The Functions of an Economy

What Does an Economy Do? Allocation, Distribution, Scale | Plus Trade, Innovation, Perverse Subsidies

Note: This section relies on both Montague and Hayes

But is really all about ecological economics as explained by Herman Daly in Beyond Growth. This also sets up Brown, couched in eco-economics.

Allocation: markets and efficiency

The efficient allocation of resources toward competing ends is the primary concern here. An externality is a consequence, positive or negative, of an economic activity that affects other parties without this affect being incorporated into market prices. Thus, market price deviates from the "true" social cost, sending the wrong signal.

Distribution: politics and fairness

Distribution is the socially acceptable distribution of the goods and the bads produced by the economy. This issue lies outside the domain of technical economic analysis, incorporates values and ethical choices, and is properly resolved by democratic political institutions. Sachs's article deals extensively with fairness in global perspective -- and may make you uncomfortable.

Scale: growth and the appropriate size of an economy

Neoclassical economics regards nature as outside the economy, not situating the economy within nature -- abdicating concern for the planet. Natural capital, the stock of resources and ecological services basic to all life, has therefore been denied economic value. This is the missing component in growth theory, within macro-economics, but absolutely grounds ecological economics.

Long Distance Trade

LDT, aka international trade, now premised on comparative advantage theory, which must be qualified. See Hayes and especially Cavanagh and Mander. All linkages must be carefully designed and managed. Exports and imports have mattered since Aristotle and mercantilism -- still does.

Innovation: institutional and technological progress

The potential of innovation derived from building a sustainable society remains enormous. Sustainability-driven innovation could define an epoch -- much for the better.

Perverse subsidies, a hidden industrial policy, must be reversed

A related topic, rarely brought into view, is the plethora of perverse, often hidden, subsidies, including externalities, enjoyed by corporations in such established industries as energy, agriculture, and transportation. Not only do these gifts typically promote older, dirtier, less efficient industries, but they also stymie the development of innovative, cleaner alternatives-depressing prospects for sustainability.

Allocation

Competitive markets -- not corporate-dominated oligopolies -- can perform well here so long as side-effects, such as externalities, are incorporated into prices. Ecological economists recognize a legitimate role of the market in society based on the efficiency of allocation of resources.

A major improvement in markets includes the side-effects, so markets tell the ecological and social truth. However, pollution provides a subsidy to firms who would otherwise have to clean up their mess. They are easy to hide, hard to calculate, so they persist. This is called a market failure. If markets fail, this means becomes a central point of contention. ESS thus should make a big deal over market failure, which then becomes an institutional failure. ^

Externalities

An externality is a consequence, positive or negative, of an economic activity that affects other parties without this affect being incorporated into market prices. Thus, market price deviates from the "true" social cost, sending the wrong signal. Note also the subtle linguistic trivialization. Interestingly, the economics profession has long neglected to assess the size or significance of externalities or to calculate the damages perpetrated on its victims, who by definition had these harms inflicted upon them without their participation-despite the obvious dysfunctions of industrialization and urbanization. Indeed, the bias of public policy in the USA has been to protect the producers, not the public at large. Daly comments on the trivialization of externalities by neoclassical economics:

When increasingly vital facts, including the very capacity of the earth to support life, have to be treated as "externalities," then it is past time to change the basic framework of our thinking so that we can treat these critical issues internally and centrally. (45) ^

Global Fairness

Read Sachs and grasp his message. This is authentic social ecology. Without a grand social contract, cooperation between the Global North and the Global South will fail. The results will be disastrous. Sachs realizes that copycat development, the replication of the economic development practices of the global rich, will surely lead to global ruin: more poverty within vast ecological catastrophe. Orthodox western economics can neither be extended to the majority of the earth's human inhabitants nor can it be sustained indefinitely by the 20% or so who enjoy its cornucopia. Sachs reveals the parasitical political character of global capitalism masquerading as shared economic development.

The USA enjoys the opportunity to provide leadership here, but this moral authority has been squandered. ESS requires such leadership, soon. A good place to start is Africa. Brown provides much insight here.

Left to itself, a market society will produce large maldistributions in wealth and income. In practice, the market-driven returns to capital, as profits and capital gains, accrue to the wealthy few, the capitalist class, while the returns to labor, wages and salaries, go to a multitude, the working class. This dynamic produces a class-based inequality of both wealth and income, which translates into differential political power. In the past, the inequalities were mitigated by redistributive tax policies--anathema to neo-liberalism, as exhibited by the recent Bush tax cuts. In the era of economic globalization, inequality has grown sharply within nations, including the USA, and on the global scene. Yet, economists regard this normative concern as outside the ken of "scientific economics." Therefore, when issues of social justice are openly discussed in the context of sustainable development, do not turn to economics for insight.

The usual deflection of the fairness discussion, now in play in the USA since the 2006 election, is to promote economic growth. Grow the pie rather than quibble over the size of the slices. But if the ingredients for physical growth become scarce, growth slows down and the quibbles morph into arguments. This can easily spin out of control. Count on it. ^

Innovation

Growth remains the engine of economic globalization without which the system as constituted would crash--although with runaway material growth earth's ecosystems will surely crash. Schumpeter put it this way: "Capitalism, then, is by nature a form of economic change and not only never is but never can be stationary" (82). Schumpeter derided the "textbook picture" that depicted economic progress as the result of market-based competition (84). Rather, he pointed to innovation in products, sources of supply, organization, and technology that created a new context "which strikes not at the margins of the profits and the outputs of the existing firms but at their foundations and their very lives" (84). Indeed, Schumpeter foresaw that capitalism itself would fall victim to the turbulent task environment of its own making:

The capitalist process not only destroys its own institutional framework but it also creates the conditions for another. Destruction may not be the right word after all. Perhaps I should have spoken of transformation (162).

The pivotal move of ESS is to open up a horizon for enormous technical and social progress while maintaining and even restoring harmony with nature. Thus, sustainability offers enormous opportunity. The language of hope must replace the language of despair. There is real opportunity here. ^

Perverse Subsidies

A related topic, rarely brought into view, is the plethora of perverse, often hidden, subsidies, including externalities, enjoyed by corporations in such established industries as energy, agriculture, and transportation. Not only do these gifts typically promote older, dirtier, less efficient industries, but they also stymie the development of innovative, cleaner alternatives --depressing prospects for sustainability. For example, subsidies to cotton farmers in the USA disadvantage cotton cultivators in Africa and subsidies to nuclear power generators present an unfair advantage to start-up wind power producers.

These often hidden subsidies undermine economic efficiency and promote environmental damage, but go largely neglected in the economic literature. A study released in 2001 by Norman Myers and Jennifer Kent estimates the global cost of perverse subsidies at two trillion dollars, about 5.6% of the $35 trillion global economy. The subsidy-rich, environmentally poor Bush-Cheney energy policy was formulated behind closed doors with input from energy giants like Enron but with no public disclosure. Eliminating perverse subsidies must be a first step toward building a sustainable economy. Thus, grappling with perverse subsidies and tilting the market toward renewable resources must be high on an ESS agenda. ^


Wayne Hayes, Ph.D. | Initialized: 2/27/2007 | Last Update: 3/1/2007