Global risks: interconnections and interlinkages

Analysis Materials 19 February 2010 12:12 (UTC +04:00)

When a series of devastating earthquakes occurred in Haiti in January, the world has once again been convinced that the interconnection of countries and their economies, the impact of different events on each other have increased so much that it is impossible to be a bystander, not to feel any effect. Without trying to look for some complicated arguments in favor of this situation, it would be enough simply to understand that those billions of dollars that the countries provided to remove Haiti from shock and restore normal functioning of the country, they could use for their own purposes, starting any new project or increasing spending on scientific research or education. The same parallel on the interconnection and the impact can be made with regards to global risks facing the world.

In the World Economic Forum (WEF) Global Risks 2010 report, the authors say that the risks have changed little over the past five years, but the understanding that they are closely inter-connected and in different way affect the whole world has radically changed. Therefore, the governments and private businesses, including Azerbaijan, taking into account and analyzing the possible impact of these risks on the situation in their countries and regions, could make corrections to the various decisions and plans.

The authors of the report write that Three themes provide the backdrop for discussion in

this report. As the first chapter discusses, the increase in interconnections among risks means a higher level of systemic risk than ever before. Thus, there is a greater need for an integrated and more systemic approach to risk management and response by the public and private sectors alike. Second, while sudden shocks can have a huge impact, be they serious

geopolitical incidents, terrorist attacks or natural catastrophes, the biggest risks facing the world today may be from slow failures or creeping risks.

Because these failures and risks emerge over a long period of time, their potentially enormous impact and long-term implications can be vastly underestimated. These are risks linked to big shifts that are recognized and which will roll out over many years, even decades. For example, global population growth, ageing and the ensuing rise in consumption have implications for resources, climate change, health and fiscal policy. The

emergence of multiple poles of economic and geopolitical influence is another shift. Finally, the third theme picks up the discussion of global governance gaps from last year's report. In light of ongoing short-term pressures on governments, business and individuals, can the necessary reform of global governance be achieved across the range of issues where it is required? Improved coordination on macro-prudential supervision, effective climate and energy policies, and new mechanisms to protect resources and security are all key to reducing vulnerability and risk. The next years will test the political will, vision and willingness of governments, business and individuals alike to make tough choices and manage the challenges ahead.

The risks are grouped in five risk classes: economic, environmental, health, geopolitical and technological risks.

Fiscal crises: In response to the financial crisis, many countries are at risk of overextending unsustainable levels of debt, which, in turn, will exert strong upwards pressures on real interest rates. In the final instance, unsustainable debt levels could lead to full-fledged sovereign debt crises. According to an IMF baseline scenario, government debt-to-GDP ratios for the G20 countries will increase from 63% in 2007 to 85% by 2014. In advanced G20 countries, the increase will be even more pronounced, from 78% to 114% The marked deterioration is likely to exert strong upward pressure on real interest rates; according to IMF estimates, an aggregate deterioration in the global debt-to-GDP ratio of 10 percentage points may raise global interest rates by 40 basis points In highly indebted economies,  spreads on government bonds may rise significantly, exacerbating the risk of sovereign debt crises. Intergenerational accounting makes it clear that a business as usual approach to fiscal policy is unsustainable. Advanced economies in particular must face the difficult task of reforming their social security systems. Many current models for health, pensions, education and unemployment protection were designed to meet the needs of populations in growing economies with comparatively short life expectancies. This has changed dramatically. Today, people live longer, and the share of retired people that will have to be supported by the working population in pay-asyou-go social security schemes keeps increasing, placing huge strains on the costs and efficacy of social systems.

Underinvestment in infrastructure: Infrastructure investment choices are key at any time but they are particularly critical, if the dual challenge of population growth and climate change is to be met, in five areas: agriculture, energy, water, transportation and climate change adaptation. The Global Risks Expert Perception Survey 2010 data shows underinvestment in infrastructure as one of the most highly interconnected risks on the RIM. The strongest links are to fiscal crises, oil prices and natural catastrophes, but it also links to health issues, including infectious diseases as well as chronic diseases, and to food price volatility. In the US alone, the American Society of Civil Engineers rated US critical infrastructure as a "D" (where "A" is the highest grade) in 2009 and estimated that US$ 2.2 trillion was necessary over the next five years. The US spends approximately 2.4% of GDP per annum on infrastructure, compared with approximately 15% of GDP on health.

Chronic diseases: The cost of treating chronic diseases has risen globally, as have associated rates of morbidity and mortality, driven by demographic changes and dietary shifts, causing some to call it a "silent" pandemic.

Asset price collapse: The last edition of this report discussed the longer term implications of the financial crisis, exploring the tight interconnections among economic and resourcerelated risks. The fact that the risk of an asset price collapse remains the strongest risk on the landscape on the severity and likelihood axes illustrates the continuing uncertainty about the resilience of the global economy and the effectiveness of fiscal and monetary responses, governance and regulation. Concerns abound about the decline in the dollar and low interest rates fuelling another bubble, this time liquidity rather than debt-driven. Experts are also worried about a lag in the impact of the recession in a number of areas. The level of corporate bankruptcies, particularly among small and medium size enterprises remains high. Credit card default rates, which are highly correlated with unemployment, are already at historic levels. The current unemployment rate of more than 10% in the US is considerably higher than the 6.5% unemployment rate that most credit card lending models assume. Finally, though residential house prices have fallen considerably in those markets considered to have been the most overheated, concerns persist about commercial real estate. As illustrated by the events in Dubai in December 2009, debt loads remain high; as refinancing needs arise, which are only expected to peak between 2011 and 2013, further shocks could emerge.