Monday, November 03, 2014

"Business leaders often give remarkably bad economic advice, especially in troubled times" (Paul Krugman)


"[D]oesn’t [successful business people's] success with money mean that they know how the economy really works? Actually, no. In fact, business leaders often give remarkably bad economic advice, especially in troubled times."
-- Paul Krugman, in his NYT column today, "Business vs. Economics"

by Ken

PK's column today is one after my own heart. I've tried a number of times to explain this distinction, between business and economic competence, drawing only on my intuitive sense of the critically different way the two groups look at the same problems, and the obviously different economic problems the two groups look at.

From the above quote, PK goes on to say, "I think it's important to understand why," meaning why the "expert" economic perspectives of "people who have been successful in business, like leaders of major corporations, entrepreneurs and wealthy investors," are so often so wide of the mark in terms of the working of economies, as opposed to companies, and offers a couple of pungent examples:

• "the hugely wealthy money managers who warned Ben Bernanke that the Fed’s efforts to boost the economy risked 'currency debasement' ";

• "the many corporate chieftains who solemnly declared that budget deficits were the biggest threat facing America, and that fixing the debt would cause growth to soar."

As it happens, PK is writing from Tokyo, and he has fresh in mind the decision last week by the Bank of Japan, the country's central bank, to pursue a new and aggressive round of monetary measures aimed at fighting the country's persistent economic deflation. The decision was made, he notes, "amid substantial internal dissent," with only five of the bank's nine governors supporting the package, and "with those closest to business voting against."

"Some of the people I’ve spoken to here," he sayd, "argue that the opposition of many Japanese business leaders to the Bank of Japan’s actions shows that it’s on the wrong track."
In saying this, they’re echoing a common sentiment in many countries, including America — the belief that if you want to fix an ailing economy, you should turn to people who have been successful in business, like leaders of major corporations, entrepreneurs and wealthy investors. After all, doesn’t their success with money mean that they know how the economy really works?
Which brings us back to where we started. And in this context we might add that among PK's examples of businesspeople giving lousy economic advice he points out that Japanese business leaders "played an important role in the fiscal mistakes that have undermined recent policy success, calling for a tax hike that caused growth to stall earlier this year, and a second tax hike next year that would be an even worse error."

"On the other side," PK writes,
the past few years have seen repeated vindication for policy makers who have never met a payroll, but do know a lot about economic theory and history. The Federal Reserve and the Bank of England have navigated their way through a once-in-three-generations economic crisis under the leadership of former college professors — Ben Bernanke, Janet Yellen and Mervyn King — who, among other things, had the courage to defy all those tycoons demanding that they stop printing money. The European Central Bank brought the euro back from the brink of collapse under the leadership of Mario Draghi, who spent the bulk of his career in academia and public service.
The point, he stresses, isn't that one group is smarter than the other, but that "success in business does not seem to convey any special insight into economic policy," and he wants to know: Why?

In a moment we're going to have PK referring back to a piece he wrote for the January-February 1996 Harvard Business Review called A Country Is Not a Company." (At that time, for the record, his biographical note began: "Paul Krugman is a professor of economics at Stanford University in Palo Alto. California." Not to be confused, I guess, with the Stanford University in Dirtlick, Alabama.) I'm going to cheat and sneak in the opening of the HBR piece:
College students who plan to go into business often major in economics, but few believe that they will end up using what they hear in the lecture hall. Those students un- derstand a fundamental truth: What they learn in economics courses won't help them run a business.

The converse is also true: What people learn from running a business won't help them formulate economic policy. A country is not a big corporation. The habits of mind that make a great business leader are not, in general, those that make a great economic analyst; an executive who has made $1 billion is rarely the right person to turn to for advice about a $6 trillion economy.
He went on to ask, "Why should that be pointed out?"
After all, neither businesspeople nor economists are usually very good poets, but so what? Yet many people (not least successful business executives themselves) believe that someone who has made a personal fortune will know how to make an entire nation more prosperous. In fact, his or her advice is often disastrously misguided.

I am not claiming that businesspeople are stupid or that economists are particularly smart. On the contrary, if the 100 top U.S. business executives got together with the 100 leading economists, the least impressive of the former group would probably outshine the most impressive of the latter. My point is that the style of thinking necessary for economic analysis is very different from that which leads to success in business. By understanding that difference, we can begin to understand what it means to do good economic analysis and perhaps even help some businesspeople become the great economists they surely have the intellect to be.
In the new NYT column, to answer the question why "success in business does not seem to convey any special insight into economic policy," PK refers back to the title of the HBR piece: "A country is not a company."
National economic policy, even in small countries, needs to take into account kinds of feedback that rarely matter in business life. For example, even the biggest corporations sell only a small fraction of what they make to their own workers, whereas even very small countries mostly sell goods and services to themselves.
It's still worth going back to the HBR piece, where PK had the time and space to go into the vast difference between the kinds of things a corporate executive has to consider and the realities of an entire economy, which includes not just of all the companies that are part of it but a vast assortment of other economic players. looking particularly at the difference between "open systems," like companies, and "closed systems," like countries. This enables him to show how hardly any of the considerations that may be eminently reasonable for a person running an open system apply to a closed one.

In the new piece, PK keeps the explanation simpler:
So think of what happens when a successful businessperson looks at a troubled economy and tries to apply the lessons of business experience. He or (rarely) she sees the troubled economy as something like a troubled company, which needs to cut costs and become competitive. To create jobs, the businessperson thinks, wages must come down, expenses must be reduced; in general, belts must be tightened. And surely gimmicks like deficit spending or printing more money can’t solve what must be a fundamental problem.

In reality, however, cutting wages and spending in a depressed economy just aggravates the real problem, which is inadequate demand. Deficit spending and aggressive money-printing, on the other hand, can help a lot.
He wonders, though, "how this kind of logic [can] be sold to business leaders, especially when it comes from pointy-headed academic types." And he says, "The fate of the world economy may hinge on the answer." He concludes:
Here in Japan, the fight against deflation is all too likely to fail if conventional notions of prudence prevail. But can unconventionality triumph over the instincts of business leaders? Stay tuned.

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