Goodbye GDP, Hello IWI

RIO DE JANEIRO – The cost of last year’s extreme floods around the world amounted to billions for insurance companies, and as a result gross domestic product (GDP) rose by a similar amount and was listed as growth in national accounts. This creative accounting method might sound dubious, but that’s how it’s done.

When growth and economic activity is measured, it’s still the GDP method that is used. Whether it’s the Department of the Treasury preparing calculations, the Central Bank conducting monetary policy or investors and companies planning their activities. However, the UN now asserts that this calculation method lives on borrowed time. According to the UN, the current economic thinking leads to irreversible destruction of natural resources that will leave future generations worse off. To rectify this, the UN has introduced a new form of measurement – the Inclusive Wealth Index (IWI).

"It is time to phase out the GDP as a proxy for growth in the 21st century. GDP completely ignores the central themes of human welfare as social issues and the importance of natural resources," said Achim Steiner, Head of the UN Environment Program at the launch in Rio, and urged government leaders to adopt the new method.

The IWI highlights nuances in different countries' evolving wealth by incorporating the changes in the produced capital (machinery, buildings, etc.), human capital (education, health, etc.) and natural capital (natural resources, land, etc.). IWI was presented alongside a new report that evaluates 20 different countries' development from 1990 to 2008, measured against the new index. And it presents some interesting results. Norway's GDP, for example, has increased by 51% during the period, but due to its consumption of natural capital (primarily oil and gas), their growth has risen by only 13% when measured by Inclusive Wealth Index. Conversely, Germany's GDP increased by 30%, but because of their massive investment in human capital their IWI increased by 38%. Japan is the only country in the report whose natural capital didn’t decline, due to an increase in forest area.

Peter Andersen, Professor of Economics at Copenhagen University and special expert with the Danish Environmental Economic Council, believes the idea is fundamentally right and emphasizes that this kind of thinking is required in order for future generations to have at least the same standard of living now. "If you are using natural resources, then other capital such as human capital has to increase accordingly. Thus, there can be a trade off between knowledge and natural resources. This is what is referred to in economic terms as "genuine savings". Genuine savings is the sum of the increase in produced capital, human capital and natural capital. And to avoid a decline in genuine savings when natural capital is reduced, the other forms of capital need to increase. This is controversial for some, but it makes sense in my opinion," says Andersen. Furthermore, he mentions that if oil resources are reduced, but our research and knowledge creates other energy sources such as wind, solar, etc., then the consumption of oil has added overall value by fuelling such research endeavours.

According to Andersen, there isn’t anything theoretically or methodologically new in the IWI. "The genuine savings principle is common knowledge amongst environmental and resource economists, and has also been used several times in the Danish Economic Council," says Andersen and predicts that if the thinking behind the index is integrated into economic policy, it will result in a long-term focus on the development in living standards, and less on cyclical fluctuations.

Kim Füchsel, Managing Partner at audit and consultancy firm PwC that advises the largest companies in Denmark, recognises the trend and believes that resource efficiency is already a competitive factor: "We are born with a children's savings with few natural resources, which we carelessly use up. As long as the full costs of manufactured products not included in the price (for example environmental costs), we will continue to see the waste of resources and pollution. However,if companies want to survive in the long run, they need to be sustainable." He also points out that the bill must be paid at some point in the future, thus affecting our long-term growth.

UN will prospectively publish the new index every two years.

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