Part 3: International practices and experience

Public sector financial sustainability.

3.1
In this Part, we set out how other jurisdictions and international organisations have developed indicators that are relevant to public sector financial sustainability. The research indicates that:

  • by itself, a debt indicator is not enough;
  • there is an evolving approach to financial sustainability, with various jurisdictions using increasingly sophisticated financial measures of public sector financial sustainability; and
  • there is an emerging trend towards national indicators (often referred to as KNIs), which are highly relevant to public sector financial sustainability. This has occurred because of the limitations of financial indicators and a growing recognition of the social and environmental factors underlying economic activities and costs.

A debt indicator is not enough – Mr Micawber's sixpence

3.2
At one level, assessing public sector financial sustainability is very simple. Mr Micawber, in Dickens's David Copperfield, describes it thus: "Annual income twenty pounds, annual expenditure nineteen pounds nineteen and six, result happiness. Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery."13

3.3
The "fiscal gap" is simply Mr Micawber's sixpence. An unacceptable level of debt (and consequential credit rating downgrades and default) is the national equivalent of debtor's prison, as the consequences of overspending extend over a long period. So, indicators of public sector financial sustainability generally start with assessments of imbalances of public revenue and expenditure (the net surplus or deficit), and their consequential effects on public debt and debt servicing costs (which compound any initial imbalance).

3.4
Literature on levels of debt generally shows that net debt above 90% of GDP may have a negative effect on GDP growth. Levels higher than 90% also increase the likelihood of other negative outcomes, such as substantial decreases in sovereign credit ratings, increased servicing costs, and default.

3.5
However, negative imbalances in public sector accounts affect not only debt levels directly but also financial flexibility and perceived creditworthiness. So, even in the "simple" world of Mr Micawber, a debt indicator is not enough to fully assess the situation.

The evolving approach to financial sustainability

3.6
Many institutions and groups have been working on public sector financial sustainability and related issues during the last several decades. Some examples include:

  • Supra-national institutions such as the International Monetary Fund (IMF) have carried out work on financial stability.
  • The Washington Consensus, which includes policies that favour public sector financial sustainability and fiscal discipline, has been used as a policy prescription for struggling nations.
  • New Zealand was a world leader with the Fiscal Responsibility Act in 1994. The Act sets out five principles of "responsible fiscal management" based on reducing debt to, and maintaining it at, "prudent levels".
  • Members of the European Union signed a "Stability and Growth Pact" in 1997. The Pact introduced a system of monitoring and sanctions aimed at fiscal discipline in member states, based on the two key planks of annual budget deficits lower than 3% of GDP and public debt below 60% of GDP.
  • A number of individual countries and sub-national jurisdictions have developed their own interpretations of fiscal sustainability.
  • The accounting profession (for example, the American Governmental Accounting Standards Board14 and International Public Sector Accounting Standards Board15) has begun looking at financial sustainability.
  • The emergence of integrated reporting initiatives (such as triple bottom line and sustainability reporting focusing on questions of sustainable growth, the "true" costs of economic activity, and intergenerational equity).

3.7
This work has varied considerably in its effectiveness, but the range of groups engaged and initiatives carried out illustrates how seriously public sector financial sustainability is now being taken.

3.8
A 2005 OECD paper16 describes four methods of measuring public sector financial sustainability:

  • Baseline projections extend the fiscal effects of current policies over longer time periods, and are about the financial sustainability of today's policies, assessing both "no-change" and defined change scenarios. The Treasury's Long-Term Fiscal Statements use this method, and it is the common method used by countries for which the offices of other Auditors-General provided information.
  • Balance sheet analysis, which will be incomplete as long as only explicit liabilities arising out of past actions are recognised. To be complete, balance sheet analysis also needs to include future obligations arising from the legitimate expectations of government and liabilities arising from current policy.
  • Fiscal gap analysis measures the gap needing to be bridged between the current fiscal policy and one that meets a target debt level in a target year.
  • Generational accounting attempts to measure and compare the net benefits received by different age cohorts, mainly by calculating transfers made less taxes paid.

3.9
Some of the national jurisdictions approached as part of the research offered information on work that had been done, and measures used, in this area:

  • Denmark operates rolling four-year caps on public spending (exclusive of unemployment benefits, which are considered a core automatic stabiliser during economic downturns).
  • Sweden, like Denmark, is outside the European Monetary Union. Like New Zealand, both Sweden and Denmark are small players with floating exchange rates. Sweden focuses on net debt rather than gross debt and also considers that long-term financial sustainability is dependent on welfare and economic resources being redistributed in an acceptable manner, with the conflict between redistribution, stabilisation, and structural policy to be "limited".
  • The United Kingdom recently established an Office of Budget Responsibility to monitor financial sustainability, which provides in its (first) 2011 report a very useful depiction of the elements of government activity, past and future, in terms of stocks and flows. It uses this to underpin its sustainability assessments and to illustrate the limitations of the different methods used. For example, flow-based methods predict future revenue and spending, while stock-based methods measure existing assets and liabilities then assess discounted future revenue and expenditure streams.
  • Canada's Parliamentary Budget Office produces a financial sustainability report, and its 2010 report provides a useful illustration of the effect of various levels of delay in addressing the fiscal gap, a concept most reporters struggle to communicate effectively.

3.10
Recently, a group of Masters students at Stanford University, under the guidance of David Walker, the former Comptroller General of the United States of America and currently at Stanford University, released a "Sovereign Fiscal Responsibility Index", which "provides unique and useful insight into the fiscal sustainability of countries ...".17 The components are:

  • fiscal space – a measure that compares a country's weighted average debt level with an assessed debt ceiling (an IMF measure based on past behaviour, stability of government, and some economic measures), at which point it is assessed that a major fiscal crisis is inevitable;
  • fiscal path – which measures how many years it will take a country to reach the debt ceiling on its current fiscal path (complementing this by measuring how long it will take to reduce the fiscal space to 50% of GDP); and
  • fiscal governance – which weights fiscal rules, transparency, and "enforceability" equally to come up with a "points out of 100" measure.

3.11
The three components are then ranked and the rankings averaged to create the overall ranking and index. Despite the limitations of such indices that various commentators have explored,18 the Sovereign Fiscal Responsibility Index has some very attractive features:

  • it attempts to measure the stability of the fiscal system by looking at both its limits, or tipping points, and its strength (and, implicitly, public confidence in it);
  • it uses a more balanced concept of debt than the other measures; and
  • it makes its assessments more useful by giving time periods before fiscal crisis is possible or likely to occur.

3.12
New Zealand fares well under the Sovereign Fiscal Responsibility Index assessment, being ranked second only to Australia out of 34 countries rated in the 2011 Stanford report.

Interconnectedness and the emerging trend to national indicators

3.13
The major limitation of the main methods used to assess public sector financial sustainability is that the measures are of matters directly related to financial activities. They are lag indicators that take little account of the social and environmental causal loops that underlie economic activity and costs.

3.14
A major finding of the research is that public sector financial sustainability is not just a matter of "spending less than you earn". Greater focus is emerging internationally on gaining a better understanding of the underlying social, environmental, and economic drivers of public spending, and the connections between them, rather than focusing primarily on the current composition of that spending.

3.15
The indicators arising from this work cross into the realm of narrow public sector accountability. Some of the most commonly used economic KNIs have clear and direct relevance to public sector financial sustainability (for example, GDP per capita, impacts on public spending, productivity, fiscal gap, infrastructure investment). Many more are underlying and – actually or potentially – causal. The research links KNIs and indicators of public sector financial sustainability together to consider how a fuller understanding of public sector sustainability in the context of wider drivers could be built.

3.16
Interconnectedness is important to public sector financial sustainability because:

  • At the simplest level, a range of issues might be characterised as competing with each other for attention and public funds.
  • However, there are multiple connections and flow-on effects between them that are not always obvious.
  • Since these are parts of complex systems, it is often extremely difficult to sort out the levels of effect (or multiplier/dampener effects) that parts have on each other. There are also hard-to-assess risks of tipping-point effects, where an accumulation of small, apparently innocuous events or changes results in a sudden discontinuity.
  • There is also the difficulty of externalising costs or effects when everything is interconnected. The current Global Financial Crisis is a vivid case in point. One of the strengths of capitalism in a market-based economy is that real costs can be externalised, as long as there is somewhere to externalise them to, but our inter-connected economies leave less and less room for such externalising.

3.17
Systems of KNIs are being increasingly explored and used to build understanding of the underlying social, environmental, and economic drivers of public spending, and the connections between them. A number of initiatives show promise in offering better views of the connections between a wider set of drivers. The purposes range from informing public debate to targeting and measuring progress in the jurisdiction. The arrangements for the systems vary in their independence from the government of the day, partly dependent on their different purposes but also partly on history and local conditions.

3.18
Indicator systems are generally organised on the "three domains" basis (society, environment, and economy). Most offer a "top 20 indicators" or equivalent, which are often selected as an overview from a larger body of published indicators. They are also usually the top of a pyramid of subject, sector, or sub-national indicator systems run by various agencies. The indicators used have been moderately stable during the last 20 years and have generally been changed in a considered and well-described way.

3.19
There is considerable overlap between systems at indicator, category, and purpose levels. However, there are as many unique or uncommon indicators as there are common, and similar indicators will often be grouped under quite different categories or even domains. The General Accountability Office (GAO) in the United States of America provides one example of how national indicators can be categorised, as shown in Figure 1.

Figure 1
General Accountability Office key national indicator categories, 2011

Figure 1 General Accountability Office key national indicator categories, 2011.

Source: United States General Accountability Office (2011), Key indicator systems: Experiences of other national and subnational systems offer insights for the United States, page 2.

3.20
The variation in possible indicators and their categories reflects the issue of interconnectedness. Switzerland uses a Venn diagram as a partial illustration of this (see Figure 2), and some jurisdictions offer different ways to slice and view the information – for example, as "cross-cutting issues".

Figure 2
Switzerland's overview of key national indicators, categorised according to three qualitative objectives

Figure 2 Switzerland's overview of key national indicators, categorised according to three qualitative objectives.

Source: Swiss Federal Statistical Office (SFSO), Swiss Statistics Web site (2013), Sustainable Development – A Brief Guide 2013: 17 key indicators to measure progress, Neuch tel, page 23. (Copy made May 2013.)

3.21
An alternative approach is the "radar diagram" (see Figure 3),19 which depicts the indicators in a way that enables effective strategic discussion of their relationships and trade-offs.

Figure 3
Example of a "radar diagram" for key indicators

Figure 3 Example of a "radar diagram" for key indicators.

Source: Mark Anielski (2006), Leduc Genuine Wealth Report 2006. Available at http://www.anielski.com/publications/. (Copy made May 2013.) © Anielski Management Inc., Edmonton, Alberta.

3.22
Recently, Australia and the OECD have done some useful thinking about designing national indicator systems. Australia proposes replacing the "Mickey Mouse"20 model with the "strong sustainability"21 model (see Figure 4). The OECD makes a useful distinction between (mainly economic and environmental) inputs and (mainly societal) outcomes in its 2010 report.22

Figure 4
The "Mickey Mouse" and "strong sustainability" models of national indicator systems

Figure 4 The "Mickey Mouse" and "strong sustainability" models of national indicator systems.

Source: Sustainable Aotearoa New Zealand Incorporated (SANZ) and Nakedize Limited (2009), Strong Sustainability for New Zealand: Principles and scenarios, page 8. Available at www.phase2.org.

3.23
The GAO's 200423 and 201124 reports, based on surveys of supra-national, national, and sub-national systems, give good information on, and examples of, lessons learned and potential benefits and pitfalls. Highlights of these are:

  • There is evidence of positive effects, notably improved collaboration in addressing public issues, providing tools to encourage progress, more informed decision-making and research, and increased user knowledge.
  • Major challenges experienced included securing and sustaining stakeholder support and funding, agreeing types and numbers of indicators, and obtaining indicators or data for the system.
  • Of themselves, and subject to set-up and consultation costs, the KNI systems are not expensive to run (because they are mostly about gathering and co-ordinating existing data sets). The GAO's 2004 report found that "[i]n most cases, one to three persons [are working] on the project full-time".25

13: The attention of the research author, Bruce Anderson, was drawn to Mr Micawber by the New Zealand Institute of Economic Research's 2012 report, Is local government fiscally responsible?, for Local Government New Zealand.

14: Governmental Accounting Standards Board (2011), Preliminary views on economic condition reporting.

15: International Federation of Accountants (IFAC) International Public Sector Accounting Standards Board (2011), Exposure Draft 46, Recommended Practice Guideline: Reporting on the long-term sustainability of a public sector entity's finances.

16: Schick A (2005), "Sustainable Budget Policy: Concepts and Approaches", OECD Journal on Budgeting Vol. 5, No.1, pages 107-126.

17: Augustine TJ, Maasry A, Sobo D, Wang D, Walker DM, and Nation J (2011), A Sovereign Fiscal Responsibility Index, Stanford Institute for Economic Policy Research Brief.

18: See, for example, Pollitt (2011), "Moderation in all things: International comparisons of governance quality", Financial Accountability and Management, Vol. 27, Issue 4, pages 437-457; and Hood C, Dixon R, and Beeston C (2008), "Rating the rankings: Assessing international rankings of public service performance", International Public Management Journal, Vol. 11, No. 3, pages 298-328.

19: This is used by Mark Anielski and others to illustrate the "Genuine Progress Indicator" and related indicator systems. See: www.anielski.com.

20: See http://nz.phase2.org/what-is-strong-sustainability.

21: Australian Bureau of Statistics (2010), Future directions for measuring Australia's progress.

22: OECD (2010), A framework to measure the progress of societies, Statistics Directorate Working Paper No. 34, STD/DOC(2010)5, France.

23: United States General Accountability Office (2004), Informing our nation: Improving how to understand and assess the USA's position and progress.

24: United States General Accountability Office (2011), Key indicator systems: Experiences of other national and subnational systems offer insights for the United States.

25: United States General Accountability Office (2004), Informing our nation: Improving how to understand and assess the USA's position and progress, page 16.

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