C A N M A R K E T S T U R N G R E E N ?
Trading on life itself: global environmental economics
The same human institution that's wrought environmental havoc, argues a prominent Columbia economist, might be adapted to undo the damage. With market approaches gaining ground worldwide, what questions need answers?
By DOUG HENWOOD
NATURE IS NO exception to the market revolution. With government and planning out of
fashion, greens are increasingly turning to market mechanisms as models for environmental
preservation. Instead of regulation, mainstream environmentalists increasingly argue that the
right to use or degrade natural assets should be traded in the style of the Chicago futures
markets. Flexible market allocations would replace the inflexible writs of bureaucrats.Most ecological economists would agree that the price system today doesn't do a very good job of incorporating environmental costs. The private activities of some people ruin the air and water of others. Ecological economists part company after agreeing to that. Market advocates believe the key is to define a new set of property rights, to define assets--claims to natural resources like clean air or the ozone layer--that then can be priced and traded. More radical green economists prefer to talk about ecological resources as common property, objecting to the commodification of nature.
One of the leading theoreticians of "costing the Earth," as The Economist puts it, is Graciela Chichilnisky, holder of the UNESCO Chair in Mathematics and Economics at Columbia. Chichilnisky, who directs the university's Program on Information and Resources, has written (or co-authored, with Professor Geoffrey Heal of Columbia Business School) a series of academic and popular articles exploring ways of using financial markets to manage natural assets.
To move against global warming, Chichilnisky wants to see an international market to trade the right to vent greenhouse gases. The total quantity of pollution permits would be determined by the best available scientific judgment, but the distribution of those rights would be determined by trading.
Such proposals are not without complications, Chichilnisky concedes. For example, would anything prevent cash-starved countries from selling their pollution rights, thereby foregoing the right to industrialize--an outcome that wouldn't necessarily be desirable, she further concedes? It's no wonder that this is a sticky diplomatic point in international climate negotiations. The so-called developing countries argue that richer Northern nations have done most of the damage to nature and see no reason why the South should bear the brunt of any reductions in gas emissions, the likely outcome if the trading scheme turned out to be a way for the rich countries to buy their way out of compliance. Still, even if the South's contribution were reduced to zero, it wouldn't be enough to reach the goals of atmospheric scientists; the rich countries would still have to make major changes to meet the targets.
Harvesting drugs and insuring bugs
IT'S ONE THING to price the right to emit carbon dioxide; what about something as hard to measure as biodiversity? Chichilnisky cites arrangements like Merck's with Instituto Nacional de Biodiversidad (INBio), a Costa Rican biodiversity institute, in which the company pays a share of its profits on drugs based on genetic material first found in Costa Rican forests. This agreement provides an incentive to preserve the forest, rather than turn it to lumber, and helps fund ecological research in Costa Rica.
Broader issues of biodiversity revolve more often around humble beetles than lucrative new drugs. The more diverse an ecosystem, the more resilient it is to shocks; warming the globe and reducing biodiversity simultaneously heighten the risk of each. Pricing these fundamental issues, to Chichilnisky, is the native terrain of financial markets. Environmental issues are about risk, and financial markets are instruments for dealing with uncertainty. We buy insurance to replace an uncertain exposure--illness, car wrecks, burglary--with a fixed premium. Portfolio managers and corporations use futures and options to reduce the risks of price volatility, whether their stock in trade is Treasury bonds, wheat, or oil. So it is perfectly natural, says Chichilnisky, to turn to financial markets to manage environmental risks. Since global warming appears to have increased hurricane severity, insurance companies have turned to futures and derivatives markets to hedge themselves against higher claims. Whether this is the best solution for society as a whole is another matter.
Options are an ideal way to price environmental assets, and Chichilnisky resists any suggestion that this is merely a metaphor; she aims to put dollar valuation on the Amazon forest. With stocks, option values can be fairly easily computed from the dividend yield and price volatility of the underlying stock and prevailing interest rates--information updated continuously to at least the second decimal point. How do you value a wilderness as an option (granting the point, which is by no means non-controversial, that money is an appropriate way of valuing nature)? You run a computer model of world output with the Amazon in the equations, then another model without it, and the difference is the basis of the valuation. Life itself (or at least lives, human and non-human) would then rely on this model--showing a great faith in economic models, which have a hard time predicting next year's GDP, let alone the "value" of the rain forest.
Risk, uncertainty, and noise
ECONOMISTS RECOGNIZE AN old distinction, famously made by John Maynard Keynes, between risk (which is calculable by statistical formulas) and uncertainty, the truly unknowable: matters such as "the prospect of a European war," as Keynes wrote in 1937, or "the position of private wealth-owners in the social system in 1970. About these matters there is no scientific basis on which to form any calculable probability whatever."(1) Aren't environmental dangers uncertain in precisely this way, difficult to quantify mathematically or in currency?
Chichilnisky observes that financial markets are now facing down issues of the fundamentally unknowable. "What do you do when you don't know something?" she asks. "You can do two things. One is worry about it. The other one is bet on it." If one person thinks there will be three hurricanes this season and another thinks six, they can make a bet with each other. This makes for efficient markets, says Chichilnisky, though "not necessarily socially desirable outcomes."
Market prices are the result of continuous changes in the balance of such wagers. How "right" are such prices? In the 1960s and 1970s, the so-called efficient market hypothesis, under which financial markets were thought to be frictionlessly accurate mechanisms for pricing risk and reward, dominated academic economics and financial theory. In the 1980s, new theories arose, offering significant if not definitive evidence that markets can go badly wrong, systematically mispricing assets. Rather than pricing the future, as they're supposed to do, financial markets grossly overweight the last piece of news. Phrases like "noise trading," "excess volatility," and "information asymmetry" entered the financial lexicon alongside "market efficiency." Do these phenomena, which different commentators regard as either market anomalies or failures, give Chichilnisky any pause?
No, she says, because this sort of trouble isn't relevant to the kinds of markets she's proposing. Unlike conventional markets, which involve the private trading of privately owned, privately produced goods, markets in nature will trade privately what economists call public goods. In the professional definition, these are goods in which there is no rivalry in consumption; no one loses when another consumes a public good, and it costs very little for an additional individual to consume a public good, though it would cost a lot to prevent that individual from doing so. The classic example is national defense; economists like Chichilnisky would include the atmosphere (though this, too, is hardly uncontroversial among ecological economists). Assigning property rights in public goods is devilishly hard: Who owns the air, and how much of it? If the markets we know are plagued by volatility, ignorance, and noise, what will these unknown markets be like?
Despite these complications, market-based approaches to the environment are spreading like a Malibu wildfire. They're being adopted across the spectrum, from the Environmental Defense Fund to the official U.S. position on greenhouse emissions at the UN climate change conference in Geneva, where Timothy Wirth, the undersecretary of state, recommended the use of "trading mechanisms around the world"(2) to meet emissions targets. Those who believe the financial markets do a good job of running the economy will be pleased; those who don't might be a bit uncomfortable that the next generation's air may depend on this generation's trading skills.
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"The General Theory of Employment."
Collected Writings of John Maynard Keynes (St. Martin's/Royal Economic
Society, 1971), vol. XIV, pp. 112-122.
DOUG HENWOOD is a contributing editor to The Nation, editor of Left Business Observer, and an economics commentator for WBAI radio in New York. His books include The State of the USA Atlas (Simon & Schuster, 1994) and Wall Street (Verso, 1996, forthcoming).PHOTO CREDIT: Jonathan Smith
