The world economy through a crystal ball

The Nobel Prize winning physicist Niels Bohr (1885-1962) is supposed to have said, “Forecasting is difficult, especially when it’s about the future” (although the comment is often also attributed to that perennial phrase-mangler Yogi Berra). But if forecasting the future is difficult for physicists, it’s even more hazardous for economists. Our forecasts are often wrong - although as the Liberal MP and columnist Bert Kelly (1912-1997) used to say, if they were right most of the time about the things they try to forecast, they would be in the south of France with their feet in buckets of champagne rather than economists. Of course, if they’re wrong most of the time, they don’t stay as economists very long either.

Nonetheless, forecasting is part of what I get paid to do, so here goes.

When thinking about the world economy over the next five years one thing we can be reasonably sure about is that China will account for an even bigger share of it than it does today. Already, properly measured, China (not Japan) is the world’s second biggest economy. If the long-run forecasts of more than 250 economists compiled last October by Consensus Economics are borne out, by 2010 China will account for about 17½ per cent of global output - still in second place behind the United States, whose share of world output will have shrunk by a percentage point to about 21 per cent - compared with around 14½ per cent in 2005.

Meanwhile India will have slipped past Japan into third place and - if oil prices stay relatively high, as seems likely if China continues to grow at the pace foreseen by the consensus forecast - Russia will have jumped from 9th to 6th.

One minor benefit of this re-shuffling of places at the top of the global economic league ladder is that France will no longer qualify - on the basis of its economic weight - for membership of the G8. So there might be a faint hope that a properly-constituted G8 could finally show some leadership on the question of agricultural trade reform.

Further down the scale, and again if the consensus forecasts are correct, Australia will have traded 16th place with currently 17th-ranked Taiwan - assuming that Taiwan is still near enough to a “country” in 2010 to figure in these rankings.

The problem with these consensus forecasts is that, for the most part, they merely extrapolate recent trends, with perhaps a cursory adjustment for demographic factors (although these don’t appear to have had much bearing on the rosy forecast for Russia, for example). Nowhere do they allow for a major cycle of recession and recovery.

One of the things that economists are particularly unsuccessful at is forecasting the timing of recessions. That’s partly because (fortunately) they don’t happen very often - typically once every 7-10 years in most advanced economies, except for Japan (where they’ve happened roughly every three years during the past decade) and Australia (where we haven’t had one now for 15 years). And (unfortunately) in some countries forecasting a recession can attract ridicule (OK, most of us can deal with that) or, more seriously, unwelcome regulatory attention or financial sanctions against one’s employer. All of which means that forecasting a recession can require a degree of intestinal fortitude as well as good judgment.

That said, it is hard to believe that, four years out from the last major slowdown in the world economy (following the “tech wreck” of 2000-01), we can expect to see another five years without a significant downturn in at least one major economy. Indeed, precisely because both economists and financial markets are currently assigning such low probabilities to such a downturn, investors need to be particularly attuned to the possibility that it could happen.

Last year, when agencies such as the OECD or the IMF sounded their bi-annual warnings about risks to the global economy, they pointed to high oil prices, elevated house prices, large US budget deficits, and persistent and widening external imbalances between the US and other major economic blocs as possible triggers for an economic downturn.

However, the world economy has proved remarkably resilient to each of these risks. Without denying that these risks are real, it would therefore be problematic to premise a point-forecast for the world economy (or any individual economy) on any of them being realised.

I suspect that a greater risk, and one for which it is easier to be more specific about timing, emanates - ironically, given the current euphoria about its prospects - from China. China hasn’t had a significant downturn since the years immediately after the Tiananmen “incident” (as the Chinese authorities refer to it) of June 4, 1989, when real GDP growth dropped to an average of about 4 per cent for two years.