Tuesday, October 27, 2009

The economics of spam measures 

While writing our book, my co-editor and I would refer to various international rankings as Spam. Not because they were noise, but because the stuff inside these measures were 'mystery meat'. So when I find today a new ranking under the pretentious title "The Legatum Prosperity Index", I cried out "Spam!" and went to see what was inside. From their executive summary:
Following a turbulent year marked by a global economic crisis, the Legatum Prosperity Index seeks to answer these two fundamental questions. It defines prosperity as both wealth and wellbeing, and finds that the most prosperous nations in the world are not necessarily those that have only a high GDP, but are those that also have happy, healthy, and free citizens.

The Prosperity Index accounts for 90% of the world�s population and is based on years of statistical analysis and research of objective data and subjective responses to surveys. The data comprises 79 different variables organised into nine sub indexes � each identified as a foundation of long-term prosperity. A country�s performance in each sub-index is given a score, and the overall Prosperity Index rankings are produced by averaging the scores of the nine sub-indexes for each country. Those countries that perform well across each sub-index do best in the overall rankings.
79 different variables? Combined into sub-indexes? Mystery meat indeed! The sub-indices are:
When written this way it's almost predictable that all Scandinavian countries will rank ahead of the U.S., which comes in ninth. Of course the U.S. gets dinged for health -- it always does, even though we know those comparative measures are fraught with error -- and education will not look as good ... which I'd accept as accurate. But the one that shocked me is that 13 countries rank ahead of the U.S. in economic fundamentals.
America has a large domestic market but a large trade deficit, and attracts relatively little foreign direct investment

America�s household spending is the highest in the world as a proportion of GDP, although domestic savings rates are only 14% of income, ranking the country 82nd in the world. Levels of capital stock per worker are in the top 10, and inflation was 3% in 2007. The US economy focuses on high value added goods and services, and is not dependent on exports of raw materials. However, its ratio of export prices relative to the cost of imported goods is weaker, ranking the country 78th in the world. The US also attracts relatively little foreign direct investment, which accounts for just 2% of GDP, ranking the country 83rd on this variable. Net interest margins are near the global average, while the amount of non-performing loans is low, ranking the country 26th on this variable and suggesting that the banking sector is moderately competitive and efficient.

I cannot tell from the information on the website how all this data is combined. (The methodology paper is apparently not ready for posting yet.) If the country is ranked lower because of the domestic savings rate I would ask why. If one can lead a full and happy life with low level of savings why wouldn't it do so? I don't understand the mention of export to import price ratios. A country that has a great amount of domestic capital does not necessarily need FDI. And many of these variables are interrelated. As I wrote (in a paper with Bill Luksetich), the independent effect of many variables is muted once one includes fundamental variables like the presence of private property rights. (The only mention of property in the Legatum measure I found was for intellectual property.)

Averaging 79 measures may be weighted or unweighted. Reading the 2008 report suggests to me some kind of weighting, but I can't tell again how it's done. Until and when we see something on the methodology, you can't rely on measures like this. GIGO.