1 Issues in Nonmarket Accounting: Pollution Accounting in Theory and Practice William Nordhaus Yale University Conference of European Statisticians Fifty-fifth Plenary Session Palais des Nations Geneva, Switzerland June 11-13,

2 Issues to be addressed 1.Question: how to redesign national income and product accounts to incorporate the environment, particularly externalities. 2.An example using global warming 2

3 Some Useful Concepts Externalities: Action in which A affects B, but the value of the action is not fully compensated in market transaction. Non-market activities: Activities, which may or may not have externalities, but in which compensation is not recorded in market accounts. “Near-market activities”: Goods or services for which market activities with similar properties can be identified. 3

4 Categories of Products Market Near Market Public and private goods 4

5 Environmental accounting Many of the issues were addressed by the National Academy panel in two reports, Nature’s Numbers (NAS Press, 1999) and Beyond the Market (NAS Press, 2005). However, these reports did not propose a particular accounting framework. Preliminary thoughts are in Nordhaus, “Principles of National Accounting for Nonmarket Accounts,” in Jorgenson, Landefeld, Nordhaus, eds., A New Architecture for the U.S. National Accounts (NBER/CRIW,

6 Analytical Issues of Externalities A.Current Treatment in the National Accounts B.Treatment with Internalized Externality (“Polluter Pay Principle”) C.Pollution Permits Allocated to Polluters (“Polluter Profits Principle”) 6

7 Current SNA treatment 7

8 Berry farmers own property rights 8 Note that dark cells are imputations for fictitious industry.

9 Analytical Issues of Externalities D. Imputing Outputs and Incomes with Externalities 9

10 Major open question Now return to the realistic situation where the externality is not internalized. Here, we need to construct a set of “as if” accounts that show the pollution and abatement flows. How to do this is not, I believe, settled in national income accounting. 10

11 A reasonable approach would add a fictitious abatement industry, and then impute the values. The quantities in this imputed industry would be actual qualities, and the prices would be net marginal damages. The presence of an externality means that marginal cost is not equal to marginal damage. – By changing the valuation of abatement flows from zero marginal cost to positive marginal damage, the output measure becomes a welfare measure in which the valuation of output consistently uses marginal utility valuation.

12 There is a major question here: –How should we treat the incomes associated with the pollution flows when there are no actual flows? –This problem reflects the fact that there are not well- established property rights. –Unless we are careful, the constructed income accounts no longer balance outputs. –The problem is that the $125 of imputed output of the berry industry does not show up as the income to any industry; similarly, the $125 of costs of the power industry from purchasing abatement does not get charged to the power industry.

13 There is no obvious answer to this. However, the closest approximation to reality is the situation described by the “polluter profits principle.” –In most countries, polluters have the right to pollute up to the legal standard, and they may actually be allocated tradable emissions allowances. 13

14 One possible approach is shown in Table 4, where I have tentatively labeled the income entry as a “pollution transfer.” –This reflects the fact that the implicit property right has been transferred to the power producer. Note that the real output and the market incomes by industry are not affected by whether the transfer or allocation of property rights is to polluter or pollute (as we see in Tables 2 and 3). However, the total value added as computed here (which includes the implicit or explicit sale of pollution permits) will be affected by the treatment of the transfer. 14

15 In summary, to create a set of environmental accounts, we need the following steps: 1. Estimates of the quantities, prices, and values of the pollution (or abatement) flows among the different industries. 2. Establishment of a fictitious abatement industry that buys and sells the abatement output among the different industries. 3. Addition of a new entry of “pollution transfers” or some similar entry that is the balancing item in the income accounts and ensures that the entries add up within and across industries. 15

16 Proposed environmental accounts with constructive internalization and pollution transfers Note that dark cells are imputations. 16

17 Analytical Issues of Externalities E. Non-market activities F. Externalities in the Future 17

18 Example with non-market health impacts Note that dark cells are market sector 18

19 Application to Global Warming 1.Assume that CO2 emissions are a global externality. 2.Assume the social cost of carbon in 2005 was $29 per ton C. 3.Use impacts estimates from DICE-2007 model. 4.Conclusions: -Net global disinvestment in 2005 was $223 billion (from global PPP GDP of $55 trillion). -Major recipients on transfers were the US, the EU, and Russia. -Major “donors” in CO2 transfers were India and Latin America. 19

20 Net international transfers, 2005 Note that positive transfers represent net transfers to the country From the rest of the world.. 20

21 Net international transfers,

22 Questions for discussion 1.Is it desirable to extend the national accounts (perhaps as satellite accounts) to include externalities and the environment? 2.Do we want to construct a fictitious abatement industry (that buys and sells the public good or externality)? 3.How do we treat the implicit property rights involved in the externality? 4.What is the proper treatment of the implicit transfer involved in the externality (subsidy? transfer? tax?) 22