2 November 2010

Measuring Sustainable Value

Posted by Admin under: Economy; Forum; People; Policy; Science; Story; Sustainability .

Although it sounds dry, this is actually a pretty interesting topic: how do we decide what actually constitutes “prosperity”?  How do we measure it?

The problem of measuring sustainable economic activity may seem like an abstract one, but it is actually critically important to how and what we manage in our economy. If we’re not measuring the right things, and actually measuring the wrong ones, our policies will continue to have increasingly harmful effects; these may be masked by our measures, but accumulating catastrophic environmental threats which will have consequences for us and for future generations. Even the normally bland Wikipedia states, “if the aim of economic activity is to produce ecologically sustainable increases in the overall human standard of living, GDP is a perverse measurement; it treats loss of ecosystem services as a benefit instead of a cost.”

How we measure, and what we measure, as economic benefit has all kinds of implications. For one thing, we consider profit, or economic prosperity, as one component of the triple bottom line, along with the social and the environmental. And yet we haven’t gotten much beyond conventional notions of “profit” or “economic growth” or measures such as GDP or GNP.

Of course, you might ask what’s wrong with GDP? It’s a measure of economic output, or at least throughput, a measure of the total value of those goods and services whose value is actually measured in dollars transacted through the economy.

The problem is, we don’t know if (a) we’re missing some things, whose value is important to us but isn’t measured in dollars; (b) if some of the things we are measuring aren’t benefits at all, but just the costs of avoiding or cleaning up disasters; or (c) if the sum total of our transactions actually leaves us with a surplus (or “profit”), or whether we’re really running a loss every year even though we’re working harder.

It turns out all of these things are real problems, and if we don’t do something about them they will be a large part of what blinds us to reality, until it really is too late and we’ve created a largely uninhabitable planet. (Uninhabitable by us, that is; the planet, however violently transformed, will continue; the questions is whether humans and perhaps much mammalian life will continue.)

This is the focus of our event on November 20th: if we’re going to go beyond GDP, and measure truly sustainable value, how do we do that?

Ecologists, and ecological economists, have been thinking about this for some time. So much so that many of the criticisms of the GDP are now well established; they just don’t seem to have succeeded in making it go away.

Here’s a recent interview with Hazel Henderson, whose work in this area has been developing over many years — see this TED talk, and several web sites, including the “quality of life indicators” at http://www.calvert-henderson.com/, and the Green Transition Scoreboard, which measures investment in the green economy and estimates it at $1.6 trillion for 2010.

And here’s a recent New York Times Op-Ed declaring that it’s time to get rid of the GDP idea entirely: EricZencey-G.D.P. R.I.P.-NYTimes.com.

The basic problem is that gross domestic product measures activity, not benefit. If you kept your checkbook the way G.D.P. measures the national accounts, you’d record all the money deposited into your account, make entries for every check you write, and then add all the numbers together. The resulting bottom line might tell you something useful about the total cash flow of your household, but it’s not going to tell you whether you’re better off this month than last or, indeed, whether you’re solvent or going broke.

For this reason, focusing on policies just to increase the total value of transactions, which don’t distinguish between costs and benefits, makes no sense.

Common sense tells us that if we want an accurate accounting of change in our level of economic well-being we need to subtract costs from benefits and count all costs, including those of ecosystem services when they are lost to development. These include storm and flood protection, water purification and delivery, maintenance of soil fertility, pollination of plants and regulation of our climate on a global and local scale. (One recent estimate puts the minimum market value of all such natural-capital services at $33 trillion per year.)

Which incidentally is about half of what is currently calculated as global GDP, i.e., the total value of good and bad economic transactions in the world on an annual basis. It stands to reason that virtually everything we consume comes from a combination of labor and natural capital, but where the value of this natural capital is not calculated because no one has to be “paid” for it. This hidden value, then, has to be treated as a cost to the system (because ultimately it’s depleted and has to be replaced), which makes our current economic growth at least in part a theft from the future. One definition of ‘sustainable growth,” then, would be growth that does not rob value from the future (which is close to the Bruntland definition).

Yet for all this “GDP,” as a convenient measure of economic growth and wellbeing, refuses to die.

Even Wikipedia’s entry on GDP lists a wide array the arguments against it; in addition to one cited above, that it treats “loss of ecosystem services as a benefit instead of a cost,” other criticisms of how the GDP is used include:

  • Wealth distribution–GDP does not take disparity in incomes between the rich and poor into account. See income inequality metrics for discussion of a variety of inequality-based economic measures.
  • Non-market transactions–GDP excludes activities that are not provided through the market, such as household production and volunteer or unpaid services. As a result, GDP is understated. Unpaid work conducted on Free and Open Source Software (such as Linux) contribute nothing to GDP, but it was estimated that it would have cost more than a billion US dollars for a commercial company to develop. Also, if Free and Open Source Software became identical to its proprietary software counterparts, and the nation producing the propriety software stops buying proprietary software and switches to Free and Open Source Software, then the GDP of this nation would reduce, however there would be no reduction in economic production or standard of living. The work of New Zealand economist Marilyn Waring has highlighted that if a concerted attempt to factor in unpaid work were made, then it would in part undo the injustices of unpaid (and in some cases, slave) labour, and also provide the political transparency and accountability necessary for democracy. Shedding some doubt on this claim, however, is the theory that won economist Douglass North the Nobel Prize in 1993. North argued that the creation and strengthening of the patent system, by encouraging private invention and enterprise, became the fundamental catalyst behind the Industrial Revolution in England.
  • Underground economy–Official GDP estimates may not take into account the underground economy, in which transactions contributing to production, such as illegal trade and tax-avoiding activities, are unreported, causing GDP to be underestimated.
  • Non-monetary economy–GDP omits economies where no money comes into play at all, resulting in inaccurate or abnormally low GDP figures. For example, in countries with major business transactions occurring informally, portions of local economy are not easily registered. Bartering may be more prominent than the use of money, even extending to services (I helped you build your house ten years ago, so now you help me).
  • GDP also ignores subsistence production.
  • Quality improvements and inclusion of new products–By not adjusting for quality improvements and new products, GDP understates true economic growth. For instance, although computers today are less expensive and more powerful than computers from the past, GDP treats them as the same products by only accounting for the monetary value. The introduction of new products is also difficult to measure accurately and is not reflected in GDP despite the fact that it may increase the standard of living. For example, even the richest person from 1900 could not purchase standard products, such as antibiotics and cell phones, that an average consumer can buy today, since such modern conveniences did not exist back then.
  • What is being produced–GDP counts work that produces no net change or that results from repairing harm. For example, rebuilding after a natural disaster or war may produce a considerable amount of economic activity and thus boost GDP. The economic value ofhealth care is another classic example—it may raise GDP if many people are sick and they are receiving expensive treatment, but it is not a desirable situation. Alternative economic estimates, such as the standard of living or discretionary income per capita try to measure the human utility of economic activity. See uneconomic growth.
  • Externalities–GDP ignores externalities or economic bads such as damage to the environment. By counting goods which increase utility but not deducting bads or accounting for the negative effects of higher production, such as more pollution, GDP is overstating economic welfare. The Genuine Progress Indicator is thus proposed by ecological economists and green economists as a substitute for GDP, supposing a consensus on relevant data to measure “progress”. In countries highly dependent on resource extraction or with high ecological footprints the disparities between GDP and GPI can be very large, indicating ecological overshoot. Some environmental costs, such as cleaning up oil spills are included in GDP.
  • Sustainability of growth–GDP is not a tool of economic projections, which would make it subjective, it is just a measurement of economic activity. That is why it does not measure what is considered the sustainability of growth. A country may achieve a temporarily high GDP by over-exploiting natural resources or by misallocating investment. For example, the large deposits of phosphates gave the people of Nauru one of the highest per capita incomes on earth, but since 1989 their standard of living has declined sharply as the supply has run out. Oil-rich states can sustain high GDPs without industrializing, but this high level would no longer be sustainable if the oil runs out. Economies experiencing an economic bubble, such as a housing bubble or stock bubble, or a low private-saving rate tend to appear to grow faster owing to higher consumption, mortgaging their futures for present growth. Economic growth at the expense of environmental degradation can end up costing dearly to clean up.
  • One main problem in estimating GDP growth over time is that the purchasing power of money varies in different proportion for different goods, so when the GDP figure is deflated over time, GDP growth can vary greatly depending on the basket of goods used and the relative proportions used to deflate the GDP figure. For example, in the past 80 years the GDP per capita of the United States if measured by purchasing power of potatoes, did not grow significantly. But if it is measured by the purchasing power of eggs, it grew several times. For this reason, economists comparing multiple countries usually use a varied basket of goods.
  • Cross-border comparisons of GDP can be inaccurate as they do not take into account local differences in the quality of goods, even when adjusted for purchasing power parity. This type of adjustment to an exchange rate is controversial because of the difficulties of finding comparable baskets of goods to compare purchasing power across countries. For instance, people in country A may consume the same number of locally produced apples as in country B, but apples in country A are of a more tasty variety. This difference in material well being will not show up in GDP statistics. This is especially true for goods that are not traded globally, such as housing.
  • Transfer pricing on cross-border trades between associated companies may distort import and export measures[citation needed].
  • As a measure of actual sale prices, GDP does not capture the economic surplus between the price paid and subjective value received, and can therefore underestimate aggregate utility.

How, therefore, are we going to reform our economic measurement, and can we reform it without thinking very differently about what we want to achieve? If we could, for example, have a commonly accepted measure of human progress on the planet, and it was reported along with GDP on a consistent basis, this would be a giant step forward. If, beyond this, we had a measure of the health and vitality of the ecosystems we inhabit, and reported that also, perhaps we could make some progress.

The purpose of the conversation on November 20th is to pose a challenge — how do we measure sustainable  value? — and invite participants to co-create a strategy for addressing this challenge. The strategy may or may not get implemented, but the exercise is worth doing for its own sake, like flexing our sustainability muscles. We invite you to check out the background materials, concepts, and arguments laid out here, and attend the event on November 20th to contribute to our collective understanding of this challenging issue and how, strategically, we ought to address it. (For the logistical details, please refer to Sat, Nov. 20, 1-4 p.m. “Measuring Sustainable Value” Discussion.)

One Comment so far...

The Sustainable Leadership Forum » Sat, Nov. 20, 1-4 p.m. “Measuring Sustainable Value” Discussion Says:

3 November 2010 at 3:12 pm.

[…] way of background, please see: “Measuring Sustainable Value,” which lays out many of the issues and provides links to videos, books, and articles on this […]

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