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I don’t believe that the solutions in society will come from the left or the right or the north or the south. They will come from islands within those organizations, islands of people with integrity who want to do something.
Extractive economy is business-as-usual and the mental model taught in business schools. It is not called that of course, but examining any business textbook will reveal that the mental model – or paradigm – of extraction is underlying most teaching. This article aims to explain in clear terms what extractive models are, point out some of the shortcomings and hopefully opens up to the possibility of other, more functional, models.
Seldom do business textbooks describe the paradigm of modern business as extractive – that is to say based on extracting resources from the earth without replenishing or recycling them. This is possibly because the practice is so ingrained in our way of life that it is taken as the only way. Extractive business practices deplete resources and downgrade capital. It is rather surprising that the dominant business paradigm is capitalism and yet it runs on degrading capital. On a finite planet, this is surely not good business let alone good for the planet. A dialogue around extractive approaches can be helped by naming what is going on and describing the paradigm. Several patterns associated with extractive approaches are described including the bell-curve of oil field extraction and the accumulated capital investment curves precluding break-even. Extractive approaches have many social downsides including externalization of negative effects like pollution and noise, but the main challenge is that they are actually not even good business, especially as investments for fiduciary investors.
The basic idea of extractive business is that there is a resource to exploit to produce goods and services which are sold at a profit.
By exploiting the resource:
We should explore the distinctions between resources and capital – both essential components of business approaches. Extractive approaches use up resources, but even risk depleting capital. One of the definitions of capital is that which is used in production of services for payment but not used up. Obviously natural capital is one of the things that firms can use, but capital also includes built capital; buildings, machines, human capital, workers and so on, and social capital; organisations.
Capital can be drawn down, or reduced. For example, natural capital can be eroded if it is treated in such a way that more is extracted than can be regenerated. In this way capital can be treated by firms as a resource. Another example might be railroads. A firm can own railroads and rent them to railroad companies. The firm can maximize profits by reducing investment in maintenance. After a while, the capital asset – the railroad system – is worth less as the functionality of the system is degraded.
Typical examples of resources firms use up to earn money include:
Indeed, extractive business like energy companies and food distributers are among the largest corporations on Earth, so it is understandable that the extractive mindset is still dominant in the way business is taught.
TABLE: Largest corporations globally by revenues and their extractive approach Source: Wikipedia
|1||Walmart, US||General merchandiser – sells products manufactured using fossil fuels and industrial agrigulture|
|2||State Grid, China||Utilities – fossil powered electricity production included|
|3||Sinopec Group, China||Petroleum refining|
|4||China National Petroleum||Petroleum refining|
|5||Toyota, Japan||Motor vehicles and parts – most fossil-fuel powered|
Typical examples of resources being used up include:
Extraction of resources typically follows a bell-shaped curve, illustrated below.
Initially, infrastructure needs to be set up to start extracting the resource, and as this is added production ramps up to about half of the resources are extracted. Typically, the other half of the resource is harder to get at, and production tails off from its peak.
This pattern is seen in oil field exploitation as shown below.
Another way to see this pattern is the “S” curve of accumulated extraction. This pattern is the corollary of the bell curve. Starting fairly slowly, the total amount of extracted resources accelerates and then tapers off towards the end.
The next pattern to consider is how business can be set up around this resource.
Typically, an investment needs to be made before anything can be extracted. This investment – money put up before any earnings can come in – typically comes from the owners of the business who are shareholders/stockholders or from outside investors who offer loans.
This investment follows the pattern below which shows money accumulated as investment.
As you see, the need for money invested rises rapidly in the beginning until a desired rate of extraction is reached. The slight rise after that represents the investment in replacing worn-out equipment.
The diagram below illustrates some key points in the business cycle.
So what are the downsides with extractive business approaches?
The amount of extractable resources is finite, so with each completed extraction there is less to find. The model only works when there is a relatively large amount of potential resources to be had. The model drives itself as the investment in one extraction in terms of knowledge and technology can be transferred to the next, so there is a incentive to continue to the next resource. This mentality is something that may have developed in conjunction with the discovery of the North American Continent, as the frontier to the Wild West pushed forwards, successful businesses sought to repeat themselves further across the frontier.
Some of the costs of this type of business are actually moved across to society as a whole to to bear, and are not born by the producer or customer. For the oil and coal business these include:
The availability of an extracted, finite resource creates dependencies that require whole system changes after the resource depletes. One example we are dealing with today is the need for investment in renewable energy as oil and gas reserves are drawn down.
One way dependency is dealt with is through globalisation. When oil reserves deplete in one country the corporations move to another. So dependency drives globalisation and the risks of exploitation that follow it.
The whole problem with extracting finite resources in ways that do not let them be re-used is selfish in a way. Firstly, they are made unavailable for future generations, and they are used just by those who happen to find them. There is no thought of just distribution in the extractive approach.
It follows from the discourse above that one way to get more money out of an investment is to reduce costs. Labour costs are one obvious target. Once an investment in infrastructure is made, with owners and borrowed money, the race is on to not only cover costs but to find a way to repay the investment with a profit. So there will always be a downward pressure on wages. That in turn creates an affordability problem for the workers’ essentials like fibre, fuel and food. If workers have less money, they have less to spend on goods produced. In order to sell goods produced from extractive practices at prices affordable to workers, there is more pressure to extract, even more cheaply, from land and from the earth. This creates a downward spiral leading to austerity, and ultimately conflicts.
Extractive business approaches tend to, where property is involved, draw down the ecological functionality of the property if it is land, and if it is machinery, emit pollution and exert other externalized pressures onto society around it.
Extractive practices are actually supported in many cases by lax laws that do not protect the rights of surrounding eco-systems or society. For an extractive approach to be acceptable in the modern society, strict environmental, waste and pollution laws should apply.
Through any project’s business cycle, institutional investors, like pension funds, will be looking to place their money to get dividends so they can pay their members’ pensions. These investors are expected to invest with prudence – to provide pensions whilst not degrading living standards for their pension-takers. Extractive businesses, whilst offering shorter-term possibilities of returns, always – by definition – reach an end-point. These businesses are only able to offer the kind of constant returns pension fund seek by having an ongoing portfolio of young, mature and ending extractive projects. As we saw earlier, this means that ordinary workers are being required to invest in extractive business approaches with externalized costs being placed onto society and bearing the risk that the available resources get depleted.
We cannot run all businesses with an extractive approach
We have to find ways to prosper in our present reality where we understand there is no Planet B. In that reality, an extractive economy is quickly seen as truly unsustainable when you start to analyze it. We can’t keep taking more from a place where there is only so much. There ARE alternative non-extractive but harvestable resources. Examples include well-managed soils that continue to be fertile for generations, well-managed forests that can provide fibre and fuel indefinitely, and the sun and wind and tides that can provide energy. There are, too, ways of recycling extracted minerals like copper indefinitely.
If extractive is the dominant business paradigm, the alternative is regenerative. This approach harvests resources whilst ensuring that the underlying capital – soil, forest, energy installation, minerals, etc remain functional and preferably function even better. This is the subject of future explainers.
For a more mathematical treatment of the subject, read this article.
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“The concept of fiduciary duty is organic, not static. It will continue to evolve as society changes, not least in response to the urgent need for us to move towards an environmentally, economically and socially sustainable financial system.”
Paul Watchman (Honorary Professor, School of Law, University of Glasgow)
Fiduciary (fɪˈdjuːʃiːəriː) A legal obligation of one party to act in the best interest of another. The obligated party is typically a fiduciary, that is, someone entrusted with the care of money or property. Also called fiduciary obligation.
Most of us would like to think that people taking important decisions – ones that affect our lives deeply – would be basing their judgement on deep criteria. We hope that they are being reasonable and rational, balancing long-term and short term, what is fair and what is equitable etc. What many might suspect, however, is that decision-maker’s logic is more ruled by the economics of the situation and the budget covering just the domain of their decision. Indeed, many social experiments like the Stanford Prison Experiment show how authority and social pressure alter decision making. Of course economics are important but should they be the trump card that overrules compassion, equity, decency and plain common sense? Continue reading
Host: Invest in Peace http://investinpeace.tssef.se
Theme: Where climate-friendly farmers need investment
Objectives: To hear progress from India involving some 20,000 farmers with achieving climate and friendly food production – bringing functioning soils, carbon mitigation and food security
Replay: Follow this link Continue reading
As world population expands, and the demand for a better standard of living drives the world economy, it is becoming clearer to many that using up the world’s resources will actually put us at risk of ending up with a lower standard of living. It could even drive conflicts. Insecurity and lack of the capability to produce the basics are likely to fan the flames of conflict and undermine peace in the world. We urgently need a new mindset – one that focusses on bringing security of the basics to everyone whilst preserving and indeed increasing the capability of society to provide.
Part of this new mindset requires us to rethink capital. This article breaks down the importance of capital to society, and how the economy should manage capital if we are to transition to a sustainable and peaceful future. Continue reading