“It is the net worth of the government that should be the focus, not its debt.”
Dag Detter is Principal, Detter & Co
Stefan Fölster is Director, Better Future Economics
Josh Ryan-Collins is Head of Finance and Macroeconomics, UCL Institute for Innovation and Public Purpose
This blog was first posted on the IIPP web site
The UK Chancellor chose to freeze public sector pay in his spending review as the Treasury seeks to improve the state of the public finances after spending more than £200bn on the Covid crisis.
But might there be a better way of dealing with the ongoing economic costs of the pandemic? In a new IIPP report we argue that the government should consider taking equity stakes in firms at risk of collapse to boost a sustainable recovery. Not only would this be preferential to piling up more publicly guaranteed debt on already highly indebted firms, but, once the economic situation has improved, it could generate a fiscal return.
The advantage of equity investment is that the state and taxpayers can recover their money when an ailing firm gets back on its feet and is either sold off; or, in other cases, the state can make a longer-term investment, hopefully attracting in other forms of finance to support firms that private investors are not yet prepared to invest in. This avoids the socialisation of losses and privatisation of risk problem that has often occurred during financial and economic crisis.
Widespread government equity ownership in hundreds of thousands of small firms is neither desirable nor practically possible. But well-targeted state investments could help pull economies out of the recession and support longer term policy objectives at the same time.
However, how to govern public assets to generate value has received little attention compared to the vociferous debate over whether or not to nationalise or privatise. If poorly managed, public equity bailouts risk damaging growth prospects.
Reviewing the evidence on state-owned enterprises across many countries, we find that they can be run effectively providing that the government ownership is institutionalized according to the highest standards of corporate governance and structured as ‘public wealth funds’ (PWFs) that combine arms-length independence from day-to-day politics with active and competent public governance.
The report argues for the creation of five different specialised PWFs: a National Wealth Fund in charge of mature assets such as airlines or energy companies; ‘mission-driven’ venture capital funds focused on innovation, climate transition and regional growth; and regional Urban Wealth Funds to support housing and urban renewal.
Successful examples of PWFs include Singapore which used these vehicles to help turn themselves from an economic backwater to one of the world’s richest countries in the space of a few decades from the 1970s onwards and a number of cities, such as Copenhagen’s City & Port Company and Hamburg’s HafenCity.
The costs of financing PWFs would be low. Even assuming that the suggested equity investments lose their value, the direct fiscal cost of investing in the above-mentioned funds would be small, only around 0.1 percentage points of GDP per year. Moreover, over time some of these investments would likely turn a profit. Historically, the yield on equity has been around 6 percent.
Managing public assets more professionally would also incentivise a wider rethink of public sector accounting, which is currently too focused on debt and short-term cash measures, and largely neglects public sector assets. A better approach for public sector accounting would be to focus on net worth (assets less liabilities) as the most comprehensive fiscal measure using accrual-based accounting. This takes into account both sides of the balance sheet and, when linked to the budget, would incentivise public sector investments.
As the IMF argued in report published last year, if the entire portfolio of public assets were properly accounted for and professionally managed, they could potentially generate some 3% of GDP in additional revenues to government budgets.
The holy grail of public asset management is an institutional arrangement that both removes governance from a government’s direct responsibilities, but at the same time encourages active commercial governance of public assets with the aim of generating value for the public and a dividend that can benefit society as a whole.
Read the full report ‘Public wealth funds: Supporting economic recovery and sustainable growth’.