Do not believe economic weathercasters

Tim Harford, one of the most prominent economic writers and a leading journalist for the "Financial Times” is discussing the fact that TV economic commentators have turned ordinary people away from economics and that the latter is wrongly considered as boring and being of little use to members of the public.
Do not believe economic weathercasters

Tim Harford (CC BY-ND adamsmithjr)

Obserwator Finansowy: Are there any universal solutions in economic policy?

Tim Harford: There are obviously none.

However, many economists claim that such solutions exist. Some say that budget cuts are absolutely wrong, others – that they are good. Some say that you have to lower taxes, others claim that in times of crisis a tax increase is a must! How will a voter know which party has a rational economic programme and which one is making foolish propositions?

Well, the answer is quite trivial: a voter must think. Sometimes a program of each political party is not rational. Here’s an example: although the UK government now says that savings are necessary, and the opposition is against them, in the period  before the election, all parties claimed that they would increase budget spending while lowering taxes. Any sensible voter who took the trouble to look into the budgetary statistics would have understood that that all politicians simply lied.

Let us, however, take the example of Paul Krugman, the Nobel Prize winning economist. He is clearly prescribing in his columns a universalistic vision of appropriate economic solutions. After having described the situation in Indonesia, he smoothly moves on to Greece and then to the economic situation in the United States.

Paul Krugman is an outstanding economist, but his essays must be read through the prism of his political views. I agree with the majority of his opinions, for example, on the economic situation in the United States, but for ideological reasons, his arguments on specific issues is at times rather simplistic. In my books, I try to take a more neutral stance. I do not provide ready-to-use solutions, but write about economics like a physicist would write about physics in a publication meant for a large audience. Let us go back to the issue of universal solutions. What is good for Poland, may not be so for Germany; yet another solution may be necessary for the United States. It all depends on the nature of the economy and the nature of the problems it is facing. A voter who reads books popularizing economic knowledge is provided with a tool to assess whether a country should save more or spend more, lower or raise interest rates, taxes, social benefits, etc.

Do you like to disprove economic myths and educate people?

I like to see how others disprove them. Steven Landsburg is an outstanding representative of this category of economists. I prefer a more positive approach to economic writing and my readers are people interested in economics, and therefore not exactly neophytes in this subject – from high school students to CEOs. I like to tell stories, explain, using the economic apparatus, why our daily life appears like it does. Why does a cup of coffee cost as much when we buy it in a café? What is the source of traffic jams and how can they be reduced? My first book was a collection of such micro examples, which I used to illustrate the fundamental principles of economics. In my latest book, I focus on explaining the concept of macroeconomics. I describe the system of links between inflation, unemployment, taxes etc. Here, I must admit, I had trouble finding simple examples from everyday life. Describing the macroeconomic situation of major economies would be boring and I wanted to explain the phenomenon of a recession in an accessible way. And I managed to do that. Do you know the difference between a recession in a prisoner-of-war camp and a recession in a cooperative whose members exchange babysitting services?

Please explain.

Let’s start with the kids. Several years ago, Paul Krugman described the functioning of a co-operative in Washington whose members would look after each other’s children. Members created an internal currency to pay each other for the services provided. At first, they would receive units of this currency equivalent to 24 hours of childcare. However, the new members of the cooperative stated that before they hired care for their children, they needed to earn extra units of currency – just in case. It turned out that everyone wanted to take care of someone else’s children, but nobody wanted to  benefit from these services.

The cooperative, as Krugman wrote, was caught in a Keynesian-type recession due to insufficient demand. I found the example of a German prisoner-of-war camp during the Second World War while reading the memoirs of one of the British prisoners, who was an economist. He described the functioning of the camp’s internal economy, what was traded and what the currency was. The camp would even export coffee, which was provided by the International Red Cross. Once these deliveries started to diminish, a recession in the classical sense was observed in the camp, caused by the combination of insufficient supply and high demand.

What type of recession did the United States fall into five years ago?

It was the Keynesian-type recession. Demand for the available products shrank. The ability to distinguish between the types of problems one has to face is the basis for making sound business decisions. This is my approach to writing about economy and economics. I am not trying to convince authoritatively that something is right because this is what Friedman, Keynes or myself say. I try to show mechanisms behind the phenomena and explain the implications of various theories; thus, I provide my readers with the tools they need to formulate their own opinions. Besides, writing about the world from an economic point of view is a great adventure for me. I myself am surprised by what I discover while writing. I used to think, for example, that it does not matter to people what currency they carry in their wallet – dollars, euros, or crowns – that the name of the currency does not matter if, for instance, we have to face inflation.

And is it important?

It is extremely important! One of the most interesting stories I have ever come across is the reintroduction of the real in Brazil as its national currency in 1994. Previously, the country had struggled with inflation for decades. The country’s currency was the cruzeiro. The first depreciated cruzeiro was replaced with a new stronger cruzeiro adorned with another symbol; later, when the value of the new cruzeiro went down, yet another one was introduced, also bearing a new symbol. Even though during the course of 40 years, a new currency was introduced on three occasions, inflation was not eradicated. Finally, economists came up with the idea of ​​a virtual currency, acting as a shadow to physical money. And so, transactions were carried out in the URV currency, incidentally related to the rate of the dollar; this currency was used for wage payments and product price denomination.

However, everything was automatically converted into cruzeiros – the currency that people already had in their wallets. You would go to a store and see, for example, that a loaf of bread cost one URV, which amounted to 6 cruzeiros. However, the value of  the cruzeiro was falling and after some time, a loaf of bread would cost eight cruzeiros, and then ten. In URV, its price would remain unchanged: it was still 1 URV. When people realized that the cruzeiro was a weak currency, while the URV was strong, they understood that a currency could be stable. Then the cruzeiro was eliminated and the ​​real was introduced. In the end, inflation was eradicated by altering the attitude of the people and the perception of the value of a currency among its users. It is quite complicated, but fascinating.

This sounds like some advanced acrobatics! Please explain something to me: if economics is such a fascinating science, why do the majority of people react to it with a yawn?

It is the fault of two groups of people: economists and the so-called TV experts claiming to be economists. Let’s start with economists who have made economics into a kind of abstract mathematical discipline. I agree that a good economist must understand mathematics, but he must also be able to explain economic processes without resorting to mathematical terminology. Economics is so complex a discipline that mathematics alone cannot describe it. Keynes said that a good economist is someone who is both a historian and a mathematician. What he meant is that a good economist is someone who is able to juggle both the concrete and the abstract.

Economics is a great science because it forces one to look at the world from so many perspectives! Economists failed to forecast the impending crisis because they focused too much on mathematical formulas. Look – economists would say – we have developed a formula that describes how derivatives work. And others would applaud. None of them, however – and I am just as guilty of this negligence – bothered to actually go to an investment bank and see if derivatives work as it is described in our models. I remember a colleague anthropologist who pointed to that, saying that she had talked to the traders of derivatives and knew that something was wrong. Economists ignored her. She was right, they were wrong.

What’s wrong with TV commentators?

They predict. I mean, they pretend to know how to predict the value of the GDP in the next six months, or which assets will go up on the stock market. These television commentators who claim to be economists are actually holding signs advertising the banks that employ them. They are over-confident in their judgments and not perceptive enough. They appear on TV just so that the name of the organization they represent can be displayed on the screen together with their name: chief economist of the X Bank, chief economist of the Y Bank… They are like poor weathercasters.

Do not listen to economic weathercasters! Let me quote Keynes once again: he said that an economist should be like a dentist. What do we expect from a dentist? Simply to fix our teeth and not to predict how many teeth we will be left with when we hit 70. I remember when the Internet bubble was expanding at the turn of the millennium and a book full of economic forecasts was published. It became a bestseller. It stated with great confidence that if everything was growing so well, it always would. And? Not only have the majority of forecasts failed to prove correct, but often the reverse has been observed. What was supposed to go up – fell and vice versa.

Maybe the need to predict the future is simply part of human nature?

In a way it is. The existence and popularity of these TV experts is our own fault, because we expect to be reassured about the future, even if it is just an illusion. Unfortunately, indulging in fortune telling distorts the science of economics. I remember that when I was working for a petrol company, I would always hear questions like, „Hey, you’re an economist, how much will oil cost next month?” Someone who bases their business, political, or life decisions on someone else’s forecasts will be easily deceived. I encourage you to acquire knowledge and make decisions on your own.

Tim Harford – British economist and columnist for the „Financial Times”, author of books promoting the knowledge of economics. His book entitled „The Undercover Economist” has been translated into 30 languages ​​and sold over one million copies.

Tim Harford (CC BY-ND adamsmithjr)

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