England has established a Natural Capital Committee to advise the government on the efficient and sustainable management of the country’s natural wealth.  In April 2013 the committee published its first report and invited comments.  Below is an abbreviated version of my submission.

“I am writing in reponse to the invitation to provide feedback on the Natural Capital Committee’s  The State of Natural Capital Report (1).  I welcome the report and would like to comment on Recommendations 1, 2, 9 and 12.  In addition to the report itself I refer below to the UNU-IDHP UNEP Inclusive Wealth Report 2012 (IWR) (2).

Recommendation 1 (pp 6-7)
“The development of a framework within which to define and measure natural capital…”

This is sensible and indeed an essential foundation for many of the report’s other recommendations.

Assets lying deep underground – minerals of various kinds, and groundwater – receive limited attention in the report. For example there are 46 mentions of fish, fisheries, etc and 3 of coal.  There is much reference to ‘sustainable use’, an important concept but one which makes most sense in relation to biological and other renewable assets.  For non-renewable assets such as minerals, no rate of use is sustainable indefinitely.  Instead, key questions are whether the rate of depletion has regard to the needs of both present and future generations, and whether profits from extraction are invested to provide for the future.

England’s mineral energy sources – not only those currently recoverable but also those which may become recoverable through technological advance – are a key part of its natural capital.  Alternative energy sources – imported fossil fuels, nuclear power, hydroelectricity, wind and solar power – all have their risks and limitations.

Groundwater aquifers may be either renewable or non-renewable, depending on rainfall and geological conditions.  Groundwater in England is a major source of domestic water supply.  It is also used extensively by industry, and to irrigate cropland in drier parts of the country. The availability of groundwater indirectly benefits ecosystems in drier areas by relieving pressures for over-extraction from surface water bodies.

Recommendation 2 (p 7)
“The development of a ‘risk register’ for natural capital assets ….”

Such a risk register could be extremely valuable. Its merits include:

1. Focussing on specific risks rather than abstractions such as ‘genuine savings’ or ‘inclusive wealth’ would by-pass some of the theoretical arguments associated with the latter.  A risk register could more easily gain credibility with politicians and the public.
2. As a list, a risk register would be robust in the sense that an error or contentious assumption in respect of one risk would not ‘infect’ all the other risks in the register.  This is in contrast to economic aggregates, where an error in the valuation of one asset has the potential to ‘infect’ any aggregates in which it is included.
3. A risk register, while not determining policy, would be a clear step towards development of policies on natural capital.
4. Listing risks together in a register should encourage a sense of proportion and facilitate informed judgments on priorities where it is not practicable to address all risks at once.

A risk register should include risks of all kinds relating to natural assets, eg unsustainable use of renewable assets, over-optimal depletion of non-renewable assets, and degradation of assets.  It should also include realistic assessments of ‘upside risks’ associated with possible technical progress, eg whether carbon capture and storage (CCS) can be made to work on an economic scale, which would reduce climate change risk and increase the value of England’s large coal reserves.

The time dimension is important in assessing risks.  For many risks, eg those associated with climate change, the probability of an outcome of given severity is likely to increase with the length of time considered.  For any asset class, the register should include not only the most immediate risks but also potentially more serious longer term risks.

Recommendation 9 (p 9)
“In addition to conventional indicators, the Government develops measures of economic growth, net of the depreciation of natural and other forms of capital as well as more comprehensive metrics of saving and inclusive wealth.”

That any new measures should be additional to conventional indicators is important.  One reason is the limited progress internationally in the development of economic performance indicators reflecting depreciation of natural capital. Another is the continuing usefulness, despite their limitations, of conventional indicators.

Even within conventional economics, it is accepted that multiple indicators are needed to assess a country’s economic performance: not only GDP and its variants such as gross national product and net national income, but also capital stock, employment, inflation, the balance of payments, and income distribution.  Adding to this list some indicators that have regard to natural capital would be an evolutionary change which politicians and the public could in time come to accept.

By contrast, dropping GDP altogether would be undesirable. Despite its limitations, it serves important purposes in the management of an economy and as a long-term performance indicator. International comparisons show strong correlations between GDP and indicators of development such as life expectancy and literacy.

The Inclusive Wealth Report represents one of the most sophisticated attempts to date to bring natural capital within the framework of macroeconomic statistics.  However, it has some important limitations:

1. Its estimates of inclusive wealth explictly include at most 5 (and for some countries including the UK only 3) classes of natural assets. Ecosystem services, for example, are not explicitly included.  Part of their value is reflected in the price of agricultural land (IWR p 146), a significant point if the sole aim is to monitor trends in a single figure representing total inclusive wealth.  However, for practical purposes it is also important to monitor trends in the values of particular asset classes.  One would like to know the trend in the value of ecosystem services, not just to know that part of it is reflected in another figure.
2. The discount rate applied to future benefits appears to be 5% per annum (IWR p 283), implying that benefits in 15 years time are valued at only half as much as benefits today.  While some such assumption is hard to avoid, the results are very sensitive to the rate chosen, and any particular rate is likely to be contentious.
3. The methodology of inclusive wealth is focused on prices which – whether market prices or shadow prices – relate to marginal units of assets (IWR p 18).  There is no mention of the concept of consumer surplus, which reflects the value of intra-marginal units of a good.  This is surprising since in the academic literature on valuation of non-market assets using revealed and stated preference techniques it is standard practice to measure asset values in terms of consumer surplus (or its Hicksian variants). The value to a consumer of the first few units of a good is often much higher than the value of the marginal unit, especially for goods essential to life such as food and water.  If the value of the ecosystem services on which food and water supplies depend were measured in a way that reflected the value to consumers of intra-marginal units, it is likely that the overall value of natural capital relative to other forms of capital would be much larger than the inclusive wealth figures suggest.  This is not to say that the inclusive wealth approach is wrong: it may be that different value concepts are useful for different purposes.

These limitations  suggest that there remains a long way to go before we have reliable, well understood and timely measures of the value of natural capital or overall wealth.  Successful implementation of Recommendation 9 will be a long-term project.

Recommendation 12 (p 9)
“The Government reviews the extent to which natural capital is being effectively priced, in particular examining the scope for reducing perverse subsidies.….”

Underlying mis-pricing is often an absence or attenuation of property rights.  The report makes no mention of property rights.  However, it is widely recognized that the difficulty of addressing climate change is closely connected to the fact that there are no property rights over the atmosphere.  Less dramatic, though still important, is the precise definition of rights associated with land ownership.  One reason for the rapid exploitation of shale gas in the US is that landowners often have rights over the assets below their land, and therefore a strong incentive to allow their exploitation.  Whether or not the UK should be exploiting its shale gas is contentious, but the example illustrates how a country’s definition of property rights can have a major impact on its management of its natural capital.  Where there are judged to be serious risks to a particular class of natural asset, it should always be considered whether property rights, or their absence, are among the causes.“

Notes and References

1. Natural Capital Committee (2013), The State of Natural Capital: Towards a Framework for Measurement and Valuation. http://www.defra.gov.uk/naturalcapitalcommittee/files/State-of-Natural-Capital-Report-2013.pdf

2. United Nations University International Human Dimensions Programme (UNU-IDHP) and United Nations Environment Programme (UNEP) (2012), Inclusive Wealth Report 2012. Measuring progress toward sustainability. Cambridge: Cambridge University Press. http://www.unep.org/pdf/IWR_2012.pdf