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.

Uber and the anti-regulations bandwagon

The news that Tfl, the regulatory body for transport in London, had banned Uber because of regulatory failures brought out the usual suspects to support or condemn the move. In addition, the company organised an online petition to reverse the decision, which half a million people have signed. Tyler Cowen declared: “The new Britain appears to be a nationalistic, job-protecting, quasi-mercantilist entity, as evidenced by the desire to preserve the work and pay of London’s traditional cabbies”, and plenty of others took a similar line.

What always strikes me on these occasions is how people can jump to conclusions without any evidence. Now it is certainly true that licensing authorities can be captured by, and therefore favour, incumbents and therefore stifle innovation. They can artificially restrict numbers to drive up prices, although Tfl do not do this. But the fact that this happens sometimes does not mean it is happening every time. Equally companies like Uber can believe that they are so big and popular that they can ignore regulations, regulations which are designed to make the market work. [1]

It is important to note on this occasion that Uber have not complained about the regulations. Instead they initially said they had complied with them. Surely the time to write articles condemning Tfl’s decision is after Tfl lose the appeal brought by Uber in the courts.

However there is public evidence in this case. We do know the that as recently as August, a Metropolitan Police Inspector wrote to TfL about his concern that the company was failing to properly investigate allegations against its drivers. Between May 2015 and May 2016 the police investigated 32 drivers for rape or sexual assault of a passenger. It appears there has been at least one case where the police allege UBER allowed a driver that had been accused of sexual assault to stay on their books, leading to another ‘more serious’ attack on a woman in his car. Here is part of the inspector’s letter:

“My concern is twofold, firstly it seems they are deciding what to report (less serious matters / less damaging to reputation over serious offences) and secondly by not reporting to police promptly they are allowing situations to develop that clearly affect the safety and security of the public.”

Uber’s boss yesterday apologised for the mistakes they had made. Whether these mistakes are serious enough to warrant revoking Uber’s license the appeals process will decide, or most likely Uber will be allowed a new license on condition that they start taking regulations seriously.

What worries me in this case is the lack of any self-awareness of those who piled in to condemn the regulator without any evidence. Ten years ago the world experienced a devastating financial crisis that was due, at least in part, to a failure of regulations and regulators to do their job that was in turn due to political pressure from those who took a similar attitude to regulations as those championing Uber. And just three months ago around 80 people lost their lives in London from a fire that almost certainly was the result of a failure to comply with regulations.

Regulation bashing has since the financial crisis become one more example of neoliberal overreach. When the two political parties that brought us neoliberalism have today brought us Brexit and a President who seems to want to start a nuclear war, it is time for neoliberals to be thinking about reform rather than just playing the same old tune. Thinking about all that and the 500,000 who signed the pro-Uber petition brought to mind a song of a well known nobel laureate called Talking WWIII Blues, the last verse of which is

Well, now time passed and now it seems

Everybody’s having them dreams

Everybody sees themselves

Walking around with no one else

Half of the people can be part right all of the time

Some of the people can be all right part of the time

But all of the people can’t be all right all of the time

I think Abraham Lincoln said that

“I’ll let you be in my dreams if I can be in yours”

I said that

[1] There is also the question of why Uber rides are cheap, and whether it is making losses simply to drive out the competition, but that is a different issue. 

Problems with triangulating over immigration

I have talked before about why triangulation over austerity did not work for Labour, but why triangulation over Brexit seems to be more successful. Tony Blair’s latest intervention suggests it is worth asking the same question about immigration. (The report that he launched is well worth reading.) It is a question that lies at the heart of many Labour MPs views on the politics of Brexit.

One of the lessons from austerity is that it is very dangerous to triangulate on an issue where you appear, as a result, to admit fault or blame. If the deficit is a problem (in 2011, say), why did you let it get so large on your watch? This was why ‘too far, too fast’ failed: you acknowledge a problem, and therefore implicitly admit guilt. Getting over the idea that there is a delicate balancing act between reducing the deficit and protecting the recovery is difficult, particularly as it is also an incorrect idea.

It is an obvious point, but exactly the same was true for immigration. Just look at the headlines. The parallels with immigration and the deficit are clear. In office, Labour did the right thing in ignoring the deficit in 2009, and they also did the right thing in allowing substantial EU immigration before then. In both cases the instincts of many voters is to do the opposite: the government should tighten its belt in a recession just like the rest of us, and the country should be able to control and limit who comes in. In both cases, the moment a government that in the past appeared to ignore these voter instincts starts to appear to suggest the instincts are valid, they trash their own record.

You could argue that while this is clearly right for Miliband and 2015, it has less salience for Corbyn rather than Blair today. You could go further and say that what works for Brexit will work with immigration. Just as triangulation gets you the votes of those who sort of want Brexit but worry about the economic consequences, so too could triangulation over immigration get you the votes of those who want to control immigration but are worried about the economic consequences of May’s obsession with hitting targets.

Here I think we need to look at a second problem with triangulation, which is that the nature of the political debate is influenced by it (is endogenous to it). With Brexit it means that neither of the two main political parties is making the case against Brexit, so the (non-partisan) mainstream political debate tends to ignore the anti-Brexit case. One of the unfortunate consequences of the way the BBC and others interpret impartiality is to see it in terms of the two main political parties, rather than (in this case) the population as a whole, so the views of half the population get largely ignored.

You could argue that this may be of secondary importance for an issue like Brexit, because the anti-Brexit case is still fresh in the mind from the referendum campaign. But that is much less true of immigration. Immigration is now well and truly defined in the media as a ‘problem’, and it is very rare to hear a politician (or anyone else) sing its praises. (Jonathan Portes does his best, but when a well known BBC commentator says his views will not win many votes, you get a clear idea of what is going on. [1]) May is quite safe from the media when she says immigration reduces wages and access to public services. The implication of all this together with a large partisan print media is politicians fear talking about the benefits of immigration because that may ruin a carefully triangulated position.

The reality is of course very different. Study after study after study (from academics, not partisan think tanks) shows how much we benefit from EU migration, and how it has virtually no impact on wages. Immigration increases the resources available to provide public services by more than it uses those services. Yet this knowledge is not reflected in the media discourse. The reason is straightforward: the political right wants to use immigration as both an excuse (for the impact of austerity) and a weapon (to achieve Brexit, for example), and the left by and large keeps quiet because it is triangulating.

People in the media may object by quoting polls that suggest the public overwhelming wants to control immigration: they are just reflecting that opinion. (But see footnote [1].) But polls also say people want less taxes. If you dig deeper public attitudes are far more nuanced than the public debate suggests. Here is some data, from an international study, by IPSOS-MORI:

“British people have become more positive about the impact of immigration over recent years. Forty-five per cent say immigration has been good the economy, up from 38% a year ago and from 27% in 2011, and 38% say immigration has made it harder for native Britons to get a job, down from 48% a year ago and 62% in 2011. However, Britain is one of the countries most worried about the pressure placed on public services by immigration, with 59% concerned – although this too is down from 68% a year ago and from 76% in 2011, when Britain was the most worried of all the countries surveyed.”

In other words, as I have emphasised before, the thing that most worries people in the UK about immigration is a myth. Yet triangulation, together with the way the media creates what I call ‘politicised truths’, means that voters are unlikely to find out what the facts are. [2]

The way this ambivalence is often articulated is through the issue of skill. 75% of people want skilled migration to stay the same or increase, while the consensus is that we should have less low or semi-skilled migrants. Yet if you name some categories of semi-skilled migrants, it turns out a majority want the same or more care worker, waiters, construction workers [3] and fruit pickers. As Rick says “apart from the care workers, construction workers, waiters and fruit pickers, what have low skilled* EU migrants ever done for us?” Skill has just become a way of people reconciling their wish for lower immigration in abstract with a recognition that immigration is good for the economy. It is like wanting lower taxes achieved through improving the efficiency of public services.

So how can something that people are ambivalent about become a major political issue that helped push us out of the EU? One answer is the sheer weight of numbers, and for some particular regions not previously experiencing inward migration that seems to be true. (It also reflects the inertia in public service provision.) But the rise of anti-immigration sentiment elsewhere in Europe where recent flows are not exceptional suggests other forces are at work. In part it is far-right parties exploiting fears about terrorism. But much more importantly in the UK, it reflects the deliberate exploitation of immigration as an issue by the Conservative party.

This predates the increase in immigration from Eastern Europe. In 2001 William Hague talked about Tony Blair wanting to turn the UK into a ‘foreign land’. The political temptation on the right to play the immigration card is strong, but until Brexit it has always been duplicitous. The wiser heads in the Cameron/Osborne government never wanted to hit their own targets because of the economic damage it would cause, and as a result they did not even bother to use all the controls that were available with free movement. As Chris Dillow says, immigration was the only scapegoat left to deflect concern about austerity and stagnant productivity. Immigration scapegoating became part of what I have called neoliberal overreach. [4]

This is I think the main reason why triangulation over immigration is not an effective strategy. By trying to appeal to those who are moderately concerned about immigration, Labour falls into a right wing trap, which is to implicitly validate their scapegoating. You can only convincingly argue that scarce public services are due to austerity rather than immigration if you can argue at the same time that immigration brings more resources to the public sector than it uses. You can only argue that economic policy is responsible for stagnant wages if you also say that it is not the fault of immigrants. Labour should go with its members and argue for the benefits of immigration, and in particular free movement with the EU. [5]

[1] This simple exchange illustrated so clearly to me why the BBC’s so called mission to inform and explain is often no more than a joke. Rather than regard popular beliefs that are incorrect as something the BBC has a duty to try and reverse, they are instead used to dismiss expertise.

[2] This is not just a UK phenomenon: around the world politicians use immigrants as scapegoats.

[3] I’m often told that economic studies of the benefits of immigration ignore ‘existing capital like housing’. Yet we need migrants to help build more houses for natives as well as migrants. The only thing that migrants cannot bring to the UK is more land, but with an effective regional policy which we desperately need anyway we have plenty of land.

[4] Some have asked why I called it overreach, when most just talk about the collapse of neoliberalism? For a start, using immigration as a political weapon is not a natural consequence of neoliberalism, and instead comes more from the social conservative part of right wing parties. Also while I think neoliberalism encouraged austerity, I can quite imagine those with neoliberal views forsaking it.

[5] There is an argument that free movement should be opposed because it is unfair to non-EU migrants. Yet you could make the same point about any trade agreement between two countries: it is unfair on all other countries. Arguments about equity that make some people worse off and no one better off give equity a bad name.