The Blankenhorn Effect: Balance Sheets

by Dana Blankenhorn

Everybody has an income statement and a balance sheet.

An income statement includes all the money you earned, the money you spent, and (if you’re really careful) how you spent it. If you’re spending more than you’re making, you feel it before the numbers hit paper. You hear it in the phone calls of creditors, see it in the checks you bounce, feel it in the guilty stares you give your friends and family.

A balance sheet is more complicated. A balance sheet measures your assets against your liabilities, resulting in your net worth. Your home is on your balance sheet. So is your retirement account, your insurance, and any investments you might have. People who put loans on their income statements quickly wind up bankrupt. They pile up personal debt on their credit cards and the payments overwhelm them. The debt goes to pay for meals and clothes and stereos and other stuff they consume right away, so there’s nothing to base payment on but their word, and their word is no good.

For the responsible minority, loans go on the balance sheet. You buy a car, pay for it over 4 years, and expect it to be a lasting asset for 8 or 10, if you take care of it. You buy a home, over 15 or 30 years, and hope it will increase in value. The loans go against real assets – they balance – and if you’re lucky you will come out ahead.

There are some loans that don’t seem to add-up in this way, loans whose purpose goes beyond even the balance sheet. When you send a kid to college, or when you go yourself, you may borrow tens of thousands (hundreds of thousands in the case of some medical schools) in the hope that you’ll do something valuable with the result. These are the hardest loans to explain, but they usually pay off the best. They’re dealing with intangibles, they’re building human capital. They mark the difference between a life and just living.

Businesses also have income statements and balance sheets. They’re the most basic pieces of any annual report, when a company is publicly traded. Many charities and even some private companies offer these statements for public view, just to show how trustworthy they are.

The income statement balances the money that came in with the money that went out. Accountants and analysts peruse these things to see how the company is making its money. They want to see all its regular expenses on the income statement, and they have finally learned that trick about “non-recurring charges” companies used to phony-up the numbers the last few years.

The balance sheet may be more important today than ever before. Companies with a future must continually re-tool, and they must borrow money to do it. Analysts look carefully to see if a company is “eating its seed corn,” holding-off needed purchases to make today’s income look better, like a family that tries to keep an old car running for another year, and then another year.

But there are many items that don’t fit on a corporate balance sheet. Companies can’t afford to educate people. They can’t afford to build the roads, sewers, or ports they need to move their products. They can calculate losses due to crime, but the value of existing in a safe, stable society is immeasurable to them. Most important, they can neither pay nor calculate the value of pure air and water.

Because of this many companies, especially smaller companies, are reflexively anti-government. They manage themselves for the short term and prefer that government do the same. They probably won’t be around in 20 years, when today’s young join the workforce, and so they don’t care. They do want to fight crime, but mainly through short-term fixes like jailing and killing – prevention doesn’t fit into it. They’re for roads, if the roads lead to their plants, but they don’t expect to pay for them. And no small business has room on its balance sheet to worry about tomorrow’s air, water or soil problems.

That’s the work of government. It’s government’s job to care about the balance sheet, to do the things no business (especially a small business) can do for itself. Without educated people there’s no one to train. Without roads, sewers, ports and other public works businesses can’t function. Without clean air and water the nation, including its businesspeople, can’t survive.

But over the last decades we have systematically forgotten this. Our politics, and thus our government, has been managed strictly to the income statement. Politicians call this management tool “the budget.” We want to know where the deficit stands. We don’t question what those loans go to pay for.

If government is borrowing money for dams and ports and schools and environmental clean-up, that’s sound investment that will bring a return to society. The results of that borrowing will be around for decades, growing the income statement and paying back the bondholders while increasing equity for everyone.

What government needs is a “capital budget,” a balance sheet for long-term investments and the returns they bring. We don’t have one, and we’ve never had one, mainly because it was assumed that everything government did was for the long-term. But that’s not true anymore. Today government does a lot of things that help only in the short run. The cost of cops, whether military or civilian, belongs on the income statement. They only protect you while they’re on the beat. You have to buy their services again every week, every year. This is also true for what conservatives call “regulation,” what liberals call the police of the market. Making sure no business gets away with cheating is a vital service of government, because without cops in the suites the cheaters will win, and everyone else will have to cheat to stay in the game.

All personnel costs belong on the income statement, including the benefits that will go to the workers later on in the form of pensions and post-retirement health coverage. So do the costs of equipment that wears out fairly quickly, including things like computers and cars that most businesses would put on the balance sheet.

There is more to a government balance sheet, however, than just loans. That’s because we, the people have assets in common, assets that are God-given, that we inherit from our parents and borrow from our children, and that we are sworn to protect. No business can bear the costs of that protection, nor can any charity. They’re not optional, either.

Families and businesses know the value of their human capital, but some factors in it are beyond their control. And there is an awful lot of human capital that appears on no private balance sheet. This is part of the government’s job, to increase the asset base so businesses can use it to prosper. And when government fails to do this long-term work, when it fails to invest in its human capital, it degrades its capital base. Every ghetto kid allowed to grow up without hope will cost money to control, in the form of cops, courts, and prisons, for the rest of their lives. We can (and often do) choose to ignore this reality, but the fact is there, on our government’s income statement. Prisons don’t pay for themselves. Every one of them sucks money out of the system, sucks it right down the drain. Every prisoner is a failure, and a cost that must be borne, for that prisoner’s entire life time. It should go on the balance sheet, under liabilities.

The same thing is true of environmental capital. We treat the Earth, the water, and the air like a free good – business and government both. We see it as something to exploit. We only look at the cost of exploiting it, never its replacement cost. That appears on no balance sheet, public or private.

Yet those liabilities are there. When we plow up a mountain for the coal underneath it, and let the tailings go down into our rivers, we’ve created liabilities for our children, and we don’t account for them. When chemical factories pour poison into the air and water, they create liabilities for our children, and we don’t account for them. When Americans slash-and-burn their forests for subdivisions, it costs their children just as much as Brazilian children pay for the destruction of their rain forests, but we don’t account for them at all.

Republicans claim none of this is the role of government. Police the marketplace? That’s “over-regulation.” Educate the children? That’s “local responsibility.” Manage the environment? That’s impossible, and besides, if we started doing it we’d lose businesses to countries that don’t.

These are choices they make. These are choices we make. They’re based on values, and in all these cases they’re short-term, income statement values.

Our lives are short, but our time horizons must go beyond our lives. Our collective balance sheets must measure everything we do, and we must grow, not degrade, the capital base of our people and planet. If we have any faith in God at all – in any God – we must believe that.

And we say we do.

So we must act on that belief. We need to manage to the balance sheet, not just the income statement. And we need new kinds of balance sheets. We need capital budgets, a balance sheet that show what our borrowings are doing. We need budgets of human capital, balance sheets that show how our people are doing. And we need budgets of environmental capital, balance sheets for how our Earth is doing.

When we manage to these balance sheets, we’ll know whether our lives really show a real profit. We’ll know if our deficits are creating new assets, or if they’re just revolving credit. We’ll know how to argue, realistically, about all kinds of political questions, and all kinds of social policies, because we’ll be arguing from facts, not myths.

To say that the problems of our country and our world boil down to accounting sounds pretty dry and tasteless, I know. But accounting is how we measure value, in our personal lives, and in our business lives. It’s time we applied that discipline to our political lives as well.

Whether we do that or not, reality will apply it to us. We can pretend to ignore the loss of human capital, until our businesses are forced to go overseas in search of it. We can pretend to ignore the loss of environmental capital, until we or our children choke on it.

It’s our choice. We should make it with our eyes open.