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Assets destroyed by natural disasters and wars are not included in consumption of fixed capital (CFC) in the US NIPA or the UN SNA.

Suppose though that the US decided to start including such asset destruction in CFC, and revised all past NIPA data to reflect this.

Certainly CFC will be revised upwards. My question is the following. Which of the following is correct?

  • A: Nominal GDP and nominal gross investment will stay the same, but nominal NDP and nominal net operating surplus will fall by the increase in CFC.
  • B: Nominal GDP and nominal gross investment will increase by the increase in CFC. Nominal NDP and nominal net operating surplus will stay the same.
  • C: Some mix of A and B.
  • D: Something else entirely.

In other words, is the same period investment undertaken to undo the natural disaster's destruction already included in gross investment (option A), or is it counted as intermediate consumption (option B)?

(It does not matter if the investment to undo the destruction does not happen instantly. In the second case, gross investment can end up being negative in the period of the disaster.)

I would have assumed it was obviously option A, but this sentence on the CFC Wikipedia page led me to doubt myself:

Ultimately, the distinction drawn between that portion of business operating expenditure included in CFC beyond depreciation, in contrast to that portion of operating expenditure included in Intermediate consumption may appear rather capricious, rather than theoretically justified.

A reference giving a definite anwer to this question would be particularly appreciated!

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I am answering this both as a PhD in economics and as a Certified Accountant (I am both).

This quote for the wikipedia page is garbage, because it comes after the article has correctly informed the reader that CFC is an estimate that attempts to capture the economic reality rather than the accounting convention as regards consumption of capital for productive purposes.

If we characterize such estimates as "capricious", then all economic theory and econometric practice is "capricious". Certainly there are people who believe that, but one could imagine that we don't think highly of such opinions in this forum. I don't think such across-the-board unsupported criticism can have, or deserves to have, a "definite answer" from some "respectable source". In other words, I do not have to prove that I am not an elephant. Let the other side prove (not just argue) that I am.

More over, the sentence seems to imply that accounting/tax data are somehow "true to the essence of things". My objection to this is not related to the possibility of falsified records to avoid taxation or boost profits etc. This phenomenon exists but all past experience says that it does not exist to such extend as to make accounting/tax data unreliable on the aggregate.

So assume perfectly "honest" accounting data. In what sense are these data true to the essence of things? What is the essence of things here? Is the historical cost (which is a certain piece of information but referring to the Past), relevant for the Present?

Also, the passage appears to ignore that modern official accounting standards (both FASB and IFRS) advocate more and more for using "fair values"/estimates related to balance sheet assets than historical costs, exactly in an attempt to capture the economic reality of things, and in full knowledge that this will lead us to estimated Financial Statements, with a degree of uncertainty, inaccuracy, etc... So what? The purpose of Financial Statements is not perform or reflect account-settling, but to be the base of financial and economic analysis.

We "settle accounts" with the government through the filing of tax returns forms. We settle accounts with customers, suppliers, personnel, banks, etc by using the accounting ledgers, journals, the detailed bookkeeping and records of financial transactions. But we adjust all these data to produce Financial Statements, to the degree that the transactional reality differs from the economic reality. The fact that we may disagree as to what is the economic reality after all, should not surprise us, nor hinder us in the pursuit of relevant knowledge. It will not be the first "reality" that we disagree on.

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  • $\begingroup$ +1 if anything it could be argued that accounting concepts are more capricious. E.g., many accounting systems allow small enterprises to write of let’s say 40% of revenue as cost which from economic perspective is completely absurd in itself and the value of this write off can change (relatively) frequently depending on government whim. This would in addition to the original absurdity imply that the cost of businesses vary with administrations (of course, this is not to disparage accounting - there are valid reasons to set it up in that way) but this makes it more capricious than econ concepts $\endgroup$ – 1muflon1 Nov 15 '20 at 14:04
  • $\begingroup$ This seems more like a comment than an answer to the question. Additionally, your discussion of accounting standards does not seem super relevant precisely because the national accounts concept of CFC is pretty remote from what goes on in business accounts. $\endgroup$ – cfp Nov 15 '20 at 14:08
  • $\begingroup$ @cfp Well, exactly what is the question here? I am asking this because the way your post was structured, eventually put all emphasis on the wikipedia comment, and I responded to that -in relation to which, the discussion of accounting standards is all too relevant. $\endgroup$ – Alecos Papadopoulos Nov 15 '20 at 14:12
  • $\begingroup$ I'd also suggest avoiding credentialism. Answers should stand on their own merits, not on the merits of the credentials you may or may not have. (I also have an econ PhD, but who cares!) $\endgroup$ – cfp Nov 15 '20 at 14:12
  • $\begingroup$ The question was very clearly stated. A, B, C or D. Ideally with a reference. The significance of the quote was nothing to do with the word capricious, and everything to do with the fact that it suggested some asset destruction could end up in intermediate consumption, consistent with B. $\endgroup$ – cfp Nov 15 '20 at 14:14

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