WHEN LARRY LINDSEY, George Bush’s top economic adviser, was asked to defend his latest upbeat economic forecast—a return to 3 percent growth by the end of the year and then clear sailing for as far as the eye can see—he cited as corroborating expert witnesses a handful of Wall Street economists who agree that the worst of the downturn is safely behind us. Uh-oh. I would have been more reassured if he had cited the Backstreet Boys as his source for confidence. In fact, if Wall Street economists agree that a financial recovery is imminent, this is about as reliable a sign as God sends to us mere mortals that we’d better prepare for some tough sledding. It turns out that for the last eight or so years, one of life’s few certainties is that the so-called Blue Chip economists are always wrong when they gaze into their crystal balls and try to discern the future of our financial affairs. If since 1996 you’d taken the consensus prediction of unemployment and economic growth made by the 40 economists that the Wall Street Journal has selected for its start-of-the-year economic forecast, and then you had invested based upon the highly defensible assumption that they were dead wrong, you would be a very rich man today. Between 1995 and 2000, the economics profession was rigidly over-pessimistic about the U.S. economy and the stock market’s potential. Back in the mid 1990s, when the Dow Jones Industrial Average was still at about 4,000, the bears ruled the roost. There’s a lot of truth to the quip that economists have successfully predicted five of the past two recessions. Slavishly devoted to the bankrupt Keynesian voodoo notion that the economy can’t grow faster than a 3 percent clip without striking a match and dropping it into the gasoline can of pent-up inflation, economists declared with unequivocal hubris that what actually happened to the economy in the late ’90s was scientifically impossible. Four to 5 percent real growth rates? Sorry, they told us, you just can’t get there from here. Not unless you’re willing to tolerate a gut-wrenching, 1970s-style burst of rising prices. David Hale, the incisive Chicago-based chief economist at Zurich Kemper and one of the few guys with a knack for getting the economic story right, recently reviewed the Blue Chip forecasts of his economics brethren and compared them with what happened in real life. The sobering findings are contained in a report called “Why Economists Can’t Predict,” to be released next month by the Media Research Center. And what a tale of economic malpractice the report conveys. During the period 1994-1999, the Blue Chip forecasters projected an average annual growth rate of only 2.3 percent for the U.S. economy. What was the actual result? An annual growth rate of 3.9 percent. This may seem like a trivial error, but in the forecasting world, this is the equivalent of going to the hospital for a tonsillectomy only to have the surgeon remove your kidney instead. If this seems an unjustly harsh assessment of my professional colleagues, consider this blunder: Between 1994 and 2000, the U.S. economy actually grew a gigantic 40 percent faster than the Blue Chip consensus forecast for the period. The forecasters had it about right—they just apparently forgot to include California and Arizona in their calculations. Honestly, how in the world do these people keep their jobs? But wait, the story gets a lot worse. When was it that economists finally realized they had been snookered once too often by the new information-age economy? When did they finally turn optimistic on the outlook for the U.S. economy? Answer: around July of 2000. What exquisite timing. The spring/summer of 2000 was the magical moment when the economy and the stock market reached their peak. The United States recorded an audacious 5 percent growth rate in the second quarter of 2000, and the Dow closed in on its high of 11,000 while the Nasdaq briefly clawed its way above 5,000. So it turns out that from 1996 through 2001, the year that economists predicted the briskest economic expansion was this year, and yet in reality we will be lucky to end 2001 with a measly 1 percent growth rate. By the end of this year, a dip into negative GDP territory is disconcertingly plausible, notwithstanding the Bush White House’s cheery message of recovery by Thanksgiving. A number of years ago, the Wall Street Journal editorial page had a field day lampooning economists by showing that a blindfolded person throwing darts at a dartboard pasted with various future economic scenarios often outperformed the grandiose predictions of overpaid Ivy League-trained Ph.D. economists. These days a $19.95 investment in that dartboard game doesn’t look all that unreasonable. So why do so many heralded economic whiz kids have such miserable track records? I have posed that question to two supply-side oriented economists, former Reagan economist Larry Kudlow and Brian Wesbury of Griffin, Kubik and Stephens. Both have been among the most accurate economic forecasters over the past half dozen years or so (in the land of the blind, the one-eyed man is king). They both agree that the villain here is the indoctrination of decades of defunct Keynesian economic logic. The Keynesian model programs economists to believe that too much of a good thing (growth) can lead to a bad thing (inflation). This theory became increasingly untenable in the ’80s and ’90s, when we had brisk economic growth and tumbling inflation at the same time. So then in the 1990s, economists like Laurence Meyer, Bill Clinton’s neo-Keynesian appointee to the Federal Reserve Board, began touting a nuanced concept called NAIRU, the non-accelerating inflation rate of unemployment. Economic growth rates above the NAIRU rate were said to be dangerously inflationary. But what rate of growth, exactly, would trigger inflation? In the early 1990s, economists like Meyer hypothesized that roughly a 3 percent rate of economic growth was about all the economy could muster without awakening inflation from its slumber. Then when growth rates well in excess of 3 percent corresponded with declining rates of inflation, Meyer conceded that perhaps the NAIRU rate had now inched up to 3.5 percent. Then when that rate of growth was exceeded in 1998 and 1999 without a whiff of inflation, the NAIRU crowd hinted that perhaps a growth rate of up to 4 percent could be sustained without inflation. NAIRU had become a moving target. Never has it occurred to these folks that perhaps the whole blasted model has been short-circuited by an information-age economy that has propelled higher rates of sustainable and non-inflationary productivity growth. The other defect of the Keynesian model is that it has diagnosed the economy’s problem as one of insufficient consumer spending. For example, former Congressional Budget Office and Office of Management and Budget director Alice Rivlin has said that the Bush tax rebate plan can only help the economy if workers rush out to K-Mart and Toys “R” Us and clear the aisles of merchandise with their $300-$600 checks. Almost all economists on Wall Street agree with her. This is absurd. Over the past two years the two major components of overall demand in the economy, consumer purchases and government spending, have been on a tear. Total public sector expenditures continue to sprint ahead at a speedy 7 to 8 percent annual pace, and retail spending by Americans has been as strong as ever until the last month or so. The driving force of the modern economy is not consumer demand but investment, which is driven by the cost of capital. When capital costs rise—for example, as a result of higher tax rates, unstable monetary policy, regulatory tightening, or rising interest rates—the economy contracts. Right now tax rates are too high and money is much too scarce to induce investors to invest, and to induce businesses to expand. In the current environment, it matters not a whit how much consumers are itching to spend if there are no profits in production. If Bush can solve the twin problems of excessive taxes and insufficient money, the economy will get squarely back on its virtuous 3 to 4 percent real growth path. The joke these days in Washington is that if the economy doesn’t turn around soon, Bush intends to go back to the Vatican to see the pope again. But as the stock market continues to decline and aggregate wealth losses now exceed $4 trillion, getting America moving again will require more than prayers and pep talks. Bush’s current strategy of sitting back, crossing his fingers, and banking the Republican party’s future on the optimistic forecasts of economists who have a woeful track record could hardly be more inadvisable. Last week, House speaker Dennis Hastert received a rousing ovation at the Republican House caucus meeting when he announced that he would make a capital gains tax cut a top legislative priority. There were groans of disgust when Hastert then intimated that the White House would prefer to wait until next year. House Republicans, who face the voters in just 14 months, realize that they don’t have the luxury of waiting another six months to discover if the dismal scientists are, for once, right. Stephen Moore is president of the Club for Growth.
