Why UK councils cannot afford to ignore Detroit

  • While local authorities cannot legally go bankrupt, they face massive financial challenges
  • Budgets are under pressure from pensions liabilities and central government cuts
  • Failing to prepare for the future now could have serious costs

In July 2013 Detroit became the largest city to file for bankruptcy in US history – introducing extreme measures such as cutting off water supplies if people did not pay their bills, in order to try and tackle its $18bn debt.

While it might be hard to imagine a scenario where a local authority in the UK could go bust like this – central Government would take action before affairs got that bad – many face some of the same problems as their embattled colleagues across the Atlantic and can learn valuable lessons from the ‘Motor City’s’ mistakes.

Chief among these is the cost of meeting spiraling pension commitments. More than 4.5 million workers in the UK are enrolled in the Local Government Pension Scheme and figures released back in 2011 revealed that authorities were already facing the time bomb of a £54 billion shortfall.

With budgets pummeled by ongoing austerity this could become a major issue.

Financial meltdown warning

In 2013, the Local Government Association warned that 86 councils were at risk of financial meltdown and there could come a point where “authorities start failing their communities”.

With an ageing population – and budget cuts projected to continue well into the next Parliament and beyond – council leaders need to take action now to prepare for the future.

Andrew Jepp, director of public sector at Zurich Municipal, recommends risk-weighted reserving for future liabilities and uncertainties to ensure sustainable financial management. 
“Robust scenario planning is important in understanding ‘financial risks’ if authorities are to be prepared for multiple incidents, ranging from natural events such as fire or flood to the continued delivery of children’s day care,” he says.

There is also a lesson to learn about civic responsibility. Detroit’s position was exacerbated by its financial isolation from Washington. While the situation is different in the UK, local authorities are currently taking back greater financial responsibility from central government, which, while it provides more opportunities and flexibility, also increases their exposure to uncertainty and risk.

For example, while new responsibilities for business rates offer the chance to profit from local economic growth, it also exposes authorities more broadly to downturns.

Reputational fallout

Similarly, while the shift from being providers to outsourcers of public services can lead to significant savings, the risk of financial and reputational fallout if third parties fail to deliver those services increases.

However, the last few years have shown that local authorities are capable of astute financial management in a tough climate.

There is every reason to believe that these strategic changes will deliver positive outcomes – if councils can display equally astute risk management, fully assess their exposures, mitigate wherever possible and take a proactive approach to effective risk transfer.

“In managing higher financial volatility, while also asserting greater independence from central government, councils appear well placed, not only to weather the financial storm but also realise the opportunity to provide a more relevant profile of local services for their communities,” says Andrew.

Detroit will continue to serve as a lesson to illustrate just how badly things can go wrong when costs spiral out-of-control – and it’s a lesson that no-one in local government can afford to ignore.