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Use and Abuse of the “Natural Capital” Concept

by Herman Daly

Herman DalySome people object to the concept of “natural capital” because they say it reduces nature to the status of a commodity to be marketed at its exchange value. This indeed is a danger, well discussed by George Monbiot. Monbiot’s criticism rightly focuses on the monetary pricing of natural capital. But it is worth clarifying that the word “capital” in its original non-monetary sense means “a stock or fund that yields a flow of useful goods or services into the future.” The word “capital” derives from “capita” meaning “heads,” referring to heads of cattle in a herd. The herd is the capital stock; the sustainable annual increase in the herd is the flow of useful goods or “income” yielded by the capital stock–all in physical, not monetary, terms. The same physical definition of natural capital applies to a forest that gives a sustainable yield of cut timber, or a fish population that yields a sustainable catch. This use of the term “natural capital” is based on the relations of physical stocks and flows, and is independent of prices and monetary valuation. Its main use has been to call attention to and oppose the unsustainable drawdown of natural capital that is falsely counted as income.

Big problems certainly arise when we consider natural capital as expressible as a sum of money (financial capital), and then take money in the bank growing at the interest rate as the standard by which to judge whether the value of natural capital is growing fast enough, and then, following the rules of present value maximization, liquidate populations growing slower than the interest rate and replace them with faster growing ones. This is not how the ecosystem works. Money is fungible, natural stocks are not; money has no physical dimension, natural populations do. Exchanges of matter and energy among parts of the ecosystem have an objective ecological basis. They are not governed by prices based on subjective human preferences in the market.

Furthermore, money in the bank is a stock that yields a flow of new money (interest) all by itself without diminishing itself, and without the aid of other flows. Can a herd of cattle yield a flow of additional cattle all by itself, and without diminishing itself? Certainly not. The existing stock of cattle transforms a resource flow of grass and water into new cattle faster than old cattle die. And the grass requires sunlight, soil, air, and more water. Like cattle, capital transforms resource flows into products and wastes, obeying the laws of thermodynamics. Capital is not a magic substance that grows by creating something out of nothing.

While the environmentalist’s objections to monetary valuation of natural capital are sound and important, it is also true that physical stock-flow (capital-income) relations are important in both ecology and economics. Parallel concepts in economics and ecology aid the understanding and proper integration of the two realities–if their similarities are not pushed too far!

The biggest mistake in integrating economics and ecology is confusion about which is the Part and which is the Whole. Consider the following official statement, also cited by Monbiot:

As the White Paper rightly emphasized, the environment is part of the economy and needs to be properly integrated into it so that growth opportunities will not be missed.

—Dieter Helm, Chairman of the Natural Capital Committee, The State of Natural Capital: Restoring our Natural Assets, Second report to the Economic Affairs Committee, UK, 2014.

If the Chairman of the UK Natural Capital Committee gets it exactly backwards, then probably others do too. The environment, the finite ecosphere, is the Whole and the economic subsystem is a Part–a completely dependent part. It is the economy that needs to be properly integrated into the ecosphere so that its limits on the growth of the subsystem will not be missed. Given this fundamental misconception, it is not hard to understand how other errors follow, and how some economists, imagining that the ecosphere is part of the economy, get confused about valuation of natural capital.

Natural Capital, James Wheeler

How can we correctly price natural capital in a full world? Photo Credit: James Wheeler

In the empty world, natural capital was a free good, correctly priced at zero. In the full world, natural capital is scarce. How do we take account of that scarcity without prices? This question is what understandably leads economists to price natural capital, and then leads to the monetary valuation problems just discussed. But is there not another way to recognize scarcity, besides pricing? Yes, one could impose quotas–quantitative limits on the resource flows at ecologically sustainable levels that do not further deplete natural capital. We could recognize scarcity by living sustainably off of natural income rather than living unsustainably from the depletion of natural capital.

In economics, “income” is by definition the maximum amount that can be consumed this year without reducing the capacity to produce the same amount next year. In other words, income is by definition sustainable, and the whole reason for income accounting is to avoid impoverishment by inadvertent consumption of capital. This prudential rule, although a big improvement over present practice, is still anthropocentric in that it considers nature in terms only of its instrumental value to humans. Without denying the obvious instrumental value of nature to humans, many of us consider nature to also have intrinsic value, based partly on the enjoyment by other species of their own sentient lives. Even if the sentient experience of other species is quite reasonably considered less intrinsically valuable than that of humans, it is not zero. Therefore we have a reason to keep the scale of human takeover even below that indicated by maximization of instrumental value to humans. On the basis of intrinsic value alone, one may argue that the more humans the better–as long as we are not all alive at the same time! Maximizing cumulative lives ever to be lived with sufficient wealth for a good (not luxurious) life is very different from, and inconsistent with, maximizing simultaneous lives.

In addition, speaking for myself, and I expect many others, there is a deeper consideration. I cannot reasonably conceive (pace neo-Darwinist materialists) that our marvelous world is merely the random product of multiplying infinitesimal probabilities by infinitely many trials. That is like claiming that Hamlet was written by infinitely many monkeys, banging away at infinitely many typewriters. A world embodying mathematical order, a system of evolutionary adaptation, conscious rational thought capable of perceiving this order, and the moral ability to distinguish good from bad, would seem to be more like a creation than a happenstance. As creature-in-charge, whether by designation or default, we humans have the unfulfilled obligation to preserve and respect the capacity of Creation to support life in full. This is a value judgment, a duty based both historically and logically on a traditional theistic worldview. Although nowadays explicitly rejected by materialists, and by some theists who confuse dominion with vandalism, this worldview fortunately still survives as more than a vestigial cultural inheritance.

Whatever one thinks about these deeper issues, the point is that determination of the scale of resource throughput cannot reasonably be based on pseudo prices. But scale does have real consequences for prices. Fixing the scale of the human niche is a price-determining macro decision based on ethical and religious criteria. It is not a price-determined micro decision based on market expression of individual preferences weighted by ability to pay.

However the scale of the macro-limited resource flow is determined, we next face the question of how to ration that amount among competing micro claimants? By prices. So we are back to pricing, but in a very different sense. Prices now are tools for rationing a fixed predetermined flow of resources, and no longer determine the volume of resources taken from nature, nor the physical scale of the economic subsystem. Market prices (modified by taxes or cap-auction-trade) ration resources as an alternative to direct quantitative allocation by central planning. The physical scale of the economy has been limited, and the resulting scarcity rents are captured for the public treasury, permitting elimination of many regressive taxes. Dollars become ration tickets; no longer votes that determine how big the scale of the economy will be relative to the ecosystem. The market no longer conveys the message “we can grow as much as we want as long as we pay the price.” Rather the new message is, “there is only so much to go around, and dollars are your ration ticket for a part of the fixed quota, not a vote that can be cast for growth.” Equitable distribution of dollar incomes (ration tickets) will then be seen as the serious matter that it is, to be solved by sharing, not evaded by growth, especially not by uneconomic growth.

Unfortunately, the more common approach in economics has been to try somehow to calculate that price that internalizes sustainability and impose it via taxes. The right price, given the demand curve, will result in the corresponding right quantity. However, there is a two-fold problem: first, methods of calculating the “right” price are usually specious (e.g. contingent valuation); and second, we don’t really know where the shifting demand curve is, except on the blackboard. In fixing prices, errors in demand estimation result in variations in quantity. In fixing quantity, errors result in variations in price. The ecosystem is sensitive to quantity, not price. It is ecologically safer to let errors in estimation of demand result in price changes rather than quantity changes. This is one advantage of the cap-auction-trade system relative to carbon taxes. Although a great improvement over the present, carbon taxes attempt to ration carbon fuels without having really limited their supply. Nor are the “dollar ration tickets” limited, given the fractional reserve banks’ ability to create money, and the Fed’s policy of issuing more money whenever growth slows down.

A monetary reform to 100% reserve requirements on demand deposits would be a good policy for many reasons, to which we can add, as a necessary supplement to a carbon tax. It would not be necessary as a supplement to cap-auction-trade, but should be adopted for independent reasons. A good symbol should not be allowed to do things that the reality it symbolizes cannot do. One hundred percent reserves would require the symbol of money to behave more like real wealth, at least in some important ways. But this is another story.

The Populations Problem

by Herman Daly

Herman DalyThe population problem should be considered from the point of view of all populations — populations of both humans and their artifacts (cars, houses, livestock, cell phones, etc.) — in short, populations of all “dissipative structures” engendered, bred, or built by humans. In other words, the populations of human bodies and of their extensions. Or in yet other words, the populations of all organs that support human life and the enjoyment thereof, both endosomatic (within the skin) and exosomatic (outside the skin) organs.

All of these organs are capital equipment that support our lives. The endosomatic equipment — heart, lungs, kidneys — support our lives quite directly. The exosomatic organs — farms, factories, electric grids, transportation networks — support our lives indirectly. One should also add “natural capital” (e.g., the hydrologic cycle, carbon cycle, etc.) which is exosomatic capital comprised of structures complementary to endosomatic organs, but not made by humans (forests, rivers, soil, atmosphere).

The reason for pluralizing the “population problem” to the populations of all dissipative structures is two-fold. First, all these populations require a metabolic throughput from low-entropy resources extracted from the environment and eventually returned to the environment as high-entropy wastes, encountering both depletion and pollution limits. In a physical sense the final product of the economic activity of converting nature into ourselves and our stuff, and then using up or wearing out what we have made, is waste. Second, what keeps this from being an idiotic activity, grinding up the world into waste, is the fact that all these populations of dissipative structures have the common purpose of supporting the maintenance and enjoyment of life.

What good are endosomatic organs without the support of exosomatic natural capital?

As A. J. Lotka pointed out, ownership of endosomatic organs is equally distributed, while the exosomatic organs are not. Ownership of the latter may be collective or individual, equally or unequally distributed. Control of these external organs may be democratic or dictatorial. Owning one’s own kidneys is not enough to support one’s life if one does not have access to water from rivers, lakes, or rain, either because of scarcity or monopoly ownership of the complementary exosomatic organ. Likewise our lungs are of little value without the complementary natural capital of green plants and atmospheric stocks of oxygen. Therefore all life-supporting organs, including natural capital, form a unity. They have a common function, regardless of whether they are located within the boundary of human skin or outside that boundary. In addition to being united by common purpose, they are also united by their role as dissipative structures. They are all physical structures whose default tendency is to dissipate or fall apart, in accordance with the entropy law.

Our standard of living is roughly measured by the ratio of outside-skin to inside-skin capital — that is, the ratio of human-made artifacts to human bodies, the ratio of one kind of dissipative structure to another kind. Within-skin capital is made and maintained overwhelmingly from renewable resources, while outside-skin capital relies heavily on nonrenewable resources. The rate of evolutionary change of endosomatic organs is exceedingly slow; the rate of change of exosomatic organs has become very rapid. In fact the evolution of human beings is now overwhelmingly centered on exosomatic organs. This evolution is goal-directed, not random, and its driving purpose has become “economic growth,” and that growth has been achieved largely by the depletion of non renewable resources.

Although human evolution is now decidedly purpose-driven we continue to be enthralled by neo-Darwinist aversion to teleology and devotion to random. Economic growth, by promising “more for everyone eventually,” becomes the de facto purpose, the social glue that keeps things from falling apart. What happens when growth becomes uneconomic, increasing costs faster than benefits? How do we know that this is not already the case? If one asks such questions one is told to talk about something else, like space colonies on Mars, or unlimited energy from cold fusion, or geo-engineering, or the wonders of globalization, and to remember that all these glorious purposes require growth now in order to provide still more growth in the future. Growth is good, end of discussion, now shut up!

Let us reconsider in the light of these facts, the idea of demographic transition. By definition this is the transition from a human population maintained by high birth rates equal to high death rates, to one maintained by low birth rates equal to low death rates, and consequently from a population with low life expectancy to one with high life expectancy. Statistically such transitions have been observed as standard of living (ratio of exosomatic to endosomatic capital) increases. Many studies have attempted to explain this fact, and much hope has been invested in it as an automatic cure for overpopulation. “Development is the best contraceptive” is a related slogan, partly based in fact, and partly in wishful thinking.

There are a couple of thoughts I’d like to add to the discussion of demographic transition. The first and most obvious one is that populations of artifacts can undergo an analogous transition from high rates of production and depreciation to low ones. The lower rates will maintain a constant population of longer-lived, more durable artifacts.

Our economy has a growth-oriented focus on maximizing production flows (birth rates of artifacts) that keeps us in the pre-transition mode, giving rise to growing artifact populations, low product lifetimes, high GDP, and high throughput, with consequent environmental destruction. The transition from a high-maintenance throughput to a low one applies to both human and artifact populations independently. From an environmental perspective, lower throughput is desirable in both cases, at least up to some distant limit.

The second thought I would like to add to the discussion of demographic transition is a question: does the human transition, when induced by rising standard of living, as usually assumed, increase or decrease the total load of all dissipative structures on the environment? Specifically, if Indian fertility is to fall to the Swedish level, must Indian per capita possession of artifacts (standard of living) rise to the Swedish level? If so, would this not likely increase the total load of all dissipative structures on the Indian environment, perhaps beyond capacity to sustain the required throughput?

The point of this speculation is to suggest that “solving” the population problem by relying on the demographic transition to lower birth rates could impose a larger burden on the environment rather than the smaller burden that would be the case with direct reduction in fertility. Of course reduction in fertility by automatic correlation with rising standard of living is politically easy, while direct fertility reduction is politically difficult. But what is politically easy may be environmentally destructive.

To put it another way, consider the I = PAT formula. P, population of human bodies, is one set of dissipative structures. A, affluence, or GDP per capita, reflects another set of dissipative structures — cars, buildings, ships, toasters, iPads, cell phones, etc. (not to mention populations of livestock and agricultural plants). In a finite world some populations grow at the expense of others. Cars and humans are now competing for land, water, and sunlight to grow either food or fuel. More nonhuman dissipative structures will at some point force a reduction in other dissipative structures, namely human bodies. This forced demographic transition is less optimistic than the voluntary one induced by chasing a higher standard of living more effectively with fewer dependents. In an empty world we saw the trade-off between artifacts and people as induced by desire for a higher standard of living. In the full world that trade-off seems forced by competition for limited resources.

The usual counter to such thoughts is that we can improve the efficiency by which throughput maintains dissipative structures — technology, T in the formula, measured as throughput per unit of GDP. For example a car that lasts longer and gets better mileage is still a dissipative structure, but with a more efficient metabolism that allows it to live on a lower rate of throughput.

Likewise, human organisms might be genetically redesigned to require less food, air, and water. Indeed smaller people would be the simplest way of increasing metabolic efficiency (measured as number of people maintained by a given resource throughput). To my knowledge no one has yet suggested breeding smaller people as a way to avoid limiting births, but that probably just reflects my ignorance. We have, however, been busy breeding and genetically engineering larger and faster-growing plants and livestock. So far, the latter dissipative structures have been complementary with populations of human bodies, but in a finite and full world, the relationship will soon become competitive.

Indeed, if we think of population as the cumulative number of people ever to live over time, then many artifact populations are already competitive with the human population. That is, more consumption today of terrestrial low entropy in non-vital uses (Cadillacs, rockets, weapons) means less terrestrial low entropy available for capturing solar energy tomorrow (plows, solar collectors, ecosystem regeneration). The solar energy that will still fall on the earth for millions of years after the material structures needed to capture it are dissipated, will be wasted, just like the solar energy that shines on the moon.

There is a limit to how many dissipative structures the ecosphere can sustain — more endosomatic capital must ultimately displace some exosomatic capital and vice versa. Some of our exosomatic capital is critical — for example, that part which can photosynthesize, the green plants. Our endosomatic capital cannot long endure without the critical exosomatic capital of green plants (along with soil and water, and of course sunlight). In sum, demographers’ interest should extend to the populations of all dissipative structures, their metabolic throughputs, and the relations of complementarity and substitutability among them. Economists should analyze the supply, demand, production, and consumption of all these populations within an ecosphere that is finite, non-growing, entropic, and open only to a fixed flow of solar energy. This reflects a paradigm shift from the empty-world vision to the full-world vision — a world full of human-made dissipative structures that both depend upon and displace natural structures. Growth looks very different depending on from which paradigm it is viewed.

Carrying capacity of the ecosystem depends on how many dissipative structures of all kinds have to be carried. Some will say to others, “You can’t have a glass of wine and piece of meat for dinner because I need the grain required by your fine diet to feed my three hungry children.” The answer will be, “You can’t have three children at the expense of my and my one child’s already modest standard of living.” Both have a good point. That conflict will be difficult to resolve, but we are not yet there.

Rather, now some are saying, “You can’t have three houses and fly all over the world twice a year, because I need the resources to feed my eight children.” And the current reply is, “You can’t have eight children at the expense of my small family’s luxurious standard of living.” In the second case neither side elicits much sympathy, and there is great room for compromise to limit both excessive population and per capita consumption. Better to face limits to both human and artifact populations before the terms of the trade-off get too harsh.

Ecosystem Services: The Traveling Salesman and the Trophic Conundrum

by Brian Czech

Some scholars make a living valuing natural capital and ecosystem services, with trips the world over pointing out the value of standing forests, free-flowing watersheds, coastal wetlands, and all those other “funds” of ecosystem services. Foreign governments, think tanks, and universities pay handsomely for such talks.  It’s a good gig for those who can settle for telling half a story.

Meanwhile the inconvenient truth languishes in obscurity. Our traveling scholars won’t be seen uttering the phrase “steady state economy,” at least not in public. They know it goes against the political tide, which is still coming in for economic growth. Grants go to those who don’t go against growth.

That’s why, after such scholars come through your town or country, you’re left to figure out the big picture on your own. By the time you realize that all the talk about ecosystem services and “green accounting” boils down to the need for a steady state economy, you’ll be left to do the heavy political lifting, too. The traveling scholar will be long gone; probably on another flight to a hefty honorarium.

Let’s get one thing straight: ecological microeconomics — deriving the value of ecosystem services — does have an important role to play in the quest for sustainability. But performed out of its macroeconomic context, all the talk of ecosystem service values is like the din of drums without the melody of a guitar. It’s hard to make sense of.

For the sake of all sustainable, I’d like to propose a new rule; namely, that no talks on valuing ecosystem services be given (especially for big bucks) without a healthy dose of ecological macroeconomics. Without explicitly pointing out the limits to economic growth and the need for a steady state economy, the speaker leaves the audience with a dangerous ambiguity. Suckers and scholars alike are led to believe they can save the world as long as they get the prices right for ecosystem services. Of course, some of the audience will “get it” — it being the need for a steady state economy — but too much ambiguity remains to turn the tide toward steady statesmanship.

This is no hypothetical matter. We see examples abounding. Take the National Wildlife Federation (NWF), which recently adopted a resolution calling for reforming GDP, which is the indicator of economic growth. NWF fully recognizes that GDP is a poor indicator of human wellbeing because it doesn’t account for many things — such as wildlife conservation — that are important to humans. They recognize that growing GDP has amounted to declining biodiversity, among other things. That’s why it is quite logical to surmise that NWF gets the need for a steady state economy.

But no, NWF clarified that they only call for reforming GDP and not for a steady state economy. Apparently they think that, by getting all the prices right for ecosystem services, GDP will be wildlife-friendly and we can have economic growth and wildlife conservation ever after. (Actually, at least one of the NWF delegates who advanced the NWF resolution was motivated by steady state economics.  We know that because he’s a CASSE chapter director! For NWF executive leadership, however, apparently it’s all drums and no guitar.)

NWF would do well to consider Herman Daly’s metaphor of the plimsoll line, the marking on a ship that tells captain and crew when to stop adding cargo. Loading beyond the plimsoll line is so dangerous that it was outlawed. To the NWFs of the world, ecological macroeconomics has a message: when you’re loaded to the plimsoll line, it doesn’t matter if you add a green puppy or a gray pig — you’re sunk!

Failure to see the forest for the trees would be greatly alleviated if only our traveling salesmen of natural capital accounting were to couple the incomplete truth (micro) with the inconvenient truth (macro). I’ll make it easy for them by offering up the “trophic conundrum” model from my upcoming book, Supply Shock. The model illuminates the inconvenient truth that all the valuation exercises in the world won’t save us from the tradeoff between economic growth and environmental protection.

We see from the model that as the natural capital supply curve shifts inward (from S1 to S2), the price of natural capital and ecosystem services increases (from P1 to P2). That’s basic economics. What is not basic (conventional, neoclassical) economics, but rather ecological macroeconomics, is the trophic theory of money, which tells us that the supply curve shifts inward as an inevitable function of economic growth.  That’s because economic growth entails the transformation of natural capital into more goods and services, plus manmade capital and waste.

We can do all the green accounting in the world, but the only way to stabilize prices of natural capital and ecosystem services — the only way to achieve sustainability — is to establish a steady state economy with stable population and per capita consumption. Meanwhile the only way to establish a steady state economy is with more, and clear, articulation of this inconvenient truth. Otherwise, with nothing but ecological microeconomics, we’re just pricing to peddle. We’re not conserving, sustaining, or telling the whole truth.