Macro-economic models need to widen their perspective

Ethical Markets Beyond GDP

The recent recession has prompted the adoption of ‘return to growth’ policies but the tools used to assess growth often have a narrow economic focus. A new report has assessed current macro-economic models and suggests they need to incorporate the impact that environmental factors can have on the economy, and vice versa, and recommends they should consider limits on resource and material consumption.

The study, commissioned by the European Commission, examined the links between 60 existing macro-economic models and sustainable development. Macro-economic models are quantitative computer based models that focus on the performance of the overall economy. The study defined sustainability on the basis of the ten policy themes outlined in the EU’s sustainable development indices, which form part of the EU Sustainable Development Strategy1.

The analysis indicated that the vast majority of existing macro-economic models assume a one-way directional impact from the economy onto areas of interest for sustainable policy, such as energy use, climate change and sustainable transport. There was little consideration of the ways in which these policy domains might have an impact on the economy: for example, models tend to assume that the economy influences the use of natural resources, but do not consider the possibility that a scarce supply of resources could have an effect on the economy (for example, through higher prices).

This limitation could bias analyses and recommendations produced by these models. Many of the models omit the links between public health and the economy, or good governance (such as the existence of democracy) and the economy. There is also little consideration of the consumption of natural resources, such as minerals and water, although it would be relatively easy to include these. Limits to stocks or recoverable resources are not usually incorporated and models do not consider how the price of scarce materials might change with availability. ‘Extreme’ scenarios, such as peak oil prices, are also not considered fully.

There are also questions about whether and how the models address uncertainty, non-linear relationships and thresholds and the impact of technology and innovation. The report made recommendations in three main areas:

The role of technology – Macro-economic models need to recognise that innovation and development of technology is an important factor for sustainable growth. To achieve this, the individual technologies could be included in each sector, for example, renewables or carbon capture and storage in the energy sector. Alternatively, technological development could be linked to capital by giving it an economic value. Although it is not possible to predict future trends in technology, a step forward would be to evaluate the role of current technological options using a method that combines both approaches.

Non-linear relationships, thresholds and limits – Most models assume linear relationships, where the rate of increase or decrease remains the same. This may be reasonably accurate for small changes but becomes less so as the changes become larger. Thresholds and physical limits also need better representation in models, although it may be difficult to predict thresholds which have not previously been reached (e.g. melting ice caps) or where capacities vary over time, for example freshwater’s dependence on annual rainfall.

Uncertainty – There are two types of uncertainty issues that are not considered in current models. Uncertainty about future developments affects human behaviour, particularly in investment decisions, and this should be included in the models. Uncertainty in the model itself must also be recognised and addressed to put its predictions into context.

1.     See: http://epp.eurostat.ec.europa.eu/portal/page/portal/sdi/indicators
Source: Pollitt, H., Barker, A., Barton, J. et al. (2010) A Scoping Study on the Macroeconomic View of Sustainability. Final Report for the European Commission, DG Environment produced by Cambridge Econometrics and the Sustainable Europe Research Institute. Downloadable from: http://ec.europa.eu/environment/enveco/studies_modelling/index.htm

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Theme(s):Resource efficiency, Sustainable development and policy analysis