Definition and measurement of assets and liabilities

Measuring capital is notoriously difficult. In this research we systematically follow the most recent international guidelines, as set forth in the 2008 System of National Accounts (SNA).³ In our online database we often refer to classification codes from the European System of Accounts.

ESA is the European Union implementation of the SNA; both are virtually identical.⁴

The SNA defines economic assets as “entities over which ownership rights are enforced by institutional units and from which economic benefits may be derived by their owners.” Because ownership rights cannot be enforced on human beings, this definition excludes human capital.

Including human capital would raise major conceptual difficulties, and we believe its exclusion is justified. In particular, treating human capital as an asset would call for treating education and health services as investment. But these services are largely viewed as having a consumption value per se, independently of the accumulation of any asset, so that the most basic distinction upon which national accounts are built – consumption vs. investment – would collapse.

All assets are to be measured at the market price prevailing at the date of the accounts.

Official wealth estimates are usually as at December 31^st. In our database, from these raw data we construct mid-year estimates by averaging end-of-year values.

There are two broad ways to measure national wealth: (i) by taking a census of wealth, whereby economic units in the nation have to report on the current value of their assets and liabilities; (ii) by cumulating past investment or saving flows, with adjustments made for de-preciation and changes in prices – what is known as the perpetual inventory method.⁵ In SNA

3The 2008 SNA, jointly adopted by the UN, the OECD, the World Bank, the IMF and the European Commission, supersedes the 1993 SNA, which was the first set of international guidelines including strict rules and concepts for national wealth accounts and balance sheets (and not only for national income). Changes from the 1993 SNA to the 2008 SNA were relatively modest and we mention them in the text below when appropriate. At the time we conducted this research, all the countries in our database followed the 1993 SNA with the exception of Australia which had already adopted the 2008 SNA. Most countries were expected to adopt the 2008 SNA by 2014 (2013 in the U.S.) For a detailed history of national accounts normalization since World War 2, and particularly of the debates and negotiations leading to the 1993 SNA, see Vanoli (2002, particularly pp.381-464).

4ESA 95 is the European implementation of the 1993 SNA and ESA 2010 of the 2008 SNA. The ESA 1995 manual is available on-line at http://circa.europa.eu/irc/dsis/nfaccount/info/data/ESA95/en/

esa95en.htm.

5A third and more seldom used way to value an asset is to take the discounted value of its future economic benefits. This method is used for some natural resources (subsoil assets, and sometimes forests). Yet a fourth method relies on asset values as reported to insurance companies (e.g., fire or theft insurance). This method was used in the past (e.g., in early twentieth century Germany) and is sometimes used today for estimating valuables such as works of art (SNA 2008, 13.43). We discuss below these estimation methods in more details

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accounts, for household, government, and foreign balance sheets, statisticians essentially rely on census-like methods. For corporate balance sheets, they rely on both methods: non-financial wealth is mostly measured by cumulating past investment flows, while financial wealth is mea-sured by census-like methods. We begin with a brief discussion of census-like vs. perpetual inventory methods.

A.1.1 Censuses of wealth

In official national balance sheets, census-like methods are used to measure all financial assets and liabilities, and they are also used for real estate – the two main components of private wealth, hence of national wealth.

To establish the current market value of the whole stock of financial claims and liabilities of all sectors of the economy, statisticians typically rely on a broad range of sources. First, they rely on the balance sheets of individual financial institutions such as banks, insurance companies, investment funds, and the like. By drawing on the balance sheets of banks, for instance, it is possible to know the amount of deposits held domestically by the various sectors the economy.

Using the balance sheets of insurance companies, one knows the amount of life-insurance claims held by households. And so on.

Statisticians also heavily rely on reports about the off-balance sheet positions of banks.

One important off-balance sheet element is the portfolio securities managed by banks on behalf of third-parties. Essentially, all portfolio securities (equities, bonds, mutual fund shares) are entrusted by their owners to custodian banks. By asking banks to report on these portfolios, statisticians can measure the amount of equities held by households, of bonds held by non-financial companies, etc.⁶

Overall, by systematically drawing on the balance sheets and off-balance sheet reports of individual financial institutions, it is fairly easy to obtain accurate market values for the amount of financial claims held by the various sectors of the economy. The main issue is that in the current reporting systems, it is not not possible to measure the portfolio securities entrusted by households to offshore custodian banks (in Switzerland, Singapore, etc.), because there is no automatic exchange of information between banks in tax havens and foreign authorities.

Zucman (2013) estimates that these securities amount to about 6% of households’ financial

when necessary.

6See Zucman (2013, Section II) for more details on the custodial activities of banks.

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wealth globally. So ideally it would be desirable to upgrade by about 6% the net financial claims of households recorded in the balance sheets of rich countries. One problem, however, is that the 6% estimate is a global figure which may conceal significant heterogeneity across countries. The figure may well be significantly higher for a number of European countries, but might be lower for Japan and the U.S. So in this research we have not attempted to upgrade the official balance sheets to account for the tax haven holdings of households. Improving the covering of tax haven wealth at the country level is an important challenge that we leave for future research.

Regarding real estate, the general practice is that its value is based on censuses of built areas (in order to establish the total surface of dwellings) and observed real estate transaction prices.

In some countries, statisticians attempt to disentangle the value of real estate in two components:

dwellings and land underlying dwellings. Typically, the value of dwellings is obtained by the perpetual inventory method (i.e., by cumulating past residential investment and adjusting for some construction price index), and land values are obtained as a residual (real estate at market values from censuses, minus PIM-estimated dwelling values).

A.1.2 The perpetual inventory method

The assets other than financial claims and real estate – i.e., essentially corporate tangible assets:

machines, structures, etc. – are usually measured by the perpetual inventory method. The goal of the perpetual inventory method (PIM) is to approximate the current market value of a number of capital assets when it cannot be directly observed. The general idea is that this value can be approximated by cumulating past investment flows and making suitable price adjustments.

Although important effort has been devoted into improving it, the PIM continues to raise a number of important theoretical and practical difficulties (see, e.g., Hulten, 1991). For our study these difficulties are largely irrelevant, because in our benchmark measure of national wealth – market value national wealth – we measure the net wealth of corporation by setting it equal to the market value of their equities. By doing so, we in effect choose not to rely on PIM estimates of corporate capital.⁷ It is important, however, to have some ideas of the pitfalls of the PIM.

7By contrast, in our alternative measure of national wealth – book-value national wealth – the net wealth of corporation is equal to corporations’ non-financial assets plus net financial assets. This measure relies on PIM-estimates of corporate nonfinacial assets.

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First, capital stocks derived from the PIM obviously rely on the quality of the underlying investment data. Very long run data are needed when depreciation is low, otherwise benchmark historical estimates are required, which are often of dubious quality. More worryingly, the PIM implicitly assumes that the assets of firms going out of business are bought back by domestic corporations. When this is not the case – which frequently happens in practice, either because assets are scraped at the time of bankruptcy or sold to foreign corporations – assets that do not exist anymore continue to be counted in the capital stock until their estimated depreciation reaches 100%. In the U.K., Mayes and Young (1994, p. 95) consider that “the major reason for mis-measurement of the [corporate] capital stock is because capital scrapped by firms going out of business remains in the measured stock.” Another implicit assumption of the PIM is that statisticians are able to identify the sales of fixed assets by firms going out of business to domestic firms. When they fail to do so, investment flows are counted twice, and the PIM again over-estimates corporate capital stocks. In France, Picart (2004, p. 99) concludes that for these two reasons the PIM may over-estimate the stock of corporate fixed assets by up to 20%. This might explain why in many countries, Tobin’s Q is structurally below 1 (see below).

The price component of the PIM also raises formidable difficulties. In private company accounts, assets are valued at the prices at which they were originally acquired – what is known as the “book value” or “historical cost” of assets. This method has the advantage of simplicity (historical prices can be easily verified) but tends to under-estimate the value of the capital stock when there is inflation. By contrast, with the perpetual inventory method assets are to be valued at the prices of a reference period.⁸ This requires being able to observe the evolution of the market prices of all corporate fixed assets, which is impossible given the enormous variety of assets of different vintages and the lack of centralized markets for many of them. Thus, in practice, price changes are not observed but estimated – a task which is fraught with difficulties.

One reason why the market price of any fixed asset changes is the fact that as time passes, the asset’s future income stream shortens. This economic depreciation is exactly what national accounts attempt to measure with the concept of “consumption of fixed capital.” Depreciation

8When the reference period is the current period, assets are said to be valued at “replacement cost” or

“current cost.” But assets can also be valued at the constant prices of a past period, in which case they are simply at “constant costs.” One should be careful with these expressions: while flows can be measured at

“current prices” (no deflator required) or “constant prices” (deflator required), for stock data, both “current costs” and “constant costs” estimates require the use of price deflators.

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is measured on the basis of estimated age-price profiles for various types of assets.⁹ There is a whole literature dealing with what are the most appropriate functional forms for this profile.¹⁰ But the 2008 SNA does not include strict guidelines and leaves the choice of specific functional forms to statisticians (SNA 2008, 20.22), so that some heterogeneity remains across countries.¹¹ Further, virtually all computations of economic depreciation face important data constraints.

Statisticians would ideally like to use age-price profiles that vary over the business cycle as plants open and close, and that change with obsolescence – but the raw data to estimate are scant and do not allow for much sophistication.

The price of fixed assets also changes for many reasons unrelated to depreciation. Ideally, these price changes should be measured at the level of each individual asset vintage category (e.g., computers with 200Mhz micro-processors, 48MB of RAM, etc.). In practice this is of course impossible and statisticians only compute a limited number of prices for pseudo-homogeneous capital goods such as commercial real estate and computers. To estimate these prices, it is essential to properly account for quality improvement and technical change – otherwise com-puters of say the early 2000s will continue being counted as part of the capital stock above their true market value. While much progress has been done thanks to the greater use of hedonic price indexes following Hall (1971) and Gordon (1989), measures of price changes in industries

9Economic depreciation (a price effect) should be distinguished from efficiency decay (a quantity effect), which is equal to the decline in an asset’s contribution to production caused by the fact that as time passes, the asset becomes less efficient. Efficiency decay is what productivity studies are usually interested in, and is measured using age-efficiency profiles. Depreciation and efficiency decay are not the same thing: for a light bulb with a duration life of 10 years, the efficiency decay between year 8 and 9 is zero but the economic depreciation is not zero. The two concepts, however, are closely related: under the assumption of competitive markets, depreciation is the present value of rental income loss due to the efficiency decay occurring in each year in the future (Hulten, 1991, p.129). From a quantity perspective, the other component of depreciation beyond efficiency decay is retirement. Not all capital goods of the same cohort retire at the same moment, so statisticians also estimate retirement profiles. To one age-price profile corresponds one and only one age-efficiency/retirement profile. Age-price and age-efficiency/retirement profiles are identical if and only if the two are geometric.

10Although there is a two-way correspondence between age-efficiency and age-price profiles, in practice there are arguments for basing estimates on assumptions about efficiency rather than price patterns (see SNA 2008, 20.18-20.20 for an intuitive exposition). For efficiency patterns, the most popular functional forms are: (i) One-hoss: assets retain full efficiency until they completely fall apart (as a light bulb does). In this case the pattern of efficiency decay is completely characterized by one parameter, the useful life of the asset. (ii) Straight-line efficiency, in which efficiency decays in equal increments every year (which is popular because in private accounts assets are often amortized in equal increments). The useful life again fully determines the efficiency decay pattern. (iii) Geometric decay, in which efficiency decays at a constant rate, which implies rapid losses of efficiency in the early years of an asset, and also that assets are never fully retired. See the discussion in Hulten (1991, pp.124-127) and the classic study by Hulten and Wykoff (1981) for tests of the three above patterns of depreciation.

11The OECD, however, recommends the use of geometric patterns for depreciation, because the combined age-efficiency and retirement profile of asset cohorts often resemble a geometric pattern. See OECD (2009), Measuring Capital, 2nd edition.

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with very fast rates of quality improvement remains a subject of both theoretical and practical difficulties, and eventually statisticians must often rely on ad-hoc techniques.¹²

It is worth stressing again that for our measure of market-value national wealth, the many shortcomings of the PIM are irrelevant, because we measure the value of corporations by their current equity values, and not by the PIM-estimated value of their capital goods.

We now turn to a more detailed discussion of the different components of SNA balance sheets.

A balance sheet is established for each sector of the economy: households (including non-profit institutions serving households), corporations (financial and non-financial),¹³ government, and the rest of the world. For each sector there are two broad types of assets in SNA balance sheets:

non-financial assets and financial assets and liabilities.¹⁴ Below we describe the main techniques used to measure the value of these assets, we provide details on various data limitations and the way we have dealt with them. The discussion closely follows the classification of the System of National Accounts.