On the “Zero Predictive Accuracy” of Most Economic Models…

CPA Trade Counsel Charles Benoit and Chief Economist Jeff Ferry told Monday’s Prosperity Summit attendees that most economic models are worse at predicting trade outcomes than the local weatherman is at forecasting precipitation levels 10 days out. 

Everyone has heard that tariffs are a tax on the consumer. The financial press often writes headlines and publishes op-eds about how tariffs were going to crush this industry or that one. But what those publications don’t say is that they are basing their reporting and commentary on an economic model being used to predict trade action.  Anyone who has ever run a Fantasy Football team knows how accurate the AI model is at picking starting lineups or the week’s games.

The economic model most often used is the GTAP model. And that model, used to predict how changes in trade policy will affect exonomies, has never been right.

An advisor to the Minneapolis Federal Reserve – Tim Kehoe – was once quoted in the Financial Times as saying that the standard GTAP model “has zero predictive accuracy.” In other words, the sky is never falling as predicted.

“Economists will take those results from the model and pretend that this is what really happened, and it becomes common knowledge or folklore, even though it is all wrong,” Ferry said at the first-ever Prosperity Summit on Monday. 

“We were told NAFTA would mean more U.S. exports to Mexico than Mexico imports to the U.S. We were told the same about China when it got Permanent Normalized Trade Relations status.  What can be done about that? What we did at CPA is to improve on the GTAP model, which is the sum of a few hundred equations, and we altered some of those equations. We allowed for new capital that goes into industries and that addition means domestic producers have an opportunity to hire more people and make more products without prices going up,” he said. “That kind of input has not been considered before.”  

Prices of goods depend on competition within a particular market, and not on tariff rates.  In fact, the U.S. has tariffs on solar, but solar prices are falling to record lows due to oversupply by Asian producers. 

More often than not, Ferry told the crowd, news articles on this subject of tariff impacts on trade will say that “economists say” but what they don’t understand is that these are just predictive models and not necessarily a reflection of reality.

Benoit said that when considering tariffs, often a dirty word among diehard free traders on Capitol Hill, legislators can signal to the market that the tariffs are not happening today, but will go into effect two years from now. That gives businesses ample time to react. Congress could legislate import quotas, as well, this way U.S. producers that surely pay more than Mexico, and have tougher environmental regulations than India, can compete and stay alive.

“Right now we have at least half of our vehicles sold in the U.S. that are imports. If you don’t want that number to go lower, for example, which means less automobile labor in the U.S., then you can put in a quota,” Benoit said, Lighthizer sitting by his side on the stage at the Ponte Vedra Inn & Club on the beach in Jacksonville.

“Write bills on trade, just to spark that muscle memory,” Benoit said. “Talk to your constituents who are manufacturers and ask them about their business so you can see what are the costs and regulatory barriers they face that their competition does not.”