Everything Flows

The concept of stocks and flows feels like a rare fragment of economic solidity in a sea of conceptual turbulence. Things flow, and these flows can pile up in heaps to form a stock of that thing, only to later ebb away and flow elsewhere. Nowhere is this account more conspicuous than in our conception, measurement and management of capital, where all three regimes are defined by the stock-flow divide. But are things so solid?

Interestingly, defining capital stocks requires applying another rare economic axiom which, like stocks and flows, is again borrowed from the natural sciences. The principle of conservation means capital accounting goes something like this: The rate at which the capital piles up into a stock is the difference between the inflow of investments and the outflow of depreciations. How the latter are handled is revealing. Depreciations are associated with depreciation rates, borrowed again from the natural sciences and the biophysics of decay. Although apparently reasonable,  investments are not designed to die through decay, but rather to live out their planned working life, hopefully providing productive returns in the process. So why the focus on depreciation rates when a working life appears more in keeping?

The natural sciences have more to say on the matter. In many settings the inverse of a decay rate of a system is the turnover timescale of that system. Take a lake which has a river flowing through it for example. The turnover timescale of this lake is the expected time a molecule of water will dwell there, just like the service life of an asset determines how long it is expected to swim in its pool of capital. But the lake is not stood stock still, it is a slowing of the rivers flow, with the lakes turnover timescale telling us this stock of water does indeed have time units attached to it. It turns out this is a far more general principle than one might imagine. For example, Little’s Law, which has proved so robust in queuing theory, articulates precisely the same dynamic.

Ironically, depreciation rates in capital accounts derive from the expected service life of an asset and the retirements this specifies, not the other way around. Now we see the turnover we are ascribing to capital stocks is telling us these stocks also represent a slowing in the river value flowing through an economy. When we look closer at detailed national accounts we see the full spectrum of this slowing, from the near millennial drift of bridges and tunnels, to the hourly churn of food purchases coursing through our bodies, or the near instantaneous pulse of electrons feeding you this information. This view forces us to put away the dull blade that once divided consumption from investment, to instead see a continuous river of value flowing on all timescales.

The spectrum of capital timescales we observed for an economy is determined by how investments select service lives, pay back times and returns on investment, with slow, low return productive structures being as vital to the functional richness of the economy as the more volatile eddies riding on them. Much like catalysts, the structures that emerge from the slowing of a flow of capital should be what enables valuable, rare events. If so, the spectrum of turnover embedded within national capital accounts provides a fresh lens through which to view the functional richness of economies. This perspective is not restricted to economics. If the ecologist had access to a similar set of accounts for the structural assets comprising the ecosystems they study, they too would abandon their course partitioning of natural capital based on pools, instead seeing the river of productive structures flowing through the landscape.

Stocks flowing is nothing new. The geologists soon realised that the patterns in the rock strata spoke not of solidity, but of flows on a vast scale. All this account needed to reconcile its paradox was to appreciate then relax the observers view of time. Deborah’s Law reminds us of our human biases in this regard, and it is small wonder the same bias has coloured our view of economies where we arbitrarily take the annual cycle to differentiate what is static from what is not. Stand back, and we quickly realise everything is flowing.

The capital-as-flow perspective is not simply academic. The timescales over which the economy transforms itself are a critical component of economic inertia, determining the turning circle available to us when navigating the obstacles ahead. The biggest of these obstacles appears to be climate change, and the spectre of achieving net-zero in under thirty years will certainly strain the more viscous elements of the economy. Of particular concern here is the human capital that has come to dominate both value and productivity across the world. The churn of the labour force is slow, dictated by the careful assembly of careers over decades. Turn the economy too fast and many of the people behind this wall of capital will be left stranded.

Andrew Jarvis, August 2020