Off-Balance Sheet Delusions

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.

31 replies on “Off-Balance Sheet Delusions”

@ Karl – fully agree.

It is remarkable that some people continue to seek a solution to the problems facing the country by some scheme relating to one of the sectors that unbalanced the economy and therefore contributed to the crisis. It seems that we are addicted to construction!

There are few who would argue that the construction sector was too small. Keeping it larger than it needs to be is senseless as it slows down the required adjustments in the economy.

As I have argued elsewhere construction jobs are not cheap so this will likely be poor value for money and the key consideration in investing in infrastructure should be the long-run return (where is the cost benefit analysis??).

I have the same problem as Karl with the creative accounting.

Aside from this, while I think there is something to be said for propping up construction industry employment through the worst of the recession by investing in infrastructure, what the Construction Industry Council is proposing seems excessive. Based on patterns of construction employment in other countries, I don’t think Ireland can support more than about 150,000 to 160,000 construction jobs over the long run. The initiative proposed seems to be aiming to maintain construction employment at about 196,000 over the next three years. Even if supporting the construction industry through the downturn is justified, it seems wrong to pump scarce resources into temporarily maintaining tens of thousands of jobs that will disappear once the spigot is turned off.

Wasn’t it all this off balance sheet nonsense that got this and other countries in the mess we’re in now.

As an accountant I’ve always believed in being upfront from day 1. It’s a pity more of my peers didn’t feel the same way.

It may be foolish to think there’s some off-balance sheet magic that can make borrowing invisible to the world, but is it really foolish to want to “slow down the required adjustments” of our economic structure? Our house construction sector clearly became massively bloated but our infrastructure is in dire need of investment.

And is it really “intellectually incoherent or simply dishonest” to think that we could both make fiscal adjustments to bring recurring or current expenditures into line with recurring revenue, while at the same time expanding or at least sustaining capital spending (i.e. stimulus)? Surely the “highly informed sovereign debt analysts” must make some distinction between a deficit based on runaway public sector pay and social welfare bills and one based on capital spending that improves the productive capacity of the economy. If so we could similtaneously get the public finances in better medium-term order and compensate for some of the contractionary effect of doing so through the capital spend.

Again, all this is seperate from the funding hocus pocus which is the main point of Karl’s post.

@KarlW. Completely agree. The 2.5% premium is a bit cheeky (that’s an extra €150m pa in debt servicing costs).

Perhaps Mr. Bruton is caught in the Keynesian idea of digging and filling in holes to stimulate the economy. But unless I’m very much mistaken, this idea is based on spending reserves accumulated during the boom years. We don’t have much of that! And I don’t think that the Pension Reserve Fund counts as an accumulation seen as it was started to account for a future liability (there’s a clue in the name).

Just to add another point to your considered analysis above. If the government agree to this deal is there a chance that international investors may take note of Ireland’s willingness to pay larger bond coupons, and therefore demand better returns for their money too?


Despite having sounded off (in previous posts) on the need for some form of investment stimulus to counteract the necessary, but contractionary, impacts of current budget policy, I fully agree with the points you have made. And, having been disabused previously of a portion of my naivete by Edgar, I also agree with your points.

However, I don’t think either of you are adverse to the idea of developing an approach which would employ currently unused and surplus resources productively, remove possible infrastructure deficiencies and bottlenecks and develop the infrastructure “platform” (both fixed and human capital) of the economy to facilitate increased productivity and output when growth resumes. This is sine qua non to convince the international capital market (as per your second point) that Ireland will have the wherewithal to ensure the return of, and on, investment.

The key issues, as you both point out, are where the money should be spent and how it should be financed. I agree that where is a separate issue, but there are some reasonable proposals out there. And despite Edgar’s justifiable caution about throwing money at the construction industry, there are probably some useful educational, health and social infrastructure projects that could be progressed.

But it is the area of financing that your post exposes the current woolly (and dangerous) thinking. Final consumer pay for almost everything – obviously the more we can get external consumers to pay via exports the better. (I prefer to use final consumers rather than taxpayers as even those who are not in the tax net pay implicitly for the tax-funding of investment recovery.)

For some semi-state sectors, such as energy, where there are specific (and regulated) utility tariffs, final consumers pay up-front for a share of investment (that should be financed by the State) and then pay the full return of, and on, investment. In other state-dominated sectors, where there are no specific “point-of-use” charges, final consumers will pay over the odds for this “off balance sheet” finance.

The objective should be the minimisation of the cost of capital and the only effective solution – which no political party has the guts to adopt (even if FG has flirted with it) – is to restructure the semi-states, sell them off and attract investment from pension and investment funds as equity holders. This is the only way to gain genuine off balance sheet benefits and to deliver the required investment outcomes for the economy.

@ Paul

I am not against infrastructure spending per se – my problem with these kinds of schemes is that they are aimed at job creation, for which they are expensive, rather than the long-run needs of the economy. The more labour intensive projects might not be those with the highest return (short-run or long-run) so we may end up using scarce resources in a sub-optimal way. The fact that these proposals are invariably not evaluated against alternatives worries me (indeed we do not seem to do that anyway). There are without a doubt lots of worthwhile infrastructure projects with good returns that should be funded, but please lets do this right rather than on some whim.


Fully agree, but as Karl has pointed out (and I agree) the “where investment should be focused” is a separate issue. My focus is on ensuring sensible – and transparent – financing of investment (rather than the current expensive murk). It will take some time to do this and, while this is happening, prospective projects may be evaluated properly. In addition, all the semi-states have elaborate investment plans. The key problem is the current financial structure, but these plans could also benefit from some hard-headed private sector scrutiny. That’s another reason why I’m in favour of selling them off.

Have read the CIC document now, and noted that the numbers quoted in the media are QNHS construction plus 40% for “indirect employment”, where I work off QNHS. Including indirect employment like this makes a target of 196,000 employment potentially sustainable over the longer term.

However, two other points about the report’s detail are noteworthy. The investment priorities suggested seem heavy on the “nice to have”, and light on potential economic return. And the no-change-of-policy projection is very negative.

If the state has to pay the interest and principal, it sounds very much like debt to me. It doesn’t read as if the infrastructure projects will produce cashflows and I suspect the pension managers view the risk as Irish sovereign risk. I think I’ll need to see a diagram to see why it’s off-balance sheet. It’s pretty expensive debt too.

It seems that the people that got the state in to this mess, aren’t satisfied yet. A little more of the same should do the trick. These folk need to spend a little time on the bold step.

I wonder if any of you could point me in the direction of empirical evidence (accessible to a non-economist) demonstrating that privatised semi-state firms deliver capital investment at a lower cost than when they were in state ownership, as per Paul’s argument above, if I understand it correctly.

Given that the bank crisis seems to be a result of regulatory failure, and that the proposed solutions on this blog and elsewhere centre on some form of nationalisation, the suggestion that national investment plans would benefit from ‘hard-headed private sector scrutiny’ seems a bit contradictory to this non-specialist!

Its pretty simple

We got through a boom without having to build this stuff, now when the economy is shrinking why do we need it?

If the investment is unavoidable to head off a future crisis, say energy, or to add real benefit to the economy e.g. produce much lower energy costs, great go for it.
If not, stop.

Havent we seen enough of off balance sheet and where “clever” accounting gets us.

Jane Gray,

I can understand your scepticism, but, first, I would caution against throwing the baby out with the bath-water. Just because a part of the financial sector lost the run of itself – aided and abetted by governments and regulators – doesn’t mean that effectively regulated private sector participation is inherently flawed.

Secondly, I could dig out empirical evidence – and I’m sure others are even better resourced – but it would be likely to generate even more contention. I would hope that a simple example might suffice.

The Summary Regulatory Accounts published by the ESB reveal that, in the period 2001-2006, the ESB invested €3,543.4 million in its transmission and distribution networks. The following table shows how this was financed:

Source € million %Share
Funds generated from operations 2,120.2 59.8%
Customer capital contributions 471.4 13.3%
Transfer from ESB central treasury 951.8 26.9%
Total 3,543.4

Funds generated from operations were provided ultimately, and almost totally, by electricity consumers via tariffs set by the CER. In one way or another, electricity consumers financed almost 75% of network investment in this period. The almost 27% from central treasury is probably comprised mainly of borrowings – the ESB does not provide a breakdown, but it may also include funds generated from other operations, which, in the main, are provided by final consumers. The Government, as the majority shareholder on behalf of the Irish people, contributed zero direct financing, but was happy to extract dividends of €334 million. The CER has used every trick in the book to ensure that network revenues are sufficient to compensate both for this failure by the dominant shareholder to invest and for the ESB’s desire to maintain a low corproate debt percentage.

How would private sector owners have financed these investments? It is impossible to be precise, but it is clear that the CER would regulate a private sector owner in a compeletely different fashion. Normally network owner/operators, under a regulated regime, work to a 60% debt percentage – on occasion even higher. This does not mean that, for the example above, a private owner would finance 60% of the total investment from borrowings, but it would be plausible to assume a much higher share than 27%.

Also taking into account the fact that a private sector investor would not pay the excessive regulatory valuation of the assets, it is clear that the regulated revenue requirement would be much lower, probably by as much as €500-700 million. And this saving would be passed on to final consumers.

I won’t be so bold as to assert QED, but I hope you get the reasoning behind my argument.

I can’t point you to empirical evidence. But as an accountant who spent 16 years doing return on investment analysis for PLCs (non banks!) I can promise you there are a few things that operate differently in the private sector to what I see and read about in the public sector.

Just check out the auditors general report for 2007
– 216 garda vehicles bought in 2006 still in storage Feb 2008
– Prison service: €18.6m of procurements without competitive tender process in 2007.
Or look at some of the headline projects over the pas t few years. Massive overspends on the Luas (€471m overrun), Port Tunnel (€150m overrun), Ppars (€131m), Voting machines (€50m), Garda Pulse computer system (overrun €14.9m) etc

What makes up good investment analysis:

1. Accurate initial budgeting. I would have been fired several times over if I had come up with the initial budgets for the above projects. We had a 10% leeway that was it.

2. Return on investment. We only carried out the proposal if it met or exceeded the companies Return on Investment hurdle. This was measured based on discounted cash flows. Does the project generate more cash than we spent over its life. The state needs some system for measuring this also. Admittedly not so easy with projects of a social nature but possible for many others.

3. Tendering. No political favours to bestow, the best proposal gets the job. Include fixed price contracts and penalty clauses for failure to finish on time.

4. Budget control. The progress on the capital projects needs to be monitored all the way on a cumulative basis (even if it spans a year end)and reported on a monthly basis.

5. Post investment analysis. Did it achieve what we set out to achieve. What could we do to improve in the future?

6. Accountability. The project goes badly wrong and the project manager carries the can.

Yes the banks have fallen spectacularly but that does not mean we throw the baby out with the bath water. There are some excellent Irish companies out there who do a great job particularly on infrastructure projects not just in Ireland but abroad also (including the ESB).

So yes I agree we need a lot more hard headed private sector scutiny when it comes to investment in our infrastructure.

One problem here is the proliferation of adhoc initiatives like Bord Snip, NAMA and so on without a core economic recovery agenda that sets out what the government sees as the core problems and outlines a simultaneous range of solutions for dealing with them. Whether one agrees with Obama’s policies or not, he has set out his stall and its written down clearly enough for people to be able to debate and monitor. The SMART Economy document is still listed as the “framework for economic renewal” on the Irish government website. As noted by many people on this blog at the time, this document is not a recession recovery document but rather a reaffirmation of strategic objectives and whatever its merits as a standalone document it does not represent an adjustment plan. The government needs to put down clearly what its actual recession recovery plan is, what principles underly it and so on, and start holding the people responsible for delivering it fully accountable. Ad hoc initiatives like this geared at one sector are suboptimal even though the development of labour intensive projects is a good idea in itself.

Thank you, Stuart. I think, Jane, you should have some evidence in two respects – efficient investment (Stuart) and efficient financing of investment (my post). In a post in another thread Richard Tol estimated potential savings of €1 billion in the energy and environment sectors alone. I would not disagree.

And in passing, I don’t wish to give the impression that I am attacking the ESB. I have every respect for its operational and technical capabilities. My problem is with the way these activities are financed – and, perhaps, with its empire-building tendencies.

The problem, is policy and the Irish addiction to a fix. No doubt the 2.5% will just be the first of the additional costs larded onto this pig!
Both political parties in favour and one worse than the other…..
Other peoples money. The only remedy is to stop them by legal action. The details will enable an attack but the problem is one of lack of standing.

We seem to be insane!

All of the above comments by the previous contributors are correct. The loss of jobs is likely to be permanent but instead of measuring what the new economy will be, and the extent of those losses, we insist on throwing all reserves and our future streams of revenue reduced to an unknown degree, on a gamble that we need more infrastructure that had not been previously identified, despite excellent national plans?

Do we have to have a revolution to remove these guys?

@ Paul and Stuart

All of these suggestions about managing tenders and investments make a lot of sense. However, I am not convinced that it moves us very far forward in understanding the relative merits of public and private investment. For a start, we have practically no evidence here of practices in the private sector. Our business sector is pretty weak in many respects so there are certainly some dodgy stories out there. By the same token, we have many well organised public and private organisations and we know very little about what they do and how they do it. Incidentally, this speaks to the almost complete lack of ‘organisation studies’ in Ireland (with some notable exceptions), that might give us some insight into the kinds of organisational practices that exist and why they are distributed the way they are.

Anyway, much of what we are discussing here as ‘public vs private’ is in fact about the particular way that public and private interact.

The cases of over-spending almost all involve contracting with private firms. The issue here is the management of tenders and contracts – not the efficiency of work organised through public bodies. I shudder to think what stories lie behind these disasters – and both the political system and private firms are likely to be implicated (and the civil service to a much lesser degree, I suspect). But it does point to the need for much greater transparency (including accounting measures like Stuart suggests) and also for the need for the state to be much tougher in its dealings with the private sector. Eoin Reeves’ research suggests similar bad value from public-private partnerships. Co-location is another gigantic transfer of resources with very dubious social or economic returns.

Another mode of interaction between public and private occurs through investment in business and the financing of development. I won’t go into it in detail as I have done so a number of times before. But here the state’s record is superior to the banks and even other sources of private capital. This seems to be a difficult piece of data for people to process but it seems pretty clear.

Finally, privatisation. We have pursued a pattern of privatisation which combines the worst of public and private. We created eircom with a commerical mandate, control over key pieces of infrastructure and no developmental role. Predictably enough, we get the broadband disaster. Telecommunications would be much better if we had a continuing public entity that invested heavily in infrastructure that was widely and equally available to market competitors. The market competitors would need to pay for this, at least in part, of course.

So …. three different public-private relations. Public contracting, industrial policy, privatisation of public utilities. And in each case, far from a clear record of private sector superiority.

But my purpose isn’t to argue for a simple superiority of public provision. Nor is it to argue for some generalised (and generally vacuous) form of ‘public-private partnership’. It is to argue that the private sector works best when supported by extensive and accountable public provision. The comparative evidence certainly suggests that economies that run such a system do significantly better than our own and other more ‘liberal’ economies.

Jane, your instincts are right. Think Eircom. I remember reading somewhere on this blog that they actually think it was a successful privatisation!

The main problem I perceive in the public versus private debate (and I know this thread is drifting off course) is accountability. Who in the public sector feels any pain for the multiple bad projects as cited above. Indeed who feels any pain in the HSE for negligent care in the Health arena. At least in the private sector you will be fired, demoted or passed over for promotion, salary etc in such a way you are forced to resign. So in a word accountability means more efficient projects/investments. I have never seen this in the public sector.

@Liam Delaney
Liam – the government have a coherent policy – its called hoping the f*** the USA gets motoring. Thats it….

@Brian and Liam

But also, sadly, it’s called ‘bailing out the banks and construction industry to the cost of indeterminate billions without any serious attempt to reform their contributions to the economy and society’. So if and when the US gets motoring, we can just go back to the old model of growth…..

Leaving aside the banks for a moment, wouldn’t that 6billion for construction be better spent on a combination of enterprise policy/ education and training/ active labour market policy? Part of which could be construction-related but only in terms of projects that develop new capabilities within the sector (eg ‘green infrastructure’) and contribute to social goals (energy efficient schools?). And the training/ ALMP components could be used to address inequality and low wages by investing in skills and maintaining labour market participation.

These are major policy decisions that takes the economy back in the direction that got us here. I totally agree with Liam – the government has a duty to show the citizens how these policies on banking and construction will lead us to the different kind of economy we need to build.

Brian – I don’t accept your implicit characterisation that its not worth thinking about how all of the different elements of public policy tie together to form a response. Cynicism like that is an irrational attitude. At present, the low degree of scrutiny that the government is receiving on wider recession policy other than the banks is deeply harmful and many people are justifying this paucity of ideas on the basis that the government wouldnt listen anyway. No political party, media pundit, academic or institution has given an attempt at stating how the broader economic system should adjust to this recession across all dimensions including housing, consumer credit, employment, taxation, training, social welfare and so on. Of course into this vacuum is going to rush such schemes as the one Karl Whelan points out in the post. Cutting expenditure, increasing taxation and salvaging the banks do not combine to form an integrated response and it would be a shame now if the pension fund was thrown on top of this in a poorly thought out single-sector stimulus effort.


I agree completely. There is a non-debate on this, despite a variety of plans from the opposition political parties, the NESC attempt to direct debate in that direction and even John McHale’s post most recently on this blog which tried to get something going. There are elements of this discussion over on and on Michael Taft’s blog. But this missing debate is also damaging the debates on banking because I can see no mechanism being proposed that will restrcture how the banks lend and contribute to financing the development of the economy, just plans to get them back in some kind of stable financial position.

Instead of an off balance sheet bond why not have the pension funds invest directly into these projects – toll roads being one obvious example.

– the govt could highlight a number of suitable projects.
– Groups like NTR could seek investment from the pension funds for the investment.
– the user of the project pays in the form of tolls or whatever method is there.

Admittedly this isn’t an ideal solution and wouldn’t suit schools and is being tried with colocation hospitals.

The govt could provide a band of income on the projects so that if revenues exceed a certain amount the govt receives the balance, and if revenues fall short of a certain amount, the govt subsidises. Not ideal, but makes it more attractive

the concept of a muni has come to ireland and that’s our great hope… yikes!

unless there is a direct revenue model from the projects (eg: Tolls on roads/bridges or fares from transport etc.) then I don’t see it as being a magic solution, really all it will do is take money -likely cashed in crystallising a loss on equities as most pensions tend to be in – from pension funds and create a debt that will rest, in the end on the tax payer.

So the only rationale I could see is if there is a revenue model upfront, otherwise why borrow from pensions? Why not anywhere?

it seems to me that we have not learned a thing.
this plan rewards the practices who got us into this mess, it is a bail out for the construction sector.

we have gotten ourselves into a situation here where pain is unavoidable. no matter what shimmy shammying the government engages in, SOMEBODY will feel pain. its not fair but its reality. we need to wise up to the fact that we cant keep all the balls of 2007 in the air. we need to let go of some of them, at least in the short term.

as a country, as an economy, we need to drastically lower spending on everything that wont grow this economy. its one step backwards and two steps forward.

the priority as far as jobs creation is not in construction, its in exports. and you cant export roads.

Sean, thank you. I have no disagreement with the thrust of your post or the specific examples you cite. I have made some comments on the thread initiated by Colm McCarthy on 07-Nostalgia that attempt to provide an overview of the proposals that are emerging on this site in reponse to the “Great Deleveraging” that Colm (and, I think, all of us) sees as inevitable and necessary – and I think some of these comments (on regulation and public-private financing) are relevant here.

Yes. We have a mixed economy model. But we need to look more closely at how this mix functions – and how it may be made to function more efficiently and effectively. Ineffective regulation, inadequate corporate governance and government complicity in some private sector irrationality got us into this mess. The State may have to grab the reins in the short to medium term, but fixing regulation, corporate governance and competition policy are more effective medium to longer term solutions.

In the context of the “Great Deleveraging” my focus is on the financing of investment where the public sector is currently taking the lead. Effective regulation aligned with an appropriate public infrastructure policy provides an appropriate revenue model that will attract and retain the financing required. The current regulatory revenue model promotes gloriously inefficient financing and imposes excessive costs on final consumers.

For example, in the territory where I have most involvment, rather than having them sold off directly (don’t mention Eircom!), the existing managements of the ESB and BGE networks could secure pension and investment fund equity investment to take these businesses off the State’s balance sheet. The proceeds would replenish the NPRF and some could be used to finance sensible investment in sectors such as health, education, etc. where no regulatory revenue model exists.

This approach is valid across all the infrastructure and utility sectors.

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