In time, two problems were noted. First, unless goods and services were valued at their appropriate prices, investment would be directed at the production of the wrong sorts of goods: the development experience soon became littered with examples of industries that managed to survive only because of protection from domestic and foreign competition. Second, the returns could be abysmally low, even if the right investment projects were chosen, if prevailing institutions were weak. During the 1970s, development economists focused on the first of these problems and searched for ways to identify socially productive investment projects and defendable economic policies. Since then their focus has shifted to the second problem, because of growing acknowledgement that governments in poor countries have all too frequently not functioned in their citizens’ interest.

Institutional reform
So development economists today study institutional reform – such as ways to increase the efficacy and reach of markets, and measures to reconstruct weakened or failed local communitarian institutions. This emphasis on institutions as a vehicle for economic development has sidelined policy analysis to a certain extent. But a policy that is desirable in one institutional setting could well be undesirable in another. Policy choice and institutional reform are interconnected exercises.

Even if the focus of research has changed, the coin with which economic development is measured has continued to be based on GNP per capita. In recent years the United Nations’ Human Development Index (HDI) – a combined index of GNP per capita, life expectancy at birth and literacy – has been added. But both measures reflect short-run concerns, while the question of whether contemporary patterns of development are sustainable requires us to peer into the distant future.

An economy’s long-term prospects are shaped by its institutions, and by the size and distribution of its capital assets. Taken together, these form its productive base, the source of a society’s well-being through time.

Economists call the value of an economy’s capital assets wealth. I adopt here a comprehensive notion of wealth: the list of assets includes manufactured ones (roads and buildings; machinery and equipment; cables and ports), human capital (knowledge and skills), and a wide array of natural capital (oil and natural gas; fisheries and forests; ecosystem services). To say that wealth has increased is to say that, in aggregate, there has been a net accumulation of capital assets. In what follows I shall call this genuine investment – in contrast to recorded investment. As the services of many capital assets are missing from national accounts, genuine investment can be negative even when recorded investment is positive.

Measuring sustainability
It can be shown that wealth measures a society’s well-being, taking both its present and future into account. After correcting for population change, the well-being of present and future generations, considered together, increases if genuine investment is positive. So changes in the wealth-like measure brought about by economic policies can be used to identify whether these lead to a sustainable pattern of development.

By contrast, GNP – as the sum of aggregate consumption and gross investment – is insensitive to the depreciation of capital assets. It can increase for a time even when an economy’s genuine investment is negative and wealth declines. This can happen if, say, increases in GNP are brought about by mining capital assets – such as by degrading ecosystems and depleting oil and mineral deposits – without investing some of the proceeds in substitute forms of capital, such as human capital. So there is little reason to expect movements in GNP to parallel those in wealth. GNP cannot be used to identify sustainable development policies: nor, as we will see, can HDI.

National accounts are now highly sophisticated, but they miss changes brought about by economic activities to the stocks of many natural resources. They also fail to record the use we make of a myriad of nature’s services – including maintaining a genetic library, preserving and regenerating soil, fixing nitrogen and carbon, recycling nutrients, controlling floods, filtering pollutants, assimilating waste, pollinating crops, operating the hydrological cycle, and maintaining the composition of the atmosphere. These are missed because they usually do not come with a price tag. The reason is that property rights to natural capital are often impossible to establish, let alone to enforce, because it is often mobile (birds, butterflies, river water and the atmosphere are proto-typical).

With effort, it would still be possible to assign notional prices to nature’s services that would go some way toward reflecting their scarcity values. As matters stand, the effect of the interconnectedness of various forms of natural capital often go unrecorded in economic transactions. So those who, for example, destroy mangroves to create shrimp farms are not required to compensate the fishermen dependent on them. Meanwhile, ponds, tanks, threshing grounds, grazing fields and woodlands harbour mobile resources, making them unsuitable as private property.

Rural communities in poor countries have long recognized these deep underlying problems and developed local institutional mechanisms to overcome them. Researchers have recently identified a wide variety of non-market – often communitarian – institutions in rural communities that mediate economic transactions in nature’s services. Unhappily, communitarian institutions have recently eroded in many of the world’s poorest regions. When they are neither stayed nor adequately replaced, the poorest frequently suffer most as their local environmental resource base deteriorates.

Tracing ripples
A policy change can create all sorts of effects rippling through the system, unnoticed by those unaffected. Tracing the ripples requires understanding non-market interactions and their interplay with markets. Identifying sustainable development policies involves, among other things, valuing the ripples and, therefore, nature’s services. We can now appreciate how the weaknesses of national accounts mirror those in policy evaluation. As nature’s services are typically underpriced, it is reasonable to fear that modern economic development has probably been rapacious in using natural capital.

How much does genuine investment fall short of recorded investment? The World Bank has provided estimates of genuine investment in some countries by adding net investment in human and natural capital to estimates of investment in manufactured capital. They are incomplete: for example, only commercial forests, oil and minerals, and the atmosphere as a sink for carbon dioxide were included among the resources making up natural capital (water resources, forests as agents of carbon sequestration, fisheries, air and water pollutants, soil, and biodiversity were excluded). So there is an undercount, possibly a serious one. Moreover, some of the methods deployed for estimating prices are dubious. Nevertheless, one has to start somewhere.



Measuring investment
The accompanying table uses the World Bank figures and assesses the character of recent economic development in sub-Saharan Africa, the Indian sub-continent and China – where the bulk of the world’s 1 billion poorest people live.

The first column contains the World Bank’s estimates of genuine investment, as a proportion of GNP, during 1973-1993. Bangladesh and Nepal have disinvested: their aggregate capital assets declined. By contrast, genuine investment has been positive in China, India, Pakistan and sub-Saharan Africa. But when population growth is taken into account, the picture changes.

The second column of figures contains the annual rate of population growth during 1965-1996. All but China experienced growth rates over 2 per cent per year, sub-Saharan Africa and Pakistan reaching 3 per cent. I next estimated the average annual change in wealth per capita during 1970-1993 – by multiplying genuine investment as a proportion of GNP by the average output-wealth ratio of an economy to arrive at the investment-wealth ratio, and then comparing changes in the latter to changes in population size.

Since a wide variety of capital assets (for example, human capital and various forms of natural capital) are unaccounted for in national accounts, there is a bias in published estimates of output-wealth ratio. Traditionally this has been taken to be something like 0.30 per year. I have used 0.15 per year as a check against the bias in traditional estimates for poor countries. Even these figures are almost certainly too high.

The third column of the table contains my estimates of the annual rate of change in the per capita wealth-like index I mentioned earlier. To arrive at the figures. I multiplied genuine investment as a proportion of GNP by the output-wealth ratio, and then subtracted the population growth rate. This is a crude way to adjust for population change, but more accurate adjustments would involve greater computation.

National accounts are now highly sophisticated, but they miss changes brought about by economic activities to the stocks of many natural resources

The striking message of the third column is that there has been capital decumulation during the past 30 years or so everywhere except in China. This may not be surprising for sub-Saharan Africa, but should be for Bangladesh, India, Nepal and Pakistan. Even China – so greatly praised for its progressive economic policies – has only just managed to accumulate wealth ahead of population growth. Using a lower – almost certainly more accurate – figure for the output-wealth ratio would reduce China’s accumulation rate. Besides, the estimates of genuine investment do not include soil erosion or urban pollution, both thought to be especially problematic in China.

Challenging conventional statistics
How do these changes compare with those in conventional measurements? The fourth column contains estimates of the rate of change of GNP per head during 1965-1996, and the fifth records whether the change in the United Nations’ Human Development Index over 1987-1997 was positive or negative.

Notice how misleading our assessment of long-term economic development in the Indian sub-continent would be if we were to look at growth rates in GNP per head. In Pakistan, for example, this grew at a healthy 2.7 per cent per year, implying that the index doubled in value between 1965 and 1993. The figures imply, however, that the average Pakistani became poorer by a factor of about 1.5 during that same period.

Bangladesh too has decumulated capital. It is recorded as having grown at a rate of 1 per cent per year during 1965-1996 in terms of GNP per head. Yet the figures imply that the average Bangladeshi was about half as wealthy at the end of the period as at the beginning. India has avoided a steep decline in wealth per head. But, if the figures are taken literally, the average Indian was slightly poorer in 1993 than in 1970.

The situation in sub-Saharan Africa is especially sad. At an annual rate of decline of 2 per cent in wealth per head, the poverty of the average person in the region doubles every 35 years. The table reveals that the region has experienced an enormous decline in its capital assets over the past three decades.

The Human Development Index is even more misleading. As the third and fifth columns show, it offers precisely the opposite picture of the one we should obtain, growing for sub-Saharan Africa during the 1990s and declining for China. Bangladesh and Nepal have been exemplary in terms of HDI, but both have decumulated their capital assets at a high rate.