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Indices, synthetic and natural, as a benchmark tool

“Synthetic indices,” as explained by the Economist, Jan. 8, 2011 at 60, are “indices combining several related measures into a single number which are often used to back broad claims.” For example, an index of corporate IP prowess might be constructed from the number of patents applied for in a year plus R&D spending as a percentage of revenue plus references in the annual report to innovation and intellectual property. For a group of companies, if you collect those three numbers for each of them, put them on a comparable scale and sum them, you create a synthetic index.

I created such an index with my rankings of industries and countries by legal intensity (See my post of Nov. 30, 2010: USA in the middle of the pack; and Dec. 1, 2010: industry ranking.). Among the methodological difficulties synthetic indices face is that interpreters may ignore margins of error: they regard tiny differences between rankings as significant. Also, minor changes in components can have magnified effects on the outcomes. Another problem comes from the common situation that a narrow component is treated like a proxy for a broader measure.

Used skillfully, however, synthetic indices can help us understand and quantify a domain better than we did before.

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