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strategy and business
 / Spring 2007 / Issue 46(originally published by Booz & Company)


Joseph Ellis: The Thought Leader Interview

S+B: What are the implications for economic policy? If I were a government official, looking to create relative prosperity in my country, should I focus less on creating jobs and more on raising the income of jobs at the bottom of the pyramid?
I think you have to separate the secular from the cyclical here. Obviously, creating jobs over the longer term is the first economic priority. Cyclically, you can’t just make jobs happen, short of government “works programs,” unless there is growing consumer demand to get the economy moving. So, in that sense, you’re absolutely correct.

One effective policy, from a cyclical standpoint, would be tax cuts distributed to low- and middle-income wage earners. These have a greater economic effect than tax cuts to wealthier people, because there is a much higher labor and production input as a percentage of total value in a $10 shirt than there is in a $100 shirt. And whatever stimulates growth in consumer demand, as opposed to dollar growth, is probably going to have a greater eventual effect on labor markets. Similarly, tax cuts to manufacturers won’t have much effect. Of course, manufacturers will happily take that tax cut, but because they won’t build a factory or buy equipment until consumer spending comes around and drives demand for their product, tax cuts to businesses in economic downturns are really like pushing on a string.

I do think the Bush administration’s 2003–2004 tax cuts were generally well timed, although too canted to higher incomes. The question is, How long should the tax cuts run, especially in the context of government spending, the size of the deficit, and the longer-term government debt burden?

S+B: Some parts of the GDP are not driven by consumer spending — for example, defense, energy prices, or global financial services. What influence do those factors have on economic growth?
That’s a very interesting issue. Obviously, major increases or decreases in defense or energy spending have an effect on the economy. But in my work, I ignored them. There was simply no effective way to take them into account in a forecasting method like mine, which was based on empirical, historical observation of economic relationships, as opposed to anecdotal, one-off factors.

But some of these international or political factors are reflected in the economic data. Energy prices, for instance, are a major factor in inflation indices and therefore are immediately taken into account in the measurement of real average hourly wages. Other external events, like Hurricane Katrina or the war in Iraq, are also taken into account because they affect inflation, which in turn affects prices.

In general, I don’t think it is helpful for economists to try to “psych it out.” I’m not a big fan of using consumer psychology, or “behavioral economics,” which is all the rage — at least not in forecasting consumer spending at the macro level. It gets us into endless anecdotal thinking. And, because they are based on today’s consumers’ answers to today’s economic questions and thus reflect today’s attitudes — many of which will change tomorrow — the consumer confidence indices have also had little predictive value. But when you look at the numbers on spending power and interest rates, and there are historic, proven lead/lag relationships, you have something to work with.

S+B: In your own small chain of gift stores, Blue Tulip, do you use this kind of forecasting?
No, in our business it has no value. There are too many other local and internal factors that affect a small business. When we have 500 stores and are more closely tied to the national economy, then this will have more relevance!

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