OPINION:
Every month, the federal government releases at least two measures of inflation: the consumer price index and the personal consumption expenditures index, which is the measure of inflation preferred by the Federal Reserve.
For decades, these have been dependable approaches for measuring price changes, turning complex data into a straightforward number on which policymakers, investors and the public can make informed decisions. Like the CPI and PCE, it goes without saying that any index should be based on consistent, relevant data and methodology, or the measure becomes meaningless.
One index that has recently been cited favorably by media outlets and members of Congress but fails to meet this basic standard is called the private equity state risk index. Published by a progressive advocacy group, this index claims to measure the footprint and risks associated with private equity investment across all 50 states. But when you peek under the hood, it clearly does nothing of the sort.
This past spring, a labor union-backed progressive group called the Private Equity Stakeholder Project, or PESP, published this index, which ranks states based on some 16 metrics of some perceived relation to private equity — real and imagined. It has since been credulously cited by national news outlets and a few policymakers in Washington. Despite the veneer of credibility and rigor, a basic review of its underlying data reveals methodological deficiencies that should give observers pause before citing any of its conclusions about the alleged risks of investments in the states.
The most obvious deficiency in the PESP index is that it’s incomplete. Purporting to measure states across four broad categories: labor, health care, housing and pensions, the index assigns scores based on metrics measuring the degree of private equity involvement in each sector. States are then ranked based on their scores in each of the index’s four main categories and the combined scores are then used to rank the states overall.
In reviewing the data, one can plainly see that data is missing for many states across several categories. These omissions may or may not alter the rankings of the states, but they undoubtedly invite skepticism about the accuracy of the index.
The data omissions compound another deficiency: inconsistency in the data sampled. Incomplete datasets make direct comparison and therefore ranking basically impossible. The PESP index includes inconsistent comparisons of measures over different time periods, which introduces the possibility of other fundamental errors.
Perhaps most glaring among the flaws in this risk index is that it does not measure risk at all. In general, it equates measures of risk to exposure to private equity but fails to correlate those risks to actual economic outcomes. Perhaps the most egregious example relates to housing. Among the four categories assessed by the index, states’ housing rankings are the most highly correlated to the overall score.
To measure the risk of private equity to state housing sectors, PESP measures home purchases by medium, large and largest housing investors. As noted above, however, this is a misleading and inaccurate proxy for intuitional investment in housing generally and private equity specifically.
The index also doesn’t reflect actual housing risk, since it rates the New York and New Jersey housing markets as the third- and fourth-least risky despite their being among the 10 least affordable housing markets in the country. The labor measure likewise does not measure labor outcomes in the broader economy to contextualize the findings. This problem is present across multiple measures in the index.
In sum, an index is only as good as its inputs and methodology. In attempting to measure inflation, federal statistical agencies examine prices across broad swaths of the economy and try to construct sound and consistent measures of price changes. It’s a serious scientific process.
The PESP index gets this process completely backward: It begins with a premise — that private equity investment necessarily poses risk — and works backward from there. This should come as no surprise, since it’s the product of an organization dedicated solely to critiquing and targeting an entire industry. As the adage says, “garbage in, garbage out,” and policymakers would be wise to consider that in this case.
• Gordon Gray is executive director of the Pinpoint Policy Institute. Before launching Pinpoint, he served as vice president for economic policy at the American Action Forum, where his portfolio included the federal budget, taxes, the macroeconomic outlook and general economic policy matters.
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