The 2008 global financial crisis changed the way the world looks at balance sheets. Now, an even more profound transformation is needed – one that recognizes the limits of narrow national-level accounting.
Balance sheets balance. This is the beauty of double-entry bookkeeping: an economic entity’s assets must ultimately be equal to its liabilities. When they are not – when the income from assets, including the ability to secure additional finance, falls short of liability-related obligations – crises become inevitable.
For many decades, economists did not pay much attention to the stocks of assets and liabilities contained within balance sheets. Instead, they focused on flows, such as GDP, savings and trade.
That changed in 2008. The global financial crisis reminded the world that when liabilities are hidden in off-balance-sheet vehicles or offshore, they end up becoming, in the words of the American investor Warren Buffett, “financial weapons of mass destruction”. As it turned out, macro disasters have micro and local components, which policymakers had ignored or missed.
After the global financial crisis, the Organization for Economic Coordination and Development began nudging its member countries to produce national balance sheets that would enable authorities to monitor not only fiscal and trade surpluses or deficits, but also the size of private and public debts and leverage ratios. Today, most G20 countries produce national balance sheets, albeit of varying quality.
But, in our globalized world, economies don’t operate independently of one another. That is why McKinsey Global Institute (MGI) has compiled a “global” balance sheet comprising the assets and liabilities of the world’s ten largest national economies – Australia, Canada, China, France, Germany, Japan, Mexico, Sweden, the United Kingdom, and the United States – which together account for 60% of global income.
In the first two decades of this century, this shared balance sheet has ballooned, despite tepid global GDP growth. Total assets grew from US$440 trillion (about 13.2 times GDP in 2000) to more than US$1.5 quadrillion in 2020. And the economy’s net worth (assets minus liabilities) grew from US$160 trillion to US$510 trillion (a 219% increase).
At the consolidated global level, net worth is equivalent to the value of real assets, because financial assets and liabilities cancel each other out. But, because the price of money is influenced by the quantity of money (which commercial and central banks create by increasing debt), that value grows as interest rates and rent yields fall.
Since 2000, low interest rates have fuelled asset price increases above inflation, with saving and investment accounting for only 28% of total growth in net worth. As a result, net worth in 2020 was nearly 50% higher, relative to income, than the long-run average for the 1970-99 period. This highlights the financial sector’s crucial role in determining the value of real assets, and thus the importance of accounting for the financial sector in policymaking.
MGI explains that it “borrows” the balance sheet – “a fundamental tool from the corporate world” – to assess the global economy’s health and resilience. And its “global” balance sheet is a good first step. But it is missing two crucial components: natural and human capital.
As it stands, few countries include natural or human capital in their balance sheets. It is thus impossible to say to what extent the expansion of net worth since 2000 came at the expense of natural capital or social well-being (such as through increased inequality).
With the adoption of the United Nations System of Environmental-Economic Accounting – Ecosystem Accounting this year, the stage is set for better natural-capital reporting. But the framework’s implementation has been delayed, and accounting of social inequalities is still lacking. Fortunately, environmental, social, and governance data are increasingly available – not least from corporations – and can serve as building blocks for more comprehensive balance sheets.
With national balance sheets that account for natural and human capital, policymakers would be far better equipped to make decisions that advance the well-being of their citizens and the environment. Yet, for maximum impact, national balance sheets must be consolidated into a single one-Earth balance sheet.
A one-Earth balance sheet would enable the world to improve overall resource allocation, deliver public goods, and ensure more inclusive development. For example, some worry that preserving and enhancing natural and human capital would mean accepting very low economic growth or even “degrowth”. But not all economies need rapid growth. Developing and emerging economies with younger populations do, because income growth is vital to poverty reduction. But advanced economies with aging populations can maintain high standards of living without it.
This demonstrates how a one-Earth balance sheet can help us to avoid the tragedy of the commons, when countries pursue beggar-thy-neighbour policies, at the expense of global public goods. But such a balance sheet would also go a long way toward averting the tragedy of the horizon: when countries lack incentive to pursue policies today to ensure the well-being of future generations, especially by tackling climate change. By building duration into balance sheets, the time dimension forces us all to take a longer-term view.
For this to work, the one-Earth perspective must be embraced at all levels. After all, global progress – for example, toward achieving the goals set out in the Paris climate agreement and reaffirmed at the recent UN Climate Change Conference (COP26) in Glasgow – can be more than the sum of local achievements.
All politics is local. But it is shaped by a fast-changing global landscape. Only a one-Earth balance sheet – a bottom-up reset of how we measure global wealth – can ensure that countries work toward a better future for all.
Andrew Sheng is a distinguished fellow at the Asia Global Institute at the University of Hong Kong and a member of the UNEP Advisory Council on Sustainable Finance; and Xiao Geng is chairman of the Hong Kong Institution for International Finance and a professor and director of the Institute of Policy and Practice at the Shenzhen Finance Institute at The Chinese University of Hong Kong, Shenzhen.
Copyright: Project Syndicate