PART VII THE INTERNATIONAL DIMENSION:

24 International environmental cooperation: the role of political feasibility Camilla Bretteville Froyn:

1. Introduction1
Why is it so difficult to establish effective institutions for the provision of
global public goods? This chapter draws on contributions from game
theory and public choice theory to explore the obstacles to creating
effective institutions for the provision of public goods and how they might
be overcome. In particular, it focuses on how international and domestic
factors influence a country’s choice regarding co-operation and compliance
in international environmental agreements (IEAs).2
The chapter argues that the bottom line in international environmental
cooperation will always be determined by what is politically feasible.
Furthermore, since shared resources are prone to overuse when countries
pursue unilateral policies, and since the provision of global public goods will
have to rely on volunteerism, the aim of any IEA should be to ensure par-
ticipation and compliance. It argues further that this can best be achieved
by restructuring the relationships among countries in a mutually preferred
way, taking into account the complexity of a country’s negotiating position
that results from the influence of different domestic constituencies with a
stake in environmental policy.
Game theory is concerned with the strategic actions of different players
(consumers, firms, governments, and so on) where these actions are in some
way interlinked. This could for example be firms interacting in an emissions
permit market or governments negotiating reductions in greenhouse gas
emissions. The fundamental assumption is that players choose their
strategies based on the beliefs they have regarding the choices of other
players. Game theory provides tools for increased understanding of
what drives the results in international co-operation.3 The public choice lit-
erature analyzes how decisions are made by governments, focusing on how
political agents motivated by self-interest seek to sway public policies. Public
choice theory suggests that a proper understanding of institutional settings
allows relatively straightforward net-benefit maximizing models to account
for a rich and complex range of policy outcomes (Congleton, 2004), includ-
ing government negotiating positions in international forums.4, 5
The next section provides a brief explanation for the need for IEAs,
while section 3 gives a theoretical argument for why optimal levels of co-
operation are so hard to achieve. The following three sections focus on ways
to increase co-operation: the prevention of free-riding (section 4); a closer
look at self-enforcing environmental agreements (section 5); and multiple
agreements (section 6). Section 7 argues that it is important to take into
account that a country’s negotiating position is a result of bargains struck
among different domestic interest groups. Concluding remarks are offered
in the last section.
2. The need for international environmental agreements
IEAs offer issue-specific remedies for almost every kind of international
environmental problem (Barrett, 2003). They establish institutions for con-
serving threatened species, unique ecosystems, and sites of cultural heritage;
for controlling pests and plagues; for reducing pollution; for safeguarding
workers from toxic substances; for protecting animals from inhumane
farming practices; for promoting the conservation of tropical forests; for
controlling desertification; for banning nuclear weapons testing; and much
more.6 Some IEAs work quite effectively, such as the Montreal Protocol,
which regulates emissions of substances that deplete the ozone layer, but
many are weak and ineffectual.
The need for international environmental co-operation is linked to
market failures in which participants’ self-interested actions do not achieve
an efficient outcome so that it is possible to increase the welfare of one or
more individuals without harming the welfare of someone else. When
market failures exist, social welfare may be increased by intervening in the
market.7 Market failures can result from externalities, which are inter-
dependencies among two or more countries not taken into account by
market transactions.8 One example is transborder pollution: if the emitting
country is not required to compensate the downwind country (or coun-
tries), then the emitter would have no incentive to curb its polluting activ-
ity. From a social welfare perspective, too much production is taking place
unless the externality-imposed costs are included in the producer’s produc-
tion costs. When market failures are of an international character there is
no world government that can intervene, but agreements constitute an
alternative form of ‘intervention’. At the international level, externalities
require bilateral or multilateral agreements.
Another source of market failure is public goods. For international
public goods, the benefits are shared by countries in a non-exclusive and
non-rival manner. This means that the benefits from the public good can be
received by payers and non-payers alike, and that one country’s consump-
tion of the good does not affect the consumption possibilities of other countries. Thus each country would be better off if all countries contribute
to the provision of the public good, but each country is still better off if it
can free-ride on the other country’s contributions.9 International public
goods can be bilateral (for example, reducing mercury discharges that affect
two countries), regional (for example, reducing sulfur dioxide emissions in
Europe), or global (for example, protection of the ozone shield, protection
of biodiversity, or the reduction of greenhouse gases to prevent global
warming). This chapter focuses mainly on international co-operation for
the provision of global environmental public goods.10
The characteristics of global public goods give rise to collective provision
issues that are difficult to overcome, and make the need for international
institutions substantial. For the purposes of this chapter, an institution is
defined as a persistent and connected set of rules that prescribe behavioral
roles, constrain activity, and shape expectations.11 The rules of any institu-
tion, however, will reflect the relative position of its actual and potential
members (Keohane, 1989). Rules also determine the type of institution that
will develop, who will benefit, and how effective it will be. In the develop-
ment of such international institutions, countries are like game players that
must choose their strategies based on their beliefs about the likely choices
of others. The existence of international regimes will, thus, not ensure
optimal levels of cooperation. Failure to solve the problem of providing
international public goods is well known, and an institution’s level of
success will depend on the different country’s response to the agreed-upon
set of rules (the design).
3. The law of the least ambitious program
The law of the least ambitious program: Where international management
can be established only through agreement among all significant parties
involved, and where such a regulation is considered only on its own merits,
collective action will be limited to those measures acceptable to the least
enthusiastic party (Underdal, 1980, p. 36).
The public goods problem of under-provision is particularly challenging
on a global scale because there is no supranational authority to enforce an
agreement. In the absence of such an authority, alternative arrangements
are needed. The process of treaty-making, however, is complex and deter-
mines the quality of the outcome. A number of problems with global en-
vironmental protection have not been satisfactorily resolved through
international institutions. One well-known example is fisheries, which
experts for years have said have been over-fished because they have not been
sufficiently regulated through international agreements. Another example
is the lack of protection of tropical forests that provide public goods to the
global economy through benefits from biodiversity, ecosystem linkages and carbon sequestration. The law of the least ambitious program blames this
shortcoming on the unanimity rule by pointing out that it invariably places
the final word with the parties who are dragging their feet.12
The law of the least ambitious program has a strong intuitive appeal, and
offers some very basic and important insights in international cooperation
(Hovi and Sprinz, 2006). What it basically says is that as long as all parties
involved have to agree on the sets of rules that form the institution, the pre-
scription of behavioral roles and constraints on activity will not be stricter
than what is acceptable to the least ambitious.13 The reason is simply that
the least ambitious will suffer the smallest loss should the negotiations
break down. This gives them bargaining power, and they will thus tend not
to give in. The other countries, on the other hand, could choose to dump
the least enthusiastic party, rather than to give in, but at a price: they could
then negotiate a more potent, but incomplete, treaty.14
The most well-known example might be the international climate nego-
tiations. The Kyoto Protocol, as agreed to in 1997,15 was merely a sketch of
an institution, and it took several years of tough negotiations to agree on
the specific rules of conduct.16 Compared to the original expectations of
the Kyoto Protocol, the final climate treaty was a compromise and signifi-
cantly watered down. The main reason for this is the minimum participa-
tion rule.17 The US withdrawal from the climate negotiations in March
2001 gave the supporters of soft rules additional bargaining power. These
parties clearly held the most rigid positions in the negotiating process, not
willing to give much to reach agreement. However, the parties supporting
strict rules, that is, the most ambitious, seemed to want the Kyoto Protocol
to survive badly enough to place the final word with the ones in favor of
soft rules (Froyn, 2001). In the end they had to give in on all areas in order
to save the Kyoto Protocol,18 which entered into force on 16 February, 2005,
after 81 countries had ratified the treaty.19
As this example points out, the existence of international regimes
will not ensure that countries will be able to achieve optimal levels of co-
operation. For global public goods provision, the incentive for nations to
free-ride and the costs of detecting and punishing such behavior will be
greater the larger the number of countries.20 Institutions must therefore be
designed to reduce these incentives.
4. Preventing free-riding in international environmental co-operation
IEAs are established in an attempt to provide international public goods
and resolve environmental externalities among government jurisdictions.
The political and institutional problems that have to be overcome are there-
fore complex. Even if policy-making authority is delegated to an interna-
tional commission, or a treaty provides incentives to participate, state sovereignty implies that domestic legislation remains the method by which
such international environmental policies are implemented. Multilateral
solutions to environmental problems are therefore clearly more challenging
to achieve than solutions to domestic environmental problems.21 Those
challenges seem likely to linger as long as nations remain sovereign
(Congleton, 2001). Since a country is likely to participate in institutions –
such as the Kyoto Protocol – only when co-operation is associated with an
individual net gain (Svendsen, 2003; Underdal, 1998),22 the provision of
global public goods must rely on some kind of volunteerism. The only way
to deal with the free-rider problem is thus to restructure the underlying
incentives, such that it is in the countries’ best interest to both participate
and comply, and this should be the primary aim of any environmental
treaty (Barrett, 2003; Barrett and Stavins, 2003). How this can be done is
discussed below.
Enforcement
In the considerable body of literature that addresses the under-provision of
global public goods, a main problem analyzed is free-riding. When potential
ratifiers are uncertain about the actions of others, each country must anti-
cipate the probability of other countries not cooperating.23 Distrust is rele-
vant whenever some parties have, or might have, an incentive to free-ride.
There are two types of incentives for free-riding: the incentive for a country
not to sign an IEA and thus benefit from the signatories’ abatement efforts
(non-participation), and the incentive for a signatory to violate its commit-
ments in an agreement (non-compliance) (Finus, 2001). Participation and
compliance are joint problems, but they have often been analyzed sep-
arately.24 A country can avoid complying with a treaty by simply not partic-
ipating in the first place, and non-participation is the biggest credible
deviation a single country can carry out. Indeed, to the extent that abiding
by the commitments of an international treaty will result in a net loss, a ratio-
nal decision-maker will avoid implementing a policy to comply (Underdal,
1998). Deterring free-rider behavior, however, requires sacrifices by others,
and larger sacrifices are less credible because they are more self-damaging
(Barrett, 2003; Barrett and Stavins, 2003). The creation of incentive mech-
anisms to ensure participation and compliance is thus a major challenge for
parties in negotiations on IEAs.
Nevertheless, a remarkably small number of treaties include enforcement
mechanisms (Barrett, 2003). The current climate regime, as specified by the
final version of the Kyoto Protocol,25 however, is an exception. But even
though the Marrakesh Accords provide details for a compliance mech-
anism,26 it has been pointed out that the current design suffers from a
number of weaknesses (cf, Barrett, 2002; 2003; Hagem et al., 2005; Hagen and Westskog, 2005).27 It is therefore not likely that the Kyoto Protocol’s
enforcement mechanism will be able to ensure that ratifying countries fulfill
their obligations. Hence, external means of enforcement are potentially
required as an alternative – or a supplement – to the provisions of the
Marrakesh Accords.28 This can be achieved, for example, by linking envir-
onmental negotiations to other economic issues.
Issue linkage
One suggested solution to offset countries’ free-riding incentives is the
linkage of environmental negotiations to other economic issues (issue
linkage). The idea is to link an issue with excludable benefits (a club good)
to the public good provision. Compared to the stand-alone environmental
agreement, an agreement with this type of issue linkage ensures that the
benefit–cost ratio for accession is increased, and participation is thus more
attractive (Barrett, 2003). Suggestions include linking the climate change
regime with the international trade regime (Barrett, 1997; 2003) by, for
example, incorporating trade sanctions as a means of enforcement; or with
research and development (R&D) cooperation, by excluding non-parties
from enjoying the fruits of cooperative R&D (Barrett, 2003; Carraro and
Siniscalco, 1995; 1997).29
It is not always the case, however, that issue linkage helps international
cooperation. The effect depends on the issues that are linked and on how they
are linked. Murdoch et al. (1997) argues for instance that, had the Convention
on Long-Range Transboundary Air Pollution (CLRTAP) not provided for
separate protocols to be negotiated for each of the different pollutants, the
outcome of the negotiations would have given smaller reductions in sulfur
emissions.30 Thus, issue linkage can hinder as well as aid co-operation.
Side payments
Another theoretic solution to the free-rider problem is international trans-
fers or side payments. Transfers may be needed to make co-operation
individually attractive in asymmetric settings, that is, when the benefits
from and/or costs of co-operation differ across countries. The basic idea is
to redistribute the surplus to be gained from co-operation to compensate
the countries that would otherwise have chosen the non-co-operative
outcome.31 Some countries are affected more than others (in absolute or
relative terms) by an environmental problem. The asymmetries often dom-
inate negotiations, and are often perceived to be a main reason for why
agreement is so hard to achieve. Barrett (2003), however, shows that side
payments (or carrots) can promote co-operation, but only when countries
are sufficiently asymmetric, and when the side payments are combined with
credible threats of punishment (sticks).
The side payment solution might be difficult to implement in the case of
a long-term problem like climate change. Simulation models for climate
change mitigation have shown that, in the long run, the gains from co-
operation will more than compensate for the initial losses due to abatement
efforts. However, the fact that the expected break-even date lies very far into
the future complicates the side payment solution because the countries
cannot borrow against future gains in order to compensate for early losses,
although these kinds of distribution problems might be solvable through
some kind of banking system.32 Side payments are not often observed, at
least not in monetary terms, but one recent example is that the EU
promised to support Russia for membership in the WTO in order to per-
suade the Russian government to ratify the Kyoto treaty.
5. Self-enforcing environmental agreements: a closer look
The structure and characteristics of IEAs will have a significant influence
on the effectiveness as well as the costs and benefits of mitigation. The
effectiveness and the costs and benefits of an international regime (such as
the Kyoto Protocol or other possible future environmental agreements)
depend on the number of signatories to the agreement and their abatement
targets and/or policy commitments (IPCC, 2001).
A main strand of the literature on international environmental co-
operation focuses on the conditions for the formation of multilateral agree-
ments (or coalitions) in game theoretic settings. The fundamental
assumption is that international agreements must be self-enforcing since
there is no supranational authority that can enforce compliance. Notable
examples are Asheim et al. (2006), Barrett (1994; 1997; 1999), Carraro and
Siniscalco (1992; 1993), Hoel (1992), and Tulkens (1979). The assumption
of self-enforcement implies that optimal co-operation can only be sustained
by an international treaty if no country can gain by not being a party to it,
and no party can gain by not implementing it. An agreement must therefore
specify a strategy that, if obeyed, must succeed in deterring free-riding and
enforcing compliance. A strategy is credible if no country is worse off
accepting the agreement (individual rationality) and no sub-coalition of two
or more countries can achieve a higher joint payoff by concluding a partial
agreement (collective rationality). Furthermore, collective rationality
implies that an equilibrium agreement must be renegotiation proof,
meaning that it must be in the (collective) best interest of other countries to
insist that a non-compliant country be punished before co-operation can be
resumed (Barrett, 1999; 2003; Finus, 2001).
International environmental agreement models differ with respect to the
specification of the utility functions of governments and the stability
concept they employ. However, they can roughly be divided into two groups – dynamic game models and reduced-stage game models (Finus and
Rundshagen, 2003).
The dynamic game models typically assume an infinitely repeated game
where governments agree on a contract in the first period that has to be
enforced in subsequent periods by using credible threats (for example
Barrett, 1994; 1999). Studies using these models have found that a global
treaty typically will achieve very little and at worst not enter into force, and
that an incomplete treaty (a sub-coalition) may achieve more than the
global treaty. The reason for these results is that the larger the number of
parties to an agreement (k), the greater the harm suffered by the (k-1) other
countries when they impose the punishment needed to deter a unilateral
deviation, and consequently the less credible the threat.
Barrett (2002), shows that a single treaty can be broadened to incorpo-
rate all countries (a consensus treaty), but at the cost of limiting the
per-country level (the ‘depth’) of co-operation. He shows that countries can
reach agreement around a weak treaty, or they can negotiate a more potent
but incomplete treaty. Thus, when the constraint of self-enforcement binds,
we cannot have it both ways. Something has to give. Either participation
must be less than full, or signatories must choose abatement levels that fall
short of maximizing their collective payoff (Barrett, 2003). Allowing the
depth of cooperation to vary, Barrett (2002) demonstrates that countries
might prefer a ‘broad but shallow’ treaty over one that is ‘narrow but deep’.
Reduced-stage game models depict coalition (or treaty) formation as a
two-stage game. In the first stage, countries decide on the coalition forma-
tion. In the second stage, they choose abatement levels and how the gains
from co-operation will be distributed (for example Chandler and Tulkens,
1992; Carraro and Siniscalco, 1993; Hoel, 1992). Some of these models
define equilibria with both internal stability, meaning that no signatory has
an incentive to leave the coalition, and external stability, meaning that no
non-signatory wants to accede to the agreement. A key result is that the
number of signatories generally falls short of the complete coalition (the
global treaty): often, the equilibrium coalition is rather small. A second
result is that the coalition typically achieves results far from the social
optimum.33, 34
There are several important lessons to be learned from these game the-
oretic models. One is that if an international treaty, like the Kyoto Protocol,
sustains full compliance, the reason is that the agreement achieves very
little. Another is that even though the Kyoto Protocol is only a first step, if
the subsequent stages in the process replicate the Kyoto formula, the
outcome is likely to continue to be very close to ‘business as usual’. A third
is that a more ambitious future version of the current climate regime would,
on the other hand, most likely either fail to enter into force or fail to sustain full compliance. Moreover, since many of the proposals for alternatives to
the Kyoto Protocol also do not address the fundamental issues of enforce-
ment and participation, they too are likely to fail (Barrett, 2001). This does
not, however, imply that negotiation is a hopeless waste of time, but rather
that the current design of the Kyoto Protocol does not restructure the game
of climate change mitigation in a way that provides the supporting incen-
tives needed to effect a change in behavior over time.35
6. Multiple agreements
In an effort to increase participation, a few contributions have addressed
the possibility of giving countries the freedom to negotiate more than one
agreement. Bloch (1997), Carraro (1998; 1999; 2000), and Carraro and
Siniscalco (1998) provide examples with the use of reduced-stage game
models. A two-stage coalition game is used to show that when more than
one coalition is possible, the equilibrium coalition structure that endoge-
nously emerges from the negotiation process is characterized by several
coalitions. It has also been shown, in this setting, that social welfare can be
higher with multiple agreements than with a single global accord due to
increased total abatement (Carraro, 2000).
The question of more than one agreement is analyzed in an infinitely
repeated game framework in Asheim et al. (2006). Using a simple dynamic
model, with weak renegotiation-proofness as solution concept,36 they
demonstrate that two agreements can sustain a larger number of co-
operating parties than a single global treaty. They also show that a regime
based on multiple agreements can Pareto dominate a single agreement
regime. The results support the conclusions reached by Carraro and others
(for example Carraro, 1999; 2000 and Carraro and Siniscalco, 1998) using
a reduced-stage game framework.
An important driving force in infinitely repeated games is the way in
which the agreements are enforced. In the global treaty regime of Barrett
(1999) and Asheim et al. (2006), a single deviation triggers punishment by
all other parties. This drives the number of participating countries down
via the renegotiation-proofness requirement.37 If not all participating
countries punish a deviator, then more than one country will cooperate in
the punishment phase, and the renegotiation-proofness requirement is less
strict. This admits a larger number of participating countries. In the two
treaty regime in Asheim et al. (2006), participation is broadened because a
deviation triggers punishment by all parties in the deviator’s treaty, but not
by the countries that are parties to the other treaty.38, 39
If a regime with multiple treaties is to be negotiated, one would need a
criterion to decide what countries to include in which agreement. One
appealing criterion might be geographical region, although other criteria are certainly also conceivable. A regime with regional agreements may, for
example, facilitate external enforcement better than a regime with one
global agreement, because countries in the same region tend to be highly
integrated. A high level of interdependence implies that a host of options
are available (via issue linkages) for providing responses to non-compliance
in any one particular issue area. In addition, countries that are in close
geographic proximity also tend to be culturally close, have similar economic
and political systems, and therefore have similar preferences.40 All of this
might lower the costs of reaching agreement in the first place. Countries
may thus both be more likely to comply with a regional agreement and
more inclined to join a regional agreement in the first place (Asheim et al.,
2006). All of these features represent a potential rationale for regional
agreements, and could make such a regime an attractive option for
example in the negotiations on future commitment periods under the
Kyoto Protocol.
7. Interest group influence
Environmental policies influence a country’s economy in a number of
different ways, and the design of such policies is thus of great concern to a
number of groups. The influence of interest groups is therefore a reoccur-
ring theme in the study of environmental politics. One of the early classics
in the public choice literature is Mancur Olson’s (1965) The Logic of
Collective Action. In this book he applies public choice reasoning to the
analysis of various collective-action problems involving interest groups.
Interest groups have been a focal point within the public choice literature
ever since.
When arguing that government intervention is needed to correct market
failures when public goods, externalities and other sorts of market failures
are present, the economics literature often makes the implicit assumption
that these failures can be corrected at zero cost. The government is seen as
an omniscient, benevolent institution that dictates policies in order to
achieve a Pareto-optimal allocation of resources. The public choice litera-
ture challenges this utopia model of government by examining not how
governments may or ought to behave, but how they do behave. It reveals that
governments, too, can fail in certain ways.
Public choice argues that if the state exists in part to provide public goods
and eliminate externalities, then it must accomplish the same preference
revelation task for these public goods as the market achieves for private
goods. The public choice approach to non-market decision-making has
been (1) to make the same behavioral assumptions as general economics
(rational, utilitarian individuals), (2) often to depict the preference revela-
tion process as analogous to the market (voters engage in exchange, individuals reveal their demand schedules via voting, citizens exit and enter
clubs), and (3) to ask the same questions as traditional price theory: Do
equilibria exist? Are they stable? Are they Pareto efficient? How are they
obtained? (Müller, 2003).
Formally, public choice can be defined as the economic study of non-
market decision-making, or simply the application of economics to polit-
ical science. The subject matter of public choice is that of political science:
the theory of the state, voting rules, voter behavior, party politics, the
bureaucracy, public goods, and so on. The basic behavioral postulate of
public choice, however, is as for economics: that people are egoistic, ratio-
nal, utility-maximizers (Müller, 2003). It is assumed that each agent acts
optimally towards his preferences. However, the preferences regarding, for
example, environmental policies differ according to who or what the agent
is. While a firm strives to maximize profit, for example, politicians seek to
maximize influence and power (Svendsen, 1998). With this rational behav-
ioral assumption, the public choice approach is able to deliver clear-cut
predictions and simplicity, which makes it very user-friendly. However,
preferences might not be as stable as the theory predicts, making it less
applicable in practice. Norms and values, which are changeable, could
influence the cost–benefit analyses behind decisions (Krogstrup and
Svendsen, 2004).41
In an open society, environmentalist groups and their opponents, gener-
ally the corporations and businesses that resist the costs involved in com-
plying with environmental regulation, are presumed to spend resources on
trying to influence policy makers. The policy makers need the votes, the
money, the moral approbation, and the publicity these groups might
provide in exchange for policy stances that gain approval and avoid disap-
proval. Environmental policy is thus a function of the different pressures
emanating from these (and other) interest groups, and hence seldom fully
reflects the interests of any one of them (Barkdull and Harris, 2002). In
public choice theory, it is assumed that the direction in which these interest
groups will try to push the policy choice will depend on the distribution of
costs and benefits from regulation (Müller, 2003; Svendsen, 1998). A proper
understanding of institutional settings thus allows relatively straightfor-
ward net-benefit maximizing models to account for a rich and complex
range of policy outcomes (Congleton, 2004), including government nego-
tiating positions in international forums.
A country’s environmental foreign policy is presumed to be the outcome
of bargains struck among different constituencies with a stake in environ-
mental policy (Barkdull and Harris, 2002). Somehow the preferences of a
country’s citizens must be consolidated into a unitary negotiating position.
At the federal government level in the United States, for example, this requires resolution of conflicting positions taken by different executive
branch departments by means of inter-agency bargaining. For wide-
ranging issues like global warming, a dozen or more government agencies
may be involved that, in turn, represent a variety of interests. Each agency’s
negotiating position is thus influenced by lobby groups such as trade asso-
ciations, industries, and environmental and other non-governmental
organizations. The internal negotiations are thus very complex, and after
finally agreeing on what the country’s interests are, the official delegation
must negotiate with delegations from other countries.
Explaining a given environmental foreign policy, a county’s position in
international negotiations, or the overall character of a country’s policy
direction therefore requires identifying the groups that participate, their
relative influence, and the strategy and tactics they employ. Because of the
economic implications of environmental policy, elites take a strong interest
in this issue area and usually attempt to direct the government towards poli-
cies compatible with corporate freedom and economic growth (Bang, 2004;
Barkdull and Harris, 2002).42
8. Concluding remarks
The bottom line in international environmental cooperation will always be
determined by what is politically feasible. Because of the multiplicity of
decision-makers, ranging from the international governmental level down
to the micro level of firms and individuals, it is very hard to find strategies
for global environmental protection that are acceptable to all. Therefore, it
is also hard for a country’s government to choose a position in international
negotiations. In combination with the fact that environmental policies
cannot be isolated from other socio-economic goals, this multiplicity makes
negotiations on international environmental cooperation particularly com-
plicated. Domestic interest conflicts are thus among the biggest obstacles
to achieving a common political strategy for the protection of the global
environment. Another is the free-rider issue.
The economics literature has focused very much on optimal solutions
and cost-effectiveness. These are important issues, but optimal solutions
are less appealing if they are not politically feasible. The primary concern
for international environmental protection should rather lie with increas-
ing cooperation. The level of co-operation is to a large degree defined by
participation and compliance. Although countries might be less likely to
participate in and comply with treaties that are excessively costly, cost-
effectiveness is neither a necessary nor a sufficient condition for participa-
tion and compliance (Barrett, 2003).
The world’s level of protection of the global environment plays for all
intents and purposes no small part in determining whether the world is on a sustainable path, since shared resources are prone to overuse when coun-
tries pursue unilateral policies. Because the provision of global public
goods relies on volunteerism, the only way to beat the free-rider issue is to
restructure the underlying incentives. A central challenge of international
co-operation is thus to figure out how the relationships among countries
can be restructured in a mutually preferred way. According to Barrett
(2003), five tasks are necessary to achieve this: first, to create an aggregated
gain, that is, a reason for all countries to come to the bargaining table;
second, to distribute this gain such that all countries would prefer that the
agreement succeed; third, to ensure that each country would lose by not
participating, given that all the others agree to participate; fourth, to
provide incentives for all parties to comply with the treaty; and fifth, to
deter entry by third parties.
The outcome of an institution will always depend on the responses of the
different countries to the agreed-upon set of rules. A sixth task that should
be added is therefore the necessity of taking into account the complexity of
a country’s negotiating position resulting from different domestic con-
stituencies with a stake in environmental policy. Thus, to achieve higher
levels of provision of global environmental public goods, incentive restruc-
turing to achieve political feasibility, not optimality or cost-effectiveness,
should be the primary focus in the negotiations on any international envir-
onmental treaty.

25 Trade and sustainable development Kevin P. Gallagher :

1. Introduction
The world community faces the enormous challenge of the need to increase
the well-being of more than half its inhabitants without jeopardizing the
ability of the natural environment to function now and into the future – the
challenge of sustainable development. The recent wave of globalization in
the world offers an opportunity to meet that challenge. However, there is
increasing concern that the current form of globalization is at odds with
sustainable development.
Although the last decades of the twentieth century ushered an unprece-
dented level of international trade and investment, poverty and inequality
remain key characteristics of the global economy in the twenty-first
century. The World Bank defines poverty as those persons who earn less
than $2 per day (1999 purchasing power parity) and extreme poverty as
those who earn less than $1. Using this definition, about half of the world’s
population are poor, almost 3 billion people. Close to half of the poor live
in extreme poverty, 1.4 billion (Cline, 2004).
The world’s ecosystems fare no better. According to the recent
Millennium Ecosystem report conducted by 1300 experts from 95 coun-
tries, ‘60 percent of the ecosystem services that support life on Earth – such
as fresh water, capture fisheries, air and water regulation, and the regula-
tion of regional climate, natural hazards and pests – are being degraded or
used unsustainably’ (UNDP, 2005). Such degradation is proving to be
costly in economic terms. The World Bank and other international agencies
estimate that the economic costs of environmental degradation range from
6 to 10 per cent of GDP on an annual basis (Gallagher, 2004).
The speed and distribution of these changes are too fast for many people
to comprehend and accept. An escalating series of protests is occurring at
nearly every major meeting surrounding global economic affairs: the
WTO meeting in Seattle in 1999, the Washington IMF/World Bank
meetings in the spring of 2000, the July 2001 G-8 meeting in Geneva, the
Summit of the Americas meeting in Quebec in April 2001, the WTO
meetings in Cancun in 2003 and so forth. These events are paralleled by
similar protests in capitals across the globe. The protests outside the
meetings, and the increasing levels of disagreement among nations them-
selves, illustrate the breadth and depth of concerns of a growing but ill-defined constituency about the potential impacts of an unfettered
global marketplace.
With this concern in mind the world community has reasserted the need
for development through the Millennium Development Goals and the
global commitment to sustainable development signed at the World Summit
for Sustainable Development. At the same time, most of the world’s nations
have also embarked on a new round of global trade negotiations – the
so-called Doha Round under the World Trade Organization (WTO). The
Doha Declaration makes explicit reference to sustainable development:
We strongly reaffirm our commitment to the objective of sustainable develop-
ment, as stated in the Preamble to the Marrakesh Agreement. We are convinced
that the aims of upholding and safeguarding an open and non-discriminatory
multilateral trading system, and acting for the protection of the environment
and the promotion of sustainable development can and must be mutually sup-
portive. (WTO, 2001)
This chapter outlines the relationship between international trade and
sustainable development. It is organized into three parts. The first discusses
the theoretical relationships between these two phenomena, the second
examines the empirical evidence, and policy considerations conclude the
chapter.
2. Trade and sustainable development: theory
In theory international trade and sustainable development can be mutually
compatible, and perhaps even reinforcing. According to independent the-
ories of international trade on the one hand, and environmental econom-
ics on the other, trade liberalization can bring economic benefits that can
be distributed in a manner to reduce poverty and protect the environment.
The economist David Ricardo showed that because countries face
different costs to produce the same product, if each country produces, and
then exports, the goods for which it has comparatively lower costs, then
all parties benefit. The effects of comparative advantage (as Ricardo’s
notion became called) on factors of production were developed in the
‘Heckscher–Ohlin’ model. This model assumes that in all countries there is
perfect competition, technology is constant and readily available, there is
the same mix of goods and services, and that factors of production (such
as capital and labor) can freely move between industries.
Within this rubric, the Stolper–Samuelson theorem adds that interna-
tional trade can increase the price of products (and therefore the welfare)
in which a country has a comparative advantage. In terms of foreign direct
investment (FDI), FDI can contribute to development by increasing
employment and by human capital and technological ‘spillovers’ where foreign presence crowds in new technology and investment. In theory, the
gains from trade accruing to ‘winning’ sectors freed to exploit their com-
parative advantages have the (Pareto) possibility to compensate the ‘losers’
of trade liberalization. Moreover, if the net gains from trade are positive
there are more funds available to stimulate growth and reduce poverty. In a
perfect world then, free trade and increasing exports could indeed be
unequivocally beneficial to all parties.
These theories have been extended to conceptualize the trade and envir-
onment relationship. A useful framework for thinking about trade and the
environment has been proposed by Gene Grossman and Alan Krueger
(1993). They identify three mechanisms by which trade and investment lib-
eralization affect the environment: scale, composition, and technique effects
(see also Chapter 15). Scale effects occur when liberalization causes an
expansion of economic activity. If the nature of that activity is unchanged
but the scale is growing, then pollution and resource depletion will increase
along with output. Composition effects occur when increased trade leads
nations to specialize in the sectors where they enjoy a comparative advantage.
When comparative advantage is derived from differences in environmen-
tal stringency then the composition effect of trade will exacerbate existing
environmental problems in the countries with relatively lax regulations.
Race-to-the-bottom discussions are perfectly plausible in economic theory.
The Hecksher–Ohlin (H–O) theory in trade economics postulates that
nations will gain a comparative advantage in those industries where they
are factor-abundant. Applying the H–O theory to pollution then, it could
be argued that a country with less stringent environmental standards would
be factor-abundant in the ability to pollute. Therefore, trade liberalization
between a developed and a developing nation where the developed nation
has more stringent regulations may lead to an expansion in pollution-
intensive economic activity in the developing country with the lesser regu-
lations. The developing country with the less stringent regulations becomes
a ‘pollution haven’ for pollution-intensive economic activity (Copeland and
Taylor, 2003).
Technique effects, or changes in resource extraction and production tech-
nologies, can potentially lead to a decline in pollution per unit of output
for two reasons. First, the liberalization of trade and investment may
encourage multinational corporations to transfer cleaner technologies to
developing countries. Second, if economic liberalization increases income
levels, the newly affluent citizens may demand a cleaner environment.
The economic and environmental dimensions of trade and sustainable
development are outlined in Table 25.1. The first column exhibits the
‘winners’ and ‘losers’ of trade liberalization. The second column outlines
the economic dimensions, the third outlines the environmental dimensions.
From an economic perspective, when liberalization occurs and nations
trade where they have a comparative advantage the ‘winners’ are those
sectors which can now export more of their goods or services. Theoretically
this will not only cause expansion of exports but also of employment and
wages in such sectors as well. The ‘losers’ of the liberalization are those
sectors that will find it harder to face an inflow of newly competitive
imports. In those sectors one would expect a contraction of that sector,
layoffs, and wages decreases. If the gains to the export sector outweigh the
losses to the import sector the net gains are positive. This leaves the ‘possi-
bility’ that the winners can compensate the losers or that the gains from
trade may be used to stimulate pro-poor growth.
Drawing on the framework on trade and environment outlined above,
the third column in Table 25.1 outlines potential environmental winners
and losers. There can possibly be environmental benefits from being an eco-
nomic winner as well. First, this can occur if trade liberalization causes a
compositional shift toward less environmentally degrading forms of eco-
nomic activity. Second, there is also the possibility of environmental
improvements in relatively environmentally destructive sectors if those
sectors attract large amounts of investment from firms that transfer state-
of-the-art environmental technologies to the exporting sector.
Trade liberalization can also have negative effects. Of course, trade lib-
eralization can cause a composition effect where the economy moves
toward more pollution-intensive industry. One example of this is Brazil,
which liberalized trade in the 1990s and subsequently its exports became
more pollution-intensive (Young, 2004). Scale effects can also adversely
impact the environment, and the health and safety of the workers in eco-
nomically expanding plants that may have to handle increasing amounts of
pollution-intensive inputs.
It is often overlooked that there can also be adverse environmental
effects of being a trade policy ‘loser’. Some analysts argue that the shrink-
ing of a sector that is environmentally degrading is beneficial for an
economy because by definition less economic activity will equal less pol-
lution. On the other hand, a shrinking sector can bring with it environ-
mental liabilities that may cost taxpayers increased funds. Moreover, from
a political economy perspective, shrinking sectors may put pressure on
governments to turn a blind eye to environmental performance in order to
maintain an economic presence (in other words causing a worsening tech-
nique effect).
Losing economic comparative advantages can also hurt the environment
when losing sectors are those related to positive externalities. In Mexico,
small holder maize growers are finding it hard to compete with a flood of
US corn imports after the North American Free Trade Agreement
(NAFTA) was signed. Mexico is the center of origin for maize and the
cradle of maize crop genetic diversity. Thus, pressure to leave the land or
convert it to other crops is threatening such diversity and global food secu-
rity (Nadal and Wise, 2004). Smallholders cultivating maize are generating
positive externalities of protecting a global public good and maintaining
diversity. Yet, such prices are not reflected in their goods. Similar examples
are with jute production in Bangladesh (Boyce, 2002).
In theory then, trade liberalization can benefit the environment but only if
winners compensate the social and environmental losers with the gains from
trade in the form of institution building for sustainable development. This is
very difficult in developing countries for political, cultural and economic
reasons. On the political level, trade liberalization costs a great deal of polit-
ical capital to begin with. It is then very difficult to get the winners of a trade
policy to agree to give away a portion of their gains. What’s more, many in
developing countries may not accept compensation for losing. Indigenous
groups see themselves as having ancient rights to land and resources and may
not be willing to be ‘bought off’ (Kanbur, 2001). Even if they could be bought
off, at what price? The fields of ecological and environmental economics have
made great strides in recognizing that there are values for the environment
that need to be incorporated into the price scheme to allocate resources in a
more socially optimal manner. However, the methodologies for identifying
the exact prices for those values are very much in their infancy, controversial,
and many times inappropriate – especially in developing country contexts
(Ackerman and Heinzerling, 2004).
3. Trade and sustainable development: evidence
The evidence on the effects of the recent wave of trade liberalization on
sustainable development is mixed. Trade liberalization has not been linked to economic growth and therefore has not brought many opportunities for
developing the necessary institutions to make trade work for development.
It is estimated that the annual gains from the Uruguay Round were
approximately $200 billion annually. However, it has also been shown that
70 per cent of those gains have gone to the developed countries and most
of the rest has gone to a small handful of developing countries. Indeed, in
the first six years following the Uruguay Round, it is estimated that the 48
LDCs were worse off by $600 million per year (Stiglitz and Clayton, 2004).
Thus, when the developed world proposed another round of global trade
talks in 2001 in Doha, Qatar, the developing countries accepted on condi-
tion that development form a core part of the negotiations.
In a comprehensive review of the literature, Rodriquez and Rodrik
(2001) have shown that there is no systematic relationship between a
nation’s average level of tariff and non-tariff barriers and its economic
growth rate. An assessment of the literature on FDI and development came
to similar conclusions; FDI alone was not correlated with local spillovers
in developing countries (Gallagher and Zarsky, 2005). Whereas developing
country per capita income growth was 3 per cent on an annual basis
between 1960 to 1980 – a period of considerable levels of state management
of developing economies – the more integrated period from 1980 to 2000
yielded average annual growth rates of 1.5 per cent in the developing world.
The latter rate is less than 1 per cent per annum if India and China (two
interventionist countries) are taken out (Chang, 2003).
More recent work has shown that trade liberalization alone is not a
sufficient condition for economic growth. Institutional innovation coupled
with macroeconomic and political stability are key to the growth process
(Wacziarg and Welch, 2003). Indeed, there is now fairly widespread agree-
ment among growth economists that institutional quality is the strongest
driver of economic growth, more so than trade or geographical contexts
(Rodrik, 2004). Whereas traditional trade theory emphasizes obtaining
welfare gains through specialization, institutional approaches emphasize
obtaining welfare gains from increasing productivity by means not neces-
sarily based on specialization.
The evidence on the environmental effects of trade is mixed as well.
Economic integration is contributing to worldwide environmental degra-
dation, but not so much because the developing world is serving as a ‘pol-
lution haven’ for developed world pollution. In 1992, the World Bank’s
World Development Report made the case that while trade-led growth may
cause sharp increases in environmental degradation during the early stages
of economic development, such degradation would begin to taper off as
nations reached ‘turning points’ ranging between $3000 to $5000 GDP per
capita (World Bank, 1992). The Bank was generalizing from a landmark 1991 paper by economists Gene Grossman and Alan Krueger. Working
with a cross-sectional database of largely developed and some developing
countries, this article examined the relationship between ambient concen-
trations of criteria air pollutants and GDP per capita. When they plotted
their regression results they found that lower income nations had higher
rates of pollution per capita where the reverse occurred for higher income
nations (Grossman and Krueger, 1993).
This relationship became known as the environmental Kuznets curve
(EKC: see Chapter 15), borrowing its name from the landmark article by
Simon Kuznets that found a similar relationship between income inequality
and GDP per capita in a cross-section of countries in the 1950s (Kuznets,
1955). For the developed countries, the three factors described earlier (scale,
composition and technique effects) are seen to be interacting – as income
has grown the composition of industry has shifted toward relatively less
pollution-intensive economic activity while at the same time improvements
in technology and environmental regulation have occurred. Although
overall levels of growth (scale) have vastly increased, they have been offset
by composition and technique effects.
To this day, generalizations of these findings have been used to make the
claim that nations should grow now through trade liberalization and worry about the environment later (Bhagwhati, 1993). EKC studies have become
a cottage industry, with close to a hundred articles published since the orig-
inal 1991 piece (see Panayatou, 2000; Stern, 1998). What is ironic is the fact
that, as the policy community has rushed to generalize the EKC in the polit-
ical realm, the consensus in the peer-reviewed academic literature on the
EKC has become much more cautious. Most importantly, the literature
shows that the empirical evidence for the EKC is relatively weak and
limited. While a thorough review of that literature is beyond the scope of
this chapter, the following limits can be outlined (for a good review see
Stern, 1998, and Chapter 15 of this volume):
EKCs are limited to a small number of pollutants.
EKC studies have relatively small representation from developing
countries.
EKC turning points are much higher than original estimates.1
Income isn’t the only factor contributing to an EKC. Later studies
have shown that factors such as the degree of political freedom and
democracy in a nation, population density, economic structure, and
historical events (such as the oil price shocks of the 1970s) correlate
with reductions in pollution.
Limited evidence for the EKC in single-country trajectories. The
majority of early EKC studies utilize cross-sectional or panel data of
largely developed countries to estimate the relationship between
income and pollution.
Yet, opponents of free trade often claim that trade liberalization will result
in a mass migration of pollution-intensive industry from developed coun-
tries with stringent environmental regulations to developing countries with
lax environmental standards. Not only will such migration cause increases
in pollution in developing countries, they argue that pressure will then be
exerted on developed country standards in the name of competition –
effectively creating a ‘race-to-the-bottom’ in standards.
Like the EKC literature, it is also ironic that the majority of the peer-
reviewed literature has found very limited evidence for pollution havens but
that the policy community continues to cite it as a dire consequence of
trade liberalization. Very recently however, a small handful of papers have
found evidence for pollution havens. Again, a full review of the literature is
beyond the scope of this chapter. However, extensive studies have been con-
ducted at the global and regional level. There have been a number of widely
cited studies on international trade flows and environmental regulations.
Many have identified and studied a set of ‘dirty’ industries, where regula-
tions might be expected to have the greatest effect. Although the definitions of dirty industries vary, many of the same industries tend to show up on
everyone’s lists.
James Tobey looked at the behavior of 23 nations in 1977, testing
whether environmental policy affected the patterns of trade in commodi-
ties produced by dirty industries (Tobey, 1990). He defined a dirty, or
pollution-intensive, industry as one where pollution abatement costs in the
United States were 1.85 per cent or more of total costs. Industries meeting
this standard were pulp and paper, mining, iron and steel, primary non-
ferrous metals, and chemicals. For international comparisons Tobey
created an ordinal variable ranging from 1 to 7 to measure the level of strin-
gency of a country’s environmental policies. He then regressed net exports
of each country’s dirty industries on their factor inputs (land, labor, capital
and natural resources) and on environmental stringency. In no case did he
find that environmental stringency was a statistically significant determin-
ant of net exports.
World Bank researchers Patrick Low and Alexander Yeats tested whether
developing countries gained a comparative advantage in pollution-intensive
products during the period 1965–88 (Low and Yeats, 1992). Their model
relies on calculation of revealed comparative advantage (RCA), defined as
the share of an industry in a country’s total exports, relative to the indus-
try’s share of total world exports of manufactures. Low and Yeats looked at
RCAs of 109 countries for pollution-intensive industries. Their list of pol-
lution-intensive industries, selected on the basis of pollution abatement
costs in the US, consists of iron and steel, non-ferrous metals, petroleum
refining, metal manufacturing, and pulp and paper. Low and Yeats found
that for these industries the RCAs of developing countries were growing rel-
ative to those of industrial countries. They observed decreases in dirty
industry RCAs in the developed world and increases in Eastern Europe,
Latin America and West Asia.
Results along the same lines were found in a study by Mani and Wheeler
(1998). They found that from 1960 to 1995, pollution-intensive output as a
percentage of total manufacturing fell in the OECD and rose steadily in the
developing world as a whole. However, the location of pollution havens has
changed over time because economic growth in any one country brings
‘countervailing pressure to bear on polluters through increased regulation,
technical expertise, and clean sector production’ (Mani and Wheeler,
1998, p. 244).
Using a different methodology, another World Bank team looked at
trade liberalization and the toxic intensity of manufacturing in 80 countries
between 1960 and 1988 (Lucas et al. 1992). Analyzing aggregate toxic
releases per unit of output, they identified metals, cement, pulp and paper,
and chemicals as the dirtiest industries. Lucas et al. found that the dirty(toxic-intensive) industries grew faster in the developing countries as a
whole, but this growth was concentrated in relatively closed, fast growing
economies, rather than in the countries that were most open to trade.
Regional work on Latin America has generated similar results (Birdsall and
Wheeler, 1993).
Very recently however, a handful of studies have indeed found evidence
of pollution havens in the world economy. A study by Cole (2004) exam-
ines North–South trade flows for ten air and water pollutants. Cole finds
evidence of pollution haven effects, but finds that such effects are quite
small relative to other explanatory variables. Another study, by Kahn and
Yoshino (2004) looks at bilateral trade data over the years 1980 to 1997 for
128 nations for 34 manufacturing industries, and examines how low-,
middle-, and high-income nations differ regarding their income elasticity in
exporting pollution-intensive products. They find that among nations
outside of regional trade blocs there is general support for the pollution
haven hypothesis. As national incomes rise, exports of pollution-intensive
products decrease relative to exports of ‘cleaner’ goods. Nations partici-
pating in regional trading arrangements have slightly weaker pollution
haven effects than those observed outside of regional trading blocs.
The reason why so many of these studies fail to find evidence for pollu-
tion havens (or find small effects) in developing countries is that the eco-
nomic costs of environmental degradation are relatively much smaller than
many other factors of production – especially those that determine com-
parative advantage. In general, the developing world is factor abundant in
unskilled labor that takes the form of manufacturing assembly plants. On
average, such manufacturing activity is relatively less pollution-intensive
than more capital laden manufacturing activities such as cement, pulp and
paper, and base metals production. A full review of this literature is beyond
the scope of this chapter (see Jaffe, 1995 and Neumayer, 2001, for compre-
hensive reviews of this literature).
A snapshot of the record on trade and sustainable development in Latin
America is useful. Perhaps no region of the world has experimented with
economic integration more that Latin America. Since the late 1980s, many
Latin American nations have introduced a deep package of reforms includ-
ing: reducing tariffs and other protectionist measures; reducing barriers to
foreign investment; restoring ‘fiscal discipline’ by reducing government
spending; and promoting the export sector of the economy. According to
a sweeping assessment of the impacts of the reforms conducted by the
Economic Commission for Latin America and the Caribbean (ECLAC),
the region’s economies grew at an annual rate of less than 2 per cent
between 1980 and 2000, compared to a rate of 5.5 per cent between 1960
and 1980. Growth was faster during the 1990s than in the 1980s, but it still did not compare to the period previous to the reforms. Chile is an excep-
tion where growth rates almost doubled over the past 20 years compared to
the 1960 to 1980 period (Stallings and Peres, 2000). The ECLAC report
concludes that the reforms contributed to an increase in poverty and
inequality in the region.2 As a result, there has been widespread popular
resistance, which is putting added pressure on governments to question
both the Washington Consensus and free-trade agreements.
The United Nations Environment Program (UNEP) and ECLAC report
that environmental trends in the region continue to worsen (ECLAC/UNEP,
2003). Increasing urbanization and the modernization of agriculture are
leading to increases in air, soil and water pollution and subsequent adverse
human health effects. The report notes that the health problems associated
with deteriorating air quality and toxic substances are as serious as the health
problems previously caused by underdevelopment. Finally, although on
average industrial manufacturing has shifted toward relatively ‘cleaner’
sectors, increasing rates of pollution are occurring because of ‘serious short-
comings’ in environmental management.
Specific to the EKC and pollution haven theories, on average, countries in
Latin America and the Caribbean experienced positive composition effects,
meaning that the composition of industry shifted toward ‘cleaner’ produc-
tion. However, pollution in Latin American industry is increasing because
nations in the hemisphere lack the proper policies to stem the environmen-
tal consequences of trade-led growth in those sectors. In addition, many
firms lack the will or ability to adhere to the environmental ramifications of
their operations, and non-governmental organizations have not always been
there to apply appropriate pressure. Of the case studies conducted here,
Brazil has actually experienced a general increase in pollution-intensive
activity, whereas Mexico follows the general trend (WGDEA, 2004).
4. Trade and sustainable development: policy and institutions
The evidence just summarized underscores the need to couple any eco-
nomic integration with social and environmental policy at the local,
national and international level. The fact that there is only mixed evidence
that trade liberalization is associated with growth shows that trade must be
coupled with institution building. The fact that there is limited evidence for
the EKC shows that economic integration cannot be relied on for auto-
matic environmental improvements. Indeed, the evidence shows that the
lack of effective institutions in the presence of economic integration has
exacerbated longstanding problems in the developing world.
However, a silver lining lies in the fact that there is little evidence of pol-
lution havens. Such evidence suggests that strengthening environmental
institutions and standards in developing and developed countries alike will not deter foreign and domestic investments. Because the abatement costs of
pollution are so small relative to other key costs, firms will not move to or
from developing countries as regulations rise (at least to US levels).
Michael Porter’s hypothesis (Porter and van der Linde, 2002), that regula-
tion-inspired innovation to decrease environmental degradation can lead to
reduced costs and therefore increased competitiveness, also deserves to be
spelled out. Environmental regulation can lure firms to seek ways of
increasing resource productivity and therefore reduce the costs of inputs.
Such ‘innovation offsets’ can exceed the costs of environmental compli-
ance. Therefore, the firm that leads in introducing cleaner technologies into
the production process may enjoy a ‘first-mover advantage’ over those
industries in the world economy that continue to use more traditional,
dirtier production methods. (For a critical rebuttal see Palmer et al., 1995.)
Rhys Jenkins (1998) has offered a synthesis of the Porter hypothesis,
arguing that regulation is more likely to lead to ‘innovation offsets’ under
three conditions. Note that each condition requires that a firm has sub-
stantial market power in an industry in which there is substantial innova-
tive activity. First, because cost reductions are more likely to occur where
new clean technologies are developed rather than in industries that adopt
end-of-pipe solutions, the level of R&D is likely to be a factor in deter-
mining the impact on competitiveness. Second, innovation offsets are more
likely in industries or firms that have the ability to absorb environmental
costs, which is most often determined by profit margins and firm size.
Finally, they are more likely in firms that have the ability to pass increased
costs on to consumers in the form of higher prices.
Creative policy does not have to be designed by government. Conroy
(2002) analyzes how advocacy organizations have used certification pro-
cesses to reward firms that produce and trade goods that use high social and
environmental standards in their production processes. Through such
efforts, the Forest Stewardship Council has certified 60 million acres of
forest between 1995 and 2001, accounting for more than 5 per cent of the
world’s working forests. Working on the demand side of the equation,
advocacy groups set up market campaigns to pressure firms to buy these
products. Indeed, some retail giants are now actually seeking to participate
in these processes. When governments or citizens’ groups recognize more
sustainable practices in the developing world, there are avenues to gain
market access for production processes that would be deemed inefficient by
an unfettered marketplace.
Although developing countries agreed to enter a new round of trade
negotiations only on the condition that development would be the center-
piece, there are growing concerns that this promise will go unfulfilled. Key
among those concerns is the notion that a new trade agreement will not give the developing world the ‘policy space’ to use the very instruments and tools
that many industrialized nations took advantage of to reach their current
levels of environmental protection and development. The verdict is still out
on this, but new agreements must give countries the space to establish the
necessary institutions to steer growth toward development. If that doesn’t
occur, the world trading system will continue to confuse the means of
increasing trade and investment with their ends of sustainable development.
Besides preserving the space for national efforts, three models of institu-
tions have emerged that deal with trade and sustainable development link-
ages at the regional and global levels. On the one hand the European Union
(EU) has a very deep set of linkages between integration and sustainable
development, whereas the WTO has quite limited linkages. Trade arrange-
ments negotiated by the United States are somewhere in the middle.
The EU has made decreasing economic, social and environmental dis-
parities a cornerstone of its regional integration strategies. According to
Anderson and Cavanagh (2004) the EU made $324 billion in development
grants to this end between 1961 and 2001. Annual aid for a new member of
the EU can be as high as 4 per cent of GDP. As a result, the relatively less
well-off European countries have improved their social and environmental
situations as well as having benefited economically from integration.
Coupled with development funds the EU has established regional social
and environmental ministries that establish independent standards and
allow for civil society participation and monitoring as well.
In its regional arrangements, the US allows for a much more limited
level of linkages between trade and sustainable development. The major-
ity of regional trade arrangements (such as the US agreements with Chile,
Jordan, Morocco, Singapore, Central America and others) have text
concerning environmental matters but leave out social concerns com-
pletely, set up no institutions, and have very limited avenues for civil society
participation. Indeed, according to Anderson and Cavanagh (2004) EU
development funds are approximately ten times the amount of US
economic assistance grants to all of Latin America. In the largest US
regional arrangement, the North American Free Trade Agreement
(NAFTA), a parallel agreement set up an environmental institution called
the Commission for Environmental Cooperation. With an annual budget
of $9 million the institution can do little more than provide technical assis-
tance to the parties involved, but it does allow interesting levels of civil
society participation. NAFTA does not include any mechanism to address
regional inequality. Thus, the experience of Ireland, Spain and Greece
with EU development funds has resulted in increasing standards of living
as well as social and environmental improvements, Mexico has become
worse off since NAFTA – incomes have grown a mere 1 per cent annually and poverty and inequality have worsened. What’s more, the economic
costs of environmental degradation have reached 10 per cent of GDP
annually (Gallagher, 2004; Gallagher and Zarsky, 2005).
On the world stage, the WTO has limited formal linkage between sus-
tainable development and trade, though that may be changing. On the
social end, the WTO (and the GATT before it) have allowed for ‘special and
differentiated treatment’ for developing countries – allowing them to
deploy many of the development policies that were used in the developed
world in the past but are now not allowed. However, successive rounds of
WTO negotiations are shrinking the policy space for such policies.
Agreements on intellectual property rights, investment rules, and services
have all made it much more difficult for developing nations to deploy
the development policies used by middle and high income nations in the
twentieth century (Gallagher, 2005).
On the environmental front, there has been a longstanding controversy
regarding the extent to which WTO laws restrict the ability of nations and
the world community to establish effective environmental policy. At the
national level, numerous cases have gone before the WTO claiming
that national environmental policies have served as unfair trade barri-
ers to member nations. Two famous cases involving tuna and shrimp
respectively occurred when developing country governments challenged
US laws that restricted imports of these fish when they were caught by
using techniques that also killed dolphins or sea turtles. Developing coun-
tries saw such laws as unfair trade barriers. The WTO has ruled that it
does not object to environmental policy per se, but to environmental poli-
cies that are trade restrictive. The US has since amended these laws
(Neumayer, 2001).
Although there has never been a WTO case to this effect, at the multi-
lateral level there is growing concern that Multilateral Environmental
Agreements (MEAs) will be overridden by WTO laws. Many MEAs use
trade restrictions as an enforcement mechanism and the fear is that such
mechanisms would be deemed WTO illegal and thus reduce the effective-
ness of MEAs and ‘chill’ the negotiations of future MEAs (Neumayer,
2001). In response to this the Doha Round of WTO negotiations (2001 –
present) is charged with examining the relationship between MEAs and the
WTO.
Some scholars and policy makers argue that more needs to be done, that
indeed a ‘World Environmental Organization’ should be established in
order to serve as a counterweight to the WTO (Esty, 1997; Speth, 2004).
Indeed, such an institution has also been proposed by none other than
former WTO head Renalto Ruggerio: ‘I would suggest that we need a
similar multi-lateral rules-based system for the environment – a World Environment Organization to also be the institutional or legal counterpart
to the WTO’ (Ruggiero, 1999).
Discussion of a World Environmental Organization has become quite
controversial, with many in the environmental community arguing against
it on numerous grounds. Some say that the existing global environmental
regime (surrounding such bodies as the United Nations Environment
Program) has not been able to fulfil its mandate and the focus should be
reforming the existing architecture, not creating new institutions that could
become plagued with the same problems (Najam, 2003).

26 The international politics of sustainable development John Vogler :

1. Introduction
There are many definitions of sustainable development, but few betray its
political nature. One exception is to be found in a 1992 statement by
Maurice Strong, the moving force behind the United Nations Conference
on Environment and Development (UNCED) held in that year.
Sustainable development involves a process of deep and profound change in the
political, social, economic, institutional and technological order, including rede-
finition of relations between developing and more developed countries.1
From the perspective of international politics, the critical part is the ‘rede-
finition of relations between developing and more developed countries’.
Sustainable development represented a political construct designed to facil-
itate a bargain across the deep structural divide between North and South.
This would allow global negotiation on the environmental concerns voiced
by developed states through the necessary accommodation of the economic
and political demands of the developing countries. In the much changed
and highly differentiated circumstances of the early twenty-first century
international system, it continues to serve this function. This article seeks to
outline the way in which the concept has been moulded by international pol-
itics, how it reflects not only the balance between the G77/China and the
OECD countries but other significant changes in the world system as well.
The concept has always been associated with the United Nations organ-
ization and landmarks in its evolution are provided by three great UN con-
ferences held over the 30 years from 1972 to 2002; at Stockholm, Rio and
Johannesburg. In this period there has been a discernible shift from a near
exclusive concern with the environmental predicament, to an integrated
conception of environmental, economic and social determinants of the
human future, in which the former is by no means dominant.
A conventional survey of these developments might regard sustainable
development as a new arena for the expression of the national interests of
a widening range of states, at various levels of economic development, with
their own political and commercial agendas to pursue. However, the
concept was not just the rhetorical plaything of self-interested states. As it became institutionalized within the UN system, it began to take on a life of
its own, to spawn new commissions and meetings and to re-shape the way
in which other organizations defined their missions. It came to be closely
associated with the growing significance of non-state actors and particu-
larly the NGOs that populate what has come to be termed ‘global civil
society’. It may also be argued that, as well as reflecting the prevailing polit-
ical and economic order, sustainable development, or more accurately the
forces that it represents, is inherently subversive of that order.
2. Stockholm and the origins of sustainable development
The emergence of the sustainable development concept can be understood
in terms of the changing structure of the international political system after
1945 and more specifically, the evolution of the United Nations organiza-
tion. In 1945, at its foundation, the UN comprised 51 members – the over-
whelming majority being developed states. European colonial empires
survived, although mortally damaged by the events of the Second World
War. In 1947 India and Pakistan were granted their independence and in
the ensuing 20 years the old colonial empires in Africa and South and
South-East Asia were almost entirely liquidated. This surge of new inde-
pendent states transformed the membership of the United Nations. By
1965 total membership was 114, of which more than 80 were newly inde-
pendent developing states. Developing countries, courted by both camps in
the Cold War, had since the Bandung meeting in 1955 attempted to pro-
claim their ‘non-alignment’.
Although sometimes divided by their allegiances and indeed lack of alle-
giance in the Cold War, the newly independent states were able to unite
around a number of other issues such as opposition to continued colonial-
ism and to the Apartheid regime in South Africa. Above all, they shared a
consciousness of their relative weakness in the international economy, of
their dependence on their former colonial masters and of the need to
promote development. By the early 1960s demands for action on the
inequities on trade and development and for increased aid funding had
become insistent in the UN General Assembly leading to the formation in
1964 of UNCTAD (The United Nations Conference on Trade and
Development). It was in this context, on 15 June 1964, that the caucus of
developing world states, the G77 (Group of 77) was founded. It now has
some 132 member states including China (it is quite usual to refer to the
G77/China). G77 Chapters will now be found at all major multilateral
organizations and conferences but the heart of its activity remains the
United Nations General Assembly, and the G77’s primary decision-making
body is its Ministerial Meeting, held annually at the beginning of the
regular session of the UN General Assembly in New York.
The G77 caucus was able to command a significant majority in the
General Assembly and although its resolutions do not have the binding
character of those of the Security Council, they can and do serve to set
the international agenda and to direct the work of the organization.
Thus, although militarily and economically weak, in relation to the devel-
oped countries, the G77 could deploy an organizational weapon. This
they proceeded to do in a number of contexts with the general aim of
advancing their own economic development and addressing the struc-
tural inequities of the existing international system. In 1967, the General
Assembly held a Special Session on development followed by its adop-
tion, in October 1970, of the 0.7 per cent of GNI aid target for the
developed countries.2
Thus, by the early 1970s, the development agenda was well established
within the UN General Assembly. By contrast, environmental concerns
had achieved very little international profile and were only just beginning,
during the 1960s, to enter the politics of developed states, as issues such as
nuclear contamination and transboundary sulphur deposition (acid rain)
began to register. There was sufficient interest, however, to stimulate calls
for UN action on international environmental issues and a conference was
proposed by the Swedish government in early 1968. By December of that
year the UN General Assembly had agreed to convene the United Nations
Conference on the Human Environment (UNCHE) at Stockholm in 1972.
The vote was unanimous even though there were misgivings amongst the
G77 that international discussions of the environment might be used as an
excuse to restrict development and curtail flows of aid (Engfeldt, 1973). It
was important to enlist the continuing support of a General Assembly
majority by establishing connections with the development agenda. This
landmark meeting, sponsored by the UNCHE Preparatory Committee
(Prep Com) and held in a motel in the Swiss village of Founex in June 1971,
first gave political definition to what later became sustainable development
(Caldwell, 1990, p. 52). There, a group of 27 experts articulated the links
between environment and development stating that: ‘although in individ-
ual instances there were conflicts between environmental and economic pri-
orities, they were intrinsically two sides of the same coin’ (Founex Report,
1971: 1.5, 2). While in advanced countries economic development might be
identified as the cause of environmental degradation, for the developing
countries development was the only solution to the linked problems of
poverty and degradation. Many of what were to become the perennial
themes of UN debates about sustainability were clearly foreseen at Founex.
The Report stressed that the ‘extent to which developing countries pursue
a style of development that is responsive to social and environmental goals
must be determined by the resources available to them’ and that this must reinforce the advanced countries’ commitment to providing development
aid (ibid., 1.15: 6). This aid should be additional to that already provided
(ibid., 4.17: 29). Environmental issues were recognized as being ‘relatively
marginal’ to countries with pressing development concerns (ibid., 3.12: 21)
and their social and economic policy fell ‘entirely and exclusively within the
sovereign competence of developing countries’ (ibid., 3.1: 15). Finally, the
Report sees, albeit ‘dimly’, some of the trade consequences of the environ-
mental agenda in the developing world: concern that raised standards of
environmental protection would become a form of disguised protectionism
to lock them out of developed world markets and that ecological dumping
might occur (ibid., 4.5: 22–3).
There were many important outcomes of the 1972 Stockholm UNCHE.
They included the creation of the UN Environment Programme (UNEP)
and the setting up of government departments of the environment across
the world.3 At the conference itself the Prime Minister of India, Indira
Gandhi, who was the only other head of government to attend alongside
the sponsor Olaf Palme, attracted much attention with her statement that
‘poverty is the greatest polluter’.4 The conference proceedings were also free
of the Cold War confrontation that tended to impair other international
gatherings at the time because the Soviet Union and its allies operated a
boycott to protest at the non-admission of East Germany. The Stockholm
Declaration, with its 26 Principles, became a significant source for the
development of ‘soft’ environmental law, some of which reflected the
Founex discussions by laying down some essential connections between
environment and development, although the term ‘sustainable develop-
ment’ does not appear in the conference records.5
3. Rio and the sustainable development bargain
While Stockholm provided the bases, in all but name, for international dis-
cussions of sustainable development it was almost immediately eclipsed by
the gathering crisis in the world economy, the 1973 war in the Middle East
and by a new G77 strategy. Dramatic rises in the price of oil in the early
1970s and the willingness of the oil-producing states, gathered in OPEC, to
exert pressure upon the West over the plight of the Palestinian people, pro-
vided the context for a sustained G77 campaign for economic justice and
the structural reform of the international economic system. What became
known as the New International Economic Order (NIEO) was launched by
a 1974 General Assembly Resolution on the Economic Rights and Duties
of states, which called for a major increase in aid transfers and the restruc-
turing of the international commodities system. The demands for NIEO
spread well beyond this and can be traced in G77 positions at a range of
other negotiations. The important third Law of the Sea Conference, which went on throughout the 1970s, included a central Southern demand for
equitable sharing of the supposed mineral riches of the deep seabed and its
declaration as the ‘Common Heritage of Mankind’. Similar ideas appeared
in discussions within that previously apolitical and technical body, the
International Telecommunication Union. Here the demand from the G77
was for ‘equity in orbit’; to change the rules for the allocation of the right
to use the geostationary orbit (GSO) such that developing countries such
as India could benefit from the new satellite technology. In the struggle at
the UN over the NIEO, and over the creation of a Common Fund for
Commodities in particular, the link between underdevelopment and envir-
onmental conservation was relegated to the sidelines. The Coyococ meeting
organized by UNCTAD and UNEP in 1974 is reflective of the times:
The quadrupling of oil prices through the combined action of the oil producers
sharply alters the balance of power in world markets and redistributes resources
massively to some third world countries. Its effect has been to reverse decisively
the balance of advantage in the oil trade and to place close to $100 billions a
year at the disposal of some third world nations. Moreover, in an area critical to
the economies of industrialized states, a profound reversal of power exposes
them to a condition long familiar in the third world – a lack of control over vital
economic decisions. (Coyococ Declaration, 1974: 3)
There is very little in the Declaration on environmental interdependence
but a great deal about resource-based power, the need for third world self
reliance and the failure of market mechanisms. What was proposed (in line
with what was being negotiated for the deep seabed in the Law of the Sea
Convention) were ‘strong international regimes for the exploitation of
common resources’ and the ‘management of resources and environment on
a global scale’ (ibid., p. 8). North–South negotiations proceeded within the
UN context and responses from the developed world, notably the Brandt
Report (Independent Commission on Development Issues, 1980) tended to
focus upon the economic interdependence between the developing coun-
tries of the South and inflation and recession afflicted economies of
Western Europe and the United States.6
The campaign for a NIEO exploited a period of economic turmoil and
political and military retreat by the United States and its allies – the debacle
in Saigon and the rest of Indochina in 1975 followed by the humiliation of
the seizure of its Teheran embassy in 1979. It was soon to be replaced by a
much more strident approach in the West involving an active pursuit of the
Second Cold War against the Soviet Union and a rejection of the politics of
interdependence, replaced by a vigorous pursuit of free market solutions.
Amongst the first casualties were the North–South dialogue which essen-
tially collapsed at the Cancun Conference of 1981 and the Law of the Sea Convention (signed but not ratified by the US and her allies in 1982). The
interesting question is how and why the seeds of the Brundtland Report
(WCED, 1987) came to be sown and nurtured in these rather unpromising
circumstances. The Commission itself was set up by the General Assembly
in 1983 and reported in 1987. Its analysis is well known, it built upon what
had been achieved at Stockholm and provided the most politically signifi-
cant of all definitions of ‘sustainable development’. By 1987 political con-
ditions were much more receptive. The Second Cold War was drawing to a
close with the Intermediate Nuclear Forces (INF) agreement of that year.
In December 1989 Resolution 44/228 of the General Assembly agreed to
convene a second great conference – UNCED – in 1992.
The concept of sustainable development acquired political impetus
through rising public concern in the developed countries over the new and
alarming phenomenon of global environmental change. In some ways it
replaced fears of nuclear Armageddon that had prevailed in the early 1980s.
Preparations for the conference ran alongside the intergovernmental nego-
tiations for Climate and Biodiversity Conventions. For the G77 it provided
a new opportunity to restore some of the negotiating credibility that had
been lost with the collapse of the NIEO. According to one British diplo-
matic participant:
The Brundtland Report shows a hard headedness uncharacteristic of such exer-
cises in the emphasis it gives institutional factors. But the genius of the piece lies
in its adoption and promulgation of the concept of ‘sustainable development’.
In one neat formula, Mrs Brundtland provided a slogan behind which first world
politicians with green electorates to appease, and third world politicians with
economic deprivation to tackle, could unite. The formula was of course vague,
but the details could be left for later. (Benton, 1994: p. 129)
Rio was preceded by a series of Prep Coms which developed key confer-
ence texts, Agenda 21 and the Rio Declaration, along with the separate
intense negotiations for Climate and Biodiversity which were scheduled to
provide completed texts for formal signature at Rio. The UN Framework
Convention on Climate Change (UNFCCC), like the other Conventions,
had to grapple with North–South issues and questions of responsibility. To
do so the Convention includes the important principle of ‘common but
differentiated responsibilities’ under which only the developed Annex I
countries are obligated to make emissions reductions commitments in the
first instance.7 Financial assistance in terms of ‘capability building’ is pro-
vided for the developing countries to fulfil their responsibilities in terms of
providing national reports. North–South difficulties were more evident in
the bad-tempered negotiations for the Convention on Biodiversity (CBD),
involving arguments about the extent of developed world finance that would support the preservation of biodiversity resources mainly located in
the South and the sharing of economic benefits from the utilization of ‘sov-
ereign’ biodiverse resources by developed world biotechnology firms.8
There was also an attempt to follow up Western public and NGO concerns
over the fate of tropical forests with a convention to conserve them, but this
foundered on developing country suspicions of violation of economic
sovereignty. It was replaced at Rio with a non-binding statement of forest
principles.
The conference itself proved to be an international event on an unpre-
cedented scale as heads of government vied to make their mark on what
was dubbed the Rio ‘Earth Summit’. Its very title, connecting Environ-
ment and Development, was indicative of North–South bargaining at the
UN, in which demands for international action on the environment were
set against claims for additional development aid and technology trans-
fer.9 At the Conference itself the most serious argument concerned the
extent to which developed nations would ‘pay’ for the implementation of
UNCED decisions on sustainable development with additional aid con-
tributions. Major aid donors re-packaged their existing programmes and
promised new funds, but the net results appear to have been minimal and
the oft-repeated UN target of 0.7 per cent of GNI is still far short of ful-
filment.10 The key outputs of the Conference (as opposed to the FCCC
and the CBD) are to be found in the Rio Declaration, Agenda 21 and the
Commission on Sustainable Development (CSD). All are quite explicitly
concerned with sustainable development and it is thus, at the conclusion
of the Earth Summit, that the concept truly arrives on the international
scene.
Agenda 21, doubtless the most enduring product of the Prep Coms and
the conference, is a vast (over 500 pages) compendium of agreed good prac-
tice and advice for achieving sustainable development in almost every con-
ceivable area, except the Antarctic. It has no legal authority but has proved
to be widely influential even down to the level of the many local Agenda 21s
that were created in the aftermath of Rio. Ten years later the next great UN
conference at Johannesburg pledged itself to discuss how the contents of
Agenda 21 might be better implemented. The Rio Declaration on Environ-
ment and Development also mentions the achievement of sustainable devel-
opment in ten of its 27 clauses. What had been intended as a visionary, brief
and inspiring Earth Charter was, when put into the hands of the Prep Com,
turned into an example of how the sustainability concept can be trans-
formed by international politics into a portmanteau of special interests,
contradictory approaches and inoffensive platitudes. Thus a right to devel-
opment, national resource sovereignty, free market economic systems, the
precautionary approach and common but differentiated responsibilities are all present alongside clauses such as Principle 25: ‘Peace, development and
environmental protection are interdependent and indivisible’. As one com-
mentary describes it: ‘Far from a timeless ethic, it was now a snapshot of
history’ (Grubb et al., 1993, p. 85).11 As such, the Declaration provides a
useful indicator of how far the new concept of sustainable development
had moved on from the discussions of environment and development 20
years previously (it itself consciously sought to build upon the Stockholm
Principles). A comparison of the two reveals some enduring themes. The
famous Stockholm Principle 21 is repeated verbatim as Rio Principle 2 and
there are many new concerns, legal innovations and the rights of women
and indigenous people that figure in the later document. However, the bulk
of the Stockholm conclusions were concerned with strictly environmental
matters while acknowledging development issues, whereas at Rio the
balance is noticeably shifted towards a range of socio-economic concerns.
This change is certainly reflected in subsequent, generally accepted, UN
conceptualizations in terms of three ‘pillars’ designed ‘. . . to ensure a
balance between economic development, social development and environ-
mental protection as interdependent and mutually reinforcing components
of sustainable development’ (United Nations General Assembly,
A/57/532/add.1, 12 December 2002).
4. Johannesburg: sustainable development under globalization
Rio institutionalized a process of continuing dialogue on sustainable devel-
opment and spread the concept across the UN system and beyond. An
important consequence was its still incomplete influence on other organ-
izations such as the World Bank, which had been traditionally prone to
funding decisions based upon narrow considerations of economic welfare.
Other bodies, such as the EU where it achieved Treaty status as an objec-
tive of the Union, came to use the concept as a means of attempting to inte-
grate disparate areas of policy and resolve contradictions between them. A
similar move, from environmental policy to the governance of sustainabil-
ity, was observable in the academic literature from Vogler and Jordan
(2003). In terms of the core politics of the UN, the creation of the
Commission on Sustainable Development, set up by the General Assembly
at the instigation of the UNCED, served to keep the Rio agenda alive by
institutionalizing the formal review of the implementation of Agenda 21 by
states and ‘major groups’. The CSD works under the auspices of the
Economic and Social Council which elects its 53 state members on a
regional basis. In 1997 a full-scale consideration of Rio ‘plus 5’ was held by
a General Assembly Special Session to be followed by the convening of a
new summit level UN conference, the 2002 World Summit on Sustainable
Development (WSSD) to be held at Johannesburg.
Rio occurred in the immediate aftermath of the Cold War, the Soviet
Union having finally collapsed in 1991. In the ensuing ten years the United
States occupied a hegemonic position and many of the old boundaries and
economic divisions in the system were obliterated in a process, hardly
noticed at Rio, of globalization. An integral role was played by the creation
of a new trade regime under the World Trade Organization (WTO), set up
in 1995 as a consequence of the previous GATT Uruguay Round.
Although deep and abiding inequalities remained, particularly between
the mass consumption societies of the OECD and parts of Africa, the
landscape of North–South relations was subject to radical alteration.
Membership or impending membership of the WTO and increasingly full
participation in the global economy meant that some key members of the
G77, such as China, India and Brazil, achieved such high rates of growth
that they came to be regarded as future economic superpowers.12 This
inevitably raised the question of the environmental consequences and sus-
tainability of such growth and of the justification for ‘common but
differentiated responsibilities’ in such radically altered circumstances. At
the same time the inclusion of agriculture in trade negotiations and the
increasing presence of powerful Southern economies at the WTO led to a
new site of North–South confrontation in what was optimistically termed
the Doha Development Round.13 One potential casualty was any attempt
to introduce environmental standards into international trade practices,
viewed (as had been predicted at Founex) with immense suspicion by devel-
oping countries as a form of covert protection for developed world markets.
These developments placed further strain on the G77 coalition, opening up
gaps between oil producers, middle income and fast growing economies
and the wretchedly poor Highly Indebted and Poor Countries (HIPC). At
the same time the North was hardly monolithic as significant differences,
traceable across most of the environmental negotiations of the 1990s,
opened up between the United States and the European Union.
Within this political context the Johannesburg Conference confirmed a
trend, evident since Rio, of the increasing importance of the socio-
economic pillars of sustainable development. The environmental agenda at
the two previous UN conferences had been sustained by peaks in the public
‘attention cycle’ of major developed countries. Public concern at environ-
mental degradation had motivated governments in the late 1960s, and the
Rio meeting had been driven on by the ‘discovery’ of stratospheric ozone
depletion and the enhanced greenhouse effect at a time when Cold War
fears had rapidly subsided. Johannesburg occurred amidst mounting devel-
oped world preoccupation with terrorism and stability in Central Asia and
the Middle East. At the same time, the plight of much of the African con-
tinent, ravaged by AIDS, warfare and under-development, was justifiably prominent in the minds of governments and the public. The Rio agenda
reflected the underlying power relations between North and South, with the
South being reduced to obstruction over particular agreements (such as
that proposed for forestry), while attempting, unsuccessfully, to obtain
some compensatory leverage to increase aid flows and technology transfer.
The WSSD occurred under changed circumstances. Held in South Africa,
it highlighted a common international concern with the urgency of poverty
alleviation alongside the increasing strength of some developing world
economies under conditions of rapid globalization.
WSSD incorporated the concept of sustainable development throughout
its deliberations and was initially dubbed ‘the implementation summit’.
Inevitably demands for additional financial resources and technology
transfer continued but much of the debate had already been pre-empted by
the establishment of the Millennium Development Goals in 2000 and by
the March 2002 meeting of finance ministers which set out the ‘Monterrey
Consensus’ on development funding.14 These, as well as the WTO’s Doha
Round, were frequently referred to at the Conference. Pride of place in the
Johannesburg ‘Plan of Implementation’ (UN, 2002), which formed the
principal output of the Conference and the plenary sessions of the WSSD,
was given to poverty eradication. It was described as ‘the greatest global
challenge facing the world today and an indispensable requirement for sus-
tainable development’ (ibid., p. 7), in effect confirming Indira Gandhi’s
statement, 30 years before, that ‘poverty was the greatest polluter’. Closely
associated were a range of so-called ‘WEHAB’ issues on water and sanita-
tion, energy, health, agriculture and biodiversity, highlighted by the UN
Secretary General as having been inadequately pursued at Rio and where,
for some at least, ‘time-bound targets’ were established. However, it would
be a mistake to conclude that strictly environmental questions were com-
pletely neglected, for a substantial part of the Plan of Implementation
covers ‘Protecting and managing the natural resource base of economic
and social development’ (Paras 24–46). What is also noticeable, in com-
parison to previous summit texts, is that there is a genuine attempt at con-
ceptual integration:
Unlike Agenda 21, the Plan of Implementation recognizes poverty as a running
theme, linked to its multiple dimensions from access to energy, water and sanita-
tion, to the equitable sharing of the benefits of biodiversity. This reflects a shift
from a uni-dimensional income focus on poverty to a multidimensional approach
that embraces a vision of ‘sustainable livelihoods’. (ENB, 2002, p. 170)
Other elements emphasize the magnitude of change since the heady days
of the New International Economic Order debates of the 1970s. The new
context was globalization, which had its own section (V) of the Plan and there was at the Conference extensive stress upon the opportunities pro-
vided by Type II partnerships between developing world governments and
the private sector (UN, 2002, p. 50). Nonetheless, some underlying
North–South problems continue to be identifiable in much the same form
as during the 1970s – declining and unstable developed world incomes from
commodity exports (ibid., p. 95) – and the 1980s – the unsustainable
indebtedness of many developing countries (ibid., p. 89). Following the
Millennium Development Goals and the Monterrey Consensus, WSSD
provided yet another opportunity to urge the developed states to meet the
0.7 per cent GNI aid commitment first established two years before the
Stockholm conference (ibid., p. 85).
In common with its predecessor, the WSSD relied on extensive Prep
Com discussion. There were four in all, producing a lengthy document
comprising an uneasy alignment of differing interests to be handled with
the greatest of care if the various underlying compromises were not to
come unstitched. A controversy emerging from Rio, and the long debates
over climate change, involved the principle of ‘common but differentiated
responsibilities’. This had become increasingly unacceptable to the
United States, whose delegates sought first to remove and then to limit in
application (to narrowly defined environmental issues).15 A number of
new issues spilled over from recent WTO and other meetings. They were
fought over not because binding financial and other commitments were at
stake, for the WSSD produced hardly any; but because of their symbolic
importance for the future and the sense in which they set the terms of an
emerging global bargain between North and South. At the North’s insis-
tence references to ‘good governance’ in the developing countries and the
full incorporation of developing countries in a reformed international
financial architecture pervade the WSSD text where they are regarded as
the basis for additional assistance. Closely related is the need for the South
to adopt ‘sound’ macroeconomic policies and to open their markets, par-
ticularly in the services sector. The G77 inserted text on common but
differentiated responsibilities; the crucial matter of the removal of the
developed world’s agricultural subsidies and tariffs and its continuing
obligations in terms of aid, debt relief and technology transfer.16 One
important environmental issue, arising in relation to the global trade
regime, had already been central to the long-disputed negotiations for a
Biosafety Protocol to the Convention on Biodiversity. This was the
fundamental question of the subordination of MEAs (multilateral envir-
onmental agreements) to WTO rules. Not directly a North–South issue,
it was still one that greatly exercised environmental campaigners
who feared the hegemony of neo-liberal ideas and trade promotion over
the protection of the environment. In the end textual compromises were achieved to the extent that the two should be ‘mutually supportive’ (ENB,
2002, p. 13).
5. The international politics of sustainability and the sustainability of
international politics
At first sight, much of the foregoing can be understood in classic power-
political terms. Sustainable development provided a new arena for the
pursuit and accommodation of state interests. Most of the compromises
reveal such factors at work, including the central one of the North’s
interest in environmental quality and the South’s development demands.
At a national level, a close study of any of the negotiations will reveal the
working of particularistic national and corporate interests. The G77,
for example, has had difficulty in reconciling the imminent peril of the small
island developing states (SIDS), in the face of climate change, with the
refusal of the energy exporters even to recognize the problem. At
Johannesburg the interests of energy producers on both sides of the
North–South divide prevented the emergence of any clear targets for
renewable energy (ENB, 2002, p. 7). The desire of Northern states to open
up Southern markets, often for GMOs, while protecting their own agricul-
tural producers and avoiding further public expenditure in aid commit-
ments was also evident. There was also more than a touch of national
commercial interest in the enthusiasm for Type II partnerships, which
would allow corporations to acquire Southern business in the provision of
water and sanitation.
Many of the interests pursued were not even remotely connected to
issues of sustainable development. The withdrawal of the Eastern bloc
from UNCHE in 1972 turned on the question of the status accorded to the
German Democratic Republic. At Rio there were difficulties with reference
to Israel’s occupation of Palestine, and at Johannesburg, the conflict
between the Zimbabwean and British governments.17 Organizations with
budgets and personnel to protect also have interests and the rivalries within
the thicket of UN bodies and specialized agencies are particularly intense.
Thus UNEP continues to have the rather lowly status of a programme
rather than becoming a fully-fledged organization like the FAO or the
World Bank.
It would, however, be wrong to leave it at that. Perhaps the central insight
of International Relations scholarship on international environmental co-
operation has been the significance of institutionalization that may serve to
tame and redirect the interests of states. Sustainable development has
become increasingly institutionalized in the international system. It began
with the creation of UNEP and a range of other initiatives stemming from
the Stockholm conference. At Rio, Agenda 21 called for the creation of the CSD under the UN’s Economic and Social Committee and its annual work
programme at the centre of a wider process of reviewing progress since
UNCED.18 Such institutionalization serves to keep the interplay between
economic and social development and environmental questions on the
international agenda. Thus whereas both Stockholm and Rio can be attrib-
uted to the stimulus of external events, Johannesburg was more the pro-
grammed outcome of an embedded process. Operating within a highly
institutionalized setting involving a great deal of organizational politics has
some other important consequences, which are central to an understand-
ing of the events described in this article and which must contradict any
simple ‘realist’ power politics account. The latter would predict that out-
comes would be determined by the relative military and economic strength
of state participants. While this may be part of an explanation of the situ-
ation at Johannesburg, where we might portray US hegemony challenged
by the rising economies of the South, this cannot fully account for the Rio
process. A common thread runs through the campaigns led by the G77
caucus that relied for their success upon an ability to mobilize voting
majorities in international organizations and to exploit perceived inter-
dependencies between North and South (Vogler, 2000, pp. 193–5).
How far does sustainable development actually subvert rather than
reflect normal international politics? There are two prominent questions
here for theorists of international relations. First there is a challenge to the
primacy of the sovereign state, most obviously represented in the enormous
encouragement given by the Rio process to what has been termed global
civil society. The structures that have been developed to deal with sustain-
ability issues, notably NGO participation and the Major Group system at
UNCED, certainly introduce a new element of functional representation
into the international system.19 NGO activity has been very significant in
changing agendas, in monitoring the behaviour of governments and in
operating inside government delegations (Princen and Finger, 1994;
Willetts, 1996; Newell, 2000). There is most certainly now a ‘mixed actor
situation’, but this does not necessarily amount to a fundamental subver-
sion of the system where sovereignty over natural resources continues to be
jealously guarded and where state participants in the Rio process are
careful to insert ‘intergovernmental’ into the title of many of the key organ-
izations. A salient characteristic of the Johannesburg WSSD was not only
the number of NGOs involved but their rising alarm at the prominence of
another, more powerful, type of non-state actor – the transnational busi-
ness corporation. The extent to which states can regulate the activities of
the corporate sector is just one part of a lively debate about the possibility
and desirability of state action for sustainability under conditions of glob-
alization (Barry and Eckersley, 2005).
Rather than considering how the international political system, as pre-
sently constituted, can manage the problems of sustainability, some
analysts have taken a more radical stance. For them, the sustainable devel-
opment agenda is indicative of a deeper crisis in global social ecology
which must prompt questions that are inherently subversive of the current
political order (Sachs, 1993; Saurin, 1996; Paterson, 2001). It challenges
the ‘issue hierarchy’, the dominance of the international trade regime and
indeed the whole apparatus of globalization that serves the interests of
capital accumulation and mass consumption societies. Since the failure of
the NIEO, North–South dialogue on environment and development has
essentially failed to engage the underlying pathologies of the global system
as both Northern and Southern states pursue their short-sighted interests
within a neo-liberal consensus. Thus the international politics of sustain-
able development represents at best a distraction and at worst an obstacle
to human survival. Endless conferences and diplomacy (which themselves
have major ecological costs in terms of air-miles travelled and paper
consumed) merely give the impression that something is being done, while
reinforcing the underlying structures of the global political economy.
From this perspective the urgent question does not concern the interna-
tional politics of sustainable development, but the sustainability of inter-
national politics itself.

27 Financing for sustainable development David Pearce

1. The issue
Does the pursuit of sustainable development require special financing?
Achieving sustainable development is about policy measures that alter
human behaviour towards the environment and towards society in general.
Behavioural change could be achieved in various ways and some of those
do not necessarily involve any financial flows. For example, moral suasion –
the process of awareness raising and encouraging moral behaviour – need
not involve any finance, although it may involve non-monetary costs to
those changing their behaviour. The argument from moral suasion is self-
fulfilling: if we all behaved ‘sustainably’ the world would have a better
chance of being sustainable. The problem, as is well known, is that humans
are complex mixtures of selfish and altruistic behaviour and simply appeal-
ing to the altruistic aspects of behaviour frequently fails to achieve goals
that might be considered to be consistent with sustainability. Simply put,
humans are not altruistic enough. In other cases, for example in its part in
combating racism, suasion has arguably worked quite well. But acknow-
ledgement of the difficulties of suasion leads to the second approach to sus-
tainability, one based on coercive laws which ban or regulate adverse
behaviour and perhaps reward good behaviour. Such laws also need not
have any financial flows associated with them. By and large, this approach
to sustainability characterizes most environmental and social policy. Such
laws have worked fairly well in many cases. But economists and political
scientists have repeatedly warned of the dangers in the direct regulatory
approach.
First, regulations, and especially bans, frequently create economic rents
which result in rent-seeking, rent capture and corruption, essentially
unproductive activities which detract from potential human well-being.
Activity shifts from creating human well-being to securing as large a part
as possible of the financial gains associated with restrictions. Second, reg-
ulation can be expensive, with the result that coalitions are formed to prevent
or water down further regulations. Third, regulations, especially those
formed at the international level, frequently achieve no more than would
have happened without the regulation: they lack ‘additionality’ (Barrett,
2003). This is because of the essentially game-theoretic nature of such
agreements whereby no one agent is going to agree to harm themselves for the overall common good. Hence what they agree to is what they would
have done anyway, with their participation and agreement being hailed in
rhetorical terms. Regulations can of course be associated with some finan-
cial flows: fines for non-compliance would be an obvious example. But, by
and large, regulation works, when it does work, by threat, where the threat
is criminal or civil liability.
No one suggests that suasion and direct regulation have no role to play
in the pursuit of sustainability, but there is an increasing interest in policy
mechanisms that do involve financial flows. In the market place for private
goods the role of finance is obvious. The seller of a good (or service) parts
with that good to a buyer in return for a cash flow from the buyer to the
seller. Finance for publicly provided (public) goods is more indirect. Public
goods are goods which when provided to one person tend to be provided to
a larger group, with few prospects of excluding any individual in that group.
In the same vein, public goods are difficult to appropriate, that is to charge
prices according to use. The provider or supplier of public goods is usually
the government or the agent of the government, and beneficiaries do not
pay directly for the good but indirectly via their taxation. The taxes paid
may not be linked directly to the benefits – that is the financing of the public
good comes out of general taxation. More recently, there has been a
growing interest in linking tax payments more directly to the public good
through ‘hypothecation’ or ‘earmarking’. One justification for hypotheca-
tion comes from the public choice literature which argues that taxpayers
will be more content to pay for public goods if they can trace the ways in
which their payments translate into public good provision.
All of this is familiar. The problem is what to do with the very large
variety of non-market goods, many of which have public good character-
istics, for which there are no markets and for which public provision may
not exist or, if it exists, may not work efficiently. It is this class of goods and
services that we focus on in this chapter. Examples are well known: reduced
global warming, avoided biodiversity loss, cleaner water and air, protected
areas where public finance is insufficient, and so on.
2. Financial flows and the Coase theorem
A financial flow involves an exchange of cash or in-kind benefits between
three agents in the economy: the individual, corporation or agency gener-
ating environmental and/or social harm; the agent suffering the harm;
and the regulator or government. For simplicity, let us call these agents
‘the polluter’, ‘the sufferer’ and ‘the regulator’. By definition, the sufferer
becomes a beneficiary if the polluter ceases to pollute. Hence we will
also speak of ‘beneficiaries’. As Coase (1960) made clear, polluters or
sufferers/beneficiaries may hold the property rights. If polluters hold the rights then sufferers should be able to pay polluters not to pollute and it will
be in their self-interest to do this so long as the marginal damage they suffer
exceeds the payment they make for a marginal reduction in pollution. In
turn, the polluter’s self-interest is served if the received payment exceeds the
marginal benefit he/she would have made from the damaging activity. If the
sufferer holds the property rights, then the polluter cannot pollute unless
he/she pays the sufferer compensation that exceeds the damage done.
Figure 27.1 shows the familiar Coasian bargain diagram.
The horizontal axis shows pollution (for which read resource degrada-
tion, social harm and so on). MNPB measures the marginal net private
benefits to the polluter from the activity creating the pollution. To fix ideas,
it is simplest to construe MNPB as marginal profits. Then, if the polluter
holds the property rights, he/she will operate at Qpriv where total profits A +
B + C are maximized, unless induced to do otherwise. MD shows the mar-
ginal damage suffered by the sufferer. MD can also be defined as the mar-
ginal external cost arising from the polluter’s activity. At Qpriv the sufferer
bears a cost of B + C + D. It is immediately obvious that there are gains to
be made by some sort of bargain. Total social welfare at Qpriv is the
difference between profits and suffering, that is A D. But if a move to Q*
could be engineered, net social welfare would be A B B = A. Given the
property rights rest with the polluter, the sufferer can pay any sum less than
C + D to induce the polluter to surrender profits associated with activity
level Qpriv. Exactly what is paid depends on the relative bargaining strengths
of the parties in question.
The reader can determine that exactly the same result holds if the sufferer
has the property rights. In this case, the starting point is the origin and payments less than A + B, but more than B, will compensate the sufferer
for tolerating pollution. Either way, the optimum Q* is achieved and the
achievement comes about without the interference of the third agent, the
regulator. For those who believe in the optimality of free markets,
the Coase theorem is a justification for the minimal role of regulation and
the government. Note that the problem of the optimal provision of non-
market goods has been solved with a flow of finance: either compensation
flows from polluter to sufferer, or payment (sometimes misleadingly called
a ‘bribe’ in the literature) flows from sufferer to polluter. It is this financial
flow that secures optimality in the sense of economic efficiency.
Economic efficiency is not necessarily the same thing as sustainability,
since that depends on the notion of sustainability adhered to (see Chapters
4 and 6 for a discussion). If it is weak sustainability, in which there is substi-
tution at the margin between environmental, social and man-made assets,
then economic efficiency is sustainability. If it is strong sustainability, which
subsumes weak sustainability but has the added constraint that environ-
mental assets must not (in some sense) decline, then this goal appears to be
achieved if the polluter has the property rights, but not if the sufferer has the
property rights. The reason for this is that pollution is reduced (which is the
same as saying environmental assets increase) in the former case, but it is
increased in the latter case. The starting point matters. But since strong sus-
tainability denies the substitutability of compensation and environmental
assets, it would effectively rule out the polluter paying compensation to the
sufferer for an increase in pollution. (There would have to be some form of
regulation that would deny the polluter paying compensation. In practice,
such payments are not uncommon, for example with airport noise compen-
sation.) Strong sustainability therefore involves an efficiency loss equal to
area A in Figure 27.1. This is not surprising since it involves an added con-
straint on the maximization of social welfare. But the nature and existence
of this efficiency loss is not always made clear in the sustainability literature.
The Coase theorem generates financial flows which act to secure sustain-
ability in the weak sense. The theorem simply does not operate with strong
sustainability and if sufferers have property rights to zero pollution – no
bargain involving compensation for suffering would be permitted. If
polluters have the property rights, then strong sustainability would presum-
ably still sanction a move like the one from Qpriv to Q* in Figure 27.1 since
it is (a) efficient and (b) reduces pollution.
While theoretically elegant, the Coase theorem is in fact very problem-
atic when efforts are made to transfer it to the real world. As such, the finan-
cial flows likely to be involved in actual bargains over non-market goods
will be more complex than simple ‘polluter pays sufferer’ or ‘beneficiary
pays polluter’.
First, the trades involve transactions costs. Indeed, many regard the most
restrictive condition in the Coase theorem to be that bargaining is costless.
In reality, we know that transactions costs are very important in actual bar-
gains. This immediately suggests a role for the regulator (government), pro-
vided regulatory costs do not outweigh the gains from trade, something
that cannot be guaranteed. Regulation here would typically mean ‘facili-
tating’ the bargain by actions which directly reduce transactions costs (for
example regulators may have more access to information about polluters or
sufferers than do the parties themselves – an obverse of the usual assump-
tion about asymmetric information), or by the regulator taking over the
bargain on behalf of one of the parties.
Second, Coasian bargains are indifferent to equity concerns – the
theorem is about efficiency alone. But governments and regulators are
highly likely to have equity concerns. Interestingly, these concerns are not
confined to contexts in which the sufferer is poor. They may arise where
either the sufferer is poor or the polluter is poor. In the former case,
government may take on the role of acting for the poor sufferer. This is the
case with the Costa Rican ecosystem service payments whereby govern-
ment pays upland forest owners not to deforest because of the otherwise
detrimental effect on poor downstream farmers (for a discussion, see
Pearce, 2004). The government effectively acts for downstream beneficiaries
of upstream forest conservation and the presumption is that many of these
beneficiaries are relatively poor and could not pay for beneficial conserva-
tion. The limitation of the Coase theorem in this context is that it assumes
the availability of a financial fund in the hands of the sufferer. However
economically rational payment to the polluter would be, if the financial
resources are not there payment cannot be made. The standard response to
this issue is that inability to pay is the same thing as unwillingness to pay,
since willingness to pay is always constrained by income. True as that may
be, the issue of unfairness remains. In such contexts, governments may well
become the agents for the poorer party. The flow of finance thus becomes
more complex. In the Costa Rican case, for example, the financial flows
arise from a tax on vehicle pollution, the flows then being used to finance
payments to upland forest owners, without any form of financial flow
affecting the sufferer.
The case where the polluter is poor is less obvious, but a striking example
is the technical and financial assistance given by Scandinavian countries to
Baltic countries to switch energy-generating technologies away from high
polluting to less polluting ones. The benefit to Scandinavia is the reduced
transboundary acid rain deposition that results. As long as Scandinavian
payments are less than the value of the avoided damage, Scandinavia is
better off. As long as the incremental cost of the cleaner technology is zero or negative to the Baltic States, they are better off. Here the sufferer is
paying the polluter. Nakada and Pearce (1999) have shown that the same
principle would be efficient for transboundary pollution from China to
Japan.
Third, non-market goods tend to have the features of public goods. As
such, in the case of pollution control there tend to be many beneficiaries
ranging from a local population to the world as a whole. The Coasian solu-
tion would be for these populations to form a coalition to bargain with the
polluter. This is exactly what does happen in a number of cases, notably
with the Global Environment Facility (GEF) which bargains with devel-
oping and transition countries to change polluting technologies to less pol-
luting ones or to conserve biodiversity that might not be preserved in the
local national interest. As a United Nations agency, the GEF receives
finance from individual subscriber nations so that taxpayers in those coun-
tries first pay the GEF for onward payments to recipient nations to change
their technology and conservation choices. Theoretically, the payments
equal or just exceed the ‘incremental cost’ to the host nation of making the
switch to the globally beneficial technology or policy. The GEF is a prime
example of ‘market creation’ whereby beneficiaries pay polluters who hold
the (in this case, sovereign nation) property rights.
The fourth problem with the Coase theorem is that it assumes one of the
two bargaining parties already has the property rights. In practice, many
environmental problems involve ill-defined or even non-existent property
rights. In the extreme, the case of no property rights is equivalent to ‘open
access’ conditions. As is well known from the bioeconomics literature, open
access produces an equilibrium in which all rents are dissipated. The equi-
librium may be stable but is easily perturbed to produce situations of total
resource loss (extinction). This will happen if technological change in
resource harvesting (guns as opposed to spears in the case of large
mammals, refrigerated ships and industrial trawl methods in the case of
fish, and so on) reduces the cost of harvesting to the point where the equi-
librium goes beyond some sustainability threshold. The massive problem of
global over-fishing arises precisely from open access combined with new
technology and rising demand.
The Coasian response to open access contexts is, correctly, to establish prop-
erty rights. In many respects this is how the institutions related to natural
resources and the environment are developing. The UN Framework
Convention on Climate Change and the Convention on Biological Diversity
are examples of attempts to establish either global communal rights to the
atmosphere (global warming) or some form of attenuation of existing
sovereign rights to biodiversity, but these rights mask the effective open-access
nature of the resources within those sovereign states. Notably, in both cases, global beneficiaries pay the poorer parties to reduce pollution or resource loss.
In the global warming case this is effected through two of the ‘flexibility mech-
anisms’ of the Kyoto Protocol – the Clean Development Mechanism and Joint
Implementation. In the biodiversity case, richer countries are supposed to pay
poorer countries for access to their resources and to share the benefits. In both
cases, finance flows from rich to poor or poorer.
Overall, then, the Coasian paradigm is a useful starting point for
analysing financial flows. When the theorem works in its original form, the
financial flows are from beneficiary to polluter or from polluter to benefi-
ciary, depending on which owns the property rights. Once it is accepted
that the kinds of goods and services in the environmental context are
public goods, then the way is open for a significant modification of the
theorem whereby governments or regulators act as intermediaries. In this
case they may collect pollution taxes or charges for onwards payment to
sufferers, or they may retain the proceeds in general funds. Where polluters
have the property rights, governments may act to finance the necessary
payments to polluters. Finally, no flows of finance occur in the open access
case where no one has defined property rights. Indeed, it is precisely
because there are no financial flows that open access risks securing equi-
libria that are easily ‘tipped’ into states of extinction, as the examples of
over-fishing show. The Coasian solution is to establish property rights in
order to facilitate some form of bargaining or exclusion. Another way of
viewing this is that the establishment of property rights permits flows of
finance to occur, with all the relevant incentives for securing optimality
now being enabled.
Financial flows: a review of the issues
Focusing financial flows on developing countries
Recent advances in wealth accounting indicate that the conditions for sus-
tainability centre round the notion of increasing stocks of overall per capita
wealth (see Chapter 19). In turn, wealth comprises a broad spectrum of
assets – conventional man-made capital, human capital, social capital and
environmental (natural) capital. Preliminary wealth accounts indicate that
it cannot be taken for granted that rich countries pursue paths of develop-
ment that obey the fundamental ‘rising per capita wealth’ rule (Hamilton,
2000; Hamilton and Clemens, 1999). Nonetheless, by far the largest pro-
portion of countries that fail to meet the rule are developing economies. In
what follows we assume that the focus should be on correcting non-
sustainability in the developing world, and hence the focus should also be
on financial flows to developing countries, or on changing financial flows
that currently harm poor countries’ prospects for sustainability.
Reducing damaging financial flows: subsidies
One approach to financing sustainability that commands wide assent, and
which appears to be ‘win–win’, is the redirection of existing financial flows
that are both inimical to economic efficiency, narrowly construed, and to
environmental progress. Subsidies to inputs and outputs both appear in this
category and a substantial literature has grown up on the issue (for example
van Beers and de Moor, 2001; Porter, 2002; Michaelis, 1996; OECD, 1996;
1997; 1998; Milazzo, 1998). The basic argument is that subsidies involve
deadweight losses of well-being regardless of any environmental effects.
Once the latter are brought into consideration, the scale of the combined
inefficiency can be substantial. Moreover, a growing part of the subsidy
literature draws attention to the fact that subsidies often do not, contrary
to initial expectations, benefit the poor. Even when targeted at the poor,
middle income groups tend to manipulate the subsidy system so that it
benefits them. This should hardly occasion surprise once it is recognized
that, like many regulations, subsidies create rents and hence a whole ‘indus-
try’ emerges which seeks to capture the rents (see also Chapters 13 and 14).
It is more likely that the powerful will capture the rents, further marginal-
izing the poor. Subsidies therefore have an equity dimension as well as an
efficiency dimension.
Van Beers and de Moor suggest that, globally, subsidies to inputs and
outputs, especially in agriculture, energy, water and fisheries may amount
to just over $1 trillion annually. Nearly 70 per cent of these subsidies are in
OECD countries. Perhaps the most startling figure is that agricultural sub-
sidies in OECD countries account for over 30 per cent of entire world sub-
sidies. From the standpoint of sustainability these subsidies can be thought
of as highly damaging financial flows that finance non-sustainability. Not
only do subsidies in OECD countries harm the environment in OECD
countries, but Anderson et al. (2000) have simulated the effects of remov-
ing rich countries’ tariff and non-tariff barriers to developing country
exports. While it is true that developing countries face even larger barriers
from protectionist policies in other developing countries, rich country pro-
tection costs the developing world over $100 billion annually.
It is hardly surprising therefore that those seeking finance for sustain-
able development should target subsidies since they appear to damage rich
country environments and also damage the growth potential of poor
countries by restricting and denying them markets. Subsidies within devel-
oping countries can often absorb significant fractions of public expend-
iture, further precluding the provision of genuine public goods in those
countries. Subsidies also deny the ability of public utilities any chance to
finance their own investment programmes since revenues systematically
tend to fall short of costs of provision. Pearce (2002) also notes hitherto neglected effects, for example subsidies in the rich and poor world encour-
age resource depletion and environmental damage that harms the well-
being of the poor by depleting their human capital through ill-health.
Water shortages, water pollution, deforestation are all examples of this
indirect link. Some idea of the potential for financing is that current
annual subsidies are some 16–17 times the annual flow of official develop-
ment aid to developing countries.
But how realistic is it to expect diversion of existing subsidies into pro-
jects and policies consistent with sustainability? The truth is that removing
subsidies involves losers, and hence such policies cannot be described as
‘win–win’. The problem is that the losers are those with the vested interest
in the subsidy regime continuing and even expanding. Since those interests
are, ex hypothesi, those with the power to capture the rents arising from
subsidy regimes, it follows that removing subsidies is far from easy. Pearce
and Finck von Finckenstein (1999) survey the various conditions under
which subsidy regimes might be radically altered. These include careful
timing of announcements to avoid likely political coalitions objecting to
the changes and even undertaking the changes during periods of major
political upheaval. But many of the efforts have been quite subtle, for
example retaining a subsidy on a good that is purchased by rich and poor
alike but differentiating the product so that the rich come to perceive it as
inferior.
Reducing damaging financial flows: debt repayments
Forgiving debt repayments has become an integral part of overseas aid
regimes in the last decade or so. The links to sustainable development are
twofold. First, debt repayments come from public funds that could other-
wise be used for the provision of public goods in the indebted country.
Hence investment in for example education and health suffers. Second, debt
repayments have to be in hard currencies, which means that the indebted
country has to earn foreign exchange. This it may do by focusing on export-
ing natural resources, such as timber, in an unsustainable manner. As far as
deforestation is concerned, the second of these linkages has been investi-
gated in two major meta studies, Kaimowitz and Angelsen (1998) and Geist
and Lambin (2001). Neither finds an unambiguous link between debt and
deforestation, while Geist and Lambin regard the link as being very weak.
This suggests that debt-forgiveness is unlikely to have any significant effect.
Strand (1995) sets out a theoretical model in which exactly this result
emerges when debt forgiveness is not backed up by conditionality.
Whatever the benefits of debt forgiveness, they are likely to show up more
in the increased flexibility of public expenditures generally rather than in
natural resource damage.
Increasing financial flows: official foreign aid
Whereas direct private investment flows from rich to poor countries will
generally be guided by market rates of return, and therefore have their jus-
tification in terms of conventional commercial criteria, official aid flows are
more directed at the provision of public goods and services. As noted above,
these public goods are integral to sustainability, including as they do infra-
structure, water, education, health, power generation and the environment.
Calls for increased foreign aid from donor countries (the OECD ‘Develop-
ment Assistance Committee’ (DAC) countries) have been long-standing.
Currently, only five nations exceed the United Nation’s target of 0.7 per
cent of donor GNP. Net Overseas Development Assistance (ODA) has
risen in real absolute terms to some US$60 billion in 2002–03 (2002 prices),
but compared to 1992–93 shows only a 5 per cent increase. The United
States’ share of ODA has fallen from 30 per cent in 1982–83 to 23 per cent
in 2002–03, the absolute real amount of US aid being approximately con-
stant over that 20-year period (www.oecd.org/dataoecd). The 0.7 per cent
target, if it was met overnight, would increase flows from some $69 billion
in 2003 to over $190 billion. Note that the implied increased scale ($130
billion) is similar to the $100 billion adverse flows arising from rich country
protection policies.
Apart from moral arguments, increasing official aid has its justification
in the potential role of official aid in increasing the provision of public
goods in developing countries. The caveat is that the aid should be effective
and here there is a further debate with claims and counter-claims about the
extent to which even existing aid flows, let alone increased ones, contribute
to development goals. Collier and Dollar (2001) conclude that aid may well
be ineffective if it is not accompanied by ‘good’ policies. Once the appro-
priate policies are in place, however, both the rate of return to those poli-
cies and the effectiveness of aid is increased. The policy reforms involved in
this assessment are those that tend not to be supported by the NGO com-
munity: macroeconomic stability and trade openness, but few would argue
that the rule of law strongly influences development potential.
Increasing financial flows: looking for deep pockets
Whereas the debate over official aid focuses on both the donor ability to pay
and the recipient’s ability to utilize funds, the NGO community has tar-
geted what might be called the ‘supply side only’ approach by looking for
sources of ‘mega-funds’. The object here is to find a tax base that could be
subject to a very modest tax rate but with the capability to yield potentially
large revenues. Currency dealings have been targeted, invoking, perhaps
somewhat unfortunately, Nobel prize-winner James Tobin’s name in the
form of a ‘Tobin tax’. Tobin was concerned with a tax to assist currency market instability. The NGO Tobin tax proposal is simply a source of
revenue. To make the tax palatable to the financial markets, the suggestion
by the Stamp Out Poverty campaign, an alliance of NGOs formed in 2005,
is for a very modest tax rate per currency transaction. Since annual foreign
exchange transactions are of the order of $250 trillion per annum, it is easy
to see that even small tax rates would raise large sums of money. The prob-
lems with these kinds of financing proposals are many. Apart from the low
likelihood of implementation and the high transactions costs, the tax is
divorced from activities that contribute to non-sustainability. Currency
transactions are either counterparts to real transactions which are likely
already to attract an element of externality tax, or they are designed for
arbitrage and a smooth functioning of financial markets. There is no
obvious link to activities detrimental to sustainability and hence no link to
the polluter pays principle. In short, it is hard to argue that foreign
exchange transactions contribute to non-sustainability. Indeed, the oppo-
site would appear to be the case. If so, the ‘Tobin tax’ becomes a tax on sus-
tainable development, not a tax to deliver sustainability.
4. Market creation: paying for environmental services
The start of this chapter indicated that the creation of markets in currently
non-market goods and services generates a flow of finance that mimics the
financial flows for market goods. The differences are likely to be that the
goods and services provided will have significant public good characteris-
tics. Those paying for the services are therefore going to be governments or
government agencies, or organizations with altruistic goals. This indeed is
how this form of market creation has evolved. Since there is now a huge
number of such initiatives, only a few of the more important examples can
be provided. Reviews of many of the transactions can be found in Daily
(1997), Pagiola et al. (2002), Swingeland (2003), Pearce (2004) and Scherr
et al. (2004).
Debt-for-nature swaps
‘Debt-for-nature’ swaps (DfNSs) began in the late 1980s and continue to
this day, although the parties involved tend to have changed over the years.
They are essentially Coasian, in that an agent concerned to secure environ-
mental conservation or some form of human capital investment buys sec-
ondary international debt denominated in hard currencies and offers to
cancel or convert it in exchange for the good or service in question. Thus,
an NGO or a government might convert debt from a forested country in
return for conservation of the forests. Other swaps have related to educa-
tion and health initiatives, but most are linked to environmental products
and services.
All swaps are confined to commercial debt – debts owed to private
lenders such as commercial banks – and official bilateral debt, that is debt
owed to foreign governments. No multilateral debt (for example World
Bank loans) is involved in the swaps, which has limited the prospects for
developing this instrument. Bilateral debt deals tend to operate through the
Paris Club, a group of bilateral lenders dedicated to reducing and convert-
ing debt that threatens poor country development. In 1990, the Paris Club
agreed to allow a considerable portion of international debt to be dealt with
via debt-for-development swaps. In the event, only a limited number of
creditor countries have operated such schemes.
Some of the most celebrated debt swaps involving governments and
NGOs are those under the Enterprise for the Americas Initiative (EfAI),
established in 1990. The debt in question is owed by Latin American and
Caribbean countries to the USA. The US Tropical Forest Conservation
Act (TFCA) of 1998 enabled further expansions of the EfAI, permitting
debt reductions against forest conservation. From 1991 to 1993 EfAI
conversions amounted to $875 million face value, creating local trust
funds in seven Latin American/Caribbean countries of $154 million. The
TFCA has provision for $325 million of funding. Another significant
government player in DFNSs is Switzerland, which set up a Swiss Debt
Reduction Facility in 1991. The Swiss programme involves several forms
of conditionality: there must be economic reform in the indebted
country, there must be rule of law, and there must be a general debt
reduction programme in the country in question. The Swiss deals have
involved some $460 million face value debt or over $160 million of
redemption value and investment funds (leverage appears to be zero on
the Swiss deals).
Pearce (2004) shows that, to 2003, DfNSs amounted to some $5 billion
when measured in terms of the face value of the debt, and just over
$1 billion when measured at the purchase price. These figures are heavily
influenced by one ‘package deal’ with Poland with a discounted value of
nearly $600 million. But the sums are also leveraged as other investors
piggy-back on the DfNSs. This raises the total value by some $2 billion.
DfNSs are attractive to the indebted country since they reduce foreign
exchange commitments, albeit for attenuated sovereignty over some natural
resources. They are attractive to NGOs since they involve modest costs for
potentially large scale conservation – costs per hectare of land conserved
appear to be no more than a few dollars – and because they meet NGO
goals of providing public environmental goods at the global level. They are
also attractive to donor governments who are faced with pressures for debt
forgiveness. DfNSs permit a kind of ‘forgiveness with conditions’, but with
the conditions being generally benevolent.
The Global Environment Facility
The Global Environment Facility (GEF) was established in 1990 in a ‘Pilot
Phase’, or GEF I, which lasted from 1991 to 1994. It is a United Nations
Agency which functions by donations from OECD countries and a few
non-OECD countries. Its initial activities were unrelated to any interna-
tional environmental conventions other than the Montreal Protocol on
ozone layer depletion. Its coverage was biodiversity, climate change, ozone
layer depletion and, curiously, ‘international waters’ – seas and lakes shared
by two or more nations. But the GEF soon took on the official role of being
the financing mechanism for the Framework Convention on Climate
Change (1992), the Convention on Biological Diversity (1992), the
Stockholm Treaty on Persistent Organic Pollutants and the Convention to
Combat Desertification. The implementing agencies were initially the
World Bank (WB), United Nations Environment Programme (UNEP) and
the United Nations Development Programme (UNDP), with various other
agencies being given similar powers later on.
The basic idea of the GEF is that it should assist in financing activities
in the developing countries and the economies in transition that would be
of benefit to the global community but which the relevant countries would
not undertake as part of their normal development activities. Put another
way, the GEF seeks to internalize the ‘global externality’ arising from devel-
opment activity. An example might be a coal-fired power plant that a devel-
oping country considers the cheapest option for meeting extra power
demand. Coal has a high carbon content so contributes significantly to
global warming. The role of the GEF would be to investigate alternatives
to coal – for example natural gas, energy efficiency, or even renewable
energy. Since, ex hypothesi, coal is the cheapest option, the developing
country needs an inducement to take on the additional or ‘incremental’
cost. By paying this incremental cost, the GEF secures the global benefit it
was set up to secure. While the notion of incremental cost is meaningful for
climate change, it is less obvious how it would be calculated in the context
of biodiversity conservation. Incremental cost would have to be compared
to a hypothetical baseline of what the host country would have done
without the GEF’s intervention. Host countries have an incentive to say
they would have done nothing so that the full cost of conservation is met
by the GEF.
The parallel with a Coasian bargain is obvious. Developing countries
have sovereign rights to use their natural resources as they see fit, but the
world as a whole has an interest in, and would benefit from, their conser-
vation. The ‘polluter pays’ principle fails because of the global pervasive-
ness of the externalities, sovereign rights, and the poverty of the polluters.
Hence, the ‘beneficiary pays’ principle is invoked. It can be seen that the GEF is ‘Coasian’ in style, but because it seeks to provide global public
goods, beneficiaries do not bargain with those who own the property rights.
Rather, an international agency representing governments bargains on
their behalf. As with DfNSs, various forms of co-financing occur, with the
ratio being approximately 2:1 in favour of the other forms of finance. The
extent to which this co-finance is ‘additional’, that is is not taken from
financial flows for other development or conservation purposes can only be
guessed at.
Table 27.1 suggests that GEF expenditures have been running at about
$1 billion p.a. across all target areas, with around 60 per cent of expendi-
tures being for climate change control.
The GEF and DfNSs exemplify the ‘beneficiary pays’ market creation
approach. How far the associated financial flows are additional is
unknown – there is some suspicion that some part of the official DfNSs
and some part of the GEF expenditure is being met by diverting other
overseas development assistance. However, both are examples of innova-
tive global market creation. Both also operate in a ‘bottom up’ mode with
outcomes being determined on a project-by-project basis. Moreover, the
skills and experience generated by these deals has direct application to the
development of other financial instruments for sustainable development,
as we see shortly. These global examples are matched by a multitude of
one-off deals in which, say, a conservation agency in the USA or Europe
will pay for conservation in an area of a developing country. In some
cases, notably in Costa Rica, an imaginative package of deals has been
developed ranging from payments for forest conservation, through to
carbon offsets and bio-prospecting (paying for genetic information from
forests for example). The Costa Rican experience has attracted extensive commentary – see for example Chomitz et al. (1998) and Rojas and
Aylward (2003).
5. Market creation: new financial instruments
One of the most interesting developments in sustainability financing has
come with the development of new financial instruments to cover environ-
mental risks or environment-related risks. These risks can be ‘natural’, for
example changes in the weather, or they can be induced by regulation. An
example of the latter would be a limit, or ‘cap’, set on greenhouse gas emis-
sions in the name of global warming control. Such aggregate caps are then
assigned in some way to those who emit the greenhouse gases. What is
needed then is a market in the emission credits or debits that arise from,
respectively, over-achieving and under-achieving an emission target. A sec-
ondary market arises which trades claims in emission reduction.
A variant on regulation-induced markets are self-regulatory markets
where the emission reduction is self-imposed either out of altruism or, more
generally, because corporate performance is socially rated according to
some environmental and social performance index. It may pay corpora-
tions to adopt ‘corporate social responsibility’ (CSR) targets in order to
have a higher social profile consistent with long term profits and the general
avoidance of bad publicity. Legal liability for environmental pollution
obviously does have an impact on corporate asset values. It is less obvious
that legal pollution has such an impact, the literature being ambiguous
because of poorly designed studies and advocacy rather than rigorous
analysis. A study by Konar and Cohen (2001) for the USA does suggest that
legal pollution may impose an intangible asset liability of around 10 per
cent of the replacement value of tangible assets.
Weather derivatives and ‘catastrophe (CAT) bonds’ are examples of
financial instruments that emerged in the 1990s to cope with natural climate
variability. Weather derivatives began in 1997 in the USA and are financial
contracts for protection of revenues in face of uncertainty about the
weather. They are akin to insurance but with the difference that payout is
triggered by the weather condition rather than by any proof of loss on the
part of the insured. Self-evidently, weather derivatives began life mainly in
the context of the energy sector where seasonal peaks and troughs of
demand have considerable impacts on energy providers. But demand from
recreational activities such as sports has also grown.
CAT bonds have a similar function, but in this case to insure against
natural disasters such as earthquakes, storms, hurricanes and so on. Where
this was once the province of insurance and reinsurance, some catastrophes
in the late 1990s produced financial losses that outstripped the capacity of
the insurance market. Insurers turned to the capital market. CAT bonds attract investors who are keen to act like reinsurers, securing returns well
above money-market yields against a default risk (the risk that the cata-
strophic event will happen) several times lower than this. By buying bonds
diversified across risks that are uncorrelated, the investor obtains consider-
able security. Moreover, CAT bonds are unaffected by the normal varia-
tions in financial markets – only the natural event risks matter. A secondary
market has also begun to emerge, that is the bonds themselves are traded.
The relevance of these financial instruments to sustainable development
may appear limited. But what these instruments are demonstrating is that
financial markets can and do adapt to the changing nature of risks. In so
far as disasters are threats to sustainability, these financial instruments have
a role to play in ensuring that catastrophes do not bring about social col-
lapse in the face of no insurance. Moreover, some catastrophes of the kind
covered by the CAT bond market may increase with global warming, so
that the market effectively adapts to the variable damage that warming is
likely to bring.
The development of a derivatives market in greenhouse gas emission
reduction is better known outside as well as inside financial market circles.
The first carbon offsets or ‘joint implementation’ (JI) projects began in the
USA in the late 1980s. Those deals were voluntary, that is they did not
reflect any requirement to comply with a regulation, national or interna-
tional. In the very first deal, Applied Energy Services invested in carbon
sequestration in Guatemala, and there was no regulatory requirement to
offset its own carbon emissions. The deal involved sequestering or reducing
emissions of carbon dioxide outside of the own source of emissions. If
there is a regulatory obligation to cut emissions the motivation for the trade
would be that it is cheaper to cut emissions or sequester carbon through the
trade rather than ‘at home’. In a voluntary context, the motivations were
primarily good corporate image and learning how the market would
operate. Later trades in the 1990s were undertaken with the aim of antici-
pating Kyoto Protocol targets, but there was also some effort to ‘capture’
the regulatory process by showing forward commitment.
Joint implementation involves bilateral trades: the investor pays for
reductions in emissions compared to some baseline in another location, but
secures the credit for emissions reduction. ‘Activities Implemented Jointly’
was initiated in 1995 by Conference of Parties to the Framework
Convention on Climate Change with the explicit aim of learning how joint
implementation would work. Joint implementation between rich and poor
countries was enabled in the 1992 Framework Convention on Climate
Change but projects could not secure credits against the 2008/10 Kyoto
Protocol targets. A significant number of the joint implementation projects
came from the US ‘Initiative on Joint Implementation’ (USIJI) begun by the Clinton Administration in 1993. USIJI was originally designed to help
the USA secure its Rio voluntary target of returning to 1990 emissions by
2000. The US had ratified the Framework Convention in 1994. The USIJI
projects range across energy conservation, energy production (mainly
switching to lower carbon energy sources in power generation), and carbon
sequestration in biomass.
Notable host countries included Costa Rica, where the benefits of being
a carbon trade host were recognized early on, Russia and Mexico. Various
other initiatives were announced. Notable among the leaders were the
Dutch Government’s ERUPT programme (Emission Reduction Unit
Procurement Tender), some programmes in Canada, Oregon, and the World
Bank’s Prototype Carbon Fund.
With the advent of the Kyoto Protocol, negotiated in 1997 and brought
into force in 2005, three forms of greenhouse gas trading, or ‘flexibility
mechanisms’, emerged:
Article 6 of the Protocol enables Annex 1 countries (basically OECD
plus transition countries) to trade among themselves to secure emis-
sion reduction units (ERUs). Trades cover emission sources, such as
burning fossil fuels, and so-called ‘sinks’. Sinks refer to the growing
of biomass (trees and other vegetation) which absorbs, or ‘fixes’,
carbon dioxide from the atmosphere at a faster rate than it emits it.
These trades must be additional, that is over and above what would
have happened without the project, and must be supplemental to
domestic actions, implying that, despite trading, the emphasis must
be on domestic reduction activities. Article 6 carbon trading is known
as ‘joint implementation’ and is project-based. The private sector may
participate in such trades if approved by the relevant government.
Article 17 states that Parties listed in Annex B (that is countries with
mandatory quantitative targets under the Protocol) ‘may participate
in emissions trading’ but, again, such trading shall be ‘supplemental
to domestic actions’ to meet stated targets. The units of this trade are
assigned amount units (AAUs). Several proposals emerged for the
establishment of an allowance trading system – for example by the
governments of Australia, Canada, Iceland, Japan, New Zealand,
Norway, Russia and the USA (before withdrawal). Article 17 carbon
trading is known as ‘emissions trading’ or allowance trading.
Article 12 defines a Clean Development Mechanism (CDM) which
involves Annex 1 countries (who have legally binding obligations)
trading with non-Annex 1 countries, that is those without any oblig-
ations. Whilst virtually identical with joint implementation, the
CDM establishes a principle of self-interest from the developing countries’ point of view, namely that trades must contribute to
their sustainable development. The Protocol is silent on the meaning
of the term ‘sustainable development’. The units of credit under the
CDM are ‘certified emission reductions’ (CERs). The CDM is
project-based.
A fourth form of trading arises for collective targets of which the prime
example is the European Union (EU) collective target. The EU emissions
trading scheme sets a ‘bubble’ over the Europen Union such that EU
member states can trade within that bubble to achieve their goals under the
EU burden sharing agreement.
Allowance-based trading of kind (b) is a cap and trade scheme. Central
authorities designate an emission limit for the country, and each source has
an emission limit given to it in a national allocation plan. The permits are
freely tradable but each source must not, at some designated date, emit
more pollutants than it has permits for. The US acid rain programme is
the best example of such a scheme, but the EU Emissions Trading Scheme
(EU ETS) also has such features. Schemes of kind (c) and (a) are baseline
and credit schemes and tend to be project-based, that is trades are confined
to a single or small set of projects. A baseline level of emissions is speci-
fied and the difference between actual and baseline emissions is credited,
and credited amounts can be traded. The sources producing the emissions
do not (necessarily) have a total emissions cap as in the cap and trade
schemes.
The scale of the existing carbon trade market is not easy to gauge (as of
2005). Lecocq and Capoor (2003) summarized the market (other than AIJ)
as comprising: (a) allowance trading currently about 4 per cent by volume
of total trades (excluding AIJ), but (b) about 70 per cent of transactions are
AAU. The main motives for trades are legal compliance, anticipatory legal
compliance with Kyoto, voluntary compliance, and ‘retail schemes’ (good
image projects). Between 1996 and 2003 project-based trades amounted to
220 mtCO2e with the annual volume doubling each year from 2001. Since
then most trades are Kyoto ‘pre-compliance’ projects, these trades having
been delayed during the period when the rules of trading were not clear.
The main players have been the World Bank’s Prototype Carbon Fund, the
Netherlands, and increasingly Japanese private buyers anticipating
difficulties with complying with Japan’s Kyoto target. Latin America has
been the largest host for projects in volume terms. Initial prices have been
lower than anticipated (the same phenomenon was witnessed with the US
sulphur trading market), but the market remains thin.
The major regional market is the EU ETS which started operations
in 2005 as part of the EU’s commitments under the Kyoto Protocol The EU ETS covers 12 000 installations and has two initial phases: 2005–07
as the start-up phase and 2008–12 as the first five-year phase, 2012 coin-
ciding with the end of the Kyoto commitment period (the time at which
targets must be met). The system is akin to a cap-and-trade with each
member State producing a National Allocation Plan (NAP) that has to be
agreed by the European Commission. There is no overall EU ‘cap’;
however, each Member State determines the total allowances in combina-
tion with the Commission. Permits are initially grandfathered (allocated
according to some formula related to past emissions or politically deter-
mined, but simply ‘given’ to emitters). There is however a facility for 5 per
cent of permits to be auctioned in the set-up period, and 10 per cent in the
first period. This is designed to make allowance for new entrants who might
otherwise be excluded by permit holders. To all intents and purposes the
currency of the EU ETS is the Kyoto AAU. Penalties for non-compliance,
that is for emissions that exceed allowances held at the end of an account-
ing period, are fairly severe at 50 euros per tonne CO2 in 2005–07 and 100
euros in 2008–12. It is anticipated that some 6 billion allowances will be
issued between 2005 and 2007 with an asset value of over 60 billion euros
(Hartridge, 2005). In early 2005, allowances were trading at around 10
euros per tonne CO2 (about 37 euros per tonne carbon).
Critics of emissions trading in the EU point to the complex way in which
the EU ETS links to national Member State policies. For example, instal-
lations covered by a domestic regulatory scheme can be exempted from
the EU scheme, provided this is agreed with the Commission. This may
limit the market. There is a linkage to the other Kyoto mechanisms, but
CDM trades can be integrated into the EU ETS only in a limited way. The
problem of ‘hot air’ remains. Hot air refers to allowances that are held by
some Eastern European countries, Russia and the Ukraine because their
Kyoto targets are actually below ‘business as usual’ emissions. They thus
have allowances that do not relate to any real emissions. If hot air is
traded, then buyers (for example EU countries) could count the allow-
ances against their own targets but there would be no corresponding real
emission reductions in the seller countries. Finally, there has been consid-
erable suspicion that the National Allocation Plans have been very gener-
ous and in alignment with ‘business as usual’ levels of emissions. Against
this, the Commission is known to have forced the revision of several NAPs
so that the national cap was lowered, and if allowances have been so gen-
erous it would be hard to explain the volume of daily trades (over 500 000
per day in 2005). Further, the 2005–07 phase is deliberately designed for
‘learning’, and experience with other trading schemes suggests that trades
will grow and prices will be firmer as the Kyoto commitment period
approaches.
6. Conclusions
Overall, carbon finance demonstrates to the full the ability of markets to
respond to regulations with government intervention being minimized. It
is easy to criticize features of all the market creation developments in this
chapter – each could no doubt be better designed and more comprehensive
in coverage. But the significant fact is that these innovative solutions have
emerged in a remarkably short space of time. If we mark the beginning of
beneficiary-pays solutions with Coase’s essay of 1960, then those markets
developed within just 40 years. The carbon finance story is even more
remarkable. The notion of tradable permits was introduced by J.H. Dales
in 1968 (Dales, 1968), and within a decade forms of sulphur oxide trading
were being practised in the USA. Sustainable development clearly is a
major challenge, and some would say an unachievable one. But one thing
is sure – economists and finance experts have shown all the imagination and
resolve necessary to develop financial markets to respond to the challenge.
In the end it may not be enough, but there seem to be no limits to options
for financing sustainability.

PART V PROGRESS IN MEASURING SUSTAINABLE DEVELOPMENT:

17 Environmental and resource accounting Glenn-Marie Lange

1. Overview of environmental accounts
Sustainable development is the stated objective of many countries and the
search for operationalizing this concept has focused in part on the system
of national income accounts (SNA) (UN et al., 1993). The SNA is crucial
because it constitutes the primary source of information about the econ-
omy and is widely used for assessment of economic performance and policy
analysis throughout the world. However, the SNA has a number of well-
known shortcomings regarding the treatment of the environment. For
example, while the income from extracting minerals is recorded in the
national accounts, the simultaneous depletion of mineral reserves is not.
Uncultivated fisheries and forests receive similar treatment. This can result
in quite misleading economic signals about sustainable national income.
Indeed, one of the primary motivations for the early environmental
accounting efforts in the mid-1980s was concern that rapid economic
growth in some developing countries was achieved through liquidation of
natural capital, a practice that appears to boost GDP in the short run, but
is not sustainable in the long run.
Equally important, ecosystems provide non-marketed goods and ser-
vices that are often not fully included in national accounts, or are wrongly
attributed to other sectors of the economy. For example, the harvest for
own use of firewood and wild foods, so critical to livelihoods in many devel-
oping countries, is often underestimated. Forests provide recreation and
tourism services, which are not attributed to the forest industry. Forests
may also provide watershed protection benefiting agriculture, hydroelectric
power, municipal water supply and so on, but the value of these services is
not recognized and, hence, not attributed to the forestry sector. Thus the
total benefits from sustainable forestry are underestimated, and other
sectors of the economy are not fully aware of their dependence on the
health of this natural resource.
Over the past few decades, many natural scientists and social scientists
have worked to develop environmental accounts as a tool to promote sus-
tainable development. This effort resulted first in the publication of an
interim handbook in 1993, the System of Environmental and Economic
Accounting (SEEA), under the aegis of the UN’s Statistical Commission
(UN, 1993), followed by a substantially revised and expanded SEEA
Handbook of sustainable development
Handbook in 2003 based on more than a decade of additional conceptual
work and empirical applications by national and international agencies,
academics and NGOs (UN et al., 2003).
The SEEA provides a comprehensive and broadly accepted framework
for incorporating the role of the environment and natural capital in the
economy through a system of satellite accounts to the SNA. As satellite
accounts, the SEEA has a similar structure to the SNA, consisting of both
stocks and flows of environmental goods and services. The SEEA has four
major components, which are constructed, wherever possible, in both phys-
ical and monetary units:


Asset accounts, which record the volume and economic value of
stocks and changes in stocks of natural resources.
Flow accounts for materials, energy and pollution, which provide
information at the industry level about the use of energy and mater-
ials as inputs to production and final demand, and the generation of
pollutants and solid waste. The flow accounts also make explicit the
input of non-market environmental services to production and final
consumption that may be implicitly included in the production
values of other sectors.
Environmental protection and resource management expenditure
accounts, and other environmentally related transactions. These
accounts reorganize information already in the SNA to make more
explicit 1) expenditures incurred to protect the environment and
manage natural resources and 2) taxes, fees and other charges, and
property rights related to the environment.
Environmentally-adjusted indicators of macroeconomic performance,
which include indicators of sustainability such as environmentally-
adjusted GDP and NDP, Adjusted Net Savings (genuine savings: see
Chapter 18), and a broader measure of national wealth that includes
natural capital in addition to manufactured capital
Environmental accounts are now constructed regularly by many
developed countries and some developing countries (Table 17.1). Of
course, environmental accounts are a broad undertaking and countries
have implemented them on an incremental basis, compiling the parts of
the accounts that are most useful for their environmental priorities.
Environmental accounts improve policy making by providing aggregate
indicators for monitoring environmental–economic performance, as
well as a detailed set of statistics to guide resource managers toward
policy decisions that will improve environmental–economic performance
in the future.
This chapter describes some of the policy applications for each compon-
ent of the environmental accounts; a more detailed review of applications
can be found in (Lange, 2003a; 2004a; Lange et al., 2003; World Bank,
forthcoming 2005). For technical aspects of the environmental accounts,
the reader is referred to (UN et al., 2003).
2. Asset accounts: monitoring total wealth
Theoretical work (by for example Arrow et al., 2003a; Dasgupta and
Mäler, 2000; Heal and Kristrom, 2005; Kunte et al., 1998; see also
Chapter 18) has demonstrated that sustainable development requires
non-declining per capita wealth, where wealth is defined in the broadest
sense to include produced, natural and human (including social) capital.
This implies that economic development can be viewed as a process of
‘portfolio management’ seeking to optimize the management of each
asset and the distribution of wealth among different kinds of assets
(World Bank, 2002). The particular challenge for resource-rich economies
is to transform natural capital into other forms of productive wealth, a
process that requires good policy in three critical areas: 1) promotion of
efficient resource extraction that maximizes resource rent, 2) recovery of
the rent by an agency capable of reinvesting rent and 3) efficient reinvest-
ment of rent.
Environmental accounts provide information to monitor sustainable
development by measuring total wealth (produced + natural capital)1 over
time, which indicates whether depletion of resources is compensated for by
investment in other assets; for example is development sustainable or not?
The environmental accounts also provide more detailed information to
assess the environmental and natural resource policies guiding this process:
the amount of resource rent being generated from each resource, the
amount of rent recovered by various agencies, and the share of that rent, if
any, that is invested in other assets.
The SEEA asset accounts in physical units provide indicators of ecolog-
ical sustainability and information for resource management. The volume
of mineral reserves, for example, is needed to plan extraction paths and
indicates how long a country can rely on its minerals. A more complete
assessment of sustainability requires calculation of the monetary value of a
resource stock as well. From the monetary accounts, trends in per capita
national wealth – a measure of sustainable development – can be derived.
These trends can also be analyzed to assess characteristics important to
economic development, such as the diversity of wealth, ownership distribu-
tion, and volatility due to price fluctuations, an important feature for
economies dependent on primary commodities (see Lange, 2003a, for a
discussion of this issue and some examples).
Environmental and resource accounting
275
Among the developed countries, only Australia (ABS, 2004a) and
Canada (Smith and Simard, 2001) regularly include natural capital in the
balance sheets of their annual national income accounts, and a number of
other countries calculate the value of some assets, particularly subsoil
assets. In the developing countries, figures for total wealth including natural
capital have been compiled for Botswana and Namibia (Lange, 2004b), and
are shown in Table 17.2 and Figure 17.1.2
Both Botswana and Namibia have significant natural capital: diamond
mining accounts for roughly a third of Botswana’s GDP; mining and
fishing account for over 20 per cent of Namibia’s GDP. But only Botswana
has been successful in using its natural capital to increase national wealth,
pushing it into the ranks of upper middle-income countries. Namibia has
not used its natural capital to build wealth.
The rapid growth of national wealth in Botswana is consistent with its
development policy, which set a goal of improving living standards and
reducing poverty based on investment of mineral revenues (see Lange and
Wright, 2004). Botswana has recovered much of the resource rent gener-
ated by its minerals and has consistently reinvested virtually all of it (see
below). Namibia, occupied by South Africa until 1990, has not based its
development strategy on reinvestment of resource rent. Namibia has not
recovered as much of the resource rent, partly due to external factors such
as the lack of control over its marine fisheries before 1990, but partly due
to domestic policy decisions even after independence. Not surprisingly,
Namibia has failed to build national wealth. The effect is significant:
Botswana’s per capita, real GDP has grown at an annual rate of 5 per cent,
while Namibia’s per capita, real GDP has stagnated, declining at an annual
rate of –0.025 per cent (Lange, 2004b).
Table 17.2 shows the breakdown of wealth by asset type. For a small
country like Botswana with limited capacity to absorb capital quickly, the
importance of net foreign financial assets has been particularly important.
Recovery of resource rent and reinvesting it in alternative assets is key to
sustainable development. Regarding recovery of resource rent, Botswana
has been rather successful, recovering on average 76 per cent of rent.
Namibia has had much more volatile rent in both mining and fishing. The
Namibian mining industry, dominated by diamonds, uranium and gold,
has paid on average at least 50 per cent of the rent in taxes. By contrast,
government has not recovered much rent from fisheries, partly because rent
taxes (fishing quota levies) were set rather low and not adjusted for infla-
tion, but also because of poor enforcement of rent collection.
As long as fisheries are not being depleted, recovery and reinvestment of
resources is not necessary for sustainable development. When managed
sustainably, fisheries will continue to generate income and employment for
future generations. However, exploitation of fisheries cannot be sustainably
increased as the human population grows. For a country with a growing
population and aspirations for higher standards of living, failure to rein-
vest resource rent represents a lost opportunity to build national wealth.
Furthermore, the recent collapse of the pilchard industry calls into ques-
tion whether the fisheries are being managed sustainably.
Regarding the final requirement for using natural capital to build
national wealth – reinvestment of resource rent – the policies of Botswana
and Namibia are quite different. Botswana developed an explicit policy of
reinvestment of all resource rent from mining and an indicator to monitor
this policy, the Sustainable Budget Index (SBI). (See Lange and Wright,
2004, for discussion of the SBI). Namibia has had no explicit policy regard-
ing reinvestment of revenues from natural capital.
3. Flow accounts for materials, services and pollution
The flow accounts of the environmental accounts are compiled and used for
economic analysis much more extensively than the asset accounts. They
provide macroeconomic indicators of sustainability as well as more detailed
information to support economic analysis of sources of environmental
pressure and options for change that can be used to improve sustainability.
The aggregate indicators provide an overview of the relationship between
economic development and the environment; the more detailed accounts
help explain the overview.
The flow accounts consist of three components: use of material and
energy resources, resource degradation and emission of pollutants, and pro-
duction and use of ecosystem services. The flow accounts are compiled in
both physical and monetary units. The physical accounts help set priorities
for policy based on the volume of resource use, pollution and so on while the
monetary accounts identify the relative costs and benefits of reducing pollu-
tion, resource use and so on. The flow accounts are also used in economic
models to evaluate options for development and specific policy instruments
for implementing a given development strategy, such as green taxes.
Physical accounts
At their simplest, the flow accounts are used to monitor the trend over time
of environmental goods and services, and pollution emissions, both total
and by industry. An example for wastewater and water pollution from the
Netherlands’ accounts is shown in Figure 17.2.
The construction of environmental–economic profiles, or ‘eco-efficiency’
indicators has become a common way of monitoring sustainability, and is
also used for benchmarking industry performance. These descriptive
statistics provide a first approach to identifying major users of resources
and sources of emissions, and provide a comparison of each sector’s rela-
tive environmental burden and economic contribution. Typically, eco-
efficiency indicators report an industry’s percentage contribution to the
national economy (value-added, employment) alongside its environment
impact such as emissions of various pollutants. A similar sector-level indi-
cator is the ‘resource productivity indicator’ calculated as materials (energy,
water and so on) or pollution per unit of value-added. (See example from
the water accounts for Australia in Table 17.3 and a more extensive example
for two industries in Sweden in Figure 17.3.)
While the eco-efficiency indicators report the direct generation of pollu-
tion associated with production, it is useful for policy makers to understand
the driving forces that result in such levels of pollution. The driving forces
for economic production are the final users. Input–output analysis has been
used to measure the total impact (direct + indirect) of a given final use. This
approach is especially useful in understanding the effects of different pat-
terns of household consumption or trade on the environment. An example
for SO2 air pollution in Sweden is given in Figure 17.4.
Monetary accounts
Effective environmental management is based not only on an understand-
ing of the volume of environmental goods and services and pollution, but
also an understanding of the economic implications. Policy makers need to
know, for example, what the welfare loss of pollution is (damage costs) and
where limited financial resources will be most effective in reducing envir-
onmental pressure, that is, the relative benefits and costs of reducing
different forms of environmental degradation from different sources.
Similarly they need to know the value of damages from deforestation in
terms of reduced productivity or increased production costs in other
sectors of the economy.
One of the most important applications of environmental accounting in
developing countries has been to identify goods and services from ecosys-
tems such as forests that are not adequately represented in the SNA. Many
non-market forest goods for example, (fuelwood, wild foods, medicines,
construction materials and so on) are, in principle, included in the SNA,

but due to measurement problems countries may underestimate the harvest
of these goods. In South Africa, for example, the value of non-market
forest goods, timber and non-timber, is greater than the commercial timber
harvest, but it is not included in the national accounts of South Africa
(Table 17.4).
In addition, forests provide environmental services that are often not rec-
ognized explicitly in the SNA. In Sweden, the value of recreation services
from forests is equal to the value of the timber harvest, but this service is
not attributed to forests. Similarly, forests in South Africa contribute sub-
stantially to agriculture (providing livestock grazing services and habitat
for wild bees that provide pollination services): a conservative estimate is
1907 million Rands in 1998; again, greater than the commercial timber
harvest, which is the only explicit value for forests in the national accounts.
In the case of these forest services, the value is included in the national
accounts, but as part of the livestock and crop activities, not as forest input
to those activities.
The issue of ecosystem services and undercounted non-market goods is
particularly important for many developing countries that may be overex-
ploiting their forests (or other natural resources, for example fisheries and
marine resources, wildlife and so on) for short-term economic growth. They
may have calculated that the revenues received compensate for the defor-
estation. But if the cost–benefit calculation does not also take into account
the loss of forest services to other sectors, such as tourism, agriculture,
hydroelectric power, fisheries, municipal water supply and so on, it is quite
possible that the losses from deforestation may outweigh the benefits.
The monetary flow accounts have also been used to address other policy
issues that are important for resource management, for example the subsidy
for water or wastewater treatment. The monetary accounts for water report
both the cost of delivery and the market price charged for water and waste-
water; the difference between the two is the subsidy. Figure 17.5 shows figures
for wastewater treatment in the Netherlands at a national level. Calculation
of subsidies from the monetary accounts for water have been compiled at the
industry level for three southern African countries; Botswana, Namibia
and South Africa (Lange and Hassan, forthcoming 2006). The accounts
for all three countries show extensive cross-subsidization, especially of
agriculture.
In many other countries, developed and developing, the cost of air and
water pollution is a major concern. After some initial experimentation with
valuation of pollution, many countries have not continued efforts to incor-
porate these into their environmental accounts. In large part, this is because
of a lack of consensus over alternative methods of valuation, and partly
because accurate valuation is quite difficult. There are two broad approaches

to valuation recommended in the SEEA: the cost of actions to prevent or
remediate degradation, and the benefit of actions to reduce pollution mea-
sured in terms of the value of the damages prevented.
In the absence of efficient markets, the cost and benefit measures are
likely to be quite different. The damage cost is the theoretically correct
approach for measuring changes in economic well-being and adjusting
macroeconomic aggregates, although both measures provide useful infor-
mation for environmental management. Until the SEEA provides more
concrete guidelines about valuation, most countries are unlikely to include
them in their environmental accounts. An example of monetary accounts
for air pollution in Sweden, based on the damage cost approach, is shown
in Figure 17.6.
Economic modeling with environmental accounts
Assessment of trade-offs in a partial equilibrium framework is a first step
towards understanding the policy impacts on the environment. But under-
standing the impact of broader changes, such as trade liberalization,
population growth, agricultural and industrial policy, energy pricing and
so on usually requires an economy-wide environmental–economic model.
One of the most important applications of the flow accounts is for eco-
nomic planning. Planning for sustainable development requires an integra-
tion of environmental and economic modeling. In the past, it was difficult

to integrate environmental and economic planning because the underlying
database for such models did not exist. The contribution of environmental
accounting is to provide the economist with a consistent, systematic, and
reliable set of accounts that are linked to the economic accounts. While this
topic is too broad to review in detail here, examples of widespread model-
ing applications include: modeling of environmental taxes and resource
user fees, modeling trade and the environment, modeling environmental
impacts of long-term development strategies, energy modeling.
4. Environmental protection and resource management expenditure
accounts
This component of the environmental accounts takes figures that are
already included in the SNA and rearranges them to make them more
useful for policy. There are three major parts: accounts for environmental
protection expenditure, accounts for natural resource management, and
environmental taxes and related fees. Two examples are provided here that
are both relevant to all countries, developed and developing.
a resource that is commercially exploited paying at least enough in taxes to
cover the costs of its management? In this case, only taxes and fees directly
related to the resource are included, not any corporate business income
taxes, which all companies may pay, regardless of what industry they are
in. In the Namibian fishing industry, the taxes contributed have always
covered the costs to government of managing the industry.
In the second example, Sweden has compared the share of carbon emis-
sions by industry to the share of carbon taxes that a given industry pays
(Figure 17.7). If a carbon tax is administered equally, on the basis of CO2
emitted, the two shares should be the same for an industry. Surprisingly,
there seems to be little relationship between the two. Households pay a
much greater share than the share of CO2 they are directly responsible for,
while manufacturing pays much less.
5. Economy-wide indicators of sustainable development
A wide range of macroeconomic indicators can be derived from the
asset and flow accounts of the SEEA; the major ones are listed in Table
17.6. The role of economic valuation in accounting, and the border
between accounting and economic analysis are unresolved issues in the
SEEA. Consequently, the SEEA does not make a recommendation for any
particular indicators and presents both physical and monetary macroeco-
nomic indicators. The Netherlands has been the major proponent of phys-

1997 (percentage of total)
ical NAMEA indicators for main environmental ‘themes’ determined by
national emission targets.
Within the monetary macro-indicators, there is further controversy over
whether sustainability is more accurately monitored from a national
income approach (for example environmentally adjusted GDP) or from a
wealth approach (for example genuine savings). These issues are addressed
in more detail in Chapter 18. There is also a view reported in the SEEA that
hypothetical national income calculated through modeling exercises should
also be included in the environmental accounts. However, most practition-
ers recognize that such indicators, while quite useful, belong firmly in the
realm of economic analysis rather than statistics.
6. The future of environmental accounting
Environmental accounts make a great contribution to further integrating
environmental and economic analysis by providing a single database that is
consistent for both sets of information. The SEEA, as an official handbook
endorsed by the UN Statistics Committee, provides the basis for viewing
environmental accounting as simply a more thorough way of doing
national accounts. However, the SEEA is far from a complete handbook
providing clear standards on all issues, and the problem is both conceptual
and empirical. The three most urgent issues are the following:
Asset valuation, depletion and degradation. At this time, the SEEA pre-
sents several alternative approaches to measuring the value of assets and
depletion/degradation but makes no recommendation for which approach
to use, even though the approaches can give widely differing results. The
issue of constant price asset values is not even discussed in the SEEA. This
situation is not one that will encourage countries to implement the asset
accounts.
Macroeconomic indicators (monetary). Ministries of Finance need to
know whether their development strategy is laying the basis for long-term
economic growth or not. In developing countries, PRSPs (Poverty
Reduction Strategy Programs) have been widely adopted as a planning tech-
nique to promote sustainable economic growth and poverty reduction.
However, PRSPs use GDP and other conventional macro indicators in their
monitoring framework; consequently, policy makers receive information
about only half of the objective, short-term economic growth, but not sus-
tainability of that growth. The long-term cost of soil erosion, for example,
is enormous in many countries and may undermine any short-term gains in
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Handbook of sustainable development
GDP. There is a great need for a complementary indicator of sustainability,
such as Genuine Savings, that can be used in PRSPs. The SEEA does not
make clear whether countries should be monitoring stocks (wealth and
changes in wealth/savings) or flows (national income).
Ecosystem accounting. Some ecosystem values, notably for forests, have
been incorporated in environmental accounts, but much of this work has
not yet been systematically incorporated in the SEEA. Accounting for
ecosystem services is especially important for developing countries for
several reasons. Developing countries contain most of the world’s
biodiversity; biodiversity protection services benefit not only local com-
munities but also the global community. Ecosystem services, such as water
and soil protection, are often under greatest threat in developing countries,
but these countries often have fewer resources to cope with loss of ecosys-
tem services (flood control, water purification, increased health care and so
on). In addition, the well-being of developing countries may be more vul-
nerable to loss of these services as a majority of people depend directly on
ecosystem health (for example soil stability for subsistence farming,
fisheries habitat and so on), and often have limited alternative sources of
livelihood. Noting that the poor are often those most vulnerable to deteri-
oration of natural systems, the Millennium Ecosystem Assessment states
that ‘development policies aimed at reducing poverty that ignore the
impact of our current behavior on the natural environment may well be
doomed to failure’ (Millennium Assessment Board, 2005).
Notes
1. There is no consensus yet about how to measure human capital.
2. The most important natural capital is included here: minerals for both countries and fish-
eries for Namibia. The value of other important natural capital, notably land and water,
has not yet been estimated, but this is not expected to seriously affect the trends in per
capita wealth. This is discussed further in (Lange, 2004b).
References
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development in imperfect economies’, Environmental and Resource Economics, 26: 647–85.
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Consolidated Balance Sheet, Canberra: ABS.
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Dasgupta, P. and K. Mäler (2000), ‘Net national product, wealth, and social well-being’,
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accounts’, report to IUCN and the Environment and Natural Resources Sector Working
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www.millenniumassessment.org.
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Bank.
18 Genuine saving as an indicator of sustainability Kirk Hamilton and Katharine Bolt
1. Introduction
Choosing sustainable development is an ethical position adopted by
society, reflecting a desire to ensure that future generations enjoy at least as
much welfare as the current generation. Because sustainability is inherently
about the future, measuring it has been a challenge. Without indicators,
promises to achieve sustainability risk being largely empty.
A common thread in the literature on sustainable development concerns
the treatment of the environment and natural resources within the System
of National Accounts (SNA). This is important because the SNA has an
incomplete treatment of resource issues. To give one example, commercial
natural resource stocks are supposed to be measured in the national
balance sheet accounts of the SNA, but there is no corresponding adjust-
ment to net national income or net saving to reflect the consumption of
capital that occurs when these stocks are exploited. Similarly, there is no
explicit accounting in the SNA for the damages to economic assets that
result from pollution emissions. The consequence is that SNA measures of
income and saving are overstated, substantially so for the most resource-
dependent economies. In many countries finance ministries are simply
working with the wrong figures.
If depletion of the environment is ignored in the most common and
powerful set of indicators used to guide economic development, then the
threat to sustainability is obvious. Decisions to exploit natural resources
now may harm future generations if the depletion of one asset is not offset
by investment in another – the fact that this depletion is occurring would
be completely invisible in standard national accounting.
To correct this flaw in the national accounts, measures of ‘genuine’ saving
account for the change in real wealth in an economy after due account is taken
of the depreciation and depletion of the full range of assets in the economy.
Pearce and Atkinson (1993) laid the conceptual foundation for such an
extended measure of saving, as well as presenting some of the first empirical
estimates using results from the green national accounting literature.
In a series of papers, Hamilton and Clemens (1999), Dasgupta and
Mäler (2000) and Asheim and Weitzman (2001) have established the growth
292
Genuine saving as an indicator of sustainability
293
theoretic basis for the linkage between saving and sustainability. While the
main result from this literature will be presented below, the intuition is
straightforward. If we conceive of wealth – the value of all assets in an
economy – as the basis of future welfare, then current changes in wealth
must have future welfare consequences. It is at least conceivable that a
decline in wealth now will lead to falls in future levels of welfare – such an
economy would not be sustainable by Pezzey’s (1989) definition. Growth
theory makes this connection concrete.
The focus in the sustainable development literature is on genuine saving
rather than ‘genuine income’ (that is consumption plus genuine saving) for
good reason – adjusting the level of income to reflect the depreciation of a
wider array of assets does not in itself indicate whether an economy is on
a sustainable path. However, the fact that genuine income would typically
be lower than the standard measure of Net National Income does send an
important message – that we should not be treating asset consumption as
income.
Genuine saving is more than a theoretical construct. In addition to the
empirical results in Pearce and Atkinson (1993) and Hamilton and
Clemens (1999), the World Bank has been publishing estimates of ‘adjusted
net’ saving (the formal name for genuine saving at the Bank) for 140 coun-
tries since 1999 in the World Development Indicators (World Bank, 2005).
The plan of the chapter is the following. The next section will lay out the
theoretical basis and measurement issues for genuine saving. This will be
followed by presentation of some of the published saving estimates from
the World Bank. Recent extensions of the saving analysis in the literature
will be presented. Finally, the chapter concludes with some thoughts on
current challenges.
2. Theory and measurement
Pearce and Atkinson (1993) made a first attack on the problem of measur-
ing sustainable development by employing basic intuitions concerning
assets and sustainability. They argued that sustainability can be equated to
non-declining values of all assets, including natural resources. The conse-
quence of this conceptualization is that changes in asset values, measured
by net saving, should signal whether an economy is on a sustainable path.
Pearce and Atkinson presented empirical results on net saving for a range
of developed and developing countries using values published in the green
accounting literature.
More recent theoretical work on savings has firmly established the
linkage between net savings, social welfare and sustainable development.
Hamilton and Clemens (1999) tackle the problem for an optimal economy,
and Dasgupta and Mäler (2000) for non-optimal economies (with suitable
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Handbook of sustainable development
definition of shadow prices). Asheim and Weitzman (2001) show that
growth in real NNP (where prices are deflated by a Divisia index of con-
sumption prices) indicates the change in social welfare in the economy.
Genuine saving is defined as,
Here the Ki are the stocks of assets in the economy, and the pi are their
shadow prices. The expression says that genuine saving is measured as the
change in real wealth. To measure sustainability it is important that genuine
saving span as wide a range of assets as possible, including assets with nega-
tive shadow prices such as pollution stocks. In principle changes in the
stocks of produced, human, natural, social and institutional capital should
all be measured in saving – in practice there are data and conceptual prob-
lems associated with the measurement of assets like social capital.
The basic theoretical insight of Hamilton and Clemens (1999) is to show
that genuine saving G, utility U, social welfare V, marginal utility of con-
sumption , and pure rate of time preference are related as follows
This says that social welfare is equal to the present value of utility, and that
genuine saving is equal to the instantaneous change in social welfare mea-
sured in dollars.1 The utility function can include consumption C and any
other set of goods and bads to which people attribute value.
Hamilton and Clemens (1999) go on to show that negative levels of
genuine saving must imply that future levels of utility over some period of
time are lower than current levels – that is negative genuine saving implies
unsustainability. Similar implications hold for the approaches of Dasgupta
and Mäler (2000) and Asheim and Weitzman (2001).
These approaches to greening the accounts, and the models that under-
pin them, are agnostic on the question of the degree of substitutability
between different assets, in particular between produced and natural assets.
An important strand of the sustainability literature, dating back to Pearce
et al. (1989), looks at the question of strong versus weak sustainability
(see also Chapter 4). Weak sustainability assumes that there are no funda-
mental constraints on substitutability. If, however, some amount of nature

must be conserved in order to sustain utility – the strong sustainability
assumption – then these saving models need to be modified to incorporate
the shadow price of the sustainability constraint.
A formal approach to the strong vs weak sustainability problem has been
explored in the ‘Hartwick rule’2 literature. Dasgupta and Heal (1979) and
Hamilton (1995) show that if the elasticity of substitution between pro-
duced capital and natural resources is less than 1, then the Hartwick rule is
not feasible – eventually production and consumption must fall, implying
that the economy is not sustainable under the rule.
The question of ecological thresholds is potentially important in
measuring sustainable development. Crossing certain boundaries may
produce catastrophic results, such as the re-routing of the Gulf Stream as
a result of global warming, or the death of most plankton in the ocean as
a result of ozone layer destruction. In environmental economic terms we
may think of a threshold as a point where the marginal damage curve is
unbounded. As long as marginal damages are smooth as a threshold is
approached, the saving approach will give correct signals concerning
sustainability, since approaching the threshold will eventually result in
negative savings. If the marginal damage curve is not smooth and
becomes vertical at the threshold, then the saving rule may not indicate
unsustainability as the threshold is approached. There is clearly an
important question of the science of threshold problems, since we do not
know a priori what the shape of the marginal damage curve is for many
important problems.3
Pezzey (2004) makes the point that genuine saving provides a one-sided
sustainability test: if saving is negative, then there must be future declines
in utility. The opposite is not true in general – positive saving at a point in
time does not indicate that future utility is everywhere non-declining.
However, Hamilton and Hartwick (2005) show that making positive
genuine saving an element of a policy rule can yield sustainability – this
result is described below.
3. Empirical experience
Each year the World Bank publishes genuine saving estimates in the World
Development Indicators (World Bank, 2005).4 The following summarizes
how the saving estimates are constructed:
Genuine saving

There are a number of points to note about the calculation. First, genuine
saving as published by the World Bank is not just a ‘green’ indicator – it
includes investment in human capital (as proxied by education expenditure)
as a part of saving. Carbon dioxide damages, a global issue representing
damages inflicted on other countries, are included in national savings on
the assumption that a certain property right holds: that countries have the
right not to be polluted by their neighbours. Finally, damages from parti-
culate matter in air are based on the value of damage to health – health-
fulness is treated as an asset, part of human capital.
In any given year 10–30 countries actually have negative genuine saving.
As Figure 18.1 shows, aggregate savings for the developing regions of the
world show distinctive levels and trends.

The Middle East and North Africa stands out for its consistently
negative saving rate, reflecting high dependence on petroleum extrac-
tion. Regional genuine saving rates are highly sensitive to changes in
world oil prices. This is clearly shown in Figure 18.1 – genuine saving
rates dropped in 1979, largely owing to the consumption of sharply
increased oil rents following the Iranian revolution.
East Asia and Pacific stands in stark contrast, with recent aggregate
genuine saving figures nearing 30 per cent, driven largely by China.
The boom in economic performance from the second half of the
1980s until the Asian financial crisis in 1997 is reflected in the genuine
saving numbers, largely driven by increases in gross national saving.
Genuine saving rates have been hovering around zero in sub-Saharan
Africa. Positive saving in countries such as Kenya, Tanzania and
South Africa is offset by strongly negative genuine saving rates in
resource-dependent countries such as Nigeria and Angola, which
have genuine saving rates of 30 per cent in 2003.
South Asia displays consistently strong genuine saving rates, fluctu-
ating between 10 and 15 per cent since 1985, with India dominating
the aggregate figure.
Latin American genuine saving rates have remained fairly constant
throughout the 1990s. The large economies in the region, Mexico and
Brazil, have positive genuine saving rates in excess of 5 per cent.
However, like many oil producers, Venezuela’s genuine saving rate
has been persistently negative since the late 1970s.
Genuine saving data for Eastern Europe and Central Asia are only
available from 1995. Saving rates have fallen from over 7.7 per cent in
1995 to 1.7 per cent in 2003, largely driven by dissaving in the oil
states of Azerbaijan, Kazakhstan, Uzbekistan, Turkmenistan, and
the Russian Federation.
One of the themes that suggests itself in the analysis of regional trends in
saving is the link between high resource dependence (typically on oil) and
genuine saving rates. Figure 18.2 looks more specifically at this question by
scattering genuine saving rates against rates of dependence on exhaustible
resources in 2003 (only mineral and energy rent shares greater than 1 per
cent of GNI are shown).
The tendency in Figure 18.2 is clear. If mineral- and energy-dependent
economies were diligently investing their rents in other types of capital, as
the Hartwick rule suggests, then there should be no apparent link between
resource dependence and genuine saving. Instead we see a clear downward

Figure 18.2 Genuine saving vs exhaustible resource dependence, 2003
trend, which suggests a tendency to consume rents that increases with
resource dependence.
Genuine saving lends itself to a variety of empirical applications beyond
the analysis of sustainability. Recent examples include Atkinson and Hamil-
ton (2003) who explore the extent to which genuine saving can explain the
‘resource curse’, while de Soysa and Neumayer (2005) look at the impact of
trade openness and other liberalization measures on genuine saving.
4. Extensions
Reference was made above to the Hartwick rule, a rule for achieving sus-
tainability that is built around genuine saving. Under this rule an economy
will achieve maximal constant consumption forever (or constant utility in
a more general formulation) if genuine saving is set to zero at each point in
time. This holds even in the canonical exhaustible resource economy of
Dasgupta and Heal (1979) with fixed technology, a single produced capital
stock and a finite resource stock that is essential for production – in this
economy the rule reduces to ‘invest resource rents’.
Hamilton and Hartwick (2005) point toward a generalization of the
Hartwick rule by deriving the following relationship between consumption,
saving and the interest rate for an optimizing Dasgupta–Heal economy:

Here C is consumption and r the (time-varying) interest rate. This expres-
sion relates growth in consumption to the sign of genuine saving and the
difference between the interest rate and the growth rate of genuine saving.
Dixit et al. (1980) showed that a slightly generalized version of the
Hartwick rule holds in any economy that is competitive – an economy
where producers maximize profits and households maximize utility. A
competitive economy is not necessarily PV-optimal (the path defined by
solving the growth problem where the present value (PV) of utility is max-
imized), so a variety of policy rules can potentially be applied. Hamilton
and Withagen (2007) show that expression (18.4) holds in competitive
economies, which means that it is possible to define a more general rule for
sustainability: in a competitive economy, maintaining genuine saving rates
that are (i) positive and (ii) growing at a rate less than the interest rate, will
lead to increasing consumption at each point in time.
Ferreira and Vincent (2005) use World Bank historical data on con-
sumption and genuine saving to test a basic proposition linking current
saving to future welfare. They start with a result from Weitzman (1976): if
the economy is PV-optimal and the interest rate is constant then,

Genuine saving is equal to the difference between a particular weighted
average of future consumption and current consumption. This relationship is
tested econometrically using per capita data from 1970 to 2000. Ferreira and
Vincent find that the relationship holds best for non-OECD countries, and
that there is a better fit as more stringent measures of saving are tested, that
is when going from gross saving to net saving to genuine saving (but excluding
the adjustment for education expenditure, which performs very badly).
Hamilton and Hartwick (2005) note that expression (18.4) can be inte-
grated to yield,5

So genuine saving is equal to the present value of changes in future
consumption. Hamilton (2005) uses historical data to test whether this
expression holds. Figure 18.3 displays the right-hand side of expression
(18.6) scattered against genuine saving in 1980. The broad conclusion is
similar to Ferreira and Vincent (2005) – using data for all countries, genuine
saving fits expression (18.5) better than other measures of saving, while the
fit is extremely poor in OECD countries.
Hamilton et al. (2006) show that a particularly simple saving rule yields
sustainability in a competitive Dasgupta–Heal economy: if genuine saving
is positive and constant then consumption will rise without bound. This
rule and the standard Hartwick rule are then used to test the counterfac-
tual: how rich would countries be if from 1970 to 2000 they had followed
either the standard Hartwick rule or had maintained genuine saving at
a constant value equal to 5 per cent of 1987 GDP? Figure 18.4 compares
the two counterfactual estimates of fixed capital (it is assumed that all
savings are invested in produced assets) with the observed level of fixed
capital in 2000 for selected countries.
The results of following either policy rule are dramatic for the oil pro-
ducers: Venezuela, Trinidad and Tobago and Gabon would all be as rich as
South Korea if they had followed the constant genuine saving rule. Nigeria
would not be rich, but it would be five times richer than it is today. It is no
simple matter for a resource-dependent developing country to maintain
positive savings through financial crises, civil unrest and natural disasters –
but the payoffs are potentially huge.
Finally, World Bank (2006, ch. 5) extends the empirical work on genuine
saving to examine the effects of population growth. The net change in
wealth per capita GN is calculated as For population N, this says that the net change in wealth per capita is equal
to total genuine saving per person minus a Malthusian term, the popula-
tion growth rate g times total tangible wealth W per person. Dasgupta
(2001) shows that this expression measures the change in social welfare
when (i) the population growth rate is constant, (ii) per capital consump-
tion is independent of population size, and (iii) production exhibits con-
stant returns to scale.
Figure 18.5 scatters the net change in wealth per capita against GNI per
capita (logarithmic scale) in 2000. The upward trend and the fact that most
low income countries (GNI of less than $750 per capita) face net declines
in wealth per capita means, roughly speaking, that the rich are getting
richer while the poor are getting poorer. However, Hamilton (2005) pre-
sents evidence that the Malthusian adjustment tends to overstate the
impact of population growth on future changes in consumption.
World Bank (2006) also calculates the saving gap – the increase in saving
that would be required to bring a country’s net change in wealth per capita
back to zero. For many African countries in particular this gap is huge,
from 10–70 per cent of GNI, suggesting that economic and environmental
policy alone will not suffice to bring sustainability in per capita terms to
these economies.
5. Challenges for the future
A conceptual challenge for the work on genuine saving concerns the ques-
tion of optimality. Hamilton and Clemens (1999) derive expression (18.3)

in an optimal economy, so the application of the theory to the real world
becomes an important question. Dasgupta and Mäler’s (2000) solution is
to derive the parallel expression for a non-optimal economy, but they are
required to use accounting prices that are defined as the partial derivatives
of the value function V for the non-optimal path – to define the prices it is
therefore necessary to define the path. Arrow et al. (2003) explore this ques-
tion in some depth.
If we assume that world prices for resources do reflect scarcities and are
therefore relatively undistorted, then the derived shadow prices should be
a reasonable reflection of the user costs associated with resource extraction.
Whether genuine saving measured using these prices truly reflects the
change in social welfare is still an open question, although there is a huge
amount of literature on cost–benefit analysis of projects which would
suggest using precisely these prices. More work on this topic is required.
The new results on saving rules in competitive economies offer promise
in this regard – there is no underlying assumption of optimality, and it is at
least a reasonable proposition that many economies are competitive. One
obvious conclusion follows from expression (18.4): if genuine saving is neg-
ative and constant then the economy is on an unsustainable path. The
general rule for sustainability was stated above: maintain positive saving
and ensure that it does not grow faster than the interest rate. These saving
rules for competitive economies offer scope for actually using the concept
of genuine saving in designing policies for sustainability.
There is no shortage of empirical questions when it comes to measuring
genuine saving. Among the challenges that appear the most urgent are:
Identifying non-linearities in the natural world that may not be cap-
tured in any simple way in measures of genuine saving. We do not
want to be assuring ministers that all is well because saving is pos-
itive, only to discover that a major flip in natural systems has severe
consequences for human welfare.
Valuing truly difficult assets such as biodiversity.
Inventorying and valuing the environmental services that underpin
so much economic activity, whether it is pollination or regulation of
flow in a watershed. While many of these values are captured indir-
ectly in other asset values – the value of farmland, for example – the
fact that there is no explicit valuation means that there are opportu-
nities for unpleasant policy surprises.
Estimating elasticities of substitution for resources. The availability
of databases of natural resource stocks and flows, in quantity and
value terms, means that there should be more scope for exploring this
important question – World Bank (2006, Chapter 8) estimates the

305
elasticity of substitution between land and fixed capital to be close to
one, an important result.
The policy challenges involved in increasing genuine saving are closely
linked to the components of saving. The ‘bottom line’, genuine saving, will
be affected by fiscal and monetary policies that influence gross saving effort.
In addition, increasing human capital investments and making them more
effective will boost the bottom line. Achieving efficient levels of resource
extraction and pollution emissions will also increase genuine saving – note,
however, that this does not imply reducing resource extraction or pollution
emissions to zero.
While the focus of this chapter has been on saving, the profitability of
investments financed by this saving is of paramount importance. If gov-
ernments invest in ‘showcase’ projects with low or negligible social returns,
then savings have in effect been consumed, with consequent effects on
future welfare.
Finally, for the poorest economies, increasing saving could be taken to
imply decreasing consumption, not a palatable policy option in countries
where consumption is already at subsistence levels. For these countries a
better alternative will be to focus on boosting the efficiency of the economy
through economic reforms, raising growth and potentially leading to a vir-
tuous cycle of increasing saving and consumption.
Notes
1. This result is foreshadowed in Aronsson et al. (1997, expression 6.18) who show that net
saving measured in utility units is equal to the present value of changes in utility for a
general (possibly time-varying) pure rate of time preference.
2. Hartwick (1977) showed that consumption is sustainable (in fact constant) in a fixed tech-
nology economy with an essential exhaustible resource if: (i) net saving is everywhere 0;
(ii) the elasticity of substitution between resources and produced capital is 1; and (iii) the
elasticity of output with respect to produced capital is greater than the corresponding
elasticity for the resource.
3. See also Pearce et al. (1996).
4. The formal name of the saving indicator is ‘adjusted net saving’. Genuine saving is the
informal name.
5. This is also proved, in a more general framework, in Dasgupta (2001) Ch. 9, appendix A.7.
References
Aronsson, T., P.-O. Johansson and K.-G. Löfgren (1997), Welfare Measurement, Sustainabiliy
and Green National Accounting: A growth theoretical approach, Cheltenham, UK and
Northampton, MA, USA: Edward Elgar.
Arrow, K.J., P. Dasgupta and K.-G. Mäler (2003), ‘Evaluating projects and assessing sustainable
development in imperfect economies’, Environmental and Resource Economics, 26(4): 647–85.
Asheim, G.B. and M.L. Weitzman (2001), ‘Does NNP growth indicate welfare improvement?’,
Economics Letters, 73(2): 233–9.
Atkinson, G. and K. Hamilton (2003), ‘Savings, growth and the resource curse hypothesis’,
World Development, 31(11): 1793–807.
306
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Dasgupta, P. (2001), Human Well-being and the Natural Environment, Oxford: Oxford
University Press.
Dasgupta, P. and G. Heal (1979), Economic Theory and Exhaustible Resources, Cambridge:
Cambridge University Press.
Dasgupta, P. and K.-G. Mäler (2000), ‘Net national product, wealth, and social well-being’,
Environment and Development Economics, 5, Parts 1&2: 69–93, February and May.
de Soysa, I. and E. Neumayer (2005), ‘False prophet, or genuine savior? Assessing the effects
of economic openness on sustainable development, 1980–99’, International Organization,
59(3): 731–72.
Dixit, A., P. Hammond and M. Hoel (1980), ‘On Hartwick’s rule for Regular Maximin Paths of
Capital Accumulation and Resource Depletion’, Review of Economic Studies, XLVII: 551–6.
Ferreira, S. and J. Vincent (2005), ‘Genuine savings: leading indicator of sustainable develop-
ment?’, Economic Development and Cultural Change, 53(3): 737–54.
Hamilton, K. (1995), ‘Sustainable development, the Hartwick rule and optimal growth’,
Environmental and Resource Economics, 5(4): 393–411.
Hamilton, K. (2005), ‘Testing genuine saving’, Policy research Working Paper no. 3577,
Washington: The World Bank.
Hamilton, K. and M. Clemens (1999), ‘Genuine savings rates in developing countries’, The
World Bank Economic Review, 13(2): 333–56.
Hamilton, K. and J.M. Hartwick (2005), ‘Investing exhaustible resource rents and the path of
consumption’, Canadian Journal of Economics, 38(2): 615–21.
Hamilton, K. and C. Withagen (2007), ‘Savings growth and the path of utility’, Canadian
Journal of Economics, 40(2), forthcoming.
Hamilton, K., G. Ruta and L. Tajibaeva (2006), ‘Capital accumulation and resource deple-
tion: a Hartwick rule counterfactual’, Environmental and Resource Economics, 34: 517–33.
Hartwick, J.M. (1977), ‘Intergenerational equity and the investing of rents from exhaustible
resources’, American Economic Review, 67(5): 972–4.
Pearce, D.W. and G. Atkinson (1993), ‘Capital theory and the measurement of sustainable
development: an indicator of weak sustainability’, Ecological Economics, 8: 103–8.
Pearce, D.W., K. Hamilton and G. Atkinson (1996), ‘Measuring sustainable development:
progress on indicators’, Environment and Development Economics, 1: 85–101.
Pearce, D.W., A. Markandya and E.B. Barbier (1989), ‘Blueprint for a green economy’,
London: Earthscan.
Pezzey, J. (1989), ‘Economic analysis of sustainable growth and sustainable development’,
Environment Dept Working Paper No. 15, The World Bank.
Pezzey, J. (2004), ‘One-sided sustainability tests with amenities and changes in technology,
trade and population’, Journal of Environmental Economics and Management, 48(1):
613–31.
Weitzman, M. (1976), ‘On the welfare significance of national product in a dynamic economy’,
Quarterly Journal of Economics, 90(1): 156–62.
World Bank (2005), World Development Indicators, Washington: The World Bank.
World Bank (2006), Where is the Wealth of Nations? Measuring Capital for the 21st Century,
Washington: The World Bank.

19 Measuring sustainable economic welfare Clive Hamilton
1. Introduction1
It has long been recognized that, above a threshold, GDP growth does not
correlate well with changes in national well-being (for example Layard, 2005
and Chapter 16 of this volume). That threshold has been well and truly
passed by OECD countries. The principal shortcomings of GDP as a
measure of changes in national well-being are: the failure to account for
how increases in output are distributed within the community; the failure to
account for the contribution of household work; the incorrect counting of
defensive expenditures as positive contributions to well-being; and the
failure to account for changes in the stocks of both built and natural capital.
There have been several attempts to construct indicators of changes in
well-being that are more comprehensive than GDP. A well-known earlier
index was built by Nordhaus and Tobin (1972). In more recent years Daly
and Cobb have constructed the Index of Sustainable Economic Welfare
(ISEW) in an influential appendix to their book, For the Common Good
(1990). The Daly and Cobb index has led to a lively debate on a series of
methodological and measurement issues (much of which was presented in
Cobb and Cobb, 1994), and construction of similar indexes for several
other countries.2
These later efforts have placed a particular emphasis on accounting for
environmental costs in the new measure of welfare. The initial Daly and
Cobb index for the USA has been refined and developed by Cobb, Halstead
and Rowe (1995) and renamed the Genuine Progress Indicator (GPI), the
name that has increasingly replaced ISEW and that will be used here.
2. Welfare and sustainability
The key to understanding the attempts to develop the GPI lies in the notion
of sustainability. The best starting point is John Hicks’ 1939 definition of
income. ‘Hicksian income’ is defined as the maximum amount that a person
or a nation could consume over some time period and still be as well off at
the end of the period as at the beginning (Hicks, 1946: 172).3 Thus income
is maximum sustainable consumption. Sustaining consumption over a
given period depends on maintaining the productive potential of the
capital stocks that are needed to generate the flow of goods and services
that are consumed.

to define and measure ‘consumption’ in a way that provides a better
approximation of actual well-being than the simple measure of mar-
keted goods and services that appears in the national accounts; and
to account for the sustainability of consumption by incorporating
measures of changes in the value of capital stocks

Taking account of these two classes of influence on welfare over time, we
may end up with a situation in which GDP is increasing while consumption
(more broadly defined) is rising or falling, and while capital stocks are
growing or declining.
The GPI combines changes in the value of stocks and the values of flows
of current consumption. Consistent with the definition of Hicksian
income, capital stocks perform two functions in the GPI method of mea-
suring changes in welfare – they yield an annual flow of services and they
contribute to the sustainability or otherwise of levels of consumption in the
future. In order to prevent the depreciation or depletion of capital stocks,
a portion of current consumption needs to be ‘set aside’ to replenish the
stocks. The implication of this is that, unlike the way in which changes in
GDP are used, year-on-year changes in the GPI are not very meaningful.
The purpose of the GPI is to illustrate trends over time.
We now look more closely at the two tasks that the GPI sets itself and
then consider some of the further methodological issues it gives rise to.
3. Measuring ‘consumption’ comprehensively
For individuals or households, consumption may be defined as annual
flows of marketed and non-marketed goods and services. Perhaps the
biggest category of non-marketed goods and services comprises those pro-
duced in the home by unpaid household work. Non-marketed goods and
services also include services provided by the natural environment, such as
the aesthetic and recreational services of old-growth forests and the health-
sustaining properties of clean air.
A more comprehensive definition of consumption that takes account of
non-marketed goods and services is particularly important because mea-
sured GDP growth may reflect nothing more than the transfer of activity
from the non-market to the market sector, a problem long recognized in the
development literature. This is most apparent in the case of household
work, but applies equally to any other ‘free’ service. Just as, in the well-
known observation, GDP declines ‘if a man marries his housekeeper’,
GDP rises if an entrance fee is levied on visits to a national park or a family
decides to eat out more often.

Measuring sustainable economic welfare
309
Consumption includes negative flows or ‘bads’. Some monetary expen-
ditures by final consumers – which are therefore included as expenditures
in GDP – represent not additions to welfare but attempts to offset some
change in social, environmental or individual circumstances which is
causing a decline in welfare. These are known as defensive expenditures and
are deducted from the value of personal consumption expenditure, which
provides the starting point of the GPI.
These observations apply to consumption by individuals. At a national
level it is important to take account of differences in the welfare impact of
consumption between households or individuals. One of the most fre-
quently heard criticisms of the use of GDP growth as a measure of national
welfare is that it assumes that an extra $1 million of consumption by wealthy
households has the same impact on national welfare as an extra $1 million
of consumption by impoverished households. The GPI rejects this assump-
tion and adjusts consumption flows by a measure of income distribution.
The GPI assumes that personal consumption spending by individuals on
marketed goods and services is the major component of welfare and that
an increase in this spending represents, ceteris paribus, a corresponding
increase in welfare. There is a large amount of literature critical of the
assumption that there is a close relationship between changes in consump-
tion spending and changes in individual welfare (see for example Layard,
2005; Frey and Stutzer, 2002). Many studies have shown that, above a
certain level of income, perceived well-being depends more on the level of
one’s income relative to other people’s incomes, or to previous or expected
levels, than on absolute levels.4 But the purpose of the GPI is to demon-
strate that, even using conventional economic methods, a more compre-
hensive attempt to account for changes in welfare may show large
deviations from GDP over time. Consequently, we adopt the assumption
that increases in personal consumption (adjusted for the distribution of
income) reflect increases in welfare. It is important to keep this ‘consump-
tion framework’ in mind because, if it is accepted, many of the criticisms of
the GPI and ISEW are neutralized.
4. Accounting for changes in the value of capital stocks
Sustaining levels of consumption requires that the productive potential of
capital stocks be maintained. Capital stocks can be divided into five forms,
which we discuss in turn. While GDP accounts for changes in none of them,
the GPI attempts to incorporate changes in the value of the first three.
Built capital This covers the stocks of physical machinery, buildings
and infrastructure that are essential to sustaining levels of GDP. These
stocks deteriorate and a portion of income must be set aside each year to
invest in them to maintain and improve their productive potential. This is

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Handbook of sustainable development
a long-recognized problem and has led periodically to attempts by statist-
ical agencies to construct measures of net national product (NNP). The
GPI adjusts consumption spending to take account of net capital growth
which, if positive, adds to sustainable economic welfare. (In principle, it
should take account of changes in annual flows of services from the stock
of built capital.)
Financial assets A nation’s ability to sustain investment in built capital
assets is diminished if it is accumulating foreign debts, since some part of
future income must be devoted to repaying the debts.5 But if those loans are
being invested productively then future income will be higher and it will be
possible to repay the debts without additional burden. To the extent that
foreign debt has been invested productively in the past, current consump-
tion will be higher. But if foreign borrowing is dissipated on consumption
goods it represents a drain on future consumption. The GPI adjusts con-
sumption spending to account for net foreign liabilities.
Natural capital Maintaining the stocks of natural capital is essential to
sustaining consumption in the future, especially when consumption is
defined more broadly. These stocks take two forms. The first are stocks of
renewable and non-renewable resources used as inputs in production, such
as minerals, fossil fuels and soils. The second take the form of waste sinks
that are provided by the natural environment and are essential for dissipat-
ing waste products so that they do not represent a danger to humans. The
GPI takes account of the depletion of both types of natural capital.
However there are some difficult methodological issues concerning the sub-
stitutability of built for natural capital that are discussed in the next section.
Human capital This represents the accumulation of health, skills, know-
ledge and experience in humans that makes them more productive than brute
labourers. Technology is partly embodied in humans. The GPI does not
account for human capital because of the conceptual and measurement
difficulties involved. If it did, the GPI would ideally be adjusted to account
not for annual investments in human capital but for the annual services
provided by the stock of human capital. This is an area for future work.
Social capital A nation that possesses sound and stable political, legal
and commercial institutions and cohesive, supportive and trusting com-
munities will be in a better position to generate flows of goods and services
than one that does not. However, this form of ‘capital’ is difficult to define
precisely and to measure and is for that reason excluded from the GPI.
Substitutability among capital assets
The depletion of one form of capital does not represent a decline in sus-
tainable consumption if other forms of capital are accumulating and can
be substituted for the disappearing asset. Thus the issue of substitutability

Measuring sustainable economic welfare
311
within and between these classes of assets is critical. For instance, the run-
down in physical capital is not necessarily a problem if financial wealth that
could be used to rebuild it (or could be used to invest in assets in other coun-
tries) is being accumulated outside of the country.
More controversially, the run-down of one type of natural asset will not
necessarily impose a cost if built capital or another type of natural asset can
perform, at the same or similar cost, the same functions. The question of the
degree of substitutability of built for natural capital is perhaps the most
strongly contested issue in the economics of the environment (see Chapters
3, 4 and 6 in this volume and, for example, Neumayer, 2003). We have taken
the view that for three classes of natural assets complete substitutability
between built and natural assets is not a valid assumption. These classes are:

Certain natural resources that are irreplaceable and form essential
inputs to continued productive activity – soils and supplies of fresh
water are examples;
Waste sinks, that is those components of the natural environment that
absorb or process wastes and render them benign, particularly the
atmosphere (covering the climate system and the ozone layer) and the
oceans; and
Assets whose services are consumed directly by final consumers
and which are valuable because of their unique natural features –
old-growth forests and coral reefs are examples.
In addition to these, there may be some natural resources for which there
are, or probably will be, substitutes, but for which the substitutes are likely
to be significantly more expensive. Fossil fuel-based energy is the most
pertinent category here. Energy is essential for economic activity, yet the
evidence suggests that the market for energy may not adequately reflect the
likely scarcity of fossil fuels (especially oil and natural gas).
Neumayer (2000) has argued that the fact that changes in the value of
these ‘non-substitutable’ assets are added in the GPI to other consumption
goods makes them substitutable, so that the GPI is an indicator of weak
sustainability only. But adding the value of haircuts to the value of oranges
in calculating GDP does not make them substitutes for each other. He also
argues, correctly, that some ISEWs or GPIs use an erroneous method to
value the depletion of natural resource stocks, which tends to exaggerate
the difference between GDP and the adjusted welfare measure.
Defensive expenditures
Whereas GDP counts them as additions to output, the GPI deducts defen-
sive expenditures undertaken by consumers and governments because, by Handbook of sustainable development
definition, they are undertaken to offset some decline in social welfare. In
principle, most defensive expenditures are reactions to a decline in the value
of the stock of social, human or natural capital, as long as they are broadly
defined. This applies to private defensive expenditures on health and per-
sonal security and public defensive expenditure on social welfare. If we
could adequately account for changes in stocks of human and social capital
then it would not be necessary to deduct defensive spending.
A more difficult question is that of how much of a given expenditure is
defensive and how much makes a net contribution to welfare (Neumayer,
1999). This is particularly relevant to some public expenditures, on social
security and law and order for instance. An increase in spending on polic-
ing, courts and prisons due to a crime wave is clearly defensive, yet some
basic level of spending on crime prevention and punishment is essential and
makes a large contribution to national well-being. Ultimately judgements
about how much spending is defensive and how much makes a positive con-
tribution to welfare will be somewhat arbitrary.
Time accounting
The GPI attempts a systematic approach to valuing time.6 The value of time
is a very important aspect of various components of the GPI, including the
value of household and community work and the costs of unemployment
and of overwork. In the Australian GPI we have adopted the principle that
the value of time devoted to voluntary activities counts as a positive in the
GPI and the value of time engaged in involuntary activities counts as a
negative. The following voluntary activities contribute to our welfare:
paid work (except the involuntary component referred to below as involuntary leisure,7 that is the times when we are unemployed but
want to be employed; and involuntary work, that is the times when we are doing paid work but would prefer not to be.
The GPI is a measure of sustainable consumption. Thus in addition to
measures of currently consumed goods and bads – including the costs of
crime, the costs of commuting, the benefits of household work, and the dis-
tribution of income – it considers the future implications of present con-
sumption (and production) activities. Thus it incorporates an estimate of
the unsustainability of foreign debt, indicated by the proportion of total
foreign borrowing that finances consumption rather than investments that
can generate revenues to be used to repay the debt. It also considers the
long-term impact of economic activities on the stocks of irreplaceable
natural capital assets. In this way, future costs are in a sense brought
forward.
As a result, while graphing GPI per person over time illustrates the direc-
tion of change, caution must be exercised in interpreting the GPI measure
in any one year as a measure of national welfare in that year. Just as a con-
sumer can increase their consumption levels and thus ‘welfare’ by spending
up on a credit card, credit binges must be paid for by lower consumption in
future years. Neumayer (1999) has observed that the GPI/ISEW cannot
function simultaneously as an indicator of current welfare and as an indi-
cator of sustainability. While there is some confusion in the GPI literature
about what it does measure, it seems agreed that the GPI does not function
as an indicator of current welfare and of sustainable income but as an indi-
cator of sustainable welfare. In other words, it measures what we might call
‘Hicksian welfare’, the maximum amount of welfare that a nation can
enjoy over some time period and still be as well off at the end of the period
as at the beginning.
The GPI therefore engages in a type of smoothing process. As a result,
we take the view that it may be misleading to construct the GPI on an
annual basis (and even more misleading to do so on a quarterly basis) if
the impression were given that an increase, say, in the GPI from one year
to the next indicated that national well-being had risen by that amount. On
the other hand, many of the items included in the GPI are current rather
than capital items and do indicate year-on-year changes in well-being.
The results of three GPI/ISEW calculations are shown in Figure 19.1.
5. Conceptual problems in the GPI
While many people have welcomed the GPI, others have raised objections.8
There are four objections to the GPI that have been raised, the first three of
which are misconceived.
‘Subjective weighting’
It is often claimed that the ‘weighting’ of various components in the GPI is
subjective. In fact, the GPI uses a range of techniques to attach dollar
values to the various components, thus converting every component into a
common unit of measurement. For instance, the value of household labour
is arrived at by multiplying the number of hours worked in the household
by the hourly wage rate of a housekeeper. The value of the loss of ozone is
arrived at by assessing the health costs of the damage caused. These are not
subjective ‘weights’ but are dollar values generated in markets of one sort
or another – actual markets, related markets or hypothetical markets.
Everything is expressed in dollar values via prices generated in markets, so
that the weights look after themselves.
Arbitrariness of components
Some critics argue that the GPI lacks a sound theoretical foundation; as a
result the inclusion of various components is arbitrary (Neumayer, 1999).
While the rationale has not always been clearly stated in previous GPIs and
ISEWs, the selection of components is not arbitrary but follows some rules.
The process begins by identifying the deficiencies of GDP as a measure of
welfare and asks how it would need to be changed to make it a better
measure. In so doing, it builds a framework for measuring sustainable
consumption.
Thus the GPI is not ‘arbitrary’ in the sense that its authors simply add in
components at random. In each case, there is an identified problem with
GDP as a measure of welfare, and an attempt is made to fix it so far as is
permitted by availability of data. When statisticians calculate NNP by sub-
tracting an estimate of the depreciation of built capital from GNP and say
that it is a better measure of changes in output, we do not accuse them of
being arbitrary; they are correcting for a known problem.
Quality of goods
It is sometimes argued that the GPI fails as a measure of changes in
national well-being because it does not account for the improvement in the
quality of goods. Thus real consumption spending may double over a given
period, but the utility derived from that spending may more than double
because the quality of goods has improved. For example, in real terms we
may pay the same amount for a TV today as we did 20 years ago, yet the
benefit we derive is much higher because the set has a bigger and flatter
screen, and the quality of picture and sound are better.
This is true; however, exactly the same criticism applies to the use of GDP
as a measure of national well-being, so it should be no surprise that since
the GPI begins with the final consumption component of GDP, all of the

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Handbook of sustainable development
problems in it will be carried over to the GPI. Arguably, the quality problem
‘cancels out’, so that if we focus our attention on the gap between GDP and
GPI then it is perfectly feasible to maintain that the GPI is a better measure
of changes in economic well-being. This does, however, temper the useful-
ness of conclusions drawn on the basis of changes in the GPI over time.
Ethical versus economic values
There is one serious problem with the GPI as a measure of national well-
being that should be acknowledged. Aggregating all of the factors into a
single monetary index strikes many people as being invalid. By converting
everything into dollars, doesn’t the GPI fall into the same trap as GDP, that
of reducing well-being to economics? This is perhaps the major flaw in the
GPI. The problems with the approach become apparent when we attempt,
for example, to estimate the costs of climate change, since the greatest costs
will be associated with loss of life, which must be given a dollar value if it
is to be included. Should the life of a person in a poor country be worth less
than the life of someone in a rich country? Placing dollar values on many
things converts ethical values into economic ones, a process that for many
people actually devalues the environment and human life (see Chapter 2 on
this issue). These profound problems with the GPI are acknowledged. For
some, constructing the GPI is the most effective way of pointing to the fail-
ings of current systems of measurement. Moreover, refusing to value some
things means they must be left out of the GPI, even though it is generally
agreed they affect our well-being.
6. Areas for future refinement of the GPI
There are a number of areas of future work that will help refine and resolve
difficulties in the GPI method. They include:
Employing better measurement of changes in income distribution
over time, including more robust estimates of the social preference
for equality, or aversion to inequality;
Development of a more comprehensive natural resource accounting
framework for incorporating environmental and resource use
impacts in to the GPI;
Securing the collaboration of various government agencies in pro-
viding the best and most consistent data on a number of variables
(for example those components affected by transport including
urban air pollution, costs of noise, costs of accidents); and
Using a full capital depreciation framework for the GPI components,
that is evaluation of the elements of human and social capital and
valuing changes in these stocks.
1. I would like to thank the editors for very helpful comments on an earlier draft of this
chapter.
2. Including the UK (Jackson and Marks, 1994; New Economics Foundation, 2004),
Canada (Coleman, 1998), Germany (Diefenbacher, 1994), Sweden (Jackson and Stymne,
1996) and Australia (Hamilton, 1997; Hamilton and Denniss, 2000).
3. Hicks also wrote that ‘the practical purpose of income is to serve as a guide for prudent
conduct’ (Hicks, 1946: 172), a comment that has particular relevance for today’s concern
with ecological sustainability.
4. For a formal treatment of the roles of relative incomes, aspirations and environmental
quality in welfare see Ng and Wang (1993).
5. In the case of debts owed to domestic creditors, increased consumption now by the debtor
is offset by a decline in consumption now by the creditor, a situation that is later reversed.
6. The most systematic attempt to sort out the problem of time valuation in the GPI appears
in Hamilton and Denniss (2000).
7. Some GPIs include the cost of (lost) leisure. Others include the costs of overwork instead.
8. See for example Castles (1997) and Neumayer (1999, 2000).
References
Anielski, M. and J. Rowe (1999), The Genuine Progress Indicator – 1999 update, San Francisco:
Redefining Progress.
Castles, I. (1997), ‘Measuring wealth and welfare: why HDI and GPI fail’, paper to a sympo-
sium on Wealth, Work and Well-being, Academy of the Social Sciences in Australia
(10 November).
Cobb, C. and J. Cobb (1994), The Green National Product: A Proposed Index of Sustainable
Economic Welfare, Maryland: University Press of America.
Cobb, C., T. Halstead and J. Rowe (1995), The Genuine Progress Indicator: Summary of Data
and Methodology, San Francisco: Redefining Progress.
Coleman, R. (1998), ‘Measuring sustainable development: the Nova Scotia genuine progress
indicator’, report published by GPI Atlantic, Nova Scotia, Canada.
Daly, H. and J. Cobb (1990), For the Common Good, Boston: Beacon Press.
Diefenbacher, H. (1994), ‘The index of sustainable economic welfare in Germany’, in C. Cobb
and J. Cobb (eds), The Green National Product, Lanham, MD: University of Americas Press.
Frey, B. and A. Stutzer (2002), Happiness and Economics, Princeton: Princeton University Press.
Hamilton, C. (1997), ‘The genuine progress indicator: a new index of changes in well-being in
Australia’, Australia Institute Discussion Paper No. 14 (October) (with contributions from
Hugh Saddler).
Hamilton, C. (1999), ‘The genuine progress indicator: methodological developments and
results from Australia’, Ecological Economics, 30: 13–28.
Hamilton, C. and R. Denniss (2000), ‘Tracking well-being in Australia: the genuine progress
indicator 2000’, Australia Institute Discussion Paper No. 25 (December).
Hicks, J. (1946), Value and Capital, 2nd edn, London: Oxford University Press.
Jackson, T. and N. Marks (1994), Measuring Sustainable Economic Welfare – A Pilot Index:
1950–1990, Stockholm: Stockholm Environment Institute.
Jackson, T. and S. Stymne (1996), Sustainable Economic Welfare in Sweden: A Pilot Index
1950–1992, Stockholm: Stockholm Environment Institute.
Jackson, T., N. Marks, J. Ralls and S. Stymne (1997), Sustainable Economic Welfare in the UK
1950–1996, Guildford, Surrey: Centre for Environmental Strategy, University of Surrey.
Layard, Richard (2005), Happiness: Lessons from a new science, New York: Penguin.
Neumayer, E. (1999), ‘The ISEW: not an index of sustainable economic welfare’, Social
Indicators Research, 48: 77–101.
Neumayer, E. (2000), ‘On the methodology or ISEW, GPI and related measures: some con-
structive suggestions and some doubt on the “threshold” hypothesis’, Ecological Economics,
34(3): 1–34.

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Neumayer, E. (2003), Weak versus Strong Sustainability: Exploring the Limits of Two
Opposing Paradigms, Cheltenham, UK and Northampton, MA, USA: Edward Elgar.
New Economics Foundation (2000), ‘Chasing Progress: Beyond measuring economic growth’,
London: www.neweconomics.org.au.
Ng, Yew-Kwang and Jianguo Wang (1993), ‘Relative income, aspiration, environmental
quality, individual and political myopia’, Mathematical Social Sciences, 26: 3–23.
Nordhaus, W. and J. Tobin (1972), ‘Is growth obsolete?’, in National Bureau of Economic
Research, Economic Growth: Fifth Anniversary Colloquium, New York: NEBR.
Pannozzo, L. and R. Colman (2004), ‘Working time and the future of work in Canada: a Nova
Scotia GPI case study’, Report published by GPI Atlantic Nova Scotia,
20 Environmental space, material flow
analysis and ecological foot printing Ian Moffatt
1. Introduction
The terms ‘sustainability’ and ‘sustainable development’ are often used
interchangeably in both academic research and policy making. They are,
however, different, and should be defined clearly and used carefully. To
sustain an activity or process is to ensure that the system runs for a long
time. In environmental and ecological economics a sustainable resource is a
potentially renewable resource which can be used indefinitely. The word
‘sustain’ is often used in the context of maximum sustainable yield (MSY)
and has been used for understanding and contributing to resource policy in
areas such as multi-species forestry and fisheries management (Clark, 1976;
Christensen, 1995). Sustainable development is a broader concept than sus-
tainability and stresses both the idea of sustaining activity for a long time
for current and future generations as well as linking such activity to devel-
opment rather than economic growth per se. It is also vital for development
to be sustainable that the life support systems of the planet are protected
(WCED, 1987). One thing is certain, you cannot have continuous growth of
economies, population, resource consumption and pollution generation on
a planet with finite biophysical stocks and limited assimilative processes
(Daly, 1972). This was noted over three decades ago at the Stockholm con-
ference on the Human Environment (Ward and Dubos, 1972) and at the
summits in Rio de Janeiro (1992) and in Johannesburg (2002). Sustainable
development is an on-going process integrating ecological, economic, equity
and ethical considerations for current and future generations of people and
other living creatures, without endangering the life support systems of the
planet upon which ultimately all life depends (Moffatt, 1996a).
This chapter examines environmental space, material flow analysis and
ecological footprints as contributions to the processes of achieving the goal
of sustainable development. The next section discusses weak and strong
sustainable development issues and resource use. Sections 3 to 5 examine
environmental space, material flow analysis and ecological footprinting
respectively. Each section defines the concept, briefly describes the method-
ology including for brevity a ‘master equation’ for the concept, and illus-
trates its application with examples. Section 6 then subjects the three
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methods to a critical assessment with regard to contemporary research
problems and policy relevance. The final section provides a summary of the
positive findings.
2. Weak and strong sustainable development and resource use
The three approaches described in this chapter are all based on the idea of
strong as opposed to weak sustainable development. Whilst we accept that
if a country is unable to pass a weak test for sustainable development then
it is unlikely to pass a stronger test (Pearce and Atkinson, 1993; Atkinson
et al, 1997; Neumayer, 2003) – the weak test is underpinned by very ques-
tionable and debatable assumptions of resource use (Beckerman, 1998;
Daly and Cobb, 1989). These include the assumption of perfect substi-
tutability between man-made (Km) and natural capital (Kn); setting the
correct price for specific resource use which is often not included in the
market and the role of technical change in areas where there may be no
technical solutions. Weak sustainable development is generally based on
neo-classically derived marginal analysis at the resource frontier rather
than on absolute limits (Mirowski, 1990). Furthermore, it could be argued
that the weak sustainability argument assumes that the ecology is sub-
servient to economics. If, however, we are to assume that economics is a
subset of ecology then we must consider strong sustainability.
Strong sustainability is based on several principles of classical science.
These recognize the fact that we only have one earth and that for sustain-
able living we have to live within its absolute biophysical limits. From the
principles of conservation of matter we cannot make matter but we can
change its form. From the laws of thermodynamics we cannot get any more
energy from a machine than we put into it. The earth ecosystems derive the
bulk of their energy from solar radiation, and in open living systems energy
consumption is hierarchically organized to maintain higher-level organ-
isms in ecosystems. From ecology we cannot expect a receiving environ-
ment to exceed its assimilative capacity without increasing levels of
pollution above a natural level. The proximity and precautionary principles
are also included in strong sustainability arguments. The differences
between the weak and strong perspectives are shown in Table 20.1.
Resources are a term of cultural appraisal (Kirk, 1963) and depend in
part on a society’s technology and on the political choices to use resources
or leave them untouched as part of nature. The indigenous Aboriginal
peoples of North Australia, for example, did not use metal as mining the
earth was seen by some tribes as desecrating the land in which their God
resides. They feared that such activity could result in divine retribution.
During the Roman occupation of Britain ( 120) coal, formed in the
Carboniferous period about 350 million years ago, was used for making jewellery. Later in the Industrial Revolution (circa 1790) the Carboniferous
capitalists used coal to fuel industrial production (Rees, 1985). In this sense
natural resources are neutral stuff which may become useful for different
purposes (Zimmermann, 1951).
When examining sustainable development it is conventional to describe
resources as a stock (that is a physical quantity) or as a flow (that is rate of
use). It is also essential to note that the use of any resource leads to waste
which, in the earth’s closed and inter-related biogeochemical cycles, gener-
ally impacts on other ecological cycles. Most of the potentially living
resources – the life support systems of the planet – depend on incoming
radiation from the sun and matter from the earth. If we are to use poten-
tially renewable resources in a sustainable manner then we must ensure that
the rate of harvesting (or fishing or hunting) is much less than the natural
rate of reproduction. Next, that the rate of pollution and waste generation
is less than the natural assimilative capacity of the receiving environment.
For strong sustainable development we need to ensure that the man-made
capital resulting from the use of the non-renewable resources (for example
minerals, fossil fuels) are set aside to fund renewable alternatives (Daly,
1990). We should also strive to minimize the damage to the environment
which always accompanies resource use. The methods underpinning envir-
onmental space, material flows and ecological footprints assume that these
ideas are well understood.
3. Environmental space
Environmental space is defined as a share of the planet and its resources that
the human race can sustainably take without depriving future generations
of the resources they would need. The idea of environmental space was first
put forward in 1994 (Opschoor and Weterings, 1994). It describes the quan-
tity of energy, non-renewable (for example minerals) and potentially renew-
able resources (for example water, food, wood, farmland) that we can use in
a sustainable fashion without exceeding environmental limits (McLaren et
al., 1998, p. 6). It was argued that at the current rates of use non-renewable
resources would have a short life, that the use of potentially renewable
resources would result in overexploitation and that the assimilative capacity
for waste would be exceeded unless reductions in resource use occur. The
second major assumption underpinning environmental space is the idea of
equity for current and future generations. This was, of course, noted in the
Brundtland definition of sustainable development (WCED, 1987). In envi-
ronmental space equity is defined as an equal per capita share of resources.
Environmental space was used in both national and European-wide
studies. The original Netherlands study defines environmental space as
estimating the global resource (such as wood energy, water, raw materials,

Environmental space and ecological footprinting
323
arable land) and dividing it by the number of world citizens, to produce an
average figure for each resource per capita for a given date. By comparing
the global average per capita figure for a given resource with the total of
that resource consumed in a particular country then the amount of envi-
ronmental space consumed by a nation can be observed. The test for sus-
tainable development using environmental space is ‘the use of resources
and pollution of that country can be compared to the environmental space
belonging to that country’ (Buitenkamp et al., 1991, p. 18). The calculation
for environmental space is simple and is given in equations 20.1 and 20.2.
The environmental space for country i is the amount (Q) of consumption
of resource x per capita. Then a country’s consumption of one resource
(ESi,x,t ) can be compared to the environmental space of global resource use
(ESx,t). The policy prescriptions which follow from the calculations of envir-
onmental space are based on a comparison of one nation’s resource use of
type x with the global average. Naively, if ESi,x,t ESx,t then policies should
be implemented to reduce resource use of type x in country i. If ESi,x,t
ESx,t then presumably no reductions are necessary. If ESi,x,t ESx,t do policy
makers increase resource consumption in country i?
The environmental space concept was actively pursued by Friends of the
Earth groups across Europe (Friends of the Earth, 1995a, 1995b). In a
series of national reports the environmental space required for countries in
a sustainable Europe as described (Buitenkamp et al., 1991; McLaren et al.,
1998). By 1996 reports on sustainable Europe and some nations within
Europe had been published (Tables 20.2 and 20.3). Generally, these studies
argued that Europeans are consuming more than our fair earth share of
environmental space and that we would have to undertake massive cuts in
resource use by 2050. To achieve these large cuts a per capita reduction
target was established for each resource for 2010. Whilst such ideas are
useful as a guide to policy they are only useful if the underlying basis for
such proposed cuts is sound; alas, even in the important example of atmos-
pheric carbon dioxide reductions, this was not the case (see section 6).
It will be observed that in both the European-wide and national studies most
of the resources have to be drastically reduced. In one sense this research effort
by numerous groups was to be welcomed as a bold statement of the degree of
unsustainability different European countries exhibited. The original
Netherlands study was set up to encourage debate over sustainable develop-
ment. This debate must not, however, ignore the technical details in the
methods used. It is wrong to assume that these technical details ‘should in no
case to be allowed to delay the debate on the consequences of the concept of
limited and finite environmental space for daily life in society’ (Buitenkamp et
al., 1991, p. 181). This is methodologically unacceptable because if the method
is wrong then the policy prescriptions offered would carry very little or no con-
viction. Quite simply if you divide the resource consumption by the global
population you obtain ‘environmental space per capita’ for a given time. As the
global population grows, the ‘environmental space per capita’ share is reduced
and, on this basis, it could be argued that countries need to control global pop-
ulation growth as well as reduce resource consumption. We will return to crit-
icisms of the environmental space method in section 6. Finally, whilst the idea
of environmental space was poorly conceived, it did point the way to more
rigorous methods such as material flow analysis and ecological footprinting.
4. Material flow analysis
The purpose of material flow analysis is to track and quantify the flow of
materials including energy in a defined area over a set time period. It is
obvious that any economy takes in raw materials from the environment
including imports from foreign nations, for further processing, manufac-
turing, production and consumption (Linstead and Ekins, 2001). Some
materials such as the construction of buildings and infrastructure add to
the stock of man-made capital. Eventually, the products become waste and
may be recycled, but finally have to be disposed via landfill or incineration.
Since any resource input sooner or later becomes an output, it is possible
to account for resource flows and use them in material balance modelling
(Figure 20.1).
The mass balance equations used in material flow analysis (MFA) can be
written as follows:
Obviously, collecting all the relevant data for each of items A, B, C and D
is a difficult and time-consuming task. Fortunately, the Statistical Office of
the European Communities has developed national economy-wide mater-
ial flow accounts (Eurostat, 2001). These accounts exclude water and air
but include energy flows through the national economy. Several studies
have been undertaken at the national scale to give an empirical account of
resource use (Linstead et al., 2004). In the United Kingdom, for example,
a material flow analysis using resource use in agriculture, forestry and
fishing together with mining of minerals, fossil fuels and other aggregates
was undertaken in 2002. The calculation also includes ‘hidden’ flows of
materials such as mining wastes which are moved during extraction but are
not used directly in the economy. In the UK for the period 1970–2000 it was
shown that the total resource use rose during the 1970s as oil and gas pro-
duction from the North Sea reserves started to flow, but eased off during
the early 1980s. Generally, there has been an increase in material flows, in
line with economic growth, in the latter part of the 1980s, but from 1990
onwards resource use has stabilized despite a considerable increase in the
size of the UK economy (Sheerin, 2002). From 1990–2001 GDP in the UK
has increased by 28 per cent yet the Total Material Requirement (TMR)
increased by 7 per cent, the Direct Material Input (DMI) remained con-
stant and the Direct Material Consumption (DMC) fell by 10 per cent
(DEFRA, 2003).
Material flow accounting can also be used at sub-national scales at either
the level of individual business enterprises, or at specific sectors of the
economy such as mineral resource use in North-West England (NCBS,
undated) or at the city and regional scales (Ravetz, 2000). In 2002 a study
of material flow analysis and ecological footprint (see later) in York was
published (Barrett et al., 2002). Although the researchers acknowledge that
both the fossil fuel carriers and hidden flows (such as the overburden left at
the site where minerals are mined) may have been underestimated (30 per
cent and 35 per cent less than the UK average respectively) they give a good
account of the material flow in the urban economy. In 2000 the total mate-
rial requirement of York was 3 387 000 tonnes; an average of 18.8 tonnes
per person for each York resident.
Just under half of this was material that entered the city, the rest being either
energy carriers (579 000 tonnes) or hidden flows (1 231 000 tonnes). The major-
ity of the material flows into York are due to the construction of houses and
roads (approximately 67 per cent). The stock of materials in York increased by
over 1 million tonnes. On the output side, over 250 000 tonnes of materials left
York or were deposited in landfill sites and nearly 70 000 tonnes were recycled.
Over 4.5 million tonnes of greenhouse gases were produced (Barrett et al.,
2002, p. xiv).
An imaginative study of South-East England has used material flow
analysis to explore different scenarios of development and waste reduction.
In 2000 the South-East region generated 36.8 million tonnes of waste
(53 per cent construction and demolition, 19 per cent industrial and com-
mercial, 16 per cent agricultural, 11 per cent household and 1 per cent
other). Whilst the different sectors do use the waste hierarchy (recycle,
recover and reuse some of the resources) it is estimated that waste is
growing at 1–3 per cent per year and could double in 25 years. This growing
problem was examined by a material flow analysis combined with an explo-
ration of four different scenarios. The four scenarios of waste generation
were: a high growth of 3 per cent per year; a Business as Usual 2 per cent
per year, a zero growth and a ‘factor four’ rapid minimization scenario
beginning with 3 per cent growth and tapering to 3 per cent, giving a net
decline in waste of 14 per cent by 2020.
Unsurprisingly, the waste minimization scenario results in less waste but
implementing such a strategy is a major task especially as economic and
demographic growth is forecast for the South-East region of the UK
(Anon, undated).
One of the policy drivers in material flow analysis is the idea of ‘Factor
Four’ reductions in resource use to half resource use and double output
(Ayres, 1978; Weizsacker et al., 1997). The scientific basis for this factor X
(where X is any positive real number) argument is very suspect (Robert
et al., 2000). It will be noted that Figure 20.2 simply shows a hypothetical
monotonically declining function for resource use. Obviously, if you
increase non-renewable resource consumption by any amount then the
quantity of resources will decline. In a series of papers Schmidt-Bleek
asserts, without any proof, that we need to make a 50 per cent cut in mate-
rials inputs advanced economies (or more if population growth is taken
into account) (Schmidt-Bleek, 1992; 1993a; 1993b). It is this assertion,
coupled with the view that technical solutions to resource efficiencies can
be implemented, that colour the thinking in this area of material flow
analysis. As a policy instrument this untested idea has had some support in
the advanced industrial nations. Whilst it is good to see innovative ideas
being produced to address the problems of unsustainable consumption of
commodity production we must, however, temper this enthusiasm for every
new idea with careful criticisms (see section 6 below).
The ecological footprint concept has captured the imagination of academics,
decision-makers and the public because it can be measured, is easy to under-
stand and it has a resonance with different scientists, policy makers and other
members of the public. There is a large and rapidly growing literature
concerned with ecological footprinting. It has been the focus of academic
scrutiny (Ayres, 2000; Haberl et al., 2004); the basis for many empirical
studies as an indicator of strong sustainability (Wackernagel and Rees, 1994)
and is being examined by both governments in Europe and businesses as a
sustainability indicator (Chambers and Lewis, 2001). The question for aca-
demics and policy makers is not just whether the footprint is attractive but
whether it is internally consistent and whether it helps as an input into poli-
cies which are designed to make development sustainable in the early years
of this century.
The ecological footprint concept can be defined as the total area required
to indefinitely sustain a given population at the current standard of living

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and at an average per capita consumption rate. The original idea of
ecological footrpinting was proposed by Rees in a study of cities which
consume vast amounts of resources (Rees, 1992). In 1994 this concept was
developed and illustrated from work in Canada (Wackernagel and Rees,
1994). Over the last ten years the early methodology of ecological foot-
printing has been substantially altered partly in response to well inten-
tioned criticisms (see Ecological Economics, 2000, Vol. 32). Essentially it is
a measure of land per person – not a density – but an expression of how
much of the earth’s surface is required to support an average person in a
specific area. More precisely, ecological footprint accounts measure the
amount of the earth’s biological productivity that a human population –
global population, a country, a city or an individual – occupies in a given
year using prevailing technology no matter where that land is located. This
methodology has now been established by setting up a global forum so that
standard methods can be used in substantive studies. The National
Footprint Accounts (NFA) constitute the underlying methodology with
which ecological footprints have been calculated for 149 countries of the
world (WWF, 2004). A detailed description of the NFA methodology has
been presented in 2004 (Monfreda et al., 2004) and also from the Global
Footprint Network (Wackernagel et al., 2004a). The unit of measurement
is the biologically productive area, termed the global hectare (gha), which
represents an equal amount of biological productivity. The gha is normal-
ized so that the number of actual hectares of bioproductive land and sea
on the earth is equal to the number of global hectares on this planet. To
calculate the biocapacity of a nation, each of six different types of biopro-
ductive areas within a nation are multiplied by both an equivalence and
yield factor for that land type. The six bioproductive areas are:
Crop land for food and animal feed, fibre oil crops and rubber;
Grazing land for animals for meat, hides, wool and milk;
Forest area for harvesting timber or wood fibre for paper;
Fishing grounds for catching fish;
Built-up areas for accommodating infrastructure for housing, trans-
port and industrial production;
Land for sequestering the excess CO2 from burning fossil fuels to
replace it with biomass, for harvesting fuelwood, for nuclear energy
and for hydropower (Wackernagel et al., 1999).
The hectares for each type of bioproductive area are converted into
global hectares (gha) by multiplying an equivalence factor (to represent the
world’s average potential productivity of a given bioproductive area or land
cover type) with yield factors (to capture the difference among local and
global average productivity). The biocapacity for an area constitutes the
supply side of the equation and the aggregate human demand (ecological
footprint) can then be compared. Whilst an individual nation’s area
demand can exceed supply it is obvious that to live ecologically sustainably
on the earth we must live within the earth’s biocapacity. If we exceed this
limit then we do so by depletion of natural capital (Kn). An individual
nation can also exceed its biocapacity by depletion of Kn and by imports
(ecological trade deficit). Obviously all nations cannot continue to live in
ecological deficit and be ecologically sustainable.
Essentially the ecological footprint ‘master equations’ for ecological
footprinting can be written as a supply and demand identity .The supply is
given as:
The right-hand side of equation (20.4) is the summation of each area in
hectares multiplied by the equivalence factor multiplied by the yield for
each land cover class. Equation (20.5) represents the ecological footprint or
demand side of the identity. Again in a general form the area given to a land
cover type is multiplied by the equivalence factor divided by yield per ha
and then summed for all six bioproductive areas. The equivalence factor
represents the world average potential productivity of a given bioproduc-
tive area relative to the world average potential productivity of all biopro-
ductive areas (Wackernagel et al., 2004b, p. 262; For full details of the
method see Wackernagel et al, 2004a).
Once the ecological footprint is calculated by summing all the resources
used in a country or area it can be compared to the demand with the actual

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Handbook of sustainable development
country or area also expressed in global hectares. Three policy prescrip-
tions follow from an ecological footprint analysis. First, if a country’s foot-
print is greater than its area measured in global hectares then some
reductions in resource consumption are required. If the ecological foot-
print demand is equal to or less than the supply, then one condition for
ecological sustainability is being met and presumably the socio-economic
practices are within the ecological footprint and are therefore contributing
to sustainable development.
Currently, ecological footprints can be calculated using an aggregate or
compound approach or alternatively a component approach using an
index. The compound approach uses national data to determine the
average person annual consumption (national data /total size of popula-
tion) whilst the component approach builds up the economy by different
sectors using an index (Simmons et al., 2000) and can be more useful for a
range of policies. These two approaches are complementary and have been
used in many studies (Wackernagel and Rees, 1994; Chambers et al., 2000;
Haberl et al., 2004). Studies have been undertaken including global scale
with the Living Planet Index (Loh, 2002; WWF, 2004; Wackernagel et al.,
2002). National studies of the economy of Australia (Lentzen and Murray,
2001), Austria (Haberl et al., 2004), UK (Barrett and Simmons, 2003)
Canada, Chile, Italy, the Philippines and South Korea (Wackernagel et al.,
2004b), Scotland (Best Foot Forward, 2004) and Wales (Best Foot Forward,
2002b; WWF, 2005a) as well as Benin, Bhutan, Costa Ricas and the
Netherlands (van Vuuren and Smeets, 2000) have been completed. Urban
studies including London (Best Foot Forward, 2002a), Liverpool (Barrett
and Scott, 2001), as well as regional studies of Guernsey (Barrett, 1998), Isle
of Wight (Best Foot Forward, 2000c), the South-East England (Anon.,
undated) and Tuscany (WWF, Italia, 2004) have been published. The
redesigned ecological footprints methodology now consists of a 2000 rows
by 100 columns spreadsheet for each country. The integration of ecological
footprinting accounting into standard economic models allows systematic
evaluation of policy options as extensive scenario analysis becomes possi-
ble. It opens up possible links with UN National Statistical accounting
which offers a consistent time series from 1970 for all UN member states
and all other countries in the world. The relevant data can be found
at (http://unstats.un.org/unsd/snaama/Introduction.asp). This permits the
integration of ecological footprinting with input–output analysis to allocate
ecological footprints and material flows to final consumption (Wiedmann et
al., 2005; Moffatt et al., 2005). It also opens up the prospect of integrating
input–output and dynamic modelling to explore future scenarios at different
geographical and hierarchical scales (Moffatt et al., 2001; Kratena, 2004;
Faucheux and O’Connor, 1998; and Faucheux et al., 1999).

Environmental space and ecological footprinting
333
The original ecological footprint was a one-shot or static review but it is
important to explore scenarios of different development paths in a dynamic
context. This approach has been used in the study of North America using
the ecological footprint scenario model (EFSM). The researchers note that
if North Americans want to maintain their lifestyles and their correspond-
ing levels of consumption while avoiding ecological deficits, then the pro-
ductive capacity of all ecosystems would have to at least double and be
coupled with a reduction in economic growth or its accompanying spend-
ing (Senbel et al., 2003, p. 90). The summary results from their work indi-
cate that reducing consumption has the most significant impact on the
ecological footprint. Without such changes in reduced consumption and
increased resource productivity, then ‘North Americans will increasingly
live in a continent of ecological deficits’ (Senbel et al., 2003, p. 92). Given
that natural and agricultural ecosystems can not continue to double their
productivity, the future looks dismal. A second study using the IMAGES
model to examine responses to global warming has indicated that the
global ecological footprint will not exceed 15 billion gha in 2050. This sce-
nario assumes that there are changes to production and reduced consump-
tion in the rich nations and economic growth in low-income areas even with
population growth (van Vuuren and Bouwman, 2005). Unfortunately, the
planet has only 11.3 billion gha, which means that even if this scenario is
followed we are still overshooting the ecological limit by approximately 33
per cent (WWF, 2005a). The message from these recent ecological footprint
studies is clear: we must reduce resource consumption if we are to live
within the ecological limits of this earth.
6. A constructive critique of the methods
The three methods described in this chapter are being developed by a variety
of individuals and groups and are being promoted as contributions to mea-
suring sustainable development. This is an important aspect of research, as
measurement can help avoid self-deception and can contribute to policy.
Indeed the UK sustainable development strategy notes the need for innova-
tive ways to measure sustainable development as well as for ways of con-
tributing to policy initiatives (Cm 6467, 2005). Ideally, these methods should
be applicable at different spatial scales and through different organizations,
for example Governmental, businesses and local communities so that we can
all contribute to the process of making development sustainable. Given the
importance of the issues we are involved in, such as maintaining the life
support systems and improving the quality of life for all inhabitants on the
planet, it is essential that we develop robust methods. This section offers
some constructive criticisms of each of the methods and then some more
general comments on how we can make progress in this area of research.

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Environmental space
There are numerous criticisms that can be made of the environmental space
concept (Moffatt, 1996b). First, from a scientific perspective it is difficult to
know with any precision the amount of non-renewable resources available
at current technologies and prices. Next, it is generally agreed that human
economic activity is putting strains on many environmental systems. It
would therefore seem sensible to reduce resource consumption but Friends
of the Earth Europe have relied on a weak argument for environmental
space to propose draconian reductions in resource use. Third, environmen-
tal space assumed greater certainty about waste assimilation processes than
is currently scientifically known. It is exceedingly difficult to establish such
limits in an accurate manner. The major exception is the atmospheric
assimilation of carbon dioxide (CO2). In this case it can be shown scientif-
ically that anthropogenic emissions to the stock of atmospheric CO2 have
grown from 276 ppmv in 1790 to over 360 ppmv by 2000 (Gorshkov, 1995).
Yet, applying the environmental space concept to this major problem yields
misleading results and, if accepted, could give rise to misguided policies. In
2000, for example, some environmentalists suggested that
assuming a global target of 11.1 gigatonnes CO2 emissions is required to main-
tain global stability by 2050, and assuming the global population in 2050 is 9.8
billion, the per capita ‘environmental space’ for energy is 1.1 tonnes per year. UK
per capita production of CO2 is in the region of 9 tonnes, thus implying a reduc-
tion in UK emissions by about 85%’. (Chambers et al., 2000, p. 21)
Fourth, statistically environmental space is simply an average number, but
no standard deviations around the mean are given. Obviously if you divide
a finite resource by a large (and growing) number of people then year on
year the ‘fair share per capita’ becomes smaller. Hence, the policy to reduce
resource use in one country simply because the global population has
grown is naive and best ignored. Fifth, the idea of a fair share of envir-
onmental space is ethically naive as it confuses inequality with inequity (Le
Grand, 1991, p. 11) this vitally important issue will be discussed below. So
what should be done?
With regard to the serious problem of humanly induced global climate
change the scientific community would like a reduction of 60 per cent put
in place by 2050 (IPCC, 1992). The reductions are based on good science
and accurate measurements and not on the poor methodology underpin-
ning environmental space. The good science refers to identifying the correct
causal processes such as burning fossil fuels and land use change as part of
the feedback loops which contribute substantially to the complex processes
known as global climate change (Moffatt, 1991; Moffatt, 2004). The accu-
rate measurement of atmospheric CO2 concentrations establishes a time

Environmental space and ecological footprinting
335
series of data from the pre-industrial to today. Given the processes and the
measurements, then it is possible to calculate the reductions in CO2
required by each country (Moffatt, 2004; Owen and Hanley, 2004). In the
case of the UK, and using the figure presented by Friends of the Earth
(McLaren et al., 1998), a 60 per cent reduction would mean a reduction
from its current 9 tonnes to 3.6 tonnes per capita by 2050 and not the 1.1
tonnes per capita required from environmental space arguments. It could
be argued that larger reductions should be preferred on the basis of inter-
national equity. So how would such reductions come about? There are at
least two strategies: the first is to reduce emissions by some international
agreement and the second is not to produce them in the first place! The
Kyoto agreement, signed by 141 nations in 2005, has started the process of
CO2 reductions. It could be argued that the Kyoto reductions are a small
step in the right direction, but from a scientific perspective they are, in
themselves, insufficient to prevent a further global warming phenomenon.
The reductions proposed at the Kyoto meetings are a first step towards 60
per cent reductions. In the political arena the ideals of CO2 reductions have
not gone far enough. Obviously, given the small nature of the proposed
reductions at Kyoto, there is much more to do politically and diplomati-
cally to get all nations (especially the USA) to agree to the proposals.
The second approach to reduce greenhouse gas emissions is to introduce
new technologies and refine older ones. The new technologies would
include hydrogen power, and more efficient electrically driven engines. The
energy for the latter would come from the use of older technologies – the
so-called alternative technologies of waves, wind and solar power. The use
of these potentially renewable resources could maintain the quality of life
and improve conditions for many of the poorer nations without causing
further damage to the earth’s life support systems. These developments
would need to be encouraged both by changes to the macroeconomics of
the global economy and by ensuring, if necessary by international law, that
large companies do not prevent these developments.
Material flow analysis
We can all agree that reductions in resource use are a good thing so that
environmental waste is all but eliminated (Jacobs, 1991). It is, however,
difficult to ensure that if resource productivity is raised, this will be enough
to offset extra demands on the environment arising from economic and
population growth. Pearce has conducted a ‘thought experiment’ to show
that resource productivity would have to increase by 1.8 per cent per annum
to offset the potential rising environmental impact from economic and
demographic growth, 1975–1998. If past trends in resource productivity
occur, rather than Factor Four or greater resource efficiencies, then the

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world ‘will be worse off environmentally in 50 years’ time’ (Pearce, 2001,
p. 12). Recent research has also reported on a rebound effect in resource
efficiencies. The rebound effect occurs when an improvement in energy or
material use is offset by an increase in the number of units consumed (for
example video recorders, washing machines, new cars) (DEFRA, 2003).
Even if a nation apparently achieves some resource efficiencies one must,
however, be very wary of assuming such elimination has been accomplished
by increases in efficiency in resource use (that is dematerialization), and by
restructuring (that is decoupling) the economy.
It is acknowledged that business has caused major ecological damage and
that this cannot continue if we are to safeguard the environment for current
and future generations as well as for other life forms. In the UK, for example,
indices of TMR alongside GDP and population all increased between
1970–1999. While GDP grew by a large amount there was only a relatively
modest increase in material flows through the economy. Some might argue
that these results show an increase in resource productivity (dematerializa-
tion) and a de-coupling of the economy from resource requirements
(DEFRA, 2002). Similarly, in the OECD nations the energy intensity (the
amount of energy used to generate 1 unit of GDP) has fallen, but the total
energy consumption has increased by over 30 per cent in 20 years. This would
indicate that resource efficiencies are taking place. The argument over dema-
terialization of the economy of the OECD countries needs to be set in
context. Relative dematerialization has occurred in certain sectors of the
OECD economies. Yet to a significant degree this has been brought about ‘by
the net transfer of energy and resource intensive industries to the developing
world, in effect displacing rather than solving the environmental problems of
production’ (Robins and Trisoglio, 1995, p. 164).
Apart from the debatable scientific basis for Factor X reductions, mater-
ial flow accounting does permit detailed analysis of resource use and pollu-
tion generation at different geographical scales and over time. Obviously,
when using MFA there is a need to be clear about whether or not the reduc-
tions proposed are an important contribution to reducing our ecological
footprint or, alternatively, they are simply applied as fine tuning to reduc-
tions in the emissions of waste to the receiving environment. Currently,
MFA is used in both contexts. The MFA approach has its limitations and
its merits. The major limitation in MFA is that the materials flowing from
the ‘cradle to the grave’ are simply measured as a mass. The impact of one
tonne of arsenic on a receiving environment such as a river system would be
more lethal than one tonne of sewage. Yet the differential impacts of the
resource flows into the receiving environment are rarely stated – simply
adding up the total mass moved is insufficient from an ecological perspec-
tive. Clearly, the determination of MFA in an economy is a good first step

Environmental space and ecological footprinting
337
towards monitoring the links between the economy and ecology. It should,
however, be noted that a blanket reduction in MFA is ‘not guaranteed to be
ecologically effective, but is guaranteed to be highly economically ineffective
with respect to whatever reduction in environmental damage that might be
achieved’ (Neumayer, 2003, p. 181). Neumayer also doubts that MFA can
be used as a strong sustainability measure. Others, however, see MFA as one
way to demonstrate the ways in which increases in efficiency as well as reduc-
tions in material and energy flows (sufficiency) can be modelled (Barrett
et al., 2002). Furthermore, MFA does allow decision-makers to examine
scenarios to assist in choosing the best options to encourage reductions in
both resource consumption and waste generation and to consider the appro-
priate technical changes as a contribution to sustainable development.
Ecological footprinting
As the ecological footprint concept evolved it has been subjected to many
criticisms (Ecological Economics, 2000). First, the unit of measure ‘global
hectares’ has been criticised as too crude an indicator for detailed policy
proposals. Initially this was true, but recent developments have integrated
footprints with more conventional national accounts. Next, the idea of
trade flows being difficult to account in ecological footprinting has been
raised, but this has also been partially answered by integrating ecological
footprinting with material flows and input–output analyses (Moffatt et al.,
2005; Wiedmann and Barret; 2005; Wiedmann et al., 2005). Clearly, it is
physically impossible for every country to be a net importer of biocapacity
as this will lead to global overshoot of resource use (Wackernagel et al.,
2002). It should, however, be noted that the ecological footprint does not
address all environmental issues involved with pollution and species loss. It
should also be realized that the earth-share of ecological footprinting is
open to the same criticism of environmental space. To argue for a fair earth
share by simply dividing the amount of land expressed as global hectares
(gha) by the total global population is meaningless as it again confuses
equity with equality (Le Grand, 1991). If, however, emphasis is placed on
absolute limits and not per capita ratios then the footprint can still be a
useful indicator of environmental sustainability. As noted in the previous
section we cannot live beyond the 11.3 gha of this planet. We need there-
fore to encourage each nation to reduce conspicuous consumption, control
population growth and introduce ecologically friendly technology. It
should, however, be noted that the variations in the ecological footprint in
different countries may be due to socio-economic rather than ecological
processes (Kooten and Bulte, 2000).
There is, however, a partial solution to the problem of living ecologically
sustainably on the earth. Numerous ecological footprinting studies have

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shown that waste, food and energy make up a large portion of the footprint.
In the case of Scotland, for example, these three components make up 38
per cent, 29 per cent and 18 per cent respectively (Best Foot Forward, 2004).
Clearly, these are sensitive parameters in the ecological footprinting
methodology and each one could be reduced. In the case of energy, ignor-
ing the nuclear option as too high a risk and potentially very damaging,
then the use of renewable resources for energy production can be an
effective way of reducing the footprint. Assuming that we move to renew-
able energy sources we could, in theory, have reduced the size of the eco-
logical footprint of anthropogenic CO2 emissions by over 50 per cent for
the period 1961–99. This was technically and practically possible but would
have to overcome the vested interests of the powerful energy lobby. It would
also require some alterations to macroeconomic policy to encourage both
the development and market for renewable energy sources. Nevertheless,
this simple example illustrates that if energy were obtained from non-
carbon resources then the ecological footprint would drop automatically
and substantially (Ayres, 2000). Similarly, if waste could be substantially
reduced then this would also have a major impact on reducing the size of
the footprint. If policies were pursued to increase renewable energy supplies
and reduce waste substantially then this would substantially reduce the
ecological footprint well below the biocapacity limit.
If the global adoption of alternative energy has the potential of reducing
the ecological footprint to well below the biocapacity limits, does this then
mean we are living sustainably? Clearly the answer to this question is a qual-
ified ‘yes’. If policies are implemented to promote reductions to zero in
nuclear and fossil fuel energy over, say, ten years, and simultaneously increase
the input from renewable energy sources to meet demand, then we have the
necessary conditions for sustainable living. In order to attain the necessary
and sufficient conditions for sustainable development we need also to address
other environmental problems (such as different pollutants and biodiversity
loss) as well as economic and social justice issues. This inevitably raises ide-
ological and ethical problems concerning contemporary globalization with
its use and abuse of the earth’s environment and its inhabitants. Harvey sug-
gests that a globalized world is one of ‘class oppression, state domination,
unnecessary material deprivation, war and human denial and that we should
strive to create our environments in a state of liberty and mutual respect of
opposed interests’ (Harvey, 2001, p. 120). He suggests that we need to adopt
a holistic, dialectical approach to understanding the dynamics of the current
trajectory that we are locked into in order to break free from the present
situation. Alternatively, those in favour of natural capitalism argue that,
‘natural capitalism is not about fomenting social upheaval. On the contrary
that is the consequence that will surely arise if fundamental social and

Environmental space and ecological footprinting
339
environmental problems are not addressed’ (Hawken et al., 1999, p. 322).
Clearly, there are ideological differences underpinning these diametrically
opposed perspectives. The current generations have a difficult choice because
making the wrong decisions can result in universal misery and the collapse
of civilizations (Diamond, 2005). Closely associated with this vital issue is
the related question of a just distribution of resources. We have suggested
that the fair share approach (equal resources per capita) confuses equality
with equity. This is an important normative issue with major environmental,
economic and social policy implications. It should, however, be noted that,
‘Policies should be equitable and that distributional consequences of policies
should, so far as possible, be just or fair. These are considerations that policy
makers ignore at their peril’ (Le Grand, 1991, p. 175). Policy making should
be transparent, accountable, just and based on sound methodologies. It is the
integration of multi-disciplinary research into ecological, economic and
equity issues that poses the fundamental methodological challenge for
making development sustainable.
7. Conclusions
Environmental space, material flow analysis and ecological footprinting
are discussed in the literature on sustainability and sustainable develop-
ment. From its inception environmental space was based on some very
suspect scientific premises. We do not know the amount of non-renewable
resources remaining in the earth’s crust nor, with the exception of atmos-
pheric CO2, do we know the global assimilative capacity of the earth’s
receiving environments. In order to contribute to sustainable development
Friends of the Earth proposed the use of environmental space as a blunt
policy tool. This method is very suspect and has resulted in the environ-
mental space concept being ignored by both the scientific community and
most policy makers.
Material flow analysis is based on sound concepts of the conservation of
matter and the laws of thermodynamics. This sophisticated form of analy-
sis allows researchers and others to explore different ways in which mater-
ials and energy flow through a system. The systems under investigation can
be at different geographical scales including natural and man-made ecosys-
tems such as factories and businesses, cities, regional and national
economies, and globally. Ideally it would be interesting to tie these models
of material flow analysis with similar models of ecosystems but this has
rarely happened (Odum and Odum, 1976). The problem of using material
balances (MFA) and conventional neo-classical economics still remains.
Nevertheless, the development of material flow analysis including the use
of scenarios has the potential to contribute to action leading to sustainable
development at different geographical scales.

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The ecological footprint concept has developed a large and rapidly
growing amount of literature. As noted earlier this methodology has now
been standardized and this also has been applied at different spatial scales.
It has also been argued that by committing to alternative energy supplies it
is possible to reduce the ecological footprint substantially. Furthermore,
recent work on integrating ecological footprinting with material flow analy-
sis and input–output analysis shows that the allocation of resource use
sector by sector can be achieved. Despite this progress it should be noted
that the problem of linking masses with monetary measures still remains –
although some attempts to bridge this gap are being made but a firmer
theoretical basis for combining mass and monetary measures is required.
At present the integration of MFA with ecological footprinting via
input–output analysis is a step along the way to a more formal solution to
this ecological–economic problem. Current work permits the examination
of scenarios and allows policies to be targeted at different sectors of the
economy as a contribution to do more with less. It would also assist in sus-
tainable consumption.
If we are to live within the ecological possible, as proponents of strong
sustainable development urge, then it can be seen that many nations are
currently living well beyond what the world’s ecosystems can withstand. At
a global level, we are exhausting the earth’s renewable and non-renewable
resources on the untenable assumption that current economic and demo-
graphic growth and resource consumption processes, together with waste
generation, can continue indefinitely on a planet of finite size. The mea-
sures described in this chapter are beginning to address these problems.
This raises issues over the radical restructuring to our economic system so
that individuals and their organizations can begin to live as part of the
ecology of the planet rather than trying in a futile manner to live apart from
it. These changes are not impossible to achieve, and there are signs of hope
as outlined in the UK Government Sustainable Development Strategy (Cm
6467, 2005). The challenge is up to the political will and determination of
our elected leaders to encourage business and individuals to behave as
citizens rather than consumers (Dobson, 2003). In this sense, individuals,
as citizens of a global community, can contribute to the creation of an eco-
logically sound and socially just economy and it is through the collective
political processes that sustainable development will be achieved.
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(2004a), ‘National footprinting and biocapacity accounts, 2004: the underlying

344
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calculation method’, Global Footprint network, Oakland California, USA, pp. 1–32,
www.footprintnetwork.org, accessed 5 April 2005.
Wackernagel, M., C. Monfreda, K.-H. Erb, H. Haberl and N.B. Schulz (2004b), ‘Ecological
footprint time series of Austria, the Philippines, and South Korea for 1961–1999: compar-
ing the conventional approach to an “actual land” approach’, Land Use Policy, 21: 261–9.
Wackernagel, M., N.B. Schulz, D. Deumling, A.C. Linares, M. Jenkins, V. Kapor,
C. Monfreda, J. Loh, N. Myers, R. Noorgaard and J. Randers (2002), ‘Tracking the
ecological overshoot of the human economy’, Proceedings of the National Academy of
Science, 99(14): 9266–71.
Ward, R. and R. Dubos (1972), Only One Earth, Harmondsworth: Penguin.
WCED (1987), Our Common Future, Oxford: Oxford University Press.
Weizsacker, E.V., A.B. Lovins, and L.H. Lovins (1997), Factor Four: Doubling Wealth, Halving
Resource Use, London: Earthscan.
Wiedmann, T. and J. Barrett (2005), ‘The use of input–output analysis in REAP to allocate
ecological footprints and material flows to final consumption categories’, REAP Report
number 2, Stockholm Environment Institute, University of York.
Wiedmann, T., J. Minx, J. Barrett and M. Wackernagel (2005), ‘Allocating ecological footprints
to final consumption with input output categories’, Ecological Economics, 56(1): 28–48.
WWF (2004), ‘Living Planet Index’, World Wide Fund for Nature International (WWF),
Global Footprint Network, UNEP World Conservation Monitoring Centre, WWF, Gland,
Switzerland, www.panda.org/livingplanet.
WWF (2005a), ‘Living Planet Report 2004’, Gland, Switzerland: WWF.
WWF (2005b), ‘Reducing Wales’ ecological footprint’, Report Summary, Cardiff: WWF
Cymru.
WWF, Italia (2004), Ecological Footprint of the Tuscany Region, Rome: WWF.
Zimmerman, E.W. (1951), World Resources and Industries, California: University of
California Press.

PART IV: GROWTH, CONSUMPTION ANDNATURAL WEALTH:

13 The resource curse and sustainable development Richard M. Auty:

1. Introduction
Resource abundance can increase the rate of investment in resource-rich
economies relative to resource-poor ones and also expand the capacity of
the economy to import the capital goods needed to build the infrastructure
of a high-income country. Consequently, natural resource abundance can
accelerate economic growth and thereby strengthen sustainable develop-
ment, provided the correction of market failure curbs environmental
damage. Renewable natural resources can yield the rent stream to promote
this outcome indefinitely under informed and rational management. But
sustainable development can also be based upon the rent from depleting
finite resources. To achieve this, resource and environmental accounting
shows that a sufficient fraction of the natural resource rent should be
invested during the exploitation of the finite resource in order to maintain
or enhance the total capital stock (see Chapter 17 and 18). In this way the
income stream generated by the resource is passed on to future generations
in perpetuity. This perspective assumes either that there are natural substi-
tutes for the depleted resource or that technological substitutes will be
found. In this view, conservation of the finite resource might be undesirable
if new technology renders the resource obsolete.
Nevertheless, the notion that natural resource abundance can be a curse
has emerged strongly since the 1980s. It is not a new idea, however. Imperial
Spain provides a long-recognized example of a country that failed to
prosper from the gold and silver shipped from its New World colonies. In
contrast, Spain’s beleaguered Dutch colonies were developing the economic
dynamic that was to win them their freedom and make them the commer-
cial model for western Europe. Subsequently, the failure of Argentina1 and,
until very recently, of Australia to sustain the successful growth that both
those countries enjoyed during the second half of the nineteenth century
(Lewis, 1978) has been attributed to the curse of wealth. A stark contrast
has arisen since the 1960s between the rapid economic transition of the four
resource-poor Asian dragons (Hong Kong, Singapore, South Korea and
Taiwan) and the growth collapses experienced through the 1970s and 1980s
by many resource-rich countries (Lal and Myint, 1996).
2. The incidence of the ‘resource curse’
The recent growth collapses in many oil-rich economies attracted particu-
lar attention from researchers. As a group these countries received transfers
from the oil consumers estimated by Chenery (1981) at 2 per cent of gross
world product (GWP) annually during 1974–78 and an additional 2 per
cent during 1979–81. For individual oil exporters, the oil windfalls ranged
from around an extra 10–15 per cent of non-oil GDP annually for
Venezuela and Indonesia, through almost 40 per cent for Trinidad and
Tobago (Gelb et al., 1988), to over 100 per cent of non-oil GDP for Saudi
Arabia (Auty, 1990). Yet with the exception of Indonesia, the oil exporters
experienced growth collapses. Nigeria provides the most spectacular
example: the country is estimated to have absorbed oil rent in excess of $300
billion during 1974–2004, averaging around an extra 23 per cent of non-oil
GDP during 1974–81. These revenues transformed a dynamic and diversi-
fied economy, which grew by 7 per cent per annum during 1967–74 into a
mono-product basket case with a per capita income by 2004 less than one-
quarter of what it would have been if it had sustained its pre-oil boom
growth rate. There is little wonder that Gelb (1988) entitled his book: Oil
Windfalls: Blessing or Curse?
Research into the resource curse focused at first upon the mineral
economies, which appeared to have performed especially poorly during the
years after 1973. Gelb et al. (1988) analysed the macroeconomic response
of six oil-exporting countries (Algeria, Ecuador, Indonesia, Nigeria,
Trinidad and Tobago and Venezuela). They concluded that most govern-
ments found it politically difficult to resist pressure to spend the oil wind-
falls, so that the over-rapid domestic absorption of the oil revenues
triggered patterns of consumption that sustained Dutch disease effects and
proved difficult to cut back when oil prices fell. Indonesia shows, however,
that a growth collapse can be avoided if sufficient oil revenue is used to
diversify the economy competitively (Timmer, 2004).
Auty (1990) examined the efforts of eight oil-exporting countries to ‘sow
the oil’ by diversifying into resource-based industrialization (RBI). He
demonstrated that few oil-rich governments had the capacity to build
RBI plants efficiently and that the sharp increase in production of energy-
intensive products caused by such investments was sufficient to glut global
markets so that the high-cost plants could not recoup their costs. In the worst
cases, like the steel plants in Nigeria, Venezuela and Trinidad and Tobago,
the RBI projects degenerated into sinks for public sector funds rather than
yielding the expected increased capital with which to further diversify the
economy. Subsequently, Auty (1993) analysed six ore-exporting countries,
which also failed to make effective use of the rent from copper, bauxite and
tin to achieve the required competitive diversification of their economies.
The resource curse and sustainable development
209
Such studies did not go unchallenged. For example, Neary and van
Wijnbergen (1986) noted that some restructuring of the mineral economy
was a rational response to a mineral boom, and would be self-correcting as
the boom faded, provided prudent policies were followed. Elsewhere,
Davies (1995) took umbrage at the alleged maladroit performance of the
mineral economies, arguing that many displayed relatively high indices of
social welfare, irrespective of their growth performance. It was at this stage
in the debate that Sachs and Warner weighed in with a series of papers
drawing upon econometric analysis of data on the performance of the
developing countries as a group since 1970.
Sachs and Warner (1995a) used the average share of exports in GDP as
their measure of resource dependence, and they confirmed a negative link
between reliance on natural resources and economic growth. They showed
that the cross-country average share of primary exports in GDP during
1970–89 was 13 per cent, but that a one unit standard deviation increase (13
per cent) in the share of primary exports reduced the growth rate of per
capita GDP by almost 1 per cent. This finding appears to be insensitive to
the inclusion of other variables in the analysis, or to changes in the chosen
measure of resource intensity. Sachs and Warner (1997) went on to demon-
strate that the underlying adverse effect of a rich natural resource endow-
ment on per capita GDP growth is indeed robust. They showed that the
finding persists after additional tests that control for institutional quality,
the share of investment in GDP, the shift in exports prices compared with
import prices, a dummy variable for a regional effect, the removal of out-
liers such as the oil-exporting countries and splitting the time period into
two separate decades.
Similarly, Auty and Kiiski (2001) detected growth collapses in three out
of four sub-groups of resource-rich countries during the 1973–85 years of
price shocks, while growth collapsed in most oil-exporting countries,
the fourth category, in the mid-1980s. In contrast, the growth rates of the
resource-poor countries remained relatively high or even accelerated
(see Table 13.1). The net effect of these trends was to lift the median
income of the resource-poor countries significantly above that of the
resource-rich countries, whereas a generation earlier it had been one-third
lower.
3. Exogenous explanations for the resource curse
Explanations for the recent disappointing performance of the resource-rich
countries have been sought in terms of falling commodity prices, high levels
of price volatility, Dutch disease effects and the commodity production
function. More recent attention has focused on endogenous explanations
like policy error and rent-seeking activity.

One early post-war explanation for the resource curse arises from the
Prebisch terms of trade hypothesis, which argues that over the long term,
prices of primary commodities decline relative to prices of manufactures
(Prebisch, 1950). Consequently, over time the resource-rich countries must
export more and more primary products in order to import a given volume
of manufactured goods. Worse, nascent industrialization is snuffed out by
competition from established manufacturers in the industrial countries,
while the industrial countries use their wealth and political influence to set
the rules of international trade in their favour. However, Duncan (1993)
found that the successful resource-driven countries diversified out of slow-
growth commodities into high-growth ones, so that the policy response
appears to be more important than the actual long-term trend in primary
commodity prices. Moreover, by the year 2000, some 80 per cent of devel-
oping country exports were manufactures compared with 20 per cent for
primary products, the reverse of the ratios in 1980.
A second explanation is that resource-rich countries experience relatively
high terms of trade volatility. This case garners more factual support than
the Prebisch terms of trade argument. Westley (1995) measures the volatil-
ity in the terms of trade as the standard deviation of their percentage rate
of change. Over the period 1960–93, the standard deviation in annual
percentage price changes for 49 primary commodities was 26.4 per cent,

while the standard deviation in the World Bank primary commodity price
index was half that percentage. The terms-of-trade volatility of the regions
with the highest primary export shares (Latin America, sub-Saharan
Africa, Middle East and North Africa) was two to three times that of
industrial countries during the 1970–92 period. However, several studies
published in the 1960s refuted the hypothesis that export price instability
constituted a significant obstacle to growth (Macbean, 1966; Michaely,
1962). For example, Macbean found that short-term export instability was
not an important constraint on development, and that the relationship
between domestic variables and export fluctuations was not a strong one.
He examined export instability in a dozen developing countries during
1946–58 and found specific local causes of revenue changes to be more
important than global prices: variations in supplies of exports have been
more problematic than fluctuations in demand (Macbean, 1966, p. 34).
A third explanation for the resource curse is the Dutch disease effect,
whereby the booming resource sector keeps the value of the currency so
high that other tradables sectors cannot compete internationally. Corden
and Neary (1982) explain the effects with a three-sector model comprising
a resource sector, a sector of other tradables, typically manufacturing and
agriculture, and a non-tradables sector. A boom in the resource sector has
three effects: a spending effect; a relative price effect; and a resource move-
ment effect. First, spending the increased export revenues boosts demand
for tradables and non-tradables, but global competition precludes price
rises on tradables so any excess demand is met by imports. Second, in the
absence of complete sterilization of the rising foreign exchange income,
the currency experiences a real appreciation that reduces the competitive-
ness of the non-booming tradable activity. Yet domestic prices of non-
tradables rise due to increased demand because they are unaffected by the
currency appreciation or by competitive imports. As a result, prices of
non-tradables rise relative to the prices of tradables, so that resources of
capital and labour move from tradables into non-tradables, reducing
exports and raising imports. Third, this movement of resources between
sectors lowers capital accumulation if the non-tradable sector is more
labour-intensive than the tradable sector. This is because movements in
favour of the non-tradable sector tend to raise wages and lower returns to
capital, reducing capital accumulation. Moreover, if resource booms cause
manufacturing to shrink and manufacturing is favourable to growth (due,
for instance, to the gains from learning-by-doing), the resource-abundant
economy can experience slower long-term growth than it would if it had
no resources (Matsuyama, 1992). Krugman (1987) identifies the con-
ditions under which temporary resource booms can lead to an enduring
loss of competitiveness.
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However, strong proponents of the dominance of Dutch disease effects
like Sachs (1999), neglect the fact that an export boom may not have
harmful consequences if the increased primary export revenue is sustain-
able and/or the adjustment process is not too rapid. Moreover, as already
noted, Neary and van Wijnbergen (1986: pp. 40–41) point out that some
de-industrialization may be a symptom of the economy’s adjustment to a
new equilibrium rather than a symptom of a disease.
The fourth explanation is more selective and suggests that commodities
with a capital-intensive production function, such as most mines and
plantations, produce socio-economic linkages that are detrimental to
growth (Engerman and Sokoloff, 1997; Woolcock et al., 2001). The capital-
intensive production function of mining stunts both backward and forward
productive linkages. This is because the specialized inputs required are
subject to localization economies and are acquired most cheaply as
imports. Moreover, the higher added value stages of mining such as fabri-
cation tend to be market-oriented due to high freight costs. In addition,
final demand linkages are also limited due to the small size of the highly
productive mine workforce and the foreign ownership of capital. This
pattern of linkages leaves fiscal linkage (taxation of the returns to capital
and labour) as the principal stimulus to the domestic economy. Baldwin
(1956) describes the growth-stunting effects of such ‘point’ linkages for the
plantation in his comparative model of the ‘West’ and ‘South’ regions of
the United States in the nineteenth century.
Engerman and Sokoloff (1997) contrast this pattern of point linkages
with the diffuse linkages of commodities like peasant cash crops, whose
more flexible production function offers few barriers to entry and funnels
revenue through many economic agents. Baldwin (1956) clearly shows with
reference to yeoman farms in nineteenth century America how the flexible
production function responds to small additions to investment, which
boost productivity and incomes. Consequently, final demand linkage is
high and stimulates a wide range of local production to supply basic farm
inputs and household consumer goods. Similarly, fiscal linkage is more
likely to be expended on boosting rural infrastructure and education than
in the case of enclave activities like plantations and mines. A further benefit
arising from diffuse linkages comes from the low sunk costs associated with
yeoman crops, like wheat and maize, which facilitate economic diversifica-
tion, pace Duncan (1993), allowing producers to respond to falling prices
by switching from low-growth to high-growth commodities.
Unfortunately for the robustness of this fourth explanation, central gov-
ernments have proved all too capable of transforming diffuse linkages into
point source linkages by imposing swingeing taxes through, for example,
commodity marketing boards that allow the government to siphon away
The resource curse and sustainable development
213
crop rent and more (Osei, 2001; Krueger, 1993). Moreover, the examples of
Chile, Western Australia and the Witwatersrand show that mining can
nurture a diversified economy, which sustains real GDP growth, while
Graham and Floering (1984) demonstrate that the presence of plantation
agriculture (in this case the nucleus plantation) need not be associated with
disappointing economic growth.
A more recent variant of the institutional explanation for under-
performance by resource-rich countries posits their institutional inheri-
tance and specifically whether that inheritance promotes wealth extraction
or wealth creation (Acemoglu et al., 2002). Basically, if the colonial settlers
worked the overseas territory themselves, as in the case of Zimbabwe for
example, the institutional structure tended to promote wealth creation
whereas if climatic conditions were less conducive to permanent colonial
settlement, the institutions tended to be aimed at wealth extraction.
However, this variant of the theory also encounters criticism. For example,
Glaeser et al. (2004) demonstrate that the statistical methods used by
Acemoglu et al. (2002) are flawed and that their thesis underestimates the
importance of human capital and policy choice.
4. Endogenous explanations for the resource curse: rent and policy error
There seems to be no clear economic reason why natural resource abund-
ance should cause countries to experience relatively low economic growth.
By following the right policies, natural resources should be a boon and
not a curse. This raises the possibility that resource-rich countries may
encounter special difficulties that prevent them from implementing sound
policies.
Lal (1993) analyses policy effects on the long-term growth trajectory of
resource-deficient and resource-rich countries, drawing upon 21 countries.
He finds that whereas eight out of ten land-abundant (resource-rich) coun-
tries pursued policies that led to growth collapses (the exceptions are
Malaysia and Thailand), only three out of eight intermediate countries did
so, while all three labour-abundant (that is resource-deficient) countries
maintained rapid growth. Lal concludes that the labour-abundant coun-
tries follow the easiest development trajectory. The resource-poor country
pursues competitive industrialization which begins with reform in favour of
outward-oriented policies at a low per capita income. This is because, if the
domestic market of the resource-deficient country is small, then reliance on
trade is inevitable so that political opposition to trade policy reform is
weaker. In contrast, the land-abundant (resource-rich) country faces a
longer initial dependence on primary product exports, which retards com-
petitive industrialization because the supply price of labour is higher than
in the resource-deficient country at a similar level of per capita income. This
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Handbook of sustainable development
tempts the governments of resource-rich countries to seek to ‘grow’ out of
their difficulty by engineering a populist boom or a state co-ordinated Big
Push (Sachs, 1989). This strategy triggers inflation, fiscal repression and a
growth collapse so that a period of declining real wages is required to
restore growth, but it elicits strong political opposition.
However, it is policies (along with basic social conditions and cultural
history) and not resource composition that determine growth. This posi-
tion is supported by Sachs and Warner (1995b, p. 23) who found that all
developing countries following a reasonable set of political and economic
policies between 1970 and 1989 achieved annual per capita growth of 2 per
cent or greater. Sachs and Warner (1995b) went on to examine the effect of
policy error, using trade openness as a proxy for the degree of state inter-
vention. They note an inverted U-shaped relationship between trade policy
measured on the horizontal axis and natural resource dependence. As
primary product export dependence increases, trade policy first closes but
then opens again at higher levels of resource dependence. The apex of this
inverted U-shape occurs where primary exports reach 33 per cent of GDP,
with most developing countries below this level. Sachs and Warner
attribute this policy closure to fear of the employment diminishing effects
of Dutch disease by governments of resource-rich countries. They hypoth-
esize that such fear leads to stronger protectionist policies in order to
sustain the fledgling manufacturing sector. Interestingly, the downswing of
the inverted U-shape (that is the subsequent opening of trade policy)
reflects the dominance of that section of the curve by those oil exporters
with extremely large oil reserves, which therefore lack an urgent incentive
to diversify away from dependence on the depleting oil asset. This may also
explain the adherence to an open trade policy of the government of
Botswana: some 60 per cent of the diamond revenue is estimated to be rent,
so Botswana shares many characteristics with the oil exporters, but with the
important bonus of experiencing far less revenue volatility because, in con-
trast to OPEC, the diamond cartel has held prices steady, so far at least.
Gelb et al. (1991) model the political process of trade policy distortion.
They model a resource-rich country whose government creates unproductive
jobs in public administration and in protected state-owned enterprises
(SOEs) in order to alleviate urban unemployment. They use a Harris–Todaro
migration model and assume a single urban wage in the three urban sub-
sectors (which comprise a private sector, a productive public sector and a
non-productive public sector). The model posits that an exogenous rise in
the urban wage creates a wage gap that raises the premium on rural out-
migration so that unemployment expands in the modern urban sector (see
Chapter 14). The government responds to additional urban unemployment
by increasing taxation (whose burden falls disproportionately on the private
The resource curse and sustainable development
215
sector) in order to invest capital in the creation of additional urban jobs. But
this process is self-defeating because it renders work in the unproductive
public sector preferable to farming, so that more people migrate to the city
where their unemployed presence intimidates the government from which the
unemployed rural migrants extract still more rent. Krueger (1992) finds
that the fraction of primary sector revenue extracted by the governments in
sub-Saharan Africa may have reached 50 per cent.
Gelb et al. (1991) use a CGE model to estimate the potential scale and
impact of the resulting rent misallocation. They test the sensitivity of the
model against widely differing savings functions. The functions range from,
at one extreme, forced saving by the government (which is assumed to use
a tax that squeezes private consumption without reducing productive
investment), through to a level of taxation at the other extreme that does
not change consumption but does cut productive investment in direct pro-
portion to the scale of the tax. Simulations using empirically plausible data
over 13 time periods suggest that the consumption losses are invariably sig-
nificant and that the efficiency of capital can be depressed below the level
required to sustain economic growth within a decade.
Auty and Gelb (2001) formalize the impact of high rents on the political
economy in terms of a two-stage process. They argue that high rents incen-
tivize governments to capture the immediate public and personal gains
from rent redistribution at the expense of promoting wealth creation,
whose gains are more long-term. In addition, prolonged reliance on natural
resource rent postpones competitive industrialization and heightens the
risk that government rent deployment will distort the economy away from
its underlying comparative advantage and lock it into a staple trap. The
essence of the staple trap is a burgeoning sector of unproductive public
employment and protected manufacturing whose demand for rent eventu-
ally outstrips the supply, causing governments to tax the returns to capital
and labour from the primary sector as well as the rent. The net effect is to
intensify the reliance of the economy upon a primary sector whose com-
petitiveness is being eroded so that it becomes vulnerable to shocks and a
growth collapse from which recovery is protracted because during a growth
collapse, all forms of capital are degraded.
5. Conclusions and policy implications
It seems that fashionable post-war policies designed to increase state inter-
vention in support of forced industrialization lie behind the recent growth
collapses in resource-rich countries. This policy was invariably captured by
vested interests, blocking economic reform so that economic distortions
intensified and reversed the required competitive diversification of the
economy. Natural resource rents sustained maladroit policies for longer,
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Handbook of sustainable development
and the higher the rent relative to GDP and the more it was concentrated
on the government, the greater the distortion and the less resilient the
economy (see Table 13.1). Ironically, the same post-war concern for the
adverse impacts of the terms of trade also encouraged the governments of
commodity-dependent economies to seek to boost prices by forming
cartels such as OPEC and the IBA. These producer groups were associated
with heightened price volatility, which yielded economic shocks in the
1970s, both negative and positive, which triggered the growth collapses.
The global economic impact of the oil windfalls can be compared to the
release of a radioactive cloud that rains destruction upon those countries
that it passes over. The 1973 price shock caused many of the distorted
oil-importing economies of sub-Saharan Africa to collapse, since they were
not deemed sufficiently creditworthy to merit the loans urgently required
to restructure their economies in order to pay for higher oil import bills. In
contrast, western banks on-loaned petro-dollars to Latin American
governments, which either invested them inefficiently or else found ways of
channelling them via SOEs into current public consumption. Consequently,
few such governments were able to service their burgeoning debt when inter-
est rates turned sharply positive in the early-1980s, ushering in Latin
America’s ‘lost decade’. Finally, the global recession triggered by high oil
prices first softened those prices and then led to precipitous decline in 1985,
triggering the collapse of most oil-exporting economies.
The implications are clear: the growth collapses result from policy failure
so that a solution must recognize the constraints of governance upon policy
formation in developing countries (see Table 13.2). Domestic and external
political interests need to ally to find ways of strengthening the motive of
governments to promote efficient wealth creation through the provision of
public goods and the maintenance of incentives to invest efficiently. This in
turn calls for the progressive strengthening of sanctions against anti-social
governance, notably property rights and the rule of law; civic society (or
voice); and political accountability for transparent public finances. More
realistically, in the highly distorted political economies that are the legacy
of the growth collapses in resource-rich countries, compromises are
required between the International Financial Institutions (IFIs), pro-poor
domestic groups and entrenched rent-seeking interests that will increas-
ingly channel the natural resource rents away from wealth-repressing activ-
ity and towards wealth creation (Khan and Jomo, 2000).
Note

14 Structural change, poverty and natural resource degradation Ramón López

1. Introduction
Structural change, defined as the process by which the output and employ-
ment shares of primary productive sectors decrease over time, is one of
the most ubiquitous and least controversial stylized facts of modern
economies.1 Both countries that have been able to grow fast, mainly in
Europe, parts of Asia and North America, and those less successful coun-
tries in Latin America and sub-Saharan Africa have experienced a process
where urban activities have grown significantly faster than primary, mostly
natural resource-dependent sectors.2
Development theorists once considered structural change to be both a
key cause and also a consequence of economic growth (Lewis, 1955; Renis
and Fei, 1961). Traditional activities in the rural sector were regarded as
largely constrained by the fixity of certain factors of production and by the
limitations of absorbing new technologies in such activities. As investment
in manufacturing and other mainly urban activities is implemented, labor
productivity in such industries expands, thus creating a wedge between
labor returns in rural and urban areas. This wedge acts as a pull effect on
the rural population, prompting rural out-migration and an increasing
share of urban output in GDP and of the labor force employed in urban
areas. Switching factors of production from the low productivity primary
sectors to the high productivity urban sectors was seen as an engine of eco-
nomic growth and as a source of concomitant real wage increases.
The above optimistic model, which can be termed benign structural
change (BSC), was hailed enthusiastically by development theorists and
practitioners alike. This was the answer to the criticisms made by many
social scientists (especially from the left) during the post-second world war
period of the western market economy. Provide adequate economic incen-
tives for industrial investments, give then some time to the system to clear
the backwardness of the traditional activities (at first wages would not
increase much as too large a segment of the labor force was really surplus
labor, with an almost zero opportunity cost) and then the miracle of ever-
increasing labor earnings would follow the initially large profit rates that
are needed to trigger such a miracle.
220
Structural change, poverty and natural resource degradation
221
Later, however, development practitioners began to realize that though
the prediction of massive out-migration from rural areas was fully
confirmed, the prediction that modern activities, especially manufacturing,
would grow rapidly was less clear and the prediction of continuous real
wage increases was even more elusive. What is clear is that, with a handful
of important exceptions mainly in Asia, rapid and persistent economic
growth has not been a common feature among the countries that were con-
sidered developing or under-developed in the 1950s. Structural change has
taken place at least to some degree even in the largely unsuccessful coun-
tries, but it has consisted mainly in a progressive diffusion of subsistence
and poverty from the rural to the urban sector. In fact, the movement from
rural labor subsistence activities has been much more toward equally back-
ward urban subsistence service and related sectors than to the high-
productivity industrial sectors. The end result: slow economic growth and
poverty on a large scale. This process can be called perverse structural
change (PSC).
It is by now clear that many of the so-called ‘fixed’ factors supporting
primary production are not in fact fixed. These factors are mostly natural
resources which, far from being fixed, are vulnerable to over-exploitation
and poor management. This is especially true in tropical and sub-tropical
areas where natural resources are much more fragile than in temperate
areas (Sánchez, 1976; López, 1997).3 More importantly, the propensity of
natural resources to degrade plays a key role in structural change. In fact,
because BSC originated in the rapid expansion of productivity in the non-
primary sector, it significantly contributes to diminished pressure on
natural resources by reducing rural population and allowing for a slower
growth in the exploitation of natural resources. By contrast, PSC originates
in the declining productivity of labor in primary sectors rather than on a
more rapid expansion of productivity in the non-primary sectors. PSC, far
from releasing pressure on natural resources, may be triggered precisely by
the degradation of the natural resource base, which in turn causes declin-
ing labor productivity in the primary sector. Thus, PSC is likely to be asso-
ciated with not only economic stagnation and worsening poverty but also
with widespread natural resource degradation.
Clearly the classical development economists, perhaps influenced by the
historical experience of the industrial economies at the time, focused their
modeling efforts on only one type of equilibrium, the benign one. Also in
consonance with the approach by most mainstream economists then and
now, they ignored the fact that primary activities are supported by natural
assets which have important dynamic properties. In reality, however, there
are pathways that may converge to at least two fundamentally different
equilibria and, moreover, the dynamics of natural resources are likely to
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Handbook of sustainable development
play a key role in determining which of these pathways the economy
follows. The dynamics of the system is essentially path dependent. As we
shall see, history matters, as well as government policy, in a way that even
relatively modest differences in these factors can cause the economy to con-
verge to an equilibrium that has dramatically different connotations for
welfare, income distribution, poverty and natural resources.
The objective of this chapter is to study the mechanics of structural
change. In particular, we study the conditioning factors that are likely to
determine whether a country follows a pathway that may converge to an
equilibrium characterized by BSC or, alternatively, PSC. In addition we
look at the consequences of these two types of equilibrium for the poor. We
show that under certain conditions, both the rate of resource degradation
and changes in the distribution of access to natural resources among the
rural population play a key role in determining whether structural change
is benign or perverse.
The orthodox response to the realization that most developing countries
appear to converge to an equilibrium that resembles more closely the per-
verse equilibrium than the benign one was to blame it on ‘inadequate’
incentives (Schulz, 1968; Krueger et al., 1991; Easterly, 2001). By inad-
equate incentives they meant excessive government intervention, market
distortions and trade protectionism. The resulting wisdom was to take the
government out of the economy by privatizing state enterprises, deregulat-
ing the economy, liberalizing international trade, eliminating restrictions to
foreign investment, and so on. This diagnostic was backed by a massive
conceptual and empirical literature developed over the 1970s and 1980s
pointing to the need for ‘structural adjustment’. The concerted actions of
international lending banks through structural adjustment lending caused
many developing countries to adopt at least certain important components
of such a program. The experience of so many countries that implemented
pro-market reforms over the last two decades, however, allows us to con-
clude that such reforms have in many countries contributed little to spur
economic growth and much less to environmentally and socially sustain-
able growth (World Bank, 2000; López 2003).4
An important feature of the policy advice from international lending
institutions was their almost exclusive emphasis on removing government
interventions that interfered with markets. At the same time, the policy
advice largely neglected the evident biases in the allocation of public
expenditures and in the way in which public revenues were raised in many
countries. There is increasing empirical evidence showing that governments
fail to supply public goods at an appropriate scale, preferring instead to
spend public resources in largely unproductive subsidies to favor the eco-
nomic elites (World Bank, 2000; López and Toman, 2006). At the same
Structural change, poverty and natural resource degradation
223
time, government revenues greatly rely on indirect taxes instead of income
and property taxes, mainly as a consequence of the lack of political will by
governments to control rampant tax evasion by the economic elites (IMF,
2003; de Ferranti et al., 2004). Even today there is reluctance among main-
stream economists and international institutions to recognize that such
government spending and revenue-raising biases are likely to cause large
economic distortions, which in turn induce slower growth, worsening
poverty and damaging the environment.5 We argue below that, whether an
economy follows a pathway closer to BSC or, alternatively, to PSC in sig-
nificant part depends on the way in which governments allocate expendi-
tures and raise revenues. The greater the pro-elite bias of governments, the
more likely it is that a perverse path will be followed.
2. Sources of structural change
Structural change means at least a relative, if not an absolute, compression
of the primary or natural resource-dependent sectors vis-à-vis the indus-
trial and service sectors. Clearly, this process is triggered by changes in the
relative productivity of the primary and non-primary sectors. BSC is
mostly originated in a continuous increase of labor demand by the modern
sector as a consequence of increased (usually private) investment and labor
productivity in non-primary sectors. The non-primary sector exerts a
strong pulling effect on the labor force linked to natural resource-intensive
activities thus inducing a continuous reallocation of the labor force from
primary to non-primary activities despite the fact that the primary sector
may maintain or even expand its productivity as well. The ‘despite’ is very
important because it conveys the idea that BSC is not associated with a loss
of productivity of the primary sectors due to, for example, degradation of
the natural resources and lack of technical change. That is, the primary
sector continues to allow a high marginal productivity of labor which sup-
ports the opportunity cost of labor. Thus, BSC is likely to result in continu-
ously increasing real wages, especially for the unskilled workers which often
have the primary sector as their main alternative employment source.
PSC, by contrast, is mainly triggered by two factors: (1) the stagnation
or even loss of productivity of the primary sectors due to, for example, the
degradation of soils, water sources, forest biomass, fisheries and other
natural resources; (2) the disenfranchising of part of the rural poor from
their natural resources even if there is no or little resource depletion.
Degradation of natural capital, a key factor of production in the primary
sectors, causes a fall of the marginal product of labor employed in such
sectors. This, in turn, reduces labor income in the primary, mainly rural,
activities leading to a progressive migration of the labor force toward the
non-primary, usually urban sectors. More importantly, the opportunity
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cost of the migrant workers is thus lower as a consequence of the dimin-
ished labor productivity in the primary sectors. That is, in sharp contrast
with BSC, in this case real wages often fall or at least remain stagnant. That
is, PSC is associated with a labor ‘push’ from the primary sectors instead of
the ‘pull’ effect from the non-primary sector that occurs in the case of BSC.
Given that the non-primary sector is not particularly dynamic in this case,
an important segment of the migrating workers become sub-employed and
have to take refuge in the informal or subsistence urban sector.6
Factor (2) above is related to distributional changes in access to natural
resources among the rural population. Certain politico-economy processes
all too common in history are also important factors that cause the push
effect in primary sectors. ‘Enclosure’ episodes, where subsistence producers
have been disenfranchised from their lands, have not been unique to the
European experience during the early phases of the industrial revolution.
Under various different forms a similar process of forced expulsion of
important segments of rural communities has often been repeated in
modern times in Latin America, Africa and Asia.7 The usurpation of the
land resources belonging to rural, usually subsistence, communities by
large commercial interests is facilitated by: (i) the existence of poorly
defined or even a lack of legal property rights of poor communities upon
their resources; (ii) the tacit or even explicit complicity of governments
which do little to protect the interests of the poor vis-à-vis those of com-
mercial interests.
When the use of the expropriated resources is shifted from traditional
usually labor-intensive activities to more capital-intensive (and less labor-
demanding) ones, the net demand for labor falls. A ‘labor surplus’ situation
occurs.8 This causes increased migration to urban areas of workers that
have a very small opportunity cost. The net effect is of course downward
pressure on real wages with the consequent increases of profits and expan-
sion of the non-primary sectors. In addition, part of the increased flow of
displaced labor is not able to find employment in the formal sector and
simply engrosses the subsistence informal service sector.
In addition to the outright usurpation of land and other resources of
rural households, there are other, more subtle, forms of usurpation which
are even more common. Large investments in mining, logging, hydroelec-
tric and other energy projects, and irrigation infrastructure have also led to
the displacement of large, often poor, populations. Significant segments of
the rural population become environmental refugees as their vital natural
resources including land and water are curtailed with little if any compen-
sation. Entire rural communities have been left with little option but to
migrate into urban areas as a consequence of massive scarcity of vital
environmental services. This has been triggered not by environmental
Structural change, poverty and natural resource degradation
225
damage caused by the subsistence communities themselves, but by spill-
overs and overuse of water and other resources vital for the survival of local
communities, caused by big extractive investments subject to little effective
regulation (World Bank, 2000).
A related process is caused by violence associated with social strife and
civil wars that tend to affect rural areas more intensively than urban ones.
Outright violence, as per its close relative ‘non-market pressures’ by eco-
nomic elites on the poor, also forces the loss of entitlement of the rural poor
to their resources, which, in turn, causes their out-migration, often toward
urban areas.
In summary, in sharp contrast with the conventional view, which regards
low productivity in rural areas as a ‘technical’ problem linked to excessive
population growth and limited resources, we consider it largely the result
of unbalanced political power.
The almost unchecked political power of the elites means that they face
few restraints from governments. They thus have the power to disenfran-
chise the poor from their resources when such resources become valuable
to them, and face few environmental regulations which can control the
externalities arising from their extractive investments affecting the rural
poor. The net result of this is that the poor end up with progressively less
access to the natural resources and/or a more degraded natural resource
and environmental base to support their labor productivity and even their
survival.
In summary, there are three major push factors affecting the rural popu-
lation: (i) outright usurpation of the resources belonging to subsistence
rural households by commercial interests; (ii) scarcity of environmental
resources that are vital for the survival of poor households caused by unre-
strained large-scale extraction of natural resources; (iii) violence caused by
civil wars and other conflicts. Factors (i) and (ii) both are associated with
environmental degradation and/or natural resource redistribution from
many poor individuals to a few wealthy ones. Also, both factors entail tacit
or explicit government policies that fail to protect the environment and the
poor in favor of promoting the benefits of commercial interests instead.
The central implication of the previous discussion is the following: gov-
ernment failure to protect the property rights of the rural poor upon their
natural resources and to prevent massive negative environmental external-
ities from the commercial exploitation of natural resources increases the
likelihood of perverse structural change.
3. Public expenditures: an analytical taxonomy
The loss of entitlement of the rural poor to natural resources, be it through
outright usurpation of part of their resources or through environmental
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externalities caused by uncontrolled exploitation of natural resources by
commercial interests, is caused by government policy failures. These gov-
ernment failures include lack of delimitation and public enforcement of
property rights as well as direct incentives to large commercial interests to
expropriate resources of the rural poor often in the name of ‘progress’. But
broader public policies have other more indirect effects on the pathways to
structural change which are perhaps even more important than policies
which directly concern the rural sector. In particular, the allocation of
public revenues (normally 20 per cent of GDP or more) is a key determin-
ant of the nature of structural change and through this of the evolution of
poverty and the environment. Of course governments spend public rev-
enues on a great variety of items. But a fundamental analytical taxonomy
of public expenditures simply divides them between two types:
(i) Type A. Expenditures on public and semi-public goods. These include
pure public goods (e.g. goods which at least approximately satisfy the
two classical criteria used to define a public good: non-excludable and
non-rival) as well as public expenditures directed to palliate the effects
of market failure.
(ii) Type F. Expenditures in subsidies to private firms not affected by
market failure (often referred to as ‘corporate welfare’).
The role of Type A expenditures in supplying (pure) public goods is clear.
Certain institutions and infrastructure can only be supplied by the state
(either directly or indirectly via concessionary investments). In addition,
government expenditures to palliate market failure or their effects can also
be regarded as public goods, or, better, semi-public goods. Capital, envir-
onmental and knowledge/intellectual rights failures are among the most
pervasive and important market failures facing most developing country
economies.
Capital market failures. Capital market failures are responsible for pre-
venting or restricting socially profitable investments available to individu-
als or firms that have no or restricted access to capital markets. Below we
show that under certain commonly assumed conditions capital market
failure does not affect the efficiency and level of aggregate investment in
physical and financial capital but it does limit the efficiency and the level of
aggregate investment in human capital.
Under constant returns to scale the distribution of physical and financial
capital among firms has no effect on the productivity of these assets. The
reason for this is clear: under constant returns to scale the marginal value
product of physical capital is constant and independent of the firm’s level
of capital.9 Therefore, credit market failure which limits the ability of
Structural change, poverty and natural resource degradation
227
certain firms (that is those that have more restricted market access) to invest
in such assets will simply imply that the investment will be concentrated in
those firms that have an advantage in the credit market. This reallocation
of investment, however, has no effect on either efficiency or on aggregate
industry output.
While the assumption of constant returns to scale for firms is not only
plausible but also follows from commonly accepted behavioral assumptions,
such an assumption is utterly unreasonable for individuals as producers.
Individual workers can be regarded as producers of an intermediate output,
labor productivity. Production of labor productivity by individuals occurs
through a production function where the main variable or semi-variable
input is human capital (education, skills, and so on) which is combined with
the worker’s fixed factor, his/her own life span and natural ability to absorb
knowledge. Thus, given the existence of these important fixed factors, it is
clear that the marginal productivity of human capital in the production of
labor productivity for an individual rapidly declines beyond a certain
point.10 Assume that there are two types of workers, those that face credit
market constraints to finance investments in human capital (which also have
little or no accumulated savings) and those that can make the human capital
investment unconstrained by financial restrictions. The latter group will
choose the investment level at the point where the present value of the mar-
ginal value product of human capital equals its marginal cost. The finan-
cially constrained individuals, however, will have to invest less, only up to
the level that their availability of financial resources allows them.
The implication of this observation for the impact of capital market
failure is obvious: if a segment of individuals face capital markets restric-
tions, those that do not face them will not make up for the shortfall of
investment in human capital that the capital-constrained individuals cause.
Individuals not facing credit constraints will quickly reach a rapidly declin-
ing marginal productivity of human capital which eventually will limit their
ability to invest further. That is, credit market imperfections affect not only
the distribution of human capital among individuals but also the total
level of investment in human capital and, therefore, the aggregate level of
productivity ‘produced’ by individuals. This is in sharp contrast with the
case of physical capital discussed earlier, where credit market failure is
likely to affect the distribution of capital across firms but not efficiency or
output levels.
Thus, if the rationale for government intervention is to promote eco-
nomic efficiency and growth, there is ample justification for intervening in
financing human capital investment for the segments of society that have
imperfect access to capital markets (generally the poor) but there is little
justification for public intervention in subsidizing investment in other
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forms of capital unless the distribution of capital among firms is a goal by
itself. In addition, given that human capital investments are much harder
to use as collateral than physical or financial assets, it is likely that the
impact of capital market failure will be much more intense for investments
in human assets than in physical or financial ones. This reinforces the
importance of public interventions in financing human capital investment
vis-à-vis interventions to subsidize non-human assets.
One important observation: it appears that capital market failures of one
form or another are universal and extremely difficult to eradicate. They are
almost a natural structural feature in a market economy (Stiglitz, 2000).
This practically rules out the possibility of first best intervention, which
would consist of creating policies and/or institutions that remove the
market failure at source; thus the importance of relying on second best
instruments consisting of publicly financing investment in human capital
for those that suffer the consequences of capital market failures. Thus, we
classify public outlays in human capital (including education and health)
as Type A expenditures, and corporate subsidies as Type F.
Other market failures. Environmental externalities as well as externalities
affecting the incentives to knowledge creation cause inefficiency and slower
welfare growth and, ultimately, more poverty. Therefore, public invest-
ments to mitigate such externalities can be considered semi-public goods.
Unlike capital market failures, it appears that these failures can be dealt
with via first best instruments. There is a degree of consensus among envir-
onmental economists that environmental regulation and the development
of adequate institutions, including property rights and others, for the sake
of monitoring and enforcement of environmental regulation, can go a long
way in preventing at least the most pernicious impacts of lack or failure of
environmental markets. The need for environmental (corporate) subsidies
once such first best policies and institutions exist is questionable. In any
case, studies have shown the significant drawbacks of using environmental
subsidies instead of taxes or even quotas as instruments to control negative
environmental externalities (Oates, 1996).
The same may be true for market failures leading to under-investment in
knowledge or R&D; it seems that there are institutional arrangements,
mainly intellectual property rights and institutions for their enforcement, that
can considerably mitigate the key externality associated with the free diffusion
of certain forms of knowledge that discourage private investments in R&D.
Whether or not subsidies to knowledge creation are needed when such insti-
tutions exist is debatable, but in any case there is some agreement that efficient
corporate subsidies, if at all needed, should be targeted directly to R&D.
The implication of this analysis is the following: there are conceptual
reasons to include certain public expenditures directed to mitigate market
Structural change, poverty and natural resource degradation
229
failures or to mitigate the effects of market failure as Type A public goods.
Public financing of human capital, expenditures in environmental regula-
tion and enforcement of such regulations, property right institutions
and intellectual property right regulations and their enforcement can
all be considered Type A semi-public goods. Targeted public invest-
ment in environmental protection as well as in R&D may also fall
within the Type A expenditures. All other corporate subsidies should be
considered Type F.
4. The composition of public expenditures and structural change
In this section we first present an analysis of the key economic distortions
caused by Type F expenditures; next we illustrate the large rates of return
of Type A public investment, and the under-investment in certain import-
ant public assets despite high rates of return. Finally we evaluate the impli-
cations of this for structural change.
Type F expenditures and economic distortions
The literature on public subsidies has traditionally emphasized the market
distortions caused by such subsidies. That is, the emphasis has been on the
fact that subsidies generally prevent prices from being ‘right’. Without
denying the importance of the price distortion effect, we here focus on the
distortions caused by the crowding out of Type A expenditures caused by
Type F (subsidy) expenditures within the public budget. The crowding out
distortion is dynamic rather than purely static. Such distortion directly
affects economic growth, poverty and natural resource dynamics through a
variety of mechanisms.
Empirical studies show that governments in developing countries spend
a large share of the public budget in Type F expenditures.11 The budget
crowding out of Type A expenditures has serious consequences for struc-
tural change and may significantly affect the potential for economic
growth. As discussed earlier, Type A investments are vital to assure an ade-
quate supply of human capital, R&D, key infrastructure and institutions,
and to prevent excessive damage to the environment and the natural
resources. That is, Type A investments are critical to provide the economy
with human, institutional and environmental assets that in general are
highly complementary with private investment in physical, financial and
knowledge assets. The best way of providing incentives to the private sector
to invest at sufficiently high levels is by providing the right public assets that
will support the profitability of private assets at high levels, not subsidies.
High levels of Type F expenditures means that governments have either to
provide fewer public goods and/or that they need to raise taxes further. As
we shall see, the under-supply of public goods has serious effects on
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growth and structural change. We focus here on the reduction of Type A
investment caused by too much Type F expenditure.12
Corporate subsidies and other forms of Type F expenditures contribute
to creating privileges and promote increased consumption by the wealthy
(the usual recipients of public subsidies) but they do not give durable incen-
tives to productive private investment. The low effectiveness of corporate
subsidies as an instrument to promote investment and productivity has
been shown by empirical studies in many countries around the world.
Empirical studies using detailed firm-level data by Bregman et al. (1999) for
Israel, Fakin (1995) for Poland, Lee (1996) for Korea, Bergstrom (1998) for
Sweden, Estache and Gaspar (1995) for Brazil, Harris (1991) for Ireland,
and several others have shown that subsidies and corporate tax concessions
targeted to specific firms are at best ineffective in promoting investment and
technological adoption and, in some instances, even counterproductive.
A large share of Type F expenditures does stimulate one type of invest-
ment within the private sector: lobbying. When half of the public budget is
up for grabs the incentives to ‘invest’ in lobbying are indeed large.
Unproductive lobbying expenditures by the private sector can reach enor-
mous proportions especially in countries where governments are most open
to corporate welfare, up to 10 per cent of GDP, according to certain studies.
A key signal that triggers the private sector to spend so many resources in
lobbying is of course the fact that a sizable share of public expenditures is
devoted to Type F expenditures. Thus, Type F expenditures not only crowd
out the productive Type A public investment but also induce crowding out
of productive investment in favor of unproductive investments within the
private sector.
The economic returns to type A expenditures
Empirical studies show extraordinarily high rates of return to investments
provided mainly through Type A expenditures including human and envir-
onmental public goods. The literature reports such high returns with an
amazing degree of consensus for many countries around the world.
Investments in formal education (especially in secondary education),
health, R&D (both in agriculture as well as in other sectors), agricultural
extension, air and water pollution abatement, and investments in the man-
agement of certain natural resources are reported to have very high rates of
return. The permanence of such high returns per se does not necessarily
reflect under-investment, mainly given the possible existence of significant
non-convexities. Non-convexities may imply that the marginal returns to
these assets do not necessarily fall, or decrease only very slowly with their
accumulation. Thus, if this is the case, even a rapid accumulation of the
assets would do little to reduce their rates of return. However, given such
Structural change, poverty and natural resource degradation
231
high returns, one would expect a great emphasis of governments on invest-
ing in such assets. Yet, as we shall see, this is not the case. In fact, in the over-
whelming majority of developing countries, investment in human and
environmental assets has not even kept up with population growth. That is,
per capita human and environmental wealth appears to be declining.
Returns to education Two recent surveys, one by Psacharopoulos (1994)
and another one, an update of the first survey by Psacharopoulos and
Patrinos (2002), report findings of hundreds of studies around the world
that have used a great variety of methodologies and diverse types of data
and time periods over the last three decades or so. Despite this variability
in data, countries and methodology, there is a high degree of homogeneity
of results for most countries. In fact, the calculated rates of return found in
the great majority of the countries analyzed are extremely high. The
average private rate of return for investment in primary education is about
20 per cent, while the average social rate of return is about 30 per cent.13
Only in a handful of countries are the returns to primary and secondary
education both below 15 per cent. In addition, from the evidence for coun-
tries that have more than one study, it follows that in the vast majority of
them the rates of return to education have not declined over time.
It is hard to imagine discount rates even near these rates as shown by the
large number of projects that are implemented with much lower ex-ante
rates of return in developing and developed countries alike. Despite these
large rates of return, in most developing countries one encounters massive
school drop-out rates, especially at the late primary and high school levels.
Even in middle-income countries such as Chile, Brazil and Mexico, high
school drop-out rates reach 40 per cent to 50 per cent (World Bank, 2000).
Even primary school drop-out rates were also high in the 1990s: Chile, 23
per cent; Mexico, 28 per cent; Indonesia, 23 per cent; Philippines, 30 per
cent. Similarly, public expenditure per student as a percentage of GDP per
capita was extremely low. According to the World Bank (2003) public
expenditure per student in primary school was about 8 per cent of per capita
GDP in Argentina, 9 per cent in Chile, 7 per cent in Mexico and 2 per cent
in Venezuela. This compared to 23 per cent in Korea or the United States.
The high rates of return of schooling and the high rates of school deser-
tion may be mutually consistent if liquidity constraints prevent parents
from affording child education even if it is ‘freely’ provided by the state.
This issue becomes more acute when children have an opportunity cost in
the child labor market or in subsistence family operations. In fact, certain
government programs that reduce the opportunity cost of children attend-
ing school at working age (above 10 or 11 years old) and that reduce
commuting time to school by increasing public school density especially in
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rural areas, have been quite successful in increasing school attendance.
Making parents more aware of the value of education and increasing their
participation in their children’s education is another effective mechanism to
promote more school enrollment. All this, however, requires a greater allo-
cation of government resources to education, including not only public
financial resources, but also human and institutional resources. In a context
of a usually tight availability of such resources, this additional allocation
of government resources to education obviously needs hard choices in
terms of cutting other expenditures or increasing public revenues. Based on
the available data on government expenditures per student as a proportion
of per capita income, governments in developing countries are not opting
for such choices. They seem to have other priorities.
R&D and farm extension A survey by Alston et al. (2000) reviewed almost
300 studies that evaluated private and social rates of return to agriculture
R&D and farm extension (both of them mostly done through public insti-
tutions) in about 95 countries. The methodologies and data used varied dra-
matically across the many studies. The simple mean (social) rate of return for
agricultural research among all studies in developing countries was over 50
per cent while the mean rate of return for public expenditures in agricultural
extension was even higher, of the order of 80 per cent! In most countries
these rates rarely fall below 30 per cent, still obviously a fantastic pay-off.
Exploiting the fact that there are many countries for which there is more than
one comparable study available, the authors concluded that, as in the case of
returns to education, there is no evidence to support the view that the rates
of return have declined over time. Despite this great social profitability,
studies often report that with few exceptions countries are not expanding
agricultural R&D and many have indeed drastically cut them back.14
R&D in non-agricultural contexts, especially those that emphasize
research on the adaptation of foreign technologies also seems to yield very
large returns. Countries that are able to incorporate new industrial tech-
nologies more rapidly into the productive system have been shown to grow
faster than countries that are slower to do so. Although, unlike agricultural
research, much industrial R&D is often directly done by the private sector
itself, the large positive externalities of such research are by now well doc-
umented. Yet well structured and systematic public programs to support
industrial R&D by the private sector are seldom encountered in develop-
ing countries.
Returns to environmental investments Pearce (2005) carefully evaluates
a large number of empirical studies measuring the rate of return to envir-
onmental investments. The rates of return of course show significant
Structural change, poverty and natural resource degradation
233
variability across the various assets and regions, but in general he found
high rates of return especially to investments in water and sanitation,
energy, anti-desertification, wetlands conservation, fisheries conservation,
and several others. World Bank (2000) examines a great number of studies
that report the health benefits of reducing air and water pollution in devel-
oping countries. As with the case of the other public goods discussed above,
the dollar value of pollution reduction vis-à-vis its cost is highly favorable
even if one uses a relatively high time discount rate. Cost–benefit analyses
for controlling air pollution in many large cities in Asia and Latin America
have sometimes yielded extremely high rates of return to such investments
(World Bank, 2000; O’Ryan, 2001). The same is true for investments in
decreasing water contamination including sewage treatment plants and
related investments. For example, according to various World Bank studies
cited in World Bank (2000), in China a $40 billion investment in clean water
within a 10-year period would yield a present value benefit of $80 to $100
billion. In Indonesia, a $12 billion investment would give benefits of the
order of $25 to $30 billion in terms of present value. Some studies for
investment in air pollution control in various countries provide estimates
even more favorable than the clean water investment. In China, for
example, according to the World Bank, a $50 billion investment for selected
cities could return benefits of the order of $200 billion in reduced illness
and death.
Despite the high rates of return to investments in urban water and air
pollution abatement, such investments do not seem to have received a high
priority as shown by available indicators for cities in developing countries.
For example, according to a sample of cities with per capita income below
$2500 for the year 1998, less than 40 per cent treated their waste water, and
less than 60 per cent of the population had water or sewage connections
(World Bank, 2002).
High returns but low investment in human and environmental assets
The emerging literature on genuine savings is providing a clearer picture
of the real changes in various wealth components over time (see Chapters
3 and 18). The World Bank has provided estimates of genuine investment
for many countries by adding net investment in human and natural capital
to estimates of net investments in physical capital (Hamilton, 2000). Apart
from extending the analysis to more than 110 countries, an important mod-
ification over previous estimates of genuine savings done by the World
Bank is that now measures of change of net wealth are expressed on a per
capita basis. Per capita rather than total wealth change is an adequate
and consistent measure of welfare change (Dasgupta and Mäler, 2002).
The measure of per capita genuine savings as defined by Hamilton in his
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country estimates equals net investment in manufactured or physical
capital minus depletion of natural resources plus net investment in educa-
tion, health and R&D.
The estimates for the year 1997 show that out of 90 low and middle
income countries in Asia, Africa and Latin America, 71 (or about 80 per
cent of them) exhibit negative per capita changes in wealth. While these esti-
mates cover a large sample of countries, the fact that they refer only to one
year raises the question of how representative this year might be. An analy-
sis using the same definition of wealth as Hamilton but that covered a 20-
year period is reported by Dasgupta (2005). Five Asian countries
(Bangladesh, India, China, Nepal and Pakistan) and many sub-Saharan
countries over the period 1973–93 were considered. This analysis shows
similar results to Hamilton’s. Not only has sub-Saharan Africa experienced
decreased per capita net wealth, rather four of the five Asian countries also
show negative per capita wealth changes. The only exception is China,
which, as in Hamilton’s analysis, has managed to accumulate wealth in
advance of its population growth.
The overwhelming majority of the countries considered by these two
studies show positive per capita growth rates for physical capital, implying
that the reason for the negative growth rates of total wealth is that human,
knowledge and environmental assets are growing at a rate below that of
population. As a minimum, 80 per cent of the countries considered are
experiencing reductions in their per capita human and environmental
wealth. Since at least some countries may be compensating the declines
of human and environmental assets with positive per capita growth of
physical assets, the number of countries experiencing declines in human-
environmental assets may be even larger.
We thus have an important paradox. Despite the apparently large rates
of return to human, knowledge and environmental assets, the emerging lit-
erature on genuine savings is showing that the overwhelming majority of
the developing countries are reducing the per capita availability of such
assets. Given the semi-public good nature of these assets and the fact that
their accumulation is seriously affected by market failures, their growing
scarcity has to be traced back to the misallocation of public expenditures
discussed earlier. Governments are spending too much in Type F goods and
too little in Type A goods.
The development consequences of public expenditure misallocation
Public expenditure policies biased in favor of Type F expenditures and the
consequent crowding out of Type A expenditures cause scarcity of public
and semi-public assets, including human capital and knowledge. This over
time means that the economy’s endowment of human capital and knowl-
Structural change, poverty and natural resource degradation
235
edge grows too slowly relative to that of countries where the government
spends more in Type A goods. Human capital and knowledge becomes
relatively scarce (and expensive). At the same time, the fact that the gov-
ernment spends too little in regulating and protecting the use of natural
capital implies that the economy develops an artificial abundance of
natural capital available to be exploited. Thus, the type F biases in public
allocation create (false) comparative advantages in primary production
and in industries that require little knowledge and human capital. Low
skill industries often use technologies that are prone to remain stagnant
with relatively slow productivity growth and are often ‘dirty’ or environ-
mentally demanding. The net effect of this model is a slow increase of
labor productivity in the non-primary sectors, insufficient to exert a large
pull effect on the labor force. At the same time, the natural capital
degrades as a consequence of the scarcity of environmental institutions,
regulations and investment in the protection of the natural capital asso-
ciated with the public expenditure policies. This triggers the push forces
on the labor force employed in the primary sectors in a context of a falling
opportunity cost of unskilled labor. These are the key factors causing per-
verse structural change.
An opposite effect takes place in countries where governments em-
phasize Type A public policies. In this case the factor endowments pro-
gressively change toward a greater abundance of human capital and
knowledge. This creates the conditions for developing comparative advan-
tages in the knowledge-intensive industries where productivity often grows
fast, thus permitting a strong pull effect upon the labor force initially
employed in the primary sectors. At the same time, the development of
property right institutions and policies that regulate and protect the
natural capital is likely to prevent both the usurpation of the resources
owned by subsistence households as well as the destruction of ecosystems
vital for the survival of the rural poor caused by large resource extraction
projects. This is likely to help support the opportunity cost of unskilled
workers in primary activities, thus permitting a slower process of out-
migration from primary activities of workers that retain a relatively high
opportunity cost. That is, this model of development promotes strong pull
forces in non-primary activities while it ameliorates the push forces in
primary sectors. These are of course conditions that increase the likeli-
hood of benign structural change.
One can thus summarize and generalize the previous analysis as follows:
PSC is in part the result of the misallocation of public revenues. Moreover,
the greater the share of Type F public expenditures, the more likely it is that
the economy will follow a perverse structural change pathway.
Handbook of sustainable development
5. Conclusions
Structural change can be an important source of sustainable development
and poverty reduction. The change of the structure of production and
employment from primary, resource-dependent sectors towards non-
resource sectors may considerably alleviate the pressures upon the natural
capital that economic growth tends to impose. At the same time it can
provide new opportunities to the poor to increase their productivity and
hence their income. However, structural change can follow a completely
different path if the change in the composition of the economy is forced as
a consequence of the degradation of natural capital and/or the disenfran-
chisement of the rural poor instead of faster productivity growth in the
non-primary sector. The labor force migrating from primary activities often
finds that the productivity of the so-called modern sector is stagnant and
provides limited employment opportunities, forcing a portion of them to
depend on urban subsistence activities. Unfortunately it appears that this
form of perverse structural change is more common than the benign form
of structural change.
The two central results discussed in this chapter show that PSC is the
product of misguided public environmental and natural resource policies,
as well as also misguided allocations of public revenues. Clearly, behind
these policy ‘mistakes’ there are powerful political economy forces, corrup-
tion and ideological biases often fomented by economists (‘corporate sub-
sidies are good because they contribute to creating jobs’). To a large extent
the real origin of the problem is the weak countervailing power of the poor
to face the great lobbying capacity of the elites and their intellectual allies.
This weakness inclines the balance toward public policies which systemat-
ically favor the most powerful segments of the economic elites, but that in
the end contribute to causing economic stagnation, environmental destruc-
tion and poverty. Which are the political failures that prevent the emergence
of adequate countervailing powers among the vast majority of the popu-
lation in developing countries that are poor or semi-poor even in democra-
tic regimes? This is certainly a key question that deserves much more
research. Notes
15 Economic growth and the environment Matthew A. Cole
1. Introduction
The complex relationship between economic growth and the environment
has been a focus of academic attention since the 1970s. During the 1970s
opinion was polarized between the pro-growth ‘technological optimists’ on
the one hand and the anti-growth ‘technological pessimists’ on the other.
The former placed great faith in our ability to find technological solutions
to environmental problems, to change the composition of output and to
find substitutes for scarce resources, thereby removing potential environ-
mental limits. Technological pessimists argued that such benefits were likely
to be short term and stressed the irreversibility of fossil fuel exhaustion.
The advent of sustainable development saw the emphasis move from
resource scarcity towards sink limits, but differing opinions regarding the
impact of economic growth on the environment remained, largely a result
of differing views of the capital stock that is to be maintained over time.
More recently, quantitative analyses, such as the estimation of environ-
mental Kuznets curves and the decomposition of emissions into scale, tech-
nique and composition effects, have illuminated the debate to an extent.
These studies suggest that economic growth does not have to be damaging
to the environment and can co-exist alongside reductions in environmental
pollution. Emissions of local air pollutants appear to have benefited from
new technology and increased energy efficiency which, particularly in slow-
growing (for example developed) countries, more than compensates for
increased emissions resulting from the pure scale effect. The evidence also
suggests that changes to the output mix (the composition effect) have only
a minor impact on emissions. However, it increasingly appears that the rela-
tionship between emissions and income, even if an inverted U-shape, is
likely to be country-specific. Much uncertainty still surrounds the precise
conditions under which emissions, and other environmental indicators, can
improve in the face of economic growth.
This chapter reviews the debate on economic growth and the environ-
ment, starting with a historical account of the so-called ‘limits to growth’
debate of the 1970s. The rise of sustainable development and its influence
on this debate will also be considered, before attention turns to a critical
review of the environmental Kuznets curve hypothesis and pollution
decomposition studies. Conclusions are then provided.
240
Economic growth and the environment
241
2. The ‘limits to growth’ debate
With a few notable exceptions, the relationship between economic growth
and the environment received little attention prior to the 1960s.1 The pub-
lication of Rachel Carson’s Silent Spring in 1962, however, increased
public awareness considerably by examining the impact of man’s indis-
criminate use of chemicals in the form of pesticides and insecticides.
Perhaps as a result of Silent Spring, environmental issues received growing
attention throughout the 1960s. In 1966, Kenneth Boulding produced his
seminal article ‘The Economics of the Coming Spaceship Earth’ in which
he highlighted the danger of steadily increasing production levels, both in
terms of reducing finite resource stocks and in terms of environmental
pollution.
With these concerns in mind, in 1972 Donella and Dennis Meadows and
a team from the Massachusetts Institute of Technology produced a report
for the Club of Rome’s Project for the Predicament of Mankind entitled
The Limits to Growth. A world model was constructed to estimate the
future impact of continuous exponential growth under a number of
different assumptions. The ‘standard’ world model assumed that the phys-
ical, economic or social relationships that have historically governed the
development of the world system would remain effectively unchanged.
Additionally, this model assumed that population and industrial capital
would continue to grow exponentially, leading to a similar growth in
pollution and in demand for food and non-renewable resources. The supply
of both food and non-renewable resources was assumed to be fixed. Not
surprisingly given the assumptions, the model predicted collapse due to
non-renewable resource depletion.
The radical nature of the report attracted much attention, not only in aca-
demic circles, but also in society at large. As a result, The Limits to Growth
fuelled a debate which continued throughout the 1970s. The contrasting
viewpoints in this debate stem from differing opinions concerning three
factors: the rate of technical progress; future changes in the composition of
output and the possibilities of substitution (Lecomber, 1975). ‘If these three
effects add up to a shift away from the limiting resource or pollutant equal
to or greater than the rate of growth, then the limits to growth are put back
indefinitely.’ (Ekins, 1993, p. 271). However, for Lecomber (1975, p. 42) the
point to be stressed is that ‘this establishes the logical conceivability, not the
certainty, probability or even the possibility in practice, of growth continu-
ing indefinitely.’
3. The rise of sustainable development
The advent of the 1980s saw attention turn from the limits to growth argu-
ments of the 1970s towards the notion of sustainable development. The
Handbook of sustainable development
term ‘sustainable development’ appears to have been first advanced in 1980
by the International Union for the Conservation of Nature and Natural
Resources (Ruttan, 1994) although it was the Brundtland Commission
Report (WCED, 1987) which brought the concept to the top of the agenda
of institutions like the United Nations and the World Bank. Since the
Brundtland Report the goal of sustainable development has been adopted
by an ever-increasing number of organizations and bodies.
The popularity of sustainable development would seem to belie, or is
perhaps indicative of, the vagueness of the term. Countless definitions of
sustainable development now exist, each typically reflecting the academic
discipline in which the author has expertise. Economists tend to emphasize
the need to maintain living standards (see especially chapters 3 and 18);
ecologists are more concerned with biodiversity and resilience (Chapters 4
and 5) and sociologists prioritize the need to maintain sociological bonds
and interrelationships within communities. The amorphous nature of the
concept means that it is impossible to state the precise relationship between
sustainable development and economic growth although, as shall be seen
below, certain general viewpoints may be defined. Opponents of sustain-
able development use its ambiguity as ammunition, however, claiming such
a vague concept to be meaningless. Wilfred Beckerman, continuing his pro-
growth stance adopted in the 1970s clearly holds such a view and believes
sustainable development to be ‘devoid of operational value’ (Beckerman,
1992, p. 491). Others are critical of the ‘watered down’ interpretation of
sustainable development that has been adopted by the political main-
stream, believing it to provide little scope for environmental improvement.
Despite the countless definitions, it is generally agreed that the most
appropriate mechanism for ensuring the well-being of future generations is
to ensure that the next generation has access to a stock of capital at least as
large as the current stock. However, two viewpoints emerge regarding the
precise nature of the capital stock which is to be maintained. These
differing viewpoints allow a distinction to be drawn between ‘weak’ and
‘strong’ forms of sustainable development (see, for example, Pearce, 1993
and Chapter 4 of this volume).
The capital stock consists of man-made capital (such as the means of
production, infrastructure, human capital) together with natural capital
(such as fossil fuels, habitat, clean water). Proponents of ‘weak’ sustainable
development simply require that the aggregate capital stock is maintained
and thus believe that a fall in natural capital can be compensated by an
increase in man-made capital. In contrast, the strong sustainability school
questions the substitutability between these two forms of capital and hence
believes it insufficient simply to maintain the aggregate capital stock irrespective of the relative size of its constituents.

With regard to the relationship between economic growth and the envir-
onment, the two viewpoints again differ. Typically, the ‘weak’ sustainable
development position is that economic growth and environmental health
are often complementary. By this definition, the recommendations of the
Brundtland Report would fall into the weak sustainability category since it
actually called for ‘more rapid economic growth in both industrial and
developing countries.’ (WCED, 1987, p. 89). Indeed, most governments
and global institutions also see no conflict between economic growth and
the environment and place great faith in future technological advance and
in our ability to find substitutes for scarce resources. Many believe there to
be an inverted U- shaped relationship between pollution and production,
as illustrated in Figure 15.1, and use this as evidence of our ability to decou-
ple pollution from production. This inverted-U relationship is also known
as the environmental Kuznets curve (EKC) relationship and will be exam-
ined in detail below.2
The ‘strong’ sustainability school believes that the only way to achieve
reductions in the scale of materials and energy throughput is to reduce the
scale of economic output. Concentrating on sink-limits rather than
resource exhaustion, supporters of this viewpoint (for example Daly and
Cobb, 1989) are therefore sceptical of the potential for decoupling and
point to the risk of irreversibility associated with damage to the natural
environment.
4. The environmental Kuznets curve
The advent of the 1990s saw a significant increase in the availability of
environmental data, particularly measuring concentrations or emissions of
244
Handbook of sustainable development
air and water pollution. This data has enabled econometric analyses of the
relationship between per capita income and environmental indicators
which were previously impossible. The first such studies by Grossman and
Krueger (1991; 1995) and Shafik (1994) found evidence of an inverted U-
shaped relationship between pollution and per capita income (again, as
illustrated in Figure 15.1) which has typically been explained in terms of
the interaction of scale, composition and technique effects. A country’s
total emissions of a pollutant (Xt) can be defined in the following way;
where Yt denotes GDP at time t, ait denotes the amount of pollution gen-
erated per unit of output in sector i at time t, and sit represents the share of
output deriving from sector i at time t. The first term, a, can be referred to
as the technique effect, the second term, s, as the composition effect and the
third term, Y, as the scale effect. As an economy develops we would expect
the scale of the economy to increase, which, ceteris paribus, is likely to
increase emissions. However, a growing economy is also likely to devote
more resources to the regulation of environmental damage and may
increasingly benefit from new technology. These changes are likely to affect
the techniques of production resulting in reductions in emissions. Finally,
as an economy develops, its composition is likely to change from an empha-
sis on agriculture, to heavy industry, to light manufacturing and services.
The contraction of heavy industry and the movement towards light manu-
facturing and services is likely, ceteris paribus, to reduce emissions. It has
therefore been argued that the inverted U-shaped relationship results from
a dominance of scale effects over composition and technique effects in the
early stages of development, with a reversal of this dominance in later
stages of development.
Typically, the basic EKC equation that has been estimated is of the fol-
lowing form, estimated in either logs or levels

Where X denotes the environmental indicator, either in per capita form or
in the form of concentrations, Y denotes per capita income, F denotes
country-specific effects and i and t refer to country and year, respectively.
Note that some studies include a cubic income term.
In equation (15.2), if1 and1 then the estimated curve has a
maximum turning point per capita income level, calculated as Y*
( /2 ). Table 15.1 summarizes the results of those EKC studies that have

covered a range of environmental indicators. Table 15.1 indicates a reason-
able degree of compatibility across studies. For local air pollutants, turning
points are estimated at reasonably low levels of per capita income indicat-
ing that emissions/concentrations are now falling in most developed
economies. Pollution concentrations in river water also tend to have rela-
tively low estimated turning points, with the exception of nitrates from Cole
et al. (1997). Municipal waste is estimated to increase monotonically with
per capita income in the two studies to have examined it.
Many other studies have included additional variables in the EKC rela-
tionship, or considered different pollutants (see for example, Cole, 2003;
Cole and Elliott, 2003; Hilton and Levinson, 1998; Torras and Boyce,
1998). There are, however, several studies that find very different results to
those summarized in Table 15.1. Dijkgraaf and Vollebergh (1998) estimate
EKCs for carbon dioxide emissions using both an OECD panel and indi-
vidual time-series regressions for each country. Interestingly, for the panel
as a whole they find an inverted U-shaped relationship between per capita
income and emissions, with a turning point level of income well within the
sample income range. This is in stark contrast to the CO2 results from other
EKC studies (for example Cole et al., 1997; Holtz-Eakin and Selden, 1995).
For their individual country time-series regressions, Dijkgraaf and
Vollebergh find very varied results thereby questioning the existence of a
meaningful global EKC for CO2 emissions.
Harbaugh et al. (2002) also question whether there is a systematic
relationship between per capita income and pollution. They estimate the
relationship between per capita income and concentrations of sulphur
dioxide, total suspended particulates and smoke and find their results to be
highly sensitive to choice of functional form, to additional covariates and
to changes in the countries, cities and years included in their sample. A
plausible reason for this, as suggested by the authors, is the noisy nature of
concentrations data which requires the use of dummies to control for a
number of site-specific determinants. Stern and Common (2001), however,
consider SO2 emissions and also question the traditional EKC methodol-
ogy (and its results). This study is briefly discussed below.
Criticisms of the EKC
Criticisms of the EKC fall into two categories, firstly those aimed at the
EKC methodology and secondly those concerned with the interpretation of
EKC results. The following are criticisms of the EKC methodology:
The basic EKC is determined by changing trade patterns rather than
growth-induced pollution abatement, and these trade patterns have
typically been neglected by EKC studies. The North’s declining share
of manufacturing in GNP, in part resulting from its more stringent
environmental regulations relative to the South, indicates that the
North is simply exporting its pollution to the South. The EKC
inverted U therefore merely represents a redistribution of pollution
from North to South. Stern (1998) and Stern et al. (1996) both cite
this as a criticism of the EKC relationship.
The EKC assumes unidirectional causality from GNP to emissions
and allows no mechanism through which environmental degradation
can affect income levels. Least squares estimation in the presence of
such simultaneity will provide biased and inconsistent estimates.
Econometric issues. The most fundamental econometric criticisms
are provided by Stern and Common (2001) and Perman and Stern
(2003). These papers raise two key issues; (a) Studies that use only
OECD data will typically estimate turning points at lower per capita
income levels than those using data for the world as a whole. This
arises because the developing countries are experiencing increasing
emissions of even local air pollutants such as SO2. (b) Per capita
income and emissions are typically non-stationary variables and EKC

regressions do not appear to co-integrate. It is also likely that there are
omitted non-stationary variables. Standard EKC estimation in the
presence of these features is likely to generate spurious results.
Other econometric criticisms have also been raised in the literature.
Stern et al. (1996) are concerned that many EKC studies ignore the
issue of heteroscedasticity which is likely to be present in cross-
section data. Furthermore, most EKC studies estimate a quadratic
relationship between pollution and income and therefore fail to allow
for the possibility of emissions beginning to increase again at high
income levels. Finally, Harbaugh et al. (2002) and Ekins (1997) argue
that different datasets, functional forms (for example logs versus
levels) and estimation techniques all provide different results, sug-
gesting that the EKC relationship is fragile.
Stern (1998) criticizes EKC regressions that allow levels of pollution
to become zero or negative as being incompatible with the laws of
thermodynamics, since all resource use inevitably produces waste.

In addition to these, a number of concerns have been raised regarding the
interpretation of EKCs:
Arrow et al. (1995) argue that although EKCs have been estimated
for some local air pollutants it is dangerous to assume that similar
relationships will exist for all other environmental indicators.
EKCs do not indicate that economic growth automatically solves
environmental problems. Emissions reductions have only been attained
through investment and regulations, neither of which are automatic
consequences of economic growth.
Mean versus median income. Although many EKCs estimate turning
points around the current world mean per capita income level, this
does not mean that, globally, emissions are about to decline. Global
income distribution is skewed with far more people below the mean
than above it. If median income levels are considered rather than
mean, EKCs indicate that emissions will continue to increase for
many years to come.
5. Economic growth and the environment: beyond the EKC
Clearly, the reliability and accuracy of the EKC framework remains ques-
tionable. To an extent, differing opinions of the EKC reflect semantic
differences in how EKCs are actually defined. Many economists would agree
that the majority of developed countries have experienced an inverted U-
shaped relationship between income and local air emissions, determined by
the interaction of scale, composition and technique effects. Since emissions Cole et al. (2005) utilize a divisia index approach to decompose aggregate
intensities of sulphur dioxide, nitrogen oxides and carbon dioxide into a
composition (product mix) effect and a technique (sectoral intensity) effect.4
This analysis is undertaken for Austria, France, the Netherlands and the
UK using industry-specific emissions data for the 1990s. For Austria,
France and the Netherlands the technique effect alone was found to be the
main factor explaining declining aggregate emissions intensities. For the
UK, the composition effect was also found to play a role. Figure 15.3
presents the results for sulphur dioxide in the UK and illustrates the joint
role played by technique and composition effects in reducing aggregate pol-
lution intensity.
Stern (2002) provides a more complex decomposition for sulphur
dioxide, as given by equation (15.4), and applies this to 64 countries for the
period 1973–90;

Stern’s findings are summarized in Table 15.2. Again, the main factors
reducing emissions are technological change and energy intensity (which
combine to form the technique effect), although it is notable that, for this
‘global’ sample, the sum of these does not exceed the scale effect.
These decomposition studies therefore suggest that, for local air pollu-
tants at least, the impact of technological change and increased energy
efficiency is likely to outweigh the increased emissions resulting from the
scale effect. Whilst a global pollutant is also likely to benefit from these
technique effects, they are likely to be dominated by the scale effect, result-
ing in a net increase in emissions.
6. Conclusions
Whilst the limits to growth debate has yet to be fully resolved, it is clear that
many of the predictions made by opponents to economic growth in the
1970s have proved to be wide of the mark. This failure to convince society
Table 15.2

at large of the need to replace economic growth as a key policy objective is
illustrated by the fact that the Brundtland Report still interpreted growth
as being compatible, even complementary, to environmental well-being.
Indeed, this viewpoint is held by most mainstream advocates of sustainable
development.
The profusion of quantitative analyses that began in the 1990s have
enlightened the debate to an extent. Although the EKC methodology has
been criticized for being too simplistic, one broad conclusion which stems
from EKC and other quantitative studies is that economic growth can
be compatible with reductions in emissions of some pollutants. Whilst a
pollution-income path that is common to all countries is questionable, it
seems probable that all countries can benefit from technique effects result-
ing from technological advance and increased energy efficiency. For local
air pollutants, these technique effects are likely to dominate scale effects,
resulting in a reduction in pollution. This is particularly likely to occur in
relatively slow-growing, developed economies. However, the relative size of
scale, composition and technique effects is likely to be influenced by the
economic, political, cultural and environmental characteristics of individ-
ual countries. The role played by governance may also be critical. Countries
with identical income levels yet significantly different levels of political gov-
ernance are unlikely to share similar emissions levels.
Although environmental improvement can occur alongside economic
growth, it is important to stress that this is not an automatic procedure.
Growth does not reduce pollution. Rather, the evidence suggests that growth
may facilitate the required legislation and investment to help reduce per
capita emissions of some pollutants. This carefully worded statement illus-
trates the great care that is needed when examining the relationship between
growth and the environment. It also suggests that future research within this
area should increasingly focus on the precise conditions under which pollu-
tion can be reduced. This is likely to require highly detailed studies of indi-
vidual countries, an examination of the role played by governance and
environmental regulations, and increasingly detailed decomposition studies.
As the availability of environmental data continues to improve, particularly
industry-specific emissions data and pollution abatement expenditure data,
so too should our ability to further increase our understanding of the
complex relationship between economic growth and the environment.
Notes
1. One such exception is the classical economist John Stuart Mill. Writing in 1848, Mill com-
ments ‘Nor is there much satisfaction in contemplating the world with nothing left to the
spontaneous activity of nature; with every rood of land brought into cultivation . . . every
flowery waste or natural pasture ploughed up, all quadrupeds and birds . . . exterminated
and scarcely a place left where a wild shrub or flower could grow’ (Mill, 1871, p. 331).
252
Handbook of sustainable development
2. The environmental Kuznets curve is named after the original Kuznets curve which pos-
tulated an inverted U-shaped relationship between per capita income and income inequal-
ity (Kuznets, 1955).
3. Similar findings are made by Bruvoll and Medin (2003) and Selden, Forrest and Lockhart
(1999).
4. Since the variable being decomposed is expressed as an intensity (that is emissions scaled
by output) the scale effect is removed.
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economic analysis and policy implications’, World Development, 28: 739–52.

16 Sustainable consumption Tim Jackson :
1. Introduction
There is an emerging recognition of the importance of consumption within
international debates about sustainable development. The actions people
take and the choices they make – to consume certain products and services
rather than others or to live in certain ways rather than others – all have
direct and indirect impacts on the environment, on social equity and on
personal (and collective) well-being.
Quite recently and somewhat hesitantly, therefore, policy makers have
begun to engage with the question of whether and how it may be possible
to intervene in consumption patterns and to influence people’s behaviours
and lifestyles in pursuit of sustainable development. The UK, for
example, has taken a (perhaps surprising) lead in this area. In 2003, in the
wake of the Johannesburg Summit, the UK Government was
amongst the first to launch a national strategy on sustainable consump-
tion and production. This strategy initiated a continuing and wide-
ranging process of consultation, evidence review and policy formation
that has already had significant impact and offers the potential for
some quite radical policy innovations in the next few years. Amongst
the activities fostered under this umbrella were the UK Round Table
on Sustainable Consumption, a new ‘evidence base’ on sustainable con-
sumption and production, a set of public engagement forums on sustain-
able living, and a sustainable consumption action plan to be launched in
2006 (DTI, 2003a, p. 32; DEFRA, 2005a). These kinds of activities may
not yet be convincing evidence that the UK as a whole has embraced sus-
tainability. But they certainly offer an indication of the importance placed
by policy makers on the relevance of lifestyle and consumption in deliv-
ering sustainable development.
The purpose of this chapter is broadly twofold. In the first part of the
chapter I present a very brief policy history of the concept of sustainable
consumption, and describe some of the political and ideological ten-
sions that underlie the concept. In the second part of the chapter, I discuss
some of the key features of the sustainable consumption debate, and place
these in the contexts of wider and deeper discussions about consumer
behaviour and the nature of modern consumer society. Finally, I will offer
some tentative suggestions concerning the extent to which these broader
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Sustainable consumption
255
understandings of consumption might be regarded as enhancing or hin-
dering the prospect of sustainable development.
2. Sustainable consumption – a brief policy history
Evidence of concern about the consumption and overconsumption of mate-
rial resources can be traced to (at least) the second or third century  (Bloch,
1950). Early modern critics of the level of resource consumption witnessed
by industrial society have included Henry Thoreau (1854), William Morris
(1891) and Thorstein Veblen (1899). Overconsumption of resources first reg-
istered in the international policy arena in 1949 when the newly-formed
United Nations held an international Scientific Conference on the Conser-
vation and Use of Resources. The issue was revisited at the United Nations
Conference on the Human Environment in Stockholm in 1972.
In the same year, the Club of Rome published one of the first and most
influential documents to bring attention to the impact that rising levels of
affluence could have in terms of resource depletion and environmental
degradation (Meadows et al., 1972; see also Chapter 15). Falling commod-
ity prices and new discoveries undermined many of the authors’ worst pre-
dictions about resource scarcity. But the relevance of consumption patterns
to pressing environmental problems (such as climate change, ozone deple-
tion and the management of hazardous waste) proved a more robust
element of the Club of Rome critique, and by the early 1990s, consumption
had become a vital element in the debate about ‘sustainable development’
(WCED, 1987).
The terminology of sustainable consumption itself can be dated more or
less to Agenda 21 – the main policy document to emerge from the United
Nations Conference on Environment and Development (the first Earth
Summit) held in Rio de Janeiro in 1992. Chapter 4 of Agenda 21 was enti-
tled ‘Changing consumption patterns’ and it called for ‘new concepts of
wealth and prosperity which allow higher standards of living through
changed lifestyles and are less dependent on the Earth’s finite resources’. In
so doing, it provided a potentially far-reaching mandate for examining,
questioning and revising consumption patterns – and, by implication, con-
sumer behaviours, choices, expectations and lifestyles.
This mandate was initially taken up with some enthusiasm by the inter-
national policy community. In 1994, the Norwegian government hosted a
roundtable on sustainable consumption in Oslo involving business, NGO
and government representatives (Ofstad, 1994). The United Nations
Commission on Sustainable Development (CSD) launched an international
work programme on changing production and consumption patterns in
1995. At the ‘Rio plus 5’ conference in 1997, governments had identified sus-
tainable consumption as an ‘over-riding issue’ and a ‘cross-cutting theme’ in
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the sustainable development debate. By the late 1990s, initiatives on sus-
tainable consumption were in full flood. The 1998 Human Development
Report focused explicitly on the topic of consumption (UNDP, 1998). In the
same year, the Norwegian government organized a further workshop in
Kabelvåg (IIED, 1998). The government of South Korea hosted a follow-
up conference in 1999. The United Nations Environment Programme
(UNEP) launched a sustainable consumption network, integrated sustain-
able consumption policies into the Consumer Protection Guidelines, and in
2001 published a strategic document emphasizing the opportunities
afforded by the new sustainable consumption focus (UNEP, 2001).
By the time the World Summit on Sustainable Development (WSSD)
convened in Johannesburg in 2002, the concept of ‘sustainable consump-
tion’ had been placed firmly on the policy map and ‘changing consumption
and production patterns’ had been identified as one of three ‘overarching
objectives’ for sustainable development (UN, 2002). But consensus on what
sustainable consumption actually is or should be about had proved remark-
ably difficult to negotiate (Manoochehri, 2002; Jackson and Michaelis,
2003; Seyfang, 2003). The Appendix to this chapter illustrates that there is
still no clear agreement either on a precise definition of sustainable con-
sumption or even on the domain of application of the concept.
Two specific points are worth noting about this range of definitions. The
first is that they take a variety of positions in relation to extent to which
sustainable consumption actually addresses the issues of consumer behav-
iour, lifestyle and ‘consumerism’. Some definitions are very much more
explicit that the domain of interest is the activity of consuming and the
behaviour of consumers. Other definitions, however, seem to favour an
approach that concentrates on production processes and consumer prod-
ucts, suggesting that the route to sustainable consumption lies mainly in the
more efficient production of more sustainable products. Others seem to
want, almost deliberately, to conflate these two issues.
A second, related point of variation between these definitions lies in the
extent to which they imply consuming more efficiently, consuming more
responsibly, or quite simply consuming less. While some definitions insist that
sustainable consumption implies consuming less, others assert that it means
consuming differently, and that it categorically does not mean consuming less.
The dominant institutional consensus has tended to settle for a position
in which sustainable consumption means (more) consumption of more sus-
tainable products and this is achieved primarily through improvements in
the productivity with which resources are converted into economic goods.
This position is typified by a speech given by the former UK Trade and
Industry Secretary, Patricia Hewitt, in 2003 in which she argued (DTI,
2003b) that:
Sustainable consumption
257
[t]here is nothing wrong with rising consumption, indeed it is to be welcomed as
symptomatic of rising living standards in our communities. And it is quite right
that the poorest in the world aspire to escape poverty and enjoy those standards.
But we need to make sure the products and services we consume are designed
not to harm our environment. We can enjoy more comfort, more enjoyment and
more security without automatically increasing harmful and costly impacts on
the environment. But it requires a re-thinking of business models to make more
productive use of natural resources.
Even on the world stage, at the second Earth summit in Johannesburg,
the WSSD Plan of Implementation (UN, 2002) appeared to retreat from
the idea of lifestyle change advanced in Agenda 21 ten years earlier.
Instead, the focus was placed firmly on improvements in technology and
the supply of more eco-efficient products, services and infrastructures –
that is to say on resource productivity improvements of one kind and
another.
Reasons for the institutional reticence to engage with thorny issues of
consumer behaviour and lifestyle are not particularly hard to grasp. In par-
ticular, addressing them would involve questioning fundamental assump-
tions about the way modern society functions. Intervening in consumer
behaviour would contradict the much-vaunted ‘sovereignty’ of consumer
choice. Reducing consumption would threaten a variety of vested interests
and undermine the key structural role that consumption plays in economic
growth. Questioning consumption and consumer behaviour quickly
becomes reflexive, demanding often uncomfortable attention to both per-
sonal and social change. To make matters worse, arguments to reduce con-
sumption appear to undermine legitimate efforts by poorer countries to
improve their quality of life.
Nonetheless, the fall-back position adopted by conventional institutions
is also problematic for a number of reasons. In the first place it tends to col-
lapse any distinction between sustainable consumption and sustainable
production. Secondly, the concentration on efficiency and productivity
tends to obscure important questions about the scale of resource con-
sumption patterns. In fact, it would be entirely possible, under this framing
of the problem, to have a growing number of ethical and green consumers
buying more and more ‘sustainable’ products produced by increasingly
efficient production processes, and yet for the absolute scale of resource
consumption – and the associated environmental impacts – to continue to
grow. Finally, and perhaps most importantly, by focusing on what are
broadly technological avenues of change, this version of sustainable con-
sumption ignores vitally important issues related to consumer behaviour,
lifestyle and the culture of consumption – key underlying factors that play
a vital role in determining the overall scale of resource consumption.
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In summary, it may well prove impossible to negotiate a common con-
sensus on what sustainable consumption is or to agree a clear definition of
it. But this does not mean that the current institutional position is adequate
to the challenge of sustainability. In fact, a growing body of literature with
a very long pedigree suggests an increasingly urgent need for policy and
public debate to reach the parts of consumption that institutional initia-
tives on sustainable consumption (narrowly conceived) have so far signally
failed to reach.
3. Dimensions of sustainable consumption
One of the many confusing tensions underlying the sustainable consump-
tion debate is the question of what, precisely, is being or should be (or
should not be) consumed in the consumer society. There is, for example, an
important (although not always very clearly articulated) difference between
material resource consumption and economic consumption. Material
resource consumption – with its attendant implications for resource
scarcity and environmental degradation – has been the principal focus of
many of the policy debates on sustainable development. But economic con-
sumers do not only buy and consume material resources. In fact, so-called
‘final consumers’ (households, for example) rarely buy materials per se at
all. Rather they consume a variety of goods and services, which employ a
variety of different kinds of material inputs and give rise to a range of
different material and environmental impacts. Resources are consumed in
the course of economic consumption; but the two processes are not identi-
cal or even congruent. Some forms of resource consumption take place
outside of the economic framework. Some forms of economic consump-
tion involve virtually no resource consumption at all.
This lack of congruence is, in one sense, precisely what has allowed the
institutional position on sustainable consumption to retain a degree of
credibility. Continued economic growth is perhaps the most deeply
entrenched political imperative of post-war modern governments. Without
a continuing rise in household consumption levels, economic growth would
stall, giving way to the spectre of recession and the fear of unemployment,
undermining the political credibility of the government that presides over
these. Thus, any attack on levels of economic consumption is anathema to
modern governments. But what if economic consumption can be decou-
pled from material resource consumption? What if consumers can be per-
suaded more and more to buy less and less materially-intensive products?
So long as the decoupling of economic expenditure from material resources
occurs faster than the growth in economic consumption, then surely it
should be possible to preserve the sanctity of economic growth and at the
same time achieve important environmental goals?
Sustainable consumption
259
This position is the one implicit in the UK’s sustainable consumption
and production framework, which sets out a variety of ‘decoupling
indicators’ showing that economic growth is faster than the growth in
material inputs and waste outputs (DTI, 2003c; DEFRA, 2005b). In spite
of this evidence, however, there is little doubt that economic consump-
tion has historically relied heavily on the consumption of material
resources; that improvements in resource productivity have generally
been offset by increases in scale (see Chapter 15 for evidence for and
against); and that the goods and services that people actually buy
continue to be inherently material in nature (Princen et al., 2002; Jackson
and Marks, 1999). Thus, simplistic appeals to reduce material consump-
tion whilst maintaining economic growth risk charges of naivity or even
disingenuity.
At the very least, a realistic programme for achieving such a ‘decoupling’
requires a robust examination of the complex relationships between
economic value and material inputs and outputs. In fact, this ‘mapping’ of
consumer demand and lifestyle choice onto resource requirements and envir-
onmental impacts represents one of the most prolific and important avenues
of current and future research in sustainable consumption (for example,
Barrett et al., 2005; Druckman et al., 2005; Tukker, 2005; Hertwich, 2005).1
But the ‘decoupling’ arguments also require a sophisticated understand-
ing of consumer motivations and behaviours, and in particular of the rela-
tionship between consumer desires and the materiality of products. Why do
we consume? Why do we consume material products? What factors shape
and constrain our choice of material products? What do we expect to gain
from consuming material goods? How successful are we in meeting those
expectations?
All these questions become vitally important in the attempt to reduce the
aggregate material impact of society’s consumption patterns. Strangely,
however, they have not yet been asked – or have only recently been asked –
explicitly within the sustainable consumption debate itself. Rather, the litera-
ture directly relating consumer motivation to sustainability has tended to fall
into two main camps. On the one hand, there is a fairly recent, empirically-
based literature which attempts to identify the psychological parameters of
‘environmentally-responsible’ or ‘environmentally-friendly’ behaviour (de
Young, 1996; Thøgersen and Ölander, 2002). On the other hand there is much
more extensive literature with a very long pedigree which attacks (over-)con-
sumption as a form of social pathology (Galbraith, 1958; Fromm, 1976;
Durning, 1992; Frank, 1999).
The first literature set strives to identify existing behavioural types and
patterns which, if replicated and extended, might lead to sustainable con-
sumption at the macro level (Thøgerson, 1999). The second literature set
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Handbook of sustainable development
highlights the social and psychological disbenefits of material consumption
(Kasser, 2002). Often based implicitly or explicitly on humanistic psychol-
ogy and couched in the (problematic) language of ‘human needs’, one of
the interesting aspects of this literature is that it suggest the existence of a
kind of double dividend for sustainable consumption. Specifically, a corol-
lary of the thesis that material (over-)consumption has social and psy-
chological disbenefits is that reducing consumption has social and
psychological benefits; that it may be possible to live better by consuming
less (Jackson, 2005a). This implication has provided the basis for the emer-
gence of a clear – if not clearly significant – movement towards voluntary
simplicity and downshifting (Schor, 1998; Elgin, 1993).
Both of these sets of literature have some potential value in forwarding
the debate about consumption and sustainability. Nonetheless, they barely
scratch the surface of the broader set of questions about consumer motiv-
ations indicated above. Ironically, of course, some at least of these broader
questions have been addressed extensively and for several decades outside
the sustainable consumption debate. For this reason, it is worth examining
that broader literature in more detail.
4. Understanding ‘unsustainable’ consumption
The problem for those engaged in sustainable consumption lies not so
much in a dearth of theories to work from as in a superabundance of pos-
sible answers, hailing from disciplines as diverse as economics, psychology,
anthropology, biology, sociology and marketing. In fact the contemporary
and historical science and social science literature is replete with different
models of consumer behaviour, each offering a variety of different versions
of the nature and role of the ‘modern consumer’. These roles include, for
example: the satisfaction of functional needs, the construction of identity,
the pursuit of status and social distinction, the maintenance of social cohe-
sion, social and/or sexual selection, negotiation of the boundary between
the sacred and the profane, and the pursuit of personal and collective
meaning.2
This multiplicity of roles for consumption is what led Gabriel and Lang
(1995) to refer to the consumer as ‘unmanageable’ and inspired Miller
(1995) to talk about consumption as ‘the vanguard of history’. Our con-
sumption patterns offer a complex, yet telling picture of the kind of society
we have become and of our relationship to material goods. Getting to grips
with this complexity is challenging. But two or three key lessons emerge
from the vast literature on modern consumption.
The first of these is that no purely functional account of material com-
modities can provide a robust basis for analysing consumer behaviour or
for negotiating more sustainable consumption patterns. Rather material
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261
artefacts must be seen as playing important symbolic roles in our lives
(Baudrillard, 1968; 1970; Dittmar, 1992; McCracken, 1990). This symbolic
role of consumer goods allows us to engage in vital ‘social conversations’
about status, identity, social cohesion, and the pursuit of personal and cul-
tural meaning.3 In short it allows us to use the ‘language of goods’
(Douglas and Isherwood, 1979) to ‘help create the social world and to find
a credible place in it’ (Douglas, 1976, p. 27).
Another hugely important lesson from the literature is that, far from
being able to exercise free choice about what to consume and what not to
consume, people often find themselves locked in to unsustainable con-
sumption patterns by factors outside their control (Sanne, 2002; Shove,
2003; Warde, 2003). ‘Lock-in’ occurs in part through ‘perverse’ incentive
structures – economic constraints, institutional barriers, or inequalities in
access that actively encourage unsustainable behaviours. It also occurs
because of social expectations or from sheer habit. At one level, consumer
behaviour is simply the manifestation of everyday routine ‘social practices’
(Spaargaren and van Vliet, 2000) which are themselves the product of a
‘creeping evolution of social norms’.
These lessons emphasize the difficulty associated with negotiating sus-
tainable consumption patterns. But they also highlight another key feature
in the literature: namely, the social and institutional context of consumer
action. We are fundamentally social creatures. We learn by example and
model our behaviours on those we see around us. Our everyday behaviour
is guided by two kinds of social norms (Cialdini et al., 1991). ‘Descriptive
norms’ teach us how most people around us behave. They allow us to mod-
erate our own behaviour. I know what kind of clothes to wear and when to
put out my recycling partly by observing continually what others around
me do. ‘Injunctive norms’ alert us to what is sanctioned or punished in
society. Driving outside the speed limit, polluting the water supply and
(perhaps) failing to separate our recyclables from the rubbish are all exam-
ples of behaviours which carry varying degrees of moral sanction.
In both cases, there is lot at stake. Our ability to observe social norms
influences the way we are perceived in our peer group and is important to
our personal success. My ability to find a mate, keep my friends and stay in
a good job are all mediated by my success in following social norms.
Descriptive and injunctive norms can sometimes point in opposite direc-
tions. Most people agree that breaking the speed limit is wrong; but many
people do it. The same is true for other environmentally unsustainable
behaviours.
Some social theories suggest that our behaviours, our attitudes, and even
our concepts of self are (at best) socially constructed (Mead, 1934) and (at
worst) helplessly mired in a complex ‘social logic’ (Baudrillard, 1970).
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Handbook of sustainable development
Social identity theory, for example, regards key aspects of our behaviour as
being motivated by the particular social groups that we belong to (Tajfel,
1982, for example). Certain behaviours are more or less ruled in or ruled
out for me, simply because I perceive myself as belonging to a particular
social group. The roots of these ‘normal behaviours’ have very little to do
with individual choice.
5. Policies for sustainable consumption
The policy implications of all this are potentially profound. Until quite
recently, consumer policy has been influenced heavily by concerns for ‘con-
sumer sovereignty’ and by an allegiance to the rational choice model
(Jackson, 2005b). From this perspective, the role of policy appears to be
straightforward, namely to ensure that the market allows people to make
efficient choices about their own actions. For the most part, this has been
seen as the need to correct for ‘market failures’. These failures occur, for
example, if consumers have insufficient information to make proper
choices. In this perspective, policy should therefore seek to improve access
to information. In addition, private decisions do not always take account
of social costs. Policy intervention is therefore needed to ‘internalize’ these
external costs and make them more ‘visible’ to private choice.
Unfortunately, the evidence suggests that policies based on information
and price signals have had only limited success in changing unsustainable
behaviours. In one extreme case, a California utility spent more money on
advertising the benefits of home insulation than it would have cost to install
the insulation itself in the targeted homes.4 Price signals too are often
insufficient to overcome the barriers to more sustainable behaviour. In
some cases, more sustainable choices are already cost-effective, but are not
taken up for a variety of reasons.
The rhetoric of ‘consumer sovereignty’ and ‘hands-off’ governance does
not help much here because it regards choice as individualistic and fails to
unravel the social, psychological and institutional influences on private
behaviours. Some behaviours are motivated by rational, self-interested, and
individualistic concerns. But conventional responses neither do justice to
the complexity of consumer behaviour nor exhaust the possibilities for
policy intervention in pursuit of behavioural change.
It is clear that sustainable consumption demands a more sophisticated
policy approach aimed at removing perverse incentive structures and
making sustainable consumption behaviours easy (Darnton, 2004;
Jackson, 2005b; DEFRA, 2005a). It is beyond the scope of this chapter to
outline in detail the components of such a strategy. But the considerations
of the previous section suggest that it must have, at the very least, the
following crucial dimensions:
Sustainable consumption
●
●
●
263
●
it must enable and facilitate access to more sustainable choices;
it must ensure that incentive (and penalty) structures support rather
than hinder the desired changes;
it must engage people in community initiatives to help themselves re-
negotiate unsustainable behaviours and practices and develop more
sustainable lifestyles; and
it must exemplify the desired changes in Government policies and
practices.
6. A ‘double dividend’ in sustainable consumption?
In closing, it is worth returning briefly to the argument that sustainable con-
sumption offers a kind of double dividend. If the consumer way of life is –
as critics have suggested – both ecologically damaging and psychologically
flawed, then the possibility remains that we could live better by consuming
less, and reduce our impact on the environment at the same time (Jackson,
2005a). But how realistic is this perspective, in the light of the discussion
above? Is it consistent with fundamental understandings about consumer
behaviour and human motivation? Does it reflect socially achievable and
culturally relevant ambitions? Or is it simply a delusion based on utopian
understandings of human nature?
These are important and as yet unexplored questions, which perhaps,
more than any other, characterize both the promise and the challenge of
sustainable consumption. A more detailed pursuit of this issue is beyond
the scope of this chapter. In closing, however, I make three specific obser-
vations about the promise embodied in this perspective.
In the first place, the insight that material commodities play symbolic
roles and that these symbolic roles serve important social and psycholo-
gical functions is perhaps the clearest message yet that simplistic appeals
to consumers to forego material consumption will be unsuccessful.
Such an appeal is tantamount to demanding that we give up certain key
capabilities and freedoms as social beings. Far from being irrational to
resist such demands, it would be irrational not to, in such a society. A
sophisticated understanding of this very real social constraint must
inform the otherwise naive appeal for a decoupling of economic and
material activity.
Secondly, and despite the fact that our present consumer society is inher-
ently material in its choice of symbolic goods, symbolic value is not solely
embodied in material artefacts. A variety of other social and cultural con-
structs have – over history – played vital roles in the construction, negotia-
tion and exchange of symbolic meaning. These include processes of ritual,
myth, and narrative and institutions such as the family, the community and
the church (Campbell, 1959; Berger, 1969; Taylor, 1989). Though the tide of
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cultural change may have swept some of these institutions away, it does not
seem impossible – in theory at least – to conceive of futures in which some
of the symbolic functions of material commodities are once again taken
back by other kinds of institutions with lower resource ‘footprints’.
Finally, however, it is abundantly clear that cultural change at this level
is not immediately or easily negotiable. As Baudrillard (1970) was keen to
point out, symbolic meaning is negotiated through a complex ‘social logic’
that lies beyond individual choice and appears to defy conventional policy
prescriptions and interventions. Perhaps the biggest challenge for sustaina-
bility policy therefore lies in identifying the myriad ways in which govern-
ments currently intervene in and could potentially influence this social
logic.
In the final analysis, these remarks should serve to warn us against sim-
plistic prescriptions for change. Material goods and services are deeply
embedded in the cultural fabric of our lives. Through them we not only
satisfy our needs and desires, we also communicate with each other, nego-
tiate important social relationships, and pursue personal and cultural
meaning. In this context, motivating sustainable consumption may be as
much about building supportive communities, promoting inclusive soci-
eties, providing meaningful work and encouraging purposeful lives as it is
about awareness-raising, fiscal policy or persuasion.
Appendix: definitions of sustainable consumption
The use of goods and services that respond to basic needs and bring a better
quality of life, while minimizing the use of natural resources, toxic materi-
als and emissions of waste and pollutants over the lifecycle, so as not to
jeopardize the needs of future generations (Ofstad, 1994).
The special focus of sustainable consumption is on the economic activity
of choosing, using, and disposing of goods and services and how this can
be changed to bring social and environmental benefit (IIED, 1998).
Sustainable consumption means we have to use resources to meet our basic
needs and not use resources in excess of what we need (Participant defini-
tion, Kabelvåg, IIED, 1998).
Sustainable consumption is not about consuming less, it is about consum-
ing differently, consuming efficiently, and having an improved quality of life
(UNEP, 1999).
Sustainable consumption is consumption that supports the ability of
current and future generations to meet their material and other needs,
Sustainable consumption
265
without causing irreversible damage to the environment or loss of function
in natural systems (OCSC, 2000).
Sustainable consumption is an umbrella term that brings together a
number of key issues, such as meeting needs, enhancing quality of life,
improving efficiency, minimising waste, taking a lifecycle perspective and
taking into account the equity dimension; integrating these components
parts in the central question of how to provide the same or better services
to meet the basic requirements of life and the aspiration for improvement,
for both current and future generations, while continually reducing envir-
onmental damage and the risk to human health (UNEP, 2001).
Sustainable consumption and production is continuous economic and
social progress that respects the limits of the Earth’s ecosystems, and meets
the needs and aspirations of everyone for a better quality of life, now and
for future generations to come (DTI, 2003a).
Sustainable consumption is a balancing act. It is about consuming in such
a way as to protect the environment, use natural resources wisely and
promote quality of life now, while not spoiling the lives of future consumers
(NCC, 2003).
Notes
1. That I have less to say specifically about this avenue of research is a potential limitation
of this chapter. However, this kind of work has a long pedigree in environmental eco-
nomics and is in part covered by other chapters in this volume.
2. See Jackson (2003; 2004; 2005a; 2005b), Jackson and Michaelis (2003), Princen et al.
(2002), Sanne (2002), Michaelis (2000), Røpke (1999), Jackson and Marks (1999),
Crocker and Linden (1998), Gabriel and Lang (1995) for reviews and overviews of some
of this literature.
3. The use of the term ‘social conversations’ in this context draws on the early work of
G.H. Mead (1934).
4. Cited in McKenzie Mohr (2000).
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