The clouded crystal ball

Fairfax economics correspondent Peter Martin previously outed the dark art of economic forecasting. 'The shocking and little-acknowledged truth,' he claimed, 'is that most expert forecasts are wrong. Not only wrong, but more wrong than if they had been generated at random.' His comments were prompted by the International Monetary Fund's short-term forecasts for Europe, which were wildly off the mark, so it may seem that forecasts to 2050 are an exercise in irrelevance, often 'revised' every couple of years to account for significant changes to previous estimates.

The divine insight offered by such long-term economic projections is that emerging economies will generally grow at a faster rate than their developed counterparts. However even taking such sustained high growth for granted belies economic reality. As economies exploit copy and paste growth, develop and become more sophisticated, they gradually lose the relative growth advantages of starting from behind. Developing economies then face the realistic prospect of the middle-income trap, where rising wages and declining competitiveness makes them unable to compete with advanced economies in high-skill innovation or with developing economies in cheap manufacturing.

Projections from PwC to 2050 made headlines in Australia earlier this year as it claimed that 'the lucky country' would drop out of the world's 20 largest economies by 2050, replaced by Argentina, Vietnam, Saudi Arabia and Nigeria. The PwC model takes into account projected trends in demographics, capital investment, education levels and technological progress. However, their analysis of capital investment is flawed as it fails to factor the importance of the rule of law, government interference, political stability, and monetary control. Indeed, PwC adopts a Panglossian view of emerging development, a view that assumes broad growth-friendly policies are followed, ignoring the central role political risk has in determining market outcomes.

PwC's most ambitious prediction is that Nigeria will become the 13th largest economy by purchasing power parity by 2050. This projection is based primarily on two superficial factors: growth in working age population and endowment of natural resources.

First, PwC projects that the working population of Nigeria will rise by 3% per annum to 2050. However, working age projections are extremely sensitive to exogenous shocks (such as disease impacting mortality rate) and political adjustments (policies resulting in changes to immigration flows). Furthermore, efficient economic infrastructure is substantially more important to sustaining growth than sheer working age population. Indeed, rapid population growth poses significant political risk in itself as it places greater demand on the provision of government services, such as education, to avoid the middle-income trap.

Second, whilst Nigeria is blessed with a wealth of natural resources, this is not a guarantor of economic success. The historical prevalence of emerging economies reliant on commodity exports suffering from the 'Dutch disease' shouldtemper any exuberance for preordaining Nigeria a success. Furthermore, the presence of natural resources can also lead to an increase in corruption, resulting in the benefits of natural wealth doing little for the population as a whole. Moreover, with the onset of the natural gas revolution, revenue from oil exports could diminish gradually.

The PwC Nigeria projection is extremely sensitive to political risk. The report itself notes that the forecast depends on Nigeria 'using its oil wealth to develop a broader based economy with better infrastructure and institutions (e.g. as regards rule of law and political governance)'. Away from best-case scenarios and back to the real world – where Nigeria faces a raft of political risks including corruption and conflict (with the destabilising influence of Islamist group Boko Haram currently crystallising) – taking flawless economic policy for granted undermines the validity and utility of any forecast.

HSBC forecasts to 2050 are slightly more nuanced, taking into account rule of law and democracy ratings. These too, however, fail to include a generalised political risk rating. HSBC claims that factoring in assessments of political stability means that forecasts lose objectivity and become a matter of opinion. Surely if measures can be created that provide a rule of law and democracy rating, a measure could be devised that assesses political risk based on recent developments and historical precedent. The Eurasia Group's broad market watching, for instance, uses political risk measures to classify emerging economies into three categories: 'becoming developed', 'still emerging and problematically so', and 'backsliding'. Perhaps a projection that takes into account such political risk would overcome the perception of economic forecasters as irrelevant stargazers. However, the continued failure to account for political risk and resultant inability of forecasters to provide accurate long-term projections ensure that I am not rushing to invest in a Nigerian Prince.