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Financial economists and the cheerleader effect

14th October 2016

By: Riaan de Lange

  

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In the article published in this column on October 23, 2015, I posed the question: Are financial economists mesmerised cheerleaders or compulsive liars? What any economist worth his or her salt will tell you is that the economy is cyclical – economists spot patterns or trends. But then you might not be told that it contains variables which tend to be subject to repetition – hence, a trend. But here is the thing: repetition is fine unless it is attributable to unlearnt lessons. In the words of Frank Sonnenberg, one of the US’s Top 100 Thought Leaders, “lessons in life will be repeated until they are learned”.

The lesson that is seemingly not being learned in South Africa is the publication of overoptimistic economic growth forecasts at the end of each year and their continuous readjustment throughout the following year.

Only a few days ago, on September 29, the World Bank halved its gross domestic product (GDP) forecast for South Africa for 2016 to 0.4%, from its April forecast of 0.8%. If it is any consolation, this forecast is now in line with that of the South African Reserve Bank (SARB) and is well below the National Development Plan (NDP) growth aspiration of over 5% a year. Do you still recall when last the South African economy grew at a higher rate than 5%? Normally, I would keep you in suspense until the latter part of the column. Well, in 2007 – nearly ten years ago – it grew at 5.4%, which was 0.2% lower than the 5.6% high recorded for 2006, and 0.1% higher than the 5.3% recorded in 2005. These were also the only years since 1994 that the economic growth rate exceeded 5%.

To what extent was this due to the South African economy’s performance? Remember the international growth boom before the 2009 financial crisis? Just to contextualise, South Africa’s lowest economic growth rates since 1994 were 0.5% in 1998 and 1.5% in 2009 and 2014. So, if the projection of both the World Bank and the SARB materialises (we will come to the International Monetary Fund, or IMF, shortly), then South Africa will this year post its slowest economic growth rate since 1994. This is one of those records that you do not want to see broken.

As a reminder, economic growth simply means an increase in real GDP; in other words, an increase in national output and national income. Economic growth is the result of two main factors: an increase in aggregate demand and/or an increase in aggregate supply (productive capacity).

So, what is the IMF’s growth forecast for the South African economy for 2016? On July 7, the fund adjusted its May 2016 forecast of 0.6% to 0.1%. This is a staggering 83.33% downward adjustment. The IMF said that “the outlook is sobering”; by this, it meant that the South African economy was not keeping up with the population growth rate of 1.7%. If ever there was an economic indicator for trouble, this is it.

So, what is the origin of the figures that the IMF and the World Bank use in their analyses? They may well be derived from the National Treasury and/or the SARB. In the instance of the National Treasury, Finance Minister Pravin Gordhan stated when he presented the 2016 Budget Review: “South Africa’s GDP growth forecast for 2016 has been revised down to 0.9% from an estimated 1.7% at the time of the Medium-Term Budget Policy Statement. The weaker outlook is the result of lower commodity prices, higher borrowing costs, diminished business and consumer confidence and drought.”

But, as has become customary, in the words of Timbuk 3, “the future’s so bright, I gotta wear shades”. Gordhan continued: “Although GDP growth is forecast to remain subdued in 2016 and 2017, improved global conditions and rising confidence are expected to result in a moderate improvement in economic growth by 2018. Government is strengthening its collaboration with the private sector, labour and civil society to speed up implementation of the structural reforms set out in the NDP. Public-sector infrastructure spending over the medium term is expected to total R865.4-billion. Government intends to roll out major partnerships with independent power producers in gas and coal over the next several years, boosting investment and energy supply. Several regulatory reforms will encourage greater private investment and improve the ease of doing business. “These and other measures are needed to enable the economy to grow more rapidly as economic conditions improve. Over the medium term, fiscal measures to narrow the budget deficit and stabilise the growth of public debt, complemented by the inflation- targeting framework, will contribute to renewed confidence and greater investment.”

Granted, this was written prior to the unexpected (what has happened to expecting the unexpected?) Brexit and yet another recurrence of the #feesmustfall debacle. Or should it be #educationmustfall? I would content that it should be #literacymustfall.

As for the SARB, on July 21, it slashed its forecast for the growth of the South African economy in 2016 to 0%, stating: “The domestic economic growth outlook remains extremely challenging, following the contraction in GDP in the first quarter of this year. Although this is anticipated to have been the low point of the cycle, the recovery is expected to be weak. The bank’s latest forecast is for 0% growth in 2016, compared with 0,6% previously. Growth rates of 1.1% and 1.5% are forecast for the next two years, down from 1.3% and 1.7% previously.” To paraphrase Timbuk 3, go grab them shades.

I believe that my observations and questions from the earlier column remain relevant. You do not have to be an economist, trained or otherwise, or be armed with or supported by an econometric model to be able to spot a trend. Obviously, the initial economic growth forecasts are continually readjusted downward, which has become standard practice since 2014. So, why does it still persist? The initial economic growth projections for the following year tend to be higher (more optimistic) than those realised the year before. How can this be, particularly if there is no indication, realistic or otherwise, of a possible improve- ment in the economy?

This reminds me of a casino gambler, who, despite losing a hand, is prepared to remain optimistic that his or her next hand will be better, thinking that he or she was merely unlucky – this without there being any conceivable reason for an improvement in his or her fortunes. Maybe the lyrics of Kenny RogersThe Gambler song are not out of place “You’ve got to know when to hold ‘em; Know when to fold ‘em; Know when to walk away; And know when to run . . .”

There is nothing to change my view that financial-sector economists are, at best, mesmerised cheerleaders, not wanting or willing to acknowledge the true state of the South African economy and its real challenges and constraints. At worst, they are liars.

You may have found “the cheerleader effect” in the headline intriguing. Let me quickly explain. I am not sure how familiar you are with the television series How I Met Your Mother. But if are not, then you have missed some excellent television. Well, according to http://bigthink.com, in the seventh episode of the show’s fourth season, Barney, the serial womaniser, complains that there are no attractive women in a bar, whereupon his friend points out a group of women in the corner. Both agree that the women are indeed attractive, but Barney knows this is simply because his brain is playing a trick on him. Barney is experiencing the so-called cheerleader effect. His brain is calculating the average of the women’s looks, which might constitute an attractive group but, individually, each woman leaves something to be desired.

So, in fact, you too can hide your flaws and ‘average out’in a group. This is according to a study published in the journal Psychological Science. Is this what financial economists, as a collective, are achieving when forecasting South Africa’s economic growth?

Edited by Martin Zhuwakinyu
Creamer Media Senior Deputy Editor

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