Uncertainty Principles

Last week I gave a presentation to GE’s Chief Financial Officers Customer Summit, at our Crotonville Learning Center (GE’s “secret weapon”). My presentation covered the global environment, and how our companies can best navigate it.

A key feature is the uncertainty we face today. I can see most of you nodding in agreement, thinking of the US elections, Brexit, the anxious checking of the French exit polls.

But just how much uncertainty is out there, and what drives it?

Nicholas Bloom, Scott Baker and Steven Davis have developed an Economic Policy Uncertainty Index that covers 19 countries as well measuring global and European uncertainty.

Global uncertainty is higher than it has ever been since January 1997, the start of the index. How much higher? The last reading, March 2017, is over twice as high as the full-period average, and over three times higher than the average of January 1997-July 2007, just before the Global Financial Crisis made a mockery of the “Great Moderation” theories.

Global uncertainty has reached new highs

Before you read on, take a minute to think what you instinctively associate with this much higher level of uncertainty.

Ok. Now look at the chart for the US.

U.S. uncertainty is high, but not the highest it has ever been. March 2017 is only 50% higher than the full-period average, and 80% higher than in the ‘good old days’ (pre-crisis). Not as bad as global uncertainty.

Not what you expected? Not what I expected either, and our customers were surprised as well. So what is driving global uncertainty?

The next three charts show the uncertainty index for the UK, Europe and China. Now we’re getting somewhere. The UK is a little worse than the US over the whole period (60% higher) and a lot worse compared to pre-crisis (over three times higher). Europe’s economic policy uncertainty is 70% and 135% higher; China’s is 300% and 540% higher — six times as high as in the decade before the global financial crisis.

Even when US uncertainty spiked with the November Presidential elections, climbing 160% higher than pre-crisis, UK, EU and China fared worse, 900%, 300% and 500% higher respectively.

Is it a case of ‘when the US sneezes, the world catches a cold’? We get a more nuanced picture if we look at a few more countries:

Brazil, Singapore, and to a lesser extent Korea have also seen a greater rise in uncertainty than the US; but Chile a much smaller one, and in India uncertainty has actually decreased. (For India and Singapore the index only begins in January 2003)

What do we make of this? A few thoughts:

— Populism and protectionism have raised global uncertainty. Small open economies feel the impact even if they enjoy a stable domestic policy environment, as Singapore.

— For larger economies, domestic policy (in)stability dominates. Brazil and India are the two extreme and opposite examples: the latter has seen a significant improvement in the policy environment with a more stable government; the former suffered increasingly unsustainable policies and a surge in political volatility.

— Stable policies can go hand in hand with extreme uncertainty. China’s leadership has run a stable and well-designed economic policy for a very long time; but its efforts to rebalance the economy from investment to consumption while boosting the private sector and moving up the value-added ladder have now entered the most difficult phase, with greater risk of accidents and policy reversals. Similarly, Europe’s policies are very stable, but utterly inadequate to boost productivity and growth, and risks to the cohesiveness of the euro area are rising.

— In the US, conversely, the potential change in tax policy and regulations is momentous, but not unprecedented in the country’s recent history of policy swings.

Economic uncertainty is higher than it has been in a long time. But it’s an uncertainty that comes in different guises, not always where you expect it. Binary outcomes (does the euro survive? Will China’s transition succeed?) are the hardest to deal with, and there are more around than usual. And economic policy stability can hide greater uncertainty than policy volatility.

What do you think? I would love to discuss this with you in the responses below or on Twitter.

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