Global Policy Forum

Joseph Stiglitz

The Arthur Andersen and Enron scandals in America have focused attention on the problems of accounting in private businesses. But the scale of this corruption should not blind us to the problem of public sector accounting, where many deceitful things are also being done. Accounting rules are designed to provide standardised frameworks within which the financial position of a firm, or government, can be assessed. Bad accounting frameworks always lead to bad information, and bad information leads to bad decisions, with serious long term consequences. This is true in the public as well as the private sector.

Enron and others showed how accounting rules can be bent and abused to provide a misleading picture of what is really happening in a company. The Bush administration, not to be left behind, has shown how public accounting rules can be bent so as to provide a misleading picture of what is really happening in a national economy. Indeed, last year saw what may be the largest accounting fraud ever conducted, as a mega-surplus of more than $3 trillion for the years 2002 to 2011 was transformed into a $2 trillion deficit.

Investors in Enron were forced to wait years before discovering that something was amiss, but sudden and vast changes in America's fiscal stance already provide the public with a clear indication of the massive scale of problems to come. Like Enron, it will be years before the full magnitude of President Bush's deception is apparent. Meanwhile, the Bush administration will blame the sinking economy, bad luck, and unintentional miscalculations for the vanished surplus.

But America is not alone in allowing for official accounting shenanigans. In Latin America and elsewhere in the developing world, the IMF imposes accounting frameworks that not only make little sense, but result in excessive austerity. In some of the poorest countries in the world — i.e., those most dependent on aid — the IMF has argued that foreign aid should not be listed as revenue in a government's budget calculations. But what else is aid if it is not revenue?

The IMF's argument seems to be this: a country cannot rely on foreign aid because aid is too unstable. The truth, of course, is that aid is more stable than tax revenues in poor countries. By the IMF's logic, neither aid nor tax revenues should be included in budgets. If that is the case, every country in the world is in deep trouble.

The absurdity here is the idea that all foreign aid should be added to reserves. But donor countries want to see the money they give to finance schools or health clinics spent on schools and health clinics; they don't want to see it added to a nation's reserves.

Governments in developing countries have the correct answer to the problem of revenue instability: expenditure flexibility. Build schools when you have aid; stop building them when you don't. For years, World Bank economists have tried to convince the IMF to see this logic, with little progress.

Other IMF accounting practices, including how the capital expenditures of government-owned enterprises are treated, are also causing outrage. If a state owned enterprise in Latin America wants to borrow to make an investment, in Latin America such borrowing is treated as an addition to the deficit. Investors, worried about the size of a government deficit, see only the bottom line. But if a company can buy a $1 billion asset for $500 million, economic logic says buy the asset. The balance sheet is improved by $500 million.

But by IMF logic, all you see in the accounts is increased expenditure and borrowing, not the value of the acquired asset. Because of this rule, investors may only see an apparent worsening of the country's fiscal position, and so may demand higher interest rates. Of course, foreign investors like this IMF logic: government corporations are put at a distinct disadvantage: with their ability to invest inhibited, these firms cannot compete to make acquisitions.

A second IMF accounting distortion involves stabilisation funds. These are national funds that, in boom years, receive revenues from sales of natural resources to be set aside against a rainy day. This makes sense. But IMF accounting inhibits the use of these funds to help stabilise an economy through counter-cyclical fiscal spending.

According to Mexican and Chilean officials I have discussed the matter with, spending from a stabilisation fund is reportedly treated as if the country is borrowing, thus adding to its deficit. It is, of course, in times of economic downturn that countries worry most about their credit rating, so the IMF stance is particularly unhelpful.

IMF accounting frameworks, rather than providing useful signals to the market, provide distorted information that exacerbates a troubled country's problems. Good decisions require accurate information, and this comes only through good accounting frameworks. Of course, no perfect accounting framework exists, but some frameworks systematically distort.

Indeed, a hidden agenda often exists in the choice of an accounting framework. Not including stock options inside the accounting framework served US corporate interests, and those of individual bosses, well. The IMF's distorted and unfair accounting frameworks may also serve a hidden purpose: to force governments to shrink expenditures. But there are high economic and social costs to this agenda, one that goes far beyond the IMF's mandate.

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