Why economic forecasts don't come true

In the middle of the last decade, the average annual growth rate of fast-growing markets for the first time in history went over 7%, and fans of looking into the future vied with sensational forecasts about what this will lead to in the near future. China would soon overtake the United States in economic power, they said, and India, with its huge population, or Vietnam, with its ability to extract maximum dividends from state capitalism, would be the next China. Looking for a political sensation, analysts predicted that Beijing would soon lead a new rising bloc of countries called the BRIC-Brazil, Russia, India, and China - to economic superiority over the fading Western powers. Suddenly, there was a race to see who could quickly invent the next " hot " abbreviation: some offered MICT (Mexico, Indonesia, South Korea, and Turkey), others - KIWETYU (Colombia, Indonesia, Vietnam, Egypt, Turkey, and South Africa).

Today, five years after the start of the 2008 financial crisis, euphoria about the bright prospects ahead for fast-growing markets and new acronyms is sadly misplaced. The average growth rate of developing countries fell to 4 percent in 2013. Meanwhile, the BRIC markets are stalling, each for its own internal reasons. Their summits only show once again how difficult it is to put together an influential bloc of authoritarian and democratic regimes with different economic interests. Those-

Ruchir Sharma is Head of Emerging Markets and Global Macroeconomics in the Investment Management Department at Morgan Stanley and the author of " Countries Taking the Leap: Chasing the Next Economic Miracle." Published in Foreign Affairs Magazine, No. 1, 2014. © Council on Foreign Relations, Inc.

Now that the hype has subsided, analysts are left to rethink the mistakes they made at the peak of the economic boom.

There were a great many of them. Forecasters stopped looking at fast-growing markets separately from each other, depersonalizing them with catchy but mindless abbreviations, through which they tried to unite completely different powers. Experts listened too closely to the words of the political leaders of fast-growing countries, who were happy to explain the economic boom with their wise leadership, but ignored other factors, such as the easy money that came from the United States and Europe and allowed them to build up their power. Analysts also overestimated a single factor in their forecasts- favorable demographics, for example, or globalization - while all research suggests that economic growth depends on a tangle of different forces and circumstances.

First of all, the cardinal mistake was extrapolation. The authors of the forecasts assumed that the trends of recent years will continue indefinitely, and the " hot " economies will remain so indefinitely. At the same time, they completely ignored the cyclical nature of political and economic development. Euphoria drove out common sense and judgment. For this reason, economic forecasts are often incorrect.

SINGLE FACTOR SYNDROME

History shows that straight-line extrapolations are almost always wrong. Yet analysts cannot avoid the temptation to use them in their forecasts, because they are often wishful thinking and often driven by fear. In the 1960s, the Philippines won the right to open the headquarters of the Asian Development Bank on the grounds that the rapid growth of the Philippine economy would make the country the star of the region for many years to come. But those hopes were not to be realized: growth stalled in the next decade due to the incompetent policies of dictator Ferdinand Marcos (despite the fact that the Asian Development Bank did not go away). But the predilection for extrapolation proved persistent, and in the 1970s such thinking led US economists and intelligence agencies to predict that the future lay with the Soviet Union, and in the 1980s with Japan. The past decade has seen a boom in fast-growing markets, and extrapolation has allowed analysts to reach new heights of confusion. Authors about-

The gnoses pointed to the economic power of China and India in the seventeenth century as proof that these countries will dominate not only in the next decade, but throughout the twenty-first century.

The boom has highlighted another classic predictive error: relying on the single-factor theory. Since China's boom was partly driven by the cheap labor provided by the rising young generation, analysts began to look for the next "hot" economy among powers with similar demographics, forgetting that the country must have a powerful industrial production that can create jobs for all young people entering the labor market. Liberals prayed for more transparent state institutions to encourage entrepreneurship, even though in the post-war era, authoritarian regimes were no less likely to move quickly to economic growth than in countries with democratic governance. For reasoners, debt is always a bad thing (the 2008 credit crunch further reinforced this bias), but at the same time, economic growth goes hand in hand with credit.

The problem with single-factor theories is that they have nothing to do with current events and do not take into account other circumstances that make each country unique. On the one hand, institutions and demographics are changing too slowly to serve as indicators of the direction of economic development. On the other hand, analysts who argue that some cultures are designed for rapid economic growth and others are not, overlook how quickly a culture can change. Just look at Indonesia and Turkey, major Muslim-majority democracies, where rapid economic growth dispels the myth that Islam is incompatible with economic development.

Generalizing theories often don't look at things in dynamics. Those who took geography into account as a key factor were unable to predict the rapid growth in the past decade of countries that did not have a favorable geographical location. We are talking, in particular, about Armenia, Tajikistan and Uganda, which have no access to the sea. Rising oil prices have allowed Kazakhstan to emerge from the economic depression of the post-Soviet years.

The clarity and comprehensibility of single-factor theories make them attractive. But, ignoring the rapid changes in global competition, they are not able to offer a convincing scenario or forecast, on the basis of which it would be possible to build plans for 5 - 10 years. The truth is that economic cycles are short, and it usually takes 3 to 5 years from rise to fall. Competitiveness of different countries of the world

during this time, it can change dramatically, either due to technological innovations or due to political transformation.

HERE AND NOW

In fact, although analysts are extremely reluctant to agree, each decade that follows is almost always radically different from the previous one, if you take into account the fact that the stars of the economy are often those who in the past were outcasts and losers. For example, Mexico, once known for its stagnant economy, has now become one of Latin America's most promising economic powers. And the Philippines, which was once widely pitied, is now among the most advanced, with an annual growth rate of more than 7 percent. Pakistan, which was described on the cover of The Economist magazine as "the world's deadliest place," is suddenly showing signs of financial stability. Its stock market performed among the best last year in terms of growth dynamics, although it was overtaken by another unexpected newcomer to the club of fast - growing markets-Greece. A number of market indicators have recently downgraded Greece from being a "developed country" to an "emerging market"; but the country has sharply reduced public spending, wages and prices, and this has made its exports competitive again.

The experience of such countries once again shows that political cycles are no less important for the country's prospects than economic ones. Crises and recessions often lead to reforms that can later turn into an economic recovery or even a boom. However, such success may result in the passivity and arrogance of political leaders, dooming the country to another downturn. The boom of the last decade seemed to refute this scenario, since almost all fast-growing economies showed phenomenal growth and were not prone to recessions. However, the big Bang of 2008 brought the cycle back to normal. Former stars like Brazil, Indonesia, and Russia are now losing ground due to poor management or complacency. The essence of this problem was expressed aphoristically by Indonesian Finance Minister Mohammad Shatib Basri, who said that "difficult times force us to implement the right policies, and favorable times usually relax."

Governments in developing countries can avoid this trap only if they stick to a consistent course, even in UAVs.-

These are bad times, because for such economies, this is the only way to catch up with the developed world. But this is not an easy task. In the post-war era, only a dozen states accomplished this feat-a few countries in Southern Europe (such as Portugal and Spain) and East Asia (Singapore and South Korea). Probably, for this reason, only 35 countries of the world are considered "developed" today.

Meanwhile, the chances that an increasing number of new States will make their way to the top echelon are slim, given that reforms aimed at improving labor productivity are very difficult to come by. People tend to grow fat at a good time and hope that it will never end. But most often, success is fleeting. Argentina, Greece and Venezuela achieved western incomes for their populations in the past century, but then fell back.

Today, in addition to Mexico and the Philippines, countries such as Peru and Thailand are developing successfully. These four powers have something in common that unites many of the stellar economies of recent decades: a charismatic political leader who understands the essence of economic reforms and has a mandate from voters to implement them. Still, don't get euphoric. Such reforms usually last between three and five years, so don't expect a Philippine or Mexican century to flourish.

A BALANCED APPROACH

Analysts should not look too far into the future, but they need to think big to take into account the full range of different factors that depend on sustained and rapid economic growth. As the country gets richer, their list changes. Simple projects, such as paving roads, can do more to support and stimulate a poor economy than prematurely launching programs to develop advanced technologies. But soon, the benefits of the underlying infrastructure start to bear fruit.

As economic conditions change, so should the strategy. Five years after the start of the global financial crisis, excessive borrowing is still a serious problem, especially if debt is growing faster than GDP. In fact, too much public debt is a burden for fast-growing economies such as China, which is accelerating borrowing in the name of maintaining economic growth. Vietnam, once lauded as

"China of the Future" actually outplayed China in the endgame, but this is by no means the victory it was hoping for. Vietnam has already suffered from an economic crisis caused by a huge national debt, and is just beginning to pick up the pieces and close down failed banks.

To keep economies running, political leaders need to ensure balanced growth that covers all sectors of the national economy (and is not too dependent on borrowing), all classes of society (not concentrated in the hands of a few billionaires), all geographical regions (not just metropolitan cities) , and manufacturing industries (not limited to corruption-prone industries such as oil production and export). And it is necessary to balance all factors, corresponding to the level of income of citizens. For example, Brazil spends too much on building a welfare state; this spending is too high for the average Brazilian income of $ 11,000 per year. However, South Korea, where the average income is twice as high as in Brazil, spends too little on social programs.

Many political leaders see certain economic evils as timeless, common developmental problems, but in reality there is a limit to greed and graft, paradoxically. Inequality usually increases during the first stages of economic growth. Having reached a certain limit, the gap between rich and poor begins to narrow. This equilibrium point is somewhere in the region of an annual income of 5 thousand dollars per capita. On this curve, income inequality is significantly higher than normal in Brazil and South Africa, but in countries such as Poland and South Korea, it is not as worrisome or critical. The same income-adjusted approach applies to corruption, which implies, for example, that Chile has surprisingly low corruption for its income level, while Russia is disproportionately corrupt.

ASK THE LOCALS

However, no theory can replace the local population, which is always more sensitive to the direction in which the national economy is turning than analysts. Thus, business people in India predicted a slowdown in the economy in advance, complaining in unison about corruption. The growing cost of bribing corrupt officials encouraged them to move more funds abroad, even though foreign investors still invested heavily in the Indian economy.

There is no substitute for studying the situation "in the field", on the ground. Analysts who track investment in fast-growing markets use China as a yardstick, as the level of investment in the Chinese economy has approached 50% of GDP, which is completely unprecedented and dangerous for any developed country. But the investment risk becomes obvious only if you are in China and see what all this money is going to-ghost cities with skyscrapers and other empty projects. At the other extreme are Brazil and Russia, where, on the contrary, lack of investment affects the development of the service sector, the state of the road network, and in Sao Paulo, CEOs of companies rely only on helicopter pads on the roofs of skyscrapers, desperate to overcome hopeless traffic jams.

Economists tend to ignore the impressions of specific people and policies as too abstract to be quantified or analyzed, and do not include them in their forecasting models. They tend to study the political environment through the lens of figures that reflect the state of government spending or interest rates. But mere statistics can't tell you how charismatic leaders like the new President of Mexico, Enrique Pena Nieto, or the President of the Philippines, Benigno Aquino III, are influencing the economy. These leaders take drastic measures against monopolists, bribe takers, and officials who fail to perform their duties.

A pragmatic approach to determining who is likely to win the next emerging market boom requires taking into account this reality and the fickle nature of global competition. An analyst trying to make a more or less reliable forecast should track a changing list of more than 10 factors, from policy to borrowing to investment flows, and assess the prospects of each developing country over the next three to five years - a realistic time horizon for current political leaders, business people, investors, or other stakeholders in current events. With this approach, there is no place for provocative forecasts for 2100 or prophecies for the even more distant future. The goal of such analysts is to provide a practical guide to the rise and fall of countries in real time and in the foreseeable future: in the current decade, not in the next and not in 30 to 40 years. Perhaps the forecasts won't be particularly dramatic. But the recent market crash has shown just how dangerous over-dramatization can be.

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