Why the need to manage a broader portfolio of assets?

As an illustration of what can happen when the complementary role of environmental assets is ignored and certain thresholds are breached, consider the Yangtze Valley in 1998. Although China has always been susceptible to flood and drought, the 1998 floods were some of the most severe in its history. Rainfall from June to August that year was 38 percent above normal, but later analysis found that these unusually high levels could only partly explain the floods. The rest was perceived to be due to logging of the river's watershed, which eroded the soil. Deforestation had been so great (forest cover had decreased by more than half since the 1950s) that the watershed could no longer stabilize the water flow.³³ The resulting floods had very high costs in human lives-tens of thousands dead-and in lost production in the area.

Similarly, the degradation of the Aral Sea highlights what can go wrong when there is inadequate recognition of the role of environmental assets in the production process-and of the costs for human welfare (box 2.3) Expansion of irrigation schemes in the Aral Sea basin has generated billions of U.S. dollars in benefits and millions of jobs. But the overall costs of these schemes have been high, both in failing to generate the expected high levels of sustainable production over time and in causing serious health effects in areas immediately surrounding the sea. Today, avoiding further declines in the sea level is possible only if appropriate operational adjustments are made to the existing irrigation systems to improve their efficiency.

Some countries' experience with shrimp farming illustrates the costs of ignoring environmental services. Over the past two decades new technologies and production systems have enabled a dramatic increase in the intensity of shrimp farm operations-the production of farmed shrimp has grown at 20-30 percent a year.³⁴ Compared with traditional systems, however, the more intensive systems require large amounts of feed to support the shrimp and large amounts of water to flush out the wastes.³⁵ Because of the high concentration of farm units in areas of limited water supplies and inadequate flushing, the effluents in many cases exceeded the capacity of the receiving waters (sink), leading to pollution inside the ponds as well, which adversely affected production since these farms require a lot of water as an input (source).³⁶ The quality of the water in traditional shrimp farms is generally better because of the lower intensity of shrimp, which are thus less prone to disease.

The collapse of many shrimp farms in China, Indonesia, Taiwan (China), and Thailand has meant large losses in physical assets and in labor.^37,38 This was a direct consequence of not recognizing the importance of ensuring good naturally provided water quality in the production process, especially as the volume of shrimp and the capital intensity of farms increased.

Breaching thresholds through the cumulative loss of biodiversity can also lead at a localized level to a loss of resilience of an ecosystem-in its capacity to absorb disturbances without undergoing fundamental changes in functional characteristics. A run-down ecosystem, (one degraded by excessive use) can succumb to shocks that would not destroy a healthy ecosystem. A famous analogy made by Ehrlich and Ehrlich (1981) relates ecosystem components to rivets in an airplane.³⁹ One by one, biological species may disappear and not be missed. Eventually, however, the cumulative loss of biodiversity will lead to the crash of ecosystem functions just as the cumulative loss of redundant rivets will lead to the crash of an airplane.⁴⁰

Thresholds are clearest when a renewable asset has been exploited beyond its capacity to regenerate or reproduce. When that threshold is reached, the productivity of other assets decreases-or if the degraded asset is the main input, production may cease altogether. The change is often sudden and discontinuous, as in cod fisheries in New England (see chapter 7).⁴¹

In some cases there may be no substitute for some of the functions of the environmental asset, so breaching thresholds can cause irreversible damage. An example of this is the ozone level: wearing a sunscreen lotion all day may protect skin from cancer caused by ultraviolet rays, but there is no known substitute for the protection ozone affords to our food chain.⁴²

Thresholds can apply to all assets. Indeed, the experience of 80 countries during 1970-99 suggests that the probability of achieving a relatively high per capita growth of 2.5 percent a year for a five-year period is highly affected by the crossing of certain minimum thresholds of physical assets, human assets, and social assets.⁴³ That probability drops from 58 percent to 28 percent if the investment of physical capital to GDP ratio is below 15 percent. Even when the ratio is above 15 percent, the probability falls by more than 23 percentage points if the level of social assets-proxied by an index of (the lack of) political and social tensions-falls below a threshold.⁴⁴ The probability of such durable growth also falls significantly (from 70 percent to 44 percent) if the education Gini-measuring inequality in the distribution of education-is greater than 0.30.

In sum, the long-term neglect of any set of assets-human, social, or environmental-can at some point sharply reduce the productivity of the other assets, whether for commodities, sectors, regions, or nations.⁴⁵ Therefore, while countries may be able to grow for a period based on a strategy of accumulating physical capital, the prolonged neglect of other assets is likely to endanger the durability and sustainability of the growth process-for example, allowing a country to fall into a state of high social and civil unrest (a drop in social capital) is likely to undermine sustained economic growth.^{46, 47} Similarly, if environmental degradation is irreversible, society can lose the option value of an asset that could make a serious difference to future productivity (box 2.4).

So far the concern has been with the potential for substituting assets in production. What about the potential for substitutions that affect human well-being directly? The need to manage all of society's assets may be even greater. The substitutability of assets that enter people's well-being directly is likely to be lower than the substitutability technically feasible in production. Some minimum bundle of social and environmental assets is likely to be needed if one is to achieve a given level of personal well-being.⁴⁸ This argument is just as valid for intergenerational well-being.

There will always be much uncertainty about the tastes and preferences of future generations-and about the technological possibilities open to them. But there is also much uncertainty about the consequences of our current actions. While many ecological problems are gradual, some can switch abruptly from one stable state to another (box 2.5). Such shifts can cause large losses of ecological and economic resources.

Very often, restoring the desired state would require drastic and expensive interventions. And sometimes the process of restoration is not even known. Technological solutions to these problems might be available in the future-or they might not be. When the potential damage can be very large-where the effects may be irreversible and where substitution possibilities may be limited-a "precautionary principle" applies: act more conservatively when you are uncertain about the effects (see chapter 5 and box 5.6 on the precautionary principle).