Better Accounting Can Get Us Through the Pandemic

(Bloomberg Opinion) — The Covid-19 pandemic has revealed just how much governments matter — and that competent management can be the difference between life and death. Good leadership requires good information to support smart, timely decisions. Further, democracy itself relies on information that is understood and trusted by its citizens. High-quality accounting is a vital source of that information.

In the fight against the coronavirus pandemic, while most governments debate how much debt is sustainable and what fiscal measures should be used to measure it, countries like New Zealand are deploying the fiscal measures that make sense on the basis of a proven technology: accrual-based accounting. This method underpins financial decision-making and reporting in the private sector — and has contributed to the wealth many enjoy today.

Unfortunately, most government accounting relies on ancient methods. Charlemagne would recognize the system of cash-based accounting that almost all governments still use today. Modern, accrual-based accounting, like that used by public companies, is mostly eschewed by governments; few, including New Zealand’s, use it as the basis for their budgeting and financial reporting. But accrual accounting recognizes and reports all transactions when they occur, rather than when and if cash changes hands, and accounts for all assets and liabilities, not just cash and debt.

The concept of net worth — assets less liabilities — is the most comprehensive measure of the fiscal health of individuals, companies or governments. Not only would accrual accounting give governments a clear view of their current financial positions, but it would also provide the information needed to make informed policy decisions. It allows for rapid, targeted and secure assistance to those in need. It reduces the potential for corruption in the distribution of funds.

Not least, accrual accounting has helped countries respond better to the pandemic. Since switching to accrual accounting over two decades ago, New Zealand has steadily built a very strong balance sheet, with substantial positive net worth. In the pandemic, that information, and the public’s trust in it, helped give the government the confidence to act decisively and quickly. As Prime Minister Jacinda Ardern pointed out, a strong balance sheet allowed the government to “go early, go hard” in its successful strategy to eliminate Covid-19. According to Johns Hopkins University, New Zealand’s cumulative death rate is one of the lowest in the world, while both the U.K. and the U.S. have two of the highest rates.

And the method has provided comprehensive feedback — earlier than for other countries’ — on the fiscal impact of a government’s response to the crisis. Countries still on the anachronistic cash system base their decisions on a partial view of their financial positions and prospects. No wonder that governmental accounting in the U.S., U.K. and Europe is often seen as largely irrelevant. For good reason, corporations don’t make crucial decisions based only on the information in their bank statements. Rather, they trust in a comprehensive system of budgeting backed up by audited accounts. Governments should do the same.

High-quality information, to support informed and speedy decision-making, is vital. But so is winning the public’s trust. New Zealand has built confidence in its political system by using a public financial-management system in which high-quality accounting information is primarily a decision-making tool but also demonstrates accountability. This system builds trust in a number of ways, including by producing monthly financial statements. These inform citizens of the government’s current fiscal performance against the budget and give them this information when it matters, not months later when nothing can be done about it.

Another, equally important mechanism for building trust is the pre-election economic and fiscal update that the New Zealand government produces 20 to 30 days ahead of a general election. This document lays out the current economic conditions and prospects, and it conveys the government’s fiscal position in updated financial statements, as well as forecasted financial statements for the next four years and projections for the following 10 years. The effect of this update is that manifestoes and policies can be assessed by political parties against the forecasts in the document to minimize the risk of appearing to promise the unaffordable.

The icing on accrual accounting’s cake is the ability to put a fair market value on public assets. The cash-based system can’t do that; attempting to measure fiscal position by reference primarily to debt, or a debt-to-GDP ratio, ignores major components of the balance sheet, including public assets such as real estate.

In contrast, a focus on net worth creates incentives both to invest in assets that provide value for future generations, and to manage more professionally the vast store of wealth held by governments, not least at the local level. Studies by the International Monetary Fund suggest that additional revenues amounting to 3% of gross domestic product could be generated annually through more professional asset management — for the U.S., this would amount to some $640 billion, money that will be much needed to recover from the pandemic.

The pandemic has strained the global social fabric to a degree matched only by war. Economic systems have been tested in a way that makes the global financial crisis seem trivial. Government finances have been pushed into unknown territory. Recovery will require markedly better information about government’s economic resources, and better management and utilization of those resources. The technology is there. Governments just need to use it.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Ian Ball is a professor of public financial management at Victoria University of Wellington.

Dag Detter is an adviser with McKinsey & Co. He led the restructuring of the Swedish portfolios of public assets, the first European country to actively manage its public wealth.

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