What is Wealth Accounting?
Central to WealthView™ is Wealth Accounting / Wealth Metrics, a methodology developed by one of our team members, John O’Connor. While Senior Advisor in the World Bank’s Environmental Department, John concluded that the Bank’s performance should be judged by its role in promoting the wealth of nations. At that time, wealth was measured as GDP, but John and other thought leaders realized “Wealth” is broadly defined to include environmental and social factors as well as conventional economic assets and liabilities. As a result, the World Bank published a report on this subject matter, Monitoring Environmental Progress (MEP) written by John in 1995. John helped create Wealth Accounting, a new method for measuring the multiple factors that contribute to wealth, and created the first assessment of the wealth of nations based on this methodology (integrated physical-social-economic accounting). The report was cited as an important new method for measuring wealth.
An important message from MEP: greater wealth in Human Resources (HR) is typical in the ‘ideal’ of advanced nations—even if one only considers Natural Capital (NC) rich economies like the US, Canada, and Norway.
"Human capital is worth more than either produced assets or natural resources, but natural resources are probably worth more than produced assets even without taking into account nature's invaluable life−support role."
Fundamentally, Wealth Accounting measures the prices, quantities, and values of stocks (i.e. balance sheet) and flows (i.e. profit and loss statement) across social, economic, environmental, and human factors for a given geography, and incorporates prices/values for things that have traditionally been ignored or assigned a de facto value of zero . In aggregate, Wealth Accounting provides a measurement of current wealth, and with historical data, provides future projections of wealth based upon values of greatest importance to citizens and stakeholders.
“The 83-page study redefines the concept of ‘sustainable development,’ arguing that it has less to do with meeting present and future “needs” than with making sure that future generations have as much or more capital to create jobs and income as they have now... Mr. O’Connor says the key to sustainable development is managing the four components of national wealth with long-term growth in mind. That means being less concerned with cash flow at any given moment and more concerned with sustaining and increasing a country’s net worth.”
Conception of “Wealth”
Wealth is commonly understood as follows: “An abundance of valuable possessions or money”. However, a person, organization, or society can have a lot of money and economic assets while breathing polluted air, suffering from poor health, worrying about safety, and having a deteriorating environment.
People know intuitively what happiness and wellbeing feels like, and they know what things contribute to their wellbeing: things like good health, adequate income, a home, family and friends, meaningful expression, sense of safety, clean air and water, freedom of expression, time to enjoy life, and meaningful work. Some of these things are within the control of an individual, but many things are the product of the society and geography they live in.
When a society provides the base for wellbeing, that society prospers and generates ongoing wealth and wellbeing across the social, environmental, economic, and human dimensions. Thus, the wealthiest nations in the world have implemented policies that help build sustainable wellbeing, and this is the alternative idea of the term wealth: Wealth is not an abundance of possessions and money. Rather, it is a balanced state of many variables that contribute to wellbeing including but not limited to the economic measures.
Wealth Accounting Basics
Fundamental to the methodology is a market-oriented, multidimensional assessment of stocks and flows. Stocks represent the quantity of assets (Manufactured Capital, Natural Capital, Human Capital, Social Capital), and flows represents how those assets move throughout an economy.
In traditional economics and accounting, you measure assets in a balance sheet, and measure flows in a profit and loss or cash flow statement. In the case of economics, money (an asset) flows from one person or organization to another as one accounts for the factors of production of goods and services and the growth of investment and business activities. For example, money can buy equipment or a building to support production (both economic assets). Those assets can be utilized in further production leading to more sales, potentially increasing profits. This is an incomplete view about the value of the assets used from the environment that provides the raw materials; the value of the people that do the work, create innovation, improve productivity; the society that provides the social infrastructure, that facilitates the process; and the perception of the citizens regarding their sense of wellbeing?
Wealth accounting takes into account that stocks and flows include all these variables which account for society’s productive base.
Comprehensive wealth accounting can provide an estimate of the total wealth of a given location by measuring the value of these different components of wealth. Changes in wealth are an indicator to assess if a location is growing its income without depleting its stocks.
For a very simplistic example of Wealth Accounting stocks and flows, consider the following wealth scenario, and ask yourself is wealth increasing or decreasing? Ideally, decisions made about this process are based on multi-stakeholder dialog and assessments of human value signals:
- A nation discovers an nationally-owned oil reserve (a form of natural capital) with 100,000 barrels (a quantity or stock of oil);
- 50,000 barrels get pumped out (reducing the natural capital stock by 50%);
- The oil is sold (increasing the stock of manufactured capital/cash);
- The cash is used to reduce corruption, build a hospital and a university (increasing social, and human capital stocks and reducing the stock of cash), and cleaning up the environment impacts of oil exploration and drilling;
- Over time, those improvements from social capital investments help improve human health and education, and provide a more just society for humans (stock increase in human capital). Human value signals provide insight into individual’s self-perception of the impact on them – their sense of wellbeing;
- Those more secure, educated and healthier people create new jobs and innovations (increasing the stock of manufactured capital);
- Each transformation of those stocks from one form to another represent flows of capital;
- The key question is: Did this sequence of events increase, decrease, or not affect wealth?
In order to calculate these transformations, each asset type needs to have a price and a quantity. Traditionally, most social, environmental, and human variables have been taken for granted - assumed to be a free resource with a de facto value or price of zero. For example, in traditional economic accounting, the value of a forest is the price that one can gain by harvesting the forest and selling the wood (price of wood sale minus cost to cut down wood). Obviously, this ignores the fact that the forest absorbs carbon, helps retain water, provides habitat for local flora and fauna, provides recreation and pleasure, etc. Most if not all of these things are valuable and can be measured and assigned a price or price equivalent (shadow price), which can be accomplished through Wealth Accounting.
The bottom line is that societies that manage to find a good balance between social, environmental, economic, and human factors end up creating wealth and the infrastructure to support additional building of wealth and well-being. Thus, Wealth Accounting is designed to evaluate and support policies and actions designed to increase sustainable wealth and well-being.
GDP (Gross Domestic Product)
Traditionally, nations measure how well they are doing using Gross Domestic Product (GDP), defined as" the sum of gross value added by all resident producers in the economy plus any product taxes and minus any subsidies not included in the value of the products. It is calculated without making deductions for depreciation of fabricated assets or for depletion and degradation of natural resources." - source: World Bank
This is a dated method of measuring wealth in society since GDP is limited to economic factors only. One needs to consider other types of capital associated with the environment, the society, and humans in order to come up with a valid description of the wealth of a nation, state, province, city, or organization. Wealth Accounting incorporates these other types of capital in order to come up with a comprehensive wealth assessment. The following chart shows some of the differences between GDP and conventional economic analysis versus the way sciGaia evaluates the economy using Wealth Accounting.
The international community has become increasingly aware of the inadequacies of using GDP and purely economic-based methodologies to measure how well a nation or state are doing. You can show strong GDP within a state that is lacking adequate healthcare, education, social infrastructure, rule of law, clean water and air, and a healthy environment and biome.
Wealth Accounting or Wealth Metrics provides a significant improvement in methodology and allows decision makers to see the true state of affairs and the future impacts of their decisions across all the major components of wealth and wellbeing.
WealthView™ was designed to be the most advanced application for implementing wealth accounting principles into real world assessments and policy decisions for cities, counties, states, and nations.