Doughnut Economics (7): Understand before you design

The sixth of Kate Raworth’s “Seven Ways to Think Like a 21-st Century Economist” is a green version of the fifth: forget the idea that economies must become dirty before they can become clean, and start designing ways to clean them up now.

What we are talking about here is a pattern in the data that is similar to Kuznets’s curve: as economies develop, environmental problems such as air quality and biodiversity decline increase, until they decline again. Again the question is whether this is a mere pattern in the data or there are fundamental mechanisms at work that justify labelling this as a ‘law’, and whether such a law, if it exists, should inspire policy recommendations. For the original Kuznets curve I explained that as far as I know, the pattern came before the purported ‘law’ (which few economists claim to be a fundamental law anyway), and that many of the policies that Raworth claims are inspired by the Kuznets curve actually aim to clear the mountains of debt that the respective countries (Greece and Argentina, for example) had accumulated. So I wasn’t so convinced her accusations stuck; with the environmental Kuznets, however, she has a point.

The mechanisms that economists commonly suggest to explain the environmental Kuznets are indeed a comfortable argument for policy makers and politicians to favour economic growth: as the argument goes, people need to get richer before they can start caring about the environment. Part of the explanation for the inverted U in environmental data is that people consider some of these environmental qualities a luxury that people can only afford once they have secured their livelihood. Indeed, as Prakash in her example illustrates, many poor countries, or rather their policy makers, argue that they are too poor to care about the environment: only when they have secured their own livelihoods they can start caring about elephants.

It is important to realise here that what we refer to so easily as “environmental quality” actually covers a lot of different variables, such as concentration of unpleasant odours, population sizes of rare species, concentration of toxic substances, all the way up to global temperatures running amok and enhancing the destructive power of hurricanes and whatnot. Compare these variables to Maslow’s pyramid: some environmental variables are of direct importance to our immediate physiological needs, such as clean drinking water; others are of more indirect but nevertheless no less importance, such as a stable climate; yet others are important for more higher-order needs, such as the sense of awe that we experience when we encounter a wild giraffe or a sperm whale, or the intense wonder and fascination when we listen to the melodic conversations of songbirds. Lumping this multitude of needs together, and pretending they are all equally essential for human life, is disingenuous. Like people worry about food and shelter before they start caring about self-realisation, it is understandable that developing countries consider poverty alleviation a more urgent matter than nature conservation. People such as Prakash might even consider Raworth’s argument colonial: there are many places in the world where nature conservation is considered a white man’s hobby. Take Skukuza, Kruger Park’s biggest camp, the name of which purportedly reflects locals’ bitterness at having lost their ancestral lands for the establishment of the park.

These subtleties, however, also mean that the environmental Kuznets curve may only show up for environmental variables that can be considered luxury goods. Moreover, Raworth makes the very valid point that rich countries may have cleaner air, but also bigger global footprints: instead of reducing their environmental impact they export it to countries that are willing to trade their air quality for income. That is their choice, a libertarian might argue, but it still gives the misleading impression that one can outgrow pollution.

Creative with green designs

I find Raworth’s recommendations unconvincing, however. “Economics is not about discovering laws: it is essentially a question of design.” I cannot begin to express how wrong this is: how can you design changes to a system if you don’t understand that system in the first place? Like Raworth, I also cringe at economists’ referring to mechanisms in an economy as “laws”. People are no Higgs Bosons: their behaviour is much more difficult to understand and predict. But that does not mean that their behaviour is completely unpredictable – if it were, Raworth’s beloved design would be pointless. What’s more, history has given us plenty of examples showing the danger of designing economic systems without understanding at least a bit of human behaviour and their interactions with institutions and each other.

This problem is pervasive in many of her recommendations. Companies should be generous, Raworth argues, giving back to the living systems on which they depend. That is a laudable goal, but those companies still have employees, and their families, with stomachs to fill. Yes, I complained in an earlier post that economists’ motto “get the prices right” treats people like incentive robots, but you can also understand this motto as making sure that companies that respect environmental boundaries at least do not go bankrupt for doing so. The same can be said for her recommendations on the cyclical economy: if recycling does not pay, markets have a way of weeding out companies that ‘overdo’ it unless governments fix the prices that companies face. Ditto for what she says about finance. The root of the problem is that the environment is a shared resource, so that individuals who cause pollution share the costs with all other users while reaping all the benefits for themselves.

There is a caveat here, however, and I wish Raworth would have considered it more closely. I just said that I don’t think people are the incentive robots that some economists seem to think they are. People are driven by considerations of morals and social norms as much as by cold economic incentives. If they weren’t there would be a lot more litter on the streets than there is already – luckily a lot of people still have the decency to use a waste bin. It’s just that under some circumstances, the economic incentives win. I don’t know whether this has been tested in the field much (this may be such a study), but it seems natural to expect that competition is a big factor here. Especially under very fierce competition, as in financial markets, companies will have limited room to act morally, and prices reign supreme. Does that mean that a little monopoly allows company owners the slack to follow their moral instincts? That would be one of those questions we would need to answer before we start designing any economic system.

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Doughnut Economics (6): Be explicit about distributive justice

The fifth of Kate Raworth’s “Seven Ways to Think Like a 21-st Century Economist” is to forget the idea that economies must become highly unequal before they can truly spread wealth, and to start designing ways to spread that wealth now.

The central theme of the chapter is what economists call the Kuznets curve. Economist Simon Kuznets found a pattern in macroeconomic data that suggested that as they grow, many economies go through a phase where inequality rises only to fall later on. Raworth criticizes how the concept has been interpreted and used by economists.

I am no macroeconomist, and therefore I’m not overly familiar with this topic, but I have always understood that to Simon Kuznets (a statistician as well as an economist), this pattern he found was no more than that: a pattern in the data for which an explanation was needed. According to Raworth, however, economists have taken the Kuznets curve to be more than a pattern: rather, they turned it into an economic law of nature as well as a policy prescription. I would not go that far. The sheer volume of literature on the Kuznets curve suggests that many economists are trying to identify the mechanisms behind this pattern, rather than treat it as a law unto itself. She especially overstates her case when she suggests that belief in some sort of Kuznets law inspired institutions such as the IMF to impose austerity upon debt-ridden countries such as Greece and Argentina. In order for these countries to grow, the IMF is said to believe, this ‘Kuznets law’ demands that they must first go through some magical cleansing procedure that involves much economic pain and inequality. As far as I’ve understood it (but I admit I’m going out on a limb here), the austerity measures recommended to, or imposed on, Greece and Argentina were necessary to pay off these countries’ mountains of debt. And yes, paying off such amounts of debt means going through the pain of repaying it before you’re free of it. That has little to do with Kuznetsian magic, but everything with accounting.

Distribution, equality, income

Raworth’s recommendations in this chapter are a mix of fairly classical redistribution policies (land taxes, for example) and a few more radical ideas, the latter of which I find unconvincing. Complementary currencies have been around for some 20-30 years and although they may have been helpful for some communities, I don’t see how they would transform our current monetary system for the better. As far as blockchain currencies such as Bitcoin have not been overhyped, they have in any case proven a boon for tax evaders, ransomware-designers, and other cybercriminals.

Neither do I share her expectations from open source as a viable alternative for intellectual property rights. Open source works very well for software, which is easy to distribute and has a host of tech-savvy users who are willing to develop and share an extension that they happen to find useful. However, you cannot expect the same model to work for innovations that require much heavier and riskier investments in research and testing, such as pharmaceuticals.

A more general concern, however, is that she may be making the same mistake as the economists that she criticizes: oversimplifying distributional concerns. First, we should not conflate inequality and poverty. An unequal society is not necessarily poor in the absolute sense: it could be that everybody earns enough to make a decent living and a few people are very, very rich. Likewise, a society can be very equal and poor at the same time. These issues are more complicated than simply about redistribution of income. Would you rather be poor amongst other poor people, or earn a modest living while everybody around you is very rich? And is income all that matters in this regard, or do other considerations matter at least as much, such as access to healthy food and clean water, the ability to take part in society, or the freedom to make your own decisions? The literature on economic justice provides many sensible and interesting ways of looking at these questions. I have been reading a lot lately on the capability approach, which emphasises the agency that people have over their own lives. I find it an appealing approach to economic justice. But, admittedly, our economics education pays too little attention to the wide variety of ideas and philosophies of economic justice. Besides utilitarianism (maximise the total amount of happiness in society) we should also introduce students to the ideas of thinkers such as John Rawls, Robert Nozick, Amartya Sen, and Martha Nussbaum.

Oh, and I take issue with the word “design” in the title, but that is better addressed in the next blog post.

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Bumfights transactions

In 2002 a Las Vegas film maker came up with a hideous business model: pay homeless people a few dollars or a six pack of beer to conduct dangerous stunts, or to engage in fistfights with other homeless people, and film them. The movies, marketed under the insensitive brand name Bumfights, caused a storm of criticism, especially from advocacy organisations for homeless people, who argued the movies legitimized violence against homeless people, and were demeaning and dehumanizing to the people who participated.

The film makers responded that all homeless featured in the movies participated voluntarily. Surely they can make their own decisions? To which a professor responded

“Even if the homeless aren’t forced to perform, it’s inaccurate to describe people without adequate shelter, food or clothing as having choices.”

I hear the same argument in debates on international trade, Payments for Environmental Services, and other transactions between highly unequal parties: once an African lady reacted angrily to the concept of REDD+, arguing “it’s not a free choice!” I believe it points towards a moral flaw in economic theory that many of my colleagues either do not see, do not want to see, or just don’t care about. I call these transactions Bumfights transactions, after the movie series.

Forgive me for getting a bit theoretical here. Consider Rufus, the homeless man who featured prominently in Bumfights. Back then, Rufus had no home, no job, and he lived by what little he could earn by collecting empty cans. Let’s call the situation he lived in A. Say the film maker offered Rufus $5 if he would ride a shopping cart down a flight of steps. In other words, the film maker offered Rufus a new situation B, which you could define as A + $5 + S, where S is the humiliation and risk of serious injury that goes with the stunt. If Rufus preferred B to A (AB in mathematical notation), he would participate in the movie; if AB he would not. Obviously the film maker preferred AB: for only $5 he would have a lot of fun filming Rufus putting his life at risk, and he would make a big buck selling the video. So they could move from A (no transaction) to B (after the transaction), which they both preferred to A. What’s not to like? In economic terms this is called a Pareto improvement: a change that makes at least one person better off, and none worse off.

The objection to this logic is that Rufus “had no choice”, but an economist would point out that he did: he could choose to refuse participation and stick with collecting cans for a living. No matter how bad this situation was (I surely don’t envy him), obviously participating in Bumfights was better than not participating: after all, he participated, right? Not offering the choice would have left him in A, which is worse than B. The problem is not the transaction; the problem is poverty.

The flaw in this logic is that this may work in the sterile, utilitarian world of microeconomics, but in the real world the film maker also had a choice. He could have paid Rufus $100; he could have offered orange juice instead of alcohol (offering alcohol to somebody with a drinking problem is particularly nasty); he could have refrained from the transaction altogether and donate his $5 to the Salvation Army.

Another issue is that this line of reasoning only works if you care only about the consequences of an act: in other words, it follows a consequentialist ethic, where one could also follow a deontological ethic, or a virtues ethic. Many people consider making money in this way unethical, regardless of the consequences, just for its abusive nature.

Collecting up to 80 kg of sulphur in
a cloud of toxic volcanic fumes and
carrying it down the slope of
Mount Ijen, East Java: hey, it beats
starving to death!

Nevertheless, the line between an “equitable” transaction and a Bumfights transaction is blurry. To take the example of REDD+ again, many developing countries have come round to this idea, after initial opposition; it seems Costa Rica and Indonesia are quite keen on it. And how many people have jobs that are dangerous, or just mind-numbingly boring, just because the only alternative is starvation?

So next time you buy your clothes in a cheap clothes store, ask yourself: am I helping a poor Bangladeshi earn an income or am I taking advantage of his poverty? The question is more difficult than you might think.

Why economists argue with ecologists (6): Can we price nature?

Can we express nature’s value in currency, such as dollars, euros, or yuan? I usually get one of the following three replies to this question.

The first is the hardcore ecologist:
“Most certainly not. Nature has a value in itself. Pricing nature is disrespectful to nature; it violates nature’s intrinsic value; it’s cynical and perhaps even blasphemous. Can’t we just enjoy something without putting a price tag on it? Why does everything have to be expressed in money?”

The second is the hardcore economist:
“Well, duh. People have preferences. Do you prefer an apple or an orange? Do you prefer a highway or a forest? From preference orderings we can derive the amount of compensation people would need for building that highway. So of course we can price nature. We do it every time we make a choice between nature and something else.”

The third is the pragmatic ecologist:
“I don’t like it, but if we don’t do it policy makers won’t listen to us. Economists rule the world, so to promote nature conservation we need to speak the language of economists, and that is money. So I’ll just hold my nose and price nature. But I will also remind people that the price tag does not mean that nature can be substituted for something else.”

Believe it or not, but my view is closer to the hardcore ecologist than any of the other two. So what am I doing teaching monetary valuation of the environment next June?

When we do monetary valuation of, say, a coral reef, we don’t value a coral reef. Does my wage say how much I am worth as a human being? (Boy, am I glad I never pursued that career in Dutch folk music.) No, at best it gives an indication of the value of the skills and expertise I am offering in the labor market as a teacher and researcher. Likewise, coral reef valuation aims to estimate the economic value of the goods and services provided by a coral reef, like diving tourism, coastal protection, or nursing juvenile fish. By “economic value” I mean how badly we want or need those goods and services, and how easy it would be to get them elsewhere if the coral reef disappears. That tension between how badly we want something and how easily we can get it is also called relative scarcity. Water is not scarce in The Netherlands, even though it is an essential resource. The fact that it is so easy to get makes that it has a very low market price. On the other hand, diamonds are hugely expensive, not because we need them so badly but because they are so difficult to come by. You rarely see newspaper headlines about the scarcity of people, but there is common mention of scarcity of skills or labor. The last time we put price tags on humans was during the shameful era of the slave trade. Likewise, monetary valuation does not, and should not, even pretend to price nature as such.

This view puts me at odds with the hardcore economist who argues that ethics can be fit in preference orderings and compensated for. I don’t agree with this line of reasoning. It would imply that one person can block a policy if he finds it absolutely unacceptable – after all, he would require an infinite amount of compensation in order to be left “as well off” as without the policy. In practice we would call him a protest bidder and remove his data point from our analysis. Another problem is that this line of reasoning assumes that moral objections are purely individual. Moral considerations, however, typically pretend to hold for everybody. If I think eating meat is wrong, I can allow you to order a hamburger while still condemning it. If it were a purely individual preference, for instance if I would have no quarrels with eating meat but I simply don’t like hamburgers, I would have no reason to condemn your ordering of a hamburger. So when we talk about the intrinsic value of a coral reef or a species, we have no other option but to debate it with others. The outcome of that debate may be that the majority dismisses the idea of an intrinsic value of a coral reef. But at least the argument would have its proper place in the political process, which it would not have if we tried to express it in a monetary value.

It also puts me at odds with the pragmatic ecologist. First, I find his line of reasoning insincere. If you think coral reefs are unique, unsubstitutable, and should be preserved for their own worth, just say so and don’t start using economic value as an argument of convenience. Second, economic value implies substitutability, period. If I compensate you for the loss of an environmental asset, I substitute the environmental asset by something that makes you just as well off as with the asset. So I have substituted the asset by something of similar value to you. If I cannot substitute the asset by all the wealth in the universe, then its value must be infinite: hence Michael Toman‘s characterization of Costanza’s $33 trillion paper as “a serious underestimate of infinity”. Third, valuation should be done sincerely, and with the prime goal to make sure that all relevant information is available for public decisions. If you blur the line between moral considerations and purely economic ones, you will be tempted to overstate the economic arguments because the moral ones didn’t work.

The bottom line is that when you do economic valuation, you need to define very precisely what it is you are measuring, and whether the methods you use answer the question you ask. I am deeply skeptical of measuring such notions as existence value (an economic value derived from no more than knowing something exists), because I doubt whether people understand the concept, and whether we will ever be able to distinguish it from moral considerations. But perhaps that is what the role of economists should be in this issue: to properly phrase the question, to explicitly lay out the arguments and considerations, and to quantify those considerations that can be quantified.