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Financial/physical capital

Physical capital includes fixed assets in production processes, which can be tangible (e.g., machinery, buildings, houses, roads) or intangible (e.g., computer software, intellectual property) (Statistics New Zealand, 2009). Financial capital includes equities, assets and liabilities that have a degree of liquidity, such as bank deposits, debt, and government bonds (Statistics New Zealand, 2009).

The level of financial and physical capital (economic wealth) and associated income flow that an individual or household has are important determinants of their material standard of living, now and over time (Stiglitz et al., 2009). Supplemented by government-provided benefits (in cash and in kind), wealth and income determine an individual or household's ability to consume market-produced goods and services.

The stock of financial wealth - be it in the form of bank deposits, financial investments, or superannuation accounts - provides people with opportunities to consume and to invest, and the financial security to take risks. Wealth can be consumed by running down assets or increasing debt, or it can be invested to generate future income flows. Increased savings (obtained either by reducing consumption relative to income or by holding an asset that has increased in value) will also add to wealth, and will therefore allow higher future consumption. In contrast, increased debt levels represent higher consumption today and must be paid for by reduced consumption in the future. Further, high public and private (national) indebtedness may increase vulnerabilities to future credit shocks, which can undermine incomes and require costly government responses. Measures of wealth that include savings and debt levels are therefore "an important indicator of the sustainability of consumption" (Stiglitz et al., 2009, p.29).

The stock of physical assets such as infrastructure and housing is also an important component of an individual, household, or country's wealth. Well-functioning infrastructure, including roads, airports and telecommunications systems, helps enable economic growth and social cohesion (New Zealand Government, 2010). Adequate housing in particular is recognised as being an important contributor to other factors that underpin living standards, such as health (Howden-Chapman et al., 2007). Housing is also directly amenable to policy interventions, for example through "ownership and maintenance of public housing stock, the availability of housing benefits, and laws against local pollution" (OECD, 2009b, p.37). The importance of housing is reflected in the fact that it is included as a key indicator (in the form of adequacy of facilities and number of rooms per person) in a forthcoming OECD Compendium of Key Wellbeing Indicators (OECD, 2011d).

Income is a flow, generated from economic production, wages and investment. As income is generally expressed in monetary terms, it is discussed primarily in this section, although it is underpinned by human, social and natural capital. Income is critical for material living standards because of its direct link to consumption, as "a large portion of what matters to individuals and families has to be paid for" (Treasury, 1999, p.11).

Not having adequate income is a key characteristic of poverty and social exclusion (Sen, 1999). Economic participation also contributes to living standards in non-material ways, through the sense of identity and self-confidence it provides. In addition, the ability to participate in voluntary economic exchanges is widely seen as an important individual right (Treasury, 2001a).[10] While income has traditionally been measured on a per person basis, recent literature emphasises the importance of measuring it at the household level (e.g., Stiglitz et al., 2009). This is because the income (and wealth) that an individual has available to them is typically a function of the household they live in. In practice, however, defining households in a meaningful way makes measurement at this level difficult.

The government provides a variety of income transfers (such as the unemployment benefit and New Zealand superannuation) and in-kind services (such as subsidised health care, educational services and the provision of infrastructure). These services (which add to an individual's income to produce what is referred to as final income) are often a substitute for, or a supplement to, household income, and will directly influence the level of consumption that the household can sustain (Stiglitz et al., 2009; OECD, 2010a-d; Treasury, 2010h).

The sustainability of income transfers and in-kind services is related to the fiscal position of the government. The same principle of sustainable consumption that applies at the household level also applies to the government and the economy as a whole (Stiglitz et al., 2009). The stock of physical assets the government owns and its balance of savings and debt determine the sustainability of the level of services the government provides (Treasury, 2001a, 2010c). As the government is ultimately owned by households, the wealth of households can be effectively augmented or reduced by the fiscal position of government.

Income measures should be considered alongside measures of consumption and wealth to provide a fuller picture of consumption possibilities. Income can differ over time without compromising a person's consumption possibilities as long as their longer-term income expectations (or permanent income) do not change (Friedman, 1957). While permanently low income levels are likely to have a significant negative effect on living standards, transitory short-term decreases in income are not. This is especially true if the person owns assets that can either be sold, or provide consumption benefits, such as housing. Consequently, for policy making purposes it is important to consider whether people's circumstances are transitory or permanent, and what the dynamic impacts of policy are likely to be on different groups.

Income is most commonly generated through employment. Employment affects living standards in two key ways. Firstly, it increases income, which leads directly to an increase in living standards for the individual, and also helps people improve their human capital and future earnings potential. Secondly, the additional living standards benefits from employment, over and above the impact of increased income, are significant. As noted in section two, the subjective wellbeing literature consistently finds that being in employment is one of the most important factors for an individual's happiness or life satisfaction, independent of the income that such employment provides (Jenkins, 2001; Layard, 2005; Veenhoven, 2007). Job quality varies and can affect the extent of benefits accordingly. But even low-wage, low-skill jobs are usually better for those in a position to work than no job at all.

Conversely, job loss and the resulting drop in income and experience of unemployment - particularly long-term unemployment - have a detrimental effect on personal wellbeing beyond the loss of income (Treasury, 2001a; Layard, 2005; Treasury, 2010d). Where job losses are widespread in particular areas, whole communities can be disrupted both socially and economically. This occurred in the 1980s in New Zealand and is currently occurring in some communities in the aftermath of the recent recession.

Paid employment also has a number of benefits from a national perspective, such as raising economic output and income per capita, and improving the government's fiscal position by providing tax revenue and reducing the demand for income and in-kind transfers. As the population ages, it will become increasingly important to raise participation rates among people of working age and those past the current retirement age in order to maintain economic growth and the government's fiscal position (Treasury, 2001a).

Unpaid employment also produces many of the above benefits, to varying degrees. Much unpaid work involves the provision of services that would otherwise need to be paid for, such as household chores, cooking, cleaning and caring for children. These tasks are of substantial economic value, regardless of whether money changes hands or not. Unpaid work can also have significant wellbeing benefits. For example, volunteering in the community improves the wellbeing of the volunteer as well as those they are assisting, particularly when it involves engaging with other people.

While employment generates a raft of material and non-material benefits, it is not a case of more is always better. As jobs become more demanding and stressful the psychological benefits diminish and they may become harmful (Treasury, 2001a). There is also a trade-off between work - whether paid or unpaid - and the amount of leisure time people have. The subjective wellbeing literature indicates that the amount of leisure time people have and how they spend it is important for living standards (Layard, 2005; OECD, 2009a). Leisure time spent doing recreational activities, building social relationships and engaging in community activities is particularly beneficial for personal health and social cohesion (OECD, 2009a). The income-leisure trade-off is one area where the importance of productivity is apparent. Higher labour productivity allows for higher incomes with the same amount of work effort, or, conversely, more leisure for the same amount of income (Treasury, 2010c).

Notes

  • [10]Sen (1999, p.6), for example, speaks about the right of people to free exchange: "To be generically against markets would be almost as odd as being generically against conversations between people".
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