Everything George Osborne announced last month was based on guesswork by people with a distinguished track record in being wrong. Why do we take economic forecasting any more seriously than astrology or football punditry?
What would you think about a weather forecaster who failed to predict a hurricane and didn’t even recognise one after it has started? If a fortune teller told you next year would be pretty much the same as every other year, would you cross his or her palm with silver? Would you take tips from a football pundit who always predicts 1-1 draws (the most common result in the English league) and only changes his view when one team has already scored twice?
Most of us would quickly dismiss such quackery. But George Osborne’s 2015 spending review was entirely predicated on this kind of punditry. The Office of Budget Responsibility (OBR), which does the number crunching for the Treasury these days, has a dire record on forecasting the future. In 2010 it told us the budget deficit would be eliminated by this year; instead Osborne will be borrowing at least £70bn. Even if we believe what the OBR is telling us now, Osborne won’t have eliminated the deficit until 2019-20. In 2010, the OBR predicted growth over the following four years of 2.3%, 2.8%, 2.9% and 2.7%. The actual figures were 1.6%, 0.7%, 1.7% and 2.6% (if you look at growth per head, a much more relevant measure for most people, its performance was even worse). In economic terms, that’s akin to mistaking a cool, blustery spell for a heatwave.
The first graph shows household income per head – probably the key indicator of how well real people in the real economy are doing. It’s hard to imagine how a forecast could be much more wrong: the lines go in opposite directions — not for a few months, but for years. (And look how even the OBR’s 2015 forecasts keep shifting to the right, each one a little more pessimistic than the last.) The OBR’s forecast for average wages, in the second graph, weren’t much better. It’s now obvious that that the OBR didn’t have a bloody clue how the economy was going to respond to the Chancellor’s austerity regime.
I suppose the Treasury has to get this kind of guff from somewhere – they need some basis for budgeting and business planning, just like anyone else. But why do economic and political commentators intone the OBR’s guesswork as if it were established fact? And when the OBR suddenly says there’s £27bn down the back of the sofa to fund the Chancellor’s various U-turns, why does anyone believe them? It’s not as if they’ve actually found it yet; they just think it might be there.
But it’s unfair to single out the OBR. The Bank of England’s record isn’t much better, and almost all private and academic forecasters produce very similar results. Economic pundits have a terrible reputation, not because they get it wrong most of the time, but because they get it wrong when it really counts. Famously, no major forecaster predicted the 2008 financial crash, or the deep and long recession that followed, even after the financial crisis had been in full swing for months. In fact, according to former US Treasury secretary Larry Summers, no post-war recession has ever been predicted a year ahead by the US Federal Reserve, the US Treasury or the consensus of economic forecasters. That’s pretty damning. But I doubt the Bank of England, HM Treasury or British economic pundits have done any better. And as for Wall Street, just read this hilarious piece on the “bullish” predictions by stock market gurus for – of all years – 2008.
When the economy goes off course, economic forecasters often seem to be following events rather than predicting them. When the storm clouds began to gather in 2007, the best most could do was mutter about a “slowdown” in 2008. Once it was clear to everyone that the economy was tanking, they assured us the recession would be short and the recovery strong – when the opposite proved to be the case. In economic forecasting, things are always “normal” unless they’re already “not normal”; in which case, they will return to normal next year and then stay normal forever.
This is odd because recessions and “unusual” economic events are quite common (we’ve actually spent 13 of the last 35 years in recession). Predicting them is what forecasters are for. We don’t really need a weather forecaster to tell us that most days in July will usually be warm, or that it will probably rain a lot in November. The useful forecast is the one that tells us not to bother getting the barbecue out or that we can delay putting the heating on for a few more weeks. And the really useful forecast is one that tells us there’s going to be heavy snowfall in London or that a hurricane is on its way. Likewise, we don’t really need an economist to tell us that “all things being normal”, next year will be, well, “normal”.
The handful of economists who saw trouble coming in the mid-noughties, like Nouriel Roubini or Paul Krugman, are often seen as mavericks or doomsayers by mainstream colleagues and the media. They also tend to be the sort of economists who think trying to predict GDP or inflation numbers for years ahead is a mug’s game. Perhaps they are better at spotting trends and warning signs because they are not hidebound by the rigid models most mainstream forecasters use. Most of these models assume that the economy is usually in equilibrium – a posh word for being stable – or returning to equilibrium, and that unusual events are unpredictable and therefore best ignored. Even when “something happens” — an oil price shock, for example, or the financial crisis of 2008 – the economy quickly adjusts and moves back to equilibrium.
This seems to me to be nonsense. The economy is always in flux, and how could it not be, when the UK economy alone involves the individual and collective decisions of 64 million people, with different motivations, different objectives, and different attitudes, all of which are themselves constantly changing? And how much more so when we’re talking about a global economy of six billion people? Whether it’s wars, trade conflicts, financial incompetence, regulation, deregulation or re-regulation, new technology or changing social attitudes, there’s always something to knock the economy off its equilibrium. Which is pretty much the same as saying there’s no equilibrium in the first place.
Even when the economy seems to be stable — during the first half of the noughties, for example — there is usually something going on beneath the surface. Growth, unemployment and inflation didn’t change much in the UK between 2000 and 2006, and even the government’s fiscal position seemed stable. But at the same time, a massive credit bubble was inflating, house prices were getting out of control, productivity was stalling, and bank balance sheets had ballooned to absurd levels (in 2007, RBS valued itself at more than the entire output of the UK economy). I don’t know if these things featured in the models used by economic forecasters, but if they did, they didn’t seem to affect the output.
Most economic forecasting is little more than magic, and very dull magic too. At least astrologists and fortune tellers try to entertain us by making attention-grabbing predictions and cloaking their art in mysticism. Perhaps the elders of the OBR should issue their proclamations at Stonehenge at dawn, donning monks’ cowls and intoning their series of 2.4s and 2.3s in choral plainsong. Or like the Cumaean Sybil consulted by powerful Romans, they could issue their forecasts in verse, wrapped in a series of cryptic riddles. At least we could enjoy trying to solve them, and we could never be entirely sure they were wrong.
None of this would matter if economic forecasting wasn’t taken so ridiculously seriously by politicians and the media. This time of year, newspapers and TV shows are full of people telling us what’s going to happen next year – in politics, music, fashion and just about everything else. We enjoy reading them, and then we forget them. Rightly, it turns out. Research by the psychologist Phillip Tetlock has found that most political punditry, for example, is little better than guesswork. And the more confident the pundit, the more likely they are to be wrong.
But big decisions that affect people’s lives and livelihoods are taken on the basis of forecasts made by economists who have an impressive track record of being wrong and who never seem to learn from their mistakes. Maybe it’s the status of economics as a pseudo-science that does it: we’re fooled by the mathematical apparatus economists use and by the spurious statistical precision of the forecasts they produce. But just because we can measure the economic past to some extent, doesn’t mean we can put meaningful numbers on what billions of human beings are going to do in the future.