Y2K Worries

CAMBRIDGE: The passage to the year 2000 involves more than the usual end-of-century doomsday fears. Even those who are comfortable that we are not approaching the end of the world and civilization anticipate a serious bump in the road. Information technology, the blessings of which are sung day in and day out, not least by investment gurus, may spoil the party. Payments systems may fail, transport systems may fail, even security installations might malfunction. But empty shops and banks are perhaps the least of the risks we face. Should we get out of the markets and into cash early, build inventories of food and simply hunker down until the uncertainties pass?

Preparedness for Y2K varies substantially around the world. Surveys show that the US is best prepared, that Japan has prepared very little, and that emerging markets basically not at all. What can go most wrong and where is the weakest link? A first useful distinction in judging the economic effects of Y2K is between what might actually happen and how people act, as a result, in anticipation. Two important areas come into play, production and inventories on one hand and financial transactions on the other. For production and inventories the story is simple: businesses fear the disruption of the supply of intermediate goods or final goods and, as a result, they increase their inventories. That way, if something goes wrong with their suppliers' systems, at least they will have something on their shelves. This effect means that there will be more production and inventory building in the run-up to the year 2000, and correspondingly inventory run-offs and less production in the beginning on next year. In the US this effect is estimated to be about one third of one percent of GDP, not small at all.

What appears appropriate for business will also be adopted by households. No one, of course, wants to face empty shelves. We know this perfectly well; anytime there is a snowstorm or other threatened disruption, households build stocks. They will act in this way even more so this time because it is in the nature of Y2K that no one can anticipate the scope and duration of the problems it will cause. All this is sound economics. But imagine if things don't work out this way. Imagine if households don't plan ahead, don't build up reserves. Clearly, we would see overproduction and unsold inventories resulting in a far sharper cut in production early in 2000.

The more important issue concerns financial markets and payments systems. Imagine if Wall Street closes down because systems fail; no one trades, debts don't get paid, payments are not received leaving would-be recipients without liquidity and unable to meet their obligations. In no time, the financial system would grind to a halt. Asset prices might collapse and payment irregularities would abound. This might happen.