Why forecasters miss the vital signs

By HAMISH McRAE

Why are people so hopeless at forecasting the world economy?

There are, of course, two short answers to this question.

One is that anyone who is any good would not publish a forecast but instead use it themselves to make some money.

The other is that anyone making a forecast has to craft it to the political and commercial interests of whoever has commissioned it and so cannot be truly frank.

The first answer is really a bit crass. Forecasters are professionals whose reputation is built on having a successful track record - and they are rewarded for that success.

Indeed, whole careers can be built on a reputation as an economic forecaster: Terry Burns, now Lord Burns, former head of the British Treasury, and Gavyn Davies, the new chairman of the BBC, both started that way.

The second answer has more substance. Official forecasters are invariably constrained by politics.

Governments do not like their agencies predicting economic failure, so hardly any of the post-war recessions have been forecast even six months in advance.

International bodies such as the OECD and the IMF are a little freer, but they too find themselves having to aim off a bit as they normally discuss their forecasts with their member governments before publishing.

For commercial forecasters there is less excuse and for academic ones, there is really none at all. Commercial forecasters are somewhat, shall we say, influenced by the needs of their employers to be upbeat.

At a company level this led to absurd growth and profit forecasts for high-tech companies, or rather forecasts that now appear absurd for they were taken very seriously at the time. But even at a Macro-economic level there has been pressure to massage up growth.

There have been heroic exceptions. My own favourites among the financial market houses are the people at HSBC. They worried about "bubble trouble" last year and this year were warning of global recession.

Ahead of September 11 they were, for example, forecasting US GDP growth this year at just 1 per cent, and the same for next year. At that time the consensus was for 1.6 per cent growth for this year and 2.6 per cent growth for next year. Now, post September 11, the consensus has caught up.

There is a big issue here. Of course September 11 has been deeply damaging to world growth. But it could hardly account for as big a collapse as we have seen.

After all, the impact on consumer confidence is being offset by further sharp falls in interest rates and there will be additional public spending as a result of the action.

No, the world economy was already in grave trouble on September 10.

We now know that industrial production in the world's big three economies was worse in the first six months of this year than at any period since the 1970s, yet this was reflected in only a few of the forecasts.

Most of them were wrong before the attacks and the subsequent turmoil has pushed the forecasters into a game of catch-up. So what is to be done?

Here are three modest suggestions for improvement. First, there should be more separation between, so to speak, church and state. Forecasters need to be more independent of their paymasters, be those in the public or the private sectors.

Second, academic forecasters should be encouraged. A generation ago, when they were the main people doing the job, everyone took notice of them. Now we tend to focus on the latest missive from some investment bank.

And third, there is a case for post-mortems. Forecasters should be asking themselves where they went wrong and why, and how they might lift their game next time.

- INDEPENDENT