The What and Why of Natural Capital

In your first week of Econ 101 you were probably introduced to the idea of capital. To a firm, capital represents the physical equipment or inputs that are used in the production of a good or service; basically capital is what you use to run your business. Traditionally, economics has separated this type of capital from natural resources primarily because natural resources were always considered to be fixed; an acre of land was, and always would be, an acre of land.

As anybody who has been to, or worked on, a farm can tell you, the idea of a natural resource’s value being fixed greatly misses the ability for people and natural processes to degrade or improve the resource. A crop of corn will drain nutrients and value from your land while a crop of soybeans can actually return some of that value.  Thus, an acre of land this year can actually be quite different from an acre of land next year.  Acknowledging that natural resources are dynamic and that their economic value is constantly shifting means that a business needs to account for and manage this “natural capital”.  An understanding of the true, and changing, value of the natural resources that a firm depends upon is what the concept of natural capital accounting attempts to capture.

So, this may be an elegant method to capture nature’s variable value, but if you aren’t a farmer why should you care?

The short answer is that no business is completely free of natural capital dependencies.  Manufacturing may require raw material inputs such as lumber, minerals, or water. Retail businesses rely on packaging derived from trees or oil.  Even hedge fund managers need electricity and computer components that depend on raw materials.  And finally, at its most basic level all business requires healthy people, and if you want healthy people you need clean air, clean water, and a stable climate, all part of a firm’s natural capital.

Now of course the longer answer is that not knowing the natural capital dependencies of your business creates risk across a variety of areas, including:

  • Financing: Increased lending requirements for firms with unstable flows of natural capital
  • Regulatory: Fines or lawsuits from degradation of shared natural capital
  • Customer: Customers switching to products with less natural capital impacts
  • Operational: Higher costs for obtaining natural capital
  • Reputational: Brand degradation from negative impacts to shared natural capital

As ecosystems change and the flows of natural capital are affected firms need to understand what natural capital is and embrace why it is important to their business.

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