Forecast errors compared

And a coda defends experts against Aditya Chakrabortty

A recent conversation got me thinking about different types of macroeconomic forecast error, and what implications they might have for macroeconomics. I’ll take three, from a UK perspective although the implications go well beyond. The errors are the financial crisis, the lack of a downturn immediately after Brexit, and flat UK productivity.

The immediate cause of the Global Financial Crisis (GFC) was the US housing market crash, but that alone should have caused some kind of downturn in the US, with limited implications for the rest of the world. What caused the GFC was the lack of resilience of banks around the world to a shock of this kind.

Were there any indications of this lack of resilience? Here is an OECD series for banking sector leverage in the UK: the ratio of bank assets to capital. The higher the number, the more fragile banks are becoming.

UK Banking sector leverage: Source OECD

The first and perhaps most important problem with forecasting the financial crisis was that macro forecasters were not looking at data like this. For most it was not on their radar, because banks, let alone bank leverage, played no role in their models. It was a sin of omission, a big gap in our macro understanding. (Whether, if forecasters had been having to forecast this data, they would have predicted a crisis is improbable, but some would have at least noted it as an issue.)

Moving on to the second mistake, it is often said (correctly) that forecasters are very bad at predicting turning points or dramatic changes. But many did predict such a change immediately following the Brexit vote: a sharp and immediate slowdown in demand caused by the uncertainty of Brexit. It didn’t happen. The main reason was consumption, which held up by more than people were expecting, given the fall in real incomes that was likely to come from the Brexit depreciation. There are two and a half obvious explanations for this. First, because of Leave propaganda half the population thought Brexit would make them at least no worse off. Second, those who did anticipate the rise in import prices may have taken the opportunity to buy consumer durables made overseas to beat the prospective price increase. The half is that the Bank cut interest rates a bit.

None of these effects are very new. They may not have been incorporated into the forecasters’ models, but they could in principle have been incorporated using the forecaster’s judgement, although getting the quantification right would have been very difficult. In the end we got the slowdown, but delayed until the first half of this year, as Leavers began to face reality and the higher import prices came through, so it was an error of timing more than anything else (although it was apparently enough to make MP Liz Truss change her mind and support Brexit!). You could describe it as an unchallenging error, because it could easily be explained using existing ideas. It is the kind of error that forecasters make all the time, and which makes forecasting so inaccurate.

The third error was UK productivity, which I talked about at length here. Until the GFC, macro forecasters in the UK had not had to think about technical progress and how it became embodied in improvements in labour productivity, because the trend seemed remarkably stable. So when UK productivity growth appeared to come to a halt after the GFC, forecasters were largely in the dark. What many like the OBR did, which is to assume that previous trend growth would quickly resume, was not the extreme that some people suggest. It was instead a compromise between continuing no growth and reverting to the previous trend line, the second being what had happened in previous recessions.

My point of writing about this again is that I think this third error is much more like the GFC mistake than the post-Brexit vote mistake. In both cases something important that forecasters were used to taking for granted started behaving in a way that had not happened since WWII. Standard models were used to treating technical progress as an unpredictable random process. Now it is just possible that this is still the case, and the absence of technical progress in the UK and to a lesser extent elsewhere is just one of those things that will never be explained. But for the UK at least the coincidence with the GFC, austerity and now Brexit seems too great. As as I showed in the earlier post growth has not been exactly zero but has oscillated in a way that could be related to macro events.

If there is some connection, both in the UK and elsewhere, between the decline in economic productivity growth and macroeconomic developments, then this suggests an important missing element in macromodels. And like the financial sector, there is an existing body of research that economists can draw on, which is endogenous growth theory. There are examples of that happening already.

But I want to end with a plea. After the financial crisis too many people who should have know better said that failing to predict the financial crisis meant that all existing mainstream macroeconomics was flawed. It was rubbish, but such attitudes did not help when some of us were arguing against austerity on the basis of standard macroeconomic ideas and evidence. Now with UK productivity, we have Aditya Chakrabortty saying that experts at the OBR “are guilty of a similar un-realism and they have proven just as impervious to criticism” as people like Boris Johnson or Liam Fox. Not content with this nonsense, he says “This age of impossibilism is partly their creation”.

This is just wrong. Look at the elements of neoliberal overreach. Economists didn’t start calling for tight immigration controls and using immigrants as a scapegoat for almost everything. Most academic economists did not call for austerity. Almost all economists did not want to get rid of our trade agreements with the EU. Even if economists had warned about the financial crisis they would have been ignored because of the political power of finance. If all economists had thought productivity would continue flat we would have just had more austerity. [1] And in making this basic mistake, it is ironically Aditya Chakrabortty who has joined Michael Gove and other Brexiteers in having had enough of experts.

[1] Less expected productivity growth means lower future output which means lower future tax receipts which means, given the government’s austerity policy, more cuts in public spending.

The politics of ignoring knowledge

Simon Tilford has a post where he explores the roots of Brexit in a kind of UK exceptionalism. He argues that “the underlying reason [for the Brexit vote] is the hubris and ignorance of much of the British elite, not just the eurosceptics among it”. I want to expand on that. I do not think this ignorance and hubris is confined to the UK’s role in the world. It also extends to an attitude to knowledge of all kinds, and I suspect it is possible to date when this began to the revolutionary zeal of the right under Thatcher.

The Thatcher government that gained power in 1979 were going to do away with what they saw as Keynesian nonsense, and run the economy using money supply targets. Treasury civil servants produced a forecast that said their policy would lead to a recession, and this turned out to be what happened. The forecast when it was made was dismissed by the politicians in government as the product of outdated civil service advice reflecting a failed consensus.**

It is of course the prerogative of politicians to reject a consensus, particularly if there is a reasonable minority of experts who think the consensus is wrong. It is what happened next that was the problem. Monetarism was a monumental and predictable failure, but Conservative politicians and their supporters spent considerable effort and resources turning this failure into a triumph of Thatcher over an establishment civil service and academic economists. One example is the letter from 364 economists objecting to a deflationary fiscal policy in the 1981 budget. The right, and in particular the IEA, have successfully cultivated a belief that this letter was wrong when in fact it was right. The recovery (using the term as it should be used) was delayed by over a year by the 1981 budget. More generally the view was that social scientists or civil servants were probably antagonistic to the neoliberal project and could safely be ignored. They were, in Thatcher’s words, not one of us. [1]

The reality was that the Thatcher and later Major governments did subsequently often take note of what experts were saying, but the myth on the right prevailed. Before the Conservatives regained power in 2010, they thought very little of going against the advice of the majority of economists over austerity, although to be fair they were later supported in this by senior civil servants and the governor of the Bank of England. Policy based evidence replaced evidenced based policy. But this was the relatively sane wing of the party, as we discovered during the referendum campaign.

We know the EU referendum campaign largely ignored experts, whether they were economists, lawyers or experts in international relations. What I think surprised many is that the Leavers fantasy was not just a device to obtain votes, but actually reflected what the Brexiteers believed. Since the referendum the government has clung to the fantasy, and ignored or dismissed all the advice it was getting from its civil servants. (In two cases dismissed meant sacking or resignation.) As Steven Bullock says, the EU side are in despair that the UK has yet to work out a realistic position on many issues. Because large parts of the UK public, relying on the right wing press for their news, still believe in the fantasy, some in the main opposition party think their best strategy is to ape their opponents.

As a result, we are in a strange bifurcated world. One part consists of pretty well anyone who knows anything about the economics, politics or legal aspects of Brexit. They realise how hard Brexit will be, know how much damage it could do, and by and large think it will be disastrous for the UK. (Experts tend to recognise and respect knowledge in other areas.) The other part lives in a different world, the world of the media and politicians, where everyone still lives the fantasy.

In this respect, we are no different from what is happening across the Atlantic. Angus Deaton notes the tragic irony that in the year the great nobel prize winning US economist Ken Arrow dies, the Republican administration is ignoring one of his great achievements, which was to show why a simple market in healthcare will not work. The only ‘expert’ this Republican administration seems to recognise is Ayn Rand. If it is successful in replacing or sabotaging Obamacare, millions will lose coverage and thousands will die as a result. The experts (such as the CBO) who predict this are accused of inaccuracy by a White House that cannot even be bothered to check its spelling of 'inaccurately'.

May holding Trump's hand shortly after he became president was indeed symbolic. Those who justify ignoring experts often talk about them as ‘unaccountable elites’ who have ulterior motives in giving the advice they do. In reality ignoring expertise means dismissing evidence, ignoring history and experience, and eventually denying straightforward facts. It leads to the politics of barefaced lying, such as asserting that a new trade agreement can be negotiated in little over a year. [2] This disdain for knowledge is not a prerogative of the right: you can find it on the left among those who say, for example, that all social science is inherently value laden and therefore political. (Ironically often dismissing mainstream economics as a buttress of neoliberalism, the same economics that the right are so keen to discredit.) The difference is that that the knowledge dismissing right have power in the UK and US, and so we are suffering the consequences of their evidence-free politics.

[1] Sir Keith Joseph tried to abolish the Social Science Research Council.

[2] It seems finally that the government has accepted a reality that was obvious months ago to those who listened to experts. 

**Postscript 21/07/17 As Sasha Clarkson reminds me, one of that group now spends his time denying climate change.

Immigration and the experts

Why does society no longer blame immigrants for spreading disease? It used to. The Jews were blamed for the Black Death, and Irish immigrant workers were blamed for Cholera in the 1830s. (See this nice science museum website.) Syphilis has been blamed on all manner of foreigners: the French blamed the Italians and the Italians blamed the French! The obvious answer is that society now knows better as a result of medical science.

Nowadays immigrants are instead blamed for unemployment, lower wages and increasing crime. They are blamed for reducing natives access to the NHS. Yet just as in the case of immigrants and disease, most experts know that popular concerns are wide of the mark. Nor are some of the sources of popular misperception difficult to understand. For example immigrants use the NHS, but they also pay taxes that allow us to fund more NHS resources, but government funding may be slow in responding to changes in local demand. In current circumstances the UK government is holding back those resources nationally, but says it is ‘protecting’ the NHS and the media dutifully repeats that they are.

Some politicians and large sections of the print media deliberately fuel popular misconceptions because they can use it to their advantage. Others feel they have to go with those misperceptions because otherwise they will lose votes. Much of the broadcast media see it as their duty to ‘reflect popular concern’ but feel less compelled to reflect expert opinion. But if you think this is inevitable and natural, imagine what would happen if a senior politician started blaming immigrants for bringing in diseases. Well you don’t have to imagine.

Watching certain Labour politicians trying to get on to the anti-immigration bandwagon is painful to see. Some are the same politicians who also argued that Labour had to accept austerity after the 2015 General Election. Now immigration is much more complex than austerity, as I discuss here, but that is all the more reason to respect the evidence. (Those who still wonder why Jeremy Corbyn is so popular among party members should note he is sticking with his principles on both austerity and immigration.) But I think it is wrong to just blame politicians. Responsibility must also rest with most of the media, who (as we saw in the Brexit campaign) treat economic evidence very differently from medical evidence.

Voters making big mistakes

In the last year we will have seen three occasions where large numbers of people voted in ways that seem to fly in the face of expert advice. I’m talking of Brexit of course, where 52% of voters chose a course of action which will make them worse off. The choice of Donald Trump as the Republican’s candidate for President, a con man and egotist who is not fit to hold public office. And finally Labour party members, who are about to elect as leader someone who seems almost certain to badly lose the next election.

The experts were different in each case: economists in the case of Brexit, people with knowledge of government for Trump, and political scientists plus psephologists for Corbyn. Now of course some people who voted for Brexit wanted it even if it cost them, but most did not. Some people think a con man and egotist would work well as President, and some Labour party members are quite happy to lose elections. But I think in every case those people are in a minority.

Why have experts been ignored in these cases? Politicians ignore experts all the time, but that is because of their own self interest or ideology. In the three cases above the experts are advising or have advised that actions will amount to self harm.

I’ve included the Corbyn case because it puts in doubt an explanation for the first two that I have seen elsewhere. It is technically known as the Dunning-Kruger effect, but I like to think of it as Springfield and the Monorail. Basically the idea is that people who know little are unaware of their ignorance, and can be easily conned. The reason this explanation is sometimes invoked is that support for both Brexit and Trump is stronger among those without college degrees. It is an explanation that leads to advocating meritocracy and questioning democracy. But that explanation cannot work for Corbyn supporters, who on average are very politically aware.

One obvious point to make is that in all three cases the expertise gets diluted in three related ways. All three disciplines are ‘inexact’. In all three, you more often see people without expertise talk about these issues in the media. And in all three some experts are subject to political or ideological bias. All that helps, but is not enough to explain self harm.

Another striking commonality is that expertise has become associated with elites who were once trusted and where voters now feel their trust has been betrayed. I talked here about how the Brexit vote was the result of combining two large minorities: those that felt they had been left behind socially, and those that had been left behind in terms of prosperity. I remember on the occasions I have written about the Conservatives continuing drift to the right, I have had comments which in essence say ‘nonsense: gay marriage’. When it came to the referendum the betrayal was the failure to control the social change implied by immigration. More directly concerned with economics were those left behind economically. I’ve been told of one meeting where the response to the argument that EU membership had increased GDP was ‘maybe your GDP but not my GDP’. This association of experts with an elite that has helped leave a whole section of society behind is discussed in this perceptive article by Jean Pisani-Ferry.

With Trump the elite in question are the elder statesman of the Republican party. For fifty years they have pursued a “southern strategy” that made elections about race and culture, and had used this strategy to enact economic policies that were certainly neoliberal but in particular favoured those who were already extremely well off. The cost of this strategy was that Republicans gradually became the party of the white, non-college educated working class which had no interest in lining the pockets of the economic elite. As Lee Drutman so clearly explains, this contradiction could only be disguised by upping the rhetoric that “allowed the party to keep its donor-class activists happy by obscuring these donors' deeply unpopular policy goals under the guise of something else.” The inevitable conclusion of that process was Donald Trump. The warnings against his candidacy by Republican leaders were discounted by an electorate who felt these leaders had given them nothing in economic terms and had failed to stop a black US president.

The Labour party under and after Blair had a model where it tried to occupy the centre ground by being just to the left of the Conservatives (triangulation). From 2010 George Osborne used this to pull Labour this way and that, and then leapfrogged over them with policies like hiking the minimum wage. In contrast the Conservative’s strategy was smarter in terms of winning votes. (A lot of it was imported from the Republicans in the US.) Play on people’s fears after the recession by going on about public debt, and use that as a lever to reduce the size of the state. Reduce welfare payments by demonising claimants as workshy and feckless. This was not triangulation. Corbyn’s election was the understandable reaction to Labour’s fruitless drift to the right. Yet it brought with it a complete distrust of not just of the PLP, but also the language and thinking that had been used by the PLP. The language of needing to be electable, and the means of deciding whether you were achieving that goal, had become tainted by its previous users. It is as if the problem with triangulation was not that it was the wrong model, but just thinking about developing strategies to win votes is wrong.

A key lesson in all cases is that what we saw, or are seeing, is a reaction to failures by an elite. Not entirely: I cannot see that much can be done about people who think gay marriage is a sign that the Conservative party has swung to the left, nor would I want to pander to racism. But the consequences of allowing sections of society to be left behind in terms of prosperity or economic dynamism are clear. Equally it is clear what happens to a political party when the elite lose touch with not just their membership, but also the consequences of profound economic change.

One final commonality is that the people who are rejecting experts are being conned. With Brexit it was the idea that leaving the EU and controlling immigration will make lives better rather than worse for those that have been left behind in economic terms over the last few decades. The people who really mattered in playing that con were not a few bumbling politicians but the right wing press. With Trump they are being conned by the notion that one rich man who is full of himself can turn things around to their advantage, a con perpetrated by both the man himself and the media outlets that give him support.

Labour party members are being conned not by a person or group of people, but by a set of ideas. The idea is that this leadership contest is a battle for democracy, and the most important goal is to create a party whose leadership and MPs reflect members views. The idea that all MPs should all agree with the majority of members, which effectively stops Labour being a broad church. The idea that it is more important to build a social movement than an effective parliamentary party (and to imagine that they are building that movement). The idea that no credence should be given to how voters perceive leaders (see here and here), because the decline in neoliberalism will ensure eventual victory. These are ideas that will destroy the party as an effective political force.  

Project Fear = We have had it with experts

Normally reading the Financial Times you are safe from ‘I cannot believe he said that’ moments. But occasionally you come across something like this, in this case from the normally reliable Wolfgang Münchau:

“Those who campaigned for the UK to stay in the EU are shaping up to be two-time losers. They lost the referendum vote on June 23; now they are losing the battle to keep the UK inside the single market. Both defeats are based on repeated misjudgments.

Their original mistake was to exaggerate the economic effects of Brexit. The long-run consequences are hard to gauge. What we do know, so far, is that the result did not cause an immediate crisis — and this is what matters politically. This is why the consensus within the Conservative party has been shifting towards a harder version of Brexit.”

Forget all the conflicting and unreliable monthly data and surveys, and focus on the two clear impacts that the Brexit vote has already had. The first is a large depreciation in sterling, which makes almost everyone poorer. [1] The second is a cut in interest rates plus a reactivation of unconventional monetary expansion. To imply that these events strengthen the Leave case is just completely and utterly bizarre. It is just another version of the ‘they predicted Armageddon’ trick which I complained about here. Any objective referee would judge the score so far to be

Economists 2 Leavers 0

As for ‘the long-run consequences are hard to gauge’, this homily implies that making trade harder with our immediate neighbours might make us better or worse off. This is wrong. Common sense, along with all the economic models, suggest the uncertainty is all one-sided. Estimates are for a reduction in UK living standards of between 3% and 8%.

Michael Gove was widely derided for saying the UK has had enough of experts. But using the label ‘Project Fear’ is exactly the same. It has been used in the Scottish referendum and Brexit as a way of discounting expert advice. Yet in the political world calling warnings about the impact of either Scottish independence or Brexit ‘Project Fear’ is seen as a successful tactic. If you believe this report, it is why the Labour leadership chose not to endorse (and in fact rubbished) the government’s warnings about the economic dangers of Brexit (although as I note here the suggested involvement of the Economic Advisory Council in that is incorrect). It is true that Project Fear is applied to government warnings about the economic impact of independence/Brexit, but when those warnings are backed by nearly all experts it amounts to an attack on expert advice.

So in the Orwellian world that we are now living in, the tactic of calling something Project Fear is newspeak for saying we have had enough of experts.

[1] If you own a large amount of assets denominated in overseas currency then you could be better off, at least for a time. However even here a permanent terms of trade loss will eat away at any wealth gain when real interest rates are negative. On average the UK is a net debtor, not a net creditor.