Why the future of the economy is as tough to predict as the weather
Jason Scheinder
1. “We can’t predict the next crisis...”
As political gridlock in Washington threatens to stall a U.S. economic
recovery, investors are once again turning to economists for guidance on
what the future holds. But a Ouija board may serve them just as well.
From Federal Reserve chairman Ben Bernanke on down, most economists
failed to predict the 2008 financial crash. In his 2011 paper, “An Award
for Calling the Crash,” Mason Gaffney, a professor of economics at the
University of California, Riverside, offers this postmortem: “The crash
of 2008 surprised most of us. The episode has led many to ask how
economists could have been so in the dark.”
And this wasn’t an isolated event. The majority of economists have been
surprised by everything from the Great Depression and the spike in oil
prices during the 1970s to the bursting of the dotcom bubble in 2000 and
2001, says Laurence Ball, a professor of economics at Johns Hopkins
University. What made it difficult to predict the mortgage crisis was
that “subprime mortgages did not really exist 15 years ago,” he says.
Economists look at past events to figure out what’s coming next, but
some events are without precedent. “The world changes quickly,” Ball
says.
Such explanations provide little solace for regular investors, many of
whom look to economists as bellwethers. “You can’t create a model for
the world. Even in projecting interest rates, income and inflation, too
much can go wrong,” says Robert Schmansky, founder of Clear Financial
Advisors in Bloomfield Hills, Mich. And when economists don’t forewarn
others, he says, investors suffer. In late 2008 as stocks were
free-falling, Schmansky says, many of his clients were scrambling to
liquidate their stock portfolios because they too were caught by
surprise.
In their defense, economists tend to make decisions based on publicly
available information just like everyone else, says Ken Simonson,
current president of the National Association for Business Economics, an
international association for applied economists, strategists,
academics, and policy-makers. Still, he admits, before the financial
crisis, “The majority of economists did take way too rosy a view of what
was happening in the economy.”
2. “...but we may help cause it.”
While rosy forecasts can leave investors unprepared for disaster,
experts say pessimism from economists can contribute to a crash. “Juicy
sound bites by economists can impact consumer confidence,” says Seth
Rabinowitz, partner at management consulting firm Silicon Associates.
Among the factors that influence consumers’ decisions to spend, he says,
are income, stock market volatility — and what economists say. “If
consumers are overly fearful, they will spend less and that will hurt an
economy on the brink of recovery,” he says. “For this reason,
economists have an even greater social responsibility in how they speak
to the press,” he says.
3. “We’re not above a little guesswork.”
Given that economists’ models did little to help alert them to the
impending problems in 2008, a growing number are now learning to trust
their gut, say experts — that is, they’re guessing. These are educated
guesses, to be sure, but guesses nonetheless. Mark Perry, a professor of
finance and business economics at the University of Michigan-Flint,
estimates that more than half of economic forecasts are based on
intuition. “Over time, economists have started to realize that people
are unpredictable,” he says, and that’s forced them to diverge from what
more formal models might predict.
Others say using a little guesswork may not necessarily be a bad thing,
arguing that mathematical models are often rendered useless in the real
world, especially when dealing with events like the terrorist attacks on
Sept. 11, 2001 and other unanticipated disasters. These models assume
consistency and predictability when actual behavior is hard to predict,
says John Kay, one of Britain’s leading economists. “Relying on
consistency is not very sensible strategy,” he says.
“Any professional economist or researcher has to use a certain amount of
judgment and creativity either to detect relationships that haven’t
been noticed by others or to sort through the many influences that are
affecting the economy,” says Simonson of the National Association for
Business Economics. No period in time can be replicated based solely on a
mathematical model. “That’s why people say economic forecasters exist
to make weather forecasters look good,” he says.
4. “Those bold predictions? Blame the testosterone.”
Most economists are male. Only about 30% of new Ph.D. economists are
female, a proportion that has increased only modestly since 1995,
according to research compiled by economists John Siegfried and Charles
Scott and published in the American Economic Review. The imbalance is
particularly striking because men are the minority in many other
financial professions. Female accountants and auditors, tax preparers,
insurance underwriters, tax examiners and collectors all outnumber their
male counterparts, according to the Department of Labor’s Women’s
Bureau.
Some commentators say the imbalance among economists could have
repercussions for economic policy. According to a 2012 survey of
American Economic Association members published in the Contemporary
Economic Policy Journal, male and female economists think differently
about issues including educational vouchers, health insurance and
policies toward labor standards. Compared with men, women in the study
were 24 percentage points more likely to believe that the the role of
the government in the economy is either “too small” or “much too small,”
and women were 32 percentage points more likely to agree that
government policies should attempt to make the U.S. income distribution
more equal.
Several other studies, including one in 2011 by Barclays Wealth, a
private banking and wealth management firm, and Ledbury Research, a
market research firm based in London, have also concluded that men tend
to engage in more reckless behavior
than women. One possible reason, according to the study: testosterone,
which increases appetite for risk. “Men tend to be a bit more impulsive,
less willing to admit their mistakes, and more focused on the big idea
and the really high-flying investment,” says Scott Beaulier, executive
director of the Manuel H. Johnson Center for Political Economy at Troy
University, in Troy, Ala. Excessive risk-taking, for economists, could
translate into bold predictions that have more to do with making
newspaper headlines than being proven true, he says.
5. “Our measures of prosperity don’t work.”
Economists rely on many measures to gauge the health of countries, but
many may not be the accurate yardsticks they’re believed to be. For
example, the growth of gross domestic product — one of the measures most
closely watched by economists — doesn’t necessarily indicate whether an
economy is healthy or not, especially since major economic crises often
occur on the heels of periods of rapid growth.
The U.S.’s own halting recovery casts some doubt on the value of GDP.
Based on that measure, the Business Cycle Dating Committee of the
National Bureau of Economic Research declared that the recession
officially ended in June 2009.But statisticians like John Williams,
editor of ShadowStats.com, a website that analyzes government economic
and unemployment statistics based on methodologies used by previous U.S.
administrations, argue that the U.S. economy still has not recovered.
“The latest GDP figures are related to distorted inflation numbers.
Since 2009, the economy has been stagnant.” Williams says that current
GDP numbers with inflation stripped out would leave annualized growth
about 0.4% instead of 2.4% during the first quarter of 2013.
“Unfortunately the base number is meaningless,” he says. “The best that
can be said for the data is that the GDP either grew or contracted for
the quarter.”
Same goes for unemployment measures. According to official government
estimates, unemployment was 7.6% in May, but Williams says that stat is
misleading. “Discouraged workers” — those who are not actively seeking
employment — are not included that estimate; adding them pushes the rate
closer to 23%. “I always advise people to look beyond the headline
figure,” says Jeffrey A. Frankel, a professor at the Kennedy School of
Government at Harvard University, adding that the Labor Department
provides stats on discouraged workers.
Still, experts say even the basic metrics have their uses — from home
prices and personal consumption rates to trade balance and inflation.
“GDP and unemployment are very good basic measures,” says Ball of Johns
Hopkins University. “Countries with high GDP have better education and
health than poorer economies.”
6. “Ours is a dismal science, but not an exact one.”
As a group, economists are nothing if not inconsistent, says Doug Short,
vice president of research at the financial advisory service Advisor
Perspectives in Lexington, Mass. According to The Wall Street Journal’s
April 2013 survey of economists, predictions for 2013 GDP growth ranged
from 1.8% to 3.9%. For 2014, they ranged from 2% to 4%, a disparity
Short describes as the difference between tepid and robust growth.
The reason for the imprecision? Economists are under pressure to be more
exacting than their science allows, says Lynn Reaser, chief economist
for the Fermanian Business and Economic Institute at Point Loma Nazarene
University in San Diego. “They are reluctant to confide in their
clients that the best they can do is provide a significant range, so
they pinpoint an estimate.” Economists are also too quick to change
their forecasts, Reaser says: “They overreact to the latest data point,
but in many cases they’d be better off taking a longer-term point of
view.”
Rather than put faith in any one economist, Short advises, look at the
average. And in times of financial stress, he says, “even the average
forecast should be taken with a grain — or a shaker — of salt.”
Economists in the April 2013 Wall Street Journal survey, for example,
forecast 2.4% average growth in 2013. Meanwhile, he says, there is good
news: “Hurricane Sandy is behind us, the fiscal cliff turned out to be a
minor bump, and sequestration hasn’t torpedoed the economy — at least
not yet.”
7. “We lean to the left.”
As of 2008, nearly half of members of the American Economic Association
said they were registered Democrats, while only 17% said they were
Republicans. Furthermore, in the same survey (commissioned by Scott
Adams, the “Dilbert” cartoonist), 60% of the economists said that among
the presidential candidates at the time, they thought Barack Obama would
make the most progress on important economic issues if elected. (The
survey was managed by The OSR Group, a national public opinion and
marketing research company.) A similar survey of members carried out
that same year of the National Bureau of Economic Research found that
46% identified themselves as Democrats and 10% as Republicans.
Those surveys, the most recent on the topic, suggest that economists
skew further Democratic than most of the population—even compared to
people with advanced degrees, who have long been skewered as “the liberal elite.”
Among people with education beyond a bachelor’s degree, self-described
Democrats had a 14 percentage point lead over Republicans among college
graduates — with 39% identifying themselves as Democrats and 25% as
Republicans — according to a 2012 study by Pew Research Center.
Left-leaning political views can even be seen in economists’ reports,
some experts say. A 2008 article in the journal American Economist
argued that economists over the past half-century have helped sell
voters on bigger government. “We find that the increased role of
economists in society and in policymaking has led to an increase in
favorable attitudes toward government intervention,” wrote the authors,
economists Scott Beaulier, William J. Boyes and William S. Mounts.
(Boyes describes himself as more libertarian than right or left wing and
Beaulier describes himself as a “free enterprise” economist.) Mounts
did not reply to requests for comment.) Others say that only tells half
the story. “A disproportionate number of academic economists favor a
limited role for the government,” says Frankel, the Harvard University
economist, “but you tell me whether that’s left or right.”
7. “We lean to the left.”
As of 2008, nearly half of members of the American Economic Association
said they were registered Democrats, while only 17% said they were
Republicans. Furthermore, in the same survey (commissioned by Scott
Adams, the “Dilbert” cartoonist), 60% of the economists said that among
the presidential candidates at the time, they thought Barack Obama would
make the most progress on important economic issues if elected. (The
survey was managed by The OSR Group, a national public opinion and
marketing research company.) A similar survey of members carried out
that same year of the National Bureau of Economic Research found that
46% identified themselves as Democrats and 10% as Republicans.
Those surveys, the most recent on the topic, suggest that economists
skew further Democratic than most of the population—even compared to
people with advanced degrees, who have long been skewered as “the liberal elite.”
Among people with education beyond a bachelor’s degree, self-described
Democrats had a 14 percentage point lead over Republicans among college
graduates — with 39% identifying themselves as Democrats and 25% as
Republicans — according to a 2012 study by Pew Research Center.
Left-leaning political views can even be seen in economists’ reports,
some experts say. A 2008 article in the journal American Economist
argued that economists over the past half-century have helped sell
voters on bigger government. “We find that the increased role of
economists in society and in policymaking has led to an increase in
favorable attitudes toward government intervention,” wrote the authors,
economists Scott Beaulier, William J. Boyes and William S. Mounts.
(Boyes describes himself as more libertarian than right or left wing and
Beaulier describes himself as a “free enterprise” economist.) Mounts
did not reply to requests for comment.) Others say that only tells half
the story. “A disproportionate number of academic economists favor a
limited role for the government,” says Frankel, the Harvard University
economist, “but you tell me whether that’s left or right.”
8. “We might have an agenda.”
Many influential economists work in academic institutions, which can
confer an aura of unbiased authority. But in reality, experts say, most
economists have political — and economic — motives of their own. “Most
economists are paid by financial institutions that have an agenda to
keep you invested long-term,” says Schmansky, the financial adviser.
What’s more, around 70% of university economists have financial
interests outside of academia, according to Gerald Epstein and Jessica
Carrick-Hagenbarth’s 2010 study “Financial Economists, Financial
Interests and Dark Corners of the Meltdown,” which analyzed media
appearances, articles in the press and research published by economists
from 2005 to 2009. But in spite of these ties to business and the
private sector, economists rarely identified themselves as working in
the private sphere, the researchers concluded.
Economists should disclose their consulting work and universities should
have clear procedures of disclosure when it comes to possible issues of
ethics, Frankel says. For his part, he says he makes public any
consulting work for which he earns $1,000 or more, and says economists
would do well to keep track of consulting jobs. “The problem with many
academic economists is that their heads are stuck in the clouds —
theoretical models — and that they are unwilling to take a clear policy
position, which is quite different from having an agenda,” he says. The
National Association for Business Economics says economists from the
organization report their affiliation when quoted in surveys or in the
media.
9. “We may as well be speaking Klingon.”
In the theory of trickle-down economics, tax breaks or other economic
benefits provided to the wealthy will benefit poorer members of society
by improving the overall economy, but in practice, it doesn’t usually
work out that way. Similarly, economic theories don’t always trickle
down to the people who need them most. Among the reasons: “No one really
understands what economists are saying,” Reaser says.
Of course, all professions have a tendency to speak in jargon. And when
they show up in the news media, economists often try to keep the jargon
to a minimum, experts say, using the most basic language to explain
often very complicated concepts. And yet dumbing down economics doesn’t
seem to be helping much: Despite economists’ efforts to explain their
concepts through the media and through research and books, Americans
have a poor understanding of even the most basic economic and financial
concepts, concludes AnnaMaria Lusardi, a professor of economics and
accountancy at George Washington University School of Business.
In a 2009 study, Lusardi, along with Peter Tufano, a finance professor
the Harvard Business School, found that only one-third of the population
understands how credit cards (and compound interest) work. What’s more,
nearly half of all adults grade themselves with a C, D or F for
personal finance knowledge, according to a 2013 survey by the National
Foundation for Credit Counseling. This is bad news for consumers, says
Gail Cunningham, spokesperson for the foundation. The lower people’s
financial literacy, experts say, the more likely they are to forgo
saving, incur debt and pay higher credit card fees. In fact, 57% of
Americans are currently worried about their lack of savings, the NFCC
survey found.
10. “We sell you what you already know.”
Do we really need economists? Some experts say that’s open to debate.
Economists provide a service for banks and other institutions, but in
some ways, they don’t know anything more than the average Joe. “Yet we
hope nobody notices that this proposition would drive down the demand
for our service,” says Frankel.
Economists’ “rational expectation hypothesis” states that workers are
rational, investors are rational and consumers are rational, and that
prices for assets like stocks and real estate reflect all available
information, Frankel says. “People have already factored in the
information that is publicly available and supplied to them by
economists in terms of trying to beat the stock market,” Frankel says.
Still, the market and publicly available information are a good arbiter
of how much assets are worth right only in the present moment, not of
what they might be worth in the future, says Ball of Johns Hopkins
University: “If you want to know what’s going to happen to the economy
five years from now, economists provide a lot of judgment.”
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