Focusing on resilience should not be misunderstood as an attempt to abandon sustainability, but instead as an approach to retain or restore it when responding to shocks and threats. Sustainability is and remains the ultimate objective. The fact that we begin to examine how systems respond to shocks and threats does not lead us to give up on preventing shocks or negative events. Similarly, if a resilient system rebounds from a shock to re-establish its initial path, this is not good enough if the initial path was unsustainable. While resilience and sustainability are not inter-changeable concepts, addressing the resilience of systems is a way to build a system-level “macro-prudential” approach about how we can prevent and adapt to shocks and threats, and transform our society. The “pressure-state-response” used in environmental economics provides an early example of the systems approach (see sidebar below). A more in-depth discussion is included in the conclusion.
THE PRESSURE-STATE-RESPONSE APPROACH AS AN EXAMPLE OF THE SYSTEMS APPROACH
The original pressure-state-response (PSR) approach, developed by Statistics Canada and popularized by the OECD with reference to natural capital, was later extended to Driver-Pressure-State-Impact-Response (DPSIR), adopted by UNDP in 1997 and used in the context of Environmental Economic Accounting (EEA). The DPSIR framework (Figure 9.1) contains the different elements describing the resilience of the State of the Environment and allows the classification of data and indicators for the different elements (drivers, pressures, states, and impact). On the basis of such data, and using estimation and extrapolation techniques, the Intergovernmental Panel on Climate Change (IPCC, 2015) has estimated the planetary boundaries for climate change. The limits of a resilient ecosystem and these boundaries were again stated in COP21 (UN 21st Conference of the Parties, Paris, 2015): we should keep global temperature well below 2°C above pre-industrial levels, and at least below 1.5°C.
Figure 9.1. The Pressure-State-Response Approach
Source: European Environment Agency (1999), Environmental Indicators: Typology and Overview, Technical Report No. 25/1999, TNO Centre for Strategy, Technology and Policy, The Netherlands.
This example demonstrates that using the best available data and estimates, a scientific consensus could be reached on the planetary boundaries. Once these are set, it is possible to look at the scientific work and political actions needed to keep the system within these boundaries (see the discussion on carbon pricing in the next section).
What Is the State of Existing Capital Measures?
The capital approach builds on the notion of preserving or increasing the different stocks (capital) that drive our welfare and well-being. This “stock” approach to sustainability can either look at variations in each stock in physical terms or convert all these assets into a monetary equivalent. So the capital approach could evolve in two directions: either as a “mainstream economic approach,” determining all types of capital and monetizing them; or as an “organizing framework,” with physical indicators covering all the main assets. In the following, both interpretations are used, depending on the maturity of the data. Each type of capital is discussed separately.
Economic Capital
Progress Since 2009
During and after the global economic crisis, many of the issues raised in the Stiglitz, Sen, and Fitoussi (2009) report gained traction, while at the same time the failure to appropriately measure economic sustainability by conventional statistics became apparent. Risks and vulnerabilities built up over time in the economic system through increased debt levels, higher financial leverage (supported by more liberal finance laws and regulations), deteriorating quality of debt through higher credit default risks, price bubbles, and increased inter-connectedness across sectors and countries. This fragility went unnoticed due, partly, to the way that economic health was measured: it did not sufficiently measure risk.
During and immediately after the crisis, it was clear that many actors lacked appropriate and timely data to help them respond effectively. The G20 Data Gaps Initiative (DGI) has been an important source of progress in providing broader and more comprehensive measures of economic sustainability.2 This initiative supports government efforts to provide comparable statistics on the build-up of risks in the financial sector, cross-border financial links, vulnerability to shocks, and communication of these statistics. It emphasizes the importance of having more and better information on how the assets and liabilities of one sector match those of others, as well as on currency and maturity mismatches. The G20 DGI provides templates for collecting balance sheet data that can be compared across countries. Many countries, especially within the EU, now make quarterly data available in a timely manner. Some even provide the institutional sector accounts discussed below.
One of the lessons on economic sustainability learned since the 2007 financial crisis is that there is no firm threshold for public debt beyond which we should expect GDP growth to fall significantly, even though high levels of public debt may raise concerns about the resilience of the economic system to shocks. Even studies showing correlations between public debt and GDP growth tell us little or nothing about causality. The only real test of the sustainability of public debt is provided by the market (i.e., the ability to sell government bonds), which is itself a function of the institutional setup of different countries (such as the existence of a central bank and the ability of monetary policy to maintain low interest rates) and of the assessment of future prospects for public finances given the evolution of demographic and other factors. There is also evidence that the relation between public debt and GDP growth may run from (low) growth to (high) public debt rather than the other way around in some circumstances.
The recovery from the crisis has been lackluster in much of the world and, in the United States and some other OECD countries, has further concentrated income gains at the top. Part of the reason for the unsatisfactory recovery across the world was the implementation of austerity measures, enacted under the misguided belief that there is a critical threshold above which debt lowers growth. Erosion of human capital due to unemployment and underemployment, discussed elsewhere in the report, is likely to have lowered growth for years to come. Investments in crumbling public infrastructure could have helped millions of people, maintained human capital stocks, and gone further toward helping the economy to recover.
Outstanding Issues and New Questions
While the 2008 SNA includes full balance sheets for economic assets and liabilities, many countries are still guided by a very limited (and possibly misleading) approach to sustainability. As described above, comparisons of (gross) public debt to GDP are incomplete measures of economic sustainability. It may be that part of the appeal of using the debt to GDP ratio as an indicator of sustainability is that it is relatively simple to calculate and understand.
However, sustainability has two additional aspects to be considered:
• A full balance sheet approach (i.e., taking stock of a broader range of associated risks and both assets and liabilities), by looking at:
• the balance sheets of all sectors (banks, households, etc.) rather than the government alone;
• both liabilities and assets (e.g., recognizing that fire sales of assets in depressed financial markets may worsen net worth);
• the distinction between types of economic capital that add to productive capacity and those that do not (e.g., land), and between changes in volumes and changes in prices (see sidebar, “W versus K”).
• A long-term sustainability analysis that takes account of the impact of demographic and other factors on the evolution of public finances.
With regard to the latter aspect, models and scenarios provide valuable guidance to societies on the choices they have to make to achieve sustainability. Models will become increasingly important to assess interactions between different types of capital and their determinants (see sidebar, “Modeling Public Finances”).
W VERSUS K
Stiglitz (2015a), in his discussion of Piketty�
��s (2015) finding of a long-term increase of the capital-output ratio, notes that such an increase should normally be accompanied by a decline in the returns to capital relative to labor and by a declining capital share in income. Neither is the case empirically, though, as data on declining labor shares and real wages indicate. Stiglitz’s resolution of the puzzle lies in distinguishing between wealth (W) and capital services in production (K):
The distinction between W and K reflects the dual nature of capital, i.e., as a factor of production and a means of storing wealth. This distinction is a well-established feature in the literature on capital measurement (Jorgenson, 1963; Jorgenson and Griliches, 1967; Diewert and Schreyer, 2008; OECD, 2009) but is sometimes overlooked in the debate. Each aspect of capital is associated with a particular measure.
• The wealth aspect of capital requires a measure that reflects the market value of capital goods. W is the conceptually correct entry into balance sheets. Balance sheets relate to particular points in time, and valuation of wealth is at the prices prevailing at these points in time. The change in wealth between these points in time is made up of investment or other additions to the stock, minus depreciation or depletion, and revaluations.
• To capture the production aspect of capital, a volume measure K is required to reflect the flow of capital services into production. Unlike the wealth stock, the price of capital service is identified with user costs, designed to capture the marginal productivity of the different types of capital.
Stiglitz (2015a) explains: “The wealth income ratio could be increasing even as the capital income ratio is stagnating or decreasing. Much of wealth is not produced assets (‘machines’) but land or other ownership claims giving rise to rents. Some of the increase in wealth is the increase in the capitalised value of what might be called exploitation rents—associated with monopoly rents and rents arising from other deviations from the standard competitive paradigm. Some is an increase in the value of rents associated with intellectual property” (Stiglitz, 2015, p. 8).
This distinction implies that the evolution of the wealth-output ratio in nominal terms can be very different from the capital-output ratio in volume terms. The distinction also raises a question of scope of the two concepts—the inclusion or exclusion of some assets can modify the entire profile of the wealth-output and capital-output ratio. One such asset is land, and in several countries the rise in the overall wealth-output ratio has been driven by the steep revaluation of land, confirming Stiglitz’s point. Despite the two distinct perspectives, the wealth and the production sphere are linked and so are its measures. Indeed, W and K should be constructed consistently and as part of an integrated framework, as laid out for instance by the 2008 SNA or in more detail by OECD (2009) and Jorgenson and Landefeld (2007).
MODELING PUBLIC FINANCES
Policy-makers in some countries are becoming more interested in modeling the path of public finances, acknowledging that demographic evolution (particularly aging) is a major factor in analyzing fiscal sustainability, alongside structural reforms and productivity developments. Notable examples of the approach include the United States,1 Australia,2 and European Union countries.3
This approach typically analyzes the situation of countries over the short, medium, and long term against their government debt level, their initial budgetary position, and the projected evolution of aging costs (notably old-age pensions, health care, and long-term care). It uses a range of assumptions, including on demographic evolution, real GDP growth, inflation, real interest rates, and labor market participation. An important aspect of the approach is to consider different scenarios, communicating clearly the sensitivity of the results with respect to the assumptions.
One advantage of this approach is that it is possible to analyze the projected path of sustainability over time, thereby identifying particular future periods of stress.
1. www.gao.gov/fiscal_outlook/federal_fiscal_outlook/overview.
2. https://treasury.gov.au/intergenerational-report/.
3. http://ec.europa.eu/economy_finance/publications/eeip/pdf/ip018_en.pd.
Arguably, macro-economic models should go further to reflect the joint determination of the paths of economic output and public debt levels by interest rates and the government primary balance (i.e., government net borrowing or net lending, excluding interest payments on consolidated government liabilities). This implies recognizing that monetary policy and budget rules cannot be set independently of each other, and that fiscal consolidation in a recession may have large effects in terms of reducing GDP growth and limited effects in terms of reducing public debt (possibly further increasing it). Macro-economic models should also highlight the path that private demand is expected to follow under a given configuration of policy instruments, and the need to adjust such instruments when the path of private demand is inconsistent with macro-economic goals of full employment and price stability.
A full balance sheet approach to economic sustainability would also imply a more nuanced approach to sustainability, one that is not likely to rely on a “single number.” This makes it more difficult to decide, to take a pertinent example, when it is appropriate to engage in fiscal stimulus.
In this context, a complete balance sheet would have several important characteristics:
• Private wealth should be considered alongside the assets and liabilities of the public sector, as private liabilities may be converted into public liabilities if particular agents fail (due to bank bailouts, for example). In addition, the tax base upon which the government can draw for meeting its liabilities depends on the net wealth of the private sector. In both of these respects, some sort of distributional information is important since aggregation may mask the fact that for many agents debt is not covered by assets. The share of households (or firms or banks) with negative net worth may be a useful indicator. There is also value in considering the transmission of wealth between generations through examining data on inheritance of assets more closely.
• A better balance sheet would also take into account the fact that, even though the value of an asset (e.g., land) has increased, and overall measures of wealth have gone up, this is not the same as an increase in the volume of productive assets.
• More detailed balance sheets of financial corporations and other institutional sectors are critical to understand risks and vulnerabilities. The G20 DGI recommends producing quarterly institutional sector accounts. We should also recognize that, when risk is not properly measured, we may underestimate the fragility of firms, households, and other institutions in the face of financial stress. Balance sheets should be more detailed, both in terms of showing more granular sub-sectors (to illuminate differences in vulnerabilities as measured, for example, by debt-to-income ratios) and more detailed data for each of those sub-sectors, while taking into account the costs and benefits of collecting and analyzing more detailed data. More detailed balance sheets within a sub-sector would allow for a better analysis of risk through examining inter-connectedness by having breakdowns by counterparty sector, or breakdowns of debt by maturity and currency.
• All relevant types of pension liabilities need to be included.
Even such improved and more detailed accounts, however, may not be sufficient to capture macro-economic risk. One reason for this is that no clear conceptual framework exists for capturing risks at a macro-level, and that a full understanding of the links between macro- and micro-level risks (such as the building up of sectoral risk) is still missing. Therefore, better indicators should be compiled to measure different types of risk (liquidity, solvency, maturity, currency, overexposure, contingencies, and guarantees) and their concentration in specific segments of the economy. Aggregate data will not suffice. One also needs more granular information to assess what fraction of firms (or households) will face financial stress in the event of changes in asset prices, and the importance of these firms for the whole economy.
There are also other aspects to risk. For example,
existing SNA conventions may lead to considering higher risks as adding to the value of financial services. This issue is reflected in an ongoing discussion about the measurement of “financial intermediation services indirectly measured” (FISIM). Financial intermediaries assume risks when they provide loans; hence, the core question is whether the higher-risk premiums that banks may incur increase their output, or whether risk is borne by other sectors or society at large and should not be reflected in the output of the financial sector. Doing so, one should make a clear distinction between developments in current and in constant prices.
These issues form part of the “systems” and “resilience” issues discussed in the conclusion.
Human Capital
Countries with higher human capital have stronger economic growth, and individuals with higher human capital and better capabilities achieve better individual outcomes. At the country level, OECD (2010) estimates that increasing PISA scores (see sidebar on page 338, “PIAAC and PISA Surveys”) by one standard deviation would increase GDP growth by 1.8 percentage points. At the individual level, people with higher education live longer, have higher earnings and accumulated wealth, better health, denser networks of connections, and are more active citizens.
Human capital has been defined as the “knowledge, skills, competencies and other attributes embodied in individuals that facilitate the creation of individual, social and economic well-being” (OECD, 2001).3 This OECD definition is all-embracing: it incorporates various skills and competencies that are acquired by people through learning and experience but may also include innate abilities. Some aspects of motivation and behavior, as well as the physical, emotional, and mental health of individuals, are also regarded as human capital in this broader definition.
For Good Measure Page 40