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Rational exuberance Featured

8:13am EDT February 27, 2003
Carl Tannenbaum has degrees in finance and economics and more than 20 years experience, but as he will quickly tell you, what he doesn't have is a crystal ball.

Tannenbaum is senior vice president and chief economist for LaSalle Bank and the editor of The Viewpoint, its quarterly investment newsletter.

But he sees himself as more of an interpreter of the factors surrounding our economic environment, not someone who can predict the future.

He freely admits that economics is a social science, not an exact science, and wrote in his most recent newsletter that he dreads making predictions for the upcoming year.

What Tannenbaum does know is a lot about where the Midwest economy has been, and he has some good ideas on where it should and shouldn't go in the future.

SBN Magazine sat down with Tannenbaum and asked him what might affect Northeast Ohio, the Midwest and the country as we get into 2003.

Some people think the job of an economist is to predict the future, tell their clients what stocks are going to do well and tell them where to invest and where not to invest. If that's not true, what's your role?

We do a lot of commentary. We do a weekly and quarterly summary of what is happening out there for our clients.

We are not out there to win the prize for being the most accurate forecaster, but the philosophy we have is to try to connect the dots -- to make sense of a multitude of data from the various sources so they can anticipate what their business might be facing.

We try to stay away from dramatizing the data of the day. Economic statistics are revised and rebenchmarked frequently and there are trillions of dollars trading every day.

The truth is that economics is social science -- there are some laws that need to be obeyed.

When you learn economics, the first thing they say is, let's assume that people behave by certain rational rules. Then, all of a sudden, using that, they build curves and theories, and then you get into the real world and you realize that people don't behave rationally.

We have recorded past behavior and we try to predict what will happen going forward, but there is a certain margin of error. Also, the budget for collecting economic data is not what it should be.

We try to get our readers and clients to look at things over time. Let's look at a few months of observation and not just the most recent. Let's see if the data is corroborated and let's put things in context instead of overreacting.

We do try and take a broader perspective on things than what is reported by a wire service story.

Everyone is so aware of what happens every day with our economy, to the point where many have a constant stock ticker running on the bottom of their computer. How has that changed the way we look at the economy and economic news?

This is my third recession. One of the things that sticks with me is that what used to occur over a number of weeks or months in the markets can now happen in an afternoon. And the reason for that is that information travels much more rapidly and people can act on information much more rapidly.

The influence of technology is paramount in this, everything from the transmission of news to companies that are able to find out what they are selling in real time. When I started, we were just able to get overnight sales reports, and prior to that we were just starting to get monthly reports. Retailers can now adjust their products and order faster, and it has become necessary.

But if you get bad info, you can overreact in the wrong direction, and that is what gives us the greater degree of volatility.

Speaking of that, one of the lead stories over the holidays was how retail sales were going. A few years ago, a news organization would never have made that a lead. How does that affect what you do?

The deluge of stories last year that the retail sector was struggling clearly may have had an effect or even precluded a bad outcome for the season. Sometimes what we say can become a self-fulfilling prophecy in that we have the potential to shape people's moods and behaviors.

There are some historical assumptions about what a war does to the economy. With the new structure of our economy, which is less industrial-based, will a war have the same effect?

The dominant element right now is that war is a great tragedy and a great source of unease, and the threat of war leads both consumers and businesses to be more conservative. We are fearful of making commitments because in a month's time, the landscape could change. It's a kind of paralysis that results from people huddled around TV watching the conflict.

It is the No. 1 factor that is keeping business on the sidelines -- because companies that aren't building inventories and investing hurt manufacturing.

On the other hand, wars over history have been very stimulating for the economy, and that comes from the military. The spending the government does as a result can be very stimulating.

We have clients that make weapons and components for weapons, and they have been extremely busy, but it is never a pleasant situation and we should hope for peace. When we try to be clinical, (war) is a net negative for the economy but not for every sector of the economy.

What about the Midwest? We have always been heavy into manufacturing. Will it affect us more?

When the Berlin Wall came down, we realized what is called a peace dividend, and in the Midwest, we did have factory complexes that were supplying and benefited from the Cold War, so the peace dividend rolled some of those industries back.

And we have never totally recovered. However, as tough as it has been in the Midwest, the reality is that the two coasts were really hit the hardest, especially California.

The irony here in Cleveland is that we chastised ourselves for not being part of the new economy, but in the end, we weren't as hurt by the burst of the bubble.

That's exactly what happened. All around the Midwest, everyone wanted to be a tech incubator. And remember, that term was an apt way of describing the kids in pajamas that were running these companies.

For the most part, they were never terribly successful at building viable businesses, but we were happy about our failure to join them when we came out unscathed from the fall.

We have seen a lot of consolidation in manufacturing and industrial in the Midwest, which is what drove the economy. There are so many different voices about what is best for these communities. Want to add your own?

We've done a very credible job at reducing our reliance on the heaviest Rust Belt industries -- the legacy which is a result of history and geography.

Aside from the impact of recession and the prospect of war, the trends of manufacturing are also very challenging. As you alluded to, a lot of basic manufacturing is moving overseas with the embrace of free trade in the last 10 years, and the jobs involved may never return to the U.S.

And what that means for an area like ours is that first, we need to make sure that what manufacturing is still here stays here. And I think it will, but it has to move into higher value-added manufacturing. That means more sophisticated equipment with more sophisticated engineering and labor.

That is where our competitive edge is still present, and if we are able to sustain it, we will do well. The challenge is that the labor pool is still based in the old manufacturing, and a new, more skilled and educated labor pool is needed -- and that is hard to do.

It may take a generation and a big turnover in the labor force to get that into place.

What do you see happening to achieve these goals?

I see something in towns around the Midwest lately. They are trying to create a bridge for their economies, to tide them over, and there are usually two components.

Many cities think, 'Let's become a center for conventions.' This is very difficult because the scale in which you have to compete has now gotten so large.

I gave a presentation in Orlando, and they now have 3 million square feet of convention space. And a lot of these shows are held outside of the summer months, when the weather is a big factor.

You also have to ask, 'What sort of inducements are there to come into town?'

Yes, you get the hotels filled and cabs are used and restaurants, etc., but is it really a net plus for economic activities? And it's going to be tough sale.

The other point is that Cleveland is in competition with Chicago. They have to compete with Chicago and McCormick Place (in that city) is close to 3 million square feet and, of course, the city has its charms, as well.

What is also happening is that some communities are looking at casino gambling as a panacea. In fact, there is a finite pool of gambling dollars out there, and communities have to ask themselves if that is really the way they want to build their economy.

Gambling is a zero sum game. It is a redistribution rather than a wealth creation.

If you are patient and nurture service industries and sophisticated manufacturing, the payoff will be a lot better. Gambling is a quick fix.

It is terribly regressive. Poor people gamble more, and what that does is exacerbate income equality.

So our best bet is to take it slow and build a sturdy infrastructure?

Yes, but unfortunately, slow, organic and patient are not words that the politicians usually embrace.

We are going through some very challenging times in general and in the Midwest, but I don't know that we should be hopeless about it.

I'm optimistic that the problems should be resolved in Iraq and inventories will be revived and we will start feeling that there is a recovery.

I'm looking forward to that day. How to reach: LaSalle Bank, 866-904-7222 or www.lasallebank.com