Well-Being vs. Wealth (3) – Inclusive Wealth

This is the third of three posts on Well-Being vs. Wealth (see 1 & 2)

Partha Dasgupta recently co-authored a paper in the Journal of Economic Perspectives with a number of well know ecologists and economists (Arrow et al 2004. Are we consuming to much? 18(3) 147-172)

They try to answer the question of whether current consumption is sustainable. They consider sustainability to mean that inter-temporal (sum of the discounted value of future) social welfare must not decrease over time. They interpret this to mean that this depends on investment from passive income that increases humanity’s productive capacities – which they term genuine wealth.

This requirement that the productive base be maintained does not necessarily entail maintaining any particular set of resources at any given time. Even if some resources such as stocks of minerals are drawn down along a consumption path, the sustainability criterion could nevertheless be satisfied if other capital assets were accumulated sufficiently to offset the resource decline.

Figure comparing yearly growth in per capita GDP and Genuine Wealth during 1970-2001. Error bars show how estimates of wealth change in response different estimates of the ratio between wealth and GDP. I created the figure based on data in Tables 2 & 3 of Arrow et al 2004.

Arrow Inclusive Wealth Table -> Figure

Arrow et al. use an number of adjustments to incorporate the effects of changing populations and technology (they note that this is problematic because there are not statistics on nation’s use of natural capital)

They then try to apply these measures to existing economic statistics.

The differences between genuine investment and the standard measure, net domestic investment, are particularly striking for the Middle East/North Africa and sub-Saharan Africa regions. In these regions, the loss of natural resources more than offset the accumulation of manufactured capital (as reflected in domestic net investment) and human capital (as reflected in expenditure on education). For the United States and the United Kingdom, estimated genuine investment exceeded domestic net investment, since the increase in human capital exceeded the value of natural resource depletion.

Arrow et al. describe the meaning of their findings

…our conclusions must be very tentative. But despite the uncertainties, it seems clear that measures of changes in per capita genuine wealth yield a very different—and often much bleaker—picture of the prospects for poor nations, as compared with the message implied by changes in GDP per capita.

This study and all previous studies of which we are aware provide only point estimates of genuine investment or of changes in genuine wealth. Given the vast uncertainties associated with the estimates, even when point estimates are positive, there may remain a significant possibility that genuine investment is negative. The uncertainties justify added caution.

Nonlinearities in ecosystem dynamics imply the presence of serious downside risks related to the losses of natural capital. Central estimates of the shadow prices for natural capital are likely to be too low if one only considers central cases rather than the entire distribution of potential outcomes from losses of natural capital. Thus, the expected values of genuine investment or of changes in per capita genuine wealth might well be lower than the values emerging when one employs only central values for parameters. Accounting for risk-aversion could lower these estimates even further.

Jon Christensen, who writes a blog on conservation science – the uneasy chair, wrote an article about the Arrow et al paper for Conservation in Practice (6(2)) also called Are We Consuming Too Much?. From that article:

Instead of asking “Are we consuming too much?” says Larry Goulder, we could ask the more central question, “Are we investing enough in the future to compensate for the loss of natural capital?” That in turn gets back to the crucial question about whether there are some forms of natural capital which we simply cannot afford to lose.

The economists take great pains to emphasize the limitations of the data when it comes to things that ecologists have long advocated. Outside of forests, which were included in their equation, there are critical forms of natural capital not yet included in the calculations.

“Many ecological resources are missing,” says Partha Dasgupta, and “we have good reasons to conclude that many of those missing resources are in worse shape now than they had been previously.”

There is abundant research, for instance, showing that fresh water and fisheries are being depleted in many places well beyond levels that can sustain current, much less future, consumption. And as Arrow adds, “much depletion of natural capital has local effects.”

The local effects of ecological changes, the economists acknowledge, could also cause ecosystems to cross what ecologists call “thresholds.” Unlike markets, which almost invariably react in a linear fashion to changes (as prices rise, demand falls), ecosystems often react in nonlinear ways (a small change in nitrogen can be the tipping point that shifts a lake from clear to clogged with algae).

The economic services that ecosystems provide to people are also not yet included in the formula, Arrow says. These would include the services that wetlands provide by controlling floods and that insects provide by pollinating crops and controlling pests, to name just two that make huge contributions. Wetland services may be valued as high as US$15 trillion annually, according to some estimates, and wetlands are being destroyed at a faster rate than any other type of ecosystem.

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