Economic Growth 4.0
Fiscal crises in key economies, asset bubbles, and structural unemployment and underemployment are among economic risks rated as both highly impactful and likely; another global systemic financial crisis is rated as somewhat less likely than last year, but similarly impactful. Taken together, these risks could result in another economic slowdown with knock-on effects on employment and, ultimately, social stability.
Economic concerns are currently centred on the corporate and public debts built up by emerging markets in the recent low-interest rate environment: the International Monetary Fund (IMF) estimates the extent of corporate over-borrowing at up to US$3 trillion,23 and the corporate debt to GDP ratio rose by 26 percentage points between 2004 and 2014 for this group of countries.24 Particular risks could emanate from China, where continued credit-based measures to address concerns about a slowing economy could further heighten vulnerability to a financial crisis.
Concern is growing over debt levels at a time when long-term global economic prospects are expected to remain weak as a result of a worldwide slowdown in productivity growth over the past decade. In the short term, lower commodity prices and further appreciation of the dollar could pose balance sheet risks to both public and private sectors in countries with a high share of debt denominated in US dollars; in emerging markets, dollar-denominated corporate debt issued in 2015 stands at US$120.5 billion in 2015.25 Also plausible is an increase in risk premiums on investments in emerging markets, which have been compressed in recent years. Interest rates are likely to go up in future, which could undermine the sustainability of high debt and lead to reversals in capital flows.
The result could be numerous corporate and potentially sovereign defaults in emerging markets, triggering a financial crisis and further slowing growth. In turn, slower growth in emerging economies could further reduce commodity prices, exacerbating exchange rate shifts.26 With declining liquidity in financial markets in emerging market economies,27 a crisis in an emerging market could spark volatility in global financial markets, leading to a global economic slowdown (see Box 1.4). This would accentuate risks associated with unemployment and the weak fiscal position of many key economies.
Box 1.4: China’s Financial Vulnerabilities and the Transition to the New Normal
Because of its sheer size and rapid development, China plays a prominent role in shaping the global economic landscape. The country is now at a critical juncture as it transitions to a new phase of its economic development – referred to as a “new normal” by President Xi – in which its economy is based less on investments and exports and more on consumption and services. In the new normal, the Chinese economy will be more driven by market forces; it is expected to grow more slowly than its recent annual average of 7%, but more sustainably. However, whether this transition will be orderly is uncertain.
Uncertainty centres on the massive corporate debt built up by traditional industries that drove China’s last two decades of growth but now face lower demand. The IMF estimates, for instance, that, at the end of 2014, the ratio of total liabilities to equity in China’s construction sector exceeded 250;1 in the oil and gas sector, the ratio has more than doubled since 2007, albeit from a lower base.
China’s financial sector is another, related cause for concern. The Chinese banks that fuelled the rapid credit growth in now-declining industries consequently face worsening asset quality and non-performing loans. Their profitability has plummeted over the past year, adding to concerns about the fragility and vulnerability of China’s underdeveloped financial system – which is dominated by large state banks and casts a large shadow banking sector. The central bank’s intervention in August 2015 to weaken the renminbi could increase the risks of capital outflows, making funding and liquidity conditions for banks even tougher. It could also exacerbate the risk of default of Chinese companies that borrowed in foreign currency.
The government faces a dilemma. If it tightens credit conditions, it could reduce investment more quickly than consumption can increase to compensate, and cause massive defaults among struggling and heavily leveraged companies. This could mean a much more severe economic slowdown, potentially causing a surge in unemployment and social unrest. However, if the government lets more credit flow to avoid these destabilizing defaults, it risks further increasing the indebtedness of underperforming industries and creating bigger problems down the line. The government seems to have opted for letting more credit flow: in October 2015, the central bank lowered its benchmark rates and relaxed reserve requirements for banks.
The hope is that more of the new liquidity will flow to productive service-based activities and high-end manufacturing that will yield higher returns and accelerate the transition to the new normal. Mitigating the risks of this further increase in debt, China still has policy buffers to absorb financial shocks – it has a relatively favourable fiscal situation, including low debt and large foreign reserves. This allows the central government to be lender of last resort for heavily indebted local governments, state-owned banks and enterprises; to intervene to stabilize the stock market; or to adopt stimulus plans.
However, overreliance on these buffers could exacerbate existing vulnerabilities and impede the transition process. Instead, the government should invest in improving the nascent safety net to boost consumption in a country where, on average, households save about 30% of their disposable income, one of the world’s highest.2
In developed countries, concerns remain about debt levels – mainly public – creating another vulnerability in the interconnected global economy. National economic crises can spark global slowdowns, but international governance does not have mechanisms in place to address the underlying risks, which are under the purview of national economic policies. Because any country could be a weak link, it is critical to strengthen resilience in all countries.
With longer-term trends such as demographic changes and rising wealth disparities likely to heighten economic and social pressure in emerging economies over the next 10 years, there is renewed urgency to generate growth. As explored in the Global Competitiveness Report 2015–2016, productivity – the major driver of growth – has been declining in recent years.28
Many hope that emerging technologies will fuel a new wave of productivity and growth. The pace of innovation is increasing and the spread of technologies is inevitable,29 giving rise to individual innovations and disrupting business models, processes and products in ways that will require rapid adaptation.30 A recent study suggests that internet-related technologies such as mobile internet, automation of knowledge work, the Internet of Things and cloud technology will be the most disruptive and generate the most economic benefit (see Figure 1.4).31
Figure 1.4: Estimated Potential Economic Impact of Technologies, US$ trillion, annual
Source: Based on Manyika et al. 2013.
Note: Projections are to 2025 and include sized applications and consumer surplus.
The failure to understand and address risks related to technology, primarily the systemic cascading effects of cyber risks or the breakdown of critical information infrastructure, could have far-reaching consequences for national economies, economic sectors and global enterprises. By one estimate, European countries that do not react appropriately to technological change could lose 600 billion euros in value added over the next 10 years, corresponding to about 10% of Europe’s industrial base.32 Businesses, policy-makers and civil society therefore need to find appropriate frameworks to address four high-level risks associated with the transformation towards a more digitized economy.
First: cyber-related risks. Cyberattacks and related incidents have been entering the global risks landscape as among the most likely and most potentially impactful risks for the past two to three years – in North America, cyberattacks ranks as the most likely risk by far (see Figure 3) – with the potential threat for doing business explored further in Part 4. Cases have been rising in both frequency and scale. They have so far been isolated, concerning mostly a single entity or country, but as the Internet of Things leads to more connections between people and machines, cyber dependency – considered by survey respondents as the third most important global trend (see Figure 4) – will increase, raising the odds of a cyberattack with potential cascading effects across the cyber ecosystem. As a result, an entity’s risk is increasingly tied to that of other entities. As cyber dependence rises, the resulting interconnectivity and interdependence can diminish the ability of organizations to fully protect their entire enterprise. As more organizations move to digitize their unique business value within more connected environments that rely more and more on machine learning and automated decision-making, cyber resilience takes on a new importance. Although organizations may recognize the benefit of cyber technologies for their bottom lines, they may not be fully internalizing cyber security risks and making the appropriate level of investment to enhance operational risk management and strengthen organizational resilience. Particular attention is needed in two areas that are so far under-protected: mobile internet and machine-to-machine connections. It is vital to integrate physical and cyber management, strengthen resilience leadership and organizational and business processes, and leverage supporting technologies.
Second: the exchange of data between countries and stakeholders. Data have been called “the oil of the 21 century”, and a predictable legal framework is needed to realize the full economic potential of digitization. Recent cases of policy reversal have created uncertainty about the legal situation, which can hamper investment and adaptation of the latest technologies. Given the inherent international nature of data flows, in areas such as supply chains or 3D printing, national governance needs to be complemented by a functioning international legal framework. However, the current regulatory regime is underdeveloped and lacks the necessary legal certainty in areas such as privacy, transparency, encryption control, the effect of intellectual property regimes on data that cross borders, and the impact of proprietary data on competition. Given the many actors and industries involved and the competing interests at stake, stakeholders will probably struggle to find common agreement. Moreover, the physical infrastructure for data exchange, such as undersea cables, could also become a target in international conflict or terrorism.
Third: changes to the work environment. Although there is a lot of uncertainty about how many new types of jobs new technologies will create and what they may be, it is likely that more existing categories of jobs will be computerized. Frey and Osborne (2013) have estimated that 47% of US jobs are potentially automatable over the next decade or two.33 Examples include robots taking over manual tasks in online retail stock keeping, healthcare and diagnostics, and checking in hotel guests, while knowledge workers in non-routine cognitive tasks could be displaced by advances in intelligent algorithms. The entire employment system may have to be re-thought to facilitate transitions between different types of jobs. Skills in STEM (science, technology, engineering and mathematics) are expected to increase in importance in the medium term, with longer-term needs projected to focus on skills such as creativity, problem-solving and social intelligence.34
Fourth: widening wealth, income and social inequalities. Access to technology is likely to exacerbate income differences within and across countries, with those who adapt gaining and those who do not losing income. Four billion of the planet’s 7 billion people still do not have access to the internet and may not be able to gain from technology-driven growth. Currently the distribution of income is largely determined by employment: advancing technology could diminish returns to labour and lead to wealth accumulating in fewer hands. Excessive inequality lowers aggregate demand and threatens social stability, and can increase risks such as involuntary migration or terrorism caused by violent extremism. Rising inequality is also correlated to upticks in security problems, such as violent deaths or robbery.35
There is a role for public, private and civil society organizations in building resilience to the risks explored in this part of the Report. In Box 1.5, the World Economic Forum’s Global Agenda Council (GAC) on Risk and Resilience shares the results of research on what makes organizations resilient.
Box 1.5: Pathways to Resilience: Effective Leadership and Institutional Values
Global risks recognize no geographic boundaries. Whether from natural or man-made or cyber disasters, the cascading effects can be felt oceans away. Escalating terrorist attacks in Africa, Europe and the Middle East; natural disasters related to climate change; and health disasters from infectious diseases increasingly impose both economic and human costs. How can the global community prevent or mitigate the adverse effects of catastrophic events in our increasingly complex and quickly evolving environment?
The Global Agenda Council (GAC) on Risk and Resilience advocates four key activities for companies, organizations and governments to build resilience at national and global levels.1 These recommendations resulted from a detailed study of entities that proved to be resilient in recent disasters, including Nepal’s 2015 earthquake, the 2014 Ebola outbreak and Chile’s 2010 earthquake, along with an assessment of data from four sources including the Organisation for Economic Co-operation and Development, the U.N. Office for the Coordination of Humanitarian Affairs, the World Bank and the Zurich Insurance Group.
1. Clarify roles and responsibilities. During a crisis, it is critical to have clearly delineated and understood senior official and c-suite executive roles and responsibilities for risk and incident management. Confusion around “who is in charge” or “who has authority” wastes crucial time and resources, and makes response and recovery less efficient and effective. The need for well-defined roles becomes heightened when an organization faces novel or rapid-onset disasters or emergencies, such as those resulting from cyberattacks. Pre-determining, training and exercising roles, capabilities and plans helps to ensure an organization’s risk readiness. The successful management of complex crises also requires a capacity for adaptability and flexibility. Crisis managers must be able to adjust pre-established plans as needed given the unique characteristics of the crisis.
2. Develop Crisis Leadership Characteristics. Organizations that successfully position for, respond to and recover from major events also consistently have effective leadership – the qualities and actions of those with authority and influence can empower their entities to be resilient. Such leaders are steady and decisive in the face of uncertainty and pressure. They make decisions in a timely and prioritized way, and communicate them transparently. Recognizing that they cannot address risks alone, they galvanize others and are clear about what assistance they require. They understand when a disaster requires them to cut through policies that may prevent or delay action. Leaders who are effective during and after a crisis are those who have earned trust through their demonstration of openness, transparency, responsiveness and accountability. They are seen as honest and standing up against corruption. For example, an IMF assessment attributes much of Chile’s effective recovery from the 2010 earthquake to the nation’s “technocratic, rules-based, and transparent” leadership – and to its institutional practices, including the rule of law.2 Another example is seen in Norwegian Prime Minister Jens Stoltenberg’s speech in the wake of the July 2011 terrorist attacks in Norway, which demonstrated how leadership during a crisis can significantly result in both increased trust in government and meet citizens’ expectations of responsiveness. These examples also highlight the role of meaning making – that is, the capacity for leaders to make sense of an adverse event and articulate to the public a clear path forward in a state of emergency.
3. Leverage expertise. When confronted with an unprecedented emergency, strategic crisis managers must be able to quickly identify and mobilize the most relevant and trustworthy expertise to help understand and respond to the crisis. Knowledge management systems and expert networks need to be set up in advance and across multiple sectoral, professional and disciplinary boundaries. Understanding the implications of the crisis beyond the immediate consequences and anticipating the potential pathways of cascading effects requires appropriate crisis management structures that enable additional expertise to formally support decision-making. For example, the United Kingdom’s Scientific Advisory Group in Emergency (SAGE) is an independent support group that provides science-based expertise for the management of complex and unprecedented crises to the UK cabinet. Access to such expert “force-multipliers” could help both public and private entities understand and address the unique aspects of a crisis. Having access to specialized expertise is especially crucial for novel or multi-faceted evolving crises – such as the Great East Japan Earthquake, which impacted the Fukushima nuclear reactor and caused many companies to struggle with what decisions to make.
4. Create a culture of integrated risk management and multistakeholder partnerships. Another necessary institutional value is the recognition of the scope of global risks and the need for partnerships to address them. A culture of risk management – the beliefs, norms and values that underpin daily actions – must span the whole organization, including its supply chains. Entities can no longer afford to have different types of risks managed by different policies and operating procedures and by different officials, executives and agencies. All parts of an organization must collaborate transparently on risk management through integrated planning because of the potential for risks to have cascading consequences, including spillovers between the virtual and physical realms – for example, a flood disabling a server farm, or a cyberattack interrupting electricity supply.
Individuals and organizations must recognize the imperative to contribute to resilience and must also know what and how they can contribute. No single entity – public or private – possesses all of the necessary authority, resources, or expertise to ensure its resilience against catastrophic events. Instead, resilience necessitates collaborative approaches. Public-private partnerships that harness the core competencies of each sector have a critical role to play in strengthening resilience capacity and maximizing the benefits of investment in risk monitoring, business continuity planning, and disaster preparedness. Instilling a culture of collaboration will enable effective partnerships before, during and after disasters. For example, in Germany, the LÜKEX Strategic Crisis Management Exercises conducted every two years by the federal government are designed to address complex crises and their potential disruptive consequences across sectors through cascading effects. LÜKEX involves a large partnership between the public and the private sectors to build a culture of crisis management and trust across multistakeholder partnerships.3