Forecasts and their failings

Forecasts and their failings

Imagine you are driving a car. I tell you that if you continue driving the car in the same direction for a long time, at some stage you will drive over a cliff. You, if you are kind, will first thank me, then point out that you are not going to drive in a straight line. You are going to change direction regularly and, well before the cliff comes, you will do something to make sure you do not go over it.

On 7 July, the Office for Budget Responsibility warned that “if economic shocks continue to hit the public finances, debt is on course to reach almost 320% of annual national income (GDP) in 50 years’ time – up from 96% now”. You can already see where I am going with this, I suspect.

Of course, the OBR is not stupid. The Fiscal Risks and Sustainability Report is far more detailed and far more thoughtful than the headlines. It focuses on three “potential pressures on the public finances”: the economic and fiscal implications of heightened geopolitical tensions; “fiscal risks from higher medium-term fossil fuel prices and potential fiscal implications of long-term changes in energy supply and demand, taking account of the UK’s decarbonisation objectives”; and demographic change. It warns that successive governments must raise revenues to offset rising costs.

In other words, the car will only drive over the cliff if we do nothing about it.

This certainly puts the highly questionable tax-cutting plans of many of the candidates in the current Conservative leadership debate into perspective. “Tax cuts don’t pay for themselves and would not improve the long-term financial position,” said the OBR’s chief of staff, Andy King. The report also highlights some of the strange mismatches resulting from the way the economy is currently structured: fuel duty is a significant revenue source, which will diminish to near zero if the government’s plans to see an all-electric car fleet introduced by 2035 come to pass; whilst domestic electricity use is relatively lightly taxed.

The projections the OBR makes are subject to a range of influences over the period of the projection. Some of these influences are explained in exhaustive detail in the report.

Some, it has to be said, are not. Most especially, the policy responses available to the government are identified in one paragraph (in the Executive Summary – there is more detail later on) as:

Bringing debt back to 75 per cent of GDP – the level at which it stabilised in the Government’s pre-pandemic March 2020 Budget – would need taxes to rise, spending to fall, or a combination of both, amounting to a 1.5 per cent of GDP additional tightening (£37 billion a year in today’s terms) at the beginning of each decade over the next 50 years”

This is where scenarios – a scenario set which can bring in all of the elements the OBR studies and more – would be useful. They would be able to incorporate more factors, including more policy responses. Something such as the SAMI Journey Game would allow an understanding of the transition through time within those scenarios and the response to systemic shocks.

Those scenarios could be supplemented by tools like the “cone of plausibility”, which we have written about before – most recently here. The cone is a tool which states, essentially, that the further away from the origin point one goes, the more possibilities are enshrined in the future. Whilst the most likely future travels through the middle of the cone, as it expands away from the origin the cone widens, as the range of possible futures expands.

It is an inherent property of forecasts that they appear – because they can be plotted on a graph or encapsulated in one of the many diagrams the OBR report includes – credible. They are a blending of factors into a nice line – one which, in the OBR’s case, goes alarmingly up over the course of the next fifty years.

But the future is not like that. It is not a straight line, but a combination of factors which interplay unpredictably, and whose messiness and complexity do not lend themselves to the nice straight line.

So we have two comments.

The first is that the future is not as simple as it looks on a graph, and the possibilities open to changing that future are near endless. The value of the OBR’s report is that its straight lines show where we do not want to be. To find out where we want to be, and how we get there, we should be thinking very much more widely.

The second reflects on a comment by Richard Hughes, the OBR chair. He said, “All these risks need to be understood and mitigated if we are to safeguard fiscal sustainability in what appears to be an increasingly risky world.” One of those risks is that the public understanding of risk, and the reporting of it, is weak. It needs to be significantly improved.

Written by Jonathan Blanchard Smith, SAMI Fellow and Director

The views expressed are those of the author(s) and not necessarily of SAMI Consulting.

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