By Paola Subacchi

'We have a prediction problem. We love to predict things – and we aren't very good at it.' These are the words of the statistician superstar Nate Silver, one of the few men in the world who actually does not have a prediction problem: he correctly forecast the results of the 2012 US presidential election in all 50 states

Each December experts are asked to predict events around the world for the coming year. Many of these are blindingly obvious -- or just plain wrong. According to Silver, one of the reasons for this is the Web, which allows bad ideas to circulate until they become conventional wisdom.

In the following pages Chatham House experts look at some of the notable surprises of 2012, and ask why no one predicted them, and what we can learn.

It has been a gloomy year, but 2012 could have been so much worse: the eurozone did not implode; the US struggled to maintain political sanity; and China's economy managed to avoid a hard landing. As a new year begins, the outlook for the world economy is ambiguous enough for optimists to claim that the glass is half full and for pessimists to say it remains half empty.

Take the eurozone. Exports have been steadily recovering since May 2010 and are now well above the pre-crisis levels. But domestic demand, and retail sales in particular, remain depressed while unemployment has reached historic highs. As a result, 2012 was a recessionary year, as economic activity contracted by 0.4 per cent in real terms, according to the latest forecasts by the European Commission. And in 2013 growth is expected to be very modest with an expansion in real gross domestic product of just 0.1 per cent.

In the autumn of 2011 the outlook for Europe did not seem so dire. While the European Commission flagged up the possibility that real GDP growth could turn negative in some member states by the end of the year, it also predicted a rate of 0.5 per cent for GDP growth in 2012 and 1.3 per cent in 2013. At that time, these forecasts seemed rather cautious. Twelve months on, they look extremely optimistic.

Projections for the British economy were equally off the mark. In late 2011 the European Commission predicted that real GDP would expand at 0.6 per cent in 2012, and this was broadly in line with what the government deemed a modest, but achievable target for GDP growth of 0.7 per cent. Independent forecasters were slightly gloomier and expected growth to be around 0.4 per cent. But like for the eurozone, 2012 was a recessionary year for Britain. Economic activity contracted by 0.3 per cent according to the European Commission's projections (and by 0.4 per cent for the IMF).

Why was the recession in Britain and the eurozone not predicted? Already by the end of 2011 it had become clear that austerity policies were likely to constrain growth. And with growth below the official forecasts, fiscal targets were becoming unattainable. Throughout 2012, economic data consolidated the view that the forecasters had missed: badly conceived and badly executed policies were responsible for pushing the eurozone and Britain back into recession.

Is there a lesson here? Perhaps there is, but it not just about economic forecasting. This was indeed the year when Germany softened its stance on the emergency measures necessary to stop the crisis in the eurozone. And it was the year when the European Central Bank became the 'lender of the last resort' and the first building block was laid for the proposed eurozone banking union.

Most importantly, 2012 was the turning point when the mantra that 'markets know best' began to be challenged. People have been questioning whether the extraordinary wealth creation of the past two decades has resulted in an increasingly unfair distribution of resources and diminishing welfare. They have been wondering whether the burden of the adjustment has also been unfairly distributed. Unless political leaders are willing to engage in an honest debate -- without any concession to populism -- then 2013 will be the year when the temperature of social discontent will become dangerously high in Europe.

 

Paola Subacchi is Research Director, International Economics at Chatham House

 

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