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Monday, October 22, 2012

Predicting Future Events in Political Risk Analysis: On the European Debt Crisis


Political risk assessment is a nasty business in that the future has a stubborn habit of not wanting to be too predictable. Even though tomorrow displays a remarkable tendency to be similar to the world of today—the status quo enjoying the right of default—forecasting future events is notoriously difficult. To use statistics to nail down probabilities may actually involve considerable luck. Not even the stature of the person making the predictions may be decisive, after all. I have in mind the predictions of Alexei Kudrin, the former Russian finance minister, on the European debt crisis and the euro.


                                                             Map of the European Union: a political union and economy.

 
Prime facie, Kudrin is just the sort of person whom corporations should listen to regarding political risk around the world. After all, he was named finance minister of the year by various publications on four separate occasions during his tenure. Keeping Greece in the euro zone? "Already impossible," he says in an interview. Spain and Italy next out? "The probability is very high." He sees both Greece and Spain defaulting on their sovereign debt, though as in a Hollywood script the euro survives (and even gets the girl, brilliantly played by Angela Merkel). "Everything should be done to avoid it, but I don't feel that the process is under control," says the finance minister who according to the Wall Street Journal “shepherded Russia from default to financial stability.” Who better situated and constituted to opine on the future outcome of the European debt crisis? He undoubtedly knows more of the “stubborn facts” known only to the insiders than you or me. He might have access to the “by the way” comments being made by E.U. and state leaders in Europe, as well as the bankers at the “hot spots.” 

 
However, what if that which is required in order to grasp the eventual outcome surpasses even such a competent insider as Kudrin?  Even well-justified respect can easily be surpassed by the sheer indeterminacy of a multitude of factors and human nature itself. Greek and Spanish finances are very risky, at least as of the final quarter of 2012. To move from this assessment of high risk to a particular event requires a leap of faith given all the variables in human organization. It is not as though we could predict Greece or Spain as though we were testing a chemical equation by running an experiment in a lab. Indeed, social science itself, including economics and political “science,” may gild the lily in appropriating the certainty that is possible in the natural sciences. Not even a very competent and respected man like the former Russian finance minister can give us the sort of certainty that can be found in a chemistry lab. He may well turn out to be correct; my point is simply that we over-reach in reaching this conclusion beforehand on the basis of his person.

 
To take a related example, Kudrin also predicts that the E.U.’s economic problems could turn into political ones. More than mere possibility is implied here. The Wall Street Journal reports his reminder for us that “democracies do not always survive when their citizens are asked to make the kinds of economic sacrifices” that Europe was facing in 2012. Furthermore, he was thinking “that citizens of the Western countries aren't ready to accept the steep drop in living standards they face, but that if governments fail to cut spending they will get even deeper collapses.” Kudrin points out that Russia faced such a crisis in the 1990s, but thanks to Russian President Boris Yeltsin the country “passed it peacefully,” whereas Western Europeans may not be able to pass through such painful hardships without tossing democracy over-board (as if Russia had retained it).  Through my sarcasm, I am suggesting that even a man like Kudrin has his subjective biases that come into play in assessing future events.

 
Particularly when phenomena of one domain (i.e., politics) are mixed in with another (i.e., economics), future events can be especially difficult to nail down in advance; there are so many variables, and they differ qualitatively. It is a mistake, therefore, to put political risk analysis to quantification because exact numbers, even as probabilities, overstate the certitude goes with such prediction. In the case of Europe, we can add the invariability of two different though related systems of government being involved—that of the E.U. and that of its states. How far will the E.U. go to keep Greece using the euro? How much pressure would be exacted against “radical parties” even though they are duly elected at the state level. The case of the right in Austria that was effectively blacklisted by the E.U. is a case in point.

 
To be sure, Kudrin might be right, particularly on Greece defaulting, though it could be piecemeal via continued percentage write-offs rather than “default” per se. The Council’s admittedly incremental action in October 2012 on a banking supervisor at the ECB could be fast enough for the Spanish banks to receive bailout funds before they have to default. As in the case of the TARP legislation in the U.S. Congress, the E.U. legislative infrastructure would likely swing into swift motion if really up against a cliff. In fact, the history of European integration has proceeded from such circumstances, including the debt crisis.

 
When France vetoed the accession of Britain in the EC in the 1970s, for example, there must surely were cries that the enterprise was at a crisis point, and yet the E.U. came out of the EC and other entities in 1993 and the euro itself some years later. This historical perspective I am offering effectively regularizes the Greek and Spanish debt crisis from the standpoint of the E.U., which can be viewed as a nonlinear work in process. From his vantage-point, Kudrin may not have weighed this less-exciting perspective against his more dire yet ultimately happy scenario that is admittedly more dramatic. The eventual results may be with him, or less dramatic. My point is simply that human nature does not get us as close to an answer beforehand as we might tend to suppose. The opera isn’t over till the fat lady sings (or gets the euro in the end).
 

Source:

Alexander Kolyandr, “Kudrin’s Outlook for Euro Zone Is Grim,” The Wall Street Journal, October 22, 2012.