Steering clear of debt

1 May 12
However hard it might be for governments to change accounting course, they need to do so urgently to avoid future financial crises, says Steve Freer

By Steve Freer | 1 May 2012

However hard it might be for governments to change accounting course, they need to do so urgently to avoid future financial crises, says  Steve Freer

There is a joke ­currently doing the rounds. Question: when will there be another global financial crisis? Answer: when the last person who has lived through this crisis dies.

There is a serious message here, of course. It is not good enough to rely on a combination of corporate memory and bitter experience to ward off future disasters. We really do have to drill down to root causes and make explicit system and behavioural changes to ensure that history is not painfully repeated at some ­far-off – or maybe ­not-too-distant – future date.

This advice seems particularly relevant in the run-up to the Group of Twenty Leaders’ Summit in Mexico in June, with the sovereign debt crisis in Europe and the broader global financial crisis bound to be high on their agenda. But will participants be in the mood to explore root causes or will their perspective be more focused on staving off ­short-term disaster by somehow muddling through?

It is easy to rehearse why the debate might be focused on the here and now. Few of the actions taken over the course of the crisis thus far have felt like long-term solutions. On the contrary, most have seemed to be temporary ‘sticking plaster’ measures to buy time. That is a perfectly good strategy providing the time bought is used wisely. Again, this brings the searchlight back to underlying causes and actions that can secure and assure financial stability for the ­long-term future.

CIPFA entered this debate in November 2011 by launching our Fixing the Foundations initiative at the International Federation of Accountants council meeting in Berlin. We argued that governments around the world needed to look close to home for one of the critical underlying causes of the sovereign debt crisis.

In most jurisdictions, public financial ­management – ie, government accounting, auditing and financial management practices – is simply not up to the challenges presented by the modern world. Many governments are still relying on ­cash-based accounts, oblivious to the full extent of their asset holdings and liabilities – critical information if management are to have a grip on their overall financial position.

This is a remarkable failing when we can also see through this crisis just how important fiscal and financial management is to us all. It has a direct impact on the availability and quality of public services, social outcomes, living standards and life chances. It affects investor confidence, economic performance, business development and employment opportunities. It has significant implications for equity, accountability, and trust and confidence in governments.

We don’t have to look to extreme case ­studies such as Greece to see all the ripples that radiate from PFM. We can see them clearly in the UK as the coalition government strives to rebalance the public finances by squeezing public ­spending and ­promoting economic growth.

Combining simplistic cash accounting methodologies with the increasingly complex financial transactions undertaken by governments, such as Private Finance Initiative schemes, fiscal stimulus programmes and bank bailouts, creates a dangerous cocktail. And, as we have seen, the escalation from a below-par financial position to a full-blown crisis can be extraordinarily rapid.

So for CIPFA the fundamental place to start is a ­commitment to shift governments across the world to more informative accrual-based accounts, prepared in accordance with modern international standards. Modern standards are a critically important part of the package. We saw a great example of their significance in the UK’s first set of Whole of Government Accounts in late 2011, which reported the consolidated financial position for the year ended March 31, 2010.

The commentary on the accounts explained the ­differences between the traditional National Accounts (based on the European System of National and Regional Accounts and used by the government and the Office for Budget Responsibility) and the WGA (based on International Financial Reporting Standards adapted for the public sector). The differences are illuminating, to put it mildly. For example, a £107bn deficit under the former grows to £165bn under the latter. Even more strikingly, Public Sector Net Debt of £760bn under the National Accounts expands to Net Liabilities totalling £1,212bn under the WGA. The government deserves credit for publishing the WGA. But now the chancellor and the Treasury need to use the information the accounts ­provide to manage the public finances and fiscal policy more effectively.

If we are serious about avoiding future crises, we have to persuade governments across the world to make these changes now. And what better place to start than in the developed economies represented by the G20? There really are no excuses. Admittedly, implementing international standards and the migration from cash to accruals are not small commitments. The change is relatively complex to undertake, requiring investment, careful planning and dedicated, specialist staff.

But without reliable accounting, governments have no basis to manage their affairs professionally, to make intelligent policy choices informed by appropriate financial data, and to demonstrate their stewardship of resources to citizens and investors.

Through Fixing the Foundations we have seen that there is a great deal of support for these changes around the world. A variety of national and international organisations, including accounting institutes and firms, have expressed support for a major push to modernise public financial management as a foundation for better, more transparent and accountable government.

However, two constituencies are notable for their ­relative absence. With one or two honourable exceptions, governments have not been rushing to support or commit themselves to the actions required. Rating agencies, too, have shown little or no interest in our initiative.

The latter is particularly puzzling. I had expected rating agencies to enthuse at the prospect of better, more assured information about the financial positions of governments. Surely that would enable them to conduct their business with much higher levels of confidence.

Indeed, focusing on this possibility brings into sharp relief how difficult it must be to formulate robust ­ratings for governments whose financial affairs are reported on a cash basis, in some cases with the considerable ­complication of underdeveloped audit arrangements.

The relative dearth of responses from governments is perhaps more predictable. Like ocean liners, governments take time to turn around. In many cases, decisions to change will need to be preceded by formal projects to evaluate options and formulate recommendations.

In practice, it is also clear that we need to do much more work to demonstrate the benefits of better financial management to politicians. Information is power, and accrual-based accounts (and budgets) provide better information than their cash equivalents. Better information can be used to evaluate policy options more thoroughly, to measure performance more effectively, and to plan with greater confidence. Improved financial accounting inspires better management accounting, providing the hard data that underpins the best ­evidence-based decision-making.

Critically, while accounting might not instinctively excite the passions of politicians, accountability should. And better financial management, including independently audited financial statements, can provide a vital key to unlock refreshing transparency and much more effective  accountability in relation to a government’s policies and performance.

So there is a great deal for politicians to gain from supporting and being early converts to the drive to modernise accounting, auditing and other aspects of financial management in public sector organisations. And the biggest prize of all, for politicians and the people they represent, is the prospect that future crises will be less likely to occur because the lessons have been learned and understood, and remedial action has been taken.

This is a great opportunity for the G20 to lead by ­example, putting their own government houses in order. Let’s hope that they seize it.

Steve Freer is the chief executive of CIPFA

This article first appeared in the May edition of Cooking Recipes

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