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What Good Are All These Numbers?

Are economic data not keeping up with reality?

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Economists have now routinely failed to predict major regional and global economic crises.

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Earlier this month, Washington Post columnist Robert Samuelson wrote: “The widespread faith that modern societies were sheltered from deep and sustained economic setbacks has been shattered, causing consumers, business managers and bankers to be more cautious in borrowing and spending.”

Is this the fault of economists, flawed statistics, outdated economic theories or too much emphasis on economic data? What if economists are giving false expectations to a society with their dismal science? What if statistical methods and economic theories have little relevance to modern day economic success? What if particular economic data are being overanalyzed, overused and overemphasized by the markets to gauge country performance?

Economists have now routinely failed to predict major regional and global financial or economic crises. Most damaging is that, despite all the modern tools available, we failed to predict one of most destructive crisis in the western world in the post-war period – the 2008 American financial crisis, the ensuing global crisis in 2009 and then the subsequent 2010 European sovereign debt crisis. This was in our backyard and yet we did not see it coming. Worse, there is still no great consensus among the brightest minds in the world on what to do in the aftermath of a crisis in which approximately 40 percent of the Western world’s middle-class wealth was eradicated.

[See a collection of political cartoons on the European debt crisis.]

And it’s not just the economists that failed, but also the so-called bastions of economic thought and theory, including the International Monetary Fund, the World Bank, the Organization of Economic Cooperation and Development, the U.S. Federal Reserve, the National Bureau of Economic Research, the European Central Bank, the Bank of International Settlement, respected think-thanks, major Ivy League university economics departments and their Nobel laureates.

More importantly, none of the above either seemed to agree on the causes or get the recovery formula quite right.

Perhaps some age old economic theories and so-called established truths need to be revisited. Most people are now hard pressed, rightly so, to believe that Ivy League economists or multilateral institutions can safely guard modern developed economies from periodically imploding.

What if our statistical methods and economic theories are no longer relevant for assessing our complex modern world? Consider these questions: Has the consistently large U.S. trade deficit, first with Japan and now with China, really ruined the U.S. economy over the last 40 years? Are the Europeans undoing their economic success with month long summer vacations or is that part of the inevitable economic decadence that comes with wealth and development? What is ultimately more important, the quality of life or the standard of living?

The same observations can be made about leading indicators such as the performance of the S&P 500, inflation standards, and housing and consumer confidence data. Data are dependent on the timeline being looked at and its interpretation. Zachary Karabell’s new book, “The Leading Indicators: A Short History of the Numbers That Rule Our World,” insinuates a bit of all of the above.

[See a collection of political cartoons on the economy.]

Perhaps it’s not the economists and their theories, but rather that the data they use and the way they use them is flawed. Recent books, such as Dianne Coyle's “GDP: A Brief But Affectionate History," highlights this point. The book tells the story about the usage and growing importance of GDP and the rate of its growth as a marker for modern day success, tracing the origins of GDP to the 18th century. The book examines the merits and flaws of this single data point and how it impacts a country and the future of billions of people. For example, a country's acceleration or decline in GDP today can determine the up- or down-grading of its sovereign bond rating. This, in turn, can either enhance or hamper a country’s ability to borrow from global capital markets, thereby rendering it functional or dysfunctional. Thus, GDP can either elevate a country's population to the mounting ranks of the middle class or doom them to languish at lower living standards for years to come. Another example of the importance of the GDP data point is that its rate of growth or decline more often than not dictates the outcome of national elections or the degree of social unrest.

Data can also outgrow their usefulness. Coyle’s book points out that while GDP was a good indicator in the 20th century, its usage in the 21st might be limited due to the increased complexity of economies (i.e. the difficulty in capturing and measuring services, which account for more 80 percent of America's $16.8 trillion GDP).

Despite economists, their theories and their data, one thing is for sure: We are all a little bit miffed in trying to make sense of new global risks. We are muddling through, hoping for clarity and certainty again. I believe it will be some time before we feel that pre-2008 security once more.