World Finance interviews Tim Harford, the ‘Undercover Economist’, on how it’s not just economists who can’t predict things like global financial crises – all experts are terrible
The financial crisis has put global economics into the spotlight. Undercover economist Tim Harford explains how experts’ forecasts can be so unreliable (but despite this, why a handful of specific economists did point to problems before the global financial crisis), discusses the difficulties with trial and error in macroeconomics, and explains his concerns about economic growth in the UK.
World Finance: So Tim, probably a question you’re a little bit sick of being asked, but I think it’s interesting anyway; why did economists fail to warn us about the financial crisis?
Tim Harford: Well I think the big picture answer to that is, no experts ever successfully warn us about anything! Or certainly any social science problem.
There’s a wonderful investigation carried out by the psychologist Philip Tetlock. Over 50 years when he quizzed different experts. Some were academics, some were more practical people like diplomats or even spies. Journalists. Some were economists, some were psychologists, some were historians, some were regional specialists. All of these experts. And he just asked them to make specific forecasts about real world events. He made all his forecasts quantifiable. And he waited. He waited nearly two decades. And having collected nearly 30,000 forecasts from about 300 experts, he came to the conclusion that basically, no expert can forecast anything! We’re all just terrible.
So this is not specifically a problem about economics and the crisis. This is really a problem about being humble in the face of what’s a very complex world.
“Specific economists looking at some detail were pointing to trouble, but the big picture stuff is always really tricky”
That said, I do think there were certain economists who were able to point to specific things that were of concern. So, you can think of, for example, Raghuram Rajan, who was chief economist at the IMF – hardly a minor figure – who was pointing to the perverse incentive structures of the way that mutual fund managers were being paid.
There was Robert Shiller, who was looking at price earnings ratios, and then price-rent ratios in the housing market. He pointed to the dot.com bubble, called it a bubble, and did the same for the housing market in 2005. I could list others. There were specific economists who were pointing to trouble. And I think what they had in common was an interest in some detail. Rather than just saying, ‘Right, I’ve got a simple model of the entire economic system, and nothing’s problematic,’ they were detail-oriented. They would look at a particular thing. ‘I’m worried about the contracts that investment managers are paid under,’ or ‘I’m worried about the way the housing market in Boston is performing.’ And those specific real-world focuses produced results. But the big picture stuff is always really tricky.
World Finance: Well since the financial crisis then, do you think the perception of economists has been changed?
Tim Harford: Oh no, I think people always knew we couldn’t forecast anything, to be honest. There’s a slightly ironic situation, because on the one hand, clearly economists deserve some blame for – I wouldn’t say so much for not seeing the crisis coming, but for not understanding that there were certain structures in place that seemed likely to cause damage. That was partly due to us. Not solely due to us. There were lawyers involved! There were accountants involved, there were politicians involved, but it’s partly our fault.
And people blame us for that, and they’re right to blame us for that. But at the same time, people want to know what’s going on. And when you want to know what’s going on, who do you turn to at this point? Well, quite often you turn to an economist. So, people love us but they hate us. I guess I’ll have to deal with that.
“The longer we go without a recession, the less people think about risks”
World Finance: Well a lot is said about boom and bust, so is it not just another time for a recession?
Tim Harford: No no, I completely disagree with that. It’s just not true that we’re due recessions from time to time, and there’s due chastisement, and we just have to take our medicine and purge the rottenness from the system. I think that’s just medieval thinking, to be honest.
The one thing I will say is, the longer we go without a recession, the less people think about risks. And you can actually track this across generations. So, you can see the years in which people were born, the economic environment they experienced as teenagers and in their 20s, when they were forming strong impressions about how financial markets work. You can track that throughout their investment careers, and people who grew up during the Great Depression see stock markets very differently. People who grew up during the 1970s see stock markets very differently from people who grew up during the 1980s. You can track it. And people who have experienced these traumatic economic events are very conservative. They don’t like leverage, they don’t like to take a lot of risks, because they’ve seen how bad things can get. And so, there is this self-correcting thing going on.
If the market is working brilliantly, the stock market is booming, there hasn’t been a recession for years and years and years and it wasn’t very serious last time, people are going to get careless. So, that is the only way in which I agree with you, that sooner or later we just relax too much.
World Finance: Based on your theory of trial and error, we know that Keynesian economics has worked in the past, so, five years on, why are we still suffering from a recession?
Tim Harford: It’s never as easy as that though, is it? I mean, I’m a believer in Keynesian economics, within reason. I think that Western governments should have spent money, particularly channelled into investment, long-term investment projects. But even though I believe that that’s true, I do not think you can say ‘We proved that conclusively in the past, and therefore it will always be true.’
“The long-term questions about the structure of the British economy haven’t been answered yet”
The wonderful thing about the trial and error that I espouse is that you can do it on a small scale, you can run randomised control trials, you can learn very specific lessons, you can scale them up. That’s much harder in macroeconomics. It’s always possible to say, ‘Well, this time it’s a bit different, the structure of the economy is different, the structure of the shock was different, banking was very different in 2008 compared to 1929…’
So, even if we could agree what happened in the 1930s – and we don’t! – that still doesn’t tell us what would work now. So, that’s the challenge for anybody who is interested in macroeconomic problems. Trial and error is the way we understand the world, but trial and error is just a very difficult thing to do when it comes to macroeconomic affairs.
World Finance: Finally, the question I think we all want answering: is the British economy now growing, and where do you see the next bubble coming from?
Tim Harford: Well if I could answer that question, I’d be arguing that economists can forecast, and I think I’ve argued very strongly that economists can’t forecast!
It is growing, we don’t know whether it will continue to grow. The things that concern me are basically just the quality of the growth. To what extent is the growth just dependent on inflation in house prices? It doesn’t mean there’s a housing bubble – although it might. But it does mean that it isn’t coming from production, it’s basically coming from consumption.
I’ll take it, for now. It’s better than no growth at all. But the long-term questions about the structure of the British economy haven’t been answered yet.
World Finance: Tim, thank you.
Tim Harford: My pleasure.