Why don’t bad ideas ever die?
Barry Ritholtz,
Washington Post December 16, 2012

 

 

“The purpose of studying economics is not to acquire a set of ready-made answers to economic questions, but to learn how to avoid being deceived by economists.” — Joan Robinson

 

This time of year is filled with retrospectives and “best of” lists. I’d prefer a more enlightened discussion about bad ideas. Or rather, zombie ideas: the memes, theories and policies that refuse to die, despite their obvious failings. Why do we embrace the terrible, fall in love with the wrong, bet money on the fictitious? Nowhere is this truer than in the fields of economics and investing. Together they have produced a long list of thoroughly debunked ideas. Despite this, many of these zombie ideas still have a vice grip on amateurs and professionals alike. What is it about us and this intellectual voodoo? We keep repeating the same mistakes over and over. It is maddening. Let’s count the ways:

1 Shareholder value: Since the early 1980s, this theory had claimed that corporate management should concentrate primarily on increasing share prices. In practice, it is fraught with problems: Short-term focus on quarterly earnings leads to a decline in long-term research and development, typically to the detriment of a company’s long-term prospects. Short-termism and stock-option compensation causes management to focus on immediate quarterly returns. It has also led to earnings “management,” accounting fraud and a raft of management scandals. Shareholders derive much less value than the name implies.

2 Homo economicus: A primary principle underlying classical economics, it states that humans are rational, self-interested actors possessing an ability to make objective, intelligent judgments about matters of investing and money. This turns out to be hilariously wrong. We are all too often irrational, frequently emotional and regularly engage in behaviors that work against our self-interest. Homo economicus? Try Nogo economicus.

3 Economics as a science: Consider how wrong the economics profession has been about, well, nearly everything: They misunderstood the risks of derivatives; economists developed models that assumed home prices would not fall (!). They misunderstood why the recovery from the 2001 recession produced so few jobs or why the current recovery was worse in so many ways. Oh, and despite myriad signs, they missed the worst recession since the Great Depression even as it was on top of them. The sooner they admit that their field is not a hard science, the better off we all will be.

4 Austerity: Conceived from the puritanical idea that we must pay a penance for our sins, the Austerians (as we like to call them) insist that a post-bubble economy can be cured with spending cuts and tax increases, producing a balanced budget. When the United States tried this in 1938, it helped send the nation back into recession. More recently, Greece was forced to adopt austerity measures as part of its financial-rescue terms. It pushed the country into a depression. Austerity measures in Britain and Ireland and Spain — indeed, everywhere they have been imposed in Europe — have all led to recessions. Despite the wealth of evidence showing that this is a terrible idea, it refuses to die.

5 Tax cuts pay for themselves (supply-side economics): Sometimes bad ideas start as good ones. When tax rates are so high as to cause all manner of tax avoidance strategies — think confiscatory rates of 75 to 90 percent — reducing them makes sense and can change investor behavior for the better. Where we run into trouble is when this concept gets extrapolated to an absurd degree. Claiming that any tax cut will pay for itself by producing greater economic activity has now reached that point. No, Virginia, cutting taxes 3 percent does not lead to more revenue. Get over it.

6 The efficient-market hypothesis: This is the mother of all academic zombie ideas. The concept is that markets are “informationally efficient.” That lots of self-interested investors hunt down every last data point about any given asset class or stock. And pricing perfectly represents all of the given information available at the time. Therefore, no one can outperform the markets for long.

Except they have. Fund managers such as Peter Lynch, Warren Buffett, Ray Dalio and Jim Simons have consistently beaten markets over such long stretches that it cannot be merely by chance. Perhaps the even bigger anomaly that this concept runs into are the all-too-regular booms and busts — the massive mispricings of assets — that economic bubbles and crashes produce.

7 Markets can self-regulate: Another example of an idea that started out reasonably enough but soon after went off the rails. After 30 years of postwar economic growth, there was a credible argument that government regulations had become too costly, time-consuming and complex. With inefficiencies holding back small businesses, paring the worst of the regulatory burden should be productive.

As so often occurs, this good idea was taken to an illogical extreme. Instead of removing onerous, expensive regulations, zealots such as then-Sen. Phil Gramm (R-Tex.) argued against all regulations. Markets can regulate themselves much better than some bureaucrat or lawyer. Besides, the self-interest of companies and the efficient market would more effectively police behavior than any government agency ever could. We know how that turned out.

8 Gurus, shamans and prognosticators: Wall Street produces market wizards at a prodigious pace. It may be NYC’s single-biggest export. We love experts to tell us what is going to happen in the future. Never mind that their track record is awful, we prefer the mysticism of the television guru to actual thought.

The data about these experts should give us pause: The more confident an expert sounds, the more likely he is to be believed by TV viewers. Unfortunately, the more self-confident an expert appears, the worse his/her track record is likely to be. And forecasters who get one single big outlier correct are more likely to underperform the rest of the time.

Why is it that we are ensnared by bad ideas? A lot of the reasons have to do with our own makeup and the structure of our society.

Fooled by randomness (a.k.a. luck): Just because something is a bad idea does not mean it cannot, through pure chance, lead to a winning investment. (It is very difficult for people to acknowledge just how lucky they got once money is made by a bad idea).

• Greed and sloth: There is a ready supply of dupes waiting to be robbed, dreaming of enormous rewards for little or no work. Bernie Madoff was no different than Charles Ponzi, and yet people lined up to hand him money by the billions.

• Institutional mandates: In academia, whatever the dominant paradigm of the moment is tends to drive jobs, tenure, even entire careers. Publish or perish leads to a repetition of “accepted” ideas, while outside-the-box research often finds getting published to be a challenge.

• Status quo: Powerful forces are comfortable with how profitable things are, and they exert tremendous force to keep them that way. Think tanks, academia and corporate consultants create a ready constituency for old, bad ideas on their behalf.

• Narratives persuade more than data: A good story is far more persuasive than data. Zombie ideas are modern fairy tales. Comprehending a data series is challenging, requiring skill, intelligence and hard work. A compelling story, on the other hand, can be understood by a child.

• Incompetency: Skilled people have a greater understanding of their limitations for a given task; unskilled people do not. This is called the Dunning-Kruger effect, and it tells us that the worse we are at any given talent, the weaker our own meta-cognition about it is.

• Bias: Bad ideas often conform to our erroneous world views. Consider the impact of selective perception and confirmation bias — they assuage our egos and are made to fit our prejudices. Bad ideas hang around in part because we seek them out and embrace them.

• Darwinism works slowly: As a reader suggested, it often takes a while for reality to catch up with bad ideas. Consider the divine right of kings, communism and the designated hitter as bad ideas that took centuries to fall.

These zombie ideas remain a stable of academia, economics and investing. We should not be surprised at this. Recall what Max Planck — who won a Nobel Prize for physics in 1918 for originating quantum theory — famously said: “Truth never triumphs — its opponents just die out. Science advances one funeral at a time.”

Investing and economics should be so lucky . . .

~~~

Ritholtz is chief executive of FusionIQ, a quantitative research firm. He is the author of “Bailout Nation” and runs a finance blog, the Big Picture. On Twitter: @Ritholtz.

Category: Apprenticed Investor, Psychology, Really, really bad calls

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

18 Responses to “WaPo: Why don’t bad ideas ever die?”

  1. JimRino says:

    Nate Silver’s book explains the failure of Political Pundits well, and right wing economic “experts” are just pundits, selling incompetent economic theory to benefit, and protect from prosecution, the .1%.

    Krugman, and others, have much better track records.
    Yourself included.

  2. JimRino says:

    Krugman explains again the front group for the .1% sociopathic class, that believes ONLY They are Human and deserve a good life, are the pushers of incompetent economic ideas, that the fiscal cliff is just a Scam on the Middle class. Bankruptcy through healthcare, and a short lifespan belong to the middle class.

    http://krugman.blogs.nytimes.com

    The difference between the .1% and the 99.9%, is they simply cannot fathom a world where there is any other problem then taxes. When we get cancer, we begin the bankruptcy process, when they get cancer they buy the cancer center.

  3. VennData says:

    If the GOP really wanted to cut the debt and deficit, really wanted to save money, really wanted to repudiate Bush’s “Compassionate Conservatism”: they’d scrap Bush’s Medicare Part D (and its experiment with not-negotiating with vendors.)

    Let seniors pay for their own damn drugs, and bravely, American’s Greatest Generation could take one more hit for the Baby-Boom billionaires ( all couple hundred of ‘em) who the GG’s rabid consumption and nurturing support for commercial ventures bequeathed.

    Oh, is THAT why bad ideas never die? They’ve always got a constituency? That’s always got at least Senate veto power?

  4. microcap says:

    Perhaps this post should be titled, “Why Don’t Good Columns Ever Get Reposted?”

    :)))

    Happy Holidays to all

  5. Theravadin says:

    Great column. Regarding number 4, though, the flip side of that one is the bad idea that it is OK to run deficits through good times. If we hadn’t done that (Ring a bell, Mr. Bush?), we wouldn’t be struggling with running necessary deficits in times like 2009-2010. There’s a great tendency to remember only one side of Mr. Keynes prescription.

  6. eliz says:

    Excellent post. You’ve really nailed many important observations, ideas, and snapshots of reality.

    Tangential to some of these, I personally think – to create a fairer and more equitable economies – the public equity market should be dissolved in toto (loans and bonds would be the sole source of outside capital), and there should be an emphasis on creating worker cooperatives and businesses with other internal profit sharing paradigms.

    Seasons Greetings

  7. ToNYC says:

    One word answer: Tribalism.

    The belief that a free-thinking individual gifted with the ability for critical analysis and interpretation of first-party (personal) data collection with whole body and emotional brain present, will gain some evolutionary advantage by joining up with the closest known winners in zero-sum games and suspend criticism. The gain of course is a fungible currency now disconnected from success in the real game within.
    Bad games last as long as bad=no thinking.

  8. BR,

    you know, for such a Topic–as this one.. “Why don’t bad ideas ever die?”

    you may consider, for the ‘new readers’, the ‘young Grasshoppers, and the ‘Old Hands’, all, (re-)running this on a ~Weekly Basis..~

    Ye Olde Adage..~”Bad Habits Die Hard..”, may be all the Reason, if any, at all, needed..

  9. boveri says:

    Love this quote because it’s true, particularly as it relates to our social evolution.

    “Truth never triumphs — its opponents just die out. Science advances one funeral at a time.”

  10. GeorgeBurnsWasRight says:

    I think you missed the one about share buybacks being a good use of cash. First, a lot of buybacks don’t reduce the number of shares outstanding because the treasury shares are then given to the execs as options, often for accomplishments which can be described as, “showed up for work and did not repeatedly walk into walls”.

    Second, I question the creativity of most companies which cannot find a use for excess cash which will not generate more profits for their companies. Do they really believe there will never be a new product or service in their field which will make someone a ton of money?

  11. Bokolis says:

    This right here was, as we used to say in the hood, droppin’ science. Consider the irony that the WaPo audience renders this the equivalent of falling on deaf ears…the more enlightened a cat thinks he is, it may mean that it’s all the more hidden his hang-ups are, even from himself. If this were to reach some more malleable minds than ours, there just may be an uptick in the chances of things ever getting sorted out (to a degree, of course).

  12. Mattw says:

    Where is the big picture here?

    Do you see it?

    When a process does not sufficiently punish bad ideas and reward good ideas, the mediocre and the wrong will rise to the top.

    Why?

    If people are not sufficiently rewarded, then they will move to other areas. People with bad ideas will tend to stay. In time the process will end up promoting the mediocre and incompetent.

  13. dancingdiva says:

    What a wonderful column!

    While all the points were good ones, my favorite was “competency”.
    Early in my career in research my boss was constantly saying it took 5 years to make a good analyst. Being young, and somewhat stupid, I privately bristled at that. Only after 5 years, when I knew so much more, did I realize how true that statement. In fact, one rises to his/her highest level of competency ONLY when realizing what they don’t know and being able to adjust forecasts for that.

    The problem with economic forecasting in general, is that there’s usually no right or wrong answer – yet the public demands it. It should always be, if this, then that. Those who think the future is pre-determined are generally wrong. That’s why one should avoid becoming a permabull or permabear. Sure, there are probabilities, and that’s what forecasts should be based upon, but one should always recognize it’s just a probability and not a certainty. And to know what to look for to tell you a thesis is wrong early enough to make position adjustments.

    Economic forecasting isn’t a science. It’s a giant never ending infinite piece jigsaw puzzle with the picture constantly changing as time progresses.

  14. [...] This week I want to highlight Barry Ritholtz’s Washington Post article, also published on his blog, Why Don’t Bad Ideas Ever Die? [...]

  15. MikeG says:

    Most of these examples can be summed up as:
    Bad ideas that increase the money and power of the moneyed and powerful will persist way longer than they should; because these ideas are propelled not by merit, but being pushed by the power of those who benefit from their perpetuation.
    The “marketplace of ideas” suffers from the powerful with megaphones throwing around disproportionate weight.

  16. [...] Why don’t bad ideas ever die? (Ritholtz / The Big Picture)  [...]

  17. I disagree with this approach and any reliance on the Planck quote – which is on its face nonsense.

    These 10 “bad” ideas are in fact terrific ideas, but they are very bad slogans. People are very good at organizing themselves behind bad slogans, if it suits the self interests of many.

    Virtually, every explanation we have for human behavior has a maximizing or minimizing theme – some of the maximization processes are open to cognitive scrutiny and change, some aren’t.

    Only if economics were like the hard sciences could we expect a list of bad ideas to avoid, as opposed to a list of responses that have been overworked.

  18. A Droyd says:

    You forgot the BIG one! The Capital Asset Pricing Model, which has locked generations of fund managers into a blinkered, formulaic approach to investment.