VI.

Economics Defining Value Measuring Wellbeing, GDP, Alternatives

A. Introduction
The concept of value in economic parlance is likely different from what you and I define as value in our personal lives. There may certainly be overlap between economic measures of value and our individual and social value systems, but there likely is a good deal of difference as well. The purpose of this section is to get a sense of the term value from an economic standpoint. As we begin to understand the assumptions behind economic principles of value, including the assumptions behind those principles, we can compare and contrast these goals with our existing knowledge and understanding of environmental policy goals, particularly the connection to systems thinking and intergenerational questions of equity and fairness.

B. How Do We Measure Value in Economic Terms?

The term value from an economic standpoint is closely tied to a general goal in economics of maximizing human wellbeing. Now, we can all imagine that the concept of wellbeing is a bit vague and likely ranges from person-to-person. Certain groups of people may have general agreement on categories or notions of what constitutes wellbeing, but there is likely a lot of difference between opinions on precisely what constitutes wellbeing in a particular context. Income disparity is one example; while all people may believe wellbeing includes a comfortable lifestyle, a person of limited economic means may define comfort very differently from someone who is wealthy. Thus, there may be general agreement on the concept of comfort (certain needs and desires being met), but the way in which comfort is being operationally defined between the wealthy and poor person is different. Economics tends to focus on large-scale measures of human wellbeing in order to try and capture a general sense of wellbeing amongst all groups of people. A different way of saying this is that economics focuses on the total potential of wellbeing while not being too discerning on the distribution of wellbeing amongst participants.1 The main mechanism used by countries to measure the wellbeing, and thus value of the country, is through Gross Domestic Product, or GDP.

It is important to note here that we are focusing mostly on macroeconomic principles in defining wellbeing for humans in general. A number of applications of economic theory look directly at equity issues like distribution of benefits among groups of people and even at the individual level. What we are talking about here is general neoclassical economic theory, including the underlying assumptions that provide the basis for macroeconomic measurements of wellbeing.

The text explains GDP, including its definition and application. The text also summarizes some of the major complications of using GDP as a measurement of wellbeing. In summary they include: GDP is a gross measure of all the goods and services produced by a nation in a given year, but such a measure does not yield meaningful information on distribution among the citizens of the nation. A country can have a very high GDP by extracting non-renewable resources and selling them, i.e., a high GDP may not be sustainable and can harm future generations. Activities that contribute to GDP can be harmful to the environment and unsustainable. GDP does not equal equitable distribution among the population (the benefits can be retained by a small percentage of the population) both today and tomorrow (future generations). A war can increase GDP this does not seem to equate to overall wellbeing.

There are many other criticisms linked at GDP and if we recall the Stone article about equity we can overlay her concerns from a policy standpoint on most of the GDP measures identified here. In essence, GDP is a very rough measure of wellbeing; it provides some evidence of economic activity (including growth), but it does not provide a full accounting of that growth, nor does it provide a sense of how that growth is connected to larger societal goals.

C. Relationship Between GDP and Public Policy

Let us take a moment now and consider GDP in relation to policy generally and environmental policy specifically. Recall from the reading that neoclassical economics favors free markets as the mechanism for achieving human wellbeing. Through the creation of free markets, humans are free to express their individual preferences by buying and selling (exchange) without coercion. Thus, an increasing measure of GDP is, under ideal circumstances, reflective of an increase in individuals expressing their preferences in free markets. There is an assumption inherent in the theory stated above that I think is closely connected to public policy and particularly environmental policy. One major assumption in this market model is that people have complete information as they are engaging in their free market activities, and thus they are making informed choices as they express their preference for one thing over another. The assumption of complete information is key in policy because, if true, then the role of government would be

limited here to, essentially, keeping the peace between market participants.2 However, what has been found to occur in free markets is a lack of complete information leading to market failures, or the result of misinformation leading to transactions that do not accurately reflect what a person might be willing to pay if they had complete information.3 Market failures (where the market does not operate on complete information) are the basis for government intervention and regulation in our economic system, and thus the need for public policy. In addition, market failures (the lack of complete information) often underlie environmental problems; the failure to internalize the costs of certain actions (the failure to add those costs to the market transaction) creates a distortion in the market because the price willing to be paid (and accepted) does not meet the costs incurred in the product. The difference between the price paid and the costs of the product must be ingested in some way. Often in environmental problems that additional cost not being paid is externalized onto the environment itself.4 When market failures occur, government intervention is often necessary to fix the problem. This is the foundation of environmental policy; government is stepping in where the free market has failed. The basis for the failure is free riding, or the externalization of costs (by not asking or paying for those costs in the transaction), and thus the externalization of those costs onto the environment (natural system). Government can engage in a variety of policy tools to remedy this kind of market failure:
2

For example, government may be required to help establish free markets and then really only help in enforcing the agreements made between market participants to ensure the legitimacy of the market itself (provide courts of law to enforce private contract agreements between parties is one example).
3

Much of the global economic collapse that occurred in 2008 was based on misinformation in market transactions. For example, home prices were being valued not on what might be considered fundamental valuations, but rather on speculation about the continuation of certain market forces (the continued future appreciation of home values). This assumption was not based on accurate information regarding home prices (historically, rationally, or otherwise), but rather on a desire to support the continuation of the market system itself. The information available to the market participants in this case cannot be considered complete in any reasonable sense of the definition.
4

The air (atmosphere) absorbs the additional costs of pollution not internalized in the price paid for using coal to produce electricity. The water (hydrosphere) absorbs the additional costs of pollution not internalized in the price paid for agriculture where fertilizer runoff leads to nutrient enrichment and dead zones in our water bodies. The Earth system absorbs the carbon that is forced outside of equilibrium storage and not internalized into the costs of carbon-forcing, leading to climate change and other impacts (in this case climate change may be evidence of the costs being incurred indirectly after-the fact).

Regulations through command-and-control (Clean Water Act, Clean Air Act, etc.). Quasi-regulations through cap-and-trade (regulation to cap, market forces to trade). Taxing through internalizing the cost of the harm that is otherwise externalized (think of taxing cigarette smoking as one example). Privatization through privatizing the resource (air, water, etc.) or pollution and then allowing owners of the resource to engage in market transactions for the harm. Government can enforce the private rights created through court systems (Coase Theorem consider individual quota systems in fisheries management as one example).

So, in summary, neoclassical economic policy presumes open markets lead to the maximization of human wellbeing, and because wellbeing is defined here through the expression of preference it can be closely linked to what we may term value. Thus, a rough measure of the amount of activity occurring in market transactions (GDP) is a way of measuring overall value. However, there are real problems with linking GDP to overall preference, and in the environmental arena the problem of market failures brought on by a failure to internalize costs of actions is a catalyst for environmental problems. In many ways this failure to internalize costs is the reason environmental policy exists; its goal is to ensure those costs are accounted for in the analysis so that the goal of wellbeing can be more transparently achieved. Another way of incorporating transparent goals of wellbeing into a nations policy is to use a measure other than GDP in determining whether a society is moving towards a maximization of wellbeing.

D. Alternate Ways of Measuring Wellbeing

The text explains two alternative methods of measuring human wellbeing (happiness) in a country: Gross National Happiness (GNH) and the Genuine Progress Indicator (GPI). Both are concerned with a more directed approach to discerning between economic activities that are good vs. bad. Each has established criteria (some more objective and others more subjective) to help in assessing the net value of economic activity. What is important to understand is that each method seeks to place economic activity into a greater context, and then use that context as a way of better understanding the cause and effect relationship between the economic activity and the impacts it has on human wellbeing. If we think of public policy as an attempt to gain greater insights into the impacts and consequences of government action, then we may find value in these alternate methods of measuring human production and linking that production to criteria that reasonably distinguishes between good and bad outcomes. I would be remiss if I did not take a moment to try and connect GNH and GPI to environmental policy by noting both of these methods tend to go further than GDP in

assessing the impacts of economic activity on the natural environment (the Earth system). Recall our figure that presents us with a major assumption about the environment in relation to our society and economy, reproduced here:

Both GNH and GPI are, in my view, attempts to better understand the role of economic activity (the orange) in achieving societal goals (the blue) by placing some emphasis on the impact of that economic activity on the natural system (green). This suggests an awareness that society is not dominated by economic concerns (rather the economy is defined by social expectations and institutions), and importantly, that both society and economic activity are constrained by the environment; failure to account for the impacts of economic activity on the environment can harm the capacity of the environment to aid in achieving societal goals, including a reasonable definition of happiness (wellbeing).5 END OF SECTION.

It is interesting to note how much of a role economic activity takes up in our society, particularly when conditions like the economic downturn of 2008 are considered. Often it is hard to think that we have choices as a society that influence our economy; it seems in much of the popular press that our society is driven by economic considerations, not the other way around. I think it is useful to contemplate this relationship as we consider the role of environmental policy in our social institutions.