Herman Daly and the True Costs of Economics

President Harry S. Truman was frustrated by the advice his council of economic advisors was giving him. On the one hand, its members would tell him, you should raise interest rates. On the other hand, they said, you should lower them. In exasperation Truman pronounced, “I’m tired of this one hand, other hand business. What I want is a good one-armed economist.” In response to this story, told at a public forum by another panel member, the economist Herman Daly leaned forward in his chair and, with a slight forward motion of his upper body, he propelled his right arm up—his only arm. Placing his hand on the back of his neck, Daly commented, “Well, I was too young for Harry Truman, but I am here now. His prophecy has been fulfilled.”
Why are economists equivocal? After all, even in Truman’s time, economics was paramount among the social sciences. The discipline achieved its academic and political status in large part because, in an attempt to be a science like physics, it grounded itself in rigorous mathematics to describe market and human economic behavior. In the eighteenth and nineteenth centuries—when Adam Smith, David Ricardo, Thomas Malthus, and other early economists were laying the foundation for economics—mathematics did not dominate economic theory. It was Francis Edgeworth in 1881 with Mathematical Psychics who tipped the balance. To apply mathematics, Edgeworth simplified the world with an assumption that allowed human behavior to be quantified: “every [hu]man is a pleasure machine.” Edgeworth’s proposal that economics could quantify not only physical things but also economic behavior was attractive. For more than a century, mainstream economists have embraced mathematics for the credibility it gave their endeavor. In emulating physics, they sought fundamental laws for economic behavior that would allow scientifically based prediction. Unfortunately, economists trusted their mathematically rigorous models without authentic validation in the human world. As a result the sound decision to employ mathematics in the discipline has led to some huge unforeseen problems as economics gained stature and the market economy became widely accepted as the central organizing principle in industrial societies…

Opportunity Costs in the Macroeconomy

Microeconomics considers component parts—firms, workers, products, materials, wages, households—of the macroeconomy and deals primarily with one issue: efficient allocation of resources. If the cost to produce an item exceeds its price, the resources to make the item (labor, transportation, raw materials, ecological impoverishment, and so on) have not been efficiently allocated. This can be easily demonstrated by means of an example such as the production of shirts. For instance, if it costs $5 to make a shirt and that shirt can be sold for only $5, no more shirts should be made; if that shirt can be sold for only $4.50, too many shirts have already been made. Clearly, to produce a shirt that costs $5 to make but sells for $4.50 is not an efficient use of resources.

Market mechanisms establish the efficient allocation of a scarce item such as a shirt, a cup of coffee, transportation, and labor (price paid for time). Marginal analysis identifies fruitless economic activity: when the market value of the next unit equals the costs to make it, it’s time to stop. Each microeconomic activity draws resources away from other activities: the $5 of resources used to make a shirt that sells for $4.50 wastes $.50 of resources that could have been used more efficiently for other things. That is, when you operate in a finite system, you choose among alternatives. These choices incur what economists call opportunity costs.

Opportunity cost is the key concept in microeconomics. Prices are supposed to measure opportunity costs, and opportunity costs presumably determine the choices people make. For each choice, the opportunity cost equals the most beneficial alternative sacrificed. Consider you have a limited amount of money that has to provide all your food for a week. You could have one very fancy meal, three fancy meals, or some food for seven days. A rational person would select food every day as the most beneficial. The opportunity cost of having food every day is not having one very fancy meal or three fancy meals, whichever you consider the next most beneficial choice. In the economist’s model of human and market behavior, a rational person will never incur an opportunity cost greater than the value of the option chosen, nor will an efficient market ever lead to a choice that has such an opportunity cost. Opportunity costs exist because each microeconomic activity competes with other activities for limited resources within the total economy.

When Daly began his economic career, this fundamental concept of opportunity cost was not considered relevant to macroeconomics. At that time, the macroeconomy—the sum of all microeconomic activity—was not considered part of a larger biophysical system; in fact, it was viewed as the whole, not a part. In this view, if the macroeconomy is not bounded by the biosphere and can grow into the void, unlimited growth—as advocated by the World Bank, International Monetary Fund (IMF), World Trade Organization (WTO), and economists in general—is possible and “sustainable,” and growth has no opportunity costs.

In the late 1960s Daly realized that the natural sciences, along with everyday observations, provided unequivocal evidence that the human economy is indeed part of the larger biotic enterprise, which is itself a subset of the even larger earth system. He has argued for more than three decades that such things as Earth’s carrying capacity, pollution of the food web and degradation of topsoil, species extinction, ecosystem loss, and climate change establish that microeconomic-type analyses in the macroeconomy are essential to avoid huge problems in the future.

Daly sums it up this way: “Ecological limits are rapidly converting ‘economic growth’ into ‘uneconomical growth’—i.e., throughput growth that increases costs by more than it increases benefits, thus making us poorer not richer. . . . As the macroeconomy grows in its physical dimensions (throughput), it does not grow into the infinite void. It grows into and encroaches upon the finite ecosystem, thereby incurring an opportunity cost of preempted natural capital and services. These opportunity costs (depletion, pollution, sacrificed ecosystems) can be, and often are, worth more than the extra production benefits of the throughput growth that caused them.” Daly labels this “negative economic growth,” because throughput grows while overall human benefits decrease, especially because of loss of life support.

Take, for example, the global fishing industry in recent years. The Inexhaustible Sea, a book representing conventional wisdom when published in 1961, purports that the oceans are an endless source of fish. We believed that this was true and acted on this belief. Today a million fishing vessels—an increase of 100 percent in twenty-five years—employing ever-more efficient techniques, are struggling to harvest fewer and fewer, and smaller and smaller, fish from the world’s oceans. The anchovy fishery off Peru collapsed in 1973 after record catches in the late 1960s. The North Atlantic cod fishery is exhausted and mostly closed. White abalone (Haliotis sorenseni) in Mexican and California waters, which once had as many as 4,000 individuals per acre, is now near extinction with densities of 0 or 1 per acre. Throughout the world’s oceans, populations of predatory fish—tuna, billfish, swordfish, codfish, Xatfish, skates, sharks, rays—have been reduced by about 90 percent since the beginning of industrial fishing in the 1960s, and some species are teetering on the brink of extinction.

Oceanic ecosystems are being further impoverished because the techniques that efficiently harvest the commercial species also catch many unwanted organisms. In the shrimp fishery only about 15 percent of the catch is shrimp; the rest is “bycatch” and discarded, often dead. This bycatch is estimated to be 60 billion pounds of wasted squid, octopuses, turtles, rays, sharks, sea anemones, starfishes, and other sea life. Industrial fishing has collapsed or put in decline 13 of the 17 major ocean fisheries and pushed the other 4 close to or beyond a sustainable yield. More boats are chasing fewer and smaller fish at greater cost per fish, so that this global-scale economic activity is, in fact, Daly’s negative economic growth. Moreover, industrial-scale commercial fishing is compromising the oceans’ capacity for supporting life and thereby collapsing major oceanic ecosystems.

The longer negative economic growth persists, the more fragile life support, or Earth’s carrying capacity, becomes. Thus, Daly’s agenda is to move as quickly as possible to a dynamic and creative, steady-state economy. To do this, negative economic growth needs to be eliminated by applying microeconomic-type analyses to the macroeconomy so as to identify and eliminate those economic activities that cost more than the benefits they provide. Although this cannot be done with great precision, we can be broadly accurate. That is, our analyses of resource use through tools such as ecological footprinting—along with our knowledge of trends in climate change, species loss, and pollution—tell us we have considerable negative economic growth. Simply put, we are using water from a rain barrel, and before the barrel is empty, we need to allow it to replenish.

Can Natural Capital Be Appropriately Priced?

We know we must curtail our impact on the environment, but to what degree is uncertain. The ultimate goal is to keep Earth’s natural resources—forests, soil fertility, fisheries, fresh water, wilderness areas, assimilation of wastes, and so on—intact so the planet can continue to provide life support for humans and the rest of the biotic enterprise. Although many economists believe that human-produced capital—machines, trucks, highways, factories, and all the rest—can substitute for natural capital, Daly points out, “What good is a sawmill without a forest, a fishing boat without populations of fish, a refinery without petroleum deposits, an irrigated farm without an aquifer or river?” That is, natural and human capital are, by and large, complements, not substitutes. Yes, we can do some things like foul our water and then purify it, but, as New York City discovered, this is costly. Preserving the Catskill watershed, a major source of New York City water, for $1 – 2 billion is a bargain compared to the $6 billion or more needed to build the filtration plant required to clean the water—and the ongoing annual costs of operating such a plant.

This New York City water-supply situation illustrates another economic shortcoming that Daly seeks to correct. Potable water from the Catskill watershed is delivered to city residents for a fee that mostly represents the “value added” to potable water. The “value added” approximates the costs of the infrastructure needed to bring the water from its source to residents. The potable water itself is, for the most part, free. This is how economists treat all natural resources; the only value is the value that humans add to “valueless,” or unvalued, stuff. Consider what happens when water becomes polluted. Energy and other resources are used to make the polluted water potable again. As a result the cleaned-up water costs more because value is added by the human manipulations that made the polluted water potable. Cleaning up polluted water is inefficient and expensive because energy is required for purification, and as a result there is less useful energy available to do other work.

Daly contends that paying for the use of natural capital is economically sound for two major reasons. First, if a natural resource is scarce but free, people waste it and it becomes even more scarce. Second, such resources in the public domain can be priced and sold so that their capacity to support the economy is used efficiently, and the money generated can be employed for the most pressing social and environmental needs. For example, until 1971, the city of Troy, New York, provided residents with free water, and predictably water consumption kept growing. When a modest fee per unit of water used was imposed, demand dropped by over 30 percent. Since the residents of Troy owned the source of the water and since it was priced close to the cost of delivery, the residents could have priced the water higher than delivery cost. If the water had been priced higher, the increased income to the city might then have displaced other taxes or been used in other ways to improve human welfare. This is exactly what Daly advocates.

Believing that all natural resources can or should be priced is, however, a dangerous idea. By setting a price for a natural resource, we presume that we know its total value, which in many cases is certainly not true. If we do not know a resource’s full value, it cannot be priced correctly. For example, what should be the price of the Catskill watershed? What value should we ascribe to its clean water supplied to New York City? Its agricultural output? Its recreational use? Its aesthetic value? Its forests and the carbon they sequester from the atmosphere or the Xood control they provide? Or the still-unidentified life support it provides? And how shall we calculate the “correct” price for all of these “goods and services” and those that future generations will need but are still unknown? Clearly preservation of some natural resources will be enhanced through market mechanisms, but many will not. In fact, many natural resources will be harmed, diminished, or eliminated by market forces. The challenge is to identify and appropriately price those elements of natural resources that the market can efficiently allocate while creating mechanisms that preserve those aspects of the natural world that have little or no currently accepted value yet may have unrecognized present or future value.

Appropriate Scale for the Macroeconomy

In the second half of the twentieth century the dominant objective of economic policy has been efficiency. In a market-driven economy with an efficiency-first policy, the following happens: (1) price goes down, (2) more resource is available, (3) more resource is used, (4) more uses for a resource are found, and (5) throughput goes up. Daly uses analogy to show that we need a measure beyond efficiency to assure sustainability, with a cargo boat as an example: “This absolute optimal scale of load [for a boat] is recognized in the maritime institution as the Plimsoll line. When the watermark hits the Plimsoll line the boat is full, it has reached its safe carrying capacity. . . . The major task of environmental macroeconomics is to design an economic institution analogous to the Plimsoll mark—to keep the weight, the absolute scale, of the economy from sinking our biospheric ark.” To establish a safe load for a boat is a relatively easy calculation based on a well-understood branch of physics, and we have learned also through observation and experience, unintentionally sinking boats by miscalculation or overloading them. Determining an economic “Plimsoll line” for our global economy will be more difficult, however, and will require objective economic and ecological measures to warn us of impending danger. Here, too, the histories of successful and failed cultures can be helpful.

The central question for mainstream economists: Is the current level of global economic activity sustainable? Unfortunately, current economic models cannot answer this question; nevertheless, when the global economy collapses, its limits will be known. Most economists are not worried, however, because, historically, substitutes for scarce resources have been found and technologies have circumvented apparent limitations.

The data, as we have presented throughout this book, show that the ark is taking on water; yet, among mainstream economists who establish policy, Daly’s recommendations, such as reducing throughput or assessing opportunity costs in the macroeconomy, have been ignored. He believes time is running out, and while we have sufficient natural capital and social resilience remaining, we need to set limits on the rate at which we use that capital. Energy (fossil and nuclear fuels) may be the element most easily controlled, and to limit energy production and consumption would constrain much of the rest of the economy and thus the throughput, as thermodynamics predicts. By setting limits on production and consumption, we would have a frugality-first policy in which energy prices would go up, less energy would be used and for fewer things, and throughput would go down, while the market would efficiently allocate the energy allowed to it. Over years or decades, depending upon the severity of the limits placed on energy use, this policy would stimulate the shift to other energy sources such as wind, geothermal, and solar, thereby making it necessary in order to create and maintain a steady-state economy to limit the economic use of all forms of energy. Unfortunately, with pervasive and powerful interest groups now championing low-priced energy—especially in the United States where the policy keeps energy cost artificially low through massive subsidies—even the first step of limiting fossil fuel and nuclear energy use seems hard to imagine.

Wisdom for a Livable Planet offers equal parts education and inspiration for readers. Carl McDaniel profiles eight path breakers who have dedicated their lives to improving the ecological health of our communities. The result is a portrait of hard-won environmental wisdom and a blueprint for taking action. For more information, please visit http://tupress.trinity.edu.