Asia-phoria meet regression to the mean

There are two common failures in economic forecasting. One is excessive extrapolation of the (recent) past into the (distant) future, particularly susceptibility to ?irrational exuberance? (Schiller). The second is excessive subjective certainty that relies on confidence in continuity and hence consistently under predicts discontinuities?even relative to their known past probabilities. While the more bullish attitudes towards growth in China and India have been softening, the official forecasts in the IMF World Economic Outlook and the general discussions about the future of the global economy are often premised on the continuation of perhaps slower but growth that is super-rapid (more than two standard deviations above the cross-national average) in both China and India. We make three points. First, the single most robust empirical finding about economic growth is low persistence of growth rates. Extrapolation of current growth rates into the future is at odds with all empirical evidence about the strength of regression to the mean in growth rates. Second, especially outside of the OECD countries, the process of economic growth is not at all well characterized by business cycle variations around a (relatively) stable mean. Developing country growth rates are strongly episodic and large (and apparently discrete) shifts in medium-term growth rates of 4 ppa or more common?and particularly prominent are large slowdowns. Episodes of super-rapid growth tend to be of short duration and end in decelerations back to the world average growth rate. Both China and India are already in the midst of episodes that are historically long and fast. Third, while we are not predicting sharp decelerations in either economy, there are plausible scenarios based on identifiable fissures in existing growth processes that could lead to sharp and sustained periods of slow growth. We are not arguing that one can predict with any degree of accuracy or confidence a slowdown but certainly policy makers need to be prepared for a wider range of extended slow-growth outcomes in these Asian giants that those that currently dominate the discourse. Hitching the cart of the future global economy to the horse of the Asian giants carries substantial risks.