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Logic, Bias and Economics

John Mauldin has outdone himself this weekend with an article entitled "Six Impossible Things Before Breakfast".  You can read the entire remarkable post (here).

I want to focus on just a couple of thoughts that tie together in a compelling way for me.  First, John discusses how bias influences how we react to things that could be presumed to be purely logical.  He proposes that how we perceive "facts" is colored by our beliefs.  He offers the following graph, which summarizes (from a study, I presume) responses in a group presented with sets of facts (or theories), some of which are valid and some of which are invalid.  First, each participant identifies which facts they believe to be valid and which to be invalid.  Then they are presented with the proof of validity or lack of validity.   

This graph shows the power of the initial bias in how the proofs are accepted.  John Mauldin applies these observations to the dismemberment of the Efficient Market Hypothesis.  The question of global warming came to my mind when seeing this.

Mauldin goes on to point out how dismal economists are in making projections of such macro economic factors as GDP, shown below.  There is an obvious bias for the average of all economists to project the long-term past averages forward, and in the case of GDP, with a rather rosy bias.

However, economists systematically can adjust toward reality as the time frame for projection becomes shorter.  In the example shown below, the average forecast was nearly 100% in error 24 months in advance.  As the timeframe shortens, the accuracy improves linearly until there is no error when "projecting" the current situation.  Would it be appropriate to say that a Ph.D. in economics is equivalent to a degree in staying awake and aware of your surroundings?  Perhaps too harsh?  Show me some different data before we discuss my bias.

Read John Mauldin's masterpiece (here).  It contains a wealth of logical reasoning and is very entertaining to boot.