British Academy: The UK's National Academy for the Humanities and Social Sciences
Partha Dasgupta: 'The Economics of the Environment'
Copyright © The British Academy, 1996
Printed in Proceedings of the British Academy, Volume 90, pp. 165-221
10. Net National Product as an Index of Social Well-Being
Ideally, institutions should be in place that make it possible for market prices and accounting prices to coincide. In practice, they don't coincide, and private agencies choose their actions on the basis of market prices (augmented by taxes and subsidies). But it is public agencies with which I am concerned here, and the idea is that they should rely on accounting prices in reaching decisions.
The argument that the right criterion for choosing among alternative policies is their social profitability, evaluated on the basis of accounting prices, is closely related to the recent suggestion that in measuring changes in societal well-being, we should estimate changes in net national product (NNP); that is, gross national product (GNP) corrected for the value of changes in the country's entire capital base, including its environmental resource-base. This suggestion is based on a well-known theorem in modern economics. The theorem states that, provided certain technical restrictions are met (on which, see below in the text), for any conception of societal well-being, and for any set of technological, transaction, information, and ecological constraints, there exists a set of accounting prices of goods and services that can be used in constructing an index of social well-being. The index in question has the following property: small policy changes (including small investment projects) that improve the index are at once those that increase social well-being. [note 28 (go to Notes)] This all-inclusive index is often called "green NNP" in the popular literature.
I cannot enter into details here, but (green) NNP, in a closed economy, reads as:
NNP = Consumption + value of net investment in physical capital + the value of the net change in human capital + the value of the net change in the stock of natural capital the value of current environmental damages. [note 29]
Current estimates of NNP are biased because depreciation of environmental resources is not deducted from GNP. To put it another way, NNP estimates are biased because a biased set of prices is in use: prices imputed to environmental resources on site are usually zero, and this amounts to regarding the depreciation of environmental capital as zero. But this in turn means that profits attributed to projects that degrade the environment are higher than their social profits. A consequence is that wrong sets of projects get selected — in both the private and public sectors.
The extent of the bias will obviously vary from project to project, and from country to country. But it can be substantial. In their work on the depreciation of natural resources in Costa Rica, Solorzano et al. (1991) have estimated that, in 1989 the depreciation of three resources — forests, soil, and fisheries — amounted to about 10 per cent of gross domestic product and over a third of gross capital accumulation. Since, under current practice, environmental resources are often unpriced, resource-intensive projects look better than they actually are. In consequence, installed technologies are often unfriendly towards the environment.
One can go further: the bias extends to the prior stage of research and development. When environmental resources are underpriced, there is little incentive on anyone's part to develop technologies that economise on their use. The extent of the distortion created by this underpricing will vary from country to country. Poor countries inevitably have to rely on the flow of new knowledge produced in advanced industrial economies. Nevertheless, poor countries need to have the capability for basic research. The structure of accounting prices there is likely to be different from those in advanced industrial countries, most especially for non-traded goods and services. Even when it is publicly available, basic knowledge is not necessarily usable by scientists and technologists, unless they themselves have a feel for basic research. Often enough, ideas developed in foreign lands are merely transplanted to the local economy; whereas, they ought instead to be modified to suit local ecological conditions before being adopted. This is where the use of accounting prices is of help. It creates the right set of incentives both among developers and users of technologies. Adaptation is itself a creative exercise. Unhappily, as matters stand, it is often bypassed. There is loss in this.
There is further loss associated with a different kind of bias, something we noted earlier: that arising from biased demand. For example, wherever household demands for goods and services in the market reflect in the main male (or for that matter, female) concerns, the direction of technological change would be expected to follow suit. Among poor countries, we would expect technological inventions in farm equipment and techniques of production to be forthcoming in regions where cultivation is a male activity (there would be a demand for them); we would not observe much in the way of process innovations in threshing, winnowing, the grinding of grain in the home, and in the preparation of food. Entrepreneurs have little incentive to bring about such technological innovations. Household demand for them would be expected to be low.
Such biases in NNP as I have identified here occur in advanced industrial countries as well. So then why do I stress their importance in the context of poor countries? The reason is that poor people in poor countries cannot cope with the same margin of error as people living in rich countries can: a 10 per cent drop in the standard of living imposes greater hardship on a poor household than a rich one. Recall too that the rural poor are especially dependent upon their local environmental resource-base. Losses in well-being due to an underpricing of this base are absorbed by them disproportionately. The estimation of accounting prices of environmental resources should now be high on the agenda of research in the economics of poor countries.
There is an important qualification to all this. The principles underlying the construction of (green) NNP assume, among other things, that ecological processes do not display threshold effects. [note 30] If threshold effects were important, a purely decentralised economic environment wouldn't do: accounting prices would need to be augmented by quantity controls on the use of certain environmental resources. This would be a way of ensuring that the magnitude of economic activity does reach a level that places undue stress on key ecosystems.
We conclude that economic liberalisation and other policies that promote growth in gross national product are not substitutes for environmental policy. On the contrary, it may well be desirable that they are accompanied by stricter policy reforms. Of particular importance is the need for reforms that would improve the quality of the signals (e.g. the array of prices and public information about stocks of various resources) on the basis of which resource users reach decisions. Environmental damages, including the loss of resilience of ecosystems, often occur abruptly. They are often not reversible. But abrupt changes can seldom be anticipated from systems of signals that are typically received by decision-makers in the world today. Moreover, the signals that do exist are often not observed, or are wrongly interpreted, or are not part of the incentive structure of societies. This is due to ignorance about the dynamic effects of changes in the variables that characterise ecosystems (e.g. thresholds, buffering capacity, and loss of resilience). It is also due to the presence of institutional impediments, such as lack of well-defined property rights. The development of appropriate institutions depends, among other things, on understanding ecosystem-dynamics. Above all, given that we are vastly ignorant about the extent to which ecosystems are resilient, we should act in a precautionary way so as to maintain their diversity.
Economic growth is not a panacea for environmental quality; indeed, it is not even the main issue. What matters is not economic growth per se, but the content (i.e. the composition of inputs and outputs) of growth. The content is determined by, among other things, the economic institutions within which human activities are conducted. Such measures will not only promote greater efficiency in the allocation of environmental resources at all income levels, but would also assure a sustainable scale of economic activity within the ecological life-support system. Protecting the capacity of ecosystems to sustain human well-being is of as much importance to poor countries as it is to those that are rich.
More: 11, Institutional Failure and the Erosion of Global Commons
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