This EU Won't Work

How professional forecasters attempt to influence politics in their own interest.

We can learn a lot from history, good and bad. It can teach us how to do things better in future; it can illuminate what lay behind the good outcomes, such as the benefits that have flowed from democracy; it can warn us of dangers; but it can’t predict when the next war will happen. Indeed, while we can make intelligent guesses about what may happen, based on our knowledge of history, historians themselves don’t make predictions (as historians). Although economics is similarly based on historical analysis, economists have invented all sorts of models (not necessarily consistent) that persuade them to make predictions. Forecasts by the Treasury, the Bank of England and the IMF of the effect of a Leave vote in the 2016 Referendum were plain wrong—and no, it’s not too soon to judge, the predictions were of the immediate effects.

Stung by criticism of political bias Mark Carney, the Bank’s governor, in his latest testimony to Parliament’s Treasury Select Committee said that its results were scenarios rather than forecasts and that the negative effect on GDP of no deal had reduced because of preparations made since last year. The ‘worst case’ scenario was now -5.5%, down from -8.0% last November and a delay to the exit could help limit the damage further. How much more would the worst case have been limited if Chancellor Hammond had not prevented preparations before he was kicked out? What other cases did the Bank model and why don’t we hear about the less pessimistic ones?

Research at a Swedish University shows that institutions that believe they have most to lose from Brexit produce more dire forecasts than those less affected. The former predicted UK GDP for the year following a Leave vote would grow by 0.5% against the latter’s 1.3% (it actually grew by 1.7%). We have seen this sort of thing often from tobacco and pharmaceutical companies, where those who sponsor the research influence the outcome. Data may be interpreted in different ways and the researchers may want to please their paymasters or be pressured into it. This is from the paper’s introduction:

“Several issues of great economic relevance have recently been addressed using referenda: the referendum held in the United Kingdom to leave the European Union, the referendum held in Greece on the agreements with the EU institutions to solve the debt crisis, the referendum held in Italy on a major change to the national Constitution, and the referendum held in Catalonia on the independence from Spain. Many of the debates leading up to those referenda focused on the potential effects on economic growth, using estimates published by professional macroeconomic forecasters. Economic forecasts can be easily communicated to and understood by voters even if advanced competence, modelling and equipment are required to produce a forecast. Voters can use the forecasts to obtain information about economic variables, such as GDP growth, before turning to the ballot. In many public debates, economic forecasts are taken as a given, without considering that the institutions publishing the forecasts may be promoting their own interests.” (our emphasis)

The paper can be downloaded here: https://uu.diva-portal.org/smash/get/diva2:1296155/FULLTEXT01.pdf

These biased forecasts may cause households, businesses and governments to make wrong decisions, they could even be self-fulfilling. Business confidence has been harmed by continuing Brexit uncertainty, if it were settled they could make appropriate decisions rather than postpone them.

The US-China tariff battle is depressing world trade, it is already seriously affecting the EU’s powerhouse economy, Germany, but no doubt many will blame Brexit for all the effects on the UK economy.

Place Your Bets

We have previously predicted the collapse of the Union but, of course, we haven’t said when it will happen. So are we disagreeing with our own case (above)? Not really, because it’s not in our interest for it to survive or to collapse, certainly not while the UK is inside, but if we were gamblers we would bet heavily on radical change to the eurozone and consequently to the EU itself, a split being the most likely. This is because it doesn’t seem possible that Italy can escape from its dire economic situation without debt forgiveness, default or a fiscal union. All of these solutions would require bailouts of Italy and others (Greece obviously) paid for by Germany, Holland and Scandinavia, and possibly the UK if we remain in the Union! Enthusiasm for the EU is unlikely to be great enough to keep all of these countries behind the project and despite the example of Brexit others will rush for the fire exit—and they probably won’t have a May-like leader to ruin their exits, they will have learnt.

We don’t know how long the ECB can keep the plates spinning but its incoming president has a poor record for finding creative solutions and her predecessor’s fixes have just about been worked to their deaths. Mario Draghi, the bank’s current head, is likely to reduce interest rates further (they are already at -4%) which will devalue the euro and probably cause retaliation by Trump, perhaps the long-threatened tariff increases. In any event negative interest rates squeeze banks which are already in trouble in Germany as well as in Italy and other EU countries.

So what are the real gamblers doing? Markets are telling us how they see the next few decades, not that they are fool-proof either but they are gambling their own money rather than other people’s as central banks do. Parking cash in a safe harbour like the Bundesbank actually costs money and longer term loans have lower returns than shorter ones, called an interest-rate inversion. This shows that punters believe that market conditions are going to be bad and they would rather lose a known and manageable amount of money than risk losing lots. In such a difficult climate how can Italians ever afford to pay what they owe Germans? (And it would be Italians, not Italy’s central bank, that would be expected to find the money.) Maybe something will turn up, but would you bet on it?