A level Economics: How to Improve Economic Forecasting

 Nicholas Gruen in The FT 

Today’s four-day weather forecasts are as accurate as one-day forecasts were 30 years ago. Economic forecasts, on the other hand, aren’t noticeably better. Former Federal Reserve chair Ben Bernanke should ponder this in his forthcoming review of the Bank of England’s forecasting. 

There’s growing evidence that we can improve. But myopia and complacency get in the way. Myopia is an issue because economists think technical expertise is the essence of good forecasting when, actually, two things matter more: forecasters’ understanding of the limits of their expertise and their judgment in handling those limits. 

Enter Philip Tetlock, whose 2005 book on geopolitical forecasting showed how little experts added to forecasting done by informed non-experts. To compare forecasts between the two groups, he forced participants to drop their vague weasel words — “probably”, “can’t be ruled out” — and specify exactly what they were forecasting and with what probability.  

That started sorting the sheep from the goats. The simple “point forecasts” provided by economists — such as “growth will be 3.0 per cent” — are doubly unhelpful in this regard. They’re silent about what success looks like. If I have forecast 3.0 per cent growth and actual growth comes in at 3.2 per cent — did I succeed or fail? Such predictions also don’t tell us how confident the forecaster is. 

By contrast, “a 70 per cent chance of rain” specifies a clear event with a precise estimation of the weather forecaster’s confidence. Having rigorously specified the rules of the game, Tetlock has since shown how what he calls “superforecasting” is possible and how diverse teams of superforecasters do even better.  

What qualities does Tetlock see in superforecasters? As well as mastering necessary formal techniques, they’re open-minded, careful, curious and self-critical — in other words, they’re not complacent. Aware, like Socrates, of how little they know, they’re constantly seeking to learn — from unfolding events and from colleagues. 

Superforecasters actively resist the pull to groupthink, which is never far away in most organisations — or indeed, in the profession of economics as a whole, as practitioners compensate for their ignorance by keeping close to the herd. The global financial crisis is just one example of an event that economists collectively failed to warn the world about. 

There are just five pages referencing superforecasting on the entire Bank of England website — though that’s more than other central banks. 

Bernanke could recommend that we finally set about the search for economic superforecasters. He should also propose that the BoE lead the world by open sourcing economic forecasting.  

In this scenario, all models used would be released fully documented and a “prediction tournament” would focus on the key forecasts. Outsiders would be encouraged to enter the tournament — offering their own forecasts, their own models and their own reconfiguration or re-parameterisation of the BoE’s models. Prizes could be offered for the best teams and the best schools and universities.  

The BoE’s forecasting team(s) should also compete. The BoE could then release its official forecasts using the work it has the most confidence in, whether it is that of its own team(s), outsiders or some hybrid option. Over time, we’d be able to identify which ones were consistently better.  

Using this formula, I predict that the Bank of England’s official forecasts would find their way towards the top of the class — in the UK, and the world.

A Level Economics 47: Privatisation

Privatisation refers to the transfer of ownership and control of government-owned or public-sector enterprises to private ownership. It involves the sale or transfer of shares or assets of state-owned enterprises (SOEs) to private investors or companies.

Justification for Privatisation: Governments undertake privatisation for various reasons, with the primary justifications being:

1. Efficiency: Privatisation is often pursued to improve the efficiency and performance of formerly state-owned enterprises. Private firms are typically driven by profit motives and have a strong incentive to reduce costs, improve productivity, and innovate to remain competitive.

2. Reducing Government Debt: Selling state-owned assets can generate significant revenue for the government, which can be used to reduce public debt or fund critical projects.

3. Enhancing Competition: Privatisation can introduce competition in previously monopolistic sectors, leading to lower prices, better services, and increased choices for consumers.

4. Focus on Core Functions: Privatisation allows governments to focus on their core functions, such as regulatory oversight and providing essential public services, while leaving commercial activities to private firms.

5. Encouraging Investment: Privatisation attracts private investment and expertise, leading to capital inflows and potential technological advancements.

6. Fiscal Discipline: Private firms are subject to market forces and must maintain fiscal discipline to remain profitable, unlike some SOEs that may receive continuous financial support from the government.

Types of Privatisation: Privatisation can take various forms, depending on the level of ownership transferred and the nature of the transaction. Some common types of privatisation include:

1. Asset Privatisation: In asset privatisation, the government sells specific assets or business units of a public-sector enterprise to private investors. For example, the government may sell a state-owned power plant or a telecommunications tower to a private company.

2. Equity Privatisation: Equity privatisation involves selling shares of a state-owned enterprise to private investors through an initial public offering (IPO) or stock exchange listings. The government may retain partial ownership or sell its entire stake in the enterprise.

Example: In 1987, the British government privatised British Airways by selling 51% of its shares to private investors, and the remaining 49% was floated on the London Stock Exchange. This allowed private investors to have ownership and influence over the airline's operations.

3. Full Privatisation: Full privatisation refers to the complete transfer of ownership and control of a public-sector enterprise to private investors. The government no longer holds any stake in the company.

Example: The privatisation of British Telecom (BT) in 1984 involved full privatisation, as the government sold all its shares in the company, transforming it into a private telecommunications company.

4. Partial Privatisation: In partial privatisation, the government retains some ownership in the company while selling a portion to private investors.

Example: The partial privatisation of Japan Post Holdings Corporation in 2015 involved the sale of a minority stake to private investors while the Japanese government maintained majority ownership.

5. Contractual Privatisation: In contractual privatisation, the government outsources specific services or functions of a public-sector enterprise to private firms through contracts.

Example: Local governments often contract private waste management companies to handle garbage collection and disposal services.

6. Management Buyouts: In management buyouts, the existing management team of a public-sector enterprise purchases the company from the government, converting it into a privately-owned entity.

Example: In 1987, British Aerospace (BAe) was privatised through a management buyout, with its management team acquiring ownership from the British government.

In summary, privatisation is pursued to improve efficiency, reduce government debt, introduce competition, encourage investment, and focus on core functions. The types of privatisation can vary based on the extent of ownership transferred and the method of sale or transfer. However, the decision to privatise remains subject to careful consideration of the economic, social, and political implications in each specific case.

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The privatisation initiatives in the UK, which began in the 1980s under Prime Minister Margaret Thatcher, aimed to achieve various objectives, including improving efficiency, promoting competition, reducing government debt, and encouraging private sector investment. Let's evaluate whether privatisation has lived up to these objectives by considering some key examples:

1. Efficiency and Performance: Objective: Privatisation was expected to make formerly state-owned enterprises more efficient and competitive due to profit-driven management.

Example: British Telecom (BT) was privatised in 1984, and it did lead to improvements in efficiency and service quality. BT invested in new technologies, expanded its services, and became a leader in telecommunications.

Evaluation: In some cases, privatisation led to improved efficiency and performance, as seen with BT. However, there were instances where privatisation did not result in significant efficiency gains, such as the rail industry, where concerns about costs and service quality persisted.

2. Competition: Objective: Privatisation was intended to introduce competition in previously monopolistic industries, leading to lower prices and better services for consumers.

Example: The privatisation of British Gas in 1986 aimed to increase competition in the gas supply market.

Evaluation: While privatisation initially increased competition in some sectors, concerns arose over the consolidation of private firms, leading to oligopolistic markets. In the case of British Gas, the industry eventually faced criticism for lacking competition, with the government taking steps to promote more competition in the energy sector.

3. Reducing Government Debt: Objective: The sale of state-owned assets was expected to generate revenue that could be used to reduce public debt.

Example: The privatisation of various public-sector enterprises, including British Telecom, British Gas, and British Airways, aimed to raise funds for the government.

Evaluation: Privatisation did generate significant revenue for the UK government, helping to reduce public debt to some extent. However, critics argued that the sale of profitable assets might have resulted in the loss of potential future revenue streams for the government.

4. Encouraging Private Investment: Objective: Privatisation aimed to attract private investment and expertise into various industries.

Example: The privatisation of ports and airports, such as the Port of Southampton and London Gatwick Airport, sought to attract private investment and modernize infrastructure.

Evaluation: In some cases, privatisation succeeded in attracting private investment and fostering innovation. For instance, London Gatwick Airport saw significant investments in infrastructure and services after privatisation.

5. Focus on Core Functions: Objective: Privatisation intended to allow the government to focus on essential public services while leaving commercial activities to private firms.

Example: The privatisation of various industries, such as steel and coal mining, aimed to reduce the government's involvement in commercial enterprises.

Evaluation: Privatisation did enable the government to focus on core functions, but it also raised concerns about the loss of direct control over strategic industries and the potential impact on certain communities and regions.

In conclusion, the evaluation of privatisation in the UK shows a mixed picture. While privatisation led to some successes in terms of efficiency improvements, competition, and private investment, it also faced challenges and criticisms. The outcomes varied across industries, and some privatisations achieved their objectives more effectively than others. Critics raised concerns about market consolidation, the loss of public ownership, and the potential impact on services and consumers. Overall, the effectiveness of privatisation depends on the specific context, industry dynamics, and the government's ability to strike a balance between achieving objectives and addressing potential drawbacks.

A Level Economics 46: The Role of Regulatory/Competition Authority

Competition authorities and regulators play a crucial role in promoting competition and contestability in non-perfectly competitive markets. They use various tools and interventions to address market distortions, protect consumers, and create a level playing field for businesses. Here are some ways competition authorities and regulators promote competition in non-perfectly competitive markets, along with examples to illustrate their impact:

1. Antitrust Enforcement: Competition authorities enforce antitrust laws to prevent anti-competitive practices, such as collusion, price-fixing, and abuse of dominant market positions. They investigate and take legal action against firms engaging in these behaviors to ensure fair competition.

Example: The European Commission fined Google €2.42 billion in 2017 for promoting its own shopping comparison service in search results and demoting competitors, violating EU antitrust rules. This action aimed to restore competition and give fair visibility to rival comparison shopping services.

2. Merger Control: Competition authorities review mergers and acquisitions to prevent the creation of dominant market positions that could stifle competition. They assess whether mergers are likely to harm competition and impose conditions or block mergers if necessary.

Example: In 2018, the U.S. Department of Justice (DOJ) filed a lawsuit to block AT&T's acquisition of Time Warner, citing potential harm to competition in the media and entertainment industry. The court-approved the merger only after significant divestitures and behavioral commitments were made to maintain competition.

3. Market Studies and Reports: Competition authorities conduct market studies to identify barriers to entry, anti-competitive practices, and market inefficiencies. These studies inform policymakers and regulators, leading to targeted interventions to enhance competition.

Example: The UK's Competition and Markets Authority (CMA) conducted a market study of the online platforms and digital advertising market in 2019. The study revealed concerns about the market power of large platforms and led to proposals for a Digital Markets Unit to enforce a new code of conduct and promote competition.

4. Consumer Protection Measures: Competition authorities protect consumers by ensuring businesses provide accurate information, fair contracts, and quality products. They may penalize firms for false advertising or unfair trading practices.

Example: The Federal Trade Commission (FTC) in the U.S. has taken action against companies making false claims about health products, deceptive advertising, or unfair billing practices, aiming to protect consumers from misleading information and scams.

5. Price Regulation: In some industries, regulators may impose price controls or regulate profit margins to prevent monopolistic pricing and ensure affordable access to essential goods and services.

Example: In healthcare, governments or regulatory bodies may regulate drug prices or set price ceilings for medical services to prevent excessive pricing and ensure accessibility to healthcare for all citizens.

6. Promoting Market Entry and Contestability: Competition authorities may encourage the entry of new firms into the market to increase competition. They may also promote contestability by removing barriers to entry and fostering innovation.

Example: In the telecommunications industry, regulators may allocate spectrum licenses to new entrants to encourage competition and introduce new technologies, leading to improved services and lower prices for consumers.

In conclusion, competition authorities and regulators actively promote competition and contestability in non-perfectly competitive markets through antitrust enforcement, merger control, market studies, consumer protection measures, price regulation, and measures to enhance market entry and contestability. Their interventions aim to create competitive markets that benefit consumers, encourage innovation, and promote economic growth while safeguarding against anti-competitive practices. 

A Level Economics 45: The Need for a Competition Policy

The need for a competition policy arises from the recognition that while free markets can be efficient and effective in resource allocation, they may not always operate optimally. Here are some reasons why the free market principle can fail, leading to the necessity of competition policies:

1. Market Failures: Free markets may encounter various market failures that prevent them from achieving allocative efficiency and promoting consumer welfare. Some common market failures include externalities (e.g., pollution), public goods (e.g., national defense), and information asymmetry (e.g., lack of information for consumers). Competition policies can help address these market failures and correct the inefficiencies they create.

Example: Consider a situation where a manufacturing company releases harmful pollutants into the environment. The free market may not account for the negative externalities imposed on society, resulting in underpricing and overproduction. A competition policy could regulate the company's environmental practices, internalizing the cost of pollution and encouraging cleaner production methods.

2. Monopoly and Market Dominance: In some cases, markets may naturally lead to the emergence of monopolies or dominant firms that have significant market power. These firms can exploit consumers, limit competition, and inhibit innovation. Competition policies aim to prevent and regulate such monopolistic practices to ensure a level playing field for all businesses.

Example: The dominance of a single social media platform may lead to limited competition, allowing the platform to control user data and impose restrictive policies. A competition policy could impose regulations to promote data portability and interoperability, fostering competition and protecting users' rights.

3. Collusion and Anti-Competitive Behavior: Without proper regulations, firms may engage in collusive behavior, cartels, or price-fixing, leading to higher prices and reduced consumer choice. Competition policies seek to prevent collusion and promote fair competition in the market.

Example: In the banking sector, banks might collude to set higher interest rates on loans to maximize profits at the expense of borrowers. A competition policy can enforce laws against such price-fixing practices, promoting a competitive interest rate market.

4. Barriers to Entry: Certain industries may have high barriers to entry, preventing new firms from easily entering the market and competing. This lack of competition can lead to reduced innovation and higher prices for consumers. Competition policies aim to remove or reduce barriers to entry, encouraging new entrants and promoting a competitive environment.

Example: The pharmaceutical industry may have high research and development costs, making it challenging for new companies to introduce generic medications. A competition policy could facilitate the approval process for generic drugs, increasing competition and reducing drug prices.

5. Exploitative Market Power: In the absence of competition policies, firms may exploit their market power to engage in unfair or predatory practices, harming smaller businesses and consumers.

Example: A dominant technology company may require app developers to use its payment system, charging high fees for transactions. A competition policy could investigate and address potential abuse of market power to protect smaller app developers and promote a more competitive app ecosystem.

In conclusion, the failure of the free market principle can lead to various market distortions and inefficiencies. The implementation of competition policies is essential to correct these failures, ensure a fair and competitive environment, and safeguard consumer welfare while promoting innovation and economic growth. By addressing market failures and regulating anti-competitive behavior, competition policies play a vital role in maintaining a balanced and dynamic economy.