A Framework for Modelling Interaction Between
Ecological and Economic Systems
This version: January 5th, 2001
Shunli Wang[1]
Peter Nijkamp1
Erik Verhoef1
Keywords:economic-ecological interaction, spatial externality
Abstract
Transboundary environmental issues, like climate change, have in recent years received much attention from the side of political scientists and economists. Within the economics discipline, we witness sometimes differences between ecologically-oriented and mainstream economists, which may form a barrier for proposing clear policy recommendations on external effects in open and interacting spatial systems. This unfortunate situation may be due to lack of an integrated analytical framework as well as to the multi-disciplinarity of the problem at hand. The present paper aims to identify some relevant aspects for a methodological synthesis for analysing sustainable development issues in open economic systems with a view to the development of an integrative framework through which a great many ecological-economic studies can be investigated. We focus on conceptual issues centring around the integration on interacting economic and ecological subsystems, inter alia in relation to spatial externalities and ecological footprints. Our discussion enables us to build a framework for a systematic categorisation of various types of models for economic-ecological interaction. The paper concludes with some reflections on the way forward.
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1.Introduction
Transboundary environmental issues have received increased attention from contemporary environmental policy-making institutions. One of the examples is the United Nations Framework Convention on Climate Change and the corresponding Kyoto Protocol. From a scientific point of view, the study of transboundary environmental issues is, among other things, interesting because of its multidisciplinary character. Analysing these problems may lead to a better understanding of, and synergy between, various disciplines, which might result in significant scientific benefits from an interdisciplinary perspective. A drawback of multidisciplinarity is, however, that some of the integrated perspectives may be disputed on specific monodisciplinary grounds. For example, from an economic point of view, there may be a tension between ecological economics and mainstream (neo-classical) economics. Given the criterion of ‘consilience’, recently introduced by Wilson (1998) and meaning that the methods and starting points of one scientific discipline need to be consistent with the accepted insights of other disciplines (see Van den Bergh 2000), this tension is unfavourable and would have to be relaxed.
Lack of coherence between these two dominant orientations in economics, henceforth denoted as mainstream and ecological perspectives respectively, seems to create a problematic situation. In particular, the ecological perspective is often seen as a fundamental critique on the mainstream perspective, especially regarding its failure in explaining and offering possibilities for correcting the severe and sometimes irreversible environmental degradation (for a review, see e.g. Van den Bergh 1996, Spash 1999). The feeble position of mainstream economics became in particular evident after the optimism in the 1960s and beyond (as expressed e.g. by the concept of the golden rule of accumulation), and notably in the destruction of the growth optimism by the Report of the Club of Rome (Meadows et al. 1972) and the subsequent increasing political popularity of the concept of sustainable development. It became gradually clear that the ecological system would have to be recognised as an integral entity - in addition to the economic system - in analysing environmental scarcity problems.
This paper aims to bring both perspectives together by putting the various models in terms of both above-mentioned perspectives in a unifying framework. Furthermore, we will illustrate this framework by presenting and discussing a spatial-economic model with environmental interactions for economic activities, markets and externalities, followed by a discussion of ecological footprint issues in terms of transboundary externalities.
The plan of this paper is as follow. Section 2 first discusses conceptual differences as well as similarities between the mainstream and ecological perspectives in analysing environmental issues; next, this section presents a unifying modelling framework for the interaction between relevant economic and ecological systems. Section 3 reviews and interprets various models, which are based on either perspective, in terms of the above-mentioned unifying framework in order to identify compatibilities between both perspectives. Section 4 illustrates the insights thus obtained by discussing (i) insights from a spatial model on transboundary externalities, firms and markets, as well as (ii) the ecological footprint in terms of transboundary externalities. Finally, section 5 offers some concluding research remarks.
2. A Modelling Framework for Ecological and Economic Interaction
2.1 The clash of ideas: economic versus ecological perspective
In this section we will concisely discuss both a mainstream, conventional economic and an ecological economic perspective. The fundamental concepts in the field of environmental economics – as part of mainstream economics – are the ‘externality’ and ‘public goods’ character of environmental amenities (Baumol and Oates 1975). In economic analysis, an externality is generally conceived of as a divergence between the marginal social and private cost of a good. Environmental damage thus typically involves a negative externality, when it is not (or not optimally) priced. The result is that a tax, subsidy or other governmental measure is justified in order to correct the impact of such an externality (Verhoef 1999). This description of an externality implies thus that (i) an externality exists when some agents’ action influences the utility of other agents, without this effect being reflected in price signals (see e.g. Mishan 1971), and (ii) necessary conditions for a socially optimal situation (i.e., the Pareto-optimality conditions) are violated (Buchanan and Stubblebine 1962, Baumol and Oates 1975, Mas-Colell et al. 1995).
Although the concept of externality is widely used, various definitions still exist (Viner 1930, Mishan 1971, Meade 1973, Ng 1988), while some of them may be imprecise (as observed by Mas-Colell et al. 1995). This may be one reason why the concept of externality is not always clear to a non-economist (Sterner and Van den Bergh 1998). A fallacious loose interpretation would be that the ecological system can be considered as external to an economic system and ‘therefore’ irrelevant for economic efficiency (see for a review e.g. Van den Bergh 1996, Sterner and Van den Bergh 1998). This interpretation of externality is obviously missing the point, since the use of the externality concept implies, on the contrary, that the ecological system does matter to economic efficiency.
The ecological perspective emphasises that economic growth will result in an increased use of natural resources or increased damage to ecological systems as a result of pollution, even when externalities are optimised (Meadows et al. 1972; Daly 1990, 1997c). More specifically, sustainable growth from a mainstream economic perspective (Solow 1974 and Hartwick 1977) may even have a different interpretation (Common and Perrings 1997) than the concept of 'sustainable development' from an ecologically-oriented economic perspective (Holling 1973). That is, even when increasing scarcity of an environmental good would be coped with by an increase in environmental taxes – or, more broadly, in taxes that would in addition reflect intergenerational equity considerations (Withagen 1995, 1996) –, the outcome may still not be regarded as strictly sustainable (over an infinitely long time frame). This conclusion derives from the assumption that the earth is a closed system, as well as from the laws of thermodynamics. These laws play important roles in the ecological perspective (Van den Bergh 2000).
The first law of thermodynamics states that, in a closed ecological system, energy cannot be created nor destroyed (Georgescu-Roegen 1993). Translated into economic activities, this law implies that sustainable economic growth is not possible, as the available energy is given. For instance, the sun will die in around 5 billion years from now. Moreover, it is questionable whether the energy available from undepletable sources would be sufficient to satisfy the demand of an imaginary maximum world population. A further complication from the thermodynamic laws is that growth inevitably declines if the second law is taken into account. This second (or ‘entropy’) law states that the entropy in the universe is increasing. Entropy may – even though the precise notion of entropy is ‘not easily understood’ (Georgescu-Roegen 1993: 77) – be seen as a measure for the unavailable energy in the system. In Georgescu-Roegen’s economic terms, this means that “matter/energy enters the economic process in a state of low entropy, and comes out of it in a state of high entropy” (Georgescu-Roegen 1993: 77). In other words, the economic process in case of natural resource use (material or energy) is always a declining process, as the closed system always changes from low-entropy to high-entropy. Therefore, as Ehrlich et al. (1993: 70) proclaimed, we [even] become worse off as energy flows to places where we can no longer get at it. These insights suggest that an ‘optimum’ development over an infinitely long time frame may be impossible to define.
In a similar vein, regarding materials use, the concept of ‘material balance’ has been put forward by ecological economists (Kneese et al. 1970, Ayres 1978, Ruth 1993, Van den Bergh 1996). This means that the same mass of input (material use) in the economic system, which is extracted from the ecological system, should return as output of the economic system into the ecological system. This feedback could be represented by, for example, material waste or pollution. In this interpretation, the resources are materials that initially have low entropy and become waste, which are materials of high entropy (Ayres 1999, Van den Bergh 1996).
The supporters of the ecological perspective argue that mainstream economics is too much ‘value-based’ (see for instance the special issue on this topic in Ecological Economics of April 1998; Daly 1991, 1998; and Ayres 1998), the main mainstream message being to get the prices right. Critics emphasise that, following Georgescu-Roegen’s application (1971) of thermodynamic laws to economics, it should be the physical quantities rather than economic values that should play a central role in studying sustainable development (e.g. Rees 1999, Wackernagel 1999a and Yount 1999). After all, the natural environment is limited in a physical sense (Daly 1995, 1997a, b, Ayres 1998).
This critique may be challenged on the ground that it seems to be based on a somewhat restricted representation of the mainstream economic perspective. For one thing, the ‘wealth of nations’, as well as the possibilities for ever-increasing growth, have intrigued mainstream economists for centuries already (e.g. Smith, Mill, Keynes, Samuelson, Solow). The ultimate goal of the ‘homo economicus’ is a quantity-oriented one – that is, the maximisation of welfare as enjoyed from the consumption of scarce physical goods, be it ordinary market goods or improperly priced natural goods (see e.g. Mas-Colell et al. 1995, Samuelson 1947). ‘Consumption’, in this sense, does not necessarily mean ‘use’: the utility enjoyed from knowing that certain rare species still exist deep sea can be seen as the consumption of the public good ‘the existence of that species’. Mainstream environmental economists thus distinguish ‘use’ from ‘non-use’ values (along with further distinctions regarding, for instance, ‘bequest’ values and ‘option’ values)
The same sort of quantity-oriented social utility function applies for the ‘social planner’ as typically assumed in mainstream economic models. Moreover, economic theory, ever since Adam Smith, shows that the transactions of the utility maximising economic subjects tend to result in a competitive market equilibrium that is Pareto-optimal (the ‘First Theorem of Welfare Economics’). Efficient prices are not the ultimate goal, but only instruments.
Of course, this theorem holds true only under the usual assumptions of absence of market failures. In case of imperfections and non-optimal outcomes in environmental issues resulting e.g. from the existence of externalities, due attention should be paid to the interaction between the economic and the ecological system, especially if the interactions between and within both systems are complex and non-linear.
For modelling these interactions, compatibility between both perspectives may be reached by interpreting the variables concerned in terms of quantities rather than values. This is not an insurmountable problem, as in the economics literature, typically only quantity based variables enter private and social utility and production functions as arguments (see e.g. general-equilibrium theory or micro-economic theory; for example, Mas-Colell et al. 1995).
On logical grounds, the two approaches would be intrinsically mutually inconsistent, only if the optimal quantities considered by the ecological perspective could not be realised by using a system of taxes (e.g. Pigouvian taxes) that is consistent with the mainstream economic approach. There is however, a priori, no fundamental and compelling reason why this should be the case. Certainly, practical pricing of all attributes or elements in an ecological system might hardly be possible, but in that case we enter the theory of ‘second-best’ environmental taxation. There is a large and growing mainstream based literature on this, emphasising the economic aspects of relaxing various simplifying assumptions that, while keeping exposition manageable, often give standard mainstream economic models a somewhat abstract and conceptual nature (e.g. Verhoef and Nijkamp, 1999).
In conclusion, insights from an ecological-economic perspective raise the question of whether flows of inputs necessary to achieve a sustainable development in terms of production and consumption flows (the one side of the coin) can be extracted from intrinsically finite stocks with bounded regeneration over an infinitely long time span and for a possibly permanently growing world population, while keeping environmental quality at an acceptable (‘sustainable’) level (the other side of the coin). The emphasis on the (very) long run can, in a way, be seen a warning against the mainstream economic practice of discounting future utility (related also to environmental quality), which tends to leave such questions to practically zero importance in intertemporal optimisation exercises. An immediate objection against such a critique would be that nothing prevents a mainstream economist from proposing different objectives and/or constraints, which would more explicitly reflect these worries. One possibility, studied for instance by Withagen (1996), is that utility per capita may be restricted to be ‘non-decreasing over time- possibility’ after allowing for some transitional phase.
2.2.Integrated economic-ecological systems
An integrated framework
The conceptual differences and similarities between both perspectives may be clarified by putting the underlying models in a unifying framework. In this subsection, we will present such a framework for modelling the interaction between ecological-economic systems, which serves as the basis for discussing a number of approaches in the literature aimed to study the relations between economic and ecological systems. We focus on two particular aspects of the debate only, namely (1) the use of quantity versus value based measures and (2) the degree of integration between the economic and ecological sub-systems. By using this integrative framework, some of the methodological differences between both perspectives previously discussed turn out to be non-fundamental, but mainly a matter of choice of objective. Furthermore, positioning the economic and ecological perspectives in terms of a ‘system’ will show that the concept of quantity may in fact be a strong link between the ecologically-oriented perspective and the mainstream models, in which consumption is the amount that is transformed from the inputs and where the price of consumption reflects the consumers’ marginal value of goods. As will be shown, the result of this framework may also be associated with relevant complementary approaches such as the material balance model (see e.g. Van den Bergh 1991, 1996; Van den Bergh and Nijkamp 1994).
In the framework proposed here, we will consider the ecology and the economy as an integrated system. Here we will follow Bossel (1986), who used the term system as a means “to describe a set of components interacting relatively strongly with each other and relatively weakly with their common environment, in a way which allows one to recognize a ‘purpose’ in the resulting overall behavior of the interacting components” (p. 51). In the context of our paper, the following four starting points are taken for granted: (i) the social objective in general is increasing in the ‘quality of life’ at all relevant points in time, and may take various forms, such as the requirement that the average quality of life should not decline over a given long-term horizon, or – more traditional – that the discounted net present value of the quality of life be maximized; (ii) a system is composed of well-defined elements, which are identified by focussing on the most essential simplification of the system; (iii) a system has a structure that represents the interaction between the elements; and (iv) a system has its boundary which separates it from the system environment (in our case, we study the integration of an economic and ecological system only).
In Figure 2.1, the general conceptual framework of an economic-ecological (henceforth: E-E) integrated system is presented. For notational purposes, in this and the subsequent figures, we use circles to denote variables (input or output) and rectangles to denote transformation processes; the straight and elbow connectors denote relationships between two elements in a pure economic system and the curved connectors denote relationships between two elements that may be extended from the standard simple economic model. The curved connectors imply possibilities for the existence of externality in case the economic system attaches a zero (or too low a) price for these elements in case of a competitive market, while in a Pareto-optimal case these elements would have the corresponding efficient value. Table 1 summarises the notation used.
Symbol / Description / Function / DescriptionK / Physical capital / A() / Knowledge accumulation function
L / Labour / () / Depreciation function
I / Investments in capital / F() / Production function
C / Consumption / E() / Emission function
S / Stock of ecological resources / R(S) / Regenerative function of the ecological system
U() / Utility function
Table 1: Notations used in a framework