Appetite for destruction supports corporate profits

March 07, 2012

The unaccounted cost of environmental damage wrought by businesses in 11 major industries probably equals 41 per cent of their profits.

That’s the estimate in a report by global accounting and consulting giant KPMG, which sought to quantify the ‘externalities’ businesses impose through environmental damage.

First of all, you may ask, what is an ‘externality’?

It is a term economists use to describe a cost (or benefit) imposed by one person or group on others who were not compensated (or did not pay) for that cost (or benefit).

Environmental degradation is an externality that is caused in varying degrees by most types of business activity, yet businesses rarely have to cover the full cost of the damage they cause.

One estimate in the KPMG report puts that unaccounted cost to the environment at $US2.15 trillion for the top 3,000 global listed companies in 2008.

And the KPMG report estimates the costs of businesses’ environmental impacts are doubling every 14 years.

But it’s not just big polluting corporations causing these externalities and innocent citizens wearing their costs.

In fact, it’s really current generations imposing these externalities on future generations.

You see, if these externalities were properly accounted for (such as through various mechanisms to put a price on pollution that accurately corresponded to its true environmental cost), then corporations would likely pass much of this increase in the cost of doing business onto consumers.

That would mean an increase in the current cost for many goods, however the trade off would be lower costs in the future than will be the case if resource depletion and environmental degradation continues at its current growth rate.

Unfortunately for Australia, this country currently relies heavily on industries where the environmental costs are worth most of, and in some cases more than, the profit generated.

For example, KPMG cites data from environmental research agency Trucost that estimates the cost of environmental damage as a proportion of pre-tax earnings for 11 industries.

The worst performer is agriculture, which is estimated to cause more than twice as much damage to the environment as it generates in profit.

Contrast that to telecommunications and the internet, where estimated environmental costs equal only 2.5 per cent of profits.

There is one key message from that finding: if you think food prices are high now, then you ain’t seen nothing yet.

Eventually, some of those unaccounted costs are going to filter through into the actual price of food, because the theoretical environmental costs estimated by Trucost’s model will eventually manifest in lower yields from degraded soil, higher input costs from depleted deposits of phosphates for fertilisers, higher water costs as competition for fresh water increases, etc.

That’s not to mention the upward price pressure caused by the rapidly growing demand from Asia’s expanding middle class.

KPMG estimates that food prices will probably increase by between 70-90 per cent over the next 20 years.

Perhaps surprisingly, mining rates better than agriculture in environmental costs v profit at 64 per cent – but that is mostly due to the surge in prices and profit the Asian industrialisation story has unleashed.

In simple terms, the price of metals is now better reflecting the true environmental cost of digging them up (although not all the benefit from those higher prices is going to those bearing the environmental costs).

You’ll notice I’ve used the word estimate a lot.

That’s because, while economists like putting a price on things, some things are inherently hard to quantify. Environmental damage is one of those things.

That’s partly because tracking the exact causation of environmental changes isn’t easy, but also because it is hard to put a definitive figure on the total cost of environmental damage which may be permanent, and may have unforeseeable flow-on impacts now and in the future.

Accepting that all these estimates are just that, what the KPMG report really highlights is that current accounting methods aren’t adequately capturing the true cost of doing business, and that is probably distorting the effective allocation of resources.

And being auditors and accountants, KPMG should know a thing or two about that.

The question KPMG’s report is effectively posing is do we try to take into account an estimate of these environmental costs and alter the way we do business now, or do we wait until the environmental damage is so great that its impact does show up in the current methods of counting profit and loss and forces companies to change the way they do business?

Via: http://www.abc.net.au/news/2012-03-07/janda-environmental-costs/3873868

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