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GDP 2.0: The Inclusive Wealth Index and Beyond

Tallis, Heather 9/6/2012

In the United States, we’re reminded every July to think about our independence and what our founding fathers had in mind for us: Life, liberty and the pursuit of GDP. No wait: that’s not right. But gross domestic product (GDP) is what we and other countries still use to measure how countries are doing and how well off — or, presumably, how happy — we are as citizens.

However, many academics, policymakers and even finance leaders have grown increasingly skeptical about whether GDP does even an adequate job of measuring human happiness — or a country’s wealth. And the reasons for skepticism have mounted in recent years. For example, measures of income like GDP can actually look good in times of great distress. Moody’s estimated that the Gulf of Mexico region lost $1.2 billion in output in the year 2010 after the Deepwater Horizon oil spill. But GDP didn’t budge. While the shrimp industry crashed, tourism plummeted, livelihoods disappeared and miles of marsh were polluted, lots of money was being spent on clean up and recovery. All that spending is classified as income, and since GDP is an income account, all that expenditure offset the lost outputs from fishing, tourism and other industries. In reality, it’s not likely that many people — environmentalists or not — would agree that the country was hardly impacted by the spill.

Another problem with GDP is that it is a measure of current income. It tells us how well a country is doing this year, but doesn’t give us a very good idea of what’s coming next. Take, for example, the ongoing global financial crisis. GDP growth in Ireland, Greece and Spain (among other countries) hovered around 5% from 2000 to 2007, when it unexpectedly plummeted into the red. Part of that high growth was built on large borrowing that could not be sustained over the long term. Similarly, aggressive harvesting of fish, timber and other natural resources can lead to large current income but be unsustainable because those practices deplete the natural capital these industries depend on.

This is where nature comes into the picture. A major reason to reform economic accounting is to be more inclusive of the many things that a robust environment contributes to human well being: jobs, education, food, water, energy, peaceful walks, spiritual moments… the list goes on. But while GDP captures the value of a new car purchase, it does a poor job as conventionally measured of capturing the value of clean air and clean water, of conserving species and natural habitat, of good health, or of living close to family and friends. In fact, much of what is conventionally thought of as contributing to quality of life is either partly or completely unaccounted for by measures of GDP.

Many countries have recognized the limitations of GDP and are ready to advance toward metrics that do a better job of accounting for economic, social and environmental components of the human condition in a more complete way. Former French president Nicolas Sarkozy commissioned an influential report on GDP alternatives. The World Bank is leading an effort to green national accounts (Wealth Accounting and Valuation of Ecosystem Services, otherwise known as WAVES). And even the financial sector has come out in support of an alternative to GDP in its Natural Capital Declaration.

So everyone agrees we can do better. But getting to better is not exactly straightforward, which highlights another reason why GDP has hung around for so long: we know how to calculate it. Ideas for alternatives exist, like “inclusive wealth” — so named because it accounts for all major forms of capital (e.g., social capital, human capital, manufactured capital, natural capital) and it considers the ability of those capital stocks to provide goods and services into the future. The concept of inclusive wealth has been around in the economics community for a couple of decades, and was popularized recently by two economics gurus (Joseph Stiglitz and Amartya Sen) in a 2010 book called Mismeasuring Our Lives: Why GDP Doesn’t Add Up. But even with all this talk, actually measuring inclusive wealth has proven difficult.

The Inclusive Wealth Index: Stunning Departures from Historic GDP Trends

The good news: We are starting to see the light at the end of the tunnel. The first Inclusive Wealth Report was released at Rio +20, put together by the UN (specifically, UN University International Human Dimensions Program, UN Environment Programme) with support from the UN-Water Decade and the Natural Capital Project. The report takes a first stab at calculating an Inclusive Wealth Index (IWI) for 20 countries. Their formulation of the index takes into account human capital (education and jobs); manufactured capital (assets like tools, machines, buildings); and for the first time, natural capital.

One of the big difficulties in implementing this index comes from the desire to calculate the monetary value of goods and services provided by natural capital. Many of these goods and services are public goods — meaning they are not traded in markets. So we cannot easily track the value of these goods to society with market values, and it thus becomes quite challenging to reflect their value in a way that’s easy to combine into one number, like GDP. So the authors of the IWI stuck to natural capital stocks that generate goods traded in markets — accounting for fossil fuels, minerals, forests, agriculture and fisheries — an approach that leaves out much of the value of natural capital.

Even with this very conservative accounting of natural capital, the differences between patterns in GDP and the IWI in the last 19 years are stunning. Between 1990 and 2008, China’s GDP grew 422%, while its IWI only grew 45%, showing the large tradeoff China has made in natural capital to achieve its more commonly reported income growth. Even the United States did not fare as well in IWI (13% growth) as it did according to GDP (37% growth).

The Long Work Ahead to Account for More Natural Capital

Given the starkly different picture of national wealth that the IWI gives, even with a very conservative representation of natural capital, it seems worthwhile to try to go further. The Natural Capital Project’s contribution to the report was to try out a way to include in inclusive wealth calculations those natural capital stocks that support regulating ecosystem services — services such as drinking-water-quality regulation, flood mitigation, climate regulation and erosion control, among others.

Working with TNC in the Northern Andes-Southern Central America program, we used ecosystem service estimation models in the freely available InVEST software to map out four regulating services at the national scale for Ecuador and Colombia. We were only able to get to present value estimates for one service: climate regulation through carbon sequestration. In Colombia, the carbon stocks in the country in 2000 had a present value of USD$376.8 billion to $3.885 trillion, depending on the price of carbon we used. The low-end estimate is based on the price the World Bank pays per ton ($20/metric ton C), and the upper end is based on the 95th percentile of reported social cost of carbon estimates ($205/metric ton C). Ecuador, being a much smaller country, has a smaller standing stock of carbon that in 2000 had a present value of USD$74.5 billion to $772.8 billion, again depending on carbon prices.

We tried to apply the same approach, with different InVEST models, to water quality regulation (nitrogen and sediment retention). We were able to estimate the amount of service provided at the national scale (e.g. in 2000, Colombia enjoyed retention of 24.5 billion tons of sediment), but we weren’t able to translate those into net present value estimates for saved drinking water treatment costs or saved reservoir dredge costs because economic data on operation of treatment facilities and reservoirs were not freely available.

Perhaps the IWI report will be enough of an eye opener for countries to see the value in taking the leap. We need countries to commit to regular collection and reporting of these kinds of data to make a better metric possible. It wouldn’t be the first time governments made such a leap. No one was collecting all the data we needed when GDP started. In fact, it was the lack of data available to help guide the United States through the Great Depression that led to the creation of the first income accounts.

In health, you are what you eat. In wealth, you are what you measure. And what we measure has a huge influence on what we pay attention to and act on. GDP (along with percent unemployed) is still the kingpin of economic measures, from the media to policy circles to dinner conversation. As long as we use GDP as our major metric of wealth, we will stay a long ways off from happiness and the sustainable management of natural capital needed to keep us in smiles.

By Heather Tallis, lead scientist, Natural Capital Project, Stanford University

Image credit: tlindenbaum/Flickr