As part of new ESCoE funded research on shadow prices, Julia Wdowin discusses why it's important to estimate the value of missing capital assets.
Measuring wealth is crucial to get a better idea about the state and progress of an economy. Many people are familiar with Gross Domestic Product (GDP) a commonly used economic measure of national output. However, welfare economists are increasingly pointing towards a group of neglected “missing capitals” that are important for assessing the growth of an economy, sustainability and evaluating changes in economic welfare.
Why is including different types of capitals important?
Whilst GDP provides useful insights, it tells only part of our economic story. For example, it excludes services provided by natural capital, and focuses only on flows of income and output, not stocks of natural capital that underpin them. Indeed, the Office for National Statistics (ONS) has published plans to “Go Beyond GDP” to gain a more holistic view of national output. Each relevant capital stock, like plant and machinery but also natural resources or heritage assets, contributes to a country’s level of economic welfare. A deterioration in any of these “capitals” could have negative effects on social welfare.
For example, GDP could be higher but social welfare lower because of environmental or cultural deterioration that has occurred alongside the increase in the level of GDP.
So, how can the social value of capital assets be measure and estimated?
Shadow prices, or accounting prices, are an important tool that allow us to measure an asset’s social value in ways that simple exchange prices cannot. Exchange prices tell us the monetary value of assets and are observable but shadow prices can be positive or negative and not observable, therefore making them more challenging to estimate. This reflects the net contribution of each asset to social welfare. Therefore, shadow prices have the potential to reflect a broader measure of economic welfare. Read more on shadow prices in this blog from Cliodhna Taylor, Assistant Deputy Director for Research Partnerships at the ONS.
A key first step is identifying the missing capitals that contribute to the economic welfare of a country. Some of these are non-market assets such as a beautiful landscape (see Figure 1). Others are assets with exchange prices but associated with other non-market types of value that mean there is a gap between the exchange price and the social value. An example of this might be woodlands, freshwater, farmlands and coasts which bring huge welfare value alongside the value of energy, food and timber, etc. that they produce.
Figure 1: An example using natural capital assets
Then we need to measure and estimate the value of these different capital assets. This is where issues may arise: Where does social value come from? How can the various sources of value from one asset be disaggregated? What are the possible market and non-market valuation methodologies to give us a final benefit or human wellbeing measure? Which methods are most appropriate for different assets?
Addressing these questions
Our new Economic Statistics Centre of Excellence (ESCoE) Shadow Prices project looks at addressing these questions. Work on estimating the value of missing capital assets (such as natural and human capital assets) has already begun. However, the asset values have previously been measured at exchange prices. This leaves an incomplete picture of how much value these assets contribute to social welfare. This is where accounting or shadow prices are helpful.
We will build a rigorous framework for classifying missing capitals. This will allow conceptual work on valuation methods fitting to different asset types. The framework will also help to pilot new approaches and empirical applications to estimate missing capital shadow prices. Most importantly, it will enable new insights into measuring and estimating social value for use in social welfare evaluations. As a result, we will develop better measures of human welfare and wellbeing.
This project is led by Julia Wdowin and Prof Diane Coyle and has been funded by the ONS as part of the Economic Statistics Centre of Excellence research programme.
This research has been funded by the UK Office for National Statistics (ONS) as part of the research programme of the Economic Statistics Centre of Excellence (ESCoE).
The views and opinions expressed in this post are those of the author(s) and not necessarily those of the Bennett Institute for Public Policy.