Controversy surrounding the use of economic modelling on the impact of negative gearing suggests the politicisation of economic modelling is becoming an issue that must be tackled by the economics profession.
Debate was sparked when BIS Shrapnel declined to reveal who had commissioned its modelling, which showed that reducing negative gearing would drive up rental prices and push down house values.
The modelling was described as “manifestly ridiculous” by the Grattan Institute’s John Daley, and “dodgy” and bringing the economics profession into disrepute , according to Fairfax’s Ross Gittins. The Australia Institute has called for a code of conduct for economic modellers.
Economics students are taught to think about an economy as a large number of complex interactions between firms which maximise profit, individuals who sell their labour and other resources they own to firms; the decisions around saving and business investment; mediated by prices (including interest rates), as well as money and financial markets, and international trade. Such a model hugely simplifies the real world, as any model must, but hopefully makes the right simplifications, or risks becoming a misleading guide.
It is not modelling per se, however, which is generating controversy at the moment, but the building of large scale mathematical versions of the mainstream economic model and calibrating them with data from the Australian economy and other economies.
Computable general equilibrium modelling
With smart programmers and a bit of computing power, such models can simulate the impact of changes outside our control (such as a fall in the world price of oil) or policy changes (such as an increase in the GST or the removal of negative gearing tax deductions). In the game it is called computable general equilibrium modelling (CGE).
Australia has been a world leader in this type of modelling through economists like Alan Powell, Peter Dixon, Brian Parmenter, Warwick McKibbin, Chris Murphy, Chris Richardson and others. The Treasury and the Reserve Bank of Australia use these sorts of economic models for forecasting and to understand the impact of policy changes.
Perhaps the most famous use of these models was the trade liberalisation debates of the 1970s and 1980s where they showed the huge costs of protectionist policies on the economy. Modellers helped win the day over those opposing liberalisation by showing that the benefits spread across the rest of the population far outweighed the losses. The models were particularly powerful in showing the indirect effects of changes as resources flowed out of a protected industry or region into a more productive use elsewhere as a result of changes.
Computable general equilibrium modelling is highly complex and only a small subset of professional economists would claim to understand how these models work. Part of the art is to keep the mathematics simple enough so that when the computer spits out numbers for the effects of a change (on GDP, employment, trade balance, prices etc), the modeller can work out and explain to others the mechanisms that are driving the numbers.
There are limitations. It is very hard to integrate financial effects into the models which are built around rational individuals and real resource flows. Models are solved for equilibrium states, and assume that the economy eventually returns to an equilibrium after a disturbance, while the market imperfections which generate unemployment are hard to model.
Independence versus funding
One of outstanding things about those Australian modelling pioneers was their deployment of models as independent university researchers on issues of national interest. Often studies were commissioned by bodies like the Productivity Commission with no suggestion that particular results were being bought, and with full disclosure of the structure of the model and the scenarios being investigated.
Why has this changed? One important difference is the lack of support from governments and government funded universities for this type of long term, public good research. The modelling teams still employed by universities are typically part of research centres that have to pay their way through consulting.
This means less money for development of the models and more pressure to provide the results that those paying for the modelling want in order to maintain the income stream which supports their jobs. If the researchers seek Australian Research Council funding, the development of modelling capacity loses out to other projects with an assured payoff in international journal publications and influence on a particular issue.
A lot of modelling has therefore moved to private consulting firms where the pressures to provide the results the client wants are often overwhelming. The consulting firm of course has a reputation to protect and this restrains the manipulation somewhat, although sometimes the reputation the consulting firm is more concerned about is reputation to provide the right advice, or to provide a large amount of influence per dollar spent.
What we have here is economists behaving more like lawyers in an adversarial system – where highly paid advocates for both sides battle it out with a judge deciding. This may work for a criminal case, but it is terrible for public policy.
It tends to be wealthy special interest groups that can afford to organise and pay for modelling while those on the other side, especially if there are a large number or if they are disadvantaged groups without the connections and access to money to hire modellers. Another problem is that the erosion of this type of specialised expertise in the public service means there is nothing like a well-qualified judge to assess the economic modelling.
Trashing economic expertise
It may well be that both sides present unsatisfactory modelling, so that even expert policy makers still lack the modelling they need to make good decisions.
The Economic Society has been documenting the falling proportion of students taking economics degrees, which means that less informed journalists and readers are easily misled by advocates waving thick economic modelling reports that has cost a lot of money.
It is true that almost 40% of Australian undergraduates now study business but the proportion taking demanding subjects like economics, statistics and quantitative methods has fallen dramatically. The norm, especially outside the G08 universities is students taking marketing, management, and other soft subjects, often dumbed-down to make failure almost impossible and keep the student subsidies from government flowing into university coffers.
Reflecting problems with our political culture?
The current problems with economic modelling probably also reflect the deterioration of the political culture in Australia – the short-termism, lack of concern for truth, and cynicism.
So what of call for code of practise for modellers? This is part of a wider debate about a code of ethics for economists, in the wake of various scandals, especially in in the US. This is discussed for instance in De Martino and McCloskey’s Oxford Handbook of Professional Economic Ethics
The experience in other fields is that codes themselves don’t make much difference where the wider system is broken and incentives to behave badly are strong. They are less likely to work in a profession like economics where there is no requirement to be registered or be part of a professional body like the Economic Society in order to call oneself an economist in public debate. Enforcement is impossible.
The only real sanction is shame amongst one’s colleagues. Perhaps there is more chance of getting a code for modellers operating than a general code for economists because governments can make compliance with a code compulsory for consulting firms and university research centres taking government contracts, not just on the government contracts but on all work the consultants and academics do. Government inquiries could make compliance with the code of ethics a requirement for modelling evidence to be admissible.
Professor Mary Morgan from the London School of Economics will be speaking on modelling as a guest speaker for the Economic Society of Australia’s Eminent Speaker for 2016 April.