Forecasting 2012

This year is going to be better than last year. That is the refrain we hear from many people today or read from the papers. Is this a forecast that is based on solid data on past trends and correct anticipation of the myriad of forces that will be at play this year or just an opinion that is based merely on hope?

About hope, I have not much to say except to rest my hand on the Bible, but this is what my forecasting book says: “Frequently, forecasts are wrong.”

What is a forecast? Because, formally or informally, we all make forecasts, my book says that we have an intuitive idea of what a forecast is—a probabilistic estimate or description of a future value or condition. As a definition, this may be enough for everyone, but my book says that good planning and control, especially in the military or business if I may add, require that a forecast includes a mean, range, and probability estimate of that range. Therefore, a forecast should not be a single value but a range of values. A good example in my book of a good forecast is this: “Expected sales next month for product X is 400 units with a 70 percent probability that sales will be 300 or 500 units” (that is a 35 percent chance of sales from 300 to 400 units and a 35 percent chance from 400 to 500 units). If you only forecast 400 units of product X in sales with no range and probability estimate, you implicitly assume that there is 50 percent change that sales will be lower than 400 and another 50 percent chance it will be greater than 400.

How do you make a forecast? Interested? I can help but not here.

Why is forecast frequently wrong? It is granted that a forecast is frequently wrong, but that is precisely the reason why a probabilistic estimate is used in forecasting. Because a forecast is frequently wrong, management should have plans for such contingencies. A contingency plan is another matter to know if you are in the military or business. For example, if sales in product X is not 400 but trending toward 300 or 500, what is your contingency plans in such events?  In short, what is your plan to minimize the negative effects of low sales or maximize the positive effects of high sales? A forecast is made to reduce the uncertainty or risks (the range of errors) in decision making; it cannot eliminate them entirely, hence the need for contingency plans.

And why is a forecast frequently wrong?  It is frequently wrong because the future can take many turns depending on present trends, many of which are undetected, and the interplay of many factors that will come in the future, many of which are not yet known today. In the larger scheme of things, for example, who knew in advance of the 2011 Arab Spring and the nature of its end? Surely, Mubarak did not forecast his ouster from Egypt, or Gadhafi, his death in the hands of his own people in Libya.

In the Euro Zone, one could have imagined many potential problems that might come with the use of the common currency. Who knew it would come in 2011 in the nature of an unsustainable fiscal deficit that could befell even to Italy, its third largest member? With the common currency, the Euro Zone economies enjoyed high sovereign ratings. It only cost little in interest for them to borrow. Many borrowed a lot like, including Italy. Now they find that in the end the market could punish the profligates with higher rates that they could not afford to pay without borrowing more.

In the US, they knew they had to stimulate the economy when Obama became president. They did not realize they were not doing enough given the real extent of the US recession that they came to know only later. In addition to the $500-billion fiscal injection to the economy that Bush made before he left the White House, the new Obama government decided to add $800 billion more in new stimulus. But that was based on a much lower fall of the US GDP as initially reported that  turned out to be wrong based on new data that came out later, which should have called for more fiscal stimulus.

That the stimulant was not needed or when made could only do more damage to the economy as argued by many critiques of the Obama government is another story to tell. Suffice it to say that the worse could have also happened had the Obama government not stimulated the economy at all or did what every sane individual would usually do in time of economic crisis—cut down on spending. For what is good to the part is not necessarily good to the whole. The UK government cut down to the bones their expenditures as an aftermath of the last global recession. Where is it now? It is in a much dire position than the US.

The Philippine economy grew in real terms, after removing the effects of inflation, by more than 7 percent in 2010. The new P-Noy government aimed to maintain this rate until 2016 to cut down our poverty. However, given the expected slowing down of the global economy after the 2010 recovery from the 2008-2009 global recession, P-Noy’s economic team realistically set the GDP growth target lower at 5 to 6 percent for 2011. It brought it much lower to 4.5 to 5.5 percent after seeing a much subdued growth in the first half of 2011. But after nine months, where the economy grew only by 3.6 percent, P-Noy would be lucky if the final growth figure for 2011 under his watch will reach 4 percent. The culprit was the drop in investments, exports and government expenditures. Were there contingency plans to meet these shortfalls? Were these effectively carried out? Ask P-Noy and his economic team.