Part 2: Risks in Focus:
2.1 Introduction: Understanding Global Systemic Risk
This section of the Global Risks report on systemic risk draws heavily on Ian Goldin and Mike Mariathasan, The Butterfly Defect: How globalization creates systemic risk, and what to do about it, Princeton University Press, Forthcoming Spring 2014. Readers are referred to this book for an extensive discussion of all the issues that are summarized in this section and for further analysis of systemic risk.
In general, the biggest challenge in making systems resilient to systemic risk is managing their growing complexities and interdependencies, by proactively addressing collective action failures and resolving problems through international cooperation.
To do this, efforts to understand, measure and foresee the evolution of these complex systems must first be improved. Next, procedures and institutions that are globally coordinated yet locally flexible and responsive must be developed. To meet rising complexity effectively, regulation must not become more complex but, perhaps paradoxically, more simple. Simple and flexible rules are required as rising complexity cannot be matched by ever more complex and burdensome regulations.
Risk in the hyperconnected environment can no longer be treated as something that is confined to particular sectors or domains. Physical transport, trade and travel networks, energy and water supply networks, and global information technology infrastructure can become either a strong support for global stability or an amplifier of cascading shocks.
Multiple trends are contributing to linking global systems ever more closely and in more complex ways. For example, the increased carbon emissions and reduced ecological diversity resulting from unsustainable economic growth now fundamentally threaten to undermine not only the stability of the global ecosystem but also the economies that depend on it.
Perhaps the oldest form of systemic risk is that arising from viruses and pandemics, a threat that has entered a dangerous new phase as people and goods move at increasing speeds and over greater distances, with many passing through a small number of airports and other hubs. Increasing antibiotic resistance is a major concern, while new technologies that promise to revolutionize healthcare also pose risks of contagious diseases being constructed synthetically in laboratories. The potential of food-based pandemics or the spread of toxic elements in an increasingly globally integrated food chain also raises major concerns.
Society can also generate its own systemic risks, notably from growing economic inequality and weakening social cohesion within countries, which threaten political stability. Globalization has left some countries behind and has been associated with rising inequality between and within countries. This is augmented by restrictions on migration and a failure of policies at the national and global levels to promote a more inclusive system. Together, these factors render poor people and poor countries vulnerable to systemic risks.
Institutions are failing to tackle these problems. The growing complexity of today’s interconnected world reduces the ability to make well-informed decisions, leading to a loss of responsibility. Politicians often do not gather the support required to focus on longer-term strategic concerns. As social cohesion weakens and citizens seek to wrest control from distant and apparently unaccountable institutions, there is more visible support for extremist parties, as well as nationalistic, protectionist and xenophobic behaviour.
When “foreign” becomes synonymous with “threat”, the case for collective action is made more difficult. Yet it is only through collective action that resilience can be built and the gravest systemic threats mitigated. Social cohesion could, therefore, underpin more effective management of systemic threats – as could a greater understanding of causal connections between actions and events, allowing for the construction of decision-making scenarios in which the consequences of actions may be anticipated.1
The financial crisis of 2007-2008 was the new century’s most widely experienced systemic crisis, and others are likely to follow. The same dynamic of individually rational decisions leading to greater systemic vulnerability is at work elsewhere. For example, in global supply chains, individual firms increase efficiency through just-in-time and other streamlined management practices, but the removal of spare capacity can reduce resilience as each firm believes that system stability and sustainability are not their responsibility.
Systemic risks are a modern manifestation of the tragedy of the commons. They typically transcend national boundaries and involve shared resources as well as causality that are indirect and time-delayed.2 They are resistant to direct technical solutions, requiring instead changes to stakeholders’ behaviour. Hence, all stakeholders must display greater responsibility – including global businesses, governments, international organizations and civil society – while efforts are made to fundamentally reform global governance. The current system, created in response to the Second World War, requires radical changes, including a renewal of mandates, shareholding and skills to reflect 21st-century realities.
Yet, as the interconnections between transport, communication, financial and other world systems become increasingly complex, the traditional concepts of risk have become inappropriate as a basis of modern global governance. Systemic risks include elements that cannot be easily quantified using traditional tools and formulas from probability theory and mathematics, or made to fit the classical distinction between risk and uncertainty. As it becomes increasingly difficult to identify direct causality, traditional risk management needs to be supplemented with new concepts designed for uncertain environments.
The next three sections explore in more detail how individual risks could combine to create systemic global risks. These sections are followed by an analysis of concrete actions that leading companies and nations are taking to deal with such risks, both individually and through public-private partnerships.