Actuaries Institute CEO David Bell discusses the place of simple, real-life economic signals, versus complex mathematical models in understanding the present and future economy.
‘It is a very sad thing that nowadays there is so little useless information’ – Oscar Wilde
Being of the generation that actually admits to listening to ABC Radio National, I was fascinated by Tom Switzer’s recent interview on Sunday Extra (30 July) with economist and author Dr Philippa Malgrem.
Malgrem, an economic advisor to President George W Bush, was talking about her new book Signals*, whose full title I have provided in the heading to this article; I have copied Oscar Wilde’s quote from her as well.
Malgrem’s essential thesis is that every day signals which people receive and pick-up in their interaction with the real economy, are often a much better guide to what’s happening in the economy, rather than complex mathematical models which attempt to predict the future.
On the face of it this might be heretical to the actuarial profession. I think otherwise – complex models always need to be balanced with a dose of common sense and their applicability to real world situations. Actuaries of course do this, understanding the dangers of compounding errors with unrealistic assumptions and unlikely scenarios.
Malgrem’s term for an over reliance on models is going through life blind in one eye and that we should trust our instincts when it comes to simple signals. And horror of horrors, she says that it is often artists and creative people who feel the ‘zeitgeist’ without realising it – it’s better to pay more attention to them than bankers and financial experts who dominate the business media.
Let’s look at some of her examples:
- The incredibly shrinking chocolate bar.
Early signs of gathering inflation can sometimes be signalled through something as relatively mundane as the number of squares in a chocolate bar. In 2010, Cadbury in the UK announced that it was removing two squares of chocolate from its Dairy Milk bar, but keeping the price the same. This so-called ‘shrinkflation’ has become widespread and has manifested itself in other foodstuffs (and in other products and services) like breakfast cereal, tuna, soft drinks, and coffee.
- (Nude) cover of Vogue.
Malgrem’s signature example is the June 2009 cover of British Vogue magazine. One of the world’s leading supermodels Natalia Vodianova (I must admit I’ve never heard of her), who was apparently, atypically, not thin like most models (not an ‘underweight waif’ in the author’s language) was featured. The importance of this event (signalling-wise) was that the fashion industry had lost its old customer base – young people who were now stretched to the limit on their credit cards. The appearance of Ms Vodianova sent a message that the industry was unsure of what its customer base was, and was taking a punt that her appearance would appeal to wider spectrum of readers. In Malgrem’s words, ‘It went back to the human form, unclothed, and started to design for a customer who could be anyone from a beautiful young supermodel to a mother of three, knowing full well that both ends of the spectrum were still cash constrained.’ (Malgrem, Signals, p.1)
- The dog that didn’t bark.
Sometimes silence sends a signal. Malgrem cites her neighbour’s dog that stopped barking because their contracted builders didn’t show up to complete the renovations during the 2007 financial crisis. She draws the wider conclusion that while this is a small example of a signal, ‘the history of wars, nations states and families are all driven by economic events.’ (Malgrem, Signals, p. 15).
The bigger picture
As an aside, in the radio interview, Malgrem talked about the importance of China, and how it is rapidly evolving as an economic power. She makes these interesting observations. Because China has experienced high rates of wage inflation – wages have gone up fivefold in three years – it is now pricing itself out of the market for some manufacturing. She evidences the fact that Apple is now shifting iPhone manufacturing from China back to the US, where it is cheaper (who would have thought).
China has always taken the long view and is now compensating by making investments in infrastructure world-wide (e.g. the Panama Canal) so that it can build a trading network, with China at its centre which, in turn, will allow it to take a more prominent role in global affairs. The recently announced Belt and Road initiative – a massive infrastructure investment in Eurasia – is clear evidence of this push. Interestingly, Malgrem cites Mexico, with its wages at 40% lower than China, as the ‘new China’.
So What ….
So back to Malgrem’s contention about the value of instinct versus expert. It can be easily argued that she has found interesting examples to fit her theory and has fallen into the trap of espousing pop economics. Alternatively, we can accept that there is at least an element of truth in her thesis. Brexit and the election of President Donald Trump are real life examples of where the elites, media and polling experts got it wrong and where, in hindsight, the opinions and views of everyday people were overlooked in an anti-establishment backlash.
What does this mean for actuaries, and for that matter any business professional? I think at least two things. Apply healthy scepticism to financial and mathematical models and look at what you have produced through the lens of real world events and circumstances. Look at the big picture and understand the intersection of macro-economic forces (and where applicable every day events) and world events to put your work into context.
* Dr Philippa Malgrem, Signals: How Everyday Signs Can Help us Navigate the World’s Turbulent Economy, Weidenfeld & Nicolson, London, 2016.
 I had to look it up too –‘zeitgeist’ – noun – the defining spirit or mood of a particular period of history as shown by the ideas and beliefs of the time.
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