The Environment as Capital

World Cities Summit Issue, June 2008

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 survival of cities and communities will depend on how well the sources and the sinks are managed.

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.

The objective is to prevent pollution loads from entering environmental sinks so that the sinks have suffi cient time to heal and re-commence the provision of service flows.

Related to the EKC observation is the growing belief that emissions trading markets will reduce pollution levels to acceptable ones, such as those dictated by the Kyoto Protocol. It is certainly desirable, if not essential, to work towards much lower pollution loads compared to present levels. But to contend that emissions trading will resolve global environmental problems and deliver the sustainability of economies is too ambitious and foolhardy. Both the EKC observation and the Kyoto Protocol overlook an important bio-physical reality, which is that the restoration of environmental sinks will not depend on the reduction of marginal pollution loads but a reduction in the cumulative pollution loads. Global warming and climate change are manifestations of the fact that cumulative pollution loads exceeded threshold levels of environment sink capacities. The implication of this is that governance regimes must seek very different types of policies and practices. It is equally important to appropriately train those who will govern.

CLOSED LOOP SYSTEM

When the importance of cumulative pollution loads is acknowledged, then closed loop production systems will begin to figure prominently in public policies. A closed loop system is one where waste is either recycled as an input into another process or returned to nature as harmless material. The objective is to prevent pollution loads from entering environmental sinks so that the sinks have sufficient time to heal and re-commence the provision of service flows. At least four areas of closed loop production options are evident in many city/urban areas. These are: Sewerage Treatment Systems; Air Conditioning and Heating Systems; Energy Supply Systems; and Innovative Methods of Commodity Development.

Sewerage Treatment Systems

Sanitation and hygiene are not the only issues that surround sewerage treatment. Because this activity eventually relies on a variety of environmental sinks—oceans, lakes, rivers and subterranean ecosystems—efficient methods of sewerage treatment have far reaching implications for sustainability. In this context, Singapore’s Public Utilities Board (PUB) offers a framework which other cities can emulate. In this city-state, every home is connected to a system where the treatment is so advanced that the recovered water is reusable for both industrial and potable purposes.

The oceans are the world’s largest naturally occurring carbon sink. The sink capacity of the oceans, when restored, could in turn restore balance to the carbon cycle.

Besides the issue of water conservation, it is equally important to note that the extent of treatment renders the residues that get deposited into the ocean sink to be inert. Most coastal cities in the world deposit untreated sewage into ocean sinks on the grossly mistaken assumption that the ocean is an infinite sink. For example, Sydney, Australia pumps out at least 12 million litres of untreated raw sewage into the Pacific Ocean each day.¹⁹ Imagine the cumulative load of pathogenic material that would have accumulated if one tallies all other coastal pumping stations in Australia and the number of years of this activity. Some would argue that the ocean is not a static body of water and that wave actions and oceanic movements will render the deposits harmless. This may be true if the loads of deposition are small and not continuous over time. However, scientific evidence now indicates that the quality of the Pacific Ocean on the Eastern seaboard of Australia could be seriously compromised. It is this type of practice (amongst others) that has rendered nearly half the Baltic Sea (below a certain depth) to be lifeless.

It is plausible to argue that the sink capacity of all oceans in all continents is compromised owing to improper methods of sewerage treatment. The oceans are the world’s largest naturally occurring carbon sink. The sink capacity of the oceans, when restored, could in turn restore balance to the carbon cycle.

Air Conditioning and Heating Systems

Compared to 20 years ago, every home and building in almost every city is now equipped with either an air conditioner (in tropical countries) or a heat pump (in temperate countries) or a reverse-cycle unit (mainly in temperate countries). Air conditioners generally pump out hot air—depending on the indoor temperature setting—and hence raise the outdoor ambient temperature. Heat pumps in winter drives out colder air and thereby lower the external ambient temperature.

The sceptics’ response would be that the change in temperature prompted by each unit is miniscule relative to the volume of the earth’s troposphere. However, if one were to add up the number of homes across the globe and across a period of time, then the cumulative effect is significant. Using the closed loop production system (or at least partially), it would mean searching for home/building designs that would reduce the demand for heating and cooling while at the same time enable the capture of the heat/cold emission for reuse within the home/building. For example, in a shopping complex, the building could be designed such that dry-cleaning establishments receive the hot air exhausts (in tropical countries) and cold rooms for refrigeration receive the cold air exhausts (in temperate countries). In both cases, the partial loop closure reduces the energy demand imposed on the grid.

Energy Supply Systems and Commodity Development

Greenhouse gas concerns have already ushered in several alternative energy initiatives which range between energy saving devices and the development of alternative energy sources to replace fossil fuels. For example, the Australian firm Oceanlinx has developed a device that converts wave energy into electrical energy; it currently has in place about six urban energy supply projects, each delivering between 5 to 15 megawatts of peak capacity. Entrepreneurs based in the United States (US) are attempting to popularise electric cars that utilise recharging stations on the mobile phone model.

Greenhouse gas concerns have already ushered in several alternative energy initiatives which range between energy saving devices and the development of alternative energy sources to replace fossil fuels.

The closed loop manufacturing model has already permeated business and is reported to have generated revenues amounting to US$53 billion in 1996 within the US manufacturing industry. There are numerous other examples of environmental innovations. One of the more prominent ones is the Hypercar which uses cheaper and recyclable material for the car exterior and interior, including a combustion system that significantly reduces reliance on fossil fuels and hence reduces toxic emissions. The building industry has also recently proposed the manufacture of building materials from renewable sources (such as making bricks from pulp and paper) and, at the same time, designing buildings that significantly reduce the demand for heating, insulation and lighting.

ENVIRONMENTAL ECONOMICS AND GOVERNANCE

Governments must choose an appropriate mix of actions so that environmental sinks that have been damaged by years of neglect, false premises and complacency can be restored. While a zero emission regime may prove difficult in the short run, it may be feasible in the long run. The lower end of the time scale given in the Stern report for environmental repatriation is only 50 years. Although this estimate is probabilistic, it is prudent to be aggressive in the search for appropriate measures such as those mentioned in this essay. Some approaches, such as globalising the PUB model of sewerage treatment, could be put in place, perhaps much sooner than global carbon trading markets.

Equally important is the role of environmental economics in guiding the governance regime. When KN is explicitly recognised in the production function, business decisions can be altered to such an extent that voluntary environmental stewardship by firms could be feasible.

Lastly, the theory of production involving KN must be incorporated within the economics curriculum of training institutions in order to cultivate environmental values and awareness in policymakers.

ABOUT THE AUTHOR

Dodo J. Thampapillai is an economist at the Lee Kuan Yew School of Public Policy, National University of Singapore. He also holds a Personal Chair in Environmental Economics at Macquarie University and an Adjunct Professorship in the same field at the Swedish University of Agricultural Sciences at Uppsala. Professor Thampapillai has written over 100 publications, including seven books and nine refereed monographs. His current research focus is on Macroeconomics and the Environment.

NOTES

Stern, N., The Economics of Climate Change—The Stern Review (London, UK: Cabinet Office, HM Treasury, 2006).
Frank, R. and Bernanke, B., Principles of Economics (New York: McGraw Hill, 2006).
Pindyck, R. S. and Rubinfeld, D. L., Microeconomics (New York: Prentice Hall, 2007).
Jevons, W. S., An Inquiry Concerning the Progress of the Nation, and the Probable Exhaustion of Our Coal-Mines (London: Macmillan and Co., 1866).
Marshall, A., Principles of Economics (London: Macmillan, 1891). For example, see Marshall, Book II, Chapter III, Paragraph II.III.2.
Fisher, I., “Precedents for Defining Capital”, Quarterly Journal of Economics 18 (1904): 386-408.
Harrod, R. F., “An Essay in Dynamic Theory”, The Economic Journal, 49 (1939): 14-33.
Domar, E. D., “Capital Expansion, Rate of Growth and Employment”, Econometrica, 14 (1946): 137-47.
Samuelson, P.A., Economics (New York: McGraw Hill, 1948).
Swan, T. W., “Economic Growth and Capital Accumulation”, Economic Record, 32 (1956): 334-61.
Solow, R., “A Contribution to the Theory of Economic Growth”, The Quarterly Journal of Economics 70 (1956): 65-94.
The World Bank, 2005 World Development Indicators, https://documents1.worldbank.org/curated/en/947951468140975423/pdf/343970PAPER0WDI0200501OFFICIAL0USE0ONLY1.pdf
Samuelson, P. A. and Nordhaus, W., Economics (New York: McGraw Hill, 1948).
This paragraph has been removed from more recent editions of this book.
Grossman, G. M. and Krueger, A. B., Environmental Impact of a North American Free Trade Agreement, Working Paper 3914 (Cambridge, MA: National Bureau of Economic Research, 1991).
Shafik, N., “Economic Growth and Environmental Quality: An Econometric Analysis”, Oxford Economic Papers 46 (1994): 162-78.
Thampapillai, D. J., Environmental Economics: Concepts, Methods and Policies (Melbourne: Oxford University Press, 2002).
http://www.environment.nsw.gov.au/resources/beach/bwsob0304/bwar03042.pdf.