Communication among economists, other social scientists, natural scientists, and lawyers is far from perfect. When the topic is the environment, discourse across disciplines is both important and difficult. Economists themselves have likely contributed to some misunderstandings about how they think about the environment, perhaps through enthusiasm for market solutions, perhaps by neglecting to make explicit all of the necessary qualifications, and perhaps simply by the use of technical jargon.
So it shouldn’t come as a surprise that there are several prevalent and very striking myths about how economists think about the environment. Because of this, my colleague Don Fullerton, a professor of economics at the University of Illinois, and I posed the following question in an article in Nature: how do economists really think about the environment? In this and several succeeding postings, I’m going to answer this question, by examining several of the most prevalent myths.
One myth is that economists believe that the market solves all problems. Indeed, the “first theorem of welfare economics” states that private markets are perfectly efficient on their own, with no interference from government, so long as certain conditions are met. This theorem, easily proven, is exceptionally powerful, because it means that no one needs to tell producers of goods and services what to sell to which consumers. Instead, self-interested producers and self-interested consumers meet in the marketplace, engage in trade, and thereby achieve the greatest good for the greatest number, as if “guided by an invisible hand,” as Adam Smith wrote in 1776 in The Wealth of Nations. This notion of maximum general welfare is what economists mean by the “efficiency” of competitive markets.
Economists in business schools may be particularly fond of identifying markets where the necessary conditions are met, where many buyers and many sellers operate with very good information and very low transactions costs to trade well-defined commodities with enforced rights of ownership. These economists regularly produce studies demonstrating the efficiency of such markets (although even in this sphere, problems can obviously arise).
For other economists, especially those in public policy schools, the whole point of the first welfare theorem is very different. By clarifying the conditions under which markets are efficient, the theorem also identifies the conditions under which they are not. Private markets are perfectly efficient only if there are no public goods, no externalities, no monopoly buyers or sellers, no increasing returns to scale, no information problems, no transactions costs, no taxes, no common property, and no other distortions that come between the costs paid by buyers and the benefits received by sellers.
Those conditions are obviously very restrictive, and they are usually not all satisfied simultaneously. When a market thus “fails,” this same theorem offers us guidance on how to “round up the usual suspects.” For any particular market, the interesting questions are whether the number of sellers is sufficiently small to warrant antitrust action, whether the returns to scale are great enough to justify tolerating a single producer in a regulated market, or whether the benefits from the good are “public” in a way that might justify outright government provision of it. A public good, like the light from a light house, is one that can benefit additional users at no cost to society, or that benefits those who “free ride” without paying for it.
Environmental economists, of course, are interested in pollution and other externalities, where some consequences of producing or consuming a good or service are external to the market, that is, not considered by producers or consumers. With a negative externality, such as environmental pollution, the total social cost of production may thus exceed the value to consumers. If the market is left to itself, too many pollution-generating products get produced. There’s too much pollution, and not enough clean air, for example, to provide maximum general welfare. In this case, laissez-faire markets—because of the market failure, the externalities—are not efficient.
Similarly, natural resource economists are particularly interested in common property, or open-access resources, where anyone can extract or harvest the resource freely. In this case, no one recognizes the full cost of using the resource; extractors consider only their own direct and immediate costs, not the costs to others of increased scarcity (called “user cost” or “scarcity rent” by economists). The result, of course, is that the resource is depleted too quickly. These markets are also inefficient.
So, the market by itself demonstrably does not solve all problems. Indeed, in the environmental domain, perfectly functioning markets are the exception, rather than the rule. Governments can try to correct these market failures, for example by restricting pollutant emissions or limiting access to open-access resources. Such government interventions will not necessarily make the world better off; that is, not all public policies will pass an efficiency test. But if undertaken wisely, government interventions can improve welfare, that is, lead to greater efficiency. I will turn to such interventions in a subsequent posting.
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Comments
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Bart Anderson Posted 5:42 am
26 Feb 2009
In fact, mainstream economics is a combination of science and wildly controversial assertions, often reflecting the interests of powerful economic entities. Soothing posts such as this one mask the conflicts of interest. When looking at advice from economists, we need to ask "Cui bono?" - who benefits?
What I find intellectually duplicitous is the slight-of-hand in a passage like this:[The first theorem of welfare economics], easily proven, is exceptionally powerful, because it means that no one needs to tell producers of goods and services what to sell to which consumers. Instead, self-interested producers and self-interested consumers meet in the marketplace, engage in trade, and thereby achieve the greatest good for the greatest number Wha? The logical fallacies in this passage are multiple: Appeal to authority. Asserting what is to be proven. Abstracting away inconvenient facts.
The key to understanding the flaws in mainstream economics is to examine its assumptions. For example, the idea of "efficiency" -- efficient for whom? what are the criteria?
Or the idea that the hypothetical markets of economics bear any resemblance to historical reality.
2. MYTH: Modern mainstream economics is the only form of economics possible.
Please! Do some reading in the historical development of economic theory! Read some of the economists (Michael Perelman for example) that are on the outskirts of American orthodoxy. A post like this will be intellectually deficient if it omits the many schools of economic thought. What about Keynes, Marx, ecological economists?
3. MYTH: Any objection to mainstream economics is due to misunderstanding.
I think what gripes me the most about posts like this is the tone of condescension - as if any objection is due to misunderstanding. The underlying message that "all is for the best in this best of all possible worlds" - don't worry your pretty little heads about economics, we experts have it all figured out. To test the truth of this assertion, a simple look at the headlines is sufficient.
Now would be a very good time for mainstream economists to begin questioning their assumptions. What went wrong? Why are societies becoming polarized into rich and poor? Why did the financial system fail so spectacularly? Why was it outsiders and not economists who warned us of a coming failure - like Nassim Taleb ("The Black Swan") and Nouriel Roubini? Why has increased economic prosperity brought devastating ecological problems (e.g. China)?
Unfortunately, I see little evidence of any change in the economics profession.
4. MYTH: The graphs and mathematics that appear in modern economics texts means that economics is as rigorous as physics.
Most of this is just for show - a mathematical formula is only as good as the model on which it is based. Garbage in - Garbage Out. For a case study, consdier "The Gaussian Copula". As Kevin Drum writes: There might have been technical problems with the Gaussian copula function, but even if it had worked the way people thought it did it wouldn't have mattered. The rating agencies and the sell-side BSDs were just using it as an excuse to pretend that house prices would rise forever anyway. That was a far more fundamental problem than the statistical shortcomings of the formulae they used.
I agree with Mythbusting in one respect - economics is a critical discipline for the most important problems we face today. I just would like to see it more rigorous, less ideological.
Bart
Energy Bulletin
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sindark Posted 7:08 am
26 Feb 2009
a sibilant intake of breath
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Jon Rynn Posted 7:24 am
26 Feb 2009
The importance of this addition to the model of a system is that microeconomics does not translate over into a discussion of the economic system as a whole. There is some work on how one industry is starved of capital because it's "sunsetting" while another is "sunrising", but there is really nothing in the neoclassical system that shows how that leads to a resilient economy.
Macroeconomics is a patch that is intended to take care of this glaring emission -- that is, you look at macro variables such as trade in the aggregate, or money supply, or government spending. But there is nothing in the canon that treats the various parts of the economy as being functionally separate, as in an ecosystem.
I go into greater detail in this in my article "The economy is an ecosystem", and certainly the work of Herman Daly, and other ecologiccal economists, as opposed to environmental economists, should be consulted to see a different approach.
Since microeconomics is so constrained, we get all kinds of cute tricks which seem to be the basis for the popularity of the book "Freakonomics", but which do not tell us how to deal with the economy as a whole, much less the global ecosystem. I hope Robert enlightens us further as to how his field can help us.
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Ted Clayton Posted 9:18 am
26 Feb 2009
We not only 'have laws', but are by definition a 'lawful society/nation' (i.e., 'laws have us')- which is a good. But, therefore, we have lawyers (and 'they have us').
We are big into the economy ... in down-home language, a hyperextenuation of & 'cover' for the Merchant Princes game. We aren't talking about 'modern economics', we're talking 'mediaeval economics'. Good news is, we enjoy the biggest such example that ever was. It takes extreme wealth to talk e.g. about Green Energy.
I think lawyers are a mayor problem. I think the primary reason why we see the push for national health care, is that lawyering has just about ruined the medical profession, 'single-handed'.
I think economists see far too much as economic transactions & stakes, and take a far too removed & deprecated view of all other sorts of transactions & stakes.
If we really need for lawyers & economists to be a 4th & 5th branch of government, then we ought to take a hard look at how they might fit into the Constitution. But I can lock in my vote, right now.
It is of course 'corporatism' that establishes the sibling relationship between lawyers & economists. Both can be addressed, by addressing their parent.
Good news is, for me, that economists will be making 100% interest payments on that $700 billion for a long time - regardless of what ever happens to the principle.
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Bart Anderson Posted 4:56 am
27 Feb 2009
The central paradigm of The Market is less and less useful, whereas the "externalities" (factors left out of the model) are proving to be of critical importance.
The neo-classical orthodoxy of the last 30 years has become intellectually lax, because it has not been seriously challenged. It does not respond to alternative schools of economics, and in many cases is ignorant of their content.
For a blistering critique of neo-classical economics, see this essay by retired economist Peter Pogany (Hidden errors in interpreting resource problems and daily news). He writes: Neoclassical orthodoxy, firmly entrenched behind the moated walls of academic institutions and in perfect control of the "discourse" through language and discipline, has become intellectually unappealing. Outspoken students at major universities in Britain and France, fed up with reified, dried formalisms, disheartened by the prospect of becoming political economic zombies that swagger around with an inflated rational pose, have labeled contemporary mainstream economics "autistic." I think that if neo-classical economics is to survive in any form, it will have to become more intellectually adventurous.
Bart
Energy Bulletin
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OilMonkey Posted 6:57 pm
22 Aug 2009
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