Until recently, relatively little attention was paid tostates’ balance sheets. Measurement and reporting were neglected. Even today,states’ liabilities receive considerable attention, while their asset sidesreceive significantly less.
In an earlier era, states owned substantial industrialassets. This “commanding heights of the economy” model was rejected largelybecause it seriously under-performed, especially when state-owned sectors wereprotected from competition (as was the norm). Efficiency declined. But, moreimportant, the absence of entry and exit by firms, a key ingredient ofinnovation, caused dynamism to suffer and losses to grow over time.
The model’s shortcomings led to privatization in manydeveloped and developing countries. In Europe, privatization was viewed as akey step in the integration process. The theory, in Europe and elsewhere, wasthat states could not be impartial owners of industrial assets. Throughregulation, public procurement, and hidden subsidies, they would favor theirown assets.
Of course, state ownership is not the only way to impedeefficiency and dynamism. Regulations in a range of countries, from Japan toItaly, create sectors that are sheltered from competition, with detrimentaleffects on productivity. This pattern is particularly pronounced in thenon-tradable sectors (which account for two-thirds of the economy), where thediscipline of foreign competition is absent by definition. Even here,foreign-based domestic competitors could improve performance.
It is important that more attention is now paid to publicliabilities – not only growing sovereign debt, but also larger, non-debtliabilities embedded in social-insurance programs. A combination of defectivegrowth models, rising longevity, and unanticipated increases in costs (such as health carein America) have caused these longer-term liabilities to explode.
Reining in debt and other liabilities has substantiallyreduced governments’ scope for sustaining demand in the face of severe negativeshocks, thus reducing their ability to buy time for structural adjustment inthe private sector. For now, investment in a shift to a sustainable growth andemployment pattern has been crowded out. Shifting consumption to investment viatax increases is possible, but too problematic politically, with theburden-sharing issue usually leading to impasse and inaction.
Meanwhile, the asset side of states’ balance sheets remainslargely invisible. States own land, mineral rights, and infrastructure. Somehave sovereign wealth funds. Many have public pension funds of substantialmagnitude, consisting of diversified portfolios of assets. These assets are, ina sense, spoken for – there are claims on them in the form of liabilities,which have grown as expected risk-adjusted returns on assets decline; but theydo represent a partial funding of public liabilities and are an element of resilience.
By contrast, in China, the assetside of the state balance sheet is very large: land, foreign-currencyreserves of $3.5 trillion, and around an 85% stake in state-owned enterprisesthat account for about 40% of output. This balance-sheet configuration hashelped China to respond to shocks and sustain high levels of public-sectorinvestment. The liability side will expand as social insurance grows – butslowly, owing to a fear of underestimating the liabilities being created.
In the best case – without a sharp decline in financialassets accelerating an economic downturn, a sudden collapse of a defective growth model, or even rapid increases inliabilities associated with demographic shiftsor health-care technology – it might make sense to focus only on controllingliabilities. But a best-case scenario provides a poor policy framework in ourimperfect world.
In fact, states are routinely called upon to deal with awide range of market failures or limitations: unsustainable growth patterns andregulatory myopia; distributional problemsassociated with the evolution of technology and globalization; acceleratingconcentration of national income; and major structural transitions associatedwith shocks and secular trends in technology and the global economy.
Here is the dilemma: Governments with substantial assetshave flexibility and the capacity to act, but they can also mismanage theirassets to the detriment of markets and economicdynamism. In China, where the asset side of the balance sheet is large, the strategyof shrinking it via privatization has been largely rejected, at least for now.The loss of resilience would be too great.
That leads to the challenge of effective management ofpublic assets – management that promotes rather than impedes market efficiencyand innovation.
Here, what might be called thepension/sovereign-wealth-fund model – in which a public entity holds andmanages a diversified portfolio of assets as a financial investor withappropriately specified duties and governance – seems to be the right way togo. The asset side of the balance sheet is maintained in the aggregate, but themanagement of the assets, particularly the diversification of holdings, can bethought of as prudent and de facto privatized.
For developed countries, increasing resilience andflexibility over time by building public assets should be a long-term priority.Periodic systemic risk affects entire economies and public finances, not onlyfinancial markets, and governments should be able to respond during periods ofrapid structural change.
In practice, this means two things. First, once acollective choice is made about the desired levels of social insurance, theimplied liabilities should be fully funded over time. Thealternative is a poor intergenerational burden-sharing choice.
Second, governments, like individuals, households, andbusinesses, need to save for a rainy day. That is all the more important inperiods – like the current one – of rapid change, high volatility, and onlypartly predictable systemic instability.