Finance

Economic performance: the wealth of nations

A nation’s wealth is not only defined by economic indicators, says economist Partha Dasgupta. His alternative report takes nature and population into account.
Coffee workers wait wait in line to measure baskets of freshly harvested coffee at a plantation in .../ Credits: Reuters
Economics – and macro-economics in particular – is ecologically illiterate, Tim Jackson charged in his book Prosperity Without Growth (2009). That may be a harsh, sweeping statement, but it is one that Partha Dasgupta, the Frank Ramsey Professor Emeritus of Economics at the University of Cambridge, agrees is justified.

“In long-term macro-economics, over periods of 30, 40 or even 100 years, there is no doubt that models should include nature as a productive asset, and yet mainstream economic models fail to do that,” Dasgupta comments.

According to current economic production indicators such as gross domestic product (GDP) and the Human Development Index (HDI), many nations are getting wealthier. But this raises the question: what is wealth?

If a national accountant claims the savings ratio of a country like Brazil or Costa Rica is 15 percent, but doesn’t take into account the natural capital, the forests being razed, then it is not a true indication of the accumulation of wealth. If depreciation of forests is deducted from savings, the picture looks significantly different.

As an example, work a few years ago in Costa Rica found the depreciation of three resources – forests, soil and fisheries – amounted to 10 percent of GDP and over a third of capital accumulation.This implies that a country can enjoy growth in GDP per capita and the HDI for a long period even while its productive base shrinks, at the cost of future well-being.

In a recent project, Dasgupta attempted to give both nature and population a more central place in consideration of a nation’s true wealth.

The Inclusive Wealth Report 2012, released by the United Nations and overseen by Dasgupta, provides a balance-sheet report for 20 countries concerning three kinds of assets: human capital (the population’s education and skills); manufactured capital (machinery, buildings, infrastructure, etc.); and natural capital (land, forests, fossil fuels and minerals).

As the report notes, we need new indicators that tell us if we are destroying the productive base that supports our well-being.
PROJECT M: Why has the environment been a blind spot for economists?
Partha Dasgupta: That’s a good question, but I’m not sure I have an answer. I’m not an historian of intellectual thought.

But if you made an educated guess?
Perhaps it is a misfortune that our discipline was born at the start of the Industrial Revolution. Adam Smith’s work The Wealth of Nations was written in 1776, and other interesting works – those of Ricardo, Mill, Hume, Marx – stemmed from the British Isles in that century and the next. At that time the population of England was small and industrial capacity was low, so it was probably reasonable to regard nature as a free good. In any case, if you ran out of a resource, you could get it elsewhere.

Colonialism reinforced this and so perhaps people got the idea that nature is substitutable, that there are no limits to growth in production and material consumption.
That may have been a reasonable assumption then. Or, let’s put a nice gloss on it: it may not have occurred to people then that nature is finite. Or they may have thought human ingenuity would always allow us to leap over resource constraints. Over time the mental models driving economists’ picture of the natural world became the benchmark around which further intellectual developments took place. That’s as much as I can guess, but I wouldn’t go to the gallows to defend this account of intellectual events.

But it must be obvious that this is a blind spot, that we are living on a finite planet?
Sure, but what does one do to change intellectual habits? I’ve written extensively about nature, but mainstream macro-economic models, the ones in the textbooks used by students and therefore the basis for the next round of growth models, still have little to say about the potential bounds on economic activity.

The word “nature” doesn’t appear in standard economics textbooks, and the mental models we carry with us greatly influence our common vocabulary and expectations about future possibilities.

Environmental scientists have always advised economists to take nature seriously. If we haven’t done so, it may be because we hadn’t created economic models that include nature seamlessly, although a few of my colleagues and I have been trying to do just that.

You’ve described the environment as “the most critical problem of our time.” What are the consequences of economists ignoring it?
Contemporary economic models give a misleading picture of the foundations of economic systems. They therefore point in the wrong direction to glimpse the economic possibilities of the future.
Our world is heading toward a population of 9 billion by the middle of this century, with everyone aspiring to the lifestyle of a resident of a high-middle-income country. But the environmental requirements of that scenario on a sustainable basis would require more than two Earths, or so the best environmental scientists tell us.

We economists don’t even begin to address that problem. Population growth remains taboo among mainstream development economists. This wouldn’t matter if economists weren’t enormously influential. But as I said before, the models we economists create influence the media and the political world.

Where does the Inclusive Wealth Report 2012 (IWR) fit in?

In the mid-1990s, my friend Karl-Göran Mäler and I asked ourselves what economic development would register if it were required that human well-being should not decline over time. By well-being we meant not just the well-being of those who are alive, but also the well-being of the people of the future.

The problem we set ourselves was more modest than the one that economists had studied with many elaborations in the 1960s and ’70s, which was to identify the character of economic policies that would maximize human well-being across generations.

Mäler and I discovered that intergenerational well-being wouldn’t decline if – and only if – an appropriate measure of wealth relative to population were not to decline. We based our reasoning on a model economy we constructed whose assets comprised not only reproducible and human capital, but also natural capital. By natural capital we meant not only subsoil resources (oil, coal and natural gas), but also ecosystems. By wealth we meant the social worth of an economy’s entire stock of capital assets, including natural capital.

In a paper (Net national product, wealth, and social well-being, 2000), we showed that economic development should mean a development path along which an economy’s wealth grows. That’s a far cry from demanding that GDP grows or that the United Nations’ Human Development Index improves.

What was the step after that?
The trick then was to find ways to value the assets that would be needed to measure wealth. At about the same time as Mäler and I published our paper, Kirk Hamilton of the World Bank did the valuable job of producing some crude estimates of wealth in member countries. He showed, however, that during 1970-1996 wealth had increased in the overwhelming majority of countries. This conveyed the suggestion that the countries had enjoyed true, that is, sustainable economic development.

The problem was that Hamilton’s work didn’t take population growth into account. So I studied how population should enter the measurement of wealth and found that if you correct for population growth, wealth in the poor countries in Hamilton’s list had in fact declined. In a series of publications, Kenneth Arrow and others at Stanford improved on those estimates substantially, to confirm that wealth is the correct operational index of economic development.

IWR 2020 is based on those publications, but it has carried the analysis further, and it has wisely restricted itself to a smaller number of countries. It’s an important publication and is the beginning of a serious investigation into the wealth and poverty of contemporary nations.

Is this a final, complete work?
Oh, good grief, no! An enormous number of items of potential importance are missing from the list of capital assets considered in IWR 2012. Ecosystem services are missing in a big way except insofar as they are picked up in the price of agricultural land, that is, if the market for agricultural land works reasonably well.

When Anantha Duraiappah was appointed executive director of the International Human Dimensions Programme [IHDP], he decided to improve on previous work on the wealth of nations. He asked me to chair his scientific advisory board. IWR stems from that collaboration, which began only two years ago. Duraiappah is an outstanding environmental economist as well as a terrific administrator. He has it in mind to produce an IWR every two years, on each occasion focusing on one class of assets. The United Nations University, where IHDP is housed, is enormously lucky to have him with them.

IWR 2012 is founded solidly on modern economic theory. I cannot overemphasize the importance of theory. It’s the absence of the attention to theoretical arguments which has created so much harm. The widespread use of GDP and the Human Development Index are examples of the dismissal of economic theory.

How important will IWR be in the long run?
I’m proud of the IWR, but it’s not even at the first base yet. It’s not a question of banging on about nature, it’s a question of getting the economics right. We have been on a trail of bad economics when it comes to long- run macro-economic thinking. I’m not making a political point here, it’s really an appeal to get our economics right. The right economic theory was already in hand – it hasn’t been re- invented, but up to now, we have done our job badly.

Read more on demography change on Project M online.

Find more information in the ALLIANZ KNOWLEDGE DATABASE!

Delve into our world of knowledge. The Open Knowledge Database offers you insights in the knowledge, skills and experience Allianz has accumulated in over 120 years of business.


Search for related articles