A flock of black swans

Is it just me, or do risky events seem to be happening with greater frequency? One might say that we are experiencing multiple black swan events, or a flock of black swans. This is therefore what I titled the speech that I gave this week at #RISK London.

For the Romans, a black swan, or Cygnus atratus, was an idiomatic expression for something that did not exist. Yet they do exist, as discovered by the Dutch upon travel to Australia in the late 1690s. Normally, a risk is perceived as an unfavourable event, but is this always the case? Daniel Kahneman and Amos Tversky, who pioneered Prospect Theory, showed that the pain of loss was twice as powerful as the pleasure of gain. It makes sense, then, that we tend to think of black swans as unfavourable unforeseen events.

Downside risk is factored into many business decisions to prevent costly mistakes. Because we as humans generally try to avoid loss, we must force ourselves to also consider the cost of missing out. Therefore, I focused my talk on two key opportunities and two significant unfavourable risks on the horizon.

Two positive black swans:

• higher US productivity growth continuing for the next few years;
• Japan ending its deflationary rut and possibly reversing its low consumption story.

Two negative black swans:

• Turkey making a misstep with its NATO and Shanghai Co-operation Organisation (SCO) alliances;
• deep fakes and other generative AI.

Technology and its application present not only an opportunity for continued productivity growth, but a potential risk, as they enable state actors and non-state organisations to produce fake media. AI has vastly lowered production costs with far greater effect. Back in 2004 a doctored photo of a US politician, John Kerry, was circulated during his presidential bid in 2004 that showed him protesting against the Vietnam war with Jane Fonda, a US actor and activist. Research showed that even after the photo was revealed to be fake, merely seeing it had been enough to alter people’s vote. Yet this was an anomaly in 2004. Twenty years on it is a daily occurrence on a large scale.

As an opportunity, technology has always been the key to advancing living standards over time. The advancements in computing that lower the cost of research and development (R&D) are blurring the lines between industries and yielding synergies not previously imagined. The 2024 Nobel Prize for Physics was won by a physicist, John Hopfield, and a computer scientist, Geoffrey Hinton, who teamed up and made “foundational discoveries and inventions that enable machine learning with artificial neural networks”. The team used tools from physics to construct methods that helped to lay the foundation for today’s powerful machine learning. Mr Hinton was cited by the Nobel Committee as having invented a method that could independently discover properties in data and that had become important for the large artificial neural networks now in use. AI is everywhere, especially in R&D, and has the power to continue driving productivity growth for years to come.

In Japan, with real compensation turning positive in the second quarter (+0.7% year on year) and likely to remain so for the coming quarters, the country could well sustain positive growth momentum. Although we expect the Bank of Japan (BOJ, the central bank) to raise interest rates gradually into 2025, the governor, Ueda Kazuo, gave himself an out should rate increases need to pause or move more slowly to maintain growth on a positive path. In an October 7th speech, Mr Ueda said that the “BOJ can afford to spend time scrutinising the fallout from US economic uncertainty in judging whether to hike rages”. This approach takes any blame off the BOJ or the government for economic outcomes and gives the BOJ cover to normalise rates more slowly if needed. The combination of these two outcomes could mean that Japan’s growth surprises to the upside over the coming year.

Turkey is at the nexus of geopolitics. Turkey’s position in the global world order centres on both its geographic location and its membership in NATO while also being an observer to the SCO, with ambitions to become one of the so-called Shanghai Five with full member status. While all eyes are on countries currently in the midst of live conflict, it might behoove risk managers to keep an eye on Turkey. We doubt that it will be able to straddle full NATO and SCO membership, should it receive both, for long.   

Although there are plenty of negative black swans on the horizon, it is equally important to focus on the many positive ones, even if it goes against our loss-aversion instincts.

Constance L Hunter

Chief economist

EIU

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