In business and finance, statistics and quantitative comparisons are daily companions. Sometimes, however, key statistics can become too familiar, and reify, i.e. harden into “facts” that everybody knows. In so doing, they play a large part in strategic surprises.
In the late 1980s, for example, the US Intelligence Community “knew” that Soviet GDP was $2.5 trillion, i.e. about 52 percent of the US GDP of $4.8 trillion. How? Their computer models told them so. These models relied upon – among other things – assumptions about ruble-dollar Purchasing Power Parity (PPP).
Western academic Sovietologists also “knew” the USSR’s economy was about $2.5 trillion. How? Mostly, they relied on an authoritative source: the CIA.
By the early 1990s, it was clear that the US Intelligence Community’s estimate of the USSR’s economy was about $1 trillion too large – that Soviet GDP was closer to $1.6 trillion. What difference did that error make? Among other things, Soviet GDP was the denominator used to estimate the burden of defense spending as a percentage of the overall economy of the USSR. When the CIA, for example, put Soviet military spending at 11-15% of GNP between 1975 and 1980, the 11-15% figure had the overall GDP number as the denominator. Simple math. But, the sustainability of the entire Soviet edifice might have been called into question earlier if the GDP number that everyone “knew” had been questioned more closely – change the denominator, and Soviet defense spending becomes unsustainable (as, in reality, it was).
The CIA model began with flawed assumptions about the appropriate discount for poor quality Soviet goods, and never adequately revised them. For PPP to work, items need to be truly comparable. The wonders of unquestioned PPP models ultimately allowed the CIA’s 1987 World Fact Book to list the GNP per capita in West Germany as lower than East Germany’s! The evidence to the contrary that one could gather in an afternoon stroll was considered “anecdotal”.
This is not to say that the CIA had an easy job penetrating Soviet misinformation and obscurantism. Even for those inside it, understanding the economy of the USSR was hard (just ask Gorbachev). It is simply to illustrate that flawed assumptions and authoritative numbers that go unquestioned can have real consequences and contribute to strategic surprises.
Why does this mostly-forgotten history matter to businesspeople today? Because it is a cautionary tale about the so-called BRIC economies. In fact (while noting that PPP is the method usually used to estimate the size of BRIC economies), let’s look at something simpler: urbanization statistics.
One “fact” that many people know about China, for example, is that one of the primary drivers of its economy’s future growth will be continued urbanization. (This is because country people on farms are less productive than city people producing goods and services). Maybe that will continue to happen in China, and it will drive economic growth. Certainly many Chinese say so, and cite their ability to “urbanize” further as a key part of the good news story that is supposedly the future of China’s economy.
At first glance, proponents of the China has Plenty of Urban Growth Left Story can cite an authoritative source, the UN Statistics Division. Check the UN’s urbanization basic statistics, and you’ll see that China is said to be only 47% urban, compared to say the US’s 82% urban figure, or Germany’s 74%. Exciting room to grow, right? It’s a part of the classic “convergence story”.
Think again. The UN uses each country’s individual definition of urban. Dig into the details of the UN statistics above and it turns out that the Chinese definition of a city is 1,500 people per sq. km (though the overall definition is complex), and the US and German definition of a city is 400 people per sq. km! In fact, most developed countries use the 400 people per sq. km definition. In short, China is already a lot more urban than you’d think looking at the authoritative UN Statistics Division headline figure! The UN’s figures are not comparing apples with apples, and neither are the BRICs cheerleaders who blithely cite them.
In fact, the CIA’s past troubles with PPP – or the subtleties of UN statistics today – should give everyone pause about how much they “know” about various economies, especially the BRICs (but also recall the subprime crisis). There are certainly China skeptics. As you consider their individual points, bear in mind that if “The largest single social science research project in the history of humanity” could overestimate the size of its primary target by about 40% for decades, will the salesmen known as Chief Economists at investment banks do any better?
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