We need to look beyond the market to beat climate change

This essay has won the Political Economy Club prize

The 21st century appears to present humanity with huge challenges. Climate change will, if unaddressed, lead to significant social, economic and political disruption. Dealing with climate change appears only slightly less economically catastrophic, requiring an overhaul of the market-based growth model which has served as the basis of global policy for the past 40 years.

Thomas Malthus and David Ricardo are giants of classical economics. Their framing of the issues around the relationship between the economy and nature, and the role of markets in pricing costs and benefits, continues to inform mainstream thought.

This essay argues that these stylised facts are not incidental. Notwithstanding the powerful insights of Malthus and Ricardo, the crises which would appear to afflict humanity in fact result from its imprisonment within the lens, and only the lens, of classical economic thought. The alienation of humanity from nature in the thought of Malthus and Ricardo is precisely the process by which the climate crisis has emerged. The attempt to react through market pricing of natural constraints is precisely what is preventing its resolution.

Markets and nature: the classical view

Malthus and Ricardo are broadly in agreement on the natural constraints on human wellbeing. Malthus’s Essay on the Principle of Population recounts his opinions on the subject, and Ricardo is gushing in his “admiration” of it. Malthus’ stark description of humanity’s problem is the regularly quoted line: “Population, when unchecked, increases in a geometrical ratio. Subsistence increases only in an arithmetical ratio. A slight acquaintance with numbers will show the immensity of the first power in comparison of the second.”

The “checking” of the population must occur through poverty and disease, the grim fate to which Malthus rhetorically condemns humanity. In his introduction, Malthus states these as immovable constraints of science. Much of his essay, however, consists in justifying his pessimism through a decidedly bleak theory of human nature.

While acknowledging that reason might lead to restraint on “the passion of the sexes”, contemporary social organisation disincentivises this: “In a state of equality, this would be the simple question. In the present state of society, other considerations occur. Will he not lower his rank in life?”

His pessimism, however, is about humanity per se, not social conditions. He is scathing of attempts at social reform, including the poor laws, for making the poor less frugal. He dismisses any possibility of a more egalitarian society because “the temptations to evil are too strong for human nature to resist”. Malthusian limits do not have their genesis in nature but in humanity itself. The essence of his thesis is that humans are irredeemably self-destructive.

Ricardo also broadly shares Malthus’s analysis of the resulting economic dynamics. His masterful exposition of this is a string of microeconomics’ greatest hits, of which many subsequent productions have been respectful covers: the law of one price, diminishing returns and marginal pricing.

As more land is cultivated, diminishing returns set in. This drives down the (marginal) return to agricultural capital and, since capital must attract the same return in all sectors, in the whole economy. Rent, on the other hand, rises because of the profit on inframarginal units. The disagreement between Malthus and Ricardo on the issue is ostensibly about the corn laws: whether, faced with this problem, it was better to reduce agricultural production, driving up returns to capital and benefiting industry, or to preserve agricultural production, supporting rural economies.

What this account masks, however, is Ricardo’s optimism about the potential of market mechanisms to optimise human welfare subject to the constraints Malthus identifies. As a result of the market mechanisms, “capital is apportioned precisely, in the requisite abundance and no more, to the production of the different commodities which happen to be in demand”.

The primary difference of perspective between the two is that Malthus is preoccupied with his dismal diagnosis of human awfulness and Ricardo is focused on the potential of mechanism design to alleviate the human condition.

They are united, however, by a shared view of the relation between nature and the economy. Malthus despairs of its implications; Ricardo seeks to price it. But both, in the language of modern microeconomics, “take nature as given”. They see it as external and separate to humanity, and valuable only instrumentally.

In Marxian terms, they “alienate” nature. Where Marx emphasises that humans are in “continuous interchange” with nature and “reproduce” nature through the productive process, both Malthus and Ricardo regard nature purely as a constraint on wellbeing. Marx identifies exactly the pitfalls of this approach with the concept of “commodification”, where our environment is transformed into a series of congealed “commodities” which obscure the natural and labour processes involved in production.

Markets and nature in the 21st century

With the benefit of more than 200 years’ experience, it is now possible to say that Malthus was wrong about the natural limits on the growth of human consumption. Technological innovation and new social organising principles have enabled breathtaking progress against poverty. The reasons he was wrong are instructive for today.

First, population need not grow geometrically. The chart below shows the historical and projected world population. Contra Malthus’s iron law of population growth, the past 30 years approximate an arithmetic sequence. The central forecast is for population to level off, reaching a maximum by 2100. Why has this happened? Partially, modern contraception allows a more complete decoupling of reproduction from “the passion of the sexes”.

This is not the whole story, however, since some contraception technology has existed for longer than its alleged impacts on fertility. Moreover, this was only part of Malthus’s argument, as he also thought that economic incentives cut against reducing the rate of reproduction.

An important development has been the effect of industrialisation in transforming the economics of reproduction. Contrary to Malthus’s assumption that incentives would always be for large families, Hanushek shows that where human capital development matters, incentives become more complicated.

Additionally, revolutions in the balance of power between genders and the nature of industrial employment both affected and gave significance to the economic incentives facing women.

Furthermore, agricultural yields need not grow arithmetically. The chart below shows that in the past 200 years, technological progress in agriculture has been typified by something approximating geometric, rather than arithmetic, growth. This was the result of a series of scientific breakthroughs including the “Green Revolution”.

Malthus was wrong on two counts, in two different ways. On population growth, he underestimated the potential for technological, cultural, social and ideational change to revolutionise the relationship between the economy and fertility. On agricultural innovation, he underestimated the power of market pricing to generate a loosening of nature’s constraints. 

The latter has come at significant cost, however. When humanity is alienated from its relationship with nature, and this relationship is congealed into a series of defined and priced agricultural commodities, the forces of competition drive towards constant degradation of the environment which sustains our existence in the service of higher short-term production, and social and cultural forces which might provide a counterweight melt away.

The interaction of humanity with nature becomes increasingly mediated by the profit motive, and nature itself is reduced to an inconvenient check on ever-increasing production and consumption. In practice this means deforestation, habitat change and degradation of ecosystems. 

Another cost of our estrangement from nature is the climate crisis. Much in the same way that pricing the agricultural sector only in terms of output leads to the degradation of arable land, pricing the energy sector only in terms of output has led to the degradation of our atmosphere. Just as in 1792, what appears a pessimistically hard limit is actually susceptible to transformation through technological and social change: lab-grown meat, digitally engineered vegetables, solar panels, electric cars. For as long as nature is treated as a simple inconvenience, however, this will not happen.

The Ricardian solution to climate change is to correct the “market failure” by incorporating the nefarious effects of carbon emissions via a tax or quota system. This has been studied academically; versions have been implemented across the world including in the EU, Australia, and Japan. It was a key plank of the recommendations of the influential 2006 Stern review in the UK.

The theory is seductive: since the current global economy does not incorporate the social costs of carbon, either the price mechanism must be “corrected” through a tax or a new market in a quota-plus-cap-and-trade must be established. We can then revert to using market mechanisms to price natural constraints on human welfare.

This argument misses four considerations. First, climate change is not one market failure but several. A summary list includes the public good of alternative transport and energy infrastructure required to enable demand for more sustainable consumption; the numerous market failures included in the development of new technology; incomplete capital markets which impede investment in switches to green technology; market failures involved in cultivating the skills required to facilitate this transition and so on.

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In other words, the extent of the economic transformation implicated in bringing economic development into harmony with nature is such that it touches every aspect of government policy which currently exists to correct other market failures. 

Secondly, market pricing of the costs of technological development and usage is difficult (read: almost impossible) in the presence of dynamic inefficiency which creates chaotic systems. In climate change economics, this occurs due to path dependency and learning-by-doing (or “the experience curve”).

Here I give one important example: the development of electric vehicles proceeded parallel to those using the internal combustion engine until a series of developments, including a collapse in the price of gasoline and the invention of the electric starter, gave petrol cars an advantage in the early 20th century. Once there was a clear advantage, these attracted research and development effort, experience accrued in manufacture and electric cars suffered additional relative setbacks due to infrastructure tailored to their competitors.

The true “marginal cost” of using petrol cars in the 1910s was therefore discontinuous at the level of demand which tipped incentives in favour of these developments, and there is no particular reason to think that any tax or quota system could encompass these considerations. Analogous arguments can be made to the adoption of renewable energy today. 

Thirdly and relatedly, this chaotic calculus gives rise to Knightian uncertainty in the private sector during the shift from fossil fuels to renewables. Specifically, where small changes in regulatory frameworks and incentives have outsized effects on the subsequent development of industries, forming opinions about the probability distribution of the benefits of investment is difficult. And where beliefs about risk cannot be formed, they cannot be priced or diversified (even in the presence of a tax or quota system).

This is why Mariana Mazzucato, the economist, emphasises the role of the state in both providing a clear and stable regulatory framework and direct financial support to innovative technology throughout its early stages of development. This goes beyond R&D to aspects of the production process (for example, Teslas have been produced in a factory constructed with loans backed by the US Department of Energy). 

Finally, notwithstanding these practical problems, if the climate crisis were solvable through incorporating the cost of carbon into a market mechanism, this would not solve the fundamental problem of humanity’s alienation from nature.

This might have material effects on the quality of policy, if a rush to reduce carbon emissions causes us to neglect the natural risks inherent in the use of nuclear power or the potential degradation of ecosystems and habitats through the overuse of hydroelectric or wind power. Just as a revolution in the social and economic role of women and industrialisation dissolved the trade-off between economic progress and population sustainability, so a shift in the place that nature takes within our material existence and understanding of wellbeing is required to dissolve the trade-off between economic progress and natural sustainability.

What does this look like in practice? Government institutions should begin to target environmental sustainability directly. In central banking, this means that quantitative easing would focus on reducing the cost of capital to businesses embodying the “triple bottom line” (profit, people and planet) principle. In the financial sector, regulatory bodies ought to make it clear that ESG (environment, social and governance) considerations need not conflict with a manager’s fiduciary duty, and investors should then foreground ESG.

This principle should expand outside of finance, to all aspects of production and consumption and to all of society. This must engender a cultural shift in which sustainably produced goods, services and “the mend economy” become as central to the typical high street as convenient low-cost consumption is now.

Markets, nature, and ethics, the post- (or pre-) classical view

Markets, as Ricardo showed, are immensely powerful institutions. Subsequent research has formalised many of his arguments on efficiency, compensating differentials, the value of international trade and the efficiency of capital markets.

The prison of classical economics is not that it advocates for the power of markets but that it reduces all economic questions to questions of markets and incentives, and not values and culture. This, I have argued, is a mistake. In taking human nature as given, Malthus failed to predict the revolution in attitudes towards fertility. In assuming that natural constraints can be appropriately priced, Ricardians midwifed the climate crisis.

In some ways, I advocate a return to the worldview of Adam Smith. Although known for his “invisible hand”, Smith’s opinion of humanity went well beyond bending selfishness to the greater good. Where Malthus was pessimistic about humanity, Smith believed that a human has “an interest in the welfare of others, and make[s] their happiness necessary to him, even if he gets nothing from it but the pleasure of seeing it”. He sees a motivation for human behaviour beyond market incentives.

Furthermore, unlike Malthus, Smith recognises the partial malleability of human morality: “custom and fashion” can work in favour or against our innate ethical outlook. This is not an idealist’s charter. The importance of Smith is that he placed market mechanisms in their context as one of many drivers of human action.

With this perspective, we can see the limitations of Malthus and Ricardo: institutions, including markets, are only one tool which shapes the world; human behaviour is partially socially determined; and, consequently, our harmonious relationship to nature might be reinstated through means other than the market mechanism. Indeed, given the analysis above, it must.

Joe Spearing is a PhD student in the economics department at the University of Georgia. He previously worked in the financial sector, as an associate director in the economics team at Record Currency Management

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