In my last post I mused over Forecasts and those guys who come up with them. In my little research I came across so many noteworthy facts and statements on that subject that I decided to collate them in a separate post.
Here we go, some 33 randomly listed observations on why Economists have a tough stand:
1) No Economist has ever convincingly explained why a normal economy has to go through booms and busts with recessions and occasional depressions, causing great harm to its people.
2) Economists’ failure to embrace the new science of complexity goes some way towards explaining why the market collapse in 1987, 1998, 2000, and 2008 were both unexpected and more severe than experts believed possible. Modern economists spend their time looking for the subatomic particle while ignoring the critical state of the system. They are looking for snowflakes and ignore the avalanche.
3) In general, predicting the economy as well as the future is pointless in a world influenced by randomness. So why are they still often doing it, looking at lagging (GDP) instead of leading indicators?
4) They measure econom
ic progress mainly by GDP-numbers. GDP is a relatively late-to-the-party statistic, thoroughly malleable in its construction and often quite contentious in its application. Yet the mainstream media regularly releases GDP numbers with the implicit assumption that they are an accurate reflection of the general economy. GDP is instead a fuzzy reflection of the economy derived from a model that is continually readjusted in a well-intentioned effort to understand the scope of the economy. The first United Nations guide on national accounts was 50 pages. The latest edition has 722 (!).
Whether the GDP reading is positive or negative, it often changes less in a given quarter than the margin of error in the figure itself and it can be—and generally is—revised significantly, often many years later when almost no one is paying attention. When’s the last time the mainstream media reported a five-year-old revision?
Did the size of the US economy increase by 3% last summer? According to the statisticians it did. They decided to include music and entertainment, and made adjustments to how we deal with investments. These changes were then calculated for all previous years and voilà, the economy was 3% bigger! Small positive annual changes can add up over 40 years.
5) History has proven that their forecasts are worse than fair coin tosses.
Example: In a survey conducted in March 2001, 95% of American economists said there would not be a recession. The recession had already started that March and the signs of contraction were evident. Industrial production had already been contracting for five months.
In December 2007, a Business Week survey showed that every single one of 54 economists predicted that the US economy would avoid a recession in 2008. The experts were unanimous that unemployment wouldn’t be a problem, leading to the consensus conclusion that 2008 would be a good year.
What would that kind of skill-level look like in another influential profession? If doctors were as slow to diagnose diseases as economists are to diagnose recessions, they would be able to tell you that you were sick only when you were already dead.
Economic forecasting appears to be a “science” that makes astrology look respectable.
6) Economists favor regimes that are against nature. Organisms need to die for nature to be resilient: nature is opportunistic, ruthless, and selfish. If nature ran the economy, it would not continuously bail out its living members to make them live forever. The weaker ones have to die.
7) Economists fail to educate the public and to influence the policy makers to do the right things. One of the basic principles of economics is that savings equal investments S = I and this principle can probably be found in the first chapter of every economics textbook. The successful countries in the world do not curb tax savings and investment. They encourage their citizens to save and invest, and to tax consumption. In America, they do the opposite; they encourage consumption. Any interest they pay is tax-deductible and Americans are actually discouraged by the tax code from saving and investing. In order to prosper, we must reverse our priorities.
8) Economic theorists have advised and/or decided to turn on the printing presses. Hence, the central banks have started monetization of debt. Economic textbooks refer to this process as “the nuclear option”–only to be used–when no other method of financing can be applied effectively. Easy to start, but almost impossible to stop. Still, they do it. Did they like to squeeze the toothpaste out of the tube to see how much is in it? And then, leave it to mummy to clean up the mess?
9) They do not help to clarify the paradox systems that we are living in. For example, Central Banks use interest rate policy to control the capital markets. Yet economic theory tells us markets are efficient and should be left to their own devices! Why then do we need Central Banks to set interest rates?
10) The renowned economist Ariel Rubinstein said that for him economics is like a fable; a fable writer is there to stimulate ideas indirectly, to inspire practice perhaps, but certainly not to direct or determine practice. Theory should stay independent from practice and vice versa and we should not extract academic economists from their campuses and put them in positions of decision making. Economics is not a science and should not be there to advise policy.
11) Goodhart’s Law is frequently paraphrased along the lines: “When a financial indicator becomes the object of policy, it ceases to function as an indicator.” In conclusion, central planning is not merely undesirable or sub-optimal; it is impossible. This, however, does not mean that economic systems cannot approach optimality, but that optimality emerges from economic complexity spontaneously, rather than being imposed by central banks through policy.
12) In the real world, people who drove a school bus blindfolded (and crashed it) are never allowed to drive another bus. The economics establishment (regulators, central bankers, government officials, and the various organisations staffed with economists) lost its legitimacy with the failure of the system. Is it responsible or plain foolish to continue to put our trust in the ability of such “experts” to get us out of this mess?
13) It is an even stranger paradox that today’s central banks are generally staffed by economists who, by and large, profess a belief in a theory which says their jobs are, at the very best, unnecessary and more likely wealth-destroying.
14) Unfortunately, some of the most powerful central banks are operated according to a confused mishmash position; one economic philosophy for an expanding economy and another quite incompatible philosophy for a contracting economy.
15) Any economist born since 1952 and having gone through the 1970s economics curricula has almost certainly no formal training in the monetary use of gold. The result has been an accretion of myths about gold instead of serious analysis.
16) Bubble spotting – Credit Growth Is Key: If credit creation is running substantially ahead of economic growth, then that growth is likely itself to be supported by the credit creation and will not be sustained once the credit expansion ends. If asset price inflation is unusually high compared to the income generated by those assets, then the assets may be overvalued. This is particularly important in the stock market where credit creation flows so directly into both earnings and price sides of the price-earnings ratio.
Given the mechanism by which most macroeconomic data can be distorted by financial bubbles, credit creation is not just an important macroeconomic variable; it is the important macroeconomic variable.
17) Learning from the mistakes of others: see Titanic or plane crashes who were/are making the next one less likely. These systems learn because they are antifragile and are set up to exploit small errors. The same cannot be said of economic crashes as the economic system is not antifragile the way it is presently built. Globalized economic systems operate as one: errors spread and compound. Every bank crash makes the next one more likely => we need to eliminate the second type of error–the one that produces contagion–in our construction of an ideal socioeconomic system (Nassim Nicholas Taleb in Antifragile; my summary of the books key message).
18) “I suspect that economists who fully believe in the rationality of businesses and people have never worked a day outside academia.” – Dan Ariely The Upside of Irrationality
19) Something that I find fascinating about economics is how little agreement there is between equally smart people. Other than politics, there are few other fields where experts can be so far apart about basic concepts. All physicists agree on gravity. All mathematicians agree on the quadratic formula. But smart economists can be miles apart about fundamental issues, like whether stocks are cheap or in a bubble. Or whether elephants have four legs or five legs.
20) The problem we have today in economics is that many people—and not a few economists—seem to regard economics as “pure science”. If you delve deep into measurement theory, you will find that all too often the way in which you measure something determines the results obtained from your experimental model. How you measure the effectiveness of a drug can sometimes determine whether it gets approved—apart from whether it actually does any good. The FDA actually works rather hard at measurement theory.
And if you’re using models—like they do in economics—to determine policies that govern nations, your efforts can result in economic misdirection that seems for a time to work, but that all too often lead to a disastrous Endgame. A short-sighted economic policy is not unlike a drug that makes one feel good for a period of time, but ultimately leads to further weakness or collapse.
And what do prominent economists have to say about their own profession?
21) John Maynard Keynes: “If economists could manage to get themselves thought of as humble, competent people on a level with dentists that would be splendid.”
22) Someone who is particularly bad at predicting can be described by the attribute “Dogmatism”. That is the unshakable belief that they know something to be true even when they don’t. They tend to be “massively overconfident”. Smart people love to make smart-sounding predictions no matter how wrong they may turn out to be.
Example: 1998 article in Red Herring magazine titled “Why most economists’ predictions are wrong” written by Paul Krugman, himself, an economist. He points out that too many economists’ predictions fail because they overestimate the impact of future technologies, and then makes a few predictions of his own. Here’s one: “The growth of the Internet will slow drastically as the flaw in “Metcalfe’s law”—which states that the number of potential connections in a network is proportional to the square of the number of participants—becomes apparent: most people have nothing to say to each other! By 2005 or so, it will become clear that the Internet’s impact on the economy has been no greater than the fax machine’s.” (Think Like A Freak)
23) “The more you study economics, the more you realize how little we know about it. People who spend 10 minutes on Google, studying monetary policy think they have it all figured out while we people with Ph.D.s and decades of experience throw up our hands in frustration.” — anonymous (of course)
24) “Stock prices have reached what looks like a permanently high plateau. I do not feel there will be soon if ever a 50 or 60 point break from present levels such as [bears] have predicted. I expect to see the stock market a good deal higher within a few months.” — Irving Fisher, leading U.S. economist, Ph.D. in economics, October 17, 1929
“The end of the decline of the Stock Market will probably not be long only a few more days at most.” — Irving Fisher, professor of economics, Yale University, November 14, 1929
“For the immediate future at least the outlook (stocks) is bright.”— Irving Fisher, Ph.D. in economics, early 1930
By mid 1932, the Dow Jones had lost 90% of its value from the peak before the crash in November 1929.
25) “Economists are at this moment called upon to say how to extricate the free world from the serious threat of accelerating inflation, which it must be admitted has been brought about by policies which the majority of economists recommended and even urged governments to pursue. We have indeed at the moment little cause for pride; as a profession we have made a mess of things.
It seems to me that this failure of the economists to guide policy more successfully is closely connected with their propensity to imitate as closely as possible, the procedures of the brilliantly successful physical sciences, an attempt which in our field may lead to outright error. It is an approach which has come to be described as the “scientistic” attitude, an attitude which as I defined it some thirty years ago, “is decidedly unscientific” in the true sense of the word since it involves a mechanical and uncritical application of habits of thought to fields different from those in which they have been formed.” — Friedrich Hayek, from the introduction to his Nobel Prize acceptance speech in 1974
And some of their critics say
26) “We really can’t forecast all that well, and yet we pretend that we can, but we really can’t.” – Alan Greenspan
27) US President Lyndon B. Johnson once summed up the general feeling about economists when he asked his advisors, “Did you ever think, making a speech on economics is a lot like pissing down your leg? It seems hot to you, but it never does to anyone else.”
28) “Engineers can compute but not define, mathematicians can define but not compute, economists can neither define nor compute.” — Nassim Taleb
29) “Economists are often asked to predict what the economy is going to do. But economic predictions require predicting what politicians are going to do – and nothing is more unpredictable.”
– Thomas Sowell
30) Why is forecasting such a frustrating activity? The simplest answer is that the forces at work in nature are not the same as the forces at work in the human psyche. The accuracy of most forecasts depends on decisions being made by people rather than by Mother Nature. Mother Nature, with all her vagaries, is a lot more dependable than a group of human beings trying to make up their minds about something. – Peter L. Bernstein
31) “Imagine how much harder physics would be if electrons had feelings!” – physicist Richard Feynman
32) Economists do have a few positive traits though. They sometimes call things by its real name. Example: the Fed’s form of theft (from savers) is called Money Illusion by some economists.
33) And they can be quite entertaining as well. Like the Freakonomist Steven D. Levitt.
In conclusion, I would never ask an economist for their opinion, forecast, or recommendation. Just ask him what he has or doesn’t have in his portfolio. If he is not willing to disclose that, no use talking to him any longer.
Phew, that was a really long version.
Congratulations to you for reading up to here.
This deserves an award: