Green Accounting: Balancing Environment and Economy

The UN recently held its first conference on happiness and well-being with the stated purpose of “realizing the future we all want.” But what is it we all want? Is it maximum well-being or happiness, or is it just meeting our needs, as proclaimed by the popular definition of sustainable development?¹ Happiness and development goals are, to a great extent, non-material. They are also hard to define, measure, and implement.

The commonly used national accounts, therefore, focus narrowly on observable market activities and economic growth. Indicators of sustainable development, well-being, human development, quality of life, or environmental sustainability seek to show that such a focus is misleading. They combine selected concerns and statistics, deemed to be representative of our broader goals in life. All these indicators are proxy measures for something bigger than what the underlying statistics suggest. Their meaning and validity need careful examination before they can be used in policy and decision making.² Some indicators give equal weight to unequal issues when calculating averages of, for instance, health, education, or pollution data. Other measures apply controversial money values when pricing “priceless” environmental services like waste disposal and the supply of natural resources.

It is not surprising that national statistical offices are reluctant to include these indicators in their regular data collection programs. Nor is it a surprise that policymakers continue to focus on the economy and its established statistics and accounts. The national accounts provide the standard indicators of economic performance and—over time—economic growth. Gross domestic product (GDP) is just one of many national accounting indicators, but has been the focus of economic analysis and policy. It has also been accused of being a misleading measure of well-being.

GDP-Bashing Is Not the Solution

The popular Genuine Progress Indicator (GPI)—supposedly a measure of national welfare—famously asked: “Why is America down, when GDP is up?”³ Dismissing GDP out of hand might jump the gun, though:

• GDP was never designed as a measure of human well-being or national welfare. It is simply the total economic value of goods and services produced in a country during one year. The final use of goods and services by households, enterprises, and other countries balances their supply. GDP is thus not only a measure of national output but also of the uses of national output for consumption, capital formation, and net exports (minus imports). As pointed out by the Stiglitz Commission: “GDP is not wrong as such, but wrongly used.”⁴
• The worldwide-adopted System of National Accounts⁵ defines and measures, among others, economic production, national income, consumption, and capital formation. Accounting equations and the use of market prices provide transparent and consistent tools for adding up the results of different economic activities, notably for the calculation of GDP. Showing the accounting results for different economic sectors (households, industries, government) makes it possible to assess production and consumption patterns and the distribution of income and wealth.
• GDP-bashing might throw the baby out with the bathwater—the baby being the national accounts and GDP the bathwater. There is indeed no other place where standardized measures of economic activities can be found and presented to policymakers in a meaningful “nutshell.” Individuals, corporations, and trade unions also find information on their economic situation and prospects, which they can compare with those of their own country and other nations.

Seeing that the national accounts will not go away, why not go right into the accounts and adjust them? Policymakers should find it easier to accept a need for reorienting the economy when their main source of information tells them to do so. The price for this is, however, limited coverage: the national accounts include only those issues that can be readily observed, measured, and valued. This includes the interaction between the economy and the environment, but excludes less well-documented social, cultural, or institutional concerns.

The System of integrated Environmental and Economic Accounting (SEEA) has been designed to assess the environment-economy interaction and, at least originally, to adjust the key economic indicators of GDP, capital, and income. The 1992 Rio Earth Summit endorsed the original SEEA.⁶ When measuring economic activity, the SEEA accounts additionally for the costs of hitherto ignored environmental impacts. It adjusts the standard economic indicators by further deducting these new environmental costs. Note, however, that the SEEA has now been twice revised. The latest 2012 version of the SEEA appears to reject the full adjustment of accounting aggregates as a matter of research and experimentation.⁷ The SEEA thus avoids being drawn into controversial measurement of well-being, happiness, the quality of life, or sustainable development. Compatibility with the national accounts should appeal to policymakers who wish to compare the conventionally measured and “greened” performance of the economy.

Accounting for Sustainability: A Practical Step toward Redesigning the Economy

At the heart of greening the national accounts is measuring the sustainability of economic activity and its use of the natural environment. The idea is to consider nature and its services to the economy as natural capital. The services of natural capital include, in particular, the provision of raw materials to the economy and the absorption of wastes and pollutants by environmental sinks. This allows treating the depletion of natural resources (e.g., by deforestation, mining, or overfishing) and the degradation of the environment (notably, by pollution) as capital consumption. The idea is to apply the accounting concepts of produced capital (such as roads, buildings, or machines) and their wear and tear to natural capital and its depletion and degradation.

The purpose of accounting for the costs of both produced and natural capital consumption is to retain funds for replacing used-up capital goods. Produced and natural capital maintenance is the accounting definition of the sustainability of future production and consumption, in other words, of economic growth. Measuring the costs of sustainability as capital consumption allows their deduction from gross indicators of economic activity, including value added, domestic product, and capital formation. The results are an environmentally adjusted net domestic product (EDP) and environmentally adjusted net capital formation (ECF).

Richard Morin/Solutions (Source: Bartelmus, 2009)

Figure 1: Environmentally adjusted net capital formation (percent of environmentally adjusted net domestic product, or EDP). The world economy and industrialized countries are—weakly—sustainable. The economic performance of most African countries has not been sustainable.

A global application of the SEEA can illustrate the meaning of these adjustments and their results. Data gaps and different cost concepts in the available data make this a rough first study of global sustainability.⁸ Global environmental depletion and degradation costs amounted to about 3 trillion U.S. dollars or 6 percent of world GDP in 2006. During 1990–2006, the world economy showed similar growth rates for GDP and EDP. For such short time periods, ECF paints, however, a better picture of the potential sustainability of economic activity: it indicates the capacity to produce new capital after accounting for the loss of produced and natural capital. Figure 1 shows large differences in the sustainability of economic growth for the world’s major regions and countries. Positive ECF in industrialized countries and China shows sustainable economic growth. Negative ECF in developing countries indicates that these countries have been living off their natural and produced capital base. Overall, the world economy appears to be sustainable, at least in terms of weak economic sustainability.

Weak sustainability maintains the overall monetary value of produced and natural capital. It implies that the different capital categories can be substituted in reinvesting for capital maintenance. This is the reason why some ecological economists prefer physical sustainability measures such as the carrying capacity of territories or the resilience of ecosystems to perturbations. The complexity and large variety of ecosystems make it difficult to apply such “ecological sustainability” at national or international levels.⁹

Produced and natural capital maintenance is a narrow but operational definition of the sustainability of economic growth. It ignores other less tangible human, social, and institutional capital categories. Measurement and conceptual problems—e.g., what is capital consumption—have so far prevented accounting for human capital (health and skills) and social/institutional capital (networking, social cohesion, law and order). Nonetheless, all these capitals have been called forth as pillars of sustainable development.

International organizations use the multiple-pillar argument to explain the connections between sustainable economic growth and development. The United Nations Environment Programme’s green-economy report suggests that sustainable development can be easily translated into economic well-being: maintaining the use of all capital categories supposedly maintains economic welfare, “now and tomorrow.”¹⁰ The Organisation for Economic Co-operation and Development’s green growth strategy is more concrete: greened economic growth, which maintains produced and natural capital, cannot replace sustainable development but is a “measurable … subset” of such development.¹¹ In both cases, sustainability, in terms of capital maintenance, looks like the anchor that prevents us from drifting off into difficult-to-measure realms of well-being or development.

The next step of actually redesigning the economy requires the allocation of the environmental sustainability cost to those households and enterprises that contributed to nonsustainability, in particular, by their environmental impacts. Well-known market instruments such as eco-taxes or pollution permits can prompt economic agents to internalize these costs in their plans and budgets. The purpose is to make them change their environmentally harmful production and consumption styles. Delayed and weak responses might make it necessary to supplement market instruments with governmental rules and regulations. Integrated environmental-economic accounts can provide the benchmarks for setting the level of market instruments and for evaluating the efficiency of sustainability policies. Greening the national accounts could unleash the greening of the economy—the leitmotiv of the Rio+20 Earth Summit.

Further Work

Arik Bartelmus (Source: Bartelmus, forthcoming)

Finding the balance: What are the trade-offs between economic production and environmental quality?

A number of open questions remain, including the following:

• The valuation of environmental services. Many stocks of natural resources and most sinks for pollutants are not traded in markets. They do not obtain a market price, and their economic value has to be imputed with the help of different valuation techniques. Contrary to the original SEEA, the latest revision relegates environmental degradation—mostly from pollution—and its monetary valuation to future research and experimental ecosystem accounting. Allowing only for the depletion of economic natural resources, which are already part of the national asset accounts, looks like omitting the environment from environmental-economic accounting.
• Satellite accounts. Agenda 21 of the 1992 Rio Earth Summit recommended implementing the SEEA “as a supplement to, rather than a substitute for, traditional national accounting.”⁶ Satellite accounts leave the conventional national accounts untouched, even if they ignore running down economic resource stocks of minerals, timber, or fish. Should the conventional accounts adjust their economic indicators for natural resource depletion? Do we need a satellite of the satellite accounts to include environmental degradation in the SEEA? Will satellite accounts continue to be ignored by policymakers? These are some of the questions that will determine the adoption of the SEEA by the official statistical services of countries.
• Strong versus weak sustainability. What is the significance of ignoring critical (i.e., essential and nonsubstitutable) natural capital in weak-sustainability accounting and policy? How can critical capital be identified in the greened physical and monetary national accounts?
• Corporate accounting. Corporations have shied away from environmental “full-cost accounting” for their environmental impacts. Obviously, they prefer showing what they have done for the environment (i.e., their expenses for environmental protection). Can the national environmental-economic accounts serve as a model for corporate accounting? Can such linkage improve corporate social responsibility?
• Coverage of human, social, and institutional capital. Capital consumption of these intangible categories is difficult to imagine and even harder to measure. Can nonmonetary indicator sets adequately describe the use of intangible capital? Can these indicators be used for aggregating all capitals into holistic measures of sustainable development, well-being, or happiness? This is an important area of further research. As we all know: noncountables count.

The first 1992 Earth Summit in Rio de Janeiro called for establishing the SEEA in all member states “at the earliest date.”⁶ The Johannesburg Summit in 2002 ignored green accounting and encouraged instead further work on indicators of sustainable development. One of the two main themes of the forthcoming Rio+20 Summit is “a green economy in the context of sustainable development.”¹² Hopefully, this will put comprehensive environmental-economic accounting back on the international agenda of monitoring and implementing sustainable growth and development.

References

1. World Commission on Environment and Development (WCED). Our Common Future (Oxford University Press, Oxford, 1987).
2. Bartelmus, P. Quantitative Eco–nomics: How Sustainable Are Our Economies? (Springer, Dordrecht, 2008).
3. Cobb, C, Halstead, T & Rowe, J. If the GDP is up, why is America down? The Atlantic Monthly (October 1995).
4. Report by the Stiglitz Commission on the Measurement of Economic Performance and Social Progress: Executive Summary [online] (14 September 2009). www.stat.si/doc/drzstat/Stiglitz%20report.pdf.
5. European Commission, International Monetary Fund, Organisation for Economic Co-operation and Development, United Nations, and World Bank. System of National Accounts 2008 [online] (United Nations, New York, 2009). unstats.un.org/unsd/nationalaccount/docs/SNA2008.pdf.
6. United Nations Sustainable Development. United Nations Conference on Environment & Development. Agenda 21, Ch. 8 [online] (Rio de Janeiro, Brazil, June 3–14, 1992). www.un.org/esa/sustdev/documents/agenda21/english/Agenda21.pdf.
7. The different versions of the SEEA are available on the website of the United Nations Statistics Division [online]. unstats.un.org/unsd/envaccounting/seea.asp.
8. Bartelmus, P. The cost of natural capital consumption: Accounting for a sustainable world economy. Ecological Economics 68: 1850-7 (2009).
9. Bartelmus, P. Sustainability Economics: An Introduction (London and New York, Routledge, forthcoming).
10. United Nations Environment Programme (UNEP). Towards a Green Economy: Pathways to Sustainable Development and Poverty Eradication [online] (2011). www.unep.org/greeneconomy/GreenEconomyReport/tabid/29846/Default.aspx.
11. Organisation for Economic Co-operation and Development (OECD). Towards Green Growth [online] (2011). www.oecd.org/dataoecd/62/59/48302542.pdf.
12. Rio+20: United Nations Conference on Sustainable Development [online] (June 20–22, 2012). www.uncsd2012.org/rio20/objectiveandthemes.html.