Economics: The Optimistic Science?
Despite being agents of the so-called ‘dismal science’, economists are actually prone to making excessively optimistic forecasts about the future, according to a recent IMF research paper written by Giang Ho and Paulo Mauro.
Ho and Mauro looked at five-year forecasts for 188 countries and found systematic errors between what the forecast said would happen and what actually did. Forecasts for annual growth were, on average, inaccurate by between 0.3-0.4 percentage points for annual GDP growth.
Growth Forecast Error for 5 Year Forecasts Across 188 Countries
Source: IMF World Economic Outlook database
Note: Forecast errors are calculated as forecast minus actual outcome.
While economists can be forgiven for errors - accurately predicting GDP is incredibly difficult - its important to remember that they lie at the base of government tax receipts and expenditure forecasts, as well as corporate investment plans.
Ho and Mauro argue that overestimating growth can directly lead to government deficits and, possibly financial crises. Unexpected growth slowdowns can explain the debt crises in Latin America, Africa and the developed world in the past 30 years, where slower-than-expected growth and narrower tax bases put governments under severe pressure to meet their pre-planned budget commitments, triggering capital flight, devaluations and, in some cases, defaults.
What to do then? Economists and analysts must consider all of the possibility ranges when making a forecast: best, worst and mean. Doing this can allow policymakers and corporate decision-makers a full range of outcomes to prepare for. Most of all, it is best to bear in mind that actual growth rarely meets forecasts and that past growth is no guide to future outcomes.