OECD National Accounts Working Party, 3-5 October 2007

1. OECD National Accounts Working Party, 3-5 October 2007 Measuring CapitalRevised Manual Paul Schreyer, OECD

2. Background • OECD Manual Measuring Capital in 2001 • Since then: • New developments in the area of measurement of non-financial assets • Canberra II Group dealt with issues in conjunction with SNA Revision • Revised and extended Manual is one of outputs of Canberra II Group • Purpose: companion product to revised SNA93

3. Background • Canberra II met last in April 2007 • First draft of present Manual was presented there • Present second draft • reflects comments from April meeting • is still incomplete (e.g., chapter on inventories missing, glossary) • But complete enough to be submitted to NAWP for general comments

4. Background • Lengthy document – comprehensive presentation here not possible • Only main points • Of which there are seven

5. Structure of Manual • Three-part structure to cater different audiences Part I: • concepts of capital measurement, • non-technical description, with numerical examples • objective: convey the economic and statistical rationale for the measurement of the flows and stocks associated with capital

6. Structure of Manual Part II: • Orientated towards precision and empirical implementation. • Objective: provide guidance for measurement • Includes some text for measures above and beyond those recognised in the SNA, for example full user cost of capital for government assets. • Where discussion goes beyond the SNA, this is made explicit

7. Structure of Manual Part III: • Algebraic exposition of the measurement model underlying capital stocks and flows. • Objective: precise propositions for implementation routines that are consistent with the SNA, such as rules of valuation (end-year for stocks, average-year for flows etc.) Annexes: • Asset service lives used in countries • Numerical example with spreadsheet

8. Scope of the Manual Fixed assets, inventories R&D: at margin only  Handbook on intellectual property rights Non-produced assets: somewhat non-systematic treatment • Land gets special attention, other non-produced assets such as natural resources do not • No strong conceptual justification for this choice except that land has long been treated as a source of capital services in economics. • A complete guide to non-financial balance sheets would not have been feasible within the time frame of the write-up of the Manual.

9. 1. Main purpose: consistent framework • In the past, main purpose of measuring capital was to provide a basis for the calculation of CFC. • CFC measurement remains key but two additional objectives: • Balance sheets • Capital services for productivity analysis. • Main objective of Manualis to present an integrated and consistent approach towards capital measurement that encompasses all three objectives

10. 2. Two basic functions of capital: wealth and production • Dual nature of capital: • storage of wealth • source of capital services in production. • Different measures for each aspect, depending on analytical purpose • Wealth and production side of capital are not independent of each other  need for consistent measurement

11. 2. Two basic functions of capital: wealth and production (cont’d) • Wealth aspect: age-price relationship • How does the price of an asset evolve as it gets older while controlling for the overall price change of the asset  depreciation rate • Production aspect: age-efficiency profile • How does the productive capacity of an asset evolve as it gets older?  rate of capital services flow • For a single asset, these profiles are different

12. Capital measures in the 1993 SNA

13. Integrated set of capital measures

14. 3. Geometric patterns • In practice, cohorts of assets are measured, not single assets. • Asset groups are never truly homogenous but combine similar types of assets. • Cohorts require retirement distributions because it is implausible that all capital goods of the same cohort retire at the same moment in time. • Thus, age-efficiency and age-price profiles for a single asset have to be combined with retirement patterns to measure capital stocks stocks and depreciation.

15. 3. Geometric patterns (cont’d) • For a cohort of assets, the combined age-efficiency and retirement profile or the combined age-price and retirement profile resemble a geometric pattern, i.e., a decline at a constant rate • While this may appear to be a technical point, it has major practical advantages for capital measurement • The Manual recommends geometric patterns for depreciation and for wear and tear – they are simple and empirically justified • Non-geometric patterns are not wrong but more complicated to implement in a consistent way

16. 4. Consumption of fixed capital • CFC or depreciation remains a central variable in capital measurement • There is a long history about its exact meaning. • With increasing importance of capital goods that undergo rapid technical change, there has been renewed discussion about the relation between depreciation and obsolescence • Should depreciation reflect obsolescence and if so, what are the implications for measurement? • The Manual confirms, in line with the SNA, that CFC should also reflect expected obsolescence.

17. 4. Consumption of fixed capital (cont’d) • Some authors have suggested that to do so it is necessary to incorporate expected real holding losses into measures of CFC; others have come to a different conclusion. • The Manual finds that there is no single ‘correct’ way of dealing with expected price changes • Different analytical questions about net income give rise to different prescriptions about how to measure depreciation. • For implementation, the Manual sticks with the approach towards measuring consumption of fixed capital that excludes real holding losses from depreciation. This corresponds to the practice of statistical offices.

18. 5. Price and volume of capital services • Manual explains how prices of capital services or unit user costs are derived and measured. • Three elements of cost of using capital in production: • CFC • Real costs of financing or a required real return to capital • Real expected holding gains or losses

19. 5. Price and volume of capital services (cont’d) • Several ways of how the return to capital is measured, including • ex-post calculations based on observed measures of property income • ex-ante calculations based on information from financial markets. • For many reasons, results are not identical but the general evidence appears to be one of robustness of capital service measures with regard to the specifications for the return to capital.

20. 5. Price and volume of capital services • Flow of capital services is measured by the volume change of the productive capital stock • Together with the price of capital services, this offers a way of splitting GOS plus capital compensation of mixed income into a price and a volume component • This means the income side of the accounts can be split into prices and volumes

21. 6. Cost of capital for non-market producers • Value of output of non-market producers = costs • Capital costs are measured as CFC only, leaving out financing costs. • Reasons: • Of practical nature (which interest rate should be chosen?) • Conceptual arguments, eg avoid that GDP rises when interest rates for government debt increase.

22. 6. Cost of capital for non-market producers (cont’d) • But also good conceptual reasons why the cost of capital should be measured as completely as possible for non-market producers. (Note: for OOH, imputation is already in the national accounts) • If not in the national accounts, then for analytical purposes it is interest to impute financing costs. • Manual discusses concepts and practical ways of implementation even if this goes beyond SNA prescriptions

23. 7. Service lives and depreciation rates • Sizable part of the Manual deals with the measurement of service lives, retirement functions and patterns of depreciation. • Generally, good empirical information on asset lives is sparse and often dated. • Examples of measurement initiatives in countries are referenced but possibly incompletely  further country information encouraged

24. Next steps • Comments are appreciated on: • General structure of document • Readability and presentation • Scope: any important areas left out? Any less important areas over-emphasised? • Usefulness from national accounts perspective • More specific comments either now or in written form before November 30th • If basic endorsement by NAWP, 2nd revision by the beginning of 2008 and transmission to CSTAT in June 2008