Integrated approach for estimation of economic progress and true wealth

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OPINION

Revised Estimation of Gross Domestic Product (GDP) Incorporating Environmental Cost Discounting

By Prof. Augustus Nuwagaba

1. Overview

Gross Domestic Product (GDP) is a key indicator of the level of economic activity within a country or group of countries. It measures the monetary value of all final goods and services produced over a specific period. GDP growth serves as a benchmark for economic performance and, by implication, indicates the level of capacity utilisation, including labour employment.

Although GDP is a standard measure of economic performance, it is increasingly recognised as an inadequate indicator of true wealth and social progress. It is a narrow concept that assigns equal value to all output, regardless of social equity, environmental health, or non-monetary aspects.

Current production processes not only deplete physical capital and non-renewable resources but also cause environmental damage, compromising sustainability for future generations. These limitations of GDP as a measure of economic progress are particularly concerning given the accelerating resource constraints and growing environmental strain.

The economic ramifications of environmental challenges have become even more evident with the increasing frequency and intensity of climate-related shocks over the past decade. These shocks are having significant and lasting effects on developing countries. For example, despite Africa’s minimal contribution to global greenhouse gas emissions, it bears a disproportionate share of the adverse consequences. It is estimated that African economies lose up to 5% of their GDP annually due to climate shocks, largely because of their reliance on rain-fed agricultural production.

Furthermore, poverty remains widespread in many of these countries, making it difficult to implement effective climate adaptation measures and advance the necessary energy transition. This challenge is further compounded by insufficient climate finance, with the continent receiving only 1% of global allocations. As a macroeconomic indicator, current GDP estimates are inadequate for capturing these dynamics. These realities have prompted a re-evaluation of how we measure economic progress, highlighting the need for indicators that account for the impacts of environmental shocks.

Similarly, Uganda’s GDP for FY2023/24 was estimated at US$53.6 billion, representing a 6.1% real year-on-year growth, driven by improvements in agricultural production, trade, and emerging oil prospects. However, this estimate conceals the associated costs - such as deforestation, soil erosion, air and land pollution, floods, prolonged droughts, and the degradation of water quality.

Uganda’s location at the frontier of climate shocks, combined with its rapid population growth, makes it highly vulnerable and poses significant threats to sustainable development. These realities underscore the urgent need to quantify and adjust for these environmental externalities to provide a more accurate and holistic measure of economic progress and true wealth.

This article documents recent advances and proposes a complementary approach to measuring economic progress by adjusting GDP statistics to account for the environmental costs and benefits of current production processes. The approach is calibrated using Uganda’s macroeconomic data to demonstrate its impact on existing measures. This new methodology captures both economic progress and ecological realities, thereby facilitating the alignment of policies with long-term prosperity.

The resulting statistics provide crucial insights for building resilience and informing policy interventions related to climate change adaptation and mitigation. This, in turn, is expected to enhance agricultural productivity, support the energy transition, and improve household welfare. Achieving these outcomes requires the development of tools to quantify environmental costs and benefits and apply them to adjust GDP estimates.

2. GDP Estimation approaches

The three approaches used for GDP estimation within the System of National Accounts (SNA) are: the production (output) approach, the expenditure approach, and the income approach. While these approaches are theoretically equivalent, differences in the datasets used for their compilation may result in slightly different outcomes.

The production approach calculates GDP by summing the value of all final goods and services produced within an economy during a specific period. It involves determining the market value of goods and services produced by all sectors of the economy, adjusted for intermediate consumption (goods used in the production process) to avoid double-counting. The difference between total output and intermediate consumption represents the value added by each sector, and the sum of all value-added contributions equals GDP.

In the expenditure approach, GDP is calculated as the sum of spending on final goods and services within the economy. This includes household consumption expenditures, private investment, government spending on goods and services, and net exports (i.e., total exports minus imports.

The income approach estimates GDP by aggregating all factor incomes earned in the economy. Under this approach, GDP is calculated as the sum of all salaries and wages, profits earned by business entities, interest on financial assets, rent on capital, and other factor incomes, including depreciation and indirect taxes.

In practice, GDP estimates involve using a combination of two or more of these approaches, depending on the availability and quality of datasets for each component. However, none of the three approaches adjust for the consumption of fixed capital, non-renewable resources, or environmental damage caused by the production process. To obtain accurate statistics on economic progress, it is important to adjust GDP estimates to account for these costs in an integrated approach.

3. The Integrated Approach (Net Domestic Product & Environmental Change)

The integrated approach begins with the estimation of Net Domestic Product (NDP), which measures a country’s economic output minus the depreciation of its productive capital stock. The capital stock includes the total value of fixed assets such as plants and machinery, buildings, and equipment used in the production process at the beginning or end of the period.

NDP is calculated by subtracting the consumption of fixed capital, thereby accounting for depreciation or wear and tear in the production process. The information provided by NDP statistics allows for a more accurate allocation of resources between current and future consumption. This adjustment can reduce a country’s GDP by up to 30%, depending on the capital intensity of its production process. The NDP offers a more accurate and sustainable measure of a country’s production for the reference period.

Productive capital stocks are not the only factors of production that suffer wear and tear during the production process. Several non-renewable resources, such as petroleum products and certain minerals, are also consumed in production. Components of these natural resources may not be recyclable to their original form and, therefore, will not be available for future production. As proposed in the SNA 2025, we subtract these non-renewable resources in the computation of NDP, as they are depleted during the production process, providing a more accurate estimate of economic activities.

It is important to note that environmental factors play a crucial role in production, especially in primary agricultural commodities and selected services, yet they are not included in the estimation of NDP. While some production processes contribute to environmental degradation, others, such as afforestation, reafforestation, and recycling activities, enhance environmental conservation. This highlights the need to incorporate environmental impact (E) into the estimation of economic activities.

This article proposes an integrated approach that adjusts NDP for the net environmental costs/benefits, accounting for sustainable future production and income flows. The environmental impact adjustments are likely to have either a positive or negative effect on a country’s integrated NDP, with a greater negative impact on countries whose production processes significantly contribute to environmental degradation, and vice versa. We calibrate the integrated NDP with data from Uganda and demonstrate that the inclusion of the environmental adjustor lowers the NDP.       

Therefore, the integrated NDP is computed as the estimated GDP less the consumption of fixed capital (CFC), non-renewable resources (NNR), and an adjustment for environmental costs/benefits (E), expressed mathematically as: . The incorporation of environmental costs/benefits will not only provide a more accurate estimate of the country’s economic benefits but also support the integration of sustainability into public policy. The updated methodology is particularly important for countries that rely on non-renewable resources, such as fossil fuels. 

The integrated NDP refines the measure of economic activities, making it useful for climate change and environmental conservation initiatives required for sustainable economic growth and development. Furthermore, these refinements make it possible to advance measures of environmental conservation (e.g., greenhouse gas emissions, waste management, etc.) as reliable data or estimates become available.

Despite the expected initial data challenges, integrating this approach is crucial for sustainability. For example, while the contribution of each country to greenhouse gas emissions remains localised, the effects tend to be global. The integrated NDP will not replace, but rather complement, GDP and related statistics. Most importantly, it will provide a strong foundation for sustainability policies.   

4. Net Wealth

Net wealth is the aggregate value of a country’s assets minus its liabilities to the rest of the world. Unlike GDP, which measures economic flows within a specific period, net wealth provides an estimate of the stock of a country’s assets. It is therefore useful for gauging long-term economic progress and facilitating international comparisons of growth. Measuring wealth involves assessing both household and aggregate economy-wide well-being. At the national level, wealth has traditionally been measured using GDP estimates, GDP per capita, and considerations of social and natural capital.

In view of the discussions in the preceding section, sustainable net wealth should be measured using the integrated NDP and NDP per capita. This may, however, include adjustments and the aggregation of net wealth across all households by subtracting their liabilities to the rest of the world. It is an exercise that may take long to adopt but the benefits are enormous. 

5. Sustainable Economic Growth and Development

Sustainable economic growth and development aim to balance economic progress with environmental protection and social equity, ensuring long-term stability and well-being for all. This approach focuses on current economic activities that do not compromise the ability of future generations to meet their needs—aligning with our proposed integrated approach. It provides the foundation for introducing a new method of estimating economic activities that incorporates environmental costs and benefits into the national accounting framework.

Environmental protection and social equity emphasise not only the conservation of natural and environmental resources but also ensuring equal access to essential goods and services for all. Achieving sustainable economic progress and development requires concerted efforts in natural resource management, the development and integration of environmentally friendly technologies, strengthening policy institutions, investing in the energy transition, and addressing inequality.

The key pillars for achieving sustainable progress include maintaining a stable and growing economy, protecting natural resources and ecosystems to ensure their long-term availability, promoting social progress through increased access to opportunities, and preserving cultural heritage and traditions. The integrated NDP provides a solid foundation for measuring and monitoring progress across all these areas.

The writer is the Deputy Governor Bank of Uganda

Prof. Augustus Nuwagaba is the Deputy Governor Bank of Uganda.