By Tony Ofori, Marc Palahí and Janez Potočnik
The recently published Dasgupta Review on the economics of biodiversity calls for changes in how we think, act and measure economic success to protect and enhance our prosperity and the natural world. Tony Ofori, Marc Palahí and Janez Potočnik argue why and how nature and natural capital should be valued and integrated better in economic and financial policy decisions.
One of the significant milestones that has helped define the modern era of finance is the ability to accurately price complex risk, reward and value within commonly accepted frameworks. For example, financial products known as derivatives (which are products deriving their values from the value of underlying assets) are sophisticated tools for transferring risk and reward between counterparties. The pricing of the most complex of these instruments can require intense intellectual and computing power, yet this has not stopped their acceptance or use in mainstream finance. Such was the significance of their standardisation that in 1997 Myron Scholes and Robert Merton were awarded the Nobel Prize in Economics for the pricing methodology they formalised 24 years earlier that significantly catalysed the global acceptance of derivatives.
According to data from the Bank for International Settlements (BIS), at the end of 2019 the total notional value of contracts in the derivatives market was estimated at $560 trillion. Notwithstanding the relative ease with which this figure is arrived at, it is a staggering amount – to put that in perspective this figure is approximately 4 times the $142 trillion attributable to global GDP in 2019, which itself is a metric that, even if not appropriate, is still accepted as a standardised measure of the abstract concept “economic health”.
The underlying message here is that assets and liabilities that are deemed to be useful are continually measured and valued, despite the presence of the complexity barrier.
Turning our attention to nature and natural capital, it seems surprising then that there is no ubiquitous way that we measure or quantify its economic value, nor is there an acceptance that there is a necessity to include them in financial calculations.
What’s the true value of a bumble bee? How much is a healthy river really worth? How much should you pay for clean air? What’s the incremental cost resulting from the loss of one species of crop in a particular region? Given their intrinsic importance, these are all questions that should have readily accessible answers but most of us would struggle to know where to begin to get them. This belies an uncomfortable truth, that many of us don’t conceptually appreciate the true value of nature.
Some studies have tried to address this gap. For example, in their 1997 paper “The Value of the World’s Ecosystem Services and Natural Capital”, a group of scientists led by the ecological economist Robert Constanza estimated the economic value of 17 ecosystem services for 16 biomes, based on published studies and ad hoc calculations. For the entire biosphere, the value (most of which falls outside of traditional markets) was estimated to be between $16 and 54 trillion per annum with an average of $33 trillion/year. Due to inherent uncertainties in the calculations, this should be considered a minimum estimate, and as natural capital and ecosystem services become more stressed and scarce in the future, we can only expect their value to increase. Note that global GDP in 1997 was approximately $45 trillion.
If the cost of nature’s degradation along with the economic benefit of her development is valued and priced accurately into all economic and financial choices, then existing frameworks of thinking can be upgraded to allow for more holistic decision-making which includes nature-based “assets”. In other words, we can argue that even without changing the basic architecture of how we currently look at finance and economics, we can end up with decisions which naturally favour outcomes that allow us to live within nature’s boundaries.
There are emerging signs that work towards this greater goal may be developing momentum. The Dasgupta Review, an independent, global review on the Economics of Biodiversity was published in February 2021. The Review calls for changes in how we think, act and measure economic success to protect and enhance our prosperity and the natural world. The cautionary adage underlying the study seems to be that nature is a blind spot in economics that we ignore at our peril. This message is echoed by the world-renowned broadcaster and natural historian Sir David Attenborough who commented “this comprehensive and immensely important report shows us how by bringing economics and ecology face to face, we can help to save the natural world and in doing so save ourselves”.
Some respectable commentators (such as George Monbiot, a British writer known for his environmental and political activism) argue that pricing nature is not a good thing, as trying to account for the value of nature could lead to its commodification and further destruction. There is also the argument that reducing natural capital to a series of numbers and values divorces the moral obligations inherent in looking after one’s environment. While such points of view have some merit and need to be respected, the fact is that natural capital is drastically depleting. Markets are where producers and consumers meet, and market signals are decisive for their behaviour. Currently producers are rewarded with higher profits if destroying natural capital, and consumers are penalised by higher prices if behaving sustainably. In order to have a balanced debate, it helps to have a common platform upon which cost-benefit discussions can be built. Finance would seem a reasonable place to start because of its history of valuing all manner of assets, and also because it has the power to redirect capital to where it is needed most. Financial flows need the right informed incentive structures put in place for them to move in a responsible manner.
The path to progress does not need to feel insurmountable. Initiatives such as the European Union’s taxonomy for sustainable activities, and the Stakeholder Capitalism Metrics developed by the International Business Council help to show leadership in laying an important groundwork for more inclusive valuing and pricing frameworks. However, members of the financial community and private sector need to proactively capitalise on the enabling environment that these systems create. A key advantage of this approach is that this is not about coming up with a completely new way of looking at finance. It is more about an acceptance that nature and natural capital should be treated as assets and liabilities that are deemed to be useful and should be continually measured and valued. We have enough knowledge and scientific evidence to understand the necessity of valuing, protecting and restoring nature, we just have to integrate it better in economic and financial policy decisions. Perhaps with this approach the most valuable company in the world right now would not be a consumer electronic enterprise … but maybe a forest company investing in natural capital while providing valuable and sustainable consumer needs.
Photo: Mintra Untharit