Economic estimates don't account for tragic bushfire toll

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Scott Morrison's Government has prioritised money over the environment (image by Dan Jensen).

Professor John Quiggin believes that GDP and economic calculation cannot capture the full value of life.

AS THE DEATH and destruction caused by the bushfire catastrophe continue to mount, Westpac has issued estimates suggesting that the associated reduction in gross domestic product (GDP) will be very modest, between 0.2 and 0.5%. There is plenty to argue within the way this estimate has been derived, but the biggest problem is with the use of the GDP concept.

I’ve pointed out many times that considered as a measure of economic wellbeing, GDP has three major deficiencies: it’s gross, meaning that depreciation (including the destruction caused by natural disasters) is not taken into account; it’s domestic, meaning that it includes output generated in Australia by foreign capital; and it’s a product, when the real interest is in income. 

In the case of the bushfires, the big problem is that GDP is gross. The destruction of houses, businesses and infrastructure by disasters is, in economic terms, a particularly drastic form of depreciation. But, since GDP takes no account of depreciation, it is unchanged.

On the other hand, the work done in repairing or replacing damage counts as a contribution to GDP. 

The same national accounts that generate GDP figures include estimates of net domestic product (NDP), which takes account of depreciation and net national income (NNI), which further deducts net income flowing to foreigners. Obviously – and despite the limitations I’ll discuss below – these are far superior to GDP as measures of economic welfare.

Why then, is so much attention paid to GDP and so little to NNI?

The answer is that GDP is a measure of economic activity, not economic welfare. For the purposes of macroeconomic management, what matters most is whether the resources of the economy are fully employed, not whether they are producing anything of value. In setting monetary policy, the Reserve Bank has an idea of the levels of employment and capacity utilisation the economy can sustain without inflation.

Measures of GDP growth show whether economic activity is above or below these levels. (This macroeconomic framework has lots of problems, but that’s an issue for another column).

If the Reserve Bank gets its policy settings exactly right, it will maintain the level of economic activity at its ideal level, regardless of shocks like bushfires, by strategically lowering and raising interest rates. So, the conclusion that the fires won’t have much impact on GDP growth is, in some sense, predetermined.  

The other side of the debate about climate change is the suggestion that Australia depends critically on coal for our economic prosperity. Once again, the use of the GDP concept creates confusion. In this case, the problem relates to the distinction between “domestic” and “national”. Coal mining contributes about 3% of Australia’s GDP, but most of the capital (physical and financial) employed in the industry is imported. That means that much of the income from coal mining flows overseas. 

A more relevant measure of coal mining’s contribution to our economic welfare is the amount paid in wages. This is about $5 billion a year or 0.3% of national income. On this basis, it is obvious that the destruction caused by climate-related disasters far outweighs the benefits of coal.

So far, I’ve discussed only the narrow measure of economic welfare to be found in the National Accounts. The effects of the climate disaster go far beyond this, including the health effects of exposure to toxic smoke, the destruction of ecosystems and the painful deaths of hundreds of millions of animals.

Some of these effects can be measured in monetary terms. For example, based on existing estimates of pollution effects in Australia, it seems likely that toxic smoke will lead to countless premature deaths in the coming years.

Under current policy, health interventions to save lives are approved if they cost up to $4.2 million per life saved. So, we would need to spend another $4.2 billion if 1,000 people passed away to offset the loss of life caused by these disasters. This amount could probably be doubled to take account of non-fatal health effects.

By contrast, there is little point in putting a monetary value on the destruction of millions of hectares of bushland and the animals living there. Any decent person would recoil in horror at the consequences of our failure to act to mitigate the climate change that has caused this disaster, but there is no way to put a dollar value on that horror. 

Sadly, we have a Government that cares only about dollars in the pockets of its funders and supporters. Unless this changes, in Australia and elsewhere, disasters like the bushfire catastrophe will be repeated again and again, getting worse over time.

Professor John Quiggin is an economist and Laureate Fellow at the University of Queensland. You can follow him on Twitter @johnquiggin.

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