Sense & nonsense in end of year reviews

The turn of every calendar year witnesses a spate of reviews by pundits in the media. For a columnist, these reviews are an attractive vehicle, ideally drawing upon events from the previous 12 months and combining them with insights into developments relating to the next twelve. At their best, these reviews help orient decision makers—managers, investors, and the like—for 2013. However, there’s plenty of room to cut corners and to mislead the unwitting reader. What follows are some words to the wise.

The first pitfall lies in failing to recognise that most data can support multiple interpretations—not just the one presented by the analyst. For example, as a chart showed in the Christmas edition of The Economist, economic growth in the Brics countries continued to slow down from its high in 2009. Is this bad news or good news? For sure, leaving aside important questions of sustainability, fast economic growth is preferred. However, other than the United States, the Brics were the only large economies to make a sustained contribution to world economic growth since the global financial crisis hit in 2008. Should the Brics performance be praised or is it a source of worry?

One response is to insist that the benchmark against which any performance is compared is specified clearly. The problem here is that the technocrat in us often argues for a benchmark that concerns maximal performance. So in the example mentioned in the last paragraph, even though India’s economic growth slowed down in 2012, did India grow as fast as it could have? This sounds like a promising benchmark until you realise it cannot be implemented uncontroversially (because doing so requires estimating how the Indian economy could have grown under a different policy mix, which itself requires taking a view on the controversial matter of what drives economic gro­wth—a subject that economists have been debating si­nce, at least, Adam Smith!)

A second pitfall is to fail to recognise that small changes in outcome can have big effects on headline counts. Take the counts of gold medals at the Olympic Games in 2012. Forty-six gold medals were awarded to American contestants and 38 to Chinese participants. Bearing in mind that each gold medal is awarded to the performance of the best participant in each sport—no matter how far that participant is ahead of the second best participant—how little would the changes in performance in the Olympics have to have been to result in a tie of 42 medals each for the US and China? In reality, the difference in the headline count almost certainly overstates the average quality of the best Chinese and American Olym­pians—which is probably what most of us are really interested in, so the US had better not sit on its laurels in the run up to the next Olympics in Brazil in 2016. These comments apply to so many league tables or rankings that analysts are so fond of using.

Indian politics in 2012 provides a perfect example of the third pitfall, namely, the difficulty in interpreting potentially important qualitative ev­ents. Given that the major economic reforms announced by the Singh government in late 2012 will take several years to implement and to benefit from, should this year be vi­ewed as another wasted opportunity attributed to political deadlock in New Delhi? Or should 2012 be seen as a breakthrough in the opening up of the Indian economy, much as the year 1991 is now seen? The honest answer is that it is almost certainly too soon to say what the economic consequences are, even th­ough my own preference is to support further opening up of the Indian economy.

Perhaps, it would be more interesting to comment here on what has actually happened in 2012 (the decision to implement further reforms), what can be learned about how opponents to reform were overcome, and whether these findings have implications for the implementation of further reforms in 2013 or 2014. In short, events in 2012 may tell us more about the constraints facing decision-makers than the medium to longer term consequences of their actions. Similar considerations apply to analyses of the recent negotiations to avert the US falling off the so-called fiscal cliff. Analysing the divisions between the Republicans and Democrats, as well as the divisions within these parties, may reveal more about the pro­spects of a reformist second term Obama administration, than the precise effect on the US economy of what will almost certainly be a series of cobbled together, last minute budgetary compromises.

An excellent analyst shows his mettle by drawing implications from the right events and trends to say something about how the future might unfold. What we readers want to know from these analysts far exceeds their capacity to deliver and we should never forget this—even during the Season of Goodwill.

This article was first published in the Financial Chronicle and is posted with permission.