Cooking the Forestry Books by Ignoring Depletion of Capital

by Tom Green

IN RECENT MONTHS, various large consumers of BC wood products like Home Depot have announced that they will only buy wood that is independently certified as coming from sustainably managed forests. If buyers carry through with this commitment, and if the certification is rigorous, they will make the most important contribution in years to putting BC's forest industry on a sound economic footing. The rate at which forests are liquidated will finally be slowed.

The above statement, especially coming from an economist, is heresy in BC, where any threat that the cut levels might have to be reduced is simply not tolerated. If the cut is reduced, the whole economy supposedly comes tumbling down. Hospital beds would be lost, schools would close, and business would grind to a halt. However, when one properly applies the economist's concept of income to the BC forestry industry, ecocertifed forestry emerges as the economically prudent choice.

No one contests that over the short term, ecocertified forests (assuming that they are worthy of the term) will bring less timber to market than the aggressive clearcutting operations that characterize BC's logging industry. With less volume leaving the forest gate under certified management, many processing jobs will inevitably disappear (or perhaps more accurately will disappear sooner than they would have otherwise). Forestry-dependent communities will feel the most serious effects. It is evident that government and communities need to work diligently on making this necessary but difficult transition.

The status quo has its own set of economic problems. BC has the capability to harvest and process far more timber than it could ever grow sustainably. The best timber has already been logged; chasing the remaining stands leads to mounting ecological and social costs. The industry requires extensive subsidies, both direct and indirect. Economic activities which depend on healthy forest ecosystems are increasingly at risk, and many future economic opportunities are being foreclosed. The benefits of liquidating timber mostly go to outside interests, leaving communities with little to show for all the wealth passing by on logging trucks. The net economic benefits of industrial forestry are diminishing, if they are indeed still positive.

Economists are responsible for much of the mismanagement of BC's forests. Economic analysis has been used to show how the provincial economy is powered by the forest industry, to show how many jobs it supports, to show how the industry fills government coffers. Economists routinely warn of the severe dislocation that would result if the rate of cut were ever reduced. Yet economists have been peddling flawed methodology which overstates the wealth derived from logging. They have abused the concept of income.

Economists understand income as the maximum value that can be consumed over a period while leaving the entity in question as well off at the end of the period as it was at the beginning. In other words, income is the maximum value that can be consumed without eating into the capital necessary to generate future income. When capital is consumed, future flows of income are reduced.

Economists working for government and industry have made the serious error of counting capital consumption as income. This error sends society the wrong signals about our economic performance, about protecting our assets. When this error is committed, the faster we liquidate the forest's wealth, the higher our apparent income, and the greater the stream of economic benefits. However, income, by definition, is that which is obtained while maintaining capital intact.

It is well accepted amongst economists that for the concept of income to provide useful guidance on economic performance, income estimation must account for the stock of manufactured capital that produced the income – the machines and factories. When an activity generates revenue partly by allowing the capital stock to be worn down, allowances must be made for the decreased value of the manufactured stock before determining net income. If a company sells off assets, the books must be adjusted to clarify that this apparent influx of wealth is illusory; it occurs because one asset was traded for another, e.g. machinery for cash.

Unfortunately, such common sense has not been applied to natural capital. Natural capital is the stock which provides the flow of natural resources (e.g. timber and deer) and ecological services (e.g. erosion control and clean water) upon which humanity depends. Economists assumed until relatively recently that the consumption of natural capital was irrelevant. But there is nothing in the definition of income or from economics more generally that justifies ignoring changes to the stock of natural capital.

If the consumption of natural capital is relevant, how does one know if forest management is maintaining or consuming natural capital? The Scientific Panel set up to provide rules for sustainable forestry in Clayoquot Sound (on Vancouver Island) can be seen as one effort to determine the required conditions for maintaining the natural capital of forests intact. Since then, there have been many similar efforts to base forest management on recent insights from landscape ecology, conservation biology and forest ecology -- as well as efforts to disguise tinkering with the status quo under new terminology.

I would suggest that the following conditions must be met to maintain the natural capital of forested ecosystems:

1. resource extraction must be constrained in a way that maintains connections across the landscape and ensures the protection of representative and sensitive habitats;
2. managed forests must not significantly "contrast" with their natural counterparts. Instead, they must contain the same structures and legacies and function in similar ways;
3. rotation ages must be set so as to allow old-growth characteristics to develop;
4. soil productivity must be maintained;
5. species, genetic, and habitat diversity must be maintained; and
6. timber extraction rates must be set cautiously, to provide a safety factor in the face of uncertainty and natural variability.

A forest worthy of certification is one where the manager restricts "withdrawals" from the capital stock to a level where ecological functions and services provided by the forest stay constant over the years. It follows that the wealth generated by such a forest can be considered income. The manager is able to meet the test set out in Principle 6 of the Forest Stewardship Council:

"Forest management shall conserve biological diversity and its associated values, water resources, soils, and unique and fragile ecosystems and landscapes, and, by so doing, maintain the ecological functions and the integrity of the forest."

By contrast, industrial forestry replaces ecologically rich old-growth forests with managed forests focused on fibre production that have little ecological value. Such forests are more susceptible to disease, support less wildlife, have impoverished biodiversity, and are not as good at providing ecological services such as clean, dependable water. While industrial logging can generate great volumes of timber for a few decades, when we count the proceeds as income we deceive ourselves.

To see the extent to which industrial forestry is predicated on liquidating income, we can look at Clayoquot Sound. To implement the recommendations of the Scientific Panel, the Chief Forester had to reduce the annual allowable cut (AAC) by approximately two thirds. Another example: the Harrop Proctor Watershed Protection Society proposed an ecosystem-based AAC of 2,700m3 to the Ministry of Forests for its community forest, while the ministry calculated that the conventional AAC would be between 6,694 and 9,701m3.

If natural capital is ignored, such figures suggest that ecocertified forestry spells doom for the provincial treasury and for forest workers. But a good economist should adjust government revenue figures to account for the consumption of natural capital under industrial forestry.

Using the interest/depletion approach to income estimation, in the case of Clayoquot, 65 percent of the government "revenue" derived from industrial forestry should really have been categorized as the proceeds from a one-time liquidation of provincial assets. Yet the province's books did not reflect this loss of assets. The apparent loss in government revenue caused by implementing the Scientific Panel's recommendations is mostly explained by poor accounting. Similarly, two-thirds of the forestry jobs formerly supported by industrial forestry were in effect supported by depletion, or by dipping into the stock of natural capital that should have been passed on intact to future generations.

Industry PR to the contrary, it is clear that BC is not maintaining its forest capital. The province has long had a policy of converting natural forests to fibre factories. The latter may produce timber, but they have few other ecological or social benefits. To make matters worse, the province sets the current cutting rate high above the level to which these fibre factories will ever be able to grow. Current cut levels indicate little about what managed forests will be able to produce. The current cut is mostly a by-product of quickly liquidating the stocks of timber that were already growing when industrial forestry was in its infancy.

Reducing the annual cut to the level required to meet rigorous ecocertification standards appears to be a hard sell, until one realizes that economically it is the sound thing to do. All the proceeds from logging could truly be considered income – and society could count on this flow of benefits to occur in perpetuity. Instead, we set the stage for another northern cod fiasco, and the economic dislocation that such mismanagement entails.

Correcting our course will result in job loss, and corporate earnings will be reduced. Yet cautious forestry employs more workers per volume removed, and it can generate modest but long-term revenue and profits. By logging cautiously, making more furniture and fewer 2 by 4's, prospects brighten for a sustainable forest industry.

Ecocertification is intended to maintain the quality of the environment on which many other sectors of the BC economy depend, and is therefore an important tool for economic diversification. More importantly, ecocertified forests protect the environmental quality that makes BC a good place to live, to work, to invest, and to retire. Managers of certified forests must respect aboriginal rights, and certified forests should be rich in the wildlife and plants which make such rights meaningful.

BC is not the only jurisdiction where flawed economic analysis leads to poor public policy. Across Canada, across the world, economists have conveniently assumed that natural capital was either infinite or unnecessary.

Economists are slowly waking to the dangers of giving society such misleading signals. Efforts to adjust indicators of economic performance such as GNP to take the consumption of natural capital into account are underway in many countries and at the United Nations. However, reform lags far behind the need.

In BC, we will read of more mill closures, layoffs, and conflicts over logging. We could have avoided this crisis by heeding some advice given almost a half-century ago.

In 1954, the Royal Commission on Dominion-Provincial Relations issued a warning that BC accounting policies were flawed in a way that created an unrealistic sense of prosperity: "Services and a standard of living established and financed by treating capital depletion as current income will be subject to extreme pressures as the first wave of exploitation passes."

BC government and economists ignored this elementary rule of sound economics. The first wave of exploitation is now coming to a close.

Ironically, those who now advocate an ecosystem-based approach and a reduction in the rate at which forests are logged are accused of threatening government finances and BC's standard of living. Their call to live within our ecological limits, and hence their call to maintain natural capital, should instead be welcomed, especially given the current conservative climate.

Reducing the cut and certifying the province's forests under an environmentally and socially credible scheme makes eminent sense as a way of both strengthening the forest industry and putting the province's finances in order. The temporary economic hardships that moving to certification will imply are not as severe as industry and government would like the public to believe.

This is not to deny that there are many hurdles to be faced by ecocertification. There are competing certification schemes, many intended to hide brown companies and practices under a green carpet. It is not yet certain that consumers will insist on certified wood, and the commitment of buyers has yet to be seriously tested. With demand for certified wood currently exceeding supply, there is pressure to dumb down standards.

At present, however, the certification movement seems to be the best game in town. Government has been captured by industry and by its own flawed economic measures and is unable and uninterested in implementing any meaningful reforms.

While the actions of Home Depot, Ikea, and Lowe's were hardly motivated by a desire to improve BC's long-term economic performance, their decision to demand certified wood is a crucial first step in that direction. BC's forest companies, workers, communities and the public-at-large would do well to embrace this opportunity. Cooking the books by ignoring the depletion of natural capital cannot hide the underlying problems forever.

Tom Green is an ecological economist residing in Nelson, who is currently a member of the FSC BC Regional Initiative Standards Team. The views expressed in this article are entirely his own and do not in any way represent the position of FSC. For more details on accounting for natural capital in the BC forest sector, see his article, Confusing Liquidation with Income in British Columbia’s Forests: economic analysis and the BC forest industry, Ecological Economics. 34(1), pp 33-46 (July 2000).

This article first appeared in the Winter 2000 edition of Ecoforestry, the quarterly of the Ecoforestry Institute, based in Victoria, BC. www.ecoforestry.ca.

Cited in Adams, R 1992. "The accounting profession." Chapter 4 in Green reporting: accountancy and the challenge of the nineties. Owen, D. Editor. Chapman and Hall, London, p85.

See Cutting For The Economy’s Sake: Setting Timber Harvest Levels That Are Good For BC’s Economy Working Paper prepared for the Sierra Club of BC (2000), 150pp.