This is the second of a three-part series looking at the global economy and uncertainty in 2016. In our first post, we addressed the challenges of slow growth in developed and emerging markets. In our next post, we will focus on the outlook for 2017.
DJ Peterson, President, Longview Global Advisors
Businesses need supportive, stable political and legal institutions to prosper, yet the global landscape has become increasingly unstable as many once-implausible events have become realities.
Since the start of 2016, the United Kingdom has voted itself out of the European Union. The U.S. Republican Party is pulling itself apart over policy and personalities. In Europe, fences are replacing open borders and Jihadi terrorists are targeting festivals, shopping centers, churches, and other public gathering places. Investors pay to lend their money to governments even as debt risks mount.
In conversations, business leaders and directors repeatedly express surprise and concern at the turn of events. What’s fueling this instability? Are recent events indicative of a “new normal,” a brief detour, or a transition to a new equilibrium? And, as the end-of-year business strategy season approaches, what should corporate directors and executives focus on?
Each country has unique characteristics, but there are some important interdependencies. Four powerful, converging political forces are at play.
1. Slow growth is fueling political volatility
As noted in a previous post, global growth has been muted and uneven since the global financial crisis, prompting some economists to ask whether the world has entered a period of “secular stagnation.” Energy and commodities exporters such as Australia, Brazil, Russia, and countries in much of Africa have been particularly hard hit.
Economic hardship often leads to political volatility, but there is a larger political force at play today: A lack of policy consensus and latitude. To turn the situation around, global financial institutions have been calling on governments to undertake bold structural reforms and assertive stimulus measures such as investing in infrastructure. But thanks to large debt piles and continuing calls for austerity from fiscal hawks, big spending increases are not politically feasible in the U.S. and Europe. Emerging markets dependent on commodities exports have been forced into belt-tightening mode as well. The inability of governments to reignite growth has forced central bankers to step into the breech with extraordinary measures.
Policymakers struggle to reignite growth, people are disaffected, and the sum of this instability is the political uncertainty and volatility we are experiencing today.
2. Inequality is adding to political frustrations
Free market liberalism is predicated on creating economic opportunity, but the benefits have not been shared. In many countries, inequality has surged since the 1980s. More recently, quantitative easing, a response to slow growth, has lifted a few boats greatly. In the past, governments often played the role of an equalizer; now proximity to political power is seen as conferring huge economic benefits, creating the belief that “the system” is not fair.
Free trade could be a casualty of increasing inequality and diminished opportunity. The perception that the benefits of globalization accrue disproportionately to certain segments of the population while the losers are left to fend for themselves is pervasive. Anti-immigrant sentiment is another by-product of limited opportunity.
Animosity towards politically connected elites in authoritarian markets is kept in check by repression. Open societies may be more at risk to economic and political polarization. As we see with Brexit, the pushback against globalization, and with the rise of anti-immigrant pressures, middle-ground policy pragmatism—a hallmark of stable democracy—is losing credibility in a world of economic resentments.
3. Populists are exploiting the governance gap
The widespread belief that establishment elites are incapable of solving important problems has created a volatile atmosphere where disaffected voters are willing to take risks and throw wrenches.
Private sector entrepreneurs exploit gaps in the market and find new ways to satisfy needs. Political entrepreneurs do the same in the public sphere: They take advantage of volatility, peddle new solutions (often from both left and right), and break rules.
Dramatic, frustration-driven policy stances of political entrepreneurs make compelling platforms—such as Philippine President Rodrigo Duterte’s anti-drug dealer campaign and French presidential candidate Marine Le Pen’s anti-immigrant stance. Donald Trump and Bernie Sanders are political entrepreneurs too.
But that’s only half the story. In this context, calls for pragmatism and staying the course (“Vote Remain!”) from establishment figures sound tired, if not suspect.
4. Social media is catalyzing volatility
Thanks to social media, populists can peddle their ideas with greater ease than previously seen, without having to adhere to the agenda of establishment media and institutions. (The self-described Islamic State is the most extreme example.) Being provocative is essential to gaining visibility in today’s crowded media landscape and this imperative promotes extreme points of view and places pressures on policymakers to react—even though in representative democracies governments are designed to be deliberative and consensual.
Just as individuals may be overwhelmed by the pace and quality of information flows, so too can governing institutions that were built to be slowed by checks and balances. Few would say policymaking in the U.S. has improved over the past couple of decades thanks to better information. Nationalism, ethnocentrism, and religious animosities seem more powerful than ever.
What can corporate directors do?
Western multinationals can no longer take political stability for granted. In these volatile times, directors have an important role to play in asking the right questions and discerning material risks and opportunity in a time of uncertainty.
Integrate political and economic risk assessment into corporate strategy setting. The political forces outlined above are unlikely to change in the foreseeable future which suggests a number of scenarios. Slow growth and low interest rates are likely to persist. The U.S. presidential election is unlikely to fundamentally change the country’s political climate for the better—indeed, it could lead to more disaffection, polarization, and gridlock. Uncertainty will increase in Europe with Brexit negotiations and national elections in France and Germany in 2017. Boards should pressure test macro-assumptions from management about the external environment affecting strategy over the next 12-24 months. What are the most important moving variables and how will they affect growth prospects?
Look for pockets of opportunity. Volatility creates opportunities as well as risks. Good governance and sound policies are differentiators between countries poised to sustain relatively stronger economic performance, and those that will continue face serious challenges in volatile markets. Watch for improving and more agile governance in Brazil, Columbia, Argentina, India, and Myanmar.
Evaluate the firm’s societal commitments.Proactive companies are seeking to address today’s societal challenges rather than just defend themselves from risks. There is a business case for promoting more inclusive growth: Work by International Monetary Fund researchers has shown that, around the world, higher levels of income inequality are correlated with slower growth. Higher wages support increased consumer spending and broader prosperity. On the other hand, failing to address inequality and other societal ills risks lowers productivity, and leads to more regulation, taxation, and labor radicalization.
NACD’s Global Board Leaders’ Summit, themed around the issue of convergence, will have dedicated sessions on global economic and political disruption, featuring subject-matter experts and seasoned directors. Review the Summit agenda to attend Peterson and others’ sessions addressing global disruption.
The “war for talent” may be a trite phrase to some, but battles to find and keep the right people rage on nonetheless. In a study of the top risks for 2016, more than 500 participating C-level executives and directors rated succession challenges and the inability to attract and retain top talent as the fourth-highest risk—holding its position as a top five issue in surveys Protiviti have conducted in prior years. Simply stated, talented people with the requisite knowledge, skills, and core values are needed to execute challenging growth strategies in a rapidly changing world.
An organization’s talent is an aspect of the overall corporate strategy that management cannot afford to fumble. Below are questions to spark productive boardroom conversations about effective oversight of talent strategy that draw from our experience (including roundtables conducted with more than 65 active directors last year).
How does our overall business strategy shape our talent strategy? Does our business strategy articulate the performance expectations and core competencies required to execute it successfully? Is the business strategy used to drive how we define the leadership capabilities, functional and operational expertise, and specialized knowledge targeted by the talent strategy? Are the significant human capital risks reduced to an acceptable level by the talent strategy?
Does our company have a comprehensive, longer-term talent strategy for sustaining our leadership and talent pipeline? As anticipated changes in the workforce will impact the available talent pool outside of our company in the foreseeable future, what’s the long-term plan for growing the company? Do we have an effective plan for accessing talent—internally and externally—when we need it? Are our retention policies and practices sufficient to achieve our established attrition targets? How well are we developing and mentoring our talent internally?
How strong is our executive team two to three levels below the C-suite? What is the health of our bench of top performers and rising stars? How has it changed in recent years, and why? Is our bench strength strong enough to engender the board’s confidence in our succession plan?
How will global market forces impact the talent pools available to us and the steps we must take to secure the best talent? What are the largest demographic risks to executing our talent strategy, and how are we managing these risks—particularly with respect to attracting and retaining millennials? What reports should be made to the board over time regarding the organization’s response to talent challenges?
How effective is our retention of “A-players?” Do we know who our top performers and rising stars are? Are we capturing their “hearts and minds?” If so, how? Why do they leave, and do we use the lessons learned from their departure to improve our retention processes?
What are the critical capabilities among senior leaders that will drive our organization’s growth? Is the company systematically supporting the development of those capabilities?Does the CEO provide a candid assessment to the board of each senior leader’s contributions to the company and demonstration of our core values? Do we conduct high-quality assessments of our current leadership linked back to performance expectations underlying our strategy? Do we assign responsibility to close any gaps that are identified?
How effective is our onboarding process at integrating external hires and preparing them to contribute? How do we ensure a smooth transition? Do we measure the success of our onboarding strategy for experienced hires? For example, what is our 90-day experienced hire failure rate for key positions and first-year voluntary termination rate for experienced hires?
Is our organization agile and resilient in the face of significant change? How effectively do we adapt to changing markets? How ready are our employees to help us transform our organization in the face of innovative and disruptive change? How well do we handle unexpected changes? How well do we realize the promised value of mergers and acquisitions, given the integration challenges and cultural differences among the acquiring and acquired entities? Are we paying attention to the generational imperative as millennials fill out key roles in the workplace? Are we sensitive to cultural diversity across the global marketplace and its potential influence on organizational behavior and decision-making? Conversely, as a multinational organization, do we “think globally, act locally” regardless of the geography to ensure sensitivity to our core values and build a global brand?
Is our compensation structure competitive and effective in delivering appropriate rewards?Is our reward system (base pay, incentive compensation, and benefits) fair when performance goals are achieved and adjusted for the risks undertaken to achieve them? How do we assess compensation across the enterprise?
By attending to the answers to these questions, directors can ensure management is focused on developing a comprehensive talent strategy that can be acted upon, measured, and adjusted to fulfill the organization’s talent requirements.
“Putting a Boardroom Lens on Cyber,” one of the final panels of the 2015 Global Board Leaders’ Summit, continued themes heard throughout Summit sessions. The panel focused on how to ask management the right questions about the state of their enterprise’s cyber security and how to assess the strength of their preparedness to manage this risk.
The panel was packed with leading technology experts: Nicholas M. Donofrio, director of NACD, Advanced Micro Devices, BNY Mellon, Delphi Automotive and Liberty Mutual, and former executive vice president of innovation and technology, IBM; Alfred Grasso, president and CEO, The MITRE Corp.; Christopher Hetner, cybersecurity lead, Technology Controls Program, Office of Compliance Inspections and Examinations, U. S. Securities and Exchange Commission; and Kimberley S. Stevenson, director, Cloudera Inc.,and CIO, Intel Corp. Bill E. McCracken, director of NACD and MDU Resources Group and former CEO of CA Technologies, moderated the discussion.
Below is a summary of the high points from that discussion.
Recognize that cyber criminals are constantly changing methods and targets. When it comes to security breaches, “The bad people are getting better, faster, and you have to assume, therefore, that you have to move quicker,” Donofrio said. For example, cyber criminals increasingly exploit human error by using social engineering—especially with “spear phishing” emails. These emails look like legitimate business from trusted sources, yet contain dangerous malware. One employee opening such an email could compromise an entire network’s security.
Scrutinize whether management really knows where key data assets reside. It’s essential to gain the confidence that management knows the location and how “crown jewel” data assets in often highly distributed IT environments are being protected. Management needs to also demonstrate an understanding of the rationale for access rights of both employees and contractors. The fine print in third-party contracts could jeopardize data security, as cloud storage companies sometimes have “quality control” clauses granting access to your data.
Ensure that general management is held accountable for effective cyber-risk management. Cybersecurity is no longer an IT issue, but a significant business risk as technology is now a critical component of most business processes. As a result, general managers must share formal accountability with IT for the strength of cybersecurity. They must foster a risk-aware culture. If, for instance, the IT department sends dummy malicious emails to test open or click rates in the network, a problem would be detected if the rate goes up. “We track the number of employees who click on malicious emails,” Grasso said. “It’s less than two percent, but if it rises, we’ll move quickly and change our training policies.”
Demand that technology leadership avoid jargon and communicate complex concepts in easy-to-grasp language. “We have our own vocabulary as IT professionals, and we have a hard time translating that into everyday language,” Stevenson said. Technology leadership must be careful to clearly communicate concepts to board members whose first imperative is to understand risks. Technology management should craft language that non-expert directors can readily grasp.
Beware the consequences of your own oversight approach. Directors must carefully craft the questions they ask management when examining cyber risks. Donofrio recommended that board members focus carefully on the questions they ask of the C-suite to avoid sending the wrong message: for example, boards that focus exclusively on the costs associated with cybersecurity could undermine much-needed investments by management in better defenses. “We as board members can mess this thing up,” Donofrio said. Continued technological literacy is integral to asking the right questions, understanding experts’ briefings, and appreciating the full impact of cyber-risks across the organization.