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Part 1. Facing the Climate Challenge: Fixing the Market
The market is a remarkable institution. It allocates scarce resources with an efficiency that no central planning body can match. It easily balances supply and demand and it sets prices. As noted earlier, however, it does have three fundamental weaknesses, namely its failure to incorporate the indirect costs of providing goods or services into prices, its inability to value nature’s services properly, and its lack of respect for the sustainable-yield thresholds of natural systems such as fisheries, forests, rangelands, and aquifers.
Throughout most of recorded history, there was little reason to be concerned about the sustainable yields of natural systems, the value of nature’s services, or the indirect costs of economic activity because they were rarely an issue. But with the 19-fold expansion in the world economy over the last century, the failure to address these market shortcomings will be costly. 33
As the global economy has expanded and as technology has evolved, the indirect costs of some goods and services have become far larger than the price fixed by the market. As noted earlier, the price of a gallon of gasoline includes the cost of production but not the expense of treating respiratory illnesses from breathing polluted air or the repair bill from acid rain damage. Nor does it cover the cost of rising global temperature, of more destructive storms, and of relocating future millions of rising-sea refugees. As the market is now organized, the motorist burning the gasoline does not bear the cost of rising sea level and the potential losses of ocean-front property, the evacuation of coastal cities, or the loss of the rice harvest from the inundation of low-lying river deltas and floodplains.
A recent study from the Centers for Disease Control and Prevention, a U.S. government agency, on the indirect costs of smoking cigarettes illustrates the kind of analysis needed for burning fossil fuels. The study reports that the market price of a pack of cigarettes, which includes the cost of growing the tobacco and processing it into cigarettes, is $2.80 in the United States. But the cost to society of smoking a pack of cigarettes, including both the medical costs of treating smoking-related illnesses and the cost of lost worker productivity as a result of absenteeism, is $7.18. The issue is not whether the additional $7.18 is paid—clearly it is paid by someone, either the smoker, the smoker’s employer, or taxpayers. The full cost of each pack of cigarettes smoked is thus $9.98. 34
If the indirect costs of burning a gallon of gasoline were incorporated into its price, would the $1.60 that Americans typically pay be $4, $6, or maybe $10 per gallon? Would the cost to society of burning a gallon of gasoline be more or less than the $7.18 from smoking a pack of cigarettes? Intelligent investment and purchasing decisions for society, whether by government policymakers, corporate planners, or individual consumers, depend on estimating these costs and incorporating them into the price of the gasoline. If the unlevied cost of using a product, such as cigarettes or gasoline, leads to extreme market distortions, it could eventually lead to economic bankruptcy.
Another market shortcoming is its failure to price properly the many services that nature provides, which are often taken for granted. Nature converts salt water from the oceans into fresh water through evaporation. It pollinates crops, recycles nutrients, and purifies water. The destruction of natural systems deprives society of these services—services with a value that society is only beginning to recognize.
New York City, with its population of nearly 17 million, recently discovered just how valuable nature’s water purification service is. Faced with the residential and industrial development of the Catskill forest region and the associated pollution of water in the watershed that is the source of New York’s water, the city was told it needed a water purification plant that would cost $8 billion to build and $300 million a year to operate. The bill for this would reach $11 billion over 10 years. City officials realized that they could restore the watershed to its natural condition for only $2 billion, and let nature purify the water, thus avoiding the need for the purification plant and saving taxpayers $9 billion. 35
The Chinese have learned the hard way the value of the flood control services provided by forests. During the summer of 1998, several weeks of some of the worst flooding on record in the Yangtze River basin wreaked enormous havoc. Direct damage caused by the flood totaled some $30 billion, according to Munich Re. Some 120 million people were directly affected by the flooding. Up until mid-August the Chinese government had been describing the catastrophe as an act of nature. But they finally recognized that deforestation, specifically the loss of 85 percent of the original forest cover in the Yangtze River basin, was a major contributor to the flooding. Once they understood this, they banned tree cutting in the basin. They justified the ban by noting that trees standing are worth three times as much as trees cut. Chinese leaders were acknowledging that the flood control value of the forests in the Yangtze River basin was worth three times as much as the lumber in the trees. The market values lumber in the trees, but not the flood control service provided by the forests. In addition to the ban on tree cutting, the government launched a tree planting program to restore the flood control service. 36
The $30 billion worth of damage from the Yangtze flood, plus the disruption it caused in the heavily industrialized Yangtze river basin, nearly derailed the Chinese economy. To put the loss in perspective, China is the world’s leading producer of both wheat and rice, but the $30 billion of flood damage exceeds the value of the annual wheat and rice harvests combined. It was the recognition in Beijing of the scale of the damage and disruption from the flooding that led to the abrupt shift in policy from tree cutting to tree planting. 37
The market’s lack of appreciation of the value of nature’s services is pervasive. In the two cases just cited, the governments of New York City and China made major policy changes once they recognized the value of nature’s services, values that were not reflected in the market. Will the world one day reach a similar judgment on the costs of climate change?
Another area in which the market is inept is in recognizing the sustainable-yield thresholds of natural systems. If an oceanic fishery’s catch increases over time in response to demand until it exceeds the fishery’s sustainable yield and stocks begin to decline, then fish prices will begin to rise. The market’s response to higher prices is to invest more in fishing trawlers, a response that ensures collapse of the fishery. Further exacerbating this problem are the subsidies that governments pay the fishing industries, which distort the market.
What some governments are realizing is that protecting an economy’s natural resource base depends on introducing the concept of sustainable yield into the market place. Australia, concerned in 1986 about the overfishing of its lobster fishery, estimated the sustainable yield of the fishery and then issued fishing permits totaling that amount. Fishers could then bid for the permits. In effect, the government decided how many lobsters could be taken each year on a sustainable basis and then let the market decide how much the permits were worth. Once the permit trading system was adopted, the fishery stabilized and has operated on a sustainable basis ever since. 38
A similar situation exists with aquifers. As the demand for water increases, the pumping eventually exceeds the sustainable yield of the aquifer and the water table starts to fall. The market simply says, “drill deeper.” But all this does is allow the use of water to continue to increase while the aquifer is being depleted. Once that happens, the rate of pumping is necessarily reduced to the rate of recharge. But if the level of use at this point is double the rate of recharge, which can easily be the case, then water use is abruptly cut in half. Needless to say, the adjustments to aquifer depletion can be abrupt and destabilizing.
Enlightened government policy could intervene by establishing the sustainable yield of the aquifer and auctioning off the rights to pump that amount of water. This lets the market allocate the water to the more high-valued uses, while stabilizing the water table.
There are two dimensions of overpumping that are of concern. One, once the rising level of water use exceeds the sustainable yield of the aquifer, the gap between that use and the sustainable yield widens each year until the aquifer is dry. This means that if countries delay until depletion occurs, they will face wrenching reductions in the use of water. Two, the overpumping of aquifers is proceeding simultaneously in literally scores of countries, which means that at some point in the not-too-distant future the world will face simultaneous “water shocks” as aquifer depletion forces abrupt and, in many cases, substantial reductions in water use.
Unless governments are prepared to intervene in the market to get prices to tell the ecological truth, to value nature’s services, and to respect the sustainable yields of natural systems, then the economy will eventually destroy its natural support systems. Thus far the ecological and economic consequences of market distortions in our modern civilization have been mostly local and manageable. But if they continue to increase, they will eventually become worldwide, setting the stage for global economic decline.
33. Output in 1900 from Angus Maddison, Monitoring the World Economy 1820–1992 (Paris: Organisation for Economic Co-operation and Development, 1995); recent growth from David Malin Roodman, “Economic Growth Falters,” in Worldwatch Institute, op. cit. note 20, pp. 58–59, and from International Monetary Fund (IMF), World Economic Outlook (Washington, DC: April 2002).
34. “Annual Smoking-Attributable Mortality, Years of Potential Life Lost, and Economic Costs—United States, 1995–1999,” Morbidity and Mortality Weekly Report, 12 April 2002.
35. Panos Institute, Economics Forever: Building Sustainability into Economic Policy, Panos Briefing No. 38 (London: March 2000).
36. “Flood Impact on Economy Limited,” China Daily, 1 September 1998; Rekenthaler, op. cit. note 9; economic losses and deaths from Munich Re, op. cit. note 9 ; removal of tree cover from Carmen Revenga et al., Watersheds of the World (Washington, DC: World Resources Institute and Worldwatch Institute, 1998); “Forestry Cuts Down on Logging,” China Daily, 26 May 1998; Eckholm, op. cit. note 9; Erik Eckholm, “China Admits Ecological Sins Played Role in Flood Disaster,” New York Times, 26 August 1998; Erik Eckholm, “Stunned by Floods, China Hastens Logging Curbs,” New York Times, 27 February 1998.
37. Damage from Munich Re, op. cit. note 9; economy from IMF, op. cit. note 33.
38. Australia in John Tierney, “A Tale of Two Fisheries,” New York Times Magazine, 27 August 2000.
Copyright © 2002 Earth Policy Institute