From international trade to interest rates, macroeconomics is in yet another tail spin
Last week, anti-Brexit campaigners started complaining about the minuscule economic benefit of joining the CPTPP, but almost no one shaking a fist knows a thing about microeconomics, writes Paul Ormerod
Fifty years ago, the Euro area accounted for 30 per cent of the world’s economy. Since then, there has been a steady fall; now, its share of world output has halved.
In contrast, the Asia-Pacific economies have grown much faster. These trends are well established, and this region will increasingly dominate the world economy.
Yet, on the logic of the received wisdom in UK economics, any weakening of our links with the EU is a disaster. In contrast, any recognition given to strengthening our links with the Asia-Pacific region is at best grudging.
Hence the estimate published last week by the Office for Budget Responsibility (OBR). It calculated the new trade deal between the UK and the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP) would only add a trivial 0.08 per cent to the size of our economy.
The CPTPP countries do not include Asian giants India and China, but their share of world output is now not much less than that of the EU. Despite this, the models used to estimate these effects churned out a dismally low number.
Truth is, the models used to predict the economy at the macro level are just not very good, to say the least. “Macro” of course means “big”: in economics, the term refers to things such as inflation, the growth of the economy and overall movements in trade.
Because of the media exposure it gets, most people think economics is mainly about macro. But whether it is in theory or in practice, most of economics is carried out at the “micro” level, trying to understand how individuals and companies behave.
Here, economics has made a lot of progress over the past thirty years. Descriptions of behaviour are now much more realistic. There is still a way to go, but this part of the discipline is in good health.
The same cannot be said of macroeconomics. The models are mathematically more sophisticated than the ones which I used when doing economic forecasting in the late 70s and 80s. But their performance is no better.
A stark illustration of this is provided by two of the 2019 Nobel Laureates, Abhijit Banerjee and Esther Duflo, in their book “Good Economics for Hard Times”. They devote a long chapter specifically to international trade.
They note that a number of key propositions in trade theory in economics lack empirical support. Indeed, the evidence even appears to contradict some of them.
Macroeconomics in the UK, whether on the Monetary Policy Committee or in the wide forecasting community, suffers from a problem which Keynes identified in the 1930s when writing about the economic crisis: “A sound banker, alas, is not one who foresees danger and avoids it, but one who, when he is ruined, is ruined in a conventional way along with his fellows, so that no one can really blame him.” What this means is that there’s a real reluctance amongst macroeconomists in the UK to go out on a limb. There are exceptions such as Tim Congdon, the founder of the Institute of International Monetary Research, but groupthink pervades the community.
The Bank of England’s recent record on inflation, for example, has been catastrophically poor. The Treasury’s original Project Fear warning of the consequences of a Leave vote was, according to many, completely wrong.
There is not, unfortunately, a rival set of theories which are scientifically unequivocally superior. But we can start by stopping treating pronouncements from the likes of the OBR as though they were science. A healthy dose of scepticism would prove useful.