Measuring sustainable economic growth and development
Concept and indicators of sustainable development
Almost two decades ago the United Nations established a commission to investigate persistent policy failures in both environment and development. The so-called Brundtland Commission considered the neglect of interdependences among nature, economy and society as the principal cause of these failures. Acting on the Brundtland report, the 1992 Earth Summit in Rio de Janeiro propagated sustainable development as the key to integrating the main – social, economic and environmental – dimensions of development in planning and policy making. Its Action Plan, Agenda 21, considered integrated environmental and economic accounting as “a first step towards the integration of sustainability into economic management”. Ten years later, the Johannesburg Summit on Sustainable Development reaffirmed the commitment to the Rio principles and Agenda 21. It did not take up environmental accounting, but called instead on governments to promote data collection and indicators for sustainable development.
The Brundtland Commission also offered the popular definition of sustainable development as “development that meets the needs of the present without compromising the ability of future generations to meet their own needs”. The definition is vague: it does not specify the categories of human needs and does not give a clear time frame for analysis; nor does it indicate particular roles for the environment or social concerns in long-term development. The paradigm needs to be operationalized, and indeed numerous indicators ‘for’ and ‘of’ sustainable development have since been advanced.
Indicators for sustainable development typically include long lists of measures considered relevant for assessing the environmental, social, economic and institutional aspects of development. Perhaps best known are the sustainable development indicators of the United Nations, developed in response to the recommendations of the Earth Summits.
The main drawback of such lists is the difficulty of comparing and evaluating indicators expressed in different units of measurement. Sustaining overall socioeconomic progress or development requires aggregation into more compound indicators or indices of sustainable development. Well-known attempts at aggregation are the Human Development Index, the Environmental Sustainability Index, the Genuine Progress Indicator and the Ecological Footprint. All these measures suffer from a more or less judgmental selection of partially correlated indicators, a questionable mix of weighting and valuation techniques, and/or inconsistency with standard accounting concepts and conventions.
A narrower focus on the immediate interactions between economic activity and the environment facilitates measurement and improves comparability. Practical methods of accounting and aggregation deal therefore only with the environmental sustainability of economic performance and growth. The trade-off is leaving out important dimensions of sustainable development such as health, security or distributional (national, international and inter-generational) equity.
Preference for dramatic nutshell information by policy makers and the public media has made global warming the surrogate measure for environmental deterioration. The risk is losing sight of other pressing environmental, social and economic concerns.
Accounting for sustainability
Natural science offers basic principles for the nature-economy interface, and economics provides the tool for the systemic and aggregative measurement of this interface. Thermodynamic laws of matter and energy conservation and dissipation govern the use of nature’s resources. Formal double-entry accounting can then be applied to assess (1) the use (input) of nature’s raw materials, space and energy by the economy and (2) the dispersion (output) of these resources as waste and residuals from the economy to the natural environment. The results are physical accounts, expressed in units of energy, area or weight of materials.
Comparing these physical flows of environmental impacts to the costs and benefits of economic activity requires putting a price on physical impacts. Environmentalists and economists – to make a crude distinction between ecological and economic views of the human environment – disagree on whether to use physical measures or prices for weighting the importance of environmental impacts. Environmental economists seek to ‘internalize’ the costs of environmental impacts into the budgets and decisions of households and enterprises. Many environmentalists, on the other hand, refute such ‘commodification’ of an indivisible (public) good on whose value markets should not have a say.
Two operational sustainability concepts can be distinguished according to the ecological and economic outlook:
- Ecological sustainability considers material flows from the environment, through the economy and back (as waste) to the environment as pressures on the carrying capacities of natural systems; the objective is to reduce this pressure to tolerable levels by ‘dematerializing’ the economy.
- Economic sustainability makes use of the established requisite for economic growth, ‘capital maintenance’, and extends the (produced) capital concept to include non-produced natural capital.
Green accounting systems seek to capture either the physical side of sustainability, i.e. dematerialization or its monetary side, capital maintenance. Figure 1 illustrates this physical-monetary dichotomy within an overall data and accounting framework. The framework distinguishes, besides physical and monetary accounting, an intermediate, hybrid (physical-monetary) approach. The figure also indicates the links of the accounting systems to data sources, represented by international data frameworks, and to the use of accounting indicators in modeling and policy analysis.
Two accounting systems have been most successful in capturing ecological and economic sustainability. Material Flow Accounts (MFA) and related Physical Input-Output Tables (PIOT) measure material flows in physical – weight – units. The United Nations System for integrated Environmental and Economic Accounting (SEEA) embraces both physical and monetary accounts, seeking compatibility with the worldwide-adopted United Nations System of National Accounts, the SNA. An international group of experts and accountants has now revised the SEEA. The United Nations and other international organizations will issue the revised SEEA as “Integrated Environmental and Economic Accounting 2003”.
Physical accounts and hybrid accounts that link physical environmental statistics to the national accounts play a dominating role in the revised SEEA. There seems to be some apprehension by national accountants about competition from monetary green accounting. In fact the revised 2003 SEEA has still not been published.
Physical and hybrid accounts are intermediate steps towards integrated environmental-economic accounting. The concept of ecological sustainability of overall economic performance requires aggregation of material ‘throughputs’. To this end, MFA calculate aggregate indicators of Total Material Requirement (TMR) of the economy as well as Total Material Output (TMO) of wastes and pollutants. The revised SEEA disdains such aggregative accounting and hence the assessment of ecological sustainability. The reason is the problem of assessing the significance of diverse environmental impacts by the weight of materials and substances.
Figure 2 shows some results of MFA compiled by non-governmental organizations. Industrialized countries seem to converge around an annual TMR per capita of 80 tonnes (with 40 tonnes for energy-saving Japan). Emerging economies like China might soon catch up with industrialized countries by rapidly increasing the material and energy intensity of its production and consumption patterns. As economic (GDP) growth rates exceed those of primary material inputs (TMR), decreasing material intensity of GDP indicates relative dematerialization. The question is whether such dematerialization generates environmentally sustainable economic growth. Most environmentalists argue for an absolute reduction of material throughput without specifying, however, how much of a decrease we need to achieve sustainability.
Truly integrative environmental-economic accounts need to use a common measuring rod for both environmental impacts and economic outputs. Physical measures of weight of materials and products cannot do justice to human preferences for environmental quality and economic goods and services. There does not seem to be a way around costing the environmental impacts for comparing them with the costs and benefits of economic activity. This is, or should be, the task of greening the monetary national accounts.
Monetary accounts: greening the national accounts
US national income accounting and the measurement of economic welfare set the tone for the first attempts at incorporating environmental and social concerns into the national accounts. The interpretation of national income as a welfare measure remains controversial since the national accounts generate indicators of economic activity rather than human well-being. There is agreement, though, that even within the narrower scope of economic production and consumption the conventional accounts ignore
- new scarcities of natural resources that threaten the sustained productivity of the economy, and
- environmental degradation as an ‘external’ (social) cost of economic activity.
Some scholars also point to a possible distortion of accounting indicators from counting environmental protection as an increase in national income. In their view such expenditure is ‘defensive’ as it is to prevent the deterioration of the environment rather than to improve its condition.
Economists like Robert Solow and John Hartwick extended the concept of capital into nature, in particular for non-renewable (‘exhaustible’) resources. The original SEEA introduced a broader view of natural capital into the national accounts, including environmental services of the disposal and absorption of wastes and pollutants, and the loss of other services and amenities.
Figure 3 shows how environmental services can be integrated in the national accounts by
- incorporating environmental assets as natural capital – in addition to produced economic assets – into the asset accounts of the SNA
- costing natural capital consumption, in addition to, and in consistency with, fixed capital consumption in both the asset and flow (supply and use) accounts.
The figure also presents environmental protection expenditures as ‘of which’ items of the supply and use of products. The SEEA identifies these expenditures in separate classifications, but does not suggest their deduction from gross domestic product (GDP) as a ‘defense’ against welfare losses. The reasons are difficulties of distinguishing between welfare improving and maintaining outlays, the objective of measuring income, consumption and production, rather than welfare, and the need for maintaining accounting balances and equations.
Sustainability is already built into the conventional net indicators of value added and capital formation, which deduct produced capital consumption from their gross values. Accounting also for natural capital consumption and maintenance extends this sustainability notion to nature’s (capital) services for the economy. In analogy to the wear and tear, i.e. the ultimate destruction, of capital goods in the production process, natural capital loss is defined as the permanent loss of natural resource stocks and capacities of waste absorption and other ecological services. This definition clarifies the content of physical depletion and degradation – beyond natural regeneration and replenishment: the self-regeneration of nature can be seen as a cost-free natural repair process, rather than a capital loss.
Adding up the rows and columns of Figure 3 obtains most of the environmentally adjusted indicators. They include, in particular,
- Environmentally-adjusted Value Added (EVA), generated by industries, and obtained by deducting environmental (depletion and degradation) cost incurred by these industries from their net value added (the difference between the value of production and intermediate consumption)
- Environmentally-adjusted net Capital Formation (ECF), obtained by deducting environmental cost from conventional net capital formation
- Environmentally-adjusted net Domestic Product (EDP), obtained (1) by deducting total environmental cost from Net Domestic Product (NDP), (2) by adding up EVA for all industries, or (3) as the sum of final consumption, ECF, and the balance of exports and imports.
Difficulties of measuring capital depreciation made gross domestic product the standard for measuring overall economic performance and growth. ‘Greening the GDP’ has therefore become a popular term for green accounting. If, however, the objective is measuring sustainability, ignoring the need to replace obsolete produced capital such as roads, bridges, buildings and machinery is hardly sustainable. Crumbling infrastructure in both developing and industrialized countries is a case in point.
The costing of environmental impacts in terms of natural capital consumption requires putting a money value on the physical changes of natural capital, i.e. changes in the availability of its (re)source, sink and possibly other ecological functions. This is a prerequisite for maintaining the accounting concepts and equations and compiling the adjusted economic aggregates. However, the imputation of monetary values on non-market transactions and processes has been challenged, not only by environmentalists but also by national accountants.
Market (price) valuation applies readily to natural resource depletion. In the absence of market prices for non-produced natural assets, natural resource ‘rents’ (profits) from selling resource outputs in markets can be used for estimating the net present value and depletion cost of an asset. For environmental degradation, the original SEEA suggests estimating the maintenance costs of avoiding or mitigating environmental impacts. A few studies used damage valuations of environmental impacts. Such welfare measurement and valuation are characteristic of cost-benefit analyses of projects and programs; they are not compatible with the market pricing and costing of the national accounts.
The above description of concepts and methods of green accounting seems to convey a picture of considerable complexity and challenges for implementation. However, much of this complexity is part of the conventional national accounts. Case studies bear evidence of the feasibility of green accounting, even in countries with limited statistical capacities. Focusing on the practical implementation of the SEEA, the United Nations issued an “operational manual”. The manual describes the set-up of a national pilot project and presents a sequence of implementation steps and related worksheets.
Policy use of green accounting
Score keeping: did our economies perform sustainably?
Physical statistics and indicators provide useful managerial information, especially for local ecosystems. At the national level, physical accounts generate indicators that aggregate material and substance flows in tonnes. As shown in Figure 2, their trends may alert to worsening environmental conditions. But how bad are these trends, especially when the ‘goods’ of the economy are also taken into account? In other words, how much dematerialization do we need to attain ecological sustainability? Setting dematerialization standards, such as Factor 4 for halving material inputs while doubling wealth, is judgmental; the standards represent the standard setter’s view of actual and potential transgressions of ultimate environmental limits.
Economists view the accumulation of real (non-financial) capital as the engine of economic growth. Re-investment to offset capital loss keeps the engine running. Greened national accounts cater to this notion of – economic – sustainability by assessing the funds required for re-investment as the cost of produced and natural capital consumption. However, the maintenance of produced and natural capital is not a sufficient condition for non-declining economic output since other (primary) production factors such as human, social and institutional capital are not taken into account. Natural capital maintenance may thus only improve the sustainability situation, but may not ensure fully sustainable economic growth.
It is another question whether the calculated cost allowances are actually used for the replacement of depleted or degraded natural capital, or whether they are otherwise saved or spent for consumption. In fact, the use of natural resource ‘rents’ (profits) in current consumption, concomitant corruption, and increases in currency value are blamed for the ‘resource curse’, i.e. the poor performance of some resource-rich developing countries. Capital maintenance costing is thus only a reminder of the need for re-investment but does not guarantee the actual replacement of worn-out or depleted capital
Total capital maintenance also represents a weak sustainability notion since substitution of different capital assets is implied. When complementarities in production and consumption processes call for the preservation of ‘critical’ natural capital, meeting weak sustainability criteria cannot ensure non-negative growth in real (constant-price) terms and with current production and consumption patterns. To preserve irreplaceable capital assets, standards for the minimal availability of critical capital assets would have to be set. Such strong sustainability standards for complementary environmental assets need to be specified in physical terms, and their assessment should be an important task of physical accounting. The identification, measurement and (e)valuation of complementarities in capital use are an unresolved issue. Still, negative or greatly reduced total net capital formation would warrant changing established growth, investment and savings policies.
SEEA pilot studies showed mostly weak sustainability of past economic performance in terms of non-declining EDP and ECF. Figure 4 indicates non-sustainability in the sense of inability to maintain the capital base, i.e. negative ECF, only for Indonesia, Ghana and Mexico. World Bank estimates point to widespread non-sustainability for Africa, in terms of negative ‘genuine savings’, an indicator that is similar to ECF.
Modeling sustainability scenarios: the ‘greened-economy’ GDP
- the occurrence of complementarities in the use of natural capital
- technological progress in capital-saving, -increasing or -substituting production processes
- change in consumption and production patterns, which may bring about changes in environmental impacts.
Forward-looking policy analysis has to consider these obstacles and opportunities when using accounting data directly or through the modeling of scenarios and policy options.
The SEEA 2003 makes a useful distinction between “environmentally adjusted” (accounting) indicators for assessing past economic performance and “greened-economy” indicators that refer to alternative environmental scenarios. A greened-economy GDP is indeed quite different from an environmentally adjusted NDP (EDP): whereas EDP represents a still-life picture of an economy that has accounted for environmental (social) cost, the greened-economy GDP is the result of modeling the consequences of environmental cost internalization for structural change and growth of the economy. The resulting scenarios may differ, of course, according to the specification of different environmental options and model assumptions.
Some models make good use of accounting indicators in a more rigorous fashion than the intuitive interpretation of data by policy makers. On the other hand, direct data use has the advantage of avoiding the analytical straightjacket of modeling techniques and abstractions.
Policy formulation and monitoring
The following brief description of direct policy uses focuses on three salient features of environmental-economic accounting: (1) natural wealth/capital assessment at the macro-level, (2) environmental cost measurement and allocation at micro- and meso-(sectoral) levels, and (3) outlays for environmental protection.
The availability of productive wealth is the key determinant of the long-term growth potential of an economy. A declining natural capital base would alert to limits of economic growth – a topic that has preoccupied environmentalists and ecological economists since the Club of Rome report on The Limits to Growth. More positively, wealth (capital stock) has been rediscovered as a prime policy tool for sustainable development. The idea is to recover all resource rents for re-investment in a development fund. To this end, the World Bank advanced “portfolio management” of (produced, natural and human) capital as a new model for sustaining economic growth and development. Such a strategy might be especially helpful to developing countries that need to manage stifling foreign debt by better use of their endowment with natural and human capital. Assigning property rights to common-access resources and assuring a more equitable distribution of wealth might turn the above-mentioned resource curse of mismanaged natural capital into a blessing for sustainable development.
One particular strength of green accounting is the measurement of environmental depletion and degradation cost caused by economic agents. The policy concern, according to the well-known polluter/user-pays principles, is to hold the responsible agents accountable for these costs. Economists deem market instruments of environmental cost internalization, such as eco-taxes, congestion pricing, deposit-refund schemes or tradable pollution permits, more efficient in bringing about sustainable production and consumption patterns than top-down regulation. In the absence of integrated environmental-economic accounting, a consistent assessment and allocation of environmental cost is hardly possible. Political exigencies rather than cost measurement appear to have determined the setting of market instruments in most countries.
The implementation of environmental protection measures, whether prompted by regulations or market incentives, requires budgetary allocations and expenses by the government and the private sector. These actual environmental expenditures are in principle covered by the conventional accounts. This might explain their popularity with national accountants. However, the segregation of environmental expenditures as ‘of which’ components of accounting aggregates (see Fig. 3) still poses classification and measurement problems.
One of the key recommendations of the Johannesburg Summit is to form “public-private partnerships” to supplement conventional top-down governmental policy. Assessing the efficiency of different measures of environmental protection, and by different actors, is probably the most useful task of monitoring environmental expenditures. It is not an easy task, given the time-lagged reactions of the environment and humans to particular protection measures.
Further reading on indicators and green accounting
- The author’s forthcoming book on Quantitative Eco-nomics – How Sustainable Are Our Economies? (Springer, Netherlands) elaborates on all issues of this article.
- Moldan, Billharz and Matravers (eds, 1997), Sustainability Indicators: A Report on Indicators of Sustainable Development (Chichester: Wiley), provide an overview of the numerous and widely differing proposals for sustainable development indicators. ISBN: 0471973521
- The United Nations (2001), Indicators of Sustainable Development: Guidelines and Methodologies (New York: United Nations), developed the prototype list of sustainable development indicators. ISBN: 9211045061
- Bartelmus (ed., 2002), Unveiling Wealth – On Money, Quality of Life and Sustainability (Dordrecht, Boston and London: Kluwer), reviews the main indicators and indices related to sustainable development. ISBN: 1402008147
- Bartelmus and Seifert (eds, 2003), Green Accounting (Aldershot and Burlington: Ashgate), is a reader on the history and approaches of green accounting at national and corporate levels. ISBN: 0754622320
- United Nations (1993), Integrated Environmental and Economic Accounting (New York: United Nations), is the original handbook on the concepts and methods of the SEEA. The United Nations also issued a practical manual for SEEA implementation: United Nations (2000), Integrated Environmental and Economic Accounting – An Operational Manual (New York: United Nations). The revised SEEA 2003 is available on the web as a ‘final’ draft.
- A special issue of Ecological Economics (2007, 61/4) reviews critically the revised SEEA.
- The statistical services of the European Union issued guidelines of material flow accounts: Eurostat (2001), (Luxembourg: European Communities). Economy-wide Material Flow Accounts and Derived Indicators: A Methodological Guide.
- Case studies of green accounting can be found in Uno and Bartelmus (1998), Environmental Accounting in Theory and Practice (Dordrecht, Boston and London: Kluwer). ISBN: 0792345592
- The World Bank (1997), Expanding the Measure of Wealth, Indicators of Environmentally Sustainable Development, and (2001), 2001 World Development Indicators (Washington, D.C.: The World Bank), compiles comprehensive wealth and genuine savings indicators as measures of sustainable development.
This article draws on a paper on “Green national accounting: measuring sustainable economic growth”, prepared for Statistics Canada and presented at the International Workshop on Green Accounting for China (Beijing, 23-24 November, 2004). Permission by Statistics Canada to use the paper for a contribution to the EoE is gratefully acknowledged.