Design For A Sustainable Economics

Economic thinking is dangerously outmoded, but an emerging new
framework could become the design guide for the 21st century

One of the articles in Dancing Toward The Future (IC#32)
Originally published in Summer 1992 on page 52
Copyright (c)1992, 1996 by Context Institute

Many of the articles in this issue have referred to the need to change the way we approach economics and economic issues. That’s a nice general thought, but is it really possible to go from this recognition of the need to a practical program?

The good news is that not only is it possible, but many of the models needed to demonstrate a more sustainable approach to economic life have existed for years. At a conceptual level as well, the pieces for a practical and positive alternative to conventional economics are falling into place.

In this article I sketch out the key features of a sustainable economics. Accompanying the article are descriptions of two models that illustrate what some of the new institutions might be like.

ECONOMICS IN CRISIS

There have always been critics of the conventional, marketplace approach to economics started by Adam Smith. Yet for more than 200 years it seems to have worked – with some modifications and additions – remarkably well. In the last two decades, however, it has become less and less effective – to the point where economists speak of their profession being in profound crisis.

I see a parallel to this with the crisis in physics that occurred at the beginning of the 20th century. Physics was then completely dominated by the tradition started by Sir Isaac Newton – a tradition that had been brilliantly successful in explaining most of the recognized physical phenomena of the time. However, as physicists began to probe into atoms, Newtonian physics just didn’t work for the new experimental results. Out of that crisis came the recognition that the Newtonian view of the world was too simple, and the scope of physics needed to be expanded to include non-Newtonian theories of quantum mechanics and relativity. Within this expanded worldview, the rules of Newtonian physics now are seen as special cases that apply only under certain limited conditions.

I think that economics is now, relative to its own crisis, where physics was in the first decade of this century: The failure of the theory is growing more acute all the time, but the profession is still dominated by those who are steeped in the old approach. A new approach is gaining strength and supporters, but it is still a few years away from full recognition as the legitimate successor.

What is this new approach that may be on its way to becoming the "new economics"? I will call my interpretation of it here "sustainable economics," although, as you might expect during a time of conceptual ferment, there are many variations on the new approach and many names used for them, such as green, holistic, ecological and real-life economics.

To understand what sustainable economics is, and why it would be superior to conventional economics, we need to start with a brief recap of conventional economics. I’ll need to go through a number of definitions and distinctions, but this is far more than an academic exercise. The conventional economics concepts I’ll be describing provide the basis on which those in power all over the world(which to some degree includes most of us in the rich industrialized countries) justify the destruction of the Earth. It would be hard to find a more pervasive, pernicious and powerful evil than the seemingly innocent concepts that currently rule our economics lives. Let me be more precise, for it is not so much the concepts on their own – they have served an historically useful role. The real evil is the continued dominant use of these concepts long after they have become seriously outdated and destructive. This is indeed the belly of the beast, and until we can replace these concepts with a more Earth-friendly approach, our prospects are grim.

THE CONVENTIONAL PICTURE

So let’s plunge in, with the aid of the following diagram:

The top diagram gives the conventional picture (used across the board by capitalists, socialists and communists alike) of the major factors involved in economic activity. It begins with the three "factors of production": land, labor, and manufactured capital.

Land was initially included in recognition of the importance of agriculture, but as industrialization progressed it has been broadened to represent all raw materials, like minerals and timber.

Labor covers all direct human inputs into economic activity, although in practice it has been treated largely as a simple head-count – e.g., how big is the "labor-force" or how many unemployed.

Manufactured Capital refers to buildings, tools, and equipment.

The oval labeled Economic Activity stands for the process by which Labor, with the aid of Manufactured Capital, converts Land (as raw materials) into Goods & Services.

Some of these Goods & Services need to be Invested back into the factors of production to either maintain or improve them. Whatever is left over can then be Consumed to produce Utility or Welfare for individuals and households.

At first glance, this picture seems fairly reasonable. After all, it would not have survived as the dominant view of economics if it was totally absurd. Yet it misses many important facets of real economic life, and distorts even those it does include. It will help, in understanding these deficiencies, to compare it to the lower diagram.

THE FIVE FORMS OF WEALTH

This lower diagram is intended as a more realistic model of economic activity. It begins by expanding the three factors of production into five reservoirs of wealth. The concept of the first four I have taken from Ekins. The fifth I’ve added for completeness in this diagram. In keeping with normal economic terminology, they are all called "capital" but that does not mean that they are thereby reduced to commodities to be bought and sold. But I’m getting ahead of my story; let’s look more closely at each of these forms of capital:

Environmental Capital (EC) expands beyond the idea of Land to include all natural systems, such as the atmosphere, biological systems, and even the sun. In recognition that these natural systems are more than just inert "resources" the diagram includes Natural Systems Activity, whose functioning depends on the quality of Environmental Capital and whose results impact, for good or ill, Environmental, Human, and Manufactured Capital, as well as directly on Human Activity. For example, sulfur dioxide released into the atmosphere becomes part of EC. The Natural System Activity of precipitation converts this sulfur dioxide into acid rain, acid rain then adversely impacts lakes and forests (EC), respiratory health (HC), and buildings (MC), among other things. In a similar way, the natural activity of the sun produces both positive and negative impacts on EC, HC, and MC.

Another aspect of the dynamic character of natural systems is that EC can be self-maintaining and even self-building. Powered by the sun, EC can be a long-term, continual source of enormous human benefit. EC is not locked into a zero-sum game.

One of the gross simplifications of the conventional picture is the idea of free substitution between capitals, i.e., it really doesn’t matter if one of the three factors of production is depleted as long as another, of equal or greater price, is built up in the process. The absurdity of this becomes clear when the notion of Land is expanded to Environmental Capital. Much of the real wealth in EC, such as the ozone layer or complex ecosystems like tropical rainforests, simply can’t be replaced by other forms of capital. As we will see with the other four capitals as well, there is some room for tradeoffs between them, but each is sufficiently unique and vital that there are strong limits to substitution between them.

Human Capital (HC) expands beyond Labor to include quality as well as quantity. According to Ekins "Human Capital has three components: health, knowledge and skills, and motivation." These three components behave differently than material forms of wealth. First, within an optimal range, all three of these are enhanced by use rather than worn down.

Second, they all obey an economy of multiplication rather than an economy of scarcity. That is, if I have a skill that I teach to you, I don’t thereby lose that skill, indeed my skill probably improves in the process. Similarly, if I am healthy, that benefits, rather than taking away from, your health, and if I am motivated, that will likely enhance the motivation of those around me. The limiting factors for HC are not interpersonal competition over the scarce resources of health, knowledge or motivation, but rather they are limits imposed by time and, in many parts of the world, competition over food, clean water, and other material supports for HC.

Social and Organizational Capital (SOC) recognizes a major form of wealth that is ignored in the conventional diagram. It includes all of the interpersonal "software" that enables societies and organizations to function: habits, norms, roles, traditions, regulations, policies, etc. – in other words, the non-physical part of culture. SOC is different from HC in that HC is attached to a particular individual (you can walk out the door with it) while SOC is transpersonal, and can remain with an organization even though the individuals who comprise that organization keep coming and going. On a broader scale, it includes law, government, the feeling of community, the dynamics within families, as well as all art and knowledge that have become part of the culture.

Like the quality, or "software," aspects of HC, SOC is generally enhanced by use and is not generally diminished by sharing. There are certain forms of knowledge whose commercial value is enhanced by keeping it scarce or difficult to come by, but that is different from the question of its overall value within the system. There are also many forms of SOC, like language, that increase in value for each individual as they are shared with more individuals.

Manufactured Capital (MC) includes, as in the conventional picture, buildings, tools, and equipment. In this picture, however, the idea of MC is broadened in two ways. First, the conventional practice is usually to count as MC only equipment, etc., used by businesses. Thus a stove in a restaurant is a tax-deductible business asset, while a stove in a home is a "consumer durable," not counted as capital. In the new approach, the assets of a households are treated on the same footing as the assets of businesses or other organizations. Second, MC in the lower diagram includes anything physical that has been manufactured and has not been returned to the environment, so it includes all kinds of supplies and material as well.

MC is the classic form of capital, and so it is the source of many of the conventional ideas about capital. Some of these are that each object of MC can be used in only one place at one time (it obeys a zero-sum economy of scarcity), and MC always deteriorates, generally faster with use. As a system, however, even MC has some of the self-reproducing qualities of EC and HC. After all, it takes factories to make factories, so in practice MC tends to grow exponentially, just like human population, if not limited by other factors.

The major limitations on MC are EC, at both ends of life. That is, at the start of the life cycle of a manufactured object, EC can provide only a limited supply of non-renewable raw materials, such as copper or oil, and can sustainably supply only a limited flow of renewable materials, such as wood. At the other end of the life cycle, as the object returns to the environment as waste, natural systems are limited in their ability to assimilate this output from MC, both in terms of the quantity and the quality of the waste.

It is crucial, in understanding the role of MC, to notice that the ultimate value in MC lies in its use, not its production or disposal, and yet frequently its use is the part of its lifecycle with the least adverse environmental impact. Thus everything that can be done to prolong the span of use between the initial extraction of raw materials from EC and the eventual disposal back to EC, such as long-life designs, easy repair, and good recycling, will enormously enhance the net value of MC within the context of all five forms of wealth.

Credit Capital (CC) is another reservoir of wealth not included on the conventional diagram, nor in Ekins’ work. It is defined here as a reservoir of credits and promises, so it includes money and debt, but not stocks or deeds, which are ownership rights tied to other forms of capital. Of course conventional economics is well aware of CC, but CC was left off of the upper diagram because that diagram began its history describing only physical flows. Only later did "Goods" become "Goods & Services." The lower diagram includes both physical (e.g., MC) and non-physical (e.g., SOC) quantities, so there is no reason to exclude CC – and it certainly is an important aspect of real economic life! CC could be considered as a special case of SOC (just as MC could be considered as a special case of EC), but it is so important for economic understanding that it has been broken out as a separate capital.

Like each of the other capitals, CC has its own unique characteristics. It makes a vital contribution to economic functioning for two reasons: First, the lifecycle of humans (and many businesses too) is such that we need to invest when we are young (in such things as education and housing), we can produce more than we need to consume when we are middle-aged, and we often need to consume more than we can produce when we are old. Thus we need a mechanism to allow us to spread the concentrated productive capability of our middle years to enable investment and consumption throughout life. Second, many goods and services can deliver more value than they cost, both for households and for businesses. Borrowing allows tapping that value to repay the loan and still have a net surplus of value left over.

Of course, that is not how borrowing always works. If the money is spent on items that do not return a net surplus, then the future is burdened with repaying the extravagance of the present. Another difficulty with CC is that it usually functions as a means to transfer wealth to the wealthiest members of society from everyone else (see sidebar). Thus the real value of CC to the society as a whole depends on how it is used and whom it benefits, as well as how much there is.

ACTIVITY

As in the upper diagram, these five capitals are blended together, in various proportions, in support of some Human Activity. A new addition, however, is the explicit recognition of Time as a limited resource that must be allocated among various alternative activities.

Another change is that the notion of "economic activity" has been broadened here to any human activity. Does this mean that everything is being reduced to economics? Hardly. Rather, it is the recognition that every human activity has impacts on quality of life, on how we allocate our time, and on the five capitals. Thus every human activity has an economic dimension, and we can not expect to get a realistic picture of economic life if we begin by categorically excluding any aspect of life.

There are two flows that emerge out of Human Activity. One of these may seem superficially like the Goods & Services in the upper diagram, but the content of the flow and the structure of the diagrams are significantly different. First for content: the notion of Goods & Services (i.e. only intended results) is broadened in the lower diagram to recognize that wastes and disservices are also a part of economic reality, whether we like it or not. In addition, transfers are added to cover changes in CC and certain exchanges among the other capitals.

These Goods, Wastes, Services, Disservices, & Transfers all flow back to the five capitals. No longer is the stream broken into two parts labeled Investment and Consumption with only Investment flowing back. This is a major change in the structure of the diagram, and it is done for the following reasons.

The notions of Investment and Consumption as used in the upper diagram are much too simplistic. For example, the upper diagram has no way of acknowledging that consumption (as in the use of energy and materials) goes on as part of the manufacture of goods.

The lower diagram replaces these notions with the more complex, and more realistic, notions of inputs and outputs from the various capitals. In this picture, Investment and Consumption are not distinct categories, but can be different aspects of the same activity. Consider eating. Let’s assume that the food is classified as EC (although some foods are more accurately MC). The most obvious aspect of eating is the consumption of this food (output from EC) as an investment in health and motivation (input to HC). In addition, if the eating is done in a building, at a table, using dishes and silverware, these forms of MC will support the activity (output from MC) and may undergo some wear and tear (output from MC, input to EC). The peace and quiet (or lack thereof) surrounding the meal will be greatly influenced by various social norms (output from SOC), and the interaction during the meal may affect the interpersonal relationships of those present (input to SOC). Air quality (output from EC) will also affect the quality of the experience. On top of all this, there may be some transfers of money (CC) involved. Now tell me, was that meal an investment or was it consumption?

Notice that not all outputs result in consumption (e.g., using social norms doesn’t "consume" them; on the contrary, using them usually strengthens them). Nor can all inputs be classed as investment (e.g. toxic wastes input to EC are at best a negative investment).

QUALITY OF LIFE

At the heart of the lower diagram is an oval labeled Human Quality of Life (QOL). There is a superficial correspondence between Utility/Welfare in the upper diagram and QOL in the lower, but, as with Activity, the meaning of the concepts and the structure of the diagrams around these elements are significantly different.

In both diagrams, these elements serve as the "goals" for activity. That is, the assumption in the upper diagram is that people want to maximize their Welfare. The parallel assumption in the lower diagram is that people want to maximize their Quality of Life.

As usual, the conventional concept is simple – too simple. Welfare is assumed to be achieved by the indiscriminate satisfying of any and all human wants, expressed in terms of the price paid for the goods or services, which, according to the diagram, are the only contributors to welfare. Thus $1 million spent on a private yacht is assumed to generate as much welfare as the same amount spent on pre-natal care for thousands of children.

The new approach recognizes that price is not the true measure of value in supporting QOL. There are many aspects of this distinction between price and value; let me describe two here. First, even if the marketplace functioned perfectly in conventional terms, "voting" in the marketplace (which sets prices) is on the basis of one-dollar, one-vote (biased toward the wealthy), whereas QOL, based on human experience, needs values allocated on a one-person, one-vote basis. Second, as the pre-natal care example illustrates, unborn children (as well as the natural environment) have no direct voice in setting today’s prices, even when they bear the brunt of today’s price-based decisions.

Developing a better measure of value require a deeper understanding of what contributes to quality of life. One particularly illuminating approach has been developed by Manfred Max-Neef, based on his experience with community development in Latin America (see sidebar on Ekins’ books on page 55). He begins by creating a matrix of universal human needs and modes of experience, and then looks at the many culturally dependent ways in which we humans attempt to satisfy these needs. (Being refers to attributes, such as health, self-esteem, passion, etc., most of which would be aspects of HC; Having covers physical objects plus institutions, i.e., MC plus some SOC and EC; Doing refers to actions, i.e. Human Activity; and Interacting refers to locations and milieus, i.e., the context aspects of MC, SOC, and EC). His matrix (without the "satisfiers" filled in) looks like this:


          Modes Of Experience
   Universal Needs  Being  Having  Doing  Interacting
   Subsistence        
   Protection        
   Affection        
   Understanding        
   Participation        
   Recreation        
   Creation        
   Identity        
   Freedom        

The matrix can be used, for example by a community group, by filling it in with various ways that each need is being or could be met.

Of course, not all supposed satisfiers are equally effective or beneficial. Indeed, one of the great strengths of this tool is that it allows those who use it to compare alternative satisfiers to see which ones 1) are most effective in what they intend, and 2) impact other needs, positively or negatively.

This matrix connects back to QOL in that each of these nine needs must be adequately met in order for a person to have an adequate quality of life. Another important aspect of many of these needs, like the needs for food and rest as part of Subsistence, is that, while they are on-going, they are not infinite. Other, more unbounded needs, like Understanding or Creation, are limited ultimately by available time. In either case, they are not best satisfied by attempting to consume ever increasing qualities of goods and services.

Contrast this rich description of the factors contributing to QOL with the upper diagram where Utility/Welfare is contributed to only by Consumption. In other words, the only way this picture allows humans to increase their welfare is through destroying the subsequent usefulness of various goods and services (i.e. consuming them), and what’s more, the degree of welfare is in direct proportion to the rate of destruction. I know that sounds silly, but believe it or not, this diagram – complete with its assumptions about consumption and welfare – forms the conceptual basis on which essentially all major economic and economically-related political decisions are made (or at least justified) all over the world. It is on this basis that politicians proclaim their conviction that "economic growth" (i.e. increases in the production of goods and services) is the key to increasing human welfare.

The structure of the lower diagram is very different, as are its implications. In this diagram, every human activity has an experience associated with it that the experiencers will assess as contributing to or detracting from their quality of life, whether that activity is primarily productive, consumptive, or neither. Even when the activity is in some sense consumptive (as with the case of eating), the positiveness of the experience is affected by many factors, not just quantity of consumption.

Furthermore, Utility/Welfare is a dangling dead end, while QOL is an integrated part of the system. The experienced level of QOL affects motivation (thus the link to HC) and it affects the amount of Allocated Time devoted to this activity.

The conventional economist may well object at this point that, "All this talk about QOL sounds nice, but unless there is an objective way to measure QOL, it is useless." There are two responses to this. At a fundamental level, we need to see these alternative conceptual approaches in historical perspective. Conventional economics was developed at a time when the model for conceptual systems was Newtonian physics – simple, linear chains of cause and effect that could be modelled with numerical precision. Today, we understand that most of life – from biological systems, to climate, to social systems -doesn’t fit the Newtonian model. The leading edge of theory now has to do with complex, highly interactive, highly non-linear systems for which numerical precision is not possible. Nevertheless, simply determining a good set of components connected by the appropriate feedback loops to represent these complex systems can lead to great insight and useful results. The old rule used to be, "If you can’t measure it, don’t include it." Today’s rule is, "Include elements on the basis of their likely significance, not their measurability."

Having said that, the second response is that in fact there is a great deal that can be objectively measured as to how well Max-Neef’s set of needs are being met, and thus the adequacy of QOL. Not necessarily with Newtonian precision, but with enough statistical accuracy to be useful.

PERSONAL APPLICATION

To ground these concepts, let’s look at how they can be used at a personal level. Think of the major activities of your day. They could likely be put into categories such as self-care (sleeping, eating, bathing, etc.), paid work (including commuting and other associated activities), household activities, recreation, shopping, and so on. Each one of these activities 1) takes time, 2) draws on the five capitals, 3) has impacts back on the five capitals, and 4) affects your experienced QOL.

Let’s assume that your goal is to maximize your on-going QOL, while also minimizing any adverse impacts on any of the five capitals. Achieving this goal (or even coming close!) requires a complicated balancing act.

The lower diagram can reflect this while the upper one can’t. Consider, for example, the time you spend on paid work. According to the lower diagram, it would be "rational" for you to choose a job that

  • provided direct job satisfaction (input to QOL)
  • placed you in a healthy environment with clean air and water (output from EC, input to HC)
  • didn’t depend on non-renewable resources or unsustainable use of renewables (draining output from EC)
  • minimized pollution and other negative inputs to EC
  • gave you opportunities to learn (input to HC)
  • had a low level of stress and other hazards to your health (avoiding negative inputs to HC)
  • had a sufficiently orderly social structure so that you could efficiently focus on your own task (output from SOC)
  • enabled you to participate in shaping the organizational routines and culture (input to SOC)
  • provided you with good tools in a pleasing and efficient building (output from MC)
  • paid you enough to cover your expenses in the rest of your life (CC).

The lower diagram says that all these things (and more) need to be taken into consideration as you pursue your goal. The upper diagram takes a much simpler approach: the only purpose of having a job is to earn money so that you can consume goods and services when you are not on the job. From the conventional point of view it is not "rational" to consider anything other than the amount you are paid. From the new point of view it is not rational to consider only what you are paid. Which approach seems more realistic to you? Which approach is reflected in the great bulk of our laws, institutions and cultural assumptions?

We can take this comparison even further. In the model represented by the lower diagram, it would be perfectly rational for people to reduce their need for income by living as efficiently as possible within their household, and then to use this reduction to allow them to work under conditions that provided more direct QOL and/or required less time in paid work. Furthermore, it would be perfectly rational for a society as a whole to facilitate all of its members to do this, developing new social and economic institutions if necessary. The net result would be an increase in per capita QOL accompanied by a decrease in the production of goods and services (which is measured by the Gross National Product).

Such a decoupling of QOL and GNP is impossible in the conventional view. As you can see from the diagram, maximizing Utility/Welfare implies maximizing Consumption, which implies maximizing the production of Goods & Services – there is no other way.

THE ROAD AHEAD

This is just one example of the profoundly different conclusions that follow from these two views of economic reality. We need to do more, however, than just explore these concepts in principle. To put them into practice will require, as best as I can tell, more movement in three main areas:

Indicators – If we are to give full and equal importance to each of the five capitals, we need good measures, good indicators, for each. We need to be able to track the changes in both quantity and quality for each, and have ways to make comparisons between them. Much work has been and is being done around the world on developing such indicators, and this work needs now to accelerate. These indicators will give us a better way to keep score.

Rights and Responsibilities – A second part of giving proper importance to each of the five capitals is clarifying our legal relationships to them. The world has begun this process relative to its environmental commons, but from the perspective of sustainable economics, the whole range of "ownership rights" needs to be reassessed for each of the five capitals. This reassessment will give us a new framework within which to play the economic game.

Institutions – Finally, to actually play the economic game in a sustainable way, we need to create institutions consistent with this framework. I’ve offered the Mondragón Cooperative Group and the JAK banking system (see sidebars) as examples of the kinds of institutions we need to establish on a much broader scale. Fortunately, there are many other such examples. We have decades of good work to build on.

Let’s get on with it.



Real-Life Economics

I’ve drawn considerable inspiration for this article from two recent books authored and edited by Paul Ekins: Real-Life Economics: Understanding Wealth Creation (coedited with Manfred Max-Neef; NY: Routledge, July 1992) and The Gaia Atlas of Green Economics (with Mayer Hillman and Robert Hutchison, NY: Anchor Doubleday, February 1992). Both books cover the same general territory, but Real-Life Economics is addressed to a professional and academic audience while The Gaia Atlas of Green Economics is more popular in its presentation.

Paul Ekins, a Research Fellow at the Department of Economics, Birbeck College, University of London, is a co-founder of The Other Economic Summit (TOES). He is also Research Director for the Right Livelihood Award, and the founder of the Living Economy Network.

His two books draw very effectively on this background to present the best overview of green economics that I have seen anywhere. I highly recommend them.



Interest-Free Banking

Could a banking system work without charging interest to borrows and paying interest to depositors? A non-profit association in Sweden, known as JAK, has been doing it successfully for more than 20 years. When I first found out about them, I was rather skeptical, expecting that they did it through some kind of hidden subsidy, but as I’ve studied their system I’ve been delighted to find that, rather than some trick, they do it through a genuine social invention.

The heart of their invention is this: Rather than operating as a bridge between two classes – borrowers and lenders – JAK expects the borrowers and lenders to be the same people, but at different times in their lives. Thus JAK requires every borrower to save, over and above repaying their loan, as much and for as long as their loan.

If I borrow $10,000 for 10 years, JAK won’t charge me any interest (although they will charge me a modest fee), but, in addition to gradually repaying the $10,000, I must gradually save enough so that I have a positive balance of $10,000 at the end of the 10 years. I won’t get any interest on this savings, but I can withdraw it once I have fully paid off the loan.

My savings provides the funds which others can borrow, just as the interest-free savings of others permitted me to borrow. It is profitable for me to do this because the combined loan payments and required savings are still less than the normal loan payments plus interest of a regular bank, plus, I get all my savings back!

For more information, write to JAK, Ängsvägen 15, S-147 43 Tumba, SWEDEN.