Economic Faults

People prefer to breathe clean fresh air rather than filthy polluted air. Clean air is obviously more valuable than polluted air. Yet this basic difference in value is not captured by our financial accounting systems and the economic systems based on them.  As a result anyone is able to pollute the air—diminishing its value to all who breathe—without incurring any financial cost. Public value is converted into private profit. This is one of many examples where economic theory, and the economies we base on such theory, fail to provide a rational result. This misallocation of resources is actually encouraged by today’s financial accounting systems.

The noble goal of economics is to allocate scarce resources to where they can best be put to use. Unfortunately several basic errors in our financial accounting systems and economic theories often cause the immense power of economics and the free market to work against the greater well-being. This essay explores these errors, their consequences, and proposes remedies.

Sharing the Commons

The air we breathe, ocean waters, ocean fisheries, public beaches, wild rivers, aquifers, forests, wilderness areas, animal habitat, and mountain vistas, are all examples of common-pool resources or simply commons—beneficial areas that are shared without cost. Because the benefits of these areas can be obtained without cost, it can lead to overuse of these areas. This is called the tragedy of the commons— the depletion of a shared resource by individuals, acting independently and rationally according to each one’s self-interest, despite their understanding that depleting the common resource is contrary to the group’s long-term best interests.  Air pollution, water pollution, waste disposal, overfishing, strip mining, mountain top removal, destruction of the rain forests, clear cutting, wildlife habitat destruction, depletion of aquifers, fossil fuel consumption, mineral consumption, and even traffic jams are all examples of the tragedy of the commons in our daily lives.

Several approaches to avoiding tragedies of the commons are known. These include:

  • Individual constraint motivated by enlightened self-interest and cooperative behavior,
  • Agreements among the users to allocate or limit use,
  • Government regulation controlling access to the commons or limiting use by any single party. Permit systems for activities such as mining, fishing, hunting, raising livestock and extracting timber are examples of this approach.
  • Usage fees, or
  • Privatization of the resource.

Free access to the benefits of the commons by organizations driven by economic gain leads to overuse of the commons and failure to allocate resources efficiently. This is a basic economic fault that is important to recognize, and to analyze in terms of fair allocation of the common resource. Advocates of free market solutions and opponents of regulation are obligated to offer some fair solution to allocating use of the various commons they seek to exploit.

Adoption of the Montreal Protocol on Substances that Deplete the Ozone Layer solved a tragedy of the commons that emerged during the 1980s. Free and unregulated release of halocarbon refrigerants, such as Freon, into the atmosphere caused significant depletion of the atmospheric ozone layer. The ozone layer is important because it prevents most harmful wavelengths of ultraviolet light from passing through the Earth’s atmosphere. It is suspected that a variety of biological consequences such as increases in skin cancer, cataracts, damage to plants, and reduction of plankton populations in the ocean’s photic zone may result from the increased UV exposure due to ozone depletion. Observed and projected decreases in ozone caused worldwide concern. This concern led to adoption of the Montreal Protocol that bans the production of CFCs, halons, and other ozone-depleting chemicals

Greenhouse gasses are a form of air pollution that contributes to global warming. This is an important example of overuse of the commons—the atmosphere in this case—for economic gain—the free disposal of waste products resulting from burning fossil fuels. Those who sell and consume fossil fuels are free to release greenhouse gasses into the atmosphere, while many people, including those in future generations, suffer the costs of global warming as a result. Economic principles and the free market fail to allocate resources efficiently in this case because a valuable assist is provided free of charge.

Valuing Ecosystem Services

We all benefit from a multitude of resources and processes that are supplied by natural ecosystems. Collectively, these benefits are known as ecosystem services and include essential products like clean drinking water and processes such as the decomposition of wastes. Although these services are essential, we rarely account for their value in our economic models. For example, pollination of crops by bees is required for 15-30% of U.S. food production. If sufficient numbers of wild bees are available this can be accomplished “for free” – that is, outside of traditional financial accounting.

Failing to place an economic value on ecosystem services causes another form of economic failure. Destruction of the wild bee population, for example by Colony Collapse Disorder, can take place without any financial cost to those responsible for destruction of this valuable ecosystem service. Yet if wild bee populations are displaced or destroyed, then crops relying on bee pollination will be lost, or some costly substitute to wild bee pollination will have to be found. In either case the economic costs, as traditionally recognized by financial accounting systems, would be substantial.

Placing a fair economic value on each of the ecosystem services we rely on but do not now pay for can allow economic systems to preserve and allocate use of these valuable resources. Alternatively, regulations that protect these resources could be put into place.

Another related accounting error is also very important. Under many accounting systems, natural resources represent income that increases as they are extracted rather than capital which depreciates as it is depleted. As a result, minerals have little value until they are extracted, and their cost represents only the extraction costs, not the value of the original resource. This accounting error encourages immediate mineral extraction and does not account for the value of the original, non-renewable, resource. Even though a non-renewable resource cannot be replaced, it is assigned little value under present accounting schemes.

Paying for Externalities

In economics, an externality is a cost or benefit that results from an activity or transaction that involuntarily affects an otherwise uninvolved party. Examples include air pollution, water pollution, overfishing, coal mining, and hydraulic fracturing, often called fracking.

The owners of coal mines increase their profits by carefully distancing themselves from financial responsibility for several important externalities. These externalities include the many dangers to miners, such as equipment accidents, suffocation, gas poisoning, roof collapse, gas explosions, and chronic lung diseases such as pneumoconiosis (black lung). These dangers are born by the minors themselves, rather than the mine operations.

Other externalities reaching far beyond the mining community are the many environmental impacts of coal. These include land use, waste management, and water and air pollution caused by the coal mining, processing and the use of its products. In addition to atmospheric pollution, coal burning produces hundreds of millions of tons of solid waste products annually, including fly ash, bottom ash, and flue-gas desulfurization sludge that contain mercury, uranium, arsenic, and other heavy metals.

There are severe health effects caused by burning coal. According to the reports issued by the World Health Organization in 2008 and by environmental groups in 2004, coal particulates pollution are estimated to shorten approximately 1,000,000 lives annually worldwide, including nearly 24,000 lives a year in the United States. Coal mining generates significant additional independent adverse environmental health impacts, among them the polluted water flowing from mountaintop removal mining.

The combustion of coal is the largest contributor to the human-made increase of CO2 in the atmosphere. Electric generation from burning coal produces approximately twice the greenhouse gasses per kilowatt compared to generation using natural gas.

A major European Union study estimates that including the cost of externalities would double the cost of producing electricity from coal.

Let’s leave coal in the dust and begin to talk about natural gas production.

Typical debates on the role of fracking often polarize into arguments for more jobs and energy independence on one hand and against the environmental impacts of fracking on the other hand. Consideration of externalities can help us shift toward a more reasoned discussion of how best to pay the full costs of the externalities that will occur if the fracking proposals proceed.

The environmental impacts of fracking include potential contamination of ground water, risks to air quality, water consumption, noise pollution, the potential migration of gases and hydraulic fracturing chemicals to the surface, the potential mishandling of waste, and the various health risks due to environmental contamination of fracking fluids.

An accurate assessment of the economic potential of fracking would include payment for the full costs of avoiding or compensating for each of these environmental impacts.

Economic arguments for or against proceeding with some activity are only accurate and honest when all the externalities are internalized and are fully included in the cost analysis. Avoiding payment for externalities requires others to incur the costs for activities you are profiting from. Failing to fully account for the full cost of externalities is closer to trespassing than it is to freedom.

Acknowledging Limits to Growth

When people talk about economic growth or the strength of the economy, they are often talking about the rate of growth of the gross domestic product (GDP). The GDP is a primary measure of a country’s overall economic output. It is the market value of all final goods and services made within the borders of a country in a year. For example, the GDP includes:

  • The costs associated with growing, harvesting, transporting, storing, and processing tobacco.
  • The costs of manufacturing, distributing, advertising, and retailing cigarettes and cigars.
  • The costs of doctor’s visits, medications, hospitalizations, and chronic care treatment for smoker’s cough, emphysema, and lung cancer.
  • The costs of FDA tobacco regulations and tobacco-related law enforcement costs.
  • Tobacco-related litigation costs,
  • The costs of advertising health warnings.
  • The costs of anti-smoking campaigns and stop smoking programs and products.

Each of these activities actually helps to grow the economy and create jobs even as they contribute to the misery of the unfortunate tobacco addict. Wouldn’t a leisurely hike with friends through the woods ending with a spectacular view of a beautiful sunset be a better way to spend time? But enjoying the splendor of sunsets does not help to grow our economy while dying a painful death from lung cancer does.

War, car accidents, chronic illness, cancer, and many other tragedies all contribute to economic growth and increasing the GDP. It is time to choose a wiser measure of progress. Despite the ubiquitous and unequivocal praise for growth among economist and politicians, there are always limits to growth. Assumptions of unlimited growth are false and dangerous.

An emphasis on more, including increasing the GDP, growing the economy, and a relentless focus on increasing stock prices has brought us: the subprime mortgage crisis, housing foreclosures, Enron and other accounting scandals, wars, hydrogen bombs and other nuclear weapons, the Holocaust and other acts of genocide, slavery, traffic jams, urban sprawl, the bridge to nowhere, wide-spread cheating, Vioxx and other dangerous prescription drugs, Twinkies, obesity, stress, anxiety, class struggles, pollution, paparazzi, deforestation, strip mining, overfishing, drought, failed states, global warming, and other waste, violence, destruction, and misery. We have become consumed.

Adam Smith never imagined how greedy the invisible hand would become. It is time to change our focus from economic growth to growth in human well-being.

We live in a world with ever-increasing levels of financial debt—public and private. We are also depleting the earth’s natural resources, including fresh water, fertile soil, forests, marine ecosystems, biodiversity, fossil fuels, minerals, waste dumps, and pollution sinks. Since debt represents a promise of future repayment of labor and resources it is inevitable that the aggregate promises to repay will eventually exceed the available resources for repayment. In fact, that may have already have happened.

However, in the economies of affluent nations, competition stimulates technology improvements that increase labor productivity to reduce costs. As labor becomes more productive, fewer people are required to produce the same goods. This would lead to unemployment unless demand grows at the same rate as labor becomes more productive. If growth stops, unemployment increases, household income drops, demand drops and the system collapses toward recession.

This presents the dilemma of growth:

  • Growth in its present form is unsustainable — unbounded resource consumption is exceeding environmental capacity, and
  • De-growth under present conditions is unstable — reduced consumer demand leads to increased unemployment and the spiral of recession.

A solution to this dilemma is essential for future prosperity.

We can begin to see a solution in the “Green new deal”. People need jobs and the world needs to manage a transition to sustainable energy. These two goals can be met simultaneously by directing investments away from opulent consumer goods and toward low-carbon systems that reduce climate change and increase energy security. In addition investments in natural infrastructure including sustainable agriculture and ecosystem protection provide long-term benefits. The engine of growth becomes creation and operation of non-polluting energy sources and selling non-material services. In addition, delivering the benefits of labor productivity to the workers would allow them more leisure and less stress as they enjoy a shorter work week.

Humans are Complex Actors

A key assumption in economic theory is that humans are rational actors. In most economic theory humans are modeled as homo economicus, or the rational economic human. This simplistic assumption is easily criticized and very often false. Economic anthropologists have demonstrated that in traditional societies, choices people make regarding production and exchange of goods follow patterns of reciprocity which differ sharply from the homo economicus model. Real humans face uncertainty and risk with only bounded rationality. Studies have shown that investors appeared as very risk-averse for small losses but indifferent for a small chance of a very large loss. Simplistic homo economicus models place excessive emphasis on extrinsic motivation as opposed to intrinsic motivation and ignore the inner conflicts that real-world individuals suffer, as between short-term and long-term goals or between individual goals and societal values.

A truly rational actor would be unlikely to choose to use tobacco products, yet the tobacco industry continues to profit from the sale of one of the most widely used addictive substances in the world.

The growing field of behavioral economics studies the effects of social, cognitive, and emotional factors on the economic decisions of individuals and institutions and the consequences for market prices, returns, and the resource allocation. This work directly contradicts a simplistic rational human model.

Money is Power

Money is a source of great power, especially to those who benefit from the status quo. Money exerts its immense influence in politics as lobbying efforts, campaign contributions, policy institutes, and political action committees all use money to distort the people’s voice in democracy.

Money influences research topics, research grants, publications, and curricula in academic institutions.

Big oil, large pharmaceutical companies, agribusiness,  mass media, the fashion industry, cosmetics industry, music industry, and financial services industries, automobile companies, airlines, and other large corporations use their dominant market positions and huge economic impacts to influence what we see, what we like, our buying habits, public opinion, and government policies.

Yet so much of this influence and power is based on economic faults.

An Inaccurate Model

Economics is an ideology with a simplistic yet incorrect premise that needs to be refined and updated.

It is essential to distinguish between economies—the exchange of valuable goods and services—and economics—a money-based model of an economy. Fractional reserve banking, debt-based currencies, and all of the faults in economic models described here allow the two to diverge significantly. As a result, our financial accounting systems are giving us false signals.

Economies are real, economics is a conceptual artifice. The two have diverged. The gap is getting wider. The gap must be closed.

Taking Action

Arguments defending the status quo or advocating expanding operations are often based on a promise of economic benefits and growth. Statements such as “drill baby drill” are often simplistic attempts to distract us from considering a more complete and accurate analysis of the externalities, benefits, risks, losses, costs, and other options.  Learn to identify the faults in these arguments and move the discussion toward identifying and preserving the commons, valuing ecosystem services, identifying and paying fully for externalities, acknowledging limits to growth, dispelling myths about humans as rational actors, and counteracting the power of money.

Compel advocates of economic systems, economic solutions, and free market mechanisms to identify and correct each of the errors in their arguments, presentations, plans, and actions.

What if more of us had the wisdom to shift our focus to what is truly most meaningful in life? What if we decided we had enough of the old thinking and decided to value: peace of mind, integrity, tranquility, clean air, clean water, the beauty of nature, a healthy environment to enjoy now and sustain for the future, awe, family, friendships, community, safety, stability, trust, leisure time, joyful play, meaningful work, authentic experiences, reciprocity, respect, good health, reduced stress, ongoing education and learning, deeper understanding and appreciation, fun, enjoyment of the arts, transcendence, and making significant contributions that help others. We can enjoy what is already available to us.

Focus on what matters. Choose the greater well-being over mindless growth. A first step is to examine our definitions of prosperity. A shift away from prosperity pursued as opulence — constantly acquiring new material satisfactions — and toward prosperity enjoyed as flourishing — deep and enduring satisfaction and well-being —  allows us to consume less while we enjoy life more. Learn to cope with abundance. Create wiser alternatives that improve the greater well-being.

We all must work to bring wisdom to life.

8 thoughts on “Economic Faults

  1. Pingback: Environmental Stewardship & Economic Growth aren't mutually exclusive

  2. Great post, Lee. In light of the post itself, the great comments so far (by Alan, Ian, and Ronnie), and the question of how to address these problems by way of improving academic philosophy, then via that, academia, and then (so on and so forth), and action, it would be interesting to consider the entries on “Philosophy of Economics” in, for example, The Cambridge Dictionary of Philosophy or (online) The Stanford Encyclopedia of Philosophy. In other words, given these sorts of problems and confusions in our mainstream approaches to economics, what — may we ask — is the “Philosophy of Economics” actually doing about them? I haven’t read the entries yet, at least not recently, so I’ll be curious to do that, to see what’s up. It would be quite interesting to talk to one of the more prominent philosophers of economics, to hear what she or he might have to say.

    On another note, regarding Lee’s post, although it is an excellent post, there are a few places in which you, Lee, seem to accept (to a degree, anyhow) the quantification/financialization of value as long as no value(s) is/are left out. In other words, as the story goes, let’s place a quantified value on “ecosystem services”, then our “accounting systems” will make sure the “market” values such things appropriately and doesn’t take them for granted. Well, I get it, of course, and that approach is certainly better than continuing with the immense gaps in our present accounting, and yet I don’t think that the quantification/financialization of all value(s) is possible or a good idea. There are some things we just have to say ‘no’ to, and regulate by other means, rather than “valuing” all “resources” and all “services” and then letting the “market” do whatever it does. I imagine that you’d agree. Indeed, even the words ‘resources’ and ‘services’ are telling. Are fish to be understood solely or even mainly as “resources” for humans, or as “services” for human use? Will it really be sufficient to “account for” the “cost” of the “resource” fish, or the service “fish”, in order to make sure that human “prices” fairly and accurately (whatever that means?) reflect the true cost of fish? I’m a bit concerned that the whole terminological paradigm perpetuates a problem in the way we think about these things. Of course, practically speaking, acknowledging and reflecting the “value of” fish in some way is better than not doing it at all, but there is much more to it than that, of course.

    Finally, I’ve been doing some work on the matter/issue of growth — much more to do — so stay tuned.

    So now what? As mentioned, I’ll be interested to read the entries on Philosophy of Economics. And then …

    Cheers and Be Well,


    • Jeff,
      Thanks for these comments.

      Perhaps it is useful to describe various generations of economic theories. “Economics 1.0” was useful in getting us through the industrial revolution by providing a basic theory to account for the value of the new things that were getting done. My essay proposes an “Economics 2.0” that “counts everything.” You envision an “Economics 3.0” (or perhaps an “anti-economics”) that captures a more fully conceived representation of all that we can distinguish. A fish is so much more than the price of a fish.

      An important question then becomes “How do we best balance the tension between ‘good enough’ and ‘as good as it could be’?”

      In new product development there is always a natural tension between the “doers” and the “dreamers”. The doers say, “We can do this today, let’s get that value out to people quickly for them to enjoy now.” The dreamers can always see a grander concept that could be provided with some more time, vision, thought, innovation, leadership, and development work. Consider the evolution of Television as an example. We went through: 1) black and white TV with rabbit ears, 2) color TV with rabbit ears, 4) Cable TV, and now 4) HD TV. It is likely that many people sat in front of their generation 1.0 TV sets and dreamed of today’s flat screen, high resolution, vivid color HD TV’s. But there were immense technological hurdles that had to be overcome to allow today’s TVs to be built. Generations of people would have been denied the joys of watching “Leave it to Beaver” and “I love Lucy” if the dreamers prevailed entirely over the doers. No one would be watching football on their 80 inch HD TVs today if the doers prevailed entirely over the dreamers.

      So is it better to deploy Economics 2.0 as I describe it or do we withhold or skip over that evolutionary step to deploy the Economics 3.0 you begin to describe? What limits the rate at which economic models evolve? Is it technology, lack of vision, rates of learning, limits of human conception, investment in the status quo, or something else?


  3. Excellent piece, Lee!!!

    I especially like:

    “A key assumption in economic theory is that humans are rational actors. In most economic theory humans are modeled as homo economicus, or the rational economic human. This simplistic assumption is easily criticized and very often false.”

    One challenge for philosophers is to explore the meaning of “rationality” in this commonly-made assumption about what sorts of beings humans are. In Debt: The First Five Thousand Years, David Graeber tells us “the word ‘rational’ is telling: it derives, of course, from ‘ratio’–a sort of mathematical calculation previously used by architects and engineers, but which, with the rise of markets, everyone who didn’t want to get cheated at the marketplace had to learn how to do” (p. 238).

    A strong tendency we share with our primate relatives is an overriding concern with our own status relative to those of the others within our social groupings (much of what apes and monkeys spend their time doing, grooming, threatening, distributing food, etc. seems intimately related to who can claim dominance over whom). The centrality of “ratio” in our thinking, I think, can be attributed to this emotion-imbued fascination with our places in social hierarchies. And with the development of mathematics and the ability to quantify uniform “units” of value in the symbolic language of monetary exchange, we clever humans acquired the perfect tool for measuring this important “ratio,” our own value relative to the others in our social sphere, calculated down to the very last penny.

    What kind of conceptual model is inherent in this of “rational-actor” thinking? Perhaps I’m overly sensitive to it now, but I find the billiard ball again. Trying to model his ethical/political theory on the newly successful Newtonian physics, Thomas Hobbes conceived of us as punctate individuals, unconcerned about one another’s welfare, rather entirely motivated by self-interest, pursuing whatever each might happen to construe as “good” in keeping with his desires of the moment; since these disconnected individuals would often, like colliding billiard balls, come into conflict with one another in the pursuit of these “goods,” ethics was negatively conceived as essentially a matter of powerful authority intervening to block one party from intruding upon what was the “right” of another.

    Much of the recent literature in primatology (as well as cognitive science and other fields) points out that we may well be, on the one hand, self-interested, as self-maintaining organisms must be, but that we are also highly social going way back in evolutionary time, and therefore also inherently empathetic and cooperative beings; the completely disconnected, billiard-ball model of human nature that Hobbes employed is wrong, and dangerously misleading if we ensconce it as metaphysically fundamental to the way we envision the world. Yes, some of the time we act for our own individual benefit, but this is normally balanced by an opposite tendency to act for the benefit of other individuals and the social group as a whole (de Waal has called this latter “community concern,” Good Natured p. 207). I would attach (if I could–I don’t seem to have the tools for it here) images of two competing models for conceiving of ourselves, one useful in this regard being the “Democritean” picture of punctate masses actually imprisoned within “voxels” that prevent their interaction (from Daniel Dennett’s Freedom Evolves, p. 31), and the other the contrasting picture Milgram sketched to illustrate the spheres of social influence acting on each of us human individuals, showing what gets left out–indeed, is ruled out–by the “billiard ball” model standing alone. We are indeed “complex actors,” not solely “rational” ones based on an impoverished notion of “rationality” that underwrites the one-upmanship of thrusting the punctate self above all the other “social atoms” in the theoretical ant-heap. Biology doesn’t work that way; humanity could never have developed the kind of “civilization” (for good and for bad) as it has without its social interconnectedness. But blind adherence to this reductionist model at the foundation of economic theory is leading to severe dysfunction in our actual economies, as Lee rightly distinguishes above.

    In response to Lee, Alan observes “economic rationalism in turn arises from philosophical rationalism rooted in definitive logic.” I would like to hear more analysis in this regard. Val Plumwood and Richard Routley have also criticized the dualistic thinking inherent in classical logic, and specifically with respect to its ultimate effects on how we treat out “environment.” As Plumwood characterizes it, “[i]n classical logic, negation (-p) is interpreted as the universe without p, everything in the universe other than what p covers, as represented in the usual Venn diagram representing p as a figure surrounded by a square which represents the universe, with p as the remainder . . . In [this diagram], p penetrates a passive, undifferentiated universal other which is specified as a lack, which offers no resistance, and whose behaviour it controls completely. There is no room here for the complexities of the dance of interaction between the one and an independent other” (Plumwood, Feminism and the Mastery of Nature, pgs. 56-57). This seems to take us back to disconnection and one-upmanship again. Does this mesh with what you see as the flaws in what you’re calling “definitive logic,” Alan?

    Best regards,

  4. Hi Lee, lots of good stuff in there.

    That failure to focus on what “matters” as opposed to what can be “accounted” arithmetically, I have taken to referring to as “Autistic Economics” …. a tendency to cling to “economic rationalism” as Alan has just tagged it. Note also that the tendency for economists to stick to the faulty model is exactly analogous to Nicks “Scientific Neurosis”.

    (Einstein of course also said “not all that counts can be counted”.)

  5. A very fine summary of some of the iniquities that arise from economic rationalism, Lee. I think it’s important to recognize that economic rationalism in turn arises from philosophical rationalism rooted in definitive logic. Until and unless academic philosophers admit to and correct the flaw in their foundations, they will have nothing useful to contribute to the socioeconomic reformation that is so desperately needed. They will simply come across as pots calling the kettle black while insisting on using the same dirty language as those they spout off about.

Leave a Reply

Your email address will not be published. Required fields are marked *