Biodiversity loss entails business risks

It is not an accident that Earth’s densest concentration of biodiversity is in the tropics and that most of the world’s poorest people live there. Rich countries are net importers and poor countries are net exporters of primary products, the extraction of which (from mines, plantations, wetlands, coastal waters, and forests) has adverse consequences for local inhabitants. For example, shrimp farms may be a useful source of export revenue, but they contaminate neighboring water bodies, thereby lowering their economic productivity. Shrimp farms thus inflict an adverse externality on neighboring ecosystems. The externality is detectable in the biodiversity loss that precipitates the decline in the productivity of neighboring ecosystems.¹

According to estimates, among net exporting countries of primary products, 35% of domestically recorded species threats on average are linked to the production for exports. In Madagascar, Papua New Guinea, Sri Lanka, and Honduras the proportion is as high as 50-60%. In contrast, among net importers of primary products, some 45% of their biodiversity footprint is linked to imports. That tells us GDP growth among net importing countries is at least in part enjoyed at the expense of some other country’s natural resource base. Today’s net importers have for the most part outsourced their needs for primary products. The United Kingdom, for example, has little biodiversity left, but that does not affect its GDP growth; the accompanying losses of biodiversity are felt elsewhere.

The adverse externalities associated with the extraction of primary products are not reflected in their export prices, which means local ecosystems are overexploited. That amounts to a transfer of wealth from the exporting country to the importing country, from a most likely poor to a most likely rich country. Common perceptions on the benefits of free trade assume that all goods and services have perfectly competitive markets. But rarely, if ever, do markets meet this condition in practice. The economics of biodiversity is necessarily built for this world, where markets neglect to account for many of nature’s goods and services. The assumptions underpinning free trade ideas are therefore not applicable here.

The presence of adverse ecological externalities within regions dependent on the export of primary products leads to the question of whether these countries should collectively impose export taxes on such products. Individually, exporting countries would not have the incentive to do so as the early mover would lose out to those who don’t impose such export taxes. But collectively they might gain. The taxes would reflect adverse local externalities associated with the export of primary products. Their imposition would ease pressure on local ecosystems and be a source of income. This is not generally appreciated.

The World Trade Promotion Organizations’ 2022 conference in Accra was aimed at finding ways to raise GDP in African countries while encouraging companies to move toward sustainable policies. However, the event fielded no quantitative models with which to ask whether GDP can be raised even while protecting the region’s ecosystems, nor whether western companies would demand ecologically sustainable primary products in the absence of export taxes.

Although exports of primary products involve wealth transfers from exporting to importing countries, they are not an unalloyed benefit to importing countries. The transfers carry risks arising from an increased unreliability of supply chains for importing companies. If the source of a primary product—say, an ecosystem upstream in a company’s supply chain—were to deteriorate, the ecosystem’s worth to the company would decline. That decline, measured in terms of the added risks to the importing firm’s profits, would be a loss to the firm. Firms need to translate ecological risks into business risks. The latter risks are embedded in the true price of primary products to importing firms.

Conventional insurance against such risks in the marketplace is not a viable option. In addition to the existing moral hazard and adverse selection that pervade long supply chains, the risks rival importing companies face are positively correlated: if a wetland in the exporting country is damaged, pollination suffers in neighboring farms. What is needed are incentives for importing firms to protect ecosystems that are upstream in their supply chains. Investment in nature is a viable form of insurance.

There are companies that believe maintaining the integrity of ecosystems in their supply chains is sound business practice, if for no other reason than that it would enhance their reputation among investors and consumers. A company unilaterally moving toward ecological stewardship faces additional risks should consumers not be ecologically minded: first movers do not necessarily have an advantage. There have, however, been examples where companies have enjoyed early-move advantages by declaring their trade practices to be fair. It is hard to generalize from these experiences. How strongly investors and consumers feel about ethical practices matters.

One way out of their dilemma is for companies to collectively disclose nature-related conditions in their supply chains. The toolkit to do so is maturing, but it contains enough kit to do so today.² This would be akin to food product disclosures in response to the demands of health-conscious consumers. Disclosure serves to reduce an adverse selection problem and is thus a substitute for missing markets. A similar argument holds for disclosure of the conditions along supply chains. Once again, problems besetting collective action among importing companies rears its head. One possibility would be for governments to make disclosure mandatory.

Short-sightedness has guided our economic thinking for too long. The economics of biodiversity tells us that the narrative needs to change. Companies, governments, and civil society have a common cause to stem biodiversity loss. They can only do that by informed cooperation.

The author its grateful for input from Mike Ryan, William Nicolle, Jackie Bauer.

¹See The Economics of Biodiversity: The Dasgupta Review (London: HM Treasury), 2021, online, for a review of the connection between the biodiversity and ecosystem productivity. This brief is based on it.
²UBS Sustainability and Impact Institute (2023), Taking Root: Mainstreaming natural capital accounting to meet global biodiversity goals.

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