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A capital stocks and flows approach

To allow the Treasury to incorporate a broad range of material and non-material factors, distributional concerns, and dynamic considerations, a 'capital stocks and flows' approach is used as the basis for the Framework. This approach borrows the concept of capital from economics - traditionally used to refer to assets that enable future flows of real income, such as building and machinery. The notion of an asset that can be built up for future use has subsequently been broadened to include natural (OECD, 2001) and human capital (Schultz, 1961; Becker, 1964). Recently, the importance of social capital has been recognised (Coleman, 1986; Kulig et al., 2010), and cultural aspects are sometimes included (Bourdieu, 1986; Dalziel et al., 2009).

The Framework comprises four types of capital that are integral to current and future living standards:

  1. financial and physical capital;
  2. human capital;
  3. social capital; and
  4. natural capital.

These four capital stocks (cultural aspects are included in human, social and natural capital) make up the national wealth of New Zealand. As illustrated below, the Framework recognises that there are a range of different stocks within each of the four types of capital. These stocks create flows of goods and services that contribute to the living standards of New Zealanders. In using certain capital stocks and flows other forms of capital (and flows) may also be affected. These effects may be positive (increasing one form of capital may lead to flows of services that benefit other forms of capital) or negative (increasing one stock of capital may undermine others). The effects may also be distributed unevenly across current and future generations.

Figure 2 - Treasury's Living Standards Framework
Figure 2 - Treasury's Living Standards Framework.

The Framework is a complementary input to the policy process, rather than an analytical, prioritisation or decision-making tool in its own right. It can be used to illustrate the potential trade-offs and synergies that exist within public policy issues, as well as informing Ministers of distributional outcomes. For example, the government may wish to invest more in education to increase skills in the general population. This will come at a cost of either a reduction in financial wealth for the government (and possibly an associated increased level of debt) or a reduction in other in-kind services, which may disproportionally affect certain groups. The benefits of increasing skills are greater levels of employment and income that add to the financial wealth of both government (through taxes) and households. Greater income may also increase consumption, which may have an impact on other stocks of capital such as the health of the population and water quality.

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