Around the world, nations define their well-being in terms of gross domestic product — the value of the goods and services they produce. However, GDP is a far-from-perfect proxy because it does not take into account the value of the ecosystems that sustain us. But what could we use instead? The Inclusive Wealth Index, which factors in the value of goods and services generated by nature as well as by humans, has bubbled to the surface as a promising alternative. But IWI is problematic, too, because nature’s worth is difficult to quantify. Partha Dasgupta, one of the developers of IWI, and Gernot Wagner, Environmental Defense Fund economist and author of But Will the Planet Notice? How Smart Economics Can Save the World, offer two views on the dilemma.

Sir Partha Dasgupta
Frank Ramsey Professor Emeritus of Economics
University of Cambridge

“The literature on economic development has suffered from a persistent weakness. The indices used to judge the progress and regress of nations are all ad hoc; they aren’t derived from any reasonable conception of intergenerational well-being. For example, GDP doesn’t account for the depreciation of capital assets, such as natural capital. That means GDP doesn’t take the well-being of future generations into account. The Human Development Index (HDI) suffers from the same weakness.

If an index is to serve economic evaluation meaningfully, it must meet two conditions. First, it should reflect intergenerational well-being — meaning that the index records an improvement if and only if intergenerational well-being increases. Second, the index should be linear in economic quantities to ease measurement problems for the economic statistician.

An inclusive measure of wealth satisfies both conditions. By wealth I mean the social worth of an economy’s entire stock of capital: manufactured, human and natural. Wealth connects any conception of intergenerational well-being to the economy’s capital assets via a system of shadow prices. Some shadow prices would be expected to equal market prices (at least approximately), but many others would have to be estimated. That’s hard work, because shadow prices depend not only on the conception of intergenerational well-being we adopt for the purpose of economic evaluation, but also on the extent to which goods and services can be substituted for one another in consumption and production. The intellectual trick that’s required is to devise useful shortcuts for estimating shadow prices.

That is not a weakness unique to wealth, of course. Shortcuts are necessary in any exercise in economic evaluation. The estimation of GDP, for example, is full of shortcuts. That wealth proves to be difficult to measure isn’t an argument for not estimating it. Our research and the International Human Dimensions Programme on Global Environmental Change’s Inclusive Wealth Report 2012 constitute a first step in what will prove to be a lengthy but necessary project.”

Gernot Wagner
Environmental Defense Fund

“GDP is broken. Robert F. Kennedy said as much in his first major presidential campaign speech. Simon Kuznets, the father of GDP, acknowledged its shortcomings. GDP is an imperfect indicator of human well-being at best, and outright misleading at worst.

Still, we shouldn’t scrap GDP and start over.

Up to a point, GDP does tell us important facts about people’s lives, livelihoods and aspirations. Living on a dollar a day is miserable no matter how you look at it.

Choking on economic growth, of course, is equally bad. There are a few simple, well-established steps we ought to take to bring GDP closer to where we should be. That, by the way, isn’t ‘Green GDP’ or ‘green accounting.’ It’s honest accounting.

Start with accounting for the true value of natural assets still in the ground. We don’t ‘produce’ coal. We extract it. And the fact that the ton of coal extracted today is no longer there for the taking tomorrow should show up in our national income accounts. A ton of West Virginian coal adds about $30 to GDP. Honest bookkeeping would decrease that amount to $15. The same holds for oil, trees, water and all the other valuable natural assets that fuel our economy but are largely treated as free in our GDP accounting.

Then quickly move on to pollution. Every ton of coal, every barrel of oil causes more in external damages than it adds value to GDP. Properly measured GDP ought to reflect that fact.

In the end, policy makers should expand their horizon and look at a dashboard of indicators to get a fuller picture of the true state of the economy, society and the planet. Yet when it comes to GDP itself, the name of the game is fixing it rather than scrapping it. We know how to do that. The U.S. Bureau of Economic Analysis is at the ready. Let’s have a go at it.” View Ensia homepage

This article originally appeared in the Fall 2012 issue of Momentum magazine, Ensia’s predecessor.