The Index of Wealth of Nations (IWN) measures the accumulation of economic benefits per citizen per year in the European Union and OECD countries. The best-known international comparative measure of wealth, gross domestic product (GDP) per capita, works similarly. The difference between the two is in the approach to public spending. GDP treats spending on final goods equally regardless of its source. In its calculation, a zloty spent by an individual is equivalent to a zloty spent by the public sector. Thus, it does not matter whether the allocation of resources is decided by the government or citizens. The approach used for the IWN is different. Private spending is calculated in the same way as in the calculation of GDP. Government spending, on the other hand, is evaluated by its outcomes rather than its monetary value. The evaluation of a zloty spent by the government depends on how good the public services are.
Private spending should be understood as that part of the economy in which the allocation of resources is decided by private parties (citizens, companies, etc.). To measure it, total GDP must be reduced by non-transfer public spending (transfers are those public expenditures that transfer purchasing power from one group of citizens to another, and thus resource allocation is ultimately decided by citizens). In other words, private spending is GDP reduced by government consumption spending and government investment.
In accordance with the so-called of revealed preference theory while developing IWN, it was assumed that the spending of private entities is optimal. Optimality here means that every zloty spent by citizens satisfies their needs to the highest possible degree. For this reason, private spending is included in the IWN in proportion to its size per capita. It is then adjusted for differences in purchasing power between countries. It makes the amount of said spending more realistic, taking into account differences in price levels between countries. In “expensive” countries, i.e. with a high cost of living, less goods and services can be purchased for a zloty of private spending than in “cheap” countries. In short, the amount of private spending per capita after adjusting for purchasing power is a measure of the real economic benefits coming from citizens’ allocative decisions in the economy.
Government expenditures here should be understood as government expenditures in a sense similar to the national accounts. It takes into account government consumption spending (i.e., on final goods and services for citizens) and government investment. The IWN measures the benefits of public spending by using a special sub-index on the quality of public spending. It evaluates the quality of public services in seven areas that correspond in some degree to the key categories of the OECD’s Classification of Functions of Government (COFOG). It also adds an eighth category to these: freedom of speech, association and information flow, this too is subject to evaluation under the sub-indicator. Country scores in each of the eight areas were calculated by aggregating existing indicators or measures of the quality of each area, sometimes after pre-processing the inputs. A full list of the eight areas, along with the measures used to evaluate them, is provided below.
The results in each area were aggregated, obtaining a public spending quality index taking values between 0 and 100. Since some measures are not calculated for the smallest countries, the IWN doesn’t include Cyprus, Luxembourg, Malta, Iceland and Costa Rica.
The value of the index
The value of the IWN is the sum of the public spending component and the private spending component. The first is directly proportional to private spending per capita adjusted for purchasing power. The second is proportional to the product of average public spending in the European Union and the public spending quality index described above. This second component is further multiplied by a factor called the public spending bonus. In order to obtain a more appropriate evaluation of the importance of public spending, and to avoid the pro-liberal bent of the IWN, the contribution of public spending to the index is multiplied by the factor (1 + bonus). It raises the potential value of public spending relative to the value of private spending. This means that a zloty spent by the government in a perfect way (i.e. in such a way that the quality indicator of public spending takes the maximum value for it) is included in the IWN as (1 + bonus) zloty (e.g. for the bonus value suggested by WEI, i.e. 50%, it will be 1 zloty 50 cents). This solution is in line with the optimistic assumption that governments spend money in areas of the economy where a market regime would yield worse results than state allocation of resources. Most importantly, regardless of the interpretation, the measure described gives an advantage to the public sector, although it may squander it by providing low-quality public services to citizens.
In short, the Index of Wealth of Nations is thus calculated as:
Private spending per capita adjusted for purchasing power + Average EU public spending per capita x Public spending quality index x (1 + bonus)
Customizing the index
Warsaw Enterprise Institute (WEI) gives users the opportunity to customize the IWN to their preferences. The WEI’s suggested parameters for the IWN can be changed using an online tool. This includes the scales of each of the eight areas of public spending, as well as the size of the public spending bonus.