Doughnut economics (3): Choose your big picture

The second of Kate Raworth’s “Seven Ways to Think Like a 21st-Century Economist” is to “See the Big Picture”, but which big picture should we be seeing? In the years just after the Second World War, economist Paul Samuelson wrote one of the first textbooks in economics, where he presented the economy as a system where labour, capital, goods, and services flowed between households and businesses. Raworth argues that this model leaves out important components of the economy, such as the environment and household labour. Even worse, this limited model has been the essential model of the economy ever since Samuelson drew it, and economists keep ignoring household labour, the environment, and common pool resources. So Raworth argues we should replace Samuelson’s model with a modern one that also includes households and commons, and better reflects the embeddedness of the economy in the global ecosystem.

We all simplify

Whichever side you are on, Raworth or Samuelson, what both are essentially doing is to make a very complicated thing a bit more understandable by simplifying it. We have this incredibly complex system – millions or even billions of individuals of varying age, gender, culture, education, and so on, each making tens or hundreds of decisions every day on what to eat, where to invest, whether or not to switch to other fishing gear, another crop variety, another job, and interacting with each other and their natural environment. With his model, Samuelson aimed to capture the essence of this system in a simple graph, or a storyline if you wish.

Simplification is not unique to economics. It is also common in ecology and population biology: the Gordon-Schaefer model, for example, is a highly abstract representation of the more complex process of how organisms reproduce, but it works for the purposes for which it is designed. Such a simplification is bound to leave out parts that may be important for some questions or situations. What exactly is important enough to be included depends on which problem you are solving. It is to some extent also a matter of judgment, and, admittedly, your political ideas, preferences, and personal morals may consciously or unconsciously have an influence on such choices.

In explaining Samuelson’s model Raworth’s narrative goes more or less like this. Paul Samuelson intended his model not to be a simplified model developed for a particular purpose or problem, but as an accurate and unchanging representation of the economy. Behind this effort was a secret plot by the Mont Pelerin Society to propagate the neoliberal belief that markets are infallible and should be left alone. Ever since, economists have bought into the neoliberal scam and ignored market failures, common property, household labour, and the environment.

The problem with conspiracy theories, however, is that no matter how plausible or nonsensical they are, they are also uniquely difficult to debunk. So instead of betraying my neoliberal paymasters, let me focus on the other allegations: that modern economists treat Samuelson’s diagram as some sort of complete and unchanging model of the economy, and therefore ignore such factors as households and the environment.

The model depends on the question asked

Bear in mind that many sciences respond to questions and concerns of policy makers and society as a whole. This applies particularly to the social sciences, and even more so to economics. Samuelson and Phillips developed their models in an age when the 1930s economic crisis was still in everybody’s memory and economies were being rebuilt after being laid to waste in a devastating world war (which, in a sense, had its roots partly in that same economic crisis). Therefore, Samuelson’s model (read: his simplification of an immensely more complicated system) reflected the concerns of the time: how to rebuild the world economy, especially that of Europe and Japan, and how to avoid future crises like the one that might very well have put Hitler and Mussolini in power? The issues that Raworth proposes to include in her model were of no concern in those days – yet. People knew Arthur Pigou’s 1920s work on external costs, but for the rest environmental concerns were on hardly anybody’s mind.

Fast-forward to the 1960s, and we see that scientists, policy makers, and activists started paying increasing attention to environmental problems. Rachel Carson wrote “Silent Spring”, and Paul Ehrlich “The Population Bomb”; WWF, Environmental Defence Fund, and the Club of Rome were founded; Santa Barbara suffered a major oil spill. The 1970s saw the Club of Rome’s “Limits to Growth” report and a global oil crisis, and in the 1980s concerns were rising over acid rain. No wonder economists also started to look into these issues, and in 1979 the Association of Environmental and Resource Economists was founded. And what do we find in one of the most widely used textbooks on environmental economics?

GraphTietenberg

Source: Tietenberg & Lewis, Environmental and Natural Resource Economics. Routledge.

That’s right: not an economic system that somehow exists independently of its environment and natural resources, but one that is embedded in a wider natural environment that provides resources and absorbs pollution. So the allegation that economists have all the time ignored the environment strikes me as odd, to put it mildly. Rather, the model we use depends on the problem we set out to address. There is as little reason to blame a regional economist for not taking into account climate change as there is to blame an environmental economist for not making his models spatially explicit. Unless, of course, such aspects are important for the problem you’re dealing with – but because you cannot take into account everything, you have to simplify. My PhD dissertation, for example, featured spatially explicit analyses because it addressed the question how habitat fragmentation can be reduced cost-effectively. It did not, however, take into account the impact of the methane emissions or nitrate leaching from the dairy farms where such habitat was being created. That wasn’t the question.

Are markets infallible?

But how about markets? Don’t economics textbooks present markets as infallible? Don’t they ignore the environment? Let’s take a classic in this respect: Economics by Greg Mankiw and Mark Taylor. Mr Mankiw self-identifies as a small-government, low-tax, free-market conservative, and he has served as chairman of president George W. Bush’s economics advisers. Students in the Occupy movement staged a walkout at one of his lectures to protest, as they put it, the market-friendly one-sidedness of his lectures. Surely his Econ 101 texbook would spread the neoliberal love? Here is what it says about market failures such as monopolies, environmental pollution, and public goods:

First, our analysis assumed that markets are perfectly competitive. In the real world, however, competition is sometimes far from perfect. In some markets a single buyer or seller (or a small group of them) may be able to control market prices. This ability to influence prices is called market power. Market power can cause markets to be inefficient because it keeps the price and quantity away from the equilibrium of supply and demand.

Second, our analysis assumed that the outcome in a market matters only to the buyers and sellers in that market. Yet, in the real world, the decisions of buyers and sellers sometimes affect people who are not participants in the market at all. Pollution is the classic example of a market outcome that affects people not in the market. Such side effects, called externalities, cause welfare in a market to depend on more than just the value to the buyers and the cost to the sellers. Because buyers and sellers do not take these side effects into account when deciding how much to consume and produce, the equilibrium in a market can be inefficient from the standpoint of society as a whole.

Market power and externalities are examples of a general phenomenon called market failure – the inability of some unregulated markets to allocate resources efficiently. When markets fail, public policy can potentially remedy the problem and increase economic efficiency. Microeconomists devote much effort to studying when market failure is likely and what sorts of policies are best at correcting market failures.

Mankiw & Taylor 2006, Economics, Thomson. Page 144-145.

Don’t start that the use of the term “side effect” suggests that externalities are unimportant – the book devotes an entire chapter on them and Mankiw himself supports taxation of fossil fuels. Externalities are a side effect to individual economic decision-makers in a market, i.e. firms, but surely not to society as a whole. Besides externalities, Mankiw’s introductory economics book also devotes chapters to monopolies and public goods. What do you mean markets can’t fail?

A few words about the commons

Raworth also appears to confuse common property resources with open access resources, and her reverence for the digital commons only adds to the confusion. Common property is exactly that – property, i.e. something that belongs to some people and not to others. Open access resources are owned by nobody, but they can be taken by anybody. It’s exactly that difference between property and no-property that is driving the overexploitation of open access resources such as high-seas fisheries.

This is in fact a common confusion, even among economists themselves. All too often I come across a false dichotomy between private property and something that is referred to, rather interchangeably, as common pool, common property, “the commons”, or open access. We should probably blame Hardin, who coined the term “Tragedy of the Commons” but in fact described a mechanism that is present in open access resources, not in commons. As Raworth rightly argues, Elinor Ostrom demonstrated that common property resources are usually managed quite well, by a mixture of peer pressure, social norms, or even religious rules. Hardin used common grazing land as an example, but in reality these lands are good examples of such well-managed resources! For this reason I try to avoid the term “Tragedy of the Commons” in my lectures. I much prefer Daniel Bromley’s distinction of four property regimes: private, public, common, and open access. The latter is in fact a no-property regime, which has seen many examples of overexploitation.

Raworth has high expectations of the digital commons, and they might indeed appear like some sort of open access resource that is nevertheless thriving. But they are incomparable to resources such as land, fish, and water. Natural resources are depletable – the more you extract, the less there is left. So to make sure that there is enough of them left in the future we should limit their extraction. But one does not “extract” a digital resource: as artists and record companies painfully experience, information can be copied endlessly. No matter how many people use R, there will always be copies available for the next user. So to avoid depletion of common property or open access resources the digital commons are a poor model. They are more like public goods, like the ubiquitous lighthouse: non-excludable and non-rivalrous. Why individuals nevertheless make programmes such as R is a question that could be answered by Ostrom’s work on the role of social norms in their management.

I consider this one of the weaker chapters of Doughnut Economics. At best its message can be understood as that Samuelson developed his big picture to address the economic problems of his time, but that subsequent generations of economists have (wrongly) treated his circular flow diagram in the way that physicists treat gravity, or biologists treat evolution: a fundamental, unchanging law that is independent of the context or the problem to be addressed. Perhaps today Samuelson might have drawn a diagram more similar to Tietenberg’s.

Nevertheless I feel Raworth overstates her case when she suggests that economics as a whole views markets as infallible and the environment as unimportant. This is a pattern throughout the book: she makes very general and wild accusations that play well with the econopobes buying her book, but will probably hamper its ability to get the sensible part of her message across to economists.

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