How useful in practice are estimates of public sector net worth?

Examining the liabilities and assets of public sector balance sheets may be analytically interesting but its not clear what practical value it has in relation to deciding policy.

The recently developed ONS measure of the UK Public Sector Net Worth has attracted one way and another quite a bit of interest. The OBR has a paper on its website looking at it. Gerard Lyons had an interesting piece about it on Conservative Home and the Financial Times carried an opinion piece looking at the same set of issues by Andy Haldane.

A balance sheet approach to the public sector 

The central ideas around the so-called balance sheet approach to public sector have been around for a long time among UK economist both in and closely connected with the Government Economic Service and in the City of London. I remember an economist specialising in the gilts market, whose usual interest was a close analysis of the flow of funds matrix identifying the potential demand for UK government bonds against its supply, expressing an interest in developing a balance sheet approach to analysing public debt on the UK.

An interesting analytical project

Constructing a comprehensive balance sheet of public sector assets and liabilities is an attractive and interesting analytical project. Where it leads you and what conclusions and practical inferences that it may have for the conduct of fiscal policy is less clear.

Public sector and private sector liabilities and assets are radically different 

This is because one part of the balance sheet involves a direct and unavoidable financial charge - public sector debt. The bonds must be sold and the resulting debt has to be serviced. That has implications for both public expenditure and future taxation. The other part of the balance sheet is public sector assets. Public sector assets do not normally earn a direct financial rate of return that can be used to finance any debt incurred to acquire them. There are public assets that in themselves do not yield a financial return but result in benefits that contribute to an overall better functioning economy resulting in higher economic growth than otherwise. A higher future tax base arising from such growth could be used to service the debt. It is difficult to measure and estimate these benefits with confidence. Where they arise they will do so with a lag many years after costs have had to be financed. 

While financial markets and bond markets are forward looking it would be asking a lot of economic agents to base their judgement on complex and remote analysis of this sort. Many public sector assets contribute to merit goods that do not have necessarily obvious direct or indirect returns, yet still have a direct financial and economic cost, including a deadweight cost that will exceed the cash cost of the expenditure involved. Taxes and bonds have to be collected and issued to finance the expenditure. 

Public sector assets that carry liabilities

Public sector investment often leads to the creation of things that are scored as assets but are in fact liabilities. For many years the UK had a large, nationalised sector that accounted for around ten per cent of the employed workforce, fourteen per cent of total fixed investment and fifteen percent of the Public Sector Borrowing Requirement while yielding around ten per cent of national output. These state-owned monopoly industries incurred huge accumulated losses from the 1940s to 1979. The Nationalised Industries White Paper published in March 1978 reported many years of negative rates of return far below the Test Discount Rate (TDR) of 10 percent that the nationalised industries were expected to earn as set out in the previous 1967 Nationalised Industries White Paper. The 1978 White Paper therefore reformulated the financial objective for the public sector corporations to be a Required Rate of Return of 5 per cent. Those industries scored as public assets were for many years liabilities.

An urban road and pedestrian network with walkways and underpasses, such as those constructed in the centre of the City of Birmingham, at Shepherds Bush in west London and in part of the East End of London were poorly designed, badly lighted and deliberately avoided by pedestrians for fear of crime. They were an asset that continued to have liabilities in terms of maintenance and management, their original cost had to be financed and they generated negative economic welfare as part of a wider urban blight. 

Need to match current spending with the public sector capital stock to get an optimal return

A borrow to invest public sector mindset, backed by fiscal rules that scores borrowing for public sector capital good and borrowing for consumption or revenue expenditure bad leads to a naive distortion of public sector management.  Public sector assets can only deliver their benefits if they are supported by appropriate running costs. A disjuncture between the two was often at the heart of the disappointment with much of Gordon Brown’s New Labour public investment. Over and again new school assets such as laboratories and hospital operating theatres could not be made proper use because there were no science teachers or doctors to work them. Moreover, it aggravates a public and political mistake which is to concentrate on a physically visible thing, usually a building rather than understanding and appreciating the stream of services that it provides that yield utility. As the Plowden Report on Education in the 1960s noted, the quality of education delivered by schools does not correlate with the quality or state of the buildings involved.  

Messing with stocks and flows

There are two important measurement issues involved in the presentation of public sector balance sheets. The first is the presentation of debt and assets in relation to GDP. This is in many respects a meaningless comparator, given that the debt and accumulation of assets are measures of a stock and GDP is a flow of income. 

The problems of defining, measuring and valuing capital – the Capital Controversy

The other difficulty is the measurement of capital, the valuation of the capital stock and the estimate of the return on it. Economists have only to recall the recondite debate on capital between Joan Robinson et al and Paul Samuelson et al. This was not only recondite, but bad tempered and came to little in terms of a conclusion. There are genuine difficulties of definition, measurement and valuation of capital, including public sector capital.

Moreover, how you value a public sector asset depends on the purpose of the valuation. The present use value of a publicly owned school, library or hospital may be close to zero or negative. While its open market value for any use may be very high. How do you measure the value of an asset that either never trades with real prices or only trades rarely in an illiquid market such as property. A distinctive feature of the 1980s privatisation programme was the repeated allegation that assets were undervalued. There were repeated NAO and Public Account Committee complaints about the valuation of the receipts.

The balance sheet approach has been around for almost forty years. The main people who have got excited about it were people looking for reasons to justify higher public expenditure, financed by higher borrowing with the rationale for it dressed up in fancy hooey to avoid engaging with the awkward issues of deadweight cost and assessing the likely financial, economic and social returns.  In principle trying to know more about an economy's capital stock as a whole is very interesting as is more information on the return on it, but it is not likely to be easily accomplished.

Where does a public sector balance sheet approach lead you?

Such ideas are interesting as an exercise in analysis, but they do not contribute usefully to day-to-day policy decisions or in helping to frame them over the longer term. Of course, the unfunded intergenerational liabilities of public sector and the national insurance state pension and potential health costs if properly scored would put a damper on things.

There has been a succession of fads that have coloured thinking about the UK public sector over the last sixty years. They include volume public expenditure planning over a five-year control period, accruals accounting, the private finance initiative (PFI) to avoid proper appraisal of public sector investment analysis and Ryrie Rules on the discount factor applied and the golden rule that borrowing should only before investment over the course of the economic cycle. Most of these initiatives have been intellectually energetic attempts to evade sensible rules that insist on rigorous assessments of public investment, realism about the likely economic return and the costs involved.

Public sector is in a different position to households and corporations in relation to debt 

The public sector is not like a household or a corporation. It has the capacity to mobilise economic resources in a wholly different manner. The power to tax enables the state to borrow and to take on long-term debts in a manner that is beyond the scope of private individuals and corporations. States can finance wars, the consequences of natural disasters, health pandemics and adverse consequences of economic shocks, such as banking crises. Modern integrated international capital markets, moreover, give governments greater access to a global supply of savings. In the 1970s governments, when issuing debt, were constrained by their own local domestic capital market in a world where capital was segmented by national investment markets buttressed by capital and foreign exchange controls. In the contemporary world that has all gone. Governments in advanced economies, such as the G7 have access to a pool of international savings that has a huge appetite for safe so-called ‘risk free’ government bonds, a market of around $50 trillion. In this market the demand for government securities has driven down the historic cost of government borrowing in real and nominal terms.

Avoiding an over accumulation of disappointing performing public assets

The issue is not can governments borrow to finance higher spending and public investment but is it wise to do so and will the returns on the spending exceed their full opportunity and deadweight costs. An enthusiastic generation of politicians are already well placed given the negative real costs of borrowing at the moment to be tempted to borrow to finance favoured projects. Without rigorous assessment of cost and return the danger will be an over accumulation of state liabilities and assets that will often turn out to be long term liabilities themselves.

Warwick Lightfoot

18 May 2023 

Warwick Lightfoot is an economist and was Special Advisor to the Chancellor of the Exchequer between 1989 and 1992. He is the author of Sorry, we have no money: Britain’s economic problem. He took part in a discussion about Public Net Worth which was broadcast by MarketPlace on the American public service broadcasting network.