Future risk - Chartered Insurance Institute€¦ · 3 Future risk: Social and economic challenges for tomorrow foreword Foreword This year the Chartered Insurance Institute celebrates

A CENTURY OF PROFESSIONALISM

Future risk Social and economic challenges for tomorrowCentenary Future Risk Series: Report 2

2 Future risk: Social and economic challenges for tomorrow

contentsContents

3 Foreword

4 1. Introduction

4 Aboutthisreport

5 2. Executive summary

6 3. Past trends and possible futures

6 Theglobaleconomy

9 Patternsofconflict

10 4. Future socioeconomic risks: what the experts say

10 Living with a shift in global economic powerDavidSmith,EconomicsEditor,TheSundayTimes

15 Global longevity trends and their potential economic and social implications GeorgeMagnus,SeniorEconomicAdviser,UBS

20 The Long-term economic outlook for the US and its international implicationsDrUriDadush,Director,CarnegieEndowmentforInternationalPeace

26 Is the Renminbi the new Dollar? Chinese monetary policy and the global reserve currency systemAndrewLeung,IndependentConsultantandChinaSpecialist

33 The shifting balance between “risk” and “uncertainty” in a globalised world systemLaurenceWhitehead,adviseronmacroriskatOxfordAnalytica

40 5. The three scenarios

41Upside:dynamicAsiaandareboundingwest

42Cental:westernstagflation

43Downside:1930sstyledepression

45 6. The importance of insurance

48 7. Conclusion


foreword

ForewordThisyeartheCharteredInsuranceInstitutecelebratesitscentenaryyearasacharteredprofessional

body.Tomarkthisachievement,wearepublishingaseriesofreports,eachofwhichexploressomeof

therisksandopportunitiesthatmightfaceusinthedecadestocome,drawingontheassessmentof

commentatorsacrossvariousfieldsofexpertise.

Whilst‘futuregazing’doesn’talwaysleadtoaccuratepredictions,itisanimportantexerciseforthe

insuranceindustrytoundertakeasunderstandingandassessingpotentialrisksisattheheartofwhat

wedo.Indeed,centraltotheroleofinsuranceistheabilitytomakeinformed,professionaljudgments

abouttherelativerisksofvarioushazardsoccurringoveraparticularperiodoftime.Byplanningforthe

long-termandchallengingassumptionsaboutwhatthefuturemightlooklike,theprofessionwillbe

wellplacedtoprovideexpertiseandinsightontherisksthatlieahead.

Thisreportisthesecondinourcentenaryseriesandfocusesonpossiblesocioeconomicfutures.

Withinthereport,fiveleadingexpertsprovidetheirviewsaboutfuturerisksinthisarea.Usingthe

expertanalysis,thereportseekstooutlinethreepossiblesocioeconomicscenariosandtheirpotential

implicationsfortheinsurancesector.

Stuart Reid

Chair,CIIInsuranceBrokingFaculty


1. introduction1. Introduction Theworldfacesavastarrayofglobaleconomicandpoliticalchallenges.Thefinancialcrisisand

eurozonesovereigndebtproblems,aswellasthepoliticalparalysisovertheUSdebtceiling,suggest

weareonthevergeofaseismicchangeinthenatureoftheglobaleconomyandinternationalrelations.

Similarly,continuingincreasesinpopulationsizeandlifeexpectancy,andchangesinpatternsof

migrationthrowuptheirownvastarrayofpoliticalheadachesandeconomictrade-offswhichneed

carefulmanagementandstrongcollaborativeleadership.Eachpresentstheirownsetofopportunities

andthreats,someofwhicharefamiliarandsomeofwhicharenot.

Crucially,theinsuranceandfinancialservicesindustrymustbeonestepaheadinordertoprovide

comprehensiveinsightintothechangingnatureofthesechallenges,andtorecommendcredible

coursesofactioninthefaceofthem.Withthisinmindandtocoincidewithourcentenaryyear,overthe

courseof2012wearepublishingaseriesofreportswhichreflectonthegreatchallengesofthepast

andexplorewhatthefuturemighthold.

About this report InearlyFebruarywepublishedthefirstinthecentenaryseries–Future Risk: Learning from history.It

setthescenefortheCIIFutureRiskseriesbyreflectingonsomeofthemostdynamictrendsofthepast

andtheirpotentialimplicationsaswellasdiscussingsomeinitialfindingsfromaglobalsurveyintothe

riskperceptionsofmembersofthepublicfromacrosstheglobe.

Acentralpointmadebythereportwasthatinsucharapidlychanginginternationalenvironment,it

isvitallyimportanttoquestionunderlyingassumptionsabouttheworldaroundusandre-evaluate

prevailingwisdom.Wequalifiedthisstatementbynotingthatwhilstahealthylevelofscepticismabout

prevailingwisdomandfutureforecastingisagoodthing,itshouldnotpreventusfromdeveloping

somescenariosonthelong-termtohelpusprepareforsomeoftheopportunitiesandrisksthatlie

ahead.Rather,itshouldensurethatwedonotbecomeoverlyconfidentanddependentuponanysingle

story.Inthiscontext,thesecondinourseriesofreportslooksatsomepossiblesocioeconomicfutures

andtheirimplicationsfortheinsurancesectorandsocietyasawhole.Cruciallyitalsoseekstoidentify

whatroletheindustrycanplayindeliveringamoreprosperousworld.


2. executive summ

ary2. Executive summaryThereportbeginsbypresentinganumberofspecially commissioned essaysonfuturesocioeconomic

risksfromleadingexpertsinthefield.Theauthorsandtheirtopicsinclude:

• David SmithoftheSundayTimesconsidershowtheUKcanmaintainacomparativeadvantageina

shiftingglobaleconomicorder.

• George MagnusofUBSfocusesontheeconomicimplicationsofgloballongevitytrendsatatimeof

continuingeconomicstrife.

• Dr Uri DadushoftheCarnegieEndowmentforInternationalPeacediscussesthelong-termeconomic

outlookfortheUSanditsinternationalimplications.

• Andrew Leung,IndependentConsultantandChinaSpecialistlooksatthefuturedirectionofChinese

monetarypolicyandthepossibilityofcontinuingexchangerateinterventions.

• Laurence WhiteheadofOxfordAnalyticaconsidershowtocopewithuncertaintyinanincreasingly

globalisedandriskaverseworld.

Takentogethertheseessaysrepresentcompellinglyarguedvisionsofthefuturewhichcanprovidethe

basisfortheconstructionofthreeillustrativescenarios–allofwhichhaveimportantimplications for the

insurance sector.

Inourupside scenariotheworldischaracterisedbyaresurgentWestandathrivingEastwhere

countriesactcollaborativelyinordertosolvesomeoftheworld’sbiggestsocioeconomicproblems.

Inthisenvironment,Westerninsurersarelikelytoremainhighlycompetitivethoughtherewillbe

increasingpressurefromAsianproviders.

Inourcentral scenariotheworldischaracterisedbyrobustAsiangrowthsetagainstWestern

stagflation.AstheUSretreatsfromitspositionasglobalhegemon,countriesincreasinglyactasisolated

regionalblocksinordertosolveglobalsocioeconomicproblems.Inthisenvironment,theinsurersmost

likelytoprosperwillbetheonesthatareabletotapintoemergingmarketsthoughtheymayfacea

toughandrelativelyineffectiveglobalregulatoryenvironment.

Inthedownside scenariotheWestisplungedintoa1930sstyledepressionfollowinganuglyeurozone

implosionandafailuretorebalancetheglobaleconomy.Severecurrencywarsand‘beggarthyneighbour’

economicpoliciesreturntoprovidethesubtextforheightenedgeopoliticaltensionandcivilunrest.

Crucially,theinsurancesectorcanplayakeyroleindeterminingwhichfutureitfaces.Historically the

sector has helped drive economic growth, ensure sustainable public finances and mitigate political

risks in emerging markets.Tomaximiseitseffectivenessintheyearsahead,thesectormustcontinueto

dothethingsithasdonewellinthepast,evenbetterinthefuture.

Being part of a professionwillbeimportantinthisregard.Inthenewworld,likelytoberifewith

uncertaintiesandcomplex,interlinkedrisks,acommitmenttohighlevelsofcompetenceandethical

practicewillbevital–notjustforprovidingappropriateadviceandadequatelyunderwritingrisks–but

also,andperhapsmostimportantly,formaintainingthetrustandconfidenceoftheconsumersand

societiesitwillserve.


3. Past trends and possible futuresOuranalysisofsocioeconomictrendsfromthefirstreportwithinourcentenaryseriesidentifieda

numberofkeylessonsfromthepastwithpotentialimplicationsforfuturerisksrelatedtotheglobal

economy,internationalconflictandpolitics.1Inthisopeningsection,webrieflyrevisitsomeofthese

lessonswhilstoutliningthekindsofinsightsthatourexpertauthorsprovide.Thisanalysisandthe

essaysthatfollow,actasthebuildingblocksforsomesimplesocioeconomicscenariossetoutlater

inthisreport.

The global economy Onekeyconclusiondrawnfromourfirstreportwasthat,whilstincreasingratesofgrowthandeconomic

integrationmaybefamiliar,theyarebynomeanstheonlyimportanteconomicnarrativesfromrecent

history.Prosperityhasoftenebbedandflowed,permeatedbysomeofthegreatpoliticalandsocial

eventsofourtime.Indeedwearguedthatwhilst‘beggarthyneighbour’economicpoliciesaregenerally

thoughttobearelicofthepre-WWIIera,akeyriskisthattheycouldreturn,particularlyattimesof

significanteconomicandpoliticalstress.

Figure 1. Levels of integration: Merchandise exports as proportion of GDP

Western Europe Latin America Africa

Western Offshoots Asia World

Eastern Europe & former USSR

0

5

10

15

20

25

30

35

40

1870 1913 1950 1973 1998

% o

f GD

P

Source:OECD(2006),The World Economy: A Millennial Perspective

ThepossibilityofareturntoprotectionisteconomicpoliciesisconsideredbyDr Uri Dadush, Senior

Associate and Director at the Carnegie Endowment for International Peace.DrDadush’sessayoutlines

twofuturescenariosfortheUSeconomyandtheirpotentialglobalimplications.Inthebadscenario,

progressontradereform,financialandmonetarysystemreform,andglobalgovernancegrindstoahalt

followingUSwithdrawalfromtheworldstageafteraprolongedrecession.Eveninthegoodscenario,

USpowerissubstantiallydiminishedthoughitisstillabletohelpleadinternationaleffortsontrade,

governanceandclimatechange.

1 Foranindepthanalysisofpastsocioeconomictrendspleasereadourfirstcentenaryreport,Future Risk: Learning from history, Centenaryfutureriskseries:report1(Feb2012)

3. past trends and possible futures


InDadush’sview,policymakersinWashingtonandBrusselsmusttakerobustactionnowinorder

toavoidtheworstcase.However,evenifthedownsidescenarioisavoided,andlevelsofeconomic

integrationincrease,thisstillmaynotensuregrowthandprosperity.Ashighlightedinourlastreport,

therecentfinancialcrisisshowedthatanimportantriskassociatedwithhighlevelsofintegration

isthatitactuallyincreasesthechancesandseverityofcriseswhichcouldinturnreducelong-term

prospectsforgrowth.Similarly,therecentfinancialcrisisaswellastheAsiancrisisofthemidtolate

1990s,highlightthepossibilitythattherisksassociatedwithdeeplyintegratedandcomplicatedglobal

economicsystemsmaybeimpossibletoadequatelymanageorunderstand.

Laurence Whitehead, Adviser on macro risk at Oxford Analytica and Official Fellow in Politics at

Nuffield College, Oxford,describesthecurrentretreatfrommeasuringriskintheprevailingfinancial

environment.Hemakestheobservationthattheacutefinancialuncertaintiesofthe1930sthatwere

relegatedtothemarginsofriskanalysisbefore2008,havereturnedintheeurozoneandpotentially

morewidely.Tosupporthisargument,WhiteheadprovidestheexamplesofItaly–aleadingcapitalist

countrywhichmayultimatelyproveunabletopaybackitsdebts,andthedollar,whichuntilthefinancial

crisiswasconsideredavirtuallyriskfreecurrency.Inresponsetosuchuncertaintieswhichthreaten

tocauseparalysisindecisionmaking,Whiteheadrecommendsgoingbacktobasicriskmanagement

principlesandensuringstrongmechanismsfortransparencyandpublicaccountability.Withoutsuch

mechanisms,publictrustinkeydecisionmakersandinstitutionscouldbeunderminedwhenmistakes

aremade.

George Magnus, Senior Economic Adviser at UBS Bank,isalsoconcernedwiththechallengesposedby

thefinancialandsovereigndebtcrises.Hisessay,however,ismorefocusedontherisksposedbythe

combinedeffectofincreasinginternationallongevityagainstthebackdropofmacroeconomicturmoil.In

thiscontext,Magnusnotestheworryingwayinwhichincreasinglifeexpectancyis‘colluding’withthe

crisisovereconomicgrowthtocreateseriousshortcomingsintheadequacyofretirementincomes,and

howgrowingfiscaldeficitsmakesolvingthechallengeofagerelatedspendingevenmorepertinent.In

response,Magnusoutlinessomeactionsthatfinancialservicesandgovernmentsmighttaketominimise

theriskofpoorreturnsinoldageandrisingpublicspending.

AshighlightedbybothWhitehead’sandMagnus’sessays,thesustainabilityofWesterneconomieshas

recentlycomeintoquestion,asdebt(bothprivateandpublic)asaproportionofGDPhassubstantially

risenacrossEuropeandNorthAmerica.IncontrasttotheWest’sindebtednessandpersistentcurrent

accountdeficits,anumberofmiddleincomedevelopingcountries2likeChina,continuetorunlarge

currentaccountsurpluseswhilstexperiencingbreakneckeconomicgrowth.Asaresultofthese

contrastingtrends,manyagreethattheglobaleconomyhasbeen,andindeedremains,dangerously

unbalanced,withaconsumerdrivenindebtedWestontheonehand,andanoverlyexportintensivehigh

savingsEastontheother.SomefearthiswillresultinalastingdeclineincompetitivenessfortheWest.

2 IntermsofGrossNationalIncomepercapita



Figure 2. Map of current account balances

2748-7336 -500 0 500

Source:IMFWorld Economic Outlook Database2009.

Graphicalrepresentationavailablefrom:http://en.wikipedia.org/wiki/File:Cumulative_Current_Account_Balance.png

TheshiftingglobaleconomicorderisthefocusofanessayfromDavid Smith – Economics Editor,

Sunday Times.HisessaydiscussestheimplicationsfortheUKofunprecedentedeconomicgrowth

acrossthedevelopingworldandarguesthatthefuturedoesnothavetobebleak–pointingtothe

absoluteimprovementinUKlivingstandardssincetheriseofAmericainthe20thCenturywhichusurped

theUKastheworld’sdominanteconomicforce.However,crucialtomaintainingUKcompetitiveness,

arguesSmith,isforittoreconfiguretradewiththeEast–whichheadmitsisabigchallenge.In

response,SmithhighlightsanumberofkeyindustriesthattheUKcouldbuildasubstantialcomparative

advantagein,includingadvancedmanufacturing,pharmaceuticals,aerospaceandfinancialservices.

ThecontinuedriseofAsiaisnot,however,aninevitability.China,forexample,whichDadushpredicts

willovertaketheUSeconomyinthenextdecade,currentlyfacesaneconomicpredicamentofitsown:

“...fast growth has fired up the country’s economic engines, but it has also led to stubbornly high

inflation, which threatens to overheat the economy and undermine the long-running boom”.Thekey

concernisthat;“soaring asset prices could eventually tumble, leading to a wave of non-performing

loans at the big state owned banks”derailinggrowth.3TheimplicationsofChina,theworld’sleading

creditor,facingitsownfinancialcrisiswouldbedisastrous–somuchso,thatitisthetopglobalrisk

identifiedbyOxfordAnalytica.4

Inthiscontext,Andrew Leung, International and Independent China Specialist,focusesonmonetary

policyinChinaanditspotentialimplications.HearguesthatanydrasticappreciationoftheRenminbi

(RMB)islikelytocausecatastrophicjoblossesandsocialinstabilityinthecountry.Asaconsequence,

LeungarguesthatChinamustretainanindependentRMBexchangerate,allowingforonlygradualand

measuredappreciation.HealsoarguesthatChinashouldretaintheprotectionofanon-convertible

capitalaccountgivenAsia’spastexperiencewithcapitalflight.Leungdoes,however,thinkthatChinais

readytoliberaliseitsfinancialservicessector.

3 DavidBarboza(April2011),Fast Growth and Inflation Threaten to Overheat Chinese Economy,articleintheNewYorkTimes

4 OxfordAnalytica(Jan2012),Global Risk Monitorhttp://www.oxan.com/Analysis/GlobalRiskMonitor/#risk1(lastaccessed,28Feb2012)



Patterns of conflict Alongsideconsideringglobaleconomictrends,ourfirstreportintheseriesalsolookedatinternational

relationsandpatternsofconflict.Inparticular,itnotedthatsincethe1960s,instancesofconflict

between stateshavebeenrarewithcivilwarandactsofterrorism,thekeysecuritythreatsnowfacing

manynationsacrosstheworldtoday.Thereasonsforadeclineinthefrequencyofsocalledinterstate

conflict,is,however,relativelyunclearandmuchdebated.Theconceptofnucleardeterrenceishighly

controversial,whilstthesocalleddemocraticpeaceisonlyrelevantforexplainingthelackofconflict

betweensetsofdemocraticnations.Weconcludedthattheriskofinterstateconflict,particularly

betweendemocraticandnon-democraticcountries,istherefore,veryreal,particularlyatatimeof

seriousmacroeconomicinstability.

Figure 3. Conflict by type 1945–2000

0

10

1946

1948

1950

1952

1954

1956

1958

1960

1962

1964

1966

1968

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

20

30

40

50

60

Internationalised internalInternalInterstateExtrastate

Source:Gleditschetal(2002) Armed Conflict 1946–2001: A New Dataset,JournalofPeaceResearch,Vol39,No.5pp.615-637

Inthisregard,Laurence Whitehead’sessaynotesthattherearesubstantialuncertaingeopolitical

implicationsofthe‘riseofChina’,theresettingofUS-Russianrelations,andthepotentiallydisorderly

weakeningoftheEuropeanUnion.However,forWhitehead,thegreatestsourceofgeopolitical

uncertaintyliesintheMiddleEast,whereturbulenceconcerningcountriessuchasIsrael,Iran,Egypt

andSyria,preventsthepossibilityofreliablelong-termplanning.Inresponsetothisissue,Whitehead

recommendsscalingbackrelianceonpredictivemodelsandembracingqualitativeevidence,interpretive

theorisingandwell-honedjudgement.

Dr DadushalsoconsidersgeopoliticalrisksstemmingfromasubstantialdemiseinUSpower.Heargues

thatshouldtheUSretreatasaglobalplayer,alargepowervacuumwouldmaterialisewhichwouldin

turnleadtoaweakenedinternationalcommunity.Asaresult,vitalaideffortstothepoorestpartsofthe

developingworldwoulddramaticallyfallincreasingthechancesofgrievanceandperipheralconflict.

Inshortthen,ourexpertauthorsidentifyanumberofsignificantandinterrelatedsocioeconomicrisks,

whichcouldhavesubstantialimplicationsforlong-termpeaceandprosperity.Crucially,anumberof

theexpertauthorsarguethateffectiveactionmustnotbedeferred–whatpolicymakersandbusiness

leadersdonowwillhaveimportantimplicationsforourlong-termfuture.Inlaterchapterswewilluse

thisexpertanalysistoformthebasisforsomesocioeconomicscenarios.



4. Future socioeconomic risks: what the experts say

Living with a shift in global economic powerDavid Smith, Economics Editor, The Sunday Times

Inaperiodofeconomicuncertainty,itiseasytolosesightofthebigpicture.Thebigpictureatthe

moment,ifweliftourheadsabovetheuncertaintyoftheglobalfinancialcrisisandeventsinthe

eurozone,isaprofoundshiftintheaxisofworldeconomicpower.

In2001JimO’Neill,aneconomistwithGoldmanSachs,ensuredimmortalitybycomingupwiththe

acronymBRICs,forBrazil,Russia,IndiaandChina.Backedupwithsomelong-termprojectionsof

wheretheseeconomieswereheading,andthelikelysupplantingoftheWestasthedriveroftheworld

economybytheBRICsandotheremergingcountries,O’Neillandhiscolleaguesputdownamarkerfor

thefuture.

Giventhevagariesofeconomicforecasting,andchangesineconomicfashion,manysuchmarkershave

beenputdownovertheyears.Mostofthemarequicklyforgottenwhentheyprovetobeinaccurate.

But,morethanadecadeon,theBRICshavestuckand,indeed,havebeenjoinedbyothergroupings,

includingtheCivets(Colombia,Indonesia,Vietnam,Egypt,TurkeyandSouthAfrica),the“7percent

club”(economiesthathaveconsistentlyachievedgrowthratesatorabovethatrate)andtheNext11

(Bangladesh,Egypt,Indonesia,Iran,Mexico,Nigeria,Pakistan,Philippines,SouthKorea,

TurkeyandVietnam).

What was a pioneering idea just over a decade ago is now commonplace. Emerging economies are driving the global economy.

Whatallthesegroupingshaveincommon–andthereissomeoverlap–isthattheyreflecttheriseof

emergingeconomies.Whatwasapioneeringideajustoveradecadeagoisnowcommonplace.Emerging

economiesaredrivingtheglobaleconomy.

TheInternationalMonetaryFund’snumberscaptureitwell.In2009,theworstyearfortheglobal

economysincetheSecondWorldWar,advancedeconomiesshrankby3.7percent,averysevere

recession,whiletheemergingworldgrewby2.8percent.WhileAmericasuffereda3.5percentfallin

grossdomesticproduct,andtheEuropeanUnionshrankby4.2percent,Chinaachieved9.2percent

growthandIndia6.8percent.

In2010,ayearofrecovery,advancedcountriesbouncedback,growingby3.1percentbuttheemerging

worldsawa7.1percentboost.In2011,accordingtotheIMF’sestimates,thecontrastgrew,advanced

economiesgrowingbyjust1.6percent,comparedwith6.4percentemerging-economygrowth,a

pictureitexpectstopersist,despitealltheuncertainty,in2012.

Itwasnotalwaysthisway.Thoughitwaspossibletopointintheearly2000stoundoubtedstarssuch

asChina,withanaveragegrowthratethenofnearly9.5percentsince1978(aratethathasstuck),its

performancewasnottypicaloftheemergingworld.

Thoughemergingeconomieshavealotofcatchinguptodowhichcanonlybeachievedbygrowingmore

rapidlythantheold,advancedcountries,foralongtimetheyfailedtodoso.

4. what the experts say


Asrecentlyasthelate1990s,emergingeconomiestakentogetherdidnotoutperformtheadvanced

world.ThoughtherewereundoubtedstarssuchasChina,theaveragewasdraggeddownbypoor

performanceinAfrica,LatinAmericaandotherregions.

Theresultwasthattheworldwasdrivenbyadvancedeconomies;America,Japan,Britainandtherestof

WesternEurope,Canadaandsoon.Thesecountriesaccountedfortwo-thirdsofglobaleconomicgrowth

andpulledtheemergingworldalongwiththem.

Nowitistheotherwayaround.Two-thirdsofglobalgrowthisfromemergingeconomies,whilethe

advancedworldisstrugglingtoprovidetheotherthird.Itisnothardtoseewhy.AmericaandEurope

aresufferingundertheweightoftheirtwinhangovers:thehangoverofadamagedandweakened

bankingsectorandthefiscalhangoverofgapingbudgetdeficitsandrisingpublicsectordebtthat

havetobetackled.

America and Europe are suffering under the weight of their twin hangovers: the hangover of a damaged and weakened banking sector and the fiscal hangover of gaping budget deficits and rising public sector debt that have to be tackled.

Emergingeconomieshaveshownthemselvescapableofgrowingeveninthedirestcircumstancesforthe

worldeconomy,aswesawin2009.Throughthickandthin,goodtimesandbad,emergingeconomies

willoutperformtheiradvanced-countrycounterparts.

ThisisnotjustbecausetheyhavefeweroftheproblemsofexcesswhicharebedevillingtheWest,

orbecausetheyhaveplentyofcatching-uptodo,thoughbothareimportant.Itisalsobecausethe

emergingworldisincreasinglytradingwithitself.TradewithinAsiabouncedbacksharplyaftertheworst

phaseoftheglobalfinancialcrisisthreeyearsago.

Growthinsomeemergingeconomies,moreover,isgeneratinggrowthinothers.Theemergingworldis

wheretheactionis.AfewyearsagoAfrica’sbesthopeappearedtoliewithaidanddebtrelieffromthe

West.Nowthereisanewprosperitydrivenbycommoditydemand,particularlyfromChina.

Theotherbigshiftistowardsdomestically-generatedgrowth.Emergingeconomieshavecometorealise

theycannotrelyexclusivelyonAmericanorEuropeanconsumers.Domestically-generatedgrowth

reducedrelianceontheWestandispoliticallynecessary:sharingthebenefitsofgrowthamongthe

widerpopulation.China’s2011–15five-yearplan,forexample,explicitlyhasthisaim.

WhatdoesallthismeanforBritain?Asnotedearlier,thisisaperiodofconsiderableeconomic

uncertainty.Theglobalfinancialcrisiswhichbeganinthesummerof2007,reacheditsmostserious

phaseintheautumnof2008beforereturningwithavengeancetotheeurozoneduring2011,has

affectedusall.

Itbrokealongsequenceofrisingprosperity–the16yearsofgrowththatprecededthecrisisbroke

recordsforthemodernera–andledtoanunusuallysharpdropinlivingstandards.

It [the crisis] broke a long sequence of rising prosperity – the 16 years of growth [in the UK] that preceded the crisis broke records for the modern era – and led to an unusually sharp drop in living standards.



Oneeasywayofthinkingofthecrisis’simpactisbyreferencetotheprojectionstheOfficeforBudget

Responsibility(OBR)presentedalongsideGeorgeOsborne’smostrecentAutumnStatement.Itsaidthat

Britain’seconomyin2016willbe13percentsmallerthanitwouldhavebeenhadTreasuryprojections

ofthe“trend”ornormalrateofgrowthmadein2008beenachieved.

Putanotherway,theOBR’scalculationsforrealhouseholdincomessuggesteditwilltakeuntil2014or

2015togetbackto2008–9levels.TheInstituteforFiscalStudieswentfurther,talkingofa“lostdecade”

formedianrealhouseholdincomes.Notuntil2016,itsaid,wouldhouseholdsgetbacktowherethey

werein2006.

Allthis,asnoted,ishighlyunusual.SirMervynKingpointedoutquiteearlyonthatyouhavetogoback

tothe1920s,inotherwordsbeforetheDepressionyears,foraperiodofdepressedrealincomesaslong

asthis.TheNationalInstituteofEconomicandSocialResearchsaysthat,onpresentevidence,thiswill

bealongerperiodof“depression”,whichitdefinesasthetimetakentogetbacktothepreviouspeak

forgrossdomesticproduct,thanthe1930s.

WhenwelookatBritain’sneighboursandcompetitors,thepictureisdepressinglysimilar.Thestruggle

foreurozoneeconomiesoftryingtoholdthesinglecurrencytogetherisbothcompoundedbyand

hascontributedtotheireconomicweakness.Thatweakness,givenBritain’stradelinkswitheurozone

economies,transmitsitselfdirectlyacrosstheEnglishChannel.

Soshouldweviewtheriseoftheemergingworldwithdespair?Doesitmarkapassingoftheeconomic

batonfromWesttoEastinawaythatwillpermanentlyimpoverishus?Somecommentators,afterall,

arguethatthefallinlivingstandardsinBritainnowistheshapeofthingstocome.Dowehavetoaccept

theendofrisingprosperity?

Theanswertothatisno,thoughIwillqualifyitinamoment.Thebiggestconfusionpeoplegetintoon

thissubjectistomuddleabsoluteprosperityandrelativeprosperity.Theeasiestwaytothinkofthisis

withtheexampleofAmerica’sriseduringthe20thcentury.

DidtheriseoftheUnitedStatesmakeBritainrelativelypoorerinthelastcentury?Itmostdefinitelydid.

Britain’sdisplacementbyAmericaasaneconomicsuperpowersawUSlivingstandardscatchupwith

thencomfortablyoverhaulthoseintheUK.ButdiditmakepeopleinBritainabsolutelypoorer?Itmost

definitelydidnot.

Bytheendofthe20thcenturyUKlivingstandardswerefarhigherthanatthestart.Inthesecondhalfof

the20thcenturytheydoubledroughlyevery25years.Historytellsusthatitiswrongtoregardtherise

ofneweconomicpowersaspurelyathreat.Theyrepresentaconsiderableopportunityaswell.Growthin

theworld,whereveritis,generatesprosperityelsewhere.

History tells us that it is wrong to regard the rise of new economic powers as purely a threat. They represent a considerable opportunity as well. Growth in the world, wherever it is, generates prosperity elsewhere.

Thereare,asnotedabove,oneortwocaveats.Onefeatureoftheriseoftheemergingworldhasbeen

muchhighercommodityprices.Oilpricesdidnotbreakdecisivelyabove$40abarreluntilasrecentlyas

2004.Morerecently,energyandcommoditypriceshavebeenpushedtorecordlevels.



Thisisbecauseemergingeconomiesarecommodity-hungry.Theirgrowthinvolvesalotmoreenergyuse

and,aslivingstandardsrise,abigincreaseincommodityuse,puttingupwardpressureonprices.Sothe

normalpost-recessionexperiencefortheWest,ofmanyyearsinwhichinflationisdepressed,hasnotbeen

repeatedthistime.Hencewehavehadthephenomenonofthesqueezeonrealincomes.Itseemslikely

thatcommoditypriceswillbeindefinitelyhigherthaninthepastalthoughtheyarebytheirnaturevolatile.

ThesecondgeneralpointisthatcountrieslikeBritainhavetolooktotheirlaurels.“Theworlddoesnot

oweusaliving”isaphrasebelovedofpoliticiansbutthatdoesnotmeanitisnottrue.

Inparticular,thechallengesthatweretherebeforethefinancialcrisisremainand,ifanything,the

urgencyofdealingwiththemhasincreased.TherearemanyofthesebutIshallconcentrateonjusttwo.

Thechallengeofprovidingforanageingpopulationinawaythatdoesnotdestroytheproductivepart

oftheeconomyisaliveone.Politiciansarestartingtorespondbyincreasingthestatepensionageand

reformingpublicsectorpensionsbutmayonlyhavescratchedthesurfaceand,inareaslikelong-term

careprovision,arenotfarbeyondfirstbase.

Theissueissimplystated.Thecountrieswhichwilldrivetheglobaleconomyinthecomingdecades

aremainlyyoung–Chinaisthebigexception–withyouthfulpopulations.Halfthepopulationof

Indiaisundertheageof25andthree-quartersarebelow35.ThoughBritainisrelativelywell-placed

demographicallyamongadvancedeconomies,theriskofbeingaweak“old”economyisarealone.

Though Britain is relatively well-placed demographically among advanced economies, the risk of being a weak “old” economy is a real one.

Totakeanotherchallenge,wehavetoensurethattheemergingworlddoesnotdecideitcandowithout

us.TradebetweenChinaandIndiaisincreasingatafarfasterratethanbetweeneitherofthemandthe

West.Britain’sshareofglobalexportsfellfrom5.3to4.1percentbetween2000and2010.TheUKsells

10timesasmuchtotheeurozoneastoBrazil,Russia,IndiaandChinacombined.IndiaisonlyBritain’s

18thlargestexportmarket.

Sothereisahugetaskinre-orientatingBritain’sexportstowardsthesefast-growingeconomiesandto

buildingupthesectorsinwhichtheeconomyhascomparativeadvantage,andingoodsandservices

thatareindemand.Theyinclude,clearly,advancedmanufacturing,pharmaceuticals,aerospace,and

financial,businessandprofessionalservices.Theyalsoincludeknowledge-basedsectorswhichhaveso

farbarelymadeitoutofthelaboratory.Stayingaheadinthesewillperhapsbethebiggestchallengein

thisrapidlychangingworld.

...there is a huge task in re-orientating Britain’s exports towards these fast-growing economies and to building up the sectors in which the economy has comparative advantage, and in goods and services that are in demand.



Itispossibletobeoptimistic.IstartedthispiecewithGoldmanSachsandIshallenditwiththem.Ina

paperpublishedinDecember2011,theinvestmentbanksaidthatonlytheUnitedStatesandCanada

wouldhavehigherlevelsofGDPpercapitathanBritainin2050.

ThoughBritainwouldslipto10thplaceintheleagueofglobaleconomiesbysize,itwouldstillbeahead

ofemergingeconomiesinpercapitaincomelevels,aswellasfaringbetterthantherestofEurope,

becauseimmigrationwouldcontinuetoeasethedemographicchallengeofanageingpopulationand

becauseofhigherlevelsofprojectinvestment.

“Lookingforward,wethinktheUKiscapableofholdingitsownandinfactmovingaheadofsomeofthe

otherdevelopedeconomies,”itsaid.Letushope,aswiththeBRICs,GoldmanSachsisright.



Global longevity trends and their potential economic and social implications5 George Magnus, Senior Economic Adviser, UBS and author of the “Age of Aging” (2008)6, and “Uprising: will emerging markets shape or shake the global economy?” (2010)

AccordingtotheGlobalAgingreport2010fromratingagency,StandardandPoors’,“Nootherforce

islikelytoshapethefutureofnationaleconomichealth,publicfinances,andnationalpoliciesasthe

irreversiblerateatwhichtheworld’spopulationisgrowingolder”.

Noonedisagreesglobalagingishaving,andwillcontinuetohaveprofoundconsequences,as

suggested.But‘nootherforce’seemsalittleoverthetop.Theglobalsystem,andoursocietiesare

facingtheirbiggestchallengesinpeacetimeperhapssincetheIndustrialRevolutionasaresultof

theriseofChinaandotheremerginganddevelopingcountries.Andtheprotractedandfractious

consequencesofthefinancialcrisisfortheeconomic,socialandregulatoryenvironmentcertainlyqualify

as‘game-changers’.WhoknowsforhowlongWesterncountriesaregoingtohavetodeleveragetheir

economies,orwhatthemulti-yearconsequenceswillbe?AndhowcanwepredictwhatEuropeisgoing

tolooklikeinthenextfewmonths,letaloneinthelonger-term?Thesephenomenawillshapethefuture

too,butwithevenlesscertainty,andmuchlesspredictableconsequences,thanglobalaging,itself.

Demographic dynamicsInadvancedeconomies,thecrossoverbetweenthenumberofpeopleagedover60andthoseaged

under14asashareofthepopulationwasreachedabout10yearsago.By2050,therewillbetwiceas

manyoldercitizensastherearechildren.Bycontrast,inemergingcountries,therearestillthreetimes

asmanychildrenasthereareoldercitizensandthecrossoverisnotpredictedtohappenuntil2040.

Therearesomenotableexceptions,whereagestructureischangingextremelyrapidly,almostonapar

withtheWest,includinginChina,RussiaandEasternEurope.

By2050,thenumberofover60sinadvancednationsisexpectedtoriseby2.5timestoaround

418million,andthenumberofover80swillrise6timestoover120million.Intheemergingworld,the

numberofover60swillgrowbymorethan3timesto1.4billion,andthisincludesa6-foldincreasein

theexpectedpopulationofthoseagedover80,to262million.Altogether,theover60swillrisefrom

759millionto2billion,equivalenttoariseintheirshareofthepopulationfrom22percentto33per

centinadvancednations,andfrom9percentto20percentinemergingnations.

Themostastoundingfeatureofglobalagingnowadaysisitsspeed.IttookFranceoveracenturyfor

theover60stodoublefrom7percentto14percentofthepopulation.Inmostotherdeveloped

countriesithastakenoristakingbetween40–80years.Butmostemergingnationswillaccomplishthis

shiftinroughly20years,withChinaalreadythefastestagingcountryonEarth.Itspopulationofover

60swillgrowfrom144millionor11percentofthepopulation,to438millionor31percentby2050.

Somecities,forexample,Shanghai,alreadyhaveanagestructuresimilartothatofJapan,whichisthe

oldestWesterncountry.

The most astounding feature of global aging nowadays is its speed. It took France over a century for the over 60s to double from 7 per cent to 14 per cent of the population…but most emerging nations will accomplish this shift in roughly 20 years.

5 Basedonanaddresstothe7thChiefRiskOfficerAssembly,SwissRe,Zurich,16thNovember2011

6 http://georgemagnus.com/books/the-age-of-aging-how-demographics-are-changing-the-global-economy-and-our-world



TheproblemforChinaandotheremergingcountriesisthattheyarestartingtoencounterthelongevity

challengeatlevelsofpercapitaincomeandsocialsecurityprovisionthataresubstantiallylowerthan

wasthecaseforWesternnationswhentheyhadasimilarmedianageandotherdemographicstothose

ofemergingmarketstoday.

Thechallengeofrisinglongevityisadarkerprospectthanthetraditionalperspectivewhichcelebrates

longerlifeexpectancyasself-evidentlygood.Thereasonisbecauseoftheeconomicimplicationsofthe

collapseinandsustainedlowlevelsoffertility.Putanotherway,therearenotenoughbabiesbeingbornto

becometheworkerswhowillsupportandfinancetherisingpopulationofoldercitizens.Inmostadvanced

countries,the3–4workingagepeopleperoldercitizenwillbecome2orlessbythemiddleofthecentury,

whileinChina,forexample,the10workerswhosupporteacholdercitizenwillbecomejust2.5.

Itistheimpliedchangeinagestructure,thatisthesoaringnumbersofoldercitizensinrelationto

workingagepeople,thatistherootoftheproblem,andboilsdowntothefundamentaleconomic

problemofastagnantordiminishinglaboursupply,andskillshortages.Boeing’sseniorvice-president

ofhumanresources,forexample,toldanaudiencein2010thatby2015,40percentoftheaircraft

maker’sworkerswouldbeeligibletoretire.Recruitmentandstaffretentionarebecomingamajor

problemforagrowingnumberofbusinesses,asevidencedinrecenttimesbyannouncementsat

SiemensandBMW,and,therefore,fortheeconomy.IntheUS,about19percentofUSmanufacturing

workersareaged54ormore,whichisroughlythesameasfortheworkforceasawhole.Butonly

7percentofmanufacturingworkersareunder25,whichishalfthatofthetotalworkforce.

With Western countries having already banked their [demographic] dividend, the headwinds to these benefits are going to gather inexorably, unless we can find new coping mechanisms to address the shortfalls in labour supply and skills.

Fromaneconomicperspective,thesignificantchange,then,isonthecomingcrunchintheworkingage

population,andonthepaybackfromwhatdemographerscallthe‘demographicdividend’.Thisisthe

phaseduringwhichchilddependencyisdeclining,andtheworkingagepopulationisexpandingfrom

priorhigherfertilityrates,butbeforerisingoldagedependencykicksin.Itiswhereadvancedcountries

wereformuchofthepost-WW2erauntilafewyearsago,andwheremostemergingcountriesarenow.

Thisdividendisassociatedwithstrongtrendsinincomeandconsumptiongrowth,increasingasset

marketdevelopmentandassetreturns,andeconomicexpansion.WithWesterncountrieshavingalready

bankedtheirdividend,theheadwindstothesebenefitsaregoingtogatherinexorably,unlesswecan

findnewcopingmechanismstoaddresstheshortfallsinlaboursupplyandskills.

The collusion of rising longevity and the financial crisisFromafinancialmarketsstandpoint,thecrisishascementedalowinterestrateenvironment,weaker

equityreturns,andaworryinguncertaintyastowhatconstitutesarisk-freerate,allinthecontextof

morestringentregulation,andincreasinglyoffinancialrepression,thatis,policiesdesignedtoensure

thatdomesticinvestorscontinuetofundgovernmentdeficits.



Butdemographicchangedoessomeofthesethingstoo,assuggestedalreadybyJapan’sexperience

withageingoverthelast22years.Afterall,astheagestructureofsocietyrises,moreandmorepeople

moveoutofproductiveworkintoretirement,butarenotbeingreplacedbecauseofweakfertilityrates.

Thistendstoshiftincomedistributionfromcapitaltolabour,underpinningweakerequityreturns.Or,as

now,itcausescompaniestocontinuouslylookforlabourcostsavings,whichinturn,depressaggregate

demandwithsimilarconsequences.Inamacabreway,wecouldarguethatrisinglongevityandother

demographicfactorsarecolludingwiththecrisisovereconomicgrowthtocreateseriousshortcomings

intheadequacyofindividualretirementfundingandofprivatepensionandinsuranceschemes,and

insovereignsolvency,givenbothexistingbudgetaryconditionsandtheunaffordabilityofpublic

age-relatedspending,basedonexistingcommitments.

In a macabre way, we could argue that rising longevity and other demographic factors are colluding with the crisis over economic growth to create serious shortcomings in the adequacy of individual retirement funding.

Itispossiblethatfinancialservicescompaniescouldplayanimportantroleindevelopingnewsavings

andinsuranceproductsthatwillhelpthegrowingnumbersofretireesmeettheirchangingfinancial

needs,andprovidingpensionandrelatedservicesasfinanciallystretchedgovernmentspassfinancial

provisionandcareresponsibilitiesbacktoindividuals.

Financialproductsandservicesdemandedbyindividuals,forexample,willcontinuetoshiftfromthose

thataccumulatesavingsduringworkinglivestothosethatfacilitatetheirdraw-downduringeverlonger

yearsofretirementandoldagecare.Thelongevityphenomenonischangingthestandardlife-cycle

hypothesisthatliesattheheartofthingswehavetakenforgrantedinfinancialservicesforalongtime,

includingpatternsofsavingsbehaviourandlifestylefinancialproducts.Putanotherway,risinglife

expectancy,longeryearsatwork,andperhapsasmuchas20yearsormoreinretirementrequirepeople

toretainatleastsomeexposuretoriskassetsforlongerthanhasbeenthecaseuntilrecently.Evidence

fortheFederalReserve’sfour-yearlySurveyofConsumerFinancesconfirmsthathouseholds,headedby

oldercitizens,continuetohavemoreconservativeassetallocationsthantheiryoungerpeers,butretain

higherlevelsofriskexposurethantheirpredecessors.Assetmanagerswillhavetodevelopproducts

thatmaintainfinancialexposuretoequitiesandotherriskproductsforlonger,whilecontrollingforthe

marketvolatilitythatoldersaversespeciallyneedtoavoid.

Asset managers will have to develop products that maintain financial exposure to equities and other risk products for longer, while controlling for the market volatility that older savers especially need to avoid.

Therearewaysinwhichgovernmentscanalsomitigatetheconsequencesofrisinglongevityforthe

economy.Immigrationisanobviousexample,exceptforthefactthatforthetimebeing,thepolitics

arehostile–andinthecaseofmostEuropeancountriesandJapan,thescaleofimmigrationneeded

tocompensatefortheeffectsofrapidageingisunimaginableinpractice.Othermechanismsareabout

keepingandbringingintoworkpeoplewhoseparticipationratesintheworkforceislow,specifically

olderworkers,andwomen.



Keepingolderworkersatworkandenticingmoreintosomeformofworkcannotbeaddressedbyage

discriminationlegislationalone.OtherthaninJapan,wherehigholderworkeremploymentratesare

thenorm(butnotforwomen),thisrequiresgovernmentsandcitizenstotakearealisticviewaboutthe

abilitytoworklonger.Toanextent,thisisalreadyevidentinthespateofpoliciesdesignedtoraisethe

retirementageinstepsoralignitwithlongevity,ortoraiseothereligibleagesforaccesstopensionand

healthcarebenefits.

GovernmentsarenowraisingretirementageseitherbecausetheyareforcedtodosounderIMF

programmesorbecausetheyareself-imposedforreasonsoffinancialduress.Butevenhigher

retirementageswon’tsolvethelongevityproblemtotally.Thiswillrequireacomprehensiveshift

inthinkingaboutthenatureandflexibilityofworkandtheworkplace,theintroductionofphased

retirementschemes,newoccupationalandcompensationstructurestosuitolderworkers,andastrong

commitmenttolife-longskillformationandretraining.

But even higher retirement ages won’t solve the longevity problem totally. This will require a comprehensive shift in thinking about the nature and flexibility of work and the workplace.

Thepositionofwomeninageingsocietieswillbecomeincreasinglysignificant.Itisworthemphasising

thatthedemographicchallengeislessincountriesthathavehigherfertility,anditisnoaccident

thatcountries,suchastheUS,Canada,theUKandSwedenthathavehigherfertilityratesalsohave

thehighestproportionsofwomenatwork.Thisisessentially,ofcourse,aboutaffordableandwidely

availablesystemsofchildcare.Buthigherfemaleparticipationinthelabourforceisalsoaboutsystems

thatbetterprotectyoungerwomen,whoheadupthevastmajorityofsingleparentfamilies,andall

womentotheextentthattheytendtodominateparttimeandlesswellpaidwork,andareatriskfrom

financialpenaltiesassociatedwithcareerbreaks,havingchildrenandgettingdivorced.

Itshouldbenotedalsothatbecauseofgreaterfemalelongevity,thefemaleproportionoftheolder

citizenagegroupisgoingtorise,andwomenaretypicallydisadvantagedcomparedtomen,especially

iftheylivealone,andastheygrowolder.IntheUK,aboutathirdofwomenagedover55haveno

retirementsavingsatall,andofthosethatdo,overhalfhavenowherenearlyadequateprovision.

Inadequacyofretirementsavings,however,isacommonproblem.Theconsequencesoffallinghouse

prices,lowinterestrates,andweakequitymarketsaside,insufficientretirementsavingswereacause

forconcernbeforethefinancialcrisis.IntheUSjustbefore2008,theFederalReservefoundthat60per

centofhouseholdsinthebottomthirdoftheincomedistributionhadinsufficientsavingsforretirement,

andalmost50percentofthemiddlethirdand42percentofthetopthirdwereinasimilarposition.

Thesenumbersareboundtohaverisenwithhigherunemploymentandweakereconomicandstock

marketconditions.

Amassiveissuearisingfromrisinglongevityincurrentcircumstancesispreciselyhowolderworkers

cansaveforretirement,especiallyiftheyarestrugglingwithtoomuchdebtorunaffordablemortgages,

butgenerallywheninterestratesareatgenerationallowsandequityreturnsaremeagreandvolatile.

Thisappliesinparticulartothosenotcoveredbyprivatepensionplans,orrelyingonpay-as-you-go

pensionsystems.Only6countriesaccountedforthevastmajorityofthe$31trillioninpensionassets

attheendof2010.TheyweretheUSwitha63percentshare,theUK(9percent),andCanada,Japan,

theNetherlandsandAustralia(17percent).Somecountries,suchasDenmark,SwitzerlandandFinland,

hadhighpensionassetsasashareoftheirownGDP,asdidChileandKorea.ButinmuchofEurope,

includingSpainandFrance,asindeedinmuchoftheemergingcountryuniverse,pensionassetsare

smallbycomparison.



Publicsectorsavings,orthelackofthem,arenowthefocusofattentiononanunprecedentedscalein

Westerncountries.TheriseintheratioofpublicdebttoGDPtowellover100percentthatwehaveseen

since2008isindeedunprecedentedinpeacetime.Mostgovernmentsfacemanyyearsofdeleveraging,

orrestructuringtheirfiscalbalancesandpolicies,soastostabiliseandthenlowerthepublicdebt

burden.Some,suchasGreece,IrelandandPortugalfaceinsolvencyrisksthathaveshutdowntheir

accesstoprivatemarkets,andforcedthemintoIMFprogrammes.Wecannotknowhowthissovereign

crisisisgoingtoendup,especiallyintheeurozone,notleastbecausesolutionsareheavilydependent

onthepoliticalwillingnessandcapacityofgovernmentsandcitizenstodealwiththeconsequences.

Sufficetosay,thatthescaleofthetaskisenormous.Thenetpresentvalueofage-relatedspendingover

thenext40yearsinadvancednationsisroughly5timestheir2010GDP.

Suffice to say, that the scale of the task is enormous. The net present value of age-related spending over the next 40 years in advanced nations is roughly 5 times their 2010 GDP.

ConclusionRisinglongevityconveysastandardfayreforactuaries,demographersandpensionfundconsultants.

Itonlysoundsthreateninginafinancialsenseforpensionplanprovidersandbeneficiaries.Ina

widercontext,though,itisalsoaboutbroad-basedfinancialsecurityinsocietiesexperiencingan

unprecedentedriseinagestructure.Itisaboutfaultlinesinthewayoureconomieswork.Anditis,

pressingly,aboutthefinancialviabilityandpossiblesolvencyofgovernments,entailingapolitically

fractiousdebateabouttheredrawingofentitlementrightsandresponsibilitiesofcitizensandthestate.

Andthesearejustsomeoftheeconomicconsequences.Therearesocialimplicationstooforpublic

policyasitapplies,forexample,toimmigration,education,andcareinthecommunity,andforfamilies,

asyesterday’stwogenerationfamilystructureswithsiblingsandcousinsbecomemultipleso-called

‘beanpole’families.

After a period in which banks and financial service providers, among others, have been pilloried for their role in creating the crisis, it would be fitting indeed if the industry played a strong role in devising at least some of the answers to the challenges posed by rising longevity.

Wehavetofindnewcopingmechanismsinthecreationofjobs,especiallyforwomenandolderworkers,

inthewaywethinkaboutthenatureofwork,theworkplaceandretirement,andinthesystemsthat

encouragepeopletosavemoreforretirementandallowthemtomanagetheirsavingsforthedecade

ortwoinwhichtheyspendtheirtwilightyears.Thefinancialcrisishascertainlyretardedtheprocess,

andaggravatedtheeconomicconsequencesofrapidsocietalageing.Afteraperiodinwhichbanksand

financialserviceproviders,amongothers,havebeenpilloriedfortheirroleincreatingthecrisis,itwould

befittingindeediftheindustryplayedastrongroleindevisingatleastsomeoftheanswerstothe

challengesposedbyrisinglongevity.



The Long-term economic outlook for the United States and its international implicationsDr Uri Dadush, Senior Associate and Director International Economics Program, Carnegie Endowment for International Peace

ThelongruneconomicsuccessoftheUnitedStateswilldetermineitsabilitytocontinuetoprovide

economicandpoliticalleadershiptotheorderitcreatedintheaftermathofWorldWarII.Thoughthe

USeconomyexhibitssomesalientareasofstrength,therearealsoareasofvulnerability.Thefutureis

uncertain,buthowtheUSeconomyevolveswillcertainlyhaveimplicationsfortherestoftheworld.

A National scorecardTheUnitedStatesispotentiallyamongthebest-placedeconomiestobenefitfromthetwinmodern-day

trendsofglobalisationandtechnology.TypicallyrankinginthetopfiveoftheWorldBank’sDoing

BusinessIndicatorsandtheWorldEconomicForum’sGlobalCompetitivenessIndex,theUnitedStates

remainsnotonlythelargesteconomyintheworldbyafactorofthreeincurrentdollartermsbutalso

amongitsmostopen,innovative,andflexible.Itshighpercapitaincomereflectshighproductivity–the

broadestandsinglebestmeasureofcompetitiveness.Despitebeinghometolessthan5percentof

theworld’spopulation,theUnitedStatesaccountedfor28percentofglobalpatentapplicationsin

2008andishometonearly40percentoftheworld’sbestuniversities.Furthermore,USdemographic

trendsarefavourablecomparedtothoseinotheradvancedcountries.Overthenexttwentyyears,the

UNexpectstheUnitedStates’populationtogrowby17percent,whileprojectingthatoftherestofthe

developedworldwillgrowbyonly1percent.Partofthisstrengthcomesfromhighimmigrantinflows

andthecountry’sunusualabilitytointegratemigrants.

The United States is potentially among the best-placed economies to benefit from the twin modern-day trends of globalisation and technology.

Nevertheless,theUnitedStatesisalsoplaguedbyseriousandgrowingweaknesses.Healthcareis

expensiveandinefficient:publicandprivatehealthspendingis50percenthigherpercapitathanthat

ofthenexthighestOrganizationforEconomicCooperationandDevelopment(OECD)country,buttheUS

infantmortalityrate,at6.7deathsper1,000births,ishigherthaninallOECDcountriesexceptTurkey

andMexico.Moreover,asthepopulationages,healthcarecosts,whichalreadyaccountforabout

17percentofUSGDP,areexpectedtoriserapidly.Secondaryeducationisweak,withfifteen-year-old

Americanstudentsrankingonly31stof65countriesinmathematicstestsand22ndinsciencetestsin

asurveythatincludesmanydevelopingcountries.ThiscouldmeanthatwhilefutureUSworkerswill

layclaimtotheworld’shighestwages,manywillbringonlymediocreskills.Somealsobelievethatthe

UnitedStateshasalargeinfrastructuredeficitrelativetoothercountries,thoughhardevidenceonthis

isdifficulttocomeby.

TheUSincomedistributionisconsiderablymoreunequalthanotheradvancedcountries,andthat

divideisgrowing.Whileincomesofthetop1percentofAmericanshavesoared,medianhousehold

incomeshavedeclinedsince1999.Moreover,theAmericanDreamhasbecomeamythformanypeople:

socialmobilityislowerandrelativepovertyratesarehigherintheUnitedStatesthaninmostother

advancedcountries.



Despiteitshighproductivityandcompetitiveness,theUScumulativecurrentaccountdeficitoverthe

lastthirtyyearsis$8.5trillion,areflectionofextremelylowhouseholdsavingsratesandgovernment

deficits.Dysfunctionaltaxpoliciesarepartlytoblamefortheindebtednessofbothhouseholdsandthe

federalgovernment.TheUStaxsystem–complexandrifewithdistortions–overlyencouragesborrowing,

includingforhousing.Itisalsoanoutlieramongadvancedcountriesinnumerousotherways–for

example,initsveryloweffectivecorporatetaxrate(thoughhighnominalrate),loweffectiveincometaxes

ontherichestAmericans,taxbreaksonlargemortgageswhichareregressive,andlowgasolinetax.

TheUnitedStatesretainsadominantmilitaryapparatus.Forexample,theUnitedStatesowns11of

theworld’s20aircraftcarriers–andItaly’sfleetoftwoisthesecondlargest.Butthisdoesnotcome

cheap.USdefencespendingaccountsfornearly5percentofitsGDP–ashareabouttwicethatofother

developedcountries–andfor40percentofglobaldefencespending.

Lastbutnotleast,anincreasinglypolarizedandevendysfunctionalpoliticalsystemiscontributing

tothefiscalmess,asevidencedbythebrinkmanshipsurroundingthedebtceilingandthefailureof

thecongressional“supercommittee.”PoliticalimmobilityhasalsooftenpreventedtheUnitedStates

fromleadingonthebiginternationalissues–fromclimatechangeandtradenegotiationstoIMF

replenishment,forexample.TheUnitedStatesprovideslessforeignaid,proportionaltoitsGDP,than

anyotheradvancedeconomy.

Some important trendsInJuggernaut: How Emerging Markets are Reshaping Globalisation,WilliamShawandIestimatethat,

by2030,theriseofemergingmarketswilladdapproximatelyabillionpeopletotheworldmiddle

class.Thesenewlyempoweredconsumerswilldemandeducation,entertainment,andproductsand

servicesdrivenbyinformationtechnology–allgoodstheUnitedStatesexcelsatproducing.Atthe

sametime,tradebarriers–whichincludelogisticalcosts–havecomedowninrecentdecadesand,

despitetheprotectionistsentimentstirredbytheGreatRecession,worldtradecontinuestofaroutpace

GDP.Moreover,asaglobaltechnologicalleader,theUnitedStatescouldinthefuturebepropelled

byinnovationsinmedicine,biotechnology,communications,transportation,orenergy.Forexample,

developmentsthatimprovetheefficiencyorextractionofshalenaturalgasandoil–ofwhichtheUnited

Statespossesseslargereserves–willprovidedisproportionatebenefitstotheUnitedStates.

...by 2030, the rise of emerging markets will add approximately a billion people to the world middle class. These newly empowered consumers will demand education, entertainment, and products and services driven by information technology.

However,thesefavourabletrendsmustbeweighedagainstloomingdangers.Afiscaldisaster–caused

byuncheckedhealthcarespending,unwillingnesstoraisetaxes,andrisingdebtintheUnitedStatesin

thecomingyears–couldleadtoasharpeconomiccontractionanddepresseddemandforaprolonged

period.Suchaprocesscouldbeacceleratedbythecollapseoftheeurozone,whichcouldtrigger

anotherworldrecessionandmoreintensescrutinyofsovereigndebtlevels.Thelastfinancialcrisis

exposedprofoundinstitutionalvulnerabilitiesintheUSfinancialsystem.Buttheeconomy’scontinued

“financialization”andafailuretoadequatelytackletherootcausesofthe2008crisisandexcessiverisk

takinginbanksmayleavetheUnitedStatesvulnerabletoanotherfinancialcrisis.Ifleftunaddressed,

povertyandincomeinequality,bothattheirhighestlevelindecades,couldunderminesocialcohesion

andfurtherpolarizenationalpolitics.



...the economy’s continued “financialization” and a failure to adequately tackle the root causes of the 2008 crisis and excessive risk taking in banks may leave the United States vulnerable to another financial crisis.

Someinternationaltrendsarepotentiallyadverseaswell.WhiletheriseofChinaandotheremerging

marketspresentsgreatopportunities,italsoerodestheUnitedStates’relativeeconomicweightand

thatofitstraditionalallies.TheabilityoftheUnitedStatestomanageandindeedaccepttherapidriseof

newglobaleconomicpowers–inotherwords,toworkwiththetrendratherthanagainstit–isunclear.

Theirriseisboundtocausenumerousfrictions,manyofwhicharealreadyvisibletoday–fromglobal

imbalancesandcurrencies,toaidpolicies,tonegotiationsovertradeandfinancialregulation.Howthis

powershiftismanagedisofutmostimportance.

Infewareasisthepotentialforconflictmoreevidentthaninthemitigationofclimatechange,

whereChinaandIndiaandmanyotherrelativelypoorandfast-growingcountriesareverywaryof

committingtoemissiontargetsthatcouldconstraintheirdevelopment.Eventhoughtheworsteffects

ofclimatechangeareunlikelytomaterialisewithinthetwenty-yearhorizonoftheprojection,itsearly

manifestationsmayintensifyasmayawarenessofitsdangers.Thiswillraisethestakesinclimate

changenegotiations,andtheUnitedStatesisill-equippedtohandlethemgivenitslackofinternal

consensusontheissue.

Two storiesInthegoodscenario,mostofthesethreatsareavoided.Relationswithkeyinternationalactorsremain

cautiousbutgenerallypeaceful.Marketsstayopenandtradecontinuestogrowrapidly.TheUnited

Statesaddressesitsfiscaldeficitandsucceedsinstabilisingitsdebt/GDPratiooverthenextdecade.

Theeurozoneremainsintactandnonewmajorfinancialcriseserupt.Andtheworsteffectsofclimate

changeareavoided.

Inthiscase,theUSeconomygrowssteadilyatabout2.7percentayear(seeJuggernautforamore

detaileddiscussion).Thiscompareswith2.5percentoverthelasttwentyyears,whichincludesthe

GreatRecession.USgrowthreflectsbothsolidlaborforcegrowthandtechnologicaladvance,while

capitaldeepeningplaysarelativelysmallrole.Averagelivingstandardscontinuetorise,asrealUS

percapitaGDPincreasesbynearly40percentandthefruitsofeconomicprogressaremoreequally

distributed,relievingsocialtensionsandattenuatingpoliticaldivisions.

ThoughtherelativesizeoftheUSeconomydeclines–fromaboutathirdofG20GDPin2010toabout

aquarterin2030inrealUSdollars–itremainsthelargestintheworldatmarketexchangerates.In

purchasingpowerparity(PPP)terms,however,theUSeconomyiseclipsedbyChina,byaround2016,

andChinais70percentlargerthantheUnitedStatesin2030.TradealsoshiftsEast:theUSshareof

worldtradedipsfromaround12to10percent,whileEastAsia’sshareisexpectedtodoublefrom10to

20percent.Thoughitsgrowthslowsquitesharplybytheendoftheforecasthorizon,Chinabecomesthe

centralplayerinworldtradeandthelargesttradingpartnerofmostcountries.

[In the good scenario] in purchasing power parity (PPP) terms the US economy is eclipsed by China, by around 2016, and China is 70 per cent larger than the United States in 2030. Trade also shifts East: the US share of world trade dips from around 12 to 10 per cent, while East Asia’s share is expected to double from 10 to 20 per cent.



The G20 in 2030

Billion 2005 US dollars, market exchange rates

Billion PPP dollars Average annual real growth rate, 2010–2030

Argentina 527 1,174 4.3

Australia 1,501 1,442 3.2

Brazil 2,440 4,217 4.3

Canada 2,083 2,087 2.8

China 21,479 37,644 9.3

France 3,323 3,025 2.0

Germany 3,593 3,360 1.2

India 5,328 13,321 8.0

Indonesia 1,073 2,446 5.5

Italy 2,197 2,102 1.2

Japan 5,786 5,170 1.2

Korea 2,122 2,510 3.9

Mexico 2,397 3,449 5.1

Russia 2,487 4,611 5.3

SaudiArabia 896 1,401 4.6

SouthAfrica 791 1,150 5.4

Turkey 1,437 2,054 5.1

UnitedKingdom 3,597 3,134 2.2

UnitedStates 22,258 22,258 2.7

Inthebadscenario,theUSeconomyslowssharply.Thebreakupoftheeurozoneleadstoamassive

financialcrisisinEurope,causingUSunemploymentandfiscaldeficitstorisefurther.Withlittle

countercyclicalpolicyspaceleftintheUnitedStates,aslowrecoveryfollowsaftertwotothreeyears

ofdeeprecession.Inthelongerrun,healthcarecostscontinuetoriserapidlyandafailuretobridge

ideologicaldivisionsovertaxincreasesandcutsinsocialspendingcausesthedebt/GDPratioto

continueitssteepascent.Investorconfidencebecomesseverelyeroded,eventuallyleadingtoafiscal

crisisandadeeprecession.Meanwhile,USforeignpolicyishandcuffedbyfiscalconstraints–asis

alreadyevidentintheUSresponsetotheArabSpringandtheeurozonecrisis–andChinaandothersare

increasinglycalledontohelp.

ConcernsaboutitswaninginfluencedetertheUnitedStatesfromreducingitsdefensespending,

causingdefensespendingtoaccelerateinChinaand,inresponse,amongitsAsianrivals.USand

foreigncompaniesshunthefiscallyandgrowth-challengedUnitedStatesasaninvestmentdestination.

OutsourcingintensifiesandgoodjobsintheUnitedStatesarescarce;socialcohesionisundermined

byrisinginequalityanddownwardpressureongovernmentspendingoneducation,infrastructure,and

socialservices.

Distractedbyitsdomesticproblemsandinternaldivisions,aparalysedUnitedStatesacceleratesits

withdrawalfromtheinternationalstage.Themultilateraltradingsystemisstalled,andtradingpartners

eschewbilateralnegotiationswiththeUnitedStatesastheycannotrelyonittodeliveronthedealsit

negotiates.TheUnitedStates’influenceintheIMF,WorldBank,andWTOdeclinesinproportiontoits

economicandfinancialweight.



Distracted by its domestic problems and internal divisions, a paralysed United States accelerates its withdrawal from the international stage. The multilateral trading system is stalled, and trading partners eschew bilateral negotiations.

Inthisbadstory,growthintheUnitedStatesslowstoasnail’space:anaverageof1.5percentayear

through2030.Weakerinternationaltradeandfinancearrangements,aswellasspilloversfromUS

andEuropeandomesticcrises,willslowgrowthinothercountriesbyabout0.5percentayear.Slower

growthholdsdownUSlivingstandards:USpercapitaGDPrisesbyonly18percentovertwentyyears,

halfasmuchasforecastinourbaseline.TheUSroleisconsiderablydiminishedinternationally–the

USshareofG20GDP(measuredinrealdollars)fallstojustunder25percentby2030,whileChina’s

economypassesthatoftheUnitedStatesindollartermsandis85percentlargerinPPPterms.Seen

asacountryonadownslide,theUnitedStatesisbothincapableofleadinganddisinclinedtolead,and

othercountrieslooktoalignthemselveswithascendantpowers.

Global implicationsEveninthegoodscenario,theUnitedStateswillbealessdominanteconomicplayerontheinternational

stage.Thatscenario,however,isunambiguouslybetternotonlyforWashingtonbutalsoforthe

internationalcommunity,whichtheUnitedStatescontinuestoleadonthestrengthofitsinstitutions

andvalues.AreinvigoratedUnitedStatesparticipatesintheconclusionofawatered-downDohaRound

andthenleadsaprocessofWTOreformthatstreamlinesnewnegotiationsandstrengthenstherules

governingtheinternationaltradingsystem.AnambitiousTrans-PacificPartnershipincludingJapan

andChinaisconcluded,asisanimportantbilateralagreementonreducingbehind-the-borderbarriers

withtheEuropeanUnion.IMFresourcesaregreatlyexpanded.Asitrebalancesitsownbooks,the

UnitedStatesstepsupitscontributionstotheWorldBankandembarksonanambitiousdevelopment

initiativeinsupportofamoredemocraticMiddleEast.WorkingcloselywithChinaandIndiaandleading

byexample,theUnitedStatesguidestheG20asittacklesthemostdifficultchallenges,fromclimate

changethroughagriculturalandenergysubsidiestofinancialregulations.

Inthebadscenario,theeurozoneunravels.TheEuropeanUnionstillexists,butasanemptyshellaround

afragmentedcontinentmiredinaprolongeddepression.Sufferingfromanotherglobalcrisis,Japan

remainsensnaredinitsdecades-longslump.WiththeUnitedStatesincreasinglywithdrawn,andfew

countrieswillingtofollowanauthoritarianandmercantilistChina(assumingitdoesnotadaptquickly

toplayingamoreprominentglobalrole),alargeanddangerousglobalpowervacuumiscreated.There

isalsoadearthofvaluesandideas,astheWashingtonConsensusbecomesdiscreditedandtheworld’s

mostsuccessfuleconomy,China,isbuiltonaone-party,state-drivensystem.

With the United States increasingly withdrawn, and few countries willing to follow an authoritarian and mercantilist China (assuming it does not adapt quickly to playing a more prominent global role), a large and dangerous global power vacuum is created.



Progressonclimatechange,tradereform,financialandmonetarysystemreform,andglobalgovernance

grindstoahalt,andthetradingsystemmaybethrownintoreversebyarevivalofprotectionism.

Aweakerandlesssecureinternationalcommunityreducesitsaideffort,leavingimpoverishedor

crisis-strickencountriestofendforthemselvesand,therefore,multiplyingthechancesofgrievanceand

peripheralconflicts.TheUnitedStateslosesitsproportionallygreatestinfluencetoregionalhegemons

–ChinainAsiaandRussiainEasternEuropeandCentralAsia–whileWesternEuropewouldremain

dividedandrudderless.TheMiddleEastfindsitselfrivenbynumerousrivalriesthatoccasionallyerupt

intoopenconflictandoilpriceshocks.Moregenerally,theabsenceofleadershipandconfusionon

valuesmakesthereconciliationofdisputesmoredifficultandtemptsthestrongesttotakerisksthey

wouldnototherwisetake.

Conclusion

The overriding lesson of these two futures is that there is more at stake in current economic policy debates in Washington and Brussels than most people realise.

Whichofthestoriesismorelikelytoberealised?Ibelievethegoodscenarioisthemorelikely,though

manywoulddisagree.Whatisclearisthattheoutcomewilldependcruciallyontoday’sdecisions,and,

ifmistakesaremade,thebadscenariomaywellmaterialise.Theoverridinglessonofthesetwofutures

isthatthereismoreatstakeincurrenteconomicpolicydebatesinWashingtonandBrusselsthanmost

peoplerealise.AreturnoftheUnitedStatesandEuropeaneconomiestohealthoverareasonable

timeframeisvitalforpreservingthecurrentinternationalorderandre-establishingasoundbasefor

continuedprosperityandpeace.



Is the Renminbi the new Dollar? Chinese monetary policy and the global reserve currency systemAndrew Leung, International and Independent China Specialist

IntroductionAmidstglobaleconomicuncertainties,theperceivedproblemofanundervaluationoftheRMBisa

perennialrefrain.AtradewarloomedwiththeUSthreateningtoimposepunitivetariffmechanisms

whichthreatenedtotriggeraglobalcurrencywar.Meanwhile,China’scurrentresource-intensive

manufacturersarealreadytradingatwafer-thinmarginsandanydrasticRMBappreciationislikelyto

causecatastrophicjoblossesandsocialinstability.TheRMBhasinfactappreciatedbysome55per

centsinceChina’sfirstcurrencyreformin1994.LiketheexperienceofappreciationoftheJapaneseyen

followingthePlazaAccord,thismagnitudeofappreciationhasnotreversedChina’sexportsorWestern

imports.GoldsteinandLardyofthePetersenInstitutehavesuggestedathree-stageapproachofhow

Chinacouldmovetoamarket-determinedexchangerateandanopencapitalaccount.However,as

Chinaisaverylargecountryinrapidtransition,anindependentRMBexchangeratepolicyisimportant

tograpplewiththemulti-facedchallengesofsocialdynamicsandgeopolitics.Inanycase,withrising

socialtensions,Chinaischangingcourseinthe12FiveYearPlan(2011–15),towardsahigher-quality,

morebalancedandmoresustainablegrowthmodelgearedtomuchhigherdomesticconsumption.

Thispromisestodiminishhercurrentaccountsurplusandforeigncurrencyreserveovertime.While

ChinaisreadytoliberaliseherfinancialservicesandtoseekarolefortheRMBasitbecomesmore

internationalised,sheislikelytoallowonlygradualandmeasuredcurrencyappreciationintunewiththe

changingtimes.China,however,wouldremainextremelycautiousingivinguptoosoontheprotectionof

anon-convertiblecapitalaccountinanuncertainworld,ifpasttraumaticexperienceisanyguide.

The dynamics of a currency warFollowingsimilarlegislationintroducedduringtheBushAdministration,7aCurrencyManipulationBill

withthreateningpunitivetariffswaspassedonCapitolHillinSeptember2010withalargemajority.

Witharecord-highunemploymentrate,depressedwages,andstrugglingexports,PresidentObama

continuedtoappealtoChina-bashingemotionsinhisStateoftheUnionaddresson24January,2012.

HisseniorofficialshavealsobeenkeepingupthepressureontheChinesecurrencyintherun-uptothe

presidentialelection.

Meanwhile,roundsofquantitativeeasing(QEs)havebeendraggingdownthevalueoftheRMBwhichis

indirectlylinkedtothedollar,makingtheChinesecurrencyseemevenmoreundervalued.

Tosafeguardcompetitiveness,otherexportingcountriessuchasJapanandBrazilhaveintervenedto

keeptheircurrenciesfromrisingtoomuchagainstadepreciatingdollar.AlongwiththeEuropean

CentralBankandtheInternationalMonetaryFund,IndiahasjoinedinthechorusforastrongerRMB.

‘Beggar-thy-neighbour’policiesareinvogue.

China’s response is that it would not be fair for the RMB to appreciate alone while the US is allowing the greenback to plummet.

7 “The Future of China’s Exchange Rate Policy”,PetersenInstituteforInternationalEconomics,WashingtonD.C,July2009,CongressionalCurrencyBillspp.77–81



China’sresponseisthatitwouldnotbefairfortheRMBtoappreciatealonewhiletheUSisallowingthe

greenbacktoplummet.Moreover,ChinaandtheUSareessentiallynotcompetinginthesamekindsof

goodsandservices.EvenifChineseproductswereentirelypricedoutoftheAmericanmarket,notmany

AmericanjobswouldbesavedasUSconsumersarepronetobuyinglow-pricedsubstitutesfromother

developingcountries.8

TheRMBhasappreciatedbysome55percentsinceChina’sfirstcurrencyreformin1994.Thishas

nothelpedUSexportsorreducedChineseimports.Thereisasimilarstoryintheappreciationofthe

JapaneseyenunderthePlazaAccordin1985.

Additionally,agreatdealofChina’sexportshasimbeddedimportedforeignparts,components,

materials,proprietarytechnologiesorservices.RMBappreciationwilllowerthecostsofsuchimports.

SotheRMBwouldhavetoappreciateevenmoredrasticallytohavetheintendedeffect.

Moreover,ever-lower‘Chinaprices’demandedbyglobalmerchandiserslikeWalmarthavedepressed

profitmarginsofChineseproductstowafer-thinlevels,oftenwellbelow5percent.DrasticRMB

appreciationwilldrivemanyChinesemanufacturersoutofbusiness,resultinginmassiveunemployment

andsocialinstability.ThiswillbeacatastrophenotonlyforChina,butalsofortheworld’sconsumers,

suppliersanddistributors.

The workings of China’s currency and monetary regime PriortoChina’sopen-doorpolicyin1978,theRMBwaskeptextremelyhigh,atRMB1.86tothedollar,

designedtosupport‘import-substitution’.AfterChinaswitchedtoanexport-orientedeconomy,the

exchangeratedroppedtoRMB5.8tothedollarby5July1986.

From1994to2001,theRMBappreciatedagainstthedollarbyatotalof18percentatanaverageof

3percentannually,withoutunderminingexportcompetitiveness.OnJuly21,2005Chinaendedthe

fixedRMB-dollarpeg,switchingtolinkagewithabasketofcurrencies,includingtheUSdollar(mainly),

theEuro,theJapaneseyen,andtheKoreanwon.

BetweenJuly2005totheendof2008,theRMBwasallowedtoappreciateagainby21percentagainst

thedollar.However,duringthisperiod,China’scurrentaccountsurpluscontinuedtosurge.

OnJune19,2010,theRMBrevertedtoamanagedfloatingexchangerateregimewithreferencetoa

basketofcurrencies.Underthisregime,theRMBspotexchangeratecanmoveintra-day+/-0.5percent

fromcentralparity.

Theoretically,anundervaluedcurrencyleadstoanever-increasingcurrentaccountsurplusandforeign

exchangereserve.Theexcessliquidityrequiresregularsterilizationviathesaleofcentralbankbillsand

increasesincommercialbanks’reserveratiorequirements.Thisactsasataxonthesebanks.Toprop

uptheircommercialviability,themarginabovethedepositratehastobekeptwide.Aslowlending

ratesareneededtospureconomicgrowth,thedepositratehastobekeptevenlowerunderamandated

interestrateregime.AsspeculationonupwardadjustmentoftheRMBbecameaone-waybet,thereisa

greatdealofcautioninraisinginterestratesasitoftenattractsdifficult-to-sterilizedisguisedspeculative

capitalinflows.

8 China’s exchange rate policy: a yuan-sided argument,TheEconomist,19November,2009,athttp://www.economist.com/node/14921327(accessedon26February,2011)



...when China’s global current account surplus stood at 3 per cent of GDP, the estimated RMB undervaluation was 15–20 per cent. By 2007, when China’s global current account surplus reached 11 per cent of GDP, the undervaluation was ‘conservatively’ estimated at 30–40 per cent.

AnanalysisbyMorrisGoldsteinandNicholasLardyofthePetersenInstituteforInternationalEconomics9

findsthatin2003,whenChina’sglobalcurrentaccountsurplusstoodat3percentofGDP,theestimated

RMBundervaluationwas15–20percent.By2007,whenChina’sglobalcurrentaccountsurplusreached

11percentofGDP,theundervaluationwas‘conservatively’estimatedat30–40percent.

AccordingtoGoldsteinandLardy,theexistingcurrencyregimehasanumberofeconomic

disadvantages,suchas:

(a) monetarypolicyinflexibility;

(b) eschewedinvestmentdecisionstowardsmanufacturingattheexpenseofservices;

(c) hinderedtransitiontoamoreconsumption-driveneconomy;

(d) reducedhouseholdincome(ofwhichinterestreceiptsareanimportantcomponentinChina),

impedingprogresstowardsatrulycommercialbankingsystem;and

(e) monetarydisequilibrium,perpetuatingChina’sexternalimbalance.

Thetwoauthorsrecommendagradualthree-stageapproachtomovetoafree-floatingexchangerate

system–duringaglobalrecession;followingglobalrecovery;andafterChina’scurrentaccountsurplus

hasdrasticallyshrunk.

Initially,duringaglobalrecession,Chinashouldavoidcompetitivedevaluationandanytaxrebatesfor

resource-intensiveexports;increaseexpenditureonphysicalinfrastructure;andexpandsocialoutlaysin

education,healthandpensions.TheRMBshouldcontinuetoappreciateby4–5percentayearwhilethe

dailyexchangeratefluctuationlimitshouldberaisedto1or1.5percent.

Duringthesubsequentstages,theRMBshouldappreciatesufficientlyrapidlytoeliminatelargecurrent

accountsurplusesin3–4years.Thegovernmentshouldreduceexchangeinterventionandsterilization;

graduallyallowdualcapitalflows;initiateinterestrateliberalisation;andsupportcentralbank

independencewithaninflationtargetingmandate.

ItisevidentthatChina’sownapproachsofarhasalreadyembodiedvirtuallyalltheingredientsofthe

firststageoftheGoldstein-Lardyrecipe.However,itisbynomeanscertainthatChinawillnecessarily

followtheothermoredrasticprescriptionsinthewayrecommendedforthesubsequentstages.

China jealously guards her monetary and exchange-rate flexibility as a powerful tool for social stability.

First,Chinajealouslyguardshermonetaryandexchange-rateflexibilityasapowerfultoolforsocial

stability.Second,whileaninflation-targetingmonetarypolicymayservetocounteractboom-and-bust

cycles10,arigidinflationtargetingapproachisnowsubjecttoseriousdebatefollowingEurope’s

mountingsovereigndebtcrisis.Third,learningfrombitterdomesticandinternationalexperience,China

remainsscepticalaboutanyone-size-fits-allrecipeforproblemsolving.Asamarketeconomyinrapid

transition,Chinaismoreweddedto‘groping for stepping stones in crossing a river’.

9 “The Future of China’s Exchange Rate Policy”,MorrisGoldsteinandNicholasLardy,PetersenInstituteforInternationalEconomics,WashingtonD.C,July2009,pp.87–96

10 “What Monetary Policy Does China Need?”,MarvinGoodfriend,ProfessorattheTepperSchoolofBusinessatCarnegie-MellonUniversityandEswarPrasad,andChiefoftheFinancialStudiesDivisionintheIMF’sResearchDepartment,postedonGlobalVision,aglobalmarketsandpovertyalleviationwebsiterunbyMercyCorps,19July,2007,athttp://www.globalenvision.org/library/3/1692(accessedon27February,2011)



The economy is more than economics IntheNovember2010issueofChinaAnalysis,apublicationoftheEuropeanCouncilonForeign

Relations,FrancoisGodementet al.11revealedapanoplyofgeopoliticalconsiderationsadvancedby

leadingChineseacademics.WhilethereisagreementontheneedforRMBinternationalisation,some

viewthisasameanstoescapeperceivedcurrencymanipulationbytheUnitedStatesastheissuerofthe

world’smostpreferredinternationalreservecurrency.

Forbackground,anApril,2005articleOur Currency, Your ProblemfortheHooverInstitutionpenned

byNiallFerguson12isinstructive.HereckonedthattheBushadministration’staxcutsandaglobalwar

onterrorwerefinancedbyamultibillion-dollaroverdraftfacilityatthePeople’sBankofChina(through

China’smassivepurchaseofTreasurybills),whichhecalled“aChinesetributetotheAmericanEmpire’.

InApril,2009,PaulKrugman,aNewYorkTimesOp-edcolumnistandNovelPrizelaureate,calledthis

China’s‘Dollar Trap’.13

AsGodementpointsout,‘since1944,thedollarhaslost97percentofitsvalueagainstgold…inthe

serviceofitsowneconomicinterests’.Nowonderon13March,2009,PremierWenJiabaoopenlyaired

hisworriesaboutChina’strillion-dollarinvestmentinUSTreasuries.14

The idea that the RMB exchange rate, a vital tool for economic and social stability, should be left entirely to a Western-dominated global marketplace in accordance with some academic criteria is regarded by some in China as a Western myth of quantitative economics.

ItmaybeasignofChina’srisingeconomicnationalismbutUSmonetarypolicyisseenbysomeinChina

as‘a mechanism for plunder’underaUS‘economic hegemony’.15TheideathattheRMBexchange

rate,avitaltoolforeconomicandsocialstability,shouldbeleftentirelytoaWestern-dominatedglobal

marketplaceinaccordancewithsomeacademiccriteriaisregardedbysomeinChinaasaWesternmyth

ofquantitativeeconomics.

RMB internationalisation barring immediate capital account convertibilityAgainstthisbackground,itmakesperfectstrategicsenseforChinatointernationalisetheRMB.The

followingregionalandinternationaldevelopmentsarebeginningtounfold:

(a)WithChinaasthecentreofAsia’sregionalproductionandsupplychain,theuseofRMBfor

internationalsettlementswithChina’stradepartnersworldwideisgatheringpaceasChina’s

economyisgrowingtobecometheworld’slargest,probablybytheendofthisdecade.

(b)Asof13March2012,JapanannouncedaplantoacquireUS$10.3billionworthofChina’streasury

bondsaspartofitsforeigncurrencyreserve,followingMalaysiaandChile.Asthegreenbackis

perceivedtocontinuetolosevalue,thetrendofincludingRMB-denominatedChinesetreasuries

inforeigncurrencyreserveswillprobablyaccelerate.Thisoptionmaybecomeincreasingly

attractivetoenergyexportingcountriessuchasRussiaandtheMiddleEast.

11 “Redbacks for Greenbacks: The Internationalization of the renminbi”,FrancoisGodementetal.,ChinaAnalysis,EuropeanCouncilonForeignRelationsandAsiaCentre,November2010

12 “Our currency, Your Problem”,NiallFerguson,HooverInstitution,StandfordUniversity,30April,2005athttp://www.hoover.org/publications/hoover-digest/article/6386(accessedon27April,2011)

13 “China’s Dollar Trap”,PaulKrugman,NewYorkTimes,2April,2009athttp://www.nytimes.com/2009/04/03/opinion/03krugman.html?_r=1&em(accessedon27February,2011)

14 “China’s Leader Says he is ‘Worried’ Over US Treasuries”,NewYorkTimes,13March2009,athttp://www.nytimes.com/2009/03/14/business/worldbusiness/14china.html(accessedon27February,2011)

15 SeeMichaelHudson’scontroversialbook,“Super Imperialism - The Economic Strategy of American Empire”,PlutoPress,NewEditionMarch2003,whichoffersano-holds-barredelucidationofaplausible“AmericanGrandDesign”toruletheworldthroughcalculated“MonetaryImperialism”



(c)WithsupportfromBeijing,HongKongisbeingdevelopedasthepremieroffshorefinancial

centreforRMBinternationalisation,includingtheissuanceof“dimsum”bondsandother

RMB-denominatedfinancialinstruments.RMBbankdepositsinHongKonghavebeenrising

rapidlytoRMB627billioninMarch2012.Itisexpectedtojumptosixtrillionby2020,much

morethanthedepositbaseoftheHongKongDollar,withimplicationsforHongKong’scurrent

USdollarpeg.

(d)SingaporeispositioningitselfasaregionaloffshorefinancialcentrefortheRMB.SoisLondon.

ThiswouldfurthersupporttheinternationalisationoftheChinesecurrency.

(e)ContinuousdiversificationofChina’soutboundsurpluscapitalisleadingtomore

Chinesemergersandacquisitionsofassetsacrosstheglobe,expandingRMBcommercial

relationshipsinternationally.

(f)Chinaisontracktocontinuetoliberaliseherfinancialsector,suchasthequalifiedforeign

institutionalinvestor(QFII)andthequalifieddomesticinstitutionalinvestor(QDII)schemes,16

allowingforafreerinflowandoutflowofRMBfundsforinvestmentpurposes.

...China is quietly extracting herself from the ‘Dollar Trap’ by creating an international monetary zone of her own.

Thisway,Chinaisquietlyextractingherselffromthe‘DollarTrap’bycreatinganinternationalmonetary

zoneofherown.

However,China’scapitalaccountnon-convertibilityhasproveditsusefulnessduringrecentglobal

financialcriseswhenitshieldedChinafrommuchofthecross-borderfinancialtsunami.Inthelightof

increasinginternationalfinancialuncertainty,Chinaisunlikelytobeinahurrytodiscardthisprotection.

Global reserve currency systemOntheotherhand,Chinaisbecominganxiousforamorestableinternationalcurrencysystem.The

clarioncallwasfirstsoundedbyZhouXiaochuan,theGovernorofthePeople’sBankofChinaon

23March,2009,17referringtotheneedtoaddresstheso-called‘TriffinDilemma’.18Zhouproposedusing

SpecialDrawingRights(SDR)oftheIMFtoreplacetheUSdollarasaprimaryreservecurrency.

WhileitisdebatablewhethertheSDRistheidealsolution,thehistoricAmericancredit-rating

downgradeandthedoubtfulfutureofthedollarasastablelong-termstorageofvaluearelikelytorevive

thisdebate.AsChina’seconomyisslatedtoovertaketheUSeconomyby2018(TheEconomist)or2027

(GoldmanSachs),19thedaywhentheRMBemergesasatleastoneoftheworld’sreservecurrenciesno

longerseemstoofaraway.

16 SeeagooddescriptionoftheseschemesonWikipedia:QualifiedDomesticInstitutionalInvestorathttp://en.wikipedia.org/wiki/Qualified_Domestic_Institutional_InvestorandQualifiedForeignInstitutionalInvestorathttp://en.wikipedia.org/wiki/Qualified_Foreign_Institutional_Investor

17 ZhouXiaochuan’s“Statement on Reforming the International Monetary System”,CouncilonForeignRelations,athttp://www.cfr.org/china/zhou-xiaochuans-statement-reforming-international-monetary-system/p18916(accessedon27February,2011)

18 Inthe1960s,aBelgian-AmericaneconomistRobertTriffinoutlinedthepotentialconflictofinterestbetweenwhatisdesirableforthereserve-currencyissuingcountryandwhatisbestformaintainingglobalcurrencystability.Thisisknownasthe“TriffinDilemma”

19 “Jim O’Neill: China could overtake US economy by 2027 ”,TheTelegraph,16March2012reiteratesthedateof2027asassessedbyGoldmanSachsearlier.Seehttp://www.telegraph.co.uk/finance/economics/8901828/Jim-ONeill-China-could-overtake-US-economy-by-2027.html(accessedon16March,2012)



Global economic imbalance Underlyingtheabovediscourseistherootcauseofmanyoftheworld’scrisesandconflicts–asystemic

globaleconomicimbalance.Wellbeforethefinancialcrisis,Asianexportingcountries’mounting

surpluseswerefedintotheWest’sfinancialsystemthroughinvestmentinUSTreasuries,supporting

perenniallylowinterestratesandeasycredit.Thelatterhasbeenexotically-leveragedunderthe

imperativeoffinancialinnovationtofeedanunbridledconsumptionerabuiltonaninflatedhousing

bubble.ThisinturnpushedupAsiancountries’exportsandsurpluses,withtheresultthatmorewas

investedinUSTreasuriestofundevenmoredebt-drivenconsumption.Inshort,theWest,particularly

theUS,isover-consumingwhileChinaandsomeothersurpluscountriesareover-saving.

...China has been rebalancing her economy towards domestic consumption. Studies ... have highlighted the burgeoning consumer market in China and how it will account for a lion’s share of global consumer growth in the coming decades.

Meanwhile,Chinahasbeenrebalancinghereconomytowardsdomesticconsumption.StudiesbyCredit

SuisseandMckinseyhavehighlightedtheburgeoningconsumermarketinChinaandhowitwillaccount

foralion’sshareofglobalconsumergrowthinthecomingdecades.20By2025,China’sconsumermarket

willbedrivenby350millionmoreurbanitesin221newcities,accordingtoaMcKinseystudy.21

Concurrently,notwithstandingquantitativeeasing,Americansarenowbeginningtosavemoreas

peopleprefertopaydowntheirdebtratherthanburningtheirfingersagainwithrecklessdebt-driven

consumption.Soaglobalrebalancingmayalreadybetakingplace,accordingtoStephenRoach,

ChairmanofMorganStanleyAsia.22

ConclusionAccordingtoChina’sRichList2010,therearemorethan550,000householdswithprivatewealthmore

than100millionRMB.Yet,Chinaisstillaverypoorcountry,withpercapitaincomerankingamongst

someofthepoorestcountriesinAfrica.Some170millionChinesepeoplestillremainatorbelowthe

povertylineof$1.25aday.

Inthiseconomicdivide,thereisrisingdiscontentduetogallopingfoodprices,irregularlandgrabs,

labourdisputes,pollution,corruption,inequality,andsocialinjustice.Withamoreeducatedand

internet-savvymiddleclass,smoulderinggrievancesmaythreatentoigniteafire,aswhathasbeen

happeningacrosstheMiddleEast.

ChinaisbeginningtoswitchtoamoreequitableandsustainabledevelopmentmodelinthenewFive

YearPlan(2011–15).Ifrealised,thetransformationwilldiminishChina’scurrentaccountsurplus,

moderateherforeigncurrencyreserve,andreduceincessantpressuresforRMBappreciation.

To promote consumption and investments of a growing middle class, China stands to benefit from gradual currency appreciation, financial system liberalisation, a more flexible interest rate regime, and freer outward and inward capital flows.

20 Forexample:Jf.Garner,“The Rise of the Chinese Consumer: Theory and Evidence”,JohnWiley&Sons,2005and“TheValueofChina’sEmergingMiddleClass”intheMcKinseyQuarterly,2006.

21 “Preparing for China’s Urban Billion”,McKinseyGlobalInstitute,March,2008

22 StephenRoach,“Next Asia: Opportunities and Challenges for a New Globalisation”,Wiley,2010



Itisnocoincidencethataraftofreformmeasuresisproposedinarecent468pagestudyreportjointly

compiledbytheWorldBankandtheDevelopmentResearchCenter(DRC)oftheStateCouncil.Manyof

thesemeasuresaredesignedtoimprovetheefficiency,equity,andsustainabilityofChina’ssystemof

allocationofresources,echoingthespiritifnottheletteroftheGoldsteinandLardystudiesmentioned

above.ThesereformmeasuresareessentialifChinaistoescapethe“MiddleIncomeTrap”23andto

becomea“Modern, Harmonious, and Creative High-Income Society”by2030.24

Nevertheless,astheexistingworldorderisnowbeingchallengedwitharisingChina,thewatersahead

remainuncharted.Moreover,withanageingpopulationprofile,Chinaislikelytogrowoldgettingrich.

Duringthenation’schallengingdevelopmenttrajectory,whilesheissettoredoubleeffortstoboostthe

RMB’sstatusasaninternationalcurrency,liberaliseherfinancialsystemandredressthesocio-economic

andecologicalimbalanceofhereconomy,Chinaislikelytoremainextremelycautiousinnotgivingup

toosoonthefinancialprotectionofanon-convertiblecapitalaccount.

23 InhisOpeningRemarkson3September2011attheConference on China’s Challenges for 2030inBeijing,RobertB.Zoellick,WorldBankGroupPresident,wantedtounderstandhowChinacouldavoidtheso-called“MiddleIncomeTrap”–thatstagewhenmanycountriesinSouthEastAsiaandLatinAmericawhenreachingabout$3,000to$8,000percapitaincomeseemtostallinproductivityandincomegrowth.

24 “China 2030 – Building a Modern, Harmonious, and Creative High-Income Society”,astudyjointlyundertakenbyTheWorldBankandtheDevelopmentResearchCenteroftheStateCouncil,thePeople’sRepublicofChina.Thereportwasreleasedon27February,2012.Aconferenceeditionmaybeaccessedathttp://www.worldbank.org/content/dam/Worldbank/document/China-2030-complete.pdf



The shifting balance between “risk” and “uncertainty” in a globalised world systemLaurence Whitehead, adviser on macro risk at Oxford Analytica, and Official Fellow in Politics at Nuffield College, Oxford.

Environmental,financial,geopoliticalandsecuritysurprisesofrecentyearsallunderscorethe

inadequaciesofrecentlyfashionable“riskmetrics”,whichaimtotameuncertaintybyattaching

numericallyprecisestatisticalprobabilitiestocontingentevents.Thetheoreticalfoundationsofthis

“bellcurve”or“standarddeviation”approachtoriskmeasurementrequiretheeventsinquestiontobe

separable,recurrentandreasonablyhomogeneous.Thishasprovedapowerfulanalyticaltoolforthe

managementofawiderangeofinsurancerisks(roadaccidents,epidemiologicalincidenceandsoforth),

anditcanalsobefruitfullyappliedtosomeenvironmentalissues(forinstancehurricanefrequenciesand

intensities)andtosomemajoraspectsoffinancialbehaviour(suchasindividualstockselection,asset

allocationandsoforth).

Ithasnowbecomeoverextended,havingbeenappliedtomacro-contingencies(suchascivilwars)

wherecasesareinfrequentandfarfromhomogenous.Andithasbeenappliedtoeventsthatarenot

fullyseparable,butthatbelonginlongerchainsofcausationwheretheparametersofinteractionare

inherentlyunstableoruncertain(theso-called“butterflyeffect”isinvokedbychaostheoriststoillustrate

suchpossibilities).Italsorequirespatternsofbehaviourtoberecurrent,therebyrulingoutantagonistic

strategicgamechanges,nottomentiontheinterventionof“unknownunknowns”(or“blackswans”).It

worksbestwhenthecausalconnectionsunderconsiderationaretightandlinear,butmostofthemajor

issuesfacingcontemporarypolicymakersrequirebothmulti-causalandnon-linearformsofanalysis.

ForthefirsttwodecadesaftertheendoftheColdWarthisconfidenceintheever-widerapplicabilityof

statisticallybasedriskmanagementtechniqueswassteadilyextendedintoprogressivelymoredubious

domains.Itchangedbehaviour,ashithertoscepticalandcautiouspolicymakersweredisplacedby

moreconfidentandaggressivestrategicmaximisers,whosereputationsforsuccessderivedfromtheir

willingnesstopresssuchriskmetricstotheverylimitsoftheirplausibility–andthenbeyond.

For the first two decades after the end of the Cold War this confidence in the ever-wider applicability of statistically based risk management techniques was steadily extended into progressively more dubious domains.

The1998collapseoflong-termcapitalmanagementprovidedanearlywarningofwherethiscycleof

behaviouralchangewaslikelytolead.Whenthiswarningwasnotheededthe2008“suddenstop”to

liberalisedfinancialflowsprovidedastarkerandmoreseverecorrective.By2011thelessonwasmore

widelyassimilated.Theoverconfidenceinsuchriskmetricsthatcharacterisedthepreviousdecades

wasfollowedbyasevereswitchbacktowardsultra-defensivebehaviourandacuteriskaversion.This

isespeciallyapparentinthemajorliberalisedinternationalfinancialmarkets,butitisalsobeginning

topromptparalleldefensiveshiftsinkeygeopoliticalarenas.AnexampleofthisisGermanpublic

aversiontobearingSouthernEuropeaneconomicrisks.Similarly,thesuccessfulalQaidaprojecttofly

commercialplanesintotheTwinTowershasstimulatedachainreactionofsecurityprecautionsever

sinceSeptember2001.The2011nuclearaccidentatFukushimahasproducedacomparablereversal

ofriskappetitesintheglobalnuclearpowersector,withmajorconsequentialimpactonbroaderglobal

energysecurityconcerns.



The current retreat from “risk” and rise of uncertainties financial sectorOneofthemosttellingconfirmationsthattheoldintellectualconsensushasfailedconcernstheedifice

ofnumericalbeliefsitconstructedaroundthenotionofa“riskfree”classoffinancialasset.According

toorthodoxfinancialtheorythiswassupposedtobeUnitedStatesTreasurybills.Neithermonetary

theorynorfinancialhistoryactuallyprovidedmuchofajustificationforthisassumption.Afterall,within

livingmemorytheUnitedStatesgovernmenthadendedtheconvertibilityofthedollarintogold,and

throughoutthefirstdecadeofthetwenty-firstcenturyfirstthePresident,thentheCongress,andthen

theFederalReservehaddedicatedtheireffortstounderminingthefiscalandmonetaryfoundations

ofthegreenback.BythetimeoftheLehmancollapsein2008therewasanevidentlynon-negligible

possibilityofanotherlegallyenforcedsuspensionofnormalcommercialbanking,andinAugust2011

Standard&Poor’sdroppedtheUSgovernment’stripleArating.Intheabsenceofanunquestionably

“risk-free”financialyardstick,alltheelaboratelystructuredhierarchyofhigherriskassetslosttheir

fundamentalmoorings.WiththeFederalReservecurrentlypromisingnegligibleinterestrateson

treasurybillsandbondsforanextended(ie,multi-year)periodoftime,itisofferingnofinancialreward

forholdingliquidity.Thiscanfeedvolatilityandcapitalflight.

Thishighlightsthebroaderprocessoftheretreatofmeasurableriskanditssubstitutionbyuncertainty.

Theuncertaintyarisesfromthefactthatshort-termmoneymanagersnolongerhaveahighlycalibrated

structureofincentivesto“lock-up”theircashfordeterminateperiodsoftime.Intheabsenceofsuch

traditionalconstraintsandincentives,theymightbemoreproneto“herdbehaviour”whichcouldtake

theformofextremelyrapidandmassiveredeploymentsoffundsfromonedepositbasistoanother,

perhapspromptedbynothingmorethanfalserumoursoranticipatorydefensiverepositioning.As

financialintermediationhasacceleratedoverthepasttwodecadesofeconomicglobalisationand

financialliberalisation,thestockofliabilitiesaccumulatedwithinboththeformalandthe“shadow”

bankingsystemshasrisentoaneverhighermultipleofthegoodsandservices(“real”)sideofworld

economicoutput.Thestabilityoftheseliabilitiesrestsonatrustworthystructureofcounterparty

interactionandarbitration,andinthelastresortonalegallyenforceabledisputeresolution,liquidation,

anddebtsettlementsystem.Thus,financialconfidencecannotultimatelybedetachedfromtheexercise

ofsovereignpower.But“toobigtosave”banksareunderpinnedbyhostgovernmentsreliantontax

basesthatinturnaredependentupontheoutputlevelsofnationaleconomicsystems.

Since2008,illusionsofsupranationalauthoritycapableofbackingup,orevenover-riding,these

sovereignstateprerogativeshavebeenshattered.IcelandandnowGreecebothprovethatnational

fiscalauthoritiescanassumecontingentliabilitiestoprivatefinancialcorporationssolargethattheir

ownsovereigncredit-worthinesscanbejeopardised.Theideathatsomehigherlevelauthority–the

ECB,theIMFortheFederalReserve–willalwaysbeavailabletoreinforcesovereignsinfiscaldistress

cannolongerbetakenforgranted.

The idea that some higher level authority – the ECB, the IMF or the Federal Reserve – will always be available to reinforce sovereigns in fiscal distress can no longer be taken for granted.

Infactitisnowbecomingapparentthatnotonlyafewover-extendedperipheralstates,butevenleading

advancedcapitalistnations(suchasItaly)may,inextremis,proveunabletopay.Ifso,statepowerwill

beusedtodisruptmarketoutcomes.TheacutefinancialuncertaintiesthathaddestabilisedEuropeand

theworldinthe1930swererelegatedtothemarginsofriskanalysisbefore2008,butarenowresurgent

intheeurozoneandpotentiallymorewidely.



Environmental sectorAlthoughthemostspectacularshiftfromriskbacktouncertaintycanbeobservedinthedomainof

finance,therearealsoparalleltrendsinevidenceelsewhere.Forexample,inthedomainofglobal

climatechangemodellingandmanagement,thedominantassumptionfromthefoundingoftheUN

IPCCtothe2010conferencetoupgradetheKyotoTreatywasthatasmoreaccuratescientificevidence

wasaccumulated,therangeofuncertaintieswouldbenarrowed,andarationalcost-benefitstrategyfor

mitigationofcarbonemissionswouldconsequentlyemerge.Thepeakofthisriskassessmentoptimism

wasprovidedbytheSternReport.Evenatitsapex,thisstillrequiredaleveloftrustthatwentbeyond

whatwaswarrantedbythehardevidence.

Overthepastcoupleofyearstheobjectivityofthescience,thereliabilityofthedata,andthe

trustworthinessoftheprocessforriskmanagingglobalwarminghaveallcomeundersustained

pressure.Whilethereisnolongermuchseriousdoubtabouttheimportanceofanthropogenic

climatechange,thisgeneratesmoreuncertaintythanconsensusonthenecessaryandfeasible

stepsrequiredforeffectivedamagelimitation.Theuncertaintiesaremultipleandoverlapping;some

concerntimeframes,othersconcerncosts,whileothersconcerntheriskofunintendedsideeffects.

Inaddition,thereareimponderablesconcerningtherespectiveresponsibilitiesofthenumerousand

heterogeneousdecision-makers.

Collectiveactionandagencydifficultiescompoundtheotheruncertainties.Confidencethattheserisks

canbeaccuratelyassessedandthenappropriatelymitigatedhasbeenthrownintoreverse.Asaresult

(compoundedbythefinancialcrisis)thiscategoryofriskanduncertaintyhassimplyslippedfardown

thepolicyagenda.Whereasariskmanagementphilosophywouldfocusonthegreatestdangers,a

switchtoundifferentiateduncertaintycancauseacrucialissuetosimplybecomeshelvedastoohardto

tackle(untiltheneglectgeneratesanunmistakablecompulsiontoreact).

Security sectorSimilarconsiderationsmaybeoperatinginthesecurityrealm.TheWest’sunexpectedlycomprehensive

victoryintheColdWardismantledtheSovietUnion,whichwasonelongstandingandrigidstructureof

securityrisks.Foradecadeorsodefencespendingwasreduced,anditseemedthatprogressmightbe

madeintamingtheremainingrisks.Butsincetheunexpectedlytraumaticandeffectiveasymmetricwar

techniqueusedbyalQaidainSeptember2001theproliferationofnewsecuritydangershasoverturned

anysuchoptimism.

In addition to “terrorism” ... these dangers include accelerated nuclear proliferation between antagonistic states; intensified vulnerability of advanced economies to cyber-attack; and various forms of biological and chemical warfare that may be operated either by non-state as well as state actors.

Inadditionto“terrorism”nurturedin“ungovernedspaces”,thesedangersincludeacceleratednuclear

proliferationbetweenantagonisticstates;intensifiedvulnerabilityofadvancedeconomiestocyber-

attack;andvariousformsofbiologicalandchemicalwarfarethatmaybeoperatedeitherbynon-state

aswellasstateactors.Inresponsetothisharshersecurityenvironment,thedominantwesternpowers

haveattemptedtomaintaintheirascendancy,andtomitigaterisk,byacceleratingtheproductionof

newmilitaryandsecuritytechnologies.CurrentlyWashingtoniscomingtodependmoreon“drone”

attacks,andtheassociatedwarfarecapabilities,topoliceremoteenemyhavens,andtoeconomiseon

increasinglylessexpendablenationalmanpower.




This,andother,innovationsmayseemtodefenceplannerstobeeffectiveinstrumentsofriskmanagement,

buttheyarerelativelyuntriedandmaycarrywiththemgraveunintendedconsequences.Forexample,

dronesdiscreditafoundationalprincipleofnationalsovereignty–citizensobeythelawinajurisdiction

inturnforanassuranceofbasicsecurity.Itisuncertainwhethercurrentwesternmilitarydoctrineand

practicewillproveasuccessfulinstrumentofriskmitigation,orapotentengineofdelegitimisationin

countrieswherethebeneficiariesofanarchythemselveswillturnouttobethemselvesanintensified

sourceofdanger.Whereasthelogicofcooperationmayhelptostabiliseinsecuritiesinthefinancial

domain(everyonesuffersifcooperationfails)inthesecuritydomainitisthelogicofconflictthat

necessarilystructuresbehaviour.Thus,everyriskmitigationstrategyhastobeassesseddialectically–

ie,byconsideringhowanopponentwillreacttoexploititsassociatedvulnerabilities.

Geopolitical realmFinally,globalisationhasproducedprofoundlong-termgeopoliticalshiftsinpowerandresources.

Suchshiftsarestillon-goingataveryrapidpace,andtosomeextenttheirdynamicscanbeassessed

andplannedfor.However,thesuccessfulmanagementofsuchtectonicadjustmentsrequiressolid

institutional,securityandfinancialbasis.Asnotedabove,therehasbeenariseofuncertaintyandthe

displacementofmeasurablerisksinthesevariousdomains.Thatcanmakethesteeringandcontainment

ofgeopoliticaltensionsmoreproblematic,moreshort-termandmorecrisis-prone.Thisismuch

discussedinrelationtothe“riseofChina”andthe“reset”ofUS-Russianrelations.Italsoariseswith

theassociatedandpotentiallydisorderlyweakeningoftheEuropeanUnion.Butperhapsthebestwayto

illustratethebroaderuncertaintiesthatcanariseistoconsidertheGreaterMiddleEast.

Thisregionremainsthemostcrucialreserveofglobaloilandgassupplies.Itisalsothemostheavily

committedtoextravagantdefenceprocurementpoliciesfundedeitherfromoilrentsorviaforeignaid.

TheinvasionandoverthrowoftheSaddamHusseindictatorshipwasimaginedasafirststeptowardthe

creationofamorestableanddemocraticMiddleEastbetteralignedwiththeinterestsofthedominant

powersinthe“internationalcommunity”.Butthetensionsanduncertaintiesthathavearisenthroughout

theregioninthewakeofthatinterventionhaveproducedrepercussionsthatarehardtocalibrate

andextremelydifficultfortheauthorsoftheoperationtomanage.Perhapstherecentinterventionin

LibyaandthecurrentconflictinSyriawillprovesideeventsalongtheroutetotheintendedoverall

restructuringoftheMiddleEast’spoliticalprofile.Buttheuncertainties(concerningIran,Israel,the

electoraloutcomeinEgypt,andsoforth)stillseemtodwarfthepredictabilities.TheMiddleEastremains

amajorpivotofgeopoliticalturbulencewhichlacksmuchreliablebasisforlong-termstrategicplanning.

...the uncertainties (concerning Iran, Israel, the electoral outcome in Egypt, and so forth) still seem to dwarf the predictabilities. The Middle East remains a major pivot of geopolitical turbulence which lacks much reliable basis for long-term strategic planning.

Insummary,riskmanagementhasweakened,anduncertaintyhasreturnedwithavengeanceoverthe

lastfewyears.Uncertaintyhasbecomemorecentraltofinancial,securityandgeopoliticalassessments.

Riskmanagementoftheorderlyandrationalvarietyderivedfrommicro-analysisofinsurableeventshas

notprovedsoextendableintothesemacro-domainsaswasexpectedafewyearsback.So,howshould

responsibleanalystsandglobalpolicymakersrespondtothisemergingpanoramaofchallenges?


Some principles for coping with macro uncertaintyDerivingprescriptiveconclusionsfromsuchanopen-endedglobalanalysisastheprecedingdependson

whattimescales,policydomainsandintereststandpointsareinquestion.Thissectionstandsbackfrom

thoseissues,andsuggestssomeverybroadandgeneralprinciples:

Alertness and sceptical monitoringThegreatdrawbacktoexcessiverelianceonquantitativeriskmanagementtechniquesisthatthey

canlulltheunsuspectinguserintoafalsesenseofsecurityanddullalertnesstocontraryindicators.

Inalltheexamplesoutlinedabove,itwaspossibletodetectsignsthatsomethingwasmissingfrom

themainstreamanalysis.Butthisrequiredscepticismconcerningthepredictivereliabilityofthemost

fashionablemanagementtools,andawillingnesstoincurthe–oftennotinconsiderable–costsof

challengingprevailing“groupthink”.Acomparativeandhistoricalperspectivecouldoftenprovidethe

foundationfordiscordantquestioning.But,ofnecessity,thedoubtermightfindhimorherselfalonefor

anextendedperiodoftime.And,giventheuncertaintiesunderconsiderationmanyscepticswouldnever

bevindicatedbytheeventualturnout.Organisations,therefore,needtocreateinstitutionalstructures

andproceduresthatshelterwell-informedandsincerelyheldminorityviewpoints.Evenwhenasceptical

stanceisnotborneoutbyexperience,itcanimproveanalyticalcapabilitiesbystimulatingalertness.

Contour analysis and scenario planningTheriseofuncertaintyandthedeclineofstatisticallyreliableriskmeasurementdonotmeanthat

allcontingenciesareequallyplausible,orthatfuturedevelopmentsareentirelyunknowable.Tothe

contrary,scalingbackrelianceonspuriouslyaccuratepredictivemodelscanopenthewaytomore

helpfulandrealisticevaluationsofprospectivetrendsbasedonqualitativeevidence,interpretative

theorisingandwell-honedjudgement.Thestartingpointforsuchevaluationsistorecognisethat

differentanalyticaltechniquesarerequiredfordifferentissuedomainsandpolicydebates.Afirststep

mustthereforebetoassesstherelativeweighttoattachtotightcausalpredictionasopposedtolooser

andmoresubjectivecontourmappingandscenarioplanning,whenaddressingthespecificproblemarea

underconsideration.

Contouranalysisinvolvesmappingtheoverall“lieoftheland”onwhichspecificcontingent

developmentswillplayout.Forexample,althoughthenatureandeffectivenessoftheGaddafiregime’s

responsetotheArabuprisingswashardtopredict(notleastgiventhecentralisationofpowerandthe

eccentricpersonalityoftheruler)therewereunderlyingstructuralcharacteristicsofLibya’spolitical

andsocialgeographyanditseconomicstructurethatcouldbestudiedwithmorereliabilityandthat

wouldbesuretocontributeconstraintsandreservestoshapetheresultingregimechange.Similarly,

eventhoughthefullconsequencesofadoublingofatmosphericCO2maybehighlyuncertain,thereare

moredefiniteelementsthatcanbestudiedandtakenintoconsideration;forexample,ifoneconsiders

thesealevelriseassociatedwiththemeltingofpolaricesheets.Whendirectmeasurementstoriskare

unreliableitmayneverthelessbepossibletotrackmajorcomponentsoftheunknowabletotalthrougha

systematiccontouranalysisapproach.

When direct measurements to risk are unreliable it may nevertheless be possible to track major components of the unknowable total through a systematic contour analysis approach.



Scenarioplanningcanalsoprovideaconstructivesubstituteformisleadinglyrigorouspredictive

forecastingtechniques.Atthetimeofwritingthereisverylittlereliablebasisforpredictingthenear-

termoutcomeofthecurrenteurozonefinancialcrisis.Thealternativepossibilitiesarestarklyat

variance,theinevitabilityofaforkintheroadisapparent,butguessingwhichoptionwillprevailisa

highlysubjectiveandbasicallyquitearbitraryexercise,atleastfornow.Insteadofattachinguntenably

precisequantitativeprobabilitiestothevariousalternatives,ascenarioplannerwouldconcentrate

onsharpeningthelogicalstructureofthecontrastingtrajectories,andhighlightingthedriversand

obstaclesatworkineachcase.Thisisamodellingprocedurethatinevitablyoversimplifiesand

stylisestherivalscenarios(inpracticeoutcomesarealmostalwayssomemessyhybridoftheoptions

considered).But,ifconductedwithjudgementandinsight,itcanprovidemorehelptodecision-makers

whoneedtoanticipatefuturetrendsthananyoverlymechanisticprojectionorextrapolation.

“Navigating” contingencies rather than “controlling” variablesThenumericalprecisionofstandardriskmanagementtechniquescancreatetheillusionthatdecision-

makersarefullyincontrolofalltherelevantvariables.Whilethatmightbeareasonableapproximation

torealityinsomepolicydomains(salesvolumewillfallbyXpercentiftobaccotaxisraisedbyYper

cent)itcanbeasourceoferroranddangerifunthinkinglyextendedtosuchmacro-domainsashave

beenconsideredabove.Policymakerswholiquidatebanksorlaunchdroneattacks,orclosenuclear

powerstationsneedtobehelpedtorecognisethelimitsoftheirabilitytoforeseealltheconsequences

oftheiractions,letalonetocontrolalltherelevantvariables.Theymaywellbecomeprisonersofthe

dynamictheyhaveunleashed,nolongerincontrolbutrathercontrolledbyforcestheycouldnotfully

anticipate.Evenso,therearemanysituationsinwhichpolicymakersmustactonewayortheother,or

accepttheconsequencesoftheirinaction.Thecourseofwisdommaybetomaptherelevantcontours,

toreviewthealternativescenarios,tocarefullyconsiderdiscordantvoices,andthenifnecessarytotake

thecriticaldecision,infullknowledgethatwhatthenfollowsmaywellbecontingentanduncertain.

The course of wisdom may be to map the relevant contours, to review the alternative scenarios, to carefully consider discordant voices, and then if necessary to take the critical decision, in full knowledge that what then follows may well be contingent and uncertain.

Themetaphorof“navigation”isrelevanthere.Eventhemostpowerfulofpolitical,economic,business

orscientificleaderswilloftenbeunabletomeasureinadvancethecostsorreturnsoftheirstrategic

choices.Onceapolicyissetinmotionitmaybepossibletoevaluatetheout-turnbycomparisonwith

initialexpectations.Butwhenlargescaleandcomplexproblemsrequirefull-scaleengagement,itcan

benoeasymatterforpowerfulleaderstoobtainindependentandobjectivefeedbackonhowwellthey

havebeenchosen.Therewillbepowerfulvestedinterestsinpresentingafavourableinterpretationof

theresults,and(ifnecessary)ingeneratingalibisorcounterfactualjustificationstocoverupfailures.

Complexdynamicprocesseslikeeurozonereform,orfinancialmarketintervention,seldomproduce

short-termclear-cutandfinalresults.Insteadtheyunfoldstochastically,witheachnewstagepresenting

furtherdecisionpoints,andchangingtheparametersoftheinitialchoiceset.Insteadoflaunchinga

rockettothemoon,thepolicymakerismorelikelytohaveembarkedonasailboatacrosstheAtlantic.

Eveniftheeventualdestinationisfairlyreliablyknown,theinterveningstormsandcurrents,andother

possiblesurprisesbothonboardandenroute,canmeanthatthetimeofarrivalanddetoursduringthe

voyagesremainunpredictablecontingencies.Recognitionofsuchimponderables,andpreparednessfor

theunexpected,constitutethefoundationsofwisdomwhencontemplatinganysuchundertaking.



Adherence to basic principles

If reaction times have become more volatile, if interaction effects have become more complex, and if key actors have lost trust in one another and become more short-term and defensive, then Fordist-style management techniques may no longer deliver as expected.

Ifstatisticallyrobusttoolsofriskmanagementwerereliablyavailablethenthetaskofthedecision

makerwouldbegreatlysimplified.Allthatwouldberequiredisforthedesiredoutcometobe

identified,followedbyatechnicalexercisetoensurethatthemeanschosentoachieveitwerethe

mostefficient/reliable/cost-effectiveavailable.ThisisroughlyhowtheSternReportconceptualised

globalstrategytolimitanthropogenicclimatechange,howtheFederalReservehasapproached

“quantitativeeasing”,anditmaybehowthePentagonoperatesitsdronesprogramme.Butdespite

theoperationalappealofthismodelofdecision-making,thepost-2008worldsystemisprovingmore

uncertain,unstableandunreliablethanthisapproachassumes.Ifreactiontimeshavebecomemore

volatile,ifinteractioneffectshavebecomemorecomplex,andifkeyactorshavelosttrustinoneanother

andbecomemoreshort-termanddefensive,thenFordist-stylemanagementtechniquesmaynolonger

deliverasexpected.Yetglobalmacro-problemsofgreaturgencyandcomplexitymustnevertheless

beaddressed.Decision-makersfacedwithsuchadverseconditionsmaydeserveoursympathyand

encouragement,buttheyalsoneedpubliclegitimacy.Theiractions(oromissions)canbeexpectedto

inflictbigcostsonsome,aswellasconferringlargebenefitsonothers.Ifthetruthisthattheyarenot

fullyincontrolofalltheconsequencesoftheirchoices,thentheywillriskprovokingresistanceand

non-cooperation.Somepragmaticmid-causecorrectionsareboundtobenecessary,butthebigdanger

isthattheholdersofpublicofficecouldappeartobezigzaggingexpedientlymerelytoservethenarrow

interestsoftheirinnercircles,andtoconcealtheirmisjudgementsfromthewiderpublic.

A final prescriptive conclusion, therefore, is that in such uncertain conditions it becomes even more important for policymakers to keep in mind some basic principles of probity and public interest.

Afinalprescriptiveconclusion,therefore,isthatinsuchuncertainconditionsitbecomesevenmore

importantforpolicymakerstokeepinmindsomebasicprinciplesofprobityandpublicinterest.Even

iftheyarenotabletoachievelegitimacybydeliveringdesiredresults,theycantrytomaintaintrust

throughtheobservanceofcorrectproceduresandthemaintenanceofstrongaccountability.



5. the three scenarios 5. The three scenarios Intheprevioussection,anumberofpre-eminentauthorsidentifiedsignificantandinterrelated

socioeconomicrisks,whichcouldhavesevereimplicationsforlong-termpeaceandprosperity.By

pullingtogethersomeoftheirkeyconclusions,itispossibletooutlineafewsimple,socioeconomic

futuresfacingtheworld.

Inthiscontext,threescenariosaresetoutbelow;anupside,whichrepresentsabestcase,adownside,

whichrepresentsaworstcase,andacentralscenariowhichrepresentssomethinginbetween.Each

scenarioreflectsonhowthedecisionsandactionstakenbypolicymakersintheshortrun(boththosein

governmentandelsewhere)canplayakeyroleindeterminingwhichlong-termfuturetheworldfaces.

Wethenrelateeachscenariotopossibleimplicationsforthefutureofinsuranceandfinancialservices.

Acoupleofcaveatsbeforedelvingintothesescenarios:ineach,weassumethat;1)Asian,andin

particularChinesegrowthisrelativelyrobustand2)whilstexperiencingrobustgrowth,China,will not

playaleadingroleinensuringglobalstabilitythroughinternationallycoordinatedaction.Crucially,both

assumptionsmaynotholdinpractice.

Forexample,asmentionedearlierinthisreport,Chinafacesaneconomicpredicamentofitsownlinked

toartificiallyhighassetprices–particularlyrelatedtothehousingmarket.Theriskisthattheseasset

pricescouldtumblederailingChineseeconomicgrowth25withadverseimplicationsfortheglobal

economy.ThereisalsothepossibilitythateconomicliberalisationinChinawillultimatelytriggera

transitiontoademocraticsystemofgovernmentbyunleashingtheforcesofanincreasinglylarge,

welleducatedandarticulatemiddleclass.WhilstademocraticChinawouldbewelcomedbymany,the

transitionprocessmaybepainful.

Regardingthesecondassumption,ithasbeensuggestedthatChina’srecentpurchasesofEuroswas

motivatedbyadesiretoseeareturntostabilityinEurope26–akeyregionalsourceofdemandfor

Chineseexports.Inthelastquarterof2011,duetodecreasingEUdemand,Chineseexportsfellway

belowmarketexpectations27negativelyaffectingthepositionofitscurrentaccount.Ensuringaglobal

frameworkforeconomicstabilityandcooperationisthereforeofvitalimportanceforChina’scontinuing

success,sothereisthepossibilitythatChinawilltakeonaleadingglobalrolesoonerthanisgenerally

believed.Thedynamicsofwhatthismightlooklike,though,arehighlyuncertain.

Insummarythen,thebelowscenariosaredeliberatelysimpleandnecessarilyexcludemanypossible

permutationsandinteractioneffectsthatcouldleadtofuturescompletelydifferenttotheones

envisagedhere.Therefore,ratherthanbeingusedasconcreteforecastsforfutureplanning,these

scenariosshouldinsteadhelpguidedecisionmakersintoconsideringhowtheymightreactasdifferent

possiblefuturesunfold.

25 DavidBarboza(April2011),Fast Growth and Inflation Threaten to Overheat Chinese Economy,articleintheNewYorkTimes

26 ChenMan-NungandStaffReporter(July2011)China buying euro debt for political reasons: academics,WantChinaTimes:http://www.wantchinatimes.com/news-subclass-cnt.aspx?id=20110708000044&cid=1502(lastaccessed,28February)

27 SimonRabinovitch(Nov2011)China export growth dips as EU slows,articlefortheFinancialTimeshttp://www.ft.com/cms/s/0/fce7b050-0b4a-11e1-ae56-00144feabdc0.html#axzz1ngo9vlIQ(lastaccessed,28Feb2012)


Scenario 1Upside: dynamic Asia and a rebounding westInthisscenario,AsiadrivesglobaleconomicgrowthbutitdoesnotleavetheWestbehind.

Acomprehensiveresolutiontotheeurozonecrisis,anendtoUSpoliticalparalysisanda

reconfigurationoftradewiththeEasthelpsensurethattheWestremainscompetitiveinthe

newworldorder.ThisreconfigurationoftradeisaidedbyChinaembarkingonapolicyof

gradualliberalisationofitseconomyandanappreciationofitscurrency.Notonlydoesthis

policyhelprebalancetheglobaleconomy,butitalsohastheeffectofimprovingpercapita

incomeinChina,easingtheriskofcivilunrest.

Inthisscenario,governmentsarealsoabletogettogripswithrisinglongevitybyensuring

easiermovementoflabouracrossborders,andbyinstitutingworkplacereformstoallowfor

moreflexibleworkinginoldage.Andcrucially,decisionmakers(ingovernmentandfinancial

institutions)maintainstrongmechanismsfortransparencyandpublicaccountabilityhelping

toensurepublictrustattimesofuncertainty.

BuoyedbyaresurgentUS,andathrivingChina,internationalinstitutionsliketheIMFand

G20helptoensurecooperationbetweencountriesinmeetingglobalchallengesrelatedto

financialregulationandabsolutepoverty.Inturn,theinternationalsystemischaracterised

byrelativelypeacefulrelationsbetweenstatesandlimitedincidencesofcivilwarandother

formsofpoliticalunrest.

Implications for insurersInthismacroeconomicscenario,Westernfinancialservicesprovidersarelikelytoremain

highlycompetitivethoughtherewillbesubstantialcompetitionfromAsia.

Whilstlifeinsurerscontinuetofacethestrainofrisinglongevity,thiswillbeeasedsomewhat

byincreasedpremiumsaspersonalincomeandlevelsoftrustintheindustryremainstrong

stimulatingdemand.ThelifesectorwillalsobenefitfromGovernmentreformswhichare

effectiveatincentivisingpeopletoworkforlongerhelpingtoreducepensionfunddeficits.

Inthisenvironment,generalinsurersarelikelytobenefitfromincreasedpremiums,

especiallythosethatareabletotapintogrowingdemandforfinancialservicesfrom

emergingmarkets.Ahealthyglobaleconomywillalsohelpensurestrongassetprices

therebyimprovingoverallinvestmentincome.

Coordinatedinternationalregulationislikelytoleadtoincreasedconsolidationinthemarket.

Itcouldalsoleadtoconvergenceinbusinesspractices–whichmay,conversely,increase

thepotentialseverityofafuturefinancialshock.However,withwellcoordinatedaction,

theinternationalcommunityislikelytobeabletoeffectivelyforeseeandmitigateagainst

sucharisk.

5. the three scenarios


Scenario 2 Central: western stagflationInthecentralscenario,AsiadrivesglobaleconomicgrowthbuttheWeststagnatesleading

toloweroverallgrowthratesthanintheupside.Theafter-effectsoftheglobalfinancialcrisis

andeurozonesovereigndebtcrisiscontinuetohangovertheWestforyearstocome,which,

compoundedbythefailureoftheWesttoreconfiguretradewiththeEast,depressesreal

incomesandaggregatedemand.Chinagraduallyopensupitseconomybutthisonlyhasthe

effectofincreasingconsumptionofdomesticallyproducedgoodsandservices.

Duringthisperiod,governmentsalsostruggletofaceuptothechallengeofrising

longevity.Theyinstitutesomereformstoprovideformoreflexibleworkingbutdonottake

necessarymeasurestoencouragefreemovementoflabour.Despitesubstantialattempts

atdeleveragingthen,Westerngovernmentsremainheavilyindebted,pulleddownbythe

burdenofanaging,andunproductivepopulation.Somekeydecisionmakersinbusinessand

publicofficedoensurefulltransparencyandaccountability,whilstothersfailtoputsuch

mechanismsinplace,which,whencombinedwiththechallengingmacroenvironment,leads

toanincreasingproportionofcitizensfeelingdisaffectedwithbusinessandpolitics.

InternationalinstitutionsliketheIMFandG20continuetorumbleonbutarecharacterised

morebydeadlockthancollaborativeaction.Regionalblocks,generallyactinginisolation,

identifysolutionstoissueslikefinancialmarketregulationandpoverty.Someprogressis

made,buteffortsarenotwellcoordinatedcontributingtooccasionalfinancialandpolitical

shocks–(ie,incidencesoffinancialturmoilandoutbreaksofviolentconflictbetweenand

withinstates).

Implications for insurersInthisscenario,Westernfinancialservicesprovidersmaystruggletoremaincompetitive

whilstlargeAsianfirms,buoyedbyincomeearnedthroughadomesticallyburgeoningmiddle

class,penetrateWesternmarkets.

Whilstgovernmentactionhelpseasesomeoftheburdenofincreasinglongevity,Western

basedlifeinsurersstillexperiencerisingliabilities,anditremainsarealchallengeto

growpremiumincomeathome,aspersonalincomeandlevelsoftrustinfinancialservices

remainsubdued.

Inthisenvironment,generalinsurersmayalsofindittoughtogenerateincreasedpremium

andinvestmentincome.And,continuallylowinterestrateswillactasafurthersqueezeon

returnsforthesector.

Suchanenvironmentwilllikelynecessitateashiftofbusinesstoregionsoftheworld

wheredemandisgreater.However,regionalregulationleadstoanincreaseincostsfor

internationalfirmscomplyingwithdifferentrulesacrossmultiplejurisdictions.



Scenario 3 Downside: 1930s style depressionInthedownsidescenario,Asiastrugglestodriveglobaleconomicgrowth,constrainedas

theWestsuffersasevereandprolongedrecession.Theeurozone’suglyimplosionleadsto

anumberofcountriesdefaultingontheircurrenciesandasecond,largerfinancialcrisis.The

resultingcreditcrunchpreventstheWestfrominvestinginthetypesofindustriesthatwill

helpmaintaininternationalcompetitivenessandfiscaldeficitsswellacrossmajorWestern

powers.ThefailureoftheWesttoreconfiguretradewiththeEastislockedin,asChina

continuestofixanartificiallylowexchangerate.Byfailingtoallowforanappreciation,China

alsofailstostimulatedomesticconsumptionandinvestment.Chinesepercapitaincomewill,

therefore,remainsubduedpotentiallyincreasingtheriskofcivilunrest.

Duringthisperiod,theWestislargelypowerlesstocounteractrisinglongevity.Effortsto

improvetheflowoflabourarefruitlessandonlyresultinanoutflowofyoungandable

workerstoAsia.Effortstoincreaseprovisionforflexibleworkingresultinthecrowdingoutof

thejobmarketandincreasingyouthunemploymentwhichactstounderminesocialcohesion.

Policymakersareparalysedbyuncertainty,resultinginreducedtrustinofficials,business

andultimatelystateinstitutions.

SincetheUSispreoccupiedatgettingitsownhouseinorder,theWashingtonConsensus

collapsesandwithit,institutionsliketheIMFandG20.And,withtheUSconcernedby

risingunemploymentandlowexports,itislikelytoinstituteprotectionisteconomicpolicies

triggeringafullblowncurrencywarwithChina.Inthefaceoftheensuingglobaleconomic

turmoilandlackofinternationalgovernance,countriesreturntothekindsof‘beggarthy

neighbour’policieslastseeninthe1930s.Economicproblemssoonboiloverintoresentment

betweennationsandagainstgovernments.Duringthisperiod,thethreatofgeopolitical

conflictsbetweenmajorworldpowersbecomeveryreal,andactsofterrorism,civilwarand

otherformsofpoliticalunrestarecommonplace.

Implications for insurersIntheshortrun,Westernfinancialservicesproviders(andparticularlybanks)facesignificant

liquiditychallengesascurrencydefaultsandthesubsequentfinancialcrisisreducestheability

offirmstorollovertheirdebts.Insurersarealsolikelytotakeanimmediateandsignificanthit

intheeventofconsiderablesovereigndebtright-downsgiventheirexposurestogovernment

andbanksecurities.

Inthelongrun,duetofallingdemandandcompoundedbylowlevelsofpublictrustin

financialservices,insurersarelikelytosufferfromfallingpremiumincome.Theeffectof

aprolongedrecessionwillalsocauseassetpricestotumbleleadingtoafurtherdecline

ininvestmentincome.Theneteffectcouldbesignificantyearonyearlossesand,insome

cases,insolvenciesmayresult.Justtosurvive,manywillhavetotryandredirecttheirefforts

toemergingmarkets.

However,duetoariseinprotectionistpolicies,exportingservicestonewmarketswillbe

tough.Andthereisalsothethreatofpoliticalturmoil–particularlycivilwaramongstso

called“periphery”countries.



Reflecting on the three scenariosAccordingtotheabovescenarioanalysis,theworldcouldlookverydifferentdependingontheactions

takenbykeypolicymakersingovernmentandelsewherebothintheshortandlongterm.Crucially,

thescenarioshavemadetheassumptionthattheinsuranceindustryislargelyexogenoustothe

outcomes–effortsanddecisionstakenbythesectordonotaffectthemacroeconomicenvironment.

Asournextchapterwillshow,thisisunlikelytobethecaseinreality.Infact,thesectorhasakeyrole

toplayindrivinggrowth,ensuringsustainablepublicfinancesandmitigatingpoliticalrisksinthe

decadestocome.



6. the importance of insurance

6. The importance of insurance Whilsttheworld’sfuturedirectionwilldependonamultitudeoffactorsandstakeholders,theinsurance

industrycanplayitspartintryingtodeliveramoreprosperousworld.Criticaltosuccess,isforthe

industrytodothethingsithasdonewellinthepast,evenbetterintheyearsaheadandthiscanonly

beenhancedbytheprogressthatisbeingmadetodevelopasaprofession.

Promoting growth and developmentTheindustrycanplayakeyroleindrivinggrowthinnewindustries,therebyensuringthecomparative

advantageofmaturedevelopedeconomiesliketheUK.Itcanalsohelpinstrengtheningthefinancial

capabilitiesofmanylivinginthedevelopingworld,helpingtobreakviciouspovertytraps.

In2010,theglobalinsuranceindustryaccountedfor$4.3trillionintotalwrittenpremiumsand

$24.6trillionintotalmanagedfunds.28Italsoemployedasignificantnumberofpeopleworldwide.

IntheUK,forexample,insuranceemployednearly350,000people,whilstinJapanitemployedover

450,000people.29AswellasaccountingforasignificantproportionofGDPandemploymentinits

ownright,theinsurancesectorcanalsostimulateeconomicgrowthoutsideoffinancialservicesin

anumberofwaysincluding,amongstothers;facilitatingtradeandcommerce,mobilisingdomestic

savings,allowingdifferentriskstobemanagedmoreefficiently,encouragingtheaccumulationofnew

capitalandhelpingtoreduceormitigatelosses.30

Robustempiricalevidencesupportsthisclaim.Forexample,astudyfromtheWorldBankfoundthatin

the1976–2004period,bothlifeandnon-lifeinsurancehadapositiveandsignificanteffectoneconomic

growth.Lifeinsurancehadaparticularlypositiveeffectinhighincomecountries,whilstnonlifehada

positiveeffectinbothhighandlowincomecountries.31

Insurancecanalsohelptheworld’spoorest.Ithasbeenarguedthatso-called‘micro-insurance’–which

referstoinsurancewithrelativelysmalltransactioncostsandlowpremiums–canhelpalleviatepoverty

strickenareaswherethereislittleconventionalinsurancepenetration.Qualitativeevidenceimpliesthat,

whencombinedwithmicro-saving,thesocialvalueofmicro-insurance“couldbeamajorsteptoward

improvingthewell-beingoftheworld’spoor”.32SwissReestimatesthatupto4billionpeoplecould

ultimatelybenefitfromsuchactivities.33Themicro-financeindustryhasseentenfoldgrowthin10years

andmicrocreditnowservesover150millioncustomers.34

Ensuring sustainable public spendingSocialinsurancehashistoricallyplayedakeyroleinprovidingsecurityandprotectiontothoseatthe

marginsofsociety.Thishasincludedtheprovisionofsimplewelfarebenefitsliketheprovisionofabasic

statepension,orprotectionincaseofdisabilityorunemployment.Whilstthishasalwaysbeentherole

ofthestate,theprivatesectorcanhelpalleviatesomeoftheburdenswhichfallonthetaxpayer.

Governmentsaretryingtoencouragesuchashiftrightnow.IntheUK,forexample,insteadoffocusing

onwaystoincreasestateprovisionforthoseinretirement,thegovernmentistryingtofindwaysto

stimulatedemandforprivatepensionsaving.Thegovernment’sflagshippolicy,automaticenrolment,is

aimedat‘nudging’millionsofpeopleintolong-termsavingforthefirsttimethroughadefaultworkplace

pensionschemeknownasNEST.

28 TheCityUK(Dec2011)Insurance,FinancialMarketSeries.http://www.thecityuk.com/research/our-work/reports-list/insurance-2011/(accessed20March)

29 OECDdataavailablefrom:http://stats.oecd.org/Index.aspx?DatasetCode=INSIND(accessed20March)

30 WorldBankPolicyResearch,(Dec2006)Does Insurance Market Activity Promote Economic Growth? A Cross-Country Study for Industrialized and Developing Countries,WorkingPaper4098

31 Ibid

32 J.Morduch(Nov2002)Micro-insurance: the next revolution?WorkingPaperforNewYorkUniversity

33 SwissRe(Nov2010)Micro-insurance: Risk Protection for 4 billion people, Sigma SeriesNo6/2010

34 A.Kuper(Nov2008)From Micro-finance to Micro-insurance,ForbesMagazinehttp://www.forbes.com/2008/11/26/aig-insurance-zurich-pf-ii-in_ak_1126soapbox_inl.html(accessed20March)


IntheviewofABIDirectorGeneralOttoThorensen,thefuturewelfarestatemustbuildonthe‘nudge’

schoolofbehaviouraleconomics.Hearguesthat“...ifthestate’swelfareandtaxsystemsrewardand

encouragethosewhoprotectthemselvesmore,thensocietybenefitsandtheindividualischannelled

intherightdirection.Thiscouldbeviamatchedbenefits,taxreliefs,greaterconditionalityinbenefit

paymentsoranyothernumberofmechanisms”.Theresult,hearguescouldbeasimplerandsmaller

statewitha“clearinterestinpromotingcertainoutcomesandbehaviours”.35

Crucially,however,shiftingtheprovisionofwelfaretotheprivatesectorwillnotjustbedownto

governmentincentives.Thepublicmust,inturn,beconvincedoftheneedtobuyprotectionandsave

forthefuture.Currently,eveninregionsoftheworldwhereinsurancepenetrationishigh,asignificant

proportionofthepopulationisunderinsured.Inthedecadestocomethen,insurers,incollaboration

withgovernment,mustfindwaysofconnectingwiththisgrouptoclosethesocalledsavingsand

protectiongap.

TherecentsuccessesintheUKofsimplesavingsproductslikeISAs36demonstratesthatevenina

challengingeconomicenvironment,peoplearepreparedtoputmoneyasideforthefuture–particularly

whenthevehicleiseasytounderstandandprovidessomeflexibility.Thisisnottosaythatthis

particularformofsavingissomekindofmagicbullet,butthatthedesignanddistributionofsavings

productswillbecrucialtoincreasingthelevelofsavingsintheyearstocome.

Thereiseveryreasontobelievethatthelifeinsurancesectorcanmeetthischallenge.Thesectorhas

proventobehighlyinnovativesinceJamesDodsonfirstdevelopedascientificselectionratingthatbased

premiumsonageandlifeexpectancyinthe17thCentury.Today,thesectorcoversamultitudeoflong

termrisksincluding,amongstothers;helpingtoprovideincomeforthoseinretirement,supporting

peoplewithlifethreateningillnessesandhelpingtofundthecostsassociatedwithlongtermcare.The

sectorisalsointheprocessoffashioningnewproductstoexploreemergingnichemarkets.Hybrid

products,forexample,combinedifferenttypesofcoversuchasincorporatingalong-termcarebenefit

intoalifeorannuityproduct.37

Distributionwillalsobeimportantincapturingtheunderinsured,andheretoothesectoriscontinuing

toinnovate.Forexample,onthegeneralinsuranceside,theGermanfirmFriendsuranceisattracting

attentionforitsuseofsocialnetworkingtoencourageuserstotakeupcoverandtocreateaninsurance

networkamongstfriends.38ResearchfromDeloittehasindicatedthatbuyersacrossallagesegments,

andparticularlytheyoung,areveryinterestedinhavingmultiplepointsofinteraction(ie,facetoface,

phone,internetsocialmediaandmobiletechnology)withtheirinsurer.39

Mitigating political risks Theindustry’scontinuingeffortstounderwritepoliticalriskscanalsoplayanimportantroleinhelping

toshapeoursocioeconomicfuture.Anumberoffirmscoverpoliticalriskssuchaswar,revolution,

terrorismandcivilunrest.Suchinsurancenotonlyhelpsprotectcompaniesandinvestmentswithlinks

toemergingmarkets,butalsohelpsbroadenourgeneralunderstandingsofpoliticalrisksandhowto

takeeffectiveactioninthefaceofthem.

35 O.Thorensen(2012)From guarantor to enabler: the future of the state,essayforReformseries,“TheNext10Years”

36 R.Evans(Feb2012)Savers shun ‘complex’ pensions for simplicity of ISAS,TheDailyTelegraph.http://www.telegraph.co.uk/finance/personalfinance/investing/isas/9113471/Savers-shun-complex-pensions-for-simplicity-of-Isas.html(accessed20March)

37 Deloitte(Mar2012)2012 Global Insurance Outlook: Generating growth in a challenging economy takes operational excellence and innovation

38 PostMagazinearticle(Mar2012),Social media-based broker heralded as five years ahead of the game

39 Deloitte(Mar2012)

6. importance of insurance


Maximising effectiveness through professionalismInshortthen,theinsuranceindustryisalreadydoingmanyofthethingsnecessarytoplayanimportant

roleinhelpingtoshifttheworldtowardsabetterfuture.Theindustryisalsorelativelywellequippedto

facesomeofthestormsthatmaycomeitswayshouldtheworstcasescenarioofaprolongedrecession

materialise,givenitsrelativelystrongcapitalposition.40

However,inordertohelpmaximiseitsimpactintermsofstimulatingeconomicgrowth,alleviating

poverty,takingonsomeoftheburdenforwelfareprovision,andmitigatingpoliticalrisks,itisessential

thattheindustrycontinuestogrowintoaprofession.Bymakingcontinualvoluntaryimprovementsin

professionalstandards,practitionerswillbebetterplacedtoprovideappropriatesolutionstomanyof

thesocioeconomicchallengesofthe21stcentury,andtoinspirenecessaryconfidenceintheindustry.

Somefirmsandpractitionersarealreadymakingsubstantialimprovementsinthisregard,as

demonstratedbythesignificantgrowthinthenumberofCharteredinsurancepractitionersandfirms

overthelastdecadeorsoandthegrowthofprofessionalstandardsinemergingmarkets.Theseefforts

areagreatstepforwardand,asmorepractitionersandfirmsmaketheleap,itshouldhelpengender

greateroveralltrustinthesector.

Researchsupportsthisclaim.A2009pollconductedfortheCIIbyYouGov41foundthat:

• ConsumershavegreatertrustinadvicefromCharteredprofessionalsthanprofessionalsthat

arenotChartered.

• ConsumersbelievethatyoucangenerallytrusttheadviceyougetfromCharteredorganisations.

• ConsumershavemoreconfidenceinthequalityoforganisationsthatusethetermCharteredthan

thosethatarenotChartered.

Itisclearthatinsurancealreadymakesanimportantdifferenceininfluencingthetrajectoryof

economiesandsocieties.Itmustnowpressontoconsolidatethesegainsandtomaximiseits

effectivenessindeterminingthesecurityandprosperityoftheworlditserves.

40 SeeSwissRe(Dec2011),Global insurance review 2011 and outlook 2012/2013.Intheresearchtheyrefertotheimplicationsofa50%haircutonGreek,IrishandPortuguesesovereigndebtfortheinsurancesector.Theyestimatethatlossescanbereadilyabsorbedthroughexistingcapital.AnadditionalhaircutonItalianandSpanishsovereigndebtwould,however,befarmoreproblematic

41 CII(PollingbyYouGov)(2009), Consumer Views of Chartered Status

6. importance of insurance


7. conclusion 7. ConclusionTherearemanysocioeconomicrisksfacingtheworldwhichhavethepotentialtoshapeourlong

termfuture.Inthisreport,expertauthorshavediscussedsomeoftheseindetail,liketheeconomic

implicationsofUSdecline,theriskstothesolvencyofgovernmentsposedbyrisinglongevityandthe

threattowesterncompetitivenessassociatedwithashiftofeconomicpowertoAsia.

Theseauthorshavealsocarefullyconsideredanumberofrelatedpoliticalriskslikerisinggeopolitical

uncertaintybetweenmajorworldpowersandcontinuingpoliticalunrestinpartsoftheMiddleEast.

Takentogether,itispossibletoenvisageableakfuture,wherestates,isolatedfromoneanotherin

ananarchicinternationalsystem,areunabletomeetthechallengesofthiscentury,condemningtheir

citizenstoalifeofunemployment,povertyandconflict.

Thankfully,suchafutureisfarfromcertain.TheriseoftheEast,forexample,mayleadtoanabsolute

improvementinlivingstandardstheworldover.Similarly,anincreasinglyoldpopulationcouldprovide

importantadvantagesthroughenhancedknowledgeandexperiencealbeitwithdangersofskills

shortagesinspecificareas.

However,inordertodeliverabetterfuture,itisclearthatdecisionmakersingovernmentandelsewhere

musttakeactionnowtoaddresscurrentproblemsliketheeurozonecrisisandUSpoliticalparalysis,

bothofwhichcouldhavesignificantlongtermknockoneffectsforWesterncompetitivenessand

globaleconomicproductivity.Cruciallythough,theinsurancesectorcanplayitsparttooinhelpingto

determinewhichsocioeconomicfutureweultimatelyface.

Insurancehasprovedtobeanimportantengineforgrowth–bothwithrespecttothedevelopedand

developingworld–sothereisnoreasonwhyitcannotperformthesamefunctioninthedecadesto

come.Theindustryisalready,forinstance,helpingsustainthecomparativeadvantageoftheWestby

underwritinginvestmentinnewtechnologies,aswellashelpingtoalleviatepovertyinthedeveloping

worldthroughnewtypesofinsurancelikemicro-insurance.

Inmanywaysthen,keytosuccessisfortheindustryistocontinuedoingthethingsithasdonewell

inthepast,evenbetterinthefuture.Beingpartofaprofessionwillbeveryimportantinthisregard.In

thenewworld,likelytoberifewithuncertaintiesandcomplex,interlinkedrisks,acommitmenttohigh

levelsofcompetenceandethicalpracticewillbevital–notjustforprovidingappropriateadviceand

adequatelyunderwritingrisks–butalso,andperhapsmostimportantly,formaintainingthetrustand

confidenceoftheconsumersandsocietiesitwillserve.

The next reportInournextreportwithinthecentenaryseries,wewilllookatpossibleenvironmentalfutures.Similar

tothisreport,expertswillsetoutdiverseandcompellingnarrativesonwhatthefuturemighthold,and

wewillseektobuildanumberofsimplescenariostosetoutsomeimplicationsfortheinsuranceand

financialservicesindustry.


CIIBen Franklin

PolicyandResearchCo-ordinator

CharteredInsuranceInstitute

20Aldermanbury

London

EC2V7HY

Email:

[email protected]

About the Chartered Insurance Institute (CII)

Professionalism in practice

TheCIIistheworld’sleadingprofessionalorganisationforinsuranceandfinancialservices,withover

100,000membersin150countries.

Wearecommittedtomaintainingthehigheststandardsoftechnicalexpertiseandethicalconductinthe

professionthroughresearch,educationandaccreditation.

OurCharterremitistoprotectthepublicbyguidingtheprofession.FormoreinformationontheCIIand

itspolicyandpublicaffairsfunction,includingexamplesoftherangeofissuesinfinancialservicesand

insurancethatwecover,pleasesee:

www.cii.co.uk/policy

Who to contactw

ho to contact

The Chartered Insurance Institute 42–48HighRoad,SouthWoodford,LondonE182JPtel:+44 (0)20 8989 8464email:[email protected]:www.cii.co.uk

©TheCharteredInsuranceInstitute2012Ref:CII_socioeconomicLFH(03/12)CII_6414

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