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Failure of economic theories

by David Howell

“Economics in crisis” is the latest theme exciting journalists and commentators on both sides of the Atlantic as they contemplate the performance of the economic forecasting profession during 2016.

This performance has certainly not been happy. First the economists, or most of them, predicted dire consequences following the Brexit vote by the United Kingdom, none of which have so far materialized. Then they predicted even greater disasters following the Trump victory in the United States, but these, too, have so far failed to appear.

On the contrary, both the U.K. and the U.S. economies are performing well. Stock markets in New York and London are bounding ahead, unemployment is low, economic growth is picking up, and in the U.K.’s case the fastest by far in Europe. The pound sterling took a hit, but buoyant trading seems to be overcoming this.

Of course, there is nothing new at all about economic forecasts either being plain wrong or just failing entirely to foresee what was coming. After the worldwide “Lehman shock” financial crash of 2008, the British queen spoke for millions when she asked plaintively why almost no one saw it in advance.

Far from being a new story, the inadequacy of economic theories, or at least macroeconomic concepts, to explain the world or foresee disruption has been blindingly obvious, and indeed well-analyzed and documented in many books, although admittedly not so much by mainstream economists. The simple fact is that with the rise of the digital age, with its swelling floods of information and data, its computer-driven high frequency trading, its crowd empowerment and its mass global connectivity, there is no toolkit available to human beings to be able to assemble and control economic events effectively.

The economic aggregates invented in the first half of the last century — largely by Lord Keynes — such as final demand, overall investment, gross domestic product and many others — have all long since become impossible to measure, let alone control, by the monetary and fiscal instruments that seemed so powerful and direct in Keynes’ day. The levers that once seemed to give central policymakers so much power to steer their respective economies have long since become disconnected. Up to the 1970s they seemed to work roughly, but with the onset of the information revolution, and the thousandfold growth (still continuing) in the capacity of the humble microchip, it is markets, with all their volatility and unpredictability, that have taken over.

In the digital age a novel world of commerce has emerged of two kinds. At one level we have people trading as individuals and small companies in their millions on a scale never seen before. At another level the global information giants of the age dominate — Google, Apple, Facebook , Twitter come to mind — all larger than any one country can control.

The result is that from central bankers and finance ministries downward, steering through the fog of shifting market data has become more and more a matter for guesstimates, and increasingly often the guesses are wrong. No central authority is any longer capable of collecting, measuring and then controlling with any precision the constantly changing and swelling floods of information available.

An illustration of the new impossibilities of top-down government management comes from the noneconomic world. For decades past policymakers and politicians have been mesmerized by opinion polls that are supposed to measure what the public wants and feels. But now the pollsters, like the economists, are finding their forecasts turning out spectacularly wrong. Their slender and static “snapshot” samples and estimates simply fail to pick up the sheer diversity, complexity and volatility of public opinion in the era of digital empowerment . “Opinion,” like economic activity, has become too diverse, too widely spread and too fluid to be gathered or intelligibly interpreted.

Thus it is not just the economic aggregates, but some of the key political assumptions of our times which turn out to have no substance. In the U.K. there is a hot debate about whether the country should be “in” or “out” of the European Union’s much vaunted single market. But with modern trade being increasingly in the form of “borderless production,” or of big data and information transmissions of countless varieties that know almost no frontiers at all, can any old-style protected market, whether in goods or services, really be sustained? And if not, how much does it matter whether exporters and traders are in or out of it?

To take another example, commentators solemnly debate whether globalization is a good or bad thing. Yet there is no possible way of halting what is in effect the onward march of technology and human ingenuity. It cannot conceivably be measured nor is it under the control of any authority or nation. Some industries will go up, some sadly down. Governments can and must step in to care and cope for those disadvantaged. But they are in reality spectators of processes and trends that none can predict and that no statistics can explain.

And where data and facts about the world become either unreliable and misleading or unascertainable, a new phenomenon steps into the vacuum. Enter the age of fake facts, bogus statistics and dud forecasts to add to the confusion. Already America seems to be gripped by this development, and you can be sure it will spread rapidly through the global connectivity system.

Are there any answers to this kind of digital Wild West that seems to be taking over? The answer is yes, but they will require entirely new governmental mindsets and methods if societies are to be provided with the reassuring framework of law, stability and security necessary for their survival, cohesion and progress.

But that, as they say, is another story.

David Howell is a British Conservative politician, journalist and economic consultant.