Global Risk Report 2007

World Economic ForumJanuary 2007

Global Risks 2007A Global Risk Network Report

COMMITTED TO IMPROVING THE STATE

OF THE WORLD

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

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

World Economic Forum91-93 route de la CapiteCH-1223 Cologny/GenevaSwitzerlandTel.: +41 (0)22 869 1212Fax: +41 (0)22 786 2744E-mail: [email protected]

© 2007 World Economic ForumAll rights reserved.No part of this publication may be reproduced or transmitted in any form or by any means, including photocopying and recording, or by anyinformation storage and retrieval system.

REF: 150107

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

3

Contents

Introduction 4

Risk Assessment 6

Scenarios 13

Understanding the Nature of Global Risks 19

Risk Mitigation 21

Contributors 31

Participants 32

At the core of this year’s overview of risks to theglobal community over the next decade is afundamental disconnect between risk and mitigation.Expert opinion suggests that levels of risk are risingin almost all of the 23 risks on which the Global RiskNetwork has been focused over the last year – butmechanisms in place to manage and mitigate risk atthe level of businesses, governments and globalgovernance are inadequate. The global economyhas been expanding faster than at any time inhistory – but it remains vulnerable.

Some tactical gains have been made in specificareas of risk mitigation: despite the raised threat ofterrorism, cooperation on dealing with the threatcontinues to improve; fears of a major pandemicoutbreak have driven a major effort to upgrade ourglobal preparedness to identify and isolate newdiseases; there is a growing recognition of the needto improve access to mechanisms of risk transfer inemerging markets, to allow risks to be priced in away that allows the potential economic growth ofthis century to be fully unlocked.

There has also been major improvement in theunderstanding of the interdependencies betweenglobal risks, the importance of taking an integratedrisk management approach to major globalchallenges and the necessity of attempting to dealwith root causes of global risks rather than reactingto the consequences.

Climate change is now seen as one of the definingchallenges of the 21st century – and as a global riskwith impacts far beyond the environment. Effectivemitigation of climate change may ultimately have theconsequence of improving resilience to oil priceshocks in developed countries by moving them fromhydrocarbons to alternative energy sources;ineffective mitigation of climate change will almostcertainly be a factor in major interstate and civil warswithin the next 50 years. The way in which climatechange is dealt with at the global level will be aleading indicator of the world’s capacity to manageglobalization in an equitable and sustainable way.

But the tactical gains may be illusory and arecertainly temporary. The manifestation of anynumber of global risks in the way described in theplausible scenarios in this report could quickly putthose gains into reverse.

Global Risks 2007 suggests two possibleinstitutional innovations that may help mobilizebusinesses and governments to approach the globalrisks of the next 10 years. One is the idea of aCountry Risk Officer – an analogy to Chief RiskOfficers in the corporate world – intended as a focalpoint for managing a portfolio of risk acrossdisparate interests, setting national prioritization ofrisk and allowing governments to engage in theforward action needed to begin managing globalrisks rather than coping with them. The second is tocreate an avant-garde of relevant governments and

4

Introduction

companies around different global risks – “coalitionsof the willing” – allowing risk mitigation to be aprocess of gradually-expanding alliances rather thana proposition requiring permanent consensus.

Above all, Global Risks 2007 makes the case for theactive engagement of all sections of the internationalcommunity in dealing with global risks. No one grouphas the ability to effectively mitigate most globalrisks. Interdependency implies not just commonvulnerability, but a shared responsibility to act.

A longer version of this report and further informationon the Global Risk Network can be found atwww.weforum.org/en/initiatives/globalrisk. Thelonger report includes further background onmethodology, risk descriptions, numericassessments, the process of workshops leading tothis report and additional mitigation and scenarioexamples.

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Risks are idiosyncratic – a risk to one group maypresent an opportunity to another. The qualificationof global risks lies in their systemic nature: theirimpacts challenge the integrity of the system. Theirconsequences are harder to predict, frequentlydisproportionate, difficult to contain and presentchallenges to us all.

The key newcomers to the list for the Global Risks2007 report include a number of geopolitical riskswhich, though difficult to measure, specify andpredict, were considered integral parts of the risklandscape. The risk of major interstate and civil war– often inadequately priced in markets – was onerisk considered. Another was the category of failedand failing states as an underlying risk to systemicintegrity. Both featured in a number of scenariosdeveloped by the Global Risk Network.

Overall, the Global Risk Network identified 23 coreglobal risks to the international community over thenext 10 years. A further description of the coreglobal risks can be found in the longer version of thereport at www.weforum.org/en/initiatives/globalrisk

“Core” Global Risks

6

Risk Assessment

Economic

• Oil price shock/energy supply interruptions• US current account deficit/fall in US$• Chinese economic hard landing• Fiscal crises caused by demographic shift• Blow up in asset prices/excessive

indebtedness

Environmental

• Climate change• Loss of freshwater services• Natural catastrophe: Tropical storms• Natural catastrophe: Earthquakes• Natural catastrophe: Inland flooding

Geopolitical

• International terrorism• Proliferation of weapons of mass

destruction (WMD)• Interstate and civil wars• Failed and failing states• Transnational crime and corruption• Retrenchment from globalization• Middle East instability

Societal

• Pandemics• Infectious diseases in the developing world• Chronic disease in the developed world• Liability regimes

Technological

• Breakdown of critical informationinfrastructure (CII)

• Emergence of risks associated withnanotechnology

These core global risks were assessed in terms oflikelihood and severity.

In addressing likelihood, actuarial principles wereapplied in the few cases where sufficient dataexisted; in most cases only qualitative assessments,based on expert opinion, were possible. Inassessing severity, two indices were considered:destruction of assets/economic damage and –where applicable – human lives lost. Although somerisks are inherently long term (such as climatechange), and others (such as an oil-price shock)could occur in the near term, all risks were evaluatedwithin a 10-year time frame.

7

Understanding Geopolitical Risk

The first years of this century have been markedby the return of geopolitical risks to globalprosperity and stability. In 2006, the deteriorationof the situation in Iraq and the Middle Eastoccupied the full attention of some governments,reducing “bandwidth” available for focus on otherglobal risks and increasing fears of thefragmentation of the international system. Shouldany of the main geopolitical risks outlined hereworsen considerably, the environment for businessand society could be changed beyond recognition.In the scenarios below, geopolitics frequentlyprovide the narrative and backdrop to theemergence of other global risks.

Despite their importance, however, geopoliticalrisks are hard to quantify in terms of likelihood andseverity, and therefore difficult to price. Whileexpert opinion suggests that geopolitical riskworsened in 2006, market expectations of volatilitytended to fall, indicating a major disconnect. Theconcerted action of governments may help toreduce overall geopolitical risks in 2007 –improved pricing of these risks may helpbusinesses to manage their consequences whenthey do occur.

The range of different trajectories along whichgeopolitical risks can develop – contingent onhuman decision-making and a range of other

factors – makes their outcomes hard to predictwith accuracy. For example, while the conditionsfor the outbreak of war may be easily identifiable –militarization, existing disputes, an inflexibleattitude by the parties – the exact sequence ofevents which turn conditions into reality areimpossible to predict. The “gambler’s mentality” isunlikely to succeed.

As a result, geopolitical risk analysts normallyfocus on underlying trends – economic decline,environmental degradation, population density –which may provide keys to the emergence of amajor event. Defence planners cope withgeopolitical risk on a prudential basis – preparingfor low-probability, high-severity risks (such asinterstate war) which present a sovereign risk, aswell as a range of more immediate challenges.

Though businesses with international exposurecannot pursue the same catch-all policy, theyshould look beyond discrete events and managetheir risk portfolio through an appreciation ofunderlying dynamics. The challenge for a geopoliticalrisk analyst advising business is to help distinguishbetween events with a tactical impact and thosethat significantly alter underlying trends and, withthem, the overall calculation of risk.

It was only in July 1914, a month before the outbreak of World War I, that liquidity in global equity markets dried up.Before then, the markets had not priced the geopolitical risk of war, one that would kill millions and trigger a retrenchmentfrom globalization.

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The 23 Core Global Risks: Likelihood with Severity by Economic Loss

Note: Likelihood was based on actuarial principles where possible. For most risks, however, qualitative assessment was used.

Likelihood

Sev

erit

y (in

US

$)

below 1%

2-10

bill

ion

10-5

0 bi

llion

50-2

50 b

illio

n

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

250

billi

on -

1 tr

illio

nm

ore

than

1 tr

illio

n

Retrenchment from globalization Asset price collapse

Fall in $Climate changeLiability regimesDeveloping world disease

Loss of freshwater servicesFailed and failing states

Proliferation of WMD

International terrorism

Oil price shock

Coming fiscal crises

NatCat: Tropical stormsNatCat: Earthquakes

NatCat: Inland flooding

Nanotechnology

Middle East instability

China economic hard landing

Transnational crime and corruptionBreakdown of CII

Chronic disease in developed countries

PandemicsInterstate and civil wars

Increasing consensus around risk

9

16 Core Global Risks: Likelihood with Severity by Number of Deaths

Note: For seven of the core global risks, severity by number of deaths was not applicable. Likelihood was based on actuarial principles where possible.For most risks, however, qualitative assessment was used.

Likelihood

Sev

erit

y (in

no

. of

dea

ths)

below 1%

1,60

0-8,

000

8,00

0-40

,000

40,0

00-2

00,0

00

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

200,

000-

1,00

0,00

0m

ore

than

1,0

00,0

00

Climate change

Developing world disease

Loss of freshwater servicesFailed and failing states


International terrorismNatCat: Tropical storms

NatCat: Earthquakes


Nanotechnology


Transnational crime and corruption

Breakdown of CII


Pandemics Interstate and civil wars

Increasing consensus around risk

In addition to risk assessment in terms of likelihoodand severity, the Global Risk Network developed aqualitative global risk “barometer”, based on expertjudgement of the outlook for global risks. This isessentially a forward-looking measure: it does notlook at how the risk has played out over the lastyear; rather, it assesses whether the seriousness of

the risk for the next 10 years has become more orless acute. For example, while 2006 saw fewertropical storms than in 2005, expert consensus wasclear that the risk trend is moving upwards, withgrowing agreement on the impact of climate changeon severe meteorological events.

10

A qualitative global risk “barometer”

Though some estimate capacity will increase to meet demand (forecast25% increase by 2015), the energy market remains tight and, as such,highly vulnerable to both physical and speculative shocks.

Although the trade-weighted real exchange rate of the US$ hasdepreciated 23% since 2002, many believe this will continue, in orderto limit a widening US current account deficit.

Chinese growth is both investment- and export-led. The expansion ofexports may generate a backlash (particularly in the US); highinvestment (over 40% of GDP) has generated excess capacity andfears of potential bad debts.

The deterioration of fiscal balances in G8 countries, combined withcontinuing large deficits in other large countries, renders a series ofmajor fiscal crises possible, exacerbated by the long-term challenges ofageing and equitable healthcare provision.

House prices have doubled in most mature markets (and in someemerging markets) in real terms over the last 10 years, putting price-to-income ratios at all-time highs. Many experts fear a major correction,with differential impacts on consumption, economic growth and otherasset prices.

Carbon emissions are growing above trend and there are indicationsthat feedback mechanisms, particularly increased heat-absorptioncaused by Arctic ice-melt, will increase the speed and scale ofwarming. New research argues that the increasing intensity of NorthAtlantic hurricanes is due to global warming.

The mitigation effects of improved water-pricing have yet to have aneffect; economic development and global warming have increased therisk to the sustainability of many already stressed freshwater systemsworldwide, particularly in Asia.

ECONOMIC Reason for increased, stable or decreased overall risk

Oil price shock/energysupply interruptions

US current accountdeficit/fall in US$

Chinese economic hard landing

Fiscal crises caused bydemographic shift

Blow up in assetprices/excessiveindebtedness

Key: Increased overall risk Stable overall risk Decreased overall risk Expert disagreement

ENVIRONMENTAL Reason for increased, stable or decreased overall risk

Climate change

Loss of freshwaterservices

11

The increasing risk from tropical storms includes two major components. The hazard itself may be increasing as global warming drives sea surfacetemperatures higher. Global vulnerability to tropical storms may also beincreasing as a result of coastal development.

The threat of earthquakes, in terms of likelihood and severity, remains thesame, driven by basic geophysics. Meanwhile, slight increases in the exposureof populations are matched by slight reductions in the vulnerability of assets.

Increasing floodplain development and an expected increase in climatechange-driven extreme weather events increase the risk of disruptive andcostly inland flooding.

The risk of future attacks has risen: according to official threat assessments inBritain, an attack is “highly likely”; the US National Intelligence Estimatereport has argued the Iraq war has heightened risks, while the situations inAfghanistan, Somalia and Pakistan continue to cause concern.

North Korea tested a nuclear device in 2006, Iran continued its programme,the US weakened its commitment to non-proliferation in a controversialdeal with India, while some Middle East states said they would seekcivilian nuclear technologies. All increase the risk of proliferation for 2007.

Civil war took hold in Iraq in 2006 while tensions fluctuated on the Koreanpeninsula and in the Middle East. The International Crisis Group identifiedNovember 2006 as the worst month for conflict prevention in 40 months.The risk of any of a number of hotspots causing a major conflagration in2007 increased.

There is little prospect of immediate improvement in serial failed and failing states – notably Somalia, Afghanistan and Pakistan. The creation ofthe UN peacebuilding commission may improve mitigation in 2007 butrisks are increasing.

Transnational crime and corruption remain endemic in a number ofdeveloping and developed countries, damaging state authority, economicprosperity and weakening the ability to deal with other global risks.

Progress on the Doha trade round appears distant, while failures will be difficultto reverse after expiry of Presidential negotiation authority. Populist sentimentin Europe and the US is set to increase. (See the Europe@Risk report.)

Overall stability is deteriorating, despite rapid growth and moves towardsstability in some Gulf countries. Grand bargains to stabilize the region maybe possible in 2007, but underlying problems of Islamist extremism,political succession (as in Egypt) and fragile economic structures will makethe region highly volatile.

ECONOMIC Reason for increased, stable or decreased overall risk

Natural catastrophe:Tropical storms

Natural catastrophe:Earthquakes

Natural catastrophe:Inland flooding

GEOPOLITICAL Reason for increased, stable or decreased overall risk



Interstate and civil wars

Failed and failingstates

Transnational crimeand corruption

Retrenchment fromglobalization


Generally, the picture provided by the risk barometerof expert opinion on the year-on-year assessment ofglobal risks is one of rising risks. Expert consensuswas that none of the 23 global risk issues identifiedhad improved since 2006. However, experts notedthat awareness on a number of risks – the first stepto effective risk mitigation – had improved in anumber of areas.

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Some measures (e.g. improved research and cooperation on early warnings)have improved response capability. However, the aggregate risk is constantas uncertainty remains over the timing and nature of any outbreak.

Although infection rates have stabilized in some countries, infection ratesfor HIV and other diseases are rising in others, presenting major risks tofuture prosperity. India passed South Africa as the country hosting the largestpopulation of HIV/AIDS infected people. (See the India@Risk briefing.)

Experts were divided on the balance between potential advances inmedical science over the next 10 years and the increasing prevalence of “life-style” diseases.

Experts were divided on the risks to global prosperity from liability regimesover the next 10 years: some argue liability regimes represent a legitimatepolicy choice, others suggest they represent a growing cost to business,yet others suggest that US-style liability regimes are unlikely to makeheadway in other parts of the world.

Expert judgement suggested a balance between increasing vulnerabilityarising from interconnectivity and growing awareness of security issuessurrounding CII with investments in resilience and spare capacity in somekey infrastructure areas.

In the absence of any major scientific discovery, experts estimated thepotential risks arising from nanotechnology were unchanged.

SOCIETAL Reason for increased, stable or decreased overall risk

Pandemics

Infectious diseases inthe developing world

Chronic disease in thedeveloped world

Liability regimes

TECHNOLOGICAL Reason for increased, stable or decreased overall risk

Breakdown of criticalinformationinfrastructure (CII)

Emergence of risksassociated withnanotechnology

Key: Increased overall risk Stable overall risk Decreased overall risk Expert disagreement

It is a central tenet of work conducted by the GlobalRisk Network that global risks do not manifestthemselves in isolation: their drivers, triggers andconsequences are interconnected. This wasapparent in 2005 when the domino effects ofHurricane Katrina briefly shook the global system.More recently, the connections between two of themajor issues for public policy and private enterprise– energy security and climate change – havereinforced the sense that global risks share acommon lineage.

How can one best think about interconnectedness?One approach is to assess correlation. This providesa simple measure of static interconnectedness. In2006 the Global Risk Network engaged in anongoing survey of academics and experts to buildup a picture of correlation between the 23 core

risks. Many of the risk issues have multiple causesand consequences beyond the risk list itself – thematrix is not supposed to be a comprehensiveexplanation of causality. However, the correlationmatrix portrays the strength of the macrocorrelations perceived by experts to exist betweenthe risk issues identified and studied in this report. Inthe graphic below, the numerical strength ofcorrelation between risk issues is reflected in thethickness of the lines connecting them.

Correlation provides an excellent overall view of linksbetween risks, but may not capture the dynamics ofinterconnectedness: even when causation orconsequence can be determined with confidence,the context in which risks emerge and interact asthey play out may lead to different assessments ofprobability and impact.

13

Scenarios

Key:

Retrenchment from globalization

Asset prices/ excessive indebtedness

Current account deficit/ Fall in US$

Climate change

Spread of liability regimes

Developing world disease(HIV/AIDS, TB, malaria)

Loss of freshwater services

Failed and failing states



Oil price shock

Coming fiscal crises

NatCat: Tropical storms

NatCat: Earthquakes


Emergence of nanotech risks


China economichard landing


Breakdown of CII


Pandemics


Stro

nger

co

rrel

atio

n

The Correlation Matrix

In order to provide this context, the Global RiskNetwork looked at how key risks could play out innarrative scenarios. These scenarios do notrepresent “best”, “worst” or even “base” cases, norare they predictions. Instead, they are possible,plausible global risk features in which the challengesof interconnectedness become plain.

The scenarios below contain a number of surprises– some of them disturbing – but understanding thepossible surprises ahead may allow policy-makersand business people to make decisions that willavert the worst consequences of surprise and turnrisk into opportunity. While all the scenarios areplausible, none is likely to play out in precisely theway described. The short-term outlook for the globaleconomy remains good: one Citigroup GlobalCapital Markets report (22 November 2006) predictsglobal GDP growth of 3.4% in 2007 and 3.8% in2008. But these scenarios show how short-termcentral expectations may plausibly deteriorate.

One of the key lessons that emerged from all therisk scenarios developed by the Global Risk Networkwas the absolute centrality of cooperation betweenthe United States and China in dealing with anumber of major global risks – from mitigatingclimate change, to managing pandemics. Withoutthe full engagement of both the US and China,global risks will be extremely difficult to managesuccessfully. The accelerating shift in influence,power and prosperity to the countries of Asiarepresents a generational opportunity to rethinkgovernance and creates the necessity to forgecommon approaches to global risks.

Global Risk Scenario A: Pandemic and Its Discontents

The following scenario illustrates the impacts on business, the financial system and politicaland economic conditions that could follow from the emergence of a new pandemic. It also illustrates the amplifying role played by “infodemics”, where the rapid spread ofinaccurate or incomplete information can amplify the effects of the core risk event.

In January 2008, reports of a new virus emerge inAsia. Its properties are not well understood, but itsroots may lie in the high viral loads present in theheavily vaccinated Asian chicken population.

From the outset, speculation about the virus spreadsfaster than essential facts. Expert commentatorssuggest the virus is more deadly than SARS, whilegovernmental data is widely questioned. Fearspreads ahead of the disease, and some neighbouringcountries close their borders immediately.

By February 2008, the disease has claimed fewerthan 50 lives. Before the end of the month, Australiaand Germany report infections carried out of BangkokInternational Airport. Many passenger aircrafttravelling to South-East Asia are grounded. But theeffect on air freight companies is worse: a numberare forced to declare force majeure on significantcontracts, pushing them towards bankruptcy.

The knock-on effects on just-in-time inventoriesappear by the beginning of March, withlongshoremen refusing to unload cargoes frominfected countries. The oil price crashes.

In late February, a large hedge fund fails due tosudden asset devaluations. Herd behaviour causesglobal liquidity to dry up. Neither the G8 nor the G20is able to coordinate a response. Central banksinject liquidity ad hoc, creating inflationary risks. Asblack box models fail to adjust, financial contagioncontinues.

By late March, there are several hundred confirmeddeaths outside South-East Asia, but the virusremains poorly understood. Conspiracy theoriesabound, with ethnic minorities a frequent target.

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By early June consensus emerges that the virus hasbeen spreading for a year. Yet characterization of thevirus continues to move slowly and the ineffectivenessof existing anti-virals has led to a containment crisis.Liability fears among pharmaceutical companiesthreaten eventual vaccine production, whilegovernments fail to credibly signal exemptions. A scaled-up response looks unlikely.

In some Asian countries, widespread discontent atthe authorities’ response to the pandemic –particularly in inland regions – leads to thecentralization and militarization of governmentservices. In developed democracies, armies becomekey emergency service providers.

Failed and failing states, particularly Myanmar, Nepaland Pakistan, end up completely isolated anddeteriorate quickly, although for different reasons. InMyanmar, different factions scramble to maintaintheir relative positions. In Pakistan, rumours ofinequitable mobilization of government resourcescause tensions between central and border regionsand between the Sunni majority and Shiite minority.In Nepal, the country is shut from all sides, affectingthe provision of stabilization assistance andsharpening political divisions.

Globally, increased fear of cross-border movementand trade feed an emerging backlash againstglobalization, which in turn compounds the hit onglobal demand.

By November 2008 the disease is a full-blownpandemic, with one million deaths worldwide.Centralized containment measures are of limitedefficacy, but private and decentralized efforts helpslow the spread. By January 2009, a partiallyeffective vaccine is produced, with distribution fromMarch. However, internationally, there are questionsof who should distribute the vaccine, to whom andat what cost. Domestically, active militaries step intoa crisis-management role helping to distributevaccines.

By summer 2009, vaccination and natural immunityhave stemmed the spread of the disease. Globally,normalcy returns, though increased militarism andauthoritarian tendencies have reshaped globalgeopolitics.

Global Risk Scenario B: Out of the Global Warming Frying Pan(and Into the Fiscal Fire)

Information asymmetry also plays a key role inthis scenario, which illustrates the knock-oneffects of a major shift in risk perception:namely, that climate change has arrived.

Events in 2007 trigger an inflection point in globalconcern over the consequences of climate change.

First, massive inland flooding in South Asia resultingfrom a late monsoon leads to crop failure, as well asmass migrations. Tensions rise on the Bangladesh-India border as thousands flee humanitarian disaster.In the Americas, oil supply is still disrupted from 2007tropical storms; an unprecedented cold snap in thenorth-east of the US leads to a spike in heating-fuelprices as domestic and local supplies are exhausted.Finally, figures released in December 2007 show anunprecedented spike in the global temperature of1.5 degrees Celsius for the year as a whole.

China’s remarkable story of 28 years of economicgrowth – a Citigroup Global Capital Markets report(22 November 2006) predicts real GDP growth of9.8% in 2007 and 10.7% in 2008 – is disturbed byawareness of environmental degradation andinequality between “many Chinas”. Some 150 millionsurplus rural workers drift between villages and citiesby 2008, with many subsisting through part-time,

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Bird flu outbreak at the Norfolk road farm, Britain, April 2006

low-paying jobs. This dislocation is masked byunreliable official figures, but eventually causeswidespread civil unrest. In part due to the BeijingOlympics, the government is initially unable to calmdemonstrations resulting from viral text-messagecampaigns. The protests seize the mood of globaldiscontent and speak loudly on the issue ofenvironmental degradation.

In North America, public concern over climatechange leapfrogs scientific consensus. High oilprices cause a pull back from US asset markets,bursting that country’s “housing bubble”. Populardiscontent results in calls for radical action.

In the United States, legislators follow California'spopulist lead, establishing a national carbon tradingscheme and creating industry incentives forconservation and alternative energy. In late 2008, theUS administration releases a white paper entitled"From Addiction to Oil, to Blessed by Biofuel",signalling an enhanced focus in US energy policy onbiofuels, particularly relevant to farming communitiesin the American Mid-West. The white paper winspolitical support both from “hawks” seeking USenergy independence and those fearing climatechange.

This policy response has the unintendedconsequence of setting up acute competition forproductive land, between food, fuel, forests andfibre, with increased carbon sequestration andmining activities competing at the margin. Prices risefor agricultural commodities and land.

Meanwhile, China concludes the only practicaloption for the country’s future energy needs isnuclear, with coal-fired electricity as a bridgingsource. The government announces large-scaleinfrastructure spending and concludes negotiationswith major suppliers of uranium.

While supply constraints and elevated demand keepoil prices high over 2007 to 2010, other developingcountries follow China’s lead, and demand the rightto sovereign control of the nuclear fuel cycle. Thisputs increasing pressure on the international nuclearnon-proliferation regime, causing it to reach a tippingpoint. The continued failure of the internationalcommunity to halt Iran’s nuclear programme leadsthat country to proclaim successful enrichment inearly 2015.

Global concerns cause risk premiums to rise, andequities to slide. In North America and Europe,retirement funds are impacted. Governments are putunder pressure to increase state financial support,causing fiscal positions to worsen, particularly inEurope. At the same time, the bursting of the UShousing bubble and declines in equity marketscause private savings in major developed economiesto rise – beginning a process of correcting long-standing global economic imbalances.

16

A farmer gathers the rice crop from his paddy field afterTyphoon “Prapiroon” hit Southern China in August 2006.

Gas emissions at a plant near downtown Toronto, November2006. Current per capita CO2 emissions in Canada and theUnited States are approximately 5 times Chinese levels. IfChina were to emit at the North American per capita rate, itstotal emissions would be more than 4 times greater than thoseof the US.

Global Risk Scenario C: Oil Shock and Its Consequences

This scenario also illustrates the ways in whichpolicy responses to a single shock can eithercreate opportunities for change or facilitate achain reaction of global risks.

In early 2008, terrorists attack multiple tankers inthe Malacca Straits, sparking a major supply-side oilprice shock. The initial shock drives oil above US$150 per barrel. Producing countries, acting inconcert, choose to “close the tap”; a global slowdowndoes not reduce demand for oil products enough tocounteract the supply shock. The short-term priceelasticity of demand for oil proves itself to be low.

A secondary reaction of oil-producing countries is tomatch economic weight with a permanent increasein international political weight. Oil-producingcountries aim to achieve this by setting up parallelalliances known collectively as ChavPec. Theoperational mode of these alliances is the expansionof development assistance from oil producers topolitically sympathetic and economically vulnerablecountries, in return for political support. Rather thanwindfall gains from high hydrocarbon prices flowingto the developed world, the windfalls generatepolitical goodwill among developing countries.

Continuing with the scenario, the collapse ofPakistan is averted in mid-2008 by redirected oilrevenues, resulting in a geopolitical realignment withArab OPEC nations. Other blocs, similarly structuredaround commodity exporters, emerge in other partsof the world: between Venezuela, Bolivia and poorLatin American countries; between Russia andformer Soviet republics with major energy deficits(notably Uzbekistan, Georgia and Armenia); betweenAfrican commodity exporters and their neighbours.While some alignments cause concern in the West,they also help to avert state failure.

But the emergence of the ChavPec block does notgo unanswered.

A countervailing OECD bloc emerges. The Malaccaevents cause an immediate slowdown, but the 2008slowdown quickly turns into a recession in 2009 asOECD governments and central banks have usedup their ability to inject liquidity. The recession is worsein the US than elsewhere. In the US, falling assetprices drive down consumption while the unwindingof long-term current account imbalances to which theUS is particularly exposed causes a deep recession. InJapan, while higher energy prices help Japan escapedeflation, growth is destroyed by the decline inEuropean and American demand for finished goods.

17

140%

120%

100%

80%

60%

40%

20%

0%

140%

120%

100%

80%

60%

40%

20%

0%61 65 69 73 77 81 85 89 93 97 01 05

Oil Shocks (Using Hamilton Filter), 1961-3Q.06

Note: The filter measures an oil shock as the greater of zero or the percent change of the inflation-adjusted US$ oil price over the peak price of theprevious three years. Shaded areas are U.S. recessions.Sources: BLS, NBER and The Wall Street Journal

In the US, Europe and Japan, events are marked byretrenchment from globalization in general,characterized by populism (in Europe and the UnitedStates), regionalism (in the emerging OECD bloc asa whole) and militarism (in the US and Japan).

But the most problematic response to high oil pricescomes from China, which experiences its owneconomic hard landing in 2009, primarily due to thecollapse in OECD consumption. The speed withwhich longstanding global imbalances unwindaffects China more than OECD bloc countries. Butthe major consequence is political. China’sleadership emphasizes militarism in an effort toconsolidate power. Tensions over Taiwan areinflamed. An emboldened military builds up powerprojection capacities from a relatively low base andturns its attentions south, with an eventual aspirationto control the sea lanes and approaches to majorchoke-points (including the Malacca Straits). India is

isolated by these events, failing to find its place inany of the emerging major blocs. Over a period oftime, tensions with Pakistan – particularly afterPakistan’s realignment with Arab OPEC countries –worsen, leading to heightened fears of a nuclearexchange over Kashmir.

The final major casualty of the oil price shock is theprospect for collective action to mitigate climatechange. Though the high oil price causes the rate ofincrease of oil consumption to fall, its major impactis to delegitimize proposals for a global carbon tax.The effect of higher oil prices on alternative energysubstitutes only plays out in a 10-year time-horizon.In the short to medium term, the chief substitute foroil – where this is possible – is an increase in theconsumption of coal. The fracturing of the internationalcommunity means that a framework that wouldmake carbon capture and storage attractivepolitically or economically does not emerge.

18

Financial market scenario

Stress case, Oil Shock, 3-month horizon

United States 5.25 4.75 -15% -3% +40bpJapan 0.25 1.50 -15% -3% +20bpEuro area 3.50 4.50 -15% +5% +40bpUK 5.50 5.00 -12% +3% +40bpAustralia 6.25 5.75 +5% +0% +30bp

Short-TermInterest Rates

Long-TermInterest Rates

Equities(Changes)

Currency (Trade-Weighted Basis)

Changes

Investment GradeCorporate Credit

Spreads

Note: Over a 3-month time horizon of oil prices above US$ 100, equities in the United States and other markets are expected to decline by over 10%.Source: Citigroup Global Capital Markets report, 22 November 2006

This section of the report provides a brief explorationof three fundamental aspects of global risks:interdependency, heuristic biases and policymistakes. The first provides an insight into the natureof interdependency and provides an example of howinterdependency affects the way in which wemanage and mitigate global risks. The secondreflects a human approach to risk in general.Humans operate with incomplete informationthrough the use of heuristics. The third, oftenconnected to the second, explores how policy, oftenintended to mitigate risk, can actually exacerbate it.

Why Interdependence Matters for Security

A major challenge for policy-makers is how toencourage firms to invest in risk-reducing measuresin a world where there are growing interdependenciesbetween different parts of the system. Since 9/11

there has been a focus by researchers andpractitioners on strategies for dealing with this issueunder the heading of interdependent security (IDS).An interdependent security setting is one in whicheach individual or firm that is part of aninterconnected system must decide independentlywhether to adopt protective strategies that mitigatefuture losses. These measures can reduce the risk ofa direct loss to a country, firm or individual, but thereis still some chance of suffering damage from otherswho do not take similar actions.

The economic incentive of a decision-maker toinvest in protective actions depends on whetherothers are expected to follow suit. The fact that therisk is often determined in part by the behaviour ofothers gives a complex structure to the incentivesthat individuals or firms face to reduce or invest inrisk mitigation measures.

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Understanding the Nature of Global Risks

Setting policy under conditions ofinterdependency: Reducing the risk of power outages

Consider a utility that is part of an integratedsystem – the power grid – and wants to determinewhether to invest in additional capacity or securitymeasures (such as taking care of growingvegetation near distribution lines) to reduce thechance that it will cause a power outage. In anyhighly interdependent system, such as the powergrid, there is a systemic tendency to underinvest inreliability. A consequence of interdependency isthat a part of the cost of a failure is passed on tocompetitors and their customers.

Since 2002 several outages in individual Europeancountries (France, Italy, Germany, Switzerland)have had cross-border impacts. An agreementbetween different European grid operators alreadyexists, defining who should provide back-uppower when an outage in one country risksundermining the stability of the Europeantransmission system as a whole. Although thisagreement was able to avoid larger damage, itcould not prevent the spread of the problem.

There are a number of alternative approaches.One is based in the provision of the service as aright for the customer, under which a utility wouldbe held responsible for the full costs of a servicefailure, wherever it occurs. This is only possible,however, if the grid is set up in such a way thatadditional costs for providing transmission servicesare not directly passed on to customers. A secondapproach, more explicitly based in regulation, is tomandate minimum reliability standards withmonitoring and serious penalties for non-compliance.

The first approach provides a clear incentive onthe part of service providers to avoid failures. But itis only a valid option when accompanied byoversight. If customers are made to bear the cost,the distribution of incentives would be asymmetric.The transaction expenses (information, provingresponsibility, legal fees) would be prohibitive forindividual customers to seek to recover outagecosts. The second seeks to prevent them throughexplicit regulatory action.

Further examples of interdependency can be foundin the longer version of the current report atwww.weforum.org/en/initiatives/globalrisk

In many interdependent security problems, if oneactor believes others will not invest in security, theincentive to do so is reduced. The end result may bethat no one invests in protection, although all wouldhave been better off if all had incurred the cost of aprotection strategy. On the other hand, should eachdecision-maker believe others will also undertakemitigation measures, the optimal strategy will be todo the same.

Heuristics

The world is increasingly complex and uncertain.With imperfect information, humans cannot makefully-informed decisions; contrary to neo-classicaltheory, humans do not make fully rational decisionseither. Our decisions frequently depend onapproximations of the world around us – short cutsthat allow quick decisions by resorting to learnedbehaviours. These short cuts and “rule-of-thumb”practices are known as heuristics, derived from theGreek word “to find”.

To a large extent, the existence of heuristics stemsfrom the fact that human brains have evolved tospecialize in rapid decision-making at the expense ofprocessing complexity. In our original condition,survival depended upon the rapid appreciation ofthreat and an effective response. Heuristics are oftenuseful, making decisions quicker and easier. Butthey can also lead to inaccurate judgements,particularly in risk perception.

There are approximately 80 specific heuristic biasesthat distort our ability to assess risk effectively. Mostare not independent of one another, but exacerbatethe effects of others. The use of highly diversifiednetworks can help overcome a number of biases:interpreting a story of events through the lens ofsuperficially similar accounts (availability), focusingon instances which seem to confirm our initialassumptions rather than those that question them(confirmation bias), overestimating our own abilitiesto assess (overconfidence) and clinging mentally tofacts or figures heard in a particular context (anchoring).

Policy Errors in Risk Management

Historically, public policy in financial markets hasboth mitigated and exacerbated risk. Global risks,difficult to understand and dependent on a range ofinterconnected factors, are particularly susceptible topolicy errors, whether on the part of governments,regulators or central banks.

In some cases, policy has dampened the effects ofthe market and thereby reduced volatility –automatic stabilizers in welfare economies, forexample, have helped to flatten economic cycles. Inothers, however, policy has seriously exacerbatedrisk: most initial government responses to the stock-market crash of 1929 – combining mercantilism witha classical approach to wages and prices –sharpened the consequences of the event ratherthan mitigated them. More recently, errors ofregulatory or monetary policy have either reducedthe ability of the market to mitigate risk, orexacerbated risks within the market itself.

Policy errors are generally obvious in retrospect butrarely obvious at the time – decisions made bygovernments and regulators depend on judgement,experience, incomplete information and the balancingof alternative paths of action. However, the awarenessof potential policy mistakes may offer the bestmitigation strategy for avoiding errors in the future.

20

Policy decisions by governments and central banks can helpimprove resilience and prevent the contagion of financial risk.In 1929, however, policy in the US and elsewhere exacerbatedthe impacts of the equity crash.

The aim of risk identification and risk assessment isto provide the tools to mitigate exposure to globalrisk. But the step from the assessment of individualglobal risks to the mitigation of global risks underconditions of uncertainty, interdependency andcompeting interests is far from simple.

Mitigation involves a constant balance betweenaction and reaction, between preventing a risk fromoccurring and dealing with its consequences when itdoes, between acting rashly and acting too late.

21

Risk Mitigation

Risk Mitigation

Note: As time progresses, the information surrounding a given risk event may increase. But as it does, the options available for effective mitigation arebound to reduce. Risk mitigation – as with risk itself – involves degrees of uncertainty. Taking proactive mitigation policies implies operating underconsiderable uncertainty, with incomplete indicators.Source: Crisis and Risk Network, Swiss Federal Institute for Technology

ACTION

REACTION

Time

Ro

om

fo

r A

ctio

n

Number of Indicators

Options for Action

Deg

ree

of

Unc

erta

inty

The approach taken to mitigate an individual globalrisk will depend on prioritization, resources andunderstanding. Some risks can effectively bemitigated with relatively few resources by changingindividual mindsets and altering behaviours – othersrequire strong institutional processes and actions.What is common to the mitigation of all global risksis that they require alignment on priorities, commonunderstanding and common efforts to overcomeproblems of collective action.

One approach involves acting to prevent themanifestation of a specific risk. The advantage of“upstream mitigation”, if successful, is that it allowsthe disruption of the risk event itself to be avoided.

However, this assumes a degree of certainty aboutthe manifestation of the risk, and the expectationthat it can be managed in isolation. The scenarios inthis report suggest that interdependency betweenglobal risks is hard to manage in this way. Analternative is to attempt to understand nodes ofinterconnectedness between global risks, and focusmitigation efforts on them.

A final approach is to improve resilience, allowing the system to cope with a range ofunexpected manifestations. Such “downstreammitigation” recognizes that not all events can bepredicted and prevented.

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Prioritizing Risk

Resources for risk mitigation are necessarilylimited; prioritization among risks is a necessarystep for deciding how mitigation resources shouldbest be spent.

The normal basis for prioritization is, firstly, anassessment of the likelihood of the risk occurringand the severity of the consequences of the riskoccurring. These assessments are necessarilyidiosyncratic and distorted by a range of heuristics– for example, perceived likelihood is affected by“recency” and “availability” biases while severitydepends on “vividness” and perceived vulnerability.A second element to prioritization is values – thedifferent values of an organization may determineits perception of vulnerability, as well as itsperception of responsibility for mitigation. A thirdand final element is openness to mitigation – riskswhere there are clear strategies for mitigation willtend to be mitigated before those where strategiesare more diffuse, even if the assessment oflikelihood and severity is less acute.

At the global level, these key elements of riskmitigation are problematic. First, the potentialconsequences of combinations of risks affect allorganizations, even if global risks are oftenperceived by individual organizations and countriesas exogenous. Second, global risks may produceconsequences outside the central expectations ofrisk managers – they represent low-probability,

high-impact events which cannot necessarily bewell understood through classic cost-benefitanalysis. Third, global risks (such as climatechange) may emerge over a multi-decade time-frame, making it necessary to compare mitigationover different generations to ensure equity. Fourth,interconnections between global risks complicateprioritization – looking at global risks in isolationmay increase the perceived costs of mitigation: asthis report argues, interdependencies are the keyfactor in the global risk environment. Finally,mitigating global risks often requires thecooperation of different groups – issues of how tomanage collective action impact heavily on howindividual and global risk mitigation priorities canbe successfully aligned (the “tragedy of thecommons”). Most global risks are not open toeffective mitigation by any individual organization.

The Stern Review on the Economics of ClimateChange offers one approach to managing riskprioritization on the multi-decade and global scale,suggesting a low discount rate for calculating thenet present value of future costs from not acting tomitigate climate change. It is an approach thataims to get beyond national vulnerabilities toassess the systemic costs. An alternativeapproach, explicitly stating a limitation on availablemitigation resources, is that undertaken by theCopenhagen Consensus project. Risk prioritizationat the global level is a major task – but anecessary prerequisite to efficient mitigation.

In reality, these approaches are not mutuallyexclusive. Mitigation strategies tend to involve partsof both – like global risks themselves they aredynamic and complex.

In the 2006 report, the Global Risk Networkdeveloped the idea of the “5 pathways” tomitigation, defining five elements of risk mitigationstrategies: improving insight, enhancing informationflow, refocusing incentives, improving investmentand implementing through institutions. In the 2007report, these “5 pathways” have been applied to the“core global risks” to achieve an understanding ofwhere mitigation efforts should focus.

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Why are organizations not moreproactive in mitigating risk?

The following is a list of common reactions torisk, which prevent a proactive approach to riskmitigation: • Someone else will manage my risk.• The risk is not relevant to my organization.• Won’t taking action just slow me down?• No one is telling me that I must act.• What reward do I get from mitigating risk?• It is too costly to mitigate.• Why worry about it?

It could never happen to me.• It is too large to manage, and success

is not guaranteed.

The “5 Pathways” to Mitigation

• Improving insight: moving risks from theunknown to the known through research. Thebest mitigation strategies often derive fromthe changed mindset which can result fromenhanced knowledge and information.

• Enhancing information flow: allowinginformation to flow effectively betweendecision-makers and those experiencing therisk first-hand, to provide early warning,inform the public and exchange best practice.

• Refocusing incentives: creating the incentiveframeworks that will allow decisions to bemade to reduce risks previously consideredexogenous.

• Improving investment: providing theinvestments necessary to mitigate risk.

• Implementing through institutions: improving(or creating) the framework needed tomitigate risks for which an institutionalresponse is required.

24

Applying the “Five Pathways” to the 23 “Core” Global Risks

Oil price shock/energy supplyinterruptions

US current account deficit/fallin US$

Chinese economic hard landing

Fiscal crises caused by demographic shift

Blow up in asset prices/excessive indebtedness

Climate change

Loss of freshwater services

Natural catastrophe: Tropical storms

Natural catastrophe:Earthquakes

Natural catastrophe: Inland flooding




Failed and failing states


Retrenchment fromglobalization


Pandemics

Infectious diseases in the developing world

Chronic disease in thedeveloped world

Liability regimes

Breakdown of criticalinformation infrastructure (CII)

Emergence of risks associatedwith nanotechnology

Improvinginsight

Enhancinginformation

flow

Improvinginvestment

Implementingthrough

institutions

Re-focusingincentivesGlobal Risk

25

Two Possible Institutional Innovationsfor Managing Global Risks

Country Risk Officer

The Country Risk Officer concept would requiregovernments to appoint a single Country RiskOfficer, prioritizing risks on a cross-sectoral basis,exploring private sector techniques of riskassessment, management and transference.

In the corporate sector, the Chief Risk Officer(CRO) is responsible for all categories of risk,particularly risk reporting, consolidation andaggregation. Enterprise CROs take a portfolio viewof risk – a Country Risk Officer would serve asimilar function, acting as a focus point forstrategic thinking (rather than day-to-daymanagement) and forward action withingovernment on how global risks can be effectivelymanaged and mitigated.

The principal advantage of the CRO conceptdomestically would be to allow effective trade-offsbetween the priorities of different ministries, and toallow governments to escape silo-thinking. This isparticularly relevant when thinking of“downstream” resilience strategies as similarmeasures can help mitigate the consequences ofdifferent risks: buildings which are protectedagainst earthquakes are also likely to betterwithstand an explosion.

At the international level, the meeting of nationalCROs could provide a coordination body for globalrisk mitigation efforts.

“Coalition of the Willing”

An alternative institutional solution to themanagement of global risks is the setting up of“coalitions of the willing” regarding individual globalrisks involving different groups of countries in asystem of flexible geometry. A common criticism ofcurrent international approaches to major riskissues is that they depend on bureaucracies that

require consensus to act and that their objectivesare frequently sidelined by institutional conflicts. Ata time of acute global risks, the lack ofdecisiveness may have severe costs.

An alternative may be so-called “coalitions of thewilling” whereby a number of individual, interestedand vital states cooperate in a non-exclusivefashion on a specific global risk issue for a specificperiod of time, acting as an avant-garde for riskmitigation. Other countries will join the initiative asit progresses towards a statement of policyactions. The incentive to join is to influence asuccessful global policy. The incentive to pursuethe risk mitigation goals seriously once insidewould be a “naming and shaming” of thosecountries that do not meet the specific, agreed,commitments and the possible risk of expulsion.

The principal advantage of the “coalition of thewilling” structure is its flexibility and theinvolvement of only interested states, therebyreducing the possibilities for obstruction andgradually drawing less interested states into adialogue. The principal disadvantage of such anapproach would be the inability to effectivelynegotiate trade-offs between different countries’approaches to different global risks. For “grandbargains” between states a coordinating rolewould still be required.

The World Economic Forum can play a key role infacilitating dialogue on risk issues, helping to achieveconsensus around the need for change and possiblemitigation solutions.

26

Focus on Mitigation: Oil PriceShock/Energy Supply Interruptions

The recent progress on mitigating the risk of an oilprice shock includes reductions in oil subsidies,higher investment in energy efficiency andincreased strategic oil inventories: • Energy price subsidies have been reduced

in some countries, for example, Indonesia and Russia.

• High oil prices have increased investments inthe oil and gas sector, public and privateinvestment in energy efficiency and alternativeenergy sources.

• Reserves have been added to StrategicPetroleum Stockpiles, in, for example, the US and China.

Future mitigation needs can be divided into thosewhich address the question of interruptionsspecifically, and those that broadly address thequestion of demand and supply. • Remove the silo-based approach to risk

management and link energy security withconsiderations on climate change.

• Promote marketing of energy-efficient productsand clean energy sources and attempt to promotesustainable economic growth as a positiveeconomic choice in the developed world and asa long-term policy for emerging markets.

• Reduce legal and political uncertainties relatedto emissions-trading schemes and renewableenergies to allow markets to fully develop theirpotential.

• Develop nuclear energy and coal-fired electricutility plants in a manner that is mindful of therisks and environmental concerns.

• Increase investment in refinery capacity and inLiquid Natural Gas plants, off-loading andprocessing terminals.

• Increase taxes progressively on fuel in theUnited States to European levels, made morepolitically palatable with an equal value cut inincome tax.

• Eliminate remaining energy-price subsidies. Thisis particularly necessary to encourage energyefficiency in emerging markets andhydrocarbon-rich nations.

• Stockpile oil in Strategic Petroleum Reserves,but release supplies unpredictably whennecessary to undercut speculative psychologyin the markets.

• Promote intergovernmental cooperation onenergy security policies in defined geographies– such as the European Union.

• Promote and ensure common standards forenergy transit.

27

Focus on Mitigation: International Terrorism

Despite the increase in the overall strategic threatfrom international terrorism (particularly in Iraq,Afghanistan and Somalia), there have been aconsiderable number of tactical advances in themitigation of terrorism risk. These range fromimproved security controls, to improved politicalunderstanding and better management ofterrorism events when they occur, includingdevelopment of terrorism insurance markets tocover some of the economic consequences ofattacks and facilitate the recovery process.

On pre-event mitigation: • In the United Kingdom, a plot to blow up

aircraft between Britain and the United Stateswas disrupted.

• The European Union is improving its securityinformation-sharing system, through work on anEU-wide counter-terrorism database.

• The United States is improving its tracking ofimports and exports, through its AutomatedCommercial Environment system.

• In Saudi Arabia, over 20 senior Al Qaedaoperatives have been killed. A few years ago,fears that the Saudi regime was under threatwere widespread – these fears are nowreduced.

• The Philippine authorities are re-establishingcontrol over Basilan and the Jolo Islands,operational centres for the Abu Sayyaf andJemaa Islamiyah terrorism organizations.

• In Indonesia, the government’s multipillarcounter-terrorism campaign is beingstrengthened, with considerable new counter-terror legislation, the prosecution of a numberof major terrorists and the support andpromotion of moderate Islam as an alternativeto radical theology.

• The private sector has improved physicalsecurity measures and screening.

In post-event mitigation: • The private sector has continued progress on

diversifying operations and building upresilience, for example, by establishing asecond computer backbone.

• Terrorism insurance schemes have beenestablished to spread the risk among thedifferent stakeholders in some markets throughpublic-private partnerships: NHT in theNetherlands, Pool Re in the UK, Gareat inFrance, Extremus in Germany and TRIA in theUS.

• Terrorism insurance has risen: one survey ofMarsh clients revealed that terrorism coveragerose from 23% in mid-2003 to 64% by the endof 2005.

Future specific needs for mitigating the terrorismrisk:• Renew terrorism insurance schemes scheduled

to sunset in 2007 in some form; improveframework for public-private arrangements inother countries.

• Reach an internationally-agreed definition ofterrorism and terrorist acts and build a body oftranscultural values to help combat terrorism.

• Expand intelligence capabilities, while re-enforcing oversight functions to ensure thatprivacy is maintained.

• Improve cooperation between intelligenceagencies. In regions where bilateral cooperationis already good and a level of trust has beenestablished, transition to a more dynamic andefficient multilateral mode of cooperation.

• Improve tracking of financial flows to cut offfunding to dispersed terrorist cells.

• Strengthen the monitoring of the shipment ofgoods to allow for the detection of explosivedevices and nuclear/biological/chemical/radiological material.

28

Focus on Mitigation: Climate Change

As the science surrounding global climate changecontinues to unfold, a range of public and privatemitigation measures are critical both in theimmediate term and over the long term.

Some steps are already under way:• Awareness of the impacts of climate change is

rising quickly (particularly in the developedworld), building public support for mitigation.Ultimately, changes in the mindset ofconsumers – altering their behaviour as a result– may produce considerable mitigation.

• The European Union launched an EmissionsTrading Scheme in 2005.

• California has passed a law aiming to reducegreenhouse gas emissions by 25% by 2020.

But there are a number of mitigation needs whichshould be introduced, updated or implementedmore fully: • Raise awareness in the developing world of the

impacts of climate change.• Involve major developing countries in new

frameworks for limiting future emissions’ growth(particularly China and India).

• Urgently begin work on a successor to theKyoto agreement with three central principles:• Involvement of the United States and major

developing countries (particularly China andIndia);

• Differential responsibilities for futureemissions’ reduction dependent upon pastemissions and stage of economicdevelopment; and,

• Common overall responsibility for climatechange.

• Allow transfer of technologies which may helpreduce climate change, or mitigate its impacts.

• Expand market mechanisms – such as carbonemissions’ credit trading – which encourageinnovation, reward efficiency and ease thedevelopment of insurance and other financialtools to manage risks inherent in emissions’reduction projects.

• Strengthen current market mechanisms byensuring a stable and predictable legalenvironment and ensuring ambitious overalllimits on emissions.

• Create strong incentive structures and provideresearch funds to foster possible “breakthroughtechnologies” such as hydrogen fuel cells oradvanced thin film photovoltaics, particularly inthe power-generation sector.

• Provide investment or tax incentives that levelthe playing field for capital intensive investmentsin clean-coal combustion and carbonsequestration.

• Improve cost-effective reductions in emissionsat the business and domestic level. Many well-managed corporations have already identifiedmore efficient processes that can lead to costsavings in their production processes,transportation and facilities management. Theseshould be extended.

• Improve the protection of private and publicoperations from discontinuities caused bysevere physical risks due to climate change,including strategic assessments of long-termvulnerabilities.

• Encourage long-term adaptation in countrieswhere impacts of climate change are most likelyto be felt, by increasing adaptation aid andcreating financial structures to leverage globalinsurance capacities.

A car struck by a tree blown down in the storm on a roadin China’s Guangdong province. Typhoon “Prapiroon”killed at least 48 and left 15 others missing after crashingashore in Southern China.

29

Focus on Mitigation: Pandemics

The nature of the pandemic threat has becomemuch more widely understood over the last year: • A pandemic is not a one-time occurrence, but

occurs as a series of waves. • An outbreak cannot be predicted – multiple,

simultaneous geographic outbreaks may occurwith concurrent failures in the supply/valuechain.

• The behavioural response to an outbreak – the“infodemic” element – may be more significantthan the virus itself.

As a result, mitigation measures have advanced,both for the specific HN51 virus, as well aspreparedness for a pandemic outbreak moregenerally: • There has been an increase in exchange of best

practices between businesses. • The coordination of international organizations

has improved. • The awareness of the significance of national

transparency in order to aid any futureinternational effort makes the control of thedisease more likely.

Some future mitigation needs may only becomeavailable once an outbreak has occurred and itsorigins and vector of transmission have beenidentified. But many mitigation options remainincomplete or not fully exploited: • Strengthen collaborative preparedness

activities, including simulations and decision-modelling exercises among national, local andvalue-chain interdependent parties.

• Manage expectations of what government willand will not do if an outbreak occurs, endorsingwider accountability in the event of a pandemicand driving financial responsibility.

• Improve governmental ability to provide timely,clear and effective information, and improveeducation of first-responders.

• Increase research into the identification ofcritical choke-points in the supply/value chainwhere skill sets are rare, interdependencies aregreatest and the risk of triggering systemicfailure is highest.

• Invest in surge capacity in healthcare services.• Encourage private sector investment in surge

capacity for vaccine manufacture. • Develop effective domestic plans for the

distribution and administration of vaccines andother medication in a pandemic situation.

• Reach understanding between manufacturingand consuming countries on an equitable andagreed basis for international distribution ofvaccines in a pandemic situation.

• Encourage the maintenance of basic suppliesat home.

• Explore the possibility of “work-from-home” forsome businesses, reducing the potential forinfection and spread.

• Undertake an administration-wide skill-setevaluation to allow planning for replacing skilledpersonnel, should they become unavailable.

• Explore the feasibility of alternate financingschemes to serve as a backstop and transferthe risk to a larger community, including thepublic sector, to avoid systemic failure.

All of the four global risks focused on here – oil-priceshocks, international terrorism, climate change andpandemics – would benefit in different ways from theinstitutional innovations suggested in this report: aCountry Risk Officer or the setting up of “coalitionsof the willing” around particular global risks.

A Country Risk Officer would allow prioritization tobe made effectively and resources to be focused ondifferent risks at different times – creating, forexample, the kind of surge capacity for dealing withpandemics which is outlined above. A Country RiskOfficer would be equally well placed to understandthe interconnections between many global risks –understanding how some mitigation measures forclimate change might help improve energy securitywhile others would transfer the risk, orunderstanding how improvements in preparednessfor natural catastrophes could also strengthenresilience to international terrorism. Faced with aportfolio of mitigation options, a Country Risk Officerwould be able to shape the necessary strategicunderstanding and response to global risks that areneeded.

The “coalition of the willing” idea would allow forflexibility and clarity in adopting many of the specificmitigation options suggested above. The appropriategovernance, management and mitigation of globalrisks are only likely to emerge from the expandingparticipation of interested parties. Some of thespecific mitigation ideas above are already underway in some parts of the world, but their impact isreduced by the partial nature of their adoptionelsewhere. Structured “coalitions of the willing”would allow momentum to build up aroundmitigation measures, bringing countries andbusinesses into an evolving set of standards, ratherthan seek to achieve an overarching arrangement atthe outset. As such, a “coalition of the willing” wouldreflect the realities of global politics – and attempt toderive dynamic advantage from them.

In some cases, this approach would not work: aglobal definition of terrorism and terrorist acts isclearly a task which requires cross-culturalconsensus from the outset. However, for others –such as an oil-price spike – this structure mightcreate exactly the balance between inclusivenessand manageability that is required to produceagreement on appropriate measures for global riskmitigation.

There is no guarantee of mitigation initiativespreventing global risks from causing major disruptionto the international system, economic damage andirreparable human loss. Global risks cannot – for themost part – be mitigated out of existence. Butinaction in the face of global risks is not an option –either for businesses or government.

30

This report was prepared by Charles Emmerson ofthe Global Risk team of the World Economic Forum,in conjunction with its partners:

Global Risk Team, World Economic Forum

Charles Emmerson, Global Leadership Fellow,editor Global Risks 2007Jesse Fahnestock, Global Leadership FellowJohanna Lanitis, Team CoordinatorThierry Malleret, Senior DirectorGareth Shepherd, Global Leadership FellowSupported by Sean Cleary, Strategic Adviser

MMC

Sara Dixter, Senior Business Analyst, Marsh, United KingdomJohn Drzik, President, Mercer Oliver Wyman, USADavid Frediani, Executive Director, MMC International,Marsh & McLennan Companies, United KingdomJohn Merkovsky, Managing Director, GlobalPractice Leader, Marsh Risk Consulting, USARoland Rechtsteiner, Director, Corporate RiskConsulting, Mercer Oliver Wyman, Switzerland

Swiss Re

Esther Baur, Head, Issue Management, SwissReinsurance Company, SwitzerlandCatherine Burger, Head, Networks and Research,Swiss Re Centre for Global Dialogue, SwitzerlandAnnabelle Hett, Head, Emerging Risk Management,Swiss Re, SwitzerlandKurt Karl, Head, Economic Research and Consulting,Swiss Re Financial Services Corporation, USAIvo Menzinger, Head, Sustainability and EmergingRisk Management, Swiss Re, SwitzerlandChristian Mumenthaler, Chief Risk Officer andMember of the Executive Board, Swiss Re,Switzerland

Citigroup

John Ingraham, Managing Director, Head of RiskAggregation, Citigroup, USA

Wharton School

Witold Henisz, Associate Professor ofManagement, The Wharton School, University ofPennsylvania, USAStephen Kobrin, Professor of MultinationalManagement, The Wharton School, University ofPennsylvania, USAHoward Kunreuther, Cecilia Yen Koo Professor ofDecision Sciences and Public Policy, The WhartonSchool, University of Pennsylvania, USAErwann Michel-Kerjan, Managing Director, Centerfor Risk Management and Decision Processes, TheWharton School, University of Pennsylvania, USA

31

Contributors

Over the past year there have been a number ofworkshops associated with the Global Risk work.Four of these, at the Wharton School in May, inLondon in June and October, and in New York inSeptember, directly contributed to the writing of thecurrent report. We would like to thank the participantsin these workshops for their time – and above all fortheir insights:

Mohammad Hossein Adeli, Chairman, Center forEconomic & International Studies (Iran) William A. Anderson, National Intelligence Officer,National Intelligence CouncilDan Ariely, Professor, MIT - Media LaboratoryDavid Bowers, Joint Managing Director, AbsoluteStrategy ResearchChristopher Bunting, General Secretary,International Risk Governance CouncilMatthew Burrows, Director of Analysis andProduction Staff, National Intelligence CouncilJon Danielsson, London School of Economics Frank Diebold, Professor of Economics, Financeand Statistics, Wharton SchoolPatrick Dill, Vice-President, Emerging RiskManagement, Swiss ReHadi Dowlatabadi, Professor, SustainableDevelopment Research Institute, University of BritishColumbiaAlex Evans, Senior Research Fellow, Center on International CooperationJean Fournier, Managing Director, Innovation,Marsh (MMC)Leon Fuerth, Research Professor of InternationalAffairs, George Washington UniversityBoris Galonske, Senior Manager, Mercer OliverWyman (MMC)Ian A. Goldin, Director, James Martin 21st CenturySchool, University of OxfordRobert L. Grenier, Managing Director, Kroll (MMC)Gary S. Guzy, Practice Leader, EmergingEnvironmental Risk, Marsh (MMC)Beat Habegger, Senior Researcher, Crisis and Risk NetworkBruce Hoffman, Professor, Security Studies,Georgetown UniversityJohn P. Holdren, Director, Woods Hole Research CenterCharles Hollis, Head, Middle East Programme, Kroll (MMC)Bob Howe, Chief Risk Officer, Swiss Re Life & Health

Sir Paul Judge, Chairman, Royal Society (UK)Ethan B. Kapstein, Professor, Department ofEconomics and Political Science, INSEADStefan H.E. Kaufmann, Founding Director, MaxPlanck Institute for Infection BiologyMicheal Keen, Chief, Tax Policy Division,International Monetary Fund (IMF)Parag Khanna, Fellow, New American FoundationDavid Knipe, Director, Mercer Oliver Wyman (MMC)Gary S. Lynch, Managing Director and BusinessContinuity Practice Leader, Marsh (MMC)Nick Mabey, Chief Executive, E3GSimon Maxwell, Director, Overseas Development InstituteVivian Menna, Managing Director, Marsh (MMC)Sean M. Mooney, Chief Economist, Guy Carpenter (MMC)Berrien Moore, Director, Institute for the Study of Earth, Oceans and Space, University of New HampshireGeoff Mulgan, Director, The Young FoundationNeil Doherty, Frederick H. Ecker Professor ofInsurance and Risk Management, Wharton SchoolTina Nelson Fordham, Director, Economic andPolitical Strategies, Citigroup Global MarketsHerbert Oberhänsli, Head, Economics andInternational Relations, Nestlé SAMartin Parry, Co-Chair, Working Group II (Impactsand Adaptation), Intergovernmental Panel on ClimateChange, Hadley Centre, Met OfficeChristian Pedersen, Director, Mercer Oliver Wyman (MMC)John L. Petersen, President, The Arlington InstituteErik Peterson, Senior Vice-President and Director,Center for Strategic and International Studies (CSIS)Sanjay Purohit, Head, Corporate Planning, InfosysTechnologies LtdDanny Quah, Professor of Economics, LondonSchool of Economics Walter V. Reid, Director, Conservation and ScienceProgramme, The David and Lucile PackardFoundationUriel Rosenthal, Professor of Government andPublic Administration, Leiden UniversityDavid Rothkopf, President and Chief ExecutiveOfficer, Garten Rothkopf LLCNouriel Roubini, Professor, New York UniversityJoanna Rubinstein, Dean, Health and ScienceInitiative, Columbia University

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Participants

Enrique Rueda-Sabater, Director, Strategy andIntegrated Risk Management, World BankMichael Ryan, Director, Epidemic and Pandemic Alert and Response, World HealthOrganization (WHO)David Salisbury, Director, Immunization,Department of Health of the United KingdomArmen Sarkissian, President and Founder, EurasiaHouse InternationalClaire Spencer, Head, Middle East Programme,Chatham HouseDon Sull, Associate Professor of ManagementPractice, London Business SchoolRolf Tanner, Director, Political & Sustainability RiskManagement, Swiss ReJames Tansey, Deputy Director, James MartinInstitute for Science and CivilizationJ. Adair Turner, Chairman, UK PensionsCommissionGary G. Venter, Managing Director, Guy Carpenter (MMC)David G. Victor, Director, Program on Energy andSustainable Development, CESPKatherine Walker, Vice-President, Europe, MiddleEast and Africa, Merrill Lynch Europe, Middle Eastand AfricaAlyson C. Warhurst, Chair, Strategy andInternational Development, Warwick Business SchoolKevan V. Watts, Chairman, Merrill LynchInternational Inc.Mark E. Welland, Head of the Laboratory,Nanoscience CentreMartin Weymann, Assistant Vice-President,Emerging Risk Management, Swiss ReDickie Whitaker, Managing Director, Guy Carpenter(MMC)Angela Wilkinson, Director, Scenario Planning andFutures Research, James Martin Institute for Scienceand CivilizationGareth Williams, Partner, Worldwide, MercerHuman Resource Consulting (MMC)Justin Wolfers, Assistant Professor of Business andPublic Policy, Wharton School, University ofPennsylvaniaNgaire Woods, Director, Global EconomicGovernance ProgrammeKeith Woolnough, Actuary, Swiss Re Life & Health

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

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

Documents

Global Risk Report 2007