Measuring Welfare With The ‘ISEW’, A Niche In Economics That May Prompt Us To Reflect On Human Impacts On The Natural World

Although science and economics tend to be conservative and slow, mainstream science now concludes that our ‘development,’ how our societies and economies pursue human ‘welfare,’ has already transgressed multiple ‘planetary boundaries,’ the safe-operating-space in which we exist. The path of development since the industrial revolution not only now threatens the natural world, but the natural systems on which we depend for survival.

Climate change, depletion of natural resources, a variety of forms of pollution and loss of habitats and biodiversity, are some of the global symptoms of ‘skewed development.’ Social challenges of inequality and power asymmetries are rising in many countries in parallel to these accelerating long-term environmental damages. Something of a threshold in global development has now been reached. How can we support the welfare of all who aspire to levels of income and consumption of the wealthy, while avoiding systemic collapse? If environmental and social ‘goods’ are over-exploited for the pursuit of economic growth, then many questions are prompted. What type of development is desirable, and for the benefit of whom?

A sense began emerging in the industrialized countries in the 1960’s and 70’s, that the edifice of 20th-century development, built on high growth and the spread of consumerism, was a vision that was starting to crumble. It became increasingly threadbare in the 1990’s as acid rain, ozone depletion and climate change crept up scientific and policy agendas. Decades of development studies have guided us to the conclusion that it is not the rate of GDP growth that should be our focus, but the type of development that we pursue.

While the pursuit of improved human welfare has had notable achievements, such as large declines in global poverty and increases in life expectancy, it is also known that global development can occur through many different pathways. These could involve potentially far greater gains to human welfare directed into forms that are not resource or pollution intensive. Where balanced human wellbeing and sustainability are put at the core of development, rather than growth-for-growths-sake, we can achieve win-win. Welfare can be improved while environmental impacts decline, but this will necessitate moving away from the obsession with growth and consumption amongst the wealthiest. In fact, indiscriminate ‘brown growth’ that relies heavily on consuming natural resources, and does not consider the negative side effects of growth¹, threatens not only human and environmental wellbeing but also economic development itself.

The development gains noted in the case of poverty and life expectancy can become an egregious red herring if not understood in the wider context. There are short and long-term social and environmental losses from the approach taken to reach these goals, and it also undermines the future economy. ‘Sustainable development’ was coined as a new approach to development that seeks to balance the economic, with the social and the environmental, to counter the myopia of the economic ‘growth model’. But if the science and the economics were slow, the political and cultural inertia were even more embedded. While we know that other forms of development are possible and even desirable, our approach to development has yet to fully catch-up.

Measurement Sets The Priority?

The growth model was underpinned by an indicator that was relatively straightforward for politicians and the public to grasp, known as Gross Domestic Product or ‘GDP’. As the measure of market value of the flow of goods and services GDP originated from Simon Kuznets, a talented Russian-American Economist tasked with understanding US income in 1931. However, Kuznets only intended it as a measure of national income and cautioned against the use of GDP as a measure of welfare to US Congress in 1934.

Nevertheless, as political and economic power tend to coalesce around particular ideas of how the world works, GDP went on to take precedence in most countries. A small but growing band of pioneering ‘ecological economists’ saw through the emptiness of the resulting GDP mantra and sought to develop a new measurement. Indicators evolved through various forms and names, from the Measure of Economic Welfare (MEW) of William Nordhaus and James Tobin (1972) to the Index of Sustainable Economic Welfare (ISEW) of Herman Daly and John B. Cobb (1989). The key to the ISEW was to respond to the weaknesses of GDP; on the plus side, by recognising the considerable value of household labour to the welfare of society, while on the minus side, subtracting the pernicious effects of income inequality, and losses to welfare due to environmental degradation and from defensive expenditures to protect from damage.

While most economists continued to favor GDP, as it was regarded as an objective value-neutral measure, it was clear that the impacts of the growth it measured certainly were not. While economics had sought to become more ‘scientific’ it was also clear that it could not fully escape the messy real-world of values, power, and politics. Applying the lens of economics is a political act whether or not this is made explicit. A long heritage of moral philosophy had existed in economics since the grandfather of modern economics Adam Smith (1723-1790) had created the ‘invisible hand’ of the free market. This was reclaimed by Amartya Sen in his work to move the focus from growth and finance to human development as the ultimate goal.

Recognising this attempt to re-integrate economics with its systemic and philosophical roots, the ISEW even morphed into the Genuine Progress Indicator (GPI), seen as a socially progressive indicator that deliberately moved further away from relying solely on GDP.

Controversies 

The ISEW and the GPI have been applied to dozens of studies of countries, regions, and states since the beginnings in 1989. A key outcome that has often arisen in these studies is that at some point GDP would depart from the ISEW. While the economy could still be growing, welfare, as measured by the ISEW, would no longer improve and sometimes even fall. This was proposed as the ‘threshold hypothesis’ by the ‘barefoot economist’ Manfred Max-Neef, suggesting that beyond certain-size conventional economies were no longer adding to people’s welfare. However, this claim proved controversial in the late 1990’s. Eric Neumayer suggested that the threshold hypothesis in the ISEW could be an artificial construct, that if two dubious assumptions in how the index was calculated were removed, the threshold would disappear.

Neumayer’s argument centered on two multipliers that were then applied in the ISEW, firstly, the escalating cost of replacing non-renewable fossil fuels, and secondly accumulating the damage costs of climate change for each additional tonne of carbon dioxide added to the global atmosphere. In the intervening years the imperative of sustainability issues in global science and policy, particularly the issue of climate breakdown, has driven a revolution in how we understand the world in which we live, and the impact of our economies and societies.

While it has given greater standing to ‘systems thinking’ and future scenarios, it has also driven advancements such as how we economically value renewable energy ‘transition’ costs and also how we count the damage costs of climate change. Both of these developments would provide potentially useful answers to the controversies that had plagued the ISEW, and a recently published study of Spain in the journal Ecological Economics sought to address these.

The Spanish ISEW And Updates To Calculations

The Spanish ISEW sought to update the approach to calculating a number of ‘items’ in an ISEW, including the cost of water pollution and of depletion of the ozone layer. But it is with non-renewable energy depletion and climate change costs that the most important developments occurred. Noting that “a dominant place for fossil fuels in future development trajectories is now anathema to a sustainable and secure future,” the Spanish ISEW study updated the arbitrary ‘replacement cost’ for the consumption of fossil fuels and nuclear energy that was originally used. Incorporating more recent advances in knowledge, a ‘transition cost’ from low-carbon transition studies was applied.

This is the modeled cost of replacing a unit of non-renewable fossil energy consumed now, with an equal unit generated from renewable energy in 2050. This approach allowed the controversial escalating cost factor to be retired and changed to the now familiar dropping renewable energy costs that have been observed. In the case of the damage costs of climate change, this has been the subject of much study in what is known in environmental economics as the ‘social cost of carbon’. This is an estimate of future global damage costs, in today’s values, from the climate change caused by each unit of carbon dioxide emissions.

Carbon dioxide from the combustion of fossil fuels such as coal, oil, and gas is widely known to be the most significant greenhouse gas in human-caused global warming. The challenges of such economic damage studies have been notorious, including estimating all of the various future impacts, valuing these appropriately and incorporating lower-probability ‘catastrophic and irreversible impacts’ of climate change. Agreement on what an appropriate social cost of carbon would be is by necessity a political process informed by science and has caused rancorous debates over the years. Nevertheless, it has been noted by the Intergovernmental Panel on Climate Change that mainstream values such as those applied in the US are too low.

The Spanish ISEW adopted a higher cost but did-away-with accumulating this cost, the approach that had proven divisive. It now appeared unnecessary to do this accumulation, as theoretically the social cost of carbon included all future damage costs in present values. The resulting ISEW for Spain was then compared against GDP, in the standard per capita form, and can be seen in the graph below (Figure 1).

Figure 1. ISEW per capita and GDP per capita in Spain from 1970 to 2012 in 2010€ (Source: O’Mahony et al. (2018)). Republished with permission from Elsevier from: https://doi.org/10.1016/j.ecolecon.2017.07.024.

The results of the ISEW suggested that despite a significant increase in GDP per capita, over a period spanning the dictatorship of General Franco until 1975, joining the European Economic Community² in 1986, and the recent recession in 2008, average welfare improved little in Spain. This was the familiar pattern in previous ISEW and GPI studies. A sensitivity test was conducted to discern the impact of the new approaches to costs in the study. This included using the original lower social cost of carbon, and yet a similar pattern emerged. The threshold hypothesis of Max-Neef was evident in the Spanish ISEW, and it was not arising due to the controversial multipliers applied in previous studies which had been omitted. Despite a large positive contribution from the value of household labor, when the social and environmental costs of economic growth were counted, the average welfare for Spaniards had improved little since 1970.

Reflections On The ISEW And Development

For decades, prominent thinkers in economics have been questioning the pursuit of economic growth as a proxy for human welfare. When the environmental and social costs of development are taken into account, the assumed welfare gains can look very different. This is the key benefit of the Index of Sustainable Economic Welfare, it questions the received wisdom and can serve as a spur to a more substantive debate.

A number of US States have officially adopted the ISEW/GPI for this purpose. The ISEW itself is, therefore, a useful tool, when it is understood in context. Because an ISEW mixes both positive and negatives it could hide a serious decline in some items if these are not flagged. In fact, some economists and statisticians argue that a better approach is to have parallel accounts of these positive and negatives alongside the monetary flows of GDP.

While approaches to some global challenges, such as depletion of the ozone layer have been quite successful, even leading to exclusion of this cost from more recent ISEW, it is clear that a number of global environmental challenges are rising to the threshold of global systems breakdown. Regardless of the approach to welfare indicators, we are now getting flashing red lights on the dashboard of development. The good news is that global sustainability science has been evolving to keep pace with these emerging challenges, to offer suggestions on how we could transform how we develop towards a sustainable balance. Our societies and politics must now endeavor to make good use of this knowledge. Our welfare and that of the natural world depends on it.

Notes

1. Negative side effects of ‘brown growth’ may include not only the pressures of higher rates of resource consumption, such as of fossil fuels but also higher rates of pollution and land take and biodiversity loss.
2. The European Economic Community was a regional economic integration organization in Europe. It was reformed and replaced by the European Union in 1993.

The study, ‘Revisiting ISEW Valuation Approaches: The Case of Spain Including the Costs of Energy Depletion and of Climate Change,’ was recently published in the journal Ecological Economics. Dr. Tadhg O’Mahony is a consultant on sustainable well-being and low-carbon transformation.