Chapter 7: Environmental and Natural Resource Economics
In 2019 the government of the United Kingdom asked an economist a question that sounds simple and turns out not to be. Sir Partha Dasgupta, an economist at Cambridge who was born and schooled in India, was invited to lead an independent review of the economics of biodiversity — in plain words, to work out what living nature is worth to an economy, and why the usual measures of national success never seem to notice when it disappears.
His review was published in 2021. Its central argument was blunt. Economies are embedded within nature, not placed alongside it. A country keeps careful accounts of its factories, its roads and its bank balances, and depreciates each of them as they wear out. It keeps no such account of its soils, its aquifers, its fisheries or its forests. So when a forest is felled, the timber enters the national accounts as income, and the loss of the forest enters nowhere at all. The books balance. The country does not.
Around the same time, statisticians at the United Nations were building a common framework so that countries could record their environmental stocks alongside their economic ones. India has been working on such accounts too.
This chapter is about that gap in the ledger, and about the tools economists have built to close it.
Diagram
Fig. 7.0-1 – a balance-sheet illustration: left panel headed “Counted” showing a factory, a road, machinery and a bank passbook; right panel headed “Not counted” showing a forest, a river, topsoil and a fish shoal, drawn faintly; a single set of weighing scales below, tilted towards the left panel
Work through this chapter, and you will be able to answer each of these questions yourself.
7.1 Resources, Scarcity and Growth
7.1.1 What a Resource Is
Look around the room you are sitting in. The iron in the window grill came out of an ore body in Odisha or Chhattisgarh. The wood of the desk grew for two or three decades before it was cut. The water in the tap fell as rain, soaked into the ground and was pumped back up. None of these things arrived as furniture, taps and grills. Each one began as something in the earth, the air or the biosphere, and became useful only after human effort and knowledge were applied to it.
That is the whole idea behind the word resource. A resource is any source or supply from which a benefit can be produced. Materials, energy, land, water, skills, information and even organised labour are all resources in the economist’s sense. A natural resource is the subset of these that occurs in nature independently of human activity — the mineral in the ground, the fish in the sea, the timber on the hill, the aquifer under the field.
Three characteristics have to hold together before something is treated as a resource. It must have utility, meaning it can satisfy some want. It must be available in a limited quantity, so that using it involves a choice. And it must actually be consumed or used up in some form. Notice what this implies: a thing is not a resource simply because it exists. Uranium lay in the earth for the whole of human history without being a resource, because nobody could use it. The rock did not change in 1900. Human knowledge did.
Almost no natural resource is used in the form in which it is found. Bauxite is not aluminium; crude oil is not diesel; standing river water is not drinking water. Each has to be surveyed, extracted, transported, processed and distributed, and every one of those steps costs energy, money and, very often, some environmental damage of its own. This is worth holding on to, because it explains why the price a consumer pays for a resource is almost never the same as the cost of taking it out of nature.
7.1.2 Classification of Natural Resources
Natural resources can be sorted in several different ways, and each way of sorting answers a different question. Classifying by origin tells you where a resource came from. Classifying by renewability tells you whether it can be replaced. Classifying by stage of development tells you whether it is usable yet. Classifying by distribution tells you where it is found. A single resource therefore carries several labels at once — coal is biotic, non-renewable, actual and localised — and each label matters for a different decision. Fig. 7.1-1 sets out the four bases side by side.
Diagram
Fig. 7.1-1 – classification tree of natural resources; single root box “Natural Resources” branching into four labelled bases: “Origin” → Biotic, Abiotic; “Renewability” → Renewable, Non-renewable; “Stage of development” → Potential, Actual (with Actual sub-branching to Reserve and Stock); “Distribution” → Ubiquitous, Localised; one example named under each end box
7.1.2.1 On the Basis of Origin
A biotic resource is one obtained from the living world — the biosphere — and made of organic material. Forests, crops, livestock, fisheries and wildlife are the obvious cases. Coal and petroleum belong here too, which surprises students at first: both were formed from the buried remains of plants and marine organisms over geological time, so their origin is organic even though nothing about a lump of coal is alive.
An abiotic resource is one obtained from the non-living, inorganic world. Land, water, air, sunlight, and metallic ores such as gold, silver, copper and iron are all abiotic. The test is origin, not usefulness: soil is a mixture of both, since its mineral fraction is abiotic and its humus and soil organisms are biotic.
7.1.2.2 On the Basis of Renewability
This is the classification the syllabus asks you to be surest about, because almost every argument in environmental economics turns on it.
A renewable resource is one that is replenished by natural processes at a rate comparable to the rate at which it is used. Solar radiation, wind, flowing water, forests, fisheries, soil fertility and groundwater are all renewable. Within this group, sunlight, air and wind are sometimes called perpetual resources, because they arrive continuously and human consumption does not reduce the flow, although at any one place and time the flow is limited.
The other renewables behave very differently, and the difference is a matter of speed. A wheat crop replaces itself in a season. A pond fishery recovers over a few years. A teak forest needs decades. A confined aquifer may take centuries to refill. The word “renewable” therefore promises nothing at all by itself. What matters is the comparison between the rate of extraction and the rate of regeneration. Where extraction exceeds regeneration for long enough, a renewable resource is depleted exactly like a non-renewable one — this is what has happened to several inland fisheries and to groundwater across large parts of north-western India.
A short calculation makes the point concrete. Suppose the aquifer under a small town receives an average annual recharge of \(R = 120\) million litres from rainfall and canal seepage, while the town and its farms withdraw \(W = 150\) million litres each year.
\[\text{Annual overdraft} = W - R = 150 - 120 = 30 \ \text{million litres per year}\]
As a proportion of recharge, that overdraft is
\[\frac{30}{120} \times 100 = 25\ \text{per cent}\]
The town is withdrawing a quarter more water each year than nature returns. If the usable stored volume of the aquifer is 900 million litres, then at this rate
\[\frac{900}{30} = 30 \ \text{years}\]
is roughly how long it can continue before the usable store is gone. Nothing in the arithmetic is difficult. What it shows is that renewability is not a property of the water but a relationship between the water and the pump.
A non-renewable resource is one whose stock is fixed for practical purposes, because it forms over geological time — millions of years — while it is consumed over decades. Coal, petroleum, natural gas and all metallic and non-metallic minerals fall here. Some non-renewables, such as metals, can be recycled and re-enter use many times, so the stock in circulation is not lost even though the ore body is. Others are destroyed in the act of use: coal and petroleum are burnt, and cannot be recovered from the exhaust.
There is a further group that depletes without any human involvement at all. Radioactive elements such as uranium decay steadily into other elements whether or not anyone mines them, so their natural stock falls with time regardless of demand.
7.1.2.3 On the Basis of Development
This classification asks a practical question: has the resource been found, measured and made usable yet?
A potential resource is known or believed to exist in a region but has not yet been put to use. Petroleum trapped in sedimentary basins offshore, or a mineral belt that has been geologically mapped but never drilled, is a potential resource. It is real, but it does nothing for anybody yet.
An actual resource is one that has been surveyed, whose quantity and quality have been determined, and which is being used. What converts a potential resource into an actual one is rarely nature. It is technology and cost — a deposit becomes actual when someone works out how to extract it at a price the market will bear.
Actual resources are often described further in two ways. A reserve resource is the part of an actual resource that can be developed profitably with present technology, and is therefore held for future use. A stock resource is a material that has been surveyed and is known to be there, but which cannot yet be used because the technology does not exist or is not viable — hydrogen as a widespread fuel is the standard example. The boundary between these categories moves constantly, which is why announcements about a country “running out” of a mineral should be read carefully: what is usually meant is that the profitable reserve has shrunk, not that the material has vanished.
7.1.2.4 On the Basis of Distribution
A ubiquitous resource is found more or less everywhere — air, sunlight, and in most inhabited regions, water. A localised resource is confined to particular places: copper, iron ore, coal seams, mineral sands, geothermal heat.
This distinction looks trivial and is not. Localisation is the root of a great deal of trade, of a great deal of transport energy, and of a great many disputes over who owns what lies beneath a piece of ground. A country with no petroleum must import it, and that single fact shapes its trade balance, its foreign policy and its emissions. A district with a rich coal seam gains employment and revenue, and bears the dust, the subsidence and the displacement that come with extraction. Where a resource sits determines who benefits from it and who lives next to the cost of taking it out.
Resources are also classified by ownership — individual, community, national and international — and this cuts across everything above. A pond owned by one household, a village grazing common, a national forest and the open ocean are four completely different management problems, even where the resource itself is identical.
7.1.3 Scarcity as an Economic Problem
Human wants are effectively unlimited and they renew themselves. Satisfy one, and another appears behind it. The means of satisfying them — resources — are limited at any given moment. That mismatch is the starting point of all economics, and it has a precise name.
Scarcity exists when the quantity of a good or service that people want at a given price is greater than the quantity available. Note the two halves of that sentence. Scarcity is not the same as rarity, and it is not the same as being small in quantity. It is a relationship between what is available and what is wanted.
This is why economists insist that air is scarce even though it is free. Ordinary air to breathe is not scarce — there is more than anyone wants. But clean air in a busy city is wanted by more people than can have it, which is exactly why cities spend money on emission standards, filters and monitoring. The moment a positive price is paid for something, in money or in effort, its scarcity has been revealed.
Because resources are scarce, every use of them involves giving up an alternative use. Land put under a housing colony is land not under a crop; money spent on a dam is money not spent on watershed restoration; a stretch of river used to dilute effluent is a stretch not available for fishing. The value of the next-best alternative that has to be given up is called the opportunity cost of a decision. It is the single most useful idea in this chapter, because it forces the question that environmental economics exists to ask: what was given up, and was it counted?
Scarcity also creates the need to economise — to allocate limited means among competing ends so as to get the most out of them. Every society faces this, whatever its political arrangement, because the constraint is physical rather than ideological.
7.1.4 Growth and the Pressure on Resources
Economic growth is an increase over time in the quantity of goods and services an economy produces. It is usually measured as the annual percentage increase in national output, and it is the single number by which economies are most often judged.
Growth and resources are tied together at both ends. At the input end, producing more goods generally requires more materials, more energy, more water and more land. At the output end, more production means more waste, more effluent and more emissions. The environment is therefore serving two roles at once: it is the source from which materials and energy are drawn, and the sink into which residues are returned. Both roles are finite, and both can be overloaded.
The two roles are also linked. A river used heavily as a sink becomes less useful as a source — a stretch that receives untreated effluent cannot supply drinking water. Damage to the sink function therefore reduces the source function, and the loss shows up twice.
None of this means growth must damage the environment in fixed proportion. How much material and energy an economy uses per unit of output — its resource intensity — varies enormously with technology, with the mix of what it produces, and with how carefully its waste is handled. Two economies producing the same value of goods can differ several-fold in the tonnes of material they draw and the tonnes of waste they emit. The debate in this subject is not whether growth is permissible; it is whether, and how far, output can rise while resource use and emissions fall.
That debate has two serious positions, and you should be able to state both. On one side, growth has been the main historical driver of rising life expectancy, literacy and the reduction of extreme poverty, and richer societies have generally been the ones able to afford sewage treatment, cleaner fuels and protected areas. On the other, the material throughput of the world economy has risen alongside output for two centuries, several key stocks are visibly being drawn down faster than they regenerate, and the improvement in efficiency per unit of output has repeatedly been outrun by the growth in the number of units. Which side the evidence favours differs by resource, by country and by decade — which is precisely why the accounting question in the next section matters so much.
7.2 Natural Resource Accounting
7.2.1 Why Resources Need to Be Counted
Any firm that owns a machine does two things with it in its books. It records the value of the machine as an asset, and every year it writes off a part of that value as depreciation — the loss in worth caused by wear and ageing. Nobody regards this as optional. A firm that recorded its sales but never its wearing-out machinery would look profitable right until the day the machines stopped.
Now apply the same test to a country. National accounts record the roads built, the factories commissioned, the vehicles sold and the crops marketed. They record the depreciation of buildings and equipment. They do not, in their standard form, record that the aquifer under a district fell by three metres, that a fishery’s catch per boat halved, or that a forest lost a fifth of its area. Those are reductions in the country’s productive base, exactly as a worn-out machine is, and they pass unrecorded.
Natural resource accounting is the attempt to close that gap. It is a system of accounts that records the stocks of natural assets a country holds, and the changes in those stocks over a period — what was added by growth or discovery, and what was removed by extraction, degradation or conversion to other uses.
The purpose is not to produce a moral verdict. It is to produce information. A government deciding between two irrigation schemes, a company deciding where to site a plant, a household deciding whether to sink a deeper borewell — all of them make better decisions when the stock they are drawing on has actually been measured. Without accounts, depletion is invisible until it is irreversible.
7.2.2 What Natural Resource Accounting Records
Every natural resource account is built around two ideas: a stock and a flow. A stock is the quantity of the resource in existence at a point in time — 5,000 hectares of forest on 1 April, 40 million tonnes of proven coal, a groundwater table at 12 metres below surface. A flow is a movement into or out of that stock during a period — 120 hectares planted, 6 million tonnes mined, 1.4 metres of water table lost over the year.
Once stocks and flows are recorded, the account balances in the simplest possible way:
\[\text{Closing stock} = \text{Opening stock} + \text{Additions} - \text{Reductions}\]
Additions come from natural growth and regeneration, from deliberate replenishment such as afforestation or artificial recharge, and from discovery, which does not create the resource but does move it from potential to actual. Reductions come from extraction and harvest, from degradation that lowers quality without removing quantity, and from conversion of the asset to another use. Fig. 7.2-1 shows the structure.
Diagram
Fig. 7.2-1 – ledger-style diagram of a natural resource asset account; a tall bar on the left labelled “Opening stock”, arrows entering from above labelled “Additions: natural growth, replenishment, new discovery”, arrows leaving to the right labelled “Reductions: extraction, degradation, conversion to other use”, and a shorter bar on the right labelled “Closing stock”; a caption strip below reading “Closing = Opening + Additions − Reductions”
Such accounts are prepared for biotic assets such as forests and fisheries, for subsoil assets such as minerals and fossil fuels, and for water and soil together with the ecosystems they support. Many countries now maintain some of them. India has had an official expert group working on green national accounts, with the aim of adjusting headline economic figures for the cost of environmental depletion, and several European countries and members of the G20 were early adopters of integrated environmental and economic accounts.
Research institutions in India work in this area as well, including the South Asian Network for Development and Environmental Economics and the Indian Society for Ecological Economics, both of which conduct research on environmental valuation and accounting for the region.
7.2.3 Physical Accounting
There are two ways to keep a natural resource account, and the difference between them is simply the unit in which the entries are made.
Physical accounting records stocks and changes in stocks in physical, non-monetary units — hectares, tonnes, cubic metres, litres, numbers of individuals, metres of water table. It never converts anything into rupees.
The basic principles
Four principles govern how such accounts are built.
First, entries stay in their natural units. Timber is counted in cubic metres, forest area in hectares, coal in tonnes, water in cubic metres or litres, fish stock in tonnes of biomass. No exchange rate, price or discount rate enters anywhere.
Second, quality is recorded alongside quantity. A hectare of dense natural forest and a hectare of degraded scrub are both one hectare, and treating them as equal would defeat the purpose. Physical accounts therefore supplement the quantity figures with qualitative classes — crown density classes for forest, quality classes for water, land capability classes for soil. When quantity and quality change together, the combined change is described as a volume change.
Third, the account is built as a balance, opening stock to closing stock, using the identity given above, so that every change has to be explained by an entry rather than simply appearing.
Fourth, physical accounts are an extension of input–output analysis — the standard economic technique of tracing what each sector of an economy takes in and puts out. Here the same tracing is done for materials and energy: how much water the textile sector draws, how much fly ash the power sector produces, how much fuelwood households burn.
A small example shows how little machinery is involved. Suppose a Forest Division holds an opening stock of 5,000 hectares of forest at the start of the year. During the year, 120 hectares are planted under an afforestation programme, natural regeneration adds 30 hectares of new crown cover, 200 hectares are diverted to a road and transmission line, and 60 hectares are recorded as having fallen from dense forest to open forest.
Read the table carefully, because it teaches the habit this chapter is really about. The closing stock is
\[5{,}000 + 120 + 30 - 200 = 4{,}950 \ \text{ha}\]
a net loss of 50 ha, or
\[\frac{50}{5{,}000} \times 100 = 1 \ \text{per cent}\]
of the opening area. But the 60 hectares that slipped from dense to open forest do not appear in the area column at all, because no area was lost — only quality. They belong in the quality classification alongside it. A reader who looked only at the area line would conclude the Division had lost 1 per cent of its forest; a reader who looked at both would see that 110 hectares in all were either lost or degraded. This is exactly why the second principle above exists.
Advantages of physical accounting
The first advantage is that it works without valuation. Assigning a rupee value to a wetland or a pollinator population is difficult, contested and often arbitrary, and a physical account sidesteps the whole problem. It can be compiled from environmental and ecological data that are already collected — survey maps, forest inventories, water table readings, catch records — without any economic assumption being imposed on them.
The second is that it captures both the current status and the trend. Because the account is repeated each year on the same basis, it shows not only how much forest there is but whether the figure is rising or falling, and how fast. For a manager, that trend is usually the more useful number.
The third is transparency. A figure in hectares cannot be quietly changed by altering a discount rate or an exchange rate. What is measured is what is reported.
Disadvantages of physical accounting
The main disadvantage follows directly from its main strength. Because the entries stay in incompatible physical units, a physical account has no single dimension in which totals can be struck. Monetary accounting can add rupees to rupees and produce one number that a finance ministry can act on. A physical account produces a set of separate figures that have to be interpreted together, and interpretation is harder than reading a total.
This makes physical accounts difficult to compare, either across resources or across countries, and difficult to integrate with the economic accounts they are meant to correct. It also makes them easy to ignore: a set of tables in twelve different units rarely competes for attention with a single headline growth figure.
In practice most serious accounting systems use both. The physical account establishes what has actually happened to the stock; the monetary account, where a defensible value can be found, translates part of that into a form a budget process can use. The physical account comes first, because you cannot value what you have not measured.
7.3 Measuring Income: GDP and GNP
Every country wants a single number that says how it is doing. Newspapers print it, budgets are built on it, and international comparisons are made with it. Several such measures exist — Gross Domestic Product, Gross National Product, Net National Income — and they differ in what they include and where they draw the boundary. The differences look technical. They matter a great deal, because whatever the chosen number leaves out becomes, in practice, invisible.
7.3.1 Gross Domestic Product
Gross Domestic Product (GDP) is the total money value of all final goods and services produced within the geographical boundary of a country during a given period, usually a year.
Two words in that definition do real work. “Final” excludes intermediate goods, so that the wheat sold to a flour mill is not counted separately from the bread it ends up in — otherwise the same value would be counted twice. “Within the domestic territory” makes GDP a measure of where production happened, regardless of who owns the factory or holds the passport.
GDP can be looked at in two ways, and they give the same answer. It is the sum of everyone’s incomes in the economy — wages, rent, interest and profit. It is also the total expenditure on the economy’s output of goods and services. These must be equal, because every transaction has two sides: each rupee spent by a buyer becomes a rupee of income for a seller. This identity is why GDP is described as measuring both a nation’s total output and its total income.
Because prices change from year to year, a rise in GDP can mean more goods were produced or simply that the same goods cost more. Economists therefore distinguish nominal GDP, measured at current prices, from real GDP, measured at the prices of a fixed base year. Growth is always reported in real terms, so that inflation is stripped out. Dividing GDP by the population gives per capita GDP, the average output per person — a very different figure from the total, and usually the more informative one for comparing living standards.
7.3.2 Gross National Product
Gross National Product (GNP) shifts the boundary from territory to ownership. It is the total value of final goods and services produced by the residents and nationals of a country, wherever in the world that production takes place.
The link between the two is a single line:
\[\text{GNP} = \text{GDP} + \text{Factor income received from abroad} - \text{Factor income paid abroad}\]
The difference between those last two terms is called net factor income from abroad (NFIA). “Factor income” means income earned by the factors of production — wages of residents working abroad, and interest, dividends and profits on assets owned abroad. It does not mean every rupee that crosses a border.
An example makes the boundary clear. A software firm owned by Indian nationals earns profits from an office in Singapore. That output is produced outside India, so it is not in India’s GDP; it is earned by Indian residents, so it is in India’s GNP. Conversely, a foreign-owned factory operating in Pune adds to India’s GDP, but the profit it repatriates to its parent company is subtracted when arriving at India’s GNP. A country with many nationals working abroad and few foreign-owned assets at home will have GNP above GDP; a country that has attracted a great deal of foreign investment will usually have GNP below GDP.
GDP and GNP are not the only measures. Both are gross, meaning that nothing has been subtracted for the wearing-out of the capital used up in producing the output. Subtracting depreciation of manufactured capital from GNP gives Net National Product (NNP), and NNP valued at factor cost is Net National Income, which is closer to what a country could consume each year while leaving its productive base intact.
That last phrase is the important one, because it exposes the gap this chapter began with. NNP deducts the wearing-out of machines and buildings. It deducts nothing for the wearing-out of aquifers, soils, fisheries and forests. A figure that adjusts national income for the depletion and degradation of natural capital as well is what people mean by a green GDP, and building one is precisely the purpose of the accounts described in section 7.2.
Fig. 7.3-1 shows the whole sequence as a set of steps.
Diagram
Fig. 7.3-1 – a descending step or waterfall chart of national income aggregates; first bar “GDP”; second bar “GNP” after adding net factor income from abroad (small arrow up or down); third, shorter bar “NNP” after subtracting depreciation of manufactured capital; fourth, shortest bar “Green / environmentally adjusted national income” after subtracting depletion and degradation of natural capital; each deduction labelled on the connecting arrow
An illustrative set of figures makes the chain concrete. These are not any country’s real accounts; they are chosen to show the arithmetic. Suppose an economy records a GDP of ₹200 lakh crore in a year. Its residents earn ₹4 lakh crore abroad, while ₹7 lakh crore of factor income is paid out to foreign owners. Depreciation of buildings, machinery and infrastructure is estimated at ₹15 lakh crore, and the depletion of groundwater, forests and mineral stocks over the same year is valued at ₹9 lakh crore.
\[\text{GNP} = 200 + 4 - 7 = 197 \ \text{lakh crore}\]
\[\text{NNP} = 197 - 15 = 182 \ \text{lakh crore}\]
\[\text{Environmentally adjusted national income} = 182 - 9 = 173\ \text{lakh crore}\]
The headline number fell by ₹27 lakh crore, or about 13.5 per cent, as each deduction was applied — and the last deduction, the environmental one, is the one no standard national account makes. Whether the true figure for that deduction is ₹9 lakh crore or ₹2 lakh crore is exactly what the valuation debate in section 7.4 is about. What is not in dispute is that leaving the line out altogether amounts to entering it as zero.
7.3.3 Advantages of GDP and GNP as Tools for Measuring Growth
These measures survive because they do several things well.
They condense an enormous, messy economy into one comparable figure. A single number allows a country to be tracked from year to year, so that it can be seen whether the economy is expanding or contracting, and whether it has entered a recession. This is the most familiar use of GDP estimates: calculating the rate of growth from one year to the next.
They allow comparison across countries and across time. Because GDP and GNP are compiled to internationally agreed definitions, one country’s figure can be set against another’s, and against its own record for earlier decades. GNP in particular is used in ranking countries by income, including in decisions about which countries qualify for concessional finance and aid.
They are relatively easy to understand and to compute. Both rest on data that governments already collect for taxation and administration, and the underlying idea — add up what was produced — needs no specialised training to grasp.
They serve as broad indicators of the state of an economy and of its capacity to provide services. A country with a higher per capita national income has, on average, more resources available for schools, hospitals, water supply and sanitation, and historically the large improvements in life expectancy and literacy have accompanied rising national income.
7.3.4 Disadvantages of GDP and GNP as Tools for Measuring Growth
The criticisms fall into three groups: what these measures leave out, what they mismeasure, and what they count with the wrong sign.
What they leave out
A large part of useful production never passes through a market and therefore never enters GDP. Household work, care of children and the elderly, subsistence farming consumed by the growing household, unpaid work on a family enterprise and volunteer work are all real production and are all recorded as nothing. This is not a small omission: in economies with large informal and subsistence sectors, a substantial share of what people actually do is missing, so the measure understates output and understates it unevenly across countries.
The informal sector — enterprises that are unregistered and workers without formal contracts — is very large in low- and middle-income countries, and is captured only through estimates. Illegal and unreported transactions, sometimes grouped as the underground economy, are missing for the same reason. GNP additionally excludes the sale of used goods, since no new production has occurred.
What they mismeasure
An average tells you nothing about distribution. Two countries with identical per capita GDP can differ completely in how that income is shared, and a rise in the average is consistent with the majority becoming no better off. Neither GDP nor GNP shows the distribution of income or wealth, and neither shows who bears which costs.
International comparison is further complicated by exchange rates. Converting one country’s GNP into another’s currency at the market exchange rate can make an economy look richer or poorer purely because the rate moved, which is why economists often use purchasing-power adjusted figures instead.
What they count with the wrong sign
This is the criticism that matters most for environmental science, and it has two parts.
The first is that these measures are indifferent to how output was produced. Output generated by drawing down a stock and output generated by living off a flow are added into the same total. When a forest is felled, the timber sold is recorded as income; the loss of the forest is recorded nowhere, because a forest was never on the balance sheet to be depreciated. A country can therefore post a high growth figure for a decade by converting its natural assets into current income, and the accounts will register the achievement without registering the cost. This is what is meant by saying that GDP does not measure the sustainability of growth.
The second is stranger. Because GDP counts all market expenditure as output, spending to repair environmental damage adds to it. Money spent treating illness caused by polluted air, cleaning up after a chemical spill, buying bottled water because the supply is unsafe, or installing filters and air purifiers all raise measured national income. The damage lowered welfare; the response to the damage raised the number. A measure that moves upward both when a river is polluted and when it is cleaned is clearly not measuring the thing we care about.
7.4 Environmental Economics, Welfare and Defensive Expenditure
7.4.1 The Purpose of Environmental Economics
The previous section ended with a gap: the standard measures of an economy record marketed output and ignore the condition of the natural assets that output depends on. Environmental economics is the branch of economics that works in that gap. It applies the ordinary tools of economics — cost, price, demand, efficiency, incentive — to environmental problems.
Its starting point is a specific diagnosis. Most environmental damage is treated by economists as a case of market failure: a situation in which a market, left to itself, produces an outcome that is not efficient for society as a whole. Markets work well when everyone affected by a transaction takes part in it and every cost is reflected in a price. Environmental goods break both conditions. Nobody owns the air; nobody is billed for the use of a river’s capacity to carry away waste; the people downwind of a chimney are not party to the sale of what the chimney’s factory produces. Because these services carry no price, they are treated as free, and things treated as free are used until they are exhausted.
From this diagnosis follow the four things environmental economists actually do. They measure the external effects and costs of economic decisions — what pollution costs in health, in lost crop yield, in shortened equipment life. They value environmental services that no market prices, so that these can enter a decision at all. They compare alternatives, weighing what a project gains against what it costs including the environmental cost. And they design instruments — charges, standards, tradable permits, deposit schemes, liability rules — that change what a producer or consumer finds it worthwhile to do.
The last of these is the practical heart of the subject. If a resource is priced at something near its real cost, less of it is wasted, and no exhortation is required to achieve that. If it is priced at zero, no amount of exhortation will do much.
A closely related field is often mentioned alongside it, and the distinction is worth having clearly.
Neither field is the “correct” one; they ask different questions and often reach different answers about the same project. Environmental economics has been more influential on policy, because its outputs slot into budget processes. Ecological economics has been more insistent on the point that a subsystem cannot outgrow the system containing it.
7.4.2 Economic Status and Welfare
Economic status is what a country produces and earns. Welfare is how well its people actually live. Section 7.3 showed that the first is measured carefully and the second is largely assumed to follow. Several attempts have been made to measure welfare directly, and the best known of these is net economic welfare.
The idea is to begin from national income and then make three kinds of correction. Add the value of production that markets miss but that plainly improves living — household work, unpaid care, subsistence farming, and the value of leisure itself. Subtract the cost of the disamenities that accompany production — pollution, congestion, noise, commuting time, urban crowding. Subtract expenditure that only defends against damage rather than adding to well-being. The result is an estimate of national income adjusted for what it actually delivers.
The concept was developed in the early 1970s by the economists William Nordhaus and James Tobin, initially under the name Measure of Economic Welfare, and every later attempt at a welfare-adjusted indicator descends from it in some form.
Its weakness is exactly the one the whole field runs into. Adding the value of leisure requires a price for an hour of rest; subtracting the cost of congestion requires a price for an hour lost in traffic; subtracting the cost of pollution requires a price for a case of bronchitis. Every one of these is an estimate, and reasonable people produce very different ones. A welfare measure is therefore more informative and less reliable than a production measure — which is a genuine trade-off, not a knock-down objection.
7.4.3 Defensive Expenditure and Its Classification
Some of the money an economy spends does not make anyone better off than they were before. It merely restores, or protects, a position that has already been lost. Spending of this kind has a name.
Defensive expenditure is expenditure undertaken to prevent, reduce, repair or protect against a decline in environmental quality, or against damage to oneself arising from such a decline.
A household that installs a water purifier because the supply is unsafe is not better off than a household with a safe supply and no purifier. It has spent money to reach the same position. In the national accounts, though, the purifier is a manufactured good sold at a price, and it adds to output exactly as a bicycle would. This is why welfare measures subtract defensive expenditure: counting it as a gain records a loss as a benefit.
Defensive expenditures are usually classified into four groups, shown in Fig. 7.4-1.
Diagram
Fig. 7.4-1 – classification chart of defensive expenditure; a single top box “Defensive expenditure” branching into four boxes: “Preventive (avoiding) — reduces damage at source”, “Abatement and treatment — removes or treats residues”, “Restorative — repairs damage already done”, “Protective and screening — shields people and property from damage”; two short example labels under each box
Preventive or avoiding expenditure
This is spending that stops the damage from arising in the first place, and it is generally the cheapest of the four. It includes changes in production technique — redesigning a process so that it uses less material or generates less residue — and the whole family of practices summarised as reduce, recycle and reuse.
Reducing means using less of a resource and creating less waste in the first place: switching off equipment not in use, travelling by shared or public transport rather than by individual car, using both sides of a sheet of paper. Recycling means returning used material — plastics, paper, glass, metal, textiles — into the production of new goods. Reuse means using an article again in its existing form rather than discarding it: refilling a container, repairing a phone or a television rather than replacing it.
The order of that list is not accidental. Reduction avoids the material entirely, reuse avoids reprocessing it, and recycling still requires collection, transport and energy to convert the waste back into a usable input.
Abatement and treatment expenditure
This is spending on removing or treating residues after they are produced but before they enter the environment: effluent treatment plants, stack scrubbers and electrostatic precipitators, catalytic converters, sewage treatment, and the classification and segregation of solid waste into recyclable, biodegradable and non-biodegradable streams so that each can be handled properly.
Restorative expenditure
This is spending to repair damage already done — cleaning up a contaminated site, dredging and de-silting a choked water body, replanting a degraded landscape, restoring an ecosystem or a stretch of coast. Restoration is invariably more expensive than prevention, and it is often incomplete: a replanted patch is not the ecosystem that was there, and a remediated site is rarely returned to its original condition.
Protective and screening expenditure
The first three groups act on the damage. This one acts on the exposure: it protects people and property from environmental quality that has already declined. Household air purifiers and water filters, dust masks, sound-insulating windows, additional health services and treatment for pollution-related illness, and repairs to buildings, machinery and monuments corroded by polluted air all fall here. So do compensatory activities undertaken to offset a loss elsewhere.
7.4.4 Natural and Ecological Capital
Everything in this chapter so far has been building towards a single reframing, and this is where it is stated.
Capital, in economics, is a stock that yields a flow of useful goods and services over time without being immediately consumed. A machine is capital: it is not eaten, and it produces output year after year. The insight at the centre of environmental economics is that a forest, an aquifer, a fishery and a topsoil behave in exactly the same way.
Natural capital is the world’s stock of natural assets — geology, soil, air, water and all living things — from which people obtain a continuing flow of goods and services.
Ecological capital is the term used when the emphasis falls on the functioning ecosystems themselves — on the intact, self-maintaining systems whose processes deliver those services — rather than on the extractable stock of materials. The two terms overlap heavily and are often used interchangeably; where they are distinguished, natural capital points to the assets and ecological capital to the living systems that keep the assets productive.
The reframing does two things at once. It makes depletion visible: drawing down a stock is not income, whatever the accounts say, and the distinction between living off a stock and living off its yield becomes unavoidable. And it makes degradation measurable: an asset that has lost part of its productive capacity has depreciated, whether it is a boiler or a river basin.
It also has a limit worth naming now, because it recurs in the next section. Treating nature as capital invites the assumption that one form of capital can substitute for another — that a lost wetland is acceptable if the money earned builds something of equal value. For some services this is roughly true. For others it is not: there is no manufactured substitute for a stable climate, a pollinator community or the ozone layer, at any price. How far substitution is possible is one of the genuinely unsettled questions in the field, and the answer differs from asset to asset.
Section 7.6 returns to natural capital in full — what kinds there are, what services it yields, how it is being degraded and how it can be regenerated. Before that, the chapter has to deal with the mechanism by which the damage occurs in the first place.
7.5 Externalities and Cost–Benefit Analysis
7.5.1 What an Externality Is
A transaction normally involves two parties. A brick kiln buys coal and sells bricks; the seller of the coal and the buyer of the bricks both agree to the terms, and both expect to gain, or the deal would not happen. Everything about that transaction is settled between them.
Now step outside it. The kiln’s chimney sends particulate matter over a village half a kilometre away. Washing takes longer to dry clean, the wheat crop nearest the kiln yields a little less, and a few children develop a persistent cough. Nobody in that village bought a brick or sold a lump of coal. They were not asked, they are not paid, and their loss appears in no price anywhere in the transaction.
That uncompensated effect on a third party is an externality.
Three conditions have to hold together. There must be a genuine effect on somebody’s well-being or production. That somebody must be outside the transaction. And no payment must pass — the effect must be uncompensated. If the kiln paid the village for the damage, the cost would have been brought inside the transaction and there would be no externality left.
This gives the central distinction of the section. Private cost is the cost borne by the producer — coal, clay, wages, transport. External cost is the cost borne by everyone else. Social cost is the sum of the two.
\[\text{Social cost} = \text{Private cost} + \text{External cost}\]
The market sees only the first term. Fig. 7.5-1 shows why that matters.
Diagram
Fig. 7.5-1 – stacked bar comparison for one unit of output; left bar labelled “Price paid by the buyer” made of a single block “Private cost + profit”; right bar labelled “True cost to society”, the same block plus an additional shaded block above it labelled “External cost: health, crop loss, cleaning, damage to buildings”; a dashed horizontal line from the top of the left bar across to the right bar, and the gap between the dashed line and the top of the right bar labelled “Cost borne by third parties”
A short calculation fixes the idea. Suppose the kiln produces 10 lakh bricks a year at a private cost of ₹6.00 per brick, and sells them at ₹7.00. Suppose an assessment estimates the health, crop and cleaning costs falling on neighbours at ₹0.90 per brick.
\[\text{Social cost per brick} = 6.00 + 0.90 = ₹6.90\]
\[\text{Total external cost} = 10{,}00{,}000 \times 0.90 = ₹9{,}00{,}000 \ \text{per year}\]
The kiln shows a profit of ₹1.00 per brick and is, on its own books, a sound business. Society gains only ₹0.10 per brick, and nine lakh rupees a year of real cost has simply been transferred to people who never agreed to bear it. Nothing illegal need have occurred. The accounts are correct. They are just incomplete in exactly the way section 7.3 described.
7.5.2 Kinds of Externalities
Externalities are classified in two ways at once: by whether the effect is harmful or helpful, and by whether it arises in production or in consumption.
Negative externalities
A negative externality imposes an uncompensated cost on a third party. It is called a negative production externality when it arises from producing something, and a negative consumption externality when it arises from consuming something.
Negative production externalities include air pollution from vehicles, industry and the burning of fossil fuels, which damages crops, buildings and human health; water pollution from sewage and industrial effluent, which harms aquatic life and contaminates rivers and streams downstream; the depletion of a shared fish stock by overfishing, which lowers everyone else’s catch; noise from construction and machinery; and the emission of greenhouse gases, whose costs fall on people in other countries and other generations altogether.
Negative consumption externalities include traffic congestion, where each additional vehicle lengthens everyone else’s journey; loud amplified music that prevents neighbours from sleeping; second-hand smoke; the light spilled by street and building lighting, which is not paid for by those it disturbs; and the accident risk that each road user imposes on every other.
Positive externalities
A positive externality confers an uncompensated benefit on a third party. It is also called an external benefit or external economy.
Positive production externalities include a beekeeper whose bees pollinate a neighbouring orchard at no charge — often worth more to the orchard than the honey is to the beekeeper; a firm that trains workers who later carry those skills to other employers; a foreign firm whose presence spreads up-to-date technical practice to local suppliers; and a new road, bridge or airport that raises the accessibility, and therefore the productivity, of everything around it.
Positive consumption externalities include vaccination, which protects not only the person vaccinated but everyone they would otherwise have infected; education, whose benefits show up in lower unemployment, better public health and more informed civic life well beyond the individual educated; a household that maintains a garden or a well-kept building, raising the amenity and the property values of a whole street; and a household that fireproofs its house, reducing the risk of fire spreading to its neighbours.
7.5.3 Impacts of Externalities
The first and most important impact is on efficiency. When a good carries a negative externality, its market price is lower than the true cost of producing it. Buyers respond to the lower price by buying more, and producers respond by making more. The market therefore settles at a quantity higher than the one that would maximise society’s net benefit — too much of the polluting good is produced, and too much pollution comes with it. Where a good carries a positive externality, the mirror image occurs: because the producer captures only part of the benefit, too little is produced. Neither outcome is anybody’s fault. Both follow from prices that do not carry the full information.
The second impact is distributional, and it is where the equity question in this subject usually sits. An externality is, by definition, a transfer of cost or benefit to somebody who did not agree to it. Those bearing the cost of an industrial externality are frequently the people living closest to the facility, who are often the least able to move, to litigate, or to buy the protective expenditure described in section 7.4.3. The benefit — cheaper products, dividends, employment — is typically spread far more widely and lands elsewhere. The efficiency loss and the distributional loss are separate objections, and a policy can fix one without touching the other.
A third impact runs through property rights. Externalities cluster precisely where ownership is unclear. Nobody owns the air; nobody owns a river’s assimilative capacity; nobody owns an ocean fishery. Where a resource has no owner, no one has either the right to exclude a polluter or the incentive to conserve it, and each user gains the whole benefit of using more while bearing only a fraction of the cost. This is why economists say that many environmental problems are, at bottom, poorly defined property rights.
The remedy in all cases is described by one word: internalisation — bringing the external cost or benefit inside the decision of the party who causes it. It can be done by charging the polluter for each unit of emission, by setting a standard that limits emission, by issuing a limited number of tradable emission permits, by making the polluter legally liable for damage, or by subsidising an activity that generates external benefits. The instruments differ in cost and in political feasibility. The principle behind all of them is the same: whoever decides should also bear.
7.5.4 Cost–Benefit Analysis
Suppose a decision has to be made about a proposed irrigation dam, a new bypass, or a rule requiring a class of factories to install effluent treatment. Each option has costs and benefits spread over many years and falling on many different people. Cost–benefit analysis (CBA), also called benefit–cost analysis, is the systematic method for comparing them.
It has two purposes. The first is to decide whether a single proposal is worth doing at all — whether its benefits exceed its costs. The second is to compare competing proposals, so that the one giving the greatest net benefit can be chosen.
Two features make it useful in environmental work and also make it contentious. It insists on a common unit, so that a saved hour of travel time, a tonne of grain and a case of avoided bronchitis can be set against a crore of construction cost. And it insists on discounting, because a benefit arriving in twenty years is not worth the same as one arriving today. Future costs and benefits are converted to their present value using a discount rate, and the sum of these present values, net of costs, is the net present value (NPV):
\[NPV = \sum_{t=0}^{n} \frac{B_t - C_t}{(1+r)^t}\]
where \(B_t\) is the benefit in year \(t\) (in rupees), \(C_t\) is the cost in year \(t\) (in rupees), \(r\) is the discount rate expressed as a decimal, \(t\) is the year counted from the present, and \(n\) is the last year considered. A positive NPV means the discounted benefits exceed the discounted costs.
Consider a small illustrative scheme. A wastewater treatment plant costs ₹100 crore, paid entirely in year 0. It then delivers benefits — avoided illness, restored fishing, water fit for reuse — valued at ₹40 crore in each of the next three years.
Read the last row carefully, because it carries the whole lesson. The physical facts of the project are identical in both columns — the same plant, the same three years of cleaner water. At a discount rate of 10 per cent the scheme fails, with an NPV of about −₹0.53 crore. At 5 per cent it passes comfortably, with an NPV of about +₹8.93 crore. Nothing changed except a judgement about how much the future counts.
That is why the choice of discount rate is the most argued-over number in environmental economics. A high rate shrinks distant benefits towards nothing, and most environmental benefits — a restored aquifer, a stabilised climate, an avoided extinction — are distant. A low rate takes the future seriously but can justify almost any long-lived project.
7.5.4.1 The Process in Brief
A cost–benefit analysis is normally carried out in the following order.
- List all the alternatives, including the option of doing nothing, since a project must be judged against what would have happened otherwise.
- Identify all the stakeholders — everyone who stands to gain or lose, including those downstream, downwind and not yet born.
- Select and list the elements of cost and of benefit for each alternative, taking care to include external effects, not merely the items that appear on an invoice.
- Fix the time period over which costs and benefits will be counted, and set them out year by year.
- Express every item in a common currency, so that unlike things can be compared.
- Choose the discount rate to be applied.
- Calculate the net present value of each alternative.
- Carry out a sensitivity analysis — recalculate using different discount rates and different valuations to see whether the ranking of options survives.
- Adopt the alternative that stands highest, taking the sensitivity results into account.
Step 8 is the one most often skipped and the one most worth insisting on. If the answer flips when the discount rate moves by two percentage points, as it did in Table 7.7, the analysis has not produced a conclusion; it has produced a question.
7.5.4.2 Advantages and Disadvantages
The advantages are real and explain why the method is used everywhere.
It is simple in structure. The underlying question — do the benefits exceed the costs? — needs no economic training to understand, which makes the results usable by administrators, engineers and elected bodies rather than only by specialists.
It forces everything into the open. Preparing a CBA requires that every cost, every benefit and every affected party be listed and defended. Items that would otherwise have been assumed away have to be written down, and a decision that omits something can be challenged on the record.
It allows genuine comparison between very different proposals — a dam against a set of check dams, a flyover against a bus corridor — by putting them on one scale, and it identifies which resources, money and manpower each option would actually require.
It can accommodate social and ecological effects. In its social and ecological forms, the analysis is extended beyond the promoter’s own costs to include effects on users, on non-users, on externalities and on the option value of keeping a resource intact for the future.
The disadvantages are equally real.
Valuation is inescapably uncertain. Assigning monetary figures to health, to scenery, to a species or to an ecosystem service involves methods that produce a range rather than a number, and different analysts using different assumptions reach different totals. Costs are also easy to omit accidentally, and an omitted cost shows up as extra profit.
It is open to subjectivity. Because so many inputs are estimates, the choice of estimate can be influenced — consciously or not — by what result is wanted. A project can be made to pass or fail by defensible-looking adjustments to the discount rate, the time horizon or the valuation of a single benefit.
It measures efficiency, not fairness. A CBA asks whether total benefits exceed total costs. It does not ask who receives the benefits and who bears the costs, and a project can show a healthy net benefit while concentrating its losses on a small group of people who gain nothing from it.
It is biased against the long term. Discounting systematically reduces the weight given to benefits and damages occurring far in the future, which is where most serious environmental consequences lie.
Coverage is never complete. In a large project the number of affected parties is very great, and some groups will always fall outside the study’s boundary. Effects that cannot be quantified at all tend to be mentioned in a paragraph and then left out of the arithmetic — which, in a method that decides on the arithmetic, is close to leaving them out entirely.
7.5.5 Extended Producer Responsibility
Internalisation sounds abstract until you look at what happens to a product after it is thrown away. A manufacturer’s responsibility has traditionally ended at the point of sale; everything afterwards — collection, sorting, disposal, the leachate from the dump — became somebody else’s problem, usually a municipality’s. Extended Producer Responsibility (EPR) is the policy instrument that moves that responsibility back onto the producer.
Familiar examples show the range of the idea. A take-back scheme under which a manufacturer collects old electronic goods for authorised dismantling and recovery of metals. A deposit–refund system, in which a small deposit paid at purchase is returned when the container is brought back — the system that kept glass bottles circulating for decades. Producer-financed collection of used batteries, whose lead and lithium are both valuable and hazardous. Producer responsibility for plastic packaging, met either by collecting an equivalent quantity or by paying registered agencies to do so.
The advantages follow directly from the definition.
It internalises the disposal cost. The cost of dealing with a product at the end of its life is brought into the price of the product, so that whoever buys it also pays for its eventual handling instead of leaving that cost with the public.
It changes design decisions. A producer that must take a product back has a direct financial reason to make it easier to dismantle, to use fewer mixed and composite materials, to standardise components, and to make the product last longer and be repairable. This effect on design is the reason economists rate EPR more highly than a simple disposal tax.
It builds collection systems that would not otherwise exist, and shifts material out of open dumping and unsafe informal processing into channels where recovery can be done with some protection for the people doing it.
It recovers materials, returning metals, glass and polymers to production and so reducing the draw on the source function described in section 7.1.4.
It also places the cost where the information is. The producer knows what the product is made of and how it can be taken apart; a municipality receiving it as mixed waste does not.
The instrument is not self-executing: it works to the extent that collection targets are verified and that the informal workers who currently handle much of this material are brought into the system rather than displaced by it.
7.6 Natural Capital and Its Regeneration
7.6.1 Types of Capital
Section 7.4.4 established that nature is a stock yielding a flow, and therefore a form of capital. It is not the only form. Economists working on sustainability usually distinguish five types of capital, and the relationship between them is the whole argument of this section.
Manufactured capital is the stock of produced goods used to make other goods rather than being consumed themselves — factories, machinery, roads, buildings, tools, irrigation works. It is an input to production, not its output.
Human capital is the stock embodied in people: their health, knowledge, skills, experience and capacity for work. It is built by nutrition, healthcare, schooling and training, and it depreciates through illness and disuse just as machinery does.
Social capital consists of the institutions and relationships through which people act together — families, schools, trade unions, cooperatives, village associations, voluntary bodies, and the norms of trust and reciprocity that make them work. Its role is to maintain and develop human capital in company with others; a school building is manufactured capital, the functioning school is social.
Financial capital — shares, bonds, deposits, currency — is different in kind from the other four. It produces nothing by itself. Its value is entirely representative: it stands for a claim on natural, human, social or manufactured capital, and enables those assets to be owned, traded and mobilised.
Natural capital, defined in section 7.4.4, is the stock from which every other form ultimately derives. Fig. 7.6-1 shows the usual way of drawing the relationship.
Diagram
Fig. 7.6-1 – five nested ovals, largest to smallest: outermost “Natural capital”, inside it “Social capital”, inside that “Human capital”; two arrows leading outward from the human capital core to labelled boxes at the right, “Manufactured capital” and “Financial capital”; a caption strip reading “Every form of capital is ultimately drawn from, and bounded by, natural capital”
The nesting carries the argument. Human capital cannot exist without food, water and breathable air; manufactured capital cannot be built without materials and energy; financial capital is a claim on things that must physically exist. The four inner forms have all grown enormously over two centuries. The outer one has not grown, and in several dimensions has shrunk. That is the sustainability problem stated in one sentence.
7.6.2 Kinds of Natural Capital
Natural capital is best understood as having two components, which are frequently confused with one another.
\[\text{Natural capital} = \text{Stock of natural resources} + \text{Ecosystem services}\]
The first is the material: the minerals, timber, water, fish and soil that can be measured, extracted and traded. The second is the work the living system does: the purification of water, the pollination of crops, the regulation of floods, the formation of soil. The first is what markets have always noticed. The second is worth more and has almost never been priced.
Within that whole, natural capital is sorted in three useful ways.
Renewable and non-renewable natural capital follows the distinction drawn in section 7.1.2.2. Forests, fisheries, soils and groundwater are renewable stocks that yield a sustainable flow if harvested within their regeneration rate. Mineral and fossil deposits are non-renewable stocks that yield a once-only flow.
Stock and flow. A forest is a stock; the annual increment of timber it produces is the flow. Living off the flow leaves the stock intact indefinitely. Living off the stock produces a larger income now and no income later. Almost every question in this chapter reduces to which of the two is happening.
Critical and substitutable natural capital. Some natural capital has a manufactured substitute, at a price: a water treatment plant can do part of what a catchment forest does. Some has none at any price — a stable climate, the ozone layer, the genetic library held in wild species, the community of organisms that turns rock and litter into soil. Natural capital of the second kind is called critical natural capital, and its distinguishing feature is that its loss is irreversible on any human timescale. This is why the substitution assumption noted at the end of section 7.4.4 has to be applied asset by asset rather than as a general principle.
7.6.3 Classification of Ecosystem Services
Ecosystem services are the benefits that people obtain from ecosystems. They are conventionally classified into four groups, and the classification is worth learning in order, because each group is invisible to markets in a different way.
Provisioning services are the tangible products obtained from ecosystems. Food, including cultivated crops, livestock, capture fisheries, wild foods and spices. Raw materials — timber, fuelwood, fibre, fodder, hides, horn, organic matter and natural fertiliser. Fresh water. Medicinal and biochemical resources, and the compounds from which many pharmaceuticals derive. Genetic resources, including the wild relatives of crops used to breed resistance and yield into cultivated varieties. Ornamental resources such as shells, feathers, resins and decorative plants.
Regulating services are the benefits obtained from the regulation of ecosystem processes. Air quality regulation, as vegetation absorbs carbon dioxide, releases oxygen and traps particulate matter. Climate regulation, both globally through carbon storage and locally through the moderation of temperature and rainfall by vegetation cover. Water regulation — the influence of vegetation and soil on infiltration, groundwater recharge and the release of water through the dry season. Water purification and waste treatment, as wetlands, soils and microbial communities break down organic waste. Erosion control by plant roots binding soil. Flood and storm moderation by forests, wetlands, mangroves and dunes. Pollination. Biological control of pests and of the vectors of human disease.
Cultural services are the non-material benefits people obtain from ecosystems: recreation and tourism, aesthetic enjoyment, spiritual and religious significance, the sense of place and identity attached to particular landscapes, and the setting for both formal and informal education and scientific enquiry. Cultural diversity itself is closely bound to the diversity of the environments in which communities have lived.
Supporting services are the underlying processes that make all the other three possible: soil formation, nutrient cycling, primary production by green plants, and the water cycle. They differ from the other categories in that their benefit to people is indirect and slow. Nobody consumes soil formation. Everything else depends on it.
7.6.4 Causes of Degradation
Degradation is the deterioration of natural capital — the loss of quantity or of quality in a natural asset, or the loss of its capacity to deliver services. It occurs whenever renewable resources are used faster than they regenerate or wastes are emitted faster than they can be assimilated. Five causes are examined here.
7.6.4.1 Acid Deposition
Rain is naturally slightly acidic. Atmospheric carbon dioxide dissolves in water droplets to form a weak solution of carbonic acid, giving clean rain a pH of about 5.6 in unpolluted air. Acid deposition is the arrival at the surface of acidity well beyond this natural level.
Its origin is combustion. Burning coal and heavy fuel oils releases sulphur dioxide; high-temperature combustion in furnaces and engines produces oxides of nitrogen. In the atmosphere these are oxidised and combine with water vapour to form sulphuric and nitric acids, which return to the surface. Because the reactions take hours to days while the air moves on, the acid frequently falls hundreds of kilometres from where the gases were released — one of the clearest examples of a negative externality crossing a boundary.
The return takes two forms. In wet deposition, the acids are removed from the atmosphere by precipitation and arrive dissolved in rain, snow, fog or mist. In dry deposition, acidic gases and particles settle directly onto ground, buildings, foliage and animal surfaces, and become acidic only when they are later wetted by dew or rain. The umbrella term acid deposition covers both, together with acid fog and acid mist. Fig. 7.6-2 traces the pathway.
Diagram
Fig. 7.6-2 – flow: combustion source releasing SO₂ and NOₓ → transport downwind in the atmosphere → oxidation and reaction with water vapour forming H₂SO₄ and HNO₃ → two parallel branches, “Wet deposition: rain, snow, fog” and “Dry deposition: gases and particles settling directly” → surface receptors drawn as soil, lake and building → effects boxes labelled “Nutrient leaching from soil”, “Falling lake pH”, “Corrosion of stone and metal”
The damage is indirect more often than direct. In soils, acidity leaches away calcium, magnesium and other base nutrients, and mobilises aluminium, which is toxic to fine roots — so trees are weakened rather than killed outright, becoming less tolerant of cold, drought and pests. Forests at high altitude are the most exposed, because they stand for long periods in cloud and fog that are more acidic than rainfall. In lakes and streams, falling pH interferes with the reproduction of fish and amphibians and can eliminate the most sensitive species first, thinning the food web from below. On built structures, acid attacks limestone and marble and corrodes metal, which is why monuments and heritage buildings in industrial regions require repeated conservation work — a restoration expenditure in the sense of section 7.4.3. On farmland the effect is partly masked, because farmers replace the lost bases with lime and fertiliser, converting an ecological loss into a cash cost.
7.6.4.2 Air Pollution
Air pollution degrades natural capital directly and continuously. Suspended particulate matter, soot and fly ash settle on leaf surfaces and reduce the light reaching them, lowering the rate of photosynthesis. Gaseous pollutants damage the leaf cuticle and the stomata, so leaves lose water more readily and become more vulnerable to drought, pests and disease. Visible symptoms include chlorosis, the loss of chlorophyll that yellows a leaf, and necrosis, the death of leaf tissue. The consequences for a crop or plantation are premature leaf fall, early fruit drop and reduced yield and timber quality.
Haze and smog are the visible forms. Fine particles, together with sulphur dioxide and nitrogen oxides that convert to particles as they drift downwind, scatter light and obscure visibility. They are produced by power stations, industry, vehicles, construction activity and open burning, and the reactions that form secondary particles are accelerated by sunlight.
Animals suffer respiratory damage from the same pollutants, and aquatic fauna are affected indirectly, since pollutants deposited from the air accumulate in sediment and can then be taken up by organisms and concentrated at successive levels of a food chain.
7.6.4.3 Deforestation
The clearing of forest removes a stock of natural capital and, with it, a whole set of regulating and supporting services at once.
Without root systems binding it, soil is carried away by rain and wind. The eroded material silts up rivers, canals and reservoirs downstream, reducing their storage capacity and shortening their working life — a cost that falls on people who had nothing to do with the clearing. Infiltration falls and run-off rises, so the same rainfall produces sharper floods in the wet season and less base flow in the dry, and groundwater recharge declines.
Habitat is lost, which is the principal driver of the biodiversity loss described next. Timber and fuelwood supply falls, and where fuelwood becomes scarce households burn animal dung instead — removing from the soil the organic matter that would have maintained its fertility, so that a shortage of fuel becomes a decline in farm productivity a few seasons later.
The economic life of forest-dwelling and forest-fringe communities is affected most directly, because their access to fuel, fodder, fruit, fibre and medicinal plants depends on the resource being there. These are the community-owned and open-access resources noted in section 7.1.2.4 — the ones that generate no receipts and therefore appear in no accounts.
7.6.4.4 Loss of Biodiversity
Biodiversity is the variety of life at three levels: the variety of genes within a species, the variety of species within an ecosystem, and the variety of ecosystems within a region. Its loss is a degradation of natural capital that differs from the others in one crucial respect — it is irreversible. A depleted aquifer can, in principle, be recharged over decades. An extinct species cannot be recovered at any expenditure.
The immediate causes are habitat destruction and fragmentation, over-harvesting, pollution, the spread of invasive species and shifting climate. The consequences run in two directions.
The first is a loss of provisioning options. The wild relatives of cultivated crops carry the genetic variation from which resistance to new pests and tolerance of heat and salinity are bred; the narrowing of that library reduces the range of problems agriculture will be able to solve later. This narrowing within cultivated species themselves — the replacement of many local varieties by a few uniform ones — is called genetic erosion.
The second is a loss of resilience, the capacity of an ecosystem to absorb a disturbance and continue functioning. A system with many species performing overlapping roles can lose some of them and still deliver its services. A simplified system cannot: when the single pollinator, or the single dominant tree species, fails, there is nothing behind it. This is the strongest economic argument for conserving species whose direct use value is nil — they are the redundancy that keeps the services running.
7.6.4.5 Emission of Carbon Dioxide
Carbon dioxide is added to the atmosphere by the burning of fossil fuels, by the clearing and burning of forests, by cement manufacture, by respiration and by volcanic activity. Of these, the combustion of fossil fuels and land-use change are the sources that have shifted the balance, because they transfer carbon that had been locked away for geological time into a reservoir that exchanges with the atmosphere in years.
The mechanism is well established. Carbon dioxide, methane, nitrous oxide, ozone and water vapour are largely transparent to incoming short-wave solar radiation but absorb the longer-wave infrared radiation that the warmed surface emits, and re-radiate part of it downwards. This is the greenhouse effect, and it is entirely natural and entirely necessary: without it the Earth’s average surface temperature would be far below freezing rather than the roughly 15 °C that supports life. What is not natural is the increase in the concentration of these gases, which strengthens the effect and raises the equilibrium temperature. That increase, and the warming it produces, is global warming.
For natural capital the consequences are systemic rather than local. Warming shifts the ranges within which species can survive, faster in many cases than populations can move or adapt. It alters the timing of flowering, migration and monsoon onset, so that relationships which evolved together — a crop and its pollinator, a fish and its spawning season — fall out of step. It raises sea level through thermal expansion of ocean water and the melting of land ice, threatening low-lying coastal land and the aquifers beneath it with saline intrusion. A part of the emitted carbon dioxide dissolves in the oceans, lowering their pH and making it harder for corals, molluscs and many planktonic organisms to build calcium carbonate structures — a change in a supporting service at the base of marine food chains.
One nuance is worth stating plainly, because it is often quoted out of context. Higher carbon dioxide concentration does, by itself, raise the rate of photosynthesis in many plants and improve their water-use efficiency. This does not make the overall effect beneficial: the gain is limited by nitrogen and water availability, it is unevenly distributed across crops, and it is set against heat stress, altered rainfall and increased frequency of extreme events. A single favourable mechanism is not the same as a favourable outcome.
The responses discussed in the literature are reduction in the use of fossil fuels, improvement in the efficiency with which energy is used, reduction of deforestation, and afforestation and reforestation to build carbon back into vegetation and soil.
7.6.5 Ecological Footprint
All the pressures above raise a single quantitative question. How much of the Earth’s regenerative capacity does a given population actually use? The ecological footprint was designed to answer it.
Four elements go into the calculation: the demand made on productive land and sea area, the quantity of resources consumed by the population, the quantity of waste generated — most importantly the vegetated area needed to absorb carbon dioxide emissions — and the rate at which the natural stocks concerned are being drawn down.
Because cropland, forest and fishing grounds differ in productivity, the areas are converted to a common unit, the global hectare, which represents one hectare of biologically productive area at world-average productivity. Once demand is expressed in global hectares it can be set against biocapacity — the area a territory actually has, adjusted for its productivity.
The comparison of footprint with biocapacity gives the concept its force. Where footprint exceeds biocapacity, the population is drawing down stocks rather than living on the flow — a condition called ecological overshoot. A worked comparison shows the arithmetic.
Region A uses more than twice the biological capacity available within its own territory. The deficit does not vanish; it is met either by importing the productive capacity of other territories through trade, or by drawing down stocks — felling forest faster than it grows, fishing faster than fish reproduce, emitting carbon dioxide faster than vegetation and oceans absorb it. Region B lives within its own capacity, though at a level of consumption that reflects far lower incomes.
Applied to the world as a whole, the same arithmetic produces the statistic quoted in the chapter opener. If humanity’s total footprint exceeds the Earth’s total biocapacity by, say, 70 per cent, the finding is reported as humanity using “1.7 Earths”.
Two limitations of the measure should be stated alongside it. A large part of the calculated footprint is the notional forest area required to absorb carbon dioxide emissions, so the result is sensitive to how that absorption is estimated. And the footprint measures area-based demand only: it says nothing about toxicity, about freshwater scarcity, or about biodiversity loss, all of which can be severe in a territory whose footprint is modest.
7.6.6 Disproportionate Use of Natural Resources
Aggregate figures conceal the fact that matters most in this subject: the demand placed on natural capital is distributed extremely unevenly.
Per-person use of energy, materials, water and land in high-income countries is several times, and for some materials an order of magnitude, greater than in low-income countries. The same disparity exists within countries, between high-consuming and low-consuming households. The consequence is that the pressure on global natural capital, and the responsibility for the emissions and depletion that follow, are concentrated in a minority of the world’s population — while the damage from a degraded climate and a degraded local environment falls heavily on populations whose own consumption is small. This asymmetry between who benefits and who bears the cost is the same structure as an externality, written at global scale.
Demand is not fixed by need alone. Planned obsolescence — designing a product so that it fails, becomes unfashionable or becomes unrepairable within a short period, so that it must be replaced — sustains a rate of consumption higher than the useful life of the materials requires. So do product designs that cannot be dismantled, spare parts that cease to be available, and software that ends support for working hardware. Each of these converts a durable good into a flow of waste, and each is a design decision rather than a fact of nature, which is why the EPR instrument of section 7.5.5 targets design directly.
Where consumption persistently exceeds regenerative capacity, the results are the ones this section has catalogued: depletion of stocks, degradation of quality, reduced ecological health, and a fall in the carrying capacity available for the future. The approaches usually discussed for reducing overshoot are slowing the rate of use of the most depleted resources, shifting towards renewable energy and towards recycling and material recovery, extending product life through repair and reuse, and reducing consumption at the top of the distribution where the scope to do so without hardship is greatest.
7.6.7 Importance of Preserving Natural Capital
Why preserve natural capital rather than convert it into other forms of capital that can be measured, traded and taxed? Four arguments, of different kinds, are usually offered.
The economic argument is that natural capital is the foundation on which the other four capitals rest, and its services are not free — they are unpriced, which is a different thing. Where they fail, they have to be replaced by manufactured substitutes at a cost that is frequently many times greater than protecting the original would have been: a treatment plant instead of a catchment, an embankment instead of a mangrove, hand pollination instead of insects.
The risk argument is that some natural capital is critical, in the sense defined in section 7.6.2, and its loss cannot be reversed. Where an outcome is irreversible and its full consequences are uncertain, the prudent course is to avoid approaching the threshold, because the option of correcting the mistake later does not exist.
The equity argument runs in two directions. Within a generation, those who depend most directly on natural capital — for fuel, fodder, water and food gathered rather than bought — are usually those with the least ability to substitute anything else for it, so degradation falls hardest on them. Between generations, a stock consumed now is a stock unavailable later, and the people affected have no voice in the decision. This is the distributional question that cost–benefit analysis, which sums costs and benefits without asking whose they are, does not answer.
The valuation argument is practical. Countries holding globally significant natural reserves — large tropical forests, major river basins, centres of biological diversity — bear the cost of protecting them locally while the benefits are enjoyed worldwide. Many such countries have argued for international financial support on precisely this ground, and finance ministries and financial institutions have increasingly accepted that natural resource sustainability is a limiting factor for economic activity rather than a separate concern. Assessing the value of these reserves is what makes it possible to fund their protection at all — which is the strongest practical case for the accounting work of section 7.2.
7.6.8 Regeneration of Natural Capital
Preservation limits further loss. Regeneration is the harder task of rebuilding a stock that has already been drawn down. It is possible for much natural capital, though not for all of it, and it works only when the rate of use is brought within the rate of replacement.
Four operating rules are generally stated for managing a stock sustainably.
For renewable resources, the harvest rate must not exceed the regeneration rate. A fishery yielding a sustainable catch indefinitely and a fishery yielding a record catch for five years and nothing afterwards differ only in whether this rule was observed.
For waste emission, the discharge rate must not exceed the assimilative capacity of the receiving environment — the quantity of waste that air, water or soil can absorb and break down without lasting damage. Beyond that point the sink function fails, and, as noted in section 7.1.4, the loss shows up twice, since a damaged sink is also a damaged source.
For non-renewable resources, extraction should be paced so that a renewable substitute is developed before the stock is exhausted. The stock cannot be regenerated; what can be regenerated is the capacity to do without it.
For pollution, reduction is more effective at source and at small scale than as remediation later — the preventive expenditure of section 7.4.3, applied as a rule of management rather than as an accounting category.
Beyond these rules, regeneration in practice means active restoration: afforestation and assisted natural regeneration of degraded forest, watershed treatment and artificial recharge of aquifers, restoration of mined and contaminated land, rebuilding of soil organic matter through organic inputs and rotation, protection of breeding grounds so that fish and wildlife populations recover, and the shift towards renewable energy and recyclable material streams so that pressure on the stock falls while it recovers.
Two conditions govern whether any of this works. The first is time: regeneration is slow, and a stock takes far longer to rebuild than to deplete. A forest felled in a season is not replaced in a season, and a soil profile lost to erosion is not replaced within a human lifetime. The second is that consumption must actually fall within regenerative capacity while the restoration proceeds, since planting trees at one end while clearing them faster at the other changes nothing but the accounts.
7.7 Summary
Resources, scarcity and growth
A resource is any source or supply from which a benefit can be produced; a natural resource occurs in nature independently of human effort. Three conditions must hold together — utility, limited availability and consumption. A material becomes a resource when knowledge and technology make it usable, not when it comes into existence.
Natural resources are classified on four bases. By origin: biotic, from the living world, including coal and petroleum; and abiotic, from non-living material such as land, water, air and metallic ores. By renewability: renewable, replenished within a human timescale, with sunlight, air and wind further described as perpetual; and non-renewable, formed over geological time. By stage of development: potential, known but not yet used; and actual, surveyed and in use, of which the profitably workable part is a reserve resource and the part awaiting technology is a stock resource. By distribution: ubiquitous, found everywhere; and localised, confined to particular places. Resources are also classified by ownership as individual, community, national and international.
“Renewable” guarantees nothing by itself. What matters is the relation between the rate of extraction and the rate of regeneration. A renewable stock withdrawn faster than it is replenished is depleted exactly like a non-renewable one — an aquifer receiving 120 million litres of recharge and losing 150 million litres a year is being run down at 30 million litres a year, or 25 per cent of recharge.
Scarcity exists when the quantity of a good wanted exceeds the quantity available; equivalently, when society is willing to pay a positive price for it. It is a relationship, not a property, which is why clean air in a city is scarce while air in general is not. Because resources are scarce, every use has an opportunity cost — the value of the next-best alternative given up.
Economic growth is the increase over time in the goods and services an economy produces. The environment serves growth twice over, as the source of materials and energy and as the sink for residues, and both functions are finite. Damage to the sink reduces the source, so the loss registers twice. How far output can rise while resource use falls is disputed; growth has historically driven large gains in life expectancy and poverty reduction, while material throughput has risen alongside output for two centuries.
Natural resource accounting
Natural resource accounting records the stocks of a country’s natural assets and the flows into and out of them, so that depletion and degradation can be measured alongside economic activity. Firms depreciate their machines; standard national accounts depreciate no forest, aquifer or fishery.
Every account balances as Closing stock = Opening stock + Additions − Reductions. Additions come from natural growth, deliberate replenishment and new discovery; reductions from extraction, degradation and conversion to other uses.
Physical accounting records these stocks and changes in physical, non-monetary units — hectares, tonnes, cubic metres, numbers — with no monetary valuation. Its principles are that entries stay in natural units, that quality is recorded alongside quantity with combined changes described as volume changes, that the account is built as a balance, and that it extends input–output analysis to materials and energy.
Its advantages are that it avoids contested valuation, uses data already collected, shows both current status and trend, and is transparent. Its disadvantage is that it has no single dimension in which totals can be struck, so it is harder to interpret, harder to compare and easier to ignore than a monetary figure. Most systems use both, with the physical account first.
The System of Environmental-Economic Accounting is the international statistical standard for this work, its central framework adopted by the United Nations Statistical Commission in 2012 and an ecosystem framework in 2021. India has an official expert group working on green national accounts.
Measuring income
Gross Domestic Product is the total market value of final goods and services produced within a country’s territory in a year. It equals total income and total expenditure, since every rupee spent is a rupee earned. Nominal GDP is at current prices, real GDP at base-year prices; growth is reported in real terms. Per capita GDP divides the total by population.
Gross National Product shifts the boundary from territory to residence: GNP = GDP + net factor income from abroad. A foreign-owned factory in India adds to India’s GDP but not its GNP; an Indian-owned office abroad does the reverse. Subtracting depreciation of manufactured capital from GNP gives Net National Product; subtracting depletion of natural capital as well gives an environmentally adjusted, or green, national income.
Advantages: both measures condense an economy into one comparable figure, allow tracking over time and comparison across countries, are easy to compute from data already collected, and broadly indicate a country’s capacity to provide services.
Disadvantages: they omit household work, subsistence production, unpaid care and much of the informal sector; they conceal distribution; they are distorted in international comparison by exchange rates; they treat output generated by drawing down a stock exactly like output generated from a flow, so felling a forest raises income while the loss is recorded nowhere; and they count defensive spending on repairing damage as an addition to output.
Environmental economics, welfare and defensive expenditure
Environmental economics studies the economic causes and consequences of environmental change. Its diagnosis is market failure: where a resource has no owner and no price, the user bears none of the cost of using it up, and it is overused. Its remedy is internalisation through charges, standards, permits, liability rules and property rights. Ecological economics differs in treating the economy as a subsystem of a finite ecosystem and asking first what scale it can sustain.
Economic status is what an economy produces; welfare is how well its people live. Net economic welfare, developed by William Nordhaus and James Tobin in the early 1970s, adjusts national income by adding non-market production and leisure and subtracting pollution, congestion and defensive expenditure. Its weakness is that every adjustment requires a valuation that no market supplies.
Defensive expenditure is spending that prevents, reduces, repairs or protects against environmental damage — spending that defends a position rather than improving it. It is classified as preventive (reduce, reuse, recycle, cleaner processes), abatement and treatment (effluent plants, scrubbers, segregated disposal), restorative (site reclamation, replanting, cleaning water bodies), and protective or screening (purifiers, filters, medical costs, repair of corroded structures). Every rupee of it raises GDP while raising nobody’s welfare, and the protective category is bought individually, so those least able to pay are left with the harm.
Natural capital is the stock of natural assets yielding a continuing flow of goods and services; ecological capital is the part consisting of functioning ecosystems. Reclassifying nature as capital makes felling a forest the liquidation of an asset rather than income, and makes degradation a form of depreciation.
Externalities and cost–benefit analysis
An externality is an uncompensated cost or benefit falling on a third party outside a transaction, and therefore absent from the market price. Social cost = private cost + external cost.
Negative externalities impose uncompensated costs — vehicle and industrial air pollution, effluent in rivers, overfishing, noise, greenhouse gas emissions, congestion, light spill, accident risk. Positive externalities confer uncompensated benefits — pollination of a neighbour’s orchard, worker training, technology spillover, new infrastructure, vaccination, education, well-maintained property. Each may arise in production or in consumption.
Their impacts are threefold. Efficiency: goods with negative externalities are overproduced and those with positive externalities underproduced, because prices carry incomplete information. Distribution: costs fall on those nearest and least able to avoid them, while benefits spread elsewhere. Property rights: externalities cluster where ownership is undefined, so no one can exclude a polluter or gains from conserving.
Cost–benefit analysis identifies, quantifies and compares all costs and benefits of a proposal in common monetary terms over its lifetime. Future flows are discounted to present value, and net present value is the sum of discounted net flows. The process runs from listing alternatives and stakeholders, through identifying cost and benefit elements, fixing the time period, using a common currency, choosing a discount rate, computing net present value and testing sensitivity, to adopting the best option.
The discount rate is decisive: an identical treatment plant costing ₹100 crore and yielding ₹40 crore a year for three years has a net present value of about −₹0.53 crore at 10 per cent and about +₹8.93 crore at 5 per cent.
Advantages of cost–benefit analysis: simple in structure, forces every cost and affected party onto the record, allows comparison of very different proposals, and can be extended to social and ecological effects. Disadvantages: valuation is uncertain and omissions are easy, it is open to subjectivity, it measures efficiency and not fairness, discounting biases it against the long term, and some stakeholders and unquantifiable effects always fall outside its boundary.
Extended Producer Responsibility extends a producer’s responsibility to the post-consumer stage of a product’s life. Examples include take-back of electronic goods, deposit–refund systems, producer-financed battery collection and obligations for plastic packaging. Its advantages are that it internalises disposal costs, changes product design towards durability and repairability, builds collection systems, recovers materials, and places the cost where the knowledge of the product lies.
Natural capital and its regeneration
Five types of capital are distinguished: natural, human, social, manufactured and financial. Financial capital has no intrinsic value and represents claims on the others; all of them ultimately derive from and are bounded by natural capital.
Natural capital consists of the stock of natural resources together with ecosystem services. It is renewable or non-renewable; it is distinguished as stock and flow, so that living off the flow is sustainable and living off the stock is not; and it is critical where no substitute exists at any price, as with a stable climate, the ozone layer and the genetic library of wild species.
Ecosystem services fall into four classes. Provisioning: food, fresh water, raw materials, medicinal and genetic resources, ornamental resources. Regulating: air and climate regulation, water regulation and purification, erosion and flood control, pollination, biological pest control. Cultural: recreation, aesthetic and spiritual value, sense of place, education and research. Supporting: soil formation, nutrient cycling, primary production and the water cycle, which make the other three possible.
Acid deposition arises when sulphur dioxide and oxides of nitrogen from combustion are oxidised and combine with water vapour to form sulphuric and nitric acids, returning as wet deposition in rain, snow, fog and mist, or as dry deposition of gases and particles. Clean rain has a pH of about 5.6 because of dissolved carbon dioxide; pH is logarithmic, so each unit lower is a tenfold rise in acidity. The damage is largely indirect — leaching of base nutrients and mobilisation of aluminium in soils, failed reproduction in acidified lakes, weakened high-altitude forests, and corrosion of stone and metal structures.
Air pollution reduces photosynthesis as particulates settle on leaves, damages the cuticle and stomata, and produces chlorosis, necrosis, premature leaf fall and reduced yield; haze and smog reduce visibility; pollutants accumulate in sediment and can be concentrated along food chains.
Deforestation removes a stock and its regulating services together: erosion and downstream siltation, sharper floods and weaker dry-season flow, reduced recharge, habitat loss, and a fuelwood shortage that leads to dung being burnt instead of returned to the soil. Forest-dependent communities are affected most directly and appear least in the accounts.
Loss of biodiversity — variety of genes, species and ecosystems — is caused by habitat destruction and fragmentation, over-harvesting, pollution, invasive species and shifting climate. It is irreversible; it narrows the genetic options available to agriculture, a narrowing within crops called genetic erosion; and it reduces resilience, the capacity of a system to absorb disturbance and keep functioning.
Carbon dioxide emission from fossil fuel combustion, land clearing, cement manufacture, respiration and volcanic activity strengthens the natural greenhouse effect, without which the Earth’s average surface temperature would be far below freezing rather than about 15 °C. The consequences for natural capital are shifting species ranges, mismatched biological timing, sea-level rise and saline intrusion, and ocean acidification. Higher carbon dioxide does raise photosynthesis in many plants, but the gain is limited by water and nitrogen and set against heat stress and altered rainfall.
The ecological footprint measures demand on the biosphere as the biologically productive area needed to supply what is consumed and absorb what is emitted, expressed in global hectares — one hectare at world-average productivity. Compared with biocapacity, a footprint in excess indicates ecological overshoot, met by importing capacity through trade or by drawing down stocks. Its limitations are its sensitivity to how carbon absorption is estimated, and its silence on toxicity, freshwater scarcity and biodiversity.
Per-person use of energy, materials, water and land differs several-fold between high-income and low-income populations, so pressure on global natural capital is concentrated where consumption is highest while damage falls heavily where it is lowest. Planned obsolescence sustains consumption above what material lifetimes require.
Preserving natural capital is argued for on four grounds: economic, since manufactured substitutes usually cost far more than protection; risk, since critical natural capital is lost irreversibly; equity, both within a generation and towards those who come later; and valuation, since reserves of global significance can be funded for protection only once their value has been assessed.
Regeneration works only within four rules: harvest renewable resources no faster than they regenerate; emit waste no faster than the environment can assimilate it; pace extraction of non-renewables so that a substitute is developed before exhaustion; and reduce pollution at source rather than remediate it later. In practice it means afforestation, watershed treatment and recharge, land reclamation, rebuilding of soil organic matter, protection of breeding grounds, and a shift to renewable energy and recovered materials — all of it slow, and all of it useless unless consumption is brought within regenerative capacity while the recovery proceeds.
7.8 Key Terms
Abiotic resource — a natural resource obtained from the non-living, inorganic world, such as land, water, air, sunlight and metallic ores.
Acid deposition — the arrival at the earth’s surface of acidity well above natural levels, formed when sulphur dioxide and oxides of nitrogen are oxidised and combine with atmospheric water vapour; it includes acid rain, acid fog and acid mist.
Actual resource — a resource that has been surveyed, whose quantity and quality are known, and which is in use.
Biocapacity — the biologically productive area a territory actually possesses, adjusted for its productivity and expressed in global hectares.
Biodiversity — the variety of life at three levels: genes within a species, species within an ecosystem, and ecosystems within a region.
Biotic resource — a natural resource obtained from the living world and made of organic material, including forests, fisheries, coal and petroleum.
CBA — Cost–Benefit Analysis.
Cost–benefit analysis — the systematic identification, quantification and comparison, in common monetary terms, of all costs and benefits of a project or policy over its lifetime.
Critical natural capital — natural capital for which no manufactured substitute exists at any price, and whose loss is irreversible on a human timescale.
Defensive expenditure — spending undertaken to prevent, reduce, repair or protect against environmental damage; it defends an existing level of well-being rather than raising it.
Degradation — the deterioration of natural capital through loss of quantity, loss of quality, or loss of the capacity to deliver services.
Depreciation — the loss in the value of an asset caused by wear, ageing or use during an accounting period.
Discount rate — the rate at which future costs and benefits are reduced to their present value in a cost–benefit analysis.
Dry deposition — the settling of acidic gases and particles directly onto ground, buildings, vegetation and animal surfaces, without precipitation.
Ecological capital — the part of natural capital consisting of functioning ecosystems and ecological processes that generate and maintain services.
Ecological economics — the field that treats the economy as a subsystem contained within a finite ecosystem and asks what scale of activity that ecosystem can sustain.
Ecological footprint — the biologically productive land and water area required to supply what a person, population or activity consumes and to absorb the wastes it generates.
Ecological overshoot — the condition in which a population’s ecological footprint exceeds available biocapacity, so that stocks are being drawn down.
Economic growth — the increase, over a period of time, in the total quantity of goods and services produced by an economy.
Ecosystem services — the benefits people obtain from ecosystems, classified as provisioning, regulating, cultural and supporting.
Environmental economics — the branch of economics that studies the economic causes and consequences of environmental change and how prices and policies can allocate environmental resources more efficiently.
EPR — Extended Producer Responsibility.
Extended Producer Responsibility — a policy approach extending a producer’s responsibility for a product to its post-consumer stage, covering collection, recycling and safe disposal.
External cost — the part of the cost of an activity borne by third parties rather than by the producer.
Externality — a cost or benefit arising from an economic activity that falls on a third party who neither chose it nor is compensated or charged for it, and which is therefore absent from the market price.
Financial capital — shares, bonds, deposits and currency; it produces nothing itself and represents claims on natural, human, social or manufactured capital.
Flow — a movement into or out of a stock during a period, such as timber felled or water recharged in a year.
GDP — Gross Domestic Product.
Genetic erosion — the narrowing of genetic variation within cultivated species as many local varieties are replaced by a few uniform ones.
Global hectare — one hectare of biologically productive area at world-average productivity, used as the common unit of ecological footprint and biocapacity.
Global warming — the rise in average surface temperature caused by an increased atmospheric concentration of greenhouse gases.
GNP — Gross National Product.
Green GDP — a national income figure adjusted for the depletion and degradation of natural capital as well as for depreciation of manufactured capital.
Greenhouse effect — the natural warming produced when atmospheric gases transmit incoming short-wave solar radiation but absorb and re-radiate outgoing infrared radiation from the surface.
Gross Domestic Product — the total market value of all final goods and services produced within a country’s domestic territory in a specified period.
Gross National Product — the total market value of final goods and services produced by the normal residents of a country, wherever produced; GDP plus net factor income from abroad.
Haze — an atmospheric condition in which fine particles obscure visibility and reduce the clarity of the sky.
Human capital — the stock of health, knowledge, skills and experience embodied in people.
Informal sector — unregistered enterprises and workers without formal contracts, whose output is captured in national accounts only by estimate.
Internalisation — bringing an external cost or benefit inside the decision of the party who causes it, through charges, standards, permits, liability or subsidy.
Localised resource — a resource confined to particular places, such as copper, iron ore or coal.
Manufactured capital — the stock of produced goods used to make other goods, including factories, machinery, roads and tools.
Market failure — a situation in which a market, left to itself, produces an outcome that is inefficient for society as a whole.
Natural capital — the stock of natural assets, including land, air, water, soil, minerals and living organisms, yielding a continuing flow of resources and ecosystem services.
Natural resource — a resource occurring in nature independently of human effort, though effort is usually needed to make it usable.
Natural resource accounting — a system of accounts recording the stocks of a country’s natural assets and the flows into and out of them over an accounting period.
Negative externality — an externality that imposes an uncompensated cost on a third party.
Net economic welfare — a welfare measure obtained by adding non-market production and leisure to national income and subtracting pollution, congestion and defensive expenditure.
Net factor income from abroad — factor income received from abroad minus factor income paid abroad; the difference between GNP and GDP.
Net National Product — Gross National Product less the depreciation of manufactured capital.
Net present value — the sum of the discounted benefits of a project less the sum of its discounted costs.
NFIA — Net Factor Income from Abroad.
NNP — Net National Product.
Nominal GDP — Gross Domestic Product measured at the prices of the current year.
Non-renewable resource — a resource whose stock is fixed for practical purposes because it forms over geological time, such as coal, petroleum and mineral ores.
NPV — Net Present Value.
Opportunity cost — the value of the next-best alternative that must be given up when a choice is made.
Per capita GDP — Gross Domestic Product divided by the population, giving average output per person.
Perpetual resources — renewable resources such as sunlight, air and wind whose flow is continuous and is not reduced by human consumption.
Physical accounting — the recording of natural resource stocks and their changes in physical, non-monetary units, without assigning any monetary value.
Planned obsolescence — designing a product so that it fails, becomes unfashionable or becomes unrepairable within a short period, requiring earlier replacement.
Positive externality — an externality that confers an uncompensated benefit on a third party; also called an external benefit.
Potential resource — a resource known or believed to exist in a region but not yet put to use.
Present value — the value today of a cost or benefit occurring in a future year, after discounting.
Private cost — the cost of an activity borne by the producer who undertakes it.
Real GDP — Gross Domestic Product measured at the prices of a fixed base year, so that inflation is excluded.
Recycling — returning used material such as paper, glass, metal or plastic into the production of new goods.
Regeneration — the rebuilding of a natural capital stock that has already been drawn down.
Renewable resource — a resource replenished by natural processes at a rate comparable to the rate at which it is used.
Reserve resource — the part of an actual resource that can be developed profitably with present technology and is held for future use.
Resilience — the capacity of an ecosystem to absorb a disturbance and continue functioning.
Resource — any source or supply, material or otherwise, from which a benefit can be produced.
Reuse — using an article again in its existing form rather than discarding it.
SEEA — System of Environmental-Economic Accounting.
Sink — the role of the environment in absorbing and breaking down the residues of economic activity.
Smog — dense haze produced by pollutants, in which visibility and air quality are both severely reduced.
Social capital — the institutions, relationships and norms through which people act together, including families, schools, cooperatives and voluntary bodies.
Social cost — the full cost of an activity to society; private cost plus external cost.
Source — the role of the environment in supplying materials and energy to economic activity.
Scarcity — the condition in which the quantity of a good or service wanted exceeds the quantity available.
Stock — the quantity of a resource in existence at a point in time.
Stock resource — a material that has been surveyed and is known to exist but cannot yet be used because the technology to do so is unavailable or unviable.
Ubiquitous resource — a resource found more or less everywhere, such as air or sunlight.
Utility — the capacity of a thing to satisfy a want, one of the three conditions a resource must meet.
Volume change — the combined change in the quantity and the quality of an asset recorded in a physical account.
Welfare — the actual well-being of the people in an economy, as distinct from the value of what it produces.
Wet deposition — the removal of atmospheric acids by precipitation, so that they arrive dissolved in rain, snow, fog or mist.
7.9 Points to Ponder
If a country’s Gross Domestic Product rises by 7 per cent in a year while its groundwater table falls and a tenth of its forest cover is diverted to other uses, has that country become richer or poorer? What would you need to know before you could answer?
A physical account can tell you that 200 hectares of forest were lost. A monetary account can tell you that the loss was worth ₹18 crore. Which of the two statements is more useful to a district administrator, and which is more likely to change a decision? Are those the same question?
Cost–benefit analysis discounts future benefits, so a benefit arriving in fifty years counts for very little today. Yet almost every serious environmental benefit arrives late. Is discounting the wrong tool for environmental decisions, or the right tool applied with the wrong rate — and how would you tell the difference?
Two families live on the same street and breathe the same air. One installs an air purifier; the other cannot afford one. Both purchases are recorded in the national accounts as consumption, and only one of them happens. What does this tell you about the difference between cleaning a shared environment and allowing people to buy their way out of it?
Natural capital can be treated as substitutable — a treatment plant standing in for a catchment forest — or as critical, with no substitute at any price. Which natural assets in your own district would you place in each category, and what evidence would justify the placement rather than the intuition?
Extended Producer Responsibility changes what a manufacturer finds it worthwhile to design. If a producer had to collect back and dismantle every product it sold, which three things about the objects around you would look most different, and what would that change cost the buyer?
7.10 Objective Questions
- (Choose the correct option. A resource that has been surveyed and is known to exist, but which cannot be used because the required technology is not yet available, is called:
- a potential resource
- a reserve resource
- a stock resource
- a ubiquitous resource) [1 mark]
- (Choose the correct option. Gross National Product differs from Gross Domestic Product by:
- depreciation of manufactured capital
- net factor income from abroad
- the value of unpaid household work
- the depletion of natural capital) [1 mark]
- (Choose the correct option. Which of the following is a supporting ecosystem service?
- Pollination of crops by insects
- Supply of timber and fuelwood
- Nutrient cycling and soil formation
- Recreation and tourism in a national park) [1 mark]
- (Choose the correct option. Money spent by a household on a water purifier because the piped supply is unsafe is an example of:
- a positive externality
- defensive expenditure
- physical accounting
- natural capital regeneration) [1 mark]
- (Choose the correct option. In a cost–benefit analysis, raising the discount rate will:
- increase the present value of distant benefits
- reduce the present value of distant benefits
- leave the present value of distant benefits unchanged
- apply only to costs and not to benefits) [1 mark]
- (Choose the correct option. Clean rain has a pH of about 5.6 because of dissolved:
- sulphur dioxide
- nitrogen dioxide
- carbon dioxide
- ammonia) [1 mark]
- (Assertion (A): A renewable resource can be depleted just as completely as a non-renewable one. Reason (R): A resource is depleted whenever the rate of extraction exceeds the rate of regeneration.
- Both A and R are true and R is the correct explanation of A.
- Both A and R are true but R is not the correct explanation of A.
- A is true but R is false.
- A is false but R is true.) [1 mark]
- (Assertion (A): Felling a forest and selling the timber raises a country’s measured Gross Domestic Product. Reason (R): Standard national accounts record the depreciation of natural capital in the year in which it occurs.
- Both A and R are true and R is the correct explanation of A.
- Both A and R are true but R is not the correct explanation of A.
- A is true but R is false.
- A is false but R is true.) [1 mark]
- (Assertion (A): Goods that carry a negative externality tend to be overproduced by a free market. Reason (R): The market price of such goods reflects private cost but not external cost.
- Both A and R are true and R is the correct explanation of A.
- Both A and R are true but R is not the correct explanation of A.
- A is true but R is false.
- A is false but R is true.) [1 mark]
- (Match the term in Column A with its description in Column B.
| Column A | Column B |
|---|---|
| a. Global hectare | i. Stock yielding a continuing flow of goods and services |
| b. Volume change | ii. Uncompensated benefit to a third party |
| c. Natural capital | iii. Combined change in the quantity and quality of an asset |
| d. Positive externality | iv. One hectare at world-average biological productivity |
) [1 mark]
- (Fill in the blanks.
- Social cost is the sum of private cost and ____ cost.
- The settling of acidic gases and particles directly onto surfaces, without precipitation, is called ____ deposition.
- The condition in which a population’s ecological footprint exceeds available biocapacity is called ecological ____. ) [1 mark]
- (State whether each statement is true or false.
- Financial capital has no intrinsic productive value of its own.
- Physical accounting expresses all natural resource stocks in a single monetary unit.
- Sunlight, air and wind are described as perpetual resources. ) [1 mark]
- (Give the full form of each of the following: GNP, NPV, EPR, SEEA.) [1 mark]
7.11 Check Your Concepts
(Define a natural resource, and state the three conditions a thing must satisfy before it is treated as a resource.) [2 marks]
(Define scarcity as economists use the term, and give one example of something that is free and yet scarce.) [2 marks]
(State the four classes into which ecosystem services are conventionally grouped, and give one example of each.) [2 marks]
(Define natural capital. Why is it described as capital rather than as income?) [2 marks]
(Give the full form of EPR and state two advantages of adopting it.) [2 marks]
(Differentiate between potential and actual resources, and explain what usually converts one into the other.) [3 marks]
(Differentiate between wet deposition and dry deposition, and state one effect of acid deposition on soil.) [3 marks]
(Give reasons: a physical account is easier to compile honestly than a monetary one, and yet harder to act upon.) [3 marks]
(Distinguish between environmental economics and ecological economics with respect to how each views the relationship between the economy and the ecosystem.) [3 marks]
(Explain, with one example of each, the difference between a negative production externality and a negative consumption externality.) [4 marks]
(Explain with an example why defensive expenditure raises measured national income without raising welfare, and name the four classes into which such expenditure is grouped.) [4 marks]
(Evaluate the claim that “a rising Gross Domestic Product shows that a country is becoming better off”. Support your answer with at least three distinct arguments.) [4 marks]
(Explain what the ecological footprint measures and how it is compared with biocapacity. State two limitations of the measure.) [4 marks]
(Describe cost–benefit analysis in full: what it is, the main steps of the process, and its advantages and disadvantages as a tool for environmental decisions.) [6 marks]
(Discuss the causes of degradation of natural capital under the heads of acid deposition, air pollution, deforestation, loss of biodiversity and emission of carbon dioxide, giving one consequence of each for the services natural capital provides.) [6 marks]
(Explain what is meant by natural resource accounting, describe physical accounting and its basic principles, and state its advantages and disadvantages.) [6 marks]
7.12 Passage-Based Questions
- (A small town draws its water from an aquifer that receives an average annual recharge of 90 million litres. Over the last decade the number of borewells has risen sharply, and withdrawal is now estimated at 126 million litres a year. The municipal council reports the water supply department as profitable, since revenue from water charges exceeds pumping and maintenance costs. Households in the older part of town have begun deepening their wells at their own expense, and several have started buying water from private tankers.
- Calculate the annual overdraft and express it as a percentage of recharge.
- Explain why the water supply department can appear profitable while the town’s natural capital is being drawn down.
- Classify the spending on deepened wells and tanker water using the classification of defensive expenditure, and state who bears this cost. ) [6 marks]
- (A cluster of small factories on the edge of a town discharges untreated effluent into a seasonal stream. Downstream, farmers report reduced yields on irrigated plots, and a group of households that once caught fish in the stream no longer does so. The factories operate within their licence conditions and pay for all the inputs they buy. A proposal to install a common effluent treatment plant has been costed at ₹4 crore, with annual running costs of ₹40 lakh.
- Identify the externality described and state precisely who the third parties are.
- Explain why the market price of the goods produced by these factories understates their true social cost.
- Name two policy instruments that could internalise this cost, and state one difficulty each would face. ) [6 marks]
- (A hill district is considering two proposals for the same valley. The first is a resort and road project expected to generate employment and revenue from the second year onwards. The second is a watershed restoration programme whose main benefits — recharged springs, reduced siltation downstream and restored grazing — would appear only after ten to fifteen years. A cost–benefit analysis carried out at a discount rate of 12 per cent ranks the first project well above the second.
- Explain how the choice of discount rate has influenced this ranking.
- State two categories of benefit from the watershed programme that a standard cost–benefit analysis is likely to have valued poorly or not at all.
- Suggest what additional step in the analytical process would have tested the reliability of this ranking, and explain what it would show. ) [6 marks]
7.13 Practice With Data
- (A Forest Division records an opening stock of 8,000 hectares (ha) at the start of the year. During the year, afforestation adds 250 ha, natural regeneration adds 60 ha, and 420 ha are diverted to a transmission corridor. A further 180 ha are reclassified from dense forest to open forest.
- Prepare the physical asset account and calculate the closing stock in hectares.
- Express the net change in area as a percentage of the opening stock.
- State why a reader looking only at the area figures would understate the loss, and name the accounting principle that addresses this. ) [4 marks]
- (For a given year, an economy records a Gross Domestic Product of ₹150 lakh crore. Factor income received from abroad is ₹6 lakh crore and factor income paid abroad is ₹9 lakh crore. Depreciation of manufactured capital is ₹12 lakh crore, and the depletion of forests, groundwater and mineral stocks over the same year is valued at ₹7 lakh crore.
- Calculate the Gross National Product and the Net National Product.
- Calculate the environmentally adjusted national income.
- Express the environmental deduction as a percentage of Gross Domestic Product, and state what its omission from standard accounts implies about the value assigned to it. ) [4 marks]
- (Study the following data.
| Region | Ecological footprint (gha per person) | Biocapacity (gha per person) | Population (crore) |
|---|---|---|---|
| P | 4.8 | 1.6 | 8 |
| Q | 1.4 | 3.0 | 5 |
- Calculate the ecological balance per person for each region and state which is in overshoot.
- Calculate the total footprint of each region in crore global hectares.
- Region P has a smaller population than the figures for total footprint might suggest to a casual reader. Explain what the comparison of the two regions shows about per-person demand on natural capital. ) [4 marks]
- (A brick kiln produces 8 lakh bricks a year at a private cost of ₹5.50 per brick and sells them at ₹6.40. An assessment values the health, crop and cleaning costs falling on neighbouring households at ₹0.75 per brick.
- Calculate the social cost per brick and the total external cost borne by third parties in a year.
- Compare the kiln’s annual private profit with the annual external cost, and state what the comparison shows about the true net gain to society.
- State one instrument that would bring the external cost into the kiln’s own accounts. ) [4 marks]