Critique of Neoclassical Economics

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This is part of the Economy of the Knowledge Base which is to help provide an understanding for why economics is part of the problem in order to ground thinking about economics that can be part of the solution.

This section will outline a few of the tools and assumptions of the neoclassical tradition and illustrate how the use of neoclassical economics with respect to long-term environmental problems, such as climate change, results in decision-making that “places ecosystems and our descendents’ future in jeopardy” [1]. The neoclassical tradition in economics is considered mainstream economics. Its tools are widely used in policymaking. It is important too analyze because “participants in the public dialogue have internalized the neoclassical economic perspective to such an extent that its assumptions and biases have become almost invisible” [2] .

Contents

Utilitarianism

The neoclassical tradition in economics flows from Bentham’s and Mill’s idea of how to measure happiness. It has adopted utilitarianism as its moral foundation, which views human happiness as the main unit of value, expressed as utility. Thus, human beings, this thinking assumes, live for happiness, and happiness is understood as a product of consumption. Therefore, “the goal of every economy is to provide consumption. So economists of all persuasions have agreed, from Smith and Mill to Keynes, Tobin, and Becker” [3]. Utility analysis has become much more sophisticated since Bentham, but the fundamental concept remains the same, and has been extended to include government rationality, understood as the “maximization of the total utility of society” [4]. Therefore, the method to achieve progress is the overall maximization of individual human utility. However, utilitarianism is problematic for the environment because it “perpetuates a false view of humanity’s place in the world” and does not explain why all the millions of nonhuman species in the world should be in service to man [5]. Furthermore, because utilitarianism is at the centre of our economic decision-making, we make decisions where progress is defined as increasing human consumption. Thus, even though we now know that our ever-increasing voracious appetite for consuming, such as flying, keeping the heat on high, and owning and driving two cars, is causing climate change, our economic models assume that increasing consumption is good, and bias us towards actions that encourage us to continue to consume with little regard for its effect on the environment.

Substitutability

The neoclassical tradition assumes that human, labour, capital and the environment services (natural capital) are largely substitutable for one another. The basic assumption is that all products are substitutable at the right price, and when the price is right, we will innovate our way out of the problem, whatever that may be. In this view, technology is viewed as capable of substituting for nature indefinitely. This represents total faith in our reason and technological progress, which is not justified either by history or by science. The neo-classicist’s narrow concentration on consumption helps to justify an attitude towards substitution which allows forests, viewed as sources of cellulose to make lumber for homes and pulp for paper, to be depleted without much concern because houses can be built of other material, and the internet can be substituted for paper [6]. However, the world is not made up of interchangeable parts, and we now know that forests serve a broad range of functions which are not easily replaceable. This includes: erosion control, water purification, wildlife habitat, and a source of recreation and aesthetic contemplation [7].

With regards to climate change, the view among economists is that, when the price of carbon permits or taxes is high enough, we will innovate our way out of the problem. Therefore, when emitting greenhouse gas emissions becomes expensive enough, humankind will be able to manage the limited ability of the atmosphere to absorb carbon through geoengineeing and technology fixes. Current ideas for substituting for the services the atmosphere provide putting “reflective sulphate aerosol in the upper atmosphere to counteract greenhouse warming” [8]. Nonetheless, natural capital does not equal human capital. Species loss and loading the atmosphere with greenhouses gases which leads to climate change cannot be repaired by any amount of money, know-how or technology. The view that we can innovate and substitute human-made fixes for natural capital allows us to mistakenly believe that we can abuse the environment and the services it offers and replace it with technology.

Discounting

Another instrument in the toolbox of neoclassical economists which leads to environmental destruction is the practice of discounting future benefits. The theory behind discounting is that a dollar today is worth more than a dollar tomorrow and that, in order to make decisions that maximize your utility, you have to weigh the opportunity costs of investments. When the discount rate is applied to any cost or benefit expected in the future, it provides an estimate of its present value [9]. When applied to financial situations, a discount rate makes sense, but its application to environmental cost-benefit analysis is problematic. This is because “any positive rate of discount assigns lower values to the future than the present,” and will therefore lead us to evaluate serious damages to future generations as less important than moderate costs today [10]. Once again, this tool of the neoclassical tradition privileges humans’ preference for consumption now rather than later over what actions are best for the environment [11]. This is particularly problematic for decision-making over whether or not to act now to mitigate climate change. Economists assure us that we must apply a discount rate when doing a cost-benefit analysis of whether it is cost-effective to mitigate climate change (Cline, p17). However, because the benefits of preventing climate change are far into the future, and the costs are incurred today, the application of a positive discount rate to a decision of whether or not to act to prevent climate change results in the decision to do nothing [12]. This justifies species extinction and widespread environmental degradation because it occurs farther into the future and it is costly to take measures to mitigate climate change now.

Cost-Benefit Analysis

Perhaps no other instrument of the neoclassical tradition has received more criticism from environmentalists than the practice of cost-benefit analysis. Governments regularly use this tool to balance the positive and negative consequences of a proposed action, and where the positive consequences are greater, the proposed policy or project is implemented. This is a direct descendent of Bentham and Mill’s utilitarian view of how to measure and achieve progress, and the methods of valuing the costs and benefits reflect our anthropocentrism. Cost-benefit analysis is a way of weighing the costs and benefits of a proposal, so all inputs into the analysis must be monetized. However, in the neoclassical economics framework, non-humans and ecosystems are only valued to the extent that they affect human utility [13]. Thus, all non-market goods such as the services of the environment and wildlife must be valued in terms of their impact on human welfare. This is reflected in the standard methods of valuation outlined by Harris in Natural Resource Economics, such as contingent valuation, existence value, consumer surplus and bequest value, which not only exemplify the central place of humans in the neoclassical tradition, but are also largely made up, and are problematic in how accurate they are. In economic decision-making, the value of a deer becomes the amount a hunter would pay for the opportunity to shoot it, and the value of wetlands becomes the monetary value of the water it filters for the nearby community [14]. Thus, in the neoclassical tradition, policymaking is informed by a valuation system where the protection of the environment is contingent on it being useful for humans.

The cost-benefit analysis method of decision-making results in projects and policies that are likely to do harm to the environment because it privileges human well-being, undervalues the benefits of the environment, and the negative consequences to the environment, and cannot take into account the risk of our actions having unintended or irreversible results. Firstly, since the valuation of the costs and benefits are contingent upon their impact upon human welfare, it privileges human well-being over that of the environment. Thus, in these analyses, the preservation of endangered species only enters the equation in terms of utility to humans [15]. This is problematic simply because it embodies the assumption that the earth’s resources for humans, so any benefits of a project for the environment which are not contingent on human welfare do not enter the equation, which biases decision-making towards projects that benefit humans at the expense of the integrity of the environment. Secondly, the cost-benefit analysis undervalues the benefits of the environment in ecological systems. Valuing environmental services solely in terms of how they benefit humans grossly undervalues them, and the ignored values are often more important than initially thought, which in turn causes bigger problems for both humans and the environment. Thirdly, the cost-benefit analysis is mediocre at taking into account the possibility of irreversible or unexpected consequences of actions taken. Exhaustive efforts have been done to include risk into cost-benefit analysis, but attempts at doing so still collapse due to problematic forms of valuation and a failed attempt to calculate the benefits of avoiding risk-prone activities [16]. In short, the neoclassical tool of cost-benefit analysis asserts that, provided there is a net gain in resources, society overall will get wealthier, and there will be more assets which will carry everyone along, but this tool inherently values human well-being over the environment, and wrongly assumes that we can make up for the damage to the environment through substitution, which leads to projects and policies that damage the environment and the ability of future generations to benefit from it.

A more fundamental critique of cost-benefit analysis is that the belief that we can ever fully measure and predict the consequences of our interventions into the environment is misguided. It exemplifies western civilization’s absolute faith in our reason and technology, but chooses to ignore the fact that we still do not fully understand ecology. While we may understand ourselves to be moving on a linear path towards progress, natural systems are not just linear, there are also exponential [17] . Moreover, the world is made up of complex adaptive systems and once an equilibrium is perturbed we “cannot predict with assurance what the new equilibrium will be or whether it will be desirable” [18]. For example, climate change will have impacts that are so “broad, diverse, and uncertain that conventional economic analysis is practically useless” [19] . If we could not even remotely accurately predict the consequences of relying on a national system of roads for transportation in the United States, it seems fatuous to think we can predict accurately all the benefits and costs of a global phenomenon we do not fully understand. Therefore, with the tools of neoclassical economics in hand, we forge ahead with projects that, on paper, provide an overall net benefit to humans, but, in fact, we really do not know the effects that our actions will have, or whether we will, in fact, be better off once the project or policy in question is completed.

The effects of using cost-benefit analysis to guide our decision-making is particularly calamitous when it is applied to climate change; specifically, to the decision of how much we should reduce our greenhouse gas emissions in order to mitigate how much we affect the climate. In this case, the benefits of reducing emissions are the damages avoided, and the costs are the costs of reducing greenhouse gas emissions. The benefits are contingent on their impact on human well-being, and, or example, include: the effect of climate change on agriculture, on electricity requirements, on forests. Non-market impacts are measured using the problematic methods mentioned above, and includes, for example, the effects of climate change on species loss, migration and air pollution [20]. The difficulty with economic valuation, and especially its accuracy, is indicated by the wide range of numbers in the literature for the benefits of avoiding climate change [21]. Lastly, these analyses fail to adequately address the possibility of large-scale, irreversible changes, such as the shutting down of the thermohaline circulation, so the estimates to the benefits of action are biased downward [22].

More importantly, cost-benefit analysis applied to the decision of whether or not to abate greenhouse gas emissions is completely removed from the idea that if we are causing climate change, then we have a duty to do what we can to mitigate it [23]. In addition, cost-benefit analysis applied here means that the decision of how much to reduce emissions is simply based on what is most cost-effective for humans, and not what will achieve the stabilization of the climate, and thus help prevent species extinction and severe environmental degradation [24]. This is illustrated by a comparison of the estimates of the reduction in greenhouse gases required between cost-benefit analysis, and estimated based on analyses of what is required to stabilize the climate. A cost-benefit analysis done by the economist most associated with the use of cost benefit analysis in climate change, William Nordhaus, found that the optimal reduction in global carbon emissions is only five percent by 2030 [25]. Conversely, estimates of the reduction in greenhouse gas reductions needed to stabilize the climate at around 2 degrees Celsius are closer to 90 percent by 2030 (Forrest 2). Ironically, in this case, the neoclassical tool of cost-benefit analysis would have us follow a plan of action that can hardly be considered a path to progress, material or otherwise.

Measuring of National Income - Gross National Product (GNP)

GNP has become our primary indicator of progress. When comparing countries in terms of how well they are doing, they are ranked by their GNP, which is a “measure of all income received by residents of a nation for current services which are not transfers…plus appreciation in the value of stocks…and then further adjusted for income received from abroad” [26]. Peter Brown identifies a few problems with using the GNP to measure growth that are relevant to the discussion here. GNP measures both costs and benefits as benefits, so actions taken to alleviate unwanted side effects of GNP growth are counted as benefits ie. money spent to buy air conditioners to offset increased temperature due to climate change (66). Furthermore, GNP is a measure of income, not of income and wealth, so declines in natural resources such as topsoil and the atmosphere’s ability to sequester greenhouse gases are not counted (66). Thus, GNP is a flawed method of measuring progress because it allows us to count irreversible environmental degradation that brings economics benefits as income.

While measuring the value of the environment in terms of human well-being is problematic, as discussed above, it is still important that our decision-making is based on increasing a measure that does not take into account a large portion of the economy that provides for that growth. For example, research done by ecological economists suggests that environmental services from the global boreal forest, such as climate regulation, water filtration, waste treatment, and biodiversity maintenance, are worth approximately US $250 billion per year. This is a huge figure that is unrecognized in country’s GNPs [27]. Therefore, we are trying to increase a measure of growth which does not even account for the importance of the forest’s ability to sequester greenhouse gases and thus help stabilize the climate. Moreover, the tools of the neoclassical tradition are designed to increase this measure of growth, but this measure of growth is flawed and results in policies skewed towards increasing the wrong things, while ignoring the benefits of others. Lastly, GNP “takes no account of the scale of the economy relative to the biosphere on which it depends,” or how much GNP affects other things like the ecosystem and climate function [28]. There is no account of how much growth is a good thing. This is problematic, especially considering that the economic models in the neoclassical model have no limit, no place to stop, and function as if the world was infinite [29]. Our behaviour reflects a worldview of a linear path to progress, but the earth cannot support human progress limitlessly in the way it is defined now (Daly 100). We have no way of thinking about the bio-physical, planetary consequences of economic expansion, which helps to explain why we are currently overloading the atmosphere with greenhouse gases and causing a global planetary emergency.

Conclusion

Despite the perverse and pervasive effects economic decision-making has had on the environment, economic textbooks and thinking offer little in response. Textbooks such as Nordhaus and Samuelson’s, Economics, are unquestioningly optimistic in their faith in science and economic efficiency, yet offer little in response to developments such as anthropogenic climate change and mass species extinction [30]. Economists seem to assume that humans are not significant actors in the earth’s biophysical systems, yet this is so obviously false. Humans are now capable of moving mountains, changing the course of rivers, and even changing the global climate. Economics is supposed to merely be the “study of what works and what does not work in organizing society efficiently and in achieving various output and other practical goals that society might set,” but behind this façade of neutrality and analysis, economists have really urged for a policy of growth-at-all-costs using models that assume the world is made for human’s pleasure [31].

References

  1. ↑ Brown, Peter G. “Are There Any Natural Resources?” Politics and the Life Sciences. 23.1 (2005) 11-20.
  2. ↑ Jamieson, Dale. “Ethics, Public Policy, and Global Warming.” Science, Technology and Human Values 17.2 (1992) 139-153.
  3. ↑ Lebergott, Stanley. 1995. “Long-Term Trends in the U.S. Standard of Living.” The State of Humanity. Ed. Julian L. Simon. Cambridge, MA: Blackwell, 1995.
  4. ↑ Nelson, Robert H. Reaching for Heaven on Earth: the Theological Meaning of Economics. Savage, Maryland: Rowman & Littlefield Publishers, Inc., 1991.
  5. ↑ Brown, Peter G. “Are There Any Natural Resources?” Politics and the Life Sciences. 23.1 (2005) 11-20.
  6. ↑ Brown, Peter G. “Commentary: Towards and Economics of Stewardship: The Case of Climate.” Ecological Economics 26 (1998) 11-21.
  7. ↑ Brown, Peter G. “Commentary: Towards and Economics of Stewardship: The Case of Climate.” Ecological Economics 26 (1998) 11-21.
  8. ↑ Hoffert, Martin et al. “Advanced Technology Paths to Global Climate Stability: Energy for a Greenhouse Planet.” Science 298 (2002) 981-987.
  9. ↑ Harris, Jonathan M. Environment and Natural Resource Economics: A Contemporary Approach. New York: Houghton Mifflin Company, 2002.
  10. ↑ Brown, Peter G. “Commentary: Towards and Economics of Stewardship: The Case of Climate.” Ecological Economics 26 (1998) 11-21.
  11. ↑ Brown, Peter G. “Commentary: Towards and Economics of Stewardship: The Case of Climate.” Ecological Economics 26 (1998) 11-21.
  12. ↑ Brown, Peter G. “Commentary: Towards and Economics of Stewardship: The Case of Climate.” Ecological Economics 26 (1998) 11-21.
  13. ↑ Brown, Peter G. “Commentary: Towards and Economics of Stewardship: The Case of Climate.” Ecological Economics 26 (1998) 11-21.
  14. ↑ Harris, Jonathan M. Environment and Natural Resource Economics: A Contemporary Approach. New York: Houghton Mifflin Company, 2002.
  15. ↑ Harris, Jonathan M. Environment and Natural Resource Economics: A Contemporary Approach. New York: Houghton Mifflin Company, 2002.
  16. ↑ Farrow, Scott. “Using Risk Assessment, Benefit-Cost Analysis, and Real Options to Implement a Precautionary Principle.” Risk Analysis 24.3 (2004) 727-735.
  17. ↑ Hollings, C.S. “A Cross-Scale Morphology, Geometry, and Dynamics of Ecosystems.” Ecological Monographs 62.4 (1992) 447-502.
  18. ↑ Brown, Peter. The Commonwealth of Life: A Treatise on Stewardship Economics. Montreal: Black Rose Books, 2001.
  19. ↑ Jamieson, Dale. “Ethics, Public Policy, and Global Warming.” Science, Technology and Human Values 17.2 (1992) 139-153.
  20. ↑ Cline, William. “Climate Change.” Global Crises, Global Solutions. Ed. B. Lomborg. Cambrdige: Cambridge University Press, 2004.
  21. ↑ Cline, William. “Climate Change.” Global Crises, Global Solutions. Ed. B. Lomborg. Cambrdige: Cambridge University Press, 2004.
  22. ↑ Nordhaus, William. “Reflections on the Economics of Climate Change.” The Journal of Economic Perspectives 7.4 (1993) 11-25.
  23. ↑ Thomas, C.D. “Extinction Risks from Climate Change. Nature 427.8 (2004) 145-148.
  24. ↑ Nordhaus, William. “Reflections on the Economics of Climate Change.” The Journal of Economic Perspectives 7.4 (1993) 11-25.
  25. ↑ Cline, William. “Climate Change.” Global Crises, Global Solutions. Ed. B. Lomborg. Cambrdige: Cambridge University Press, 2004.
  26. ↑ Brown, Peter. The Commonwealth of Life: A Treatise on Stewardship Economics. Montreal: Black Rose Books, 2001.
  27. ↑ Anielski, Mark. “Carbon Capture, Water Filtration, Other Boreal Forest Ecoservices Worth Estimated $250 Billion/year.” 25 Sept. 2006. 1 Nov. 2006. <http://www.sciencedaily.com/ releases/2006/09/060924175538.htm>.
  28. ↑ Brown, Peter. The Commonwealth of Life: A Treatise on Stewardship Economics. Montreal: Black Rose Books, 2001.
  29. ↑ Daly, Herman. “Economics in a Full World.” Scientific American 293.6 (2005) 100-107.
  30. ↑ Nelson, Robert H. Economics as Religion: from Samuelson to Chicago and Beyond. University Park, Pennsylvania: Pennsylvania State University Press, 2001.
  31. ↑ Nelson, Robert H. Reaching for Heaven on Earth: the Theological Meaning of Economics. Savage, Maryland: Rowman & Littlefield Publishers, Inc., 1991.
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