THE GLOBAL ECONOMY

Aurora College Economics HSC Study Day, Sydney, Thursday, July 27, 2017

Globalisation is very much in the news. You won’t need me to tell you that the quite remarkable political developments around the world in recent times – Britain’s surprise decision to leave the European Union, Donald Trump’s unexpected election as US President and, here, the resurrection Pauline Hanson’s One Nation at last year’s federal election – represent to a significant extent a backlash against globalisation. This is a shock to many governments, which is causing them to reconsider their economic policies. Today I want to talk about these recent developments rather than just revise the syllabus. But let’s start by reminding ourselves what that much used and abused word “globalisation” means.

Definition

The OECD defines globalisation as “the economic integration of different countries through growing freedom of movement across national borders of goods, services, capital, ideas and people”.

That’s a good definition, but I like my own: globalisation is the process by which the natural and government-created barriers between national economies are being broken down.

A process

With this definition I’m trying to make a few points. The first is that globalisation is a process, not a set state of being. Because it’s a process, it can go forward – the world can become more globalised – or it can go backwards, as national governments, under pressure from their electorates, seek to stop or even reverse the process of economic integration. This is just what Donald Trump promised to do in last year’s US presidential election. Just how much he actually tries to reduce America’s economic links with the rest of the world – and how much success he’s likely to have – remains to be seen.

Among the advocates of globalisation there has tended to be an assumption that the process of every greater integration is inevitable and inexorable. That was always a mistaken notion, but this has become more obvious since Brexit and the election of Trump. First, the British have voted to reduce their degree of economic integration with the rest of Europe – a decision most outsiders see as involving a significant economic cost to the Brits’ economy. Second, the Trump Administration has withdrawn from the Trans Pacific Partnership, an agreement between the US and 11 other selected countries (including Australia) to reduce barriers to trade between them. Third, the Trump Administration has withdrawn from the Paris global agreement on reducing greenhouse gas emissions.

Climate change

Climate change, but the way, is an unusual example of a global problem that can be fixed only by a global response – sufficient emissions reduction by sufficient large-emission countries. Individual countries, such as Australia, can contribute to the combined effort, but there is nothing smaller countries can do by their own efforts to reduce the effects of climate change on them. Only a concerted effort by many countries will make a difference to global warming. Economists recognise this as an example of market failure they call a “free-rider problem”. If everyone else pulls their weight then it won’t matter if I don’t bother helping because I’ll still benefit. The trouble with this thinking, of course, is that if too many people think the same way, the improvement doesn’t happen and everyone loses out.

Earlier globalisation

But to get back to the point that the process of globalisation is and always was reversible, people should know this because this isn’t the first time the process of globalisation has occurred. The decades leading up to World War I saw reduced barriers and greatly increased flows of goods, funds and people between the old world of Europe and the new world of America, Australia and other countries. But this integration was brought to a halt in 1914 by the onset of a world war. And the period of beggar-thy-neighbour increases in trade protection, to which countries resorted in response to the Great Depression of the early 1930s, greatly increased the barriers between national economies. Indeed, you can see that, in the years after World War II, the many rounds of multilateral tariff reductions brought about under the GATT – the General Agreement on Tariffs and Trade, which has since turned into the World Trade Organisation – were intended to dismantle all the barriers to trade built up in the period between the wars.

The channels of globalisation

The four main economic channels through which the world’s economies have become more integrated are:

1. Trade in goods and services

2. Finance and investment

3. Labour

4. Information, news and ideas.

Trade is probably the channel that gets most attention from the public. Donald Trump’s populist campaigning against globalisation has focus on the belief that America’s greater openness to trade – particularly with developing countries – has caused it to lose many jobs, particularly in manufacturing, as cheaper imports caused many domestic producers to lose sales, or as factories have been moved offshore to countries where wages are lower, without America receiving anything much in return. These sentiments would be shared by many voters for One Nation.

Surprisingly, financial globalisation didn’t get as much blame as it could have for the global financial crisis and the Great Recession it precipitated. Although the crisis began in America, caused by unwise lending for homes that many borrowers couldn’t afford, compounded by the proliferation of highly contrived derivatives, it quickly spread to most other countries. This spread of trouble from America to the rest of the world was caused by two main factors: first, the world’s financial markets are highly integrated, which meant that many European banks had bought securities and derivative contracts that were revealed as toxic and threatened to bring those banks down. Second, the globalisation of the internet and the news media meant news of wobbling banks was transmitted almost instantaneously to the living rooms of homes in countries across the world. This continued for several weeks, causing a world-wide shock to businesses and consumer confidence. This, indeed, was the main channel through which the crisis reached Australia.

But it’s easier for Australians to remember that the global crisis of 2008 was preceded by the Asian financial crisis of 1997-98, indicating that our highly integrated global financial markets are prone to crises – crises which invariably spill over from the “financial economy” of borrowing and lending, saving and investing, to the “real economy” of producing and consuming goods and services. The push by the G20 to strengthening the capital and liquidity requirement imposed on the world’s banks, though the Basel agreements, is intended to make financial markets more stable.

Most countries have not liberalised the flow of labour into their economy in the way they have the other factors of production. Although increasing numbers of people are fleeing their country to escape war, famine and persecution, many choose the country they’d like to arrive at on economic grounds. Many voters object to the inflow of immigrants, whether they be boat people arriving in Australia, Mexicans crossing the border to the US, or Poles taking advantage of the European Union’s single market to look for jobs in Britain. Immigration seems to have been a major motive for some Brits voting in favour of Brexit.

Income distribution and the gains from trade

One of economists’ core beliefs is that there are mutual gains from trade. Provided the exchange of goods is voluntary, each side participates only because it sees some advantage for itself. This is undoubtedly true, but in the era of renewed globalisation we’ve been reminded that, though the gains may be mutual, they are not necessarily equal. Some countries do better than others.

Similarly, the benefits to a country from its trade aren’t necessarily equally distributed between the people within a country. When, for example, a country imports more of its manufactured goods because they are cheaper than its locally made goods, all the consumers who buy those goods are better off (including all the working people), but many workers in the domestic manufacturing industry may lose their jobs.

Another factor that has been working in the same direction is digitisation and other technological change which, in its effect on employers’ demand for labour, seems to be “skill-biased” – that is, it tends to increase the value of highly skilled labour, while reducing the value of less-skilled labour. It seems likely that, between them, trade and technological trade have worked to shift the distribution of income in America, Britain and, to a lesser extent, Australia, in favour of high-income families and against many middle and lower-income families.

The unwelcome surprise many politicians and economists have received from the high protest votes for Brexit, Trump and One Nation is causing them to wonder if too little has been done to assist the workers and regions adversely affected to retrain and relocate, and too little to ensure the winners from structural change bear most of the cost of this assistance.

The factors promoting globalisation

I want to make a last point arising from my definition that “globalisation is the process by which the natural and government-created barriers between national economies are being broken down”. It’s that some of the barriers between national economies are government-created – such as restrictions on the free flow of goods and services, money and people – but the biggest barriers have been natural: the physical distance between countries which, historically, has increased the time and cost involved in moving goods, travelling and communicating between them. Historically, most services weren’t able to be traded across national borders.

This means the process of globalisation is being driven by two, quite separate factors: decisions by governments to lower the barriers between economies they themselves have erected – deregulation – and technological advance that is lowering the natural barriers between economies by lowering the cost of freight, travel and communication. Improvements in diesel engines and this size of tankers, the invention of shipping containers and the jumbo jet, are examples. Then there are advances in telecommunications which have hugely reduced the cost of telephone calls, and the development of computers and the internet, which allows instantaneous global communication at negligible cost. These advances have turned the provision of many digitisable services from non-traded to traded.

It suits many people who are part of the backlash against globalisation to blame the loss of jobs wholly on the actions of government and, in particular, on the signing of trade agreements. This way, they can tell themselves that getting the government to abrogate its trade agreement will return the world to the way it was. What they fail to realise is that many of the jobs lost from particular industries were lost not because of trade but through automation and computerisation. But governments can do little to halt technological change. Even if new protective barriers were raised – greatly increasing the prices of the protected goods – the rebuilt factories would be much more highly automated and employ far fewer workers than they used to.

So governments can, by reverting to protectionism, attempt to reverse the tide of globalism. But, since so much of the tide is driven by advances in digital technology, it’s likely many barriers between economies will to continue to shrink.

Shares of the World Economy, 2016

GWP Exports Population

China          18   11     19

United States   16   11         4

Euro area (19 countries)   12   26         5

India     7     2       18

Japan     4     4         2

Advanced economies (39) 42   64       15

Developing economies (153) 58   36       85

            100 100     100

Source: IMF; GWP based on purchasing power parity

Read more >>

How we're scammed by our fear of terrorism

These days there aren't many scams bigger than all the fuss we're making about the threat of terrorism coming to our shores.

What makes the scam worse is that we bring it on ourselves.

But I'm not first to point out that this degree of concern is totally out of whack with the actual risk of being attacked.

In the past two decades, just three people have died as victims of terrorist attacks (broadly defined) in Australia. They were the two victims of the Martin Place siege and the NSW police accountant Curtis Cheng.

When Malcolm Turnbull was announcing the formation of the mega Home Affairs department last week, which he insisted was all about improving the domestic security response to "the very real threat of home-grown terrorism that has increased with the spread of global Islamist terrorism", he said that intelligence and law enforcement agencies had successfully interdicted 12 imminent terrorist attacks since September 2014.

There's no way of checking that claim, nor guessing how much harm would actually have transpired, but if that figure of 12 impresses you, you're making my point. Relative to all the other threats we face, it's chicken feed.

Professor Greg Austin, of the Australian Centre for Cyber Security at the University of NSW, has written that more Australians have died at the hands of police, lawfully or unlawfully, in 10 years – at least 50 between 2006 and 2015 – than from terrorist attacks in Australia in the past 20 years.

You reckon terrorism's a great threat? What about the more than 318 deaths from domestic violence just in 2014 and 21015?

The former senior bureaucrat John Menadue has written that Australia's alcohol toll is 15 deaths and 430 hospitalisations a day.

The journalist Bernard Keane says that between 2003 and 2012, there were 2617 homicides and 190 deaths from accidental gun discharges. More than 130 rural workers died from falling off vehicles, 206 died from electrocution and 1700 Indigenous people died from diabetes.

Why do we so greatly overestimate the risk of being affected by terrorism? Many reasons.

Part of it is that, as psychologists have demonstrated, the human animal is quite bad at assessing probabilities. We tend to underestimate big risks (such as getting killed on the road) and overestimate small risks (such as winning Lotto or being caught up in terrorism).

We tend to assess the likelihood of a particular event according to its "salience" – how well we remember hearing of similar events in the past and how much notice we took of them.

Trouble is, most of what we know about what's happening beyond our personal experience comes to us from the news media, and the media focus almost exclusively on happenings that are highly unusual, ignoring the everyday occurrences.

They do so because they know this is what we find most interesting. They tell us more about the bad things that happen than the good things for the same reason.

The media know how worried and upset we get by terrorist attacks, so they give saturation coverage to attacks occurring almost anywhere in the world.

The unfortunate consequence is we can't help but acquire an exaggerated impression of how common terrorist incidents are and how likely it is one could affect us.

But it's not all the media's fault. Of the many threats we face, we take special interest in terrorism because it's far more exciting than boring things like road accidents or people drinking too much.

The other special, anger-rousing characteristic of terrorism is that it comes from overseas and thus stirs one of our most primeval reflexes: xenophobia.

Our response to terrorism is emotional rather than thoughtful. And that leaves us open to manipulation by people with their own agendas.

After the media come the politicians. It's conventional wisdom among the political class that security issues tend to favour the Liberals over Labor. That's why conservative politicians are always trying to heighten our fear of terrorism (see Turnbull above) and why Labor avoids saying anything that could have it accused of being "soft on terror".

After the politicians come all the outfits that make their living from "domestic security" – spooks, policy people, equipment suppliers and myriad consultants – all of them doing what they can to keep us alarmed but not alert.

Domestic security is probably the fastest-growing area of government spending. None of the budget restraint applies to it. That's partly because of public pressure, partly because of the security industry's success in wheedling money out of the pollies, and partly because, should some terrible event ever happen, the pollies want to have proof they tried their best to prevent it.

What's this got to do with economics? Everything. Economics is about achieving the most efficient use of scarce resources.

We face many threats to life and limb and are right to expect the government to do what it can to reduce them. But there's a limit to how much tax we're prepared to pay, and the more money we lavish on the tiny risk of local terrorism, the more we underspend on many far greater risks to our lives.

Read more >>

Big business influence wanes as public rejects ‘bizonomics’

The collapse of the "neoliberal consensus" is as apparent in Oz as it is in Trump's America and Brexitting Britain, but our big-business people are taking a while to twig that their power to influence government policy has waned.

Their trouble is the way the era of micro-economic reform initiated by the Hawke-Keating government in the 1980s eventually degenerated into "bizonomics" – the pseudo-economic belief that what's good for big business is good for the economy.

Part of this is the belief that when you privatise a government-owned business, or outsource the delivery of government services to for-profit providers – when you move economic assets and activity from the "public" column to the "private" column – you've self-evidently raised economic efficiency and wellbeing.

Provoking an engrossing debate between economists, Dr Mike Keating, a top economic adviser in the (no relation) Keating era, used a post and a rejoinder on John Menadue's blogsite to claim the early reformers believed that who owned a business wasn't as important as whether privatising it would make its industry more competitive or less.

True, Mike. Trouble is, the advisers and ministers who followed the Keating² era weren't so discerning, nor so scrupulous.

In those days, the goal of making industries more "competitive" meant turning up the competition from imports, or removing government regulation designed to inhibited competition between local players.

These days, following the degeneration to bizonomics, making industry more competitive means granting concessions to make chief executives' lives easier.

I remember when part of the Keatings' motive for dismantling protection against imports was to cure Australia's lazy business people of their predilection for running to Canberra for help whenever times got tough.

No more rent-seeking, was the cry. But the degeneration from economics to bizonomics amounted to wholesale rent-seeking by business. Is productivity improvement weak? Obviously, that's the government's fault for not pressing on with economic reform.

What reform? Cutting tax on companies and high income-earners and increasing the tax on consumers. Shifting the legislative power balance between employers and their workers even further in favour of employers.

Sorry, but as has been well demonstrated by Malcolm Turnbull's refusal to increase the goods and services tax, his inability to cut the company tax rate for big business, and the public's overwhelming disapproval of the Fair Work Commission's decision to cut Sunday penalty rates (complete with the Coalition's attempt to deny paternity of the bastard child), those days are ending.

These days, it's not just leftie troublemakers who doubt that benefits going direct to big business will trickle down to the rest of us, it's every punter in the street.

Another element of bizonomics is governments in many anglophone countries maintaining the facade, but not the substance, of business regulation.

They tell the public it's protected by laws governing treatment of consumers, employees, shareholders, taxpayers and others, but then rob the regulatory agencies – in our case the ACCC, Fair Work Ombudsman, ASIC and the Tax Office – of the resources they need to adequately enforce the laws they administer.

In this game of nudging and winking, it didn't take long for business to realise that, its chances of apprehension being tiny, obeying any law it found standing in the way of higher profits was now optional.

And that, though they could never admit it, this was the way governments of both colours secretly wanted it to be.

This is what explains the plethora of business law-breaking being uncovered by Fairfax's Adele Ferguson and other investigative journalists. What's notable is the way the business lobby groups have failed to condemn corporate lawbreaking.

A few decades of bizonomics have left our big business chiefs with the assurance they possess a God-given right to have their every demand accommodated by governments.

Sorry guys, apart from the lack of evidence that allowing you to aggrandise yourselves leaves the rest of us better off, democracies don't work that way.

In the end, power derives from voting punters, not corporations making generous donations to party coffers. The donations work only as long as the pollies can use them to amass enough votes for a government trying to swing it for biz business.

That's what's no longer happening, and the sooner you wake up to it, the sooner you can move to profit-making Plan B: find it within your business, not by lobbying Canberra.

The pollies have already got the punters' message. That's why the Coalition is becoming less willing to do your bidding and Labor has realised getting tough with business has more upside than down.

If this means you stop donating to either side, so much the better.

Read more >>

Occupations are changing as the jobs total grows

Have you heard that most of the jobs being created in the economy these days are part-time? No? Good. Yes, you have? Sorry, your info's out of date.

It was true last year, but not this year. As this week's figures for the labour force from the Australian Bureau of Statistics showed, of the 176,000 additional jobs created in the first six months of this year, 93 per cent were full-time.

That, BTW, was an exceptionally rapid annualised rate of growth of 2.9 per cent. Doesn't sound like the economy's dead yet.

Admittedly, it was a very different story last year. The calendar year saw growth in total employment of just 100,000 jobs – a very weak 0.8 per cent – of which 135 per cent were part-time.

Huh? Think about it: there must have been a fall of 35,000 in the number of full-time jobs. And there was.

It was a particularly bad year, and with all the happy scare stories about the rise of the "gig economy" it was enough to convince a lot of education-leavers that their chances of ever getting a decent, full-time job were low.

Moral: don't count your nightmares before they've hatched.

Dr David Gruen, a deputy secretary in the Department of Prime Minister and Cabinet, noted in a speech this week that "the displacement of jobs by technology ... is one of the developments that is leading to a sense of unease among many in the community."

People may fear that their own job may be taken over by a machine, or worry there'll be insufficient meaningful jobs for their kids.

Maybe, maybe not. Before we leap to cataclysmic conclusions, Gruen reminds us that fears of technological advances rendering many jobs obsolete is an idea with a long pedigree – back to the Luddites going around smashing machines in the early 1800s.

In the 200 years since then, employers have never ceased seeking out the newest and best labour-saving technology, but so far this has failed to cause mass unemployment.

Coming to today, Gruen says there's little sign of a quickening in the rate of change in occupations that might signal big, new technology-driven changes in the labour market. Nor is there any sign of the rapid improvement in the productivity of labour that you'd expect to see if there was widespread replacement of workers with machines.

But what's been clear for some time, he says, is that jobs across the economy are not equally susceptible to being displaced by technology and automation.

"Routine or predictable tasks are more susceptible to displacement than non-routine tasks. This observation applies to both manual and cognitive tasks – whether manual or cognitive, routine tasks are easier to automate than non-routine ones."

Dr Alex Heath, of the Reserve Bank, has used the stats bureau's figures on workers by occupation to see how these distinctions have affected our workforce over the 30 years to 2016.

She finds no sign of a recent quickening in the pace of change in occupations, but she certainly does find such change over the 30 years since 1986.

The proportion of routine manual jobs (such as labourers and machinery operators) in total employment has fallen from 40 per cent to 30 per cent, while the proportion of routine cognitive jobs (such as salespeople and clerical workers) has fallen from 27 per cent to 24 per cent.

In contrast, the number of non-routine manual jobs (such as nurses and hospitality workers) has risen from 6 per cent to 11 per cent, with non-routine cognitive jobs (such as management and professional occupations) rising from 27 per cent to 36 per cent.

This means routine jobs' total share of the workforce fell by 14 percentage points, whereas non-routine jobs' share rose by 14 points.

The share of routine and non-routine manual jobs fell by 5 percentage points, meaning the share of all cognitive jobs rose by the same.

(If you're wondering, over that 30-year period, total employment grew by almost 5 million jobs – an increase of more than 70 per cent – with the extra jobs spread about equally between part-time and full-time.)

Gruen says we should expect these trends to continue. But he makes a point first made by American economist Daron Acemoglu, that there's not one big trend going on in the workplace, but two.

The one that gets all the headlines is automation – jobs being taken over by machines. But the trend that gets much less notice – thus contributing to the public's excessive anxiety – is the continuous creation of new, useful, complex (that is, non-routine) jobs.

We've seen that, for at least the past 30 years in Oz, both trends have been at work. One displacing jobs, the other creating them. And so far, their effect on the composition of jobs has been roughly equal, and hasn't prevented continued growth in the total number of jobs.

Of course, it remains possible that the digital revolution will cause an acceleration in trend of displacement of jobs by machines, thus overwhelming the creation of new, complex jobs.

But another American economist, David Autor, has explained that certain tasks are particularly hard to automate.

These are tasks "that people understand tacitly and accomplish effortlessly, but for which neither computer programmers nor anyone else can enunciate the explicit 'rules' or procedures ... [The] tasks that have proved most vexing to automate are those demanding flexibility, judgment and common sense – skills that we understand only tacitly".

Of course, it's possible that "machine learning" may overcome these problems, but there's another constraint on machines taking all our jobs away to remember: the need for interpersonal skills in a growing number of jobs, plus our human preference for being served or helped by humans, not robots.

Don't discount the human factor.

Read more >>

ETHICS IN ECONOMICS

Australian Conference of Economists, Special Session, Sydney, Friday, July 21, 2017

The notion that ethics has anything to do with economics, that economists should subject their professional behaviour to some sort of ethical standard, is such a foreign one that we have a long way to go in just accepting the idea, let alone finding a way to put it into practice.

I don’t pretend to have all the answers, though I do have some strong opinions. And it probably won’t surprise you to know that, as a journalist, my work is subject to a clear and detailed ethical code, set by the journalists’ union, accessible on its website, endorsed by many media companies and updated as necessary. Journos don’t delude themselves that they merely explore a “positive” science, without resort to “normative” considerations.

There are two ways to think of the economists’ role. One is that it’s to provide the community with dispassionate advice about the best ways for it to go about achieving its economic objectives. The other is to explain/convince/assert to the community what its economic objectives should be, and hence the policies that must be followed to achieve them.

The term “economic rationalism” was in use long before the sociologist Michael Pusey took credit for coining it, but the growing influence of this Treasury-style thinking during the term of the Hawke-Keating government – the Australian equivalent of what people overseas call neoliberalism – was very much in this second, more missionary approach of telling governments exactly what policies they should and should not be following.

In my own career as an economic commentator it wasn’t until around the turn of the century that I found my own ethical anchor in the slogan, Serve the Reader. Although I haven’t stopped supporting those policies I consider to be better than others, I have switched my mission from trying to persuade readers of the rightness of the economic rationalist cause, to acting as a kind of theatre critic to economics, elucidating the strengths and weaknesses of economic theories and policies for the benefit of my readers. When I see someone – politician, vested interest, economist – using economics to pull the wool over my readers’ eyes, I’m on their case.

Which brings me to the main point I want to make and the main reason I was so easily enticed to be on this panel today. If ever there was a part of the economics profession where behaviour seems most in need of ethical standards it must surely be the relatively new industry of “economic consultancy” – economists who make their living providing economic analysis – usually in the form of econometric modelling – to paying customers, usually industry groups lobbying the government for or against some policy proposal, but occasionally the government itself.

Sometimes I think economic consulting is little more than the up-market end of the public relations industry. I suppose there must be occasions where these consultants provide their clients with analysis purely for their use internally but, for the most part, the analysis is sought so that it can be made public, complete with oversimplified press release, in order to influence public opinion and put pressure on the government.

Often the attempt is made to give this analysis greater authority and credibility by calling it “independent” analysis. I can’t remember ever hearing the economists who produced it contradicting this claim, but nor can I imagine how anyone who believes in the power of market forces could believe that analysis that’s the product of a commercial transaction – where the producer is hoping the paying customer is pleased with what they paid for and will make repeat orders – is in any way “independent”. Is it the behaviour of an independent authority to keep its mouth tightly buttoned while your client, and the politicians who agree with his cause, repeatedly misrepresent your findings to the public?

This lack of independence is just as much the case when Treasury or some other department is commissioning analysis on behalf of the government. Sometimes the government may be genuinely uncertain and in need of external advice, but it’s far more likely it’s after “modelling” intended to help it persuade the public and the Senate that the policy it has determined to introduce should be accepted. In such transactions, Treasury knows what policies it favours, it knows what the government wants to be told, and it has a fair idea which consultants will be more amenable to giving it and its political masters the advice they’re hoping for. Forum shopping is a vice not limited to lawyers. Why do you think successive governments have refused to allow the Productivity Commission to analyse the costs and benefits of the so-called free trade agreements they make? They know the trouble with the PC is that it really does consider itself independent.

You don’t need to be a modeller to know how easy it is for the modeller to get the results desired by the choice of model used and by tweaking the variables. And yet the results are so often presented to the public as though they are God’s immutable truth. There’s no accompanying acknowledgement of the chosen model’s strengths and weaknesses, no admission of the key variables that are driving the models results, no sensitivity analysis, no admission that the model is a combination of both empirically measured variables and mere economic theories about how the variables combine to produce the model’s much touted results. No admission that exogenous variables for the future are set quite subjectively. No admission that many economists would disagree with the particular theories underlying the model you used.

Sometimes cannier modelers seek to insure themselves against criticisms such as these by burying in the very fine print of their reports jargon-ridden acknowledgements of some of them. But they stay mute when their results are presented and debated in a way that makes clear these insurance clauses haven’t been read by the very people who should have read them, as it was always intended they not be. This is ethical behaviour? Caveat emptor makes it all OK?

But I suspect there’s a related, less commercially driven reason why the use of economic modelling in the public policy debate is more about bamboozling non-economists than enlightening them. The other explanation is that, consciously or unconsciously, economists seek to avoid the Wizard of Oz Moment, when we see behind the curtain and realise the powerful wizard is really just a little man shouting into a megaphone, using tricks to make out he knows a lot more than he actually does.

Consider just two examples. Although many economists bang on endlessly about the adverse incentive effects of high marginal tax rates, we purport to show the effects of major tax reform using a model that can represent income tax only as a flat-rate tax. Why? Because it has just a single, “representative” household. We use a model utterly inadequate to the task – because it’s the best we’ve got – and present the results as definitive without any up-front admission that we don’t have the tools to answer the question we’ve been asked.

Or, take the very common modelling practice of assuming a short-term Keynesian world and a long-term neoclassical world. We ask such a model to tell us the long-term economic cost of introducing the carbon pollution reduction scheme. It starts in equilibrium, introduces the disturbance of a CPRS, wobbles a bit, then starts on its inexorable journey back to long-term equilibrium. Then we announce to the punters that our modelling shows the scheme’s long-term cost in forgone economic growth is, fortunately, quite minor. Then we wonder why they don’t trust us.

They say forecasters have a lot to be modest about. I’d add they have a lot to be more ethical about.

Read more >>