WELLINGTON/STOCKHOLM - National and local governments often waste resources and hide their obligations. Politicians consistently underestimate - or completely ignore - the value of public assets and liabilities. Yet this financial mismanagement attracts far less criticism than when it occurs at listed private companies. Although it is a recipe for poor governance, if not outright corruption, it very rarely features in political debate.

The explanation lies with flawed accounting. Though the topic is far from exciting, poor or risky accounting practices can shake and ultimately bring down entire societies. The accurate measurement of assets and liabilities is crucial for confidence in banks, companies and governments.

The public sector needs better accounting. From Greece to Puerto Rico to Detroit, improved book-keeping could have helped to avoid many of the personal tragedies that resulted from severe fiscal stress or default. Though many governments build up huge amounts of debt, it is not clear at which point this becomes damaging. This uncertainty is less pronounced in the private sector, where accounting gives investors and creditors a clearer picture of a company’s net worth, and therefore its solvency.

National and local governments own subway stations, water utilities, ports, airports, parking lots, office buildings, and more. In aggregate, these commercial assets are often worth more than any asset class listed on the stock market. But they are generally not managed in the best interests of citizens. Better accounting will not guarantee better stewardship. But knowing what assets you own and what they are worth increases the chances they will be properly looked after. Those odds improve further if public sector asset managers are shielded from political interference and given financial incentives to boost returns.

Basic tools such as double-entry bookkeeping, accrual accounting and independent auditors underpin the modern corporation and capital markets. In the past, they helped Britain establish a global empire. Yet our appreciation for accounting’s formative role remains minimal. For too long, governments have been influenced by economists whose perspective on the management of public finances is limited to simple measures of cash flow and debt, ignoring balance sheet assets and liabilities. This would be like trying to manage a modern corporation using only the information available from cash transactions recorded in its bank accounts. Corporate managers demand more complex information. So should governments.

Politicians instinctively understand the risks associated with adopting a more rigorous approach to public accounting. It would constrain their spending and even potentially call into question their legitimacy. When the French Crown's accounts were published in 1781, the revelation of the disastrous state of the public finances provoked an outcry that helped fuel the French Revolution.

Today governments in countries such as Turkey, Argentina and Pakistan are facing significant fiscal problems. In the United States, many cities and states are also in trouble as a result of large pension liabilities which have been badly accounted for. The path from poor accounting and management of public assets to financial distress may not be linear. After all, most governments have the power to raise taxes, and can print money to stave off a fiscal meltdown. But fiscal strain is often visible in the failure to maintain basic services and infrastructure.

Nearly 30 years ago, New Zealand’s public finances were in a similarly poor state. This led to some remarkable actions. The government implemented its financial management reforms, leading to the adoption of accrual accounting for budgeting, appropriations, and financial reporting. In effect, the government held itself to the same accounting standards that it required of the private sector. It was the first nation to undertake reforms of this kind.

Since the crisis of the early 1980s the New Zealand government has increased its net worth, principally by running a budget surplus in most years. Since the reforms were completed in 1994, it has achieved and maintained significantly positive net worth. Comparable governments like Australia and Canada, as well as larger countries such as the United Kingdom or United States, have liabilities that greatly exceed their assets. What’s more, New Zealand’s net worth has rebounded from the global financial crisis in a manner that demonstrates significantly greater fiscal resilience.

Yet this example of the value of fiscal prudence and financial management remains an outlier. Governments of other developed economies have adopted or are moving towards accrual accounting. But they tend to use this information primarily for reporting and transparency, rather than for fiscal management. This is because economists tend to manage the budget process. In contrast, New Zealand deploys more accountants in key fiscal management roles.

We rely on engineers to design and build sturdy bridges. To build robust public finances, we need more accountants. This will benefit societies today and reduce the burden on future generations.

 

CONTEXT NEWS

- Ian Ball is Professor of Public Financial Management, Victoria University of Wellington, New Zealand.

- Dag Detter is an investment adviser and author, with Stefan Folster, of “The Public Wealth of Nations: How Management of Public Assets Can Boost or Bust Economic Growth”.

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(Editing by Peter Thal Larsen and Bob Cervi)