Limitations of economic forecasts

I was invited to speak at the PICPA Eastern Visayas Conference last week on the topic, Philippine Economic Forecast 2023 and Beyond. I suggested earlier, that as it is already May and many forecasts have been made since December last year, I would instead talk about the Limitations of Economic Forecasts.

I was at DENR recently and dropped by the NEDA office to inquire if the Q1 official GDP statistics were available. It will be on May 11 yet, but they emailed me economic data for the last seven years including for the Regional GDPs, which showed that Eastern and Western Visayas economic growth mirrored that of the whole country in 2022 at 7.6%, which brings us to the first limitation of economic forecasts.

The 7.6% GDP growth in 2022 was coming from the low base in 2020 and 2021, so it was expected to be big in percentage. The Philippine economy shrunk by -9.5% in 2020 to $361.75 billion from $376.82B in 2019, then went positive by 2021 at $394B. This is the “base effect” that economists always caution when talking about economy percentage growth. From a low base the percentage increase would always look bigger. Nevertheless, the Philippine economy did recover and grow, but it would have been bigger if we didn’t experience recession due to the pandemic and government’s response.

Another unavoidable problem of economic forecasts is the inability of most forecasts to consider “black swan” events like the pandemic. Arguably it may have been impossible to predict the pandemic, but some “think tanks” posited the probabilities of Russia invading Ukraine, so the impact on the global and individual countries’ economies could have been better estimated. In 2018, the World Bank’s prediction for the Philippine economy for 2020 was for a GDP growth of 6.6%, which is 15% wrong in the opposite direction of the -9.5% contraction. The impact of science and technology is also another limiting factor in forecasts. Technological advances and their impacts on the economies are really unpredictable. The advent of computers, internet, artificial intelligence (AI), alternative energy sources, etc., and their adoption into the economy while mostly positive are uneven among countries. This should get better in the coming years as AI takes over most data analytics and robots take over more mechanical operations.

The impact of the “informal economy” is another limiting factor in economic forecasts. Particularly in developing and underdeveloped countries, there’s a sizable portion of the economy that are unrecorded as they do not get licenses or pay taxes or have records. These could be as big as 20% of the total economy and are mostly in the lower income group. These are the street vendors, home businesses, small agriculture and services. In an economic downturn, like in the pandemic, they were affected most as they had no savings or spare capital, so they suffered the most. Government subsidies were never enough and most of them survived through the help of better-off neighbors. If we factor them in economic loss of output, the Philippine recession was worse off than the 9.5% economic contraction. The positive side of the informal economy is that in a growing economy, they also recover faster and better due to the smaller capital/logistical requirements. They make the formal economy grow faster with the peripheral input in the demand and supply side even if unrecorded.

Limited discussion in economic forecasts of the impact of the GDP components on the lives of the people is another aspect than can be improved. While there are enough details in the GDP components both in the demand and supply side of the economy, it doesn’t get the attention of enough government officials. The annual budget appropriations don’t reflect needed economic priorities. Enormous “confidential and intelligence” funds appropriations, means the government and politicians prioritize political expediency over economic development.