Get your crystal balls out folks! Tim Harford is going to talk about applying economics in being able to look into the future. He is going to talk about irrational decision making that affects your future and how the experts are almost never the best forecasters and many more. Well, better an economist than some scary gypsy woman in a dark room any day.
In this fourth and last episode of Trust Me, I'm an Economist Harford focuses on how our long term decision making can be improved with the help of tools from economics. But first of all, he wants to talk about why you make the irrational and wrong decision about the future.
The reason people make wrong decisions is because of fear of risk. Because the future is unknown, it is difficult to predict and is therefore risky. However, people's take on the degree of risk that future holds is grossly overrated. Our fear of the unknown and the unpredictable makes us vulnerable and easy prey for experts and companies who deal in the business of uncertainty.
Take product insurance for example. Harford pays a visit to a cell phone store where nearly all of the phones come with an added package of insurance. If you are scared out of your pants about losing your new smart phone, then you are very likely to have it insured- often at a very high premium. However, if you asses the risk yourself in an objective fashion, you would find that it is very unlikely that you are going to lose your phone- unless you are the very careless type. Yet, exploiting your fear of the future, the cell phone company may fleece you even further.
This is true for nearly all of our durable goods purchases but it is also true about our big life decisions. It is necessary for all of us to save for the future and insure such things as life and major properties. However, dealing with retirement issues bring us to a very important point. Do we trust the experts who tell us where to put our money?
It turns out that the experts who are paid to predict the future of markets are no better at it compared to random guesses. Financial markets are what the economists call “efficient” markets: it adjusts very quickly to new information. So such things as hot tips or expert opinions on investment opportunities are useless. Harford points out that finding a good stock to invest in is like looking for the shortest queue in the supermarket- as soon as someone spots one, every one moves to it, making the relatively shorter queue no longer short. Similarly, as soon as a stock becomes a good investment opportunity, the market will adjust to the information very quickly- making the opportunity obsolete.
However, experts would like you believe that they can predict the future-but often it is in their interest to be wrong about it as well. In a bull market that is overheating, an expert who predicts a crash would hounded out of the market because he makes investors nervous. So there is a lot of incentives for an expert to keep predicting a rise in the market even though it could be a bubble. In the end, the average investor will lose out but the expert would pocket his cash. Harford strongly cautions against trusting expert opinions- particularly those that are overtly optimistic.
Harford goes on to examine the business of predictions at the horse racing circuit. Here he explores a particular idea about forecasting: the wisdom of the crowds. We see that a large body of people making predictions and putting their money on it often makes better forecasting results than random picks or expert advice. Often, the majority opinion about the future is the right opinion!
I think over all this has been one of the most enjoyable TV shows I have seen. Of course I am biased because the subject matter, economics, is what I am primarily interested in. But Tim Harford, with his easy going style, sense of humor and depth of knowledge in economic analysis has proved himself to be a great ambassador of the discipline to the mass audience. Not to mention the fact that venturing economics into hitherto unexplored fields is precisely what we should be doing and what would bring new popular interest in the subject.
I have a new hero: his name is Tim Harford and he's an economist!
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