Connecting the Dots

×

Connecting the Dots, Patrick Watson’s online newsletter, now lives exclusively on the Mauldin Economics website.

Please bookmark this page so you can always find his latest take on the geopolitical, cultural, and technological forces decentralizing and disrupting the global economy.

The Dismal Science Depends on Bad Data

June 19, 2018

Those who call economics “the dismal science” are half right. It is indeed dismal (“dingy and unwelcoming”) to think about, except for dweebs like me.

But economics is definitely not a hard science, like physics or chemistry. It has nothing like Isaac Newton’s “laws.” Had Newton been an economist, he might have said gravity applies most of the time, until enough people decide it shouldn’t.

So economics is more a social science. If it has any fixed rules, they are so complex as to be practically unknowable.

The problem is, many economists don’t want to admit this—and we all pay the price.


Photo: Getty Images

Unrealistic Assumptions

John Mauldin likes to call Dr. William White his favorite central banker. White, the former chief economist for the Bank of International Settlements, has an extraordinary gift for defining problems and solutions in precise yet understandable language. I read everything he writes because it’s always interesting.

Recently, White wrote the foreword to a report analyzing college-level economics education in the Netherlands. You can read it here (skip ahead to page 11 of the PDF file). Here are some excerpts.

What does an economist do? He or she first seeks to understand how the economy works. Then an economist asks how different policies might help it to work better, to improve the well-being of all people in a sustainable way.

Evaluating policy prescriptions requires an understanding of the theory of knowledge – how do you know you know? Making policy trade-offs requires a broader sense of morality and ethical choices.

Implementing policy suggestions requires an understanding of political realities – it is easier to go through an open door than a locked one. And above all, there must be an understanding of contemporary problems. What is broken and needs to be fixed?

In effect, what is now defined as ‘economics” is no longer a discipline to understand how the economy actually works. It has been transformed into an agreed method of inquiry, using models that are based on a whole host of unrealistic assumptions.

Models based on these assumptions simply have no place for the global economic crisis and the slow economic growth that have characterized the last decade. In the world of the models, these events are impossible. One might have thought that this fact alone would have triggered a fundamental rethink of the models and the academic curricula associated with them.

Do not true sciences advance by confronting theories with facts? Indeed, would it not be better to assume that the economy is a complex, adaptive system often generating highly non-linear outcomes?

While there are some welcome signs of change, we are still far from the “paradigm shift” required to make academic economics a practical discipline again.

I think he states this eloquently and accurately. The economy is a complex system with “highly non-linear” outcomes. You can’t capture it with math equations.

Consider psychology for comparison. We don’t fully understand why people make all the choices they do, nor can we reliably predict them in all cases. Economics is exponentially more complex because it deals with the choices of millions—or even billions—of people.

So, I’m glad Dr. White said all this, and I hope the economics profession takes it to heart. But even if they do, we have another challenge.


Photo: Getty Images

Faulty Inputs

You’ve heard “garbage in, garbage out.” It’s a good rule for any kind of data analysis. Your analytical methods can be top-notch and still fail if the inputs are faulty.

The US government generates much of the economic data we use. If it’s wrong or incomplete, policymakers, businesses, and consumers could all make poor decisions.

Recently, I got to be on the other side of the government’s data collection. It was enlightening.

In addition to writing about economics, I’m also a small-business owner. My wife is a hair stylist and we own a seven-chair salon. I don’t cut hair (nor would you want me to!), but I help on the administrative side.

Last month, we received a giant “OFFICIAL BUSINESS” envelope from the US Commerce Department.

Somehow, they selected us to participate in a government survey. The packet contained a long list of nosy financial questions, plus a stern warning that complete answers were required by law. You can imagine how thrilled we were.

It turned out to be not so complicated. Most of the questions didn’t apply to our business. The ones that did apply were easy to answer because we keep good records.

But then there was the gray area—ambiguous questions you could fairly interpret in different ways. I did what I could, but I still don’t know if it’s what they wanted.

Guess what, though: those answers are now part of the official data.

Furthermore, I know of other salons whose bookkeeping is, shall we say, relaxed. Some probably got picked for the survey too. How did they answer those questions?

Nor is it just hair salons. All small-business owners tend to be busy folks. I suspect many of these surveys get rushed through. The answers are either wild guesses or complete fiction.

Having gone through this, I’m now a lot more skeptical when I see government-collected business numbers. I’m sure the agencies do their best, but getting it right seems almost impossible.


Photo: Getty Images

Recipe for Disaster

The problem with economics is really three problems.

  • Economists produce models that don’t (and can’t) capture the full complexity of the economy.
  • The data that goes into the models is often flawed or incomplete.
  • Central banks, regulators, and lawmakers rely on both to make important decisions.

If you think this is a recipe for disaster, you’re right. I think it had something to do with the 2008 crisis. And since we haven’t fixed it, these problems might lead us into another crisis.

When will it happen? Your guess is as good as mine—or the government’s.

See you at the top,

Patrick Watson
@PatrickW

Discuss This

We welcome your comments. Please comply with our Community Rules.

Comments

There are no comments at this time.


Use of this content, the Mauldin Economics website, and related sites and applications is provided under the Mauldin Economics Terms & Conditions of Use.

Unauthorized Disclosure Prohibited

The information provided in this publication is private, privileged, and confidential information, licensed for your sole individual use as a subscriber. Mauldin Economics reserves all rights to the content of this publication and related materials. Forwarding, copying, disseminating, or distributing this report in whole or in part, including substantial quotation of any portion the publication or any release of specific investment recommendations, is strictly prohibited.
Participation in such activity is grounds for immediate termination of all subscriptions of registered subscribers deemed to be involved at Mauldin Economics’ sole discretion, may violate the copyright laws of the United States, and may subject the violator to legal prosecution. Mauldin Economics reserves the right to monitor the use of this publication without disclosure by any electronic means it deems necessary and may change those means without notice at any time. If you have received this publication and are not the intended subscriber, please contact service@mauldineconomics.com.

Disclaimers

The Mauldin Economics website, Yield Shark, Thoughts from the Frontline, Outside the Box, Over My Shoulder, Transformational Technology Alert, Rational Bear, The 10th Man, Connecting The Dots, Stray Reflections, Street Freak, ETF 20/20, Macro Growth & Income Alert, In the Money, and Mauldin Economics VIP are published by Mauldin Economics, LLC. Information contained in such publications is obtained from sources believed to be reliable, but its accuracy cannot be guaranteed. The information contained in such publications is not intended to constitute individual investment advice and is not designed to meet your personal financial situation. The opinions expressed in such publications are those of the publisher and are subject to change without notice. The information in such publications may become outdated and there is no obligation to update any such information. You are advised to discuss with your financial advisers your investment options and whether any investment is suitable for your specific needs prior to making any investments.
John Mauldin, Mauldin Economics, LLC and other entities in which he has an interest, employees, officers, family, and associates may from time to time have positions in the securities or commodities covered in these publications or web site. Corporate policies are in effect that attempt to avoid potential conflicts of interest and resolve conflicts of interest that do arise in a timely fashion.
Mauldin Economics, LLC reserves the right to cancel any subscription at any time, and if it does so it will promptly refund to the subscriber the amount of the subscription payment previously received relating to the remaining subscription period. Cancellation of a subscription may result from any unauthorized use or reproduction or rebroadcast of any Mauldin Economics publication or website, any infringement or misappropriation of Mauldin Economics, LLC’s proprietary rights, or any other reason determined in the sole discretion of Mauldin Economics, LLC.

Affiliate Notice

Mauldin Economics has affiliate agreements in place that may include fee sharing. If you have a website or newsletter and would like to be considered for inclusion in the Mauldin Economics affiliate program, please go to http://affiliates.ggcpublishing.com/. Likewise, from time to time Mauldin Economics may engage in affiliate programs offered by other companies, though corporate policy firmly dictates that such agreements will have no influence on any product or service recommendations, nor alter the pricing that would otherwise be available in absence of such an agreement. As always, it is important that you do your own due diligence before transacting any business with any firm, for any product or service.

© Copyright 2018 Mauldin Economics