The Theoretical Basis for Estimating SNI

Speech for the World Bank Seminar, October 1, 2001

To leave room for discussion later on, my introduction will be brief. This brevity will certainly provoke questions, but I hope these will be addressed in the second part of the seminar. 

In the theoretical basis for the calculation of sustainable national income, the environment is defined as the non-human-made physical surroundings, or elements thereof, on which humanity is entirely dependent in all its doings, whether these be producing, consuming, breathing or recreating. It is true that our observable surroundings are largely human-built. However, houses, roads and farm crops are the result of two complementary factors: labour, that is technology, and elements of the physical surroundings as here intended. Producing is defined, in accordance with standard economic theory, as the adding of value. This value is added to the physical elements of our environment. In our physical surroundings, a great number of possible uses can be distinguished, which are indispensable for production, consumption, breathing, etcetera, and thus for human existence. These are called environmental functions, or in short: functions. As long as the use of a function does not hamper the use of other functions, an insufficiency of labour, that is intellect or technology, is the sole factor limiting sustained production growth. As soon as one use is at the expense of another, though, or threatens to be so in the future, a second limiting factor is introduced. The emergence of competition between functions marks a juncture at which functions start to fall short of meeting existing wants. Competing functions are by definition economic goods. In this situation, in which we are now living, labour is not only reducing scarcity, and thus causing a positive effect on our satisfaction of wants, that is our welfare, but is also increasing scarcity, thus causing a negative effect on welfare. Mutatis mutandis the same holds for consumption. The availability of functions, or, in terms of the System of National Accounts (SNA), their volume, decreases from 'infinite', that is abundant with respect to existing wants, to finite, that is falling short. As a result, the shadow price of environmental functions rises, and with it their value, defined as price times quantity, from zero to an ever-higher positive value. This rise in value is a rise in costs. To determine the extent of the loss of function, we must know the value of the function. Since environmental functions are collective goods that are not traded on the market, supply and demand curves have to be constructed. Without data on both preferences as well as on opportunity costs, determination of value is impossible. The estimated costs of measures to restore functions, that rise progressively per unit of function restored, can be seen as a supply curve. We call this the cost-effectiveness curve or the elimination cost curve, because it refers to measures that eliminate the pressure on the environment. Except in the case of irreparable damage, this curve can always be constructed. Preferences for environmental functions, on the contrary, can only partially be determined, since these can be expressed only partially via the market. Therefore, it is not possible to construct a complete demand curve. Expenditure on compensation of loss of function and restoration of physical damage resulting from loss of function, however, constitute revealed preferences for the availability of functions, so that some impression of these preferences can be obtained. Examples are the additional measures for the production of drinking water as a result of the loss of the function 'drinking water' because of pollution, or the restoration of damage caused by flooding due to forests losing their 'hydrological regulation' function. I mention briefly some causes through which the expression of preferences for environmental functions via the market and budget mechanism is blocked. 

1. The impossibility to measure the preferences for safeguarding vital environmental functions for future generations by using expenditures on compensatory measures and restoration of damage. 

2. The workings of the prisoners' dilemma. 

3. The lack of correct information such as on the relationships between environment and employment and between environment and growth. 

4. The confusion about money and commodities: producing and consuming without environmental destruction namely is much cheaper than with it, although often, but not always, economic sacrifice is involved, and although a shift to environmentally benign behaviour always has a negative effect on the volume of national income; thus bicycling is cheaper than driving a car and raising two children is cheaper than raising ten. 

5. The complexity of the life support systems of our planet and the problem of conceptualising the effects of its disturbance and of conceiving the technological possibilities and impossibilities to cope with those disturbances. 

The blocked preferences for vital environmental functions cannot be established by contingent valuation techniques since these techniques do not provide reliable data precisely for vital functions. According to key authors like Tinbergen, Kuznets and Hicks, who pioneered and developed the practical implementation of the concept of NI, changes in the level of NI are explicitly intended as one of the indicators for the development of welfare, so for economic success. This is the way such changes in the level are understood by the public, the media and governments. Which is logical. For, all economic action is aimed at the satisfaction of wants, so at the increase of welfare, so at economic success. In the nineteen-thirties, however, the environment did not play a role in economic thought. That is different today. Safeguarding the vital functions of our physical surroundings, the basis of our existence, has become the most important economic issue confronting mankind. Therefore, publication of 'green' NI's, that is NI's corrected for environmental losses, alongside the standard NI's, is indispensable information for society and policy-making. This was the firm conviction of Tinbergen, that is documented in his papers, while it is implied in the work of Kuznets and Hicks. From the above it follows that the shadow prices for environmental functions, which are indispensable for this correction and which are determined by the intersection of the first derivatives of the constructed curves for demand and supply, cannot be determined, because individual preferences can be measured only partially. Consequently, these shadow prices remain unknown. This means that the correct prices for the human-made goods that are produced and consumed at the expense of environmental functions remain equally unknowable. However, to provide the necessary information, assumptions can be made on the relative preferences for environmental functions and produced goods. This means that there are as many shadow prices for environmental functions and produced goods as reasonable assumptions can be made - and consequently as many green NI's. Each of these assumptions in associated with the optimal path of the economy that belongs to it. That is the path on which, by way of assumption, the annually available package of goods, human-made goods and environmental functions, perfectly reflects the preferences. One of the possible assumptions is that the economic agents, individuals and institutions, have a dominant preference for an environmentally sustainable development. This assumption is legitimate since governments and institutions all over the world have stated support for this. Another possible assumption is that the economy is currently on an optimal path that is described by the changes in the standard NI. So both the SNI and the standard NI are fictitious in the context of what is at issue in economic theory and statistics, namely to provide indicators of the effect of our actions on our welfare. When assuming absolute preferences for sustainability, the unknown demand curves must be replaced by physical standards for sustainable use of the environment. The standards are scientifically determined and in this sense objective. They must, of course, be distinguished clearly from the subjective preferences for whether or not they should be attained. From an economic perspective, sustainability standards approximate demand curves that are vertical in the relevant area of a diagram that has the availability of functions measured in physical units on the x-axis and the demand for functions and their opportunity costs on the y-axis. The shadow price for environmental functions based upon the assumed preferences for sustainability then follows from the intersection of the vertical line and the marginal cost-effectiveness curve. In this manner the distance to sustainability, denoted in physical units on the x-axis, is translated into monetary units. This is the well-known figure from my study "New Scarcity and Economic Growth" from 1974. For a correct approximation, such calculations have been done with the aid of a general equilibrium model, which also generates the shadow prices for produced goods in a sustainable economy. From this, the level of sustainable national income follows. Bart de Boer would like to tell you more about that. Ekko van Ierland would like to do so, too, during the discussion. The book to be presented today deals with the relationship between environment and growth of production, just like "New Scarcity". In conclusion, I would like to make two remarks about this relationship which are based on empirics. 

1. From research on the basic source material of the Dutch national accounts, it appears that roughly one third of the activities making up national income (measured as labour volume) does not contribute to its growth, one third contributes a little, while one third contributes by far the largest part to the growth of production. Unfortunately, this latter part consists of activities that cause the greatest damage to the environment, by use of space, pollution and depletion of resources, in production and consumption. 

2. Any price rise in real terms means a decline in the volume of national income and therefore a check on production growth. For a given technology, product costs will rise progressively as the yield (or: effect) of environmental measures is increased. Technological progress leads to higher yields, of course. As production increases further, however, so too must the yield of the measures in order to maintain the same state of the environment, while the fact of progressively rising costs with rising yield remains unaltered. There is thus a 'race' between environmental technology and production growth, the outcome of which cannot be predicted. 

See Ekko van Ierland cs. (2001), "Economic growth and valuation of the environment: a debate", conference book of the Hueting congres, Edward Elgar