Can History Be Used in Risk Analysis?

Can history be a viable tool in enhancing political risk analysis?

This question has become particularly pertinent in the light of the latest economic crises in the euro-zone.

Past experience is an instinctual learning process in human beings.  A child who touches a hot stove once, for example, will most probably be careful at touching it again.

The variables in this example, of course, are rather different than those that apply to political risk analysis.

Recognizing a hot stove is much simpler than identifying identical phenomena in the realm of political and economic decision-making.  The fact that an apparently similar event occurred in the past does not necessarily mean that the event being studied in the present is indeed similar, let alone identical.

In both cases, memory and perception play an important role.  In the first, though, the variable being assessed is monolithic in cause and effect:  a hot stove is a hot stove.  If touched by a human being it will cause the same effect wherever and whenever it happens.

In the case of political risk analysis, the variables being analyzed are usually more complex and varied in cause and effect as to allow a scientific formula to the effect that if A emerges then B is bound to happen.

This is, in essence, what makes the use of history in political risk analysis more of a phenomenal rather than a factual thought-process.  In other words, history can teach by helping the political risk specialist recognize similar phenomena, not identical facts.

For our purposes, a totalitarian regime is a phenomenon; Communist North Korea is a fact.  A liberal democratic regime is a phenomenon; Greece's socio-political system is a fact.

A sovereign default is a phenomenon.  Argentina's default in 2002 is a fact.

Drawing comparisons between similar phenomena can be useful, but one must be careful about it.

Two phenomena may be similar.  The past may thus help in better understanding the present by a process of analogy.  However, that by itself should not necessarily lead to a similar conclusion.

Comparing the risk of sovereign default in Greece today with Argentina's default in 2002 may be instrumental in enhancing our understanding of sovereign default, of the risks entailed in adopting or eschewing certain policies, of the effects on foreign investors of such a default.

However, the conclusions might be different.

Argentina managed to survive its sovereign default, however painfully, and return to the international markets, albeit gradually.  The case of Greece may be different in case of default.  The regional ramifications of Argentina's default were not severe; the regional repercussions of a similar default by Greece might be significantly different, leading perhaps to what is called a contagion process and to Greece's withdrawal from the euro-zone.

In other words, once it is established that history does not repeat itself, the political risk analyst must look for similar phenomena to enhance understanding, not necessarily to draw a mathematical-like conclusion.

There is a misconception that history has to offer a ready-made recipe for analysis.  Many mistakes in the realm of politics and investments are more often than not said to be the result of a failure to learn from history.  That may be so, but learning from history entails, first and foremost, a humbling attitude towards it.  Knowing the limitations of history as an analytical device is no less important than being aware of its usefulness in political risk analysis.

This is not to belittle the use of history in political risk analysis.  History has an important role to play in clarifying events by the use of analogy. The question, of course, is how to use analogy in a careful and accurate manner.  After all, the person drawing similarities between a present and a past event is driven by a subjective perspective and is confined by personal experience.  It is the role of the political risk analyst to be aware of this before embarking on his/her analysis.

It should be noted, though, that being subjective in the use of history does not necessarily mean that the political risk analyst is wrong.  Indeed, objectivity is no guarantee of a successful analysis.  Nevertheless, in order for history to be a useful tool, the political risk analyst must be aware of his own limitations and eschew facile comparisons and simplistic conclusions.

A political risk specialist needs to make use of history in a two-fold manner:  as a tool to enhance and sharpen analysis and as a device to understand how decision-makers use history in their decision-making process.

This point cannot be overstated.  A politician, a president of a central bank, an investor—all of them employ historical analogy, on occasion, in order to reach a decision.  Understanding how they do that can help improve the quality of the analysis performed by a political risk specialist.

History is thus not only an important analytical tool to be employed in political risk analysis.  An awareness of its use by decision-makers is equally pertinent in order to enhance the work undertaken by the specialist in this field.