This week we ask: what is fiscal transparency, what goes on in government finances, and why is transparency important for governments’ fiscal performance?
During the recent pandemic, unprecedented public spending was required to help tackle the deadly disease and minimise its economic fallout. But faced with heightened uncertainty, rapidly changing conditions, and imperfect information, fiscal transparency was perhaps not at the forefront of politicians’ minds when making important public investment and spending decisions.
Post-pandemic, in the middle of a cost-of-living crisis, and on the edges of a recession, there is a greater desire to understand the government’s fiscal position and policies. In order to understand exactly what’s going on, a degree of fiscal transparency – which refers to the publication of information on how governments raise, spend, and manage public resources – is needed.
We are joined by Dr Mike Seiferling, Assistant Professor in Public Finance here in the Department of Political Science at UCL and an expert (and former economist) at the IMF. Mike discusses the cost of non-transparency, and the importance of citizen engagement and civil society organizations in promoting fiscal transparency and accountability in government asset management.
Mentioned in this episode:
SUMMARY KEYWORDS
fiscal transparency, government, financial assets, countries, loan, investments, uk, balance sheets, ucl, emily, paper, councils, commercial banks, money, deficit, transparency, decisions, financial statements, portfolios, part
SPEAKERS
Emily McTernan, Mike Seiferling
Emily McTernan 00:06
Hello. This is UCL Uncovering Politics. And this week we ask: what is fiscal transparency, what goes on in government finances, and why is transparency important for government's fiscal performance?
Hello. My name is Emily McTernan and welcome to UCL Uncovering Politics – the podcast of the School of Public Policy and Department of Political Science at University College London.
During the recent pandemic, unprecedented public spending was required to help tackle the deadly disease and minimise its economic fallout. But in the face of heightened uncertainty, rapidly changing conditions and imperfect information, fiscal transparency was perhaps not at the forefront of politicians' minds when making important public investment and spending decisions.
Post-pandemic, in the middle of a cost-of-living crisis and on the edges of a recession, there is a greater desire to understand the government's fiscal position and policies. How well is the government performing? We might ask, where are taxes going? Should we worry about the size of government debt?
But as our guest today will explain, when assessing government fiscal performance, we ought not to only consider the liability side of a government's balance sheet in asking about debt. We also need to take a look at government's financial assets.
Indeed, the recent string of local council bankruptcies in the UK, and a report published in August stating that at least 26 councils in some of the country's most deprived areas are at risk of bankruptcy in the next two years, indicates that fiscal performance on this front – at least on the local level – is worrying.
And in order to understand exactly what's going on, a degree of fiscal transparency – which refers to the publication of information on how governments raise, spend and manage public resources – is needed.
Mike Seiferling is an Assistant Professor in Public Finance here in the Department of Political Science at UCL and an Expert and former Economist at the IMF. So an expert on all things fiscal policy and transparency, he has recently published a new paper which highlights the importance of fiscal transparency for financial performance and the importance of scrutinising financial assets.
And I'm delighted to say that Mike joins me now.
Welcome, Mike, to UCL Uncovering Politics.
Mike Seiferling 02:32
Thank you, Emily. I'm delighted to be here.
Emily McTernan 02:33
Before we get to the paper, Mike, perhaps we could start by talking about the local councils case and Thurrock. So Thurrock has recently become effectively bankrupt as a council and tried to conceal the bad news about its disastrous investments and avoid public scrutiny. What does this tell us about the policies and incentives – or lack thereof – for councils to be transparent with their finances in the UK?
Mike Seiferling 02:56
Yeah, this is a really good question to start out this podcast.
I think it'd be useful for us to take a quick step back and realise that this has been happening for a long time. And this is not the first time that governments have made, let's say, risky or wacky decisions when it comes to investments in financial assets.
If we go back to the financial crisis in 2008, there were small councils across the world, not just in the UK and not just in the US, where they invested in mortgage-backed securities only to find out that those assets were toxic and bankrupted a lot of small councils in Scandinavia and throughout the world. So this isn't the first time that local authorities have made decisions where they tried to maximise returns on financial assets or maximise returns for their local councils, only to find out that those investments didn't pay off in the long run.
In this particular case – so it was obviously highlighted, and there were a lot of dramatic parts that came with it, including the private jet and the solar panels and all of these things. But the main message we should be thinking about is holding governments accountable in terms of their investments in financial assets.
And then there is also a bigger question of: is it a government's role to invest in financial assets? Should it be a private sector thing? You know, if there's a solar panel company, and it's a high-risk investment, is it something where the government has sufficient expertise to make those type of investments, and is it in the taxpayer's interest to have governments make those investments?
Emily McTernan 04:33
It sounds like from that you think the answer is 'no' – that they shouldn't make that kind of investment. Is that your thought? Or does it depend?
Mike Seiferling 04:40
It really comes down to expertise. So if you have a council that's made up of people who don't have backgrounds in finance, and maybe are not well versed in interrogating balance sheets or interrogating the future potential of a company, and are simply investing off a whim or because somebody in a fancy suit and tie told them that they're going to get rich or they're going to enrich their consoles, then probably the answer is no.
But I mean in many countries across the world there's different philosophies when it comes to investment in financial assets. In fact, if you look at countries like India and Bangladesh, several commercial banks are within the public sector, and they do play a role in potentially providing access to finance for those who might not be able to access it in a private sector setting.
But there are several caveats that come with that. And I think that that kind of centres in on the discussion we're having today about fiscal transparency. So, you know, with privilege comes responsibility. And if governments are going to be making these decisions, then there needs to be a great deal of clarity for the public to hold them accountable on those decisions.
Emily McTernan 05:49
Great. Let's talk a bit about how we're going to go about holding governments or local governments accountable. So I guess a crucial part of the story is fiscal transparency. Perhaps you could talk our listeners through what's going to be involved in greater fiscal transparency and how it's going to help us hold governments to account.
Mike Seiferling 06:05
Yes, a very interesting and excellent question, Emily.
So fiscal transparency can mean many things to many people. The IMF has an excellent framework that goes over like a fairly comprehensive framework that considers the decision-making processes – so procedural side – as well as kind of financial statements, balance sheets, integration of stocks and flows, that's very important to understand the entirety of not just how investments are made, but how those investments perform over time.
But transparency – there's probably not an agreed definition amongst political scientists, economists, financial experts, so on and so forth. So I can't give you a definite answer.
But from my personal perspective, I would say that financial transparency should include both procedural elements, clear balance sheets, clear financial statements, and the performance of assets over time.
And I would add one layer to that, for example, in the case of local councils, that we should have very micro level data. So sometimes we suffer from aggregation when it comes to looking at financial investments or financial positions of governments, where you simply get one aggregate figure, let's say, for investment in equities, which would still not allow us to go into enough detail to scrutinise what companies does the government own equity in. So you know, it could be Coca Cola, or it could be Alphabet or, you know, one of these companies that potentially is more stable over time, or some more risky investments. So we need to have very detailed data in order to hold governments accountable on each individual investment that they make.
Emily McTernan 07:49
And your idea is this should be publicly available. Is that correct?
Mike Seiferling 07:52
Yes. And not just publicly available, but publicly available in a way that a regular person can understand what it means and how to interpret it so that they can follow along with those investments if they if they so choose, and they don't need to have a PhD in finance to do it.
Emily McTernan 08:10
And that will enable the accountability that you were talking about because then the citizens will know what's going on behind closed doors.
Mike Seiferling 08:15
Yes. But there are two sides to that coin.
So fiscal transparency in itself is not sufficient. There also needs to be members of the public or NGOs or... We're fortunate enough in the UK to have organizations like the OBR and IFS that actually look at that data. So to be transparent is a good thing. But you also need somebody to be looking at that information and to interpret it correctly and to hold government accountable on those decisions they make.
Emily McTernan 08:45
And it's your view that that should predominately be done inside a country, or do you think there's an important role for bodies like the IMF to get involved?
Mike Seiferling 08:52
I think it's an important role for people who come through the education system, for example, at UCL. We should in departments like Public Policy and Economics – we should be teaching students how to interpret balance sheets, how to interpret financial statements. And to some extent public sector accounting is ignored in universities.
If you're in an accounting department, you're generally going to be studying IFRS, not Ipsos. And in an economics department you do some national account stuff and some introductory accounting stuff, but there's not much depth. And in political science we're pretty lean when it comes to teaching accounting.
So the first step is educating the public in a way that they can understand the meaning – the story behind the numbers. But also contributing to a wider set of knowledge.
So I don't I don't want to have this come across as only universities should be providing skills so that people can hold government accountable. My belief is that anybody in any line of work in any level of education should be able to understand the basics of holding government accountable for their financial decisions. It can happen sometimes that the language becomes unnecessarily overcomplicated so that regular people can't interpret things that are actually much clearer if they're explained properly.
Emily McTernan 09:31
And moving away from the case of Thurrock and national cases. What about the more wide... So I know a lot of your work has been overseas. So what are the more dramatic and corrupt ways in which governments can behave badly through their management of assets or investments?
Mike Seiferling 10:30
Oh, this is a great question. So I'll try to keep it limited.
There was a case in – I think this was in Iraq after the invasion. And it was either the central bank or commercial banks were... So the easy part is to do the physical invasion and military takeover and so on and so forth. The difficult part is sorting out the mess once you're in there. And this happens in many countries, so I don't want to isolate just one.
But you can find that – going to the kind of centrepiece of this discussion – portfolios of financial assets, because they can be so well hidden, and they don't appear in high profile numbers like gross debt, or even in the deficits.
Suppose, Emily, that you're my sister, and I want to give you a nice gift coming from the commercial bank or from the central bank or one of the public sector institutions. The easiest way for me to do this without being caught is to give you a loan, quote unquote, for $100 million, let's say, and then over time I simply write that down very slowly.
So when you're writing down a loan, this will never appear in the deficit, this will never affect the deficit, and it will never affect my gross debt. So essentially unless the general public is looking at the portfolio of financial assets and centring in on, you know, who did this loan go to and why does it keep getting written down, then essentially I can just give you that money.
And they found after the invasion of Iraq that 40% of the portfolio financial assets were these types of loans that were just basically gifts and slowly written down. And there wasn't sufficient public scrutiny.
And this doesn't only happen in one country. This still happens to this day. And I mean there's several good stories that we could get into that centre around the exact same thing.
Emily McTernan 12:34
Troubling stuff. And I guess is that less common in the UK context, that very egregious kind? Or do you think that's also happening here?
Mike Seiferling 12:40
Yeah, I don't know any particular cases. I never want to go on the air saying that this happens in the UK.
I will say this: the Bounce Back Loan Scheme in the UK, you know, got a lot of high-profile attention, because £5 billion were found by the National Audit Office to be lost due to fraud. And I know that this has been contested, but there are several excellent, excellent reports written by the NAO that have gone into great detail on this. And part of that could be attributed to the very loosely defined restrictions on those loans and the very favourable conditions that were given to commercial banks to provide those loans. So we did lose, according to the NAO, £5 billion of funds, which in the context of current-day government where we're tightening our belt, and a lot of public sector employees feel like they're being underpaid, that's a huge amount of money that shouldn't be under understated.
So these kinds of things happen. Fraud happens. And in lots of cases, it's part of the financial assets side of government's balance sheet, or, in the case of the UK, we would consider this a contingent liability that materialised. And to be fair, it enriched the commercial banks while defrauding the public sector in the UK.
So there are things that defraud the general public from funds that could have gone to better places. And this can be done in a variety of ways in a variety of contexts.
Emily McTernan 14:15
That is absolutely fascinating. What an extraordinary amount of money we're talking about.
Now we've got that motivation set in the background, I wonder if we can get to grips with your paper.
So in the paper, your focus is on the performance of government portfolios of financial assets. And we can now see why that's of such interest. And you evaluate the relationship between these government portfolios and fiscal transparency.
So just to make sure that we're on exactly the same page, what do the government's balance sheets consist of and how do our financial assets fit into them? Obviously, we've touched on that already, but let's just get really concrete.
Mike Seiferling 14:47
Yeah, okay. Very good. So there's two different ways to think about the performance of government.
One is to look at how they make decisions over time. So Emily, you already mentioned tax and expenditure. And those two together will determine your deficit. And this is one high profile figure. So we can think about this as: suppose that you're coming to the UK to study, and you have some income, but you're limited in terms of how much you can work, and your expenditures outweigh that. Then over the course of the year you run a deficit, or you need to either borrow some money or draw on your savings to finance that thing. So that's kind of how we can think about a deficit.
But then the other way we can think about a country is in terms of its net worth. So net worth would be like a snapshot of how rich are you in net terms, which is, in very simple terms: how much stuff do you own versus how much do you owe. This concept is very interesting from several perspectives. One, if we think about who is the poorest entity in the world, the answer is the US government by far, because the liability side of their balance sheet is extremely large. And the US is a bit of an outlier in that they hold very few financial assets when we compare them to countries in Europe or Japan or so on and so forth.
So probably the best approach would be to have, you know, a one-week course for everybody in the UK to understand financial statements, balance sheets, and the integration of stocks and flows. So how the value of assets and liabilities change over time, which is not a complicated thing. And then to have those kind of emerge as a wider picture of financial sustainability, financial health, and so on and so forth in the UK.
So there's different ways of thinking about financial health and financial sustainability. And some advocates would say that we should be thinking about changes in net worth, rather than deficits, and deficits is kind of a subset of financial decisions that are made. But part of that change in net worth may not be attributed to government policies, which kind of obfuscates the analysis a little bit.
Emily McTernan 17:15
Fantastic. And what kind of assets are we talking about here? So when you say the US has very few of the kinds of assets that we see in Japan and in Europe, which kinds of things do you have in mind there?
Mike Seiferling 17:28
Yeah. Excellent, excellent question. So we need to quickly differentiate here between, so, there's non-financial assets and there's financial assets.
Non-financial assets is a very tricky topic because this includes forests and trees and fish and bears, the Taj Mahal. So valuation obviously is a huge challenge when it comes to, you know, how do you value a lake? You need to know how many fish are in it, how much is each fish worth, how much is the water worth.
I went several years ago to Rwanda and went on the gorilla tour in Virunga National Park, which is incredible. And the ticket to get in was like US$750. So when they're thinking about making a decision between you know, protecting the park, protecting the gorillas, then you can actually get a figure, or you can get a number for, you know, how valuable are those things in economic terms. You know, what's the market value of a gorilla. But it becomes very difficult.
Although I will say that now that we're moving towards being, let's say, more aware – more financially aware – of the climate, there's more efforts being put into this. But valuing these types of assets is a very difficult and a difficult thing that's a bit of a balance between, you know, science and art, let's say.
So this paper focuses only on financial assets, which would mean that we're looking at like equities, loans, debt securities, these types of things that, to some extent, we can get a market value just by looking at indices or looking at the market, as long as there's demand. So they're a little bit easier to track. And that's why we only follow those in this paper.
Emily McTernan 19:14
You're looking into fiscal transparency in relation to this portfolio of financial assets. It's quite a broad idea. I mean we've talked about it. We can see why it's really important.
How do you go about measuring it in your paper? Or how should we go about measuring it? What's difficult about measuring it? Is that a better way to frame that question?
Mike Seiferling 19:33
So we talked a little bit before about the definition. And I think that's the starting point – you need a clear definition of what is fiscal transparency. And then you will need sufficient amount of information to create like a nice index or a nice kind of a way to make it conveniently measurable for a large number of countries over a large period of time if you wanted to do some kind of statistical analysis.
There are several very good papers. There's one by Hameed in 2006 from the IMF who did a measure of fiscal transparency.
And then since then, the IMF has dedicated a lot of resources, especially within the fiscal affairs department, to financial transparency missions where they go and they do a very in-depth diagnostic check for individual countries, and they spend several days there with a team of highly talented economists. And they write a report that you could back out. You could create an index by backing out those reports. Unfortunately, they're not in huge abundance, so you wouldn't have a great sample over a long period of time.
But if you want a very rich and detailed analysis of fiscal transparency that covers a very broad range of topics, then I would definitely say that that's the cutting edge of the gold standard. Unfortunately, there's the trade-off between: if you want long time series data that covers lots of countries and very detailed assessment, and you kind of have to find the middle ground there.
Emily McTernan 21:00
Which is what you did in the paper.
Mike Seiferling 21:01
In a sense, yes.
Emily McTernan 21:03
Yes. Great. And your data set that you chose – last question on the methods before we get to grips with the finding – the dataset you chose ends in 2020. So given the unprecedented nature of government finances in 2020, why did you include it in your paper?
Mike Seiferling 21:17
Very good question. So I would, I would say more so, why did we cut off at that point? I think that the data that we used in the paper, there was no big jumps at the endpoint. But we did explicitly try to cut off any Covid data.
So I just give one plug to another paper and to a very interesting database that's been produced by the IMF on Covid financing. There's an IMF database that's over 100 countries that looks at measures that were taken by government – financial measures taken by government – to finance Covid that's broken down into health spending, non-health spending, and then financial measures like loans, so on and so forth. So we talked about the Bounce Back Loan Scheme, which would be a contingent liability. And this is concluded in the database. And this is a current research project of mine that's looking at the role of trust and whether it costed more money for governments to encourage people to lock down that were less trusted.
So going back to your questions, slight tangent there, we tried to either control for or not include periods where there were exogenous shocks, because the point of the paper is to look at the performance of financial assets in in normal times, not when exogenous shocks are forced upon a country and it has nothing to do with policymakers' decision making.
Emily McTernan 22:47
Is your sense that these shocks lead to a decrease in fiscal transparency? Or do we not have the evidence that would let us know that yet? One could imagine that governments are maybe a bit more rushed and a bit less careful and a bit less good at being clear about what they're doing during these periods, or?
Mike Seiferling 23:03
Yes. I would say that governments, from a political perspective, it would be a good opportunity to say we're too busy with other things and, you know, financial statements and balance sheets are not important right now – we're concerned with safety and, you know, all these terms that then allow governments to sometimes do some sneaky things. And decisions are made in haste. So with the Bounce Back Loan Scheme, you have this kind of trade-off between: you need to provide liquidity to these small businesses that are suffering and households as well that are that are locked down, but you also want to do it in a responsible manner.
And my feelings on things like the Bounce Back Loan Scheme – there could have been definitely much more transparency. So, for example, I can go on Companies House this afternoon and register a company. And during this Covid era, during the kind of madness that was taking place, if I can manufacture a company and have kind of some believable records, and I approach a commercial bank and say, you know, I need this loan to cover my employees and so on and so forth, there was there was 100% incentives for commercial banks to provide me that loan and 0% incentives for commercial banks not to provide me that loan, based on their own financial returns, and regardless of whether I'm fraudulent or not fraudulent.
So I think from that perspective, I saw in the newspaper today that one of Labour's new pledges is that they're going to try to chase down this $5 billion of fraudulent money. And in order for them to do that they would need some very detailed and transparent information on who took out these loans. And then they would need to investigate those on a case-by-case basis.
So I think during financial crises or any other crises, financial transparency becomes even more important. But it is easier from a political perspective to say it's not our top priority, until, in hindsight, we realise that we got robbed.
Emily McTernan 25:10
And that Labour policy – I take it you think that's a good policy? They should go look-
Mike Seiferling 25:14
Well I think it sounds nice, but it's much more difficult in practice to do these things than it is to say these things.
So, you know, for me to say a five million loss is a bad thing, you know, that sounds nice. But to track down where it went and find who are the legitimate actors and who are the fraudulent actors. And, you know, some of them are probably no longer in the UK – some of them are, you know, all over the world, maybe at this point.
So I think it would be nice to see what strategy Labour is planning to employ in order to successfully get that £5 billion back. But it would be wonderful if they could,
Emily McTernan 25:56
Let's turn to your findings. So you find amongst other results, that fully transparent governments are expected to generate around 7% higher returns on their equity portfolios than fully opaque governments. What's the causal mechanism there?
Mike Seiferling 26:10
So we could look at this as a procedure. If governments know in advance that their portfolio – their financial portfolios – are going to be scrutinised by the public. And we go back to the example of let's say, Emily, you're my sister or my wife or whatever, and I give you this loan for £100 million.
If there was sufficient transparency, then some media outlet would potentially catch on to that, and we both know that would be a front-page paper, right. So if I'm a senior official, and then we discover that, you know, Emily – my daughter, sister, wife, whatever – has received this massive loan from the government, there would be a lot of speculation and I would probably have to back out of that thing at some point.
Whereas if there's absolutely no scrutiny, then you basically just received a free gift of £100 million. So the return on that type of transaction, or that type of a financial contract, is zero. I've lost everything. Whereas, you know, if I'm investing in, say, some blue-chip stocks or something like that, and I'm getting three, four, or five, whatever percent or right now, debt securities, and you're getting five, six percent. So you can see how those differences kind of merge.
And the causal framework is that when governments know that they're being held accountable, they're less likely to make investments that are essentially not investments and gifts. And those cost a huge amount of money. And the main point that we were trying to emphasise here is just the sheer amount of money that the lack of transparency, and how that allows politicians to make decisions that are not in the public interest, how much that can affect the public purse.
Emily McTernan 27:57
Fantastic. Were you expecting this finding? Did you expect to find such a clear benefit from fiscal transparency?
Mike Seiferling 28:03
No, no. And I would caveat this in saying that the countries that we looked at in this in this paper, it's a truncated sample, because countries that didn't report any financial data are obviously not included. So if you don't report anything, then we can't include you in a statistical analysis. So to be fair, Emily, probably the worst performing or the least transparent and potentially, let's say, least financially responsible countries are simply not in our database.
So this finding I think is a good gateway to push other academics and other members of the general public to push for data in their own home countries or to push for more detailed data in their own countries in order to prevent things like Thurrock happening again in the future, which probably will.
Emily McTernan 28:56
That was an absolutely fantastic introduction to fiscal transparency, the nature of government finances, internationally and nationally.
So we've been looking at Mike's paper, co-authored with Shamsuddin Tareq. It's called 'Hiding the Losses: Fiscal Transparency and the Performance of Government Portfolios of Financial Assets'. It's available now in Public Finance Review. And, as ever, these details are in the show notes for this episode.
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I'm Emily McTernan. This episode is researched by Alice Hart and produced by Eleanor Kingwell-Banham. Our theme music is written and performed by John Mann.
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