“We have 2 classes of forecasters: Those who don’t know… and those who don’t know they don’t know.” — John Kenneth Galbraith
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.
Nonfarm Payrolls, Post Recession: 2001-05 vs. Average Recovery
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) (Accelerated Depreciation)
5. Dividend Tax Cuts
6. Political Bias
7. NILFs (Not-in-Labor-Force)
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 . . .
UPDATE: March 5, 2005 7:25am
You can download the full report here.
How would the dividend tax cuts contribute to economic recovery without job creation? Honest question: I can’t follow how that would work out [not because I’m skeptical, but because I’m dumb].
And what are NILFs ? Google is unhelpful and thinks I have misspelled a search for porn.
Interesting. I am inclined to believe that this is something to do with consistently over-stating growth forecasts and understating productivity forecasts, but, as you say, these are well known factors. Many of the other factors that you mention seem to be related to productivity. Incidently, there are examinations of consistent forecast errors here http://w4.stern.nyu.edu/glucksman/docs/McCabe%20Paper%202004.pdf
and here
http://www.phil.frb.org/files/spf/spfq304.pdf
Barry —
Thanks for advertising the Cleveland Fed’s work, but I will confess that I’ve lately begun to disavow the picture you show. Here’s what I mean: Organizing the data in terms of the trajectory of employment since the last business cycle peak invites us to think of the employment picture in terms of a single event that followed from the last recession. I now think that the story is one of multiple events, largely having to do with energy-price shocks. In other words, there is no real puzzle. Energy shocks are generally bad for the economy, and we have had two of them (at least) since the end of the last recession.
I lay out my case in full here: http://macroblog.typepad.com/macroblog/2005/01/a_different_tak.html .
Cheers.
Thanks for the excellent article.
I just have one quibble, with the following:
“The math is simple: The employment rate is a percentage of people with fulltime jobs divided by the labor force. The unemployment rate is the balance (100% minus employment rate% = unemployment rate%).”
I know you know what the official unemployment rate measures, so why this description, with no mention of unemployment insurance? I’ve seen others (notably DeLong) stress using the labor force participation rate as the best measure. Is there a reason you do not?
Thanks,
David
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Under “Dividend tax cut” you state “the cash is neither spent nor reinvested in the broader economy”. Unless cash is kept in a safe deposit box or under the mattress, I don’t understand how it can lay fallow. Even in a bank account, it becomes part of the flow of loans. Used to buy more of the stock that paid the dividend, it goes to some other investor who spends or invests it. Maybe you could explore this more fully in some future article.
Most economists tend to look for factors that will cause incremental changes from the current state and believe in reversion to the mean. Like, we’re in a recession so things will improve at a typical pace. They tend to miss big picture issues.
One big picture issue is the decoupling of employment from corporate profits. US companies are increasingly off shoring work, which increases their profits without increasing employment.
Another big issue, yet to impact, is the huge debt that households have been accumulating relative to their income. Even with record low interest rates, the ratio of interest payments to income is at an all time high. This is why retail sales have held up better than employment.
Why have so many economists missed these issues? They’re a bunch of lemmings. Very few have enough confidence in their own opinions to deviate significantly from the consensus of their peers.