Perspectives 2020-2021 Public Sector

Citi Perspectives for the Public Sector 8 9 Realizing value from public assets The largest segment of any portfolio of public commercial assets is real estate. Government- owned commercial real estate assets account for a significant portion of each country’s land. But governments typically know about only a fraction of these properties, as they do not have a comprehensive list of the assets nor even a proper underlying cadaster or land registry, a system that defines the dimensions, locations and titles of all land parcels. 6 Even in an economy such as the United States that is perceived as having a relatively small public sector, the indicative valuations of public real estate in urban areas is substantial. In the case of Pittsburgh, for example, the difference between book value and indicative value was 70 times, according to one analysis. 7 If professionally managed, this real estate portfolio could generate an additional income well beyond what the city raises in taxes today. 8 European countries have experimented with managing public wealth for a wide range of different purposes, and with varied results, for almost a century. Sweden became the first country in Europe to introduce active management of public assets with a clear financial purpose. Instead of wholesale privatization, the Swedish government decided to manage the public portfolio “as if owned by private shareholders.” 9 This Swedish experiment from 1998 to 2001 included introducing private sector discipline and an equity culture to the management of public assets, and boosted the value of the portfolio by 12% over the three-year period, or almost twice the growth of the local stock market during the same period, resulting not only in a better outcome from vital services but also a substantial dividend to the government, as well as a boost to economic growth. 10 By deploying a similar model, Solidium, Finland’s National Wealth Fund, has generated a total return on equity of 8% per annum, and the value of its equity holdings has increased from €5.5 billion to €5.7 billion since 2008, while €5.9 billion was paid as a dividend to the state during the same period. 11 At local government level, Hamburg and Copenhagen have both learnt lessons from MTR, the Hong Kong railway company that built an entire subway system the size of New York City by developing the properties adjacent to its stations rather than via taxes. 12 Through their respective Urban Wealth Funds, these two cities have developed tens of thousands of new residential housing units, hundreds of thousands of workspaces and education facilities, as well as new parks and retail and cultural facilities. With the financial surplus from its operations, Copenhagen was even able to help fund part of the extension of the local metro system. Similarly, London Continental Railways (LCR) and Jernhusen (in Sweden) have successfully developed areas around train stations in cities, without using taxes. While most of these examples come from developed markets, the concept and operational steps are readily applicable to the emerging markets. As a prime example, professional use of public commercial assets was a core component of Singapore’s strategy to move the economy from developing to developed status in a single generation. 13 How to manage public assets professionally A public wealth fund (PWF), structured as an independent holding company, can be set up to manage commercial public assets. Using the same tools of financial management as the private sector, a PWF makes it possible for the government to maintain ownership and manage assets professionally, while interacting with the private sector on equal terms. It should of a year’s activities on the net worth of the government — net worth being the most comprehensive measure of fiscal position. For example, a privatization might enable the reduction of debt relative to GDP; however, unless the asset is sold for more than its balance sheet value, the privatization will reduce net worth and the government’s balance sheet strength. The value of a balance sheet approach to fiscal decision making is increasingly being recognized. The work of the IMF, reported in the October 2018 Fiscal Monitor, was a major step forward in this respect. One of the significant potential benefits of using accrual accounting and a balance sheet approach to public financial management is the attention it focuses on the assets on a government’s balance sheet, encouraging more reliable information on what assets the government owns and what those assets are worth, and better systems of asset management. In response to COVID-19, governments have taken a greater role in their economies and increased the size of their balance sheets, yet their fiscal positions are more fragile than before. Under these circumstances, the value that can be extracted from the assets held by governments will become increasingly crucial, whether it is in the revenue generated by commercial assets or the services provided by assets that are held for public policy reasons. Interacting with the private sector ‘wall of money’ on equal terms The weight of international evidence is that government ownership is generally inefficient compared to private ownership in terms of corporate economic performance. 3 On average, government-owned operational assets are a third less productive than private firms’. 4 This diminished productivity hampers economic growth, creates waste, and tends to drive an overreliance on a narrow base of taxes as the major source of government revenues. The most reasonable explanation for the relative underperformance of government-owned operational assets lies in weak governance practices arising from opposing objectives, poor incentive structures, political interference and the lack of public scrutiny. But if public assets — meaning public commercial assets, rather than public parks or historical heritage sites — were properly accounted for and professionally managed, they could potentially generate additional revenues worth 3% of GDP, boosting government budgets. 5 Managing these assets better could help offset the growing debt problem facing many governments and support future economic growth, while the additional yields could help fund public goods such as public housing, health care and infrastructure, or even R&D to mitigate the impacts of climate change. New Zealand and COVID-19 The New Zealand Government has had a PFM system with accrual numbers at its core for three decades. During that time, its fiscal position has progressively strengthened (apart from the four years following the global financial crisis and the Canterbury earthquakes) from a position of negative net worth to one, just prior to COVID-19, where net worth was equivalent to just under 50% of GDP. The Government’s COVID-19 strategy took advantage of the strong fiscal position to “Go early, go hard”, leading to the effective elimination of the disease and less than thirty deaths. A strong balance sheet, a good health system and a competent state sector have dramatically contained the human impact of the pandemic. 3 Megginson, W. and Netter, J. 2001. “From State to Market: A Survey of Empirical Studies on Privatization.” Journal of Economic Literature, 39 (2): 321-389. 4 https://www.imf.org/en/Publications/FM/Issues/2020/04/06/fiscal-monitor-april-2020 5 https://blogs.imf.org/2019/06/18/a-global-picture-of-public-wealth/ 6 https://www.imf.org/external/pubs/ft/fandd/2018/03/pdf/detter.pdf 7 Valuations made by Urban 3. 8 https://www.imf.org/external/pubs/ft/fandd/2018/03/pdf/detter.pdf 9 Financial Times, Nov 12 1999 10 Detter, D. and Fölster, S. (2015) The Public Wealth of Nations 11 https://solidium.studio.crasman.fi/file/dl/i/2DHkmA/j3nr0dWCYA-HZDZJiYjTIQ/Solidiumcorporatepresentation20200331.pdf 12 https://www.mckinsey.com/industries/capital-projects-and-infrastructure/our-insights/the-rail-plus-property-model How Smart Public Assets Management Can Drive the Post-COVID-19 Recovery