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posted on 21 January 2017

Economics, Society, And The Environment: What's Wrong With This Picture?

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A common view of some is that the relationship between economics and the environment is that environmental considerations are "externalities" for economic systems. In other words, effects produced by economic activity in the environment result from a limited overlap between the economic "system" and the environment, such as the diagram shown (from Giddings, Hopewood and O'Brien):


The diagram above is adopted by some to describe the fields of enivonmental economics and environmental science. describes their discipline:

Environmental economics is an area of economics dealing with the relationship between the economy and the environment. Environmental economists study the economics of natural resources from both sides - their extraction and use, and the waste products returned to the environment. They also study how economic incentives hurt or help the environment, and how they can be used to create sustainable policies and environmental solutions.

This seems a reasonable description. But the accompanying diagram indicates a lack of understanding of the scope of the field.

Giddings, Hopewood and O'Brien (Environment, Economy and Society: Fitting Them Together into Sustainable Deveopment, Sustainable Development, Vol 10, p. 187-196, 2002) point out the logical shortcomings of the traditional concept above, and suggest a more correct way of conceptualizing the relationships:

A more accurate presentation of the relationship between society, economy and environment than the usual three rings is of the economy nested within society, which in turn is nested within the environment (Figure 2). Placing the economy in the centre does not mean that it should be seen as the hub around which the other sectors and activities revolve. Rather it is a subset of the others and is dependent upon them. Human society depends on environment although in contrast the environment would continue without society (Lovelock, 1988). The economy depends on society and the environment although society for many people did and still does (although under siege) exist without the economy.


The importance of recognizing that all of society is a subset of functions within the environment is that society cannot violate the proven physical laws of the physical world (actually universe, but we will return to that thought later). Likewise, the economy exists totally within society so economics must also obey the same physical laws.

Steve Keen has argued that the forgotten parameter in economics is energy. Whereas economists develop models and theories based on labor and capital as the components of production, energy should also be explicitly defined as separate and co-variant with labor and capital. Keen argues that failure to do so has led economists to propose models and theories which violate the fundamental laws of our environment, the Laws of Thermodynamics.


A good discussion is found at, which includes the following statements of the three Laws of Thermodynamics:

  • The first law, also known as Law of Conservation of Energy, states that energy cannot be created or destroyed in an isolated system.

  • The second law of thermodynamics states that the entropy of any isolated system always increases.

  • The third law of thermodynamics states that the entropy of a system approaches a constant value as the temperature approaches absolute zero.


  • absolute zero: The lowest temperature that is theoretically possible.

  • entropy: A thermodynamic property that is the measure of a system's thermal energy per unit of temperature that is unavailable for doing useful work.

The discussion of systems and closed system boundaries at will be helpful for those who want to dig a little deeper.

Thermodynamics and Economics

Steve Keen has identified the crises of conflict in economics as occuring in five phases:

  1. The event that I personally identify as the real point at which economics went wrong: Smith’s replacement of “the division of labour" as the source of rising productivity in capitalist over the Physiocratic argument that human productivity actually emanated from employing the energy of the Sun. Though the Physiocrats were wrong that agriculture was the only “productive" sector - manufacturing being “sterile" according to them since all it did was transform the outputs of agriculture into different forms, when in fact it harnesses “free energy" (energy from the Sun, fossil fuels and nuclear processes) to do useful work even more effectively than agriculture - they were right that harnessing free energy was the basis of the productivity of capitalism.

  2. The Neoclassical revolt against the Classical school after Marx had turned the latter into the basis for a critique of capitalism, rather than a defense of it as it was with Smith and Ricardo; and

  3. The “Methodenstreit" dispute between the Austrian and German Historical Schools - which was a dispute about a priori reasoning versus empirical data;

  4. Keynes' battle with neoclassical economics in the 1930s.

  5. The current crisis of the new classical and neoliberal period (1960s-2010s).

His argument is that the common economic modeling assumptions of the last couple of centuries violate the laws of thermodynamics which can be restated to have the following consequences:

  • Energy is a constant within any isolated system.

  • Energy has two components: available energy and unavailable energy (entropy).

  • When energy is used in any process the output is less than would be assumed if all the energy was available to do work.

The violations endemic in economic theory and modeling is that outputs can be increased directly one-to-one by increasing inputs violates the laws of thermodynamics. The ratio is less than one-to-one, the amount of energy successfully used depending on the exact process (some more efficient than others, but none fully using all the energy for production).

Concluding sidebar

The correctly nested diagram above is actually incomplete. As man (hopefully) continues to expand human activity into the solar system it will become increasingly important to consider a broader definition of systems, as illustrated:

The global environment is contained within the solar system, all that within our galaxy, etc. The boundaries are not drawn in. Of course, we could also extend our array of all systems to include parallel universes, but let's wait until we at least get some idea of how the boundaries function as implicated in the diagram as shown above.


This issue is discussed in detail in Documentary Of The Week: Value And Thermodynamics.

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