Since the Global Financial Crisis of 2007-2008, the concerns about uncertainty were increasing. Initially, the efforts made to measure the economic and political uncertainty were only successful for just a few economies, of which most were advanced. To bridge this gap, a new metric was needed which could be used for developing economies as well.
The World Uncertainty Index (WUI) was released on October 29, 2018, which made it possible to measure the economic and political uncertainty for 143 countries.
WUI was created by text mining the quarterly country reports of 143 countries provided by the Economist Intelligence Unit (EIU) from 1996 onwards of all the countries with a population of at least 2 million, for the word ‘uncertainty’ and its variants. A higher number indicates higher uncertainty.
WUI showed that synchronization in uncertainty strengthens with stronger trade and financial linkages across countries. It has also been observed that there is an inverted U-shaped relationship between uncertainty and democracy. As countries shift from autocracy and anocracy toward democracy, uncertainty tends to increase. However, as countries move from some to full democracy, uncertainty falls.
The index has shown a significant rise near various notable historical episodes like the SARS outbreak, Gulf War II, 9/11 attack, etc. justifying the economic importance of the index.
While the Coronavirus Pandemic raised the WUI to a soaring high level of 55,685 in Q1CY20, it has come down to 28,914 in Q2CY20. The significant drop in the index suggests that the normality is resuming as the lockdown in various countries are being lifted.
How to Construct the Index Value?
WUI is better than the existing measures for economic policy uncertainty since it uses country reports by the EIU which provides specific coverages of economic and political developments. Further, EUI reports are made by following a standardized process that mitigates the concerns about accuracy, ideological bias, and consistency of the WUI. Also, it uses the same source of information for every county, it is easier to make cross-country comparisons. The index also foreshadows the decline in GDP, making it an early warning indicator.
The index has revealed the various stylized facts given below:
- Higher uncertainty is seen in emerging and low-income economies than in advanced economies.
- Global uncertainty has increased significantly since 2012.
- Spikes in uncertainty are more synchronized in advanced economies.
- Average uncertainty is higher in advanced and developing economies during the recession.
Correlation of WUI with various countries:
As evident, the correlation is much more in advanced economies than the emerging and low-income economies. Also, the movement between European countries is much more synchronized within the advanced economies.
However, the average level of uncertainty has been found to be higher in low-income economies compared to that of emerging market and advanced economies.
Correlation of WUI with other measures of uncertainty:
- The low correlation between WUI and all risks (Economic Structure, Political, and Financial Sector) depicts that the WUI is limited to capturing the different aspects of economic and political uncertainty and not all risks.
- The stock market price and bond price volatility tend to be higher near elections for firms operating in a politically sensitive environment. Thus, the increased volatility reflects a higher political risk. The WUI also shows a similar increase before elections and stays above average after the elections for a few quarters.
Uses of the index:
- WUI can be used as an alternative measure when the quarterly GDP data for countries is not available.
- The index can be used to see the difference in the level of uncertainty across the countries.
- The index overcomes the problem of data limitation leading to the exploration of important research questions that could not be answered previously. For example, change in the level of uncertainty by the change in regulations, examining the response of economic variables to uncertainty shocks.
World Pandemic Uncertainty Index
A new index named the World Pandemic Uncertainty Index (WPUI) had been released on April 4, 2020, to measure the uncertainty regarding the pandemics across the Globe. WPUI is also determined by counting the number of times the word “uncertainty” has been mentioned near the pandemic terms in the EIU Country Reports. A higher number indicates higher uncertainty related to pandemics.
Uncertainty due to coronavirus is unprecedented. It is almost 4 times the size of the uncertainty during the 2002–03 Severe Acute Respiratory Syndrome (SARS) outbreak and nearly 26 times the size during the Ebola outbreak. The level of uncertainty is expected to remain high as cases are still rising.
Thus, we see, the WUI and WPUI can be extremely helpful in measuring uncertainty prevailing in the world, whether it is related to measuring the economic and policy uncertainty or pandemic uncertainty. The dataset could be used to study the unfolding of uncertainty over the years, uncertainty across countries, or by grouping them under advanced, emerging, or low-income economies, etc. Thus, the indices can be of extreme utility in today’s environment where we are fighting with a pandemic, declining GDP, engaging in trade wars because of which the future uncertainty is also increasing.
Contributor: Team Leveraged Growth
Co-Contributor: Ria Verma
Research Desk | Leveraged Growth