Managing risk in an era defined by escalating geopolitical tension, degenerating global trade networks and unprecedented economic turmoil is no simple task — and doing so well may require adopting a new perspective.
“We aren’t thinking about risk in a way that’s appropriate for the world that we’re moving into,” said Janice Gross Stein, founding director of the Munk School of Global Affairs at the University of Toronto, during the keynote address at the Canadian Investment Review’s 2022 Risk Management Conference.
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“We’ve, essentially, siloed the way we think about risk. That’s true in your industry and that’s true in my profession. The next 20 years are going to require that we get together in the same room and build the vectors of risk, so that I understand how your risk influences my estimates and you understand how my risk assessment influences yours because they’re interacting. If we don’t do that, we’re going to get it wrong.”
According to Stein, very few academics or institutional investors understand what it means to operate during periods with major European conflicts and rising inflation and interest rates. “Most of us, in this room, started their careers in the 1970s through about 2010. Those were the golden years — there was no war between major powers. It was a long peace period, but with globalization on steroids. . . . It was a golden age — exceptional and not at all the norm.”
As today’s investors lack experience dealing with the risks posed by global political instability, Stein said she believes they should be paying a little more attention to history. One issue that’s especially important to view through a historical lens is de-globalization, she added, noting it was unknown in the latter half of the 20th century, but was a defining feature of the early 20th century and the European Dark Ages. It’s even credited with ending the Bronze Age — and sparking the Iron Age.
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“Global trade is in retreat — it’s dropping as a proportion of the global economy. . . . Remember, global supply chains accounted for 70 per cent of the world’s growth over the last 40 years, but no more. In Ottawa, I recently had a conversation with [former U.S. Treasury Secretary] Janet Yellen about friend-shoring — trading with partners you trust not to cut down supply if there’s a problem.”
Stein also said the next four decades will be defined by a resurgence in the strength of governments. “[Does] anybody remember when government was the problem, not the solution? That’s over. Government is back and not only as a regulator but as an investor. . . . We have billions of dollars that will be invested by the United States in key strategic industries.”
While the distant past may be a guide to some of the world’s issues, Stein noted some challenges facing humanity in the coming decades are unprecedented. One such issue is the world’s aging population. With fewer people entering the workforce than leaving it, the foundations of a productive economy are left shaken. “And, second, old people don’t spend as much money as young people. . . . Frankly, my kids’ spending is on an entirely different order of magnitude than my own.”
The only major economy with a steady supply of young people is India, she said, whereas China’s demographics challenges may be more significant than in the West. “China is racing against the clock to beat its tough demographics and build a productive economy before time runs out. . . . It’s got 10 years at the most. A lot of the really alarming and worrying behaviour we’re seeing from China comes from these underlying tough economic problems.”
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Two other issues — global warming and the transition away from fossil fuel reliance — also lack clear historical precedent. “The good news is that almost every industry and every sector, both public and private, has woken up to this and is beginning to build that risk into their assessments,” said Stein. “And there are huge opportunities for countries that move ahead of the curve — in green tech, sustainable fishing and agro tech.”
Assessing risk is, by its nature, an imperfect art, she concluded. While she said she’s certain the Canadian government is trying to figure out how likely internal political divisions in the U.S. will lead to a civil war, she’s unclear on what methodology could provide a useful answer. “Can I use a probability distribution? The last one was in 1865, so there’s not enough data points.”
While Stein acknowledged the idea of a full-scale domestic conflict occurring south of the Canadian border is outlandish, she noted that, in the long run, outlandish events occur with surprising frequency. “In 2019, if you’d asked my colleagues if [Russia] was going to invade Ukraine, almost everyone would have said no, it wouldn’t have seemed rational. It would be too costly and it would have led to the sanctioning of the Russian economy — so who would make that decision?”