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Michael Gasiorek23 February 2018

Dr Michael Gasiorek is Senior Lecturer in Economics at the University of Sussex and Director and  Managing Director of InterAnalysis respectively. He is a Fellow of the UKTPO.

Before and since the Brexit referendum there have been numerous criticisms made of economic models, of the views of ‘experts’ and the supposed inaccuracy of their forecasts.[1] But these critiques are mostly based on misunderstandings, so, as an economist and long-time modeller, I want to explain the value – and the limitations – of modelling.  Models are indeed extremely useful and should be used to help inform public policy – but you need to use them appropriately.

Myth buster: “Models are not designed to provide accurate predictions / forecasts of future reality”.

This is for at least two reasons. First, by definition, any prediction or forecast (I am using these terms interchangeably) is concerned with an uncertain event in the future.  There may be uncertainty both with regard to what is being explicitly included in the model, and there may be uncertainty with regard to other events that will also impact on the final outcomes. There are always unforeseen events and interactions which no model can capture.

Second, and closely related, all models require simplification. Think of a geographical map as a two-dimensional spatial model.  Most people find maps extremely useful as a way of navigating around. But a physical map that was a complete representation of reality would have to be on a scale of 1:1. This would not be useful as it contains too much information and would be unmanageable. If I am travelling from A to B, I want to know where the roads are, and the quality of those roads and I do not need to know the position, size and structure of every single building along the way. If I am going for a trek in the mountains, I am likely to want to have a map that includes the paths and the contours which give me the lie of the land. I choose the map (model) that is suited to the objective, and each map involves simplifications, and those simplifications are useful. They are useful precisely because they do not capture all of reality. They highlight areas of importance and enable us to examine those areas which are of interest.

Consider the two maps below of the London Underground. The first is geographically accurate and is useful for understanding where the actual location of the different underground services. The second is more schematic and is more useful for the traveller wishing to use the underground to get from A to B.

The same reasoning applies to economic models. They involve simplifications. Each model will have its own objectives, in the same way as do different maps.  Each model will shed light on particular characteristics and mechanisms and by design leave others out. This is intentional.  Of course in setting some things aside, the model cannot fully capture all the underlying economic mechanisms and therefore can never provide a completely accurate prediction of the future. It is not designed to do so. A good model will provide insights into those aspects which it deals with; for policy work, it will provide a coherent and consistent framework for considering how changes in policy may translate into economic outcomes. Frameworks can and should be assessed and challenged, but they should not be dismissed simply because they are frameworks, i.e. models.

Let me give a simple Brexit related example, derived from modelling work I have recently been engaged in with colleagues at the UKTPO.[1] There is much talk about different possible Brexit outcomes ranging from an EEA style deal, to a CETA++ deal, and to crashing out with no-deal. If I were a policymaker I would want to understand how an EEA style option might impact on trade and output in comparison to, for example, having no deal with the EU. Similarly, I might want to understand how a given Brexit scenario might impact differentially on UK regions. Suppose the model suggested that no deal was considerably worse: first I would want to make sure that I understood why this was the case, and what was driving the differences in magnitude, or the regional differences.  Second, understanding these factors may help me in deciding on the desired policy (or route). Third, it may help to focus on policies that may mitigate against negative outcomes or  consider other factors that may also impact on trade and output.

If I want to know how long it will take to get from A to B, I would look at a map to see, for example, whether or not there is a motorway between A and B, and if not how hilly the road is. I might also wish to understand why route A, might take longer than route B. If I want to know how much bigger are the impacts from no deal in comparison to an EEA style deal, I would look at how much the UK produces, how much it trades with the EU, how much it trades with other countries and what the possible increase in trade barriers associated with these two scenarios might be.

Note that all of the preceding is data (fact) and is central to any model just as it is central to any map. To that data, we then need to add some assumptions as to how producers and consumers might respond to the changes in prices driven by the changes in policy. These are also central to the model. Just like in travelling from A to B we need to make some assumption about the normal level of traffic on the road, and the speed I am likely to drive at. If my assumptions about speed and the level of traffic are reasonably accurate then my predicted time of arrival will be more or less right. Similarly, if the assumptions the modeller makes about the way producers and consumers respond are reasonably accurate then the predicted impact will be more or less right given those assumptions. As one of my colleagues puts it (paraphrasing Keynes): “the numbers are precisely wrong, but roughly right”.

This does not mean that this will necessarily be the outcome. Clearly, in reality, other factors may intervene, so to continue with my analogy there may be a traffic jam or poor weather conditions. This does not make the map wrong. It simply means that the map and the model did not and could not take certain factors into account. That is the nature of uncertainty. Note also, this does not mean that all models are good. Just as it is perfectly possible to create an illegible or inaccurate map, it is equally possible to create a bad model. But, just because bad models are possible, this does not mean that all models are bad. It is also possible to have an excellent model but simply not to understand how to use and interpret the results from the model. In the same way, as it is possible to read a map and still get lost.

But to generically rubbish models and denigrate experts is dangerous for public policymaking.  What is needed is to understand the purpose and limitations of models, and thus to recognise their usefulness in informing the debate and decision-making as opposed to providing the last word.

To answer the rhetorical question at the beginning – can economists gaze into crystal balls? The answer is no. We cannot predict the future. But we can provide useful models to guide policymaking.

 

Footnote

[1] Some examples of this from politicians engaging in the Brexit debate include: “people in this country have had enough of experts”; “The reports from the government on the economic effects of Brexit have been such rubbish so far that I can’t think it is worth the paper it is written on; “I am not a fan of economic models because they are all proven wrong”; the only purpose of economic forecasts is to make astrology look respectable” .

 

Disclaimer:

The opinions expressed in this blog are those of the author alone and do not necessarily represent the opinions of the University of Sussex or UK Trade Policy Observatory.

February 23rd, 2018

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22 February 2018

Alasdair Smith is an Emeritus Professor of Economics at the University of Sussex, and is a Fellow of the UK Trade Policy Observatory.

This week  Economists for Free Trade (EfFT) suggested that if the post-Brexit UK were to embrace unilateral free trade (UFT), the net effect of Brexit would be positive rather than negative. Earlier work on unilateral free trade has focused exclusively or largely on tariff reductions – and this latest paper has the merit of recognising that border costs and non-tariff measures (NTMs) should be brought into the analysis. Unfortunately, as Jonathan Portes and Chris Giles have observed, the EfFT assumptions are not credible.[1] (more…)

February 22nd, 2018

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15 February 2018

Rob Amos, Research Fellow in Law, Sussex Sustainability Research Programme, University of Sussex. Rob is conducting a project on Sustainable Trade Post-Brexit in collaboration with the UK Trade Policy Observatory.

As the UK begins to devise its independent trade policy, it is essential that any new trade agreements it negotiates are subject to Parliamentary, as well as public, oversight and scrutiny. To facilitate such oversight, the UK should undertake Sustainability Impact Assessment (SIA) for these agreements. If the UK is serious about sustainable development, it must ensure that any future trade agreements do not negatively impact the environment and communities either at home or abroad. (more…)

February 15th, 2018

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Image of Alasdair SmithMichael Gasiorek6 February 2018

Alasdair Smith is an Emeritus Professor of Economics at the University of Sussex, Dr Michael Gasiorek is Senior Lecturer in Economics at the University of Sussex and Director and Managing Director of InterAnalysis, Ilona Serwicka is Research Fellow in the Economics of Brexit. All are Fellows of the UK Trade Policy Observatory (UKTPO).

How would different versions of Brexit affect the UK economy? Are some parts of the economy likely to be affected more than others? Will trade deals with the rest of the world make up for any loss of UK access to EU markets? These are highly topical questions this week as the UK Cabinet’s Brexit committee makes important decisions about its objectives in the next stage of the Brexit negotiations.

They are the questions we seek to address in our new Briefing Paper ‘Which Manufacturing Sectors are Most Vulnerable to Brexit?’, published today. As it says on the tin, we answer them only for the manufacturing sectors; and in doing so we take a very disaggregated approach to UK manufacturing. (more…)

February 6th, 2018

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16 January 2018

Dr Peter Holmes Reader in Economics at the University of Sussex and Fellow of the UKTPO. Nick Jacob is a PhD Candidate in Economics at the University of Sussex.

The need for UK firms to comply with detailed Rules of Origin in a possible post-Brexit Free Trade Agreement with the EU has been widely reported. But the different procedures which firms could use to prove their compliance — and the costs to firms in time and money — have been mostly overlooked. (more…)

January 15th, 2018

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11 January 2018

Dr Ingo Borchert is Lecturer in Economics and a fellow of the UK Trade Policy Observatory.  Nicolo Tamberi is a Research Assistant in Economics for the Observatory

The North East and West Midlands are the most reliant on the European market, sending around half of their services exports to the EU. Sources: Office for National Statistics (2017a); and authors’ calculations.

Two of the biggest Brexit-voting regions would be hit hardest by a potential fall in services exports upon leaving the EU, new analysis suggests.  (more…)

January 11th, 2018

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15 December 2017

Alasdair Smith is an Emeritus Professor of Economics at the University of Sussex, and is a member of the UK Trade Policy Observatory.

The deal done on Friday December 8 in the Brexit negotiations has already been subject to conflicting interpretations. The UK has committed to having no hard border in Ireland, and committed in terms which seem to admit no rowing back. (more…)

December 15th, 2017

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8 December 2017

Jim Rollo is Deputy Director of UKTPO, Emeritus Professor of European Economics at the University of Sussex and Associate Fellow, Chatham House. Dr Peter Holmes Reader in Economics at the University of Sussex and Fellow of the UKTPO.

The agreement to proceed to the next phase of  Brexit talks is a step forward on the road to a softer Brexit. But it does not offer a definitive solution to the status of the Irish border, which will depend on the nature of the final agreement on the UK-EU trade relationship. At best, it represents an exercise in constructive ambiguity designed to allow the shape and length of any interim agreement, which will help determine the shape of the long-term agreement and, in turn, will be the basis of any permanent solution to the status of the Irish land border with Northern Ireland. (more…)

December 8th, 2017

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Photo of Emily Lydgate7 December 2017

Dr Emily Lydgate is a lecturer in Law at the University of Sussex and a fellow of the UK Trade Policy Observatory.

How can the UK uphold its commitment to leaving the EU Single Market and Customs Union while also preserving the invisible intra-Irish border? Leaving aside crucial questions of political feasibility, this post looks at some of the options and their trade and border implications. Notably, there are limits to ‘flexible and creative’ solutions that involve turning a blind eye to customs and regulatory checks solely on the intra-Irish border: trade rules leave little room for such ad hoc approaches. (more…)

December 7th, 2017

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16 November 207

Ilona Serwicka is Research Fellow in the Economics of Brexit at the UKTPO.

The European Chief Negotiator for Brexit, Michel Barnier, has recently confirmed that the UK will cease to be a member of the EU at midnight (Brussels time) on 29 March 2019. This means that we are now less than 500 days and under 350 working days away from the Brexit date. More time has already passed since the United Kingdom voted to leave the European Union on 23 June 2016. (more…)

November 16th, 2017

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