Making Economics Useful
It is not always apparent that Economics can be useful in life or business. Banks and big institutions use economics to forecast many things. These forecasts are not always accurate, intelligible or useful in everyday life. Although, in fairness, a select few managed to forecast the 2008 financial crisis. Undergraduate economics exposes people to the useful delights of marginal utility, indifference curves and the IS/LM framework.
Economics is useful beyond being just interesting. It can be used to realistically forecast the economic outlook of a country or potential interest rate changes. These can be done in a simple framework without the need for or danger of using sophisticated econometric models. This has been the focus of my MBA Economics courses in Cape Town and Rotterdam over the last few decades.
Yet Economics is useful beyond macroeconomic forecasting. For example, it can be used as an analytical framework for understanding competitive behaviour, pricing policy and optimizing investment decisions.
The intention, over the next few months, is to publish a series of articles on LinkedIn that outline how we at StratEcon (my company) have used economics to solve difficult problems for our clients. StratEcon specializes in applied economics typically using a modelling approach. So the focus of the series is on using economic modelling to solve problems. Th intention is that you will be guided by our approach to solving some of your business problems.
The selected topics attempt to cover a range of techniques used or developed by StratEcon. To give a taster some of the articles include:
Tourism is big business. It is the lifeblood – directly or indirectly for many firms and destinations. It can also be a difficult business. A recession in a source country can decimate arrivals. Growing competition from other destinations, albeit slower, is also a challenge. Even conditions at the destination – tsunamis or droughts – affect perceptions and arrivals. This article will outline an approach to anticipate possible future changes. This allows you position yourself to limit short term damage or benefit from booms and address the challenges in the longer term.
Big industries face challenges both from their external environment – over which they have no control – and from role-players and stakeholders – over which there may be some influence. This article outlines the development of an innovative methodology that can, potentially, make two important contributions to estimating an industry value. The first is the industry value under a variety of external factors. The second is the relative contribution of role-players and stakeholders and the value of addressing any related constraints. It was developed for the South African oil & gas industry but has the potential for applications in other industries.
There are many businesses that are dependent on a commodity or commodity based product. These could be through direct production – sugar farmers or suppliers, copper producers, etc. They can also be through the use of commodities as inputs – bunker fuel for cargo vessels, bitumen for road surfacing, copper in electrical components, sugar in candy or biscuits. It is possible to use econometric analysis to develop forecasting models of these commodities. This is a fascinating topic and clearly of major importance to you if you are in the commodities business or at the mercy of commodity markets.
This introductory note closes on an entirely different matter. It was sparked by a LinkedIn question from a former student (thank you Andrew). The question is: “Looking at the recent raise of interest rates from FED, I wonder if they are just paving the path to next crisis of the same extend (or even bigger) as in 2008? If you have a time to share your thoughts on that, it will be greatly appreciated”.
Here is how the question was answered:
The world appears to be slowing economically. Italy is in recession, Germany is or will be in recession. The Netherlands could follow. India is in trouble. China is slowing. The UK is a mess which could become worse with the current Brexit options.
None of this is problematic in itself because it would be a global recession rather than a 2008 scenario.
There are three factors that are different from 2008 and for this being a normal but not deep global recession:
Politics. The political landscape is very different from anything in recent history. Politically the UK ‘lives in interesting times’. The relationship between the UK and EU is more than strained. The US political changes speak for themselves. However also consider the yellow vests in France and that Macro had to back down from where he was, Angela Merkel is going and AKK is an unknown person outside of Germany. Russian relationships with the rest of the world, especially the US are a real problem, as is the new possible arms race. China is increasingly more authoritarian and there are major political problems between US and China even beyond the trade war - Huawei is a real problem and could escalate. So politics is a real issue and you need to watch that space if you are asking the question could 2008 be replicated. Politics could be the tipping point, not a housing bubble and banking collapse as was the case in 2008.
Policy room to manoeuvre. Prior to 2008 governments had sufficiently low borrowing (albeit too high even then) to allow them to borrow more to spend their way out of the recession. Austerity did bite towards the end of that spending spree. Central banks had room to manoeuvre after 2008 because interest rates were sufficiently high to allow them to lower rates. They could also bring in the nuclear weapon of QE. Now there is no room to manoeuvre. Real interest rates in Europe are still negative and have only just become positive in the US. Nominal interest rates are very low. You could make them lower or even negative. That is uncharted territory at a global level. You could renew QE. We do not know what the unintended consequences could be but there have to be consequences. QE is just more money. Money is just paper. More money more inflation, or asset bubbles, or overvalued emerging market currencies. These are all problems in their own right. Emerging markets suffer and asset bubbles burst.
China is about to change for a net saving country that has powered investment and borrowing in the rest of the world, to a net borrower. This is going to have major short term – business cycle – and long term implications.
So there you are. World recession is probably on the horizon. Not a problem in itself. However there is little macroeconomic policy ammunition left. So it will be more difficult to address the recession. What then? Not sure. Watch the space.
Should that happen, and given the limited macro room to manoeuvre, the economic downturn would go beyond a mere recession.
So the answer: on the one hand a global recession of no major consequence. On the other a more serious recession because there is no macroeconomic ammunition left to overcome the recession. In addition politics really complicates the whole story. It also has the potential to deliver a killer blow and turn a minor recession into an international catastrophe.
I hope you find this series useful. Feedback would be welcome.