The Great Debate

Five overlooked global risks

— Rafael Ramírez is the James Martin Senior Research Fellow in Futures at Oxford University and author of “Business Planning for Turbulent Times: New Methods for Applying Scenarios” edited with John W. Selsky and Kees van der Heijden. Ramírez attended a session at the World Economic Forum’s gathering in Dalian, China, on managing global risks.

Reuters asked Ramírez to elaborate on five overlooked risks the world is confronting as it works its way through the current recession. His response is below. The views expressed are his own.

Risk one: Confusing risk with uncertainty

The first — and perhaps most important risk — is confusing categories of ignorance. This most centrally is about confusing risk with uncertainty. It entails pretending that probability (with data sets of past events with distributions of occurrence which are relevant for the future) is relevant for both “known unknowns” one cannot model with probability as well as unknown unknowns in one’s plausible futures where no data set is available, such as those of unique events.

Unfortunately, while the uncertainty that we became aware of as the financial crisis unfolded did not obey to the characteristics of “risk”, a lot of the policy interventions and “solutions” that were put in place pretended that the risks were known — and thus are well positioned to create new trouble. What we need to do instead is accepting that uncertain ignorance – for which forecasting, probability and risk are irrelevant – is now a common characteristic of our environment, and that we need technologies based on plausibility, like scenario planning. Plausibility is not going to be easy to implant in large organizations with established teams whose livelihood depends upon calculation of probability – but is necessary.

Risk two: Failure to link different types of knowledge

A second under-explored risk is keeping different forms of knowledge disconnected. This is typically manifested as keeping knowledge in the organizations that develop and use knowledge (like universities, corporations, or patent offices) in silos, while also ignoring that different scales create difficulty to translate applicability from small to large contexts and vice-versa. Failure to link different types of knowledge together, and to organize the architectures that enable this, prevents effective action. So the risk is that insufficient conversations linking different forms of knowledge will be made available, and that “solutions” in one context create (bigger) problems in others that have not been consulted.

from The Great Debate (Commentary):

Redefining balance between state and free enterprise

-Ashraf Ghani is Chairman of the Institute for State Effectiveness and co-author with Clare Lockhart of "Fixing Failed States: a Framework for Rebuilding a Fractured World". His opinions are his own. -

The current financial crisis has called into question our trust in globalization as a spontaneously generated order. Such orders, while of human making, are not of human design. The market can be seen as a force capable of generating solutions to the most difficult of economic problems.

We should not forget, however, that the visible hand of the state is necessary to set the appropriate regulatory mechanisms that keep the market functioning according to a set of rules, and to put in place the risk management systems to deal with market failures. The return of the state to the center stage of economic management in the current global economy highlights the shift in values that will guide economic policy for the next decade, or possibly even the rest of the century. All business models operate with assumptions regarding the enabling regulatory environment. With the return of the state to active management of the financial sector in the short-term, and the emerging consensus on a more assertive role by the state in the regulation of the market over the longer-term, business models now require major revisions.

The crisis is global in nature, yet the response mechanisms have been predominantly national in character. The resumption of prosperity is going to require concerted global action, and the most powerful nations will have to agree to give up some of their powers in the national arena in return for collaborative powers within a more predictable global arena. Agreeing on such rules requires a shift in values to highlight the need for cooperative solutions and rule based behavior, rather than unilateral actions based on individual interests. While the state is "back in", the market that it needs to regulate is fundamentally different from the national markets after World War II.

The market operates with speed, while bureaucracies are bound by rules and procedures. We must now arrive at regulatory instruments that can satisfy public demand for accountability while having the speed to keep up with the market. Failure to establish alignment between the pace of the market and government will be extremely dangerous.

Since the time of U.S. President Ronald Reagan and British Prime Minister Margaret Thatcher in the 1980s, the market has been seen to provide both the instruments for assessing risks and the instruments of risk management. Trust in market ratings systems led to underestimation of the risks to which the banking sector was exposed and the massive failure of the market has now made the state, and thereby the public, assume management of risks.

The challenge both to the state and business is going to be in the determination of the balance of risks to be assumed between a revitalized market and an interventionist state. Decisions regarding these options will have immense consequences for they way business models are to be built, operated and endure. Assumption of a more assertive role by the state requires a massive shift in the values of public service as well as the skills, mental models and mechanisms of interaction between the government and the market.

The end of the Davos consensus

J Saft

Jan 30, 2009 07:20 EST

– James Saft is a Reuters columnist. The opinions expressed are his own –

It’s not exactly a wake, but participants at this year’s World Economic Forum have witnessed many of their most cherished beliefs being challenged, upended and sometimes ground in the mud.

Think of it as the “Davos Consensus,” a loose alignment of principles that held sway in this Swiss mountain resort and in large parts of the world over the past decade.

This consensus, which generally favoured the market over the state, “light-touch” regulation of financial services and the free flow of goods and capital across borders, is somewhere between on the defensive and in full, not always organised retreat.

What is a lot less clear is what might replace it.

It’s true that the global economic crisis and the debt bubble that preceded it did not deliver on much of the promises made by defenders of globalisation and market forces. Instead it was one of the biggest misallocation of resources in history; to housing and consumption that either wasn’t needed or really couldn’t be afforded.

Banks wiped out much of their capital base and their regulators failed spectacularly too, missing everything from the dangers of a build up in leverage to the Madoff Ponzi scheme.

Trust: the commodity in shortest supply

Reuters Staff

Jan 28, 2009 11:29 EST

Where do I put my money? What do I read? Who do I listen to? Who saw it coming? Who made money from it? Who will make money from it? Who can I trust?

As Davos gets under way, my feeling from chatting with contacts and listening to conversations around me is that one thing the world economy is really suffering from right now is a crisis in trust.

Institutions failed us. Governments failed us.

Our own intuition failed most of us (George Soros said today that he protected his capital and had a satisfactory return — that’s certainly better than I did!).

Our advisers failed us. The media failed us too.

So before we buy again, or invest again, or behave normally again, people need an answer to the fundamental question — where can I invest my trust.

I think that’s the issue behind all of the discussions here.

Building a three-legged stool

Reuters Staff

Jan 28, 2009 09:44 EST

-  Lawrence Bloom is deputy chairman of Noble Cities and chairman of the World Economic Forum, Global Agenda Council on Urban Management. His views are his own –

The chaos generated by the meltdown of the global economic system provides environmentalists and human rights advocates with utopian opportunities to promote a new economic model, which will not only help sustain life on our planet, but actually increase its quality for many. As world leaders search for creative solutions to restore global equilibrium, the opportunity for recognising the importance of both human and environmental capital has perhaps never been so possible or achievable. Recognising all three types of capital: financial, environmental and human, will help us to build the equivalent of a balanced three-legged stool . Hopefully, this stool will be more stable than the current one-legged model of financial capital. Last week the United Nations Environment Program recommended the business world use the global downturn to press ahead with green technologies that will save firms money and help save the planet. It also recommended using micro-finance loans to help developing countries provide sustainable solutions in such places as Bangladesh where small loans have allowed women entrepreneurs to install solar panels and bring electricity to 100,000 homes. Society has been operating on the belief that if the engines of capitalism are powered to churn constantly, wealth will prevail and all of human society will benefit. But this system has served to create great income disparities by generating incredible wealth and incredible poverty, and has been the main driver in causing catastrophic environmental damage. The unregulated, trickle-down financial policy is necessary to generate positive GDP figures, but traditionally these data do not include the cost of rainforest or biodiversity loss. Thanks to the United Nations Green Economy Initiative, and the work being undertaken by Pavan Sukhdev and his colleagues who are engaged in the Economics of Ecosystems and Biodiversity project, we can now put GDP-like values on these losses. As a result, we are beginning to recognise that the credit crunch in the financial markets is a minnow in comparison to the credit crunch in our environment and biodiversity systems. It appears that we have been “borrowing” $2.5 trillion every year for the last 25 years without any significant compensating payback. Over time, we may acquire the wisdom to realise that what traditional economics considers “externalities”, as if they were irrelevant, are closer to our survival needs than the creation of economic wealth. The 90 pence we pay for a litre of petrol is divided between government tax and profit for the oil company, but who picks up the tab for the damage that is done by burning the fuel in the atmosphere? We privatise profit and we socialise loss. We need to start valuing people first, and then we will collectively begin to operate on the principle that the environment is not just another word for commodity market, but that it supports life. Valuing human capital means acknowledging that each person on this planet is entitled to fresh water, nutritious food, proper shelter, healthcare, education, justice and access to capital. This way we can release the creative potential of all of humanity. Only when we are clear on these values can we create a financial system that serves it. The current financial credit drivers are akin to the booster rockets on a space craft. In the same way as the boosters blast the craft free of the Earth’s atmosphere and gravitational pull, so the current financial system has created wealth, education and freedom for 1.5 billion people. But for many – the remaining 4.5 billion – the cost has been very great and to our ecosystems it has been disastrous. The skill in a space shot is knowing when to blow the explosive bolts, releasing the boosters and continuing the mission with the second stage only. Our skill will be in jettisoning our current economic model and designing a new and more inclusive “second stage”. What we should be talking about now at a strategic level is urgently restructuring our monetary system into a non-debt, or minimal-based debt structure using Sharia-type finance and complementary currencies with government spending money directly into circulation. In whichever way we choose as a society to tackle the global financial crisis, we must create a system that protects and nurtures all of humanity and the environment before it is too late. An inspirational quote attributed to a North American First Nations Chief Seattle states: “We are all connected like the blood that unites one family. Whatever befalls the Earth befalls the sons of the Earth. Man did not create the web of life, but he is part of it, whatever he does to the web, he does to himself.” These words written more than one hundred years ago speak directly to us today. Will we have the intelligence to listen?

From financial crisis to sustainable global economy

- Jonathan Lash is president of the World Resources Institute. The views expressed are his own -

Much of the world’s attention is fixed on the brutal effects of the global financial crisis. But sooner or later – sooner we hope – the global economy will rebound. Markets will recover, and stocks will rise. Nature, on the other hand, does not do bailouts. The effects of today’s greenhouse gas emissions – like those of yesterday and tomorrow – will be permanent, at least in the timescales that we care about.

They are what will shape the lives and markets of tomorrow.

My view of sustainability is very simple: what can’t be sustained won’t be. It was impossible for real estate values to continue to rise much faster than economic growth. It had to end sometime . . . and it did. When the bubble burst, the consequences were severe.

The same lesson applies to the ecological sphere. We simply cannot continue changing the chemistry of the atmosphere, through rising greenhouse gas emissions, without inviting enormous consequences. We cannot continue to increase human use of fresh water at twice the rate of population growth. Not only are there are limits on available supplies, but in many places these are reduced by climate change and pollution. Nor can we continue to create coastal dead zones, in areas where hundreds of millions of people depend on fisheries, by releasing ever more nitrogen into the surface waters of the Earth.

Since these behaviours can’t be sustained, they won’t be. The key question is whether we choose a managed transition to sustainability, or wait until the bubble bursts. That choice will have a profound effect on tomorrow’s markets.

So what is the solution, the way forward?

Less social dialogue and more social change

Reuters Staff

Jan 28, 2009 09:34 EST

- Andy Stern is the president of the Service Employees International Union. His views are his own -

We are living through the third economic revolution. The first was the agricultural revolution, and it took nearly 3,000 years. The second was the industrial revolution, which took about 300 years. This revolution is going to take 30 years. As we move from an industrial economy based in factories to a knowledge and finance economy that lives on the Internet, no generation of people has ever witnessed so much change in a single lifetime.

And this revolution is televised, it’s Googlized, it’s digitized, it’s in your face, on your screen, 24/7. It is relentless and it’s unending and it’s far from over.

The problem is this revolution is not working for the vast majority of the world’s citizens.

Despite the exponential increases in productivity and profits that have resulted from the globalization of our markets and economies, nearly half the world’s population lives on less than $2.50 per day. The richest 20 percent of the world’s people earn 86 percent of the income, consume 80 percent of the resources, and create 83 percent of the waste.

This is an unsustainable model, and we are seeing the cracks in the system each day.

It is a humbling and mind-opening moment for those whose wholesale embrace of a privatizing, deregulating, free-market-worshiping ideology has put us on the fast track to global financial collapse. Financial manipulation, greed and deregulation have led to economic havoc.

A stimulating energy policy

- Robert Engle is the Michael Armellino Professor of Finance at New York University Stern School of Business and a Nobel Laureate. His views are his own. -

We have faced energy crises before. The last energy crisis was about running out of oil. This one is about the fear that we might not. The future health of our planet is jeopardized by the greenhouse gases emitted by our industrial society. But can we afford an expensive energy policy in this time of economic distress?

The simplest and best solution to reducing emissions is thought by most economists to be a comprehensive tax on the emission of greenhouse gases. Only in this way will individuals and businesses that avoid the tax be doing what is socially desirable. Only in this way will it become profitable to find substitute energy sources; no longer would it be necessary to subsidize alternatives. The price of oil will rise naturally when we begin to run out, but in this proposal, the price would rise before we reach the bitter end. It is only a matter of timing.

However, a tax is generally considered politically impossible and in this time of deepening recession, it is especially unpalatable. But what about the money – what happens to the money that is raised by this tax? This revenue could be divided evenly among all U.S. residents and sent out in a periodic cheque. This check could even be sent before the tax revenue was received. A substantial emission tax would generate a substantial check. This could be used for anything but might well be used to buy a more fuel efficient car, insulate a house, move closer to work or otherwise reduce the impact of the impending tax.

Because this tax would be returned to consumers, it would stimulate the economy. The sectors that might expect benefits would be automobiles, construction and real estate. These all can use good news. Because of the per capita redistribution, this would be particularly beneficial to low income groups who would pay less than an equal share of the taxes. Because the tax would reduce our consumption of oil, we would be sending fewer petrodollars abroad and instead returning it to Americans.

We already know that high oil prices induced dramatic changes in our economic behavior which had clear benefits for reduced emissions. Driving miles fell, sales of SUVs fell and the only growth areas of automobile sales were in small cars. Housing prices fell more in the distant suburbs than in the central cities, and public transportation rider ship increased. But these gains are now being reversed as the price of oil has dropped dramatically.

Global crisis politics – A Davos debate with Nouriel Roubini and Ian Bremmer

Andrew MacGregor Marshall

Jan 28, 2009 08:35 EST

As governments grapple with the global crisis, politics has taken on central importance in determining the course of the world economy — and political risk is more significant than ever.

Two leading experts on the financial crisis and its political dimensions — Nouriel Roubini and Ian Bremmer — gave exclusive answers this week to Reuters questions on the key risks for 2009 and beyond, and the countries to watch.

Roubini is professor at the Stern School, New York University and chairman of economic forecasting consultancy RGE Monitor. He is widely credited as one of the few leading economists to forecast the onset of the crisis and its implications. Bremmer is president of political risk consultancy Eurasia group, and co-author of the forthcoming book “”The Fat Tail: The Power of Political Knowledge for Strategic Investing”

In which countries do political and economic risks intersect most ominously in 2009?

Bremmer – I would start with the United States. How U.S. policymakers respond to the meltdown of the U.S. economy hugely affects both the global financial crisis itself and much of the associated political risk. The politics are especially worrisome because the new Congress will likely wrestle with the White House for control in several key policy areas.

In Congress, members of both political parties have complained that the legislative branch ceded too much policy authority to the executive branch over the past eight years. The new Congress wants that power back. The Democratic leadership now enjoys large majorities in both the House (257-178) and the Senate (probably 59-41). Feeling empowered, even Democratic senior lawmakers won’t always wait on the inexperienced young president to set the agenda. That dynamic creates even greater risks than usual that policy will become a product of political horse-trading rather than coherent economic analysis.

Elsewhere, the economic and the political fronts are colliding to generate turmoil and risk. In Russia, the financial crisis has slowed the economy and put downward pressure on the ruble, reducing the purchasing power of ordinary Russians. The government has had to spend down significant amounts of its considerable financial reserves. There is anxiety about the health of Russian banks. Prime Minister Putin and President Medvedev remain popular and fully in charge — for now.

Turning the tables: Can you help Davos leaders?

Reuters Staff

Jan 27, 2009 13:46 EST

Davos is a well-rehearsed event and everyone knows the part they should play. Business and political leaders gather each year to tackle the major challenges of a global economy while the rest of the world, or those of its citizens who are interested, look on from afar. But this year, for obvious reasons, things are different. The notion of leadership has been coupled in the public mind with that of responsibility. The tone here is a little more humble and the attitude more open-minded. There’s a recognition that new thinking is required.  A suitable time, perhaps, to turn the tables on convention and have Davos delegates ask the questions they can’t answer and for global citizens to offer solutions.

Gamefully opening the discourse is Professor Klaus Schwab, Founder and President of the World Economic Forum.

If you’ve got suggestions for Klaus then use the comments section below.