Economics: The proper way to sell off the family silver

Gordon Brown has joined the Bank of England (and ourselves) in the camp that thinks the economy will display slow growth next year. His pre-Budget Report tilted the odds further in favour of a slowdown.

For one thing, an upward revision to the Treasury's 1998 inflation forecast gives the hawks on the Bank of England's Monetary Policy Committee further ammunition for raising interest rates. Moreover, despite announcing a further reduction in the mainstream corporation tax rate, changes in the timing of corporation tax payments will initially hit corporate cash-flow to the tune of pounds 2.3bn in 1999/2000. This is going to cut investment rather than boost it.

Yet the most significant fiscal policy initiative came, not in the pre- Budget Report itself, but the previous day and was flagged up by Alistair Darling, the Chief Secretary to the Treasury, when he published the National Asset Register.

Departments will be allowed to sell some of these "Domesday Book" assets as a source of finance for capital spending.

Contrary to popular opinion, it was a Labour Chancellor, Denis Healey, who started the privatisation ball rolling in the late 1970s with the sale of Associated British Ports. The Tories took the idea up in a massive way. To date, around pounds 70bn has been raised from privatisations.

Many believe there were efficiency gains from transferring these assets to the private sector.

What was not so efficient was the macroeconomic impact of using the revenues raised to help finance the tax reductions of the 1980s.

The Government's current plans assume no privatisation receipts next fiscal year. Part of the rationale is that privatisation proceeds should only be scored for sales that have already been announced. However, it may also be an indication that the Government is running out of assets to privatise.

What's more, the Government's new code for fiscal stability puts an emphasis on public sector balance sheets which will not encourage further widespread privatisations.

On current official estimates, public sector net wealth (the difference between Government-owned assets and liabilities) fell sharply from about 70 per cent of GDP in the 1980s to less than 10 per cent in 1996 (see chart).

The privatisations and historically low levels of public sector investment in the three years prior to the 1997 election have reduced the stock of Government assets to very low levels indeed. Transferring additional assets to the private sector would further weaken the balance sheet of the public sector.

So how can it be that the Treasury will permit limited asset sales uncovered in the new "Domesday Book"? The big difference (at least in theory) is that the proceeds can be used only to finance capital expenditure.

In effect, Mr Darling has paved the way for a significant increase in public sector investment.

Previous estimates suggested that, excluding local authorities and public corporations, central government has around pounds 100bn of tangible assets, including land and buildings.

The National Asset Register suggests a much higher figure when small but valuable items are included. Although the 546-page document only puts a value to relatively few items, including Royal Botanic Gardens, Kew (value pounds 2.8m), officials were suggesting a total figure as high as pounds 300bn.

For the three years from April 1998 to March 2001, the Treasury is to allow government departments to reinvest all receipts from the disposal of such assets, up to a limit of 3 per cent of their budgets on an annual basis. At any one time, government departments may only dispose of assets up to a value of pounds 100m. However, the sums involved could still prove highly significant.

Potentially, with net departmental outlays totalling around pounds 270bn a year, almost pounds 25bn could be released over the next three years to fund existing or additional capital expenditure. On present rules, money raised from the disposals cannot be transferred between government departments.

Even if some departments fall a long way short of their maximum allowable sales - as they no doubt will - total disposals could still far exceed the scale of privatisations in recent years and have a significant impact on the wider economy.

The public sector's overall balance sheet will remain unaffected, since the Government will only be swapping one public sector asset for another.

However, it could represent a much more productive use of assets. Few would disagree with the idea of selling off bracket clocks or car parks to finance a new hospital.

Nevertheless, there would be a difference depending on whether the government decides to use the finance raised to fund additional spending or simply to help finance the existing targets.

Literally selling the family silver could circumvent the problem that Mr Brown will face later in this parliament of either having to raise taxes or running a higher PSBR to fund greater public sector investment.

Kenneth Clarke was only able to maintain current spending and fund tax cuts by savagely cutting public sector capital expenditure in the three years running into the 1997 election.

Such sharp reductions in public sector capital expenditure were never likely to prove sustainable, even if the PFI picked up momentum later in this parliament.

Even if he hits his near-term targets, the City has been concerned that Mr Brown could have been forced to relax the purse strings nearer the next election.

Indeed, historically there has been a correlation between general election results and the strength of public sector capital expenditure.

Allowing government departments to sell their less productive assets to the private sector could free up the cash for capital spending on politically sensitive areas, such as infrastructure, health and education.

At least, this is the theory. To say that any asset sale could only be used to finance capital spending sounds easy.

In practice, how can the Treasury ensure that the money raised from asset sales goes only to finance additional public sector investment?

It is easy to see this rule slipping. The key test is whether "Domesday"- financed investment is an addition to investment that is already in the plans.

There is a big difference between the sale of an asset to finance additional capital expenditure and flogging it off simply to meet existing public sector capital expenditure targets.

If, as is likely, the overall control total for spending (both current and capital) is left unchanged, the use of asset sales in the latter case would merely free up money to boost current spending, including perhaps the public pay bill.

This would not have the same beneficial impact on the public sector's balance sheet as spending the money raised on capital expenditure over and above the existing plans.

The bigger problem is that, when the asset sales dry up in March 2001, Mr Brown would be left with high ongoing spending commitments which he would find difficult, if not impossible, to cut.

Running into an election, there would be pressure on him to maintain the momentum of spending in areas which were seen as earning a relatively immediate return.

Even with the best will in the world, it is easy to see the release of "Domesday" assets as ending up having unintended consequences.

David Owen is UK economist and a director of Dresdner Kleinwort Benson.