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Environment: Sharing a finite world

Dr Aled Jones looks at the impact of earth’s dwindling resources on economic growth

01 FEB 2013 | DR ALED JONES


Environment - a finite world

Resource constraints will, at best, steadily increase energy and commodity prices over the next century and, at worst, could represent financial disaster, with the assets of pension schemes effectively wiped out and pensions reduced to negligible levels.

This is the bleak vision of the future emerging from a major report launched by the Actuarial Profession in association with Anglia Ruskin University on 17 January 2013. It also suggests that financial models fail to factor in the risks of climate change and resource scarcity, apart from a narrow focus in some insurance products related to direct weather events.

It is imperative that actuaries recognise that dwindling resources raise the possibility of a limit to economic growth in the medium term and urgently dedicate research effort into the implications this has for their advice.

How resource constraints affect the economy is complex and depends on a number of factors. Political and market responses to the challenges associated with resource constraints will have far-reaching consequences that need to be understood. To a large extent, these can be managed or, at the very least, influenced.

Does the current ‘no growth’ economy in developed countries give us enough time to innovate, or does it distract us from our real long-term challenge? Will the increasing cost of resources, the effect of climate change and the scale of biodiversity loss result in investment into new methods of doing things, or will it merely increase investment into business as usual? Will any individual, organisation or sector take responsibility for managing a transition to a new economic paradigm or a new technological revolution? Will society or physical events force us to accept this responsibility in time, or will we avoid it until it is too late? Modelling such a high-impact set of issues is critical – not just for actuaries but also for society as a whole.

 


Sharing a finite world graph

Economic growth


The gross domestic product (GDP) measure of growth was developed by Simon Kuznets in the 1930s, when the US was trying to address the Great Depression. The rising role of government in the economy led to an increased need for a comprehensive set of data for national economic activity. The use of GDP spread globally after the Bretton Woods Conference in 1944, when the International Monetary Fund (IMF) and World Bank were created. These institutions followed the US and UK in using GDP to guide their policy advice and investment choices. This is widely believed to have reduced the severity of business cycles and promoted the era of strong economic growth after the Second World War.


In 1972, the Club of Rome produced a report called The Limits to Growth. This used systems dynamics theory and computer modelling to analyse the long-term causes and consequences of growth in the world’s population and material economy. Twelve scenarios illustrated how world population and resource use interact with a variety of limits. In every realistic scenario, the model found that these limits would force an end to growth, or even a collapse, some time in the 21st century. The report attracted significant controversy and its scenarios were rejected. However, the path taken during the past 40 years by the measures modelled corresponds worryingly well with the projections.


Even without resource constraints, it has been argued that we have already entered a period of low economic growth, and the current economic crisis has reinvigorated the debate on how society should react. Opinions can be grouped around four broad themes.


1) Growth is the solution Economic growth brings with it technological innovation that would bring about the required changes to meet resource constraint challenges.


2) Green growth By examining and changing indicators of growth to be more aligned with resource constraints and climate change, global economic development would more naturally develop the required solutions to global challenges.


3) End of growth The finite size of the planet combined with the fact that the economy is now operating on a world-wide scale means that growth cannot continue and must stabilise to remain within global boundaries.


4) Beyond the limits Resource limits and/or climate change have been ignored for too long and the global economy and population are now too large to be supported at current rates of consumption. A long-term decline is inevitable.

Environment graph

Effect on actuarial assumptions

If economic growth is limited by resource constraints, this could be reasonably expected to significantly affect future financial and demographic outcomes. As such, the assumptions that actuaries use should take into account a number of potential developments.

Reduced economic growth caused by resource constraints and reduced confidence.

Reduced access to many commodities, hence increased prices or lack of availability.

A series of price shocks caused by greatly reduced access.

Reduced coordination and international security as countries compete for resources.

Repression of investment returns as governments direct investment into sectors required to make the economy more resilient.

Increased differential of investment returns in countries with varying starting points for resources, efficiency and debt levels.

Increased bankruptcy as indebted countries, companies and individuals fail to make repayments owing to the lack of growth.

Warmer temperatures and unpredictable weather caused by climate change.

Increased social tension as inequality and hardships are exacerbated.

Changes to life expectancy and morbidity caused by changes in temperature, access to resources or ability to afford medical care.

Three broad categories are explored in more detail in the published report, namely discount rates (this includes interest rates and investment returns), inflation (including salary and prices), and demographic factors (mortality and morbidity).

How society reacts will be a major determinant of outcome. For instance, the reaction of monetary authorities to increases in commodity prices will determine whether increases in commodities result in general inflation. Society will also need to invest more and consume less, and the way this is achieved will determine investment returns, both absolute and relative to wage growth.

In certain circumstances, governments could intervene – either proactively or reactively – to address a threat that could constrain investment returns and wage growth. Resource constraints could lead to international tension, potentially reducing trade, economic activity or even threatening security. They will also have a clear impact on international investment, upon which many institutions rely.

If resource constraints do provide a limit to economic growth, it is vital that these impacts are understood.


References

[1] Data taken from BP Statistical Review 2012

(www.bp.com/statisticalreview) and David Cohen, ‘Earth’s natural wealth: an audit’, New Scientist,

Issue 2605, 23 May 2007, pp 34-41

[2] Mark Strauss, ‘Looking back on the Limits to Growth’, Smithsonian Magazine, April 2012

(bit.ly/Smithsoniangrowth)


Dr Aled Jones is a director at the Global Sustainability Institute, Anglia Ruskin University
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