Thought Theater

Economists: Riding The Waves Without A Board? genre: Econ-Recon

Today's gloomy jobs report...and the associated downward revision of the prior months figures...reminded me of my time as an economics major many years ago. I've always found economics fascinating. While in college, it was my major for three years before I elected to reconsider...eventually majoring in psychology.

I decided to drop economics for one particular reason...one that may no longer be as ingrained in the field as it was back in the day. I can trace my decision to one particular class. That particular day the class focused upon what was at the time a little discussed topic...the role which politics and psychology played in economics and whether such considerations ever influenced economic decisions.

The professor made the case that economics was primarily a function of formulas, statistics, and mathematical equations...while other considerations lacked the means to be measured leaving them deserving of no role whatsoever. In retrospect, he was a purist...a likely result of being an educator rather than a practitioner. I disagreed with his assessment and proceeded to argue that politics and psychology in fact played an integral role and that it was impossible and imprudent to ignore them. I offered some examples to support my contention, but in his zeal for basic mechanics, he dismissed my observations.

Following that exchange in class, I met with my advisor to ask if the department offered any classes which emphasized that particular area of economic thought. Much to my disappointment, I was told that the program had no such emphasis. When I asked if he knew of a university with such a program, the only one he knew to be offering such a focus was in London. Needless to say, I wasn't prepared to make such a move.

Over the years, I've continued to follow economics...and while my particular area of interest has expanded...the field is still populated with rigidity. I've concluded that this results from an ingrained need...one which mimics the protection of intellectual property. Many economists like to think that the average individual is woefully unable to understand the mathematical mechanisms which drive the discipline.

To be fair, economics is complex and many wouldn't understand the elaborate equations. However, many within the field have a virtual blind spot when attempting to provide predictive analysis...which results from their strict adherence to formula and their stupefying insistence upon discounting the impact of politics and human psychology. Fortunately, some progress has been made but it has been far slower than one should expect.

Returning to our current economy, this new jobs report...coupled with the numerous other vulnerabilities and factors...provides a perfect example of the shortcomings which result from a refusal to move beyond the chalkboard. Let's look at the specifics.

From The Washington Post:

Job creation in the United States came to a standstill in August, according to a Labor Department report today, as the worsening housing market led employers to sharply slow hiring.

The nation lost 4,000 jobs in August, the first time employment has shrunk since August 2003. Economists had expected a gain of about 125,000 jobs. The report also revised previous month's job growth downward and indicated that the unemployment rate held steady at 4.6 percent.

The report indicates that employers became more cautious about hiring before any impact of the breakdown of many credit markets in August could be felt. The survey was taken in the second week of August, when problems in the financial markets were just starting to emerge.

It suggests that the risks of a serious economic downturn due to problems in the housing markets are higher than had been thought, said economists. "People have been saying for some time, the consumer will be affected by housing, but as long as job growth continues, the consumer will be OK," said Nigel Gault, a U.S. economist with consulting firm Global Insight. "Well, now here we are at minus 4,000 jobs."

"It's not the kind of number I'd like to see," Treasury Secretary Henry Paulson told Bloomberg Television. "Data does not always move in a straight line, so occasionally you will find some surprises. The economy will continue to grow in the second half of the year."

Others called on the Fed to act.

"Too little has been done to quiet the market's justifiable fears that things are headed downhill," said Sen. Charles E. Schumer (D-N.Y.), chairman of the Joint Economic Committee.

From Forbes:

The economy lost 4,000 jobs in August, an unexpected loss compared with the 118,000 increase economists polled by Thomson's IFR Markets had expected. The August decline is the first drop in non-farm payrolls since August 2003.

I provided the Forbes citation to point out the concerns I have with the field of economics. In comparing the actual loss of 4,000 jobs with the 118,000 new jobs predicted by those economists who were surveyed, one begins to see my contention. Economic projections are accurate so long as the political and psychological environment remains stable. Once people (politicians, business owners, consumers) become alarmed, the formulas begin to fail. As such, I've long felt that credible economic analysis is lacking at the time when it is most needed...times when the economy is facing dramatic change or turbulent conditions.

An example is warranted. Many within the banking industry have economic backgrounds. Unfortunately, banks are notorious for being much too slow to react to shifting conditions; relying upon historical data and trends while missing key warning signals. The sub-prime lending mess and the overall lack of restraint in mortgage lending are perfect examples of this virtual complacency in the midst of pending doom. I view it as a seesaw effect...meaning banks generally tighten their lending practices long after they are in crisis and then fail to ease them when they are most warranted. In essence, they push when they should pull and visa versa.

For months, those economists willing to consider the full spectrum of factors have been suggesting that the sub-prime/mortgage lending crisis had the potential to push the economy into recession. At the same time, bankers and economists who are prone to predictive paralysis become mesmerized by stable profits and persistent trends...ignoring the storm hovering on the horizon.

By the time they look up, the storm is upon them and they lack the means to react and respond. Suddenly, the cumulative effect of mistakes at the margin are multiplied into a full scale crisis...hence the domino effect we're now witnessing...and the astonishing miscalculations evidenced in today's job report.

Note the language in the Washington Post which states, "The report indicates that employers became more cautious [...]" and ""People have been saying for some time, the consumer will be affected by housing [...]" and "Too little has been done to quiet the market's justifiable fears [...]"...all factors which will not fit into tidy economic formulas but undoubtedly have a dramatic impact.

Until such time as those in the field of economics...the number crunchers if you will...can see fit to cultivate a curiosity for abstraction and human nature, they will continue to chase the curves that so consistently evade their awareness. The last thing we need is someone to tell us we're in a recession...well after we've arrived.