Challenges in Sustainability | 2013 | Volume 1 | Issue 1 | Pages 16–26
DOI: 10.12924/cis2013.01010016
Research Article
Sustaining Welfare for Future Generations: A Review Note on
the Capital Approach to the Measurement of Sustainable
Development
Thorvald Moe
1
, Knut H. Alfsen
1,
*, Mads Greaker
2
1
Center for International Climate and Environmental Research Oslo (CICERO), P. O. Box 1129, Blindern,
0318 Oslo, Norway; E-Mail: [email protected] (K.H.A.); Tel.: +47 22858569; Fax: +47 22858751
2
Research Department, Statistics Norway, P. O. Box 8131, Dep, 0033 Oslo, Norway
* Corresponding author
Submitted: 8 January 2013 | In revised form: 28 March 2013 | Accepted: 22 April 2013 |
Published: 12 May 2013
Abstract: Measuring sustainable development based on analytical models of growth and
development and modern methods of growth accounting is an economic approach—often called
the capital approach – to establishing sustainable development indicators (SDIs). Ecological
approaches may be combined with the capital approach, but there are also other approaches to
establishing sustainable development indicators—for example the so-called integrated
approach. A recent survey of the various approaches is provided in UNECE, OECD and Eurostat
[1]. This review note is not intended to be another survey of the various approaches. Rather
the objective of this paper is twofold: to present an update on an economic approach to
measuring sustainable development—the capital approach—and how this approach may be
combined with the ecological approach; to show how this approach is actually used as a basis
for longer-term policies to enhance sustainable development in Norway—a country that relies
heavily on non-renewable natural resources. We give a brief review of recent literature and set
out a model of development based on produced, human, natural and social capital, and the
level of technology. Natural capital is divided into two parts—natural capital produced and sold
in markets (oil and gas)—and non-market natural capital such as clean air and biodiversity.
Weak sustainable development is defined as non-declining welfare per capita if the total stock
of a nation's capital is maintained. Strong sustainable development is if none of the capital
stocks, notably non-market natural capital, is reduced below critical or irreversible levels. Within
such a framework, and based on Norwegian experience and statistical work, monetary indexes
of national wealth and its individual components including real capital, human capital and
market natural capital are presented. Limits to this framework and to these calculations are
then discussed, and we argue that such monetary indexes should be sustainable development
© 2013 by the authors; licensee Librello, Switzerland. This open access article was published
under a Creative Commons Attribution License (http://creativecommons.org/licenses/by/3.0/).
indicators (SDIs) of non-market natural capital, and physical SDIs, health capital and social capital.
Thus we agree with the Stiglitz-Sen-Fitoussi Commission [2] that monetary indexes of capital should be
combined with physical SDIs of capital that have no market prices. We then illustrate the policy
relevance of this framework, and how it is actually being used in long term policy making in Norway—a
country that relies heavily on non-renewable resources like oil and gas. A key sustainability rule for
Norwegian policies is to maintain the total future capital stocks per capita in real terms as the country draws
down its stocks of non-renewable natural capital —applying a fiscal guideline akin to the Hartwick rule.
Keywords: capital approach; indicators; national wealth; sustainable development
1. Introduction
Twenty-five years after the World Commission on
Environment and Development (WCED) published the
book Our Common Future [3], there is an emerging
view in economic literature on sustainable
development that one should focus on sustaining well-
being per capita in real terms for future generations,
and that analyses of measurement and policies should
be based on analytical models of growth and
development and modern wealth accounting.
Thus, a main message from the Stiglitz, Sen and
Fitoussi Report from 2009 is:
The report distinguishes between an assessment of
current well-being and an assessment of sustaina-
bility. Current well-being has to do with both
economic resources, such as income, and with
non-economic aspects of peoples' life (what they
do and what they can do, how they feel, and the
natural environment they live in). Whether these
levels of well-being can be sustained over time
depends on whether stocks of capital that matter
for our lives (natural, physical, human, social) are
passed on to future generations ([2], p. 11).
However, there are other approaches to defining
and measuring sustainable development. In a recent
report from UNECE, OECD and Eurostat [1] differ-
ences of views are described thus:
One view, referred to as the integrated view, held
that the goal of sustainable development is to
ensure both the well-being of those currently living
and the potential for the well-being of future
generations. The second approach is that the
concern for sustainable development is properly
limited to just the latter.
For a survey of both "economic and non-economic"
approaches, the reader is referred to this report.
An illustration of the difference between empirical
work based on the integrated approach and work
based on the capital approach is whether one should
include estimated gross domestic product, GDP, as an
indicator of sustainable development or not. According
to present national accounting conventions, the use of
non-renewable natural resources is not deducted
when GDP is estimated. Thus, one may boost GDP by
rapidly drawing on such resources, but if the revenues
are spent on consumption rather than building up
other types of capital, the country in question may be
worse off in the medium or longer term as their stock
of capital or wealth is reduced. Sustainable indicator
sets using GDP based on an integrated approach may
thus be misleading to policy makers. GDP is a
measure of economic welfare in the short term, but
not an indicator of sustainable development.
Finally, the World Bank put forward the view:
Conceive of development as a process of
building and managing a portfolio of assets. The
challenge of development is to manage not just
the total volume of assets – how much to save
versus how much to consume – but also the
composition of the asset portfolio, that is, how
much to invest in different types of capital,
including the institutions and governance that
constitute social capital ([4], p. 4).
Instead of using GDP one may use Adjusted Net
savings (ANS) as a macro indicator of sustainable
development as presented by The World Bank. ANS,
also called genuine saving, is defined as national
saving adjusted for the value of resource depletion
and environmental degradation and credited for
education expenditures (a proxy for investment in
human capital). Since wealth changes through saving
and investment, ANS measures the change in a
country's national wealth, see [4].
In section 2 we elaborate on our analytical
framework based on the capital approach, and in
section 3 we illustrate the current measurement of the
economic elements in our model of development with
reference to current wealth accounting practices in
Norway.
We argue, furthermore, that measures of economic
or national wealth in monetary terms have their limits,
and one thus needs a few indicators in physical terms
of non-economic aspects of development, such as
critical elements of non-market natural capital and
17
health and social capital in order to make a
comprehensive assessment of whether a country is on
a sustainable path.
A main reason for measuring the main elements
that drive development over time is to inform policy.
In section 4 we illustrate how our analytical frame-
work and SDIs are actually used for policymaking in
Norway, which is a resource-producing country with
large reservoirs of non-renewable, or exhaustible
resources, in its oil and gas sector. S ection 5 concludes.
2. The Analytical Framework
In the 1970s economists reacted to the challenge of
OPEC and the "doomsday predictions" of the Club of
Rome by introducing energy, natural resources and
environmental pollution into the neoclassical theory of
growth. In the 1990s they reacted to global climate
change and the Report of the Brundtland Commission
[3] by introducing the same considerations into the
theory of endogenous growth.
Economic growth involves a two-way interaction
between technology and economic life: technological
progress transforms the very economic system that
creates it. The purpose of endogenous growth theory
is to seek some understanding of this interplay
between technological knowledge and various
structural characteristics of the economy and society,
and how such interplay results in economic
development. According to Aghion and Howitt [5],
endogenous growth theory is inherently more suitable
for addressing the problems of sustainable develop-
ment than neoclassical theory, because the central
question to which endogenous growth theory is
addressed is whether or not growth can be sustained.
See [5], especially chapter 5.
We take the view that economic development
should be evaluated in terms of its contribution to
intergenerational well-being. Specifically, we identify
sustainable development paths along which
intergenerational well-being per capita in real terms
do not decline. The idea that movements in wealth
should be used to judge the sustainability of
development paths was put forward by Pearce and
Atkinson [6], who defined sustainable development to
be an economic path in which (comprehensive)
wealth does not decline. The connections between
movements in wealth and changes in intergenera-
tional well-being or welfare were identified indepen-
dently by Hamilton and Clemens [7] and Dasgupta
and Mäler [8]. For further discussions of criteria for
sustainable development, see [9-11].
According to [8] welfare is very closely related to
what we think of as wealth, as wealth represents the
totality of resources upon which we are able to draw
to support ourselves over time. From this it is clear
that welfare is a forward looking concept in which
what counts is not how well off we are today, but our
prospects for being well off in the future. In other
words, welfare is an intertemporal concept.
As for well-being, there seems to be no single
definition, and there remains a considerable debate
regarding its determinants. Some use it synonymously
with welfare. Others, including Dasgupta, claim that
well-being encompasses welfare but goes beyond it to
include benefits derived from things other than
consumption, for example human rights. While the
formal distinction may continue in academic debates,
it is not of great importance for the discussion in this
paper. For this reason, and because it may be the
more encompassing term, well-being is the term used
in this paper.
A large number of empirical econometric tests
confirm the importance of technological change and
resulting productivity increases for growth and develop-
ment. We observe, for example, steady energy
efficiency improvements over an extended period in
most OECD countries. Thus, we include the level of
technology, TL, in our model. Our analytical frame-
work for explaining longer-term development of well-
being can be summarized thus:
WB= f (RC , HC , NC , HSC , TL)
(1)
where:
WB = Well-being;
RC = Real or produced capital;
HC = Human capital;
NC = Natural capital which has two main elements,
resources sold in markets—Market Natural Capital
MNC, and Non-Market Natural Capital NMNC (clean
air, biodiversity);
HSC = Health and Social capital;
TL = The level of technological knowledge.
In standard wealth accounting, National Wealth,
NW equals the stocks of capital, thus the definitional
equation:
NW = RC + HC + MNC + NMNC + HSC
(2)
and thus:
WB= f ( NW , TL)
(3)
Development of well-being is a function of the
stock of national wealth, NW, and the level of
technology, TL.
In literature, weak sustainable development, WSD,
is total real NW per capita not declining over time.
Strong sustainable development, SSD, requires that
none of the individual capital components, i.e. RC,
HC, MNC, NMNC and HSC, are reduced below critical
or irreversible levels. For further discussion of criteria
for sustainable development, see for example Pearce
and Atkinson [10] and Alfsen and Moe [11].
Whether economic development will be sustainable
in the longer term may, in the final analysis, depend
on technological developments, see Aghion and
18
Howitt [5], chapter 5, and Hamilton and Atkinson
[12], chapter 8. We return to this issue in section 3.4
below.
The criteria for assessing sustainable development
should then be that national wealth per capita in real
terms and adjusted for productivity growth should be
non-declining, and that none of the components in
equation 2 above is reduced below critical or
irreversible levels.
3. Measurement
The Stiglitz Commission ([2], recommendation 11,
p.17) recommends:
Sustainability assessment requires a well-defined
dashboard of indicators. The distinctive feature of
components of this dashboard should be that they
are interpretable as variations of some underlying
stocks. A monetary index of sustainability has its
place in such a dashboard but, under the current
state of the art, it should remain focused on
economic aspects of sustainability.
We now have fairly well developed methods for
such monetary indexes, i.e. measurement methods
for economic wealth, EW, cfr. section 3.1 below.
3.1. Monetary Indexes of Economic Wealth (EW)
Norway has been a resource-producing country for a
long time, and wealth accounting goes back to the
1980s. Present methods used and presented regularly
in order to inform policy are presented below.
Calculating Economic Wealth goes through three
steps.
3.1.1. STEP 1: Calculating Resource Rents
The first step, based on an approach by Eurostat [13]
and the United Nations et. al. [14], is to calculate the
resource rents from market based natural resources,
MBNC.
Resource rent = (4)
Value of production
± Product specific taxes/subsidies
- Raw materials
- Wage payments and capital costs
± Not sector specific taxes/subsidies
3.1.2. STEP 2: Decomposing Net National Income
(NNI)
The next step is to decompose the observed net
national income, NNI, on returns from the various
types of capital.
NNI = (5)
Resource rents from non-renewable natural resources
(oil and gas, etc.)
+ Resource rents from renewable resources (fish,
agriculture, forestry, etc.)
+ Return on real capital calculated as an average rate
of return on the total capital stock
+ Net income from financial wealth
± A residual containing return on human (and social)
capital as well as income from natural capital not
captured in the resource rent calculations
3.1.3. STEP 3: Converting Streams Into Wealth
The third step is to convert future income streams of
income into (stocks of) Economic Wealth (EW):
Economic Wealth (EW) = (6)
Present value of future resource rents of non-renewable
resources
+ Present value of future resource rents from renewable
resources
+Real capital stock
+Present value from future returns on human capital
+Net foreign assets
For further details and concrete calculations of EW
in Norway, see Alfsen and Moe ([11], pp. 14–17).
Figure 1 shows development over time of the
renewable natural capital of Norway.
Note that "agriculture" has a negative value. This
follows from the definition of resource rents, and the
extensive subsidizing of the sector, that is, all product
specific subsidies should be treated as a cost of
production. Note also that hydropower has had a
significantly higher value for the last 8 years. This is
most often explained by the liberalizing of the power
sector in Norway. Finally, note that all in all the
management of the renewable natural resources
seems to be improving. A majority of the natural
resources have a positive rent, and the negative rents
in agriculture are becoming less prominent.
Figure 2 shows the development in the components
of national wealth (NW) in Norway from 1985 to
2011.
Non-renewable resources consist of oil, natural gas
and mining, however, mining is only a tiny fraction of
the total value (close to zero on average). We further
note that the value of the non-renewable resources
has been declining since 2004. The rent has however
been invested in a fund, The State Pension Fund—
Global, which transforms revenue from non-renewable
resources to financial capital abroad according to
sustainability criteria elaborated on in section 4 below;
note the yellow bar.
Dividing total national wealth by the population
gives national wealth per capita, see Figure 3.
19
Figure 1. Development of renewable natural capital in Norway 1985–2011.
Figure 2. Decomposed national wealth (NW) in Norway 1985–2011
20
Figure 3. Development of national Economic Wealth per capita in Norway 1985–2011.
National wealth per capita has been increasing for
most of the period, despite a large increase in
population due to migration. Our measurements
appear to be stabilizing at 12 million NOK per capita.
In order to ensure sustainability, development must
be followed close