Behind the numbers What can Black Swan events teach us about our economic narrative?
A Black Swan event – according to the academic Nassim Nicholas Taleb – is any occurrence that is hard to predict, has a major impact, but in hindsight might’ve been deemed entirely predictable.
Indeed, the 2008 financial crisis and the vote to leave the European Union in 2016 – arguably the most pivotal economic events in generations – have both been branded ‘Black Swans’ by analysts.
They were both largely unexpected (at least amongst the mainstream commentariat), they both have, and will have, a significant impact in rewriting the nation’s economic narrative, and they both have been quite easy to rationalize ex-post: The financial crisis was precipitated by a quite evident systemic build-up of risky financial products, while the Brexit vote was also staring analysts in the face given the rising tide of mistrust in globalism, regional imbalances, and the slow economic recovery since the 2008 crash itself. So if they were so obvious how did we miss it?
Part of the issue lies in our individual, and collective, tendency to revel in the good times and disregard future risk events with an ‘it won’t happen to me mindset.’ Much of that behaviour underlies the ‘boom’ and ‘bust’ cyclicality of our economy (we assume the bubble will never burst). This type of thinking cannot continue. It’s an issue Christine Lagarde, managing director of the International Monetary Fund, has echoed. “A key challenge in economic cycles is trying to gain perspective on what comes next while you are in the midst of it,” she said in a speech at Harvard University in October. “If we take a step back, what might we see?”
Indeed, in the UK, there’s much to celebrate in the resilience the economy has so far shown in the face of gloomy growth projections, alongside considerable progress in deleveraging, recapitalizing, and monitoring across the banking sector. But, whilst we ought to take comfort from that, it mustn’t blind us from preparing for future shocks.
The financial and related professional services industry for example remains a potential source of contagion. It accounts for roughly the same proportion of the economy as the entire manufacturing sector, employs over 7% of the workforce, and contributes over £70 billion in tax revenue for the Exchequer. That combined with the UK’s global financial interconnectedness through trade, supply chains, and investment, means prudence in the sector ought to continue, and new sources of risk – from financial innovation, to cyber risks – should also be considered.
What’s more, though public finances are improving, debt still hovers above 80 percent of GDP. At the same time we remain sensitive to a snapback in household spending with consumer expenditure the driving force behind our economy, whilst our reliance on services exports also leaves us vulnerable to shifting trade patterns. Sure, we’ve ramped up regulation, and credit conditions look healthier, but that doesn’t mean we’re totally safe from new risks emerging and exposing our susceptibilities – whether that’s triggered by global, technological, social, or political developments.
Whilst one eye is on building up our economic strengths, another must constantly be horizon-scanning and contingency planning for risks
The point is not to be in an eternal state of paranoia; but rather whilst one eye is building upon our economic strengths – whether in our comparative advantages in finance, entrepreneurship, and services – another must be horizon-scanning and contingency planning for risks. After all British institutions have been lulled into a false sense of security before, as was the case during the low inflation and steady growth period – also known as the ‘Great Moderation’ – in the 15 years leading to the 2008 financial crisis.
That led to the creation of independent financial oversight institutions – the financial policy committee, prudential regulatory authority, and financial conduct authority – to mitigate, and monitor, the build-up of financial risks. We must now bring that pre-emptive thinking to the wider economy. As such, we must make a habit of evaluating our economic agility, productivity, and competitiveness – and report on long-term risks – as regularly as we deep-dive into monthly updates of our growth figures. That, in turn, will help create confidence in the country’s economic stability that businesses and entrepreneurs need to make growth and investment decisions with conviction.
And so, even if economic growth beats experts’ forecasts this year and next, it will be largely academic if the country merely kicks the next crisis ‘can’ down the road — when it may simply undo any gains. So, even though the sun may not be shining as brightly as it could be, there’s never a bad time to be reinforcing the roof.