The author is one of several CIGI-sponsored Canadian university students who attended the INET conference, Crisis and Renewal: International Political Economy at the Crossroads, at Bretton Woods, NH, April 8-11, 2011. Each student was asked to write a short reflection on the conference themes.
When I was invited to attend the INET conference at Bretton Woods, I felt it was an opportunity to do something quite different from my ordinary studies. It was a chance to meet and learn from world-class thinkers, who use the tools of economics and apply them to some of the greatest challenges our society faces today. It was a chance to see the tools I am studying in action, in the hands of some of their most able practitioners.
The speakers at the conference discussed a wide breadth of topics, but some stood out over the course of the weekend. The most prominent topic of discussion was the recent global financial crisis, but a close second was the issue of environmental sustainability, a topic not typically associated with orthodox economics. Though most economic models abstract the economy completely from the environment, it would surprise no one to learn that the economy and the environment are highly interrelated. What I suspect is more surprising, however, is that the tools of economics are very well suited to studying issues related to the environment. Inevitable tradeoffs exist between environmental emissions and economic production. It is tempting to characterize these decisions as “the environment versus the economy,” and for individuals concerned with the environment to dismiss economists as partisans of the opposite side. Yet economics is, to a large extent, the study of tradeoffs, much of it founded on making optimal decisions regarding resource allocation under conditions of scarcity. In his keynote address, Lord Adair Turner referenced Britain’s Stern Review, a massive and wide-reaching economic study of the environment chaired by economist Nicholas Stern, which concluded that significant increases in investments combating global climate change are warranted and economically justified. The lunchtime panel on “Sustainable Economics,” introduced by CIGI’s founder and chair Jim Balsillie with a bevy of facts and figures, continued with three knowledgeable panellists, all actively studying and highly concerned about the environmental impact of economic growth. While the scarcity of environmental resources (such as tolerance to atmospheric carbon) has traditionally been overlooked in economic circles, the speakers at Bretton Woods made it abundantly clear that this is no longer the case.
As I absorbed the information from presentations relating to the recent global financial crisis and the menacing environmental one, it struck me that the two areas share many fundamental issues and lessons. First, both issues boil down to a core problem of externalities. An externality occurs when the true cost of a decision is not factored into its price, such as when firms or countries do not pay for all of the costs of their carbon emissions, because as carbon dioxide diffuses in the atmosphere, so too does the harm its pollution causes. Similarly, as discussed by Garry Schinasi, independent adviser and a visiting fellow at Bruegel, financial firms choosing the optimal level of balance sheet risk to maximize their returns do not consider the systemic risk their decisions create, because that cost is paid by society and not the individual firms. If the actors making decisions are not forced to take into account the costs of their actions, we end up with collectively suboptimal outcomes — even crises, if they become serious enough.
Second, both financial and environmental problems are exacerbated by global entanglement and interdependence. Before the recent crisis, the interconnected nature of the financial industry was not fully understood by economists or politicians — a point emphasized by former UK Prime Minister Gordon Brown and many others throughout the conference. Issues of solvency in a single major financial institution could quickly spread to others through a complicated and not scrutinized web of interdependence. Moreover, problems in a single major country's financial system could quickly spread across the globe, since financial entanglements are in no way contained domestically. The result is that, as Claudio Borio from the Bank for International Settlements put it, countries can no longer be content that all is well if they simply “keep their house in order.” The world learned the extent of global financial interdependence only through crisis; with regard to the environment, we have had more warning. In recent decades, advances in our scientific understanding of climate dynamics have shown that environmental damage has global consequences, not simply local or regional ones. An environmental crisis as a result of this interconnectedness could be far more devastating than the financial crisis the world has recently weathered.
A final point of similarity is that although these problems have economic causes at their root, they require political solutions, which will necessitate global cooperation. This idea was easily the most oft-repeated refrain of the conference. Eric Berglof, chief economist at the European Bank for Reconstruction and Development, encapsulated the financial crisis as “a large shock to deeply integrated markets without an integrated crisis management mechanism.” The challenge now is to develop those integrated mechanisms, both for crisis management and crisis prevention. It is a challenge that was addressed by many speakers at Bretton Woods. Alex Evans from the Center on International Cooperation in New York highlighted the challenge of environmental cooperation, noting that “192 countries need to agree on how to divide the carbon budget,” and that “any agreement needs to be seen as fair.” The ideas underpinning such an agreement need to be developed now, and are often motivated by economic observations and thinking. Solutions to these economic problems will ultimately require difficult political action.
The intersection of political and economic thinking required to improve the welfare of our society, a prominent topic in the weekend's discussions, has a long history in the economic discipline. In The Wealth of Nations, published in 1776, Adam Smith discusses the economics of optimal trade policy, but recognizes that political decisions and considerations must be taken into account. Attending the conference provided me with the pleasure of witnessing the intersection of economic ideas and reform-minded proposals. The speakers in attendance applied the tools of economics to the pressing issues of today, and presented their suggestions of how the world might be made a better place.
For more information and videos from the INET conference, visit http://ineteconomics.org/initiatives/conferences/bretton-woods/agenda.
Michael Stepner is a second year undergraduate student in economics at McGill University.