Who You Gonna Believe, Economists Or Those Lyin’ CEOs?
When it comes to forecasting, no year is a truly good year for economists. And that's an issue because in most professional settings, economists are tasked with making predictions.
To be sure, criticism of the economics profession long ago passed the threshold marked "gratuitous," but I'd gently suggest the overarching problem resides with practitioners, not critics, no matter how insufferable and petulant those critics can be.
In the simplest possible terms, economics is the only profession t
Downgrading economics to what it is – a social science seems correct. It is an informative discipline, but its models should be regarded as models of human behavior. Human behavior is not prone to accurate forecasting, especially in the short run. And it is not stable in the long run either.
If I may, I’ll annoy you and your readers with an old man’s recollection.
Bank CEOs can be blindsided like the rest of us.
I recall a conversation with a colleague back in early 2009 when bank CEOs presented optimistic forecasts while discussing their 4Q 2008 earnings. I kept harping on the widely overlooked credit issues, like CDO squared products. (I should be rich!). Meanwhile Tobias Lefkowitz highlighted bank stocks as the #1 must-have sector for 2009 because of those CEO forecasts and the juicy dividends banks were still paying.
My colleague asked me “So, do you think that they are all lying?” After a moments hesitation I mumbled “yes”. In retrospect should have been more forthright in my assessment. Most were not deliberately lying, just humans who knew only a little more than the rest of us.
It’s not bank CEOs telling Solomon that inflation is endemic across their supply chains.
Derek, as the market bottomed in early March 2009 they were actually all correct that the banks were a buy. Here in Canada bank yields were around 9 to 10%. Over the next few years they increased their dividends aggressively and the stocks went up between 200 to 500% since then, so it was the buy of a lifetime, for those who had money. But most everyone was scared silly and on one bought even if they had cash.
I imagine there is a pretty wide gulf between ecomonists’ data sources and company managements’ data sources. Economists use aggregate time-series data, often national or otherwise very broad. Company managers look at prices for specific services and products bought and sold in their business. Companies don’t generally share that data with economists, as far as I know, and I suspect most economists might have trouble using data that is scattered, anecdotal, and highly specialized. The Fed likely has the influence to get proprietary and internal company data (when I was covering UPS, the CFO told me that the Federal Reserve would routinely ask for, and receive, internal data on UPS’ shipment activity in the weeks before FOMC meetings). Street economists probably don’t.
In theory, if all companies fed real time internal data to some central database, some pretty cool economic analysis and maybe even forecasting could be done. But for now, each company management feels up his or her part of the elephant while economists follow behind the elephant measuring its stride and the temperature of its droppings, and it’s perhaps not surprising that no-one has a detailed understanding of the entire pachyderm.
Thank you for sharing!
H-Man, if you wanted to know how much gold could be found in a gold mine, would you ask an economist or the guy digging the gold?
Geologist
Economics and economic forecasting might yet one day become a hard science if we live long enough to achieve quantum computing and advanced AI, a powerful future algorithm might succeed in predicting patterns of human behavior with enough accuracy to render human economists useless.
Central bankers are saying what they see and how they see it. They do acknowledge they need to rely on the data to make decisions. They’ve changed their mind when faced with new data and changed their decisions accordingly.
This approach is pretty scientific and at least adds rationality to decisions that are being made, even if in hindsight different decisions would have been best.
I think future generations will benefit from the updated supply/demand shock models being developed now by economists the same way we’re benefitting now from previous lessons in economic catastrophes dissected and studied by economists. We should give the central banks more credit for having averted a major Depression when the economy seized in 2020.
Sure, by avoiding a known bad path we may have entered a new worse path, but at least we’ll learn the new lesson and aren’t repeating a past mistake. We’ll get this right eventually.
Engineers get to perfect our craft by building prototypes informed by models. Surgeons can practice on cadavers. Economists don’t have the luxury to build prototype miniature economies to quickly check what they have yet to learn.
Side note: engineers do keep their jobs even after messing up terribly. Look at the Tesla cars barging into emergency vehicles with bright lights. No one at Tesla has been fired for releasing this kind of life-threatening-ly undercooked, haphazardly-put-together technology.
Actually, the top engineer running the autopilot program at Tesla has quit and Musk has just closed the office where the autopilot function has been developed and laid off all its personnel.
Reading this, I find myself wondering – if we all collectively decided to demote economics as a science, what (if anything) would replace all the economic advisors to politicians, central banks, etc. In that world, if central banks did not rely on their economic models and forecasts (which seem to be just as wrong as anyone’s economic forecasts), what would guide their policy decisions? There’s probably good answers to those questions but I find myself struggling to picture in my head.
I submit that the intersection of economics and politics is very much like the intersection of meteorology and politics. Trump’s 2019 forecast of hurricane Dorian is a good example. Politicians will bend the data, forecast and ultimately the history to suit their narrative. https://www.nbcnews.com/politics/donald-trump/why-does-trump-s-hurricane-map-look-different-others-n1049711
And remember, CEO & CFO are political positions.
The prescribed method for making such forecasts in Roman times was the reading of animal entrails or noting the flights of various birds. Emperors, Senators, and other important types had their own go-to Augur, who was supposedly skilled in such techniques. Romans, and later civilizations,also believed in omens, patterns in bones or stones thrown randomly, as well as listening to various learned “oracles.” No economist does any better than these ancient seers because, as H has often pointed out often in these posts, there is just no getting around the laws in statistics.
There is a cute ad running right now which pictures a little girl riding in a car with her dad. The little girl suddenly asks, “What is the future?” Taken aback he says something like it’s what is coming next. In “No Country for Old Men” a girl at a motel pool asks the Josh Brolin character what he’s doing and he replies, “Looking for what’s next.” She says no one can see that.
I earned a BA in Econ and took the same core Econ courses in my doctoral program as the Econ PhDs took and I came to three conclusions. First, adding a Nobel Prize in Econ was a big mistake. Second, economists should come with term limits, as in they are limited in practicing their craft to a certain time frame, say 20 years, then they have to quit and become welders or something. Finally, they should also have some coupons on their degrees. To make a forecast affecting the lives of real people requires spending a coupon. When the coupons are gone, no more forecasts allowed. In my experience, the main trouble with economists who get tangled up in the “tar baby” that is real world business, is that academic economists aren’t taught about business. The don’t understand it and they don’t really like getting involved because it doesn’t fit the models.
“In my experience, the main trouble with economists who get tangled up in the “tar baby” that is real world business, is that academic economists aren’t taught about business. The don’t understand it and they don’t really like getting involved because it doesn’t fit the models.”
Great observation, and a scary one. Scary because it also applies to quite a few economists in position to do some real damage to real people.
I’m not sure how you propose to demote economics. Economics drives most decisions that American’s make. Their access to money drives how large those decisions are, but at the end of the day, everyone is weighing how to spend and invest money. Money is what drives the work we do, how well off families are, and whether or not we live or die. To demote economics would be to demote money. I just never see this happening though. Economics was boiled down to a simple definition for me once. Economics is the science of dealing with scarcity. No matter how much we optimize production, goods, services, water, air, land, etc. do not stop being scarce.
To your point about lack of consequences, I view the weather in a similar vein. Weather is a hard science but we call the people giving us forecasts “weather guessers” for a reason, they are reliably unreliable. Do we stop listening to them? No, we just accept that whatever forecast we are given, it has some chance baked in of being completely wrong. These mistakes can also be deadly, just on a smaller scale than economist’s missteps. I think the point about consequences does matter though. The miss on inflation last year wasn’t due to a lack of data, it was due to ignorance of it. That analysis should have led to changes at the FOMC, sorry we want the wealthiest economy in the world to not ignore important data that will impact everyone’s lives. Good luck going back to the bank you used to work for with a huge salary. Perhaps economists having those types of consequences on their back will force them to not arrogantly ignore obviously bad data?
Another great piece on the problems with economics/economists.
I have gone out of my way to focus on the markets side of things and think more like a trader. But, my role is often that of an economist and I’ve always tried to do exactly what you suggest: “take the initiative and disavow the pretentiousness afforded to them by the rest of us”. Those of us who have to forecast the future need a healthy dose of humility, especially at the moment, and any forecast should be accompanied by a level of conviction. Let’s not kid ourselves or our audience.