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ANALYZING RISK
Excerpts from “Global Risks 2008”
Published by the World Economic Forum, January 2008
Analysis by Geoffrey Craig
An awareness of geopolitical risk is vital for business and political leaders, according to a recent report by the World Economic Forum (WEF). The third “Global Risks” report highlights four emerging areas of geopolitical risk: systemic financial risk, food security, supply chains and the role of energy. Their associated risks may be impossible to eliminate, the report states, but they need to be understood and managed.
“Systemic financial risk is the most immediate and from the point of view of economic cost, the most severe. The financial conditions of the past decade have allowed for an exceptional period of economic growth and stability. But, with so many potential consequences of the 2007 liquidity crunch unresolved, the outlook for the future is more uncertain at the beginning of 2008 than it was a year ago.”
The increasing complexity and interconnectivity of financial markets heightens the danger that a system-wide financial crisis could spread into the real economy, as was the case with the Asian financial crisis of 1997. A related concern is whether the US economy will go into a recession this year, and whether Asian-led growth would be enough to sustain the global economy, as the world struggles to cope with soaring commodity prices and food shortages.
“Food security, at the nexus of a number of issues from energy security to climate change and water scarcity, may be emerging as one of the major risks of the 21st century. Long- and short-term drivers – population growth, changing lifestyles, climate change and the growing use of food crops for bio-fuels – may be shifting the world into a period of more volatile and sustained high prices. The consequences, particularly for the most vulnerable communities, may be more harsh.”
Prices for many staple foods reached record highs in 2007. Corn prices were 50 percent higher in late 2007 than 12 months earlier and wheat prices doubled. Global food reserves, which are at 25-year lows, remain vulnerable to international crises and natural disasters. The unanswered question is whether the present shortage is the result of recurring short-term conditions or represents a more fundamental change.
“Extended supply chains, which have allowed global economic integration to flourish in the last two decades, may be concealing increased vulnerability of the global system to disruptive risks. Geographic concentrations of risk in economically efficient zones of production may have improved global welfare, but are businesses and governments prepared for the consequences of a risk event in these concentrated areas?”
Supply chains, similar to financial markets, have become more efficient through outsourcing, rather than keeping the production process local. This trend has been a driver of global prosperity, but the integrated nature of supply chains also makes them more vulnerable to disruptions. Effective management may prevent global risks from spreading, but mismanagement could amplify the risks. A bigger challenge, however, is finding a solution to high energy prices.
“Energy is a key input to the global economy, but its safe, secure and sustainable provision is increasingly problematic. At the nexus of a number of different global risks – including climate change, economic and some geopolitical risks – current and future policy decisions about energy will inevitably shape the overall global risk landscape. But the incentives in place to reform the global energy economy in a way which reduces global risk holistically are not in place.”
Energy prices, nearing the inflation-adjusted highs of the 1980s, are unlikely to come down over the next 10 years, the time frame considered in the report. Demand will continue to outstrip supply, as producers face uncertainty over future returns and may not make the necessary investments in exploration and infrastructure. Meanwhile, green technologies will have to overcome the problem of scalability. Per unit costs are too high to compete on a large scale with traditional, fossil fuel-burning technology. Research and development can help drive down the costs, but is currently insufficient because the risks and rewards are spread globally.
Globalization has meant greater diversification of assets, including risk. The problem arises when each agent fails to adequately assess his own level of risk. The accumulative effect is a systemic under-appreciation of risk.
“This underscores the necessity to improve understanding of how risks interconnect, how we can build coalitions to manage risk, and how the different trade-offs between risk mitigation solutions can be appropriately identified. Our main conclusion is the need for the governance of globalization to enhance efficiency, ensure equity and manage a global risk environment which is both more complex and more challenging than ever before.”
The report suggests that companies need to assess the risks they are most susceptible to. On the international level, the remedy is better dialogue between the public and private sectors on risk. But companies should also review their risk exposure. Sometimes the risk level may be acceptable, and risk mitigation isn’t necessary. Otherwise, alternatives are worth considering, such as back-up suppliers to create a buffer zone in case of an emergency.
Excerpts from this report are available on the WEF website at www.weforum.org
| Risk Assessment (selected cases) |
| Scenario |
Likelihood |
Cost (US$) |
Lives lost |
| Rising and volatile prices create significant shortages for poor people globally (those whose consumption basket is more than 50% food) |
3 |
3 |
5 |
| An abrupt, major fall in the value of the US dollar over time with impacts throughout the financial system |
3.5 |
3 |
N/A |
| Middle East instability |
4 |
3.5 |
3 |
| Worsening conflict in the occupied Palestinian Territories claims thousands of lives over a 10-year period, and exacerbates geopolitical tensions and economic decline throughout the region |
3 |
2.5 |
2 |
| All forms of violence in Iraq – sectarian, insurgent, terrorist – worsen and claim thousands of lives. Failure to achieve peace destabilizes the region on an ongoing basis |
5 |
2.5 |
3.5 |
| More frequent and severe heatwaves and droughts have harsh impacts on agricultural yields around the world |
3.5 |
3 |
2 |
| A pandemic disease jumps from the animal population to humans, with high mortality and transmission rates following |
3 |
4 |
5 |
| |
Likelihood |
Cost (US$) |
Lives lost |
| 1 |
below 1% |
2-10 billion |
1,600-8,000 |
| 2 |
1-5% |
10-50 billion |
8,000-40,000 |
| 3 |
5-10% |
50-250 billion |
40,000-200,000 |
| 4 |
10-20% |
250 billion-1 trillion
200,000-1 million |
200,000-1 million |
| 5 |
above 20% |
> 1 trillion |
> 1 million |
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