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Leontief Prize

"Reconciling the Economics of Social and Environmental Sustainability"

Remarks by Herman Daly
on the occasion of his receipt of the Leontief Prize
at Tufts University, on November 13, 2001

The current answer to poverty is growth in aggregate production, as measured by GDP. Redistribution of GDP from rich to poor is rejected as "class warfare", and any recomposition of GDP from private goods toward public goods is rejected as government interference in the free market. We are assured that a rising tide lifts all boats, that the benefits of aggregate growth will eventually trickle down to the poor, and that increasing inequality is unimportant as long as the poor are experiencing growth in their absolute incomes.

I will argue that this growth solution will not work for two reasons, one having to do with environmental sustainability, the other with social equity.

(1) Ecological limits are rapidly converting "economic growth" into "uneconomic growth" growth which increases costs by more than it increases benefits, thus making us poorer not richer. The macroeconomy is not the Whole it is Part of a larger Whole, the ecosystem. As the macroeconomy grows in its physical dimensions (population and per capita resource use), it does not grow into the Void. It grows into and encroaches on the larger ecosystem, thereby incurring an opportunity cost of preempted natural capital and services. These opportunity costs of sacrificed natural services can be, and often are, worth more than the extra production benefits of growth. We cannot be absolutely sure because we measure only the benefits, not the costs. And even if we measure the costs we add rather than subtract them. But whatever the true benefits of economic growth, it is clear that they cannot apply to uneconomic growth.

(2) Even if growth were still economic, much of what we mean by poverty is a function of relative rather than absolute income, that is, of social conditions of distributive inequality. Growth cannot possibly increase everyone's relative income. We cannot all be above average, like the children of Lake Wobegon. There is a degree of inequality that is legitimate and in accord with a larger concept of fairness and incentives, but also there is a degree beyond which further inequality destroys community and social cohesion, as well as undermines incentive to work. Growth, both economic and uneconomic, seems to have increased the consumption of the present rich at the expense of:

(1) the present poor;

(2) the future; and,

(3) nonhuman species.

Am I saying that wealth has nothing to do with welfare, and that we should embrace poverty? Not at all! I am saying that growth, as we currently measure it (GDP), no longer necessarily reflects increases net wealth that we may actually be increasing illth faster than wealth, making ourselves poorer, not richer, even as GDP increases. Moreover, the amount of welfare derivable from a given increment in real net wealth has diminished because the increasing inequality of its distribution results in the trivial wants of the rich being satisfied ahead of the basic needs of the poor.

One might object that growth in rich countries might be "uneconomic", growth in poor countries where GDP consists largely of food, clothing, and shelter, is still very likely to be "economic". There is much truth in this, even though poor countries too are quite capable of deluding themselves by counting natural capital consumption as income. But, more to the point, the current policy of the IMF, WTO and WB is not for the rich to decrease uneconomic growth while the poor increase economic growth. Rather the vision of globalization is for the rich to grow rapidly in order to provide markets in which the poor can sell their exports. It is thought that the only option poor countries have is to export to the rich, and to do that they have to accept foreign investment from corporations who know how to produce the high-quality stuff that the rich want.

The whole global economy must grow for this policy to work, because unless the rich countries grow rapidly they will not have the surplus to invest in poor countries, nor the extra income with which to buy the exports of the poor countries.

Under the current ideology of export-led growth the last thing poor countries are supposed to do is to produce anything for themselves. Any talk of import substitution is nowadays met by trotting out the abused and misunderstood doctrine of comparative advantage. The logic of comparative advantage is unassailable, given its assumptions. Unfortunately one of its assumptions is capital immobility between nations. When capital is mobile, as indeed it is, we enter the world of absolute advantage, where there are still global gains from specialization and trade, but no longer any guarantee that each country will necessarily benefit as under comparative advantage. One way out of this difficulty would be to greatly restrict capital mobility thereby making the world safe for comparative advantage. The other way out would be to introduce international redistribution of global gains from trade based on absolute advantage. Which solution does the IMF advocate? Neither. They prefer to pretend that there is no contradiction, and call for both comparative advantage-based free trade, and free international capital mobility.

In an economically integrated world, one with free trade and free capital mobility, it is difficult to separate growth for poor countries from growth for rich countries, since national boundaries become economically meaningless. Only by adopting a more nationalist approach to development can we say that growth should continue in some countries but not in others. But the globalizing trio, the IMF, WTO, and WB cannot say this. They can only advocate continual global growth in GDP. The concept of uneconomic growth just does not compute in their vision of the world.

Let us have a closer look at GDP, that alchemical elixir whose growth is supposed to forever transmute base poverty into gilded wealth. It is defined by economists as the sum of all value added by labor and capital in the process of production. Value added is simultaneously created and distributed in the very process of production. Therefore, economists argue that there is no "pie" to be independently distributed according to ethical principles. As Kenneth Boulding put it, instead of a pie, there are only a lot of little "tarts" consisting of the value added by different people or different countries, and stupidly aggregated by statisticians into an abstract "pie" that doesn't really exist as an undivided totality. If one wants to redistribute this imaginary "pie" he should appeal to the generosity of those who baked larger tarts to share with those who baked smaller tarts, not to some invidious notion of equal participation in a fictitious common inheritance.

I have considerable sympathy with this view, as far as it goes. But it leaves out something very important.

In our one-eyed focus on value added we economists have neglected "that to which value is added", namely the flow of resources and services from nature. "Value added" by labor and capital has to be added to something, and the quality and quantity of that something is important. It cannot be reduced to value previously added to nothing by labor and capital. Now there is a real and important sense in which the original contribution of nature is indeed a "pie", a pre-existing, undivided totality that we all share as an inheritance. It is not an aggregation of little tarts that we each baked ourselves. Rather it is the seed, soil, sunlight, and rain from which the wheat and apples grew that we converted into tarts by our labor and capital.

The claim for equal access to nature's gifts is not the invidious coveting of what our neighbor accumulated by her own labor and abstinence. The focus of our demands for income to redistribute to the poor, therefore, should be on the value of the contribution of nature, the original value of that to which further value is added by labor and capital. In sum, we must bring increasingly scarce environmental services under the discipline of the price system, because these are truly rival goods) the use of which by one person imposes opportunity costs on others. The necessary price or scarcity rent that we collect should be used to alleviate poverty.

It should be noted at least in passing that there are some goods that are by nature nonscarce and nonrival, and should be freed from illegitimate enclosure by the price system. I refer especially to knowledge. Knowledge is not divided in the sharing but multiplied. There is no opportunity cost to me from sharing knowledge with you. Yes, I would lose the monopoly on my knowledge by sharing it, but we economists have long argued that monopoly is a bad thing because it creates artificial scarcity that is both inefficient and unjust. Once knowledge exists, the opportunity cost of sharing it is zero and its allocative price should be zero. Consequently, I would urge that international development aid should more and more take the form of freely and actively shared knowledge, and less and less the form of interest-bearing loans.

I am aware that although the proper allocative price of existing knowledge is zero, the cost of production of new knowledge is usually greater than zero, sometimes much greater. This of course is the usual justification for intellectual property rights in the form of patent monopolies. This is an area needing much reconsideration. I only mention it here, and signal my skepticism of the usual arguments for patent monopolies, so emphasized recently by the free-trading globalizers. As far as I know, James Watson and Francis Crick receive no patent royalties for having unraveled the structure of DNA, arguably the most basic scientific discovery of the twentieth century. Yet people who are tweaking that monumental discovery are getting rich from monopolizing their relatively trivial contributions that could never have been made without the free knowledge supplied by Watson and Crick.

The point of the above digression, again, that although the main thrust of my remarks is to bring newly scarce and truly rival natural capital and services into the market discipline, we should not overlook the opposite problem of freeing truly nonrival goods from their artificial enclosure by the market.

Returning to my main theme, economists have traditionally considered nature to be infinite relative to the economy, and therefore not scarce, and therefore properly priced at zero. But nature is scarce, and becoming more so every day as a result of growth. Efficiency demands that nature's services be priced. But to whom should this price be paid? From the point of view of efficiency it does not matter who receives the price, as long as it is charged to the users. But from the point of view of equity it matters a great deal who receives the price for nature's increasingly scarce services. Such payment is the ideal source of funds with which to fight poverty and finance public goods.

Value added belongs to whoever added it. But the original value of that to which further value is added by labor and capital belongs to no one, or to everyone. This original value of nature should be the focus of redistributive efforts because its existence is a scarcity rent required by allocative efficiency, and its public appropriation is in the service of distributive justice.

Appeals to the generosity of those who have added much value by their labor and capital are more legitimate as private charity than as a foundation for fairness in public policy. Taxation of value added by labor and capital is certainly legitimate. But it is both more legitimate and less necessary after we have, as much as possible, captured natural resource rents for public revenue.

The above seems to be the basic insight of Henry George. Neoclassical economists have greatly obfuscated this simple insight by their refusal even to recognize the productive contribution of nature in providing "that to which value is added". In their defense it could be argued that this was so because in the past economists considered nature as non-scarce, but now they are beginning to reckon the scarcity of nature. Let us be glad of this. But there is also a flaw in their very understanding of production as a physical process. Neoclassical production functions depict output as a function of two inputs, labor and capital. In other words, value added by labor and capital in production is added to nothing, not even valueless neutral stuff. But value cannot be added to nothing. Neither can it be added to ashes, dust, rust, and the dissipated heat energy in the oceans and atmosphere. Only low-entropy matter/energy is capable of receiving the imprint of value added by labor and capital. Since human action cannot produce low entropy in net terms we are entirely dependent on nature for this ultimate resource by which we live and produce. Any theory of production that ignores this fundamental dependence is bound to be seriously misleading.

As an example of how students are systematically misled on this issue I cite a textbook used in the microeconomic theory course at my institution. On p. 146 the student is introduced to the concept of production as the conversion of inputs into outputs via a production function. The inputs or factors are listed as capital (K), labor (L), and materials (M) -a promising beginning. We turn the page to p.147 where we find the production function written symbolically as q = f(K, L). M has disappeared, never to be seen again in the rest of the book. Yet the output referred to in the text's "real world example" of the production process is "wrapped candy bars". Where in the production function are the candy and wrapping paper as inputs? Production functions are often correctly described as technical recipes. But unlike real recipes in real cookbooks we are never given a list of ingredients!

The modern form of the Georgist insight is to tax the resources and services of nature (those things left out of the production function)- and to use these funds for fighting poverty and for financing public goods. Or we could simply disburse the earnings from a trust fund created by these rents to the general public, as in the Alaska Permanent Fund, which is perhaps the best existing institutionalization of the Georgist principle. Taking away by taxation the value added by individuals from applying their own labor and capital creates resentment. Taxing away value that no one added, scarcity rents on nature's contribution, does not create resentment. In fact, failing to tax away the scarcity rents to nature and letting them accrue as unearned income to favored individuals has long been a primary source of resentment and social conflict.

Charging scarcity rents on natural resources and redistributing them to the poor can be effected either by ecological tax reform, or by quantitative cap and trade systems. In differing ways each would limit expansion of the scale of the economy into the ecosystem, and also provide revenue to be redistributed to the poor. I will not discuss their relative merits, but rather emphasize the advantage that both have over the currently favored strategy. The currently favored strategy might be called "efficiency first" in distinction to the "frugality first" principle embodied in each of the mechanisms mentioned above.

Efficiency first sounds good, especially when referred to as "win-win" strategies or more picturesquely as "picking the low-hanging fruit". But the problem of "efficiency first" is with what comes second. An improvement in efficiency by itself is equivalent to having an increased supply of the factor whose efficiency increased. The price of that factor will decline. More uses for the cheaper factor will be made. We will end up consuming as much or more of the resource than before, albeit more efficiently. Frugality first induces efficiency; efficiency first does not induce frugality- it makes frugality less necessary.

I am afraid I will be told by some of my neoclassical colleagues that frugality is a value-laden concept, especially if you connect it with redistribution of scarcity rents to the poor. Who am I, they will ask, to impose my personal elitist preferences on the democratic marketplace, blah, blah, etc. etc. I am sure everyone has heard that speech. The answer to such sophistry is that ecological sustainability and social justice are fundamental objective values, not subjective individual preferences. There really is a difference, and it is past time for economists to recognize it.

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