Natural Capital: A Paradigm Shift in Valuing the Environment
Knowledge

Natural Capital: A Paradigm Shift in Valuing the Environment

August 10, 2021

Key Takeaways

  • Natural Capital represents the global stock of environmental resources and ecological systems, providing goods and services necessary to support life and sustain industries

  • By incorporating the core concepts of Natural Capital into business models, companies can realize profits and achieve sustainable initiatives by allowing for better accounting of long-term costs and capturing a growing segment of consumers who place a premium on sustainable business practices and products

  • The World Bank, United Nations, and the U.S. Department of Commerce have all advocated for broad-based adoption of Natural Capital by both governments and private entities

 

Historically, the conflict between economic development and environmental conservation was viewed as a zero-sums game. However, the emergence of Natural Capital may finally bring a détente to the conflict.  Incorporating economics, accounting, and environmentalism, Natural Capital represents a paradigm shift in understanding the relationship between economic growth and environmental conservation.

While there are many definitions of Natural Capital, it is best understood as the global stock of environmental resources and ecological systems providing the goods and services necessary to support life and sustain industries. Examples include potable water, the Great Barrier Reef, and arable land.  Understanding these resources as economic assets is the core notion of Natural Capital, as each provides the means to sustain both life and industries.

The discussion surrounding Natural Capital is expansive. Its touchstone concepts are seen in sustainable investment strategies, such as sustainable ETFs. It can also be seen in governmental programs, specifically as demonstrated in 2015 when the U.S. Department of Commerce hosted a roundtable discussion to promote and examine the incorporation of Natural Capital strategies in the business world.  The relationship between the environment and economy is no longer viewed as antagonistic, but now as reciprocal and synergetic.

Application

Due to its flexibility, applying Natural Capital and its principles can take many forms. Among these is employing Natural Capital as a framing device in the corporate decision-making process. By using Natural Capital as a framing device, it serves key stakeholders by presenting a fuller and more robust image of the potential costs not readily apparent in the traditional decision-making process. This implementation of Natural Capital typically takes the form of IMV: identification, measurement, and valuation. Identification requires the company to recognize the direct and indirect impacts the corporate decision will have on natural resources and ecological systems. Once the resources and impacts are identified, the measurement stage requires calculating and quantifying the associated metrics, such as number of gallons of water consumed, total greenhouse gasses emitted, etc. The final phase, valuation, determines the total cost of the natural resources used and the potential economic gains. While this strategy does not compel sustainable practices, it does serve the critical purpose of better informing companies of the total costs associated with potential profits.

Beyond the application of Natural Capital as a tool in the corporate decision-making process, Natural Capital is increasingly finding its way onto balance sheets. The World Bank has advanced that Gross Domestic Product (GDP), is an antiquated accounting system failing to account for the declining natural assets that are “invisible in GDP.” Likewise, the United Nations has established a comprehensive education program to teach accountants its System of Environmental Economic Accounting, which applies traditional accounting practices to Natural Capital. The goal of placing Natural Capital on the balance sheet is to more fully integrate the concept into traditional forms of capital, allowing for better measuring and valuing techniques and standardizing the accounting practices surrounding Natural Capital.

Natural Capital strategies can also be implemented in more direct ways. Many corporate entities are investing in undeveloped areas, as a means to offset greenhouse gas emissions to realize aggressive ESG initiatives. In these scenarios, the importance of understanding Natural Capital can be seen at every angle: There must be an understanding of the potential environmental harm, the ecological and environmental systems at play, the costs of the transactions, the profits to be made in being a net neutral emitter, etc. Thus, while the most direct way may be transactionally the simplest, it represents the culmination of a deeper understanding of the principles and concepts associated with Natural Capital.

Conclusion

A new and emerging concept, Natural Capital is still in its infancy. It has not yet been widely adopted, despite the World Bank, United Nations, and U.S. Department of Commerce advocating on its behalf.  A major hurdle in the wide spread adoption of Natural Capital practices is that it requires a fundamental shift in understanding the natural environment as an asset. By educating itself on ESG practices and emerging concepts, a company will be better positioned to realize long-term sustainable growth.  Accordingly, businesses should begin gathering information on ways to incorporate Natural Capital into their ESG platforms.

Natural Capital’s robust nature lends itself to being amendable and responsive to a wide variety of business needs and accounting practices. Whether a business has one or 1,000 employees, it can adopt practices which incorporates the principles of Natural Capital. There are multiple benefits of incorporating Natural Capital into ESG initiatives, including revealing the true costs of operations and production. With access to this knowledge, businesses are better positioned to reduce expenses and maximize social utility, while capturing new customers who place a premium on sustainable business practices. Further, adopting Natural Capital principles into sustainability platforms ensures those natural resources that an industry depends upon are not exhausted. Finally, by voluntarily adopting ESG initiatives, such as Natural Capital, industries may prevent costly regulatory enforcement regimes from coming into existence.

*The author was assisted by legal intern and University at Buffalo student Colin M. Jackson.

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