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What’s the Secret to Economic Growth? We Just Don’t Know


 On Nov. 2, Federal Reserve Chairman Ben Bernanke confidently predicted that in 2012, the U.S. economy will grow at a rate of 2.5 percent to 2.9 percent. A few months earlier Bernanke predicted that the economy would expand 3.3 percent to 3.7 percent next year. A few months before that, the Fed projected growth in 2012 to be somewhere between 3.5 percent and 4.2 percent.

These shifting forecasts tell us two things: The U.S. continues to experience excruciatingly slow growth, and economists continue to have little success predicting it.

Understanding the drivers of economic growth is crucial to planning investment strategies, fending off recessions, and working out a country’s debt sustainability, among other things. If we knew how to raise long-term growth rates, it would be far easier to deal with Europe’s debt problems, tackle global poverty, and improve the quality of life for everyone on the planet. So it is no surprise that, every year, thousands of papers are published in economic journals and online, employing sophisticated models to explain past and predict future GDP performance of countries everywhere.

You would think that, armed with so much learning, their powerful models, and reams of data, economists would have anticipated that the recovery in the U.S. and Europe would stall, that growth in such places as China, India, and Brazil would accelerate, and that poverty rates would plummet in Africa. You’d be wrong. In fact, the myriad consultants and institutions purporting to understand the root causes of fast and slow growth resemble those stockpickers who offer a sure-fire return, but who are regularly outperformed by someone selecting a portfolio by throwing darts at a board. Anyone who says he knows the secret to growth is lying.

A few years ago, Prakash Loungani of the IMF looked at the accuracy of short-term economic growth forecasts by industry experts across a range of countries. Sixty recessions occurred in the countries he studied during the period covered by the forecasts. A grand total of two of those 60 were predicted by forecasters a year before they happened—which means the other 58 took economists by surprise. Two-thirds of all recessions remained unpredicted by April of the year in which they occurred. “The record of failure to predict recessions is virtually unblemished,” Loungani concluded. 

So don’t put too much credence in predictions either of a double-dip recession or of an economic recovery in the U.S. over the next 18 months. We just don’t know. Pretty much the only safe bet is that something will happen.

Loungani’s study was relatively limited in scope: It looked at economists’ attempts to predict economic shifts a year or two out in a set of largely advanced countries. Imagine the much larger challenge of predicting longer-term growth outcomes in a wider range of countries—not just rich ones, but also the Nigerias and Vietnams of the world. In fact, there’s no need to imagine: We are awful at it. 

In their 1997 paper trying to explain “Africa’s Growth Tragedy,” former World Bank staffers Bill Easterly and Ross Levine noted that in the 1960s, Africa was expected to grow faster than East Asia over the next 30 years by many, if not most, development economists. In the same decade, the economic model in the Soviet bloc was widely touted as a harsh but highly successful approach to escape poverty—not least because the Soviet Union had an immensely high investment rate. We know now, of course, that Africa stagnated and Eastern Europe collapsed, while East Asia boomed. 

And so predicting future growth in developing countries is pretty much a fool’s errand. But economists are not much better at simply explaining why growth happened where and when it did in the past.

Since 2005, according to Google Scholar, as many as 18,000 statistical analyses have been published of the causes of GDP per capita growth around the world. Lots of people are still out there searching for the answers to why East Asia grew fast and Latin America stumbled over the past 50 years, among other developments.

Yet policy answers have proved elusive. Economists Dani Rodrik, Ricardo Hausmann, and Lant Pritchett identified more than 80 periods since 1950 of “growth acceleration” worldwide—in which a country increased its growth rate 2% or more for at least seven years. The vast majority of those surges seemed to have had nothing to do with concrete economic policies.

So what’s the secret to economic growth? The short answer is that there appears to be no short answer. Economist Francisco Rodriguez exhaustively examined the cross-country evidence on “the causes” of economic growth and found that what is a good growth strategy for one country at one time isn’t necessarily a good growth strategy for another country in a different time. “We do not live in a simple world, where the same rules can be used to design growth strategies in China and in Chile,” he concludes. There are those who believe good acts are the path to economic salvation—liberalizing trade, raising investment. There are those who argue that wealth and poverty are predestined by climate and geography. Rodriguez’s paper suggests we can’t really know if either is right. But he doesn’t stop there. He argues that the available data don’t allow us to make any hard and fast statements about “what causes economic growth” at all. 

That there might not be a holy grail of growth policy, however, is unlikely to prevent people of economic faith from looking. The next six years will undoubtedly see another 18,000 papers on the topic. Just don’t spend too long reading them. Episodes of fast growth and stagnation around the world will continue to take us by surprise.

This might seem like discouraging news for policymakers—after all, GDP growth rates are a common metric of their success. Certainly, the evidence suggests that blindly following the successful growth models of Singapore or South Korea (if we could agree what that model was) is no guarantee of future wealth. But at the same time, the absence of answers should offer some measure of comfort for leaders struggling to drive their economies out of the ditch, in President Obama’s metaphor. Unless you are following the truly ruinous strategies of North Korea’s Kim Jong-il or Zimbabwe’s Robert Mugabe, you really don’t deserve too much blame for what happens. After all, even the supposed experts are pretty clueless about what works. And for investors, all this uncertainty suggests that the same advice that works with stocks might well work with countries. In a random walk through the global economy, it is best to diversify. China and India may look like excellent bets now, but don’t wager your whole retirement fund on their staying that way. Historically, growth spurts end. Consider putting some money behind the penny stocks of emerging Africa: McKinsey notes that foreign capital flows into Africa’s $1.6 trillion economy increased nearly sixfold from 2000 to 2007, to $87 billion. But most importantly, treat long-term growth forecasters with only a little more respect than you should be treating technical analysts. The snake oil-to-salve ratio is close to the same. There’s a reason it is hard to predict the future: It hasn’t happened yet.

Kenny is a senior fellow at the Center for Global Development and author of The Upside of Down: Why the Rise of the Rest is Great for the West.

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