Reliably High-Yielding 211-Year Investments

If economists cannot predict the GDP growth in the U.S. in a year or two, how can they predict the GDP growth in 5 years? Or in 30? The Nobel Prize-winning economist Robert Fogel believes that China will have an average annual growth rate of eight percent until 2040. This sounds ominous, until you stop to ask how Fogel knows what China will look like in 30 years.

In 1950, Mao and his Communist forces had just won the Chinese Civil War and proclaimed the People’s Republic of China. They were financially drained from both their civil war and the Second World War (Sino-Japanese War). To have had accurately predicted the growth rates from 1950 to 1980, one would have had to have known of the forthcoming Great Leap Forward, the Cultural Revolution, the Sino-Soviet split, and the opening of trade with the US. Understandably, all 30-year predictions of China’s growth were wildly off the mark.

In 1980, China was only beginning the “Reform and Opening” under Deng Xiaoping, including increased trade,  the decollectivization of agriculture, and special economic zones, combined with their one-child policy and massive urbanization. Who in 1980 predicted that China would soon be growing at ten percent per annum for two decades? They would have been laughed at.

Yet we still take such predictions seriously: barring any unforeseen events, China will become a juggernaut in X years. Unfortunately there are always unforeseen events that have significant effects.

In response to Fogel, Salvatore Babones says,

Like many other forecasts of China’s continued rise, these projections are based on careful formal economic modeling. But are they convincing? Extrapolating from current trends may make sense when predicting growth in the next year and the year after that, but once the years turn into decades, such assumptions seem more questionable. If my ancestors had invested a penny in my name in 1800 at a real compound interest rate of six percent per year above inflation, that penny would now be worth about $280,000. That does not mean, however, that reliably high-yielding 211-year investments are easy to find. Things change; things go wrong. Past returns are no guarantee of future performance.

When it comes to gauging China’s future growth, economic modeling can offer only so much guidance. The models predict future economic outputs on the basis of projected future levels of economic inputs, but future economic inputs are impossible to predict. In the end, there is little to do but extrapolate from current inputs. But inputs, as well as other key features of any economy, change over time. China’s economy is evolving rapidly: from subsistence agriculture to smokestack industries to the latest electronics to consumer services. And at some point in the future, perhaps in the not-too-distant future, China’s excess growth rates will level out and its economic growth will slow down, returning to rates more like those experienced by comparable countries.

The article is a great read to counter the steadily growing body of writing that suggests China’s rise is inevitable. But in addition, it offers us this important reminder: be skeptical of long-term forecasts and predictions.

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1 Comment

Filed under China, Economics

One response to “Reliably High-Yielding 211-Year Investments

  1. Ernesto

    Couldn’t agree more. Economic forecasters are not paid to be bold or challenge assumptions, they are paid to marginally adjust growth rates according to a basket of factors they do not really understand and cannot predict.
    If the underlying social/political tensions don’t rock the boat the inevitable burst of the ridiculously upside-down real estate bubble certainly will. The problem is, I think I actually may be more afraid of a serious Chinese political and economic crisis than I am of mindless projections of their compound growth over 30 years.

    No es Grecia, es China | Internacional | EL PAÍS http://bit.ly/oT6Knw

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