Strategic View: Time to rethink scenarios

   The most correct prediction in the last few years may have been made by Ray Fitzgerald, president at Wallenius Wilhelmsen Logistics, at the Georgia Foreign Trade Conference last February, when he spoke about operating in a VUCA (volatility, uncertainty, complexity and ambiguity) environment. Recent and forthcoming political decisions in many parts of the world, such as presidential elections and referendums on a variety of issues like Britain’s membership in the European Union, have defied predictions. As the parameters that characterize the macroeconomic environment change, particularly trade agreements, so do the types of scenarios that can pan out. This impacts investment decisions, specifically public and private sector transportation infrastructure investment which has a long design life and is therefore increasingly determined by scenario-based planning strategies. 
   For both short-term and long-term freight movement planning purposes, scenario development consists of identifying trends and events that are expected to set the level and composition of freight flows. It is useful to review both elements included in the scenarios used for planning.
   The trends included in scenario planning are normally those that have been in place for some time and are believed to be sustainable. These tend to be the most predictable, but it is important to recognize that they are not perfectly predictable and require at least occasional review. Specific trends in this category tend to be population and productivity, also known as output per capita growth. 
   Population growth forecasts tend to be reasonably accurate over a medium-term horizon. On a year-to-year basis there are deviations due to economic conditions and variations in migration between regions and countries. On a longer-term basis, assumptions about fertility and mortality rates have often turned out to be wrong. The most accurate one in this regard is to assume that the size of the population, as well as the share that is of retirement age, will continue to increase.
   Productivity is driven by investment activity and varies across regions. Less-developed economies have a lower capital base and therefore tend to see higher productivity growth, provided there is investment in both public and private sector infrastructure. Mature industrialized economies tend to see lower productivity growth rates. Productivity growth is very volatile and difficult to predict on either a short-term or long-term basis. However, like population growth, it is very likely that productivity will continue to increase. In other words, the amount of output per person is expected to continue to increase.
   Looking at population and productivity growth trends, it seems likely that global economic activity will continue to increase. Some countries and regions are expected to grow faster than others. For example, Asia’s economies are expected to grow faster than North America and Europe. However, how economic growth translates to growth in trade and therefore demand for transportation or freight movement depends on other factors. 
   Among other trends that impact the demand for freight movement and therefore transportation infrastructure are raw material resources availability and prices, as well as foreign exchange rates. Fuel is a significant cost of transportation. Petroleum remains the primary source of fuel for transportation. While it is reasonable to expect demand to continue to grow in line with demographic and productivity trends, this does not mean that prices will continue to rise, since that will also depend on how production capacity evolves. 
   Increases in oil prices make transportation more expensive, which in turn can reduce the demand for trade and potentially domestic freight movement if there are less expensive local goods that can be substituted for imported ones. The price of fuel also depends on foreign exchange rates. Oil prices are normally quoted in U.S. dollars; however, if the consumer is based in a country whose currency has appreciated against the dollar, the fuel price paid there could actually be lower. 
   Currently, demographic and productivity trends indicate that global trade and domestic freight movement demand will continue to increase. However, resource price and foreign exchange rates have been unstable, which makes it difficult to produce an accurate forecast. It is necessary to develop a range of potential scenarios. 
   The scenarios generated from sustainable trends and variations in raw materials prices and exchange rates must also take into consideration how policies and regulations may change. As the population and output of goods and services grow globally, so does the size of the global middle class. The world’s population continues to migrate from lower value-added employment in raw material production to higher valued-added, and therefore compensated, manufacturing and services employment. Growth generates externalities such as congestion and emissions. 
   Reaction to externalities is somewhat predictable. Emissions regulations are likely to become more restrictive and costly to those providing transportation services. Congestion relief, which requires public sector investment, is likely to continue lagging the private sector’s needs. This is unfortunate since congestion slows freight movement down and therefore increases delivery time and inventory costs. It is essentially a barrier to trade, much like tariffs and expensive freight rates can be.
   It is important to review the scenarios upon which infrastructure investment strategies are based and revise them as new information becomes available. Great care must be taken to identify leading indicators that not only help point out the probability of scenarios developing but also when those scenarios used for planning need to be reviewed. Given the political event schedule and changing policies, a great deal more consideration must be given to scenario development these days.