World Cities Summit Issue, Jun 2008

The Environment as Capital
Dodo J. Thampapillai

Following the 2006 Stern report,¹ global warming, climate change and the scarcity of basic resources have become dominant themes in policy forums concerning sustainable development. There is now widespread consensus that these environmental challenges must be explicitly acknowledged in the formulation of development policies. Therefore, the sustainability of cities will very much depend on policy and planning practices that address environmental concerns.

In the case of existing cities, there is a need to modify prevailing practices and in some instances, adopt drastically different practices. With regard to the development of new cities, the objective should be to recognise mistakes made in previous planning and development practices, and adopt governance regimes that offer due recognition to environmental challenges.

Environmental economics plays a fundamental role in developing environmentally-conscious public governance. The central theme of environmental economics is that nature is capital and that without nature, an economy will not exist. This is because while nature acts as a source of an economy’s basic resources, it is also a sink for the economy’s wastes. This principle explains why environmental economics is centred on the bio-physical realities of the natural environment. While all standard economics texts confine the concept of equilibrium to and within the economic system, environmental economics takes this concept beyond the economy and exposits the need for a perpetual equilibrium between nature and the economy as the basis for sustainability. The analytics of a sustainable equilibrium does not simply rest on a derived game theoretic bargaining solution, as some might suggest. Instead, it is based on internalising the laws of thermodynamics into frameworks in economics that permit the maintenance of a permanent stock of environmental capital (sources and sinks).

The challenges posed by the scientific realities of the natural environment are real and formidable. At the risk of over-simplification, these challenges stem from the diminution of nature as both a source and sink. Hence, the survival of cities and communities will depend on how well the sources and the sinks are managed. In most instances, the source and the sink are one and the same. For example, the air-shed provides a community with clean air. At the same time, it is also a sink for the emissions that stem from a wide range of economic activities. Yet the source-sink role of nature is not clearly understood by many policymakers—especially those trained as professional economists. The result: a mistaken set of ideologies and premises that can frustrate meaningful approaches to sustainable development.

IDEOLOGICAL CHALLENGES
The ideological challenges stem from the fact that environmental economics began as a peripheral area of study within the discipline of economics—which is the training ground for a significant proportion of individuals who are tasked with the role of governance. Besides, important frameworks in economics, especially those dealing with production and economic growth, fail to account for the vital role of environmental capital (KN).

In almost all standard economics texts, such as Frank and Bernanke² and Pindyck and Rubinfeld,³ production is attributed to the role of labour (L) and manufactured capital (KM). However, early neoclassical economics, such as Jevons,⁴ Marshall⁵ and Fisher,⁶ exposited production in terms of not only L and KM but also KN. Marshall’s explanation on the role of KN was profound: “… man does not create things but only rearranges matter”.⁵ Fisher, who was instrumental in setting the stage for the development of capital theory on stocks and flows, relied on the premise that nature is a capital stock that provides a flow of services.

The omission of KN from the explanation of production in contemporary economics is perhaps due to two sets of reasons. The first is that the formalisation of a theory of economic growth by economists such as Harrod,⁷ Domar,⁸ Samuelson,⁹ Swan¹⁰ and Solow,¹¹ confined the explanation of growth (expansion of production) to L and KM. This simplification—the omission of KN in the explanation of growth—was perhaps premised on the assumption that KN is infinite. The second set of reasons stem from the belief that technology can persistently offset the scarcity of KN. When the Malthusian notion of “Limits to Growth” surfaced in the 1970s to discuss the consequences of a rapidly growing world population in a world of finite resources, overwhelming counter evidence on the role of technology was presented by the World Bank¹² and Samuelson and Nordhaus.¹³

For instance, Samuelson and Nordhaus stated that:

“The dour Reverend T. R. Malthus thought that population pressures would drive the economy to a point where workers were at the minimum level of subsistence... What did Malthus forget or at least underestimate? He overlooked the future contribution of investment and technology. He failed to realise how technological innovation could intervene—not to repeal the law of diminishing returns but to more than offset it. He stood at the brink of a new era and failed to anticipate that the succeeding two centuries would show the greatest scientific and economic gains in history—a chastening fact, and one to keep in mind while listening to modern Malthusians sing on their baleful dirge.” (pp 854-5)

The net result of these two sets of reasons has been the development of an economics curriculum that offered very little space for the study of environmental economics, let alone giving it the recognition it deserves. This applies to almost all contemporary economics texts as well. For example, Frank and Bernanke² and Pindyck and Rubinfield³ devote no more than a few pages to a discussion of environmental issues. As the appreciation of the scientifically-driven linkages between KN and the economy is limited within the economics curriculum, this can lead to mistaken premises which give rise to the emergence of ineffective policies and policy tools. This can be seen in the period between 1970 to the 1980s where the World Bank funded several forest clearing programmes¹⁵ on the premise that growth needs only L and KM. Since then, there has been a reversal of this ideology and the World Bank has subsequently undertaken reforestation programmes accompanied by a transmigration programme for people.

In addition, the Environmental Kuznets Curve (EKC) offers a mistaken premise—namely that continued growth would eventually lead to lower emission loads that demand the sink services of KN. Grossman and Krueger¹⁶ and Shafik¹⁷ have observed that the EKC is an inverted U-type relationship between income levels and the emission of specific pollutants. This suggests that environmental damages which tend to increase with the onset of economic growth begin to diminish after a certain threshold level of income—estimated to be a per-capita income of between US$5,000 to US$6,000¹⁸—is reached. This gives the misguided idea of growth first and the environment later.

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