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What is Wrong with a Zero Interest Rate?

by Herman Daly

Herman DalyThe stock market took a dip, so the Fed will likely continue to keep the interest rate at zero, in conformity with its goal of supporting asset prices by quantitative easing. What is wrong with a zero interest rate? Doesn’t it boost investment, growth, and employment?

There are many things wrong with a zero interest rate. Remember that the interest rate is a price paid to savers by borrowing investors. At a zero price, savers will save less and receive less return on past savings. Savers and pensioners are penalized. At a near zero price for borrowed funds, investors are being subsidized and will invest in just about anything, leading to many poor investments and negative returns, furthering the economy’s already advanced transition from economic to uneconomic growth. Zero interest promotes an infinite demand for savings with zero new supply. But the “supply” is provided artificially by the Fed printing money. The infinite demand would be checked by the rising costs of natural resources and environmental damage if those costs were internalized, but they are not. Yet the environmental costs are real and do not disappear just because they are not counted. With free money and uncounted environmental costs, why not invest heavily in fracking? A very unequal distribution of income does check demand, at least for non-luxury goods. Rich people have an increasing surplus of money to invest, which also helps hold down the interest rate. Yes, mortgage rates fall, and that benefits citizens as home buyers, but they lose more in terms of their retirement accounts. And there is still a significant spread between the zero rate paid to savers and the positive rates charged on credit card and other debt, so the banks are doing quite well.

Also think for a moment about the calculation of present value in finance—a perpetual stream of future income divided by the interest rate gives its capitalized value. If the interest rate is zero, then the capitalized present value of any positive perpetual income stream becomes infinite. To put it another way, a zero interest rate is equivalent to saying that a hypothetical stream of income into the infinite future is all totally available today. Supply of financial capital in terms of its present value is infinite. But financial capital is supposed to be a measure of real capital, which is not infinite. Furthermore, the interest rate, to a significant degree, reflects the risk of loss. With infinite capital it matters little if you lose some, so risk too is uncounted.

U.S. Treasury.Elfboy

U.S. Department of the Treasury, Washington, D.C. Photo Credit: Elfboy

Zero interest rates encourage aggregate growth in scale of the macro-economy to ecologically unsustainable, as well as uneconomic, levels. Zero interest rates also neglect risk of loss, while encouraging microeconomic misallocation to stupid projects. At the same time, it redistributes income inequitably. Does all this make you think that something might be screwy with the policy of zero interest rates? Economists pride themselves on their knowledge of advanced mathematics, but they don’t seem to mind the fact that their policies imply dividing by zero!

Granted that with severe unemployment it is worthwhile, as Keynes said, to hire people just to dig holes and fill them up again in order to increase spending. However, this would better be done by the Treasury paying the hole diggers with new Treasury money than by the Fed doing it by distorting the scale, distribution, and resource allocation of the whole economy with zero interest rates in order to create new bank money. Also, the money created by the Treasury costs no interest to the public, while the money created by the Fed costs us the positive rate charged to borrowers, not the zero rate paid to depositors. Money is a public utility like a road. Should private banks be allowed to set up a tollbooth and charge us for using public roads? By the way, the Fed is owned by its member private banks.

How does the Fed keep the interest rate at zero? By printing money—quantitative easing, so called. Some hyper-Keynesians want a negative nominal interest rate (we already have a negative real rate when corrected for inflation) because we still don’t have full employment even at a zero interest rate. But this is so crazy that it requires a separate discussion of its own.

Why has this huge monetary expansion not led to more inflation? For one, because the dollar is a reserve currency and other nations hold large dollar assets. Also, other major currencies, following the same expansionary policy, have been depreciating relative to the dollar. This will not likely continue. Furthermore, there really has been inflation, but of a hidden kind. Instead of stimulating new production and employment, the new money has increased the demand for existing assets such as stocks, houses, art, etc., providing little employment and leading to speculative bubbles. The Consumer Price Index (CPI), the official measure of inflation, does not include capital assets. And concurrent cheap-labor policies—off-shoring of production and tolerance of illegal immigration—depress wages, holding inflation in check. In addition, the externalization of increasing environmental costs keeps prices lower than they should be. Further, as any consumer can testify, the quantity per package of food is getting less, and the quality of service of airlines, internet providers, public utilities, etc. is deteriorating. Our leading newspaper, the New York Times, now repeats many of the same articles over and over for weeks at a time. Getting less quantity or quality or more repetition for the same price is equivalent to a price increase—hidden inflation. So the claim that quantitative easing has not yet led to inflation is at best only half true—it has certainly led to inflationary substitutes not measured by the CPI. Some official versions of the CPI even exclude such basics as energy, food, and housing (too “volatile” is the excuse). Do you ever feel that you are being lied to?

It is a bad idea to manipulate the interest rate as a policy variable—it has too many side effects cutting in too many different directions, especially in a fractional reserve monetary system. Better to control the money supply directly by moving to a full reserve banking system. We should abolish the Fed, let the Treasury directly control the money supply, constrained by avoiding inflation, not by a budget. An entity that can create money does not face a budget constraint, and has no need to borrow. But it does have a price-index constraint, and must be disciplined by avoidance of inflation (or deflation). As long as the public wants to hold more money, the Treasury can keep creating and spending it. When the public wants to hold more real goods and less money, they will exchange money for goods driving the price index up, which is the signal to the Treasury to stop issuing money, and if necessary to withdraw some. Money, in a full reserve banking system, becomes non interest-bearing government debt rather than interest-bearing private debt. Seigniorage (profit from creating token money at negligible cost and receiving its face value in exchange) will go entirely to the government, not largely to private banks. Also, banks no longer have the extortionary power to crash the entire payments system that fractional reserves gives them. The interest rate, like other prices, can take care of itself, determined by supply and demand. The policy focus should be to manage the money supply, constrained by a constant price index. In effect, the real value of the dollar is backed by all the commodities in the price index, rather than gold, or the “full faith and credit of the US government.” (See Nationalize Money, Not Banks)

Policies of this general kind, but elaborated on in much more detail, are currently suggested by the British NGO known as Positive Money. They are reviving and updating the sound monetary economics of Frederick Soddy, Irving Fisher, Frank Knight, and other leading economists of the 1920s. Fractional reserve banking supports the whole pyramid structure of Ponzi finance, and we badly need to move toward a full reserve banking system to escape instability.

 

The Future History of Political Economy – Part 2

Thermodynamics in Economics: Revolutionary portent, future history

by Eric Zencey

Eric ZenceyEcological Economics represents the extension into economics of the thermodynamic revolution of the nineteenth and twentieth centuries. In physics, that revolution dethroned Newton and brought relativity. In biology, it was midwife to the birth of ecology, the study of ecosystems as wholes in which energy networks—food webs—are a defining structure. In chemistry the laws of thermodynamics brought clarity and rigor to a science that struggled to bring theoretical unity to diverse phenomena. So far, though, most economists are perfectly willing to treat their subject matter as if the laws of thermodynamics simply don’t apply to it.

2 models 5

But the thermodynamic revolution in economics can’t be permanently forestalled. For one thing, it’s getting harder and harder for the neoclassical model to reassure us that its system of Newtonian abstractions is a good fit to the real world. The Great Collapse of 2008 demonstrated that whatever else it is, the discipline of economics isn’t very good at predicting major economic phenomena. Climate change and the Sixth Extinction make it hard for economics to maintain its pretense that economic activity takes place in abstractia, on the clean white pages of textbooks or on whiteboards holding formulae, with no roots in or consequences for anything outside of itself. Truths derived on the model of Newtonian mechanism are supposed to be abstract and ahistorical, but our planet and our economy are most assuredly evolving concretely and over time.

The driving dynamic of this economic and planetary change—the driver of history for the past three centuries—has been human use of high-EROI fossil fuel. The driving dynamic of the history yet to come will be the declining EROI of our civilization’s energy sources.

Oil Well 3.Texas State Archives

Oil used to gush out of the ground under pressure, making for a very high Energy Return on Energy Invested (EROI). In the 1920s, wells like this gave the industry an average EROI of 100 to 1 or more. Today’s petroleum industry has a much lower EROI. Photo Credit: Texas State Archives

You can see some of the consequences of declining EROI already:

  • Despite a rising real per capita GDP, for a significant percentage of workers in OECD nations personal income has flatlined or is declining. An increasing concentration of income helps explain this but another dynamic is at work as well. As EROI falls, it takes more economic effort to get the energy that’s needed to support economic effort. Even as gross economic activity (GDP) grows, production of net benefit is shrinking.
  • Other sectors of the economy have been affected by this ongoing increase in the economy’s matter-and-energy overhead. “Austerity” has become the watchword for governmental budgets, even in the wealthiest nations in the world. Developed countries find it increasingly difficult if not impossible to pay maintenance and upgrade costs on infrastructure investments made in the heyday of 100-to-1 oil.
  • In its 2013 report card on America’s infrastructure, The American Society of Civil Engineers estimated that the U.S. needs to invest $3.6 trillion over seven years to restore and maintain existing infrastructure.
  • Worldwide, many of the ecosystems that support human civilization are degraded and close to collapse. Forced by both ideology and declining EROI into austerity budgeting, governments are reducing their scope and energy at the exact moment that sustainability would have them take strong action to rein in the rational, free-market tendency of corporations to maximize profits by degrading the commons and externalizing other costs.
  • Pension-fund wipeouts are becoming common as one way to fulfill the economy’s structural need for debt repudiation—a need that lies in our system’s willingness to let debt grow faster than a declining EROI economy can pay back, even after growth has been stimulated by lifting or reducing regulations that limit the environmental damage done by economic activity.
  • The planetary carbon sink is full, producing climatic effects that even an abstraction-inhabiting, arithmo-morphizing economist has to acknowledge as a troubling reality.

Centuries from now economic historians are likely to understand the relationship between EROI and wealth creation much better than does the average economist of today. I think it likely that future political economists will express wonder not at the 20th century’s enormous economic success, but at how little we actually added to our stock of wealth for all the high-EROI coal and oil it was our pleasure to burn. They are almost certain to shake their heads in wonder that we, enjoying an energy supply and an EROI never seen on the planet before or since, could ever have experienced an economic downturn, could ever have let a human starve from want, could ever have been so programmatically blind to the physical origins of our fortunes.

The Future History of Political Economy – Part 1

Economics Ignores Thermodynamics

by Eric Zencey

Editor’s Note: An earlier version of this essay appeared as a comment in the Great Transition Network Forum, which will appear on the Great Transition Initiative website next week along with a new essay by Herman Daly, “Economics for a Full World.”

Eric ZenceyEcological Economics and its corollary, Steady State Economic thinking, represent a step forward for the discipline of economics and also a return to how it was practiced in the past. In the nineteenth century, economics was a part of a larger enterprise: political economy, the integrated treatment of morals and economics, ultimate ends and efficient means. Late in that century economics calved off from political economy, leaving behind political science and political philosophy as the residuum. It did this in service to the ideal of becoming rigorously scientific.

It’s odd, then, that alone among disciplines with any pretense to analytic rigor, economics has steadfastly resisted the thermodynamic revolution that swept physical and life sciences in the nineteenth and early twentieth centuries. Physics, biology, chemistry, geology, even the study of history were transformed, but not economics.

I think we can blame this on bad timing, willful ignorance, and oil.

Bad timing

In the late nineteenth century the archetypal science was physics and physics was Newtonian mechanism. Ignorant of what a young thermodynamic theorist named Albert Einstein would soon do to the Newtonian paradigm they emulated, Stanley Jevons and other economic “scientists” set about mathematically modeling the economy as sets and subsets of self-contained, equal-and-opposite actions and reactions, happily (and explicitly) assuming that all economic activity consists of ahistorical, which is to say completely reversible, processes. No one who has a nodding acquaintance with the law of entropy could have countenanced this. Entropy is Time’s Arrow, the law of irreversibility; it describes the one-way flow of energy use. A purely mechanical process can be run forward or backwards, but we’ll never invent a machine that can suck in exhaust gases, heat and motion and transform them into gasoline. The entropy law can tell you why. Newton couldn’t.

Just as a consumer might choose to keep a recently purchased appliance even though a newer, better model has been brought onto the market, neoclassical economists weren’t about to re-tool their brand-new thinking to reflect changes in the underlying metaphysics they had been so keen to adopt. It didn’t seem to them that there was any reason to.

“Seem” is the operative word here. Because the entropy process is time’s arrow, and because Ecological Economics places the entropy process at the center of its analysis, it’s entirely appropriate for Ecological Economics to understand its subject matter and itself as a discipline in historical terms. Like other paradigm-defining insights, this one seems obvious once it has been stated: elements of the neoclassical model that could pass for true on a large and forgiving planet a hundred years ago are obviously not true today, when the planet’s source-and-sink services are severely taxed, when natural capital is the limiting factor in production, when there are seven billion of us and our economic wants, capacities and expectations have been amplified by our access to the ancient sunshine of fossil fuels.

Willful ignorance

By modeling the economy as a closed and circular system, neoclassical economists have encouraged themselves to operate in a methodologically enforced state of denial about the physical roots and ecological consequences of our wealth-creating activities. And yet economics has experienced no paradigm-shaking crisis as a result. Neither climate change nor any of the other source-and-sink catastrophes facing civilization have been laid at the feet of bad economic theory. One reason: Neoclassical economists succeed in treating environmental costs as “externalities.” How could environmental degradation be the result of economic activity if it’s external to the economy?

Midas.Giovanni Caselli from the Age of Fable

The power to create wealth gave Midas an unsustainable life as a complete solipsist. Oil’s power to create wealth has had a similar effect on Neoclassical economics. Illustration by Giovanni Caselli from The Age of Fable.

In its self-confirming isolation of the economy from nature and theory from reality, neoclassical economics amounts to a highly principled practice of solipsism. When this pathology is manifest in an individual it produces unpleasant consequences that might eventually prompt some reflection and personal growth. Not so with the collective delusion of mainstream economists. Evidence of our ongoing ecological catastrophe falls far from their purview—not just disciplinarily but geographically, as the wealthier nations (wherein the vast majority of economists reside) export their ecological footprint to the impoverished nations of the world. And for several generations (at least since Reagan defeated Carter, removed Carter’s solar panels from the White House and ushered in an era of GDP growth through de-regulation of the social and ecological consequences of economic activity), there has been a strong self-selection among students of economics. Undergraduates with any kind of deep personal connection to natural systems tend to find the study of standard economics unattractive, displeasing, even soul-deadening. This leaves the field to those most willing to bracket off as irrelevant to their professional purpose any question about the moral and ethical consequences of economic activity, any question about the health and maintenance of nature, any question about the economy’s relation to the larger social and natural systems within which it operates.

Oil

Even so, you might expect that a discipline with such a demonstrably deficient view of its subject matter would fail of its object—would fail to offer wise counsel about the collective project of augmenting the stock of wealth that humans can enjoy. But economics has had much apparent success. Despite regular downturns and financial crises, the wealth produced by our economies has grown and grown and grown. I think there’s a ready explanation that becomes visible through the conceptual lens of Ecological Economics, which tells us that energy isn’t a commodity like any other but a fundamental factor of production (part of a trio: matter, energy and human design intelligence). When your economy operates on an energy source that cranks out wealth-making value in a ratio of 100 to 1 or better—the estimated Energy Return on Energy Invested that petroleum offered us in the early 20th Century—you can believe any damn thing you want about how economies operate and your economy will still generate a great deal of wealth.

Which is to say, high-EROI oil granted the new science of economics immunity from being proven false by events. But falsifiability of principles and propositions is one solid measure of a science. (Non-falsifiable beliefs are called faiths.)

In effect the discipline of economics has a free rider problem—it’s been given a free pass by the enormous power of oil to misunderstand itself and its subject matter. You could also call it a Midas Problem, after the legendary king whose touch turned everything he touched into gold, including his dinner and his daughter. The power of wealth-generation that oil granted to our economy made it impossible for the discipline of economics to connect in any fundamental way with otherness, including the otherness of the planet and its role in the very processes that economics presumes to model.

 

Paul Krugman on Limits to Growth: Beware the Bathwater

by Brian Czech

BrianCzechCongratulations to Paul Krugman, whose New York Times opinion on “Slow Steaming and the Supposed Limits to Growth” hit the bulls-eye of at least one balloon. Landing at Washington-National the very day his opinion column appeared was like crashing back into the growth fetish of the American Fourth Estate. Out came the fresh air of an Australian balloon; back to the polluted, cynical rhetoric that “there is no conflict between growing the economy and protecting the environment.”

Why the drama with Krugman’s column? Partly due to uncanny timing; partly due to the stark juxtaposition of opinions. Having delivered the keynote address–on limits to growth no less–at the Australian Academy of Science’s annual conference on environmental science, it struck me that decades of careful research could be undermined by the presumptuous pen of a well-placed economist. Something is wrong with that picture.

But only for so long, because those of us who recognize limits to growth have sound science, common sense, and burgeoning evidence on our side. The same cannot be said for Krugman’s opinion.

Krugman got off to a shaky start with the very title of his column. No matter what he could say about “slow steaming,” this was bound to be an article wrong-headed in using one sector (shipping) for drawing broad conclusions about a macroeconomic issue (economic growth). To extend a conclusion from the part to the whole is to commit the fallacy of composition. In this case, it’s a bit like Krugman saying, “Your fingernails keep growing; why not the rest of you too?”

The mistake is common and destructive. When this mistake is made by a highly acclaimed economist in a widely-read opinion, the potential for destruction is multiplied. Politicians hide behind such Pollyannaish opinions to pull out all the stops–fiscal and monetary–for economic growth. The casualties include not only environmental protection but the future economy and ultimately national security.

Next, in Krugman’s lead-in paragraph he laments the “unholy alliance on behalf of the proposition that reducing greenhouse gas emissions is incompatible with growing real GDP.” Already we have two more problems. First, the argument alluded to in the title–that is, refuting limits to growth–is reduced to refuting just one negative impact of growth (that is, climate change). What about all the other impacts and limitations of economic growth: liquidation of natural resources, pollution at large, habitat loss, biodiversity decline, and social side effects such as noise, congestion, and stress?

Second, in a maxed-out, over-stimulated, 90% fossil-fueled economy, Krugman wants us to believe we can grow the economy even more while reducing greenhouse gas emissions. No need to worry about little trends such as tar-sands mining in Canada, coal mining in China, and fracking in the USA. Slower steaming will save the day on climate change, and presumably for the rest of the planetary ecosystem.

Let’s not let Krugman delude us. “Growing real GDP” isn’t about an efficiency gain here and there. It means increasing production and consumption of goods and services in the aggregate. It entails a growing human population and/or per capita consumption. It means growing the whole, integrated economy: agriculture, extraction, manufacturing, services, and infrastructure. From the tailpipe of all this activity comes pollution.

Krugman seems to have fallen for the pixie dust of “dematerializing” and “green growth” in the “Information Economy.” He may want to revisit Chapter 4 of The Wealth of Nations, where Adam Smith pointed out that agricultural surplus is what frees the hands for the division of labor. In Smith’s day that included the likes of candle-making and pin manufacturing. Today it includes everything from auto-making to information processing, but the fundamentals haven’t changed. No agricultural surplus, no economic growth. And agriculture is hardly a low-energy sector.

Adam Smith was among the great, classical economists who readily recognized limits to growth, all the way until at least John Stuart Mill. After that and throughout the 20th century, things got murky for economists as they turned increasingly to microeconomics, losing the forest for the trees. Mr. Krugman appears to be yet another victim of the “neoclassical” evolution of economics. Look to him for insightful opinions on banking regulations, fiscal politics, and other such topics that fit naturally under the rubric of an economics columnist. These are his babies, but beware the bathwater. Take his opinion on limits to growth at your peril, and that of your grandkids.

A Question of Scarcity

by Andrew Fanning

Andrew Fanning‘Tis the season for untold numbers of undergraduate students around the world to receive their first exposure to “Principles of Economics.” During the first couple of lectures, economic terms and concepts are thrown at impressionable young minds at a dizzying pace: opportunity costs, rational choice, marginal change, market economies, and the mother of them all, scarcity.

The conventional economic meaning of “scarcity” appears on the first page of virtually every first-year economics textbook. Here’s the version from the textbook I use: “Although we have boundless wants, our resources are limited.” The perceived battle between unlimited wants and limited means forces us to make tough choices about how to manage scarce resources. Conventional economists assure us that their “science” provides the proper instructions for making these tough choices. Thus, the “scarcity principle,” besides having intuitive appeal, provides the justification for the very existence of neoclassical economics.

The scarcity principle, however, is just an assumption, and it appears to be a dangerous one. Maybe in the empty world of the 18th century classical economists, it was mostly harmless to assume that people have unlimited wants because the vast majority of people had so little. But now that we live in a full world where the global economy is bumping against ecosystem limits, it’s time for economists to stop assuming that everyone always wants more and start accepting that it’s possible to have too much.

Still, questioning the relevance of scarcity in driving human behavior is a no-no in a conventional economics class. The student doing the questioning is likely to be shut down by the accursed phrase, “That’s not economics.”

The first reason why it’s tough to argue the point with conventional economists is that they only concern themselves with the scarcity of resources relative to other resources in a market, neglecting the reality of absolute scarcity. Philip Lawn shows the difference between relative and absolute scarcity clearly by asking, on the one hand, what happens to the price of a non-renewable resource like oil as the stock is depleted? Most people see that stock depletion leads to an increase in absolute scarcity and predict that the price would increase. On the other hand, he asks, what will happen to oil prices if OPEC significantly increases extraction rates and floods the market? Here, most people would predict that the price of oil would decrease as the increased flow of oil makes it less scarce relative to substitutes like coal. Of course, these scenarios are two sides of the same coin. In an empty world, the flow effects of relative scarcity on prices have dominated the stock effects of absolute scarcity, but this cannot continue indefinitely on a finite planet. In his book, Steady-State Economics, Herman Daly writes:

Absolute scarcity increases as growth in population and per capita consumption push us ever closer to the carrying capacity of the biosphere. The concept presupposes that all economical substitutions will be made. While such substitutions will certainly mitigate the burden of absolute scarcity, they will not eliminate it nor prevent its eventual increase.

If there is no choice to substitute one scarce resource for another, then there is no relative scarcity, and conventional economists will often concede the point, holding that such a situation lies outside the domain of economic analysis. Without choices it’s easy, they say — you just do what you gotta do. It’s not big-E economics. Case closed.

Dry Lake Bed with Cattle Skeleton

Neoclassical notions of scarcity differ from the absolute scarcity seen in a full world (credit Kiel Bryant).

A second reason it’s hard to argue with conventional economists about scarcity is because they disregard two features of human behavior. The first feature is that people prioritize some wants above others. Economists often ignore the fact that some goods and services are fundamentally more important and sought earlier than others. No, they cry, this would introduce unacceptable value judgements to our “positive” theory! As John K. Galbraith wryly noted, “Nothing in economics so quickly marks an individual as incompetently trained as a disposition to remark on the legitimacy of the desire for more food and the frivolity of the desire for a more expensive automobile.” The second behavioral feature is susceptibility to advertising and other marketing techniques. Despite the omnipresent sheen of the $500 billion global advertising industry sparkling on modern society, mainstream economists maintain that consumers know exactly what they want because, well, they just do. It’s not big-E economics if people don’t know what they want. Case closed. Again.

Economists often make strange assumptions about the scarcity of resources, but maybe their assumption about wants is stranger. Do people actually have unlimited wants, and has anyone bothered to test this hypothesis? Toward an answer, I recently came across a couple of studies that provide compelling evidence demonstrating people don’t have unlimited wants ingrained in their DNA.

The first is a fascinating book edited by John Gowdy titled Limited Wants, Unlimited Means about the economics of nomadic hunter-gatherer societies. As the title makes abundantly clear, the authors argue that our society of mass consumption has much to learn from members of these highly mobile societies who do not want to carry material possessions beyond those which they can make and replace from resources readily available.

The second study is an experiment whereby researchers team up with a Chinese fast-food restaurant in the United States to test a number of strategies for reducing calorie consumption among unsuspecting customers. They find that a much better strategy than calorie labeling is to simply ask people if they would like to “down-size” their meals during the ordering process. In particular, the researchers found that more than 30% of customers accepted the opportunity to receive less food, regardless of whether or not they received a discount! Although this result does not reject the unlimited wants hypothesis outright, the question of why calorie labelling is less effective than a verbal offer cannot be explained under neoclassical assumptions.

An alternative explanation is that people have difficulties controlling themselves. The best part of the fast-food study is that a substantial portion of customers readily recognized that they wouldn’t be able to stop consuming food once it had been placed on their plates, so they opted for less when given a nudge at a strategic point in their consumption decision. Clearly, finding these strategic points to encourage “right-sized” consumption is an urgent challenge on a full planet. Hopefully researchers can help us find more of them.

Andrew Fanning grew up on the blustery east coast of Canada where he eventually earned a master’s degree in economics. His interests include lots of things, especially the capacity of the planet to support life.

The Triumph of Fantasy over Science, Part 2

Restoring Science as the Basis for Economic Policy

by Rob Dietz

Right now “economics” means “neoclassical economics,” especially in the halls of government and business boardrooms.  At the same time, ecological economics remains an under-appreciated and under-utilized sub-discipline of economics. To reverse this situation, such that when people talk about economics, they’re talking about ecological economics, we need to address the three factors described in Part 1 of The Triumph of Fantasy over Science:

  1. The psychology of inclusion drives people to follow the dominant economic philosophy (neoclassical), even if it comes straight out of Fantasy Camp.
  2. Neoclassical economics has become entrenched in the culture.
  3. The fanciful stories that support neoclassical theories are more emotionally compelling than the logic (straight out of Science Camp) that underlies ecological economics.

Overcoming these three factors requires three countermeasures.

Countermeasure 1. Frame the limits to growth and ecological economics in a way that prevents people from feeling threatened.

For decades, the denizens of Science Camp have been broadcasting messages about the shortcomings of neoclassical economics and the problems posed by its obsession with growth. To a lesser degree, they have also been promoting ecological economics (and its focus on well-being) as a positive alternative. But to bypass protective cognition — the defense mechanism that allows people to accept faulty premises — Science Campers need to frame their ideas differently.

Many people, when confronted with the possibility that the economic paradigm they’ve embraced may be harming society and causing significant environmental damage, react defensively. I know that I’ve been called all sorts of names (even the “C” word — communist) for presenting an alternative economic view. The key to disarming the defensiveness that comes along with protective cognition is to focus the conversation on needs that all people share (e.g., subsistence, security, and participation) and how an ecological economy can meet these needs without growth. Such framing can dampen denial and open minds.

For example, one time I was part of an “economic vitality” team tasked with providing ideas to a city council about how to achieve a prosperous local economy. The team included a sustainability guru, a business owner, a representative of the Chamber of Commerce, and a banker, among others. In one of our first meetings, I gave my standard spiel about the difference between a prosperous economy and a growing one. Since it was a small group seated around a table, I could see right away the misgivings some of my teammates had about my ideas. The banker must have set the world record for quantity of disapproving head shakes. We ended up butting heads for the next several meetings until I tried a different approach. I drafted a short document about our “areas of agreement,” which focused on the city’s needs. By steering the conversation toward things we all hoped to achieve in the city’s economy, such as available jobs, meaningful work, sufficient infrastructure, healthy ecosystems, and local production and consumption, we were able to have a constructive discussion and develop useful strategies for the city.  Once the walls of protective cognition have been toppled, people can access their considerable capacity for logic when assessing policy options.

Countermeasure 2. Use student demand to supplant neoclassical economics in universities.

Since this countermeasure focuses on university economics, let’s use a couple of standard economic graphs. First let’s consider the production possibility frontier for teaching in economics departments (see graph). An economics department can offer only a certain amount of economics courses, defined by the production possibility frontier. If it is spending that “certain amount” on neoclassical economics, then it can teach very little ecological economics. The goal is to move along the curve from point A (where we currently reside) to point B where we want to be.

Now let’s use supply and demand to see how to move from A to B. The quantity (and price) of neoclassical economics offered by universities is determined by student demand and departmental supply (see graph). To lessen the quantity of neoclassical economics supplied, students need to lower their demand for it. This is a natural place to start, since neoclassical economics offers students very little in the way of long-term prospects for healthy and happy lives. Student uproar over the downsides of neoclassical economics is already percolating, and activists have begun organizing efforts to increase demand for ecological economics.

If students decrease their demand for neoclassical economics, then the quantity supplied will decrease.

For example, Adbusters started a campaign called Kick It Over that invites students around the world to join the fight to revamp Econ 101 curricula and challenge the myopic views of neoclassical professors. Another outstanding effort is Kate Raworth’s work with Oxfam on the “doughnut economy.” Raworth is trying to unseat neoclassical orthodoxy and replace it with an economic framework based on meeting society’s needs within nature’s limits. Besides offering a sound premise for structuring the economy, she suggests that students engage in a guerilla campaign to rewrite economics textbooks.

As students decrease their demand for neoclassical economics, casting it into the dustbin of obsolescence, economics departments will move along their production possibility frontier to point B where their core will become ecological economics. At that point professors will focus their research on how to achieve sustainable and equitable well-being, and new generations of students will be grounded in the principles of Science Camp.

Countermeasure 3. Tell a better story.

Rob Hopkins, the founder of the Transition Towns movement has poked fun at the standard Science Camp story. He says, “Environmentalists have often been guilty of presenting people with a mental image of the world’s least desirable holiday destination — some seedy bed and breakfast… with nylon sheets, cold tea and soggy toast — and expecting them to get excited about the prospect of NOT going there. The logic and the psychology are all wrong.” We need to tell a more inspiring story about the transition to a steady-state economy.

That’s exactly what CASSE authors have been up to, and two new books will be available in early 2013.  Enough Is Enough (by Dan O’Neill and me) and Supply Shock (by Brian Czech) will serve as a one-two punch to knock out the neoclassical obsession with growth. These two books can accompany the ecological economics textbook by Herman Daly and Joshua Farley to provide options for new economics courses along the path from point A to point B on the production possibility frontier.  As more such books and resources come out of Science Camp, professors, politicians, and pundits will have fewer excuses for remaining in Fantasy Camp.

From reframing to organizing, from protesting to storytelling, there’s a lot of work to do to get past the collective mental block and start walking a sustainable economic path. For decades, we’ve shown ourselves to be incapable of accepting facts, unable to modify failing social institutions, and unwilling to adjust our lifestyles. But now is the time to overthrow the academic programs and economic institutions that got us into this mess in which we undervalue our most important assets. Now is the time to tell the story of ecological economics — the hopeful story of long-term prosperity on a healthy planet. Now is the time to demand the economy that we want and that the planet needs.

The Triumph of Fantasy over Science, Part 1

The Rise of Fantasy as the Basis for Economic Policy

by Rob Dietz

Two competing camps attract people from all over the world. One is Science Camp, and the other is Fantasy Camp.

At Science Camp, the counselors teach campers that we live on a single blue-green planet with finite resources. The curriculum at Science Camp focuses on figuring out how to conserve and share those resources. There’s a strong undercurrent of appreciation (maybe even reverence) for nature and humanity’s place in it — a desire to learn about and safeguard life on this planet.

At Fantasy Camp, the counselors educate campers to believe that humanity can circumvent natural limits. Campers are taught that our unstoppable ingenuity can overcome any resource shortages or manage any amount of waste generation. There’s a strong undercurrent of consumption — a desire to accumulate ever more power and stuff in an attempt to gain complete control over life (and even death).

This division of the world’s people into two camps is a bit crude. After all, some people can’t attend either camp, since they’re engaged in a struggle to get by on the meager resources available to them. Other people are so taken up by their jobs, ideology, or religion that they don’t pay attention to either camp. Still others may be in transit from one camp to another. For example, people learning the ins and outs of climate change, planetary overshoot, biodiversity loss, etc., might begin to disentangle themselves from Fantasy Camp and start leaning toward Science Camp.

Counselors and campers at Science Camp put a lot of stock in observations and facts. Facts like these:

  • When we extract and burn fossil fuels, carbon dioxide accumulates in the atmosphere. A higher concentration of carbon dioxide produces side effects (e.g., increasing temperatures and acidifying oceans) that threaten global climate stability.
  • When we convert forests, grasslands, and wetlands to farms, cities, and suburban sprawl, we decrease the amount of habitat available to non-human species, and we reduce the ecological richness of the landscape.
  • When we extract fish, trees, or other natural resources faster than Mother Nature can replace them, we collapse populations and sometimes cause long-term ecological damage.

Grappling with such facts can lead to clear-headed thinking about limits — recognition that we need to limit the burning of fossil fuels, limit the conversion of natural habitat, and limit the rate of resource extraction. Ecological economists are some of the most clear-thinking enrollees at Science Camp. They approach economic growth and ecological limits with practicality, seeking policies and institutions that enhance human well-being without overwhelming the capacity of planetary life-support systems.

In contrast, the people registered at Fantasy Camp, especially the neoclassical economists, tend to ignore, deny, or dispute facts that conflict with their pre-existing ideas about infinite economic growth. At the same time, they cling to tidbits of conventional wisdom that support their current worldview. Their refusal to incorporate facts into their thinking about how to operate the economy is especially dangerous because it feeds the consumptive frenzy that pushes ecosystems and societies to the brink.

When you compare the foundational principles of ecological economics to those of mainstream/neoclassical economics (see table), it becomes ever clearer that one has a strong basis in reality. The principles of ecological economics stem from the laws of physics and ecology instead of “truthy” assumptions about human behavior and markets. The logic behind ecological economics suggests a different policy path than the theories behind neoclassical economics.

Foundational Principles of Fantasy Camp and Science Camp

Neoclassical Economics (Fantasy Camp) Ecological Economics (Science Camp)
People are rational utility maximizers. They make decisions rationally (at the margin) with the explicit goal of improving their own lives and maximizing their well-being. Sometimes people behave rationally, and other times irrationally. Behavior is influenced by emotion, culture, circumstance, and many factors beyond rational self interest.
People consume goods and services to meet needs. Since meeting needs increases people’s utility (satisfaction with life), more consumption is better. Consuming enough is preferable to continuous pursuit of more, given the diminishing returns of additional consumption and the social and environmental consequences of overconsumption.
The goal for an economy is growth — continuously increasing production and consumption. Growth means more jobs, more consumer utility, more purchasing power. The goal for an economy is optimal scale — the size at which the rising marginal costs of growth equal the diminishing marginal benefits. Growing the economy past this point is counterproductive.
Value is determined by prices in the market. If something of value does not have a price, we should find a way to bring it into the market. Some things that have value are not priced in markets. We need to establish mechanisms beyond the market to recognize this value.

There’s one other big difference between Science Camp and Fantasy Camp. Science Camp draws many fewer supporters than Fantasy Camp. To make a positive economic transition, we need to orchestrate a reversal of this situation, and to do so requires us to address two questions:

  1. Why do so many people pitch their tents in Fantasy Camp?
  2. After decades of failing to attract people to Science Camp, what should we do?

Why People Favor Fantasy

As Bill Rees has noted, “If intelligence and logic were the principal determinants of economic policy, the primary goal would be to ensure that growth slows as we reach the optimal scale and that the economy not exceed this optimal size.” But given the struggle of ecological economics to gain ground on neoclassical economics, we can mostly eliminate “intelligence and logic” as driving forces that motivate people to decide which camp to enter. Indeed, three factors that have little to do with intelligence and logic are behind this.

1. The psychology of inclusion drives people to follow the in-vogue philosophy. Dan Kahan, a legal scholar at Yale University, defines the term “protective cognition” as a sort of automatic defense mechanism that people employ to dismiss scientifically sound evidence that poses a threat to their worldview. Like an immune system fighting off invading viruses, protective cognition works in people’s minds to repel invading facts that would require them to rethink their dearest beliefs. Kahan writes, “Because accepting such [facts] could drive a wedge between them and their peers, they have a strong emotional predisposition to reject it.” With so many people having internalized the concepts of unlimited economic growth and the triumph of technology over nature, protective cognition puts up a formidable obstacle to widespread adoption of ecological economics. It can take years of fact bombardment to begin chipping away at this obstacle.

Fantasy Camp counselors shouldn’t be setting economic policy.

2. Neoclassical economics has become entrenched in the culture. The way people approach daily living and interactions within the economy has become aligned with the neoclassical tenet of self interest (mostly by seeking high-paying jobs and adopting lifestyles of materialism). Neoclassical ideology permeates universities. With so many business and economics students, universities are churning out graduates who buy into the neoclassical approach. The degree of entrenchment came about because neoclassical prescriptions worked at a time when increasing material goods meant increasing well-being. As Herman Daly has pointed out, this was the case when the Earth was relatively empty of people and our stuff. We could extract resources and dump wastes without worrying about running out of supplies (of either inputs or waste absorption capacity). But that logic has become faulty, and even dangerous, as we have filled the planet with ourselves and our things.

3. They spin a real good story over at Fantasy Camp. The message of unending growth is enticing, as long as we disregard the Icarus-like consequences of being seduced by it. This message makes regular appearances in fantasy movies. For example, in The Matrix, Neo (the hero) says, “I’m going to show these people what you don’t want them to see. I’m going to show them… a world without rules and controls, without borders or boundaries, a world where anything is possible.” Although this sort of message belongs in a movie theater, it seems to pop up even more often in the political theater. After Ronald Reagan cruised to Presidential victory over Jimmy Carter (whose message of conservation failed to resonate), he said, “There are no limits to growth and human progress when men and women are free to follow their dreams.” This quote, which makes it seem like Reagan employed Disney’s top talent to write his speeches, is literally set in stone in a Washington, DC monument. Reagan’s message is far more compelling than something like, “Individual freedom is a cornerstone of society, but freedom of choice may be constrained by social and environmental limits to growth. Men and women need to take such constraints into account when deciding which dreams to follow.”

These three factors won’t go away on their own. To increase the prominence of Science Camp, we have to take concerted action. Part 2 will explore how to enroll more people in Science Camp and supplant fantasy as the basis for economic policy.

Growth and Free Trade: Brain-Dead Dogmas Still Kicking Hard

by Herman Daly

Herman DalyThere are two dogmas that neoclassical economists must never publicly doubt lest they be defrocked by their professional priesthood: first, that growth in GDP is always good and is the solution to most problems; second, that free international trade is mutually beneficial thanks to the growth-promoting principle of comparative advantage. These two cracked pillars “support” nearly all the policy advice given by mainstream economists to governments.

Even such a clear thinker as Paul Krugman never allows his usually admirable New York Times column to question these most sacred of all tenets. And yet in less than 1,000 words the two dogmas can easily be shown to be wrong by just looking at observable facts and the first principles of classical economics. Pause, and calmly consider the following:

(1) Growth in all micro-economic units (firms and households) is subject to the “when to stop rule” of optimization, namely stop when rising marginal cost equals declining marginal benefit. Why does this not also apply to growth of the matter-energy throughput that sustains the macro-economy, the aggregate of all firms and households? And since real GDP is the best statistical index we have of aggregate throughput, why does it not roughly hold for growth in GDP? It must be because economists see the economy as the whole system, growing into the void — not as a subsystem of the finite and non-growing ecosphere from which the economy draws resources (depletion) and to which it returns wastes (pollution). When the economy grows in terms of throughput, or real GDP, it gets bigger relative to the ecosystem and displaces ever more vital ecosystem functions. Why do economists assume that it can never be too big, that such aggregate growth can never at the margin result in more illth than wealth? Perhaps illth is invisible because it has no market price. Yet, as a joint product of wealth, illth is everywhere: nuclear wastes, the dead zone in the Gulf of Mexico, gyres of plastic trash in the oceans, the ozone hole, biodiversity loss, climate change from excess carbon in the atmosphere, depleted mines, eroded topsoil, dry wells, exhausting and dangerous labor, exploding debt, etc. Economists claim that the solution to poverty is more growth — without ever asking if growth still makes us richer, as it did back when the world was empty, or if it has begun to make us poorer in a world that is now too full of us and our stuff. This is a threatening question, because if growth has become uneconomic then the solution to poverty becomes sharing now, not growth in the future. Sharing is now called “class warfare.”

(2) Countries whose growth has pushed their ecological footprint beyond their geographic boundaries into the ecosystems of other countries are urged by mainline economists to continue to do so under the flag of free trade and specialization according to comparative advantage. Let the rest of the world export resources to us, and we will pay with exports of capital, patented technology, copyrighted entertainment, and financial services. Comparative advantage guarantees that we will all be better off (and grow more) if everyone specializes in producing and exporting only what they are relatively better at, and importing everything else. The logic of comparative advantage is impeccable, given its premises. However, one of its premises is that capital, while mobile within nations, does not flow between nations. But in today’s world capital is even more mobile between countries than goods, so it is absolute, not comparative advantage that really governs specialization and trade. Absolute advantage still yields gains from specialization and trade, but they need not be mutual as under comparative advantage — i.e., one country can lose while the other gains. “Free trade” really means “deregulated international commerce” — similar to deregulated finance in justification and effect. Furthermore, specialization, if carried too far, means that trade becomes a necessity. If a country specializes in producing only a few things then it must trade for everything else. Trade is no longer voluntary. If trade is not voluntary then there is no reason to expect it to be mutually beneficial, and another premise of free trade falls. If economists want to keep the world safe for free trade and comparative advantage they must limit capital mobility internationally; if they want to keep international capital mobility they must back away from comparative advantage and free trade. Which do they do? Neither. They seem to believe that if free trade in goods is beneficial, then by extension free trade in capital (and other factors) must be even more beneficial. And if voluntary trade is mutually beneficial, then what is the harm in making it obligatory? How does one argue with people who use the conclusion of an argument to deny the argument’s premises? Their illogic is invincible!

Like people who can’t see certain colors, maybe neoclassical economists are just blind to growth-induced illth and to destruction of national community by global integration via free trade and free capital mobility. But how can an “empirical science” miss two red elephants in the same room? And how can economic theorists, who make a fetish of advanced mathematics, persist in such elementary logical errors?

If there is something wrong with these criticisms then some neoclassical colleague ought to straighten me out. Instead they lamely avoid the issue with attacks on nameless straw men who supposedly advocate poverty and isolationism. Of course rich is better than poor — the question is, does growth any longer make us richer, or have we passed the optimum scale at which it begins to make us poorer? Of course trade is better than isolation and autarky. But deregulated trade and capital mobility lead away from reasonable interdependence among many separate national economies that mutually benefit from voluntary trade, to the stifling specialization of a world economy so tightly integrated by global corporations that trade becomes, “an offer you can’t refuse.”

Will standard economists ever pull the plug on brain-dead dogmas?

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.

Economics Unmasked

by Herman Daly

Economics Unmasked: From Power and Greed to Compassion and the Common Good by Phillip B. Smith and Manfred Max-Neef, Green Books, UK, 2011.

Manfred Max-Neef is a Chilean-German economist noted for his pioneering work in human scale development and his threshold hypothesis on the relation of welfare to GDP, as well as other contributions, for which he received the Right Livelihood Award in 1983. Phillip B. Smith (deceased, 2005) was an American–Dutch physicist with a devotion to social justice that led to an interest in economics. Smith died before this collaborative work was completed, so it fell to Max-Neef to finish it, respecting what Smith had done. Although this results in differences in style and approach between chapters, Max-Neef informs us that they both read and approved each other’s contributions, so it is a true collaboration. These differences between the physical and social scientists are complementary rather than contradictory.

As clear from the title, the book argues that modern neoclassical economics is a mask for power and greed, a construct designed to justify the status quo. Its claim to serve the common good is specious, and its claim to scientific status is fraudulent. The latter is sought mainly by excessive mathematical formalism to the neglect of concrete facts and real values. The mathematical formalism is in imitation of nineteenth century physics (economics viewed as the mechanics of utility and self-interest), but without any empirical basis remotely comparable to physics. Pareto is identified a villain here, and to a lesser extent Jevons.

The hallmark of a real science is a basic consensus about fundamentals. There is no real consensus in economics, so how can it claim to be a mature science? Easy, by forcing a false “consensus” through the simple expedient of declaring heterodox views to be “not really economics,” eliminating history of economic thought from the curriculum, instigating a pseudo-Nobel Prize in Economics, and attaining a monopoly on faculty positions in economics departments at elite universities. Such a top-down, imposed consensus is the opposite of the true bottom-up consensus that results when independent minds all bow before the power of the same truth. “Mathematics was simply built into the laws that describe the behavior of the atomic nucleus. You didn’t have to impose it on the nucleus.” (p.67). The same cannot be said of people, even atomistic homo economicus.

The authors give due attention to the history of economic thought, drawing most positively on Sismondi (for statements of value and purpose), Karl Polanyi (for his treatment of labor, nature, and money as non commodities that escape the logic of markets), and Frederick Soddy (for his thermodynamics-based analysis of money, wealth, debt, and the impossibility of continuing exponential growth of the economy). Negative references are reserved mainly for Friedrich von Hayek and Milton Friedman, with a mixed review for Amartya Sen. While I understand their antipathy to Hayek I found their case against him less than totally convincing. More convincing and fruitful is their building on the neglected work of Sismondi, Polanyi, and Soddy. That effort cries out to be continued by others.

Their criticisms of globalization, free trade, and free capital mobility are well founded. Economists must remember that the first rule of efficiency is to count all costs, not to specialize according to comparative advantage, especially if that “advantage” is based on a standards-lowering competition to externalize environmental and social costs. Indeed comparative advantage is irrelevant in a world of international capital mobility that gives priority to absolute advantage. While specialization according to absolute advantage gives gains from trade, they need not be mutually shared as in the comparative advantage model.

Chapter 10 provides a summary of the basics of ecological economics as “the humane economy for the 21st Century,” as well as a review of Max-Neef’s insightful matrix of needs and satisfiers.

Of particular interest is Chapter 11 on “the United States as an underdeveloping nation” — the process of development in reverse, or retrogression in the U.S. is chronicled in terms of unemployment, wage stagnation, increase in inequality, dependence on food stamps, bankruptcy, foreclosure, health care costs, incarceration, etc. Not happy reading, but a necessary reminder that gains from development are not permanent — they can be squandered by a corrupt elite employing a self-serving economic model to fool a distracted populace.

As a teacher of economics I was especially glad to read Chapter 12 on “the non-toxic teaching of economics.” I concur with the authors’ view that the teaching of economics today is a scandal. Reference has already been made to the dropping of history of economic thought from the curriculum — why study the errors of the past now that we know the truth? That is the arrogant attitude. And we certainly do not want any philosophical or empirical questioning of the canonical assumptions upon which the whole superstructure of mathematical deduction teeters. Growth must not be questioned because it is by definition the solution to all problems — even those that it causes.

As late as the 1960s economics students could study approaches other than the neoclassical — there were the remaining classical economists, institutional economists, the Marxians, the Keynesians, the Austrian School, Labor economics, Fabian Socialists, Market Socialists, Distributists, etc. Now there is a cartel of elite, expensive universities, “the Big Eight” as the authors call them (California, Harvard, Princeton, Columbia, Stanford, Chicago, Yale, and MIT) to which we could add Cambridge, Oxford, and a few others. They all teach the same growth-oriented, globalizing economics. The IMF and the World Bank hire economists from many countries and pride themselves on their diversity. But the diversity of nationality and color masks homogeneity of viewpoint since 90% of these economists graduated from the Big Eight, and are comfortable with both their position and their economic views. One wag succinctly described a frequent career path as: “MIT-PhD-IMF-BMW.”

Further evidence of the corruption of economics arrives daily. The documentary film Inside Job exposed the complicity of some Big Eight faculty in the financial debacle of 2008. I recently read that the Florida State University economics department has accepted a grant from the right-wing Koch Brothers to hire two prestigious economists with acceptable views, no doubt products of the Big Eight, whose presence on the faculty will raise FSU a step on the academic ladder. All corruption in academia cannot be blamed on economics departments, but the toxicity level there is high, and Max-Neef and Smith are right to accuse. One good way for honest economics professors to fight back is to recommend this book to their students!

The book ends with a hopeful review of some concrete, real world, bottom-up, human-scale development initiatives. The World Bank and the IMF are necessarily absent from this final chapter’s discussion of moving from village to global order. Might it be that after globally integrated collapse we will move to village reconstruction, and then to a global federation of separate national economies under the principle of subsidiarity?