope” (2000:123) but discuss an optimal policy to set a benchmark to compare policies. The optimal policy, which reduces the global temperature rise to 2.3 degrees Celsius, costs the world $5 billion (in 1990 dollars) yearly (2005 prices would be 35–40 percent higher), and would be levied in 2000–2010 at about $5–10 per ton. This most efficient policy would be relatively inexpensive but would slow climate change surprisingly little. Less efficient policies would be variations of the Kyoto Protocol, with the least efficient where no trading is allowed (cost would be 15 times the optimum) and the most efficient where trading is allowed among the OECD, the former Soviet Union, and East Central Europe (called Annex I trading, begun by the European Union in 2005). Nordhaus and Boyer agree with Weyant that other alternatives discussed (limiting CO2 concentrations to twice preindustrial levels, limiting climate change to a 2.5 degrees Celsius or less temperature rise, and stabilizing global emissions at 1990 levels) would be even less efficient than Kyoto plus Annex I trading.

Nordhaus and Boyer conclude that the Kyoto approach has no economic or environmental rationale. Kyoto with trading permits, however, would be close to the optimum in the early years of the century but would reduce emissions less than the optimal amount in later years. To reduce emissions efficiently later in the century, Nordhaus and Boyer favor targeting today’s LDCs. Freezing emissions for LDCs will no longer be feasible later in the 21st century, as by then DCs’ emissions will be a dwindling fraction of the globe’s. The distributional consequences, the authors contend, will be that LDCs and other DCs will break even or benefit at the expense of the United States.

Multilateral aid and agreements in funding global common property resources in tropical countries. DCs and transitional countries are the major carbon emitters. When D. S. Mahathir Mohamed was Malaysian prime minister (1992:C-5), he contended that if humankind is to clean up the global environment, “those most responsible for polluting [the environment] must bear the burden proportionately. Eighty percent of Earth’s pollution is due to the industrial activities of the North.” The World Bank (1992i:3) concurs, arguing that the North should bear the burden of finding and implementing solutions to global warming, ozone depletion, and other environmental problems.

To be sure, the share of emissions from today’s lowand middle-income countries (now roughly half – see Table 13-2) will increase as the century progresses. However, low-income countries, primarily located in the tropics, will pay little to avoid long-term environmental degradation. Tropical countries are not just poor, but their environmental problems, such as rain forest and species destruction, are not just public bads internal to the country but also global public bads. Tropical countries receive only a portion of the gain from maintaining tropical rain forests or reforestation to limit greenhouse gases, adverse climate change, and the loss of

biological resources. Because tropical rain forests are global public goods, affecting global climate and genetic stock, we cannot expect individual tropical countries to provide forests in sufficient quantities, as much of the gain spills over to other countries.

If DCs want to protect themselves against the risk of explosive harm and care about LDC economic and environmental vulnerability, they will want to contribute resources to invest in reducing environmental degradation. Indeed, DC contributions to technological transfer, such as switching LDCs from high-carbon to low-carbon fuels, could add to DC national income. Additionally, DC aid might include concessional aid to tropical LDCs to help avoid global damage from tropical deforestation and species loss, while partially compensating tropical countries for forgoing private gain. This compensation can reduce the tropics’ sacrifice of immediate basic needs. As discussed in Chapter 16, some DC governments and nongovernmental organizations have undertaken debt-for-nature swaps in Africa and Latin America. In the 1990s and early part of this century, DCs and their environmental nongovernmental organizations (sometimes supported by legislation, for example, in the U.S. Congress) purchased portions of the debts of tropical countries in exchange for their preservation of tropical rain forest and its biodiversity.

Humankind generally has an interest in providing funds to preserve these tropical global common-property resources. DCs need to focus on agreements to reduce global public bads associated with deforestation and species destruction in tropical regions. These countries might regard their spending as investment in ecosystems that influence the productivity of the common resources of humanity. Such agreements would benefit the world as a whole but would particularly benefit tropical countries in reducing their environmental degradation and adverse climate change.

Still, international environmental agreements to fund and regulate global public goods have had a mixed record. The Montreal Protocol, signed in 1987 and strengthened in 1990, to reduce ozone depletion through the cutting of chlorofluorocarbon (CFC) production, enjoyed widespread compliance among the predominant CFC producers, the DCs, which had already developed cost-effective substitutes. However, the International Convention on Climate Change (ICCC), signed in 1994, which required national inventories on greenhouse gas emissions, has not been so successful, partly because of the ICCC’s substantial costs and complexity, and opposition, especially in the United States, to taxes on carbon emissions. The institutions for implementation, enforcement, and financing the ICCC are thus far poorly developed (World Resources Institute, U.N. Environment Program, and U.N. Development Program 1994:202–203). In addition, the Global Environment Facility established in 1991, under which funding for global public goods might take place, has had only limited success, partly because of the lack of funding and difficulties in agreeing how to divide the funding.

No single nation acting alone can stabilize greenhouse gas emissions. Additionally, unilateral national policies do not achieve the least-cost method of reducing emissions. Moreover, international competition to attract industry through less stringent emissions standards may undermine environmental policy making. Thus, a

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supranational approach is essential. However, coordinated international action is difficult to achieve (Poterba 1993:48–49).

Harold Demsetz (1967:347–359), an economist from the University of California, Los Angeles, thinks it is unlikely that users of a global common property resource (such as air and water) would agree to manage the resource even though it is in the interest of all to cooperate in reducing use of the resource. Although all users benefit, each user will earn even higher returns by free riding on the virtuous behavior of the remaining cooperators. Global optimality requires global cooperation, yet the incentives facing individual countries work in the opposite direction. As with the international nuclear nonproliferation treaty or ICCC, we might expect the united action by users to be unstable. Demsetz argues that the only way out of the common property dilemma is intervention by the state. However, the world lacks an international government that can dictate the environmental policies of individual states.

Still, a number of countries may collude to sign an international environmental agreement even when a number of countries do not cooperate. Countries may agree to pursue the global optimality strategy if all other countries in previous periods abide by this strategy. Also, countries can punish those that refuse to abide by whaling conventions, nonproliferation treaties, or other environmental agreements by import embargoes or other sanctions. Concerns about fairness can reduce the free-rider problem. Furthermore, a noncooperator may find it advantageous to join the agreement if strengthening it increases others’ abatement levels in excess of the abatement costs the country incurs. Pulling out of a treaty may result in less abatement by other countries, so that the cost of pulling out exceeds the benefits (Barrett 1993:454–463). If major nations fail to make commitments to a global environmental accord and choose to free ride on the actions of other nations, the prospects for the success of environmental agreements are limited (Poterba 1993:48–49).

The United States has an interest in rejoining the multilateral Kyoto Treaty process but insisting on the use of green markets with tradable emission permits, a more efficient approach than setting temperature and emissions limits. The main opposition by U.S. politicians to Kyoto is exempting LDCs, such as highly populated China and India, from reduced carbon emissions. No doubt the United States will insist that LDCs, at least middle-income countries, reduce emissions. If the United States joins Kyoto, the United States could benefit by selling and transferring green technology, including that to increase carbon absorption. Still, we can expect difficult negotiations before the United States rejoins Kyoto.

Limits to Growth

The 19th-century English classical economists feared eventual economic stagnation or decline from diminishing returns to natural resources. The concept of diminishing returns was the foundation for Malthus’s Essay on the Principles of Population (1798, 1803), which argued that population growth tended to outstrip increases in food supply. Economists have long disputed whether diminishing returns and Malthusian population dynamics place limits on economic growth.

THE CLUB OF ROME STUDY

In the early 1970s, the influential Club of Rome, a private international association organized by the Italian industrialist Aurelio Peccei, commissioned a team of scholars at MIT to examine the implication of growth trends for our survival. The study, The Limits to Growth (Meadows, Meadows, Randers, and Behrens 1972) based on computer simulations, uses growth trends from 1900 to 1970 as a base for projecting the effects of industrial expansion and population growth on environmental pollution and the consumption of food and nonrenewable resources. The study and its sequel (Meadows, Meadows, and Randers 1992) suggest that as natural resources diminish, costs rise, leaving less capital for future investment. Eventually, new capital formation falls below depreciation, so that the industrial base, as well as the agricultural and services economies, collapses. Shortly after population drops precipitously because of food and resource shortages. Limits concludes that if present growth continues, the planetary limits to growth will be reached sometime in the 21st century, at which time the global economic system will break down.

The message of Limits is that because the earth is finite, any indefinite economic expansion must eventually reach its limits. Exponential growth can be illustrated by the following. Take a sheet of paper and continue to fold it in half 40 times. Most of you will give up long before the 40th time, at which time the paper’s thickness, initially one millimeter, will stretch to the moon! In a similar vein, we can appreciate the contention of Limits that without environmental controls, economic growth and the attendant exponential increase in carbon dioxide emissions from burning fossil fuel, thermal pollution, radioactive nuclear wastes, and soluble industrial, agricultural, and municipal wastes severely threatens our limited air and water resources.

The previous pages have explored some of the limits associated with the overuse of common-property resources, the “tragedy of the commons.” No one can ignore the warnings to humankind to pay attention to these limits.

Yet many of the assumptions the MIT scholars make are seriously flawed. For example, their estimates indicate that they apparently believe that proven petroleum reserves represent all the petroleum reserves of the world. However, proven reserves are not satisfactory for making long-term projections, as they are only the known reserves that can be recovered profitably at prevailing cost and price levels. Proven reserves are no more than an assessment of the working inventory of minerals that industry is confident is available. Profit-motivated, commercial exploration tries to find only sufficient new reserves to meet the industry’s requirements over its forward planning period (typically 8 to 12 years), plus any new reserves that promise to be more profitable than previous discoveries.

Thus, it is not surprising that proven reserves are rather meager in comparison to the reserves that can ultimately be recovered. We therefore have the spectacle in 1864 of W. Stanley Jevons, one of the great economists of the 19th century, predicting that England’s industry would soon grind to a halt with the exhaustion of England’s coal. A modern example of this disparity between proven and ultimately recoverable reserves is that in 1970, the proven reserves of lead, zinc, and copper were much larger than those in 1949, even though the amount of these metals mined between

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1949 and 1970 was greater than proven reserves in 1949. Moreover, although in 1977, U.S. President Jimmy Carter said that we “could use up all the proven reserves of oil in the entire world by the end of the next decade,” by 2004 these reserves were larger than ever (Will 2004:B7).

A further criticism of the MIT team is that their model analyzes the world’s population, capital stock, natural resources, technology, and output without discussing differences by world region. It also treats food output as a single entity, ignoring differences among cereals, fruits, vegetables, and animal products.

Another flaw in the MIT study concerns the assumption of exponential growth in industrial and agricultural needs, but the arbitrary placement of nonexponential limits on the technical progress that might accommodate these needs. As Robert Cassen (1994:7) contends, “Only where specific binding constraints cannot be compensated for by human ingenuity do economies encounter effective limits to growth.”

A complex computer model only aids understanding if its assumptions are valid. Critics (Robinson 1975:28–31; Surrey and Page 1975:56–64; Simon 1981; Clark 1977) argue that Limits is not a “rediscovery of the laws of nature,” as the authors’ press agents claim, but a “rediscovery of the oldest maxim of computer science: Garbage In, Garbage Out” (Passell, Roberts, and Ross 1972).

DALY’S IMPOSSIBILITY THEOREM

Herman E. Daly (1977) more clearly indicates the assumptions, calculations, and causal relationships behind limits to economic growth and, unlike Limits, goes on to calculate their effect on increased international conflict. According to him, a U.S.- style, high mass consumption, growth-oriented economy is impossible for a world of 6.5 billion people (updated to 2005). The stock of mineral deposits in the earth’s crust and the ecosystem’s capacity to absorb enormous or exotic waste materials and heat drastically limit the number of person-years that can be lived at U.S. consumption levels. Daly believes that how we apportion these person-years of mass consumption among nations, social classes, and generations will be the dominant political and economic issue of the future. The struggle for these limited high-consumption units will shape the nature of political conflict, both within and between nation-states.

Daly’s argument that the entire world’s population cannot enjoy U.S. consumption levels – the impossibility theorem – can be illustrated in the following way. Today, it requires about one-third of the world’s flow of nonrenewable resources and 26 percent of gross planetary product (the gross production value of the world’s goods and services) to support the 5 percent of the world’s population living in the United States. By contrast, the 80 percent of the world’s population living in LDCs use only about one-seventh of the nonrenewable resources and produce only 17 percent of the gross planetary product, according to Daly. Present resource flows would allow the extension of the U.S. living standard to a maximum of 15 percent of the world’s population with nothing left over for the other 85 percent.

Daly (1993:29–38) argues that natural capital is the limiting factor in economic evolution. Thus, we need to concentrate on increasing output per natural capital, as we cannot substitute physical capital or labor for natural capital. Daly illustrates

the impossibility of continuing growth in the use of natural capital by pointing out that humans directly use or destroy about 25 percent of the earth’s net primary productivity (NPP), the total amount of solar energy converted into biochemical energy through the photosynthesis of plants minus the energy these plants use for their own life (Postel’s definition, 1994:4–12). Other land-based plants and animals are left with the remainder, a shrinking share. At a 1.3-percent yearly population growth, population and humankind’s proportion of NPP double in 54 years; another doubling means humanity’s share of NPP is 100 percent, which is not possible. Indeed, Daly thinks humankind’s share of net productivity is already unsustainable.

For some, the solution to this dilemma is to increase world resource flows sixfold, the amount needed to raise world resource use per capita to that in the United States. However, to increase resource flows this much, the rest of the world would have to attain the capitalization and technical extracting and processing capacity of the United States. Such an increase in capital would require a tremendous increase in resource flows during the accumulation period. Harrison Brown (1970:195–208) estimates that it would take more than 60 years of production at 1970 rates to supply the rest of the world with the average industrial metals per capita embodied in the artifacts of the ten richest countries. Furthermore, because of the law of diminishing returns, a sixfold increase in net, usable resources, energy, and materials implies a much greater than sixfold increase in gross resources and environmental impact. Enormous increases in energy and capital devoted to mining, refining, transportation, and pollution control are essential for mining poorer grade and less-accessible minerals and disposing safely of large quantities of wastes.

Brown’s estimates are based on rough input–output relationships with no allowance for new discoveries and technological improvements. Nevertheless, the required increases in resource flows suggest the difficulty, if not impossibility, of the world attaining a U.S.-style consumption level by the early to mid-21st century.

ENTROPY AND THE ECONOMIC PROCESS

The application of the physical law of entropy to production shows, from a scientific perspective, the finite limits of the earth’s resources. What goes into the economic process represents valuable natural resources; what is thrown out is generally waste. That is, matter-energy enters the economic process in a state of low entropy and comes out in a state of high entropy. To explain, entropy is a measure of the unavailable energy in a thermodynamic system. Energy can be free energy, over which we have almost complete command, or bound energy, which we cannot possibly use. The chemical energy in a piece of coal is free energy because we can transform it into heat or mechanical work. But when the coal’s initial free energy is dissipated in the form of heat, smoke, and ashes that we cannot use, it has been degraded into bound energy–energy dissipated in disorder, or a state of high entropy. The second law of thermodynamics states that the entropy of a closed system continuously increases, or that the order of such a system steadily turns into disorder. The entropy cost of any biological or economic enterprise is always greater than the product. Every object of economic value – a fruit picked from a tree or a piece of clothing – has a low

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entropy. Our continuous tapping of natural resources increases entropy. Pollution and waste indicate the entropic nature of the economic process. Even recycling requires an additional amount of low entropy in excess of the renewed resource’s entropy (Georgescu-Roegen 1971).

We have access to two sources of free energy, the stock of mineral deposits and the flow of solar radiation intercepted by the earth. However, we have little control over this flow. The higher the level of economic development, the greater the depletion of mineral deposits and, hence, the shorter the expected life of the human species. For the theorist Nicholas Georgescu-Roegen, every time we produce a Cadillac, we destroy low entropy that could otherwise be used for producing a plow or a spade. Thus, we produce Cadillacs at the expense of future human life. Economic abundance, a blessing now, is against the interest of the human species as a whole. We become dependent on, and addicted to, industrial luxuries, so that, according to GeorgescuRoegen, the human species will have a short but exciting life.

Georgescu-Roegen’s perspective is one not of decades but of millennia, as his preoccupation is with our survival as a species. But even if we have little concern beyond the lifetime of our great-grandchildren, we ignore pessimists such as Daly and GeorgescuRoegen at our peril.

Natural Asset Deterioration and the Measurement

of National Income

The most widely used measure of economic progress, gross income or product, has major failings as a measure of economic welfare. Chapter 2 indicates that GNI or GDP is overstated as a number of items included in their national incomes are intermediate goods, reflecting the costs of producing or guarding income. Gross product assigns a positive value to any economic activity, whether it is productive, unproductive, or destructive.

The former World Bank President Barber B. Conable (1995) contends that

Unfortunately, [gross product figures] are generally used without the caveat that they represent an income that cannot be sustained. Current calculations ignore the degradation of the natural resource base and view the sales of nonrenewable resources entirely as income. A better way must be found to measure the prosperity and progress of mankind.

The expenditures on smog eradication, water purification, health costs from air pollution, and the reduction of traffic congestion that add to national income are really costs of economic growth. The 1989 Alaskan oil spill actually increased GNP, since much of the $2.2 billion spent on labor and equipment for the cleanup added to income. Shifting from the automobile to the bicycle and light rail transport would probably enhance urban life but reduce GNP. The quality of services and sustainability of consumer services are more important indicators of progress (Bracho 1989; Brown, Flavin, and Postel 1991:124).