The time is ripe for green accounting

Factoring in growth's impact on environment gives better gauge of a nation's well-being
Jessica Cheam Straits Times 24 Jul 11;

The review of Singapore's economic growth forecast made front-page news last week. Amid concerns from the Government, business leaders and citizens on what impact the European sovereign debt crisis and other risks would have on the nation's growth, jobs and pay cheques, I found myself wondering: What does GDP really mean?

Some economists may disagree with me when I say that the current definition of gross domestic product, or GDP, as we know it, is deeply flawed.

But I'm not the only one who thinks so. In fact, awareness of the shortcomings of GDP as a measure of a nation's well-being and an economy's sustainability has grown steadily in recent years.

GDP measures the value of output produced within a country in a given time period, usually a year or a quarter.

The key flaw is this: Any depreciation included reflects only changes to man-made capital such as equipment, but does not include growth's negative impact on public goods such as water, forests and clean air - that is, the environment.

The European Commission recognised this when it launched an initiative called 'Beyond GDP' in 2009, which aimed to develop indicators that are 'as clear and appealing as GDP, but more inclusive of environmental and social aspects of progress'.

Economic indicators such as GDP, the European Union's Beyond GDP website says, were 'never designed to be comprehensive measures of prosperity and well-being' - yet today, we see almost all countries, including Singapore, pursuing it as the ultimate sign of success.

Today, a combination of economic crises (think the 2008 financial crisis, and the more recent United States and European debt woes) and environmental disasters (flood, famine and deforestation) has created a global momentum for a radical revision of national accounting methods.

The World Bank accelerated this momentum earlier this year when, working with non-profit organisations such as Conservation International (CI), it launched Waves, or Wealth Accounting and Valuation of Ecosystem Services, which recognises the under-valuation of ecosystem services (such as tourism, clean air and water) as one of the main causes of ecosystem degradation and biodiversity loss.

In an interview with The Sunday Times last week, Dr Andrew Rosenberg, chief scientist at CI, explained how Waves seeks to engage finance ministries and economic planning agencies across the globe in implementing a process that values natural capital such as ecosystems in the national income.

National income measures the monetary value of the flow of output of goods and services produced within an economy over a period of time.

National income accounts are crucial because they form the primary source of information about the economy, such as GDP, and are widely used for assessment of economic performance and policy analysis in all countries, said Dr Rosenberg.

This is why it is important to integrate the economic value of ecosystems into national income accounts. This helps to address shortcomings in managing the environment and natural capital.

For example, while the income from harvesting trees for wood is recorded as income in national accounts, the simultaneous depletion of natural forest assets is not seen as a loss in capital.

This is despite the fact that deforestation would lead to lower air quality, increased risk of soil erosion and flooding, which have far-reaching consequences.

By focusing only on flows of output, GDP provides misleading signals to policymakers. This can result in leaders making wrong and misinformed decisions, said Dr Rosenberg. 'That's why we need to have green accounting... putting a market value on things like fisheries, forests and natural foods,' he added. 'One way to think about it is how much would it cost to replace the function that this environment provides?'

Hypothetically, the argument for green accounting is robust. However, in reality, the implementation has been challenging.

Nanyang Technological University environmental economics professor Euston Quah said the big question is how to get everyone to agree on a common method of valuing natural capital.

'There is tremendous disagreement within the scientific, business and government communities as to how we can put monetary valuations on the environment,' he said. This is why, even though the subject gained much attention when it first emerged in the 1980s, interest in it eventually fizzled out.

But Prof Quah recognises this: The concept is making a comeback now. 'Across the world, we have become more environmentally aware. There are big multilateral treaties on climate change being discussed, and people are putting pressure on governments to factor in the cost of the environment in the pursuit of economic growth,' he said.

'The world needs to sit down and convene more meetings to discuss this, and agree on a methodology of evaluations.'

The ramifications of this overhaul of GDP and national income are great. If the world succeeds and countries take stock of economic growth in relation to the depletion of their natural assets, net growth will be smaller, said Prof Quah.

'Society will then be able to decide, is it worth it? For example, if growing output by 10 per cent requires an 8 per cent loss in natural capital... this would affect how governments pursue policies of economic growth, and will also affect government spending.'

One interesting question: If all countries had been equipped with such accounting methods, say, 50 years ago, and it had been the standard, would it have changed the growth path of all the economies?

Take Singapore, for example. If we had had to account for our natural capital before our development years, would it have changed our industries or physical landscape?

The answer depends on how much natural resources a country has, said Prof Quah. In the case of Singapore, which has few natural resources, stable employment and income were, rightly, big priorities in the early development years.

Green accounting would unlikely have made a big difference to economic decisions as land would still have to be cleared to make way for housing and industries, he added.

What's interesting is, as the country develops, citizens now put a higher priority on the quality of life, and on things such as noise and air pollution, and clean, green spaces, he observed.

For resource-rich countries, however, green accounting becomes more important. The government needs to recognise the trade-offs involved in pursuing certain economic policies and the extensive impact they could have on its environment and the future cost of losing certain resources, especially if they play a big part in generating 'unseen' income, like providing regular rainfall, or tourism locations.

But if poor, developing countries wanted to do this, they would not likely have the capacity. Rich, developed nations can help build this capacity.

'It is right that we should put some resources into it to come up with a framework... the EU's efforts in driving 'Beyond GDP' are encouraging,' Prof Quah said.

Meanwhile, Dr Rosenberg feels companies can make a start by applying green accounting principles to their own business strategies.

'There will be increasing requirements for transparency and sustainability... I wouldn't be surprised if ultimately, stock exchanges, for example, demanded green accounts from their listed firms,' he said.

Ultimately, companies should realise that green accounting helps management to improve the decision-making process, save costs and assess potential liabilities, he said.

This can only be a good thing. And the earlier governments start to catch on, the better.