How So-Called Experts

How So-called Experts

Mislead Us about

the Economy

Richard A. Stimson

Published by

Westchester Press

2132-G Crossing Way

High Point, NC 27262

(336) 884-1038

E-mail:

Library of Congress Catalog Card Number: 99-93764

ISBN 0-9671232-6-7

Printed in the United States of America

CONTENTS

Part One: Miscounting Growth, Efficiency, And Debt

1. Who Are The Economic Experts? …………………… 1

2. Faulty Wisdom ………………………………………. 6

3. Measuring Growth …………………………………… 10

4. False Boom Of The Eighties …………………………. 17

5. Deficits And Debt ……………………………………. 24

6. Social Security As Scapegoat ………………………… 34

7. Whose Welfare? ………………………………………. 39

Part Two: Nonsense about Taxes and Income Distribution

8. The Illusion Of Tax Cuts ……………………………… 45

9. Beware Of Tax Reform And Simplification …………... 49

10. Is The Tax Burden Shared Fairly? ……………………. 55

11. The Strange History Of Capital Gains ………………... 62

12. Should Corporate Income Tax Be Abolished? ………… 67

13. Can You Take Tax Shelters With You? ………………. 70

14. The Flat Tax As The Ultimate Simplification ………… 73

15. The Growing Gap Between Rich And Poor ………….. 77

Part Three: Propaganda Of The Privateers

16. Decentralization Of Government …………………….. 86

17. Deregulation ………………………………………….. 93

Privatization ………………………………………….. 110
Saving America From Government Health Care ….…. 130
Why Unemployment Exists ……………………..…… 137
Downsizing And Downgrading ….…………………...145
Old Theories In New Clothing …………………….... 150

Part Four: The Awesome Power Of Bankers

23. The Unelected Rulers Of The U.S. Economy ………… 155

24. The Bugaboo Of Inflation …………………………….. 161

25. The Trouble With Banks ……………………………… 168

26. The Great S & L Robbery ……………………………. 176

27. Man-Made Global Disaster …………………………… 184

Part Five: Corporations Rule The World

28. The Corporate New Order ………………………….. 198

29. A Legal Fiction That Hurts …………………………. 206

30. Monopoly And Restraint Of Trade …………………. 212

31. Changing Views About The Balance Of Trade …….. 229

32. A New Kind Of Trade War …………………………... 237

33. The Arcane World Of Foreign Exchange …………… 246

34. The Challenge Of Straight Thinking …………………. 250

ABOUT THE AUTHOR

Richard Stimson's long-time interest in economics began with his B.A. studies at Yale, which included as many courses in economics as in his major subject (government), but it was many years after his graduation with honors (Orations) in 1943 that he did graduate study and teaching in economics.

Meanwhile, after overseas service in World War II, he began a career in public relations that included pioneer work in civil rights and race relations, co-authoring the Connecticut fair employment law and helping obtain similar antidiscrimination legislation in Pennsylvania.

In New York, he ran the tax information program of the American Institute of CPAs for several years. Later as a special assistant to the senior partner of Price Waterhouse, he helped CPAs put their professional advice and explanations into language understandable by non-accountants.

Serving as president of Stimson Associates, Inc., a financial communications firm representing publicly-owned companies throughout most of Florida during the 1970s, marked the culmination of his public relations career.

From 1977 to 1985 he engaged in a second career of university teaching, having earned a master’s degree from Florida International University, and studied finance in the doctoral program of the University of North Carolina at Chapel Hill. He taught economics, management, and finance at universities in North Carolina and Connecticut, and in the MBA program of the University of New Haven.

His third career in the 1980s, was in the federal government, where he used his computer programming skills to bring a confused military budget under control, and then became the civilian head of computer operations at a U.S. Naval Hospital.

PlayingwiththeNumbers is his second book, the first having been a family history with the title Aldens, Stimsons, andtheirKin (1994), tracing 13 generations from the settlement of New England in the 17th century to their descendents in the late 20th century.

Part One: Miscounting Growth,

Efficiency, And Debt

1. WHO ARE THE ECONOMIC EXPERTS?

Some of the leading businessmen and corporate executives of South Florida were gathered for a deluxe meal to hear a speaker who had flown down from New York City. They were the favorite customers of a Florida banking chain which was their host at this event, he was the chief economist of a leading New York bank, and the stock market had recently reached an historic new high.

The speaker predicted that in a matter of months the Dow would double—and he was dead wrong. While almost all the experts then saw the market going up forever, it actually was teetering on the verge of a crash. Soon it plummeted and South Florida was hit harder than most areas in the recession that followed.

This occurred early in 1973, as the Dow Jones Industrial Average broke the 1,000 barrier for the first time, but it is only one example of how Wall Street bulls run riot whenever there is a record high. Similar enthusiasm erupted, for example, after the DJIA reached 9,000 early in April 1998, as there was talk that the Dow would rise to 12,000 in 18 months and double in ten years to 18,000.

In 1973, the outcome was called correctly by only a handful of bearish forecasters, the best known of whom was Eliot Janeway. He said the DJIA would drop to 500 before it would reach 2,000, and he was about right. The Dow closed below 578 in 1974 and did not reach 2,000 until 1987, which was 14 years later than the experts predicted.

In the prevailing euphoria of 1973, economists generally did not expect the widespread unemployment of the 1974-75
recession. Their excuse for being wrong, in most cases, was that unanticipated events occurred, especially the Arab oil embargo and President Nixon’s resignation due to the Watergate scandal.

Since life consists mostly of unanticipated events, forecasts and predictions always need to be viewed with skepticism. News media habitually call on Wall Street “experts” to explain daily stock market movements. They sound as if they have three explanations prepared in advance: one if the market goes up, another if it goes down, and a third if there is no change.

Financial analysts can always invent explanations for market behavior, but their predictions are as dubious as those of long-range weather forecasters. While it may be disconcerting when the experts disagree about the economy, it can be even worse when they agree, because often they are all wrong.

Meaningless title

There is no law limiting the use of the term “economist.” If a person is a lawyer, CPA, registered nurse, or medical doctor, you have some idea of the training involved, but an “economist” is likely to be anyone who observes and comments on business or market trends. Paul Krugman, then professor of economics at Stanford University and now at MIT, complained in a 1995 article[1] that lawyers, political scientists, historians, and others “cheerfully offer their views” on economics “and especially international trade” in ignorance and contempt for “whatever it is that the [economics] professors have to say.”

Krugman’s article is one of many reprinted in his 1996 book Pop Internationalism[2] attacking the widely held view that unemployment and declines in U.S. wage levels are due to foreign competition, a subject to be discussed in a later chapter of this book. In his view, “the sources of U.S. difficulties are overwhelmingly domestic, and the nation’s plight would be much the same even if world markets had not become more integrated.”[3] “The growth of employment is not determined by the ability of the U.S. to sell goods on world markets or to compete with imports,” he asserted, “but by the Fed’s judgement of what will not set off inflation....”[4]

Another article by Krugman illustrates disagreements among economists and non-economists, pointing to errors by three prominent sources chosen from among dozens of similar cases where the author or speaker was so committed to a viewpoint that “if any data were used at all, it was only to lend credibility to a predetermined belief, not to test it.”[5]

People identified in the news media as economists and treated as authorities are most often employees of large banks, Wall Street securities firms, or major corporations, and sometimes “think tanks” that are financed by the same interests and wealthy individuals. Their statements may be clothed in academic jargon but generally reflect the viewpoints of their employers (which may, of course, coincide with their own).

Even government economists and financial speakers are often recruited from the private financial sector. As explained by a veteran of 30 years in the Treasury Department, Francis X. Cavanaugh, in his 1996 book, The Truth about the National Debt: “The economic spokespersons for the various government agencies are usually subcabinet political appointees whose average tenure is only about two years. Their government service is just a brief interruption in a career in industry, banking, academe, or other parts of the private sector. During their terms in office they are expected to echo the views of the president, cabinet members, and other top officials of the administration they are committed to serve.”[6]

What about university and college professors of economics? With their jobs protected by tenure we might hope for more objectivity and, in fact, most of the non-orthodox public statements come from the academic world. Tenure has become a weaker protection of independence in modern times, however, as universities make more use of part-time untenured faculty and often decline to renew contracts for faculty who are up for tenure.

Well-established professors like James Tobin of Yale and Lester Thurow of MIT, for example, have taken independent and objective positions that challenge conventional wisdom. Several past presidents of the American Economic Association, including Robert Eisner and Franco Modigliani have made some of the same criticisms of conventional wisdom as you will find in this
book. Some other professors, although probably quite sincere in their views, are unfortunately carried along on the tide of conformity, accepting authoritative declarations by their peers rather than insisting on objective proof.

This is nothing new. As long ago as 1897 the famous author of Progress and Poverty, Henry George, complained bitterly about the way most economists rejected his criticisms and proposals without considering their merits: “While a few of these professional economists...resorted to misrepresentation, the majority preferred to...treat as beneath contempt a book circulating by thousands in the three great English-speaking countries and translated into all the important modern languages....”

Had they accepted what he felt he had thoroughly proved, he continued, “it would have converted them and their science into opponents of the tremendous pecuniary interests that were vitally concerned in supporting the justification of the unjust arrangements that gave them power.”[7]

The cult of the Federal Reserve

The research positions at the twelve Federal Reserve Banks tend to be filled by people who fit in with the attitudes of the bankers who make up their boards. At the apex of the pyramid is the Federal Reserve Board, whose chairman’s words are attended with bated breath by Wall Street. Its members are appointed by the President, but each has a 14-year term that equals three and a half presidential terms of office, and they are further entrenched because their terms are staggered. Although its members never have to answer to the voters and are largely independent of both the President and Congress, the FRB sets the limits on economic growth for this democracy.

The law under which it operates requires it to aim for full employment as well as stability of the currency. The first requirement seems to have been forgotten by these bankers’ bankers, who seem to fret at the least hint of inflation but offer only sympathy for unemployment. Raising interest rates when there is no inflation in sight, is what they call a “preemptive
strike.” Perhaps pronouncements from the Federal Reserve should be taken with much greater skepticism than is usually applied.

2. FAULTY WISDOM

Economics is an important and valuable field of study, but also it has dangerous weaknesses. Economists worry that their subject lacks the precision and predictability of the physical sciences and try too hard to make up for it. Like others in the social sciences, they tend to worship mathematical cleverness, forgetting the uncertainties that underlie their data. They often seem unaware of a mathematical principle I learned in high school, an extension of the “weakest link” axiom. The result of a calculation can never be any more exact than the least precise of the quantities that entered into it (that is, if a quantity correct to one decimal place is multiplied by another more precise quantity, the answer is still only correct to one decimal place).

A good example of emphasizing math at the expense of the real world from which the numbers are taken comes from the experience of a doctoral student in a seminar at the University of North Carolina at Chapel Hill where students were each to present a critical review of a scholarly paper. The professor gave him a copy of an article by a graduate student at another university that was to be submitted for publication in a journal.

The author of that article manipulated symbols to develop a theory. His complicated calculus may have been mathematically correct, but his assumptions never recognized the difference between commercial banks and thrift institutions. The Chapel Hill student didn’t bother to check the math because, as he pointed out, the elaborate manipulations of mathematical symbols were all based on a faulty premise.

The professor, surprisingly, said the student should have “suspended disbelief” and just verified the author’s calculus. The article was published later in a professional journal and the author was hired as an economist by one of the twelve regional Federal Reserve banks! The overemphasis on mathematics was the subject of a witty remark attributed to prominent economist Robert L. Heilbroner: “Mathematics has given economics rigor, but alas, also mortis.”

As an extension of this kind of thinking, an article, “Math Against Tyranny” by Will Hively in the November 1996 issue of Discover, presented physicist Natapoff’s mathematical defense of the electoral college, showing that the probability of deciding a presidential election by one person’s vote is greater under the existing system than with direct popular election. Natapoff and Hively (like the news media) seem to regard politics as a sport. The more exciting, interesting, and entertaining the better—especially if the outcome can be decided by a lucky shot in the last minute of the final game. Completely ignored was whether the election outcome would reflect the choice of the public as a whole.

The fallacy of “economic man”

Economists, like others who work in their own narrow fields, tend to ignore whatever has been learned in other disciplines, notably psychology in their case. They have invented “economic man” who always acts rationally in terms of his economic interest (this idea having been handed down from a time when women were not thought worth considering). Technically, he makes all choices to “maximize his marginal utility.” Having used this concept in their analyses, they don’t usually recognize that their results are based on a fiction rather than a real person.

Some of the problems of such a view were well described in an article, “The Limits of Markets” by Robert Kuttner, editor of TheAmericanProspect, in theMar.-Apr.1997 issue: “People help strangers, return wallets, leave generous tips in restaurants they will never visit again, and give donations to public radio.” He could have added that some people choose occupations that offer opportunities for useful service but little in monetary terms.

When the “economic man” concept is criticized, defenders answer by claiming that altruism is a special form of selfishness where the reward comes from enhanced reputation. If countered by the example of those who follow the Biblical injunction to give secretly, they talk of “psychic income,” a concept that gets lip service but doesn’t seem to fit their equations and models.

By their rules, as Kuttner illustrated, economic theory can even make voting irrational, because the “benefit” derived from
the likelihood of one’s vote affecting the outcome is not worth the “cost.” Kuttner’s 1997 book, Everything for Sale: The Virtues and Limits of Markets, summarized the extreme views of Anthony Downs, a leader of the “Public Choice” movement that applies market analysis to political institutions. In An Economic TheoryofDemocracy (1957), Downs argued that the democratic ideal is a sham, because the “median voter” is uninformed and organized groups dominate politics. Kuttner described Downs’s work as “pure theory and logical manipulation, in narrative form supplemented by algebra,” with “no empirical or historical description of the actual political process.”[8]

Another problem is the traditional use of a set of assumptions largely borrowed from Adam Smith’s Wealth of Nations (1776) that bear little resemblance to today’s global economy of multi-national corporations and cartels. Many economists act as if we lived in Adam Smith’s world where markets consist of many small buyers and sellers of standardized products, each acting independently with perfect information and no barriers to new firms entering the industry. It is also easy for them to forget the “other things being equal” assumption.