Politicians and investors adapt to the age of radical uncertainty

Moderate leaders have mistaken the expedient for the universally true
by: Wolfgang Münchau

Matteo Renzi, David Cameron, Theresa May — all were fooled by the polls. The problem was not that the polls were wrong. Some were quite good, and most were right at the time when the leaders took the politically fateful decisions. The former Italian and UK prime ministers clearly had the support of a majority of their electorates when they called referendums and were sure they could win. The Conservative party was indeed well ahead of Labour in April this year when the prime minister called her snap election. The speed with which the electorate changed its mind was more fateful than the polls themselves.

The French electorate has been more extreme than any other. It managed to eradicate virtually the entire political establishment in a short sequence of elections. This brutality outstrips anything we have seen in the US or the UK, where the two traditional parties still dominate politics. The French are in a process of exhausting all their alternatives. It is painful to think what they might do if they ever become disillusioned with Emmanuel Macron.

In all these countries the global financial crisis has become a historical turning point, caused by the effect of crisis resolution on income distribution, and on the quality of the public sector. It has triggered a lasting political backlash against globalisation and against modern-style trade agreements. It has challenged previously held beliefs about economic policy and financial regulation. And now it is challenging how we think about politics.
The victory of capitalism over communism was the single most formative event for many of today’s commentators and analysts like myself. Our generation has fully bought into paradigms of global financial capitalism, even though we may have been sceptical about the end-of-history euphoria of the 1990s. We celebrated the advent of centre-left pragmatism and a new generation of centre-left leaders.

Our failure was to mistake the politically expedient for the universally true. The financial crisis turned what outwardly seemed a stable political and financial environment into what mathematicians and physicists would call a “dynamical” system. The main characteristic of such systems is radical uncertainty. Such systems are not necessarily chaotic — though some may be — but they are certainly unpredictable. You cannot model them with a few equations.

The best you can do is to identify spots of instability and stay away from them, muddle through and keep your eyes wide open.
Radical uncertainty is a massive challenge, because you can never be sure of much. In particular, you can no longer be certain that you can extrapolate the trends of the past into the future. Opinion polls are becoming less relevant (even if they were able to produce a correct snapshot of opinion at any one time). Even ultra-modern tools like social network analysis cannot break through into an unknown future. The usefulness of these tools is confined to explaining what went wrong in the past.

In a world of radical uncertainty, gambles become harder because the information on which they are based is less trustworthy. This is naturally true for investors but also for politicians. It is no surprise that the big political gambles of our time, like the recent referendums in the UK and Italy, have failed.

The most successful politicians are those who rely on a deep knowledge of their voters and on their own intuition, rather than on focus groups or modern polling. To succeed we need to understand the difference between risks we can calculate, and deep uncertainty that we cannot.

Take Brexit as an example. A British government would be foolish to risk a policy that would drive the British economy off a cliff. A smart strategy would recognise that Brexit must happen but minimise the costs. The sensible choice is the most risk-averse one: a long transition phase.

The age of radical uncertainty and the need for risk-aversion will end at some point. But until then, I expect it to devour further relics of the golden age of moderation such as inflation targeting. The idea stems from an economic model linked to the economic orthodoxy of the previous period. Once you look at the global economy as a dynamical system, you would no longer want to subject a central bank to the rigour of a single target. And you may want to question the independence of the central bank as well, since it is based on a consensus that may no longer hold.

Once we accept that our globalised world has characteristics of a dynamical system, many of our assumptions will fall like dominoes, and so will the political parties that cling to them.

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