A peek behind the veil of ignorance

Last week's post about a paper that documented the remarkable level of economic ignorance amongst New Zealand's business managers seems to have hit the spot, going by page views and comments.

Comments have been somewhere on a spectrum between head-shaking bafflement and outright incredulity, with a soupçon of "how can people this ignorant stay in business?". And, mostly, I'm somewhere in that range myself.

But one commenter pointed me to something that shows managers' beliefs in a modestly less awful light. It's an earlier paper by largely the same people, 'How do firms form their expectations: new survey evidence', an NBER working paper from April of this year. The abstract is here, but the whole thing will cost you US$5 unless you 're in academia or the media or a developing economy: us common or garden bloggers have to pay up, and I did. Oh, and the NBER is funny about copyright, so here it is - © 2015 by Olivier Coibion, Yuriy Gorodnichenko, and Saten Kumar.

What this paper found is that managers may be terrible at estimating the current or likely rate of consumer inflation - no better than the populace at large, which seems rather strange for people at the business coalface - but they are rather better at knowing what producer prices are doing in their industry. Here's the graph that shows it.

The left-hand panel A shows the distribution of managers' estimates of various recent macroeconomic data - the inflation rate in their own industry, inflation overall, GDP growth, and the unemployment rate. Negative values mean that the managers' estimates are too high relative to the real number.

Managers aren't too bad at getting their own sector's inflation rate right: on average, in fact, they're bang on, though there's still quite a big dispersion around the right answer. They're reasonably good at the unemployment rate (they have it a little higher than it really is), but not so hot at GDP growth (they have it about 1.5% - 2.0% higher than reality, from eyeballing the graph). And as my previous post said, they're really bad at the CPI inflation rate, being well off the mark on average and with estimates all over the shop.

The authors show that you can explain the managers' ignorance of the true rate of inflation in terms of 'rational inattention' - life's too short to be on top of everything, and if it's not important to you, you don't bother. Equally they show that managers who think inflation is important for their business do a better job of tracking it, and as we've seen in the graph above, managers stay on top of their industry's inflation pretty well, given that they've got both the incentive and the opportunity. And the paper's authors also show that if you give managers some additional information on actual and forecast data, they improve their estimates. Managers, in sum, aren't the complete ignoramuses you might have imagined when (for example) you see their level of ignorance about the basics of what the Reserve Bank does.

But it all still leaves that basic question: why do so many managers think inflation isn't important to them, and hence or otherwise get it so wrong?

There'a clue in the right-hand Panel B. It takes the (badly overestimated) inflation estimates in the left-hand panel, and breaks them out by the sector of respondent. You can see that there's a decent proportion of people in manufacturing and trade who have an accurate idea of inflation (though even then there's a tail of people with shots that are too high). But there isn't even a semblance of getting within cooee of the right answer for the average managers in professional and financial services firms, or in construction and transport businesses.

So here's my interpretation, not the authors' (though there are also bits of the paper that point the same way, such as the bit that shows managers in businesses with more competition pay more attention to inflation). That sectoral breakdown in Panel B is pretty much along tradables/non-tradables lines. Managers in tradables sectors have to be reasonably okay at getting inflation right, as there are enough competitors (domestic and overseas) who will eat their lunch if they're systematically bad at it. And managers in non-tradables sectors don't have to be, because there aren't.

I've thought it before, and I'm thinking it again: there are a lot of businesses in non-tradables sectors who can coast on a cost-plus mentality, and I doubt if we're going to make much inroads on our national productivity issues until stronger competitive pressures are brought to bear on them.

Extraordinary ignorance

We got a remarkable insight recently into something very odd indeed in New Zealand, and it came from a rather unlikely source, the latest Brookings Papers on Economic Activity conference.

One of the papers presented was 'Inflation targeting does not anchor inflation expectations: Evidence from firms in New Zealand', a paper with four co-authors, one being AUT's Saten Kumar. You can read the abstract and media release, or the whole paper: even if you don't often read more academic papers, this one's worth it. It's pretty easy to follow - indeed, the authors have a rather non-academic flair for making their points crisply and colourfully.

The main focus of the paper is whether inflation expectations are 'anchored': roughly, do people clearly believe that inflation will stay reliably low? They look at five possible ways of assessing it: for example, do expectations vary very widely across the population rather than most people being in the same sort of place? Do expectations jump all over the place from one time period to the next? And so on.

On all five criteria, they find that the business managers they polled did not have settled inflationary expectations. As the abstract puts it

Managers of these firms display little anchoring of inflation expectations, despite twenty-five years of inflation targeting by the Reserve Bank of New Zealand, a fact which we document along a number of dimensions. Managers are unaware of the identities of central bankers as well as central banks’ objectives, and are generally poorly informed about recent inflation dynamics. Their forecasts of future inflation reflect high levels of uncertainty and are extremely dispersed as well as volatile at both short and long-run horizons. Similar results can be found in the U.S. using currently available surveys.

This leads into all sorts of serious cogitation about the efficacy of monetary policy, the need for central banks to communicate better, and how people form their inflation expectations, and if you're a monetary policy tragic you'll love it.

But it also says something pretty damning about the level of ignorance among New Zealand's business community. I'll pass quickly over the facts that only 31% of managers could identify the main objective of the Reserve Bank, and that only 30% could name its governor (even when, in both cases, they were given prompt sheets of the possible answers), and concentrate on this one. Here's a table (clipped from table 7 of the paper) of responses to the question, what inflation rate do you think the RBNZ is trying to achieve? Column 1 shows the possible answers, column 2 shows the percentage of managers who opted for each possible answer, and column 3 shows what they thought actual inflation would be over the following year.

As the authors summarised it, "Of the respondents, only 12% correctly responded 2%, although an additional 25% said either 1% or 3%, the bottom and top of the target range of the RBNZ. But 15% said the RBNZ’s target inflation rate was 5%, 36% said the target was more than 5%, with 5% of respondents saying that the RBNZ’s target inflation rate was 10% or more". Just over half (50.9%) thought that inflation was going to be at least 5%. It turned out to be 0.8% (year to December '14).

Now, I know that there will be a lot of managers doing a perfectly acceptable job of getting the widgets made and out the door, with or without knowing what the rate of inflation is or exactly what the Reserve Bank is trying to do. I'd suggest, particularly if they come anywhere near the strategic planning end of the business, that they're nowhere near as effective as they might be, but there's surely a valid role for heads down, bums up, and get the salads packed and despatched.

And I know that those of us who are into macroeconomics can sometimes forget that others aren't as familiar with the jargon and the details, and that you can actually have a life without delving into the national accounts or the CPI. People get caught up in their own preoccupations, but we don't all need to know the niceties of the LBW rule.

And I know that other countries can be just as bad: the paper documents a similar pattern in the US, though that's little comfort. Not many of us would like to be found on a par with what's happening in twilight Trump-or-Cruz America.

Apologetics apart, though, let's face it: this is a staggering level of ignorance. It makes you ask, among many other things, what on earth the secondary schools can have been teaching in their economics classes over the last twenty years. It leaves you thinking that one of the reasons for our well-documented issues with productivity might well be ill-equipped management. And it makes you wonder about the level of understanding voters have brought into the polling booths: as I've written before, every general election has brought proposals for changing our monetary policy regime, ranging from the potentially promising to total nonsense. How likely is it we'll get a good outcome when people have only the foggiest idea of the current arrangements?

A statistical addendum The first, and often the only, rule when you find extraordinary data like these, is that the data are wrong. They've been mismeasured, someone didn't clean the test tubes, there's an error in the spreadsheet. And I can't quite shake the doubt in this case that there might be a self-selection bias in the survey the researchers carried out. When they first sent the questionnaires out, they got a 20% response - a pretty good outcome. But what if the more clued-in managers opened the envelope and said, "Jeez, I've done enough of these, I'll pass", and the less clued-in ones said, "Wow, no-one's asked for my opinion before"? And if that happened, the potential self-selection bias probably became more acute as an issue in later waves of the survey, since the researchers only went back to people who responded to the first wave. There's a risk that the surveys could have progressively zeroed in on the most clueless. Whether it happened, or what difference it might have made, I can't tell, and it might be completely off the mark, so I'll take the data at face value. Overseas evidence of the same ignorance is rather suggestive that this paper is broadly right anyway.

Indian Economy At a Glance [Infographic]

Our globalized world is shaped by an increasingly complex economic system. As a result, it has become more and more important for people to know what is going on around them. Unfortunately, finding and processing the relevant information to do just that has become more difficult as well, due to the increased complexity and information overload. In reaction to this issue, we have been working on a series of infographics that illustrate the most important facts and figures about the economies of various countries all over the world. 

This infographic shows the Indian economy at a glance. India has a productive economy with high growth rates. It is developing into an open-market economy, yet traces of its past autarkic policies still remain. In 2014, slightly less than half of India's workforce (49%) was in agriculture. Nevertheless, services were the major source of economic growth, accounting for nearly two-thirds of India's output with less than one-third of its labor force (31%). Meanwhile, the industrial sector employed the remaining 20% of India's labor force. Despite the fact that it is counted among the most important emerging economies of the world today, employment conditions in the country still remain poor. Take a look:

Other Economies At a Glance

Australian Economy At a Glance
Canada's Economy At a Glance
Dutch Economy At a Glance
German Economy At a Glance

UK Economy At a Glance
US Economy At a Glance

Embed Code

<a href="http://principles-of-economics-and-business.blogspot.com/2015/09/indian-economy-at-glance.html"><img src="http://i.imgur.com/f0LhfpV.png" alt="Infographic - Indian Economy At a Glance"></a><br />Source: <a href="http://principles-of-economics-and-business.blogspot.com">Principles of Economics and Business</a>

Another blast from the past

Statistics NZ's Twitter feed just posted this fun item:

It has a link back to a piece that Stats published in 2012, 'Delving into the clothes basket - tracking women's and men's clothing in the CPI', which went back to 1924 to look at what men and women and children wore.

It's fascinating - today's girls will be pleased that they don't have to wear the woollen bloomers of 90 years ago, and today's women will be pleased they don't have to make their own clothes - and it's one of a terrific series of time capsules that Stats have unearthed and published. Last time I wrote about them, in 'The way we live now', I said that this analysis of past CPIs was "almost a complete social history in itself". It's also a great timewaster, so cancel an hour, head to my post, and follow up the links there to the various Stats publications.

For me - and here I stress this is my take, not Stats' view or interpretation - the clothes basket piece fortuitously showed the potential benefits of trade liberalisation. From the late '80s onwards, tariffs and quotas on clothing imports were lowered or abolished. The results were that clothes prices have risen much more slowly than prices more generally (as the first graph below shows) and people have been able to buy much more (as the second one shows).

And the "cost"? - "the number of jobs filled by paid employees in the clothing and knitted product manufacturing industry fell nearly 60 percent – from 9,550 to 4,120". Four million people, give or take, got a large benefit, while 5,500 people, give or take, lost their jobs. And I put "cost" in apostrophes because many - maybe all - of those people will have found other jobs, and in activities that the community values more highly than keeping a small-scale rag trade going.

It's also very likely that liberalising clothing imports was a progressive move (in the tax policy sense of "progressive" as opposed to "regressive"). At home, the household budgets of lower and middle income families, and particularly those with children, will have had one of their bigger costs reduced. And overseas, people in poorer countries will have got real jobs, instead of aid, and started down the road of economic development that will make them better off and, along the way, better customers for our exports. That's a pretty good outcome all round.

A defining moment?

Last night we had the latest seminar from the Law and Economics Association of New Zealand (LEANZ) - AUT's Dr Lydia Cheung on "Quantitative techniques for competition analysis: An Overview, and Application to the Z Energy / Chevron Merger", which traversed market definition, modern demand estimation, and merger simulation. It was billed as "for non-economists as well as economists" - a tough challenge if you're going to take the laity through things like critical loss analysis and systems of demand equations - but she pulled it off.

It's also left me thinking about a few things, and in particular about market definition.

The trend these days for competition agencies, when considering mergers and acquisitions, is to rather downplay the importance of exact or precise definitions of markets, a trend which has been gathering some global oomph since the 2010 edition of the US merger guidelines. As an example, in the latest merger clearance for which the Commerce Commission has published its full decision (Staples/Office Depot), the Commission said (at para 49) that "it is not necessary for us to reach specific conclusions on relevant markets".

I'm somewhat uncomfortable with this, from a number of perspectives, including a legal one. While I'm not learned in the law, I have had to wrestle from time to time with the fine print of the Commerce Act, and I do wonder about the bit (s66) that allows the Commission to grant acquisition clearances. Under s66(3), the Commission must either be satisfied or not satisfied that "the acquisition will not have, or would not be likely to have, the effect of substantially lessening competition in a market" (my italics), and how can it do that, to an Act-satisfying standard, without specifying one?

Coming back to hopefully safer economics ground, I'm not sure the current move towards more fuzzy market definition is the right way to go, particularly as we may be getting closer (as Lydia explained) to being able to do a better job of taking a more robust empirical approach to measuring things like demand curves, and own- and cross-elasticities of demand. If, using things like scanner data, improved econometric methods, sophisticated consumer choice testing, and clever analysis of 'natural experiments' - what happened, say, after a fortuitous interruption to one source of supply - we can get a more scientific handle on the extent to which products are or are not substitutes for each other (and so are or are not likely to be in the same market), why wouldn't we use that information to derive empirically grounded market definition? More precise, rather than less?

It's also not clear to me - and here you can peel off if you like, as I'm venturing into some deeper undergrowth, and I may be gone for some time -  it's not clear how a competition authority can sign up for applying a SSNIP test (as many agencies say they do, including the Commission in its Merger and Acquisition Guidelines, paras 3.15 to 3.21) and subscribe to a fuzzyish, not completely defined definition of a market. Sure, in many jurisdictions the SSNIP test is more paid lip service than formally implemented, but if you were to take it out over the fences, as agencies say they're committed to do, then you need the demand curve that the hypothetical monopolist faces. And how can you have a reliable demand curve for an ill-defined product?

In any event, that's one of the benefits of these LEANZ events: they get you thinking, and often across formal disciplinary lines. Get to them if you can, and maybe LEANZ ought to follow up on the feedback I got last time I wrote about them, that they ought to take the show on the road to Christchurch as well, and not just to Auckland and Wellington.

Thanks to Lydia for presenting, to AUT's Richard Meade for chairing the evening, and to AUT more generally for hosting and catering.

Nothing to see here, folks, move along

No surprises in today's Monetary Policy Statement - and that's fine: it's best if central banks don't have to make abrupt moves, and it's also a good thing when market expectations, and what the RBNZ actually delivers, are lined up. One 0.25% cut today, and another one likely by the end of the year, is what everyone expected,  and that's what they got. All good.

Sometimes the most interesting things are in the details of the text (pdf), but again there's not a lot to pick over this time. You may have seen some folks talking about potential recession ahead: that's not the RBNZ's view. Here's their forecast for GDP growth: the low point for growth is around now, with things picking up next year.

If I had to pick on anything, it's on the inflation outlook, and especially the outlook for the inflation that we generate here in New Zealand ('non tradables inflation'). Here's the Bank's best guess at what's going to happen.

You'll see that non-tradables inflation is expected to drop a bit more (in June it was 2.1%), and then pick up again. But inflation everywhere in the western world has turned out lower than central banks had expected: will it actually pick up again like the Bank thinks?

The reason I ask, is that domestic non-tradables inflation tends to be associated with the economy running flat tack - or in the jargon, at or above its 'potential output' level. But on the Bank's own projections (shown below), the economy isn't likely to be going flat tack (the forecast blue line in the graph never heads well above 0).

So there's still a risk that inflation, which has been somewhat stubbornly below the middle of the Bank's target 1%-3% range (and indeed, currently below the 1% end, never mind the midpoint), will stay that way. But that said, this was otherwise very much an 'as expected' announcement.

That house price "fall"

Barfoot & Thompson have just come out with their latest sales report on the Auckland housing market. Early media commentary has tended to latch onto the fall in median price in August - as in 'First Auckland house price fall in six months' (Herald) and 'Have Auckland's house prices turned?' (NBR). Here are the B&T results, for the median price.

But hang on.

First of all, these numbers aren't seasonally adjusted, and there's always a drop in August. This year, though, the fall was minute (-0.3%) and noticeably smaller than previous years' (2011: -1.7%, 2012: -2.5%, 2013: -4.1%, 2014: -2.3%). On its face, the smaller than usual fall in a winter month is more compatible with a strengthening market than a weakening one.

And secondly there isn't much sign of a slowdown in the year on year rate of increase, which I've graphed below.

B&T say that you need to be careful with these year on year comparisons:

August’s average price [they're using the average rather than the median here] is 15.4 percent higher than the average price at the same time last year, but making this year-on-year comparison is misleading as it infers prices are continuing to rise, when they are not. Most of the increase that has occurred year-on-year did so in the first four months of the year.

In applying year-on-year price comparisons over the next quarter also requires care, as last year sales patterns were interrupted by the run in to the 2014 general election

Fair enough, but even if the underlying increase is only 15%, or even 10%, you struggle to see a clear break with the trend of the past year and a half.

B&T's own conclusion is that "The most likely scenario is that prices will increase modestly in coming months from where they are at present", and I'm perfectly happy to go with their judgement call. All I'm saying here is that people may be leaping to premature conclusions that the August data don't properly support.