Monday, 17 March 2014

Can Economists Ever Get It Right? [updated]

What do economists do all day, and why should anyone care?

Working economists promote their “science” on the basis of their forecasts.  But are their forecasts any better than throwing a dart at a board?  Recent reports say “No.”

It's hard to find nice things to say about economists. Their detachment from the real world of human activity is matched only by their enormous influence over it, and by their unearned assumption that this arrangement is well deserved.

Both unearned and undeserved, as a new OECD report on their own economists’ reports makes clear enough. Translate this from economists’ blancmange, and this is damning:

The OECD economists looked at their own work forecasting the direction of the world economy over the last several years and admitted: “GDP growth was overestimated on average across 2007-12, reflecting not only errors at the height of the financial crisis but also errors in the subsequent recovery.”
   The passive voice in the first clause of that sentence is squirmy; a flat assertion in the first person -plural would be more seemly and more accurate. But give them credit for the rest of the sentence. How big were the errors? Pretty big. 
    In May 2010, for example, with one-third of the calendar year already over, the OECD economists predicted the U.S. economy would grow 3.2 percent for the year. As it happened, gross domestic product grew 1.7 percent. Note that this is not a small error. That 1.5 percentage point spread between the two numbers means the original projection was off by nearly half. It’s as if you thought you saw a car go by at 60 miles per hour while it was actually going 30.

And it’s not just the OECD’s alleged economists who get it famously wrong.

In late 2009 the economist William McEachern impishly looked back at the previous year’s forecasts by the Wall Street Journal’s panel of economic experts. The Journal surveyed its experts in September 2008 when U.S. unemployment was at 6.2 percent; the average prediction among the economists was for the rate to stay more or less flat. By the following September the unemployment rate was 9.8 percent. At the same time, the average prediction among Journal economists was that growth for the last quarter of 2008—the quarter, you’ll note, that was just about to commence—would be 1.2 percent. Instead it was -2.7 percent.

Local economists are no better. No, really.

Economists make excuses for their failure. They say accurate forecasting is not the role of a forecaster. They use words like “endogenous.” They say things like “it’s not the numbers that matter but the qualitative analysis of risks and market direction.” And they complain about things from the real world that throw off their neat models like “oil prices, fiscal policy, the course of the euro crisis … turning points in the business cycle, the beginning and end of recessions, changes in trends in productivity,” “the impact of new banking regulations …), global droughts, earthquakes in Canterbury, snow storms during lambing in the South Island, and government policy change.”

But the world is full of stuff that changes every day – either things they can’t foresee so don’t model, or things (like recessions) they should but don’t.

Most events that occur—even the actions of governments, sometimes—are beyond the control of economists, much as they might like to daydream otherwise. But isn’t that the point? This admission just begs the question of why anyone should pay attention to their wizardry to begin with. The forecaster’s chief conceit is that by feeding numbers into one end of a statistical model he can see the future come out the other side. The conceit touches off a phantasmagoria of argument in Washington, where politicians and policymakers sift the numbers from one set of econometricians or another, and then use their favourite figures to determine how they will orchestrate the activities of the folks back home. In thrall to economists, government policy-making is a fantasy based on a fantasy.

Read the whole article:  “Wrong Again: The Economists’ Confession,” by Andrew Ferguson, WEEKLY STANDARD

[Hat tip Jeff Perren Novelist]

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16 comments:

  1. I'm reminded of a presentation by, I think it was, ASB's chief economist. He made a telling comment as part of his disclaimer before he started his presentation on the latest state of the economy and where it's headed. He commented that "Economists make predictions, not because they know, but because they're asked."

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  2. You do of course realise that 99 percent of economists never forecast. Also note for those that do some business is paying them to do it so those businessmen must think the forecasts are worth the money.

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  3. "...businessmen must think the forecasts are worth the money."
    Maybe they should be told they're not.

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    1. Why would they need to be told? If the forecasts sre wrong then aren't the businessmen in the best position to know this? Also the forecasts don't have to be right they just have to be better than the alternative. And if the forecasts are not better why do people pay for them?

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  4. Mind you, for box-tickers the forecasters provide an organised way of going wrong with confidence -- and a tangible excuse for failure ("see, it's not just me...")

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  5. "Why would they need to be told?" Presumably because they haven't noticed that the results are dire.

    "Also the forecasts don't have to be right they just have to be better than the alternative." What alternative? Better than continuing to the pretence they can forecast the future? Than the fiction presented that economics is about mathematical manipulation? That forecasts can be used to justify politicians and policymakers orchestrating the activities of folks back home?
    Or to the alternative of not making forecasts at all?

    Why do people continue to pay for them? Perhaps as a tangible excuse for their own failures ("see, it's not just me...")? Or because they share the same misconceptions as the forecasts' authors? Or, as a combination of the above, because that's the model of economics that governments continues to purchase.

    You might ask yourself why the omens and forecasts of seers and soothsayers were valued in ancient royal courts when they were no more accurate than the forecasts of today's court economists. The reasons were very similar...

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  6. >"Why would they need to be told?" Presumably because they haven't noticed that the results are dire.

    But if you are so knowledgeable about the results how is it that those buying them are not? Do the customers not have the best information and best incentives to check the results? Why if entrepreneurs are smart enough to handle all other issues to do with their business are they not smart enough to handle the results of forecasts?

    >Or to the alternative of not making forecasts at all?

    Could be, but the market tells me that isn't better than having the forecasts. If it was entrepreneurs would stop buying forecasts.

    >Why do people continue to pay for them? Perhaps as a tangible excuse for their own failures ("see, it's not just me...")? Or because they share the same misconceptions as the forecasts' authors? Or, as a combination of the above, because that's the model of economics that governments continues to purchase.

    In which case the forecasts are proving a service people are willing to pay for and markets are about giving people what they want. The value of the forecast, just like any other good, is subjective. How can we know the value that someone else get from an good or service? What we observe is market outcome and that says people value forecasts.

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  7. @Paul Walker

    You seem to be arguing that forecasts from economists must be worthwhile because people are willing to pay for them. That doesn't make sense. There are lucrative markets for scientology and astrology but that doesn't mean they have merit.

    Some people are idiots and spend money for no actual benefit. Or they have ulterior motives.

    PS I'm glad the rumours of your death were false.

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  8. Ben

    >You seem to be arguing that forecasts from economists must be worthwhile because people are willing to pay for them. That doesn't make sense. There are lucrative markets for scientology and astrology but that doesn't mean they have merit.

    "Merit" in this case is subjective. People's valuation of a a good or service is up to them. Scientology or astrology may not be worth much to you and me but as a result we don't pay for it. But for some people it is worth paying for, that up to them. Same with forecasts, some people are willing to pay for them. That tells us they get something from them. Also there is a selection pressure for firms. If firms that use forecasters and act on their advice make less profit they will be forced out of the market or forced to change how they do business including getting ride of their forecasters. Either way if we see a market for forecasting that is long lived, and we do, then we have to conclude forecasting firms survive because these firms are doing something somebody values.

    >PS I'm glad the rumours of your death were false.

    Not half as glad as I am !!

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  9. @Paul, You are arguing then that forecasts are, in Menger's terms, an imaginary good, i.e. things that are incapable of actually satisfying the needs they are supposed to serve, but valued either because of imagined properties or because of imagined needs.
    In other words, they have about as much value as a good luck charm.
    Menger expected that as civilisation advanced examples of this sort of nonsense would become progressively fewer. He's still right.

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  10. Successful entrepreneurs are proving that they are probably best at understanding true macro economics and applying it at a micro level.

    Conversely my economics tutor, Dr Shamim Shakur whould have arrived in a lear jet to Uni each day. He did not.

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  11. @ Paul: Firstly, I think you're over-estimating the demand for these economic predictions in the free market. I don't know of many entrepreneurs who would pay for them. Gov't departments might, and the mainstream banks might, but few others to my knowledge.

    Secondly, you seem to be arguing against a straw man. If Peter was arguing for economic predictions to be banned by the state, then your argument would be relevant - in that if someone wants to pay for them, they obviously see some value in it (real or imagined), and so it should be there choice. But that's not what he's arguing.

    Pointing out that some people are prepared to pay for predictions really adds nothing to the argument, because some people are prepared to pay for palm readings too. Human progress depends on testing ideas against reality and discarding those that don't work. If we adopted your position that we can't critique bad ideas just because somewhere, someone sees some value in them, there would never be any progress in any field - and we'd still be assuming the world is flat.

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  12. I have 2 problems with the "Free market in predictions" being peddled above:

    Firstly: Most predictions are paid for with taxpayer money. Without an interventionist govt most economists will be out of business.
    Secondly: There is an inherent conflict of interest in most commercial economists work. An economist working at a bank/real estate agent may have a rather negative message internally (as he may be well versed in Mises etc), however, the bank/real estate agent as a business requires a "growing" economy based on positive sentiment, meaning the external message needs to be sexed up.

    No doubt that this contributes to the fact that most economists are overly optimistic. They are paid to be.

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  13. Mark. Most government and banking econ work is done in house so if we see a supply of private forecasters its likely because there is private demand for their services. Also if businessmen who pay for forecasts make less profit because of it you would expect them to be driven out of the market. So if they keep buying them they must see some good business reason for it.

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  14. Peter. May be. And if it were households doing the buying I would be more likely to agree with you. But market pressures forces firms to be more rational. Firms that are using them as "good luck charms" make less profit than firms that don't and thus should exit the market or stop using forecasters. What we should see therefore is a market with no forecasters or a market with forecasters who provide some useful information to those who hire them.

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  15. Mark. "Pointing out that some people are prepared to pay for predictions really adds nothing to the argument, because some people are prepared to pay for palm readings too."

    One of the points I made to Peter applies here as well. I should have thought of it earlier. Individuals, households, buy palm reading not firms. The market pressure and objectives of the two institutions are different. Households set out to maximise utility and getting palm readings may do this for some people. Households can spend their income in anyway to achieve utility maximisation. Firms on the other hand wish to maximise profits and face market pressure to do this. This means that they face pressures to desist with any activities that lower profits. Paying for worthless forecasts must lower profits, they are a cost with no benefit. Household don't face such pressure and thus can indulge in what we may see as irrational, but fun, activities.

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