GDP assumes natural resources are free
If planet earth was a company, it would send us a huge bill for the natural resources we have used and the damage we have caused to the environment. Our latest report, "The Future of GDP," analyzes the (dis)connection between the environment and the economy.
For a very long time, humankind has treated the world's natural resources as free and unlimited. It is still often assumed that the environment is here to serve us at any cost and that it is impossible to conduct successful business in symbiosis with the planet. Adding fuel to the fire is the way that gross domestic product (GDP) is measured. This key metric was developed in the early 20th century and is still widely used to monitor economic growth. However, it doesn't take into account many issues that today are seen as critical to maintaining growth in a sustainable, long-term way, like protection for the environment.
It's time to redefine capital to include natural resources
In traditional economics, capital is anything man-made that is used to provide goods or services, including factories, machinery, and money.
It's only recently though that nature is beginning to be recognized as an essential source of capital. The goods and services provided by nature and its ecosystems are a fundamental (albeit taken for granted) part of any economy. Fresh water, breathable air, fertile soil, renewable energy sources, a relatively stable climate, or the assimilation of pollution and waste – all flow from natural capital.
Like man-made capital, natural capital can increase and grow, thereby increasing prosperity – or it can diminish and depreciate, threatening our future well-being, and resulting in real economic damage.
Why GDP is at odds with the environment
Although environmental factors do have an impact on our economy, they are not integrated in GDP in an intentional, systematic, or comprehensive way.
Worse still, GDP often seems to be at direct odds with environmental imperatives. The most obvious illustration is that the oil and gas exploration and production industry – a big contributor to climate change – also makes a very large direct contribution to GDP (around 5% of GDP) and indirectly supports much of the consumer economy.
A study by Trucost (now part of S&P Group) identified USD 7.3 trn of unpriced natural capital costs, equating to 13% of global economic output in 2009. In fact, the study claims that so far off track are we in our relationship to earth systems that many of the primary production and primary processing sectors around the world would not be profitable if environmental costs were taken into account – e.g. coal generation in the US, cattle ranching in South America, or wheat production in East Asia.
The strange economics of making profit from disasters
Less obviously, environmental disasters also have the potential to increase GDP in the short term. Two months after BP's Deepwater Horizon oil spill began in the Gulf of Mexico, some Wall Street analysts noted that this disaster was likely to cause a slight increase in the US GDP in the coming year.
Most affected were the large tourism and fisheries industries around the Gulf of Mexico coastline and the oil industry itself, which faced a moratorium on deep water drilling. Sales of products and services suffered dramatically as a result of the disaster and thousands of employees were laid off, with the effects rippling outward through the regional and national economies, dragging down GDP.
Even so, Wall Street economists estimated that the enormous expenditure on the clean-up effort, including hiring thousands of unemployed workers, would more than offset this damage, leading to an overall increase in GDP.
This demonstrates the strange economics of GDP – as long as damage to the environment is not factored in, disasters like this appear to be actually "good" for the economy in the short term. Failing to reflect the impact of our activities on the long-term health of the planet or its "natural capital" is perhaps the greatest shortcoming of GDP.
Prosperity requires a healthy planet
Our economy needs to nourish the biosphere and promote its health. True prosperity will be achieved only when we can build natural and social capital at the same time as financial capital. This challenge is far from trivial. It will require deep systemic change and that will include how we measure success. GDP falls short of our needs today. True prosperity is when we are building natural and social capital at the same time as financial capital. GDP needs to change to reflect this fact or we need to give prominence to another indicator.