Sunday, 14 April 2013

Interactions Between the Economy and the Environment

The economy and the environment is a topic that divides opinion. There are groups of people that feel very strongly either way and a bunch sitting on the fence. One thing is for certain - it is an important issue that needs addressing. The interaction between the economy and the environment is vast, almost all economic action has some impact on the economy and vice versa.

The interaction can be summarised fairly easy. Environmental inputs are taken from the environment for use in the economy and are exchanged with waste created from their use. While this is going on the environment and the economy also operate independently. If the link was broken then both would suffer.
Where does this all come from then? Well, we assume the economy functions in a circular motion. (P)Production produces (C) consumer goods and (K) capital goods, which produce more (C). This yields societies (U) welfare:

Environment's Economic Function

So where does the environment come into this? Well, the environment starts off the chain. We can add (R) the flow of natural resources leading to (P) production. We can also add waste (W). At each stage of the process waste is created and fed back into the environment. Using the First Law of Thermodynamics that states we cannot create or destroy energy and matter, the amount of waste used in a time period must be equal to the amount of resources used. The start of the chain now looks something like this:


Now the final stage to convert this into the circular system is to add in recycling (r). This gives us the full circular system. Natural resources add to production which adds to consumer/capital goods. All three of these create waste which is fed back into the environment. Some of this waste is taken to be recycled and fed back into the system as a natural resource. Ultimately the consumer/capital goods lead to consumer welfare. The environment also adds to consumer welfare as it is.

Circular Flow of the Environment and Economy

This is how the system works, but can it be improved? Yes, yes it can. We can reduce R by using energy more efficiently. This will in turn reduce waste which is of course a good thing. We have to take care of the assimilative capacity of the environment. This is the ability for the environment to break down waste, it becomes more and more limited with higher amounts of waste. Therefore, the more waste we create, the less can be broken down naturally by the environment - a bad thing.

The question now might be why don't we recycle all waste? That way the assimilative capacity of the environment would never get strained and natural resources could remain very much intact. Well, we can't because of the Second Law of Thermodynamics. This states that energy can change states and become unusable. The word for this dissipation is 'entropy'. Unused resources have low entropy but once they've been used it becomes high entropy. This explains why we cannot recycle everything.

So, we've essentially covered the three main economic functions of the environment above: a supplier of natural resources, an assimilator of waste and a source of utility. Environment damage occurs because us as the consumer do not value these functions correctly. We treat them as free when in actual fact if they were marketable goods they would have higher prices.

The concept of sustainable development can be touched upon here. There are many different definitions for this phrase, you've just got to pick one. The one I like is "Development that meets the needs of the present without compromising the ability of future generations to meet their own needs".

How do we ensure that future generations can meet their wellbeing needs? We need to make sure we look at the ideas of intergenerational and intergenerational equity. This means providing for the most needy in today's society (intra) but also meeting the needs of the next generation (inter). A good way of doing this is to ensure that we leave a stock of capital at least as large as the current one. This comes in two forms: weak and strong sustainable development. Weak will involve maintaining the aggregate level of capital stock. A fall in natural stock can be substituted by a rise in man-made capital. Strong differentiates between the two types of stock, it understands that some natural stock is a necessity. It encourages the need to be cautions and beware of irreversibility.


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