Natural Capital Coalition with the help of WBCSD and IUCN has brought together several businesses to develop the Natural Capital Protocol, a framework to internalize the externalities that will be tested by 40 leading businesses including The Coca Cola, Hugo Boss, Dow Chemicals, Shell and several others. The testing programme of the framework will be led by Cambridge Institute of Sustainability Leadership (CISL) to understand its robustness.

This is the result of the large businesses realizing the flaw in the current accounting systems that do not reflect the true external environmental costs.

Why do they want to do this?

In 2013, climate change impact of drought and floods cost Unilever €300 million. It is estimated that the top 100 environmental externalities cost the global economy around US$4.7 trillion a year. Also, as per the TEEB study, cost to the society of just the top 3000 listed companies is estimated at US $2.15 trillion or 3.5 % of world GDP every year.

Paul Hawken in his book ‘Ecology of Commerce’ stated that the central problem with capitalism is the assumption that continuous exponential growth (forever) is possible on a finite planet. The reason we assume this is because externalities (cost or benefit that affects a party who did not choose to incur that cost or benefit) have never been accounted for and there is no law that prevents this.

One of the major reasons that the cost of the products go down over time are often attributed to technology and mass production techniques employed by business. The cost actually has not gone down; it only appears to be cheap. As per one of essays written by Rupert Howes, the CEO of Marine Stewardship Council, in 2004, cost of deforestation, landslides, floods, displaced communities, low wages, and poor working conditions that occurred during production of that product do not get factored in. This is total misallocation of the environmental costs that are currently not captured by business accounting methods.

The diagram below captures the true price of a product which includes the social and environmental costs that add up to the price gap, which if included will result in a higher price.

Business case for true pricing. Source: 2014 Report, Deloitte, EY, PwC, True Price

Externality adjusted growth

A study conducted by Vouvaki & Xepapadeus in 2009 found that unaccounted contributions of the environment may be an important driver for growth in Total Factor Productivity (TFP). They measured the TFP growth for 23 OECD countries, both in traditional way and as externality-adjusted growth. What they found is actually not surprising. A country like the USA with a traditional TFP growth of 0.275 moves to a negative 2.206, when externalities are accounted for and as do several other countries such as Belgium, Denmark, Canada, Australia, and Finland and others fall drastically below their traditional TFP mark.

Other initiatives

Natural Capital Declaration (NCD) signed by the financial sector in 2012 at Rio +20 Summit is an initiative to integrate natural capital into various financial products and reporting frameworks.

The Principles for Sustainable Insurance launched by UNEP developed a framework for global insurance industry to take into account the environmental, social and governance risks as well as opportunities.

The Economics of Ecosystems and Biodiversity (TEEB) study in 2007 called for a process of analysing the global economic benefit of biological diversity and the costs associated with the loss of biodiversity and eco-system degradation.

In 2013, a report known as the System of Environmental-Economic Accounting (SEEA) came out commissioned by European Commission, OECD, United Nations and World Bank that laid down a broad conceptual framework for eco-system accounting.

Even though there are criticisms to valuing the natural capital, it cannot be denied that it does give visibility to nature in the business costs where previously there were none. In 2011, Puma was the first company to bring out an Environmental Profit and Loss account statement, which disclosed its external costs as a result of their own operations. The P&L showed that if natural capital was taken into account then Puma’s real profits would have dropped from €230 million to only €85 million for that year.

Is natural capital accounting a Silver Bullet?

Needless to say, natural capital accounting has its limitations. Even though at the surface it looks to address and capture the external costs, it is not a silver bullet that will solve all the environmental problems. Food and Water Watch Europe has stated that natural accounting is a “desperate attempt to fix the failing economic model” and not to better manage it because it puts back the control of nature back into the hands of those who destroyed it in the first place (Hauter, 2013).  Putting monetary value on nature requires assessing each and every aspect of nature and it is extremely difficult to put a value on nature based on the subjectivity and the biases involved (Food and Water Europe, 2013)

The current accounting system has evolved over decades of practices and will largely be unaltered. But if we somehow manage to put the ‘correct’ monetary value to environmental externalities and internalize those costs, then true costs of the products could be achieved. The reason it is so difficult to correctly put the value to natural capital is because of the difficulty in knowing which of the environmental services are important and what forms the basis to accurately measure them. Historically, authors and experts have been calling for businesses to start accounting for natural capital and its depreciation as they have been doing for their manufactured capital.

Will Natural Capital Protocol be the answer?

Cover Image credit: Source: Constanza et al, 2014. Interactions between built and human which form the part of social capital which in turn fall under the overall natural capital