Navigating in the 21st Century: Where To?
When you go on a road trip, what do you use to navigate? Google Maps, a GPS system, maybe a printed map of the area? How about a map printed in 1776? Probably not - there have been so many changes since then that it wouldn't be an accurate guide, and you might not reach your intended destination.
In a way, we are using an old map in our economy when we use the concepts and practices originally set out by Adam Smith in "The Wealth of Nations", published in 1776,1 which formed the basis for the market economy model of economic transactions.
It's not a matter of the principles being "wrong", it's that there have been significant changes since 1776 and new information needs to be incorporated into our economic framework so that it reflects the realities of the world today, and better guides our choices for the long term.
Then and Now
In 1776 our impact on the world was a tiny fraction of what it is today. The world population was short of a billion (about 900 million)2 and the Watt steam engine was just beginning to power the Industrial Revolution in Europe. The combined rise of powered industrial technology and human population since then has hugely expanded our ability to impact the world around us. Today over 7.3 billion people3 need food, water, shelter and other resources; projections for peak human population are in the range of 9 to 10 billion4 , and the technologies to extract and process natural resources into products have expanded along with population.
As products were made and sold in 1776, there were adverse impacts, and costs were incurred that were unknown, thus not considered as Adam Smith created his economic model. For instance, air pollution from coal-burning engines began around that time, but it wasn’t recognized as being harmful to human health. In contrast, a recent World Health Organization report estimated that around 7 million people died in 2012 as a result of global air pollution exposure5. Similarly, other forms of pollution and various other adverse impacts occur, and these costs are often not reflected in the accounting of the businesses which cause pollution as they manufacture and sell their products.
Incentives and Externalities
Logic and ethics might suggest that the costs of adverse impacts from the making of products be added to the books of the firms making and selling those products. For example, those cost figures could be for pollution abatement equipment, installed to prevent or reduce the health impacts to people downwind from the plant. More commonly, these kinds of costs are incurred by the public, and measured by public health agencies, in terms of hospital visits, reduced productivity and premature deaths.
One of the primary tenets of the market system is that the purpose of a business is to maximize profits for investors and management. This is typically done by maximizing sales and profits, and in order to maximize sales and profits, and to maintain a competitive pricing position in the market, production costs must be minimized. So businesses have a fundamental disincentive to add to their costs, including the costs to public health and the health and productivity of natural resources, both of which have been left out of the market model and are referred to as “externalities”. Protecting the public interest is not the function or purpose of business; this is the responsibility of the representatives we elect to govern in the public interest.
Another development not envisaged when the Wealth of Nations was published was the depletion of natural resources, sometimes to the point of species extinction. This is reflected in the following statement from “TEEB - The Economics of Ecosystems and Biodiversity: Mainstreaming the Economics of Nature”:
“The invisibility of biodiversity values has often encouraged inefficient use or even destruction of the natural capital that is the foundation of our economies.” 6
Consider the example of the Cod community population, a rich fishery around the Grand Bank in the North Atlantic Ocean. In 1950 there was a total population of about 2.5 million metric tons; by 2000 the population was down to around 0.25 million metric tons – a 90% reduction in population7. U.S. and Canadian fisheries agencies coordinated to manage this valuable natural resource and prevent the extinction of Atlantic cod. The same story has played out in the Chesapeake Bay with the oyster population, which is estimated today to be about 1% of the population that existed when Europeans arrived in the 17th century8. Why were these resources so overfished and jeopardized?
From a business perspective the market economy is based on competition and individual decision making, so each fishermen seeks to maximize their catch, not to manage a regional fishery resource. There is no provision for rational, science-based natural resource management within the market economy. The actions of individual producers and consumers pursuing their self-interest determine resource utilization, and left to the mechanisms of the market will consume the resource if the demand is high enough.
This is rational for each individual fishing company and consumer, but collectively the result is irrational. The market economy does not address the combined effects of individual actions. So despite the litany of comments from some business leaders, and, not coincidentally, some politicians, that government is wrong to “burden” companies with regulations, it is clear that the incentive structure of the market model needs to be updated to incorporate “external” costs and to protect ecological and human health in the public interest. From the TEEB study, what is needed is:
“To recalibrate the faulty economic compass that has led us to decisions that are prejudicial to both current well-being and that of future generations6.”
Consider an example of making a rational decision on public health, in the public interest. If you take steps to reduce air pollution in compliance with the Clean Air Act, it will cost up to $65 billion a year by 2020. The benefits of these steps have been estimated at $2 trillion per year9. That’s quite a return on investment - what would you do? What would be rational?
Predictably, a relentless sales campaign by the vested parties of the status quo uses the tools of modern advertising to push emotional buttons and manipulate public opinion. Words like “freedom”, “individual liberty”, “God-given right”, “consumer choice”, “big government”, “extremists” and “socialists” seek to portray any efforts to support and protect the interests and well-being of the public at large as un-American, or worse.
It’s ironic, and cynical, to consider such messages, when more and more of the benefits of our work – profits – are going to fewer and fewer very rich and politically connected people. It is undermining the very foundation of proportional representative government (votes) with vast sums of money. Lobbyists, lawyers and unlimited corporate campaign contributions are powerful tools with which to defend the status quo, on behalf of less than one percent of the population.
Adam Smith considered the importance of human motivation in establishing his model of a system of economic transactions:
“It is not from the benevolence of the butcher, the brewer or the baker that we expect our dinner, but from their regard for their own interest”
Adam Smith, “The Wealth of Nations”, 1776, p.24.
Certainly this is an important truth, one with deep roots in our survival instincts. Another important truth is that for humans, survival and success in evolving and expanding has been based on our social nature and the power of groups to accomplish things that single individuals cannot. Specialization of activities, which is the prerequisite for exchanges and economy, requires the interdependence and coordination of individuals within the group, and a balance between the needs of the individual and the needs of the group.
By the 1980’s, Mr. Smith’s notion of self-interest had morphed into something else:
“Greed … is good”
Gordon Gekko, in “Wall Street”, 20th Century Fox, 1987
Nature is the foundation of our continued existence. Natural capital is the foundation of our economies. Short term greed and willful ignorance are serious threats to our current and future well-being. Business as usual is not a viable option. United (and diverse) we may stand, if we can agree on the fundamentals of how to live together, in accord with nature.
Jack F. Brennan, 2015
References http://www.econlib.org/library/Smith/smWN.html http://ourworldindata.org/data/population-growth-vital-statistics/world-population-growth/ http://www.prb.org/pdf14/2014-world-population-data-sheet_eng.pdf http://www.un.org/esa/population/publications/sixbillion/sixbilpart1.pdf http://www.who.int/mediacentre/news/releases/2014/air-pollution/en/ TEEB (2010) The Economics of Ecosystems and Biodiversity: Mainstreaming the Economics of Nature: A synthesis. http://www.teebweb.org/our-publications/teeb-study-reports/synthesis-report/ http://ram.biology.dal.ca/~myers/depletion/ On the Brink: Chesapeake’s Native Oysters http://www.cbf.org/document.doc?id=523 http://www.epa.gov/cleanairactbenefits/feb11/summaryreport.pdfnav21.pdf