Box 1: The Maintenance of Natural Capital: Something is missing from Corporate Accounts

Can wealth creation and environmental sustainability ever be reconciled or is there an inherent conflict between profits and the environment? Much of the business school rhetoric, from the late 1980s to the present day, would suggest there is no conflict. The talk is all of 'win-win' or 'double dividend' opportunities, measures that bring reduced environmental impact and enhanced profitability. Clean and efficient industries, it is said, will produce new products and technologies without environmental destruction. But despite their obvious appeal, the adoption of clean technology, waste minimisation and the pursuit of energy and eco-efficiency in isolation will never be enough. While these activities need to be encouraged and actively promoted, given the magnitude of the environmental challenges we face, it would be naïve to rely entirely on 'win-win' outcomes to deliver necessary environmental improvements. Producing more from less is not the same as sustainable industrial production.

The Role of Natural Capital:

The problem, in part, stems from the failure of accounting systems — at the national level and at the corporate level — to fully account for 'natural' capital. While companies account for the depreciation of manufactured capital, to ensure that productive capacity and hence the ability to generate future returns and income is maintained, no account is made for the degradation of natural capital when calculating corporate profits. Natural capital can be thought of as the exploitable resources of the earth's ecosystem, its oceans, forests, mountains and plains, that provide the raw material inputs, resources and flows of energy into our production processes. It also consists of a range of 'ecosystem services'. These services include the provision of an atmosphere and a stable climate, a protective ozone layer, and the absorptive capacities to disperse, neutralise and recycle the material outputs and pollution generated in ever increasing quantities from our global economic activities. While some account is taken of the depletion of resources, no account is taken of the degradation of what has been described as 'critical natural capital', the essential ecosystem services without which no life, let alone economic activity, would exist.

Evidence of this incomplete accounting is abundant. For example, while companies may account for the timber (i.e. the actual resource) which they extract from a forest, they do not account for the ecosystem services provided by that forest. These include water storage, soil stability, habitat and the regulation of the atmosphere and climate. Unfortunately, the cost of these essential ecosystem services become all to apparent when they start to break down. In China's Yangtze basin in 1998, for example, deforestation triggered flooding that killed 3,700 people, dislocated 223 million and inundated 60 million acres of farmland. This $30 billion disaster forced a logging moratorium and a $12 billion emergency reforestation programme (Lovins et al., 1999). Similarly, external costs of global climate change are beginning to become more obvious. Storm and extreme weather event-related damage (global climate change is expected to increase the frequency and severity of such events) caused upwards of $90 billion of damage in 1998 alone. This represents more weather related damage destruction than reported in the entire decade of the 1980s (Lovins et al., 1999).

The key to resolving the conflict between profits and the environment, as many have pointed out, lies in getting the prices right. Businesses (and consumers) should pay for the external costs of their activities. Farmers should pay for the contamination of ground water (and not be subsidised to pollute the water in the first place); timber companies should pay for the destruction of water catchments, and industry should pay for its myriad external environmental impacts. These include industry's contribution to global climate change, it's impact on poor and declining urban air quality, loss of agricultural production and productivity as a result of aqueous and gaseous emissions and direct impacts, and disposal of waste to land. Until this happens, the conflict will remain. Only when these costs have been internalised will profits, as reported in financial accounts, approximate to what can be regarded as environmentally sustainable profits. One way of getting the prices right is through the process of ecological tax reform (ETR); i.e. moving taxes from the goods, such as employment and profits, to the bads of resource use and pollution. The UK's landfill tax, aggregates tax and climate change levy are examples of ETR. The revenues raised from these taxes are redistributed back into the economy by reducing employers' National Insurance (NI) contributions. However, these taxes do not fully reflect the extent of the external impacts resulting from the disposal of waste, use of aggregates or the business use of fossil fuel derived energy.

In the absence of the political will to establish a comprehensive and radical ETR programme, companies committed to improving their environmental performance need to move beyond simple corporate environmental reporting, to begin to account more completely and transparently for both their internal environmental costs and their external impacts. In effect, they need to begin to account for the depreciation of 'natural capital' in the same way that accounting rules and standards require them to account for the deprecation of manufactured capital. Once these costs are internalised, everything changes: prices, costs and what is or is not profitable.