Wednesday, December 3, 2008

21st Century Economics -- Part 2

Before discussing the key points of ecological economics, I would like to present a brief overview and critique of classical economics as a contrast.

Off to an ugly start....

Classical economic theory has its roots in European colonialism. As Europeans expanded throughout the world exploiting the resources of newly discovered lands and peoples, massive new wealth began flowing from the colonies into Europe, and the money supply grew rapidly. These were the early days of capitalism. Some powers, such as Spain, extracted raw money, in the form of gold and silver bullion, from their colonies. Others extracted raw materials and then added value through manufacturing (i.e. British furniture makers using American lumber). And of course the most brutal and inhumane colonial enterprise was the institution of chattel slavery in order to maximize profits through the cultivation of cash crops. Regardless of the specific strategy, the goal was simple: to bring wealth back home to Europe.

For the European societies at the receiving end of this epic transfer of wealth, the discovery of the New World must have felt like finding a hidden treasure of inexhaustible abundance. The proverbial ‘land of milk and honey’ had at last been found, and the European powers began hoarding copious amounts of gold and silver to signal their newfound wealth. Resources were there for the taking, and the only factor limiting production was labor.

Not surprisingly, the greedy ambitions of these early entrepreneurs afflicted them with an insatiable appetite for cheap labor. This blinding self-interest is the original sin of the free market and it set capitalism on an unethical and inhumane course which led to the enslavement and subjugation of countless individuals all across the globe. For these unfortunate souls, European expansion and the imposition of merchant capitalism were twin curses that forever changed them. Timeless traditions were banned, languages lost, and entire cultures muddled as the Portuguese, Spanish, English, French and Dutch marched across a world they felt they owned.

A Few Enlightened Souls?

Far from the front lines of colonial exploitation and oppression, the first thinkers to attempt to explain the inner workings of capitalism emerged out of the European Enlightenment. Among them the political economists of the Scottish Enlightenment took the lead. During the late 18th century, as the industrial revolution was just beginning to ramp up in Britain, the world was introduced to the first fully articulated theory of self interest, division of labor and free trade. Appropriately enough, Adam Smith published Wealth of Nations in 1776, the year a bunch of rebellious British transplants in America decided to throw off the yoke of merchant capitalism and make their own money.

Wealth of Nations is widely regarded as the founding treatise of capitalism. In it Adam Smith criticized the restrictive tariffs of merchant capitalism, or mercantilism, and touted the free market as the most efficient mechanism for allocating the resources of society. In the most often quoted and paraphrased excerpt from his magnum opus, Smith employed his now famous metaphor to describe the miraculous efficacy of free markets:

“the invisible hand” of the market ensures that the pursuit of individual self interest in the marketplace will naturally benefit the whole of society. This was clearly written before the age of derivatives markets and credit default swaps and securitized debt. It seems more than a bit naive to assume that the selfish whiz kids on Wall Street who devised these investments were naturally benefitting society.

Among the most incisive observations presented in Wealth of Nations is Adam Smith’s labor theory of value. Smith recognized that in an industrial system, labor was the essential medium of exchange in the economy. In the previous agriculture based system of feudalism, one’s wealth was equal to the amount of productive land one controlled.

But in societies characterized by a high degree of specialization within the work force, where workers depend on the markets to provide for their needs and wants, one’s wealth is measured by the amount of labor one can purchase in the form of goods and services. So for Smith, the value of a given commodity was roughly equivalent to the trouble and toil that went into producing it.

This was a brilliant insight, and in the 18th century, Smith had no way of foreseeing any limits on production other than labor. In his world, it made perfect sense to think of labor as the only significant factor limiting production. But in the modern world, when efficiency improvements are replacing human labor and natural resources are being extracted at unprecedented rates, labor is no longer the key to understanding value in the economy.

In our time, resource scarcity, pollution and population growth comprise a set of unprecedented ecological limits to growth. These are new limits for us, and we need new thinking about how to adapt an economy that fits within them.

Beyond Wealth of Nations

With the publication of Wealth of Nations, the field of economics was born, and later contributors elaborated upon the ideas of Adam Smith. One of the most significant early developments was David Ricardo’s theory of comparative advantage, which presaged globalization.

Ricardo made the observation that if country A was blessed with a tropical climate and a year-round growing season but no fossil fuel, and country B had a massive endowment of coal but harsh winters; then country A should exchange its fresh produce for the coal of country B.

This insight eventually led to a rapid expansion of international trade. International trade of this kind can be understood as simply another type of division of labor; it is specialization between nations rather than workers.

During the nineteenth century, John Stuart Mill was the first economist to write about the value of preserving nature. Like a true Romantic, Mill waxed poetic when lamenting the prospect of watching the whole earth divided and conquered by the capitalists. In Principles of Political Economy, Mill issued a prophetic warning to the future generations of industrial society regarding the environment:

There is little satisfaction in contemplating the world with nothing left to the
spontaneous activity of nature; with every rood of land brought into
cultivation, which is capable of growing food for human beings; every flowery
waste or natural pasture ploughed up, all quadrupeds or birds which are not
domesticated for man's use exterminated as his rivals for food, every hedgerow
or superfluous tree rooted out, and scarcely a place left where a wild shrub or
flower could grow without being eradicated as a weed in the name of improved
agriculture. If the earth must lose that great portion of its pleasantness which
it owes to things that the unlimited increase of wealth and population would
extirpate from it, for the mere purpose of enabling it to support a larger, but
not a better or a happier population, I sincerely hope, for the sake of
posterity, that they will be content to be stationary, long before necessity
compel them to it.

Unfortunately he never fully explained how nature is valuable to the economy, or how a system which depends on processing natural resources might temper its destructive proclivities.

Taken together the ideas of Smith, Ricardo and Mill represent the nucleus of mainstream economic thought to this day. Criticisms and contributions have fallen in and out of favor (i.e. Marxism, Keynesian economics, supply-side monetarism). But the core set of conclusions that emerged from classical economics remain fundamental and unchallenged.

So, we have essentially inherited an eighteenth century economic paradigm. We believe in the efficiency of the so-called free market. We regard division of labor, including international trade, as a net positive for society. And we depend wholeheartedly on prices to balance the supply and demand in the market. Unfortunately, these assumptions don’t make sense in our time.

For example, classical economics fails to acknowledge that growth on a finite planet has limits. In fact a central premise implicit in conventional economic theory is that such limits are illusory. A classical economist would argue that as the natural limits of a given resource are approached the price of the limited resource increases, which creates an incentive for the market to invest in alternatives and/or more efficient productivity. Thus economic growth, albeit in a new direction, can continue in spite of the limit.

However, when the scarce resources in question include everything from fresh water and top soil to crude oil and natural gas, it seems ludicrous to assume that the market can truly deliver enough in the way of alternatives and increased productivity to allow for this hypothetical, perpetual economic growth.

My next essay will focus on how the field of ecological economics proposes to redress the glaring ineptitude of the markets to deal with limits.

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