By Christopher Koch, Dan Wellers, SAP Insights
GDP counts what economies create but not what they destroy. Measuring both would spark investment in a nonpolluting energy, food, and transportation infrastructure that can lift us from recession.
The coronavirus pandemic has delivered the global economy a gut punch. Economists have predicted worldwide GDP growth could fall by half. In the United States, the halt in business activity had cost 38 million jobs by May 2020. The shock may elicit a new way to think about the economy altogether, as after the Great Depression in the 1930s.
At that time, the world economy was also amid an unprecedented collapse from which almost no one was spared: unemployment had hit 44% in Germany in 1932; in 1933 the rates were 38% in the United States and 33% in Norway. Worse, no one could explain why the collapse had happened, or what to do about it. Modern economics was still in its infancy.
In desperation, the U.S. Congress asked one of the leading economists of the day, Simon Kuznets (a Soviet émigré and future Nobel Prize winner) to create a calculation for determining national productivity so policymakers could work with a standard measurement. His calculation, the gross domestic product (GDP), became the world standard for measuring the health of economies.
Business people and policy makers of that time jumped onto the GDP bandwagon because they were facing new challenges, and the existing ways they measured what was happening were not up to the task.
The same is true today. How we measure what we’re experiencing doesn’t always give us the information we need to make business and policy decisions.
As world economies recovered after World War II, GDP got lucky. Social welfare improved in parallel with huge GDP growth. The middle class blossomed, and improvements in healthcare, schools, and infrastructure manifested into the greatest gains in human well-being the world had ever seen. In the minds of most people, growth in GDP became synonymous with a better life.
Trouble was, it wasn’t true. GDP was not an indicator of well-being. It was just along for the glorious post-war ride.
No one knew that better than Kuznets himself, who, when he finished creating his famous calculation in 1934, cautioned the world that “the welfare of a nation can … scarcely be inferred from a measurement of national income.”
The disconnect between GDP and well-being is evident today. From 2009 until this year, GDP recorded a nearly unbroken run of global growth, but in the United States, for example, wage growth, when adjusted for inflation, hadn’t budged for most people since the 1970s.
Meanwhile, GDP has been concealing a crisis that is in many ways an echo of the 1930s, for which we have no agreed-upon answer: climate change. It is a threat to the economic growth that we have come to take for granted, as well as our well-being. Writing in Vox, Ezra Klein suggests that managing through and beyond the pandemic offers an opportunity to create a “better, fairer, more sustainable” economic system that addresses climate change. If that is the case, we will need a new way to measure it.
What GDP Leaves Out
GDP does not account for the climate crisis. In fact, it compounds it. For example, GDP makes no distinction between economic production that pollutes and that which does not; all that matters is the market value of the goods and services produced. That means that cleanup efforts after disasters such as the California wildfires are counted as an economic gain. But who would argue that anyone is better off because of this kind of growth?
There are alternate formulas that incorporate damage to the environment and depletion of natural resources into a national calculation, but none of them have been able to dislodge GDP.
If we treated environmental and resource destruction as what they are – economic losses – there would be an impetus for solving the crisis we are in. The markets would force business leaders and politicians to invest in technologies that diminish the losses. For that to happen, the losses need to show up on corporate balance sheets and GDP needs to be either corrected or replaced as the accepted measure of economic growth.
Calculations To Drive Expansion
If we started measuring and holding organisations accountable for those losses, we could spark an economic expansion that would make the post-war era look weak by comparison. Building out a nonpolluting energy, food, and transportation infrastructure from the rubble of the emerging global recession would spark what infrastructure investment always does: sustainable and long-term economic growth. Just think of how the global investments in superhighways after World War II sparked an economic growth explosion.
Growth would be further buoyed by a shift away from the traditional make, use, and dispose mindset to a circular mindset in which we design products from the start to be taken apart, repaired, reused, or recycled. In fact, this shift in mindset is defining the next era of competitive advantage.
Sustainability has gone from being thought of like philanthropy – at the edge of what companies do – to being central to business strategy and innovation, especially in industries that rely heavily on natural resources. And just as with any business practice, companies that take the extra step and adopt sustainability practices that are truly strategic (innovative and difficult to duplicate), such as circular business models, are already creating sustained competitive advantage according to a recent study of 3,800 companies.
Changing the way we measure growth would clarify the business advantages of circular methods and spur a new industrial revolution. Emerging technologies such as Internet of Things (IoT), cloud, artificial intelligence, autonomous vehicles, and data analytics are ready to support this shift through such advances as inexpensive, iterative digital design processes; greater resource and supply chain transparency; and lower-cost logistics and recycling processes. Accenture estimates that organisations could create up to US$4.5 trillion in value by 2030 by adopting circular economy principles more widely.
Meanwhile, signs are all around us that the traditional paths to economic growth are narrowing. Even before the current crisis disrupted global supply chains, the skyrocketing demand for consumer goods had turned finding and maintaining reliable sources for raw materials into an increasingly risky business. There was record price volatility for metals during the 2000s – greater than that of any decade of the 20th century, according to a report by the McKinsey Global Institute. Price volatility of raw materials has had a significantly higher impact on the bottom line than traditional financial measures of volatility, such as currency exchange rates. When consumer demand rebounds, circular business models would reduce or even end resource cost and volatility risk by reusing existing materials rather than relying on finding and buying new ones.
Consumers are also applying pressure to the traditional growth model. One of the most significant insights in a study by SAP (registration required) is that, increasingly, the value of a product is determined by the values of the company that makes it. In addition, more consumers are only choosing products from companies that align with their personal values. Indeed, a New York University study found that products marketed as sustainable grew 5.6 times faster between 2013 and 2018 than those that weren’t.
And there are signs that if businesses don’t act soon, at least some governments will. Europe, for example, has already moved to regulate single-use plastics: a ban on disposable plastic cutlery, straws, and plates in the European Union takes effect in 2021.
But such regulations are only partial solutions.
The climate crisis will never be solved solely by forcing companies to act; those companies must see it as being in their economic interest to do so. That opportunity is already here: The costs of “green” technologies such as solar energy are plummeting, while efficiency is increasing at an exponential pace – a kind of green Moore’s Law.
But for organisations to adopt these technologies on a large scale, investors must give them credit for doing so. New ways of measuring growth that consider the environmental costs of the status quo will do that. They will reward businesses for finding substitutes for plastics and oil. Stock prices will rise when companies pursue sustainable design, sustainable supply chains, and reintegrate used products into their production and manufacturing capabilities, because those kinds of solutions will be more cost-effective than the old ways.
Now might seem like a time to put ambitious ideas like these on hold. But crises have a way of spurring innovation. If companies invest in the circular economy now, the payback in growth from new business models will be boundless.
This article first appeared on SAP Insights. https://insights.sap.com/a-formula-for-post-pandemic-growth/