http://www.investorsinsight.com/article.asp?id=jmotb030705
The Mystery of the Awful Economists
By Barry Ritholtz
2005 March 7
John Mauldin's Outside The Box
I've been making a fortune lately. (No, I don't own any Google IPO
shares). Each month, I've been betting on the outcome of the Non-Farm
Payroll report against my economist colleagues. I've been taking the
under, and, over the past year, it's been money 87% of the time. I
expect this wager on a monthly jobs shortfall to remain successful for
the foreseeable future.
Less lucrative, but much more fascinating than my book-making activity
is the perplexing question Why? Why have the dismal scientists been
unable to accurately discern what the employment situation is? It has
certainly been perilous predicting job growth this business cycle; aside
from a tendency towards over-optimism, what explains the consistent
forecasting errors? Job growth predictions have been wronger, longer,
and by a greater amount, than at any other time in the modern era of
economics.
This is an intriguing whodunit to me.
Non Farm Payrolls, Post Recession: 2001-05 versus Average Recovery:
Chart 1
Source:Federal Reserve Bank of Cleveland (Caveat Forecaster, February 2005)
As Yogi Berra so wisely observed, It's tough to make predictions,
especially about the future. Those of us who work in glass houses -
strategists, economists and weatherman - ought to be careful about
throwing stones. But my crowd (Market Strategists) are typically wrong
about the future. This cycle, Economists have been unusually bad at
predicting what happened just last month. The monthly consensus on
Non-Farm Payrolls plays out like an old joke: There are 3 types of
economists: Those who can count, and those who can't.
Clearly, something is amiss.
But rather than merely poking fun, we should be asking ourselves why
this recovery is generating such weak job creation and correspondingly
bad forecasts. Has something changed structurally? Are some basic
assumptions about the business cycle flawed? Perhaps econometric models
are missing or over-weighting a key factor. Indeed, what is it that
nearly the entire field of economics has been somehow getting wrong?
I've been pondering this question for some time now. I have considered -
and disposed of - the myriad excuses proffered: The disproved claims of
the BLS Payroll Survey undercounting jobs versus their Household Survey;
the uncounted self-employed, work-at-home-independent contractor; that
the Bureau of Labor Statistics data is somehow bad; the rationale that
(somehow) eBay is the explanation for 7 million missing jobs..
As a person unburdened by a Classical Economics education - I'm not
an economist, but I sometimes play one on TV - I am free to ask the
questions most economists can't. I have my suspects in the mystery of
the awful economist. These are the most likely factors contributing to
forecasting errors:
1. Globalization Outsourcing
2. Productivity Gains
3. Post-Bubble Excess Capacity
4. ADCS (ERP)
5. Dividend Tax Cuts
6. Political Bias
7. NILFs
8. Permanent versus Temporary Layoffs
9. Underemployment
10. Shell Shocked Executives
The first two points - Outsourcing issues and Productivity improvements
- have been pretty thoroughly reviewed by economists - so neither of
those issues is likely the cause.
But that still leaves a long list of unconventional issues that may be
at least partly responsible for anemic jobs numbers. Let's delve into
the details of these topics more closely:
3. Post-Bubble Environment: The 1990s bubble saw a massive amount of
over-investment, with capital as plentiful and cheap as it was. This
created excess capacity across many industries, but most especially in
the fast growing technology and telecom sectors. Part of the hangover
caused by the bubble's bursting has been that demand has not yet
ramped up to the point where it can absorb all this excess. (You can
see exactly how far below trend the economy is regarding industrial
production and capacity utilization at the Federal Reserve's Web
site). Five years after the bubble burst, some people think its ill
effects are behind us. I suspect we will continue to pay for the
excesses of the 90's for some time to come.
Regardless of your economic persuasion - be it Supply-sider or Keynesian
- excess capacity in a post-bubble environment makes it especially
difficult for the economy to absorb any slack in the labor market.
4. Unintended Consequences of Accelerated Depreciation of Capital
Spending (ADCS): There's no such thing as a free lunch. While the (now
sunsetted) accelerated depreciation schedule undoubtedly generated a
boon in capital spending, the unanswered question is At what cost?
It has long been a staple of economic theory that capital spending makes
companies more competitive, boosts profits, adds to the gross domestic
product, and puts people to work. This held true throughout most of
