Some true indicators of human progress are absent from today’s economy
By Meghna Tare and R. Paul Herman
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 percent.
According to their study, countries above a debt-to- GDP ratio of 90 percent grew much more slowly 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, or even gross national happiness (GNH) of citizens. Despite positive economic accounting, the earth is viewed as largely free, and happiness is invisible. We need a better metric that accounts for not only monetized economic wealth but, more importantly, includes vital human, environmental and social factors. GDP is an inaccurate representation of a nation’s wealth, but could be improved with a more holistic approach.
GDP doesn’t measure everything that is good for our economy and society, like stay-at-home parents, volunteer work for non-profits, nor coaching or mentoring. GDP also does not count impacts like polluted air, wasted water or un-recycled materials. GDP also fails to reflect the happiness and satisfaction of citizens. The focus of GDP primarily on manufacturing output, which also produces toxic chemical and gases, always counts as a positive in the GDP calculation.
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 as an asset 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. In fact, a group of professors has estimated the equivalent GDP of natural capital and biological processes, which is estimated at $2 of natural-capital GDP for every $1 of traditional- economic GDP.
Momentum is growing for 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.
The nation of Bhutan has implemented Gross National Happiness (GNH), tracking 72 metrics of health, education, culture, and environment – including asking citizens to keep a diary of their life for the past 24 hours to track quality of life.
The U.N. Human Development Index tracks human, social and environmental progress for all countries globally. Nearly all countries are showing positive progress over the past several decades. You can build your own “human development index” and peer group on its website.
To show how these new measures of progress link to financial vitality, HIP Investor has adapted the Human Development Index into nearly 200 country ratings that quantify five pillars — Health, Wealth, Earth, Equality and Trust – for investors seeking impact as well as profit. This HIP Rating can be applied to a portfolio of sovereign debt, including inflation-protected bonds. EIRIS is another firm that rates the impact of countries and its linkage to investment goals.
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 U.N. 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 financially. Between 1990 and 2008, the wealth of these two countries as measured by GDP per capita rose 34 percent and 120 percent 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 – this broader definition of wealth actually declined 46 percent in Brazil and 31 percent in India, according to the report.
Norway’s financial GDP has increased by 51 percent during 1990-2008, but due to its consumption of natural capital like oil and gas, its growth has risen by only
13 percent when measured by the Inclusive Wealth Index. Conversely, Germany’s GDP increased by 30 percent, but because of the country’s massive investment in human capital, its IWI increased by 38 percent. Japan was the only country who natural capital did not decline due to an increase in forest area.
Recommendations from the Inclusive Wealth Report 2012 include incorporating the IWI within national planning and development ministries to forge 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 yet monetized. Sustainability focuses on future generations, and intelligent investors today are allocating funds to mitigating future risk and pursuing new opportunities that benefit us all.
(R. Paul Herman is CEO of investment ratings firm HIP Investor. Co-author Meghna Tare is Executive Director of the Institute for Sustainability and Global Impact at the University of Texas at Arlington, and MBA candidate in Sustainable Management at the Presidio Graduate School. For full disclosures, see www.HIPinvestor.com.)