Factor in natural capital, and China's growth rate plunges

PUBLISHED : Friday, 22 June, 2012, 12:00am
UPDATED : Friday, 22 June, 2012, 12:00am


Ask any 10 Hongkongers where they think China ranks in the economic league table of different countries, and the chances are that all 10 will give you the same answer.

'Second,' they will say, 'behind the United States but gaining fast'.

And they will be right - up to a point.

China is indeed the world's second-largest economy measured by gross domestic product, and has been since 2010, when it overtook Japan in the country league table.

The trouble is that GDP is a lousy way to rank economies.

It was adopted during the second world war as a handy measure of how many guns, ships and planes the US economy was able to produce, and it's been the standard gauge of economic strength ever since.

But while GDP tells you the quantity of stuff you churn out each year, it tells you nothing about the quality of your economic development.

For example, GDP fails entirely to account for the costs of environmental damage inflicted in the pursuit of ever greater output growth.

So if a pulp and paper plant produces $1 million worth of toilet rolls, $1 million gets added to GDP. No deduction is made for the natural forest that was felled to provide the lumber. And no allowances are made for the dioxins the plant pumped into the local river, poisoning fisheries, tainting meat and dairy products and polluting the drinking water of millions.

This is a critical omission. If our pulp and paper plant produces a million dollars of toilet rolls, but causes $400,000 of agricultural losses and creates $600,000 of future health-care costs, the net economic gain is not $1 million, but zero.

Nowhere is this shortcoming of GDP as an economic measure more glaring than in China. A few years ago, the State Environmental Protection Administration did try to factor pollution costs into the country's GDP figures. But when it found that including environmental costs would have reduced growth by at least a third, the attempt was quickly stopped.

Now, to coincide with the Rio+20 United Nations Conference on Sustainable Development, the UN has had a stab at coming up with a new measure of economic development that includes not just GDP-style output of goods and services, but also measures of human and environmental capital.

Human capital covers education, health and mortality, workforce participation and employment. Environmental, or natural, capital accounts for a range of factors, including agricultural land and productivity, mineral and energy resources, and pollution costs.

The result is the UN's new Inclusive Wealth Index, and the view it gives of economic development is startlingly different from the picture painted by GDP.

The discrepancy is especially pronounced when it comes to China. Whereas China's GDP has grown at an average 10 per cent rate since 1990, only modest growth of human capital and a steady deterioration in natural capital mean that China's inclusive wealth has only grown at an average 3 per cent rate over the same period.

To put that another way, while China's GDP leapt six times over between 1990 and 2008, the country's inclusive wealth grew by only two-thirds (see the first chart).

As a result, while China's economy is still big, in relative terms it is a lot smaller than most people think. On the UN's measure, the US is by far the world's biggest economy, with an inclusive wealth of US$118 trillion in 2008. Japan comes second with US$55 trillion, while China manages only third place, with an inclusive wealth of US$20 trillion, roughly the same as Germany.

On a per capita basis, the gap is even starker. China's inclusive wealth per head is just US$15,000. That's less than half South Africa's and just 4 per cent of the US level.

Now, no doubt there are all sorts of objections to the UN's new index. But it does make one thing abundantly clear: GDP is a deeply flawed measure of genuine development.