In 2024, the Global Footprint Network estimated that “humans use as much ecological resources as if we lived on 1.7 Earths.” This significant overuse of resources clearly shows how the global economy has developed at the expense of continuous environmental degradation. The 2021 Dasgupta Review, a comprehensive report on the economics of biodiversity, indicated that between 1992 and 2014, human capital per person, including labor, skills, and knowledge, increased by around 13%, and produced capital per person such as roads, buildings, and factories doubled. However, natural capital per person, defined as “the stock of renewable and non-renewable natural assets that yield a flow of benefits to people,” fell by 40%.

Why Incorporating Nature's Value in Economic Decisions is Crucial

As we face the challenges posed by climate change and the loss of biodiversity, there is an increasing need to incorporate environmental considerations into economic decision-making. This explainer delves into why financial markets struggle to incorporate the value of nature and the potential solutions that have been proposed.

Challenges in Incorporating Nature's Value

Environmental degradation stems from what economists call the externality problem. This occurs when individuals directly involved in a transaction fail to account for the indirect costs borne by society. For example, a landowner cutting down a forest may not consider its role in absorbing greenhouse gases. Quantifying the value of clean air or unpolluted rivers using traditional economic metrics is also difficult in the absence of a formal market. As a result, humanity has treated nature's services as if they were free, without considering the depletion of these resources.Addressing externalities involves incorporating societal costs into the price of goods and services. Ideally, we would estimate and price the carbon emitted during production, the loss of biodiversity caused by water pollution, and the depletion of oxygen from deforestation. However, valuing other environmental externalities is more complex, such as assigning a monetary value to biodiversity loss.

Examples of Incorporating Nature into Financial Markets

Despite the difficulties in assigning a monetary value to environmental externalities and ecosystem services, financial markets can offer tools and mechanisms to address these challenges.Sustainable Investments: Sustainable investments aim to generate financial returns while promoting environmental or social value. These investments range from green bonds to ESG-focused exchange-traded funds. Recent studies show that demand for ESG investments has increased, but there are concerns about the effectiveness and transparency of ESG labels. Some studies suggest that sustainable investment strategies may not always lead to the expected environmental benefits.Credits: Environmental credits allow purchasers to support specific environmental actions indirectly. The carbon credit market is well-established, but other nature-related credits, such as biodiversity credits, face challenges in ensuring that revenues are used for their intended goals and in accurately measuring environmental impact.Nature Preserving Companies: These companies purchase or lease land and manage it to generate ecosystem services. They aim to generate economic returns while protecting the environment. However, integrating the value of nature into these companies is challenging due to issues such as ensuring transparency and rigorous oversight.

Challenges and Opportunities

Nature-preserving companies face several challenges, including attracting investors while preserving the natural environment. They need to find a balance between generating economic returns and protecting biodiversity. Additionally, the lack of standardized metrics for biodiversity makes it difficult for investors to evaluate the true impact of their investments.Despite these challenges, nature-preserving companies hold great potential. By attracting private capital into conservation efforts, they can help bridge the funding gap to prevent biodiversity loss. With proper safeguards and transparent operations, these companies can make a meaningful contribution to environmental preservation while offering investors the prospect of long-term returns.

Conclusion

Valuing nature within financial markets is a complex task that requires innovative approaches and careful considerations. While sustainable investment and nature-preserving companies show some promise, significant challenges remain. By addressing these challenges, we can create financial institutions that support economic development while promoting environmental sustainability.