You cannot work out what's next for China by extrapolation

Investment means dealing with an uncertain future, but forecasting is a tricky undertaking.

The First Law of Forecasting

Human beings tend to follow a pretty simple formula when forecasting the future, namely: assume that current trends will continue. We might even call that the First Law of Forecasting.¹

That is not a bad approach when it comes to the short-term. But the longer the period we’re looking at, the more flawed that simple formula becomes. Because while trends are powerful, they don’t persist forever. A current example: Instagram was launched in 2010; the first picture of food was presumably posted somewhere around mid-October that year. Let’s suppose (based on rough anecdotal analysis) that, in 2016, 2% of all meals eaten by millennials in the U.S. are photographed and posted to that or another social media site. If the exponential growth trend continues, then by the time that generation reaches middle age they will be unable to actually eat anything on account of being so busy taking pictures.

China’s recent growth—and the future

Since 1990, official real GDP growth in China has been roughly 10% a year. That means the economy is more than 30 times as large today as it was 25 years ago. Astounding as the pace of growth has been, it is notable that nobody saw it coming. As I noted in a recent post: “China’s emergence as the world’s second largest economy is taken for granted today, but would be astonishing to an observer in 1980.”

Indeed, Dan Gardner (co-author of Superforecasting) has described how the popular books forecasting the economic future written in the 1990s rarely mentioned China at all and, if they did, reached a conclusion along the lines of this one from the then-bestselling Head to Head² by Lester Thurow: “While China will always be important politically and militarily, it will not have a big impact on the world economy in the first half of the 21st century.” That was published in 1992.

So even though China’s economic transformation became obvious once the trend was established, it would have taken unusual insight to foresee in advance. And just as it’s difficult to imagine changes that are not yet underway, so it can also be difficult to imagine the slowing or reversal of trends that are currently in full throttle. Difficult, too, to foresee the emergence of new trends and a change in the nature of the development. But history does not advance in a straight line.

So any forecasts looking beyond the immediate short term need to look beyond simple trends. And, as Gardner points out, the smart thing to do may be to temper our desire to forecast at all: “The focus must shift to preparing for an unpredictable future.” In other words, the key to dealing with uncertainty—not just in China but in every part of the investment process—might not be forecasting at all, but adaptability.

Author’s note: One of the nice things about working at Russell Investments is the sabbatical program; a chance to take a prolonged break after each ten years of service. As a result, I shall be away from the office from next week until August. While I am away, content for the Fiduciary Matters blog will be provided by guest authors.