What economists can learn from weather forecasters

In a speech to the Australian Business Economists Association, the Australian Reserve Bank Governor Mr Glenn Stevens compared weather forecasts to economic forecasts and made some interesting points. One can read the complete speech here(http://www.bis.org/review/r111129d.pdf). Some points he made were

1. Weather forecasts are based on understanding the big forces. that day's dynamics and explictly state their margin of error/give a range. Also, these are based on huge masses of data
2. Economic forecasts are similar but do not generally explicitly state margin of error.
3. Decisions based on economic forecasts may alter the outcome(like policy making, saving, spending) and so the process of economic forecasting is much more difficult. 

 Many financial authors and investors(in particular Mr Howard Mark of Oaktree) have trashed economic forecasts because they are often wrong, because there is little amity among forecasters, and because they have wide margin of errors. In contrast, despite our jokes about the weathermen, their short term forecasts are usually correct.

But to satisfy the logical side of us that hates ambiguity, forecasts are essential. So how to improve economic forecasts? Apart from not forgetting the big trends, having and using huge data masses of stock price/economic indicators should improve the accuracy. But most importantly, like how auditors are careful to word their audit reports to reflect the limited scope/margin of error, even economic forecasters should do the same, to bring more credibility to the profession.

Role of Distribution Channels in Value Creation

Earlier, it was proudly claimed that human capital was the non replicable asset. But now, with the free agent mentality firmly in place, it is 'real assets' which act as the entry barrier to competition. Even if competitors pay top dollar for the skilled/experienced employee, they may not have the deep pockets to pay superior margins to retailers for stocking the product/service in preference to the incubent. Competition laws intervene, and then the prospect of customer revolt at not getting his/her favorite product/service, would make even the strong hearted wilt. Investors/companies have both identified this trend and that is why

1. Network economics focuses on building that infrastructure first to obtain captive customers(though regulators may defeat it later by imposing open access) and dealers. 
2. Telecom companies are leveraging their vast dealer network(point of prescence) and payments expertise, to vye for mobile banking permits
3. Fertilizer showrooms are turning into FMCG godowns+All in 1 agricultural supermarkets, leveraging that fixed infrastructure in now desired locations(like DCM hariyali)
4. FMCG entry barriers are high because of the costs, time and issues in setting up distribution network-which would often overlap with the competition's incubent.
5. Insurance companies/Mutual funds are desperately trying to strike that golden mix between online and offline, as the regulators(SEBI for MF entry load, IRDA for ULIP commissions) are clamping down on commissions and imposing firmer entry conditions for the distributors. 
6. NPS(New pension scheme) despite being one of the best designed scheme in the globe, is not getting attention/subscribers because of demotivated distribution channels(banks/post offices etc)
7. Pharma is trying to secure its distribution chain to avoid the estimated 30% fake drugs in India.
8. Amul's strength is in its lakhs of dealers and milk collectors, who religiously supply milk daily. Besides the supply chain(milk), the distribution chain(showrooms, shops) is also efficient.

As marketing students know(and the above examples illustrate), distribution affects product design, success and company image. The company which cracks the puzzle, may take the ultimate prize of becoming the natural monopolist. So next time you analyze a company, pay attention to this aspect. B2B companies may not have so much issues, but B2C companies directly are impacted.

Gross or Net Capital flows to use in economic analysis?

In the financial world, the issue of which figure to use(gross or net) is quite important in several contexts

1. Revenue recognition:- Accounting rules have strict conditions for when to use gross/net values
2. Regulatory restrictions:- The stock exchanges margin requirements(for derivatives trading) permit netting out only in certain defined situations
3. Disclosures:- Where there are rights of setoff etc, the reporting institution(bank/FI) may want to netout the exposures and disclose only the net asset/liability on its balance sheet.

But it is in the area of investment policy and monetary management that this distinction is of most significance. Proponents of a gross approach(add inflows+outflows)  feel that(as mentioned in Dr Shyamala Gopinath's address to FEDAI in Feb-11 here)

• Gross capital flows contribute immensely to diffusion of technology and international knowledge flows. This is also why gross trade flows(imports +exports)  are considered while comparing the extent of 'openness' of economies
• It is gross flows that determine risk exposures and are therefore important for financial stability
• Netting of cross-temporal flows does not capture the real impact of gross capital flows on exchange rate as well as asset price impacts.  

 While proponents of the net approach(take the difference of inflows/outflows) feel that the reserves change only to the extent of the net flows, so that value only should be taken.

Before the subprime crisis, the net approach was widely considered but now the gross approach is also considered to be more representative. Still, for currency analysis, the net approach may probably work better
Bottom Line:- Depending on the purpose you want to analyze capital flows more, select the appropriate indicator(gross/net)