Prognosis: Rosy

• Author: Giang Ho and Paolo Mauro
• Position: an Economist in the IMF's European Department and is a Senior Fellow at the Peterson Institute for International Economics and Visiting Professor, Johns Hopkins University Carey School of Business.

It is human nature to be optimistic. We tend to expect things to turn out better than they often do. “People hugely underestimate their chances of getting divorced, losing their job or being diagnosed with cancer; expect their children to be extraordinarily gifted; envision themselves achieving more than their peers; and overestimate their likely life span . . . .” wrote neuroscientist Tali Sharot in The Optimism Bias (2012).Â

Economists are not immune to optimism bias—the belief that the future will always be as good as or even better than the past and present. It can affect the way they predict economic growth, especially over longer-term horizons.Â

Many emerging markets and developing economies have enjoyed an extended period of remarkable economic growth. For example, between 2003 and 2013, China’s per capita real (after adjustment for inflation) GDP increased at an average rate of 9.6 percent. Nigeria, the largest developing economy in Africa, also fared well at 5.8 percent. This has been great news for the world economy and lifted millions out of poverty. But how long will this exceptional performance last? Forecasters often predict rapid growth to continue into the medium and long term, particularly for star performers such as China and Nigeria. But historically, the association between a country’s growth rate in a given decade and the next is weak (Easterly and others, 1993); in other words, past growth is not a very good predictor of future growth over longer periods.Â

Ebb and flow

Economic growth, like many things in life, is subject to a natural ebb and flow. In the late 1880s, English statistician Francis Galton showed that children of tall fathers tend to be shorter than their fathers. To describe this phenomenon, he coined the term “reversion to the mean.” Similarly, exceptional growth performance also tends to dissipate. Nevertheless, as economists Lant Pritchett and Lawrence Summers recently pointed out, professional forecasters may fail to take into account “reversion to the mean” (Pritchett and Summers, 2014). A closer look at professional growth forecasts over horizons of up to 20 years for a large group of countries confirms the existence of widespread optimism bias (Ho and Mauro, 2014).Â

Forecasts of economic growth into the medium term (say five years) and beyond are a crucial, if often overlooked, input into economic policymaking and strategic business choices. It is also notoriously difficult to forecast well, especially as the horizon gets longer. Yet decisions based on erroneous forecasts can have major adverse consequences for various aspects of macroeconomic policymaking, as well as for the bottom line of multinational companies and international...