Forecasting for Fun

After a large creative project captured my time and energy, I’m returning to the Ruminathans. When appropriate, I’ll reveal more about that project! In the meantime, I’m thinking about economic forecasting.

Forecasting: Near, Medium, and Long-Term

The leadership team of a company I know intimately has been spending a good amount of time trying to read the tea leaves on the direction of the economy. Will it grow? Will it contract? What implications will that have for direct customers and for sales?

It’s inevitable that companies fret about the economy and try to make contingency plans. Of course, what actually happens to the economy in the near term is a result of everyone’s fretting and planning on the one hand. On the other, it’s a function of events – like wars and pandemics – whose timing and impact are unforeseeable. For both reasons, forecasting near-term deviations from an underlying trend is probably pointless.

As a going concern with a product and paying customers, there doesn’t seem to be that much you can do about near term economic fluctuations other than prepare a financing cushion – whether through savings or through credit access – that is proportional to your cost structure: your ability as a company to dial down expenses as your volume of business goes down. What qualifies as “near term” varies based on what kind of business you’re in, probably between six months and two years.

At the same time, the long-term economic prospects are also too hard to plan for. Your mileage may vary depending on your industry, but with the rapidity of technological, social, political, and – to be brutally realistic – environmental change, I no longer find any forecasting beyond ten years to be useful for most individual businesses, and even for the economy as a whole.

In a future Ruminathan, I might come back to this topic of the limits of knowledge in the near and long terms, and how that is (or isn’t) reflected in the standard investment planning concepts like the cost of capital. For now, I’m trying to wrap my head around the medium term – say two to ten years – the range where our crystal balls aren’t clouded by near-term noise or long-term chaos.

Here’s the story I’m toying with.

Abundance and the Marketing Arms Race

At present, inflation is a significant concern. Our concern is partially shaped by a skewed perspective. We got used to inflation being so low for so long. Inflation seemed to defy all expectations given the ultra-low interest-rate policy sustained for over a decade on a near-global scale. That policy ought to have provoked inflation, with money supply growing faster than economic activity. Inflation didn’t develop, though, for a complicated set of mutually reinforcing reasons.

Possibly the biggest reason was free trade and the entry of China into the global economy. For anyone living in conditions of extreme scarcity this will sound ludicrous, but on the whole, since the 1990s, the world has enjoyed unprecedented abundance, a glut of goods. Inevitably under market competition, prices stayed low.

But pricing is not the only lever producers use to compete for demand. Marketing/advertising is another way producers try to move their output. The thing about marketing is that it’s an arms race. You can’t afford not to do it when your competitors are. My perception is that the marketing arms race has been a significant driver of economic activity and technological development over the past two decades.

Advertising’s growth rate alone easily outstrips global GDP growth, meaning it takes up an ever greater share of the economy. In 2022, advertising spending stood at about 0.8% of global GDP, which doesn’t sound like much, until you remember that it doesn’t create value for anyone besides advertising company shareholders. Google, Facebook, and co. are the most obvious beneficiaries of the marketing arms race.

Additionally, innovation in the distribution angle of marketing – in particular the development of online sales/distribution platforms, your Amazons, airBnBs, booking.coms, Netflixes, etc. – has been equally crucial driver of change (and possibly, but not necessarily, growth).

As far as inflation – or the absence thereof – is concerned, these marketing-oriented technological innovations reinforced the downward pressure on prices. Sales/distribution channels put competitive pressures on traditional channels (retailers, movie theaters, etc.). Or cut out the middlemen entirely. And new advertising behemoths like Google offered services you’d previously have had to pay for – or didn’t have access to at all – for free.

Our rhetoric about technological change often carries a hidden assumption about its inevitability. “Change is going to happen; you can embrace it or be swept aside.” Maybe change is inevitable, but the direction of change need not be. Why do we develop certain technologies and not others? Why did the internet take off during the 1990s and not clean energy and batteries? The choice of directions in which we – as a society – innovate (or devote capital towards innovation) are guided partly by cultural preference, but also by economic constraints.

Did we choose to develop information technology rather than energy technology because for individual economic actors, the more urgent perceived problem was the glut of goods, not climate change? That’s my working hypothesis.

Scarcity and Demographic Change

Back to inflation. The proximate causes of the sudden surge in inflation were undoubtedly related to the pandemic and the responses to it: shifts in demand from services to goods, shutdowns in key sectors like semiconductors, the reduction of labor hours paired with a continued willingness to pay thanks to fiscal income supports.

But the pandemic coincidentally arrived at a demographic inflection point. Starting around the midpoint of 2020s (i.e., now), across much of the developed world (in which we may as well include China at this point), the ratio of the working-age population to the retired population is going to shift downwards. The pandemic may have accelerated this trend, as people on the edge of retirement decided to throw in the towel during the lockdowns.

The implication is a global labor shortage, without a commensurate decline in demand. Retirees will need food, utilities, shelter, transportation, and importantly, healthcare. They will want entertainment. Their retirement portfolios will have nominal dollars to pay for these things. But there will not be enough people to produce goods and services to meet their demand. Prices will rise: the savings portfolios meant to support retirees’ consumption will lose value relative to the goods the savings were meant to pay for.

Ironically, interest rate increases, insofar as they have historically curbed inflation by throwing a bunch of people out work, ought not to be effective against this kind of inflation. Rate increases might even exacerbate the problem: Fewer people working means fewer goods and services. Higher interest rates mean lower investment activity, which means fewer opportunities to boost output per labor-hour. 

Higher interest rates also mean more nominal income generated from retirement savings. Retirees may have more nominal dollars to spend.

The total result might be an equilibrium of relatively high inflation, relatively high interest rates, full employment, and low or even negative economic growth.

In that context of chronic scarcity of goods and services, will sales and marketing activities be as important as in the context of a glut? Probably not. If your product constantly sells out, why spend any money to drive more demand?

In the broadest terms, under these assumptions, we should see a shift of labor resources away from the marketing arms race, and towards increased production of goods and services that sustain and enrich lives. Fewer influencers and software engineers working on Tweets. More nurses and tradespeople, and more software engineers figuring out how to get the most out of each unit of labor.

And in the context of a persistent labor shortage, maybe the idea of “personal branding” will disappear entirely. Hope springs eternal.