Social and natural capital is the wealth all around us and we should invest in it

Photo: IB Wira Dyatmika on Unsplash

Dimitri Zenghelis explores the fundamental concept of social capital, a key means of creating societal trust, and explains the necessity of investing in social capital for climate change and environmental policies to be successful

Decarbonising our economy and getting more out of the resources we have, as well as coping with rapid technological change, will require a systemic transformation in the activities and behaviours that have shaped society since the Industrial Revolution. Yet the main barriers to such a transformation are not economic or technological: they are institutional, behavioural and political.

Without a common understanding of the risks, challenges and opportunities associated with systemic change, ill-will, distrust and suspicion risk undermining the effectiveness of public policy. Developing a political consensus for decarbonisation and environmental sustainability requires a degree of trust in fellow citizens and the institutions designed to serve our best interests and protect us from threats. Collective action is facilitated through the inhibiting short-term seemingly self-interested behaviour in favour of encouraging a longer term cycle of trust and reciprocity. The latter is self-reinforcing because it generates greater opportunities which encourage further cooperation. This requires investment in social capital.

What is social capital, how is it wealth and why does it matter?

Wealth is our best measure of prosperity. It captures a stream of benefits into the indefinite future, not just today’s income. Because it captures the future, it captures sustainability. These future benefits include the consumption of goods and services, of course. But they also accrue from living in a trusting, politically stable and fair society with a stable climate and a sustainable environment. People are evidently willing to forgo current economic goods to secure the latter, so it is appropriate to consider these intangible social and natural assets as part of our wealth.

But what exactly is this social capital and how important is it for sustainability and prosperity?

Social capital encompasses personal relationships, civic engagements and social networks, as well as the social norms and values that shape acceptable behaviour. Social capital is a resource for individuals, whereby people access support and opportunities, but it is also a public resource for society in general. The shared norms and rules enable cooperation and reduce the costliness of economic exchange by building trust.

As a result, social capital is often referred to as the glue that holds societies together. Without it, there can be little or no economic growth or human wellbeing. This notion has strong intuitive appeal, but social capital has proven hard to pin down, not least because it encompasses so many interrelated elements. Most of these elements relate closely to generalised trust across a society and the functionality of key institutions. Generalised trust enables social and economic cooperation. Some argue that social capital can therefore be best understood as a means to creating trust.

From social capital to ‘true wealth’ – including healthy natural capital

A key channel from social capital to economic and environmental outcomes is reduced transaction and monitoring costs, allowing the efficient allocation of resources in goods, labour and capital markets. Society wastes resources when people distrust and are dishonest with each other. The economic literature on repeated games and punishment shows why cooperation makes social sense when people expect to interact in the future. Yet people are surprisingly cooperative over and above what theory suggests is in their immediate self-interest. This probably reflects the fact that we gain direct utility from living in a trustworthy society; perhaps for evolutionary reasons, social connectedness brings most humans intrinsic pleasure.

The World Bank has begun to measure the ‘true wealth’ of nations, taking into account economic and natural capital, as well as ‘intangible’ productive capital. The latter is regarded as consisting primarily of human, social and institutional capital. The Bank estimates that intangible capital may make up between 60 and 80 per cent of total wealth in most developed countries. Further studies show that much of this is social capital.

Some growth is derived by depleting other forms of capital. This is why natural capital is so important to measure. Natural capital, which includes the water, air, soil, geology, and living things that provide us with the basic – though at times complex – building blocks of all other forms of capital, is more than just a ‘feel-good’ issue. Dieter Helm, Independent Chair of the UK Natural Capital Committee, claims economic growth in the 20th century was spectacular, yet it was – and continues to be – fuelled by a massive free ride on the environment. Whereas human, physical and knowledge capital may be growing, natural capital generally is not, with grave prospects for wellbeing.

Robust social capital based on trust, civic engagement and effective institutions goes hand-in-hand with sustainable economic wellbeing. One influential study found that a moderate increase in a survey-based measure of country-level trust significantly increases economic growth (not just the level of activity). Workers in poor countries turn out to be three to five times less productive than those in the United States, taking account of the quality of machines and skill levels available for production. Yet when these same workers migrate, they quickly earn salaries comparable to those of workers in their new countries. Something unrelated to the amount of physical and human capital available seems to be holding back productivity in poor countries.

It is, of course, likely that generalised trust and the quality of governance are a result of, as well as a cause of, productivity growth and higher reported wellbeing. These feedback mechanisms mean sustained, carefully targeted policy interventions could trigger a virtuous cycle of good governance and higher productivity. Governments can and should invest in the quality of economic and political institutions.

The importance of institutions, generalised trust – and the right kind of rules

A number of studies find that the quality of institutions and economic policies explains a significant part of the variation in growth rates across countries. Others find that the quality of governance and institutions is important for explaining rates of investment. Good institutions, checks on government that limit corruption, and environments that encourage social inclusion, creativity, and enterprise tend to attract investment and benefit from learning, experience, and innovation. High levels of social capital are also associated with improved environmental outcomes by lowering the costs of collective action and increasing cooperation. This serves to reduce resource degradation and depletion and promote investment in common lands and public goods such as clean air, water and environmental protection.

The changes in governance and economic policy when Deng Xiaoping reformed Maoist mainland China, or the reforms in South Korea after Park Chung-hee replaced Syngman Rhee, offer historical examples. Even unsavoury regimes have sometimes engendered economic stability for middle-class entrepreneurs. Cross-sectional evidence also illustrates institutions exerting different economic and environmental influences on culturally similar societies: East and West Germany during the Cold War; North and South Korea; mainland China compared to Hong Kong and Taiwan. In all these cases, institutional change preceded – and appeared to cause – changes in productivity.

When Daron Acemoglu and James Robinson asked why nations fail in their bestseller of the same name, they concluded that the main determinant of economic prosperity was functioning, inclusive and law-based institutions. The centrality of institutions explains the infamous ‘resource curse’: some countries with large endowments of primary commodities fail to benefit from subsequent economic growth when politically powerful groups enrich themselves through unabated rent-seeking and corruption. Corruption causes significant dissipation of resources. In rich countries, increasing focus is being placed on the role of institutions and generalised trust in explaining growing disaffection and populism among those ‘left behind’.

Last year’s Nobel Prize winner Paul Romer pointed out that innovation that drives endogenous growth is not limited to technological capital and knowledge capital: it also applies to rules, governance, and policies, all of which drive total factor productivity. He argues that social rules often hold back the potential introduction and exploitation of new technology. Indeed, new technologies are potentially harmful if not accompanied by rules that make growth sustainable – for example, rules that limit pollution, soil degradation, and overfishing – or rules that regulate economic rent-seeking from innovation via patents or market power.

We need better statistics and information on social as well as natural capital to respond to climate change

The policy response to climate change, perhaps the most pressing social challenge of our generation, and to coping with the challenges presented by new technologies such as AI, big data and automation, requires institutions that enable the implementation of a range of policies, with winners and losers. Any policy not built on strong foundations of trust and effective institutions will fail.

This is why improving the quality of statistics and information on social capital is vital. Even partial success in developing metrics while acknowledging what is missing can better help inform policy and business decisions. The New Zealand Treasury already augments GDP with a small dashboard recording access to key assets including social and natural capital. The Bennett Institute’s Wealth Economy project aims to improve the measurement of social capital and enhance statistical research globally. The aim is to establish guidelines for standardised comparative measures. The potential returns for society are hard to overstate.

This commentary is based on ‘Social Capital – the wealth all around us’ by Dimitri Zenghelis, published by the Bennett Institute for Public Policy at Cambridge University in February 2019. The views in this commentary are those of the author and are not necessarily those of the Grantham Research Institute on Climate Change and the Environment.