The time is ripe for green accounting

The debate over how to measure national prosperity is not new. As the quote above illustrates, 'disillusioned critics' of national accounting have been around since at least the 1970s. Perhaps surprising, though, is the fact that the terms of the debate have changed so little. Despite ever more evidence of its shortcomings, economic growth has remained 'the reigning fashion'.

Given the apparent lack of change in 40 years, the disillusioned critics may have felt more demoralised than ever when France's President Sarkozy last week questioned the use of gross domestic product (GDP) as a measure of wellbeing. At last, however, they may have cause for optimism. As Sarkozy himself noted, the global economic crisis and fluctuating commodity prices of recent years have laid bare both the deficiencies of our accounting structures and our dependence on finite and fragile natural systems.

Citizens, businesses and governments today fret about the accumulation of huge debts, exposure to concealed liabilities and the effectiveness of huge untested rescue packages. More than ever, there is global awareness that our current tools are unreliable measures of the state and sustainability of our economies.

Importantly, this demand for better indicators is being met. Besides the Stiglitz-Fitoussi-Sen Commission launched by President Sarkozy, other activities include the European Commission's 'Beyond GDP' process and the United Nations Environment Programme (UNEP) Green Economy Initiative.

Together these elements suggest that the time may have come to move from debate to action.

What's wrong with GDP?

In the last sixty years, GDP has come to be seen as the primary indicator of the state of national economies and social wellbeing and a key guide to policymakers and investors. Unfortunately, it wasn't designed for that purpose so doesn't perform the role particularly well.

Although a variety of criticisms can be levelled against GDP, from a sustainability perspective the key concern is that it measures what an economy produces, not the state of capital stocks that underpin that output. Such stocks include manmade capital but also other resources — natural, social and human — which together determine how much a society can produce.

At the micro level, of course, accounting practice does acknowledge the importance of capital (at least of the manmade variety). Business accounts have always included an element of depreciation to reflect the decreasing value of a firm’s productive capital over time. The rationale is obvious: sustained output is only possible if a firm invests in maintaining its capital stock.  

Oddly, governments and international institutions pay less attention to the underlying robustness of the economy when calculating national accounts. In GDP, 'G' stands for 'gross', which means 'before subtracting capital depreciation'.

Even when calculating net domestic product (an aggregate far less popular than GDP) the depreciation only reflects changes in manmade capital, not those public goods that are not produced but play a vital role in determining economic output — above all nature.

By focusing only on flows of outputs, GDP provides misleading signals to policymakers. Activities that maximise production in the short term need not preserve the capital stocks that are central to long-term prosperity. Indeed, focusing just on GDP actually creates incentives to deplete capital stocks because the returns are treated as income.

Ultimately, not recording the cost of reinvestments to sustain healthy ecosystems creates and conceals ecological liabilities. This distorts our perception of the future when restoring ecosystem services will demand that we repay the debts.

The shape of things to come

Decision-makers need the right indicators to ensure that policies and investments maximise wellbeing for current and future generations. Equally, citizens need access to such information to hold their governments to account: robust and transparent information is a prerequisite for public empowerment and engagement.

In practical terms this means that we must develop systems of national accounting that fully incorporate the capital stocks that determine our earnings.

Clearly, this poses conceptual and practical difficulties. From the environmental perspective, the key challenge lies in defining, quantifying and valuing natural capital. Whereas economic activity is quantified in monetary terms and recorded in business accounts, we have far fewer systems to measure the scale and cost of our impact on the environment.

To address this need, the European Environment Agency and its partners have been developing techniques consistent with national accounts methods to record the contribution of ecosystems to society's welfare. The methods, collectively known as ecosystem accounts, comprise both physical and monetary accounts of stocks, material and energy flows and services.

The EEA's basic approach entails quantifying the level of investments needed to ensure that ecosystems continue to provide the same level of services. This takes account of a variety of 'indicators of ecological potential', accounting for the state of the landscape, ecosystem production, biodiversity, water, absorption of external inputs and the capacity to support healthy populations.

Over the next 18 months, EEA will elaborate its natural capital accounting methodology further. At the same time, EEA is preparing land, carbon and water accounts that will shed light on the physical changes occurring in the European environment and their interaction with local and national economies. In addition, EEA will continue to build up its network of data sources, drawing on resources ranging from satellites to local people and organisations.

Evidently, developing a complete methodology, complemented with all necessary data collection and analysis processes will take years. EEA believes strongly, however, that simplified ecosystem accounts can and should be launched today.

In fact, the United Nations System of National Accounts (SNA), which sets out the standard methodology for national accounting, provides a useful example. First published in 1953, the SNA manual totalled just 56 pages and provided a much less comprehensive approach than the 750 page version produced in 2008. The message is clear: start simple.