Economic crystal balling

I’ve heard it said that we must discount government economic managers’ economic growth projections by up to 2 percentage points, because their positions oblige them to be publicly optimistic “cheerleaders.” If one is to go by the official government GDP growth projection for 2021 of 6.5 to 7.5 percent, the more realistic outlook would then be 4.5 to 5.5 percent. But as I explain below, even that may be a significant overestimate.

I, too, found myself in this “cheerleading” situation back in the 1990s, when as head of the National Economic and Development Authority (Neda) during the Ramos presidency, economic projections I announced were often described as overly optimistic. But these numbers are not plucked out of thin air, or generated via what some jokingly call the “ceiling method”—that is, staring at the ceiling and finding a number there. Neda then, and I’m sure now, had an econometric model of the Philippine economy as its primary economic “crystal ball.” The model had been developed and was being maintained under the expert tutelage of Dr. Roberto S. Mariano, a highly respected Filipino econometrician from the University of Pennsylvania and Singapore Management University.

But no mathematical model of any economy can claim to be a precise predictor of economic performance. Formulation of these models is informed by historical data on key variables found by careful statistical analysis to be closely related, based on sound economic theory, to the economic indicator in question (say GDP or inflation rate). The input data could be on variables such as employment, prices, trade, investment levels, money supply, previous years’ GDP, and others. Econometric model building entails seeking the most relevant data that have historically shown a strong relationship with the variable of interest, which could be GDP, inflation rate, employment, or others. A class of models called time-series models relies primarily on past trends of the same object variable to predict its levels in the future, in contrast to “structural models” that rely more on theoretical relationships with other economic variables affecting it. Whether structural, time-series, or a combination thereof, a model is judged on how accurately it can predict future GDP growth, price inflation, or other key variables.

Scientific as they may be, mathematical models of the economy can never capture all the factors affecting its performance. No economic model predicted the deep recession that COVID-19 caused in the past year, for example. Political, social, and environmental disturbances are either neglected or omitted in such models simply because these cannot be put into numbers. Thus, most practical modelers and economic forecasters are careful not to take the numbers spit out by their models at face value, and in reality, “fudge” them to account for those unquantified factors on the basis of instinct or best educated guess. One might surmise that the most accurate economic forecasters are the ones with the best combination of a good econometric model and sharp economic intuition. My Ateneo colleague Dr. Alvin Ang has earned a reputation for such accuracy, and I can attest that he is armed with a good combination of both, with credits for our economic model going to our modeler colleague Dr. Louie Dumlao.

So what does the Ateneo model say about 2021? I’d hate to preempt our upcoming Eagle Watch economic briefing later this week, but I would simply say that the number we’re getting is significantly less than even the discounted numbers I mentioned earlier. And it does make sense. After all, it took us five to six years to get back to our 1983 GDP level after the Aquino assassination then triggered a deep (-7.3 percent) recession. It also took the American economy six years to get back to where it was before the global economic crisis struck in 2008.

If we are indeed able to grow by up to 7.5 percent this year, as our government and other high-profile analysts boldly declare, it implies that it would take us less than two years to recover what we lost to COVID-19 last year. How I wish they’re right, but it sounds like wishful thinking to me.

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