Accounting for nature in euro area economic activity

Prepared by Mariana Martins Cardoso and Miles Parker

Published as part of the ECB Economic Bulletin, Issue 6/2024.

Nature contributes a range of critical services to economic production, many of which are insufficiently accounted for in standard economic statistics. Generally referred to as “ecosystem services”, these inputs include crucial functions such as pollination, air and water filtration, carbon sequestration, and the provision of crops, timber and other resources. The value of these services is rarely directly measured in statistics like GDP. For example, the price of food implicitly includes the economic value of natural pollination, but in the absence of direct measurement, that value is attributed to the agricultural sector.

There are ongoing efforts to better account for nature in measures of economic activity. This box considers two: the Integrated Natural Capital Accounting (INCA) project from the European Commission’s Joint Research Council (JRC), and the initiative of the Organisation for Economic Co-operation and Development (OECD) to measure pollution-adjusted GDP growth. Although these measures only partially cover nature’s economic contribution, they already offer useful insights into its role in euro area economic activity.

INCA draws on a large array of geospatial data and utilises a variety of modelling tools to derive fair value for ecosystem services.^[1] For example, the value of carbon sequestration is calculated by multiplying estimates of the social cost of carbon by the volume sequestered, using satellite data on vegetation coverage. In 2019, the estimated value of ecosystem services in the EU amounted to over €234 billion, broadly equal to the combined gross value added of the agriculture and forestry sectors (Table A). While these two sectors account for a large share of ecosystem services usage, other sectors were also substantial users. Households benefited from nature recreation, the highest value ecosystem service of those studied.

Incorporating nature and environmental factors enriches analysis of the drivers of economic growth.^[2] The OECD calculates pollution-adjusted GDP by subtracting the estimated cost of pollution, including from carbon dioxide, nitrogen, sulphur and particulates. Those costs include climate change, ecosystem damage, illness and death.^[3] Pollution-adjusted GDP is therefore lower than the GDP featured in the national accounts. In standard growth accounting analysis, there are three main contributors to economic growth: produced capital (such as machinery, buildings and infrastructure), labour and total factor productivity (TFP). TFP is usually calculated as the residual once the contributions of capital and labour have been subtracted from output. The OECD augments this exercise by also measuring the contribution to growth arising from greater exploitation of nature (for example by increased mining or logging). Environmentally adjusted TFP can then be calculated as the residual arising from subtracting these inputs from pollution-adjusted GDP.

Producing the same output from fewer inputs is value-added growth; and, equivalently, producing the same output with lower pollution is value-added growth, seen from a long-run environmental perspective. Between 1996 and 2018, pollution declined substantially in most European economies, adding more than 0.3 percentage points to annual (pollution-adjusted) GDP growth in Germany, France and Italy (Table B), which was more than double the pollution adjustment for the United States. In China and India, GDP growth came at the expense of higher pollution. In terms of contributing factors, greater exploitation of nature contributed little to average growth in OECD countries but made a small contribution in China and India.

These environmental adjustments result in higher measured productivity growth in Europe (Chart A). Recent ECB publications have highlighted how reducing emissions during the green transition may temporarily lower measured productivity.^[4] These data suggest that this process may already be occurring. Standard TFP measures show slowing average annual productivity growth in the period 2009 to 2018 relative to the period 1996 to 2008 in both a set of 12 euro area (EA12) countries (0.2% versus 0.5%) and the United States (0.6% versus 1.2%).^[5] Although environmentally adjusted TFP also fell between these two periods, it paints a less pessimistic picture of recent productivity growth. On this basis, TFP growth averaged 0.6% in EA12 countries and 1% for the United States over 2009 to 2018.^[6]

Chart A

Difference between standard TFP and environmentally adjusted TFP growth

(annual percent)

The true importance of nature for economic activity likely exceeds the above estimates, so the continued degradation of nature may substantially reduce future productive capacity. ^[7] Many ecosystem services are not yet quantified, resulting in their value being understated. Moreover, their economic importance also depends on whether they can be substituted by other factors of production. For example, manual labour already replaces natural pollination for some high-value crops, but it would be impossible to do so for all crops. Overexploitation of natural resources can boost output in the near term but may be unsustainable over longer horizons as nature degradation ultimately reduces the flow of ecosystem services and hence economic activity.^[8]

Directly measuring ecosystem services within GDP is important progress but insufficient for understanding long-run impacts. Some data improvements are already envisaged, with Eurostat planning to publish ecosystem accounts as of 2026, building on the work carried out under INCA. Initially, it will cover seven ecosystem services in physical units (for example volume of crops attributable to wild pollination or tonnes of carbon sequestered), with the feasibility of calculating the monetary value being studied.^[9] Yet Gross Domestic Product does not capture all impacts of nature degradation since it does not include capital depreciation. Nature degradation arising from unsustainable exploitation will therefore never be included in GDP, even when ecosystem services are recognised. Fully understanding the implications for future output requires paying attention to Net Domestic Product, which does account for depreciation. Moreover, several ecosystem services reduce the impact of climate extremes, such as floods. The economic benefits can be substantial but are unobservable and can only be calculated using economic models to establish by how much activity would be lower without their protection.

Advances in economic modelling are also required to better quantify the benefits provided by ecosystem services and identify which sectors rely on them. That knowledge will help identify cases where investment in nature could provide net benefits over the medium term. It will also help clarify how ecosystem service disruptions, both domestic and overseas, propagate through the economy via supply chains. Such disruptions will dampen actual economic activity regardless of whether ecosystem services are directly measured or not. See Article 2 in this issue for a more detailed discussion of the economic and financial impacts of nature degradation and biodiversity loss.