What Should We Demand from Our Economy?

✑ ROBIN ERIC HAHNEL | 13,789 words
‟The criteria for comparing the desirability of economic systems are…

If another world is possible, including another economic system, what characteristics of the current economy should we oppose and what alternative economic system should we be demanding? Hahnel begins to answer this question in this long read (13789 words) in which he argues that an economic system should provide: (1) economic justice (2) efficiency (3) self-management (4) solidarity (5) variety and (6) sustainability.

Robin Eric Hahnel (1946) is Professor Emeritus of Economics at American University in Washington DC. He has published on marxian economics, liberating theory, economic crises , ecological issues and “participatory economics”. He has frequently contributed to Znet and is the co-director of Economics for Equity and the Environment.

Originally published as chapter two of Hahnel's book The ABC's of Political Economy: A Modern Approach (2014) by Pluto Press (a radically progressive publisher), a book which is "lucidly written, comprehensive in coverage, based on expert understanding and insight" (says Noam Chomsky).

It is easy enough to say we want an economy that distributes the burdens and benefits of social labor fairly, that allows people to make the decisions that affect their economic lives, that develops human potentials for creativity, cooperation and empathy, and that utilizes human and natural resources efficiently and sustainably. But what does all this mean more precisely?

1. Economic Justice

Is it necessarily unfair when some work less or consume more than others? Do those with more productive property deserve to work less or consume more? Do those who are more talented or more educated deserve more? Do those who contribute more, or those who make greater sacrifices, or those who have greater needs deserve more? By what logic are some unequal outcomes fair and others not?
    Equity takes a back seat to efficiency for most mainstream economists, while the issue of economic justice has long been a passion of political economists. From Proudhon’s provocative quip that “property is theft,” to Marx’s three volume indictment of capitalism as a system based on the "exploitation of labor," economic justice has been a major theme in political economy. After reviewing evidence of rising economic inequality within the United States and globally, we compare conservative, liberal and radical views of economic justice, and explain why political economists condemn most of today’s growing inequalities as escalating economic injustice.

Increasing Inequality of Wealth and Income

I introduced this section in the 2002 edition saying: “As we begin the twenty-first century, escalating economic inequality makes all other economic changes pale in comparison. The evidence of increasing wealth and income inequality is overwhelming.” While progressives lamented this trend, the major media, politicians in both the Democratic and Republican parties alike, and the mainstream of the economics profession ignored or belittled the issue. A dozen years, and a major economic crisis later, rising inequality continues unabated. However, it is no longer the case that few take notice. If Occupy Wall Street accomplished nothing else, it put this historic increase in economic inequality at front and center of public discourse. As a matter of fact, the Occupy slogan referring to the fact that the top 1% had captured almost all productivity gains for decades, leaving the bottom 99% no better off than they had been a generation earlier, turned out to be an understatement! Once attention was drawn to the issue, it turned out that it was the top one tenth of the top 1% who had managed to appropriate the lion’s share of all productivity gains in the US economy for decades. I have left intact my summary of the evidence on increasing inequality published in the 2002 edition to show that what political economists had clearly documented by 2000 should have been more than enough to set off alarm bells a full decade before they finally went off in 2011. After which I have added a brief factual update on the first decade of the twenty-first century showing that despite the greatest economic crisis in eighty years rising inequality has continued unabated.
    In a study published in 1995 by the Twentieth Century Fund, Edward Wolff concluded:

Income inequality has increased over the past twenty years. Upper-income groups have continued to do well while others, particularly those without a college degree and the young have seen their real income decline. The 1994 Economic Report of the President refers to the 1979-1990 fall in real income of men with only four years of high school -- a 21% decline -- as stunning. But the growing divergence evident in income distribution is even starker in wealth distribution. Equalizing trends of the 1930s-1970s reversed sharply in the 1980s. The gap between haves and have-nots is greater now than at any time since 1929.1

In 2000 Chuck Collins and Felice Yeskel reported: “In 1976, the wealthiest one percent of the population owned just under 20% of all the private wealth. By 1999, the richest 1 percent’s share had increased to over 40% of all wealth.” And they calculated that in the twenty-one years between 1976 and 1997 while the top 1% of wealth holders doubled their share of the wealth pie the bottom 90% saw their share cut almost in half.2 In 1995 the Center for Popular Economics reported that between 1983 and 1989 the average wealth of households in the United States grew at an annual rate of 3.4% and the average financial wealth of households grew at 4.3% after being adjusted for inflation. But the top 1% of wealth holders captured an astounding 66.2% of the growth in financial wealth, the next 19% of wealth holders captured 36.8%, and the bottom 80% of wealth holders in the U.S. lost 3.0% of their financial wealth. As a result the top 1% increased their share of total wealth in the US from 31% to 37% in those six years alone, and by 1989 the richest 1% of families held 45% of all nonresidential real estate, 62% of all business assets, 49% of all publicly held stock, and 78% of all bonds.3

    In 1994 Lawrence Mishel and Jared Bernstein estimated that

most wealth growth arose from the appreciation (or capital gains) of pre-existing wealth and not savings out of income. Over the 1962 to 1989 period, roughly three-fourths of new wealth was generated by increasing the value of initial wealth -- much of it inherited.4 

The bi-annual economic report of the Economic Policy Institute concluded that the same pattern emerges when we look to see who benefited from the stock market boom between 1989 and 1997. The top 1% of wealth holders captured an astonishing 42.5% of the stock market gains over those years, the next 9% of wealth holders captured an additional 43.3% of the gains, the next 10% captured 3.1%, while the bottom 80% of wealth holders captured only 11% of the stock market gains.5
    The Economic Policy Institute reported its 1994-95 edition that while growing wealth inequality had been more dramatic, income inequality had been growing as well. Real wages fell starting in the mid 1970s to where the average hourly wage adjusted for inflation was lower in 1994 than it had been in 1968. And this decline in real hourly wages occurred despite continual increases in productivity per hour. Between 1973 and 1979 productivity rose at an annual rate of 0.6% while hourly wages fell by 0.1%; between 1979 and 1983 productivity rose by 1% per year and hourly wages rose by 1.1%; between 1983 and 1989 productivity rose by 0.8% and wages rose by 0.2%; and between 1989 and 1992 productivity rose by 1.5% per year while hourly wages fell by 0.9% per year.6 Overall, between 1973 and 1998 labor productivity grew 33%. Collins and Yeskel calculated that if hourly wages had grown at the same rate as labor productivity the average hourly wage in 1998 would have been $18.10 rather than $12.77 – a difference of $5.33 an hour, or more than $11,000 per year for a full-time worker.7 Moreover, the failure of real wages to keep up with labor productivity growth has been worse for those in lower wage brackets. Between 1973 and 1993 workers earning in the 80th percentile gained 2.7% in real wages while workers in the 60th percentile lost 4.9%, workers in the 40th percentile lost 9.0%, and workers in the 20th percentile lost 11.7%, creating much greater inequality of wage income.8
    In contrast, I reported in the 2002 edition that corporate profit rates in the US in 1996 reached their highest level since these data were first collected in 1959. According to the Bureau of Economic Analysis the before-tax profit rate rose to 11.4% in 1996 yielding an eight year period of dramatic, sustained increases in corporate profits unparalleled in US history. Moreover, whereas previous periods of high profits accompanied high rates of investment and economic growth, the average rate of economic growth over these eight years was just 1.9% In short, whatever was good for corporate profits was clearly not so good for the rest of us.
    While there are a number of different ways to measure inequality, the most widely used is a statistic called the gini coefficient. A value of 0 corresponds to perfect equality and a value of 1 corresponds to perfect inequality. In the 2002 edition I reported that the gini coefficient for the US had increased by 18.3% between 1966 and 1993, and noted that this .68% average annual rate of increase was “remarkable” and “historically unprecedented.”
    I also wrote in 2002 that trends in global inequality were just as disturbing, if not more so. Walter Park and David Brat reported in a study of gross domestic product per capita in 91 countries that the value of the gini rose steadily from .442 in 1960 to .499 in 1988.9 In other words, between 1960 and 1988 there was an increase in the economic inequality between countries of 13%, which is an average annual increase of .72%.
Figure 2.1 Gini coefficients for US household income 1947 - 200510.

    What does more recent data show? A quick check of the most recent data on the gini coefficient for the US shows that the “unprecedented” average annual rate of increase of .68% a year from the mid 1960s to the early 1990s has continued unabated. According to recent UN data the US gini coefficient increased from .428 in 1990 to .470 in 2006, which is an average annual increase of .60% a year. According to the latest World Bank estimates of gini coefficients for income for the entire world the most rapid rise in world history dating back to 1820 took place between 1980 and 2002, after which relatively strong economic performances in a few large developing countries like China, Brazil, and India seem to have slowed the trend.11
Figure 2.2 Real average hourly compensation and productivity growth 2000 – 201312

Nor is it hard to identify why inequality has continued to rise in the US since 2000. Despite increases in productivity wages have continued to stagnate so that profits have continued to grow. We can break the period from 2000-2012 into the pre-crisis boom period from 2000-2007, and the period after the crisis hit, for 2007-2012. In the pre-crisis “boom” productivity rose by 16% but average compensation rose by only 9.4%. Since the crisis productivity has risen by only 7.7% but average compensation has risen by only 0.9%. Over the entire 12 year period productivity rose by 24.9% but average hourly compensation rose by only 10.4%.13 In contrast, according to data from the Bureau of Economic Analysis pre-tax US corporate profits as a percentage of GDP rose from 7% in 2000 to just over 12% -- a record high -- in 2007. When the crisis hit they fell back to 7% in 2009, but then rose just as quickly back to a new record high of 12.6% in the final quarter of 2011 and remained high ever since.14 In short, since 2000 wages have lagged far behind productivity while profits have soared, and while profits recovered quickly and spectacularly from the crisis, wages have hardly recovered at all.
    So the facts are clear: We have experienced an increase in economic inequality that is not only “reminiscent of the Robber Baron era,” as I wrote in 2002, but now surpasses it. Nor did the greatest economic crisis in over eighty years reverse the trend. We are now ready to face the more difficult question of when unequal outcomes are also inequitable, and when they are not -- which has long been a subject of much controversy.

Different Conceptions of Economic Justice

The subject of economic justice can be formulated as follows: What is an equitable distribution of the burdens and benefits of economic activity? Philosophers, economists, and political scientists have offered three different distributive maxims attempting to define equity, which we can think of as the conservative, liberal, and radical definitions of economic justice.

Conservative Maxim 1: Payment according to the value of one’s personal contribution and the contribution of the productive property one owns.

The rationale behind the conservative maxim is that people should get out of an economy what they and their productive possessions contribute to the economy. If we think of the goods and services, or benefits of an economy, as a giant pot of stew, the idea is that individuals contribute to how big and rich the stew will be by their labor and by the productive assets they bring to the kitchen. If my labor and productive assets make the stew bigger or richer than your labor and assets, then according to maxim 1 it is only fair that I eat more stew, or richer morsels, than you do.
    While this rationale has obvious appeal, it has a major problem I call the Rockefeller grandson problem. According to maxim 1 the grandson of a Rockefeller with a large inheritance of productive property should eat 1000 times as much stew as a highly trained, highly productive, hard working son of a pauper -- even if Rockefeller’s grandson doesn't work a day in his life and the pauper’s son works for fifty years producing goods or providing services of great benefit to others. This will inevitably occur if we count the contribution of productive property people own, and if people own different amounts of machinery and land, or what is the same thing, different amounts of stocks in corporations that own the machinery and land, since bringing a cooking pot or stove to the economy “kitchen” increases the size and quality of the stew we can make just as surely as peeling more potatoes and stirring the pot more does. So anyone who considers it unfair when the idle grandson of a Rockefeller consumes more than a hard working, productive son of a pauper cannot accept maxim 1 as the definition of equity.
    A second line of defense for the conservative maxim is based on a vision of “free and independent” people, each with his or her own property, who, it is argued, would refuse to voluntarily enter a social contract on any other terms. This view is commonly associated with the writings of John Locke. But while it is clear why those with a great deal of productive property in Locke’s imaginary “state of nature” would have reason to hold out for a social contract along the lines of maxim 1, why would not those who wander the state of nature with little or no productive property in their backpacks hold out for a very different arrangement? If those with considerable wherewithal can do quite well for themselves in the state of nature, whereas those without cannot, it is not difficult to see how requiring unanimity would drive the bargain in the direction of maxim 1. But then maxim 1 is the result of an unfair bargaining situation in which the rich are better able to tolerate failure to reach an agreement over a fair way to assign the burdens and benefits of economic cooperation than the poor, giving the rich the upper hand in negotiations over the terms of the social contract. In this case the social contract rationale for maxim 1 loses moral force because it results from an unfair bargain. This suggests that unless those with more productive property acquired it through some greater merit on their part, the income they accrue from this property is unjustifiable, at least on equity grounds. That is, while the unequal outcome might be desirable for some other reason such as improving efficiency or economic freedom, it would not be just or fair. In which case maxim 1 must be rejected as a definition of equity if we find that those who own more productive property did not come by it through greater merit.
    One common way people acquire productive property is through inheritance. But it is difficult to see how those who inherit wealth are more deserving than those who don’t. It is possible the person making a bequest worked harder or consumed less than others in her generation, and in one of these ways sacrificed more than others. Or it is possible the person making the bequest was more productive than others. And we might decide that greater sacrifice or greater contribution merited greater reward. But in these scenarios it is not the heir who made the greater sacrifice or contribution, it is the person who made the bequest, so the heir would not deserve greater wealth on those grounds. As a matter of fact, if we decide rewards are earned by sacrifice or personal contribution, inherited wealth violates either norm since inheriting wealth is neither a sacrifice nor a personal contribution. A more compelling argument for inheritance is that banning inheritance is unfair to those wishing to make bequests rather than that it is unfair to those who would receive them. One could argue that if wealth is justly acquired it is wrong to prevent anyone from disposing of it as they wish – including bequeathing it to their descendants. However, it should be noted that any “right” of wealthy members of older generations to bequeath their gains to their offspring would have to be weighed against the “right” of people in younger generations to start with “equal economic opportunities.”15 Indeed, these two “rights” are obviously in conflict, and some means of adjudicating between them is required. But no matter how this matter is settled, it appears that those who receive income from inherited wealth do so unfairly.
    A second way people acquire more productive property than others is through good luck. Working or investing in a rising or declining company or industry constitutes good luck or bad luck. But unequal distributions of productive property that result from differences in luck are not the result of unequal sacrifices, unequal contributions, or any difference in merit between people. Luck, by its very definition is not deserved, and therefore the unequal incomes that result from unequal distributions of productive property due to differences in luck appear to be inequitable as well.
    A third way people come to have more productive property is through unfair advantage. Those who are stronger, better connected, have inside information, or are more willing to prey on the misery of others can acquire more productive property through legal and illegal means. Obviously if unequal wealth is the result of someone taking unfair advantage of another it is inequitable.
    The last way people might come to have more productive property than others is by using some income they earned fairly to purchase more productive property than others can. What constitutes fairly earned income is the subject of maxims 2 and 3 which we discuss below. But there is a difficult moral issue regarding income from productive property even if the productive property was purchased with income we stipulate was fairly earned in the first place. In chapter 3 we will discover that labor and credit markets allow people with productive wealth to capture part of the increase in productivity of other people that results when other people work with the productive wealth. Whether or not, and to what extent the profit or rent owners of productive wealth initially receive is merited we will examine very carefully. But even if we stipulate that some compensation is justified by a meritorious action that occurred once in the past, it turns out that labor and credit markets allow those who own productive wealth to parlay it into permanently higher incomes which increase over time with no further meritorious behavior on their parts. This creates the dilemma that ownership of productive property even if justly acquired may well give rise to additional income that, while fair initially, becomes unfair after some point, and increasingly so. The simple corn model we explore in chapter 3 illustrates this moral dilemma nicely.
    In sum, if unequal accumulations of productive property were the result only of meritorious actions, and if compensation ceased when the social debt was fully repaid, using words like “exploitation” to describe payments to owners of productive property would seem harsh and misleading. On the other hand, if those who own more productive property acquired it through inheritance, luck, unfair advantage, -- or because once they have more productive property than others they can accumulate even more with no further above-average meritorious behavior by using labor or credit markets -- then calling the unequal outcomes that result from differences in wealth unfair and exploitative seems perfectly appropriate.
    Most political economists believe a compelling case can be made that differences in ownership of productive property which accumulate within a single generation due to unequal sacrifices and/or unequal contributions people make themselves are small compared to the differences in wealth that develop due to inheritance, luck, unfair advantage, and accumulation. Edward Bellamy put it this way in Looking Backward written at the close of the nineteenth century:

You may set it down as a rule that the rich, the possessors of great wealth, had no moral right to it as based upon desert, for either their fortunes belonged to the class of inherited wealth, or else, when accumulated in a lifetime, necessarily represented chiefly the product of others, more or less forcibly or fraudulently obtained.

One hundred years later Lester Thurow estimated that between 50 and 70 percent of all wealth in the US is inherited. Daphne Greenwood and Edward Wolff estimated that 50-70% of the wealth of households under age 50 was inherited. Laurence Kotlikoff and Lawrence Summers estimated that as much as 80% of personal wealth came either from direct inheritance or the income on inherited wealth.16 A study published by United for a Fair Economy in 1997 titled “Born on Third Base” found that of the 400 on the 1997 Forbes list of wealthiest individuals and families in the US, 42% inherited their way onto the list; another 6% inherited wealth in excess of $50 million, and another 7% started life with at least $1 million. In any case, presumably what Proudhon was thinking when he coined the phrase “property is theft” was that most large wealth holders acquire their wealth through inheritance, luck, unfair advantage, or unfair accumulation. A less flamboyant radical might have stipulated that he was referring to productive, not personal property, and added the qualification “property is theft -- more often than not.”

Liberal Maxim 2: Payment according to the value of one’s personal contribution only.

While those who support the liberal maxim find most property income unjustifiable, advocates of maxim 2 hold that all have a right to the “fruits of their own labor.” The rationale for this has a powerful appeal: If my labor contributes more to the social endeavor it is only right that I receive more. Not only am I not exploiting others, they would be exploiting me by paying me less than the value of my personal contribution. But ironically, the same reason for rejecting the conservative maxim applies to the liberal maxim as well. Economists define the value of the contribution of any input as the “marginal revenue product” of that input. In other words, if we add one more unit of the input in question to all of the inputs currently used in a production process, how much would the value of output increase? The answer is defined as the marginal revenue product of the input in question. But mainstream economics teaches us that the marginal productivity, or contribution of an input, depends as much on the number of units of that input available, and on the quantity and quality of other, complimentary inputs, as on any intrinsic quality of the input itself -- which undermines the moral imperative behind any “contribution based” maxim -- that is, maxim 2 as well as maxim 1. But besides the fact that the marginal productivity of different kinds of labor depends mostly on the number of people in each labor category in the first place, and on the quantity and quality of non-labor inputs available for use, most differences in people’s personal productivities are due to intrinsic qualities of people themselves which cannot be traced to differential sacrifices. No amount of eating and weight lifting will give an average individual a 6 foot 9 inch frame with 350 plus pounds of muscle. Yet professional football players in the United States receive hundreds of times more than an average salary because those attributes make their contribution outrageously high in the context of US sports culture. The famous British political economist, Joan Robinson, pointed out long ago, that however “productive” a machine or piece of land may be, that hardly constitutes a moral argument for paying anything to its owner. In a similar vein one could argue that however “productive” a high IQ or a 350 pound physique may be, that doesn't mean the owner of this trait deserves more income than someone less gifted who works as hard and sacrifices as much. The bottom line is that the “genetic lottery” greatly influences how valuable one’s personal contribution will be. Yet the genetic lottery is no more fair than the inheritance lottery -- which implies that as a conception of economic justice maxim 2 suffers from a similar flaw as maxim 1.17
    In defense of maxim 2 it is frequently argued that while talent may not deserve reward, talent requires training, and herein lies the sacrifice that merits reward -- doctor’s salaries are compensation for all the extra years of education. But longer training does not necessarily mean greater personal sacrifice. It is important not to confuse the cost of someone’s training to society -- which consists mostly of the trainer’s time and energy, and scarce social resources like books, computers, microscopes, libraries, and classrooms -- with the personal sacrifice of the trainee. If teachers and educational facilities are paid for at public expense -- that is, if we have a universal public education system -- and if students are paid a living stipend -- so they forego no income while in school -- then the personal sacrifice of the student consists only of their discomfort from time spent in school. But even the personal suffering we endure as students must be properly compared. While many educational programs are less personally enjoyable than time spent in leisure, comparing discomfort during school with comfort during leisure is not the relevant comparison. The relevant comparison is with the discomfort others experience who are working instead of going to school. If our criterion is greater personal sacrifice than others, then logic requires comparing the student’s discomfort to whatever level of discomfort others are experiencing who work while the student is in school. Only if schooling is more disagreeable than working does it constitute a greater sacrifice than others make, and thereby deserve reward. So to the extent that education is paid for publicly rather than privately, and the personal discomfort of schooling is no greater than the discomfort others incur while working, extra schooling merits no compensation on moral grounds.
   In sum, I call the problem with maxim 2 the “doctor-garbage collector problem.” How can it be fair to pay a brain surgeon who is on the first tee at his country club golf course by 2 PM even on the four days a week he works, ten times more than a garbage collector who works under miserable conditions forty plus hours a week, if education is free all the way through medical school?

Radical Maxim 3: Payment according to effort, or the personal sacrifices one makes.

Which brings us to the radical maxim 3. Whereas differences in contribution will be due to differences in talent, training, job assignment, luck, and effort, the only factor that deserves extra compensation according to maxim 3 is extra effort. By “effort” is meant personal sacrifice for the sake of the social good. Of course effort can take many forms. It may be longer work hours, less pleasant work, or more intense, dangerous, unhealthy work. Or, it may consist of undergoing training that is less gratifying than the training experiences of others, or less pleasant than time others spend working who train less. The underlying rationale for maxim 3 is that people should eat from the stew pot according to the sacrifices they made to cook it. According to maxim 3 no other consideration, besides differential sacrifice, can justify one person eating more stew than another.
    One argument for why sacrifice deserves reward is because people have control over how much they sacrifice. I can decide to work longer hours, or work harder, whereas I cannot decide to be 6 foot 9 or have a high IQ. It is commonly considered unjust to punish someone for something she could do nothing about. On those grounds paying someone less just because she is not large or smart violates a fundamental precept of fair play. On the other hand, if someone doesn't work as long or hard as the rest of us, we don't feel it is inappropriate to punish her by paying her less because she could have worked longer or harder if she had chosen to. In the case of reward according to effort, avoiding punishment is possible, whereas in the case of reward according to contribution it is largely not.
    Moreover, the "punishment" meted out by maxim 3 to those who make fewer sacrifices than others is not even social disapproval. There is no reason for society to frown on those who prefer to make fewer sacrifices as long as they are willing to accept less economic benefits to go along with their lesser sacrifice. There is no reason that just because people enter into a system of equitable cooperation with others this precludes leaving the sacrifice/benefit trade-off to personal choice. Maxim 3 simply balances any differences in the burdens people choose to bear with commensurate differences in the benefits they receive. I think this is the strongest argument for reward according to sacrifice. Even if all were not equally able to make sacrifices, extra benefits to compensate for extra burdens seems only fair. When people enter into economic cooperation with one another, for the arrangement to be just should not all participants benefit equally? Since each participant bears burdens as well as enjoys benefits, it is equalization of net benefits, i.e. benefits enjoyed minus burdens born, that makes the economic cooperation fair. So if some bear more of the burdens justice requires that they be compensated with benefits commensurate with their greater sacrifice. Only then will all enjoy equal net benefits. Only then will the system of economic cooperation be treating all participants equally, i.e. giving equal weight or priority to the interests of all participants. Notice that even if some are more able to sacrifice than others, the outcome for both the more and less able to sacrifice is the same when extra sacrifices are rewarded. In this way all receive the same net benefits from economic cooperation irrespective of any differences in their abilities to contribute or to sacrifice.
    Many who object to maxim 3 as a distributive principle raise questions about measuring sacrifice, or about conflicts between reward according to sacrifice and economic efficiency. But measurement problems, or conflicts between equity and efficiency are not objections to maxim 3 as a definition of what is fair, i.e. they are not objections to maxim 3 on equity grounds. To reject maxim 3 because effort or sacrifice may be difficult to measure, or because rewarding sacrifice may reduce efficiency is not to reject maxim 3 because it is unfair. No matter how weighty these arguments may prove to be, they are not arguments against maxim 3 on grounds that it somehow fails to accurately express what it means for the distribution of burdens and benefits in a system of economic cooperation to be just, or fair. Moreover, even should it prove that economic justice is difficult to achieve because it is difficult to measure something accurately, or costly to achieve because to do so generates inefficiency, one presumably would still wish to know exactly what this elusive or costly economic justice is.
    Even for those who reject contribution based theories of economic justice like maxims 1 and 2 as inherently flawed because people's abilities to contribute are different through no fault of their own, there is still a problem with maxim 3 from a moral point of view that I call the “AIDS victim problem.” Suppose someone has made average sacrifices for 15 years, and consumed an average amount. Suddenly they contract AIDS through no fault of their own. In the early 1990’s a medical treatment program for an AIDS victim often cost close to a million dollars. That is, the cost to society of providing humane care for an AIDS victim was roughly a million dollars. If we limit people’s consumption to the level warranted by their efforts, we would have to deny AIDS victims humane treatment, which many would find hard to defend on moral grounds.
    Of course this is where another maxim comes to mind: payment according to need. Whether taking differences in need into consideration is required by economic justice or is required, instead, for an economy to be humane is debatable. But as long as we conclude that ignoring either effort or need is morally indefensible it reduces to a question of semantics.

2. Efficiency

As long as resources are scarce relative to human needs and socially useful labor is burdensome, in part, efficiency is preferable to wastefulness. Political economists do not have to imitate our mainstream colleagues and concentrate on efficiency to the detriment of other important criteria such as economic justice and democracy in order to recognize that people have every reason to be resentful if their sacrifices are wasted or if limited resources are squandered.

The Pareto Principle

Economists usually define economic efficiency as Pareto optimality -- named after the late nineteenth century Italian economist Wilfredo Pareto. A Pareto optimal outcome is one where it is impossible to make anyone better off without making someone else worse off. The idea is simply that it would be inefficient or wasteful not to implement a change that made someone better off and nobody worse off. Such a change is called a Pareto improvement, and another way to define a Pareto optimal, or efficient outcome, is an outcome where which there are no further Pareto improvements possible.
    This does not mean a Pareto optimal outcome is necessarily wonderful. If I have 10 units of happiness and you have 1, and there is no way for me to have more than 10 unless you have less than 1, and no way for you to have more than 1 unless I have less than 10; then me having 10 units of happiness and you having 1 is a Pareto optimal outcome. But you would be right not to regard it very highly, and being a reasonable person, I would even agree with you. Moreover, there are usually many Pareto optimal outcomes. For instance, if I have 7 units of happiness and you have 6, and if there is no way for me to have more than 7 unless you have less than 6, and no way for you to have more than 6 unless I have less than 7; then me having 7 and you having 6 is also a Pareto optimal outcome. And we might both regard this second Pareto optimal outcome as better than the first, even though I am personally better off under the first. So the point is not that achieving a Pareto optimal outcome is necessarily wonderful -- that depends on which Pareto optimal outcome we have achieved. Instead the point is that non-Pareto optimal outcomes are clearly undesirable because we could make someone better off without making anyone worse off -- and it is “inefficient” or wasteful not to do that. In other words, it is hard to deny that there is something wrong with an economy that systematically yields non-Pareto optimal outcomes, i.e., fails to make some of its participants better off when doing so would make nobody worse off.
    It is important to recognize that the Pareto criterion, or definition of efficiency is not going to settle most of the important economic issues we face. Most policy choices will make some people better off but others worse off, and in these situations the Pareto criterion has nothing to tell us. Consequently, if economists confine themselves to the narrow concept of efficiency as Pareto optimality, and only recommend policies that are, in fact, Pareto improvements, we would be rendered silent on most issues! For example, reducing greenhouse gas emissions makes a lot of sense because the future benefits of stopping global warming and avoiding dramatic climate change far outweigh the present costs of reducing emissions. But since a relatively few people in the present generation will be made somewhat worse off no matter how we go about it, the fact that many more people in future generations will be much, much better off does not allow us to recommend the policy as a Pareto improvement -- that is, on efficiency grounds in the narrow sense.

The Efficiency Criterion

The usual way around this problem is to broaden the notion of efficiency from Pareto improvements to changes where the benefits to some outweigh the costs to others. This broader notion of efficiency is called the efficiency criterion and serves as the basis for cost benefit analysis. Simply put, the efficiency criterion says if the overall benefits to any and all people of doing something outweigh the overall costs to any and all people of doing it, it is “efficient” to do it. Whereas, if the overall costs to any and all people outweigh the overall benefits to any and all people of doing something it is "inefficient" to do it.
Figure 2.3 The Efficiency Criterion

    We can illustrate the efficiency criterion using a very useful graph. Suppose we knew the cost to society of growing each and every apple. That is, suppose we knew how much of society's scarce land, labor, fertilizer, etc. it took to grow each and every apple, and we also knew how much pesticide it took, and how much it "cost" society when more pesticide seeped into our ground water, etc. We call this the social cost of producing apples, and we call the social cost of the last (or next) apple produced the marginal social cost of apples, or MSC for short. Suppose we also knew the benefit to society of having another apple available to consume. The social benefit of the last (or next) apple consumed is called the marginal social benefit of apples, or MSB for short. Now let us assume that the more apples we have consumed already the less beneficial an additional apple will be, and the more apples we have produced already the more it costs society to produce another one. In this case if we plot the number of apples on the horizontal axis and measure the marginal social benefit and marginal social cost of apples on the vertical axis, the MSB curve will be downward sloping and the MSC curve will be upward sloping as it is in figure 2.3. What is incredibly useful about this diagram is it allows us to determine how many apples we should produce and consume, i.e. the socially efficient or "optimal" quantity of apples to produce, A(0). It is the amount where the marginal social cost, of producing the last apple, MSC is equal to the marginal social benefit from consuming the last apple, MSB. We can demonstrate that the socially efficient, or optimal level of apple production and consumption is the level below where the MSC and MSB curves cross by showing that any lower or higher level of production and consumption generates a decrease in net social benefits and therefore violates the efficiency criterion.
    Suppose someone thought we should produce fewer apples than the level where MSC equals MSB, such as A(1) < A(0). For any level of production less than A(0), such as A(1), what would be the effect of producing one more apple than we are already producing? To see what the additional cost to society would be, we go up from A(1) to the MSC curve. To see what the additional benefit to society would be we go up from A(1) to the MSB curve. But when we produce and consume at A(1) the MSB curve is higher than the MSC curve, indicating that producing and consuming another apple increases social benefits more than it increases social costs. In other words, there are positive net social benefits from expanding production and consumption of apples.
    Suppose someone thought we should produce more apples than the level where MSC equals MSB, such as A(2) > A(0). For any level of production greater than A(0), such as A(2), what would be the effect of producing one fewer apple than we are already producing? To see what the savings in social cost would be we go up from A(2) to the MSC curve. To see what the lost social benefit would be we go up from A(2) to the MSB curve. But when we produce and consume at A(2) the MSC curve is higher than the MSB curve indicating that producing and consuming one less apple reduces social benefits by less than it reduces social costs. In other words, there are potential positive net social benefits from reducing production and consumption of apples.
    The conclusion is for all A < A(0) we should expand apple production and consumption, and for all A > A(0) we should reduce apple production and consumption. Therefore the only level of apple production that is efficient from society's point of view is the level where the marginal social benefit of the last apple consumed is equal to the marginal social cost of the last apple produced, A(0). In any other case we could increase net social benefits by expanding or reducing apple production and consumption.
    Mainstream economists do not like to admit that policies recommended on the basis of the efficiency criterion are usually not Pareto improvements since they do make some people worse off. The efficiency criterion and all cost benefit analysis necessarily (1) “compares” different people’s levels of satisfaction, and (2) attaches “weights” to how important different people’s levels of satisfaction are when we calculate overall, or social benefits and social costs. Notice that when I stipulated that a few would be worse off in the present generation if we reduce greenhouse gas emissions while many will be benefited in the future I was attributing greater weight to the gains of the many in the future than the loses of a few in the present. I think it is perfectly reasonable to do this, and do not hesitate to do so. But I am attaching weights to the well being of different people -- in this case roughly equal weights, which I also believe is reasonable. If one refuses to attach weights to the well beings of different people the efficiency criterion cannot be used. I also stipulated that the benefits of preventing global warming to people in the future were large compared to the cost of reducing emissions to people in the present. I was willing to compare how large a gain was for one person compared to how small a loss was for a different person. If one refuses to compare the size of benefits and costs to different people the efficiency criterion cannot be used. In other words, unlike the narrow Pareto principle, the efficiency criterion requires comparing the magnitudes of costs and benefits to different people and deciding how much importance to attach to the well being of different people.
    Put differently, it requires value judgments beyond what are required for the Pareto criterion. So when mainstream economists pretend they have imposed no value judgments, and have separated efficiency from equity issues when they apply cost benefit analysis and recommend policy based on the efficiency criterion they misrepresent themselves. While a Pareto improvement makes some better off at the expense of none -- and therefore does not require comparing the sizes of gains and losses to different people or weighing the importance of well being to different people -- policies that satisfy the efficiency criterion generally make some better off precisely at the expense of others, which necessarily requires comparing the magnitudes of costs and benefits to different people and making a value judgment regarding how important the interests of the “winners” are compared to the interests of the “losers.”
    Mainstream economists like to point out that if a policy passes the efficiency criterion that means the magnitude of benefits enjoyed by the winners is necessarily larger than the magnitude of costs suffered by the losers, which means it would be theoretically possible for the winners to fully compensate the losers and still be better off themselves. But first, this requires a comparison of the magnitude of gains to some compared to the magnitude of loses to others – already a large step beyond the narrow conceptualization of efficiency enshrined in the Pareto principle that does not permit comparing different people’s satisfactions. Secondly, either compensation is paid, or it is not paid. If a policy requires winners to fully compensate losers then it is a Pareto improvement and we do not need the weaker efficiency criterion to recommend it. If, on the other hand, a policy does not require that losers be fully compensated from the gains to winners, then it requires a value judgment that those who win deserve to do so, and those who lose deserve to do so, before it can be recommended – however much economists who claim to forswear “value judgments” may wish otherwise. In the end, the only reason we need the efficiency criterion in the first place is precisely because so many important choices fall outside the purview of the Pareto principle, i.e. cannot be reduced to efficiency defined narrowly.

Seven Deadly Sins of Inefficiency

How might an economy be wasteful in the sense that it fails to achieve a Pareto optimal outcome? It turns out there are seven different ways that any economy might be inefficient. I facetiously call them the seven “deadly sins” of inefficiency.

The production sector of an economy will be inefficient if:
  1. It leaves productive resources idle. (Example: unemployed workers, or idle crop land.)
  1. It uses inefficient technologies, that is, uses more of some input than necessary to get a given amount of output. (Example: The same number of shoes can be made with less leather by more careful cutting.)
  1. It mis-allocates productive resources so that swapping inputs between two different production units would lead to increases in output in both. (Example: Employing carpenters on a farm and agronomists in the construction industry.)
The consumption sector will be inefficient if:
  1. There are undistributed, or idle consumption goods. (Example: Wheat rotting in silos while people go hungry.)
  1. Final goods are mis-distributed so that two consumers could exchange goods and both be better off than under the original distribution. (Examples: Apples are distributed to orange lovers while oranges are distributed to apple lovers.)
And the production and consumption sectors will be inefficiently integrated with one another if:
  1. Goods are mis-allocated between consumers and producers so it is possible for a producer and consumer to swap goods and have the output of the producer rise and the satisfaction of the consumer increase as well. (Example: Personal computers are distributed to households that suffer for lack of heat while employees at accounting firms are unproductive in overheated offices without personal computers to work with.)
  1. Resources are mis-allocated to different industries so it is possible to shift productive resources from one industry to another to produce a different mixture of outputs more to consumers’ tastes. (Example: Most land suitable for orchards is planted in pear trees even though most consumers prefer apples to pears.)
The seven deadly sins of inefficiency provide an orderly, and not overly intimidating, procedure for checking to see if an economy will be inefficient in the narrow sense of the Pareto criterion. All we need to do is check if the economy is prone to "sinning" in any of these seven ways. If not, we can conclude the economy is efficient, or will achieve pareto optimality, whatever other desirable or undesirable qualities it may poses. Moreover, if the economy is prone to inefficiency we will know what kind of inefficiency it suffers from.

Endogenous Preferences

But there is an important issue traditional treatments ignore which complicates how we should think about efficiency. When people make choices in light of their present preferences, the actions they take not only fulfill their present preferences (to a greater or lesser degree), they also change people’s characteristics to some extent, and thereby change their future needs and desires. In chapter 1 we saw this is what it means to say people have "consciousness" and are "self-creative." While traditional treatments of efficiency take account of the first effect of people’s choices -- the “preference fulfillment effect” -- the second effect -- the “preference development effect” -- is usually ignored. But evaluating the effect of economic choices and institutions on people’s human development patterns may be as important as evaluating how well those choices and institutions succeed in fulfilling present preferences. However, when economic choices have human development effects that means they also change people’s preferences, creating the following dilemma: How are we to judge the efficiency of economic institutions using people’s preferences as our yard stick if those preferences are in part a product of those same economic institutions in the first place? While this may appear to be a vicious circle giving rise to a philosophical conundrum that cannot be resolved, it turns out that there are some conclusions we can draw about economic efficiency even when we recognize that people’s preferences are influenced by the economic institutions that purport to satisfy those preferences.
    The view that people are self-conscious agents whose characteristics and preferences develop can be summarized in a model of “endogenous preferences.” Using such a model it is possible to demonstrate that if an economy is biased against a certain kind of activity -- that is, if people must pay more than the true cost to society to engage in the activity:
  1. The degree of inefficiency in the economy will be greater than recognized by traditional theory that fails to treat preferences as endogenous, and the inefficiency will increase, or “snowball” over time.
  1. Individual human development patterns will be “warped” in the sense that they will not develop in ways that could generate the most fulfillment they could enjoy, and the warping will increase or “snowball” over time.
  1. These detrimental, non-traditional effects of the bias in the economy will be disguised to the participants who adjust unconsciously, or forget they have adjusted after the fact.
The intuition behind these political economy welfare theorems18 is that to the extent people recognize the “preference development” as well as the “preference fulfillment” effects of their economic choices, it is sensible for them to take both effects into account when making decisions. If an economic institution is biased against some activity -- charging people more than the true social cost of making the activity available to them -- then rational people will choose activities in part to develop a lower preference for that activity than if they were only charged the lower true social cost for engaging in it. It follows that the demand for the activity will be less than had people not adjusted their preferences. But this reduced demand implies that even less resources will be allocated to supplying the activity than had people not adjusted their preferences. The more time people have to make these individually rational adjustments the lower demand, and therefore supply of the activity will be, leading to ever greater misallocation of resources as time goes on, and ever greater deviations of people’s human development trajectories from those that would have maximized their wellbeing under a system of unbiased prices. If after the fact people forget that they adjusted their preferences to conform to the biased prices, they will only see themselves as getting what they want.
    In other words, if an economic institution introduces a systematic bias in the terms of availability of an activity, the consequence will be a “snowballing” divergence from efficient allocations. This implies that a major criterion for judging the efficiency of economic institutions should be determining whether they exert any systematic biases on individual choice, because to the extent that people's preferences are "endogenous" any biases are more detrimental than traditionally recognized.
    While traditional economists limit their evaluations of economies to efficiency (without considering the complication of endogenous preferences) and equity (about which they have little to say), political economists have good reason to take other criteria into account as well. Specifically, how and by whom decisions are made, and the social and environmental effects of economic activities are important to evaluate and take into account.

3. Self-management

I define self-management as decision making input in proportion to the degree one is affected, and believe more self-management is desirable, all other things being equal, or as economists like to say, ceteris paribus.
    The first thing to notice is that defined in this way self-management is seldom equivalent either to individual freedom or majority rule. Only if a single individual were the only person affected by a decision would self-management be the same as individual freedom, i.e. the right of a single individual to decide whatever she pleases. And only if all were equally affected by a decision would self-management be the same as majority rule, i.e. one person one vote. Since most economic decisions affect more than one person, but affect people to different degrees, self-management as I have defined it usually requires that some people have more decision making power while others have less regarding any particular economic decision.
    But why is more self-management a good thing? For the last ten thousand years most humans have lived in circumstances with few opportunities for self-management. So admittedly, most people don’t die without it. However, political economists contend that just as denial of material means of subsistence conflicts with human “natural” needs for food, shelter, and clothing, denial of self-management opportunities is in conflict with our “species nature.” The capacity to analyze and evaluate the consequences of our actions, and choose among alternatives based on our assessments, in conjunction with the need to employ this capacity is what we called “consciousness.” Development of the capacity and desire for self-management is nothing more than development of the capacity to garner satisfaction from this innate human potential. For that reason, economic institutions that satisfy this need and nurture this capacity are preferable to economic institutions that stifle self-management. In brief, we human beings have the ability to analyze and evaluate the consequences of our actions and choose accordingly, and we garner considerable satisfaction from doing so!

4. Solidarity

By solidarity I simply mean concern for the well-being of others, and granting others the same consideration in their endeavors as we ask for ourselves. Empathy and respect for others has been formulated as a “golden rule” and “categorical imperative,” and outside the economics profession solidarity is widely held to be a powerful creator of wellbeing. Solidarity among family members, between members of the same tribe, or within an ethnic group frequently generate wellbeing far in excess of what would be possible based on material resources alone. But in mainstream economics concern for others is defined as an “interpersonal externality” -- a nasty sounding habit -- and justification is demanded for why it is necessarily a good thing.
    In addition to consciousness, sociability is an important part of human nature. Our desires develop in interaction with others. One of the strongest human drives is the never ending search for respect and esteem from others. All this is a consequence of our innate sociability. Because our lives are to a great extent joint endeavors, it makes sense we would seek the approval of others for our part in group efforts. Since many of our needs are best filled by what others do for/with us, it makes sense to want to be well regarded by others.
    Now compare two different ways in which an individual can gain the esteem and respect of others. One way grants an individual status by elevating her above others, by positioning the person in a status hierarchy that is nothing more than a pyramid of relative rankings according to established criteria -- whatever they may be. For one individual to gain esteem in this way it is necessary that at least one other -- and usually many others -- lose esteem. We have at best a zero-sum game, and most often a negative sum-game since underlings in hierarchies far outnumber superiors. The second way grants individuals respect and guarantees that others are concerned for their wellbeing out of group solidarity. Solidarity establishes a predisposition to consider others’ needs as if they were one’s own, and to recognize the value of others’ diverse contributions to the group’s social endeavors. Solidarity is a positive-sum game. Any group characteristic that enhances the overall wellbeing members can obtain from a given set of scarce material resources is obviously advantageous. Solidarity is one such group characteristic. So political economists consider economic institutions that enhance feelings of solidarity are preferable to economic institutions that undermine solidarity among participants.

5. Variety

I define economic variety as achieving a diversity of economic life styles and outcomes, and believe it is desirable ceteris paribus. The argument for variety as an economic goal is based on the breadth of human potentials, the multiplicity of human natural and species needs and powers, and the fact that people are neither omniscient nor immortal.
    First of all, people are very different. The fact that we are all human means we have genetic traits in common, but this does not mean there are not differences between people’s genetic endowments. So the best life for one is not necessarily the best life for another. Second, we are each individually too complex to achieve our greatest fulfillment through relatively few activities. Even if every individual were a genetic carbon copy of every other, the complexity of this single human entity, their multiplicity of potential needs and capacities would require a great variety of different human activities to achieve maximum fulfillment. To generate this variety of activities would in turn require a rich variety of social roles even in a society of genetic clones. And with a variety of social roles we would discover that even genetic clones would develop quite different derived human characteristics and needs.
    While the above two arguments for the desirability of a variety of outcomes are “positive,” there are “negative” reasons that make variety preferable to conformity as well. Since we are not omniscient nobody can know for sure which development path will be most suitable for her, nor can any group be certain what path is best. John Stuart Mill astutely pointed out long ago in On Liberty that this implies the majority should be thankful to have minorities testing out different life styles, because every once in awhile every majority is wrong. Therefore, it is in the majority’s interest to have minorities testing their dissident notions of ‘the good life’ in case one of them turns out to be a better idea. Finally, since we are not immortal, each of us can only live one life trajectory. Only if others are living differently can each of us vicariously enjoy more than one kind of life.

6. Sustainability

In the 2002 edition I introduced this section with the observation: “It took a massive movement to raise the issue of whether or not economies were ‘environmentally sustainable,’ or instead, on course to destroy the natural environment upon which they depend.” Let me begin this section in the 2014 edition by apologizing for providing as little guidance on this crucial subject as I did a dozen years ago.19 Like most of my fellow political economists, I have been far too slow to recognize the severity of the ecological crisis our economies have created. I tried to make amends in Green Economics: Confronting the Ecological Crisis published by M.E. Sharpe in 2011 which interested readers should consult for a fuller treatment of environmental economic issues. However, more needs to be said here than briefly distinguishing between “weak” and “strong” conceptions of sustainability, as I did in the 2002 edition.
    First we need to amend figure 1.1 which was our representation of society as comprised of a human center and an institutional boundary. We need to add another circle, or boundary, called the natural environment around the outside of both the human center and institutional boundary because human societies always interact with their natural environment, and we ignore the nature of that interaction at our peril.
Figure 2.4 Human society as part of a natural ecosystem

However, this does not settle how best to conceptualize the interaction. Economists initially thought of the natural environment simply as the source of raw materials, or natural capital – minerals, fossil fuels, fertile soil, forests, fresh water etc. – and saw resource depletion as what threatens sustainability. Belatedly economists came to appreciate that the natural environment also serves as a useful sink – and recognized limits to its capacity to absorb economic waste products as a threat to sustainability. Ecologists, who study the natural environment as their primary job rather than as a side-line, think of the environment as interconnected ecosystems – and see destabilization of vital ecosystems as what threatens sustainability. If we consider climate change, for example, the economic perspective sees the problem as humans exhausting the capacity of the upper atmosphere as a sink to absorb more greenhouse gases. The ecological perspective sees the problem as humans destabilizing a vital ecosystem, the carbon cycle. In general the economic perspective sees society taking raw material “inputs” from, and releasing waste “outputs” back into the natural environment, while the ecological perspective sees earth as a single network of ecosystems that includes one rather recent arrival, a species that has become a major destabilizing force – a veritable bull in the china closet.
    In Green Economics I wrote a whole chapter to answer the question: “What on earth is sustainable development?” I began by noting that it is tempting to follow the lead of former Supreme Court Justice Potter Stewart who, when asked to define pornography famously quipped, “I shall not today attempt to define it, but I know it when I see it,” and answer with regard to sustainable development, “I am not sure what it is, but I am quite sure what it is not!” The problem is that delving into the meaning of sustainable development opens several Pandora’s boxes: How does one reconcile the notion of sustaining a status quo with progress? When is adding more of something an adequate substitute for less of something else? How can we measure the value of a capital stock whose composition is heterogeneous?
    The most famous definition of sustainable development is from the report of the United Nations World Commission on Environment and Development, better known as the Brundtland Commission, after its chair: “Sustainable development is development that meets the needs of the present without compromising the ability of future generations to meet their own needs.” However, this delightfully concise definition has been criticized from every angle. It has been ridiculed as so vague that it says nothing. As the philosopher Luc Ferry remarked: “Who would like to be a proponent of an untenable development!” When reworded as sustainable growth and interpreted broadly to anticipate new technologies and permit full substitution of produced capital for natural capital, many environmentalists regard it as a license to continue to kill the planet. When interpreted strictly as requiring that stocks of different categories of natural capital not be permitted to decline, it is criticized by business leaders and many economists as imposing unreasonable and unnecessary restrictions.

Weak vs. Strong vs. Environmental Sustainability

The core idea of sustainability as intergenerational equity is that we must leave future generations in conditions at least as favorable as those we enjoy.20 If we interpret “conditions” as “assets,” and “assets” as “capital,” this reduces to leaving future generations with an overall capital stock at least as “valuable” as what we have today. It is now common to talk of produced capital, natural capital, human capital, and sometimes social capital. If we ignore problems of how to incorporate technical knowhow, and how to aggregate heterogeneous components to calculate a value for the overall capital stock – problems which are, in fact intractable, even if they are often dismissed as merely technical -- weak sustainability simply requires maintaining the value of the overall capital stock per capita, and is the definition mainstream economists are most comfortable with. Strong sustainability requires, in addition, maintaining the overall value of the natural capital stock as well, which environmentalists prefer to weak sustainability which allows substituting produced for natural capital without limit. And what is sometimes called environmental sustainability requires, in addition, maintaining the physical stocks of every important category of natural capital, which many environmentalists are even more comfortable with.
    The critical issue is obviously what we might call “fungibility.” To what extent can one kind of capital be substituted for another? There is a large literature debating how realistic it is to assume that produced capital can adequately substitute for different components of natural capital, where differences of opinion between so-called technological “optimists” and “pessimists” play a central role. Economists are generally optimistic about technical progress and long accustomed to assuming that everything is infinitely substitutable for everything else at the margin, albeit with diminishing effects, of course. Ecologists generally begin with the opposite assumption, namely that key components of natural systems are irreplaceable without destabilizing the entire system. Since in many cases attempts to substitute produced capital for natural capital are irreversible, and since our understanding of ecosystem complexity is often imperfect, many environmentalists argue that the precautionary principle should be applied: Do not assume some part of natural capital can be adequately replaced by produced capital until it has been proven beyond any reasonable doubt to be the case.

A Workable Definition of Sustainable Development

Sustainable means repeatable. However, humans in the modern age have not been content with mere survival -- repeating the same activities, with the same results, year after year. We have grown accustomed to aspire for more. We hope to progress, or develop, and we hope to progress along many dimensions. I think the word sustainable can best be used as a warning about dangers we must avoid during our quest for progress, or development, if we do not wish to compromise the prospects of those who will follow us in ways that cannot be morally justified. For our behavior to be sustainable we must operate under constraints as we struggle to develop.
    If the prospects of the next generation depended only on how much seed corn they had to work with the traditional economic concept of maintaining the seed stock would be a sufficient condition for intergenerational equity. When “seed stock” became hoes and plow horses as well as seeds, the idea became that as long as the capital stock as a whole equipped our descendants with the means to be as productive as we were, intergenerational equity was observed. But when we came to our senses and realized that the earth was filling fast—that is, that per capita stocks of different components of natural capital were already scarce and shrinking fast—necessary conditions for intergenerational equity became more complicated and more stringent. In truth, methodological problems associated with aggregation of different components of the capital stock, as well as practical questions of substitutability, became troublesome issues as soon as hoes were added to seed corn. But these problems became acute as soon as we realized that the prospects of the next generation depend on how much natural capital they will have to work with as well as how much produced capital we have left them. And since the environment also provides amenities, as well as a variety of vital sink services that do not neatly fit the metaphor of capital as enhancer of human productivity, the problem of defining how development—that is, human progress—could simultaneously be sustainable—that is, not compromise the ability of future generations to continue to develop—became even more problematic. So I suggest something more along the lines of an intergenerational social contract as a lawyer would draft it, rather than a traditional definition of sustainability:

WHEREAS the natural environment provides valuable services as amenities, as the source of resources, and as sinks to process wastes,

WHEREAS the regenerative capacity of different components of the natural environment and ecosystems contained therein are limited,

WHEREAS ecosystems are complex, contain self-reinforcing feedback dynamics that can accelerate their decline, and often have thresholds that are difficult for us to pinpoint,

And WHEREAS passing important environmental thresholds can be irreversible,

WE, the present generation, now understand that while striving to meet our economic needs democratically, fairly, and efficiently we must not impair the ability of future generations to meet their needs and continue to progress.

In particular, WE, the present generation, understand that intergenerational equity requires leaving future generations conditions at least as favorable as those we enjoy. These conditions include what are commonly called produced capital, natural capital, ecosystem sink services, environmental amenities, human capital, social capital, and technical knowhow.
    Moreover, SINCE the degree to which different kinds of capital and sink services can or cannot be substituted for one another is uncertain, and since some changes are irreversible,
    WE, the present generation, also understand that intergenerational equity requires us to apply the precautionary principle with regard to what is an adequate substitution for some favorable part of overall conditions we permit to deteriorate. The burden of proof must lie with those among us who argue that a natural amenity, resource, or sink service that we permit to deteriorate on our watch, is fully and adequately substituted for by some other component of the inheritance we bequeath our heirs.


Most economists regard economic growth as something positive, and for many it continues to be their primary goal. On the other hand, many environmentalists view growth as the ultimate cause of our environmental problems. Growth is good? Growth is bad? What are we to think? A good place to start is by asking precisely what it is that is growing, because usually environmentalists and economists are not talking about the same thing at all.
    When economists talk about economic growth they mean the growth of gross domestic product, or GDP, defined as the value of all the goods and services produced during a year. Net domestic product, NDP, is then defined as GDP minus any deterioration in the value of the productive capital stock, which, as we have seen, should include natural, human, and perhaps social “capital” as well as produced capital like plant and machinery. Putting aside a host of important issues about ways in which GDP and NDP are miscalculated, the rate of growth of NDP per capita should therefore, at least in theory, represent the sustainable increase in the value of what we produce per person in the economy from one year to the next, which we measure in dollars. However, when the ecological economist Kenneth Boulding said: “Anyone who believes in indefinite growth in anything physical, on a physically finite planet, is either mad or an economist,”21 he was talking about growth of throughput, which is defined as quantities of physical matter humans draw from the natural environment as “inputs” for our production processes – things like tons of coal, tons of iron ore, cubic meters of top soil eroded, and clean water drawn from aquifers, etc. – as well as quantities of physical matter we release as side-product “outputs” back into the natural environment – things like cubic meters of carbon dioxide released into the upper atmosphere, tons of slag left in heaps, and deposition of dirt into water or air, measured in parts per million, etc. Net domestic product and throughput are not the same thing at all. They are not even measured in the same units.
    Throughput has been growing mightily over the past few hundred years not only because population has grown, but because throughput per capita has grown among all but the most impoverished, and as a result we are nearing crucial limits on the ability of important components of throughput to continue to grow much longer without serious adverse consequences. Contrary to what environmentalists believed in the early 1970s, it is the ability of the planet as a “sink” to absorb throughputs we release as wastes that we seem to be exhausting more rapidly, rather than the ability of the planet to continue to provide natural resources we use as inputs. Either way, there is strong evidence that we left the “frontier economy” where our impact on the natural environment was not yet significant long ago, and we are now well into a “bull in the China closet economy” where we are a serious threat to ecosystem resilience, and are fast approaching a “spaceman” economy where every aspect of our natural environment will have to be meticulously managed. In short, we are pressing up against limits on some components of throughput, and have surpassed limits for others, threatening sustainability.
    This is where the goal of a “steady state economy” first proposed by a founder of the school of ecological economists, Herman Daly, comes in. Daly argued that if throughput continues to grow we will soon destroy the planet irreparably, and therefore our goal should be what he called a steady state economy, i.e. an economy where throughput, in general, does not grow any further, but remains constant, or “steady.” However, it has now become clear that holding some parts of throughput “steady” is not good enough. For example, climate scientists tell us that unless we decrease emissions of greenhouse gases substantially over the next few decades we risk triggering cataclysmic climate change. In other words, with regard to greenhouse gas throughput at least, we must lower throughput every year, which is where the de-growth movement comes in. Sustainability now requires not only keeping some components of throughput “steady,” but shrinking other components as well.
    However, throughput is not gross domestic product. What economists call “real GDP” is measured in “constant” dollars in order to prevent inflation from deceiving us into thinking that the quantity of goods and services produced is rising when really all that is happening is the price of goods and services is rising. However, the word real in front of GDP should not be taken to mean “physical” because it does not. Nor should valid arguments that we systematically mis-measure GDP and NDP, or that many exaggerate its importance compared to other economic and non-economic goals, be interpreted as demonstrating that the value of what we produce per hour of work cannot, at least in theory, rise without limit -- because it does not.
    Limiting throughput to sustainable levels need not prevent us from increasing economic wellbeing per capita. The question is how to increase the value of goods and particularly services people enjoy even while the throughput used to produce them, and the throughput released as by-products in their production and consumption, do not increase, and in some cases even decline. For example, in the computer industry, throughput per unit of computing capacity has dropped dramatically since the 1940s. Suppose it had dropped by a factor of 10. This would mean that we could consume five times more computing capacity now than in 1940 while cutting throughput for computing services in half. It is also possible that before we exhaust one kind of throughput, we can change production technologies to substitute a different input that is still plentiful or, if necessary, we can consume a different good or service instead. As noted, we must become carbon neutral well before the end of the century in order to avoid risking cataclysmic climate change. That means those planning to prevent climate change believe it is possible to substitute renewable sources for fossil fuels before we run out of atmospheric storage space for greenhouse gases. Meanwhile, GDP could still grow 5% a year while carbon emissions decrease 10% a year as long as energy efficiency grew at 15% a year.22
    So instead of sterile debates where people fail to specify what is growing and talk past one another, what we should be asking ourselves is this: Is there something about our economic system that keeps us on a trajectory to produce the kinds and quantities of goods and services that will continue to increase throughput? In other words, is there a growth imperative in our economic system that is environmentally unsustainable? In the words of Herman Daly, is there something about our economic system that generates uneconomic growthgrowth that is environmentally destructive and fails to yield real economic development? If so, what are the causes of uneconomic growth, and what can be done to stop it? Of course, this is the question concerned environmentalists thought they were asking all along, which we will take up in chapter 10: What is to be Undone?


So the criteria political economists should consider when evaluating the performance of an economy, or evaluating the consequences of different economic policies, or comparing the desirability of different economic systems are: (1) Equity, defined as reward according to sacrifice and need; (2) efficiency, defined narrowly as Pareto optimality, and more broadly as the efficiency criterion, but with the preference development effect accounted for rather than ignored; (3) self-management, defined as decision-making power in proportion to the degree one is affected, (4) solidarity, defined as concern for the wellbeing of others, (5) variety, defined as achieving a variety of economic life styles and outcomes, and (6) sustainability, which may be difficult to define in a few words, but at a minimum rules out behavior which is environmentally destructive to the point of jeopardizing the wellbeing of future generations.


1 Edward N. Wolff, Top Heavy: A Study of the Increasing Inequality of Wealth in America (New York: The Twentieth Century Fund, 1995): 1-2.
2 Chuck Collins and Felice Yeskel with United for a Fair Economy, Economic Apartheid in America (New York: The New Press, 2000): 54-57.

3 The New Field Guide to the US Economy, by Nancy Folbre and the Center for Popular Economics (New York: The New Press, 1995)
4 Lawrence Mishel and Jared Bernstein, The State of Working America 1994-1995 (Armonk New York: M.E. Sharpe, 1994): 246.
5 The State of Working America 1998-1999: 271.

6 The State of Working America 1994-1995, p. 112.
7 Economic Apartheid in America, p. 56.

8  The State of Working America 1994-95, p. 121.
9  Walter Park and David Brat, “A Global Kuznets Curve?” Kylos, Vol. 48, 1995: 110.
10 Source: Edward Wolff, Economics of Inequality, Poverty, and Discrimination, (South-Western Publishing, 2009): ??

11 Branko Milanovic, “Global Inequality and the Global Inequality Extraction Ratio,” World Bank. 2009.

12 Lawrence Mishel and Heidi Shierholz, “A Decade of Flat Wages,” EPI Briefing Paper #365, August 21, 2013: 6.

13 Ibid: 4.

14 Ed Dolan, “US Corporate Profits at All Time High,” EconoMonitor, September 26, 2013.

15 We are not talking about willing personal belongings to decedents, which is unobjectionable, but passing on productive property in quantities that significantly skew the economic opportunities of members of the new generation.
16 Lester Thurow, The Future of Capitalism: How Today’s Economic Forces Will Shape the Future (New York: William Morrow, 1996), Daphne Greenwood and Edward Wolff, "Changes in Wealth in the United States 1962-1983," Journal of Population Economics 5, 1992, and Laurence Kotlikoff and Lawrence Summers, "The Role of Intergenerational Transfers in Aggregate Capital Accumulation," Journal of Political Economy 89, 1981.

17 Milton Friedman argued this point eloquently in Capitalism and Freedom (University of Chicago Press, 1964), chapter 10. However, his conclusion was that since maxim 2 cannot be defended on moral grounds, critics of capitalism, which distributes the burdens and benefits of economic cooperation according to maxim 1, should mute their criticisms. Essentially Friedman reminded critics of capitalism who favor maxim 2 over maxim 1 that those who live in glass houses shouldn't throw stones!
18  For a rigorous derivation of these results see chapter 6 in Robin Hahnel and Michael Albert, Quiet Revolution in Welfare Economics (Princeton NJ: Princeton University Press, 1990).
19 In particular I am ashamed to have written in the 2002 edition: “It is not clear that if we leave aside the political question of how to popularize important ideas, there is anything in the notion of ‘sustainability’ that is not already implicit in the values of efficiency, equity and variety. If an economy uses up natural resources too quickly, leaving too little or none for later, it has violated the efficiency criterion. If an economy sacrifices the basic needs of future generations to fulfill desires for luxuries of some in the present generation, it has failed to achieve intergenerational equity. If we chop down tropical forests with all their biodiversity and replace them with single species tree plantations, we have destroyed, rather than promoted variety.” While these observations may be logically sound, they are unworthy of anyone well versed in the severity of the ecological crisis we have created. Failure to include sustainability as an explicit economic goal on grounds that other goals already subsume it would be a colossal mistake.

20 This is clearly what critics would call an anthropocentric view of environmental sustainability which says nothing per se about preserving the present natural environment. For instance, if it were possible to transform planet earth beyond recognition, but the new planet was still as accommodating to humans as it is today, this would be consistent with sustainability interpreted as intergenerational equity.

21 This is the actual quote, which is almost universally misquoted as: “Anyone who believes in infinite economic growth on a finite planet is either a mad man or an economist.”

22 Strictly speaking, this conclusion assumes that the ratio of fossil fuels to renewables in our energy system remains constant. If we also substitute more renewables for fossil fuels a 15% increase in energy efficiency combined with 5% growth of GDP would decrease carbon emissions by even more than 10%.


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