Beyond Debt: The Case for Public Sector Net Worth

By Hua Chai and Yan Wang

In recent years, the traditional focus on public debt as the cornerstone of fiscal policy has come under scrutiny. Many countries anchor their fiscal policy on the level of public debt, either implicitly or explicitly through fiscal rules. However, the prolonged period of low interest rates in advanced economies prior to the recent inflation episode has led to a reassessment of the costs associated with public debt and the broader role of fiscal policy.

This is particularly relevant in situations where the interest rate on debt (r) is lower than the economy’s growth rate (g). This reassessment has been further fueled by the urgent need for increased public investment to address challenges such as climate change, social insecurity, infrastructure deficits and rising inequality in both rich and poor countries. The conventional debt-to-gross domestic product (GDP) ratio target is therefore increasingly seen as inadequate as the only tool for guiding fiscal policy.

The case for public sector net worth

To address these challenges, we propose shifting fiscal policy’s focus from debt levels to public sector net worth. This approach considers both the public sector’s assets and liabilities, providing a more comprehensive view of economies’ fiscal health. By focusing on net worth, fiscal policy can better account for the economic benefits of public investments, particularly those that enhance productive capacity and long-term growth.

Adopting accounting-driven, Net Worth-based fiscal rules/anchors creates major opportunities to improve long-term growth and public finances without cutting public services or increasing taxes.

Targeting public sector net worth (PSNW), defined as the difference between the value of public assets (including physical assets such as public infrastructures) and liabilities, offers several advantages over traditional debt-based fiscal anchors as guidance for medium-to-long-term fiscal policymaking.

1. Encouraging productive investment

Unlike debt targets, which often do not distinguish between different types of spending, a net worth target incentivizes investments that increase public assets. This includes investments in infrastructure and other forms of productive capital that can drive economic growth. On the other hand, most current spending, such as government consumption and transfers, does not increase the value of public assets. Therefore, compared to a debt rule, a net worth target provides stronger incentives for fiscal authorities to pursue productive public investment. This is generally true, but especially pronounced in a low-interest rate environment, when the associated rise in debt service burden is low.

2. Preventing unsustainable debt dynamics

By linking fiscal policy to net worth, governments are encouraged to balance increases in debt with corresponding increases in public assets in order to meet net worth targets. This helps keep the public debt-to-GDP ratio in check.

3. Responding to interest rate changes

A net worth anchor is more responsive to changes in interest rates, as the valuation of public assets depends on the level of interest rates—the discount factor. For example, as interest rates rise, the present value of public non-financial assets such as public infrastructures would decline, prompting fiscal consolidation by reducing both current expenditure and public investment, thereby lowering debt levels.

A recent International Monetary Fund (IMF) working paper uses model simulations to show that replacing a public debt ceiling with a properly chosen net worth target can lead to better economic outcomes. Both high-debt and low-debt economies can sustain higher long-term growth by adjusting their net worth targets without jeopardizing debt sustainability. Earlier IMF work makes it clear that governments with stronger net worth recover faster from recessions and have lower borrowing costs.

Practical applications and policy implications

The idea of utilizing public sector net worth to inform fiscal policy isn’t entirely new. Countries like the United Kingdom, New Zealand and Australia have incorporated variants of net worth targets within the constellation of their fiscal policy formulation. These countries regularly publish estimates of their public sector balance sheets and project these into the future in their budget documents. For example, in New Zealand, budget documents provide forecasts of the public sector balance sheet, including net worth, for the budget year and the following three years.

Information on public sector balance sheets has become increasingly available for a growing set of countries, including in the form of a comprehensive database compiled by the IMF.

In the context of climate finance, the discussion around green fiscal rules highlights the need for fiscal frameworks that allow for necessary public investments without exacerbating debt burdens, particularly in countries with elevated public debt and those facing high interest rates. A rule based on public sector net worth allows for green investments as these investments could create valuable green capital, increasing public sector net worth. Similarly, the ongoing debate over the Euro Area’s fiscal rules, which were suspended during the pandemic, could benefit from considering net worth as an alternative or additional anchor.

In development finance, a focus on net worth could help broaden policy attention from debt level alone to whether public debt is effectively used to create productive public assets. For example, a recent working paper uses nighttime luminosity as a proxy for economic activity and shows that infrastructure projects in sub-Saharan Africa, financed by China and the Belt and Road Initiative, have built up public capital and resulted in an  increase in economic activities at the second sub-national level regions (equivalent to cities and counties).

Conclusion

As the global economic landscape evolves, so too must the approach to fiscal policy. The traditional reliance on debt-to-GDP ratios is insufficient for addressing the complex challenges of the 21st century. By shifting the focus to include public sector net worth, policymakers can better balance the need for fiscal sustainability with the imperative for productive public investment. This approach not only provides a more accurate picture of fiscal health but also promotes long-term economic growth and resilience.

Hua Chai is a Senior Economist at the International Monetary Fund. The views expressed herein are those of the author and should not be attributed to the IMF, its Executive Board or its management.

*

Never miss an update: Subscribe to the Global China Initiative Newsletter.