Sat, 12 Jun 1999 08:00:57 EDT


dismal science

When Good Things Happen to Bad Ideas: Time and chance happeneth to
economists, too.

By Paul Krugman

A few weeks ago, I was looking for something to watch on television
while I made dinner, and there was CNN's Lou Dobbs introducing
financial columnist James K. Glassman, identifying him as the
author of Dow 36,000 (presumably a forthcoming book ). I
immediately switched to the History Channel. But over the next few
days I found myself thinking, one might almost say brooding, about
the sighting.

You see, last fall, Glassman--who has used such forums as the Wall
Street Journal editorial page to propound his view that the
prospect of future earnings growth justifies much higher stock
prices than anything yet seen--participated in a Slate "Dialogue"
about the subject. His sparring partner was Clive Crook of the
Economist, a publication that has repeatedly asserted that U.S.
stock prices are not only excessively high but dangerously so and
that the history of Japan's notorious "bubble economy" is being
repeated. Alas, the dialogue came to a sudden screeching halt when
it became clear that Glassman's views were based not on some at
least debatable vision about America's economic prospects but
rather on a simple misunderstanding of corporate accounting (in
essence, Glassman was claiming that businesses can eat their seed
corn and plant it too). It is unclear from that exchange whether
Glassman understands even now that his famous calculation involved
naive double-counting--he certainly did not concede any
mistake--but an embarrassed Crook saw no point in continuing the
(I'm sure Paul is second guessing here)

It isn't all that unusual a story. Indeed, it is quite commonplace
for influential people to propound economic doctrines that are "not
even wrong," that is, that involve a basic conceptual or accounting
impossibility. But there is a kicker in this case. Imagine a Slate
reader who for some reason just could not grasp Crook's point, who
despite everything found Glassman's position convincing. That
reader would presumably have invested heavily in the stock
market--and profited handsomely as the Dow rose from around 9,000
at the time of the dialogue to more than 11,000 by May. Meanwhile,
someone who did understand Crook's logic, and who therefore
understood why even the most optimistic economists have been
finding it increasingly hard to justify current stock valuations,
might well have shifted heavily into cash, perhaps even shorted the
market, and would soon have been gnashing his teeth. The guy who
had no idea what he was talking about gave what turned out to be
good advice. (This would be me). The guy who made sense got the prediction
all wrong. (This would be _ _ _ _ _ ).

How could such a thing happen? One reason is that since last fall
the economic news, both at home and abroad, has been better than
most people expected. But, anyway, stock prices are at best very
loosely related to fundamentals--if people believe they are going
higher, they do, at least for a while. And so it is very easy for
someone who is completely wrong about the fundamentals to make a
correct prediction about the direction of stock prices, and

But the Glassman-Crook episode set me thinking, for it is not the
only recent case in which good things have happened to bad ideas.
And as you might guess, another major example involves yours
truly--and the debate over the so-called New Paradigm.

The basic idea of New Paradigmatics was and is that the old speed
limits on U.S. economic growth have been repealed. In the past,
sustained growth at more than about 2.5 percent eventually led to
an overheated economy, one in which the pressure on scarce capacity
led to accelerating inflation. But according to believers in a "new
economy," those constraints were a thing of the past: Because of
rapid productivity growth--much faster than the official statistics
indicated--and globalization, rapid growth would no longer lead to

Now to anyone who was prepared to do a few thought experiments, it
was immediately apparent that this argument was logical nonsense.
As many economists (including me in a Slate article) tried to
explain, measured productivity and measured growth are constructed
from the same data. Even if there was an unmeasured acceleration in
productivity, it would not allow the GDP numbers published by the
Commerce Department to grow any faster than before. And global
economy or no global economy, a national economy has a speed limit
determined by the sum of labor force and productivity growth. And
so, a couple of years ago, when the measured rate of productivity
growth showed little sign of increasing, it was natural for people
like me to dismiss the New Paradigm argument as silly.

The trouble is that since then the U.S. economy has in fact grown
rapidly, without any signs of inflation until very recently. This
performance has been made possible partly by an acceleration of
measured productivity growth, partly by the surprising quiescence
of wages (so sad), despite a very tight labor market; but the effect is that
those who believed in the New Paradigm feel vindicated, and those
of us who made fun of it have some explaining to do.
(No, I feel clueless but lucky)

To be fair, you can make a better case on behalf of the New
Paradigm than on behalf of the hapless Glassman. While the NP crowd
may have engaged in some garbled logic, they were nonetheless onto
something--namely, businessmen were telling them tales of a
"productivity revolution," and even if the data didn't show any
evidence of that revolution, they felt sure that somehow growth was
going to accelerate. They couldn't articulate their feelings very
well, and what they actually said didn't make any sense, but they
were nonetheless right in their sense that something new and good
was happening to the economy.

Still, both cases show that in the buzzing, blooming confusion that
is the economy it is all too easy for those who would make economic
predictions to be right for the wrong reasons, and conversely.
Confused thinking does not necessarily lead to disaster; steel-trap
logic is no guarantee of success. Or to quote a more authoritative
source (see the note at the end of the article):

"I returned, and saw under the sun, that the race is not to the
swift, nor the battle to the strong, neither yet bread to the wise,
nor yet riches to men of understanding, nor yet favour to men of
skill; but time and chance happeneth to them all."

But there is also, I think, another moral. If being smart is no
guarantee of being right, having been right is not necessarily an
indicator that someone is smart. Suppose that you hear someone
making what sounds like a dumb argument, but you know that he has
an impressive track record at market or economic prediction. Guess
what: The argument may be as dumb as it sounds.


In his classic essay "Politics and the English Language," George
Orwell translated this verse from Ecclesiastes into modern
officialese: "Objective consideration of contemporary phenomena
compel the conclusion that success or failure in competitive
activities exhibits no tendency to be commensurate with innate
capacity, but that a considerable element of the unpredictable must
invariably be taken into account." Now that sounds like an
economist talking!


cut and pasted by Geege