Chapter 5

Sustainability
Guido Pepermans
Introduction
• Some people worry about the future of our planet
• Past century: population x 4, Industrial output x 35, Energy use x 16, Fishing output x 35…
• Increasing utility for future generations cannot be guaranteed
• A non-sustainable path (pessimistic view)
• Others argue that
• Past generations invested in capital goods, R&D, education, allowing current generations to
achieve high levels of consumption
• Current generations can make the same efforts for future generations (optimistic view)
• Essentially, the question is ‘is consumption excessive or not?’
• Several frameworks exist that might be used to assess these claims
• Economist's view: maximize the net present value of future utility Intertemporal social welfare
• Alternative view: allow future generations to maintain living standards Sustainability
• Do these frameworks result in different outcomes? (Based on Arrow et al. (2004))

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Objective
• Students should be able to
• Explain the differences between the net present value framework and the
sustainability framework, both conceptually and in terms of conclusions

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Outline
• Introduction

• Maximize net present value

• Guarantee utility of future generations

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Discounted utility
• Common vehicle:
• Intertemporal social welfare evaluated at
• Some important assumptions
• Utility of consumption
• Concave utility function
• One ‘aggregate’ consumption good , produced by transforming inputs into consumption good
• Determined by the ‘productive base’, the stock of all society’s assets at time : (see chapter 1)
• One discount rate is used to weigh all (future) levels of utility of consumption
• Resources can be (technically) transferred over time with a rate of return of
• Are current consumption levels excessive?
• 2 criteria to judge both are difficult to implement in practice
• Maximize present value criterion (economist’s framework)
• Sustainability criterion: (ecologists’ framework)

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Maximize Net Present Value

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Maximize net present value
• Actual consumption is excessive when lowering current consumption results
in an increase of future utility enough to compensate the loss of current utility
• Trade-off between current and future ‘utility of consumption’ levels over
different generations
• Easier to reason in terms of consumption rather than utility from consumption
• One can rewrite intertemporal social welfare in terms of consumption
rather than in terms of utility of consumption

• Check whether consumption is excessive by comparing the social discount

rate of consumption with the market return on investment (labeled )

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Maximize net present value
• Interpretation of
• Social discount rate of consumption depends on social rate of ‘pure’ time
preference
• is the rate of growth of aggregate consumption (1%-2% in de long term)
• is the elasticity of marginal utility w.r.t. consumption ( between and )

• Higher indicates a lower need for current generations to save for future
generations

• Overall, is in the range of 2% - 8%

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Maximize net present value
• Compare with the market rate of return on investment
• reduce consumption now and invest for future generations ( excessive consumption)
• increase consumption now and invest less for future generations
• Preliminary conclusion
• At current -levels difficult to claim that consumption level is excessive, as
• Other pieces of evidence pro or contra
• Incomplete markets & capital taxes
• Pricing of natural resource inputs
• Imperfect competition (e.g., OPEC)
• Overall, not clear whether current consumption is excessive or not
• Some evidence indicating that current consumption level is too high

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Guarantee utility of future
generations

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Guarantee utility of future generations
• Sustainable development is broadly defined as (Brundtland commission, 1987)
• Development that meets the needs of the present without compromising the
ability of future generations to meet their own needs
• ‘Sustainability’ criterion in Arrow et al. (2004): does not decrease in (or )
• Guarantee future generations the production possibilities to have the same
consumption levels as we have
• ‘Production possibilities’ stock of all society’s capital assets
• Manufactured capital, human capital, natural capital (resources), but also the
level of technology
• The ‘productive base’ is the value of this stock
• Define ‘genuine investment’ as the change in the productive base
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Guarantee utility of future generations
• One can show that iff genuine investment is non-negative at
• Does not apply at the level of one particular asset
• Decrease in stock of one resource can be compensated by an increase in
the stock of another resource
• Clear theoretical concept, but very challenging to apply in practice

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Guarantee utility of future generations
• ‘Productive base’ or ‘production possibilities’ are function of Natural capital and “man- made”
capital
• Labor is kept constant for illustrative purposes
• Express evolution of total welfare as a function of net production and thus of inputs and over
time
• Derivative of w.r.t. time

• Function of substitution possibilities between and (see next – hidden – slides)

• Central question
• As natural capital decreases (GHG concentration, biodiversity,..) and man-made capital
(knowledge, technologies) increases, is sustainability guaranteed or not?

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Guarantee utility of future generations

Example: UK (% of GDP)
Physical Investment : +3.7
Education: +5.2
: -0.3
Energy: -1.2
NET: +7.4
Source: Arrow et al.

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Guarantee utility of future generations
The optimistic view: substitutability allows us to increase
welfare (or not reduce) over time

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Guarantee utility of future generations
The pessimistic view: no substitutability means every
decrease in natural stock decreases future production
possibilities

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Guarantee utility of future generations
Genuine investment
= Domestic investment
+ Education expenditure
– Natural resource depletion

Some caveats:
- Availability of data
- Quality of data
- Measurement of education
(depreciation)
- How to handle population growth or
technological progress (see paper
Arrow et al.)

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Key message

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Final remarks and conclusion
• Two criteria, reflecting different ethical considerations
• Satisfying one criterion does not necessarily imply satisfying the other
• ‘Maximize social welfare’ criterion
• Some indication that current consumption levels are too high (considering
also that some pieces of evidence are lacking in the simple analysis)
• ‘Sustainability’ criterion
• Current consumption is excessive with low substitutability between man-
made and natural capital
• At first sight, several nations/regions on the globe fail to meet the
sustainability criterion
• Irrespective of the criterion used, available evidence is inconclusive

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References
• ARROW, K., DASGUPTA, P., GOULDER, L., DAILY, G., EHRLICH, P., HEAL, G., LEVIN, S.,
MÄLER, K.-G., SCHNEIDER, S., STARRETT, D. and WALKER, B. (2004), Are We Consuming
Too Much? The Journal of Economic Perspectives, 18(3), pp. 147-172.

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