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02 Dec 2013

Natural capital implications

Zoe Knight, Analyst, HSBC

by Zoe Knight

Analyst, HSBC

Natural capital implications

Natural capital contributes to economic activity

Economic systems do not exist independently from natural capital – they exist within it. Air, water, land and habitat all provide life-support mechanisms that enable growth and development.

The contribution of these natural-capital components to economic activity and to society are no longer so difficult to analyse. Natural-capital imbalances at local levels, for example, water availability, and on a global basis, for example, carbon, driven by population, economic activity and technology have increased in prominence.

Governments are starting to manage the risks through policy and investors are demanding natural-capital risks and opportunities are considered at the macroeconomic level.

Danger zones

  • National water risk: Saudi Arabia and South Africa are already water scarce (less than 1,000 cubic metres per person). India, South Korea and Germany are water stressed (less than 1,700 cubic metres).
  • Sub-national water risk: national averages can hide significant regional risks. China and India are particularly exposed; Australia has high national per capita water availability but local droughts trigger conservation controls, water tariffs and compensation packages.
  • National carbon risk: China and the US have the highest emissions, but Australia, Canada, Saudi Arabia, South Korea and the US have the highest emissions per head. Of the G8 economies, the US is farthest away from the carbon improvement target.

Natural capital intersects with the macroeconomy – notably output and prices – in three main ways. First, it contributes to economic value; second, economic activity can depreciate natural capital; and third, response measures to restore it can have macroeconomic effects.

Stocks of natural capital provide a direct contribution to economic output: water in hydro power indirectly improves human welfare, for example, clean drinking water. Nature’s replenishment system is a regulating mechanism: the water cycle can dissipate effluent. But these benefits are often taken for granted and are over-used and abused.

Changes to the availability and quality of natural-capital resources impact economic productivity. For instance, a lack of water for cooling power facilities could cause electricity outages that hit industrial production, low canal levels might delay freight, or flooding could reduce growth or fuel inflation.

Economic activity can cause natural-capital depreciation. In India, for example, the World Bank estimates that natural-capital degradation costs USD36 billion to USD124 billion a year – equivalent to 2.6 per cent to 8.8 per cent of GDP. For China, it estimated costs were USD76 billion in 2007 – 2.2 per cent of GDP. These costs impair human health, reduce growth and undermine the quality of the ecosystem.

Investment is necessary to maintain natural-capital stocks and the ecosystem services that flow from them, but public funding for natural capital is small compared with other sectors. For instance, the EU15 – the first 15 European Union members – spend just 0.9 per cent of GDP on the environment compared with 7.5 per cent on health, 5.3 per cent on education and 1.5 per cent on defence. The UN Environment Programme concluded that 2 per cent of GDP invested in the environment allowed superior growth.

We believe the assessment and management of natural capital is becoming more important, particularly for countries with large and growing populations and relatively scarce natural capital, such as China and India. Ignoring the natural-capital factor could result in nasty surprises in the difference between expected and realised growth rates and values.

This research was first published on 19 November 2013.