Saturday, June 23, 2012

We're adding the environment to the national accounts

How do you get economists and business people to take the environment and its relationship with the economy seriously? Change its name to one that resonates with commercial values. What's a word that denotes great value, preciousness to a capitalist? I know - "capital".

You've heard of physical capital (machines, buildings and other structures), financial capital (securities such as shares and bonds), human capital (an educated and skilled workforce) and social capital (the shared values and norms of behaviour that enable mutually advantageous cooperation).

So why don't we rename the environment "natural capital"? It wasn't me who thought of it, however.

It doesn't sound like a lot of progress has been made at the Rio+20 summit on sustainable development. But one thing giving me hope is the "natural capital declaration" made by banks and big businesses, including our National Australia Bank, represented by its chief executive, Cameron Clyne.

"Natural capital," it says, "comprises Earth's natural assets (soil, air, water, flora and fauna) and the ecosystem services resulting from them, which make human life possible. Ecosystem goods and services from natural capital are worth trillions of US dollars per year and constitute food, fibre, water, health, energy, climate security and other essential services for everyone.

"Neither these services, nor the stock of natural capital that provides them, are adequately valued compared to social and financial capital. Despite being fundamental to our wellbeing, their daily use remains almost undetected within our economic system.

"Using natural capital this way is not sustainable. The private sector, governments, all of us, must increasingly understand and account for our use of natural capital and recognise the true cost of economic growth and sustaining human wellbeing today and into the future," the declaration says.

It goes on to say that "because natural capital is a part of the 'global commons' and is treated largely as a 'free good', governments must act to create a framework regulating and incentivising the private sector - including the financial sector - to operate responsibly regarding its sustainable use.

"We therefore call upon governments to develop clear, credible and long-term policy frameworks that support and incentivise organisations - including financial institutions - to value and report on their use of natural capital and thereby working towards internalising environmental costs."

Lovely. Great stuff. Most enlightened. But if you think we're just at the earliest stages of realising we need to measure our impact on the environment and incorporate it into our decision making, I have good news. At the level of national accounting, we're a lot further advanced than you realise.

You often see me banging on about the "national accounts", from which key economic indicators such as gross domestic product emerge. You've also seen me pointing to the limitations of GDP as a measure of wellbeing or progress, particularly its failure to take account of the costs economic activity is imposing on the environment and of the environment's present state of repair.

The "system of national accounts" we use is laid down by the United Nations Statistical Commission for use in all countries. It's an accounting framework that measures economic activity and organises a wide range of economic data into a structured set of accounts. It defines the concepts, classifications and accounting rules needed to do this.

So here's the news: earlier this year the UN Statistical Commission adopted as a new international statistical standard with equal status to the system of national accounts, the "system of environmental-economic accounting" - SEEA.

Our Bureau of Statistics has been at the forefront in the development of SEEA. Last month, it published a document, Completing the Picture: Environmental Accounting in Practice, explaining what SEEA is. I'm drawing on this document.

SEEA is another accounting framework that records as completely as possible the stocks and flows relevant to the analysis of environmental and economic issues. So SEEA is different from the various present independent sets of statistics because it demands coherence and consistency with a core set of definitions and treatments.

Get it? An accounting framework allows you to add a lot of different things together, making sure they fit together logically and there's no double-counting. SEEA puts information about changes in the environment on the same basis as the existing information about changes in the economy, so they can be combined and give us an integrated picture of how the environment and the economy are affecting each other.

Just a small problem, however. The existing national accounts measure economic activity in money terms. To achieve this, they stick almost wholly to measuring transactions in the market, since these reveal market valuations.

But the very reason economists and business people have been taking too little notice of the environment for the past centuries is that, for the most part, it's outside the market system - a "free good". There's not one price for clean air and another for dirty. Photosynthesis, pollination and precipitation are ecosystem services to the economy that aren't paid for, so it's hard to put a figure on what they're worth.

Despite this, SEEA extends the national accounts by recording environmental data that are usually available in physical or quantitative terms in coherence with the economic data in monetary terms. Maybe one day we'll discover a way to value natural capital so we can add it all together.

There are three main types of account in the SEEA framework that are added to the existing monetary flow (the change in something over a period) and stock (the position at a point in time) accounts of the national accounts.

First are physical flow accounts that record flows of natural inputs from the environment to the economy, flows of products within the economy and flows of "residuals" (various forms of waste) generated by the economy. These flows include water and energy used in production and waste flows to the environment, such as solid waste to landfill.

Second are functional accounts for environmental transactions between different economic sectors (such as industries, households, governments). Such transactions include investing in technologies designed to prevent or reduce pollution, restoring the environment after it has been polluted, recycling, conservation and resource management.

Finally, asset accounts in physical and money terms measure the stocks of natural resources available and changes in the amount available. There'd be accounts for minerals and energy, timber, fish, soil, water and land.

The bureau is beavering away to produce more of these accounts. It's making progress in turning SEEA into an Australian reality.