George M. Mangion | Wednesday, 10 September 2008

Green credentials

A lot of attention has been given to air pollution of late. Hence the controversy of testing buses and heavy vehicles for their exhaust emissions and the use of correct fuel mix.
Equally, many books have been written and theories discussed in academia on the need to properly account for the cost of sustainable environmental wellbeing, but local journalism on the subject is sparse. In overseas journals one reads about the desire to incorporate a national regime to cater for green or sustainable accounting which incorporate environmental assets and their sources. Once implemented, this also means that we cannot avoid taking notice of similar adjustments to corporate accounts. Gradually we are becoming aware of the need to start measuring environmental and natural resource accounting.
As a general rule, one finds that conventional national accounts largely ignore the costs of say pollution and other damage to the ecology. This does not mean that local pressure groups do not raise their voices when they are aware of infringements to the sustainability of the environment, particularly when these measures threaten to undermine the sustainability of economic performance and growth. What is so vividly missing is the difficult part of costing the environmental degradation as an ‘external’ (social) cost of economic activity. This accounting concept hones on capital maintenance, as applied to the biosphere, in recognising the need to maintain the stock of natural capital for future generations.
Typically one expects that sustainable cost is deducted from the accounting profit of polluting agents calculated by using I.F.R S accounting principles to arrive at a notional level of sustainable profit or loss. In rare cases where the sustainable cost exceeds the accounting profit, the degree of unsustainability is conveniently measured in monetary terms. To quote a vivid example one can mention the environmental damage to garigue in pristine areas when MEPA approves this to be dug up to make way for luxury villas and condominiums. The value of the villas and flats when finished is added to the gross domestic product (GDP) as part of the burgeoning construction industry, while no deduction is made for the loss of that ecological asset and all the nonmarket services it provided. Again, when farmers spray crops with pesticides parts of which occasionally permeates the water table, the farming community boosts the GDP in terms of produce, but no deduction is made for the health costs associated with the water pollution.
The lists goes on but on an international scale, one reads figures published by the World Bank for the depreciation of several natural resources such as oil, natural gas, minerals. This is not to mention the deleterious effect on the atmosphere in enriched doses of carbon dioxide acting as a deadly pollutant. As a frequently quoted example we find that in contrast, in the Indian subcontinent, even while GDP per capita has increased, proper green accounting reveals degradation in sustainability has resulted in a decline in wealth per capita. The decline has occurred because relative to population growth, investment in produced capital and improvements in institutions have not compensated for the degradation of natural capital. Moreover, countries that have experienced higher population growth have also lost wealth per capita at a faster rate.
Even though this may not be relevant to Maltese islands one ponders to reflect that during the past three decades the rich world has enjoyed sustainable development, while development in the poor world (barring China) has been unsustainable. So the answer is blowing in the wind that we should seriously start considering going green accounting.
As stated above, the age-old measure of GNP only measures economic activity in terms of the amount of final demand satisfied by economic output. The use of this figure as a distorted measure of wellbeing rests on the assumption that wellbeing is proportionate to consumption of produced goods.
However, as in the case of the local transport industry saving on fuel cost by allegedly mixing fuel in heavy vehicles the resultant cost of health remedies for asthma and resultant respiratory deceases is not accounted for.
These fallacies in accounting terms can often be described as environmental externalities, a major example being the pollution to air, water and soil caused by excessive farming and animal husbandry on small parcels of arable land. In a tightly populated islands, we witness some of the damage caused by pollution is invariably reflected in reduced output, as in the case of diminished agricultural output due to polluted soils and untreated water extraction from illegal bore holes. As can be expected, environmental damage from dirty beaches and uncollected rubbish in villages directly affects human welfare. Yet, the national accounts of these islands mask this loss. Children bathing in areas where the air is polluted by heavy emissions of speedboats and other pleasure crafts are often more susceptible to viruses and coughing which may resurface when schools open.
So does the solution lie in applying the theory of green accounting? If yes the leap in knowledge is a harbinger of hope. Linked to this is the drive to reduce the consequences of pollution particularly from burning fossil fuels by slowly converting to alternative clean energy. Naturally this adds to the cost in our ‘Green’ accounting manual.
It is a relief that the European Union has set a target that 5.75 per cent of transport fuels should come from biological sources by 2010. Realistically, to meet the 5.75 per cent EU target would require, according to one study, a quarter of the EU’s arable land. The ecological cost to convert such vast acreage to bio fuels will be insurmountable. Most probably the burden is likely to be shifted onto developing countries where land is abundant and farmers welcome any assistance to grow new crops and improve on their standard of living.
Yet green accounting dictates that the alternative cost to convert arable land to raise corn, or sugar cane for distilling into bio fuels has to be carefully assessed. For example, Brazil leads the world in bio-fuel production and use, making about 16 billion litres per year of ethanol from its sugarcane industry. Crossing over to the Atlantic we notice that by popular demand Americans are been cautioned to cut their petrol use by 20 per cent over a decade, mostly through a use of home grown fuels, such as ethanol. So the writing on the wall is pointing to start reducing our carbon footprint (which is causing irreparable damage) and one palatable way is the ample use of bio-fuels. The green accounting theory defines sustainable cost as the hypothetical measure of restoring the earth to the state it was in prior to a plan for heavy planting of energy crops. Yes switching to organic solutions to generate energy heralds its own problems and costs. In Thailand the government is subsidizing the cost to farmers of vast tracts of wasteland to be converted to produce oil palm. Studies show that bio-fuels produce up to 60 per cent less carbon dioxide than fossil fuels.
Biofuels are also making the headlines through bad publicity because land previously used for food crops are being turned over to bio-fuels. To properly account for the green cost of such large scale plantations, one can factor in the 43 per cent rise in global food prices.
According to Whitefox, a company which recently set up its headquarters in Malta, it focuses on developing technologies for cleaner energy production, the ethanol industry needs disruption if it is going to thrive. Dr. Stephan Blum, Chief Operating Officer of Whitefox Technologies Limited, says: “Real change requires more than disruptive innovation. Membrane dehydration, for example, has been around for three decades and while the technology promises major improvements in production, we’ve seen some really alarming failures due to the application of this technology.”
Whitefox has been retrofitting plants in Europe for over five years and has recently begun retrofits in the USA. Two of the US plants now being retrofitted will together produce 220 million US gallons of fuel ethanol on an annual basis. To conclude the introduction of green accounting on a national scale helps us to focus on the concept of capital maintenance, which also applies to our natural environment, air quality, biosphere. Only thus can we maintain a healthy balance sheet for future generations.

George Mangion
Partner at PKF – an audit and business advisory firm
[email protected]