Chapter 12Global economic risksLecture 5 talked about risks in general from an individual’s viewpoint, andLecture 4 talked about the risk-reward tradeoff in the spe ci al setting ofstock market type investment. One can consider risks and chance from theviewpoint of an organization, but the variety of organizations and risks i s solarge that I’m not competent to write a lecture on that topic. Instead let mejump up to the global level – risks to the world as a whole. When preparingthe 2011 course, the r epercussions of the Late-2000s financial cr i s is (W )were still prominent i n the news. What undesirable events with comparablemagnitude consequences might you be reading in headlines sometime withinthe next 10 years?12.1 Future global shocks: a 2011 OECD reportThe working definition of futu r e global shocks in this report1:arapid onset event with severely disruptive consequences coveringat least two continents.History tells us what shocks have happened in the past. The focus of thereport to consider how ongoing changes in the state of the world – economies,technologies, social and governmental structures – may allow quite novelshocks, or amplify the magnitude of previously experienced shocks.The report points out 5 ongoing changes as potential “drivers” of shocks.• Heightened mobility of data, people and commercial transactions.1www.oecd.org/dataoecd/24/36/48256382.pdf . Only 11% of my 2011 students knewwhat the OECD (W ) is, without contextual clue121122 CHAPTER 12. GLOBAL ECONOM IC RISKS• Herd behavior and “groupthink” in corporations and professions andamong regulators.• Interdependency of production and delivery systems and their infras-tructure. In brief, if the electric power grid were disrupted then mucheconomic activity, in part i cu l ar communcation networks, would ceaseto function, but the electrical power industry itself is dependent uponsuch com munications to function.• Centralisation and concentration of systems exemplified by the hub-and-spoke organization of air freight carriers.• Urbanisation and concentration of populations and assets.The report then analyzes 5 possibl e shocks, not ncessarily the most likelyor the most serious, to illustrate the variety of possibilities.• Social Unrest.• Financial Crisis.• Pandemic.• Critical Infrastructure Disruption.• Geomagnetic storm.The first three are familiar from history, so I will be brief.Social unrest runs from pr ot es t s against a government, at a level sufficientto disrupt economic activity within a country, up to revolutionary changeof government. It is widely believed that the modern instant availabilityof news and opinions from many sources makes social unrest more liable tospread qui ckly from one country to simi lar other countries.Quoting the report: Financial crises are situations in which financialinstitutions or an asset class suddenly lose a large part of their value, e.g.bank-runs, financial asset bubble bursts, currency crises, balance of pay-ments crises and sovereign default. The direct results of such event s area loss of paper wealth, but more importantly they may spread t o the realeconomy with the onset of recession due t o de pendence of consumer demandand business investment on high levels of debt. When lending contracts,debt-fuelled expansion is no longer possible and a sharp ec onomi c slowdownbecomes inevit abl e. [Severe price drops] in the housing market during thelatest recession worsened the slowdown in consumer spending as households12.1. FUTURE GLOBAL SHOCKS: A 2011 OECD REPORT 123could no longe r borrow against rising e qu i ty values. The resulting s l owdownof investment in the real economy impacts actors at all levels, from smallbusinesses to home-buyers. Bankruptcies lead to job losses and a drop inaggregate demand, leading to more businesses and individuals being unableto repay their loans, reinforcing a downward spiral that . . . . . . can have adevastating impact not only on economic prosperity across the board, butalso on consumer sentiment and trust in the ability of the system to generatelong-term wealth and growth.Pandemic may refer to a new disease, exemplified by the “near pan-demic” of SARS (W) , or an existing disease, in particular influenza. Qu ot -ing the report,Three influenza pandemics occurred during the 20th Century:1918-19, 1957-58, and 1968-69. Most professionals in publichealth, m ed ic i ne and epidemi ol ogy consider the next fl u pan-demic to be inevitable [sometime]. The WHO considers 2 to 7.4million deaths globally as a conse rvative estimate of an H5N1avian flu pandemic, with substantial effects on both the physicaland financial health of countries.Increased mobility and population de ns i ty are widely expected to increasethe frequ en cy of future pandemics.Regarding infrastructure, an industrial economy is dependent on a widerange of physical networks – electricity, gas, water; road and rail and air;telephone and internet. In the past there were only a limited number ofways in which a whole network might be disrupted – widespread naturaldisasters or widespread human conflict at the physical locations. Nowadaysthere are concerns that because of dependence on softwar e and th e internet,by accident or deliberate attack, e i th er a large part of the internet or aspecific part of infrastructure accessible via the internet or software (e.g. aless focussed analog of Stuxnet (W) ) could be disrupted, from anywhere inthe world. A different examp l e is identity verification in online c omme r ce;sufficiently large scal e fraud would destroy confidence.Geomagnetic storms (W) are a comparatively little-known kind of nat-ural disaster. A repeat of the largest observed ( 1859) such storm would(it is estimated) do massive damage to electrical transmission equipment innortherly latitudes, and to satellites (and ther eby GPS an d communicationdevices). It is a timely topic, because such storm are most likely at the2012-3 peak of the 22-year solar cycle .124 CHAPTER 12. GLOBAL ECONOM IC RISKS12.2 So how good are such risk estim a tes ?In the previous sect i on I merely summarized the report. Spe cu lat i n g onthe accuracy of the assessments of this particular report doe s not seemuseful. But of course one could look at similar exercises in the past, andcompare their probabil i ty estimates to w hat subsequently happened.. Forinstance, a cynical view of retrospe ct i ve analysis of the late-2000s financialcrisis