Sir Vince Cable, former MP for Twickenham and secretary of state for business innovation and skills, is no stranger to uncertainty. As an economist, he worked for the Kenyan government and Royal Dutch Shell and in his political career he was closely involved in guiding the UK through the aftermath of the 2007 financial crash as part of the coalition government under David Cameron. His book The Storm: The World Economic Crisis and What It Means was published in 2009. He was knighted in 2015.
While he was business secretary, Cable was fiercely critical of bankers and the global banking system, excessive remuneration for chief executives and of forces promoting short-term strategies in business. His experience of the well-publicised frustrations within the coalition government gave him first-hand insight into the workings of sensitive political negotiations – lessons that are perhaps relevant to those working towards Brexit negotiations today.
Cable was a previous keynote speaker at Chartered IIA’s annual conference. We asked him for his thoughts about the challenges – including Brexit – that are facing organisations today and what he believes internal auditors can do to help them weather continuing economic uncertainty.
Q: Economists have come up with wildly varying – and often incorrect – predictions about recent political events such as Brexit. Who should organisations believe and can anyone offer them sound advice on a post-Brexit future?
A: Good professional economists shouldn’t make predictions. They make forecasts based on assumptions that should be explicit and they should build in a range of error and recognise a variety of probabilities that will affect these forecasts. When government economists are quoted as saying, for example, that Brexit will cost £x per family or x percentage of GDP, I do not believe that’s what they actually said; it’s what they were quoted as saying by the press or by politicians.
When I was appointed chief economist at Shell I was shown an Arabic proverb that meant: “Those who claim to predict the future are lying even if they are later proved to be right.”
That’s not to say that economists are not useful. Large organisations need to do long-term planning and someone needs to create a view of the future. Economists provide an important component by helping organisations to think about different scenarios and creating logical, consistent models showing how the world works and how different areas of business and business risks interconnect. However, these have to be used well and their limitations need to be understood. At the moment, I believe financial services organisations tend to use economists quite well, but they are less well used by organisations that make things.
In the case of Brexit, some of the forecasts that were made have already materialised – for example, the value of the pound has fallen. This has boosted UK exports, but it has also increased the cost of living.
Q: How can internal audit help to improve the way in which organisations use economic forecasts and ensure they gain value from them?
A: Internal auditors should be considering the underlying assumptions behind the forecasts and how the forecasts are updated and modified as things change. They should look at how the organisation uses scenario planning and be aware of how and when scenarios are updated.
They also need a proper process to challenge assumptions and to ask for clear evidence that the organisation uses scenario planning effectively. Organisations must prepare for the worst case scenario even when they are hoping for the best. They mustn’t be under delusions about risk and they must be able to show that they are thinking the unthinkable.
Q: What do you see as the major risks of the Brexit negotiations and what warning signs should organisations look for that will provide a “red flag” for impending post-Brexit problems?
A: In the long-term we may well see an effect on our economy and on investment levels, but it’s premature to predict this because it depends to a large extent on how the Brexit negotiations proceed and what deal we get from Europe.
Some companies are acting out their long-term plans very publicly – for example, BMW and others in the car industry. Many in the financial services industry are also particularly concerned about potential loss of single-market status and their ability to sell services in the EU.
All organisations should be looking for signs of whether the negotiations over our impending divorce are being carried on in a business-like way. There are various indicators of this. At the moment it looks as if negotiations will never get off the ground because the Europeans are saying we owe them money and our government is saying we don’t. If we don’t get past this dispute we can’t go ahead, and businesses should be watching this carefully. They also need to be watching for any signal that we will reach an agreement on our access to the EU market, rather than “crashing” out of it, which will have serious consequences.
Q: What would you do now if you were in charge of the Brexit negotiations?
A: I would be doing in-depth scenario planning. It seems to me dangerous that the government does not appear to be doing this. I think Parliament needs to see our negotiating strategy and the way we are planning and thinking about contingencies. This shouldn’t threaten our position in Europe – if anything, it should strengthen it.
Q: What would you like the UK’s relationship with Europe to be in five years’ time?
A: I’d like to see an agreement that preserves as much of our trading relationship with Europe as possible – for example, the framework of EU regulations, our customs union and access to the single market. I think we need to retain amicable relations with EU countries as they are our closest partners.
The worst case scenario would be that we crash out amid recriminations with European leaders causing bad feeling and reduced ability to trade freely. The World Trade Organisation rules are not clear and we would have to reapply them, which would create profound, damaging uncertainty.
Q: What can organisations do if they think a worst-case scenario is materialising?
A: Most companies are already looking to diversify their markets, suppliers and manufacturing processes. This was happening already, but it has certainly gone up a notch.
Good businesses take a long-term view and they will survive shocks and upsets if they are fundamentally sound. Political risk isn’t new – just because an emerging market has high risks, it doesn’t mean you can’t do business there. When I was at Shell we did lots of business in Nigeria, despite huge political and corruption problems there. The brutal truth is that emerging markets represent a growing share of the world’s economy, so organisations have to be looking to places such as China, India and many African countries because they have such dynamic economies.
Q: We are seeing a global rise in nationalistic fervour and Donald Trump is threatening to put American companies first in global trade. How will this affect UK organisations seeking new markets?
A: One major danger is that people get so preoccupied with Brexit that they take their eyes off more serious risks. US foreign policy is the most important issue globally at the moment. The biggest red flag I can see is around President Trump and a possible trade war with China. There has been a lot of rhetoric, but if Trump puts all the policies of the past 20 years into reverse and starts a trade war with China that will have a profound effect on global trade.
In addition to this there are other global concerns around banking stability, emerging markets and specific sectoral issues, for example around a property bubble in the UK. These are all important.
However, I’m not sure there is more uncertainty today than in the past. In the 1990s we had war in Yugoslavia, the collapse of the Soviet Union, the end of Apartheid in South Africa and a clamp-down in China that led to the Tiananmen Square massacre. We have different risks today, but the world has never been a benign and happy, predictable place. One major change has been the technology that means we can get information quickly and things can change more rapidly, but this in itself is neither good nor bad, it has to be used well.
Q: How well do you think most companies deal with long-term risk and strategy?
A: The thing that worries me most is the short-term culture of many organisations. This was a problem when I was in government and we put various things in place around competition and takeovers, and we got a legal ruling on the duty of directors to put in place a long-term focus, but we could probably have done more. The problems are now exacerbated by our currency depreciation because it is encouraging opportunistic takeovers of UK businesses. The government says it has an industrial strategy, which is promising, but it’s not clear whether this goes beyond using the right rhetoric.
Sir Vince Cable will be speaking at Internal Audit 2017 on 10-11 October.
This article was first published in Audit & Risk May/June 2017.