Princeton University's Professor Stephen Kotkin

The disintegration of globalisation is a path the world has walked down before, according to Professor Stephen Kotkin, and while there are lessons we can learn from previous exposures the most pressing for investors is that a fundamental shift in the way we assess risk is needed.

Speaking on a podcast hosted by Top1000funds.com editor Amanda White recently, Kotkin – a Professor of History and International Affairs at Princeton University – said the measurement of risk during normal times doesn’t work during abnormal times.

“Our risk assessments are smart, they’re thorough and they’re improving, but they generally regard the kind of events we’ve been experiencing as black swans,” he said.

Contemporary risk models view everything that upends them as a black swan, he says, which is a problem. When black swan events – such as the recent pandemic – occur regularly it indicates the risk models themselves are part of the problem.

To mitigate the issue, Kotkin argues, we need to take more seriously the “dynamic, non-linear, complex interactions”. That is, the events that aren’t predictable, stable or easily discernible.

“They’re very, very difficult, almost impossible to model, which is one of the reasons we can’t pay enough attention to them,” he says.

Listen to the full podcast, ‘Is this the end of globalisation?’ featuring Professor Stephen Kotkin here.

Kotkin says there is “tremendous work” being done in biology and physics around how small changes in one part of a system can precipitate large and delayed effects in another part of the system. These findings are only now being transposed onto economics, he adds.

He gives the example of meteorologists, who have a great understanding of the difficulty in predictability.

“They talk about the climate ‘weirding’, getting weirder and more extreme,’ he describes. “They don’t talk about a linear progress… they talk about it moving in many directions at once.”

The uncomfortable truth for economists and investors, he explains, is that they need to move away from financial data and seek more adaptive systems.

“There are just tremendous amounts of single points of failure,” he says. “And if you can’t model systemic risk very easily it’s very hard to work it into your portfolios.”

Globalisation’s second death

The need for investors to factor ‘the unknown’ into risk models is heightened due to the disintegration of globalisation, Kotkin argues, yet there are lessons from the past we can leverage.