The non-reaction of the markets to the ratings agencies downgrades of European debt underlines a persistent characteristic of the markets that is all too often forgotten. Especially by economic commentators. If it were simply a matter of extending the arithmetic of current economic performance into the future, then economic predictions would usually be right. On the contrary, they are usually wrong.
This piece in the Financial Times has a salutary reminder of just that:
Perhaps the most honest perspective, and one cherished by forecasters, is that we have “low visibility” on the US economy. It is one of those catch-all phrases that might one day serve as an epitaph for our times. It may also help to remind ourselves just how bad the forecasters have been. A few years ago a Berkeley study apparently found that monkeys aiming at a dartboard were more accurate than professional forecasters.
Perhaps we need to hire those monkeys to help us anticipate where the euro crisis is going (dart boards don’t cost much). In the meantime, it is worth asking why economists are so often wrong. There are the obvious reasons. Too many “factors” to consider. The folly of projecting to the future what has happened in the past. The irrationality of those supposedly rational actors, with their paroxysms of fear and greed. There is the problem of poor or partial information. One person I know who works in the ratings agencies says they really know little about government finances, and in any case they are required to follow certain lines to please their pay masters.
Then there are some deeper reasons. The problem of non-linearity in complex systems, which makes them inherently unpredictable. The impossibility of including in any predictive model the knowledge that people have of that model. This of course renders any prediction fragile. In a sense it means that the only predictive models that can actually be considered reliable are those that nobody knows anything about. Those that are understood can of course be undermined by the development of strategies to exploit the predictions, and those strategies will, by definition, be outside the models.
One could go on, but I believe there is another blindness in economic commentary that is especially telling. Jane Gleeson-White, in her book “Double Entry” shows how economic statistics derive from the double entry system developed by the Italian mathematician Pacioli in 14th century Venice. It is a worthy reminder that financial transactions, the capital markets, are a social artifice, a created thing. They are not laws of the universe, immutable and sovereign. Yet that is how economists treat them and that is the prism through which we have come to see the world.
Gleeson-White tracks how ubiquitous the binary system of accounting has become in economic statistics and economic theory, including Marxism. Weber equates double entry with capitalism itself. She does not mention it, but the idea of “balancing the books”, credits matching debits, is implicit in General Equilibrium theory, which drives our idea that “economic imbalances” are to be guarded against (an idea with merit, of course, if transactions are not to be undermined).
The insistence on interpreting economic transactions as an inviolate system, like a natural system, that is subject to scientific laws is, I suspect, the main reason why economists are so wrong. They are not looking at a natural system, they are looking at a created, artificial system that need not be the way it is. The statistics, as Gleeson-White shows with her description of Keynes’ development of GDP and other national economic statistics, was based on a series of assumptions about what should be considered valuable. Different assumptions could have been made. If they had been, we would now have a different picture of economic progress and relative wealth.
So here’s a suggestion.
Maybe economists should view the “euro crisis” or indeed any other economic phenomenon, as a social artifice that must be interpreted using non-scientific methods — you know, look at the people involved, for instance. As for me, I suspect that the supposedly irresolvable arithmetic cul-de-sacs of European national finances are a bit of a mirage that the market will eventually tire of. That which is created can be uncreated. There is also something suspiciously biased about the concerns with, say Italian debt. At about $2 trillion, it is one sixth of Japanese debt and one eighth of American debt. It is little more than 1% of global debt. So why is it getting all the attention? The answer, I would suggest, is to do with ideology, politics and trading plays. People, in other words. Not arithmetic.