Skip to content

Models and measurement in economics 3

↓ Jump to responses

Download the newsletter ›

By Merijn Knibbe

[Continued from Part 1 and Part 2 in previous Newsletters]

  1. Introduction and summary

This post is the third in a series which investigates differences between the concepts of economic variables in (neoclassical) macro-economic models on one side and in the national accounts on the other side. Earlier posts, an introductory one and one which provides a comparison of the national accounts with the models, can be found here and here. This third compares the concept of ‘fixed capital’ as used in the models and the national accounts. Differences are large: neoclassical macro ‘DSGE’ models exclude non-produced capital like land and the government can treat capital as a kind of fixed ‘jelly’ which can be readily substituted into consumer goods. This must be rated as a regression compared with earlier ‘vintage models’ of capital goods used in for instance growth models. Remarkably, the recent introduction of ownership of capital into these models leads to a much more classical approach, including a class of capital owners and a class of labourers. Neither the accounts nor the models include non-owned natural capital, like clean river water. The accounts contain a detailed operationalization of capital goods, which precludes the possibility of ‘jelly’ and recently extended the concept of ‘unproduced’ fixed capital to items like production permits and patents. The (re-)introduction of economic classes into the models and the extension of the concept of unproduced capital in the accounts shows an increasing divergence between the models and the accounts. The inclusion of non-monetary banks, international flows of capital and real estate into the models however mitigates this. The re-introduction of economic classes – which were purged from economics by the marginalists – into neoclassical economics really is a big thing.

  1. The concept of (fixed) capital

One of the remarkable data in the famous Piketty book, Capital in the twenty-first century is an estimate of the value of pre-civil war fixed capital, expressed as a percentage of GDP, of the slave holding states of the USA (Piketty, 2014A, figure 4.11 on p. 161). Fixed capital includes for instance the value of houses, land, means of transport, cattle and machinery. Despite this, the value of slaves was over 50% of total value. After the US civil war (1861-1865) this value dropped to zero as slavery was abolished. After 1865 cotton production soon rebounded – but the southern slave society was destroyed forever. Clearly, what we call ‘fixed capital’ is not homogenous over time and not just an economic but also a legal and political variable which is (at least) as important to distribution as to production. It changes, sometimes gradually but sometimes also in a revolutionary way. This is not only true for fixed capital itself but also for the way economic statisticians define the concept. In the last version of the guidelines of the system of national accounts (Eurostat/European Commission 2013; further references: ESA 2010) the concept of ‘fixed capital’ is extended to include not just machinery, dwellings and land but also production permits, patents, ‘goodwill’ and even research and development. See the annex at the end. Which leads to the question: what is ‘fixed capital’? Why are patents included and privately owned cars excluded while slaves were included? What are the economic or legal demarcation lines used to make these choices? The question this post tries to answer is how ‘fixed capital’ is, explicitly and implicitly, defined in the national accounts and neo-classical macro-economic models and if there are any discrepancies between the concepts of the accounts and the models, to investigate if there are any discrepancies between the concepts of capital used by economists. It might well be possible that the implicit and explicit definitions of the models are not the same as the (much more explicit) concepts and definitions of the accounts.

  1. (Fixed) capital in the national accounts

3.1 Concepts


Capital in the sectoral balance sheets of the national accounts consists of financial capital (loans and stocks and the like) and fixed capital. This post is about ‘fixed capital’: what is it? The graph gives some clues. For one thing: we do measure it. But what do we measure and why? In this paragraph I will use a ‘bottom up’ approach to investigate this, not starting with the formal definitions but with the measurements. As the concept of capital of almost any economist is, consciously or unconsciously, strongly influenced by neoclassical economics, I will make some explicit comparisons with these ideas. In the next paragraph a more detailed overview of the way modern neoclassicals use (and therewith define) the concept of capital is provided.

Capital consists (looking at the asset side of the balance sheet) of items like dwellings, land, machinery and equipment, weapons systems and production permits (in the graph the last item is included in ‘other non-produced non-financial assets’). The annex contains an exhaustive list. But these items are only the operationalization of ‘fixed capital’. The question is: why and how do we lump these items together? Looking at the graph, a first characteristic of fixed capital is clearly, and probably surprisingly, something which at least in France (which in this respect is typical) is mainly owned by households. This leads to the first characteristic of capital. It is owned, by a person, an institution, an organisation or the government. This may seem trivial, but it isn’t. Non-owned natural resources, like clean air or fish in the ocean, are not considered capital. According to the most recent Eurostat national accounts manual (Eurostat/European Commission 2010, hence: ESA 2010), which is consistent with the UN guidelines, “Natural assets where ownership rights have not been established, such as open seas or air, are excluded” (ESA 2010 7.26).1 I’ll return to this below when I discuss ‘natural capital.

Also, the second characteristic of fixed capital, it shows that it mainly consists of ‘dwellings’ and ‘land’, or unproduced capital goods, while (delving deeper into the data) this land is to quite an extent ‘land underlying houses’.2 ‘Unproduced’ fixed capital is of prime importance! The present preponderance of land in the total value of capital is not a law of nature. In the nineteenth century land was, in non-slavery societies, the most important kind of fixed capital (Piketty 2014A). But back in the fifties of the twentieth century, when Solow formulated his famous growth theory (Solow 1956), the value of land had (driven by a decline of relative prices of agricultural goods (Knibbe 2014)) reached a historical low (Piketty 2014A). Which enabled Solow to state that his growth theory, consistent with neoclassical ideas but in stark contrast to the ideas of the classical economists of the nineteenth century, was about produced capital only and not about land and other unproduced capital. This (plus assuming that capital goods and consumer goods are totally comparable) enabled him to link total stock of ‘fixed capital’ to the rate of investment and depreciation. But ‘land’ is back. The increase in the value of land in fact drove the large long term swings in the capital to GDP ratio which is central to the analysis of Piketty (Piketty 2014A, 2014B, also Knibbe 2014, De Rognlie 2015). This means that, focusing on distribution, we are living in a much more classical, ‘Ricardian’ economy again were banks have taken the role of the nineteenth century land owners (Hudson 2012). It might not be entirely coincidental that almost at the same time when one set of researchers (Bokan et al., 2016) (re-)introduce economic classes into neoclassical macro-models (see below) De Rognlie de facto (re-)introduces land in the corpus of neoclassical thinking (De Rognlie 2015)! In both cases, this has mayor implications for the distribution of income. Anyway: produced capital, like bridges, as well as unproduced capital, like ‘land’ as well as subsoil assets like natural gas, diamonds or water in aquifers are considered to be ‘fixed capital’ in the accounts. At this moment, economic statisticians have even extended the concept of natural unproduced capital to ‘human’ unproduced capital items, like patents, production permits and even research&development (R&D):non-produced non-financial assets … are economic assets that come into exist­ence other than through processes of production. They consist of natural assets, contracts, leases, licences, permits, and goodwill and marketing assets. (ESA 2010 7.24)”. Fixed capital, as defined in the national accounts, is not just a function of investment. It is also a legal and political variable – just think of copyright law.

Depending on the rules and the laws, the distribution of the monetary benefits connected with the ownership of capital can vary. Just think of the duration of a patent or the fact that sub-soil assets in continental Europe are, thanks to the code Napoleon, owned by the state while in Texas the owner of the surface is also owner of the sub-soil assets. Which leads to a third characteristic of fixed capital (as measured in the national accounts): capital is not just a factor of production but it is, via ownership and the legal system, also an independent factor of distribution (just think of prices of patented pharmaceutical products): “an economic asset is a store of value representing the benefits accruing to the economic owner by holding or using the entity over a period of time.” (ESA 2010 7.16). In the national accounts, this distribution aspect is, all lemma’s considered, even more important than the production aspect of fixed capital! And one of the storylines of the history of capitalism is about revolutionary and non-revolutionary changes in ownership of capital, like the seizing of the extensive land holdings of the cloisters in the protestant parts of sixteenth century Europe, the abolishment of slavery in the USA after the civil war and, nowadays, the struggle about TTIP and the denationalization of government fixed assets in countries like Greece.

The accounts define ‘value’ and ‘benefits’ as monetary value and benefits. These benefits do not only consist of a return on capital but for instance also of the possibility to spend chartal money (part of financial capital, not of fixed capital) after holding it for some time. It also consists of, in case of valuables, the possibility to sell these in a later period, or even production costs of fixed capital foregone. Without its extensive, costly coastal defences, which are part of government owned fixed capital, my country, the Netherlands, would not even exist. Benefits are in this case the costs of production which do not have to be paid by the future generation because the asset already exists (which is not the same thing as paying for maintenance). Assets that do not engender a clear identifiable flow of monetary rewards like return on capital, resale value or identifiable production costs foregone to an identifiable owner are not considered to be ‘fixed assets’. Examples are consumer durables, human capital and ‘contingent assets and liabilities’ (like implicit government guarantees for banks). 3

This monetary nature of national accounts fixed capital is not an accident. In the national accounts fixed capital is included in balance sheets which also show the net financial position of entire sectors owning fixed assets, a financial position which next to fixed assets of course also includes financial assets and liabilities, i.e. the net financial relations (debts!) between one sector and the others. This means that fixed assets without a resale price, like coastal defences, have to be valued. Much more on this in the next sub-paragraph. On the national level, financial assets and liabilities net out, which is the reason why Piketty only looked at the value of fixed capital (plus the often rather small Net International Investment Position, NIIP of countries). Using balance sheets to show the value of capital leads thus, by necessity, to the fourth essential characteristic of fixed capital: it has a monetary value and are part of an economic system in which they, somehow and depending on contracts and legal system, often serve as some kind of collateral for all kinds of debts (including commercial credit and, in the Eurozone, government debt and even equity). The national accounts only show net positions of entire sectors. Such aggregate balance sheets do not show differences between for instance generations of households (many members of the younger generations of house owners may be under water, contrary to older generations). The value of fixed assets can be used, though, and together with information about financial assets and liabilities, to gauge not only net wealth of a sector but also balance sheet risks or the extent to which a sector, after a financial crisis, is withdrawing money from the flow of expenditure to rebuild its balance sheet position. Or, as the ESA 2010 states it, the balance sheet ‘completes the sequence of accounts, showing the ultimate effect of the entries in the production, distribution and use of income, and accumulation accounts on the stock of wealth of an economy’ (ESA 2010 7.03). We should not forget that this ‘accumulation account’ is influenced by housing bubbles, too. Which means (and this is a fundamental criticism of the analysis of Piketty) that national accounts capital is not stock-flow consistent with the production and income accounts!

It is of course possible to call non-owned items, like whales and other ‘free game’, capital, too. Often the phrase ‘natural capital’ is used to do this. This is remarkable. The word capital, as used by economists, has an impeccable monetary background and was used, in the middle ages, to denote the principal sum of a money loan (compare: ‘raising capital’). The concept has however been extended to all kinds of ‘principals’ which yield returns of a monetary or non-monetary nature. Examples are ‘human capital’ (i.e. education and experience) or ‘natural capital’. In an excellent overview of ‘natural capital accounting’ the (Australian) Bureau of Meteorology (BM), which is highly interested in water accounts, defines natural capital, as: ‘The stock of living and non-living components of the earth that provide a flow of valuable ecosystem goods or services’ (BM, 2013) (see also Figure 1 below). It is even possible to find scientific articles which (I do not approve) include the sun in our concept of ‘capital’ (Monfreda, Wackernagel and Deumling, 2004). The national accounts however restrict ‘capital’ to private, government or institutional ownership and identifiable monetary benefits. Which also means that ‘capital’ (and therewith the distribution of income) has a clear legal and political side to it – a point which might not always be appreciated enough by people defending the idea of ‘natural capital’ (I recall the cod wars between the UK and Iceland in the twentieth century).. It is however important to define ‘national accounts’ capital and especially unproduced natural capital as part of the total stock of ‘living and non-living components of the earth’ and the ESA 2010 might well be rewritten in this regard (picture). After all, we do spend a lot of money to (re-)create (or at least to try to re-create) non-monetary assets, like clean air. Just think of all the production costs of all the catalytic converters built into hundreds of millions of cars (which, when the car is a consumer durable, are not counted as fixed capital…). But there are very good reasons to separate ‘monetary’ assets, natural or not, from non-monetary assets. Money does matter. But, returning to natural capital, this of course also means that depletion of stocks of the natural assets which are included in the accounts should be a negative when we calculate GDP. Which would also enhance the stock-flow consistency of the balance sheets.

3.2 The value, price level and volume of fixed capital

In growth theory the amount of fixed capital is theoretically related to GDP via investments and depreciation. The value of capital is, i.e., stock-flow consistent. We’ve already seen that this is not the case, which leads to remarkable developments. In the western world, the level of investment has been declining for decades, often by as much as 8 to 10% of GDP (Knibbe 2014). Even when fixed capital is not entirely stock-flow consistent one would expect a decline of the value of fixed capital (expressed as a % of GDP). Piketty pointed out that the opposite happened, until 2008 (Piketty 2014A). This increase was (fuelled by credit creation) not caused by a high level of investments but by price increases of houses and especially land underlying houses (Knibbe 2014; De Rognlie 2015). We use (a running average of) the house price index to value these houses. But can we really value houses which are not ‘on the market’ with the price of houses which are sold? And isn’t it more interesting to have an estimate of the volume of capital instead of only an estimate of its value, i.e. the stock of capital valued with some kind of fixed prices? But which fixed prices should we take to make such a volume estimate? Can we really value heterogeneous capital goods with different ages and rates of depreciation with fixed prices, taking discontinuous technological change as well as changes in demand, availability of credit, interest rates and legal systems into account?

Figure 1. The national accounts in a ’broad’ system of accounts including natural capital.


Source: Bureau of Meteorology, 2013 .

There are problems. In the case of the flow of value added choosing a price to value transactions is not too difficult: we use transaction prices. But in the case of existing fixed capital

  • There often are no transaction prices.

Can we use the price series of the flow of investments to overcome this problem? Or, as in the DSGE model of Bokan (2016) even the consumer price index? There are conceptual problems with this procedure – unless we assume, like Bokan et al. (2014), that there is a homogenous ‘jelly’ stock of capital which does not show any historical changes in its composition and can be readily substituted into consumer goods. But there isn’t. Which means that some of the conceptual problems are comparable to those of the consumer price level, though they loom (much) larger because of the larger variability in prices of investment goods as well as the larger variability of the set of products purchased (partly due to the often large sums involved). This means that the price series of investments is influenced by:4

  • Changes in relative prices
  • Changes in the set of products purchased (more planes or more bridges?)
  • Changes in quality (computers are the obvious example, genetically changed farm animals another)

And in the case of fixed assets some additional problems have to be added, like

  • large differences in depreciation rates
  • changes in prices of existing assets not due to depreciation (houses, but also assets which become worthless because of technological change or changes in for instance environmental rules)

When we deflate the stock of assets with the investment price series we will overstate the importance of items with a high rate of depreciation which, exactly for that reason, have, compared with their importance for the rate of investment, a relatively low value in the stock of fixed assets (Groote (1995) is an example of this procedure, but he only looks at infrastructural investments which mitigates these problems). The low depreciation rate of buildings and structures is one reason why they figure so heavily in the graph! Next to this, the house price bubbles are of course a reason. Aside: Bokan et al. (2016) show that even a DSGE model consisting of different countries and using a loanable funds instead of a credit creation model of the lending market, deregulation (i.e.: institutional change) in one country (read: Spain) can lead to capital inflows from other countries (read: Germany) and a housing bubble. Constructing a deflator for the flow of investments is already difficult; constructing a deflator for the entire stock of fixed assets is even trickier.

So, it is pretty difficult to construct a series of the volume of our stock of assets. But can we at least construct a series of their value? Piketty (2014A) uses these series, taking data from the national accounts. So we do value capital. But how? The ESA 2010 suggests that market prices are best. And Piketty wrongly states that a market price valuation is the defining criterion to include items in our definition of fixed assets (Piketty 2014). But even market prices are, when it comes to specific pieces of equipment or dwellings not sold in a specific year, not real transaction prices of the assets in question. In such cases, they only are a metaphor. In many cases they are however used to value capital. Many well developed second hand markets exist for fixed assets (planes, trucks, houses, military equipment) and in these cases second hand market prices are often used to value such assets. But for other items (like coastal defences) no second hand markets exist.5 In such cases, production costs, replacement costs or ‘perpetual inventory value’ are used, production costs in cases like coastal defences and perpetual inventory calculation (value at time t plus investments minus write offs) in cases when the stock of assets changes at an irregular pace. Or even other methods. The natural gas reserves of the Netherlands are valued using a three year average of market prices. Sometimes it’s stated that assets should be valued by discounting the expected flow of future monetary benefits to gauge the value of assets. In ESA 2010, this method is mentioned – but as a method of last resort. Statisticians deplore discounting expected future flows of income as expectations as well as interest rates as well as available technologies change all the time in unpredictable ways (Knibbe 2014). Discounting just does not deliver any kind of stable estimate. This does not mean that the other methods which are used do deliver any kind of estimate of the ‘true’ value of fixed capital. The value of fixed assets on the balance sheets is nothing more than a rather crude guess of some kind of value which itself changes all the time (this contrary to the value of the debts on the liability side!). This does not mean that those estimates are worthless. There are clear long term patterns. The post 1965 increase of the capital to GDP ratio in almost all western countries which is pointed out by Piketty (2013) were driven by increasing house and land prices (Knibbe 2014; Rognlie 2015) – prices which are used by households to plan their future (and which through connections with lending and borrowing brought down the western economic model in 2008). The momentous run up of household debt alone warrants some kind of estimate of the value of the assets at the other side of the balance sheet. But it is a crude shot at a fast moving target. More about the value of capital and the way economists tried to circumvent the valuation problems in the next paragraph.

  1. Capital in neoclassical macro models

A decrease in the real interest rate from 3% to 2% is a 33% decline. In neoclassical macro-models this tends, as the amount of fixed capital is related to the interest rate as well as a (stable) depreciation rate, to lead to an immediate increase of the capital/output ratio of about the same magnitude unless some kind of friction is introduced into the model. What does this tell us about the nature of ‘fixed capital’ in these models? Typically, neoclassical macro-models do not provide detailed discussions of the conceptual nature of the variables they use while – quite an omission when we compare neoclassical economics with other branches of science – no manual or anything like it is available. This means that we have to read between the lines of texts for the implicit neoclassical definition of capital. As stated before we will base ourselves mainly on ECB DSGE models, fortunately a recent ECB text which extends the neoclassical concept of capital as used in DSGE models has been published (Bokan et al. 2016). First we will however delve a little into the history of the concept of capital in the history of neoclassical economics.

An important name is John Bates Clark who, to counter the ideas of Henry George (Mason 1994), purged ‘land’ and unproduced inputs from the neoclassical concept of capital by focusing on the liability side of the balance sheet and the fact that the total value of liabilities was ‘eternal’ and not dependent on the fixed assets in question, which (except land) would wither away anyway (Clark 1899 IX.7)). Clark was criticized for using a ‘jelly’ concept of capital already in 1907 by Böhm-Bawerk (as quoted in Cohen and Harcourt, 2003). Reading Clark this does not seem just: subsequent economists, not Clark, mixed up the asset and the liability side of the balance sheet – Clark is only guilty of using the marginalist idea that economic classes (for instance: land owners) do not matter and stating that it is the liability side which really matters. I could find no mention of the ‘one good’ idea of fixed capital, used by Solow, in the work of Clark (which I did not read in its entirety).6 And the posts on the liability side are of course highly substitutable and ’eternal’ (a main point of Piketty 2014A). But the idea that as firms can substitute fixed assets for others society can do so, too, is a fallacy of composition. Firms can divest or purchase existing assets (though even these possibilities are limited) while this does not necessarily have to lead to a change in the total value of the balance sheet. But on a national scale this does not lead to a change in the physical composition of the stock of capital. And we’ve already seen that, taking a historical view, it is quite complicated to make an estimate of the volume of fixed assets.. Only looking at the liability side doesn’t solve this problem.

A second defining moment was the publication of the growth theory of Solow (Solow 1956). He did look at fixed assets. Unlike Clark, Solow explicitly rejected ‘land’ from his analysis and understood fixed capital as a ‘one good’ concept to solve the problems of composition. He had some empirical (though not convincing) reasons to do this as his article was published when ‘land’ had reached a historical minimum as part of the stock of capital (see the data in Piketty, 2014). A theoretical reason to do this was however that one of the basic rules of accounting is that land itself does not depreciate, including a non-depreciating non-produced kind of capital in his model would have played havoc with the way his model crucially relates the stock of capital and the capital/output ratio to investment and depreciation. Another reason to do this is that supposing the existance of one good which could be both an investment good and a consumer good enables the economist to deflate the stock of fixed assets with the consumer price index. None of these reasons is very convincing.

A third defining moment was the fall out of the ‘battle of the Cambridges’. After World War II economists increasingly focused on estimates of the stock of fixed capital and growth theory. A side show of this tendency was this confusing discussion that was in the end about the obvious (but not very neoclassical) fact that when you have an existing stock of capital and interest rates change the existing stock of fixed capital (which includes capital/labour ratios) won’t change in any immediate way, which is however what neoclassical models imply (remember the 33% above). But the composition of the existing stock of capital does matter. Even when oil prices decline and interest rates rise, many existing oil wells will keep producing. The practical solution to this problem was to get rid of ‘jelly’ and to use so called putt-clay models, which used different vintages, every vintage with its own labour/capital ratio. See also footnote 17 in Stiglitz, 2006. An example of this approach is Wei, 2003. Another modelling solution will be discussed below.

A fourth defining moment was Samuelson’s definition of public goods and, hence, the introduction of government fixed capital into the corpus of neoclassical economics. In the course of the twentieth century, government investment and government owned capital goods had become ever more important. The Hoover dam in the USA, the Afsluitdijk in the Netherlands and the highways in Germany (Konrad Adenauer opened the Bonn-Cologne highway in 1932) are iconic examples. Samuelson’s theory of public goods incorporated such investments into the corpus of neoclassical ideas.

A fifth defining moment was the introduction of neoclassical DSGE macro-models (first originated as Real Business Cycle models) which in the cases in which they model capital discarded government owned produced and non-produced capital, did not use the putty-clay models in vogue by earlier generations of neoclassical economists. In almost all DSGE models the government is however not more than a set of monetary rules and a redistribution mechanism and government expenditure, including government investment in dams, dykes and roads, is considered to be wasteful by definition – it just diminishes the amount of goods available for consumption or private investment. The ‘putty clay’ models of existing capital as well as the idea of government capital were abandoned without even discussing them. Capital is also defined as by definition yielding a rent income, resale value of ‘valuables’ or production costs foregone are not important.

This leaves modern neoclassical macro-models with a limited set of capital goods: private, produced fixed capital with a ‘jelly’ structure which can be rented. Bokan et al. also adhere to the ‘one good’ idea of an economy. “Final goods can be used both for private consumption and investment”, while the model at the same time states that all final goods are the same. There is no difference between a plane and a haircut. This enables ‘total substitutability’ between investment goods and consumer goods. A plane and a haircut are the same. The total substitutability of capital in DSGE models causes modelling problems. On ‘Stackexchange’ (a site where economists can pose questions to other economists) one question was (New Keynesian models are neoclassical macro-models):

In New Keynesian models, like the ones in Gali’s simple New Keynesian model or even Mankiw-Reis NK model on sticky information, capital is often not included. Now people do say that there are modeling difficulties and that’s why capital (K) is not included, but is there another justifiable reason…?

Part of the answer was, “Capital is included in all the big estimated New Keynesian models”. But also:

you’re absolutely right that the stylized core NK model does not have capital – which is hard to defend on empirical grounds, since capital investment is a very important part of business cycle fluctuations and the response to monetary policy.

The reason given why it is often excluded is enlightening:

the two core equations (the intertemporal Euler equation and New Keynesian Phillips curve) of the ordinary log-linearized NK model are completely forward-looking. Adding K to the mix eliminates this nice analytical feature” and ”seemingly small changes in the real interest rate must be accompanied by massive swings in the capital-output ratio, which we never see in practice’ and ‘Capital adjustment costs are needed to avoid absurd results’.

The models do not specify the nature of these ad-hoc adjustment costs in any way. Bokan et al. also introduce two kinds of fixed capital into their model and have to be lauded for this: real estate as well as ‘other fixed capital’. ”Households and entrepreneurs demand real estate, which is assumed to be nontradable across countries and in fixed (per capita) aggregate supply” (Bokan et al. 2016). The nontradeability of houses across countries limits the substitutability, which enables Bokan et al. to model asset price bubbles caused by international flows of capital.

A most remarkable aspect of Bokan et al. is that introducing ownership of capital into their model also necessitates them to introduce economic classes – the very idea that Clark and other marginalists had purged from economics. This makes their model clearly less neoclassical and (in combination with a flexible concept of capital – more classical and indeed almost Marxist.7 It distinguishes between a class of ‘entrepreneurs’ (10% of the population, might we call them ‘capitalists’?) who own all fixed capital (called physical capital in the model) as well as a lot of real estate, a class of ‘normal’ households (labourers?) who seem to have nothing to sell but their labour and which are subdivided into ‘patient’ (which lend deposit money to the banks) and not so ‘patient’ households (who are borrowing existing deposit money from the banks). Aside from this there are some bankers. Capital as well as real estate is used in a Cobb-Douglas production function which related the model to growth theory. In technical terms the authors seem to have a putty-putty as well as a putty/clay model of capital in the sense that normal fixed capital seems to be totally substitutable while real estate has a fixed relation to labour and does not seem to be substitutable at all. ”Households and entrepreneurs demand real estate, which is assumed to be nontradable across countries and in fixed (per capita) aggregate supply”.

Reading the Bokan paper it seems as if the authors are in a naïve way unaware of their introduction of elements of political economy (economic classes) as well as, next to the standard DSGE putty-putty production function, a kind of putty-clay production function into their model (houses in their production function). Next to this, they also introduce at least elements of stock-flow consistent modelling into their model. And they acknowledge the destabilising nature of institutional deregulation in combination with international capital flows. They however do not try in any way to compare these theoretical concepts – none of which are discussed in a meaningful way – with the rich array of empirical estimates we have about these concepts or earlier literature. Still, it is fascinating to see how a number of European economists who are not aware of the ‘Chicago’ tradition and who try to make sense of the post 2008 world reintroduce all kind of classical elements into their models, as well as old school improvements. But again: the empirical and theoretical discussion of these improvements is woefully lacking.

  1. A Comparison

The information above leads to the next comparison of fixed capital the models and the accounts:

National Accounts Neoclassical macro models
Basic method of accounting Quadruple accounting (for the stock flow consistent idea even eightfold accounting, see Bos 2000). Basically single accounting though inclusion of a financial sector in the models by necessity leads to more emphasis on double and even quadruple accounting
Basic method of valuation Using market or cost prices or estimates of replacement costs Model consistent valuations (a mark-up on the consumer price level)
Contains not owned natural capital (including human capital) No No
Contains owned ‘unproduced’ natural capital, like land and subsoil stocks of oil Yes No
Contains owned ‘unproduced’ human capital, like production permits Yes No
Contains government owned produced capital, like coastal defences Yes No in the case of DSGE models, yes in the case of growth models. DSGE which acknowledge the existence of productive government capital exist but this idea is not incorporated in our benchmark ECB models.
Contains accounts for Household, company and non-financial monetary institutions owned produced capital Yes Yes but not explicit. NPISH and monetary financial institutions, i.e. money creating banks, are excluded.
Contains accounts for financial monetary institutions and Non Profit Institutions Serving Households (NPISH) owned produced capital Yes No
A distinction between capitalists (‘entrepreneurs’) and labour exists No Yes
Nature of fixed capital Heterogeneous with regard to composition and depreciation rates, detailed classification of items exists. Capital can only in special cases be used for household consumption (i.e. second hand cars). Defining criterion is ‘possible future economic benefits’ which include resale value and production costs foregone. Except for distinction between real estate and other capital: homogenous. All capital can be used for household consumption instead of production. Capital yields rents, no other monetary benefits are acknowledged.
Measured or derived price of existing capital Measured amalgam of cost prices, perpetual inventory methods, replacement prices and the market price of items which are sold on the second hand market. Only a limited relation with investment prices. Derived mark-up on consumer prices which is influenced by borrowing behaviour and borrowing rules, as all capital is ‘jelly’ all capital has the price of investments of period t.
Stock-flow consistent with production accounts? Partly. Autonomous price changes of assets (houses, sub-soil assets) are excluded and declines of the stock of natural assets are not subtracted from GDP. Autonomous price changes might overwhelm investments. Grave measurement issues. To a limited extent. There is no unproduced capital, but prices changes because of exogenous changes in the financial market do exist.
Sectoral consistent (sectoral balance sheets match with each other) Yes (but measurement problems with NIIP) Theoretically: yes. But sectoral division is incomplete (government, NPISH and monetary financial institutions are excluded).
Nature of financial market Money creating banks plus loanable funds. Loanable funds, with international flows of capital.


Bokan, Nikola, Andrea Gerali, Sandra Gomes, Pascal Jacquinot and Massimiliano Pisani (2016). ‘EAGLE-FLI. A macroeconomic model of banking and financial interdependence in the euro area’, European Central Bank working paper series no. 1923. Available here.

Bureau of meteorology (2013). ‘The environmental accounts landscape’. Environmental information program publication series no 1. Canberra. Available here.

Clark, John Bates (1899). The distribution of wealth. A theory of wages, interest and profits. New York: The MacMillan Company. Available here.

Cohen, Avi and G. Harcourt (2003). ‘Whatever happened to the Cambridge capital theory controversies’, Journal of Economic Perspectives 17-1 pp. 199-214.

Eurostat/European Commission (2013). European system of accounts ESA 2010, available here.

Groote, Peter (1995). Kapitaalvorming in infrastructuur in Nederland 1800-1913. Capelle aan den Ijssel: Labyrinth publication.

Hudson, Michael (2012). Finance capitalism and its discontents. Dresden: Islet.

Knibbe, Merijn (2014). “The growth of Capital: Piketty, Harrod-Domar, Solow and the long run development of the rate of investment”, Real-world economics review 69 pp. 100-121. Available here.

Lafrance, Adrienna (April 5, 2016). ‘A history of technology, via the consumer price index. The story of America’s relationship with appliances and gadgets, as seen in seven decades of government statistics’’, The Atlantic. Available here.

Mason, Gaffney (1994). ‘Neoclassical economics as a stratagem against Henry George’ in: Fred Harrison and Mason Gaffney (eds.), The corruption of economics pp. 29-164. London: Shepheard-Walwyn. Available here.

Monfreda,C., M. Wackernagel, D. Deumling (2004). ‘Establishing national natural capital accounts based on detailed Ecological Footprint and biological capacity assessments’. Landuse policy 21 pp231-246.

Piketty, T. (2014A). Capital in the Twenty First century. Harvard: The Belknap press of Harvard University Press. Originally printed in French in 2013 as: ‘La capital au XXI siècle’.

Piketty, T. (2014B), ’Technical appendix of the book ‘Capital in the twentieth century’, Harvard University Press, available at` (assessed July 10, 2014).

Rognlie, Matthew (2015). ‘Deciphering the fall and rise in the net capital share’, Brooking papers on economic activity. BPEA conference. Available here.

Solow, R. M. (1956). ‘A contribution to the theory of economic growth’, The quarterly journal of economics 70-1 pp. 65-94.

Stiglitz, Joseph. “Samuelson and the Factor Bias of Technological Change: Toward a Unified Theory of Growth and Unemployment,” in Samuelsonian Economics and the Twenty-First Century, Michael Szenberg, et al. eds., Oxford University Press, pp. 235-251



  1. He did introduce the idea of the representative consumer.
  2. Classical economists, including Marx and Mises (in his Ph. D thesis), used an economic definition of classes. Your economic position (labourer, capital owner) and not for instance your education, profession and income define your class.
  3. These problems might also be understood as basic characteristics of the dynamism of our economy, which to me seems a more fruitful way to think about them. A good example of the insights an analysis of these developments yields: Lafranc 2016.
  4. My opinion: as the national accounts more or less define fixed assets as a factor of distribution it seems all right to me to include production permits and the like into the concept. R&D is however a ‘sunk cost’ as well as, in business accounts, not treated as an investment. It might yield patents which can be included in our concept of capital. But R&D itself should be excluded even when it yields a whole bunch of small but significant improvements in quality or productivity.
  5. The ‘7.26’ is a lemma of the ESA 2010 manual..
  6. The concept of ‘land’ sometimes leads to confusion. It relates to ‘unimproved’ land and is more or less the ‘location, location, location’ value of real estate.
  7. Consumer durables do have a second hand value and can be included, as happens in the USA flow of funds statistics.

From: pp.8-17 of World Economics Association Newsletter 6(4), August 2016

Download WEA newsletter Volume 6, Issue No. 4, August 2016 ›

2 responses

  • David Harold Chester says:

    In note 6 and in the place where it refers, there is great confusion. Land has value which depends on its location but whether it is in proper use or not, it “creates” a rent in a continuous manner. Henry George argues that this ground-rent should be returned to the government since morally, most of the value of the land is due to the density of its nearby population. Thus city centers are very costly to use whilst farm land has little value when the same amount is being considered. It is important to include the land in any model for representing the national economy and it is equally important not to miss out other parts of the whole social system.

    before discussing these subjects it is necessary to get the terms properly defined and this problem (the one of correct language) can be so serious that a) we don’t really understand each other and b) if we did, then we would not agree. This is why graphic models have such significance here and allow us to be more specific.

  • Peter Groote says:

    A remark on the suggestion that in national accounting stocks of fixed capital are often deflated with an investment deflator (which would indeed be problematic). Normally, however, one would use the perpetual inventory method for building stocks of capital (net or gross) from flows (of investment, scrapping and depreciation) in constant prices. So the flows are deflated, but the stocks do not need to be as they are by definition in constant prices. This is exactly what I did in for the Netherlands capital stock in infrastructure 1800-1913, as referenced in the text. So not a problem if stocks are built the way they are supposed to be …

Respond to this article

You may use these HTML tags and attributes: <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <strike> <strong>

Please note that your email address will not be published.