Intergenerational Accounting in the UK

Angus Hanton explains why the UK needs to start looking at its assets and liabilities from an intergenerational perspective

The question of what one generation owes to another has never been more topical. This is most often considered in terms of duties, such as paying for education or leaving a habitable environment but, more narrowly, it can also be worked out in financial terms.

The government have recently worked out their own measurable liabilities and compared these to the assets they own – with disturbing results. They have discovered that their debts exceed their assets by about £1,200 billion – or £20,000 for each UK citizen.

Almost half of the debts are official borrowings through the bond markets, but there are a lot of other obligations as well.

For example over £1 trillion (a thousand billion) relates to paying public employee pensions where no actual reserve has been set
aside. These figures would be vastly higher if you included the obligation to pay the state pension, but this wasn’t included as the Treasury argues it is not a contractual commitment – had the state pension liability been included this might have added another £2 trillion.

This project is called the Whole of Government Accounts (WGA), which looks at the picture from the government’s point of view and shows that, from this perspective, they (i.e. we!) are handing on massive debts to the younger and future generations.

It also revealed how large the PFIs and some other commitments have become, such as nuclear decommissioning, which is set to cost over £60 billion alone. This is a pure intergenerational obligation as it relates to energy that has already been consumed.

However, the picture is more complex in that there are clearly other assets which are not included such as the rail and road infrastructure and parts of the utility network such as the drainage system.

The private sector side of intergenerational accounting

The Whole of Government Accounts looks at the government’s income and expenditure to produce the State’s balance sheet. However, there is also the question of how things look from the point of view of the private sector: what does the balance of private assets and liabilities look like?

In reviewing this, it is very difficult to work out on what basis you should do the accounts. In particular, how should the largest asset, housing, be valued?

One approach is to look at the current market value of all the privately owned homes, but this surely exaggerates their value to future generations. After all, people in the future could simply build more, to remove the scarcity value of housing.  This extra supply would push house prices down to near to their replacement cost.

This suggests another, more realistic, approach to valuing the housing stock would be to look at its rebuilding or replacement cost. But this would still be too high – the housing stock has seriously deteriorated since it was built.

This is particularly true in a world of high energy prices and where carbon emissions need to be curtailed. Houses built with cold, single-skin brick walls, un-needed chimneys and windows that are often single-glazed and ill-fitting cannot be worth to future generations what they cost to build. But they do have some value, so perhaps they should be valued at a percentage of their replacement cost, maybe 75% or 50%?

The average private home might then be worth about £50,000, and with 15 million private-sector homes that suggests a value of about £750 billion would be appropriate, which is less than the total debt secured against them, so in terms of intergenerational accounting this housing stock, when taken together with the associated borrowing, could even represent a net debt.

Other private assets for the intergenerational account

There must be lots of value in other private assets, such as pensions, but the key question is: what is the value of the assets that the next generation is likely to inherit from us?

Presumably there are private companies and privately held shares in quoted companies. However, many of these assets are already spoken for as they are expected to be used for paying pensions and for long-term care.

Overall, intergenerational accounting of the private sector involves so many variables that there are two main risks:

1. that people say it is too difficult, so they decide not to even try working out the net assets or liabilities;
or that
2. the assumptions going in will be too uncertain and the results end up being “rubbish in –
rubbish out”.

However, in order to make meaningful projections we definitely need some sort of intergenerational calculation of the private sector position.

Intergenerational accounting – does it have a future?

Several people have started doing intergenerational accounting – in the US, Professor Laurence Kotlikoff at Boston University has been advocating this approach for the last 20 years, while in the UK Martin Weale and the National Institute for Economic and Social Research (NIESR) have more recently tried to get the ball rolling on some work in this field.

The lead given by the UK government in working out its contractually binding liabilities against its assets is useful and may prompt similar initiatives for the private sector.

This is particularly important given that, in order to fill its huge deficit, the government will have to tax private assets more strongly in the coming years, so it would be very useful for the government to know precisely what these assets amount to.

Posted on: 31 July, 2011