I once worked with a woman who had a degree in economics. Her boyfriend drove her crazy by arguing that the entire field of economics could be boiled down to the notion of supply and demand. Everything else, he asserted, was an unnecessary complication of the obvious. It’s funny, but how accurate was the boyfriend?
Before we go on, I should confess that I have a degree in economics. All I remember from my college classes is that the professors talked like Charlie Brown’s teacher (mwa-mwa-mwa), and something was said about supply and demand. So I don’t approach this topic as an expert. I’m just a curious observer.
Some years ago, I attended a wedding and ended up seated next to two young chiropractors. They described to me the many benefits of the chiropractic arts, including – they claimed with straight faces – the ability to cure both AIDS and the common cold by boosting a patient’s immune response. I just listened and smiled. I was smug in my knowledge that these two gullible simpletons believed in some sort of magic, whereas my economics degree – which is more like a real science – would allow me to predict the future and become wealthy without any real effort. At that point in my life, the benefits of my economics training hadn’t yet kicked in, but I figured it was only a matter of time. Science was on my side.
Since then, I’ve achieved some humility about the value of my economic superpowers. For example, when I first started making serious money from writing Dilbert books, I paid financial experts to manage my investments. They invested my money in Enron, WorldCom, and several other sketchy companies with high price-earnings multiples. This was right before the dotcom bust. Do you know who could have done a better job with my investments? Answer: chiropractors.
All of this makes me wonder how one would go about analyzing the field of economics to find out if it’s mostly legitimate, albeit imperfect – like weather forecasting, or mostly psychological, like horoscopes. Let’s dig into that question.
In recent years, the definition of economics has broadened, thanks to popular books such as Freakonomics. Now when we speak of economics we can include scientific studies and analyses on just about any interesting aspect of life, from crime rates to prostitution. I consider that a red flag for the legitimacy of economics. In my experience, whenever someone tinkers with the definition of a thing, it’s because the original thing is broken and no one is willing to admit it. Back in my cubicle days, if we failed to achieve a goal, we changed the definition of success until whatever fresh hell that was happening on its own fit the new definition. When I became a cartoonist, and the public astutely noticed that my art skills rivaled those of an inebriated chimpanzee, I defined myself as more of a writer. Be wary of shifting definitions.
I’ll grant you that our newly expanded definition of economics – the one that involves studying human behavior as opposed to business and money – is legitimate and useful. And I will grant you that the common sense elements of economics, such as portfolio diversification, and paying off your credit cards, are legitimate and important. What I’m skeptical about is anything that involves complicated models and predictions about the future of the economy.
In my corporate days, I wrote business cases and created financial projections. Over time, I observed how well my predictions matched reality. In my perfect models of the future, I could estimate the likely outcomes with confidence. In the messy real world, the surprises always dominated the results. We never knew for sure what our competitors were cooking up. We didn’t know to what degree our vendors were lying about their products. We didn’t know management would change priorities mid project. The stuff we didn’t know was always more important than the stuff we knew. My predictions were only useful for short term budgeting and to give the decision-makers some buttocks-shielding.
In this presidential election season, we see more babbling about economics than usual. You’d think the experts could agree on the basic stuff, such as tax rates and stimulus packages. But politics will always dominate those discussions. And economists are rarely in universal agreement on anything complicated. So even if we imagine that somewhere in the world an economist has a model that accurately predicts the future, as long as you feed it accurate assumptions, it still does us no good because there is no hope that the assumptions will be accurate.
If I haven’t convinced you that rotten assumptions ruin all predictions, allow me to take another path to the same conclusion. Let’s imagine there is an economist who has, against all odds, reliable assumptions and a good economic model for predicting the future. How would the world identify this lone genius so we could take advantage of his skills?
By analogy, there are over 10,000 individual stocks you can buy in the United States. Your first instinct might be to hire an expert to do the picking for you. But what if there are more than 10,000 experts and all of them have different opinions? Given that past performance is no indication of future performance, isn’t it just as hard to pick the right financial expert as it is to pick the right stocks? As long as there are thousands of economists with different opinions, and some portion of them have a good track record by chance, we have no way to know who can predict the future best.
My working hypothesis is that economics can be divided into three categories. There’s the common sense stuff, such as supply and demand, and diminishing returns. Then there’s the extended definition of economics that includes looking at statistics in fields unrelated to money. And there is the third category, which might be called pure economics, existing in a smeared state of being potentially legitimate, but giving us no way to know for sure.
Here’s my advice: If you meet an economist, ask him to adjust your spine so you no longer get the common cold. Then ask him for some specific investment tips and do exactly what he recommends. Let me know which one works out best.