To Punt or not to Punt: Policy Advice based on Observational Data

Rocky Long, second year head football coach of the San Diego State Aztecs, is facing a problem that is similar, in some respects, to what voters face.  Coach Long may choose to never punt the football once the Aztecs cross midfield, regardless of distance on fourth downs.  He is listening to advice suggesting that the strategies of many previous coaches were wrong.  Coach Long says “We had one of our professors in our business school … go over a system we are thinking about using.  We’ll have a chart come game time that will determine what we do in different situations.”

Voters must decide whether the policies of another Obama Administration will help turn the economy around and contribute to more job creation, or if the Romney campaign proposals will be more successful in achieving these goals.  Football and economic policy advice are both derived from observational, not experimental, data.  It is difficult to know what might happen if alternative policies were to be enacted.  Analysts look to history, in similar circumstances with similar policy options, and hope this provides useful guidance.

Coach Long’s decision apparently follows the strategy of high school coach Kevin Kelley of Pulaski Academy in Little Rock, Arkansas who has been remarkably successful.  But college football is not high school football.  The strategy also appears similar to advice given by Berkeley macroeconomist David Romer, who several years ago found that NFL teams kick surprisingly often on fourth down.

Romer concluded that teams are not pursuing strategies that would maximize their chance of winning the game.  Romer may be correct, but we should be cautious because his study is based purely on observational data.  It is possible that the real world problem is more complicated than the model used to analyze the data.  Whenever economics (or other social science) professors explain that agents motivated by self-interest are making choices not in their self-interest, the professors may have mis-specified their model or may misunderstand the real-world problem that people are attempting to solve.

Romer’s paper is interesting, well written, and well executed.  All of the criticisms raised here are ones that Romer acknowledges, but they aren’t enough to sway his opinion and policy advice.  The data Romer analyzed indicated that NFL teams rarely try for a first down on fourth down.  The primary question is why?  Romer’s explanation is myopia.  An alternative explanation is that a failed fourth down attempt will shift momentum in the game.

The key problem with observational data is that it is difficult to calculate the expected outcome from counterfactual decisions and policies.  Romer argues that teams are not optimizing because he believes they would be successful fairly often on fourth down and two yards to go.  He concludes this despite rarely seeing teams attempting this play.  So how does Romer “guesstimate” the likelihood of success on fourth down and two?  He looks at outcomes of third down plays with two yard to go in the first quarter of games.  He uses first quarter plays because once enough game time has elapsed and the score is uneven, both teams will adjust their game strategies.  He assumes that third down strategies and outcomes are very similar to what would happen on fourth down plays (if they actually were to occur) because he doesn’t have enough data on fourth down plays.  Even if he observed more fourth down plays, they would not be a random or representative sample of teams and/or game situations.  Romer’s assumptions are made out of necessity, not because they are realistic or accurate.

It is also important to note that Romer’s empirical model does not allow for momentum.  The value of having possession of the ball with first down and ten yards to go on a given yard line (say midfield) in his empirical model is completely independent of how one reached that position on the field.  In the language of dynamic programming, the state variables for the optimization problem include down and yardage, but not the sequence of plays leading up to that point.  He imposes this assumption, as good applied economists often do, to make the problem tractable.  He recognizes that momentum could matter and makes some supplemental calculations to show that teams don’t perform much differently immediately after very bad plays (fumbles, interceptions, blocked kicks, and long kickoff and punt returns by the opponent) and just after very good plays (touchdowns) than they do after typical plays.  This is, at best, a half-hearted attempt to determine whether there is momentum in NFL games.  The model simply doesn’t take the idea of momentum shifts seriously, but avoiding these shifts seems to be a key reason why coaches kick field goals rather than go for it on fourth down.

Rocky Long, at San Diego State, may follow the advice of economics and business school professors and forsake the punt.  But he should do so understanding how the policy advice was determined.  It is extremely difficult for economics professors to evaluate counterfactual policies- whether it is a forecast of what will happen if teams ran and passed on fourth down or a “guesstimate” of the 2012 unemployment rate had there been no stimulus package in 2009. 

Asking economics professors, the Congressional Budget Office or other forecasters to evaluate alternative policies and predict what might happen over the next decade also has limited value.  Many of these same professionals either didn’t forecast the recession or underestimated its severity.  Government economists and advisors didn’t know how deep the downturn was until a year or two later when the data came in.  Mis-estimation of the recession in the midst of the downturn is the explanation given for the woefully inaccurate prediction that the stimulus would keep the unemployment rate below 8%.

It is unwise to rely too heavily on economists as authorities on counterfactual policies.  Economists can’t easily determine what would have happened had there been no stimulus, or how the economy might perform if taxpayers earning more than $200,000 were to face higher marginal tax rates.  In fact they struggle to measure output and employment in real-time.  Predictions about hypothetical economic policies are as fraught with error as predictions about fourth down decisions that have rarely been tried in the past.

Joe Klein, Kevin Kline, and Qualifications for the Oval Office

Many journalists, pundits and politicians have offered opinions about whether Mitt Romney’s experience at Bain Capital is an asset in his bid to become the next President of the United States.  Joe Klein, who writes for Time magazine, may have the most misguided analysis of all.  This weekend he was a guest on the Chris Matthews show and offered this assessment of private equity and profit maximization:

You know, it’s true that it’s kind of cheesy to go after Romney because some of these companies that he tried to change, you know, failed and jobs were lost. The real argument against Romney and that form of capitalism is that it was all about short-term. It was all about maximizing shareholder value.  And what the president’s argument could be and should be is, `I’m not about short-term. I’m about long-term, and it’s going to take us a while to get out of this mess.’

Maximizing shareholder value is about the short-term?  Does Mr. Klein understand that the market value of a company’s equity depends on the expectation of future earnings?  Has he paid any attention to the debate about the price of Facebook shares in the wake of its IPO?  If the shareholder value of a company only depends on the short-term, why is there so much disagreement and uncertainty about the appropriate stock price for Facebook?  The uncertainty arises because the future profitability of the company is unknown.  Future profits depend on how well Facebook will be able to sell advertising to its hundreds of millions of users, and how that may change as more Facebook users access the site through their smart phones.

Joe Klein knows little about the way private companies or the economy works.  Increasing the shareholder value of a company requires changing expectations about the future stream of profits from a company.  It is all about the long term.

Klein’s ideal Presidential candidate, other than Barack Obama, may well be the Kevin Kline character from the movie Dave.  Dave was the manager of a temporary help agency before filling in for the President in the 1993 movie.  Helping people find jobs sounds like the ideal experience for the Oval Office for movie-goers and voters who believe that Presidents create jobs.  Dave’s last act as President was to initiate “a program to try to find a decent job for every American who wants one“ because “if you’ve ever seen the look on someone’s face the day they get a job — I’ve had some personal experience with this – – they look like they could fly.”  Hollywood wouldn’t support a President that said “I’ve seen the look on investors’ faces the day they realized they had turned around a company and created a lot of wealth.”  But, as Brit Hume of Fox News said over the weekend “the business of making a profit has jobs as a by-product.  It’s not as if there’s some favorite industry out there called Jobs R Us, which is in business for the purpose of creating jobs.”

The President and the Congress establish and enforce the laws, taxes and regulations that impact the creation of wealth and consequently the creation of jobs.  Running a business is not the same as governing, but private sector experience helps one understand the costs and benefits of government intervention in markets.  President Obama believes that the Presidency is different than running a private company because maximizing profits is “not always going to be good for communities or businesses or workers.”  The President also said: “When you’re president, as opposed to the head of a private equity firm … then your job is not simply to maximize profits. Your job is to figure out how everybody in the country has a fair shot.”

Voters should consider how each candidate proposes to change taxes and regulations to encourage more wealth and job creation and provide equal opportunity and a fair shot for everyone.  Mischaracterizing the economic role of private equity firms and trying to count the number of jobs that were created or lost as Bain invested in start-ups or troubled companies is largely a waste of time.  The Romney campaign believed that promoting Bain as a job creator would ameliorate the view that their candidate is an out-of-touch rich guy.  The Obama campaign continues to push this unimportant issue and their best explanation seems to be that Romney was the first to mention job creation at Bain.  Let’s hope that both campaigns get off this topic and turn to the important economic policy issues facing our country.

If Presidents Can’t Lower Gasoline Prices, Can They Be Blamed For Stagnant Wages?

Many pundits have opined that there is little President Obama can do to lower gasoline prices.  Richard Thaler, of the University of Chicago’s Booth School of Business, explained in the Sunday New York Times that this is because the U.S. is a “price-taker” in the world market for petroleum products.  The U.S. has a limited influence on world prices because we control only about 2% of the world’s oil reserves and consume about 20% of the world’s oil, according to Thaler.  He also cited a University of Chicago panel of leading economists who unanimously agreed that changes in U.S. gasoline prices are “predominantly due to market factors rather than U.S. federal economic or energy policies.”

The U.S. is also a “price-taker” in the market for unskilled labor.  There are about 50 million Americans with a high school diploma or less in our labor force.  The world’s adult population exceeds four billion and most are relatively unskilled workers.  U.S. demand for and supply of unskilled labor is small relative to the rest of the world.  Thus changes in the wages of less educated and less skilled workers are also “predominantly due to market factors” rather than U.S. federal economic or labor policies.  Working class wages have stagnated relative to the salaries of college educated employees over the past few decades primarily because of shifts in labor supply and demand and not the policies of Presidents and Congresses, whether Democratic or Republican.

Does this mean that federal policy has no impact on gasoline prices or the wages of working class Americans?  Obviously not, but as Professor Thaler noted some policies are more efficient than others in achieving “societal goals.”  For example Thaler, an informal advisor to President Obama, described the Obama administration’s decision to increase the corporate average fuel economy standards for automakers to 54.5 miles per gallon by 2025 as “not the best way” of reducing oil consumption.  Similarly, minimum wage laws are “not the best way” of raising the standard of living of young, inexperienced and relatively unskilled workers.

Thaler’s discussion of oil prices illustrated why one can’t evaluate policies or assess the welfare of consumers or producers by merely observing price fluctuations.  In one section of the op-ed he wrote:

Presumably, no one would call President George W. Bush unfriendly to the oil industry.  Yet the price of gasoline rose steadily during most of his administration. In February 2001, just after Mr. Bush took office, the average price of regular gasoline was $1.45 a gallon. By June 2008, that price had risen to $4.05. Still think presidents and oil-friendly policies can determine oil prices?

Many readers are probably confused by this passage.  Doesn’t the oil industry want higher gasoline prices?  Wouldn’t a President friendly to the oil industry be pleased that gasoline was $4.05 per gallon?

The price of any good or service, including wages and interest rates, can rise or fall for many different reasons.  Corn producers prefer higher corn prices if they result from demand increases but not if they are caused by a drought.  Energy policy should distinguish between high oil prices caused by high GDP growth in the U.S., Europe and Asia, a moratorium on oil exploration, uncertainty in the Middle East or the declining value of the U.S. dollar.  A price change alone tells us little about what caused the change and which policies might be effective at mitigating the impact of the change.

Increasing gasoline prices and a widening wage differential between more educated and less educated workers are determined largely by shifts in supply and demand.  Without understanding the market forces that caused these changes one can’t be sure whether they are a cause for concern.  If the policy goals are to mitigate the impact of these price changes the least effective and efficient government policies are direct price controls, such as the minimum wage.  Price controls treat a symptom of a problem but do not address the underlying forces of supply and demand that caused the problem.

Commentators and pundits who are quick to note that presidents  have little control over gasoline prices, should also make it clear that the decline in the pay of less educated workers relative to college graduates has much more to do with world supply and demand for unskilled labor and much less to do with presidential politics.

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