The Economic Approach to
Environmental and Natural
Resources, 3e
By James R. Kahn
© 2005 South-Western, part of the Thomson Corporation
Part IV
Further Topics
Chapter 19
Prospects for the Future
© 2004 Thomson Learning/South-Western
4
Introduction
 There are reasons to be optimistic about the
environment.
 Conventional air and water pollutants have been
regulated and birth rates have declined to the point
where zero population growth will be realized in the
near future.
 The ozone depletion problem has been addressed,
the global warming problem is being recognized, and
moving to a sustainable economy is being
discussed.
 There are reasons to be pessimistic about the
situation in developing countries.
 Population growth is far from being under control.
5
Introduction
 Environmental degradation is taking place at a
massive and unprecedented rate, which is leading to
the loss of much of the world's renewable resources.
 The economic conditions in much of the world's
developing countries prevent the people from having
a long-term perspective.
 This, combined with a lack of understanding of the
long-term economic importance of maintaining the
environmental quality, implies that many developing
nations have not recognized the need to take
immediate steps to preserve the environment.
 This chapter will attempt to summarize some of the
debate on prospects for the future.
6
Absolute Scarcity
 The concept of absolute scarcity originated in the work of
Malthus, who argued that since there was a fixed amount of
land, scarcity was inevitable because of the law of diminishing
marginal returns.
 As pointed out in the previous chapter, Malthus failed to
consider technological innovations which would change the
relationship between population and land.
 The idea of absolute scarcity has been revisited in modern
times, as world population exploded, pollution intensified,
hunger increased, and shortages of energy and other
resources materialized.
 Many scholars, citing the finite nature of the world and its
resources, argued that scarcity was inescapable.
7
Entropy and Economics
 Nicholas Georgescu-Roegen has argued that
entropy is the source of ultimate scarcity.
 Entropy refers to the amount of disorder in a system:
the higher the entropy, the higher the state of
disorder; the lower the entropy, the greater the order.
 The third law of thermodynamics (the entropy law)
states that the universe (or a subsystem of the
universe) is in a constant state of entropic
degradation.
 A simpler way of phrasing this is that as time and the
physical forces of the universe progress, energy and
materials tend to dissipate and become more
difficult to access.
8
Entropy and Economics
 The relevance of the entropy law of economic activity and prospects
for the future is that useful goods and resources tend to be low
entropy, and the economic process increases their entropy.
 For example, a fossil fuel, such as coal or oil, is characterized by low
entropy.
 Coal is a relatively homogenous substance, with a much higher
concentration of carbon than the environment as a whole.
 When the coal is burned in the economic process, the carbon is
scattered though the atmosphere.
 The process of using the coal increases its entropy and reduces its
usefulness.
 Since the amount of low entropy on earth is fixed, and since entropic
degradation is irreversible, it will be the ultimate constraint on the
human species.
 Georgescu-Roegen argues that entropic degradation implies that the
time span of human existence is limited because we will eventually
run out of low entropy matter to support life.
9
Entropy and Economics
 There are two basic criticisms of the work of GeorgescuRoegen.
 Since we do not really know the initial stock of low entropy
matter, we do not know if our rate of consumption is high
relative to the stock.
 In addition, we receive constant infusions of energy from the
sun, and this energy can be used to slow the process of
entropic degradation.
 The policy implications of the relationship between entropy and
the economic processes are that activities should be
encouraged that are less degrading of low entropy, as these
impose less costs on the future.
 Conserving low entropy is conceptually equivalent to saying
that we should minimize the use of inputs and minimize waste.
10
Doomsday Models
 The Limits to Growth model of Meadows and Meadows and
similar models attempted to predict the future based on
assumptions regarding resource quantities and production
techniques.
 The first step is to specify initial conditions (of population,
wealth, arable land, capital, natural resources, etc.) and then
allow these variables to grow.
 The implications of growth are computed (that is, more output
implies more pollution, more output implies faster resource
depletion, and more people mean more food cultivation and
more soil erosion).
 What these models found was that in a rather short period of
time (20-50 years), some sort of constraint interfered with the
ability of the economic system to support population and the
system collapsed.
11
Doomsday Models
 These models caused considerable excitement for
two reasons.
 Society was just beginning to become aware of the
problems of environmental degradation and
population growth through books such as Rachel
Carson's Silent Spring and Paul Ehrlichs' Population
Time Bomb.
 And the public was enthralled by (and did not really
understand the nature of) computers and computer
models.
 Many people felt that if a computer predicted the
collapse of humankind, this must be taken seriously.
12
Doomsday Models
 There are two criticisms of these doomsday models.
 They are tremendously sensitive to the assumed rates of
exponential growth.
 If population is assumed to increase at 2 percent per year, it will
double in 35 years. However, if population is assumed to
increase at 3 percent per year, it will double every 23 years.
 These models have no endogeniety or positive feedback in the
model, including the effect of scarcity on prices and prices on
scarcity.
 There is no mechanism for increasing scarcity, pollution, or
population to affect behavior in these models. In other words,
even as we are forced to wear gas masks because of hideous
pollution, we take no steps to reduce the level of pollution.
13
Doomsday Models
 The most important drawback to these
models is the failure to represent market
prices in the model.
 As scarcity increases, price will increase
which will trigger a full set of market
responses that tend to lessen the scarcity
problem.
 The importance of the neo-Malthusian
models is that a new intellectual paradigm
was created to address the role of scarcity
and the long-term prospects for humankind.
14
Price, Scarcity, and Neo-Classical
Economics
 The work of Hotelling (who identified user cost as the
mechanism that makes price reflect scarcity) forms the basis of
the neoclassical (modem economic) approach to scarcity.
 Barnett and Morse, who investigated the scarcity question in
the 1960s, discussed the mechanisms through which price
mitigates scarcity.
 If oil becomes more scarce, the price will rise.
 The higher price generates added incentives for exploration for
new sources of oil and makes it more profitable to remove oil
from more difficult places.
 The higher price gives added incentive for research and
development into new technologies for finding, extracting, and
utilizing oil and discourages current consumption of oil.
 Finally, higher prices encourage the development of substitutes
for oil.
15
Price, Scarcity, and Neo-Classical
Economics
 Barnett and Morse also examined Malthus’ hypothesis that the
law of diminishing returns implies that as labor increases, the
marginal product of labor must decline.
 They found that while this hypothesis held in an economy
where the only inputs were labor and land, it did not hold in an
economy with more than 2 inputs.
 If land is held constant in an economy with labor and capital, it
is possible to see quantity or quality changes in capital that will
increase the productivity of labor.
 The authors felt that the question of scarcity was an empirical
one that could only be answered by looking at real world
phenomenon.
 The authors stress that it is important to examine scarcity of
individual resources and scarcity of resources in general.
 It is important to examine resources in general, because as
particular resources become scarcer, other resources could be
substituted for it.
16
Price, Scarcity, and Neo-Classical
Economics
 Barnett and Morse developed two hypotheses on
which to build an empirical test.
 Both hypotheses are based on the supposition that if
resources become more scarce, their opportunity
cost should rise.
 Their strong scarcity hypothesis looks at whether
the cost of extracting resources (labor and capital
costs) has been increasing over time.
 Their weak scarcity hypothesis looks at whether the
price of extractive materials has been rising relative
to the price of other goods.
 Both of these hypotheses were tested using
historical data and their general conclusion is that
scarcity is not increasing.
17
Price, Scarcity, and Neo-Classical
Economics
 There are two major criticisms of the above conclusion.
 It is difficult to make predictions into the future by looking at past
trends and this is particularly true when the forces underlying the
trends are not included in the analysis.
 The authors examine the changes in extraction costs over time, but do
not look at the factors that affect extraction cost, such as the
characteristics of resource reserves, technological innovation, and the
availability of cheap energy, and so on.
 In addition, Barnett and Morse choose a monotonic specification for
their empirical tests.
 A monotonic function is one that is always increasing or decreasing. If
one fits a monotonic function through a long time series of data,
recent changes in the data will not be reflected in the sign of the slope
of the function.
 Slade (1982) has re-estimated some of these functions for selected
minerals with a quadratic (u-shaped) function and found that we are
now on the upward sloping part of the "u".
18
19
Price, Scarcity, and Neo-Classical
Economics
 An additional argument against the findings in the Barnett and
Morse study is that the measure employed by the authors
might not be the best indicator of scarcity.
 For the purpose of this chapter, the most important missing
dimension is that these measures do not include the full social
cost of removing extractive resources, as they exclude
environmental costs.
 The cost of labor and capital could be falling while the
environmental costs are rising.
 The increase in environmental costs is likely to come about for
three reasons.
 As lower grades of ore are extracted, the amount of waste
material increases. As lower grade ore and deeper deposits are
extracted, the use of more energy is required. As environmental
degradation increases (from both extractive and non-extractive
activities) the marginal social damages of degradation may be
increasing.
20
Price, Scarcity, and Neo-Classical
Economics
 One might argue that if the price of the
extractive good includes its environmental
cost, then price would still serve as a good
signal of resource scarcity.
 It has been argued that the current
environmental regulations in the United
States fully internalized the environmental
cost of goods.
 There has been insufficient time since the
implementation of this legislation to allowing
time series testing of this argument.
21
System-wide Change and Sustainability
 Authors such as Meadows and Meadows and Gore
and Brown argue that the current methods of
economic production are not sustainable in that they
generate a system-wide change which interferes
with the long-term ability of the planet to support
human population.
 These changes include global warming, acid rain,
ozone depletion, deforestation, soil loss, water
availability, and quality problems.
 Since environmental resources and the state of the
environment are fundamental to the production
process, system-wide decline could lead to a great
future loss of productive capability and severely limit
the prospects of future generations.
22
System-wide Change and Sustainability
 Disagreement over whether or not system-wide
change exists leads to an extremely important policy
question and one that had not been adequately
addressed.
 This question is: “What level of proof is required
before one acts?”
 The scientific method requires rigorous proof before
claiming that a result holds.
 Typically, 95 percent or 99 percent confidence is
required before rejecting a null hypothesis.
 A null hypothesis is the supposition that the
researcher attempts to disprove, in order to accept
the alternative hypothesis.
23
System-wide Change and Sustainability
 In the global climate change area, the null hypothesis is that
CO2 emissions are not causing global warming.
 A 95 percent confidence can be interpreted to mean that we are
95 percent sure that there will be global warming as a result of
carbon dioxide emissions.
 A risk adverse posture would be to begin to take actions now to
limit system-wide change in the future.
 According to the criterion of sustainability, we do not need to
prohibit economic growth.
 We need to constrain growth and pursue growth paths that are
sustainable, where the change that the economic activity
engenders does not undermine the ability to engage in that
activity or alternative economic activities in the future.
24
System-wide Change and Sustainability
 The concept of sustainable development implies that some
growth paths are possible, while Malthusian concepts say that
growth is fundamentally limited.
 Some of the most noted neo-Malthusians have backed away
from their prediction of societal collapse and become
advocates of sustainability.
 The relationship between sustainability and the past work in
traditional economics, which shows that price can limit
scarcity, can be found in John Krutilla's 1967 call to reconsider
the concept of conservation.
 Krutilla argued that we need to refocus our old concern with
the conservation of extractive resources and be more
concerned with the conservation of unique natural
environments.
25
System-wide Change and Sustainability
 A current extension of Krutilla's reconsideration argument
would be to extend the concern with conservation to the
viability and sustainability of entire environmental systems.
 People who argue for movement towards a theory of
sustainable economics argue that system-wide environmental
degradation will not be incorporated into market prices, so
public policy is necessary.
 The advocacy of sustainable economics is also not
inconsistent with cost/benefit analysis.
 However, costs and benefits are treated differently in the
sustainability paradigm.
 Future costs and benefits are not necessarily converted to
present values. As a result, these costs may be more fully
incorporated into decision making.
26
System-wide Change and Sustainability
 Many scholars have developed plans to move the
global economy onto a sustainable path. These
plans share many elements, including operating
goals and attitudinal goals.
 Advocates of sustainable growth argue that
sustainability will not occur unless values change.
 This would include a move to be more concerned
with equity, both intratemporal and intertemporal,
and to be more willing to accept short term sacrifice
for long term gain.
 Since these attitudes are not synchronized with the
way political systems have developed, political
systems will have to change to be more futureoriented.
27
System-wide Change and Sustainability
 Meadows et al. speak of this change as the next in a
series of revolutions that transform economic
systems.
 The first of these was the agricultural revolution, as
people moved from hunting/ gathering to
domesticated agriculture.
 The second revolution that dramatically changed
human existence was the Industrial Revolution.
 Meadows et al. argue that it is time for a new
economic revolution and that is a sustainability
revolution.
28
System-wide Change and Sustainability
 Although each author has suggested a different set of
operation goals that must be met for sustainability to occur,
there are common threads. Sustainability requires that
countries:
1. control population growth,
2. eliminate the reliance on fossil fuels,
3. reduce pollution emissions and waste,
4. eliminate the pressing Third World poverty that is the source of
so much degradation,
5. slow deforestation, desertification, soil erosion and other
assaults on our renewable resource base,
6. eliminate military conflict and the devotion of resources to
military hardware and
7. develop new "appropriate" technology that is capable of
meeting economic needs at minimal environmental costs,
particularly in developing countries.
29
Summary
 Severe problems have been identified in this text,
and often little has been done to rectify them.
 Pollution, environmental degradation, global
warming, loss of biodiversity and other problems
have been shown to have the potential to drastically
affect the quality of life in the future.
 However, the future is not already determined; the
future is a choice and our actions today will
determine the future.
 Through an understanding of scientific
relationships, social institutions, and economic
principles, we can understand the forces that govern
environmental change and choose a set of policies
that move us toward a sustainable future.
30