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Convened by Senator Robert Hill, Minister for the Environment and Heritage, Canberra, 5 July 2000
Environmental Economics Research Paper No. 7
© Commonwealth of Australia, 2000
ISBN 0 642 19485 8
Mr LOVINS–I think my biases will clearly emerge: I come from the school not of environmental economics, in which the environment is a minor external factor of production, but of ecological economics. As Herman Daly puts it, ‘the environment is the envelope that contains, sustains and provisions the economy.’ I view the economy as a wholly owned subsidiary of the environment, not the other way around.
I would like to spend a few minutes summarising a recent book with Paul Hawken, Natural Capitalism. You will find both the book and the Harvard Business Review paper, giving its basic business case, posted on the web at www.natcap.org or www.naturalcapitalism.org. The book is about a different way of doing business, as if nature and people were properly valued. I say ‘as if’ because it is not necessary to know what they are worth. However it is necessary to observe that if capitalism is about the productive use of and reinvestment in capital, we ought to be talking about practising that with all forms of capital, not simply financial and physical or manufactured capital but also human and natural capital–which are more valuable. Indeed without them there is no economic activity anyhow. But they are typically off the balance sheet, so the ecosystem services that we are running short of, and cannot live without, are tending to get inadvertently liquidated in pursuit of the monetised resources that do get counted.
The logic of natural capitalism is arrestingly simple. The first industrial revolution came about because the relative scarcity of people was limiting progress and exploiting seemingly boundless nature. It made sense at that time to make people about 100 times more productive, a concept hitherto unknown. Today, however, although the logic of economising on the scarcest resource remains perennially true, the pattern of scarcity has reversed. We now have abundant people and scarce nature, not the other way around. Therefore it is nature we ought to be using far more productively, wringing four or 10 or 100 times as much benefit from each unit of energy, water, minerals, fibre, topsoil–whatever we are borrowing from the planet.
This turns out to be highly profitable even when, as now, nature is valued at approximately zero, simply because there is so much waste to turn into profit. For example, the materials flow in the global economy–by the way, not counting water that is returned clean but only counting water that is returned contaminated–is in the order of half a trillion tonnes per year. In an economy like Australia’s, it is probably about 20 times our body weight per person per day. Of that flow, only about one per cent actually ends up in durable goods. In fact, 93 per cent never gets into products in the first place; it is lost first in extraction and manufacturing. Of the one per cent that ends up in durables, about two per cent actually gets recycled back to create more value; the rest is thrown away. So this system of materials flow that is putting such stress on nature is actually about 99.98 per cent pure waste. That is a business opportunity. Similarly, no economy in the world is even one-tenth as energy efficient as the laws of physics permit. After a century of development, our cars use only one per cent of their fuel energy to move the driver. That is not very gratifying. At thermal power plants, the United States throws away as much waste heat as Japan uses energy for everything. The list goes on like that. We can do a great deal better.
As a small example, my own house has a 99 per cent saving on space and water heating energy, 90 per cent on household electricity, the bill for which is about A$25 a quarter for 372 square metres before we take credit for our larger solar production. That was all a 10-month payback in 1983 but today’s technology is a lot better. In fact, we have now eliminated both heating and cooling equipment from new houses in climates from minus 44 to plus 46 Celsius, with lower construction cost and better comfort. In new large commercial buildings, the energy savings are more in the order of 90 per cent, with lower construction costs and again better comfort, and strikingly better labour productivity–which is much more valuable than the energy savings.
I think the basic headline about resource productivity is that it can yield expanding returns, not diminishing returns. If you do whole-system engineering optimised for multiple benefits, you can usually make very large resource savings cost less than small or no savings. This was hinted at in our previous book Factor Four, but it has now been much more systematised and you will find hundreds of cases of it in the book. The design mentality that produces it is now pretty well understood. It does not even need new technology, although that helps as well. Radical improvements in resource productivity are exceptionally profitable with today’s prices without any regulatory pressure, although there are certainly some economic and other mechanisms we can use to make it simpler to achieve.
Advanced resource productivity is only the first of four interlinked principles of capitalism as if nature were properly valued. The second such principle is to redesign production on biological lines, with closed loops, no waste and no toxicity, eliminating the very concept of waste. There are again many striking examples of how this is actually being achieved in quite a few sectors.
The third principle is a new business model, which Paul Hawken calls ‘service and flow’ because it changes the form of the transaction from sporadic production and sale of objects to delivery of a continuous flow of value and service. I prefer Jim Womack’s term ‘the solutions economy,’ because the important change in this business model is to change the relationship between the provider and the customer so, instead of having opposed interests, their interests are fully aligned. They both make money by doing more and better with less for longer; that is, by following the first two principles of natural capitalism.
An example, wrapping together all of the first three principles of natural capitalism, would be what we could do instead of the carpet in this room. We do not really want to own carpet, it does not do any good on the balance sheet, but we do want to walk on it and look at it. The old system of broadloom carpet does not really make a whole lot of sense. One takes maybe 10 or 100 million years to make oil, the oil is then made into nylon and, after about 10 years on the floor, parts of the carpet start to look a bit worn. So you have to shut down operations, move out all the furniture, roll up the partly worn carpet, send it to the rubbish tip for 10,000 or 20,000 years. You lay down fresh carpet, move back in, resume operations and get sick from the fumes of the carpet glue. We did not even want to own the stuff in the first place. Why are we doing this?
Ray Anderson at Interface said, ‘Well, I’ll just own the carpet and lease you a floor covering service. You pay me a little every month on a tax-deductible operating lease in return for which every month my little elves will come in the night, inspect your carpet, take away the worn bits (which are in one-square-metre carpet tiles) and immediately replace them with fresh ones. There is no glue and no disruption because the worn bits are not under the furniture. The mass flow I need to move across your floor to keep it looking fresh will be only one-fifth of what it was before because I’m not replacing the parts that aren’t worn.’ So far so good. On that business model and eliminating some internal waste, in the first four years the company more than doubled its revenues, more than trebled its profits and nearly doubled its employment all at the same time. It substituted abundant people for scarce nature, because perhaps it lost some jobs at the factory through making less carpet but gained more jobs than that on the service end–and probably also gained market share by having a better-value proposition.
For their next step, they came out with a carpet 15 months ago tuned to this business model. It is four times as durable as before and uses 35 per cent less material per square metre. When you combine those two attributes with the service-leasing model–replacing just the worn parts–there is altogether a 97 per cent reduction in mass flow. Moreover, the service provided is superior in every respect. There is no toxicity. It is the world’s first certified climate-neutral product. And for the first time it can be completely remanufactured into identical product with no down-cycling and can even be made out of renewable feedstocks in the first place. Those last two steps will be implemented over the next couple of years, at which point we will have completely broken the loop to the oil well at the front end and the rubbish tip at the back end. We will just have a continuous flow of technical nutrient between your floor and the remanufacturing plant, creating value each time around.
I do not understand how anyone can expect to compete with a business model that uses three per cent of the raw material, one-tenth of the capital, provides a superior product in every respect–completely uncompromised–with a higher margin and a lower cost to the customer, and a tax benefit to boot. This is an example of the sort of stunning competitive advantage that early adopters of natural capitalist business practices are achieving. What do you do with all the profits? A prudent capitalist would reinvest them in the most productive place, which typically turns out to be in natural capital, because that is what we are shortest of. If you can more productively, abundantly and durably produce what we are shortest of, that sounds like a very good deal. In fact, it is the easiest of the four principles to follow, because God does the production. All we need to do is get out of the way and allow life to flourish wherever possible.
There are very interesting examples, initially from industries whose health depends most directly on that of the nature around them–such as farming, forestry, ranching and fishing–where such reinvestments are bearing very good fruit (so to speak), typically redesigning practices to take one’s values from the customers, one’s design from nature and one’s discipline from the marketplace. These are the hallmarks, I think, of successful 21st century businesses, particularly taking design from nature. There is 3.8 billion years of design genius out there–a lot of experience with a lot of experimentation and rigorous testing and whatever did not work already got recalled by the manufacturer. Typically the successful businesses are taking biomimetics or biomimicry very seriously in their design of what they do, how they do it, how they are organised and even how they run themselves.
The principles of natural capitalism I have just enunciated turn out to have important social implications. My favourite chapter of our book is the next to last one which is about Curitiba, Brazil, a city of 2.5 million, which has quadrupled in the past 20 years. It has one-fifteenth of the per capita municipal budget of, say, Detroit, Michigan, so it does not sound like a very nice place. It is actually one of the world’s great cities by design. It is not paradise–it has some problems–but it has solved its problems better than maybe any city I know in the rich countries. It has treated its formidable economic, ecological and social needs not as competing priorities to be traded off but rather as integrated design elements with synergies to be captured. It does lots of small projects bottom-up, chiefly through the private sector, often with community involvement. Each project is designed to solve many problems at once. There are no single-purpose top-down mega-projects brought to you by the sellers of complexity. They are applying in a very entrepreneurial fashion the same whole-system design approach that our book is about. You could say it is a book about design that achieves such strong resource productivity and elimination of waste for fun and profit. I think the early corporate practitioners of natural capitalism are really proving what Ed Woolard, who chaired DuPont, said–that companies that take such principles seriously will do very well. He added that those that do not will not be a problem because ultimately they will not be around.
I want to draw out a few more conclusions that might help stimulate discussion this morning. One is that I think what are framed in the World Trade Organisation’s globalisation trade debate as ‘environmental’ and ‘labour’ issues are best thought of as reflecting the complete absence of natural capital and human capital respectively from the trade ideology. They are playing with only half the deck. As soon as you start to put it in those terms, people who view free trade as an important contributor to prosperity can start to understand better what their opponents are labelling as ‘environmental’ and ‘labour’ issues, but within the conventional framework and rhetoric of capitalist orthodox practice. I think that is a useful idea, which my co-CEO, Hunter Lovins, is pursuing.
Pigouvian taxes, which I see some of the background papers discuss, and ecological tax shifting are generally a good idea. They can be valuable tools. But I think, even at existing prices, natural capitalism can be extremely profitable without that sort of price manipulation or internalisation. I am not saying that internalisation is not a good idea. I am saying we can do a great deal without it, if it is politically difficult. I think we are already heading towards an economy in which traditional environmental regulation (or its pursuit by other means, such as market instruments) becomes a quaint anachronism, because just the private internal cost structure we see today is already enough in most industries to wring out waste pretty rigorously. Pollution is typically a resource out of place; that is, what in the 20th century we used to call ‘wastes’ and ‘emissions’ we are now learning to call by the right name–namely, ‘unsaleable production.’ It is a term I would urge us all to adopt. I got it from a guy in California who is making industries report their unsaleable production under that name rather than their waste and emissions as they did before. This term really focuses our minds on the question: if we cannot sell this product, why are we producing it? Let’s design it out. That is what the sorts of competitive pressures that my carpet example illustrates will lead us to. We will often get there by better cybernetics. Systems without feedback are stupid but we can certainly design feedback better than we have done.
I was delighted last night to meet Australia’s first environment minister, Jack Beale, who told me that back in 1950 he actually required a pulp and paper mill in New South Wales to put its water intake downstream of its outfall. They designed it much better that way. He said he has done that in about 20 places around the world. How clean a car would you buy if its exhaust pipe, rather than being aimed at pedestrians, were plumbed into the passenger compartment? I daresay it would be pretty clean. How clean would you make your factory if its air intake were hooked to its smokestack? How safe would you make your explosives factory if you built your house next to it? Very safe. That is what Mr DuPont did, and his firm has been the world leader in industrial safety ever since. So there are some rather simple cybernetic tricks we can use, but I think the solutions economy business model is the most interesting of the four principles. It is particularly powerful for a primary-based economy like yours.
The Canadian finance minister a few weeks ago just started to understand this and has been making interesting speeches about it. In a world where people are buying fewer tonnes because they are using the tonnes of stuff much more productively, do you want to be in the business of selling tonnes or do you want to move around to the other side of the table, sit next to the customer and experience the reduced tonnage through more productive use of resources, not as your reduced revenue but as a reduced cost to both of you, providing the service the customer was getting out of the tonnes? Or, to put it more boldly, if for example you are a copper miner, you are a price taker in a volatile market in a very long lead-time, capital-intensive business. That is a painful position to be in. Wouldn’t it be a better deal not to sell tonnes of copper to people who are trying to use less of it and use it more productively but instead to lease copper services, so that you both have a stake in using the copper with more elegant frugality, more durability and more retrievability? When the world’s richest copper deposit, which happens to be under the streets of Manhattan, gets freed up because we are laying US optical fibre at a rate of mach 3 you can actually get the stuff back again and lease it to someone else. This is a very fundamental question for the future of the Australian economy. It is one that I would be happy to pursue with any of you. I know some mining and forest products companies that are taking it very seriously.
I have just a few more words about environment and economics that might be a trifle provocative. I was told to be provocative, which is utterly foreign to my nature, but I will try to improvise. First of all, are there any economists in the house? I thought there might be. I would like to suggest that, although price matters, the ability to respond to price matters more. I will give you two small existence proofs. First of all, since 1996–that is, over the past three full years–the United States has very nearly beaten its all-time record for the speed of saving energy as measured in the crude fashion of ‘aggregate primary energy consumption per dollar real GDP.’ We have been reducing that intensity of primary energy use at a rate averaging 3.25 per cent a year at a time of record low and falling energy prices. The only time we beat that was just after the second oil shock, about 1981 to 1984, a time of record high and rising energy prices; at that time we reduced energy intensity 3.5 instead of 3.25 per cent a year. What is going on here?
It is not about price. There are other drivers for it. My colleague, Joe Romm, suggests that maybe as much as one-third of it–probably at least one-fourth of it–may be due to structural changes in composition of output that are associated with e-commerce. He makes a pretty good case for that at the web site www.cool-companies.org. But the rest appears to be improvements in technical efficiency and tiny weather adjustments. I daresay quite a lot of it is due to the sort of competitive pressure we see now, to move overheads to the bottom line by saving them, viewing utilities as a profit centre and not an overhead cost. Some of it is corporate fashion; some is individual concern or personal political leadership; I think quite a lot of it is from companies capturing the knock-on benefits of resource productivity, which can be far more valuable than the direct resource savings and yet were not taken into account in conventional elasticity kinds of calculations.
As a small example, in more efficient buildings, it turns out that people can see better what they are doing, hear themselves think and feel more comfortable. They typically do six to 16 per cent more, and better, work. But in a typical industrialised-country office, you are paying 100 times as much for people as for energy, so a one per cent gain in labour productivity would have the same bottom-line effect of eliminating the entire energy bill. We are typically seeing not one per cent but six to 16 per cent in rigorous case studies. It is not just in office productivity; we see 20-odd per cent higher test scores in day-lit schools, 40 per cent higher retail sales pressure in day-lit shops and much better quality and productivity in well-lit factories where workers can see what they are doing. The list goes on like that. These kinds of knock-on benefits are obviously very important to corporate success and we are starting to see them picked up and being seen as a source of core competitive advantage.
A second example of how price is less important than ability to respond to price is a very simple one. Take a look at Seattle and Chicago from 1990 through to 1996. In Seattle, people pay half as much per kilowatt hour for electricity as they do in Chicago. Yet, during that period, people in Seattle were reducing their electric load 12 times as fast, and their electric consumption 3,600-odd times as fast, as people in Chicago. It is the opposite of what you would expect from relative prices. I think what is going on is quite simple: the utility in Seattle helps you save; the utility in Chicago tried to stop you from saving.
I think the real focus of greenhouse policy ought to be not price–even though it matters–but barrier busting. I would commend to your attention a little prospectors’ guide on pages 11 to 20 of our publication Climate: Making Sense and Making Money, November 1997, which you can download off the web at www.rmi.org. There you will find a list that in the left-hand column carries 60 or 80 specific obstacles to buying energy efficiency. You could call them market failures, but I did not because I wrote this for CEOs who might not think markets can fail. Actually, I rather enjoy being rung up by senior executives who say, ‘You know, I just had an epiphany reading your climate paper. I thought our clever engineers were already doing everything worthwhile to cut our energy costs until I read your description of market failures at the level of the firm. You’re precisely describing how we actually behave, so now I see how much more we have to do and we are going to go pursue it vigorously for competitive advantage.’ How do you do that? The right-hand column shows opposite each obstacle the corresponding business opportunity you can turn it into.
I think that would make a good shopping list for you to redo for Australian circumstances. You will have many common elements; you will have some novel ones. There are eight main categories of obstacles that we list. Some are at the level of the firm; some are in public policy. As small examples, if what Chris Dunstan told me at SEDA yesterday is correct, I believe New South Wales may just have done a very good thing–that is, to decouple electric distributors’ profits from their sales volumes and let them keep as extra profit part of what they save the customer. In other words, it is rewarding them for not selling more energy but for cutting customers bills, which one would have thought was the objective all along. But, throughout the rest of the country and throughout all but one of the United States and practically everywhere else in the world, we have a perfectly perverse incentive: we are rewarding utilities not for cutting bills but for selling more energy. So guess what they do? Why do you suppose they are not terribly enthusiastic about energy efficiency? It is because it is cutting their throats financially, because we got the rules wrong. Why is it that we reward architects and engineers for what they spend rather than for what they save? We have tried performance-based fees in five experiments. They have a very salutary effect on design. The Federal Government buys a lot of design services. There is no reason you could not buy the design services with performance-based fees. That, I think, would shift practice in the private sector as well.
In principle, barrier busting is the most important element of US federal greenhouse policy from the executive branch. As you know, we have a number of embarrassments in our federal energy policy, as you do in Australia. Ours come from the Senate; yours may come from elsewhere. But we have similar challenges in a lot of ways. I think the barrier busting successes have already moved the private sector into the vanguard of climate protection in the US where it belongs; that is, smart companies are behaving as if our Senate had ratified the Kyoto Protocol because it is so profitable to do so. I will give two tiny examples.
The world’s eighth-biggest semiconductor firm, ST MicroElectronics–which was twelfth biggest when we started working with them–has very able management who saw early that it would be better to sell emission permits to their competitors than have to buy them. So we figured out with them how to cut carbon emissions per chip by 98 or 99 per cent by doing seven things of which five are profitable now and the other two will be shortly. The consequences are that late last year they declared a goal of zero net carbon emissions for the entire company by 2010, by which time they expect to be making 40 times the volume of chips they were in 1990.
Another example is DuPont. The chemical giant announced late last year that over the next 10 years, as they grow revenue six per cent a year, they intend their energy use to be, at worst, flat; that is, to increase their energy productivity six per cent a year. This is in an industry that has more than doubled its energy productivity since the first oil shock, yet the more they look, the more opportunity they find. They found in DuPont two interesting things. First, that their European factories, which had long been exposed to double the energy price of the North American ones, were no more energy efficient simply because they were designed in the same way by the same people using the same kinds of equipment. Second, that every tonne of carbon they did not put in the air would add $US6 to their bottom line, not counting the potential billions they might make off trading later.
They decided that not only would they raise their energy productivity by another six per cent a year in this decade at least, but also that by 2010 they would be getting one-tenth of their energy and a quarter of their raw materials from renewable sources. By 2010 they expect to be emitting 65 per cent less greenhouse gas than they did in 1990–all in the name of shareholder value. This kind of corporate leadership is, I think, extraordinarily important and valuable, and I hope to see more of it coming from Australia.
I want to emphasise that on the technological side–this is, again, where the private sector really shines–we are starting to see not just shifts along demand curves but jump shifts; discontinuous and radical relocations in demand curves. I mentioned earlier the tunnelling through the cost barrier idea that if you design engineered systems properly (buildings, industrial processes, vehicles and so on), you can often make very large savings cost less than small ones. This has actually been demonstrated empirically in a huge range of technical systems, everything from cars to clean rooms, pumping and fan systems, big and small buildings in hot and cold climates–you name it. One of my favourite examples is the 92 per cent reduction in energy in a supposedly optimised, industrialised pumping loop just by using fat, short, straight pipes instead of skinny, long, crooked pipes. This is not rocket science; this is good Victorian engineering rediscovered.
I think many economists do not appreciate how discontinuous the changes in technology can be and how they can be driven purely by benefits to the customer and the manufacturer that do not depend in any way on changes in price or in government policy. A remarkable example would be the hypercar, which you will find on the web at www.hypercarcentre.org or www.hypercar.com. This is a thing I dreamed up about 10 years ago that makes cars about three times lighter and more slippery so they need only about one-third as much power to make them go. But they are uncompromised; they are better in all other respects. They are not just clean and efficient (emitting nothing but hot drinking water and being 3.5 to eight times as efficient as present cars); they are also safer, more comfortable, more durable, the same price, perform like a sports car in a large suburban assault vehicle and so on.
We did something a little sneaky. We put this work in the public domain in 1993 where no-one could patent it and got them all fighting over it on two principles. First, that it would be a better buy for the customer and would therefore redefine market expectations, so people would buy hypercars for the same reasons they buy compact discs rather than vinyl gramophone records. (Not because polycarbonate became cheaper than polyvinyl chloride, it was just a better product.) Second, there are decisive advantages for the manufacturer because hypercars need about one-tenth the capital investment product cycle time of old cars–concept-to-street, assembly effort and space and body parts count–so early adopters win. By now about $US10 billion has been committed to this line of development. It is doubling about every year and a half. You can read an open source chronology on the web of how quickly it is moving to market. This is going to save as much oil as OPEC now sells. In fact, it is the end, as we know them, of the car, oil, steel, aluminium, nuclear, coal and electricity industries and the beginning of successor industries that are more benign and more profitable. Just in this sphere, we are about to see an orgy of Schumperterian destruction, driven again by customer and maker advantage; not by government policy, not by taxation, not by mandates, not by subsidies. Economists need not apply; this is for marketers and engineers.
The reason I mentioned electricity and coal–very relevant here–is that each hypercar with a direct hydrogen fuel cell is a 20- to 40-kilowatt power plant on wheels. As part of a strategy for the hydrogen transition that is profitable at each step starting now (and firms like Shell are starting to adopt rather rapidly), we could see a practical way to use each parked car as a plug-in power station–cars are parked 96 per cent or so of the time–and sell back to the grid enough electricity to earn back half the cost of owning the car. A very nice value proposition, and the car fleet will ultimately have five or 10 times the generatic capacity of the national grid.
I think with that sort of discontinuity coming at us there are still vital roles for economic tools, but they may be quite different from what we thought. They may be in appreciating the 75 or so distributed benefits that make decentralised waste to meg electricity a magnitude more value than we thought. There are certainly new ways to make markets and save resources so that megawatts, for example, become a commodity subject to competitive bidding, arbitrage, secondary markets, derivatives–all of the things that happen in commodity markets. We have made good progress in making that happen in electricity and water efficiency, but this is not simply the traditional role of economics of trying to get the prices right supposing there are no market failures and not really paying attention to technological discontinuities. They can make our jobs much easier.