In an accounting framework, there are two ways to handle environmental improvement or degradation that is tied to market production. One can think of pollution created by a firm in the course of its production of goods as a negatively valued output—the firm is producing goods, but it is also producing harmful emissions. Also, one can think of pollution-related environmental damage as a cost of production—to produce, the firm needs workers, equipment, and the environment for waste disposal. In either case, pollution can in many cases be quantified in terms of particulate levels or other physical units. It should be noted that pollution damage and the input of waste disposal services are not alternative measures of exactly the same thing: pollution associated with production. In fact, they are usually unequal in dollar terms and, indeed, waste disposal values can be quite high even when pollution damage is near zero (the reverse is also possible). For this reason, environmental accounting systems should keep these concepts distinct. Valuing degradation as it affects nonmarket outputs (e.g., health and recreation) is difficult because the link between pollution and health is not well understood and because valuing health increments is controversial, though the development of such valuations is a clear goal. Ideally, methods for valuing changes in output associated with changes in the quality of the environment would parallel those developed in the other nonmarket accounts.
Formal accounting systems, such as the System of National Accounts (SNA) or the NIPAs, provide a useful way of viewing the interactions between the inputs and outputs that characterize the modern economy. Indeed, one definition of a formal accounting system is that it is a summary of a process—a relationship that transforms inputs into outputs. Ideally, the accounting structures proposed and described in this report would contain information that would help researchers better understand underlying production functions for areas of nonmarket activity.
A principal weakness of conventional accounting systems is that they ignore those inputs and outputs that do not trade in ordinary markets. In other words, they misspecify the economy’s “true” production function. Nonmarket accounting can be viewed as an effort to correct this misspecification. Concerns with the particular failure to measure nonmarketed environmental inputs and outputs has a history that parallels the concern with the failure of conventional economic output measures to reflect deteriorating environmental quality.4
There is widespread agreement that the conventional accounting systems, in spite of their neglect of environmental factors, have served their users well. Thus,