4
Sustainable Resource Accounting

Henry M. Peskin

Edgevale Associates, Inc.

Silver Spring, Maryland

INTRODUCTION

Coinciding with the recent interest in resource and environmental accounting are worldwide concerns over "sustainability." Indeed, some of the interest in resource and environmental accounting may stem from a belief that improved national accounting practices will enhance the chances that a nation's economic growth will be sustainable.

The purpose of this paper is to investigate this proposition and to raise the question: how can resource and environmental accounting contribute to the management of sustainability? I will argue that this contribution depends, first, on how "sustainability" is defined and, secondly, on how one views the accounting process. I will conclude that the benefits of resource and environmental accounting for addressing sustainability issues are greater the more the accounting process is viewed as an information system to support broadly economic (or humanistic) objectives. These benefits diminish the more one focuses on narrow environmental objectives.

To make these arguments, I must first discuss the purposes of accounting and define three terms: "sustainability," "depreciation," and "income." I believe that confusion over the meaning of these terms can lead to disappointment by policymakers who might expect resource and environmental accounting efforts to shed more light on their policy interests than, in fact, will be possible.

ACCOUNTING FUNCTIONS: SCOREKEEPING AND MANAGEMENT

Any accounting activity, whether for a private business or for a nation, serves two distinct purposes. One I call "scorekeeping"—the computation of the "bottom line" (profits and losses) in a business or of one of several indicators of economic performance for a nation: gross domestic product, net domestic product, etc. Knowing the right "score" is of as much policy interest to a business manager and policymaker as it is to a manager of an athletic team. Indeed, the belief that conventional national economic accounting provides a misleading "score"—misleading because of a failure to account for the depletion of natural resources and the quality of the environment—is one of the principal motivations behind some of the more pioneering



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Assigning Economic Value to Natural Resources 4 Sustainable Resource Accounting Henry M. Peskin Edgevale Associates, Inc. Silver Spring, Maryland INTRODUCTION Coinciding with the recent interest in resource and environmental accounting are worldwide concerns over "sustainability." Indeed, some of the interest in resource and environmental accounting may stem from a belief that improved national accounting practices will enhance the chances that a nation's economic growth will be sustainable. The purpose of this paper is to investigate this proposition and to raise the question: how can resource and environmental accounting contribute to the management of sustainability? I will argue that this contribution depends, first, on how "sustainability" is defined and, secondly, on how one views the accounting process. I will conclude that the benefits of resource and environmental accounting for addressing sustainability issues are greater the more the accounting process is viewed as an information system to support broadly economic (or humanistic) objectives. These benefits diminish the more one focuses on narrow environmental objectives. To make these arguments, I must first discuss the purposes of accounting and define three terms: "sustainability," "depreciation," and "income." I believe that confusion over the meaning of these terms can lead to disappointment by policymakers who might expect resource and environmental accounting efforts to shed more light on their policy interests than, in fact, will be possible. ACCOUNTING FUNCTIONS: SCOREKEEPING AND MANAGEMENT Any accounting activity, whether for a private business or for a nation, serves two distinct purposes. One I call "scorekeeping"—the computation of the "bottom line" (profits and losses) in a business or of one of several indicators of economic performance for a nation: gross domestic product, net domestic product, etc. Knowing the right "score" is of as much policy interest to a business manager and policymaker as it is to a manager of an athletic team. Indeed, the belief that conventional national economic accounting provides a misleading "score"—misleading because of a failure to account for the depletion of natural resources and the quality of the environment—is one of the principal motivations behind some of the more pioneering

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Assigning Economic Value to Natural Resources resource accounting efforts: those of Robert Repetto and his colleagues at the World Resources Institute.1 However, the value of good "scorekeeping" depends, of course, on the ability of the manager to use the score to make the appropriate adjustments that will eventually lead to victory. The value of good "scorekeeping" also depends on timeliness: it does the manager little good to first learn the score after the ball game is over. Yet, in practice, accounting scores do come in late. It is not unusual for a business to learn of its "bottom line" more than six months after the close of its accounting year. Even in this circumstance., however, the manager would rarely fire his accountant. In spite of the lateness of the score, the accounting process is serving another important function. It is organizing the basic information—sales, costs, production, inventory-needed to run the business. This second function of accounting—the "management" function—will justify an accounting effort even if there is an ultimate failure to provide a "score" or, as is more likely with the computation of environmentally-adjusted scores, wide disagreement as to whether the score is accurate. The importance of this observation as it relates to the contribution of resource and environmental accounting to addressing sustainability issues will become apparent later. First, we must define what we mean by "sustainability." SUSTAINABILITY John Pezzy, in a World Bank paper, did us all a favor by surveying the many ways authors have been using such words as "sustainable" and "sustainability."2 I will not attempt to summarize this literature except to note that all the definitions seem to fall into one of three categories: those that refer to sustaining the environment, those that refer to sustaining the economy, and those that refer to sustaining one or the other, subject to one or the other being set at some predetermined level (e.g., sustaining economic growth subject to maintaining the environment at some "clean" level). It is true that on the part of several authors, their sustainability notions may be mixed. Many have a sincere belief that sustaining the environment is a necessary condition for sustaining the economy while, for others, the opposite view is held: sustaining the economy is a necessary condition for sustaining the environment. I do not wish to enter this debate but only to point out that there is a difference in priorities. Some, when they use the word "sustain-ability," focus on sustaining resources and the environment; others focus on sustaining the economy. 1   Robert Repetto, William Magrath, Michael Wells, Christine Beer, and Fabrizio Rossini, Wasting Assets: Natural Resources in the National Income Accounts, Washington, D.C.: World Resources Institute, 1989. 2   John Pezzy, Economic Analysis of Sustainable Growth and Sustainable Development, Environment Department Working Paper No. 15, Washington, D.C.: The World Bank, March, 1989.

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Assigning Economic Value to Natural Resources Paralleling this distinction between the two meanings of ''sustainability'' is a distinction that can be made with respect to an older economic concept: "depreciation." DEPRECIATION First, I would like to distinguish between definitions of depreciation and rules-of-thumb for estimating depreciation. There are several ways of measuring depreciation, many of which have been codified in tax laws. I am not especially interested in these measures for this paper. What is of more concern is the concept of depreciation that these measures are attempting to reflect. I believe that there are essentially two concepts of interest: physical depreciation and economic depreciation. Physical depreciation refers to the decline in the physical ability of capital to generate useful services. A popular term for physical depreciation is "the wearing out of capital." When applied to the environment and to natural resources, physical depreciation means a physical decline in the ability of these forms of natural wealth to provide services—services ranging from the provision of energy and minerals to the provision of clean air and water. Economic depreciation, in contrast, refers to the decline in the ability of capital to provide services of value. Since the value of a stock of capital is defined in terms of the value of the services generated, an equivalent definition of economic depreciation is the change in the value of capital over time. The important distinction between the two definitions of depreciation is that while physical depreciation can "explain" economic depreciation, it is quite possible that economic depreciation can occur without any physical depreciation at all. For example, a machine that produces large ladies' hats could be so perfectly and strongly constructed that its ability to generate hats remains unchanged over time—it does not physically depreciate. However, if such hats go out of style, the value of the hats produced will decline. As a result, the value of the machine will decline: it experiences economic depreciation. Likewise with the environment or with a stock of natural resources: physical changes in natural wealth may have little to do with its economic depreciation. Thus, with increasing recreational use, a pristine lake may become more polluted physically. Yet, as the number of users increase, its recreation value may not decline and could even increase: it could experience negative economic depreciation or appreciation. The linkage between the two concepts of sustainability and depreciation should now become clear. Sustaining the environment suggests some actions designed to minimize or, if possible, prevent the physical depreciation of the environment. Sustaining the economy, in contrast, suggests some actions designed to minimize or prevent economic depreciation of the environment or of any other forms of wealth that contribute to economic activity. To see how all these concepts link to accounting, it is first necessary to link concepts of depreciation with concepts of income.

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Assigning Economic Value to Natural Resources INCOME AND DEPRECIATION One of the more controversial issues in economics concerns the appropriate definition of income as a measure of social well-being. Should it be a measure of society's current well-being or potential well-being? Should it be a measure of what has been the case in the past or what could be the case in the future? One particular choice for a definition of income is that of Professor Hicks.3 He would define income as an amount of goods and services that we could consume without destroying the ability to maintain this consumption in the future. Thus, while it is possible to enjoy a high level of consumption by liquidating all your wealth, this level will only be temporary. A more permanent—a more sustainable—definition of income would be the level of potential consumption after incurring such expenses necessary to maintain the income-generating services of your wealth or capital. This definition of income corresponds to the national accounting definition of net income: gross income less depreciation. Net income is sustainable income in the sense that, in principle, its level could be maintained indefinitely. There is, however, no guarantee that a nation's net income will be maintained indefinitely. In the first place, the potential may not be realized because of poor policy choices. In addition, the depreciation estimate, as we shall see, depends on assessments of the future ability of present capital to generate valuable services. Unforeseen events, such as war or world-wide depression, could mean that depreciation was grossly underestimated. While I would like to avoid being too technical, I shall use a little algebra to make a basic point: that the only concept of depreciation that is consistent with net or Hicksian income is economic depreciation. The relationship between income and economic depreciation can be shown as follows. A society's capital has value presumably because it generates a stream of goods and services, i.e., income. Let V0 represent this value at the beginning of the year, and Q1, Q2, etc., represent the gross value of these services before any depreciation (that is, "gross income") at the beginning of the next and subsequent years. Thus, Q1 is gross income in year 1. The theory of investment relates V0 to the Q's as follows: (1) where i is the rate of interest. Since V1, the value of V0 at the end of year 1, is simply 3   J. R. Hicks, "The Valuation of the Social Income," Economica, vol. VII, no. 2 (May, 1940) pp. 105-124 and "Maintaining Capital Intact: A Further Suggestion." Economica, vol. IX, no. 34 (May, 1942), pp. 174-179.

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Assigning Economic Value to Natural Resources equation (1) can also be written: (2) from which it follows that (3) The term (V0-V1), representing the loss in value of the initial capital stock, is, by definition, economic depreciation occurring in year one, or D1. Gross income, Q1, can also be defined as consumption plus gross investment. By definition, net income equals gross income less depreciation. It follows from (3) that, since Q1 is gross income, the term iV0 can be identified with net income. Thus (3) can be rewritten as: (4) where C1 and I1 are consumption and net investment in year 1. In words, Gross income = net income plus economic depreciation. or Net income = gross income less economic depreciation. Note that this relationship between gross and net income and depreciation was developed without any reference to the physical destruction of capital. It does not matter why there is economic depreciation. It could be due to physical depreciation or simply due to a change in tastes for the goods or services generated by the capital. The important point is that Hicksian (net) income—or economically sustainable income—is consistent only with depreciation defined economically—not physically. An important implication of this finding is that the physical sustainability of certain kinds of capital—such as natural resource capital—does not, in itself, say very much about economic sustainability. Environmental and natural resource capital has not been "sustained" in a physical sense in the United States nor has it ever been in the nation's history. Yet, by any economic

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Assigning Economic Value to Natural Resources measure, the nation is far better off than it was 200 years ago basically because the total value of national wealth—reproducible capital, human capital, and environmental capital—is far larger than it was 200 years ago. It has been argued, however, that the use of conventional income measures is misleading. Perhaps if the income were measured in the United States in a way that explicitly accounted for both environmental and economic deterioration, the story of success would have to be modified. Perhaps we are being deceived by the wrong "score." I turn to this argument in the following section. INTERPRETATION OF ENVIRONMENTALLY-ADJUSTED INCOME Some of the more well-known work in environmental and resource accounting concerns adjusting conventional income for environmental and resource deterioration—adjustments that supposedly yield a better "score." It is my contention, however, that as important as this work is, its implications for policy have been misunderstood, perhaps even by the authors of the work. For example, referring to the findings of Repetto et al. for Indonesia, (now) Vice-President Al Gore wrote: That nation's net losses of forest resource now exceed timber harvests: so much topsoil has eroded that the net value of the timber crop has been reduced by approximately 40 percent. Yet while this economic tragedy was unfolding and Indonesia was racing toward the precipice, the official economic reports all showed a rosy picture of steady progress.4 What the Repetto results did show is that Indonesian GDP, if adjusted for the decline in natural resources, would be lower by an average of about 4 percent over the period investigated. Suppose these estimates were perfectly correct in that the adjusted figure presented a true picture of net domestic product. Then the only implication of the finding would be that Indonesia's Hicksian, sustainable income is perhaps lower than the Indonesians originally believed. Yet the lower income is still sustainable (assuming again that it is a true indication of net income). There is no implication from these findings that Indonesia is heading for a "precipice." There is another policy implication that has been drawn from these findings. There is the implicit implication that the resources have been "wasted" (thus, the title of the report, Wasting Assets). The contention appears to be that had Indonesia not used up their natural resources and thus eliminated the need to adjust their income downward by 4 percent, their (net) income, on average, would have been at least 4 percent greater. This contention might be true if everything else were equal—but everything else is not equal. In particular, it is apparent that the Indonesians converted their forests, minerals, petroleum, and soil resources into other forms of wealth—principally reproducible wealth and human capital. Perhaps this conversion has not been totally efficient. Perhaps some of the assets have been "wasted." However, whether this has been the case cannot be ascertained merely by looking at adjusted net domestic product 4   Al Gore, Earth in the Balance, New York: Houghton Mifflin, 1992, p. 185.

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Assigning Economic Value to Natural Resources totals—that is, by looking at corrected "scores." What would be needed to ascertain the existence of waste is a careful simulation of Indonesian income paths with and without the resource exploitation. I believe that resource and environmental accounting would have an important role to play in this analysis. ACCOUNTING SUPPORT FOR SUSTAINABILITY ANALYSIS The basic strength of comprehensive accounting systems—whether business or national economic accounting systems—is that they provide a complete picture of all inputs and outputs associated with a complex economic process. Most comprehensive resource and environmental accounting schemes (such as the UN Statistical Department scheme5 or my own "neo-classical economics" approach6) try to expand conventional economic accounts by including the nonmarketed input and output services of the natural environment. In spite of this attention to the natural environment, conventional economic inputs and outputs are not forgotten. As a result of this comprehensive focus, the accounting process generates data sets that permit complete analysis of interactions between conventionally measured economic activity and environmental and natural resource activity. The accounts and supporting databases do not substitute for the requisite analyses but rather provide the empirical information that supports the analyses. Past implementations of resource and environmental accounting systems in the United States have supported comprehensive analyses of such policy issues as how the costs of environmental policies differentially affect the rich and poor, the relative effects on water quality of agricultural and industrial pollution-control policies, and whether the social benefits of various air and water pollution controls are commensurate with their social costs. While all these analyses could have been done without the comprehensive accounting framework, because of the accounts, they were done at very low cost. (Similarly, a business could operate without an accounting system, but at much higher managerial costs.) Presumably, a comprehensive resource and environmental accounting system could support analyses of "sustainability" in the same way. For example, the accounts could support input-output-type programming models in order to explore the feasibility of future optimal income paths subject to assumed limitations on the availability of resource inputs. In addition, similar input-output models could be used to estimate pressures on resource stocks as assumed 5   Peter Bartelmus, Carstan Stamer, and Jan van Tongeren. SNA Framework for Integrated Environmental and Economic Accounting paper presented to the 21st Conference of the International Association for Research in Income and Wealth, Lahnstein, Germany (August 21, 1989). 6   Henry M. Peskin, "Alternative Environmental and Resource Accounting Approaches," in Robert Costanza, ed. Ecological Economics: The Science and Management of Sustainability New York: Columbia University Press, 1991.

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Assigning Economic Value to Natural Resources levels and composition of income change. In effect, such models would link concerns for sustaining the environment with concerns for sustaining the economy. CONCLUSION: THE ECONOMICS POINT OF VIEW What a system of resource and environmental accounts will not do is identify best management schemes for sustaining the environment per se (other than giving some indication of the economic costs of such schemes). Environmental and resource management design requires much more information than can be expected to be forthcoming from the accounts. It must be remembered that there is a difference between environmental and resource accounts and environmental and resource data systems. The latter contain the physical and scientific data that are essential for the development of resource and environmental policy measures. The former contain the data that support a much broader economic policy framework. I believe that if environmental policy interests are defined solely by environmentalist concerns for the protection and conservation of the natural environment, the contribution of resource and environmental accounts will be only of peripheral interest. On the other hand, if policymakers have a broader humanistic focus—a focus wherein environmental wealth has an important but not exclusive role to play in the production of human well-being—then I believe that resource and environmental accounting can make a key contribution to the process of policy formation.