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Where is the Wealth of Nations?

by Kirk Hamilton

Can poverty reduction be sustained? The end of the twentieth century saw a renewed commitment to ending poverty embodied in the Millennium Development Goals. However, deep concerns remained that current rates of depletion and degradation of natural resources may undermine any progress to date. Achieving sustainable outcomes will require sustaining the total wealth — produced, human, institutional, and natural — on which development depends.

A 2006 World Bank publication, Where is the Wealth of Nations? Measuring Capital for the 21st Century approaches the problem of sustainable poverty reduction from two angles: What is the composition of national wealth? And how rapidly is it being accumulated? The latter question is the key to sustainability.

There are no sustainable diamond mines, but there are sustainable diamond-mining countries. Implicit in this statement is the assumption that it is possible to transform one form of wealth — diamonds in the ground — into other forms of wealth, such as buildings, machines, and human capital. Achieving this transformation requires a set of institutions capable of managing the natural resource, collecting resource rents, and directing these rents into profitable investments. Resource policy, fiscal policy, political factors, institutions, and governance structure all have a role to play in this transformation.

Natural resources play three basic roles in development:

• The first role, mostly applicable to the poorest countries and poorest communities, is that of local natural resources as the basis of subsistence.
• The second role is as a source of development finance. Commercial natural resources can be important sources of profit and foreign exchange. Rents on exhaustible, renewable, and potentially sustainable resources can be used to finance investments in other forms of wealth. In the case of exhaustible resources these rents must be invested if total wealth is not to decline.
• The third role is as the source of environmental services—watershed protection and pollination, for example — that underpin many other economic assets. The value of agricultural land, for example, is closely tied to the value of the environmental services supporting its productivity.

Evidence on the importance of natural resources

Figure 1 provides summary information on the shares of natural resources in the total wealth of high income and developing countries. A high share of natural wealth does not automatically imply that natural resources are important for growth, but it does at a minimum imply that these resources are important for current well-being.

This figure decomposes the total wealth of nations into three broad components across low-, middle-, and high-income countries. Produced capital is the familiar blend of buildings, machines, and infrastructure that is measured in standard national accounts. Natural capital is the value of agricultural land, forests, and subsoil resources such as minerals and energy. ‘Intangible’ capital is the value of everything else — human capital, social capital, and the quality of institutions and governance. The underlying estimates of total wealth per capita are nearly $440,000 in high-income countries, nearly $28,000 in middle-income countries, and less than $8,000 in low-income countries.

Intangible capital is by far the largest share of total wealth in all countries. For the poorest countries, however, natural capital is a larger share of total wealth than produced capital— demonstrating how important natural resources are for social welfare in these countries. This suggests that properly managing natural resources must be a key part of development strategies, particularly since the poorest households in these countries are usually the most dependent on these resources.

This analysis also shows how the share of natural resources in total wealth declines as incomes rise. This does not mean they are unimportant or that they can be exploited indiscriminately—food, fiber, minerals, and energy are essential for economic activity and well-being. Rather, this demonstrates how intangible assets become proportionately much more important as countries develop, with the productivity of people increasing along with the quality of their institutions. In fact, Where is the Wealth of Nations? reports that the value of natural capital per person actually rises with income, from roughly $2,000 per capita in lowincome countries to nearly $9,000 in high-income countries.

From a development perspective, a key message of Figure 1 is that natural resources make up a significant share of the total wealth in low-income countries—26 per cent—and that this is substantially larger than the share of produced capital. Sound management of these natural resources can support and sustain the welfare of poor countries and of poor people in those countries as they move up the development ladder.

Natural resources and wealth accumulation

Saving is a core aspect of development. Without the creation of a surplus for investment, there is no way for countries to escape a state of low-level subsistence. Saving is measured in national accounts as the difference between income and consumption — what is saved is by definition that which is not consumed. But standard national accounts do not measure the dissaving associated with the depletion of natural resources.

Adjusted net or ‘genuine’ saving measures the true level of saving in a country after accounting for depreciation of produced capital, for investments in human capital (as measured by education expenditures), for depletion of minerals, energy, and forests, and for damages from local and global air pollutants. An important body of economic theory suggests that if current net saving is negative in a given country, then its future welfare must decline—in other words, if we care about sustainability, we need to be concerned with the net rate of wealth creation.

Resource dependence complicates the measurement of saving effort because depletion of natural resources is not visible in standard national accounts. Countries can believe they are on a sustainable path, when in fact they are running down their total wealth. Figure 2 looks at genuine saving in Bolivia to illustrate this point.

Figure 2 makes clear the importance of resource depletion and pollution damages in assessing wealth creation in a resource-dependent economy. While investments in human capital partly offset the value of depreciation of produced capital, the depletion of natural resources (mostly natural gas in this instance) plus damages from local and global air pollutants results in a negative net saving rate—total wealth in Bolivia actually declined in 2003.​

Decision makers in Bolivia presumably believed that the rate of wealth creation in the country was nearly 12 per cent of Gross National Income (GNI) in 2003—this is what was reported in the national accounts. A fuller analysis highlights the extent to which depletion and damage to the environment affect the bottom line on wealth creation.

Some conclusions on natural resources and sustainability

If development is approached as a process of portfolio management, then the figures make clear that both the size and composition of the portfolio vary hugely across levels of income. Managing each component of the portfolio well and transforming one form of asset into another efficiently are key facets of development policy.

The linkage between measured changes in real wealth and future well-being only holds if our measures of wealth are suitably comprehensive. This is the prime motivation for expanding the measure of wealth to include a range of natural and intangible capital. This richer picture of the asset base also opens the door to a range of policy interventions that can increase and sustain growth.

The notion of development as portfolio management is powerful. Certain assets in the portfolio are exhaustible and can only be transformed into other productive assets, such as infrastructure or human capital, through investment of the resource rents. Other assets are renewable and can yield sustainable income streams. Economic analysis can guide decisions concerning the optimal size of these assets in the portfolio. Some assets, such as produced capital, depreciate over time. National savings can be used to invest in natural assets, produced capital, or human capital, whichever yields the highest marginal return.

Each year some 10–20 developing countries have negative genuine saving rates. What should the policy response be? Monetary and fiscal policies affect saving behaviour, and public sector dissaving can be a key target of policy. If investment in human capital is treated as saving, then efforts to increase education expenditures and make them more effective can boost overall saving. For natural resources, the general prescription is not to simply reduce exploitation but rather to reduce incentives for overexploitation—this will typically entail reforms in the resource sectors. For pollution the question is clearly one of bringing marginal damages to human health and other assets in line with the marginal costs of reducing pollution emissions.

The figures in Where is the Wealth of Nations? make visible what is often obscured in our standard economic indicators. The value of natural wealth is nearly twice as large as produced capital in low income countries. And the depletion of this wealth, combined with pollution damages, is placing many countries on an unsustainable path.

Kirk Hamilton is Lead Environmental Economist and Team Leader, Policy and Economics, Environment Department, the World Bank, where his current projects include analytical work on the links between poverty and environment.