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When World Bank economist Herman Daly searched through the indexes of three leading macroeconomic textbooks, he turned up no entries for the terms "pollution," "environment," "natural resources," or "depletion." These glaring omissions help to illustrate what a handful of economists now see as a fundamental flaw in their discipline: an almost complete lack of regard for the environment.

While the environment and the economy are tightly interwoven in reality, they are almost completely divorced from one another in economic structures and institutions. Modern economics has barely heard of the natural world, no less begun to incorporate environmental concerns into its everyday workings.

This oversight traces back to the work of John Maynard Keynes, the father of modern economics, who, troubled by the Great Depression, focused on unemployment, inflation, and other elements of the money cycle. For Keynes and his contemporaries, natural resources appeared so abundant that notions of scarcity, depletion, and environmental damage did not even appear in their picture of how the economy functions.

A tiny cube inside a large sphere just a few decades ago, the global economy is no longer small relative to the earth's natural systems. It now takes only 15 days to produce what it took an entire year to produce in 1900. Increasingly, the corners of the cube have begun to puncture the sphere -- and the damage appears in the form of acid rain, holes in the ozone shield, and the buildup of greenhouse gases.

"Progress," as defined by our modern economic system, is not only perpetuating environmental deterioration, but accelerating it. Reconciling our economic rules and practices with the dictates of environmental sustainability is now much more than a purely academic interest; it is essential for human survival.

Gaining Income, Losing Wealth

No single economic indicator is more popular than the Gross National Product (GNP). A measure of the total output of goods and services in an economy, the GNP is the basis upon which countries are ranked from rich to poor. Almost universally, a climbing GNP is taken to mean that a country's health is improving -- and that its people are becoming better off.

But a closer look at the accounting system used to produce the GNP shows major failings in its ability to assess both economic performance and human welfare. A country's economic bookkeeping consists of income accounts, which when tallied produce the GNP figure, and capital accounts, which track changes in wealth.

As lumber factories, textile mills, office buildings and other artifacts age and fall into disrepair, a subtraction is made from the capital accounts to reflect their depreciation in value. No similar subtraction is made, however, for the deterioration of forests, soils, air quality, and other natural endowments. Natural wealth of all kinds is whittled away with no losses appearing in the national accounts.

When trees are cut and sold for timber, for example, the proceeds are counted as income, and thus added to the GNP. But no subtraction is made for the deterioration of the forest, an economic asset that, if managed well, could provide revenue long into the future. The result is an inflated sense of both income and wealth, creating the illusion that a country is better off than it really is and can sustain higher levels of consumption than is actually possible.

As economist Robert Repetto of the World Resources Institute points out, this failure to distinguish between natural asset destruction and income generation makes the GNP "a false beacon, and can draw those who steer by it onto the rocks."

Most in danger of running aground arc-developing countries whose economies remain closely tied to primary resources, such as fuels, timber, minerals, and agricultural crops. Bolivia, Colombia, Ethiopia, Ghana, Indonesia, Kenya, and Nigeria are among the countries that depend on primary products for 75 percent or more of their exports.

Nigeria is an example of a country that overspent its natural account. Once among the world's largest tropical log exporters, the country's timber shipments fell off dramatically after many years of overcutting forests. In 1988, Nigeria earned only $6 million from forestry exports while spending $100 million on forest product imports. During the period of rapid logging, Nigeria's accounts failed to warn of the impending downturn. Indeed, a country can be headed toward ecological bankruptcy and still register GNP growth.

Repetto and his colleagues have examined the implications for Indonesia's resource-based economy of more accurately measuring income and wealth. Taking into account the depletion of just three natural resources -- forests, soils, and petroleum -- the researchers found the average annual growth in Indonesia's GNP from 1971 to 1984 dropped from 7.1 percent to 4 percent. If the exploitation of coal, mineral ores, and other nonrenewable resources had been included, along with the deterioration of fisheries and other renewable assets, the drop would have been even steeper.

Pollution Pays

Besides being blind to the destruction of natural wealth, the GNP as currently calculated has another major failing: it counts as income many of the expenditures made to combat pollution and its adverse consequences. The Alaskan oil spill of March 1989, the most environmentally damaging accident in U.S. history, actually created a rise in the GNP, since much of the $2 billion spent on labor and equipment for the cleanup was added to income.

Equally perverse, much of the $40 billion in health care expenses and other damages incurred by U.S. citizens annually as a result of air pollution is counted on the plus side of the national income ledger. Although the nation certainly would be better off had the Alaskan oil spill never happened and if people didn't suffer respiratory ailments from air pollution, the GNP suggests otherwise.

As the environment deteriorates further, the discrepancy between the GNP's measure of progress and actual human well-being is widening. Over the next several decades, global temperatures will rise, biologically damaging ultraviolet radiation will increase, thousands of plant and animal species will become extinct, vast tracts of tropical rain forest will disappear, and several billion people will be added to a planet already overtaxed by humans. To enter such a period with economic indicators that ignore environmental deterioration is like steering an aircraft toward a fog-shrouded, windswept runway with no instruments to guide the landing.

Clear-Cut Economics

Given a choice, people prefer to receive $100 today over the same amount made available next year. The reason is obvious enough. That money can purchase a radio or a bicycle offering a year's worth of enjoyment that would be forgone if the payment is delayed. Put in a bank, the money earns interest, which would be lost if the payment is pushed back a year.

Economists capture this time-preference for money in a decision-making tool called the discount rate. It is used to determine the present value of a future stream of costs and benefits, and thereby helps investors choose among a range of profit-making options. But by denominating all investment choices in money terms, and weighing future benefits much less heavily than those nearer the present, the practice of discounting --especially at the high rates used today -- makes sustainable management of most natural resources impossible. Under the economic logic of discounting, it is perfectly rational to drive a resource to extinction if its growth rate lags behind the market rate of interest. As Colin Clark, professor of applied mathematics at the University of British Columbia in Vancouver, puts it: "If dollars in banks are growing faster than a timber company's forests, it is more profitable (indeed, more economical) to chop down the trees, sell them, and invest the proceeds elsewhere." Clear-cutting a forest and slaughtering a marine species thus make, in Clark's words, "a certain mathematical sense."

The upshot has been the systematic destruction of forests, fisheries, groundwater supplies and other biological resources in the name of increasing capital wealth. Not only are private investors responsible, but public ones as well. The World Bank, the largest funder of development projects in the Third World, with an annual lending portfolio totaling some $20 billion, currently uses a discount rate of 10 percent. A forest growing at a rate of 2 or 3 percent per year simply doesn't stand a chance against a required rate-of-return that high. Viewed another way, if greenhouse warming is estimated to cause $ 100 billion in damage in the year 2075, today's valuation of that damage using a discount rate of 10 percent is a mere $30 million, hardly worth worrying about.

Killing the Goose

Today's investment rules also assume that natural capital and human-made capital are interchangeable, and what matters is only that total capital is increasing. But natural and human-made assets are substitutes only up to a point. Without any forests to supply it with timber, for instance, a $50-million lumber mill is useless.

More important, there are no known replacements for some life-supporting natural systems. Scientists can offer no substitutes for the radiation-absorbing ozone layer, the earth's thin mantle of topsoil, or the current climate to which agriculture and other human activities have carefully adapted. Driven by the economic calculus of discounting, these vital natural assets are being destroyed irreversibly, leaving our children and grandchildren to fend for themselves.

Economic decision making also fails to account adequately for the many functions natural systems perform that are difficult to quantify. Compared with a clothing factory or a steel mill, which both produce tangible, easily valued products, only some of the products and services provided by renewable resources are valued in the marketplace. A forest producing wood for timber is also protecting upland soils from erosion, safeguarding downstream croplands from flooding, providing habitat for countless plant arid animal species, and storing carbon that would hasten global warming if released to the atmosphere. But because these are social benefits, a private investor doesn't take them into account. And because they are difficult to quantify, they are often left out of public investors' decisions as well.

As a result, a small measurable private gain can result in a large unquantified social loss, and the economic rules will detect nothing wrong. As Herman Daly and John Cobb write in their book, For the Common Good: "The fact that individual capitalists are made better off by killing the goose and putting their money in a faster-growing asset does not alter the fact that society has lost a perpetual stream of golden eggs."

Who is Better Off?

The economic models guiding the development process are virtually silent on questions of distributive justice and equity. If a particular investment will result in a net gain, but the relatively well-off will get richer and the poor will become more impoverished as a result, should the investment be made? Does such a project promote progress?

A growing body of knowledge suggests that answering these questions is vital to promoting sustainable development. Some 1.2 billion people -- more than a fifth of humanity -- remain largely untouched by economic growth. Since they often subsist outside the market economy, their livelihoods depend on the abundance and quality of the natural resources around them.

When a natural forest is converted to a cash-crop tree plantation, the new plantation owner profits and the GNP registers a net gain. But the poor rural families who had been using the forest as a source of cooking fuel suffer. Rarely is a cost even counted for the women who now must trek four hours instead of two to gather fuelwood for the evening meal.

As the poor are driven into greater deprivation, the environment degrades further. With fewer areas of natural forest from which to collect their cooking fuel, they are forced to overcut the remaining wood resources, which in turn compounds their hardship. In this way, as economists Partha Dasgupta of Stanford University and the University of Cambridge and Karl-Goran Maler of the Stockholm School of Economics point out, separating the goals of economic development from the quality of the natural environment "has proved to be enormously costly in terms of wasted and lost lives."

Since poverty breeds environmental destruction and vice versa, a necessary condition for sustainable development is that the poorest of the poor benefit. Keeping vigilant watch over the welfare of the most destitute will, in turn, be a good barometer of environmental quality. Yet the economic rules and indicators followed by national governments and development institutions, including the World Bank, do nothing of the kind.

Honest Income

Recalculating the GNP so that it takes account of the depletion and deterioration of forests, fisheries, water supplies, and other natural assets is a critical first step toward bridging the growing gap between illusory and real economic gains. Some initiatives in this direction are under way, but the pace of change is far too slow.

Australia, Canada, France, the Netherlands, and Norway are among the countries that have begun compiling inventories of their natural resources, a prerequisite to making the needed accounting adjustments. But these figures have not been integrated into the standard national capital and income accounts, so they have not led to improved GNP estimates.

So far, two countries -- West Germany and the United States -- have plans to calculate an alternative GNP figure that takes environmental damage into account. But these new indicators probably will not be produced on a regular basis until the mid-1990s. Statisticians in both countries will continue to compute the conventional GNP as well, offering the opportunity to show how far from sustainability their economies have wandered, but also leaving open the possibility that the new indicators will be largely ignored.

The pace of GNP reform could be greatly quickened by a push from the United Nations Statistical Commission. Currently, the commission is in the process of revising its System of National Accounts, something that happens only once every twenty years. Because most market economies follow the U.N.'s accounting procedures, altering them to reflect environmental deterioration could widely improve the GNP's reliability.

Unfortunately, the U.N. Statistical Commission has decided to make only limited reforms this round. It agreed to draft guidelines for countries wishing to develop environmental and resource accounts, along with procedures for calculating a new GNP. But the traditional approach to figuring the GNP still will be deemed acceptable. A stronger stand is needed. By the time the commission begins the next round of revisions, presumably around 2010, an increasing number of countries will be trapped in economic decline from the destruction of their natural assets.

Progress Properly Measured

More accurate estimates of national income and GNP, while important, would still be insufficient to determine whether or not human welfare is improving -- the ultimate aim in assessing progress. A better approach is to supplement a recalculated GNP with a basket of other indicators that monitor literacy, infant mortality, housing, income equality and other areas affecting societal health. If these indices were publicized and used frequently, as the GNP currently is, a broader and more accurate picture of progress -- or the lack of it -- would result.

The United Nations Development Program (UNDP) has come up with a "Human Development Index" (HDI) derived from three components: life expectancy, literacy, and purchasing power. A comparison between the traditional GNP and the HDI makes clear that high levels of economic output do not always correspond with high levels of human development. The United States, for instance, ranks second in 1987 per-capita GNP, but comes in 19th on the HDI scale, largely because of its comparatively high illiteracy rate. The people of Sri Lanka, on the other hand, appear better off according to the UNDP index than the traditional GNP since the nation's life expectancy of 71 years and adult literacy rate of 87 percent -- both high among developing countries -- somewhat offset the low per capita annual income of $400. Economist Herman Daly and theologian John Cobb have developed an "Index of Sustainable Economic Welfare" (ISEW) that not only accounts for air and water pollution, cropland and wetland losses, and other forms of environmental deterioration, but also for the costs of commuting and car accidents, for income inequality, and a range of other factors affecting human welfare.

A calculation of this index for the United States over the period 1950-86 shows that during the 1950s and early 1960s, it tracks closely with the traditional GNP (see Figure 1). After that period, however, the two indices diverge markedly. Per-capita economic welfare on the ISEW scale peaked in 1976, arid by 1986 had dropped 10 percent. By contrast, the standard per-capita GNP rose 21 percent over the same 10-year period.

The most speculative factor in the ISEW is that of long-term environmental damage from climate change and other unfolding global threats. But whether the estimate is a bit high or low matters less than the contribution it makes to a more complete picture of economic welfare. Completely ignoring such costs perpetuates the illusion of progress and allows political leaders to escape the hard choices needed to put the economy on an environmentally sound track.

New Rules of the Game Reshaping investment criteria to conform with the principles of environmental sustainability is no small task; currently, they are stacked solidly against future generations.

Among the first priorities is to make public investments place more weight on the future rather than systematically undervaluing it. One solution is to lower the discount rate to a level closer to the real rate of capital productivity, around 1 to 3 percent. This would allow investments offering benefits long into the future, such as tree planting, to stand a better chance against those that turn a quick profit. Having eliminated much of the bias against the future, public investors can then select those projects that offer the highest long-term rate of return.

Government and public agencies can also influence private investors' decisions by issuing grants or tax breaks to compensate for the lower short-term profits yielded by some renewable resources. Robert Goodland, an ecologist at the World Bank, argues that such incentives are critical to slowing the pace of tropical forest destruction until more tree plantations can be developed to take the pressure off of virgin stands.

In addition, a more thorough analysis of costs and benefits would make economically unattractive many of the environmentally destructive projects now being promoted and funded. In a detailed examination of a small plot of Peruvian rain forest, Charles Peters of the New York Botanical Garden and colleagues found that the long-term revenues from sustainably harvesting fruits and rubber from the plot were double those from converting it into a fast-growing tree plantation or a cattle pasture: 52,562 per acre compared with $1,289 for the plantation and $1,198 for the pasture. Logging and selling all the merchantable timber in one quick cut would yield net revenues of only $405 per acre.

The findings arc even more impressive given the researchers' generous assumption that the plantation and the pasture would be sustainable and thus provide income forever. In reality, many such projects in the tropics fail after several years because of rapid declines in soil fertility. Had the researchers also included potential income from products such as medicinal plants, as well as the forest's environmental services (such as the protection of biodiversity and climate), the case for preserving the forest would be even stronger.

A Natural Quid Pro Quo

With many parts of the world sliding toward ecological bankruptcy, one overarching investment criterion now seems warranted: no net loss of natural capital. Requiring that future development protect biological productivity rather than perpetuate its decline would ensure that the next generation inherits an undiminished stock of natural assets.

In practical terms, this criterion would preclude projects that destroy forests, drain wetlands, or pave over croplands unless additional investments were made to compensate for the resource damaged or lost. For instance, if construction of a new road eliminated an area of forest, the road developer would pay to reforest a parcel of degraded land somewhere else. The new tree plantation would not provide as many benefits as the original forest (indeed, this criterion is insufficient for irreplaceable values, such as biodiversity, which are far more pronounced in original ecosystems), but it would at least partially make up for the loss. If the cost of reforestation rendered the whole project unprofitable, the road would not be built.

An initiative along these lines was put forth last April by the government of the Netherlands. It proposes planting a total of 625,000 acres of trees in five Latin American countries over the next 25 years to offset the estimated carbon emissions from two coal-fired power plants to be built in Holland during the 1990s. Besides their many other functions, trees absorb carbon from the atmosphere through photosynthesis, so planting more of them can counteract emissions from fossil fuels and help lessen the risk of greenhouse warming.

Making such compensating investments mandatory -- for both public and private investors -- would ensure that future economic activity does less overall harm to the environment. Those who profit from development would automatically plow some of their expected proceeds back into safeguarding the natural systems they have placed in greater jeopardy.

Shifting the Tax Base

Along with establishing new investment criteria, "green taxes" appear to be a promising way of making private decisions take environmental costs into account. The idea is by no means new. Japan and at least a half dozen European countries already have various kinds of pollution or resources taxes. In late 1989, the U.S. Congress passed a tax on the sale of ozone-depleting chlorofluorocarbons (CFCs). The most widely used CFCs are initially being taxed at $1.37 per pound, roughly twice their current price, with the tax rising to $3.10 per pound by 1995 and to $4.90 by 1999.

Tax policy, however, can be a far broader and more effective instrument for environmental protection. Most governments raise the bulk of their revenues by taxing personal and corporate income, a convenient way of collecting money that serves little inherent social purpose. By systematically taxing economic activities that pollute, deplete or otherwise degrade the environment, governments can raise revenue in a way that promotes environmentally sound practices. To avoid the dampening effect such taxes might have on the economy, income taxes could be reduced so that the total level of taxation remains the same. And credits or payments could be given to poor people hit hard by a particular tax, such as one that raises gasoline prices or heating costs.

By placing a tax of $85 per ton on the carbon content of fossil fuels, the United States could cut current emissions of carbon dioxide (the leading greenhouse gas) by 14 to 20 percent, according to William U. Chandler and Andrew K. Nicholls, researchers at the Battelle Memorial Institute, a policy research group in Washington, D.C. Such a tax would initially generate $112 billion in annual receipts, which would fall somewhat after energy efficiency improvements and other adjustments had been made. The government then could reduce federal income taxes in the range of 15 to 25 percent -- and ease the threat of global warming at the same time.

A comprehensive set of environmental taxes would do much more. It would penalize the use of virgin rather than recycled materials, generation of toxic waste, emission of acid rain-forming pollutants, and overpumping of groundwater. It would tax agricultural chemicals, and thus lessen the risks of their contaminating food and drinking water. In the United States, a 1 percent tax on pesticides and fertilizers would initially raise more than $100 million annually. By making environmentally damaging practices economically unattractive, such a change in tax policy would speed the transition to an ecologically sound economy. With the public increasingly in favor of spending more on the environment, but naturally averse to higher income taxes, the moment seems ripe to launch this reform.

A Question of Scale

Time to build the needed bridges between the economy and the natural systems on which it depends is disconcertingly short. Continued economic growth of the sort engineered in recent decades -- for from being the answer to society's varied ills -- will usher in a period of widespread environmental deterioration and social disruption.

With politicians of all stripes espousing ever more growth, it is easy to overlook the fact that the economy's optimum size is not its maximum size. Anyone who has lost a favorite park to a new housing subdivision knows that not all economic growth enhances the quality of life. As ecologist and philosopher Garrett Hardin says: "For a statesman to try to maximize the GNP is about as sensible as for a composer of music to try to maximize the number of notes in a symphony." Unfortunately, decision makers have not yet grasped that at some point growth begins to cost more than it is worth.

As long as our economies and those who steer them remain blind to the earth's natural limits, indicators of economic performance will bear less and less relation to human welfare. Reversing the tide of environmental destruction will require fundamental shifts in other realms besides economics-most importantly in individual values, the driving force of social change. But a major overhaul of the rules, measures, and goals of our economic systems would be a giant step off the road to ruin and toward the path of sustainable progress.