Off-Balance Sheet Delusions
This post was written by Karl Whelan
This morning’s Irish Times contains a report that Irish pension funds have “indicated to the Government” that they “would be prepared to invest up to €6 billion over the next three years in a range of State infrastructure projects” under a plan “devised by the Construction Industry Council.” This would take the form of a specially issued government bond:
The funds would receive a return on their money over a period of possibly 20-25 years at a rate superior to that paid on Government gilts – possibly 2.5 percentage points above the rates offered for gilts.
The news article and accompanying commentary piece are wildly enthusiastic about the proposal. We are told that it is “innovative”, that it would be a “win-win situation for construction and the state”, that it would “protect about 70,000 jobs” and, that “after months of relentless bad news this proposal should be welcomed.” Best of all, we’re told that
it would sit “off balance sheet” and not count towards the crucial debt-to-GDP ratio, which has to be agreed with Brussels.
On RTE’s Morning Ireland, further support for this plan came from Fine Gael finance spokesman, Richard Bruton, who quibbled only that it didn’t go far enough. He instead put forward FG’s plan to spend €11 billion on energy, environmental and communications projects, funded by the Pension Reserve Fund and off-balance-sheet borrowing by a new state utilities agency, as a better approach.
This all sounds like good news—potential for bipartisan agreement on innovative ways to stimulate the economy. However, it is my opinion that these plans are bad ideas that are being mis-sold to a public desperate for positive proposals to “do something” to help the economy. Let me spell out a number of reasons why I take this position.
First, the public as taxpayers are not one iota better off from the fact that proposals like this involve “off balance sheet” funding. Ultimately, this bond will have to be paid back with interest. In fact, since this bond is supposed to come with an interest rate of 2.5 percentage points above current borrowing rates, taxpayers will be worse off than if the plan was funded through a regular bond.
Second, for all the talk about Brussels, there is no good reason to view the European Commission as the binding constraint in relation to our fiscal policy. The key concern relating to fiscal sustainability is that we need to continue to convince international bond investors that we are able to pay back our debts. These investors rely on highly informed sovereign debt analysts and these guys are not in any way fooled by off-balance sheet chicanery. Because switching from regular borrowing to bonds of this type does not change the net solvency position of the state, it does not change the perception of default risk.
Third, financing projects by spending our Pension Reserve Fund (how many times over is this thing going to be spent?) has the exact same effect on the net solvency position of the state as does financing by borrowing. To propose that we need to raise taxes and slash government spending on various items to restore fiscal stability and then to simultaneously claim that we should spend billions of euros on “stimulus” is either intellectually incoherent or simply dishonest.
Fourth, we must remember that money is fungible, so focusing on particular projects as being financed by off-balance-sheet spending confuses the relevant question. The true change in our fiscal position is determined by the amount that we spend minus the amount that we raise in revenue. Given a particular desired amount of spending, we should allocate that spending as best as possible.
Perhaps there are good arguments for maintaining capital spending at high rates and preserving construction jobs (that’s a substantive debate worth having at some other time – there are also good arguments for other types of spending and for limiting tax increases). But the existence of a construction industry\pension fund plan to provide off-balance sheet funding does not strengthen this argument in any way.
Tags: Off-Balance Sheet