Friday, May 7, 2010

Mis-measurement of socio-economic performance

Dear Colleagues

It is amazing how fragile the global economy seems to be ... and, to be honest, it really makes no sense.

The US banking system and capital markets completely froze around September of 2008 and were only revived by a huge commitment of resources by the US Government ... the "full faith and credit" and all that. The bankers ... the economists ... and all the experts in finance ... blew it! The financial fiasco spread around the world ... and one after another governments had to bail out banks. The capital markets became completely dysfunctional ... stockmarkets declined to levels not seen in more than a decade!

During 2009, the stockmarket bounced back ... pulled in part by the comfort of having Government backing for "too big banks", though the rhetoric against Government involvement would have you think otherwise! The rebound was also pulled by solid fundamentals in places like China, India and Brazil ... not to mention a lot of government involvement in pulling China back onto a growth path!

But all is not well ... the financial problems in Iceland, Greece, Portugal, Spain and maybe other countries around the world ... not to mention the USA and the UK ... cannot be ignored. Developing countries are not front page news, but their financial positions are also fragile.

None of this makes any sense! What might be the reason for such a huge economic mess?

Part if the answer is that there is serious mis-measurement of socio-economic performance ... and with this there gets to be serious mis-allocation of scarce resources. The idea that there has been many decades of US and global corporate profit growth on top of a tremendous decline in the socio-economic situation for many people in developed countries and a continuing obscene level of poverty and hunger in developing countries does not sit well. In the US especially, corporate profit has been good while the public infrastructure has deteriorated dramatically with inadequate investment for decades! The metrics being used do not show this with the clarity needed.

Neither the academic economists nor the professional accountants seem to have become engaged adequately in the issue of getting the metrics right. The capital markets respond to money profit reporting from the corporate community, buzz about stockmarket trends and GDP growth but measures about socio-economic performance are missing. The prevailing measures have little or nothing to do with the fundamentals of socio-economic performance and do not generate resource allocation that is needed to build the socio-economic strength of society.

A society is not strong when its working people are not working and doing things of value ... this may be a result of unemployment, early retirement, excessive leisure time or simply unproductive work. A society is strong when working people do work that delivers value adding for society. As things stand at the moment, there are no widely used metrics about value adding so no differentiation between ordinary jobs and really valuable jobs!

Similar issues of metrics exist in the public sector. Government spending that builds value is different from government spending that does not. Most governments measure spending performance against revenue available and the periodic deficit without giving much consideration if any to the value of the spending. There is a very big difference between the spending of government on investment in its infrastructure and spending of government to offset low productivity of the economy with subsidies ... or the spending of government on unemployment benefits for workers that are not gainfully employed doing valuable work.

The accounting in the public sector is mainly cash based ... meaning that there is very little attention being paid to the "balance sheet" of the public entities and of society. This was recognized as an accounting problem in the 19th century and corporate accounting was required to be based on accrual principles with balance sheets and operating statements used for reporting. Yet more than 150 years later most public entities still operate with cash based accounting and without the rigor of reporting about the balance sheet. This is not a detail ... this is a very big deal. It changes the whole financial picture of government deficit spending and helps to differentiate deficit spending that is weakening a society and deficit spending that is strengthening a society.

In my experience, the experts who engage in high level finance at the government level do not seem to have much of a "balance sheet" view, and accordingly the advice that has been given by the IMF, World Bank and others intended to strengthen economic performance has done nothing of the sort. These expert interventions may have the effect of "calming" markets, but have less impact on improving socio-economic performance. In my view, what is going on today is not significantly better or different from what was taking place several decades ago ... merely that communication technology is way better ... but the fundamental process of analysis pretty much unchanged as it has to be when the underlying metrics are more or less the same.

I will argue that when the needs of society are understood ... and the human resources of the society are mobilized to address the needs ... and the know-how and organization to manage a process to address needs are mobilized ... then it is possible to allocate financial resources so that quality of life is improved and the socio-economic foundation of society strengthened. Quantitative austerity ... the IMF medicine ... is not a great solution. The mindset for the 21st century should be material qualitative performance improvement ... with an improved value balance sheet of society being the outcome.

A balance sheet is a concept that every professional accountant understands ... and it is amazing to me that the balance sheet of society is rarely, if ever, in the spotlight. In the corporate world profit is not reported independent of the balance sheet ... but in the public sector deficit and balancing the budget is talked about all the time without any rigorous connection to the impact on the balance sheet of the public entity or society as a whole.

I cannot pretend to be impressed by the intellectual leadership of either the economists or the accountants ... yet I would argue that economists and accountants ought to be heavily engaged at this time in resolving the problem of mis-measurement of socio-economic performance!

Peter Burgess

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