Sunday, October 23, 2011

"Economic Forecasting"...the term reeks of oxymoronism.

Forecasting anything to do with human beings and the choices they make under varying conditions is very much like trying to use your fingers to pick up a spoonful of mercury lying on a flat surface. Good-Luck-With-That!

In the field of Economics it's even more difficult. Peoples' wants change all the time. Any marketing manager worth the salt will tell you that almost all of the choices people make are, at best, irrational. They are irrational in the sense that people act on the basis of the emotions they feel that are generated as a result of their current perception of their environment and their place in it. They then justify their choices through the application of logic (though not necessarily good logic.)

This is not to say that an historical picture of the past choices of people cannot be painted nor that general patterns of behavior cannot be detected from a study of the picture. But, it is irrational to expect that the future will be just like the past. And this is where the idea of doing forecasting in the area of economics, with the idea of inducing changes, breaks down. To be fair, forecasting is not prediction, but I think most people unintentionally conflate the meanings due to fuzzy thinking.

To be sure, we do drag part of our past behind us as we go into the future. The past, however, is not a reliable indicator of future happenings, as any reasonably astute reader of history can tell you.

People have the ability to, and do, make choices, Despite the efforts of many economists to convince people otherwise, people, being animate and desirous of having an influence on their future, do not act like inanimate objects that follow the laws of physics. This truth seems to escape many economists who continually butt heads with it.

With respect to governments and economies, forecasting implies planning; planning implies control; control implies having the power to make people do things; having the power to make people do things implies the use of law; the use of law implies government intervention in peoples' private affairs, government intervention implies enforcement; enforcement can only be done by the state using its police powers. When a state can use its police powers to enforce its choices on how the economic factors of production are going to be used by those to whom they belong, it is, de facto, no longer a "free market." it is a "planned economy." "Planned Economy" is a synonym for "Socialism."

The Soviet Union tried it, Nazi Germany tried it, Italy tried it. They called it by different names but it was the same thing. The Soviets called it just plain Socialism, the Nazis called it National Socialism, the Italians called it Corporatism. It didn't work for even one of them. The reason: it can't. Socialism is self-contradictory and ultimately must implode.

The proof of the pudding with respect to forecasting gone berserk is to look at what is happening in a Europe that is essentially Socialist, right now. Those in power believed they could forecast what was going to happen when they interjected the government into private affairs. They just "knew" what was going to happen in the economy because, after all, one of the most famous economic forecasters told them so. His name: Lord Keynes. Just ask the people in Britain, Greece, Ireland, Italy, Spain etc., "How's your wonderful Keynesian economic system working for you?"

Why elected government should be able to "experiment" on its people with macro systems (or any other systems) is beyond me. Most of them don't even know how it's supposed to work. In their ignorance or desire to escape responsibility, will the elected government not turn to economists or scientists to help them do the "experiment?" Unfortunately, they have already done that, The economists and scientists are already there and involved in incessant experimentation using the government as their instrument and the citizenry as their lab specimens.

In the medical field, experimentation is going on all the time. Medical ethics require that the human subject of an experiment: certify understanding that there will be risks and consequences that cannot be known in advance. They must also have the options to accept the risks and consequences or decline to participate in it. In other words, the subject must be a full-fledged volunteer. A government-run experiment should be no different.

FDR so loved Mussolini's "State Capitalism" model that he wanted to shape the United States in that image and began the process by surrounding himself with Keynesians and implementing policies based on Keynes's theory. Those policies helped FDR to extend an economic depression from what probably would have been over in two to four years (as had all previous depressions) into one that, instead, lasted for ten long years. Isn't that why it is called "The Great Depression?"

None of the foregoing is to say that forecasting cannot be helpful. Marketing Managers use it all the time. What is different about the Marketing Manager operating in the private sector compared to the economist or politician is that the Marketing Manager knows there are risks involved that could kill his company if his forecast is sufficiently wrong. That's known as the "free market" in operation. To borrow an engineering term, it can also be known as "testing to destruction." In a free market, if his company goes down the tube, it's OK; it's possible for another can take its place. This is how the free market protects itself. Testing to destruction is not a viable option for a country. Need I bring up Europe again?

So, we don't need nor do we want a scientist to come up with a brilliant model of the economy and try to convince politicians to follow it. As previously said, they are already doing that with easily visible consequences.

It is asked, "Why [would] someone take the political cost today for something that could happen after ten years when someone else will be in the government?" Exactly right! What does that do to the forecast?

Financial institutions are heavily government-regulated already; maybe not the way they should be, but they are, nevertheless. It is asked, "Why [would] a banker accept to sacrifice his profits for the economy to benefit after many years?"
 This misses the point that all profits benefit the economy when they are realized and sacrificing profits can lead to the bank not being around after many years, maybe even just a few years if the banker keeps that up.

The big picture here is that it is not only difficult, it is impossible to find the appropriate prediction model. "Appropriate" is a moving target that may be ephemeral. There is no real headache in persuading the right people to follow the right course of action. The real headache is in understanding that there are no "right people" in government. Governments can't do much of anything "right" on the short term. There is too much inertia.

The forecasting science can be further developed but due to inherent problems with the number of variables that must be considered, there is no way it can provide a proven success record. Right now, the only "common sense" in the field of economics is built on a foundation of fallacies.

If "we" want to don't want to "just go in the dark without using any of the forecasting tools we have today," keeping government in the forecasting business is what is not a viable option.

If "we" want to secure long-term growth for our economy, we have to get the government intervention out of the equation and let it do its constitutional duty to promote the conditions where its citizens can enjoy their individual rights to "life, liberty and the pursuit of happiness."

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