“We seem to be living in the riskiest moment of our lives, and yet the stock market seems to be napping,” said Richard Thaler recently. He is not alone in expressing such views, although since he had just won the Nobel memorial prize in economics, his comment understandably drew attention.
Money is loose and global economic growth is robust, yet the strength and the stability of the S&P 500 is still puzzling. This week it was the 30th anniversary of Black Monday, the largest-ever one-day crash in US stock prices, and it is eerily quiet.
One explanation of the puzzle is that markets have finally got smart: when behavioural economists turned their attention to financial markets in the 1980s, two key findings were that shares were implausibly volatile and implausibly cheap. They are now much less volatile and much less cheap; perhaps that is simply a long-awaited recognition of the way things should be. Perhaps.
An alternative view is that, while 2017 seems risky, it really isn’t. This is hard to believe. Among the obvious political risks: Donald Trump’s attempts to undermine both the North American Free Trade Agreement and the Iran nuclear deal; the rise of the far right in Germany and Austria, with Marine Le Pen waiting for President Emmanuel Macron to stumble in France; serious unrest in Spain over the Catalan independence movement; a Brexit process that seems as unclear as ever; and of course, the small-yet-conceivable chance of a nuclear war on the Korean peninsula. This is no time to panic, but it hardly seems a time for euphoria either.
There is never a good moment to create uncertainty over the prospects of a nuclear first strike. As the great Thomas Schelling once explained: “If I go downstairs to investigate a noise at night, with a gun in my hand, and find myself face to face with a burglar who has a gun in his hand, there is a danger of an outcome that neither of us desires. Even if he prefers to just leave quietly, and I wish him to, there is danger.” The danger results from mutual uncertainty over what the other person may do.
Other threats are less apocalyptic, but still have the potential to cause serious economic harm. Those who think Brexit will boost the British economy — I am not among them — have begun to acknowledge that the uncertainty is damaging. Business can no longer afford to wait for the British government to finish negotiations with itself and begin serious negotiations with the EU27.
Similar damage is likely to be done by Donald Trump’s attacks on Nafta. As the economist Nuno Limão has shown, unpredictable trade policy is itself a form of trade barrier.
And yet, despite all these political risks, the world economy might benefit from a little more disruption. Whether a more volatile stock market might usefully puncture complacency, in the real economy volatility can be an asset. We should expect old companies to fade and die, being absorbed or replaced by fresh ideas: that corporate failure is the flip side of economic vitality.
For example, a study by Kathy Fogel, Randall Morck and Bernard Yeung — published in 2008 — compiled lists of the 10 largest employers in each of 44 countries across the world. More churn in the list was a sign of a strongly growing economy, and a predictor of fast growth to come, too. The results were being driven by the extinction of corporate dinosaurs more than the rapid ascent of new stars.
The upbeat word to describe this process of success through failure is dynamism. But economic dynamism is at risk. The economist John Haltiwanger has charted a fall since the early 1980s in the rate of start-ups, business exits, job creation and job destruction. It is probably not a coincidence that low-productivity companies are able to limp on rather than disappearing.
Calm waters eventually stagnate. It is time to agitate the real economy. But how? Even acts of economic vandalism such as a train-crash Brexit can have unexpected benefits, much as Tube strikes have been shown to help some commuters discover better routes. Yet overall the costs of chaos seem likely to outweigh the benefits.
There are more positive ways to shake things up: looser planning regulations in the sclerotic UK economy, more infrastructure in much of the western world, and support for small-business finance, would all add much needed fizz to the economic system.
And the authorities could be much more assertive in challenging market power. According to the economist Luigi Zingales, federal antitrust cases in the US were five times more common between 1970 and 1999 than since the year 2000. In a world of high profits and high concentration, that passivity is hard to excuse.
I have little doubt that financial markets will rediscover the knack of panicking in due course, but the real economy may need more help. If only our politicians would stop shaking the nitro-glycerine of geopolitics, and start stirring the cocktail of market forces instead.
Written for and first published in the Financial Times on 20 October 2017.
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