TULIPUTIANS & MAGICAL EXILIRS FOR SALE
Hi elmat,
Something to add to your cynical commentary. (And how dare you? We have a market to bull up, after all!)
news.ft.com
TITLE: A true and fair view of productivity
Alan Greenspan has endorsed an overstatement of US economic performance comparable to Enron's accounting methods, says John Kay
Published: February 28 2002 19:36 | Last Updated: February 28 2002 19:51
The collapse of Enron has shaken markets because it has
reminded everyone that corporate accounts are interpretations,
not facts. Even the most conservative of accountants has been
under pressure to find statistical confirmation of the stories of
heroic leadership, organisation transformation and technological
revolution. Everyone knew these things were true, even if data
were sometimes slow to reveal it.
This hubris distorted perceptions not only of the performance of
US companies but also of the performance of the US economy
itself. We talk about economic growth as if it were objective fact, like population growth or
temperature. But national income accounting is every bi t as much a subjective enterprise as
the private- sector accounting on which it ultimately depends.
When politicians and pundits talk about economic growth they are referring to movements in
the level of gross domestic product at constant prices. This concept is measured gross - no
account is taken of asset depreciation or obsolescence. And GDP is deflated by a price
index so that it represents the volume, rather than the value, of output. Such deflation was
easy when output was mostly steel but is much harder in the knowledge economy.
A bar of steel is - more or less - a bar of steel: the volume of computers is an elusive
concept. As computer prices have fallen, people have got more computer for their money.
But how much more? Statisticians use two main techniques. One is to track the falling price
of the same computer. The other is a technique known as hedonic price measurement, which
allows for changes in the quality of goods. Depending on how you do the sums, the fall in
computer prices in the past five years ranges from 30 per cent to 75 per cent. Britain is
relatively conservative while the US is very aggressive.
This makes a big difference. Real expenditure on computers in 2000 in Britain was about
£10bn. The UK's Office for National Statistics estimates that computers that cost £10bn in
2000 would have cost £18bn in 1995. But if US price indices were used, the figure would be
£37bn. The difference amounts to 2 per cent of British GDP. Over the five years, Britain's
reported growth rate would have been almost ½ per cent a year higher if UK statisticians
had used US price indices.
So what is the right answer? We are not trying to measure the benefits of computers. These
may well be much larger than £18bn, or even £37bn, but such effects are already included in
the output of the industries that use computers.
The £18bn figure is an attempt to answer a different question. What part of business
spending on computers should be capitalised, rather than treated as a cost against current
output, because it contributes to future rather than current output? General accounting
practice allows you to avoid charging such expenditures against profits, with two
qualifications.
You must capitalise it at its actual cost, not at some hypothetical measure of what it might
have cost in the past or be worth in the future. And you must write off capitalised
expenditure over the lifetime of the asset.
The rules for measuring GDP do not impose either of these conditions. They allow
extravagant revaluation. And they do not require depreciation of the capitalised expenditure.
Under standard accounting principles, the maximum expenditure you could capitalise would
be the whole of real spending on computers in 2000: £10bn or so. And you could justify this
only if you could argue there was no need for any write-down of previous expenditure on
computers as a result of scrapping or technological obsolescence.
My estimate is that the replacement cost of the stock of computers in Britain in 2000 was
probably about £20bn. Available computing power probably rose in 2001 by 20 per cent or
so as a result of net new investment, minus depreciation and scrapping. Because of the
falling price of computers, this larger stock of computing power was probably not worth any
more at the end of the year than the smaller stock was worth at the beginning.
A kindly auditor, such as the Andersen folk down in Houston, might allow you to treat £5bn
or so of computer expenditure as capitalised. If a commercial company seriously proposed to
credit £37bn to its profit and loss - on the grounds that this is what it might have had to pay if
it had not bought them so cheaply - its directors would certainly face a congressional
committee and probably end up in jail.
The bottom line of all this is that published data on GDP probably overstate output growth in
the UK over the past five years - but by less than 1 per cent. Economists have known for
years that constant price GDP was a flawed measure of output. But until the information and
communications technology (ICT) revolution, errors were small and were offset by the
advantages of data series that were comparable over time and between countries. US
statisticians were quick to see the difficulties falling computer prices might pose and adopted
a procedure called chain linking to reduce the distortions. Britain's ONS will follow but has not
yet done so. The problems of interpreting US accounts are both complicated and reduced by
chain linking. But the aggressive US assumptions about ICT price falls mean that the
difference between GDP growth and output growth is larger in the US than in Europe.
Over the period 1996-2000, ICT investment contributed almost 1 per cent a year to reported
US growth. Simply substituting net investment at cost for gross investment at revalued prices
reduces this by about half.
The effect is that reported US GDP growth overstates the real growth of US output by about
½ per cent a year over the period. This accounting difference is equivalent to the main part
of the productivity miracle that still enthuses believers in the new economy.
[[RGD: A viewpoint, I dare say, that will never see the light of day in Gilder's world....]]
It is not just US companies whose figures are now in question. USA Corp capitalised much of
its software expenditure, revalued that expenditure at the highest price it might ever have
paid, calculated its profits without any depreciation of revalued assets and announced
stunning results to its investors on the basis of these assumptions.
Who were its officers at the time? Bill Clinton, the former chief executive, may be spending
more time with his family. But Alan Greenspan, who has repeatedly argued that US economic
statistics should be more consistent with the optimistic reports of US business people, is still
the chief financial officer.
An extended version of this article can be found at John Kay's website |
