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The Evolution of Global Risks: The First Decade of the World Economic Forum Global Risks Reports

Abhijnan Rej - 25th June 2015
The Evolution of Global Risks: The First Decade of the World Economic Forum Glob

Abhijnan Rej explores what a decade of the World Economic Forum’s Global Risks Reports tell us about thinking on the global economy, instability and inequality.

In 2011 the world was gripped by social unrest. The Middle East witnessed the Arab Spring, beginning with the Tahrir Revolution in Egypt that resulted in the ouster of Hosni Mubarak. In Syria, the Assad government all but lost grip over its restless population outside Damascus. Anti-corruption protests in India rocked the social and political status quo. The West was not spared either: the United States saw the beginnings of the Occupy Movement, which highlighted the growing income disparity in that country. Britain was hit by the worst urban rioting in Europe in a generation.

Seemingly disparate in geography and demands, these events have continued to shape geopolitics since. Yet underlying causes of these momentous events are the same: massive social and economic inequity, a financial system plagued by the aftermath of the explosion of asset price bubbles that encouraged unnecessary risk-taking and speculation and, not the least, structural unemployment problems across the world stirring a generation which bore the brunt of events it was too young to shape. It is in this context that a barometer of global interconnected risks, both present and extrapolated, becomes a very important tool for policy and analysis.

This year saw the publication of the 10th edition of the Global Risks Reports (GRR). Sponsored by the World Economic Forum and released around the time of its summit at Davos each year, the GRR serves as a valuable marker of perceptions around long-term global risks among academics, practitioners and policy-makers. The GRR are based on workshops of different stakeholders where the participants are asked to assign numbers to different risks – economic, geopolitical, societal, technological and climate-change related – on given scales of likelihood in the long run (typically 10 years) against severity (financial loss or number of deaths, in the some of the early reports).

Yet, the GRR are not simply surveys that report perceptions. Built into the analytical framework of these reports are two very important dimensions of global risks, namely (a) that they are nonlinear and (b) that they are systemic. Point (a) was succinctly summarized in the 2006 report as saying that global risks “have impacts [which] can be greater than the sum of their parts”. Point (b) is more subtle. A risk is said to be systemic if its effects can not be localized in terms of geography or nature and, instead, ends up becoming magnified as it spreads. The world learned a vivid lesson on systemic risk when a small fragment of the U.S. financial economy — trading of bad collateralized debt obligations — ended up causing a global recession whose breadth and depth far exceeded that of capital markets alone. Positioning global risks as nonlinear and systemic has served to alert stakeholders to threats that are more than just “here-and-now”.

My aim in what follows is neither to summarize 10 years of deep-dive content nor to draw up a likelihood/impact-severity laundry-list. Instead, I want to discuss socio-economic global risks that have, time and again, shown up in the history of the GRR. I will also concentrate on the feed-back/feed-forward relationship between geopolitical and economic variability and focus on risks that are likely to have the greatest impact on developing economies.

Essentially, there are seven such risk classes: (i) the threat from unsustainable fiscal deficit and its effect on economic growth, (ii) a “retrenchment from globalization” both in the developed and emerging economies, (iii) possible bubbles of asset prices both real and capitalized, (iv) global governance gaps and governance failures, (v) unemployment and underemployment, (vi) severe global and regional economic disparity and (vii) under-investment in infrastructure. A first glance at this list confirms the interdependence of the risk classes that were considered in the GRR.

The first, 2006, report (while listing terrorism as the greatest global risk) listed potential fall-outs from unsustainable fiscal deficit. A textbook argument, neatly summarized by Laura Tyson, spells out this risk: the desire to curb national deficits leads to shrinking of government spending which, in turn, leads to a reduction in government-led job creation, thereby slowing national growth. The other side to the story is that widening deficits weaken the national currency which, in turn, leads to serious balance-of-payment and sovereign debt issues. Respondents in 2006 had categorized this risk as high but had underestimated its likelihood. The Great Recession has since brought this back front and center in any serious economic debate, not the least in the United States but also in southern Europe.

The 2007 report was almost prophetic in nature two different ways. First, it sounded an early warning on the possible reversals to gains from globalization in terms of economic and, possibly, political retreats in terms of free-market commitments both from the developed and emerging economies. Second, it noted that “housing prices have doubled in most mature markets... many experts fear a major correction with differential impacts on consumption, growth and asset prices” [emphasis added]. The irony must not have been lost on the authors when in 2008 the second become the driver of the first risk with reverberations lasting till date.

The 2008 report also delved into systemic risks, but with a focus on vulnerabilities of the global “hyper-optimized” supply chain. To quote the report, “the economic optimization of supply chains, with the geographic concentration of risk as a frequent corollary, has enhanced the vulnerability of a supply chain failure ” [emphasis added]. This too has proved to be prescient. For example, activism around Special Economic Zones in India has been termed an investment risk. The 2008 respondents, when they expressed their apprehension about emerging economies advancing policies that harm FDI, would have also been right on the mark if they had included local partisan politics as another threat to the “engine of global growth”.

The 2009 report added global governance gap as a separate class of global risk. Defining it as “absence or lack of effective and inclusive governance on global issues such as financial stability, trade, climate change, water and security”, the issue of governance gaps or failures assumed a central role in the later reports as the risk hub at center of geopolitics, economics and environmental issues. One of the major concerns of the 2009 report was the restoration of financial stability, particularly when entire geographies were exposed to asset price bubbles. This context demands effective governance that aids stability. A global downturn implies the possibility of greater protectionist postures from both developed and emerging economies. This systemic effect of the 2007 – 2009 crisis was also highlighted by the authors.

The 2010 report continued to warn of economic and fiscal consequences of asset price bubbles but also brought another major class of risk into focus: the problem of structural unemployment. Calling the problem of unemployment and underemployment in developed economies that followed the severe downturn of capital markets both a “cyclical response” as well as a “structural shift”, the authors argued that the latter was a consequence of the former in terms of the “[financial] crisis hasten(ing) structural changes”. The 10-year long horizon for the 2010 report means that the respondents had the 2020 dateline in mind when marking structural unemployment as a global risk.

Economies with long-standing structural employment problems (alongside jobless growth) raise the specter of severe and increasing economic disparity. This disparity, along with governance failure in curbing it, “influence the evolution of many other global risks and inhibit our capacity to respond effectively to them”. This was the central point of the 2011 report. Economic disparity is a far-reaching problem. The US National Intelligence Council's Global Trends 2030: Alternative Worlds Report called this the “Gini-Out-of-the-Bottle” scenario where, to quote the same, “inequalities explode as some countries become big winners and others fail. Inequalities within countries increase social tensions.” GRR 2011 also flagged under-investment in agriculture as a major risk affecting food security. With great overlap between countries likely to face structural employment problems and the ones most in need of long-term food security measures, food insecurity and unemployment are likely to feed each other. This dyad of risks remain of particular concern in the global South.

It is therefore not surprising that a major theme of the 2012 report was a “constellation of risks” around a dystopic future where macroeconomic and fiscal imbalances, chronic labor market inefficiencies and demographics – perhaps pushed by a second systemic financial crisis – obliterates all growth gains from the previous decades, causing widespread social unrest and deep economic disparity both inter- and intra-nationally. The report was unequivocal when it marked “severe economic disparity as the most likely global risk to manifest itself in the next 10 years” [emphasis added]. As evidence of these seeds of dystopia the report gave the example of the world-wide social unrest that occurred in 2011 and “demonstrated how governments everywhere need to address the causes of discontent before it becomes a violent, destabilizing force”. This theme was carried through to the 2013 report which also marked chronic fiscal imbalances, chronic labor market imbalances and severe income disparity as major global economic risks.

Economic risks continued to be the predominant theme in the 2014 report which marked “fiscal crises in key economies” and “structurally high unemployment/underemployment” as two global risks of the highest concerns. In the Interconnections Map, unemployment and underemployment were linked to income disparity, political and social instability and fiscal crises. The finding that “society can also generate its own systemic risks, notably from growing income inequality” is consistent with the dystopic future authors of the previous report imagined. Youth unemployment rates, which have increased since the financial crisis, and its effect on the “the lost generation” (as the report termed the generation coming to age in the 2010s) make for the darker hues of a not-so-distant future.

The 10th anniversary edition of the GRR situates these persistent concerns in the context of the rising co-dependency of geopolitics and economics. The authors write: “In a retreat from the prevailing logic of globalization that characterized the 1990s and 2000s, today's international environment is in large part marked by self-interested nation-states trying to gain relative power over the others, even at the expense of economic considerations. Rising unemployment and more difficult fiscal situations are contributing to the inward orientation of economies.” Undoubtedly, the crisis in Ukraine and the rise of a new generation of nationalist and self-interested leaders in Asia contributed to this view.

The concrete policy prescriptions that emerge out of a decade of Global Risks Reports mostly center around the need to address the causes of socio-economic inequity and disparity. The “constellation of risks” addressed in the GRR essentially centers on a single structural problem – namely, the generation of viable jobs. Solving this problem, in turn, addresses income inequality and attendant social problems. At the same time, there is a growing recognition that the real economy and the financial economy need to be, to the extent possible, decoupled. Insofar as this decoupling is achievable and structural changes are brought to play which redress unemployment globally, the global risk landscape will look much more tractable.

 

Abhijnan Rej is Economist, JustJobs Network and is based out of New Delhi.