jamesz

What’s the point of forecasts?

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Matt blogs every now and then defending economic forecasters and always seems to draw out at least a couple of comments slagging off forecasters for being inaccurate. His reponse is that it’s not the numbers that matter but the qualitative analysis of risks and market direction. His defence came to mind when I was reading a recent AEJ article about testing the performance of expert advisers.

The authors make the point — which isn’t central to their hypothesis — that there’s a difference between forecasters who get the numbers right and forecasters who are useful to their clients.

…a decision maker must take some default action even in the absence of any expert, and may not appreciate forecasts that suggest the same actions, even if they are provided by an informed expert. On the other hand, if forecasts lead to better decisions, the decision maker may appreciate them, even if they are provided by an uninformed expert.

All of which suggests that trying to judge economic forecasts by the accuracy of their predictions alone may miss much of the value that they provide. Of course, there is probably a correlation between the accuracy of the forecasts and the usefulness of the accompanying advice but the two need to be judged together by their usefulness to the forecasters’ clients. Given that people continue to purchase forecasts it appears that their value in improving decisions is far from negligible.

Matt Nolan

Bleg: Facts and beliefs

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Question:

Why is it that, in economics (compared to other disciplines), people are a lot less likely to let observed facts change their opinion on what is going on, or how the world works?  Is it because:

  1. The data is too unreliable
  2. The data requires “value statements” to make sense that cannot be separated from beliefs
  3. People invest themselves in their world view – and are unwilling to trust evidence above what makes them feel comfortable.

Answer, discuss, all that jazz.

Note:  Any answer should be consistent with the historical fact that people want to pretend right now is “different” and that we are living through “historical” times of change – after all how else can we make ourselves feel important if we don’t stress how important the times we live in are 😉

Matt Nolan

Economics and the environment: Perception and reality

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Wow.  I realised David Suzuki was a little bit loose when he talked about economics – but he’s a smart man.  I assumed that when he talked he was merely bemoaning the fact that environment issues get ignored in policy, not that he actually had no idea how economics or the allocation of resources worked.

If these quotes are true, my view of him was far too generous (via Offsetting Behaviour).

“David Suzuki is another skeptic and he offers a great anecdote about economic thinking. While at the University of British Columbia, Suzuki figured it would be a good idea to supplement his academic background in biology with an understanding of economics. During the first class, Suzuki’s instructor stood at the blackboard drawing lines in chalk to show the flow from the resource base into the market, with subsidiary industries adding value and creating wealth for investors.

Suzuki pointed to the side of the blackboard that was empty of equations, the resource base, and asked whether the calculations took into account the effect of human activity on the environment, the diminishing reserves and growing waste that Suzuki reasonably regarded as a cost mortgaged into the future. “That’s an externality,” the instructor responded drily. In other words, the environment is something external to the grand human workings of the market and not worth factoring in. Suzuki left the class on the spot.”

Holy sh*t, this is one of the dumbest – most arrogant – things I’ve read this morning … and I’ve just finished reading some of my own writing!

An externality is one of the central reasons why an economist justifies policy – it is a concept used to define thing that aren’t captured in market prices, and justify intervention.  It is the very reason why so many economists actually do believe something needs to be actively done in environmental policy … contrary to the view among many people that economists don’t care.

I’ve been told by people that “one of the main weaknesses of economics is that it ignores the environment” – my reply is always “actually, one of economics main strengths is the way it can coherently put the environment, and trade-offs, into a framework”.

If the very icon for environmental policy has such a poor understanding of Econ 101 ideas – ideas that are REQUIRED to form GOOD policy – I have to admit I generally feel very concerned about the whole issue.

Note:  If anyone wants to know how bad this mistake is, its sort of like if you had to do some accounts for your business – but you thought the idea of addition was some voodoo way of transforming numbers without any meaning.  Externalities are one of the earliest concepts that are taught in economics – immediately after we learn what supply and demand represent.

Matt Nolan

Forecasts are wrong, but is there some reason for them?

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I see that, once again, we have people attacking forecasters because what happened was very different to the numbers that they pulled out of their computer (here and here).

Now if your belief is that this is the role of a forecaster, then this criticism is fair enough – after all, there is so much that is “unknown” and “unknowable” about the world it is pretty ridiculous to think you can state exactly what will happen, especially when the numbers themselves are often both wrong and meaningless.  But I don’t believe this is the role of someone in this sort of position, and it is definitely not how they should “sell themselves”.

I would be seen as a forecaster myself – but outside of making sure my data is up-to-date and that my empirical methods are robust, I spend all my time catching up on reading, talking to people, and trying to bring as much information together as I can.  I then distill it down and try to give it to clients in an easy to digest way – so that they can understand what is going on, and what the risks are for the future.

Its a service, we are paid to provide information, and to always be available to help inform people in government and business – so that they can make the decisions they think are appropriate.  If any of you have been to one of my presentations, you’ll remember how much I bang on about this – and how I spend the whole time focus on “why” and discussing “risks” and the reasons for them, rather than focusing on arbitrary numbers.

Now, I thought this would be obvious – as Peter says it is entrepreneurs that make the choices, and so they will value this type of service insofar as it helps give them information that allow them to make better informed choices.  Explanation, discussion, and helping to make the economic jargon transparent, is the sort of service that is provided by all these guys … so what’s with the angst?

But the view of the last year has been very wrong

Undeniably, and if it was possible to forecast the sharp rise in fuel prices, the impact of new banking regulations (with no relevant history), the global droughts, the earthquakes in Canterbury, the snow storms during lambing in the South Island, and government policy changes they would have been less wrong – but there is no change someone would have picked the actual numbers.

But just because so much is “unknowable” does not mean there isn’t value in discussing what we do know – and keeping informed.  If a client feels ill-informed, the guy is failing and needs to up their game – that is the issue that really needs to be looked at if we want to judge these people.

Matt Nolan

Do we need the same job as our friends: The country edition

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Via Kiwiblog I see that another member of the Labour party is shooting themselves in the foot, again.  This issue has been done to death, and we’ve already had Dim Post and No Right Turn discuss the ridiculousness of what was stated.

But I’m an economist, I don’t care about “politics” in this party sense – and I especially don’t care when it is just someone making a dumb-ass statement that they don’t really mean.  Given I don’t think Clare Curran wants to remove democracy, what really concerned me more was at the end of the post:

Our economies are too important for the juggernauts of China and other bigger nations to turn us into service economies.

This appears to be saying that New Zealand shouldn’t focus on the things it has a comparative advantage over – instead it should be looking to model itself like other countries, larger countries who have greater scale and greater advantages at making things like manufactured goods.  I find this strange.

Although I don’t like comparing countries to individuals, one clear way to see this from my perspective is to think about me.  I am a service economy.  I have to admit it works pretty well for me, I get to write, I get to do economics all day AND I get to trade income from this to rent a house and buy a computer … excellent.

If other people are investing in making computers better, and improving the quality of the rental stock – that is GREAT for me.  It would be weird for me to then say “hell, I need to start building my own computers”.

Yet this is exactly the sort of few that Curran is trying to push – she seems willing to lower living standards in New Zealand and among our trading partners, just so we can make the same stuff as them (but more poorly).  For me, it is this sort of thinking that is preventing me from voting Labour – far moreso than the latest political gaffe by one of their MPs.

jamesz

Wants, needs and production

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What is a ‘want’ and what is a ‘need’? Do these things change over time and how do we provide for them? These are the issues being considered by Pablo at Kiwipolitico in a fashion that may confuse many economists. He says:

The current phase of globalised capitalism brought with it the uncoupling of production from consumption even as the “wants into needs” syndrome persists. The specific result is that, relatively speaking, global production of goods has declined while the consumption of non-productive commodities has increased. That means that there is an excess of wants with respect to needs. In fact, mass focus on obtaining a proliferation of wants has served to obscure the basics of needs.

When I read that I had no idea what it meant and I think that is because of some definitional problems. First, what are ‘wants’ and ‘needs’? To an economist the distinction is fairly meaningless because there are only ‘things that people want to varying degrees’. Of course, there are trade-offs that one must make — I can’t buy a car and a bicycle with the same $5,000 — but the things we want are not inherently different and the degree to which we want them differs between individuals.

So, when Pablo talks of ‘wants’ being converted to ‘needs’, what does he really mean? What I think he means is that, as technology advances, our incomes rise and the relative cost of purchasing complex goods drops. Consequently, more people buy them and they become ubiquitous. You don’t need the nature of goods to change for that to happen. You don’t even need peoples’ preferences to change — although that may have happened, too — for smartphones to be in every pocket, either. It is enough that the cost of manufacturing has dropped and our incomes have risen due to technological progress.

What of his contention that these smartphones are ‘unproductive consumption’? I’m a bit baffled by that because it suggests that everything we purchase should be useful for producing something else. As if enjoying our purchases were not enough in itself. Either he is suggesting he knows better than we do about what makes us happy or, more likely, I am reading too much into a poetic flourish!

Finally, he suggests that there has been a ‘decoupling of production from consumption’, which is probably the most confusing statement of all. All production is consumption – as it is either consumption now, or it is investment which translates into consumption in the future. There can be no sustained difference between production and consumption in modern, market-based economies.

Rather than railing against the way he perceives society to be, it would be helpful for Pablo to refine the problems he sees and ask why things are the way they are. Once we understand the problems we can ask whether there has been a systematic misallocation of resources that has caused these problems. At the moment it appears that these issues are being clouded by some confusion over what wants, needs, production and consumption really are.