National Accounts and Measures of Sustainability Rui Mota Tel Ext Tiago Domingos October 2011

National Accounts Identity C I X M

Main Aggregates Gross Domestic Product Gross Domestic Product (GDP) + Net primary income flows to ROW = Gross National Income (GNI) + Current net transfers from ROW = Gross National Disposable Income - Final consumption (Private and Government) = Gross Saving (S) Net Domestic Product (NDP) = Net National Income (NNI) = Net National Disposable Income = Net Saving (NS) Subtract CFC

Main Aggregates National (Residence) - Primary income flows to ROW Product / Income + Primary income flows from ROW Domestic (Territory) Net + Consumption Fixed Capital (CFC) Aggregate X - Consumption of Fixed Capital (CFC) Gross X – Domestic produc, Income, Saving, Disposable income,...

GNI = GDP + Y’ RM. Where Y’ RM = Net income payable to non-resident units for production factors. Domestic Product vs. National Income Source: AMECO database

Gross Product vs. Net Product [Million euros 2000] Source: AMECO database

GDP growth rate Source: AMECO database

Gross Product per hours worked [euros 2000] Source: AMECO database

Net Saving in Portugal [Mrd euros 2000] Source: AMECO database Net savings are negative when consumption is higher than net disposable income

National Disposable Income [Mrd euros 2000] Source: AMECO database

“Development that meets the needs of the present without compromising the ability of future generations to meet their own need.” –Intra- and inter-generational equity –Anthropocentric Sustainability of what? –non-declining aggregate output or consumption, –non-declining utility, –non-declining aggregate resources (productive base), –non-increasing pollution, … Weak vs. Strong Sustainability –Limits to substitution, –Is the combined value of all assets remain constant, that is, it is possible to substitute one form of capital for another, so natural capital can be depleted or the environment degraded as long as there are compensating investments in other types of capital? –Critical levels of natural capital. Sustainable Development

International Efforts World Bank’s Adjusted Net Savings (Genuine Savings) Rate of savings after taking into account investment in human capital, depletion of natural resources and damage caused by pollution. Time series ( …) for 140 countries. ( ) European Commission ( ) Indices to measure progress integrated into the decision-making and public debate? “We cannot face the challenges of the future with the tools of the past. It's time to go beyond GDP.” Durão Barroso Extending European National Accounts to environmental and social issues. OECD work on alternative measures of welfare ( ) Extending GDP to include leisure time and inequality. Changes in country rankings Stiglitz Commission ( ) Identify the limits of GDP as an indicator of economic performance and social progress. SEEA 2003, United Nations ( ) Satellite system of the SNA including economic and environmental information in a single framework to measure the contribution of the environment to the economy and vice-versa.

World Bank’s Genuine Savings

Resource Curse: Countries dependent on natural resources tend to depict unsustainable development (negative GS). World Bank’s Genuine Savings

Sustainability vs Optimality A Sustainable Economic path at time t is one that obeys where is the maximum sustainable utility, defined as A Present Value Optimal path is one that results from the maximization of Present Value (PV): Future utility is being discounted with a constant discount rate Hicks (1946) : Individual’s income “maximum amount of money which the individual can spend this week, and still expect to be able to spend the same amount in real terms in each ensuing week".

Sustainability vs Optimality (DH economy) If C(t) > C m (t) then C(t) must decline to below C m (t) at some future time. For low enough discount rates, the path is sustainable. For high enough discount rates, the path is unsustainable. These conclusions also depend on the assumption that man-made capital is more important to production than the resource.

Dynamic Optimization: Cake-Eating Economy What is the optimal path for an economy “eating” a cake? Optimal System: Optimal and sustainable? subject to

Dasgupta-Heal Model Capital resource economy with no technological progress: Production can be used to consume or invest: Extraction of a non-renewable resource used in production Optimal Path: Hotelling’s rule Ramsey’s rule Optimal and sustainable? subject to

Production Capital resource economy with Cobb-Douglas production: Factors of production are essential. But with different importance (factor elasticities). Elasticity of substitution: Provides a measure of how easy it is to substitute one input for another in production (curvature of isoquants).

R K  =  R K F1F1 RARA KAKA KBKB RBRB A B F2F2 R K  = 0 Constant Elasticity of Substitution (CES) Perfect substitutes Complements R K F1F1 F2F2 R K F1F1 F2F2  = 1 Essential  < 1

Sustainability vs Optimality (Cobb-Douglas) Consumption tends to zero (resources are essential). Since K is more important to production than R, then C m (t) is positive. Consumption becomes unsustainable (C >C m ) before it becomes unsustained (C >F).

Sustainability vs Optimality For low enough discount rates, the path is sustainable. For high enough discount rates, the path is unsustainable. These conclusions also depend on the assumption that man-made capital is more important to production than the resource.

Hartwick’s Rule Can this economy maintain constant consumption even though the resource is being depleted? What is the role of substitution between man-made capital K and the natural resource R in the production of the composite good? If then Net investments = value of the ‘revenues’ from exploitation If the accumulation of man-made capital always exactly compensates in value for the resource depletion, then consumption remains constant at the maximum sustainable level.

To Sum Up In Cobb-Douglas, consumption declines to zero (with no tech. progress). If the elasticity of substitution is > 1 (man-made capital is more important than exhaustible capital), such resources are not essential for production, so consumption may not decline to zero. If consumers are sufficiently patient (low discount rates – high value to the future), then consumption will be sustained in the optimal path. If there is technological progress, it is possible to sustain consumption even if inputs are complements (no substitution). The effect of essential resources may be offset by sufficient substitution possibilities and technological progress.

m-dimensional consumption bundle, including everything that influences well-being. –Includes all market and non-market commodities, e.g, produced at home, environmental services, … n-dimensional capital vector: –Includes man-made capital, natural resources, human capital (education and knowledge) and foreign capital. Time is included as a capital, to depict technological progress in production. Attainable production possibilities The model s.t. Green Accounting Theory

Green Net National Income Genuine Savings Changes in Green Net National Product measure changes in welfare. Genuine Savings measure changes in welfare. Define sustainable development as: - non-decreasing utility. Then, a one-sided sustainability test is (Pezzey, 2004) un-sustainable development. Green Accounting Theory

Include –stocks of commercial forests, –welfare costs of air emissions, The capital stocks are : –Domestic man-made capital, –Net foreign capital held privately or by the government, –Stock of commercial natural resources –Human capital Production Small Open Economy

Households’ utility function depends on material consumption rate and (negatively) on the flow of emissions The vector of emissions depends on production and abatement expenditure. Maximize welfare subject to the dynamics of the forms of capital considered. Green Net National Income: Genuine Saving: The value technological progress (TFP): Small Open Economy

Starting from conventional SNA aggregates: –Deduct the damage from flow pollution emissions, –Deduct (add) the value of rents from resource depletion (or not), GNNI and GS in Portugal

Impacts considered: –Exposure to PM 2.5 and ozone –Health damages of PM2.5 (both acute and chronic effects) and ozone, O3 (only acute). Both long-term (chronic) and short-term (acute). Both mortality (i.e. deaths) and morbidity (i.e. illness) Marginal cost of emission per emitted pollutant [€2000/ton]: [€2000/t] Best Low High SO NH NO x VOC PM2, GNNI and GS in Portugal – Air Emissions

The damages from air emissions are around 8% of Portuguese GNI: - [4, 11]% GNI

The depreciation of commercial forests in Portugal is on average 10% of the contribution of forestry to national product (around 4%). GNNI and GS in Portugal – Forests

Without the value of time – Decreasing tendency throughout the period and negative GS after With the value of time – Decreasing tendency until 2001, but GS are always positive. Genuine Savings

In 1993, SO2 costs of emissions, which represent around 30% of total emission costs, decreased substantially. Increases welfare but does not counteract the loss of production. Sustainability Message

The depletion of water resources. The depletion of biodiversity. Depletion of stocks of fish. Inclusion of the value of ecosystem services. Soil quality. Distributional issues (intragenerational concerns). Looking at an extended but incomplete range of assets may produce a result further from the truth Indicators need to be treated with caution as tests for sustainable development and guides to policy.... What’s Missing?