The other day I commented that economists know as much about business as does the average house cat, and Dean Baker penned a piece on Wednesday in which he sets out to correct a mistake published by a Stanford Business School professor and proves that my statement was right on the mark.
To clarify my remark, a businessman does actual bookkeeping and manages a business, planning based on those numbers for the future course of his company and keeping track of whether or not his business is or is not making money. Sometimes he lies about the latter, of course, but even so he knows the facts even when he is not revealing them accurately. Economists, on the other hand, create “models” and formulas which explain why the overall economy does what it does. That largely consists of developing a mathematical formula from present conditions and claiming that it predicts what will happen in the future, much like predicting based on the El Nino of 1998 that San Diego would get 28” of rain this year and then trying to explain why we only got 6” of rain.
At any rate, Professor Joshua Rauh of Stanford Business School wrote that state and local pension funds are more seriously underfunded than claimed by the funds, because they are using a 7% rate of return on their investments rather than a more reasonable rate of return on risk free investments of 2.5% which currently prevails.
Dean Baker refutes the professor’s claim, saying that the numbers used by the funds “are not pulled out of the air,” but rather are “projections of investment returns based on actual experience and a range of standard economic projections.” That is to say history and numbers pulled out of the air by people like him. History is good because interest rates have not dropped recently. Oh, wait…
And Professor Rauh’s projections are no good because he is a business professor, while Baker’s projections are good because he’s an economist. You say tomato…
Then he gets to the real proof that economists should never be allowed to discuss business. He discusses how pension funds “typically average the value of their assets over the prior five years,” and points out that in 2013 that average “would have included 2009 and 2010 when the stock market was badly depressed.” He does not point out what part of Professor Rauh’s discussion involved 2013, nor does he say why that has anything to do with this discussion, because no reputable pension fund manager would put more than a very small portion of a fund into the volatility and high risk of the stock market.
As even further proof that Baker is badly out of his field of expertise, he acknowledges that the stock market is not a "risk free" investment which pension funds require by going on to say that as 2009/10 was replaced in those averaged years “with the much higher stock market values of 2014 and 2015, the funding status of these pensions will look considerably stronger.” Yes, it would look considerably stronger but, due to the risk that those stock values will dive back down to 2009/10 values, it would not be considerable stronger.
So, aside from the fact that pension funds are not materially invested in the stock market, something that Dean Baker should know if he does not, his little journey into fantasy land points out that economists are concerned with how things look, while businessmen are more concerned with how things are.