Bill Jamieson: Economic forecasters should proceed with caution

A body has been set up to produce independent projections of Scotland's economic prospects. Good luck, says Bill Jamieson

No crystal balls are required at the Scottish Fiscal Commissions new forecasting unit.
No crystal balls are required at the Scottish Fiscal Commissions new forecasting unit.
No crystal balls are required at the Scottish Fiscal Commissions new forecasting unit.

We’re deep in the season of autumn mists - and not just with the weather. The coming weeks will see a bold venture into the heart of darkness – economic forecasting by the Scottish government.

No rusted, dusted down crystal ball suffices here. The next month brings the finishing touches to a new, whirring, signal-sending statistical behemoth: the Scottish Fiscal Commission’s new forecasting unit.

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The Commission, established in April, is charged with producing independent forecasts of Scotland’s economy, tax receipts and devolved social security expenditure. The purpose is to inform the next Scottish Budget and “to enhance confidence in the fiscal decision-making process in Scotland” – and this when political ambitions for radical change have seldom been higher.

It’s the loftiest of ambitions. But as with all such lofty peaks it is wreathed in mist. And once the mist clears, previous forecasting has often come to look like a Flodden field strewn with error.

A formidable amount of work has been put in to improve the quality of research and findings. As Sandy Stewart, head of accounts for the Chief Economic Adviser points out, economic statistics published for Scotland are now more comprehensive, and more timely, than for any other part of the UK, and for many other devolved governments internationally.

So credit to where credit is due: the SFC’s first reports testify to an impressive forensic effort by its economists “to get it right”.

There are now 27 professional statisticians producing Scottish economic statistics including quarterly GDP, monthly labour market updates, annual exports statistics, detailed annual business statistics and one-off publications.

Now comes the SFC assessment – and with an extraordinary health warning. The tremulous preamble by SFC’s chief executive John Ireland and his deputy Mairi Spowage to their first report runs far further than any conventional pro forma cautionary note as to make readers wonder whether this is a useful exercise at all.

Mark these opening words: “A forecast cannot generally be judged to be right or wrong at the time of making... The past is an imperfect guide to the future … Forecasts will be subject to error: the economy may not develop fully as expected, the effect on tax receipts may not be entirely as predicted… Analytical models, based on historic data and theory, can help provide some insight into how the economy and public sector finances may change over time, but all models have limitations”.

And public finance is about more than models and formulae. Time and again, judgments have to be made. And these, says the SFC paper, “may change from one forecast to the next as the economy evolves and our understanding develops along with it”. The Commission “will always have to rely on subjective judgment in creating its forecasts where there exists uncertainty or limited evidence…. Ultimately, the forecast will be driven by the judgment of the Commissioners, rather than depending mechanistically on the output of any one model.”

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Phew! Typical jelly-legged forecasters, you might think – blazing a trail of retreat and dissemblage before a single heavily qualified number is inched forward. Is this not an excess of caution?

But consider what has just unfolded. This follows the unanticipated collapse of oil prices; the near disappearance of Scottish government oil revenues; the yo-yo ups and downs of the construction sector; a widely predicted slump in employment that failed to materialise; repeated mis-calls by the central bank on interest rate changes and the impact of ever changing digital technology on how we work.

And I’ll skip on the spectacular failure of almost all forecasters, here and overseas to predict the global financial crisis and the debacle that holed Scotland’s two largest banks.

Even relatively small scale changes to the tax regime have proved difficult to get right. Estimating behavioural responses to movements in tax can bedevil budget planning.

Take the frenzied dart-throwing that has marked attempts to forecast the yield from the recently introduced Land and Buildings Transactions tax. They have been bedevilled by confusion. Scottish government forecasts produced in December 2015 overestimated residential LBTT revenues in 2016-17 by £68 million, while the forecasts produced in December 2016 underestimated the amount of revenue raised by £33 million.

Latest figures from Revenue Scotland now estimate the shortfall at £55 million: it says it collected £483.6 million from LBTT in 2016-17 against a Scottish Government budget forecast of £538 million.

The failure to collect as much as expected follows repeated warnings from property experts that the introduction of the tax would lead to a slowdown in house sales, particularly at the top of the market.

House price forecasting methodology has now been revised. But it is not just the housing market where forecast failure is evident. The non-residential LBTT forecast produced in December 2015 overestimated revenues by £44 million as “the forecast for prices was too high.” Such changes in tax revenue can be swung by a very few high priced transactions, which makes it difficult to forecast accurately.

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Meanwhile forecasts of the tax revenue from the Scottish Landfill Tax fell short by £14 million – an absolute percentage error of 10 per cent.

Now imagine the challenge of predicting the behavioural response to changes in income tax that the Scottish Government has in its sights. Making allowances for these can be fraught with difficulty. At the UK level, Labour shadow chancellor John McDonnell is reported to be ‘war-gaming’ for a run on the pound if Labour wins with its tax raising programme. But the prospect of such a government would be enough to trigger a flight of savings and investment overseas well before it could be in a position to rush in controls.

Even ‘straightforward’ forecasting, assuming no political change at Westminster, now has to contend with possible fiscal changes in the UK budget in November and Brexit negotiation uncertainties.

For the record, the latest Fraser of Allander Institute report highlights a cooling UK economy with business investment weak, consumer confidence falling and growth slowing. In Scotland, it says, “the picture is if anything arguably more fragile” as Brexit “may well intensify the degree of uncertainty or lead to an adverse long-term trading environment.”

Its latest forecast for Scotland – following previous efforts that have been overly gloomy - is for growth of around 1.2 per cent this year, picking up to 1.4 per cent in 2018 and then 1.7 per cent in 2019. So whilst growth will be faster than last year, it is likely to remain below trend.

Will the SFC address all the concerns raised about the breadth and reliability of official statistics? That it can never do, given the relentless changes in digital technology, changes in our business composition, the growing range and dynamism of the small business sector and demands for more focused, regionalised statistics.

But it is right that John Ireland and his colleagues have set out the need for caution in such prominence and detail. They have done so ably and exhaustively. This is truly an excursion into the heart of darkness: an attempt to set about answering that existential question that forever haunts us: what happens next? In such a journey, mind how you go.