07/27/2010 09:27 am ET Updated May 25, 2011

BRIC and Beyond: Should You Believe Long Term Economic Forecasts?

BRIC and N-11 are lists of countries expected to play important roles in the world's economy in the 21st century, according to Goldman Sachs. By 2050, many of these countries have been projected to have economies that will exceed some of the G-7 countries. This raises a key question which is, "what validity does an economic projection 40-50 years in the future have?"

When I was running forecasting teams in the corporate world, we had excellent accuracy out one quarter and good accuracy out 2-3 quarters. Beyond that timeframe, there were countless factors that we either (a) could not capture in our models, (b) could not predict accurately, (c) relied on someone else's prediction or (d) were severely influenced by new business decisions. The projections out a year or so would point to general trends but would be highly influenced by the broader economy as well as the actions the company would take in marketing, risk management and other areas based on these projections. Every new business was skilled at drawing "hockey stick curves" where exponential growth would take over a few years out and we needed to be careful as to which one these curves we should trust.

Projecting profit and loss at a company is conceptually similar to projecting economic growth at a national level. Many of the challenges are the same and I would suggest the time horizon for reasonably accurate forecasts is probably also similar. We can easily recall the '90s debates about how to spend the massive budget surplus arising from the end of the cold war...which turned to record breaking budget deficits only a few years later. In the most recent economic crisis (to be distinguished from the S&L crisis of the '80s and '90s, the Asian Crash of 1997, the Dot-Com crash of 2000-2) we once again saw that economic forecasts only a few years out tend to be too optimistic during boom years and too pessimistic in bust years.

So what should we make of economic forecasts 40 years in the future? How many economic forecasts from 1970 projected that China would be the largest exporter in the world in 2010? How many economic forecasts from the late '80s, when Japan was buying prized New York real estate, predicted Japan's future economic stagnation?

Clearly, I am not a big believer in long term economic projections but I recognize that they are necessary in spite of their vast limitations. These long term forecasts often consist of little more than a modified historical growth rate being plugged into an exponential growth curve then searching for arguments for why we should believe that this growth curve has any relationship to the future economy.

Let's recall that we can disaggregate the total GDP into two components: the total GDP of a country is equal to the total population of the country times the GDP per capita. While it's difficult to get a good projection of the GDP per capita decades out in the future, the total population can be reasonably projected. Population projections are based on the birth rates, death rates and immigration rates where, for most countries, the birth and death rates are the dominant factors. So, why do I feel confident that populations can be reasonably projected a few decades out? Because birth rates and death rates tend to have slow changing trends unless a major policy has been put in place that impacts birth rates or a major disease impacts death rates. For example, the U.S. birth and death rates have changed only slightly in the last 40 years. China and India are the only countries that have a population greater than 325 million (China currently estimated to have about 1.34 billion; India currently estimates to have about 1.18 billion). Barring a radical change in national borders or some cataclysmic event, there is virtually no question that these two countries will populations more than twice any other country in 2050.

How does this relate to BRIC and N-11? -Given the challenges in projecting GDP per capita we should pay special attention to the countries which are projected to have large populations/ population increases (a more accurate projection) and be more cautious about the projections from countries that are projected to have larger increases in GPD per capita (a less accurate prediction). In our list of BRIC countries, Russia is the one country not projected to be in the top 7 populations in the world by 2050. In fact, Russia's population is projected to decline by over 20% in the next 45 years. South Korea is the only N-11 country not projected to be in the top 18 populations by 2050 (population projected to remain relatively flat).

Not only is the total population an important factor in economic growth, but the age distribution is important. In the next article we'll talk about the "demographic bonus" and how this should play into economic forecasts.