Which specific political risks do you expect the prolonged financial crisis to trigger?
Before I get into specifics, I think it’s important to separate the idea of the “economic crisis” from the “financial crisis.” The economic crisis is global, because the global economy is in recession and because even China’s economy has slowed dramatically (at least temporarily) from its torrid pace of the last three decades. The financial crisis is NOT global. China’s expansion has lost some momentum because its exports to the EU, US, and Japan have taken a hit. But China’s banks have largely avoided exposure to the toxic assets that have spread throughout Western banks. The US and Europe have liquidity problems; China has plenty of cash on hand.
As for political risk, in today’s environment, there are three broad categories of fat tails—the low probability, high impact events that move markets much more often than we think. First, there are geopolitical risks, the traditional threats of political, economic, or military conflict.
Some are a direct result of greater volatility in particular countries and regions. Pakistan faced serious political, economic, and security problems long before the global recession made things worse. Now the intensifying fight between President Asif Ali Zardari and opposition leader Nawaz Sharif (and maybe Pakistan’s military) is threatening to come to a head. In fact, unpopular governments and growing security threats have pushed both Pakistan and Afghanistan into turmoil.
From Moscow’s aggressive approach toward some of its neighbors to the risk of conflict between Israel and Iran, traditional forms of political risk are on the rise this year. And though US public attention has largely shifted away from Iraq toward economic troubles at home, that country has unresolved problems that could still generate another spike in violence—particularly when the US increases the pace of troop withdrawals following Iraq’s parliamentary elections in December.
Second, there is the risk produced by a shift in economic power from capitals of finance (like New York, Shanghai, and Mumbai) toward capitals of political power (like Washington, Beijing, and Delhi), as tough economic conditions persuade political officials to assume responsibility for decisions normally made by market forces.
When Barack Obama became president, he warned that if lawmakers failed to quickly rescue the US economy, the country would face catastrophe. Whatever bankers and business decision-makers do, whatever plans the automakers draw up, however many hundreds of thousands of layoffs come from other sectors of the U.S. economy, it’s Washington, not New York, which will determine the country’s economic future for the next several years.
This is not just an American trend. Large-scale state spending meant to create jobs and jumpstart growth in both developed and developing states all over the world will ensure that domestic political factors drive markets on an enormous scale for the foreseeable future.
Third, the global recession will continue to trigger its own political instability, and the fallout from a range of second-order risks will sometimes overshadow the recession itself. In testimony before Congress earlier this year, US Director of National Intelligence Dennis Blair identified political instability generated by the financial crisis as the largest threat to U.S. national security in 2009. A sharp economic downturn in emerging markets with embattled political leaderships and relatively weak middle classes (like Argentina, Ukraine, Pakistan, Turkey and even some developed states) leave these countries especially vulnerable to political turmoil.
Do you take “market fundamentalism” for a political risk because its “invisible hand” didn’t protect unsolved investors and citizens from buying “snake oil” from selling-people on the financial and real estate markets?
I consider that to be a very significant problem, but it’s more a question of economic risk than of political risk—and solutions should probably come from economists and market strategists rather than political scientists.
The notion that banks could be self-regulated led to hyper-leverage and underappreciated risks—maximizing short-term profitability and compensation at the expense of longer-term productivity. As economist Joseph Stiglitz once said, “The reason that the invisible hand often seems invisible is that it is often not there.”
You claim in your book that it’s not easy, given the complexity of its causes (not quantifiable, not “mappable” etc.), to find hard data on political risk. What about the operational costs for risk management to incorporate the political risks into strategic investments?
If a company has robust risk management systems in place, it’s simply a matter of additional training, data collection and assessment, and communication mechanisms. Costs deserve consideration, certainly. Every risk assessment comes with a price tag. But there are clearly operational costs that come from not incorporating them too. My book, The Fat Tail: The Power of Political Knowledge for Strategic Investing, provides dozens of real-world examples of both the costs of failure to properly recognize, assess, and mitigate political risk—and the tremendous market opportunities that proper risk management practices can create.
Thank you very much.
Ian Bremmer is President of Eurasia Group and author of The J Curve. He is a regular contributor to the International Herald Tribune and Contributing Editor for the National Interest. The Fat Tail is his new best-selling book.