Accounting for the Environment (362-372)

Introduction
SNA devised by UN Statistical Office is not adequate

for measuring the impact of environmental changes on income and wealth National accounts governed by income and wealth Externalities not included or given negligible value

Criticism of the present system

1. Include only man-made capital and ignore natural capital
e.g. fishing stocks, ores and minerals etc

2. National Accounts make no allowance for the depletion of natural resources

Therefore, national accounts overestimates the true national income

3. Defensive expenditures are included but no allowance

made for corresponding environmental damage.
Latter should be treated as environmental degradation

Move towards Green GNP

Formulate a separate system of environmental

accounts It could complement conventional SNA Express stocks and flows in physical units Annual publication Used in Canada, US, Netherlands, Norway and France

Environmental accounts and Environmental Indicators

If an environmental change has reduced the income of the affected parties Fall in income is associated with fall in consumption levels

It would imply a loss in welfare (as perceived by economists)

Environmental accounts and Environmental Indicators

Two issues are discussed in this section How to express environmental changes in monetary means Difficulties involved in it

Monetizing is difficult
Only some environmental changes can be captured

through market mechanism.

e.g. difference in house prices reflect the differences in

the perceived quality of local environment.

Physical units vs Monetizing

Physical unit measurement is dependent on the

environment good in question No need of assigning monetary values in this case but aggregation is impossible Units and different and no standard weighting system in existence

Stocks and Flows of Environment

Stocks
Opening Stock and closing stock represent the state of environment at the beginning and end of the accounting period.

Flows

Records the impact of actions of economic agents on the environment.

Stocks and Flows of Environment

Both are possible for environmental goods. In some

cases stocks cant be inferred, only the flow can be deduced Examples:
area of protected habitat area of contaminated land number of species in flora and fauna

emission of CO2 (only flow)

List of Environmental Indicators

OECD identified a list of 50 environmental indicators

to avoid omissions and unnecessary inclusions. Canadian Environment Ministry also proposes a list 46 indicators proposed by UK

Criteria of selecting the indicators (UK)

Time series data of indicator should be available.
Indicator should be sensitive to actions by the

authority Should allow the setting of meaningful targets Data should be official Data should not require much additional collection and processing Indicator should be readily understood and considered appropriate for audience.

Suggesting a better measure: ISEW

A single measure or index is desirable.
The Index of Sustainable Economic Welfare (ISEW) is

an example ISEW is calculated by adjusting the conventional national accounts measure of personal consumption expenditure to take into account the environmental costs. Only those environmental costs are included which have a monetary value

Integrating Economic and Environmental Accounts (IEEA)

Present Economic Accounting: Concepts GDP: Value of final goods and services produced in an economy over the year GNP: GDP + Net factor income earned from abroad NNP: GNP - depreciation

Integrating Economic and Environmental Accounts (IEEA)

Depreciation or depletion should be applied to natural

capital also
Marketed assets like farmland, forests, fishing stocks Non-marketed assets like wildlife areas, rainforest

Some income is also kept aside to replace or

compensate for the depletion of the natural stocks. This introduces the concept of sustainable income or true income.

Sustainable Income: J.R. Hicks

It is the maximum value that a person can consume

during a period and still be as well off at the end of the period as at the beginning. It takes into account the depreciation of man-made capital Similarly, depletion of natural capital should be also be included otherwise income will be overestimated.

Three Adjustments to NIA

Depletion of natural capital
Environmental degradation Defensive expenditures

Lets consider each adjustment in detail..

Depletion of natural capital

Example: A country is exploiting a non-renewable mineral resource like oil or coal. NNP = GNP D where D is the depreciation of the man-made capital Receipts from resource (R) are included in income but depletion is not included
Two methods to include depletion

Depreciation Method User Cost method

Depletion of natural capital: Depreciation method

Value depletion as that part of receipts from sale of the

resource which can be attributed uniquely to that resource

If extraction costs is zero
R is attributable to depletion of resources

If extraction costs are not zero

R includes labour costs and returns to man-made capital (mining equipment etc)

NNP = GNP D - R

Depletion = Gross trading profits from the sale of resources estimated return on man-made capital employed in extraction of resources

Depletion of natural capital: Objections to depreciation method

Under this method, measurement of GDP and GNP

continues to include receipts from the sale of natural assets, thus, overestimates income from production. If two countries are similar except that one has abundant supply of a natural resource which is extracted at negligible cost. Though their GNPs will differ but not the NNP. The advantage of resource rich country is not visible by depreciation method.

Depletion of natural capital: User Cost Method

Receipts from the sale of a natural resource comprise

of two elements: capital consumption (user cost) and income, depending on the level of reserves, current rate of extraction etc.

Depletion of natural capital: User Cost Method

Share of true income in receipts from the natural

resource sales:

Where X = true income R = net receipts from sale r = a discount rate n = number of years the current extraction could be sustained, i.e. exploitative reserves divided by current rate of extraction

Depletion of natural capital: User Cost Method

Complementary expression

L.H.S is the depletion share. It is inversely related to n

(lifetime of resource) and r (the rate at which resource owners discount future revenues) If resource is abundant, n is large, R.H.S is small, X is close to R. N , X R (the current national income practice).

Depletion of natural capital: User Cost Method

If society decides to lend considerable weight to the

consumption possibilities of succeeding generations, then r will be low. R.H.S will be high Share of income in receipts from sales will be relatively small.

Depletion of natural capital: User Cost Method

Principle: From the receipts from sales of an

exhaustible natural resource, a certain proportion is set aside and invested at rate of return r in order to yield the same level of true income X indefinitely. It is consistent with the idea of sustainable development. Combined capital (natural and man-made) is sufficient to at least maintain the same rate of income in successive periods.

Depreciation method vs User Cost Method (I)

Depreciation method overestimates the depletion as

all oil and gas GDP is counted as depletion except that portion attributable to labour or man-made capital used in extraction. User Cost method attributes an additional income element to the natural resource sale, so that the residual estimate of depletion is typically less.

Depreciation method vs User Cost Method (II)

Using the depreciation method, the standard and

conventional measure of GDP/GNP would be unaffected nut net measures will be reduced by the amount of depletion. In User Cost method, GDP/GNP would be redefined to exclude the user cost depletion estimates and hence would be less than the conventional measures currently in use.

Depletion of natural capital: Special cases

Case of renewable natural resources: the level of

expenditure required to maintain capital (for sustainable income) can be calculated more directly as the volume of replacement investment. Case of natural resources which cant be monetized: depletion can be estimated using replacement or restoration costs, or willingness to pay.

Environmental Degradation
Degradation decline in the quality of natural

environment. There is no difference between this case and the earlier (depletion of mineral resources) but the practical problems are severe.

Environmental Degradation
Common approach establish certain desirable

quality standards and measure degradation as deviation from these quality levels. Value can be achieved by finding the cost of making degradation good or achieving the quality levels. Set standards where Marginal social cost of pollution = Marginal Abatement Cost

Environmental Degradation
Another approach: Use Willingness of Pay either to

avoid the degradation or to make it good. Value of degradation = Sum of the individual WTP bids Disadvantage: WTP measure includes consumer surplus which is not having market priceand hence overvaluation occurs.

Environmental Degradation
In addition to depreciation of man-made capital and

depletion of natural resources, the costs of environmental degradation should also be deducted from GDP/GNP to arrive at sustainable national product. Implementation is difficult

Defensive Expenditure
Defined as the expenditure which are expressly

designed to protect the environment and to prevent degradation. It is treated as expenditure in national accounts Environmentalists argue that it should be excluded or deducted from GDP based on the concept of sustainable income.

Defensive Expenditure
Difficult to measure indirect defensive expenditures
An alternative/ complementary measure should be

designed rather than changing GDP.