Accounting

Introduction

Perhaps because we are now in the longest growth cycle in 30 years of U. S. history, there is an increased interest in how we ensure that quality of life is increasing along with the level of GDP. Communities around the nation are grappling with ways to better measure quality of life, unsatisfied with the answer given by traditional measures such as income level or growth rates. There is also a focus in many communities on how to move toward a sustainable economy. Sometimes the terms "sustainability" and "quality of life" are used almost interchangeably, but it is important to keep in mind how they differ.

Quality of life measures focus on outcomes and reflect community values. Depending on the individual values of a particular community one or another of the following questions will have a higher priority than the other. How many bike paths does the community have? How many people have easy access to hunting?

Sustainability, in contrast, refers to the preservation of capital stocks used to produce quality of life, now and in the future. Sustainability relates to the preservation or enhancement of long-run capacities: human, natural, and manmade. Most individuals show more interest in what they have in the present, and have a harder time thinking about whether they are prepared for the future. Thus, it is not surprising that surveys reveal less interest in long-term sustainability issues than in more immediate quality of life issues among the general population.

In the title to this paper I posed a question -" Do the numbers we have determine the questions we ask?" I believe that the answer to this question is in great measure "Yes". Until we systematically collect numbers on a subject -sustainability, quality of life, or any other -- it is unlikely that we will give it a high priority. Businesses, governments and even individuals all like to maximize what they can measure, rather than focusing on more amorphous goals. But before we talk about devising new measures of well being it is important to recognize the reasons for the system we have been using for over half a century.

A brief history of national income accounting: How did we get here?

Over half a century ago, when the U. S. was coming out of the Great Depression and preparing to enter World War II, the first great effort to measure national productive capacity resulted in the national income accounts we still use today. Other countries around the world quickly adopted similar accounting schemes during the next decade or two. The structure of the national income accounts reflected the economic concerns of the day. The first concern was that the full capacity of the capital and labor stocks would not be utilized, as they had not been during the Great Depression. Changes in investment spending, through which private businesses acquire more capital stock, were thought to be a key determinant of the level of utilization. The second concern was that there be sufficient economic capacity to successfully challenge the Axis powers in World War II. While labor and natural resources seemed abundant in 1940 the long depression in economic activity had discouraged investment in private capital.

It is now widely recognized that in focusing on the utilization of the labor force and the capital stock, along with the rate at which additions were made to the private capital stock, the accounts ignored or glossed over other important elements of production. In particular, production relies on the stock of natural capital available and on public infrastructure, in addition to private capital. And while private capital embodies many elements of new technology other elements show up in labor skills (human capital) and new ways of organizing production (management or entrepreneurship). Over the last twenty-five years, we have become increasingly aware of the importance of human capital investment and natural capital preservation. However, we still tend to focus our assessments of how we are doing and our policies for the future on the measures emphasized in our national accounts over half a century ago.

Economic policies and national income accounts

While the questions economists and policymakers were asking sixty years ago shaped the way the national income accounts were formed, the shape the accounts took profoundly influenced the questions economists and policymakers have asked during the last fifty years. Business investment in private capital was often treated as the sole form of investment in economics textbooks and journal articles, in real life tax policy, and in public debate. By the 1970's, spending on public infrastructure as a percentage of national income had fallen substantially. U. S. public policy in the 1980's created tax incentives for private saving and investment but raised national deficits. These made it more difficult to reverse the decline in public infrastructure investment and to increase human capital investment through spending on education. It was difficult for policymakers and economists to see beyond the accounting framework on which they had settled.

On another front, the concept of a "spaceship earth" for which natural resources are finite, and sometimes nonrenewable, has been with us for over thirty years. The inadequacy of conventional national income accounts in this arena is well known. Undergraduate economics texts of the 1970's began to include examples of "goods" which raise the level of GDP but actually create by-products such as pollution that are "bads". Environmental cleanup expenditures dealing with these "bads" raise the GDP even more, and so a system was set up decades ago to separate these cleanup expenditures out in the accounts. Interested parties could then re-subtract (or even double subtract) these clean up expenditures to get a better picture of our actual production of "goods". Of course, this adjustment still doesn't begin to deal with land use issues or the additional infrastructure costs related to a mobile, and sprawling, population. But despite the fact that environmental cleanup costs are separately tabulated in the GDP, they have not received significant attention from policymakers or economists concerned with growth.

Two other measures stand out in sharp contrast to our inability to measure the damage done to natural capital. The first is the computation of the unemployment rate following the Great Depression. This made possible the Full Employment Act of 1946 in which Congress explicitly accepted as its responsibility the support of full employment (as long as it is commensurate with low inflation) through fiscal policy.

The second measure on which we focus a great deal is the level of personal income. Income makes possible consumption of goods and services, and thereby a higher standard of living. We are all aware that only goods and services produced in the market are measured in the national accounts. We know that leisure and household production are both omitted. We know that more of each of these is generally sacrificed in order to gain more income and market goods. Although leisure is clearly a normal good (the tradeoff between household production and market good consumption is somewhat more complex), the average workweek has not been reduced in over half a century. Households actually provide more total hours of market labor today than they did several generations ago due to more two-worker families. While it is true that much of this increase in market labor time is offset by fewer hours of household production it is still quite interesting that large increases in affluence have not led to a demand for more leisure time. Once again, we seem drawn to focus on our official measures of well being to the exclusion of those less well measured.

Sustainability: Physical, Natural, and Human Capital Stocks

Sustainability refers to the relationship between current economic phenomena, such as incomes, prices, and jobs, and long term measures of economic growth and well being. The classic definition of sustainable development, from the UN's Brundtland Commission, is "development that meets the needs of the present without compromising the ability of future generations to meet their own needs". In economic terms this is development that preserves or enhances initial capital endowments - human capital and natural resources as well as physical capital.

Social capital and infrastructure are also important components of the full endowment of capital which sustainability indicators must address. Political scientist Robert Putnam has recently popularized the idea of social capital. It is very similar to the concept of institutions in institutional economics. Production depends on formal and informal institutions to provide the "rules of the game" in business and personal relationships. The system of laws and contracts developed by society, the degree of informal trust between workers and employers, buyers and sellers, citizens and their government, as well as among family members and neighbors, alters the productivity with which a society functions. Two societies may have equal levels of technology and capital equipment, natural resources, public infrastructure, and human capital. If one society has very low trust levels relative to the other, it will spend a larger share of its resources fighting crime, and policing and regulating itself, leaving a smaller share for other goods and services.

Social capital can also be thought of as an intangible form of infrastructure. Sustainability indicators typically address intangible measures such as trust in social institutions or in neighbors as well as levels of volunteerism and civic participation in an attempt to measure the increase or decline in social capital.

The connection between sustainability and capital provides a framework for determining a set of sustainability indicators, which signify changes in the stock of capital. Clean air, uncongested highways, competent high school graduates, and open space areas are examples of various forms stocks of capital. Each stock is used either to produce consumables or consumption services for the current generation, or to replenish, enhance, and preserve capital stocks. The uses of these stocks are often linked, one example being the stock of clean air and of uncongested highways.

Sustainability indicators should show the connection between the various capital stocks. For example, the number of good quality air days is an indicator of clean air, but asthma-related admissions shows the link between natural capital - clean air, and human capital - good health. Population growth increases the potential future labor force, but also strains the existing transportation and educational systems. A growing youth population requires substantial "up front" investment in order to yield future benefits. Increased population may also require a substantial alteration in lifestyles (land use patterns, average commute to work lengths, transportation modes) in order to preserve natural capital stocks.

Changes in most of the current economic and social indicators in use cannot be understood in isolation as "good" or "bad". Most indicators describe components of an economic and social system (ex: more housing starts) rather than desired ends, or goals, such as a broad based increase in the standard of living. To assess changes in the current standard of living one needs "quality of life" indicators. To assess expected changes in the level and quality of the various capital stocks and the inherent linkages between them requires the development of a set of sustainability indicators. These indicators should help policymakers and the public maintain a constant awareness of the interrelationships between physical, human and natural capital in both its private and public forms. For example, policies which increase one kind of capital at the greater expense of another (better highways at the cost of clean air, for example) may be actually antithetical to broad based economic development in the long term.

Has traditional economics led to the wrong patterns for solving today's problems?

Traditional economic thinking viewed private capital as the engine of growth, because it embodied new technologies, which resulted in more efficiency and more output. This resulted in more output, yielding more choices, and eventually a better standard of living. Of course, distribution of the benefits of growth has always been a problem within traditional economics. Not everyone reaps the benefits, and some may even become worse off. But growth at least gave the possibility of a better standard of living for all.

Land and natural resources were once called "free gifts of nature" because they did not require human labor and foregone consumption to create them in the way that manufactured capital did. The irony is that economic growth and the larger world population and use of resources per capita have forced the realization that natural resources are finite. Natural resources once seemed to have the lowest value, because they cost nothing to create, but if they are irreplaceable actually have the highest value. Markets are unable to determine these values accurately because the present value of even a very valuable item far into the future, because the length of years intervening cause it to be so heavily discounted.

Human labor was also valued less than capital in early economic thought. The agricultural revolution increased food supply, and thereby the population of the unskilled. It is only in recent times we have realized that technological progress is embodied in human beings more than machines. The rebuilding of western Europe and Japan after the destruction of their physical plant in World War II, based on the skills (and social capital) of the population, should have made this abundantly clear to economists and policymakers of the 1950's and beyond. Instead, analysis seems to have been driven by what we knew how to measure and what we had committed to measuring.

Quality of life and sustainability issues raised in the late 1960's and the 1970's took a back burner for several decades as the U. S. economy struggled with poor productivity growth as well as high inflation and/or unemployment rates. Now, far into the longest expansion of the last thirty years, these questions are once again coming to the fore. They are being addressed more often at the local level, rather than the national, which is in many ways appropriate. Non-economic measures needed to supplement income are often specific to a particular community. A great deal of the natural capital , public infrastructure, and social capital which a community depends on is specific to that community, although as a nation and a world we certainly share other elements and depend on the well-being of capital stocks not in our back yards. Similarly, the elements commonly listed as quality of life measures (see Jacksonville, Florida) are also highly community specific. Thus, it is likely that a great deal of the movement for quality of life and sustainability indictors will occur at the local level. An interesting challenge for economists is how these will be reconciled with our national income accounts.

SELECTED REFERENCES

• Blomquist, G., M. Berger, and J. Hoehn. 1988. "New Estimates of Quality of Life in Urban Areas." American Economic Review, March.
• Brundtland Commission. 1987. Our Common Future. Oxford University Press.
• Chiras, D. 1994. Sustainable Development in Colorado. Colorado Sustainability Project.
• Daly, Herman E. 1977.Steady State Economics. W. H. Freeman & Co.
• ___________ and R. Cobb. 1989. For the Common Good. Beacon Press.
• Ekins, P. 1992..Green Economics. Doubleday Press.
• England, Richard W. 1997. "Alternatives to Gross National Product: A Critical Survey," Human Well-Being and Economic Goals. Island Press.
• Hart, Maureen. 1999. "Guide to Sustainable Community Indicators, 2nd edition", Hart
• Environmental Data, P. 0. Box 36 1, North Andover, MA 01845.
• Norris, T. 1997. The Community Indicators Handbook. Redefining Progress.
• Putnam, Robert. 1995. "Bowling Alone: The Strange Disappearance of Civic America," Journal of Democracy 6: 65-78.
• Tietenberg, T. 1992. Environmental and Natural Resource Economics. Harper Collins.
• Tomen, M. 1992. "The Difficulty in Defining Sustainability," Resources 106, Winter.
• Weaver, James H., Michael T. Rock, and Kenneth Kusterer. 1997. Achieving Broad-Based Sustainable Development: Governance, Environment, and Growth with Equity. Kumarian Press.

SELECTED WEBSITES

• Central Texas (Austin) http://www.austinindicators.org/reports/
• Jacksonville Florida www.unf.edu
• Seattle, Washington www.scn.org/sustainable

This paper was first presented at the Southwest Economic Association meetings, March 2000, Galveston, Texas. I want to thank Michael Mueller for the contributions he has made to my thinking through our joint work on sustainability.