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They call economics "the dismal science." We got a good example why this week.

Three years ago, Harvard economists Ken Rogoff and Carmen Reinhart published a paper based on solid history and rigorous statistics showing that when a country's debt-to-GDP ratio breaches 90%, its growth plunges into negative territory. As highly respected economists, the paper influenced policymakers around the world.

"[I]t is widely acknowledged, based on serious research, that when public debt levels rise about 90% they tend to have a negative economic dynamism, which translates into low growth for many years," said EU Commissioner Olli Rehn in 2010.

"Economists who have studied sovereign debt tell us that letting total debt rise above 90 percent of GDP creates a drag on economic growth and intensifies the risk of a debt-fueled economic crisis," said Congressman Paul Ryan in 2011.

"It's an excellent study," said former Treasury secretary Tim Geithner two years ago.

But it wasn't an excellent study. A separate group of economists tried replicating Rogoff and Reinhart's results, and couldn't. Stumped, they asked for the actual spreadsheet used in the seminal study, and found it littered with data omissions and Excel coding errors. Rogoff and Reinhart showed economies with debt-to-GDP above 90% experience average GDP growth of negative 0.2%. Fix the math errors, and the real figure is positive 2.2%. Oops.

Economists and pundits have been floored at the discovery all week. As they should; it was a flagrant error.

But these kind of "now-you-know-it-now-you-don't" moments are more common than people think in economics.

Take the monthly jobs report. Almost every initial report is revised in subsequent months, often by a lot.

In September 2011, the initial report from the Bureau of Labor Statistics showed zero jobs were created that August. "Zero Job Growth Latest Bleak Sign for U.S. Economy" wrote The New York Times. "Hiring Grinds to a Halt" wrote CNNMoney. "President Zero." Wrote the Republican National Committee. "THE ECONOMY ADDED ZERO, ZIP, NADA JOBS IN AUGUST."

Except that, yes it did. Revisions later showed the economy added 132,000 jobs in August 2011, not zero. It was actually the third-best August jobs report in the previous decade. Few seemed to care about the revisions, or even notice. By then, the damage had been done.

Or take productivity. For most of the last decade, it was assumed that the American manufacturing sector became more productive, as employment shrank by output grew. "The decline in U.S. manufacturing employment is explained by rapid growth in manufacturing productivity over the past 50 years," said Columbia Business School dean Glenn Hubbard.

But maybe not. As The Washington Post pointed out, many economists now think the productivity numbers are grossly inflated, since determining whether, say, a car assembled in Ohio with Japanese parts should be counted as domestic or foreign manufacturing is a messy subject. Cost savings from outsourcing can mistakenly show up as domestic output. Adjust for that bias, and as much as half of manufacturing output growth between 1997 and 2007 melts away, according to economist Susan Houseman. As Rob Atkinson of Information Technology and Innovation Foundation put it: "I bought into this idea for a long time that it was superior labor productivity that caused most manufacturing job losses. Then I began to dig into the numbers."

Everyone knows Japan's economy has stagnated over the last two decades. Everyone, it seems, except Tokyo-based journalist Eamonn Fingleton. Japan, Fingleton notes, calculates GDP and inflation differently from other countries. He writes:

Luckily there is a yardstick that finesses many of these problems: electricity output, which is mainly a measure of consumer affluence and industrial activity. In the 1990s, while Japan was being widely portrayed as an outright "basket case," its rate of increase in per-capita electricity output was twice that of America, and it continued to outperform into the new century.

This is true for companies, too. AIG (NYSE: AIG  ) blew up in 2008 after making suicidal derivative bets. Last month I asked Hank Greenberg, AIG's former chairman and CEO (who left three years before the blowup) whether an investor could have possibly known how much risk AIG was taking, even with hindsight. "No, I don't think so," he said. "I'm not sure the [annual reports] that they filed were complete ... I was a major shareholder of AIG, the largest individual shareholder. I lost about 90% of my net worth." Investors thought AIG was a good, old-fashioned insurer suitable to hold in a retirement account. And then they learned otherwise.

The evidence is just overwhelming that we know much less than we think we do, even when we're armed with data and studies. Sometimes especially when we're armed with data and studies, because they give us a false sense of confidence. British neurologist John Hughlings Jackson once said, "It takes 50 years to get a wrong idea out of medicine, and 100 years a right one into medicine."

And this spreads far beyond economics. In his excellent book The Half-Life of Facts, Sam Arbesman writes:

Facts change all the time. Smoking has gone from doctor recommended to deadly ... We used to think that the Earth was the center of the universe, and our planet has since been demoted. I have no idea any longer whether red wine is good for me. My father, a dermatologist, told me about a multiple-choice exam he took in medical school that included the same question two years in a row. The answer choices remained exactly the same, but one year the answer was one choice and the next year it was a different one.

The takeaway here isn't a plea to ignore data, statistics, and studies. But they have to be taken for what they are: Fallible and often incomplete. People get tripped up when they take one set of data or one study and put all of their weight behind it. "I'm investing in X because this study shows Y." Or, "I'm selling everything because this economic report shows trouble ahead." At best, data guides us in a certain direction, but investors always have to have a healthy appreciation for the unknown. We talk a lot about how bad analysts are at predicting the future, but it's really worse than that. We barely know what's happening right now, or even what happened in the past.

Rogoff and Reinhart wrote a book titled This Time is Different, poking fun at what have been called "the four most dangerous words." I disagree. The four most dangerous in the English language words may be, "This study proves that ..."

Check back every Tuesday and Friday for Morgan Housel's columns on finance and economics. 

Read/Post Comments (35) | Recommend This Article (82)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On April 18, 2013, at 12:16 PM, jpanspac wrote:

    You hit it out of the ballpark again.

  • Report this Comment On April 18, 2013, at 2:38 PM, ddepperman wrote:

    Actually, some do have an idea of what's going on.

    Economics may be a science, but it's not got a single working basis yet. There are the Keynesians, and the Chicago Schoolers. They are like particle physics vs einsteinium relativists.

    Some argue that The Keynesians, and FDR didn't do they right thing and the economy dithered until WW2 came along and then the economy got into high gear. Give Me A Break, kiddies.

    Who financed our participation in the war?

    Unca Sammy-poo.

    He represents Government, BTW.

    The truth of that matter is that we got FULL EMPLOYMENT at that juncture.

    It all swims into view if you think about it.

    It is called, FULL EMPLOYMENT.

    I won't go any farther here.

    But the banks whom our same Unca Sam done gived billions to to lend out to small bizniz DIDN'T DO THAT. They paid back their TARP loans.

    And probably gave their wunnerful C E/O Os, etc nice huge bonuses for getting them into that predicament.

    Further, now big beeznez not paying their payables on time but extending them out for many many months. Supposedly to fund company beeznez, but also to increase CEO bonuses further.


    What are you fools arguing over?

  • Report this Comment On April 18, 2013, at 3:03 PM, MartyTheCanuck wrote:

    A study shows that one out of two internet posts are off-topic. This article was good, and the subsequent comments confirms the study findings.

  • Report this Comment On April 18, 2013, at 5:36 PM, jlclayton wrote:

    Excellent analysis Marty!

  • Report this Comment On April 18, 2013, at 5:55 PM, dennyinusa wrote:

    "Harvard economists Ken Rogoff and Carmen Reinhart"

    Harvard should be so proud.

    Are these people now unemployed?

    How can a study be published if it has that many mistakes?

    Last month I asked Hank Greenberg, AIG's former chairman and CEO (who left three years before the blowup) whether an investor could have possibly known how much risk AIG was taking, even with hindsight.

    "No, I don't think so," he said. "I'm not sure the [annual reports] that they filed were complete.

    So Greenberg admits to signing off on reports he either knew were incorrect or was too dumb to understand that they were wrong.

    Another overpaid CEO without a clue. Shocking.

    We have far too many people making money at think tanks and other useless organizations.

    People need to be paid for actually doing something useful, like digging a ditch.

  • Report this Comment On April 18, 2013, at 6:05 PM, colleran wrote:

    Morgan, your going to have to stop proving that all our "facts" about the economy, the financial system, health care, etc. are wrong. We find this difficult to take because we have to believe in SOMETHING even if it is incorrect.

  • Report this Comment On April 18, 2013, at 6:31 PM, ThorsteinVeblen wrote:

    As Mark Twain once said, "There lies, damn lies, and statistics"

  • Report this Comment On April 18, 2013, at 6:48 PM, seattle1115 wrote:

    As always, it's not what you don't know that will get you in trouble - it's what you know that just plain isn't true.

  • Report this Comment On April 18, 2013, at 7:03 PM, bornboring wrote:

    Is this an excuse to start writing trash articles from now on? Or an elegant way to cover the batch of poor quality Fool's articles in recent weeks?

  • Report this Comment On April 18, 2013, at 7:52 PM, 9BLOW0 wrote:

    My economics professor in grad school referred to Economics as a "dark art" with an emphasis on art. Obviously, things have not changed in the last 35 years.

  • Report this Comment On April 18, 2013, at 10:41 PM, NOTvuffett wrote:

    "dark art"? I got a laugh out of that one, although I think I would put the emphasis on the dark part. It is about as artful as the photography of Robert Mapplethorpe. Hell, while we are at it, let's include Andy Warhol.

    Their "dismal science" is about as scientific as alchemy or necromancy.

  • Report this Comment On April 18, 2013, at 10:50 PM, 2motley4words wrote:

    Whether the realm be religion or politics or economics---or even (or especially?) science---most of us can't abide being uncertain. Why? Well, many of us don't have an inkling of the fundamental contingency/temporality of our "knowledge" (and of our situation and our existence), and, of those who've glimpsed it, most are so freaked out that they do whatever's necessary to ignore it. (If anything really is certain, it's that I'm naught but the messenger here: in different words/contexts, Heraclitus, Socrates, Pascal, and many others have made this case much more convincingly than I ever could---and they did so long before the advent of behavioral finance and neuroeconomics.)

  • Report this Comment On April 18, 2013, at 10:51 PM, EconoMaven wrote:

    Absolutely brilliant discussion of how in the dark we all are. Should be saved and read annually by anyone who thinks he/she understands economics, market behavior, and the meaning of data.

  • Report this Comment On April 18, 2013, at 11:02 PM, tomd728 wrote:

    Economics a "dark art" allright. So dark you have to have a guide to steer through the nonsense the economists spew.

    Just avoid them, as hard as that might be, as we know too many will act off their pronouncements.

    Not much different than technical's there and people act on it. Technical analysts are O.K but I wouldn't want a loved one marry one.

  • Report this Comment On April 18, 2013, at 11:20 PM, NOTvuffett wrote:

    Paul Krugman now has his panties in a twist because we do not all recognize his towering intellect, lol.

  • Report this Comment On April 18, 2013, at 11:56 PM, enginear wrote:

    They call economics a 'science', but many don't attach the prefix social... it is a social science.

    All of the social sciences have so many variables contributing to the outcome of a system that they are usually quite unmanagable. It can get tricky in engineering, but the physical sciences are much more well defined and easier to deal with.

    Hank Greenberg basically relied on the experts to know what they were talking about, and understand the issues in their broadest sense. they were looking at the part they thought would do the boss (and their own paychecks) the most good - not unusual.

    Be careful what you believe.

    Very good article. Mr. Housel is a gem

  • Report this Comment On April 19, 2013, at 1:04 AM, whereaminow wrote:

    Please change the post title to "Keynesians" have no idea what is going on.

    Robert Wenzel of EPJ hasn't make an incorrect forecast (including the gold pullback) in many many years.

    David in Liberty

  • Report this Comment On April 19, 2013, at 1:05 AM, whereaminow wrote:


  • Report this Comment On April 21, 2013, at 11:31 AM, ibuildthings wrote:

    I read the portion of the linked article, especially the portion that describes how their errors skewed the results. At the end, there is a comparison chart, showing that (at least) an associated relationship between higher debt loads and slowing economy still exists. However, it didn't drop off as quickly at the magic 90% boundary. So the story doesn't refute the "bad" of higher Debt/GDP ratios, it only shows that the higher debt drop-off of GDP growth happens slower than the original RR paper showed, and not a "cliff" effect at 90%.

    This is reminiscent of the global warming data fiasco several years back. The bogus data and bogus conclusion was used by some to refute all of the climate change data, rather than just that conclusion.

  • Report this Comment On April 21, 2013, at 11:33 AM, ibuildthings wrote:

    Oops, typo. "I read the portion of the linked article" should be "I read the linked article"

  • Report this Comment On April 21, 2013, at 1:17 PM, EricTheRon13 wrote:

    Read the book "Wrong" if you want a complete discussion of the various problems with each of the scientific study methodologies. Of course, very little in economics is really scientific, mostly statistics are just used to prove a point that is posited for some other reason--usually personal bias. But that's also true of most of the "pure sciences" as well, and hopelessly true of "soft science" like sociology and phychology.

  • Report this Comment On April 22, 2013, at 7:05 AM, devoish wrote:

    "Of course, very little in economics is really scientific, mostly statistics are just used to prove a point that is posited for some other reason--usually personal bias" - EricTheRon13

    I see that as much more commonly being an issue of the reporting or politicking in favor of conflicting outcomes desired by different people than a lack of "science" or understanding.

    Best wishes,


  • Report this Comment On April 22, 2013, at 11:15 AM, SkepikI wrote:

    ^A persistent skepticism regarding the application of statistics to "data" (I use the term loosely) is rewarding more times than not. Even more commonly, the data is simply random observations of unrelated variables that "science" forces to fit some model or line or curve or theory. In the absence of statistical tests for randomness of the underlying data and rigorous error analysis -completely lacking in most economic studies- I generally presume the worst and am seldom disappointed. Remaining a skeptic is easy.

  • Report this Comment On April 23, 2013, at 10:40 AM, bhessel wrote:

    Heh, of course it’s not just economics. How many times have the medical establishment wavered back and forth as to whether margarine or butter is better for us over the last several decades? And a little closer to home, there’s the old joke saw about why G-d invented stock analysts: to make weather forecasters look good by comparison.

    Note to ibuildthings: Rogoff-Reinhart published a response to the Herndon-Ash-Pollin critique acknowledging their Excel errors but maintaining that their thesis remained intact because—they said—the critique agreed with their conclusion that greater debt levels were associated with slower growth. However, one of the authors of the critique responded that THEIR findings were definitely NOT consistent with the original Rogoff-Reinhart conclusions: they found no such relationship. FYI, here is a link to that response:

  • Report this Comment On April 23, 2013, at 1:41 PM, CashRulez wrote:

    What happens if we change cell C8 to 95%

  • Report this Comment On April 23, 2013, at 6:47 PM, grusilag wrote:

    Economics is a social science at best. Painting economics as something akin to physics is just plain incorrect. It is simply a study of human social behavior confined to the area of human economic activity. Economic "laws" will never be even close to inviolable like the law of gravity or something.

    I love the discussion re electricity output in Japan as I think it exposes the fallacy of using selective economic statistics to gauge a country's health. So many folks talk about Japan's "lost decade" and its high debt to GDP ratios as if Japan is crumbling. So much of these statistics depend on how a country wants to allocate its numbers. Japan essentially owns its central bank so having high debt ratios is not a big a deal for them but only seems so from our perspective because the numbers (and growth) look bad. A simpler and usually more reliable way to figure out whether a country is economically healthy is to just look at the standard of living of its citizens (as the electricity output number indirectly does). Looked at it this way, countries that we love to tout as success stories, seem less so (e.g. BRIC countries). And countries that we love to paint as nearing the precipice of a cliff are more than likely better off than they seem (e.g. U.S.A.)

  • Report this Comment On April 23, 2013, at 7:03 PM, BrokeInDaBurgh wrote:

    Hi Morgan,

    Thank you for another excellent, thoughtful article.

    You got every important thing right, as far as I can tell – well done!

    Now I am about to exhibit why I do not have any friends. The following sentence contains a textbook example of a grammar error commonly featured in the Writing Section of the SAT test:

    “As highly respected economists, the paper influenced policymakers around the world.”

    Do you (or others) see the error? Does anyone care?

    One of my many avocations is preparing children of close friends for the SAT, hence my inability to ignore this incredibly minor point.

    One follow-up question:

    Can you tell that I am the life of the party at convivial get-togethers?


    Triangle Anomaly

  • Report this Comment On April 23, 2013, at 7:28 PM, TMFMorgan wrote:

    <<Does anyone care?>>

    I don't, to be honest. The point of writing is to communicate effectively, not to score well on the SATs.

    Thanks for the comments, however.


  • Report this Comment On April 23, 2013, at 8:50 PM, NOTvuffett wrote:

    Nobody likes a grammar Nazi, even when they when they know that they are right, lol.

  • Report this Comment On April 23, 2013, at 9:04 PM, NOTvuffett wrote:

    I think all of you will like this- about grammar nazis:

  • Report this Comment On April 23, 2013, at 10:30 PM, Pat4Ra wrote:

    no serious philosopher of science ( say Karl Popper) will consider the study of economics as science.

  • Report this Comment On April 23, 2013, at 10:36 PM, NOTvuffett wrote:

    Ok, serious time now. I have found the Japanese people to be intelligent and industrious. But they also seem rigid in their thinking. If I were Japanese and I was frugal in my day to day living, and I put my savings away into the Nikkei(Japanese equity market) starting 20 yrs ago, I wouldn't be a happy camper.

    grusilag does have a point. The Japanese people are not prone to reckless exuberance in spending nowadays. Energy use is as good a measure as any. It shows confidence in the economy going forward.

    Ok, un-serious time. When a teacher in the lower grades told me not to use a preposition at the end of a sentence, I took that as a challenge. I asked her "then what should I end my sentences with?", lol. Unfortunately, my brain is now wired up that way.

  • Report this Comment On April 24, 2013, at 12:47 AM, BrokeInDaBurgh wrote:

    "When a teacher in the lower grades told me not to use a preposition at the end of a sentence, I took that as a challenge. I asked her 'then what should I end my sentences with?' "

    My personal favorite was for years thinking that the word "misled" was the past tense of the verb "to misle" meaning, srangely enough, roughly the same thing as "to mislead."

    So I would write things such as "Defendant seeks to misle the Court . . . " even in court filings, etc. -- and no one ever mentioned it, for over 30 years. Then one day I realized that there is no verb ""to misle" -- Whoops! Sorry!

    Helping kids prepare for the SAT has a hidden curse attached -- now I notice SAT errors in everything I read. It is like hearing the song, "It's a Small World" and realizing that you are doomed -- it will be in your head for hours, driving you crazy.


    Triangle Anomaly

    who realizes that he has taken a very important topic and gone 100% Off Topic . . . sorry about that too!

  • Report this Comment On April 24, 2013, at 2:14 AM, NOTvuffett wrote:

    @triangle guy, you mean in 30 yrs a judge didn't say 'what the effing hell are you talking about?' isn't a judge appointed for life for the specific task of weighing both arguments with consideration and wisdom?

    i guess things could be worse. you could be teaching the lsat or mcat.

  • Report this Comment On April 27, 2013, at 3:18 AM, seattle1115 wrote:

    TriangleAnomaly wrote: “'As highly respected economists, the paper influenced policymakers around the world.'

    "Do you (or others) see the error? Does anyone care?"

    Yeah, that's the sort of thing that will stop me cold, and I have to regroup before I can continue reading. It always amazes me when I'm reminded how many people don't, somehow, feel their teeth set on edge when they read something like that.

    That notwithstanding, another excellent Morgan Housel piece. ;)

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