Aalto University: Eighth Economic Defence Course digged into the topic of risk
Scenarios support strategy work
Decision-makers must be able to take decisions under conditions of radical uncertainty, where the risks are high and changes can come quickly and forcefully. But what should one do when the predictive power of traditional statistical models evaporates and the world is suddenly completely different from the one from which the models’ data was collected? According to Eeva Vilkkumaa, it is best in such situation to give up on trying to predict the future.
‘In times of radical uncertainty, it is essential to switch from predicting to instead outlining different possible futures. These scenarios are, at best, both concrete and credible, yet offer differing descriptions of the future. In long-term strategy work, the construction of scenarios usually requires that many uncertainties be taken into account, and that several alternative trajectories be determined for each one.’
Vilkkumaa also believes that it is important to harness the creative capacities of human experts to imagine trajectories that have never taken place before. Analytical methods are nevertheless useful for dealing with the complexity of combining multiple trends and trajectories.
‘For example, we were approached by a company that was considering transitioning into a new market and wanted to look into the different uncertainties involved. We outlined ten uncertainty factors related to the new market and three or four different trajectories for each of them. Through combining these, we built nearly 800,000 scenarios from which we could use analytical methods to select four scenarios that were both credible and as different from each other as possible.’
Scenario-based strategy work can be done from two different perspectives: preparing for different future scenarios or steering the operating environment towards the desired future. The preparedness approach is particularly needed when there are limited opportunities for influencing the future. There is often scope for such influence, however, which means that a strategy which focuses purely on preparedness is sub-optimal. Typical strategy measures aimed at shaping the operating environment include regulatory intervention, the development of radical innovations, and company acquisitions. A strategy based purely on shaping the operating environment, on the other hand, is a risky undertaking, as the future may well turn out to be completely different from what was hoped.
‘In my own research, I have developed decision-analytical methods that help towards simultaneously taking into account both the preparedness perspective and efforts to shape the operating environment. These methods help to identify the ways a company can deal with different future scenarios while also steering the company’s development in the desired direction,’ Eeva Vilkkumaa explains.
Dangerous talk about harmless debt
In his presentation, Professor Matti Keloharju raised the question of whether we are living in a ‘new age’ in which the traditional laws of economics no longer apply. He wondered why this tale of a new era is being told, even though history shows that there is no basis for it.
‘There are many examples from history of similar pronouncements of a new era – which later proved to be wrong. Among other examples, the famous American economist Irwing Fisher predicted that stock prices had permanently risen to a higher level – just days before the huge stock market crash of 1929.’
In Keloharju’s view, people want to hold on to this talk of a new era because provocative statements and headlines attract attention and help to market services to consumers or investors. If striking claims are repeated for long enough, many people start to really believe in them. Then they start thinking that this ‘new age’ calls for new measures to be taken. Also, because stories are easier to grasp than individual facts, they are more likely to be passed on from one person to the next.
‘Indeed, I wonder if you would have come here today if the theme of this event had not been risks but rather “let’s do everything just like we always have”,’ Keloharju asked.
Stories also play a role in political decision-making, as decision-makers have little time to get into the details. In such situations, an exaggerated story can tempt people to act in accordance with the story’s plotline and, for example, share out the economic pie in a different way. Stories can be harmless, but Keloharju warns against basing one’s own finances, or economic policy, on exaggerated stories.
‘In politics, it is easy to hand out money by alleging that everything is different this time. For example, the story of the harmless debt is a dangerous one,’ Keloharju pointed out, reminding the audience that some things stay the same even in times of radical risks and crises.
‘Even if there are changes to the constraints on economic operators, the economic equilibrium and economic institutions, the basic laws of economics are unlikely to change.’