V.

Economics - Categories Natural Resource, Ecological, Discounting, Substitution, Tradeoffs

A. Introduction
Economics is really about creating a universal set of rules that can be applied consistently across a subject matter. As noted in the introductory materials to this section in the text, economics is used in environmental policy to explain the potential and actual impacts of human actions on the earth house natural systems. To do this we need to accomplish a few goals: First, we need to have an understanding of the categories of economic theory that may be applied to environmental issues. Second, we need to understand how economics, as an instrument, helps to define value so that clear environmental policy goals can be derived from this definition. Finally, specific tools of economics total value accounting and benefit-cost analysis will be highlighted and explained as conceptual frameworks for evaluating environmental problems with the goal of developing meaningful policy directions.

Our job in this section of the materials is to focus on the nomenclature and categorization of economics that apply most clearly to environmental issues. Remember, our ultimate goal in environmental policy is determining what is best for the environment, and what actions (policy directions) are best capable of getting us to that goal. In both cases, we are using a term (best) that is normative, meaning the term is subject to interpretation; what I believe is best in terms of both the outcomes for the environment and the process of getting to those outcomes can vary from what you believe is best. Even if you and I agree on the definition of best for the outcome of the environment (the goal), we may not agree on the process (policy direction) to get to that goal. Understanding some basic economic principles can help guide us to a clearer understanding by helping us create more objective criteria for assessing what is best in terms of both environmental outcomes and the policy process for getting to those outcomes. Before we explore environmental economic principles in detail, I want to take a moment and highlight an important conceptual assumption about the environment in relation to economic activity. The assumption, replicated from the text, is visually presented here:

The assumption stated in the figure above suggests the environment constrains our economic capacity. What this means is that the environment acts as an outer limit for economic activity: economic activity cannot exceed this outer limit, whatever it might be.1 This is an important presumption because it influences the ways in which economics aids in our understanding of environmental problems; this point will be highlighted in greater detail below with the distinction between natural resource and ecological subdisciplines of economics. The figure also shows society as existing wholly within the confines of our environment (natural system). In addition, economic activity is shown bounded by our social institutions. This is important because it suggests that social choices help to define our economic choices. We will see how economic analysis is subject to social interpretations, for example how natural resource economics focuses mainly on natural resources as extractive inputs for human wellbeing, while ecological economics looks more to the
1

Thomas Malthus, Paul Ehrlich, and others (Limits to Growth study, etc.) have argued the environment is the upper-limit on economic capacity (through population limits, etc.). Others, like Economist Julian Simon, see economic principles such as substitution as a means of never reaching these outer limits, thus they discount the notion of the environment providing an outer limit simply because basic economic principles will favor substitutes before any such limits are reached. This difference in opinion highlights an important philosophical distinction in economic theory (particularly the presumptions about certain things) that will be discussed in greater length throughout this section of the course.

systems relationships in the natural system, determining the values created through those relationships and interactions within and among system components.

B. Nomenclature Values vs. Assets

As we explore different forms of economics applied to environmental issues, let us take a moment on one specific term and devise an accepted nomenclature for that term. As suggested in the text, I propose we use the term asset(s) in place of the term value(s) in much of this section so that we can properly differentiate the accounting aspects inherent in economic analysis. The main reason for the use of asset here is that the term value will have specific meaning in the following chapter of the main text. In addition, I think the term asset can help us think in accounting terms, allowing us to see how we are categorizing different environmental attributes in a way that highlights economic valuation as a technique that categorized aspects of environmental attributes, rather than a hard truth that is set in stone. In order to help us move in this direction, we can first decipher between positive and normative economics. These terms are defined in the text, and I would like to propose the following in terms of accounting for the two categories: Positive (objective) economics may refer to understanding the ways of valuing assets of the natural system.2 Normative (subjective) economics may refer to an understanding of the ways of ranking between assets when engaging in valuation techniques and, ultimately, making decisions (considering tradeoffs).3

Recall from our work on natural systems that the Earth is a natural system and the energy flows between components of that system can be measured. In addition, the scientific principles of equilibrium, closed system, and mass-energy equivalence allow us to see that energy flows between system components are finite. This means that we can account for the total assets of the Earth system because it exists in a closed steady state. For example, we can identify the value of the regulating services of a wetland as an asset of the system, and through measuring the services provided, come to some dollar valuation through economic techniques that then allow us to compare the value of the wetlands regulating services against some other defined value.
3

For example, positive economic instruments might allow us to determine the valuation of the regulating services of a wetland. Normative economics allows us to rank-order (prioritize) between the regulating service values of a wetland and other values, for example the use of that wetland area for other purposes such as aquaculture development. The normative aspects of economics helps us understand the bias that can exist in valuation techniques, for example whether we believe the well-being of humans existing today should take precedent over the well-being of future generations (humans that have yet to come into existence). We will see how this bias reflects itself in economic analysis

Positive economic principles will help us identify natural assets in as much objectivity as possible, while normative economic principles will help us place a relative ranking on different assets, and also help us understand the assumptions underlying certain rankings.

C. Two Types of Economic Approaches Resources vs. Systems

As noted in the text, there are two primary subfields of economics that are used in understanding environmental issues: Natural Resource Economics focuses on resources as things (inputs); what can we get out of what nature provides? This is very much an extractive way of looking at nature; nature provides certain assets that we extract from the environment and put to some human use. Ecological Economics focuses more on a systems approach. Rather than looking at natural resources as inputs (what can the wood fiber of a tree be used to make?), ecological economics take a systems approach and tries to understand what natural resources provide for humans. This certainly can include the extractive value of natural resources, but it also includes other considerations like the provisioning services provided by those resources (trees also serve a function in creating oxygen, carbon sequestration, soil stabilization, and other functions).

In order to understand the relative merits of natural resource and ecological economics, we can analyze the extent to which each subfield provides an understanding of natural systems and thus incorporates the various assets of those systems in their accounting process. The following table, copied from the text, helps us understand how each accounts for natural system attributes:

through the discussion of discounting. The policy implementation of this process is alternatives analysis through the consideration of tradeoffs.

We can see here that natural resource economics adheres to valuations of environmental assets based on market transactions. This means that natural resource values are identified in relation to what individuals are paying for the item. Commodity markets may be one clear example of natural resource valuation; the value placed on a resource like timber, oil, or gold is connected to the actual price being paid for the product on an open market. We generally refer to these kinds of valuations as direct values. Excluded from this valuation technique are valuations that consider system-based interactions, for example regulating services provided by natural resources (either individually or in combination with other natural system components). Ecological economics tends to expand its valuation methodology, looking beyond the prices being paid for environmental assets in open markets (direct values) to the other services provided by natural assets, and also to the ways in which humans derive value out of natural areas for non-consumptive reasons (like aesthetic and spiritual connections to natural resources). The way in which ecological economics expands its valuation of nature is by adopting a systems approach to understanding the relationships between natural systems and human wellbeing. This means identifying and (where possible) quantifying these relationships. For example, trees have additional values beyond their extractive use; trees provide carbon sequestration, oxygen, and soil stabilization as noted earlier. These are indirect values because they are not generally considered in market transactions (they are more process-orientated and less capable of division for consumptive purposes).4 In addition, trees can also have non-use values; giant sequoias
4

Consider that it is relatively easy to divide a tree into quantifiable units for sale in an open market (the wood product itself). However, it is difficult to divide and quantify the

provide an awe inspiring visual experience where people often express an intense aesthetic preference (spiritual experience) in their setting. This kind of value does not depend on the extraction of the tree or the kinds of regulating services provided by the tree; the value is personal to the user. Collectively ecological economics strives to incorporate these additional valuations into the quantification of natural system assets.

D. The Language of Economics

Three concepts are discussed in the text relevant in understanding economic principles related to environmental policy: discounting, substitution, and tradeoffs. All three are part of the language of economics that helps place environmental issues into a human context. Recall earlier in our studies that we identified two categories of information when discussing ecosystem-based management: objective (science-based) and subjective (human-based). The principles of discounting, substitution, and tradeoffs fall into our subjective categorization because they are economic principles that derive from humanbased presumptions. This is an important point to understand because each principle is heavily influenced by the assumptions that accompany the employment the principle. Thus, it is not enough to understand the principle itself, but one must also be aware of the assumptions being made when applying the principle as the assumptions will ultimately impact the analysis (more on this point later). Discounting means that we attribute less value to something over time. For example, if we value the immediate attainment of some good, we will discount the future value of that good in relationship to its value now: because we want the thing now, it means more to us now than at some future time. Discounting can also be seen as a means of lessening the true value, or costs, of a particular activity. The example in the text is of burning coal. Coal is burned to produce electricity and it is often seen as a cheap source of fuel for creating electricity because the market price of coal (what is paid) does not include the impacts burning coal has on our natural environment; the effects on our air, water, and climate are generally not internalized into the price of using coal at least not directly. Rather, those costs are externalized to the air, water, and climate. As suggested in the text, by using coal we discount the costs (negative externalities) to the environment.5 The concept of substitution draws in large part on the impact of applied science (technology) in our discussion of environmental policy. The concept behind substitution regulating services provided by trees; how exactly would one quantify and divide the carbon sequestration value of a single tree? Even if one could, where is the market where these values are identified and openly traded by humans?
5

Consider that natural resource economics would discount the environmental harms by not having them identified in the price of coal (looking solely at the direct value of the resource). Meanwhile ecological economics would identify the effect of using coal on the natural system to include the costs borne by the components of the natural system: the air, water, and climate.

is that there is more than one way to do something, or said another way, more than one thing can accomplish the same goal. The example in the text is the use of alternative means of producing electricity besides coal including wind, solar, hydro, geothermal, and others. Substitutions often work best when they are deemed superior under some established criteria (the dominant criteria in our current economic paradigm seems to be direct cost). Alternative sources of creating electricity are often considered costly in comparison to coal; coal has a very cheap marginal unit cost per output of energy. However, coal is deemed cheap because only the direct costs are considered. If the costs to the natural system (the negative externalities) of burning coal were included in the price of coal (as may be done in an ecological economics analysis), then the actual cost of coal may be deemed more expensive than some or all of the alternative ways of producing electricity (assuming the alternatives are not also being discounted by externalizing certain costs). Finally, the concept of tradeoffs (opportunity costs) incorporates the assumption that once a thing has been put to one use, it is not readily available to be put to another use. I use the example of time in the text; time spent in one way cannot be taken back and used in another way the particular unit of time is gone. In environmental policy planning, tradeoff discussions can be an important part of forecasting potential issues. One can envision committing resources in one way, and then think about committing those same resources in a different (alternative) way. One of the ways of evaluating between the alternative commitments of resources is to consider tradeoffs. Just what are the tradeoffs depends very much on where priorities are established. Priorities, in-turn, are very much derived from values. For example, those who value natural system integrity will tend to follow the kind of asset assessment explained under ecological economics. Those who favor immediate human wellbeing may tend to discount some of the natural resource values at-stake in a decision. Depending on how the question is framed, the examination of tradeoffs will tend to differ. As noted earlier, these three economic concepts help to derive information that, while constrained by rules of economic analysis, are human-induced and subject to value-laden influences. Probably the largest influences come from assumptions about priorities (what is most important). One question in environmental policy that tends to garner a lot of attention is what role, if any, should intergenerational considerations play in decisions made today? Said another way, how much influence should the consideration of future generations have on us when we make decisions about how we choose to interact with the environment today? You can imagine how this question becomes difficult when certain priorities today (say economic wellbeing of the current generation) may lead to policy directions that have the potential to negatively harm future generations. This is not an easy area to engage in policy discussions for a variety of reasons. However, what we can agree on is that these discussions are steeped in value-laden judgments. It is this focus on value that will help to define the remainder of the economic section of this course. END OF SECTION.