Over the past few days, I have received all sorts of economic forecasts of 2013 penned by economists in large financial outfits who are confidently telling me what is going to happen next year. Most of these guys were the same people who didn’t foresee this crisis, yet few have lost their jobs and here they are, without the slightest hint of doubt, outlining what is likely to happen in 2013.
Of all the characters we should fear, the overconfident economic forecaster is surely one of them. When the Queen of England asked why none of these professionals warned of the credit crunch, she was only articulating what many people must have thought, which is “if you guys are so clever, why didn’t you see this crisis coming – and if you didn’t see it coming, why should I listen to you now”?
The failure of economics to predict human behaviour is a significant charge that modern economists have not properly answered and the failure to answer this accusation adequately has undermined economics as a whole.
In the final column of the year, we are going to take a quick look at the state of the economics game and ask whether the fundamental laws of traditional economics bear any relation to reality or offer any insight into how people actually behave every day.
Maybe the first place to start in analyzing the failure of economics is to start at the first assumption of modern economics: that people are rational.
Economics, as taught in our schools and universities, begins with the assumption that we are rational. Nothing could be further from the truth. Humans are possibly the most irrational of animals. We are driven by emotions, exuberances, impulses and frenzies. We fall in love, gamble and even support useless football teams.
These irrational, illogical and beautifully human urges dominate our decision-making. We don’t generally learn from mistakes; we think ‘next time it will be different’. Even when faced with overwhelming statistical and analytical evidence, we ignore it, imagining the odds that apply to other people do not apply to us. The National Lottery, with its ‘It could be you’ slogan, trades on this. But it’s not just the average Joseph or Mary on the street who takes irrational risks.
Consider those who gamble on horses.
Over the Christmas season we Irish will have gambled millions on horses. Interestingly, professional gamblers in Ireland display an amazing weakness for backing an Irish horse even when the form tells us a foreign horse has a better chance of winning.
This irrationality perplexed me a few months ago, so in order to explore and find out more about it, I visited one of the most interesting and dynamic workplaces in the country. It is one of the few companies in Ireland employing mathematic graduates (so the Maths students out there, listen up). It is not the R&D department of a large foreign, tech based multinational, nor is it the academic hotbed of one of our aspiring fourth level universities. It is the headquarters of Paddy Power — the bookie – in Clonskeagh.
The quantitative or “quants” department of the Paddy Power operation is a fascinating place. Up in “Power Towers” young mathematics boffins apply probability theory and statistical analysis to the huge amount of data gleaned from bookies to assess and price risk.
In order to get a handle on human behaviour and rationality, I asked the good people at Paddy Power for figures on Irish betting patterns, and the data confirmed what we all probably suspected: that we are deeply irrational. In Paddy Power’s shops on the main streets of most Irish towns and cities, the average Irish-trained runner in a race in the UK takes 21 per cent more of the book than an equivalent UK-trained runner. The figures from Paddy Power’s online, phones and mobile business — by far the fastest-growing side of the business — are even more remarkable: the average Irish-trained runner, competing in a race in the UK, takes 24 per cent more of the book than an equivalent UK-trained runner.
If the guys who read the form and calculate the odds are so irrationally driven by emotion, what hope is there for the rest of us?
Our irrationality has profound implications for the way the economy works. It also might shed a bit of light on the next moves in the Irish economy.
When the economy is thriving, we believe that things will continue to go well and we get overly exuberant. When things are going badly we become overly pessimistic, overly self-doubting, and gripped by depression, angst and insecurity.
In the real world it is those who behave irrationally, not rationally, that actually make money. In recent years investors who made money are those who sell when everyone else is buying and buy when everyone else is selling. They are the exceptions; the norm is the rest of us. So the exceptional ones behave in the way economists like to think the rest of us do, and the rest of us behave the way economists think is the exception.
This dilemma at the heart of modern economics was well summed up by J. P. Morgan — the American banking titan of the early twentieth century and a man who had seen a number of booms come and go — who understood this irrationality and caught the essence of the madness of a boom when he noted that ‘Nothing so undermines your financial judgement as the sight of your neighbour getting rich.’
All this implies that much economics as it is taught at present in the Leaving Cert and in our universities has little or nothing to do with human behaviour as we know it. This is a big challenge for economics because many economists purport to have some insight into the complex field of human behaviour and this insight gives them the confidence to predict the future.
So the next time you read forecasters announce confidently that such and such a series of events will come to pass in the next year or two, be warned they are basing this on rationality, when we know that we human are beautifully and gloriously irrational.
Happy New Year.
David McWilliams’ new book The Good Room is out now.
David, and all on this fantastic blog, I had to look at the Independent head line shouting at me about recovery just yesterday. Peoples pent up spending it said. Folks in reality are so depressed with the past years bullshit they splurged a little bit over Christmas to lift their spirits. Now I will, “without the slightest hint of doubt” tell you what is going to happen. Retail figures will fall back to the uninspiring figures they were just before the Christmas period, in fact many will be worse than before. Less disposable income, higher motoring costs, higher insurance costs,… Read more »
Thank You David for all the articles/gigs/punkeconomics/album choices and crackin’ tunes :) over the year 2012….and also for letting us comment on the blog, even if we go doolally on occasion….
Please keep up the good work; and all the very best wishes for 2013.
Oh…and on irrationality of the Irish…well d’you remember the Rubberbandits ‘F*** your Honda Civic; there’s a horse outside’? Well here’s same horse outside Tesco at Clare Hall…no really!!:
http://www.worldirish.com/story/1293-did-you-leave-your-horse-outside-tesco
Happy New Year :)
Dorothy
David, the same applies in football. Ever notice when a sub is coming on, you often see some guy with a clipboard trying to coach the player about tactics. The player usually nods away pretending to listen, and then goes and plays his own way regardless. Clipboard guy is the equivalent of your economic forecaster, trying to apply theory in a situation where the human nature of the player will outweigh anything he says. Clipboard guy will carry on clip boarding as long as the club pay him. If the team lose game after game, clipboard guy will say the… Read more »
Ah! The certainty of the ill-informed, The assurance of the ignorant. The strange thing to me is the willingness of those in charge to pay huge amounts to such people. I have long maintained that at the heart of all failure is the failure of management, a species whose enlargement has exactly coincided with the downturns. I also recall chastising one failure in terms of you sought the job on the basis that you had the answers, now that it appears you do not, why are you asking the rest of us to ‘sacrifice’ Said person appeared not to be… Read more »
Santa Claus, the tooth fairy, a highly esteemed economist, and an old drunk were walking down the street together when they simultaneously spotted a €100 note. Who got it?
The old drunk, of course… The other three are mythical creatures:-))
Happy & prosperous New Year David.
David, many thanks too for allowing me ‘to continue’contributing to your wonderful blogg .Its been great fun reading everyones ideas and having an opportunity to challenge theirs …..even in their doolally moments .
Enjoy The Journey in 2013
Boldog Uj Evet Kivanok Mindenkinek.
Well done on this one David. Perhaps you and I are finally starting to get on the same page. I have only been reading you for a few months and am not aware whether this is a change of heart or I had misjudged you. When your book “The Good Room” came out I drafted a comment but never posted it as I judged it might have sounded a little snarky as unfortunately I can be sometimes. Actually it was meant to be constructive and I can now at least share the thought without fear of sounding snarky. I had… Read more »
I suppose it is possible to agree with this article but I feel that it isn’t the whole picture. Economists are ignoring many more parameters for example social, technological and other developments and also the abilities and intelligence of people on both side. In my opinion the badly educated, not experienced and not so intelligent( without any bad meaning) people should be protected and not exploited. On the other hand well established,well educated and famous expert not necessarily must be intelligent and quite often doesn’t really understand the problem (in fact is not even able) and is hardly able to… Read more »
Happy New Year 2013 to David, all posters and all (free) people. Once talking about rational and irrational, you should first define the terms before starting using them. Terms irrational should not be really used in economy so I need to criticise you in that manner. One cannot term an action as irrational without imposing an external and arbitrary standard of value. Researchers view human beings as rational only if they obey certain axioms or models of the researchers. This implies that researchers almost surely will uncover irrationality because human behavior rarely coincides with a model. All of this just… Read more »
It is a tad cheap to attack forecasting as being without value because so many got the current collapse wrong. The reason it was an economic collapse was because so many were on the other side of the market when the sentiment shifted. Therein in lies the paradox. Yes human beings can behave irrationally but in groups we consistently show patterns of highly evolved deductive reasoning too. The recent economic collapse was for this generation and a number of previous ones without any reference. We were victimised by cheap / free money which had very predictable consequences. I don’t particularly… Read more »
“Economics is extremely useful as a form of employment for economists”- John Kenneth Gailbraith.
A big thanks to David for this wonderful platform, consistently great articles and great commentary discussion, an oasis of clarity. Look forward to your analysis of game-changer 2013. Happy New Year.
The Rationality of Being Irrational I liked this article because it shows the limits on a man made science namely Economics . I believe its function in the future will only be based on ‘fact finding’ to decipher the change in human behavior . It demonstrates the frustration what cannot be delivered when the need is there namely ‘Prediction’. It is time for this science to move on to a new level and make life more interesting and more understanding and pragmatic. Lets look at what I mean . Today is a sunny day and the sky is blue. I… Read more »
If only we discussed our irrationality before we all went on a binge of borrowing and splurging about 15 years ago.
Of course, low interest rates facilitate binging.
It seems that Irish betting customers are bigger losers than British betting customers.
Business knows how to make us irrational.
It is up to each of us, to make sure that we are free from such button pressing.
Ah Freud, how ahead of your time you were! Any economic equation will determine some sort of predictable human behaviour but that does not mean human behaviour is understood. We choose to see what we want to see and use the paradigms that are convenient to service our desires but this is not the truth.
Thanks for that quote from JP Morgan: it bolsters my assertion that we calibrate our bahaviour relative to a smallish group of peers we deem significant: in evolutionary time that was perhaps a hierarchicy within a tribal group of a few extended families living in significant isolation; perhaps 80 people or less. We cannot really relate significantly at any one time to more than 15 or 20 individuals within even that group. In modern society the significant group we relate to will gradually change over a lifetime and may become geographically dispersed, so a trader in London may have a… Read more »
Free will, it’s a bitch! I’ll bet on one thing for the future: we haven’t learned a thing and will continue to make the same mistakes! Societies never learn.
I keep expecting to turn the 6.1 news on and hear our finance minister…
“In the garden, growth has it seasons. First comes spring and summer, but then we have fall and winter. And then we get spring and summer again.”
:)
Happy new year David, and keep those thoughts flowing.
“In the real world it is those who behave irrationally, not rationally, that actually make money. In recent years investors who made money are those who sell when everyone else is buying and buy when everyone else is selling. They are the exceptions; the norm is the rest of us. So the exceptional ones behave in the way economists like to think the rest of us do, and the rest of us behave the way economists think is the exception.” This is such an important observation, not only for economic activity but for other areas where research and statistics guide… Read more »
Good Morning David & a very happy,peaceful new year to you & all on this wonderful site. I enjoy my time here very much,reading,learning,arguing,laughing and sometimes even getting really freaking angry..!! [ working on it,one day at a time!] I have enjoyed meeting some of the fine people who walk the “corridors” of this site. 2012 was a great year for my family & I..We know today what is important and sure as hell isn’t money. I realized how important a positive attitude is while dealing with hardship & crisis and the importance of living one day at a time…its… Read more »
the irrationality of economics has boundaries. things like food and resource shortages in a depleted ecosphere do not get solved by irrationality; it’s at best only a partial theory, just like rationality.
Happy new year David and thank you for your articles and this blog. Happy new year also to my fellow posters. Good article. For a change I find myself in agreement with you. I hope you will persist in your analysis of the failure of modern economics. There are many here who will agree in principle if not in detail. Modern economics has developed as an ideology; not as a science. As you point out, it is based on unproven assumptions or axioms; and it theorises from those flawed premises to various macro theories about the economic activity of human… Read more »
Ou fear of change is our main driver. It is poweful when combined with groupthink. The majority of economists will get caught up in it and predict incremental change never crashes etc but soft landings. Also whoever pays for the advice normally the incumbent government will pay for forecasts that support their policies. He who pays the piper.
Happy New Year All
Ben Dyson from Positive Money in the UK was on BBC Radio 4 recently discussing how irrational people are relative to what economists assume they are.
Ben went a step further though and talked about how economists really spend such little time studying how money is created and even less time discovering how it is destroyed.
You can listen to him here;
http://www.bbc.co.uk/programmes/b01ngmjr (15minutes long)
http://youtu.be/uUk8O6NOJqQ
Review,reflect..Share ?
Barry
I’m going back to Old Moores Almanac. And Rune Stones. The only accurate prediction I can see coming through for next year is that the vested interests in general will become even more right wing fundamentalist to protect their dwindling interests. Croke Park will become a battleground once the private sector is finally bled dry though this won’t really manifest itself until 2014. David mentions the bright young things working for Paddy Power. Good economics (and thereby economic policy) is intrinsically linked to genetics. Since we’re exporting 200 or so of our people every single day, don’t expect any earthshattering… Read more »
David thanks for organising a fantastic blog. It’s a privilege to get ideas and an education from every person who has taken the time and energy to contribute.Thank you all.I’m not a Quaker but I admire their ideals and the concept of “that of God”(which I translate as decency)is in everyone.Each to their own. This site acts as a meeting house for ideas without a “middleman” of written scripture or a cleric getting in the way. The medium of the internet is slowly removing the middleman in commerce,economics,politics and religion. I watched two TEDtalks contributors this year who I thought… Read more »
Hi David. Happy New Year to you and yours and to all contributors to this blog. Sorry for having to put a ‘damper’ on things, but for the first 6 months of 2013 the shower of idiots we have for a government will be running around like headless chickens with Ireland having the presidency. Our lot will be tugging the forelock and bowing and scraping to all and sundry in the EU that nothing will be done, so, you can forget about anything in the line of any ‘positives’ for those 6 months and I think you can forget about… Read more »
These irrational, illogical and beautifully human urges dominate our decision-making. We don’t generally learn from mistakes; we think ‘next time it will be different’. Even when faced with overwhelming statistical and analytical evidence, we ignore it, imagining the odds that apply to other people do not apply to us. Now put this into context with the main players who in some way caused Ireland to go belly up most of these are still being rewarded of have not suffered or have fled the country,to start a new life . The lucky Irish are the ones who bought into the Irish… Read more »
Best Wishes for 2013 to you David, thanks for the forum!
Happy New Year to all the contributor’s, it’s been a pleasure!
HERES A FORCAST FOR THE FUTURE DAVE,SUPERCYCLE TOP MAY 1999 REF(DJIA}+2007 {NB CORRECTION TOP}=8YRS,NOW END OF DEFLATION DEPRESSION CORRECTION 1978 FOR CORRECTION =29YRS OF BEAR MARKET,GIVE OR TAKE A YEAR OR TWO,AND BY THE WAY U CAN CALCUTATED HUMAN BEHAVIOR/SOCIAL MOOD ALWAYS REMEMBER PATTERN OVER PRICE AND NEVER FOLLOW THE HERD,HAPPY NEW YEAR TO WHO EVER READING THIS AND GOOD LUCK FOR THE FUTURE,EXCITING TIMES INDEED AHEAD
PADDY POWER ODDS
MOST SEATS IN THE NEXT GENERAL ELECTION.
FG 8/11
FF 6/4
Sinn Fein 8/1
Labour 20/1
Direct Democracy Ireland 50/1
Greens 500/1
Direct Democracy Ireland coming up on the inside,
with little or no coverage by Irish Main street media.
I wonder why??
Watch out they are only 6 weeks old,
Give power back to yourself.
Happy New Year to one and all.
Happy New Year David. Yup, its all about getting some of the pile. At some point you realize it, but are never told it especially when you are young. If you were you would behave rather differnetly, and there would eventualy be no pile to get a bit of ! For growth our Economic Systems need a growing and gullible population, how else in a finite world in terms of resources do we kid ourselves about neverending growth. The whole concept, and its silent collolary, (the notion of pieces of paper earning interest)is inherently flawed, by the very decent idea… Read more »
Very interesting article David. There actually is a branch of economics which views the economy from the perspective of millions of individuals interacting in the market place. This branch correctly predicted the crash of 2007, which is really just a continuation of the crash of 2000, and is quite clear that none of the underlying causes of these asset bubbles are being addressed and the situation is going to get worse and will inevitably lead to a currency crisis and the destruction of our current system of floating unbacked currencies. For anyone interested in looking into this branch of economics,… Read more »
David, Hope you had a Happy Christmas and all the best for 2013. Keep up the great work. Am I the only person who finds it strange that a country that is supposedly on it knees, lurching from cutback to crisis and with many families supposedly living on cornflakes, and yet a sizable proportion of the population still have money to fritter away on the geegees? I’ve left Ireland, and have money in my pocket, but I am not inclined at all to seek to ‘win’ more money and I am loathed to lose it as it is hard earned.… Read more »
Interesting and very enjoyable article David. Made me think on several levels Q. If the guys who read the form and calculate the odds are so irrationally driven by emotion, what hope is there for the rest of us? A. We are emotional beings who have developed amazing powers of reasoning. Fear is probably the greatest motivator there is next to love and we are always consumed by these two emotions. That’s my personal experience and I am open to being corrected as there are many posters here who could explain this better than I To want to give and… Read more »
Happy New Year to All “In the real world it is those who behave irrationally, not rationally, that actually make money.” In recent years investors who made money are those who sell when everyone else is buying and buy when everyone else is selling. They are the exceptions; the norm is the rest of us. So the exceptional ones behave in the way economists like to think the rest of us do, and the rest of us behave the way economists think is the exception. “The words inside the” are not rational! It is actually the rational who make the… Read more »
See between 11-12 minute mark for comment on Anglo Irish debt bailout
Talk about irrational….
http://www.youtube.com/watch?v=LRPCTrSDaqY
“I visited one of the most interesting and dynamic workplaces in the country. It is one of the few companies in Ireland employing mathematic graduates (so the Maths students out there, listen up). It is not the R&D department of a large foreign, tech based multinational, nor is it the academic hotbed of one of our aspiring fourth level universities. It is the headquarters of Paddy Power — the bookie — in Clonskeagh.” so irish companies do not employ maths graduates, maybe if the banks had employed a few of them the country might be in better shape. As for… Read more »
Even medicine has it’s periods of turbulence
“Dr. P. Maxwell Foshay (1900), Editor of the Cleveland Journal of Medicine once said: “It will thus be seen that medical journalism is in a state of chaos…. The greed for advertising patronage leads the editor only too often to prostitute his pen or his pages to the advertiser, so long as he can secure the coveted revenue.”
http://rense.com/general95/hillbldclt.html
I am surprised people were impressed by this article, Ten minutes at breakfast I would say david.
http://youtu.be/4ECi6WJpbzE
If Governments Bailed out Banks…who will bail out Governments ?
Is The derivative Market the next bubble…?
New Year’s morning?….hooray!!!
Time to embrace 2013 unburdened by the weight of the last 12 years. These years exist, in the way that a firehose reel at the top of a staircase exists, necessary but only to be called up when the situation demands it.
Migrating..from the estuary here in North Dublin…to the Nordsee…again…time to move on…
Now, on with the runners and on with life!
The world is full of well paid charlatans taking like parrots. So what you describe is becoming the norm rather than the exception. People who produce nothing of value for the rest of Society, but are very useful for to keep the Show going on, for Private Banks and the Elites. And while one of our main native industrialist is behind bars; politicians of very dubious abilities, regulators of all sorts, and bloodsucking bankers, are enjoying life, pay, and conditions. The Queen should not have addressed the question to us, but to the Centres of Knowledge that educate Spin Doctors… Read more »
http://hbr.org/2012/12/saving-economics-from-the-economists/ar/1
What most people don’t seam to realise is the changes that have come and are comming will propell people in to a type of war a survival war.
The more you look at who’s running the country and who was running the country and if there was a total change with SF and the indepents running the country we are fucked with any of the four said choices.
So unless we the people go for a complete change of who we want to run this country we will limp along in a country with selective hardship.
“Humans are possibly the most irrational of animals. We are driven by emotions, exuberances, impulses and frenzies. We fall in love, gamble and even support useless football teams.”
Think I’m only part human if that’s the definition
“When the Queen of England asked why none of these professionals warned of the credit crunch” – her brain washing program did a really good job.. So many still being fooled..
I hope some day David you’ll follow the money properly – and this time all the way to the Globalists. Maybe it’ll happen in 2013. I won’t hold my breath though
http://www.zerohedge.com/news/2012-12-29/ron-paul-fiscal-cliff-we-have-passed-point-no-return Ron Paul says the US is broke and it is too late to mend.
go directly to 5.45 min
2013 Trends by Gerald Celente (you don’t need an economist when you have him!!)
http://usawatchdog.com/2013-more-of-the-same-but-worse-gerald-celente/
The monstrous arrogance of the economists is only matched by the genocidal tendencies of the politicians.
The econimists complain that the world is irrational because their “theories” don’t work. A little cabal of mad people raving against the world, accusing everywhere else of being mad.
A little cabal of politicians supporting “regime change” and drug money laundering by their appointed and regulated financial services sector, so having personal responsibility for millions of deatsh, torture, carnage, and mass destruction, while raving against the world, accusing everyone else of being a threat.