2016: A post-mortem of the year the UK’s “economic experts” failed

For the UK’s economic establishment, particularly forecasters, introspection is more appropriate. Complete with their New Keynesian models, most have been proven utterly wrong so far that voting for Brexit would lead to a short-term downturn ...

527 views

Tuesday 20 December 2016 4:59am

Ryan Bourne

Ryan Bourne is a member of Economists for Brexit.

Forecasters implicitly made judgements on long-term political outcomes for which they had no particular expertise (Source: Getty)

The end of a calendar year and the start of a new one provides a chance for reflection.

For the UK’s economic establishment, particularly forecasters, introspection is more appropriate. Complete with their New Keynesian models, most have been proven utterly wrong so far that voting for Brexit would lead to a short-term downturn. As the most significant economic event since the financial crisis, this is some failure.

Much proverbial ink has been spilled in recent weeks about what this “failure to forecast” tells us about the underlying economics. Was it simply some faulty assumptions or fundamentally misguided models? Did modellers take for granted things that are as yet unknowable? Are their models better for short-term analysis but just bad for the long-term assessment in hand? Some of the country’s top economic commentators and forecasters are currently jousting on these questions via email. Sadly, those whose forecasts have proven so faulty have not offered up any rigorous assessment of why they failed.

I do not claim to have all the answers either. But the lack of humility has been astonishing. In a recent Times article defending the Treasury and other forecasting bodies, David Smith explained away the Treasury’s mistaken prediction of recession by claiming they had not appreciated the Bank of England might act, nor that Article 50 would not be triggered straight away.

This is dire sophistry. That these two things could swing an economy from immediate recession to sustained growth goes against most received knowledge about the time lags through which monetary policy operates and the forward-looking nature of consumers and investors.

Read more: Holdout Remainers’ delay and pray strategy is wishing the UK economic harm

If we really want to improve policymaking, far more self-critical analysis needs to be undertaken on both the assumptions of the analysis and the nature of these models in the first place.

The importance of this cannot be understated. As John Llewellyn outlined in an interesting Financial Times article, forecasting as a general concept is very important in facilitating planning. Get it wrong, and the results can be disastrous. And the truth is that economic forecasting, in seeking to predict the results of billions and billions of daily choices, actions, purchases and investments, is likely to be less easy than that in many scientific fields. This requires acknowledging uncertainties and the limits of knowledge.

That something is difficult does not mean one should not try, of course. But that something is difficult does not mean one can explain away large errors by repeating that the task is difficult.

Many of us pointed out on publication that the Treasury and others made very negative assumptions about the long-term policy choices made outside of the EU. The Treasury assumed leaving meant a Britain which politically decided to become a more closed economy. It assumed we’d raise tariffs and other trade barriers, and would not use any of our new-found freedoms to positively change regulation.

Read more: How the Treasury’s dodgy dossiers grossly exaggerated the impact of Brexit

This long-term finding that Brexit could only have downsides, and make us poorer, was fed into shorter-term forecasts. Customers and investors, foreseeing a worse economic outlook, would (it was thought) cut investment and spending now. Add in the uncertainty of political negotiations, and a short-term downturn looked inevitable.

This was not forecasting per se, but scenario analysis fed into forecasts. At least one problem of the forecasts then was that forecasters implicitly made judgements on long-term political outcomes for which they had no particular expertise. They overreached, without acknowledging this clearly in public debate. Since the referendum, economic agents are not acting as if they expect Brexit to be economically disastrous, of course. Maybe the voters have more faith in our political processes developing better outcomes on trade and regulation than the experts envisaged!

Read more: Brexit: Unequivocally good for the UK economy in the short and long term

But biased assumptions only get us so far in explaining away failures. These models also seem less adept at ever foreseeing anything out-of-the-ordinary occurring (see the financial crisis), or predicting downturns and recoveries (see 2010 to 2013).

Theses could be written on why. But as a starter, you might be surprised to learn that the basic models utilised by the alphabet soup of acronyms mostly do not even incorporate modelling of banking and money, an observation long-lamented by the economist professor Tim Congdon. If such components of modern economies are missing, then what hope have these models of assessing fundamental policy regime change, such as Brexit?

If this all seems like a lament without a solution, it is. Economies are complex organisms, and there’s not a top-down answer or perfect replacement model available. What we must hope for is that Brexit can catalyse the humility necessary for continual improvement. Forecasters should spell out their assumptions and model limitations more clearly. And we, particularly the media, must always be careful not to raise them to the pedestal of truth. How’s about that for two geeky New Year Resolutions?

http://www.cityam.com/255919/2016-post-mortem-year-uks-economic-experts-failed-

Tim Congdon: Serious flaws in the Treasury's analysis of EU costs

25th May 2016


Tim Congdon

Serious flaws in the Treasury's analysis of EU costs

Dear fellow member of UKIP (and others concerned about the UK's relationship with the EU),      

 As I said in my last UKIP e‐mail, I have written a long piece for Standpoint magazine demolishing Chancellor Osborne’s statement that the average UK household would be substantially worse off because of Brexit. That piece is due out tomorrow, when the next issue of Standpoint hits the newsstands, but I thought you might be interested in a video on the same subject. 

The video shows that Osborne has engaged in the Goebbels tactic of “repeat Big Lies often enough and they will be believed”, except that in this case we have a Big Lie in the form of a Big Number. To justify his Big Number Osborne appeals to a team of Treasury economists, who have written his White Paper (Cm 9250). My discussion is on the contents and argument of Cm 9250.      

The video may be a bit technical in places, but I am confident it is easier to follow than the extraordinarily obscure and abstruse Cm 9250. Osborne and the Treasury say that   
 ‐ EU membership increases the UK’s openness to the world, 
 ‐ the greater an economy’s openness the higher is its productivity (i.e., output per person), and
 ‐ living standards depend on productivity.      

My main points are:     

1. The growth of productivity in UK manufacturing in the decade after joining the then Common Market (i.e., the European Economic Community which became the EU in 1993) in 1973 was less than half that in the previous decade, 

2. Crucial to the Treasury’s analysis is the claim that openness has increased enormously since the 1940s. I show that the Treasury’s measure of openness (i.e., the ratio of the volume of trade to the volume of national output) rises in all dynamic economies for reasons which have nothing to do with openness, in the sense of participation in international trade deals, such as the EU. The Treasury has made an analytical blunder. 

3. The EU is to a significant extent a protectionist organization. Leaving it would enable to the UK to pursue unilateral free trade (like its former colonies, Hong Kong and Singapore). Contrary to the assumption in Cm 9250, the UK’s openness could increase after leaving the EU. On the Treasury’s own reasoning, that ought to be good for productivity and living standards. 

4. The main text of Cm 9250 more or less ignores the contents of the annual White Paper (published since 1980) on European Union Finances, which documents the definite fiscal cost of EU membership, and indicates a cost per household running at over £500 a year. 

5. Such notions as “benefit tourism” and “health tourism” are undoubtedly meaningful, because governments departments are known (from press reports) to have investigated their size. Benefit and health tourism are ignored entirely in Cm 9250. 

6. Much EU regulation has an undoubted cost to the UK, while immigration reduces the pay of low‐ income workers. The costs of regulation, and the cost of lost employment and income of the UK‐born, are also ignored entirely in Cm 9250.    

The Treasury analysis in Cm 9250 is dishonest and worthless, while Osborne is a bare‐faced liar. No other phrase makes any sense in the context. Happily, many other people – even many who want the UK to remain in the EU – have seen that the government’s conduct of its publicity campaign has been disgraceful. A backlash is emerging, not least from those who feel that demands that government departments support political propaganda are an abuse of power.    

I hope you enjoy and value the video. The Powerpoint file I use is available for wider circulation, but please request it (for use in public meetings or whatever) only if you really need it. Fan e‐mail is nice, but on this occasion can you please not send me an e‐mail in reply unless essential?

http://www.timcongdon4ukip.com/docs/SeriousFlawsInTheTreasurysAnalysisOfEUCosts20160525.pdf

‘Can the promoters of Project Fear not see that Brexit would merely result in the UK becoming just like any other non-EU nation?’

Marketplace May 2016


Tim Congdon

Two kinds of nation are found in the modern world—a minority (28) that belong to the European Union and a majority (more than 160) that do not. Most of the world’s roughly 190 nations have their own currencies. All have assets that constitute national wealth, and a great many have stock exchanges where the assets can be bought and sold.

Economists and others have put forward numerous theories to explain the valuation of both currencies and assets, where the word “assets” embraces houses, land, equities, bonds and so on. Currency markets behave crazily from time to time, but the most plausible view is that an exchange rate is just another price. Like every price it is set by supply and demand. If governments and central bankers create too much money relative to demand (as they did in Germany in 1923 and Zimbabwe in 2008, and as they are doing now in Venezuela), the value of money falls.

No theory proposes that the value of a currency depends on the nation’s loneliness, its geographical location or its abstention from this or that international organisation. Counter-examples are so obvious that they can be limited to one paragraph. Switzerland is a country of eight million people, little more than 1 per cent of the continent (defined mostly widely) in which it is situated. It does not belong to the EU and until 2002 it did not belong to the United Nations. The Swiss franc is about as lonely a currency as could be imagined. But it has appreciated against all the world’s other currencies, including the euro, in the last 50 years. Japan could claim to be Asia’s most peripheral nation, in the atlas sense. But, again, its currency has been impressively strong for much of the last four decades.

Further, not one school of macroeconomic thought has argued that assets within EU member states have systematically more expensive valuations than nations which are not EU member states. No evidence whatsoever has been presented that companies quoted on the stock markets of Germany and France are more highly rated (in terms of price/earnings ratios, market-value-to-book ratios and so on) than their equivalents on the stock markets of the US or Australia, or that any such superiority in valuation is attributable to their EU membership. Not a single published academic paper has attempted to claim that EU membership by itself improves the valuation criteria of corporate equity.

Yet the promoters of Project Fear and far too many headline writers have been busy in the last few weeks with silly alarmism. They say that the day after a vote for Brexit will see collapses in the value of the pound and the stock market. Can they not see that Brexit would merely result in the UK becoming just like any other non-EU nation? No facts or data show that EU membership affects the long-run valuation basis of the currencies, stock markets and assets in general of EU member states relative to the currencies, stock markets and assets of non-EU member states. The sky hasn’t fallen in because the US, Japan, Canada and others are not EU members; the sky will not fall in because the UK is not an EU member.

Remember that the UK has had a dress rehearsal for the day after Brexit. In the summer of 1992 its economy was suffering from a severe recession clearly due to its membership of the European exchange rate mechanism. A number of observers—including a weirdly-named “Liverpool Six” group of economists (of whom I was one)— said that the Exchange Rate Mechanism, with its fixed exchange rate between the pound and other European currencies, was responsible for too-high interest rates. The UK therefore needed to leave, so that monetary policy could again be geared to our own needs.

But the then Prime Minister, John Major, disagreed. According to his memoirs, “We had looked at the precipice and decided against jumping.” In the event, the UK did not jump over the precipice, or leap in the dark, or plunge into the abyss, or otherwise throw itself downwards into some great unknown. Instead, it was pushed. Overwhelming selling pressures in the foreign exchange markets forced the pound out of the ERM on “Black Wednesday”.

Except that it turned out not to be black at all. Although the pound did indeed fall in late 1992, interest rates came down and the economy recovered. The period to the May 1997 general election saw steady output growth with moderate inflation. Black Wednesday became Golden Wednesday. The pound’s value against other currencies was higher when Major lost the general election than when he and his Cabinet colleagues had behaved so idiotically on Black/ Golden Wednesday almost five years earlier. When politicians use words like “precipice” and “abyss” in matters of economic policy, they are waffling. Even more than usual, they don’t know what they are talking about.

http://www.timcongdon4ukip.com/docs/2016_Standpoint_May_Non_EU_EU_countries.pdf