This is a guest post by Dag Detter, who led the restructuring of the Swedish portfolios of public assets, Stefan Fölster, President of the Swedish Reform Institute and Josh Ryan-Collins, a Senior Research Fellow at IIPP.
Local governments across the UK are being hit from several directions. Business rates, council tax and transport incomes are all being squeezed by local and national lockdowns, just as new demands are being made on local public health and social care budgets. As the second wave of the virus spreads, there is increasing recognition that the central government’s commitment to “level up” prosperity across England is failing. The UK’s cash-strapped local authorities are among the most stretched in Europe, according to Moody’s Investors Service. This is leaving them vulnerable to the economic contraction caused by the pandemic.
It doesn’t have to be this way. In a new report from the
UCL Institute for Innovation and Public Purpose (IIPP) we propose governments should consider the formation of ‘Public Wealth Funds’ (PWFs). These are wholly publicly owned but politically independent holding companies operating with strict commercial corporate governance standards for the purpose of maximising value for the public sector and thereby adding revenues to the government beyond taxes.
Local governments own a vast amount of commercial assets. The real estate holdings alone could have a value equivalent to the economic output of the local area, if properly accounted for at a fair market value. If professionally managed the assets could generate additional revenues to the local council that would not only help it survive but also help improve its financial independence and the much talked about devolution. Professionally executed across the country, we believe PWFs could add as much as 3 per cent of GDP in additional revenues to the public sector.
We suggest local governments should be encouraged to consolidate their substantial real estate assets into Urban Wealth Funds (UWFs) with a mandate to maximize the value of their portfolio. Together with private investors, as have been done by London Continental Railways at King’s Cross and other developments in the UK, local governments can drive the levelling up revolution without the help from central government. Pension funds and insurance companies, requiring long term, reliable returns, would be good investors in better and mixed-neighborhood social housing.
UWFs offer huge potential to improve the availability and affordability of housing without using taxes but rather developing the assets that the local government already has. Copenhagen and Hamburg have developed substantial parts of their cities without using tax money from the central government. Investments into public housing, schools, universities and hospitals was paid for by the respective UWF and not by taxes or grants from the central government. In Copenhagen it even led to a surplus that helped fund the extension of the subway.
The UWF as an independent and professional corporate vehicle would also be the best place to consolidate all the speculative real estate assets that local governments have invested in recently, since it would have the same governance system as if owned by the private sector, including IFRS accounting.
A better understanding of the financial situation at the local level is required urgently, as a number of towns had borrowed 10 times their annual budgets to fund large commercial investments that could leave them badly exposed in a market downturn, without the proper tools to manage that risk. The collapse in commercial real estate yields due to Covid-19 could create serious financial problems for many of these councils, if not properly insulated into independent and professionally managed vehicles.
The Financial Reporting Council, which regulates the accounting industry, said 60 per cent of English local authority audits it had reviewed did not meet its required standards. Introducing proper accounting in the public sector would mean accrual accounting that fully reflects all revenues and expenses and gains and losses. A perennial problem of financial management in the public sector is poor asset utilisation, which can be most obviously seen in decaying infrastructure and the fact that it provides governments with an incentive to dispose of assets, since decisions are often made without information based on an asset’s fair market value. Instead governments need to go the whole mile and adopt accrual accounting as the basis for their budgetary system, linking the balance sheet to the budget.
Comprehensive and relevant numbers are a prerequisite for effective financial management in the private sector and should equally be so in the public sector. Using the right tools to uncover the hidden strength in their own balance sheets offers governments better prospects for achieving a faster and more sustainable exit from the current crisis to the benefit of society as a whole.