A central presumption in modern development discourse is the significance of income growth for human betterment. By income, in the context of a country, we mean gross domestic product (GDP), which is the market value of the flow of final goods and services in a given year. GDP is a measure of economic activity. Rising GDP creates employment and investment opportunities, which means that as incomes increase in a country where GDP was once low, households, communities, and governments are increasingly capable of setting aside funds for the production of things that make for a good life. Today, GDP has assumed such an important place in the macroeconomic lexicon, that if someone says “economic growth”, we immediately know they are referring to growth in GDP (adjusted for the distribution of GDP among people).

And yet, search far and wide and you will still not find justification for that conflation in the economics literature. The reason is simple. The rogue word in GDP is “gross”, which signals that GDP does not deduct the depreciation of capital goods that accompany their usage. Just as a household can increase its disposable income by running down its bank balance and selling off its material assets, a country can achieve high growth rates by depleting its productive capital. The problem is that income would not be sustainable under those circumstances. At some point in the future, GDP would simply have to decline.

Economists who devised the notion of GDP were not seeking to find a measure that would reflect the well-being of people across generations. Their motivation was different. Measuring the magnitude of economic activity became necessary during the Great Depression of the 1930s, when more than 25 percent of working-age people in Europe and the United States were recorded as being unemployed and a corresponding proportion of factories and resources were lying idle. In the years following the end of the Second World War, when reconstruction of Europe and the Far East and economic development in what were previously European colonies became a point of economic policy, GDP became the yardstick by which economic progress was judged. I have no explanation for how that conceptual shift was allowed to happen.

The Idea of Wealth

For a household, income growth is a means of improving quality of life. However, because the household cares about its future, income figures are only relevant once the depreciation of assets has been taken into account. Economic betterment for the household requires that it consumes less than its net income. In simpler terms, a household should not live beyond its means. That, in turn, means that the household accumulates wealth.

…human betterment on a sustainable basis can be assured if, and only if, a country is able to accumulate wealth… A nation’s wealth is the social worth of its assets… Economic growth should mean growth in wealth, not growth in GDP.

Similar logic applies for nations. In recent years, economists have shown that human betterment on a sustainable basis can be assured if, and only if, a country is able to accumulate wealth. Essentially, wealth and well-being enjoy an unbreakable bond: if wealth increases, the well-being of contemporary people and the potential well-being of future generations, taken together, will also increase. Contrarily, if wealth were to decline, the well-being of contemporary people and the potential well-being of future generations, taken together, would decrease (I am abstracting from demographic changes and the distribution of wealth.). Wealth and well-being are not the same of course, but they move together unerringly.

The finding has no empirical content. It does however tell us that in seeking to improve the lives of the country’s inhabitants, a government should, as a starting point, instruct its statistical office or department to prepare wealth accounts. Just as firms create annual balance sheets, so too should governments prepare wealth accounts. A nation’s wealth is the social worth of its assets. Because capital goods (I am using “assets” and “capital goods” interchangeably), taken together, comprise an economy’s productive capacity, wealth is taken as a measure of productive capacity. Economic growth should mean growth in wealth, not growth in GDP.

But there is some subtlety here. When we speak of a household’s wealth, we usually have in mind the market value of the material and financial assets it owns. As financial assets can be converted into material assets, the household’s wealth is ultimately traceable to the market value of its material assets. If, however, national wealth is to reflect the well-being of the country’s inhabitants across the generations, it has to be interpreted in a far wider context.

Shadow Prices as Social Worth

Wealth is an aggregate concept. To construct it requires imputing a numerical value to the stock of each asset and summing up the values. By an asset’s value we mean its social worth, judged in terms of human well-being. To identify an asset’s social worth, imagine that the economy is provided with an additional unit. Even if other things are kept the same, the injection of that additional unit would disturb the economy. The task before the evaluator is to measure the disturbance using human well-being as a yardstick. In order to do that he or she has to track the ripples that spread through the economy over time and space as a consequence of that injection. And in order to do that, he or she has to apply his or her understanding of the social and environmental processes at work and the way he or she believes they will evolve over time and space. Finally, the evaluator has to value those ripples in terms of human well-being. The value of that entire disturbance is the social worth of that additional unit of the asset. Economists refer to that social worth as the asset’s shadow price. The qualifier “shadow” signals that it may well differ from the asset’s market price.

Experience shows and theory suggests that when estimating shadow prices the person conducting the evaluation will find it useful to make market prices a first port of call. The evaluator may even discover that market prices of many capital goods are reasonable approximations of their shadow prices. He or she will also discover that there are assets whose market prices are not only bad approximations of their shadow prices, but that some assets (for example, environmental assets) do not even have markets.

The Breadth of Capital Goods

A brief tour of an economy’s stock of assets would uncover three categories:
1. Reproducible (or manufactured) capital (roads, buildings, ports, machines, equipment)
2. Human capital
A. personal character, knowledge, and skills (aptitude, self-awareness, sociability, education, tacit knowledge)
B. health (body mass index, life expectancy)
3. Natural capital (agricultural land, forests, grasslands, coastal fisheries – more generally, ecosystems; the atmosphere; the oceans; sub-soil resources).

Category (1) is self-explanatory and comes to mind when the term “capital good” is used. Today, category (3) is also familiar, because ecologists and environmental scientists have taught us to recognize the services nature provides for all our ends, not only survival. Category (2) would seem obvious too, but it is only in the past few decades that economists have developed methods for estimating the capital that is embodied in people. We may call assets in the three categories “produced capital”. Categories (1) and (2) are produced by human effort, while category (3) is produced by “nature”. They range from private goods (machines and equipment), through semi-public goods (water quality, primary education) and local public goods (wetlands), to global public goods (the atmosphere, the open seas). An economy’s wealth is the social worth of the stock of produced capital to which it has access. The composition of an economy’s population (gender and age distribution) is reflected in the measure of its human capital. Wealth per capita is wealth divided by population size. Because the idea of wealth here is far more inclusive than wealth conventionally measured, some authors refer to it as “inclusive wealth”.

The Social Environment

What finds itself on the list of capital goods is to some extent a matter of choice. Today, it is customary to regard any durable commodity we care to think of as a capital good. We speak of social capital, cultural capital, institutional capital, knowledge capital, even religious capital. Those intangible goods matter enormously; so where do they appear in the notion of inclusive wealth?

We could have, in principle, included them on the list but measurement problems would have proved insurmountable. The route economists have followed is to exclude them from the list of assets. Instead, we are to think of them as representing the social environment in which people go about their lives and make decisions regarding the allocation and accumulation (or decumulation) of the capital goods in categories (1)-(3). The social environment is present in the measure of inclusive wealth, but it enters through the shadow prices of capital goods. A less formal way of putting it is to say that the social environment bestows effectiveness on produced capital.

Illustration

What does all this mean for national accounts? Imagine that we are assessing the performance of an economy over the past year. We want to know whether the economy was wealthier at the end of the year than it was at the beginning of the year.

To avoid extraneous issues, imagine the economy is egalitarian, closed to international trade, and has a constant population. These assumptions, taken together, allow us to use the strong bond between wealth and well-being without further qualification. Suppose, on using shadow prices, we discover that during the year in question the economy invested US $40 billion in reproducible capital, that households spent US $20 billion on primary education and health, and that the economy depleted and degraded its natural capital by US $70 billion.

Even if the government prepared national accounts using shadow prices, they would be misleading. Under the system of national accounts that is universally followed, the US $40 billion of expenditure would be recorded as investment (“gross capital formation”) and the US $20 billion as consumption. Significantly, there would be no mention of the US $70 billion lost in stocks of natural capital. National wealth accounts, in contrast, would re-classify the US $20 billion as expenditure on the formation of human capital (“investing in the young”, as the saying goes) and the US $70 billion as depreciation of natural capital. Aggregating them and assuming that expenditure on education is a reasonable approximation of gross human-capital formation, we would conclude that owing to the depreciation of natural capital the economy’s wealth had declined over the year by US $10 billion; and that’s before taking note of the depreciation of reproducible and human capital. The message to be taken from this is that there had been economic regress during the previous year.

Practice

In April 2013, an expert group convened by the then Prime Minister, Dr. Manmohan Singh, submitted their report to him on “Green National Accounts for India: A Framework”. The report, which I was privileged to chair and whose convenor was India’s Chief Statistician, provided a picture of the steps that need to be made to create wealth accounts for the nation. We noted that, as a starting point, the Government’s Statistical Office should make an inventory of the nation’s assets, and we warned that there are assets that will inevitably go unrecorded. We sketched the methods that have been developed by economists for estimating shadow prices, in particular those of human and natural capital, and we insisted that not all assets can be valued, certainly not within tight bands. We therefore cautioned statisticians against offering point estimates of the country’s wealth and advised that it would be far better to encourage the public to accept national accounts as figures within defendable bands. With this in mind, we suggested that it would be prudent to create satellite accounts of assets that escape clear measurement. The report offered only a framework (albeit with illustrative examples) and advised that the move to wealth accounts should be taken in stages. Caution is required because many of the steps are untried.

However, research scientists are not obliged to practise restraint. For some it was time to put the theory to work on raw data (such as they are to be found) and estimate movements in the wealth of nations. In what will be seen increasingly as a pioneering document, the “Inclusive Wealth Report 2012”, the International Human Dimensions Programme (IHDP) at the UN University published estimates of movements in wealth per capita in 20 countries for the period 1990-2008. Last year, IHDP published its “Inclusive Wealth Report 2014”, in which its authors provided estimates of movements in wealth per capita in 140 countries for the period 1998-2010. Natural capital was seen to comprise agricultural land, forest as stocks of timber, sub-soil resources, and fisheries. The publication reported that of the 140 countries, 89 percent had enjoyed growth in per capita GDP, but that only 61 percent had shown an increase in wealth per capita. GDP and inclusive wealth pointed in opposing directions in those countries.

Inclusive Wealth and the Sustainable Development Goals

Later this year, the United Nations will launch its Sustainable Development Goals (SDGs). They will be 17 in number. There is no evidence that they are all compatible with one another. The SDGs will not tell governments what to do should they come into conflict. They do not say, for example, what a government should do if in pursuing them the wealth of the nation declines. Weakness is inevitable when goals are drawn without an underlying theory to shape them. “Sustainable development” is today a much-used expression. But not too many people recognize that the term should mean growth in the wealth of nations.

Professor Sir Partha Dasgupta is the Frank Ramsey Professor Emeritus of Economics at the University of Cambridge. An economist and social scientist of international fame, Professor Dasgupta’s research interests have covered welfare and development economics, the economics of technological change, population, environmental and resource economics, the theory of games, the economics of under-nutrition, and the economics of social capital.