When Good Things Happen to Bad Ideas
A few weeks ago, I was looking for something to
watch on television while I made dinner, and there was CNN's Lou Dobbs
introducing financial columnist James K. Glassman, identifying him as the
author of Dow 36,000 (presumably a forthcoming book ). I immediately
switched to the History Channel. But over the next few days I found myself
thinking, one might almost say brooding, about the sighting.
You see, last fall,
Glassman--who has used such forums as the Wall Street Journal editorial
page to propound his view that the prospect of future earnings growth justifies
much higher stock prices than anything yet seen--participated in a
Slate
"" about the subject. His sparring partner was Clive Crook
of the Economist , a publication that has repeatedly asserted that U.S.
stock prices are not only excessively high but dangerously so and that the
history of Japan's notorious "bubble economy" is being repeated. Alas, the
dialogue came to a sudden screeching halt when it became clear that Glassman's
views were based not on some at least debatable vision about America's economic
prospects but rather on a simple misunderstanding of corporate accounting (in
essence, Glassman was claiming that businesses can eat their seed corn and
plant it too). It is unclear from that exchange whether Glassman understands
even now that his famous calculation involved naive double-counting--he
certainly did not concede any mistake--but an embarrassed Crook saw no point in
continuing the discussion.
It isn't all that unusual a story. Indeed, it is quite
commonplace for influential people to propound economic doctrines that are "not
even wrong," that is, that involve a basic conceptual or accounting
impossibility. But there is a kicker in this case. Imagine a
Slate
reader who for some reason just could not grasp Crook's
point, who despite everything found Glassman's position convincing. That reader
would presumably have invested heavily in the stock market--and profited
handsomely as the Dow rose from around 9,000 at the time of the dialogue to
more than 11,000 by May. Meanwhile, someone who did understand Crook's logic,
and who therefore understood why even the most optimistic economists have been
finding it increasingly hard to justify current stock valuations, might well
have shifted heavily into cash, perhaps even shorted the market, and would soon
have been gnashing his teeth. The guy who had no idea what he was talking about
gave what turned out to be good advice. The guy who made sense got the
prediction all wrong.
How could such a thing
happen? One reason is that since last fall the economic news, both at home and
abroad, has been better than most people expected. But, anyway, stock prices
are at best very loosely related to fundamentals--if people believe they are
going higher, they do, at least for a while. And so it is very easy for someone
who is completely wrong about the fundamentals to make a correct prediction
about the direction of stock prices, and conversely.
But the Glassman-Crook episode set me thinking, for it is
not the only recent case in which good things have happened to bad ideas. And
as you might guess, another major example involves yours truly--and the debate
over the so-called New Paradigm.
The basic idea of New
Paradigmatics was and is that the old speed limits on U.S. economic growth have
been repealed. In the past, sustained growth at more than about 2.5 percent
eventually led to an overheated economy, one in which the pressure on scarce
capacity led to accelerating inflation. But according to believers in a "new
economy," those constraints were a thing of the past: Because of rapid
productivity growth--much faster than the official statistics indicated--and
globalization, rapid growth would no longer lead to inflation.
Now to anyone who was prepared to do a few thought
experiments, it was immediately apparent that this argument was logical
nonsense. As many economists (including me in a
Slate
) tried to
explain, measured productivity and measured growth are constructed from the
same data. Even if there was an unmeasured acceleration in productivity, it
would not allow the GDP numbers published by the Commerce Department to grow
any faster than before. And global economy or no global economy, a national
economy has a speed limit determined by the sum of labor force and productivity
growth. And so, a couple of years ago, when the measured rate of productivity
growth showed little sign of increasing, it was natural for people like me to
dismiss the New Paradigm argument as silly.
The trouble is that since
then the U.S. economy has in fact grown rapidly, without any signs of inflation
until very recently. This performance has been made possible partly by an
acceleration of measured productivity growth, partly by the surprising
quiescence of wages, despite a very tight labor market; but the effect is that
those who believed in the New Paradigm feel vindicated, and those of us who
made fun of it have some explaining to do.
To be fair, you can make a better case on behalf of the New
Paradigm than on behalf of the hapless Glassman. While the NP crowd may have
engaged in some garbled logic, they were nonetheless onto something--namely,
businessmen were telling them tales of a "productivity revolution," and even if
the data didn't show any evidence of that revolution, they felt sure that
somehow growth was going to accelerate. They couldn't articulate their feelings
very well, and what they actually said didn't make any sense, but they were
nonetheless right in their sense that something new and good was happening to
the economy.
Still, both cases show
that in the buzzing, blooming confusion that is the economy it is all too easy
for those who would make economic predictions to be right for the wrong
reasons, and conversely. Confused thinking does not necessarily lead to
disaster; steel-trap logic is no guarantee of success. Or to quote a :
I returned, and saw under the sun, that
the race is not to the swift, nor the battle to the strong, neither yet bread
to the wise, nor yet riches to men of understanding, nor yet favour to men of
skill; but time and chance happeneth to them all.
But there is also, I think, another moral. If being
smart is no guarantee of being right, having been right is not necessarily an
indicator that someone is smart. Suppose that you hear someone making what
sounds like a dumb argument, but you know that he has an impressive track
record at market or economic prediction. Guess what: The argument may be as
dumb as it sounds.
