Tuesday, March 3, 2009

Flying blind without econometrics models

There is a good reason why the Malaysian government's economic managers were in denial until the waning days of February 2009. Our "economic managers" are the First and Second Ministers of Finance, the Minister in the Prime Minister's Department responsible for economic planning and the Minister of International Trade and Industry. Let's also add the Bank Negara Governor into the mix.

I have not included the Minister of Domestic Trade and Consumer Affairs for charitable reasons since his Ministry is so far backward that it doesn't even have a Retail Index. But, even this planned Retail Index contains weaknesses that this posting will address.

Why the economic managers were in denial
The simple truth is that the economic managers were relying on stale data. They were relying on the data compiled by the Statistics Department. Go to any of the websites maintained by these ministries. You will find that the data displayed are two months old. Historical data.

I am almost 100% certain that the Retail Index proposed by the Ministry of Domestic Trade and Consumer Affairs will be based on these types of two-month old data.

The inefficiency of the Statistics Department
The inefficiency of the Statistics Department is one factor that has to be seriously looked into.

Planning with historical data
When each 5-year Malaysia Plan is being conceived, reliance on historical data is quite okay. Preparation for a 5-year plan has the luxury of several months of time-window before being tabled at the Cabinet and, later, Parliament.

Likewise, Annual Budgets are fiscal policies that, in the norm, has a 12-month time-window. There is time for coffee and cakes at the cavernous conference halls in Putrajaya with industry groups.

So, too, with monetary policies where Bank Negara can fete stakeholders from the financial sector in each quarter to chit-chat about the state of the velocity of M1, M2, M3 and, even M4 from the preceding quarter. Then they decide on SRR ratios, OPRs and so on.

Those are processes that Malaysia's economic management have been praised for. Some have even won awards internationally. These are the laurels that Malaysia's economic managers have sat on and basked in. Joy! Enjoy!

What does one do in a fast unfolding economic crisis?
Can the time-tested languorous fiscal and monetary processes described above apply to a precipitous drop in almost all economic sectors? You know the answer to that.

In their serendipitous and over-sized offices, Malaysia's economic managers must have waited patiently for economic data to be compiled by the Statistics Department, then wait further for the data to be delivered to whoever is in charge of summarising the data in their respective ministries before being (probably) summarised into a one-page executive summary (maybe double-spaced, with coloured bar charts and pie charts) to be presented to the Minister. Some superficial questions may be asked or, not.

The Minister will probably ask a minion to include the data in speech to be delivered at some function some time later in the month.

As I said, in the norm, when the cosmic order is in harmony and the stars are all aligned in proper order, this languid pace is not a problem.

But, we have an economic crisis. It is hardly good enough to say that as at Q3 2008, Malaysia was fine. It is terrible to say that they could only confirm a possible crisis only when the data from Q4 2008 is available at the end of February 2009 (which is the middle month for Q1 2009).

So, what does one do in a fast unfolding economic crisis?

Timely data gathering, high-powered econometric forecasting
The Malaysian government needs to immediately set up a high-powered and well-funded team of economists and econometricians to pore over economic data and formulate quarterly, annual and 5-year forecasts and projections.

http://www.statoek.wiso.uni-goettingen.de/mitarbeiter/ssperlich/gentree2.JPG. Diagram from here.

What is econometrics? This is how Wikipedia describes it:

Econometrics is concerned with the tasks of developing and applying quantitative or statistical methods to the study and elucidation of economic principles. Econometrics combines economic theory with statistics to analyze and test economic relationships. Theoretical econometrics considers questions about the statistical properties of estimators and tests, while applied econometrics is concerned with the application of econometric methods to assess economic theories.

Although many econometric methods represent applications of standard statistical models, there are some special features of economic data that distinguish econometrics from other branches of statistics. Economic data are generally observational, rather than being derived from controlled experiments.

Because the individual units in an economy interact with each other, the observed data tend to reflect complex economic equilibrium conditions rather than simple behavioral relationships based on preferences or technology. Consequently, the field of econometrics has developed methods for identification and estimation of simultaneous equation models.

These methods allow researchers to make causal inferences in the absence of controlled experiments.

To put it simply, a team of econometricians are required to use the economic data collected and create economic forecasting and projection models based on certain assumptions given by economists.

These econometric models will provide the Malaysian government with a picture and, an idea, of what the worst case scenario is. They will give the economic managers an idea of what policy options are available. They will give the economic planners an idea of which economic sectors require how much fiscal input or stimulus to generate the required multiplier effect.

At the moment, our impression of economic crisis planning in Malaysia is akin to someone licking his forefinger and holding out the forefinger to determine the direction of the wind. Or, a golfer pulling a blade of grass and tossing it high to see the direction of the wind before deciding on club selection and direction to address the golf ball.

http://cache.daylife.com/imageserve/08wpflp7YWdmi/340x.jpg.Pix from here.

The alchemy of economic planning
The alchemy in economic planning is actually in being able to obtain timely economic data and, being able to econometrically "crunch" the numbers and, being able to make one assumption after another to test the effect of fiscal policy options and monetary policy options.

Educated guesses from econometric forecasting trumps flying blind
Needless to say, our economic managers really need to get their act together and direct some resources towards creating a high-powered team of economists and econometricians fast.

While doing that, kick the asses of the Statistics Department to gather economic data even faster.


flyer168 said...

- Why are our Government, etc so “Sombong Bodoh” trying to “Reinvent ANOTHER OF MANY, MANY FAILED WHEELS” (Back to Square One!), when our “BASIC WHEEL” since 1957, just needs to be “REDEFINED and REFINED”?

- If we just “Swallow our False Pride, be Honest & Sincere” to acknowledge & admit....the “Whole Nation and the World” will be with us to HELP out!

- We only have to “Look, Acknowledge, Ask and Learn” from our neighbour down South

- their TESTED, TRIED and PROVEN solutions which have “ENDURED THE TEST OF TIME”


- Even their SEVERAL Decade old Successful Cost Effective 2 - 3 year National Service Model for the FUTURE NEEDS of the nation, with no “Surplus to Needs” - Ready for its “Battlefront” duty after graduating from their Military, Police, etc Bootcamps!

--Our Southern neighbour adopts the best criteria Brains, Politicians, Implementers, etc with Academic, Professional,

- With Long and Proven Track performance of “Excellence”, who are “Accredited and Remunerated” very well (from a few hundred thousand to more than a Million Singapore Dollars per annum) with “Structured Job Specs” in this 21st century context…and they DELIVER !

- Sometimes Foreigners (Asian first, then others) are taken for a short contract period to “Groom” the Local “Best” personnel.

- Every National/State Project - DELIBERATION/Decision/ Implementation for the Nation, State and its People are “COST EFFECTIVE” and “NOT SURPLUS TO ACTUAL NEEDS”!

- As such no squabbles/disputes

- Right person for the job at hand! Integrity and Accountability

- Either “deliver or else you are out”.

- With such a Policy in place, their Senior Leaders, Generals, CEOs, etc do not even have to be seen…but everything runs the way it should for the nation and its rakyat’s “Guaranteed Basic Needs” (In this Bolehland it is the reverse !).

- They are the “True Leaders” involved in the “Bigger Vision” for the Nation’s International Political, Security, Economic, R & D, Manufacturing, etc Policy and Standing

- The DBS, MAS and Termasek together have financial “Reserves” of more than 600 Billion Singapore Dollars.

- For a small nation, they have acknowledged, deliberated, identified and mobilized a “Structured and Dynamic” contingency financial plan to mitigate this financial meltdown

- with an initial package of 20.5 Billion Singapore Dollars and they are “Rock Solid” with their cash reserves.

- Anyone involved in “Graft, Corruption, etc” would rather “Self-Destruct” than have to face the Senior PM and their peers.

-With the Global Financial Meltdown, NO Country or Government can understand & appreciate the "Actual Impact" to the "Nation" & its "People" until they get hit "Hard" like "Iceland."



- A "New Government is now in place" to "Salvage" the nation !

-Whilst the G20 Presidents, PMs, FMs, Governments are strategising & synergising their positions on the GLOBAL FINANCIAL "Chess Board"....

- there is still no "Structured Contingency plan nor Quantums" in place in this Bokehland...

- The UMNO/BN is still in “Denial” even at this 11th hour of our nation’s "Double Whammy, Political & Financial Tsunami” at our doorsteps....

Our PM & Finance Minister/PM wannabe are still...

"Quarreling with PR & Anak Bangsa Malaysia with POLITICS JAGUH KAMPONG ala KINDERGARTEN style & still playing with Marbles" when all the other nation's PM & FM are playing "Chess."

This Bolehland has a “Long” way to go with their “Blatant Denial” even at this eleventh hour, to be able to catch up!

We the "Rayaat" have to be "Proactive" and it is a matter of "What can I do for myself & my family NOW" rather than...

- "Ayooo...will the gomen help me....

- how to live with no money lor !"

For the present it is “Every Man for Himself” when it happens!

So consider “Repositioning” yourself and family financially, professionally (career/job), etc, fasten your “Seatbelts” tight, to safely ride this Tsunami!

May God bless and protect this nation and its rakyat.

Anonymous said...

Hi Mr. Ct,
I totally 100% agree with the complete caveman mentality in our statistics department. Nothing is available online, one needs to purchase books, and the entire process is still arhaic.

I guess international investors, or even domestic investors vote with their feet if they can't do some solid research or analysis.

But I've got a better conspiracy theory. Perhaps they have to produce 2 volumes of data, one labelled Truth and the other BS and they just don't have the time.

hishamh said...

de minimis, thank you for your post. It was both thought provoking and an enjoyable read. I have to issue a partial rebuttal though - I don't think DOS and especially BNM are doing that bad a job:


A two month lag in data is fairly typical, even in advanced economies. A lot of the infrastructure for better data collection and publication, as well as more comprehensive coverage, was put in place after 1997-98.

For a view of future and present economic conditions, check DOS Economic Indicators, or alternatively MIER's surveys.

flyer168: I cannot in all honesty blame the government for their response. The global downturn only really got bad in September after the Lehman Brothers collapse, and from the Malaysian perspective, the real economy didn't start getting hit (through the trade channel) in October. Having a stimulus package in place by early November (before the 3Q numbers were even in yet) is pretty fast.

Wenger J Khairy: most of the relevant DOS series are available through BNM's Monthly Statistical Bulletin, which is available online in both pdf and xls formats.

Here's an insider trick for you guys: the pdf versions mimic the print version, but the xls versions are far more extensive. All you have to do to get the extended data series is to unhide all rows and columns.

Anonymous said...


Good article. A bit deep for me though. I think we have to go back to 1970 and start afresh. It has been downhill ever since Tun Razak took over.

Economics said...

The reason that it's hard to beat the market is because the market is dynamic, transparent, and corrects itself. That's the beauty of free and open markets; arb opportunities are not for very long. So, the quants are not a good indicator of the problematic nature of some social science work.

The deeper problem is that most people don't have a fundamental grasp of econometric modeling or statistics to begin with, and thus are unable to hammer at the methodology in a peer-reviewed article.