Future shock: the world reaches a risk crossroads

The world has entered a period of unprecedented vulnerability to global risk, according to a new report from the World Economic Forum. In the run-up to the annual Davos meeting of world leaders later this month, the WEF’s sixth Global Risks report says that the financial crisis has drained the world’s capacity for dealing with shocks.

Launching the report at a press call in the London offices of insurance broker Marsh, Robert Greenhill, WEF’s managing director, said the frequency and severity of risks has grown but the ability of global governance systems to deal with them has not. “Domestic cohesion is diminished, risks are more interconnected and faster moving,” Greenhill said. “We need new networked systems to identify and address global risks before they become global crises.”

The report explains how wealth and income disparities and failures of global governance combine to shift risk to other stakeholders, or parts of society. The failures of the Doha Development Round of the World Trade Organisation and the lack of agreement at the Copenhagen conference on climate change are examples.

Commodity price time bomb

John Drzik, CEO of Oliver Wyman and a member of the report steering group, forecast that food and commodity price volatility would contribute to global instability for years to come, with serious consequences. “Natural catastrophes and climate change will cause interruptions to supplies while speculators will increase volatility,” he warned. “Unilateral government actions will heighten geo-political tensions.”

Businesses will suffer earnings volatility, moving commodity price risk up the agenda of CEOs and place greater emphasis on supply contracts, hedging strategies, energy and water efficiencies, he added.

The water, food and energy risk cluster, created by rapidly rising populations and growing prosperity, could lead to social instability, according to the report, as well as geopolitical conflict and irreparable environmental damage: “Any strategy that focuses on one part of the water-food-energy nexus without considering its interconnections risks serious unintended consequences.”

The report also examines what it calls the “illegal economy” nexus that includes state fragility, illicit trade, organized crime and corruption. The report says that illicit global trade was estimated at $1.3 trillion in 2009 and is growing. These risks, while creating huge costs for legitimate economic activities, also weaken states, threaten development opportunities and undermine the rule of law. “International cooperation is urgently needed,” the report concludes.

Debt induced crises

The third important risk cluster identified by the WEF report relates to macroeconomic imbalances, currency volatility, fiscal crises and asset price collapse that could be worsened by the increasing wealth and influence of emerging economies and high levels of debt in advanced economies.

Crisis induced indebtedness has reduced our capacity to handle further shocks to critically low levels, said Daniel M. Hofmann, chief economist at Zurich Financial Services Group. “Current fiscal policies are unsustainable in most industrialised countries and, in the absence of far-reaching structural corrections, there will be a high risk of sovereign defaults,” Hofmann said, making a case for spending cuts rather than increased taxes as a means of improving fiscal positions.

Demographic challenges will add to the fiscal pressures being experienced by advanced economies, as well as creating severe social instability in emerging economies, the report warns.

The ageing population is having an impact on society, said Christian Mumenthaler, chief marketing officer at Swiss Re. “Debt as a percentage of GDP will increase due to [governments’] age related liabilities and governments will not be able to fulfill their promises,” Mumenthaler said. “Governments and pension funds have always underestimated longevity risk.”

Cyber security a risk to watch

The report outlines several other “risks to watch” that were identified by a WEF survey linked to the report. Cyber security issues, for example range from the growing prevalence of cyber theft to the little understood possibility of all-out cyber warfare.

Weapons of mass destruction and the renewed possibility of nuclear proliferation between states are also on the WEF risks to watch list.

In an attempt to address the complexity of risks that leaders face, the WEF is planning to launch a Risk Response Network at its annual meeting in Davos.

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