Western governments are even more indebted than you might think

We’ve heard a lot in recent years about the large levels of public debt harboured by many nations around the world. The fight between Brussels and Madrid over the rescue of Spain’s banks shows that to get the true picture, you sometimes need to consider private debt too, especially if it is in reality backed by the state.

However, some experts fear that the problem of public sector debt goes even deeper than this. More to the point, they also believe that this problem isn’t just limited to countries like Greece and Spain.

Ian Ball of the International Federation of Accountants (IFAC) has some very strong views on this. He thinks that public sector accounting is flawed. Indeed, he points out that while the Enron debacle forced wide-ranging changes to private sector accounting, the public sector remains unreformed.

What does this mean for government finances – and for investors? I recently asked him to outline his views in more depth to find out.

Cash versus accrual accounting

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 – ie 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 – ie when you commit to something.

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 to temporarily ‘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 are now 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. Even if you think that pensions are too high, most of us would agree that there’s something not entirely fair about agreeing to one set of terms when people start a career, only to change the terms a decade or two down the line once they are locked in.

In contrast, accrual accounting should reduce this problem. It should stop the number-fudging shenanigans of PPP, for example. And it also forces the government to think about the long-term costs of its commitments, or at least to make sure that they are properly funded.

In theory, this should lead to greater control of costs. Ball cites the case of New Zealand, which moved to accrual accounting in the early 1990s. This forced it to properly fund public pensions. 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 implications for Europe

So what implications does this have for investors? It makes it very clear that 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% 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%, 231% and 298% respectively. And even these are not the worst countries: Germany and France top the table, with 330% and 360% of GDP respectively.

France’s problems are made worse by the fact that it can’t reform the general state pension system. Indeed, the Hollande government has just cut the retirement age for some French workers to 60.

Supporters of this move point out that the French government will also be raising taxes to try to pay for this. However, there are limits to how far this ‘tax and spend’ strategy can go, given that French taxes are already high. Overall, it further reduces the chances of France being able to make inroads into the deficit.

It also shows that the political will, even (or perhaps we should say particularly) outside the ‘peripheral’ countries, for balanced budgets is very low. As we’ve said before, if Paris is unwilling to go along with austerity and get its house in order, it will be very hard to make the likes of Spain and Greece cut further. Meanwhile, the high levels of liabilities also suggest that Germany may be over-rated as a safe haven.

In short, Ball’s view of how governments fiddle their accounts makes us even less happy about the idea of holding developed world government debt. Tim Price, who writes The Price Report newsletter, is similarly unimpressed with bonds in the developed world. But he does have a suggestion for a fund that might suit those who are looking for bonds issued by more solvent sovereigns – the Wealthy Nations Bond fund. You can learn more about from Tim’s colleague Killian Connolly, who was at our most recent Roundtable: Nine investments our experts would buy into now

  • Boris MacDonut

    But actuarial life expectancy in the UK is 80 for women and 78 for men. So the income available to meet this 90% 0f GDP bill is up to 19 years of tax revenues at 45% of GDP….. at a conservative estimate that is £14 trillion.You are talking about 0.6% of our GDP….it is below de minimis levels for accounting purposes.
    Yet again, this is not a story. It is a bit of Daily Mail sensation.

  • Critic Al Rick

    IMO only a fool or a short-sighted, blinkered and indoctrinated ‘cash-based accounting’ Public Sector devotee could consider the UK to be a rich country! By the time the Banksters have off-loaded their potential liabilities onto the proles the UK, indeed the West, will be officially declared bankrupt.

    The ‘rich’ UK is accrually bankrupt now!

  • uncommercial

    The arguments offered are muddled. Schemes such as PFI should be attacked as a form of off balance sheet accounting, equivalent to the treatment of financial leases which corporate accounts must nowadays bring into the balance sheet. With proper capital accounting, PFI would be obviously bad value. On the other hand, it would be meaningless to attempt to capitalise future liabilties for benefits such as pensions, unless future tax revenues were also capitalised. While there is uncertainty over future tax revenues, governments are quite different from companies. There is no doubt that there will be substantial future tax revenues, whereas companies can and do go bust. Given that benefits are variable, the books can always be balanced, even if there may be political fallout.

  • Boris MacDonut

    The UK is the world’s sixth richest nation worth about £9 trillion when you include the money hidden in a network of tax havens. Total debt including the massive Bank debts are only £7.5 trillion so an 81% debt to wealth ratio. It is just a shame the money is so poorly shared out among us and our leaders conspire to keep it that way.

  • Mike

    As I understand it the UK was the seventh richest country in the world. That was until this year 2012, when Brazil overtook the UK. So the UK is now the eighth richest country in the world. China according to old forecasts was predicted to grow at a rate of 6.5 % GDP, (which is similar to the rate of growth during the UK industrial revolution) but China has been growing at a staggering 10%. Ok, China’s rate of growth has slowed down to about 7%. At the old forecast rate China would have grown to become the worlds second richest country, but would never overtake the USA. Well according to current news China is now the worlds riches country and the Yuan is shortly to become the worlds reserve currency.

  • Critic Al Rick

    As I understand it the criterion for the ‘richest country’ is the one with the highest GDP. If that’s the case it is a criterion which is fundamentally flawed; as is, IMO, much of the basis of modern academic economics; one of the contributors to the Mess.

    Consider the single business model; it is not necessarily the case that turnover is proportional to profit. An analogy is a single country where turnover is crudely represented by GDP and profit by Balance of Payments.

    I suspect our contribution to the EU is related in some way to our GDP; if commonsense ruled the roost it would be proportional to profit, i.e. Balance of Payments; the UK should be a net recipient of moneys FROM the EU! Extrapolate!!

    The UK has been a loser for three decades; it is up to its neck in debt. If the criterion for richest country were Balance of Payments/head of capita (a more sensible parameter), where do you think the UK would then stand in the world rankings?

  • Boris MacDonut

    #5 Mike. The World Bank, the IMF and the CIA all agree on the first 5 by GDP as ; USA,China, Japan,Germany and France. They variously put the UK or Brazil 6th and have both nations at broadly similar GDP’s within one percent of each other. Not sure where you get us being eighth from. Behind us are Italy ,Russia and India, none of which is close to our GDP.
    On total wealth we are way ahead of Brazil. We have an extra £2 trillion stashed in our network of tax havens. We have about 4.7% of total global wealth, Brazil has only 3%….and they share it between 190 million souls (usually quite badly).

  • Critic Al Rick


    If you consider the wealth of a nation to be the realistic value of its assets less the realistic value of its liabilities, including those being foisted upon it by Banksters, then the UK is effectively bankrupt.

    As a certain commentator on TiM blogged on 24/11/2011:
    “It is a conspiracy. We are being had over. We should be very angry indeed.”

  • Boris MacDonut

    #8 Rick .On that measure( lack of debt) I make it Uzbekistan, Madagascar and Bangladesh that are the richest nations in the World. The UK is not bankrupt anymore than someone who earns £25k borrowing £100k over 25 years. They are expected to earn £625,000. I tend to measure wealth in the ability to look after 63 million people, give them a high standard of living, decent education, healthcare and a safe place to raise children. The UK has that in spades………but we are being done over in having bank debt foisted on us rather than let them fail. RBS will sink soon with its Irish ball and chain dragging it under for good.

  • Critic Al Rick

    Quote Boris:
    “The UK is not bankrupt anymore than someone who earns £25K borrowing £100K over 25 years.”

    The UK is not a net earner … its Balance of Payments has been negative for, in all practicality, three entire decades; and it is worsening. The UK will never be a net earner before it as a whole:

    a) becomes (drastically) more competitively viable in the world

    b) drastically reduces its so-called standard of living and lives within its means.

    In the meantime, whilever this reality is being shunned, the Middle Classes and any freedom we currently have face annihiliation; as does the “high standard of living, decent education, healthcare and a safe place to raise children”.

    Wealth, Boris, is the ability to MAINTAIN in the longer term a “high standard of living, decent education, healthcare and a safe place to raise children”; but moreso – freedom!

    Upon current trends we are going to lose our freedom.

  • Boris MacDonut

    #10 Goodness me Rick .You risk embarassing yourself with such nonsense. The UK’s GDP is already £1,550 billion and it is set to double by 2045. That is an expected wealth (for it is this which will repay debt) of £68 trillion in the next generation.

  • Critic Al Rick

    Boris, you just don’t get it. But then, it appears, neither do modern academic economists (there really is a conspiracy if they do); or are they as commonsense stupid as they are practicably incompetent?

    You can pay an army of men to dig a load of holes and then pay them to refill them. It’ll increase GDP, but it won’t bring money into the country. Still don’t get it do you?

    But then you’ve probably never had to make a profit to survive.

    And how in our present circumstances do you propose increasing GDP other than by inflation, the destroyer of true wealth creation!

    Like I say, if there isn’t a conspiracy to ruin us, your ever so wonderful establishments of academia have.

  • Boris MacDonut

    #12 Rick . How silly. The UK has run an average balance of payments deficit of 1.5% pa for three decades. We can do this because we are very rich. I am thinking especially of the huge wealth secreted abroad. £2 trillion in tax havens, millions of overseas second homes, shares in foreign companies. It is foolish to suggest we only make money from what comes in from abroad. Our country produces huge wealth. Our trade is dwarfed by our domestic GDP. Our income may take 28 years to double instead of 25 but so what?

  • Critic Al Rick

    Quote Boris:
    “We can do this (continue to run a Balance of Payments Deficit) because we are very rich.”

    Now where have I heard that kind of complacency before; ah yes, Margaret Beckett – “Britain is a rich country and doesn’t need farmers.”

    Quote Boris:
    “It is foolish to suggest we only make money from what comes in from abroad.”

    You’re right, but the only money that makes the UK richer in monetary terms is that coming from abroad which is over and above that money leaving these shores. The other money we make, that plucked out of thin air, is destructive to our ability to trade profitably in the world.

    You may be considering money the UK has made by selling off its assets (asset-stripping) abroad. Well Boris, the UK has been well stripped of its money-making assets.

    Quote Boris:
    “Our trade is dwarfed by our domestic GDP”

    Like I say, you just don’t get it!!

  • Boris MacDonut

    #14 Rick. So the only way to make money is to be a net gainer from abroad. That’s very funny. It would mean half the World permanently starving. You are badly mistaken. But it is a complicated subject to understand properly.

  • Critic Al Rick

    Quote Boris:
    “It (for some countries to make gains from abroad) would mean half the world permanently starving.”

    Not necessarily Boris; if a country is completely self-sufficient it doesn’t (need to) trade with other countries. Within such a country, any country, however, one man’s gain is another man’s loss.

    Within a group of trading non self-sufficient countries one country’s gain is another country’s loss; Germany has gained at the loss of many other EU countries, including the UK; China has gained at the expense of the West, including the UK.

    That’s the brutal truth; I’m not the one who’s badly mistaken. It just takes commonsense to see it; you’ve perhaps been influenced by those amongst us who have complicated the issues with academic pomp and associated theories.

    I know there is more to it than that, the basics, but if you still think I’m badly mistaken please enlighten me; I’m open minded and open to criticism. Go on, try and baffle me with your complexities!

  • Boris MacDonut

    #16 Rick .Your failing is to seek to conjure up doom. You want to overegg the UK’s shortcomings at every opportunity. I disagree with you because I believe we are fundamentally sound. One of the richest nations on earth. Yes, our standard of living will moderate slightly as an inevitable consequence of other nations advancing, but it will be modest……. a few percent per decade.
    You need to be more realistic and look at the whole picture, not just stats that favour your doom agenda. Trying to predict the future is very difficult and even more so if you ignore reality.

  • Critic Al Rick

    Boris, your failing is your not recognising that circumstances are much different this time; I don’t have a doom agenda, I’m just the messenger being shot at.

    Our so-called standard of living has been maintained whilst our Balance of Payments has been negative, firstly until about 2008 by ever increasing debt, and since the credit crunch largely at the expense of Savers and Pensioners; one man’s profligacy is being spared by another man’s reduction in wealth; or, in the case of Banksters, one man’s profligacy is being spared by a million men’s reduction in wealth.

    Okay, the UK’s assets may still be very impressive on paper at the moment but it’s potential liabilities not ignoring the potential possible very significant reduction of those paper values is staggering.

    cont. …

  • Critic Al Rick

    … cont.

    Unless the UK gets its house in order by:
    a) at the very least, balancing its Budget, and
    b) the establishment of a positive Balance of Payments

    it IS doomed.

    I’m sorry, but in the absence of a suitable miracle, there is absolutely no way the UK is going to get its house in order.

    And the Establishment, in its infinite wisdom, had the gall to criticise its hard working, hard pressed, down trodden Livestock Farming Community. The Establishment needs to take a long hard look at itself in the mirror.

    Embittered, you say. Maybe, but not without very good reason!!

    Quote: “We should (ALL) be very angry indeed.”

  • Boris MacDonut

    #18&19. Thanks Rick. I knew I was going wrong somewhere but this has helped no end. How very worrying that we are all doomed. If only some of the bigwigs knew what you do. Let’s hope they are all reading MW and not easily embarrassed.

  • Critic Al Rick

    A bit more more wisdom Boris: there’s non so arrogant as them that don’t want to know, and there’s non so blind as them that don’t want to see.

  • Critic Al Rick

    Oh, and another pearler Boris: it is said that sarcasm is the lowest form of wit!

  • Boris MacDonut

    21 & 22. We’ll have to disagree then. You think we’re all doomed. I think we are in for a modest reduction in relative living standards. What time scale is the doom working to Rick? Decades or centuries. If the latter I’ll leave a note for the grandkids.

  • Critic Al Rick

    Hi Boris, sorry for the delay; time scale?

    Well, it was nearly 25 years ago that because of the attitude the Establishment had towards Livestock Farmers I predicted the UK was headed for a food shortage and that it would start with eggs; I do believe the shortage of eggs is beginning.

    But I have recently realised that the attitude towards Livestock Farmers is symptomatic of a much more general complacency of the Establishment towards the basics of society; the rot has not been restricted to just the provision of food, it has simultaneously extended throughout the foundations of Western society which now has ‘feet of clay’. The Credit Crunch is/was a further ‘clinical’ symptom of this decay, a decay which I would say has been ongoing for much more than 25 years.

    Boris, I should optimistically think decades at best and that we’re in for far more than a modest reduction in absolute living standards. I’m quite amenable to agree to disagree!