Why the need to manage a broader portfolio of assets?

Limits to substitutability among assets

Because assets generally complement each other and because the returns to a particular asset diminish, the rate at which one asset can be substituted for another in production (while maintaining a given unit of output) tends to diminish as well. As the level of one asset declines relative to another, the rate at which it can be further replaced falls. Moreover, when the quality or level of an asset falls below a threshold, there can be little further substitution without jeopardizing the productivity of the other assets, as well as overall production.

When environmental or natural assets are fairly abundant relative to human-made assets, substitution of the former by the latter can be expected to lead to higher returns. But there are limits to a long-term strategy that focuses primarily on replacing natural assets by human-made assets. Severely degraded farmland or fisheries will yield little wheat or fish, no matter how many plows or boats are used.

Development strategy to date has often relied on drawing down environmental resources and replacing them with human-made assets. This was the strategy followed by today's industrial countries.²⁸ Most developing countries' growth strategies continue to focus largely on the accumulation of human-made assets (physical capital). Indeed, a review of 60 countries in the late 1980s and 1990s shows that the growth of 16 countries considered to be serious policy reformers was accompanied primarily by physical capital accumulation. The increase in per capita GDP growth of this group of countries-rising from 2.8 percent in the late 1980s to 3.5 percent in the 1990s-entailed an increase in the rate of physical capital accumulation from 2.1 percent to 3.5 percent. In contrast, spending on education-a proxy for human capital accumulation-rose only slightly, from 3.2 percent of GDP in the late 1980s to 3.5 percent of GDP in the 1990s. And the rate of deforestation-a proxy for the depletion of natural assets-rose from 0.7 percent to 1.1 percent.²⁹

The limits to focusing on physical capital alone are borne out empirically. An econometric study of 70 developing countries found that countries with low physical capital-labor ratios tend to experience a rise in their growth rates with increases in the stock of physical capital. But after countries reach a certain capital intensity, the contributions of further physical capital accumulation to growth-for any given human and natural capital-decline.³⁰ A separate study of 20 middle-income countries also found the marginal productivity of physical capital to diminish.³¹ So although there may be economies of scale and technological spillovers for physical capital,³² these do not seem to be large enough to continually offset diminishing marginal productivity.