research@hec - Issue #31 - (Page 2)

economy research hec Countries falsifying economic data: How statistics reveal fraudulent figures China and Greece are among the nations believed to deliberately misreport economic data in order to attract investment or keep borrowing costs low. Such governmental “creative” accounting has hitherto been mostly impossible to prove, but now an innovative study tested statistical data to reveal which countries have an incentive to falsify their economic figures. Tomasz Michalski et Gilles Stoltz B iographies Tomasz Michalski has been professor of economics at HEC since 2006. Previously, he was a researcher at the National Bank of Poland and at the European Central Bank. He holds a Ph.D. in economics from Columbia University. Gilles Stoltz has been affiliate professor at HEC since 2007, where he teaches statistics. He is also a research fellow of CNRS at École Normale Supérieure. He obtained his Ph.D. in mathematics from the University of ParisSud, Orsay, in 2005. 2 Argentina has long been suspected of understating its inflation figures to avoid paying high interest rates on government bonds indexed to inflation. Greece and Italy have been accused of tinkering with their budget deficit figures prior to joining the Eurozone, with the suggestion that this allowed the Greek government to enjoy lower borrowing rates from investors than would have otherwise been the case. China is believed to embellish its growth figures. And the list goes on, with a number of countries around the world suspected of lying about their economy for strategic reasons, such as to attract investors or obtain cheaper financing to service their debt. Despite this (somewhat cynical) take on government accounting, it is difficult to discern whether such countries deliberately mislead investors or simply put out inaccurate figures because of measurement errors and poor data collection. The literature on the truthfulness of national government accounting has been meagre so far, but HEC professors Tomasz Michalski and Gilles Stoltz have developed a model to uncover cheating. THE TELL-TALE DISTRIBUTION OF DIGITS The two researchers assembled data on balance of payment spanning nearly two decades and covering more than 100 countries. They then put this data to a statistical test. In theory, the first digits of the numbers should not be distributed in a uniform • January-February 2013 way but should follow a specific distribution pattern conforming to what is known as Benford’s law. According to this statistical law, the smaller values (1, 2, and 3) occur more frequently as a first digit than larger values. This is true for large quantities of data, whatever the source – capital flows, street addresses, surface area of rivers, and so on. It may not sound intuitive for some data but for economic series that grow in a multiplicative manner due to inflation or growth, the effect can be visualized with a simple thought experiment, as articulated by Gilles Stoltz: “Start with the figure 100, and add 10%. In the time it takes to reach 200, the first digit of your result will be 1, but after 200, you will be adding a larger number and so it will take a shorter time until your first digit turns from 2 to 3, and so on.” Since any large enough amount of data should conform to Benford’s law, it has been used as a test to detect manipulations of figures in auditing and accounting since the 1990’s. Applying the same test to standardized figures about balance of payments, the HEC researchers found evidence that a number of countries were misreporting their macroeconomic data. While the method did not allow them to detect the point at which specific governments provided false information, they managed to find patterns when grouping countries according to certain characteristics, such as type of exchange rates or foreign asset positions.

Table of Contents for the Digital Edition of research@hec - Issue #31

Cover & Contents
Countries falsifying economic data: How statistics reveal fraudulent figures
Extending product lines up and down in quality: Asymmetric effects on brand evaluation
Institutional change Promoting the emergence of a natural order

research@hec - Issue #31