An Economist's View of Sustainability
Introduction:
The World Bank has been criticized by several environmental groups for funding environmentally
destructive development projects. Professor Herman Daly was a senior economist with the World Bank for six
years and is now a professor at the University of Maryland. He received the Ph.D. in 1967 from Vanderbilt University and was a professor of economics at Louisiana State University for twenty-one years.
We spoke with professor Daly about his ideas for improving the performance of the World Bank.
In his farewell letter to his colleagues, Professor Daly made four suggestions to better meet the Bank's objectives: stop counting consumption of natural capital as income; tax labor less and resource use more; change policies to increase supply of natural capital; and move away from the ideology of global economic integration.
ER: Professor Daly, how do you respond to the criticisms of the World Bank about its environmental record?
HD: The World Bank has made a real effort to improve its environmental record. They have done so largely as
a result of outside pressure but without that pressure I do not think too much would have happened. So I think
the Bank needs to be pushed on the subject.
In the Bank's defense, however, in spite of all its problems with the environment, the World Bank is
probably more environmentally sensitive than most of its member countries' governments. Frequently the World
Bank is on the right side in conflicts with its member countries. The Scandinavian and the Nordic countries are
more environmentally sensitive than the World Bank; the United States is probably still a bit less
environmentally sensitive than the World Bank. And, of course, many other countries are eager to chop down
everything they can for exports and short-run gains.
Quite a few of the World Bank's loans are designed for projects which increase exports. And often
simultaneous World Bank investments in many countries in the same commodities, leads to a fall in the world
price of that commodity and greater needs to export. So there are many complications and problems, but I think
the World Bank does have a reasonable defense when it says that very often they are more environmentally
sensitive than their member countries.
ER: The first suggestion in your letter is to stop counting the consumption of natural capital as income. The
World Bank is already moving in that direction, is it not?
HD: Yes. The World Bank is moving in that direction. About eight or nine years ago they took the lead on
national income accounting to reflect environmental costs - costs of depletion of natural capital. The Bank was
a leader in that area for a while and then they fell out of it or did not follow through quite as hard. One
particular person there - Salah el Sarafy - has been a leader in that area. Other good work has been done by
Ernst Lutz.
There are also problems of counting the consumption of capital as income at the micro-level on actual
projects. And in the Bank's evaluation of projects, its record is quite mixed because sometimes the Bank does
not count the cost of consumption of natural capital as a cost of a project and sometimes it does. In projects
involving natural gas, they count depletion cost, in other areas they do not; there is inconsistency in the Bank's
own operation.
That is a case where one department is doing it right others are doing it wrong. So let's praise the
department that is doing it right and everyone else is urged to start doing it right also.
Let's say, for example, you are going to clear a forest in order to plant corn. You have to count as a cost
the yield that you could have gotten from the forest the way it was before you cleared it. So if you take the
sustained yield of the forest in perpetuity - the forest that you are cutting down - that has to be counted as a
cost of the agricultural project. This is not an easy thing to do: to count the cost of depletion of natural capital
involved in projects. If you do not count that cost, then the net return on that project is overstated and then the
rate of return on the project is overstated. And so you will have a bias towards increasing investments in projects
which do not count the depletion of natural capital, and that is against the direction of sustainable development.
ER: To be sustainable you have to count the true costs of a project. Otherwise you are extracting rather than using sustainable practices.
HD: Exactly. The bread and butter activity of the Bank is to do evaluations of projects, so that is a fairly serious
correction. And I think it is long overdue. This is not druid economics; this is standard stuff right out of the
textbooks.
ER: How would you judge the World Bank's environmental performance in recent years?
HD: I have only been closely associated with the World Bank for the past six years. I would say over that
period the Bank has become more environmentally sensitive. I think the pace of change has been much too slow
compared to the urgency of the problems that need to be faced.
However, to be fair to the World Bank, it is not all their fault, because the World Bank is run by
economists. And all of the economists at the World Bank - whether they came from Thailand or Zambia or
California - all went to pretty much the same universities: Harvard, Stanford, Cambridge, Oxford. And they all
learned basically the same thing in economics; they all had the same economic model inculcated in them and
internalized it.
So to look on it sympathetically, these economists are like the practicing church out in the world trying to
do good. They all learned this theology they are trying to apply. But the theology is badly flawed; the economic
model they learned, abstracts almost entirely from elements of the environment and community. And that is
where the problems are. And a theory which abstracts from those things is not useful.
So I think a lot of the criticism that is directed at the World Bank might with considerable justice be passed
right on back to the economics departments from which the World Bank's officers received their training.
ER: What is the flaw in their training?
HD: I think the fundamental flaw is at a level some economists have referred to as a pre-analytic vision: your
starting point before you start analyzing. What is your overall vision of the nature of the world? And here we
have a big difference between neoclassical economics and ecological economics.
The vision we need to have is that the economy is a subsystem of a larger ecosystem. And the larger
system that the economy depends upon for inputs and it depends upon for sinks for outputs, does not grow.
So as our economy becomes an ever larger subsystem of this total system, it will have to conform more to
the conditions of the total system: principally non-growth. So our economy will have to adapt to that same non-growth pattern, which is what I think should be meant by sustainable development; namely, qualitative
improvement without quantitative expansion.
Now contrast that vision with a neoclassical, orthodox economics which simply sees the economy as a total
system; it is not a subsystem of anything larger. And if you think of nature and the natural world at all, you
think of it as the extractive sector of the economy. That is the fundamental difference in the pre-analytic vision.
And which view is right? It seems to me screamingly obvious that the subsystem view is right. Other people
simply say that is not the right way to look at it. I have been told that on several occasions when I have made
this argument; economists have answered by simply saying that is not the right way to look at it.
ER: Your second suggestion is to tax throughput and to decrease the taxing of labor. You want to encourage
labor and economize the use of resources.
HD: Yes. This idea is beginning to gain some support around the world. It is going under the title of ecological
tax reform, which is to emphasize that it is not an addition of more taxes but rather a shift in the tax base away
from value added, onto that to which value is being added; namely, the resource flow or the throughput. That
means you are taxing the two ends of the throughput - depletion and pollution, which are both costs - and
you are easing up on taxing value added income, which is something you want more of.
So it seems to be a pretty reasonable idea, very much within the confines of standard economics. One does
not have to go far afield to see that there are efficiency improvements to be had in taxing what is bad and stop
taxing goods.
We should move away from the income tax. We want to put the tax on the resource throughput flow, not
on the consumption of final products, but on the resource flow itself. And as we begin to increase revenue from
the resource tax, we should ease up on the income tax, starting first with the tax on lower incomes and then
working our way gradually up the income scale.
ER: What is the environmental rationale for easing up on lower income brackets?
HD: That is based on justice. The environmental benefit comes from taxing the throughput. But a throughput tax
would tend to be regressive, taxing the poor relatively heavier than the rich. So we would want to correct that in
our tax rebate scheme.
ER: How do you propose to tax labor less?
HD: We would shift taxes. We would start taxing energy and basic raw materials. That would tend to make us
much more careful in the use of them. That would stimulate recycling because you would tax the raw materials,
and whatever then could be gathered by recycling would not bear the tax, so it would be relatively cheap.
Now also, if you are taxing energy more, then it will be more expensive relative to labor. So to the extent
possible, there would be an attempt to substitute labor for inanimate energy. Now that would increase
employment; it would probably lower average labor productivity however. So it is a mixed blessing.
ER: Increasing labor and reducing energy use would go counter to the last two hundred years of
industrialization.
HD: We have to switch. We have been increasing the productivity of labor and capital on the notion that labor
and capital is what is fundamentally scarce. Once you shift the vision from an empty world to a full world, what
is scarce is the remaining natural capital. We have to shift our economizing effort onto the limiting factor. In the
past, when the human population was small relative to the total world, it was reasonable to say that man-made
capital was the limiting factor. The fish catch was limited by the number of fishing boats, not by the number of
fish in the sea. You could always get more by adding more boats, and you would not deplete the fish. Now we
have an excess capacity of fishing boats; adding more fishing boats is not going to increase the catch, it will just
increase the idle time the boats sit there. To increase the fish catch, you need to increase the limiting factor,
which is now the population of remaining fish and their ability to reproduce.
So the shifting of the tax base is aimed at making us economize more on the exploitation of natural capital
as it yields natural resources by raising its price relative to other factors of production. This is fundamentally
important for the Bank.
That leads into the third point in my letter, which is to maximize the productivity of natural capital in the
short run and to invest in increasing its supply in the long run. The important idea here is the idea of a limiting
factor and that the limiting factor has changed from man-made capital to natural capital. Economists do not
usually see that because they tend to think of man-made and natural capital as being substitutes. And if goods
are substitutes, then neither one is limiting; a shortage of one does not limit the productivity of the other. If,
however, goods are complementary, then the complementary factor in short supply limits the productivity and
usefulness of the other factor. So if you are a farmer and you keep on adding nitrogen after potassium has
become the limiting factor, you are just wasting nitrogen. We are in a similar situation if we just keep on adding
man-made capital when we are more and more moving into an era in which remaining natural capital is the
critical and limiting factor. So the World Bank then should refocus its attention more on investing in and
economizing on rebuilding natural capital.
ER: How would that apply to an actual development proposal to the Bank?
HD: It is difficult. You stop and think for just a moment, how do you invest in natural capital when natural
capital, almost by definition, is something you do not know how to make? I think the answer is, that you do it
by "fallowing" types of investment. We restore the fertility of the land, the capital value of the land, by letting it
recuperate. The same thing with fish stocks. You let them recuperate.
The key idea of investment in economic theory is a reduction in present consumption for the sake of
improving future capacities to produce. You are refraining from consuming out of the system today in order to
let it lie fallow and regenerate itself so that it will be in the future able to give you a higher sustainable yield.
That means in the present you will consume less, which is sad news in an overpopulated world with an
unjust distribution of income. That just throws a stronger spotlight on the issue of overpopulation and unjust
distribution. If we have to reduce our consumption, then it becomes all the more important that we share what
we are able to consume more equitably and that we gradually reduce the number of people that we have to share
it among, if we want to improve the average for each person.
ER: Is there any practical way of redressing unjust distribution of income, even at a national level, much less the
international level?
HD: Different countries have had different levels of success with that, so I think it is certainly not impossible.
The Scandinavian countries and Japan have a much smaller range of income inequality than the United States;
Brazil has a vastly greater range of inequality. So there is plenty of variation and possibility of learning from the
experience of other countries.
I think we need to decide politically what is an acceptable, reasonable, justifiable level of inequality, and
then have a maximum and a minimum income. People long before me have advocated the minimum income. But
the idea of a maximum income creates apoplexy and disbelief. But if you are going to have a minimum, and if
the total is limited, then implicitly there is a maximum.
ER: It has been argued that human nature is not amenable to engineering. People respond to incentives.
HD: Well, I think people respond to incentives up to a certain level. At some point, as you get more wealthy,
leisure becomes more important to you than more goods.
I personally find that, even at my meager income now, I am less likely to accept outside jobs than I was
ten years ago, when my income was less. If we really believe in incentive, you certainly would not want massive
inheritance knocking out incentive. So I think the incentive argument is largely overdone.
And also, we have been taught by economists for a long time that human nature is atomistic and selfish, but
there is a world of evidence that that is very far from being the whole story. Yes, we do have a selfish side to
us, but people are fundamentally community oriented. Our whole identity is tied up with the people who are
important to us and our function in the larger society. So I do believe people are much more responsive to
community than economists have led us to believe; and that a certain level of inequality is consistent with
community and is good for community. But there are limits beyond which, the degree of inequality begins to
destroy community. I think we could come up with some reasonable limits.
ER: The fourth point, in your letter is to move away from global economic integration. What is your rationale
for that?
HD: Let's tie it to my first point. If you count natural capital depletion and you get all environmental and social
costs reflected and internalized into prices, and you do that by national policy which mandates it with accounting
rules, and you make all your firms abide by those full-cost rules of accounting - OK - that is an internal
policy of abiding by full-cost accounting. Now, our external policy has to be consistent with that internal policy.
If we say, OK, now we can have free trade with all countries, including countries which do not count full-cost
pricing, that would put our own producers in a totally untenable position. We are making them compete against
people who follow entirely different accounting procedures; what is a cost here is not a cost over there. Well,
naturally that will lead to a cheaper product for the foreigner who is exporting to us, so it is necessary to have a
compensating tariff in order to protect domestic producers.
Let me emphasize that we are not protecting inefficient industries domestically. We are protecting an
efficient national policy of full-cost pricing from being undercut by competition with countries which, for
whatever reason, do not count environmental and social costs to a proper extent.
The World Bank's charter is to serve its members, and its members are nation states. So the World Bank -
and I think it is correct in this - must look at welfare mainly from a nationalist perspective. Nationalist is a bad
word now, but the nation is where you have community.
ER: They have shared culture and language.
HD: And community is already under attack; it is being shredded by economic forces. So I think it is extremely
important to protect and nurture community where it exists and not to subject it to further centrifugal forces
resulting, in this case, from globalism and free trade.
I do not think that the World Bank has any charter to serve this cosmopolitan vision of converting many
loosely independent national economies into one tightly integrated world economic network. The idea of one big
globally integrated economic system is to me quite a frightening and unstable vision. But the idea behind GATT
and NAFTA and the whole global integration is the more interdependence there is, the greater the chance of
peace and prosperity. I do not think so. I think it is likely to result in perhaps greater conflict. Probably in future,
conflict will be less international and more class conflict. In the old Ricardian view of free trade, capital was
immobile; capital stayed at home. Now capital moves all over the world and economists still preach comparative
advantage, but the basic assumptions of that argument have been eliminated. Economists have forgotten that
entirely.
So if you have the Ricardian world in which capital stays at home and goods trade abroad, then you have
national capital cooperating with national labor to produce goods which then compete internationally. So that
tends to make for a greater emphasis on cooperation within the country.
But then when you allow capital to be mobile, then capital says to national labor, "You are just workers;
we are not fellow citizens in any meaningful sense. I can hire people just as good as you only a couple hundred
miles away for a tenth of the price."
ER: That is happening.
HD: Which is what they are doing. And then not only that, "I can import whatever I produce back and sell it
here. And so I do not need you." So what you get then is greater conflict between labor and capital as you
globalize capital. And capital, then, is able to tell national communities and of course local communities to go to
hell. "We don't need to do anything for you. We have all these other alternatives." And that is the real danger to
community; we are tearing community apart by capital mobility. And I think the ideology of free trade and free
capital mobility simply weakens nation states as the boundaries of a nation become permeable to goods and
capital, and to a greater extent even to people. Then the nation loses its power to enact any measures for the
common good.
ER: How would we as a nation, reverse that trend or regulate it?
HD: We could start with knocking out things like NAFTA; not let it get any worse, and then tackle the problem
of how to get capital to be more nationally and community rooted. But the trend is going exactly the other way.
You are right. It is hell bent to go the other way, and probably it will go that way until things get sufficiently
bad where people say, "Well, maybe that was a mistake." And then we can start picking up the pieces.
ER: Why do you think John Keynes thought it was important to keep finance national - was it for these
reasons?
HD: Yes, I think it was for these reasons. It was an extension of the argument of absentee ownership. He felt
that you end up diluting responsibility as you further separate ownership and control. It is bad enough to have it
separated as much as it is within the nation, but then when you go across nations and decisions in Tokyo are
affecting what happens in Schenectedy, then, even with the best will in the world, it becomes very hard to be
responsible.
Copyright 1995 Environmental Review