Redefining Gross Domestic Product (GDP) to Account for Sustainability

In 2010, Carmen Reinhart and Ken Rogoff published a study “Growth in a Time of Debt” that became one of the most famous, most talked about economics papers since the financial crisis. In an era of economic recession, it answered a basic question everybody was asking: How much debt is too much? They had a number: 90%. According to their study, countries above a debt-to-GDP ratio of 90% grew much slower than countries below this ratio. It was all glory for these two Harvard professors until a 28-year-old grad student and his professors published a startling finding: Reinhart and Rogoff had made a simple Excel error in one part of their study. The authors of the new critique also questioned other elements of the study and argued that, in fact, there is no healthy debt threshold.

Countries are ranked by GPD or GDP per citizen, implying that countries with higher rankings are doing better overall than countries with lower rankings. But GDP doesn’t actually tell us much about the value of natural capital, like clean air or healthy forests. Such natural goods and services, despite their great economic contributions, are largely viewed as free. We need a better metric that accounts for not only monetized economic wealth but, more importantly, includes vital environmental and social factors. GDP is an inaccurate representation of a nation’s wealth, but could be improved with a more holistic approach.

Redefining Gross Domestic Product (GDP)

So why not incorporate sustainability into the equation while calculating the nation’s GDP? Gross domestic product, or GDP, measures goods and services produced in a given country in a given period, with a focus on growth. The calculation ignores the value of natural capital, like clean air, clean rivers, or healthy forests. Such natural goods and services, despite their great economic contributions, are largely viewed as free.

GDP also doesn’t measure things that are good for our economy and society, like home production and volunteer work, and does not count impacts like pollution. GDP also fails to reflect the quality of economic activity, which means that increased manufacturing output, which often produces toxic chemical and gases, always counts as a positive in the GDP calculation.

Natural Capital on the Balance Sheet of Earth

As Paul Hawken writes in his book “Natural Capitalism” conventional economic theory will not guide our future for a simple reason: we have never placed natural capital on the balance sheet of Earth. Incorporating metrics beyond GDP offers a more holistic view of economic growth and would begin to shift our economic growth in a way that is more sustainable, and the benefit of environmental sustainability would finally be measured and accounted for.

There is a lot of momentum behind the idea of moving beyond GDP. The World Wildlife Fund launched the Natural Capital Declaration at Rio+20, the United Nations Conference on Sustainable Development to “measure what we treasure.” The declaration is a global statement demonstrating the commitment of the financial sector to work towards integrating natural capital criteria into financial products and services.

States like Maryland and Vermont have adopted a metric called the Genuine Progress Indicator (GPI) as an alternative to GDP. Vermont is the first state to legislate the use of GPI and use it as a policy tool to identify public policy priorities. In Maryland, the GPI is a composite of 26 indicators in three categories: economic, environmental, and social.

Inclusive Wealth Index

The United Nations Environment Program (UNEP) proposed an index called the Inclusive Wealth Index (IWI) designed to augment GDP as a measure of economic progress. The first ever Inclusive Wealth Report 2012 was released in June at the Rio+20 Conference in Brazil. The report was a joint project of the UN University International Human Dimensions Programme (IHDP) on Global Environmental Change and UNEP. The IWI adds natural capital to the list of economic measurements in a bid to assess the sustainability of a country’s growth. The IWI highlights nuances in different countries evolving wealth by incorporating the changes in the produced capital (machinery, buildings, etc.), human capital (education, health, etc.) and natural capital (natural resources, land, etc.).

Brazil and India are growing economies. Between 1990 and 2008, the wealth of these two countries as measured by GDP per capita rose 34% and 120% respectively. But if you move away from the myopic focus of GDP and calculate the natural capital — the sum of a country’s assets, from forests to fossil fuels and minerals – actually declined 46% in Brazil and 31% in India, according to the report.

Norway’s GDP has increased by 51% during 1990-2008, but due to its consumption of natural capital like oil and gas; their growth has risen by only 13% when measured by Inclusive Wealth Index.  Conversely, Germany’s GDP increased by 30%, but because of their massive investment in human capital their IWI increased by 38%. Japan was the only country who natural capital did not decline due to an increase in forest area.

Incorporate IWI into the planning process

Recommendations from the Inclusive Wealth Report 2012 include incorporating the IWI within nations’ planning and development ministries for making of sustainable policies and increased investment in renewable natural capital like reforestation or preventing erosion. As we reach planetary boundaries, endless growth and consumption is not the answer. Economics dictates that we need progress, but we cannot have progress without measuring what we value, even if it isn’t monetized.