Over the last six years, companies have had to grapple with five major “uncertainty shocks”: First it was Brexit in 2016, followed by the U.S. presidential election, China-U.S. trade-tensions, the Covid-19 pandemic, and in 2022 the Ukraine war.
These shocks reflect a new normal of greater global turbulence, driven by domestic and international political fragmentation. And these are subtly different from the economic shocks that executives may be more used to thinking about.
An uncertainty shock may coincide with a typical economic shock, as in the case of Russia’s invasion of Ukraine, which disrupted energy and food supplies and therefore raised their prices. But it doesn’t have to: The U.S. election created significant uncertainty for companies, even before it had any direct effect on the real economy.
Our research suggests these uncertainty shocks have real consequences for companies, and that they’re becoming more common. Businesses should internalize this and adjust for the new reality in three ways we outline below: by closely tracking global events, paying for flexibility, and considering contingency plans.
Uncertainty is, by its very nature, hard to define. We have been researching its economic impact for almost 25 years, and find it is best to take a practical approach. The Economist Intelligence Unit produces standardized monthly reports of about 30 pages in length for over 140 countries. We counted the frequency of the word “uncertainty” (and its variants) in these reports, which are sourced from a range of reporters and analysts following each country, edited into a consistent format, and aimed at national and multinational businesses and investors. To make the index comparable across countries we adjusted the raw counts by the total number of words in each report. And then we weighted the reports by each country’s GDP, to create a measure of uncertainty across the global economy.
Here’s what that measure looks like for the last three decades.
Since the 2008 global financial crisis and subsequent European debt crisis, economic and policy uncertainty has been rising. It surged in 2016 and reached all-time highs in 2020 with the onset of the Covid-19 pandemic. It fell in 2021, as Covid-19 started to become endemic in many parts of the world, but has picked up again since the Russian invasion of Ukraine.
One advantage of our text-based approach is that we can break out the drivers of uncertainty, by analyzing which words appear alongside mentions of uncertainty in our dataset. From that approach, we see that in June 2016 uncertainty arising from the UK Brexit situation surged after the unexpected Leave vote. This was overtaken by uncertainty arising from the U.S. after its presidential election. In 2018 the China-U.S. trade tensions began to cause major uncertainty for countries globally, becoming the biggest single driver. In 2020 the Covid-19 pandemic surged as a key driver of global uncertainty, only dropping back recently to be overtaken by uncertainty arising from the war in Ukraine and the renewed trade uncertainty associated with sanctions to Russia.
Responding to Uncertainty
Our view is that these global shocks are here to stay. While each event is different, the common theme is greater geo-economic fragmentation and more polarized politics in the U.S. and Europe. These trends are powering the rise in global uncertainty and they are not going away.
To cope with this we advise organizations to take three steps.
First, it is more valuable than ever to pay attention to global economics and politics. In calm times it makes sense for firms to focus on markets, following the old saying that “the business of business is business.” But in turbulent times there is value in following current events to avoid being caught by surprise by global shocks. Indeed, for larger firms there can even be value in trying to steer the political process through engagement and lobbying. Invest in the people and tools to track geopolitics more closely, with special focus on the issues and regions that most affect your business.
Second, greater uncertainty makes flexibility more valuable. Therefore, be willing to spend more to keep your options open. This involves anything from signing shorter leases, leasing rather than buying property, hiring contractors rather than permanent staff, and renting rather than buying equipment. Pay more to avoid long-term commitments as these make it hard to nimble in the face of major shocks.
Finally, use contingency planning. When major shocks happen – like the war in Ukraine – there is huge value to making rapid decisions. Firms which have contingency plans in place can act faster and reduce the risk of mistakes. You don’t have to perfectly predict the specifics of the next shock to do this: Companies can model more generic scenarios, like a steep decline in consumer demand, the failure of a key supplier, or an increase in the cost of doing business in a specific country. Making contingency plans is like paying for insurance: You hope to never have to use them, but if you do, they can be invaluable. With greater global volatility this is likely to happen more than ever, so the value of contingency plans has never been higher.
This content was originally published here.