TCS Daily

Economic Attribution Errors

By Arnold Kling - June 2, 2003 12:00 AM

"Psychologists call this tendency the Fundamental Attribution Error (FAE), which is a fancy way of saying that when it comes to interpreting other people's behavior, human beings invariably make the mistake of overestimating the importance of fundamental character traits and underestimating the importance of the situation and context."
- Malcolm Gladwell, The Tipping Point, p. 160

Recently, a book club in which I participate met to discuss Gladwell's book. Ironically, one of the participants proceeded to commit what I think of as the Economic Attribution Error. That is when someone attributes the behavior of key macroeconomic indicators, such as the exchange rate, the Budget deficit, or the unemployment rate, to the fundamental character traits of government officials, such as the President or the Chairman of the Federal Reserve. In fact, the values of these variables depend mostly on the context provided by the private sector - the influence of fiscal and monetary policy tends to be vastly overstated.

What happened at the book club was that one participant complained that her forthcoming trip to Europe was going to be expensive, because of the recent decline in the value of the dollar. Another participant quickly assured her that this was due to the Bush administration's irresponsible economic policies. Although I did not want to get into a heated argument (we were there to discuss Gladwell's book, not economic policy), I felt compelled to murmur something about Stein's Law.

I was hardly being original. Over three years ago, Paul Krugman warned,
"Our current position, where we pay for many of our imports by attracting inflows of capital - in effect by selling the rest of the world claims on our future exports - cannot go on forever. And as the late economist Herbert Stein declared, 'If something cannot go on forever, it will stop.'

The most likely scenario is that the trade deficit will eventually be reined in by a decline in the foreign-exchange value of the dollar. The great dollar slide of 1985-87, precipitated by a trade deficit that was actually smaller compared with G.D.P. than the deficit today, reduced the value of a dollar by 40 percent in terms of German marks and Japanese yen. And there is no obvious reason why the same thing can't happen again.

...foreign investors, and therefore the value of the dollar, are arguably doing a Wile E. Coyote - one of these days they will look down, realize that they have already walked over the edge of the cliff, and plunge."

Similar warnings were made by Steve Roach in numerous settings (e.g., last July) and by Brad DeLong, who favorably passed this along from The Economist, also last July.
"There is also persistent concern among economists and, now, investors, about America's huge current-account deficit - now running at over 4% of GDP. In historical terms, that is a very high level for an economy just emerging from recession. Some research suggests that such high deficits tend to be unwound quickly, by a rapid downward adjustment in the currency."

Krugman's column about the dollar bubble appeared almost a year before President Clinton left office. Roach, DeLong, and The Economist gave their warnings before either "dividend tax cut" or "John Snow" were anywhere on the economic policy horizon.

The "Clinton" Surplus

Another case of the Economic Attribution Error concerns the Budget surplus. During the Clinton administration, the projected Budget surplus improved by over one trillion dollars. However, most of this change came as a surprise to the administration. A reasonably non-partisan analysis by Douglas W. Elmendorf, Jeffrey B. Liebman, and David W. Wilcox shows that less than 20 percent of the revision to the Budget outlook came from economic policy. (See figure 4 in the paper).

In fact, it appears from Table 2 of the paper that by the latter part of the Clinton administration the policy contribution had turned adverse - in the absence of the policy changes made during those years, the surplus would have been higher. A cynic might say that throughout most of the 1990's fiscal restraint was adhered to only because policymakers under-estimated the growth of the economy and tax revenues. Our representatives in Congress likely would have spent the surplus sooner had they known it was coming.

According to the economic attribution error, all of the movement toward surplus in the 1990's would be credited to the actions of President Clinton and Congress during that time. However, the best reading of the data would seem to indicate that at least 80 percent of the change reflected a context in which revenues grew faster than forecast.

Monetary Maestro?

Federal Reserve Chairmen are always revered. Even Arthur Burns, who unleashed a torrent of money during President Nixon's 1972 re-election year, thereby serving to aggravate the problem of inflation, was at the time viewed as wise and irreplaceable.

Today, Alan Greenspan is regarded, in Bob Woodward's term, as a maestro. Again the economic attribution error is at work. Journalists - and even some economists - will attribute every wiggle in macroeconomic performance to Federal Reserve policy. In fact, the Fed only affects one minor interest rate - the rate that banks charge one another for overnight loans - and for the most part the Fed is content to passively keep that rate in line with general market trends.

In his analysis of monetary policy in the 1990's, Greg Mankiw, now President Bush's choice to be chairman of the Council of Economic Advisers, does not share the widespread view that Alan Greenspan's brilliance is what accounts for the strong economy.
"A large share of the impressive performance of the 1990s was due to good luck. The economy experienced no severe shocks to food or energy prices during this period. Accelerating productivity growth due to advances in information technology may also have helped lower unemployment and inflation."

Journalists see the economy as a puppet, with Greenspan pulling the strings. But the reality is quite different.

Judging Policy

The economic attribution error means that people assign too much credit or blame for economic performance to the President and other officials. But shouldn't the President be held accountable, just as a corporate CEO is held accountable for corporate performance?

First, I believe that we commit attribution errors in our evaluation of corporate CEO's. The rise and fall of America Online had much more to do with the context in which it operated than with Steve Case's character traits. One of the reasons that I am not a fan of stock options as compensation is that their value tends to depend a lot on context rather than performance - options are worth more in a rising market than in a falling market.

In fact, the whole issue of CEO compensation is made murky by the economic attribution error. If CEO's really make enough of a difference to merit their centerfold spreads in business magazines, then they are badly underpaid. On the other hand, if context plays the dominant role in determining corporate profitability, then CEO pay is biased upward by the attribution error. I suspect the latter.

The President of the United States is not the CEO of our economy. The President operates under much tighter constraints - and we should be happy about that. Limitations on executive power are a good thing.

I do not think that the President should be held accountable for the decline in the dollar, the rise in unemployment, or the rise in the deficit so far. However, I want to make clear that while I am arguing against making the economic attribution error, I am not giving President Bush a "pass" on economic policy.

The Bush economic policy can be evaluated on its own merits. I would give the administration a bad grade on trade, because of the steel tariffs. I would give the administration a bad grade on fiscal policy, because it is making no attempt to identify and implement spending reductions, and because it has not pursued any sort of "exit strategy" for Medicare, which threatens to capture a huge share of GDP for the government. I would give the administration a bad grade on energy policy, because the proposal to subsidize hydrogen fuel cells shows a failure to understand Oil Econ 101. I would give the administration a bad grade on education policy, because it continues to undermine local control of schools.

These policy disappointments cannot be explained away by the economic attribution error. I can say only one thing in defense of the Republicans. On the issues that I just mentioned, their policies are only the second-worst of the two major parties.

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