02.27.14 6:50 PM ET
Don’t Trust the Economic Numbers That Govern Our World
Every week we’re bombarded by numbers about GDP or consumer confidence or some other leading indicator about our economic health and prosperity. Enough, says Zachary Karabell, these numbers don’t accurately reflect our world. An excerpt from his new book, The Leading Indicators.
A week does not pass without another set of economic numbers blasting through the ether. Many of these receive instant coverage in the media and become fodder for financial market gyrations. This week alone we’ve had a home price index, consumer confidence number, a series of regional manufacturing surveys, and then on Friday, the Bureau of Economic Analysis will release its latest estimate of the mother of all indicators, GDP.
But for all the noise that these numbers generate, what do they actually tell us? What if I told you that many of the assumptions we make about our economic life are wrong, and that these assumptions based entirely of what these statistics, our “leading indicators” say. What if those assumptions shape our domestic economic policies, dictate how the federal government spend trillions of dollars, and shapes consequential decisions by tens of millions of individuals and millions of companies?
We live in a world shaped by economic numbers, yet none of these numbers existed a century ago, and most barely existed in 1950. They were invented during the Great Depression and World War II, and they excel at measuring the world that existed then, a world of industrial nations states making stuff. They do not, and were not designed to, measure the 21st century world of services, information technology and global supply chains of billions of emerging middle class consumers.
Even more, most of these numbers are simple averages. Take per capita income, which is a number that has been much in discussion as we debate how to address growing wealth inequality in the United States and globally. Per capita income is simply the Gross Domestic Product of the country divided by the number of citizens. Period. It tells us little to nothing about variability by region, by education level, by type of jobs. If one profession, say information technology, is seeing 10 percent growth in wages, and another with the same number of workers is seeing wage declines of 10 percent, then the per capita average is zero change. If Warren Buffet reads this posting along with everyone else, the per capita income of all of its readers will say that everyone who is reading is a millionaire. Not a very useful number to answer the very important question of whether our economic system is meeting people’s needs.
Or take consumer confidence, which can move markets and is easily picked up for use as talking points about how Americans are feeling. Consumer confidence was an index created in the 1940s by an émigré psychologist turned economist named George Katona, and while it often reveals how those surveyed are feeling about the world, its ability to predict behavior is remarkably limited. In fact, people are perfectly capable of feeling good about their economic future and spending little and feeling bad and spending lots. The only thing that ultimately determines how much people spend isn’t what they feel; it’s how much money they have, whether through income or debt.
The limitations of our economic numbers aren’t the fault of the numbers. Indicators are designed to measure what they measure. GDP is a number that measure how much output a nation produces. It is not meant to measure how happy we are, or how well an economic system distributes rewards. It is not meant to, and it doesn’t. The problem lies in how dependent we have collectively become on these numbers to guide us. A hundred years ago, no president or politicians anywhere in the world derived legitimacy from whether GDP rose under their watch, or whether inflation fell. No did because the numbers didn’t exist. Now they can make or break an administration.
Relying so heavily on these numbers does not serve us well. When they were invented, we had no economic metrics, and no reliable way to gauge what was going on. Today, we have many, but the pendulum has swung too far. Not one of our leading indicators was designed to carry the weight they now do. They were not invented to be absolute markers of whether we are doing well or poorly, whether our nations are succeeding or failing, and whether our governments are visionary of destructive. They were not created so that a college graduate in Chicago can assess her opportunities or to help someone starting a small business figure our whether now is a good time. And they were not worked one by generations of economists and statisticians in government and academia in order to determine whether Congress should take on more debt or spend more, or whether General Electric should build a factory in Mississippi or China, and whether our economic priorities are correct.
At best, our indicators are loose guides, better than shadows on a cave wall but much less than definitive markers of the worlds we inhabit. They are useful justifications for the collection of vast amounts of data that we could use better, but who among us dives into the annex to each unemployment report or the hundreds of tables that accompany each GDP release. We might all be the better for doing so, but that is hardly a realistic suggestion.
We do, however, have the power to use the data at our fingertips much more actively and to cease relying on our 20th century indicators so intensely. We can analyze the questions we have, whether to buy a home, state a business, invest abroad or address poverty, with much greater use of the wealth of information at our disposal in an information age. That may mean less of a common narrative about “the economy” but at least it would end the fiction that we all live in a shared economy.
In short, our leading indicators have been powerful tools to cast light on what for most of human history was mysterious—how much wealth do we have collectively, how much employment and what price, how prices are moving and at what rate. But they were never meant to rule our world, and it is time to move on and embrace the power of the information age rather than cleaving to a 20th century industrial world that we continue to measure even as it fades into the past.