Rolling out the Red Carpet

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Wednesday, August 6, 2008

Designing a Sustainable Economy

The choice of who allocates resources is crucial. We see spectacular examples of government mismanagement. The market should be left free to allocate resources. Markets alone can assemble and convey essential information about security and value. Prices and profits will work to maximize production and minimize resource use.

Market mechanisms are sufficient to protect forests, for instance. Growing scarcity will drive up the price of wood, reduce consumption, as well as prompt landowners to plant more trees in anticipation of higher prices.

Traditional economics asks how to produce what for whom. Sustainable economics examines these same questions, but includes future generations in the ‘for whom.’ It asks how irreplaceable resources—water, air, soil, and fish and wildlife—can be adequately conserved. It also recognizes that economic mechanisms that do not efficiently and equitably satisfy human needs are not likely to be sustainable.

Sustainable economics analyze issues complicated by politics, ideology, and nationalism. It tries to ascertain what works to make resource use more efficient. How do people behave in relation to their, natural resources? How does a country’s economic system alter its prospects for survival? Measuring national performance in food security, energy efficiency, environmental pollution and equity can form the beginnings of an answer.

The issue is not socialism versus capitalism; it is the efficacy with which economic systems achieve their intended ends. Ideally nations could be graded for degree of market orientation and assessed for changes in resource use. But no one has invented a grading system for economic philosophy or environmental sustainability. It is instructive, nonetheless, to categorize nations as centrally planned or not and to assess their resource-use efficiency. A centrally planned economy is one that through price controls, state ownership, or allocation of capital effectively, managers more than half of a nation’s industrial and agricultural production.

From the end of World War 11 until a few years ago, centralized state planning has served as a model for almost half the world. Newly independent developing countries faced with the choice between centralized control and market orientation usually chose the former. That their foreign ruler had been capitalists turned them against market systems, while the tradition of colonialism eased the transition to tight central control. In the postwar era, many military states and even most market-orientated nations also expanded the role of government in the day-to-day management of their economies.

The world today is at a turning point in economic management. The abrupt Chinese shift to market mechanisms is the most dramatic example, not only because of the vast number of people affected, but because of the reform’s spectacular early successes. Many African nations, plagued with agricultural decline, have begun to extend market incentives for agriculture. Latin Americans, burdened with debt, have moved to sell off state-owned companies. Meanwhile the Soviet Union, its confidence in uninterrupted growth shaken, is debating the need for economic reform. Ironically, although Western governments have also begun to sell off state-owned concerns, they increasingly subsidize private agriculture, restrict trade, and permit concentration of economic power in industrial conglomerates.

The efficiency with which nations produce food and consume energy provides a useful indicator of their progress toward sustainability. Countries of all political stripes seek to avoid excessive dependence on food imports. Air and water pollution and land degradation are closely associated with agricultural production and energy-use efficiency. Thus, if market pricing and competition provide greater efficiency, both economists and environmentalists have a stake in the changing role of the market in the world’s economies.

Some environmentalists reject both markets and bureaucratic planning as incapable of dealing with the crisis of sustainability. Putting a sober twist on an old joke: ‘In capitalism, man exploits man; in socialism, it’s the other way around,’ they say both exploit nature. But important differences exist between systems, as shown by comparing their efficiency in agricultural production.

Agricultural production can critically affect the consumption and disruption of resources—water, wood, and air. Soil erosion and deforestation can result from low agricultural productivity if new, marginal lands are pressed into production to make up for lost potential. Overuse of chemicals can cause water pollution. Efficiency is consequently an essential ingredient of agricultural sustainability. Economists define efficiency, roughly, as maximizing output while minimizing input. When farmers produce a given value of grain with a least-cost combination of land, labor, fertilizer, and machinery, production is efficient. When grain production increases faster than consumption of the inputs, productivity and the outlook for sustained production improve. When productivity declines, a society is headed for trouble. Inflation, the need for costly imports, even famine can result.

Land and labor productivity, two partial but important measures of performance, reveal several advantages of market orientation. Crop production per hectare is generally higher in market-orientated countries. Of course, factors others than the economic system affect these ratings, such as rainfall levels, inherent soil fertility, and farm price policies that may either encourage or discourage farm efficiency. Japan’s population pressure, for example, has pushed it to increase land productivity, but this explains only about a third of the more efficient record it has than the Soviet Union. The remainder is attributable to policies that, among other things, keep prices high, encourage larger numbers of people to farm, and keep farm size low. Similar policies have placed market oriented Hungary even higher in land productivity.

Ranking nations by agricultural labor productivity shows a dramatic advantage for market economies. European countries enjoy labor productivity rates often double of countries like Poland, Cuba and Lithuania.

Labor productivity naturally tends to be higher when farmers earn high incomes, which in turn indicates higher levels of development, a central goal of economic policy. Strictly regulated prices reduce profitability for farmers, and deprive them of capital to invest in machinery and fertilizers to raise productivity.

Land productivity says little about the ‘total factor’ productivity of an agricultural system, which also takes into account inputs of labor, fertilizer, and machinery or animals. Efficiency can be distorted and productivity diminished by poorly crafted policies. For example, high price subsidies and protective trade barriers account for part of the relatively high land productivity in Japan. Consumers bear the cost of these distortions, paying almost three times the import price of food commodities.

Total factor productivity is relatively easy to determine in a perfectly competitive economy. Ideally, price signals instruct farmers on how much to spend on production, and they maximize their earnings by choosing the least-cost combination of labor, land, machinery, and fertilizer. According to microeconomic theory, they produce at the level at which the cost of their last, or marginal, unit of production—their most expensive ton of grain—just equals the price they receive. They maximize profits in this case, making efficiency and productivity almost synonymous. In non-market economies, on the other hand, prices of resources usually do not reflect their scarcity, and so resources must be allocated by plan, a fact that directly affects productivity.

In Europe resource efficiency in agricultural sector is frequently undermined by heavy farm production subsidies, both with trade barriers and direct budgetary expenditures. The United States is by no means unique among market-oriented countries in failing to adjust agricultural policies properly.

Common Market countries’ agricultural policies drive prices one fourth above world market levels on most products. Such subsidies hurt not only domestic consumers but also exporters of developing countries who could produce more efficiently and sell cheaper. The policies have the aim of preserving and sustaining the farm sector and its way of life. Cut the goal could be equally well served without the damage caused by price distortions if governments substituted direct income transfers for agricultural price supports.

Western nations, nonetheless, have long satisfied basic and fiber needs, and government policies have played a major role in this success. When policies such as minimum price supports are introduced in order to ensure food security and stabilize markets—this is, when supports are set below international market levels—they can be useful. When supports exceed world market levels, however, they interfere with trade, stimulate environmentally disruptive over production, waste taxpayers’ and consumers’ money. These distortions, like their more pervasive counterparts in planned economies, have political motivations that may well be worthy. But their impact on environmental and economic sustainability cannot be ignored. Ultimately, they become counterproductive. (