IMPROVING THE STATE
                                      OF THE WORLD

The information in this report, or on which this report is based, has been obtained from sources that the authors believe ...

Introduction                                                            4

Focus on Emerging Issues in Global ...

Over the last year, a series of risk issues – from the    possibility of an escalation in tensions with Ir...
The second part of the report presents our collective
Under conditions of global stress, one core question
1. Focus on Emerging Issues in Global Risk

                                                           Extended supply c...
A. Systemic financial risk: do we                           This section of the report discusses the key drivers,
even essentially solvent financial institutions, and       supervisors and central banks. Financial crises may
raising the...
What are the implications of these changes
• Rise of alternative capital pools: The rise of
Anatomy of a Systemic Financial Crisis

                                                    A triggering shock – either
complexity and unpredictable nature of financial         It may not make sense to attempt to eliminate risks
crises. State...
B. Food security: the emerging risk of
   the 21st century?

In 2007, prices for many staple foods reached
record levels. ...
Rising Food Prices, Unequal Impacts

            (food weighting within consumer price index, percent)
The drivers: population, biofuels
and climate change

Global population and changes in lifestyle

The United Nations has p...
C. Hyper-optimization and supply                          mismanagement of supply chains may result in them
   chain vulne...
chain, from sourcing of raw materials to customer                                 increase buffer inventory, arrange alter...
D. Energy and global risk:                                                       In the immediate term, the tightness of g...
consequence of financial surpluses in energy-                  The disparity between the impact of global risks on
The next few years will be crucial for determining a
long-term global strategy on many of these issues,
as a successor agr...
2. Assessing Global Risks in 2008

The global risk landscape at the beginning of 2008       risk, separating trends of i...
• International terrorists mount multiple attacks      • Penetration of organized crime in the global
  with c...
Societal risks: Increasing “globalization of risk”    world and chronic diseases in the developed world
(see pages 27-29) ...
The 26 Core Global Risks: Likelihood with Severity by Economic Loss
                            250 billion - 1 trillion m...
The 18 Core Global Risks: Likelihood with Severity by Number of Deaths
3. Networked World, Networked Risks

None of the global risks identified and assessed in
this report manifest in isolati...
the risk; the thickness of connecting lines reflects                            The correlation map highlights the differe...
basis of the responses to the current survey, the top     to identify potential coalitions of actors around global
four ri...
Global Risk Report 2008
Global Risk Report 2008
Global Risk Report 2008
Global Risk Report 2008
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Global Risk Report 2008
Global Risk Report 2008
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Global Risk Report 2008
Global Risk Report 2008
Global Risk Report 2008
Global Risk Report 2008
Global Risk Report 2008
Global Risk Report 2008
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Global Risk Report 2008

  1. 1. COMMITTED TO IMPROVING THE STATE OF THE WORLD Global Risks 2008 A Global Risk Network Report A World Economic Forum Report in collaboration with Citigroup Marsh & McLennan Companies (MMC) Swiss Re Wharton School Risk Center Zurich Financial Services World Economic Forum January 2008
  2. 2. The information in this report, or on which this report is based, has been obtained from sources that the authors believe to be reliable and accurate. However, it has not been independently verified and no representation or warranty, express or implied, is made as to the accuracy or completeness of any information obtained from third parties. In addition, the statements in this report may provide current expectations of future events based on certain assumptions and include any statement that does not directly relate to a historical fact or a current fact. These statements involve known and unknown risks, uncertainties and other factors which are not exhaustive. The companies contributing to this report operate in a continually changing environment and new risks emerge continually. Readers are cautioned not to place undue reliance on these statements. The companies contributing to this report undertake no obligation to publicly revise or update any statements, whether as a result of new information, future events or otherwise and they shall in no event be liable for any loss or damage arising in connection with the use of the information in this report. This work was prepared by the Global Risk Network of the World Economic Forum. World Economic Forum 91-93 route de la Capite CH-1223 Cologny/Geneva Switzerland Tel.: +41 (0)22 869 1212 Fax: +41 (0)22 786 2744 E-mail: © 2008 World Economic Forum All rights reserved. No part of this publication may be reproduced or transmitted in any form or by any means, including photocopying and recording, or by any information storage and retrieval system. REF: 090108
  3. 3. Contents Introduction 4 Focus on Emerging Issues in Global Risk 6 Assessing Global Risks in 2008 20 Networked World, Networked Risks 25 Financial Markets, Risk Transfer and Risk Mitigation 30 Structuring Mitigation at the State and International Level: Taking the Country Risk Officer Forward 36 Conclusion 39 Appendix 1: Taxonomy of Global Risk: Trends, Issues of Concern, Risks 41 Appendix 2: Risk Assessments 45 Contributors 52 Participants 53 3
  4. 4. Introduction Over the last year, a series of risk issues – from the possibility of an escalation in tensions with Iran and liquidity crisis in the financial markets to the concerns over the long-term integrity of the states of emerging concerns over the long-term security of Iraq and Afghanistan. food supply – have focused global attention on the fragility of the global system. An awareness of risk The result of uncertainty could be inaction in dealing and risk management is increasingly viewed as a with other, less immediate, global risks. Action to prerequisite for effective control in both the private mitigate climate change, for example, may be put in and public sectors. danger should the global economy weaken substantially – even though many of the political, This year will be no different. Uncertainty about the economic and investment decisions which will shape short- and medium-term future is as high as it has the future path of global climate will need to be been for a decade. Economically, the uncertainty made in the next five years. Proactive management centres on how the global economy will respond to of globalization to ensure its long-term sustainability the spreading liquidity crunch of 2007. The may be derailed by the prevailing currents of mispricing of financial risk, a central theme of Global uncertainty. But inaction on long-term risks will only Risks 2007, may have further to unwind. weaken the global capacity to manage future Geopolitically, uncertainty is focused on the challenges. 4
  5. 5. The second part of the report presents our collective Under conditions of global stress, one core question assessment of global risks in 2008, based on a of global risk management will become more salient revised taxonomy of risk, and building on the than ever: who owns the risk? Without a shared assessments of past years. In the third part, we look understanding of ownership, achieving the trade-offs at the methodological hurdles around the which may be necessary to mitigate global risk representation of interconnectedness and equitably and sustainably will be extremely difficult. demonstrate how risk “squeezing” and Without clarity on who is responsible for managing homogenization of risk are changing the way we global risk, turning aspirations into actions will be perceive risk globally. In the fourth part of the report, impossible. Without frameworks which connect we examine the role of financial markets as tools of ownership of risk with the responsibility to mitigate it, risk transfer and risk mitigation for an increasingly and which share the upside and downside of risk broad range of global risks. Finally, in the fifth part, among stakeholders efficiently, the market we take forward our discussions on the construction mechanisms for managing risk will fail to improve of risk mitigation coalitions and country risk our aggregate global resilience in the face of management, establishing a set of principles for inevitable risk events. And without leadership from country risk management which the Global Risk the business and political communities on all of Network will develop in 2008-2009. these issues, we may find our global future shaped more by risk events than by our power to anticipate, manage and mitigate them. The Global Risk Network, part of the World Economic Forum since 2005, will continue to generate discussion and dialogue between the The present report looks at global risks from a range corporate and public sectors. In 2008-2009, the of different perspectives. World Economic Forum and partners of the Global Risk Report – Citigroup, Marsh & McLennan The first part of the report focuses on four emerging Companies, Swiss Re, the Wharton School Risk issues that are shaping the global risk landscape: Center and Zurich Financial Services – will broaden systemic financial risk, food security, supply chains the participation of the global business and policy and the role of energy. On systemic financial risk, we community. put current market turmoil in the historical context and ask how the transformation of the global financial system over the last two decades may require us to rethink our expectations and understanding of systemic risk in the future. On food security, we discuss how the subject has moved from the periphery of the global risk landscape to its centre, and ask whether the world is ready to cope with the various trade-offs that the new food economy is generating. On supply chains, we investigate a potentially hidden set of vulnerabilities in the global economy to supply chain disruptions. Finally, on energy, we outline the emergence of a range of energy-related risks and ask if the world can move towards secure and sustainable energy. 5
  6. 6. 1. Focus on Emerging Issues in Global Risk Extended supply chains, which have allowed global In Global Risks 2008, the Global Risk Network has economic integration to flourish in the last two focused on four emerging issues which may decades, may be concealing increased vulnerability fundamentally shape not only the year ahead, but of the global system to disruptive risks. Geographic the decades to come. These issues – systemic concentrations of risk in economically efficient zones financial risk, food security, supply chains and the of production may have improved global welfare, but role of energy – are all central to the functioning of are businesses and governments prepared for the the world economy and to the well-being of global consequences of a risk event in these concentrated society. The risks associated with them cannot be areas? eliminated. But they can be better understood and better managed. Finally, this section looks at some of the problems associated with managing the long-term future of Systemic financial risk is the most immediate and, energy, particularly perceived risks to energy security from the point of view of economic cost, the most and risks from global climate change. severe. The financial conditions of the past decade have allowed for an exceptional period of economic What emerges from discussions is a common growth and stability. But, with so many potential problem: the growing misalignment of risk bearers consequences of the 2007 liquidity crunch under conditions of globalization. In financial unresolved, the outlook for the future is more uncertain markets, the atomization of risk has generally at the beginning of 2008 than it was a year ago. allowed far greater participation in the risk economy and vastly improved financial diversification, but it A recession in the United States cannot be excluded may also have resulted in a systemic under- in the year ahead, and economists are divided on appreciation of risk. For the food economy, shifts whether domestic-led growth in Asian markets can towards policies perceived to improve domestic drive the global economy. In Europe, the impact of energy security – such as an increased use of economic uncertainty may be highly divergent. The biofuels – and risks associated with water and role of the financial sector in the United Kingdom climate change may be shifting power and leaves it particularly vulnerable to financial turmoil, resources to crop producers and some developed while large current account deficits in some central economies at the expense of global equity. In global and eastern European economies may prove supply chains, dangerous accumulations of risk may increasingly unsustainable in 2008. The resilience of not be recognized and, yet, may threaten a systemic the export-led growth of other major European crisis should one part of the supply chain fail. Finally, economies may also be brought into question if the mismatch between incentives for fundamental disruption in the financial markets spreads more changes in the global energy economy – between widely. Over the much longer term, the dollar may developed and developing countries and between find itself under increasing pressure as the global different elements of the private and public sectors – reserve currency, undermining the geopolitical is complicating the emergence of global solutions. position of the US and foreshadowing the end of a hegemonic period in global economic history. This underscores the necessity to improve understanding of how risks interconnect, how we Food security, at the nexus of a number of issues can build coalitions to manage risk, and how the from energy security to climate change and water different trade-offs between risk mitigation solutions scarcity, may be emerging as one of the major risks can be appropriately identified. Our main conclusion of the 21st century. Long- and short-term drivers – is the need for the governance of globalization to population growth, changing lifestyles, climate enhance efficiency, ensure equity and manage a change and the growing use of food crops for global risk environment which is both more complex biofuels – may be shifting the world into a period of and more challenging than ever before. more volatile and sustained high prices. The consequences, particularly for the most vulnerable communities, may be harsh. 6
  7. 7. A. Systemic financial risk: do we This section of the report discusses the key drivers, understand it, can we mitigate it? characteristics and impacts of systemic financial risk, which private financial institutions, governments, regulatory authorities and central banks will need to integrate into their approaches to What is systemic financial risk? markets if they are to identify and survive the next systemic financial crisis. In general terms, the manifestation of systemic financial risk involves a system-wide financial crisis, typically accompanied by a sharp decline in asset values and economic activity. In all cases, systemic financial risk involves the spread of instability throughout the financial system as a whole with results that are sufficient to affect the real economy. Manifestations of systemic financial crisis are relatively rare. In the past 20 years, systemic financial risk events have included the equity crash of October 1987 (“Black Monday”), the Japanese asset price collapse of the 1990s, the Asian financial crisis of 1997 and the Russian default Mispricing risk: the underlying of 1998 (which led to the demise of the Long- seeds of crisis Term Capital Management (LTCM) hedge fund). At the beginning of 2007, the economic mood was Each of these episodes was characterized by an generally positive. The consensus pointed to a year abrupt loss of liquidity, discontinuous market of continued strong global economic growth. Risk moves, extreme volatility, sharp increases in premiums were at historically low levels. In correlations and contagion across markets, and hindsight, the widespread complacency with systemic instability. While the pathways of respect to the true nature of risk served only to contagion of systemic financial risk are often well confirm the weakness of financial markets in understood in retrospect, and the conditions for predicting systemic crisis. a systemic financial risk event may be well identified ahead of crisis, the precise triggering But there were identifiable “weak signals” which event is rarely predicted. Systemic risk is an suggested the potential for financial crisis. An asset inherent element of the global financial system. price collapse was the top risk identified in Global Risks 2007. Warnings voiced by the Bank of The increasing complexity of financial markets, and the International Settlements were ignored, while a rate at which financial markets are evolving, make the Global Risk Network briefing issued in January 2007 task of avoiding and managing systemic financial risk warned that a global re-appreciation of risk could be extremely difficult. Increasing global interconnectedness expected, with three major challenges to the global has multiplied the possible pathways for the economy: a housing recession, the beginning of a contagion of financial risk. Layers of leverage may liquidity crunch and high oil prices. have increased the possibility for magnification of risk. Financial innovation, in the form of complex All three were realized over the course of 2007. First, financial instruments, may ultimately contribute to the US housing recession, which began in late 2006, the opacity of systemic risk. At the same time, has accelerated, with new housing construction at however, the increasing importance of the financial its lowest level since the early 1990s and house sector in the real economy has made the question of prices down nationally. Second, the world has systemic financial risk more important than ever. experienced a crunch in global liquidity, affecting 7
  8. 8. even essentially solvent financial institutions, and supervisors and central banks. Financial crises may raising the prospect of tightening credit as banks are never be avoided. But their frequency and severity forced to readjust their capital ratios. Finally, the may be significantly reduced. dollar price of oil rose to an all-time high, close to the inflation-adjusted peak of the early 1980s. Is the financial system now more stable and resilient? Some recent experiences – such as the But if an eventual global re-appreciation of risk was relatively benign Y2K rollover, the very short-lived foreseeable in early 2007, the timing and precise market disruption following the events of 9/11, and nature of the trigger event was not. the relatively muted effects of more recent spikes in the dollar price of oil – have led experts to conclude In early 2007 many expected that any systemic that markets are now more resilient to exogenous crisis would be the consequence of an unwinding of shocks. But many would argue that the overall global economic imbalances – notably the US resilience of the global financial system will only current account deficit. The actual trigger for the become fully evident under conditions of severe current systemic crisis was the collapse of a critical stress over the next year. segment of the US mortgage business – the sub- A system transformed prime mortgage market. It was widely thought in early 2007 that the main threats to financial stability would come from leveraged hedge funds. But it Over the last 20 years, financial markets have turned out to be problems related to complex undergone a revolution, driven by deregulation, a security structures and off-balance-sheet vehicles rapid pace of financial innovation, global financial created by the banking sector that have generated integration and the increasing role of the financial the systemic elements to the current crisis. sector in the economy. Predicting what will happen is easier than predicting when and how events will unfold. The salient features of the transformation can be summarized in six points. Liquidity crunch: history repeats itself? • Deregulation: The process of deregulation has The meltdown of the US sub-prime mortgage deeply affected the financial markets of advanced market and the growing prospect of a global credit economies by removing barriers to entry; crunch dominated financial markets in the second reducing artificial borders between types of half of 2007. An abrupt evaporation of liquidity and financial institutions; increasing cross-border dramatic repricing of risk led to widespread financial competition; encouraging the emergence of large, instability, ultimately threatening the viability of complex financial institutions; and spurring smaller financial institutions even in well-regulated financial innovation. markets such as Germany and the United Kingdom. • Financial innovation: There has been an The US Federal Reserve has projected direct losses explosion in derivative and structured products. related to sub-prime of US$ 150 billion; non-sub- Such innovations have allowed for more efficient prime financial losses may be considerably greater. allocation of financial resources. Many argue that this has helped strengthen the global financial As in past systemic financial crises, complacency in system by better apportioning risk. However, credit standards – driven by perverse incentives and innovation raises challenges in terms of evaluating moral hazard – lowered risk premiums to risk, correctly identifying ultimate bearers of risk and unsustainable levels. The periodic underpricing of assessing whether they can manage it. Rating risk in financial markets may be structural and to asset classes without market history has put rating some extent unavoidable. But few systemic financial agencies in a crucial position in global markets. crises are entirely dissimilar to earlier episodes. This Regulators may not have the capacity to monitor suggests room for improvement in the management the range of risks within the financial system. And of crisis including better early warning systems and even as Basel II comes into force, regulation may more coordinated and forceful action by market not be evolving as fast as market innovation. 8
  9. 9. What are the implications of these changes • Rise of alternative capital pools: The rise of for the nature of systemic financial risk? hedge funds, private equity and sovereign wealth funds has changed the balance of the global financial system. Hedge funds are sometimes When considering the implications of these changes highly leveraged (with consequently higher risk for systemic financial risk, three major observations profiles) with shorter investment time horizons stand out: than standard investors, operating under • Risk ownership has been decentralized: The conditions of reduced disclosure and oversight. growth of securitization and risk transfer has led to Private equity firms, while often investing for the risks being disaggregated and spread to diverse longer term, are similarly unburdened by owners. This demands a shift in emphasis from regulatory oversight, and sometimes highly the widely studied and understood “bank run” leveraged. Sovereign wealth funds, which have model of systemic risk to a new “market-based” become particularly important as rising oil prices model, where financial crises manifest themselves and global economic imbalances have massively in markets rather than institutions; though of increased the foreign reserves of certain course institutions must still be monitored. countries, present a new set of challenges, • Risk transmission has become more including relative lack of transparency over important: Increasing interconnectedness has investment strategies, concern over possible multiplied the points of potential failure and political intervention and potential large-scale increased the significance of systemic linkages. market moves. Behavioural dynamics are critical. One example of • Financial services convergence: The borders the importance of risk transmission is the carry between different types of financial institutions are trade where there is potential for large, abrupt becoming blurred, increasing risk transfer between reversals of cross-border capital flows which them. Banks are supplying capital for insurance could trigger systemic crisis. risks, while both banks and reinsurers are using • Risk management is critical: Complexity has insurance-linked securities (see page 32) to increased the need for effective risk management. transfer insurance risks to the capital markets. At the enterprise level, there is rising adoption of • Role of non-bank institutions and enterprise risk management. At the national and intermediaries: The increased role of market international level, increasing attention is paid to intermediaries may have widened the offering of financial and political coordination. structured financial products to investors. But not all intermediaries are subject to consolidated risk- On balance, these developments appear to have based capital frameworks or the full complement increased the financial system’s capacity to assume of supervisory constraints. The originate-to- and distribute risk, and they also appear to have distribute (OTD) model may have lowered made it more stable. More risk is apportioned to underwriting standards while the growing market participants who have indicated a willingness importance of credit rating agencies – which play to absorb risk. But, as recent developments a key role in pricing risk but which do not hold it highlight, this appears only to be true under “normal” themselves – may raise similar challenges with market conditions. The complexity and near infinite respect to incentives. feedback loops of the modern financial system have • Shift to multipolar currency regime: While the exposed it to a small risk of very large systemic US dollar remains the global reserve currency and shocks. Some analysts postulate that the financial is likely to remain so for years to come, over time system may indeed be more pro-cyclical if the the creation of the euro and the growing growing dispersion of risk is not coupled with a importance of emerging country currencies will better understanding of the driving factors of risk lead to a weakening of the dollar’s dominance, segmentation and diversification. with consequences for the global management of central banks’ reserve holdings and the resolution of currency alignments. 9
  10. 10. Anatomy of a Systemic Financial Crisis A triggering shock – either real or financial – initiates a decline in asset prices Panic/contagion Apprehension Liquidity evaporates as Credit crunch as escalation crowded trades and asset fire of credit concerns leads to sales overrun arbitrageurs position liquidations, margin Fear/repricing (limits of arbitrage) calls and de-leveraging of risk Note: Whatever the proximate cause of a systemic financial crisis, the anatomy of apprehension, fear and contagion is common to most. Source: World Economic Forum Pathways to catastrophic failure Hence, we may be facing a paradox: while the financial system has been made more efficient and stable in normal times, it is now also more prone to All the trends above can be observed in the recent excessive instability in really bad times. At the same turmoil in financial markets. time, the increased importance of the financial sector in the global economy means that the impact of financial The ensuing liquidity freeze and broad-based asset instability on the real economy has also increased. write-downs indicate that many existing risk models were inadequate, failing to reflect the dynamic Open questions on systemic financial risk • What types of systemic propagation mechanisms might result in a small shock becoming a major financial crisis? • How can negative or self-reinforcing feedback loops (such as bank runs) be interrupted or short-circuited? • What is the role of central banks in an environment where lending activities are performed by many unregulated market participants? • To what extent does the mandate to forestall and defuse financial crises introduce moral hazard and underinvestment in management of market and liquidity risks? • What potential avenues for cross-pollination exist to identify useful concepts and mitigation models from other domains? • What role will the emerging giants of China and India play in the international financial system? • Will market-driven, regulatory and supervisory approaches be sufficient, or is more regulatory oversight required? And how could private sector initiatives supplement these? • What is the role of credit rating agencies in financial stability, if any? 10
  11. 11. complexity and unpredictable nature of financial It may not make sense to attempt to eliminate risks crises. Statements to the effect that 10-standard which ultimately represent a source of opportunity as deviation events were occurring several days in a well as hazard. Rendering the global financial system row demonstrate how much is still to be learned as flexible and resilient as possible by improving about the underlying distributions, and so-called early indicators, enforcing more stress testing, “tail” events, which refer to the extremes of a enhancing understanding of tail risk and requiring probability distribution. better contingency planning may be more effective. New thinking may be urgently required. Ultimately, strategies to deal with systemic financial risk must reflect the fundamental shift in the global Conventional wisdom emphasizes, in equal financial system to a market-driven model. There is measure, the two components of risk: likelihood and considerable scope for increased public and private severity. This naturally drives risk ratings, sector collaboration on stress testing, liquidity prioritization and corrective actions focused both on management, risk assessment and prevention. One prevention (i.e. reducing likelihood of the event) and example is the formation of the Counterparty Risk mitigation (i.e. reducing severity of the event). Management Policy Group in the wake of the collapse of Long-term Capital Management, which But changes in the financial markets, while providing has helped to reduce risks stemming from hedge many benefits, have also created new and fund leverage. unforeseen risks which may be more susceptible to exogenous shocks (such as geopolitical risk) or internal factors (such as speculative bubbles). Many of these risks are unpredictable, making prevention and mitigation impossible. 11
  12. 12. B. Food security: the emerging risk of the 21st century? In 2007, prices for many staple foods reached record levels. The price of corn in late 2007 was 50% higher than 12 months previously. The price of wheat was double. Global food reserves are at their lowest in 25 years and, as a result, world food supply is vulnerable to an international crisis or natural disaster. Food security has emerged as a major risk, marked by both local and global consequences, trade-offs dietary needs and food preferences for an active between different mitigation priorities and a and healthy life. Food security, similar to energy disproportionate impact on poorer communities. security, is not only about avoiding physical Embedded in a web of other global risks, there is disruptions to supply, but also about ensuring supply considerable uncertainty as to whether food at a price which allows economic activity and well- insecurity in 2007 is the result of short-term being to flourish. conditions which have existed in various times Impacts are global and varied throughout history, or whether a more fundamental change is taking place, with a range of underlying trends bringing food from the sidelines to the centre In the past, food security generally concerned the of the global risk discussion in years to come. least developed countries, particularly those in conflict and those facing uncertain weather patterns. What is food security? But, more recently, concerns about sustainable food security have spread to developed countries which According to the Food and Agriculture Organization have not generally considered themselves exposed (FAO), food security is achieved when all people, at to food insecurity. For example, the United Kingdom all times, have physical and economic access to has historically relied on the depth of international sufficient, safe and nutritious food to meet their markets to ensure food supplies at a reasonable Food Security: At the Nexus of a Range of Global Risks More frequent and Oil and gas prices severe heatwaves Food security Interstate and Reduction in Chinese civil wars economic growth Declining quality and quantity of water Source: World Economic Forum 12
  13. 13. Rising Food Prices, Unequal Impacts (food weighting within consumer price index, percent) 80 Bangladesh 70 Nigeria 60 Afganistan 50 40 Kenya Russia 30 20 10 Brazil China India US UK 0 0 1 2 3 4 5 6 7 8 Per capita income (in log) Note: Poor people tend to spend relatively more of their income on food, and therefore suffer more when food prices go up. Source: International Monetary Fund price, but this model may be put under stress in the September, Italians organized a one-day strike future. In 2007, food and drink prices rose at their against rising pasta prices. In October, in West fastest rate in 14 years, at 4.7%. In the US, food Bengal (India), food riots erupted as a result of prices were up 4.4% year-over-year at the end of disputes over food rationing. 2007 – double the rate of non-food, non-energy inflation – partially due to increased acreage devoted In some countries, particularly where the success of to corn to make ethanol. government has been historically linked to administrative control of basic supplies, China and India are also exposed to pressures on governments have intervened to limit the political global food security, and their domestic experiences consequences of rising food prices. The Russian may have global economic consequences. In China, government acted to control prices of staple foods average incomes have barely risen while food prices ahead of the December 2007 parliamentary have soared: by 17.6% overall, 70% for pork elections. In Egypt, which experienced political products, 30% for vegetables and 34% for cooking oil. upheaval in the wake of price increases of bread in Combined with the sharply rising dollar price of oil, high 1977, subsidies to bread producers have been food prices in China could increase global inflation. increased to mitigate the impact of rising global wheat prices. In China, soybean import duties have Beyond the potential economic consequences of been reduced, subsidies to farmers have been rising food prices is the well-established relationship boosted to encourage agricultural production – between food prices and political stability. In 2007, particularly of pork and milk – and plans are to surging prices of basic foods caused domestic provide support for low-income urban residents unrest in a number of different countries. In March, against food price increases. thousands of Mexicans demonstrated against the four-fold increase in the price of flat corn. In 13
  14. 14. The drivers: population, biofuels and climate change Global population and changes in lifestyle The United Nations has predicted the global population will rise above 9 billion by 2050, placing additional pressure on the global food supply. But these pressures are sharply accentuated by an increasing The second concerns the trade-off between global demand in developing countries for protein-rich foods efficiency and perceptions of energy security: while which require more grain (and water) to produce, and global efficiency would best be served by a market- by the increasing constraint of available agricultural determined allocation of crop resources globally to land. Annual per capita consumption of meat in food and biofuels based on price and relative China has increased from 10 kilograms in 1950 to environmental efficiency, concerns over energy security 40 today. Over the same time period, the availability may undermine the attractiveness of global of arable farmland per head of global population has collaboration. Not all techniques for manufacturing declined from one acre to half that. Many experts biofuels are equally efficient in terms of reducing believe that for these reasons increases in the price aggregate carbon emissions. It is often a perceived of food are likely to be sustained. national security imperative, rather than a global imperative to reduce carbon emissions, which is Food or fuel: how biofuel production may driving the frameworks in which biofuels are being impact food security produced. The use of crops to manufacture biofuels is Climate change increasing globally – often with support of governments aiming to reduce carbon emissions or Climate change alone is forecast to increase the to reduce dependence on imported sources of number of undernourished people globally by between energy. Biofuels are on course to consume up to 40 million and 170 million in 2100, according to 30% of the US corn crop by 2010. forecasts by the Intergovernmental Panel on Climate Change (IPCC). Climate change may affect agricultural Over the long term, the growing importance of production by increasing the severity of weather biofuels has prompted fears that the dynamics of events, by increasing the volatility of weather and by the energy economy will be introduced into global shifting rainfall patterns. Changing rainfall patterns food markets, dramatically increasing price volatility, could mean that in just over a decade, rain- particularly of staple foods. But, even over the short dependent areas of South Asia and Africa could be term, the use of crops for biofuels raises a number producing half their current agricultural yield. of complex trade-offs common to the management The result: uncertainty of many global risks. The first of these concerns global equity: any shift The consequences of all these trends for from food production to biofuel production has perpetuating the escalation of food prices are different consequences for different communities. difficult to predict. Some experts expect higher food Crop exporters may benefit, as may communities prices to be sustained. Others believe that markets where food expenditure is a minor part of overall will gradually readjust to shortages as higher prices expenditure. But others may suffer, from crop make it profitable again to grow crops for food. importers − including agricultural communities which Policy-makers may have to return to thinking about import grain as feed for animals – to poorer food as a strategic asset and begin to modify food communities where food purchased on the open policies. Given the amount of uncertainty, the market is a major component of overall expenditure. resilience of the world’s food system will be severely tested in the next few years. 14
  15. 15. C. Hyper-optimization and supply mismanagement of supply chains may result in them chain vulnerability: an invisible serving as a transmission mechanism of global risk, global risk? amplifying the disruptive impacts of a local risk event at the systemic level and producing consequences Economic globalization has transformed the far beyond the corporate sector. A crisis in the operational structures of both business and supply chain of a private sector manufacturer of government. Outsourcing – particularly of vaccines, for example, could rapidly develop into a manufacturing but increasingly of standard business public health crisis, particularly in the context of the services – has been a major driver of global ongoing global risk of pandemics and infectious prosperity by allocating scarce global resources to diseases. Building a culture of supply chain risk businesses and geographies with a comparative management across public and private sectors may advantage to produce particular goods and services be a first step to broader global risk mitigation. most efficiently. Improvements in technology and global logistics, and reductions in trade barriers have However, despite their importance both at the level all facilitated the integration of previously separate of individual enterprises and at the level of the global regional economies. As a result, international and economic system, vulnerabilities to the supply chain intra-regional trade has expanded at a faster rate are generally poorly understood and managed. This than the global economy over the last 20 years. is partly because the risks in the supply chain are obscured, as enterprises and governments may be But, as the global economy has become more indirectly exposed to a global risk disruption through integrated, vulnerability to disruption of the supply a complex range of sub-supplier arrangements. But chains which hold the global economy together may in some measure this is due to the range of possible have increased. Resilience is no longer just about global risk disruptions – from geopolitical risk to a internal management. natural catastrophe to pandemics. A US- or European-based company which sources key A global issue components from Asia will indirectly face risks that they may never encounter domestically, as well as very different cultural approaches to the management All companies and governments dependent on of risk. Conversely, a recent survey conducted by external suppliers are exposed to the risks of Marsh Inc. on 62 companies based in Asia found disruption in their supply chain. But the extent and that only 21% had full business continuity plans to complexity of current global supply chains mean that protect against business interruption arising from the problem of supply chain management is not events such as natural disasters or terrorist attacks. limited to a single enterprise or industry: even a relatively small supply chain disruption caused by a Given the complexity and interdependency of global global risk event may ultimately have consequences risks, developing a realistic and effective risk across the global economic system. management and mitigation strategy can be daunting. However, there are measures that can be The economic optimization of supply chains, with taken to better understand the volatility of supply the geographic concentration of risk as a frequent chains and to reduce the impact of global risk corollary, has enhanced the systemic vulnerability to transmission through supply chains at the enterprise a supply chain failure. In September 1999, global and national level. semiconductor prices nearly doubled following an earthquake in Taiwan, China, a key centre for supply. At the enterprise level, the first step is to understand Supply chains frequently appear to disperse risk the value added in each stage of the supply chain between multiple parties, but they can also, as in this and to assess the risk to delivery of this value. A case, lead to an unrecognized aggregation of risk. risk-return perspective – based on profit, revenue or reputational considerations – will support Effective preparation and management of supply management prioritization and deliver the greatest chains may prevent the contagion of global risks and return on investment. A thorough view of the supply limit the consequences of a localized risk event. But 15
  16. 16. chain, from sourcing of raw materials to customer increase buffer inventory, arrange alternative or fulfilment, will provide a clearer view of key back-up suppliers in different countries, or work with vulnerabilities and risk concentrations. This should suppliers to improve their own business continuity be coupled with an assessment of how these affect and resiliency planning and thus the firm’s own the supply chain in terms of recovery time or extra supply chain integrity. Whichever option is chosen, it cost implications. should be influenced by understanding the risk- return of different options, and the corporate A comprehensive assessment and/or quantification strategy and risk appetite of the business. of the risk in the supply chain will facilitate evaluation and prioritization of proposed risk transfer, financing But, ultimately, effective management of global risks and mitigation strategies. For example, a certain requires a collaborative and coordinated approach in level of loss that could arise from one of these risks public-private partnership at an international level. may be acceptable given the firm’s balance sheet Given the macroeconomic and microeconomic and risk appetite. Hence, no risk mitigation is impact of supply disruptions arising from a range of required. It is also possible that the risk level could global risks, improved dialogue and policy on these be increased, e.g. by reducing the buffer inventory, risks is crucial to the effective management of the thus facilitating cost savings. If the risk is global economy. This could also be facilitated by a unacceptable however, then a firm could opt to forum of country risk officers, suggested on page 36. Managing Global Supply Chains: External and Internal Management Note: Identifying critical dependencies in the supply chain, vulnerabilities to disruption and the risk threshold of the organization is the first step to managing global supply chains. But there are both internal responses and proactive external responses which need to be considered. Less traditional external management of risks may ultimately be more efficient. Source: Marsh & McLennan Companies (MMC) 16
  17. 17. D. Energy and global risk: In the immediate term, the tightness of global interconnected risks, disconnected markets has accentuated vulnerability to a supply incentives? interruption. Over the next 10 years, the International Energy Agency has identified the risk of a far sharper Energy is a key input to the global economy, but its supply-side crunch as investment in updating energy safe, secure and sustainable provision is increasingly infrastructure fails to keep pace with demand. problematic. At the nexus of a number of different Capital expenditure required is estimated at US$ global risks – including climate change, economic and 11.6 trillion to 2030, but uncertainty over future some geopolitical risks – current and future policy returns and future regulatory frameworks around decisions about energy will inevitably shape the greenhouse gas emissions has meant that such overall global risk landscape. But the incentives in investment may not be forthcoming. The place to reform the global energy economy in a way International Energy Agency has predicted a 37% which reduces global risk holistically are not in place. rise in demand for oil to 116 million barrels per day (bpd) by 2030, but investment in exploration has Outline of the risks fallen and many experts suggest that oil production is unlikely to exceed 100 million bpd. Last year saw an increase in oil prices close to the inflation-adjusted peak of the 1980s. There is The global economy has demonstrated remarkable considerable uncertainty in the long term over supply resilience to increases in energy prices since 2004. and demand. But over the 10-year horizon of this But the limits of resilience may be close to being report there are few reasons to believe that energy reached. The easiest gains in energy efficiency are prices will fall significantly – and there are several likely to already have been realized. Moreover, the reasons to believe that energy prices may rise. financial conditions which have prevailed in recent years – abundant liquidity, itself a partial Matrix of Impacts of Global Risk Events on the Oil and Gas Industry Economic cost Reduction in GDP ($bn) China slowdown 1 100 O&G supply disrupted Long Pandemic 900 contagious by air Climate change Short Short 700 Health major crises 500 Blockade only - long SARS spreads 300 US$ crisis Iran – US war Multiple 100 Blockade only - short Terrorist attack attacks -100 Air single attack -300 Industry gain Industry loss Oil & Gas industry cost Profit pool reduction Note: Assessments of impact are derived from a number of different global risk scenarios developed for the oil and gas industry by Marsh & McLennan Inc. 17
  18. 18. consequence of financial surpluses in energy- The disparity between the impact of global risks on exporting countries resulting from high prices – have different sectors of society and the economy can be changed. Not only has the risk of higher energy seen with reference to the impact of an oil price prices increased but, potentially, the vulnerability of shock. At the simplest and most immediate level, the global economy. such a shock would essentially be positive for oil and gas producers, but negative for the broader At the same time, the objectives of secure, global economy. reasonably priced energy and reductions in emissions of greenhouse gases (GHG) seem both The matrix shows an analysis of the impact of a out of reach and in conflict. number of risk events using the oil and gas sector as an example. Results for the electricity sector show Coal, the only cheap, widely available fossil fuel, is a similar pattern of disparate impact. One striking linked with carbon emissions which will be output from the graph below is the aggregate GDP unsustainable environmentally without carbon cost of a disruption of oil or gas supply – reflected in capture and storage technologies. The world’s major the overall Global Risk rating of a steep rise in oil or oil reserves are located in regions of geopolitical gas prices as one of the most salient risks for 2008 instability. Gas, the cleanest fossil fuel, is difficult to – compared to the potential (short-term) benefits for transport and is increasingly viewed as a political the oil and gas industry. The mismatch between bargaining chip by some major supplier states. gains and losses at the industry/aggregate level, as Nuclear power, probably the best option for carbon- well as the national/international level makes risk neutral energy from the perspective of currently management extremely complex. available and easily scaleable technologies, continues to cause anxiety given problems of waste But many of the more interesting impacts are disposal, fear of nuclear accidents and questions on the subtler: for example, the power sector in both desirability of the global spread of nuclear technologies. Europe and the US is delaying investments necessary to replace an ageing fleet of power Public policy has focused on green technologies stations because of uncertainty on future regulation such as wind power and biofuels. But these to reduce greenhouse gas emissions. technologies come with their own problems, notably Underinvestment today increases the likelihood of scalability. As discussed above, the use of crops for future power shortages, and consequently of future biofuels may promote greater insecurity for other high prices for electrical power. crucial resources: food and water. Meanwhile, failure to develop a clear holistic policy Globally, energy supplies are less secure even as approach to management of both energy security emissions of greenhouse gases continue to rise. and reducing carbon emissions may end up And the global risks continue to be strongly on the threatening both objectives. At present, the downside. European Union appears to be drifting into high dependence on gas from a single source, high Can the world move towards secure and investment in renewable energy technologies that sustainable energy? may not offer the scalability necessary to achieve ambitious targets of reductions in carbon emissions, and a highly differentiated approach to nuclear Such an outcome is possible, but it requires policy- power. Should the current situation continue, it is makers to confront their constituencies with difficult almost inevitable that the European Union will be trade-offs and requires a major shift in thinking about vulnerable to future energy shortages and will fail to risk and how dialogue on risk sharing can be achieve its stated goals for reductions in carbon established. One key issue, highlighted elsewhere in emissions. The situation in the US, while different, is the current report, is the inherent mismatch between no better: high investment in biofuel production may those who bear risk and reward. Without alignment of bring its own risks, while dependence on foreign interests and alignment of risk and reward, building energy supplies continues. complex coalitions to manage global risks will be difficult. 18
  19. 19. The next few years will be crucial for determining a long-term global strategy on many of these issues, as a successor agreement to the Kyoto protocol is negotiated, as major investment decisions will have to be made on energy infrastructures in producer countries, as political changes may drive shifts in energy policy in the developed world, and as the emerging economies of Asia become increasingly attached to particular energy sources. Better dialogue is needed at all levels – between emerging and developed countries and between the corporate sector and the government and regulators – so that the current misalignments of incentives can be addressed effectively. Energy security has two sides, and both producers and consumers have much to gain from predictability. Similarly, to unlock investment and innovation in cleaner energy, long- term economic viability must be assured by forward- looking regulatory frameworks and, ultimately, an economic price for carbon. Whether or not such policy changes are forthcoming at the global and national level, individual companies and the energy industry need to improve their capacity to link their own risk management and strategic decisions. 19
  20. 20. 2. Assessing Global Risks in 2008 The global risk landscape at the beginning of 2008 risk, separating trends of issues of concern from is broadly similar to the risk landscape at the risks themselves, has allowed for a more granular beginning of 2007. Many of the risks have remained approach to assessment. (This is available in stable in terms of the ratings ascribed to them by Appendix 2 of the current report.) The graphics on the Global Risk Network for likelihood and severity. A the following pages should be read in conjunction number of risks have been sharpened in definition, with a description of what has and has not changed others have been disaggregated and one new risk – over the past year. food security – has been identified. The taxonomy of Economic risks: The main shift between the increasing vulnerability to a supply-side shock – but outlook in early 2007 and the outlook in early 2008 the world has demonstrated remarkable resilience has been a major re-appreciation of risk over the in absorbing higher prices. From a relatively positive course of 2007 as many of the mismatches picture of the stability of the world economy in early highlighted in Global Risks 2007 have begun to 2007, the world is entering 2008 under conditions unwind. The trade-weighted exchange rate of the of considerable economic uncertainty. The US dollar has fallen, and the risks of a further possibility of a US recession has undoubtedly sharp fall have edged up. Oil prices have continued increased, but there is considerable debate as to to rise to close to inflation-adjusted peaks – how this would impact global prosperity. ECONOMIC • Rising and volatile prices create significant • Domestic social/political issues combine to slow shortages for poor people globally (those Chinese growth to 6% or less (sustained over whose consumption basket is more than 50% time). food). • Declining fiscal positions force multiple • Oil or gas prices rise steeply due to a major governments of wealthy countries to raise supply disruption (decreased global supply of taxes, leading to economic stagnation. 10% for several months). • House and other asset prices collapse in the • An abrupt, major fall in the value of the US US, United Kingdom and continental Europe, dollar with impacts throughout the financial reducing consumer spending and creating a system. recession. Geopolitical risks: Geopolitical risks remain global governance will continue to complicate broadly divided into three categories: geo- moves to improve global governance of global economic, structural shifts and regional instability. risks, either in terms of security or management of On the geo-economic side the main risks are financial imbalances. Finally, the focal points of associated with a potential retrenchment from global geopolitical risk – Afghanistan, Iran and Iraq globalization, whether from growing protectionism – are likely to continue to engage the world in in the developed world or from political pressures 2008. The possibilities for positive game-changing in the developing world. Political risk has returned developments, such as peace between Israelis to the management of the global economy in a and Palestinians, are always present. But few major way in recent years, and that trend looks set experts predict that the geopolitical picture will to continue. In terms of structural shifts, the change significantly for the better in 2008. pressures for change on the post-1945 model of 20
  21. 21. GEOPOLITICS • International terrorists mount multiple attacks • Penetration of organized crime in the global with conventional and chemical (but not economy increases significantly over a 10-year nuclear) weapons, causing significant economic period, weakening state authority, worsening and human losses and exacerbating the the investment climate and slowing growth. retrenchment from globalization. • Multiple developed economies take steps • Collapse of the Non-Proliferation Treaty (NPT) (tariffs, WTO disputes) which slow existing trade leads to multiple states simultaneously pursuing and further undermine talks on increased global nuclear technologies and weaponization, with integration. associated increase in geopolitical tensions • Multiple significant emerging economies dragging on the global economy. advance policies that harm foreign direct • US/Iran conflict. investment and slow the engine of global • US/Democratic People’s Republic of Korea growth. conflict. • Worsening conflict in the Occupied Territories • Nation building in Afghanistan fails, providing claims thousands of lives over a 10-year period, haven for international terrorist groups and and exacerbates geopolitical tensions and triggering the decline of the Pakistani state. economic decline throughout the region. • Disorder in the Horn of Africa worsens as • All forms of violence in Iraq – sectarian, multiple states descend into conflict and offer insurgent, terrorist – worsen and claim haven for terrorist groups. thousands of lives. Failure to achieve peace • A fragile Latin American regime collapses destabilizes the region on an ongoing basis. suddenly, spreading political and economic uncertainty throughout the region. Environmental risks: The main shift in severity of both tropical storms and earthquakes understanding of environmental risk has been have not changed. In 2007, the world has increased awareness of the potential experienced two “near misses” in terms of consequences of climate change. The geophysical potential economically catastrophic inland flooding factors behind an assessment of likelihood and in northern Europe and eastern China. ENVIRONMENT • Extreme weather events linked to climate • Natural catastrophe: A strong earthquake hits change will impact businesses and society at an economic centre such as Tokyo, Los large (e.g. multiple tropical cyclones make Angeles or San Francisco. landfall along the Gulf Coast, India, Bangladesh • Natural catastrophe: A strong earthquake or or China over a 10-year period). seaquake (followed by a strong tsunami) hits a • More frequent and severe heatwaves and developing country such as China, India or droughts have harsh impact on agricultural Indonesia. yields around the world. • Natural catastrophe: Extreme inland flooding of • Declining quality and quantity of water in several the Mississippi, Yangtze, Thames or Rhine major watersheds leads to water shortages and rivers causes direct economic and human increased prevalence of water-borne disease. losses and serious disruption downstream. • Natural catastrophe: Category 5 tropical cyclone hurricane hits an economic centre such as Tokyo or southern Florida. 21
  22. 22. Societal risks: Increasing “globalization of risk” world and chronic diseases in the developed world (see pages 27-29) may mean that the distinction may be less operable, while the recognition of between infectious diseases in the developing economic costs of both is rising. SOCIETY • A pandemic disease jumps from the animal • Chronic diseases are widespread in the population to humans, with high mortality and developed world. transmission rates. • US liability costs increase at four times the rate • Incidence of infectious disease continues to rise of GDP growth, and spread rapidly to Europe in Africa and rises dramatically in Russia and and Asia. Capacity for global insurance is South-East Asia (TB and HIV/AIDS). reduced, undermining investment and growth. Technological risks: Increasing human exposure common – versus custom – applications) makes to nanotechnology will increase severity should an predicting specific attacks difficult, but there is event occur, but this has to be balanced against increasing risk of attacks in general due to lack of the multiple opportunities created by resources devoted to cyber-security and constant nanotechnology. The constant interplay of risks probing of systems. In 2007, a growing number of within the critical information infrastructure electronic espionage attacks was considered to (complexity of systems, number of vulnerabilities, have been driven by foreign state authorities. failure to effectively patch security holes, use of TECHNOLOGY • Attack or system failure in critical information • Studies reveal health impairment due to infrastructure (CII) creates a domino effect, exposure to widely used nanoparticles (paint, shutting down IT-dependent applications in cosmetics, healthcare). Primary impact on power, water, transport, banking and finance, public health and secondary impact on and emergency management. investment in a range of nanotechnologies. 22
  23. 23. The 26 Core Global Risks: Likelihood with Severity by Economic Loss 250 billion - 1 trillion more than 1 trillion Retrenchment from Asset price collapse globalization (developed) Slowing Chinese economy (6%) Oil and gas price spike Pandemic Infectious disease, Transnational crime CII breakdown developing world Severity (in US$) and corruption Chronic disease, developed world Middle East instability NatCat: Cyclone Heatwaves & droughts Liability 50-250 billion NatCat: Earthquake regimes Major fall in US$ Interstate & civil wars Retrenchment from globalization (emerging) Food insecurity Fiscal crises in advanced economies Extreme climate change related weather Emergence of NatCat: Failed & failing states nanotechnology risks Extreme 10-50 billion inland International terrorism flooding Loss of freshwater Collapse of NPT 2-10 billion below 1% 1-5% 5-10% 10-20% above 20% Likelihood Note: Some risks were disaggregated for the purpose of assessment in Appendix 2 to the current report. For ease of visual representation they have been shown aggregated on the current graphics. 23
  24. 24. The 18 Core Global Risks: Likelihood with Severity by Number of Deaths 200,000-1,000,000 more than 1,000,000 Infectious disease, developing world Food insecurity Pandemic Severity (in no. of deaths) Interstate & civil wars NatCat: Earthquake Chronic disease, developed world Failed & failing states 40,000-200,000 NatCat: Cyclone Middle East instability Extreme climate change Loss of NatCat: Extreme related weather 8,000-40,000 freshwater inland flooding International terrorism Heatwaves & droughts Collapse of NPT CII breakdown 1,600-8,000 Emergence of nanotechnology risks Transnational crime and corruption below 1% 1-5% 5-10% 10-20% above 20% Likelihood Note: Some risks were disaggregated for the purpose of assessment in Appendix 2 to the current report. For ease of visual representation they have been shown aggregated on the current graphics. 24
  25. 25. 3. Networked World, Networked Risks None of the global risks identified and assessed in this report manifest in isolation. Many are interconnected, not necessarily in a direct causative relationship, but often indirectly, either through common impacts or mitigation trade-offs. At each stage of the process of managing global risks, from identification and assessment to mitigation, an understanding of interconnectedness enhances the approach taken. 1. Risk identification – identifying indirect exposures and potential tight couplings to exogenous risk events (shocks) 2. Risk assessment – accommodating the reality of risk conflation whereby risks are rapidly transmitted across geographical, industry and company boundaries 3. Risk mitigation – moving from managing risk in isolation (ring fencing) to addressing the transmission channels of risk (which may require collaborative action) as well as considering second and third order effects Understanding the interconnected nature of global risks is methodologically and conceptually complex. “Interdependence is the defining issue Yet, if an understanding of interconnectedness is to of the 21st century.” be integrated into prioritization and decision-making at the level of government, business and Tony Blair, Prime Minister of the United Kingdom international organizations, representing complexity (1997-2007); Member of the Foundation Board of the is crucial. Bringing together expert views on how to World Economic Forum (January 2007) think about interconnectedness is an ongoing mission of the Global Risk Network to exchange understanding of their dynamic interactions over ideas and methodologies. time. Third, the correlation approach only considers positive correlations, excluding negative correlations One approach, pursued for the Global Risks 2007 (such as the potentially negative correlation between report and continued in this report, was to build a risks related to climate change and the risk of picture of correlation of core global risks through an sustained high oil prices) which may also inform the ongoing survey of independent experts. In 2007, this appropriateness of mitigation policies. resulted in a matrix of correlation between the core global risks. For the 2008 report, the Global Risk Network considered the application of social network analysis The approach has both strengths and limitations. to understand correlation between global risks, First, the matrix measures strength of correlation, constructing a network diagram with nodes denoting rather than pathways of causation. Correlation can individual global risks and ties showing the strength tell us that risks manifest together, but it does not of correlation between the risks. Rather than treating tell us how and why. As a result, correlation may risks as discrete units of analysis, the focus is on provide as much “noise” as “signal”. Second, the how the structure and ties affect risk transmission. matrix provides a useful measure of “static” interconnectedness, providing an overview of There are three dimensions of risk rendered by the potential linkages between risks, but not an map: the size of the nodes denotes the severity of 25
  26. 26. the risk; the thickness of connecting lines reflects The correlation map highlights the different ways in the strength of correlation; and the spatial proximity which risks can be interconnected, adding to the of the nodes is based upon similarity in risk understanding of assessment and potentially correlations. The last dimension ensures that risks providing input into stress test simulations and with similar bivariate correlations are clustered close scenario processes. The correlation map may also together, reducing the ratio between “noise” and provide a proxy for understanding some of the “signal” compared to the correlation matrix mechanisms of risk transmission. A secondary produced for Global Risks 2007. analysis of “pivotal nodes” was conducted, based on Monte Carlo simulation techniques, which identified the risks that are most critical to the diffusion of global risk through the system. On the Social Networking Diagram of Global Risks Note: The sizes of the nodes in the social networking diagram indicate the assessment of the risk itself. The thickness of lines represent strength of correlation, while proximity of the nodes represents similarity of correlations Source: Witold Henisz, Associate Professor of Management, The Wharton School, University of Pennsylvania, USA, based on expert assessments of correlation (October 2007). 26
  27. 27. basis of the responses to the current survey, the top to identify potential coalitions of actors around global four risks are food (in)security, an abrupt fall in the risk issues and how a forum of country risk officers US dollar, international terrorism and a US/Iran could provide a mechanism for coordinating the conflict. mitigation of global risks. Risk squeezing In 2008-2009 the Global Risk Network will work to expand an understanding of correlation and causation by bringing together experts on these High labour and social costs, and tougher issues from public and private sectors. environmental legislation in the developed world, coupled with historic reductions in barriers to The globalization of risk international trade, have moved economic production from a national to a global basis. Supply Interdependency implies that we are all vulnerable to chains have become more complex – see section 1 disruptions in the global flow of people, capital and – and the full exploitation of differences in technology. But there are at least two additional comparative advantage has unlocked global elements to the globalization of risk which may economic growth. broaden our understanding of the mechanics of interconnectedness in the global risk environment. One result has been a delocalization of risk. Even as primary risks in production are reduced in one The first is risk “squeezing”: the transfer of negative location, those risks may be “squeezed” to new externalities of a production process, such as centres of production where costs, standards and environmental and human costs, from one area to conditions are lower. Some of the effects of risk another. In recent years, this has happened on a squeezing may remain in geographies of production, massive scale as a result of economic globalization, posing an ethical dilemma at the heart of raising a number of dilemmas for effective and globalization. equitable global governance of risk. The first is that shifting production to less regulated geographies But other effects of risk squeezing may have wider may, in itself, increase the aggregate negative global consequences. externalities associated with that production. The second is that the transfer of risk may, in any case, First, and most clearly, risk squeezing simply be an illusion if the negative externalities affect the displaces the original source of risk, but without global system as a whole, or if other costs may be mitigating the systemic consequences of risk and, re-imported in other forms. The globalization of occasionally, worsening both the underlying risk and capital has so outpaced the globalization of aggregate systemic vulnerabilities to it. One clear governance that returns to capital have been example of this is in environmental matters: decoupled from environmental and other costs. improving environmental regulation may reduce environmental costs in the near term, but if The second is risk “homogeneity”. For example, regulation pushes production to a less-regulated chronic diseases, such as heart disease, cancer and geography which is less equipped to deal with its diabetes, traditionally considered to be problems of consequences, then the aggregate long-term the developed world, are becoming common in impacts may be worse. developing countries. As lifestyles become increasingly convergent globally, the trend towards For example, developed country measures to reduce similar risk profiles is likely to continue. Another carbon emissions will not be meaningful in the example is global pandemics. One consequence of absence of global frameworks and action. Yet the this growing risk homogeneity is that the case for lack of a global price for carbon means that common and coordinated global mitigation action economic incentives to enhance carbon efficiency or has strengthened. In section 5 of the current report, produce in more carbon-efficient geographies are we look at how a region-at-risk model may be used not there. 27