Water as driver of economic capacity: Introducing a physical economic model

Ecological economics has long affirmed that all economic activity takes place within a context of physical, ecological, and biological systems we commonly refer to as ‘the environment’. As a subsystem of the environment, the economy cannot escape the rules and behaviors of the systems that form its context. This places constraints on the rate at which inputs can be extracted and transformed into outputs of useful goods and services, and on the rate at which the emission and waste by-products of economic activity can be processed and absorbed. Extracting resources and releasing emissions and waste in excess of the processing capacities of the environment will result in growing pressures on resourcing and sink capacities and ultimately impair the capacity of the economic subsystem itself. We examine the hydrological cycle as an empirical example of the constraints a physical/environmental context system places on the economic capacity of five countries with different economic characteristics: China, Germany, India, Russia, and the United States. By calculating the amount of energy available for freshwater evaporation and the allocation of freshwater to domestic, industrial, and agricultural uses, we replicate the Gross Domestic Product (GDP) of the five countries with our calculated GDP levels ranging from 93 to 99% of the reported levels. Our findings suggest four important lessons: (1) the hydrological cycle impacts the capacity of economies with different characteristics; (2) the processing capacity of nature is considerably more efficient than available technological substitutions; (3) the non-use of water, and possibly of other resources, is as valuable (or more) as its use; and (4) price policies can be effective in steering resource use and non-use in the right direction by incentivizing higher savings in available freshwater rather than incentivizing its efficient use. Our findings encourage further research on the capacity implications of other critical physical cycles (i.e. the carbon and nitrogen cycle) captured in the ecosystems category ‘supporting ecosystem services’.