Global Agenda: Identifying the risks

Although there is more risk, there are now many financial tools being used to disperse it.

By PINCHAS LANDAU
January 25, 2007 22:38
3 minute read.
Global Agenda: Identifying the risks

global agenda 88. (photo credit: )

Most people would agree that not only is the world a very risky place, it has become considerably more so in recent years. True, the financial markets are currently characterized by extraordinarily low risk premia; almost every indicator of risk is registering readings that are low in both absolute and relative terms. The dissonance between the markets' perception of risk and the degree of risk visible to the untrained and unaided eye has been the subject of intense debate among analysts, but no consensus explanation has emerged. The sophisticated answer is that although there is more risk, there are now a plethora of advanced financial tools that are being used to disperse it, so everyone can be more comfortable. The unsophisticated school, led by such unsophisticated people as Warren Buffett, says that the higher risk is being obfuscated by the sophisticated people and their sophisticated tools, but that these ' "weapons of financial mass destruction" will eventually blow up with disastrous results. Both schools thus agree that the risk is there, but they disagree as to whether it is a problem. The markets, meanwhile, continue on their merry way, fuelled by unprecedented levels of liquidity. But, behind the scenes, the concerns mount. A fascinating example of how the biggest players in the global economy are, however reluctantly, addressing rising risk levels, is "Global Risks 2007," a report produced by the World Economic Forum (WEF), with the participation of Citigroup, Marsh & McLennan, Swiss Re and the Wharton School Risk Center (available via the WEF's site, www.weforum.org). The WEF is, of course, the entity that hosts the annual bash underway this week at the Swiss mountain resort of Davos, where all the big shots from the world's political, economic and business elites get together. The report is one of the pieces of research that the WEF produces annually as background to and preparation for the formal discussions. The first noteworthy point is that there is such a thing as an annual risk report, because it means that the general subject of risk, as well as particular aspects of it, is being given serious and ongoing attention. This more than compensates for any shortcomings in the analysis itself, because if the material is debated and found wanting, it will be overhauled and improved for next time, as part of an ongoing process. The quality of the analysis is anyway a subjective issue. The report identifies 23 subjects it terms "core global risks." Obviously, the number is arbitrary, and the list could as well include 21 or 25. What is much more important is that this year the list was expanded to "include a number of geopolitical risks which, though difficult to measure, specify and predict, were considered integral parts of the risk landscape. The risk of major interstate and civil war - often inadequately priced in markets was one risk considered. Another was the category of failed and failing states as an underlying risk to systemic integrity" (p. 6). This change is critical: of course geo-political risks are "difficult to measure, specify and predict - but the old attitude, wherein what can't be measured doesn't exist, is simply untenable and ludicrous if you want to relate to the real world. The other interesting feature of the analysis is its concept of interaction between the various risk factors. Clearly, the fact that a certain risk exists is important and, insofar as it is quantifiable or assessable, that helps a lot. But there's little point in considering each risk as a discrete factor, because many of them feed into each other so that risk factor A becomes larger, or more likely, if risk B or C has become a reality. Several scenarios laid out in the report illustrate this idea and depict possible transmission mechanisms between risk factors. A simple example is how a natural catastrophe can cause a breakdown of "critical information infrastructure," which in turn increases the chances of a pandemic developing, and/or of countries becoming "failing" or "failed states." None of this makes for pleasant reading. However, ignoring unpleasant subjects in the hope that they will mend themselves or go away is not a valid option - for individual people or countries, let alone for the whole world. The WEF approach, of finding and implementing solutions based on cooperation between countries and regions, is the only practical way to address global risks, but it is predicated on accepting that these risks exist and pose real and present dangers. This high-profile organization's decision to highlight the severity of geopolitical risk is therefore a major step in the right direction. [email protected]


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