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Management in Practice

Can we afford sustainability?

If sustainability is understood as the continuation of human life on earth, there is no alternative. Whatever the cost, we have to bear it. But how do we determine the right price to pay right now to ensure survival in the distant future?

  • Richard Kauffman
    Lecturer in the Practice of Management; Chairman of Energy & Finance for New York, Office of Governor Andrew M. Cuomo
  • Robert O. Mendelsohn
    Edwin Weyerhaeuser Davis Professor of Forest Policy & Professor of Economics
  • Gretchen Daily
    Professor, Department of Biological Sciences, Stanford University; Chair, The Natural Capital Project

Q: How do you think about the question, "Can we afford sustainability?"

Robert Mendelsohn: One thing that's going to be very interesting is coming up with a definition of what we mean by "sustainability." Economists have a very clear idea of what they mean by sustainability, but it's not always consistent with what you might see in the natural sciences. For an issue like pollution, a sustainable pollution control is one where the marginal cost of abatement is set equal to the marginal damage of pollution. It would be nice to get rid of all pollution, but it turns out it's very expensive to eliminate it entirely. So this idea of balancing the abatement costs against the damages is a critical way that economists would look at sustainability in trying to minimize the total cost to society.

When it comes to other issues, like the management of natural resources, such as fisheries or forests, I think the economists and the biologists might have a very similar definition, where sustainability means that the resource can sustain itself over time. In other words, you're getting a level of harvest that you could maintain indefinitely.

Looking at the question, "Can we afford sustainability?" with this definition of sustainability, we can't afford not to be sustainable. That is, choosing not to be sustainable is to choose a worse outcome. And so we definitely can afford it.

Q: Could you talk for a minute about how you use economic modeling to try to project the effects of current decisions over long periods of time?

Mendelsohn: I just mentioned that economists want to balance the costs and benefits of abatement, but, historically, all we knew about was costs. As a result, economists had this negative view, saying, well, it's too expensive to protect the environment. But in the last 30 years, economists have been working very hard at trying to measure the damages that are associated with things like pollution or, to put it another way, the benefits of protecting the environment, so that you could weigh those benefits against the costs. I personally have been studying that very issue, trying to put together a model that actually follows what pollution does in the environment, from the moment it's released to the final consequences of that pollution. By following that through, you can link an actual emission to its final consequences to society and put a value on those final consequences, and then come back and put a value on the emission itself. And that ability to measure just how harmful particular emissions are is going to be very useful over time, in terms of trying to design more efficient regulations.

Q: Kevin Curtis, does this question inform what you do when you're looking at policy?

Kevin Curtis: The relevance of sustainability to our work — and, I think, a real advantage of it — is in the area of process. So much of the environmental policy debate over time has been presented as a zero-sum game, where it's economic growth versus environmental protection. The definition of sustainable development has provided a big step forward. There are multiple definitions, but the version I like best is one that says economic growth, environmental protection, and social justice are all important — and sustainable development is about doing all three. It may strike some just as a semantic difference, but I think it's a very fundamental difference. Instead of pitting all three against each other, you say, look, all three are important. That's what leads to a sustainable society and a sustainable economy and a sustainable environment. And then what all of us need to do is engage in discussions and decision making around how to triage and how to pursue progress on all three. But it's no longer ideological fights or political fights, one versus the other.

Q: Is there something about this concept of sustainability that makes it easier for you to communicate to different constituencies?

Curtis: Absolutely. It allows the Alliance to work with businesses. It allows us to work with other nonprofits and say that environmental protection, economic development, and social justice are goals that we all share. It's not saying that my goal of environmental protection is more important than your goal of economic development. It sounds simplistic, but it can profoundly change the discussions.

Q: Professor Daily, do you as an ecologist define sustainability differently than the economists do?

Gretchen Daily: I have long been brainwashed by economists, so there isn't any difference there. Indeed, I think what we need is an integrated approach. There are a lot of people in the biophysical sciences now who have worked extensively with people in economics, with the goal of integrating approaches and developing a way of clarifying the values of living, natural capital.

If we think about ecosystems as a type of natural capital, then the big question is what benefits society derives from that sort of living, natural capital — from land, freshwater systems, oceans, and so on. And if you do that, just thinking about what those benefits are — whether it's the provision of commodities that we consume directly and have traditionally traded in markets, like food and timber, or whether it's things we're just now starting to develop more formal institutions around, like climate stability or purification of freshwater supplies or provision of flood control, or intermediate services like pollination of agricultural crops, which is critical to the production of about a third of the calories that people consume — if you start to parse those things out, then the key issue in asking whether we can afford sustainability gets down to how we value those things.

Where we need to head is toward defining the production function around these different benefits or services that we get from natural capital so that we can understand better how a change in the environment might cause a change in the supply that we experience. An example would be how reducing forest cover in the upper reaches of the Yangtze River basin likely enhanced the flood risk in that river system.

But we need a much better understanding of these production functions, of how the aspects of these systems affect their ability to supply society with benefits. And then, with these production functions, we can project scenarios of change into the future, whether changes of policy and the ways that land and water resources are managed or changes in climate, and see how those scenarios of change will affect the production of ecosystem service benefits in both biophysical terms and in economic terms. There's a lot of work going on now to advance this type of integrated approach.

Richard Kauffman: I think that the points that have been brought up are excellent, and they point to the purpose of capitalism and the need to have a broader perspective when looking at capital costs. In other words, the genius of capitalism is connecting providers of capital with entrepreneurs, business owners, to invest in activities to generate returns in excess of the cost of that capital. In so doing, two things happen: One is that those that provide the capital get paid a fair rate of return, and then value is created in excess of that cost that creates wealth for society. That all works fine, as long as one looks only at very narrow financial measures. So the point that is emerging here is about considering the other capital costs that are being incurred — whether degradation of the environment or of human capital. Intuitively, I'd say that we're in a period now where we're generating positive returns on financial capital, but we're in liquidation or value destruction in terms of a broader meaning of capital.

If we had an aggregated model, and we had the data and the analytics to incorporate a broader view of capital, then the capitalist model ought to work. We ought to then be able to allocate capital appropriately. Right now it's being allocated inappropriately, and it's hard for market forces to work because some things are being measured and some things aren't being measured. Another problem with the disaggregated model is that corporations, as an example, do what investors tell them to do. And what do investors look at? Investors in the main look at financial measures. They are not looking at nonfinancial measures.

Q: Is that changing?

Kauffman: There are sustainability annual reports, there are metrics which companies can prepare which say something about their effect on the environment, or what they're doing with their employees, or what impact they're having on their suppliers. And we can imagine a whole set of metrics that could be included that are relevant to resource use. But these reports are the exception rather than the rule and so-called sustainability investing among public investors is a tiny percentage of the money under management.

But right now the problem is that a company can put out a sustainability report, but without a really robust asset management industry that cares about this, it's not going to have much traction. The problem right now with the asset management industry is that it's just that, it's just an asset management industry. It's not an asset-liability management industry. We know that many of the things we're talking about are going to eventually show up in financial costs, or in some kind of future liability, but if investors are not taking that into account today, then the market forces are not going to act or not going to impinge properly on corporate actors.

Mendelsohn: The problem is that a lot of the services that the environment gives us, we all share together. As a result, because they're shared goods, they're not things the market itself can provide. This is where we need the government to interact with the economy and give us prices for things like pollution or the conservation of important resources that will reflect these public values that aren't going to be visible in the marketplace.

Curtis: To build on my point earlier, if you get people around the table to agree to the concept of sustainable development, you can then have a much more rational conversation about measuring the costs that fall outside current measurements. That's still very hard economics — hard politics, too — but you can then start doing it.

Mendelsohn: You're right. Then you can create this balance that you want to see between economic development and protecting the environment. You could see those forces balancing rather than being choices.

Daily: There is a lot of policy change underway now at the national government level around the world that tries to accomplish this.

I'll just give a couple of examples in the area of natural capital. In Colombia, the government has just redone all of their resource licensing and mitigation requirements, and going way beyond pollution, they're looking at all aspects of value that we can analyze and quantify that come from natural capital assets in the country. For any sort of resource licensing, whether for timber or agriculture, mining, transportation, energy, or water, they're requiring an assessment of the impact that would likely be made on natural capital, in both biophysical and economic terms. And they're trying to come up with new ways of offsetting that to achieve the balanced approach that is being promoted by the group here.

Another example is in China. In the wake of the 1998 flooding of the Yangtze River system, the Chinese Academy of Sciences and policy leaders decided to undertake a series of policy changes that boiled down to providing incentives to protect natural capital in different ways. And one of the major policies that came out of this was an agreement to establish what are called "ecosystem function conservation areas." About 18% of China's land area is now being designated as an area for providing ecosystem functions. They're in a final round now of delineating exactly where these ecosystem function conservation areas will go, and there's a lot of work underway now to determine exactly how to implement that designation, because people live in all of these places. Poverty alleviation is a huge goal in all of this. They envision a wealth transfer from the more developed parts of the country to the much more rural and impoverished parts of the country to achieve flood control, hydropower production efficiency, climate stabilization, and a range of other services. But it's pretty dramatic to see how much is being invested there. It's more than $100 billion over roughly a 10-year period going into trying to secure the most vital elements of natural capital in that country.

Those are just two examples of many where the agreement Kevin was referencing has been made: Okay, we're going to try to harmonize production and conservation. There are all these experiments underway around the world to put that idea into practice.

Curtis: Similarly, if and when we finally get a climate bill through the Senate to become the law of the land, we're going to have a fascinating experiment in implementing an economy-wide cap-and-trade system. What are all the economic metrics and measurements needed to allow an accounting of carbon emissions to be fungible, whether it comes from reduced emissions from a power plant or sequestering carbon in soil or in trees or individual behavior that results in less energy use? How do you get that market to work? From the environment's perspective, it doesn't matter where the reductions come from — they just need to happen.

Mendelsohn: That's one of the beauties of the cap-and-trade program, that you harness the capitalist tendencies that Richard was talking about to make a reduction in total emissions in the most efficient possible way.

Kauffman: Right now the problem is that we have market failure because there are only some things that are in the market and other things that aren't.

Mendelsohn: So there's an important role for government to get some of these things that are not in the marketplace to be reflected in the market, and then there's a role for the private sector to take these new signals and bring them into their decision making.

Q: How much expectation is there in the private sector that there will be a price on carbon sometime in the near future?

Kauffman: I've heard from a number of companies that they are already doing shadow carbon accounting. I think most large companies would say it's not an if, it's a when.

Q: Is there agreement on what the price of carbon should be, and what effects that will have?

Kauffman: The actual price of carbon is really a government decision. The government should make the decision based on how bad this problem is versus what it costs to get rid of it. But the more technical decisions about who exactly should cut back what and how they should do it, that's where the private sector should jump in.

Curtis: I think where it's headed is the government will probably not pick a price, nor do I think they should, but they will put a cap, and then indirectly set a price by picking some reduction goals. The current range is 17% reduction by 2020, and a very massive 80% reduction by 2050. So that sends a very clear signal of the level of reduction that's needed. Then the market kicks in and starts putting a price on what that means.

Daily: The work in the climate arena is inspiring a lot of careful investigation of how markets might work for a range of other services, like provision of water purification or regulation of water supply, flood control, coastal protection. There are a lot of tools now being created and there is a lot of investment in these tools to make it easier for the decision makers to make smart investments — to know what the return on investment would be of, say, conservation or restoration of ecosystems. An example is a software system that the Natural Capital Project has produced, called InVEST, which lets the user input data on natural capital — soil type, basic climate, elevation, and that kind of thing — and basic information on built capital and demand for services by human populations, and it then estimates what value is being produced today, in both biophysical and economic terms, by the landscape. There are a number of other efforts along these lines, though I'd say all this work is still in its infancy. But it's a revolutionary time in seeing how much investment is going into clarifying what's going on biophysically and relating that in economic terms to the consequences of different policy choices that governments and others in society are making.

Q: How big are the unknowns in all these areas?

Kauffman: On the investing side, one of the big things that's unknown is whether we're going to have any kind of climate legislation and, if so, what's going to be in it. So the regulatory uncertainty in the United States is huge. I was with a group of investors recently in Washington, talking to people on the Hill, and one of my colleagues said, "We have a choice to invest in the United States or anywhere else in the world, and right now, because there's a lot less regulatory uncertainty, it looks more sensible to invest in India than in the United States."

Q: How much uncertainty is there in the science?

Mendelsohn: The climate scientists are reasonably certain that the planet's going to get warmer, but it turns out their level of uncertainty is between one and a half degrees and six degrees. And that's between "it might be warmer but it actually might be better for us" and "it might be disastrous." Then on the economic side, I think there's still enormous uncertainty about trying to evaluate the impact of those changes. We have a pretty good idea of what a small amount of warming might do, but as the warming gets further and further away from our current experience, the uncertainty grows quite a lot.

Curtis: I have a different take on the question of uncertainty. Once you have a goal, once you've set the rules of the road, then there are lots of reasons to turn it over as much as you can to the marketplace to find the best solutions. Before that can happen, though, there have to be some political decisions made that take into account uncertainty, but are also political value judgments — for instance, that the body politic of the United States believes that the threat of climate change is real enough to put in a policy that caps carbon and reduces it over time. There's always going to be uncertainty when one makes a political or a value judgment. That's okay. You make a decision and then you try to implement it.

Mendelsohn: You can't just wait for everything to be perfectly clear. But some decisions have a lot more uncertainty around them than others. And I think climate change, with all the long-range implications to it, is probably one of the most uncertain things that I've seen. In the short run, it's pretty clear, but the long-run consequences of making different choices today isn't very clear at all.

Curtis: But the consequences seem to range between some negative impact to lots of negative impact.

Mendelsohn: No, I'd say they range from being beneficial to being very, very harmful. And that's a pretty big range.

Daily: Another area that strikes me as being a big deal, with massive change underway and just huge uncertainties, is biodiversity loss. This is the year in which the biodiversity convention is being renegotiated. People are recognizing several things. One is that we're likely to lose about half of the other plants and animals with whom we share the planet in the current 100-year period. The second is that we haven't come close to achieving the modest goals set out by the convention 10 years ago. We're just miles from slowing biodiversity loss, much less halting it. Third, we realize how little is known.

Until the next asteroid hits, it's people more than any other force that will dictate the future course of all known life. So at really deep philosophical and ethical levels there are issues about what types of decisions we ought to be making as individuals and as a society. And then at a very pragmatic and anthropocentric level, there is no Yellow Pages to other life forms. We know a little bit, obviously, about the things that we grow for food or timber, but when it comes to holding whole systems together, there's a lot that's not known. When you look at forests and how much they are connected to the climate situation as huge stores of carbon that can be rapidly liquidated and put into the atmosphere, there is a big open question as to whether we're even really going to have forests in the latter half of the century we're in now. That's not considered crazy science. It's within the normal bounds of expected outcomes that could result from the climate system changing as it's projected to possibly change. In terms of uncertainty, it's tough.

In terms of what to do about it, I think we need to establish clear metrics of natural capital and clear objectives for protecting it. This is also tough, not knowing so well what the return on investment might be from investments in biodiversity. But we need to start advancing these systems for a broader suite of natural capital and services, so that we can be more comprehensive and not single-problem oriented around the climate. It's really a wide range of systems and all their interactions that are key to securing the basic life-support systems that, obviously, sustainability hinges on.

Mendelsohn: I'd love to echo what Gretchen just said, because climate by itself might be the single biggest issue, but it's not the only issue in sustainability. There are many other things we've got to make sure we stay on top of.

Q: Looking back at the question, "Can we afford sustainability?" you might all answer yes, but how costly will it be? And what are the big challenges?

Mendelsohn: When it comes to big global issues, one of the serious roadblocks that's preventing us from making a lot of progress is who is going to pay for it. There's a tendency for everybody to look to their neighbor and say, well, why don't you pay for it? That clearly has made it very difficult to come to binding global agreements, because everybody is trying to shift the burden to somebody else. And this is especially difficult when it comes to questions that involve the relatively rich countries versus the relatively poor ones, because it's quite often the case that the relatively poor countries have a lot of the valuable natural resources that we'd like to see maintained for conservation purposes. And so the question is, who has to pay for that? Do the developing countries have to pay for that, or would some of the richer, developed countries be willing to pay the bill?

Curtis: I'd like to introduce the other side of that question: It's not just who will pay for fixing it, but what's the cost of not fixing it? A lot of what we've talked about here is creating a framework to quantify what are currently externalities and bring them into the mix. If you're starting from a different point and acknowledging that there are costs to inaction, it can sometimes make the conversations easier. They're still difficult negotiations, but…

Daily: One remarkable thing I find is just how many developing countries are recognizing the critical importance of sustaining certain aspects of their natural capital, especially in the context of water supply. They're taking on the costs internally. But it opens up this much bigger question that I think Robert Mendelsohn was teeing up, which is, what's going to happen if climate change really shifts things like water supply? Who should be held accountable? Who is going to pay for the whole range of actions that we'd need to take?

Kauffman: I don't know if this is optimistic or pessimistic, but I guess I'd make one point here about the prospects of global cooperation on these issues. When I think about the financial crisis that we've all lived through, it's rather striking that, even though there was global intervention, there wasn't tremendous ideological debate about it. In other words, there was a group of people that worked on the financial crisis in an extraordinarily coordinated and effective way. I don't think that would have happened 20 or 30 years ago. And I think the reason for that is that there was a community that developed over a period of decades, and there had been enough debate and building of common perspectives that people could respond to the crisis without debating the fundamental premises of what needed to be done. By contrast, part of the difficulty we have in addressing sustainability issues is that that community is still in its early phases of developing. The academic community, I think, is well-developed. The NGO community is also working well. But when we start including government actors and businesspeople, then I think that community is not yet complete. That's something that needs to occur for us to make many of the changes we need to make.

Curtis: I agree with Richard, but I think the trend is in the right direction. The conversations are starting to happen more and more, reaching across sectors. It's not just companies filing voluntary reports on sustainability, but the SEC starting to require them. That's leading to a whole development of the accounting tools necessary to do that. And so some common language and some common metrics and some common tools are really being developed. The world as a whole is making a big investment in new energy technologies. The trends are in the right direction. We're just starting to run out of time.

Discussion conducted and edited by Jonathan T.F. Weisberg