Daniel Ben-Ami: Avoid the confidence trap

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When a blatant error is repeated frequently it is worth thinking about why. In this case the example is not directly related to investment or economics but there is an important parallel.

Some readers might have seen the recent report apparently showed six-year-olds outstripping adults in their understanding of information technology. Since it was reported widely in the media and the source given was Ofcom, the official communications regulator, the claim appeared unimpeachable. The coverage gave the impression that even young children are leaving adults behind in this brave new digital age.

But look carefully at the Ofcom website and a different pattern emerges: “The study, among nearly 2,000 adults and 800 children, finds that six year olds claim to have the same understanding of communications technology as 45 year olds” (added emphasis). The key phrase here is “claim to”. Just because a six-year-old believes something is true it does not mean it should be taken at face value.

Do Ofcom’s online digital aptitude test and things start to become clearer. Many of the questions ask respondents to rate how much they know about technologies such as Google Glass or smart watches. No doubt the typical adult is likely to be reluctant to claim they know a great deal about a subject unless they do. In contrast, young children are likely to have fewer inhibitions about exuding confidence.

What is really being measured here, contrary to what much of the media claimed, is confidence in the use of digital technologies. Young children are more confident because they do not appreciate the world’s complexity. They are unlikely to express doubts because they do not know any better. Adults, in contrast, tend to be more equivocal simply because they have a better appreciation of the vastness of human knowledge.

This confusion of confusion and knowledge is where the economic parallel comes in. It is often claimed that confidence is the key factor driving markets and economies. Consequently analysts often pay great attention to confidence surveys of consumers, investors and companies. Buoyant markets are also often associated with high levels of confidence.

The problem with this approach is that confidence is a poor indicator of economic strength. At best the two may be correlated. But it is more likely that any economic uptick is driving higher confidence than the other way round.

More likely the confidence numbers are simply a response to short-term buoyancy in the economy or markets. For instance, easy credit can give the economy a temporary boost that in turn boosts confidence. But in such circumstances the underlying fundamentals can remain weak. Key indicators such as productivity levels or the strength of corporate investment are not reflected in the confidence figures.

All the talk of confidence can also give a misleading impression of the challenges facing the economy. Mainstream economic debate often suggests that recovery is simply an act of will: if consumers and companies would only become braver an upturn will not be far behind. It sees little need to find ways to rejuvenate the real economy.

Confusing confidence with knowledge inevitably leads in the wrong direction.

Daniel Ben-Ami is a writer on economics and finance. His personal website can be found at www.danielbenami.com