Economic forecasting wastes time and money

Freud described our ability to stage major battles over relatively minor disagreements as the “narcissism of small differences”. He would have had even more faith in his doctrine if he had been able to witness the war fought over the trivial differences between economic forecasts.

The run-up to budget 2014 has started depressingly early, with the debate firmly focused on whether the economy is likely to grow by 1.75 per cent or 2.2 per cent.

There is a good rule of thumb when it comes to forecasts for the economy: ignore them. Economic forecasts are almost bound to be wrong. When, unusually, they are accurate it is always by mere chance. Economic forecasting is the ultimate exercise in futility. That doesn’t stop very smart people from trying – it is a waste of time and money.

It’s partly our own fault. The uncritical and devoted attention we give to the output of the forecasting bodies is reason enough for them to continue. Like most bad habits, like all addictions, forecasting, once ingrained, is hard to give up.

Unlike some bad habits it would be wrong to think that most of this is pretty harmless. When it comes to fiscal policy and the setting of the annual budget, the arguments over forecasts amount to a textbook bait-and-switch exercise.

We immediately become bothered about precisely the wrong things; we are consumed by issues that don’t actually matter very much at all.

The fiscal debate becomes focused on that difference between 1.75 per cent and 2.2 per cent. That difference gives rise to a number, one that has to be either "given away" or "found" via higher taxes or lower government expenditure. The sums involved are always trivially small in the context of the overall budget.

Errant children
Somebody always produces an "optimistic" forecast suggesting there is budgetary "leeway". The Department of Finance is always quick to shoot this down.

And post-bailout now includes a spectre at the feast: the Troika. The authorities can always use “the Troika” to discipline the errant children with muttered threats akin to “wait until your father gets home – he has a different forecast”.

The differences between the current crop of forecasts for the Irish economy are meaningless. The debate that nevertheless ensues successfully deflects attention from a proper budget discussion, one that looks at strategic priorities – the most important questions. Inconvenient facts can be ignored. It is much more fun to talk about how small amounts of money can be given back to the squeezed middle.

Strategic priorities
We should stop forecasting and refocus on what the budget should be all about: the setting of strategic priorities.

Over the medium term, taxes have to rise and expenditure be further cut. Is anybody thinking about this? The public sector capital budget was decimated in the crisis; how will it be restored? The list is a long one.

Any budgeting exercise requires an estimate of income and expenditure. For the Government, this requires a guess about likely GDP – the forecast. I suggest picking 0 per cent. I like the minimalist number: that way we force the authorities to think strategically rather than on the tiny numbers that are thrown up by different growth assumptions.

By design, there is no “economic buoyancy” to distribute. All of the thinking, by definition, has to be about the longer term. Nested within that discussion can be a description of what will happen should the economy actually grow (or, for that matter, shrink).

Should GDP growth, which is the norm, generate some extra revenues, the government only gets to spend them after they have entered the bank. The current set-up sees us trying to spend and tax on the basis of what might happen, but usually doesn’t.

We should stop planning to spend money that may or may not materialise.

Just assume the economy stays the way it is and spell out the contingency plans for what you will do when things, inevitably, turn out differently.

The Department of Finance, the Central Bank and the Fiscal Advisory Council devote an awful lot of precious public sector resources to economic forecasting. Just stop. Save some money. Switch some of the cash and personnel into proper budgetary planning.