New Perspectives

In Economics and Finance

The Forgotten Cause of the European Malaise

While managing debt has become a matter of great concern during the European financial crisis, public wealth remains opaque and largely ignored. Yet, most countries' public wealth is larger than their public debt. According to our calculations an achievable improvement in public wealth management would yield returns greater than the combined investment in infrastructure. In addition to the direct economic benefits, better governance of public wealth could also render more robust democratic institutions.

The European crisis is mostly ascribed to spending sprees, the euro or inept debt management. How public wealth is managed is rarely mentioned. We argue that this misses a crucial ingredient, and therefore also a promising contribution to recovery.

Altogether there are six European nations whose debts are larger than their economic output, and 16 that have debts larger than the 60%-of-GDP limit set out in the Maastricht Treaty.

Greece’s public debt is, unsurprisingly, the highest in the EU - standing at 177% of its GDP. Italy and Portugal are the next most indebted countries, with debts of 132% and 130% of national economic output respectively.

Yet, in our new book on the governance of public wealth we show that nearly all countries have public commercial wealth that exceeds the value of their debt. Here we are not counting roads or national parks. Only state or locally owned real estate, corporate entities, or other assets that should provide som yield, but often don´t, tally up to holdings that exceed 75 trillion dollars in the world as a whole.

From a pure economic point of view, every percentage point marginal improvement of return on this vast global portfolio, would generate some € 600 billion per year. This is the equivalent to the GDP of the Netherlands. From our comparisons of global yield we conclude that world public commercial assets, if professionally managed, could potentially generate an additional annual yield of 2.7 trillion dollars, more than current global spending on infrastructure: transport, power, water and communications taken together.

In Europe, better governance of public assets might render some 3 percent of GDP annually that could be invested in dilapidated infrastructure. That would lift many countries from their current dismal growth paths.

While there are excellently run state-owned firms, such as Norwegian Statoil evidence is rife that public management of commercial assets can be much improved. A large research literature often (but not always) concludes that state owned firms earn lower returns than comparable privately owned firms. In recent years studies by Bloom and van Reenen, using detailed information on management methods, shows that state-owned firms lag considerably.

In fact, poor governance of state run firms was an important contributor to the financial crisis. In countries such as Spain and Germany the local savings banks, mostly owned by local governments, were among the most reckless lenders in the run-up to the financial crisis. In countries such as Greece and Italy, state owned firms drew down productivity growth and hampered competition.

Yet, the indirect effects of public wealth mismanagement may have been even more important. Management of public wealth is most often bogged down in an uneasy relationship with politics. Opportunities for better management are ignored, or even worse, become the victims of political meddling, clientelism or corruption.

Arguably politicians may be more interested in representing consumer and citizen concerns if they are not at the same time directly in charge of state-owned firms that fail to deliver. This does not mean that all wealth needs to be privatised. Privatization is not always a simple alternative, or politically possible. Finding ways to put public assets to better use should therefore be a central aim of economic policy. The holy grail of public wealth management is an institutional arrangement that removes management from government´s direct responsibilities, but at the same time encourages active, value-creating governance.

A growing number of countries with a financial surplus have introduced so called Sovereign Wealth Funds, that resemble Hedge Funds. These are usually staffed with financial experts and invest in short or medium term liquid securities, which are more quickly convertible to cash, and where they do not aspire to have direct control over the business or asset in which they are investing. Generally, they do not have the expertise to exert active governance of public commercial assets. 

Instead we propose a National Wealth Fund for governance of public wealth, where long term value maximization is achieved with active ownership in professional hands, and fairly independent from the government.

Some countries around the world have national wealth funds. The most remarkable example is Singapore´s Temasek which was established as a holding company in 1974, with the aim to separate the regulatory and policy making function of the Government from its role as a shareholder of commercial entities. While the institutional framework for political independence is firmly in place, the personal component is called into question due to the crucial role Temasek has in the economy and its personal ties with the government officials. In spite of this Temasek has a track-record as an investment house that would be impressive even compared to any private sector competitors, reporting an average annual return of 17% over the 35 years since inception.

Better governance of public assets is a crucial lever in the toolkit for economic recovery. European governments are ignoring it at their own risk.

Dag Detter, Managing Director of Whetstone and former President of Stattum, the Swedish government holding company, and a Director at the Ministry of Industry. 

Stefan Fölster, DPhil. from Oxford University, Director of the Reform Institute in Stockholm and associate prof. at the Royal Institute of Technology in Stockholm.

The Public Wealth of Nations