About Forecasting

The Dow Jones Industrial Average is going to 16,000. China will undergo a democratic revolution. The Euro will finally collapse. Stephen Harper’s Conservatives will finally win a majority government. Yes, it’s that time of year when predictions abound.

In today’s National Post, Dan Gardner does a superb job of belittling the whole forecasting enterprise. He reminds us, for example, how Niall Ferguson, currently the world’s most prominent business historian, warned in February 2009 that the financial crisis would unleash civil wars and coup d’etats the world over. Then there is the group of policy experts who predicted that North Korea would, by 2010, forge amicable relations with its southern neighbour. My favorite is Canada’ s financial guru du jour, Jeff Rubin, who back in 2008 called for US$200 oil just before it crashed from US$140 per barrel to its subsequent low of US$35.

Austrians versed in the writings of Ludwig von Mises will not be surprised by any of this. In Human Action (Ch. 38), Mises said the following about economic forecasting:

If it were possible to calculate the future state of the market, the future would not be uncertain. There would be neither entrepreneurial loss nor profit. What people expect from the economists is beyond the power of any mortal man.

A less than careful reader of Mises might come away thinking otherwise when he or she reads economics being described as a deductively certain branch of knowledge. But Mises well recognized that the certainty attainable at the level of theory through praxeological methods is not readily translatable to the empirical realm.

In theory, B follows A, assuming everything else is kept constant.  But in the real world, nothing stays constant.  Moreover, when part of that world one is trying to map contains a multitude of human beings interacting with each other in pursuing their distinctively valued ends, it becomes all the more glaring that only a divine mind will be able to run through all the possible permutations.

Still, we cannot help trying to predict. This practical necessity, as Mises pointed out, is implied in the very logic of human action. We do X, after all, to improve our current condition towards Y. In doing so, we are effectively forecasting that X will help bring about Y. The best that can be humanly done, according to Mises, is to ensure  that theory is illumined by an empirically grounded understanding of specific circumstances and how these could interact.

Interestingly enough, this dovetails nicely with a key finding of Philip E. Tetlock’s Expert Political Judgment (2006, Princeton Univ. Press). He tracked the prediction of 284 political experts on topics ranging from the evolution of the communism in the Soviet Union to the outcome of the 2000 US elections. While concluding that political experts turned out to be poor forecasters, he did note that foxes had a slight edge over groundhogs. This foxes vs. hedgehogs dichotomy was originally put forward by Isiah Berlin.  Hedgehogs are those who sought to make sense of the world through the application of one central idea; foxes are those that delve into the messy details of the issue at hand and weigh opposing specific factors.

There can be no doubt that Mises tells us to be groundhogs in our theorizing. But in our practical speculations, he wisely counsels us to be foxes.

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