Let me put the positive up front. Professor Herman Daly and his colleagues in the school of ecological economics (SEE) have made important contributions to the study of sustainability and have increased awareness on the relations between economics and the environment. But there are serious problems with their approach that will hamper the future development of SEE. This is why I want to raise a couple of critical issues. What follows is a discussion on value theory that may sound old fashioned, but it needs to be brought out if we want to move ahead with a more meaningful discussion on economic forces and the environment.
According to Daly and colleagues, the fundamental problem with mainstream economic theory is its inability to analyze physical flows in economic systems. The story line is that conventional economic theory relies on the fallacy of a circular flow of commodities in a system in which natural resources are not finite. The flows are expressed in abstract or monetary units and can therefore be expanded indefinitely. According to Daly, from this flawed beginning of “money fetishism” economics erroneously concludes that physical quantities are also amenable to infinite growth.
But economic theory’s starting point is exactly the opposite of what Professor Daly and his friends believe. Economic theory proceeded first by excluding money from its field of analysis in order to develop its theory of how markets operated. This is why Adam Smith opened his Wealth of Nations by constructing a value theory, in opposition to money. This vision is shared by neoclassical theory and contemporary general equilibrium theory.
To verify this, take the following question: why do we need a value theory? The answer is straightforward: the purpose of value theory is to restore a common unit of measurement (or a unit of account) in a world of physical and heterogeneous objects (commodities). Once money had been abstracted from the analysis, it was necessary to build a concept of value allowing for the analysis of trade between equivalent magnitudes of the same “substance” (using Marx’s terminology).
For Smith mercantilism was not only a bad recipe for economic policy, it was a portentous fallacy. Money is not wealth, he argued, so he proposed we analyze market relations in terms of real value. I won’t go here into the details of his particular (labor commanded) value theory, but I will insist on the fact that value theory was the logical response to the expulsion of money from the analytical space of the emerging discipline.
Today economic theory carries on its analysis with the help of a value theory that is centered on how physically determined objects (called commodities) are related to each other by “relative prices” (physical rates of substitution). The same approach can be found in general equilibrium theory, from Walras to Debreu, whose Theory of Value explicitly recognizes that money is not covered by the model (in contrast to the set of physically determined commodities).
The problem that logically follows from here is the integration of monetary theory with value theory. In a famous article published in 1968, Frank Hahn discussed the nature of this problem. Franklin Fisher analyzed the same difficulty in the context of stability analysis. The summing up article by Carlo Benetti reveals this problem remains unsolved.
Mainstream economic theory has failed to demonstrate how equilibrium prices are formed through the free interplay of market forces. Daly believes markets solve the allocation problem and that they do this very well. This ignores the fact that economic theory was never able to replicate the dynamics of convergence to equilibrium prices and allocations. The Sonneschein-Mantel-Debreu theorems of 1974 should have clarified this forever. All of this is ignored by Daly and colleagues thus their misguided critique of mainstream economics.
The problem of mainstream economic theory is not that it is incapable of integrating physical flows into its analysis. In fact, there are many examples of general equilibrium models used to evaluate environmental policies in terms of physical flows. The problems of mainstream economic theory are more important and they are related to the concept of money, as well as its incapacity to prove that markets guide economies to equilibrium allocations.
By emphasizing the role of physical flows, Daly and the school of ecological economics leave aside the social relations that underlie economics and look at the question of sustainability from a very simplistic angle, namely, the logic of carrying capacity and limits to growth. Physical or materials’ flows can be very useful but they cannot reveal the nature of the economic forces behind environmental destruction.