This article explores the developing concept of global risks and highlights how the study and management of systemic risk has become a major challenge to multinational business. Lloyd’s 360 Risk Insight research platform serves as an example. Special reference is given to the recent report Globalisation and Risks for Business – Implications of an increasingly interconnected world.
The concept of global systemic risk marks the beginning of a new paradigm in combining globalization studies and risk research. By global risks we mean risks that arise in certain topical fields, for example climate change or pandemic risk, which are not limited to a particular region, but have the potential to spread across regions, or are of concern to more than one region or continent. This is the spatial dimension of the concept. Global risks are abundant and include various topics ranging from the already mentioned environmental and health issues to energy and natural resources supply, fresh water retrieval and distribution, nutrition and food security, demographic changes including migration, shifts in the economic and financial world order, the quest for democratic governance and social improvement, risk of international or regional conflicts, transnational terrorism and organized crime. Global risks are systemic if they are also interconnected, thus having a positive or negative impact on each other, and most of them do. Comprehensive research into the dimension of causal risk links represents a major challenge for contemporary and future global studies.
Today, there is a common knowledge regarding the fact that climate change and health risks, or climate change and food supply risks are interconnected, but we need to know more about the precise causal relations and variations in impact on specific countries and regions. The motivation to encourage research on these matters is straight forward. Interconnected risks are also systemic because they have a high potential to affect the political security, economic viability and social development of countries. Apart from stability concerns for countries and entire regions, it has to be taken into consideration, that global risks are also systemic on an international level, because they will increasingly determine the relationship between the industrial countries, emerging powers and the developing countries.
Following the debate about climate change, it was the financial crisis of 2008 and its tremendous percussions to date, that raised and broadened public awareness of the new quality of global systemic risks. In particular, the severe consequences of the crisis, sending economic and social shock-waves around the globe, seem to have induced the business sector to take the need of understanding global systemic risks more seriously. This is a promising development, because despite the failures of financial risk regulation in the past, the establishment of innovative and effective risk management systems to deal with global issues is hard to imagine without the involvement of globally active companies and business associations.
One of the remarkable examples is the 360˚ Risk Insight platform set up by Lloyd’s London. Given the age-long risk insurance tradition, Lloyd’s is particularly eligible to deal with global risk matters. Apart from providing relevant risk news and reports, the company also experiments with innovative risk intelligence tools, like a interactive global risk map. Moreover, Lloyd’s invited academic support from the James Martin 21st Century School of the University of Oxford. Director of the James Martin School is Prof. Ian Goldin, who is distinguished not only as a prominent scholar in the field, but also by his extensive experience as a Vice-President of the World Bank and in other former executive positions. Goldin authored the report Globalisation and Risks for Business – Implications for an increasingly interconnected world presented by Lloyd’s in July 2010.
The report Globalisation and Risks for Business
The report starts out with an analysis of the trends in globalization since the end of the Cold War. The first part is mainly a concise summary of the factors that have driven the extensive global integration process, namely the fall of national barriers, standardisation and uniformity in various sectors, and the spread of global participation, which has benefited a majority of countries and people, apart form those who have been kept isolated from those trends.
The term integration is well chosen to describe systemic globalization, because it is obvious that the overall positive nature of integration also has a negative side to it: interdependence and increased vulnerability to risks that have become more and more interconnected. The report notes that “both the sources and the speed of transmission of risks have multiplied as a result of globalisation”. Global integration, therefore, also entails complex risks for business and society. The report aims to promote risk management initiatives in business and government in order to be able to prevent “cascading failures” and “jumping risks” from occurring in the first place, or fully bringing to bear their systemic impact if they happen.
The second part investigates the new kind of risk, treating six topics, namely economic and financial risk, global pandemic risk, infrastructure risk , supply chain risk, food security, and geo-political risk. Environmental and climate issues have been excluded as well as oil and gas exploitation and the virulent problem of natural resources supply. Even though it is legitimate to focus on specific risks, it should be pointed out, however, that some of the risks not covered in the report are equally of major systemic relevance to global development. The interrelation between, e.g. energy security or resources supply on the one hand, and climate issues, health or food security on the other hand, often involve negative risk amplification.
Nevertheless, Lloyd’s report fills a gap, since it informs the reader about selected systemic risks that are of particular concern for business. And it still represents a rare understanding of the extent to which dealing with those risks is in the public interest. Each section of part two gives an instructive overview of the relevant risk features of the respective topic, with a special emphasis on the systemic dimension, followed by an account of the risks to business arising from these features. Thoroughly researched and accessibly written, the report is an exciting read, recommendable to everybody interested in the field of risk management.
Instead of summarizing each section, only a few topics will be highlighted here, in order to give an impression of the report’s approach to understanding systemic risks. The section about infrastructure risks stresses the intensified dependence on functioning critical infrastructure, including electricity, transportation and telecommunications. Demographic trends, namely population growth in those countries of the world whose economies are at the same time rapidly developing, further necessitate building and maintaining high-capacity and stable infrastructures. Increasing electricity demand facing insufficient electricity infrastructure, however, will make power shortages a more serious risk of doing business in the future. The report explicitly refers to India and China, and other parts of Asia, as well as South Africa, in that regard. Improving and securing infrastructure networks is therefore becoming a basic condition for future investments and prosperous global trade.
Related to infrastructure risk is the topic of supply chain risk. Globalization of production and sales has made supply chains more extensive and complex with increasing vulnerability to failures in transportation, communication or coordination. More choice of suppliers often means less control and risks along the supply chain may involve partners that turn out to be unreliable. One of most serious threats are errors in the manufacturing process requiring recalls of products. The costs and reputational losses involved due to product recalls resemble the worst-case-scenario for a company. Recent examples given in the report include toy and car manufacturers. Toyota, once a role model company for cost-effective just-in-time business models, now serves as a case for cascading risks stemming from minor failures in the supply chain.
Given the importance of infrastructure and supply chains, security threats stemming from terrorism aiming to disrupt critical networks, and from piracy targeting key shipping routes are also treated in more detail in the section on geo-political risks. According to the report, there is further evidence of certain political trends which might slow down globalisation. In particular, protectionism putting up new barriers to trade, the resurgence of nationalism curtailing migration flows, and economic re-regulation together with a spread of anti-globalization sentiments are of strategic concern to multinational corporations.
What can be done to better manage systemic risks? It is clear from the overall approach of the report that analysis and monitoring of risks needs to be conducted on an aggregate level, in order to detect interconnections of global risks in advance. Part three gives recommendations to business, including thorough systemic risk audits, extensive future scenario-building, and adopting codes of conduct as laid out by the OECD Guidelines for Multinational Enterprises and the Global Reporting Initiative, which would also support acting in accordance with the public interest. Work with governments is also suggested in order to improve cross-sectoral assessment of systemic risks and in order to coordinate risk prevention and mitigation strategies. Better private and public funding is required to promote academic research on emerging risks, which, finally, would also serve to better educate society to the risks they face.
In sum, the recommendations point at adapting risk assessment and communication to the new kind of systemic risk, that requires the collaboration between business, public authorities and the society. However, this is also the crux of the matter. Commercial competition, political conflict of interest and divergent views on issues prioritization, between businesses, governments, and non-governmental organisations will determine the reality of future global risk management. The term of risk governance better indicates the highly political and therefore controversial nature of the endeavour. A common cognitive risk perception is therefore conditional for developing joint risk governance strategies. Offering a new paradigm of systemic risks is a bold step in that direction, but it will require persistence since cognitive science reminds us that there is hardly anything more volatile than risk perception.