Citi GPS - The Public Wealth of Nations

Citi GPS: Global Perspectives & Solutions

June 2015

THE PUBLIC WEALTH OF NATIONSUnlocking the Value of Global Public Assets

Dag Detter Stefan Flster Willem Buiter

Citi is one of the worlds largest financial institutions, operating in all major established and emerging markets. Across these world markets, our employees conduct an ongoing multi-disciplinary global conversation accessing information, analyzing data, developing insights, and formulating advice for our clients. As our premier thought-leadership product, Citi GPS is designed to help our clients navigate the global economys most demanding challenges, identify future themes and trends, and help our clients profit in a fast-changing and interconnected world. Citi GPS accesses the best elements of our global conversation and harvests the thought leadership of a wide range of senior professionals across our firm. This is not a research report and does not constitute advice on investments or a solicitation to buy or sell any financial instrument. For more information on Citi GPS, please visit our website at www.citi.com/citigps.

Citi GPS: Global Perspectives & Solutions June 2015

Dag Detter is the co-founder and partner of Whetstone Solutions, advising investors in Europe and Asia, specialized in identifying underperforming high potential assets and advising in the acquisition/disposal process for private and public institutions. Dag has served as Non-Executive Director on a range of boards of private and public companies. As President of Stattum, the Swedish government holding company, and a Director at the Ministry of Industry, he led the first deep-rooted transformation of state commercial assets. He has worked extensively as an investment banker and advisor within the corporate, real estate and financial sector in China and Europe.

Stefan Flster is Director of the Reform Institute and associate Professor of economics at the Royal Institute of Technology, in Stockholm. He has previously been Chief Economist at the Swedish Confederation of Enterprise, and is an author of numerous books and academic articles in industrial organization and public economics. He also on the board of several companies.

Willem Buiter joined Citi in January 2010 as Chief Economist. One of the worlds most distinguished macroeconomists, Willem previously was Professor of Political Economy at the London School of Economics and is a widely published author on economic affairs in books, professional journals and the press. Between 2005 and 2010, he was an advisor to Goldman Sachs advising clients on a global basis. Prior to this, Willem was Chief Economist for the European Bank for Reconstruction & Development between 2000 and 2005, and from 1997 and 2000 a founder external member of the Monetary Policy Committee of the Bank of England. He has been a consultant to the IMF, the World Bank, the Inter-American Development Bank and the Asian Development Bank, the European Commission and an advisor to many central banks and finance ministries. Willem has held a number of other leading academic positions, including Cassel Professor of Money & Banking at the LSE between 1982 and 1984, Professorships in Economics at Yale University in the US between 1985 and 1994, and Professor of International Macroeconomics at Cambridge University in the UK between 1994 and 2000. Willem has a BA degree in Economics from Cambridge University and a PhD degree in Economics from Yale University. He has been a member of the British Academy since 1998 and was awarded the CBE in 2000 for services to economics.

+1-212-816-2363 | [email protected]

Contributors Michael Bilerman Roger Elliott

Andrew Howell Edward L Morse

Anthony Pettinari Harvinder Sian

June 2015 Citi GPS: Global Perspectives & Solutions

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THE PUBLIC WEALTH OF NATIONS Unlocking the value of global public assets In his foreword to the book The Public Wealth of Nations, Adrian Wooldridge, Management Editor of The Economist, suggests that Dag Detter and Stefan Flster have proposed a new idea in the public policy arena which not only identifies a problem that few people had realized existed, but suggests a relatively pain-free way to tackle it while at the same time boosting the size of the global economy.

The idea rests on the observation that governments around the world have an estimated $75 trillion of dollars of public assets, ranging from corporations to forests, which are often badly managed and frequently not even accounted for on their balance sheets. Over recent decades, policy makers have focused almost solely on managing debt while largely ignoring the question of public wealth. Given that in most countries public wealth is larger than public debt, just managing it better could help to solve the debt problem while also providing the material for future economic growth. A higher return of just 1% on global public assets would add some $750 billion to public revenues. Poor management not only throws money down the drain, but also forecloses opportunities. As an example, the fracking revolution, which is making the US self-sufficient in oil, has taken place almost entirely on private land.

In this Citi GPS report and as a preview to their upcoming book, Dag Detter and Stefan Flster present their thesis that the governance of public wealth is one of the crucial institutional building blocks that divides well-run countries from failed states. They argue that the polarized debate between privatizers and nationalizers has missed the point what really matters is the quality of asset management, and the focus when it comes to public wealth should be on yield rather than ownership. They calculate that improvements in public wealth management could yield returns greater than the worlds combined investment in infrastructure such as transport, power, water and communications. They also note that improvements in public wealth management could help to win the war against corruption as assets are moved at an arms length from politicians. They thus address at a single stroke two of the great problems of our age: the shortage of infrastructure investment thanks to the overhang of the public debt and the halt in the advance of democracy assisted by the prevalence of poor government.

Improving the quality of asset management starts with transparency. Back in 1983, Chief Economist Willem Buiter argued that governments needed to have a clearer picture of their total balance sheet and should construct a comprehensive balance sheet including all assets and liabilities of the state, including commercial and non-commercial assets as well as central bank assets. He notes that even partial success and the recognition of what information is still missing and preventing the completion of the comprehensive balance sheet can inform policy debate and improve the accountability of the state and its agents.

Finally, the authors argue that the best way to foster good management and democracy is to consolidate public assets under a single institution a national wealth fund which is removed from direct government influence. This structure maximizes economic value consistent with the principles of corporate governance. It can also be a vehicle for improving access or the cost of borrowing on the international capital markets for financing infrastructure projects or other commercial ventures or assets.

2015 Citigroup

Global Public AssetsUnlocking asset value through National Wealth Funds

The total value of global public assets is equal to global annual GDP and greater than total global public debt

The largest segment of global public commercial assets is real estate

$75 Trillion

$75 Trillion $54

Trillion

86% 80% 70%

Percent of the worlds forests that are publicly

owned

Global public commercial

assets

Total annual global GDP

Total global public debt

State and local share of total value of nonfinancial public

assets in the US

World oil reserves controlled by national oil companies

PE and Hedge Funds

SWF Central Bank

Reserves

Insurance Companies

Pension Funds

HNWI Mass affluent

Public Commercial

Assets

Better management of public assets can generate big returns

Source: PwC, World Bank, authors calculations

Governments are the largest wealth managers with $75 trillion of assets under management

80

60

40

20

0

1% increase in return on public assets

1% of worldwide annual GDP

Annual GDP of Saudi Arabia

2% increase in return on public assets

Total world spending on R&D

Annual GDP of Austrtalia

3.5% increase in return on public assets

Total world spending basic infrastructure

Annual GDP of France


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Contents Introduction 7

The Comprehensive Balance Sheet of the State 8Which Real Assets Should Be Included and How Should They Be Valued? 8Why Would a Government Hide Its Assets? 11

What Will Public Wealth Do for You? 12Defining Public Wealth 13

A Definition of Public Wealth 13Management Is Key 15

The Honey Trap of Public Wealth 16The Cost of Poor Governance 18

Privatization and the Transport Industry 19Toward Better Governance of Public Wealth 21The Pros and Cons of State Ownership 22

Emerging Markets 26Assessing the Size of Public Wealth 27

Natural Resources: Often a States Largest Asset Base 29Forests Are the Next Frontier 32

How Large Is Public Wealth? 33How Simplified Reporting Can Improve Yield 33Asset Management and Public Commercial Assets in a Global Perspective 35

Implications for Rates Markets 38National Wealth Funds: A Better Alternative 39

Temasek: The Innovator from Singapore 40The National Wealth Fund Approach 41

National vs. Sovereign Wealth Fund 41Consolidating All Assets in an NWF: Strategy, Risk, and Reward 43

Creating Value with an NWF 44Real Estate in a National Wealth Fund 45 Substantial Opportunities in Government-owned Real Estate 48We All Want to Build Roads Now But Can We Afford It? 49Shifting State-Owned Assets Toward Infrastructure Through NWFs 50Smarter Infrastructure 52

References 54


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Introduction Dag Detter and Stefan Flster have written a remarkable book, The Public Wealth of Nations, which Citi is privileged to be able to preview in this GPS report. In it they demonstrate that, remarkably at first blush, governments across the world are either ignorant of the true value (or indeed the existence) of some of their most important assets they often have actively tried to hide these assets and have been highly successful in doing so. The hidden public assets are the real commercial assets of the state, or perhaps more accurately the real commercial or real potentially commercial assets of the state. Many of these assets have not been managed effectively, let alone commercially to the detriment of the citizens. A large part of these assets is land and real estate, including ports, airports, canals, bridges and other infrastructure, but it also includes publicly owned corporations. Although valuing these assets is often extremely difficult, the likelihood is high that in many countries a fair valuation would price them at more than 100% of annual GDP.

Most of these assets are poorly accounted for. Some dont occur in any accounts. Even proper ownership registers are sometimes lacking: Greece still does not have an integrated national land registry or cadaster. The word account has the same root as accountability: without transparency, openness and clarity (including the proper application of International Public Sector Accounting Standards (IPSAS) to these real commercial assets of the state), there can be no accountability of the beneficial owners (the government) and its agents to the ultimate beneficial owners the often sadly uninformed and disenfranchised citizens.1

With better information, the monetization of these under-exploited real commercial state assets will likely require considerable innovation in capital markets and investment banking. Liquid, tradable financial claims on the future income streams from these often illiquid and non-traded (or even non-tradable) real public assets will have to be developed. Intelligent securitization is likely to be essential an opportunity to restore some kudos and respect to an asset class whose reputation got damaged badly by the subprime mortgage securitization debacle.

We are all familiar with governments trying to understate the true magnitude of their indebtedness. Even if we restrict ourselves to contractual commitments and omit political commitments like social security retirement benefits or Medicare benefits that are political promises, hopes, expectations or aspirations rather than legally enforceable contractual arrangements, a wide range of off-balance sheet vehicles has been used to hide government liabilities. According to the (often severely defective) public sector accounting conventions currently in widespread use, contingent liabilities like guarantees or the exposure created by a government-backed deposit insurance scheme are often not included among what counts as government debt for the purpose of meeting constitutional, legal or other gross or net debt ceilings. Public-private partnerships (PPPs) often are no more than an arrangement for deferring the recognition of the financial consequences of commitments undertaken by central, state, provincial and local governments, even if the projects in question, by design, have no hope of ever yielding a positive cash flow. Examples included PPPs for the construction of non-fee-paying, not-for-profit schools in countries where there is also no education voucher-style mechanism for making public money follow pupils to schools, or PPPs for non-profit prisons. If there is a realistic prospect of capital and operating costs being recovered out of fees, other charges or access pricing, PPPs can of course make sense.

1 On IPSAS see http://www.ifac.org/public-sector

Willem Buiter Citi Chief Economist

Without transparency, openness and clarity to assets of the state there can be no accountability

Better information on these assets should lead to better monetization through paths such as intelligent securitization


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The Comprehensive Balance Sheet of the State To obtain a truly informative picture of the fiscal/financial health of the state, all present and anticipated or contingent future cash flows of the state must be allowed for, including non-contractual commitments to future payments by the state, such as Social Security or Medicare benefits. Before we can determine what decisions about public spending and taxation are desirable or optimal, we have to determine what is feasible. What is feasible the present and future fiscal space can only be determined by constructing the most comprehensive set of accounts of the state what in 1983 I called the comprehensive balance sheet, which includes all assets and (contingent) liabilities of the state, valued as the present discounted value (NPV) of their uncertain future cash flows.2 The assets and liabilities of the two government-sponsored enterprises (GSEs), Fannie Mae (Federal National Mortgage Association) and Freddie Mac (Federal Home Loan Mortgage Corporation), are definitely part of the federal governments comprehensive balance sheet (and of the comprehensive balance sheet of the general government the consolidated federal, state and local government sector). Although the practical implementation of such a comprehensive balance sheet (or inter-temporal budget constraint) of the government can be a bit of a nightmare assigning probabilities to highly uncertain future cash flows and applying the appropriate (stochastic) discount factors to these uncertain future cash flows is a rather daunting task countries like New Zealand have had a serious go at it for decades.3 Even partial success and the recognition of what information is still missing and preventing the completion of the comprehensive balance sheet can inform policy debate and improve the accountability of the state and its agents.

Which Real Assets Should Be Included and How Should They Be Valued? Strictly speaking, to construct the comprehensive balance sheet of the state, all real assets for which the state (central/federal, state/regional/provincial or local/municipal) either is the beneficial owner (has a claim on the residual income or profits) or has fiduciary responsibility should be included. The distinction between commercial assets (e.g. forests or other land that can be exploited and developed commercially without restrictions other than those that apply to privately owned forests or land) and non-commercial assets (e.g. national or state parks) where commercial exploitation is restricted or impossible is not a binary but a continuous one. A national park in the US is likely to present the US federal government with a negative cash flow the costs of managing, policing, protecting and maintaining the national park. The value (the financial value, given by the discounted future cash flows) of the national park is therefore most likely negative. This negative value as a commercial asset can, of course, be justified by the social returns yielded by the national park, now and in the future. Now consider the case where there is a chance that, at some future date, there could be some commercial exploitation of the national park (drilling for gas and oil or fracking might, for instance, be permitted, or the construction of residential or commercial real estate). In that case, the commercial value of the national park would be boosted by the NPV of the future cash revenues from these commercial activities. These uncertain future cash flows would be discounted at the appropriate stochastic discount rate that reflects both the likelihood of commercial exploitation occurring at various future dates and the likely revenues that would be appropriated by the federal government should commercial exploitation take place. Of course, a higher valuation of the national park as a commercial asset would likely be at the cost of a reduction in its non- 2 Buiter (1983) 3 New Zealand Treasury (2014

A comprehensive balance sheet should be compiled including all assets and liabilities of the state

All real assets for which the state either is the beneficial owner or has fiduciary responsibility should be included, and both commercial and non-commercial assets should be considered in continuum


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pecuniary social value as an amenity for rest and recreation and as a reservoir of environmental treasures. We are not advocating strip mining Yellowstone National Park, only outlining the way in which the federal governments guardianship of Yellowstone National Park ought to be reflected in the federal governments comprehensive balance sheet. Only that way can a well-informed cost-benefit analysis be conducted to determine the socially optimal use of this public asset.

Calculating or estimating the pecuniary value of a government real asset by discounting its uncertain future cash flows, positive and/or negative, is therefore not a sneaky way to open the door to turning the Acropolis into a bowling alley, casino or parking lot. But even a real public asset that is a jewel in the crown of the nation or all of humanity and whose non-pecuniary value is immeasurably vast will have a financial footprint that will have to be recognized, estimated and entered into the comprehensive public sector balance sheet if informed social choices are to be made.

Again going beyond the scope of the commercial government assets of the state that are the focus of Detter and Flster analysis, I would like to draw attention here to another state asset that tends to be left out of the governments accounts. The Treasury or Ministry of Finance of the central or federal government is the beneficial owner of the central bank. Some countries make this very clear. In the UK, for instance, the Bank of England is formally a joint stock company all of whose stock is owned (since 1946) by HM Treasury. In other countries this fundamental beneficial ownership structure under which the Treasury/Ministry of Finance is the claimant to the residual income of the central bank is obscured by legacy pseudo-private ownership structures (Italy, Japan and the regional Reserve Banks in the US, for instance) or by hiding the beneficial ownership structure in a vague independent government agency construction, as with the Board of Governors of the Federal Reserve System. In recent years, the Federal Reserve System has contributed around $80 billion annually to the US Treasury. With the massive increase in the size of the Federal Reserve Systems balance sheet since the beginning of the Great Financial Crisis in 2007 (from 6% of GDP to 24% of GDP), seigniorage profits are likely to remain massive for the foreseeable future, especially if interest rates return to less abjectly low levels and normal spreads between interest rates on the Feds liabilities (even its interest-bearing ones, like excess reserves) and on its assets are restored.

Not only should the conventional balance sheet of the Federal Reserve System be consolidated with that of the general government (which for reasons unknown excludes the central bank), the invisible, off-balance sheet asset of the central bank (the NPV of its future net interest income) has to be entered into the comprehensive balance sheet of the state. We are talking trillions of US dollars in the case of the Fed (see Buiter (2013)).

Central banks are an additional asset that should be added to the comprehensive balance sheet


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A stylized version of the comprehensive balance sheet of the consolidated general government and central bank (taken from Buiter (2014) is shown in Figure 1 below.

Figure 1. Comprehensive Balance Sheet of the State (consolidated General Government and Central Bank)

Source: Buiter (2014)

If we were to restrict ourselves to the consideration of financial and tangible real assets and liabilities only, omitting the net present values (NPVs) of the future revenues and outlays entered in Figure 1, we would end up with the complete conventional balance sheet in Figure 2.

Figure 2. Complete Conventional Balance Sheet of the State (consolidated General Government and Central Bank)


The way the governments accounts are typically presented is 1) to omit the consolidation of the general government and the central bank and present the general government accounts by themselves, and 2) to omit the value of the real assets of the government.4 Only a subset of the financial assets of the government is included. For simplicity I assume that the second omission amounts to not allowing for K in Figure 2.

What we end up with is the incomplete conventional balance sheet of the general government. The general government debt held by the public and the central bank should be net, although many debt norms imposed on governments are specified in terms of gross debt.

4 In the US it is bizarrely difficult to get timely and detailed general government accounts. Federal, state and local government accounts are readily available, but the consolidation at the general government level is sadly deficient.

Assets LiabilitiesValueofrealassets,equityinpublicenterprisesandotherfinancialassets BasemoneyNPVoftaxes,leviesandsocialsecuritycontributions

NonmonetaryliabilitiesofcentralbankNPVoffutureinterestsavedthroughtheissuanceofbasemoneyandothernetinterestincome

Statedebtheldbythepublic

NPVoftheterminal(longrun)stockofbasemoney

NPVofstateprimarycurrentexpenditure

Statecomprehensivenetworth

K M

({ })V T N

({ })V I B

( )V M ({ })V G

W

Valueofrealassets,equityinpublicenterprisesandotherfinancialassets Basemoney

NonmonetaryliabilitiesofcentralbankStatedebtheldbythepublic

Statecompleteconventionalnetworth

Assets LiabilitiesK M

N

B

W


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Figure 3. Incomplete Conventional Balance Sheet of the General Government


Figure 3 is a sad travesty of Figure 1 and even of Figure 2. Detter and Flster put the K back into Figure 3. With central bank consolidation, they get us to Figure 2. It is an important step forward.

Why Would a Government Hide Its Assets? Why would governments want to hide these assets? The sad but simple political economy answer is that hidden assets, that is, hidden actual or potential wealth, grants the owner and the agents who manage these assets the power to appropriate rents and to distribute these rents among beneficiaries selected by the owner and/or the managers. Lack of information about the existence and the key economic and commercial characteristics of these real government assets, and a failure of openness and transparency as regards the way in which these assets are managed and their returns distributed, mean there is inadequate accountability of the government for these assets. Even though, from a social perspective, the assets may be poorly managed and yield returns far worse than could be achieved with first-best management, from the perspective of the incumbent government and its agents, these inadequate social returns include private returns (to the government, its agents and its beneficiaries) that may well be higher than the private returns they can hope to extract under open, transparent and accountable management.

Detter and Flster propose putting all central government commercial real assets into a single national wealth fund (NWF), which would act as a gigantic publicly owned private equity fund (or public equity fund). This would be managed at arms length from the political leadership of the country, and in a transparent, accountable manner using suitable modified private sector accounting and management practices.

I agree that putting all commercial real assets in a single fund would help accountability and transparency. If the assets are very heterogeneous, however, it may not be possible to manage all of them with just one management team we are talking of assets worth well over 100% of annual GDP in some countries. Diseconomies of scale, scope and span of control may dictate splitting up the NWF either along regional, industrial or other categorical lines. But these are minor quibbles. Detter and Flster are leading the way toward the realization of value for real public sector assets. Not before time.

Generalgovernmentdebtheldbythepublicandthecentralbank

Generalgovernmentincompleteconventionalnetworth

Assets LiabilitiesgB

W

Lack of transparency on government assets leads to inadequate accountability

NWFs would put public assets at arms length from political leadership in a transparent and accountable manner


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What Will Public Wealth Do for You? A surprising fact is that the single-largest owner of wealth in nearly every country is not a private company or an individual like Bill Gates, Carlos Slim, or Warren Buffett. The largest owner of wealth is all of us collectively you and your fellow taxpayers. And we all have our own personal wealth manager, whom we usually call the government. As far as we can calculate, governments own a larger stock of assets than all the very wealthy individuals put together, and even more than all pension funds, or all private equity funds.

What is more, most governments have more wealth than they are aware of, including the many nations currently caught in the grip of debt crises. Many of these troubled countries own thousands of firms, land titles, and other assets, which they have not valued, let alone manage for the common good. Public wealth is a gold mine waiting to be managed professionally for the common good. Like a gold mine, most of the wealth is not visible without some effort to bring it out in the open.

For decades, a phony war has raged between those in favor of public ownership and those who see privatization as the only solution. We argue that this polarized debate is partly to blame for neglect of a more important issue the quality of public asset governance. This makes all the difference to how well public wealth delivers value to its owners the citizens. Even public assets that are privatized can achieve widely differing outcomes depending on the quality of government regulation, the privatization process, and the competence of private owners. The price for the phony war between privatizers and statists has been the lack of transparency, financial waste and underperformance in the public sector. The only winners are vested interests on both sides of the debate.

In this report, we will argue that how public wealth is governed is one of the crucial institutional building blocks that divides well-run countries from failed states. In fact, the governance of public wealth is not merely a matter of how efficiently state-run companies deliver. Unchecked, public wealth can ruin entire countries and undermine democracy as well. Public wealth can be a curse if it is left as an open cookie jar, tempting its overseers into corruption and clientelism. Even in successful countries like the US, which are, by and large, well organized, public wealth can invite a perversion of democracy that potentially incites policy failures and impose unreasonable hardship and social costs on at least some of its people.

We will argue that democracy is at its best when governments have little direct access to public wealth. This does not mean that all wealth needs to be privatized. The process of privatization itself offers tempting opportunities for quick enrichment, thus risking crony capitalism, outright corruption, or dysfunctional regulation.

We will provide examples of how countries have removed the governance of public wealth from politicians direct ambit. Freeing governments from having to run public firms changes the mission and focus. Wily politicians will hardly act as consumer activists if they know they are in charge of public companies that fail to deliver, and will have to live up to higher expectations. Freeing politicians from administering public wealth allows them to squarely align themselves with the citizens, formulating expectations, goals, demands, and, where needed, also regulations that attenuate market failures. This goes to the heart of a well-functioning democracy: accountability, transparency and disclosure.

Dag Detter Managing Director, Whetstone Solutions

Stefan Flster Director of the Reform Institute in Stockholm

Quality public-asset governance is the important issue

Public wealth governance is an important building block of well-run countries

Freeing politicians from asset management allows them to align themselves with citizens


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Defining Public Wealth The most visible public wealth holders are government-owned corporates held by the central government, often called state-owned enterprises (SOEs). Among the worlds 2,000 largest companies, SOEs represented 11% of market capitalization of all listed companies worldwide in 2011.5 Several emerging markets, led by Russia and China, have thousands of SOEs. Others, such as Brazil, India, Poland, and South Africa, have several hundred SOEs at the national level. In addition, many countries have thousands of publicly owned corporations at the state/regional and local level.

The central governments of most European countries own dozens or hundreds of large, well-known companies, while countries like Australia and New Zealand have relatively few SOEs. Less visible are the many government-owned corporates, or corporate-like assets owned at a regional and local level. Some of these are proper corporates, but more often they are disguised as various legal entities, but sell commercial services paid for by clients and consumers.

Beyond the corporate organizations owned by governments at different levels lie vast stretches of productive real estate by far the largest component in public wealth portfolios. More than two-thirds of all public wealth ownership remains opaque: Large holdings are owned by local and regional governments or quasi-governmental organizations that are formally independent, but are actually controlled by politician board members. Local savings banks often work like that.

A Definition of Public Wealth

Our definition of public wealth is the sum of the public assets owned by government, namely:

Pure financial assets, such as bank holdings or pension funds

Public commercial assets, such as firms and commercial real estate

Public noncommercial assets, such as roads

Minus government debt.

We use public in the financial sense, meaning the wealth owned by various levels of government. It is important to note that public assets should not be confused with public property, which normally refers to assets and resources that are available to the entire public for use, such as public parks.

This report concentrates on public commercial assets, by which we mean assets or operations generating an income (mainly non-tax-based) that could be given some kind of market value if properly structured and used. Typical examples include:

5 According to Kowalsky et al. (2013). Based on firm-level ownership data and considering direct and indirect ownership.

SOEs are the most visible examples of public wealth

Real estate is the largest category of public wealth


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Corporations typically SOEs

Financial institutions

Real estate

Infrastructure where toll-based or PPP-related

Non-corporatized commercial activity (e.g. the sale of geographical data or a water utility).

Our definition of public wealth comprises all levels of government: central, regional and local. However, most statistics or attempts to value public wealth ignore the regional and local level, or capture it only in part.

We generally exclude from our estimates of public wealth public noncommercial assets such as national parks, historic buildings, or non-toll-generating roads. We do, however, discuss how even these often can be managed in ways that generate higher social value.

Outside our definition of public wealth, we sometimes refer to and discuss quasi-governmental organizations, such as the US home mortgage institutions Fannie Mae and Freddie Mac, or formally independent local savings banks in many countries with local politicians on their boards.

More than 25% of all land in the US is owned by the federal government. Along with all this land, the government portfolio holds buildings with a book value of $1.5 trillion. In addition, state and local government assets amount to four times these federal holdings, or approximately $6 trillion, according to a cautious estimate by the International Monetary Fund.6

The US General Accounting Office (GAO), the government spending watchdog, found that many [federal] assets are in an alarming state of deterioration, noting that the federal government has many assets it does not need. 7 These include billions of dollars worth of excess, or vacant buildings. The federal government spends billions of dollars each year maintaining excess facilities in the Departments of Defense, Energy, and Veterans Affairs.

The total worldwide public wealth in government hands, conservatively calculated, is so vast that a higher return of just 1% would add some $750 billion annually to public revenues.8 Thats a sum equivalent to the GDP of Saudi Arabia. We argue that the professional management of public commercial wealth among central governments could easily raise returns by as much as 3.5%, to generate an extra $2.7 trillion worldwide. This is more than the total current global spending on national infrastructure for transport, power, water, and communications combined.9

In the US, for every 1% increase in yield from the federal government asset portfolio, total taxes could be lowered by 4%. This alone should make every individual citizen, taxpayer, investor, financial analyst, and stakeholder stand up and pay attention. And it should spur demand for action.

6 IMF (2013). 7 GAO (2005); see Managing Federal Real Property. 8 Based on our estimate of global public commercial assets totaling $75 trillion. 9 Spending on global basic infrastructure according to the World Economic Forum.

Assets owned by state and local governments in the US are almost 4x bigger than federal assets

Adding a 1% return on worldwide public wealth in government hands adds $750 billion to public revenues

A 1% yield increase in the US federal government portfolio could decrease total taxes by 4%


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As an illustration of the huge difference the governance of public wealth can make, we can look at Panama after the US turned over the management of the Panama Canal Zone in 1977 to the government of Panama. One of the most highly indebted nations in the world at the time now held a potential goldmine. Property within the Canal Zone was an attractive location for many international firms, and, in fact, the property value alone at that time was enough to cover Panamas entire national debt. That is, if it had been managed in a professional and commercial way. With a proper focus on value maximization, the Panamanian government could have monetized this attractive asset by renting or selling off attractive parcels. Instead, this opportunity was wasted, with much of the land being overrun by vested interests and used as municipal garbage dumps, informal unregulated housing and noneconomic military use.10 In recent years, however, the Panama Canal Authority has become much more efficient and has started to develop the area around the canal, also creating the Coln Free Trade Zone.

Management Is Key Many cities and states, like Chicago and California in rich countries such as the US, have similarly been seen to mismanage land holdings that could have been an integral part of public finance and used to fund government budgets, lower taxes or pay for vital infrastructure. Countries like Greece and Italy, currently in the throes of a financial and fiscal crisis, could use their considerable public assets if managed more efficiently, to help pull themselves out of their bind, without even selling these assets.

The traditional public sector approach to budgeting almost guarantees the misuse of public commercial assets. Most countries do not have a comprehensive register of public assets (a cadaster). Many governments, be they national, local or regional, would not be able to list, never mind describe, the assets they own and their market value. This makes it difficult to manage these assets in a way that exploits synergies and alternative uses of public assets.

Alas, all too often, the management of public assets is not conducted in peoples best interests. This may come as no surprise in countries where governments are not elected by the people, or are downright kleptocratic. Yet, even democratically run countries can sometimes make decisions that do not ideally reflect the peoples will or best interests. The institutional governing setup makes all the difference. Greece and Switzerland, for example, are geographically very close and both are democracies. Yet Switzerland, with solid institutions, is one of Europes richest countries, while Greece is one of the poorest, partly due to some of its institutions acting in a disorganized manner.

To some extent, techniques for better management can be borrowed from the best in private sector corporate management. This would include transparency, proper accounting and realistic balance sheets.11 Empirical studies show that better management techniques make a big difference and tend to be more common in private financial environments, especially those that are exposed to competition.12 Yet, the management of public assets must also work in a political environment, and sometimes respond to social aims beyond financial returns.

10 Peterson (1985). 11 As proposed by Buiter (1983). 12 Detter & Flster (2015)

More-efficiently-managed public assets could help governments in financial crisis pull themselves out of their bind

Techniques in better management can be borrowed from the private sector


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Removing the governance of public wealth from direct government control allows them to concentrate on running their country rather than running a number of public firms and a vast portfolio of real estate. They can then align themselves squarely with consumers and the general public in monitoring performance, and, where needed, implement regulations to attenuate market failures. The holy grail of public commercial asset management is an institutional arrangement that detaches management concerns from direct government responsibility, and simultaneously encourages active governance designed to create greater societal and financial value. Institutional structures that achieve this also help provide a firmer foundation for sound democracy.

Some nations successfully manage their commercial assets using professional wealth managers working with a measure of political independence in national wealth funds (NWFs), or similar arrangements. NWFs enable transparency. Debt ratings for these funds enable independent borrowing that optimizes capital structure and maximizes value. Public listing is also possible, providing the ultimate form of transparency, while broadening the shareholder base and potentially maximizing value to the taxpayer.

Despite the successful examples over several decades, only a small percentage of global public commercial assets are managed in these independent and more transparent NWFs, that is, at arms length from daily political winds. Instead, the vast bulk of public wealth is still managed by civil servants inside the government bureaucracy and held in various forms of conglomerates. At best, this is a bureaucratic system designed for handling the allocation of tax money. At worst, it is an arena for political meddling and, even worse, potential downright profiteering. Publicly owned commercial assets that remain hidden with no transparent economic value are at risk of being whittled away.

The Honey Trap of Public Wealth In recent decades, many wealthy nations have begun to employ more professional managers and board members in SOEs. But much less progress has been made in establishing professional ownership functions that take responsibility for vast portfolios of real estate, corporate restructuring, stock offerings for new investments and other strategic issues.

One example is Amtrak, the National Railroad Passenger Corporation in the United States, a publicly owned entity operated and managed as a for-profit corporation. Amtrak operates a 22,000-mile nationwide passenger railroad service. Apart from the multiple instances of mismanagement frequently taken up by the GAO, the more costly problem is that state ownership has perverted the democratic process. Amtraks long-haul routes are deeply unprofitable. Yet maintaining them is necessary for Amtrak to receive the continued support of senators from states that would otherwise lose services. If lossmaking long-haul trains were canceled, Amtrak would serve just 23 states, down from the current 46. That would generate the railroad more profit, allowing it to improve services in areas where it actually has profitable riders. But support from only 23 states is not enough for Congress to keep providing subsidies. Many question why their train tickets often cost much more than an airline flight, despite the more than $30 billion in subsidies Amtrak has received since 1971. This has two important implications. The political deadlock of Amtrak poisons the governments ability to implement an effective railroad or transport policy. Moreover, members of Congress must spend valuable time and energy lobbying to keep Amtrak services to their state.

National wealth funds are one way to outsource management and increase transparency


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This examples helps illustrate how managing public wealth can pervert democracy, an issue that tends to receive much less attention than the mismanagement of public monopolies. Public wealth within easy reach of governments creates incentives for abuse through, for example:

Buying political favors in exchange for lucrative contracts or positions in SOEs;

Offering organized interests free access to federal land, or water from public water companies in exchange for political support; or

Buying the support of unions by allowing higher wage increases in SOEs.

In each of these ways, democracy for the common good degenerates into clientelism. Politicians are rewarded for deftly buying support from various special interest groups rather than enacting reforms that benefit wider public interests. This is the essence of what is also called a soft state.

In a clientelist or soft state, governments have little interest in making the management of state assets more transparent. It is hardly an accident that Greece had no consolidated accounts of its considerable state assets. Even the US, which one could not describe as a soft state, has no central registry of federal, state or local government assets. As long as state ownership stays murky, it is easier for government institutions to distribute favors without scrutiny.

This came back to haunt countries when the financial crisis hit in 2007. No country experiencing financial problems had a remotely true picture of all their public commercial assets. Not only were the assets owned by local or regional governments unknown, but, surprisingly, even central governments had little understanding of their portfolio of assets, its value and yield. Spain and Portugal had both previously pulled together some of their holdings into SEPI (Sociedad Estatal de Participaciones Industriales) and Parpblica (Participaes Pblicas (SGPS) S.A.), respectively, but each held only a fraction of nationally owned assets. Still, this partial consolidation helped to create transparency and save public finances by selling some assets and establishing some creditworthiness with the remainder. Similarly, Ireland set up the National Asset Management Agency in 2009 to manage the bad banking assets from its forced restructuring of the banking sector.

Greece, on the other hand, established a privatization agency without clout. Without a mandate to own any commercial assets, it was reduced to a mere adviser to line ministries, to liquidate assets rather than being allowed to develop and maximize value. With this fragmented approach, potentially driven by vested interests and crony capitalism, international investors understood that, at best, it would take Greece many years to assess its vast state holdings and be able to reorganize them into productive and valuable assets. Whats more, when the government actually produced a consolidated financial review of its commercial asset portfolio, as required by international lenders, publication was stopped.

Those who profit from unscrupulous accounting will always argue that revealing the monetary value of public assets will promulgate narrow financial rather than social aims. We show the opposite to be true. When the value of public assets is revealed, and their managers are told to focus on value creation, then a government can make informed, transparent choices around the level of resources required to pay SOEs for achieving social aims. Without this transparency, social aims can be proclaimed by those with selfish agendas.

Public wealth within easy reach of government can create incentives for abuse

In times of crisis, knowing the value of public assets is crucial


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Even in countries with less outright profiteering, public commercial assets force politicians into a producer mindset. In countries as diverse as Sweden and India, governments have rarely shown any interest in responding to consumer demands for more reliable railway services while being the main owner and provider of train services. Any criticism of state railways threatens to raise questions about government responsibility. As it happens, both countries have mismanaged and underinvested in railroad maintenance for decades. Only when deregulation in Sweden enabled private sector operators to compete did it become politically expedient for the government to pay attention to consumer interests.

The Cost of Poor Governance Anyone flying from an American airport to any of the many newly built airports in Asia, or even some of the privately held airports in Europe, cannot help but notice a remarkable difference. The tired appearance of many American airports is not, in fact, a sign of thrift. Quite the opposite. Nearly all major US airports are owned by state or local governments that receive federal governmental subsidies for renovation and expansion. This mixing of responsibilities is in itself an obstacle to efficient management. But it does not stop there. Numerous federal roadblocks make cities hesitant to privatize. For example, government-owned airports can issue tax-exempt debt, which gives them a financial advantage over potential private competitors.

By contrast, many thriving airports around the world have been fully or partially privatized, even in Europe. This long list includes Athens, Auckland, Brussels, Copenhagen, Frankfurt, London, Melbourne, Naples, Rome, Sydney, and Vienna. Britain led the way with the 1987 privatization of the British Airports Authority, owner of Heathrow and other airports.

Even without privatization, more-efficient public management could accomplish obvious improvements, for example increasing income from commercial activities and renting out space more efficiently and in a more attractive way to private vendors. The captive audience of an airport is an ideal client base and a good source of revenue for commercial interests, and attractive vendors tend to be appreciated by travelers with spare time.

Thus, a properly incentivized owner, private or public, that can manage an airport professionally can earn a much better return than many American airports currently achieve.

American airports are only one small example of the unintended consequence of poor public enterprise governance. In many emerging market economies, however, SOEs have been used as a tool for national ambitions. Some of the largest and fastest expanding multinationals are government-owned companies in China, Russia, and many other countries. They increasingly compete with private firms and other SOEs for resources, ideas, and export contracts. A January 2013 special issue of The Economist, The rise of state capitalism, argued that: The spread of a new sort of business in the emerging world will cause increasing problems. SOEs have always been an important element of most national economies, but these were often confined to domestic markets and lagged behind in business performance.

A mixing of responsibilities is an obstacle to efficient management


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Privatization and the Transport Industry The landmark 1987 privatizations of British Airports Authorities (BAA) and British Airways (BA) began a global trend that has seen transport second only to telecoms in generating receipts for governments and offering a range of investment opportunities. State ownership and particularly the operation of airports, ports, postal companies, shipping and airlines are increasingly rare. Full privatization of complex, often loss-making rail systems, bus service and public roads is less common, with concession arrangements usually the preferred private participation.

Figure 4 below illustrates global privatization receipts from private sales and public offers since 1988 that have totaled nearly $3 trillion. Marked differences are apparent in annual volumes with troughs of receipts associated with disrupted capital markets. Over time, we note the complexity gradually increasing, with more what the OECD term hard nut privatizations where governments were caught between the fiscal burdens of subsidizing loss-making enterprises, often with strong public and employee resistance to change. Here the typical outcome was to let the enterprise operate until it was essentially insolvent and a strategic investor could be invited to acquire a significant stake for a limited consideration to ensure the continued viability of the enterprise or acquire certain assets only. The case of Alitalia and Olympic Airlines in 2008 could fall into this category.

Figure 4. Global Privatization Receipts, 1988-2013 (US$ bn)

Source: Privatization Barometer

In the period 2000 to 2007, the OECD estimates that transport privatizations (notably airlines, airports, postal companies and toll roads) generated 19% of global proceeds, second only to the telecom sector at 31% (the telecom sector peaked as high as 57% of total proceeds in 2000 at the end of the dot.com period). The OECD reported that privatizations in traditional sectors such as manufacturing and finance has (except for a few, large, standalone transactions) generally tapered off across OECD countries.

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Roger Elliott Citi European Transport Analyst


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Figure 5. Distribution of European Transport Privatization by Segment, 1997-2012 Segment Proceeds (US$m) % Proceeds Number Airlines 9,458 9% 17 Airports 18,030 18% 41 Bus 579 1% 3 Logistics 18,928 18% 19 Maritime 10,386 10% 9 Other 7,200 7% 40 Rail 3,484 3% 5 Toll Road 34,462 34% 18 All 102,526 100% 162

Source: Privatization Barometer

We note that all sub-segments of transportation were represented but that 70% of all proceeds and 48% of transactions came from toll roads, airports and logistics. Toll roads were the most important single segment with 34% of proceeds from 11% of transactions. Privatization Barometer also reported 49 Public Offers realized $41 billion and Private Sales $61 billion from 113 transactions in Europe in the period 1997 to 2012. Developed Europe generated 96% of receipts and 78% of transactions.

Mixed success

The UK has fully privatized most major airports, ports, airlines, bus service, air traffic control, most of the rail industry and most recently their postal service. We judge the majority to be successful from multiple perspectives (efficiency, innovation, investment, etc.) but with de-listed Railtrack and BAA ultimately failures as investments due largely to shifting political objectives and regulatory changes that compounded uncertainties inherent in delivering multibillion capital expenditure programs.

We believe the three listed Japanese railway companies succeeded because of the application of market principles and management efforts post-privatization plus smooth functioning of the industry and regulatory structures established at privatization. After its 2004 listing (still 70% privately held), Airports of Thailand completed the main Suvarnabumi International Airport and has since generated outsized returns and strong share price performance. In contrast 51% state-held Thai Airways has struggled since its July 1992 IPO to address intense competition, capacity management, orderbook and operating expenses. Post IPO, Thai Airways shares have fallen around 75%.

Privatization is a key component in Chinas ongoing SOE reform. Some SOEs have improved their operating efficiency through privatization, such as Air China. At the same time, we also see some less successful examples, e.g. Dalian Port, whose return has continued to fall post privatization. We believe the contrasting fortunes reflect the respective abilities to adopt a market-oriented mindset, focused on efficiencies and profitability. Likewise, a significant point of failure exists when a company cannot abandon old SOE practices.


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Toward Better Governance of Public Wealth In our view, the best way to foster good management and democracy is to consolidate public assets under a single institution, removed from direct government influence. This requires setting up an independent ring-fenced body at arms length from daily political influence and enabling transparent, commercial governance.

A similar international trend has been to outsource monetary and financial stability to independent central banks. A central bank is a deposit for reserves and a source of revenue from profits gained from creating money. Easy cash also renders central banks tempting for politicians seeking a quick fix. In blatant cases, a government will force its central bank to print too much money, eventually leading to hyperinflation. Even in many well-run countries, though, government meddling has consistently led to excessive money creation or excessively low interest rates. Following the inflationary 1970s and 80s, the most common response among OECD countries was to make central banks independent of short-term government influence, vesting the responsibility for the institution with a board, nominated and approved by the legislative branch, or parliament, and given a long-term mandate.

Independent central banks were controversial in many countries when introduced. In particular, trade unions were worried they would punish negotiated wage increases with higher interest rates, and criticized the idea as undemocratic. Over time, however, experience with independent central banks has been positive and has been widely copied.

A few countries have placed most public wealth in holding companies or funds with remarkable independence. We use the term national wealth funds (NWF) for these institutions for independent governance of public commercial assets. As with independent central banks, NWFs do not offer a watertight guarantee of better management in kleptocratic governments. But they would help most countries that are trying to make their democratic institutions more robust. Even stable democracies stand to gain from more professional governance of their assets. Interestingly, a few Asian countries now have state-of-the-art governance of state assets.

Our proposals extend beyond the governance of just commercial assets. An NWF with sufficient independence from government control could be allowed to rebalance its portfolio and not only help finance infrastructure investments, but also act as the professional steward and anchor investor in newly formed infrastructure consortia. This could mean that an NWF could be a great boon to investment in much needed infrastructure.

In the aftermath of the financial crisis, many countries remain heavily indebted and fettered by fiscal austerity, attempting to restore budgetary balance and thereby economic growth. Policy choice is confined to saving more, either now or later. Structural labor market reforms and competition rules are also on the cards, but these can take years to nudge growth and employment rates in the right direction.

When people describe the economic situation of a country, they often ignore an essential element. Most European countries own huge portfolios of commercial assets, as do both federal and local governments in the US. The value of these public portfolios may be even larger than the corresponding public debts in each country, but governments rarely possess the detailed information needed to understand the extent of their own wealth. Even heavily indebted countries like Greece may be asset rich. This is why we should start asking: What can public assets do for the economy?

Consolidating public assets fosters good management

NWFs could govern commercial and infrastructure consortia


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The Pros and Cons of State Ownership Today, more than 30 years after the Thatcher/Reagan privatization drive, and with state socialism abandoned all over Europe, a common myth in western countries may be that government ownership of commercial assets is ancient history.13 But the reality is quite different, albeit concealed by scanty accounting. For example, the most recent official statistics of the number of SOEs in Germany were published as far back as 1988. At the end of 1988, the country had 3,950 companies owned by the federal or local governments, equaling 16.7% of gross financed capital formation and employing 9.2% of all employees with a concentration in the postal and rail services, utilities, credit institutions and insurance companies.

In the following years, some companies were sold while others are now listed on the stock market, although still government controlled, as with the Deutsche Bundespost, the federal postal service, in 1995. Researchers at the University of Potsdam tried to reassess the amount of state ownership and, in 2006, they found close to 10,000 government-owned firms in Germany, on all levels, including federal, regional, and local. When the OECD later initiated a study to assess the size of SOE portfolios in each member country, the German government did not participate or support the study.

The continuing plethora of state-owned firms in Germany and many countries may be surprising. After all, between the 1970s and 2000, countries have sold off many state firms and tried to modernize the management of the ones they kept, with corporate governance reforms, performance contracts for firms and managers, and training programs for SOE executives. They tried to create a level playing field for private sector competitors that were now able to compete with these former monopolies.

But in the early years of the 21st century, prior to the financial crisis of 2007, state capitalism rebounded, this time mainly in the emerging markets. Plans for complete privatization were scrapped. Instead, minority holdings of SOEs were sold to private investors. For example, Chinese SOEs were floated in Hong Kong, Shanghai, and New York. Seemingly unconcerned by government control, investors poured more than $100 billion into the largest 20 IPOs (initial public offering) alone. These ranged from construction firms to banks and railways. In India, the government sold shares in Coal India, large government owned entity with a vast array of open pit mines. Even Indonesia and Malaysia introduced a range of public assets on the stock exchange.

13 The Economist (2014), The $9 trillion Sale, January 11, 2014.

Government ownership of commercial assets is not ancient history

Investors poured money into SOEs in the early 2000s


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Figure 6. Asset Value of SOEs Owned by Central Governments in OECD Countries before the Financial Crisis (billion USD PPP 2003)

Source: OECD Questionnaire on corporate governance of state-owned enterprises, 2003

By 2014, the picture had changed dramatically again. Asias 65 largest SOEs have lost a trillion dollars in value since their peak in 2007, much more than private firms, while their share of Asian companies market value fell from well above to well below half the total. And their aggregate price-to-earnings ratio is nearly half that of private firms. Investors became highly skeptical of buying into partially state-owned firms. Worldwide, the share of large listed SOEs in global market capitalization has been cut nearly in half from a peak of 22% in 2007. Between 2007 and 2014, the SOEs among the worlds top 500 firms have lost between 33% and 37% of their value.14 Global shares as a whole rose by 5%.

In part, the changing preferences of investors reflect overall stock market trends. But the new dim view of state-owned firms prevailed even as stock markets in the US and Europe soared in 2013 and 2014. Moreover, SOEs ran into other kinds of trouble. Investors have become increasingly wary of state meddling, graft (the use of a politicians authority for personal gain), and the simple risk that SOEs are outcompeted by nimbler rivals. NTT DoCoMo, the Japanese state-controlled mobile phone operator, has struggled to keep up with savvier private rivals. State-owned banks in China that dominate the market are being outsmarted by private rivals that offer higher returns on savings accounts.

In light of these suspicions, why do governments bother with administering a wide array of public assets? The case for public ownership essentially rests on the presumption that the people are not always capable of contracting individually with private firms to achieve socially beneficial outcomes. Some of the frequently stated aims are:

14 In dollars since 2007, depending on how one treats firms that were unlisted at the start of the period. According to The Economist (2014).

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Stated aims for governments owning public assets include industry polity, regional development, fiscal policy and environmental goals


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Industrial policy: through a government-owned enterprise, the state may be ableto launch emerging industries, save declining industries, or help the privatesector carry greater risk.

Development: to help develop poorer regions through investment in infrastructureor new production plants.

Fiscal policy and redistributive goals: as when national post office servicescharge monopoly prices for delivery in cities in order to subsidize postaldistribution in rural areas.

Environmental goals and protection of national heritage.

For countries such as South Korea, Turkey, and Mexico, direct state intervention was justified with national development goals. Similarly, many European countries and Japan nationalized companies or established national companies after World War II especially in the energy, transport and banking sectors hoping this would aid efforts to rebuild the economy.

Even state monopolies, however, may abuse their pricing power. Many countries have tried regulation to avoid this, or even forced firms to split and spin off their downstream operations. For example, the state may run the rail infrastructure network, but encourage competing private providers to operate the various transport services.

State capitalism has sometimes appeared to successfully produce national champions that can compete globally. Two-thirds of emerging market companies that made it to the Fortune 500 list in 2014 were state owned, and most of the rest enjoyed state support of some kind. Typically, they get various types of government help in reaching global markets, such as low-cost financing from state-owned banks. A lingering suspicion is that when SOEs occasionally out-compete their rivals, it may often be by accepting lower rates of return or taking greater risks at taxpayers expense. For that reason, the treatment of SOEs is also a bone of contention in the ongoing Trans-Pacific Partnership negotiations.

Brazils Vale, for example, considers itself a private sector mining company, but the national government treats it as a government-owned national champion, because three golden shares belong to the Brazilian government, apart from a significant holding by the national pension funds. The Brazilian government recently used these shares and forced Vales boss, Roger Agnelli, to step aside because they did not like his plans to institute layoffs.

Similarly, Chinas Lenovo likes to portray itself as a private sector computer company, but the Chinese Academy of Sciences, a government institution controlled by the Chinese Communist Party (CCP), provided it with seed money (and still owns a large share of the company as a parent), and the government has repeatedly stepped in to smooth its growth, not least when it acquired IBMs personal computer division for $1.25 billion in 2004. At the beginning of 2014, Lenovo, now the worlds largest personal computer maker, announced that it would acquire IBMs industry standard x86 server business valued at $2.3 billion in cash and stock.15 The deal was completed in October. In the same month, it completed

15 Financial Times (2014) Lenovo to buy IBM server unit for $2.3 billion, January 23, 2014.

State capitalism can produce national champions that compete globally

but it can also be hidden behind pseudo-private sector companies


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its $2.91 billion acquisition of Motorola Mobility from Google, to continue its expansion in the global smartphone market.16

Indeed, the CCP remains an omnipresent factor in the Chinese economy, not least through its Organization Department, which controls the appointment of the three main executives in an SOE. Its influence at a regional and local level is even greater, with provincial officials controlling the much larger number of appointments in regional and local corporations. In a penetrating analysis, Richard McGregor17 unveils how a long list of national champions operates in the shadow of the state, including Geely in cars, Huawei in telecoms equipment, and Haier in white goods, all with an opaque ownership structure and party connections that enable them to benefit from the cheap capital that the CCP makes available to potential national champions.18 This makes the CCP and its leaders extremely influential, presiding over the largest concentration of commercial assets in the world.

SOEs account for between one-third and one-quarter of Chinese GDP, yet their reported success has been questioned. According to a recent book by Nick Lardy, state capitalism in China is almost a complete failure, with the return on SOE assets being extremely low, not even half the cost of capital.19 This makes them a drag on Chinas economic growth. SOEs are, however, less common in the manufacturing sector, which partly explains the success of Chinese industry. But they are prevalent in vital service sectors such as telecoms, business and leasing services, and transportation. If Chinese economic growth has been impressive, it is despite, not because of, its SOEs.

16 Wall Street Journal (2014), Lenovo completes Motorola acquisition, October 20, 2014. 17 MacGregor (2012). 18 MacGregor (2012). 19 Lardy (2014).


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Emerging Markets One of the welcome by-products of the privatization of state assets is the development of public equity markets. Public equities offer a number of advantages that other, more private, forms of ownership lack, such as transparent and frequent price discovery and a low-cost mechanism for ownership transfer. In many countries, privatization has played a key role in getting equity markets off the ground and giving them a critical mass. This has been particularly true in emerging markets with a socialist legacy, where much of the national wealth was previously in state hands.

Governments should encourage the growth of equity markets, because they tend to be associated with economic development. Whether or not they actually cause economic development or whether the causality works the other way around is the subject of some debate.20 What is undeniable, however, is that countries with larger equity markets tend have a higher standard of living. A scatterplot of 53 countries (Figure 7) plots equitization (market capitalization-to-GDP) against wealth (GDP-per-capita) and shows a clear relationship between the two21. Here we see that the worlds richest country (Switzerland) also has one of its largest equity markets (160% of GDP). Poor countries such as Bangladesh, Nigeria and Vietnam have much smaller equity markets (< 10% of GDP).

Of course, there are outliers. South Africa has a considerably larger equity market (80% of GDP) than its income level would seem to justify. Conversely, Qatar and Norway look undersized in equity terms, relative to their wealthy populations. In all three cases, these deviations are driven by privatization policy towards natural resources: South Africas miners are largely listed (and have significant overseas assets), while the energy sector in Norway and Qatar remains in state hands. Other outliers include Ireland and Austria, whose equity markets were both laid low by the financial crisis of 2008, which led to the renationalization of some listed banks. China is one to watch: in our chart, it looks in-line with other markets of its income level (8% market cap), but that is because MSCI currently excludes the local A-share market due to restrictions on foreign investment. As these shares become more investable and are eventually included by MSCI, as seems likely, Chinas market cap/GDP will rise substantially.

Where will privatization have the greatest impact on equity market development? Well, that will depend on a given countrys starting level of equitization. Market cap/GDP for the developed markets (as classified by MSCI) fell sharply in both the technology bust of 2001-02 and the financial crisis of 2008-09. However in the subsequent bull market, that lost ground has mostly been recovered: equitization is closing in on its all-time high of 82% of GDP.

20 See, for example, Do Stock Markets Promote Economic Growth? (Randall K. Filer, Jan Hanousek and Nauro F. Campos, CERGE-EI Working Paper Series No. 151, December 2000). 21 We use nominal GDP per capita in USD versus MSCIs free float-weighted market cap. Other measures (such as using PPP-weighted GDP-per-capita or full market cap) would show a similar result. Our samples exclude countries with annual GDP below $100 billion.

Andrew Howell Citi Frontier Markets Equity Strategist


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Figure 7. Market Cap/GDP and GDP/Capita for the Worlds 53 Largest Economies in 2014

Source: Haver Analytics Citi Research

Assessing the Size of Public Wealth Public wealth comprises much more than state-owned companies. In fact, SOEs and financial institutions constitute the smallest part of the government portfolio, be it at the central government level or the regional and local level. The largest segment of public commercial assets is real estate: property and land with an economic value that often does not appear on any balance sheet.

On top of that, but outside our attempts to value public assets, is infrastructure roads, bridges, and railroads financed through the state budget for which no market may exist, but which could be run in ways that better promote growth and development. Also included are national parks and other assets held by quasi-governmental organizations and run by politicians in governmental positions.

Governments worldwide have only a patchy idea of the national wealth under their control, as many of these assets are hidden. Poor accounting standards, unclear and poorly defined economic statistics and the lack of a consolidated asset list are part of the problem. Accounts are mostly maintained by central national governments and somewhat arbitrarily labeled, as in financial versus nonfinancial assets.

USA

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The largest segment of public wealth is the hardest to value

The elusive quest of assessing value to public wealth

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Information on publicly owned real estate assets is often stuck somewhere between a formal cadastral survey and disorderly land registries, and sometimes kept by users or managers in different ministerial departments, due to inconsistent legislation. Attempts to centralize information has even met with resistance, where some departments refuse to deliver documentation they have on file or under management, seemingly due to staff fears of losing authority.22

Few governments, however, face challenges as overwhelming as the Greek government, which lacks a proper land registry. Despite having received more than $100 million in European Union aid over the past two decades in order to establish a national land registry, less than 7% of the country has been properly mapped.23 The majority of assets in the government portfolio also lack proper documentation, covering everything from simple clear title, to registration, zoning and licensing issues.

The biggest challenge in valuing public wealth in many countries remains with real estate, where records are often fragmented and scattered among several departments, each holding on to their piece of the puzzle, denying others access to their information. Any attempt to assess value, budgeting for asset management activities, and evaluating public asset portfolio performance get lost in procrastination and bureaucracy. As a result, assets are managed on an ad hoc, often reactive basis.24

The use of better accounting or budgeting methodologies alone does not automatically guarantee better use of these assets. Professional and consolidated organization is also necessary, with the intention of governing the assets to create value. The current institutional design in many countries begs the question: Is the government even interested in more efficient governance? Consider the US, where many local governments have budgeting, accounting and asset management units as three different branches with little interaction.

Policy analyses and statistics often focus entirely on the financial assets held by central governments and the more visible, listed SOEs. Few attempts to value nonfinancial assets such as real estate have been made at this time. Moreover, as with icebergs, assets at lower levels, in local and regional governments, or more anonymously, land and property, are rarely included in the available information. The question to ask here is how much any countrys balance sheet would improve if these assets were valued (whether correctly or at all) and made more transparent. Still, this is a difficult exercise, and one which most governments shy away from.

The primary conceptual problem is that the value of state property depends entirely on how well it is managed. A nationalized company, operating at a low level of profitability that can therefore only replace depreciated capital, has no value at all in a balance sheet where assets are recorded at market value. But with only a small improvement in management efficiency, a slight lift in profitability engenders a stream of expected returns, and thus, potentially, also significantly increases present value.

22 Grubii, M., Nuinovi, M. and Roje, G. (2009) Towards efficient public sector asset management, Financial Theory and Practice, 33(3): 32962. 23 The New York Times (2013), Who Owns the Land? In Greece, Who Knows?, May 26, 2013. 24 Grubii, et al. (2009).

Real estate is difficult to value with fragmented and scattered records

Few analyses attempts to value nonfinancial assets such as real estate

Value of state property is dependent on the quality of management


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This conceptual problem with determining the true value of property is especially relevant when considering government-owned land, as this is used without accounting for the opportunity cost of the land. Militaries around the world, for example, often use buildings and land with potentially high market value for purposes that could easily be located on less valuable property. Recent examples are the various barracks in central London, such as the Chelsea Barracks in one of Londons most expensive residential areas, which was only recently sold in order to be developed by Qatari Diar and the CPC Group.

In many cases, these underutilized public assets are simply treated as if their value were zero. As an example, the US Department of the Interior oversees approximately 260 million acres (105 million hectares), mainly through the Bureau of Land Management. The largest known source of oil shale in the world is the Green River Formation in the US states of Colorado, Utah, and Wyoming. But this happens to be mostly on (under) federal and state land. The shale gas and oil revolution in the US has taken place almost entirely on private land. Whether a patch of land has an oil well on it or not makes a big difference to its value.

Natural Resources: Often a States Largest Asset Base

While resources below the ground constitute tens of trillions of dollars of asset value, monetizing those assets poses significant obstacles. Few resources globally are privately owned or held. The US is a rare instance of private resource ownership. Throughout most of the world, sovereigns own the resources below the surface while the rest of the world is divided between government-held resources, which are privately produced, and government-held resources produced exclusively or largely by government-controlled firms. There are a few instances in which these resources have been or are likely to be privatized, so state management of assets becomes critical to monetization.

Natural resources often constitute the states largest asset base, and in many resource markets, the majority of reserves are held by governments. Hence government stewardship of assets has been a central feature of commodity markets.

In the case of oil, about 70% of world reserves are controlled by National Oil Companies (NOCs) according to Energy Intelligence, a trend that became pronounced across emerging market commodities producers in the 1960s and 1970s, when oil resources in particular were nationalized across the world. Today, 30 of the top 50 oil producing companies in the world are fully or partially state-owned, and about 50% of global petroleum liquids production is produced by NOCs (EIG).

US coal production is an example of government owned but privately leased and operated resources. Roughly half of US production occurs on federal lands where production rights are auctioned to producers who can book reserves. Hence most energy assets are not only already on the balance sheet, they are also managed by institutions, which across the world have complex and often conflicting objectives.

Often, it is difficult to divorce the management of resources from governments multiple objectives and political situations. Where political situations are stable and objectives are longer-term, governments production strategies tend to imply a low discount rate when making production decisions by optimizing the NPV of their resources. But where the future is highly uncertain and the priority is political survival, the discount rate may be extremely high (i.e. Libya).

Edward L Morse Citi Global Head of Commodity Research


2015 Citigroup

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Norway is the prime example of a long planning horizon state, with political stability and a desire to preserve what is believed to be the key source of national wealth over a long horizon. The government and regulator ration available oil resources to private and state exploitation believing that the best way to preserve the resource. At the other end of the spectrum has been the United Kingdom, whose goal was to maximize resource development as rapidly as possible in a country where the oil and gas holdings were a small fraction of total GDP.

In many emerging markets NOCs dominate exploitation and serve short-term political interests of governments, which often involve consolidating power and maximizing short term production and revenue to serve political aims. Petroleos de Venezuela (PdVSA) is a glaring example where a government gutted the professional management after 2003 when they resisted Hugo Chavezs efforts to sacrifice resource development for short-term revenues for domestic political purposes. Revenues were siphoned for social causes to the point of pushing the firm towards insolvency. In the middle, we see examples of bloated state bureaucracies which are confronted with the challenge to reform or perish, as has been the case in Mexico, prompting reform designed to create a more competitive environment and force greater efficiency (see Citis Energy Reform: History in the Making and Energy Reform Bill Proposal: Massive and Transformational).

The issue of where NWFs might be most practical, therefore, might be centered on instances where resources are owned by governments but not produced by governments to serve political objectives. A prime example is federal ownership of land and mineral rights in the US. A significant amount of unconventional resources in the US are on Federal lands or beneath federal waters. At present, these lands are managed by the Department of the Interior, which has been beset by scandals and critiques that it inefficiently monetizes government assets.

This area seems ripe for improved transparency and more professional management. Government reviews have found that around 90% of leasing of federal coal assets receives only one bid; critics have charged the process is uncompetitive and leaves millions of taxpayer dollars on the table. In the case of oil, a significant and growing amount of resources globally are owned by governments but exploited by private firms alongside NOCs. Privately leased mineral and metals resource also abound, providing potential assets for monetiza

Citi GPS - The Public Wealth of Nations

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