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Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
What should fiscal policy target? A debate has recently emerged over the merits of focusing on debt and deficits, as now, or a broader measure of public sector net worth, which includes assets and liabilities. So, which is superior? It depends on the question.
In its latest Green Budget, the Institute for Fiscal Studies examines these alternatives and concludes that “the benefits of moving to balance sheet targeting would likely be insufficient to justify the potential costs involved”. Making this the sole target of fiscal policy might be foolish. But so is focusing solely on debt sustainability. Government is a complex activity. Simple targets are dangerous.
A necessary condition for successful government is to avoid a fiscal crisis. For this reason, it makes sense to assess sustainability. Yet even here it is essential to look beyond debt and deficits. Assets matter, too. It is vital to know what they are, not least because better management could improve government income, either directly or via higher tax revenues. This is one of the points made in a forthcoming book, Public Net Worth — Accounting, Government and Democracy, by Ian Ball and several co-authors.
As the IFS itself admits, a focus on deficits and debt can lead to bad decisions. In the UK it led, for example, to selling off the student loan book, merely to lower reported debt, even though the value of the loan book to the government was higher than to private buyers. It led to the mistaken decision to slash public investment after the financial crisis, despite exceptionally low long-term interest rates. It justified the private finance initiative, which replaced visible debt service obligations with invisible (and costlier) future spending.
Some argue that the focus on net debt and deficits forces the government to concentrate on something vital. But too often it has just found costlier ways around its own rules. When it cannot do that, it changes them: according to the Institute for Government, the UK has had nine sets of fiscal rules and 26 specific rules since 1997. This is a joke.
Yet there is a far bigger point, which the IFS ignores. Yes, the government needs to survive financially. I agree. But that is just a means. It is not a government’s end. That is to govern well and so help create a more prosperous society. In order to do this, it has to pay close attention to its own balance sheet as well as that of the country.
Government is a steward. As Oxford’s Sir Dieter Helm argues in his new bookLegacy, it should protect and develop a country’s natural capital, alongside its physical and human capital. Underinvesting, as both the state and the UK as a whole have been doing for far too long, is terrible stewardship.
To do its job properly, the government — the country’s most complex, largest and most enduring organisation — needs at the very least the information a private company would possess and publish about its own financial position. In 2021, for example (according to the IMF), the UK public sector’s net worth was minus 96 per cent of gross domestic product. In the G7, only Italy’s was worse. Surprisingly, Japan’s latest figure (for 2020) was far better, at only minus 16 per cent. The IFS suggests, rightly, that such figures can mislead. But so can a narrow focus on debt and deficits alone. We should be discussing public sector net worth and the national balance sheet, along with debt sustainability. If we did this, we would necessarily discuss many, though not all, of the important political choices. Moreover, we would be doing so quite naturally, as we would be trying to measure reality.
The invention of modern accounting is among the most important advances in human history. Without it, today’s complex economies would be impossible. Its application to national income has immeasurably improved our understanding of economies, too. But we persistently refuse to focus on what such accounts tell us about our governments. We concentrate instead only on the question of whether it is on a path to default. Our ambitions must surely be greater than that. Moreover, even if one focuses only on sustainability, non-debt liabilities — such as public sector pensions — cannot be ignored. These, too, must be included.
In the foreword to Public Net Worth, I argue that “if something is to count, it must first be counted”. Moreover, “it is always far better to be roughly right than to be precisely wrong. Ignoring reality because it is hard to take everything into account, is a big mistake.”
Instead of trusting simple rules that embarrassed governments then change, we must confront reality. Governments do need to survive. But they must also do their job. Without using fuller accounts, they will fail.