Economists are used widely by attorneys in personal injury and commercial litigation. The reliance upon economists calls for scrutiny by attorneys regarding the expert’s credentials, and vigilance regarding the potential biases in assumptions and methodology. Plaintiff and defense attorneys can learn some simple rules to check an opposing economist’s work for obvious bias in methods that violate certain basic ground rules in economic assessment. Simple guidelines can assist attorneys to become aware of the degree of neutrality exercised by their own, and the opposing expert.
BIASED ECONOMIC ASSESSMENTS
Economic experts may use biased methods to portray favorable results in earnings loss calculations. When calculating the loss of earnings from a personal injury, wrongful death, wrongful termination, or other career interruption there are four main determinants of such lost earnings: the earnings base, the expected economic growth rate of earnings, the period of future loss, and the interest rate used to discount to present value. Biases may appear modest in any one of the four assumptions but, combined, can lead to a significant bias in the overall result. Many of these biases are simple to detect.
Earnings Base: The estimate of the earnings loss expected in the first year after the plaintiff’s injury is the platform upon which all else is built. Suppose that an earnings history, whether of a company, a product, or an injured employee, has progressed upwards for a five-year period prior to the injury in the following manner: $70,000, $71,000, $72,000, $73,000 and $74,000. To the untrained eye, a projection of $75,000 the following year appears reasonable. But this simplified approach does not take inflation into account. To properly forecast the future, the past earnings must first be recalculated and stated in the same year’s (constant) dollars. If inflation for the five-year period in question had been 2 percent each year, the losses all recalculated and stated in the base year’s (constant) dollars are $75,770, $75,346; $74,909; $74,460; $74,000. This shows a distinct pattern of declining real wages. If inflation is low, we can estimate that the actual earnings may remain close to $74,000, or even possibly fall to the average of past earnings, since real wages are indeed falling. Further any rapid earnings grown early in a person’s career generally does not persist in the long run. However, future prospective promotions cannot be ignored.
Other biases result from assuming without foundation that future recessions will not impact earnings, that overtime hours worked in the past will persist long term, or that economic expansions either in an industry or in the overall economy will not end. Sometimes an economist will use just one strong past year’s earnings to project the future. Alternatively, an economist may offer a “dismal” view of an individual’s earnings future, assuming that only recession-era earnings continue to the future, or assuming earnings from only a partial year worked. In tandem with the wage base, proper calculation of fringe benefits likewise requires scrutiny. For example, sick time or vacation time isn’t strictly a monetizable benefit. Profit sharing in a good year may not persist.
Earnings Growth: The bias of an inflated earnings base can be compounded by the bias of an inflated growth rate. In the example above, a real growth rate above zero may not be justifiable. In seven of the last 20 years, including four of the five years from 2009 through 2013, wages have shown negative real growth. A fair estimate is to use the last twenty years or so as a standard, which has been shown to be a reasonably good and relatively valid predictor of the future. Some careers may merit strong future wage growth assumptions while others may merit the contrary.
Period of Economic Loss: Many economists will offer the loss to only a specific age, calculating one terminal figure. It is relatively easy, however, to show losses for each year through the plaintiff’s life expectancy. The losses from working through any age can be read off such tables. The Jury can be in charge!
Many economists will use a retirement age from statistically average work-life tables; these tables present many problems even if appropriately used in states where expected or likely earnings are the standard of recovery. However, in Nevada it is the capacity to earn income that is the measure of damages, not expected earnings. Further, work-life tables cannot differentiate between people who are forced to retire due to health concerns, and those who could continue to work, but choose to retire to spend time with family, purse hobbies, or volunteer. And importantly, work-life tables don’t necessarily apply to a specific individual. Some economists “front load” the work-life by assuming that future years of salary would have been earned through consecutive, full-time employment instead of spreading out over all future years in a manner equal to the statistical work-life expectation of an average worker; this front-loading can result in an upward bias of 5 percent to 10 percent.
Discount to Present Value: Discounting to present value means taking into account the fact that an award, invested safely, will earn interest. One of the common plaintiff- biased approaches is to use the total offset method which assumes that the discount rate is equal to the wage growth rate. This assumption is made by some vocational experts or others such as MBAs or CPAs who have only a bachelor’s of accounting and who do not have serious, advanced economic training and cannot justify the selection of individualized growth and discount rates. By assuming rates to be offsetting, presto! the problem of explaining the choice of specific growth and discount rates disappears. But these rates have not been not offsetting historically.
Generally, government bonds are regarded as safe, and free from risk of default. For the defense, some experts use high yield instruments such as Corporate Bonds, Municipal Bonds, or Equity Funds which are distinctly riskier than government bonds. Many municipalities have declared bankruptcy in recent years. On the other hand, there may be times when using a higher interest rate assumption is warranted.
When calculating a present value of the cost of future life care, an economist should differentiate the future growth of medical services from those of non-medical services and commodities. Home health or institution care for injured parties are custodial, not true medical services. Yet the cost is often erroneously projected to grow at the much higher expected rate of growth of medical care services. In addition, institutional care provides for some of the personal consumption costs of the injured party, whereas economists seldom deduct the sum of the expected personal consumption from lost wages in an injury case.
Lack of adequate credentials can negatively impact the jury and reduce the weight given to expert economic witness testimony, especially if the opposing expert has excellent credentials. How will a jury weigh testimony from a Ph.D. in economics versus a bachelor’s in accounting or a business major? Many persons testifying to economic loses lack serious advanced economic training in a graduate degree-oriented curriculum in economics or finance; and you should challenge the admissibility of any economic testimony proposed by experts who lack proper training in economics. Even if Einstein took a summer course in economics, he wouldn’t be an economist. At times, nurses, psychologists, physicians, and physiatrists and life care planners purport to estimate the present value of future medical care cost assessments merely by multiplying the actual annual costs by the number of years of remaining life expectancy, circumventing the present value process completely. Some without an advanced degree in economics also frequently estimate the present value of a business or future lost income, but they are not trained in estimating future economic growth or the likely future rate of interest as a discount rate. Vocational rehabilitation counselors at times also purport to provide economic forecasts. A few may have proper credentials, but others may be trained solely as high school vocational guidance counselors. Some consultants have a master’s degree in business which, per se, does not indicate serious advanced training in economics. After hearing testimony on lost earnings from one MBA, a judge commented at court that he had never heard an expert so “utterly and totally lacking in credibility.”
What does credentialize an economist mean? In general, there are four Gold Standards for economists and other experts. First, the highest degree in their field, in this case a Ph.D. in economics or finance. This demonstrates mastery of the subject at the highest level of education. Second is published, peer-reviewed empirical research, proving that an expert’s thinking has “passed muster” of their peers. This shows mastery of the subject at the level of an empirical researcher who contributes to the field. Third is teaching a college-level course at an accredited college or university. This shows mastery of the subject at a professorial level deemed sufficient to pass on wisdom to students in the field. The final “Gold Standard” that can be offered by an expert is the authorship and publication of a textbook used at an accredited college or university in courses taught by others. This shows a broad mastery of the field at a level that is relied upon by other academics and professors in the field.
Additionally, practical experience working in the field of economics and finance in academia, or in industry, outside the area of expert witness testimony, should be viewed as important. An ivory tower academic “egg head” may lack practical knowledge. If the consultant does not have the proper education and training and other accompanying credentials; discrediting his or her testimony can easily happen. The cross-examination will concentrate on the relative lack of credentials, not on the opinions.
Fair and unbiased estimates produced by a properly trained expert economist may shorten the dispute and reduce case expenses, and increase the likelihood of a settlement. The simple biases discussed here are easy to detect by hiring attorneys, and should be abided by either side. Most Ph.D. economists adhere to and use proper economic standards; but by keeping in mind some simple principles you will help to insure it. Laid head to toe, all the biased economists of the world may never reach a fair conclusion. Nevertheless, you should not be forced to accept anything less.
Stan V. Smith, Ph.D., is president of Smith Economics Group, Ltd. headquartered in Chicago. Trained at the University of Chicago (one of the world’s pre-eminent institutions for the study of economics and the home of the law and economics movement), Smith has also taught at the university and co-authored the first textbook on the subject of economic damages. A nationally-renowned expert in economics who has testified nationwide in personal injury, wrongful death and commercial damages cases, Smith has assisted thousands of law firms in successful results for both plaintiffs and defendants, including the U.S. Department of Justice. To that end, Smith also developed the first course in forensic economics at DePaul University, and pioneered the concept of “hedonic damages,” testifying about the topic in landmark cases. His work has been featured in the ABA Journal, National Law Journal, and on the front page of The Wall Street Journal. Kyle Lauterhahn is a Senior Economic Analyst at Smith Economics Group in Chicago.
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