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Economy Feb 19, 2013

Montek has a turkey problem while forecasting growth

By Vivek Kaul

How the mighty fall. Montek Singh Ahluwalia, Deputy Chairman of the Planning Commission, is now talking about the Indian economy growing at anywhere between 5-5.5 percent during this financial year (the year ending on 31 March 2013).

What is interesting that during the first few months of the financial year he was talking about an economic growth of at least 7 percent. In fact, on a television show in April 2012, which was discussing Ruchir Sharma's book Breakout Nations, Ahluwalia kept insisting that a 7 percent economic growth rate was a given.

Reuters

Forecasting is a difficult business.Reuters

Turns out it was not. And Ahluwalia is now talking about an economic growth of 5-5.5 percent-and thus way off the mark. When someone predicts an economic growth of 7 percent and the growth turns out to be 6.5 percent or 7.5 percent, one really can't hold the prediction against him. But predicting a 7 percent growth rate at the beginning of the year, and then later revising it to 5 percent as the evidence of a slowdown comes through, is like not hitting the broad side of the barn.

And when its the Deputy Chairman of the Planning Commission who has been way off the mark with regard to predicting economic growth, then that leaves one wondering: if he has no idea of which way the economy is headed, how can the other lesser mortals?

Forecasting is a difficult business. The typical assumption is that those who are closest to the activity are the best placed to forecast it. So stock analysts are best placed to forecast which way stock markets are headed. The existing IT/telecom companies are best placed to talk about cutting edge technologies of the future. Political pundits are best placed to predict which way the elections will go and so on.

But as we have seen time and again, that is not the case. Surprises are always around the corner.

One of the biggest exercises on testing predictions was carried out by Philip Tetlock, a psychologist at the University of California, Berkeley. He asked various experts to predict the implications of the Cold War that was flaring up between the United States and the erstwhile Union of Soviet Socialist Republics at the time.

In the experiment, Tetlock chose 284 people, who made a living by predicting political and economic trends. Over the next 20 years, he asked them to make nearly 100 predictions each, on a variety of likely future events. Would apartheid end in South Africa? Would Michael Gorbachev, the leader of the USSR, be ousted in a coup? Would the US go to war in the Persian Gulf? Would the dotcom bubble burst?

By the end of the study in 2003, Tetlock had 82,361 forecasts. What he found was that there was very little agreement among these experts. It didn't matter which field they were in or what their academic discipline was; they were all bad at forecasting. Interestingly, these experts did slightly better at predicting the future when they were operating outside the area of their so-called expertise.

People get forecasts wrong all the time because they are typically victims of what Nassim Nicholas Taleb in his latest book Antifragile calls the Great Turkey Problem. As he writes: "A turkey is fed for a thousand days by a butcher; every day confirms to its staff of analysts that butchers love turkeys "with increased statistical confidence." The butcher will keep feeding the turkey until a few days before Thanksgiving. Then comes that day when it is really not a very good idea to be a turkey. So with the butcher surprising it, the turkey will have a revision of belief - right when its confidence in the statement that the butcher loves turkeys is maximal and "it is very quiet" and soothingly predictable in the life of the turkey."

When Ahluwalia insisted in late April 2012 that the economy will at least grow at 7 percent he was being a turkey. He was confident that the good days will continue, and was not taking into account the fact that things could go really bad. As Ruchir Sharma writes in Breakout Nations, a book which was released at the beginning of this financial year: "India is already showing some of the warning signs of failed growth stories, including early-onset of confidence."

What applies to Ahluwalia applies to the government's other crystal-ball gazers, including the boffins in the finance ministry who were up in arms when the CSO said this year will see just 5 percent growth.

In fact, expecting a trend to continue is a typical tendency seen among people who work within the domain of finance and economics. As a risk manager confessed to the The Economist in August 2008, "In January 2007 the world looked almost riskless. At the beginning of that year I gathered my team for an off-site meeting to identify our top five risks for the coming 12 months. We were paid to think about the downsides but it was hard to see where the problems would come from. Four years of falling credit spreads, low interest rates, virtually no defaults in our loan portfolio and historically low volatility levels: it was the most benign risk environment we had seen in 20 years."

Given this, it is no surprise that people who were working in the financial sector on Wall Street and other parts of the world did not see the financial crisis coming. This happened because they worked with the assumption that the good times that prevailed will continue to go on.

Taleb calls the turkey problem "the mother of all problems" in life. Getting comfortable with the status quo and then assuming that it will continue typically leads to problems in the days to come.

That brings me to Ahluwalia's new prediction. "I would not rule out 7 percent next year". He continues to be believe in the number 'seven'. How seriously should one take that? As hedge fund manager George Soros writes in The New Paradigm for Financial Markets - The Credit Crisis of 2008 and What It Means, "People's understanding is inherently imperfect because they are a part of reality and a part cannot fully comprehend the whole."

For the current financial year Ahluwalia as someone who closely observes the economic system could not comprehend the 'whole'. Whether he is able to do that for the next financial year remains to be seen.

Vivek Kaul is a writer. He can be reached at vivek.kaul@gmail.com

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by Vivek Kaul

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