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  • Ben Ettridge

Forecasting the Future: A Climate of Change with Sir David Hendry

Ben Ettridge and Damely Akizhanova –from King’s College London discuss economic modelling, climate change and AI with Sir David Hendry - the eminent econometrician, former President of the Royal Economic Society, and Head of Oxford University’s Economics Department.

Imagine a world where economic forecasting is as straightforward as following a recipe, where predicting future social trends is as simple as seeing the rain coming, and where fixing climate change is as easy as flicking off a light switch. In this utopian world, our conversation with the eminent econometrician and climate economist, Sir David Hendry, would have been a light-hearted chat over a cup of coffee. However, the reality is a far more riveting and intricate tale, where the future of our economy and planet hangs in the balance.

The stage is set, and we open with a fundamental question – how are economic forecasts actually put together? "Well,” Hendry begins, “obviously, you have got to build a quantitative model." The outcome of any economic model depends on the quality of the foundation – the source of your data. Afterall, as the computer science maxim goes: “garbage in, garbage out!” Hendry cites the Office for National Statistics or Eurostat as reliable sources, but his insistence on data credibility came with a pointed observation: “Make sure that [the data used] actually describes the evidence that you've got historically. If you don't do that, [your model is] probably not going to work too well into the future.” Hence, understanding the interplay of different variables and events is incredibly important, as is the timing of data collection, which he posits, should mirror the rhythms of a symphony - annual, monthly, or quarterly, each beat equally crucial to the melody. Econometric techniques and equations also come into play, contributing to the grand composition that is a quantitative model.

But unforeseen events can disrupt the rhythm of forecasts. Hendry cautions that events like world wars, oil crises, and pandemics reshape our world and our economies – often rendering existing models useless. Hendry notes, “In December 2019, nobody knew that COVID was going to cause massive disruptions to the world in 2020.” Here, AI and machine learning present exciting possibilities, yet with a caveat. AI can sometimes miss the mark, spreading misinformation and struggling with an ever-changing script. Therefore, we must not place our entire trust in this digital newcomer, he warns, lest we fall prey to its limitations. "We've seen rapid advancements," Hendry says, but "machine learning uses the past and current information to try and see how things are connected. But what you need to know is what will happen tomorrow, and in a world of change, that's not necessarily going to be the best way of doing it." His tone was one of caution rather than cynicism, reminding us there will always be “future unknown unknowns” that AI will be unlikely to forecast any better than existing models. Other academics, such as the economist Tyler Cowen, are more optimistic about AI’s future capabilities in the sphere of forecasting, but as Hendry identifies, their abilities are currently not competitive against existing computer models, performing badly in international competitions.

One of Hendry’s ‘future unknown unknowns’ is the impact of climate change - an issue that threatens to bring the curtain down on our global economy. "The impacts of climate change," Hendry warns, "will be absolutely massive, and potentially very damaging.” He wasn't shy about presenting a bleak picture but was hopeful that government intervention and careful business management could rewrite the script. "Addressing climate change," he states, "also brings opportunities, particularly in terms of job creation and the development of a low-carbon economy." He presented an image of a world where retrofitting buildings for net-zero emissions, developing electric cars and investing in renewable energy could drive economic growth. He says there are potentially “35 million houses in the UK that need converting to lower emissions – imagine how many jobs that’s going to create!”

Despite his optimism, Hendry did not shy away from acknowledging the challenges of economic modelling amidst climate change. For example, “nobody anticipated the heat dome that settled over Vancouver a few years ago, which caused huge fires and destroyed complete towns. I mean, how do you begin to contemplate modelling something like this?!” Tackling this kind of challenge, Hendry admits, is as tricky as choreographing a ballet blindfolded. Unforeseen weather events and geopolitical conflicts pirouette around the stage, and geopolitical events, such as the Russian invasion of Ukraine and subsequent energy crises serve as sobering reminders of these uncertainties. Another plot twist is the unpredictable nature of human behaviour. “At the moment, people aren't doing much to deal with climate change,” but Hendry suggests that if extreme weather events become more regular, a behavioural shift may ensue, but this is hard to forecast; “A big shift in behaviour can happen, but also, it may not.” Advances in behavioural economics and understanding of how to model individual human behaviour, through the likes of narrative economics promoted by Richard Shiller, might make future trends easier to model, but for the time being this unpredictability leaves the future uncertain.

But what about a resolution for this climactic climatic problem? Hendry highlights the role of public policies in setting the stage for a low-carbon future. Public policies, he stressed, play a critical role in facilitating investments towards a greener future. With the focus at the minute on balancing the budget, the government is reluctant to splash on green policies, but Hendry argues that "identifying investment with cost is completely wrong, because an investment is undertaken all the time by private individuals to get a good return. And that would happen with climate change, if we invested in a really good grid, that should be able to earn enough from supplying electricity to cars, to houses and so on.” He expressed frustration that the “Government wasn't even willing to help Centrica invest in the thing called the rough storage system for natural gas, even though socially, that would be hugely beneficial.”

Hendry also elucidated on the impact that government policy can have at key ‘Intervention points,’ citing the Climate Change Act of 2008 of a shining example of impactful legislation which, despite being light on detail, committed all actors in the UK economy to work towards net zero emissions by 2050 and triggered a change in the culture of many firms, where sustainability is now, noticeably, a top priority. Understanding where future ‘intervention points’ lay and how to implement policy at critical junctures will be important for tackling the economic impacts of climate change. Hendry suggested that renewing the national grid to cope with larger electricity demand will be one important supply side reform of the future, without which transition from fossil fuels to electricity won’t be possible.

Hendry also turned his attention to the corporate world. He encouraged businesses to strive towards eliminating their carbon footprints by 2050. “Firms need to start planning now for what they're going to do. What's going to be their backup system? Are they going to use liquid hydrogen for high heat? Are they going to use electric arc? All these things needed to replace smelting by coal or charcoal?” Whilst Forbes reported in 2021 that 90% of executives think sustainability is important, only 60% of companies surveyed had a sustainability strategy, highlighting a dissonance between thought and action. To trigger action, Hendry floated the idea of imposing taxes on products from countries with high emissions, nudging the world towards environmentally responsible practices.

So there you have it, a thrilling drama of economic forecasting, climate change, and our collective global future. Hendry’s deep insights and discerning analysis offer a thrilling narrative that captures the trials, tribulations, and opportunities that lie in our path. In the end, this isn't just a story of economics or climate change; it's a story of survival, innovation, and the power of collective action. And that's a show worth watching.

Quickfire questions:

What books would you recommend for aspiring economics students?

- Sex, Drugs and Economics by Diane Coyle

- The Undercover Economist Strikes Back by Tim Hartford

What skills are important for aspiring economics students to develop:

- Maths and statistical skills

- Computer software skills

- Knowledge of general science, as well as climate change

- Understanding of history

What do you think are the most important trends in future of economics field?

- Big data, AI and machine learning

- Climate change

- It is difficult to suggest what will be important in future – unforeseeable events can take control

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