The System of National Accounts and its bellwether indicator, gross domestic product (GDP), have together proved an antiquated compass for steering our economies. This has resulted over the years in policy failures, as the compass does not tell us whether our resources are scarce or sustainable, whether the quality of life has improved along with GDP growth or not, and so on. It does a very poor job of measuring what matters.

There have been persistent efforts over the last two decades to reform our national accounting system through “green accounting” or “inclusive wealth” measures. It is expected that one of these new measures will finally provide a yardstick for sustainable development. These improved measures of national performance will also reflect our institutional and political commitments through the Agenda 21 document “Our Common Future,” an outcome of the 1992 Earth Summit at Rio, and “The Future We Want” document accepted at Rio+20 in 2012.

The effort comes not a moment too soon. The United Nations is now formulating Sustainable Development Goals starting in 2015 with the expectation of being able to compare how the world responds to sustainability targets. Fixing the accounts of society so that they measure what matters becomes even more crucial in this context.

Better indicators for economic welfare have been sought as far back as the 1960s. William Nordhaus and James Tobin proposed alternative indicators in 1973, while Herman Daly and John Cobb proposed an index of sustainable economic welfare in 1989.

Pioneering efforts to compute alternatives have also been made by statistical agencies in the Netherlands and the Philippines. The United Nations Statistics Division (UNSD) and World Bank developed a framework for a satellite accounting system in the early 1990s, resulting in the publication of a handbook in 1993 that has since gone through a number of revisions.

Some progress is being made. Efforts to green national accounts are now underway in many countries, including Australia, Austria, Canada, Denmark, Finland, France, Germany, Italy, India, Netherlands, Norway, Sweden, the United Kingdom and United States.

In 2008, Nicolas Sarkozy, president of France at the time, set up a Commission on the Measurement of Economic Performance and Social Progress, headed by economists Joseph Stiglitz, Amartya Sen and Jean-Paul Fitoussi. Their prime mission is to identify the limits of GDP as an indicator of economic performance and social progress. The commission’s mandate is also to assess the feasibility of alternative measurement tools, and to discuss how to present such statistical information in an appropriate way.

At the same time, there is a significant global effort underway to build a partnership among countries interested in including natural capital in their national accounts. The initiative was announced at the COP-10 meeting in Nagoya, Japan, in 2010 by World Bank president Robert Zoellick. Christened WAVES, which stands for Wealth Accounting and the Valuation of Ecosystem Services, the goal is to develop guidelines for ecosystem accounting. Several developed and developing countries are part of this initiative, including Australia, Botswana, Colombia, Costa Rica, Madagascar and the Philippines. WAVES partners also include several UN agencies, such as UN Environment Programme (UNEP), UN Development Programme and UNSD, as well as non-governmental organizations and academic institutions.

In May 2012, in the run-up to Rio+20, Botswana President Ian Khama hosted a summit of 11 African nations to discuss the significance of natural capital to their respective countries. No less than five African heads of state attended this meeting in person. The result of this gathering was the Gaborone Declaration, which committed this group of African first-movers to including natural capital in their national accounts. The document sent a powerful political message during Rio+20 negotiations. It told the world that these African nations were not only aware of the importance of natural capital, but also willing to do something about it.

Also at Rio+20, the World Bank and its partners initiated the “50/50” campaign, inviting the public and private sectors to join forces in support of natural capital accounting. The response was overwhelming: 62 countries, 90 corporations and 17 civil society members signed up. UNEP and the United Nations University added momentum to the discussion with the release of their Inclusive Wealth Report, a ground-breaking document that measured the change in man-made capital, natural capital and human capital for a selection of 20 countries over the last 18 years. Although Rio+20 has been criticized as an underwhelming event, it was clearly a success for efforts to boost acceptance of natural capital accounting.

In a related sphere, Rio+20 also saw considerable interest and cohesive action to initiate a parallel process by which corporations could begin to measure and report their own impacts on natural capital. Apart from the obvious dependencies of some business sectors on nature – tourism, agriculture, forestry, fisheries and pharmaceuticals, to name a few – the world of business also has significant impacts on the natural environment.

These are the so-called “externalities” of business, including greenhouse gas emissions, freshwater extraction, pollution and waste. A recent 2011 estimate of the economic size of these externalities was as high as $2.15 trillion (U.S.), or 3.5 per cent of GDP contributed by just the top 3,000 listed companies in the world. You can’t manage what you don’t measure, and at present there is very little measuring or reporting on natural capital going on in the corporate world. Guidelines and standards are urgently needed to help corporations integrate natural capital metrics into their statutory reporting process, which is at present limited to just financial accounts. “Mainstreaming” these issues can only be achieved if mainstream analysts and investors discover sustainability information as part of the annual reports they read and respond to with ratings and market actions.

Meanwhile, the UNSD has improved guidelines for reflecting natural capital in national accounts. The latest version of the internationally accepted standard for how one counts natural capital and ecosystem services, the System of Environmental-Economic Accounting (SEEA), was updated in 2012. It prescribes ways to reflect the market-priced value of nature’s goods and services in national accounts. But this is not new. What is new is that it also provides experimental accounting guidance to reflect the values of non-market goods and services, such as freshwater and nutrient cycling and pollination. It also sets out monitoring and analytical approaches that countries can follow, and suggests ways for such data to inform policy.

Can the leading nations accomplish much of this accounting advancement by 2015, when the UN’s Sustainable Development Goals will signal a new phase of sustainable development? The jury is out on this question. But if five or 10 leading nations from both developed and developing worlds can focus their collective efforts, there is no doubt that these trailblazers can be ready in time with national accounts that actually reflect development’s biggest asset: natural capital.

If they succeed by 2015, we would all have cause to celebrate the arrival of a brave new world.

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The question begged to be asked is: Why not?

Was it because natural capital losses are losses of public wealth, and therefore less newsworthy than private wealth? Or was it because nature’s benefits are difficult to quantify and express in monetary terms, having no markets and no prices? Or perhaps it was because natural capital and its benefits—and losses—are missing from that ubiquitous measure of national economic performance, gross domestic product (GDP).

GDP is the most commonly used paradigm today for measuring human progress. Virtually all economic policy is currently oriented directly or indirectly towards maximizing GDP growth. It is so deeply ingrained that people forget that it is an entirely artificial construct created in the mid-20th century as part of the war effort and Marshall Plan recovery that followed.

Of course, rulers from ancient times have kept some record of economic activity for the purposes of taxation. However, national accounts as we know them were designed by economists Richard Stone and James Meade, with support from John Maynard Keynes, as a way to keep track of wartime economic activity. Given the circumstances, their framework was necessarily industrial in its essence. There was no space in it for niceties such as environmental degradation and socio-demographic developments. After the war, this framework was adapted to create the GDP number that is now used around the world.

Lost in the margins

In theory, GDP is a measure of the value added by an economy in a particular year; that is, the value of all outputs after deducting the value of all inputs. A simple method, yet in practice it has proved to be a limited and often arbitrary measure for three main reasons.

The first lies in the treatment of natural and environmental capital, both in depletion of natural capital (say, through mining) and in the production of environmental ills (such as pollution). For instance, if we cut down a pristine rain forest, we are clearly destroying value in terms of biodiversity, watersheds, carbon sequestration, flood control, non-timber forest produce, and so on. Yet, in the current system, this destruction of value will register as GDP growth from logging.

The second major drawback of GDP is that it is an inadequate measure of human well-being. It tells us little about issues such as security, leisure, social mobility, education and health, and other facets of social capital. In some cases, this is a methodological or computational problem, as these are difficult things to quantify, but in others it can be a fundamentally conceptual problem. For instance, the overall GDP number tells us little about income distribution or how it is affecting the well-being of the people.

The third major problem with GDP relates to its treatment of activities and transactions that happen outside the marketplace, both in ecological and social infrastructure. GDP ignores the work done by stay-at-home parents, including cooking, housekeeping and looking after children. There is clear value-addition from these services, but they do not enter the marketplace. Yet they would be included in national accounts if they were offered as market transactions. In this particular example, the problem is not conceptual but one of practicality (one has to draw a line somewhere). However, there are other areas where markets do not exist at all and are simply left out—in the case of carbon sequestration and other ecological services provided by a forest, for example.

The creators of GDP were aware of its limitations. In his Nobel Memorial Lecture in 1984, Richard Stone began by stating: “The three pillars on which analysis of society ought to rest are studies of economic, socio-demographic and environmental phenomenon.” While his work had focused mostly on economic accounting, he realized that “environmental issues, such as pollution, land use and non-renewable resources, offer plenty of scope for accounting.”

The creators of GDP thought of it as work-in-progress. Unfortunately, 60 years on, the world continues to focus its energy on maximizing an incomplete and outdated paradigm.

Nature’s invisible economy

Biodiversity, or wild nature, is the living fabric of this planet. It is the whole extent and variety of the earth’s ecosystems, the diversity and abundance of all species that inhabit them, and the number and variability of genetic material. This living fabric provides us many benefits—from food and fuel, to services such as freshwater cycling and carbon sequestration by forests; from leisure to prospecting for new medicines.

But as citizens, are we sufficiently aware of our share of the free flow of nature’s goods and services to be willing to object when they are lost? The loss of a wetland or forest diminishes nature’s free public services. We certainly would not let our bank CEOs or our pension fund managers off the hook if they simply lost our deposits or lost our pensions. But how often do citizens hold businesses and governments to account for immense losses in natural capital? Our planetary home is something to which we as human beings should ascribe infinite value, but through the usual lens of economics, this value is invisible. A 50-year scenario analysis done for TEEB concluded that if we continued with business as usual, by 2050, we would lose a wilderness area roughly the size of Australia, or 7.5 million square kilometres. The lost value of this biodiversity would amount to as much as seven per cent of global GDP. The natural capital being lost, every year, was estimated at US$2.0 trillion to US$4.5 trillion.
The economic invisibility of nature is one of the key drivers for nature’s destruction. But how do you start putting an economic value on what comes largely free from nature?

A study done by Trucost for the United Nations Principles for Responsible Investment estimated the negative externalities (or third-party costs to society) generated by about 3,000 listed companies at close to US$2.2 trillion per annum, or one-third of their profits. This can evidently make the difference between profit and loss, but in this case they were externalities and were not accounted for. The main externalities were greenhouse gas emissions, water extraction and air pollution.

We need two main transformations to make people aware of the true costs of externalities. First, we have to measure the value of these externalities, so they can be managed. Second, we have to remodel the corporations themselves, because the old ways of behaviour are not likely to survive. Change will happen; the question is how sharp, unsettling and costly to society and corporations the transition will be.
Encouragingly, there is some movement in the right direction. At the 10th meeting of the Convention of Biological Diversity in October 2010 at Nagoya in Japan, President Bob Zoellick of the World Bank made a surprising and bold announcement of a project to measure and report the natural capital of countries as an addendum to their national accounts. India took the bold step of announcing that it would incorporate natural capital into its national accounts by 2015, and has since launched a national TEEB study to help. And in March 2011, a group of international experts convened by the World Bank in Washington compared experiences and ideas, and agreed to move forward to achieve this goal with a group of “first mover” nations.

Still, it is remarkable how little nature is accepted today as part of economic infrastructure. Attitudes and responses change when you talk nature versus talking “man made.” For example, when one is pitching investment in a carbon capture and storage facility at a cost of only $5 billion, there’s interest until you mention that the technology is a forest.

As people become more comfortable with the idea of including natural capital in economics, beginning with our national accounts, we will surely move towards a society that not only makes profit, but also lives harmoniously with nature—our most valuable and all-encompassing asset.

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