大象传媒

Why the world is like San Francisco

• Evan Davis | Notes on Real Life |
• 28 Jan 07, 11:08 AM

What are economic forecasts for? A lot of what the professional economists in the city do, is make forecasts. But is it a useful activity?

Take the forecasts for 2007. It's been a rocky start, with an unexpected jump in inflation. Already, some forecasts made at the turn of the year are being updated. But most professionals would accept that a business-as-usual scenario is still more likely than any other. That implies:

路 base rates will end the year at 5.0 to 5.5%;

路 house prices will rise by five to ten per cent;

路 inflation will edge back down towards its target;

路 the economy will grow by 2.5% or thereabouts and

路 there will be a new Chancellor by this time next year.

In addition, globally, India and China will grow fast, while there will be a moderate slowdown in the US economy.

Unfortunately, none of these predictions are particularly interesting. They are either obvious, common currency or mere continuations of what's already happening.

I could give you some more remarkable predictions. That a major celebrity will turn into a werewolf for example. Or that a plague of frogs will descend upon Macclesfield. Unfortunately, while these would make more fascinating reading, they would perform badly in terms of likelihood-of-occurring.

The contrast between the interesting and the likely offers general lessons about economic predictions and the way they are framed. The economy is usually not terribly interesting - it conforms to conventional patterns, and moves rather slowly.

As a result, on any given day, you are far safer predicting the economy will carry on with business as usual, than you are predicting something more exciting.

However, economics is at its most interesting when it is least predictable. And that's when you would most like to know what's going to happen.

So, rather than giving the business-as-usual scenario for 2007, shouldn't we be thinking about the business-not-as-usual scenario.

This might involve the following outcomes:

• First, the authorities in China allow the yuan to rise against other currencies; or simply let inflation take hold in China so that the export prices of Chinese goods are marked up considerably.

• Second, higher prices in the West, force central banks to raise interest rates causing our economies to slow down substantially. Consumers, instead of saving between zero and five per cent of income revert to saving closer to 10%.

• Third, a substantial proportion of households are crippled by higher interest rates having borrowed heavily in previous years, on the understanding that rates never rise above five per cent.

• Fourth, house prices fall as higher interest rates make force buyers to reconsider what they can afford.

• Finally, a wave of corporate insolvencies occur as heavily indebted private equity investors realise they too had borrowed money to buy companies on the understanding that interest rates never rise above five per cent.

So that's five non-predictions which are quite possible and quite coherent but which are less likely this year than business-as-usual.

Those five all relate to the great problem in the world economy, of the unsustainable imbalance between low savings in some of the large western economies, and very high savings in some of the Asian economies. It's an imbalance which most obviously manifests itself in a large trade deficit in the US, and a huge trade surplus in much of Asia.

None of us can be sure how our economy will perform if or when the Asian economies stop saving and stop sending us ever cheaper goods. But my business-not-as-usual-scenario provides one - albeit a rather uncomfortable - route by which the imbalances resolve themselves.

(It is possible to think of others).

So with two scenarios in mind -- business-as-usual and business-not-as-usual -- what kind of economic forecast is useful?

The more likely uninteresting one?

Or the less likely interesting one?

In my view, it is difficult to make a choice. Offering just one scenario is either unduly reassuring, or unduly alarming. Taking some kind of average of the two forecasts doesn't work, as it is quite likely to be one or other, but not something in-between.

So maybe we should just be less bothered with the conventional forecasts that give us one view only, and be more concerned with understanding the different plausible scenarios for our economy.

Indeed, perhaps economists can take a lesson from seismologists.

What earthquake-watchers do not do, is make outlandish predictions that "there will be an earthquake on the west coast of the US, in the second half of next year". If forced to make a prediction about next year, it would probably be that life will be rather geologically unexceptional.

However, what their science does allow them to do, is to talk more generally about earthquake risks. There will probably not be a San Francisco earthquake next year. But there is a good chance, given the fault line beneath the city, that at some stage there will be an earthquake there. Or at least, a big series of rumbles.

It seems like a useful way of thinking about issues, as much for economies as for earthquakes. Although I dare say it will be hard to wean ourselves off conventional forecasts most of the time because if you do have to reduce the economy to one number, then the average forecast of the growth rate in the next 12 months seems like the one number you want.

Incidentally, I got caught up in thinking about this because the seismological analogy is a good one for economists to use at the moment. In many respects, you might think of the world economy as being like San Francisco. A place where the climate is benign, and the lifestyle comfortable, but a place located on top of a rather ominous fault-line, of global imbalance.

2007 will probably be quite normal in the world economy and in San Francisco for that matter. But if those fault-lines get disturbed in some way, it could turn out rather differently.