Tuesday, 6 July 2010

A Bankruptcy Foretold 2010: Post-Financial-Crisis Update (IEA Discussion Paper No. 28, June 2010) by Nick Silver

This paper makes for interesting (as well as depressing) reading. Two years ago, the author published a paper (A Bankruptcy Foretold: The UK’s Implicit Pension Debt IEA, London) arguing that if the UK government’s debt is calculated in line with the generally accepted accounting practice the overall public sector balance sheet would also include the implicit pension debt (debt ignored in all official figures). This meant that the debt of the UK government was about 276% of GDP. In this paper, he notes that he did not even taken into account the effects of the financial crisis and bank bail outs. Thus, updating the previous study, allowing for these effects, as well as other developments in the fiscal situation he now gives what he deems to be “a realistic assessment of the UK’s debt.”

However, the author raises a counterargument and never really rebuts it. This is to the effect that private sector accounting principles are not suitable for calculating a government’s debt since governments almost always have access to liquidity to satisfy their obligations. This is because unlike the private sector, governments may tax, borrow or print money. Hence, the correct government borrowing figure is the money that needs to be raised from the markets in each given year. Nonetheless, he shows that although the pensions promise is difficult to evaluate there is hardly any cogent reason why pension liabilities should not be measured and reported.

The Office for National Statistics (2010) reported that the official current debt of the UK was £772bn (53.8% of GDP) at the end of April 2010, excluding the allowance for financial interventions. Thus, the UK is ranked 22nd in the world (compared to 50th in 2008). However, Silver argues that including the liabilities of Northern Rock and Bradford and Bingley, Lloyds Banking Group and The Royal Bank of Scotland would increase the debt to £73bn (5% of GDP) as at end April 2010. This is because the UK government undertook some obligations (if for example the assets of these banks did under-perform it would have to meet the liabilities) by “nationalising” these banks. His calculations show that the total government debt is actually £4.8trn or about 333% GDP or approximately £78,000 per person in the UK. This implies that the UK would displace Zimbabwe, which is currently the defending champion.

Nonetheless, he pointed out that most countries of Western Europe, North America and also Japan with relatively old populations and generous PAYG schemes also have large unreported implicit pensions debt which would also rank them higher than Zimbabwe (which interestingly does not have a large implicit pensions debt). He then concludes in a philosophic manner by explaining why his calculations may either be wrong or pension liabilities may not be considered debt per se or the astoundingly high number may simply be “meaningless.” These explanations only leave the reader thinking the author belongs to the school of philosophers of whom it may be said “asserted nothing but only opined.”

Picture credit: http://www.iea.org.uk/index.jsp

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