The Financial Implications of the Dasgupta Review on the Economics of Biodiversity
By John Adams, Director, AMCD and HR Financial and China, with assistance from Bob Collins and Tim Matheson, Advisers, AMCD
The Economics of Biodiversity by Partha Dasgupta, Emeritus professor of economics at Cambridge University, comes in at a hefty 600 pages. It was commissioned by Philip Hammond as UK Chancellor of the Exchequer in 2019 and draws on nearly 40 years of study by Professor Dasgupta.
Gross Domestic Product, as the Review says, is well named. It does not include the depreciation of nature and declines in biodiversity. Yet the World Economic Forum has estimated that around half of global GDP in 2019 was moderately or highly dependent on natural capital. Ultimately the Review points out that all economic activities both depend on, and influence the condition of, ecosystems.
As Professor Dasgupta points out, depreciation and loss of natural capital has for many years been a main source of ‘economic growth’ but is nowhere taken into account in the calculations. The Review considers how to capture the true values, or ‘accounting prices’, of natural capital in order to measure the financial risks and avoid further rapid destruction of our common biodiversity.
Estimates of current investment in natural capital and its regeneration come in at a miserly 0.1% per year of global nominal GDP. This figure is easily outstripped by the around US$500bn (3.5% of global GNP) per year spent by governments on initiatives damaging to biodiversity. IMF estimates suggest that the social cost of ‘perverse’ subsidies that damage nature is around US$4-6 trillion per year.
One of the Review’s conclusions is a call to arms: governments are ‘failing to internalise externalities’ through fiscal measures, standards, regulation and market mechanisms. Financial markets cannot, therefore, fully calculate risks and so ‘price them in’ under the status quo. There is some hope, however, that initiatives such as carbon trading and taxation will eventually generate realistic accounting prices for the damage done to the climate by CO2.
The Review sees governments as playing a key role. This raises the question of whether the US, for example, can override its independent states to arrive at sufficient leverage. It is also unlikely that preserving biodiversity is a top priority in countries with budget crises – Brazil springs to mind, with a record budget deficit in 2020 approaching 10% of GDP, and total national debt at about 100% of GDP. To its government, initiatives to save the Amazon rain forests must seem detached from any pressing economic reality.
Ways in which the private financial sector has contributed to ecosystem depletion, for example through funding unsustainable mining and agricultural practices, are highlighted by the Review. To combat this, biodiversity needs also to be priced into supervisory stress testing and bank risk assessments. Asset managers, such as pension funds and sovereign wealth funds, should also be encouraged to include biodiversity in their ESG investment criteria.
Issues around fiduciary duty still face investment trustees, who may feel they have to prioritise financial gain. The Review rightly sees this as an essential legal change that could embrace biodiversity as well as climate risk. HMG and Alok Sharma, President for COP26, please note.
An important distinction is made between investment in ‘real’ sustainable economic activity and conservation or restoration projects. Pure conservation involves protection of a habitat; restoration can include activities like rewilding. These kinds of activity are unlikely to be profitable and so are unattractive to private investment. Real economic activity, such as sustainable agriculture, low-carbon energy production and green infrastructure, are more likely to give a measurable return.
The solution, as the Review points out, is for asset managers to develop a more sophisticated approach to the cost of nature loss – 75 of the world’s most influential asset managers have no comprehensive policy on biodiversity, according to ShareAction. The problem is partly the small size of many projects, and partly the length of time needed to generate a revenue stream – if ever. Blended public and private finance can assist, but the administrative costs and lack of comparative case data can be a deterrent.
Lack of harmonisation of ESG criteria also allows leeway for greenwashing. The recent EU and Chinese Green Taxonomies are useful, but subject to lobbying from nuclear, steel, coal, gas and forestry interests and show the difficulty in achieving transition in these areas. (The new UK non-EU taxonomy is not expected for two years.)
The Review distinguishes nature risks from climate change risks. The latter are well studied and categorised into physical, acute physical, transition, chronic, litigation, technological, policy and legal. Some of these categories have been carried over into nature-related risks – namely physical (eg loss of mangrove swamps), transition (eg closure of Coca-Cola plants in India because of their impact on water shortages) and litigation (bond investors suing a California energy generator for mis-representing the risks of wild-fires).
Similarly, banks and investors may be adversely affected by holding sovereign bonds of countries highly dependent on over-exploitation of natural resources. The Review points out that even in 2020 this risk was still under-priced by the market. There is a parallel to the kind of ESG index provided by MSCI – but the CNSI, or Climate and Nature Sovereign Index, does not appear to be widely used yet.
Metrics do already exist to incorporate nature loss into risk models –among them, ENCORE, IBAT and SCRIPT and the Natural Capital Protocol. But these are not well known and there is no accepted single method of biodiversity footprinting.
The risks are far from minor. External natural capital risk analysis shows that 13 of the 18 sectors in the FTSE 100 have a high dependence on natural capital. At the simplest level, this can be soil erosion risks in cereal and other crops, or the reliance of metals processing on groundwater.
Another key concept in the Dasgupta Review is the new ‘Impact Equation’. This illustrates how the biosphere can heal itself over a period of time. But the current rate of depletion, driven by activity to create physical and human capital, threatens our very life support system.
Finally, there is a visionary proposal for a Commons Fund, which might be carried by the UK to COP26 in November and promoted more widely. The Review calls for an international organisation to monitor and manage forms of natural capital as global public goods, similar to the way the World Bank advances the cause of global economic development and the IMF comes to the rescue of financial stability.
The high seas, for example, are global commons – for transportation and leisure, as a refuse dump and for fisheries. Since they are open access, no-one pays for their use. Ideally, a new rent could be collected through a global organisation. The money raised would pay the compensation required to prevent further deterioration. So, we are not necessarily looking at additional taxation to finance preservation. The global commons themselves could generate the funds needed to restore our natural capital: air, water and land.
This article first appeared on CSFI’s website on 21st May 2021 and is reproduced here with the kind permission of the author.