Remarks by Walter B. Wriston

Wriston, Walter B.

2007

For the past six or seven years we have been treated to a standard economic forecast by learned economists that went something like this: "We were surprised that this quarter was so strong, and we look for a weakening economy with a recession occurring four or five quarters from now." The problem with this standard forecast was that it was wrong--and indeed it has been wrong for more than five years. Since the calculations were made in good faith by skilled men and women, it is useful to inquire why so many have been so wrong for so long.

This group knows far better than most the ambiguities that lie behind seemingly finite numbers. The common calendar is a good example. The lunar month is almost 29 1/2 days long - not 30. The solar year is nearly 365 1/2 days long - not 360. And the solar year is 12 4/10 lunar months - not 12. There are in fact no whole number ratios between the time periods we use of day, month and year, so we stretch a month by a day in such a way that 12 months are a 365 day solar year. To add to the confusion, in addition to the Gregorian calendar, the world uses the Muslim and Jewish calendars. Since the Muslim calendar is based solely on the phases of the moon, the Muslim New Year moves back 10 or 12 days a year in relation to the Gregorian calendar. The Jewish calendar produces even different results. Each system serves the purpose for which it was designed, but one has to look behind the numbers before becoming too dogmatic about one's conclusions based on the data. The first step in solving any problem is to assemble the facts. When assessing our national economy, this is not as simple as one would think, as our national accounting system, which is 50 years old, was designed for different times and is no longer congruent with today's world -- and yet it is the numbers produced by that system that forecasters use. Our government gathers data and produces statistics according to Standard Industrial Classification codes, called SIC for short, which break down the economic activity in the industrial sector in great detail, but give only summary information about the service sector which now employs more than 80 percent of our workers. The government carefully counts the number of brakemen on American railroads, a figure that once had some significance, but is hardly relevant today -- but the number of knowledge workers, like computer programmers, eludes us. Because we concentrate on SIC-based government statistics, which basically define work in terms of physical output, our data are misleading at best, since for the last forty years more than half of our GNP was produced by the service sector.

This fact alone makes many of the productivity numbers we read suspect, if not downright wrong. Recently the Bureau of Labor statistics revised the GNP numbers for 1986, 1987, and 1988 sharply upward while announcing downward adjustments in the number of hours worked. With more products produced and less hours worked to produce them, obviously output per hour increased. Even if we were to assume these latest figures of productivity are accurate, they are totally misleading in that they do not take any account of improvement in quality or even in computer power which is increasing at an enormous rate while prices decline.

Even such a basic statistic as the Federal Budget deficit is not an easy number to come by. Many of the numbers that are announced in breathless tones on the evening news are based on somebody's estimate of what is going to happen. Such estimates are often politically biased. The numbers produced by the Congressional budget office are almost always substantially at variance with those produced by OMB. All estimates, from whatever source, of what our Federal deficit is going to be in the future are by necessity based on someone's idea of the future growth of our GNP. The rosy scenario clashes with gloom and doom. The facts are that no one knows for sure just how the economy will behave in the future. Even the past performance is hard to determine. The Government is incapable of telling us what the last quarter's GNP was with any precision. Each quarterly announcement is followed by a revision. Final figures are not issued until three years after the close of a quarter. The difference between the Commerce Department's first reports on the GNP for a quarter and the final figures shows huge variations. If, for example, the initial report indicated a GNP growth of three percent, half of the time the final figure would show a growth of less than 1.5 percent or more than 4.5 percent. One time in ten the adjusted final figure would show the GNP growth to be less than one half percent or more that 5.5 percent. Figures that move about that much and take so long to prepare rarely furnish a firm foundation for policy decisions.

The Federal deficit has been blamed for just about everything, and we receive daily warnings that dire consequences will surely, follow unless we mend our ways. While there is much to be said for this point of view, perhaps we should first mend the numbers we use. The figures we used to describe the Federal deficit are based on accounting concepts that if employed in your business would bring an S.E.C. enforcement action for misrepresentation. This is true because, unlike your business, the Federal Government expenses everything it buys - a billion dollar aircraft carrier, the interstate highways, the space shuttle, or a ten cent pencil. Aside from the misrepresentation of the economic results portrayed by this type of bookkeeping, the IRS would doubtless join the S.E.C. in court to protest your action. And yet that is the way our Federal Government keeps its books. The familiar refrain that every American family has to balance the household budget, so why can't the Government, has a nice ring to it, but no one I know expenses his or her home, and not many their car. If the Federal Government had a capital budget like all businesses, households and most states, the Federal operating budget would be close to balanced. No one should fool themselves that there are not thorny issues involved about which honest men and women may differ. Are military bases or national parks true capital expenditures? Or is one and not the other? What rates of depreciation should be used for capital assets? These are hard questions, but difficulty is not an excuse for inaction. The sad truth is that not many trust our governmental process to capitalize only true capital items, and not succumb to the temptation to slip operating costs into the capital account to "balance" the budget. This was one of the things that N.Y. City did, which helped bring on the fiscal crisis. Good accounting may tempt politicians to play games, but our current bad accounting misleads us all.

Because of the way we keep our books, many have failed to recognize that today is very different from yesterday. The engine that drives the American economy in the Information Age bears little resemblance to that which drove the Industrial Age. But even more than that, we are now inextricably bound to the rest of the world to a degree and in a manner never before seen. The knitting together of the world through the construction of electronic networks has fundamentally changed how we must approach attempting to understand our economy. Indeed, no national economy can be understood except as a part of the world economy. The erosion of a national border as a true barrier is proceeding apace all over the world.

The man who first foresaw the use of satellites for communication, Arthur C. Clarke, recently wrote that "Radio waves have never respected frontiers, and from an altitude of 36,000 kilometers, national boundaries are singularly inconspicuous. The world of the future will be an open world."

The concept of an open world becoming a reality is a truly revolutionary idea, and it is now and will continue to be resisted by the world's power structures whose livelihood and influence are based on ideas and structures of a world order that is rapidly disappearing.

The world, for better or for worse, is now bound together by an electronic infrastructure that carries news, money and data anywhere on the planet with the speed of light.

This is a far cry from the situation which obtained on May 27, 1921, when the Congress in its wisdom passed an Act mandating "that no person shall land or operate in the United States any submarine cable directly or indirectly connecting the United States with any foreign country...unless a written license to land or operate such cable has been issued by the President of the United States..."

The global market for news, money and capital, which now exists, has fundamentally altered the traditional power of governments and central banks to control events. Whenever anything of importance happens anywhere in the world, tens of thousands of computer screens light up in the trading rooms of the world and traders buy and sell currencies based on their evaluation of the news. This enormous flow of data has created the Information Standard which has replaced the gold standard and the Bretton Woods agreements. The global market has produced a giant vote-counting machine which conducts a running tally of what the world thinks of a government's diplomatic, fiscal and monetary policies. That opinion is immediately reflected in the value the market places on a country's currency.

Governments do not welcome this Information Standard any more than absolute monarchs embraced universal suffrage. The size and speed of the worldwide financial market doom all types of central bank intervention in the exchange market to expensive failure over time. The fundamental difference between the Information Standard and all former arrangements is that no nation can resign from the global market by holding a press conference. There is no place to hide. No matter what political leaders do or say, the screens will continue to light up, traders will trade, and currency values will continue to be a global plebiscite on governments.

This is a truly new phenomenon in the world and is causing a fundamental shift of power. Indeed the very definition of sovereignty is being altered.

This situation has also created a complexity that is mind numbing. No wonder that one of the fastest growing fields in mathematics is the theory of complexity. James Gleick in his recent book on the chaos theory tells us that: "Tiny differences in input could quickly become overwhelming differences in output...In weather, for example, this translates into what is only half-jokingly known as the Butterfly Effect -- the notion that a butterfly stirring the air today in Peking can transform storm systems next month in New York." The chaos theory holds that if the system is complex enough it is impossible to make accurate predictions since events may be controlled by factors that have no statistical significance. No complex system can overlook anything external, and in the short term there is no system, only chaos.

In our complex world, no further evidence of the futility of "fine tuning" the economy is needed. This relatively new branch of mathematics helps explain perhaps why government regulations do not work as their authors had hoped, but often have the opposite effect. The Nobel laureate, George Stigler, has demonstrated this phenomenon in detail. As an expert witness, his facts are incontrovertible, but the political process has not yet caught up with the law of complexity. This is why the broad economic policies of Margaret Thatcher and Ronald Reagan have worked, while more detailed attempts have failed. Another Nobel laureate, Friedrich Hayek, in his new book, The Fatal Conceit, put it this way: "The market is the only known method of providing information enabling individuals to judge comparative advantages of different uses of resources of which they have immediate knowledge and through whose use, whether they so intend or not, they serve the needs of distant unknown individuals. This dispersed knowledge is essentially dispersed, and cannot possibly be gathered together and conveyed to an authority charged with the task of deliberately creating order." This central reality is what has doomed all centralized planning in socialists countries, and in all others which have tried a planned economy.

The Trade Deficit is another figure that appears on the front pages of newspapers, but whose accounting integrity in this day and age is suspect. It was not so long ago that companies used to export products, and the balance of trade figures aggregating these transactions were regarded as a kind of a zero-sum game. Today this is no longer the rule. Indeed the difference between the world's total imports and exports today represents a black statistical hole of $70 billion -- a sum larger than the GNP of many countries. Part of the reason for this huge omission is that our international accounting system was constructed for a simpler time. Today a product may have value added in several different countries. For example, the dress a customer purchases at a smart store in New York a may have arrived on the rack after a long journey. The cloth may have been woven in Korea, it may be finished in Taiwan, cut and sewed in India, sent to Milan for the attachment of a "Made in Italy" label and shipped to Fifth Avenue. This kind of phenomenon is occurring in hundreds of manufacturing products. This was dramatized by former Secretary of State George Shultz in a speech last December in which he said: "I recently saw a snapshot of a shipping label for some integrated circuits produced by an American firm. It said, 'Made in one or more of the following countries: Korea, Hong Kong, Malaysia, Singapore, Taiwan, Mauritius, Thailand, Indonesia, Mexico, Philippines. The exact country of origin is unknown.' That label says a lot about where current trends are taking us." These trends are being driven by the growing realization that the concept of a global market has moved from rhetoric to reality almost before we knew it.

The bewildering array of cross-border alliances, joint ventures and other agreements makes it all but impossible to make sense of the trade numbers. Recently William Sheperd and Dexter Hutchins put it this way. "Consider the riddle of a product's national identity. The traditional view is that a product is American if it is made by American workers. Does that mean a new Hyundai automobile, designed by Koreans and owned by Koreans, is a French Canadian car if it is made in Quebec while the profits from its sale in the U.S. (by American dealers) go into Korean pockets? What nationality is an electronic monitoring device, using American technology under license, with components made in Malaysia and Hong Kong, but assembled in Mexico by a Japanese-owned company and marketed in America under the label of a U.S. hospital supply company?"

Since capital flows are now greater than trade numbers, we have even further complications. If the Japanese, for example, buy American-made products, it decreases our trade deficit with Japan, but if they buy half of Manhattan Island, it does not. Should we base our worry on one number or the other, or on neither?

Nothing that I have said today is by way of denying that we have many serious problems to address. We do. Finding out what those problems really are is critical to their solution. It is hard to come by the facts since the data we currently work with was designed for another age.

As we come to understand our global economy better, we have to devise better ways of measuring it if sound policy decisions are to be made. Just as the first mortality tables compiled by John Grant in the early 17th century are no longer adequate to run a sound insurance business, so our National Accounting system is overdue for a thorough review and revision. Only then can policy makers have the kind of data they need for the formation of good economy policy.

 
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  • The document was created from the speech, "Remarks by Walter B. Wriston," written by Walter B. Wriston for the Casualty Actuarial Society on 14 November 1989. The original speech is located in MS134.001.010.00003.
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