The Irrelevance of the Economists

by BILL WADDELL

Several years back one of my sons played on a little league baseball team that happened to be losing 15 or 20 to nothing, which happened quite often with that team that year.  At any rate, toward the end of the game, a kid on my son's team was called out in a close play at second base and the coach stormed onto the field to argue with the umpire.  The umpire didn't engage in the debate.  Instead he just laughed and pointed to the scoreboard and said, "You're probably right coach, but I am about the last problem you need to solve."

The economists remind me a lot of that hapless coach.  According to Tobin Smith of Change Wave Research, the financial services sector has gone from accounting for 16% of all profits in the United States a few years ago to almost 50% - up until the whole thing blew up, any way.  During that time, the amount of borrowed money being used by these folks to post these fantastic profits quadrupled.  In other words, they took a real dollar from some innocent guy, leveraged it with 3 pretend, margin dollars to call it 4, put it into some derivative scheme and turned it into 5 or 6 on paper, and paid themselves a whopping bonus.

Over that same time period, we lost another 2,000,000 manufacturing jobs.  Over the last 10 years, we have lost better than 5 million manufacturing jobs.

So we are rapidly converting ourselves from a country that actually creates value to one that plays paper games.  Of course, paper games are not real - as we found out quite painfully over the last several months - so here we are approaching double digit unemployment and passing legislation to borrow trillions of dollars from our grandchildren to pay for what has quite obviously been very, very bad behavior.

Where are the economists in all of this?  They are arguing about how many angels can dance on the head of a pin, debating with each other over arcane nuances of Keynsian theory and attempting to trump each other with new insights into the details of Friedrich Hayek's thinking.  In short, they are ignoring the real problems and engaging in issues that are about the least of our problems.

The economists are rendering themselves largely irrelevant because they accept cost as a fait accompli - a done deal, an absolute.  The notion that money out the door should be categorized as an expense or an asset according to a detailed code of Generally Accepted Accounting Principles, and that the code is an accurate methodology for doing so is taken as fact.  Economics begins where accounting leaves off.

But those GAAP principles are by and large a load of arbitrary nonsense.  When the economists try to build their theories of taxation and government involvement - or lack of it - on a foundation of accounting mush, their theories are mush.  Numbers like GDP are all based on GAAP rules.  Change GAAP and you change GDP.  The cost of labor and the value of companies all depends on what your definition of is is, to quote our esteemed former President.

Lean manufacturing is the key to manufacturing growth and health.  And lean manufacturing has lean accounting as its prerequisite. In particular, getting inventories off of the balance sheet and eliminating the nonsense that follows when the law of the land says that companies can make a bunch of stuff, assign huge buckets of fixed overhead to it and move those overheads over to the balance sheet, making themselves look more profitable.  If we were to return to a cash based accounting scheme, our sense of good and bad business would change radically, our management principles would all change, and our understanding of our economy would be completely different.

The economists who grapple with how money affects behavior ought to grapple with this one.  Very well educated business leaders over-spend and over-produce to play games with the balance sheet and inventory; make the company look more profitable than it really is; pay unnecessary taxes on those artificially goosed up profits; then complain that the USA is a lousy place to manufacture because we have the highest tax rate in the world.

Those business leaders complaining about the tax rates, and the economists who focus in on the how taxes impact the economy are a lot like the little league coach - probably correct but completely irrelevant.  Free markets? Free trade? Free enterprise? Nothing but trivial theories that have little bearing on how our economy works compared to how capricious accounting rules drive the economy.

In 1953 the law of the land was set in place that determined that a vast amount of our national wealth was going to be put into warehouses, where it would consume even more of our national wealth and the fruits of our citizen's labor to take care of it.  The government dictated that every cost - including the kitchen sink if the company had one - would be added to the GDP, added to the value of our businesses, and called profit.  We set in place economic policies that sowed the seeds for our national exit from manufacturing.  What some politician may or may not do with NAFTA or the capital gains tax at this juncture doesn't really matter.

The economists need to get in the game, for the sake of their own relevance and for the sake of the country.  Buying into the patently phony productivity numbers spewed out oy the Bureau of Labor Statistics, defending a global theory of economics because some guy in Malaysia will work for a few pennies, all the while ignoring the fact that reported costs, profits and the worth of companies are miscalculated by orders of magnitude doesn't get the job done.  Price elasticity theory is a waste of paper and brain cells when all of the prices are the product of an increasingly foul accounting stew. 

Comments

[Susan Schalk]

Great analogy. I encourage more such posts.

[Joseph C Samuel]

I am fan of yours!

I read all your articles with great interest. It brings new insights, no crap and a lot of commonsense.

Thanks for the great posts.

[Neutron Jerk]

Bill - when you say:

"Over that same time period, we lost another 2,000,000 manufacturing jobs. Over the last 10 years, we have lost better than 5 million manufacturing jobs."

What's that have to do with the financial shenanigans that you started your post with?

Is the point economic output or is it jobs?

Manufacturing OUTPUT hasn't fallen that dramatically, there's been big productivity improvements... and Lean helps drive productivity improvement.

So if you want more jobs, should we give up on Lean and be inefficient?

Dr. Deming is about the only one I read who said one of the purposes of a company is to create jobs. That's sacrilege to the MBA crowd, who thinks the only job of a company is to create profits.

You make a lot of sense here in this post (and always), but isn't it a bit of a red herring to complain about the job loss?

Another point -- we have the highest tax rates... so what is this new Obama plan going to do? It makes things even worse that they are going to tax U.S. companies' overseas profits... where are the economists on that? Double taxation, won't that drive companies out of the U.S. altogether?

[Bill Waddell]

It has been a while, I suppose, since we published it, but, in fact, there have not been the significant productivity gains the politicians and defenders of the flat earth theories claim. By the Bureau of Labor Statistics' own admission, they do not know how to take outsourcing into account.

When a manufacturer stops making components and becomes a final assembler only - as many (perhaps most) have done - the output of the factory remains the same but they have less workers.

For example, a company that makes chairs lays off all of the people who make chair legs, seats and backs, keeping only the people who assemble those parts into the finished chair. They then buy all of those parts from China. The total number of chairs the factory ships remains the same, but most of their employees have been laid off and essentially replaced by a greater number of less efficient Chinese workers.

The BLS only knows total output and total number of employees - same number of chairs, but fewer emplloyees = productivity gain, according to the BLS. They acknowledge that this is erroneous, but do not know how to take it into account.

This has been well documented on these pages over the years, including citing the chapter and verse in the BLS publications that acknowledge the fact. I can only conclude that our economic policy leaders prefer to ignore it. It is far more comfortable to proclaim great improvements in worker efficiency and the application of technology than it is to admit that we are really doing little or nothing to promote the deployment of the best manufacturing practices (i.e. lean) and are simply shifting our manufacturing base and long term economic health to China in pursuit of short term profit.

Take the 'great productivity gains' argument away and the economic gurus have a big hole in their rationalizations of the wonders of our burdgeoing service economy. It becomes obvious that we are doing nothing but swapping value creation work for burger flipping jobs.

Concerning the foreign taxation issue, I think Obama is pretty much right on this one. There is no real 'double taxation' going on. Say an American company operates in the some foreign country with a 25% tax rate. When the company repatriates those earnings (brings the cash back to the US), they currently have to pay the difference between the foreign rate and the 35% US rate. They pay the difference of 10% only - not both - so that the total tax is the US rate.

What the Obama folks are doing is getting after those companies that never repatriate the profits - they keep them offshore - but they claim deductions on their US tax returns for expenses (such as administrative and engineering) incurred in the US to generate those foreign profits. Their argument is that if a company is going to take US deductions they have to be paying US taxes, which does not strike me as unreasonable at all.

I wholeheartedly agree that the corporate tax rate in the United States is obscene and has a huge negative impact on our economy. I am also sure that the meat fisted, bureaucratic hand of government will throw a lot of babies out with the bath water in their effort to close this loophole. And if Obama is right on this one, he is still that blind pig who got lucky and found one, while the main of his economic policy is a train wreck. But the companies affected by closing this loophole for the most part really have a thin argument in their own defense.

[michael baxter]

The most recent winner of the Nobel Prize for Economics Paul Krugman wrote a book a few years ago in which he laid into precisely this type of reasoning.

Actually, economics is a lot more sophisticated then people realize. The base their criticism on information they may have gleaned from a text book which might be 30 years old, and fail to grasp that there have been wave upon wave of ideas since.

The purpose of a company is not to provide jobs. This old socialist thinking.

The purpose of a company is to provide goods and services people want. If they do that they make a profit and jobs are created. If two people could single handedly produce all the goods we need, then the rest of us would focus on services-this would be a good thing, and we would be better off as a result.

The Law of Comparative Advantage is probably the most important theory relating to social sciences ever. Free trade is the means by which the world can specialise. Specialisation is the key to generating wealth.

The single most important economic development of the last ten years or so has come about as a direct result of globalisation facilitating specialisation, namely that the world’s ability to produce has risen significantly.

Advanced economies usually migrate from manufacturing to service based industries as they mature. There is nothing wrong with this. The US is no more defunct now then it was 20 years ago when Japan was seen as the unstoppable economic power.

The US has enjoyed 60 years of wealth creation, and two years of crisis so people start ripping up all the assumptions that laid behind such unprecedented wealth creation.

The single biggest danger is that we look at the present crisis in isolation, without seeing it in the context of the last 60 years of advances.

Michael Baxter defaqto http://defaqtoblog.com/iabn/

[Bill Waddell]

Mr Baxter,

I would suggest to you that "the last 60 years of advances" in the USA had more to do with flattening Europe and Asia in the course of WWII and, by defacto as the last man standing, the monopoly on the work to rebuild it, than on any theory of of global specialization - unless you want to argue that the USA proved our special talent for manufacturing because we had the skills to keep our's intact while we, the British, the Germans and the Japanese collectively blew up all of the factories in the rest of the world. Believing that we prospered on the strength of a superior culture and a superior economic theory, rather than acknowledging the reality of that fact has been a great curse. Too many people think we were really that good, which makes it awfully difficult to deal with current reality.

I would also suggest that we have become more and more a debtor nation over the last 20 years - not 2 years - as the rest of the world reached a fully recovered state.

"The Law of Comparative Advantage is probably the most important theory relating to social sciences ever. Free trade is the means by which the world can specialise. Specialisation is the key to generating wealth." I ask you exactly where do you see this in practice?

The current golbalization rage has nothing to do with specialization, and everything to do with exploitation. Chinese, Indian and Malaysian people are not 'specialists' at making toys or much of anything else. They merely live in such abject poverty that we can use them to make our toys without having to pay for things like good food, health care, education and leisure time with the family - all the things we want and would have to pay for if we had Americans or Western Europeans make the toys.

Under the guise of this sort of self-serving economic thinking we are digging ourselves into a very, very deep hole. We don't want the cost of our standard of living embedded in the products we buy, so we look to the government to pay, and borrow money from future generations to do so ... then kid ourselves into thinking it makes sense!

Finally, I would suggest to you that the last two years are not the mere blip in a great long term positive trend, but the first of a series of major corrections we will face as the piper demands his due for our our decision to get out of the business of creating wealth, that we justified on the back of thinking like your friend Mr. Krugman's

[Paul Todd]

Bill:

All I can say is "Preach on, Brother!" I am continually dismayed to see reasonable, educated people like Mr. Baxter explain that the decline of manufacturing is a natural and acceptable trend, especially when using the post-WWII era as evidence. We are haunted by Peter Drucker's observation of 1954: "There is real danger that in retrospect the United States of 1950 will come to look like the Great Britain of 1880 - doomed to decline for lack of vision and lack of effort."