Adam Smith wrote The Wealth of Nations in 1776.
236 years later I’ve just read an interesting article in The Economist about a new report that looks to assess the real wealth of nations. In it the researchers attempt to go beyond GDP – a measure of income – to get under the skin of wealth, a stock measure rather than a flow measure.
They’ve divided wealth into 3 categories:
- Human – covers the population’s education and skills
- Natural – covers land and other natural resources such as oil
- Physical – covers infrastructure, e.g. roads, railways, factories etc
Unsurprisingly, America is estimated to have the greatest total wealth ($118tn in 2008). However it’s Japan that’s estimated to have the highest wealth per person at over $400,000 (Britain’s is estimated to be just over $200,000).
The report also highlights significant differences in the make up of each country’s wealth: 88% of Britain’s is human, whereas for Saudi Arabia, human capital is perhaps unsurprisingly significantly less than 50%.
What are the benefits of attempting to look at countries’ wealth in this way?
If nothing else, it highlights something that seems odd in hindsight: that we’ve been fixated on an income measure (GDP) for so long. An adviser would never assess a client’s wealth purely in terms of income, so why would we look at countries that way?
It also makes the three measures interchangeable. If a country depletes its natural resources by X, but as a result increases it’s physical resources by the same amount it’s, prima facie at least, no worse off.
But the methodology also throws up some questions that may need to be answered in a different way:
- What is the relationship between income measures and wealth measures?
- Is the former simply an output of the latter? The report would indicate not, given there’s not a direct correlation with GDP.
- Is there an optimal mix between human, natural and physical capital?
- Is one of three preferable?
Replacing natural resources is usually somewhere between difficult (trees) and impossible (oil). However, huge wealth can be extracted from natural resources, as we’ve seen with the Gulf States and their pouring unheard of amounts of cash into football clubs, property and anything else that takes their fancy. But is extraction the same as creation?
Physical resources can be replaced, but depreciate and therefore need maintenance with the all costs that entails. 30 years of neglect has meant that despite huge investment in Britain’s railways in recent years, the standards of service are still far behind most continental railways.
Property will be split across natural (the land) and physical (the buildings) – we often struggle to make this differentiation for individuals, never mind countries.
Perhaps human resources seem most open to delivering plentiful benefits with less of the downsides. Politicians are forever pontificating about where we are on international league tables of numeracy or the declining percentage of people with a chemistry qualification.
All wealth realisation (not creation, given natural resources are largely already there) requires human intervention. Humans have vast capacity for learning and improving. But the costs of education and health are significant and, for better or worse, humans also ‘depreciate’ as old age impacts, so there’s significant cost of renewal here as well.
A good measure may be GDP divided by wealth, i.e. income over assets. This should give a view as to how efficiently the assets are being used to drive income. However, this simple measure won’t easily highlight whether the mix between different assets is optimal – or indeed how straightforward it is to change if you’re a country with very limited natural resources.
This isn’t meant to be an economics blog, but I think this latest research does map across well to some of the questions advisers and their clients will be considering:
- How should we measure total assets?
- Should we go beyond investments, property etc and also include the earning capacity of the client and what they can do to change that?
- Do we separate the value of land and buildings when reviewing the value and potential of property?
- Are the assets delivering income and/or growth as effectively as possible?
- Is the right asset mix today also going to deliver on client’s needs in the future?
It may appear that we already have better measures of individual wealth than we do for the wealth of countries. However, stepping back and reconsidering how we review the financial position of clients may still be a worthwhile exercise.