February 6, 2019 / 3:18 PM / 5 months ago

Breakingviews - Hadas: GDP forecasters need to lower their sights

LONDON (Reuters Breakingviews) - Global economic growth forecasts are drifting downward. The errors are not really surprising.

A child poses for her mother in front of the China Pavilion at the Shanghai World Expo site April 25, 2010. REUTERS/Aly Song

Changes to the International Monetary Fund’s predictions are typical. In April 2018, the international lender expected the world economy to grow 3.9 percent in 2019. By January 2019, its forecast had fallen to 3.5 percent.

The IMF blames trade tensions and tightening financial conditions for this year’s lost output, worth roughly $350 billion. Berenberg Economics is worried about a “cocktail of risks”, including U.S. and British political gridlock, populist governments’ bad economic policies and “a potential drop in U.S. confidence”. And everyone is fretting about a Chinese slowdown.

These can only be part of the explanation. Financial conditions were widely expected to tighten, trade tensions and Brexit have been bubbling for some time, and populist governments mostly seem keen on fiscal stimulus, which tends to push up economic activity in the short term. Falling confidence sounds more like an excuse than an explanation.

More likely, forecasters’ models are poorly calibrated to bigger trends in the global economy. First, GDP is a measure that misses many improvements in the quality of life. It was designed to count up traditional industrial production – cars, cement and other stuff that comes out of big factories. It is too crude to capture many of the gains created by information and communication technologies, reductions in pollution and improvements in health. In developed economies, striving for these more intangible life-enhancements account for a big portion of new economic activity. GDP is out of touch.

Meanwhile, the statistics agencies in developing countries, home of much of the world’s economic dynamism, generally struggle to include higher output from the informal economy. National GDP calculations tend to miss the significant lifestyle improvements from improved productivity at small firms and farms.

The result, in both rich and poor countries, is what might be called cognitive dissonance. GDP statistics tend to miss good economic news, while the forecasters, who look at improving labour skills and enlarging capital stock, tend to expect it to be counted.

Demographic changes could be another source of forecast error. The prognosticators know about falling birth rates, but may underestimate their effect. It’s fair to expect the declining number of children to lead to smaller houses, lower investments in infrastructure and less time and energy dedicated to GDP-increasing careers.

If so, some striking demographic imbalances point to sustained lower growth rates. In Germany, there are 48 percent more people in their 40s than under-10 year olds, according to the populationpyramid.net website. In Japan and Italy there are 74 and 77 percent more respectively.

China does not yet suffer from a lack of consumer drive, even though it has 39 percent more people in their 40s than in the under-10 set. But its GDP per person is only 36 percent of Germany’s, according to the IMF. The typical Chinese worker would love to see the country meet the official 6.5 percent annual GDP growth rate target for decades to come.

Forecasters should not, however, live on government-hyped hopes. Even without considering the growth-depressing effects of China’s high debts, still-pervasive corruption and increasingly restrictive governance, economic expansion inevitably becomes harder after a country reaches upper-middle-income status. The shift from mass production to services requires more skills and coordination than the initial move from farm to factory.

Commodity producers inspire another type of unjustified optimism among economists. Few countries have made good use of the profits from exporting oil and other raw materials. Hopes for Saudi Arabia, Iran, Iraq and other lands with more wealth than social infrastructure are likely to prove vain.

Similarly, forecasts for developing countries often rely on generous estimates of the effect of financial capital from developed peers and of their ability to overcome weak institutions. Sometimes that money brings growth-reducing financial, currency and political crises.

The effects of these trends on the real economy vary. Undercounted economic gains and lifestyle choices reduce reported GDP growth without eroding actual prosperity. China’s more arduous path to growth and the weak institutions will weigh on measured GDP and the actual quality of life relative to forecasters’ expectations.

However, all these trends cause the same problem for debtors. If GDP growth rates keep undershooting expectations, the burden of making payments will increase. Unexpectedly high inflation can keep defaults away but price rises have generally been tame for the last three decades.

Any financial pressure comes at a bad time. Globally, leverage is high, policy interest rates are still low and wealthy financiers are widely distrusted. The ingredients are present for something much worse than reductions in forecast numbers.


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