Business Sustainability and Carbon Markets

Submitted to: Prof Sushil Kumar

There is rising criticism of the widespread use of GDP as an indicator of the health of an economy. In fact, some experts are of the opinion that GDP growth is making the society poorer. Critically analyze this opinion in view of the concept of sustainability and also discuss some alternate measures being suggested. What will be the implications to businesses of these alternate measures?"

Gross Domestic Product (GDP) is the standard measure of a countrys economic activity. GDP can be defined as an aggregate measure of total economic production for a country; it represents the market value of all goods and services produced by the economy during the period measured, including personal consumption, government purchases, private inventories, paid-in construction costs and the foreign trade balance. The following is the diagrammatic representation of how GDP is calculated:

CONSUMPTION

Net exports Business Investment (exports imports)

GDP

(personal + government

spending)

Since, World War II, GDP has been used as a measure of the health and wellness of the society. It helps in gauging whether the economy is expanding or contracting. It captures the well-being that results from production of goods and services. It is the most followed indictor by economists, investors and policy makers. The corporate profits and inventory data can be helpful to investors and it is a great investor tool for analyzing figures and trends.

Even though GDP is used widely, it has been criticized for its shortcomings. It fails to account for the goods and services produced outside the official market. It accounts only for the monetary transactions. The free services provided by the people go ignored. There are many situations where GDP grows because of negative occurrences. For example, if the healthcare industry is booming, the money people spend on medicines, operations, and surgeries increases which are captured as growth of economy even though it implies a deteriorating lifestyle of the society. In another example, if the number of law suits being filed for divorce, crime, corruption cases increase, then the GDP also increases. Depletion of natural resources is treated as current income. If a farmland is converted into a parking lot or if a forest is converted to an industrial area, the money involved in this process will be termed as current income and the capital depreciation wont be taken into account. GDP does not differentiate between depleting assets or generation of incremental wealth.

Apart from the examples mentioned above, the following are major limitations of GDP when it comes to measuring the well- being of the society:

Household production and voluntary work is not covered under the realm of GDP. Black money in the country goes unaccounted and barter services are also not covered under GDP. GDP does not measure the quality of life being led by the people in the country. Sustainability of growth is not accounted for by GDP. A nation may have high economic growth by over-exploitation of natural resources. A country selling oil will be growing continuously but will be losing out on its assets. An economy experiencing a stock bubble or a housing bubble with a low personal savings rate statistically appears to grow faster due to higher consumption, basically a nation mortgaging its future for current growth. The income disparity between the rich and poor is not reflected in GDP. GDP doesnt measure inputs used to produce the output. Herein, an increase in GDP may not reflect the true underpinnings of the output. For it is, if people worked twice the number of hours and the GDP doubles as a result, it doesnt mean that people are better off as they have less time for rest and recreation. The mean wealth not median wealth is reflected in the GDP. For example the gap between the rich and the poor is increasing in developing countries like India. Rich are becoming richer and Poor are getting poorer. It fails to show how equitably the countrys income is distributed. For example, in United States the per capita income has risen by 70% while the median wage has decreased in the same period. It does not account for pollution, environmental degradation, and resource depletion.

There are numerous examples where economic growth was not accompanied by similar progress in human development. Kerala for instance has per capita income of about $ 1000 a year, compared to the national average of $1200. But it is the only state in the country to achieve 100% literacy rate, long life expectancy and a controlled birth rate. Therefore, there is no strong correlation between the quality of life indicators and GDP.

In short GDP measures the growth on quantitative scale whereas development is qualitative improvement. For the development to be sustainable, it should successfully balance economic goals with social and environmental. The following issues should be incorporated in the assessment of a sustainable development: Net income, economic degradation, employment, education and literacy, knowledge and human capital, poverty , availability and allocation of resources and products, health, life expectancy and mortality, safety, crime, quality of life, happiness, leisure, cultural identity, democracy. Human rights, equity, environmental pollution, water and air quality, overconsumption and depletion of natural resources, value of ecosystems, biodiversity loss and deforestation etc. Hence, Sustainability requires an integrated view of the world. It requires multidimensional indicators that show a link between a countrys economy, environment and society. The following approaches have emerged over a period of time to measure sustainable development: Three Pillar Approach The three pillars economic, environmental and social systems are interconnected and are independently crucial. Ecosystem Health Approach It considers economic and social systems as sub-systems of the global environment. It focuses on the pressure placed on ecosystems by human activities and the response of the ecosystems to these pressures (like material extraction and pollutants emissions). Resource or Capital Approach It broadens the concept of economic capital by integrating concepts of economic capital by integrating concepts from physical and social sciences to include measures of human, social, natural and environmental capital.

Happiness Genetics Family friends

Living conditions Economic wellbeing Environment Leisure Health Wealth Non market activity (unemployment)

GDP
consumption Net investment

Depreciation Net income going to foreigners regrettables

Education Work satisfaction Community Ties

(insecurity)

On the basis of the above approaches, new indices have been introduced. The following are a few of the indices that have been used by different countries to measure the development of the economy. They have been explained in brief. a. Measure of Economic welfare (MEW) by Nordhaus & Tobin James Tobin and William Nordhaus in their article Is growth obsolete proposed the Measure of Economic Welfare index( MEW) The following equation explains how MEW is calculated:

MEW = GNP economic bads (pollution, repairs) regrettable necessities (money spent to combat crime, defense) + household production, unreported activities and leisure The problem with this index is that it is hard to correlate happiness with consumption. b. The index of Sustainable Economic Welfare( ISEW) and Genuine Progress Indicator ( GPI) Herman Daly and John Cobb developed ISEW in 1980s. ISEW = Personal consumer expenditure adjustment for income inequality + services from domestic labour costs of environmental degradation defensive private expenditures + non defensive public expenditures + economic adjustments depreciation of natural capital Genuine Progress Indicator is similar to ISEW but incorporates additional elements such as crime, divorce, unemployment and changes in leisure time. c. Green GDP Green GDP is calculated based on the user costs of exploiting natural resources and on the value for social costs of pollution emissions. The flaw in Green GDP is that it focuses only on environmental pollution and does not take into account the depletion costs for mines, forests land, water and wild life and damage to ecosystems. d. Human Development Index ( HDI) HDI measures the achievements of the country in three basic human development dimensions: o Life expectancy o Knowledge measured by literacy rate o Living standard measured by GDP per capita

Dimension index is calculated for each dimension by the following formula: Dimension Index = (actual value minimum target value) / (maximum Target value minimum target value) The HDI is a simple average of the dimension indices. It can be used for formulating policies on health and education and to highlight internal disparities within countries. e. Ecological Footprint( EF) It is a resource accounting tool which measures the extent to which the ecological demand of human economies stays within or exceeds the capacity of the biosphere to supply goods and services. EF measures how much land area is required to sustain a given population at present levels of consumption, technological development and resource efficiency. f. Quality of life index It links the results of subjective life satisfaction surveys to the objective determinants of quality of life across countries. The indicators used in survey are: Material well being (GDP per capita), health political stability, family life, community life, climate, geography, job security, political freedom, gender equality g. Environmental Sustainability Index (ESI) It has 5 building blocks: environmental systems, reducing environmental stress, reducing human vulnerability, social and institutional capacity and global stewardship. Commitment to environmental indicators and greater emphasis on statistical analysis might strengthen environmental problem solving at national policy level. h. Indicators supplementing GDP based System of Integrated Environment and Economic Accounting (SEEA) It is a hybrid accounting system that integrates environmental pressures and economic activities. It comprises of 4 categories of accounts : o Data relating to flows of pollutants and materials o Environmental protection and resource management accounts o Natural resource assets measures in physical and monetary terms which allow monitoring stock changes over time.

Conclusion
Using GDP as a proxy for development fails because GDP is a potential means to development and is not an end in itself. Therefore, it makes sense to examine development by composite measures of the ends themselves: life expectancy, infant mortality rates, literacy, education, happiness rates, etc. Specifically, alternative development indicators such as the HDI are steps toward a more holistic and balanced approach to measuring development.

References: 1. Article on Problems with GDP as an Indicator of Development and Better Alternatives by Julian Dautremont-Smith 2. Article on Towards sustainable development by Arttu Makippa 3. Article on Is GDP a good measure of economic progress?* by Olivier Vaury 4. A report by the EU Parliament: Alternative progress indicators to Gross Domestic Product (GDP) as a means towards sustainable development 5. An extensive article: Real Wealth - use of gross domestic product figures as economic indicator may no longer be valid http://findarticles.com/p/articl... 6.