In his groundbreaking study on the economics of climate change, former World Bank chief economist Nicholas Stern describes the changes now under way in Earth's atmosphere as "the greatest and widest-ranging market failure ever seen." It is an economic failure that the global economy is not prepared to cope with and that most of today's economic analysis is not able to understand.

It is ironic that it is the very triumph of market economics that is now challenging the basic tenets that have helped make it so successful. Conventional economics relies on markets—large numbers of buyers and sellers—rather than planners to determine the most efficient allocation of resources. The price mechanism and profit motive have been enormously successful in spurring technological change and meeting human needs, bringing adequate nutrition, clean water, housing, transportation, and myriad other goods and services to billions of people. Market capitalism has, in the words of Daniel Yergin, reached the "commanding heights" of the modern world, leaving communism and other competing theories in the ash heap of history.

Early economic thinkers such as Thomas Malthus had a sense of the biophysical limits in which the economy of their day operated. But the Industrial Revolution at the end of the eighteenth century allowed many of these limits to be overcome—with new materials replacing those that had grown scarce and new technologies allowing unexpected gains in everything from agricultural production to energy use. At the same time, colonial expansion and migration opened up little used resources in the Americas and other parts of the globe. By the twentieth century, economic growth had become the primary goal of most governments and their economic advisors: rising incomes helped bring many people out of poverty, while creating opportunities across the economic spectrum.

That economic model has lasted a long time, but it will not survive the twenty-first century. In a physically constrained world, material growth cannot continue indefinitely, and when that growth is exponential—and involves mega-countries like China and India—the limits are reached more abruptly and catastrophically than even the best scientists are able to predict. From falling water tables to soaring oil prices and collapsing fisheries, the ecological systems that underpin the global economy are under extraordinary stress. Economists who thought they could analyze the economic world as if it were separate from the physical world may have a hard time finding work in the years ahead.

Continued human progress—both material and spiritual—now depends on an economic transformation that is more profound than any seen in the last century. A world of limits will require a shift from the unfettered conventional economics that prevailed then to the emerging field of sustainable economics, which embraces many of the principles of market economics, including its ability to allocate scarce resources, while at the same time explicitly recognizing that the human economy is but a part of the larger global ecosystem that contains it. This new field of sustainable economics goes on to analyze the economic limits imposed by the physical world, and proposes a range of innovative ideas for bringing the economy into balance with the global ecosystem.

The focus of State of the World 2008 is on the innovations that will be needed to make a sustainable economy possible. To do that, we have recruited an unusually thoughtful group of expert authors who have written on topics ranging from new approaches to industrial production to new measures of economic progress, microfinance, and the development of markets for carbon emissions and protection of biodiversity. The book includes scores of exciting examples of pioneering business ventures in fields like solar energy, venture capitalists who are financing the creation of environmental businesses, and communities that are mobilizing to spur sustainable innovation at the local level. These diverse initiatives create new economic models and business practices that foster economies that meet people's needs while protecting the planet.

We come away from this project with a strong sense that something large, perhaps even revolutionary, is struggling to be born as business leaders, investors, politicians, and the general public create the architecture of sustainable economics. Indeed, it is breathtaking to see how much innovation has been unleashed by the wave of concern about climate change that has broken across the world in the past year, culminating in the awarding of the Nobel Peace Prize to the world's leading climate scientists and their most effective evangelist, Al Gore.

Emblematic of the innovative proposals emerging on an almost daily basis is one announced just as we were going to press: Virginia Tech has teamed up with a private investor, Hannon Armstrong, to put $100 million a year into improving the energy efficiency of Washington area buildings. As with hundreds of similar announcements, this one involves a creative combination of private capital, nonprofit expertise, and supportive government policies.

Innovative ideas and big money are a powerful combination—and the sums now moving in a green direction are eye-popping. Citigroup announced plans in May 2007 to invest $50 billion to address climate change over the next decade. And Goldman Sachs invested $1.5 billion in renewable energy in 2006, exceeding its initial commitment by 50 percent. Global investment in new energy technologies is estimated at $71 billion in 2006, up 43 percent from the previous year. Both in China and the United States, "clean technology" is now the third largest sector for venture capital investment. More momentous still are innovations such as China's new renewable energy law and Europe's carbon emissions trading system, which ensure that these kinds of investments will continue to flow for many years to come.

Shifting from the conventional economic paradigm to one based on ecological or sustainable economics will require years of change on many levels—from classroom theory to business practice and government policy. Pricing goods and services so that environmental costs and benefits are counted is one key measure—easy in principle but often difficult for people or politicians to accept. And creative ways must be found to knock down the barriers to change— for example, changing electric utility regulations so that saving energy is at least as profitable as building new power plants.

Sustainable economics will need to meet human as well as planetary needs if it is to prevail. Proponents of market economics and globalization often point to the 300 million people who have escaped from poverty since 1990—most of them in China and India. This still leaves more than a billion desperately poor people in today's world, and the developing countries that have not yet benefited from the immense growth in the global economy over the past century are determined to close this gap in the decades ahead. It is therefore gratifying to see that the same kinds of innovation—from $100 laptops to drip irrigation—that is going into environmental improvement is also delivering new approaches to agriculture, health care, and education in poor rural communities.

There is a great deal to be admired—and valued—about market economics in today's ever-smaller world. With so much to do in such a short time, efficient allocation of resources and motivating people to action are more important than ever. But twenty-first century economics must be grounded in a more realistic understanding of the physical and biological world on which we depend. As Albert Einstein once said, "We can't solve problems by using the same kind of thinking we used when we created them." This sentence should be posted on the walls of economics classrooms, corporate boardrooms, and the grand halls where the world's legislators make public policy

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