Unconventional Wisdom

The Fosbury Flop, an unusual high jump technique where athletes go over the bar backwards, was introduced by Dick Fosbury at the 1968 Mexico City Olympics. Despite initial skepticism and negativity, Fosbury won the gold medal, demonstrating the technique's superiority. His success led to widespread adoption, proving that a willingness to try something new, even if it attracts skeptics, can be a key to success. This innovative approach, seeing things others don't, offers a significant advantage in a competitive world, according to Jonathan Burke, a finance professor at Stanford Graduate School of Business. Burke's research often challenges conventional wisdom. One example is his work on the national debt, specifically the debt-to-GDP ratio. Historically, debt is compared to GDP to gauge an economy's indebtedness, as simply measuring total debt doesn't account for economic growth. The debt-to-GDP ratio has significantly increased in the last 20-30 years, reaching levels similar to World War II, leading to concerns about economic decline and potential default. However, Burke and his co-author, Jules Van Binsbergen, question the validity of this single ratio as the primary indicator of economic health. From a finance perspective, they argue that GDP is a flow (annual production), while total debt is a stock (accumulated amount). In corporate finance, comparable metrics often involve comparing stock to stock (e.g., debt to equity) or flow to flow (e.g., interest to earnings). When Burke and Van Binsbergen applied these alternative measures to the US economy, they found astonishing results. The debt-to-equity ratio (total US debt over the total value of the US stock market) has remained flat, despite the explosion in the debt-to-GDP ratio. Similarly, the interest-to-earnings ratio has also been largely flat over the last 40 years. This suggests that other equally plausible measures do not display the same alarming behavior as the debt-to-GDP ratio. The paper's core argument is that economists lack a robust theoretical framework for determining the best measure of national debt. Burke emphasizes that before declaring a crisis, a sound theory is needed to justify the chosen metric. He points out that the debt-to-equity measure has an advantage because equity is a forward-looking measure, reflecting expectations about future cash flows, which might offer a better prediction of future economic conditions. However, he acknowledges this is a loose argument and a convincing theoretical model is necessary. Another paper by Burke, "Regulation of Charlatans in High-Skill Professions," also pushes against conventional wisdom by arguing that, when regulating in the interest of consumers, no regulation is often the best approach. While this seems counterintuitive for professions like doctors or pilots, Burke's crucial insight is that consumers are not "stupid." Without regulation, consumers would demand high standards, especially when their lives are at stake. The only regulation that would be "interesting" is one that raises the standard even higher. However, the cost of higher regulation is reduced competition, which leads to increased prices. Burke's research demonstrates that this effect dominates, ultimately reducing consumer surplus (the difference between a consumer's willingness to pay and the actual price). Therefore, he argues that regulation, by increasing prices, makes consumers worse off. He doesn't suggest consumers are perfectly sophisticated, but questions whether government regulation is inherently better at protecting consumers. The paper's point is not to abolish all regulation but to challenge the assumption that regulation is always in the consumer's best interest; regulators must justify why consumers are better off with regulation than without it. Burke suggests that regulation often serves the interests of producers, who benefit from reduced competition. When discussing the types of regulation, Burke distinguishes between government licensing, which makes it illegal to practice without a license, and certifications, which can be issued by professional organizations. Both can decrease competition by setting higher standards, thereby benefiting producers. Burke reiterates his belief in consumers' ability to make good decisions, especially when money is involved, and challenges the notion that consumers need constant parental guidance. He also argues that there's no evidence that the government can consistently make better decisions for consumers, often disrupting industries and worsening outcomes. While acknowledging the risk of fraud, he believes that laws against fraud and increased consumer caution in the face of potential fraud are more effective than broad regulation. Burke reflects on his personal inclination to challenge conventional wisdom, noting that while many organizations claim to value such feedback, few truly embrace it. Such behavior can be personally costly. However, academia is an environment where pushing back can lead to success. He attributes his ability to solve complex problems in financial economics to his unique way of thinking, which allows him to see things others miss. He emphasizes that fostering such critical thinking in organizations requires leadership by example from the very top, creating a culture where admitting mistakes and learning from them is not only accepted but celebrated. He uses the example of Navy SEALs who prefer soldiers who admit and learn from mistakes over those who deny them, illustrating that a well-run organization embraces this principle to become elite. The value of this approach lies in seeing problems from different perspectives, conferring an enormous advantage in a competitive world, even if it comes with the personal cost of often being misunderstood or challenged.