Global Risks 2013
Global Risks 2013
Testing Economic and Environmental Resilience
Testing Economic and Environmental Resilience
Economic and environmental systems are simultaneously under stress worldwide and this is testing resilience at the global and national levels. Economic difficulties worldwide are continuing to make greater demands on political attention and financial resources. Meanwhile, the impact of climate change is more evident as temperature rises and more frequent extreme weather events loom on the horizon. The economic and environmental challenges require both structural changes and strategic investments, but are countries prepared to manage both fronts, conceivably at the same time? See Figure 7
Five years after the financial crisis, macroeconomic worries continue to weigh heavily on leaders’ minds. This is confirmed by data from the World Economic Forum’s quarterly confidence indexvi as well as the Global Risks Perception Survey, in which respondents rated major systemic financial failure as the economic risk of greatest systemic importance for the next 10 years.
The very same survey respondents also identified the failure of climate change adaptation and rising greenhouse gas emissions as among those global risks considered to be the most likely to materialize within a decade. Compared to last year’s survey, the failure to adapt to climate change replaced rising greenhouse gas emissions as the most systemically critical. This change in our data mirrors a wider shift in the conversation on the environment from the question of whether our climate is changing to the questions of “by how much” and “how quickly”.
The narrative emerging from the survey is clear: like a super storm, two major systems are on a collision course. The resulting interplay between stresses on the economic and environmental systems will present unprecedented challenges to global and national resilience.
Will countries be able to address complex challenges unfolding on very different time scales simultaneously? A cynic may argue that any future environmental loss could actually have a stimulative economic effect – this is the same rationale used to criticise GDP-driven growth policies, whereby the reconstruction after a massive earthquake can boost overall GDP over the long term. However, this view ignores two realities. First, more people live and work in urban areas than ever before in human history – this concentration will continue and is likely to drive environment-related losses to even greater historic highs. Second, the existing debt levels of many major economies can be unsustainable. Given this fiscal constraint, we are witnessing the use of extraordinary monetary policies to stimulate global growth, which some argue are essentially experimental.
The fact remains that today’s huge socio-economic challenges demand immediate attention, yet availability of public resources is limited – especially to finance efforts to avert the long-term effects of climate change, which, in turn, could severely disrupt the global economy. We face a daunting negative feedback loop. The logic of risk management prescribes that countries should invest today to safeguard critical infrastructure and centres of economic activity against future climate-related losses that could be of much greater magnitude. And there is an even more compelling political logic to do this in order to generate new employment and to revive economic growth as soon as possible. But investment in strategic infrastructure is more easily said than done, despite the short- and long-term benefits.1 New approaches are needed that are based on a meeting of minds across varied professions, sectors and geographies; a capacity to act decisively is also needed, despite considerable uncertainty about what the best plan of action might be. Hesitating to act now will only add to the burdens of the next generation.
Persistent Global Economic Fragility
The global economic situation remains fragile. The International Monetary Fund projects slow growth in the advanced economies, an annual rate of between 1.3% and 2.6% between 2012 and 2017.2 Combined with fiscal fragility, this will continue to strain government spending. Given the current levels of government debts and deficits in these economies, “it will take years of concerted political and economic effort before debt to GDP levels of the United States, Japan and many Euro Area countries are brought down” to stabilize at lower levels.3 Also, the economic growth of emerging markets and developing economies is projected to be slower than at its peak in 2010.4 See Figure 8
The current eurozone instability will continue to shape global prospects in the coming years.5 The associated risk of systemic financial failure, although limited, cannot be completely discarded. Given the anti-austerity protests across the eurozone, the election of “rejectionist” governments could lead to further economic paralysis and bring the eurozone crisis to a head,6 potentially destabilizing a global financial system in which confidence is already waning.7
This persistent global economic fragility continues to divert our attention from longer-term solutions by limiting the availability of public resources and generating greater caution in use of scarce funds for strategic investment projects. There are other looming issues related to ongoing prescriptions to counter economic malaise. Will the massive quantitative easing undertaken by key central banks to stave off deflation inevitably lead to destabilizing hyper-inflation? Will structural economic reforms deliver the necessary employment gains over the long run?
The Changing Debate on the Global Climate
Mitigation efforts have made significant progress at country level in the past 15 years in areas such as emissions regulations and financial incentives – for example, the US$ 3.4 billion made available to match private sector investment funds in the US Smart Grid Investment Grant program.8 Nonetheless, in today’s increasingly multi-polar geopolitics, it has become harder to reach and effectively implement international agreements on climate change mitigation. Pledges made in the run-up to the 2009 Copenhagen climate change negotiations, which were intended to limit global warming to 2 degrees Celsius, now appear collectively insufficient to meet this target of 2 degrees.9 Recent scenario projections based on existing government policies and declared policy intentions predict that a long-term increase of more than 3.5 degrees Celsius is probable. The more pessimistic scenario assuming no change in government policies and measures beyond those adopted or enacted by mid-2011 talks of a conceivable increase of 6 degrees Celsius or more.10
If the current mitigation commitments remain unmet, a global mean temperature increase of 4 degrees Celsius could occur as early as the 2060s. This would likely lead to negative impacts including an increase in the frequency of high-intensity tropical cyclones, inundation of coastal cities as sea levels rise, and increased drought severity in several regions (see Figure 9). Together, the effects would not only mean significant economic losses but also mass displacement of populations, rising food insecurity and aggravated water scarcity.11
Recent climate and weather events, some of which are visualized in Figure 10, have reminded us of the economic and human cost of the kind of natural disasters that we know are likely to become more frequent and severe as climate continues to change. The estimated economic cost of the 2011 Thailand floods, for example, was US$ 15 billion to US$ 20 billion,12 and of Hurricane Katrina US$ 125 billion; meanwhile, the 2003 European heat wave resulted in more than 35,000 fatalities13 and the Horn of Africa droughts in 2011 claimed tens of thousands of lives and threatened the livelihoods of 9.5 million people.14 More recently, Hurricane Sandy left a heavy bill, estimated today at more than US$ 70 billion for New York and New Jersey alone.15 Such events remind us that many economies remain vulnerable to damages arising from climatic events today, let alone those of the future. 16
While there is no consensus on how fast and how much our climate is changing, the growing realization that some degree of climate change is inevitable is reflected in a shifting of the debate to how to adapt. Advocating for greater attention to be paid to adaptation is controversial in some quarters as it is interpreted as a tacit admission that mitigation efforts are no longer worth pursuing. However, the less effective mitigation efforts are, the more pronounced adaptation challenges will become. Therefore, mitigation and adaptation need to be addressed in concert while taking advantage of all possible synergies.
A number of climate adaptation related initiatives and reports have been emerging.vii While poorer countries will need help from the international community to finance adaptation investments, adaptation efforts are by their nature local, with countries, companies and individuals being largely responsible for their own adaptation costs.
While it is possible to make various underlying assumptions in modelling the effects of climate change, it is clear that the economic costs are likely to be considerable. A report by Mercer,17 which considers the cumulative economic cost of changes to the physical environment, health and food security due to climate change, quotes a possible range of US$ 2 trillion to US$ 4 trillion by 2030 across different climate scenarios.18 The EU Climate Change Expert Group suggests that the costs of climate change impacts, increasing in magnitude with the rises in global temperature, may amount to 5% to 20% of GDP (or higher) in the long term.19
Some people affected by climate change may seek to recover costs from past emitters of greenhouse gases. Although the Alaskan village of Kivalina – which faces being “wiped out” by the changing climate – was unsuccessful in its attempts to file a US$ 400 million lawsuit against oil and coal companies,2021 future plaintiffs may be more successful. Five decades ago, the US tobacco industry would not have suspected that in 1997 it would agree to pay US$ 368 billion in health-related damages.22 For some businesses, investing in climate change mitigation now could be as much about enterprise risk management as about mitigating a global risk.
Decisive Action in a Climate of Uncertainty
As the consensus that climate change is becoming more evident grows, data across many disciplines (including forestry, water and land management, for example) remains limited, not readily available or communicated in a format that might not facilitate actionable decisions on climate adaptation. Yet, future climate risks may require human judgement today or in the coming years, while the full scientific data may not come until it is too late. Complex systems such as the climate are non-linear by nature – chain reactions through the system are unpredictable and not directly proportional to the size of the triggers. A limited amount of data and constraints on computational power have been strong impediments to bringing greater clarity into predicting future climatic developments at a local level.2324 For instance, there have been inconclusive predictions regarding the likely impacts of global warming on rainfall patterns in Guyana: possibilities ranged from a 5% rainfall decline by 2030, lessening the risk of flooding, to a 10% rainfall increase, worsening this risk significantly.25
Faced with uncertainty about the likely effectiveness and risk of unintended consequences of a proposed intervention, policy-makers can be paralyzed by a desire to wait for more detailed analyses and data regarding the precise timing, manifestation or impact of future climatic changes in their local environments. Greater support for scientific research, better computational power and data are needed to shed greater clarity into predicting future climatic developments, especially the climate and weather extremes.
While this will come, can leaders embrace the need to make a decision without the complete assurance that they are making the best decision? This is more easily said than done, especially when there are competing demands for attention and resources. For example, the 2008 financial crisis shows how urgent macroeconomic difficulties can divert attention from other significant global governance challenges, from climate change negotiations to the Millennium Development Goals. Yet the actions of the G20 during the crisis also demonstrate the potential for bold, coordinated international action.
As global risks ultimately require a national response, much more attention must be given to how decisions are made in the face of such overwhelming economic and environmental challenges. Perception is typically regarded as a passive process, in which people view an objective reality. Yet perception is actually an active process of understanding, through which people construct their own version of reality.26 Research in cognitive psychology and decision-making suggests that people use “rule of thumb” to make judgements in the face of ambiguity and complexity.viii This approach usually serves well but can lead to predictably faulty judgements in some circumstances. Psychologists call such predictably faulty judgements cognitive biases,27 and these biases influence how we respond to the best information at our disposal and integrate it in decision-making structures. Cognitive biases become important when addressing the slow-moving future threat of climate change in the context of an ongoing unstable economic outlook. Some examples are:
- We tend to place too much emphasis on recent personal experience when estimating the likelihood of a risk occurring. For example, experience in the United States shows that many more people buy flood insurance immediately after a major flood. On average, those people hold flood insurance for only two to four years before letting it lapse if they have not suffered a claim because they are likely to view insurance as a bad investment rather than seeing it as a form of protection.28
- Through a process known as hyperbolic discounting, we tend to give disproportionately more weight to immediate costs and benefits than to delayed ones. Individuals, for instance, may often be reluctant to incur the upfront costs of measures such as investing in climate change adaptation measures when the benefits will not be felt for several years.2930
- We fail to take protective measures if the perceived likelihood of the risk in question is below our threshold level of concern – for example, discounting entirely the possibility of a natural catastrophe that has a low chance of occurring. This bias is exacerbated by a tendency to underestimate the likelihood of a negative event occurring due to misperceptions of the risk.3132
The cumulative effect of such cognitive biases is that we may not pay due attention, or act effectively on, risks that are perceived to be long-term and relatively uncertain. The impossibility of fully eradicating ambiguity, along with the relatively lengthy time scales involved, mean that cognitive biases are likely to remain significant hurdles to be acknowledged and overcome on the path towards effective action on climate change and related risks.
Exploring New Approaches with Climate-Smart Mindsets
Acknowledging the effect of our cognitive biases may be the first step towards building resilience against a future perfect storm of economic and environmental challenges. Only then can we start weighing the various demands equally, in the near and the long term, on scarce public resources and dwindling risk-mitigation budgets.
To reconcile the challenge of building environmental resilience amid economic stress, current policies and strategies may need to be re-evaluated. For instance, in several countries, government insurance schemes and building-permit policies continue to encourage further urbanization in coastal or high flood risk areas rather than preventing it.33 In doing so, they may be creating large pockets of vulnerability to climate risks. A 2007 OECD study analysing 136 port cities around the world concluded that the population exposed to coastal flooding could triple by the 2070s due to the combined effects of climate change and urbanization, among others.34
In light of the increased certainty that global temperatures will rise to some extent, a “climate-smart” mindset needs to permeate all levels of decision-making. “Climate-smart” is a term that originated in agriculture, to describe such agriculture that not only increases resilience in light of climate adaptation but also reduces greenhouse gas emissions.35 A climate-smart mindset incorporates climate change analysis into strategic and operational decision-making. It entails a search for synergies across climate change mitigation and adaptation-related efforts where possible. Such a mindset needs to become an integral part of our urban planning, water- and food-security management, investment policy, and demographic policy development, among others. In 2006, during its term over the rotating European Union presidency, Finland introduced a policy innovation which encouraged ministers with other portfolios – from transport and urban planning to agricultural and employment policies – to consider the effects of their decisions on the population’s health.36 Something similar may be needed to ensure that all ministers enact policies in their domains that are informed by a climate-smart mindset.
The current debt crisis of several leading economies will make it more difficult to finance climate-smart activities, such as the Smart Grid Investment Grant. That said, the private sector has a critical role here as well. In the United States, about 80% of critical infrastructure is owned or operated by the private sector, not governments.37 It is likely that many of the preparations to weather the colliding economic and environmental storm systems will be found in private-sector initiatives to reinforce critical assets and shield them from potential future risks and liability.
Given the pressure on public finances generally and their scarcity to address climate change-related challenges, new funding models will need to be found. Private funds can be unlocked through innovative public-private collaboration that ranges across disciplines as well as stakeholders. In order to enable scalable, effective partnerships, a variety of actors and professional disciplines will need to converge on mutually beneficial and economically sustainable solutions. This is no minor task since, in addition to the diversity of interests at stake, different professionals often have conflicting biases and have been trained to think in siloed ways. Yet such partnerships have started to emerge. In order to address the current shortfall in green infrastructure in a number of emerging economies, more than 50 leading companies from finance, infrastructure, energy and agriculture sectors joined public institutions to form the Green Growth Action Alliance (G2A2). As described in greater detail in the section below, the aim of this initiative is to unlock greater sums of private investment for green infrastructure.
Other examples of innovative partnerships include a company in China which has partnered with government, industry associations and international NGOs to enable a sector-wide replication of green prefabrication production, currently saving 360 hectares of forest and 314,000 tons of greenhouse gas emissions a year. The Desertec Foundation for Clean Energy Generation has assisted in founding an industrial initiative of 55 industrial and financial companies and institutions working to enable large-scale generation of renewable power from deserts to serve markets in North Africa, Middle East and Europe.38
As the world faces a squeeze in public funds at the same time as the effects of climate change are increasing, it is only through collaboration among governments (to further the public interest), businesses (to search for innovative products and solutions), legal experts (to mitigate fear of liability), science (to bring good quality supporting data and analyses) and the financial sector (to innovate and avoid future damaging costs) that the limits of environmental and economic resilience can be successfully navigated.
Questions for Stakeholders
- How will we reconcile climate change mitigation and adaptation efforts with the desire for prosperity given current demographic trends?
- How can like-minded municipalities, companies and communities drive forward a new set of climate-smart approaches that avoid cognitive biases?
- How can we rethink cross-industry collaboration to find the right balance between competition and cooperation among companies in a resource-constrained and increasingly interconnected world?
The Green Growth Action Alliance (G2A2)
As emerging economies grapple with how to grow their economies without worsening their environments, many are developing “green growth” strategies designed to attract investment in sustainable water, energy, transport and agricultural infrastructure. Up to US$1 trillion a year of private sector investment is needed, according to the 2012 B20 Green Growth Task Force. However, due to the limited track record of some technologies, combined with the perception of investment risk, private capital providers are often reluctant to invest in green growth.
To address the current shortfall in green infrastructure investment, more than 50 leading companies from finance, infrastructure, energy and agriculture sectors joined with public finance institutions to launch the Green Growth Action Alliance (G2A2) at the 2012 G20 Summit in Mexico. Chaired by the then Mexican President Felipe Calderón, the G2A2 will pursue four strategic activities over a two-year timeframe:
- Highlight innovative models for public-private collaboration: The G2A2 will launch a report at the 2013 World Economic Forum Annual Meeting identifying existing sources of finance and pinpointing innovative ways for public policy to unlock private funds.
- Stimulate private investment at country level: The G2A2 is working with the governments of Kenya, Vietnam and Mexico to incubate innovative financing models with the domestic and international private sector.
- Provide new ideas and models to shape the policy agenda: The G2A2 has formed working groups on green free trade, end-user financing of renewable energy, institutional investors and energy efficiency. The energy efficiency working group is looking to pilot new financing structures for energy services companies; the green free-trade group has led calls to establish free-trade regulations for clean technologies such as solar.
- Help to scale up and replicate successful approaches: To help governments, development banks and finance institutions to ensure rapid replication and to scale up successful models, the G2A2 will document case studies in the Green Investment Report and engage with policy platforms and investor networks, such as the G20 Development Working Group and Finance Track group on climate finance, the UNFCCC’s Momentum for Change Initiative and the International Development Finance Club. The G2A2 will also collaborate closely with the UN Sustainable Energy for All Initiative and the Global Investor Coalition on Climate Change.
The World Economic Forum is serving as the secretariat for the G2A2.
Source: Adapted from IMF Fiscal Monitor, 2012 as cited in Global Economic Prospects, Managing Growth in a Volatile World. June, 2012. Washington DC: World Bank.
Source: Adapted from Shaping Climate-Resilient Development: A Framework for Decision-Making. 2009. Economics of Climate Adaptation Working Group.
Source: Adapted from sigma natural catastrophe data base of Swiss Reinsurance Company.