Friday, November 14, 2014

Historical path and growth forecast: Regression to the mean

Lant Pritchett and Lawrence Summers argue that growth forecasters should taken into account the potential of a slowdown in China and India, especially their growth averaging towards the mean based on both internal (institutions) and external conditions (commodity prices, climate change, geopolitics, etc).

Excerpts from the paper:

Regression to the mean is the single most robust finding of the growth literature, and the typical degrees of regression to the mean imply substantial slowdowns in China and India. relative even to the currently more cautious and less bullish forecasts.

India and, even more so, China are experiencing historically unprecedented episodes of growth. China’s super-rapid growth has already lasted three times longer than a typical episode and is the longest ever recorded. The ends of episodes tend to see full regression to the mean, abruptly.

It is impossible to argue that either China or India has the quality institutions that have been associated with the steady dynamic of growth in the currently high productivity countries. The risks of sudden stops are much higher with weak institutions and organizations for policy implementation. China and India have very different modalities of this risk, but both have tricky paths to continued prosperity.

We suggest several implications of these conclusions. First, there will be a strong tendency to assume that, if growth slows substantially in China or India, it will represent an important policy failure. This is not right. Regression to the mean in a decade or so is the rule, not the exception. What would require much more explanation would be continued rapid growth, which would be very much outside the general run of experience. Second, those making global projections should allow a very wide confidence interval with respect to growth for countries whose current growth rates are far from the mean. Given the sensitivity of commodity demands in particular to growth rates in Asia, this suggests substantial uncertainty about the medium-term path of commodity prices. In the same way, forecasts of global energy use and climate change impacts should also recognize the possibility of discontinuities in Asia. Third, much geopolitical analysis has focused on the implications of a rising China, and certainly Chinese international relations theorists have extensively studied past rising powers. Contingency planning should also embrace scenarios in which Chinese growth slows dramatically, presumably bringing with it a range of domestic and international political implications.