The IMF's Statistical Systems in Context of Revision of the United Nations' A System of National Accounts IMF's Statistical Systems in Context of ... United Nations' a System of National Accounts 1557751595, 9781557751591

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The IMF's Statistical Systems in Context of Revision of the United Nations' A System of National Accounts IMF's Statistical Systems in Context of ... United Nations' a System of National Accounts
 1557751595, 9781557751591

Table of contents :
Cover
Title Page
Copyright Page
Table of Contents
Foreword
Preface
Introduction
Part I: External Sector Transactions
1. Residents of an Economy
2. Treatment of International Organizations
3. Change of Ownership and Time of Recording in the National Accounts
4. Conversion of Balance of Payments Transactions as a Source of Valuation Changes: Problems, Principles, and Practical Solutions
5. Currency Conversion in a Multiple Exchange Rate System
6. Treatment of Exchange Rate Differentials in the National Accounts
7. Harmonization of the Classification of External Current Account Transactions
8. Proposed Treatment of Reinvested Earnings on Direct Investment
9. Classification of International Transactions in Services, Income, and Unrequited Current Transfers
10. Measurement of a Nation's Terms of Trade Effect and Real National Disposable Income within a National Accounting Framework
11. Classification of Capital Account Transactions
12. Classification of Corporate Enterprises
13. New Financial Instruments and the Balance of Payments
14. Classification of Transactions in Zero-Coupon Bonds, Junk Bonds, and Indexed Bonds in the Balance of Payments
15. Some Issues in the Balance of Payments Presentation of Arrears and Debt Reorganization
Part II: Public Sector Accounts
16. A Discussion of Public Sector Accounts
17. An Example of Progress in Delineating Relationships between Government Finance Statistics and National Accounts Concepts
18. Overall Relationships between the IMF's Government Finance Statistics and A System of National Accounts
19. Derivation of System of National Accounts Value from Government Finance Statistics Data
20. Sectorization of Social Security Funds
Part III: Financial Flows and Balances
21. Flow-of-Funds Accounts, A System of National Accounts, and Developing Countries
22. The Financial Sector
23. Monetary Concepts and Definitions
24. Repurchase Agreements and Financial Analysis
25. Recording of Financial and Operational Leases and of Income on Zero- and Low-Coupon Bonds Balance of Payments Division
26. Financial Leasing
27. Treatment of Deep-Discounted and Index-Linked Bonds in the National Accounts
28. Principles of Valuation and Reconciliation Items in the IMF's Money and Banking Statistics and A System of National Accounts
29. Treatment of Output in the Banking Industry
30. A Further Look at the Treatment of Insurance in A System of National Accounts
31. How to Treat Nonproduced Assets and Exceptional Events in the National Accounts? Considerations on the Variations in Wealth Accounting
32. Fixed Capital Formation by Owner and User
Contributors
Abbreviations
Back Cover

Citation preview

THEIMF'S STATISTICAL SYSTEMS in Context of Revision of the United Nations' A System of National Accounts

As of May 1,1991, while this book was in press, the IMF's Bureau of Statistics became the Statistics Department of the Fund. Consequently, all references to the Bureau of Statistics herein should be understood to refer to the Statistics Department.

THEIMF'S STATISTICAL SYSTEMS in Context of Revision of the United Nations' A System ofNational Accounts

Statistics Department Edited by Vicente Galbis

International Monetary Fund Washington, D.C. • 1991

© 1991 International Monetary Fund Reprinted May 1995

Library of Congress Cataloging-in-Publication Data The IMP's statistical systems in context of revision of the United Nations' A system of national accounts I Statistics Department; edited by Vicente Galbis p. em. "A selection of papers presented at three expert group meetings sponsored by the Fund in 1987-88" -Foreword. Includes bibliographical references. ISBN 1-55775-159-5 1. National income-Accounting. I. Galbis, Vicente, 1942ll. International Monetary Fund. Statistics Dept. lll. International Monetary Fund. HC79.15144 1991 339.3'2'015195- dc20 91-2489 CIP Both this book's cover and its interior were designed by the IMF Graphics Section. The following symbols have been used throughout this book: to indicate that data are not available; to indicate that the figure is zero or less than half the final digit shown, or that the item does not exist; Between years or months (e.g., 1991-92 or January-June) to indicate the years or months covered, including the beginning and ending years or months; Between years (e.g., 1991/92) to indicate a crop or fiscal (financial) year. "Billion" means a thousand million. Details may not add to totals shown because of rounding. The term "country," as used in this book, does not in all cases refer to a territorial entity that is a state as understood by international law and practice; the term also covers some territorial entities that are not states but for which statistical data are maintained and provided internationally on a separate and independent basis.

Price: US$35.00 Address orders to: External Relations Department, Publication Services International Monetary Fund, Washington D.C. 20431, U.S.A. Telephone: (202) 623-7430 Telefax: (202) 623-7201 Cable: Interfund internet: publications @imf.org recycled paper

Foreword HE INTERNATIONAL MONETARY FUND has always attached consider-

T able importance to the development of appropriate methodologies in its work in balance of payments, government finance, and monetary statistics. The Fund's contribution to the development of international statistics also takes other forms, including a system of statistical communications with member countries, technical assistance to member countries on statistical matters, cooperation in these matters with other international organizations, and compilation of its own statistical publications. The role of the IMF within the international statistical community has allowed the Fund to participate actively in the ongoing revision of the United Nations' A System of National Accounts (SNA), last revised in 1968. The work on revision of the SNA may be seen as part of the Fund's commitment to achieve a greater degree of coordination in the statistical field with other international agencies. The Fund has also begun to revise the fourth edition of its Balance of Payments Manual, issued in 1977, and to refine further its methodology for monetary statistics, based on the draft of A Guide to Money and Banking Statistics. A Manual on Government Finance Statistics was published by the Fund in 1986. The Fund hopes that these efforts will not only lead to methodological improvements and a greater consistency in national statistics but will also promote harmonization of these statistical systems among themselves and with the SNA. This volume contains a selection of papers presented at three expert group meetings sponsored by the Fund in 1987-88 for the revision of the SNA. These meetings dealt with issues in the balance of payments, government finance, and monetary statistics and were part of a sequence of expert group meetings organized by the interested international organizations to oversee the revision process. The papers place the Fund's statistical methodologies in the context of revision of the SNA and explain the contr;bution that the Fund has made, and can make, to the process of harmonization. Although the papers represent the views of individual contributors v

vi

FOREWORD

and not necessarily those of their respective institutions, I trust that they will be of interest to those whose task it is to compile macroeconomic statistics and to develop new ideas to cope with the challenges of the interrelation, simplification, and evolution of these statistics. MICHEL CAMDESSUS

Managing Director International Monetary Fund

Preface session in 1981 the Statistical Commission of

A the United Nations discussed proposals for improvement of the T ITS TWENTY-FIRST

United Nations' A System of National Accounts (SNA), last published in 1968. Following this, an Expert Group Meeting on the Review and Development of the SNA, held in New York in March 1982, recommended that a long-term review of the SNA be undertaken to produce a revised SNA. To assist in this process, the Intersecretariat Working Group on National Accounts-a group comprising representatives of the UN, the Organization for Economic Cooperation and Development (OECD), the European Community (EC), the World Bank, the IMF and the five UN Regional Economic Commissionswas established. The main goals set for the revision of the SNA were to simplify the 1968 SNA so that it will be more directly relevant to the needs of member countries; to resolve methodological issues and internal inconsistencies noted since publication of the 1968 SNA; and to harmonize the SNA as much as possible with related statistical systems, especially the Fund's systems and methodologies relating to balance of payments, government finance, and monetary statistics. The revision process has centered on a series of meetings of expert groups composed of national experts and the members of the Intersecretariat Working Group. In 1987 and 1988 the Fund sponsored three of these expert group meetings. They dealt with external sector transactions (March 23-April2, 1987), public sector accounts Oanuary 25-29, 1988), and financial flows and balances (September 6-15, 1988). This volume contains a selection of the papers prepared for the expert group meetings sponsored by the Fund. The structure of the volume has three parts, corresponding to the issues discussed at each of the three meetings. In all, 32 papers are presented, most of them short. A brief introduction has been provided by the editor. Some of the papers have been modified for publication, with certain material, especially annexes and appendices, deleted to simplify and shorten the presentation or to avoid unnecessary repetition. The papers have vii

viii

PREFACE

not been reviry and financing aspect, payments-based accounting recognizes only one transaction. Under this accounting regime, transactions will be recorded only when a payment of cash is involved, and such transactions will be recorded when that payment is made. Neither transactions covering the supply of resources without cash payments, nor the financing (or credit) associated with transactions that involve cash payments, will be recorded. In a world in which transfers between economies are significant, barter and financing transactions are voluminous, and the many forms of financing are of concern to governments, the coverage and timing characteristics of a payments- or cash-based system of

CHANGE OF OWNERSHIP AND TIME OF RECORDING

33

accounting make its application unsuitable for meaningful national accounting compilation. The time of contract might also be considered an interesting piece of information. Contracts can be used for planning purposes, to meet delivery targets, to muster financial resources, and to project resource flows. By its very nature, however, a contract is contingent. Resource flows do not accompany the creation of a contract; rather, the parameters for subsequent resource flows are set by the contract. The time of the contract itself is, therefore, of no analytic value, but the informational content of a contract (prices, volumes, delivery dates, and the like) is relevant.

IV. Implementation of the Change-of-Ownership Principle The rules contained in the fourth edition of the BPM closely approximate the broader principle of ownership described in Section II. This section discusses possible improvements to some of these rules to match the time of recording more closely to the general principle (the first three subsections below), together with some discussion of particular issues for which the application of the rules may not be obvious (the fourth and fifth subsections below).

Transactions Between Affiliates Goods and services passing between components of the same legal entity should be recorded when control of the goods passes from one component to another. The capital account entries reflecting the financing of the goods and services should be recorded simultaneously. However, the data sources often used for balance of payments compilation (that is, the customs and the exchange records) may not achieve the correct timing or may omit the transactions completely. Therefore, asymmetries may develop because recording of the goods and services flows is not matched by the recording of the corresponding financial flows or because the two transacting economies record the transactions at different times. (These problems also arise when transactions are to be recorded on the basis of the legal change of ownership.) Because it is likely that the transacting entities' records will reflect the principle of change in control, data from those entities should either replace the data from the customs and the exchange records or should be used to adjust them for the more significant transactions. The time of recording under this recommendation is

34

EXTERNAL SECTOR TRANSACTIONS

obviously associated with the general principle and may be different from the rule of thumb currently recommended (that is, the crossing of the exporter's customs frontier).

Financial Leases and Similar Arrangements Goods transferred under a financial lease present a problem similar to that for affiliated enterprises. Because legal change of ownership does not occur, a point for recording must be chosen that most closely approximates the change in control. As with goods transferred under a legal change of ownership and those transferred between affiliates, trade and exchange record data will not necessarily reflect a change in control. Control will pass, in the case of financial leases, at the commencement of the lease. Data sources from enterprises, used either for compiling or for adjusting other sources, should reflect this point in time. For arrangements similar to financial leases, a suitable trigger that identifies the change of ownership or control must be sought. Because of the variety of forms these financing arrangements may take, the guidelines cannot be specific. A long-term purchase contract or a management contract might provide evidence of a shift in control and of the risks of ownership. If so, then the commencement of these contracts would indicate the change of ownership. In other circumstances, different vehicles might be used, and the point that most closely approximates the change in ownership should be used for recording the transactions. Again, these points need not accord with the existing rule of thumb, which recommends the crossing of the exporter's customs frontier as the point at which entries are recorded.

Time of Recording for Income The currently recommended rule of thumb for recording interest in the national accounts is on a due-for-payment basis. This rule, however, can produce some anomalous entries in the balance of payments and reconciliation accounts of an economy. Consider the following example of a bond issued on day 1 of year 1, by economy A to economy B. The face value of the bond is 100 currency units, bearing annual interest coupons worth 12 units. The passage of time between coupon dates will result in economy B's holding an additional asset, accrued interest. Such an asset must be recognized, but no flow can be recorded to explain its emergence because the income, which gives rise to the asset, cannot be recorded until the coupon date. The recon-

35

CHANGE OF OWNERSHIP AND TIME OF RECORDING

Table 1. Recording_ Interest Income on Due-[or-Pa~ment Basis Balance of Payments Account Entr;r Economy A Interest paid Bonds issued Foreign currency balances EconomyB Bonds purchased Bonds sold Accrued interest asset Foreign currency balances EconomyC Interest received Bonds purchased Bonds sold Accrued interest asset Foreign currency balances EconomyD Bonds purchased Foreign currency balances

Year1 Credit Debit

Year2 Credit Debit 12

100 100

12

100 100 11

11 12 100

100

11

112

111

100 100

ciliation accounts must, therefore, show an unrealized valuation change. Further to the above example, economy B sells the bond 11 months after issue to economy C. Economy C sells the bond to economy D the day after the coupon date (day 1 of year 2). The balance of payments statements in Table 1 summarize these transactions. The current rule of thumb, together with the trading in the bond, require, among others, the following entries: the recording of an unrealized capital gain in the balance sheet for economy B, to be realized in the balance of payments accounts at sale; no income to be recorded for economy B despite the provision of capital; for economy C, a large income entry to be recorded, relative to the value of the asset and the holding period. The reconciliation accounts for economy C will also show a large unrealized capital loss over the short period for which the bond is held. The adoption of accrual accounting for interest income, in contrast, would see the recording of income, both payable and receivable, commensurate with the provision of capital. Thus the increasing value of the asset-accrued interest-held by economy B would be

36

EXTERNAL SECTOR TRANSACTIONS

Table 2. Record1ng Interest Income Under Accrual Accounting Balance of Payments Account Entry Economy A Interest payable Bonds issued Accrued interest liability Foreign currency balances EconomyB Interest receivable Bonds purchased Bonds sold Foreign currency balances EconomyC Interest receivable Bonds purchased Bonds sold Accrued interest asset Foreign currency balances Economy D Interest receivable Bonds purchased Accrued interest asset Foreign currency balances

Year1 Credit

Year2 Debit

Credit

12

Debit 12

100 12 100

12

11 100 100 11 1 100 12

100 12

111

112 12 100 12 100

recorded as a flow in the capital account and would be matched by income receivable in the current account. Economy C would record interest income only in proportion to the period for which it held the asset, and it would be measured as the difference between the amount paid for the accrued income asset and the amount received, which in this example is the coupon payment of 12 units less the purchase price of 11 units. No unrealized valuation changes are necessary for either economy B or C. Economy D would also record interest income, reflecting its provision of capital for year 2. The balance of payments accounts in Table 2 present the entries appropriate under accrual accounting. Adopting the accrual method of accounting for income not only avoids the need for the valuation changes but also matches the cost of capital with the provision of the capital. It results in a more meaningful analysis of debt servicing in the short term and avoids the possible understatement of current income and, therefore, of current account

CHANGE OF OWNERSHIP AND TIME OF RECORDING

37

surpluses that, under a due-for-payment basis, could be achieved through judicious acquisition and disposal policies timed to avoid coupon dates. A particular distortion arises in the case of deep-discounted bonds. These are issued with zero-coupon or low-coupon rates and at a discount that, on bonds with maturities of ten years or longer, can be 70 percent or more of the face value of the bond. The due-forpayment basis requires reporting this interest at maturity. An argument for recording interest on a due-for-payment basis is that some instruments are not negotiable, and the income cannot be realized before the coupon date. This is analogous to recording wages only on payday or goods transactions according to payment terms. Another argument is that data are only available for contract terms. This is unlikely, given modern commercial accounting standards and practices. Adopting the accrual method would result in interest being matched to the life of the debt while the capital account would reflect the increasing debt associated with accumulating interest. Stock data, incorporating the accrued interest (and dissected by maturity) would better reflect the liability of the debtor and the causes of that liability. Any asymmetry in current account measures of interest paid and received because of the inability of economies to report interest earned or accrued would be matched, and possibly be identifiable, by the asymmetry in the interest liability and asset reflected in the capital account. Where royalty and other property income payments are also payable at discrete points in time and where such payments represent the use of an intangible asset over a number of time periods, again the accrual basis, rather than the due-for-payment basis, would result in a proper matching of the use of an asset and the cost of that use. Provision and Time of Recording for Financial Items The BPM (paragraph 360) defines transactions in financial items to involve, in general, change in legal ownership. The exceptions it allows to legal change of ownership are the substitution of an imputed financial claim for (1) immovable assets held abroad and nonfinancial intangible assets issued abroad; (2) assets attributed to a notional branch; and (3) goods transferred under a financial lease. In these instances real resources are deemed to have changed control, and a financing transaction is imputed as the balancing entry in the accounts.

38

EXTERNAL SECTOR TRANSACTIONS

It is useful to consider what legal change of ownership of a financial claim means in general. Must the claim be legally enforceable? Outstanding claims for payment of smuggled goods might not be legally enforceable but certainly should be recognized, as noted earlier, if the change of ownership of the physical asset has been recognized. For that matter, the claims to contraband might not be legally enforceable but, as noted above, the present analysis recognizes claims to ownership of goods as sufficient. The corollary is similarly to recognize claims to financial claims. (Analogous problems will apply to the valuation of claims, where the parallel market price may not be legally enforceable but will be honored.) Contingent claims and liabilities are an area of possible confusion. For example, a transactor A expects to recognize a liability to another party B, but subject to the latter's having fulfilled certain terms and conditions of a contract. Presumably the liability is not legally enforceable until those terms are met. Such contingent liabilities will, in the normal course of events, be replaced by actual liabilities, and the recognition or otherwise of the contingent liability might be regarded largely as an issue of timing. In the above example, a buyer A enters into a purchase contract. At the time of the contract he recognizes a contingent liability to pay and arranges his finances accordingly. On delivery from B (or whenever stipulated by the contract), a legal liability is generated to replace the contingent liability. The accounts of buyer A might be as shown in Table 3. The first four account entries in Table 3 represent useful planning and budgeting information. They do not, however, represent flows of real resources, nor do they represent the financing of resource flows or financial assets that can be used in final consumption or traded for assets that could be so used. Doubtless, the information is useful, but it does not find a place in the national accounts, which are designed to capture events, not anticipations. The appropriate time of recording is at the creation of the actual liabilities.

Overdue Obligations The failure to deliver real resources according to contractual arrangements will not be recorded in the balance of payments. Shipping delays, production stoppages or other impediments to supply, or the refusal of buyers to take contracted tonnages are obvious concerns for balance of payments managers, but they do not represent transactions. No real resource has changed ownership. Although not representative of a change of ownership, the failure to meet financial

39

CHANGE OF OWNERSHIP AND TIME OF RECORDING

Table 3. A Period Contract Period 1 Delivery Period2

Payment Period3

Bu~er's

Contins.ent Liabilit~

Account Entr~

Credit

Contingent liability for goods Contingent asset

100

Contingent liability for goods Contingent asset Liability for payment Purchase Bank balance Liability for payment

Debit

100 100 100

100 100

100 100

obligations may, however, result in a change in the nature of financing arrangements and may therefore require recording in the balance of payments. The classification of financial assets and liabilities in the BPM calls for the identification of these items with respect to whether they have a contractual maturity that is long term or short term. When the issuer of a long-term liability fails to meet that liability, the nature of the liability changes from one that was redeemable at a specific maturity to one immediately payable. Financing of a long-term nature, initially raised to finance real or other resource acquisitions, essentially expires at the due date, and a new liability, one for immediate payment in the form of an overdue obligation, is raised to finance the previous financial instrument. The balance of payments recording would include entries for the repayment of a long-term liability and for the net increase in short-term liabilities, which represents the overdue obligation. A short-term liability that is not met will likewise be deemed to be settled, and a new short-term liability will be generated to replace it. Such changes will normally not be distinguishable in the net presentation adopted for short-term assets and liabilities. Where the cause of the overdue obligation was balance of payments difficulties, however, the newly created short-term obligation would be identified in analytic presentations as exceptional financing. What if a financial liability is due to be settled by delivery of a real resource? In a barter or prepayment situation, a transactor will be due to settle an outstanding financial liability through the delivery of a good. Failure to make the delivery does not require any entry in the current account. As noted above, no change in ownership has

40

EXTERNAL SECTOR TRANSACTIONS

occurred. Rather, the financial liability-financing an earlier delivery of goods (barter) or cash (prepayment) for which a specific maturity applied-has been replaced by a new obligation that calls for immediate settlement. The same treatment accorded long- and short-term financial obligations discussed above will apply in these instances.

V. Conclusions Accounting systems can and have been designed to monitor a vast array of activities. Each such system has its purposes-for example, personnel management, cost control, work performance reporting. The national accounts are designed to monitor the economic performance of economies (and subsets of economies) by means of analysis of the real and financial stocks held by the economies and the flows of these resources. Any consideration of accounting regimes for the external accounts and the balance of payments in isolation may involve a system of commitment or contingency recordings to provide plausible forecasting scenarios, a cash-based recording to monitor not financial but cash flows, or a transactions-based system designed to record real and financial resource flows. The choice of any such system is obviously at the discretion of the authorities. But the choice of a balance of payments accounting system that is in harmony with the goals and objectives of national accounting implies correlation between the balance of payments and the external accounts of the SNA. To achieve such harmonization, it is necessary that the time of recording transactions within the system is consistently applied, so that: • Ownership (however approximated) is the measure of economic wealth • Ownership is uniquely determined for any occurrence • The real and financial aspects of any transaction must be consistently recorded. Without the first condition, the usefulness of the accounts for their stated purpose would be diminished or lost. The absence of the second condition could result in asymmetry, with transactors disparately recognizing transactions. Lack of the final condition could lead to asymmetry as the articulated nature of the accounts breaks down.

4 Conversion of Balance of Payments Transactions as a Source of Valuation Changes: Problems, Principles, and Practical Solutions PIERRE LUIGI

PARCU

economic accounts requires the recording C of a large number of transactions, many of which will be expressed in a currency other than the unit of those accounts. For all OMPILING A couNTRY's

such transactions, it will be necessary to convert the original values into the unit of account. When improperly conducted, however, conversion will introduce misleading information into the accounts. This problem can surface in compiling domestic transactions, but it will be most prevalent in compiling international transactions. The first section of this paper discusses the concept of valuation change in order to clarify the nature of the problems encountered by compilers; it also examines the specific role of conversion in introducing valuation changes in the accounts. Section II discusses the theoretical solution to the conversion problem. Section III identifies some practical difficulties that any attempt to apply rigorous principles will unavoidably face and also develops some practical suggestions. Section IV discusses the conversion of resident-resident transactions. The final section briefly summarizes findings and offers some concluding remarks. I. Valuation Changes and Conversion

as a Source of Such Changes Balance of payments and other external sector accounts are statistical statements that primarily record the value of transactions effec-

41

42

EXTERNAL SECTOR TRANSACTIONS

tively concluded between the residents of an economy and the rest of the world. A transaction should be recorded using the market price at which a good is acquired and disposed of by the parties involved in the transaction. This essential rule of recording implies that changes in the price of a good that occur before or after the moment at which the transaction price is defined in a contract are irrelevant for the compilation of the accounts. This point deserves clarification. The price of a good fluctuates over time as a result of changes in demand and supply for that good. From the point of view of the transactors and the compilers of the accounts, however, only the price specified in a given contract is relevant. As a consequence, any change in the price of the good being transacted-between the time the contract is concluded and the time of the acquisition and disposal of the good-is not part of the transaction but represents a valuation change. By convention, the accounts exclude all valuation changes unless and until they are realized under a new contract. Some corollaries to the concept of valuation change deserve illustration. Valuation changes derive from the fact that, at the moment a contract is closed, the party acquiring a good assumes a valuation risk. The assumption of this risk is independent from, and antecedent to, the assumption of legal ownership of the asset and of the risks connected with it. For example, if cars being transported to a U.S. importer were lost, perhaps through a shipping accident, the importer would not be exposed to any loss if ownership of the cars still resided with the exporter. Figure 1 helps to distinguish between these two kinds of risks. The lower part of the figure shows how the ownership risk extends from the moment an economic entity receives delivery of an asset to the moment in which that entity delivers that asset to another entity. The upper part of the figure shows that the valuation risk for that asset starts at the moment an entity contracts to acquire that asset and ends when it enters into another contract to dispose of it. As the price of an asset is fixed in a contract, the party disposing of the asset has no economic interest in price fluctuations for that particular asset once the contract is closed. From that point on, the party acquiring the asset bears the full economic burden of any change in its price. The shift of the valuation risk is full and immediate, a circumstance that gives added importance to the choice of the contract price as the price at which to record the transaction in the balance of payments and external sector accounts. A contract may not, however, specify a price for the transaction in question but may, instead, specify the basis on which to determine the contract price-for example, by reference to prices quoted on commodity markets at the time of delivery.

43

CONVERSION AND VALUATION CHANGES

Figure 1. Valuation Risk Versus Ownership Risk VALUATION R I S K !

Market

T

Date of the contract to acquire

1

Change of 0

~rip Delivery

1

0WNERSr RffiK

Market

Change of

0

pr Date of the contract to dispose

~r: Time

Delivery

An interesting by-product of the way in which valuation changes are treated in the balance of payments and external accounts involves cases in which realized valuation changes may be the only entries to be shown in the accounts. This occurs when an asset is acquired and disposed of at different prices in the same accounting period. In general, economic transactions relevant to the balance of payments and external sector accounts of an economy are conducted in many different currencies. Thus, the compiler will have to choose a currency as the unit of account in which to denominate the accounts. As the price of the transaction currency may vary in relation to the unit of account, the process of converting different economic values into the chosen unit of account may introduce valuation changes akin to the ones deriving from price changes. For the compiler of the accounts, the valuation change is highlighted by the conversion of transaction values into a different unit of account. Of course, if the exchange rate did not change, the process of conversion would not cause any valuation change, but once the exchange rate has changed, it is through conversion that valuation changes enter into the accounts. In the given example, it is the fact that the accounts are expressed in U.S. dollars, and not the change in

44

EXTERNAL SECTOR TRANSACTIONS

the exchange rate per se that produces the valuation change in the statistics. When transactions are expressed in different currencies, and exchange rates between currencies fluctuate widely, a second source of valuation changes acquires significance. When compiling a country's economic accounts in its preferred unit of account, the conversion of transactions originally expressed in a currency other than the unit of account may require the explicit inclusion of an account for valuation changes in the statistical statement.

II. The Solution in Principle The analogy between valuation changes resulting from price changes and those stemming from exchange rate changes clarifies the nature of the problem for balance of payments and external sector accounting and also points to a theoretical solution. For changes in asset prices expressed in the transaction currency, the solution for ensuring that unrealized valuation changes are not included in the statistics has been to use the transaction price as defined in the contract. The advantage of this practice, besides its theoretical merits, is that it allows statisticians to adopt a consistent procedure for identifying a unique price at which to record a transaction. Price changes that occur after the contract is entered into should not affect the price at which the transaction is recorded, unless the contract allows for this possibility. Thus, irrespective of the market price when the change of ownership occurs, the accounts record the transaction at the contract price. Similarly, the exchange rate that will establish a uniquely defined value for recording a foreign transaction denominated in a currency other than the unit of account is the exchange rate existing at the contract date. If this method is not applied, the market value in terms of a unit other than the transaction currency would not have to be a single, determinate value but could vary. This principle is set out in paragraph 123 of the IMP's Balance of Payments Manual (BPM). In principle, subsequent conversions from the domestic unit of account to other currencies or units used as a standard for international comparison would not present further difficulty. As long as the conversion-directly from the original transaction currency or indirectly from the domestic unit of accounts-is made by using the exchange rate in existence on the day of the contract, no unrealized valuation change would be included in the statistics. Restated, then, the principle is that only one exchange rate and one

CONVERSION AND VALUATION CHANGES

45

price exclude all kinds of unrealized valuation changes from the accounts: these are the exchange rate prevailing on the date of the contract and the price specified in the contract. Although the principle of choosing the exchange rate prevailing at the date of the contract follows the logical analogy between the two kinds of valuation changes, it is useful to examine the limits of this analogy to appreciate better why the conversion problem is more difficult than that of pricing foreign transactions when conversion is not necessary. Section I reviewed the question of who bears the risk of priceinduced valuation changes in the market value of assets that are exchanged and during the period that risk is borne. It should be reemphasized here that the market price that prevails when the valuation risk shifts is the one relevant for the definition of the contract price. For valuation changes stemming from a change in the price of the transaction currency, the situation is identical, irrespective of whether the transaction currency and the unit of account are the same. Such valuation changes do not show up in the accounts, however, unless the unit of account differs from the transaction currency, and conversion from the latter into the unit of account is necessary.

III. The Solution in Practice Although the theoretical solution for avoiding the introduction of conversion-related valuation changes is clearly stated, its practical applicability, unfortunately, is severely limited by the lack of statistical information. The principle for conversion discussed in the previous section requires knowledge of the date of the contract of each transaction. But contract dates usually are not reported in documents available to the compilers. Furthermore, even in the rare instances in which the date of the contract is available, it would be extremely difficult to identify all the phases of a transaction that need to be converted using the exchange rate of the date of the contract. Not surprisingly, a much simpler method is generally applied in practice. Transaction values are usually converted into the unit of account at an average rate for the period in which the transaction occurs. This commonly used method of conversion introduces unrealized valuation changes and also incorrectly eliminates some realized ones, as shown in the following example. Assume that, say, on a Monday a U.S. investor contracts to acquire a German bond for the price of OM 1,000, and that the deutsche mark-dollar exchange rate is OM 3 = US$1. The asset is delivered and paid for on, say, the Friday

46

EXTERNAL SECTOR TRANSACTIONS

of the same week when the exchange rate is OM 2 = US$1, and on that same day is sold for OM 1,000 to a German bank with the OM 2 = US$1 exchange rate still in force.l There are two transactions. Following the principle of conversion at the rate prevailing on the contract date, the U.S. accounts should show a debit entry of $333.3 for the acquisition of the bond and a credit entry of $500 for its sale. (Actually, because of net recording, only a net credit of $166.7 stemming from the realized valuation change should appear in the statistics.) If in practice both transactions are converted at the period average rate for the week of, say, OM 2.5 = US$1, the debit entry for the purchase of the bond will be $400. This entry, when compared with the theoretically correct value of $333.3, introduces into the accounts an unrealized valuation change of $66.7. The sale of the bond, also converted at the weekly average rate, will result in a credit entry of $400, which, compared with the "correct" credit entry of $500, introduces another valuation error by excluding the realized valuation change. Thus, the practical solution of using average exchange rates distorts the statistics. The degree of distortion will vary with several factors: the volatility of the exchange rates, the extension and variability of the time lag between the contracts and their realization, and the degree of dispersion of a country's transactions in many different currencies. At one extreme, exchange rate stability, the rapid execution of contracts, and a high concentration of transactions in the currency used as the unit of account are the conditions that minimize statistical distortions. At the other extreme, widespread exchange rate instability, marked variability in the pattern of trade, and dispersion in currency invoicing all add to the distortions. There seems to be no doubt that the increased volatility of exchange rates in recent years has rendered the problem of conversion more severe and the practical compromise of using period average rates less reliable. There may be additional practical compilation difficulties resulting from the necessity of converting from the domestic unit into another currency or unit of account used for international comparison. Because this further conversion should be implemented by applying the principle expounded in this paper, it would be necessary to maintain and use information on the date of contract to convert either directly, from the transaction currency to the international standard, The price of the bond in deutsche mark does not change during the week under examination. 1

CONVERSION AND VALUATION CHANGES

47

or indirectly, from the transaction currency through the domestic unit into the unit of account used for the international standard. Moreover, when the compiler has only aggregated data, it would not be feasible to apply anything but an average rate for the second stage of the conversion, even if the first stage of the conversion had been done at the correct exchange rate. This kind of practical difficulty, however, applies no matter which uniquely specified conversion method is used. Any solution using a period average for conversion is a compromise dictated by considerations of statistical feasibility. Therefore, conceptually more satisfactory criteria for conversion should be used whenever possible. One good example is the recording of large transactions, such as the sale of a ship or an aircraft. In this case the source of information may be different from the trade returns and very likely will be sophisticated enough to allow the identification of the date of the contract. Another case in which conversion at an average rate should be avoided is when stocks of assets at two balance-sheet dates are being compared. In the balance of payments this is particularly important when a compiler wants to calculate total changes in reserves. Conversion is necessary because the composition of reserves will, at least to some extent, reflect the composition of a country's trade, so that it is unlikely that any country will keep all of its reserves in the currency chosen as the unit of account. If a compiler wants to identify total changes in reserves between two balance-sheet dates, he cannot use period average exchange rates for conversion. Instead the compiler has to use the exchange rates at the beginning and end of each period and compute the difference between the two levels. An example will help to clarify further the drawbacks of using period average rates. Assume that a country holds a part of its reserves in dollars and compiles the accounts in its own currency (OC). Assume, furthermore, that the stock of dollars the country holds is $1 million and, for the sake of simplicity, that these holdings do not change from the beginning to the end of the period. Consider now a case where the exchange rate between the country's domestic currency and the dollar changes during the period from US$1 per OC 1 to US$1 per OC 3. Conversion of the stock of dollars at the exchange rates in force at the beginning and end of the period will indicate a change (increase) of OC 2 million in the value of reserves. Applying the period average rate for converting the opening and closing balances would lead to the wrong conclusion: that is, that there had not been any change in the value of reserves when expressed in the unit of account. The problem here stems from the fact that stocks are

48

EXTERNAL SECTOR TRANSACTIONS

measurable only at precise points in time. Therefore, the use of a period average exchange rate (a "flow" rate) is clearly misleading.

lV. Conversion of Resident-Resident Transactions The choice of the correct exchange rate for converting international transactions expressed in a currency other than the unit of account used to compile the balance of payments and external sector accounts is based on a clear principle. This section discusses how that principle extends to transactions among residents of the same economy that have to be included in the external accounts. The accounts are not restricted to exchanges between residents of the compiling economy and nonresidents. Indeed, the accounts for the compiling economy should also include exchanges of financial claims on another economy between residents that do not belong to one and the same sector of the compiling economy. The number of such transactions is quite large, since most international transactions trigger a related resident-resident transaction. For example, when an exporter sells foreign exchange acquired through his transactions with the rest of the world to a commercial bank or to the monetary authority in his economy, or an importer does the opposite, a transaction between residents of that economy is to be recorded in the accounts. Furthermore, there may be residentresident transactions that are not directly related to an international transaction. For instance, the private sector's acquisition (or disposal) of foreign exchange for speculative purposes, when contracted with another sector of the same economy, must be entered into the accounts. Often, however, such resident-resident transactions are expressed in the national currency and, therefore, will not present a conversion problem. The conversion of resident-resident transactions can be best explained by reference to the transactions of an importer who is acquiring a foreign good and is paying for it in foreign exchange. For this purpose, it is assumed that the conclusion of the contract, the delivery, and the payment are all simultaneous and that at the time the contract is concluded the importer owns the foreign exchange for concluding the transaction (for example, in the form of a deposit in a foreign bank) and, hence, does not have to procure it. In such a case, the international transaction calls for a debit in the merchandise account, to reflect the import, and a credit in the account for shortterm assets of the private sector, to reflect the reduction in foreign assets. In principle, the compiler should convert the transaction at the

CONVERSION AND VALUATION CHANGES

49

market spot rate of the day of the transaction when expressing the accounts in national currency. H, instead, the importer does not own the foreign exchange but contracts with a domestic commercial bank to make the payment in foreign currency on the day he contracts to acquire the import, the accounts should again show a debit entry for the merchandise import, but the credit entry should reflect the reduction in the shortterm assets of the commercial bank. The resident-resident transaction, which transfers the ownership of an amount of foreign exchange from the commercial bank to the private sector, will not show up in the accounts because the holdings of the private sector, which increase as a result of the purchase of foreign exchange from the commercial bank, are immediately brought back to their initial position by the payment abroad of the foreign exchange. The effect of the resident-resident transaction, albeit real, is offset immediately, and the accounts show only the entries for the merchandise import and the reduction in the commercial bank holdings. Even in this case, the resident-resident transaction does not create conversion problems. When the time of the contract to buy the merchandise differs, however, from the time of the contract to buy the foreign exchange, conversion is more complex. If, for example, it is assumed that cars are paid for at delivery and the importer contracts to buy foreign exchange to pay for the cars on the day of delivery, the presence of a transaction between the importer and his commercial bank brings out any capital gain (or loss) the importer experiences, in terms of national currency, as a result of the lapse of time between the contract to buy the cars and the contract to buy foreign exchange. The exchange rate applied to the resident-resident transaction-the spot market rate at which the importer buys the foreign exchange from his commercial bank-is the correct one for that transaction, but it is not necessarily the rate to be used in converting into national currency and recording in the accounts the price contracted for the cars. The correct exchange rate for converting that price is the one prevailing when the purchase contract was concluded. In this example, the accounts should record the importer's realized capital gain (or loss) by an entry in the account of the private sector. The role of the resident-resident transaction is that of making explicit the loss or gain of the investor. The point to be emphasized is that a conversion problem emerges only if there is a time lapse between the conclusion of a contract and its realization. Furthermore, the presence of a resident-resident transaction involving a foreign asset will make explicit, in terms of the national currency, the values to be attached to the entries in the accounts.

50

EXTERNAL SECTOR TRANSACTIONS

In summary, it can be said that in cases in which time plays a significant role-because of exchange rate changes between the contract of the international transaction and the contract of the related resident-resident transaction-a resident-resident transaction will bring out any capital gain or loss induced by the international transaction. Incidentally, the necessity of putting different values on the international transaction and the resident-resident transaction (that is, the need to convert them at different exchange rates) makes clear, in contrast with the case when there is no lapse of time between contracts or a lapse of time does not matter (because the exchange rate does not change), that the two transactions should be considered separately. Although an international transaction often triggers a resident-resident transaction, there are in fact two distinct transactions. The resident-resident transaction should not be seen as part of the contract concluded between the resident and the nonresident.

V. Conclusions Converting different transaction currencies into a single unit of account tends to introduce valuation changes into the balance of payments and external sector accounts. This paper has argued that these valuation changes should be excluded from the statistics and that only one principle-conversion at the exchange rate prevailing at the date of the contract-completely guarantees this result. An analysis of the widespread practical difficulties in correctly implementing this principle has led to a search for possible compromises between theory and statistical feasibility. In practice, the most commonly applied technique is to convert at the average market rate prevailing during the period in which the transaction occurred. The type of average (arithmetic or geometric) that should be used for this purpose is not a matter of great significance, since inexact results will be achieved by any practical method of conversion.

5 Currency Conversion in a Multiple Exchange Rate System MARIANNE 5cHUIZE-GHAITAS

B in a variety of national currencies and, occasionally, in other units ECAUSE DATA

on economic transactions are frequently expressed

of account such as the SDR, they can only be compared and aggregated if they are converted into a single unit of account. In a unitary exchange rate system, currency conversion is essentially a matter of determining the time period to which the conversion rate should relate. In contrast, in a multiple exchange rate system, currency conversion is complicated by the fact that at any time, the national currency is exchanged against any other currency at different rates, depending on the type of transaction or transactor (or both) involved. 1 In these circumstances compilers of national accounts and balance of payments statistics have to determine not only the time period to which the conversion rate, or rates, should relate but also the exchange rate at which a given transaction should be converted. 1 Although in a unitary exchange rate system buying and selling rates for foreign currencies differ by certain margins, these margins usually reflect normal costs and risks of exchange transactions and do not constitute separate exchange rates. Based on a standard of reasonableness for such margins, the IMF' s Executive Board has adopted the view that a multiple currency practice exists if, as a result of official action, spreads between buying and selling rates for spot foreign exchange exceed 2 percent, unless such spreads reflect additional costs and risks, or midpoint spot exchange rates for other members' currencies deviate by more than 1 percent and for more than one week from the corresponding rates derived from the spot exchange rates for these currencies in their principal markets. See Executive Board Decision No. 6790-(81/43), March 20, 1981, reprinted in Joseph Gold, SDRs, Currencies, and Gold: Sixth Suroey of New Legal Developments, Pamphlet Series, No. 40 (Washington: International Monetary Fund, 1983), pp. 107-08.

51

52

EXTERNAL SECTOR TRANSACTIONS

In a multiple exchange rate system there are, in principle, two possible methods for converting transactions denominated in foreign currencies into the national currency: conversion of each individual transaction at the exchange rate at which it was effected or conversion of all transactions at a unitary conversion rate. This paper examines these conversion methods in view of existing guidelines for the compilation of national accounts and balance of payments statistics. More specifically, it examines which of these methods agrees with the general principles of valuation and conversion underlying these guidelines and which method ensures that, for statistical purposes, the taxes and subsidies implicit in a multiple exchange rate system are treated like corresponding explicit taxes and subsidies in a unitary rate system. The main conclusion of the paper is that, given these criteria, conversion of all transactions at a unitary exchange rate is the appropriate conversion method in a multiple exchange rate system. Multiple exchange rate systems can take various forms, ranging from relatively simple dual exchange rate systems, in which an official fixed rate for selected transactions coexists with another rate, fixed or floating, for the remaining transactions, to more complex systems with a large number of rates differentiated according to the type of transaction or transactor (or both). For the conversion problems arising in a multiple exchange rate system, these are differences of degree, not of substance. Moreover, it is also immaterial whether all exchange rates in a multiple exchange rate system are officially recognized. 2 Consequently, the arguments developed in this paper apply to multiple exchange rate systems in general, regardless of the form a particular system takes. The paper is organized as follows. Section I briefly examines whether the conversion problems arising in a multiple exchange rate system can be avoided if national statistics are expressed in a unit of account other than the national currency. It argues that, under the circumstances most likely to prevail, compilers of national statistics will confront conversion problems no matter which unit of account they choose. Section II discusses the alternative conversion methods outlined above in view of the general principles of valuation and conversion underlying existing guidelines for the compilation of

2 In contrast, from the Fund's perspective, this distinction is crucial because the Fund's jurisdiction does not apply to multiple exchange rates arising from illegal markets for foreign exchange, unless these are officially recognized.

MULTIPLE EXCHANGE RATES

53

national accounts and balance of payments statistics. Section III focuses on the implications of each conversion method for the treat ment of the taxes and subsidies implicit in a multiple exchange rate system. Section IV discusses problems relating to the determination of a unitary conversion rate. Finally, the conclusions summarize main findings of the paper.

I. Can a Judicious Choice of Unit of Account Avoid Conversion Problems? Because of the difficulties associated with determining the appropriate exchange rate for converting a given transaction from foreign into national currency in an economy that maintains a multiple exchange rate system, compilers of national accounts and balance of payments statistics may find it preferable to try to avoid conversion problems by expressing national statistics in a unit of account other than the national currency. This is possible when a country's economic transactions are exclusively denominated in one or more foreign currencies. When a country's transactions are not exclusively but predominantly denominated in foreign currencies, using a foreign currency as the unit of account does not avoid conversion problems, but it does reduce the errors that result if an inappropriate conversion method is applied. Some countries maintaining multiple exchange rates have chosen to express the balance of payments in a unit of account other than the national currency. This option is also suggested in the fourth edition of the IMP's Balance of Payments Manual (BPM). The majority of transactions between residents of a country, however, are likely to be denominated in domestic currency. Thus, using a unit of account other than the national currency may avoid conversion problems in the case of balance of payments statistics, but it will do so by compounding these problems for the national accounts statistics-if these are expressed in the same unit of account-or by losing comparability between balance of payments and national accounts statistics, if the latter are expressed in national currency. Hence, compilers of national accounts and balance of payments statistics who wish to ensure the comparability of both systems will generally not be able to avoid or even substantially reduce the conversion problems arising from a multiple exchange rate system by expressing statistics in a unit of account other than the national currency.

54

EXTERNAL SECTOR TRANSACTIONS

II. Choice of Conversion Method: General Principles of Valuation and Conversion Because current methodologies for national accounts3 and balance of payments statistics (for example, the BPM) establish general principles for the valuation and conversion of transactions, it appears appropriate to consider the application of these principles to the special conversion problems that arise in a system of multiple exchange rates. More specifically, the choice between the alternative conversion methods-between conversion of each individual transaction denominated in foreign currency into national currency at the rate at which it was effected, or conversion of all transactions at a unitary rateshould be based on these general principles. To determine the value of a given transaction, generally an exchange of real or financial assets, compilers of economic statistics have to determine at least one, and frequently two, prices: the price of the good, service, or financial asset exchanged in terms of the currency in which the transaction was originally expressed, and, if this currency differs from the chosen unit of account, the price of that currency in terms of the unit of account. However, neither the price of a real or financial asset nor the price of a currency or unit of account in terms of another is a unique concept. Guidelines for the compilation of economic statistics, therefore, define the price that is to be used to determine the value of a given transaction in terms of the currency or unit of account in which it was originally expressed, as well as the exchange rate that is to be used to convert a transaction from one national currency or unit of account into another. In the SNA and in the BPM, the recommendations about the valuation of transactions are based on the market price principle. The BPM (paragraph 76), following the United Nations' Provisional Guidelines (paragraph 6.5), defines a market price as "the amount of money that a willing buyer pays to acquire something from a willing seller, when such an exchange is one between independent parties into which nothing but commercial considerations enter.'' This definition neither implies that a market price is the price applicable to a set of supposedly identical transactions nor presupposes a certain market structure. Instead, it views a specific market price as relating to one speThe United Nations' A System of National Accounts (SNA) and Provisional International Guidelines on the National and Sectoral Balance-Sheet and Reconciliation Accounts of the System of National Accounts, Statistical Papers, Series M, No. 60 (New York, 1977). 3

MULTIPLE EXCHANGE RATES

55

cific transaction only, which may take place in any type of marketpurely competitive, monopolistic, or monopsonistic. However, the definition of a market price outlined here draws a clear distinction between transactions carried out by independent parties and transactions that do not fulfill this criterion. The Brussels Definition of Value, 4 from which the criterion of independence is derived, stipulates that buyer and seller shall be considered independent of each other only if the price is the sole consideration relevant to a transaction and if the price is not influenced by any commercial, financial or other relationship, whether by contract or otherwise, between the seller or any person associated in business with him and the buyer or any person associated in business with him, other than the relationship created by the sale itself . . . [and] no part of the proceeds of any subsequent resale, other disposal or use of the goods will accrue, either directly or indirectly, to the seller or any person associated in business with him. For transactions between parties that do not fulfill the criterion of independence-for example, affiliated enterprises-the BPM (paragraph 82) suggests that any transfer prices associated with such transactions be adjusted to reflect market value equivalents. In agreement with the principle of market price valuation, the BPM suggests that transactions should be converted from one unit of account into another at exchange rates that qualify as market prices in the above sense. More specifically, for the system of par values, the BPM (paragraph 127) recommended conversion at parity. For the currently prevailing system of floating exchange rates, the BPM (paragraph 128) suggested conversion at the exchange rate for spot delivery at the time of contract. s In a system of multiple exchange rates, the question arises whether conversion at the rates prescribed for individual transactions agrees with the principles of valuation and conversion outlined above. Consider, for example, the following system. For a certain group of export goods, exporters have to surrender their foreign exchange proceeds at the exchange rate ev defined as the price of a foreign currency in terms of the domestic currency. For a certain group of import goods, Customs Cooperation Council, General Secretariat, The Brussels Definition of Value for Customs Purposes: Its Origins, Characteristic Features, and Applications (Brussels, July 1972), Article II, p. 35. s However, the BPM (paragraphs 131-33) recognizes that balance of payments compilers may find it difficult to determine the contract date of a transaction, and that, in practice, average spot rates for the period in which the transaction is recorded may have to be used for conversion. 4

56

EXTERNAL SECTOR TRANSACTIONS

importers purchase foreign exchange at the same rate. All remaining current and capital account transactions are settled at the rate e2, which is floating freely. At e2 the domestic currency is more depreciated than at e1 ; that is, e1 < e2 • The question then is whether the exchange rate e1 qualifies as a market price in the sense of the BPM. As emphasized earlier, the definition of market prices adopted in the BPM does not presuppose the existence of a unique price for a group of supposedly identical transactions. Therefore, the fact that, in a system of multiple exchange rates, foreign exchange transactions take place at different rates does not violate the principle of market rate conversion. However, the BPM concept of market prices presupposes independence of buyer and seller. In a system in which the seller of foreign exchange (in the above case, the exporter of those goods for which e1 is prescribed) is prevented by law from selling his foreign exchange proceeds at the most favorable available rate (that is, e2), the buyer (the government through the monetary authority or some other government institution) uses its legal authority over the seller to determine the purchase price for foreign exchange. In these circumstances, the criterion of independence of buyer and seller is not fulfilled, and the legally prescribed exchange rate e1 cannot be considered a market price. The legally prescribed exchange rate e1 in the above example differs fundamentally from a legally prescribed unitary rate in a par value system. In a par value system it is the monetary authority that is required, by law, to buy and sell foreign exchange in order to keep the exchange rate within a given margin around par value. Private agents buy and sell foreign exchange at the existing rate because it is the current market price, not because they are prevented by law from concluding transactions at different rates. Hence, in contrast to the legally prescribed exchange rates in a multiple exchange rate system, exchange rates in a par value system qualify as market prices according to the definition outlined above. 6 If in the above example of a multiple exchange rate system the legal restrictions forcing certain sellers to sell at the rate e1 were removed, these sellers would clearly prefer to sell their foreign exchange proceeds at the higher price e2 . At the same time, buyers of foreign exchange, who previously could purchase at the preferential rate e11 6 The recommendation of the BPM (paragraph 127) regarding conversion in a par value system rests on the assumption that par values are, in fact, observed, and that the movements of the exchange rates within the margins, especially when averaged over a certain period, are sufficiently small to be neglected in conversion.

MULTIPLE EXCHANGE RATES

57

would be forced to pay a higher price. The system of multiple rates would be replaced by a unique equilibrium rate e0 • This rate qualifies as a market price, irrespective of whether it is floating freely (that is, is determined entirely by private demand for and supply of foreign exchange) or is kept within a more or less narrow band around a fixed value, because the monetary authority assumes responsibility for closing the gap between demand for and supply of foreign exchange at that rate. Hence, in a multiple exchange rate system only conversion at the equivalent of the rate e0 would be consistent with the principles of market price valuation and the conversion adopted in existing guidelines for national accounts and balance of payments statistics.

III. Choice of Conversion Method: Treatment of Taxes and Subsidies Implicit in a Multiple Exchange Rate System In a system of multiple exchange rates, exchange regulations drive a wedge between the rates at which transactions are settled and the equilibrium exchange rate that would prevail if all transactions were carried out at a single rate.7 This creates a system of implicit taxes and subsidies. 8 The following example illustrates this point. Let q be the foreign currency price of a certain good (that is, the amount of foreign currency an exporter or importer receives or pays for that good); let p be the amount of domestic currency that an exporter or importer receives or pays for one unit of the same good; and lett denote the tax or subsidy rate. For a certain group of export and import goods, exporters or importers have to sell or buy foreign exchange at the rate e1, defined as the price of one unit of foreign 7 Note that this equilibrium exchange rate is not necessarily the free market rate that would prevail if all restrictions on foreign exchange transactions, and on international transactions such as import quotas, licenses, and so on were removed. 8 The equivalence of explicit taxes or subsidies and the taxes or subsidies implicit in a multiple exchange rate system is embodied in the Fund's concept of multiple currency practices. This concept relates to "effective exchange rates"; that is, the price of foreign exchange received or paid after allowing for taxes or subsidies that are closely related to foreign exchange transactions. However, whereas the Fund's concept of multiple currency practices considers only taxes or subsidies applying to the payments aspect of a transaction, as opposed to taxes or subsidies relating to the trade aspect, the discussion in this section applies to taxes or subsidies on international transactions in general.

58

EXTERNAL SECTOR TRANSACTIONS

currency is more appreciated than at the equilibrium rate e0 that would prevail if all current and capital account transactions were settled at the same rate, e1 < e0 • An exporter who is forced to sell his foreign exchange proceeds at the rate e1 < e0 , and hence receives p = e1q = e~[l - (e0 - e1)/e0 ] in domestic currency for one unit of his export goods, is effectively taxed at the rate t = (e0 - e1 )/e0 > 0. Similarly, an importer who is able to purchase foreign exchange at the rate e1 is effectively subsidized at the same rate. 9 In contrast, if the rate e1 were more depreciated than e0 (if e1 > e0 ), then exporters entitled to sell foreign exchange at the exchange rate e1 would be effectively subsidized at the rate t = (e0 - e1 )/e0 < 0. Similarly, importers forced to purchase foreign exchange at the exchange rate e1 would be effectively taxed at the same rate. Depending on the exchange rate that is used to convert foreign currency values into domestic currency, the domestic currency value of exports or imports will reflect the price the exporter or importer would receive or pay before paying or receiving the tax or subsidy implied by the exchange rate system, or it will reflect the price the exporter or importer receives or pays after paying or receiving this tax or subsidy. If, in the above example, the foreign currency value of exports is converted at the rate e1, the domestic currency value will reflect the proceeds the exporter receives after paying or receiving the implicit tax or subsidy. If, however, the foreign currency value of exports is converted at the rate e0 , then the domestic currency value will reflect the proceeds that the exporter would receive before paying or receiving the implicit tax or subsidy. Similarly, if imports are converted at the rate e1 , the domestic currency value will reflect the price the importer pays after receiving or paying the implicit subsidy or tax. If the same imports are converted at the rate e0 , however, the domestic currency value will reflect the price the importer would pay before receiving or paying the implicit subsidy or tax. Because the taxes and subsidies implicit in a multiple exchange rate system are equivalent to comparable explicit taxes and subsidies on international transactions in a unitary rate system, it appears appropriate to choose a conversion method that implies equal treatment of implicit and explicit taxes and subsidies. The BPM recommendations regarding the treatment of explicit taxes and subsidies on international transactions focus on the question of whether the payment or receipt of a tax or subsidy represents a resident-resident or a residentnonresident transaction. If explicit taxes or subsidies are paid or 9 Note that t > 0 implies a tax on exports and a subsidy on imports, whereas t < 0 implies a subsidy on exports and a tax on imports.

MULTIPLE EXCHANGE RATES

59

nonresident transaction. If explicit taxes or subsidies are paid or received by residents of the reporting economy, they represent resident-resident transactions, and the value of the transaction on which a given tax or subsidy is levied or granted should reflect the price that the resident of the reporting economy receives or pays before paying or receiving the tax or subsidy. In the case of the exports in the example outlined above, the foreign importer pays q units of foreign currency for one unit of goods purchased from the domestic exporter. If the multiple exchange rate system were changed into a unitary rate system with the equilibrium rate e0 , and if the implicit taxes or subsidies were replaced by explicit taxes or subsidies, the exporter would receive e~ units of domestic currency for one unit of export goods, on which he would pay or receive a tax or subsidy to or from his government equivalent to t = e~(e0 e1)/e0 • This tax or subsidy is a resident-resident transaction, since it is the exporter who actually pays or receives it. Consequently, the domestic currency value of the resident-nonresident transaction involved is e~; that is, the proceeds the exporter would receive before paying or receiving the tax or subsidy. Similarly, in a unitary rate system with explicit taxes or subsidies, the importer in the example outlined above would pay e~ units of domestic currency for one unit of import goods but would receive or pay a subsidy or tax equivalent to e~(e0 - e1)/e0 , which would reduce or increase his cost to the equivalent of e1q. This subsidy or tax is a resident-resident transaction. Hence, the domestic currency value of the resident-nonresident transaction involved is e~; that is, the price the importer would pay before receiving or paying the subsidy or tax. The argument outlined here can be summarized as follows. Since taxes or subsidies on exports and imports generally represent resident-resident transactions, the domestic currency value of a given export or import should reflect the domestic currency price the exporter or importer receives or pays before paying or receiving a tax or subsidy. 1o Consequently, if the taxes or subsidies implicit in a system of multiple exchange rates are to be treated like comparable explicit taxes or subsidies in a unitary rate system, the conversion method chosen must ensure that the value of exports or imports in terms of domestic currency reflects this price. As shown above, however, conversion at the exchange rates at which transactions are actu10 This recommendation agrees with the guidelines for valuation in international trade statistics suggested in the United Nations' International Trade Statistics: Concepts and Definitions, Department of Economic and Social Affairs, Statistical Office, Statistical Papers, Series M, No. 52 (New York, 1970), p. 43.

60

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ally settled in a multiple exchange rate system implies that the derived value of exports or imports reflects the domestic currency price exporters or importers receive or pay after paying or receiving the taxes or subsidies implicit in the exchange rate system. Hence, conversion at the equivalent of the equilibrium exchange rate is required.

IV. Determining a Unitary Conversion Rate The discussion in the preceding sections suggests that, from an analytical point of view, in a system of multiple exchange rates transactions denominated in currencies other than the chosen unit of account should be converted at a single conversion rate. 11 According to a recent survey, several countries maintaining multiple exchange rates have adopted unitary conversion rates at least in the area of foreign trade statistics.12 However, there is no detailed information about how this rate is defined. In theory, the unitary rate at which transactions should be converted is the rate that would prevail if all foreign exchange transactions were carried out at the same rate. According to the BPM (paragraph 129), this "notional rate could be considered as the equivalent of either an equilibrium rate that the authorities would be able to defend under a system of fixed par values or a market rate prevailing under a regime of free floating." In practice, however, such a notional equilibrium rate cannot easily be determined. In general, the exchange rate that would prevail if all foreign exchange transactions were carried out at the same rate depends not only on the price elasticities of the different components that constitute total demand for and supply of foreign exchange but also on a whole range of potential policy measures, including compensatory financing transactions and direct central bank interventions in the foreign exchange market, designed to influence the exchange rate according to given policy objectives. Recognizing that a notional equilibrium rate cannot be determined without detailed knowledge about the structure of the economy in question and about the policy assumptions that should reasonably be 11 For an alternative view, see International Monetary Fund, International Financial Statistics, Supplement on Exchange Rates, Supplement Series, No. 9

(Washington, 1985), p. vii. 12 Dev Kar, "Currency Invoicing and Exchange Conversion in International Trade," Papers in International Finance Statistics, PIFS/86/1 (Washington: International Monetary Fund, February 14, 1986).

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MULTIPLE EXCHANGE RATES

made, the BPM does not provide specific recommendations for defining the appropriate single conversion rate. This lack of detailed guidelines leaves room for defining unitary conversion rates that suit the specific conditions in individual countries, but it also leaves ample scope for defining conversion rates that are not necessarily "realistic." A more standardized approach taken by the Fund staff is to construct a weighted average of the different exchange rates observed in a multiple exchange rate system, the weights being the estimated shares of the transactions effected at a particular rate. Admittedly, this is but one possible approach to approximating the notional equilibrium rate.

V. Conclusions The major findings of this paper can be summarized as follows. • Compilers of national accounts and balance of payments statistics who wish to ensure the comparability of these statistical systems will in general not be able to avoid conversions involving the national currency, irrespective of what unit of account they choose. • Given the necessity to convert transactions denominated in foreign currency into domestic currency, or vice versa, compilers operating in a multiple exchange rate system have to choose between two possible conversion methods: conversion of each transaction at the exchange rate at which it was effected, or conversion of all transactions at a unitary conversion rate. • From the point of view of existing guidelines for the valuation and conversion of transactions, which are based on the market price principle, conversion at a unitary exchange rate is preferable because the different rates at which transactions are effected in a multiple exchange rate system do not qualify as market prices according to the definition adopted in these guidelines. • From the point of view of the taxes or subsidies implicit in a multiple exchange rate system, conversion at a unitary exchange rate is preferable because it ensures that, for statistical purposes, these implicit taxes or subsidies are treated like corresponding explicit taxes or subsidies in a unitary rate system. More specifically, conversion at a unitary exchange rate ensures that the domestic currency value of a given transaction reflects the amount the transactor would receive or pay before paying or receiving an explicit tax or subsidy. • The unitary conversion rate at which all transactions in a multiple exchange rate system should be converted is the equilibrium

62

EXTERNAL SECTOR TRANSACTIONS

exchange rate that would prevail if all transactions were effected at the same rate. This notional equilibrium rate cannot be easily determined because it depends on the price elasticities of the different components that constitute total demand for and supply of foreign exchange, as well as potential policy measures designed to influence the exchange rate according to given policy objectives. One possible approach to approximating such a rate is to construct a weighted average of the different exchange rates observed in a multiple exchange rate system, the weights being the shares of the transactions effected at a particular rate.

6 Treatment of Exchange Rate Differentials in the National Accounts }AN VAN TONGEREN

A System of National Accounts (SNA) does not

T explicitly deal with the question of exchange rate differentialsthat is, income generated by banks and government authorities holdHE UNITED NATIONS'

ing foreign exchange as a result of differences in the purchase and sale prices of foreign currency. This paper offers suggestions on how to deal with this question, covering three situations: stable monetary conditions, volatile changes of exchange rates over time, and multiple exchange rate regimes. On the basis of the general principles of the SNA, and taking into account practices in a limited number of countries, the paper develops the following proposals. • Distinctions should be made within the exchange rate differentials among three components-bank service charges, capital gains or losses, and taxes or subsidies. • Global adjustments for bank service charges and taxes or subsidies under multiple exchange rate regimes should be included in the external account of the SNA, so that individual categories of transactions (exports, imports, and so on) reflect the actual transaction values, whereas the balances of the external account reflect the adjustments for differences between purchase and sale prices of foreign currency. • Adjustments should be applied to all external transactions, except those in kind; these adjustments should be based on an equilibrium exchange rate that would have existed if no government monetary controls had been in effect. 63

64

EXTERNAL SECTOR TRANSACTIONS

• Taxes or subsidies, including the bank service charges on foreign exchange, should be allocated directly to the government sector; bank service charges on foreign exchange should be treated as payments by the government to banks for services received from banks in implementing the government's exchange rate policy. • No adjustments should be made for exchange rate change over time. Revenues derived from those changes should be treated as capital gains or losses. • Because the exchange rate differentials do not accrue only on goods and services but also on other external transactions, the adjustment for taxes or subsidies should distinguish between indirect taxes or subsidies, direct taxes (including negative direct taxes), and capital transfers. The SNA and recent discussions during its review have focused on the role of banks in the redistribution of financial capital and on the service charges implicit in the interest flows to and from banks. Until now no concerted attention has been paid to the service charges implicit in exchange rate differentials, which derive from the difference between banks' purchase and sale prices for foreign currency. The same questions raised about the bank service charges implicit in interest flows-that is, how they are to be measured, treated, and allocated-need to be answered with regard to the role of banks in the foreign currency market. Other questions unique to exchange rate differentials also merit attention. Until several years ago, questions about exchange rate differentials were relevant, but quantitatively unimportant, and therefore the SNA does not mention this factor explicitly. There was a difference between the purchase and sale prices of foreign currency, but the difference was very small because foreign exchange rates were generally stable over time and did not differ for transactions that took place at the same time. In addition, national accountants found it difficult to identify the differentials separately, since information was often hidden in data on other revenues of banks and allocated together with those revenues. The situation has changed considerably in recent years. Fixed exchange rates have been replaced by floating rates that, in some countries, change frequently and considerably over time, and other countries have introduced multiple exchange rate regimes that maintain different exchange rates for different transactions at the same time. As a result, substantial exchange rate differentials are affecting the profits and losses of banks or government agencies that maintain foreign currency reserves. They also influence

EXCHANGE RATE DIFFERENTIALS

65

the profits or losses and retained earnings of other nonfinancial enterprises that are engaged in the export or import of goods and services or that make or receive foreign payments for the transfer of profits, external debt, and so on. This paper supplements two parallel papers written by staff members of the IMF: one on multiple exchange rates (Chapter 5 in this volume), and another on changes that occur in exchange rates over time (Chapter 4 in this volume). These two papers focus primarily on the exchange rate conversion of transactions in the balance of payments and external account. The present paper deals with the treatment of exchange rate differentials, not only in the external account but also in the accounts of other sectors included in the national accounts (particularly the banking sector), and with the effects on gross domestic product (GOP) and its components. The conclusions reached in the paper are in line with those of the cited papers: to use a uniform rate of exchange in circumstances of multiple exchange rate regimes (Chapter 5) and not to include changes in exchange rates over time (Chapter 4). The remainder of the paper is organized as follows. Section I reviews country practices in foreign exchange controls and shows how they would affect the national accounts aggregates if no adjustments were made. It distinguishes among the three situations earlier identified: stable monetary conditions with minor differences between sale and purchase prices of foreign currency; considerable changes over time in the local value of foreign currency; and, finally, multiple exchange rate regimes. Section II includes proposals to adjust the national account aggregates for exchange rate differentials in order to avoid anomalies. It distinguishes among three components of exchange rate differentials that should be treated differently in the national accounts-bank service charges, taxes or subsidies, and capital gains or loses-and shows what consequences these treatments have for the valuation of stocks and flows of foreign exchange and other national account transactions that are supported by the purchase and sale of foreign currency. Section III discusses the measurement of exchange rate differentials and the derivation of a uniform or accounting exchange rate. Section IV includes a quantitative example based on adjusted 1983 national accounts data for Venezuela. This example illustrates the proposed treatment of foreign exchange differentials in the national accounts and assesses the sensitivity of GOP and other macroeconomic aggregates to different assumptions made in the national account compilation regarding the value of exchange rate differentials.

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EXTERNAL SECTOR TRANSACTIONS

I. Foreign Exchange Policies Affecting National Account Aggregates To date there has been limited experience with the treatment of exchange rate differentials in the national accounts. The experiences of three countries-El Salvador, Colombia, and Jamaica-have been described by Pinot de Libreros in two papers. 1 A fourth experience was described by officials from Venezuela, also in the context of review of the SNA.2 The four practices, which refer to the mid-1980s, are different and can be summarized as follows. • El Salvador had three exchange rates: an official rate, a free bank rate, and a black market rate. The government had direct control over the first two. The official rate of the U.S. dollar was the lowest and was fairly stable. The free bank rate was higher and varied according to the supply of and the demand for foreign currency for transactions that the government allowed to take place in the foreign currency market. The black market rate varied considerably over time, and the government had very little control over it. • In Colombia, two rates were in effect: an official rate controlled by the Banco de la Republica and a black market rate. The official rate was flexible and had changed considerably over time, resulting in a peso value of the dollar that was, by the mid-1980s, more than ten times higher than it was in 1970. As a result of the flexible central bank exchange rate policy, the black market rate was not significantly different from the official rate. • In Jamaica, according to Pinot de Libreros' description, three rates Marion Pinot de Libreros, "Effects of Devaluation on the Calculation of How of Funds Accounts," paper presented at the Nineteenth General Conference of the International Association for Research in Income and Wealth (IARIW), Noordwijkerhout, Netherlands, August 1985; and "Los mercados multiples de cambio y su tratamiento en Cuentas Nacionales" (Multiple Exchange Rate Markets and Their Treatment in the National Accounts), paper presented at the Regional Seminar on National Accounts, UN Economic Commission for Latin America and the Caribbean (ECLAC), Santiago, Chile, April1986. 2 Banco Central de Venezuela, "Experiencias y dificultades de Venezuela en el tratamiento de los cambios multiples en el Sistema de Cuentas Nacionales" (Experiences and Difficulties in Venezuela in the Application of Multiple Exchange Rates in the SNA), paper presented at the Regional Seminar on National Accounts, ECLAC, Santiago, Chile, April1986. 1

EXCHANGE RATE DIFFERENTIALS

67

existed in the mid-1980s: two official rates-one for trade with Caribbean Community (CARICOM) countries and another for foreign exchange transactions with other countries-and a free or black market rate. Subsequently, the government abandoned the official rates and tried to control the market rate through a system of auctions for foreign exchange. • Venezuela had a dual market for foreign exchange. The first was a low rate for the U.S. dollar, which was fully controlled by the government. This rate held for the exchange of dollars obtained from oil exports and for the use of those dollars by the oil industry and some other sectors importing essential goods. It also was used by the government and public enterprises to repay the foreign debt principal and interest and to provide education grants for studies abroad. The dollars obtained from, or needed for, these transactions were directly sold to or purchased from the central bank. A higher exchange rate for the dollar held for the remaining transactions, which could be either exports of industries that the government tried to stimulate or imports that it wanted to discourage. The higher dollar rate was not a black market rate. In effect, the Central Bank of Venezuela was the main supplier of dollars, providing private banks and other foreign exchange dealers with dollars in order to influence the free market price. If no adjustments were made, there would be three main effects on the local currency value of external transactions and on other national account aggregates as a result of multiple exchange rate regimes, rapid changes of exchange rates over time, and regular differences between the purchase and sale prices of foreign currency. The first effect is on the foreign trade balance. If expressed in local currency,it may be smaller or larger than the balance in foreign currency relative to the size of exports or imports. The same may hold for the current balance of the external account. It may show that the current surplus that supplements domestic savings in financial capital formation is lower or higher in terms of local currency than the value of current revenues from or disbursements to other countries, when this relative value is compared with its foreign currency equivalent. When the difference between purchase and sale values of foreign currency is large, the foreign trade or current external balance may even have a different sign when expressed in foreign exchange units compared with the balance in local currency units. This may occur when imports or other disbursements to the rest of the world take place at exchange rates that are much higher in terms of local currency than the exchange rates used for the local currency conversion

68

EXTERNAL SECTOR TRANSACTIONS

of exports or other revenues. Under multiple exchange rate regimes, this effect on the foreign trade balance may be a direct consequence of the government's foreign exchange policy. In the case of rapid changes over time in the rates of exchange for foreign currencies, the effect may happen because export revenues and other revenues may be received at the beginning of the year, when the exchange rates are still low, whereas import payments or other disbursements abroad may be made toward the end of the accounting period, when exchange rates have already increased considerably. Another effect is on the value added in industries that export or import goods and services and on the profits and retained earnings of enterprises that pay interest, dividends, and other property income to nonresidents or receive revenues on investments abroad. The value added, profits, and retained earnings calculated in local currency are affected by the same discrepancies between the value at which foreign exchange receipts are converted to local currency and the value at which foreign currency is purchased in order to import goods and services and to pay dividends, interest, and so on to nonresidents. Finally, the exchange rate differentials may cause inconsistencies in the national accounts. One reason would be because the accounts of the central bank or any other government authority that holds foreign currency would record exchange rate differentials as a revenue, while there is no explicit counterpart in accounts of other sectors in the national accounts. A further inconsistency may arise because the foreign exchange authority calculates the exchange rate differentials by using a valuation of foreign exchange balances that is different from the stock valuation measures used by other sectors in the national accounts or recommended in the national accounts.

II. Components of Foreign Exchange Rate Differentials Exchange rate differentials refer to the income accruing to banks or government agencies holding foreign currency reserves that arises from differences between the sale and purchase prices of foreign exchange. More precisely, exchange rate differentials are an aggregate of three components: a bank service charge, a tax or subsidy, and a capital gain or loss. The three components can be associated with the three types of exchange rate circumstances cited earlier in this paper. The distinction among the three components is necessary, since each refers to transactions that are treated differently in the

SNA.

EXCHANGE RATE DIFFERENTIALS

69

Bank Service Charges The bank service charge is based on the difference between sale and purchase values of foreign currency; the charge is always maintained, even under circumstances of monetary stability. Under stable conditions, the difference between sale and purchase values is generally small and includes only the implicit bank service charge. This was the situation in most countries before the fixed exchange rate regime was abandoned. The implicit service charge is imposed in the domestic territory by resident financial institutions. Implicit charges are reflected in all foreign exchange transactions: a higher price is charged for foreign exchange to those that need to make payments to entities abroad and a lower rate is applied to those who receive foreign currency from abroad. This implies that receipts from abroad expressed in local currency are net of the implicit bank charges, whereas payments to entities abroad expressed in local currency include the charges that banks impose through their higher sale rate for foreign currency. Because exports are valued f.o.b. (free on board) in the national accounts and imports are recorded ci.f. (cost, insurance, freight), however, the implicit bank service charges thus imposed by domestic institutions should not be deducted from exports and should not be included in imports. For reasons of consistency, a similar treatment should be accorded to other receipts from and payments to other countries. The implication of this suggestion is that payments to and receipts from abroad should be recorded at the same rate of exchange if the bank service charge is the only difference between the purchase and sale values of the foreign exchange. This uniform exchange rate will be referred to here as the "accounting exchange rate."

Taxes or Subsidies The tax or subsidy component exists under multiple exchange rate regimes when the central bank or government monetary authorities stipulate that different rates of exchange must be paid or received for different transactions, favoring some sectors and discouraging transactions carried out by other sectors. The exchange rate differential caused by multiple exchange rate regimes should be considered a tax or subsidy because the exchange rate policy influences the prices or values of transactions that are expressed in local currency. The tax or subsidy component should be calculated in a way similar to the treatment of the implicit bank service charge, described above. Assuming that there are no exchange rate changes over time and no

70

EXTERNAL SECTOR TRANSACTIONS

explicit bank service charges, the total tax or subsidy component should be based on the difference between the sale and purchase values of the foreign currency. The difference with the bank service charge is that, under multiple exchange rates, the banks' sale prices of foreign currency for some imports and other payments to entities abroad might be low because the government considers these transactions essential, whereas the banks' purchase prices of foreign currency for some exports and other receipts from abroad, which the government wants to promote, might be high. The government's total tax receipts may even be negative, and thus turn into a subsidy, when the external receipts and payments based on "promotional" exchange rates dominate the external transactions of the country. Because the government is a domestic institution that imposes the tax or grants the subsidy, the implicit taxes and subsidies should not affect the foreign trade and other balances of the external account for the same reasons that held for bank service charges. This implies that exports and other receipts from abroad should be recorded in the external account before taxes are deducted or subsidies are granted, and that imports and other payments to entities abroad should be registered net of taxes to be imposed or subsidies to be granted. Several complications should be considered before this treatment is adopted. One question that needs to be resolved is how to treat the exchange rate differential caused by foreign currency purchases and sales that are not channeled through the central bank or other government exchange authority but are carried out by private banks and foreign exchange dealers. For exarr.ple, in Venezuela during the period of multiple rates in the mid-1980s the private banks operating in the free exchange market purchased dollars at a much higher rate than the Central Bank. To stimulate production in selected industries, the government allowed certain exporters to change their dollars in private banks at the much higher rates. This implied a subsidy for these exporters, and the local currency price of those exports is thus a consequence of a government policy. Similarly, importers of nonessential goods were forced by the government to purchase their dollars in the free exchange market. Those imports were thus implicitly taxed. The difficulty was that private banks cannot really impose taxes or grant subsidies. But the problem seems more difficult than it really is. First of all, the private banks do not pay the subsidy or receive the indirect tax because they establish only a small difference between purchase and sale prices of foreign currency and generally maintain small foreign exchange balances. Implicit indirect taxes and subsidies therefore cancel out. If, however, banks would benefit from the exchange rate policies and would not have to transfer a part of the

EXCHANGE RATE DIFFERENTIALS

71

differentials to the government, a subsidy would have to be imputed from the government to the private banks, which would reflect the extra benefits such banks receive from the government's exchange rate policy. The second problem concerns the taxes and benefits (subsidies) that are a consequence of the government's policy. In the example above, it was assumed that only exports and imports were affected. In practice, however, the policy also affected other external transactions. In Venezuela, it also affected payments of the external public debt principal and interest, and foreign currency grants for Venezuelans studying abroad. This immediately raises the question of whether all implicit taxes and benefits should be considered indirect taxes and subsidies. There are three ways of approaching this matter. One way would be to channel implicit taxes and benefits through the bank service charge. Doing this would imply that the government's exchange rate policy affects the market value of bank services and, through those services, the prices of exports and imports and the value of other transactions in foreign currency. The consequence of this treatment is that all taxes and benefits could be considered indirect taxes and subsidies, since they would be levied or granted on (bank) services. With this treatment, however, the value of bank services could become negative, particularly if the service charges were allocated to sectors. This is so because the size of subsidies in some sectors might be much higher than the value of the foreign exchange bank service charges excluding the subsidies. Hence this alternative is not very attractive. Another possibility is to deal with bank services and taxes and benefits separately and to allocate the taxes minus benefits directly to the government. The consequence is that taxes and benefits levied or granted on external transactions other than exports or imports of goods and services cannot be considered indirect taxes or subsidies. They are levied or granted on other revenue or expenditure components that do not form part of the production cost, and those taxes and benefits therefore do not immediately affect the prices of goods and services. It is suggested that they be treated as direct taxes when levied on transactions of the income and outlay account (for example, payment of interest on the public debt or the transfer of education grant funds) or as capital transfers when they are levied on transactions of the capital (accumulation or finance) account (for example, repayment of the public debt principal). There are some disadvantages to this treatment. Contrary to what is now recommended in the SNA, one would have to deal with negative direct taxes when implicit benefits are paid on transactions in the income and outlay accounts.

72

EXTERNAL SECTOR TRANSACTIONS

Such a concept, however, is not completely unknown at present, because some countries (for example, the United States) have introduced tax systems whereby explicit tax benefits are paid to taxpayers when their income is below a minimum level. The SNA may therefore have to be revised on this point. A third possibility is to allocate the taxes minus benefits, including the bank service charge, to the government. This treatment implies that foreign exchange bank services are charged to the government, since banks help the government to implement the exchange rate policy. This treatment has several advantages: the bank services need not be allocated to sectors, and thus the problem of measuring those services for each sector is avoided. Negative bank service charges could not occur, and one also avoids changes in the actual values of external transactions as a result of the inclusion of the implicit bank service charges. The last question that should· be dealt with here is the allocation of the implicit taxes and subsidies to the activity or institutional sectors of the economy that are affected by the exchange rate policy of the government. There is much analytical and policy interest in this allocation. From an accounting point of view, however, there are some disadvantages of trying to build the allocation into the national accounting framework. One would be that all transaction values in the external account would be changed, and the change is dependent on the accounting exchange rate selected. Also, input-output rela tions would be distorted, since both gross output and intermediate consumption of those sectors that are involved in the export or import of goods and services would be changed by the amount of indirect taxes minus subsidies. Because these sectors base their costing procedures on the actual prices that they pay or receive in local currency, the analysis of technical behavior of those industries would be distorted. To avoid the distortions, it is preferable to treat the adjustments for taxes and benefits as global adjustments in the external account and to allocate foreign exchange bank service charges directly to the government sector, as suggested above. For analytical uses, the global adjustments could be supplemented, however, by an alternative presentation of data in which the taxes and benefits and bank service charges are allocated to activities and sectors.

Capital Gains or Losses With the abandonment of the fixed exchange rate regime, exchange rates started to fluctuate, and in some countries they rose or fell

EXCHANGE RATE DIFFERENTIALS

73

continuously over time. Thus banks accrued revenues that were in fact realized capital gains net of losses. The capital gains or losses should not be included in the flow accounts of the SNA, however, but should be dealt with in the reconciliation accounts, where all valuation changes in assets are recorded. Before this treatment in the SNA accounts is illustrated, an explanation is needed about what is meant by capital gains and losses, which are only summarily treated in the SNA (paragraph 6.109) or defined in the Provisional Guidelines (paragraph 6.21) on balance sheets. 3 The explanation is given with the help of Table 1. The table presents an illustrative example showing the bank's balances (b) of U.S. dollar holdings at the end of 1985, the purchases (p) and sales (s) that took place during 1986, and the final balance of U.S. dollar holdings at the end of that year. The transaction value of balances, purchases, and sales is presented in U.S. dollars in the second column of the table. This information is converted to local currency values in the third column using the actual exchange rates at which dollars are purchased and sold during the year, as shown in the fourth column. It is assumed here that there is no difference between the sale and purchase values of U.S. dollars and that there is therefore no implicit bank service charge. The capital gains accruing to the banks are calculated each time dollars are purchased or sold, and they are presented in the last column of the table. For example, the capital gains of 1,160 accruing on March 3, 1986, are calculated as the change in the value of the balances of U.S. dollar holdings before the purchase on that date, as a result of changes in the exchange rate between February 1 and March 3, 1986 (1, 160 = 290 (9 - 5)). The subtotals of capital gains and net purchases minus sales in terms of U.S. dollars and local currency are presented at the bottom of the table. The net total of the capital gains (5,350) is equal to the difference between the closing and opening values of the stock of U.S. dollar holdings converted to local currency at the beginning and end of 1986 (4,900 = 6,000 - 1,100) minus the difference between purchases and sales of foreign currency ( -450) valued in local currency at the subsequent exchange rates at which sales and purchases were carried out. Capital gains and losses defined in this manner are consistent with the valuation of purchases and sales of foreign currency at their actual exchange rates. This example illustrates a situation whereby the net purchases of foreign currency by the central bank in terms of U.S. dollars is posi3 United Nations, Provisional International Guidelines on the National and Sectoral Balance-Sheet and Reconciliation Accounts of the System of National Accounts, Statistical Papers, Series M, No. 60 (New York, 1977).

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EXTERNAL SECTOR TRANSACTIONS

Table 1. Illustration o[ Capital Gains or Losses on Transactions in Foreiz.n Exchanz.e

Date

T:n~e

31 December 1985 1 February 1986

b p b s b p b s b

3March 1986 4 April1986 SMay 1986 6June 1986 7 August 1986 9 November 1986 5 December 1986 31 December 1986 Subtotal

p b s b p b s b

Transaction Value In U.S. In local dollars currenc;t 220 70 290 -60 230 20 250 -50 200 60 260 -30 230 20 250 -10 240 20

Exchange Rate (Local currency per US$1)

Capital Gains or Losses(-)

1,100 350

5 5

-540

9

1,160

140

7

-460

-750

15

2,000

900

15

-600

20

1,300

300

15

-1,150

-250

25 25

2,500

6,000 -450

5,350

Note: b = stock of U.S. dollars; p = purchases of U.S. dollars; s = sales of U.S. dollars.

tive (20) and, when converted to local currency at the exchange rates prevailing at the time of the transactions, the net value becomes negative ( -450). This change in sign of the balancing item occurs because the exchange rate of the dollar has increased over time and a larger portion of the foreign exchange sales is concentrated in the latter part of the year. The treatment of this effect is further illustrated in Table 2, which presents the treatment of these types of foreign exchange rate differentials in the national accounts. The figures in Table 2 are consistent with those in Table 1. It is assumed that all foreign currency transactions in Table 1 concern imports and exports of goods and services in Table 2. The net purchases of U.S. dollars in terms of local currency ( -450) show up as a deficit in the external account in Table 2 and

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EXCHANGE RATE DIFFERENTIALS

Table 2. Illustration of Treatment of Capital Gains or Losses

on Foreis_n Exchans_e in the National Accounts National Economy Banks Item Consumption/capital formation Exports Imports GOP/foreign trade balance Gross savings (net lending) Cash Local currency U.S. dollars Other assets

R

D

Other sectors R

D

5,000 1,690

450 (450)

Local currency R

D

1,690

u.s.

dollars R

D

170

2,140

2,140

150

4,550

(450)

20

(450)

4,550 (450)

(450) 5,000

Balancing item Note: R = revenue; D

External Transactions

4,550 4,550

(450)

(450)

= disbursement.

reduce the value of GOP in the account for the national economy. No adjustments have been made in the current account part of the table. The capital gain or loss component does, however, affect banks' balance sheets, other sectors of the national economy, and the external balance sheet as it relates to the national economy. But not all changes in the value of these assets are included in the capital finance accounts of those sectors, only those changes that are an immediate consequence of the real transactions mentioned before. These are the reduction in the local currency cash or other asset balances of other sectors of the economy ( -450) and the counterpart increase of those balances in the capital finance account of the banks ( +450); also included are the reductions in the U. 5. dollar balances of the banks in local currency ( -450) and the counterpart reduction of the U.S. dollar balances in the external account in local currency ( -450). Not included are the capital gains accruing to the banks as a result of the increases in the value of their foreign currency holdings. These capital gains are to be dealt with in the reconciliation accounts, as explained above. The net effect of the treatment shown in Table 2 thus maintains the deficit of the external sector, which is a consequence of changes in exchange rates over time, while compensating it with an

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EXTERNAL SECTOR TRANSACTIONS

adjustment factor in the external capital finance account and in the capital finance account of banks.

III. Measurement Issues The three components of exchange rate differentials rarely exist in isolation. Only under stable monetary conditions might one expect to find the implicit bank service charge for foreign currency transactions alone. Under the present conditions of volatile movements of exchange rates over time, however, capital gains and losses and bank service charges are included in the exchange rate differentials. Furthermore, many countries that have multiple exchange rate regimes also experience considerable changes in exchange rates over time, so that under these circumstances all three components of exchange rate differentials are present: bank service charges, capital gains or losses, and taxes or subsidies. To separate the three components, one would first need to determine the accounting exchange rate, or a series of accounts exchange rates if there are considerable changes in the exchange rates over time. On the basis of these accounting exchange rates, a distinction can be made between bank service charges and taxes or subsidies on the one hand and capital gains or losses on the other. The next step is to determine the bank service charge to be imputed to the government as a cost of the exchange rate policy. The accounting exchange rate-which can only be approximated because the actual value is not recorded-is an equilibrium rate that would exist at one point in time if there were no government control of part or all of the foreign currency market. The equilibrium rate should exclude the bank service charges. On the basis of this general criterion, the different possibilities of measurement will be reviewed under conditions varying from stable exchange rates to multiple exchange rate regimes combined with changes in the exchange rates over time.

Stable Monetary Conditions The simplest situation would be one in which there are fairly stable rates over time and, correspondingly, only minor operating margins charged by banks. Under these circumstances one might assume that there is an equilibrium between supply and demand and that purchasers and sellers of foreign exchange share the operating cost equally. The accounting exchange rate might be estimated as the

EXCHANGE RATE DIFFERENTIALS

77

unweighted average of the purchase and sale prices of foreign exchange.

Changing Exchange Rates Over Time The approximation of an accounting rate is more difficult when the foreign currency value is fluctuating over time or increases or decreases all the time. This is the most common situation at present. Under those circumstances information will be available on the margin between the purchase and sale prices of the foreign currency, but the margin may actually be much larger than in the case of stable monetary conditions because it not only reflects the operating cost but also includes a compensation for past and expected future losses in the value of foreign currency between the moments of purchase and sale. The difference attributable to the latter factor, if realized, is a capital loss and should in principle not be incorporated in the bank service charge. Because the separation of the capital loss element is, however, difficult to carry out in practice, the actual margin at one time between the purchase and sale values may be taken as an approximation of the bank service charge-that is, the accounting value for conversion will again be the unweighted average of purchase and sale values. Under these circumstances there would not be one accounting rate but a time series that reflects fluctuations in rates over time.

Multiple Exchange Rates The situation would be more difficult to deal with in national accounts when there are multiple exchange rates existing for different transactions that might take place at the same time. Most countries that have introduced these multiple rates are also faced with exchange rate changes over time. If there is a free or parallel (black) market, it may be possible to observe the differences between the purchase and sale values of foreign currency, which might be taken as an approximation of the bank service charges. It should be noted, however, that as in the previous case, in which exchange rates change over time, the margin may include compensation for realized and expected losses in the value of foreign exchange over time. Furthermore, the estimated margin may refer only to a small market where the margin between the sale and purchase values of foreign exchange is not representative for margins in other foreign currency markets that are government controlled.

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Several considerations should be taken into account in determining the accounting or equilibrium rate under multiple exchange rate conditions. The accounting exchange rate should probably be somewhere between the lower rates, generally controlled by the government, and the much higher rates, which dominate the free or parallel market. Presumably, if the government did not control the market, some who purchased foreign exchange at the low official rates would not exercise their demand; this would increase the supply of foreign exchange at the free market, which might then reduce the free market rate. A reasonable approximation of the accounting rate might be the weighted average of actual rates-after the estimated bank service charges are deducted. The weights would be the foreign currency values of all external transactions that took place during the period of account, including exports and imports as well as other transactions registered in the external account. In determining this average, one should be aware that the external account includes some transactions that are actually carried out without any foreign currency. These include loans tied to purchases of goods and services from the country providing the loan at a prearranged exchange rate, or current and capital grants-in-kind for which not even an explicit foreign exchange conversion is considered. These transactions should be excluded from the weighted average. Two approaches for deriving an estimate of the accounting exchange rate, suggested by Pinot de Libreros, are less appropriate. One suggestion is to choose an actual exchange rate as the rate that would come closest to the equilibrium accounting rate. 4 Such a choice would be reasonable only if the amount of foreign exchange transactions through this market were a very large percentage of all foreign exchange transactions. It is not sufficient, as Pinot de Libreros suggested, that the selected exchange rate be determined in a free market without government intervention because, although the government does not explicitly enter this market, it does influence the price in that market through a foreign currency market of its own that has attracted foreign exchange transactions otherwise channeled through the free market. Pinot de Libreros also suggests that, under multiple exchange rate conditions, the accounting exchange rate should be determined on the basis of the foreign exchange revenues, which the central bank says that it has accumulated as a result of the foreign exchange controls.5 The weakness of this approach is that the central bank can only 4 5

Pinot de Libreros, "Los mercados multiples de cambio," pp. 9-11. Pinot de Libreros, "Effects of Devaluation," pp. 14-16.

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79

determine these revenues on the basis of an accounting exchange rate, and in a manner similar to that illustrated in Table 1. This accounting rate may be different from the one that should be used in the national accounts calculations, and this therefore makes it difficult to use the central bank calculations as a point of departure for the national accounts conversion.

IV. A Quantitative Example The following quantitative example of the treatment of multiple exchange rates is intended to illustrate and clarify the previous discussion and proposals. The example is based on national accounts data for Venezuela for 1983. Because no unpublished, detailed national accounts information was available at the time this study was written, aggregate data as published by the United Nations in its annual national accounts publication6 were used and somewhat modified to fit the adjustments for exchange rate differentials. The Venezuelan national accounts figures are presented in Table 3 in the T-account format. The table is divided into two groups of accounts: one account for the national economy (the first two columns), and three alternative accounts covering external transactions in three modes of valuation-U.S. dollars (the last two columns), local currency based on the conversion using actual unadjusted (transaction) exchange rates (the third and fourth columns), and local currency based on the conversion using an accounting rate of exchange (the fifth and sixth columns). Each account has a revenue (R) and disbursement (D) side. The transaction breakdown presented in the table covers the main aggregates-GOP, gross savings, and net lending-together with the external transactions equivalents-foreign trade surplus or deficit, current surplus, and net lending. The transactions in the external accounts are recorded from the point of view of the national economy; that is, exports are presented as revenues, imports as disbursements, and so on. The accounting exchange rate used in the table is 10 local currency units per US$1. It was calculated as the weighted average of actual exchange rates, using the U.S. dollar values of the transactions presented in the last two columns as weights. All external transactions are included in the weights, except for the balancing items. By using 6 United Nations, National Accounts Statistics: Major Aggregates and Detailed Tables (New York, 1984).

80

EXTERNAL SECTOR TRANSACTIONS

Table3. National Accounts Aggregates in U.S. Dollars and Local Currency,

Including an Adjustment for Exchange Rate Differentials: Illustration with Venezuelan Data

External Transactions

National Economy Transactions

R

Final consumption Gross capital formation Exports Oil Others Imports By oil industry Others Exchange rate differential Banking service charge Indirect tax/subsidy

221.4 34.1

D

33.0 11.2

Local currency transaction exchange rate R

3.0 49.6 6.8 29.6

R

D

55.0 7.0

33.0 11.2

u.s.

dollars R

D

5.5 0.7

3.0 49.6

5.0 31.0

0.5 3.1

28.0

26.0

2.6

6.8 29.6 283.5

GOP/foreign trade surplus/deficit 283.5 Factor income (interest on external debt) 3.6 8.4 Current transfers 1.6 Final consumption 221.4 Exchange rate differential Direct taxes (3.3) 52.4 Gross savings/current surplus ( + )/ deficit (-) 52.4 Gross capital formation Capital transfers 34.1 Exchange rate differential Capital transfers (2.1) 16.2 Net lending Acquisition of financial assets

D

Local currency accounting exchange rate

16.2

28.0 3.6

26.0 8.4 1.6

6.0 14.0 1.0

0.6 1.4 0.1

(3.3) 18.3

17.0

1.7

17.0

18.3

1.7

(2.1) 16.2 16.2

14.4

2.6

17.0 17.0

14.4

1.7 1.7

9.0

0.9

81

EXCHANGE RATE DIFFERENTIALS

Table 3 (concluded) External Transactions

National Economy Transactions Repayment of external debt principal Incurrence of liabilities

R

D

Local currency transaction exchange rate R

(6.6)

(6.6)

4.8

4.8

D

Local currency accounting exchange rate R (11.0) 3.0

D

u.s.

dollars R

D

(1.1)

0.3

Exchange rate differential (increase in U.S. dollar balances due to changes over time in exchange rates) Source: Banco Central de Venezuela, "Experiencias y dificultades de Venezuela en el tratamiento de los cambios multiples en el Sistema de Cuentas Nacionales" (Experiences and Difficulties in Venezuela in the Application of Multiple Exchange Rates in the SNA), paper presented at the Regional Seminar on National Accounts, UN Economic Commission for Latin America and the Caribbean (ECLAC), Santiago, Chile, April 1986.

Note: R = revenue; D = disbursement. Calculation of the exchange rate differentials is based on an accounting rate of 10 local currency units per US$1.

all transactions as weights, it is assumed that transactions-in-kind are not included in the external account nor are linked transactions, such as foreign loans that are tied to imports of goods from the countries providing the loans. Five types of global adjustments for exchange rate differentials, which were discussed in Section II, are presented in different parts of Table 3. Banking service charges and indirect taxes or subsidies are presented as adjustments to exports and imports in order to affect GOP and the foreign trade balance. Net direct taxes are included before gross savings and the current external balance; net capital transfers are included before net lending. A final adjustment item, called net increase of U.S. dollar balances due to changes of exchange rates over time, is included as a final balancing item. The banking service charges (6.8 in the table) are assumed to be 5 percent of the total local currency value of all external transactionsrevenues and disbursements-converted on the basis of the actual

82

EXTERNAL SECTOR TRANSACTIONS

unadjusted (transaction) exchange rates (third and fourth columns). The implicit taxes or subsidies on external transactions are calculated separately for the production, income and outlay, and capital transactions. For each group of transactions, they are equal to (1) the difference between the local currency value of revenues converted on the basis of the accounting exchange rate minus the local currency value converted according to the actual exchange rate, plus (2) the difference between the local currency value disbursements converted on the basis of the actual exchange rate minus the local currency value converted on the basis of the accounting exchange rate, and minus (3) the implicit banking service charges. Based on this formulation, indirect taxes minus subsidies are 29.6

= (55.0 + 7.0- 33.0 - 11.2) + (3.0 + 49.6- 5.0- 31.0) - 0.05(33.0 + 11.2 + 3.0 + 49.6); net direct taxes are -3.3

= (6.0 - 3.6) + (8.4 + 1.6 - 14.0 - 1.0) - 0.05(3.6 + 8.4 + 1.6); and net taxes on wealth are -2.1

= (3.0 - 4.8) + (14.4 + 6.6 - 9.0 - 11.0) - 0.05(14.4 + 6.6 + 4.8). The increase of foreign currency balances due to changes of exchange rates over time has a value of zero because it has been assumed that no exchange rate changes have taken place during the period of account. The two accounts that ultimately enter into the national accounts are those for the national economy (the third and fourth columns of Table 3) and for external transactions, converted on the basis of the actual (unadjusted) exchange rates. Both columns include adjustments for exchange rate differentials. This means that GOP and the foreign trade balance are increased with the amount of indirect taxes (6.8) and banking service charges (29.6). Gross savings are thereafter reduced with the negative net direct taxes ( -3.3), and net lending is subsequently reduced with the negative net taxes on wealth (- 2.1). Because there are assumed to be no exchange rate changes over time, the external account (the third and fourth columns) balances without further adjustment. The case of Venezuela in Table 3 is an example of a country whose foreign trade balance in U.S. dollars is positive ( + US$2.6); if no adjustments had been made, the foreign trade balance in local currency would have been negative ( -8.4). The effects on GOP, gross savings, foreign trade, and other external balances depend on the choice of the accounting exchange rate

83

EXCHANGE RATE DIFFERENTIALS

Table 4. Value of Main Aggregates Calculated on the Basis of Different Accounting

Exchange Rates: Illustration with Venezuelan Data

Alternative Accounting Exchange Rates (Local currency units per US$1) Item GOP/foreign trade balance• Gross savings/ current external balance• Net lending Exchange rate differential Bank service charges Indirect taxes/subsidies Net direct taxes Net taxes on wealth GOP GOP per capitab

6.0

10.0

12.0

16.0

Valueinlocalcurrency 273.1 17.6 45.6 11.5 16.2 31.0 6.8 19.2 0.3 4.7 45.5 2,630.7

283.5 28.0 52.4 18.3 16.2 31.0 6.8 29.6 (3.3) (2.1)

288.7 33.2 55.8 21.7 16.2 31.0 6.8 34.8 (5.1) (5.5)

In U.S. dollars

28.3 1,638.6

24.1 1,390.5

299.1 43.6 62.6 28.5 16.2 31.0 6.8 45.2 (8.7) (12.3) 18.7 1,080.5

Source: Based on Table 3 under alternative exchange rates. •Surplus ( + ); deficit (- ). bBased on a population of 17.3 million (Venezuela).

(which was 10 local currency units per US$1 in Table 3). If a different accounting exchange rate were selected, all macro aggregates would be different. The difference is analyzed in Table 4. The table presents alternative values in local currency of the balancing items-GOP, foreign trade balance, gross savings, current external balance, and net lending-and the components of exchange rate differentials-bank service charges, indirect taxes net of subsidies, net direct taxes, and net taxes on wealth. Also reflected are the effects of changes in the accounting exchange rate on GOP and per capita GOP in U.S. dollars, which have been derived on the basis of the accounting exchange rate conversion. The first effect that should be noted is that if the accounting exchange rate is increased, the local currency value of GOP also increases. This is because a shift takes place within the total of exchange rate differentials, between the value of indirect taxes or subsidies and direct taxes and net taxes on wealth. The total of exchange rate differentials itself does not change, because it has been assumed that no changes take place over time in the accounting

84

EXTERNAL SECTOR TRANSACTIONS

exchange rate. Gross savings also increase, but net lending remains the same because of the unchanged total of exchange rate differentials. The shift toward indirect taxes or subsidies when the accounting exchange rate increases can be clearly observed from the trend.in the breakdown of the total exchange rate differentials in the table. Another effect of the change in the accounting exchange rate is on GOP and per capita GOP in U.S. dollars. Assuming that the accounting exchange rate is the most appropriate one for converting local currency GOP to U.S. dollars/ the U.S. dollar data are much more sensitive to a change in the accounting exchange rate than is the local currency GOP. The change in the U.S. dollar value of GOP is the result of two opposite effects. On the one hand, an increased accounting exchange rate increases GOP in local currency through the conversion of exports and imports; on the other hand, it decreases GOP and per capita GOP when converted back into U.S. dollars. The net effect is a considerable decrease in the U.S. dollar value of GOP and per capita GOP.

7 The adjustments to the exchange rates suggested in the present paper make the accounting exchange rate more attractive than any other exchange rate for the conversion to U.S. dollars of GOP and per capita GDP. However, not all limitations in the use of exchange rates are removed through the suggested adjustment procedure to arrive at an equilibrium rate, as the equilibrium rate applies in principle only to external transactions and remains less appropriate for the conversion of domestic transactions.

7 Harmonization of the Classification of External Current Account Transactions ARIE

C. SoUTER AND }AN VAN TONGEREN

here responds to repeated recommendations T by the United Nations Statistical Commission that statistical standards for related but specialized fields of statistics be harmonized, to HE STUDY DESCRIBED

the extent possible, with the present guidelines of A System of National Accounts (SNA). 1 This recommendation was taken up again by the 1982 Expert Group Meeting on the SNA, which initiated a review of the SNA and made harmonization one of the main themes of revision of the SNA. With regard to the IMF's Balance of Payments Manual (BPM), this focus on the review of the SNA is a continuation of the orientation already reflected in the 1977 edition of the BPM, which includes an appendix on the relation between the BPM and the SNA. 2 Several discrepancies between the two have remained, however, because at the time of the 1977 edition of the BPM it was thought to be neither statistically feasible nor analytically useful to incorporate in the BPM all details of the external account of the SNA. The first phase of the present harmonization project was finalized in 1981, when a reconciliation between the components of the external account of the SNA and the BPM was drawn up. A discussion of the differences between the SNA and the BPM took place at the 1982 1 An earlier version of this study was prepared for the Nineteenth General Conference of the International Association for Research in Income and Wealth (IARIW), Noordwijkerhout, Netherlands, August 25-31, 1985. 2 "Comparison of Balance of Payments Classification with External Transactions in SNA," Appendix C in International Monetary Fund, Balance of Payments Manual, Fourth Edition (Washington, 1977), pp. 177-80.

85

86

EXTERNAL SECTOR TRANSACTIONS

SNA expert group meeting. Unfortunately, little was accomplished in terms of harmonization. The present phase of the project, which was initiated in 1983 in close cooperation between the UN Statistical Office (UNSO) and the IMF Bureau of Statistics, tries to revive the discussion and narrow the gap between the components by studying the availability of data in selected countries and identifying the explicit or implicit links between them. This paper reports on the results of the country studies carried out until October 1985, draws conclusions, and makes proposals for the adaptation of the SNA and BPM components that would be compatible with further harmonization. Because the survey was restricted to current account transactions, the analysis is limited to that part of the SNA and BPM only. The characteristics of the present SNA and BPM components and the relations between them, as reflected in the present reconciliation, are briefly reviewed in Section I of the paper. Section II discusses the survey of selected countries and summarizes results. Section III takes up issues reflecting the differences between the SNA and BPM components and discusses them one by one. For each of the issues the section includes a brief summary of the present SNA and BPM practices, the results of the survey (if available), and, where necessary, the proposed modifications of SNA and BPM components that would result in further harmonization of the two systems. This section also includes a description of the modified reconciliation, after incorporation of the proposed modifications of the components. I. Present Reconciliation of SNA and BPM Components The differences between the components of the external account of the SNA and the BPM can be seen from two perspectives.3 The first defines BPM components in terms of details-"building blocks"that are needed to derive the SNA components; the second defines the SNA components in terms of the same building blocks, which are in turn needed to reconstruct the BPM components. Some of the BPM components are not covered in the SNA, while other building blocks are not included in the BPM because of differences in the coverage of transactions in the two systems. The reconciliation, although quite complex, provides all the elements needed to derive the components of both the SNA and the BPM and, thus, offers a guide to national Two reconciliation tables, omitted from this volume, are available from the authors on request. 3

CURRENT ACCOUNT TRANSACTIONS

87

compilers who want to derive the data for one system from that in the other. The number of differences is large, although the majority constitutes discrepancies that are quantitatively small and often ignored by national compilers, as will be seen in the discussion in Sections II and III. The main differences can be summarized briefly, however. Both the SNA and the BPM use the change-of-ownership principle for recording transactions. The SNA deviates from this principle in several instances, whereas the BPM is consistent in its application. For example, for the recording of merchandise transactions, the SNA follows the physical movement basis in line with foreign trade statistics and includes an adjustment item in the external account in order to bring this account in line with the other accounts of the SNA. Another difference concerns the treatment of reinvested earnings of directinvestment enterprises with foreign branches or subsidiaries, which are not included in the SNA but are included in the BPM, in conformity with the change-of-ownership principle. Other differences include the valuation of imports, which are valued on a c.i.f. (cost, insurance, freight) basis in the SNA and on an f.o.b. (free on board) basis in the BPM; the treatment of monetary and nonmonetary gold; the separate identification of labor and property income received by factors of production, which is made in the SNA but not in the BPM; and, finally, the treatment of insurance transactions, for which the SNA requires various imputations that are not made in the BPM.

II. The SNA-BPM Questionnaire on the Availability

of Separate Data or Estimates for Building Blocks Following the completion of the conceptual reconciliation of the two classifications of international transactions, the UN and the IMF proceeded to collect information from a small but representative group of national compilers on the current and future availability of separate data for each of the approximately 150 building blocks that are needed for the link. Two questionnaires were designed, based on the two reconciliation tables prepared earlier. One questionnaire, listing the building blocks in the order of the BPM components, was sent by the IMF to compilers of balance of payments statistics; a second questionnaire, seeking identical information but structured according to the SNA components, was sent by the UN to compilers of national accounts statistics in the same countries. Follow-up visits were made by staff of both institutions to some of the selected countries in order to obtain clarification and additional information. Nine countries had

88

EXTERNAL SECTOR TRANSACTIONS

completed the questionnaires by the time this study was prepared: Australia, Canada, France, Germany, the Republic of Korea, the Netherlands, Turkey, the United Kingdom, and the United States. The analysis and conclusions reached in this and the following sections are based on these responses. The information obtained from the UN and IMF questionnaires is summarized in the matrix shown in Table 1, which reproduces, in an alternative form, the present link between the current and capital account transactions of the SNA (rows) and the BPM (columns). The information presented in the matrix shows whether or not separate data or estimates for the building blocks are available in the majority of countries that have responded until now. When separate data or estimates for a given building block or component are available, the matrix shows an "A," whereas for other building biocks or components the notation is a dash(-). For instance, the BPM component "travel" needs to be broken down into separate building blocks for expenditures reimbursable by resident and nonresident employers, which are treated in the SNA as miscellaneous commodities or direct purchases by government; other travel expenditures, which are included in the SNA in direct purchases by households; rent on land, which is property income in the SNA; passport, visa fees, and airport taxes, which are included in SNA transfers; and the value of free goods and services acquired by and provided to travelers, which are not included in the SNA. The dashes in the BPM column for travel show that sufficient detail for these building blocks was not available in the responding countries. A similar analysis of the SNA details, required to derive the BPM components, may be carried out along the rows of the matrix. Further information on the availability of detailed data will be provided in the next section, where country practices are analyzed in detail. A general impression obtained from the survey was that the number of individual building blocks for which separate data or estimates are available in more than half of the responding countries is small and that the composition of the smallest available combinations of building blocks comes closer to the composition of the BPM components than to the composition of the components of the SNA. The survey results on data availability and country practices have been important elements in drawing up the proposals made below. They are not, however, the only justification for either amending or not amending the present guidelines. Coverage, concepts, and classifications in both systems are governed by underlying principles and analytical usefulness, which in some instances have been used as

CURRENT ACCOUNT TRANSACTIONS

89

justification for making recommendations that differ from what may have been implied by the survey results.

III. Proposals to Harmonize SNA and BPM Classifications of International Transactions This section includes three proposals to harmonize the composition of the components of the SNA and the BPM; the proposals are based on the survey results and also take into account the underlying principles of both systems. The first is a proposal to consolidate the components of the external account of the present SNA into fewer, more aggregated components representing the essential transaction categories of the SNA that have counterparts in other sector accounts of the SNA. The second recommendation is to apply more consistently the change-of-ownership principle in the SNA in order to bring it more in line with the BPM. The third set of recommendations refers to other changes in the composition of the components of the SNA and the BPM that would bring the composition of the two systems in line with data availability.

Consolidation of Goods and Services Components of the SNA The classification of goods and services flows in the SNA and the BPM differs considerably. The SNA external transactions account distinguishes between exports (imports) of merchandise and services; it includes a further breakdown of services into transport and insurance services, and direct purchases abroad by resident units, and in the reporting economy by nonresident entities, including those of households and governments. The BPM distinguishes between merchandise, shipment, passenger services, other transportation, and travel and has, furthermore, components for other goods and services (including income) broken down by interofficial, other resident official, other foreign official, and other goods and services. The considerable divergence between the breakdowns of the two systems requires a very large number of detailed building blocks to link the SNA and BPM components. The survey shows that the commodity detail required by the SNA is generally not available in countries and that countries instead accommodate unadjusted BPM components in single or combined SNA categories. It is therefore proposed to eliminate this commodity detail from the SNA. This can be done without affecting the SNA, since

90

EXTERNAL SECTOR TRANSACTIONS

Table 1. Comparison of Data Availability for Building Blocks in SNA and BPM

BPM Components

c

"'01

-~

e:

01

:a"'c ..c:"'

SNA

Com_I>onents Merchandise Transport on merchandise imports Other transport and communication Insurance service charges on merchandise imports Other insurance service charges Miscellaneous commodities Adjustment of merchandise to change-ofownership basis Direct purchases, government Direct purchases, households Compensation of employees Property and entrepreneurial income Current transfers, nongovernment Current transfers, general government Capital transfers, nongovernment Capital transfers, general government Capital flows Excluded from SNA

~

01

~

01

c01

"'...01

:.c til

"' c."'"'

E Q.,

00

c01

-

0

c

.!2

~

C)

01

..c:

0

01

01·-

:a~

0::"0

0.5

E ·0 c c01 v Iii01-E c u-o"' !: c ~~ M), though since . . . an accumulation of assets can be used either to increase future imports or reduce future exports, and an accumulation of liabilities can be liquidated by either reducing future imports or increasing exports, it is not dear why the deflator should depend upon the sign of net exports.1s 13 J.L. Nicholson, "The Effects of International Trade on the Measurement of Real National Income," Economic Journal, Vol. 70 (1960), pp. 608-12; antiNicholson; R.W. Burge and R.C. Geary, "Balancing of a System of National Accounts in Real Terms," in Meeting of the International Association for Research on Income and Wealth, 1957; R.C. Geary, "Problems in the Deflation of National Accounts: Introduction," Review of Income and Wealth, Series 9 (1961); UNSO, "Treatment of Terms-of-Trade Effect"; R. Courbis, "Comptabilite nationale a prix constants et a productivite constante," Review of Income and Wealth, Series 15 (No. 1, 1969), pp. 33-76; and Y. Kurabayashi, "The Impact of Changes in Terms of Trade on a System of National Accounts: An Attempted Synthesis," Review of Income and Wealth, Series 17 (No. 3, 1971), pp. 285-97. 14 Stuvel, "A New Approach"; M.F.G. Scott, "What Price the National Income?" in Economics and Human Welfare: Essays in Honor of Tibor Scitovsky, ed. by M.J. Boskin (New York: Academic, 1979); W. Godley and F. Cripps, "London and Cambridge Economic Bulletin II," The Times (1974); and the present SNA. 15 Denison, "International Transactions," p. 27, citing a comment by Walter Salant.

MEASUREMENT OF TERMS OF TRADE EFFECT

135

Averages of Px and Pm have been proposed; the Geary formula is an unweighted arithmetic formula, and the United Nations' an unweighted harmonic mean. The terms of trade effects can be seen from Table 4 to be generally identified in terms of what has been called a "projection basis" multiplied by the difference in relative import and export prices; that is, 1/Pm- 1/Px- The United Nations Statistical Office claims that its formula can be justified in an economic sense. In its example, if X = 240 and M = 200, it is claimed that the economic justification for using (X + M)/2 = M + (X - M)/2 = 200 + 40/2 = 220 as a projection basis is "one can assume that for 200 the whole external trade cycle was completed, while for 40 only half of the cycle (it was already exported but not yet imported; similarly . . . if it had already been imported but not yet exported)."16 Yet, this is not an economic justification since nowhere in economic theory are reserves considered to be halved simply because they have not been spent. It might be argued that the formula has an economic justification if export-import surpluses cancel in the long run. However, a terms of trade effect is evaluated for a current period and should be meaningful in these terms. It has also been claimed that the results can be clearly interpreted. That the projection basis is the arithmetic mean, or the deflator a harmonic mean, of export and import prices is a clear interpretation of the basis of the Clllculation. We know that the unit terms of trade effect is applied to an arithmetic mean of X and M, or ". . . the whole of what has been completed entirely plus we take half of what has been completed at 50 percent. "17 This is hardly a clear interpretation of its effect. The United Nations cites as a justification for its formula that terms of trade should only have a redistributive effect. However, as Nicholson has argued: IS It is wrong to assume, as is sometimes done, that the adjustments to income (or the adjustments to product) in the two-country case should be equal and opposite. The desire for articulation should not lose touch with economics. The gain (or loss) from changes in the terms of trade in the product of the one country is necessarily equal to the loss (or gain) in the income of the other country [our emphasis].

Finally, Courbis and, later, Kurabayashi proposed a linear combination of export and import prices, weighted respectively by the relative shares of real exports and real imports in real total trade. If a weighted 16 UNSO, ''Treatment of Terms-of-Trade Effect.'' 17Jbid. 1s Nicholson, "Effects of International Trade."

136

EXTERNAL SECTOR TRANSACTIONS

index is required, there is much to commend the Tornqvist, or translog, formula. This is given by

1(

(p

Xe Xb ) ex) P -exp[ 2 Xe + Me + Xb + Mb 1nPbx -

+

l( Xe Me+Me + xb Mb+ Mb )1n(pPbmem)] 2

I

where the subscripts c and b respectively denote current and base periods. The formula has much to commend it. First, on intuitive grounds, the formula improves on the Courbis and Kurabayashi formula in that it uses an average of current- and base-period weights, and not just base-period weights. Given that very few additional resources are necessary to compile this formula, compared with even Nicholson's simple formula, there is no justification for using a simple base-period-weighted index as proposed by Courbis and Kurabayashi. The Tornqvist formula may be chained to ensure that the weights used remain representative. Second, Diewert and Morrison have shown that it is suitable for ascertaining the effects on welfare (indicated by short-run output changes) of changes in a country's terms of trade in a manner that fits into an analytical framework for measuring technical change and total factor productivity. 19 Third, since the Tornqvist index utilizes an average of base- and currentperiod weights it will fall within the bounds defined by Konus 20 and Samuelson and Swamy21 for a "true" constant utility (or production) index defined in economic theory. Finally, Diewert has related the formula used for an index number to the functional form of the underlying aggregator function.22 For example, in price index num19 W.E. Diewert and C.J. Morrison, "Adjusting Output and Productivity Indexes for Changes in the Terms of Trade," Economic Journal, Vol. % (1986), pp. 659-79. 20 A.A. Konus, "The Problems of the True Index of the Cost of Living," Econometrica, Vol. 7 (1939), pp. 10-29 (English translation). 21 P.A. Samuelson and S. Swamy, "Invariant Economic Index Numbers and Canonical Duality: Survey and Synthesis," American Economic Review, Vol. 64 (1974), pp. 566-93. 22 W.E. Diewert, "Exact and Superlative Index Numbers," Journal of Econometrics, Vol. 4 (1976), pp. 115-45; "The Theory of the Cost-of-Living Index and the Measurement of Welfare Change," in Price Level Measurement, ed. by W.G. Diewert and C. Montmarquette (Ottawa: Statistics Canada), pp. 163-233.

MEASUREMENT OF TERMS OF TRADE EFFECT

137

ber work there is an underlying utility function by which a theoretical price index can be defined with regard to maintaining a constant utility or cost of living. The Tornqvist index is exact for a translog functional form and, more importantly, is also defined as being superlative since it is exact for a flexible functional form. A flexible functional form is one that is capable of providing a second-order differential approximation to an arbitrary twice continuously differentiable linearly homogeneous aggregator (in this case utility) function. That the index provides a good approximation to a class of other functions is thus an advantage. However, it is one shared by Fisher's "ideal" index, the geometric mean of Laspeyres and Paasche, which also lies within the Konus bounds. In practice, Tornqvist and Fisher's indexes provide similar results.23 In summary, we note the following for trade-based deflators. • The Nicholson and anti-Nicholson formulae both provide results that can be quite clearly interpreted, yet the interpretation does not provide an indicator of the objective change in real income since there is no reason to believe, for example, in the case of the Nicholson formula that a surplus will be used to buy imports at the time that it arises or in the future. It is difficult to justify one over the other since both formulae are simply different ways of viewing the same phenomena. Indeed, the Geary-Burge formula is based on the idea that Pm provides a more illuminating view when there is a deficit and Px when there is a surplus. However, the lack of consistency in the interpretation of the result, along with other difficulties, precludes the use of this formula. • The Nicholson and anti-Nicholson formulae for the terms of trade effect will diverge as X and M diverge. It will be shown in the empirical work that the differences between the results are quite substantial for developing countries. That two formulae give substantially different results, while both being equally justified, is not unknown in the SNA (for example, Laspeyres versus Paasche). However, it is not a state of affairs that we would wish to encourage. • An average of the two formulae is neither conceptually sound nor justifiable in economic theory. It is purely a compromise. If a weighted average is to be adopted (and the justification for this is not clear) a Tornqvist (or translog) formulation is preferable to the Courbis and Kurabayashi formula. 23 B. Hansen and E.F. Lucas, "On the Accuracy of Index Numbers," Review of Income and Wealth, Series 30 (No. 1, 1984), pp. 25-38.

138

EXTERNAL SECTOR TRANSACTIONS

Non-Trade-Based Deflators The non-trade-based deflators (Stuvel, Scott, Godley and Cripps, and the second SNA) given in Table 4 use one or a combination of the implicit deflators of the domestic economy for deflation of the surplus or deficit. Stuvel's formula is based on the implied deflator for net domestic product at market prices, as an expression of changes in the purchasing power of money. Scott argues that the ultimate purpose of both foreign and domestic investment and trade is to meet present and future consumption. The consumer price index (CPI) is therefore advocated as the appropriate deflator. Godley and Cripps chose the implied price index for total domestic expenditure at factor cost as a deflator. The SNA, while never mentioning the effects of terms of trade, discusses two approaches. The first yields the Nicholson formula; the second is to deflate the gross national product by a price index number of current and capital final expenditure in the domestic market. The two methods will give different results only if the balance of payments is different from zero and then only if the price index number for imports differs from the price index number of final purchases in the domestic market (SNA, paragraph 4.8, p. 53).

Choice Between Deflators Before drawing some conclusions on alternative approaches it is worth mentioning a criterion for choice between deflators that is often cited.24 This is that the terms of trade effects should be symmetrical when viewed from the domestic earner or the rest of the world; that is, the gains in one sector should be equal to the losses in the complementary sector. The Geary-Burge, Geary, Courbis-Kurabayashi, and Tornqvist formulae appear to possess this property.25 The Nicholson and anti-Nicholson formulae do not produce symmetrical terms of trade effects; however, the Nicholson formula applied to one country and the anti-Nicholson formula to the trading partner will be symmetrical. Too much attention should not be paid to the criterion of symmetry. As Nicholson has pointed out, symmetry is not a desirable property. 24 For example, Hibbert, "Measuring Changes," and P. Gutmann, "The Measurement of Terms of Trade Effects," Review of Income and Wealth, Series 27 (No. 4, 1981), pp. 443-53. 25 Gutmann, ''Measurement of Terms of Trade Effects.''

MEASUREMENT OF TERMS OF TRADE EFFECT

139

Nicholson's formula gives the gain (loss) in income in terms of its ability to purchase (forgo) imports:26 ... The other possible adjustment to terms of trade, symmetrical to the one just described, would consist in replacing imports by the value of exports at base year prices, needed to finance the actual level of imports. The result would indicate the level of domestic product needed to meet the current level of national expenditure [that is, the anti-Nicholson formula] .... It makes sense as economics. For the same goods and services which form part of the domestic and national product of one country form the imports and hence are part of the real income of the other country. These are simply two sides of the same coin. Thus, symmetry would not be a desirable property for the Nicholson formula since it would not make economic sense. Indeed the symmetry properties of the other formulae cited do not justify their use. A substantial positive terms of trade effect would mean that a country no longer has to export so many goods to maintain import levels. Thus, the previously exported goods can now be used for domestic consumption. The terms of trade effect is thus used to purchase home-produced goods. The price movement of the bundle of goods produced by those resources will dictate the extent of the terms of trade effect. There is now no reason to expect symmetry. If the resources are used for domestic production of chocolate as opposed to biscuits, that should not be mirrored in any calculation for the country's trading partner. · A similar argument applies to a factory (or industrial sector). If the price increases of what it sells are greater than what it buys in, there is a terms of trade gain. What it spends this gain on will dictate the extent of the gain. If spent on machinery, whose price increases at a faster rate than the price of the output of the factory, the gain becomes a loss. However, machinery may be regarded as a third sector, and terms of trade gains may be aggregated across sectors. As should be apparent, intersectoral terms of trade can be calculated as long as sufficiently detailed information on input-output flows (volume and price) between sectors (including the rest of the world) are available. Many of the issues discussed in this paper apply to intersectoral terms of trade effects, though see Bjerke for more details. 27 The choice between these deflators can only be judged in terms of how appropriate they are for measuring how much more was earned (from production and other sources) in terms of quantities of goods 26 27

Nicholson, ''Effects of International Trade.'' Bjerke, "Some Reflections."

140

EXTERNAL SECTOR TRANSACTIONS

and services for which this income is utilized. A broader analytical framework is required for this. The effect on real income of a change in the terms of trade ultimately depends on what the surplus is spent on, or the nature of the response to the deficit, be it drawing on financial assets, cutting expenditure on inventories, and/or fixed capital and/or labor, exporting more or curtailing consumption of imported goods. In the case of imported goods Nicholson's formula would be the appropriate deflator. Three approaches are considered. Approach A is to use a single deflator and to interpret it as implying one possible way of meeting a deficit or utilizing a surplus. Approach B is to use a single deflator or set of deflators, but also to use several further deflators-for example, the CPI, implied deflator for current and/or fixed capital formation, import-export unit values. Thus, several measures are provided on the possible terms of trade effects arising, for example, from the different ways in which a trade surplus is utilized, or what is forgone when there is a deficit. If all give similar results, the single-measure formula provides a reasonable approximation to the terms of trade adjustment. If, for example, one indicator is widely divergent from the rest, the question must be asked whether this is a likely target of expenditure from the trade surplus and, if so, the bias borne in mind. Users would be warned by the very publication of several results that a reliable estimate of the objective economic change in real income may not be given in the table. The different estimates would show the real income changes under different spending scenarios. Little additional resources are required to deflate by the alternative deflators available. Approach Cis to calculate a deflator as a weighted average of the price movements of consumption, imports, investment, expenditure, and so on. Problems inherent in calculating such a deflator include, first, that the weights should reflect the additions to consumption expenditure, investment expenditure, imports, and so on that will arise from the surplus (or be forgone due to the deficit), as opposed to the existing pattern. Second, there may be a time lag between the occurrence of the trade gap and its effect on the economy. Approach A, as argued earlier, may be misleading; approach C has severe measurement problems. Approach B is therefore proposed. There are some advantages in proposing a single deflator that should always be used, the effect from alternative deflators also being included or being relegated to footnotes. The Nicholson formula has some clear advantages in that, first, it has a plausible explanation (reserves or surplus may be used to finance more imports or imports may be curtailed when there is a deficit), second, it is already in use and, third, it is appropriate for the terms of trade effect because it is

MEASUREMENT OF TERMS OF TRADE EFFECT

141

grounded in trade relations. However, the anti-Nicholson formula should be used along with the Nicholson formula. It may strike some readers that Nicholson's formula was rejected earlier but is being proposed here. As a trade-based deflator, the Nicholson and antiNicholson formulae can both yield very different results, yet neither can be considered theoretically superior. The use of Nicholson's formula in this context is highly problematic. However, the use of his formula within an interpretative framework, where it is clearly given as one of many options, is conceptually sound. In summary, it is concluded that an appropriate framework should take the following points into account. • It should be based on the use of two identifiable standard selections of goods and services; the Nicholson and anti-Nicholson formulae would be suitable for this, though others might be considered. • Users should be clearly warned that these formulae do not provide indicators of objective economic flows, but ones contingent on particular scenarios. As such, estimates of alternative spending patterns by use of a range of further deflators are proposed as footnotes to the table of results. • The differences between using different deflators are shown by the empirical work to be substantial in many cases and, therefore, can mislead the economist if a single measure is published. • If a single trade-based deflator is to be used the Tornqvist index has many advantages.

Extension to Net Factor Income and Current Transfers from Abroad It was noted in the second subsection above ("Non-Trade-Based Deflators") that a measure of real income not only requires the adjustment for terms of trade effects but also adjustment first to include net factor income and current transfers from abroad and, second, to express these aggregates in real terms. Again, the stance taken is to ask what the net factor incomes and current transfers will be spent on or, if negative, what sacrifice will be made to meet the outflow. If net factor incomes are a surplus of migrants' earnings being sent home, the deflator for consumption expenditure is applicable. If the factor income is composed of a repatriated surplus from investment abroad, and this is to be used to finance fixed capital formation, the deflator for fixed capital formation is applicable. If the transfers are to finance particular activities, appropriate deflators may

142

EXTERNAL SECTOR TRANSACTIONS

be found. If these sums are in deficit, the task is more difficult. We have to ask what has been forgone to meet the deficit and what was the price increase of these items. It is proposed that the Nicholson and anti-Nicholson approaches be extended to these items so that a systematic interpretation can be put on the GNOI. However, alternative deflators should also be applied to net factor incomes and current transfers to identify the effects from alternative scenarios. Thus, if, for example, there is a very large change in net factor income, which can be identified by the user as being from migrants' wages, then the user may use the results based on a consumer expenditure deflator. In conclusion, we note the following. • Net factor income and current transfers may amount to quite substantial flows in proportion to the GOP; as such, guidelines are necessary on their deflation. • It is proposed that the interpretive framework used for measuring the terms of trade effect be extended to these items; the Nicholson and anti-Nicholson formulae would be the main deflators with the effects of using alternative deflators also shown.

Empirical Work It has been argued that the choice of deflator may be of little practical importance since different deflators give similar results and the terms of trade effect is generally small. This has been based on the results of empirical work undertaken by Gutmann and the United Nations Statistical Office.28 Gutmann only considered seven industrialized countries and Saudi Arabia. Little difference was found for the industrialized countries, yet for Saudi Arabia one formula led to a gain from terms of trade larger than Saudi Arabia's GOP, while a different formula showed a gain of only half that size. The United Nations' study had quite an extensive coverage of countries, yet only Nicholson's and the United Nations Statistical Office's formulae were considered. Table 5 provides results on the effects of using different deflators for measuring terms of trade effects. The study covered 50 countries (20 industrial and 30 nonindustrial). The purpose of this study was to illustrate that terms of trade effects calculated by different formulae Gutmann, "Measurement of Terms of Trade Effects"; UNSO, "Growth Indices Adjusted for Terms-of-Trade Effect for Seventy-Nine Countries," Report ESA/STAT/AC.27/4, Annex 1 (New York, 1986). 28

MEASUREMENT OF TERMS OF TRADE EFFECT

143

may, for some years, yield substantially different results. The period chosen varied between countries, being constrained by the availability of data for each country. At best, the data set included annual figures from 1948 to 1985. The terms of trade effects were calculated with respect to a reference period of 1980 equivalent to 0.00. It is noted that the levels as well as signs of the effect would differ if another reference period were chosen. In addition, it is stressed that 1980 weights are not being applied throughout the series; in many cases, the base period may be changed every five to ten years. Some of the differences may be substantial because of the time span used for the analysis. Yet in most cases, the maximum difference fell quite close to 1980, but the differences remained marked. Space constraints precluded the presentation of results for individual years. Because the study was concerned with differences in individual years, growth rates were not used as summary measures for comparisons. The following summary measures were used. The absolute difference between the terms of trade effects as measured by Nicholson's formula and, for example, Courbis and Kurabayashi' s formula was derived for each year and the mean, standard deviation and maximum (absolute) difference were calculated. This was repeated for each of the formulae given in Table 4. Since Nicholson's formula was used as a point of reference, its mean (absolute) value is given, as are its values for those years when the differences between Nicholson's formula and any other formula were at a maximum for the period. The results for Brazil can be used to illustrate the use of these measures. The Nicholson and anti-Nicholson measures differed most, for the period 1961-84, in 1974 by 123.5 million cruzeiros (at notional 1980 prices). Yet, as the final column shows in 1974, the terms of trade effect calculated by Nicholson's formula itself was only 167.6 million cruzeiros, the difference between the two formulae amounting to nearly three fourths of Nicholson's estimate. On average, the Nicholson formula gave an (absolute) value of 145.6 million cruzeiros. The average (absolute) difference between the Nicholson and anti-Nicholson formulae was 30.9 million cruzeiros, around one fifth of the average value for Nicholson's formula, but still substantial. The high standard deviation shows that in many years the results might be much higher than this average. The overall results show the following. • The difference between using import and export unit value indices (Nicholson and anti-Nicholson formulae) as deflators can be substantial. The results show that for nonindustrial countries not only are the maximum differences substantial but also the means and

144

EXTERNAL SECTOR TRANSACTIONS

Table 5. Comparison of Terms of Trade Effects Using Various Deflators:

Mean Absolute Difference, Standard Deviation of Absolute Differences, and Maximum Difference Between Nicholson's Formula and Others Anti-Nicholson Mean

Country

(standard devYtion)

CPI Deflator

Maximum

(standard

Maximum

(year)

deviation)

(year)

Geary

GOP Deflator Mean

Mean

(standard deviation)

Mean

Maximum

(standard

Maximum

(year)

deviation)

(year)

Non-industrial countries Brazil. 1961-84 (thousand million Brazilian cruzeiros) Burkina Faso, 1954-83 (thousand million CFA francs)• Colombia, 1950-85 (thousand million Colombian pesos) Cyprus, 1950-84 (million Cyprus pounds) El Salvador, 1952-83 (million Salvadoran colones) Ethiopia, 1961-80 (million Ethiopian birr) Fiji, 1960-83 (million Fiji dollars) Greece, 1951-85 (thousand million Greek drachmas) India, 1960-80 (thousand million Indian rupees) jordan, 1969-84 (million Jordanian dinars) Kenya, 1965-85 (million Kenyan shillings) Korea, 1961-84 (thousand million Korean won) Libt>ria, 1971-84 (million Liberian dollars) Malawi, 1967-85 (million Malawi kwacha)

30.9 (32.1)

123.5 (1974)

45.7 (47.0)

161.4 (1974)

32.0 (33.1)

134.6 (1984)

16.8 (17.5)

69.0 (1974)

3.2 (2.5)

8.2 (1983)

6.1 (5.7)

17.8 (1976)

8.0 (6.9)

20.0 (1983)

1.5 (1.2)

3.9 (1983)

5.8 (5.3)

20.1 (1966)

1.7 (2.0)

8.7 (1976)

1.5 (1.8)

7.4 (1976)

2.5 (2.3)

8.8 (1977)

4.4 (4.0)

16.0 (1973)

3.8 (2.6)

10.7 (1973)

5.3 (6.4)

22.2 (1984)

2.3 (2.2)

8.8 (1973)

41.4 (62.7)

287.2 (1983)

21.7 (35.1)

155.7 (1974)

25.9 (27.2)

109.6 (1974)

19.2 (27.2)

112.5 (1983)

25.6 (24.4)

72.0 (1975)

44.2 (34.4)

114.5 (1975)

32.7 (17.0)

67.6 (1978)

12.8 (12.7)

36.8 (1978)

9.8 (10.2)

38.0 (1981)

4.3 (4.1)

14.7 (1972)

4.4 (4.0)

15.4 (1981)

4.2 (4.4)

16.7 (1981)

12.3 (9.5)

39.2 (1973)

10.9 (9.3)

31.4 (1973)

12.5 (11.7)

45.5 (1973)

6.7 (5.4)

21.8 (1973)

3.9 (3.2)

10.3 (1966)

5.8 (4.8)

14.6 (1965)

5.2 (4.7)

14.1 (1966)

2.3 (1.9)

6.1 (1966)

30.4 (19.6)

67.7 (1969)

33.5 (26.8)

82.1 (1975)

33.5 (26.8)

82.0 (1975)

16.1 (11.4)

39.1 (1969)

504.7 2,213.2 (505.2) (1971)

161.2 (167.9)

618.6 (1971)

302.7 1,080.1 (304.3) (1971)

366.3 1,752.0 (413.6) (1971)

178.1 (173.2)

507.2 (1971)

208.9 (204.3)

670.9 (1971)

167.6 (205.4)

711.1 (1974)

98.9 (98.7)

289.2 (1971)

7.4 (8.8)

32.1 (1971)

12.3 (16.9)

46.9 (1971)

13.4 (16.2)

52.9 (1971)

3.7 (4.6)

17.3 (1971)

30.3 (21.4)

65.5 (1978)

16.6 (18.3)

54.1 (1972)

20.8 (20.4)

64.0 (1972)

18.4 (13.4)

39.2 (1968)

145

MEASUREMENT OF TERMS OF TRADE EFFECT

United Nations Statistical Office Mean

Courbisand Kurabayashi Mean

(standard

Maximum

deviation)

(year)

Tornqvist

Nicholson

Mean

(standard deviation)

Maximum (year)

(standard deviation)

Maximum (year)

15.5 (16.1)

61.8 (1974)

14.4 (14.6)

51.1 (1984)

14.7 (14.8)

53.3 (1974)

1.6 (1.3)

4.1 (1983)

0.9 (0.6)

2.2

(1982)

0.9 (0.6)

(1982)

2.9

10.1 (1966)

(2.4)

9.0 (1966)

(2.4)

8.0 (1973)

1.9 (1.7)

6.9 (1973)

1.9 (1.8)

(1973)

143.6 (1983)

18.9 (27.7)

128.6 (1983)

19.3 (27.7)

(12.2)

36.0 (1975)

11.3 (10.3)

31.1 (1975)

4.9 (5.1)

19.0 (1981)

4.5 (4.4)

6.1 (4.7)

19.6 (1973)

2.0

(1.6)

Valul'at

Mean

specified dat('

145.6

1974 1984

167.6 -194.6

2.1

1982 1976 1983

-5.2 0.7 -3.0

8.6 (1977)

40.0

1966 1976 1977

82.2 10.5 67.7

7.2

17.2

1973 1984

47.4 25.9

121.9 (1983)

349.8

1983 1979

-1,229.8 -310.8

11.0 (10.5)

30.0 (1977)

112.1

16.3 (1981)

4.3 (4.3)

16.1 (1981)

72.5

1975 1977 1978 1981

229.3 254.5 146.4 113.5

4.4 (3.3)

14.1 (1973)

5.2

16.8 (1973)

17.3

1973

50.8

(4.0)

5.2 (1966)

1.7 (1.2)

4.0 (1966)

1.8 (1.4)

4.5 (1966)

16.3

1966 1965

17.4 14.1

15.2 (9.8)

33.8 (1969)

8.1 (5.2)

18.4 (1974)

9.5 (6.4)

22.2

19.0

(1974)

151.3 (152.2)

540.0 (1971)

140.1 (135.4)

481.3 (1971)

138.6 (139.2)

506.5 (1971)

3,139.1

1969 1974 1975 1971

18.1 43.8 25.1 4,422.3

89.1 (86.6)

253.6 (1971)

69.1 (66.1)

199.4 (1979)

78.6 (76.6)

223.8 (1971)

606.2

1971 1979 1974

750.7 1,705.3 97.6

3.7 (4.4)

16.0 (1971)

4.0 (5.0)

18.4 (1971)

3.9 (4.8)

17.9 (1971)

54.6

1971

125.5

15.2 (10.7)

32.7 (1978)

12.1 (8.0)

23.4 (1972)

13.5 (9.5)

27.3 (1978)

68.0

1978 1972 1968

77.1 106.3 68.8

(2.7)

2.2

(2.0) 20.7

(31.3)

12.8

2.8

2.6

2.1

146

EXTERNAL SECTOR TRANSACTIONS

Table 5 (continued) Anti-Nicholson

Country

Malaysia, 1955-85 (million Malaysian ringgit) Malta, 1965-84 (million Maltese liri) Morocco, 1957-77 (thousand million Moroccan dirhams) Pakistan, 1970-84 (thousand million Pakistani rupees) Philippines, 1948-85 (thousand million Philippine pesos) Seychelles, 1976-82 (million Seychelles rupees) South Africa, 1948-85 (million South African rand) Sri Lanka, 1960-84 (million Sri Lanka rupees) Tanzania, 1965-80 (million Tanzanian shillings) Thailand, 1950-85 (thousand million Thai baht) Togo, 1971-78 (million CFA francs)" Trinidad and Tobago, 1966-82 (million Trinidad and Tobago dollars) Tunisia, 1961-83 (million Tunisian dinars)

CPI Deflator

GOP Deflator Mean

Mean

Mean

Geary Mean

(standard

Maximum

(standard

Maximum

(standard

Maximum

(standard

Maximum

deviation)

(year)

deviation)

(year)

deviation)

(year)

deviation)

(year)

300.2 1,220.7 (339.4) (1982)

330.0 1,005.6 (239.1) (1969)

173.0 (174.0)

536.9 (1979)

137.0 (150.5)

541.3 (1982)

6.7 (6.5)

22.8 (1970)

10.7 (11.5)

34.1 (1970)

14.1 (15.2)

44.9 (1970)

3.7 (3.8)

13.1 (1970)

0.3 (0.4)

2.0 (1976)

0.4 (0.7)

3.3 (1976)

0.4 (0.7)

3.1 (1976)

0.1 (2.7)

0.9 (1976)

1.6 (1.4)

3.8 (1982)

1.9 (1.8)

5.6 (1970)

2.0 (1.8)

5.7 (1970)

0.8 (0.7)

2.0 (1979)

1.5 (1.3)

5.5 (1949)

1.3 (1.6)

6.6 (1949)

1.3 (1.5)

6.7 (1949)

0.9 (0.8)

3.9 (1949)

6.1 (6.8)

18.8 (1982)

7.0 (11.6)

32.5 (1982)

10.0 (14.0)

37.0 (1982)

3.1 (3.4)

9.0 (1982)

218.7 1,007.3 (259.4) (1985)

249.5 (182.1)

649.3 (1962)

421.1 1,067.7 (302.6) (1962)

409.9 1,278.7 (356.1) (1971)

1,312.7 3,635.5 2,326.0 6,953.7 2,233.2 6,474.5 (849.6) (1969) (1,581.8) (1969) (1,454.4) (1969) 174.9 (191.7)

626.7 (1978)

265.8 1,269.3 (339.3) (1974)

252.5 1,142.8 (299.7) (1971)

2.3 (2.4)

9.0 (1969)

2.3 (2.8)

10.6 (1969)

2.3 (2.8)

6.8 (6.8)

18.9 (1974)

1.7 (1.3)

4.0 (1977)

4.1 (3.2)

285.5

790.2

235.0

676.0

(245.4)

(1972)

(194.9)

97.2 (71.2)

244.0 (1965)

11.5 (9.1)

812.6 2,296.0 (564.2) (1969) 90.3 (99.3)

328.7 (1978)

10.5 (1969)

1.2 (1.4)

5.5 (1969)

11.0 (1974)

4.0 (4.4)

12.0 (1974)

125.1

343.3

120.8

318.9

(1972)

(100.5)

(1972)

(101.8)

(1974)

32.3 (1961)

9.0 (7.1)

25.0 (1976)

31.1 (21.0)

68.6 (1965)

147

MEASUREMENT OF TERMS OF TRADE EFFECT

United Nations Statistical Office Mean (standard

deviation)

Courbisand Kurabayashi

Mnimum (year)

(standard deviation)

Tornqvist

Nicholson

Mean

Mean

Maximum

(standard

Maximum

(year)

deviation)

(year)

Value at Mean

150.1 (169.7)

610.4 (1982)

156.0 (171.8)

562.2 (1982)

148.0 (162.6)

557.8 (1982)

2,933.3

3.4 (3.3)

11.4 (1970)

2.8 (2.1)

8.8 (1970)

3.2 (3.1)

10.7 (1970)

0.1 (0.2)

1.0 (1976)

0.1 (0.1)

0.7 (1976)

0.1 (0.1)

0.8 (0.7)

1.9 (1982)

0.6 (0.5)

1.3 (1975)

0.8 (0.7)

2.7 (1949)

0.7 (0.6)

3.0 (3.4)

9.4 (1982)

210.5 (151.3)

specified date

3.9

1982 1979 1969 1970

-7,127.9 731.5 -940.8 37.8

0.7 (1976)

0.3

1976

-2.1

0.6 (0.5)

1.4 (1979)

2.6

1982 1979 1970 1975

-3.5 3.9 3.4 -4.8

2.2 (1949)

0.8 (0.7)

2.9 (1949)

12.0

1949

11.5

2.7 (2.9)

7.7 (1982)

2.8 (3.0)

8.0 (1982)

70.7

1982

-41.9

533.9 (1962)

223.2 (167.8)

631.1 (1962)

251.0 (184.1)

676.1 (1962)

3,245.5

1962 1971 1985

3,966.2 4,518.0 -2,498.1

656.3 (424.8)

1,817.8 (1969)

598.9 (376.6)

1,554.9 (1969)

622.7 (417.2)

1,687.8 (1969)

11,101.6

1969

10,754.6

87.4 (95.8)

313.3 (1978)

70.0 (69.9)

206.2 (1978)

65.3 (68.0)

213.4 (1978)

699.8

1978 1974 1971

603.9 438.4 955.9

1.1 (1.2)

4.5 (1969)

1.0 (1.1)

4.0 (1969)

1.1 (1.2)

4.5 (1969)

18.2

1969

36.0

3.4 (3.4)

9.4 (1974)

3.2 (3.9)

11.9 (1974)

3.3 (3.8)

11.1 (1974)

13.6

1974 1977

45.4 12.1

142.7 (122.7)

395.1 (1972)

152.8 (136.6)

467.1 (1974)

145.4 (126.1)

415.1 (1974)

1.7

1972 1974

-3,209.1 -1,520.3

48.6 (35.6)

122.2 (1965)

40.7 (27.5)

90.5 1965)

34.3 (23.0)

75.9 (1965)

357.0

1961 1965 1976

-250.5 -350.4 -431.1

148

EXTERNAL SECTOR TRANSACTIONS

Table 5 (continued) Anti-Nicholson Mean

Country Turkey, 1968-81 (thousand million Turkish liras) Zambia, 1964-80 (million Zambian kwacha) Zimbabwe, 1964-83 (million Zimbabwean dollars)

CPI Deflator

GOP Deflator Mean

Mean

(standard

Maximum

(standard

Maximum

(standard

Maximum

(standard

deviation)

(year)

deviation)

(year)

deviation)

(year)

deviation)

183.8 (1977)

114.4 (82.0)

282.4 (1977)

389.3 1,673.7 (452.4) (1969)

232.6 (254.7)

951.6 (1969)

79.1 (56.0)

107.5 (80.9)

260.6 (1977)

300.2 1,197.0 (1969) (359.5)

47.0 (33.2)

Mnimurn (year)

107.7 (1977)

298.6 1,337.6 (1969) (363.7)

10.3 (12.2)

43.7 (1965)

21.5 (21.6)

64.3 (1982)

21.5 (20.8)

73.4 (1982)

5.7 (6.9)

25.9 (1965)

0.5 (0.6)

2.3 (1952)

0.4 (0.5)

2.1 (1973)

0.3 (0.4)

2.0 (1973)

0.3 (0.4)

1.5 (1952)

0.3 (0.4)

1.5 (1977)

1.3 (1.8)

8.6 (1951)

1.4 (2.2)

10.5 (1951)

0.2 (0.2)

0.8 (1977)

1.6 (2.0)

8.0 (1972)

2.9 (2.5)

10.4 (1972)

3.5 (3.3)

14.0 (1972)

0.8 (1.0)

4.2 (1972)

0.2 (0.2)

1.0 (1984)

0.4 (0.6)

2.4 (1984)

0.3 (0.5)

2.0 (1984)

0.1 (0.1)

0.5 (1984)

0.4 (0.5)

1.7 (1976)

0.5 (0.4)

2.0 (1950)

0.6 (0.5)

2.1 (1950)

0.2 (0.2)

0.9 (1976)

0.2 (0.3)

1.6 (1975)

0.3 (0.3)

1.1 (1975)

0.3 (0.4)

1.7 (1975)

0.1 (0.1)

0.9 (1975)

0.6 (0.7)

2.3 (1982)

1.4 (1.4)

4.8 (1960)

1.5 (1.5)

5.2 (1960)

0.3 (0.4)

1.2 (1972)

2.6 (2.1)

8.6 (1973)

3.2 (2.6)

11.1 (1973)

3.8 (3.0)

11.0 (1973)

1.3 (1.1)

4.7 (1973)

0.2 (0.2)

0.9 (1973)

0.6 (0.6)

2.3 (1952)

0.8 (0.8)

3.0 (1950)

0.1 (0.1)

0.5 (1973)

33.4 (37.1)

152.4 (1973)

41.3 (42.7)

193.0 (1951)

53.8 (57.9)

303.8 (1951)

17.6 (20.2)

86.5 (1973)

Industrial countries Australia, 1949-85 (million Australian dollars) Austria, 1948-85 (thousand million Austrian schillings) BelgiumLuxembourg, 1953-84 (thousand million francs) Canada, 1948-85 (thousand million Canadian dollars) Denmark, 1948-85 (million Danish kroner) Finland, 1951-84 (thousand million Finnish markkaa) France, 1951-85 (thousand million French francs) Germany, 1952-85 (thousand million deutsche mark) Iceland, 1950-85 (million Icelandic kronur) Ireland, 1948-85 (million Irish pounds)

Geary Mean

149

MEASUREMENT OF TERMS OF TRADE EFFECT

United Nations Statistical Office

Courbisand Kurabayashi

Nicholson

Tornqvist

(standard dniatiun)

Maximum

Mean (standard

(year)

deviation)

39.5 (28.0)

91.9 (1977)

27.6 (16.3)

52.2 (1974)

29.9 (19.4)

62.1 (1977)

111.2

1977 1979

117.9 171.0

194.6 (226.2)

836.9 (1969)

233.1 (297.7)

1,120.6 (1969)

265.1 (330.0)

1,224.8 (1969)

1,446.8

1969

3,305.7

5.2 (6.1)

21.8 (1965)

5.0 (5.7)

20.3 (1965)

5.2 (6.2)

22.7 (1965)

125.2

1965 1982

298.7 88.2

0.2 (0.3)

1.2 (1952)

0.2 (0.3)

1.2 (1973)

0.3 (0.3)

1.2 (1973)

0.8

1973 1952

12.3 3.6

0.1 (0.2)

0.8 (1977)

0.1 (0.1)

0.7 (1977)

0.1 (0.2)

0.8 (1977)

8.1

1977 1951

18.5 -0.6

0.8 (1.0)

4.0 (1972)

0.8 (1.0)

4.2 (1972)

0.8 (1.0)

4.1 (1972)

58.4

1972

109.6

0.1 (0.1)

0.5 (1984)

0.1 (0.1)

0.5 (1984)

0.4 (0.9)

4.0 (1984)

2.8

1984

-7.7

0.2 (0.2)

0.8 (1976)

0.2 (0.2)

0.8 (1976)

0.2 (0.2)

0.8 (1976)

6.7

1976 1950

10.5 2.0

0.1 (0.1)

0.8 (1975)

0.1 (0.1)

0.7 (1975)

0.1 (0.1)

0.8 (1975)

2.3

1975

6.5

0.3 (0.4)

1.1 (1982)

0.3 (0.4)

1.2 (1972)

0.3 (0.4)

1.1 (1972)

14.8

1960 1972 1982

1.1 43.4 -17.6

1.3 (1.0)

4.3 (1973)

1.4 (1.1)

4.6 (1973)

14.6 (11.3)

38.9 (1974)

24.0

1973 1974

65.0 32.5

0.1 (0.1)

0.5 (1973)

0.1 (0.1)

0.5 (1973)

0.1 (0.1)

0.5 (1973)

5.6

16.7 (18.6)

76.2 (1973)

15.0 (16.7)

69.9 (1973)

15.3 (17.3)

73.6 (1973)

177.6

1950 1952 1973 1973 1951

-395.1 -521.4 890.3 895.3 -4.2

Mean

Mean

Maximum

(standard

Maximum

(year)

deviation)

(year)

Value at Mean

spedfied date

150

EXTERNAL SECTOR TRANSACTIONS

Table 5 (concluded) Anti-Nicholson Mean

Country Italy, 1951-84 (thousand million Italian lire) Japan, 1952-85 (thousand million Japanese yen) Netherlands, 1950-85 (thousand million Netherlands guilders) New Zealand, 1950-84 (million New Zealand dollars) Norway, 1950-85 (thousand million Norwegian kroner) Spain, 1954-84 (thousand million Spanish pesetas) Sweden, 1951-85 (thousand million Swedish kronor) Switzerland, 1948-85 (thousand million Swiss francs) United Kingdom, 1949-85 (million pounds sterling) United States, 1948-85 (thousand million U.S. dollars)

CPI Deflator Mean

GOP Deflator Mean

Geary Mean

(standard

Maximum

(standard

Maximum

(standard

Maximum

(standard

Maximum

deviation)

(year)

deviation)

(year)

deviation)

(year)

deviation)

(year)

485.9 2,254.0 (523.9) (1973)

558.4 3,703.0 (1973) (762.4)

531.6 3,291.1 (1973) (640.5)

269.6 1,250.1 (294.1) (1963)

540.5 3,013.4 (1972) (732.7)

462.6 2,925.6 (746.2) (1985)

485.0 2,678.2 (771.8) (1978)

328.0 1,953.5 (457.0) (1972)

0.2 (0.2)

0.9 (1973)

0.6 (0.6)

2.3 (1952)

0.8 (0.8)

3.0 (1950)

0.1 (0.1)

0.5 (1973)

73.7 (1G.63)

593.4 (1974)

53.5 (95.7)

537.4 (1974)

54.0 (98.4)

455.9 (1974)

41.1 (59.0)

325.6 (1974)

1.3 (1.5)

6.3 (1977)

1.0 (1.5)

6.3 (1984)

0.9 (1.3)

5.6 (1984)

0.6 (0.8)

2.8 (1977)

48.2 (65.7)

226.8 (1967)

26.3 (26.0)

94.5 (1967)

27.4 (23.5)

89.5 (1984)

27.8 (39.9)

138.7 (1967)

0.2 (0.3)

1.1 (1973)

0.4 (0.5)

2.6 (1973)

0.4 (0.5)

2.3 (1973)

0.1 (0.1)

0.5 (1973)

0.1 (0.1)

0.5 (1978)

0.3 (0.2)

0.9 (1948)

0.4 (0.4)

1.4 (1948)

0.1 (0.0)

0.3 (1978)

0.2 (0.4)

2.0 (1974)

0.2 (0.4)

2.1 (1974)

0.3 (0.5)

2.5 (1974)

0.1 (0.1)

0.9 (1974)

3.7 (3.4)

14.6 (1985)

5.1 (5.9)

29.6 (1985)

5.2 (5.9)

29.3 (1985)

2.1 (1.9)

7.8 (1985)

Source: Compiled from the International Monetary Fund's database, similar data being available from various issues of its International Financial Statistics. • Franc de Ia Communaute financiere africaine.

151

MEASUREMENT OF TERMS OF TRADE EFFECT

United Nations Statistical Office Mean (standard

Maximum

deviation)

(year)

Courbisand Kurabayashi Mean

(standard deviation)

Tornqvist

Maximum

Mean (standard

Maximum

(year)

deviation)

(year)

Nicholson Value at Mean

specified datP

242.9 (261.9)

1,127.0 (1973)

228.6 (235.2)

1,030.4 (1973)

237.0 (251.2)

1,079.5 (1973)

6,186.7

1973 1963

12,015.8 6,983.3

270.3 (366.3)

1,506.7 (1972)

289.1 (407.4)

1,680.0 (1972)

467.5 (459.5)

1,630.9 (1978)

5,150.8

1972 1978 1985

12,653.3 12,982.3 5,801.4

0.1 (0.1)

1.0 (1973)

0.1 (0.1)

1.0 (1973)

0.1 (0.1)

1.0 (1973)

5.6

1973 1952 1950

13.6 1.4 2.2

36.8 (53.1)

296.7 (1974)

35.0 (44.5)

230.0 (1974)

37.7 (51.1)

274.7 (1974)

738.6

1974

1,023.9

0.6 (0.8)

3.2 (1977)

0.6 {0.8)

2.8 {1984)

0.6 {0.8)

2.9 (1977)

14.5

1977 1984

23.6 26.1

24.1 {32.9)

113.4 {1967)

18.4 {21.3)

77.2 {1968)

22.2 {29.1)

101.7 {1967)

210.5

1967 1968 1984

214.0 280.8 -337.8

0.1 {0.1)

0.5 {1973)

0.1 (0.1)

0.6 {1973)

0.1 {0.1)

0.5 {1973)

4.6

1973

10.4

0.1 (0.0)

0.3 {1978)

0.1 {0.0)

0.3 {1978)

0.0 {0.0)

0.3 {1978)

2.3

1978 1948

7.5 -0.9

0.1 {0.2)

1.0 {1974)

0.1 {0.1)

0.9 (1974)

0.1 (0.1)

0.9 (1974)n

2.5

1974

-10.9

1.8 (1.7)

7.3 (1985)n

1.8 (1.7)

6.0 (1948)n

1.9 {1.8)

6.7 {1985)

36.0

1948 1985

28.0 33.9

152

EXTERNAL SECTOR TRANSACTIONS

variances of these differences are high relative to the mean (using Nicholson's formula) with high standard deviations. Thus, high differences are not isolated events in any one year. A mere glance at the values will show this to be the case for almost all nonindustrial coun tries. For many industrial countries, the differences are less marked on average; yet, for particular years, the maximum differences remain high. The results are likely to be similar for countries with small trade balances. It may be argued that large imbalances are unlikely to hold for a given country over a long period. However, the SNA cannot be useful if it gives a good estimate most of the time, especially if "most of the time" is when the phenomenon is having little impact on the economy. • If a trade-based deflator is to be used, a weighted or an unweighted average must fall between the results from using an import and export price index. The difference between the Geary and the United Nations Statistical Office's formulae can be seen to be generally small. Both use unweighted averages (arithmetic and harmonic mean, respectively) of import and export unit value indices as deflators. The United Nations formula differs only slightly from the weighted Courbis and Kurabayashi formula, the use of a weighted, as opposed to unweighted, formula not being crucial, though differences can be quite high in certain circumstances (for example, for Greece in 1976 and Morocco in 1973). The differences between the weighted formulae, Tornqvist's and Courbis and Kurabayashi' s, can again be seen to be generally small, but there are cases (for example, Canada in 1984) when it is quite significant. If a weighted trade-based formula is to be used, the question whether the base period or any average of base- and current-period weights needs to be addressed. Since the use of a chained formula would involve little extra resources, this demands consideration, though empirical work on this has not been carried out.

• The use of a range of deflators shows that the measure of terms of trade effect can be quite dependent on the selection of goods and services chosen. The deflators used represent a small selection of those available, and their choice was somewhat arbitrary. The CPI and GDP deflator were selected to be analyzed in conjunction with the Nicholson and anti-Nicholson deflators. It has already been shown that the Nicholson and anti-Nicholson deflators can diverge substantially, especially for nonindustrial countries. There are often quite marked differences between Nicholson's and the CPI and GDP deflators (for example, Trinidad and Tobago, Belgium, Luxembourg, and Malaysia). The differences between the Nicholson and the

MEASUREMENT OF TERMS OF TRADE EFFECT

153

implicit GOP deflator and the CPI are not as pronounced as between the Nicholson and anti-Nicholson deflators owing to the interrelationship between import price changes, consumer price changes, and the implicit GOP deflator. Yet, what is apparent is that the four results in many cases can be quite different but become more meaningful when viewed together.

V. Conclusions This paper has argued for an analytical framework for the measurement of terms of trade effects and NNDI that was based on separately identifying the GOP at constant prices and separately ascertaining the effects of terms of trade movements, net factor income, and net current transfers from abroad. Several possible deflators were surveyed, and empirical work has been provided to show that the measurement of terms of trade effects are very sensitive to the choice of deflator. Since there is no single deflator that is appropriate to all countries in all circumstances, an interpretive framework has been proposed. Under this framework the economist can ascertain changes in real income based on different spending scenarios. This may be unique in national accounting, but so is the problem of measuring real income flows. Countries that continue to use a single measure may, as shown by the empirical work, provide economists with seriously misleading results if the assumptions implicit in a different formula are more likely to apply at that time. The United Nations Expert Group on the SNA Review was sympathetic to the case presented for the adoption of the framework given in Table 2 but has, at the time of writing, yet to propose a recommended choice of deflator.

11 Oassification of Capital Account Transactions MAHINDER 5. GILL

proposes some revisions in the structure and classificaT tion of the capital account of the balance of payments. Since the publication of the fourth edition of the IMF' s Balance of Payments ManHIS PAPER

ual (BPM) in 1977, innovations have occurred in a range of financial instruments and transactions, necessitating a reappraisal of the existing classification scheme for the capital account. A related consideration is the ongoing work on the revision of the United Nations' A System of National Accounts (SNA), one of the goals of which is to harmonize it with related standards on balance of payments, government finance, and money and banking statistics. Although some of the other papers in this volume focus on the special features of newly introduced financial instruments, this paper essentially addresses the need for modifications in the existing BPM classification of capital account items 1 that would facilitate links between the classification of the capital account of the balance of payments, on the one hand, and the corresponding classification as reflected in the SNA, on the other. The structure of the capital account as proposed in this paper reflects (1) the Fund's analytical and operational needs; (2) the need to devise a classification scheme for financial assets and liabilities that would not only permit links between flow and stock data but would also facilitate comparison of data on stocks of assets and liabilities with data on the associated income flows as portrayed in the current account; (3) the need for harmonization between the balance of payments classification of capital account transactions and the corresponding classification of external transactions used in the SNA; and See the BPM, paragraphs 191-97 and the list of standard components of the capital account on pp. 67-69. 1

1 1:\d.

CAPITAL ACCOUNT TRANSACTIONS

155

(4) the need to promote compatibility between the Fund's systems on balance of payments, government finance, and money and banking statistics. The revised classification scheme proposed for the capital account of the balance of payments is presented in Table 1.2 Section I discusses the content of the capital account of the balance of payments, whereas Sections II and III examine the classification of financial assets and liabilities and its application to the different capital account categories that are distinguished. Section IV discusses the desirability of countries, furnishing supplementary information on certain transactions that are deemed to constitute balance of payments financing transactions. Some concluding remarks and points for discussion are offered in Section V.

I. Coverage of the Capital Account The capital account of the balance of payments is defined to cover the receipts and payments of capital transfers; transactions in foreign financial assets and liabilities; and valuation changes (including reconciliations and reclassifications) affecting the stock of reserves, together with their counterparts.

Capital Transfers In contrast to the existing BPM, this paper proposes that a differentiation be made between current and capital transfers and that the latter be shown as part of the capital account of the balance of payments. The separation of current from capital transfers is required to compile measures of national and sectoral saving. The distinction between current and capital transfers is to be made according to the criteria described in paragraphs 7.60 and 7.74-7.77 of the SNA. Although the guidelines for distinguishing between current and capital transfers are reasonably clear, problems are encountered in applying them in the context of international transactions, in particular because both the donor and the recipient are required to treat a transfer payment or receipt as current or capital. The distinction may be clear in domestic transactions, but statisticians do not always have all the relevant facts for international transactions. This consideration led previous editions of the BPM to refrain from differentiating 2 The proposed scheme contrasts with that of the fourth edition of the BPM and the one for external transactions in the SNA.

156

EXTERNAL SECTOR TRANSACTIONS

Table 1. Proposed CIJlssification of Capital Account Items A.

Capital, excluding reserves Capital transfers General government Other sectors Direct investment Abroad Equity capital Reinvestment of earnings Other long-term capital Short-term capital In reporting economy Equity capital Reinvestment of earnings Other long-term capital Short-term capital Other capital Long-term capital: assets General government Bonds Corporate equities Drawings and repayments on loans extended Other assets Monetary authorities Bonds Corporate equities Drawings and repayments on loans extended Other assets Deposit money banks Bonds Corporate equities Drawings and repayments on loans extended Other assets Nonmonetary financial institutions Bonds Corporate equities Drawings and repayments on loans extended Other assets Other sectors Bonds Corporate equities Drawings and repayments on loans extended Trade and other suppliers' credits Other loans n.i.e. Other assets

CAPITAL ACCOUNT TRANSACTIONS

Table 1 (continued) Long-term capital: liabilities General government Liabilities constituting foreign authorities' reserves Other bonds Drawings and repayments on other loans received Trade and other suppliers' credits Other loans n.i.e. Other liabilities Monetary authorities Liabilities constituting foreign authorities' reserves Drawings and repayments on other loans received Other deposits Other bonds Other liabilities Deposit money banks Liabilities constituting foreign authorities' reserves Drawings and repayments on other loans received Other corporate equities Other deposits Other bonds Other liabilities Nonmonetary financial institutions Liabilities constituting foreign authorities' reserves Drawings and repayments on other loans received Other corporate equities Other deposits Other bonds Other liabilities Other sectors Liabilities constituting foreign authorities' reserves Drawings and repayments on other loans received Trade and other suppliers' credits Other loans n.i.e. Other corporate equities Other bonds Other liabilities Short-term capital: assets General government Currency and deposits Loans extended Other assets Monetary authorities Currency and deposits Loans extended Other assets

157

158

EXTERNAL SECTOR TRANSACTIONS

Table 1 (continued) Deposit money banks Currency and deposits Loans extended Other assets Nonmonetary financial institutions Currency and deposits Loans extended Other assets Other sectors Currency and deposits Loans extended Trade and other suppliers' credits Other loans n.i.e. Other assets Short-term capital: liabilities General government Liabilities constituting foreign authorities' reserves Other loans received Trade and other suppliers' credits Other loans Other liabilities Monetary authorities Liabilities constituting foreign authorities' reserves Other currency and deposits Other loans received Other liabilities Deposit money banks Liabilities constituting foreign authorities' reserves Other deposits Other loans received Other liabilities Nonmonetary financial institutions Liabilities constituting foreign authorities' reserves Other deposits Other loans received Other liabilities Other sectors Liabilities constituting foreign authorities' reserves Other loans received Trade credits and other suppliers' credits Other loans Other liabilities

CAPITAL ACCOUNT TRANSACTIONS

159

Table 1 (concluded) B.

Reserves Monetary gold Total change in holdings Counterpart to monetization or demonetization Counterpart to valuation changes SDRs Total change in holdings Counterpart to allocation or cancellation Counterpart to valuation changes Reserve position in the Fund Total change in holdings Counterpart to valuation changes Foreign exchange assets Total change in holdings Counterpart to valuation changes Other claims Total change in holdings Counterpart to valuation changes Use of Fund credit Total change in holdings Counterpart to valuation changes Note: "N.i.e." indicates "not included elsewhere."

between current and capital transfers and to treat them indistinguishably as current. It seems desirable to adopt a uniform treatment throughout the various sectors of the SNA in differentiating between current and capital transfers.

Transactions in Financial Assets and Liabilities Transactions in financial assets and liabilities are first grouped into three functional categories: reserves (including use of Fund credit), direct investment, and other capital (see Table 1). Where appropriate, a distinction is made between long-term and short-term capital flows on the basis of original contractual maturity of more than one year and one year or less, respectively. In the SNA, long-term financial assets and liabilities are defined in terms of an original contractual maturity of one year or more. It is suggested that the one day's difference between the two classifications be eliminated and that, in the revised version of the SNA, this difference be brought

160

EXTERNAL SECTOR TRANSACTIONS

into line so that long-term capital is defined in terms of an original contractual maturity of more than one year. A distinction is drawn between assets and liabilities, and the residual functional category of "other capital" is also broken down by sector. The next level of disaggregation suggested is by financial instrument.

Reseroes Reserves constitute a separate category owing to their characteristic as assets that are conceived of as available for use by an economy's central authorities in meeting a balance of payments need. Availability is not necessarily closely linked in principle to formal criteria such as ownership, currency of denomination, or maturity of assets. The coverage of this group derives from an analytic concept rather than from precise definitions based on observable characteristics possessed by the financial items concerned. In contrast to nonreserve capital flows, the list of standard components of the capital account calls for supplementary information on the total change in holdings of reserve assets and on the counterpart of any portion of that change that is not the result of a transaction between two parties. For these counterpart items, a separate entry is shown for the monetization or demonetization of gold, the allocation or cancellation of SDRs, and valuation changes (defined to include reclassifications as well as fluctuations in market values). Experience has shown that, for thecategory of reserves, information on the total change in holdings and on the counterpart to changes not due to transactions provides for the construction of a variety of analytic presentations of the balance of payments, including the identification of a performance balance in addition to a payments imbalance whose magnitude is explained by the change in the stock of reserves. Furthermore, data on the total change in holdings of reserves are generally available on a monthly basis; thus, in the absence of other data, information on the total change in the stock of reserves provides a preliminary assessment of the payments imbalance. In the present SNA, gold is classified both as a commodity and as a financial asset. Under the conventions of the SNA, gold could be held as a financial asset not only by the central authorities (that is, the central bank and the central government) but also by other sectors of the economy. Any reclassification of commodity gold to a financial asset is recorded as an export or import and as an increase oi decrease in holdings of gold as a financial asset. Furthermore, any interna-

CAPITAL ACCOUNT TRANSACTIONS

161

capital account. In the BPM, however, gold is classified either as a commodity or as a monetary asset (monetary gold) when held or controlled (owned by other entities, such as commercial banks) by the central authorities. When gold is held, supposedly as a financial asset, by entities other than the central authorities, it is classified as a commodity or nonfinancial asset under the conventions of the BPM. Consequently, any reclassification of gold-that is, a monetization or demonetization-is recorded in the reserves category in the capital account of the balance of payments with a counterpart entry (also in the same category) denoting the monetization or demonetization. In addition, international purchases or sales of gold held as a financial asset by entities other than the central authorities are recorded as commodity transactions under imports or exports. With a view to aligning the SNA and the BPM, the BPM treatment of gold transactions should be adopted in a revised version of the SNA because this would obviate the need for making entries under exports or imports when gold is reclassified from a nonmonetary to a monetary asset and would thereby avoid asymmetries both in the current account and in the capital account of the balance of payments. Furthermore, the joint UN-IMF questionnaire sent to a sample of countries during 1983/84 and the follow-up discussions that took place on the countries' responses revealed that few countries had data on holdings of financial gold by the nonfinancial sector, although in a few countries (for example, Germany and the United Kingdom) the practice was to classify gold as a financial asset if held by the commercial banks. Since 1970, the Fund has issued SDRs at intervals to its member countries as a means of augmenting international reserves. Because for the recipient country the SDR allocation has the effect of increasing the authorities' international means of payment, and because the issuance of SDRs is not construed as a transaction in the sense of a change of ownership between two parties, a counterpart entry denoting the allocation of SDRs is reflected in the balance of payments statement. A change in the level of reserves held in the form of foreign exchange may come about through the assumption or relinquishment of effective control by the monetary authorities over asset holdings of, say, the commercial banks. Because a transaction is not involved in this case, the BPM convention is to make a counterpart entry denoting the change in reserves stemming from the process of the assumption or relinquishment of control by the authorities. To make the balance of payments statement responsive to a variety of analytical needs, the BPM extends the strict notion of a transaction

162

EXTERNAL SECTOR TRANSACTIONS

(that is, provision of economic values by one transactor to another) to encompass changes in reserves stemming from gold monetization or demonetization, allocation or cancellation of SDRs, and reclassification of reserves to nonreserve assets and vice versa. In a related vein, the BPM also includes valuation changes (together with their counterpart entries) in reserve assets.

Direct Investment Direct investment, identified as a separate category in the capital account because of its distinctive behavior, is made to acquire a longterm interest in an enterprise operating in an economy other than that of the investor, the investor's purpose being to have an effective voice in the management of the enterprise. The foreign entity or group of associated entities that makes the investment is called the direct investor. The unincorporated or incorporated enterprise-a branch or subsidiary, respectively-in which the direct investment is made is referred to as a direct-investment enterprise. At the request of the Committee on International Investment and Multinational Enterprises of the Organization for Economic Cooperation and Development (OECD), the OECD Group of Financial Statisticians undertook a study during 1981-82 to expand the Fund's definition of direct investment and make it more operational. The OECD Group's report was approved by the Committee in June 1982.3 Although concurring with the BPM's definition of the concept of direct investment, the OECD Group recommended (paragraph 13, page 7) that ... A direct-investment enterprise be defined as an incorporated or unincorporated enterprise in which a single foreign investor ... either: (a) controls 10 percent or more of the ordinary shares or voting power of an incorporated enterprise or the equivalent of an unincorporated enterprise, unless it can be established that this does not allow the investor an effective voice in the management of the enterprise; or (b) controls less than 10 percent (or none) of the ordinary shares or voting power of the enterprise but has an effective voice in the management of the enterprise.

The OECD Group's report recognized that the stipulation of 10 percent equity participation would have to be applied flexibly to encompass marginal cases of a direct-investment relationship. In 3 See OECD, "Detailed Benchmark Definition of Foreign Direct Investment," General Distribution, BOP.B2 (Paris, February 1983).

CAPITAL ACCOUNT TRANSACTIONS

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encompass marginal cases of a direct-investment relationship. In such cases the OECD Group's report proposed that evidence of a direct-investment relationship could be suggested by such factors as (1) representation on board of directors, (2) participation in the policymaking process, (3) interchange of managerial personnel, (4) provision of technical information, and (5) provision of a long-term loan that bears no relationship to the existing market rates. It is interesting to note that, whereas the BPM (paragraph 410) states that "foreign influence that is not accompanied by at least some ownership of voting stock is rarely, if ever, seen as constituting direct investment," the OECD Group's report recognizes that, in exceptional circumstances, an effective voice in the management of an enterprise could be exerted without any equity participation, such as through the provision of vital technical know-how. Because there is general concordance between the BPM's and the OECD Group's "Benchmark Definition" of the concept of direct investment, the adoption of the Group's elaboration of the concept in a future revision of the BPM should be considered. The scope and classification of direct-investment capital flows discussed in this paper remain the same as in the present BPM and in the OECD Group's "Benchmark Definition." A distinction is made between direct investment abroad and direct investment in the reporting economy rather than strictly in terms of assets and liabilities. Consequently, any flows between affiliated enterprises should be reported on a net basis without regard to whether certain flows pertain to changes in assets or in liabilities, since the direct investor and the enterprise in question may have claims on each other. Both categories of direct investment are broken down into equity capital, reinvestment of earnings, other long-term capital, and other short-term capital. As in the current edition of the BPM, it is also suggested that flows of short-term capital between monetary institutions and their direct-investment affiliates be allocated to the "other" category of capital rather than to direct investment, on the grounds that the flows presumably reflect the regular business activities of those institutions more than the direct-investment relationship.

Other Capital In contrast to the approach taken in the BPM, this paper proposes that portfolio investment be merged with other capital movements and that the relevant capital flows be distinguished in terms of the

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domestic sector of the creditor or debtor. In the context of the Fund's operational and analytical work, a sectoral approach to analyzing nonreserve and nondirect investment flows appears to be generally favored over the strict functional approach. Furthermore, a sectoral specification of capital flows not only facilitates reconciliation with related bodies of economic statistics-for example, money and banking, government finance, and external debt-but also lends itself to a variety of economic analyses, such as the extent of financing provided by the domestic banking system, and the construction and analyses of flow-of-funds (FOF) accounts. In addition, since the compilation of balance-sheet data is done on a sectoral basis, it would facilitate the link between flow and stock data. The use of sectorization as the primary organization principle for the presentation of statistics on nonreserve and nondirect investment capital flows does not preclude the derivation of data on portfolio investment that may be needed in a particular analytical context. Indeed, the sector specification, in conjunction with the proposed breakdown of financial claims by instrument, could yield the desired measures through a "building block" approach. In the interest of not overextending the list of standard components of the capital account, only the following sectors are distinguished: general government, monetary authorities, deposit money banks, nonmonetary financial institutions, and a residual category representing other sectors. These sectors are deemed, from a global perspective, to be the most important transactors in external financial assets and liabilities. Individual countries may find it necessary, for their presentation of data, to modify the sectoral classification somewhat to reflect varying circumstances with regard to the quantitative importance of the capital account transactions of the groups of transactors. For example, it may be useful in particular circumstances to highlight the external borrowing transactions of the public nonfinancial enterprises within the category "other sectors." The proposed BPM coverage of sectors-in particular, general government, monetary authorities, deposit money banks, and other nonmonetary financial institutions-represents a slight departure from the SNA, which emphasizes an institutional approach. Thus, the scope of general government is intended to be identical with that defined in the SNA except for the exclusion of monetary authority functions-for example, issue of currency, management and holdings of international reserves, and transactions with the Fund. These functions are classified under the monetary authorities sector. At the same time, the monetary authorities classification differs from one centering on the central bank through the inclusion of certain governmental

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units that perform monetary functions, such as an exchange equalization fund and governmental entities in charge of the currency issue. In principle, any commercial banking activity undertaken through a separate department in the central bank is excluded from the coverage of the monetary authorities sector and included under deposit money banks. Conceptually, the functional approach is also applied to the other subsectors of the financial system; that is, deposit money banks and other nonmonetary financial institutions. To facilitate a reconciliation of balance of payments data on external financial claims with related statistical systems on government finance and money and banking data, this paper follows the principle of sectorization as reflected in the Fund's draft of A Guide to Money and Banking Statistics in International Financial Statistics (MBS Guide) rather than the strict institutional approach espoused in the SNA.

II. Classification of Financial Instruments The following types of financial instruments are separately identified in the capital account: monetary gold, SDRs, reserve position in the Fund, use of Fund credit, bonds, corporate equities, loans (distinguishing between trade and suppliers' credits and other loans), currency and deposits, and reinvested earnings.

Monetary Gold Monetary gold covers gold owned by the authorities (or gold owned by others that is effectively subject to the control of the authorities) that is held as a financial asset.

SDRs SDRs are unconditional reserve assets created by the IMF to supplement existing reserve assets. They are allocated to Fund members, in proportion to their quotas, that are participants in the Fund's SDR Department. Six SDR allocations totaling SDR 21.4 billion have been made by the Fund (in January 1970, January 1971, January 1972, January 1979, January 1980, and January 1981). Entities authorized to conduct transactions in SDRs are the Fund itself, participants in the Fund's SDR Department, and prescribed "other holders." SDRs can be used for a wide range of transactions and operations-for instance, to acquire other members' currencies,

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settle financial obligations, make donations, and extend loans. They may also be used in swap arrangements and as security for performance in meeting financial obligations. Forward as well as spot transactions may be conducted in SDRs.

Reserve Position in the Fund A member's reserve position in the Fund is determined by its reserve tranche position and the creditor position under the various borrowing arrangements (except for lending with a maturity of less than three and one-half years under the policy on enlarged access to Fund resources). 4 A reserve tranche position in the Fund arises from the payment of part of a member's subscription in reserve assets and from the Fund's net use of the member's currency. Usually, a member's reserve tranche position is equal to its quota less the adjusted Fund holdings of its currency, less subscription receivable, and less the balances held in the administrative accounts of the Fund to the extent that they do not exceed 0.1 percent of a member's quota, if positive.

Use of Fund Credit Use of Fund credit is the sum of a member's outstanding drawings ("purchases") and the Fund's net operational receipts and expenditures in that currency that increase the adjusted Fund holdings above the member's quota. This item measures the amount that a member is obligated to repay to (to repurchase from) the Fund. Outstanding purchases are equal to purchases other than reserve tranche purchases, less repurchases, less other members' purchases of that member's currency, and less any other use by the Fund of that member's currency (except administrative expenditures) that the member wishes to attribute to specific purchases.

Bonds Bonds, debentures, and similar instruments cover those securities that give the holder an unconditional right to a money income (that 4 Loans extended to the Fund under its enlarged access policy involving a maturity of less than three and one-half years, and also involving the issuance of negotiable bearer notes by the Fund, are classified as part of foreign exchange reserves.

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is, an income in the form of interest, which is not dependent on the earnings of the debtor), and they are usually issued and traded in organized markets. Bonds, except for perpetual bonds, also give the holder the unconditional right to a stated fixed sum on a specified date or dates. Bonds are considered to include negotiable certificates of deposit, preference shares (except participating preference shares), and marketable promissory notes. Mortgages are not classified as bonds.

Corporate Equities Corporate equities, including capital participation, refer to instruments and records acknowledging claims to the residual value and residual income of incorporated enterprises after the claims of all creditors have been met. Ownership of equity is usually evidenced by shares, stocks, participation, or similar documents.

Loans Trade and other suppliers' credits refer to loans between the principals in the change of ownership of merchandise as well as transactions in services that are directly related to these flows. In the present SNA, trade and other suppliers' credits are not defined precisely, although short- and long-term loans are. Hence, one can infer that the coverage of trade and suppliers' credits would be restricted to open-book accounts and that any suppliers' credits financed through trade bills drawn on the importer would be classified as short-term bills and bonds. Country practices in the compilation of statistics suggest, however, that trade and other suppliers' credits encompass credits on open-book accounts as well as those financed through trade bills. Therefore, in conformity with country practices, trade and other suppliers' credits should be defined to include both open-book accounts and trade bills, except those negotiated by banks. Other loans n.i.e. (not included elsewhere) refer to direct transactions between a borrower and a lender, when the lender either does not receive any security (for example, a bill, bond, or corporate equity) evidencing the transaction or else receives a nonnegotiable instrument, such as a lien or mortgage created as a surety.

Currency and Deposits Currency refers to notes and coins, other than coins primarily of numismatic value. Deposits refer to claims on financial institutions

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that are represented by evidence of deposit, including shares in small denominations or similar evidence of deposit issued by savings and loan associations, building societies, credit unions, and the like that are legally, or in practice, redeemable on demand or on relatively short notice.

Reinvested Earnings The reinvestment of earnings by direct-investment enterprises represents the counterpart entry to the amounts reflected in the current account with respect to undistributed earnings of direct-investment enterprises. Any portion of the earnings of direct-investment enterprises that is not formally distributed and is attributable to the direct investors is conceived of as providing additional capital to the enterprises, thus increasing the value of an economy's stock of foreign assets and liabilities.

III. Application of the Breakdown of Instruments The classification of financial assets and liabilities is not uniformly applied in each functional category of capital movement (that is, reserves, direct investment, and other capital). Instead, it is applied selectively to each category of capital movement in order to highlight those flows that would contribute to an analysis of balance of payments developments and to keep the list of standard components manageable. In other analytical contexts, such as the construction of FOF accounts, there undoubtedly would be a need for not only a uniform application of the breakdown of instruments but also, in certain cases, for a further specification. In the category of reserves, the breakdown of instruments covers only monetary gold, SDRs, reserve position in the Fund, and use of Fund credit. The standard component "foreign exchange" covers the claims that are shown as the foreign exchange component of the series for "international liquidity" published in the IMP's International Financial Statistics (IFS). It includes monetary authorities' claims on foreigners in the form of bank deposits, treasury bills, short- and long-term government securities, and other claims usable in the event of a balance of payments deficit, including nonmarketable claims arising from intercentral bank and intergovernmental arrangements whether or not the claim is denominated in the currency of the debtor

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or the creditor. Other claims cover any additional claims that constitute reserve assets. In the cases of foreign exchange and other reserve claims, the emphasis is on their availability for balance of payments financing rather than on formal criteria, such as maturity or the nature of the underlying financial instrument. In the case of direct investment,. all flows other than equity capital and the reinvestment of earnings are grouped together as other shortterm or other long-term capital. This classification recognizes that, given the special relationship between the direct investor and the direct-investment enterprise, there is considerable similarity in the nature of financial flows, so that any further specification of instruments would not contribute materially to an analysis of the behavior of direct-investment capital flows. In the case of other capital flows, a standard component is provided within each sector's liabilities for identifying liabilities that constitute foreign authorities' reserves. In the rearrangement of standard components of the balance of payments for the purpose of constructing analytic presentations, users of statistics may wish to group with reserve assets those liabilities that perform a function similar to reserves in the context of the approach that analysts are following. For example, although a country may freely draw on its reserve position in the Fund when it has a balance of payments need, it may use Fund credit only if it pursues policies designed to overcome its problem; this distinction is not usually seen as relevant in measuring the size of the deficit that has been financed by the authorities. Therefore, the use of Fund credit-construed as a liability for the member-is customarily included with changes in reserve assets in analytic presentations, a practice that has been followed by setting out the functional category for reserves in the BPM. Relationships between most other liabilities and reserve assets, however, are not as straightforward. First, reserve assets may be viewed as performing more than one function, and the liabilities that may be related to them in each of those functions could be somewhat different. Second, the underlying cause of changes in particular liabilities may be impossible to assign with any reasonable degree of assurance. Liabilities classified in the category for direct-investment capital would never be regarded as constituting a close substitute for reserve assets, but the same does not necessarily hold true for other types of liability. It is not easy to find objective criteria that would help to single out liabilities to be identified as building blocks for an analytic presentation of the balance of payments that focuses on some version

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of an "overall" balance. A reasonable approach is to specify that any liabilities that constitute reserve assets when seen from the side of the creditor are to be shown as separate standard components, even though the compiling country itself (the debtor) may not actually regard some or any of them as a supplementary means of financing its payments imbalance or as an offset to its own reserves. How the behavior of liabilities of this kind is to be interpreted will depend on the purpose of the analysis and the factors that brought about the changes recorded in the balance of payments. The figuresalong with those for reserves, of course-clearly do not purport to be a satisfactory measure under all circumstances, either of the means that a country's authorities may have used to finance a payments imbalance or, thus, of the size of that imbalance. Moreover, the figures may be difficult to interpret. For example, a shift in holdings of claims on deposit money banks in a reserve-currency country, from a foreign central bank to foreign private deposit money banks, may or may not be taken as an indication of strength in the reserve-currency country's own payments position. Nevertheless, changes in the liabilities that are the counterpart of another economy's reserve assets may aid one's understanding of the global process of reserve creation or destruction. Because identifying certain assets as reserves is not always clearcut, even for their holders, the problem of identification is likely to be even more complicated for the debtor, who presumably has less access to the facts on which to base judgment. In many cases, the only practicable procedure will be for the compiler in the debtor country to adopt a rule of thumb. In formulating such a rule, the compiler should bear in mind that a foreign creditor will probably classify as reserve assets any liability of the compiling country that is (1) repayable on demand or in the short run, marketable, or that the debtor is in fact prepared to redeem on short notice; (2) repayable in an asset that the debtor would regard as a reserve asset; (3) owed to a central bank, central government, or other agency of the central authority except a public nonmonetary enterprise. Although each of the sectors distinguished under the category of other capital could conceivably incur liabilities that would constitute foreign authorities' reserves, data reported to the Fund's Bureau of Statistics suggest that the bulk of such liabilities are likely to be shortterm liabilities of the monetary institutions (that is, the monetary authorities and deposit money banks).

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IV. Supplementary Information on Balance of Payments Financing Transactions Although the classification of transactions in financial assets and liabilities, as shown in Table 1, provides for the identification of reserves (including use of Fund credit) and liabilities constituting foreign authorities' reserves, categories of instruments that are generally conceived of as instruments typically used by a country's authorities to meet a payments imbalance, the authorities may in certain circumstances engage in other financial transactions to meet a balance of payments need. The Fund has had a particular interest in eliciting information on these transactions, with a view to constructing and publishing analytic presentations for countries that show, "below the line," all forms of transactions undertaken in balance of payments support. In the Fund's IFS and Balance of Payments Statistics (BOPS), three categories of balance of payments financing transactions are distinguished: reserves, liabilities constituting foreign authorities' reserves, and exceptional financing. The term "exceptional" in the context of balance of payments financing transactions simply represents a shorthand descriptor for all forms of balance of payments financing, other than use of reserves and liabilities constituting foreign authorities' reserves, that the authorities have either engaged in themselves or have encouraged other sectors to conduct. As with reserves, the coverage of this group of financing transactions derives from an analytic concept rather than from precise definitions. The following types of transactions are usually deemed to be motivated by balance of payments considerations: (1) accrual of payments arrears; (2) rescheduling of existing debt; (3) borrowing (including bond issues) by the government or the central bank for balance of payments support (for example, from foreign commercial banks); (4) borrowing (including bond issues) by other sectors of the economy that is induced by the authorities with some kind of exchange rate guarantee or interest subsidy; (5) deferment of loan repayments pending negotiations with creditors for debt rescheduling; and (6) grants received for balance of payments financing-for example, from the Fund's Subsidy Accounts, the Stabilization System for Export Earnings (STABEX) under the Lome Convention, and other intergovernmental grants. Given their importance for analyzing balance of payments developments, the question arises whether these types of transactions should be introduced as standard components within the category for "unrequited capital transfers" and "other capital"

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movements. This would entail further expanding the standard components that are listed in Table 1. In light of this concern, it is suggested that, instead of introducing additional standard components, countries furnish supplementary information on all balance of payments financing transactions other than the use of reserves (including use of Fund credit) and the incurrence of liabilities constituting foreign authorities' reserves. A suggested format for the provision of such supplementary information in this regard is provided in Table 2.

V. Conclusions This paper has put forth proposals for revising the structure of the capital account of the balance of payments reflecting the IMF' s analytical and operational needs and the need for harmonization with the classification of financial transactions in the external transactions account of the SNA. Consistent with the structure of the rest of the capital finance accounts, the external sector account of the SNA is structured almost exclusively in terms of a classification of financial transactions by instrument. The classification scheme proposed in this paper advocates combining characteristics relating to capital flows: functional role, sectorization, and instrument specification. A review of data reported for publication in the Yearbook of National Accounts Statistics suggests that only 9 countries report data in the format of the capital account of the external transactions account of the SNA, but more than 100 countries furnish information on the capital account of the balance of payments for publication in the Fund's BOPS. In light of this finding, the classification scheme proposed in this paper may be considered as a point of departure for the external transactions account of the SNA. Alternatively, if only a breakdown by financial instrument along the lines of Table 26 of the present SNA is desired for national accounts purposes, one may wish to consider further expansion in the breakdown of instruments in the context of compiling balance of payments statistics either as standard components or as supplementary information, bearing in mind the need to limit the list of standard components to a manageable number. Additional points for consideration are the following. • Should the BPM reclassification of commodity gold to a monetary asset and vice versa (gold monetization or demonetization) be adopted in the SNA? In addition, should gold holdings be viewed as financial assets only when they are either held as financial assets by

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Table 2. Proposed Supplementary lnformlltion on Balance of Payments Financing

Transactions Other Than the Use of Reseroes and Liabilities Constituting Foreign Authorities' Reserves Capital Transfers Government Other sectors Other long-term capital: liabilities• Drawings on new loans received Rescheduling of existing debt Rescheduling of payments arrears Bond issues Other short-term capital: liabilities• Drawings on loans Net change in payments arrears Deferred payments

•For "other long-/short-term capital: liabilities," the sector involved and the standard component of which this is a subitem should be specified.

the monetary authorities or (if held by other sectors of the economy) when they are subject to the control of the central authorities? • The Fund's systems of balance of payments and government finance statistics classify financial items as long term if the original contractual maturity of the instruments is more than one year. On the other hand, the SNA, the European System of Integrated Economic Accounts (ESA), and the Fund's system of money and banking statistics classify financial instruments as being long term if their maturity is one year or more. A criterion for differentiating between short-term and long-term financial instruments should be devised that could be uniformly applied to all economic statistics. • Should the distinction between current and capital transfers be introduced in the balance of payments and, if so, should capital transfers be incorporated in the capital account? • Currently, the coverage of the capital account in the BPM includes certain changes (together with their counterparts) in external assets and liabilities that are conceived of as reconciliation and revaluation items in the SNA (Section I, under "Transactions in Financial Assets and Liabilities"). The desirability of explicitly incorporating and explaining all changes in the stock of reserves in the balance of payments statement and the external transactions account of the SNA should be considered.

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• Should standard components be introduced with respect to balance of payments financing transactions (other than reserves and liabilities constituting foreign authorities' reserves) or should information on these flows be collected as supplementary details, as proposed in this paper?

12 Oassification of Corporate Enterprises D. Ine stream of floating-rate interest payments is exchanged against another stream of different floating-rate interest payments. For example, interest payments based on a Eurodollar London interbank offered rate (LffiOR) are exchanged for interest payments based on the U.S. commercial paper composite rate. No exchange of currencies is involved. Cross-Currency Interest Rate Swaps. This arrangement involves the exchange of interest payments in different currencies as well as different interest rate bases. In general, this transaction involves the exchange of nondollar interest payments at a fixed rate against dollar payments at a floating rate, but an exchange on the basis of two different floating rates is also possible. Arrangements such as these are usually treated as a single transaction, but separating the transac-

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tion into an interest rate component and a cross-currency component also occurs.

Currency Swaps A currency swap refers to a transaction in which two parties exchange with each other specific amounts of two different currencies at the outset and repay over time according to a predetermined rule. The repayments reflect both interest payments and amortization of principal. In these contracts, fixed interest rates are normally used. In some cases, there is no exchange of principal either initially or at maturity.

Options and Futures An option can be defined as a contract that provides the purchaser with the right, but not the obligation, to buy or sell a specified amount of an underlying asset at a specified price within a given period. The underlying asset could cover a wide range of items, which might include equities, foreign currencies, interest rate instruments, commodities, and the like. The seller (or writer) has the obligation to complete the transaction if the buyer (or holder) exercises the option. In a typical transaction, the buyer of the option generally pays a premium (the price of the option) to the seller for his commitment to sell or buy the underlying instrument when demanded by the buyer. Options are either listed on an exchange or traded "over the counter" (not traded on organized exchanges). The latter type of trading usually involves negotiations among parties on all details of the transaction or some agreement on certain simplifying market conventions. One can further distinguish the American-style option, which permits the buyer to exercise his right to buy or sell at any time before the expiry date, and the European-style option, which may be exercised only at the expiry date. Options are divided into two categories: "call" options and "put" options. For instance, under a contract to purchase a foreign currency, a call option provides the buyer with the right to buy an agreed amount of foreign currency at a specified price. The writer thus has the obligation to deliver the foreign currency if a call option is exercised. In contrast, a put option provides the purchaser of the option with the right to sell an agreed amount of foreign currency at a specified price, and the writer is therefore under obligation to take delivery of the foreign currency. The specified price is called the strike price.

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In contrast to options, a futures transaction is a contract that provides the buyer with the obligation to take delivery of, and the seller with the obligation to deliver, a specified amount of an underlying asset at a fixed price at a set future date. A futures or forward contract thus entails a binding obligation, irrespective of subsequent changes in prices, exchange rates, and the like. The parties to a futures contract can, however, transfer their obligations to others by trading in the futures market.

Forward Rate Agreements A forward (future) rate agreement is an agreement between two parties who wish to protect themselves against interest rate movements during a specified period. To this end, both parties agree on an interest rate covering a notional amount of principal. Neither party is committed to lend or borrow this amount of principal. At the end of the agreed period, on the settlement date, only the difference between the agreed interest rate of the agreement and the then current interest rate is paid. If the then current interest rate is higher than the agreed rate, the party wishing to protect itself against a rise in the interest rate, being the buyer of the forward rate agreement, receives payment of the difference from the counterparty. Vice versa, a party wishing to protect itself against a fall in interest rates (the seller of the forward rate agreement) receives payment from the counterparty when the then current interest rate is lower than the agreed rate of interest of the forward rate agreement.

Eurobonds A Eurobond is an international bond issued and sold through a syndicate of banks or other financial institutions in various national capital markets on behalf of a foreign corporation, a foreign government, or an international agency. These bonds are usually issued as an unsecured obligation of the borrower. As a result, only borrowers of good quality are able to issue such bonds, so that in some cases state enterprises and municipalities require a government guarantee. Six main types of Eurobonds are distinguished.

Straight (Fixed-Rate) Bonds Straight bonds carry a fixed rate of interest, normally paid annually, with maturities ranging from 3 years to as long as 25 years.

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Eurobonds with maturities shorter than 5 years are often known as notes.

Floating-Rate Bonds In response to rising inflation and often volatile rates of interest in the international financial markets, a growing number of Eurobonds have been and are being issued at a variable rate of interest. The rate of interest depends on the conditions in the market and is usually set at some margin over the prevailing LffiOR, depending on the quality of the borrower. This rate applies to a predetermined period (normally six months), with the interest usually payable semiannually. The rate of interest changes when LffiOR changes, but the margin remains the same.

Convertible Eurobonds Convertible Eurobonds carry a fixed interest rate but are convertible in the sense that they give the holder the right to convert these bonds into equity shares (common stock) of the issuing company. The bonds carry fixed redemption dates, but the conversion right stipulates that bonds may be converted into stock either on a series of given dates or at any time in the future between specified dates. The price at which equity may be purchased through conversion is normally fixed at a premium over the share price prevailing at the time of issue. Convertible bonds are attractive to the borrower because the rates of interest are usually lower than those paid on straight bonds. In addition, the borrower may receive cash for the shares to be issued when the bond holder uses his or her option to convert. Convertible bonds usually specify conversion features in terms of the number of shares into which the bond is convertible.

Eurobonds with Warrants Eurobonds with warrants are similar to convertible Eurobonds, except that it is not the Eurobond itself but the warrant that can be used to purchase shares of the borrowing company. The warrants are physically separate from the bonds, may be detached from them, and can be traded as securities in their own right. The warrant therefore represents an option to purchase rather than to convert into shares, since additional cash must be advanced if the warrants are exercised.

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The value of the warrant is usually only a small fraction of the share price but is highly dependent on changes in the share price. In addition, warrants can also be issued independently by a borrower, giving the investor the opportunity to buy a wide range of securities.

Option Eurobonds Option Eurobonds are essentially straight Eurobonds that provide the bond holder with the option to receive interest or principal (or both) in a currency that differs from that in which the bond is denominated. The rate of exchange at which interest is paid is normally determined by the exchange rate prevailing a few days before interest is due.

Zero-Coupon Bonds Zero-coupon bonds are bonds on which no interest payments are made during the lifetime of the loan but which are issued at a substantial discount from their par value. The difference between the value at which the bond is issued and the par value is usually considered as income accruing to the investor over the life of the bond. In some countries this income is regarded as a capital gain rather than as regular income. Deep-discounted bonds are similar to zero-coupon bonds except that they carry a very low rate of interest instead of a zero rate of interest. Other Bonds In addition to the categories of Eurobonds mentioned above, two other types of bond merit description.

Junk Bonds Junk bonds are high-yielding bonds that are rated below investment grade. Investment-grade securities are generally rated at or above "Baa" by Moody's Investors Services or "BBB" by Standard & Poor's Corporation. At times, junk bonds have been used as an instrument in corporate takeovers or buy-outs.

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Indexed Bonds Indexed bonds are debt securities, the redemption value or the interest (or both) of which are linked to some price index in order to defend the debt against inflationary depreciation.

II. Classification and Recording of Financial Instruments The diversity of the financial instruments now available in the international capital markets and the enormous increase in transactions in these instruments has confronted the compiler of balance of payments statistics with two problems: that of classification, and that of obtaining data. Guidelines for the classification of these transactions are clearly needed. This section therefore explores how these instruments fit into the classification system of the present BPM. A detailed discussion of problems encountered in the collection of data for transactions in these instruments would be beyond the scope of the paper. Occasionally, however, suggestions will be made about what type of data should be collected in order to conform to the recommendations in the BPM.

Note Issuance Facilities For a balance of payments compiler, three aspects of a NIF are of concern: the payment of interest, the payment of fees associated with the operation of the NIF, and the issuance of the notes and their repayment by the borrower. The BPM recommends that fee payments be classified in the account for other goods, services, and income; therefore, the classification of fees associated with the NIF in this account would be appropriate because these payments are made for the service of operating the NIF. As far as the issuance of the notes and their repayments are concerned, the BPM recommends that entries accounting for these transactions should be recorded in the balance of payments, to reflect actual changes in the assets and liabilities of the transactors. But no entries should be made for the contractual commitments of participating banks. Only when this commitment is called upon and the notes have actually been sold to the banks that have underwritten the NIF, or to other investors, should the transaction be recorded as a balance of payments transaction. The sale of the notes will appear both as a liability in the balance sheet of the borrower and as an asset in the

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balance sheets of the banks (if held by the banks themselves) or of other investors. Another important problem associated with the recording of NIFs is the valuation of the notes acquired by the participating banks at a discount. The BPM recommends that, for debt securities (such as bonds and notes) originally issued at a value different from the stated fixed sum received by the holder unconditionally at maturity, the premium or discount should be regarded as negative interest or interest, respectively, rather than as a capital loss or gain. This treatment would seem to be appropriate for notes acquired by banks at the time of issue and held in their own portfolio, but when notes are placed with investors other than the banks that have underwritten the NIF, the difference between what those investors pay and the amount received by the issuer represents a fee earned by the banks. Finally, because the original term to maturity usually is less than one year and the BPM recommends the classification of securities as portfolio investment only if they have an original contractual maturity of more than one year, it would seem appropriate to classify transactions in these instruments in the category of short-term capital movements. Swaps In principle, the classification of swap transactions should pose no problems for a balance of payments compiler. Streams of interest payments should be recorded in the current account, and streams of principal payments in the capital account, irrespective of the currency or the rate of interest at which these flows are paid or recorded. In the case of an interest rate swap, where typically the two interest payments that have been swapped are made on the same day, entries should be made for the flows of interest only. To the extent that the dates do not match, there will presumably be an amount due from one transactor to the other that will entail an entry in the capital account. In the case of a currency swap, where an exchange of both interest and principal takes place, and again assuming that payments are matched, entries should be made for the flows of interest as well as the repayments of principal. The appropriate entries in the balance of payments also depend on whether the transactor is acting for his or her own account, and making a profit, or acting as an agent, and earning a fee. The flows between the two parties engaged in a swap agreement do not represent interest payments, but an exchange of capital items

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and, to the extent the flows are not equal, a payment for a service. Assuming that the capital flows take place at the same time, the capital account entries would net out.

Options For options, two aspects are important for a balance of payments compiler: the premium to be paid at the signing of the contract and the acquisition of the underlying security, valued at the strike price, if and when an option is exercised. Because options are marketable, it would seem that trading in options, as well as the payment of the premium for the acquisition of an option, should be recorded in the capital account. But the seller of an option does not incur a financial liability, so an option represents a real, not a financial, asset. Therefore, the acquisition of the option and subsequent trading in the option should be recorded in the current account. At any rate, if the option is exercised, the purchase of the underlying financial instrument should be entered in the capital account. If commodities instead of a financial instrument are acquired, however, the acquisition of the goods should be entered in the merchandise account. For the valuation of options, it is recognized that, from the time of the purchase of the option to the date of its exercise, the option represents an asset for the holder. For instance, an investor has purchased an American call option on £10,000 with an exercise price of US$1.20, giving him the right to buy £10,000 at the rate of US$1.20 per £1 anytime between the signing of the contract and the expiration date. If during this period a strengthening of the pound sterling had taken place and the market price of sterling had risen above the exercise price, the holder of the option would have benefited because his option would have increased in value. Even though an option represents an asset that might change in value, the underlying commitment should be viewed as a contingent asset for the purchaser of the option and a contingent liability for the seller, until the option is exercised. Only entries for premium payments, and subsequent trading in the options, would be recorded in the balance of payments, unless and until the options are exercised.

NEW FINANCIAL INSTRUMENTS

191

Forward Rate Agreements Balance of payments entries associated with forward rate agreements are limited to current account transactions only, as principal amounts are never exchanged. However, the recording of the difference between the agreed rate of interest of the forward rate agreement and the prevailing interest rate is a problem. In essence, this difference does not represent interest but is more like an insurance premium or some other service. The flows in the balance of payments associated with a forward rate agreement are illustrated in the following example. Suppose a bank commits itself to extend a 9 percent loan to be drawn sometime in the future. It covers itself by entering into a forward rate agreement at 8112 percent with a nonresident. If at the time of the extension of the loan the prevailing interest rate is 11 percent, the bank will receive from the seller of the agreement the difference between the prevailing rate of 11 percent and the forward rate of 81/2 percent. In the balance of payments the receipt of that amount should be recorded as a credit in one of the current account items, as discussed in the preceding paragraph.

Eurobonds The classification of Eurobonds does not pose problems within the existing framework of the BPM. Because these bonds are issued with an original maturity of more than one year, they should be classified as portfolio investment. In the case of convertible Eurobonds, the conversion of bonds into equity does not change their character as portfolio investment. The BPM provides for the explicit showing of these conversions as changes in both bonds and equities separately. The valuation of transactions in which bonds are exchanged for equities should be at market values. Although different approaches are possible, warrants appear to be similar in nature to options and therefore might be classified in the same way.

Other Bonds Considerations pertaining to the treatment in the balance of payments of junk bonds, indexed bonds, and zero-coupon bonds are provided in Chapter 14 of this volume.

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EXTERNAL SECTOR TRANSACTIONS

III. Methodological Implications From this review of the emergence of the new financial instruments, two features of importance to a balance of payments compiler can be observed. One is the movement away from syndicated bank loans to the securitization2 of debt, and the other is the increasing importance of off-balance-sheet transactions. 3 In addition, although not related to the emergence of a new financial instrument, attention has been focused increasingly on debt capitalization programs under which debt is converted into equity. This section offers some considerations that might be taken into account if it is deemed necessary to review the classification framework of the balance of payments.

Securitization of Debt Bonds and floating-rate notes are the most common examples of securitized long-term credits, and NIFs are the main facility in which short-term credits are securitized. At present, the BPM classifies longterm bonds and corporate equities, other than those included in direct investment and reserves, as portfolio investment. Bonds are defined to have an original maturity of more than one year. Therefore, transactions in securities identified separately in the balance of payments are limited to long-term instruments. Transactions in securities that are originally short-term are at present indistinguishably included in categories other than portfolio investment. The question arises as to whether transactions in securities originally issued as short-term should be identified separately. Specifically, it can be argued that sales and purchases of securities, both long-term and short-term, are influenced by more or less the same factors. Under the present recommendations of the BPM, transactions in short-term securities can only be made explicit as a nonstandard component. In the balance of payments statements of some industrial countries, however, transactions in short-term instruments are identified separately. Securitization has also resulted in an increase in the negotiability of the banks' conventional assets. These efforts are focused mainly in two areas: the outright sale of loans (with or without recourse) and The term most often used to denote the process by which bank assets, mainly loans or mortgages, are converted into negotiable securities. 3 A widely used term to refer to banking activities that do not involve booking assets and taking deposits. 2

NEW FINANCIAL INSTRUMENTS

193

the converting of loans (notably mortgages) into marketable instruments. From the standpoint of classification, the question is whether these instruments should be classified in the portfolio investment account: should the securitization of loans, for instance, continue to be classified as drawings and repayments of loans, or should these transactions be classified as portfolio investments?

Off-Balance-Sheet Transactions Off-balance-sheet transactions can best be described as transactions in which one party is committed to act when called upon, but the need for action is uncertain at the time the contract is made. For instance, under a NIF, a group of banks might be called upon to fund whatever notes they were not able to sell for a corporate borrower. Similarly, in an option, the seller faces the obligation to act if the buyer exercises his option. In all these cases, the action to purchase notes by the banks or the honoring of the option by the seller is uncertain at the time the contract is made. The question therefore arises whether a contract to undertake possible future action should be considered as a transaction appropriate for inclusion in the balance of payments. As defined in the BPM, transactions refer to any exchanges of assets that by convention are to be shown in the balance of payments. Other than the payments of fees, premiums, and the like, it cannot be said that an actual exchange has taken place at the time the contract was entered into. Therefore no capital transaction, in the sense of the BPM, could have occurred. Capital transactions will be recorded when, in the case of NIFs, the notes are placed with investors or purchased by the banks for their own accounts or when, in the case of options, the purchaser exercises his or her rights.

Debt Capitalization Debt capitalization is not a new development, but recently its use has become more widespread as a result of mounting difficulties faced by many developing countries in servicing their external debt. Typical of debt capitalization is the conversion of external debts, payable in foreign currencies, into equity capital, denominated in local currency. The framework in the BPM for the classification of transactions that convert external debt into equity is fully adequate and poses no problem. The main problem associated with these conversions is the valuation of the transactions. The BPM recommends that transactions in debt instruments be

194

EXTERNAL SECTOR TRANSACTIONS

recorded at their market value. It is likely that, at the time a debt capitalization program is being negotiated, part of the loans or bonds to be converted are already being sold or traded at a value below their face value. The loans or bonds that are being converted into equity should therefore be recorded in the balance of payments at their reduced value. This treatment regards the difference between the market value and the face value as a realized capital loss from the creditor's point of view and as a realized reduction in the value of a debt from the debtor's point of view. The value of the equity capital should, of course, be the same as the value at which the loan or bond is considered to be repaid or redeemed.

I'V. Conclusions In recent years innovations in the international financial markets have brought into being a multitude of financial instruments. The emergence of these instruments has led to uncertainties about the collection of data for transactions in these instruments and about their classification. In general, it can be said that the guidelines for classification under the present BPM are sufficient to ensure a proper classification of these instruments. The shift away from syndicated loans to securitization of debt, however, raises some questions about the analytical usefulness of the present definition of portfolio investment in the BPM. In addition, the BPM definitions of long-term and shortterm capital have tendeq to become less important from an analytical point of view because of the increased marketability of these financial instruments. To market participants, the original term to maturity has become less important. Instead, other considerations prevail, such as hedging interest rate exposures, the possibilities of earning fees, the management of interest rate risks, the remaining term to maturity, and so forth. In addition, the distinction between temporary, reversible movements and more permanent, less volatile movements has become more difficult as long-term instruments have become subject to volatile movements and reversals.

14 Oassification of Transactions in Zero-Coupon Bonds, Junk Bonds, and Indexed Bonds in the Balance of Payments RoBERT McCoLL of the fourth edition of the IMF's Balance of

S Payments Manual (BPM) in 1977, the international capital markets INCE PUBLICATION

have seen a burgeoning in the variety of financial instruments in use. Either because these instruments did not exist or were not of significance before 1977, they were not expressly mentioned in the BPM. This paper will examine three such instruments-zero-coupon bonds, junk bonds, and indexed bonds-for which the application of the BPM's recommendations with regard to the classification of transactions may not, at first glance, be clear-cut. Section I of the paper briefly reviews the BPM's recommendations for the separation of transactions in financial instruments into those that constitute the extension or redemption of principal and those that constitute income payable for the provision of that capital. Sections II-IV deal, in order, with each of the new financial instruments listed in the previous paragraph, highlighting any unusual features of those instruments and identifying and applying the relevant recommendations as outlined in Section I. Section V brings together the observations about the nature of the instruments chosen for analysis and concludes that they can be accommodated within the framework oftheBPM.

I. Income and Principal in the Balance of Payments Transactions in foreign financial assets can be thought of as having three possible components: (1) the extension of principal and its sub195

1%

EXTERNAL SECTOR TRANSACTIONS

sequent repayment; 1 (2) income; and (3) capital gains and losses (from the realization of valuation changes). Together, components 1 and 2 reflect the exchange of a sum to be delivered in one or more installments, the principal, against another sum to be delivered in one or more installments, covering the principal plus the positive or negative income over that principal. Thus, the principal refers to the amount originally advanced by the creditor and, with the exception of perpetual bonds, is equal to the sum required at maturity to redeem the debt. Any additional (positive or negative) amount expended at the time the debt is redeemed, at maturity, constitutes income generated by the asset. Investment income is generally regarded as a gain or recurrent benefit derived from the ownership of capital. In the balance of payments, it is income derived from the ownership of foreign financial assets. Component 3 reflects two transactions, a purchase and a sale, at different prices. Capital gains and losses present the realization, through a change in ownership, of a change in the value of a financial asset because of general interest rate changes, a change in the creditworthiness of the issuer of the debt, and so on. Such capital gains should not be confused with income, which accrues because of the passage of time. Unrealized valuation changes, including write-offs, although of importance in generating balance-sheet data, do not represent transactions and are omitted from the flow accounts. Any debt security will provide a return that can be considered to have three components: an income component to compensate the owner of the capital for providing its use to others; an inflationary component to compensate for any decline in purchasing power of the capital advanced; and a risk component to compensate for exposure to the possibility of a failure by the debtor to return the funds advanced. All such compensations form the return or income on the security. It would seem that the identification of principal is easily made. Once a credit has been extended, that amount continues to reflect the principal. For example, where securities are issued "at a value different from the stated fixed sum that their holder has the unconditional right to receive when the obligations mature" (BPM, paragraph 293)-that is, the principal-that difference is to be regarded as· income and recorded when payable. Such discounts or premiums might range from small adjustments to coupon bonds (to take acPerpetual bonds or loans by definition do not call for repayment of principal. 1

ZERO-COUPON, JUNK, AND INDEXED BONDS

197

count of minor fluctuations in the market interest rate between the time the prospectus specifying the coupon rate is issued and the bonds are sold), to large adjustments to those securities that bear no coupon and provide their holders with a return solely in the form of a discount. When such instruments are traded after they have been issued, separating income from capital gains (losses) becomes more difficult. Then, any difference between the price at which the instrument was initially sold and the price at which it was purchased (at the time of issue or thereafter) does not represent income but a realized valuation gain (loss), to be recorded in the capital account. In the following three sections the above general principles and specific recommendations will be applied to the three instruments chosen for analysis to determine the appropriate classification of transactions in these securities.

II. Zero-Coupon Bonds Zero-coupon bonds are debt securities that pay no coupon interest during the life of the bond, so that the income is composed solely of the difference (or discount) between its redemption price and its issuance price. Such bonds, therefore, represent the extreme situation for discount income and, as described in the previous section, according to the BPM this discount is recorded as income at the time that it is due for payment. The principal is the value for which the bond is issued. At redemption (at maturity), the transactions will involve the repayment of principal (equivalent to the issue value) and the payment of accrued income (equivalent to the redemption price less the issue price). If the security is traded before maturity, the transaction price may include, in addition to accrued income, a realized valuation change for the seller of the asset. That valuation change will appear in the capital account by recording purchases and sales of the bonds at market prices. An obvious problem in accounting for zero-coupon bonds is that, because the entire income is generated through the discount, the cost of providing the capital is not appropriately matched to the periods for which the capital is provided. Minor inconsistencies for discounts or premiums that represent adjustments to coupon issues become major distortions for zero-coupon bonds. Accruing the income over the life of the bond, as recommended in Chapter 3 of this volume, would eliminate the distortion.

198

EXTERNAL SECTOR TRANSACTIONS

III. Junk Bonds Junk bonds, also referred to as high-yielding or speculative bonds, are debt securities that yield a significantly higher rate of return than top-grade bonds because these issues are perceived to be high-risk ventures. A junk bond differs from other bonds in that the risk component of the rate of return is large compared with the other elements in that rate. Nonetheless, the composite rate is still income, just as high nominal interest rates drawn in periods of high real interest rates or of high inflation are income. The degree to which any element within the composite interest rate may be dominant is irrelevant. For example, in any economy there will be a wide divergence in the risk assessments awarded the various debtors in the capital markets. Government-guaranteed debt might be trading at interest rates substantially below a high-quality corporate or "prime" rate for similar maturities. The difference is in the magnitude of the risk component. New debtors to the market will pay considerably more than the prime rate, again because of the higher risk assessment associated with their issues. The junk bond represents an extreme in which the risk component is very large indeed. To consider the exceptional risk component of the interest rate applicable to a junk bond as capital being returned to the investor would require all interest on all securities to be reassessed and a new notion of income to be derived to exclude that risk element. Some threshold level of risk would have to be set arbitrarily, above which interest payments might be deemed to represent capital repayments. It is not obvious what analytical usefulness would be derived from such an arbitrary allocation between income and capital. A similar exercise could be required to remove the inflationary element from income when inflation is high or volatile. Such redefinitions of the basic notion of income, however, are beyond the scope of this paper.

I'V. Indexed Bonds Indexed bonds are debt securities for which the redemption value or coupon payments (or both) are linked to a price index2 in order to 2 Although indexed bonds are usually linked to a price index of one or more commodities, there are also other types of linkage, such as linkage to the exchange rate of a currency or a basket of currencies, or to the price of a basket of shares.

ZERO-COUPON, JUNK, AND INDEXED BONDS

199

protect the holders of the bonds against a depreciation in terms of purchasing power of the asset. These two types of indexing, of the redemption value or of the coupon payments, will be considered separately to facilitate their analysis. Bonds whose coupon payments are indexed are essentially floating-rate bonds. The intention may be to accommodate only changes attributable to inflation, but the choice of the target may actually alter the income component by over- or undercompensating for inflation. It would appear, therefore, that bonds carrying indexed coupons should be treated like any other variable rate bond; that is, the coupon payments are considered to be income. Bonds for which the redemption values are indexed are essentially discount bonds, except that the conventional discount bond has the redemption value expressed in money terms. The yield or rate of return expected from the bond determines the difference between the issue price and the redemption price. For indexed bonds, the issue price is known and the "stated fixed sum" that the holder has an unconditional right to receive is a monetary amount multiplied by an index. In other words, the discount rate is determined ex post. For bonds that have the redemption value indexed, the issue price should therefore be recorded as the principal value for the bond, with the additional indexation payment payable at maturity being the discount part of the income. Of course, the considerations with regard to accrued income for deep-discount, zero-coupon, and other bonds will also apply to bonds with the redemption value bearing an indexed return. However, whereas the application of compound interest rate formulas may be necessary in the calculation of accrued income for other bonds, the index will provide a direct and easily applied factor for compiling the discount or indexed income over the life of the bond. Bonds bearing a combination of indexed coupons and redemption values resemble coupon bonds issued at a discount. Each element will be separately recorded in accordance with the above discussion.

V. Conclusions From the analyses presented here, it would appear that the three financial instruments chosen for consideration do not exhibit any features for which the BPM does not make provision in its recommendations. The apparent novelty of each of the instruments discussed lies in the magnified significance of particular standard elements contained in the more regular instruments discussed in the BPM. Zero-

200

EXTERNAL SECTOR TRANSACTIONS

coupon bonds emphasize the discount element of income to the exclusion of coupons; junk bonds emphasize the risk element contained in the interest yield on such securities; and indexed bonds simply match the rate of return, through either coupons or discounts, to some specified index in the hope of accurately setting the inflationary element in the interest rate.

15 Some Issues in the Balance of Payments Presentation of Arrears and Debt Reorganization }OHN E. THORNTON

addresses some methodological issues in balance of T payments accounting for external debt-servicing arrears and for debt reorganization. It attempts to clarify some of the concepts and HIS PAPER

issues involved in the balance of payments accounting procedures and to supplement the guidelines offered in the fourth edition of the IMF's Balance of Payments Manual (BPM), which was prepared before the emergence of widespread balance of payments difficulties associated with arrears and reorganization of external debt. The paper begins with a review of the Fund's current balance of payments accounting methodology for the treatment of external arrears and debt reorganization as prescribed by the BPM and as practiced in the Fund's Balance of Payments Statistics (BOPS). It then examines how the use of accrual accounting (that is, recording entries when payment is due) rather than cash accounting (that is, recording entries when disbursement takes place) may allow the identification of arrears and debt reorganization transactions. It is argued that many of the operational problems encountered in identifying these transactions in the balance of payments accounts may be overcome by an increase in the degree of detail, and some suggestions are put forward to this end.

I. The Fund's Treatment of Arrears and Debt Reorganization in the Balance of Payments Statistics An important purpose of balance of payments accounts is to provide an indication of the need for policy adjustment to rectify external

201

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EXTERNAL SECTOR TRANSACTIONS

imbalance. The double-entry system used in balance of payments accounting implies that the accounts must be in balance. Therefore, arriving at a surplus or deficit in the balance of payments requires summing a subsection of all external transactions and distinguishing the transactions "above the line" from those "below the line." The decision on where to draw the line requires a judgment about the set of external transactions that best indicates the need for balance of payments adjustment. A broad approach is to place below the line only transactions undertaken to compensate for balance of payments deficit on net autonomous transactions-that is, to compensate for transactions undertaken for their own sake. This approach gives the deficit for which the central authorities have provided the financing by drawing on their reserves, by engaging in official foreign borrowing, or by inducing other residents to borrow. It therefore focuses on the use of reserves and the short-term constraints that result from the limited availability of balance of payments financing. In the aggregated presentation of the balance of payments employed in the BOPS, this deficit is covered by liabilities constituting foreign authorities' reserves, the total change in reserves, and exceptional financing. It is exceptional financing that links the concept of balance of payments need to the accounting procedures for dealing with arrears of external debt and debt reorganization. Transactions that are considered appropriate for inclusion under exceptional financing include arrears in payments and deferments of payments of external obligations (including overdue financial obligations to the Fund) resulting from the authorities not providing foreign exchange; any rescheduling arrangements arising from arrears and deferments; drawings on loans or refinancing loans for the purpose of balance of payments support; and debt forgiveness. In the presentation of the balance of payments, separate practices are followed for the accounting of arrears of interest and amortization, debt rescheduling, debt refinancing, and debt forgiveness. In practice, a debt reorganization package, particularly if it is a multiyear arrangement, may combine elements of each of these. The treatment of the reorganization in the balance of payments accounts may, therefore, include entries in several accounts that may be both above and below the line in the aggregated presentation. In the case of a multiyear arrangement, it is also frequently the case that a rescheduling of obligations due beyond the current accounting period is subject to certain conditions being in place when the obligations fall due. In this case, balance of payments accounting practice is to record entries only in the period when the particular conditions have been fulfilled and the debt reorganization has been concluded. No entries are made in

ARREARS AND DEBT REORGANIZATIONS

203

the current period's balance of payments for conditional arrangements affecting future periods, although these arrangements may give rise to future entries. The relevant balance of payments entries for arrears and debt reorganization are summarized in Table 1. The accounting procedures are described below.

Arrears of Interest and Amortization Arrears are defined as amounts that are past due and therefore unpaid. As in all balance of payments entries, interest and amortization payments on loans are recorded on an accrual basis-specifically, when payment is due. Accordingly, payments in arrears are recorded in the balance of payments as if they had been made, and a new, corresponding liability is created.

Interesti\rrears Table 1 shows that in the aggregated presentation of the balance of payments, if interest payments are not made when they fall due, the arrears are accounted below the line as exceptional financing. The accounting comprises a debit entry in the current account and a credit entry in exceptional financing. In the detailed presentation of the balance of payments, the credit entry is the short-term capital account.

J\mortization J\rrears In the aggregated presentation of the balance of payments, if repayments on a short-term (long-term) loan are not made when they fall due, a debit entry is recorded in the appropriate capital account, and a credit entry is made below the line in exceptional financing. In the detailed presentation of the balance of payments, the credit contraentry is in the short-term capital account regardless of the account in which the debit is recorded-that is, the credit contra-entry is viewed as a short-term liability whether the loan for which the amortization is being recorded was short term or long term.

Debt Rescheduling In balance of payments statistics, entries arise when a debt reorganization gives rise to a change in the existing contract or to a new

Disbursements and arrears Disbursed interest payments Interest arrears Disbursed amortization Short-term Long-term Amortization arrears Short-term Long-term

Type of Transaction Investment income Investment income Short-term capital Long-term capital Investment income Long-term capital

Reserves Reserves

Exceptional financing Exceptional financing

Debit

Reserves Exceptional financing

Credit

Aggregated

Short-term capital Short-term capital

Reserves Reserves

Debit

Short-term capital Long-term capital

Short-term capital Long-term capital

Investment income Investment income

Detailed

Reserves Short-term capital

Credit

Balance of Pa~ments Presentation

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contract. In the case of a debt rescheduling, the existing contract is changed to extend the maturity of payments due to lenders. A formal deferment of debt service payments takes place, and new maturities are applied to the deferred amounts. Balance of payments accounting practice with respect to debt rescheduling reflects the accounting period in which the debt service obligations fall due.

Rescheduling Obligations Past Due Obligations past due are in arrears. When arrears are rescheduled, the accounting reflects a reduction in arrears and the creation of a new loan that is treated as a balance of payments financing item. In the aggregated presentation of the balance of payments, therefore, what is being recorded is a change in the nature of exceptional financing-the repayment of arrears and the drawing of a new loanand both the debit and credit entries appear below the line in the category of exceptional financing. In the detailed presentation of the balance of payments, the rescheduled debt payment is recorded as a debit entry in the short-term capital account (other loans received) and the credit contra-entry is recorded in the long-term capital account (drawings on loans received).

Rescheduling of Obligations Due Interest and amortization obligations that fall due in the current accounting period and are rescheduled are viewed as paid on time and financed by the rescheduled loan. The accounting reflects the reduction of payments associated with an existing loan (that is, interest and amortization) and the creation of a new loan, which is treated as a balance of payments financing item. In the aggregated presentation of the balance of payments, the accounting entries are a debit to the current account (investment income, interest) and to the short- or long-term capital account (other loans received) according to the maturity of the original loan, and a credit to exceptional financing (debt rescheduled). In the detailed presentation, the credit entry is in the long-term capital account.

Rescheduling of Obligations Not Yet Due When obligations that are due beyond the current accounting period are rescheduled, balance of payments entries are required to

ARREARS AND DEBT REORGANIZATIONS

207

reflect the change in maturities. Balance of payments need is not attributed to the rescheduling of obligations not yet due and, so as not to distort the measure of the current period's external performance, the entire accounting is above the line, with no distinction in the entries in the detailed and the aggregated presentations of the balance of payments. A distinction is made between a rescheduling that involves the conversion of a short-term loan into a long-term loan and one that involves extending a long-term loan. In the case of the former, a debit entry is recorded in the short-term capital account, and the credit contra-entry is in the long-term capital account. In the case of rescheduling a long-term loan, both entries are in the longterm capital account.

Sectoring When a debt is rescheduled, it is frequently the case that some resectoring of the debt takes place, typically when private sector debt is assumed by the official sector. When one sector assumes the debt of another sector, the entries in the detailed presentation of the balance of payments are a credit to the capital account of the assuming sector, to reflect the assumption of an obligation, and a debit to the other sector's capital account, to reflect the reduction of a liability. In the aggregated presentation of the balance of payments, the credit entry is recorded as exceptional financing to the assuming sector in the case of obligations due in the current accounting period; both entries are accounted below the line, in exceptional financing, in the case of obligations past due; and there is no distinction between the treatment in the detailed and aggregated presentation in the case of obligations due beyond the current accounting period. Debt Refinancing When a debt is refinanced, a new loan is arranged to cover the timely payment of the original debt. Either a rollover of maturing debt obligations takes place, or existing or future debt service payments are converted to a new loan. When a debt is refinanced out of balance of payments need-for example, as part of a multiyear debt reorganization-the balance of payments entries are the same as those described for the rescheduling of obligations due in the current accounting period. That is, the debit entries are to the current account in the case of interest payments refinanced, and to the short- or longterm capital account in the case of amortization payments refinanced

208

EXTERNAL SECTOR TRANSACTIONS

(according to the maturity of the original loan); the credit entries are to exceptional financing in the aggregated presentation and to the long-term capital account in the detailed presentation. When balance of payments need is not the motivating factor behind a debt refinancing, the entire accounting is above the line, and there is no distinction in the treatment in the aggregated and the detailed presentation of the balance of payments. The entries in the balance of payments are the same as those described earlier for the rescheduling of obligations not yet due. That is, the debit entry is in the capital account according to the maturity of the loan, and the credit entry is in the long-term capital account. Debt Forgiveness A creditor may forgive all, or part, of the debt of a debtor in a country that is experiencing balance of payments problems. In balance of payments accounting this act of "forgiveness" is treated as an unrequited transfer from the creditor to the debtor-that is, the accounting reflects the reduction of a liability offset by an unrequited transfer. Like other aspects of debt reorganization, the accounting treatment of debt forgiveness differs according to the accounting period in which the debt service obligations fall due.

Forgiveness of Obligations Past Due When obligations that are in arrears are forgiven, the accounting reflects a reduction in arrears and an unrequited transfer that is treated as a balance of payments financing item. In the aggregated presentation of the balance of payments, just as in the case of the rescheduling of obligations past due, it is a change in the nature of exceptional financing that is recorded, and both the debit and the credit entries appear below the line in the category of exceptional financing. In the detailed presentation of the balance of payments, the debit entries for interest and amortization forgiven are to the short-term capital account, and the credit entries are to the current account, unrequited transfers.

Forgiveness of Obligations Due When obligations that are due in the current accounting period are forgiven, the accounting reflects a reduction of payments associated

ARREARS AND DEBT REORGANIZATIONS

209

with an existing loan and an unrequited transfer that is treated as a balance of payments financing item. In the aggregated presentation of the balance of payments, the debit entries are to the current account (investment income, interest) in the case of interest forgiven and to the capital account (other loans received), according to maturity, in the case of amortization forgiven; the credit entries are to exceptional financing (unrequited transfers). In the detailed presentation of the balance of payments, the credit entries are to the current account (unrequited transfers).

Forgiveness of Obligations Not Yet Due When obligations due beyond the current accounting period are forgiven, the accounting is above the line, and there is no distinction in the treatment in the aggregated and detailed presentations of the balance of payments. In this case, a debit entry is recorded in the appropriate capital account (other loans received), and the credit entry is recorded in the current account (unrequited transfers).

Debt Write-Offs In balance of payments methodology debt forgiveness is distinguished from a debt write-off, whereby a creditor may, because of bank supervisory requirements or for prudential reasons, provision against a bad debt without extinguishing the repayment obligation of the debtor. Debt write-offs are treated in the balance of payments accounts in the same way as a valuation change, since no contract with another party disposing of the claim has been made whereby a capital loss could have been realized. Accordingly, debt write-offs are not included in the balance of payments accounts. II. Derivation of Statistics on Arrears and Debt Reorganization from Balance of Payments Accounts For those who wish to derive complete data on arrears and the various forms of debt reorganization from balance of payments accounts, a number of difficulties arise that are due to the level of detail at which balance of payments data are currently compiled. Balance of payments categories in which the relevant flows are recorded do not distinguish between transactions associated with arrears and debt reorganization and transactions that are autonomous.

210

EXTERNAL SECTOR TRANSACTIONS

An increase in the degree of detail presented in the aggregated and detailed presentations of the balance of payments would provide a partial remedy to these difficulties. Additional entries would enable data on arrears and debt reorganization to be directly compiled from the balance of payments accounts on an accrual basis and from other sources on a cash or disbursement basis. It is uncertain, from a practical standpoint, to what extent additional detail would be forthcoming from national compilers. With this in mind, an increase in the detail requested could be either in the debit or credit entries. For obligations past due and for obligations due in the current accounting period, the additional detail could be recorded in the capital account in the detailed presentation and in the category of exceptional financing in the aggregated presentation of the balance of payments. In the case of obligations due beyond the current accounting period, for which there are no entries in exceptional financing, the additional detail could appear in the capital account in both the detailed and the aggregated presentations. The suggestions put forward below illustrate some of the possibilities.

Detailed Presentation National compilers could be requested to distinguish: • Recorded capital inflows that are counterparts of interest and amortization arrears • Credits entered to reschedule obligations due, past due, and not yet due, specifying the maturity of the obligation rescheduled • Credits entered to refinance obligations due and not yet due, specifying maturity of the obligation refinanced • Unrequited transfers that are counterparts of interest and amortization forgiven.

Aggregated Presentation The aggregated presentation of the balance of payments might be expanded such that: • For obligations past due and due in the current account period, the entries in exceptional financing would distinguish -credits that counterpart interest arrears -credits that counterpart amortization arrears -debits due to rescheduling debt obligations

211

ARREARS AND DEBT REORGANIZATIONS

-debits due to refinancing debt obligations -amortization forgiven -interest forgiven • For obligations not yet due, the entries in the capital account would distinguish -amortization forgiven -credits to reschedule short-term loans -credits to reschedule long-term loans -credits to refinance long-term loans -credits to refinance short-term loans.

III. Presentation of Arrears and Debt Reorganization: A Case Study In this section the expanded accounting procedures for arrears and debt reorganization suggested in Section II are illustrated by a hypothetical scenario of a debtor country whose arrears and debt reorganization result from the central bank's not providing foreign exchange for balance of payments reasons (Tables 2-4). The hypothetical position for the resident official sector of a debtor country at end-1984 for total debt outstanding, debt maturity, and projected debt service is represented in Table 2. Faced with a foreign exchange crisis, the debtor country pays in 1985 only US$2.0 billion of the $5.0 billion ($2.0 billion short-term, $3.0 billion long-term) of amortization due and $4.0 billion of the $7.0 billion ($3.0 billion shortterm, $4.0 billion long-term) of interest due; in both cases the pay-

Table 2. Scheduled Amortization and Interest Payments of a Hypothetical Borrower (In billions of U.S. doUars)

Item

1984

1985

1986

1987

Debt outstanding Short-term Long-term Amortization Short-term Long-term Interest Short-term Long-term

60.0 20.0 40.0

55.0 18.0 37.0 5.0 2.0 3.0 7.0 3.0 4.0

51.0 16.0 35.0 4.0 2.0 2.0 6.0 3.0 3.0

47.0 14.0 33.0 4.0 2.0 2.0 6.0 3.0 3.0

212

EXTERNAL SECTOR TRANSACTIONS

Table 3. HypothetiCill Balance of Payments Accounting for Arrears

and Debt Reorganization: Aggregated Presentation (In billions of U.S. dollars) Item

1985

1986

1987

Current accounta Investment income, interest Unrequited transfers Direct investment and other long-term capitala Actual repayments Repayments in arrears Repayments rescheduled Repayments of refinanced debt Loans drawn to refinance debt Repayments forgiven Other short-term capitala Actual payments Payments in arrears Exceptional financing Accrual of arrears Interest Long-term Short-term Amortization Long-term Short-term Rescheduling of arrears Interest Amortization New liabilities Rescheduling of payments due Interest Amortization Refinancing of payments due Interest Forgiveness of arrears Interest Unrequited transfers Forgiveness of payments due Unrequited transfers: amortization due Total change in reserves

-7.0 -7.0

-6.0 -6.0

-6.0 -6.0

-3.0 -1.0 -2.0

-2.0

-2.0

-1.5 -1.0 1.0 -0.5 -2.0 -2.0

-1.5 -0.5 -2.0 -2.0

~

0.5

• Excluding items included in exceptional financing.

-2.0 -1.0 -1.0 6.0

2.0 1.0 2.0 1.0 -2.5 -3.0 5.5 1.0 1.5 1.0 -0.5 0.5 6.0

0.5 6.0

0.5 8.0

213

ARREARS AND DEBT REORGANIZATIONS

ments are equally distributed over the maturities. The following events subsequently unfold. • In 1986 official creditors agree to forgive $0.5 billion of the $2.0 billion of arrears in long-term interest and $0.5 billion in amortization payments of $2.0 billion due on long-term debt. A further agreement is concluded in 1987 to forgive an additional $0.5 billion of amortization payments due on long-term debt. • The amortization arrears of $3.0 billion and the remaining interest arrears of $2.5 billion are rescheduled in 1986 into long-term debt. Table 4. Hypothetical Balance of Payments Accounting for Arrears

and Debt Reorganization: Detailed Presentation (In billions of U.S. dollars)

Item Current account Investment income, interest Unrequited transfers Interest arrears forgiven Amortization forgiven: long-term Capital account Other long-term capital, net Drawings on other loans received To reschedule: payments arrears Long-term interest due Long-term loans due To refinance Short-term interest due Long-term loans not yet due Repayments on other loans received Other short-term capital, net Drawings on other loans received Interest arears Short-term Long-term Amortization arrears Short-term Long-term Repayments !Jn other loans received Reserves

1985

1986

1987

-7.0 -7.0

- 5.0 -6.0 1.0 (0.5) (0.5) - 1.0 7.0 (10.0) 5.5 1.0 1.5

- 5.5 -6.0 0.5

(-) (-)

1.0 - 3.0

(-)

( -3.0) 4.0 (6.0)

(-)

(0.5) -2.5 - 0.5 (1.5)

1.0 1.0 ( -3.0) -8.0

( -2.0) - 2.0

(-)

(-)

( -8.0) 6.0

( -2.0) 8.0

1.0 2.0 1.0 2.0 ( -2.0) 6.0

214

EXTERNAL SECTOR TRANSACTIONS

• In 1986 the debtor country pays $4.0 billion of the $6.0 billion of interest due, equally distributed over the maturities. In 1986 it reschedules into long-term debt the remaining $1.0 billion of ~nterest due on long-term debt and refinances, with a long-term loan, the remaining $1.0 billion of interest due on short-term debt. Interest payments resume in full in 1987. • Of the amortization payments due in 1986 and 1987, in each year the annual payments of $2.0 billion due on short-term debt are paid, but the annual payments of $1.5 billion on long-term debt ($2.0 billion less $0.5 billion forgiven by official creditors) are rescheduled to 1988. In addition to the negotiated debt reorganization later in 1986, to take advantage of lower market interest rates the debtor country decides to refinance $1.0 billion of long-term debt not yet due. To simplify the illustration, it is assumed that no new lending or disbursements take place during the period shown. By way of example, Tables 3 and 4 illustrate how the case study might be treated if the aggregated and detailed presentations of the balance of payments were expanded in the manner suggested in Section II. The expanded presentation in each case overcomes the potential problems for users of balance of payments statistics that were outlined in Section II. In addition, identifying the individual items in the manner suggested would allow a full debt reorganization package to be presented as a memorandum item to the balance of payments.

Part II PUBLIC SECTOR ACCOUNTS

16 A Discussion of Public Sector Accounts }ONA1HAN LEVIN, }AN VAN TONGEREN, BRIAN NEWSON, AND DEREK BlADES

was prepared as a guide for discussion at the January T 1988 Expert Group Meeting on Public Sector Accounts, with particular reference to the structure of the present United Nations' A HIS PAPER

System of National Accounts (SNA) and its relationship to the methodology of the IMF's Manual on Government Finance Statistics (GFSM). It is organized in response to questions with respect to the main issues, as follows. Section I examines the objectives and roles of the two data systems, the resulting structural and data relationships between them, and the principles that should guide any changes designed to clarify and strengthen these relationships. Section II considers proposals for clarifications, revisions, or additional alternatives to coverage of transactors in the light of developments over the past two decades in institutions, economic practices, and analytical needs, with a brief discussion of the statistical units used in the government sector. Section III examines data compilation procedures in both systems that may require revision and their bearing on more explicit reconciliation of the two systems. Section IV considers possible modifications to some analytical concepts and whether the addition to the SNA of several cash-based alternative concepts applicable to government but not to other sectors would enhance analytical usefulness of the SNA or generate ambiguity. Section V examines whether various previous SNA classifications should be revised to reflect general usage in fiscal analysis, national institutions, and data availability. This paper was prepared by Jonathan Levin, except for subsections that should be attributed as follows. Jan van Tongeren: in Section I, "Data Links"; in Section II, "Community Production of Services and

217

218

PUBLIC SECTOR ACCOUNTS

Capital Goods," "Nonprofit Institutions," "Majority Ownership," "Accounts and Tables for Nonfinancial Public Enterprises and Public Financial Institutions," and "Statistical Units in the Government Sector"; in Section III, "Accrual Versus Cash Basis," "Depreciation of Government Fixed Assets," "Rent on Government-Owned Buildings," and "Debt Cancellations as Transfers"; in Section Iv, "Distinction Between Current Expenditure and Capital Formation" and "Government Operating Surplus"; in Section V, "Indirect Taxes" and "Withdrawals of Entrepreneurial Income." Jan van Tongeren and Jonathan Levin: in Section II, "Government Employees' Pension Schemes" and "Government Employees' Welfare Schemes"; in Section III, "Gross and Net Treatment." Brian Newson: in Section II, "Supranational Authorities"; in Section III, "Separate Identification"; in Section V, "Functions of Government: Revision of COFOG." Derek Blades: in Section II, "Ownership, Control, or Both"; in Section III, "Valuation in Current and Constant Prices."

I. Conceptual and Data Links Between A System of National

Accounts and the IMF' s Government Finance Statistics The structural and data relationships between the SNA and the Fund's system of government finance statistics (GFS) are discussed in this section.

Structural Relationships Differences between the two systems-in objectives and in concepts-are discussed, and areas for reconciliation identified, in the following subsections.

Objectives What types of data on government are needed by the Fund and member countries as a guide to fiscal and financial policies, what types of data on government are needed for the construction of national accounts, and to what extent could the objectives of either statistical system be incorporated and met by the other? Basic differences between the SNA public sector accounts and the Fund's system of government finance statistics (GFS) arise from the development of the two systems along separate tracks, with two separate sets of objectives.

DISCUSSION

219

The GFS system codifies forty years of practice by Fund missions and Fund publications in attempting to measure and present, in a framework of financial analysis, the actions of a sector that cannot be expected to respond like other sectors to monetary and exchange rate stimuli and constraints. To meet the Fund's needs, and those of its member countries, for an immediately verifiable current record of government actions, GFS data are derivable directly from government accounts, with no reliance on estimates or imputations. Because they must be closely integrated with analyses focusing primarily on bank deposits, bank credit, and other financial targets, GFS data are based on government payments and receipts, with only secondary reference to the accrual-basis assets and liabilities generally unavailable in government bookkeeping records. The primary aggregates of policy importance in the GFS are the overall deficit or surplus; financing from abroad, from the monetary authorities, and from deposit money banks; and aggregate revenue, grants, expenditure, and lending minus repayments. The GFS reflect the characteristic differences between the motivation and significance of government actions and those of market-oriented sectors by organizing these major aggregates differently from those in other sectors-grouping government lending with government expenditure, for example, rather than with government borrowing. Within these primary aggregates, the more detailed components also carry significance for the light they shed on the government's impact or dependence on particular groups and activities. Of limited policy significance in the framework of financial analysis within which the GFS operate are a number of aggregates of greater importance to other sectors and to the economy as a whole. These include concepts of physical output (such as the government's product or value added) as a component of gross domestic product (GOP); the concept of government consumption, as distinct from the delineation of current versus capital expenditure or of purchases of goods and services versus transfers; and the concept of change in the government's net financial position, a concept of little applicability to government units that take and give rather than purchase and sell. The SNA public sector accounts, in contrast, focus primarily on government product and value added, government consumption, and changes in a government's financial position, as reflected in its net lending. Organization of these aggregates for government in the SNA public sector accounts is largely symmetrical with their organization for other sectors, so as to permit calculation for the entire economy as the consolidated sum of the aggregates for the sectors. To measure the physical output constituting product, and to parallel also

220

PUBLIC SECTOR ACCOUNTS

other measurements for other sectors with which they must be aggregated, the public sector accounts present the data for government operations not on the basis of payments and receipts but on an accrual basis, requiring various estimates and imputations. In addition, to facilitate use of the more readily available data on government transactions to measure the operations of transactors in other sectors, classification and timing of transactions in the public sector accounts are kept fully symmetrical with those for other sectors. The perception and timing of transactions from the government point of view (as reflected in the GFS, for example) may, however, be asymmetrical with that of the other transactors. Given the continuing needs for both SNA measurement of government production, value added, income, consumption and capital formation, and for GFS measurement of government financial performance, it is unlikely that either statistical system can be entirely replaced by the other. Considerable saving of statistical resources and avoidance of users' confusion may be achieved, however, by closer integration of the two systems in aspects that do not face basic differences of objective and by the clarification of the relationships between the two systems' major concepts. Most issues under consideration in the review of GFS and SNA measurements of government involve bringing both systems closer to evolving government practices. Other issues involve modification of either or both systems to bring them closer to each other without jeopardizing their basic objectives. These may be viewed as efforts at harmonization to the extent consistent with differing objectives and reconciliation to the extent feasible at a relatively aggregate level of detail. A description of progress over the past decade in delineating the relationships between concepts in the two data systems is contained in Chapter 17 of this volume.

Changes to Facilitate Reconciliation What principles should govern decisions to change the treatment of particular account items to provide additional or alternative groupings of existing categories in order to identify aggregates common to both the SNA and GFS? The sources of difference between the two systems should be identified and related to the basic nature and objectives of the two systems, and possible flexibility should be considered in this context. • Reconciliation of major items, facilitating cross-use of data with few and identified adjustments, should be attempted.

DISCUSSION

221

• Changes should not destroy or sacrifice items needed to measure other sectors or parts of either system; treatment should not be out of keeping with the system's basic principles. • Alternative treatment could supplement, but should not replace, items needed for a system or for the building of a component of a system. • When treatment in SNA is the result of an asymmetry in the nature of an item with respect to the government sector and the other transactor, a presentation of the item from the government standpoint for both sectors, or with different treatment and an explicit adjustment to reconcile the SNA sectoral accounts with each other, should be considered. • Reroutings that facilitate major concepts should be favorably considered. Identification of the major components of both GFS and SNA and of the relationships between them is the focus of Chapter 18 of this volume.

Small Conceptual Differences What should be done about conceptual differences between the GFS and SNA that remain after conceptual reconciliation efforts, that are quantitatively tn"vial, and for which no data are available? All data systems follow conventions on the treatment of items insignificant in magnitude and not measured by available data. A standard of reasonableness governs compilers' efforts to search out data or information permitting estimation of such items. Why, therefore, does this question arise in connection with the reconciliation or harmonization of the two data systems of SNA and GFS? Probably because in the detailed articulation of relationships between GFS and SNA tables and concepts a long list of minor, insignificant, and unmeasurable difference items emerge. This is to be expected when a general system designed to measure activities and concepts applicable to all sectors is contrasted with a particular system formulated to measure the characteristic activities of a single sector with different objectives, behavior patterns, and accounting standards. Items of significance in other sectors may have little if any bearing on government operations. For consistency in the measurement and aggregation of all sectors, however, they remain part of the concepts applied to government in the SNA. The question of what to do with difference items between the uni-

222

PUBLIC SECTOR ACCOUNTS

versal, accrual-based, estimate-supplemented concepts of the SNA government accounts and the particular, cash-based, accountingnumber-restricted concepts of the GFS data is posed in several forms. First, does inclusion of such insignificant or unmeasurable difference items in the "bridge table" spelling out the relationship between the two data systems overemphasize differences and underemphasize basic similarities? Second, for practical purposes, would bridge tables omitting insignificant difference items provide derivation procedures more likely to encourage compilation of national accounts for government and cooperation between GFS and SNA compilers? Third, should presentation of data for SNA concepts derived from data for approximately similar, but not identical, GFS concepts require explicit qualifications that such data differ from the strict SNA standard? Clearly to be avoided is the publication of differing numbers for the same SNA concept-one based on data derived from GFS sources without adjustment for insignificant or unmeasurable differences, and the other based on GFS data but adjusted by estimates of such items. The confusion to users resulting from such practices would undermine users' confidence in the integrity of the compilation procedures. The importance of relatively simple reconciliation procedures between the two data systems may call for a revaluation in some cases of the degree of accuracy needed.

Data Links What should be done about discrepancies that arise in the compilation of data for GFS and SNA and that are not a result of conceptual differences? Frequently, discrepancies between GFS and SNA data are simply the result of the different compilation procedures followed for each, rather than a reflection of conceptual differences. It has been suggested that compilation of SNA and GFS data from the same sources would be preferable in preventing such discrepancies, avoiding unnecessary duplication of effort, and making explicit the subsequent adjustments required to meet the standards of each system. This would appear to create unnecessary difficulties if there are two data sources-one on an accrual basis meeting SNA standards, and one on a cash basis meeting GFS standards. Neither standard is likely to be met completely by government sources. More frequently, other elements, unconnected with differences between the two data systems, may be encountered and may be adjusted for differently in the two compilation procedures, introducing additional, unnecessary discrepancies between their results.

223

DISCUSSION

Few countries are likely to have two complete sources of data on government operations. They are more likely to have two sources for particular parts of their operations, such as tax assessments and tax collections or payment orders and checks issued for purchases of goods and services. In these circumstances, evaluation of alternate data sources and determination of how they may best be reconciled for overall consistency would be necessary for both data systems and could be carried out uniformly with provision for explicit adjustments to meet the different standards of each system. This would facilitate a sequential compilation procedure, starting with the basic government accounts, adjusting them to GFS, and then making the additional adjustments necessary for SNA. Procedures for the adjustment of GFS data for use in the SNA are illustrated in Chapter 19 of this volume.

II. Transactor Coverage This section provides a discussion of coverage in the SNA and GFS of transactors at the borderline of general government, borderline transactors within general government, public sector transactors, as well as a discussion of statistical units for the government sector.

Borderline of General Government Four classes of transactors are examined: nonfinancial enterprises, financial institutions, nonprofit institutions, and international organizations.

Nonfinancial Enterprises or Establishments Within this category of transactor, departmental enterprises, ancillary enterprises, and community production are considered. Departmental Enterprises and Dual Sectoring. Should departmental enterprises that sell to the public and have identifiable current costs be excluded from government and classified as quasi-corporations in the SNA and as nonfinancial enterprises in GFS, thus ending this aspect of the dual sectoring of government? Production accounts for producers of government services differ from production accounts for enterprises in that the former have no

224

PUBLIC SECTOR ACCOUNTS

market price valuation of output, which is not sold, and instead value output by the sum of input costs and calculate no operating surplus. The two types of producers differ also in that enterprise sales proceeds are required to meet production costs, whereas government revenues (primarily taxes) approximate disposable government income available for whatever purposes governments choose. Similarly, government production costs are assignable to various government functions or purposes, whereas enterprise production costs, except to the extent that they exceed sales proceeds and are covered by subsidies, are not. To avoid the addition of government service production costs, equal to government services output, to government enterprise production costs, and to avoid the addition of enterprise sales proceeds to taxes, two choices are possible: classifying all government-owned or government-controlled enterprise activity with identifiable production costs in the enterprise sector, or leaving such activity in government but measuring its production activity in a separate production account and aggregating only the outcome of such activity-the operating surplus-with data for the producers of government services. The present SNA chooses the first alternative for government-owned or government-controlled enterprises that are incorporated or have large-scale sales to the public and the second alternative for unincorporated units with only small-scale sales to the public. Government sales to the public of industrial or commercial goods and services that have no separately identifiable costs remain in the production account for producers of government services. This sectorization is followed also in the GFS, which nets departmental enterprise sales to the public against their identifiable operating costs and aggregates with the producers of government services only the resulting cash operating surplus or deficit. One reason for leaving in the government sector unincorporated enterprises with small-scale sales to the public may have been the difficulty in some instances of separating their income and outlay, and particularly their capital accounts, from those of the government. The proposal to classify such enterprises in the nonfinancial public enterprise sector, rather than in government, is associated with a desire to eliminate the "dual sectoring" in the production account for government. This would restrict the government sector production account to operations whose output is valued as the sum of their inputs, with no market price of output and no operating surplus derivable as the difference between their sales to the public and identifiable costs of inputs. The effect of classification of departmental enterprises as nonfinancial public enterprises would appear to be as follows.

DISCUSSION

225

• Although GOP would be unaffected, departmental enterprises' production would be attributed to the enterprise sector rather than to government. This change would generally be small in magnitude, but it might be argued that, since departmental enterprises differ only by size and incorporation from nonfinancial public enterprises, their inclusion in enterprise production totals would be preferable to their grouping with nonmarket services provided to the public without a sales price. Classification by purpose (as in The Classification of Functions of Government, COFOG) 1 of government outlays, for example, would more appropriately include only a government subsidy to cover a departmental enterprise that is operating a deficit rather than full departmental enterprise production costs. • Classification of departmental enterprises with nonfinancial public enterprises should have little effect on government income and outlay accounts, which would continue to reflect the enterprises' operating surpluses or deficits financed by government. To the extent that interest or transfer transactions were carried out by departmental enterprises, they would be assigned to the enterprise, rather than to the government sector. • Removal of departmental enterprises' capital accumulation account transactions from government, to the extent they are identifiable, would alter the totals for both government and enterprise sectors. A more unitary concept of capital formation would result because changes in enterprise stocks would not have to be added to the more limited concept of changes in government strategic stocks. • Similarly, the effect of such removal on the government's capital finance account would separate any enterprise lending from the characteristically different lending undertaken by government for public policy purposes. Should such public policy lending-or any other clearly governmental activity-be undertaken by departmental enterprises, it could be attributed to government by considering it to have been carried out by the enterprise for government in an agency capacity. This would be the case with similar occurrences involving nonfinancial public enterprises or other institutions. It must be noted also that the criterion of small-scale versus largescale sales to the public used to distinguish between nonfinancial public enterprises and departmental enterprises raises difficult problems in practice, leading those seeking to apply the standard to question its validity. 1 United Nations, The Classification of the Functions of Government, Studies in Methods, Series M, No. 70 (New York, 1980).

226

PUBLIC SECTOR ACCOUNTS

On balance, a decision on whether to classify departmental enterprises with the nonfinancial public enterprise sector rather than with government would appear to depend on whether the advantages of (1) separating market-valued output from input-valued output, changes in operating stocks from changes in strategic stocks, and commercial lending from lending for public policy purposes outweigh (2) the difficulties of separating out departmental enterprises' capital transactions from the capital transactions of government. Whichever choice is made, however, the elimination of dual sectoring in the government production account without removing departmental enterprises from government-that is, leaving departmental enterprises' gross receipts and payments to be aggregated with those of producers of government services-would exacerbate present difficulties and hinder the measurement of government activity. Ancillary Enterprises. Should ancillary enterprises selling to other parts of government, at sales prices that cannot be taken to represent market prices, and own-account production of capital goods be treated as part of government-with their output valued, like that of the rest of government, as the sum of their inputs rather than at their sales price-thus ending this aspect of the dual sectoring of government? Ancillary enterprises may be defined as government-owned or government-controlled (or both) industries that are primarily engaged in the provision of goods and services to other parts of government and that, because they are unincorporated and do not have large-scale sales to the public, are classified in the government sector. Under present dual sectoring practices in the government production account, the output of ancillary enterprises is valued at the prices such enterprises charge other parts of government for the goods and services the enterprises provide them, giving rise to an operating surplus or deficit as the difference from the cost of the enterprises' inputs. In practice, however, an ancillary enterprise's charge to other parts of government may differ substantially from market prices, for political or internal administrative reasons. This would undervalue or overvalue GOP, government gross output, government consumption, and capital formation under present SNA practices and misstate the enterprise's operating surplus or deficit.2 To eliminate dependence on such unrealistic internal pricing, such This issue does not arise in GFS, which eliminates in consolidation transactions between departmental enterprises and producers of government services and calculates only the cash operating surplus or deficit of departmental enterprises' sales to the public. 2

DISCUSSION

227

ancillary enterprises could be assimilated to producers of government services and have their output valued at the cost of their inputs. Own-account capital formation within government also lacks a marketlike output sales price, since the capital formation may be carried out for the unit itself or may be carried out for another part of government at an unrealistic, administratively determined charge. More accurate valuation of such own-account capital formation could be based on the cost of inputs. This would appear to be preferable also to attempting estimates of own-account government capital formation on the basis of similar capital formation by enterprises. Regardless of whether departmental enterprise production is measured at its market sale price in a separate (dual sectoring) production account within government or in the nonfinancial public enterprise production account outside government, measurement of ancillary enterprises' output sold to other parts of government at unrealistic prices and of own-account capital formation by government could more appropriately be carried out within the production account of producers of government services, with output valued at the cost of inputs. Although this may result in including within the production account for producers of government services some activities classified as industries by International Standard Industrial Classification (ISiq,3 the preferable criterion for inclusion in the different production accounts would appear to be not industrial character but whether output should be valued by market sale or by the cost of inputs. This need not detract, however, from the breakdown of production account information for the government sector into separate activities corresponding to !SIC categories. Community Production of Services and Capital Goods. Should the seroices and capital goods resulting from informal community production be attributed to government or to the household sector? Some services and capital goods resulting from informal community production are closer in character or organization to households, some to private nonprofit institutions, and some to gov:ernment. In GFS, for lack of payment transactions, there would be no registration of the services or capital goods produced. In SNA, estimating procedures for valuation of output, inputs, and consumption or capital formation would be necessary regardless of the sector to which the activity is attributed. Consideration may be given to the character of the activity by 3 United Nations, International Standard Industrial Classification of All Economic Activities, Statistical Papers, Series M, No.4, Rev. 3 (New York, 1986).

228

PUBLIC SECTOR ACCOUNTS

which the services or capital goods are produced, to the character of the service or capital goods themselves, to control of their distribution or use, to whether depreciation of the capital goods will have to be included in future accounts, and to whether maintenance may have to come from households, nonprofit institutions, or government. Discussion at the SNA Expert Group Meeting on the Household Sector (Florence, August 31-September 4, 1987) concluded that capital assets constructed on a communal basis should be attributed to the sector responsible for their upkeep; that sector may be different from the sector that produced the assets.

Financial Institutions The treatment of flows originating in monetary authorities' functions, of government employees' pension schemes, and of government employees' welfare schemes is discussed in this subsection. Monetary Authority Functions and Acceptance of Deposit Liabilities. Should flows to or from government-from the performance of monetary

authorities' functions or the acceptance of demand, time, or savings deposit liabilities-be rerouted and shown as government inflows from or outflows to the financial institutions sector?

Some reroutings of transaction flows are carried out in the SNA for analytical purposes. Thus, employer contributions to pension schemes or social security schemes are rerouted through households and give rise to a corresponding increase in the compensation of employees that constitutes household income. For purposes of money and banking statistics, similarly, it is useful to gather all transaction flows constituting the acceptance of money or near-money liabilities or the management of the money supply and international reserves-including transactions with the Fund-and attribute them to the financial institutions sector and its appropriate parts. This permits money and banking statistics to keep track of the liquidity in the economy as indicated by the monetary and near-monetary liabilities of the banks. Were such activities to be attributed to the government sector directly, the coverage of money and banking statistics would have to expand to include a part of government. The task of measuring financial intermediation, liquidity, and bank credit would be possible but more difficult. To facilitate simplification of the task of money and banking statistics, government sector statistics reroute, through the financial institutions sector, all such banking function flows reaching government. Deposit flows reaching government, therefore, are classified as flows

DISCUSSION

229

reaching government through the financial institutions sector. So long as money and banking statistics continue to group in the financial institutions sector the provision of liquidity to the economy and management of the money supply and international reserves, the reflection of this rerouting in the statistics for government is necessary for the sake of consistency. Depending on practices to be followed with other SNA reroutings, it may be found appropriate to identify such reroutings explicitly for the use of analysts who prefer the identification of all transaction flows by actual transactors. An alternative to such rerouting would be to redesign money and banking statistics to cover the banking activities of government. Government Employees' Pension Schemes. Should government employee pension funds, invested with the employer government or elsewhere, form a part of government or of the insurance and pension fund subsector of the financial institutions sector? For pension funds invested entirely with the employer, the present SNA provides an exception to the classification of pension funds in

the financial institutions sector. Because the conduct of such pension funds is thought to follow more closely the conduct of the employer than of households or of an independent pension fund subsector, pension funds invested entirely with the employer are classified as part of the employers' sector rather than in the pension fund and insurance subsector of the financial institutions subsector. This classification is followed also by the GFS. In the case of government employee pension funds, however, the distinction drawn on the basis of investment with the employer is not so clear. Pension funds are frequently invested in government securities for reasons of prudence, whether by legal requirement or by choice, so that investment of government employee pension funds with the employer-the government-does not indicate the degree of employer control that investment with a nongovernment employer does. Classification of such government employee pension funds with the majority of other pension funds, in the financial institutions sector, may therefore be preferable. This would permit the type of analysis of government employee pension funds that can best be provided in the context of pension funds and insurance companies, including the calculation of actuarial liabilities and reserves. It would remove from government accounts several noncharacteristic actual and imputed flows, such as the imputation of household equity in pension fund reserves, and the distribution and reinvestment of interest earnings on such equity. Analysis of pension funds would thus be carried out entirely in the context of pension funds, independently of whether reserves are

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invested entirely or partially with the securities of the employer government. With the classification of government employee pension funds in the financial institutions sector, the separate identification of contributions to such funds would be retained. All imputations of service charges, net equity of households with pension funds, and interest on this household equity would be omitted from the government accounts and registered instead in the accounts of the financial institutions sector. Government Employees' Welfare Schemes. Should government employee welfare funds and unfunded welfare and pension schemes for government employees be considered social security schemes, with their contributions and benefits classified as social security contributions and benefits? For the government sector, the SNA groups together government employee welfare schemes and unfunded government employee pension schemes and distinguishes them from pension funds, social security schemes, and social assistance grants. In practice, however, the distinction with social security schemes may be rather difficult to make. Although schemes provided by employers and those imposed by government .are clearly different in the rest of the economy, they may not be readily distinguishable from each other when the government is the employer. Government employees are often not covered by the social security schemes that apply to other sectors, so that, as an examination of country practice reveals, many countries include as social security schemes the pension and welfare schemes that are exclusively for government or public sector employees. Other countries that do cover government employees in their general social security schemes have supplementary pension and welfare schemes for government employees that may or may not be classified as social security schemes, depending on the interpretation of the SNA by the national accountant. As a result, SNA distinctions between different kinds of contributions and benefit payments are generally not applied in the prescribed detail in most countries, either because all schemes envisaged in the SNA are not relevant in all countries or because the distinctions are difficult to make. Many countries, in fact, do not distinguish between social assistance grants and unfunded employee pension and welfare benefits and make no imputations of contributions to unfunded employee welfare or pension schemes. To simplify the prescribed breakdown in contributions and benefits, therefore, it has been suggested that in the SNA for the government sector the distinction be eliminated between social security

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schemes and government employees' welfare funds and unfunded welfare and pension schemes. This would bring no change in the total of employee and employer contributions and of benefits registered in the SNA for the government sector, but all such contributions and benefits would be shown as social security contributions and social security benefits, respectively. The imputation of a service charge component of contributions would not continue, since no service charge is calculated for social security contributions. The service charge component of pension and casualty insurance premiums does provide a measure of output and value added when applied outside government, but its elimination from contributions to the government would have no effect on government output and value added because these are calculated from the sum of inputs rather than sales. Elimination of the imputed service charge on contributions to government employee welfare funds and unfunded pension and welfare schemes would merely shift, to services produced for own use, the service charge amount now attributed to government sales in the production account for government. Imputed employer contributions to unfunded pension and welfare schemes for government employees would continue to appear as part of the compensation of employees and, at the same time, as a government sector receipt from households in the income and outlay account. As in the past, noncontributory pension or welfare benefits provided to government employees as members of the general population rather than as employees would continue to be classified as social assistance grants.

Nonprofit Institutions Should government include nonprofit institutions that serve households or enterprises but that have majority financing and control by government? If so, should the criteria of control and finance be maintained, or should other criteria be applied? At present, the SNA includes in the government sector all nonprofit institutions that are mainly financed and controlled by public authorities. Private nonprofit institutions that serve enterprises but that are not wholly or mainly financed and controlled by the public authorities are included in enterprises. In the present SNA, however, private nonprofit institutions serving households form a separate sector on their own that is of an equivalent status with government, enterprises, and household sectors. The SNA Expert Group Meeting on the Household Sector in Sep-

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tember 1987 dealt with nonprofit institutions as one group, including those to be allocated to the enterprise sector, those to be included in the household sector, and those to be incorporated with the government sector. The distinction between nonprofit institutions included in the government sector and the rest was left open for recommendations by the Public Sector Expert Group Meeting. With regard to the remaining nonprofit institutions, the Household Sector Expert Group recommended that the allocation of these to the household and enterprise sectors should be based on whom the institutions serve, not on who pays for most of their outlays. It decided, furthermore, that nonprofit institutions serving households should be included as a subsector of the household sector, and that this subsector should include all such institutions serving households regardless of the number of their employees. Also included as nonprofit institutions should be religious missions, private aid agencies, and community activities including those production activities carried out on a communal basis that result in capital assets such as roads, schools, and the like. The present SNA criterion for inclusion of nonprofit institutions in government requires both majority government financing and government control, leaving institutions that are not controlled by government outside the government sector, regardless of their degree of dependence on government funds. This has had advantages in leaving outside government institutions that maintain operating independence and for which operating statistics would, as a consequence, be less likely to be available through government accounts. Such institutions may be quite sensitive about their separate existence outside government, moreover, and may feel with some justification that their ability to raise funds from private sources could be jeopardized by their classification as part of government. Adoption of a criterion of majority government finance or control as a condition for including nonprofit institutions in government would also bring in institutions controlled but not majority-financed by government. Institutions that are controlled by government but are not majority-financed by government are likely to form a part of government in any case, perhaps collecting fees or compulsory levies for the greater part of their receipts. Their classification would not be affected by adopting a criterion of majority government financing or control to determine inclusion of nonprofit institutions in government.

International Organizations Issues pertaining to the treatment of two types of international organization-supranational authorities and other international organizations-are examined in this subsection.

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Supranational Authorities. Should general government include, as a nonresident subsector, the nonheadquarters operations of supranational authorities within the country; that is, international organizations empowered to levy taxes within the country? Supranational authorities are defined in the GFS as those international organizations that are empowered to levy taxes within countries. Seemingly the only case that exists at the moment is the institutions of the European Community (EC). The SNA does not discuss supranational authorities but stipulates that "international bodies, such as political, administrative, economic, social or financial institutions, in which members are governments, are not considered residents of the country in which they are located or operate" (SNA, paragraph 5.113). The European System of Integrated Economic Accounts (ESA) 4 follows the same line but specifies further by showing the EC institutions separately as a subsector of the rest of the world and in specifying that taxes collected for (or subsidies paid by) Community institutions are to be recorded as direct transactions between producer units in the country and the Community institutions, without passing through the accounts of the national general government sector. Hence, for instance, total taxes paid by the resident producers are the sum of those destined for the national government and those for the Community institutions. In the GFS the "general government" is expanded to encompass both the national general government (the SNA sector) and a nonresident subsector for the operations of supranational authorities (excluding their headquarters). This is not done, however, for other international organizations. In the GFS as in the ESA, taxes collected for Community institutions (and subsidies paid by them) are recorded as direct transactions between the producer units and the supranational authorities. The advantage of the GFS treatment is to bring together all taxes paid in a country into one "government" receiving sector instead of two. The disadvantages from the SNA point of view are as follows. • Nonheadquarters operations of supranational authorities, at least in the EC case, are merely an amalgam of income and outlay account transactions, not a real institutional unit at all. • The enlarged government sector is both resident and nonresident at the same time. • It would seem that the normal consolidation rules applied to the 4 EUROSTAT, European System of Integrated Economic Accounts-ESA, 2d ed. (Luxembourg, 1979).

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enlarged sector would be inconsistent with both the balance of payments and the gross national product (GNP). A rationale for the GFS treatment of supranational authorities is delineated in the following paragraphs. Over the years since adoption of the SNA in 1968 there has been a growth of governmental activities on a supranational level not fully anticipated by the national framework of the current system. Some of these issues have been approached in the Fund's Manual on Government Finance Statistics (GFSM) and GFS Yearbook, and consideration may be given to whether review of the SNA may call for a similar approach. The view adopted in the GFSM and GFS Yearbook is that, just because the countries of the EC have assigned several of their governmental functions to authorities that encompass several countries, there is no cause for a reduction in the measurement of overall governmental activities in these countries, as regards both taxes and governmental expenditures. This requires statistical recognition that, in these countries, government is no longer solely national and that there are transactions being carried out within the country by governmental authorities that are nonresident. The GFSM and GFS Yearbook recognize this fact by adding to the traditional resident, or national, government the activities within the country of the nonresident, supranational government authorities to reach the overall concept of general government for the country. This causes no contradiction with balance of payments concepts so long as it is recognized that, although national government is resident, general government need not be entirely resident. The delineation of the transactions of supranational authorities from those of national government is accomplished in the GFS by defining supranational authorities as a separate level, or subsector, of ge11eral government and by using the same principles of attribution of receipts and payments-for example, between collecting and beneficiary governments-as are employed for other levels of government. Thus, particular taxes set by supranational authorities but collected for them by national governments are attributed directly to the supranational authorities and appear in neither the receipts nor expenditures of the national governments. Payments levied on the national governments by the supranational authorities without specifications as to how the funds are to be raised within each member country are registered as receipts of the supranational authorities from each national government. Both the raising of money domestically and its payment to the supranational authorities are registered in the data for

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the national government. Similarly, expenditures paid by supranational authorities to individual and enterprise residents of a member country are registered as transactions of the supranational authorities with these residents and not as transactions with the national government of the country. Data for both national governments and supranational authorities are shown separately for ten EC countries in the GFS Yearbook. Data are also shown for general government, consolidating the data for all levels of national government and the supranational authorities and eliminating any transactions between them. To reflect the nature of its activities and relationships, data for the supranational authorities subsector of general government exclude headquarters or central office operations-such as those in Brussels and Luxembourg and the several nuclear research centers-and are restricted to operations within the country, with all transactions abroad viewed as proceeding through headquarters. Transactions of supranational authorities with their headquarters are not viewed as giving rise to claims or liabilities but are shown as transfers that serve as balancing items, averting the calculation of any overall deficit or surplus for the supranational authorities subsector of general government that would be parallel to the deficit or surplus concept of other levels of government. All transactions of supranational authorities with nonmember countries are classified as transactions of the supranational authorities' headquarters, and no supranational authorities subsector of general government is considered to exist in nonmember countries because no governmental functions have been taken on by supranational authorities there. Other International Organizations. Should the operations of all international organizations excluded as nonresident from all countries' national accounts be aggregated as an additional unit to complete the universe of national accounts? Participants in the Expert Group Meeting on External Sector Transactions concluded that, for completeness and symmetry of national accounts, an additional unit embracing international organizations that are classified as nonresident everywhere they operate should be defined and measured through the compilation and consolidation of data on their activities. Such international organizations were defined to include organizations that meet three criteria: (1) authority derived directly from the authority of the organization's members, which may be independent states or other international organizations; (2) sovereign status (that is, the laws and regulations of the country or countries in which the international organization is located do not apply to

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it); and (3) production of services that are primarily nonmarket services. To facilitate the work of national compilers and international organizations working in the field, the expert group recommended that a list of such international organizations be drawn up. Accordingly, the Fund now collects balance of payments data from international organizations, consolidates them, and uses them to round out global totals; the results are presented in the Balance of Payments Statistics Yearbook (BOP Yearbook). Such aggregate data for international organizations would not provide data on their activities in individual countries. This would form a part of national balance of payments data on transactions with nonresident official entities, which include both international organizations and public sector entities of other individual countries. International organizations covered by the aggregate data would cover both organizations governmental in nature and those performing functions of financial intermediation. A strict parallelism with the distinction of government versus financial institution used in national sectorization, and any thought of aggregate governmental activity at both the national and international level, would require the preservation of subcategories for groupings of governmental and financial institutions within the overall aggregates for international organizations.

Borderline Within General Government This subsection considers treatment of various government levels and of social security funds.

Central, State, Local, and Other Government Levels Should state or provincial governments and local governments be shown as separate subsectors of general government when they operate as levels of government separate from central government and from each other? Although the 1968 SNA distinguishes only between central government and local government, the significance of separate state or regional governments within the noncentral government group has led the Fund's GFS Yearbook, and more recently the revised UN-SNA questionnaire, to distinguish a separate intermediate level of government (where it exists) between central and local governments. Data for state, provincial, or regional governments are published for some

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22 countries in the GFS Yearbook. State, provincial, or regional governments are defined in the GFSM as governmental units exercising a competence independently of central government in a part of a country's territory that encompasses a number of smaller localities-that is, that occupies an intermediate position between the central government and any independent local governments that may exist. Governments are considered to have an independent competence if they have the power to raise a substantial portion of their revenue from sources they control and if their officers are independent of external administrative control in the actual operation of the units' activities. For some purposes, such as the usual definition of the money supply to exclude only holdings of the central government, state governments may be grouped with local governments. For other purposes, perhaps where closely coordinated central fiscal policy extends effectively through the state government level, state governments may be grouped with the central government. In other instances state governments may most fruitfully be measured alone, permitting analysis of the separate pattern of revenues and expenditures they may represent. Although separate state or provincial governments exist in a minority of countries, they are not restricted to federal states and have been added to a number of countries in recent years to meet political conditions of regional or cultural identity. Distinguishing between state and local governments may be difficult where there are several layers of local government, such as counties and towns. Separation of all distinctive categories of government units may be warranted for analytical purposes, but identification of state or provincial governments will usually depend on their regional character and their exercise of jurisdiction over lower units of government. The benefits of separating state from local government data, where state governments exist, are most clearly evident in clarifying relations between levels of government and financial flows between them. The role of a separate level of regional government in such flows may be particularly significant, justifying separate measurement.

Social Security Funds Should social security funds be shown as a separately identified portion (or subsubsector) of each level or subsector of government at which they operate or as a subsector separate from other levels or subsectors of government? The SNA classifies social security funds as a separate subsector of government, whereas the GFS shows their operations separately but

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incorporates them as a part (subsubsector) of the level of government at which they operate. This difference reflects differences in the organization of social security, both between countries and with the passage of time, and different considerations of policy and analysis. In countries with older social security systems, early employeroperated arrangements, mutual benefit insurance, or other mechanisms came under laws governing their operations beginning in the nineteenth century. "Finally, to consolidate earlier piecemeal efforts, a particular program was codified for the first time for an industry or for the country as a whole, almost always on a compulsory basis. " 5 As separate decision-making centers managing their own finances, social security funds required separate analysis both to portray their impact on the economy and to report to participants on the stewardship of their funds. Over the past two decades, however, broadening social concerns have extended government budgetary operations into areas previously served exclusively by social security funds. The separateness of the functions, finances, and decision-making powers of social security funds has been substantially diminished. In practice, for example, unemployment benefits have been integrated with employment services and means-tested welfare benefits; old-age benefits have been tied to universal or means-tested pension plans or awarded early to ease unemployment in recessions or in particular industries; family allowances have been adjusted to replace tax credits or exemptions; and sickness plans have been coordinated with government hospitals, clinics, or health services. (For a further discussion of these issues, see Chapter 20 in this volume.) The financial independence of social security funds was diminished by the indexing of benefits in the face of unemployment-caused reduction of contributions, the maturing of many systems, demographic changes, and the broadening of many benefits without corresponding increases in contributipns. Increased portions of social security costs were met out of general budgetary revenues. The independent decision-making powers of social security funds diminished as central decisions were taken to integrate social security changes with other countercyclical, social, or political moves and as the financial base for independence eroded. Although the functional, financial, and decision-making independence of social security funds declined, however, recognition of their separate existence remained United States, U.S. Department of Health and Human Services, Social Security Programs Throughout the World-1983, Research Report 59 (Washing5

ton: Government Printing Office, 1984), p. viii.

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important to the confidence of their contributors in many countries and to evaluation of their financial soundness. Against this background, although separate identification of the operations of social security funds has continued to have value, separate measurement of central government operations excluding social security funds has become increasingly inadequate. Social security contributions comprise 44 percent of combined central government budgetary and social security fund revenue in France, 55 percent in Germany, and 40 percent in the Netherlands. The impact of government on the economy and the potential weight of central countercyclical fiscal policy is not adequately measured by data for central government excluding social security funds. Separate presentations for social security funds or for central government excluding social security funds would fail also to give a complete picture of government expenditures for various functions, since some activities are carried out in combination by social security funds, by social security schemes that do not constitute funds, and by other government programs. To meet the needs for both separate identification of social security fund operations and combined data for central government operations including social security funds, an appropriate characterization or status for social security funds is necessary, whatever words may be used. In practice, two issues need to be resolved. First is the classification of any state or local level social security funds, which are now classified as part of the social security fund sector by the SNA and as part of the state or local level of government by the GFS. Second is the working out of appropriate consolidation procedures for presentation of social security fund operations in a manner portraying both their own operations and their relations with budgetary central government. This would involve, more specifically, whether budgetary government transfers to social security funds or lending by social security funds to budgetary central government would be eliminated in showing a consolidated deficit or surplus for social security funds, with memorandum items for eliminated amounts, or would not be eliminated in showing an unconsolidated deficit or surplus for social security funds. Although alternative consolidated and unconsolidated presentations are possible, it would be useful to avoid the confusion that would result from users encountering unexplained data in the two formats.

Public Sector Questions about treatment of various public sector transactors are addressed in this subsection: definition of the ownership of public

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enterprises, a public-private delineation in the national accounts and supporting tables, and issues relating to the nonfinancialnonmonetary public sector.

Definition of Ownership The distinctions between majority ownership or control by government are discussed in the following paragraphs. Ownership, Control, or Both. Should public enterprises be defined as enterprises majority-owned or controlled by government, or both? Because of their special relationship with government, public enterprises may be subject to different influences and motivations than private enterprises, so that their analysis in separate public enterprise groupings may serve to delineate separate patterns of behavior. Whether the relationship influencing public enterprises' behavior is the result of government ownership, government control, either, both, or a combination of factors is difficult to determine in any one country at a given time and probably cannot be determined for all countries in general. The need for general guidelines to promote comparability in the identification of public enterprises among countries and over time, however, has stimulated efforts to formulate generally applicable criteria. The present SNA (see Table 5.1, for example) proposes that both nonfinancial enterprises and financial institutions should be divided into public and private groupings on the basis of ownership "and/or" control. This criterion for distinguishing between public and private has been criticized for lack of clarity: does "and/or" mean "and" or "or," and how is "control" to be defined? At a national accounts meeting in May 1984, the Secretariat of the Organization for Economic Cooperation and Development (OECD) proposed that the next SNA give four necessary conditions for classifying an enterprise as "public": it is owned by government, it is controlled by govemment, it is large, and it is intended that the enterprise will be retained in public ownership on a more or less permanent basis. The Secretariat also offered suggestions about how "control" and "large" should be defined. All participants in the May 1984 meeting agreed with the ownership criterion and recommended that, in general, all enterprises with 50 percent or more public ownership should be counted as public. Some participants noted, however, that guidance should be given for deciding borderline cases. Sometimes public ownership, although majority ownership, is split among different levels of government so

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that the largest single block of shares is actually held by private interests. There may also be difficulties in deciding on the ownership of subsidiaries of public enterprises. As regards the control criterion, it was argued that this was usually superfluous because ownership almost always implies control. One participant noted, however, that governments could te.mporarily acquire enterprises in rescue situations without any intention of controlling their commercial operations, and in such cases it was not helpful to classify them as public enterprises. There was also support for the view that the degree of government control could be useful in borderline cases-for example, in deciding how to classify subsidiaries of public enterprises when the extent of public ownership could not be clearly established. Moreover, in cases where government ownership was less than 50 percent, the extent of government control-through the power to appoint board members or directors, for example-might justify classifying an enterprise as public. In summary, although most participants did not object to control being regarded as a condition for classifying an enterprise as public, they felt that it would usually be superfluous. The OECD meeting in May 1984 had suggested a size criterion on the practical grounds that the elimination of small public enterprises-usually municipal undertakings-would simplify the work of compiling accounts for the public enterprise subsector and thus encourage more countries to publish such data. Most participants in the meeting rejected the size criterion, however, because no single rule for measuring enterprise size could possibly be appropriate for countries as diverse as the United States, Japan, Iceland, and Luxembourg. Some participants also noted that, with the increasing use of central enterprise registers, all enterprises regardless of size would necessarily be classified as either public or private, so that there would be no practical advantages in eliminating small enterprises. The fourth proposed criterion-that there should be an intention to keep the enterprise in public ownership on a permanent basis-was criticized by one participant on the grounds that statistics should record current facts rather than future intentions. Policymakers may change their intentions, or a new set of policymakers with different intentions might come to power. It would be unreasonable to expect statisticians to change their public enterprise subsector to accommodate new statements of intent. The view was also expressed that, although "intended permanency" was not a necessary condition, it would often be an important practical consideration in deciding whether or not an enterprise is to be counted as public. Under that

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condition, government ownership and government control would also normally go together. But if the public authorities have temporarily taken possession of an enterprise with the expressed intention of returning it to the private sector at the earliest opportunity, control would normally not be intended, and it would be best to leave the enterprise in the private sector. In light of this discussion, varying experiences and conditions in different countries, and discussions in other forums, it will be necessary to decide whether the revised SNA should retain the present ownership "and/or" control criteria or adopt a new formulation designed to encompass enterprises with behavior patterns reflecting their special relationship to government. Majority Ownership. Should government majority ownership be defined to include units in which majority ownership is held by a parent unit in which the government holds majority ownership? Regarding the definition of ownership, the Handbook of National Accounting: Public Sector Accounts contains the following statement: 6 The owner of an enterprise is the holder of the majority of the equity or common stock. This owner should also be regarded as the owner of subsidiaries in which the enterprise holds the majority of the equity or common stock, and iteratively if subsidiaries have subsidiaries.

Accounts and Tables for Nonfinancial Public Enterprises and Public Financial Institutions Should the next SNA provide for a public-private breakdown in the accounts or supporting tables? The present SNA does not provide for a public-private split in the main accounts of the system although it does recommend a publicprivate breakdown in two supporting tables: "Domestic Factor Incomes According to Kind of Activity and Institutional Sector of Origin" (Table 17) and "Capital Transactions of the Private and Public Institutions" (Table 19). The UN-OECD annual questionnaire calls for the public-private split for capital formation, saving, consumption of fixed capital, and capital stocks. 6 United Nations, Handbook of National Accounting: Public Sector Accounts, Studies in Methods, Series F, No. 50 (New York, 1988).

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Nonfinancial or Nonmonetary Public Sector Should the revised SNA include accounts for a public sector concept and should it recognize also alternative formulations of the public sector, such as the nonfinancial public sector (excluding public financial institutions) or the nonmonetary public sector (excluding monetary public financial institutions)? To measure not only the performance of government functions but also the commercial and financial activities carried out under government majority ownership and/or control, the present SNA suggests that in countries where the public authorities play a particularly important role in the economy it may be useful to prepare accounts for the "Public Sector" consisting of general government plus nonfinancial public enterprises and public financial institutions. 7 Thus, although the disparate nature of some government and enterprise activities poses obstacles to their aggregation, aggregates may be calculated for other aspects of their operations, such as saving, capital formation, and financing, recommended by the GFS. Because financing transactions between units included in such aggregates are eliminated in consolidation, however, analytical needs may be better served by restricting the units covered for some purposes. Consequently, the GFSM recommends consolidation of only the government and the nonfinancial public enterprises, leaving out the central bank and other public financial institutions, so as not to eliminate in consolidation their lending to the government and to nonfinancial public enterprises. This partial coverage of the public sector is referred to as the nonfinancial public sector. In some countries, government policy is carried out extensively through nonbank lending institutions that rely heavily on borrowing from the central bank and other government-owned and/or government-controlled monetary financial institutions (that is, from institutions whose liabilities primarily constitute money). In such instances, one measure of the financial impact of government operations and government-controlled operations has focused on the nonmonetary public sector, so as not to eliminate in consolidation the borrowing from the central bank and other public monetary institutions. 7 Chapter IX of the SNA (pp. 222-25 of the English version) suggests a set of accounts for production, income and outlay, and capital finance for this "Public Sector"; separate (nonconsolidated) production accounts are shown for general government and nonfinancial public enterprises and public financial institutions, but the other accounts are shown on both a consolidated and nonconsolidated basis.

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Recognition of the validity of such limited-coverage variations of the public sector for particular analytical purposes could add a degree of flexibility to an SNA public sector concept.

Statistical Units in the Government Sector Two questions will be raised-one concerning statistical units in COFOG, and the second concerning the definition of an institutional unit in the government sector.

Should the unit of classification for COFOG be in principle a transactor unit rather than a transaction unit, applicable to all government expenses? If so, should this transactor unit be the same as the establishment-type unit that is recommended in the SNA for the classification of production accounts and capital formation by economic activity? The present SNA (paragraphs 5.86-5.90) and COFOG (pages 2 and 3) opt in principle for the transaction as the unit of classification. However, only for practical reasons, both recommend using the establishment unit for the classification of production and capital formation expenses, leaving the transaction unit as the basis for the classification of other expenses such as transfers and loans. It could be argued that an orientation toward transaction units would not be in line with the analytical aim of COFOG, which is to analyze by purpose the government policies carried out through government expenditure programs. The expenditures are coordinated through programs, offices, or bureaus that are the focal points for government budgeting. Each program integrates a series of alternative or supplementary expenditures that serve the same purpose or the same group of purposes. For instance, education can be promoted by running public schools (production of government services for own consumption), constructing school buildings (government gross fixed capital formation), "subsidizing" private schools (current transfers), or providing funds for private school construction (capital transfers, loans). Thus, it seems inconsistent with the aim of the functional analysis for the COFOG scheme to determine the function or purpose of each expenditure separately. Instead, the function of an outlay should be determined with regard to the function of the program as a whole. Taking the above point of view does not mean that one has to accept that all outlays of one unit serve one function only. In the same manner that establishments produce characteristic and secondary products, a government unit may serve a primary purpose and a

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secondary one. If the secondary purpose is important and if separate records are available, there may be a need to try to split off those expenses that serve the secondary purpose and treat them together as the expenses of another COFOG unit. It is not only convenient but also logical to use the same unit for COFOG as is used for the activity breakdown of government production and capital formation. The reason is that government production cannot be analytically separated from government consumption, since the major part of government services are assumed to be consumed by the same government unit. Furthermore, government consumption is only one of the expenditure types that should be looked at in a COFOG breakdown, in addition to other types of government expenses that are registered in the SNA income and outlay and capital accounts for the government sector. Production analysis in the government sector therefore cannot be separated from analysis of other government expenses. The connection of the two types of analysis is recognized in the SNA, which defines the establishment type unit in the government sector as a unit for which separate accounting records are available on production cost, sales, capital formation, and employment and which serve in principle one purpose (SNA, paragraphs 5.31-5.34). Using the same unit of classification for classifying government "production expenses" by COFOG and !SIC categories does not imply that the two classifications are the same. For instance, if a ministry of education has one program for the construction of schools and another to run public schools, the two units should be allocated to different !SIC categories (construction and education) but included in one purpose category (education). The modified orientation of the statistical unit in COFOG may also help to clarify some of the questions recently raised by the Statistical Office of the EC (EUROSTAT) with respect to revision of CO FOG. The distinction suggested between administrative expenses of. a specific nature (to be included in individual consumption) and those that are directed to more general purposes (to be included in collective consumption) is the same as distinguishing between expenses that serve the purpose of the transactor unit by which they are carried out and general administrative expenses that serve a different purpose and therefore should be integrated with another COFOG unit. Also, the question of classifying subsidies by CO FOG category may be clarified; subsidies should not be classified by the purpose of the transaction itself or on the basis of the industry that receives them, but by the function served by the unit as a whole that makes the subsidy payments.

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The second question concerns the institutional unit in the government sector.

Is there a need to clarify the definition of the institutional unit of government as a unit of decisions, control, and management, or should additional criteria be included, such as availability of separate accounting records on income and outlay and capital transactions or existence of a separate accounting or budget office, or should the unit be further restricted to be one that is funded for the majority of its expenses by its own revenues (taxes)? The present institutional unit of government in the SNA is very broad (SNA, paragraph 5.68). The central government is taken as one unit, and various state, provincial, and local governments and individual social security schemes are each considered as separate institutional units. The units selected are those that are units of decision, control, and management. For more refined analysis of government operations (by government subsectors, regional analysis, and the like) there is a need to have a further breakdown of the government sector, particularly of central government. Thus, it may be argued that the above definitions and coverage of government institutional units may be inadequate. Government subsectors can only be distinguished if complete institutional sector accounts can be drawn up for the units included in each subsector. These sector accounts should cover not only expenses but also revenues. With regard to revenues, the government differs from other sectors. Its revenue generation is generally much more centralized, for example, than that of enterprises. Central government revenues usually are all channeled through a central treasury, making it impossible to consider ministries, for instance, as separate subsectors of government. There are government agencies, however, that keep separate accounts, and those are not restricted to the local government sector but also include units that generally carry out central government programs. In Latin America there are many decentralized government agencies for education, health, and so on that are separately administered and keep separate accounts. But separate accounts do not mean that such agencies are necessarily financially independent. In fact, many at the central government level and some operating at the regional levels are funded to a major extent by central government transfers of tax revenues. Development of these criteria for an institutional unit in the government sector might help to clarify some of the other questions raised here and assist in arriving at correct answers. For example, should the monetary function of the government be split off only if

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complete income and outlay and capital accounts can be set up for that function? Should social security funds, government pension funds, and welfare schemes be split off from other government units only if complete and separate accounts are available or are separately funded, or both?

III. Registration of Transactions This section considers questions regarding registration of transactions in the national accounts: accrual versus cash accounting, consolidation practices, gross and net treatment, imputation and rerouting, and valuation in current versus constant prices.

Accrual Versus Cash Basis How should accruals be defined for various government payments and receipts, and how should they be related to cash-basis statistics? The SNA recommends that transactions should be recorded on an accrual basis, whereas the GFS adheres to cash-basis reporting. The accrual basis used in the SNA was defined before the IMF's GFSM defined the cash basis of related transactions in the GFS. Since then various queries have arisen with regard to the difference between the basis of recording the same transactions in the GFS and SNA. Within the SNA, questions have also arisen about what should be included in the capital finance accounts in the items ''other accounts receivable and payable" and "trade credit and advances," which reflect in the SNA the difference between the cash and accrual bases. Particular attention should be paid to the difference between the recording in the SNA and GFS with regard to the following transactions.

• Transactions in goods and services. These are to be recorded in the SNA as of the date when the legal title to the goods changes, or when the services are rendered. The only exception is capital formation in building and construction, where the transaction is deemed to occur as the work is put in place. According to the accrual principle, payments for capital goods may be made either before or after the date when the transactions should be recorded. The GFS recording of transactions in goods and services takes place when payment is made. • Compensation of employees. The SNA records it at the time it is earned, but the GFS records it at the time when payment is made.

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• Indirect taxes and subsidies. These are to be recorded in the SNA at the time of the production or sales transactions to which they relate; in the GFS, they are recorded when the taxes are received or the subsidies are paid by the government. A difficulty in interpreting the SNA rule occurs when tax authorities allow a period after the obligation arises during which the tax can be paid without penalty. Many enterprises take advantage of this grace period and delay their actual payments to the government as long as possible, although recording the tax in their accounts and including it in their prices at the time the obligation arises. • Property income, direct taxes, and other transfers to or from government.

These transactions are to be recorded in the SNA when due for payment without penalty; in the GFS they are to be recorded at the time of government payment or receipt. • Transactions in financial claims. These are to be recorded in the SNA when the ownership of assets is transferred or when liabilities are incurred or liquidated. In the GFS, they are recorded at the time of government payment or receipt. In considering the recording of the above transactions, guidance is necessary particularly with regard to whether the difference between the GFS and SNA criteria of recording should result in actual differences between what is included in each transaction item in the GFS and SNA, and if so how they should be calculated or estimated and perhaps explicitly recorded. Additional questions arise when noncash transactions are registered on an accrual basis in the SNA but are not recorded at all in the GFS except in particular instances as memorandum items. Examples would be transactions in kind, assumption of debt, or debt cancellations. Explicit identification of such transactions is necessary for reconciliation of SNA and GFS concepts and data.

Consolidation Should different consolidation practices be applied for different purposes in the SNA? Consolidation consists of eliminating transactions between transactors within a group in the process of combining or aggregating the group's mutual 'transactions. In the SNA, transactions within the group are eliminated only if they appear in the same account for both transactors. Transactions within the group that appear in the production account of one transactor but in the income and outlay account of

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the other, such as indirect taxes, are not eliminated when operations of the two transactors are combined into a single set of accounts. This limit on consolidation is necessary because elimination of such intragroup transactions would alter input costs, value added, the output of government, and, hence, GOP. The same basic consolidation rules are followed in the central framework of the ESA. In the GFS, however, and in the ESA supplementary accounting system for analyzing general government expenditure and receipts, the objective is not to measure government production, value added, or consumption but to measure the flow of revenues, expenditures, lending, and financing between the government sector and the rest of the economy. In the GFS and the ESA supplementary accounts for general government, therefore, all transactions between transactors within the group are eliminated in consolidation. This includes the additional elimination, beyond SNA rules, of intragroup payments and receipts for indirect taxes, subsidies, and government social contributions to itself that are paid as employer but are deemed to pass through the income and outlay account of households. The United Nation's Handbook of National Accounting: Public Sector Accounts recognizes that such further consolidation may be warranted-for example, of payments and receipts of taxes and subsidies between government units-when the object of the analysis is not the measurement of gross output but the relationship between government and the rest of the economy. The particular flows to be measured as indicators of the relationship between government and the rest of the economy are not specified in the Handbook, however, and the extent of further consolidation warranted is therefore not detailed. Whether such key sectoral indicators of relations with the rest of the economy as tax revenues, total revenues, total expenditures, lending, and the overall deficit or surplus are to be included in the SNA or left to sectoral data systems, such as GFS and the ESA supplementary analysis, remains to be resolved. In either case, however, explicit identification of the additional flows-such as intragovernmental tax payments, social security contributions, and subsidies-eliminated in calculation of such key sectoral indicators, although not in calculation of the regular SNA accounts, would be useful as memorandum items to both the SNA accounts for government and the GFS and ESA supplementary analysis for general government. Gross and Net Treatment Should flows previously shown net in the SNA be shown gross so as to increase infonnation on actual flows?

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When flows in opposite directions are different in nature or significance, there are advantages in showing each separately in addition to any net entry for the two entries offset against each other. In the GFS, as a general rule, all nonfinancing flows are shown gross with the exception of corrective transactions, such as refunds, and departmental enterprises' sales to the public, which are offset against corresponding operating costs. Aside from the netting that occurs in consolidation, eliminating an intragroup transaction from the accounts of both transactors rather than offsetting against each other two transactions of the same transactor, few SNA entries are not shown gross. Entries previously shown net only for statistical convenience, such as transfers given and received, have been converted to separate gross listings in SNA questionnaires of recent years. Several concepts defined as net by nature, however, continue to be shown in the SNA without a separate listing of their gross components. These include net acquisition of fixed capital assets, which does not show separate entries for the gross acquisition or gross disposition of fixed capital assets, and the net acquisition of land and intangible assets. It includes also government final consumption, which is only shown net of any disposition of previously purchased goods registered in consumption at the time of purchase because government is deemed to carry no inventories other than strategic stocks. The addition of separate gross entries could be useful in such cases. Thus, without prejudice to the net character of the concept of fixed capital formation as the increase in the government's stock of fixed capital assets during the period (before or after allowance for consumption of fixed capital), separate information on both the acquisition and disposition of fixed capital assets could be significant in portraying the nature of government operations. Separate information on gross flows of fixed capital assets or land may have little significance among households or enterprises, since most sales and purchases may represent both sides of the same transactions taking place within the sector. This would not be the case with government, however, for which acquisitions and dispositions of fixed capital assets or land represent significantly different activities with the rest of the economy. A third category of flows that are not shown gross in the SNA is the capital finance account. Borrowing and amortization are not registered separately but only as net borrowing. There may be several reasons for this practice. Data may come from balance sheets, in which a combination of flows results only in changing a single entry for the stock. With liabilities of a short-term character, one year or less

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in maturity, the turnover can result in borrowing and amortization that exceed the total amount outstanding and have little independent significance. In other cases, the automatic rollover of obligations at maturity may cast doubt on the separate identity of borrowing and amortization. Recognizing the validity of these reservations, there may still be merit in the separate identification of borrowing and amortization, excluding if feasible both short-term maturities and automatic rollovers. The burden of debt service-amortization plus interest payments-constitutes an important aspect of economic developments, both domestically and for the balance of payments. Projections of future amortization coming due and data for past amortization payments made reflect important elements of economic policy. Data on borrowing, moreover, indicate the extent to which the government finds it necessary to enter the capital market or approach potential lenders. Therefore, the addition of separate borrowing and amortization entries, perhaps for liabilities of more than a year, may be a useful means of providing such information.

Imputations and Reroutings In this subsection questions with respect to four issues are addressed: separate identification of imputations and reroutings, depreciation of government fixed assets, rent on government-owned buildings, and debt cancellations as transfers.

Separate Identification Separate identification of imputations and reroutings facilitates alternate presentations, but to what extent is it feasible? For the SNA system as a whole, the consensus of previous expert group and working party meetings has been that, in general, the present imputations and reroutings should stay in the SNA, but that they should be identified separately in order to (1) facilitate the interpretation of the accounts, (2) permit a wider range of types of analysis, and (3) allow micro-macro links. A document entitled "Imputations and Reroutings in SNA," discussed at the SNA Expert Group Meeting on the Household Sector in September 1987, attempted a complete catalogue of all imputations and reroutings in the SNA and the repercussions in the accounts and tables of attempting to identify them all separately. The expert group concluded that it would overburden data publications if all cases of

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imputation or rerouting were shown, and therefore that only the most important should be identified. But the expert group also agreed that it is necessary to specify all the imputations and reroutings in the manuals for the benefit of both compilers and the most sophisticated users. For the government sector, the SNA's imputations and reroutings are the origin of many of the differences between the SNA and the GFS and are therefore already itemized in Bridge Table II of the GFSM (pages 263-73). Apart from two general differences, one of coverage (net treatment of identifiable costs of departmental enterprises in the GFS) and one of recording (cash basis in the GFS),s the imputations or reroutings that give rise to differences are as follows: • Employer contributions imputed with respect to unfunded employee pension and welfare benefits • Employer contributions to social security schemes at other levels of government (not consolidated in the SNA because routed through households) • Consumption of fixed capital • Cancellation of bad debts (capital transfer in the SNA and balance of payments) • Casualty insurance service charge separate from net premium • Maintenance and property tax components of rent received • Imputed interest with respect to household equity in employee pension funds' reserves with government • Stock valuation adjustment • Payments in kind (only memorandum items in the GFS) -compensation of employees -social security and social assistance benefits -international cooperation (aid). Few if any of these items would be considered important enough for the economy as a whole to warrant being identified separately in statistical publications; some are even trivial for the government sector. It would, however, be difficult to modify the SNA concepts to eliminate them. The SNA, however, does not follow the GFS reroutings through the financial institutions sector of government transactions involving performance of monetary authorities' functions or the acceptance of demand, time, or savings deposit liabilities by units without the authority both to acquire financial assets and to incur liabilities in the capital market. 8

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One approach, which has been applied in the EC for the past ten years, is to specify some of these-the first three listed above as well as the subitems needed for consolidation-within the SNA (ESA) general government questionnaire, so that they can be eliminated to produce a budgetary presentation similar in intention, but not identical, to GFS. The other items listed above are treated in the EC's budgetary presentation in the same way as in the national accounts. EUROSTAT then publishes data in two forms: in accordance with the SNA (ESA) in the national accounts, and in the budgetary presentation in "General Government Accounts and Statistics." It would be possible, although EUROSTAT does not currently do so, to add a table showing the transition from one form to the other.

Depreciation of Government Fixed Assets For what government fixed assets should consumption of fixed capital be calculated? Consumption of fixed capital (or depreciation) in the present SNA is calculated for all assets that have finite lives. These include buildings, plant, machinery, and vehicles but exclude roads, dams, and bridges, which are assumed to last forever with normal maintenance. As experience suggests, however, no matter how well the roads, dams, and bridges may be maintained, they do become obsolete and so have finite useful lives. In these circumstances, the present SNA rule will give a false picture of the total value added generated in the government sector. This view was specifically stressed in the Economic and Social Commission for Asia and the Pacific (ESCAP) Seminar on the Review and Development of National Accounts (Bangkok, July 1-7, 1986), which recommended that capital consumption estimates should be calculated for public goods such as roads.

Rent on Government-Owned Buildings Should rent on government-owned buildings be imputed? The present SNA does not include imputations for rent on government-owned buildings or on buildings owned by nonprofit institutions. The ESCAP seminar noted this as a serious omission, which would result in underestimation of the contribution of the government sector to GOP. This is particularly so because the contribution of this sector to GOP is based on cost, which includes only intermediate consumption, depreciation, and compensation of

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employees, and does not include any operating surplus that would have resulted from valuation of gross output in the market. Inclusion of imputed rent on government-owned buildings, based on market value, would imply that GOP originating in the government sector would include an operating surplus in addition to depreciation and compensation of employees paid out to government personnel.

Debt Cancellations as Transfers Should debt cancellations be treated as transfers and, if so, when should they be registered? The GFS does not include debt cancellation because it involves a noncash transaction. The SNA now treats debt cancellation in the flow accounts; that is, as a reduction in the value of an asset or liability with a counterpart flow of current transfers. It has been argued that the present SNA treatment is inconsistent with the rules regarding the reconciliation accounts, which should include all changes in the value of assets and liabilities that are the result of price changes or the creation or destruction of assets rather than the consequence of current production or income generation. Debt cancellation dearly falls in this category and should therefore be dealt with in the reconciliation accounts. This would also be in line with the recommendations of the Expert Group Meeting on the SNA Structure (Geneva, July 1986) that capital gains and losses and other changes in the value of assets should not be included in the flow accounts.

Valuation in Current and Constant Prices The treatment of transactions in kind and of deflation to real terms are discussed in this subsection.

Transactions in Kind How should transactions in kind be valued-at cost, or at prices for comparable marketed goods and services? Governments commonly engage in two types of transactions in kind. First, as for any other employer, the government's wage and salary bill may include some payments in kind-free food and lodging, for example. Second, and quantitatively more important, gov-

DISCUSSION

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ernments typically provide a wide range of free education and health services. The SNA, in common with all national systems of accounts, values these transactions in kind "at cost." Thus, free meals provided to government employees, or free schooling provided to the general population, are valued at direct production costs: as the sum of compensation of employees, consumption of fixed capital, and intermediate consumption. It can be argued that valuation at cost understates the intrinsic value of these transactions in kind in the sense that, if they were provided on a market basis, their valuation would also include a profit margin. It might therefore be appropriate to revalue these inkind transactions at prices that include an imputed profit-either by using the prices of comparable marketed goods and services or by directly imputing a profit margin calculated, for example, as some average rate of return on capital employed.

Deflation to Real Terms How should final consumption expenditure and value added of government be calculated in real terms? Most countries presently calculate all government value added and final consumption expenditure in real terms by some kind of "input method." This involves revaluing cost components-mainly compensation of employees and intermediate consumption-at base-year prices, either by deflating current price values by wage and price indices, or by extrapolating base-year values by volume indices. The basic objection to input methods is that they do not reflect changes in productivity. In 1975 EUROSTAT published a report on the measurement of nonmarket services at constant prices, which recommended that government services that are supplied to individuals, such as health and education services, should be calculated at constant prices by the use of output measures. 9 Examples of such measures include pupil-hours of instruction, numbers of medical treatments supplied, and the number of social security transactions handled. The EUROSTAT report recommended that for "pure public services" -such as defense and most public administration-values at constant prices should be measured by reference to labor inputs, but that inputs should be measured in person-hours of duty and that different types T.P. Hill, Price and Volume Measures for Non-Market Services (Luxembourg: EUROSTAT, April1975). 9

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of person-hours should be weighted by total cost per person-hour, including the cost of equipment and consumables used. In discussions of the EUROSTAT report in Luxembourg and at the OECD, virtually all national accounts experts agreed with its main recommendations, which were subsequently included in the United Nations' Manual on National Accounts at Constant Prices.1o In practice, very few countries have adopted output measures of this kind. Thus, whether these recommendations may need to be modified in the light of country experience may need further consideration, especially as regards the three output measures described above. ·

IV. Analytical Framework Three analytical issues are considered in the questions raised below: the distinction between current expenditures and capital formation, saving versus the overall deficit or surplus, and the operating surplus of government.

Distinction Between Current Expenditure and Capital Formation Should military expenditures classified as capital formation be restricted to dependents' housing or extended to include military hospitals, structures, or durable equipment? According to the SNA "Blue Book," government outlays with respect to construction works and other durable goods intended for defense purposes are all classified as current expenditures and not as capital formation. However, outlays by producers of government services on the construction or alteration of family dwellings, but not military barracks for personnel of the armed forces, are classified as gross fixed capital formation. The distinction between family dwellings and military barracks is based on the type of housing provided; family dwellings are facilities that are similar to the dwellings normally used by civilians. In contrast, the construction of schools, hospitals, airfields, or roads for use by the armed forces is classified as intermediate consumption even though these facilities might be put to civilian use. This is also the case for motor vehicles used for military purposes. United Nations, Manual on National Accounts at Constant Prices, Statistical Papers, Series M, No. 64 (New York, 1979). 10

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The transfer of such facilities to civilian purposes at a later date constitutes an addition to the stock of fixed assets. The value of the assets when transferred to civilian uses plus other outlays made on the conversion of schools, hospitals, motor vehicles, and the like to civilian use are to be included in gross fixed capital formation. The counterpart entry is a reduction in the intermediate consumption of the relevant government service. In many countries, assets are used for mixed civilian and military purposes; examples are airfields, roads, hospitals, and the like. Because the SNA does not address this issue, many have argued that the present guidelines should be clarified, possibly toward some extension of what is now included in gross fixed capital formation. This discussion is reflected in the United Nations' Handbook of National Accounting: Accounting for Production: Sources and Methods, which proposes to include certain items of a clearly nonmilitary character in government fixed capital formation, even if they are financed out of military budgets. 11 These are family-type housing, schools, hospitals caring for civilians as well as military personnel, and highways, port facilities, and airports, if they are not limited to military use. Because this treatment is different from that recommended in the SNA Blue Book, guidance is needed.

Saving and Overall Deficit or Surplus Should the SNA include two major balancing items that are important for analysis of the government sector, and are therefore included in the GFS, but are unnecessary for analysis of the economy as a whole or inapplicable in other sectors? This question is broken into further questions pertinent to saving and the overall government deficit or surplus.

Saving Should the SNA for the government sector, although not for other sectors, recognize, in addition to the concept of government saving, representing the portion of all current income remaining after current outlays, the concept of the government's own saving, comprising the portion of current income other 11 United Nations, Handbook of National Accounting: Accounting for Production-Sources and Methods, Studies in Methods, Series F, No. 39 (New York, 1986).

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than grants from governments and international organizations remaining after current outlays? The net saving of government, as for other sectors, is calculated as the residual in the income and outlay account. That is to say, government saving is calculated as the portion of current income remaining after current outlays, excluding capital and financial transactions from both income and outlay. As distinct from other sectors, however, in the case of government significance is found also in the measurement of saving excluding grants received from other governments or official international organizations. This concept is referred to in the GFSM as own saving. It is used to reflect the special position of grants (that is, official transfers) in government operations. Because such grants are sometimes provided as a form of budgetary support or to meet a deficit that would otherwise ensue, there is a need for measures of budgetary performance that exclude the effects of the grants themselves. It is for this reason that such official grants are identified in a separate category in the GFSM, permitting alternate calculations of both the overall deficit and of saving. Recognition of the alternate concept of government's own saving would facilitate such analysis in the SNA as well. It must be recognized, however, that this concept is not applicable to other sectors. The distinction between the continuing, ordinary flow of tax and property income to government and the extraordinary, politically determined flow of official grants to government finds no easy parallel in the household or enterprise sectors. Nor is own saving a concept that preserves symmetry between grantreceiving and grant-making governments. While own saving is lower than saving for the receiving government, own saving is not higher than saving for the government making the grant, since current transfers paid, whether to governments or to others, would not be excluded in calculation of own saving. Grants between levels of government within a country would in any case be eliminated in consolidation of general government as a whole. It is in the measurement of the performance of individual governments, or of general government insofar as there are official grants from abroad, that the concept of own saving offers an additional measure useful in the analysis of government.

Overall Deficit or Surplus Should the concept of government's overall deficit or surplus, met through the net incurrence of liabilities plus the net decrease in holdings of currency

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and transferable deposits and in holdings of any other financial assets acquired for liquidity management purposes, be introduced into the SNA for the government sector, although not for other sectors? The single measure of government performance most frequently cited in analysis and policy discussions is the overall deficit or surplus, which represents the result of current, capital, and lending operations and the consequent government financing requirement. Because it has no close parallel in other sectors, the overall deficit or surplus is not explicitly defined in the SNA and is not generally derived from SNA data on government. Whereas the SNA saving concept measures the government's current account deficit or surplus, the SNA net lending12 concept represents the balance drawn after government capital receipts and expenditures, in the capital accumulation account, but not after government lending, which is included in the SNA capital finance account. Government lending is included in determination of the government's overall deficit or surplus, however, because the government, unlike other sectors, generally lends and acquires equity not for purposes of liquidity management or earning a return but to promote public policy objectives. In this respect, government lending is like government spending, in that whatever portion cannot be met out of government revenues, grants, or repayments of previous government lending affects the deficit or surplus and requires government borrowing or the drawing down of previously accumulated cash balances. From a policy and analytical point of view, therefore, government lending is not symmetrical with either government borrowing or the borrowing of those receiving government loans, since borrowing is undertaken for liquidity management purposes. Although this asymmetry requires care in the consolidation of two governments that have lent to or borrowed from each other, it is an essential element in the measurement of government operations in accordance with the nature of such operations. The overall government deficit or surplus concept makes it possible to measure the extent to which government spending and lending undertaken to carry out the government's policy objectives are covered by the government's tax and nontax revenues, grants, or repayments of previous government lending. In general, the overall government deficit or surplus is met through The SNA net lending concept, of course, represents the net result of government lending and repayment of previous lending, and government borrowing and amortization of previous government borrowing. 12

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the net incurrence of government liabilities plus the net decrease in government holdings of currency and deposits. That is, a government deficit would normally be met from government borrowing less amortization and any drawdown of government balances. In general, this would permit calculation of the overall government deficit or surplus in the SNA as the balance drawn in the capital finance account before the net incurrence of liabilities and changes in holdings of currency and deposits. In some instances, however, governments hold assets other than currency and deposits for liquidity purposes. Sinking funds may acquire securities to match the maturities and currencies of their liabilities; social security funds may acquire financial assets for liquidity management rather than public policy purposes; and local governments may invest their temporary excess cash in the securities of higher levels of government or of corporations. Such government acquisition of financial assets, other than cash and deposits, for liquidity management purposes is usually minor in magnitude but can be quite significant. U.S. state and local government holdings of Federal government securities, for example, total about US$100 billion. Were such acquisitions for liquidity management purposes counted as a part of lending, they could seriously distort the meaning of the deficit or surplus. Accommodation of this distinction is achieved in the GFS in accordance with guidelines set out in the GFSM. Provision of a parallel distinction when required in the determination of a deficit or surplus concept in the SNA would maintain the meaning of the concept and avoid the occasional occurrence of disparate concepts for the deficit or surplus in the SNA and GFS presentations. To accommodate instances in which government net acquisition of financial assets other than currency and transferable deposits occurs for liquidity management purposes, it would be necessary to insert an adjustment item above and below an overall deficit or surplus line for government in the SNA capital finance account. It might read "Less: financial assets (other than currency and transferable deposits) acquired for liquidity management purposes" above the overall deficit or surplus line, and "Financial assets (other than currency and transferable deposits) acquired for liquidity management purposes" below the line. As with the consumption of fixed capital item appearing with opposite signs in the SNA production account and capital accumulation account, insertion of this adjustment item would permit calculation of the appropriate balance within the accounts. Because procedures are already carried out for the derivation of such numbers for GFS presentations in some 130 countries, determination of the

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amounts involved for the SNA compilation should not pose significant difficulties. The cash-based GFS concept of overall deficit or surplus has become a widely accepted standard for analysis of government operations. There may be both advantages and disadvantages, therefore, in adding an SNA-based concept of overall deficit or surplus, which may yield a result differing from the GFS-based concept and could instill ambiguity in the analysis of government operations.

Government Operating Surplus Should the value of government output be calculated to include an element of interest payments in addition to other cost items of government inputs so as to avoid undervaluation of government output and approximate an operating surplus element in the value added of government services? Gross output of government is defined in terms of costs, including wages, depreciation, and the purchase of goods and services, which is called intermediate consumption. Interest payments are not considered as costs in this sense because they reflect the price of borrowing money, and interest on the government debt is therefore excluded from the contribution to GOP of the government sector. It has been suggested that at least part of the interest payment on government debt should be included as costs so as to avoid undervaluation of government output and thus approximate an operating surplus element in the value added of government services. This addition to the value added of the government sector is particularly important in order to avoid the distorting effects of the present SNA, which suggests that government output is to be valued at cost because of the lack of information on the market value of government services. V. Classification

This section addresses possible revisions to various SNA classifications: taxes, property income, social assistance to households, and the functions of government. Taxes Indirect taxes, estate and gift taxes, social security contributions, and fees paid to the government are considered in the following paragraphs.

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Indirect Taxes Should indirect taxes be restricted to commodity taxes only, thus eliminating the need to distinguish between tax payments by business and others? Commodity taxes are indirect taxes on commodities (that is, goods and services) or activities of an industry that are proportional to the quantity or the value of commodities produced or sold by the industry. These commodity taxes are included in indirect taxes, which in addition cover noncommodity taxes. The latter are payments by business of regulatory and administrative fees, such as court fees, business license fees, or airport taxes, that are treated as current transfers if paid by households. Noncommodity taxes also include real estate taxes if these are not levied as a replacement of income taxes. The GFS includes a detailed breakdown of tax revenue but does not identify indirect taxes. It also does not distinguish between payments made by households and those made by business. As a result, GFS includes in some of its tax categories payments by households that are treated in the SNA as transfers (for example, motor vehicle tax) and includes in some of the nontax categories payments by business that are treated in the SNA as indirect taxes (for example, court fees). In practice, countries do not usually make the distinction of tax payments by business or nonbusiness units when responding to the SNA. In most instances, they allocate the total tax payment of one category to either indirect taxes or current transfers, depending on the major component of the category in question. In addition, analysis of national accounts data shows that the difference between total indirect taxes and commodity taxes is very small. Because of practical considerations and in order to facilitate the link with GFS, it has been suggested that indirect taxes be restricted to commodity taxes only. If this restriction of indirect taxes were accepted, the present noncommodity indirect taxes might be treated in the SNA as direct taxes or as other current transfers, depending on their nature.

Estate and Gift Taxes Should estate and gift taxes, inheritance taxes, and nonrecurrent taxes on property be classified as taxes in the SNA and, if so, should they be classified as current? The present SNA classifies estate and gift taxes and nonrecurrent

DISCUSSION

263

taxes on property not as taxes but as capital transfers to government. In contrast, the Fund's GFSM, the OECD's Revenue Statistics,n and general usage in fiscal analysis classify such taxes as taxes and classify all tax revenues as current revenue of government. Although the magnitude of such taxes is relatively small-constituting less than 1 percent of central government tax revenues in almost all countriesthis represents a significant conceptual difference between the SNA and GFS as regards tax revenues, current revenues, and saving. Governments levy estate and gift taxes in order to raise revenue and, in some instances, to reduce inequality or help shift property to more productive uses. Although occasional to the taxpayer, such taxes are recurrent to the government, which receives a continuing flow of such payments and regards them, as it does other taxes, as current, regular, tax revenue. No connection is made in government policy between estate and gift tax receipts and government capital expenditure, and efforts are not made to earmark such receipts for particular purposes. There is no perception in government that estate and gift taxes are capital in nature or different from other tax receipts. The perception in the household sector matches this government view of estate and gift taxes. They are viewed, as are other taxes, as a cost that must be met by a tax payment to government at specified events or occasions with no expectation that it will be used differently from other taxes. What distinguishes estate and gift taxes from other taxes is the irregular transmittal of wealth, at death or before, that occasions their payment, usually out of accumulated wealth rather than current income. When the cost of estate and gift taxes is met out of accumulated wealth rather than out of income, its payment constitutes dissaving-payment of a cost in an amount exceeding current income and resulting in either a decrease in assets or an increase in liabilities. A part of the value of a taxed estate, or of the proceeds of its sale, is viewed as unfortunately used up, lost, or "consumed" in payment of the tax to government. Payment of the tax represents a loss of previously accumulated household savings, and this is most appropriately represented as involuntary, unavoidable, household sector dissaving. If payment of estate and gift taxes brings no corresponding government capital formation, this dissaving of the household sector becomes the dissaving of the consolidated economy as a whole. The present SNA, by classifying estate and gift taxes as capital transfers, shows the same dissaving for the consolidated economy as 13 Organization for Economic Cooperation and Development, Revenue Statistics of OECD Member Countries, 1965-1986 (Paris: OECD, 1987).

264

PUBLIC SECTOR ACCOUNTS

a whole but attributes this dissaving to government, rather than to the household sector. Given the prevailing government perception of estate and gift taxes as an indistinguishable part of total government tax revenues, with no particular tie to capital expenditures, an increase in government estate and gift tax receipts, under the present SNA calculation, is likely to lead to an increase in government dissaving. The policy implications of such a classification would tend to discourage government use of such taxes because of their negative impact on one measure of government operation-saving-although more careful analysis of the economic, social, and revenue effects of such taxes may point in the opposite direction. For household sector dissaving results not only from taxes on wealth, but also from any level of taxes that households do not meet out of current income and find it necessary to pay for by drawing down previously accumulated wealth or by borrowing. Thus, the classification of estate and gift taxes as taxes, and their removal from consideration as capital transfers, would more closely approximate the concepts generally accepted for the measurement of government by those carrying out or analyzing government operations, as well as by the taxpayers involved.

Social Security Contributions Should social security contributions be included in total taxes? Social security contributions are levied on payrolls, or on a proxy for payroll in the case of the self-employed, and are earmarked for operation of a system of benefits to which the contributor, by virtue of the contribution, is admitted. Such contributions represent as much as 30 percent to 50 percent of total nationally collected government revenues in many developed countries, but less than 10 percent in most developing countries outside Europe and parts of Latin America. They are vital, therefore, to a complete portrayal of government finances. Because they are associated with admission to a benefits system, though not vested and returned like provident fund or retirement fund contributions, social security contributions may be more readily acceptable than other tax payments. Their separate identification is often held to be important, moreover, to ensuring their dedication to social security purposes. Reflecting these characteristics, social security contributions are not classified as taxes in the SNA. Employer contributions are deemed to be routed through households as compensation of employees and simultaneously paid to government

DISCUSSION

265

by households, whereas employee contributions are collected from households. In the OECD Committee on Fiscal Affairs (Working Party 2), after several years of deliberation on the classification of government revenue, and in regional and country discussions preparatory to publication of the GFSM, it was determined that the balance of advantages lay with classifying social security contributions as a separate category within the overall total of taxes. Given the definition of taxes as compulsory, unrequited, nonrepayable payments to government, social security contributions, other than the exceptional voluntary contributions provided for in some systems, are classified as taxes. To preserve the distinctiveness of social security contributions, they are separated from payroll taxes that are not devoted to social security. They are also distinguished from levies collected on a personalized income tax base, rather than on payroll, although they may be identified with social security, and from taxes on other bases, such as sales taxes, earmarked for social security purposes in some countries. In both the OECD Revenue Statistics beginning in 1973 and the Fund's GFS Yearbook beginning in 1977, social security contributions are separately identified as a category of taxes levied on a payroll base and devoted to social security purposes. The resulting portrayal of total taxes explicitly includes social security contributions but identifies them separately for the analytical purposes noted above. There would appear to be some advantage in maintaining such a separate identification of social security contributions within an overall total of taxes in the SNA.

Fees Paid to Government Should fees paid to government, whether by business or others, be classified as payments for government services rather than as taxes, except for fees out of all proportion to the cost or distribution of government service provided to the payer? At the border between taxes and sales lies the difficult-to-classify realm of administrative fees and charges. The SNA (paragraphs 7.65 and 7.66) classifies fees paid to government by households as direct taxes ... if they are not directly connected with the provision of non-regulatory service by the public authorities, and are primarily designed to raise general revenue .... However, if the service furnished is regulatory in character, the fees which households pay for the service . . . are classed as compulsory fees since they are obligatory and unavoidable in the only

266

PUBLIC SECTOR ACCOUNTS

circumstances in which they are useful. . . . The compulsory fees and duties are classed as indirect taxes when paid by producers.

In practice, these distinctions have been conceptually difficult to understand and difficult, if not impossible, for governments to apply. Practice has varied widely, and attempts to reach consensus among practitioners on the application of these criteria to specific administrative fees have encountered opinions that are sharply divided. In these circumstances, extensive discussions were held over a period of years in the OECD Committee on Fiscal Affairs (Working Party 2) with a view to clarifying, at the borderline, the distinction between tax and nontax revenues of government. The conclusions reached are now reflected in both the OECD Guidelines and Revenue Statistics and in the Fund's GFSM. Taxes are defined as compulsory, unrequited, nonrepayable payments to government and as any collections of fees and charges out of all proportion to the cost or distribution of government service provided to the payer. Classified as taxes are business and professional licenses and, reflecting prevailing administrative practice among governments, taxes on permission to hunt, shoot, or fish, taxes on the ownership of dogs, and radio and television licenses, unless the public authorities provide general broadcasting services. Nontax revenue, therefore, includes fees for the provision of a service, whether compulsory fees for provision of a regulatory service, such as driver's licenses, passports, or court fees, or voluntary charges for the provision of a nonregulatory service, such as museum admission fees, or school or hospital charges, unless such fees are out of all proportion to the cost or distribution of the government service provided to the payer. In the application of this classification, a determination of whether a service is regulatory or nonregulatory or whether it benefits the payer or others is not necessary. Should it be found desirable to assign consumption of the services rendered in exchange for the fees to business or households, the distinction presently applied in the SNA to payment of fees could be continued for the more broadly defined category of fees, with treatment of the business and nonbusiness-paid components classified appropriately.

Property Income In this subsection, questions are addressed regarding withdrawals of entrepreneurial income from quasi-corporate enterprises, operat-

DISCUSSION

267

ing deficits of departmental enterprises, and indexation payments on debt.

Withdrawals of Entrepreneurial Income Should the category of dividends received by government be combined with withdrawals of entrepreneurial income from quasi-corporations and, in the case of GFS, with the cash operating surplus of departmental enterprises, which would thus no longer be treated separately from corporate nonfinancial public enterprises? In the income and outlay account, the SNA includes as receipts the operating surpluses of departmental enterprises and withdrawals of entrepreneurial income from quasi-corporations; it includes interest, dividends and land rent, and royalties as both receipts and disbursements. Dividends are defined as those received only from public and private corporations (and also from cooperatives), whereas withdrawals from entrepreneurial income cover actual payments of property income made to government by quasi-corporations. The GFS lists on the receipts side only two property income categories-cash operating surpluses of departmental enterprise sales to the public, and other property income-and on the expenditure side only cash operating deficits of departmental enterprise sales to the public and interest payments. In practice, countries often do not make the distinction between dividends received by government from public corporations and withdrawals of entrepreneurial income from public quasi-corporations. The latter are frequently registered as dividends received. If departmental enterprises were included as quasi-corporations in the SNA and as public enterprises in the GFS, and all own account production of capital goods were separated out as a public enterprise or quasi-corporate activity, this would eliminate the present distinction between the operating surplus of departmental enterprises and withdrawals from the entrepreneurial income of quasi-corporations. Both would then be treated as withdrawals and could be combined with dividends as suggested above.

Operating Deficits of Departmental Enterprises Should current transfers to quasi-corporate enterprises and to cover the operating deficit of departmental enterprises be shown as subsidies in the SNA? Current government transfers to enterprises are classified as sub-

268

PUBLIC SECTOR ACCOUNTS

sidies, which by definition permit market price to vary from factor cost. Several elements have complicated the application of this principle to departmental enterprises, however: their close relationship with government, determination of price, and inadequate data. Because departmental enterprises are owned by government and operate within government administration and accounts, no explicit government transfer permitting sale at lower prices is generally identifiable. Instead, prices set below operating costs are reflected in an operating deficit that is met by government as an explicit subsidy payment would be. Although an operating surplus reaching government would be registered as entrepreneurial or property income, the dual role of government as owner and provider of public policy subsidies would appear to offer the alternative of classifying operating deficits as either subsidies or negative withdrawals from the entrepreneurial income of quasi-corporate enterprises. Given the basic public policy orientation of government, including its responsibility for the operation of departmental enterprises, classification of the operating deficits of such enterprises as subsidies would appear to be preferable. When departmental enterprises sell to other parts of government at prices set administratively without regard to market price or costs, calculation of an operating deficit or surplus does not yield a realistic value of either subsidy or property income or of the enterprise's output or value added. In these circumstances, integration of such departmental enterprise activity in the production account of producers of government services, with no calculation of an operating deficit or surplus, would yield a more valid measure of government and enterprise activity, as discussed elsewhere in this chapter. The operation of departmental enterprises within government administration and accounts frequently makes it difficult to measure the consumption of fixed capital within operating costs and, hence, the operating deficit or surplus. Thus, in the GFS, a cash operating deficit or surplus for departmental enterprises' sales to the public is calculated that does not take into account consumption of fixed capital, changes in stocks, or changes in accrued trade credits outstanding. Any resultant cash operating deficit is classified in the GFS as a government subsidy, and any cash operating surplus is classified as entrepreneurial or property income received by government. Where data for consumption of fixed capital, changes in stock, and changes in accrued trade credits are difficult to obtain, they may have to be estimated so as to calculate the fully accrual-based measure of output, value added, and the operating deficit or surplus for the SNA. This would be true in any case, whether departmental enterprises selling

DISCUSSION

269

to the public are classified within government or in the nonfinancial public enterprise sector.

Indexation Payments Should indexation payments on debt be classified as interest paid for use of capital or as amortization paid for repayment of capital in real terms? Although the issue of classifying indexation payments as interest or amortization goes well beyond the public sector accounts, it may be useful to note its major implications in the analysis of government. Government debt instruments are usually of considerable magnitude in countries that find it necessary, because of price inflation, to index their liabilities. At present, indexation payments are in general classified as interest payments, both in GFS and in the SNA, where they would consequently appear in the income and outlay account rather than in the capital finance account. This classification results in lower totals for saving and net lending for the paying sector, although there is no change for the economy as a whole because debt payments abroad would usually be denominated directly in foreign exchange rather than being indexed to domestic prices. Correspondingly, classification of government indexation payments as interest rather than amortization increases a government's deficit. Several arguments have been cited in discussions about the classification of indexation payments as interest or amortization. • The inflation component is not separated out and treated differently for payments other than for debt. • All adjustments for inflation should be reserved for the revaluation account. • Because repayment of debt denominated in foreign exchange is classified as amortization, classification of indexation payments on debt denominated in local currency as interest could be viewed as inconsistent. • Although indexation payments formally separate out the explicit inflation component, an implicit inflation component is included in interest in the absence of indexation and is treated as interest. • Because the implicit inflation component in normal interest payments may be viewed as a return to capital, it should be classified as amortization, with a consequent reduction in the deficit of the paying government to reflect only real interest payments. • Because a primary purpose of the compilation of both the GFS and SNA is to understand, relate, and forecast behavior and its

270

PUBLIC SECTOR ACCOUNTS

impact on the economy, determination of the appropriate classification of indexation payments should be based on the behavior of those receiving indexation payments. If lenders in an inflationary environment understand their indexation payments to constitute a return to capital to be reinvested for maintenance of their capital's value, classification of such payments as interest in the income and outlay account would tend to overstate income and saving. Whatever the merits of these arguments, classification of indexation payments remains a contentious issue for the few countries that index debt payments. The implications are substantial for the presentation of government accounts and for treatment of the implicit inflation component in normal interest payments. Consistency of treatment will require a determination of appropriate practice.

Social Assistance to Households Classification of two forms of social assistance to households-food coupons and welfare work assignments-is considered in the following paragraphs.

Food Coupons Should the issuance of coupons to households for use in purchases of food or other commodities, with subsequent redemption by government, be classified as subsidies or social assistance grants to households? Government issuance and redemption of coupons, such as food stamps, to households raises several statistical questions. • If households are allowed to choose some of the products for which the coupons are to be used, should the overall operation be viewed as a government purchase of goods and services or as an unrequited government transfer? Proposed establishment of a category of individual consumption financed by sectors other than households would appear to affect this question in a way similar to that of government reimbursement for medical costs. • If such operations are classified as transfers, should they be regarded as subsidies to enterprises or as social assistance grants to households? Subsidies are defined as all unrequited current transfers to enterprises that, by definition, permit them to charge lower prices

DISCUSSION

271

for their sales. It is for this reason that subsidies are added to the market price to arrive at factor cost. That enterprises are required to provide households with goods and services in exchange for the coupons makes the payments the enterprises receive from the government requited, rather than unrequited, from the enterprises' point of view. Hence, such payments would be inappropriate for classification as subsidies permitting market prices below factor costs. • Although cash-basis GFS data can register the operations only when payment is made to enterprises redeeming the coupons, should accrual-based SNA data register the operation when the coupons are issued to households, when the households use the coupons to make purchases and receive delivery, when enterprises present their claim for payment from the government, when such payment is due some interval after presentation for payment, or when payment is actually made? The answer depends at least in part on the actions in the household or enterprise sectors that registration of the government's operation is meant to parallel and portray.

Welfare Work Assignmen~s Should payments to welfare recipients that require performance of work assignments be classified as social assistance grants or as payments for factor services? In some instances, to prevent malingering, to introduce welfare recipients to the work ethic or to particular kinds of work, or to provide particular services to the community, recipients of government welfare payments are required to perform work assignments. Whether such work should be included as an addition to GOP, and its performance classified as provision of factor services, may depend on whether it is viewed as contributing primarily to improving the character, motivation, or skills of the individual performing the work, or to the remainder of the community, which could be regarded as consuming the product. With the growing reform of welfare systems in some countries to include such work requirements, guidelines for their consistent classification take on greater importance. Measurement questions arise also from the symmetrical, but opposite, phenomenon of government employees hired for incomemaintenance purpose without the performance of work assignments. These questions are usually resolved by adding the value of such employees' wages and salaries to GOP, since government output, in the absence of sales proceeds, is valued as the sum of its inputs.

272

PUBLIC SECTOR ACCOUNTS

Functions of Government: Revision of COFOG COFOG was produced in the late 1970s, published in 1980, and is now applied by many countries. COFOG replaces SNA Table 5.3. It is essentially a United Nations dassification, but it has also been adopted as it stands in the Fund's GFS and in the ESA. Data on the breakdown of government expenditure by function are much in demand and widely used. Although COFOG was in many ways an improvement over SNA Table 5.3, applying it has highlighted some problems that should be examined in the SNA revision process. They relate to (1) the treatment of administrative, regulatory, and research activities; (2) the functional allocation of subsidies; and (3) relationships with the !SIC. These issues are discussed in the following subsections. It may seem unfortunate to be proposing changes for such a classification so shortly after its introduction, but it should be borne in mind that the SNA revision will only affect data in the late 1990s. Therefore, if there are problems with COFOG, the sooner they are identified the better.

Treatment of Administrative, Regulatory, and Research Expenditures COFOG differs from the former SNA Table 5.3 in that COFOG distributes all expenditure on general administration, regulation, and research among the headings of the classification served, down to the most detailed three-digit level. First, and most important for the revision of the SNA, this practice creates difficulties in attempting to isolate individual consumption expenditure of general government to add to private consumption in the calculation of total or enlarged consumption of the population. The reason is that government administration is of two types:

• Local administration within units that produce services (hospitals, for example) that could be rendered by comparable private sector units (this expenditure should be included in the value of the services considered as individual consumption in order to make valuation as comparable as possible) • General administration, regulation, and research that cannot be found in private sector institutions providing individual services (this expenditure should be considered collective consumption).

DISCUSSION

273

Functional Allocation of Subsidies Interest in this question first arose from proposals to include the value of certain subsidies in total consumption of the population, but the question also seems to have more general aspects. For calculating total consumption of the population, some exercises have added the value of certain social or consumption subsidies to the values, according to SNA, of household consumption and the "individual" consumption expenditure (mainly education and health) of general government and private nonprofit institutions. The reason is that these "social" subsidies are considered to have an effect similar to social benefits or direct provision of the good or service by government. In fact, for calculating a total consumption aggregate within the main SNA accounts, the Expert Group Meeting on the Household Sector in September 1987 concluded that consumer subsidies should not be introduced as a form of final expenditure; instead, a detailed classification of subsidies by type and purpose should be developed and included as part of the SNA analysis of government expenditure. Even if adding certain subsidies to consumption in future only has the role of an alternative analysis, greater clarity of the allocation of subsidies by function is desirable. COFOG, which is used to delimit the individual consumption expenditure of government, makes special mention of several consumption subsidies, moving them from the "economic" to the "social" categories. For example, under subgroup 07.11, "Housing affairs and services," it says that Subsidies, grants or loans for increasing, improving or maintaining the housing stock other than rent subsidies paid to households are considered a form of income assistance and are classified to subgroup 06.15 (Family and child allowances) or 06.16 (Other social assistance to persons) as appropriate.

The precise meaning is not clear because the terminology is rather loose, since strictly a subsidy can only be paid to a market producer unit. If one retains the words "paid to households," then the text is saying either that "rent subsidies paid to households" should be considered as social benefits, not as subsidies at all, or that they should be restricted to subsidies to owner-occupiers to "charge" themselves a lower imputed rent. Slightly clearer is the section on "Distributive trade affairs and services including storage and warehousing" (13.11), which says that

274

PUBLIC SECTOR ACCOUNTS

Food and other subsidies applicable to particular population groups or individuals (for instance, those applied to milk for babies) are considered welfare and are classified to the appropriate subgroup of 06. The inclusion of this sentence under the distributive trades function may imply a deliberate intention to restrict this treatment to subsidies that are on goods, not services, and that are paid at the distribution stage. Alternatively, it may be intended to represent a principle applicable to other areas. From the text of COFOG, one cannot tell whether its authors, in mentioning these cases, were simply asserting the functional nature of the classification or were anticipating a definition of consumption subsidies based on the social functions in the same way as on individual consumption. In the latter case, the problem is to determine exactly which subsidies should be singled out for such treatment, or whether a general definition of them could be given. A problem does, however, arise in applying this solution when one comes to compile total consumption not just in aggregate but by function. For example, to show total consumption of the population on, say, transport, one needs to bring transport subsidies back out of welfare. In fact one can ask quite generally what is the proper functional classification of a subsidy: does it depend on (1) the ministry that pays it, (2) the industry that receives it, or (3) some perhaps more subjective assessment of its purpose (for example, welfare)? Surely the aim and spirit of a functional classification favors the last of these. Classification by receiving branch already exists elsewhere in the national accounts; classification by the ministry that pays may also be interesting for budgetary analysis, but it is not "functional." The function served is, however, not unambiguous and may ultimately be rather a matter of subjective judgment. Subsidies do, in general, bring benefits to both producers and consumers as well as in some cases to producers' employees, underdeveloped or declining regions, and so on. This problem is recognized in the introduction to COFOG section I.C (and repeated in the GFSM on page 144), which attempts to make a distinction between purpose and function by means of certain examples. For example, a subsidy to the shipbuilding industry may have as its purpose maintaining facilities to build warships in time of need, but its function, according to COFOG, is manufacturing affairs and services.

DISCUSSION

275

Relationship with the ISIC COFOG stipulates that "the units of classification are, in principle at least, individual transactions," but that for many types of outlays related to production of goods and services "COFOG codes will have to be assigned to agencies, offices, program units, bureaux and similar units within government departments" (pages 2-3). Exactly what those units might be in practice is not clear. The SNA (paragraph 5.31) states that they are establishment-type units and recommends that they be the same as for the activity (!SIC) breakdown of producers of government services. This, it concludes, would allow ''transferring data classified according to kind of economic activity of the producers into data classified according to the purpose they serve.'' Even if the statistical units are the same, however, the structure and the detail of the two classifications (!SIC and COFOG) hardly seem to have been developed with this aim in mind. Some detailed improvements have been made in the recent revision of !SIC (rev. 3); for example, military schools and hospitals are now classified the same way in both the !SIC and COFOG. But the general structure of the two systems remains very different. One feature is the different treatment of general administration (ministries), which in the !SIC is separated from the activity the ministries serve. At a more detailed level the correspondence is not good at all: for instance, education and health services are both broken down rather differently in the two systems. Further detailed study would undoubtedly reveal other problems. Whether convergence of these two classifications is desirable and whether a detailed study should be undertaken in this area are matters for further consideration.

17 An Example of Progress in Delineating Relationships Between Government Finance Statistics and National Accounts Concepts }ONA1HAN LEVIN AND }AN VAN TONGEREN

of government finance statistics, which are comH piled as a guide to the conduct and analysis of the sector itself, and the government account in the national accounts, which are comARMONIZATION

piled as an indispensable component of a statistical system analyzing the economy as a whole, should produce two kinds of benefits. It should eliminate unnecessary duplication of effort by compilers, and it should reduce confusion among users regarding the relationships between concepts in the two data systems. To reap these benefits, harmonization should delineate existing relationships between concepts in the two data systems, examine the feasibility of compiling data to measure both sets of concepts, and consider adjusting concepts to meet the essential needs of both data systems within the framework of coordinated compilation efforts. Efforts to define the exact relations between concepts in the government accounts of the United Nations' A System of National Accounts (SNA) and in the IMF's system of government finance statistics (GFS) began soon after circulation of the draft of the Fund's Manual on Government Finance Statistics (draft GFSM) to governments and international organizations for comment in 1974. Interest in defining the relationship was expressed at the six regional seminars convened to Note: This chapter is extracted and updated from a paper first presented by the authors at the Nineteenth General Conference of the International Association for Research in Income and Wealth, Noordevijkerhout, Netherlands, August 25-31, 1985.

276

GFS AND NATIONAL ACCOUNTS

277

discuss the draft GFSM, and joint efforts by the staffs of the Fund's Bureau of Statistics and the United Nations Statistical Office (UNSO) resulted in the issuance of the first "bridge tables" between the two data systems in 1976. The draft GFSM, codifying Fund practice in the measurement of government operations, was developed over the previous two decades and was followed, beginning in 1977, by publication of the Fund's Government Finance Statistics Yearbook (GFS Yearbook). This publication presents detailed statistics, together with lists of institutions included in the government sector, of nonfinancial public enterprises and of public financial institutions. Until the 1989 issue, derivation tables were included that showed the national sources and adjustments utilized by correspondents within each finance ministry or central bank to compile the principal aggregates in accordance with the GFSM, which was published in 1986. The institutional tables have now been limited to show changes occurring after publication of the previous issue of the GFS Yearbook. Data on derivation and adjustments remain available, however, on request. Correspondents receive training in the application of the GFSM in annual eight-week courses held at the IMF Institute and in brief seminars thus far conducted in more than 50 countries. The 1989 GFS Yearbook presented statistics for 124 countries, with greater detail for central government than for state, local, and, consequently, general government. To make use of the detailed, comparable government statistics contained in the GFS Yearbook, the GFS-SNA bridge tables have been applied so as to arrive at broad, albeit approximate, SNA categories covering central government operations in over 100 countries, published beginning in 1981 in the UN Statistical Yearbook. In June 1983, following emphasis on harmonization of the SNA and related statistical systems by the United Nations Statistical Commission and by a March 1982 Expert Group Meeting on Review and Development of the SNA, the United Nations and the Fund undertook joint case studies in selected countries on the feasibility of linking SNA and GFS concepts on the basis of detailed data. Questionnaires were sent to compilers in Colombia, Finland, India, Kenya, Mexico, the Netherlands, Thailand, the Philippines, the United Kingdom, Venezuela, and Zambia. In early 1985, visits to several countries in the sample were carried out by UN and Fund staff members as a basis for further harmonization of the two data systems. The lessons from this joint work were instrumental in the preparation of the main discussion paper for the Expert Group Meeting on Public Sector Accounts in January 1988 (Chapter 16 of this volume).

18 Overall Relationships Between the llv1F' s Government Finance Statistics and A System of National Accounts jONATHAN LEVIN

A Nations' A System of National Accounts (SNA) and the IMF's govLTHOUGH THE DETAILED

relationships between items in the United

ernment finance statistics (GFS) have been worked out over the past decade in the bridge tables appearing in A Manual on Government Finance Statistics (GFSM) and the UN Handbook on public sector statistics1 and are explored further in Chapter 19 of this volume, it may be helpful to explore briefly the larger relationships between the two data systems and the relative significance of particular differences for their reconciliation. A useful starting point for this purpose may be the origins and purposes of the GFS system. In both respects, the GFS system is designed to measure and forecast behavior on the basis of observed relationships of motivation and effect. The classifications of government transactions in the GFS system have sought to reflect current thinking in the field of public finance as a means of fitting the analysis and planning of government policies into overall national programs for stabilization and growth. Thousands of Fund country missions have concluded that the strategic role and motivational structure of government require an analytical and planning framework of government operations different from that for any other sector. This framework, over the years, has become the GFS system. United Nations, Handbook of National Accounting: Public Sector Accounts, Studies in Methods, Series F, No. 50 (New York, 1988). 1

278

GFS AND THE SNA

279

In essence, this framework has called for comprehensive coverage of a government's transactions with the rest of the economy and the world, measuring primarily government payments and receipts and, secondarily, any unpaid accruing obligations. Because it focuses on past and expected future behavior, GFS is based on behavioral or motivational, rather than institutional, relationships. For the sake of such analytical, and predictive, relationships, GFS departs from institutional"integrity" when all or parts of an institution carry out economic functions that differ from its legal or institutional classification. To focus on analysis of government behavior, moreover, GFS classification of some transactions may have to differ from the perceptions of some transactors with whom the government deals. Within its overall requirements of comprehensive coverage and the gross measurement in real time of government payments and receipts, the heart of the GFS system is the classification of all government transactions from the government's point of view by the nature of what flows. Because government accounting systems are unable to keep track of all flows of accruing liabilities and resources to and from government, these systems are based on money flows. The GFS system utilizes government accounting data, rather than estimates or imputations, of money flows, classified by the nature of what flows in the opposite direction, to construct its analytical framework of government operations. This GFS analytical framework is represented graphically in Figure 1, which divides all flows between payments and receipts, with an undivided balancing cell at the bottom for changes in cash balances. Flows of receipts and payments are divided horizontally by what flows in the opposite direction: goods and services or resources, nothing, others' liabilities to government, and government liabilities to others. Money flows in exchange for goods and services (or nothing) are further divided by whether or not they involve capital goods-either in direct purchase or sale or in transfers for their acquisition by the recipient. Flows in exchange for others' liabilities to government are divided between those undertaken for public policy purposes-that is, government lending or equity acquisitions undertaken for the same types of goals as government spending-and those undertaken for the management of government liquidity. A further horizontal division among government receipts for which nothing flows in exchange separates grants from other governments or international organizations from flows of taxes or other transfers from nongovernmental sources. Figure 2 illustrates the classification of various government transactions within this analytical framework. Figure 3 identifies the principal

280

PUBLIC SECTOR ACCOUNTS

Figure 1. Analytical Framework of the IMF's Government Finance Statistics (GFS) RECEIPTS Capital Current

PAYMENTS Current Capital

~

:E ....

z 0

-------- -------Liquidity management

Public policy

Public policy

Change in cash balances

qquidity management

281

GFS AND THE SNA

Figure 2. Location of Various Transactions in GFS Analytical Framework

RECEIPTS Current Capital

~ :E ....

PAYMENTS Current Capital

Fees & charges Nonindustrial sales Property income

Sales of capital

Acquisition of capital

Wages & salaries Purchases of goods & services Interest

TAXES Fines, forfeits, licenses

Capital transfers from nongovernmental lending

Capital transfers

Current transfers

Liquidity management

z0 1---------

--------

Current grants

Capital grants

Liquidity management

Public policy

Public policy

Repayment of past government lending

Gross government lending

..... ....~ ..... ~ ;.:3

....I::

Borrowing

Amortization

Q)

E

E ~

0

C)

Change in cash balances

282

PUBLIC SECTOR ACCOUNTS

Figure 3. Identification of Major GFS Aggregates in GFS Analytical Framework

RECEIPTS Current 1 Capital

PAYMENTS Current Capital

b() ~

:.E ....

z 0

G R A

Liquidity management

Liquidity management

Change in cash balances

283

GFS AND THE SNA

Figure 4. Components ofSNA Accounts in GFS Analytical Framework

RECEIPTS Current Capital Current sales Services produced for own use

PAYMENTS J Current Capital

Own account capital formation

Consumption of employees Intermediate consumption Consumption of fixed capital Indirect taxes

Consumption of fixed capital

Net purdulses of fixed capital Own •«ount capital formation CJ>aase ill otocb Net pard>Ma of laud" intangible illl8els

Estate and gift taxes

Capital transfers

··-' Property income

0.0 1:

£0

z

lndirect t.)).e~ Dired ta--.c., Social o;u:uri~· contributions CompuJo;.,ary feco, Lnfunded employee pension & wt.•lfare

Current

lr.:mo;fc~

Liquidity management Gold&SDRs

Subsidies Social security benefits Social assistance grants Cnfunded employee pension & welfare benefits

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Liquidity management Gold&SDRs

PUBLIC SECTOR ACCOUNTS

284

Figure 5. SNA Accounts and Balancing Items in GFS Analytical Framework PAYMENTS Current Capital

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Liquidity management Gold&:SDRs

GFS AND THE SNA

285

aggregates of the GFS system fitted into this analytical framework, with shading for each. As may be seen from Figure 3, Revenue plus Grants, less Expenditure and Lending Minus Repayments, equals the Deficit/Surplus, which, in tum, is equal to Financing. To provide an approximate comparison between the GFS and the SNA, a number of SNA components are superimposed on this GFS analytical framework in Figure 4. An approximation of the SNA accounts, with shading for each account, is superimposed on the GFS framework in Figure 5, with notation also of the balancing itemsoperating surplus, saving, and net lending-carried from each account to the next. Examination of Figures 4 and 5 permits identification of several components that are classified differently in the GFS and SNA and that contribute to differences between major aggregates in the two systems. One such example is estate and gift taxes, which are classified as capital transfers in the SNA and as taxes, and hence current, in GFS, resulting in differences between the two systems' concepts of taxes, current receipts, capital receipts, and saving. Overall comparison of the GFS and SNA in the GFS analytical framework serves also to point out similarities and differences between the two systems. The similarities are quite strong in the identical classification of most, though not all, components by the nature of the flows involved. Organization of the two systems differs, dearly, in the single, comprehensive account used by the GFS in contrast to the several accounts used in the SNA to measure separately production, income and outlay, and capital accumulation and finance. The single account structure of the GFS calls for each flow to appear only once, whereas the multiple account structure of the SNA requires the repetition of some components and the insertion of balancing items along the way. Restriction of the nonfinancial major GFS aggregates to either the receipt or payments side contrasts with the combination within some SNA components to include both receipts and payments in a single net concept. Whatever conclusions are reached about the feasibility of closer future relations between the two data systems, it is evident from this examination of their principal features that they have developed different formats and organizational structures to serve their different objectives: the GFS for overall evaluation of fiscal performance and its impact on financial conditions, and the SNA for measurement of government production, income and outlay, capital formation, and finance as a component with other sectors in the calculation of national aggregates. The primary parameter in any prescription for possible future changes must not divert either system from its primary purpose but should strengthen each as a result of its dose relation to the other.

19 Derivation of System of National Accounts Value from Government Finance Statistics Data }AN VAN TONGEREN AND IRENE TSAO

I field of public sector statistics, the IMF' s government finance statisN AN EFFORT

to link the two international standards covering the

tics (GFS) and the United Nations' A System of National Accounts (SNA), staff members of the Fund and the UN Statistical Office (UNSO) worked closely together and developed a set of conceptual bridge tables, which was published in the Fund's Manual on Government Finance Statistics (GFSM) in 1986 and included in the United Nations' Handbook of National Accounting: Public Sector Accounts.1 The bridge tables delineated the one-to-one item interrelations of the two systems and have added about 200 further breakdowns of the GFS data, or estimates for items not included in the GFS, in order to derive the public sector accounts according to the SNA concepts. In practical terms, this thorough conceptual consideration may lead to a formidable statistical task while treating minor theoretical differences. Questions have sometimes been raised about whether the bridge tables can actually be applied to derive one set of data from the other and about whether, on the basis of country practices, all detailed links are necessary, feasible, or significant. I. Purpose

The present paper aims to illustrate a sequential compilation procedure for obtaining SNA government accounts from GFS data, using United Nations, Handbook of National Accounting: Public Sector Accounts, Studies in Methods, Series F, No. 50 (New York, 1988). 1

286

DERIVING SNA VALUE FROM GFS

287

the conceptual bridge tables only for guidance in the estimation process. By giving an actual example, the paper attempts also to illustrate and quantify the effects of the differences between GFS and SNA concepts, although it should be emphasized that it does not pretend to cover the needs or circumstances of all countries by using the data sets of only one country. Furthermore, it is hoped that this exercise can provide a basis for devising a shortcut data link between the GFS and SNA from which quantitatively unimportant adjustments or considerations that are not applicable to the majority of countries can be eliminated. II. General Description of Procedure

The procedure for the GFS-SNA conversion adopted in this paper involves two stages, as shown in Figure 1. The first stage of the conversion requires the reclassification of available GFS data to corresponding SNA categories. In the case of a combined GFS item with no breakdown, it is usually assigned to the SNA category according to the predominant component of the GFS item. This stage of conversion has, in fact, been implemented already, and the results were published for more than 100 countries in the Government Sector Statistics chapter of the UN Statistical Yearbook (1981-85 editions). It should be noted that this reclassification yields only a crude approximation of SNA categories. The second stage represents a refinement of these approximate values by making the adjustments necessary to convert the GFS data according to SNA definitions. All the topics covering the conceptual differences of the two systems have to be considered at this stage, but only a few issues can be dealt with and adjustments applied because of the lack of information. An example is given in Figure 1 to show the two stages of the derivation procedure. For instance, the GFS revenue item A9, "Administrative fees, charges and nonindustrial sales" is a combined item with no breakdown in the data published in the Fund's Government Finance Statistics Yearbook (GFS Yearbook). It is linked in the first stage of conversion to the SNA item "Sales" of the production account. In the second stage, adjustment is needed to deduct the portion of administrative fees and charges from the approximate SNA values. The amount of administrative fees and charges is further divided into the part paid by households and the part paid by business units, with the former rerouted to the SNA item "Fees, fines and penalties" and the latter to "Indirect taxes."

I

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DERIVING SNA VALUE FROM GFS

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It should be noted that the first-stage approximate conversion is uniform among countries because it has been designed on the basis of internationally comparable and computerized statistics available in the GFS Yearbook. The selection of topics for adjustments in the second stage varies, however, from country to country according to circumstances and data availability.

III. Derivation of SNA Central Government Accounts of the Netherlands from GFS Data This section presents the results of an exercise to derive the SNA central government accounts of the Netherlands from GFS data. Only the production account, the income and outlay account, and the capital accumulation account of the central government are covered because the most complete sets of data are available for these three accounts of the subsector. The exercise has been carried out with the use of Lotus spread-sheet software.

Adjustment Categories (Annex I) Before proceeding to the explanation of the numerical derivation, it is necessary to know first which topics, among those defining the differences between GFS and SNA concepts, are dealt with in the exercise as data availability dictates. Annex I shows all the adjustments elaborated in the detailed conceptual bridge tables grouped into 12 categories of topics. Indicated in the columns are those adjustments applied (or not applied) regarding each topic in the process of making the data conform to SNA definitions. In the first stage of the approximate GFS-SNA conversion, two types of adjustments have already been incorporated because data are separately available in the GFS. They are inheritance tax treated as capital transfers in SNA and as tax in GFS (Annex I, item 6b). Sales of stocks, fixed capital assets and land, and intangible assets are treated as negative purchases of these items in the SNA and considered as revenues in the GFS (Annex I, item lOa). The major adjustments, however, are those carried out in the second stage, after the approximate GFS-SNA conversion, to refine the estimates. The adjustments applied in the second stage are own-account capital formation of departmental enterprises, the distinction of taxes paid by household or business, the separation of social security funds from other levels of government, the imputation of unfunded employee welfare contributions, consumption of fixed capital, sales of used goods treated as negative expenditures in

290

PUBLIC SECTOR ACCOUNTS

the SNA and the statistical details of the GFS items property income, casualty insurance transactions, subsidies and transfers, social transfers, and administrative fees and nonindustrial sales. Despite the adjustments listed above, many more issues have not been dealt with in the exercise because of the lack of information, such as the cash versus accrual basis of recording, operating surplus of departmental enterprises, consolidation of transactions within the government in GFS and their separate identification in the SNA, revaluation of assets and liabilities (for the capital finance account), voluntary contributions to social security funds, casualty insurance contributions, and all types of transactions in kind. Reference should be made to Annex I before the analysis of the derivation worksheet contained in Annex II.

Derivation Worksheet (Annex II) Annex II presents the illustrative worksheet containing the twostage derivation of SNA central government accounts of the Netherlands from GFS data. In preparation for this exercise, the 1980 data for the Netherlands, as published in the GFS Yearbook (1984) and the UN National Accounts Statistics: Government Accounts and Tables (1983), were thoroughly examined to see the feasibility of recasting these data into SNA items. National publications were also used to gather information required for various estimates. From this basic information, it was determined which adjustments could be applied. For this exercise, it was possible to have estimates for the ten adjustment items shown in columns 1-10 on the right-hand side of the various panels of the worksheet (see also the preceding subsection on adjustment categories). In the panels of the worksheet, the column of SNA categories is an exact reproduction of the UN National Accounts Questionnaire, Table 3.11, "Production Account" (part A of Annex II; code 100 in this column); Table 3.12, "Income and Outlay Account" (parts B.1,2 of Annex II, "Receipts" and "Disbursements," respectively; code 200); and Table 3.13, "Capital Accumulation Account" (part C of Annex II; code 300). Items are coded in the same order within the respective account as in the National Accounts Questionnaire. The GFS categories are shown opposite their corresponding SNA categories regardless of their original GFS order of presentation, although the GFS item codes have been retained.

First Stage The first-stage approximate conversion constitutes several types of linking: (1) item-to-item linking (for instance, the approximate SNA

DERIVING SNA VALUE FROM GFS

291

"Sales," equal to 2.39 billion guilders, is taken from GFS item A9, "Administrative fees, charges, and nonindustrial sales"; likewise, the approximate SNA "Intermediate consumption" in the amount of 8.57 billion guilders, which is derived from the GFS item C1.3, "Other purchases of goods and services"); (2) the approximate SNA value equals the sum of several GFS items (to obtain the approximate SNA "Indirect taxes," the GFS taxes on payroll or manpower, on immovable property, on financial transactions, on goods and services, on international trade, and so on have to be added up first); (3) the difference of two GFS items gives the approximate SNA value (for example, SNA "Gross fixed capital formation" equals GFS "Purchases of fixed capital assets" minus "Sales of fixed capital assets," which represent, in fact, the adjustment of ''netting'' incorporated at this stage of conversion because data are separately available in the GFS). After this horizontal linking is carried out, the remaining SNA items can be derived by applying the formulas that determine the interrelations of SNA items. For instance, "Services produced for own use" is a residual item equal to "Gross output" minus "Sales" and "Own account capital formation." "Final consumption expenditure" of the income and outlay accounts equals "Services produced for own use" of the production account. (Please refer to "Vertical Relationships of SNA Items," part D of Annex II, for the list of all formulas for vertical relationships.)

Second Stage On the right-hand side of the various panels of the worksheet are entered ten columns of adjustments called for in the second stage of the procedure. 2 The first column, "Social security funds," is required because GFS data represent ''consolidated central government,'' covering both central government and national social security funds net of intersectoral transactions, whereas social security funds constitute an individual subsector of general government in the SNA. Therefore, the GFS data include contributions to social security funds as income and social security funds payments to the households as outlays, 2 The space limitations of book format prevent full, horizontal spread-sheet presentation of Annex II. The adjustment columns 1-10, on the right-hand side of the worksheet, are distributed in numerical order across the panels of Annex II. The left-hand columns-for GFS and SNA categories, GFS cash basis, and approximate SNA value-are repeated for convenience in each panel; their values do not change across the panels.

292

PUBLIC SECTOR ACCOUNTS

which have to be deducted to obtain the SNA central government accounts. For this purpose, the GFS item A2, "Social security contributions," was eliminated from the receipt side, and the SNA item 20016, "Social security contributions," was left blank. Furthermore, the SNA item 20033, "Transfers to households," was reduced by 69.17 billion guilders, which represents the GFS figure of 70.91 billion guilders for social security transfers to the households minus the estimate for unfunded employee pension benefits, 1.74 billion guilders. In contrast, central government transfers to the social security funds, although netted out in the GFS, should be added back as part of SNA central government disbursements. An estimate of 11.48 billion guilders was available in the UN National Accounts Statistics, which was added to the SNA item 20032, "Transfers to government subsectors." The above adjustments reduced the SNA item 200300, "Other current transfers paid," by 57.69 billion guilders, which is reflected in the increase of the same amount in the SNA item 20040, "Net saving." The second column shows the adjustment of "Taxes paid by business or households." In the approximate conversion, the total amount of all types of indirect taxes was assigned to SNA "Indirect taxes.'' However, the SNA considers some types of indirect taxes paid by household as direct taxes. To achieve conformity with SNA definitions, an estimate of 1.24 billion guilders for motor vehicle taxes paid by households was deducted from "Indirect taxes" and rerouted to "Direct taxes." "Own-account capital formation" (column 3) is estimated to be 0.50 billion guilders, which represents, in gross input, 0.20 billion guilders for wages and salaries paid and 0.30 billion guilders for other purchases of goods and services used in the ownaccount construction of fixed assets. The amounts for "Consumption of fixed capital formation" (0.66) and "Imputed unfunded employees' contributions" (1.74) have been estimated and entered in columns 4 and 5, respectively, and this in tum has increased gross output and related items by the same amount. In column 6, "Sales of used goods" is separated from the GFS residual item "Other nontax revenues" (assigned to SNA "Other transfers" in the approximate conversion), which is then deducted from "Intermediate consumption," since the SNA specifies the net treatment of "Purchases less sales of goods and services." As a result, gross output and related items decrease by the same amount. The rest of the adjustments-in columns 7-10, for classification details of property income, casualty insurance, subsidies, and administrative fees-are all caused by the broader GFS categories, which require breakdowns for SNA compilations.

DERIVING SNA VALUE FROM GFS

293

The figures for "Final SNA" (shown in the last column of the final panels of parts A-C of Annex II) are obtained by summing up horizontally the values in "Approximate SNA" and those in columns 1-10, where adjustments exist. The accuracy of the data in this column can be cross-checked by applying the formulas for vertical relationships (part D of Annex II).

Comparison of Results (Annex III) Annex III compares the derived SNA values with those published in the UN National Accounts Statistics: Government Accounts and Tables.3 Given that so many adjustments have not been applied because of the lack of information, the differences between the derived values and those obtained through the UN National Accounts Questionnaire and subsequently published in the yearbook are not significant for most of the items, except for transfers and the balancing items. Furthermore, adjustments for the timing of recording (from cash basis of GFS to accrual basis of SNA) have not been attempted in this exercise, and this might account for some of the discrepancies. The usual procedure for this kind of adjustment is to study the government accounting records to calculate the average time lag between the authorization and the actual cash payment or receipt of various expenditure or revenue items, and to adjust the GFS data accordingly to convert them to an accrual basis.

IV. Uses of the Bridge Tables The exercise described above is a simple illustration of the operational procedure to compile SNA government accounts from GFS data. Much of it could be improved if more basic information were available. Nevertheless, analysts may use the worksheet to assess the effects of eliminating conceptual differences between the GFS and SNA to harmonize further the two standards. Decisions taken on the issues raised here and in expert group discussions could simplify the bridge table. For example, if the SNA concept of "Indirect taxes" is modified to cover only "Commodity taxes," then all the adjustments for taxes paid by businesses or households can be eliminated. If the separate treatment in the SNA of inheritance taxes as capital transfers rather than as taxes is abolished and social security contributions are United Nations, National Accounts Statistics: Government Accounts and Tables (New York, annual). 3

294

PUBLIC SECTOR ACCOUNTS

considered as taxes, then the coverage of taxes will be identical in both systems. Furthermore, harmonization of the two systems in the treatment of departmental enterprises and own-account production of capital goods will bring the content of the government sector for these activities in the SNA and GFS fully in line, and adjustments will not be required in this regard. 4 Given the decisions to modify the two standards, a shortcut for deriving SNA value from GFS data along the lines shawn in the illustration presented here can be designed. In comparison with the detailed conceptual bridge tables, the shortcut method will be more practical and easier to apply, and it will not cause much loss of information (as country practices reveal). UNSO plans to use the procedure in its Lotus format, with the cross-check mechanism installed, in technical cooperation projects to help countries to develop the government sector statistics within the national accounts framework.

4 Jonathan Levin and Jan van Tongeren, "Harmonization of International Statistical Standards on Government Finance Statistics (GFS) and System of National Accounts (SNA)," paper presented to the Nineteenth General Conference of the International Association for Research in Income and Wealth, Noordevijkerhout, Netherlands, August 25-31, 1985.

1. Cash or accrual basis of recording 2. Monetary authority functions separated from government in GFS, not in SNA 3. Departmental enterprises (a) Own-account capital formation, separately in GFS, not SNA (b) Departmental enterprises presented net (operating surplus) in GFS, included gross in SNA 4. Consolidation of transactions within the government in GFS, separately identified in SNA (a) Indirect taxes paid by government units (b) Social security contributions paid by government as employer (c) Interest paid by government institutions to other levels of government 5. Revaluation of assets and liabilities (a) Revaluation of stocks applied in SNA; in GFS historical cost estimates are used (b) Cancellation of debt treated as capital transfer in SNA, not dealt with in GFS

Topics (1)

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Sources: U.S. Department of Health and Human Services, Social Security Programs Throughout the Wor/d-1983, Research Report 59 (Washington: Government Printing Office, 1984). Note: An asterisk(*) indicates central government covers the whole cost of the program; "x" indicates social security program operating without central government contributions; "(x)" indicates central government subsidizes the program.

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PUBLIC SECTOR ACCOUNTS

Switzerland, ''all sickness insurance funds are entitled to federal subsidies. "6 The degree of central government participation varies among developing countries. Central government does not appear active in the financing of specific risks in Africa, except for family allowances, for which central government pays the whole cost in Mauritius and a portion in nine other countries. Central government pays the entire cost of family allowances and old-age, invalidity, and death benefits in South Africa. In nonindustrial Europe, central government contributes to all benefits in Malta, Romania, and Cyprus, assuming the whole cost of sickness and maternity benefits in Cyprus and the whole cost of family allowances in Romania. Moreover, it may be noted that in Greece, "arrangements financed from public funds have been introduced to cover agricultural pension scheme contributors and pensioners, and their dependents, against the cost of pharmaceutical products."7 In half of the Middle Eastern countries listed, central government subsidizes most social security benefits, but does not cover the whole cost of any particular program. Furthermore, in Egypt, "the financial situation of the fund is examined by actuaries every five years in order to establish existing commitments. If there is a deficit in the fund, it is borne by the Treasury and is to be settled later if there is a money surplus. " 8 Central government plays a more active role in Latin America, sharing in the financing of old-age, invalidity, and death benefits and in sickness and maternity benefits in most countries. Because work injury, unemployment, and family allowance benefits are less common in this region, government participation in their financing is limited. Only in Chile does the central government pay for the whole cost of unemployment and family allowance benefits, since employer contributions to these programs were abolished in 1980. A study based on Brazil, Colombia, the Dominican Republic, Nicaragua, Peru, and Venezuela indicated that "with the exception of Peru, legislation in these countries prescribes state participation in Jean-Francis Charles, "Social Security in Switzerland: Main Features of the Schemes and Current Problems," International Social Security Review, 2/84, p. 186. 7 International Social Security Association, "Social Security News," "Social Security in the Member States of the European Community in 1983," International Social Security Review, 4184, p. 448. 8 Ministry of Social Insurance, Arab Republic of Egypt, "Social Insurance in the Arab Republic of Egypt," International Social Security Review, 4/84, p. 425. 6

SECTORIZATION OF SOCIAL SECURITY

339

the financing of social security through direct transfers from general government funds"; however, "direct state participation in the financing of social security is subject to considerable delays in most of the schemes and can be considered nonexistent in the Dominican Republic."9 Moreover, it has been observed that "the chronic delay in payment of state contributions is often a major factor in the financial difficulties of the institutions. "10 To obtain an indication of the magnitude of central government support of social security funds in financial terms, it is useful to examine such support expressed as a percentage of total social security fund revenue, as shown in Table 4. Such contributions appear most important among industrial countries, particularly in Denmark and Iceland, where they amounted to about 70 percent and 90 percent of total social security fund revenue during 1975-83, followed by Finland, Germany, Ireland, Italy, Luxembourg, and Spain, with ratios ranging between 10 percent and 30 percent. Also during this period, ratios for Finland and Spain showed a threefold increase; only those for the Netherlands showed a decline, from a peak of 15 percent in 1980 to 3 percent in 1984. The magnitude of central government contributions to social security funds varies also among developing countries. Thus, in Chad they represent 100 percent of social security fund revenue, followed by Uruguay with about 40 percent; Burundi, Malta, and Colombia with about 30 percent; and Malaysia, Cyprus, Israel, and Trinidad and Tobago with ratios of about 20 percent. In the remainder of developing countries list€d in Table 4, government contributions amount to 10 percent or less of total social security funds revenue. Thus, a comparison of the magnitude of central government employer contributions and of other government contributions to social security funds, based on Tables 2 and 4, shows a significant difference in the relative importance of these items as sources of social security revenue, particularly among industrial countries. Government contributions other than as employer constitute a more important source of revenue to social security funds in industrial countries and in certain developing countries such as Chad, Cyprus, Greece, Malta, Israel, Malaysia, Colombia, Trinidad and Tobago, and Uruguay. Central government contributions as employer, however, are not a major source of revenue for most social security funds, and 9 Hernando Perez Montas, "Problems and Perspectives in the Financing of Social Security in Latin America," International Social Security Review, 1/83, p. 77. 10 Ibid., p. 75.

Industrial Countries Canada Denmark Finland Germany Iceland Ireland Italy Luxembourg Netherlands Spain Developing Countries Africa Benin Burkina Faso Burundi Cameroon Central African Republic Chad Congo Cote d'Ivoire Mali Niger Rwanda Senegal Tunisia

Country

100.00

7.10

1974

1.90

4.18

0.57

100.00

32.38

34.74 100.00

11.91 4.59

3.21 72.51 8.35 14.58 87.15 20.62

1976

8.97 4.35

8.84 15.68 85.44

2.58

1975

2.01

7.60

51.04 2.57

4.45

10.22 3.00

3.22 76.67 8.48 13.45 82.82 17.63

1977

0.77 7.05 2.26

-

4.29

1.43 0.80 4.18 2.42

33.33 2.32

14.84 8.85

14.41 7.54

41.95

3.56 75.69 9.51 13.72 82.93 20.05 19.54

1979

3.39 80.91 10.61 14.27 83.64 19.12 27.87

1978

1.77 3.21 11.64 4.10

...

0.05 1.33

5.05 58.29 3.86

15.54 14.36

22.65

4.31 71.68 10.92 13.54 83.83 23.08 21.19

1980

5.11

...

0.03

24.05 4.39 2.85

4.50 74.76 10.61 14.05 88.60 28.77 26.46 23.86 13.04 16.72

1981

4.03

9.15

0.03

4.55

4.01 71.46 12.94 14.27 88.81 27.24 37.21 24.87 10.97 25.76

1982

Table 4. Central Government Contributions to Social Security Funds (Excluding Contributions as Employer) as a Percentage of Social Security Fund Revenue

5.75

0.10

8.78

27.40 32.72 26.38 4.19 21.10

3.57 68.13 22.94 12.63

1983

3.31

32.94

1984

n

Ul

zo-1

c::

0

> n n

Cl110

rrl

Ul

ca

cn

.,c::

~ 0

6.54 38.91

7.35 33.31 3.43

4.93 0.41 1.56 16.14 9.27

4.47 1.04 1.07 17.98 14.95

15.57 10.03

0.44 1.22

-

-

-

1.87 4.55 1.26 1.00

1.64 4.35 14.37

16.36

1.16 4.80

20.43

0.47

-

17.22

5.41

16.25

28.78 7.17

20.83

20.49 6.44

0.67 0.99

0.51

-

31.16

1.42 3.82 14.72

12.74

26.14 4.94

22.81

19.91 29.19

0.64 0.79

26.35 0.12 1.05

-

1.49

0.86

24.25 7.12

24.66

0.77 0.73 2.57 18.46 28.07

34.43 2.96 1.48

-

1.33

1.89

19.68 8.15

22.86

45.98

0.44 0.80

10.35 0.98

8.77

1.31

16.53

19.05

41.35

6.72

10.42 5.45

1.84

18.07

18.70

38.29

Source: IMF, GFS Yearbook (1985). Note: A dash(-) indicates that a figure is zero or less than half of a significant digit; an ellipsis( ... ) indicates a lack of statistical data that can be reported.

Argentina Bahamas Barbados Bolivia Colombia Costa Rica Dominican Republic Honduras Panama Paraguay St. Lucia Trinidad and Tobago Uruguay

Western Hemisphere

Israel

Middle East

4.81

33.82 7.59

26.64 6.96 33.33 1.88

Cyprus Greece Malta Portugal

Europe

15.00

6.67

Malaysia

Asia

Ul Ill

~ ......

~

22

c:

t"l

r" Ul Ill

>

t"l

0

Ul

""

0

z

0

:::!

>

N

22

0

-,)

t"l

342

PUBLIC SECTOR ACCOUNTS

their importance has declined over the years. Significant exceptions appear among the English-speaking Caribbean countries with relatively new social security schemes, where the central government seems to contribute mostly in its role as employer. To provide the budgetary support for social security needs, central governments, particularly in the industrial countries, have found it necessary to tap additional sources of revenue. In Germany, for example, part of a package to deal with the financial crisis caused by the recession of 1974 included a "general tax increase to permit a larger federal subsidy to the pension system." 11 In general, among industrial countries "total reliance on national government aid with regard to the entire cost of the pension dynamic is either a fact, as in the United Kingdom, or a mounting demand. " 12 France in 1983 introduced a 5 percent tax on advertising expenditures by the pharmaceutical industry, added new taxes on alcohol and tobacco, and doubled the auto insurance surcharge paid to the health insurance funds. 13 Special taxes were imposed in Brazil (on lottery, other gambling, petrol, and imports) and in Panama; value-added taxes and production taxes are levied in Argentina and Uruguay.14 Throughout a conference convened by the International Social Security Association in 1979, "there was acknowledgement of past, and prediction of future, increases in general revenue subsidies in the financing of social security." 1s Both statistics and policy discussions, therefore, reflect the financial stress that most social security funds around the world now face and their increased dependence on central government support. This takes the form of direct budgetary transfers or earmarked collections from special taxes levied for this purpose, with consequent increases in central government influence over benefits, policies, and performance. In many countries, part of central government's strategy to deal with inflation has included curbing of social security fund expenditures by altering the automatic adjustment mechanism for cash benefits, reducing other benefit expenditures, and controlling social security investments. Price increases that accompanied rising unemployment and slow economic George Rohrlich, "Maintaining Social Security Pension Schemes Adequate and Solvent-A Transnational Synopsis of Problems and Policies," International Social Security Review, 2180, p. 151. 12 Ibid., p. 152. 13 U.S. Department of Health and Human Services, Social Security Programs Throughout the World, p. xiii. 14 Perez Montas, "Problems and Perspectives," pp. 70-71, 77. 15 Rohrlich, "Maintaining Social Security Pension Schemes," p. 152. 11

SECTORIZATION OF SOCIAL SECURITY

343

growth resulted in financial difficulties for social security funds and the rest of central government. Governments were faced with the need to reduce expenditures, particularly those on public health care and pensions, which "are the two largest items in the social budgets of western states, and represent on average about two-thirds of social expenditure. ''16 Thus, "since 1981 several countries have postponed or limited benefit adjustments. " 17 In Canada, old-age and family allowance benefits that were previously automatically linked to changes in the consumer price index were capped at 6 percent for 1983 and 5 percent for 1984. Denmark temporarily suspended, from January 1983 to April1985, the indexation to price changes for certain benefits. Similar changes took place in Finland, Greece, Sweden, Germany, and the United States. In the Netherlands, Finland, and the United Kingdom, the government adjusts the rates at its discretion, whereas Switzerland and Italy adhere to mixed indices. II. Central Government Control Over Investment of Social Security Fund Reserves

The financial independence of social security funds has been increasingly subjected, in recent years, to the overarching requirements of national fiscal management. "It is only during the past decade that the need has been keenly felt for a thorough study of the relationship between social security and the economy, and the integration of social security resources with the economic strategy. Conventional planning has tended to ignore the interaction between the factors of social security and economic aggregates. " 18 To carry out their broader policy objectives, central governments in many countries have found it necessary to control or direct the investment of social security funds reserves, for the management of government debt and the promotion of programs of interest to the government. Central governments have guided social security funds toward investing part or all of their reserves in government securities yielding lower rates of return, or in social projects such as construction of 16 F. Kaufmann and L. Leisering, "Demographic Changes as a Problem for Social Security Systems," International Social Security Review, 4/84, p. 395. 17 U. S. Department of Health and Human Services, Social Security Programs Throughout the World, p. xii. 18 Mohamed Gourja, "The Contribution of Social Security to Development of Objectives: The Role of Income Support Measures," International Social Security Review, 2/81, p. 131.

344

PUBLIC SECTOR ACCOUNTS

hospitals and medical facilities or projects intended to generate income and contribute to economic development. In a meeting of experts on investments of social security funds in developing countries, called by the International Labor Organization in November 1983, it was stressed that "the demands made on the social security system to invest its reserves in projects having social or economic value could not be ignored."19 For example, "in Mauritius, the law requires that reserves be invested mainly in long-term government stocks and Treasury Bills"; in Morocco through 1972, "social security investments could be made only in Treasury Bills or bonds guaranteed by the state."20 The law was changed thereafter, requiring that social security funds' reserves other than those needed for current operations be deposited with the Deposit and Administration Fund which "acts in accordance with the government policy and the objectives of the Economic and Social Development Plans." 21 In Sudan, "the general policy has been to invest in government bonds and in property, provided that a balance was maintained between social and commercial investments. At the end of June 1982, the investment portfolio consisted mainly of 60 percent in loans to the Government or in Government bonds, 22 percent in fixed deposits in banks, and 16 percent in property. "22 During the Eighth African Regional Conference of the International Social Security Association in September 1984, it was observed that "most of the social security schemes invested the bulk of the reserve funds in government bonds and loans, bank deposits, and property, particularly those concerned with improvements in health infrastructures.' ' 23 In several Latin American countries, ''social security institutions lack sophisticated investment machinery or the legislation itself prevents them from obtaining maximum yield on their investments compatible with the capital market situation. "24 Among the Englishspeaking Caribbean countries, it was apparent that in Barbados, Jamaica, Guyana, and Trinidad and Tobago, "the national insurance boards were making strenuous efforts to identify sound and profit19 International Social Security Association, "International News," "Meeting of Experts on Investment of Social Security Funds in Developing Countries," International Social Security Review, 2184, p. 219. 20 Gourja, "Contribution of Social Security to Development," p. 145. 21 Ibid., p. 142. 22 International Social Security Association, "ISSA News," "Eighth African Regional Conference," International Social Review, 4/84, p. 480. 23 Ibid., p. 481. 24 Perez Montas, "Problems and Perspectives," p. 85.

SECTORIZATION OF SOCIAL SECURITY

345

able investments, but were subject to ministerial authority in establishing their investment portfolios.' '25 Clearly, a major concern facing all social security funds with investible reserves has been how to reconcile their requirements for sufficiently high yields with the social and economic objectives imposed by investment decisions taken by the central government. Any financial independence exercised in the investment of social security fund reserves in early periods has more recently been constrained by the control of social security fund investments as one more instrument of central fiscal policy.

III. Use of Social Security Funds to Control Unemployment Central governments, especially in industrial countries, have used social security funds not only to compensate the unemployed but also as a tool to reduce unemployment. To enhance employment opportunities for the unemployed and younger people, authorities have acted to lower retirement ages. In the United Kingdom, for example, 1976 legislation provided for retirement one year before the normal retirement age, with a higher than normal pension when the vacancy created was filled by an unemployed person. "As part of a general policy to encourage employment, France is paying full pensions at age 60 (instead of the previous 65) and has eliminated the incentive of 5 percent a year for delaying retirement."26 Similar legislation has been passed in other industrial countries (for example, Belgium and Spain). Lowering the retirement age and making early retirement more attractive has also been used to control unemployment among developing countries, such as Tunisia, Nicaragua, and Nigeria.27 The increased benefits that social security funds are called upon to support must be viewed as the cost of meeting the broader social and economic objectives of central government. Central governments have also used variations in social security contributions as a fiscal policy tool to control unemployment. In Belgium in 1982, for example, employers were exempted from social security contributions over a period of six months in an effort to stimulate employment. In Italy, through a law of November 1980, the 2s International Social Security Association, "ISSA News," "Third Meeting of the Heads of ISSA Member Organizations in the English-speaking Caribbean," International Social Security Review, 1183, p. 117. 26 U.S. Department of Health and Human Services, Social Security Programs Throughout the World, p. xiii. 27 Ibid., pp. xii-xiii.

346

PUBLIC SECTOR ACCOUNTS

central government assumed responsibility for ''a reduction in the employers' social security contributions in manufacturing firms and certain other undertakings."28 In Chile, employer contributions for family allowances and unemployment benefits were abolished in 1980, to be financed out of general tax revenue.29 Central governments have also used social security funds as direct creators of employment. For example, in Seychelles, in order to fight unemployment, the social security system "provides subsistence wages to unemployed persons who choose to work on governmentapproved work projects."30 Central governments have also used social security funds to attract foreign workers. In European countries, it has been observed that "where wages are more or less equal, the preference of immigrant workers goes to the countries whose social legislation offers the best advantages"; in Morocco, "social legislation was the means of enticing skilled European manpower to the country shortly after colonization ended.''31 Independent financial management of social security funds has had to give way to the variation of social security benefits and contributions as a fiscal policy instrument to counteract unemployment within the central government's broad mix of economic policies.

I'V. Central Government as Direct Provider of Social Security and Welfare Services The burgeoning size of health, social security, and welfare costs in recent years has stimulated a sharing in the provision for these functions between social security funds and other parts of government. Measurement of social security funds' expenditures alone, or of central government's expenditures excluding social security funds, now fails to portray the full measure of such functions carried out by government. An indication of participation in the provision of health care ser28 International Social Security Association, "International News," "Social Security in the Member States of the European Community in 1980," International Social Security Review, 2/81, p. 210. 29 International Social Security Association, "Social Security News," "New Pension Legislation in Chile," International Social Security Review, 2/81, p.198. 30 International Social Security Association, "Social Security News," "Seychelles: Full Employment Scheme Established," International Social Security Review, 2/81, p. 201. 31 Gourja, "Contribution of Social Security to Development," p. 147.

SECTORIZATION OF SOCIAL SECURITY

347

vices by parts of central government other than social security funds is given in Table 5, which shows budgetary expenditures on health as a percentage of the combined expenditures on this function by central government and social security funds in 20 countries during 1974-84. A wide contrast is evident. In Finland, about 75 percent of all health expenditures are executed inside the budget, followed by the United States and Iceland, with about 40 percent. Other industrial countries listed, however, show low ratios not exceeding 16 percent (Norway in 1977). Latin American countries show ratios ranging from 33 percent in Brazil in 1974 to 73 percent in the Dominican Republic in 1983. The few ratios available for Africa (Cameroon, Djibouti, and Tunisia) suggest that public health in the African countries is offered mainly through health programs carried out directly by central government. Another indication of the magnitude of other social services provided directly by central government can be obtained from Table 6, which shows budgetary central government expenditures on social security and welfare (excluding health) as a percentage of the combined expenditures on this function by central government and social security funds for the period 1974-84. Here, too, contrast is evident. In half of the 16 industrial countries listed, at least 30 percent of social security and welfare expenditures are made by government units inside the budget, with Denmark, Sweden, and Canada showing ratios between 70 percent and 90 percent, and France and Germany showing ratios of about 20 percent. Only Belgium and Italy show ratios not greater than 10 percent. Among developing countries, only 4 of the 16 African countries listed show ratios of 10 percent or less in 1980, while in the remainder up to 67 percent of social security welfare expenditures is carried out by budgetary government units. About half of the nonindustrial European and Middle Eastern countries listed show high but declining ratios of social security and welfare expenditures carried out by budgetary central government, ranging between about 30 percent and 60 percent in the early 1980s, except for Romania, where almost all such expenditures are carried out by the budget. In the Western Hemisphere, most of the Englishspeaking Caribbean countries also show large but declining ratios of budgetary social security and welfare expenditures, ranging from 80 percent in Trinidad and Tobago in 1980 to about 30 percent in Guyana in 1983. Of the 13 remaining countries in this area, Paraguay, Costa Rica, the Dominican Republic, Honduras, and Venezuela show ratios ranging from about 50 percent to 80 percent, followed by Panama, Argentina, Brazil, and Mexico with ratios between 10 percent and 25 percent. The sharing of responsibilities for health, welfare, and social secu-

39 100 66

...

40 100 63

...

72 49 69

... ...

33 100

6 76 6 2 38 8 12 2 53

1975

82 43 73

...

...

33 100

2 39 8 13 2 54

...

7 74

1974

76 49 75 35 38 100 66

... ...

27 100

5 74 6 2 45 8 12 2 51

1976

39 35 100 69

77 48

... ...

25 100

5 71 6 2 46 8 16 1 48

1977

33 33 94 68

79 56

... 63 34 98 67

25 100 10 66 78 63

1 45

1 46 23 100 15

9 74 5 1 39 8

1979

9 71 5 2 40 8

1978

Source: IMF, GFS Yearbook (1985). Note: An ellipsis( ... ) indicates a lack of statistical data that can be reported.

Developing Countries Brazil Cameroon Costa Rica Djibouti Dominican Republic Greece Honduras Nicaragua Panama Tunisia Venezuela

Industrial Countries Austria Finland France Germany Iceland Netherlands Norway Switzerland United States

Country

34 91 62

72 62

...

32 92 67

74 60

20 100 14

1 42

1 44 23 93

8 72 4 1 40 6

1981

8 75 5 1 39 7

1980

o[ Consolidated Central Government Expenditures on Health

29 96 68

74

19

18

...

1 39

8 74 4 1 39 6

1982

Table 5. Central Government (Excluding Social Security Fund) Expenditures on Health as a Percentage

61

73

63

98

36

1 37 24 100 12

7

1984

7

2

9 75

1983

~

c:: ;:;

r.n

zo-1

c::

0

(")

> (")

::;tl

0

o-1

(")

r.n m

1:1!1 r-'

'"0

00

Industrial Countries Austria Belgium Canada Denmark Finland France Germany Italy Luxembourg Netherlands Norway Spain Sweden Switzerland United Kingdom United States Developing Countries Africa Benin Burkina Faso Burundi Cameroon Central African Republic

Countrl::

56

33

25

8 20 14 13 87 24

17

42 10 96 89 35

1974

52

87 19 24 35

76 21

86 20 25 31

11

11

15

8 24 14

42 9 94 83 42 22 12

1976

8

22

23 12

40

43 10 95 84

1975

80 18

49

14 8 85 20 27 29

22

9

41 9 93 80 45 22 14

1977

13

48

7 92 78 47 22 14 8 10 21 ... 10 83 20 31 32

44

1978

5

48

13 81 21

12 82 20 33 31

31

10

34

64

32

15 79 21

11

19 17 5 16 21

48

62 13

...

27

20 77 21

11

10 18 29

48

90

42

1983

71

29

19 77 21

25 11

19 21 9 16

46

90

90

69

42

1982

41

1981

67

32

41 5 91 75 47 20 17 5 10 19

.. .

1980

43 5 91 77 48 21 15 3 12 20

...

1979

7

26

75

30

10

1984

Table 6. Central Government (Excluding Social Security Fund) Expenditure on Social Security and Welfare as a Percentage of Consolidated Central Government Expenditure on Social Security and Welfare

(,/)

1!1

>

~ \C

i!:! ~

0

n

1!1

(,/)

r"

n

0

(,/)

"'I

0

z

0

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i!:!

d

n

Bahrain Egypt Iran, I.R. of Israel

Middle East

Cyprus Greece Malta Portugal Romania

Europe

Malaysia

Asia

Country Cote d'Ivoire Djibouti Mali Mauritania Morocco Niger Rwanda Senegal Togo Tunisia Zaire 40

56

32

56 39

52 47 54

6 49

-

56

33

62 10

53

34

99

32

99

45

59

40

1975

1974

71

37 60

51

40

44

47

91 4

50 31 45

28 56

11

71

36

41 31

99

32 45

34

98

44

33

98 4

61 31 52

99

57

40

69 1

11

52

1978

1

60

52

13 51 1 27

1977

1976

Table 6 (concluded)

47 55

60 11

37 31

99

6 58

34

62 59 10 56 2 42

1979

54

31

11

67

96

33 37

99

... 7 35

48

53 2 29

...

1980 9

63

40

70 9

%

30 36

99

12 39

64

50

56

...

1981

53

36

6

71

96

29

52 61

60

41

1982

6 47 55

64

96

25

54

45

57

44

1983

24 5

25

61

1984

w U1

c:: Ul

~

z

0

> n n

Cl1:10

n

trl

Ul

n

= c

~

0

46

12 67

2 52

29 52

22

18

84

90

78 17 27 2

68 82

68 82

83 24 68

73 21 49 1 46

64

10

83

1 48

20

63

72

83

72 68

84

51 78 87

17 19 21

17 21 16

20 13 17

25 6 18

78

48

81 77

8 48 79

11

14 52 76

21 61

83

9 59 1 45

73

66

16 14 51 77

10 47 77

14 60

84

11

82 19 39

16 15 53 54 74 18

17 38 75

69

80 22

-

26 1 32

77

31

18 17 10

73

11

70

72 22

44

2

-

79 39

16 28 54

65

19

24 66

2 56

-

35

79

15 31 54

43

17

21 62

57

-

28

80

4 18 29 66

38

15

23 55

2

28

23

Source: IMF, GFS Yearbook, (1985). Note: An ellipsis( ... ) indicates a lack of statistical data that can be reported; a dash(-) indicates that a figure is zero or less than half of a significant digit.

Argentina Bahamas Barbados Bolivia Brazil Chile Costa Rica Dominica Dominican Republic Guyana Honduras Jamaica Mexico Nicaragua Panama Paraguay Suriname Trinidad and Tobago Uruguay Venezuela

Western Hemisphere

Ill

>

~ ~

::;!

n c:: !!:!

Ill

U:l

r"

>

n

0

U:l

""

0

z

0

::!

N

!!:!

0

n-'I

U:l

352

PUBLIC SECTOR ACCOUNTS

rity functions between social security funds and other parts of government is reflected also in more closely integrated administrative arrangements. The many ramifications of social security activities in industrial countries have required coordination of social security funds with other central government units in order to economize resources, avoid overlapping of services, promote uniformity of the services provided, and avoid abuse of these benefits. For example, efficient administration of housing benefits available under some social security funds requires close cooperation with the housing authorities of central government. Administration of employment benefits must be integrated with labor market research, placement services, and education policies, which fall outside the confines of social security funds' functions. In the area of health and occupational injury, the prevention of technological risks has required direct central government efforts to make the working environment safer and healthier. In some countries there is evidence of a movement toward centralization of social security programs within one institution, or the turning over of the administrative powers of social security funds to the budgetary central government. In Greece, for example, "in addition to building up national health service, the Government has continued its efforts to bring the many different social security bodies together within one organization."32 In Hungary, "as from July 1, 1984, the management of social insurance was transferred to the State, through a new National Insurance Administration, which carries out its functions with the status of a state body with national competence, coming directly under the Council of Ministries." 33 In Uruguay, under the Constitutional Decree of October 23, 1979, "the administration of social security was centralized in a new General Directorate under the Ministry of Labour and Social Security." 34 As a result, several autonomous social security agencies have been abolished, and their funds transferred to central government. In France, the Social Security Scheme created in 1930 was endowed with International Social Security Association, "International News," "Social Security in the Member States of the European Community in 1984," International Social Security Review, 3/85, p. 309. 33 International Social Security Association, "Social Security News," "Hungary: Transfer of the Management of Social Insurance to the State," International Social Security Review, 4184, p. 444. 34 International Social Security Association, "Social Security News," "Uruguay: Pension Age Raised," International Social Security Review, 2180, 32

p. 208.

SECTORIZATION OF SOCIAL SECURITY

353

a certain degree of autonomy in relation to the public authorities. The institution carried out its activities with limited government intervention. However, "the 1967 Ordinances put an end to 20 years of selfmanagement."35 Structural reforms introduced in 1967 ensured tight control by the state over the institution at the national level: "Both through the exercise of supervision and through the reforms in the system the public authorities have gradually carved out for themselves a decisive role in the management of the institution."36 With the increase in the nature and variety of social services demanded, central governments, particularly among developed countries, have assumed a more active role in the provision of such services as an integral part of budgetary operations, creating the need for coordination with social security funds and making social security funds more dependent on central government guidance and support. An adequate measure of the performance of social security functions in a country has come to require consideration of both the activities of social security funds and those carried out by ministries or departments inside the budget.

V. Importance of Social Security Funds in Overall Government Operations Although evidence of shared responsibilities indicates the inadequacy of measuring the operations of social security funds alone as a gauge of government health or social security functions, the effect of omitting social security fund operations on the adequacy of data representing central government fiscal policy must also be considered. Social security funds may play an important role in any measure of central government operations that is to be used for economic analysis, planning, and policy purposes and for intercountry comparisons. An indication of the magnitude of social security fund operations in financial terms is provided in Table 7, which shows revenue, expenditure, lending minus repayments, and the deficit or surplus as a percent of GOP for social security funds in 60 countries, before consolidation with the rest of central government. Among industrial countries, where social security fund operations are most important, their revenues range from about 15 percent to about 20 percent of Js Antoinette Catrice-Lorey, "Social Security and the State in France: What Management Autonomy Should the Institution Enjoy?," International Social Security Review, 2/83, p. 193. 36 Ibid., p. 203.

1979 1983 1981 1984 1981

1983 1983 1983 1983 1983 1982 1983 1984 1983 1984 1983 1984 1983 1984

Industrial Countries Austria Canada Denmark Finland Germany Iceland Ireland Italy Luxembourg Netherlands Spain Sweden United Kingdom United States Developing Countries

Africa Benin Burkina Faso Burundi Cameroon Central African Republic

Year

Countrr

1.41 1.44 0.59 1.15 1.10

11.94 1.52 7.90 5.32 19.03 9.12 7.33 20.91 14.74 21.95 15.42 8.96 6.05 6.80

Social Security Fund Revenue

1.24 0.65 0.33 0.92 0.89

14.73 0.89 6.64 5.87 19.04 8.43 7.49 20.39 14.76 21.49 15.62 5.44 6.98 7.73

Social Security ExEenditure

0.00 0.00 0.02 0.45 0.00

0.17 0.57 0.00 -0.39 0.00 0.17 0.00 0.00 0.50 0.00 -0.58 1.19 0.00 0.00

Social Security Lending Minus ReEarments

0.17 0.79 0.24 -0.22 0.21

-2.96 0.06 1.26 -0.16 -0.01 0.52 -0.16 0.52 -0.52 0.46 0.38 2.33 -0.93 -0.93

Social Security Deficit or Surplus

Table 7. Social Security Fund Aggregates as Percentages of GDP Before Consolidation with the Rest of Central Government

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Bahrain Iran, I.R. of Israel

Middle East

1984 1983 1983

1.06 1.58 5.18

7.43 11.49 6.45 9.08

1983 1981 1976 1977

Cyprus Greece Malta Portugal

Europe

0.19

1.81 1.56 3.22 1.13 1.49 1.75 1.24 0.73 0.72 0.72 0.37 3.06 4.12 0.25

1981

1983 1980 1979 1974 1983 1979 1983 1980 1980 1983 1982 1984 1982 1983

Malaysia

Asia

Congo Cote d'Ivoire Djibouti Madagascar Mali Mauritania Morocco Niger Rwanda Senegal South Africa Togo Tunisia Za'ire

0.45 1.58 3.99

4.42 11.12 6.46 8.04

0.01

1.18 0.84 2.20 0.83 1.66 1.29 0.88 0.32 0.29 0.72 0.30 1.54 3.60 0.18

0.10 0.00 0.00

0.00 0.00 0.00 0.00

0.00

0.00 -0.04 0.01 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.08 0.00 0.07 0.00

0.51 0.00 1.19

3.01 0.37 -0.01 1.04

0.18

0.63 0.76 1.01 0.30 -0.17 0.46 0.36 0.41 0.43 0.00 -0.01 1.52 0.45 0.07

1:11

Ul

w

01 01

~

c:: 2!!

n

1:11

Ul

I""

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n

0

Ul

....

0

0 z

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Source: IMF, GFS Yearbook (1985).

Western Hemisphere Argentina Bahamas Barbados Bolivia Colombia. Costa Rica Dominica Dominican Republic Guatemala Guyana Honduras Jamaica Mexico Panama Paraguay St. Lucia Trinidad and Tobago Uruguay Venezuela

Country

1983 1979 1983 1983 1981 1983 1979 1983 1983 1984 1976 1981 1983 1982 1982 1981 1981 1984 1984

Year 4.92 2.67 5.39 2.03 2.13 7.33 2.84 0.64 1.40 8.77 1.19 2.21 2.82 8.53 2.00 3.17 1.48 8.77 1.50

Social Security Fund Revenue

Table 7 (concluded)

5.74 0.90 3.21 1.95 2.17 5.% 0.67 0.63 1.45 1.64 0.75 0.49 2.66 6.57 1.53 0.70 0.64 8.68 1.54

Ex~enditure

Social Security

0.00 0.00 0.00 0.00 0.15 0.10 0.44 0.00 0.00 0.00 0.00 0.00 0.03 1.97 0.28 0.00 0.00 0.00 0.04

Re~ayments

Social Security Lending Minus

-0.82 1.77 2.18 0.08 -0.19 1.27 1.73 0.01 -0.05 7.13 0.44 1.72 0.13 -0.01 0.19 2.47 0.84 0.09 -0.08

Social Security Deficit or Su!:£lus

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SECTORIZATION OF SOCIAL SECURITY

357

GOP in 5 of the 14 countries listed in the years shown (1982, 1983, or 1984). The remaining industrial countries show ratios ranging from about 5 percent to about 12 percent, except for Canada, where the low ratio (1.5 percent) reflects the existence of important social security programs within the budget. In the four nonindustrial European countries listed, social security fund revenues range from about 7 percent to about 11 percent of GOP, with Greece showing the highest ratio (11.5). Social security funds are the least important in Africa, where most of the countries listed show social security fund revenue ratios of less than 2 percent of GOP. Approximately half of the Latin American countries listed have social security funds with revenues ranging between 2 percent and 5 percent of GOP, and in five countries revenues are higher, amounting to as much as 9 percent of GOP. About a fourth of the countries listed in Table 7 show deficits of less than 1 percent of GOP. Surpluses shown for the remaining countries fall within a range of 0.01 percent to 2.5 percent, except for Guyana, which shows 7.1 percent. The primary sources of income for social security funds are contributions from employers, employees, and the government and returns on investments of social security reserves. According to the data for social security funds published in the 1985 GFS Yearbook, employers' and employees' contributions account for at least 70 percent of total social security fund revenue in most countries. In Canada, Finland, and Sweden such contributions amount to about 60 percent of total revenue; in Denmark, Egypt, Argentina, and Brazil, between about 40 percent and 50 percent. Whatever their magnitude, social security contributions represent compulsory payments and thus resemble a wage tax. Social security contributions by employers and employees are an important part of the tax structure in many countries and cannot be omitted from the statistics of central government without giving an incomplete picture of tax revenue. To measure the importance of contributions to social security funds in overall central government tax revenue, Table 8 compares central government tax revenue for 72 countries as a percentage of GOP both before and after consolidation with social security funds, for the earliest and most recent years available in the 1985 GFS Yearbook. Again, sharp contrasts in the importance of social security funds are evident. Among industrial countries, the central government tax ratio is raised by only about 1 percent of GOP in Canada, Denmark, and Iceland when consolidated with social security funds, but by as much as about 20 percent of GOP in the Netherlands, followed by about 19 percent in France and about 16 percent in Germany. About a third

358

PUBLIC SECTOR ACCOUNTS

of the industrial countries show tax ratio increases ranging between 10 percent and 13 percent of GOP when consolidated with social security funds. In the African countries, by contrast, the central government tax ratio increases by less than 2 percent when consolidated with social security funds, except for Tunisia, which shows a 3 percent increase. The effect of including social security funds on the tax ratios of the nonindustrial European countries listed varies from less than 1 percent in Romania to about 12 percent in Hungary. Among Middle Eastern countries, the most noticeable increases as a result of including social security funds in central government tax ratios appear in Egypt and Israel, with 5 percent and 3 percent, respectively. In about two thirds of the Western Hemisphere countries listed, the tax ratio increase from inclusion of social security funds does not exceed 2 percent of GOP, but among the remaining countries the ratio is raised by between 3 percent and 7 percent. The most significant increases (5 percent or more) appear for Brazil, Costa Rica, Guyana, Panama, and Uruguay. It is among industrial countries, as a group, that contributions to social security funds are most important, with 12 of the 18 industrial countries listed showing such contributions of not less than 6 percent of GOP. Although social security fund benefit payments resemble other central government expenditures for these purposes, they may differ significantly in whether they cover long-term risks or short-term risks. Programs providing for old-age, invalidity, and survivors' benefits are characterized by accumulation of large reserves during the initial years of operation to cover future benefit costs. Programs covering sickness and maternity, work injury, unemployment, and family allowances are usually financed out of current contributions, accumulating only small contingency reserves. Overall, however, the importance of social security fund expenditures relative to other central government expenditures shows the same pattern of contrasts between countries as obtained for tax revenues. Table 9 shows central government expenditure as a percentage of GOP both before and after consolidation with social security funds. The consolidation process involves the elimination of all payments between social security funds and the rest of central government before adding the expenditures together. Among industrial countries, the most significant increases in central government expenditure as a percentage of GOP as a result of consolidation with social security funds appear for the Netherlands (about 20 percent), followed by Germany (about 17 percent), Austria (about 14 percent), and Spain (about 12 percent). In seven industrial countries the ratios are increased by between 4 percent and 10 percent

Italy

Ireland

Iceland

Germany

France

Finland

Denmark

Canada

Belgium

Industrial Countries Austria

Country 1975 1983 1975 1983 1975 1983 1975 1984 1975 1983 1975 1984 1975 1983 1975 1982 1975 1983 1975 1984

Year 19.89 20.76 26.09 29.11 16.85 15.37 27.68 31.76 21.30 21.81 18.95 21.16 11.81 11.49 25.02 27.81 24.42 31.88 15.08 25.85

Central Government Tax Revenue, Excluding Social Security Fund Tax Revenue 9.57 11.04 12.53 13.25 0.83 0.88 0.48 1.16 4.36 3.78 14.40 18.65 13.56 16.18 1.20 0.77 4.11 5.32 12.13 13.88

Social Security Fund Tax Revenue

29.46 31.80 38.62 42.36 17.68 16.25 28.16 32.92 25.66 25.59 33.35 39.81 25.37 27.67 26.22 28.58 28.53 37.20 27.21 39.73

Consolidated Central Government Tax Revenue

Table 8. Central Government Tax Revenue as a Percentage of GDP Before and After Consolidation with Social Security Funds

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Ill

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0

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Benin

Africa

Developing Countries

United States

United Kingdom

Switzerland

Sweden

Spain

Norway

Netherlands

Country Luxembourg

1976 1979

Year 1975 1983 1975 1984 1975 1983 1975 1983 1975 1984 1975 1983 1975 1983 1975 1984 16.22 14.07

27.07 12.79 11.62

25.44

Central Government Tax Revenue, Excluding Social Security Fund Tax Revenue 23.22 24.51 27.55 24.02 22.31 26.80 9.59 11.49 26.48 30.52 8.07 9.01

Table 8 (continued)

1.45 1.31

Social Security Fund Tax Revenue 10.93 8.70 18.40 21.08 11.43 11.01 9.32 11.91 2.87 4.80 8.57 9.87 5.41 6.03 5.56 6.66

17.67 15.38

33.10 18.35 18.28

30.85

Consolidated Central Government Tax Revenue 34.15 33.21 45.95 45.10 33.74 37.81 18.91 23.40 29.35 35.32 16.64 18.88

zo-l

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n o-l 0

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Tunisia

Togo

Senegal South Africa

Rwanda

Niger

Morocco

Mauritania

Mali

Central African Republic Congo Cote d'Ivoire Djibouti Madagascar

Cameroon

Burundi

Burkina Faso

1977 1983 1975 1981 1975 1984 1981 1980 1980 1980 1978 1982 1975 1983 1975 1979 1975 1983 1976 1980 1975 1980 1983 1975 1981 1977 1984 1975 1982

12.92 9.79 8.86 11.37 12.63 20.94 13.92 25.43 19.06 21.49 16.53 10.38 20.22 23.94 15.34 15.26 19.80 20.50 11.20 12.30 7.52 10.47 17.70 18.25 20.55 24.11 22.84 19.52 22.75 0.98 1.19 0.15 0.38 0.97 0.70 1.04 1.56 1.27 2.52 2.15 1.73 1.16 1.50 1.01 1.44 1.17 1.24 0.52 0.61 0.47 0.53 0.70 0.25 0.29 1.65 1.80 2.58 3.05 13.90 10.98 9.01 11.75 13.60 21.64 14.% 26.99 20.33 24.01 18.68 12.11 21.38 25.44 16.35 16.70 20.97 21.74 11.72 12.91 7.99 11.00 18.40 18.50 20.84 25.76 24.64 22.10 25.80

rtl

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Countr~

Egypt

Middle East Bahrain

Romania

Portugal

Hungary Malta

Greece

Europe Cyprus

Asia Malaysia

Zai're

1976 1984 1975 1984

1975 1983 1975 1981 1984 1975 1978 1975 1983 1980 1983

1975 1981

Year 1975 1983

8.14 4.04 20.73 21.13

13.39 16.04 16.27 16.66 36.04 19.66 20.23 16.22 24.02 9.35 8.99

18.92 21.91

Central Government Tax Revenue, Excluding Social Security Fund Tax Revenue 21.39 16.91

Table 8 (continued)

0.32 0.93 5.13 5.20

1.67 4.43 7.31 9.57 11.99 3.74 4.95 7.22 7.83 0.69 0.56

0.11 0.14

Social Security Fund Tax Revenue 0.60 0.21

8.46 4.97 25.86 26.33

15.06 20.47 23.58 26.23 48.03 23.40 25.18 23.44 31.85 10.04 9.55

19.03 22.05

Consolidated Central Government Tax Revenue 21.99 17.12

Ul

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Honduras

Guyana

Guatemala

Dominican Republic

Dominica

Costa Rica

Colombia

Chile

Bolivia Brazil

Barbados

Bahamas

Argentina

Western Hemisphere

Israel

Iran, I.R. of

1975 1983 1975 1979 1975 1983 1983 1975 1983 1975 1984 1975 1981 1975 1983 1976 1979 1975 1983 1980 1982 1975 1983 1973 1976

1975 1983 1975 1983 5.51 8.16 13.25 16.12 22.55 22.45 2.44 10.68 11.55 21.75 20.46 9.71 8.49 12.54 15.51 19.54 24.84 16.08 8.88 8.84 7.35 38.34 33.22 10.43 11.97

8.23 5.99 32.49 24.19 3.44 4.48 2.52 1.77 1.98 4.05 1.16 7.13 6.80 3.17 2.39 1.54 1.34 3.80 5.79 2.79 2.17 0.54 0.49 1.25 1.24 1.62 6.99 0.68 0.89

0.74 1.58 3.57 2.83 8.95 12.64 15.77 17.89 24.53 26.50 3.60 17.81 18.35 24.92 22.85 11.25 9.83 16.34 21.30 22.33 27.01 16.62 9.37 10.09 8.59 39.96 40.21 11.11 12.86

8.97 7.57 36.06 27.02 1:!1

Ill

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1:!1

Ill

r"

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Ill

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Country

Source: IMF, GFS Yearbook (1985).

Venezuela

Uruguay

Suriname Trinidad and Tobago

St. Lucia

Paraguay

Panama

Netherlands Antilles Nicaragua

Mexico

Jamaica

Year 1975 1981 1975 1983 1982 1975 1983 1975 1982 1975 1983 1978 1983 1984 1976 1981 1975 1984 1975 1984

23.81 28.04 9.12 14.05 5.67 10.60 24.00 13.78 14.28 8.57 6.46 20.80 25.72 15.75 29.03 34.95 11.43 12.58 25.60 24.56

Central Government Tax Revenue, Excluding Social Security Fund Tax Revenue

Table 8 (concluded)

0.87 1.28 2.22 2.07 3.09 1.60 3.27 6.13 6.14 1.43 1.65 1.46 1.53 1.20 0.83 0.87 6.27 4.81 1.17 0.95

Social Security Fund Tax Revenue 24.68 29.32 11.34 16.12 8.76 12.20 27.27 19.91 20.42 10.00 8.11 22.26 27.25 16.95 29.86 35.82 17.70 17.39 26.77 25.51

Consolidated Central Government Tax Revenue

w

In

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In rtl

~ 1:111

t: n

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Spain

Netherlands

Luxembourg

Italy

Iceland Ireland

Germany

Finland

Denmark

Canada

Industrial Countries Austria

Country 1975 1983 1975 1983 1976 1983 1975 1983 1975 1983 1982 1976 1983 1978 1984 1980 1983 1975 1984 1974 1983

Year 21.99 25.25 20.29 23.24 34.38 44.62 23.32 26.52 15.00 14.51 31.75 36.62 47.96 33.34 46.32 26.87 26.94 33.34 38.16 11.73 18.59

Central Government Expenditure Before Consolidation

30.86

29.56 31.15 31.98 41.10 53.44 41.11 54.76 39.12 37.21 51.34 58.84 19.80

30.88

34.93 39.62 20.60 24.07 34.51 44.% 27.73

Central Government Expenditure After Consolidation 12.94 14.37 0.31 0.83 0.13 0.34 4.41 4.36 14.56 16.64 0.23 4.48 5.48 7.77 8.44 12.25 10.27 18.00 20.68 8.07 12.27

Difference

Table 9. Central Government Expenditure as a Percentage of GDP Before and After Consolidation with Social Security Funds

IJ'J !!I

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Djibouti Madagascar

Central African Republic Congo Cote d'Ivoire

Cameroon

Burkina Faso Burundi

Benin

Africa

Developing Countries

United States

United Kingdom

Country Sweden

1977 1979 1980 1975 1981 1977 1984 1981 1980 1979 1980 1979 1972

Year 1981 1984 1974 1983 1977 1984

23.45 20.58 15.01 20.26 23.34 16.04 21.84 21.13 48.27 30.72 29.66 38.59 19.23

Central Government Expenditure Before Consolidation 41.65 42.78 29.94 34.48 15.78 17.27

Table 9 (continued)

24.49 21.75 15.55 20.46 23.52 16.90 22.68 21.99 49.37 31.46 30.49 40.23 20.22

Central Government Expenditure After Consolidation 44.70 47.10 36.07 41.46 22.45 24.99

1.04 1.17 0.54 0.20 0.18 0.86 0.84 0.86 1.10 0.74 0.83 1.64 0.99

Difference 3.05 4.32 6.13 6.98 6.67 7.72

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al

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Portugal

Malta

Greece

Cyprus

Europe

Zaire

Tunisia

Togo

South Africa

Senegal

Rwanda

Niger

Morocco

Mauritania

Mali

1976 1983 1974 1981 1974 1976 1975 1977

1976 1983 1977 1979 1977 1983 1978 1980 1975 1980 1980 1983 1974 1982 1977 1984 1979 1982 1975 1983 28.86 30.78 23.76 30.25 44.58 39.16 23.99 28.50

30.60 63.70 41.01 36.23 39.38 33.00 16.78 19.25 10.69 14.19 23.70 26.73 19.95 25.24 42.22 35.86 32.43 35.07 36.43 26.14 30.37 32.73 29.85 40.17 48.19 43.47 32.82 33.64

31.72 65.27 42.22 37.26 40.00 33.88 17.03 19.47 10.70 14.31 24.34 27.45 20.31 25.54 43.06 37.03 33.79 37.29 36.88 26.32 1.51 1.95 6.09 9.92 3.61 4.31 8.83 5.14

1.12 1.57 1.21 1.03 0.62 0.88 0.25 0.22 0.01 0.12 0.64 0.72 0.36 0.30 0.84 1.17 1.36 2.22 0.45 0.18

Ul

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1:1!

Ul

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0

Ul

0 ...,

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1:1!

Country

Dominica

Costa Rica

Bolivia Colombia

Barbados

Bahamas

Argentina

Western Hemisphere

Israel

Iran, I.R. of

Bahrain

Middle East

1976 1983 1975 1979 1978 1983 1983 1979 1981 1975 1983 1977 1979

1976 1984 1975 1983 1975 1983

Year

14.95 14.61 17.86 18.82 27.49 26.98 9.18 11.05 12.47 15.13 19.38 32.75 45.75

32.15 24.16 45.24 26.48 58.97 47.16

Central Government Expenditure Before Consolidation

Table 9 (concluded)

17.65 20.25 17.98 19.37 27.65 29.08 10.66 12.24 13.89 19.14 24.26 32.79 45.75

32.17 24.61 45.98 28.06 61.34 48.80

Central Government Expenditure After Consolidation

4.01 4.88 0.04 0.00

1.42

2.70 5.64 0.12 0.55 0.16 2.10 1.48 1.19

0.02 0.45 0.74 1.58 2.37 1.64

Difference

zo-1

1/'J

~

0

> n n

"'

0

o-1

n

1/'J t!l

= c n

~

~

Source: IMF, GFS Yearbook (1985).

Venezuela

Uruguay

St. Lucia Trinidad and Tobago

Paraguay

Panama

Mexico

Honduras

Guyana

Guatemala

Dominican Republic

1977 1983 1980 1983 1972 1984 1972 1976 1975 1983 1975 1982 1975 1982 1981 1976 1981 1976 1984 1975 1984 13.98 13.09 13.38 11.94 33.19 84.58 14.46 16.71 12.32 23.75 25.91 31.14 10.02 10.25 36.24 25.70 29.88 17.33 18.59 22.22 23.40

14.59 13.73 14.79 13.33 33.71 85.67 14.87 17.21 14.70 26.07 31.60 37.67 11.11 11.77 36.86 25.77 30.25 24.17 23.47 23.30 24.68 0.61 0.64 1.41 1.39 0.52 1.09 0.41 0.50 2.38 2.32 5.69 6.53 1.09 1.52 0.62 0.07 0.37 6.84 4.88 1.08 1.28

$

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n

0

Ul

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0

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Ul 1:1:1

n

370

PUBLIC SECTOR ACCOUNTS

as a result of consolidation, and only in three countries (Canada, Denmark, and Iceland) are central government expenditures increased by less than 1 percent of GOP as a result of consolidation with social security funds. Again, the African countries listed show relatively insignificant increases in central government expenditures as a percentage of GOP after consolidation with social security funds, ranging from 0.12 percent in Rwanda in 1980 to 2.2 percent in Tunisia in 1982. Among nonindustrial European countries, the most significant increases from inclusion of social security fund expenditures appear for Greece, with about 10 percent in 1981, followed by Portugal and Malta, with increases of about 5 percent in 1976 and 1977. Middle Eastern countries show increases of less than 2 percent of GOP in 1983-84. Among Western Hemisphere countries, the largest increases in central government expenditure as a result of including social security funds range between 5 percent and 7 percent of GOP for Argentina, Costa Rica, Panama, and Uruguay but are no more than 2.5 percent of GOP in the remaining 14 countries. These results parallel those for the tax revenues of central government and social security funds, with relatively large increases in central government ratios of expenditure to GOP resulting from consolidation with social security fund expenditures in industrial countries, nonindustrial European countries, and several Latin American countries, and relatively small increments elsewhere.

VI. Conclusions Several conclusions are suggested by this analysis of the nature and magnitude of the operations of national social security funds and their relationship to other parts of central government. Reflecting both the evolution of social security needs and broader developments in many economies, social security funds have experienced a trend toward greater financial dependence on central government support, have increasingly been used by central government as a tool for the implementation of broader fiscal policy, and have been paralleled by increasing participation by other parts of central government in the direct provision of social security benefits. These developments have implications for the treatment of statistics on social security fund operations. Insofar as such statistics serve the purpose of alerting or reassuring contributors and beneficiaries about the financial health of these institutions, their separate compilation may be necessary. As a measure of the performance of social security functions, however, data for social

SECTORIZATION OF SOCIAL SECURITY

371

security fund operations alone cannot be viewed as adequately comprehensive. At the same time, because social security fund operations have reached significant proportions in many countries, particularly in industrial countries, their omission detracts appreciably from the usefulness of central government data for purposes of economic analysis, policy making, and cross-country comparison. The persistent contrasts between countries in the proportion of social security functions carried out by social security funds and by other parts of central government, finally, give rise to inconsistencies in any crosscountry comparisons based on either social security funds alone or on other parts of central government alone. The most useful course of action, it would seem, would lie in the initial compilation of data on social security fund operations to show their financial health, followed by the consolidation of such data with the statistics for the rest of central government for the more comprehensive analysis of central fiscal policy and the performance of social security functions.

Part ill FINANCIAL FLOWS AND BALANCES

21 Flow-of-Funds Accounts,

A System of National Accounts, and Developing Countries }OHN C. DAWSON

T

HE PURPOSE of this paper is to survey flow-of-funds (FOF) or national financial accounting in the context of the forthcoming revision of the United Nations' A System of National Accounts (SNA), with special emphasis on the potential of FOF analysis for developing countries. The task has been divided into three main sections. Section I considers the analytical uses of the FOF accounts, using simple data matrices of the sort that could be available in most of the countries of the world. A key scheme for the analysis of financial fluctuations-the saving-investment process-is presented and related to the data matrix. The data are also related both to financial policy problems that are commonly faced by developing countries and to more sophisticated types of projections and programming. In all, the substantial usefulness of FOF data in the formation and execution of public policies in the financial area is emphasized. In Section II the conceptual relations between the FOF accounts and the SNA are examined by considering how certain key features of the SNA standard accounts have evolved during successive revisions of the SNA, with particular emphasis on the representation of finance in the SNA and how financial data should be portrayed in the forthcorning SNA revision (labeled SNA 1993). Section II also addresses the closely related matter of harmonization between the Fund's statistical systems and the SNA as well as the technical problem of relating financial flows and balances in the accounts. Section III considers the procedures to be used in the estimation of FOF accounts in the developing countries. It is demonstrated that an

375

376

FINANCIAL FLOWS AND BALANCES

effective FOF system can now be implemented quickly and easily by most of these countries. The data problems that these countries face, however, are seen to have implications for the design of SNA 1993. Section IV presents conclusions.

I. Analytical Uses of the Flow-of-Funds Accounts

The broad purpose of the FOF accounts, or the sector capital finance accounts as they appear in the SNA, is to facilitate analysis of the operation of the financial system. That is, these accounts aim to interpret the transactions in financial markets carried out by the various economic sectors and to relate these transactions to the behavior of the nonfinancial economy. To this end, the sector accounts record for each sector its capital formation, its gross saving (that is, its operating surplus), and its acquisitions of various types of claims (financial uses of funds) and incurrence of various types of liabilities (financial sources of funds). Financial institutions are separated in the sectoring scheme in order to distinguish their functional role. Finally, the whole can be presented as a technically interlocking matrix with balancing cross and down totals. Tables 1 and 2 present simple examples of this type of matrix format that could be currently produced by most of the nations of the world. The analytical power of the FOF system of accounts-like that of the income and product accounts-stems fundamentally from the interlocking character of the system-from the cross and down totals that balance for every period. Social accounting consistency requires that a flow change in any matrix cell be accompanied by corresponding changes in at least three other cells. For example, if increased government capital formation is to be financed by government debt issues, some sector must absorb the issues. To do so that sector must have larger sources of funds or must reduce other acquisitions. By making use of this feature in various forms, it is often possible to trace the impact of each sector's financial behavior on the others and eventually on the nonfinancial economy, or vice versa. In the following four subsections, the intent is to indicate the range of different forms of FOF analysis. The level of detail naturally depends on the sector and the transaction detail available in the accounts, but the focus here is on condensed matrices of the sort that many countries are able to construct. Although the emphasis is on structures that are best revealed by the matrices, substantive work would be largely expressed as time-series analysis.

142

6

109

-51

27

u

142

6

1

159

-24

5

5

92

-27

27

92

u

92

6

4

77

5

5

Central Bank

117

10

80

14

117

-2

23

464

16

144

12

304

u

-53 93

3

5

2

1

u

Commercial Banks

464

-20

109 6 80 38

251

5

Other Domestic Sector

Table 1. Financial Flow Matrix I

87

33

54

97

u

87

2

-12

97

5

Rest of World

Note: "U" indicates uses of funds; "S" indicates sources of funds; a dash(-) indicates that the entry is zero.

Total sources, uses

Other claims and discrepancy, net

Foreign assets

Other domestic debt

Other loans and advances

Central bank advances

Central government loans

Central government debt

Currency and deposits Bills, bonds, and loans:

Net lending ( + ), borrowing (-)

Gross saving

Gross capital formation

Item

Central Government

u

0

8

-9

-

-

-2

17

902

43 -21

176 109 27 80

156

-14

-

-

332

u

Total

-

5

Discrepancy

902

-

43 -21

176 109 27 80

156

332

5

~

(/)

~

g

n

~

(/)

0

z

11 ~

~

6

Note: See Table 1.

Total sources, uses

discrepancies, net

Currency and deposits Bills, bonds, and loans: Central government debt Central government loans Central bank advances Other loans and advances Other domestic debt Foreign assets Other claims and

Gross capital formation Gross saving Net lending ( + ), borrowing (-)

Item

142

6

109

-51

27

u

142

6

1

159

-24

5

Central Government

39

7

-1

-47

33

u

39

20 126

10

9 -2

13 1

21

5

88

126

6

-99

120

u

Government Enterprises

19

-14

5

Provincial Government

5

92

-27

27

92

u

92

6

4

77

5

5

Central Bank

117

10

80

14

12

2

1

u

117

-2

23

93

3

5

Commercia! Banks

14

2

8

3

1

1

u

14

3

3

6

1

1

5

Nonbank Financia! Institutions

Table 2. Financial Flow Matrix II

302

13

138

92

u

302

-52

45

66

151 243

5

Other Domestic Sector

87

33

54

97

u

87

2

-12

'17

5

Rest of World

u

0

7

-9

-

1 -2

17

-14

-

5

Discrepancy

919

52 -21

27 88

109

176

156

-

27 88

109

176

156

332

5

919

0

52 -21

Total

332

u

'

t/)

Ill

(1

> z

~

0

z>

t/)

~

5

I"'

>

(1

z

'TI

z>

Oci

UJ

FLOW-OF-FUNDS ACCOUNTS

379

Saving-Investment Process Analysis Perhaps the most frequently used structure in FOF analysis is the saving-investment process, by which saving is transformed into ultimate lending, whence it passes through various financial channels to ultimate borrowing, and then into real investment. An important feature of this scheme is the insertion of financial institutions in the center between ultimate lending and ultimate borrowing in order to portray their role as financial intermediaries. The way in which the details of the process are worked into the scheme will vary with the analyst. One such scheme is shown in Figure 1, which is designed to reveal the domestic financing process.l Private saving appears at the right of the figure and, as the arrows indicate, is either placed internally into real investment or into ultimate lending (that is, used to acquire claims). The claims acquired may take any of three major forms: claims on financial institutions, thus placing funds with these institutions; private credit instruments, thus passing funds directly through these markets to finance private ultimate borrowing; or federal securities, thus advancing funds in this market. In tum, financialinstitutions (bank or nonbank), in lending out the funds placed with them, must acquire either federal securities or private claims. Finally, private ultimate borrowing assembles the borrowing from banks, nonbanks, and ultimate lenders, which together with internal financing provides the funds to finance real investment. Federal ultimate borrowing in Figure 1 also assembles the lending of the various sectors and provides the financing for the federal deficit. Here, however, there is also a "feedback" arrow (at the top of the diagram). This is a somewhat awkward expression of the fact that governments often borrow not to finance the government deficit, narrowly defined, but to on-lend the funds. In developing countries this is a key form of finance for government enterprises. In this way general government becomes a kind of financial intermediary. Note that, in effect, in Figure 1 the saving-investment account is split down the middle, with the financial system inserted between. As a result, the placement of saving and the financing of investment appear to be two distinct activities. But they necessarily articulate: whatever saving is placed with the financial system necessarily provides the financing of investment. Further, because saving and real 1 Rest-of-world saving, lending, and borrowing could easily be shown separately in another variant.

Real investment

(B 1)--l

I

1-- (O Z)-i



a

...

h.

I.

Private ultimate borrowin!_j•

Federal ultimate borrowing

c

(E4) - (C3) - (03).

Note: Codes for all flows refer to cells in Table 3. a (Cl) + (Dl) + (El). b (A2) - (Cl) - (Dl) - (El).

Federal deficit

(A 3)--l

I

\IJ ~I

(0 1) + (03)

Nonbank financial institutions

Banking sector

Internal financing

__.,.

tr

0

> z

Ul

~

I'"'

(1

> 6""

""z z>

~

R-R;

R;-R

K-RP

K -RP

Gross accumulation

Long-tenn loans•

Net incurrence of financial assets•

K-RP

Net acquisition of liabilities•

Long-tenn loans•

R;-R

Financing of gross accumulation

-RP

-c

Consumption of fixed capital

-

K-RP

K-RP

R-R;

c

R-R;-C

• The value of the capital good, K, affects the accounts only in the first year; it is therefore omitted from the row and column totals.

R-R;

R; -R

Net lending

R;+C-R

C-R+R;

R;

C-R

Saving

Receipts

Interest received

Operating surplus

-

R; + C -R

R;+C-R

K

C-R

R;

C-R

R;

-K

Gross fixed capital fonnation•

Capital finance account

Disbursements

Final consumption expenditure

Interest paid

Income and outllly account

K-RP

-RP

C-R+R;

R;

C-R

~

~

C)

z

> til

1'11

I"" I""

>

z> n

z

.,

Gross input, of which gross value added

Operating surplus Consumption of fixed capital

Intermediate consumption Adjustment for bank service imputed

Production account

Disbursements

C-R

-c R, -R R,-R

C-R

-c

R,-R

R, -R

Total

R,

Lessee

R,

Lessor

Gross output

Output

Receipts

R,-R

R,-R

Lessor

Lessee

Table 4. Effect of Proposed Change on SNA Production, Income and Outlay, and Olpital Finance Accounts: Lessee Is Final Consumer

R,-R

R,-R

Total

z >

1ft f/1

n

s:z

> z c 1:11 >

f/1

~

0

I"' "!! I"'

n

> z

"!!

~

Income and outlay account

C-R+R;

Disbursements

-

R -R;

R-R;

R;-R

R;-R

K -RP

-RP

Net lending

Gross accumulation

Long-term loans•

Net incurrence of financial assets

-RP

Net acquisition of liabilities•

R -R;

R -R;

K-RP

R;-R

-c

C- R +R;

C-R+R;

R;

C-R

Long-term loans•

Financing of gross accumulation

Consumption of fixed capital

Saving

Receipts

Interest received

Operating surplus

• The value of the capital good, K, affects the accounts only in the first year; it is therefore omitted from the row and column totals.

-RP

-RP

-

-K

C-R+R;

c

K-R

K-R

R-R;

R;

R;

-K

Gross fixed capital formation•

Capital finance account

C- R +R;

Saving

Interest paid Final consumption expenditurea

-RP

-RP

-c

c

C-R+R;

R;

C-R

~ .......

C')

z

> til

!;j

1:""

>

z

n

z> "ll

482

FINANCIAL FLOWS AND BALANCES

In contrast, as shown in Table 3, when the lessee is a government producer or private nonprofit institution, gross value added is changed by (R; - C + R). For GOP as a whole, R; disappears for the reason noted above, but GOP will still change by R - C. H the user is a household (Table 4), for final consumption purposes the good is transferred from gross fixed capital formation to final consumption. Incidentally, this makes consumption of fixed capital decline. Saving is particularly affected in the year of acquisition of the good, but this simply aligns this situation with that which would pertain if the goods had been bought on hire purchase. In addition, both value added and consumption in each year of the contract go down by R, and so does GOP (orR - R; if imputed bank output is allocated to final demand categories). Similarly, if the lessee is a nonresident unit, in the first year the value of the equipment will no longer be gross fixed capital formation, but an export. For other years there is a decrease in the value of exports of services equal to the value, R, of the rental. As a result, GOP also decreases by R. The external sector account will show imputed interest flows and indebtedness resulting (as in the earlier cases) in a shift of net lending toward the lessee sector, in this case the rest of the world. Conversely, if the lessor is a nonresident unit, there will be a decrease in the value of imports of services (rentals) and a corresponding increase in the value added of the lessee (user), hence an increase in GOP. In the first year the capital good will be recorded as gross fixed capital formation of the user (and as an import if the capital good itself comes from the rest of the world).

27 Treatment of Deep-Discounted and Index-Linked Bonds in the National Accounts BRIAN NEWSON AND 5oREN BRODERSEN

securities and deep-discounted bonds take a variety

but have one significant feature in common. In both, the Iassetof forms carries only a fairly low explicit rate of interest (say 0 percent to NDEX-LINKED

2 percent), but the holder of the security is guaranteed some upward revaluation of the principal invested during or at the end of the term of the security.

I. The Problems Posed For the United Nations' A System of National Accounts (SNA), the question then is whether this upward revaluation should be shown in the reconciliation account or as interest in the income and outlay account, possibly distributed over the lifetime of the bond. This paper is based on experience in the European Community (EC) in the 1970s and 1980s, particularly in the United Kingdom and Denmark, where the "imputed" interest payments represented as much as 8 percent of gross domestic product (GOP). The issue, however, would appear to be important for a wide range of countries in conditions of inflation.

Deep-Discounted Bonds Deep-discounted bonds are bonds with a maturity of several years that are issued at a price substantially below their redemption value, sometimes as little as 50 percent of the redemption price. This arrangement is associated with a very low-or even zero-explicit rate 483

484

FINANCIAL FLOWS AND BALANCES

of interest. Investors receive their return mainly from the difference between the issue price and redemption price. For accounting purposes, treating this gain as interest is attractive for several reasons. • It seems to be treating this case in the same way as a "normal" bond, which is issued at or around face value with a higher coupon interest. • It also takes into account the very important point that the increase in the value of the asset (over its complete term, whatever its market value in between) is foreseeable and known to both parties in advance and could almost be said to form part of the contract. • There is also a direct parallel with short-term bills for which the discount is treated as interest, although in this case, of course, transactions occur mainly within one year. However, this approach seems to raise many problems when introduced into an integrated system of accounts. • There are other cases in which differences exist between face value and market value of an asset, hence a risk exists in generalizing this solution. • It introduces an imputation of interest, whereas both the letter and the spirit of the present SNA and European System of Integrated Economic Accounts (ESA)l definitions of "actual interest" seem to preclude such imputations. • It departs from the principle, underlying all financial accounts, of recording transactions as they actually occur. • For the balance sheets, the implication would be that such assets are always valued at the price at which they were first issued, even at redemption time. This is, of course, necessary to avoid holders' benefiting twice-once from the imputed interest, and once from the capital gain on redemption-but it would seem to require several other imputations to balance a complete system of accounts (for example, there is in fact a redemption at the full price, for which other types of assets are used, such as currency and sight deposits). Section II of this chapter shows how the discount on deepdiscounted bonds can be treated as interest, with support from data for Denmark. 1

EUROSTAT,

European System of Integrated Economic Accounts-ESA, 2d ed.

(Luxembourg, 1979).

DISCOUNTED AND INDEXED BONDS

485

Index-Linked Securities Various index-linked savings schemes were developed in the United Kingdom in the inflationary conditions of the 1970s.2 They were designed to protect the capital of small investors-indeed, the first example was government savings certificates known as "Granny bonds" that were available only to old-age pensioners. However, index-linked financial assets also exist in other countries and other sectors. The basic mechanism is that the investor receives a small nominal interest rate (0 percent to 2 percent), but the value of his or her asset increases in line with some price index. Frequently a general retail price index is used, but it could also be an index related to the purposes of the investment, such as an index of housing costs or even of foreign exchange rates. Frequently, too, the whole gain from indexation is only obtained if the investment is maintained for the whole contract period (for example, five years). That is, early redemption is penalized by being granted at a less favorable rate. (This is therefore not the same as actual payment of interest at a rate defined as "2 percent plus the rate of inflation.") There is no disagreement about how to record the initial investment and all interest actually received in the period when they do in fact happen (that is, in the same way as for non-index-linked assets of the same type). The problem is how to treat the index-linked increase in the value of the asset itself. Three treatments of the index-linked component seem possible. • Because there is a revaluation of the principal invested without any transaction occurring, the most obvious solution is to record this upward revaluation only in the reconciliation account. • The increase in the value of the investment that results from indexation could be counted as a capital transfer. Such a treatment is already accorded to nonrecurrent bonus payments on savings granted by general government to households to reward them for their saving carried out over a number of years. • The United Kingdom opted to record the increase in value of the asset as interest. This treatment portrays such assets in a way similar to the normal case of high nominal interest. It does, however, add two imputations: of interest paid out to the household, and of reinFor an excellent discussion, see "The National Accounts Treatment of Index-Linked Bonds," in Economic Trends (London: Central Statistical Office, February 1984). 2

486

FINANCIAL FLOWS AND BALANCES

vestment of the same amount in the asset in order to show in the balance sheet the increasing claim and liability of households and government, respectively.

Time of Recording For both deep-discounted bonds and index-linked securities, it frequently occurs that the capital revaluation is only available to the creditor at the end of the contract period. However, in both cases the value is known (in advance, for deep-discounted bonds; when the price index is published, for index-linked securities). Thus, the imputed interest could be distributed over the life of the asset. Most experts advocate showing this gradual increase in the value of the asset and liability. It is true that for individual contracts there frequently is no legal.liability for the debtor until the end of the term; indeed, early redemption, if allowed, takes place at much less advantageous terms. However, since only a very small proportion of contracts are prematurely terminated, in general it is probably more reasonable to treat outstanding claims as accruing in line with the price index throughout the period.

The Crucial Argument In discussions within the EC Working Party on National Accounts in 1984, 1986, and 1988, experts have been fairly equally divided. Roughly half of these advocated recording transactions as they actually occur and so would record all these revaluations in the reconciliation account, but separately identified so that analysts could combine them with actual interest payments for specific analyses. Other experts considered that these revaluations are a mechanism of equivalent effect to more traditional interest and should be portrayed accordingly. The argument for this behavioral view essentially rests on how creditors and debtors perceive their capital gain. Recording it as interest raises disposable income and saving, although it is not actually available to the household. Do households behave as if their capital gain were interest, a capital transfer, or a revaluation? One vital characteristic of deep-discounted bonds-and, to some extent, of index-linked securities-is that increases in the value of assets and liabilities are foreseeable, guaranteed, and known to both parties in advance and, thus, could be regarded as part of the initial contract. These gains are therefore different in nature from normal

DISCOUNTED AND INDEXED BONDS

487

holding gains and losses arising from changes in market prices of assets, which generally do not affect the liability of the debtor. II. The Concepts in Practice In both the SNA and the ESA, the transaction date for interest is, as a general rule, the date on which the interest falls due. For discounts and upward revaluations of the nominal values of index-linked bonds, this means that the amounts due are accrued up to the date when the bond is redeemed.

Accrual of Discounts and Index-Linked Revaluations as Interest Because bonds are issued in series that are often redeemed by being called (or "drawn") as and when the borrowers pay installments, th~ discounts and index-linked revaluations have to be divided up over time in line with the installment schedule of the bond series. This is illustrated in Table 1, which shows Danish kroner bonds broken down by borrower sector over the period 1982-86. It can be seen from the table that the special installment schedules for government bonds led to a sharp rise in the interest element between 1982 and 1983. The considerable fluctuations in market rates of interest and bond prices during the period 1982 to 1986 had no noticeable effect on the figures shown. However, the fact that market interest rates and the specified bond interest rate move closer together toward the end of the period will lessen the impact of the distributed discount over a period of years. But because the first index-linked bonds of any importance in Denmark were not issued until1982, the upward revaluation through indexing has not yet begun to have any significant effect on the redemption of bonds, although it will be of considerable importance in a few years' time. Whether this interest element will be of greater or lesser significance for the Danish economy in the future will depend, among other things, on the future level of inflation.3 The following paragraphs show how the overall system of accounts-from opening balance to closing balance via the distribution and use of income accounts, financial account, and revaluation 3 The actual procedures used in Danish national accounts for the accrual of discounts as interest are described in "How Discounting on Bonds Is Dealt with in the Danish National Accounts," Annex to Document Bl/CN/59 (Luxembourg: EUROSTAT, 1984).

488

FINANCIAL FLOWS AND BALANCES

Table 1. Discounting and Index-Linked Upward Revaluations of Danish Kroner Bonds, by Installment Periods for Borrower Sectors Sector 1. Public sector 2. Private sector 3. Total

1982 3.7 2.6 6.3

1983

1984

1985

1986

Billions of kroner 9.7 10.0 9.3 2.7 3.0 3.1 12.0 12.7 13.1

9.1 3.2 12.3

Percentage 4. Line 1 as a percentage of the public sector's current expenditure (including line 1) 5. Line 1 as a percentage of the public sector's current .expenditure 6. Line 3 as a percentage of GNP

13

23

18

16

16

1 1

3 2

3 2

3 2

3 2

account-may look when two different definitions of interest are used: actual interest payments (the market interest rate based on the date of issue) and nominal interest. Because the interest is computed according to when it falls due, the actual interest in the examples will have a different time schedule from the one it would have had with a purely mathematical computation. This last point may be illustrated by a comparison of lines 13 and 14 in Table 2. The entries made according to the two definitions of interest are compared, assuming in the one case constant market interest rates over the period under consideration and, in the other, varying market rates. In both cases, the system of accounts is shown one and two years after a bond creditor has acquired a given, newly issued bond holding. It is assumed in the examples that bond creditors acquire only newly issued bonds for a five-year term, on which installments are paid according to the serial loan principal. It is also assumed that the bonds are issued at an annual nominal interest rate of 10 percent and that the bond holding acquired, 1,000 units (for example, a million kroner), on date t0 is large enough for the actual calling of the bonds to correspond to the theoretical probability of their being called. In Table 2 the market-determined quoted value (line 7) and the effect of the shortening of the term on the remaining holding (line 10) are calculated for the whole of the period for which the bond series is to run, assuming a constant market interest rate of 15 percent and disregarding risk elements in the quotation. Lines 4, 13, and 14 respectively show the nominal interest, the actual interest calculated

Face value Installments Outstanding debt Nominal interest (10 percent) Debt service (lines 2 + 4) Market interest rate (percent) Quoted value

7. Total

1. 2. 3. 4. 5. 6.

Item

-240 -1.153

-2204

260 -1.153 240 -1.154

890.15

220 -1.155 723.67

1.15

260 1.152

280.

-1.152

-1.15

200 BOO 100 300 15 280

552.22

1.15

-2203

-1.152

240

1.15

--

200 600 80 280 15 260

12/31 = 1/1 t2

tl

12/31

t0 = 1/1 t 1

300 -1.15

1,000

1,000

t- 1 = 111 t0

12/31

over the Five-Year Term of a Serial Bond

t2

375.05

1.152

-

220

1.15

--

200 400 60 260 15 240

= 1/1 t3

12/31 t3

191.30

1.15

--

200 200 40 240 15 220

= 1/1 t4

12/31

Table 2. Illustrative Calculation of Quoted Value and Interest in Accordance with Varying Definitions 12/31 = 1/1 t 5

0

200 0 20 220 15

t4

t:l

~

II)

zt:l

0

1:1:1

t:l

II!

)(

II!

zt:l

z>t:l

t:l

;!

zc::

0

(')

u;

12/31

89.01

t- 1 = 1/1 t0

6.88

9.48 19.08

21.98 101.98

108.56

11.60

21.98

21.98 121.98

133.58

82.80

81.98

21.98

15.92

1.72

1.58

1.45

93.76

12/31 t2 = 1/1 t3

92.04

12/31 tl = 1/1 t2

90.46

12/31

t0 = 1/1 t1

41.98

28.60

56.36

21.98

8.6

12/31 t4 = 1/1 t5

61.98

21.98

12.48

3.88

1.94

95.70

12/31 t3 = 1/1 t.

• Price increase (line 9) multiplied by outstanding debt (line 3) divided by 100. b Installments (line 2) minus installment (line 2) multiplied by the price of the bond one year before (line 8). c Installments (line 2) minus installments (line 2) multiplied by the price of the bond at date of issue (December 31, year t - 1). d Actual interest calculated on the basis of when it falls due (total for the period= 409.9). e Actual interest calculated on the basis of mathematical price adjustment (total for the period = 409.9).

8. Price (lines [7 + 3] x 100) 9. Price increase (percentage points) 10. Mathematical adjustment of residual holding" 11. Drawing profits following mathematical price adjustmentb 12. Drawing profits excluding mathematical price adjustment (measured in relation to the issue date)

t"l

> z

"JJ

~

DISCOUNTED AND INDEXED BONDS

491

on the basis of when it falls due (nominal interest plus drawing profits measured in relation to the issue price), and the actual interest according to the "mathematical" method (nominal interest, plus mathematical price adjustment, plus drawing profits in relation to quoted values mathematically revalued upward). Line 13 corresponds to the definition of interest used for bonds in national accounts; when compared with line 14, it can be seen that this definition results in a certain deferment of interest compared with the mathematical price adjustment system, but that both interest definitions, when totaled over the whole of the bond term, give the same absolute return: 409.9. The figures in the accounts shown in Tables 3-6 are based on Table 2. In all of them, the accounting system is shown using the actual interest calculated on the basis of when it falls due (on the left-hand side, under main heading A) and nominal interest alone (on the righthand side, under main heading B). All the figures are rounded, which accounts for minor discrepancies. The opening and closing balances and financial account show both nominal (N) values and market (M) values in order to make it easier to understand the entries, which in national accounts are assumed to be entered at market values or the actual values of the transactions. The valuation principles in these fields have been discussed many times in connection with the revision of the SNAIESA and will not be dealt with in this paper. To make the layout clear, only certain transactions in the accounting system have been shown, and the values shown for interest, consumption, investments, bond transactions, and so on have not been selected as a reflection of the conditions prevailing in the economy of any particular country. Accounting System for Actual Interest Under Constant Market Rates of Interest Tables 3 and 4 show the accounting system under a constant market rate of interest. Table 3 shows the opening balance of a newly issued bond holding with a nominal value of 1,000, the issue (market) value of which can be calculated as 890 (compare Table 2, line 7). During the first period, bonds with a nominal value of 200 are called, resulting in a profit of 22 over the issue price, which is included under interest income in the distribution of income account. It can be seen from the financial account that new bonds are bought with the same nominal value as the drawn bonds had, and the closing balance therefore

Disposable income Consumption Saving

Nominal interest Term-shortening effect (due) Disposable income

Bonds

Item

890

1,000

40

82

122

Uses

M

Assets N

100 122

82 18

Use of income account

100 22

Distribution of income account Resources Uses

1,000

890

100

100

Resources

Liabilities

B. Nominal Interest

0Eening balance, year 1 Assets Liabilities N M

A. Actual Interest Calculation on the Basis of When It Falls Due

Table 3. Illustrative Bond Transactions for the Creditor Sector at Constant Market Rates of Interest, Year 1

z

Ul

1!1

t"l

z

~

>

Ill

0

> z

Ul

~

6

I"'

..,>

t"l

> z

..,

~

Note: N, nominal value; M, market value

Bonds

Bonds At drawing Residual holding

Bonds Drawings New purchase Term-shortening effect (due) entered as income Net change in financial assets and liabilities

Saving Investments Net lending ( +) or net borrowing (-)

200 1,000

N 800

902

-178 -

724

M

0

-200 +178 22

Assets

+12

0

-200 +200

Change in assets N M

0

40

-22

40

+22 +12 -+34

902

-178 -

Oosing balance, 1:ear 1 Assets Liabilities N M 800 724

200 1,000

Revaluation account

-22

-200 +178

Financial account Change in Change assets in liabilities M

40

CaEital account

Liabilities

Change in liabilities

18

0

""'~

en

z 0

0

al

0

II!

X

II!

0

z0

z>

0

~

c::

0

n

u;

Disposable income

Interest

Bonds

Item

126

Uses

-

1,000 902

724 178

M

--

Assets 800 200

N

80 20 22 4

100

902

724 178

M

--

Assets 800 200 1,000

N

~ear 2

80 20

Resources

Liabilities

B. Nominal Interest

Distribution of income account Resources Uses

--

Liabilities

Opening balance,

A. Actual Interest Calculation on the Basis of When It Falls Due

Table 4. Illustrative Bond Transactions for the Creditor Sector at Constant Market Rates of Interest, Year 2

~

VI

II!

(')

> z

>

lj 1:11

> z

VI

~

0

r"

'rl

r"

>

(')

> z

z

~

Term-shortening effect (due) entered as income Lending Net change in financial assets and liabilities

New purchase

Bonds Drawings

Saving Investments Net lending ( +) or net borrowing (-)

Disposable income Consumption · Saving

+4 4

+4 4

+40

+178 +36 +26

-40

+200

-200

-40

M

44

-200

N

Change in assets

4

40

82 44

Change in liabilities

M

18

+4 -22

+178 +36

-40

-200

Change in assets

Financial account

40 -22

Capital account

Use of income account 126 82 18

Change in liabilities

---

100

c

zc

~

Ul

0

all

c

I'll

X

I'll

zc

c z> c

;!

z

c:

0

u; n

Note: N, nominal value; M, market value.

Lending

Bonds

Residual holding

Bonds At drawing

Item

--

1,000 4 1,004

40

915

- -4

-911 -

552 145 178 36

600 160 200

-

M

M

N

Assets

-3 0 9 -3 9

N

Change in assets N

--

19 4 9 3 35

M

--

-4 1,004

915

911 4

--

1,000

Closing balance, year 2 Assets N M Liabilities 552 600 145 160 178 200 40 36

liabilities

Liabilities

liabilities

in

Change

B. Nominal Interest

Revaluation account Change in Change assets in

A. Actual Interest Calculation on the Basis of When It Falls Due

Table 4 (concluded)

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l"l

zs:

= >

0

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~

0

r"'

"ff

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l"l

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"ff

z >

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DISCOUNTED AND INDEXED BONDS

497

shows an unchanged holding in nominal terms. However, the market value of the bond holding has risen by 12, owing to the unrealized effect of the shortening of the term on the remaining holding (nominally 800; compare Table 2, line 10). No other revaluations are shown because it is assumed that the market rate of interest remains unchanged at 15 percent. In the financial account, the effect of the shortening of the term4 ( +22), which is posted as income, is entered as a special increase in financial assets at market value, and this figure is also included under bonds drawn at market value (-200). The term-shortening effect entered in the financial account is not intended to be an imputed figure but is an accounting device that is necessary because "drawing profits" are to be classified as both interest income and a negative change in assets. On the right-hand side (under main heading B), it can be seen that drawing profits (measured in relation to the issue price) have to be entered as resources in the revaluation account. The financial closing balance is then shown as the sum of the opening balance, the financial account, and the revaluation account. In period 2 (Table 4) a loss on bond holdings occurs (under main heading A) in the revaluation account ( -3), corresponding to the upward revaluation at the end of the first period of the price of the bonds drawn during the second period. This is because the distributed discount, included under interest in the distribution of income account, is computed to the time of maturity as a drawing profit measured in relation to the issue price (excluding the not-due mathematical upward revaluation as a result of the shortening of the term). The market (mathematical) upward revaluation of the remaining initial holding of period 2 amounts to 9 + 3, which is included in the revaluation account under both headings A and B. Under heading B, the drawing profit is also entered, measured in relation to the value of the bond holding in the opening balance (19 + 4). Lending of +4 is also shown in the financial account, since for the purpose of the illustration it was decided to restrict the reacquisition of bonds to exactly what was needed to maintain a constant, nominal bond holding. The total revaluation of 35 under heading B thus corresponds, under main heading A, to the sum of the term-shortening effect entered as income, 26, as shown in the financial account, and the total revaluation of 9. In connection with national accounts, it is frequently the total earnThe "term-shortening effect" is another way of phrasing "drawing profits" (see Table 2, lines 11 and 12). 4

498

FINANCIAL FLOWS AND BALANCES

ings on investments, corresponding to 35 in the example, that can be seen, for example, in the accounts of the financial institutions that are most often entered as income together with the nominal interest. Since it is proposed to calculate the drawing profits entered as income in national accounts (corresponding to 26 under main heading A of Table 4), the revaluation entry (corresponding to 9 under main heading A) can be calculated as a residual when the total revaluations (corresponding to 35 under main heading B) are known.

Accounting System for Actual Interest Under Variable Market Rates of Interest Tables 5 and 6 show the system of accounts when market rates of interest fall during the first period and rise to their initial level during the second period. In the financial account on the left-hand side of Table 5 (under main heading A), there is a technical set-off to the drawing profits, which in this example is shown both in the distribution of income account as interest ( + 22) and in the financial account as part of the termshortening effect (due) entered as income, and is exactly the same as in Table 3 under heading A. It can also be seen that, as a result of the fall in market interest rates, there has been a rise in the price of bonds, since the newly issued bonds with a nominal value of 200 were acquired at a market value of 180, whereas the initial price for the corresponding bonds was 178. In the revaluation account, the increase in market value is entered for the part of the initial holding that has not been drawn. The market value for bonds with a nominal value of 800 increased from 712 at the start of the period to 732 at the end of the period as a result of the shortening of the term ( + 12) and the drop in interest rates ( +8). The whole of the difference (20) is entered in the revaluation account. In Table 5 under main heading B, further drawing profits ( +22) are entered in the revaluation account, since it is only the nominal interest that appears in the distribution of income account. Under main heading A of Table 6, drawing profits (22 + 4) are entered as income, measured in relation to the issue price and to the price at the beginning of period 2. As in period 1, a set-off is entered in the financial account-a term-shortening effect of 126 entered as income-since the drawn bonds are assessed at transaction values (- 200 - 40). This means that there was an indirect discount when the bonds were drawn, which was the difference between the initial market value in period 2 of the drawn amounts and the market value

Saving Investments Net lending ( +) or net borrowing (-)

82

Disposable income Consumption Saving

0

40

40

122

Uses

1,000

N

Assets

Disposable income

Interest

Bonds

Item

890

M

100

40

122

-22

40

Capital account

82 18

Use of income account

22

Distribution of income ~ccount Resources Uses 100

18

100

Resources 100

Liabilities

B. Nominal Interest

Opening balance, year 1 Assets Liabilities N M 1,000 890

A. Actual Interest Calculation on the Basis of When It Falls Due

Table 5. Illustrative Bond Transactions for the Creditor Sector with Falling Rates of Interest, Year 1 (Beginning of year = 15 percent; end of year < 15 percent)

g

tii

0

~

tn

0

z

0

1:111

0

~

rr:t

0

z0

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0

~

()

Note: N, nominal value; M, market value.

Loans

Bonds

Bonds

Bonds Drawings New purchase Term-shortening effect (due) entered as income Loans Net change in financial assets and liabilities

Item

180

200

912

732

800

1,000

M

N

+22

M -200 +180

Assets

+20

0

-200 +200

N

Change in assets N

2

2

Liabilities

1,000

200

N 800

Assets

Oosing balance, year 1

912

M 732 180

2

2

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n

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~

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Ul

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6

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Liabilities

+2

Change in liabilities

8

+20

+22

-22

-200 +180

M

Change in assets

B. Nominal Interest

Revaluation account

+2

Change in liabilities

Financial account

A. Actual Interest Calculation on the Basis of When It Falls Due

Table 5 (concluded)

Disposable income

Interest

Loans

Bonds

Item Assets

126

Uses -

1,000

800 200

N

912

M 732 180

Assets

1,000

800 200

N

80 20 22 4

Resources

100

Uses -

Distribution of income account

2

2 -

Liabilities

912

732 180

M

80 20

Resources

2

2

Liabilities

B. Nominal Interest

Opening balance, rear 2

A. Actual Interest Calculation on the Basis of When It Falls Due

Table 6. Illustrative Bond Transactions for the Creditor Sector with Rising Rates of Interest, Year 2 (Initial rate < 15 percent; final rate = 15 percent)

0

....~

II)

0

0

"'z

0

~

1!1

z0

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(ii

Term-shortening effect (due) entered as income Lending Net change in financial assets and liabilities

New purchase

Bonds Drawings

Saving Investments Net lending ( +) or net borrowing (-)

Disposable income Consumption Saving

Item

+4

-200 -40 +200 +40

-200 -40 +178 +36 +26 +4 +4

Change in assets M N

4

40

44

82

40 -22

Capital account

82 18

Change in liabilities

+4 -22

-200 -40 +178 +36

M

Change in assets

Financial account

44

126

Change in liabilities

18

100

B. Nominal Interest

Use of income account

J\. J\ctualinterest Calculation on the Basis of When It Falls Due

Table 6 (concluded)

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1:!1

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Loans Lending

Bonds

Residual holding

Bonds At drawing

+4 1,004

1,000

-40

160 200

N 600

+4 915

2

2

40 --

36 --

+4 1,004

1,000

160 200

911

600

M

25

--

+17 +4 +3 +1

+4 915

36 -911 -

552 145 178

Closin8 balance, l:ear 2 Assets Liabilities N M

552 145 178

Assets

-5 -0 +3 - +1 -1

Revaluation account

2

2

Liabilities

z

s

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0

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1:11

0

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z0

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504

FINANCIAL FLOWS AND BALANCES

upon issue ( -5 - 0). These amounts are entered in the revaluation account together with the market value increase on the part of the initial bond holding that was not drawn during the course of the period. This market value increase ( +3 + 1) is a combination of the shortening of the term (rising prices) and rising market interest rates (falling prices). Under main heading B of Table 6, the revaluation account has to include, in addition to the above-mentioned amounts, drawing profits measured in relation to the initial price in period 2 ( + 17 + 4). In this case, the total revaluation remains, with nominal interest, 25, which corresponds to the sum of the balance in the revaluation account and the term-shortening effect entered as income under main heading A of Table 6 ( -1 + 26). This can also be expressed as the balance in the revaluation account under main heading A being equal to the revaluation under main heading B minus the term-shortening effect entered as income under main heading A. The closing balance in Table 6 is 2 less than in Table 4 because the reacquisition of bonds at a nominal value of 200 at the close of the first period cost 180 as a result of the drop in interest rates, whereas when market interest rates were constant they cost 178. In the example shown in Table 6, the bond creditor has financed this difference by borrowing 2.

28 Principles of Valuation and Reconciliation Items in the IMF's Money and Banking Statistics and A System of National Accounts I

(")

....

~

7. Capital gains or losses on disposal/ scrapping of assets

6. Adjustment of fixed capital consumption

Transaction value National accounts residual value Capital gains or losses(NB: historical monuments)

Unforeseen obsolescence Discrepancy between the "risk" componentofFCC and the actual losses of the period. Placing back in activity of totally consumed assets or assets previously become obsolete

I

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z z

0

9. Destruction or wear and tear of stocks by insurable risks

:oods

8. "Assetization" of previously consumed durable

Factors

I

Types of Produced Assets Assets (tangible and intangible)

Financial Assets/ Liabilities (as a reminder: offbalance-sheet liabilities or quasi-liabilities) Nonfinancial intangible assets (patents, leases, trademarks, etc.) Subsoil resources

Table 3 (concluded) Nonproduced Assets Human Physical environments and resources (reminder) living organisms (ecosystems)

Other intangible assets (reminder)

(I)

~ Ill

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1:11

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(I)

6 :E

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n

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12. Changes in classification -Changes in sector -Changes in the nature of assets or liabilities

10. Destruction of assets by non- insurable risks: -Natural catastrophes -Political events 11. Uncompensated seizures

Seizures of financial assets Repudiated debts Uncollectable debts

(reminder)

Frauds on patents, licenses, trademarks (reminder)

$

~

< 111

t"' 111

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0

~

111

~

111

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(I) (I)

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0

111

~

~

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± ±

-

+

± ± ± ±

+

+

+

• For financial assets and liabilities, notes or bearer securities destroyed in a fire are an example.

Revaluation Effect of change in the general price level Effect of change in relative prices Fixed capital consumption adjustment Capital gains or losses on disposal or scrapping of assets "Assetization" of previously consumed durable goods Destruction and wear and tear of stocks by insurable risks Destruction of assets by noninsurable risksa Natural catastrophes Political events Uncompensated seizures Changes in classification Change in net worth

Stock entries Stock exits Fixed assets acquisitions Resale of fixed assets Fixed assets, own-account production Acquisition of financial assets Redemption of financial assets Incurrence of liabilities Refund of liabilities Fixed capital consumption

Item

± ±

-

± ±

+

Changes in Assets Nonfinancial Financial assets assets

Table 4. Variations in Wealth Account in the Absence of Nonproduced Assets

± ±

-

± ±

+

Changes in Liabilities Financial liabilities

(I)

!11

n

z

> !;:

1111

0

> z

(I)

:e

0

I"'

I"'

> ..,

zn

..,

z >

01

~

NONPRODUCED ASSETS AND EXCEPTIONAL EVENTS

571

Table 5. Variations in Wealth Account

Produced assets: Capital finance account Changes in stocks Net saving Gross fixed capital formationa Consumption of fixed capital Capital transfers received (net) Net lending Net incurrence of liabilities Net lending Nonproduced values account

Net acquisition of financial assets

Revaluation ( + or -) Adjustment of the residual value of assets ( + or - )b Destruction and wear and tear of stocks by insurable risks Destruction of assets by noninsurable risks (-) Uncompensated seizures ( + or -)

Change in nonproduced net worth

• Purchases of land or intangible assets n.e.c. are not recorded because it is supposed, for the time being, that such assets do not exist. b Sum of adjustment of fixed capital consumption and capital gains or losses on disposal or scrapping of assets, "assetization" of consumed goods ( + or - ).

• A third component deriving from the balance of movements appearing in the second part of the variations in wealth account (revaluation and the like). The common characteristic of the value generated by these movements is that they do not derive from production (that is, from the value added by production and distributed or redistributed). 4 We will call them nonproduced values. Here they are nonproduced values relating to produced assets or financial assets or liabilities. They are gains or losses that do not derive from normal operations of the period and that are generally called "extraordinary gains or losses" in business accounts. To get back to the SNA familiar accounts (capital finance account), the single variations in wealth account presented in Table 4 merely has to be partitioned for produced assets, as shown in Table 5. In the discussion of nonproduced assets that follows, we will leave aside both human resources, which within the framework of the SNA conventions call for complete treatment in satellite accounts, and also 4 Sectoral changes or changes in asset or liability classification are elements of adjustment that, finally, do not represent a variation in the net worth of wealth.

572

FINANCIAL FLOWS AND BALANCES

Table 6. Variations in Wealth Account Nonproduced assets: CApital finance account Purchases of land (net) Purchases of nonfinancial intangtble assets (net) Net lending (sellers) Net borrowing (buyers)

Net acquisition of financial assets Net incurrence of liabilities Net borrowing (buyers) Net lending (sellers) Nonproduced values account Revaluation ( + or -) Creation of assets otherwise than by production, and the corresponding consumption (+or-) Destruction of assets (-) Uncompensated seizures (+ or -) Change in nonproduced net worth

intangible cultural assets, which have been scarcely noted until recently in analyses of wealth. The other nonproduced assets are sometimes the subject of transactions. H the asset sold is entered in the opening wealth (cultivated land), there is no problem. If this asset does not appear in the opening wealth (as with nonfinancial intangible assets in the SNA sense, identified at the first transaction concerning them), its creation ex nihilo must be accounted for, as a counterpart for its sale; otherwise, the seller would sell something that he does not have.s When these rights lapse, their phasing out of existence must also be shown. Furthermore, if they can be measured, the discoveries of new subsoil resources or the change in the level of exploitability and the decrease in the stock of exploited resources can be shown. Similarly, the natural growth of ecosystems, their depletion, and changes in their characteristics can eventually be shown. The variations in wealth account for nonproduced assets can be compiled as shown in Table6. The accounts drawn up separately for produced and nonproduced assets can now be combined as shown in Table 7. The nonproduced values account thus comprises both nonproduced value movements 5 Of course, if such assets were included in wealth as soon as they were created, independently of any transaction, the recording mentioned in the text would take place at that moment.

NONPRODUCED ASSETS AND EXCEPTIONAL EVENTS

573

Table 7. Variations in Wealth Account

Capital finance account Changes in stocks Net saving Gross fixed capital formation Consumption of fixed capital Purchases of land (net) Capital transfers received (net) Purchases of nonfinancial intangible assets (net) Net lending Net acquisition of financial assets

Net incurrence of liabilities Net lending Nonproduced values account

Revaluation Effect of change in the general price level ( + or -) Effect of change in relative prices (+or-)

Creation of assets otherwise than by production Adjustment of the residual value of assets ( + or - )• Uncompensated seizures ( +)

Consumption of non produced assets Destruction and wear and tear of stocks by insurable risks Destruction of assets by noninsurable risks Uncompensated seizures (-) Change in nonproduced net worth

• Under this heading are grouped factors 6, 7, and 8 of the variations in wealth.

concerning produced assets and value movements (nonproduced, by hypothesis) concerning nonproduced assets. In the present SNA, the nonproduced values account constitutes the largest part of the reconciliation account (seeM 60, Table 7.1 and Table 2 of this paper). Proposals have been made to include part or all of its content in the capital finance account.6 To a certain extent, there would be no problem in doing so. Because the whole set constitutes the variations in wealth account, everything that constitutes wealth in one manner or another is broken out for entry in this account. The breakdown of the variations in wealth account into subaccounts is indeed a very open question, which can be given various answers. The purchases (net of land and nonfinancial intangible assets) are already placed by the SNA in the higher part of the capital finance 6 Nancy D. Ruggles, "Financial Accounts and Balance Sheets: Issues for the Review of SNA," Review of Income and Wealth, Series 33 (March 1987).

574

FINANCIAL FLOWS AND BALANCES

account because they are market transactions bringing about a change in net lending and, correlatively, in financial assets and liabilities. To a certain extent, it is already a matter of "reconciliation" operations with respect to the "normal" sequence of economic operations described by the national accounts. The items relating to nonproduced values could be placed back "at the top," with a "change in nonreproduced net worth" counterpart being introduced to take account of the fact that the movements considered do not have an incidence on net borrowing or lending. A remark must be made in relation to this last point. Because the unilateral noncollectibility of debts, whether explicitly repudiated or not, has been placed among uncompensated seizures (see Table 3), a change in assets and liabilities can appear in the finance account if the cancelled debts are entered in the variations in this account. A statistical adjustment thus exists between the net borrowing or lending and the net change in financial assets and liabilities. In the context of the SNA revision, the position adopted beforehand consists in distinguishing between the cancellation of debts that were the subject of an agreement between the creditor and the debtor-a counterpart would in this case be entered in the capital transfers-and the unilateral cancellation of debts with a counterpart entered in the reconciliation account. In this second case, a statistical imbalance appears between the two parts of the capital finance account. To make it disappear, in the present SNA framework there are two possibilities: either the unilateral cancellation of debts is included in the higher part of the capital finance account in a subcategory of capital transfers (or in a specific item), or else the corresponding changes in assets and liabilities are excluded from the second part of the capital finance account and placed only in the reconciliation account. Let us now come back to the main topic. There is really no definitive argument against mixing what we have called the nonproduced values account (in other words, the main part of the M 60 reconciliation account) with the capital finance account. But should this be done? Let us set aside the measurement difficulty, which is very real for many items but which does not alone control the solutions chosen in a long-term accounting system. Truly, the effective calculation of these items would only be partial and would vary from one country to another for a very long period. The disadvantage would be minor only insofar as, clearly isolated and designated and including a counterpart of an equivalent amount, these items would not hamper the analyses and comparisons. Those who propose the integration solution use a similar consideration, but draw an opposite conclusion. H the items that are difficult to measure are not placed in an account

NONPRODUCED ASSETS AND EXCEPI'IONAL EVENTS

575

considered as having a high priority ranking, then scant efforts will be made to measure the underlying magnitudes. The argument is not unfounded, and it shows that national accounts are widely underdeveloped in most countries and are nowhere totally developed. It is preferable to distinguish the nonproduced values account, provided that it is given conceptual consistency that the present reconciliation account does not have, and as long as it is clearly shown that the SNA framework includes a variations in wealth account that comprises the nonproduced values account, the financial account, and the present capital account (whose name should be changed).7 Regardless of the possible presentation variations, to our mind the variations in wealth account enables one to address more explicitly the question of the relation between income and wealth in the national accounts. The implicit hypothesis in the SNA is that movements in nonproduced values and capital transfers do not influence the measurement of the net disposable income defined as the sum of final consumption and net saving. It follows that net saving is not equal in the national accounts to net change in wealth, and that income is not what can be consumed without tapping one's wealth.s The SNA therefore does not follow either the wisdom of nations, which readily speak of "consuming one's wealth" or "consuming 7 The respective positions of the financial account and the nonproduced values account are conventional. They could be reversed with respect to the presentation made above. The best solution, but one that would probably change habits too much, would be to place the nonproduced values account first by including in it the purchases (net) of land and non-intangible assets, which would make a balance (net) to be financed appear in this account. Placed last, the balancing item of the financial account would then be equal, leaving aside the statistical adjustment, to the total of the balances (net) to be financed of the "capital" account and the nonproduced values account. 8 Recall that consumer durables (households, military goods) do not appear in wealth in the SNA sense; so wealth does not include everything that, at a given time, is available for the future. As regards households (military forces raise more complex problems that have not been discussed in this paper), the exclusion of durables that are actually consumption goods does not matter very much; to give the value of the stock of these goods as a complementary item can be considered sufficient. On the contrary, some durables are acquired and held exclusively or essentially as reserves of value (gold and other precious metals, precious stones, antiques, and the like). Except accidentally, they do not disappear progressively when using them and can be thought of as "financial investment goods." It certainly would be wise to exclude them from consumption and to put the corresponding flows in the capital account.

576

FINANCIAL FLOWS AND BALANCES

one's capital'' with reference to spendthrifts, or economists who have drawn up and perfected a common notion of income. Reference to Hicks is essential here: "We ought to define a man's income as the maximal value he can consume during a week and still expect to be as well off at the end of the week as he was at the beginning. "9 In this commonplace formulation, it is nothing more than the wisdom of nations, or else, as Adam Smith (An Inquiry into the Nature & Causes of the Wealth of Nations, Tome 2, Chapter 2) is quoted by Schumpeter: "neat revenue" was what people, individually and collectively, "without encroaching upon their capital ... can . . . spend upon their subsistence, conveniences and amusements. " 10 But the Hicksian notion comprises many refinements. It is only in ex ante forecasting (short-term) that it is useful to theoretical economists, since it is then revealing of behavior. The wealth referred to is the "capitalized money value of the individual's prospective receipts" or the individual's gain expectations. Expectations concerning changes in the interest rate and in prices intervene. The sum of the incomes of individuals understood that way does not make any sense except arithmetically. "Income is a subjective concept dependent on the particular expectations of the individual in question,'' which do not have any reason to tally with the expectation of any other individual; if the forecasts do not come true, the "value of his (the individual's) prospect at the end of the week will be greater or less than it was expected to be, so that he makes a 'windfall' profit or loss. " 11 In addition, in order to neutralize the effect of fluctuations in receipts, Hicks defined an individual's income as "some sort of standard stream of values whose present capitalized value equals the present value of the stream of receipts which is actually in prospect. "12 Economic definitions on one side, and accounting measurements on the other side (in the national accounts, but also in accountancy more generally), thus appear irreducible. The absence of a link would be total if Hicks had not recognized that ex post income notions have great usefulness, in particular as a convenient measurement of economic progress, that grants them a specific place in economic and statistical history. Furthermore, macroeconomics and econometrics 9 John R. Hicks, Value and Capital: An Inquiry into Some Fundamental Principles of Economic Theory, 2d ed. (Oxford: Oxford University Press, 1946), p. 173. 10 Joseph A. Schumpeter, History of Economic Analysis (Oxford: Oxford Uni-

versity Press, 1954), p. 628. 11 Hicks, Value and Capital, pp. 177, 178. 12 Ibid., p. 184.

NONPRODUCED ASSETS AND EXCEPTIONAL EVENTS

577

have developed approaches and techniques that enable making the theoretically imperfect magnitudes constituted by income and saving, in the SNA sense, "say" things about the behavior of economic agents. The debate therefore cannot be avoided by advocating the ''lack of a bridge.'' The national accounts are indeed confronted, if not with the Hicksian notion of income, for the reasons stated, at least with that of common sense. Recall that the SNA net saving is not equal to the net change in wealth. Its relation to wealth is defined as follows: Net saving = net change in wealth +capital transfers (net) paid -change in nonproduced net worth. If one wishes to introduce into the SNA a "quasi-Hicksian" concept of income, one is faced with the following alternative:

• Include in the current flows of the period ("current" here means the flows of the production and income and expenditure accounts in the sense of the 1968 SNA) capital transfers and operations that make the nonproduced net worth vary (the variations in wealth account is then reduced to the present capital finance account after elimination of the capital transfers item) or • Consider that the central concept of income in the national accounts is, by nature, different from the "quasi-Hicksian" concept and that the latter can be applied only to the set constituted -by the accounts of the "normal" operations of the period accounted for in the production and income and expenditure accounts -and by an "extraordinary" operations account covering the nonproduced values account and possibly capital transfers. This does not mean that putting something in either the normal ("current") or the extraordinary operations account makes no difference. A satisfactory solution has to be found for the difficult problem raised by the treatment of • Direct indexation of financial assets and liabilities • Their indirect indexation through an actual amount of ''something" explicitly directed to the compensation of inflation • Their implicit indexation by means of the "compensation for inflation" component of undifferentiated rates of interest. In effect, if an element of compensation for inflation remains included

578

FINANCIAL FLOWS AND BALANCES

in the interest appearing in current flows (as presently in the national accounts), then current income (consequently current saving, according to the terminology used in the following paragraphs) covers redemption of a part of the real value of creditors' claims and is calculated after refunding a part of the real value of debtors' liabilities. Given the high inflation prevailing in some countries (but the problem in principle is the same everywhere; even low rates of inflation may influence the real value of very large amounts of financial assets and liabilities), the impact on the measurement of (current) income, (current) saving, and net lending of institutional sectors can be very meaningful. A full discussion of this question, of course, is beyond the scope of this paper. As regards the alternative raised when a quasi-Hicksian concept of income is considered for the SNA, a few observations are necessary. It is assumed that the magnitudes in question are known or can be known. Considering the first part of the alternative, one must consider the additive quality of current economic life and extraordinary events. Hicks's analysis may be thought to apply mainly to the former, but Hicks referred explicitly to "windfall losses due to natural catastrophes and war" in one of his concepts of ex post income.t3 From the point of view of wealth value, regardless of its concrete consistency, additivity cannot be discarded. Analysts would probably not like simply substituting new concepts of income and saving for the present ones, preferring instead to see a distinction made between several notions of income and saving. This would bring us back to the second part of the alternative, except for differences in presentation. A specific problem arises in the revaluation of assets and liabilities. The first reaction is to exclude them from the quasi-Hicksian notion of income and saving. Being "as well off at the end of the week as [one] was at the beginning" is being as rich as one started in real terms. To consume the equivalent of the revaluation of one's assets would manifestly mean tapping one's capital. However, these remarks must be qualified. Being as rich in real terms applies to the abstract global value of wealth. H the revalued value of the opening wealth of an economic agent increases more than the general price level, we will say that this agent has grown richer and that an income is constituted, in Hicks's sense, by the difference between the evolution of the revalued value of his wealth and the evolution of that value if the revaluation had been done in terms of the general price level. The 13

Ibid., p. 180, fn. 2.

NONPRODUCED ASSETS AND EXCEPTIONAL EVENTS

579

economic agent could consume this difference while being as well off at the end of the period as he was at the beginning. 14 Conversely, an economic agent obtaining a negative difference should, everything else being the same, reduce his consumption by an equivalent amount in order to remain as well off at the end of the period as he was at the beginning. A distinction must thus be drawn in the nominal capital gains or losses 15 between the two elements that have been isolated in the presentation of the variations in wealth account: • Capital gains or losses linked with relative price movements (real capital gains or losses calculated as the difference between the revaluation of assets or liabilities made with their specific prices, or by using specific price indexes, and the revaluation of the same elements obtained by using a general price index)16 • The effect of changes in the general price level, as just described. The sum of the two constitutes the revaluation, at specific prices, of the assets or liabilities. Only the first element represents capital gains or losses; the second corresponds only to maintaining wealth intact. Finally, one might think about the following accounts on the assumption of concurrent treatment of extraordinary operations (Table 8).17 The sum of current income and extraordinary income 14 Of course, prudence would require the economic agent to make sure about the stable nature of this gain. 15 Nominal capital gains or losses are defined as the difference between the value of the assets (or liabilities) at their date of exit (or end of a period) and their value at the beginning of the period (or subsequent date of entry), with these values being measured at the specific prices of each of the assets (or liabilities) at each of these dates. 16 The choice of the general price level indicator will not be discussed in detail here. Should it relate to the sole assets, or to goods and services (gross domestic product-GOP-or gross national expenditure), or to this last set increased by nonproduced assets that are the subject of transactions or increased by all the nonproduced assets? Let us say simply that this indicator must be unique because it aims to measure the change in real value of money in general. Should it be chosen so that capital gains and losses compensate each other exactly? Not necessarily, for the same reason that it is required to be unique. This would lead to choosing in principle the widest possible cover indicator. 1 7 Recall that throughout this paper the distinction between current or extraordinary refers to the borderline of the production. Thus, some elements of the extraordinary income account can be recurrent, such as the effects of relative price movements and the appearance of patents.

Current income use account Consumption I Current income Current net saving

Current income

Cu"ent income account

Production account

Extraordinary income use account Extraordinary income Extraordinary net saving

Extraordinary income account Capital gains or losses linked with relative price movements Creation of assets Consumption of otherwise than by nonproduced production assets Destruction and wear and tear of stocks by insurable risks Destruction of Adjustment of the residual value of assets assets by noninsurable risks Uncompensated seizures Uncompensated seizures Extraordinary income

Table 8. Parallel Sequences of Accounts

Ul

II!

~

>

Ill

Ul

~ ~

....

> r-o

n

z

z>

....

~

Net incurrence of liabilitiesa Changes in classification Closing liabilities

Uncompensated seizures (net)

Revaluation

Opening Liabilities

Changes in classification Closing net worth

Current net saving + Extraordinary net saving + Capital transfers received (net) = Net accumulation + Effect of change in the general price level = Change in net worth

Opening Net Worth

• To be added "off balance sheet": opening financial quasi-liabilities and quasi-financial assets; opening provisions; changes; closing financial quasi-liabilities and quasi-financial assets; closing provisions. b Of course, on the whole, changes in classification balance each other for assets and liabilities, respectively, and their effect on net worth is zero. But for a given category of asset or liability or for a given institutional unit or sector, the result can be either positive, negative, or zero.

Adjustment of the residual value of assets Uncompensated seizures (net) Destruction and wear and tear of stocks by insurable risks Destruction by noninsurable risks (-) Net acquisition of financial assetsa Changes in classificationb Closing assets

(-)

Purchases of nonfinancial intangible assets (net) Revaluation Creating of assets otherwise than by production Consumption of nonproduced assets

Consumption of fixed capital (-) Purchases of land (net)

Changes in stocks Gross fixed capital formation

Opening Assets

Variations in Wealth Account

~ .......

Ul

~

~

l'll

~

l'll

~ ti 0

~

Ul

l'll

Ul

> Ul

t:l

l'll

~

~

~ z

582

FINANCIAL FLOWS AND BALANCES

corresponds to the quasi-Hicksian income, subject to the acquisition of capital transfers. In a presentation of this type, nothing would go against placing capital transfers in the extraordinary income account. However, this would mean that wealth donations do not "notionally" have the right to exist. For households in particular, the question arises if accounts per category of households are drawn up or if life-cycle types of analyses are made. More broadly, the problem concerns "heritages," including deceased estates. A possible interpretation of the SNA and M 60 would consist in saying that, were these flows known, they would be entered in the "changes in sector" item. But this solution would not be correct because it is the assets or liabilities that are transferred from one institutional unit to another one (and possibly, as a consequence, from one sector to another) and not the institutional units that change sector. It thus appears preferable to choose the solution appearing in the above presentation. In Tasi-Hicksian terms, this could be expressed in the following manner: "the income of an economic agent (of an institutional unit) is the maximal value that he can consume in the period without tapping his wealth (without prejudice, however, to the wealth transfers he can make or receive).'' If the beneficiary of such a transfer uses its amount to increase his consumption, this supplement is therefore not financed by income but by a reduction in wealth. The person who makes the transfer does not undergo a reduction in income. The accounting framework we propose is independent from the precise production concept. If that concept were modified to include the creation of assets that at present are considered as nonproduced, this would change the content of certain items presented without modifying the approach itself. It is therefore not necessary to discuss, for example, the problem of subsoil resources or degradation of the natural environment.

III. Capital Gains or Losses The proposals made in.the foregoing raise many technical accounting questions. In this section we propose to treat only one of these: the measurement of capital gains and losses.

Nominal Capital Gains and Losses The variation in the value of wealth is at the beginning equal to W = E + VNP + PVC,

583

NONPRODUCED ASSETS AND EXCEPTIONAL EVENTS

where W = variation of the value of wealth

E = net savings VNP = operation on nonproduced values not linked with price movements PVC = nominal capital gains or losses. Consider the case of an element q of this wealth, the price of which is p. The value at time t of the wealth is thus Wq(t)

= p(t)q(t).

The instantaneous variation is then dWq(t) = d[p(t)q(t)] = p'(t)q(t)dt

+ p(t)q'(t)dt,

where p(t)q'(t)dt represents the instantaneous flow similar toE + VNP and p'(t)q(t)dt represents the instantaneous nominal capital gains or losses. Over a period represented by the passage of t from 0 to 1, one has

= Wq(1)

[p(t)q(t)JA

- Wq(O)

= 4Wq

wq = 1:p'(t)q(t)dt + tp(t)q'(t)dt. ~~

E + VNP

PVCq

However, this notation in continuous time is not really usable. It is necessary to give an accounting form to this expression in which the time t becomes "discrete." We then have, with i and j > 1, the times when the quantities are modified:

PVCq

= (Pt +

Po)q~

iO

~

L: (pj

iO

jO

.

- p;)q{,

This formulation shows that the nominal capital gains or losses on the element q can be broken down into four terms: (Pt- Po)q~

Revaluation of quantities present all year

iO

584

FINANCIAL FLOWS AND BALANCES

Revaluation of quantities present at the beginning of the year and having left during the year ii

1:

L:

(pi - P;)q{

Revaluation of elements having entered and left during the year.

The valuations for each element q can be added so as to obtain the nominal capital gains or losses for all the wealth of an agent, sector, or nation. The complementary term should be treated in the same way to obtain the sum of saving (E) plus operations on nonproduced values (VNP) not linked with price movements. Note that this expression is in all points similar to the theoretical formula used to calculate the revaluation of stocks of products, materials, and goods. Among the well-known consequences of this identification, also note that the global "capital gain" cannot be calculated by referring only to the wealth at the beginning and end of the period. Global capital gain depends on all the acquisition and resale movements (and more widely, on entries and exits) of the wealth components during the period in question.

Real Capital Gains or Losses The problem of real capital gains or losses relates to comparing nominal capital gains or losses with what would be obtained by valuating the same wealth elements with a general price (or money purchasing power) index. Given k(t) as this index, we will assume that k(O) = 1. The real capital gains or losses will then be [p'(t) - k'(t)]q(t)dt for an elementary period, which can be integrated in the period. We obtain

1:

[p'(t) - k'(t)]q(t)dt.

This is a formula that will be applied here too, wealth element per wealth element. (For elements such as money that do not have a specific price, we consider that p(t) = k(O) = 1.) The accounting translation of this calculation, however, is not obvious. We can proceed in a manner similar to that related in the previous paragraph. The results are summarized in the recapitulative Table 9 (columns 2 and 4). The valuations in column 2 are with reference to the prices at the beginning of the period in which elements of wealth are held; those of column 4 are in reference to end of period. Interpretation of this real capital gain is quite simple: it is the differ-

585

NONPRODUCED ASSETS AND EXCEPI'IONAL EVENTS

Table 9. Recapitulative Table on Real Capital Gains or Losses Calculation Most Coherent with the National Accounts Concepts

PVC

PVC

Item Capital gains or losses on elements kept in the wealth Oatent capital gains or losses) Capital gains or losses on elements having entered in i and present in 1 (latent capital gains or losses) Capital gains or losses on elements present in 0 and having left in j (realized capital gains) Capital gains or losses on elements having entered in i and having left in j (realized capital gains)

PVC 1

P1- Po

Real capital gains or losses (PVR1) 2

Revaluation of the initial purchasing power (RA1) 3

P1- Po - k1Po

k1Po

Real capital gains or losses . (PVR2) 4

-

P1- Po k1 P1 1

P1 -pi

P1- Pi -k1iP1

k1iP1

-

P1- Pi k1iP1 1

Pi- Po

Pi- Po - kjOpO

kjO Po

-

Pi- Pi -kiiPi

kiiPi

+ kli

Pi- Po k;oP; 1

Pi- Pi

+ kl

+ kjO

Equivalent of the final purchasing power (RA2)

5

k1P1 1

+ kl

k1iP1 1

+ kli

k;oP; 1 + kjO

Pi- Pi k;iPi

k;;P;

1 + kii

1 + kii

Note: This table provides the elements for calculating the price elements of the capital gains. They must be multiplied by the corresponding quantities and then added to all the elements of the wealth to calculate the total capital gains or losses. The reader's attention is drawn to the following fact: if in i a certain quantity of the wealth element described here is acquired, on the same date another element is sold for the same amount. The capital gains or losses concerning all the wealth result from the

586

FINANCIAL FLOWS AND BALANCES

Table 9 (continued) Calculation Coherent with Maintenance of the Real Value of the Initial or Final Wealth

PVC

PVC

Real gain on the intitial wealth

Maintenance of the purchasing power of the initial wealth

Real gain on the final wealth

Equivalent of the final wealth purchasing power

(GR1)

(RR1)

(GR2)

(RR2)

Item

PVC

6

7

8

9

Capital gains or losses on elements kept in the wealth (latent capital gains or losses)

Pt- Po

Pt- Po - k,po

k1 Po

Pt- Po k,p,

k,p,

Capital gains or losses on elements having entered in i and present in 1 (latent capital gains or losses) Capital gains or losses on elements present in 0 and having left in j (realized capital gains)

-

1

Pt- Pi

0

Pt- Pi

-

Capital gains or losses on elements having entered in i and having left in j (realized capital gains)

P;- Po -k,po

k, Po

P; -pi

0

P;- Pi

1

Pt- Pi k,p, 1

P;- Po

+ k,

+ k,

k, Pt

+ k,

1 + k,

P;- Po

0

P;- P;

0

(continued)

algebraic sum of the gains or losses relating to the two elements of this transaction. PVC is nominal capital gains or losses; P(t) is the price index of an element of wealth that is studied; p(O) = Po; p(l) = p1; and k(t) is a general price index: k

1

= k(l) '

- k(r) · k k(r) ' 10

= k(~11

- k(O)· k '

1'

=

k(J)- k(r) · k(O) k(r) '

=1

·

587

NONPRODUCED ASSETS AND EXCEPTIONAL EVENTS

Table 9 (concluded) Calculation with Fixed Prices Specific to the Element Concerned PVC

PVC

Item

PVC

Specific price gain with respect to the initial wealth (GPS1) 10

Capital gains or losses on elements kept in the wealth (latent capital gains or losses)

P1- Po

0

P1- Po

0

P1- Po

Capital gains or losses on elements having entered in i and present in 1 (latent capital gains or losses)

PI- Pi

PI- Pi

0

-(pi- Po)

P1- Po

Capital gains or losses on elements present in 0 and having left in j (realized capital gains)

P1 - Po

-(pi-P;)

P1- Po

p,- Po

0

Capital gains or losses on elements having entered in i and having left in j (realized capital gains)

P;- Pi

0

P;- Pi

0

P1

-

Pi

Revaluation ofthespecific price initial wealth (RPS1) 11

Specific price gain on the final gain (GPS2) 12

Revaluation of the specific price final wealth (RPS2) 13

(continued)

The capital gain realized in the third line is the sum of the capital gain of the year in which the element leaves the wealth and of the capital gains of the two preceding types accumulated in the course of the prior periods.

588

FINANCIAL FLOWS AND BALANCES

ence between a permanent revaluation of wealth made by using the specific price variation of goods (if the good does not have a price, like money, its price remains equal to 1) and a permanent revaluation made by using a general index. The real capital gain is positive if the specific prices weighted by the structure of the movements have increased more quickly than the reference index used, and it is negative if the opposite applies. It is natural to conclude that this notion of real capital gain derives logically from the national accounts conventions. It must be the subject of the same remarks as for nominal capital gains; in particular, its valuation depends on all the wealth entry and exit movements. Nevertheless, real capital gain cannot be calculated exactly in practice either in the continuous form or in its two accounting expressions. We have thus included in Table 9 various simplifications that lead to calculable notions and correspond to often-used methods, such as those deriving from the Hicks formulation, if specific importance is attached to the structure of wealth at the beginning or at the end of the calendar period. These solutions are also based on the nominal capital gains or losses and seek to provide a correction taking account of the maintenance of the "real" value of the initial wealth, or to refer to the equivalent in purchasing power of the final wealth. Simplifications consist in abandoning the idea of making corrections for each elementary capital gain or loss and in making a global correction. The calculations can nevertheless be presented so as to be compared with the four configurations of wealth elements: present throughout the year; having entered and not having left; present at the beginning of the year and having left during the year; or having entered and having left (see columns 6 and 8 of Table 9). By aggregating all these elements, real gains can be defined as gains against the initial wealth: GR1 =PVC- k1 W0 ,

where W0 is the wealth on January 1; and as gains as against the final wealth: GR2 = PVC -

k1 W1

1

+ K1

'

where W1 is the wealth on December 31. With respect to the notion of real capital gains or losses (PVR) defined previously, the cumulative effect of the variation of relative prices noted for wealth at each moment is no longer considered. Instead, the current capital gains or losses are compared with the

NONPRODUCED ASSETS AND EXCEPTIONAL EVENTS

589

effect of revaluation of a fixed structure of wealth over the whole period. Finally, we have included in Table 9 a calculation of the capital gains made at fixed prices specific to each of the wealth elements. The result (not directly discussed here) corresponds, for GPSl, to the surplus gain obtained with respect to that which we would have had by keeping the initial wealth; for GPS2, to the same surplus gain with respect to the final wealth. In other words, with the average index of the initial wealth as the k price index, GPSl = GR1; with the average index of the final wealth as the k price index, GPS2 = GR2.

32 Fixed Capital Formation by Owner and User HEINRICH LOTzEL

A System of National Accounts (SNA) and the

T Provisional Guidelines (M 60)1 do not distinguish between the concepts of owner and user when allocating fixed capital formation or HE UNITED NATIONS'

fixed assets to investing sectors (producers). It seems to be obvious that in the SNA fixed assets have to be attributed to the owner.2 For many purposes of the data, this way of recording should indeed be given priority and be included as the predominant concept in the revised SNA. In particular, the owner concept should be used for recording the financing of fixed capital formation, calculating the operating surplus (allocation of fixed capital consumption), and drawing up property balance sheets recording the net worth. H fixed capital formation and the stock of fixed capital are analyzed in conjunction with the production of goods and services (capital stock, capital as a factor of production), it is expedient to record these commodities where they are actually used in production for a long period. This is also what the Guidelines on Statistics of Tangible Assets suggest.3 For the recording of fixed assets, a distinction between the two concepts has always to be made if tangible assets are recorded in

1 United Nations, Provisional International Guidelines on the National and Sectoral Balance-Sheet and Reconciliation Accounts of the System of National Accounts, Statistical Papers, Series M, No. 60 (New York, 1977). 2 The term "owner" is not used here in the strict legal sense, but rather in an economic one. As a rule, the enterprise that enters the capital good on the asset side of its balance sheet is considered as its owner. 3 United Nations, Guidelines on Statistics of Tangible Assets, Statistical Papers, Series M, No. 68 (New .York, 1979).

590

FIXED CAPITAL FORMATION

591

the balance sheets of their owner while they are actually being used in production for a long period by other economic units (in other words, if producers are using fixed assets that are not part of the property of these users). As a rule, the fixed assets thus are rented to producers. Over the past few years, the renting of fixed assets in the form of financial leasing has gained considerable importance (see Chapters 25 and 26 of this volume). This is, from an economic point of view, a special form of financing of fixed capital formation rather than a type of renting in the normal sense of the word. Therefore, it has been suggested that the revised SNA should consider financial leasing as a pure financial activity, on the one hand, and as an acquisition of a fixed asset on credit, on the other. Thus, the assumption is made that the investor immediately takes ownership of the commodity purchased on credit and that this commodity is shown neither as part of the fixed capital formation nor as part of the fixed capital of the lender. Because of these changes in the treatment of financial leasing, the differences between the owner concept and the user concept are substantially reduced in terms of quantity (especially with respect to machinery and equipment). It has to be examined whether the remaining differences owing to the renting of tangible assets are so large that a clear distinction between the two concepts should be drawn in the revised SNA. In the following, some types of renting will be studied, and suggestions will be made about how rented objects should be recorded according to the owner concept and the user concept in the revised SNA. The user concept should be applied only to fixed assets that are employed in production by the user. This is not the case with housing; the lessee is not a producer, but acts as the final consumer of the services rendered by the lessor. According to the user concept, rented dwellings would therefore also have to be attributed to the lessor. The user concept should relate only to fixed assets rented (or leased) for a long period. A period of one year could be chosen as a minimum limit. This would entail that for several types of rentingsuch as renting a car, the renting of film studios, and the short-term "renting" of agricultural or construction machines (including, perhaps, the operating staff)-the rented fixed assets would have to be attributed to the lessor according to the user concept as well. This norm seems to be favorable with regard to both theoretical considerations ("renting" including personnel probably is not renting at all) and practical reasons concerning the statistical realization. As regards application of the owner concept or user concept, three types of leasing have to be distinguished.

592

FINANCIAL FLOWS AND BALANCES

• Leasing to households is always considered as purchasing goods on credit, irrespective of the kind of leasing arrangement. Neither the owner concept nor the user concept provides for a recording of fixed capital formation. A passenger car leased by a household is part of household consumption. • In the case of financial leasing, the revised SNA is to proceed from the assumption that the fixed asset purchased on credit immediately passes into the ownership of the lessee. These fixed assets are allocated to the purchaser (lessee) according to both the owner concept and the user concept. • In the case of operation leasing, the leased object remains the property of the lessor. According to the owner concept, the leased assets thus are allocated to the lessor; according to the user concept, they are attributed to the lessee. Apart from leasing, the "normal" renting of commercial J;"Ooms, or rooms used by general government, of buildings or built-up land is of considerable significance in terms of quantity. For this type of renting, too, the recording of fixed assets differs with regard to the owner concept and the user concept. If the user concept is applied, in the first year of renting an addition to the stock of fixed assets of the lessee and a corresponding loss of fixed assets for the lessor would have to be shown. With respect to the application of the owner concept and the user concept, leased agricultural land, farms, and so on should be treated the same way as rented fixed assets. In isolated cases, which nevertheless may have considerable quantitative effects, legally independent enterprises are founded that only make investments and then rent the assets to another legally independent enterprise. Thus it may occur that an enterprise is subdivided into two corporate enterprises: a producer unit and an investor unit. According to the owner concept, there is no fixed capital formation (or capital stock) attributed to the producer unit. It is even for large-scale investment projects, such as the construction of a nuclear power plant, that such investing enterprises are founded, which then rent the asset to another enterprise (frequently the parent company). In this case it is particularly controversial to use the owner concept, for the fixed capital formation would then have to be allocated to service industries. A possible solution for this problem would be to attribute legally independent enterprises, which render services usually considered as intrafirm ancillary activities and provide these services only to one other enterprise, to the industry to which the enterprise receiving the services belongs.

FIXED CAPITAL FORMATION

593

When disaggregating fixed capital formation by investing producers (industries and other producers in the present SNA), the question arises whether the owner concept may be applied to establishments at all. From a legal point of view an enterprise consisting of several establishments as a whole, and not the individual establishment, is considered to be the owner. Despite this difficulty, the owner concept must also be used for establishments in order to calculate their fixed capital consumption and operating surplus. Therefore, it should be agreed by convention that, in an enterprise with several establishments, fixed assets are allocated to that part of the enterprise where they are used. The individual establishment should always be considered as the owner if the enterprise owns the capital good. This convention seems to be expedient because all other solutions (for example, the enterprise "rents" to its establishments) would entail considerable complications. If, however, the enterprise has rented or leased reproducible assets or land, the establishment should also be considered as lessee. In conclusion, it primarily depends on the intended purpose of the data whether the owner concept or the user concept should be applied for recording fixed capital formation by investors. In the revised SNA the owner concept should prevail, including also the classification of fixed capital formation by producers. The user concept, in contrast, is suitable for analyzing production processes and should be included in the revised SNA as an additional way of recording. In this context, it will be important to show the additions to and the losses of fixed capital as well as the fixed capital (capital stock) in the breakdown by investing producers. It is a quite conceivable and consistent approach to apply the user concept also in the production accounts and the input-output tables. In this case the consumption of fixed capital would have to be reclassified from the lessor to the lessee, and the value of the renting service would have to be reduced accordingly. But because of the additional imputations, the effects on gross output of the renting industry, and the poor additional knowledge to be gained, it is proposed here that the user concept should not be extended in the revised SNA to the core accounts and the input-output tables. In those cases where the user is not the owner, the user concept should be confined strictly to the renting of fixed assets for production purposes on a long-term basis (for a period of at least one year). With respect to the application of the user concept, taking land on lease and renting should be treated in the same way. Despite the fact that it is intended to treat financial leasing as a pure

594

FINANCIAL FLOWS AND BALANCES

financial activity, the remaining types of renting of capital goods are sufficiently important to necessitate an application of the user concept. In Germany, for instance, more than 5 percent of the stock of buildings (excluding dwellings and public civil engineering) are rented by other producers, not including financial leasing.

Contributors institutional affiliations are those at the time when C ontributors' their papers were prepared. Derek Blades Economic Statistics and National Accounts Division, Organization for Economic Cooperation and Development (OECD), Paris Arie C. Bouter Former Assistant Director in charge of the Balance of Payments Division, Bureau of Statistics, International Monetary Fund (IMF), VVashington Soren Brodersen Danmarks Statistik, Copenhagen Marta Castello-Branco Financial Institutions Division, Bureau of Statistics, IMF John C. Dawson Department of Economics, Grinnell College, Grinnell, Iowa Keith G. Dublin Financial Institutions Division, Bureau of Statistics, IMF Vicente Galbis Immediate Office, Bureau of Statistics, IMF Mahinder S. Gill Balance of Payments Division, Bureau of Statistics, IMF George H. Hoezoo Balance of Payments Division, Bureau of Statistics, IMF Emmanuel 0. Kumah Financial Institutions Division, Bureau of Statistics, IMF Jonathan Levin Government Finance Division, Bureau of Statistics, IMF Heinrich Liitzel Statistisches Bundesamt, Germany Khashayar Mahdavy Intern, General Economy Division, Bureau of Statistics, IMF 595

596

CONTRIBUTORS

D. Keith McAlister Balance of Payment Division, Bureau of Statistics, IMF Robert McColl Balance of Payments Division, Bureau of Statistics, IMF Jean-Paul Milot Institut National de Ia Statistique et des Etudes Economiques (INSEE), Paris Brian Newson Statistical and Accounting Coordination Unit, Statistical Office of the European Communities (EUROSTAT) Pierre Luigi Parcu Balance of Payments Division, Bureau of Statistics, IMF Gerard G. Raymond Balance of Payments Division, Bureau of Statistics, IMF Geoffrey J. Robertson Balance of Payments Division, Bureau of Statistics, IMF Edward W. Saunders Financial Institutions Division, Bureau of Statistics, IMF Marianne Schulze-Ghattas Balance of Payments Division, Bureau of Statistics, IMF Abul Siddique General Economy Division, Bureau of Statistics, IMF Mick Silver Consultant, General Economy Division, Bureau of Statistics, IMF Pierre Teillet INSEE, Paris John E. Thornton International Banking and External Debt Division, Bureau of Statistics, IMF IreneTsao National Accounts and Special Projects, United Nations Statistical Office (UNSO), New York Andre Vanoli Director, Department of Statistical Coordination and Accounting, INSEE, Paris Jan van Tongeren National Accounts and Special Projects, UNSO Teresa Villacres Government Finance Division, Bureau of Statistics, IMF

Abbreviations BIS "Blue Book" BOPS

BOPS BOP Yearbook BPM c.i.f. COFOG

DOTS EC

ESA EUROSTAT f.o.b. FOF

Bank for International Settlements (Baste)

TheSNA The data system and compilation methodology used by the IMF in preparing its balance of payments statistics IMF, Balance of Payments Statistics (Washington; available by subscription on magnetic tape, updated monthly) IMF, Balance of Payments Statistics Yearbook, Parts I and II (Washington, annual) IMF, halance of Payments Manual, Fourth Edition (Washington, 1977) Cost, insurance, freight United Nations, Department of Economic and Social Affairs, Statistical Office of the United Nations, The Classification of the Functions of Government, Studies in Methods, Series M, No. 70 (New York, 1980) IMF, Direction of Trade Statistics (Washington, quarterly). European Community EUROSTAT, European System of Integrated Economic Accounts-ESA, 2d ed. (Luxembourg, 1979) Statistical Office of the European Communities (Luxembourg) Free on board Flow of funds 597

598 GOP GFS

GFSM GFS Yearbook GNP lAS IASC

IFS IMF INSEE

ISIC

ABBREVIATIONS

Gross domestic product The data system and compilation methodology used by the IMF in preparing its government finance statistics IMF, A Manual on Government Finance Statistics (Washington, 1986) IMF, Government Finance Statistics Yearbook (Washington, annual) Gross national product International Accounting Standard International Accounting Standards Committee IMF, International Financial Statistics (Washington, monthly and Yearbook) International Monetary Fund (Washington) Institut National de la Statistique et des Etudes Economiques (National Institute of Statistics and Economic Studies) (Paris) United Nations, Department of Economic and Social Affairs, Statistical Office of the United Nations, International Standard Indus-

trial Classification of All Economic Activities,

MBS MBS Guide

Statistical Papers, Series M, No.4, Rev. 3 (New York, 1986) The data system and compilation methodology used by the IMF in preparing its money and banking statistics IMF, Bureau of Statistics, A Guide to Money

and Banking Statistics in International Financial Statistics, draft (unpublished; Washington, 1984)

n.e.c. n.i.e. OECD

Provisional Guidelines

Not elsewhere classified Not included elsewhere Organization for Economic Cooperation and Development (Paris) United Nations, Department of Economic and Social Affairs, Statistical Office of the United Nations, Provisional International

Guidelines on the National and Sectoral

ABBREVIATIONS

599

Balance-Sheet and Reconciliation Accounts of the System of National Accounts, Statistical

SNA

UN UNSO

Papers, Series M, No. 60 (New York, 1977) United Nations, Department of Economic and Social Affairs, Statistical Office of the United Nations, A System of National Accounts, Studies in Methods, Series F, No.2, Rev. 3 (New York, 1968) United Nations United Nations Statistical Office (New York)