12 June 2012

MoneyWeek: Western government reporting and indebtedness

Ian Ball points out that most countries around the world still use what is termed “cash-based” accounting for public finances. This means that cost of a policy is only assessed when payment is made – i.e. when the bill comes due. However, under “accrual” accounting, which is used by the private sector, costs are counted at the time the obligation is incurred.

The distinction may sound minor. However, Ball argues that the former system can lead to long-term obligations being overlooked. In the worst case, it may actually encourage dodgy schemes to massage the figures. For example, David Cameron and George Osborne have been criticised for taking over the Royal Mail pension system in order temporarily to 'cut' the deficit. Meanwhile, 'public private partnerships' (PPP) may have helped the last government to hide the true cost of new public projects.

A subtler problem is that of large unfunded public sector pensions. It makes sense for some state-funded professions, for example teaching, to have good benefits relative to salaries. This is because such a structure rewards loyalty. However, for others there is little such business need. But a lack of focus on the long-term costs - driven partly by accounting methods - means that governments have ignored these issues and now are facing a huge bill.

Of course, Ball concedes that it is possible for governments to change the terms of the schemes, even to existing members. Indeed, he accepts that future liabilities related to old-age pensions paid to the general public should not be counted for this very reason. 

However, he thinks that the employee pension schemes should be included because they are much harder to modify.

Ball cites the case of New Zealand, which moved to accrual accounting in the early 1990s. This forced it to fund public pensions properly. As a 2006 study points out, gross public liabilities fell from two-thirds of GDP in 1993 to a quarter of GDP twelve years later, while those of other OECD countries increased.

The traditional measures of public debt do not tell the whole story. Even for the UK, adding in public sector pension liabilities adds another 90 per cent of GDP to debt.

Yet Britain is in a relatively secure position compared to other eurozone countries. As the Wall Street Journal reports, Spain, Greece and Portugal’s liabilities are 204 per cent, 231 per cent and 298 per cent respectively. And even these are not the worst countries: Germany and France top the table, with 330 per cent and 360 per cent of GDP respectively.

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