Robert Nadeau is a full professor of environmental science and public policy at George Mason University. An intensely interdisciplinary scholar, Nadeau has attempted throughout his career to bridge the knowledge gap between what British physicist and novelist C. P. termed the two-cultures of humanists-social scientists and scientists-engineers.

• An Introduction to Ecological Economics
• Capitalism 3.0: A Guide to Reclaiming the Commons

Environmental Economics

Environmental economics, the orthodox approach to positing economic solutions to environmental problems, is taught in universities and practiced in government agencies and development banks, and virtually all of these solutions are based on the mathematical formalism of general equilibrium theory. This formalism obliges environmental economists to assume that production and consumption does not alter the material substances out of which goods and commodities are made. The creators of neoclassical economists arrived at this assumption after they substituted economic variables for the physical variables in the equations of a mid-nineteenth century theory in physics.

The resulting formalism obliged these economists to claim that there is symmetry between production and consumption in an immaterial energy field of utility in which lawful or law-like mechanisms govern and control decisions made by economic actors and determine the value of goods and commodities.

This explains why there is no basis in the mathematical formalism used by environmental economists for representing economic activities as physical processes embedded in and interactive with natural processes. The environment in this formalism has value only as environmental goods, services and amenities that can be bought, sold, traded, saved, or invested, like any other commodity, in a closed market system that must, if it is functioning properly, grow or expand.

When environmental economists calculate environmental costs, they assume that the relative price of each bundle of an environmental good, service, or amenity reveals the “real marginal values” of the consumer. In the mathematical theories used by these economists, a marginal value essentially represents how much a consumer is willing to pay a little bit more of something to acquire a little bit more of something else. Note what the writers of a standard textbook on environmental economics have to say about the dynamics of this process:

The power of a perfectly functioning market rests in its decentralized process of decision making and exchange; no omnipotent planner is needed to allocate resources. Rather, prices ration resources to those that value them the most and, in doing so, individuals are swept along by Adam Smith’s invisible hand to achieve what is best for society as a collective. Optimal private decisions based on mutually advantageous exchange lead to optimal social outcomes.

In environmental economics, one of the fundamental assumptions is that optimal private decisions “based on mutually advantageous exchange” in an amorphous field of utility lead to optimal social outcomes for the state of the environment. But according to these economists, this will not occur unless the following conditions apply—the market system in which economic actors make optimal private decisions must operate more or less perfectly, and the prices, or values, of environmental goods and services must be represented as a function of those decisions. But if these conditions are met, environmental economists assume that the lawful or law-like operation of the market system will resolve environmental problems when the “prices are right.”

Arthur Pigou

Since the “right price” in neoclassical economic theory is a function of the dynamics allegedly revealed in the mathematical formalism, environmental economists assume that the results of computations based on this formalism will determine if a putative price is actually right. This explains why much of the work of the these economists attempts to represent environmental costs of economic activities in terms of prices that economic actors have paid, or are willing to pay, in order to realize some marginal benefits of environmental goods and services. This view of right prices also explains why the term “environmental externalities” has a rather peculiar meaning in the literature of mainstream economists.

Externalities are situations in which the production or consumption of one economic actor affects another who did not pay for the good produced or consumed, and externalities are viewed as either negative or positive. For example, environmental economists often cite pollution as an example of the former and preservation of biological diversity as an example of the latter. When these economists use the phrase “environmental externalities,” they are referring to environmental goods and services that are “external” to market systems in the sense that they are presumed to exist outside of the allegedly lawful or law-like dynamics of these systems.

From the perspective of environmental economists, markets fail if prices do not accurately communicate the desires and constraints of a society, and an environmental problem is a negative externality that represents such a failure. A market system is alleged to operate properly when a set of competitive markets generates a sufficient allocation of resources at a level of efficiency known as “Pareto optimality.” This term refers to a hypothetical idealized state or condition where it is impossible to reallocate resources to enhance the utility of one economic actor without reducing that of another. The assumption here is that if the natural laws of economics are allowed to maximize the private net benefits of consumers and producers with minimal restraint, a set of markets will emerge in which each economic actor will have access to a socially optimal allocation of resources.

The most traditional approach to internalizing a negative environmental externality is to impose a tax defined by Pigou in The Economics of Welfare (1932) which is presumably equal to the value of the marginal social damage associated with the externality. The aim of this tax, said Pigou, “is to ascertain how the free play of self-interest, acting under the existing legal system, tends to distribute the country’s resources in the way most favorable to the production of a large national dividend, and how it is feasible for State action to improve upon ‘natural’ tendencies.” There are, said Pigou, “natural” tendencies at work in market systems associated with the operation of the natural laws of economics and any tax imposed by the state should enhance these tendencies. He also claimed that the value of production will be maximized in the vast majority of economic situations if government refrains from interfering with these “natural” tendencies. Pigou also argued, however, that exogenous “human institutions” can interfere with the dynamics of closed market systems and, therefore, government must take some limited action “to control the play of economic forces in such ways as to promote the economic welfare, and through that, the total welfare, of their citizens as a whole.”

When environmental economists are asked to assess the potential impacts on market economies of environmental tax reforms, they typically factor a Pigouvian tax into the mathematical formalism of neoclassical economic theory. One problem with the optimal social outcomes which the calculations are intended to assess is that they are almost invariably premised on the assumption that the proposed environmental tax reforms must not impede the “natural” tendencies of market systems to grow and expand. Consequently, the calculated impacts of these reforms tend to emphasize economic losses associated with decreases in the consumption of environmental goods and services and to grandly minimize the environmental costs.

In dealing with pollution problems, environmental economists generally favor emissions charges or fees, and they often appeal to Pigou to make the case that this instrument is more efficient and effective than regulations imposed by the exogenous agency of government. They argue that these charges or fees will reduce the quantity or improve the quality of pollution by making polluters assume a portion of the costs for every unit of harmful pollution they release into the environment. The scheme is Pigouvian in the sense that the anticipated result is that the charges or fees will be equal to the marginal social damage associated with the externality. The expectation here is that firms will be induced to lower their emissions to the point where the incremental cost of pollution control equals the emissions charges they might otherwise pay. It is also presumed that if individual polluters use pollution control strategies that represent least cost solutions, the invisible hand will cause the aggregate costs of pollution control to be minimized.

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