Capital Offence – focusing on GDP rather than wealth jeopardises the future

rethink sustainability

Capital Offence – focusing on GDP rather than wealth jeopardises the future

Dimitri Zenghelis - Senior Visiting Fellow at the Grantham Research Institute, LSE

Dimitri Zenghelis

Senior Visiting Fellow at the Grantham Research Institute, LSE

Ignoring or neglecting planetary balance sheets comes with great risk. Comprehensive national wealth accounting is necessary to understand the economy and inform policymakers and businesses of the consequences of their investment choices. It can guide forward-looking business plans, safeguard economic strategies and help address many of the social and economic challenges we face. It offers a necessary and urgent means to steer the world away from existential crisis.


Time for a rethink

On May 24 hundreds of thousands of students in more than 110 countries went on strike. They were protesting against political inaction over climate change. More strikes are planned. These children are angry and understandably so. The planet they will inherit is in deep crisis. An oft overlooked but central reason for its neglect is policymakers’ obsession income or GDP.

Our quality of life depends on more than annual income. It depends on access to key assets.

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Our quality of life depends on more than annual income. It depends on access to key assets. Individuals think about more than one period’s earnings when assessing ‘prosperity’. They think of their savings, pensions and the human capital in their head as well as their mortgages, debt and student loans. They are concerned about their future ability to access a broad range of goods and services including, but not limited to, material consumption in the future. They think about access to opportunities, justice and whether they are insured against risks of upheaval, conflict and insecurity. Most business leaders think about their balance sheets, including debt and fixed and intangible assets which determine their ability to generate future profits. When balancing portfolios, investors think of stocks of wealth.

Welfare increases if, and only if, access to these assets increases. If young people are to attain a quality of life recent generations have taken for granted, wealth must be preserved and built. Knowledge capital can be expected to expand as we learn and innovate, but prosperity also depends on our ability to live in a peaceful and trusting society, with functional institutions, safe from climate risks, without degraded ecosystems that generate reliable ecosystem services. The net present value of these benefits determines our comprehensive wealth. We must also recognise that assets are not strictly substitutable. Natural asset depletion, such as deforestation of the Amazon or mass extinction of fish or insects, cannot be compensated by production and human capital. Any study of sustainability must identify the forms of capital that need to be preserved for the well-being of future generations. None of this is in GDP.

Natural asset depletion, such as deforestation of the Amazon or mass extinction of fish or insects, cannot be compensated by production and human capital.

Net worth it  - wealth and balance sheets

GDP has advantages. It is a standardised, commonly understood and commonly applied measure of the flow of output, income and expenditure comparable across time and between countries. Yet forward-looking economic policy is increasingly looking to manage a portfolio of assets that a country can access, to ensure that citizens enjoy a sustainable flow of benefits into the indefinite future.

Measuring wealth is a prerequisite for a more comprehensive understanding of the modern economy.  Intractable challenges ranging from tackling climate changes to explaining the ‘productivity paradox’ plaguing many advanced economies will prove impossible without adequate information about assets necessary to generate production cleanly. Coping with the challenges faced by new technologies such as AI, big data and automation will be politically unfeasible without institutions which enable winners and insure losers from change.

Intractable challenges ranging from tackling climate changes to explaining the ‘productivity paradox’ plaguing many advanced economies will prove impossible without adequate information about assets necessary to generate production cleanly.

At Cambridge University, I am working with colleagues on a new project that asks how we can move to a world beyond GDP? The idea is to progressively augment GDP with a small dashboard recording access to key assets, a process spearheaded by the New Zealand Treasury. These include produced, natural and human capital, as well as intellectual capital, social and institutional capital and financial assets. Our measurement of economic success needs to include these diverse critical assets in a framework that accords more closely with our conception of prosperity. This allows us to ask what forms of capital need to be preserved for the well-being of future generations?


Planet healthy nations wealthy

The World Bank now measures the ‘true wealth’ of nations, taking into account economic and natural capital, as well as ‘intangible’ productive capital (regarded as consisting primarily of human, social and institutional capital). The World Bank estimates that intangible capital may make up between 60% and 80% of total wealth in most developed countries. Ignoring this immense source of wellbeing is to act blindly.

The World Bank now measures the ‘true wealth’ of nations, taking into account economic and natural capital, as well as ‘intangible’ productive capital.

Our project in Cambridge begins by focussing on social and natural capital. Social capital because cross-sectional data has long shown that robust social capital based on trust, civic engagement and effective institutions go hand-in-hand with economic wellbeing and economic growth. For example, one influential study found that a moderate increase in a survey-based measure of country-level trust significantly increases economic growth. Another seminal study showed how regional differences in social capital (levels of cooperation, participation, social interaction and trust) dating back several hundred years determined Italian cities’ and regions ability to function effectively.
 

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In addition, GDP growth which is derived from depleting capital is not sustainable and deprives future generations of well-being. This is why natural capital is so important to measure. Natural capital, which includes the water, air, soil, geology, and living things that provide us with the basic—and at times quite complex—building blocks of all other forms of capital, isn’t just a feel-good issue. It is in real trouble. Dieter Helm, Independent Chair of the UK Natural Capital Committee, claims economic growth in the twentieth century has been spectacular, yet it has been fuelled by a massive free ride on the environment. Whereas human, physical and knowledge capital may be growing, natural capital generally is not with grave prospects for wellbeing.

GDP growth which is derived from depleting capital is not sustainable and deprives future generations of well-being.

Value propositions

Improving the quality of statistics and information on the assets at our disposal is not easy – but even partial success in developing metrics while acknowledging what is missing, can better help inform policy and business decisions. One problem is that the valuation of assets, unlike that of goods and services, needs to be forward-looking and based on expectations. As a result, value can never be nailed down. This makes the valuation of wealth more volatile but no less real. The morning after a stock market crash, the factories, land and labour which generate output have not disappeared, but the expectation of their ability to generate benefits in the future has diminished.

Yet the forward-looking element is precisely what makes wealth a better indicator of sustainability and the health of a nation than annual output or GDP. The future is ‘priced in’. Moreover, because expectations can be influenced, credible leadership and innovation from business and government can change the real world by creating and destroying wealth through steering new behaviours, technologies and markets to replace old. Measurement itself can also shape the economy. Statistics are a lens for observing the economy and policymakers, businesses and individuals change their behaviour in response to the picture they see through that lens.

The forward-looking element is precisely what makes wealth a better indicator of sustainability and the health of a nation than annual output or GDP. The future is ‘priced in’.

The time is now

Young people have a vision of the future which will become increasingly politically attractive and profitable to business. To enable this vision, however, protesting schoolchildren and investors alike urgently require the collection and assembly of comprehensive wealth figures by national statistical offices. For example, one could envisage the creation of an institution charged to report to parliament every year on the state of the future using wealth accounts and changes in broad national balance sheets as that institution’s measuring stick. This will improve the quality of policy advice, invigorate public debate and spark discussion in democratic bodies. Most importantly, it will finally allow investors and innovators to profit from protecting the planet and design the safe, secure and sustainable future our children demand.


Biography

Dimitri Zenghelis is Project Leader for the Wealth Economy project centred at Cambridge University and a Senior Visiting Fellow at the London School of Economics. He was Head of Climate Policy at the Grantham Research Institute at the LSE and Acting Chief Economist for the Global Commission on the Economy and Climate. Previously, he headed the Stern Review Team at the Office of Climate Change, London, and was a lead author on the Stern Review on the Economics of Climate Change, commissioned by the then Chancellor Gordon Brown. Before working on climate change, Dimitri was Head of Economic Forecasting at HM Treasury. He currently advises the Mayor of London and the UK Committee on Climate Change and was a Coordinating Lead Author for the UN Global Environment Outlook, GEO-6. Dimitri is also on the advisory board of the Oxford Sustainable Finance Programme.
 

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