How should economists think about biodiversity?

WHAT IS THE contribution of nature to the economy? Students of economics are well acquainted with production functions, which work out how inputs like capital and labour combine to yield output. These functions make all sorts of assumptions, many of which economists know well (that the contributions of capital and labour are subject to diminishing returns, say). Others rarely get a thought: that a mix of inputs that generates output on Earth will not on Venus, for example. The breathable air, drinkable water and tolerable temperatures that allow humans to do everything they do, and the complex ecosystems that maintain them, tend to be taken for granted. This is more than a mere analytical oversight, reckons a new report on the economics of biodiversity commissioned by the British government, and produced by Partha Dasgupta of the University of Cambridge. By overlooking the role nature plays in economic activity, economists underestimate the risks from environmental damage to growth and human welfare.

Professor Dasgupta’s review is similar in spirit to a report on climate change by Nicholas Stern, commissioned by Britain’s Treasury in 2006, and now widely regarded as a seminal economic work on the subject. It does not seek to play on the heartstrings with tales of starving polar bears. Rather, it makes the hard-headed case that services provided by nature are an indispensable input to economic activity. Some of these services are relatively easy to discern: fish stocks, say, in the open ocean. Others are far less visible: such as the complex ecosystems within soil that recycle nutrients, purify water and absorb atmospheric carbon. These are unfamiliar topics for economists, so the review seeks to provide a “grammar” through which they can be analysed.

The report features its own illustrative production function, which includes nature. The environment appears once as a source of flows of extractable resources (like fish or timber). But it also shows up more broadly as a stock of “natural” capital from which humans derive “regulating and maintenance services”: the work of environmental cycles that refresh the air, churn waste products into nutrients, and keep global temperatures hospitable, among other things. With this new production function in hand, economists can properly account for nature’s contributions to growth. Functions that omit nature misattribute its benefits to productivity, exaggerating human capabilities.

The inclusion of natural capital enables an analysis of the sustainability of current rates of economic growth. As people produce GDP, they extract resources from nature and dump waste back into it. If this extraction and dumping exceeds nature’s capacity to repair itself, the stock of natural capital shrinks and with it the flow of valuable environmental services. Between 1992 and 2014, according to a report published by the UN, the value of produced capital (such as machines and buildings) roughly doubled and that of human capital (workers and their skills) rose by 13%, while the estimated value of natural capital declined by nearly 40%. The demands humans currently place on nature, in terms of resource extraction and the dumping of harmful waste, are roughly equivalent to the sustainable output of 1.6 Earths (of which, alas, there is only the one).

To reduce these demands without slowing growth would be a monumental task. Between 1992 and 2014, Professor Dasgupta estimates, the efficiency with which humans transformed natural capital into GDP grew at about 3.5% a year. To stop natural capital declining by 2030 while maintaining current growth trends, however, would require growth in efficiency of about 10% a year.

Even these sorts of rough calculations fail to capture fully humans’ potential vulnerability, because complex natural systems can flip from one equilibrium to another under pressure. The cost of restoring an ecosystem that has been destroyed can be larger than the value of the services it provided when healthy—assuming restoration is possible. Deforestation of the Amazon rainforest beyond some critical threshold is likely to cause an abrupt transformation of the forest into savannah, a change that may prove irreversible. Indeed, Professor Dasgupta argues that economists should acknowledge that there are in fact limits to growth. As the efficiency with which we make use of Earth’s finite bounty is bounded (by the laws of physics), there is necessarily some maximum sustainable level of GDP.

This is a striking admission from an economist. For now, these ultimate limits to growth are not yet binding. There is still considerable room for efficiency to improve (in part, the review notes, because of government subsidies, worth 5-7% of global GDP, which encourage environmentally wasteful activities). But a more pressing worry is that activity pushes nature beyond critical thresholds—in terms of global temperatures, the chemistry of the oceans, the productivity of the soil, or something else—before humans are able to recognise the danger and react.

Down to earth

That economics stands to benefit from a better understanding of nature’s contributions to activity seems clear enough. But whether a better understanding of the economics of biodiversity is essential to improving humans’ relationship with nature is another question. Economists’ work on climate change has yielded insights, for example, but it is less clear that the profession has improved the policy response.

Professor Dasgupta hints at this problem by appealing to the “sacredness” of nature, in addition to his mathematical models and analytical arguments. Clear thinking about nature can benefit from framing it in economic terms: as an asset and input to production, the overuse of which is a problem of incentives and property rights. Building the political will to prevent irreparable damage to the environment, though, may require an appeal to values that are beyond the purview of economics. ■

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This article appeared in the Finance & economics section of the print edition under the headline “The natural question”

Source: Finance - economist.com