World Economic ForumJanuary 2008

Global Risks 2008A Global Risk Network Report

COMMITTED TO IMPROVING THE STATE

OF THE WORLD

A World Economic Forum Report in collaboration with CitigroupMarsh & McLennan Companies (MMC) Swiss ReWharton School Risk CenterZurich Financial Services

This work was prepared by the Global Risk Network of the World Economic Forum.

World Economic Forum91-93 route de la CapiteCH-1223 Cologny/GenevaSwitzerlandTel.: +41 (0)22 869 1212Fax: +41 (0)22 786 2744E-mail: globalrisks@weforum.orgwww.weforum.org

© 2008 World Economic ForumAll 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 anyinformation storage and retrieval system.

REF: 090108

The information in this report, or on which this report is based, has been obtained from sources that the authors believe tobe reliable and accurate. However, it has not been independently verified and no representation or warranty, express orimplied, is made as to the accuracy or completeness of any information obtained from third parties. In addition, thestatements in this report may provide current expectations of future events based on certain assumptions and include anystatement that does not directly relate to a historical fact or a current fact. These statements involve known and unknownrisks, uncertainties and other factors which are not exhaustive. The companies contributing to this report operate in acontinually changing environment and new risks emerge continually. Readers are cautioned not to place undue reliance onthese statements. The companies contributing to this report undertake no obligation to publicly revise or update anystatements, whether as a result of new information, future events or otherwise and they shall in no event be liable for anyloss or damage arising in connection with the use of the information in this report.

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

Over the last year, a series of risk issues – from theliquidity crisis in the financial markets to theemerging concerns over the long-term security offood supply – have focused global attention on thefragility of the global system. An awareness of riskand risk management is increasingly viewed as aprerequisite for effective control in both the privateand public sectors.

This year will be no different. Uncertainty about theshort- and medium-term future is as high as it hasbeen for a decade. Economically, the uncertaintycentres on how the global economy will respond tothe spreading liquidity crunch of 2007. Themispricing of financial risk, a central theme of GlobalRisks 2007, may have further to unwind.Geopolitically, uncertainty is focused on the

possibility of an escalation in tensions with Iran andconcerns over the long-term integrity of the states ofIraq and Afghanistan.

The result of uncertainty could be inaction in dealingwith other, less immediate, global risks. Action tomitigate climate change, for example, may be put indanger should the global economy weakensubstantially – even though many of the political,economic and investment decisions which will shapethe future path of global climate will need to bemade in the next five years. Proactive managementof globalization to ensure its long-term sustainabilitymay be derailed by the prevailing currents ofuncertainty. But inaction on long-term risks will onlyweaken the global capacity to manage futurechallenges.

4

Introduction

Under conditions of global stress, one core questionof global risk management will become more salientthan ever: who owns the risk? Without a sharedunderstanding of ownership, achieving the trade-offswhich may be necessary to mitigate global riskequitably and sustainably will be extremely difficult.Without clarity on who is responsible for managingglobal risk, turning aspirations into actions will beimpossible. Without frameworks which connectownership of risk with the responsibility to mitigate it,and which share the upside and downside of riskamong stakeholders efficiently, the marketmechanisms for managing risk will fail to improveour aggregate global resilience in the face ofinevitable risk events. And without leadership fromthe business and political communities on all ofthese issues, we may find our global future shapedmore by risk events than by our power to anticipate,manage and mitigate them.

The present report looks at global risks from a rangeof different perspectives.

The first part of the report focuses on four emergingissues that are shaping the global risk landscape:systemic financial risk, food security, supply chainsand the role of energy. On systemic financial risk, weput current market turmoil in the historical contextand ask how the transformation of the globalfinancial system over the last two decades mayrequire us to rethink our expectations andunderstanding of systemic risk in the future. On foodsecurity, we discuss how the subject has movedfrom the periphery of the global risk landscape to itscentre, and ask whether the world is ready to copewith the various trade-offs that the new foodeconomy is generating. On supply chains, weinvestigate a potentially hidden set of vulnerabilitiesin the global economy to supply chain disruptions.Finally, on energy, we outline the emergence of arange of energy-related risks and ask if the worldcan move towards secure and sustainable energy.

The second part of the report presents our collectiveassessment of global risks in 2008, based on arevised taxonomy of risk, and building on theassessments of past years. In the third part, we lookat the methodological hurdles around therepresentation of interconnectedness anddemonstrate how risk “squeezing” andhomogenization of risk are changing the way weperceive risk globally. In the fourth part of the report,we examine the role of financial markets as tools ofrisk transfer and risk mitigation for an increasinglybroad range of global risks. Finally, in the fifth part,we take forward our discussions on the constructionof risk mitigation coalitions and country riskmanagement, establishing a set of principles forcountry risk management which the Global RiskNetwork will develop in 2008-2009.

The Global Risk Network, part of the WorldEconomic Forum since 2005, will continue togenerate discussion and dialogue between thecorporate and public sectors. In 2008-2009, theWorld Economic Forum and partners of the GlobalRisk Report – Citigroup, Marsh & McLennanCompanies, Swiss Re, the Wharton School RiskCenter and Zurich Financial Services – will broadenthe participation of the global business and policycommunity.

5

In Global Risks 2008, the Global Risk Network hasfocused on four emerging issues which mayfundamentally shape not only the year ahead, butthe decades to come. These issues – systemicfinancial risk, food security, supply chains and therole of energy – are all central to the functioning ofthe world economy and to the well-being of globalsociety. The risks associated with them cannot beeliminated. But they can be better understood andbetter managed.

Systemic financial risk is the most immediate and,from the point of view of economic cost, the mostsevere. The financial conditions of the past decadehave allowed for an exceptional period of economicgrowth and stability. But, with so many potentialconsequences of the 2007 liquidity crunchunresolved, the outlook for the future is more uncertainat the beginning of 2008 than it was a year ago.

A recession in the United States cannot be excludedin the year ahead, and economists are divided onwhether domestic-led growth in Asian markets candrive the global economy. In Europe, the impact ofeconomic uncertainty may be highly divergent. Therole of the financial sector in the United Kingdomleaves it particularly vulnerable to financial turmoil,while large current account deficits in some centraland eastern European economies may proveincreasingly unsustainable in 2008. The resilience ofthe export-led growth of other major Europeaneconomies may also be brought into question ifdisruption in the financial markets spreads morewidely. Over the much longer term, the dollar mayfind itself under increasing pressure as the globalreserve currency, undermining the geopoliticalposition of the US and foreshadowing the end of ahegemonic period in global economic history.

Food security, at the nexus of a number of issuesfrom energy security to climate change and waterscarcity, may be emerging as one of the major risksof the 21st century. Long- and short-term drivers –population growth, changing lifestyles, climatechange and the growing use of food crops forbiofuels – may be shifting the world into a period ofmore volatile and sustained high prices. Theconsequences, particularly for the most vulnerablecommunities, may be harsh.

Extended supply chains, which have allowed globaleconomic integration to flourish in the last twodecades, may be concealing increased vulnerabilityof the global system to disruptive risks. Geographicconcentrations of risk in economically efficient zonesof production may have improved global welfare, butare businesses and governments prepared for theconsequences of a risk event in these concentratedareas?

Finally, this section looks at some of the problemsassociated with managing the long-term future ofenergy, particularly perceived risks to energy securityand risks from global climate change.

What emerges from discussions is a commonproblem: the growing misalignment of risk bearersunder conditions of globalization. In financialmarkets, the atomization of risk has generallyallowed far greater participation in the risk economyand vastly improved financial diversification, but itmay also have resulted in a systemic under-appreciation of risk. For the food economy, shiftstowards policies perceived to improve domesticenergy security – such as an increased use ofbiofuels – and risks associated with water andclimate change may be shifting power andresources to crop producers and some developedeconomies at the expense of global equity. In globalsupply chains, dangerous accumulations of risk maynot be recognized and, yet, may threaten a systemiccrisis should one part of the supply chain fail. Finally,the mismatch between incentives for fundamentalchanges in the global energy economy – betweendeveloped and developing countries and betweendifferent elements of the private and public sectors –is complicating the emergence of global solutions.

This underscores the necessity to improveunderstanding of how risks interconnect, how wecan build coalitions to manage risk, and how thedifferent trade-offs between risk mitigation solutionscan be appropriately identified. Our main conclusionis the need for the governance of globalization toenhance efficiency, ensure equity and manage aglobal risk environment which is both more complexand more challenging than ever before.

6

1. Focus on Emerging Issues in Global Risk

A. Systemic financial risk: do weunderstand it, can we mitigate it?

The increasing complexity of financial markets, and therate at which financial markets are evolving, make thetask of avoiding and managing systemic financial riskextremely difficult. Increasing global interconnectednesshas multiplied the possible pathways for thecontagion of financial risk. Layers of leverage mayhave increased the possibility for magnification ofrisk. Financial innovation, in the form of complexfinancial instruments, may ultimately contribute tothe opacity of systemic risk. At the same time,however, the increasing importance of the financialsector in the real economy has made the question ofsystemic financial risk more important than ever.

This section of the report discusses the key drivers,characteristics and impacts of systemic financialrisk, which private financial institutions,governments, regulatory authorities and centralbanks will need to integrate into their approaches tomarkets if they are to identify and survive the nextsystemic financial crisis.

Mispricing risk: the underlying seeds of crisis

At the beginning of 2007, the economic mood wasgenerally positive. The consensus pointed to a yearof continued strong global economic growth. Riskpremiums were at historically low levels. Inhindsight, the widespread complacency withrespect to the true nature of risk served only toconfirm the weakness of financial markets inpredicting systemic crisis.

But there were identifiable “weak signals” whichsuggested the potential for financial crisis. An assetprice collapse was the top risk identified in GlobalRisks 2007. Warnings voiced by the Bank ofInternational Settlements were ignored, while aGlobal Risk Network briefing issued in January 2007warned that a global re-appreciation of risk could beexpected, with three major challenges to the globaleconomy: a housing recession, the beginning of aliquidity crunch and high oil prices.

All three were realized over the course of 2007. First,the US housing recession, which began in late 2006,has accelerated, with new housing construction atits lowest level since the early 1990s and houseprices down nationally. Second, the world hasexperienced a crunch in global liquidity, affecting

7

What is systemic financial risk?

In general terms, the manifestation of systemicfinancial risk involves a system-wide financialcrisis, typically accompanied by a sharp decline inasset values and economic activity. In all cases,systemic financial risk involves the spread ofinstability throughout the financial system as awhole with results that are sufficient to affect thereal economy.

Manifestations of systemic financial crisis arerelatively rare. In the past 20 years, systemicfinancial risk events have included the equity crashof October 1987 (“Black Monday”), the Japaneseasset price collapse of the 1990s, the Asianfinancial crisis of 1997 and the Russian defaultof 1998 (which led to the demise of the Long-Term Capital Management (LTCM) hedge fund).

Each of these episodes was characterized by anabrupt loss of liquidity, discontinuous marketmoves, extreme volatility, sharp increases incorrelations and contagion across markets, andsystemic instability. While the pathways ofcontagion of systemic financial risk are often wellunderstood in retrospect, and the conditions fora systemic financial risk event may be wellidentified ahead of crisis, the precise triggeringevent is rarely predicted. Systemic risk is aninherent element of the global financial system.

even essentially solvent financial institutions, andraising the prospect of tightening credit as banks areforced to readjust their capital ratios. Finally, thedollar price of oil rose to an all-time high, close tothe inflation-adjusted peak of the early 1980s.

But if an eventual global re-appreciation of risk wasforeseeable in early 2007, the timing and precisenature of the trigger event was not.

In early 2007 many expected that any systemiccrisis would be the consequence of an unwinding ofglobal economic imbalances – notably the UScurrent account deficit. The actual trigger for thecurrent systemic crisis was the collapse of a criticalsegment of the US mortgage business – the sub-prime mortgage market. It was widely thought inearly 2007 that the main threats to financial stabilitywould come from leveraged hedge funds. But itturned out to be problems related to complexsecurity structures and off-balance-sheet vehiclescreated by the banking sector that have generatedthe systemic elements to the current crisis.Predicting what will happen is easier than predictingwhen and how events will unfold.

Liquidity crunch: history repeats itself?

The meltdown of the US sub-prime mortgagemarket and the growing prospect of a global creditcrunch dominated financial markets in the secondhalf of 2007. An abrupt evaporation of liquidity anddramatic repricing of risk led to widespread financialinstability, ultimately threatening the viability ofsmaller financial institutions even in well-regulatedmarkets such as Germany and the United Kingdom.The US Federal Reserve has projected direct lossesrelated to sub-prime of US$ 150 billion; non-sub-prime financial losses may be considerably greater.

As in past systemic financial crises, complacency incredit standards – driven by perverse incentives andmoral hazard – lowered risk premiums tounsustainable levels. The periodic underpricing ofrisk in financial markets may be structural and tosome extent unavoidable. But few systemic financialcrises are entirely dissimilar to earlier episodes. Thissuggests room for improvement in the managementof crisis including better early warning systems andmore coordinated and forceful action by market

supervisors and central banks. Financial crises maynever be avoided. But their frequency and severitymay be significantly reduced.

Is the financial system now more stable andresilient? Some recent experiences – such as therelatively benign Y2K rollover, the very short-livedmarket disruption following the events of 9/11, andthe relatively muted effects of more recent spikes inthe dollar price of oil – have led experts to concludethat markets are now more resilient to exogenousshocks. But many would argue that the overallresilience of the global financial system will onlybecome fully evident under conditions of severestress over the next year.

A system transformed

Over the last 20 years, financial markets haveundergone a revolution, driven by deregulation, arapid pace of financial innovation, global financialintegration and the increasing role of the financialsector in the economy.

The salient features of the transformation can besummarized in six points.

• Deregulation: The process of deregulation hasdeeply affected the financial markets of advancedeconomies by removing barriers to entry;reducing artificial borders between types offinancial institutions; increasing cross-bordercompetition; encouraging the emergence of large,complex financial institutions; and spurringfinancial innovation.

• Financial innovation: There has been anexplosion in derivative and structured products.Such innovations have allowed for more efficientallocation of financial resources. Many argue thatthis has helped strengthen the global financialsystem by better apportioning risk. However,innovation raises challenges in terms of evaluatingrisk, correctly identifying ultimate bearers of risk andassessing whether they can manage it. Ratingasset classes without market history has put ratingagencies in a crucial position in global markets.Regulators may not have the capacity to monitorthe range of risks within the financial system. Andeven as Basel II comes into force, regulation maynot be evolving as fast as market innovation.

8

• Rise of alternative capital pools: The rise ofhedge funds, private equity and sovereign wealthfunds has changed the balance of the globalfinancial system. Hedge funds are sometimeshighly leveraged (with consequently higher riskprofiles) with shorter investment time horizonsthan standard investors, operating underconditions of reduced disclosure and oversight.Private equity firms, while often investing for thelonger term, are similarly unburdened byregulatory oversight, and sometimes highlyleveraged. Sovereign wealth funds, which havebecome particularly important as rising oil pricesand global economic imbalances have massivelyincreased the foreign reserves of certaincountries, present a new set of challenges,including relative lack of transparency overinvestment strategies, concern over possiblepolitical intervention and potential large-scalemarket moves.

• Financial services convergence: The bordersbetween different types of financial institutions arebecoming blurred, increasing risk transfer betweenthem. Banks are supplying capital for insurancerisks, while both banks and reinsurers are usinginsurance-linked securities (see page 32) totransfer insurance risks to the capital markets.

• Role of non-bank institutions andintermediaries: The increased role of marketintermediaries may have widened the offering ofstructured financial products to investors. But notall intermediaries are subject to consolidated risk-based capital frameworks or the full complementof supervisory constraints. The originate-to-distribute (OTD) model may have loweredunderwriting standards while the growingimportance of credit rating agencies – which playa key role in pricing risk but which do not hold itthemselves – may raise similar challenges withrespect to incentives.

• Shift to multipolar currency regime: While theUS dollar remains the global reserve currency andis likely to remain so for years to come, over timethe creation of the euro and the growingimportance of emerging country currencies willlead to a weakening of the dollar’s dominance,with consequences for the global management ofcentral banks’ reserve holdings and the resolutionof currency alignments.

What are the implications of these changesfor the nature of systemic financial risk?

When considering the implications of these changesfor systemic financial risk, three major observationsstand out:• Risk ownership has been decentralized: The

growth of securitization and risk transfer has led torisks being disaggregated and spread to diverseowners. This demands a shift in emphasis fromthe widely studied and understood “bank run”model of systemic risk to a new “market-based”model, where financial crises manifest themselvesin markets rather than institutions; though ofcourse institutions must still be monitored.

• Risk transmission has become moreimportant: Increasing interconnectedness hasmultiplied the points of potential failure andincreased the significance of systemic linkages.Behavioural dynamics are critical. One example ofthe importance of risk transmission is the carrytrade where there is potential for large, abruptreversals of cross-border capital flows whichcould trigger systemic crisis.

• Risk management is critical: Complexity hasincreased the need for effective risk management.At the enterprise level, there is rising adoption ofenterprise risk management. At the national andinternational level, increasing attention is paid tofinancial and political coordination.

On balance, these developments appear to haveincreased the financial system’s capacity to assumeand distribute risk, and they also appear to havemade it more stable. More risk is apportioned tomarket participants who have indicated a willingnessto absorb risk. But, as recent developmentshighlight, this appears only to be true under “normal”market conditions. The complexity and near infinitefeedback loops of the modern financial system haveexposed it to a small risk of very large systemicshocks. Some analysts postulate that the financialsystem may indeed be more pro-cyclical if thegrowing dispersion of risk is not coupled with abetter understanding of the driving factors of risksegmentation and diversification.

9

Hence, we may be facing a paradox: while thefinancial system has been made more efficient andstable in normal times, it is now also more prone toexcessive instability in really bad times. At the sametime, the increased importance of the financial sector inthe global economy means that the impact of financialinstability on the real economy has also increased.

Pathways to catastrophic failure

All the trends above can be observed in the recentturmoil in financial markets.

The ensuing liquidity freeze and broad-based assetwrite-downs indicate that many existing risk modelswere inadequate, failing to reflect the dynamic

10

A triggering shock – either real or financial – initiates a decline in asset prices

Credit crunch as escalation of credit concerns leads to

position liquidations, margin calls and de-leveraging

Liquidity evaporates as crowded trades and asset fire

sales overrun arbitrageurs (limits of arbitrage)

Apprehension

Fear/repricing of risk

Panic/contagion

Anatomy of a Systemic Financial Crisis

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

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?

complexity and unpredictable nature of financialcrises. Statements to the effect that 10-standarddeviation events were occurring several days in arow demonstrate how much is still to be learnedabout the underlying distributions, and so-called“tail” events, which refer to the extremes of aprobability distribution.

New thinking may be urgently required.

Conventional wisdom emphasizes, in equalmeasure, the two components of risk: likelihood andseverity. This naturally drives risk ratings,prioritization and corrective actions focused both onprevention (i.e. reducing likelihood of the event) andmitigation (i.e. reducing severity of the event).

But changes in the financial markets, while providingmany benefits, have also created new andunforeseen risks which may be more susceptible toexogenous shocks (such as geopolitical risk) orinternal factors (such as speculative bubbles). Manyof these risks are unpredictable, making preventionand mitigation impossible.

It may not make sense to attempt to eliminate riskswhich ultimately represent a source of opportunity aswell as hazard. Rendering the global financial systemas flexible and resilient as possible by improvingearly indicators, enforcing more stress testing,enhancing understanding of tail risk and requiringbetter contingency planning may be more effective.

Ultimately, strategies to deal with systemic financialrisk must reflect the fundamental shift in the globalfinancial system to a market-driven model. There isconsiderable scope for increased public and privatesector collaboration on stress testing, liquiditymanagement, risk assessment and prevention. Oneexample is the formation of the Counterparty RiskManagement Policy Group in the wake of thecollapse of Long-term Capital Management, whichhas helped to reduce risks stemming from hedgefund leverage.

11

B. Food security: the emerging risk ofthe 21st century?

In 2007, prices for many staple foods reachedrecord levels. The price of corn in late 2007 was50% higher than 12 months previously. The price ofwheat was double. Global food reserves are at theirlowest in 25 years and, as a result, world foodsupply is vulnerable to an international crisis ornatural disaster.

Food security has emerged as a major risk, markedby both local and global consequences, trade-offsbetween different mitigation priorities and adisproportionate impact on poorer communities.Embedded in a web of other global risks, there isconsiderable uncertainty as to whether foodinsecurity in 2007 is the result of short-termconditions which have existed in various timesthroughout history, or whether a more fundamentalchange is taking place, with a range of underlyingtrends bringing food from the sidelines to the centreof the global risk discussion in years to come.

What is food security?

According to the Food and Agriculture Organization(FAO), food security is achieved when all people, atall times, have physical and economic access tosufficient, safe and nutritious food to meet their

dietary needs and food preferences for an activeand healthy life. Food security, similar to energysecurity, is not only about avoiding physicaldisruptions to supply, but also about ensuring supplyat a price which allows economic activity and well-being to flourish.

Impacts are global and varied

In the past, food security generally concerned theleast developed countries, particularly those inconflict and those facing uncertain weather patterns.But, more recently, concerns about sustainable foodsecurity have spread to developed countries whichhave not generally considered themselves exposedto food insecurity. For example, the United Kingdomhas historically relied on the depth of internationalmarkets to ensure food supplies at a reasonable

12

Food security

Oil and gas prices

Reduction in Chinese economic growth

Declining quality and quantity of water

Interstate and civil wars

More frequent and severe heatwaves

Food Security: At the Nexus of a Range of Global Risks

Source: World Economic Forum

price, but this model may be put under stress in thefuture. In 2007, food and drink prices rose at theirfastest rate in 14 years, at 4.7%. In the US, foodprices were up 4.4% year-over-year at the end of2007 – double the rate of non-food, non-energyinflation – partially due to increased acreage devotedto corn to make ethanol.

China and India are also exposed to pressures onglobal food security, and their domestic experiencesmay have global economic consequences. In China,average incomes have barely risen while food priceshave soared: by 17.6% overall, 70% for porkproducts, 30% for vegetables and 34% for cooking oil.Combined with the sharply rising dollar price of oil, highfood prices in China could increase global inflation.

Beyond the potential economic consequences ofrising food prices is the well-established relationshipbetween food prices and political stability. In 2007,surging prices of basic foods caused domesticunrest in a number of different countries. In March,thousands of Mexicans demonstrated against thefour-fold increase in the price of flat corn. In

September, Italians organized a one-day strikeagainst rising pasta prices. In October, in WestBengal (India), food riots erupted as a result ofdisputes over food rationing.

In some countries, particularly where the success ofgovernment has been historically linked toadministrative control of basic supplies,governments have intervened to limit the politicalconsequences of rising food prices. The Russiangovernment acted to control prices of staple foodsahead of the December 2007 parliamentaryelections. In Egypt, which experienced politicalupheaval in the wake of price increases of bread in1977, subsidies to bread producers have beenincreased to mitigate the impact of rising globalwheat prices. In China, soybean import duties havebeen reduced, subsidies to farmers have beenboosted to encourage agricultural production –particularly of pork and milk – and plans are toprovide support for low-income urban residentsagainst food price increases.

13

80

70

60

50

40

30

20

10

00 1 2 3 4 5 6 7 8

Per capita income (in log)

(food weighting within consumer price index, percent)

Bangladesh

Nigeria

Afganistan

Kenya

India China BrazilUK US

Russia

Rising Food Prices, Unequal Impacts

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

The drivers: population, biofuels and climate change

Global population and changes in lifestyle

The United Nations has predicted the global populationwill rise above 9 billion by 2050, placing additionalpressure on the global food supply. But thesepressures are sharply accentuated by an increasingdemand in developing countries for protein-rich foodswhich require more grain (and water) to produce, andby the increasing constraint of available agriculturalland. Annual per capita consumption of meat inChina has increased from 10 kilograms in 1950 to40 today. Over the same time period, the availabilityof arable farmland per head of global population hasdeclined from one acre to half that. Many expertsbelieve that for these reasons increases in the priceof food are likely to be sustained.

Food or fuel: how biofuel production mayimpact food security

The use of crops to manufacture biofuels isincreasing globally – often with support ofgovernments aiming to reduce carbon emissions orto reduce dependence on imported sources ofenergy. Biofuels are on course to consume up to30% of the US corn crop by 2010.

Over the long term, the growing importance ofbiofuels has prompted fears that the dynamics ofthe energy economy will be introduced into globalfood markets, dramatically increasing price volatility,particularly of staple foods. But, even over the shortterm, the use of crops for biofuels raises a numberof complex trade-offs common to the managementof many global risks.

The first of these concerns global equity: any shiftfrom food production to biofuel production hasdifferent consequences for different communities.Crop exporters may benefit, as may communitieswhere food expenditure is a minor part of overallexpenditure. But others may suffer, from cropimporters − including agricultural communities whichimport grain as feed for animals – to poorercommunities where food purchased on the openmarket is a major component of overall expenditure.

The second concerns the trade-off between globalefficiency and perceptions of energy security: whileglobal efficiency would best be served by a market-determined allocation of crop resources globally tofood and biofuels based on price and relativeenvironmental efficiency, concerns over energy securitymay undermine the attractiveness of globalcollaboration. Not all techniques for manufacturingbiofuels are equally efficient in terms of reducingaggregate carbon emissions. It is often a perceivednational security imperative, rather than a globalimperative to reduce carbon emissions, which isdriving the frameworks in which biofuels are beingproduced.

Climate change

Climate change alone is forecast to increase thenumber of undernourished people globally by between40 million and 170 million in 2100, according toforecasts by the Intergovernmental Panel on ClimateChange (IPCC). Climate change may affect agriculturalproduction by increasing the severity of weatherevents, by increasing the volatility of weather and byshifting rainfall patterns. Changing rainfall patternscould mean that in just over a decade, rain-dependent areas of South Asia and Africa could beproducing half their current agricultural yield.

The result: uncertainty

The consequences of all these trends forperpetuating the escalation of food prices aredifficult to predict. Some experts expect higher foodprices to be sustained. Others believe that marketswill gradually readjust to shortages as higher pricesmake it profitable again to grow crops for food.Policy-makers may have to return to thinking aboutfood as a strategic asset and begin to modify foodpolicies. Given the amount of uncertainty, theresilience of the world’s food system will be severelytested in the next few years.

14

C. Hyper-optimization and supplychain vulnerability: an invisibleglobal risk?

Economic globalization has transformed theoperational structures of both business andgovernment. Outsourcing – particularly ofmanufacturing but increasingly of standard businessservices – has been a major driver of globalprosperity by allocating scarce global resources tobusinesses and geographies with a comparativeadvantage to produce particular goods and servicesmost efficiently. Improvements in technology andglobal logistics, and reductions in trade barriers haveall facilitated the integration of previously separateregional economies. As a result, international andintra-regional trade has expanded at a faster ratethan the global economy over the last 20 years.

But, as the global economy has become moreintegrated, vulnerability to disruption of the supplychains which hold the global economy together mayhave increased. Resilience is no longer just aboutinternal management.

A global issue

All companies and governments dependent onexternal suppliers are exposed to the risks ofdisruption in their supply chain. But the extent andcomplexity of current global supply chains mean thatthe problem of supply chain management is notlimited to a single enterprise or industry: even arelatively small supply chain disruption caused by aglobal risk event may ultimately have consequencesacross the global economic system.

The economic optimization of supply chains, withthe geographic concentration of risk as a frequentcorollary, has enhanced the systemic vulnerability toa supply chain failure. In September 1999, globalsemiconductor prices nearly doubled following anearthquake in Taiwan, China, a key centre for supply.Supply chains frequently appear to disperse riskbetween multiple parties, but they can also, as in thiscase, lead to an unrecognized aggregation of risk.

Effective preparation and management of supplychains may prevent the contagion of global risks andlimit the consequences of a localized risk event. But

mismanagement of supply chains may result in themserving as a transmission mechanism of global risk,amplifying the disruptive impacts of a local risk eventat the systemic level and producing consequencesfar beyond the corporate sector. A crisis in thesupply chain of a private sector manufacturer ofvaccines, for example, could rapidly develop into apublic health crisis, particularly in the context of theongoing global risk of pandemics and infectiousdiseases. Building a culture of supply chain riskmanagement across public and private sectors maybe a first step to broader global risk mitigation.

However, despite their importance both at the levelof individual enterprises and at the level of the globaleconomic system, vulnerabilities to the supply chainare generally poorly understood and managed. Thisis partly because the risks in the supply chain areobscured, as enterprises and governments may beindirectly exposed to a global risk disruption througha complex range of sub-supplier arrangements. Butin some measure this is due to the range of possibleglobal risk disruptions – from geopolitical risk to anatural catastrophe to pandemics. A US- orEuropean-based company which sources keycomponents from Asia will indirectly face risks thatthey may never encounter domestically, as well asvery different cultural approaches to the managementof risk. Conversely, a recent survey conducted byMarsh Inc. on 62 companies based in Asia foundthat only 21% had full business continuity plans toprotect against business interruption arising fromevents such as natural disasters or terrorist attacks.

Given the complexity and interdependency of globalrisks, developing a realistic and effective riskmanagement and mitigation strategy can bedaunting. However, there are measures that can betaken to better understand the volatility of supplychains and to reduce the impact of global risktransmission through supply chains at the enterpriseand national level.

At the enterprise level, the first step is to understandthe value added in each stage of the supply chainand to assess the risk to delivery of this value. Arisk-return perspective – based on profit, revenue orreputational considerations – will supportmanagement prioritization and deliver the greatestreturn on investment. A thorough view of the supply

15

chain, from sourcing of raw materials to customerfulfilment, will provide a clearer view of keyvulnerabilities and risk concentrations. This shouldbe coupled with an assessment of how these affectthe supply chain in terms of recovery time or extracost implications.

A comprehensive assessment and/or quantificationof the risk in the supply chain will facilitate evaluationand prioritization of proposed risk transfer, financingand mitigation strategies. For example, a certainlevel of loss that could arise from one of these risksmay be acceptable given the firm’s balance sheetand risk appetite. Hence, no risk mitigation isrequired. It is also possible that the risk level couldbe increased, e.g. by reducing the buffer inventory,thus facilitating cost savings. If the risk isunacceptable however, then a firm could opt to

increase buffer inventory, arrange alternative orback-up suppliers in different countries, or work withsuppliers to improve their own business continuityand resiliency planning and thus the firm’s ownsupply chain integrity. Whichever option is chosen, itshould be influenced by understanding the risk-return of different options, and the corporatestrategy and risk appetite of the business.

But, ultimately, effective management of global risksrequires a collaborative and coordinated approach inpublic-private partnership at an international level.Given the macroeconomic and microeconomicimpact of supply disruptions arising from a range ofglobal risks, improved dialogue and policy on theserisks is crucial to the effective management of theglobal economy. This could also be facilitated by aforum of country risk officers, suggested on page 36.

16

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 tomanaging global supply chains. But there are both internal responses and proactive external responses which need to be considered. Less traditionalexternal management of risks may ultimately be more efficient.Source: Marsh & McLennan Companies (MMC)

D. Energy and global risk:interconnected risks, disconnectedincentives?

Energy is a key input to the global economy, but itssafe, secure and sustainable provision is increasinglyproblematic. At the nexus of a number of differentglobal risks – including climate change, economic andsome geopolitical risks – current and future policydecisions about energy will inevitably shape theoverall global risk landscape. But the incentives inplace to reform the global energy economy in a waywhich reduces global risk holistically are not in place.

Outline of the risks

Last year saw an increase in oil prices close to theinflation-adjusted peak of the 1980s. There isconsiderable uncertainty in the long term over supplyand demand. But over the 10-year horizon of thisreport there are few reasons to believe that energyprices will fall significantly – and there are severalreasons to believe that energy prices may rise.

In the immediate term, the tightness of globalmarkets has accentuated vulnerability to a supplyinterruption. Over the next 10 years, the InternationalEnergy Agency has identified the risk of a far sharpersupply-side crunch as investment in updating energyinfrastructure fails to keep pace with demand.Capital expenditure required is estimated at US$11.6 trillion to 2030, but uncertainty over futurereturns and future regulatory frameworks aroundgreenhouse gas emissions has meant that suchinvestment may not be forthcoming. TheInternational Energy Agency has predicted a 37%rise in demand for oil to 116 million barrels per day(bpd) by 2030, but investment in exploration hasfallen and many experts suggest that oil productionis unlikely to exceed 100 million bpd.

The global economy has demonstrated remarkableresilience to increases in energy prices since 2004.But the limits of resilience may be close to beingreached. The easiest gains in energy efficiency arelikely to already have been realized. Moreover, thefinancial conditions which have prevailed in recentyears – abundant liquidity, itself a partial

17

Industry gainOil & Gas industry cost

Profit pool reduction

Industry loss

Economic costReduction in GDP ($bn)

Health major crises

Pandemiccontagious by air

SARS spreads

US$ crisis

Terrorist attack

Air single attack

Blockade only - shortMultipleattacks

Blockade only - long

Iran – US warIran – US war

O&G supply disruptedLong

Short Short

China slowdown

Climate change

1 100

900

700

500

300

100

-100

-300

Matrix of Impacts of Global Risk Events on the Oil and Gas Industry

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.

consequence of financial surpluses in energy-exporting countries resulting from high prices – havechanged. Not only has the risk of higher energyprices increased but, potentially, the vulnerability ofthe global economy.

At the same time, the objectives of secure,reasonably priced energy and reductions inemissions of greenhouse gases (GHG) seem bothout of reach and in conflict.

Coal, the only cheap, widely available fossil fuel, islinked with carbon emissions which will beunsustainable environmentally without carboncapture and storage technologies. The world’s majoroil reserves are located in regions of geopoliticalinstability. Gas, the cleanest fossil fuel, is difficult totransport and is increasingly viewed as a politicalbargaining chip by some major supplier states.Nuclear power, probably the best option for carbon-neutral energy from the perspective of currentlyavailable and easily scaleable technologies,continues to cause anxiety given problems of wastedisposal, fear of nuclear accidents and questions on thedesirability of the global spread of nuclear technologies.

Public policy has focused on green technologiessuch as wind power and biofuels. But thesetechnologies come with their own problems, notablyscalability. As discussed above, the use of crops forbiofuels may promote greater insecurity for othercrucial resources: food and water.

Globally, energy supplies are less secure even asemissions of greenhouse gases continue to rise.And the global risks continue to be strongly on thedownside.

Can the world move towards secure andsustainable energy?

Such an outcome is possible, but it requires policy-makers to confront their constituencies with difficulttrade-offs and requires a major shift in thinking aboutrisk and how dialogue on risk sharing can beestablished. One key issue, highlighted elsewhere inthe current report, is the inherent mismatch betweenthose who bear risk and reward. Without alignment ofinterests and alignment of risk and reward, buildingcomplex coalitions to manage global risks will be difficult.

The disparity between the impact of global risks ondifferent sectors of society and the economy can beseen with reference to the impact of an oil priceshock. At the simplest and most immediate level,such a shock would essentially be positive for oiland gas producers, but negative for the broaderglobal economy.

The matrix shows an analysis of the impact of anumber of risk events using the oil and gas sectoras an example. Results for the electricity sector showa similar pattern of disparate impact. One strikingoutput from the graph below is the aggregate GDPcost of a disruption of oil or gas supply – reflected inthe overall Global Risk rating of a steep rise in oil orgas prices as one of the most salient risks for 2008– compared to the potential (short-term) benefits forthe oil and gas industry. The mismatch betweengains and losses at the industry/aggregate level, aswell as the national/international level makes riskmanagement extremely complex.

But many of the more interesting impacts aresubtler: for example, the power sector in bothEurope and the US is delaying investmentsnecessary to replace an ageing fleet of powerstations because of uncertainty on future regulationto reduce greenhouse gas emissions.Underinvestment today increases the likelihood offuture power shortages, and consequently of futurehigh prices for electrical power.

Meanwhile, failure to develop a clear holistic policyapproach to management of both energy securityand reducing carbon emissions may end upthreatening both objectives. At present, theEuropean Union appears to be drifting into highdependence on gas from a single source, highinvestment in renewable energy technologies thatmay not offer the scalability necessary to achieveambitious targets of reductions in carbon emissions,and a highly differentiated approach to nuclearpower. Should the current situation continue, it isalmost inevitable that the European Union will bevulnerable to future energy shortages and will fail toachieve its stated goals for reductions in carbonemissions. The situation in the US, while different, isno better: high investment in biofuel production maybring its own risks, while dependence on foreignenergy supplies continues.

18

The next few years will be crucial for determining along-term global strategy on many of these issues,as a successor agreement to the Kyoto protocol isnegotiated, as major investment decisions will haveto be made on energy infrastructures in producercountries, as political changes may drive shifts inenergy policy in the developed world, and as theemerging economies of Asia become increasinglyattached to particular energy sources.

Better dialogue is needed at all levels – betweenemerging and developed countries and between thecorporate sector and the government and regulators– so that the current misalignments of incentives canbe addressed effectively. Energy security has twosides, and both producers and consumers havemuch to gain from predictability. Similarly, to unlockinvestment and innovation in cleaner energy, long-term economic viability must be assured by forward-looking regulatory frameworks and, ultimately, aneconomic price for carbon. Whether or not suchpolicy changes are forthcoming at the global andnational level, individual companies and the energyindustry need to improve their capacity to link theirown risk management and strategic decisions.

19

20

2. Assessing Global Risks in 2008

The global risk landscape at the beginning of 2008is broadly similar to the risk landscape at thebeginning of 2007. Many of the risks have remainedstable in terms of the ratings ascribed to them bythe Global Risk Network for likelihood and severity. Anumber of risks have been sharpened in definition,others have been disaggregated and one new risk –food security – has been identified. The taxonomy of

risk, separating trends of issues of concern fromrisks themselves, has allowed for a more granularapproach to assessment. (This is available inAppendix 2 of the current report.) The graphics onthe following pages should be read in conjunctionwith a description of what has and has not changedover the past year.

• Rising and volatile prices create significantshortages for poor people globally (thosewhose consumption basket is more than 50%food).

• Oil or gas prices rise steeply due to a majorsupply disruption (decreased global supply of10% for several months).

• An abrupt, major fall in the value of the USdollar with impacts throughout the financialsystem.

• Domestic social/political issues combine to slowChinese growth to 6% or less (sustained overtime).

• Declining fiscal positions force multiplegovernments of wealthy countries to raisetaxes, leading to economic stagnation.

• House and other asset prices collapse in theUS, United Kingdom and continental Europe,reducing consumer spending and creating arecession.

ECONOMIC

Economic risks: The main shift between theoutlook in early 2007 and the outlook in early 2008has been a major re-appreciation of risk over thecourse of 2007 as many of the mismatcheshighlighted in Global Risks 2007 have begun tounwind. The trade-weighted exchange rate of theUS dollar has fallen, and the risks of a furthersharp fall have edged up. Oil prices have continuedto rise to close to inflation-adjusted peaks –

increasing vulnerability to a supply-side shock – butthe world has demonstrated remarkable resiliencein absorbing higher prices. From a relatively positivepicture of the stability of the world economy in early2007, the world is entering 2008 under conditionsof considerable economic uncertainty. Thepossibility of a US recession has undoubtedlyincreased, but there is considerable debate as tohow this would impact global prosperity.

Geopolitical risks: Geopolitical risks remainbroadly divided into three categories: geo-economic, structural shifts and regional instability.On the geo-economic side the main risks areassociated with a potential retrenchment fromglobalization, whether from growing protectionismin the developed world or from political pressuresin the developing world. Political risk has returnedto the management of the global economy in amajor way in recent years, and that trend looks setto continue. In terms of structural shifts, thepressures for change on the post-1945 model of

global governance will continue to complicatemoves to improve global governance of globalrisks, either in terms of security or management offinancial imbalances. Finally, the focal points ofglobal geopolitical risk – Afghanistan, Iran and Iraq– are likely to continue to engage the world in2008. The possibilities for positive game-changingdevelopments, such as peace between Israelisand Palestinians, are always present. But fewexperts predict that the geopolitical picture willchange significantly for the better in 2008.

21

• International terrorists mount multiple attackswith conventional and chemical (but notnuclear) weapons, causing significant economicand human losses and exacerbating theretrenchment from globalization.

• Collapse of the Non-Proliferation Treaty (NPT)leads to multiple states simultaneously pursuingnuclear technologies and weaponization, withassociated increase in geopolitical tensionsdragging on the global economy.

• US/Iran conflict.• US/Democratic People’s Republic of Korea

conflict.• Nation building in Afghanistan fails, providing

haven for international terrorist groups andtriggering the decline of the Pakistani state.

• Disorder in the Horn of Africa worsens asmultiple states descend into conflict and offerhaven for terrorist groups.

• A fragile Latin American regime collapsessuddenly, spreading political and economicuncertainty throughout the region.

• Penetration of organized crime in the globaleconomy increases significantly over a 10-yearperiod, weakening state authority, worseningthe investment climate and slowing growth.

• Multiple developed economies take steps(tariffs, WTO disputes) which slow existing tradeand further undermine talks on increased globalintegration.

• Multiple significant emerging economiesadvance policies that harm foreign directinvestment and slow the engine of globalgrowth.

• Worsening conflict in the Occupied Territoriesclaims thousands of lives over a 10-year period,and exacerbates geopolitical tensions andeconomic decline throughout the region.

• All forms of violence in Iraq – sectarian,insurgent, terrorist – worsen and claimthousands of lives. Failure to achieve peacedestabilizes the region on an ongoing basis.

GEOPOLITICS

Environmental risks: The main shift inunderstanding of environmental risk has beenincreased awareness of the potentialconsequences of climate change. The geophysicalfactors behind an assessment of likelihood and

severity of both tropical storms and earthquakeshave not changed. In 2007, the world hasexperienced two “near misses” in terms ofpotential economically catastrophic inland floodingin northern Europe and eastern China.

• Extreme weather events linked to climatechange will impact businesses and society atlarge (e.g. multiple tropical cyclones makelandfall along the Gulf Coast, India, Bangladeshor China over a 10-year period).

• More frequent and severe heatwaves anddroughts have harsh impact on agriculturalyields around the world.

• Declining quality and quantity of water in severalmajor watersheds leads to water shortages andincreased prevalence of water-borne disease.

• Natural catastrophe: Category 5 tropicalcyclone hurricane hits an economic centre suchas Tokyo or southern Florida.

• Natural catastrophe: A strong earthquake hitsan economic centre such as Tokyo, LosAngeles or San Francisco.

• Natural catastrophe: A strong earthquake orseaquake (followed by a strong tsunami) hits adeveloping country such as China, India orIndonesia.

• Natural catastrophe: Extreme inland flooding ofthe Mississippi, Yangtze, Thames or Rhinerivers causes direct economic and humanlosses and serious disruption downstream.

ENVIRONMENT

22

Societal risks: Increasing “globalization of risk”(see pages 27-29) may mean that the distinctionbetween infectious diseases in the developing

world and chronic diseases in the developed worldmay be less operable, while the recognition ofeconomic costs of both is rising.

• A pandemic disease jumps from the animalpopulation to humans, with high mortality andtransmission rates.

• Incidence of infectious disease continues to risein Africa and rises dramatically in Russia andSouth-East Asia (TB and HIV/AIDS).

• Chronic diseases are widespread in thedeveloped world.

• US liability costs increase at four times the rateof GDP growth, and spread rapidly to Europeand Asia. Capacity for global insurance isreduced, undermining investment and growth.

SOCIETY

Technological risks: Increasing human exposureto nanotechnology will increase severity should anevent occur, but this has to be balanced againstthe multiple opportunities created bynanotechnology. The constant interplay of riskswithin the critical information infrastructure(complexity of systems, number of vulnerabilities,failure to effectively patch security holes, use of

common – versus custom – applications) makespredicting specific attacks difficult, but there isincreasing risk of attacks in general due to lack ofresources devoted to cyber-security and constantprobing of systems. In 2007, a growing number ofelectronic espionage attacks was considered tohave been driven by foreign state authorities.

• Attack or system failure in critical informationinfrastructure (CII) creates a domino effect,shutting down IT-dependent applications inpower, water, transport, banking and finance,and emergency management.

• Studies reveal health impairment due toexposure to widely used nanoparticles (paint,cosmetics, healthcare). Primary impact onpublic health and secondary impact oninvestment in a range of nanotechnologies.

TECHNOLOGY

23

The 26 Core Global Risks: Likelihood with Severity by Economic Loss

Note: Some risks were disaggregated for the purpose of assessment in Appendix 2 to the current report. For ease of visual representation they havebeen shown aggregated on the current graphics.

Likelihood

Sev

erit

y (in

US

$)

below 1%

2-10

bill

ion

10-5

0 bi

llion

50-2

50 b

illio

n

1-5% 5-10% 10-20% above 20%

250

billi

on -

1 tr

illio

nm

ore

than

1 tr

illio

n

Food insecurity

Oil and gas price spike

Major fall in US$

Slowing Chinese economy (6%)

Fiscal crises in advanced economies

Asset price collapse

International terrorism

Collapse of NPT

Interstate & civil wars

Failed & failing states

Transnational crime and corruption

Middle East instability

Extreme climate change related weather

Heatwaves & droughts

Loss of freshwater

NatCat: CycloneNatCat: Earthquake

NatCat:Extreme inland flooding

Pandemic Infectious disease, developing world

Chronic disease, developed world

Liability regimes

Emergence of nanotechnology risks

CII breakdown

Retrenchment from globalization (developed)

Retrenchment from globalization (emerging)

24

The 18 Core Global Risks: Likelihood with Severity by Number of Deaths

Note: Some risks were disaggregated for the purpose of assessment in Appendix 2 to the current report. For ease of visual representation they havebeen shown aggregated on the current graphics.

Likelihood

Sev

erit

y (in

no

. of

dea

ths)

below 1%

1,60

0-8,

000

8,00

0-40

,000

40,0

00-2

00,0

00

1-5% 5-10% 10-20% above 20%

200,

000-

1,00

0,00

0m

ore

than

1,0

00,0

00

Food insecurity

International terrorism

Collapse of NPT

Interstate & civil wars

Failed & failing states

Transnational crime and corruption

Middle East instability

Extreme climate change related weather

Heatwaves & droughts

Loss of freshwater

NatCat: Cyclone

NatCat: Earthquake

NatCat: Extreme inland flooding

Pandemic

Infectious disease, developing world

Chronic disease, developed world

Emergence of nanotechnology risks

CII breakdown

None of the global risks identified and assessed inthis report manifest in isolation. Many areinterconnected, not necessarily in a direct causativerelationship, but often indirectly, either throughcommon impacts or mitigation trade-offs. At eachstage of the process of managing global risks, fromidentification and assessment to mitigation, anunderstanding of interconnectedness enhances theapproach taken.

1. Risk identification – identifying indirectexposures and potential tight couplings toexogenous risk events (shocks)

2. Risk assessment – accommodating the reality ofrisk conflation whereby risks are rapidlytransmitted across geographical, industry andcompany boundaries

3. Risk mitigation – moving from managing risk inisolation (ring fencing) to addressing thetransmission channels of risk (which may requirecollaborative action) as well as consideringsecond and third order effects

Understanding the interconnected nature of globalrisks is methodologically and conceptually complex.Yet, if an understanding of interconnectedness is tobe integrated into prioritization and decision-makingat the level of government, business andinternational organizations, representing complexityis crucial. Bringing together expert views on how tothink about interconnectedness is an ongoingmission of the Global Risk Network to exchangeideas and methodologies.

One approach, pursued for the Global Risks 2007report and continued in this report, was to build apicture of correlation of core global risks through anongoing survey of independent experts. In 2007, thisresulted in a matrix of correlation between the coreglobal risks.

The approach has both strengths and limitations.First, the matrix measures strength of correlation,rather than pathways of causation. Correlation cantell us that risks manifest together, but it does nottell us how and why. As a result, correlation mayprovide as much “noise” as “signal”. Second, thematrix provides a useful measure of “static”interconnectedness, providing an overview ofpotential linkages between risks, but not an

understanding of their dynamic interactions overtime. Third, the correlation approach only considerspositive correlations, excluding negative correlations(such as the potentially negative correlation betweenrisks related to climate change and the risk ofsustained high oil prices) which may also inform theappropriateness of mitigation policies.

For the 2008 report, the Global Risk Networkconsidered the application of social network analysisto understand correlation between global risks,constructing a network diagram with nodes denotingindividual global risks and ties showing the strengthof correlation between the risks. Rather than treatingrisks as discrete units of analysis, the focus is onhow the structure and ties affect risk transmission.

There are three dimensions of risk rendered by themap: the size of the nodes denotes the severity of

25

3. Networked World, Networked Risks

“Interdependence is the defining issue of the 21st century.”

Tony Blair, Prime Minister of the United Kingdom (1997-2007); Member of the Foundation Board of theWorld Economic Forum (January 2007)

the risk; the thickness of connecting lines reflectsthe strength of correlation; and the spatial proximityof the nodes is based upon similarity in riskcorrelations. The last dimension ensures that riskswith similar bivariate correlations are clustered closetogether, reducing the ratio between “noise” and“signal” compared to the correlation matrixproduced for Global Risks 2007.

The correlation map highlights the different ways inwhich risks can be interconnected, adding to theunderstanding of assessment and potentiallyproviding input into stress test simulations andscenario processes. The correlation map may alsoprovide a proxy for understanding some of themechanisms of risk transmission. A secondaryanalysis of “pivotal nodes” was conducted, basedon Monte Carlo simulation techniques, whichidentified the risks that are most critical to thediffusion of global risk through the system. On the

26

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 ofcorrelation, while proximity of the nodes represents similarity of correlationsSource: Witold Henisz, Associate Professor of Management, The Wharton School, University of Pennsylvania, USA, based on expert assessments ofcorrelation (October 2007).

basis of the responses to the current survey, the topfour risks are food (in)security, an abrupt fall in theUS dollar, international terrorism and a US/Iranconflict.

In 2008-2009 the Global Risk Network will work toexpand an understanding of correlation andcausation by bringing together experts on theseissues from public and private sectors.

The globalization of risk

Interdependency implies that we are all vulnerable todisruptions in the global flow of people, capital andtechnology. But there are at least two additionalelements to the globalization of risk which maybroaden our understanding of the mechanics ofinterconnectedness in the global risk environment.

The first is risk “squeezing”: the transfer of negativeexternalities of a production process, such asenvironmental and human costs, from one area toanother. In recent years, this has happened on amassive scale as a result of economic globalization,raising a number of dilemmas for effective andequitable global governance of risk. The first is thatshifting production to less regulated geographiesmay, in itself, increase the aggregate negativeexternalities associated with that production. Thesecond is that the transfer of risk may, in any case,be an illusion if the negative externalities affect theglobal system as a whole, or if other costs may bere-imported in other forms. The globalization ofcapital has so outpaced the globalization ofgovernance that returns to capital have beendecoupled from environmental and other costs.

The second is risk “homogeneity”. For example,chronic diseases, such as heart disease, cancer anddiabetes, traditionally considered to be problems ofthe developed world, are becoming common indeveloping countries. As lifestyles becomeincreasingly convergent globally, the trend towardssimilar risk profiles is likely to continue. Anotherexample is global pandemics. One consequence ofthis growing risk homogeneity is that the case forcommon and coordinated global mitigation actionhas strengthened. In section 5 of the current report,we look at how a region-at-risk model may be used

to identify potential coalitions of actors around globalrisk issues and how a forum of country risk officerscould provide a mechanism for coordinating themitigation of global risks.

Risk squeezing

High labour and social costs, and tougherenvironmental legislation in the developed world,coupled with historic reductions in barriers tointernational trade, have moved economicproduction from a national to a global basis. Supplychains have become more complex – see section 1– and the full exploitation of differences incomparative advantage has unlocked globaleconomic growth.

One result has been a delocalization of risk. Even asprimary risks in production are reduced in onelocation, those risks may be “squeezed” to newcentres of production where costs, standards andconditions are lower. Some of the effects of risksqueezing may remain in geographies of production,posing an ethical dilemma at the heart ofglobalization.

But other effects of risk squeezing may have widerglobal consequences.

First, and most clearly, risk squeezing simplydisplaces the original source of risk, but withoutmitigating the systemic consequences of risk and,occasionally, worsening both the underlying risk andaggregate systemic vulnerabilities to it. One clearexample of this is in environmental matters:improving environmental regulation may reduceenvironmental costs in the near term, but ifregulation pushes production to a less-regulatedgeography which is less equipped to deal with itsconsequences, then the aggregate long-termimpacts may be worse.

For example, developed country measures to reducecarbon emissions will not be meaningful in theabsence of global frameworks and action. Yet thelack of a global price for carbon means thateconomic incentives to enhance carbon efficiency orproduce in more carbon-efficient geographies arenot there.

27

But the principle of risk squeezing in theenvironmental context also applies to air and waterpollution. While air and water quality have improveddrastically in recent decades in developed countries,quality elsewhere has been declining – calling intoquestion the long-term, risk-adjusted sustainability ofeconomic growth. Moreover, some of these problemsare easily exported. A toxic spill in a river from afactory in China could pollute agriculture throughirrigation, enter into the production of goods forglobal export, and even threaten the water supply ofa major Russian city. Environmental degradation mayultimately lead to political unrest, both locally andacross borders. Such a problem requires, at aminimum, a bilateral agreement and frequently globalstandards of production or pollution control.

Second, as semi-finished or finished products areexported, the effects of “risk squeezing” may be feltin less obvious and less controllable ways, withmajor consequences in importing countries. In 2007,the discovery of toxic chemicals in children’s toys,made in China for an American brand name, madeconsumers aware of health risks in imported

products which they had previously not considered.The companies involved suffered both a reputationalhit and major economic losses.

Third, the perception of lack of transparency inproduction processes and supply chains mayundermine popular support for globalization. Theargument for consumer protection can lead tooutright economic protectionism, going far beyondthe genuine risks and beyond the original product orgeographic source of risk.

Risk homogeneity

While specific vulnerabilities will remain,interconnectedness, globalization and the spread ofsimilar economic and social structures may generatea degree of homogeneity of risk at the global level.

One example of this is in health risks. Just asglobalization has increased the commonality ofhabits and lifestyles, so has it raised thehomogeneity of the risks associated with thoselifestyles. Non-communicable diseases, such as

28

14 000

12 000

10 000

8 000

6 000

4 000

2 000

0

Tota

l dea

ths

(000

)

Low income countries

Lower middle income countries

Upper middle income countries

High income countries

Communicable diseases, maternal and perinatal conditions, and nutritional deficiencies

Chronic diseases*

Injuries

Projected Deaths by Major Cause and Income Group, All Ages, 2005

Note: *Chronic diseases include cardiovascular diseases, cancers, chronic respiratory disorders, diabetes, neuropsychiatric and sense organdisorders, musculoskeletal and oral disorders, digestive diseases, genito-urinary diseases, congenital abnormalities and skin diseases.Source: © Copyright World Health Organization (WHO), 2007. All Rights Reserved.

cardiovascular disease, cancer and diabetes whichare traditionally associated with a Western lifestyle,have rapidly become prevalent in the developingworld as lifestyles have moved more towards urbanand less physically active jobs. Ironically, as peoplelive longer, they are now suffering from thesediseases. Another negative habit is the increaseduse and consumption of tobacco, alcohol andunhealthy foods. Companies confronted with taxesand regulations against these products in thedeveloped world now target new consumers in thedeveloping world. Finally, global travel patterns havemade the risk of a pandemic homogenous acrossthe world. All countries are equally vulnerable to apandemic that originates in one country.

According to the World Health Organization, chronicdiseases are worst in low- and middle-incomecountries where 80% of non-communicable diseasedeaths occur, and are now widely considered –against the perceptions of many developedcountries – to be the poor nation’s major healthproblem, with the notable exception of Africancountries, where deaths from infectious diseaseremain higher.

The policy conclusion: global cooperationis required

To address externalities at the golobal level and theincreased homogeneity of global risks, internationalcooperation is a necessity. One potential forum forsuch cooperation would be an annual meetingbetween country risk officers where they couldreview global risks and mitigation strategies.Problems between individual countries could bedealt with on a bilateral basis.

29

Financial markets are increasingly seen as a majortool of the transfer and mitigation of an increasingvariety of global risks. Insurance and reinsurancehave traditionally been the key to management andmitigation of risk, and the principles which allow formaintaining both economic efficiency and socialequity will be key to maintaining the healthy role ofinsurance and reinsurance in the future (see box onpage 34) on insurance and risk mitigation lessonsderived from the US experience of naturalcatastrophe insurance).

The growth of financial markets has opened up thepossibility of using markets to help mitigate non-traditional risks (see box on this page) the possibleuse of financial markets to reduce the risks fromnuclear non-proliferation). Also, the rapid emergenceof a new market in insurance-linked securities ishelping to cover peak risks, which cannot becurrently covered adequately by traditional insuranceand reinsurance. In some cases, financial marketsare principally acting as a vehicle of risk transfer. Inother cases, accurate pricing of risk may be helpingto drive mitigation of the primary risk.

This section of the report explores some of thosedevelopments and asks how effective they can be inthe future. The first part reviews a proposal of howfinancial markets may help mitigate a non-traditionalrisk: nuclear proliferation. The second describes howthe expansion of insurance-linked securities andother financial instruments are being used toincrease risk transfer, diversify risk into capitalmarkets and increase the pool of capital available forinsurance. A final part examines how an in-depthstudy of insurance dealing with natural catastrophesin the US may have broader application to how wethink about the management of global risks.

30

4. Financial Markets, Risk Transfer and Risk Mitigation

Energy, security and nuclear non-proliferation: How privatemarkets can help

The nuclear renaissance

Concerns over climate change and long-termenergy security have put nuclear power firmly backon the 2007-2008 global agenda. As a non-carbon-based energy source with a much-improved safety record since the Three Mile Islandand Chernobyl disasters, nuclear technology has anumber of attractions in an era of uncertainty.

Many of the nuclear power plants planned orcurrently under construction – a total of over 300 –are in countries that already have a functioningnuclear industry: Europe, the US, China, India andRussia. But a growing number of non-nucleartechnology states are exploring the nuclear poweroption: Turkey, Vietnam and Egypt, among others.

The problem is that nuclear power relies on accessto enriched uranium. Some countries exploring anational capacity for nuclear energy fear that theycould be blocked in the future by the six stateswhich currently produce enriched uranium on acommercial basis: France, Germany, theNetherlands, Russia, the United Kingdom and theUS. To avoid this, they may decide to build theirown uranium enrichment facilities. But were this tohappen, the international structures governingnuclear technologies would be shattered, and therisks of wider proliferation would rise dangerously.

The economic/security trade-off

Given that the same process used to enrichuranium for fuel in power plants can also produceweapons-grade nuclear material, the only way toreduce the risk of proliferation of weapons-gradematerial is to dissuade states from building newenrichment facilities.

31

But, were the international community to crediblyensure reliable supplies of uranium-based fuel forpower generation for all countries, the incentive forany one country to build new enrichment facilitieswould be removed.

Turning the risk of the spread of nucleartechnologies into an opportunity to create asustainable framework for the production of safe,clean and secure electrical power should be amajor objective of global policy. The innovative useof financial markets may offer a way to achieve it.

The innovation: “insure to assure”

The International Atomic Energy Agency (IAEA)and governments have been grappling with thisdilemma for years. Various mechanisms to assurestates’ access to enriched uranium withoutpolitical interference have been considered. Butsome fear that any IAEA solution remainssusceptible to political pressure from producermembers.

A truly innovative concept has been proposed by ajoint team from the Wharton Business School andHarvard’s Kennedy School: “insure to assure.” Theproposed solution – complementary to the effortsof the IAEA and others – would create apartnership between financial industries andgovernments to create the world’s first internationalnuclear fuel insurance fund.

The fund would operate as follows: Premiums,collected from all member countries, would bedeposited in a mutual insurance company (MIC)which, in turn, would use some of the money tobuild a cash reserve and to purchase supplyoptions. Residual funds would go to a consortiumof insurers and reinsurers that would providelayered financial protection to all participating

countries. The IAEA member governments wouldserve as a financial backstop for the consortium. Inthe event of a fuel disruption, the MIC wouldexercise its options and work with fuel suppliers,energy producers and transporters to arrangetimely fuel delivery or alternative electricitypurchases off the energy grid (if available). Theinsurance consortium would compensate membercountries and others involved in replacing fuel forany loss of efficiency as previously contractuallyagreed.

The concept is based on a key principle ofmitigating global risks: while everyone is looking toensure energy security through energyindependence, the “insure to assure” conceptmight help improve energy security by creating aclear framework for “energy interdependence.”

There are a number of classic global risk questionson the financial market response to nuclearproliferation – among them issues on moral hazardand joint liability – and certainly this concept couldnot be expected to be effective in the absence of aconcerted policy in other areas and trust in theintegrity of the system. However, the power offinancial markets, as a complement to othermeasures, is often under-appreciated.

Implementation: nuclear and beyond

The proposal, which is now being studied bydifferent stakeholders, would bring together twoworlds that rarely talk to one another: the worlds ofinternational security and international finance. Asit stands, the proposal only deals with nuclear fuelsupplies, but there is no reason why a largermutual insurance company could not help turnwider global energy interdependence from asource of perceived vulnerability to a source ofsystemic coherence and security.

Insurance-linked securities: how much canfinancial markets diversify risk?

The process of pooling risks and dividing that poolinto portions sold to a wide range of investors on thesecondary market – known as securitization – hasexpanded massively in recent years. Securitizationsnow account for one-third of the US fixed incomemarket. Transactions that were once consideredhighly innovative are now mainstream.

More recently securitization has spread to insurance,as insurers have transferred their risks to capitalmarkets through securities’ issues. The result hasbeen a diversification of risk for insurers and anincrease in the pool of capital available to coverinsurance risks. The use of financial markets to raiseinsurance capital is not without potential drawbacks:systemic risk could eventually be created byinsurance-linked securities. However, these potentialconstraints on securitization are far into the future.Currently, the relatively small size of the insurance-linked securities market and a growing understandingand sophistication of insurance-linked securitiessuggest considerable scope for financial marketdiversification of an increasingly broad set of risks.

The market in insurance-linked securities initiallydeveloped in response to insurers’ capitalrequirements in covering four traditional “peak” risks:windstorms in Europe, earthquakes in Japan,hurricanes in the US and earthquakes in California.After Hurricane Andrew in 1992 the price ofcatastrophe risk coverage rose considerably andcoverage became increasingly scarce. Insurance-linked securities covering catastrophe – so-called“cat” bonds – provided additional capital to theinsurance industry, helping it to manage catastropherisk and prepare for the next major event. Presently,catastrophe bonds are issued to cover a range ofnon-peak risks, from Mexican earthquakes to floodsin the United Kingdom.

Subsequent transactions have further broadenedinsurance-linked securities. In January 2006, SwissRe securitized US$ 252 million of credit risk linked toclaims and reserves on its credit reinsurancebusiness for underwriting years 2006 through 2008.Catastrophe securitizations – or mortality bonds –can also be used by insurers and reinsurers tohedge against the risk of increased death ratescaused by a major global risk (such as a pandemicor a major terrorist attack). In all of these cases,

32

Investments

SPV

SwapCounterparty

SPONSOR Investors

Note Guarantor

1

3

2

54

Cashproceeds

Investmentearnings Principal

& interest

Notes

Financial guaranteeScheduled

interest

Investmentearnings

Premium

Contingent claim payment

1 The Sponsor enters into a financial contract with a Special Purpose Vehicle (SPV)

2 The SPV hedges the financial contract by issuing Notes to investors in capital markets

3 Proceeds from the securities offering are invested in high quality securities and held in a collateral trust

4 Investment returns are swapped to a LIBOR-based rate by the Swap Counterparty

5 In some transactions, principal and interest on the Notes may be guaranteed by a Note Guarantor

Typical Cat Bond Structure

Source: Swiss Re

securitization improves the diversification of risk and,therefore, the risk-bearing capacity of the insurancesystem. As securitization grows more cost effective,insurers will be able to increasingly share cost benefits,contributing further to the risk transfer market.

Insurance-linked securities have grown considerablyin recent years in terms of depth, breadth andoverall market capacity (see figure below). Forinvestors, insurance-linked securities are attractiveas they provide an investment in a specific insurancerisk with potentially low correlations with equity andcredit markets, and with a reduced counterparty riskbecause some funds can be held in trust.

Other insurance-linked financialinstruments

Besides insurance-linked securities, a wide variety ofderivatives and other financial instruments are nowbeing used to transfer insurance risks. The market forweather derivatives is large, growing rapidly and fairlywell known. Most of these derivatives pay out whenthe weather is exceptionally warm, or exceptionallycold. They are also promoted in emerging marketsto reduce agricultural income volatility. In addition,the market for over-the-counter industry losswarranties is growing. These instruments provideprotection against US hurricanes and are triggered

33

50

2011

3%

8

150

# investors outside of (re)insurance

24

41

5%

15%14

32

# of sponsors securitized

# of risks securitized max annual expected loss

Note: The increasing threshold of annual expected loss, the range of different risks being securitized and the number of sponsors involved insecuritization of insurance-linked securities indicate the growing maturity of insurance-linked securities, and the market appetite for themSource: Swiss Re

Significant Increase in Market Depth and Breadth

0

3000

6000

9000

12000

15000

0

5

10

15

20

25

30

35

Total non-life bonds outstanding, by year Total ILS outstanding, by year

billions US$

Issued OutstandingIssued Outstanding

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

Note: New issuance in 2007 (to November) had already exceeded that of 2006. Total non-life bonds outstanding totalled approximately US$ 14billion. Fourth quarter 2007 also saw over US$ 600 million of extreme mortality cover placed. Total bonds outstanding exceeded US$ 34 billionSource: Swiss Re

34

when insurance industry losses for a particularhurricane are high. Also in the US, the ChicagoMercantile Exchange and the New York MercantileExchange are attempting to establish exchange-traded derivatives that provide protection againsthurricane losses. Finally, there are a wide variety ofcustomized derivatives, providing protection againstlosses from earthquakes and typhoons in Japan,earthquakes in Turkey, excess mortality losses, aviationperil, etc. All of these instruments are arranged by(re)insurers, brokers and banks for companies andinsurers, with protection provided by capital markets –often hedge funds that specialize in insurance risks.

Applying the “5i” framework to financialrisk transfer instruments

Applying the “5i” framework of risk mitigation toinsurance-linked securities yields an analysis of thestrengths, weaknesses and requirements ofinsurance-linked securities in global risk mitigation.

• Insight: Broader and deeper markets shouldmotivate a more sophisticated understanding ofthe drivers and impacts of risks – for example,the inclusion of capital market investors in apandemic risk transfer might heighten awarenessof the correlation between extreme mortality risksand economic risks.

• Information flow: Broadening of markets shouldimprove the quality and flow of information aboutrisks – and should encourage transparency in thereinsurance industry.

• Incentives: Accurate pricing of risk transferinstruments should, in principle, act as anincentive for ex-ante mitigation measures andeven, where appropriate, risk avoidance.

• Investment: Using financial markets increasesthe pool of investment available to indemnify theconsequences of global risks.

• Institutions: Financial markets require strongpublic institutions to allow the market to flourish.These institutions and financial markets are in asymbiotic relationship. Efficient financial regulationand a secure legal environment for insurance-linked securities is a prerequisite to their expandeduse, and to help improve global risk mitigation.Should transaction costs prove too high, the rangeand scope of the market will be constrained.

Insurance and risk transfer: lessons from natural catastropheinsurance in the US

Natural catastrophes have had a greater nominal USdollar impact on insurers over the past 15 years thanin the entire history of insurance. Hurricane Katrinaalone cost insurers and reinsurers an estimatedUS$ 45 billion, while losses paid by private insurersdue to major natural catastrophes in 2005 totalledUS$ 83 billion.

A significant part of the increase in naturalcatastrophe damage is due to increasedconstruction in hazard-prone areas in recentdecades, but there may be a longer-term driver aswell: global warming may be resulting in increasingfrequency of severe storms in certain parts of theworld. While new construction in hazard-proneareas could be easily reduced by governmentregulation, the inertia effect of historical carbonemissions means that global warming will continuefor decades, even if the future rate of warmingmay eventually be slowed and reversed byconcerted international action.

Yet, insurance can help manage the impact of thisrisk in two important ways: directly, by providingfinancial protection to businesses and individualsagainst losses from catastrophic events andindirectly, by encouraging risk mitigation measuresthrough lower premiums for those who invest inrisk-reducing measures. In principle, insurance, bybasing its prices on the risk of losses, can providea strong incentive for improved risk management.In addition to serving an important social function,insurance can create the conditions for efficienteconomic allocation of resources. Often, however,the politics and economics of insurance clash.

Insurance will only be provided if premiums reflectactuarial risk: the insured damage resulting from aspecific event, weighted by the probability of that

35

event occurring. Natural disasters cannot beprevented, though reducing climate change in thefuture could limit the increases in intensity andfrequency of some natural catastrophes. Actuarialrisk to individual properties can be reduced byfortifying them, and aggregate risk can be loweredby decreasing construction in vulnerable zones.

Developing guiding principles

Two guiding principles for using insurance andother financial instruments to effectively mitigaterisk have been developed by the Wharton RiskManagement and Decision Processes Center inthe context of a research project on “ManagingLarge-Scale Risks in a New Era of Catastrophes”.

• Principle 1 – Premiums Reflecting Risk:Insurance premiums should be based on risk,to provide signals to individuals as to thehazards they face and to encourage them toengage in cost-effective mitigation measures toreduce their vulnerability to catastrophes.

• Principle 2 – Dealing with Equity andAffordability Issues: Any special treatment givento residents currently residing in hazard-proneareas (e.g. low-income homeowners) shouldcome from general public funding and notthrough insurance premium subsidies.

Mitigation

Economic analysis of case studies in four hurricane-vulnerable US states revealed that a range ofphysical mitigation measures – such as stormshutters, roof anchors and safety film on windows– could reduce insured losses from a severehurricane considerably (by up to 61% in Florida).

But property owners rarely make these voluntaryinvestments because they believe thatcatastrophes will not happen to them, and

because the economic incentives to invest aresuppressed by artificially low premiums.

In a survey of those living along the US Atlanticand Gulf Coasts, undertaken in the spring of 2006,83% of respondents had taken no steps to fortifytheir homes with relatively inexpensive measures,even after the devastating 2004 and 2005hurricane seasons.

Lessons for global risk management?

What lessons can be drawn from US naturalcatastrophe insurance to understand the role ofinsurance in managing global risks?

• First, understanding the nature of the risk andquantifying it is the prerequisite for insurance.

• Second, there is a need for new risk transferinstruments such as catastrophe bonds andother financial instruments, which cansupplement traditional reinsurance, to enableinsurers to protect themselves againstcatastrophic losses and reduce the need forgovernment intervention.

• Third, insurers need to be able to charge apremium that reflects the risk they assume andwhich rewards those who undertake mitigationmeasures. Government intervention to artificiallysuppress premiums may have unintendedconsequences, including reducing theeconomic sustainability of insurance by skewingincentives. However, government codification ofmitigation measures may help.

• Finally, the way in which equity concerns aremet is vital. It would be more efficient to provideinsurance vouchers and mitigation grants tolow-income groups in the US living in naturalcatastrophe zones, than to mandate artificiallylow insurance premiums. Similarly, addressingequity issues at a level should not be done in away which reduces the ability to leveragefinancial markets to mitigate risk.

36

5. Structuring Mitigation at the State and InternationalLevel: Taking the Country Risk Officer Forward

In Global Risks 2007, the Global Risk Networkintroduced the concept of the country risk officer asa public sector equivalent to corporate risk officers inthe private sector, who are growing in importance.Given the complexity and correlations of risk, possibletrade-offs across government department silos, andthe agreed need for better communication betweenthe public and private sector, managing risk on aportfolio basis is as important in government as it isin the private sector. More importantly, identifying acommon language of risk and risk assessment acrossthe public and private sectors may make it easier inthe future for both to cooperate in mitigation initiatives.

For Global Risks 2008, the Global Risk Networkconvened an informal group of experts to explorethe country risk officer concept, to understand itslimits and its strengths and to begin to understandwhat principles of best practice could be developedto guide country risk management.

It was concluded that the country risk officer wasnot necessarily a single role to be held by oneindividual – it might be a committee, a process, ormultiple coordinated positions. Much would dependon the specific political and economic structures inwhich the concept of country portfolio riskmanagement is applied – a centralized system suchas the United Kingdom or a federal system such asGermany or Switzerland would necessitate verydifferent structures to achieve a similar objective.

It was also agreed that, while an individual countryrisk officer in one country might vastly improveunderstanding and coordination of risk on thenational level, many global risks require an inherentlyinternational response. A forum of national countryrisk officers might be one way of achieving commonassessment, trust and institutional confidence toenable much improved management of global riskswhen they manifest across international borders.

Currently, government bodies play a four-part role inrisk management at the national level.

• Action: from identification of risks to crisismanagement and risk communication

• Regulation: the use of legislation to help preventthe emergence of risks and to protect against theconsequences of risks should they arise

• Economic continuity: the use of measures(such as release of financial reserves or strategicenergy reserves) which ensure economicrobustness in the face of a wide range of riskevents

• Insurance: acting as an insurer of last resort

The group established five principles of country riskmanagement which could be applied across thespectrum of governments to guide country riskofficers, whether the officer is an individual, acoordinating committee or takes some otherinstitutional form.

• Accountability: The need for accountability ofrisk assessment is seen as a fundamentalcondition of the legitimacy of assessment as abasis for concerted government action bothvertically (within departments of government) andhorizontally (across branches of government).Clarity of accountability would increase theincentives for effective mitigation measures.

• Integrated assessment: Establishing commonprocedures across government departments toassess risks, cross-disciplinary scenarios and the

Global risk, government and business:different incentives, different goals,common opportunities

The incentives for business and government inrisk mitigation are different: • Doing business involves taking risk;

government largely avoids risk.• While businesses aim to maximize profit and

shareholder value, both relatively easilymeasured metrics, governments seek tosatisfy a much broader set of stakeholders,with far more complex trade-offs.

• Government assessments of global risk arenecessarily idiosyncratic in that they considerstakeholder concerns differentially – but theymust obtain broad legitimacy to beconsidered as a basis for action.

However, opportunities exist for collaborationbetween government and business ondeveloping and sharing common methodologies.

37

language of risk would provide a basis not onlyfor better crisis management but also for definingmore effective prevention and mitigation of globalrisks. Too often positive externalities are overlookedand negative externalities are exaggerated by lackof an integrated assessment of risk.

• Devolved implementation: Integratedassessment should not imply centralizedimplementation. Devolved implementation of riskmitigation strategies should allow flexible andadaptive responses to common risks.

• Separation of analysis and policy: The casefor devolved implementation is strengthened bythe argument in favour of separation of analysisand policy. Analysis is better kept within aseparate structure, so as to prevent bureaucraticpressures impinging upon independence ofanalysis.

• Disclosure and transparency (if possible):Governments are constantly caught betweenpressure to disclose risk assessments and theneed to keep some assessments confidential soas to avoid panic, protect sources and maintainresilience. But even the maintenance ofconfidential information can create the conditionsfor incomplete or inaccurate information leadingto an “infodemic” situation in a crisis, where theconsequences of popular reaction to a perceivedrisk far outweigh the risk itself. The developmentof much more granular risk communicationstrategies will ensure a culture of maximumdisclosure and transparency, while safeguardingagainst information overload.

Region at risk: A basis for identifyinginternational risk mitigation coalitions?

An additional institutional innovation suggested inGlobal Risks 2007 was the creation of an “avant-garde of relevant governments and companiesaround different global risks.” The report arguedthat the urgency, complexity and multiple trade-offs in global risks require structures which canrespond flexibly, assemble quickly and achievelegitimacy through success. “A process ofgradually expanding alliances rather than aproposition requiring permanent consensus” mayoffer a better way forward.

But, even under conditions of extremeinterdependency, the problem of mobilizingcollective action to mitigate global risks remains.One strategy to activate coalitions to mitigateglobal risks may lie in an improved understandingof national risk exposures and identifying clustersof countries that are exposed to the same risks insimilar orders of magnitude.

The region at risk model, which will be developedin 2008-2009, will achieve this by drilling downinto the frequencies and severities of global risk atthe national level, gathering expert input oncountry risk exposures, and creating a frameworkwhich is compatible with the global approachtaken in previous Global Risk reports.

Individual countries can then be represented by aspecific set of risks, and an aggregate riskmeasure can be derived that allows for cross-country comparisons. Cross-correlations, whichaccount for different causal relationships amongthe various global risks, complete the countrymodel. The more interesting features will derivefrom the model’s capability to integrate a wealth ofdata, account for cross-correlations among risks,analyse specific vulnerabilities, identify countryclusters, engage in what if scenarios and,ultimately, point to potential coalitions of countriesto mitigate risk.

38

The country risk officer: an examplefrom the United Kingdom

As discussed above, the country risk officer is notnecessarily a single individual. It may equally be across-government process, a secretariat, afunction within different ministries, or acombination of all three. The common principlesfor effective country risk management identifiedabove may take a variety of institutional forms.

One of the pioneers in coordinated riskmanagement is the United Kingdom, which set upthe Civil Contingencies Secretariat (CCS) in 2001initially to improve the effectiveness of post-crisismanagement, but increasingly to play a moreforward-looking role in identifying and assessingpotential risks to national resilience. The CCSprovides a single framework for governmentactions to absorb, respond to and recover fromdisruptive challenges, but serves a number ofdifferent functions: establishing the risk landscapefacing the United Kingdom, improving consistencyacross government in terms of assessment andmanagement of risks, clarifying roles andresponsibilities and providing a basis for effectiveperformance management.

One of the key problems within government interms of risk management in general has been theexistence of either horizontal disconnects betweenlevels of government, or vertical disconnectsbetween departments of government. In somecountries the response to interconnectedness ofglobal risks has been to merge existinggovernment departments with existing operationalresponsibilities, with varying degrees of operationalsuccess. The CCS, in contrast, is a relatively newand relatively small entity at the centre of theUnited Kingdom government (the Cabinet Office)designed to act as a focal point within governmentfor identification, assessment and management ofrisk, and as an entry point for dialogue with theprivate and voluntary sectors, as well as with thepublic sector at local, regional and national level.

The keystone of national risk management in theUnited Kingdom has become the annual nationalassessment process on an all-hazards basis toidentify, describe and quantify risks which mayimpact the resilience of the country, lookingforward over a five-year period. Identification,analysis and prioritization of risks are placed aheadof measuring capability gaps, so as to avoid aretroactive fitting of risk identification on existinggovernment structures. The widest possible rangeof government agencies is involved in identificationand description of the national risk landscape, soas to ensure a comprehensive list of risks andenhance a common understanding of global risksfacing the country.

At the assessment stage, the same method isused to measure the severity of all risks while twoapproaches can be taken to quantify the likelihooddepending on whether the risk is considered anatural hazard and, therefore, more amenable toobjective measurement on a historical or scientificbasis, or a threat of malicious harm for whichobjective assessments have to be blended withmore subjective judgement. In both cases,however, the end result is an estimation of thelikelihood and severity of plausible worst-casescenarios which allow for comparison andprioritization across risk categories. The highestrated risks are then considered in terms of theirgeneric and specific consequences and whether,at the local, regional or national level, governmentplans, infrastructure, equipment, legislation, supplies,doctrine and training are adequate to manage andmitigate them. The CCS coordinates capabilityenhancements where this is not the case.

This approach is thought to be effective in prioritizingand quantifying the risks to homeland security –broadly defined – needing to be dealt with. It is tooearly to conclude the effectiveness of the CCSapproach in improving the United Kingdom’s abilityto manage global risks. But one obvious constraintis the lack of obvious interlocutors in othercountries, despite the transnational andinterconnected nature of many of the risks whichthe CCS identifies and assesses.

This year it will be difficult to manage global risks.Both political and economic uncertainties are likelyto act as a focus for global discussion and energy.On the economic side, an exceptional period ofglobal growth may come under pressure as theliquidity crisis of 2007 impacts the real economy. Onthe political side, changes of government in severalmajor countries and an uncertain situation in theMiddle East will dominate. Leadership on global riskissues will be an increasingly precious commodity.

As this report has indicated, some progress onunderstanding and managing global risks is takingplace. Opportunities for a peaceful settlement in theIsrael-Palestine conflict may be stronger in 2008than at any time since the turn of the century. Majoremerging economies have increasinglydemonstrated their willingness to take a leadershiprole in managing global risks. New financial productsmay be increasing the potential of financial marketsto diversify and absorb risk. Risk management hasbecome a key element of the management andstrategy of both business and government.Recognition of the need to reform the global energyeconomy has set the stage for a multi-decade shiftin direction.

But, for many of the global risks discussed in thisreport, the question of ownership of these risksremains unanswered. The fragmentation ofownership of global risks and the complexity ofinterdependencies will make equitable andsustainable management of global risks hugelychallenging. Should systemic financial risk lead to aserious deterioration in the world economy, theprospects for collaborative mitigation may bereversed on several fronts simultaneously asattention turns to more immediate concerns.

The Global Risk Network will continue to bringtogether policy-makers, business leaders and non-governmental organizations to help alignassessments of risk, to understand institutional gapsand to better grasp the interconnectedness ofsectors and risks.

39

6. Conclusion

41

Appendix 1: Taxonomy of Global Risk: Trends, Issues of Concern, Risks

In 2007-2008 the Global Risk Network identifiedtrends, issues of concern and risks. Trends areobservable facts in the contemporary world. Issuesof concern are potential challenges which arise fromthose trends. The risks identified are specificrealizations of those challenges in a format which issufficiently specific to be open to a level ofassessment in terms of relative severity andlikelihood, without being so specific as to precludethem as a basis for decision-making.

The probability of a specific scenario occurringreduces as the parameters of the scenario becomemore described. But scenarios with negligibleprobability are unlikely to be a firm basis fordecision-making. A balance is therefore requiredbetween specificity and generality.

In some domains the path between trends, issuesand risks is clear. In others, notably geopolitical risk,the pathway from trend to risk is less clear,contingency is greater and common issues canmanifest in many different ways.

1. Economics – 6 trends, 6 issues of concern, 6 risks

1.1. Trend: Growing imbalances in food/agricultural production and use, driven in part by biofuel productionand a shift to water-intensive crops1.1.1. Issue of concern: Rapidly rising and increasingly volatile food prices

1.1.1.1. Risk: Rising and volatile prices create significant shortages for poor consumers globally(those whose consumption basket is more than 50% food)

1.2. Trend: Tightening energy markets1.2.1. Issue of concern: Vulnerability to supply-side disruption

1.2.1.1. Risk: Oil or gas prices rise steeply due to a major supply disruption (decreased globalsupply by 10% for several months)

1.3. Trend: Macroeconomic Imbalances1.3.1. Issue of concern: Unsustainability of US current account deficit

1.3.1.1. Risk: An abrupt, major fall in the value of the US dollar with impacts throughout thefinancial system

1.4. Trend: Rise of Chinese Economic Power1.4.1. Issue of concern: Sustainability of Chinese economic growth

1.4.1.1. Risk: Domestic social/political issues combine to reduce Chinese growth to 6% or less(sustained slower growth)

1.5. Trend: Ageing populations in developed economies1.5.1. Issue of concern: Potential for fiscal crises

1.5.1.1. Risk: Declining fiscal positions force multiple governments of wealthy countries to raisetaxes, leading to economic stagnation

1.6. Trend: High and increasing asset prices fuelled by unprecedented liquidity1.6.1. Issue of concern: Asset ‘bubble’ and credit crunch

1.6.1.1. Risk: House and other asset prices collapse in the US, United Kingdom and Europe,significantly reducing consumer spending and creating a recession

42

2. Geopolitics – 7 trends, 9 issues of concern, 12 risks

2.1. Trend: Rise of non-traditional/asymmetric warfare2.1.1. Issue of concern: International terrorism

2.1.1.1. Risk: International terrorists mount multiple attacks with conventional and chemical (butnot nuclear) weapons, causing significant economic and human losses andexacerbating the retrenchment from globalization

2.2. Trend: Proliferation of Weapons of Mass Destruction2.2.1. Issue of concern: Potential spread of nuclear capabilities

2.2.1.1. Risk: Collapse of the Non-Proliferation Treaty (NPT) leads to multiple statessimultaneously pursuing nuclear technologies and weaponization, with associatedincrease in geopolitical tensions dragging on the global economy

2.3. Trend: Reconfiguration of global power2.3.1. Issue of concern: War

2.3.1.1. Risk: US/Iran conflict2.3.1.2. Risk: US/Democratic People’s Republic of Korea conflict

2.4. Trend: Widening gap between “geographies of order and disorder”2.4.1. Issue of concern: Failed and failing states

2.4.1.1. Risk: US/Iran conflict Nation building in Afghanistan fails, providing haven forinternational terrorist groups and triggering the decline of the Pakistani state

2.4.1.2. Risk: Disorder in the Horn of Africa worsens as multiple states descend into conflict andoffer haven for terrorist groups

2.4.1.3. Risk: A fragile Latin American regime collapses suddenly, spreading political andeconomic uncertainty throughout the region

2.5. Trend: Global integration outpacing international policing capabilities2.5.1. Issue of concern: Transnational crime

2.5.1.1. Risk: Penetration of organized crime in the global economy increases significantly over a10-year period, weakening state authority, worsening the investment climate andslowing growth

2.6. Trend: Retrenchment from globalization2.6.1. Issue of concern: Rising protectionism in developed economies

2.6.1.1. Risk: Multiple developed economies adopt policies (tariffs, WTO disputes) which retardexisting trade and further undermine talks on increased global integration

2.6.2. Issue of concern: Rising economic nationalism in developing economies2.6.2.1. Risk: Multiple significant emerging economies advance policies that harm foreign direct

investment and slow the engine of global growth

2.7. Trend: Intractability of Middle East conflicts2.7.1. Issue of concern: Israeli/Palestinian conflict

2.7.1.1. Risk: Worsening conflict in the Occupied Territories claims thousands of lives over a 10-year period, and exacerbates geopolitical tensions and economic decline throughoutthe region

2.7.2. Issue of concern: War in Iraq2.7.2.1. Risk: 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.

43

3. Environment – 3 trends, 6 issues of concern, 7 risks

3.1. Trend: Climate Change/Global Warming3.1.1. Issue of concern: Increase in extreme weather events

3.1.1.1. Risk: Extreme weather events linked to climate change will impact businesses andsociety at large (e.g. multiple tropical cyclones make landfall along the Gulf Coast, India,Bangladesh or China over a 10-year period)

3.1.2. Issue of concern:Changing rainfall patterns3.1.2.1. Risk: More frequent and severe heatwaves and droughts have harsh impacts on

agricultural yields around the world

3.2. Trend: Ecosystem degradation3.2.1. Issue of concern: Loss of freshwater services

3.2.1.1. Risk: Declining quality and quantity of water in several major watersheds leads to watershortages and increased prevalence of water-borne disease

3.3. Trend: : Increasing human exposure to natural catastrophes3.3.1. Issue of concern: Earthquakes

3.3.1.1. Risk: Natural catastrophe: A strong earthquake hits an economic centre such as Tokyo,Los Angeles or San Francisco

3.3.1.2. Risk: Natural catastrophe: A strong earthquake or seaquake (followed by a strongtsunami) hits a developing country such as China, India or Indonesia

3.3.2. Issue of concern: Inland flooding3.3.2.1. Risk: Natural catastrophe: Extreme inland flooding of the Mississippi, Yangtze, Thames or

Rhine rivers causes direct economic and human losses and serious disruption downstream3.3.3. Issue of concern: Tropical hurricanes

3.3.3.1. Risk: Natural catastrophe: Category 5 tropical hurricane hits an economic centre suchas Tokyo or southern Florida

4. Society – 4 trends, 4 issues of concern, 4 risks

4.1. Trend: Greater interconnectedness of social systems4.1.1. Issue of concern: Potential for fast-travelling pathogens

4.1.1.1. Risk: A pandemic disease jumps from the animal population to humans, with highmortality and transmission rates following.

4.2. Trend: Increasing prevalence of infectious disease in the developing world4.2.1. Issue of concern: Potential for worsening of global AIDS/TB/malaria epidemics

4.2.1.1. Risk: Incidence of infectious disease continues to rise in Africa and rises dramatically inRussia and South-East Asia (TB and HIV/AIDS)

4.3. Trend: Increasing burden of chronic disease in the developed world4.3.1. Issue of concern: Conflation of obesity/diabetes/Cardiovascular disease

4.3.1.1. Risk: Chronic diseases are widespread in the developed world

4.4. Trend: Spread of liability regimes4.4.1. Issue of concern: Potential spread of US-style liability regimes domestically and internationally

4.4.1.1. Risk: US liability costs increase at four times the rate of GDP growth, and spread rapidlyto Europe and Asia. Capacity for global insurance is reduced, undermining investmentand growth

44

5. Technology – 2 trends, 2 issues of concern, 2 risks

5.1. Trend: Increasingly interdependent critical information infrastructure (CII)5.1.1. Issue of concern: Vulnerability of CII to attack or system failure

5.1.1.1. Risk: Attack or system failure in CII creates a domino effect, shutting down IT-dependent applications in power, water, transport, banking and finance, and emergencymanagement

5.2. Trend: Development of technology on the nanoscale5.2.1. Issue of concern: Potential toxicity of nanoparticles

5.2.1.1. Risk: Studies reveal health impairment due to exposure to widely used nanoparticles(paint, cosmetics, healthcare). Primary impacts on public health and secondary impactson investment in a range of nanotechnologies

45

Appendix 2: Risk Assessments

ECONOMICS

Rising and volatile prices create significantshortages for poor people globally (those whoseconsumption basket is more than 50% food)

Oil or gas prices rise steeply due to a majorsupply disruption (decreased global supply of10% for several months)

An abrupt, major fall in the value of the USdollar over time with impacts throughout thefinancial system

Domestic social/political issues combine toslow Chinese growth to 6% or less (sustainedover time)

Declining fiscal positions force multiplegovernments of wealthy countries to raisetaxes, leading to economic stagnation

House and other asset prices collapse in theUS, United Kingdom and continental Europe,reducing consumer spending and creating arecession

3

4

3.5

3.5

2

4.5

3

4

3

4

3

5

LIKELIHOOD SEVERITY

2008

ECONOMICS

Oil price shock

US current accountdeficit

China hard landing

Coming fiscal crisescaused bydemographic shift

Blow up in assetprices/indebtedness

4

3

4

2

4

4

3

4

3

5

LIKELIHOOD SEVERITY

2007

Risk Assessments – Economic Loss LIKELIHOOD SEVERITY (US$)

1 below 1% 2-10 billion2 1-5% 10-50 billion3 5-10% 50-250 billion4 10-20% 250 billion-1 trillion5 above 20% >1 trillion

The risk assessments below provide the bestaggregate view of the partners involved in this report.All assessments have resulted from group discussion,but they contain varying degrees of certainty andagreement as to the manifestation of the risk both interms of likelihood and severity. Certain risks can beassessed for likelihood using traditional actuarialmodels – particularly natural catastrophe risks. Forother risks – particularly geopolitical risks – theranges of possible outcomes are much wider andcorrespondingly uncertainty looms large.

The assessments below are not a fixed view of howthe world will turn out over a 10-year time frame.Many of the risks are open to mitigation measures

which will alter likelihood and severity within 10years; for others likelihood and severity may changedue to inaction or shifts in underlying causal trendsand, in all cases, new information may alter ourfuture perspective on likelihood and mitigation.

Most risk definitions are broadly similar from 2007 to2008, but a number of other definitions have beensharpened to increase granularity of measurement,and geopolitical risks have been disaggregated forthe purposes of assessment. The 2007 and 2008assessments are therefore broadly, but not directly,comparable.

46

GEOPOLITICS

International terrorists mount multiple attackswith conventional and chemical (but notnuclear) weapons, causing significanteconomic and human losses and exacerbatingthe retrenchment from globalization

Collapse of NPT leads to multiple statessimultaneously pursuing nuclear technologiesand weaponization, with associated increase ingeopolitical tensions dragging on the globaleconomy

Interstate & civil wars• US/Iran conflict• US/Democratic People’s Republic of

Korea conflict

3

3.5

33

2.5

2

1.5

333

GEOPOLITICS

International terrorism

Proliferation of WMD

4

3.5

2

2

LIKELIHOOD SEVERITY

2008LIKELIHOOD SEVERITY

2007

Failed & failing states• Nation building in Afghanistan fails,

providing haven for international terroristgroups and triggering the decline of thePakistani state

• Disorder in the Horn of Africa worsens asmultiple states descend into conflict andoffer haven for terrorist groups

• A fragile Latin American regime collapsessuddenly, spreading political and economicuncertainty throughout the region

Penetration of organized crime in the globaleconomy increases significantly over a 10-yearperiod, weakening state authority, worseningthe investment climate and slowing growth

Multiple developed economies take steps(tariffs, WTO disputes) which retard existingtrade and further undermine talks on increasedglobal integration

Multiple significant emerging economiesadvance policies that harm foreign directinvestment and slow the engine of globalgrowth

44.5

4

2

3

3

3.5

2.52

1

2

3

5

3

Failed and failingstates

Interstate and civilwars

Transnational crimeand corruption

Retrenchment fromglobalization

4

3.5

3.5

2.5

2.5

4

3.5

5

47

Declining quality and quantity of water inseveral major watersheds leads to watershortages and increased prevalence of water-borne disease.

Natural catastrophe: Category 5 tropicalcyclone hits an economic centre such as Tokyoor southern Florida

Natural catastrophe: A strong earthquake hitsan economic centre such as Tokyo, LosAngeles or San Francisco

Natural catastrophe: Extreme inland flooding ofthe Mississippi, Yangtze, Thames or Rhinerivers causes direct economic and humanlosses and serious disruption downstream

3

2

2

2

2

3

3

2.5

Loss of freshwater

Natural catastrophe:Tropical Storms

Natural catastrophe:Earthquakes

Natural catastrophe:Inland Flooding

3.5

2

2

2

2.5

3

3

2.5

LIKELIHOOD SEVERITY

2008LIKELIHOOD SEVERITY

2007

ENVIRONMENT

Extreme weather events linked to climatechange will impact businesses and society atlarge (e.g. multiple tropical cyclones makelandfall along the Gulf Coast, India, Bangladeshor China over a 10-year period)

More frequent and severe heatwaves anddroughts have harsh impacts on agriculturalyields around the world

3.5

3.5

3

3

ENVIRONMENT

Climate change 3 3

GEOPOLITICS

Middle-East instability• Worsening conflict in the Occupied

Territories claims thousands of lives overa 10-year period, and exacerbatesgeopolitical tensions and economicdecline throughout the region

• All forms of violence in Iraq – sectarian,insurgent, terrorist – worsen and claimthousands of lives. Failure to achievepeace destabilizes the region on anongoing basis

43

5

3.52.5

2.5

GEOPOLITICS

Middle East instability 4.5 3.5

48

LIKELIHOOD SEVERITY

2008LIKELIHOOD SEVERITY

2007

SOCIETY

A pandemic disease jumps from the animalpopulation to humans, with high mortality andtransmission rates following

Incidence of infectious disease continues torise in Africa and rises dramatically in Russiaand South-East Asia (TB and HIV/AIDS)

Chronic diseases become widespread in thedeveloped world

US liability costs increase at 4x the rate of GDPgrowth, and spread rapidly to Europe and Asia.Capacity for global insurance is reduced,undermining investment and growth

3

2.5

4

3

4

3

3.5

3

SOCIETY

Pandemics

Infectious disease inthe developing world

Chronic disease indeveloped countries

Liability regimes

2

3

4.5

3

4

2.5

3

3

TECHNOLOGY

Attack or system failure in CII creates a dominoeffect, shutting down IT-dependent applicationsin power, water, transport, banking andfinance, and emergency management

Studies reveal health impairment due toexposure to widely used nanoparticles (paint,cosmetics, healthcare). Primary impacts onpublic health and secondary impacts oninvestment in a range of nanotechnologies

3.5

2

3.5

2-2.5

TECHNOLOGY

Breakdown of criticalinformationinfrastructure (CII)

Emergence of risksassociated withnanotechnology

3

2

3.5

2

49

ECONOMICS

Rising and volatile prices create significantshortages for poor people globally (those whoseconsumption basket is more than 50% food)

3 5

LIKELIHOOD SEVERITY

2008

ECONOMICS

LIKELIHOOD SEVERITY

2007

Risk assessments – Lives lost LIKELIHOODSEVERITY

(deaths)

1 below 1% 1 600-8 0002 1-5% 8 000-40 0003 5-10% 40 000-200 0004 10-20% 200 000-1million5 above 20% >1million

GEOPOLITICS

International terrorists mount multiple attackswith conventional and chemical (but notnuclear) weapons, causing significanteconomic and human losses and exacerbatingthe retrenchment from globalization

Collapse of NPT leads to multiple statessimultaneously pursuing nuclear technologiesand weaponization, with associated increase ingeopolitical tensions dragging on the globaleconomy

Interstate & civil wars• US/Iran conflict• US/Democratic People’s Republic of

Korea conflict

Failed & failing states• Nation building in Afghanistan fails,

providing haven for international terroristgroups and triggering the decline of thePakistani state

• Disorder in the Horn of Africa worsens asmultiple states descend into conflict andoffer haven for terrorist groups

• A fragile Latin American regime collapsessuddenly, spreading political and economicuncertainty throughout the region

Penetration of organized crime in the globaleconomy increases significantly over a 10-yearperiod, weakening state authority, worseningthe investment climate and slowing growth

3

3.5

3.53

2.5

44.5

4

2

3

2

2

433

3.52

2

1

1

GEOPOLITICS

International terrorism

Proliferation of WMD

US/China conflict

Failed and failingstates

Interstate and civilwars

Transnational crimeand corruption

4

3.5

3.5

4

3.5

3.5

1.5

0.5

4

3.5

4

2

50

GEOPOLITICS

Middle-East instability• Worsening conflict in the Occupied

Territories claims thousands of lives overa 10-year period, and exacerbatesgeopolitical tensions and economicdecline throughout the region

• All forms of violence in Iraq – sectarian,insurgent, terrorist – worsen and claimthousands of lives. Failure to achievepeace destabilizes the region on anongoing basis

43

5

32

3.5

GEOPOLITICS

Middle East instability 4.5 3

LIKELIHOOD SEVERITY

2008LIKELIHOOD SEVERITY

2007

ENVIRONMENT

Extreme weather events linked to climatechange will impact businesses and society atlarge (e.g. multiple tropical cyclones makelandfall along the Gulf Coast, India, Bangladeshor China over a 10-year period)

More frequent and severe heatwaves anddroughts have harsh impacts on agriculturalyields around the world

Declining quality and quantity of water inseveral major watersheds leads to watershortages and increased prevalence of water-borne disease

Natural catastrophe: Category 5 tropicalcyclone hits a densely populated area in anemerging country such as India, China orBangladesh.

Natural catastrophe: A strong earthquake orseaquake (followed by a strong tsunami) hits adeveloping country such as China, India orIndonesia

Natural catastrophe: Extreme inland flooding ofthe Mississippi, Yangtze, Thames or Rhinerivers causes direct economic and humanlosses and serious disruption downstream

3.5

3.5

3

4

2

2

2.5

2

2.5

3

4

2.5

ENVIRONMENT

Loss of freshwater

Natural catastrophe:Tropical Storms

Natural catastrophe:Earthquakes

Natural catastrophe:Inland Flooding

3.5

2

3

2

Not available

Not available

51

SOCIETY

A pandemic disease jumps from the animalpopulation to humans, with high mortality andtransmission rates following

Incidence of infectious disease continues torise in Africa and rises dramatically in Russiaand South-East Asia (TB and HIV/AIDS)

Chronic diseases become widespread in thedeveloped world

3

2.5

4

5

5

4

SOCIETY

Pandemics

Infectious disease inthe developing world

Chronic disease indeveloped countries

2

3

4

4

5

4

TECHNOLOGY

Attack or system failure in CII creates a dominoeffect, shutting down IT-dependent applicationsin power, water, transport, banking andfinance, and emergency management

Studies reveal health impairment due toexposure to widely used nanoparticles (paint,cosmetics, healthcare). Primary impacts onpublic health and secondary impacts oninvestment in a range of nanotechnologies

3.5

2

1

1

TECHNOLOGY

Breakdown of criticalinformationinfrastructure (CII)

Emergence of risksassociated withnanotechnology

3

2

1

1

LIKELIHOOD SEVERITY

2008LIKELIHOOD SEVERITY

2007

52

Contributors

This report was prepared by the Global Risk Team ofthe World Economic Forum, in conjunction with, andwith inputs from, its partners.

Core team

Global Risk Team, World Economic Forum Charles Emmerson, Associate Director, WorldEconomic Forum; Editor, Global Risk Report 2008Viktoria Ivarsson, Team CoordinatorJohanna Lanitis, Research AnalystSylvia Lee, Global Leadership Fellow, EnvironmentalRisksFiona Paua, Head of Strategic Insight TeamsGareth Shepherd, Global Leadership Fellow,Economic and Financial RisksSupported by Sean Cleary, Strategic Adviser

CitigroupJohn Ingraham, Managing Director, Head of RiskAggregationMaggie Xie, Senior Vice-President, RiskAggregation

Marsh & McLennan Companies (MMC)John Drzik, President and Chief Executive Officer,Oliver Wyman Group, USAMatt Elkington, Vice-President, Marsh RiskConsulting, Marsh, United KingdomChloe Franklin, Project Manager, MMCInternational, United KingdomDavid Frediani, Executive Director, MMCInternational, United KingdomRoland Rechtsteiner, Director, Corporate RiskConsulting, Oliver Wyman, SwitzerlandJohn Merkovsky, Managing Director, GlobalPractice Leader, Marsh Risk Consulting, Marsh(USA), USA

Swiss ReEsther Baur, Director, Head Issue Management,Swiss Re, SwitzerlandCatherine Burger, Director, Senior Issue &Partnership Manager, Swiss Re, SwitzerlandKurt Karl, Senior Vice-President, Head of EconomicResearch & Consulting, Swiss Re American HoldingCorp., USAIvo Menzinger, Managing Director, HeadSustainability and Emerging Risk Management,Swiss Re, SwitzerlandChristian Mumenthaler, Head of Life & HealthProducts, Member of the Executive Board, SwissRe, SwitzerlandLisa Wyssbrod, Director, Senior Issue andPartnership Manager, Swiss Re, Switzerland

The Wharton School, University of PennsylvaniaWitold J. Henisz, Associate Professor ofManagementHoward Kunreuther, Cecilia Yen Koo Professor;Co-Director, Risk Management and DecisionProcesses CenterErwann Michel-Kerjan, Managing Director, RiskManagement and Decision Processes Center

Zurich Financial ServicesDaniel M. Hofmann, Group Chief Economist Hanspeter Frei, Global Head Risk EngineeringGeoffrey M. Riddell, Chief Executive Officer, GlobalCorporate, and Member of Group ExecutiveCommittee

53

Participants

Over the past year the Global Risk Network hasengaged with a wider group of experts in workshopsheld at The Wharton School in May, in London andZurich in July, and in New York in October. Theseworkshops, along with the risk assessment processand risk-related sessions in the broader context ofWorld Economic Forum events in Singapore, Dalianand elsewhere, have provided broad expertise andinvaluable insight for the writing of the current report.They are an integral part of the Global RiskNetwork’s mandate to originate and supportmultistakeholder dialogues to improve understandingof global risk and to increase the possibilities for riskmitigation.

We would like to thank participants for their time –and above all for their insights:

Dan Alamariu, Analyst, Global Macro, EurasiaGroupLuca Albertini, Managing Director, Swiss ReCapital Management and Advisery, SwissReinsurance CompanyLarry Alberts, Managing Partner, Asia, Director,Oliver Wyman (MMC)Heike Allendorf, Director, Global FinancialInstitutions, CitigroupWilliam Anderson, National Intelligence Officer,Economic and Global Issues, National IntelligenceCouncilKaren Avery, Managing Director, Continuity RiskPractice, Marsh (MMC)Jamie Azhar, Risk Management Associate,Citigroup Ulrich Benterbusch, Director, G8 Summit, GermanFederal Ministry of Economics and TechnologyStein Berre, Managing Director, Oliver Wyman(MMC)Olivia Bosch, Associate Fellow, InternationalSecurity Programme, Chatham HouseStefan Brem, Head of Risk Analysis and ResearchCoordination, German Federal Department ofDefence, Civil Protection and SportHans-Kristian Bryn, Director, Corporate RiskConsulting, Oliver Wyman (MMC)Christopher Bunting, General Secretary,International Risk Governance Council (IRGC)Adrian Butt, Impacts and Adaptation, UKDepartment for Environment, Food and Rural Affairs

Martin Caddick, Business Continuity ManagementPractice Leader, Marsh (MMC)Benjamin H. Cohen, Member of Secretariat,Financial Stability ForumBlake A. Coppotelli, Senior Managing Director,Business Intelligence and Investigations, Kroll (MMC)Patrick M. Cronin, Director of Studies, InternationalInstitute for Strategic Studies (IISS)Frank Diebold, W.P. Carey Professor of Economics,University of PennsylvaniaPatrick Dill, Vice President, Emerging RiskManagement, Swiss ReThomas Epprecht, Director, Risk EngineeringServices, Swiss ReAlex Evans, Senior Research Fellow, Center onInternational Cooperation (CIC)Gareth Evans, President, International Crisis GroupJesse Fahnestock, Climate Policy Team, VattenfallJean Fournier, Managing Director, Innovation,Marsh & McLennan Companies (MMC)Leon Fuerth, Research Professor of InternationalAffairs, George Washington UniversityTina Gabbrielli, Director, US Department ofHomeland SecurityRafael Gil-Tienda, Chairman, Asia, Marsh &McLennan Companies (MMC)Rafael Gomes, Deputy Director, Political Risk,Exclusive AnalysisMarc-Alexandre Graf, Risks Analyst, Federal Officefor Civil ProtectionRobert L. Grenier, Managing Director, Kroll (MMC)Gary Guzy, Global Practice Leader for Climate Riskand Sustainability, Senior Vice-President, Marsh RiskConsulting, Marsh & McLennan Companies (MMC)Beat Habegger, Senior Researcher, Center forSecurity Studies, ETH ZurichRobert Hall, Vice-President, Risk ConsultingPractice, Marsh & McLennan Companies (MMC)Scott Harrington, Health Care Systems andInsurance Risk Management, The Wharton School,University of PennsylvaniaMelissa Hersh, Vice-President, Risk IntelligenceStrategies & Resiliency Solutions, Marsh &McLennan Companies (MMC)Charles Hollis, Managing Director, ConsultingServices Group, Kroll (MMC)John Huff, Managing Director, Claims & LiabilityManagement, Swiss Re

54

John Hurrell, Head of Risk Consulting PracticeEMEA, Marsh & McLennan Companies (MMC)Brian Ivanovic, Senior Vice President, L&HProducts, Swiss ReJason Johnston, Robert G. Fuller Jr Professor ofLaw and Director, Program on Law, the Environmentand the Economy, University of Pennsylvania LawSchoolSteve Kobrin, Professor of MultinationalManagement, The Wharton School, University ofPennsylvaniaGary Lynch, Managing Director, Global Leader -Risk Intelligence Strategies and Resiliency Solutions,Risk Consulting Practice, Marsh & McLennanCompanies (MMC)Thierry Malleret, Partner, Rainbow InsightGregoire Mauchamp, Director, Insurance andPensions Structured Solutions, CitigroupRobert Meyer, Gayfryd Steinberg Professor;Professor of Marketing; Chairperson, MarketingDepartment; Co-Director, Risk Management andDecision Processes Center, The Wharton School,University of PennsylvaniaChristoper Michaelson, Director, Governance,Risk & Compliance, PricewaterhouseCoopersFrederick Morlaye, Senior Vice President,European Capital Market Group, Guy Carpenter &Company (MMC)Herbert Oberhänsli, Head, Economics andInternational Relations, NestléRyan Ogaard, Global Practice Leader - Instrat, GuyCarpenter & Company (MMC)Christian Pedersen, Director, Finance & Risk,Mercer Oliver Wyman (MMC)Jean-François Rischard, Vice-President, Europe,World Bank (1998-2005)Stephen Roberts, Senior Vice-President, RiskConsulting Practice, Marsh & McLennan Companies(MMC)Melinda Roth, Head of the Integrated RiskManagement team, World BankArmen Sarkissian, President and Founder, EurasiaHouse InternationalRoss Schaap, Analyst, Asia, Eurasia GroupPierre-Alain Schieb, Counsellor, Advisory Unit tothe Secretary-General, Organisation for EconomicCo-operation and Development (OECD)

Lynn Slepski, Deputy Director, Office of RiskManagement and Analysis, US Department ofHomeland SecurityRosie Smith, Economist, UK Department forEnvironment, Food and Rural AffairsDavid Steven, Managing Director, River PathAssociatesJohn Stroughair, Managing Director, CorporateRisk, Oliver Wyman (MMC)Rolf Tanner, Head of Socio-Political and RiskResearch, Swiss ReJohn Tesh, National Risk Assessment, UnitedKingdom GovernmentLeo Tomlin, Pakistan Desk, Foreign andCommonwealth Office of the United KingdomMaryam Umar, Risk Management Associate,CitigroupMike Useem, Professor of Management andDirector, Center for Leadership and ChangeManagement, The Wharton School, University ofPennsylvaniaPhilippe Velard, Advisor, Operational Risk -Financial Institutions, Marsh & McLennanCompanies (MMC)Gary G. Venter, Managing Director, Guy CarpenterInc.David G. Victor, Professor of Law and Director,Program on Energy and Sustainable Development,Stanford UniversityMartin Weymann, Vice-President, Emerging RiskManagement, Swiss ReDickie Whitaker, Managing Director, GuyCarpenter & Company (MMC)Nathalie Wlodarczyk, Deputy Director of Analysis,Exclusive AnalysisNgaire Woods, Director, Global EconomicGovernance ProgrammeKeith Woolnough, Vice-President, L&H RiskManagement, Swiss ReJustin Wolfers, Assistant Professor of Businessand Public Policy and Faculty Research Fellow, TheWharton School, University of PennsylvaniaAnn Wyman, Managing Director, Economic andPolitical Strategies, Citigroup

The World Economic Forum is an independentinternational organization committed to improvingthe state of the world by engaging leaders inpartnerships to shape global, regional andindustry agendas.

Incorporated as a foundation in 1971, and basedin Geneva, Switzerland, the World EconomicForum is impartial and not-for-profit; it is tied tono political, partisan or national interests.(www.weforum.org)