Thursday, April 12, 2012

Forecasting Errors are Reason for Optimism

Over the past several weeks, maybe even months, the tone of many posts has been relatively pessimistic. This is not my stated intention, but rather a consequence of a naturally contrarian viewpoint facing off against an extremely bullish tide of economists and investors. While my current view on US stock markets and global economic growth over the next couple years remains bearish, my long-run expectations for society align with my general disposition as a rational optimist. (Quick note: I highly recommend reading The Rational Optimist: How Prosperity Evolves (P.S.) by Matt Ridley)

Forecasting errors in economics are frequent, and for good reason, since reliable predictions based on the future actions of human beings are extremely difficult, if not impossible. Institutions often muddy these attempts by imposing pressure on forecasters to offer predictions that benefit the political, social and economic standing of individuals, groups and political parties. For these reasons corporate earnings forecasts, year-end stock market outlooks, and economic growth projections often have an upward bias. Contrary to these often overly optimistic opinions, forecasts for life expectancy growth are consistently too pessimistic. This morning Timothy Taylor asked the question “What if Life Expectancy Grows Faster?” Taylor quotes a recent report from the IMF, Chapter 4: "The Financial Impact of Longevity Risk, which states that:

forecasters, regardless of the techniques they use, have consistently underestimated how long people will live. These forecast errors have been systematic over time and across populations. ... In fact, underestimation is widespread across countries: 20-year forecasts of longevity made in recent decades in Australia, Canada, Japan, New Zealand, and the United States have been too low by an average of 3 years.”
Think about that for a moment. Although 3 years may sound trivial to some, my personal view is that few things in life are more valuable than extra time.

Taylor and the IMF primarily focus on the extra costs associated with unexpected increases in life expectancy for pensions and other retirement benefits. Rather than focus on that negative aspect, I think it’s important to recognize that in spite of all the wars, economic crises and other struggles over the past 100 years, life expectancy continues to move significantly higher (chart below from IMF report):

These projections alone are reason enough to be optimistic, but the potential that they vastly understate life expectancy growth into the future is truly exciting!

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