Enlightened Economics

Economics for an Enlightened Age

Posts Tagged ‘economists’

• Financial and Economic Modelling – A Waste of Time?

Posted by Ron Robins on May 30, 2011

By Ron Robins. First published April 21, 2011, in his weekly economics and finance column at alrroya.com

“…both risk models and econometric models… are still too simple to capture the full array of governing variables that drive global economic reality,” wrote Alan Greenspan, former chairman of the US Federal Reserve in the Financial Times on March 16, 2008. And if anyone should know about the quality and predictive validity of such models, it would be Mr. Greenspan. Time and again it has been shown that reliance on the predictions from such models is foolhardy.

It was the reliance on, and failure of their predictions, that caused enormous global financial and economic carnage in 2008 and 2009. Yet today dependence on these models seems greater than ever. I suggest our overt focus and use of them is often a wasted effort.

A truth that many modellers and their followers seem to have difficulty accepting is that the past—which most modellers use to prognosticate the future—has frequently been shown to be a poor basis upon which to determine future outcomes. Modellers can continue to refine their models in great detail, and then some unusual event occurs with a one in a million chance of happening—such as the US sub-prime mortgage fiasco—and their models fail. Sadly, the variables which may encompass a one in a million event are numerous. Among them are sudden changes of investor attitudes, weather patterns, geological events, and political and social upheavals.

If we look around today from the sudden movements in sovereign bond markets to the extraordinary weather recently in Australia, to the horrific Japanese earthquake, tsunami and nuclear reactor troubles, to the political upheavals in North Africa and the Middle East—all are kinds of exogenous events that can trash the predictions of the most exacting risk or econometric model.

Furthermore, a ‘perfect’ econometric model would only be possible, metaphorically speaking, if the modeller had ‘the mind of the creator.’ Only then perhaps, could all be known and predicted. Sadly—and I do not mean any disrespect to the modellers—I do not believe that many (if any) of them have that level of intelligence and consciousness at this time. So those constituencies that trust in these models are doomed to suffer continuing disappointments.

Another problem with these models is how to model for human behaviour, as it is both rational and irrational at different and unpredictable times. Therefore, before such modelling can ever hope to fully succeed, it must completely understand human consciousness: who we are, and how and why we act. And the modellers are a long, long way from such an understanding. Incidentally, there is a branch of economics, ‘behavioural economics,’ that is moving in that direction. I wish them good luck with that!

Economists today, unlike those of earlier eras, seem to believe that the only way they can be perceived as legitimate is to be scientifically oriented. Hence their passion for increasingly complex models and their statistician-like orientation.

The type of economic modelling that incorporates mathematics and statistical relationships to economic data, is termed econometrics. Google econometrics and you will probably find over 5,000,000 links. They are largely links to innumerable academics, research institutions, studies, papers and journals. With so much effort put into this field, any independent observer could conclude that econometrics must be a highly successful and seemingly scientific endeavour. It reminds me of the enormous quest for artificial intelligence (AI) to recreate the abilities of the human mind in computers. At least AI is somewhat plausible as it advances the field of computing and robotics which have many, many practical applications that we all know about.

But unlike AI research, economic and econometric models—with their significant variances and failures—have much less to offer society at this time. Mark Thoma, Professor of Economics at the University of Oregon offers these pertinent remarks in his blog, Economist’s View, on February 8. “Much of the uncertainty in economics derives from our inability to do laboratory experiments, and that includes uncertainty about which model best describes the macroeconomy. When the present crisis is finally over, those who advocated fiscal policy, those who advocated monetary policy, and those who advocated no policy at all will all say ‘I told you so’ based upon their reading of the evidence… the answers you get are only as good as the model used to get them, and considerable uncertainty remains over which macroeconomic model is best.”

In the 19th century’s Europe and North America, there were no econometric models (not in the way we know of them today), yet those continents experienced unprecedented economic growth. And the concept of gross domestic product (GDP)—which is usually a top concern in econometric modelling—was not created and used until World War II.

We know that econometric models are unreliable in providing information on how economies behave as well as their projections of future economic activity. Similarly, modelling for financial risk has been shown to be more than problematic and history shows reliance on risk models brings eventual failure and grief.

Therefore, given the facts, we need to be much, much less anxious about trying to create perfect risk and econometric models—and not rely on these models, generally. After all, it was mostly intuition and drive, not decisions based on risk and econometric models that led our greatest inventors, financiers, entrepreneurs and leaders to great success, thereby creating our modern economies.

Copyright alrroya.com

Advertisements

Posted in Economic Measurement, Economics, Finance & Investing, Statistics | Tagged: , , , , , , , , , , | Leave a Comment »

• Eliminate Corporate Taxes and Spur Economic Growth

Posted by Ron Robins on April 12, 2011

By Ron Robins. First published April 7, 2011, in his weekly economics and finance column at alrroya.com

What should overly indebted developed country governments do to spur economic activity and reduce deficits and debt? Should they spend more, or less? Should taxes be increased, or lowered? A number of recent studies collectively suggest that government stimulus spending provides no stimulus at all beyond the amount spent. But where there are large deficits, spending should be cut. However, the best way to stimulate the economy is through lower taxes—and especially to cut corporate taxes! But what a political bombshell these policies would be in many countries.

Increased government spending, say numerous economists trained in traditional Keynesian economic theory, should have a ‘multiplier’ effect that increases overall economic activity by an amount larger than the sum spent. However, some recent empirical research disputes that assumption.

In a prestigious US National Bureau of Economic Research (NBER) study, Identifying Government Spending Shocks: It’s All in the Timing, by Valerie A. Ramey, published in October 2009, she found that, “… none of my results indicate that government spending has multiplier effects beyond its direct effect.” That is a dollar of government spending contributes only about a dollar to economic activity.

Furthermore, the same conclusion was noted by Harvard University’s Economics Professor Greg Mankiw while reviewing new research in his blog post, “Spending and Tax Multipliers” on December 11, 2008. He stated “…Bob Hall and Susan Woodward look at spending increases from World War II and the Korean War and conclude that the government spending multiplier is about one: A dollar of government spending raises GDP by about a dollar.”

So, these studies indicate that increasing government spending does not increase economic activity by anything more than the original sum spent.

By contrast, cutting taxes may have a much larger economic multiplier effect. Quoting Professor Mankiw again, he says, “…research by Christina Romer and David Romer looks at tax changes and concludes that the tax multiplier is about three: A dollar of tax cuts raises GDP by about three dollars…” (Incidentally, Christina Romer was chairman of President Obama’s Council of Economic Advisers in 2009-2010.)

Furthermore, Professor Mankiw adds that, “…these findings are inconsistent with the conventional Keynesian model. According to that model, taught even in my favourite textbook, spending multipliers necessarily exceed tax multipliers… How can these empirical results be reconciled? One hypothesis is that compared with spending increases, tax cuts produce a bigger boost in investment demand. This might work through changing relative prices in a direction favourable to capital investment–a mechanism absent in the textbook Keynesian model.”

Reviewing the spend and tax empirical data for most developed countries suffering from large deficits and debt is this study, Large Changes in Fiscal Policy: Taxes Versus Spending, by Alberto F. Alesina and Silvia Ardagna—another NBER paper, dated October 2009. They state, “we examine the evidence… of fiscal stimuli [stimulus] and in… fiscal adjustments [reducing deficits] in OECD countries from 1970 to 2007. Fiscal stimuli based upon tax cuts are more likely to increase growth than those based upon spending increases. As for fiscal adjustments, those based upon spending cuts and no tax increases are more likely to reduce deficits and debt over GDP ratios than those based upon tax increases. In addition, adjustments on the spending side rather than on the tax side are less likely to create recessions.”

So if cutting taxes gives the best boost to economic activity, are there particular taxes to cut that provide the most economic stimulus? The answer is yes, according to the OECD study, Tax Policy Reform and Economic Growth, November 3, 2010. The reviewers say that, “…corporate taxes are the most harmful type of tax for economic growth, followed by personal income taxes and then consumption taxes, with recurrent taxes on immovable property being the least harmful tax.”

Corroborating these findings is another recent peer reviewed study supporting lower corporate taxes: The Effect of Corporate Taxes on Investment and Entrepreneurship, published in the American Economic Journal in July 2010. It stated, “in a cross-section of countries, our estimates of the effective corporate tax rate have a large adverse impact on aggregate investment, FDI [foreign direct investment], and entrepreneurial activity… The results are robust to the inclusion of many controls.” (The authors were from the World Bank: Simeon Djankov, Caralee McLiesh and Rita Ramalho. And from Harvard University: Tim Ganser and Andrei Shleifer.)

Based on this evidence, some observers argue to significantly reduce or even eliminate corporate taxes entirely! In fact, many countries and jurisdictions are reducing corporate taxes significantly, exactly because of such studies. Though no country has yet eliminated them altogether.

Most of these respected studies variously infer that one optimal solution to spur economic growth in developed countries is to cut taxes, while to reduce onerous government deficits and debt, Alberto F. Alesina and Silvia Ardagna suggest cutting spending. Moreover, some of these studies clearly demonstrate that to promote economic growth, governments should most especially cut corporate taxes. Of course this is advocated by some US ‘Tea Party’ leaders, though it is a problematic issue for electorates in many developed countries.

However, shouldn’t at least one country try eliminating corporate taxes entirely? Now that would be one country to study!

Copyright alrroya.com

Posted in Economics, Finance & Investing, Monetary Policy | Tagged: , , , , , , , , , , , , , , , , , , , | 2 Comments »

 
%d bloggers like this: