TCS Daily


Common Sense and Sensibility

By Arnold Kling - March 28, 2002 12:00 AM

Editor's Note: This article is the first of two parts. Part two is here.

Economists are not well thought of these days by environmentalists. Or so it seems from accounts such as a recent Scientific American excerpt of Edward O. Wilson's book, The Future of Life. He characterizes economists as narrow, myopic environmental ignoramuses.

"The bottom line is different from that generally assumed by our leading economists... The economist's thinking is based on precise models of rational choice and near-horizon timelines. His parameters are the gross domestic product, trade balance, and competitive index... The ecologist has a different worldview. He is focused on unsustainable crop yields, overdrawn aquifers, and threatened ecosystems."

And Wilson's right. It's true that economists have trouble with the views of many environmentalists. But this just reflects our frustration with the ecologists' use of the most naive and inappropriate economic models and assumptions in their forecasts and policy prescriptions.

That's why Bjorn Lomborg's new book The Skeptical Environmentalist is such a distinctive, rare, and important work. In addition to sharing the ecologist's concerns about aquifers, sustainability, and global warming, Lomborg accepts the economist's paradigm. By combining economics with ecology, he comes up with a rational, balanced analysis. Unfortunately, environmentalists' denial of the validity of economic analysis runs through much of their criticism of Lomborg's work.

Doing Economics Badly

To understand the threat to environmentalists posed by Lomborg and his ideas, it's important to recognize that the economic theory implicit in the traditional environmentalist position is flawed in the following ways:

  • It ignores the crucial phenomena of substitution and technological improvement.

  • It rejects any finite measure of the cost of environmental damage.

  • It fails to appreciate the role played by interest rates in providing a logical connection between the future and the present.

(In this essay, we'll examine the first issue. In a future essay we'll look at the other two. )

Environmentalists tend to assume a constant relationship between inputs and outputs. If you are going to produce X tons of grain, then the acreage of land required will be X/y, where y is the average yield of an acre of land. Economists call this the "fixed-coefficients" model, because the relationship between acreage and grain is governed by the coefficient y. Simply put, this is not a realistic model. In practice there are always a variety of production techniques that use different combinations of inputs to produce the same output.

The fixed-coefficients model applies, if at all, only in the very short run. In the long run, there is substitution and technical change. Substitution means that producers will vary the inputs used in production, depending on changes in the cost of various inputs. For example, if land becomes more expensive, producers will substitute capital, labor, fertilizer, or other resources in order to utilize the most efficient combination.

The other long-run factor is technical change. As we accumulate knowledge, we come up with ways to produce more output with fewer resources.

The fixed-coefficients model has a built-in implication that society will "run out" of resources. If you assume that each additional unit of output requires a fixed amount of some resource, then it is mathematically certain that at some level of output you use up all of that resource.

But economists don't believe that we will "run out" of any important resource. As a resource becomes scarce, its price will go up, and people will substitute away from that resource. In addition, the processes of research, accumulation of knowledge, and technical change enable us to reduce the resources needed to produce valuable goods and services.

For example, if you believe in fixed coefficients, then at some point we will run out of oil. But if you believe in substitution and technical change, then you expect that as the price of oil rises we will substitute alternative forms of energy. If you believe in fixed coefficients, then it may seem possible or even likely that we will run out of fresh water. But if you believe in substitution and technical change, then you expect that as the price of fresh water rises we will use it more carefully, and eventually desalination of sea water will be economical.

The Wager

The difference between an economic model that assumes fixed coefficients and a model that allows for substitution and technical change was tested in a famous bet between economist Julian Simon and ecologist Paul Erlich. In 1980, Simon allowed Erlich to select a set of five minerals that were supposed to become scarce. Simon then bet that the prices of those minerals would fall rather than rise in ten years. By 1990, the relative prices of all five minerals had declined, and Simon won the bet. If the fixed-coefficients model were correct, then population growth and rising standards of living should have enabled Erlich to win the bet.

In a recent interview, inventor Ray Kurzweil extrapolated the tendency to substitute human knowledge for material resources in creating wealth.

"[T]he knowledge component of products and services is asymptoting towards 100 percent. By the time we get to 2030 it will be basically 100 percent. With a combination of nanotechnology and artificial intelligence, we'll be able to create virtually any physical product and meet all of our material needs."

In other words, at the rate that we are enhancing human knowledge, we can satisfy all human wants without any resources becoming scarce! Although Kurzweil may be overly optimistic, his characterization of long-run economic dynamics is much more reasonable than the fixed-coefficients model that is the basis for ecological doomsayers.

Which Economic Model?

There is an inevitable component of economics to the science of ecology, because it speaks to the relationship between environmental resources and human consumption. Many environmentalists choose the fixed-coefficients model for this component. But as The Skeptical Environmentalist demonstrates, changing to a more reasonable model leads to vastly different assessments and predictions for the state of the environment.

The fixed-coefficients model is manifestly inappropriate for long-run analysis, and its empirical failure is well demonstrated. That, rather than professional incompetence, is what explains why economists stubbornly resist ceding our professional judgment to environmentalists. It also explains why, despite the rhetorical scorn heaped on Lomborg by many environmentalists, his approach provides a much better foundation for discussions of public policy.

Arnold Kling has a Ph.D in economics from the Massachusetts Institute of Technology. His web site is http://arnoldkling.com, and he also writes a weblog column at http://www.corante.com/bottomline
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