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the indicators are characterised according to the OECD model. The selection of indicators was gov- erned by the following criteria:
n a time series of the indicator should be available, including recent observations;
n the indicators should be sensitive to action by the UK authorities, and should allow the setting of meaningful targets for the monitoring of actions;
n the data should be uncontentious (as far as this is ever possible) and be from official or otherwise accessible sources;
n they should require little or no additional collection or processing;
n the indicator should have resonance with the intended audience; that is, be readily understood and be considered appropriate by that audience.
Comparing Tables 19.1 and 19.2 it is apparent that while the coverage of the ‘Issue’ and ‘Theme’ lists is similar, the indicator lists show greater differences.
The exercises reported on in Tables 19.1 and 19.2 are examples of what is called ‘state of the environ- ment reporting’. In such exercises, as illustrated in these examples, there is an emphasis on issues relat- ing to environmental quality, as opposed to issues relating to natural resource use and availability.
State of the environment reports are typically intended for an audience which is the concerned general public, as indicated by the final criterion used in selecting the UK list of indicators. They report, again as illustrated in these two examples, mainly in biophysical units. While this approach avoids the problem of assigning monetary values to physical or qualitative flows which are not exchanged through a market, it makes it difficult, and some would argue impossible, to aggregate the effects of a number of environmental changes since there is no standard unit of measurement or agreed system of weights. In the next two sections we discuss, under the rubric of ‘environmental accounting’, work, mainly by economists, which is directed at using monetary valuation to capture in a smaller set of numbers the implications for human welfare of changes in the state of the natural envir- onment. To date, this work has focused mainly on issues concerning the use of natural resources in production and the measurement of sustainable income, but many working in the area envisage that
environmental quality issues can be handled in similar ways.
19.2 Environmental accounting: theory In a lecture delivered at the Washington DC ‘think tank’ Resources for the Future in 1992 (Solow, 1992, 1993), the Nobel laureate economist Robert Solow suggested that ‘an innovation in social accounting practice could contribute to more ra- tional debate and perhaps more rational action in the economics of non-renewable resources and the approach to a sustainable economy’. We use the title of his lecture as the heading to the next subsec- tion. In it he outlined the basis in economic theory for his view that proper national income accounting would promote sustainability. As we have noted, many environmentalists share this view, as do many economists. For the economists, the theory outlined by Solow is the basis for their views on this matter.
In this section we shall consider that theory, and the modifications to current national income accounting conventions that it is taken to imply. We shall also make the important point that there appears to be some misunderstanding of the theory and its im- plications for the ability of revised national income accounting conventions to promote sustainability.
In the text here we shall try to tell the story in fairly intuitive terms. Appendices 19.1 and 19.2 tell the same story in mathematical terms. The theory to be considered here builds on the theory of natural resource use covered thus far in this Part of the book – Chapters 14, 15, 17 especially.
19.2.1 An almost practical step toward sustainability
We consider an economy that uses a non-renewable resource and human-made, reproducible, capital to produce output, which can be either consumed or added to the stock of capital. There is no technical progress. A sustainable path is one that involves constant utility for ever. Given that there is just one commodity produced and consumed, and that utility depends only on consumption, constant utility is the same as constant consumption. We are going to
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consider the question: what kind of economic behavi- our is necessary for sustainability in this sense? There is, of course, a prior question, which is: can such an economy be sustainable? Given that the stock of the resource is finite, it is obvious that the answer to this question depends, as discussed in Chapters 4 and 14, on the possibilities for substitution in production as between the resource and reproducible capital. If those possibilities are such that sustainability is infeasible – as they would be if the production func- tion was Q=KαRβ, α + β =1 and β < α– then fol- lowing the rules for economic behaviour that are the answer to the first question could not deliver sustainability. Those rules are necessary but not sufficient conditions for sustainability. We return to the question of feasibility at the end of this section.
As set out by Solow, the theory involves two ‘key propositions’. The first is that ‘properly defined net national product’
measures the maximum current level of consumer satisfaction that can be sustained forever and is therefore
a measure of sustainable income given the state of the economy
The second proposition is that
Properly defined and properly calculated, this year’s net national product can always be regarded as this year’s interest on society’s total stock of capital where the total stock of capital includes both repro- ducible capital and the resource stock. When these two propositions are put together, we get the rule for economic behaviour that gives sustainability. It is to maintain society’s total stock of capital intact, by consuming only the interest on that capital. This implies adding to the stock of reproducible capital an amount equal to the depreciation of the resource stock – which is Hartwick’s rule, discussed in Chap- ters 4 and 14 – where the depreciation of the resource stock is measured by the Hotelling rent arising in its extraction.
In his lecture, Solow was careful to state, several times, a caveat that attends these propositions as guides to policy in an actual economy. This is that the ‘right prices’ are used to value the capital stock and the resource stock. Note that without prices we could not add together the stocks of reproducible
capital and the resource to get a figure for ‘society’s total wealth’. In order to be ‘right’, the prices must be, as Solow puts it, such that they ‘make full allow- ance even for the distant future, and will even take account of how each future generation will take account of its future’. The theory ensures that the prices do this by working with a model in which there is a single representative agent with perfect future knowledge, who works out and follows a plan for consumption, investment and resource depletion on the basis of maximising the discounted sum of future utilities subject to the constraints imposed by the availability of the resource and the need to forgo consumption in order to invest in reproducible cap- ital. Such a model is set out in Appendix 19.1, and was previously considered in Chapters 3, 4, 14 and 15.
The justification for using such a model to think about these questions is that, given some very strong assumptions about agents’ foresight and institutions, competitive markets would produce the same price behaviour. The model shows, for example, that the resource price is required to evolve according to Hotelling’s rule, and, given strong assumptions, it can be shown that resource prices determined in competitive markets will follow the same rule.
Solow is absolutely explicit about the relationship between actual market prices and the ‘right prices’
for guiding the economic behaviour that is necessary for sustainability:
This story makes it obvious that everyday market prices can make no claim to embody that kind of foreknowledge. Least of all could the prices of natural resource products, which are famous for their volatility, have this property; but one could entertain legitimate doubts about other prices, too. The hope has to be that a careful attempt to average out speculative movements and to correct for the other imperfections I listed earlier would yield adjusted prices that might serve as a rough approximation to the theoretically correct ones. We act as if that were true in other contexts. The important hedge is not to claim too much.
Unfortunately, in their enthusiasm to use economic theory to promote sustainability, some economists do not explicitly qualify their contributions to policy analysis with ‘the important hedge’.
There is, as set out in Appendix 19.1 and dis- cussed below, a further ‘hedge’ of some importance,
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not made explicit in Solow’s lecture, and which tends to be glossed over in much of the literature.
This is the fact that, even within the context of the representative agent model itself, the prices may not be ‘right’. The ‘right’ prices are those which go with a constant consumption path. However, the repres- entative agent will not necessarily choose a constant consumption path, unless constrained to do so.
Hence, the prices ruling along the optimal path in such a model will not be the correct prices to use for the implementation of Hartwick’s rule in pursuit of sustainability, unless it so happens that the rep- resentative agent’s optimal path is one with constant consumption.
What has all this got to with environmental accounting? What is Solow’s ‘almost practical step’? It is the idea that if at a point in time we knew what sustainable income for the economy was we would know whether or not we were behaving in the interests of the future. Consumption in excess of sustainable income would indicate that we were not, while consumption equal to or less than sustain- able income would indicate that we were. The step is ‘almost practical’ because of the need to use not currently observable market prices, but the ‘right’
prices.
19.2.2 A resource owner in a competitive economy
The idea that to behave sustainably involves keeping wealth intact by consuming just the interest income on that wealth has considerable intuitive appeal.
We can make that appeal explicit by considering the situation of a resource owner in a competitive eco- nomy. Doing this will also serve to provide some insight into how the Hartwick rule works when it does, and some basis for a further discussion of the caveats noted above.
Consider, then, an individual who owns an oil deposit and sells extraction permits to a company in the oil production business. The individual pays the proceeds from permit sales into his or her bank ac- count, from which is paid his or her expenditure on consumption. Let us use here the following notation:
Bis the size of the bank account, units £s Cis consumption expenditure, units £s
Wis total wealth, units £s
Ris the total of permit sales, units tonnes Xis the size of the remaining stock of mineral, units tonnes
his the price of a permit, £s per tonne Vis the value of the mine, units £s
ris the interest rate, assumed constant over time Let us also use t−1 to denote the first day of the relevant period of time, say a year, and tto denote the last day of the period. At t−1 the mine owner sells permits and banks the revenue. At the or she writes a cheque on the bank account to pay for his or her consumption during the period. While this con- struction is somewhat special it serves to make what is going on clear. In this context, considering, as we shall, an infinite time horizon and the question of constant consumption by an individual for ever is obviously rather strange. Individuals do not live for ever. However, pretending that they do, or at least that they behave as if they do by treating their heirs as simple extensions of themselves, is not uncom- mon in economics, and does serve to generate some useful insights.
The behaviour over time of Bis given by Bt=(1 +r)Bt−1+(1 +r)ht−1Rt−1−Ct (19.1) because Bt−1is the principal at the start of the year, to which is added, to earn interest over the year, the proceeds from permit sales at the start of the year.
Equation 19.1 can be written as
Bt−Bt−1=rBt−1+(1 +r)ht−1Rt−1−Ct (19.2) At tthe value of the mine is given by the permit price at tmultiplied by the amount of oil remaining, which is the amount remaining at the start of the period less the amount for which permits were sold at the start of the period. That is:
Vt=ht(Xt−1−Rt−1) (19.3) The price of an extraction permit in a competitive economy will be the difference between the mar- ginal cost of extraction and the price for which extracted oil sells; that is, the Hotelling rent. That is why we have used ‘h’ here as the symbol for the price of an extraction permit. Again given a com- petitive economy, we know from Chapter 15 that Hotelling’s rule governs the behaviour of rent, and