Don’t know much about Statistics, either

Groucho Marx about to explain the Boskin Commission’s hedonics, substitution and weighting to a young economics student.

Once upon a time, there was a man named John Williams. He wrote the music for the Star Wars movies and became quite famous. This is quite unfortunate for the John Williams I’d like to tell you about today. The John Williams I’m writing about has no aspirations to music as far as I know. He’s a business guy and an economist who was also a statistician and consultant. And now he puts out a widely read, expensive newsletter to business people who want to know what the economy is really doing.  This is his story as he has told it. Warning: I am the simple artist–I do not understand the business world.

One of Mr. Williams’ more interesting early assignments had to do with revenue projections of a major airline manufacturer. Many businesses (express delivery companies, airlines, copier services, etc) do the same basic thing over and over and over again. They hire statisticians to figure out profit margin on those activities, and to make sure the Executive committee (and the CEO) are deriving maximum profit. So in the airline business, a manufacturer has an econometric model to predict profit based on number of passenger miles and other variables such as the GDP and inflation.  The revenue number that comes out becomes the guide on what final profits (or losses) will be over a given quarter. If the two are out of alignment, then management needs to find out why–and if they are low, the management team is replaced.

Anyway, one such manufacturer called Williams in on such a problem. Their business model wasn’t working anymore–the real pre-tax profits were out of line with the predictions. John Williams was called in to see why the model was broken. And after struggling with this problem for some time, John Williams found out the cause. The Commerce Department had changed the way it computed GDP. Essentially, they had changed some part of the formula in order to make the overall GDP look more expansive and successful. Once the change was understood, Williams had to adjust his algorithm to reflect the revised number (and as a proof, to recalculate GDP for months past in order to confirm the numbers). Voila! All fixed!

Except, well, it isn’t fixed. I don’t want to sound like a conspiracy theorist, but I’m not the one putting this out–Mr. Williams is. And per Mr. Willams, all the important numbers that we get from government are increasingly being gamed.

This isn’t necessarily new. The first gaming began under LBJ, when President Johnson was concerned about the way the budget of the US government looked what with nearly half its discretionary tax money going for military expenditures and the war in Vietnam. Before LBJ, there were two federal budgets. One was the Social Security Fund, which was completely paid for by the FICA tax and (until recently) always ran huge surpluses. The other budget was the ‘real’ budget (derived from income and corporate taxes and other tariffs), and the ‘real budget’ showed far too much money going to the military. By creating the fiction of a ‘unified budget’, Johnson shrank the military spending to roughly a quarter of all federal spending, even though technically nothing had changed. LBJ took a nominal amount of heat for the change, but nobody remembered it after awhile, and it sure made us look better as a nation to have ‘only’ 23% of federal money going for dropping napalm on Vietnamese children and building delivery systems for a nuclear holocaust.

So naturally, once something works, others try it. Oil prices shot up drastically starting in 1971 and 72, and during the 1973 Arab-Israeli war it really hit Americans in the pocket. It was especially bad because in 1970-71, unnoticed by almost anyone, American oil production peaked at around ten million barrels a day.  So we continued to build land cruiser monstrosities and other gas-guzzling toys, but by 1972, we were no longer masters of our own energy future–consumption had passed production, never to catch up again.  The inflation numbers starting in 1972 were horrible–oil touches everything in the economy, and as the price increases rippled through, there were great dislocations. Nixon‘s answer was a sleight of hand called the Core Inflation rate. The claim was simple–food and energy prices were too volatile to indicate inflation was really doing. So they were removed from inflation calculations going forward.  Of course, even taking ‘core inflation’ as the new computation method didn’t hide the huge price increases caused by the OPEC embargo and subsequent price increases. And needless to say, these sorts of changes kept people like John Williams working.

And thus began the gaming of statistics. Chris Martenson has done a series on this called the Crash Course, and I don’t wish to repeat his work here. It’s long but worth a viewing, and if you want to skip to the pertinent parts, start at #14 and play through.

Some of the more egregious gaming happened under Clinton through the Boskin Commission, which was charged with determining a ‘real’ inflation rate for seniors. the tools:

Hedonics: which says that if your phone service cost $50 a month last year and just went up to $60 a month, there’s no inflation because they’ve made it faster and thus improved;

Substitution: If one thing gets expensive, people substitute something else for it, so the hit on the family budget stays unchanged. If grandpa used to eat tuna salad for lunch and now makes it with cat food, that’s not because of inflation. And grandpa is fine. Trust us. have a bite.

Weighting: Seniors spend nothing on some things (condoms come to mind) and only moderate amounts on others (most seniors aren’t as affected by inflation in housing prices, for example, because they don’t move very often). So change the priority of how they spend, and inflation goes away! (BTW, the reverse isn’t true–seniors consume more healthcare than anyone else, and health costs rise at double the rate of inflation. But that isn’t counted for in the computation of the COLA).

Thanks to all of this gaming, SS checks haven’t kept up with ‘real’ inflation for more than a decade. And since most people lucky enough to have COLA adjustments built into their pay are getting those adjustments made by a broken measurement, they aren’t keeping up with inflation either.

I pay attention to prices when I go to the grocery store or supermarket. we aren’t in some zero-inflation Xanadu–the price of peanut butter (a staple food item for me) is up some 35% over the past few years, and coffee and chocolate and cereal aren’t far behind.  And I know that unemployment is not ‘down’ right now except in the sense that more people have given up their search.  In 2007, some 63% of people over 16 and under 65 were employed. Currently, we’re stuck at 58%. Those other 5% have to eat and live indoors–what happened to them?

So–if you want a look at where the economy really is, you should drop by John Williams’ Shadow Government Statistics site, where he calculates the numbers in a consistent way and avoids the gaming. And you should google ‘Paul Craig Roberts’ who has done a great deal to popularize Williams’ work outside of policy wonks.

You can’t get yourself out of a hole you’ve dug if you don’t know how deep you’re in it.

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