Sunday, May 1, 2011

Botoxed U.S. Figures

Botox and Beancounting, published in The Economics last week, examines whether “official statistics cosmetically enhance America’s economic appearance”. The answer is that it does. Moreover, it probably is just the tip of the iceberg. Most statistics are misleading to a certain extent if you do not know precisely how they are computed. But some statistics are more misleading than others.

In the article below, the focus is on how American statistics compare favorably to those published in European countries. However, another analysis could be done to examine how the compilation of certain statistics has evolved over time in the U.S. to paint a very different picture of current inflation for instance. If we calculated today’s inflation like we did in the seventies, we probably would obtain much higher inflation statistics. For one, as it is mentioned in the article below, accounting for the improvement in the quality of a good is a relatively new “trick” and contributes to lower inflation today.

How such changes have influenced the conduct of monetary policy in recent years? In particular, how would the “status quo”, in terms of inflation measurement, have prevented or limited the housing bubble in the middle of the last decade? Or how it would now accelerate the Fed’s next rate increase?. These are all difficult questions to answer but they are certainly intriguing.

Here is the piece:

“COSMETIC surgery is more popular in America than in Europe. Statistics, too, may be making things there look less saggy. For several headline economic gauges, America uses a different (and more flattering) measure from that employed on the other side of the Atlantic. The number-crunchers are not deliberately massaging the figures but the effect of some of America’s official statistics is to Botox its performance relative to Europe’s.

“Take public-sector debt. The definition used in Washington, DC, is “federal government debt held by the public”, which stood at 62% of GDP at the end of 2010. But if you instead use Europe’s preferred measure—general government gross debt, which also includes the borrowing of state and local governments and Treasury securities held by other government bodies, such as the Social Security Trust Fund—it jumps to 92% of GDP (see left-hand chart). That is on a par with Portugal’s level of public debt. Likewise, America’s budget deficit of 8.9% of GDP last year would have been 10.6% using Europe’s preferred measure.

“Official figures also flatter America’s relative performance on productivity growth. The headline figures compiled by America’s Bureau of Labour Statistics are based on output per man-hour in the non-farm business sector. The European Central Bank tracks GDP per worker across the whole economy. By excluding the less efficient public sector, America’s productivity growth is bumped up. And by taking output per worker rather than output per hour, Europe’s measured productivity growth is reduced because average hours worked have fallen. Between 1995 and 2010 America’s real GDP per hour worked rose by an annual average of 2.1%, considerably less than the 2.7% rate in the non-farm business sector although still faster than the 1.1% pace in the euro area.

Nice figure, is it yours?

“A third cosmetic treatment is the way quarterly GDP figures are published. European press releases give the increase in GDP during the latest quarter—a rise of 0.9%, say. But Americans annualise quarterly growth, so an identical increase would be announced as a more impressive-sounding growth rate of 3.6%. Much more important, European economies’ initial estimates of GDP growth tend to be more cautious than those in America. Kevin Daly, an economist at Goldman Sachs, estimates that during the ten years to 2008, America’s quarterly GDP growth rate was, on average, revised down between the first and final published estimates by an annualised 0.5 percentage points. In contrast, GDP figures in the euro area were revised up by an average of 0.3 points. This matters because financial markets and the media focus heavily on the first estimate, but largely ignore revisions several years later.

“A more controversial issue is the extent to which different methods of measurement distort international comparisons of GDP growth. A decade ago some studies suggested that if America compiled its national accounts in the same way as European countries did, its real growth rate might be reduced by between a quarter and half a percentage point.

“In some areas divergences have narrowed. America has historically taken more account of improvements in the quality of goods than many European countries. If a computer costs the same as two years ago but is now twice as powerful, this is counted as a 50% fall in price, which has the effect of boosting real output. A decade ago this inflated America’s growth rate relative to Europe’s, but European countries have also now adopted so-called “hedonic pricing” in some sectors. Another area where Europe has followed America’s lead is in counting software spending as an investment (thereby adding to GDP) rather than a business expense as it used to.

“Some measurement differences remain, however. For example, America, unlike Europe, counts government spending on military equipment as capital rather than current spending, so the sharp increase in the defence budget over the past decade will have slightly nudged up its GDP growth rate. Another area where measurement differences may have exaggerated America’s growth relative to Europe’s is in financial services and property. The output of the financial industry is one of the most difficult to measure because most financial services are not explicitly priced. It is also particularly tricky to define the unit of output: is it the sale of one share, for example, or the sale of a block of shares? Finance, insurance and real estate accounted for one quarter of America’s GDP growth during 1995-2009 and enjoyed a measured productivity gain of 38%. Yet in the euro area productivity in these sectors fell by 9% over the same period. This looks fishy.

“America’s financial activity may somehow be reflecting trading gains, which should not be counted as income. It is also possible that the increase in the value of America’s housing stock and hence the growth of shelter services consumed by owner-occupiers was overstated. One mitigating factor is that half of the income of the financial sector is from intermediate services provided to non-financial businesses. If the value of such services had been overstated in “America, then the growth of real value added in finance would need to be reduced, but that of non-financial industries would be increased, with no effect on overall GDP growth. But if services to households and foreigners had been overstated this would reduce GDP growth.

“Conspiracy theorists might conclude that the American government is trying to nip and tuck its way to attractiveness. The persistent downward revisions to GDP growth do look suspicious. But in other areas American number-crunchers seem to believe that their measures are better; indeed, history shows that European statistical agencies have often later adopted their methods. The world’s biggest economy is also much less bothered about the international comparability of its numbers than smaller European countries. True, when the statisticians at the IMF or the OECD produce comparative data, they do so on the basis of standardised definitions. The snag comes if investors fail to grasp that official national figures can show the American economy in an overly flattering light.”

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