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«ENVIRONMENT AND DEVELOPMENT The Changing Wealth of Nations ENVIRONMENT AND DEVELOPMENT A fundamental element of sustainable development is ...»

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Decomposition: A Note on the Methodology Annex 3.1 explains the application of the decomposition methodology, so a few brief observations will suffice here. We may think of the value of an asset as being determined by a combination of three factors: (a) the unit rent it generates over time, (b) the quantity of the resource it is possible to extract in any given period, and (c) the length of time over which the resource is expected to be available.

For simplicity, let us assume the three terms are combined with each other in a

multiplicative manner:4

–  –  –

Assume we wish to decompose changes in the asset value (V) between period 1 and period 2. We are interested in the relative importance of each factor in the

right-hand side of equation (3.1):

–  –  –

Imagine for the moment that the only thing that changes between period 1

and period 2 is the unit rent the resource generates. In this case the decomposition is very simple, since the Q effect and the T effect are zero:

–  –  –

Notice that the higher the change in unit rents and the higher the initial values of Q and T, the higher will be the R effect. The same logic can be applied to the case in which production quantity and exhaustion time change one at a time.

Let us now assume both unit rents and quantity change. The decomposition will have two positive terms, the R effect and the Q effect (the T effect will be zero),

and a residual term:

V2 V1 (R2 R1)Q1T1 (Q2 Q1)R1T1 0 (Q2 Q1) (R2 R1) T1. (3.4) The residual term in the right-hand side of equation (3.4) serves to balance the equation. Provided price and quantities do not change too much, the fourth term will be negligible compared to the other effects and can be ignored. The important issue here is that the decomposition works by looking at changes in each factor separately, holding everything else constant, and then adding up the various effects. It allows us to separate the effects of price changes from the effects of physical quantity changes. We turn now to the analysis of the numbers.

Contribution of Land and Subsoil Assets to Changes in Wealth Changes in natural capital often account for a large part of the variation in total wealth over time (see annex 3.2 and chapter 2). For example, between 1995 and 2005, changes in natural capital accounted for 56 percent of the change in total wealth in the Middle East and North Africa and for 46 percent of the change in high-income oil exporters. Other regions have suffered declines in natural capital values, notably Sub-Saharan Africa, where the decline amounted to 15 percent of the change in total wealth. In some regions, changes in natural capital have a negligible effect, such as in the OECD countries. In others, such as South Asia and Europe and Central Asia, values for different natural assets have changed with opposite signs, offsetting each other’s effects.

In developing countries, increases in subsoil asset values have driven most of the growth in natural capital. Land values, on the other hand, have had a relatively small effect (figure 3.1). This is somewhat surprising given that land accounts for a large share of total wealth in many low- and middle-income countries. We can shed light on this issue by disentangling the effects of changes in unit rent, or price, and changes in physical quantity, such as yields and production area. Figure 3.2 shows that in developing countries, productionside variables such as area and yield have increased by an amount equal to 7 percent of the change in total wealth, while price declines have amounted to 5 percent of the change. The detailed data in annex 3.2 show that yields for all crops have increased throughout the developing world. This can be observed across income groups and regions.

54 THE CHANGING WEALTH OF NATIONS

FIGURE 3.1 Decomposition of Changes in Natural Capital by Asset and Income Group, 1995–2005

–  –  –

Source: Authors’ calculations.

Note: Europe and Central Asia countries are excluded.

FIGURE 3.2 Decomposition of Changes in Natural Capital by Factor in Developing Countries, 1995–2005

–  –  –

Source: Authors’ calculations.

Note: Europe and Central Asia countries are excluded.

The story of subsoil assets is qualitatively different from that of land values:

price and quantity changes have both been positive. However, as can be seen in figure 3.4, changes in unit rents account for the majority of the growth in subsoil asset values in both developed and developing countries.

CHANGES IN NATURAL CAPITAL: DECOMPOSING PRICE AND QUANTITY EFFECTS 55

The different regions in the developing world have distinctive natural resource endowments. It is useful, therefore, when decomposing changes in natural capital to summarize the changes by region.

Sub-Saharan Africa and South Asia In Sub-Saharan Africa and South Asia, declining land values are only partly offset by increases in subsoil asset values. Drops in land values amounted to 25 percent of the change in total wealth in Sub-Saharan Africa.5 These declines diminish in absolute value but keep the same sign if we exclude Nigeria and South Africa (see annex 3.3). In South Africa, the decline in land values amounted to 29 percent of the change in total wealth. In Nigeria the effect is even greater ( 170 percent).

The decomposition analysis shows that a sharp decline in unit rents drove the drop in value of land assets in Sub-Saharan Africa (figure 3.3). The fall in crop prices contributed 17 percent and was not offset by the relatively modest increases in area under cultivation (+4 percent) and yields (+5 percent). It is important to note that the effect is mostly explained by drops in real prices rather than in nominal prices. Nominal prices have not shown substantial changes between FIGURE 3.3 Decomposition of Changes in Land Values by Region, 1995–2005 % change in land values

–  –  –

Source: Authors’ calculations.

Note: Values for Europe and Central Asia refer to the change between 2000 and 2005.

56 THE CHANGING WEALTH OF NATIONS

1995 and 2005, but once they are adjusted for inflation, the value of most crops goes down substantially. Also in Sub-Saharan Africa, pasture price drops have contributed 23 percent to the change in total wealth. The results do not change qualitatively if one excludes Nigeria and South Africa from the sample (see annex 3.3). Most of the effect is due to changes in real prices, but prices for pasture land products have also declined substantially in nominal terms.

In South Asia, drops in crop prices have contributed 8 percent to the change in total wealth, and drops in pasture product prices have contributed 11 percent. Inflation played an important role here as well. Price drops have been just barely offset by increases in cultivated crop area (+1 percent), yields (+2 percent), and pasture production (+7 percent).

While land values declined, subsoil asset values in Sub-Saharan Africa and South Asia increased between 1995 and 2005 (figure 3.4). In Sub-Saharan Africa, subsoil assets contributed 17 percent to the growth in total wealth, and the effect remains substantial even after Nigeria is excluded from the sample. This has partially offset the slump in agricultural land values. The increase in subsoil assets has been driven partly by unit rents and partly by production increases.

FIGURE 3.4 Decomposition of Changes in Subsoil Asset Values by Region, 1995–2005 % change in subsoil asset values

–  –  –

Source: Authors’ calculations.

Note: Values for Europe and Central Asia refer to the change between 2000 and 2005.

CHANGES IN NATURAL CAPITAL: DECOMPOSING PRICE AND QUANTITY EFFECTS 57

Increases in oil prices have contributed 5 percent to total wealth growth in the region, while increases in oil production have contributed 6 percent. Natural gas prices have contributed 1 percent, and increases in gas production 2 percent.

Across all subsoil assets, price increases accounted for 45 percent of increases in value. That figure goes up to 53 percent if one excludes Nigeria from the sample. Nigeria stands out from other major oil producers in that it increased production at a much faster pace, and prices only accounted for 34 percent of the rise in subsoil asset values.

In South Asia, increases in subsoil asset values and timber values have also helped offset part of the agricultural land declines. This has been driven mainly by unit rent increases, particularly for oil, natural gas, and timber, and to a lesser extent by increases in production of natural gas, coal, and minerals.

Europe and Central Asia In Europe and Central Asia, changes in natural capital show features that are broadly similar to those in South Asia and Sub-Saharan Africa. But there are some differences. For this reason, and because our dataset only allows us to estimate changes for the period 2000–2005 in this region, we keep the discussion of Europe and Central Asia separate.

Natural capital’s contribution to changes in wealth appears to be modest ( 4 percent), but this is because land values and subsoil asset values are moving in opposite directions. In fact, the value of land assets and forest assets has declined substantially over the period between 2000 and 2005, while the value of subsoil assets has increased in the same period by a similar order of magnitude (annex 3.2).

The data on change in land value show that there has been a consistent drop in unit rents for cereals, fruits, vegetables, sugar crops, and other crops (including roots, pulses, and oil crops). At the aggregate level, unit rent declines accounted for 116 percent of the decline in crop land values. This has been partially offset by increases in yields, particularly for cereals and vegetables (+1 percent). Pasture product prices have also declined, causing a drop in pasture land values. Unit rent declines in agriculture substantially affect our estimates of protected areas, which are conservatively valued using a quasi–opportunity cost. The estimates show a negative contribution of 10 percent. Forest land values also declined, driven by a drop in both the unit rents for timber and the value of nontimber forest products.

In this region the increase in subsoil asset value completely offset the decline in agricultural land values. The change is largely driven by the increase in oil and gas unit rents, which cumulatively account for 70 percent of the change in subsoil assets. Increases in oil and gas production account for 26 percent and are only marginally offset by a decline in the exhaustion time of oil reserves.

58 THE CHANGING WEALTH OF NATIONS

Middle East and North Africa Subsoil asset value increases between 1995 and 2005 have driven 50 percent of total wealth growth in the Middle East and North Africa. They explained 46 percent of wealth growth in high-income non-OECD countries. A common feature of oil exporters in the Middle East and North Africa and in the non-OECD group is that mostly unit rent increases—and not production increases — explain the growth in natural capital. Production increases accounted for only 27–28 percent of total increase in subsoil asset values. In the Middle East and North Africa, production only contributed 6 percent to the increase in oil wealth.

In high-income non-OECD countries, production contributed 20 percent to the increase in oil wealth. In the case of natural gas, the relative contribution of unit rents and production increases has been more even.

As seen in annex 3.3, the values for the Middle East and North Africa are determined by a few countries, namely Algeria, the Arab Republic of Egypt, the Islamic Republic of Iran, and the Syrian Arab Republic. In the Islamic Republic of Iran, production has only contributed 10 percent to the increase in oil wealth; unit rent increases contributed the other 90 percent. In Syria, production of oil declined and the increase in exhaustion time and unit rents each contributed nearly 50 percent to the oil wealth increase. Algeria is the country in the group with the largest increases in oil production, accounting for 51 percent of growth in oil wealth.

The decomposition analysis shows that the Middle East and North Africa and the group of high-income oil exporters have been investing in produced capital and accumulating financial assets. On the other hand, the numbers show a very small growth in intangible capital, which contributed only 9 percent of total wealth growth in the Middle East and North Africa and 10 percent in high-income non-OECD countries. This fact is consistent with the idea that high resource dependence, while making it possible to boost infrastructure and financial assets, may hinder the process of institution building and human capital creation that is the basis of income growth in the long term.

Latin America and the Caribbean and East Asia and the Pacific Between 1995 and 2005, natural capital contributed 17 percent of total wealth growth in Latin America and the Caribbean and 15 percent in East Asia and the Pacific. In both regions, agricultural land, forest land, and subsoil assets all grew in value over the period.

Agricultural land has been gaining importance, thanks in particular to production increases. It contributed 4 percent of total wealth growth in Latin America and the Caribbean and 7 percent in East Asia and the Pacific. Changes in production area and yields have been positive and have more than offset the decline in crop and pasture prices that we observed globally. In Latin America and the Caribbean, increased crop land area and yields each contributed 2 percent to growth in total

CHANGES IN NATURAL CAPITAL: DECOMPOSING PRICE AND QUANTITY EFFECTS 59

wealth, and pasture production increases contributed 1 percent. In East Asia and the Pacific, increases in area under crops contributed 5 percent to growth in total wealth, yield increases contributed 3 percent, and pasture production contributed 2 percent.

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