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Posted by Ian Ball, John Crompton and Dag Detter[1]
Good leadership requires good information to support smart, timely decisions. More fundamentally, modern democracy itself relies on information that can be understood and trusted by its citizens and interpreted by all stakeholders. Nowhere is this more important than in the management of our public resources.
A comprehensive public financial management system enables leaders to make better informed decisions and allows their actions to be measured and judged by the broader public - politicians, the media, NGOs, and individual citizens. This means looking beyond easy-to-measure near term flows (e.g., public spending, tax revenues, net borrowing, or for that matter, GDP) that governments tend to focus on, and to look at more fundamental measures, including the use of public assets, the incurrence of liabilities, and the creation or destruction of public net worth from one period to the next, or from one generation to the next.
We should be able to use the accounting system that supports the management of our common resources in the same way that a traveller might use a GPS navigation system when planning and making a journey.
Navigation systems have two main elements. First, an underlying map which provides an up-to-date picture not just of the terrain (which doesn't change), but also of the road system and points of interest (which change quite slowly). Second, a dynamic overlay, which provides real time information about traffic conditions and the current position of the user. With this information, the traveller can make plans based on good information, and adapt to reflect changing circumstances - or, indeed, changes in the traveller's plans.
Applying this analogy to public accounting reveals two major problems.
First, the "underlying map" - the description of the assets and liabilities on the public balance sheet - is radically distorted by the use of severely outdated information. In our travel analogy, this is rather like making a journey in 21st century Britain using maps from before the motorway age. This is exemplified in valuing property assets (usually the largest asset class held by governments) based on historic cost or current use - both of which reflect assessments or decisions taken decades or even centuries earlier. The result is accounts that massively understate the value of assets being deployed in the public sector - and hence obscure the potential for radical redeployment of those assets to meet current needs. Such accounting systems might be described as accrual-based, and hence "up-to-date" - but if they "accrue" based on non-market values, they offer very little insight into how resources are allocated.
Second, the "dynamic overlay" in public accounting is very far from dynamic - and crucially, is much slower to update than other financial management tools at governments' disposal. Accounts are often published over a year after the fiscal year-end, whilst other financial measures - income, expenditure, borrowing - are measured daily or monthly, and hence are much more readily usable by financial decision-makers. As a result, governments are likely to pay far more attention to outstanding public debt (measured daily, if required), than to outstanding pension obligations (assessed annually a year in arrears, very commonly) - even though these might exceed public debt by a substantial margin and represent just-as-certain calls on future resources. But there is no real excuse for this. Companies make decisions using financial management systems that can provide accounting information daily if so required - the equivalent of real-time navigation information.
High-quality accrual accounting, using real market valuations and supported by independent audit, is a vital source of that information for governments as for businesses. Modern MIS systems can ensure that these data are made available to government decision-makers in a timely manner, just as would be expected in the private sector, and hence integrated into the decision-making process. This modern version of accounting gives governments a clear view of their current financial positions and can provide the information needed to make informed policy decisions. It allows for rapid, targeted, and secure support in times of crisis. It reduces the potential for corruption in the distribution of funds. And perhaps most importantly, it provides proper support to the democratic debate about how public resources are being employed, and about how financial burdens are being distributed across society and between generations.
Industry bodies report that almost half the world’s governments will adopt accrual-based accounting within a few years. But for the reasons discussed above, for this to do any good, accruals must reflect market values - and hence the scope for alternative uses of assets. And information will need to be produced in a timely manner, so it can be integrated into the decision-making process. Only full integration will enable better informed decision-making that reflects all resources and flows. And only then can governments - and citizens - enjoy the benefits of a financial management system that has the potential to promote optimal use of public resources. Given the political will, such changes could be accommodated relatively easily within existing accrual accounting systems.
[1] Ian Ball was a principal architect of the New Zealand government’s financial management system; John Crompton is an investment banker and a former HM Treasury official, and Dag Detter is a principal of Detter & Co.
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