The Natural Edge Project The Natural Advantage of Nations Whole System Design Factor 5 Cents and Sustainability Higher Education and Sustainable Development




"The TNEP book, The Natural Advantage of Nations, will be a very useful educational tool for government and industry in showing how to make the right steps toward a sustainable economy. The Natural Advantage of Nations will provide a graphic and compelling view of the kind of future we all might have if we truly commit to achieving sustainable development."
Dr John Cole, Environmental Protection Agency Queensland





The Natural Advantage of Nations (Vol. I): Business Opportunities, Innovation and Governance in the 21st Century

 
 
   

Section 3: Achieving a Natural Advantage of Nations

Chapter 12: Towards a Deeper Understanding
1 Markets and efficiency
1.1 What is a market?
1.2 How do economists define efficiency?
1.3 The classical understanding
1.4 Perfect complete markets
1.5 The economics of information
1.6 Financial markets: what they do and why they are fragile
1.7 Anti-monopoly legislation: competition policy
2 Challenges to governments and institutions (Stephen Dovers)
2.1 Attributes of policy problems in sustainability
2.2 Clarifying government, governance and institutions
2.3 Available scales of sustainability governance
2.4 Scaling responses
2.5 Principles and elements of policy and institutional reform
2.6 Is there 'credible commitment' to sustainabilty?
3 Reference List from the Book
   
Sample of Resources to Support Chapter 12
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Markets and efficiency

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Historical Perspective on the debate over the role of Market and State
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Significant Developments in Economics

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Institutions and the Market

Those who believe that the market on its own is the most efficient way to allocate scarce resources would disagree with many of the previous suggested government measures. Giving free reign to the invisible hand of the market, they argue, is the best way to ensure the most desirable outcomes for society as a whole. In Section 1, and again in the introduction to Section 3, it was stated that over the last 30 years a far more sophisticated understanding of the market has developed that allows us clarity to see when markets may fail and when it may be beneficial for governments to act.

As communities we have a range of goals, one of which is protecting the health of the natural ecosystems on which we depend. As neither our resources nor our lives are infinite, not all goals can be fully realized and somehow we have to make choices about what to do. In this context, efficiency matters precisely because we are interested in realizing as many of our goals as possible. Hence, the strong call for markets to be efficient. Governments and their detractors have often suggested that the state should not intervene in markets for this very reason. They claim that free markets allocate resources in the most efficient way possible and interference would only make matters worse. Is this really the case? Before we can answer this important question, we need to understand two main concepts: first what is a market?, and second how do economists define efficiency?

Dr Stephen Dovers, Senior Fellow at

theCentre for Resources and Environmental Studies,

Australian National University.

Institutions can be either significant allies or obstacles to achieving sustainability and understanding the issues and challenges for institutions in addressing sustainability is critical to assist nations achieve genuine progress. We invited Dr Dovers, a world renowned expert in institutions and sustainability, to provide an overview of how nstitutions are tackling sustainability issues.

Markets and efficiency

Many years ago the economist Keynes wrote:

"The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed, the world is ruled by little else. Practical men, who believe themselves quite exempt from any intellectual influences, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back". Keynes [1936].

 

This chapter provides an introduction to the important work of the 2001 Nobel Laureates in Economics: George A. Ackerlof, A. Michael Spence, and Joseph E. Stiglitz, for their analyses of markets with asymmetric information.

View Website

 

In his Nobel Prize Lecture, Joseph Stiglitz states:

"The research for which George Akerlof, Mike Spence, and I are being recognized is part of a larger research program which, today, embraces hundred, perhaps thousands, of researchers around the world. In this lecture, I want to set the particular work which was sited within this broader agenda, and that agenda within the broader perspective of the history of economic thought. I hope to show that Information Economics represents a fundamental change in the prevailing paradigm within economics. Problems of information are central to understanding not only market economics but also political economy, and in the last section of this lecture, I explore some of the implications of information imperfections for political processes."

 

"Many of the major political debates over the past two decades have centered around one key issue: the efficiency of the market economy, and the appropriate relationship between the market and the government. The argument of Adam Smith [1776], the founder of modern economics, that free markets led to efficient outcomes, 'as if by an invisible hand' has played a central role in these debates: it suggested that we could, by and large, rely on markets without government intervention. There was, at best, a limited role for government. The set of ideas that I will present here undermined Smith's theory and the view of government that rested on it. They have suggested that the reason that the hand may be invisible is that it is simply not there - or at least that if is there, it is palsied."

 

From Joseph Stiglitz's Nobel Prize Lecture

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Michael Spence's Nobel Prize Lecture

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George Akerlof's Nobel Prize Lecture

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Key references of their work include:

For a seminal model of the market for insurance under conditions of imperfect information see;

 
Rothschild, M. and Stiglitz, J. (1976) 'Equilibrium in competitive insurance markets: an essay on the economics of imperfect information', Quarterly Journal of Economics, 90(4).
 
Shapiro, C. and Stiglitz, J. (1984) 'Equilibrium Unemployment as a Worker Discipline Device', American Economic Review, 74(3).
 
Greenwald, B. and Stiglitz, J. (1986) 'Externalities in Economies with Imperfect Information and Incomplete Markets', Quarterly Journal of Economics, 101(2).

 

 

Historical Perspective on the debate over the role of Market and State

To understand the significance of their work one needs to understand the history of the debate over the role of market and state. For an introduction to this debate seethe PBS website Commanding Heights : the Battle for the Global Economy.

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Significant Developments in Economics

For further information on the individuals and the key breakthroughs in economics fromthe last 40 years, see the following web sites on Nobel Prizes in Economics from 1969-2004

View web site #1

View web site #2

 

 

Institutions and the Market

Building Institutions for Markets: World Bank Development Report 2002

"Effective institutions can make the difference in the success of market reforms. Without land-titling institutions that ensure property rights, poor people are unable to use valuable assets for investment and income growth. Without strong judicial institutions that enforce contracts, entrepreneurs find many business activities too risky. Without effective corporate governance institutions that check managers' behaviour, firms waste the resources of stakeholders. And weak institutions hurt the poor especially. For example, estimates show that corruption can cost the poor three times as much as it does the wealthy."  

World Bank (2002), 'Building Institutions for Markets',

World Development Report, 2002.

View PDF | View Website

 

Institutions for Sustainability

Dovers, S. 2001. Institutions for Sustainability. Tela paper 7. Melbourne : Australian Conservation Foundation. This paper discusses the institutional arrangements that help or hinder the pursuit of an ecologically sustainable and humanly desirable society.

Download PDF | View Website

 

National Councils for Sustainable Development (NSCDs)

Agenda 21, together with numerous other statements, also argues that furthering the sustainable development agenda will require ongoing collaboration between governments, the private sector and community organisations (civil society), in the development and implementation of national policy that integrates ecological, social and economic dimensions over the long term. NCSDs are promoted as a core element of such an approach, for particular purposes and at a particular scale.

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References from the Book

1 Named after the economist Vilfredo Pareto (1848-1923), who made several important contributions to economics, especially in the study of income distribution and in the analysis of individuals' choices.

 

2 Smith, A. (1999) An Inquiry into the Nature and Causes of the Wealth of Nations, Penguin, London , Book I, Ch vii.

 

3 Ibid (Book V, Ch i).

 

4 Arrow, K. and Debreu, G. (1954) 'Existence of an Equilibrium for a Competitive Economy', Econometrica, vol 22, no 3, pp265-290.

 

5 Indeed, the conditions are arguably inconsistent: the more we narrow the definition of a particular good, the less likely is competition.

 

6 For a seminal model of the market for insurance under conditions of imperfect information see Rothschild, M. and Stiglitz, J. (1976) 'Equilibrium in Competitive Insurance Markets: An Essay on the Economics of Imperfect Information', Quarterly Journal of Economics, vol 90, no 4.

 

7 Shapiro, C. and Stiglitz, J. (1984) 'Equilibrium Unemployment as a Worker Discipline Device', American Economic Review, vol 74, no 3.

 

8 In fact, informational imperfections form one of the principal reasons that the completeness and competitiveness requirements of the First Fundamental Theorem do not hold in real-world economies. We noted above that completeness requires a complete set of 'risk markets', yet the informational asymmetries outlined above mean that many insurance markets are fragile and prone to collapse. Similarly, perfect competition requires that there is no 'price dispersal': a can of tomatoes in South Sydney on a Tuesday night should cost the same in every shop. But searching the city to find the lowest price for a tin of tomatoes is time-consuming. Some firms capitalize on this by raising prices and marketing to those customers who are 'money-rich and time-poor', whilst others sell themselves as 'no frills' shops. The cost of obtaining information about prices means that these prices are dispersed and competition is imperfect.

 

9 Greenwald, B. and Stiglitz, J. (1986) 'Externalities in Economies with Imperfect Information and Incomplete Markets', Quarterly Journal of Economics, vol 101, no 2.

 

10 In a democracy, the electoral process confers (some degree of) legitimacy upon the government. This in turn enables governments to exercise their power of compulsion: the state, unlike private institutions or individuals, can compel all of its citizens to adhere to its laws, pay it money, and so on. Such compulsion, legitimately exercised, is one of the principal strengths of the government; unlike trades in the private sector, which are conducted only if they are mutually beneficial, the power of coercion relieves the state of the need to make everybody better off all of the time.

 

11 For a more detailed discussion of the roles and regulation of capital markets, see Stiglitz, J. (1994) Whither Socialism?, MIT Press, Cambridge MA , Ch 12.

 

12 An early seminal paper on credit and asymmetric information: Stiglitz, J. and Weiss, A. (1981) 'Credit Rationing in Markets with Imperfect Information', American Economic Review, vol 71. The model in this paper predicts that interest rates may not necessarily adjust to equalize the supply and demand for bank loans, explaining the 'credit rationing' observed in real world economies, but which classical theories of the interest rate cannot explain.

 

13 For example, suppose I expect that the Thai baht is going to depreciate in the near future, then, as a speculator, I can sell my baht today and buy it back more cheaply after the depreciation. If I buy and sell in very large quantities I can make a very large amount of money.

 

14 For a very readable account of the pressures applied to developing countries, see Stiglitz, J. (2002) Globalization and its Discontents, Allen Lane , London , Ch 3.

 

15 For a statistical study of the relationship between capital market liberalization and economic performance, see Rodrik, D. (1998) 'Who Needs Capital Account Convertibility?', paper prepared for the 1998 Princeton International Finance Section Symposium. Rodrik investigates the relationship between a country's capital account regime and economic performance using data from nearly 100 countries over the period 1975-1989, finding no evidence that countries without capital controls grow faster, invest more or experience lower inflation.

 

16 For a more detailed account of the Asian crisis and how Malaysia and China were able to weather the crisis whilst other economies in the region floundered, see Wade, R. (2000) Governing the Market a Decade Later, London School of Economics Development Studies Institute Working Paper No 00-03, London School of Economics, London.

 

17 Suggestions for further reading: one of the best technical papers on the causes of the Asian crisis is Corbett, J. and Vines, D. (1999) 'The Asian Crisis: Lessons from the Collapse of Financial Systems, Exchange Rates and Macroeconomic Policy', in Agenor, P., Miller, M., Vines, D. and Weber, A. (eds) The Asian Financial Crisis: Causes, Contagion and Consequences, Cambridge University Press, Cambridge. For a more detailed examination of the issues introduced in this chapter, see Stiglitz, J. (1999) Must Currency Crises be this Frequent and this Painful? In Agenor, P., Miller, D., Vines and Weber, A. (eds) The Asian Financial Crisis: Causes, Contagion and Consequences, Cambridge University Press, Cambridge .

 

18 Gittens, R. (2003) 'The Humbled Fund has had to Rethink its Operations', Sydney Morning Herald 29 March and 'The International Monetary Fund does a www - we were wrong', The Age 29 March.

 

19 IMF response to criticism on the issue of its handling of the Asian economic crisis is as follows: 'When the IMF was created in 1944, its founders envisioned a world in which trade was free but in which the restrictions on movement of capital across countries then in place were to be retained. In the jargon, current accounts were to be open, but capital accounts highly regulated. Capital account restrictions were considered necessary to support the "Bretton Woods system", the system of fixed exchange rates then in place. There is no denying the vision of the world being promoted by the IMF in the mid-1990s was different. At the 1997 IMF-World Bank meetings the proposal on the table was to amend the IMF's articles of agreement to give it jurisdiction over the liberalization of capital movements. But while the popular characterization of a greater push toward capital account liberalization is broadly correct, it is inaccurate in many important details. The IMF did not encourage countries to liberalize short-term flows through the banking sector, which is what turned out to be the Achilles Heel during the Asian crisis'.

 

20 Prasad, E., Rogoff, K. , Wei, S.-J. and Kose, M.A. (2003) Effects of Financial Globalization on Developing Countries: Some Empirical Evidence, 17 March, International Monetary Fund, Washington , DC .

 

21 Dawson, T. (2002) The IMF's Role in Asia : Part of the Problem or Part of the Solution?, prepared remarks for the Institute of Policy Studies and Singapore Management University Forum, Singapore , 10 July.

 

22 Braithwaite, J. and Drahos, P. (2000) Global Business Regulation, Cambridge University Press, Cambridge , p704. Professor John Braithwaite and Professor Peter Drahos have been awarded the Grawemeyer Award For Ideas Improving World Order. This award is presented annually to the winner of a competition designed to stimulate the recognition, dissemination and critical analysis of outstanding proposals for improving world order.

 

23 Ibid.

 

24 Ibid.

 

25 World Bank (2003) World Bank Development Report 2003: Sustainable Development in a Dynamic World, Oxford University Press, Oxford, Ch 1, p3.

 

26 Dovers, S. (1997) 'Sustainability: Demands on Policy', Journal of Public Policy vol 16, pp303-318.

 

27 Commonwealth of Australia (1992) National Strategy for Ecologically Sustainable Development, Australian Government Publishing Service, Canberra .

 

28 Stein, J. P. (2000) 'Are Decision Makers too Cautious with the Precautionary Principle?', Environmental and Planning Law Journal, vol 17, pp3-24; Dovers, S. (2002) 'Sustainability: Reviewing Australia's Progress', International Journal of Environmental Studies, vol 59, pp559-571.

 

29 Connor, R. and Dovers, S. (2004) Institutional Change for Sustainable Development, Edward Elgar, Cheltenham .

 

30 Goodin, R. (1996) 'Institutions and Their Design', in Goodin, R. (ed) The Theory of Institutional Design, Cambridge University Press, Cambridge .

 

31 Dovers, S. (2001) Institutions and Sustainability, ACF Tela Paper 7, Australian Conservation Foundation, Melbourne .

 

32 This is a central and contested proposal in the sustainability literature, i.e. that environmental protection depends on economic growth. Here, the issue is not belief or disbelief in this proposal, but rather policy and institutional settings aimed at either establishing such a link in practice, or further testing the proposition.

 

33 Connor, R. and Dovers, S. (2004) Institutional Change for Sustainable Development, Edward Elgar, Cheltenham .

 

34 For example, local and state government coordinated action on a widely dispersed but nodal economic activity with particular environmental or social implications.

 

35 This is illustrative and far from a comprehensive listing of either sustainability principles or options.

 

36 Note that it is argued by some that such reorganization is unnecessary in local government, given the small size and thus non-fragmentary nature of local councils.

 

37 Dovers, S. and Wild River , S. (eds) (2003) Managing Australia's Environment, Federation Press, Sydney. This study, and the one reported in Connor and Dovers (see below), were funded by Land & Water Australia , and R&D agency of the Australian Government.

 

38 Connor, R. and Dovers, S. (2004) Institutional Change for Sustainable Development, Edward Elgar, Cheltenham .

 

39 Drawing on this idea from North, D. (1993) 'Institutions and Credible Commitment', The American Economic Review, vol 84, pp359-368.

 

40 Filmer, D. (2000) The Structure of Social Disparities in Education: Gender and Wealth, World Bank Research Policy Working Paper 2268, World Bank, Washington , DC .

 

41 The following piece summarizes an analysis of NCSDs more fully reported in Connor, R. and Dovers, S. (2004) Institutional Change for Sustainable Development, Edward Elgar, Cheltenham, Ch 5.

 

42 United Nations (1992) Agenda 21: The UN Programme of Action from Rio , United Nations, New York , Chs 8, 27, 30.

 

43 This draws on d'Evie, F. and Beeler, B. (eds) (2002) Integrating Global Environmental Conventions at National and Local Levels: NCSD Report 2001, Earth Council, San Jose, Costa Rica; d'Evie, F., MacDonald, M., Mata, R. and Rodriguez, R. (eds) (2000) National Experiences of Integrative, Multi-Stakeholder Processes for Sustainable Development: NCSD Report 2000, Earth Council, San Jose, Costa Rica.

 

44 Boyer, B. (2000) 'Institutional Mechanisms for Sustainable Development: A Look at National Councils for Sustainable Development in Asia ', Global Environmental Change, vol 10, pp157-160.

 

45 For basic descriptive material, see d'Evie, F., MacDonald, M., Mata, R. and Rodriguez, R. (eds) (2000) National Experiences of Integrative, Multi-Stakeholder Processes for Sustainable Development: NCSD Report 2000, Earth Council, San Jose, Costa Rica; d'Evie, F. and Beeler, B. (eds) (2002) Integrating Global Environmental Conventions at National and Local Levels: NCSD Report 2001, Earth Council, San Jose, Costa Rica.

 

46 d'Evie, F., MacDonald, M., Mata, R. and Rodriguez, R. (eds) (2000) National Experiences of Integrative, Multi-Stakeholder Processes for Sustainable Development: NCSD Report 2000, Earth Council, San Jose, Costa Rica.

 

47 Basic information and a range of the Council's submissions to governments are available in English on the website for the Belgian Federal Council for Sustainable Development.

 

48 Doering, R. (1993) Canadian Round Tables on the Environment and the Economy: Their History, Form and Function, Working Paper 14, National Round Table on the Environment and the Economy (NRTEE), Ottawa .

 

49 NRTEE (2001) National Round Table on the Environment and the Economy Annual Report 2000-2001, NRTEE, Ottawa .

 

50 Information can be found on the website for the UK Sustainable Development Commission.

 

51 d'Evie, F. and Beeler, B. (eds) (2002) Integrating Global Environmental Conventions at National and Local Levels: NCSD Report 2001, Earth Council, San Jose , Costa Rica