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From the November 1999 SURVEY OF CURRENT BUSINESS



The Future of Environmental and Augmented National Accounts: An Overview

By William D. Nordhaus

William D. Nordhaus is the A. Whitney Griswold Professor of Economics at Yale University, New Haven, Connecticut. He recently chaired the National Research Council Panel that produced the report Nature's Numbers: Expanding the National Economic Accounts to Include the Environment. This summary draws heavily on that report. The views expressed do not necessarily represent those of BEA.

The national income and product accounts (NIPA's) are the most important measures of overall economic activity for a nation. Nevertheless, since their first construction by Simon Kuznets, there have been concerns that the accounts are incomplete and misleading because they omit nonmarket activity such as unpaid work, the value of leisure time, and most investment in human capital. Most recently, attention has focused on extending the accounts to include natural resources and the environment.

Intensive work on environmental accounting began in the Bureau of Economic Analysis (BEA) of the U.S. Department of Commerce in 1992. The BEA published the first official U.S. environmental accounts, known as the Integrated Environmental and Economic Satellite Accounts (or IEESA's), in 1994. Shortly thereafter, Congress directed the Commerce Department to suspend further work in this area and to obtain an external review of environmental accounting. A panel working under the aegis of the National Research Council's Committee on National Statistics was charged "to examine the objectivity, methodology, and application of integrated environmental and economic accounting in the context of broadening the national economic accounts" and to review "the proposed revisions...to broaden the national accounts..." This month's SURVEY OF CURRENT BUSINESS contains the highlights of that report, and other chapters are scheduled to be published next spring.

I had the opportunity to chair the panel, and I have been asked to summarize some of the major issues and conclusions in the report. While these are my personal views, I believe they accurately reflect the deliberations of the larger panel.

Integrated Environmental
and Economic Accounting

Over the last quarter century, we have become increasingly aware of the interactions between human societies and the natural environment in which they thrive and upon which they depend. This awareness has been heightened by concerns about resource scarcity, local and national environmental degradation, and global environmental issues. The combination of increased awareness of the environment and recognition of the primitive state of much of the Nation's environmental data has led to a widespread desire to supplement U.S. national economic accounts to include the services of natural resources and the environment. The idea of including environmental assets and services in the national economic accounts is part of a larger movement to develop broader social and environmental indicators. This movement reflects the reality that economic and social welfare does not stop at the market's border, but extends to many nonmarket activities.

The traditional national accounts include primarily the final output of marketed goods and services—that is, of goods and services that are bought and sold in market transactions. Notwithstanding the importance of the traditional accounts, it has long been recognized that limiting them to market transactions distorts the accounts as a measure of economic activity and well-being. There is a vast and rapidly evolving array of "near-market" goods and services—ones that are similar to marketed goods but that are omitted from traditional accounts. This boundary distorts our measures of economic activity. Nannies' services are reckoned as part of the gross domestic product (GDP), while mommies' and daddies' services are not; the value of swimming in a commercial swimming pool is captured by GDP, while the value of swimming in the Atlantic Ocean is not.

In response to growing concerns about the accuracy of traditional measures of economic activity, many efforts have been undertaken to broaden the traditional accounts to include important sectors of nonmarket activity. Most of the early efforts were undertaken by private scholars, beginning in the early 1970's, but there were few efforts to broaden the official national accounts until the 1980's.

Augmented national economic accounts are designed to provide better measures of genuine national output—of what consumers currently enjoy in the way of goods and services, and of the accumulation of capital, of all kinds, which will permit the future production of goods and services. Although many different approaches have been taken, the guiding principle in augmented economic accounts is to measure as much of economic activity as is feasible, regardless of whether it takes place inside or outside the marketplace.

Extending the accounts is not just an academic exercise. Better natural-resource and environmental accounts can provide valuable information on the interaction between the environment and the economy, help in determining whether the nation is using its stocks of natural resources and environmental assets in an unsustainable manner, and provide information on the implications of different regulations, taxes, and consumption patterns. We seek better measures for scorekeeping—to devise better measures of national saving and investment or broader measures of economic well-being. But the data in augmented accounts are also useful for management—to help the Nation better manage its subsoil assets, public lands, and precious environmental heritage.

BEA's proposal for developing the IEESA's envisions a phased approach, adding satellite accounts for other productive natural-resource and environmental assets in three phases—starting with minerals, expanding to renewable resources such as timber in forests, and then addressing nonmarket assets and public goods such as clean air. If the phased approach is undertaken, a useful initial step would be to refine the initial estimates of subsoil minerals. Constructing forest accounts, focusing initially on timber, is a natural next step for integrated economic and environmental accounts. Other sectors that should be high on the priority list are those associated with agricultural assets, fisheries, and water resources.

The panel urged the adoption of a more ambitious approach, under which a comprehensive set of near-market and nonmarket accounts would be developed. In addition to the environmental arena, significant extensions would include the value of home production and unpaid work, the value of research and development capital, the value of nonmarket time of the population, and the value of informal and home education. (A useful step in this direction came in the last round of NIPA revisions, which incorporated investment in software.) This work is motivated by the idea that expanding the boundaries of the accounts would provide a better estimate of the size, distribution, and growth of economic activity and economic welfare than that offered by the current accounts.

An important issue concerns the relationship of the environmental and other nonmarket accounts with the existing accounts. BEA proposed putting the IEESA's in satellite accounts, which are a useful innovation in national accounting. For the environment, satellite accounts provide the raw material needed by policy makers, businesses, and citizens to track important trends and to determine the economic importance of changes in environmental variables. In addition, developing environmental satellite accounts allows experimentation and encourages the testing of a wide variety of approaches.

BEA has not proposed redefining the core national income and product accounts to include nonmarket flows or investments in natural resources and the environment. The panel agreed that the core income and product accounts should continue to reflect chiefly market activity and that natural-resource and environmental flows should be recorded in satellite or supplemental accounts. Moreover, developing augmented accounts must not come at the expense of maintaining and improving the current core national accounts, which are a precious national asset.

The panel's central recommendation was that Congress should authorize and fund BEA to recommence its work on developing natural-resource and environmental accounts and that BEA should be encouraged to develop a comprehensive set of near-market and nonmarket accounts.

Link Between Economic Accounting
and Measures of Sustainable Income

In light of increasing environmental concerns, questions have been raised about the sustainability of current patterns of economic activity. What are the environmental and economic implications of continuing "business as usual"? Will the current path of population, energy use, and human settlements do irreversible harm to the natural ecosystems and life-support systems of the earth? Is our economy on a sustainable path?

Measures of national income take two fundamentally different approaches—one based on current production and one based on sustainable consumption. The definition of net domestic or national product used in the national income and product accounts of virtually every nation today—sometimes called Hicksian income—is production-based in the sense that it measures production in a given period measured at market prices. While standard production-based measures of income are useful tools, they do not directly address concerns about the sustainability of current decisions. Economists often define sustainable national income as the maximum amount that can be consumed while ensuring that all future generations can have living standards that are at least as high as those of the current generation.

What is the relationship between current measures of national output, such as net national product, and sustainable income? One of the most surprising results of modern economic theory is the output-sustainability correspondence principle. This principle holds that under idealized conditions net national product and sustainable income are identical. More precisely, when population is constant, when the national accounts include all stocks of capital and other dynamic features that affect production, and when market prices accurately capture the social value of economic activity, net domestic product is an accurate measure of sustainable income. In other words, in this idealized situation, the sum of total consumption and net capital formation is equal to the maximum sustainable level of per capita consumption that an economy can maintain indefinitely. The operational point is that, again under idealized conditions, extending the NIPA's to include comprehensive measures of consumption and net investment would make output and income more accurate indexes of sustainable income.

The principles for measuring sustainable income are useful for guiding decisions about the design of the NIPA's. However, important practical and theoretical qualifications to these principles must be emphasized. Augmented net domestic product will fail to measure sustainable income accurately (1) if the list of consumption and asset categories is incomplete, (2) if there are technological advances or similar processes that are not captured in investment data, (3) if there are revaluation effects not captured in the accounts, or (4) if prices do not adequately capture social values, as occurs most dramatically with public goods like the environment and increases in knowledge. While these qualifications are important, the basic insight is of great value for the designing of augmented accounts.

Accounting For Subsoil Mineral Resources

The first phase of BEA's integrated economic and environmental accounts, published in 1994, presented a full set of subsoil mineral accounts with estimates of the value of mineral reserves. From a substantive point of view, the subsoil mineral accounts provide a useful summary of trends in the value of subsoil mineral assets. The initial IEESA's found that subsoil assets constitute a relatively small portion of total U.S. wealth and that real proven mineral wealth has remained roughly constant over time. Mineral wealth as calculated by BEA represents a small fraction of the total nonhuman wealth of the United States. The total value of mineral resources in 1987 was between 3 and 7 percent of the tangible capital stock of the country. One surprise in the accounts was that conventionally measured corporate profits are significantly reduced when depletion of subsoil assets is taken into account.

Developing improved natural-resource accounts at home and abroad would be particularly useful for those sectors in which international trade is important. Indeed, as is evident from recent turmoil in financial markets—such as the Mexican crisis of 1994–95 and the financial crises of East Asian countries in 1997–98—the United States can suffer when foreign accounting standards are poor. Better international mineral accounts would help improve understanding of resource consumption and production trends abroad and help assess the likelihood of major increases in oil and other minerals prices of the kind witnessed in the 1970's. To the extent that the United States depends heavily on imported fuels and minerals, it would benefit from better minerals accounts abroad because the reliability and cost of imports can be more accurately forecast when data from other countries are accurate and well designed.

For all these reasons, the panel recommended that BEA develop and maintain a set of accounts for domestic subsoil mineral assets and develop alternative measures for assessing trends in minerals scarcity.

Accounting For Renewable
and Environmental Resources

BEA had not yet begun developing its accounts for renewable and environmental resources when Congress suspended BEA's work on environmental accounting. Environmental accounting is a useful way to represent interactions between market activity and the environment. There are three major types of interactions: Quantitative additions and depletions of natural resources occur when minerals and energy resources are discovered or mined, when timber grows or is harvested, and when groundwater is withdrawn or replenished; qualitative alterations in the natural environment occur when the composition of air, water, or soil changes; and expenditures are made to reduce the effect of economic activities on the environment. The main value of natural-resource and environmental accounting is to illuminate the full interactions between the economy and the environment.

Two central problems that arise in constructing environmental accounts are obtaining reliable data on quantity and valuing the quantities. Valuing environmental goods and services requires distinguishing between private and public goods. Private goods can be provided separately to different individuals with no external benefits or costs to others; public goods have benefits or costs that are spread indivisibly among the entire community or even the entire planet.

Price data are relatively reliable for private market goods, such as the timber produced from forestry assets. Values for near-market goods—such as freely collected firewood—can be constructed by comparing the near-market goods with their market counterparts. By contrast, techniques for valuation of public goods have proven costly and often unreliable. Some techniques—such as hedonic-price or travel-cost studies—rely on behavioral or market-based estimates; while these estimates are subject to significant measurement problems, they are conceptually appropriate in economic accounts. Other techniques, such as contingent valuation, are not based on actual behavior, are highly controversial, and are subject to potential measurement errors. The panel concluded that, for valuation, BEA should rely whenever possible on market and behavioral data. However, novel valuation techniques, such as contingent valuation, will be necessary for the development of a comprehensive set of nonmarket accounts.

A second major issue is obtaining reliable quantity data. Surprisingly, quantity data on many market and near-market environmental and natural-resource activities are relatively reliable because there are often well-established conventions for their measurement. Quantity data on some near-market activities, such as the collection of fuel wood for private use and recreational fishing, are conceptually straightforward, and many of these data are currently collected by Federal agencies. The measurement of quantities for nonmarket goods and services, particularly those that have public-good characteristics, suffers from severe methodological difficulties and insufficient data. There are relatively good physical data on emissions of many pollutants from industrial and human activities, but there is very little systematic monitoring of human exposures to most harmful pollutants. The data on many environmental variables are currently poorly designed for the construction of environmental accounts.

True public goods—including climate change, biodiversity, species preservation, and national treasures such as the Florida Everglades and Yellowstone National Park—present major conceptual difficulties for incorporation into a national accounting system. More work will be needed on techniques for measuring production flows and values for the assets and services of true public goods in order to make them compatible with the prices and quantities used in the core accounts. Notwithstanding the awesome difficulties that arise in accounting for public goods like air quality, these are likely to be the single most significant sector in environmental accounts.

The panel recommended that BEA continue its work to develop accounts for renewable natural resources and the environment. The panel further recommended a concerted Federal effort to identify and collect the data needed to measure changes in the quantity and quality of natural-resource and environmental assets and associated nonmarket service flows. Greater emphasis should be placed on measuring effects as directly as possible, particularly for measuring actual human exposures to air and water pollutants.

Summary

In considering future directions for environmental and augmented accounting in the United States, the panel concluded that there is great value in developing a comprehensive set of near-market and nonmarket accounts. In a complex and wealthy country like the United States, providing information on the structure and interactions of the economy and the environment is an essential function of government. It deserves more support.