Hardisty Environmental and Economic Sustainability Ch 3

Quantifying Sustainability for Improved Decision Making

• The global crisis of sustainability is a direct result of an economic system that has not kept up with the realities of this new century.
• The fundamental problem is embedded in how we measure national and global economic success: gross domestic product (GDP) and global product (GP).
• GDP and GP represent the value of market-traded goods and services produced in an economy.
• Business and industry measure their success in the same fundamental way as GDP.
• Decision making that balances environment, society, and economy is essential for a solution.

The Problem with GDP

• Gross domestic product (GDP) is the de facto measure of wealth, well-being, and progress in our society.
• GDP measures the total value of market-traded goods and services produced and consumed in the economy in a given year.
• GDP equates to the total income earned and spent by consumers in that same year.
• Governments worldwide use GDP to assess their economies' performance.
• "Growth" refers to a net annual increase in GDP.
• A slowing rate of GDP growth over a year is called a recession.
• The global financial crisis (GFC) of 2008–2009 saw the largest contraction in economic activity (measured by GDP) since the Great Depression.
• A massive spending spree was triggered to "stimulate" the economy, with spending over a 2-year period comparable to what the OECD estimates is needed to decarbonize the world's economy and prevent the worst effects of climate change (over US$4 trillion).
• If GDP is not increasing year after year, there is panic.

Promoting Unsustainable Behavior

• GDP is a poor measure of real wealth, well-being, and happiness in society.
• It assumes that only things traded in the market economy contribute to well-being, excluding externalities.
• When the Exxon Valdez spilled oil, Alaska's GDP increased due to cleanup spending, but the death of wildlife and environmental damage were not reflected.
• GDP does not include the value of unpaid labor (raising children, caring for family, housework, volunteering).
• Governments pushing unpaid workers into the labor force is an easy way to increase GDP statistics.
• GDP does not account for the external costs of economic activity (environmental or social damage).
• China's GDP growth in 2003 was strong, but the cost of polluted rivers/lakes, biodiversity loss, and health impacts was estimated at almost 4% of GDP.
• The value of environmental damage should be subtracted from GDP.
• GDP counts expenditure used to protect ourselves against environmental damage as a positive.
• Medical care for pollution-related illnesses is counted positively in GDP.
• Defensive measures like bottled water, increased holiday travel, and environmental remediation efforts boost GDP.
• Such expenditure is like digging a hole, filling it again, and calling it productive work.
• GDP does not account for depreciation of natural capital.
• Depletion of natural resources means we are worse off, but this is not reflected in GDP.
• As we use up petroleum reserves, erode topsoil, or mine biodiversity, these losses are not reflected in our calculus of well-being.
• Dedication to the GDP concept promotes unsustainable behavior by ignoring costs, giving credit to repair efforts, not recognizing unpaid work, and turning a blind eye to mining natural capital.

A More Sustainable Alternative: Net National Welfare

• Many economists promote an adjusted measure of economic success: net national welfare (NNW).
• NNW adjusts GDP upward for nonmarket efforts, consumption, and capital services.
• NNW subtracts all costs of economic growth (defensive costs and externalities).
• NNW removes depreciation of natural and created capital.
• The genuine progress indicator (GPI) provides a similar adjustment.
• In 2004, the GDP of the United States was $US\$10.8$ trillion, but the GPI was only $US\$4.4$ trillion.
• Adjusted versions of GDP would alter our notions of progress and growth, and almost surely our behavior would change.
• This chapter builds on adjusting economics to account for externalities and capital depreciation at a microeconomic level.

From Macro to Micro

• Microeconomic project and policy decision-making systems reflect the macroeconomic bias embedded in GDP.
• Project and business decisions are based on a narrow view of net present value (NPV), excluding external costs or benefits.
• Economic analysis at the core of decision-making places no value on the environment or society.
• Only revenue produced and market costs incurred matter.
• Under these conditions, external issues are relegated to a secondary, qualitative position.
• Issues quoted in nonmonetary units make trade-offs difficult and their relative importance hard to understand.
• Business-as-usual (BAU) decision making remains largely unaffected by sustainability.
• Traditional NPV-based economics continues to hold primacy, and environmental and social issues are not considered on an equal footing with the financial.
• Because national and global economies are the sum of individual project and policy decisions, the net result is a global deterioration of our environment and an ever-more-unsustainable world.
• Economists justify an expenditure based on the anticipated benefits resulting from that expenditure. If the benefits accruing to society (including the proponent) from a project exceed the costs of implementation, then the project is worth doing.

How Industry Makes Decisions

• Economics in industry is often defined in terms of project NPV: the time-discounted profit that a project is expected to generate for the company.
• Profit is defined as expected proceeds from the sale of the commodity on the open market minus capital expenditures (CAPEX) and operating expenditures (OPEX) over the project lifetime.
• This "economic" analysis is done purely from the perspective of the company.
• No issues external to the company, other than those regulated by government (taxes, royalties, or penalties), are included.
• Damages to the environment (e.g., greenhouse gas emissions) are not included in the analysis.
• What the private sector calls an economic analysis is actually a financial analysis.
• An economic analysis requires a complete evaluation of all costs and benefits accruing to all segments of society.
• A financial analysis is inherently skewed since potentially significant costs and benefits that the company does not directly experience are not included.
• Misconstruing the financial for the economic means that important social and environmental price signals are not available to decision makers.
• People cannot make rational decisions with incomplete information.
• What has been missing is the value of common environmental and social assets (measured and expressed in monetary units).

Economic Quantification of Sustainability

• A lack of transparent and complete accounting is at the heart of the sustainability problem.
• A shift in behavior and significant improvements in sustainability can be triggered by changing the way we assess policies, projects, and investments.
• Sustainability can be defined more rigorously and usefully through full social and environmental economic analysis.
• The concept of the environmental and economic sustainability assessment (EESA) is introduced.
• EESA is a whole life-cycle, physically based economic analysis designed to integrate sustainability into decision making quantitatively and objectively.
• To do this, the following are needed:
  1. Set the objective of the assessment.
  2. Determine a range of practical options for meeting that objective.
  3. Identify environmental and social assets at risk or impacted.
  4. Quantify the damage done to those assets in physical terms.
  5. Quantify the benefits that accrue to society and the environment.
  6. Estimate monetary values for each of the external environmental and social assets affected.
  7. Apply monetary values to the physical estimates of impact and benefit.
  8. Combine the external valuation of costs and benefits with the traditional financial costs and benefits.
  9. Compare the socioeconomic NPV to the financial NPV.
  10. Compare a range of options designed to achieve an outcome, in terms of their overall socioeconomic and financial NPVs, to identify an economically optimum solution.
  11. Conduct sensitivity analysis.
  12. Select the option that provides maximum overall net benefit over the widest range of likely future conditions and values for key assets.
• EESA allows balancing the financial, environmental, and social implications of a project or policy decision.

An Economic Definition of Sustainability

• This approach provides a useful, quantitative definition of sustainability.

• It moves away from qualitative definitions without compromising the ideals they represent.

• By explicitly valuing the environment and society and including them in the overall economic analysis, optimal decisions for all of society are revealed.

• An economic definition of sustainability:

  If over the long term a proposition delivers more benefit than cost over its complete life cycle, when all environmental, social, and economic factors are taken into account, using a socially acceptable discount rate, then the proposition is sustainable.

• If costs exceed benefits, the project is unsustainable.

• EESA will eventually drive society to recognize that the expenditure of time, effort, energy, and materials is simply not worth it.

A Double-Edged Sword

• If the benefits accruing to society from a project exceed the costs of implementation, then the project is worth doing.
• Therefore, environmental protection spending should relate to the value of the resulting benefits.
• If costs vastly exceed benefits, society loses.
• By explicitly valuing natural resources, appropriate restoration and protection expenditure levels can be determined.
• Common goods are much less likely to be treated as worthless if valued.

The Externalities Can Be Worth a Lot

• The application of economic tools to the environment is a relatively new approach.
• The total annual value of services provided by the world’s biosphere has been estimated to be as much as $US\$33$ trillion, more than the world’s combined conventional annual GP.
• Regulatory impact assessment (RIA), now required within the European Union and the United States, explicitly considers the economic costs and benefits of a new policy or regulation.

An Illustration: The NPV-Internal Rate of Return Trap

• Many firms require that process and equipment modification to achieve reductions in energy consumption or reuse waste heat meet financial