Sunday, May 31, 2020

Why making economic predictions now is useless

In one of his poems, Constantine Cavafy distinguished, in the art of foretelling future events, three groups: men who are able to see what exists now, Gods who alone know the future, and wise men who perceive "what is just about to happen":

Ordinary mortals know what's happening now,
the Gods know what the future holds
because they alone are totally enlightened.
Wise men are aware of future things
just about to happen.

            We all aspire to be the wise men and women who can see the immediate future (Cavafy does not believe that even wise men can see the distant future) and the demand for such seers is high when the times are troubled as they are now. Economists are often in particular demand because they claim they can tell the shape of future demand and supply, unemployment and growth. To do that they resort to models that through behavioral equations and identities, show the future evolution of key variables and pretend to predict how long the depression will last and how quick and strong the recovery will be.

            My argument is that such models are useless under today’s conditions. There are several reasons for that.

All economic models, by definition, take the economy as a self-contained system which is exposed  to economic shocks, whether in form of more or less relaxed monetary policy, higher or lower taxes, higher or lower minimum wage etc. They cannot by their very nature take into account extra-economic discrete shocks. Such shocks are simply not predictable. One cannot tell today whether China might invade Hong Kong, or whether Trump might ban all imports from China, or whether the race riots in the US can continue for months, or similar riots break out elsewhere in the world (Latin America, Africa, Indonesia) or even if the US may not end this year with a military government in charge.

All of these social and political shocks that I have listed are due to, or have been exacerbated, by the pandemic. There is little doubt that the “most important relationship” (to quote Henry Kissinger), the one between China and the United States, has significantly deteriorated because of the pandemic. Some in the United States see the pandemic as intentionally engineered by China to weaken the US economy and its president. There is also little doubt that the differential reactions, between the countries, in countering the pandemic have either destabilized domestic political situations (Brazil, United States, Hungary, Great Britain) or changed the relative correlation of global economic and political power (most notably between the US and China).

            It is therefore utterly wrong to believe that history does not matter and that the social and political changes wrought by the pandemic can be ignored so that, if the pandemic is miraculously over in December 2020, December 2020 will be just like December 2019 with a twelve-month lag. Not at all: even if the pandemic is over by then, December 2020 will be entirely different than  December 2019, and the political forces that these twelve months will have set in motion—and which we currently cannot predict—will fundamentally affect how economies behave in the future.

            With covid-19 we are facing a situation that (with the exception of the two world wars) has no precedent. This, in two respects: the global nature of the problem, and its open-ended,  uncontrollable nature. This pandemic, unlike the most recent other pandemics (SARS, MERS, swine flu) is truly global. It has affected almost all territories in the world. Compared to the previous economic crises, its global nature also stands out. Whether we think of the debt crisis of the 1980s, the crisis faced by post-communist economies in the 1990s, the 1998 Asian financial crisis, or even the Great Recession, they were all regionally contained crises. To be sure, there were spillovers, but we could essentially, in our assessment or prediction of global affairs, place the countries that were most affected between the brackets (so to speak) and look at the rest of the world using the standard economic approach. We cannot do that now when the entire world is affected.

            The second feature of today’s situation is its open-ended nature: no one knows when the pandemic will end, how it will affect different countries, and even whether thinking of a sharp and clear end to the pandemic makes sense at all. In fact, we may live for years with stop-and-go policies where movements to open up the economy are followed by increased flare-ups of the infection, and then new closures and lockdowns. We also have no idea not only what countries and continents would be hit next by the pandemic and whether there would be a second wave, but we cannot at all predict how successful individual countries will be in curbing it.  No one could have predicted that a country with the highest health expenditures per capita in the world, and with hundreds of universities that sport public health  departments and publish probably thousands of scientific papers annually, would totally fail in the control of the pandemic and have the highest number of cases and fatalities. Similarly very few would have predicted that the UK, with its fabled NHS, would lead Europe in the number of deaths. Or that modestly wealthy Vietnam would have zero deaths from the pandemic.

            Similar unknowns abound. These are not one-level unknowns, but unknowns at three or four dimensions.  The future geographic spread of the pandemic is unknown (will it severely hit Africa?), the reactions of countries, as we have just seen, are equally impossible to predict (how successful may be India? Will China stop the second wave?), and perhaps most importantly the social and political consequences are unknown. They may turn out to be, as I argued in March 2020 article in Foreign Affairs, the most nefarious long-term product of the pandemic with obvious effects on global recovery.

            There are only a few things—the same ones that I  mentioned in mid-March—that we can, with some dose of confidence, predict:
1. aggravation of the conflict between the US and China with China being “upgraded” to the status of “challenger”;
2. tendency toward greater state role in many countries;
3. set-back for globalization, in terms of ability of people to travel internationally and capital to move across borders (driven in part by political uncertainties); and
4. increasing political instability both internally and globally.

            This crisis is like “the warrior that leaves devastation in its stead”, and to make projections assuming that none of that devastation has occurred, and even if has occurred, that it will have no impact on future functioning of the economy is simply wrong. We  have to admit that there are limits to our ability to tell the future: we are not “Gods that are totally enlightened".