Economic Hindsight: Me, Wrong? Never!

[david_myers]

One of psychology’s most reliable phenomena is “the overconfidence phenomenon”—the tendency, when making judgments and forecasts, to be more confident than correct. Stockbrokers market their advice regarding which stocks will likely rise while other stock brokers give opposite advice (with a stock’s current price being the balance point between them). But in the long run, as economist Burton Malkiel has repeatedly demonstrated, essentially none of them beat the efficient marketplace.

Or consider psychologist Philip Tetlock’s collection of more than 27,000 expert predictions of world events, such as the future of South Africa or whether Quebec would separate from Canada. As Nathan DeWall and I explain in Psychology, 12^th Edition,

His repeated finding: These predictions, which experts made with 80 percent confidence on average, were right less than 40 percent of the time. Nevertheless, even those who erred maintained their confidence by noting they were “almost right.” “The Québécois separatists almost won the secessionist referendum.”

My fellow Worth Publishers text author and Nobel laureate economist, Paul Krugman, has described similar overconfidence and reluctance to admit error among economists and politicians.

• When Bill Clinton raised taxes on the rich, conservative politicians and economists predicted economic disaster—but the economy instead boomed, with 23 million jobs added during the Clinton years.
• When Kansas politicians passed large tax cuts with the promise that growth would pay for them, the result was an unexpected state funding crisis.
• When, in 2008, the Federal Reserve responded to the recession by cutting interest rates to zero, conservative economists and pundits published an open letter warning of soaring inflation to come. But it hasn’t.

When none of the predicted economic outcomes happened, did the forecasters own their error and change their thinking? Contacted by Bloomberg, not one of the inflation open letter signatories acknowledged error. Instead, they offered (in Krugman’s words) “some reason wrong was right … and never, ever, an admission that maybe something was wrong with [their] initial analysis.”

Overconfidence—the human bias that our own Nobel laureate, Daniel Kahneman, would most like to eliminate—feeds another potent phenomenon, “belief perseverance”—our tendency to cling to our beliefs in the face of contrary evidence. The more we explain why our beliefs might be true, the more they persist. Thus we welcome belief-supportive evidence—about climate change, same-sex marriage, or the effects of today’s proposed tax cuts—while discounting contrary evidence. To believe is to see.

Perhaps, then, we should all aspire to a greater spirit of humility. Such recognizes, as I have written elsewhere, that

We are finite and fallible. We have dignity but not deity. [Thus] we should hold our own untested beliefs tentatively, assess others ’ ideas with open-minded skepticism, and when appropriate, use observation and experimentation to winnow error from truth.