Environmental Systems and Societies | Environmental and ecological economics

ESS Higher Level Lens (HL.b): Environmental and Ecological Economics

Welcome to one of the most intellectually rewarding parts of the HL course! If the thought of economics makes your eyes glaze over, don't worry. In ESS, we use economics as a powerful tool to understand why we damage the environment and, more importantly, how we can fix our systems to promote true sustainability.

This lens requires you to move beyond simple scientific descriptions and engage in critical evaluation (AO3) of how human systems value (or often, undervalue) the environment.

1. The Limits of Conventional Economics

Traditional, mainstream economics—focused primarily on growth and production—often treats the environment as an infinite sink for waste and an infinite source of resources. This approach leads to unsustainable practices because it fails to account for the true cost of production.

1.1 The Problem of Externalities and Market Failure

A critical concept in environmental economics is the externality.

Externalities are costs or benefits resulting from an economic transaction that affect an uninvolved third party. They are "external" to the market price.

• Negative Externalities: Costs imposed on society without compensation.
  Example: A factory produces cheap plastic goods (a benefit to consumers), but the pollution resulting from the factory's process damages the local fishing industry and causes health problems for residents. The factory does not pay for these damages.
• Positive Externalities: Benefits provided to society without being paid for.
  Example: A farmer maintains a healthy forest boundary next to their fields, which provides habitat for pollinators (benefiting nearby farms) and cleans the local air, but the farmer receives no financial reward for these ecological services.

When negative environmental externalities are ignored, it leads to market failure. The price of the product does not reflect its true environmental cost, resulting in overproduction and overuse of resources.

Quick Fix Tool: Internalizing Externalities
The goal of environmental policy (like taxes or regulations) is to "internalize" the externality—forcing the producer or consumer to pay the true cost. For instance, a carbon tax internalizes the cost of climate change pollution.

1.2 Gross Domestic Product (GDP) as a Flawed Measure

The most common measure of economic health is Gross Domestic Product (GDP), which is the total value of all goods and services produced in a country over a year.

Why GDP is a Poor Measure of Sustainability:

1. It ignores non-market transactions: Services like volunteer work, parental childcare, and the provision of clean water by a forest are crucial for well-being but are not counted in GDP.
2. It treats natural capital depletion as income: Cutting down a valuable old-growth forest for timber immediately boosts GDP, even though the country has lost long-term ecological wealth.
3. It includes defensive expenditures: Money spent on cleaning up oil spills, rebuilding after a climate disaster, or treating pollution-related illnesses actually increases GDP, even though these activities represent a decline in social or environmental well-being.

Key Takeaway: Conventional economics relies on prices that ignore true environmental costs (externalities), and its primary measure of success (GDP) often confuses economic activity with genuine human and ecological progress.

2. Redefining Wealth: The Four Types of Capital

To understand sustainability properly, we need a broader view of what constitutes wealth. Ecological economics defines wealth not just as money or factories, but as four interconnected types of capital. Sustainable development requires maintaining or increasing all four.

2.1 Natural Capital (The Foundation)

This refers to the resources and services supplied by the environment. It is the basis for all other forms of capital.

• Definition: Natural resources that can yield goods or services.
• Examples: Timber, fossil fuels, clean air, fresh water, fertile soil, biodiversity.
• The ESS Challenge: Natural capital is often treated as fungible (easily replaceable), but in reality, many resources (like biodiversity) are critical natural capital that cannot be substituted by human ingenuity. Depleting natural capital means reducing future productive capacity.

2.2 Manufactured Capital (The Tools)

This is capital made by humans, using natural resources.

• Definition: Goods and infrastructure made by people to produce other goods and services.
• Examples: Factories, roads, machinery, computers, tools.

2.3 Human Capital (The Skills)

This relates to the productive potential embodied in people.

• Definition: The accumulated skills, knowledge, health, and abilities of the population.
• Examples: Education levels, worker health, training, innovation capacity.

2.4 Social Capital (The Glue)

This is the intangible resource derived from human relationships and institutions.

• Definition: The trust, norms, relationships, and networks within a society that facilitate cooperation and collective action.
• Examples: Strong laws, effective governance structures, community ties, reliable justice systems. (A community with high social capital can solve local environmental issues more easily.)

Did you know? The concept of Strong Sustainability argues that natural capital must be conserved, because manufactured capital cannot truly substitute for essential ecological functions (like climate regulation or ozone protection).

3. Valuing Ecosystem Services

If conventional economics ignores the value of nature, how can we make governments and businesses care? By giving nature a financial value, or monetary valuation.

3.1 Definition and Categories

Ecosystem services are the benefits provided by ecosystems that contribute to making human life both possible and worthwhile. They represent the functions of natural capital.

This valuation effort is necessary to show policymakers that protecting nature is not just an environmental issue, but a core economic necessity.

• Provisioning Services: Products obtained from ecosystems.
  Examples: Food (crops, seafood), fresh water, raw materials (timber, medicines).
• Regulating Services: Benefits obtained from the regulation of ecosystem processes.
  Examples: Climate regulation (carbon sequestration by forests), flood control (wetlands absorbing water), waste decomposition, disease control.
• Cultural Services: Non-material benefits obtained from ecosystems.
  Examples: Aesthetic beauty, spiritual enrichment, recreational opportunities (tourism), sense of place.
• Supporting Services: Services necessary for the production of all other ecosystem services (often operate over very long timescales).
  Examples: Nutrient cycling, soil formation, primary production (photosynthesis).

3.2 Methods of Monetary Valuation

Putting a price tag on a natural service is difficult, but economists use several approaches:

1. Avoided Cost: Valuing nature based on the cost society avoids by having the service naturally. (Example: The cost of building water treatment plants avoided because a healthy watershed provides clean water for free.)
2. Replacement Cost: Valuing nature based on what it would cost to build an artificial, human-made system to replace the service. (Example: The cost of constructing sea walls to replace the storm protection offered by mangrove forests.)
3. Contingent Valuation (Willingness to Pay): Surveying people to find out how much they would be willing to pay to protect a resource (or how much they would accept in compensation for its loss). (This method measures perceived value, which can be prone to bias.)

Analogy: Think of the atmosphere’s ability to filter UV radiation (a regulating service). Its replacement cost—the massive machinery required to filter UV on a planetary scale—is effectively infinite. This shows just how vital and irreplaceable these services are.

Key Takeaway: Valuing ecosystem services shifts them from being considered "free gifts" to being considered essential economic assets, making conservation a rational economic choice.

4. Alternative Measures of Economic Progress

Since GDP is inadequate, environmental economists have developed alternative accounting methods designed to internalize environmental costs and reflect real changes in well-being and sustainability. HL students must be able to compare and evaluate these alternatives.

4.1 Net Domestic Product (NDP) and Green GDP

The first step away from GDP involves accounting for the depreciation of capital.

• Net Domestic Product (NDP): This measure adjusts GDP by subtracting the value of Manufactured Capital depreciation (the wear and tear on factories, roads, and machinery).
  \(NDP = GDP - \text{Depreciation of Manufactured Capital}\)
• Green GDP (or Environmentally Adjusted NDP): This takes the adjustment further by attempting to subtract the cost of environmental degradation and natural capital depletion.
  \(Green\, GDP = NDP - \text{Cost of Environmental Damage and Depletion}\)

Limitation: Calculating the monetary "Cost of Environmental Damage" is incredibly complex and subjective, making Green GDP difficult to implement consistently across countries.

4.2 Genuine Progress Indicator (GPI)

The Genuine Progress Indicator (GPI) is considered the most comprehensive alternative because it attempts to account for social and environmental factors ignored by GDP.

Don't worry if this seems complex—just remember the three ways GPI differs from GDP:

1. It Adds Value: It includes the value of non-market services that improve well-being (e.g., household work, volunteer work, public infrastructure).
2. It Subtracts Costs: It deducts defensive expenditures (e.g., crime costs, pollution cleanup costs, traffic congestion) and the costs of environmental degradation (e.g., resource depletion).
3. It tracks Inequality: It adjusts for income inequality, recognizing that wealth concentrated among a few does not equal genuine progress for the whole society.

Why is GPI often lower than GDP?
Studies often show that while GDP has consistently risen since the 1970s, GPI has leveled off or even slightly declined. This suggests that the economic gains shown by GDP are being offset by the increasing social and environmental costs (rising inequality, environmental damage).

Key Takeaway for Evaluation: The shift from GDP to Green GDP and especially to GPI represents a conceptual leap in economics—moving from merely measuring production to measuring sustainable welfare and true well-being.

Remember, as an HL student, you are expected to synthesize these economic concepts (e.g., GPI, externalities) when evaluating environmental policies and solutions across *all* ESS topics.