Video transcript: Sound financial footing: Why this is important for the public sector

Transcript for a video of a presentation about the public sector's financial footing given at the 2019 Audit New Zealand information updates.

Title: Sound financial footing: Why this is important for the public sector

Professor Ian Ball

Tēnā koutou, tēnā koutou, tēnā koutou katoa. Good morning everybody. This is a fantastic turnout. I have to say, I’m very impressed. It’s a privilege to be speaking to you after Steve and John. And the topic I’ve been given to talk about today is sound financial footings and why this is important in the public sector. I have to say that, based on some of the experience I had while I’ve been living outside of New Zealand, my immediate reaction to this topic: there’s a song, “You don’t know what you’ve got till it’s gone.” And I’ve just got, on the slide there, a few examples of governments that don’t have sound financial footings. The flames there are riots in Greece, as a result of their financial difficulties. Puerto Rico has gone through a very difficult period, is still going through it. The Financial Times piece suggests that Italy might be about to trigger another crisis for the European countries.

And, at the bottom right, there’s an article from Forbes Magazine in the US that’s ranking the financial performance of state governments, and it identifies that New Jersey is the worst in terms of its fiscal position. And, just to give you a sense of what that means in numbers, for the average taxpayer in New Jersey, the amount by which the New Jersey Government is underfunded or has negative net worth is $90,000 per taxpayer. I’d like you to keep that number in mind, $90,000 per taxpayer, because I’m going to come back a little to that. What this means is that the reason why financial footings are important is that, if you don’t have them, the costs are very high. And we see that in things like that the social disorder that we’ve seen in Greece, but we also see it more developed countries.

So, for example, New York City is currently approaching a position which is very similar to the one it approached about 30 years ago when it essentially lost democracy. It was taken over by an emergency financial control board, because it was basically bankrupt. And so the citizens lost control of the budget. So the cost of poor financial management – poor financial footings, if you like – is either social disorder and/or a loss of democracy. And in some countries we’ve seen that when the country gets into such a bad position that the military have to come in because a civilian government cannot restore order.

So why are these financial footings important then? Well, I think we often see financial strength as being somehow in opposition to social wellbeing. And the point that I want to make – and I’ll come back to this a little bit later – is that financial footings, a sound financial position in the government, supports social wellbeing, and it does it in a number of ways. I should just perhaps preface my further comments by the fact that, if it isn’t obvious to you, New Zealand has, relatively speaking, a sound financial situation, and I will give you some numbers to support that shortly. But having a sound fiscal position means, for example, that you don’t need to be making reactive policy changes. You can see this in many governments where they’re sailing close to the wind. They get some bad news; they have to change their policies.

In New Zealand, we don’t have to do it in that way. It enables shocks to be absorbed – and again, I’ll give you some numbers in a minute, but New Zealand came through the Global Financial Crisis and the earthquakes in a way that’s not matched by other comparable countries – and, as I say, I’ll give you some numbers to support that. So it enables shocks, which are inevitable, to be absorbed without undue stress. And it reduces uncertainty, whether it’s to us as individual citizens and taxpayers or businesses. People know that the government is in a financial position where it can manage shocks to the system and it’s not going to change the way the government impacts on you in a direct way.

So what do I mean by the financial footings in the case of the New Zealand Government? Well, Clint mentioned in the introduction that I was involved in the development of the Public Finance Act in 1989. That’s quite a long time ago now. I suspect some of you might not have even been born in 1989. Just to put it in context, it’s the year that the worldwide web was invented. So that Act, as you know, it’s currently under review – that’s part of the set of reviews that John referred to – and the Treasury’s issued a couple of discussion papers, one of which is they’ve also published the responses to. So it’s very timely to look at our financial footings.

But now the commercial break. And I have authority to do this, but you can figure out: 1989 to 2019 – that’s 30 years. And Victoria University is having a conference at the end of July to celebrate this 30-year anniversary. I’m not sure we’ll get quite this number but it’ll be good to have a few of you along. We’re going to look at what the Act was intending to do, what it achieved, what it didn’t achieve, where we are now and where we might be going. So, just a small commercial break there.

I should perhaps say, in light of what I’m about to go into, that, when the Public Finance Act was written in 1989, the system of accounting and financial management we had in the New Zealand Government was very similar to the one that still operates in many governments around the world. That is, it was cash-based; we didn’t have a balance sheet. It was run entirely by Treasury; all the payments were made from Treasury. And, as managers within a government department, you got the information that Treasury decided you needed to do your job. So it was a fairly significant change, and, in fact, New Zealand was the first country in the world to produce a full set of accrual-based financial statements.

But where are we now? I said, “You don’t know what you’ve got till it’s gone.” Well, what have we got? What we’ve got is a fiscal position, from the latest set of financial statements. You can see that this is a graph of the track of the New Zealand Government’s net worth. Now, you don’t often hear about net worth in the press, but net worth is the most comprehensive measure of the government’s fiscal position. If you talk about debt, you’re only talking about one component of your fiscal position. I’ll come back to this point. But I’m using net worth as a measure, because it’s the one that I think best reflects a government’s fiscal position. So that graph starts at 2006, in the period that, since the Public Finance Act was first put in place fully in 1994 to 2006, the government’s net worth increased every year.

Now, this was after two decades where it ran deficits every year. So we’ve moved from a situation where we had year-on-year deficits to one where, over a period of about 25 years, the government has built up net worth pretty much every year except four years, which were the years in which the Global Financial Crisis occurred and the Christchurch earthquakes occurred. And then, fairly quickly – four years later – net worth started to increase again. So what have we got? Well, clearly we’ve got a position where the government’s balance sheet is in reasonably good shape. I’d like to compare it with some other comparable governments.

But, before I do that, I’ve used these numbers before, and people look at me… well, they sort of look blank when I talk about them, because I think we often don’t have a very good sense… I’m going to be talking about billions and trillions, and I don’t think people have a very strong intuitive sense of what a trillion dollars is. And so just look at it like this: a million seconds lasts 11 and a half days – a million seconds. A billion seconds lasts 31 and a half years. A trillion seconds lasts 31,500 years roughly. There’s a very big difference. So when we talk about trillions, we are actually talking about quite big numbers. So the point I’m making is that not only do we have a good fiscal position, we also have a very resilient fiscal position.

And what I’ve got here is the numbers for Australia, Canada, the United States and the United Kingdom, and New Zealand. First of all, in 2008 when the financial crisis struck, and in 2017, which is the latest set of numbers we’ve got for those countries. You can see that Australia had a positive net worth in 2008. It’s been basically going downhill ever since, except for the last year, where it went up a little bit. And it’s gone from positive 67 billion to negative 391 billion. Canada’s gone from negative 457 billion – it was already negative when the financial crisis struck – to negative 631 billion. Now we get into the trillions. The UK was negative 1.2 trillion when the financial crisis struck. It’s headed consistently south since then; it’s now negative 2.4 trillion. And the US was negative 10.2 trillion when the crisis struck, and it’s now negative 20.4 trillion. By comparison, New Zealand was positive 105 billion when the crisis struck, and, as of 2017, it was positive 116.

Now, I could also give you – and I won’t, for reasons of time – what that amounts to per citizen, but, just very quickly by way of comparison, on a per-citizen basis for New Zealand, the government’s net worth is equivalent to about $25,000 per citizen positive. For the US, it’s equivalent to about $90,000 negative per citizen. And you remember, if you happen to live in New Jersey, you’ve got another 90,000 on top of that – but that was actually per taxpayer; this is per citizen so it’s worse. The point is, New Zealand has a set of fiscal and financial arrangements that mean that we recovered from the Global Financial Crisis and the earthquakes very much quicker than those other countries, all of which, except Australia, are still heading down.

But what else have we got? Well, we’ve also got, comparatively, very high levels of social performance. Now, I’ve just got there a couple of the indices which attract these things. The OECD ranks us in the top 10 in the tier-one countries in terms of social performance. And the Legatum Institute has us as number two globally. So I don’t think it’s possible to say that we’ve achieved the strong fiscal position at the cost of our social performance. However, having said that, there are significant issues that do remain to be addressed, so this is not a, “Do not change the Public Finance Act, do not change the financial management system in New Zealand.”

We have complex social problems which we really are struggling to know exactly how to address. We’ve got a long-term fiscal outlook. If you look at what our net worth is likely to be in 40 years’ time, given existing policies, we are seriously in the red by then. The aging population and the effect of national superannuation will erode our fiscal position quite substantially. And we absolutely run the risks of further global shocks, further earthquakes, further natural events, the effects of climate change and so on. So we do have significant issues that remain, and we need to think, when we’re thinking about how do we change our management system, what are these issues that we still need to address, and how does that relate to the system that we run.

So, just to cover a couple of the points that might change in the Public Finance Act, there are two things that have been already raised as possibilities. And, as I say, Treasury’s released discussion papers on independent fiscal institutions, and on the issue of wellbeing. Independent fiscal institutions are something we don’t have in New Zealand but they’re very common in other countries like the United Kingdom or Australia, or the United States. And that’s something that the government has clearly expressed the view that they believe that we should have one. I must confess that I’m pretty lukewarm in this. I think there’s some merit; there are some things that a fiscal institution as proposed could do.

Both Stephen and John talked a lot about trust. One of the differences between New Zealand and Australia and the United Kingdom, or America, is that the numbers that the Treasury produces in New Zealand are actually trusted. They are the Treasury’s numbers, and the law makes the Treasury independent in the role of producing, whether it’s financial statements or the budget numbers. Whereas in other countries, that’s not the case. And one of the roles of the fiscal institution – and in many cases the key role – is to basically give an independent view of the numbers the Treasury produces. But I personally don’t think we need that. There are arguments about whether the institution could be used to strengthen parliamentary scrutiny, which may well be a good idea.

One of the interesting things is that the French arrangements for an independent fiscal institution actually have it as part of the operation of the Controller and Auditor-General. So they basically put it within the audit function. So it starts with independence; it doesn’t have to establish its independence. And there is an issue about whether or not policy costing should be produced. However that’s one of the issues. The other one is around wellbeing, and again, there’s a discussion paper that’s been produced, and the government’s talked a lot about a wellbeing budget. I think if you look at what’s happened over the period since the Public Finance Act was first enacted in 1989, we’ve seen a succession of changes, not in the Act itself, but in the way it’s implemented, that really say what a difficult issue it is to deal with the whole outcomes- wellbeing area. That’s really the hard bit of public management.

In the Act itself it talked about outcomes. They’re no longer in the Act. We had strategic result areas. We’ve had better public services. We’ve had the Performance Improvement Framework. We’ve had social investment. We have the Living Standards Framework. Now we’ve got wellbeing. So all of those things are essentially operating in the same area. One of the ways in which I think the Public Finance Act could well be improved is all of your organisations produce a set of financial statements and what used to be called a Statement of Service Performance – may still be in some cases – but something which says non-financially, what did you do; what did you deliver?

There’s no equivalent for that at the whole of government level. There’s no statement of “what are the outcomes that government said it would achieve, or aim to achieve?”, and what it actually did achieve. So I think there’s, at the very least, a case to be made that we’re now in a position that we could have sitting alongside the financial statements, if you like, a government performance statement which says, “This is how we’re doing on the outcomes.” It’ll be interesting to see. One of the things, however, that counters that a little bit – there are two things that I’d observe that I’m not sure will get addressed in the Act, but I’d certainly like to see them addressed in the Act.

The first is dealing with outputs. Now, I better check: is there anybody from police in the audience? Okay. I’m not picking on police. John referred to one of my colleagues at Victoria University and quoted him in his presentation. I was just reading in the last couple of days a draft of a paper he’s done where he took the 2015/16 and 16/17 annual reports of all the departments and looked at how well they reported on financial performance. I guess the conclusion is: not very well. Unclear; structures are strange; the relationship between strategic objectives and the non-performance information is not clear. And, in preparation for this, I also did a little bit of my own checking, and one of the things that I found very interesting is that outputs seemed to have progressively been – what’s the term? Diminished, ignored, become less clear, less well specified. To the point where I have to question whether or not we really know what they are any longer.

And I’ve used a couple of slides from Police to illustrate this. In this first slide, in the centre of this slide there is a column which says What We Do. And in it you’ll see strategies and targets, but you actually won’t see what it is that the police do. And I thought, well, that’s not necessarily so bad if somewhere else we get the outputs clearly specified. So I went further through in the annual report, and I came to this page here. It’s a description of the Road Safety Programme and what outputs were purchased within this expense, in the right-hand column. I guess you can’t read that; let me read you a couple. In fact, I could have a small test here. So the first one, Outputs Purchased Within this Expense: “Reduce the impact of high-risk drivers.” Is that an output? No, it’s an outcome. That’s not what the police are doing. That’s not the service they’re delivering.

“Increase the safety of young drivers.” Is that what police actually… is that the service they produce? No, it’s not. “Increase the safety of motorcycling” – something I take a personal interest in, but it’s not an output. And, in fact, of those 12 outputs, only one of them is what I would regard technically an output. So I think we moved a long way from a clear specification and understanding of what outputs are. And I don’t want to spend a lot of time on this, but outputs are not as important as outcomes; we all know that. But outputs are how you achieve outcomes; you can’t do anything about outcomes other than through producing outputs. So those are the services that achieve the results, and you need to know what they are.

So that’s one of the things that I would like to see covered. The other is non-GAAP measures. The two most common numbers you hear in the fiscal debate in New Zealand are debt, net debt, and over OBEGAL. Neither of those will you find in accounting standards. They’re both numbers that are not GAAP measures. And the article that I’ve got there, and the extract from it, is in the Financial Times recently, where one of their writers was basically encouraging people not to trust too much non-GAAP measures because companies, or governments, can manage them in ways that is not helpful. I’m not arguing against not having any non-GAAP measures. But one of the interesting things is that, almost universally, it’s seen as being the case that you cannot give a non-GAAP measure greater emphasis or greater significance than the GAAP measure.

And I think in these two cases, we do that all the time in New Zealand. We give these measures greater significance than the operating balance or the net worth number, and obviously I’d like to see the GAAP numbers given much greater prominence in the debate. So I suppose where I get to at the end of this is, when you think about the fiscal footings or the financial footings in New Zealand, and we think about where we are in terms of the financial strength of the New Zealand Government relative to any of our normal comparators, I think what that suggests to me is that we should have a fairly high bar before we change anything that’s fundamental in the system. There are things in the system that enable – and I’ll use the capital charge; that’ll probably be an unpopular example. The capital charge enables departments to do things. It’s not used very much as an enabler; I think it’s seen as a compliance cost.

We need to fight, to some extent, what I think all systems do: they run down over time. You have to work actively to make them work well. You have to keep them tuned, so to speak. And what I think is really important is we should not ignore the role of leadership in effecting the way the public sector and public service departments operate. The Productivity Commission recently did a study on state sector productivity and identified a number of challenges to improving productivity in the state sector, and a number of those were around ministerial behaviour. If ministers aren’t interested in your department’s balance sheet, it probably won’t get the attention it deserves. If they are interested, you’ll take a greater interest. If they don’t like failure, they’re not prepared to tolerate failure, you’ll be risk-avoiding. So I think those aspects are also important to be considered before the Act itself is changed – or changed further, because it is already a very different Act now than it was in 1989.

And, finally, there are a few things that I think just should not be changed. The system is coherent. New Zealand is unusual in that we budget, appropriate and report on an accrual basis. A lot of governments budget on a cash basis and then report on an accrual basis, which, from a management perspective, is just a nightmare. It’s why the British Government puts its financial statements out 14 months after year-end, by which time, of course, they’re not really worth very much. So we should stick with our accrual information; that’s the basis for the system. Monthly financial statements, I personally believe, are really important in shaping the way New Zealanders think about fiscal management. You see it alluded to every month.

There are some other things. Two things that I think are really important: using independent standards – New Zealand does that; most other countries are very reluctant to use accounting standards that they don’t themselves set. They want to be able to write the rules so that, essentially, they can avoid accountability for their actual results. And, finally, I would comment that that point that I made earlier about the Treasury is seen as being independent – in terms of the production of numbers in New Zealand, I think that’s a really great asset for the country.

So that’s really what I think about the financial footings. I think they’re not too bad at the moment. They look pretty good by comparison with other countries. It’s absolutely not to say that we shouldn’t consider whether there are improvements. But when you’re playing with the footings, you want to be really sure you’re not weakening the structure. Thanks very much.

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