We Should Not Focus On Public Sector Net Worth As A Fiscal Target

8th October 2023

Ben Zaranko, Senior Research Economist considers the case for and against a fiscal target for public sector net worth.

There have been numerous calls for the UK to adapt its fiscal rules to place greater weight on improving public sector net worth, a measure that aims to summarise both sides of the government balance sheet: its assets (financial and non-financial) as well as its liabilities. The Labour Party has promised to ‘take greater account of public sector assets as well as debt in fiscal policy', which could imply some sort of target for public sector net worth.

This is a debate worth having. Public sector net worth is a valuable addition to have alongside the more traditional set of fiscal metrics.

But a public sector net worth target should not supersede or stand in place of more traditional measures of debt, debt interest and borrowing. Performance against a public sector net worth target would tell us little or nothing about the government's ability to access capital markets or service its debt. That is particularly true if the change in net worth is driven by a change in the value of non-financial assets (such as the road network, or the schools estate) that cannot realistically be sold to meet financing needs. An increase in the estimated value of an asset the government cannot sell cannot be taken as a signal that the government can afford to borrow more.

This is especially true right now. Debt and debt interest are at such high levels that it is they which are likely to be the binding constraint on fiscal policy, irrespective of any target for, or change in, public sector net worth.

These are among the findings of new research from the Institute for Fiscal Studies, published today as a pre-released chapter of the 2023 IFS Green Budget, produced in association with Citi and with funding from the Nuffield Foundation. The chapter considers the case for and against a fiscal target for public sector net worth, and finds:

There are definitely cases where a narrow focus on public sector debt can be misleading and/or unhelpful, and where public sector net worth would provide a more complete picture of the impacts of government action or inaction. This is most obviously the case when the government is considering asset purchases (such as nationalisations) or asset sales (such as the selling of the student loan book).
Public sector net worth can provide a useful framework for holding the government to account when it promises to ‘borrow to invest', and it can strengthen the incentives for governments to invest well, to manage public sector assets better and to think about the long term. In short, it has clear theoretical attractions. UK public sector net worth is also relatively low by international standards, something which is often pointed to by proponents of a public sector net worth target.
But a public sector net worth target might work rather less well in practice, and not just because it tells us nothing about a government's ability to borrow or to service its debt.
The most significant difference between public sector net worth and other balance sheet measures is its inclusion of non-financial assets. These assets are extremely difficult to value, both practically and conceptually. In many cases, the recorded value (often the ‘replacement value' - how much it would cost to replace the asset in its current condition) bears little relevance to the economic or social value of the asset, or to assessments of fiscal sustainability. This would limit the usefulness of a net worth target in practice.
Choices over definitions and modelling assumptions also matter enormously for estimates of net worth - more so than in the case of a debt target. Whichever measure of public sector net worth is used, it would be complex and difficult to communicate.
Public sector net worth is the broadest and most comprehensive balance sheet measure available. But it does not and cannot comprehensively capture the assets and liabilities of the government: it ignores the state's single greatest asset (its ability to tax future generations) and its greatest liabilities (the implicit promise to provide healthcare, pensions, education and security to future generations).
All told, while there is a strong case for considering public sector net worth alongside a broader suite of fiscal metrics, it ought not to be at the centre of the UK fiscal framework. Labour’s proposal to ‘take greater account’ of public sector net worth appears sensible, but we caution against going further.
Ben Zaranko, Senior Research Economist at IFS and author of the chapter, said:

‘The current fiscal rules are crude and can be, and have been, gamed. Keeping a watchful eye on a measure of public sector net worth would be sensible and could discourage some forms of bad fiscal behaviour. But that doesn’t mean that it can form the basis of a good fiscal rule, and it doesn’t mean that changes in net worth are a good guide for policy.

‘In any case, adopting a public sector net worth target would not change the fiscal fundamentals facing this or the next government. Some subset of more traditional measures of debt, debt interest and borrowing should be retained, and it is those which are likely to be the binding constraint on fiscal policy in the years to come.’

Key findings
1. The government has made a welcome investment in the development of a wider set of measures of the public sector balance sheet. There have been numerous calls for the UK to adapt its fiscal rules to place weight on a particular one of these balance sheet measures, public sector net worth. This is a statistical measure that aims to summarise what the government owns and what it owes: it captures both the government’s assets (financial and non-financial) and its liabilities. It attempts to provide a broader and more comprehensive picture of the public finances than commonly used measures of debt and borrowing.

2. UK public sector net worth is relatively low by international standards. This is driven by the UK having unusually low levels of public sector assets and unusually high public sector pension liabilities. We should be careful, though, not to equate public sector net worth with the country’s net worth, and should not over-read into such comparisons (which partly reflect different boundaries of the state and the precise set of assets and liabilities included). Nonetheless, the UK’s position at the back of the international pack is often pointed to by proponents of a public sector net worth target.

3. This is a debate worth having. Public sector net worth is a valuable additionto the set of information about the financial position and assets of the government, and to the set of measures estimated by the Office for National Statistics (ONS) and forecast by the Office for Budget Responsibility (OBR). Recent improvements in the quality and timeliness of public sector net worth measures have the potential to contribute to better policymaking.

4. In particular, there are reasons to suppose that a public sector net worth target might be preferable to a simple target for public sector net debt. Most obviously, by capturing a more comprehensive range of liabilities and assets, it can provide a more complete picture of the impacts of government action (or inaction). This is particularly advantageous when the government is considering asset purchases (such as nationalisations) or asset sales (such as of the student loan book), when a narrow focus on debt can be particularly misleading and/or unhelpful.

5. More generally, a public sector net worth target could helpfully strengthen the incentive for governments to focus on investing in high-quality projects where the value of assets created is expected to exceed the cost of financing, and could provide a framework for holding the government to account when it promises to ‘borrow to invest’ (often under the implicit assumption that such investments will pay for themselves). It could also encourage decision-makers to think more about how well public sector assets are managed and maintained, and to confront longer-term liabilities that might otherwise be ‘out of sight and out of mind’ (such as public sector pension liabilities, or the costs of decommissioning nuclear sites).

6. There are, however, good reasons to be cautious, and to suppose that - whatever its theoretical attractions - a public sector net worth target might work rather less well in practice.

7. One issue is that performance against a public sector net worth target will not necessarily tell us much - if anything - about the government’s ability to access capital markets or service its debt. That is particularly true if the change in net worth is driven by a change in the value of non-financial assets. These assets (such as the road network) are extremely difficult to value, both practically and conceptually. In many cases, the recorded value (the ‘replacement cost’) bears little relevance to the economic or social value of the asset, or to assessments of fiscal sustainability. Importantly, these assets cannot generally be sold to meet financing needs – or if they can, it would presumably be because the new private owners would be able to start charging for something (e.g. driving on a motorway) that was previously free to the public. Put differently, should an increase in the estimated value of an asset the government cannot sell really be taken as a signal that the government can afford to borrow more?

8. For that reason, more traditional measures of debt, debt interest and borrowing will remain important for fiscal policy, and ought to be considered alongside any target for public sector net worth when setting policy. Under current circumstances, traditional measures of debt and/or debt interest are at such high levels that it is they which are likely to be the binding constraint on fiscal policy, irrespective of any target for, or change in, public sector net worth.

9. A further issue is that choices over definitions and modelling assumptions matter enormously for estimates of net worth – more so than in the case of a debt target. Different definitions would likely send different signals to fiscal policymakers. Under one measure, rising interest rates (and falling market prices for gilts) have improved the UK’s public sector net worth by 40% of GDP over the past two years. On the face of it, and if we were to rely on such a measure alone, that might point to space for a substantial debt-fuelled fiscal expansion – even as borrowing costs surge and markets are being asked to absorb more gilt issuance than at any point in recent history. But under a different measure, net worth has remained effectively flat, suggesting no substantive change in the amount of fiscal headroom.

10. Whichever measure of public sector net worth is used, it would be complex and difficult to communicate. It also would not be truly comprehensive: public sector net worth ignores the state’s single greatest asset (its ability to tax future generations) and its greatest liabilities (the implicit promise to provide healthcare, pensions, education and security to future generations). For that reason, forecasts of future spending flows on things such as healthcare and pensions – as already produced by the OBR – are a more valuable tool for assessing the long-run sustainability of the public finances. We might also worry about the volatility of forecasts for public sector net worth, and the fact that they can be subject to large shifts in levels following changes in accounting parameters.

11. In our view, many of the potential advantages of a public sector net worth target stem from the fact that it would reduce the incentives for governments to engage in certain types of ‘bad fiscal behaviour’ (such as selling off public sector assets for less than they are worth in an effort to reduce public sector net debt). It would not, however, eliminate all incentives for Chancellors to engage in ‘short-termism’ or for them to allow accounting treatment to determine economic policy. And it would be possible to improve some incentives (e.g. for governments to invest only in high-return projects) without adopting a net worth target.

12. The fiscal fundamentals would remain unchanged, in any case. There would still be a need for a well-designed ‘escape clause’ to allow for countercyclical fiscal policy in a crisis; the UK would still face daunting public finance pressures; and there would still be a need for fiscal policy to be tighter in the ‘good’ times to build up fiscal buffers and provide the space to respond to adverse shocks when they arrive.

13. All things considered, our view is that the benefits of moving to balance sheet targeting might be insufficient to justify the potential costs involved. In other words, wholesale adoption of a public sector net worth target could prove to be a long walk for a small sandwich: there might be simpler and less complicated ways of achieving some of the policy objectives espoused by its proponents, and it would likely create as many problems as it solved. There is, nonetheless, a strong case for considering public sector net worth as part of a broader suite of fiscal metrics – particularly when assessing asset sales and purchases, and other balance sheet policies. The government’s Charter for Budget Responsibility already includes a commitment to do this. Labour’s proposal to ‘take greater account’ of public sector net worth appears sensible. But public sector net worth ought not, in our judgement, to be at the centre of the UK fiscal framework.

6.1 Introduction
There have been numerous calls for the UK to alter its fiscal framework to place greater weight on improving the net worthof the public sector, rather than overly focusing on the level of public sector debt. Supporters of such a shift include the current Chair of the Office for Budget Responsibility (OBR) and a former Chief Economist at the Bank of England (e.g. Hughes, 2019; Hughes et al., 2019; Haldane, 2023; Wren-Lewis, 2023; Odamtten and Smith, 2023). At the 2019 general election, the Labour party pledged to ‘improve public sector net worth over the course of the Parliament’ (McDonnell, 2019), and it has more recently made a softer pledge to ‘take greater account of public sector assets as well as debt in fiscal policy’ (Labour Party, 2022). This comes on the back of more than a decade of work within government to develop better and more timely measures of both sides of the public sector balance sheet.

This debate, and the investment in and development of a broader suite of public sector balance sheet measures, is welcome. Public sector net worth is a valuable addition to the set of fiscal aggregates estimated by the Office for National Statistics (ONS) and forecast by the OBR, and has the potential to contribute to better fiscal policymaking.

There are also several theoretical reasons to suppose that targeting public sector net worth might represent an improvement over a simple target for public sector net debt. Most obviously, by capturing a more comprehensive range of liabilitiesandassets, it can provide a more complete picture of the impacts of government action (or inaction), and reduce the incentive for Chancellors to pursue certain types of short-term policymaking. It would also provide a better framework for holding governments to account when they promise to ‘borrow to invest’, often under the implicit assumption that such investments will more than pay for themselves, and could strengthen the incentive for public sector assets to be well managed in the interests of future generations.

Theoretical attractions are one thing, but there are reasons to suppose that a public sector net worth target might work less well in practice. The key difference between a net debt measure and a net worth measure is that the latter incorporates the value of non-financial assets (such as physical infrastructure like roads and buildings).1 Estimating the value of these assets is fraught with difficulty – how much is a road worth? – and such estimates can be extremely sensitive to changes in accounting parameters, and not especially informative about fiscal sustainability. Choices over definitions and modelling assumptions can be hugely consequential: under one measure, rising interest rates (and falling market prices for gilts) have improved the UK’s public sector net worth by 40% of GDP over the past two years. On the face of it, that might point to space for a substantial debt-fuelled fiscal expansion – even as borrowing costs surge and markets are being asked to absorb more gilt issuance than at any point in recent history. Under a different measure, though, net worth has remained effectively flat, suggesting no change in fiscal headroom.

This relates to two broader problems with a net worth target. First, the choice of definition matters hugely – more so than in the case of a debt target. Even the more comprehensive measures, which include unfunded public sector pension liabilities, are not truly comprehensive: a government’s greatest asset is its ability to levy future taxes, and its greatest liability is its implicit promise to provide healthcare, education, pensions and security to future generations. These are not captured in public sector net worth. Whatever measure is chosen, it will be complex and difficult to communicate.

Second, changes in a country’s public sector net worth will not necessarily tell us much – if anything – about the government’s ability to access capital markets or service its debt. That is particularly true if the change in net worth is driven by a change in the value of assets that cannot be sold to meet financing needs. Put differently, should an increase in the estimated value of an asset the government is unlikely to – or simply cannot – sell really be taken as a signal that the government can afford to borrow more? Furthermore, it is not difficult to imagine a world where a deterioration in public sector net worth is disregarded as being caused by a ‘technical measurement issue’, but where tax cuts and/or spending increases are announced when the reverse happens. That would exacerbate the asymmetric behaviour described in Chapter 5 of this Green Budget.

Together, this ought to give us pause. The UK government’s current debt target is poorly designed and should be reconsidered. But rather than disregard debt entirely, a better outcome might be to retain some sort of debt or debt interest target alongsidea greater focus on public sector net worth – particularly when the government is considering nationalisations or asset sales, at which point a narrow focus on debt can be especially unhelpful. Even if public sector net worth were to be given greater prominence, there would still need to be an ‘escape clause’ of some kind in the face of major shocks: strict adherence to a public sector net worth target would almost certainly have (inappropriately) precluded borrowing for the COVID-19 furlough scheme, for instance. Labour’s proposal to ‘take greater account’ of public sector net worth therefore appears sensible, but we would urge caution about going much further than that.

More generally, it is worth considering whether there are alternative solutions to the problems a public sector net worth target is intended to address. A wholesale shift to targeting public sector net worth could prove to be a long walk for a small sandwich. It is true that the UK has relatively low public sector net worth by international standards.2 But we note that governments in other comparator countries have managed to achieve higher public sector net worth without a public sector net worth target. Similarly, other governments have managed to spend more than the UK on public investment over past decades without such a target. And though the UK has unusually large unfunded public sector pension liabilities (by international standards), this is not because it was the only country without a public sector net worth target.3 Something else has clearly driven those policy decisions.

We might also worry that moving to a net worth target would simply shift the ‘fiddling’ and creative accounting from one boundary (what is included/excluded from public sector net debt?) to another (what is included/excluded from public sector net worth?). If the ultimate concern is that Chancellors are prone to short-termism and inappropriately letting accounting treatment guide economic policymaking, then perhaps the answer is for independent watchdogs to call this out (even) more forcefully – or for parliament and ultimately voters to demand better behaviour from them.

The aim of this chapter is not to provide firm recommendations about what the ideal set of fiscal rules would look like, but to assess the relative merits of public sector net worth as a fiscal target. We proceed as follows. Section 6.2 provides definitions and both historical and international context for the strength of the UK public sector balance sheet. Section 6.3 outlines the case for targeting public sector net worth rather than public sector net debt. Section 6.4 considers some of the concerns we might harbour about such an approach. Section 6.5 concludes.

Read the full report HERE
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