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Showing posts with label scenario. Show all posts
Showing posts with label scenario. Show all posts

Friday 17 February 2023

Unreliable Macroeconomic Forecasts and Corporate Business Plans

Anne-Sylvaine Chassany in The FT


Top Ikea executive Jesper Brodin says he is not usually one to indulge in nostalgia. But at a pre-Christmas gathering for senior managers that used to work at the Swedish furniture group, he could not help but join with the chorus of those who said they missed the old times — when the world seemed relatively stable, trends were predictable and this could be translated into a more or less credible multiyear business plan. 

“We always debate whether it was better before. I used to always argue it is better now. This time we tended to agree it was better before,” he said. “The risks, the uncertainty, everything that used to be in a ‘risk matrix file’ is more or less happening . . . We laugh about the time when we were doing one-year budgets, and how we would be right or wrong by 0.3 per cent.” 

Brodin’s reflections resonate across the corporate world. CEOs are struggling to make sense of confusing macroeconomic signals. In Europe and the US, an economic downturn is combined with record low unemployment and labour shortages. Consumer behaviour is a mystery: up until recently people have kept spending even though the price of almost everything has gone up. 

The worst predictions of economic crisis and energy shortages from last year have not materialised. But it feels uniquely hard to predict the path ahead at the moment. On both sides of the Atlantic, little consensus is heard about where the economy is going, and for listed businesses, delivering guidance to the market is more difficult than ever. In the UK, auditing firms worry that the forecasts their corporate clients submit to them for sign-off are impossible to assess. 

In the game of adjusting to these new forms of chaos, some are better placed than others. Generally pressure is less on privately owned companies that do not have to publish profit targets. 

Ikea, for instance, has changed tack. Instead of setting out specific goals for the year, it has a set of “scenarios” to give the business wiggle room as the outlook changes. It means acknowledging that widely different outcomes are possible. “It’s teaching us agility in how we operate,” said Brodin. 

A year ago, the 54-year-old firm expected customers to cut spending because of high energy bills and mortgage rates. That did not happen. Meanwhile, supply chain disruptions improved more quickly than anticipated, leaving the group with more inventory and, in turn, the need to lower the prices of some of its products. 

“We are celebrating that things are going in the right direction,” said Brodin, “but we have no concept of predicting with precision what’s going to happen in 6 to 12 months.” 

For Ikea, input costs are the trickiest to forecast. Transport prices have fallen. But Brodin did not expect that greater demand for wood to burn as fuel would make some of the company’s materials more expensive. 

It is not just the traditional variables of financial modelling such as inflation and consumer spending that have become harder to predict. The past few years have also provided some unexpected lessons on how business and society cope with shocks and uncertainty. 

“Look at what people have gone through: the pandemic, the economic damage, the tragedy of war, energy prices,” Brodin said. “What people might have underestimated is human resilience.”

Monday 6 July 2020

This pandemic has exposed the uselessness of orthodox economics

Post Covid-19, our priority should be to build resilient systems explicitly designed to withstand worst-case scenarios opines Jonathan Aldred in The Guardian 

 
‘Framing the future in terms of probabilities gives us the illusion of knowledge and control, which is extraordinarily tempting, but it’s all hubris.’ Photograph: Daniel Sorabji/AFP via Getty Images


Even before the pandemic came along, the world economy faced a set of deepening crises: a climate emergency, extreme inequality and huge disruption to the world of work, with robots and AI systems replacing humans.

Conventional economic theories have had little to offer. On the contrary, they have acted like a cage around our thinking, vetoing a range of progressive policy ideas as unaffordable, counter-productive, incompatible with free markets, and so on. Worse than that, economics has led us, in a subtle, insidious way, to internalise a set of values and ways of seeing the world that prevents us even imagining various forms of radical change.

Since economic orthodoxy is so completely embedded in our thinking, escape from it demands more than a short-term spending splurge to prevent immediate economic collapse, vital though that is. We must dig deeper to uncover the economic roots of the mess we’re in. Putting it more positively, what do we want from post-coronavirus economics?

Mainstream economics has taught us that the only rational way to deal with an uncertain future is to quantify it, by assigning a probability to every possibility. But even with the best expertise in the world, our knowledge often falls far short. Frequently we struggle to predict which outcomes are more likely. Worse still, there may be outcomes we haven’t even considered, futures that no one had imagined, as the pandemic has so vividly shown.

Framing the future in terms of probabilities gives us the illusion of knowledge and control, which is extraordinarily tempting, but it’s all hubris. In the run-up to the 2007 financial crisis, bankers were proud of their models. Then that August, the Goldman Sachs chief financial officer admitted the bank had spotted huge price moves in some financial markets, several times in one week. Yet according to its models, each of these moves was supposed to be less likely than winning the UK national lottery jackpot 21 times in a row. World events sometimes demand humility.

There are clear lessons here for how to address the climate emergency: rather than focusing on the average climate impacts predicted by mathematical models that depend on probabilistic knowledge that is highly unreliable, we must think seriously about worst-case scenarios, and take steps to avoid them. Yet economic orthodoxy pushes us away from precautionary action. If mainstream economics has a single overarching objective or principle, it is efficiency.

Efficiency means getting the most “bang for your buck”, the most benefit for every pound spent. Any other course of action is wasteful, surely? But eliminating waste implies eliminating excess capacity, and we now see the consequences of that in health systems worldwide. Our obsession with efficiency, if it means failing to plan for a pandemic or a climate emergency, will cost lives.

Our priority should be resilience, not efficiency. We need to build resilient systems and economies that are explicitly designed to withstand worst-case scenarios – and have a fighting chance of coping with unforeseen disasters too.

Ultimately the problem with economic orthodoxy lies in how it frames our values and priorities. Decisions must always be about trade-offs – the weighing up of costs against benefits, ideally measured through prices in markets. If we take our ignorance about the future seriously, this cost-benefit calculus should not even get started. Because costs outweighing benefits is the oldest excuse for not taking precautions – and is a recipe for disaster when the benefits, or the costs of inaction, are vastly undervalued.

Cost-benefit thinking also leads us to assume that all values can be expressed in monetary terms. Many politicians and business leaders fixate on statements such as “a 2°C rise in average global temperature will reduce GDP by up to 2%”, as though a fall in GDP measures the true costs of the climate emergency.

In practice, this thinking means that the value of everything is measured by how much people offer to pay for it. Since the rich can always pay more than the poor, priorities get skewed towards the desires of the rich, away from the needs of the poor. So more money is spent on R&D for anti-wrinkle creams than for malaria treatments. Big Pharma has been relatively uninterested in developing vaccines, because a vaccination programme only works if the poor get vaccinated too, which limits the price manufacturers can charge.

We might seem to be beyond that now: the world has woken up, and rich countries will spend “whatever it takes” to tackle the pandemic. But Covid 19 vaccine research – and countless other fields of medical research with the potential to save as many lives in the long-term – needs continuous, reliable funding over many years. Once the market sees better profit elsewhere, funding will be cut, and the researchers will retire or move on, their experience lost.

Economic orthodoxy supports the narrative that this pandemic is a unique disaster no one could have prepared for, and with no wider lessons for economics and politics. This story suits some of the world’s billionaires, but it’s not true. There is an alternative: the pandemic provides further evidence that to tackle the climate emergency, inequality and any emerging crises, we must re-think our economics from the bottom up.

Saturday 24 November 2018

Why good forecasters become better people

Tim Harford in The FT

So, what’s going to happen next, eh? Hard to say: the future has a lotta ins, a lotta outs, a lotta what-have-yous. 

Perhaps I should be more willing to make bold forecasts. I see my peers forecasting all kinds of things with a confidence that only seems to add to their credibility. Bad forecasts are usually forgotten and you can milk a spectacular success for years. 

Yet forecasts are the junk food of political and economic analysis: tasty to consume but neither satisfying nor healthy in the long run. So why should they be any more wholesome to produce? The answer, it seems, is that those who habitually make forecasts may turn into better people. That is the conclusion suggested by a research paper from three psychologists, Barbara Mellers, Philip Tetlock and Hal Arkes. 

Prof Tetlock won attention for his 2005 book Expert Political Judgment, which used the simple method of asking a few hundred experts to make specific, time-limited forecasts such as “Will Italy’s government debt/GDP ratio be between 70 and 90 per cent in December 1998?” or “Will Saddam Hussein be the president of Iraq on Dec 31 2002?” 

It is only a modest oversimplification to summarise Prof Tetlock’s results using the late William Goldman’s aphorism: nobody knows anything

Yet Profs Mellers, Tetlock and Don Moore then ran a larger forecasting tournament and discovered that a small number of people seem to be able to forecast better than the rest of us. These so-called superforecasters are not necessarily subject-matter experts, but they tend to be proactively open-minded, always looking for contrary evidence or opinions. 

There are certain mental virtues, then, that make people better forecasters. The new research turns the question around: might trying to become a better forecaster strengthen such mental virtues? In particular, might it make us less polarised in our political views? 

Of course there is nothing particularly virtuous about many of the forecasts we make, which are often pure bluff, attention-seeking or cheerleading. “We are going to make America so great again” (Donald Trump, February 2016); “There will be no downside to Brexit, only a considerable upside” ( David Davis, October 2016); “If this exit poll is right . . . I will publicly eat my hat” (Paddy Ashdown, May 2015). These may all be statements about the future, but it seems reasonable to say that they were never really intended as forecasts. 

A forecasting tournament, on the other hand, rewards a good-faith effort at getting the answer right. A serious forecaster will soon be confronted by the gaps in his or her knowledge. In 2002, psychologists Leonid Rozenblit and Frank Keil coined the phrase “the illusion of explanatory depth”. If you ask people to explain how a flush lavatory actually works (or a helicopter, or a sewing machine) they will quickly find it is hard to explain beyond hand-waving. Most parents discover this when faced by questions from curious children. 

Yet subsequent work has shown that asking people to explain how the US Affordable Care Act or the European Single Market work prompts some humility and, with it, political moderation. It seems plausible that thoughtful forecasting has a similar effect. 

Good forecasters are obliged to consider different scenarios. Few prospects in a forecasting tournament are certainties. A forecaster may believe that parliament is likely to reject the deal the UK has negotiated with the EU, but he or she must seriously evaluate the alternative. Under which circumstances might parliament accept the deal instead? Again, pondering alternative scenarios and viewpoints has been shown to reduce our natural overconfidence. 

My own experience with scenario planning — a very different type of futurology than a forecasting tournament — suggests another benefit of exploring the future. If the issue at hand is contentious, it can feel safer and less confrontational to talk about future possibilities than to argue about the present. 

It may not be so surprising, then, that Profs Mellers, Tetlock and Arkes found that forecasting reduces political polarisation. They recruited people to participate in a multi-month forecasting tournament, then randomly assigned some to the tournament and some to a non-forecasting control group. (A sample question: “Will President Trump announce that the US will pull out of the Trans-Pacific Partnership during the first 100 days of his administration?”) 

At the end of the experiment, the forecasters had moderated their views on a variety of policy domains. They also tempered their inclination to presume the opposite side was packed with extremists. Forecasting, it seems, is an antidote to political tribalism. 

Of course, centrism is not always a virtue and, if forecasting tournaments are a cure for tribalism, then they are a course of treatment that lasts months. Yet the research is a reminder that not all forecasters are blowhards and bluffers. Thinking seriously about the future requires keeping an open mind, understanding what you don’t know, and seeing things as others see them. If the end result is a good forecast, perhaps we should see that as the icing on the cake.

Saturday 25 June 2016

Likely Scenarios after the Brexit vote?



By Girish Menon

Now that a majority of Britons have voted to leave the EU, Nigel Farage has denied his claim to fund the NHS, David Cameron has resigned and the markets have fallen; so what happens next?

Scenario 1: The Status Quo

The Conservative party will elect a leader who will try to develop a national consensus on the EU. . S/he will then embark on negotiations with the EU and this time the spooked EU leaders will concede enough to make a difference. S/he will conduct another referendum in 1-2 years time and the UK will continue to be a part of the EU.

Scenario 2: The Nightmare

True Eurosceptics with strong neoliberal leanings will come to power. They will fan xenophobic forces to mask the budget cuts to public services. They will negotiate trade deals from a weak position, dilute workers' rights and help their rich funders convert England into another Russia.

Scenario 3: The Ideal

There will be intense and honest soul searching across the EU. A realisation will dawn that inequality is the major cause for the rise of fissiparous forces. The EU will become a transparent organisation with accountability. It will ensure a Universal and Unconditional Basic Income, Free Education, Free Health and subsidised Housing for all its citizens.


There could be many more scenarios which will be variations on the above themes. I hope the EU will choose scenario 3 but as a betting man I think it will choose scenario 1. The case for scenario 1 becomes stronger as the government is in no hurry to invoke Clause 50 which is the next step to start the Brexit negotiation and Boris Johnson appears subdued after the victory.