Mike Young is a Senior Principal Research Scientist with CSIRO Land and Water and directs the Policy and Economic Research Unit in Adelaide. He specialises in transdisciplinary analysis of policy alternatives, the design of property-right systems and resource accounting. He is past President of the Australia and New Zealand Society for Ecological Economics and a Fellow of the Academy of Social Sciences in Australia. He is an Adjunct Professor with the University of New England's Centre for Ecological Economics and Water Policy Research.

Economic aspects of sustainability
by Mr Mike Young

Sustainability science and economics
Modelling frameworks
Alternative assessment frameworks
Alternative models
Salinity – we know but do not act
Sustainability policy – economics
Ecological and economic truth?
Gaps and opportunities
Questions/discussion

Sustainability science and economics

I woke up about a month ago and opened up the Financial Review, as all people in my profession do, and read headlines that said 'Progress has a green price tag'. The Australian Bureau of Statistics had just looked at Australia's progress and they said that material wellbeing in Australia is coming at the expense of two things: personal safety and the natural environment. And I thought, 'I've got to speak to the Academy about that. This is going to be interesting.' But I think the point is really very important, what we are here to talk about: Do we just want economic growth? Do we want to have nice lifestyles and nice environments to live in? Should the natural environment be there for the future?

Thinking about the whole science of this, and from an economic perspective, I see two very clear roles for economics. One is really about what I would describe as assessment reporting, the science of telling people what is happening. The political goal, in a very naive sense, is a set of indicators, a set of vectors that are all increasing over time, structured the right way so every one, if it increases, is better; if all the increases are all going up every year, we have got perfection. The problem is that some go up and some go down.

One thing that has been suggested, which we don't do in Australia, is that we should try and line them all up and report them all in parliament on the same day – rather than having a State of the Environment report one month, and unemployment the next month, and so on – so we are forced to talk about the entire picture. We don't do that.

The second role which economics is quite good at, I think, is to give management advice, to advise on how to change things, to advise what might make a difference and how much difference it would make if you did it.

Modelling frameworks

As to the way, in terms of reporting, that we have gone about it, in terms of trying to look at the environment, there are a number of competing approaches around. I don't think we have the answer. There are frameworks that take the national accounts, GDP, and extend them or adjust them. There is a lot of debate and theory and discussion around, about looking at stocks of capital and how they are changing through time. There is a large amount of work looking at indicators, and how to assemble them up, and I'll come back to that. And then the other way in which it is done, which is the normal way at the moment, is to just audit what is going on and to commission some people to have a learned look and try and advise how to go forward.

So where are we? Let's look first at the economic framework. In a very simple framework, the way it works is that GDP and the economy, as economists model it, is about the relationship between economic production and consumption. GDP is like a speedo on the economy. It tells you how fast you are going. If you are going faster, you are going better. If you think about it, though, all of the advice that is around says you really should allow for changes in stocks and factor in depreciation. Hardly any country in the world ever does that. It is too difficult, the errors in doing it are too hard, and people assume that people look after capital so all we need to do is watch the speedo and the people who are driving the car will keep on driving it correctly.

If you look at it in terms of the environmental perspective, the standard environmental economics models say, 'Well, they're resource stocks, and we have to look at those,' and we have national land and water resources audits and so forth that go through and look at the stocks. We have to understand how waste flows out of the system. There are a number of non-market benefits that flow through and benefit that are not part of the production system. And we put all that together as an extended model and try and describe it like that. More recently we have said, 'Well, perhaps we have to put waste down so we can include ecosystem services in there and model that, and it is so important that it has to be done separately.' The model starts to get more complex, and this is where we are at in terms of going towards building more and more complex models that take longer to construct and longer to understand.

We have been told already in this symposium that there are three pillars, and there is a thing called the triple bottom line. The Financial Review ran another story only last month and said there is governance, and if you are smart as a company, there is a quadruple bottom line. That made me think again, as I thought through where we really are. Governance, I think, is part of the problem, and the debate on sustainability – because it leaves out consideration of how we act as a community and how we govern – is a flawed debate, because the real issue is how we make decisions about the future.

So we can build economic models that are pretty good, serve us quite well, are proved and survive the test of time. They have flaws. They are simple but, because they are simple, are powerful.

The environmental accounting frameworks are still fairly crude. We assemble thick reports; we can't reduce the State of the Environment report down to one or two numbers. We haven't even started to work out how to do that.

The social stuff is also out. There are no arrows, no flows in this that really flow into social health. And if we think about community governance issues, they are not yet in the debate.

Alternative assessment frameworks

Let's just look at a couple of the frameworks as they are developing. (I want to go back into the science of actually trying to assemble this.) The science is moving in a number of directions simultaneously. There are a set of single-indicator models that are trying to develop one number that can be tracked and assessed and modelled through time. The characteristic of those is that they have formal rules on trade-offs: you give up some of this to have some of that, you take off five and you add on 10, and there is a weighting factor in there of some sort. This might not actually operate in a linear fashion, but it would be there with a formal trade-off system.

There is a lot of debate, particularly in Europe and in the European Parliament, about searching for some indicator systems, and a number of ministers have said to me, 'I want a set of less than 10 numbers that I have to worry about. If you can reduce it down from 10, it'll be great. Every time the scientists get together they always produce a list of somewhere between 50 and 100.' Australia has been involved in the same exercise. These allow, though, room for subjective mental models to take over where the science stops, and that is the state of the art at the moment.

There is also the current real state of the art, which is just a whole set of separate reports and separate talks and separate processes, and we optimise within subcategories and we try and avoid talking to each other.

Alternative models

One of the most interesting attempts is to try and understand genuine progress. There has been an Australian attempt to do this. This model points out that defensive expenditure is a cost. If we have to spend more just to stay still, if we could find a way to stay still and not have to do that we would be much better off. So if we have to invest money to stay healthy, through controlling pollution, reconstructing things and so forth, it is expensive and is not worthwhile unless there are big gains. We should see that and take the defensive expenditure out of the GDP calculation, which says if we have an oil spill we are doing better. We should take off all of the environmental costs, the externalities, as economists call them, and then modify for shifts in wealth amongst the community. I don't have time to go through it. The Australian attempt points out that if you run the algebra this way, instead of having had per capita growth at around 13 per cent since 1996, it drops to about 3.6, so we are not doing as well. Our material growth starts to look less exciting and less attractive. The same story operates all over the developed world.

Another model which is interesting is talking about inclusive wealth. That says that really there are three types of capital. There is natural capital, the natural environment, and we need to value that; there is human capital, which is through education, knowledge and learning; and there is built capital, or manufactured capital, which is all the infrastructure. If you look into the debate, there is a very difficult issue on trade-offs. There is what is called the weak sustainability framework and model, which says that really it is okay to run down one set of capital if you build up the other. There are arguments about what the ratios are, but substitution is occurring. A lot of that is happening, and there are a lot of rules about how you actually analyse that.

The other one is the strong sustainability rules, which say, for example, that natural capital should be non-declining. The difficult part in the models, which is not openly discussed yet, is what about doing it on a per capita basis. Do we have to maintain the value of our natural capital on a per capita basis across the world, or are we just aiming to keep the stocks of capital constant? This gets back to the links between the social, the economic and the biophysical: how do we start thinking and having honest, open discussions about this?

So where is reporting science up to? There are a number of conceptual problems that are there. I don't think we yet know how to do the trade-offs, particularly how we trade off what is good for what is bad: if we get some more 'goods' and 'bads', how do we do that? The market is there.

Salinity – we know but do not act

There is an important issue over the way we construct the accounts. All of you will understand, I hope, the difference between current accounting and accrual accounting. If I cause some dryland salinity, as I did as a young child in South Australia, clearing for my father's property, driving the tractors, the scientists tell me the salt – which is the only real problem from that – goes into the Murray in about 400 years' time. If you have a current accounting framework, the accounts register that difference in 400 years time. Or should we do the national accounts now in a way that puts the 400-year cost in? How do we get the biophysical scientists to build the models to do that, and do we put it in this year or next year, and how do we do that? These are very difficult conceptual problems that we have not yet started to talk about honestly and openly.

Measurement problems are another tremendous headache. The reason why we go for GDP and not NDP is the problem of measuring depreciation. Errors are very big. Factors of concern are often swamped. If we are really concerned about agriculture in Australia – agriculture is only 3 per cent of GDP – the land degradation components are quite small in terms of the big picture. We can mislead people by saying we have green national accounts, when most of the stuff of concern is not really counted in the framework. So we have the risk that the errors in the thing can be larger than the trends, and we can mislead people by trying to build something which conveys the message to people incorrectly, because the knowledge conveyed through the indicator is not appropriate.

Sustainability policy – economics

Let me now turn to the second side of the equation: where things are going. I think in economics a lot of the concepts are well developed. Benefit and cost is well understood. Something economists say that ecologists don't understand is that the past can't be changed. Economists talk about 'sunk costs' – what is behind us is behind us – and the real focus has to be on opportunity costs and change at the margin. I am amazed that in ecology and environmental science we still use pre-European Australia as a benchmark. Economists would say, 'Forget about that. Look what you have today. Talk about what you want and where you want to go. Where you have been, unless there is some social reason or something there that you really want to have, don't go back and worry about it. That's history, the past.' Having a benchmark and talking about things in terms of percentage natural, which is percentage 1777, creates massive communication problems, and I think builds data sets that economists can't use. So we never get to integrate. Economists want to look to the future; a lot of scientists want to go back and do science of the past.

A lot of the principles are well known too. We know we have to improve property rights and specify them completely and, I would say, honestly. Australia specifies very few of its property rights honestly. You have to read the super-superfine print to find out what the property rights really mean. We talk about fixed 'allocations' for water, not 'shares', which tell people it might change because the climate might change in the future. If we have less water, clearly you only have a share of what is there, not a guaranteed claim to fiction.

We know we have to make polluters pay. Australia signed off at the OECD back in 1972 and promised to make polluters pay. We just haven't got around to doing it yet.

We know we have to internalise externalities, but we don't do it. Because we haven't got governance in the debate, we don't know how to do what we know we have to do if we are actually serious about sustainable development.

There are a lot of problems that still exist. We don't know how to value the market, we don't know how to talk about economics of communities. Economists sum up all the individuals and assume the sum of the individuals is what we need to worry about, and don't talk about communities and communities as a separate entity. We don't know how to talk about long-term decisions, about trade-offs between 300 years, 400 years and 500 years. Salinity is really what that's about. And we have to understand and talk about distribution of wealth and equity among people and between generations or among them. We don't know how to do that. We also don't yet have agreement on what we are really after, which is part of the debate.

Ecological and economic truth?

We know that we have to tax the 'bads' and not the 'goods', but we don't do it. Our tax framework in Australia doesn't do that. We know that we have to go to full-cost pricing, but we don't do it. We know we have to have tradeable rights, without misleading names, but we don't do it. We need to signal clearly. If we were really concerned about long-term infrastructure, we would have a system where people who lived in sustainable houses would pay slightly less tax, just to give clear signals about what we wanted. We don't do those sorts of things.

So with salinity, for example, if we really wanted to solve the problem, all we would need to do is to ask every farmer to complete a recharge account every year and to calculate how much salt they put into the aquifers through groundwater rise, and charge them accordingly. The Dutch already do this and have been doing it for 10 years, for nitrate pollution of groundwater, because they came to the conclusion they had to solve the problem. The technology is there but we still let our farmers go on doing it, debating the science of whether or not we know how to fix it. We could fix it. We just don't want to.

Gaps and opportunities

Three gaps, three opportunities. One is integration of the social and economic sciences. We haven't thought about how to do that. It's a real challenge. The science doesn't know how to do it. We need to then take those two and combine them with the biophysical science, and build models that do that. And we don't know how to do that yet. There are some brave attempts being done, but it is only just starting. And somehow we have to reduce all the complexity that I have been talking about so we can model the bottom-line outcomes, and model it with confidence, which we can't yet do, so that we can govern in the same style – also with confidence.

Questions/discussion

Question: I wonder can I be a bit provocative, in a sense. I am really interested by the idea of, if you will, setting a baseline where the baseline is now, and presumably on that philosophical stance the baseline keeps continually moving. The provocative comment I would make, in a sense, is that much of economic theory to a non-economist seems to be based on what an ecologist would call an R-strategy, basically a density-independent process, which ultimately leads to growth, then collapse, and then further growth, where much of sustainability an ecologist would see as being a K-strategy, a density-dependent function, where resources are limited and you have to constrain yourself within that particular line.

I wonder, in terms of the shifting base, if we have a reference point that is not completely defined, whether in fact we just have a continually moving argument and perhaps that difference between the R and K view of the universe is where the lack of communication between economists and scientists, or ecologists, is occurring.

MY: I agree with your assessment to some extent. The baseline is now. Most economists and most economic models will, though, ground themselves in the recent past. Some of them don't; some of them also ground themselves in some models and aims and plans of where you could be.

I think there is a compromise, which is looking recently at where we are, but we do need data so that we can start to link the two together. In the National Land and Water Resources Audit a decision was made politically only to collect data on vegetation prior to European settlement and vegetation now, not to collect data on changes in vegetation in the last 10 years or the last 20 years, because it would be too dangerous politically to have such data sets around.

If you ask an economist to model where Australia is going and to take account of what is happening, you need to assemble data sets that are about where we are today, in a way that you can build trends forward. And that is really what I am saying, to have a baseline which starts from now, but in five years' time the decisions which we have made will change that baseline. We can't re-run history.

Question: I really do think that settling these objective functions is of very high importance, because otherwise we really have no measure of where we are going. It seems to me that the objective functions should be the sum of the individual economic welfares but also, added to that, the discounted evaluation of expected future welfare.

When you spoke of the genuine progress indicator and said you would deduct the defensive expenditure on health, having something like that alone is obviously inappropriate because the expenditure on health can affect the future welfare. So I think you really have to have the present sum of the individual economic welfares plus that discounted evaluation of the future.

MY: Can I just add to that? I am not going to try and actually defend that model at the moment. I don't think that's my role; it's someone else's model.

Increasingly, in the work that I do, largely in water and natural resource policy, I am being told that there is a thing called the 'community', which is different from the sum of individuals. And I am now, as a professional economist, worrying about how I do economics of communities other than the sum of the individuals. I sense that what people are saying to me is there is another branch of algebra – I might call it economics, but another calculus and another way of thinking – which is about thinking about community, and communities through time.

Question: I've got a somewhat related question. I hear economists talking all the time about the 'bottom line', and reducing everything to a single index such as the GDP. How is it possible to have a single index for a very complex system? There is not a single science that reduces itself to a single index. Take any of the sciences and look at the indexes that they have to use: they've got a multitude of them. They interrelate in various ways. So how can economics ever become a science if it restricts itself to a single index?

MY: Economists don't try and reduce economics to a single indicator. I think this needs to be understood. I think an informed economist would explain economic policy as being like flying an aeroplane. If you're sitting in the back, you just want to know if it gets there on time and you want to feel happy and not sweating when you get there. Up the front, the people who are running the economy are like the pilots and they have hundreds of dials there, some that they look at occasionally, some that they look at all the time. One of the most important ones is how fast you are going, because if you go too fast your wings fall off, if you go too slowly you crash. Speed is very important. And GDP is the speedo of the economy. No economist would supply policy advice on the basis of one indicator. It is a reporting indicator, in the same way that often it is very useful to know how fast a car is going. And that's all it does. But economists use lots of other indicators, lots of accounting structures and lots of techniques before they give advice.

Question: I suppose in recent years there has been a move to deregulation, particularly in agriculture. You talked about internalising costs in terms of industry at the macro level. At the micro level, I suppose, then, we are going to move to internalising costs for the individual. Do you see that there is going to be an increase in the regulation of pricing, in future years?

MY: I think we will move towards internalising costs by actually taking prices that markets set and adding bits on top. There will be a lot of instruments used to do that. Some will work through licensing-type arrangements and through standards, rather than through direct charges and costs.

The problem with our political system at the moment is that whenever you set a levy or a charge you can't change it when circumstances change. I worked for a while in the OECD and I got very excited as a young scientist at the time, thinking about how Germany could solve its nitrate pollution charges with a simple nitrate tax. We worked it out and our advice was a certain percentage – I've forgotten what the percentage was. Just after we'd finished it and released the paper, there was an oil shortage around the world and the price of oil doubled very quickly. That meant the price of fertiliser jumped, because fertilisers are essentially made from oil, and it meant that we had to then double the tax. We sat down and asked the question: Would a minister, having announced a horrible tax on fertilisers this week, go out a month later and say, 'I'm sorry, I've now got to double the tax again because the world has changed'? So I don't think pricing and putting extra charges on, and regulatory pricing, is going to solve a lot of the problems.

In some areas it is important. The really challenging bit is to get the signals into the things we invest in long-term that impose rigid costs. I think particularly of houses, the way we construct sewerage systems, the way we construct roads, railways, and so forth. We are stuck with that; we get opportunities to change them very occasionally. When we meet one of those opportunities, if we miss the chance then, we actually miss it for another 100 years.

So I would hope that the focus will be on the fundamental structures of society, and the signals for the things that last for a long time, because that is very important.