Modern economic systems are dependent on loans. From trade and investments to education, homes and consumption, many things are financed with the help of loans. The loss of financial loans was what made the global crisis of 2008 so threatening. Just like in the 1930s, trade loans ran out, and companies had difficulties obtaining short-term financing. At times, there was a real danger that the economy would suffer a structural collapse.
Financial loans for companies are not the only form of credit, however. Loans come in all different shapes and sizes. If we compromise our future living standards in order to increase our current living standards, that is also a kind of loan. Consumers accept that their purchasing power will be decreased in the future in return for increased purchasing power in the present.
“Environmental debt is a threat to the global economy.”
Paul Donovan, Global Chief Economist at UBS Wealth Management
The term “loan” can also be applied to any situation in which a reduction in living standards is deferred. We also take out loans with the environment.
An “environmental loan” in this sense results from the unsustainable use of environmental capital. We know that the removal of water from aquifers, the combustion of oil and the excessive exploitation of arable land will lead to a reduction in our future living standards. Yet we accept this worsening of our future lives in order to increase our current living standards.
The only problem is this: environmental debt is now a threat to the global economy. And this threat is more serious than the risks posed by financial loans. The living standards that we benefit from today could collapse.
“We are dependent on resources that will no longer exist in the future.”
Paul Donovan, Global Chief Economist at UBS Wealth Management
Caught in the debt trap
We use about 150 percent of the available renewable energy to maintain our current living standards. In other words: we have environmental loans to thank for a third of our current living standards. We are dependent on resources that will no longer exist in the future. We are acting like a person who finances their lifestyle year in, year out by taking out a loan that amounts to 50 percent of their income.
The risk now lies in the potential scarcity of the ecological capital, and this may well have much more far-reaching consequences than the financial crisis of 2008/2009. A credit crisis will occur when the future is no longer able to issue loans in order to improve our current living standards.
“The effects of ecological limits on our standard of living are already becoming apparent.”
Paul Donovan, Global Chief Economist at UBS Wealth Management
If the people of today had to live sustainably and not spend more than their actual ecological “income,” living standards would fall by a third all around the world. And taking into account the expected population growth over the next thirty years, future living standards could actually be halved – that is unless sustainable change occurs.
The effects of ecological limits on our standard of living are already becoming apparent. China’s project to build oil and coal-fired power stations on a large scale failed – not because the stocks of oil and coal were exhausted but due to a shortage in the water required to cool the power plants. China is not capable of generating electricity and growing food at the same time. Food production in the Western United States is restricted by a shortage of water. Pollution leads to residents of the major cities developing health problems which decrease productivity and can only be rectified at considerable cost, if at all. These limits to growth possibilities are merely indications of the potential consequences that an “ecological credit crisis” could entail.
The use of environmental credit cannot continue as it is at the moment. Despite that, living standards can still be maintained or even improved. Economists have found a solution. It consists of a new type of growth that is focused on innovation and efficiency. This kind of growth could reduce our dependency on environmental debt.
The objective of innovative growth is to generate more performance with less energy and more products with fewer raw materials. This is precisely what is needed for us to maintain our standard of living without relying on environmental debt. Digitization and the virtual economy have a role to play, too. The environmental cost of owning a music album, for instance, is lower today than it was ten years ago. A decade ago, consumers bought a manufactured CD which included a plastic case and packaging and had to be transported. Now, consumers simply download the album directly to their iPod. Downloads may not be entirely free from an environmental perspective, but the innovative, virtual economy has reduced the environmental cost of buying music considerably.
“The obvious solutions for avoiding the imminent environmental credit crisis are innovation and efficiency.”
Paul Donovan, Global Chief Economist at UBS Wealth Management
Food for thought
The way we treat environmental resources is characterized by inefficiency and wastefulness. Almost half of the food produced in the US is thrown away. But the same is true of developing countries such as India: fifty percent of the food produced goes to waste. The Indian distribution chain is so inefficient that the food goes off before it reaches the consumer. Cutting food waste in both countries would massively reduce the amount of energy and water that is needed for agriculture and food production, while at the same time mitigating the consequences of the pollution caused by production. Efficiency – such as a reduction in the amount of waste we create – is synonymous with a decrease in our environmental debt.
Humankind is faced with a crucial decision. We cannot continue to live “on credit” from an environmental point of view, and the obvious solutions for avoiding the imminent environmental credit crisis are innovation and efficiency.
Paul Donovan is Global Chief Economist at UBS Wealth Management.
