Public Finance magazine - January / February 2022

THE JOURNAL FOR THE CHARTERED INSTITUTE OF PUBLIC FINANCE & ACCOUNTANCY

DEUTSCH COURAGE ‘Levelling up’ lessons from Germany’s reunification CORPORATE TRUST Have local authority companies lived up to their promise?

JANUARY/FEBRUARY 2022 PUBLICFINANCE.CO.UK

NATURAL MEDICINE The research revolution with the potential to transform public policy

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New year, new fear Pandemic, recession or war?

Experts predict the next ‘black swan’ event

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EDITORIAL

WELCOME Redactive Publishing Ltd, Level 5, 78 Chamber Street, London E1 8BL +44 (0) 20 7880 6200 publicfinance.co.uk

COLIN MARRS

@public_finance_

Unknown unknowns

EDITOR Colin Marrs 020 7324 2796 colin.marrs@publicfinance.co.uk GROUP EDITOR Jon Watkins 020 7324 2788 jon.watkins@publicfinance.co.uk

F

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Public Finance reserves the copyright in all published articles, which may not be reproduced in whole or in part without permission. Public Finance is published for CIPFA by Redactive Publishing Ltd. Public Finance, Redactive Publishing Ltd, Level 5, 78 Chamber Street, London E1 8BL Tel: 020 7880 6200 Fax: 020 7324 2790

ISSN 1352-9250

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ormer US defence secretary Donald Rumsfeld passed away at the end of June 2021, little more than a month before the shambolic departure of the last US troops from Afghanistan. The final flight out of Kabul airport marked the end of a 20-year war, of which the Washington veteran had been a major architect. In a report released the same month, US academics put the cost of the Afghanistan conflict to the US taxpayer at more than $2trn.

History is likely to remember Rumsfeld as a cheerleader for disastrous and expensive Western military action in the Middle East during the post-9/11 era. Today, however, he is almost as well known for a 2002 press conference, widely mocked at the time for its inclusion of the soundbites “known knowns”, “known unknowns” and “unknown unknowns”.

Much of the derision stemmed from the context – Rumsfeld was using seemingly pretentious language to justify the invasion of Iraq on the basis of non-existent evidence of nuclear and chemical weapons. But the wording had been used in engineering circles as far back as the 1960s to describe different forms of risk, and survived its association with Rumsfeld to enter common usage.

These days, the expression ‘black swan’ is often used in place of Rumsfeld’s ‘unknown unknowns’ to describe catastrophic situations that are impossible to predict. Whether Covid-19 is a true ‘black swan’ is hotly debated, not least by author and statistician Nassim Nicholas Taleb, who introduced the phrase in a 2007 book. He points out that a pandemic was not only predictable but actually predicted years ago.

Nevertheless, although far from straightforward, anticipating and preparing for plausible future calamities could help save billions in public money. In our cover feature (p26), we speak to futurologists about where the next nasty surprise might emerge from.

On p46, we take a deep dive into the work of the academics who were awarded the 2021 Nobel Prize in economic sciences and how it could help governments make better decisions on targeting their resources.

And, with the issue of public standards continuing to dominate UK headlines at the end of 2021, we talk to Margaret Hodge MP, someone who, as former chair of parliament’s Public Accounts Committee, knows more about the topic than almost anyone else (p40). Local government, she says, could provide lessons.

Anticipating and preparing for plausible future calamities could help save billions in public money

COLIN MARRS Editor colin.marrs@publicfinance.co.uk PUBLICFINANCE.CO.UK 3

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15/12/2021 16:41

End slavery

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CCLA Investment Management Limited and CCLA Fund Managers Limited are authorised and regulated by the Financial Conduct Authority.

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CONTENTS

JANUARY / FEBRUARY 2022

NEED TO KNOW

26

7

60

Catch up

OECD pandemic recovery warning; EU Global Gateway initiative 10 News analysis

Sunak’s tax conundrum; COP26 financial fallout; Rail plan disappointment 14 Big picture

Delhi smog 16 Talking points 17 World in numbers

OPINION

20

19 Taxing issue

Demographic changes hindering tax cuts

32 Enterprise culture

Evaluating a decade of municipal companies 40 Interview

MP Margaret Hodge worries about a decline in accountability 46 Eyes on the prize

Nobel-winning research methods could improve public sector decisions

25 Lender option

The UK needs a public development bank

46

37 Mind your business

Ensuring effective governance of local authority companies 51 Positive identification

How a spreadsheet error proved the value of Covid-19 contact tracing

IN PRACTICE 55 Policy

Better planning 57 Ethics

Personal investment rules 59 Regeneration

Managing borrowing 60 Treasury management

IN DEPTH 20 Joined-up thinking

40

What the UK can learn from the process of 1990s German reunification 26 Waiting in the wings

Futurologists predict the next disaster that could hit public finances

Growing social as well as monetary returns 61 Management

Engaging staff in conversation is vital 63 Procurement

Green purchasing 64 Events 65 On account

Accounting qualification 66 Where next?

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1SPDVSJOH XJUI DPOEFODF .BYJNJTF UIF WBMVF PG FWFSZ QPVOE TQFOU Robust and compliant procurement is key in the delivery of public services with organisations needing to meet statutory obligations and deliver value for money for taxpayers. CIPFA is committed to helping public sector organisations reduce the costs and risks associated with procurement, and improve outcomes as a result.

We offer: Advisory and consultancy: a range of services to support public sector procurement – highlighting areas for improvement against best practice.

Upskilling your teams: a range of training to upskill NjūƭƑ ƎƑūČƭƑĚŞĚŠƥ ƥĚîŞƙ îŠē ĺĚŕƎ ƎƑūƥĚČƥ NjūƭƑ ǛŠîŠČĿîŕ sustainability.

Find out more Start your procurement conversation today: visit ČĿƎIJîȦūƑijȬƎƑūČƭƑĿŠijDžĿƥĺČūŠǛēĚŠČĚ email chris.tidswell@cipfa.org call 020 7543 5600

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N E W S / A N A LY S I S / O P I N I O N / D E B AT E

p10

p12

p19

A FAIR COP? Renewed pledges on climate aid for developing nations

OFF THE RAILS Property schemes hit by highspeed rail plan downgrade

HEAVY DUTY Will Rishi Sunak really be able to reverse his big tax hike?

PANDEMIC RECOVERY

OECD issues warning to policymakers over post-Covid-19 spending plans

By Colin Marrs

P

olicymakers must seize the opportunity presented by economic recovery from Covid-19 to overhaul public finances, according to the OECD’s chief economist, Laurence Boone. In the introduction to the latest OECD Economic Outlook, published in December, Boone said that governments around the world have failed to produce robust medium-term plans for fiscal interventions.

He called for new plans to produce more resilient and stable economies in future.

In the introduction, Boone also voiced worries that policymakers would fail to act on lessons learnt during the coronavirus pandemic.

He said: “The recovery presents an opportunity to revamp public finances — failing to grasp it would be a mistake with long-lasting consequences.

We are worried at the lack of discussion about this crucial topic.”

Photography: Getty

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14/12/2021 15:06

NEED TO KNOW

CATCH UP

AUTHORITIES KEEP BACK MORE FOR BUSINESS RATE APPEALS The level of business rates income held in reserve by UK local authorities to cover future appeals rose by almost a third last year – an increase of close to £1bn. Councils held £3.9bn in their appeals provisions at March 2021, compared with £2.92bn held the previous year.

Although relaxed about the increase in government debt during the crisis, Boone warned that more attention needs to be paid to how additional funds are being spent. “We are more concerned by the use made of debt than its level – the increase in debt during the pandemic was needed to underpin economies during the most intense period of the crisis.”

Fiscal support from governments should focus on investment to boost growth, Boone said, highlighting education and physical infrastructure.

“Detailed medium-term plans for public finances are missing – work on these should start now,” he said.

“A clear, strong and responsible fiscal framework would strengthen confidence that growth will rise and diminish imbalances and risks.”

Boone also fears that governments might fail to address weaknesses in health systems highlighted by the pandemic. He said: “Preventive and curative healthcare systems need reform, pandemic preparedness needs improvement, and the distribution of medical equipment and drugs needs better coordination. Failure to take these steps would be inexcusable.”

However, recovery plans face a number of risks, not least from new

variants of Covid-19, the report found.

It also warned that inflation could “become entrenched at levels above central bank targets”, with major central banks being forced to tighten monetary policy earlier and to a greater extent than projected. The OECD said that underlying inflation rates – which remove the distorting effect of sharp swings in particular items – rose to 4.1% in October. “These developments suggest that the rise in prices has become more broad-based in recent months,” the report said.

Writing in the wake of November’s COP26

climate change conference, Boone voiced alarm over whether governments are taking the necessary steps to prevent global warming. He said that “there is too much talk and not enough action when it comes to climate change”. Uncertainty over policy towards net-zero carbon emissions is hindering investment in clean energy and infrastructure, he warned. “The longer governments wait, the greater the risks of an abrupt transition in which energy prices are higher and more volatile.

Inaction therefore increases the risks to people’s living standards and may undermine public support for the energy transition.”

In a section focusing on the UK, the OECD said the government could help stimulate the economy by being clear about its approach to the transition to a net-zero economy, providing certainty for businesses.

The report also called for increased investment in green heating in homes and advised the UK government to focus on improving residential heating alongside infrastructure measures, such as making the electricity system more suitable for much higher volumes and varied sources of renewable energy.

UK government set to publish ‘levelling up’ plans

CIPFA in tie-up talks with ICAEW

Local governments’ credit outlook improves

January will see the long-awaited publication of UK government plans to encourage regional prosperity. The Department for Levelling Up, Housing & Communities has confirmed that its ‘levelling-up’ white paper will be published during the first month of the year. The draft legislation is the successor to the abandoned devolution white paper announced in September 2019. According to press reports, the white paper will set out devolution deals for counties and areas with populations of 500,000-plus.

CIPFA is in discussions with global accountancy body ICAEW to draw up plans for closer collaboration, it has announced. The two bodies will now conduct detailed discussions, with the aim of bringing forward firm proposals in 2022. In a joint statement, CIPFA chief executive Rob Whiteman and ICAEW chief executive Michael Izza said: “We believe there is significant strategic benefit in our two bodies working more closely in the future, and our discussions will examine ways of achieving that.”

Central government support for local and regional governments (LRGs) around the world during Covid-19 has increased the sector’s credit outlook, according to ratings agency Standard & Poor’s. But the agency said that 12% of local and regional government credit ratings still have a negative outlook, compared with just 6% having a positive one. “Even though our ratings on LRGs outside the US have been stabilising since the beginning of the year, we note a modest negative bias above pre-pandemic levels,” the report said.

Detailed mediumterm plans for public finances are missing.

A clear, strong and responsible fiscal framework would strengthen confidence Laurence Boone, OECD

IN BRIEF

8 PUBLIC FINANCE JANUARY/FEBRUARY 2022

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14/12/2021 15:07

The Global Gateway strategy will ‘reaffirm the EU’s vision of boosting a network of connections… to provide a level playing field’

DEMOGRAPHIC CHANGE

Warning over cost of ageing populations

INFRASTRUCTURE

EU launches global investment initiative

By Calum Rutter

T

he EU has unveiled plans to mobilise €300bn of global infrastructure investment, rivalling China’s massive Belt and Road Initiative (BRI). The total will come from the EU, member states and leveraged investment from the private sector, the European Commission said in late November. Announcing what they have called the Global Gateway, officials said the money will be spent by 2027 on digital, energy and transport infrastructure, plus health, education and research around the world.

“We will support smart investments in quality infrastructure, respecting the highest social and environmental standards, in line with the EU’s democratic values and international norms and standards,” said commission president Ursula von der Leyen. “The Global Gateway strategy is a template for how Europe can build more resilient connections with the world,” she added.

Photography: Shutterstock

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Although not referring directly to China, whose influential BRI has seen it invest hundreds of billions in infrastructure around the world in the past decade, the plans repeatedly stressed the ethical approach the EU plans to take.

“A stronger Europe in the world means a resolute engagement with our partners, firmly grounded in our core principles,” said the commission’s high representative Josep Borrell. “With the Global Gateway strategy, we are reaffirming our vision of boosting a network of connections, which must be based on internationally accepted standards, rules and regulations in order to provide a level playing field.”

China’s BRI has faced criticism for contributing to so-called ‘hidden debt’, which can be difficult to track because the borrowers are often state-owned companies, special purpose vehicles, joint ventures and the private sector, rather than central governments with strict reporting requirements.

Growing government spending resulting from increases in life expectancy could cause sovereign debt-to-GDP ratios to rise by 140% in the next few decades if governments fail to act, according to a leading ratings agency.

Higher costs from pensions and healthcare, combined with falls in output and tax income owing to a relatively smaller workforce, are set to pressure governments in the coming years, Fitch said.

In a paper covering 33 countries, the agency projected that median costs to the public purse would rise by 2.4% of GDP annually by 2045 and 3.6% by 2070, while public debt-to-GDP would rise by 46% and 140% of GDP by the same years. This would probably come with a rating downgrade of an average of 1.1 notches by 2045 and 3.8 by 2070, the paper said.

However, the projected impact, based on governments taking no action, varies widely – from a 4.2-notch upgrade for Greece, to a 10.5-notch downgrade for Slovakia by 2070. Fitch said: “Positive or benign projection paths reflect governments’ comprehensive pension reforms in recent years, while more severe demographic ageing profiles and insufficient reforms explain the more adverse projection paths.”

Some pension reforms have improved prospects in several of these countries in recent times, Fitch said. But it warned that reform could become more difficult politically, as populations age.

The paper said most of the projected impact would be seen after 2030.

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NEED TO KNOW

NEWS ANALYSIS

W

ith the world at a seemingly critical point in the fight against climate change, COP26 was seen as a vital chance for decisionmakers to reach agreement on slowing global warming.

Experts in green finance have given a qualified welcome to the outcomes of the event.

In Glasgow, rich nations agreed to finally provide $100bn of climate finance per year to developing countries, starting in the next two years – a target first set in 2009 for 2020, when it was missed. But even this figure represents “a drop in the ocean” compared with the trillions needed to shift to renewable energy, said Harald Heubaum, senior lecturer in global energy and climate policy at SOAS University of London.

“What the target really does is signal to investors that things are moving,” he said. “It also has a catalysing effect.” By investing wisely, added Heubaum, governments can mobilise private capital. “If you can leverage several times the original investment – or even more – it is important.”

The US, UK, France, Germany and the EU announced an $8.5bn deal with coal-dependent South Africa to help it decarbonise its electricity system during the next five years. The deal could form an “important prototype” for how to support a global ‘just transition’, said Danae Kyriakopolou, senior policy fellow at the Grantham Research Institute on Climate Change and the

C L I M AT E F I N A N C E

What did COP26 achieve?

Deals at the UN climate summit could see government funds lever in more private finance for green projects

By Calum Rutter

Environment. It includes grants, concessional loans, investments and risk-sharing instruments, focusing on supporting workers in affected sectors, like coal mining, into ‘green’ jobs.

“The big issue with decarbonisation is going to be unemployment, especially among the youth and coal miners. Getting South Africa right is really important.”

COP26 also saw a shift towards climate finance for adaptation (measures to help communities live with the results of climate change) rather than mitigation

(actions to slow global warming). “Although the commitments need to translate into policies, there has been a realisation that, even in the best-case scenario, we need adaptation,” said Kyriakopolou.

“The best adaptation strategy is a successful mitigation strategy,” said Heubaum. “However, we have realised that mitigation has not been as effective as we had hoped.” He added that public finance for adaptation is set to reach $40bn if COP26 commitments are met. “This is a lot of money,

but it has a less catalysing effect than mitigation measures often do,” he said.

While energy projects might attract private investors via part-ownership or rate collection, adaptation measures such as flood defences do not. “Adaptation is more of a public good that accrues over a longer period of time,” Heubaum explained.

At COP26, 20 governments committed to ending – by the end of 2022 – finance for overseas fossil fuel projects, although some of the world’s most coaldependent countries – such as Australia, China and India – did not sign up. “With strong implementation, this initiative could shift at least $24.1bn per year in direct public finance out of fossil fuels and into clean energy, which will move even larger flows of private finance,” said Laurie van der Burg, global public finance campaign co-manager at research and advocacy organisation Oil Change International. “This is a massive and real impact.”

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