EXECUTIVE SUMMARY
As a result of programming decisions made during their creation, computer software and hardware may not recognize the Year 2000 accurately, causing operational errors. This report assesses the economic implications of this Y2K problem for the U.S. economy. The Department of Commerce’s Economics and Statistics Administration reviewed how firms and governments should be expected to react in the face of the knownY2K problems and compared these results with available progress reports on Y2K readiness and other published Y2K economic assessments.
Overall Assessment & Key Judgements: Y2K is having an impact on U.S. business activity well in advance of the actual 1999 to 2000 changeover. Expenditures by firms and public agencies to hunt down and correct error-prone technologies have been running on the order of $30 billion a year since 1997 and will total in the neighborhood of $100 billion. Since the economy is essentially fully employed, the Y2K expenditures are coming at the expense of productivityenhancing investments and consumption. Once Y2K is resolved, more resources will be available for both.
It appears that Y2K problems will not be of sufficient size or scope to have more than a transient effect on overall U.S. economic growth. With no shortage of information about the problem, firms are correcting what is clearly a messy but not intractable situation. Y2K readiness and assessment reports by government agencies, the private sector, and private consultants are, for the most part, optimistic. While international organizations have reported a lower level of Y2K preparedness in many foreign countries, the countries that are highly dependent on information technology, and
thus exposed to substantial risks, are reported to be well along with their fixes. There appears to be little chance that Y2K disruptions abroad will be transmitted to the United States to a degree that could substantially damage the economy. There are still important unknowns, and no one knows with certainty the precise economic consequences. However, the U.S. economy has faced many such pressures and has proven to be highly resilient in recent years.
How Firms Can Be Expected to React to Y2K: At the firm level, the Y2K problem is not that different from other risks businesses face every day. Firms can be expected to balance, from their own points of view, the perceived costs and benefits of identifying, fixing, and testing for Y2K problems and developing contingency plans.
- In competitive markets, where it is difficult to pass on new costs to customers, firms can be expected to spend enough to avoid significant losses while accepting a risk of some failures. The level of precautionary Y2K spending among firms may vary, depending on the degree of a firm’s risk aversion and its financial means.
- In more concentrated markets, where there is a greater ability to pass on costs, firms can be expected to make efforts to figure out what their competitors are doing, and defensively to copy that behavior. The variation in spending between firms will probably be less in these more concentrated markets.
- For well regulated markets and government agencies, where there is a greater ability to pass on costs and where a sustained Y2K failure could be severely disruptive for others, there will be a strong incentive to find and fix all Y2K problems. But in countries that are poorly governed, or where monopoly firms or public services are poorly managed, these are the areas of greatest risk.
Clearly, some firms will make rational choices that include risks of failures. Some of these decisions will end up being wrong, and some profits and jobs will be affected as a result. It is unlikely these errors will be large enough to cascade into an economy-wide disruption, but this is not knowable with certainty.
Economic Basis for the Governmental and Public Role in Y2K: Even with the best of intent and the most rational decisions possible, the effects of these firm-level Y2K remediation decisions on the general economy could be influenced by special factors. Clearly, any sustained failure in critical infrastructure system, such as telephone or electricity, would be very disruptive, could have cascading effects, and is outside the control of most firms. Misinformation about the Y2K problem or the state of its resolution—whether or not the misinformation is deliberate—could lead to incorrect actions or levels of investment in Y2K fixes. Also, private decisions on Y2K spending can have good or bad effects on the broader society. Left to their own devices, firms might choose Y2K strategies that, while rational from their view, could still have negative implications for other people.
The potential for these factors to influence private Y2K decisions provides a strong public policy justification for the executive and legislative branches of government, industry regulators, industry associations and consultants, and the media to pay close attention to Y2K vulnerabilities. Public scrutiny has increased the level of private investment in fixing Y2K, thus reducing the potential external effects on society as a whole. In principle, governmental activities intended to mitigate the impact of the problem could also encourage behavior that makes the problem more likely. Government Y2K policies and programs have tried to avoid the danger of such “moral hazard” by insisting that responsibility to fix Y2K problems lies with the individuals, firms and agencies involved.
Domestic Y2K Readiness: The Y2K-problem is, at its core, a technological error that can be tested and corrected. By most accounts, the domestic U.S. economy is generally well-prepared. The President’s Council on the Year 2000 Conversion believes that “important national systems will make a successful transition to the Year 2000,” and that it has a “high degree of confidence” in financial institutions, electric power, telecommunications, and the federal government. The
Senate Special Committee on the Year 2000 Technology Problem concludes that sectors “critical to the safety and well-being of Americans, as well as to the economy, have made significant progress in the last eight months...”. Both reports indicate continuing concern for certain domestic sectors, including health care, local government, small business, and education, without however, finding general economy-wide risks. Private sector Y2K consultants and polls on
corporate Y2K readiness, with a few exceptions, have the same general views.
An additional consideration supports these optimistic assessments: Surveys suggest that the majority of firms have already experienced some Y2K failures, and reports indicate that these have produced temporary, fixable disruptions. There will be a spike in failures at the turn of the year, but it may not be as large or as significant as commonly expected.
International Y2K Readiness and Implications for the U.S. Economy: Some concern remains about the level of international preparations and how foreign Y2K problems might effect the U.S. economy. However, for the most part, economically-sound behavior appears to be occurring overseas as well. U.S. firms that depend on suppliers overseas have a strong incentive to make sure that they are Y2K ready and that there are contingency plans in place–e.g., inventories, alternative suppliers–in case there are Y2K related disruptions. No information indicates that U.S. firms are doing less overseas than they are doing domestically.
Overseas problems are most likely to occur in countries with highly centralized, poorly supervised organizations and where there is current, severe economic distress. However, these nations do not play a major economic role in the U.S. economy. The major U.S. trading partners of Canada, Mexico, Europe, and Japan–where information technology plays a large role in the economy–report a strong degree of preparation and Y2K readiness.
For a foreign nation’s Y2K failures to present a sustained threat to our economy, the foreign nation and its firms would have to be IT-intensive, very poorly Y2K prepared, important economically to the U.S., and have significant Y2K-related links that could generate sustained economic disruption. Available country-level assessments do not indicate any nations where all four of these risk factors to the U.S. are present.
The structure of economic incentives to U.S. firms, the reports of U.S. firm-level preparations involving the overseas supply chain, and country-level assessments of the major U.S. trading partners are consistent with the expectation of transient effects in trade-dependent sectors of the U.S. economy. Additional inventories, contingency preparations, and the time lags between foreign production and domestic use suggest that disruptions abroad should not immediately affect U.S. producers and ultimately, may not affect them very much. Trade takes place between tens of thousands of individuals and firms, and that is where Y2K readiness, contingency planning, and response to any glitches when they occur will rest. The incentive to get fixes or work-arounds in place quickly will be very high.
Estimates of U.S. Y2K Spending: Cumulative U.S. spending to address the Y2K problem is difficult to estimate. However, based upon several methodologically conservative estimates, cumulative Y2K readiness spending appears to be in the neighborhood of $100 billion, or about $365 per U.S. resident. Y2K spending, which started as early as 1995, appears to have peaked in 1998 and 1999 at about $30 billion per year.
Effects on Productivity: Spending to fix the Y2K technological errors increases costs and creates a diversion of spending from other productive investments. Some of the Y2K spending may involve ‘shifting forward’ new, productive, software and hardware investments which would have occurred eventually, offsetting to some extent the drag on productivity. Because Y2K spending has occurred over a number of years and is small relative to the economy, it is difficult to estimate
the extent of productivity effects with assurance. For the future, the lifting of the Y2K repair burden should free resources that can be used in ways that will raise productivity.
Inventory and GDP Effects: Y2K contingency planning by firms and Y2K-related consumer behavior may have implications for inventory shifts and the composition of GDP at the turn of the year. Because of these issues, consensus economic forecasts anticipate some inventory build-up now, offset by a reduction in the early part of next year. Also, Y2K contingency planning may involve, at least for some firms, a ‘lock-down’ that could reduce installations, if not orders, of software and hardware from what they otherwise would have been in the fourth quarter of 1999. As with the productivity effects, it will be very difficult to estimate after the fact these inventory and capital spending effects with either precision or assurance.
Consumer Behavior Concerns: A sudden rise in risk aversion associated with Y2K concerns—translated into unusual demand for cash or household goods—could prove disruptive to finance and commerce even with advance preparation. Current polls, however, suggest that the public is becoming less worried about Y2K as the date approaches. And financial institutions appear to be among the best prepared for Y2K. Most importantly, even if risk aversion rises, two-way markets ensure that the choice of holding more cash or hoarding goods will come at higher prices that reward those who accept modest risks.
Need to Avoid Complacency: While the general assessments of Y2K readiness and the implications for the U.S. economy as a whole are optimistic, Y2K glitches will surely happen and disrupt the firms and individuals involved. All firms and individuals should be sure that they have taken steps to identify, fix and test for Y2K problems, and put in place appropriate contingency plans.