During the past decade theoretical and empirical advances in neoclassical economics have resulted in the virtual rejection of the two pillars of traditional welfare economics-- rational economic man and perfect competition. Surprisingly, many ecological economists are moving closer to the discredited neo-Walrasian welfare model just at the time it is being replaced within the mainstream. We call for a return to the roots of ecological economics and an engagement with current developments in mainstream theory.

John M. Gowdy

Jon D. Erickson

English

Research Papers in Economics

 
Working Papers in Economics 
 
Department of Economics, Rensselaer Polytechnic Institute, 110 8
th Street, Troy, NY, 12180-3590, USA. Tel: +1-
518-276-6387; Fax: +1-518-276-2235; URL: http://www.rpi.edu/dept/economics/; E-Mail: keenak@rpi.edu 
 
 
 
Ecological Economics at a Crossroads 
 
John Gowdy 
Rensselaer Polytechnic Institute 
 
Jon Erickson 
University of Vermont 
 
 
 
 
 
 
 
Number 0417 
June 2004 
 
 
 
______________________________________________________________________________ 
For  more  information  and  to  browse  and  download  further  Rensselaer  Working  Papers  in 
Economics, please visit: http://www.rpi.edu/dept/economics/www/workingpapers/   1 
 
 
 
 
Commentary 
 
Ecological Economics at a Crossroads 
 
John Gowdy 
Department of Economics 
Rensselaer Polytechnic Institute 
110 8
th Street 
Troy, New York, USA 12180-3590 
e-mail gowdyj@rpi.edu 
 
 
Jon Erickson 
Rubenstein School of Environment and Natural Resources 
344 Aiken Center 
University of Vermont 
Burlington, Vermont USA 05405-0088 
e-mail Jon.Erickson@uvm.edu  
 
 
 
Abstract 
During the past decade theoretical and empirical advances in neoclassical economics 
have resulted in the virtual rejection of the two pillars of traditional welfare economics--
rational economic man and perfect competition. Surprisingly, many ecological 
economists are moving closer to the discredited neo-Walrasian welfare model just at the 
time it is being replaced within the mainstream. We call for a return to the roots of 
ecological economics and an engagement with current developments in mainstream 
theory.        
 
   2 
Ecological Economics at a Crossroads 
 
Theory evolves by succession or surrender.  By succession, one theory leads to 
the next iteration – the version is updated but the platform remains intact.  By surrender, 
the old yields to the new based on refutation of theory inconsistent with observation.  
Similarly, the speed in which hard won knowledge enters new texts, educates new 
practitioners, and informs new management and policy ranges from gradual transition to 
revolutionary shifts.  Both the path and speed depend on the structure of social 
institutions, in particular the public affinity for and entrenched power of the status quo.  
Evolution by natural selection, the invisible hand of a market economy, and the 
environmental movement were all ideas “in the air” long before they crystallized in the 
minds of Charles Darwin, Adam Smith, and Rachel Carson.  Even good ideas must wait 
until the socio-political climate is ripe in order to fuse into the public conscious.   
In economics, the path and speed of theory has been characteristic of painfully 
slow succession, reinforced by a status quo inseparable from the elite of the industrialized 
world.  Economic theory taught in 21
st century undergraduate and graduate programs is 
barely distinguishable from the last revolution in economics, the neoclassical era ushered 
in over 100 years ago with the elegant mathematical justification of free market 
capitalism by the likes of Marshall, Walras, and Pareto.  Twentieth century challenges to 
the mainstream were most often characterized as anomalies to assumptions of consumer 
and firm behavior (e.g. Veblen’s conspicuous consumption and the Allais, Boadway and 
Scitovsky paradoxes); or as being easy to deal with through minor government 
intervention to correct market failure consistent with the general equilibrium framing of 
the problem.  Some new ideas were absorbed into the mainstream, as long as they didn’t 
challenge the bedrock principles of isolated individual rationality, material consumption 
as utility, perfect competition between firms, and the primacy of efficiency through free 
market enterprise. 
However, evidence is mounting that the current era of mainstream theory is 
coming to an end – and by surrender.  Mainstream economic theory is changing so fast 
that the previously narrow descriptor “neoclassical” is now hard to define.  Perhaps the 
surrender of a “neo-Walrasian model” is the best portrayal given a decades-old reliance 
on the general equilibrium model in economic theory, practice, and policy advice.  While 
theoretical critiques of general equilibrium theory have been brushed aside, a more recent 
era of empirical tests of the predictions of general equilibrium theory could be the 
proverbial nail in the coffin.  Most notably, during the past few years, Nobel prizes have 
been awarded to economists holding beliefs considered heretical in the 1970s and 1980s. 
Looking back it is difficult to understand how the Walrasian model held sway for 
so long.  Its two foundations include a model of behavior (Homo economicus) that makes 
every living human “irrational” and a model of production (perfect competition) that 
makes every existing firm and market “imperfect”.  These two pillars are essential to the 
general equilibrium framework.  But without them it cannot be demonstrated that 
competitive market outcomes are Pareto optimal (the First Fundamental Theorem of 
Welfare Economics) and thus intervention to correct “market failures,” that is to establish 
the “socially optimal” Pareto position (the Second Fundamental Theorem of Welfare 
Economics), has no theoretical basis.  This leaves no reference point to use in cost-benefit   3 
comparisons.  It’s not enough to say that neo-Walrasian assumptions are “close enough” 
– either Pareto optimality can established or it cannot.  
Two recent Nobel Prize winners in economics highlight the growing rejection of 
these caricatures of consumer and firm behavior.  Daniel Kahneman (2003, p. 1457) 
writes: 
 
Utility cannot be divorced from emotion, and emotions are triggered by 
changes.  A theory of choice that completely ignores feelings such as the 
pain of loss and the regret of mistakes is not only descriptively unrealistic, 
it also leads to prescriptions that do not maximize the utility of outcomes 
as they are actually experienced – that is, utility as Bentham conceived 
it… 
 
Joseph Stiglitz (1994, p. 28) is equally critical of the neo-Walrasian model of market 
behavior: 
 
It is the first welfare theorem [asserting the efficiency of competitive 
markets] that provides the intellectual foundation for our belief in market 
economies.  Like any theorem its conclusions depend on the validity of its 
assumptions.  A closer look at those assumptions, however, suggests that 
the theorem is of little relevance to modern industrial economies. 
 
If the mainstream is truly changing, at least amongst its theorists, then this 
presents an interesting challenge to ecological economics.  Ecological economics was, 
and for many remains today, an outright rejection of the Walrasian general equilibrium 
framework.  Herman Daly laid the foundation of ecological economics in two books 
published in 1973 and 1977.  The first was a reader containing several now-classic papers 
including two by the intellectual fathers of ecological economics, Nicholas Georgescu-
Roegen (The Entropy Law and the Economic Process) and Kenneth Boulding (“The 
Economics of the Coming Spaceship Earth”).  Georgescu’s work, dating back to the 
1930s, stressed that consumer theory should be consistent with actual human behavior 
and production theory should be consistent with biophysical laws.  Boulding succinctly 
pointed out the absurdity of believing that economic growth could continue indefinitely 
on a finite planet.  In the second book, Daly refined his criticisms of neoclassical theory 
and presented his blueprint for a steady state economy, including the three-tier goals of 
sustainable scale, just distribution, and efficient allocation. 
The economic process is a social, not individualistic, phenomenon taking place 
within a finite biophysical universe.  This simple observation constitutes the core belief 
of ecological economics and has great relevance for recasting social policy (Gowdy and 
Erickson, in press).  Consider the two approaches to environmental policy advocated in 
every standard environmental economics text: the Coasian assignment of property rights 
and the Pigovian application of taxes and subsidies.  Both approaches embody all the 
assumptions of Homo economicus and both have been shown to be flawed.  According to 
the Coase theorem the optimal allocation of resources among individuals who can freely 
bargain at no cost should be independent of the initial assignment of property rights.  
Experimental evidence clearly shows this theorem to be false (Kahneman et al. 2004).    4 
Individual choice is consistently influenced by an “endowment effect” where higher 
value is placed on things already in possession (Thaler 1980), a particular example of 
“loss aversion,” where people are more averse to taking a loss as to enjoying an equal 
gain (Kahneman and Tversky 1979). 
The success of Pigovian polices depends on rational actors responding in 
predictable ways to price incentives.  Here again the empirical evidence fails to support 
the behavior implied by the model’s assumptions.  The effect of incentives on behavior is 
mixed at best and is frequently perverse.  When people are paid to do something that was 
previously part of their social norms – donating blood for example – the amount of the 
social good provided can decline (Gneezy and Rustichini 2004).  The presence of an 
award (or penalty) may actually have an opposing (or reinforcing) influence on what 
cognitive psychologists refer to as intrinsic motivation.  This calls into question the 
relative importance of “getting the prices right” in environmental policy, over potentially 
more effective non-price adjustments.  For example, rather than assume exogenous 
preferences that respond in predictable ways to price signals, economists have begun to 
stress the pervasiveness of endogenous preferences and the importance of an individual’s 
personal history, interaction with others, and the social context of the individual choice 
(see the papers in Camerer, Lowenstein, and Rabin, 2004).  Economists have only 
“discovered” what advertisers have known for a long time, consumer tastes are ever 
changing and changeable. 
Given the current revolution in economic theory, there is good reason to believe 
that economic textbooks will look entirely different 10 years from now.  For example, the 
wildly varying assumptions about human behavior currently held by economists, 
psychologists, anthropologists, and sociologists are in the process of being reconciled 
(Gintis, 2004), and when this process is completed, Homo economicus will only be a 
historical anecdote in the classroom, and ultimately, abandoned in the policy arena.  The 
realization that previously dubbed “anomalies” of market behavior may actually be more 
representative of the human condition has fueled the current revolution sweeping 
mainstream economics. 
This realization was the result of one simple step: economists began to 
empirically test their theory’s most basic assumptions.  When this was done in 
cooperation with other disciplines and with emerging approaches from game theory and 
behavioral economics, general equilibrium failed its own test of success – its basic 
assumptions failed to predict real economic behavior (Gintis 2000).  Even the most 
sacred “laws” of supply and demand are now subject to intense scrutiny, putting into 
question the mantra of every economics course ever taught: “incentives matter”.  
Incentives do matter, but not only price incentives.  In fact, price incentives may not be 
the most efficient means to change market behavior and, at times, can have quite perverse 
consequences.  Broadly rational actors respond to a variety of incentives in a variety of 
ways. 
What is the relevance of all this to ecological economics?  On the negative side, 
too many ecological economists are still applying optimization models that assume Homo 
economicus and perfect competition.  Too many ecological economists are still using 
simplistic forms of cost benefit analysis embodying assumptions on value and incentives 
known to be empirically invalid and theoretically flawed (Gowdy 2004).  Too many 
ecological economists are falling into the trap of “right prices”, calling upon irrational   5 
agents and imperfect markets (as defined by reigning theory) to somehow correct market 
failures. 
On the positive side, ecological economics has a critical role to play in the current 
revolution in economic theory.  Of the many heterodox approaches currently taking shots 
at the neo-Walrasian model, ecological economics is the only approach treating the 
human economy both as a social system and as one imbedded in the biophysical universe 
(Gowdy and Erickson 2004).  While the social and psychological critique of general 
equilibrium models that is now sweeping the mainstream has long been integral to 
ecological economics, we also bring to the revolution the sorely needed biophysical 
critique grounded in the harsh realities of the laws of thermodynamics.  All aspects of the 
economic process require low entropy matter and energy, and all aspects produce high 
entropy waste.  Environmental externalities are the rule, not the exception.   
And so, ecological economics is at a crossroads.  We can embrace the revolution 
in economic theory – inspired by recent empirical tests of the core assumptions of noe-
Walrasian theory – or we can turn our backs to both the turning tide of the mainstream 
and our own roots in the social and psychological critique.  We can abandon the narrowly 
conceived Homo economicus model of behavior and reliance on correcting market prices 
as the primary policy lever, or we can further wed ourselves to a marginal cost and 
benefit framework built upon the fundamentally flawed postulate of isolated individual 
response.  We can recognize the pliability of preferences and the importance of a myriad 
of non-price influences on human behavior, or we can depend on an outdated, unrealistic 
model of human behavior that the forefathers of ecological economics took great pleasure 
at picking apart.  We can lead the charge to merge the social and biophysical critiques, or 
we can fall prey to a caricature of ecological economics as Walrasian wine in a new 
bottle.  
 
 
Acknowledgements 
 
For valuable comments and critique, thanks to Jeroen van den Bergh, Robert Costanza, 
Herman Daly, Faye Duchin, Herbert Gintis, Rich Howarth, Neha Khanna, Karin 
Limburg, Dick Norgaard, David Stern, and Arild Vatn. 
 
 
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Daly, H.E., 1977. Steady State Economics. W. H. Freeman, San Francisco. 
 
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Ecological Economics at a Crossroads

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