Delineation of government in ESA 2010

Delineation of government in ESA 2010
ESA 2010 course January 2014 Martin Kellaway Sector delineation - ESA 2010

Sector delineation - ESA 2010
Session Introduction Sectors and sub-sectors Notion of control Non-market public enterprises Groups of corporations Public holding corporations Special bodies (SPVs etc) Market / non-market borderline Sector delineation - ESA 2010

Introduction ESA2010 follows on from SNA update Different audiences, different detail of guidance, some deliberate differences “The ESA 2010 is broadly consistent with the worldwide guidelines on national accounting set out in the System of National Accounts 2008 (2008 SNA).” (ESA ) Sector delineation - ESA 2010

Introduction ESA10 relevant from September 2014, ESA95 beforehand ESA10 retains same structure as ESA95 for first 13 chapters “Chapter 2 describes the institutional units used in measuring the economy, and how these units are classified into sectors and other groups to allow analysis.” (ESA ) Sector delineation - ESA 2010

Introduction ESA10 then has 11 new chapters elaborating the system “Chapter 20 describes the accounts for the government sector – an area of special interest as issues of fiscal prudence by Member States continue to be critical in the conduct of economic policy in the EU.” (ESA ) Sector delineation - ESA 2010

Introduction Message: if there are apparent differences in interpretation between chapter 2 and chapter 20 Take chapter 20 as the definitive version Chapter 2 is general, chapter 20 is specific Chapter 20 brings into ESA10 much of MGDD but need for MGDD to interpret ESA10 where necessary still exists So ESA10 version of MGDD in preparation Sector delineation - ESA 2010

1. Sector definitions General government - central government - state government - local government - social security funds Public sector Sector delineation - ESA 2010

1. Sector definitions “Definition: The general government sector (S.13) consists of institutional units which are non-market producers whose output is intended for individual and collective consumption, and are financed by compulsory payments made by units belonging to other sectors, and institutional units principally engaged in the redistribution of national income and wealth. (ESA )” Similar to ESA , “mainly financed” Sector delineation - ESA 2010

1. Sector definitions ESA – “The institutional units included in sector S.13 are for example the following: a) General government units which exist through a legal process to have judicial authority over other units in the economic territory, and administer and finance a group of activities, principally providing non-market goods and services, intended for the benefit of the community; …” Sector delineation - ESA 2010

1. Sector definitions ESA “… b) A corporation or quasi-corporation which is a government unit, if its output is mainly non-market and a government unit controls it; c) Non-profit institutions recognised as independent legal entities which are non-market producers and which are controlled by general government; …” Sector delineation - ESA 2010

1. Sector definitions ESA “… d) Autonomous pension funds, where there is a legal obligation to contribute, and where general government manages the funds with respect to the settlement and approval of contributions and benefits.” Again very similar to ESA Sector delineation - ESA 2010

1. Sector definitions As with ESA95, ESA10 retains the four S.13 sub-sector approach SNA08 continues to allow option of 3 or 4 (ESA10 chapter 2 takes the SNA08 sub-sector names despite not offering the option, chapter 20 does not) Sector delineation - ESA 2010

1. Sub-sector definitions
Central government (S.1311) ESA same as ESA except for incorporation of MGDD guidance on MROs: “Market regulatory organisations which are either exclusively or principally distributors of subsidies are classified in S Those organisations which are exclusively or principally engaged in buying, holding and selling agricultural or food products are classified in S.11.” (ESA ) Sector delineation - ESA 2010

Central government (S.1311) … but ESA gives more detail and a commentary. For example: 20.59 … a large and complex sub-sector in most countries. It is generally composed of a central group of departments or ministries that make up a single institutional unit plus miscellaneous bodies operating under the control of the central government with a separate legal identity and enough autonomy to form additional central government units.” Sector delineation - ESA 2010

Central government (S.1311) … but ESA10 ch20 does introduce into ESA the concepts of ‘budgetary central government’ and ‘other central government’. ‘budgetary central government’ not called “the State” to avoid confusion with S.1312 ‘other central government’ = “extra-budgetary units” Sector delineation - ESA 2010

Central government (S.1311) “This partition is a matter of judgment and can be influenced by practical considerations. An important criterion is the institutional coverage of the "budget". However, the exact composition should be precisely known and agreed between compilers at the national level, to reinforce the consistency of source data. The ability to draw a complete sequence of accounts for these two "subsectors“ … is important in assessing the quality of the data. (ESA ) Sector delineation - ESA 2010

State Government (S.1312) ESA unchanged from ESA S.1312/S.1313 concept of units operating at lower geographical levels than the entire territory ESA gives helpful guidance on what to include, consistent with IMF GFSM01 Sector delineation - ESA 2010

State Government (S.1312) … units in a federal system of government having a state or regional sphere of competence ... Largest geographical area into which the country as a whole is divided for political or administrative purposes … known by [various] terms … The legislative, judicial, and executive authority …extends over the entire area of an individual state …but does not extend over other states. In many countries, state governments do not exist. (modified summary of ESA ) Sector delineation - ESA 2010

State Government (S.1312) usually has the fiscal authority to levy taxes … must be able to own assets, raise funds, and incur own liabilities … must be entitled to spend or allocate at least some of its revenue according to its own policies … may receive transfers from S.1311 tied to certain specified purposes. … able to appoint officers independently of external administrative control … Sector delineation - ESA 2010

State Government (S.1312) … [boundary with S.1311] If entirely dependent on funds from S.1311, which also dictates the way funds are to be spent, then agency of S.1311 (modified summary of ESA ) Sector delineation - ESA 2010

Local Government (S.1313) ESA identical to ESA ESA more detail, including joint bodies ”… two or more contiguous local governments may organise a … unit with regional authority that is accountable to local governments. Such units are classified to [S.1313] – (ESA ) Sector delineation - ESA 2010

Social security funds (S.1314) ESA similar to ESA Helpful link to chapter 4 on ‘government as employer’ schemes deleted, but chapter 4 paragraph still exists Sector delineation - ESA 2010

Social security funds (S.1314) Hospitals supporting SSFs “If public hospitals provide a non-market service to the community as a whole and if they are controlled by social security schemes, they are classified to the social security funds subsector” [ESA ] Sector delineation - ESA 2010

1. Sector definitions Public sector ESA95 had references to public producers, public corporations but no definition of public sector. ESA defines the public sector. Second step in sector classification is to determine whether a unit is public or private sector. If public we then need to decide whether it is S.13 or not. Sector delineation - ESA 2010

1. Sector definitions In summary: ESA10 not substantially different to ESA95 Chapter 20 offers helpful additional text Delineation of a number of borderline units will be covered later in the session Sector delineation - ESA 2010

2. Control The ESA95 classification paradox: ESA b stated that non-market NPIs that were controlled and mainly financed by government were in S.13. ESA restricted NPISHs to private sector. So where to classify non-market NPIs that were controlled but not mainly financed by government? Sector delineation - ESA 2010

2. Control The ESA95 classification paradox: ESA introduces a chart that resolves this. Control is the factor that is important, so in S.13. ESA10 resolved the paradox by reducing the importance of the second criteria (financing) to a factor considered within the determination of control. ”Control is defined as the ability to determine the general policy or programme of an institutional unit. A definition of control is given in paragraphs 2.35 to 2.39” (ESA ) Sector delineation - ESA 2010

2. Control ESA gives improved guidance, and a list of indicators, as to whether government controls an entity further improve this guidance. Once we determine whether a unit is public sector (i.e., government-controlled) we test whether it is market or non-market. Under ESA10 more judgement is required on borderline cases than apparent in ESA95 Sector delineation - ESA 2010

2. Control indicators (ESA10 2.38)
a) Government ownership of the majority of the voting interest; b) Government control of the board or governing body; c) Government control of the appointment and removal of key personnel; d) Government control of key committees in the entity; e) Government possession of a golden share; Sector delineation - ESA 2010

2. Control indicators (ESA10 2.38)
f) Special regulations; g) Government as a dominant customer; h) Borrowing from government. A single indicator may be sufficient to establish control, but, in other cases, a number of separate indicators may collectively indicate control. Sector delineation - ESA 2010

2. Control List of indicators based on UK practice, aligned with GAAP, as part of SNA08 TFHPSA much more helpful in explaining practical cases than chapter 2 is Some listed as determinants of control, others as indicators Sector delineation - ESA 2010

2. Control of NPIs 20.15: control of NPI is “ability to determine the general policy or programme” – 5 indicators: (a) appointment of officers (b) obligations in its statute of creation (c) contractual agreements (d) degree of financing [MGDD – fully or close to] (e) risk exposure Why separate from ? SNA08 separates Sector delineation - ESA 2010 32

2. Control of NPIs Education specifically covered in MGDD NPI school in S.13 if government approval for: - creation of new classes; - significant GFCF; - to borrow; - to end its relationship with government; - or permanently majority finances or pays teacher salaries General regulation (of quality of education, maximum pupil number limits) is not control Sector delineation - ESA 2010 33

2. Control Have to make judgement based on aggregated powers Each case on its own merits as different factors have different importance Case law evolves, MGDD guidance will evolve Don’t worry – easier than it first sounds! Sector delineation - ESA 2010

3. Non-market government enterprises
Public sector controlled enterprises that fail the ‘market test’ are classified to general government 1.35 control “by government” 2.12b “A corporation or quasi-corporation which is a government unit, if its output is mainly non-market and a government unit controls it ESA95, SNA08, ESA10 ch1 have careful use of words here: controlled by general government (meaning controlled by the sector) Sector delineation - ESA 2010

3. Non-market government enterprises
Elsewhere in ESA10 (20.18 and ) we see this restriction is not present, indeed clearly discusses the collective rights of many public sector units when considering control Take chapter 20 as definitive Sector delineation - ESA 2010

4. Groups of corporations
ESA10 has guidance on these, which is not in ESA95. “Each member of the group is treated as a separate institutional unit if it satisfies the definition of an institutional unit.” (ESA ) This reinforces the approach in MGDD12 I.7 to look at each Public enterprise subsidiary individually by conducting the market test on them individually. Sector delineation - ESA 2010

5. Public sector holding corporations
ESA states that “Head offices and holding companies are institutional units” and guides their classification as S.11 or S.12, or as captive financial institutions (S.127). [n.b. HOs actively manage subsidiaries, HCs passive] This is general guidance, however although not mentioned in chapter 2, ESA b (pg 180) covers the case where they can be classified to government, consistent with public holding companies guidance in MGDD12 I.7. Sector delineation - ESA 2010

6. Special bodies Chapter 20 includes guidance previously in MGDD on particular types of special ‘government-linked’ bodies: Privatisation agencies, restructuring agencies, defeasance structures, SPEs, joint ventures, market regulatory agencies Defeasance is not particularly detailed and will rely on the further guidance in MGDD Sector delineation - ESA 2010

6. Special bodies ESA10 does not cover deposit/insurance/pension protection schemes. MGDD classifies those “for the financial sector” as S.126 when separate institutional units (although re-route the levies as taxes via government) However, such schemes are usually “for households” and other no protection for financial institutions Sector delineation - ESA 2010 40

6. Joint ventures ESA introduces the subject Explains difference between a joint venture (qualifies as institutional unit) and a joint operation (no unit) Sector delineation - ESA 2010

6. Joint ventures “Normally, the percentage of ownership will be sufficient to determine control. If each owner owns an equal percentage of the joint venture, the other indicators of control must be considered” (ESA ) In practice, the rationale of a joint venture is that control is shared Sector delineation - ESA 2010

6. Joint ventures ESA give further guidance A non-market joint venture between private and public sectors will be classified as S.13 general government “since its behaviour is that of a government unit”. This is new guidance not previously covered in MGDD. overwrites if non-market? Sector delineation - ESA 2010

6. Joint ventures A market joint venture between private and public sectors, with joint control, will be partitioned half to private sector and half to public corporations (ESA ) Sector delineation - ESA 2010

6. Sovereign Wealth Funds
These special purpose government funds are specifically mentioned in ESA10 for the first time ESA e defines them as S.127 (captive financial institutions) if they are financial corporations Usually associated with profits from a natural resource, such as oil, and rare in Europe (Gulf, Norway has an ‘oil fund’) Sector delineation - ESA 2010

Not to be confused with pension reserve funds, or sale & leaseback units Very restrictive classification For example , Bulgaria has ‘silver fund’ of proceeds from state-asset sales, used to pay pensions after 2020 = not SWF Sector delineation - ESA 2010

SWF seem to exist in few European countries. More work needed on SWFs Sector delineation - ESA 2010

6. Quasi-corporations Sector classification guidance unchanged from ESA95 But some notable changes to transactions: ‘super-dividend test’ (20.205) investment grants are recorded as capital transfers (20.42) – ESA was additions to equity Sector delineation - ESA 2010

6. Special Purpose Entities (SPEs)
One of the major changes in ESA10 is that more specific guidance is given on SPEs ( ), including those of non-resident SPEs. New terms (SPEs, captive financial institutions) The use of government-controlled non-resident SPEs abroad has been clarified to specify that the activity is included in the government accounts. Sector delineation - ESA 2010

6. SPEs Traditional argument that SPVs not institutional units Securitisation SPVs in ESA95, logic to separate financing vehicle from MFI but to retain in S.12 Application of separating unit from its parent into different sectors made less sense Again, a bank holding corporation as a captive (S.127), is logical, a government holding corporation as S.12 would not be Sector delineation - ESA 2010

6. SPEs ESA now clarifies that bank SPVs are not necessarily institutional units “Financial vehicle corporations engaged in securitisation transactions … that satisfy the criteria of an institutional unit are classified in S.125, otherwise they are treated as an integral part of the parent” (ESA ) Banks tightened rules, government different behaviour Sector delineation - ESA 2010

6. SPEs Since some SPEs that operate on behalf of government are created abroad, ESA d is useful as it specifies that “residence is determined according to the economic territory under whose laws the enterprise [SPE] is incorporated or registered”. Sector delineation - ESA 2010

6. SPEs “captive financial institutions, artificial subsidiaries and special purpose units of general government with no independence of action are allocated to the sector of their controlling body. The exception occurs when they are non-resident, in which case they are recognised separately from their controlling body. But in the case of government, the activities of the subsidiary [notional unit] shall be reflected in the government accounts.” (ESA ) Sector delineation - ESA 2010

6. SPEs EFSF Resident of Luxembourg “But in the case of government[s], the activities of the subsidiary [notional unit] shall be reflected in the government accounts” Suggests no change of impact from EFSF transactions on government accounts In practice SPEs are created by others on behalf of the main beneficiaries, this will be the case even for government SPEs so a description of what was intended to be conveyed by “set up” within MGDD is ideally required. Sector delineation - ESA 2010

6. SPEs ESA is very clear ”General government may also set up special units, with characteristics and functions similar to the captive financial institutions and artificial subsidiaries. Such units do not have the power to act independently and are restricted in the range of transactions they can engage in. They do not carry the risks and rewards associated with the assets and liabilities they hold. …” Sector delineation - ESA 2010

6. SPEs “… Such units, if they are resident, shall be treated as an integral part of general government and not as separate units. If they are non-resident they shall be treated as separate units. Any transactions carried out by them abroad shall be reflected in corresponding transactions with government. Thus a unit that borrows abroad is then regarded as lending the same amount to general government, and on the same terms, as the original borrowing” (ESA ) Sector delineation - ESA 2010

6. SPEs 2.27 makes the key aspect for classification whoever sets up the units More important factors are that they lack autonomy (power to act independently, restricted transaction range) and who carries the risks and rewards? SPEs where government effectively controls (or is on auto-pilot) and has risks & rewards, but is not set up by government, should be S.13? Would be in line with the general principles of ESA chapter 2 but goes further than 2.27 does In practice SPEs are created by others on behalf of the main beneficiaries, this will be the case even for government SPEs so a description of what was intended to be conveyed by “set up” within MGDD is ideally required. Sector delineation - ESA 2010

6. SPEs However, chapter 20 covers the types of government-related units that may be considered as captive financial institutions So, whatever freedom chapter 2 gives, chapter 20 takes away! In practice SPEs are created by others on behalf of the main beneficiaries, this will be the case even for government SPEs so a description of what was intended to be conveyed by “set up” within MGDD is ideally required. Sector delineation - ESA 2010 58

6. SPEs MGDD I gives some guidance on independence (or actually lack of it): - de facto management of SPE debt by government; - government approves significant decisions on management of assets; - auto-pilot – contract or convention pre-determines SPEs operations Sector delineation - ESA 2010 59

6. SPEs MGDD I also explains that notion of control over entity is not important with SPEs, instead independence refers to substantive control over assets/liabilities and risks/rewards associated with them Sector delineation - ESA 2010 60

7. Market/non-market borderline
Probably the biggest ESA10 issue concerning general government delineation. MGDD, as it evolves, will need to provide further interpretation to resolve the issues described here Sector delineation - ESA 2010

ESA b1 explains that ESA10 has specific guidance here that SNA08 doesn’t, so therefore we should not refer back to SNA08 for any additional clarity on this subject. Wise move, as SNA08 is inconsistent: SNA defines market producers as, at a minimum covering their costs (e.g. 100%) and then in redefines it so that sales cover at least half of costs (e.g. 50%) Sector delineation - ESA 2010

What does ESA10 say? The first relevant mention is 1.37: “Differentiating between market and non-market, and so for public sector entities classifying them into the general government sector or the corporations sector, is decided by the following rule. …” Sector delineation - ESA 2010

“An activity shall be considered as a market activity when the corresponding goods & services are traded under the following conditions if: (1) Sellers act to maximise their profits in the long-term, and do so by selling goods and services freely on the market to whoever is prepared to pay the asking price; (2) Buyers act to maximise their utility given their limited resources, by buying according to which products best meet their needs at the offered price; …” Sector delineation - ESA 2010

“(3) Effective markets exist where sellers and buyers have access to, and information on, the market. An effective market can operate even if these conditions are not met perfectly.” The third point adds little, since nowhere else is there any mention of restrictions concerning the effectiveness of the market. Sector delineation - ESA 2010

So, using 1.37(1) we would expect that most NPIs, which seek to break even and hence don’t maximise profits, are non-market. However, some may maximise profits but retain them (the ESA10 definition of NPI is that they can’t distribute surpluses to their owners) so market NPIs possible. This suggests the market:non-market borderline should be at 100% and based on profit Sector delineation - ESA 2010

ESA refers back to 1.37 as the criteria 2.112 then tells us that S.13 includes: “b) A corporation or quasi-corporation which is a government unit if its output is mainly non-market, and a government unit controls it; c) Non-profit institutions recognised as independent legal entities which are non-market producers and which are controlled by general government.” Sector delineation - ESA 2010

ESA10 chapter 3, which guides on production and output, explains in 3.16 that: “The distinction between market, for own final use and non-market is fundamental in view of the following: a) It affects the valuation of output and related concepts [value added, GDP, govt & NPISH FCE] b) It affects the classification of institutional units by sector, e.g. which units are included in the sector general government and which are not.” Sector delineation - ESA 2010

On 3.16a the importance is due to the approach to valuing output: the valuation of non-market producers’ output is derived through summing the costs of production. 3.16 also states that: “The distinctions are defined in a top-down way, i.e. the distinction is first defined for institutional units, then for local KAUs and then for their output.” Sector delineation - ESA 2010

3.18a tells us that “Market output includes … products sold at economically significant prices” 3.19 defines economically significant prices as: “prices that have a substantial effect on the amounts of products that producers are willing to supply and on the amounts of products that purchasers wish to acquire. These prices result when both of the following conditions apply: ..” Sector delineation - ESA 2010

“… a) The producer has an incentive to adjust supply either with the goal of making a profit in the long run or, at a minimum, covering capital and other costs; “ “Not economically significant prices are likely to be charged in order to raise some revenue or achieve some reduction in the excess demand that may occur when services are provided completely free.” Sector delineation - ESA 2010

“For the output of other institutional units, the ability to undertake a market activity at economically significant prices will be checked notably through a quantitative criterion (the 50% criterion), using the ratio of sales to production costs. To be a market producer, the unit shall cover at least 50% of its costs by its sales over a sustained multi-year period. Other = other than household unincorporated enterprises Sector delineation - ESA 2010

This is counterintuitive: 50% is inconsistent with “covering capital and other costs” in “the long run”. 3.24 defines “Market producers are local KAUs or institutional units the major part of the output of which is market output.” Sector delineation - ESA 2010

So, taking this literally: if 51% of output is sold at economically significant prices (taking the ratio on those products at for example 100%) and the rest provided free, then the unit is market [test result is 51%]; if 100% of output is sold at amounts below economically significant prices (taking the extreme case the sales:costs ratio as 99%) then the unit is non-market [test result is 99%]! Sector delineation - ESA 2010

The traditional 50% test was conducted across all products because practically it is difficult to make an assessment of whether each product is charged at economically significant prices due to the absence of micro data guides us to continue with this practical approach, 3.24 doesn’t! Sector delineation - ESA 2010

New 3.32: “In distinguishing between market and non-market output and between market and nonmarket producers, several criteria are to be used. These market-non-market criteria (see paragraph 3.19 on the definition of [ESPs] seek to assess the existence of market circumstances and sufficient market behaviour by the producer. According to the quantitative market-non-market criterion, products sold at [ESPs] should cover at least a majority of the production costs by sales.” Sector delineation - ESA 2010

Definition of sales and costs have changed (3.33) Sales: “ …but payments to cover an overall deficit or settle debts are excluded.” “Sales exclude other sources of revenue like holding gains (though they could be a normal and expected part of business revenue), investment grants, other capital transfers (e.g. debt redemption) and the purchase of equity.” Sector delineation - ESA 2010

Definition of sales and costs have changed (3.33) Costs: “production costs are equal to … plus costs of capital. … For the sake of simplicity, the costs of capital may in general be approximated by the net actual interest payments.” Interest payments or payables? Onto chapter 20 Sector delineation - ESA 2010

Chapter 20 on “Market/non-market delineation” consistent with chapter 3, with commentary “the unit’s prices may be established or modified for public policy purposes, which may cause difficulties in determining whether [ESPs]. Public corporations are often established by government to provide goods and services that the market would not produce in the quantities or at the prices to meet government policy … Sector delineation - ESA 2010

20.22 suggests look at (i) who is the main consumer and (ii) whether it is the sole supplier without competition or competes Sector delineation - ESA 2010

when primarily household or corporations: 20.23 “goal of making a profit in the long run or, at a minimum, covering … costs” and “consumer free to choose” No distinction between monopoly supplier or not Sector delineation - ESA 2010 81

When sales only to government: - if ancillary unit part of government [20.24] - if sole supplier – assume non-market [20.25] - if has private competitor - test whether prices are ESP [20.26]; but MGDD is different: instead of ESP says check against the quantitative market test Sector delineation - ESA 2010 82

sales [primarily] to government [but also] others {ESA10 unclear as actually says output is sold to government and others, but we have already had case of primarily to non-government} If several suppliers, market if it competes with the other producers through tendering [20.28] If sole supplier, market if it competes with private producer through tendering [20.27] 20.27 uses output in the definition, but circular as need to decide whether market or non-market first before we can value output! Sector delineation - ESA 2010

20.29 summarises steps to take to see if market: Is it institutional unit? Ancillary services? purchaser test ( ) and “The producer has an incentive to adjust supply to undertake a viable profit-making activity, to be able to operate in market conditions and to meet his financial obligations.” Sector delineation - ESA 2010

20.29 also then says: ” The ability to undertake a market activity will be checked notably through the usual quantitative criterion (the 50% criterion), using the ratio of sales to production costs (as defined in paragraphs and [same as chapter 3]). To be a market producer, the public unit shall cover at least 50% of its costs by its sales over a sustained multi-year period.” Sector delineation - ESA 2010

Conclusion? is unclear 50% important but for some criteria 100% Will need MGDD interpretation to deal with the ‘apparent inconsistencies’ in ESA10 Sector delineation - ESA 2010

What does MGDD say? To be market “must sell its products at an ESP which, in practice, … sales … cover a majority of the production costs” [50%] [I ] Sector delineation - ESA 2010 87

Delineation of government in ESA 2010

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