[A-List] New economy bull
Michael.Keaney at mbs.fi
Fri Mar 1 01:39:14 MST 2002
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
Financial Times: March 1 2002
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 bit 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
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.
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.
Full article at:
Mercuria Business School
michael.keaney at mbs.fi
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