THE WORLDBANK Public Disclosure Authorized InternalDiscussion Paper ASIA REGIONALSERIES ReportNo. IDP97 Public Disclosure Authorized Sustainabilityas IntergenerationalEquity: The Challengeto EconomicThought and Practice Public Disclosure Authorized Richard B.Norgaard June 1991 Public Disclosure Authorized The views presented tere e ffioseof the author, and thy shouldnot be interted as reflecting ose of the World 8ank. ASIA DIRON NGIONP SS lids13Jf^A [ AG Orimnato-r IDP2 The LPborFore PWauicpe of Woman1 thdRepublc of Korea: Evoltdo andPolcy bsm C. OGootam May198S P. Iqbal IDPIS TheRole of Exchae Rte Pdicy in Four Eat AdenCountries Saog-WooNam Ma 1988 D. Loilger (81388) IDP28 TheSmall-Scale Bateapr CreditPrp (S.S.E.P.) Under the Secod and Thrd Calcut Urban D wvdopmtProject F. Kabhast March 1988 F. Kahncrt (81413) (CUD?PD andCUDP l) - AnAsxmen IDP3.S Ir TaxPicy Mvice: Lessonsand UnresolvedI_ fromAda Eqxper H. Feidg June 1989 H. Floelig(81413) IDP36 Direl Tam and Fisa Poliy Isse: An mUuratlonfor BEastAda A. Virmni Jun. 1989 H. FloisIg(81413) IDP37 CommodityTaxation In Seleed Caouni In SotaEt and Bat Ada Z. Shlizi June1989 H. Fledsig(81413) IDP38 TaxAnayis InDeveoping CountrySettgS R. Musgrave June1989 H. Flesdg(81413) IDP39 Indoesia Etern Shods Policy Ress and Adjutmet Performace S. Abmod Jaw. 1989 Saq Ahmed(82467) IDP42 An Analys of theNatre of W.T.Dk July 1989 R. Zaglu (80433) UnemplYMetIn SdiLa andK. Lang IDP44 Awitg Poor RUal Arms Trough Grunwater Irigon F. KIhaht August1989 C. Chamberin(81409) IDPS1 Educaton Dveopmet in Asia: A Comparvo StudyFocussing on Cost Je-Pag Tan Ocor 1989 Joe-PengTan (81408) and Fling suw AlainMinget IDP52 Chiese form, bIflion naddho Allocain of Invetomuin a Soili Economy OklayYzl Ocober 1989 OktayYenal (81415) IDP63 Pbic Pdicy to Prote n : TheEpOiee of theEast Asin NIC and Less_ for Thaild D. Dollar Mv 1990 D. Dolar (80518) IDP6S A Study of tbe Poor in Sri Lak C. Roose June1990 Y. Huang (80434) IDP68 Heal SectorFiaig in Asa C. GriMn Augut 1990 Joe-PangTan (81408) Note: Eta copqsmy be obainedfrom the Asiainf otio ServiceConter. SUSTAINABILITYAS IINTERGENERATIONALEQUITY: THE CHALLENGETO ECONOMICTHOUGHT AND PRACTICE Richard S. Norgaard ABSTRACT RichardB. Norguardis Associate Professor,Energy and ResourcesProgram, University of Califomia (Berkeley,California 94720). He wrote this discussionpaper as a Visiting ResearchFellow in the Office of the Chief Economistof the Asia Regionin early 1991. RichardB. Howarth,an economist th the AppliedScience Division of the LawrenceBer- keley Laboratory,prepared the ff . presentedin Appendices2 and 3, wrote the text of Appendix3, and contributedgenerally as the coauthorof earlierarticles from which many of the points in this discussionpaper follow. The paper evolved in responseto the challengingreactions of numerousBank staff who attendedtwo seminarsbased on early drafts and of the attendeesof a Depanmentof Economicsseminar at the Universityof Californiaat Davisand at the workshopon sustainableagriculture sponsored by the Science Councilof Canadaand Canadian Agricultural Economics and Farm Management Society held in Winnipeg. SarmaJoyanthi produced the graphics. SUSTAINABILITYAS INTERGENERATIONALEQUITY: THE CHALLENGETO ECONOMICTHOUGHT AND PRACTICE ABLEOF CONTENTS Page 0. ExecutiveSummary 1. The Challengeto DevelopmentPolicy 5 2 The Challengeto EconomicThought 13 3. Sustainabilityas IntergenerationalEquity 16 4. ReframingEnvironmental, Forestry, and ResourceEconomics 20 5. The Discount Rate Controversy 28 6. IntergenerationalAsset Transfersand Capital Markets 33 7. The Transfer of Natural and Other Assets to Future Generations 38 8. Sustainabilityand CapitalTheory: Dilemmasof Asset Aggregation 41 9. The Challengeto EconomicPractice 44 Appendices Al. The Challengeof SustainingTropical Rainforests 52 A2. An IntergenerationalCompetitive Equilibrium Model of a Non-Renewable 56 ResourceEconomy A3. An IntergenerationalCompetitive Equilibrium Model of a RenewableResource 62 Economy A4. Monitoring and Distributive Mechanismsfor Tropical Rainforests 68 Bibliography 72 SUSTAIANAUTYAS INTERGENERATIONALEQUiTY: THECHAULENGE TO ECONOMICTHOUGHT AND PRACTICE Richard D. Norgaard 'Our theories ... are rays of light, which illuminatea part of the target, leavingthe rest in darkness. ... It is obviousthat a theorywhich is to performthis function satis- factorily must be well chosen;otherwise it will illuminethe wrong things. Further, since it is a changingworld that we are studying,a theory which illuminesthe right things at one time may illuminethe wrong things at another.' John R. Hicks (Wealthand Welfare:Collected Essays on EconomicTheory. 1981. pp. 232) EXECUTIVESUMMARY 0.1. This paperpresumes the intemationaldiscourse on the sustainabilityof development is concernedwith a) the rights of future generationsto the servicesof naturaland produced assets and b) whether formal and informal institutions which affect the transfer of assets to future generationsare adequateto assurethe quality of life in the long-run. Sustainability is primarilyan issue of intergenerationalequity. The noneconomicdiscourse on sustain- ability is clearly about caring for the future. 0.2. Conversely,this papercontests the implicit premisesof economicsas now practiced. FiMat.in the face of the sustainabilitydebate, many academicand practicingeconomists still assumethat technologywill offset resourcedepletion and environmentaldegradation. Tech- nologicaloptimism may or may not be appropriate,but it is not inherentto economicreason- ing. Second, existing theory on intertemporalresource allocation, oft cited to justify prac- tice, tacitly assumesthat current generationshold all rights to asets and should efficiently exploit them. Ibi. there has been an Implicit assumptionthat the mechanismsaffecting the maintenanceand transfer of assetsto future generationsare both working optimallyand are unaffectedby current economicdecisions. The interplaybetween institutions and envir- onmentalmanagement Is now well recognized,but analysesto date have only addressed marketdistortions and the Internalizationof externalities. While new technologieshave dra- matically increasedpeople's ability to use resourcesand degradeecosystems, no analyses have been undertakenof the adequacy of Institutions for protecting the rights of future generations. This paperaddresses each of these working premisesof economics. Suiabityas Int o a Equity Page2 0.3. Differentintergeneratioial distributions of assetsare as5 ciated with differenteffici- ent allocationsof resources.This paper is informed by threeoverlapping generations models. Thefirst, availablein the academicliterature, is a partialequilibrium model which illustrates how alternatedistributions of rightsto a stockresources across generations affects the effi- cientallocation of resources.The second, presented in Appendix2, is a generalequilibrium modelwhich Illustrates a stockresource economy in whichconcem for the futue is achieved throughincome transfers to future generations.The third, presentedIn Appendix3, is a generalequilibrium model which illustrates a renewableresource economy in which concem for the future occursthrough the oldergeneration's utility from the utility of the younger generationas well as its own. Thesemodels demonstrate how resourceuse, consumption, and prices,including interest rates, change with differentlevels of concernfor the future. 0.4. Whileenvironmental, forestry, and resource economics are concemed with the long- term,this concemhas been rooted in the presumptionthat marketfailures prevent the main- tenanceof resourcesfor future generations.Hence improvements in long-termallocation havebeen pursued in termsof internalizingenvironmental externalities. While environmental extemalitiesare no doubta problem,suboptimal allocations due to inappropriatedistribution betweengenerations cannot be solved solely by correctingextemalities. Indeed, intemalizing externalitieswithout protectingthe future can hastenresource exploitation. 0.5. Intertemporalgeneral equilibrium models incorporating overlapping generations and resourceconstraints demonstrate that the efficientallocation of resourcesis a functionof intergenerationaldistribution. Whilethis "finding"is theoreticallyelementary, it is at odds with the understandingsabout allocation and valuation developed through partial equilibrium modelingundertaken in environmental,forestry, and resource economics. A few economists are now admittingthat economiesmay not achievesustainability because sustainability is a matterof equityrather than efficiency.But to date,these economists advocate achieving equitythrough imposing environmental and resource constraints on economicefficiency con- ceivedin a partialequilibrium framework. The modelsinforming this discussionbetter illu- minethe problemand provide new insightsby incorporatingequity into a generalequilibrium modeland observing how equity affects efficiency. While maintaining natural capital through constraintsmight protectthe future,thinking of the problemas oneof how this generation expressesits concemfor the next highlightsthe importanceof institutionsand social values affectingbequests and othermechanisms. 0.6. Manyeconomists, as well as environmentalists,have notedthat discountingthe benefitsreceived and costs bomeby future generationsin projectanalysis is contradictory with a concemfor sustainability.While lower discountrates give greaterweight to the future,using rates different than market rates, or what markea.rates would be without distor- tions, resultsin inefficientuse