The Direction of Environmental Policies: Economic administration built around the improvement of "inclusive wealth"

MANAGI Shunsuke
Faculty Fellow, RIETI

The Inclusive Wealth Index (IWI) is a new economic index presented in the Inclusive Wealth Report 2012, which was launched in the United Nations Conference on Sustainable Development (Rio+20) in 2012. The report originally covered only 20 countries, but the 2014 version, which was released in December 2014, substantially expanded the scope of analysis to 140 countries.

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In recent years, there has been increasing awareness around the world that the overemphasis on economic growth has caused serious damage to future generations with the excessive use of resources. The gross domestic product (GDP) which is used widely, is a flow index that shows the short-term economic fluctuations. Some point to the fact that it is not necessarily linked to human well-being. The IWI has been developed with an emphasis on a diverse stock of capital assets to measure long-term sustainable development.

More specifically, the index assesses the value of a country's capital assets as a whole and quantifies them with an emphasis on (i) produced capital (machines, buildings, infrastructure, etc.), (ii) human capital representing labor and knowledge (population, education, skills, etc.), and (iii) natural capital that provides the foundation for the flow of valuable goods and services into the future (climate change, land, forests, oil, minerals, etc.). (See the Figure.)

Figure: The Concept of "Inclusive Wealth" Figure: The Concept of "Inclusive Wealth"

Most importantly, in order to mitigate the damage caused by climate change and the loss of biodiversity in consideration for future generations, the index enables the measurement of various forms of natural capital that are not available commercially. When a country has a healthier and higher quality of labor, its human capital will increase in number. It is remarkable that this enables the effect of education and healthcare on the population in terms of monetary returns to be identified.

Countries with an identical stock of assets could still have a different capability for utilizing them. The IWI applies the concept of total factor productivity (TFP) under the growth theory to measure the efficiency of utilizing various assets. It also takes into account the impact of factors such as potential carbon damage and gains or losses from the fluctuations of crude oil prices. Thus, the IWI is an index that represents "wealth" comprehensively.

The index has been compiled in the approach of enhancing "totality" in examining the links between factors so as to assess the fluctuations of a country's production bases. In the past, it was difficult to gauge this from the perspective of measurement methodology, but recent data accumulation and advancement of methodology have enabled compiling relevant data for numerous countries.

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The report states that produced capital, which has been widely used as "capital" within the framework of the System of National Accounts (SNA), only accounts for 18% of the inclusive wealth of 140 countries. The remaining 82% is comprised of human capital (54%) and natural capital (28%).

The per-capita inclusive wealth grew by 6% on average in approximately 60% of the countries--85 out of the 140--over the analysis period from 1990 to 2010. This is broken down into an increase of 56% in produced capital, an increase of 8% in human capital, and a decline of 30% in natural capital. Over the same period, the per-capita GDP in 124 countries increased by 50% on average. Against the backdrop of environmental degradation and decline in renewable resources, the amount of natural capital shrunk, causing the growth of per-capita inclusive wealth to go below that of GDP.

As for the contributors to the growth in per-capita inclusive wealth, human capital is the foremost one in 101 countries, while produced capital is the primary contributor in 27 countries. While 127 countries experienced a population growth, 116 countries saw the total value of their natural capital decline. The depreciation of natural capital amidst a population growth led to a slowdown in per-capita inclusive wealth.

There has been some discussion on incorporating human capital and natural capital measures into the SNA as satellite accounts, but it has not yet been analyzed quantitatively. In the future, the SNA must be expanded to include other forms of capital such as human and natural capitals.

The rate of change of per-capita inclusive wealth in Japan, the United States, the European Union, and China is lower than that of GDP across the board when all factors such as capital efficiency are taken into account. Over the analysis period, the rate of change was 0.3%, 0.6%, 1.2%, and -3.7%, respectively. Japan's rate of increase represents just 38% of the nation's GDP growth.

In Japan, produced capital is the primary contributor to the growth in per-capital inclusive wealth, followed by human capital and, lastly, natural capital. The efficiency of Japan's usage of all capitals is rated at -0.4%, as opposed to 0.2% for the United States, indicating the lack of qualitative improvement. In other words, there is tremendous potential for Japan to raise its inclusive wealth by more efficiently utilizing its capitals.

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Given the situation, how should Japan apply the IWI to its future policy management? The current economic policy with flow-focused strategies places a greater emphasis on its impact on the GDP, and fails to explicitly examine the impact on the nation's stock of capital assets. It would be more desirable to improve the benefit of natural capital in addition to accumulating produced and human capitals.

Here is my suggestion for specific policy directions. First, it should be noted that investment in natural capital often leads to dual benefits, especially in the case of farmland and forestland, which directly enhances natural capital. Improving agricultural resiliency would also contribute to food security, therefore it can accommodate anticipated population growth in the long run. In this process, instead of taking the conventional approach of subsidization, the government should opt to deregulate forms of land use, so as to generate room for further improving the capital value of land.

Renewable energies offer even a greater potential, delivering triple benefits. The first benefit is the direct increase of natural and produced capitals. The second benefit is their contribution to energy security, lowering the risk of oil price fluctuations for oil-importing nations. The third benefit is the mitigation of CO2 emissions.

There is an initiative for developing an index that shows the level of energy security, reflecting factors such as the political conditions of energy exporting countries. Such an index may be used in combination with the IWI to assess the benefit of feed-in tariff for renewable energies, so as to make a comprehensive judgment on the level of feed-in tariff to be offered for each of the renewable energies.

In order to take advantage of the benefits that renewable energies bring to inclusive wealth, it is important to swiftly build a mechanism among electric utilities for inter-connectively accepting renewable energies, eliminating the grid capacity limits that they impose.

The scope of inclusive wealth analysis should be further expanded to the regional level to help explore a more desirable way of measuring cities. The IWI will enable urban planning from the perspectives of livability and sustainability.

Companies could also use the IWI in their corporate strategy for determining how and in which regions their human resources and business sites should be located. This highlights the importance of optimizing capital flow for the qualitative improvement of the stock of capital assets.

The IWI is characterized by its ability to comprehensively assess different capital elements in a monetary unit, and can be used for comparing the effectiveness of individual policy factors. There is great potential for it in policy formulation. I hope to see proposals based on this index when the 2015 United Nations General Assembly examines the world's common sustainable development goals (SDGs).

>> Original text in Japanese

* Translated by RIETI.

December 31, 2014 Nihon Keizai Shimbun

April 7, 2015