The Importance of the Balance Sheet in Managing Government Finances

A more professional approach to managing our public wealth could generate trillions of dollars in non-tax revenue worldwide. Even in the US, it could contribute multiple percent of GDP in non-tax revenues.

Managing wealth is not rocket science; it is done daily in the private sector. What is often overlooked is that the government functions as the largest wealth manager in any country, including in the US. And just as a company or household would examine its balance sheet when looking to improve its wealth, so too should a government.

To strengthen public finances, we must continually consider the government’s budget, its spending habits, and whether these are managed in the most efficient manner and aligned with the right priorities. We should also examine the government’s balance sheet closely: Are we investing sufficiently in the appropriate areas that genuinely create value and enhance public net worth? Should we divest certain assets that are no longer beneficial to us?

During the early 1980s recession, the focus in the UK officially shifted towards selling core public utilities, with the expectation that this would enhance efficiency and productivity, thereby making the British economy more competitive in relation to its continental rivals. In certain industries, particularly water utilities, the aim was also to move the responsibility for capital expenditure off the government’s balance sheet, thus avoiding conflicts with public sector borrowing targets.

The perceived need for further state downsizing and privatisation has occurred unevenly across continental Europe. We argue that what matters concerning publicly-owned assets is not only the nature of ownership but, perhaps more significantly, the quality of management — alongside the necessity for accurate and honest accounting and high-quality regulation before privatisation is even contemplated.

Privatisation, as a policy, has had mixed success, with some state assets sold for very low prices. Following the fall of the Soviet Union, Russia stands out as perhaps the worst example, effectively transferring substantial wealth from the government to individuals or companies with minimal benefit to taxpayers. Conversely, in other instances, privatisation led to significantly improved services and lower prices, ultimately benefiting consumers.

Various factors influence the success or failure of privatisations, including the methods employed to prepare assets for sale, the sales process itself, the regulatory framework governing the sector, and the characteristics of the goods or services.

Our view is that privatisation is neither inherently good nor bad; rather, it is about identifying what will work best in a specific set of circumstances. Our concern is that, far too often, privatisation is perceived as a quick means of generating “revenue” to fill a budget deficit and avoid artificial debt constraints. Without a balance sheet perspective, governments cannot effectively measure debt sustainability, as they do not distinguish between borrowing that is invested and debt that is used for consumption. This is not only misleading but also exhibits an anti-investment bias, leaving politicians without the necessary insight or accountability, which results in suboptimal resource use and potential unfairness across generations.

To illustrate the point above, if rail transport is provided by a government department, and there is a desire for greater efficiency, selling the department outright might not be a good idea. Instead, it might be desirable to first establish it as an independent publicly-owned corporation with proper financial statements, including a balance sheet, as any privately owned operation would maintain. This will give a clearer picture of the cost of providing its services, as well as value of its assets and liabilities. Having this information would provide a better sense of the appropriate selling price.

Ensuring the board of the company has clear commercial goals and the power to run the company effectively will give a better sense of its profitability and value. All the more so if it operates in a transport market that has a well-designed regulatory regime, enabling fair competition between it and other transport providers.

Having reached this point, the government will be in a much better position to consider whether privatization is the best option, or whether there are good public policy reasons for retaining the asset in public ownership.

In summary, ownership and management are both important—apart from anything else, the information flows from product and capital markets to a listed entity are very different in content and effect than those to a government-owned service provider.

The aim of having public assets in a separate holding vehicle at arms-length from short-term political influence is not only that its operations and value can be improved before being divested. It also gives the owner the option of whether and when to sell, thereby avoiding political influence on commercial decisions which inevitably lead to ‘fire sales’ and massive loss of taxpayers’ money.

The “holding company” model aims to achieve some of the benefits of private ownership for the benefit of citizens, both consumers and taxpayers. That does not mean the assets should be privately produced, but it is an option.

Being the largest wealth manager in our economy, a government could learn from the best in the business. Just as a company or a household would look at their balance sheet when making investment decisions, so should a government.

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