A national accounting framework for environmental assets

JOURNAL OF ENVIRONMENTAL ECONOMICS AND MANAGLMENr

2, 255-262 (1976)

A National Accounting Framework for Environmental Assets1 HENRY M. PESKIN Resources for the Future, htc., 1755 Massachusetts Ave., N. IV., IVashhtgton, D. C. 20036

Received May 10, 1975; revised December 29, 1975 A procedure is discussed for entering the values of service flows and associated environmental damages into a system of national economic accounts. The proposed double entry accounting system is based on the theory of externalities and the optimal management of environmental assets. The resulting sector accounts consolidate into an expanded gross product account. Four alternative gross product measures are consistent with this consolidated account. Each of these has its own advantages for special purposes. Thus, it is argued that there is no uniformly best adjustment to the conventional measure of gross national product. INTRODUCTION This paper discusses a procedure for entering into a system of national accounts imputations of the values of flows associated with environmental assets. This procedure is logically consistent with the theory of externalities and the relationship between this theory and the principles of optimal management of environmental assets. ~ It also conforms to standard national accounting procedures, especially as practiced in those countries that create their consolidated accounts from industrial input-output accounts. The accounting framework discussed here represents one aspect of a large effort by the National Bureau of Economic Research to improve upon existing national accounts and thereby develop better measures of social performance. With respect to the treatment of environmental problems, the need for improvement to at least the G N P measure has been expressed in both the popular press and in more academic publications by Herfendahl and Kneese [-4], Juster [6], and Olson [-10"]. However, the conventional G N P accounts have been defended by Denison [ 2 ] and Jaszi I-5]. The accounting framework discussed here and its implications for national gross product measures should help clarify the debate. T H E T H E O R Y O F ASSET-SERVICE A N D R E S I D U A L S V A L U A T I O N One basic premise underlying much of the following discussion is that while otherwise undesirable, the generation of residuals is beneficial to the polluter. The theory *Much of the accounting framework discussed in this paper is a joint product of the author and Richard and Nancy Ruggles. lte wishes to thank the Ruggles for their valuable suggestions. This research was supported by the National Science Foundation. ~-Thus, the next section of this paper depends heavily on such articles as [1, 15-1,both basic to the externality literature. Examples of applications of this theory to environmental problems are [8, 13"1. Mohring and Boyd [9] present a good discussion of the relationship between environmental asset use and externalities. 255 Copyright ~ 1976 by Acadcmlc Press, Inc. All rights of reproduction in an)" form rcscrvcd.

256

HENRY M. PF_SKIN MU~,-MUG MUs,-MU ~

j

-MUG

I Residual

I I

I I

)f A=f(r)

Asset

Use(A)

FzG. I. Relationship between residual generation, asset utilization, and their optimal allocation. behind this premise requires that the concepts of "polluter" as opposed to "pollutee" be defined with care. The polluter refers to any agent in the society that generates a residual or otherwise consumes the service of a (nonmarketed) environmental asset directly or indirectly. The pollutee refers to any agent in society whose utility may be (usually adversely) affected by the polluter's activity, either directly or indirectly. It is not necessary for the polluter and the pollutee to be distinct individuals. In fact, it is usual for a given individual to be both a pollutee and a polluter at the same time) An admittedly artificial and simple model is sufficient to demonstrate that polluters generally place one value on the consumption of environmental asset services while the pollutee implicitly places a different value (with opposite sign) on these same services. The pollutee's valuation of these asset services is somewhat indirect. His primary concern is the damage caused by the residuals that are generated as the polluter uses the environmental asset. His valuation is also affected by any other disbenefit he may suffer if the polluter's activity limits his use of the asset. However, as long as there is a monotonic relationship between asset use and the flow of residuals, the pollutee's valuation of the residuals can be converted into an implicit valuation of the polluter's asset services. ~ If it is assumed that there is only one environmental asset, one residual, and that all polluters and pollutees can be aggregated into two groups, and thus be considered as a single polluter and single pollntee, the simplified model can be diagrammed as shown in Fig. 1. The polluter is assumed to derive a positive marginal benefit, MUB, from each unit of asset used, A. The relationship between MU/; and A is shown in 9 quadrant IV. As file asset is used, wastes are emitted. As a consequence, the pollutee is assumed to suffer a marginal damage or negative benefit equal to - - M U a . The relationship between these waste residuals, !" and - M U c , , is shown in quadrant 1. 3 Often the distinction between polluter and pollutee is an institutional one. Lairs and courts often grant implicit property rights or "ownership" over environmental assets to particular groups and individuals. Those who receive these rights are consequently the pollutees while those who are denied the rights, the polluters. Moreover, often these rights have shifted over time. In the following, we assume that all pollutee disbenefits are due to the flow of undesirable residuals. Of course, for long-lived residuals, the stock rather than the flow may be more important.

ACCOUNTING FOR ENVIRONMENTAL ASSETS Input

257

Output

VA~ --EA,NEB,. (=EA~ -- R~)

--R~

Sector input - R~

Sector output -- Ri

Fro. 2. Typical input-output account sector i. The means to express these marginal benefits and damages in dollar terms is provided by the theory of cost-benefit analysis) In principle, M U ~ will be measured by the social opportunity cost that faces the polluter as he is denied access to successive units of the environmental asset. Again in principle, - - M U o will be measured by the least amount the pollutee is willing to pay either to avoid successive units of damage or to deny the polluter access to successive units of the asset. In practice however, data limitations inhibit close fulfillment of these principles. 6 The connection between residuals and asset use is described by the function, A = f ( r ) , shown in quadrant II. This function and the 45 ~ line in quadrant III permit a mapping of the polluter's marginal benefit as a function of asset use, the function MU1~ in quadrant IV, into an equivalent relationship showing marginal benefit as a function of residual damage, the function MU'1~ in quadrant I. Similarly, the marginal damage function, - - M U a , in quadrant I can be converted into an equivalent form showing marginal damage as a function of asset use, the function - - M U ' a in quadrant IV. Of course, in practice, the relationship between asset use and the level of residual damage depends in a rather complex way on the geographical configuration of polluters and pollutecs, meteorological conditions, hydrology (with respect to water-borne residuals), etc., all of which are deceptively summarized by the function A = f ( r ) . However, the real-world complexities should not obscure the basic connection between residual damage and asset use demonstrated in Fig. 1.7 Moreover, real-world complexities should not obscure one other important implication of the model: namely, that except for asset use at level E', equivalent to residuals at level E, the absolute magnitude of the marginal evaluation of asset use and residuals by the polluter and the pollutee will differ. As is well-known, E and E ' represent utility-maximizing residual generation levels and asset allocations, respectively. However in the absence of well-functioning markets for environmental assets or in the absence of optimal environmental management on the part of the government, there is no reason why residual levels or asset allocations should be at this optimum. Another way of stating the implication of the model is that except for optimal asset allocation or residual levels, there is no single number that simultaneously for both polluter and pollutee can represent the absolute value of a given unit of asset service 5See Haveman and Weisbrod 1-33 for a good discussion of this theory and its application to environmental issues. A monograph discussing the methods for making these imputations is being prepared by the author. 7 Certain externality problems involve competition for environmental assets without any residual generation, e.g., highway congestion problems. This does not make the model invalid. It only suggests" that the function A = f(r) falls on the vertical axis in quadrant II, yielding no mapping into quadrant I. Thus, only quadrant IV would be necessary to describe the marginal benefit relationship.

258

IIENRY M. PESKIN

or residual. The model thus suggests that any national accounting system that attempts to account for environmental externalities should accept two valuations--one from the polluter's point of view and one from the pollutee's. 8 Fortunately, a standard input-output sector accounting framework accepts these two valuations quite easily. INDIVIDUAL SECTOR A C C O U N T I N G Figure 2 shows a typical industrial input-output account for sector i expanded to include the values of environmental asset services. The sector, in its role as a polluter, uses environmental asset services for purposes of waste disposal, as a source of chemicals (e.g., the oxygen in air), a transport medium (e.g., the use of water to convey process materials), etc. These services are valuable inputs to the production process and their imputed values thus enter on the input side of the account (the entry --EA;). As a matter of convention, this entry will be valued negatively. The imputed value of the damage, due to this use of the environment--the pollutee's valuation--is treated as a negative output, --R;. Keeping in mind that in general --EA; and --R~ will not be equal, a balancing entry equal to their difference is required to maintain balance in the sector accounts. This entry is termed the "net environmental benefit," NEB;, and by definition is equal to EA~ -- 12;. In effect, NEB~ measures the net value of the environmental asset: its total service value, EA;, less the "disvalue", /2~, due to pollution damage. The other account entries are conventional: M;, the purchased inputs, VA,., value added, and P:, sales of outputs. Note that gross sector output is equal to conventionally measured output less environmental damage. F I N A L DEMAND ACCOUNTS In input-output accounting, final demand sectors, by definition, include those governmental and household activities that produce nothing, but receive, as inputs, consumption goods, governmental purchases, investment goods, and exports less imports? The modifications for environmental accounting requires only one change to this approach. Since final demand activities account for a large portion of environmental asset use and the generation of residuals, there should be explicit entries, - - E A r and --Rr, for final demand asset use and damage, respectively, as well as the balancing entry NEBr. THE N A T U R A L SECTOR A natural sector is introduced into the accounting framework for two purposes. In the first place, this sector is necessary to "close" the system. It is the "producer" of all environmental asset services and net environmental benefits and the "consumer" of all environmental damages. In the second place, nature is in fact a major source of environmental damage. A large portion (indeed, often the major portion) of the generation of air and water pollutants have natural origins. Particulates, nitrogen oxides, and dissolved inorganic salts are prime examples. Thus, an entry, - - R x , accounting for natural damage is This dual valuation also applies to in-kind governmental transfers such as public housing. This fact and its implications for national accounting is discussed by Smolenskyet aL 1"14]. 9Those governmental and household activities that produce output--such as governmental corporations-are treated the same as private industrial sectors.

A C C O U N T I N G FOR E N V I R O N M E N T A L ASSETS

Input

Output

-R

(R= ~ R i + R r + R x ) NEBx(= -R

-Rx)

259

--EA (EA = ~ E A ~ + E A r ) NEB (NEB = ~] NEB~ q- N E B r q- NEB.v) --R.v NEB--EA (Since N E B

= --R ~ E A -- R)

FIG. 3. Natural sector input-outputaccount.

included as an output of the natural sector. The balancing entry NEB,v identically equals --:-.Ru since EA,v is assumed to equal zero. The input-otttput accounting for this sector is schematically shown in Fig. 3. THE CONSOLIDATED ACCOUNT The industrial, final demand, and natural accounts consolidate into a modified gross national product account. This consolidation is shown schematically in Fig. 4 . To simplify the presentation, natural damage, Rx, has been included with the aggregate damage, R, generated by the industrial, household, and governmental sectors and is thus not shown separately. Similarly, NEBx has been subtracted f r o m both sides of the natural sector account. By so doing, the NEB "produced" by nature excludes NEB,v and is consequently exactly equal to the NEB "consumed" by industries, households, and governments. It can be seen that the consolidated gross national product total can be presented in four alternative ways, depending on how many items common to both sides of the account are subtracted out. Each of these alternatives will be discussed in turn.

Alternative 1 The first alternative modifies conventionally measured G N P ~~by adding in the net product of nature, NEB, equal to EA-R. Since NEB can be positive, negative, or zero, G N P modified to include the services of environmental assets can be greater or less than conventionally measured G N P or there may be no effect. Inspection of Fig. 1 and common sense suggest that EA will tend to exceed R in absolute value the less the environmental asset is used. However, a more precise comparison of EA and R depends on how these values are measured. The curves in Fig. I only indicate the marginal values. The corresponding total value for either EA or R can be obtained by measuring the area under the marginal curves. This value will be termed tile total vahtation. Another valuation is the marghlal vahtation which equals the number of asset services consumed (or units of residual generated) times the value of the marginal unit. This marginal valuation is the exact analog to the price-times-quantity valuation used for ordinary goods in the national accounts. 10 In order to highlight the modifications due to the inclusion of environmental assets, conventional

GNP has been left unmodified. This should not leave the reader with the impression that the adjustments proposed in this paper are the only ones the author feels worth making. Under the aegis of the National Bureau of Economic Research Social Measurement Project, many other adjustments to conventional GNP are bein~ investiaated, many of which may be of far greater quantitative significance.

260

HENRY M. PESKIN Income originating Industries, households, and governments

Final expenditures

~VA(EA-_ ~ VA,)

GNP

~NEB**

--R*

Nature

--R*

Total

"Alternative 1: VA + NEB Alternative 2: VA-R Alternative 3: VA + EA Alternative 4: VA

--EA

NEB** GNP -b EA -- R or GNP -k NEB GNP -- R GNP -b EA GNP

FI~. 4. Consolidated gross national product account. Notes: *, includes R,v; **, excludes NEB.v (see text). Using the total valuation to measure R and EA, little can be said about their relative magnitudes, even when asset use and residual levels are at the optimum points E and E' in Fig. 1. However, if the marginal valuation is used, the following can be stated unambiguously. If actual asset use and pollution levels are less than E and E', then lEA[ > ]RI; if greater than E and E', then IEAI < IRI; if equal to E and E', lEA[ = !R I. The implication of this is that if G N P modified by the addition of NEB is accepted as the "correct" GNP, then in periods when there is less than optimal use of the environment, conventionally measured G N P understates the "correct" GNP. In periods when there is greater than optimal use of the environment, conventionally measured G N P overstates "correct" GNP. Finally, if the environment were optimally managed, NEB would equal zero and conventional G N P would be the "correct" measure. Thus, if marginal valuations of EA and R are possible, n NEB can be used as an indicator of successful environmental management.

Alternative 2 The second alternative modifies conventional G N P by subtracting out the value of residual damage. This is also equivalent to the sum of conventional G N P and the gross output of nature, --R. The idea that conventional G N P would be a better welfare measure were it diminished by the amount of residual damage has a considerable amount of popular support among general critics of the GNP. This adjustment has been rigorously defended by Olson [-10-] using the theory of public goods and externalities. Furthermore, both Olson and Juster have noted in private discussion with the author, that Alternative 1 can be faulted--at least as a welfare measure--because including both G N P and EA involves doublecounting. The logic of the position is based on the notion that an increase in EA--i.e., an increase in the use of the environment--will free scarce resources and thus permit conventional G N P to rise. Thus, to add NEB to GNP measures the social benefit of EA twice: first, as a benefit to the n A method for approximating marginal valuations, giving estimates of total valuation is discussed in [-11].

ACCOUNTING FOR ENVIRONMENTAL ASSETS

261

producer and secondly, as a benefit to final consumers. Moreover, since EA is intended to account for the full social opportunity cost of denying the polluter a unit of environmental asset, these two benefits could be very closeY- Of course, because of the practical difficulty of estimating EA, empirical estimates of marginal changes in EA will be difficult to associate with specific changes in the components of GNP. Alternative 3 The third alternative adjustment to conventional G N P is to add in the total of environmental asset services, EA. In view of the previous discussion, such an adjustment, because of doublecounting, would not serve the purpose of making G N P a better welfare measure. However, one other traditional purpose of the G N P measure is that it provides an index of a society's productive capacity. In terms of this purpose, adding in EA makes sense in that the sum of G N P and EA would measure the total man-made and natural productive services. Indeed, the ratio of EA to conventional G N P could be used as an indicator of a nation's dependence on the environment or the "importance" of the environment to the nation. Alternative 4 The final alternative adjustment to conventional G N P is to make no adjustment at all. Of course, since NEB, EA, and R all could be zero (assuming they are measured with the marginal valuation), this alternative could coincide with any of the other three. Yet even in the usual case where this alternative will be different, it may be preferred for certain purposes. Essentially, conventional G N P , while perhaps not a desirable welfare measure, is a measure of the productive capacity of human resources alone. In view of the fact that economics traditionally has dealt with human activity, the feeling that it is best not to alter the conventional G N P measure should not be dismissed lightly. FINAL COMMENT The accounting framework presented here has the virtue of providing a way of displaying information that could serve many purposes--including the construction of the four alternative gross product measures discussed above. The fact that all four alternatives are consistent with the framework should put to rest the debate on which is the "best" way of adjusting the G N P in order to reflect the environment and the problems of pollution. There is no best way. The first alternative seems preferable for environmental management purposes; the second, as a welfare measure; the third, as an index of total productive services; and the fourth, as an index of human productive services. N o single alternative measure can serve all these functions simultaneously. It is not the purpose of this paper to advocate the adoption of any of these alternative indexes. What is being advocated is an internally consistent national accounting system that allows environmental assets to share a role with other assets as contributors to the operation of our economy. Efforts to implement this system have already demonstrated its value as an efficient organizer of an ever-growing body of environmental cost and benefit data. x2They would be identical if conventionally measured GNP accounted for all social benefits and if use of EA did not imply a reduction in some harmful residuals--a phenomenon that is technically possible under certain circumstances.

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H E N R Y M. PESKIN REFERENCES

1. J. M. Buchanan and W. C. Stubblebine, Externality, Economica 371-384 (1962). 2. E. F. Denison, Welfare measurement and the GNP, Sttrve)" o f Cttrrent Bttshtess (January 1971). 3. R. Haveman and B. Weisbrod, The concept of bcnefits in cost-benefit analysis with emphasis on water pollution control activities," hz "Cost Benefit Analysis and Water Pollution Policy" (H. M. Peskin and E. P. Seskin, Eds.), The Urban Institute Washington, D. C. (1975). 4. O. C. Herfindahl and A. V. Kneese, Measuring social and economic change: benefits and costs of environmental pollution, bl "The Measurement of Economic and Social Performance," (M. Moss, Ed.), Studies in Income and Wealth, Vol. 38 The National Bureau of Economic Rcscarch, New York (1973). 5. G. Jaszi, Comments on F. Thomas Juster, A framework for the measurcmcnt of economic and social performance, hz "The Measurcmcnt of Economic and Social Performance" (M. Moss, Ed.), Studies in Income and Wealth, Vol. 38 The National Burcau of Economic Research, New York (1973). 6. F. T. Juster, A framework for the measurement of c'conomic and social performance, h~ "The Measurement of Economic and Social Performance" (M. Moss, Ed.), Studies in Income and Wealth, Vol. 38, The National Bureau of Economic Research, New York (1973). 7. F. T. Juster, On the measurement of economic and social performance, in "50th Annual Report of the National Bureau of Economic Research, pp. 8-24 (September, 1970). 8. A. V. Kneese, R. U. Ayres, and R. C. d'Arge, "Economics and the Environment," Resources for the Future, Inc. John Ilopkins Press, Washington (1970). , 9. 11. Mohring and J. Boyd, Analyzing "externalities": "Direct interaction" vs. "asset utilization" frameworks, Economica 347-361 (1971). 10. M. Olson, "The Evaluation of Public Performance" Unpublished manuscript (undated). I 1. H. M. Peskin, "Environment Assets, Residuals, and National Accounting," Unpublished monograph (April 30, 1974). 12. II. M. Peskin, National accounting and the environment: A progress report," Social Indicators Res. 2, No. 2, 191-210 (1975). 13. R. G. Ridker, "Economic Costs of Air Pollution," Praeger, New York (1967). 14. E. Smolensky, L. Steifel, M. Schmundt, and R. Plotnick, "Adding In-Kind Transfers to the Personal Income and Outlay Account: Implications for the Size Distribution of Income," Discussion Paper 199-74, Institute for Research on Poverty, University of Wisconsin (March 1974). 15. R. Turvey, On divergences between social cost and private cost, Economica 309-313 (1963).