Silvia suggests “Wobbly Legs” holding up our economy

Earlier this week, John Silvia, the Charlotte-based Chief Economist of the Wells Fargo Securities Economics Group, gave a presentation to Cornell’s School of Hotel Administration that outlined concerns he had over current economic conditions. A “Special Commentary” containing information from the presentation is available below:

Special Commentary – Four Wobbly Legs Beneath the Throne of Economic Growth.

Silvia specifically pointed to four specific areas of uncertainty that could prove to be the difference between the start of long-term economic growth, a return to malaise, or the resumption of declining positions:

  • While aggregate job numbers might indicate an increase in employment opportunities, the distortion effect of the stimulus has focused most growth toward the public sector. In addition, job opportunities in skilled trades have disappeared in several parts of the country, creating a serious problem for groups of people “in the middle” that will either need retraining or relocation. Silvia’s commentary suggests that job supplies will not return back to pre-recession levels for two to three years, an estimate less austere than the five to six year estimate made recently by the Federal Reserve’s Open Market Committee.
  • Generally speaking, the future of the housing market will reflect significant corrections with respect to inventory, types of future construction, and reset of actual values due to manipulative impact of past financing and subsidy programs.
  • The growth and permanent presence of a true global market have served to minimize price changes in “core” products and services. As a result, many businesses believe they do not have the pricing power they possessed in the future, potentially minimizing the opportunity for continued significant growth in corporate profits. Therefore, recent growth in profits will likely subside, with no certainty that growth rates will be significant over an extended period of time.
  • The utilization of expanding Federal deficits and issuing unprecedented levels of Federal debt in an attempt to offset the negative impacts of the economic downturn have not created the desired impact. Silvia contends that permanent shifts in the structure of our economy and its influencing factors have changed the reliability of the “multiplier effect” associated with the Keynesian economic approach preferred in the public policy arena since the Great Depression.

On the final of these points, Silvia offers explicit warnings with respect to the actions being taken by politicians and public policy experts:

What have we observed as lessons for decision-makers from the events of the past year? From our viewpoint, there are three problems, or biases, that have hindered effective decision-making over the past year. First, and most critically, is the overconfidence bias of both public and private decision-makers. This is most readily seen in the public sector with the assertion on the economic multiplier effect and the prediction of jobs and growth. In reality, our economic models are not perfectly specified or perfectly rational. Instead, real-world decisions exhibit bounded rationality—we look for an answer that works, satisfices, not the perfect answer.7 We have limited resources of time and ability to try all solutions. Therefore, we find a solution that works, if only temporarily, or imperfectly. We “sacrifice.” Unfortunately, the multiplier approach that was used to guide public policy as a rule of thumb was a critical mistake given the implications of the size of the deficit in a global capital market as examined above as well as the special role of credit constraints in the current recession/recovery period. Private market decision-makers simply cannot rely primarily on such rules of thumb as an indication for future top-line revenue gains.

Second, there is a confirmation bias, certainly in public decision-making and, unfortunately in the media, where evidence in support of the suggested or enacted program is exulted and signs of failure ignored. The whole concept of “saved” jobs is a classic example of this bias. We cannot recall any discussion about stimulus “saving” jobs in either undergraduate or graduate courses. This concept presents a false target for success, especially given the real structural challenges for the labor market as highlighted in our earlier discussion. Moreover, “saving” public-sector jobs today by issuing more debt that must be repaid out of future generations and, therefore, cost future private-sector jobs, is a misleading enterprise. Politicians make political decisions, not economic ones, and awarding jobs to “what is” today at the cost of “what will be” tomorrow is not good economic policy. For the media, there is too much of a tendency to decide the answer before looking at the evidence. Political biases dictate the choice of sound bites and anecdotes, while the public fails to get the careful discussions and analysis it needs to make informed decisions.

Finally, there is a sunk cost problem where policymakers up the ante in their commitment to a program even as the program is a failure. Military escalation abroad and climbing Mt. Everest are classic examples of this bias.8 In public policy, continued large public subsidies to agencies and even private companies as well as consideration of a more of the same, just another stimulus program, reflects this bias. There is very little honest discussion in public circles on the failures of these programs—which is understood given the penalties to any public servant who ever admits a mistake. Many thoughtful analysts doubt the wisdom of another stimulus program given what we know as the high level of uncertainty of success.
For decision-makers, the problem remains to develop a set of guidelines for strategic decision-making given the wobbly nature of the outlook for economic growth and the high level of uncertainty, not simply of risk, in the environment. Finally, private decision-makers must also be aware of the decision-making traps that appear to have affected the effectiveness of decision-making in recent years.

Finally, there is a sunk cost problem where policymakers up the ante in their commitment to a program even as the program is a failure. Military escalation abroad and climbing Mt. Everest are classic examples of this bias.8 In public policy, continued large public subsidies to agencies and even private companies as well as consideration of a more of the same, just another stimulus program, reflects this bias. There is very little honest discussion in public circles on the failures of these programs—which is understood given the penalties to any public servant who ever admits a mistake. Many thoughtful analysts doubt the wisdom of another stimulus program given what we know as the high level of uncertainty of success.For decision-makers, the problem remains to develop a set of guidelines for strategic decision-making given the wobbly nature of the outlook for economic growth and the high level of uncertainty, not simply of risk, in the environment. Finally, private decision-makers must also be aware of the decision-making traps that appear to have affected the effectiveness of decision-making in recent years.

You can download a copy of this Special Commentary (PDF) below:

Special Commentary – Four Wobbly Legs Beneath the Throne of Economic Growth

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