Globalization and economic volatility

Businesses and households face substantial idiosyncratic and aggregate economic risk. As a general principle, economic risk for businesses reflects the myriad of factors that impact the profitability of the business, while for individuals economic risk reflects the myriad of factors that impact the earnings and employment outcomes of household members. While aggregate risk gets most of the headlines, the volatility of profitability and income that an individual business or household faces is dominated by idiosyncratic risk. That is, of the plethora of economic shocks impacting the outcomes for households and businesses, the evidence shows that the variance of idiosyncratic shocks is at least an order of magnitude larger than the variance of aggregate shocks. For example, whether a business is profitable reflects primarily idiosyncratic factors such as product quality, product mix and choice of technology, broadly defined, including the choice of business organization, factor mix, location and business-specific productivity, and cost and demand factors. Similarly, for households, earnings and employment outcomes primarily reflect the education and skills of household members as well as whether household members are well matched in the labour market.