Measuring sustainability: the problems facing investors

(Chapter 3 of Report: Appraising sustainable investment in renewable energy)

3.0 Given the international imperative to make future development sustainable and the rationale for including renewable energy is any strategy to achieve this end, the question for any individual or group interested in taking local action is how do you appraise the investment? This chapter looks at the theory and techniques of 'traditional' investment appraisal and the broad range of work that has been undertaken to measure sustainability to see what guidance this can give towards a solution to the problems raised by this question.

Money and sustainability

3.1 As has already been noted (paragraph 2.24), the British Government assumes that investment decisions about renewable energy will have to be justified in conventional economic terms. This is also tends to be the case internationally, as is illustrated by the final text of the Ad Hoc, Open-Ended, Intergovernmental Group of Experts on Energy and Sustainable Development, which '…notes the importance of renewable energy, with due consideration to cost effectiveness' (Churie, Doran and Hanks, 2000, p.6). The UK Government's published information gives money-based values but with caveats. Thus, the 'Economics' case for wind power says:

 

The costs of installing wind energy plant are very site-specific, usually related to the terrain and distances from grid lines and access roads. It is therefore not possible to give a single estimate of the likely capital cost of a wind power scheme. Moreover, manufacturing costs for wind turbines can vary by as much as 20% depending on how well the manufacturer is established in the market. Operation and maintenance costs are on average about 0.5p/kWh. (Undated DTI web site www.dti.gov.uk/renewable/index.html)

 

3.2 This lack of an established idea of the monetary cost of renewable energy systems is a consequence of the fact that there is not, as yet, a well-developed market. There are some economically viable niches, such as low wattage, wind power units for boats and remote sites. The production of larger 'off the shelf' wind generators for wind farms has been stimulated by demand, first in the USA and in Europe, especially Denmark (Kirby, 2000 pp. 6-16). The UK Government's Non-Fossil Fuel Obligation (NFFO) was, at least in part, designed to have the effect of encouraging electricity suppliers to invest in specified renewable energy technologies, as is clear from Ministerial statements (Page, 1995).

 

3.3 However, the fundamental problem of relying on the 'market' to dictate the best courses of action is that short-term monetary values do not always reflect what is seen as 'underlying reality'. A good recent example is the Stock Market valuation of Internet companies. That this is a widely recognised historical problem can be deduced from an article in the newspaper 'The Times', written before the later downturn in prices, which forecasted that:

 

Internet, computer and telecommunications stocks are unquestionably in a speculative bubble. In itself there is nothing surprising or unusual about this…in the tulip mania of the early 17th century, a single Dutch tulip bulb could briefly be sold for the price of a large house in Mayfair…( Kaletsky 2000, p.3)

 

3.4 Nonetheless, money is widely used as 'a medium of exchange, a unit of account, a store of value and a standard of deferred payments' (Wall, Marcouse, Lines and Martin, eds., 2000, p.209). Investment techniques have been created that use monetary value as the basis for their calculation. According to Wall et al. (2000, p.234), the most commonly used method in Britain is that involving the so called 'payback period' and this observation confirms 30 years personal experience of DTI cases. This simple (some academics say 'simplistic') method 'estimates the length of time it will take to recoup the cash outlay on an investment' (Wall et al., 2000, p.234). More sophisticated monetary value methods of have been available for over a quarter of a century, such as discounted cash flow (DCF) and net present value (NPV). These take into account the time value of money, which recognises that any investment consumes money that could otherwise be earning interest elsewhere, such as if it were lent to a bank or building society (Sizer, 1975 pp. 163-166). However, they have not been able to replace the popularity of 'payback', especially within the Private Sector. Because Public Sector projects 'cannot all be assessed on a commercial basis', cost-benefit analysis is sometimes used as a 'means of weighing up the financial and social costs…against the financial and social benefits (Wall et al., 2000, pp.62). However, the 'quantification of the external costs (such as pollution) and of the social benefits (such as jobs)…can be very difficult to achieve, which may undermine the analysis' and the 'absence of a market' make money valuation difficult (Wall et al., 2000, pp.62-63).

 

3.5 Significantly, some economists have questioned the applicability of money and the market economy to the evaluation of the problems of sustainability. Nelissen and his fellow editors draw attention to the writings of Pigou, in the nineteen twenties (1997, pp. 25-26) and Mishan, who criticised the use of cost-benefit analysis to decide on the location for the third London Airport in the sixties (1997, pp. 81-83). Daly (in Kirkby, O'Keefe and Timberlake, 1995, p.335) refers to what he calls 'money fetishism', which he sees as a specific case of what the philosopher and mathematician Alfred North Whitehead (Maunter, 1999, p.600) described as the 'fallacy of misplaced concreteness'. Paul Ormerod, a former Head of the Economic Assessment Unit at 'The Economist', suggests that one of the giants of modern economics, John Maynard Keynes, 'believed that the market system could not communicate efficiently…demand to companies and individuals in the economy' (1994, p. 141). Richard Douthwaite, in 'The Ecology of Money', gives the answer 'no' to the question 'is the money supply system compatible with sustainability?' (1999, p.31). The reason he gives is 'because it requires the value of production to rise constantly', a condition Daly calls 'Growthmania' (Daly in Kirkby, O'Keefe and Timberlake, 1995, p.333).

 

Conceptual alternatives to money

3.6 As Pepper has pointed out (1996 pp.230-233), there is a school of thought in Economics, which believes that measuring energy flows provides a better method of economic evaluation than money. An even broader methodology has been pioneered in the last decade by the New Economics Foundation (NEF). This comprises both a social and ethical accounting regime that advocates using both quantitative and qualitative indicators (Pearce, Raynard and Zadek, undated, stage 4, p.2) and the use of 'alternatives to cash' also known as 'local exchange and trading systems (LETS) (Boyle, 1999, p.xx-xxi).

 

3.7 NEF claim that 'one in three people actually take ethical considerations into account when they are purchasing' (NEF, 1999). This view is partially supported by Harrison and Burgess (1994 pp. 297-298), who describe how social scientists have proposed that there are four potential sets of beliefs and attitudes about environmental change, only one of which ('Individualism') stresses 'the bottomline' - jargon for net profit (Wall et al., 2000, p.24). Their study of the conflicts over the development of Rainham Marshes led to the conclusion that both individuals and organisations base their environmental evaluations on a variety of ideas and 'rationalities' (Harrison and Burgess, 1994 pp.307-308).

 

Measures of sustainability

3.8 Wackernagel and Rees (1996), as a result of over twenty years work, have produced a method of calculating human impact specifically because of their worries about future sustainability. They say of their idea 'ecological footprint analysis is an accounting tool that enables us to estimate the resource consumption and waste assimilation requirements of a defined human population or economy in terms of a corresponding productive land area' (Wackernagel and Rees, 1996, p.9). A search of the World Wide Web shows that this technique has been applied, as an academic exercise, for cities as far apart as Southampton (SEC, 1998) and Tokyo (Titech, 1998).

 

3.9 An alternative approach, 'seen as a vital element in achieving world-class manufacturing' is benchmarking, a 'means of setting competitive performance standards against which progress can be measured' (Wall et al., 2000, p.21 - original emphasis). When the Interface Corporation of the USA, 'one of the world's largest interior furnishings companies', decided to create a plan for 'the prototypical company of the 21st century', it used The Natural Step as the benchmark (Anderson, 1998, p.114). It is also of note, in the present context, that switching to the use of renewable energy is seen as an important stage within the Interface plan (Anderson, 1998, p.116).

 

3.10 The Natural Step is a consensus document first developed in Sweden in 1989 by Dr. Karl-Henrik Robčrt. It provides four qualitative conditions, based on the Laws of Thermodynamics (see Angrist and Hepler, 1973, p.3), which also influenced the thinking of Daly and Georgescu-Roegen (Kirkby, O'Keefe and Timberlake, 1995, p.331), against which progress towards sustainability can be measured:

  1. In order for a society to be sustainable, nature's functions and diversity are not systematically subject to increasing concentrations of substances extracted from the earth's crust.
  2. In order for a society to be sustainable, nature's functions and diversity are not systematically subject to increasing concentrations of substances produced by society.
  3. In order for a society to be sustainable, nature's functions and diversity are not systematically impoverished by physical displacement, over-harvesting or other forms of ecosystem manipulation.
  4. In a sustainable society resources are used fairly and efficiently in order to meet basic human needs globally. (Robčrt, 1989, pp.3-4)

 

3.11 The concept of tradable permits provides an alternative way of creating a means of exchange that can be varied in its supply, like money, and also provide a measure of progress towards sustainability. It is suggested that 'regulators could specify the emissions reductions and then allow the market mechanism to determine the price' (Pearce et al. in Kirkby, O'Keefe and Timberlake, 1995, p.348). This is an idea that is already said to be attractive to the United States because it 'is unable to meet the legally binding greenhouse gas reduction target it accepted at the Kyoto climate conference' (Brown, 2000, p.5). The criticisms of this approach 'are the difficulties with actual trading arrangements, and the possibility of countries hoarding permits and using monopoly power to eliminate competition' (Pearce et al. in Kirkby, O'Keefe and Timberlake, 1995, p.353) and countries 'doing tricks with arithmetic rather than deal with some of the fundamental problems of profligate use of fossil fuel' (Juniper in Brown, 2000, p.5). 'Emissions trading', as this process is known in international negotiations, was established within 'The Protocol', Annex I of the UN Framework Convention on Climate Change (FCCC) agreed at Kyoto, Japan in December 1997 (Sell and Spence, 2000, p.3).

 

3.12 The Commission on Sustainable Development (CSD) began a work programme on indicators of sustainable development in 1995. CSD aimed to build an international consensus about a framework, core set of indicators and related methodology sheets that reflected the work already done at national level and within the UN system (Flanders and Bryld, 1997, p.1). The framework that was chosen is called 'Driving Force-State-Response' (DSR) to 'encompass human activities, processes and patterns that impact on sustainable development' (Flanders and Bryld, 1997, pp.2-3). The categories chosen for the 'Working List' of indicators are: Social, Economic, Environmental and Institutional. Twenty-one countries, including the UK, agreed to test the indicators over three years from 1997 (Flanders and Bryld, 1997, pp.3-4). Two years later, in May 1999, the IISD hosted a ' Science and Policy Dialogue on Designing Effective Indicators for Sustainable Development' in Costa Rica, the title of which was 'Beyond Delusion' (Bettelli and Pinter, 1999, p.1). Some participant felt that a single good indicator might be better than the large list developed from the DSR framework and 'several participants agreed that, given the scope and nature of environmental problems, it is time to proceed with the development of indicators that assist in determining whether ecological or socio-economic capital stocks are being depleted' (Bettelli and Pinter, 1999, pp.13-15).

 

3.13 Long lists of indicators are also the subject of work at all levels of Government, for example the European Sustainable Cities Project produced its second proposal in October 1999. The New Economics Foundation (NEF) produced a guide 'for people working in community development, environmental work, Local Agenda 21, local authorities, voluntary organisations, business and education' called Communities count (MacGillivray, Weston and Unsworth, 1998). This included over 30 different lists and reported that 'over 1500 indicators have now been chosen in over 40 communities in the UK (MacGillivray, Weston and Unsworth, 1998, p.43).

 

3.14 The UK Government produced a first consultation list of over 130 indicators in 1996, which resulted from work done under the Conservative Administration, post 1992 (DoE, 1996). As a result, in part, of criticism about the length of this list, the Environment Minister in the then new Labour Government announced the idea that a set of 'headline indicators…should be developed in order to capture the public imagination' (Meacher, 1997, para. 63). Two of the DETR's most senior statisticians presented a paper, setting out their methodology, to the Royal Statistical Society in January 1998 (Custance and Hillier, 1998, pp.281-290). A paper, expressing an alternative view that gave greater consideration to environmental protection was read on the same occasion by Roger Levett (1998, pp291-302). In November 1998, the Government issued a consultation paper on its 'headline' indicators (DETR, 1998). Levett led the criticism in an article for Town & Country Planning magazine, in which he said:

In particular they make no attempt to measure what is arguably the single most important issue for reconciling environmental and social goals, the `eco-efficiency of welfare’ – things like how much energy people need to consume to keep warm in their homes, how far a family have to drive each week to get to their choice of shops, workplaces and recreations, or how much soil degradation, energy, traffic and packaging it takes to supply their food. Nor do the indicators give any clue as to how the UK’s levels of environmental consumption compare to other countries’ or to global fair shares, or how Britain’s economy affects the environment in other countries. Or how many people in this rich country still can’t afford to keep warm, get to basic amenities or eat well – odd given the emphasis on equity and poverty in all the classic texts of sustainable development and the government’s own very welcome professed emphasis on social exclusion (Levett, 1999, p.2).

 

3.15 The Government added an extra 'headline' indicator on crime and issued them as part of the strategy document, published in May 1999, together with a long list of other indicators (DETR, 1999).

 

Conclusions about measuring sustainability

3.16 The conclusions that can be drawn from this review of the work to measure sustainability and the investment appraisal techniques are that:

    1. investment appraisal has 'traditionally' tried to value even environmental costs and benefits in money terms
    2. Governments and international agencies have sought to apply money based values to sustainable development
    3. Economic and social 'sustainability', rather than environmental unsustainability alone, has become the focus of international and national sustainable development indicator building
    4. Academics and NGO sources have suggested several alternative non-monetary measures of sustainability.

References

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