Why Australia’s best-known economist says we need to be valuing natural capital on our farms

October 6, 2021

If you were to ask Dr. Ken Henry, Australian economist and former Treasury Secretary, what his most important work from 2008 was, you’d be surprised to hear that it had nothing to do with the Global Financial Crisis.

When Lehman Brothers in the US collapsed and it became clear the GFC was unfolding, Ken Henry had just returned from a five-week break in central Queensland where he and his wife had been rescuing and rehabilitating injured wildlife.

Ken Henry will go down in history as critical to Australia’s response to the GFC, moving quickly to “go early, go hard, and go households,” by recommending stimulus packages to prevent the nation from slipping into a recession.

But while Ken Henry is undoubtedly proud of the response to the GFC, his career highlight that year was the time he spent as a caretaker at the Epping Forest National Park, which was, at the time, home to the last remaining colony of the Northern Hairy Nosed Wombat.

To some, it seemed incongruous that the most senior economic policy advisor in the country would be in a remote area, looking after wildlife (and he received some public criticism for it too). But to Ken Henry, his deep passion for conservation and economics have always aligned.

“It was a rather peculiar year, 2008, but I still consider the most rewarding thing I did that year was caretaking.”

Economics 101 has always valued nature — we’ve just been largely ignoring it

Far from being a coincidence that these two worlds are connected for Ken, it is significantly because of the connection between economics and the environment that Ken chose to pursue a career in economic policymaking.

“I’m pretty sure it’s got something to do with the fact that eventually, I ended up Secretary of Treasury. And in that job, I took very seriously the obligations of policy advisors to ensure that governments were aware of the environmental consequences of decisions that they were taking.”

Ken related an early childhood story of a conversation with his father, a timber worker in the NSW state forestry system, which left him questioning the positive and negative connections between economics and the environment. He noted that there was no real consequence of significant damage to the natural environment when logging activity was only focussed on the direct commercial outcomes.

As a lecturer in economics, Ken would go on to educate students about the concept of negative externalities. That is, that environmental degradation often occurs because there is no requirement for the true cost of that degradation to be factored into commercial decision-making — textbook negative externality.

In the past, there hasn’t always been a willingness to look closely at this connection, and appreciate how commercial activity and policy settings can catalyze such negative consequences. However, Dr. Henry believes things are moving in a different direction now.

“Increasingly people are coming to the realization that far from being a trade-off between the two things, there’s a core dependency of development upon conservation.”

A Natural Connection to Farming

It’s harder to ignore the economics of nature in agriculture. When it comes to agriculture, the linkages between production and the natural environment are more apparent. Farming relies directly on natural resources to support production. With climate change and increasing societal expectations, it’s perhaps the central issue of our times that this reliance is under unprecedented pressure.

Economics comes to the fore again. Firstly, many farmers already protect the environmental condition of their land. In fact, there can’t be intergenerational wealth and succession without paying equal attention to the economic and environmental health of the farm.

Despite the fact that there are already reasons to focus on natural capital, Ken is also predicting significant growth in tools to measure soil carbon, vegetation, and biodiversity. He says it’s only logical that farmers should be seeking out these new opportunities. “I think the next year or so we could see an absolute explosion in the development of financial instruments that reward farmers for soil carbon for other forms of terrestrial carbon, also for enhancement of environmental conditions,” Dr. Henry said.

The Need for Incentives

Ken is no stranger to policy incentives intended to drive major societal shifts. Back in 2004, Dr. Henry recommended the implementation of an emissions trading scheme to help thwart climate change. His advice was ignored at the time. Seventeen years ago, views about the need for climate action were very different, at least in Australian political discourse. Subsequent government attempts to establish the Carbon Pollution Reduction Scheme (CPRS) were ill-fated, but recently the momentum has shifted. In Australia today, we have the Emissions Reduction Fund (ERF) which provides direct incentives for farmers to reduce emissions and sequester atmospheric carbon in vegetation and soil.

Importantly, this provides the opportunity for farmers to create new economic opportunities by trading in new commodities (carbon and biodiversity credits, for example) with new business partners.

“It’s a completely new opportunity … that agricultural enterprises can have a commercial relationship with other businesses that have absolutely nothing to do with agriculture.

And the relationship is developed because of a common interest in emissions reduction. And by the way, it’s not just the potential to sell these intangible products to other Australian businesses, there’s a potential to sell them globally.”

Another big change from 2004 is the role technology is playing in allowing these new opportunities to be accessible to a wider audience and at a more reasonable cost, without a compromise on scientific integrity. Technology, in fact, has come so far that it presents both challenges and opportunities. Ken observed that he sometimes wonders about others observing his farm from afar and that this can be done with great accuracy and at a low cost. While acknowledging that this can be confronting, he concludes that we should take this opportunity to be open, transparent, and proud. And it’s this transparency that will better link farmers to the growing number of consumers who want proof that their food has been produced sustainably.

Why we should be welcoming a sustainability-linked farming future

Ken is very hopeful about the future of farming and the opportunities to participate in the global market for natural capital incentives. He also notes that the attitude of Australia’s Federal Government is very positive in regards to agriculture’s role in providing climate and sustainability solutions, including soil carbon, as outlined in the National Soil Carbon Initiative

Ken has also seen firsthand the increased focus on natural capital in farming coming from Australia’s big four banks. As the former Chair of the National Australia Bank, he said the approach to natural capital is mainly based on assisting bank managers in credit-decision making, “that is, to develop metrics that could be used as inputs into the pricing of loans.”

One of the keys to these types of initiatives will be the emergence of quantitative systems for the measurement of the state of natural capital. This is the main focus for Accounting for Nature (AfN), an organization set up specifically to solve this challenge and where Ken Henry currently sits on the board. The systems being developed by AfN will provide the hard data needed by the financial services industry to get these sustainability-linked products into the market

While some farmers may fear being financially penalized by bank managers, there is evidence of the financial sector looking more towards rewards and incentives for improvements in environmental conditions. We are already seeing the emergence of specialized financial products that will see farmers directly recognized for great land stewardship with improved loan conditions and favorable reductions in costs.

Ultimately, this is perhaps the most tangible way to accelerate the involvement of Australia’s farmers in valuing natural capital. And for Ken Henry, it’s an example of those negative externalities in economics, not just being accounted for, but being flipped on their head entirely. The result being, on-farm environmental improvements not just having second-order economic value (linked to improved yields or amenity), but being a directly measured, financial value in its own right.

For more insights on natural capital, check out the full interview with Dr. Ken Henry on Agtech…So What? or subscribe to our bi-weekly newsletter here.