Published:

7 comments

LILICO Andrew looking down

Earthquakes happen all the time, and most of the time even quite large earthquakes pass by without notable impact upon humanity.  Would it be possible systematically to predict, well in advance, every earthquake that kills more than 5,000 people?  I say no.  It might well be possible to predict an earthquake that would kill more than 5,000 people if it were not predicted, but not to predict every earthquake that does in fact kill more than 5,000 people.

Why not?  Because if you were able to predict earthquakes that kill more than 5,000 people, folk would react – knowing the accuracy of your predictions, they would move away from the site of the earthquake and that earthquake would, in the event, kill very few people, if any.  The act of predicting the deaths of 5,000 people means that no-one in fact dies, so your predictions of 5,000 or more deaths would rarely, if ever, come true.

It follows, therefore, that we shall never have any technology that allows us, systematically and reliably, to predict earthquakes killing 5,000 or more people.  That doesn’t mean there will never be any earthquakes that kill more than 5,000 people.  Some earthquakes may just be unpredictable after all.

In exactly the same way, and for almost precisely the same reasons, we shall never have any technology that allows us, systematically and reliably, to predict huge stock market crashes or financial crises.  For if we had such a technology, our predictions would affect behaviour, and the stock market crashes or financial crises that we predict would not occur.  Just like the folk moving away from the earthquake site, folk trading stocks and bonds would trade out of the assets that would fall before the event, meaning the event predicted would not occur.

Therefore, when there is a financial crisis (which is bound to happen from time to time, for ineradicable reasons to do with the functioning of economies), asking “Why was this not predicted?” is the wrong question.  If there had been a reliable way of predicting it, it wouldn’t have happened, so there would have been nothing to predict!

Now obviously a lot of crazy folk make a lot of ill-informed predictions about a lot of things. So when there is an earthquake with many fatalities that standard technologies did not predict, someone somewhere will say: “Ah, but my astrology / tea-leaves / entrails / spirit guide method did predict it!  So that shows orthodox earthquake prediction techniques are all flawed and you should give up on them and do my thing instead!”  You would struggle to be polite about such a claim.

Well, in exactly the same way, when there is a financial crisis, someone somewhere will say: “Ah, but my astrology / tea-leaves / entrails / spirit guide method did predict it, when you said it couldn’t be predicted!  So that shows orthodox economics and finance prediction techniques are all flawed and you should give up on them and do my thing instead!”  And I am inclined to be just as rude in response to that claim.  It’s utter garbage, and it disappoints me when otherwise intelligent people appear to buy it.

Now, of course, earthquake prediction and economic prediction techniques are dynamic – they change through time, improving in response to events and new ideas.  And obviously there is the possibility that when some event happens that was not predicted, we might learn from that.  It might even show that an entire class of prediction techniques or models are less good than some new class of models.

Maybe some person out there whose prediction methods were not previously taken seriously will be vindicated.  There is a chance that one of those entrails-gazers will be such a person.  But it absolutely does not follow from the fact that amongst the thousands of folks making random prophetic utterances all the time, the one that randomly gets something right on one occasion therefore has a hot-line to God.

The events of 2008 onwards have not led economists to believe that the core models of finance theory or macroeconomic theory are flawed.  There is not the slightest reason to believe that.  If anything, exactly the opposite has happened – in the period since 2008 the most hard-core fundamentals-based orthodox models of economic and finance theory have worked better than other models, and economists and finance practitioners now place more reliance upon them than before the crisis, not less.  That is not because “economics is in denial” or any of that verbiage one increasingly hears (sorry to be blunt and a little coarse, but the view I’m attacking really should not be regarded as intellectually respectable – though it sadly appears to be becoming so – and remember I’m the one these “Economists are all rubbish” preachers are insulting).

It is because orthodox economists were right all along when they said that volatility is an ineradicable element of any healthy economy and when they said (and used models in which) financial crises were fundamentally unpredictable.  If your response is “Well, they should be predictable!” then you simply haven’t tried to understand why the economists claimed they were unpredictable in the first place.

7 comments for: Andrew Lilico: Economics is not in crisis – only charlatan entrails-gazers claim they can predict everything

Leave a Reply

You must be logged in to post a comment.