Covid-19, inflation make a mess out of predictions

Cars lining up at a Covid-19 testing site at the Zoo Miami site in Florida. Picture: AFP

Every year the World Economic Forum asks business, political and thought leaders to rank the biggest risks in the coming year or two. At the start of 2020, infectious disease didn’t make the list. Covid-19 became the most disruptive pandemic in a century. At the start of this year, inflation didn’t make the list either. It is now the most vexing problem in the US economy.

This isn’t to mock the World Economic Forum, merely to note how flawed our perceptions of risk are. They are heavily influenced by the recent past and the news cycle – extreme weather now routinely makes the WEF’s threat list. Yet the biggest threats are regularly things we hadn’t imagined.

Advances in computing power, artificial intelligence and big data were supposed to make prediction a science. But technology can’t see around corners any better than humans. An algorithm can predict what song you want to hear or video you want to watch based on past habits but can’t predict what has never happened or happens so rarely the data provides no reliable pattern.

These limitations have become all too apparent in the past two years. Early in the pandemic a widely followed epidemiological model at the University of Washington, working from behavioural patterns established in other countries, struggled to predict state level deaths with any precision. Just last week a model used by the Centers for Disease Control and Prevention estimated that the Omicron variant comprised 73 per cent of new Covid-19 infections in the week ended Dec. 18.

On Tuesday it revised that down to 23 per cent, which fell outside the 95 per cent confidence interval of the original estimate.

Economic models haven’t fared much better. Last spring, predictions of inflation at year’s end from 68 economists surveyed by The Wall Street Journal ranged from 1.3 per cent to 4.3 per cent. Federal Reserve officials projected with 70 per cent confidence inflation would lie between 1.5 per cent and 3.3 per cent now. It hit 6.8 per cent in November, by the consumer-price index (5.7 per cent using the Fed’s preferred index).

Gabriel Boric, a 35-year-old leftist who wants to scrap Chile’s free-market model, was elected the country’s president on December 19. Picture: AFP

Economists’ models failed because they didn’t incorporate unprecedented changes to spending patterns and shortages, in particular of labour, caused by the pandemic. An economist would have had to predict how social distancing would push up demand for laptop computers, game consoles and associated semiconductor chips, thereby reducing the supply of chips for autos, and thus constricting the supply and raising the price of new cars.

A world of existential uncertainty calls for humility and a willingness to revise one’s mental models in response to new information. Unfortunately, much of the world seems to be sorting itself into polarised camps where mental models are fixed and new information is always filtered through pre-existing biases.

This is a global phenomenon, and one of its signs is the withering political centre. Chile, under centre-left and centre-right governments, achieved one of Latin America’s highest per capita incomes and lowest rates of poverty, and steady reductions in inequality.

Chileans, though, seemingly dissatisfied with this performance, chose radically different approaches for addressing it. No centrist candidate made it past the first round of this year’s presidential election. In the run-off, voters had to choose between the extreme left and extreme right: Gabriel Boric, the eventual winner, a former student protest leader whose allies include communists, and José Antonio Kast, a defender of the military dictatorship that ruled Chile until 1990.

Americans, too, have faced binary choices. Presidents Donald Trump and Joe Biden both sought to remake the country according to the preferences of their political base rather than the country as a whole.

“The centre is weaker than it once was,” said Bill Galston, co-founder of the New Center, a think tank devoted to centrist policies. “But politicians act as though it has vanished altogether, which it has not.”

Commitment to one agenda makes it hard to change course when circumstances require another. Mr. Biden built his Covid strategy around mass vaccination, and lacked a backup (such as mass testing) when many people declined the vaccine and a variant that evades some of the protection of vaccines, Omicron, emerged. He built his economic strategy around boosting demand and reducing inequality via generous aid to families and the unemployed, which is unsuited to the current challenge of inflation and shortages, in particular of labour.

Meanwhile, polarised voters are inclined to blame errors and policy shifts on politics or incompetence rather than the inherent difficulty of making decisions under uncertainty. Evidence on the optimal response to Covid has steadily evolved, from washing hands and disinfecting surfaces to lockdowns to targeted restrictions to mask and vaccine mandates, yet public attitudes increasingly fall along partisan lines. The same is true for inflation: Democrats think it will average a bit above 2 per cent in the next five years, around its historic level, while Republicans think it will top 4 per cent, according to the University of Michigan.

So here’s a prediction: One of these groups is going to be wrong. If you want to be prepared for the future, flexibility, not ideology, is your friend.

The Wall Street Journal