Neoclassical Economist Recants Key Article of Faith

by Eric Zencey

Mark this down as minor good news: in Vermont, a neoclassical economist who has long served as a media “go-to guy” for commentary on economic matters appears to have recanted a key element of the neoclassical model. He didn’t put it in those terms, and the scope of his readership is rarely larger than his (and my) home state, but still, this counts as progress.

The element of the neoclassical model that has come under critical scrutiny in the Vermont press lately is the notion that GDP — a measure of the dollar value of all goods and services produced by the economy — is a practical and useful measure of economic well-being. It’s not hard to see why GDP is being re-thought: last month tropical storm Irene dumped tropical-rainforest quantities of water on the state in just a few hours, leading to major damage from unprecedented flooding. Rivers filled their flood plains and kept rising, sweeping away roads, bridges, and houses, ruining homes, lives, farms, and communities. The publicly owned infrastructure is being put back with great speed and efficiency (and should be in good shape for the upcoming foliage season, so if you’ve planned a visit don’t think that you need to cancel). That repair work is the source of some economic confusion. The construction industry had been slumping; now workers are busy, doing productive things, getting paid. Is all this public works effort a net benefit to the economy, or not?

GDP says yes, absolutely. Common sense — and steady-state economic theory — says no.

GDP smiles on this scene.

GDP gets it wrong because it fails to take into account the ongoing benefit we derive from the services of physical wealth that’s already in place — public and private infrastructure that is paid for and in use. My car is a capital investment that provides me with transportation services; if I own it, the only aspect of its delivery of services that shows up in GDP comes from the spending I do on operating costs and maintenance. And perversely, if gas prices go up so does GDP — telling us that because there’s more spending, the economy must be delivering more economic benefit. If I make the switch to renting a car rather than owning it, the rental fee shows up as a monetary transaction and gets counted in GDP — though there’s no net increase in the quantity of services I’m getting. Those services count in GDP only if I pay for them incrementally and continually (and don’t get an equity stake in my vehicle).

The same miscounting happens with the services provided by (non-rental) housing, roads, bridges, etc.: the ongoing benefit is simply not counted. GDP is an indicator for amnesiacs. It has no memory, no room to allow that the economy has been operating for quite a while and has produced forms of durable wealth — things like buildings and bridges and roads and communications systems — that continue to be useful long after they’ve been paid for.

So, when disaster leads to major new spending, a by-the-book accounting has to say: GDP is up, so we must be better off. The downside — the loss of wealth (and the loss of services derived from that wealth) can’t show up in the books because it wasn’t counted in the first place. Disaster looks to be good for business, good for the economy, good for us; within the limits of neoclassical concepts, tools, and analysis, when we repair storm damage the result is “net positive.”

Will Vermont end up net positive in economic benefits as it repairs the damage from Irene? There are additional complexities when we ask such a question about a particular location or region, and the answer is “it depends.” The net economic effect of damage and repair for any one location depends in part on where the funding comes from — whether it is raised within or outside the economy being considered. (At the macro level, there is no “outside,” and the answer is no.) If Vermont’s repairs are paid for with money from outside the state — from the Federal government, say, through FEMA grants — disaster repair might or might not have a net positive effect in the state; it may or may not exceed the loss of wealth from the disaster. If there is a net positive effect, the surplus comes either from deficit spending by the central government, or through direct transfer of resources (through Federal taxes) from other states. If it’s a transfer, it represents loss of purchasing power and economic activity in the areas from which the money is transferred: there’s been no net gain in the system, just a shift in who benefits and who pays. If the funding comes from deficit spending, the stimulus may be just what’s needed to put people back to work, but there is still a shift: the transfer is inter-generational rather than geographic. Wealth creation that might have occurred later, benefiting a future generation, has been brought forward to benefit us.

This wouldn’t be a problem in an economic system on an infinite planet. In a world without resource constraints, deficit-financed investment can always increase the amount of production in the future, and the deficit can be repaid from that increase. Thus, on an infinite planet it would be possible for both the present and the future to benefit from our deficit spending today. But on our planet, with an economy built beyond the limits of what’s sustainable, expanding production today diminishes the wealth and well-being of people in the future. On a finite planet at maximum capacity, there’s no room to expand the economy’s ecological footprint without causing harms and losses, and economic growth today is a transfer of wealth and well-being from the future to the present.

Casting up GDP accounts, even when corrected this way, doesn’t begin to measure the personal and social costs of the damage — people’s loss of livelihoods and secure expectations, their loss of the personal effects that help define them and their familial and community relations, and sometimes — as when farmland is poisoned by toxins in floodwaters and herds and breeding stock are swept to their deaths — their loss of a known, satisfying way of life in a familiar landscape. When those softer, less quantifiable costs are included, it’s very hard to think that the catastrophe in Vermont had any sort of net positive benefit.

But economics as neoclassicists practice it slices off those less quantifiable aspects of well-being and looks at cold, hard cash. In those strictly monetary terms, disaster looks good for business, and more business looks good for Americans. That’s the flaw in GDP that one neoclassical economist has recanted in his latest appearance in our local media.

I interviewed this particular economist by phone in 2009, when I was putting together an op-ed piece on the shortcomings of GDP for the New York Times. When I asked the professor about the perverse way GDP tallied the results of Hurricane Katrina ($82 billion in property damage, so an $82 billion boost to GDP if all the damage were to be repaired), he defended GDP. “That figure is going to include a lot of improvements,” he said. “Those people are getting new cars, new carpets, new refrigerators.” Notice that this way of thinking gives a disciplinary seal of approval (“100% rational behavior”) to a very uneconomic, irrational exchange: you’d be crazy to pay the cost of complete destruction of your household in order to get incremental upgrades of some of the things it contains.

While it isn’t always possible to map theoretical insight directly from individual households to the larger household of planet earth, here I think we can. Because GDP doesn’t count the flow of services from existing household wealth as an economic benefit, GDP fails to treat destruction of that wealth as a cost item, and so it treats reconstruction of that household wealth as a net gain. Ditto when we look at the whole system: in the planetary household GDP fails to count ecosystem services as a benefit, and so fails to count ecosystem destruction as a cost item, and so makes continual economic growth look like a net gain. Because of our shoddy accounting, we’re destroying the ecosystems that support civilization, often to get nothing more than an incremental upgrade to the wealth we already have. At some point, we’ve got to admit that this is uneconomic, irrational: crazy.

This far the go-to economist didn’t go, at least not as he was quoted in the paper. But fixing our accounting system is a commonsense idea that subverts infinite planet thinking, and in what he did say the neoclassical economist showed that he had taken the first step on that path. He allowed that Tropical Storm Irene wasn’t an economic boon to Vermont, because “there’s a tremendous amount of wealth that’s destroyed, and that’s not a good thing.” Having recognized the existence of that already-built wealth, he should be ready to take the next (logical!) step: start measuring that wealth and start counting the services we derive from it as part of our economic benefit. That means getting beyond GDP, which focuses on the now, the moment, the instantaneous rate of change in our market-based economic activity.

Getting off of GDP and implementing an accounting system with a memory will prove to be the first step on a path to broader changes. If we take into account the services we derive from our considerable stock of built wealth, and also take into account the services we derive from our considerable-but-declining stock of natural wealth, we’re led by inexorable logic to re-evaluate the concept of economic growth. When we have a system of economic accounting that includes all costs and all benefits, it will be easier to see that much economic growth is uneconomic, because it costs more in degradation of ecosystem services and other costs than it brings in benefits. Once we get over GDP it will be easier to see that the only sane, sustainable economic doctrine is one that calls on us to live within our current solar income, a steady-state flow of matter and energy through the economy. By then this truth will have become self-evident: on a finite planet, we can’t grow the economy’s ecological footprint forever.

If, thanks to unprecedented storm damage, neoclassical economists are led to reject the valuations offered by GDP and follow their thinking to this conclusion, then unprecedented weather events like Irene may yet prove to have a net positive economic effect: they will have nudged economic theory onto the path to a sane, rational, sustainable, steady-state economy.

New Evidence for Changing the Nature of the Global Economy

by Brent Blackwelder

Billion-dollar weather catastrophes this year, along with the latest figures on Chinese consumption, emphasize the urgency of a shift in economic thinking.

The National Oceanic and Atmospheric Administration cites 10 massive weather disasters in the U.S. this year, each exceeding a billion dollars. The nine months of unprecedented weather extremes include these estimates of death and damage:

  • Hurricane Irene: 50 deaths and $7 billion;
  • Upper Midwest flooding along the Missouri River: $2 billion;
  • Mississippi River flooding in spring and summer: $4 billion;
  • Drought and heat waves in Texas and Oklahoma: $5 billion;
  • Tornadoes in the Midwest and Southeast in May: 177 deaths and $7 billion;
  • Tornadoes in the Ohio Valley and Southeast in April: 32 deaths and $9 billion;
  • Tornadoes in Oklahoma and Pennsylvania in April: $2 billion;
  • Tornadoes in the Northeast and Midwest April 8-11: $2.2 billion;
  • Tornadoes in central and southern states April 4-5: $2.3 billion;
  • Blizzard in January from Chicago to the Northeast: 36 deaths and $2 billion.

Although we cannot conclude that any particular event was caused by global warming, climate models predict growing frequency and intensity of storms. The tragic weather events of 2011 could well be due to the accumulation of dangerous levels of greenhouse gases in our atmosphere.

This year’s disasters are sending a powerful signal that the time has arrived for a new economic framework. The current structure of markets puts the wrong prices on goods and services, because it neglects the ecological costs of producing them. This market failure is especially critical in the energy sector, where overconsumption of fossil fuels is driving climate destabilization.

How long can governments keep spending huge amounts to deal with catastrophe after catastrophe? Weather disasters undermine governance in two ways: first, they require large amounts of money and human resources for emergency relief, cleanup and rehabilitation. Second, they impair the ability of governments to provide ongoing public services by diverting revenue and personnel.

At the beginning of summer, New York Times columnist Thomas Friedman pointed to alarming evidence that the human race is consuming at a rate that requires one and a half planet earths to maintain. Friedman describes the consumer-driven growth model as broken and suggests a transition to a “happiness-driven growth model, based on people working less and owning less.” Many of us have been making these very points for some time, but it is noteworthy that a major growth advocate has had a change of thinking. And now there is new data on consumption in China that reinforces our concerns.

In a recent article entitled “Learning from China: Why the Existing Economic Model Will Fail,” Lester Brown provides some sobering statistics. When compared to the U.S., China consumes twice as much meat, three times as much coal, and four times as much steel. The per capita consumption of the 1.2 billion people in China is far below that in the U.S., but it is moving upward and is on track to equal ours in 25 years, Brown notes.

What does such growth in consumption mean if the Chinese embrace the same spending habits as U.S. consumers? Take a look at two factors: paper and automobiles. If the projected 1.4 billion people in China in 2035 consume paper at the American rate, then China itself would consume a quantity equal to four fifths of today’s paper usage. The world’s forests, already under intense pressure, would suffer under this additional onslaught.

Lester Brown considers what would happen if Chinese car ownership in 2035 matched that of the U.S., which currently has three cars for every four people. China would have 1.1 billion cars. Today the world has roughly one billion automobiles. Brown estimates that such a fleet of vehicles would necessitate so many new roads and parking areas, that an area two thirds the size of the acreage now growing rice in China would have to be paved. All these new vehicles would consume about the same volume of gasoline that the entire world auto fleet currently uses each day.

Why are the Obama Administration and Congress so focused on the debt panel when there are such pressing problems with the economy at home and around the world? They are missing the big picture and failing to enact changes that are called for in these perilous times. Now is the time to write letters to the editor about real economic solutions. We don’t need to be slashing government programs; we need to be making progress toward the transition to a steady state economy.

The Errant Economics of Detrimental Dams and Ruined Rivers

By Brent Blackwelder

Quick Note on Another Matter: On September 3, BP officials threatened not to pay for damage claims and clean up work on its huge spill in the Gulf of Mexico if it is not granted new offshore drilling permits. If you are offended by this blatant blackmail attempt, see Dr. Blackwelder’s call for banning BP from doing further business in the United States.

Lessons from the massive flooding that has beset Pakistan, uprooting 14 million people, underscore the need for a new economic paradigm. River engineering (a mainstay of the old economic paradigm) in the Indus Basin reduced small and medium floods, but set up the conditions for millions to be harmed when larger floods occurred.

Flooding in Pakistan. Image credit: Matloob Ali/Oxfam

Sustainable infrastructure forms the foundation of a steady state economy, but that foundation will have to be rebuilt from the ecologically ignorant infrastructure constructed throughout the 20th century. Big river engineering projects have actually heightened flood damages and destroyed vital renewable resources such as forests and fisheries.

Pakistan has always had monsoon seasons, and for generations people have adapted to them. However, the increases in extreme weather conditions, deforestation, population, and large infrastructure projects like mega-dams have created huge vulnerability. Both the Pakistani and the Indian governments resorted to massive water releases from their flood-swollen reservoirs in order to “save” their dams.

Friends of the Earth International reports that these water releases proved fatal to scores of people around these dams. For years, communities and civil society groups opposed these mega-dams, pointing out that they were catastrophes waiting to happen. They predicted that in the event of extreme weather, as we are seeing now, communities located along so-called “protected” rivers would suffer the most severe impacts. Sadly, in the last few weeks these predictions have been realized.

The engineering of the Mississippi River carries important lessons for Pakistan and the rest of the world. Big dams on the Mississippi’s longest tributary, the Missouri River, have blocked the flow of sediment downstream. The massive dikes and levees along the banks of the Mississippi itself prevented the river from spreading out and depositing silt during flood stages. The end result is the lack of silt for the delta at the mouth of the Mississippi in Louisiana – home of the nation’s greatest wetlands, which are eroding at the rate of two football fields each hour. The loss of these outstanding wetlands means less natural flood protection for New Orleans and other susceptible areas.

To move to a healthy steady state economy, civilization must not repeat the engineering mistakes of the 20th century. In Tim Jackson’s Prosperity Without Growth report, the author stresses the need for appropriate infrastructure and maintenance of ecosystems. The problem with the “big dam and levee approach” is that it ruins productive river ecosystems that contain abundant fisheries, bottomland forests, and fertile land. To make the transition to a sustainable economy, scarce financial resources must not be spent on counterproductive infrastructure that traps governments in a worsening spiral of flood relief, damage repair efforts, and environmental degradation.

Throughout most of the 20th century, politicians and the construction lobby disregarded the annual cycles and natural dynamics of rivers and did not care about impacts of giant dams on fisheries and forests. The big dam builders created an unsustainable and highly destructive infrastructure.

A little noticed phenomenon is the dam removal movement in the U.S. Since 1970, communities and governmental agencies have taken down over 500 dams. The cruel irony is that just as the U.S. began to protect rivers and to remove dams that were doing more harm than good, the rest of the world failed to learn from our experience.

Hoover Dam on the Colorado River, where native fish have been almost totally replaced by non-natives.

Captivated by stories of the gigantic Hoover and Grand Coulee hydropower dams, many nations chose to emulate the big dam and levee approach without critically assessing what was and wasn’t working. For example, of the 64 dams built by the Tennessee Valley Authority (TVA), an ex-post analysis showed that only 4 actually produced benefits in excess of costs (see The Myth of the TVA by William U. Chandler).

Massive flooding has also occurred this summer in China despite the Three Gorges Dam, the world’s largest, and the claims that it would control the 1,000-year flood. To “control” flooding, this dam permanently flooded out hundreds of towns and cities, forcing the relocation of over one million people.

If transnational construction companies and river engineers have their way, major rivers around the world will be loaded with dams. The implications for fisheries are devastating as migratory fish passage will be destroyed. For example, on Southeast Asia’s Mekong River, over 3 million fish per hour during migration season pass the spot where a gigantic dam is planned. In Cambodia the large lake Tonle Sap increases six-fold during flood stages on the Mekong. Dams on the river will wreck these centuries-old flood patterns and destroy the fisheries that one million people who live near the lake depend on.

We will never get to a sustainable and prosperous economy if scarce economic resources are spent on wrecking great river basins that provide enormous benefits when they are maintained in a more natural condition. Big dams are the equivalent of putting giant doses of cholesterol in the arteries of planet earth and have no place in the infrastructure for a prosperous steady state economy. So it is time to cease giving foreign aid to the transnational construction industry for more “dam” foolishness.