The Fat Tail

The authors

A conversation with Ian Bremmer and Preston Keat

The following Q&A was published on RealClearPolitics.com. To read the authors' full biographies, click on their names to the left.

Exactly what is a fat tail risk and what is the book about?

Answer: A fat tail is the storm of the century that now seems to appear once every six months. It's the low-probability, high-impact risk that occurs more often than we think. These risks are not necessarily unpredictable or unknowable -- though some are. But too many companies and investors think they don't need to worry about "extreme" events or that, especially when it comes to politics, it isn't worth analyzing risks that don't neatly fit into standard statistical models. The central idea of the book is that fat tail political risks have become increasingly important for governments, companies, and investors -- and that they're both more predictable and more manageable than other sort of fat-tailed risks.

What are some of the political risks that may stem from the current global financial crisis?

A: In response to this particular fat tail risk, governments around the world (especially in developed states) are using stimulus packages, direct intervention in financial institutions, and regulatory reforms to deepen their direct involvement in domestic economies. Detailed understanding of the motives and incentives that guide political officials and lawmakers as they make decisions on economic policy will help us forecast how the crisis will separate winners from losers. After all, some companies, industries, investors and governments will benefit from this crisis -- at least relative to others.

There are three broad types of fat tail risks in the current environment:

1) Geopolitical. These are the traditional forms of political risks that flow from international conflict. Some are the direct result of greater global volatility. Some have grown because political leaders are now so focused on economic problems that political and security questions have been neglected. Looking at the major sources of political risk today country by country, the only marked improvement from 2008 is, ironically, the stabilizing security environment in Iraq. On virtually every other meaningful geopolitical front-from the prospects of failed states and growing terrorism in Afghanistan and Pakistan to the deteriorating security environment in Mexico and US-Mexican border tensions; from international tensions emanating from an increasingly troubled Moscow to the prospect of conflict between Israel and Iran --geopolitical risks this year are substantially greater.

2) The new capitals of capital. President Obama made the point clearly just before Congress passed the stimulus package: If Washington didn't act quickly and effectively, the United States faced economic catastrophe. In other words, whatever the banks do, whatever plans the automotive companies draw up, however many hundreds of thousands of layoffs come from other US economic sectors, it is Washington (not New York) that will determine the economic future of the country. A similar dynamic is unfolding elsewhere: economic power has shifted from Shanghai to Beijing, from Mumbai to New Delhi, and from Dubai to Abu Dhabi. As a result -- in developed and developing states -- domestic political factors will drive the performance of markets.

3) Political instability. The global recession is itself the focus of our attention, but the fallout created in unstable markets creates a host of second-order risks which, in many cases, will overshadow the recession itself in severity and the breadth of their impact. In fact, US Director of National Intelligence Dennis Blair has warned that political instability triggered by worsening economic conditions will likely prove the largest threat to US national security over the next year.

In which countries around the world is risk overstated?

A: Despite a swirl of media attention on the possibility for social unrest in China, we can expect that country to remain stable for 2009. The slowdown now underway is causing some pain. We've seen six consecutive quarters of slowing growth. Thousands of manufacturers have shut their doors in recent months. More than 30 million are now unemployed, many of them economic migrants without affordable housing. But three decades of double-digit economic growth have helped the Chinese Communist Party leadership amass considerable political capital and capitalize on growing national pride across the country. There is risk for the party elite, but the real risks are probably further down the road when many of the contradictions of China's rapid rise-the environmental damage, the growing gap between rich and poor, and the policy challenges that come with an aging population-begin to have a greater impact. For now, risks for China's stability are over-rated.

And despite the sharp slide in oil prices-from $147 per barrel in July 2008 to around $45 today-the countries of the Persian Gulf are doing relatively well for themselves. Dubai is an exception. There we see a government in need of bailout turning toward Abu Dhabi for infusions of cash. But elsewhere in the Gulf, particularly in Saudi Arabia, governments have managed their wealth wisely. Unlike countries like Iran and Venezuela, the Saudis have crafted budgets with conservative forecasts on oil prices. As a result, they and others in the region are not dipping as deeply into foreign reserves for government spending.

Brazil is another relatively stable haven for foreign investment. Some market players once feared that President Luis Inacio Lula da Silva would govern as a Chavez-style populist and a leftist ideologue. Those days are long gone. Instead, Lula has helped solidify a consensus in favor of responsible and predictable macroeconomic policy. That's why Brazil is well positioned to navigate the financial slowdown and to continue to welcome foreign investment in the process.

Where are we likely to see the most political turmoil?

Q: Emerging market countries with politically embattled leaders and relatively weak middle classes like Argentina and Turkey (and even some developed states, like Greece or South Korea) are more likely to face political turmoil as a consequence of severe economic downturn, creating space for radical political movements and undermining decades of gradual political stabilization.

But with the exception of Iceland and Latvia, the crisis' earliest victims, political officials have yet to feel the full brunt of public anger over the global recession. They will. For the moment, governments around the world are muddling through by increasing state spending and rolling out stimulus packages to create jobs and stoke economic activity. But there isn't much that the most vulnerable politicians can do to derail the train that's headed in their direction. Historically, civil unrest and large-scale protests lag behind economic shocks by about 12 to 18 months as unemployment rises, personal wealth declines, and it gradually becomes clear that things won't soon get easier.

It's been generations since we've seen political risks have such a determinative impact on global market outcomes. This trend will be increasingly obvious -- with enormous implications for investors and policymakers alike -- over the course of 2009. And that, in a nutshell, is what "The Fat Tail" is about.