The Dismal Science

We recently attended a business conference where we heard an economist making extensive predictions about where the economy was headed. Our concern immediately turned to the many attendees who left the conference with a conviction that this particular view of the future was accurate (after all, they just heard it from an economist).

The problem is that most economics as it is taught in the halls of higher learning consists primarily of mathematics. Economists are comfortable plugging data into their models, which may do a fine job of extrapolating current trends into the future, but which are entirely unsuitable for predicting what will actually happen.

This is the exact same "quantitative" quagmire that has overtaken general finance theory. We have written before that no mathematical model can predict the next entrepreneurial development that will create new markets and drive economic activity in a completely different direction. For example, the iPhone has transformed the concept of mobile computing, and developed markets for the adoption of software applications that never existed previously. In turn, this has created wealth where it did not exist before. This radical change was not visible or predictable in an economist's model prior to its actual occurrence.

The problem lies in the misbegotten idea that economists have the wherewithal to truly "forecast" when in fact most are not suited or trained to identify important trends in economic activity when they are about to happen.

We would suggest that economists, in general, should not be a primary factor in the decision-making process of investors because it is at the most crucial inflection points that the economist is unable to identify what innovation will create new markets that drive economic activity beyond any level that his mathematical models suggest are possible.

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For later posts dealing with the same subject, see also:

• "News flash! Computer model enables you to beat Wall Street!" 06/10/2010.

• "Free markets, free enterprise, Friedrich Hayek, and active allocation of investment capital" 07/13/2010.

• "Professor Amar Bhide's latest essay, 'The Judgment Deficit'" 08/17/2010.

• "Investors fleeing equity funds for bond funds" 08/25/2010.

• "The ideology of modern finance" 01/12/2011.