Y2K: Recession almost certain

[Guest guest]

Dallas Business Journal

January 4, 1999

 

Front Lines

 

RECESSION `ALMOST CERTAIN' EFFECT OF Y2K BUG

 

Reynolds Griffith

 

Discussed in computing circles for many years, "The Year 2000

Problem" has spread into general awareness over the past year.

As businesses have become aware, they have concentrated

mostly on the direct impact on their operations. However, they

need to consider also the overall economic effects.

 

There are two major sources of economic effects from Y2K.

The first is simply the cost of correcting the problem. Large

companies may have millions of lines of code in their computer

applications, much of it not well documented. It may cost

hundreds of millions of dollars for such a company to have each

line examined and the necessary corrections made.

 

For example, BankAmerica expects to spend $550 million,

AT&T, $900 million and J.P. Morgan and Wells Fargo, $300

million each.

 

Estimates of the total cost are up in the hundreds of billions of

dollars and have risen over time. In a July 1996 report, analysts

at J.P. Morgan Securities estimated the cost of Y2K

remediation was likely to be at least $200 billion. In a

subsequent report in May 1997, they raised their estimate. A

widely cited estimate by the Gartner Group in that year was

$300 to $600 billion worldwide.

 

Cap Gemini, a major consulting firm tracking Y2K, "estimates

that the total cost of dealing with the issue has increased to

$858 billion from $719 billion." Their figure is for the United

States and Europe only.

 

Whatever the cost, it will be a drag on the real economy,

although it may not show up as such in the published numbers.

The cost would be included in Gross Domestic Product even

though there's no positive economic benefit.

 

The second major effect is what happens when not all

companies and agencies get their systems corrected. Not all

will.

 

It's not merely a matter of cost that keeps companies from being

ready, but of the number of man-hours of programmer time that

will be required. There is simply not enough time for companies

who started late in dealing with the problem to get it corrected.

 

At a conference in November, Harris Miller, president of the

Information Technology Association of America, reported that a

survey of corporations suggests "the countdown to failure has

started." The ITAA survey showed 44% of companies had

already experienced actual failures, 67% reported having test

failures, and almost half were still in the awareness/assessment

phase.

 

POTENTIAL DISLOCATIONS

 

With problems so likely, there is potential for major economic

dislocations. Segments of the economy such as manufacturing,

retail and services will be directly affected to the extent that

firms in these sectors have problems. However, the direct

effects seem more dispersed and less crucial than indirect and

infrastructure problems.

 

Even compliant firms may be affected if their customers and

suppliers are not year 2000 compliant. We saw the potential

effect of supply-chain problems with the General Motors strike

last summer.

 

In infrastructure, the two really key systems are the banking and

electrical systems, with telecommunications not far behind. If

these stop working, we're in real trouble. Short of failures in

those areas, the impact on governments may be the most

far-reaching.

 

My tentative conclusion is that some banks will not be compliant

by the end of 1999. However, in the absence of massive

widespread bank runs, which at this point I do not expect, the

whole banking system will not collapse. (See my bank Web

page http://cobweb.sfasu.edu/~rg/ bankpage.htm for more

details.)

 

The status of the utilities is difficult to judge. A report prepared

by the North American Electric Reliability Council (NERC) in

response to a request from the U.S. Department of Energy in

September 1998 sounded optimistic on avoiding major

problems.

 

However, Rick Cowles, a noted utilities expert, commented:

"The NERC report acknowledges that the pace of industry

Y2K programs must be accelerated dramatically. Yet this

acknowledgement is buried beneath a mountain of hopeful

words that are not supported by the statistical and empirical

evidence."

 

It appears that at the least we can expect some brownouts and

blackouts, which will have a dampening effect on economic

activity.

 

The word on the federal government has not been encouraging,

either. The House Subcommittee on Government Management,

Information and Technology issued its updated report card on

federal agencies' progress last fall. Chairman Horn noted:

"Overall, the executive branch of the federal government has

earned a `D.' Unfortunately, the federal government has not

made enough progress since the last report card, when it also

received a `D.' Executive branch departments and agencies are

responding too slowly in assessing and repairing their

mission-critical systems, their telecommunications equipment,

their embedded chip systems and their data exchanges. ... More

important, over one-half of the agencies have not completed

contingency plans to ensure that service will continue should

their mission-critical systems fail."

 

NOT TAKING IT SERIOUSLY

 

It seems that not many economists are taking the Year 2000

problem seriously. USA Today did a survey of economists in

September asking about the economic effects of Y2K. They

reported: "The consensus: Y2K is likely to add 0.1 percentage

points to economic growth next year as businesses gear up

spending on updating their computer systems. The economists

surveyed estimate the economy will grow about 2% next year.

The following year, the economists estimate, Y2K disruptions

would probably shave 0.2 percentage points off gross domestic

product growth."

 

An exception to the prevailing view is Dr. Ed Yardeni, chief

economist of Deutsche Morgan Grenfell in New York. Besides

testifying before Congress on the seriousness of the problem, he

maintains pages on his Web site on Y2K

(http://www.yardeni.com/ cyber.html.) He estimates a 70%

chance of a recession starting in January 2000, possibly as

severe as the 1973-74 global recession. In July 1997, he had

estimated the probability of a resulting global recession at 30%.

 

Even Dr. Yardeni may be an optimist. I would judge a recession

almost certain. Given the interrelationships in our economy, even

a small percentage of firms and agencies not being compliant

can produce a significant downturn.

 

Texas may be affected more than some other parts of the

country because of its connectedness to Mexico. Border areas,

especially, have already felt the impact of this relationship when

the peso was devalued. Latin America is far behind the United

States in preparing for Y2K.

 

My conclusion is that the Year 2000 Problem is likely to have

significant economic effects, including a recession. Businesses

that ignore these effects do so to the detriment of their chances

of surviving.

 

The severity of the problems is still uncertain. However,

businesses must begin now to prepare for their impact.

 

Dr. Griffith is professor of finance in the Department of

Economics and Finance at Stephen F. Austin State University in

Nacogdoches. He has been researching the economic and

financial aspects of Y2K for the past two years, has written

numerous articles on the subject and maintains the Y2K

Economic Forecast Web page http://cobweb.sfasu.edu/~

rg/forecast.htm.