In Focus

Measuring economic progress and prosperity - thoughts on 4 capitals

Sunday March 25, 2018 Dr Ganesh Nana

“The best economic managers”, I hear one party say.  Countered, almost immediately, by the other party with “nine surpluses in a row and paid debt down to zero”.

 

Then, usually, there is the line, “but we had the GFC and earthquakes and still got eight years of uninterrupted growth”.

 

However, neither party will likely mention increasing private sector debt and stratospheric house prices; and will also overlook our miserable productivity story.  And this sorry story occurs despite the windfall gains reaped by both parties from historically high terms of trade along with the sheer luck of coat-tailing on China’s insatiable appetite.

 

On balance, either party’s claims to economic management credentials are thin, at best.

So how can we get past the above selective choice of indicators and reach a balanced picture of the state of a nation’s economy? And get a clearer indication of the economic management prowess (or otherwise) of its government?

 

In this context, I am more than heartened by the new government’s move to adopt Treasury’s development of a ‘Living Standards Framework’ or ‘4 capitals approach’ in establishing benchmarks for its Budget and policy proposals.  This potentially provides a more transparent and conclusive framework for assessing prosperity and the government’s contribution to that.

 

The headline description of the 4 capitals as targeting ‘intergenerational wellbeing’ is also appropriately challenging.  Placing intergenerational wellbeing at the centre of decision-making will be a welcome and refreshing change from the narrow ‘how much will it cost?; will it add to GDP?; what is the BCR? or the RoI? where is the business case? mantra of recent years.

 

For those in business, ask yourself what’s more important: P&L indicators of costs and revenues or Balance Sheet measures of assets?  Or, the household equivalent: should I be more concerned about the state of this month’s credit card bill, or that the roof on the house is in a critical state of disrepair?

 

The most heartening aspect of the 4 capitals approach is that it puts the state of long-term assets at the forefront of decisions.  This year’s surplus, income, GDP, or dividend return to shareholders, can all easily be manipulated for short-term gain.  However, the health of assets that are required for tomorrow are now signalled as at the apex of decision-makers performance measures.

 

We have long known that GDP is a poor proxy for economic health or performance.  Damage to productive assets along with distribution/equity factors being ignored are but a couple of shortcomings.  So, moving away from a focus on this year’s GDP towards the assets required for tomorrow is to be welcomed.  In short, the Balance Sheet is just as (if not more) important than that P&L.

 

Unfortunately, when we have turned our attention to the Balance Sheet in recent times it has invariably been with an eagle-eye on the debt position.  The 4 capitals approach encourages a peek over the other side of the Balance Sheet as well – i.e. assets.

 

Even more promising is the view of assets across several dimensions, rather than a narrow financial perspective.  The Treasury framework proposes the 4 capitals as: financial/physical capital; human capital; natural capital; and social capital.  I’m sure we could argue the definitions for each category, and whether something should have its own category (e.g. cultural capital).  However, the principle is more than encouraging.  It conveys the importance of a multi-dimensional perspective, including individual as well as community dimensions.

 

In particular, including social capital reinforces the view that our progress and prosperity are inherently linked (or woven) together.  If the rule of law has little status, then the ability of the economy to engage in contracts and trade is severely undermined.  If institutions (businesses, government authorities, organisations, service providers) are not trusted to adhere to social norms and rules of behaviour, then the connections between people and communities will be eroded.  Respect for te Tiriti adds to connections and the underpinning rules of community.  In contrast, a lack of connections and/or the exclusion of certain groups, economic endeavour becomes increasingly transactional requiring more resources to be devoted to welfare safety nets.

 

It is perhaps blindingly obvious to many non-economists that well-functioning communities, with strong connected networks, accepting diverse cultural identity are positive for business and economic outcomes.  It is heartening indeed that economists are not only beginning to recognise these facets, but that we are now considering these in measures of progress and prosperity.

 

Of course, none of this will overcome the political dimension.  However, the beauty of a 4 capitals approach is that all parties will be forced to explain why they think budget surpluses, alongside increasing human, natural and social deficits, are indicative of good economic management.

 

BERL Chief Economist talks to Herald Business Editor at Large Liam Dann about Treasury’s Living Standards Framework ‘4 capitals’ approach and intergenerational wellbeing.

 

Please read the full article here: http://www.nzherald.co.nz/business/news/article.cfm?c_id=3&objectid=12018043