Thursday, 5 July 2012

More 'good hunches'

In previous texts, I've pointed out to some more and some less precise predictions on future economic events. While Samuelson was way off on the Soviet Union's economic expansion (as are so many economists today on China), Mankiw was pretty accurate regarding the problems of the US debts and budget deficits along with the unsustainability of the US social security model and subsidized mortgages (this was the topic of the original 'Good hunches' post). Other good hunches include Rajan, Roubini (aka Dr. Doom), Shiller (Mr. Bubble) and a few others on the upcoming financial turmoil.

However, good predictions are usually very hard to find. In fact the economic science is faced with much more bad predictions. Not to go too deep in history and examine the predictions on the demise of the Soviet Union and communism in general, just remember how many pundits claimed in November 2011 that the Eurozone will break up by the new year? And yet it still stands, not out of the gutter quite yet, but still determined to remain and reform. 

And not even the most notable forecasters out there can always be correct. How many of "Dr. Doom's" predictions went wrong? No one know as he won't brag about them, obviously. Here's one though. Look up his Financial Times article from September 2011 where he claims that in order to avoid turmoil Greece should default and exit the euro immediately, having currency depreciation leading its further recovery. He even claimed that a Greek exit might have "secondary benefits to other Eurozone economies who could then decided by themselves whether they want to follow suit, or remain in the euro, with all the costs that come with that choice". In his latest article for the FT (June 2012) co-written with Niall Ferguson, they claim that an exit out of the euro would initiate a potentially explosive event and that more needs to be done to reduce the probability of exits. In retrospect they imply it was good Greece didn't exit and devalue (or in other words it was good Greece didn't listen to Roubini back in September). Mankiw also made a few blunders of his own, where there is even a web page set up offering prizes to those who recognize the "worse predictive and policy follies in his textbook". I won't even touch upon Krugman who had as many bad predictions as he had good ones. 

The legacy of Adam Smith 

However, EconLog's David Henderson points out yesterday (with reference to the 4th of July) how Adam Smith goes a long way in making strikingly precise predictions. In his essential 1776 "The Wealth of Nations" he had this to say on the outcomes of the 13 colonies' Independence war, Britain's possible and likely reactions and, most impressively, further development path of the newly found nation: 
"To propose that Great Britain should voluntarily give up all authority over her colonies, and leave them to elect their own magistrates, to enact their own laws, and to make peace and war as they might think proper, would be to propose such a measure as never was, and never will be adopted, by any nation in the world. No nation ever voluntarily gave up the dominion of any province, how troublesome soever it might be to govern it, and how small soever the revenue which it afforded might be in proportion to the expence which it occasioned. Such sacrifices, though they might frequently be agreeable to the interest, are always mortifying to the pride of every nation, and what is perhaps of still greater consequence, they are always contrary to the private interest of the governing part of it, who would thereby be deprived of the disposal of many places of trust and profit, of many opportunities of acquiring wealth and distinction, which the possession of the most turbulent, and, to the great body of the people, the most unprofitable province seldom fails to afford. The most visionary enthusiast would scarce be capable of proposing such a measure with any serious hopes at least of its ever being adopted. If it was adopted, however, Great Britain would not only be immediately freed from the whole annual expence of the peace establishment of the colonies, but might settle with them such a treaty of commerce as would effectually secure to her a free trade, more advantageous to the great body of the people, though less so to the merchants, than the monopoly which she at present enjoys. By thus parting good friends, the natural affection of the colonies to the mother country which, perhaps, our late dissensions have well nigh extinguished, would quickly revive. It might dispose them not only to respect, for whole centuries together, that treaty of commerce which they had concluded with us at parting, but to favour us in war as well as in trade, and, instead of turbulent and factious subjects, to become our most faithful, affectionate, and generous allies..." 
"...They are very weak who flatter themselves that, in the state to which things have come, our colonies will be easily conquered by force alone. The persons who now govern the resolutions of what they call their continental congress, feel in themselves at this moment a degree of importance which, perhaps, the greatest subjects in Europe scarce feel. From shopkeepers, tradesmen, and attornies, they are become statesmen and legislators, and are employed in contriving a new form of government for an extensive empire, which, they flatter themselves, will become, and which, indeed, seems very likely to become, one of the greatest and most formidable that ever was in the world."
How's that for a good prediction! 

3 comments:

  1. Adam Smith realized what it takes to make a nation great: individual liberty, freedom of choice, freedom from coercion, freedom to work, and freedom to create.

    Somewhere along the line the US has forgotten these important lessons, and that's the REAL reason for its current downturn

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  2. Predictions based upon economics are difficult. Predictions based upon politics though are sometimes quite easy. For instance I converted most of my savings to Gold just after the election of Barack Obama. Why? Because I could see that their policies were a return to the 1970's.

    I was incorrect in the sense that I predicted a lot of inflation which did not happen because we are in a world wide deflationary slump. But it did not matter because gold still went up and I more than doubled my assets.

    So some things are easy to see. If taxes are already high it is easy to predict what will happen when taxes go up. If tax rates are not high, it is more difficult to predict what will happen if you raise or lower the tax because it is difficult to see just where you are on the Laffer curve. Furthermore, that point of equilibrium probably shifts according to other factors such as consumer confidence, etc.

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    1. That's a good point you raise, and I absolutely agree with you; it's much easier to make predictions on bad policies. Even though I still refrain from making any predictions on what the outcome of the current malign set of policies will be (primarily because nothing good can arise from them, and I'm still foolishly optimistic that something will change).

      Btw, as you mentioned the switching of your investment strategy after the 2008 election, you reminded me of a good paper I think you could find interesting - it's called "A perspective on US regime change and the global financial crisis"

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