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What is the best way to measure a country’s financial health? For the
past 50 years, mainstream economics has assumed that the increase in goods
and services produced domestically (gross domestic product, or GDP) and
national income (gross national product, or GNP), are adequate yardsticks.
The World Bank uses per capita GNP as its main criterion for classifying
national economies , and a global industry has developed around predicting
quarterly GNP and GDP changes: governments watch their rises and dips with
nervous expectation.

But is this the most useful approach? In the words of Robert Repetto,
chief economist at the World Resources Institute (WRI) in Washington, ‘a
country could exhaust its mineral resources, cut down its forests, pollute
its aquifers and hunt its wildlife and fisheries to extinction without
affecting its measured national income.’ Environmental degradation can
actually boost GNP growth: if a company strip mines foreign quarries, the
revenue it repatriates contributes to its country’s GNP. The cost of cleaning
up the oil and toxins from the Shetland oil spill will actually boost GDP.
Even if there were no cleanup, GDP might eventually rise – by the public
spending more on medicines to treat any illness caused by the toxins.

So GDP figures are poor measures of economic welfare. But designing
suitable indicators and collecting information to measure true economic
welfare – the services that money can supply, rather than money itself –
is a huge problem. The most widely respected indicator is the UN Development
Programme’s human development index (HDI), calculated annually since 1990.
The HDI integrates a wide range of welfare statistics such as life expectancy,
educational attainment, GDP (reduced by factors such as poverty levels)
and deprivation. The index is worked out by taking the global maxima and
minima for each measure, and using the position of each country along that
base as the measure of development.

TOP OF THE WORLD

Canada is top of the latest HDI, with Barbados, at 20th, above Italy,
Ireland and Spain (respectively 21st, 22nd and 23rd). Among the industrialised
nations, Romania comes bottom at 60th, while Guinea is last in 160th position.

Now the debate has switched from welfare to income, and economists are
asking whether GDP is an adequate measure of income. Some economists and
politicians have tried to wed economic growth with sustainable development,
but in order to do this there needs to be a way of measuring ‘true’ income.
In economic theory, sustainability and income are inseparable. In 1939 Sir
John Hicks, later a professor in economics at the University of Oxford
and Nobel prizewinner, redefined income as ‘the maximum value which you
can consume in a given time and still expect to be as well off as at the
beginning’. This implies that income must be derived from constant or rising
stocks. But GDP fails to distinguish between windfall profits (income derived
from selling stock) and true income. Though GDP follows relatively closely
the formation and maintenance of fabricated capital (such as machines and
buildings), it fails to reflect adequately changes in natural capital stocks
(such as mines and forests) through depletion or pollution. GDP is a good
speedometer for the vehicle of the national economy, but it is not a rev
counter or a fuel gauge. In fact it says little about economic efficiency
or long-term sustainability.

Clearly, implementing a sustainable economy would mean slower growth
in GDP than the business-as-usual approach that has prevailed. Sometimes,
the predicted differences can be striking. In 1987 Roefie Hueting, an
economist at the Netherlands Central Bureau of Statistics in Voorburg, produced
a scenario for the country changing to a sustainable economy. In it, the
country’s GNP rose by 27 per cent between 1980 and 2000 – equivalent to
a compound growth of 1.2 per cent annually.

In comparison, the business-as-usual approach would produce a cumulative
growth of 64 per cent – 2.5 per cent annually. Such growth is similar to
that projected by the 1992 World Bank Development report, which predicts
that global GDP will grow from $20 000 billion in 1990 to $69 000 billion
by 2030 (an annual compound growth of 3.1 per cent), with average per capita
incomes in developing countries more than trebling. The Brundtland report,
published in 1987 by the World Commission on Environment and Development,
argued that the global economy should expand by between five and ten times
by 2030 to get rid of growing poverty in developing countries. Such expansion
would require per capita GDP growth of between 3.2 and 4.7 per cent annually.

But these projections look highly optimistic when set against the fact
that between 1950 and 1980 the average figure for developing countries
was only 2.7 per cent, and that two-thirds of those countries now have negative
annual economic growth – some as large as 25 per cent. A further weakness
is that the per capita figure is an average which says nothing about the
variation of personal income within a country, which can have a far greater
impact on the population’s welfare.

Moreover, GDP figures do not paint the whole picture. Last year, the
US National Academy of Science and the Royal Society of London jointly
declared that: ‘if current (UN) predictions of population growth (from
5.3 billion now to 8.5 billion in 2025) prove accurate, and patterns of
human activity remain unchanged, science and technology may not be able
to prevent irreversible degradation of the environment or continued poverty
for much of the world.’

TIME FOR RAPID CHANGE

According to a 1986 paper, the human race already uses some 40 per cent
of land-based net primary productivity – defined roughly as the total amount
of new ‘food’ made available for living organisms – for its own needs (Bioscience,
vol 36, p 368). A growing band of ‘environmental economists’ – generally,
trained economists seeking to integrate ecological thinking into their work
– are urging a rapid change in thinking. They say ’empty world’ economic
growth (often parodied as the philosophy of the Wild West, where one would
shoot a bison solely for the tongue) should give way to ‘full world’ sustainable
development, where people would build more efficient light bulbs rather
than new power stations, for example.

Although the need for this transition might seem obvious, the accounting
system used worldwide remains trapped in empty world economics, because
it dates from a time when people could ignore maintenance of natural capital
(the sum total of benefits people might derive from nature).

Since 1942, countries have employed growing armies of accountants to
record their economic activity. An international standard System of National
Accounts (SNA) and procedural rules for calculating GNP were agreed in 1968,
and are codified in the ‘blue book’ produced by the UN Statistical Office
(UNSO). These national accounts provided the raw statistics for macroeconomic
management of national economies, allowing a small group of countries to
achieve enormous growth in the past 50 years.

BLACK MARKS FOR ECONOMIES

But the weakness of the national accounts, like most accounting systems,
is that goods with no measured value (such as unpaid housework and the
untaxable ‘black economy’) are completely omitted. The balance sheets only
record assets such as land, and fabricated capital (such as buildings and
machines) or human capital (such as knowledge and computer software), where
value has been added by work. Natural capital is not recorded because the
SNA was drawn up in an era when the prices of raw materials were at an all-time
low, and natural resources were treated either as ‘free goods’ from nature,
or as so abundant that they had no marginal value. This meant economists
did not have to attach a value to them. The result is that GDP figures do
not properly record the depletion or the degradation of natural capital.

To be truly sustainable, a national economy must maintain its total
capital stock. If its population is increasing, then to maintain constant
income per capita either the total capital stock must also grow, or production
efficiency from the same capital must increase.

Many environmental economists argue that ‘weak sustainability’ is acceptable:
that it is all right to deplete natural capital as long as at least the
same amount of fabricated or human capital replaces it. But this assumes
that fabricated or human capital is an adequate substitute for natural capital.
This is not the case: you can’t eat opera and you can’t burn software. But
producing both sorts of capital requires natural resources. So ‘strong sustainability’
has to be based on maintaining natural and fabricated capital at independently
determined safe minimum levels. All this would mean substantial modifications
to the present SNA.

Yet even faced with these criticisms, the UNSO has been slow to act.
It worked throughout the 1980s revising the SNA rules and in 1991, after
consulting the World Bank and the UN Environment Programme, it acknowledged
the growing importance of natural capital and agreed that national accounts
should reflect degradation of the environment. Its results can be found
in the draft handbook Concepts and Methods of Environmental Statistics:
Statistics of the Natural Environment.

The UNSO considered several ways of drawing up an SNA that took the
environment into account. One involved subtracting the value of natural
capital depletion, degradation and defensive expenditure (defined as money
spent compensating for the unwanted side effects of other production) from
the normal GNP figure. In principle, this is like subtracting the depreciation
in value of fabricated capital from GNP to give the traditional net national
product, or NNP.

A more rigorous method would be to calculate GNP including only truly
sustainable income from natural resources. This GNP would exclude harvests
of natural resources beyond scientifically determined maximum sustainable
yields and defensive expenditures. Deciding what those values should be
contains a classic ‘social trap’ (so-called because it was identified by
social psychologists), where future effects of unknown size are totally
ignored. But there are proposals to counter social traps too. Robert Costanza,
an economist at the University of Maryland, and Charles Perrings, professor
of economics at the University of California at Riverside, have proposed
a flexible assurance bond scheme, in which a company would have to deposit
a sum of money equivalent to the maximum possible ‘damage’ from a project
before beginning its work. The interest earned, plus the original bond,
would be used over an indefinite period to mitigate damage as it arose;
what remained would be returned to the company.

THE PRICE OF EXHAUSTION

For nonrenewable resources such as fossil fuels and minerals, Salah
El Serafy, an economist at the World Bank, proposed a method which uses
the expected duration of extraction and a discount rate (chosen independently)
for the value of the resource. The net profit would be true income, a proportion
of which must be reinvested to replace the exhausted resource. For example,
part of the revenues from coal sales would be invested in, say, solar or
wind power. This way, only true income would contribute to GNP.

Despite the existence of these and other potential modifications to
traditional GNP, the UNSO has shied away from incorporating environmental
valuation into the core SNA. At the last SNA Expert Group meeting in Luxembourg
in January 1989 it declared that ‘environmental valuation is difficult
and more work is required before standard valuation techniques can be applied
and no international consensus has been reached on how to incorporate environmental
costs and benefits into national accounts.’ Perhaps more significantly,
it added that ‘the present GNP construction serves a number of different
short and medium-term socioeconomic analyses which require consistently
derived long time series of data to be useful’. In other words, the status
quo was fine, even if it was depleting the planet.

The revised SNA, due to be published this year, recommends the compilation
of a satellite System of integrated Environmental and Economic Accounts
(SEEA) based on the environmentally adjusted NNP plan. (El Serafy’s more
radical plan to modify GDP directly has been shelved.) The SEEA would allow
economists to calculate environmentally adjusted net domestic products,
or NDPs, correcting GDP for natural capital depletion and defensive expenditure.
Although this represents a major breakthrough, it leaves the basic measure
of GDP unaltered, meaning that distorted views of sustainability will continue
to dominate macro-economic planning.

BARRIERS TO SUCCESS

The trouble is that until environmental accounting has hauled itself
over two formidable barriers, it will remain too inaccurate and inconsistent
to take its place in core accounts. The first hurdle is persuading governments
to prepare physical accounts which record the changing state of environmental
resources (such as depth of topsoil in centimetres and live timber in cubic
metres). Most countries produce inventories of natural resources, although
it is surprising how incomplete and inaccurate some of these are. But even
these would be sufficient to document the depletion of natural capital .

The second difficulty is finding consistent valuation techniques to
transform physical accounts, in physical units, into financial accounts
that can be integrated into an SNA. The World Bank has sponsored pilot studies
using the SEEA. These show that after adjustments for environmental degradation
and resource depletion caused by mining, the NNP in Papua New Guinea is
reduced by as much as 10 per cent. In Mexico it is reduced by 12 per cent.

In a pioneering study first published in 1989, the WRI and the government
of Indonesia tried re-vising its national income accounts by incorporating
the use of oil, timber and soil resources in Java. From 1971 to 1984 the
country’s GNP rose by 7.1 per cent annually. But taking the depletion of
natural capital into account reduces this to 4 per cent. The true income
would have to be revised further downward if the calculations were extended
to other islands and included natural gas, coal and minerals. More significantly,
comparing resource depletion values with national investment revealed that
Indonesia has been investing too little of the profit from natural capital
in fabricated capital to guarantee the future income of its growing population.

Similarly, a study completed in 1990 by the Costa Rican Tropical Science
Centre, also with the WRI, found that the country’s GDP growth averaged
4.6 per cent annually from 1970 to 1989. But the depreciation over that
period in the value of its forests, fisheries and soils was equivalent to
a reduction of potential GDP growth of between 1.5 and 2.0 per cent.

In industrial countries, partial environmental deterioration estimates
can be made (even without environmental accounts) from pollution and abatement
costs (PAC). Among members of the OECD, the club of leading industrialised
countries, such defensive expenditure against pollution averaged between
0.8 and 1.5 per cent of annual GDP in the mid-1980s. In the US and former
West Germany, where reliable data series are longest, PAC costs as a percentage
of GDP are rising: in the US they are forecast to rise from 1.47 per cent
of present GDP to over 2 per cent by 2000, and much of this rising expenditure
will still be recorded as GDP growth.

Results like those of the few national studies completed to date will
emerge from other countries. A 1992 survey, Are National Economies Sustainable?
Measuring Sustainable Development, by David Pearce and Giles Atkinson of
the Centre for Social and Economic Research of the Global Environment, funded
by the UK Social and Economic Research Council, estimated environmental
damage ranging from 1 per cent of GNP in the Netherlands to a massive 17
per cent of GNP in Indonesia and Nigeria. From its survey of the sustainability
of 21 national economies, comparing depletion of natural and fabricated
capital with savings – defined as potential investment to generate new capital
– the centre concluded that, even on the partial data available, eight
countries have unsustainable economies, two others are teetering on the
brink, and 11 appear to be sustainable only at the ‘weak’ level (see Figure).
Applying a ‘strong sustainability’ test, where both natural and fabricated
capital are kept constant, all 21 countries fail to balance their books.

In the words of one critic, present GNP statistics are like sausages:
readily consumed by economists, politicians and the media, but most prefer
not to dwell on what does (and does not) go into them. Right now, too many
countries are feasting on them and ignoring the fact that the farm is emptying.

David Duthie teaches environmental biology at Oxford Brookes University.

* * *

1: Defining economic performance and welfare

Gross domestic product (GDP): the total production of a country, measured
as the monetary value of all final goods and services produced; or the expenditure
on all goods and services produced; or the income received for goods and
services. In theory, all three calculations should give the same total.

Gross national product (GNP): the total income of a country, measured
as GDP plus share dividend payments, interest, profits and rents flowing
into a country from abroad, minus share dividends, interest, profits and
rents flowing out.

Per capita GDP or GNP: respectively, GDP or GNP divided by population;
often used as a measure of the average standard of living. Because it is
an average, it is a crude measure which can mask enormous inequalities in
incomes.

NNP (net national product): GNP minus an allowance for depreciation
of capital (that is, the cost of replacing machinery and buildings is not
true production).

NI (national income): NNP minus any indirect taxes paid by producers
to government.

National accounting system: the rules used by governments to avoid double-counting
income and to produce estimates of economic activity that can be compared
internationally. National accounts were first produced in America in 1942
and GNP figures were first calculated in the US, Britain and Canada in
1944 in order to estimate possible levels of defence expenditure and the
impact this would have on the economy. In 1947 the first sets of national
accounts were produced. Last altered in 1968, they remain a product of
the great days of neoclassical macro-economic theory, heavily influenced
by the theories of John Maynard Keynes and the twin problems of unemployment
in the industrialised economies of the 1930s and attempts to manage periodic
‘business cycles’ lasting between seven and 11 years.

* * *

2. Countries that value their environment

Norway and France stand out as countries committed to developing extensive,
integrated systems of environmental accounts: France because it decided
in 1978 to monitor them, and Norway because its economy is almost totally
dependent on natural resources. Norway’s physical accounts (recording natural
assets in physical units), drawn up since the 1970s by its Central Bureau
of Statistics and Ministry for the Environment, record the state of most
natural resources, but only energy and pollution are linked into national
economic accounts and macro-economic models.

In France, the Natural Heritage Accounts, produced by its National Institute
of Statistical Studies in Paris, represent an ambitious attempt to integrate
economic, ecological and socio-cultural functions of the natural environment.
A set of accounts first transforms raw physical data into five sectoral
statistics (for water, air, soil, flora and fauna, and ‘others’), then
hierarchically into ‘state of the environment’ reports, forecasting and
simulation models, aggregate welfare indicators and, finally, a modified
GDP. However, this is not comparable with ‘official’ GDP.

The main drawback of this approach is actually its completeness and
flexibility: it is so wide-ranging that, given their limited finances,
the French have been forced to concentrate attention on forests, water,
soil, land use and wildlife, while the rest of system develops more slowly.
Elsewhere, environmental and natural resource accounting frameworks are
developing, piecemeal, in Australia, Canada, Germany, Japan, the Netherlands
and the US.