View from Dalian, China: The New Risk Architecture and Our Growing InterdependencePublished: December 12, 2007 in Knowledge@Wharton
In early September, nearly 1,700 leaders representing business, politics, the arts and universities gathered in the city of Dalian, 600 miles east of Beijing. Erwann Michel-Kerjan, managing director of the Wharton Risk Management and Decision Processes Center, who was selected as one of the World Economic Forum's Young Global Leaders this year, attended the five-day event, which included participants from 90 countries. Below, he offers his report on what he calls "The New Risk Architecture."
A Balance between East and West
Given the incredible growth of China as a strong economic and political force in the new era of globalization, the country will now host, each year, what is likely to be seen as the summer edition of the World Economic Forum: the Annual Meeting of the New Champions. At the core of the "new champions" is a rising generation of leaders who will fundamentally change the global competitive landscape, balancing new risks and opportunities, and transforming society.
"By moving from Davos to Dalian, the World Economic Forum underscores an explicit message that China has sent to the world: China, with its new champions has changed, is changing and will continue to change the global economic landscape," said Jiang Jianqing, chairman of the Industrial and Commercial Bank of China (ICBC), which went public in 2006 in a record-setting IPO and in July 2007 reached a market capitalization of more than $250 billion. Another example of companies becoming bigger faster is PetroChina, which on November 5 joined the Shanghai stock exchange and, within a few hours, increased its capitalization to $1 trillion -- more than ExxonMobil and Microsoft combined.
The Dalian meeting, like the one in Davos, was made up of multiple sessions and plenary conferences, out of which emerged two important topics: The first is what I call "The New Risk Architecture," an important feature of which is our growing interdependence; the second is the work that is being initiated by the community of Young Global Leaders (YGL).
The New Risk Architecture
Most globalization experts agree that a series of major catastrophes can be a true limitation to the high-speed growth in emerging economies and Organization for Economic Development and Co-operation (OECD) countries. We used to consider catastrophic risks as very low probability events since they did not occur often.
In a sense, that assumption was very reassuring for any top decision maker in the public and private sectors. The expected losses of these catastrophes -- keep in mind that the potential loss associated with a disaster multiplies by the probability of that event occurring -- were usually relatively low. With some luck, no major crisis would occur during the decision maker's term of office. But in the first few years of the 21st century, catastrophes have occurred at an accelerating rhythm and increasing scale of impact, one after another. That is the new era we have entered.
Even the United States has been hit on almost every front since 2001 -- failure in our national security (9/11), profound distrust in corporate America (Enron, WorldCom, and the subsequent SOX regulation), failure in our technology (the Shuttle Columbia disaster), network failure (the 2003 blackout), and basic infrastructure breakdown (bridge collapse and poor levee system). And four years after the 9/11 attacks, a violent but long-anticipated hurricane -- Katrina -- overwhelmed the vulnerable New Orleans coastline, encountered a still unprepared government and inflicted lasting damage on a population. A superpower had failed to meet the most basic needs of its citizens in crisis. Moreover, the event was watched live on TV by several billion people worldwide.
All these cases were discussed at the World Economic Forum in Dalian as vulnerabilities that businesses, but also governments, NGOs and citizens must now consider. The key point in many sessions was this: that the emergence of combined forces are creating a new world order, the risk component of which must be managed to assure sustainable value creation.
Below are the six main features that characterize the new risk architecture:
The revolution of globalization: an interdependent world: As a result of a growing globalization of social and economic activities, these activities are more dependent on each other. While this is not totally new, we have reached a degree of interdependence that no other society has experienced before us: What happens on one continent today can affect those on another continent tomorrow.
Changes in scale: from local to global risks: Hyper-concentration of value at risk will lead to more devastating consequences when something bad happens. Dealing with large-scale disasters is much more challenging than a series of local small accidents. That is a radically different ball game many do not appreciate. Resources and collaborative effort needed at the same time are not simply additional but exponential. Further, because operations are no longer local, global response and global reaction capacity are needed. Multinational coordination becomes key. Climate change is one of the best illustrations.
Preparedness: confusing distribution of the role and responsibilities: When it comes to preparedness, the conventional wisdom is often wrong. If one asks people on the street -- "Who do you think is in charge of preparing the country against future crises?" -- the most cited response will certainly be state and federal governments (whether as regulators or first responders). While these entities certainly play a crucial role, a large portion of critical services that allow our countries to operate is owned or operated by the private sector (85% in the U.S., for example). We must look at how private actions affect public vulnerability so that we are better prepared for prime time.
Extreme cost, extreme benefits: Globalization and interdependencies open to new markets and opportunities are certainly extreme. Yet the costs of catastrophes are increasing because of the concentration of assets and first- and second-order ripple effects. On the financial side, one figure is eye-opening: If you consider the 20 most costly insured catastrophes in the world during the past 36 years (1970-2006), all of them occurred after 1987 (in 2006 prices, corrected for inflation, so you can compare apples to apples). Further, among these 20 catastrophes, half of them (10) occurred since 2001, nine of them in the United States. That's the new era we have entered. The number of U.S. disaster Presidential declarations has dramatically increased as well, from 162 over the period 1955-1965 to 545 for 1996-2005.
Celerity: toward a just-in-time society: With the fantastic development of transportation and cheap communication, we are creating a "just-in-time" society. Things are moving faster and faster. Think of a pandemic starting in a poor area of Asia, for instance, and spreading all over the world thanks to the fantastic development of the jet; viruses now fly business class too.
Uncertainty, if not pure ignorance: We were trained to solve problems with clear questions and clear scientific knowledge. Knowing the risk profile, we made investment decisions. Unfortunately, historical data does not shape the future anymore, given how rapidly the world is changing. As a result, there are often more sources of conflicts between experts and a growing tension between probabilistic risk assessment approaches and scenarios-based ones.
While this is a simplified framework, these six complementary features fit a large number of recent crises we all have witnessed in different parts of the world and across industries.
Growing Interdependencies between Asia, Europe and the U.S.
Let me focus in more detail on the growing interdependence element. The talk in Dalian was not so much about "globalization" (I heard the word only a few times), but about "interdependence:" My actions affect yours, and vice versa. The terms are related, but not synonymous: "Interdependence" is the direct consequence of "globalization." It is also the recognition that we all live in a village that seems to be getting smaller and smaller. Telecommunication costs are close to zero, sharing of information instantaneously has never been easier (and perhaps riskier); supply chains are becoming even more innovative, combining increasing numbers of suppliers from many countries; and companies are now looking for new hires who speak multiple languages, know multiple markets and value multiple cultures, so that they are better suited to understand these interdependencies.
An important feature of the discussion that took place in Dalian was the growing interdependence between Asia and the U.S. For example, the world's emerging markets, particularly China and India, have become an economic locomotive in their own right, and could insulate global economic growth, to some extent, from the fallout of the recent U.S. sub-prime mortgage crisis. It is clear from sessions at Dalian that Asia remains vulnerable to any dramatic downturn in U.S. consumer spending, which would affect exports. Asia is also vulnerable to a downturn in U.S. asset prices because so much of its own savings are invested in American capital markets. A significant downturn in the value of U.S. stocks, bonds or the dollar will reduce the relative value of these investments. On the other hand, what would happen if a large proportion of Chinese investments were redirected tomorrow toward other foreign markets?
On the Chinese side, Prime Minister Wen Jiabao clearly stated that "China cannot achieve its development in isolation from the world, and the world needs China to ensure its development." World Economic Forum participants debated China's progress: Will it continue for several years or should the country prepare for a hard landing? As the New York Times' Thomas Friedman, author of The World is Flat, told a group of Dalian participants: "In China, one now drives on what looks like a well-built six-lane highway; but looking ahead some also see a bump, and no one is quite clear whether it's real or just a mirage. But for sure, no one wants to take a bump at 100 miles per hour." He's certainly right. In the words of William R. Rhodes, chairman of Citigroup and Citibank, who also attended Dalian, "The key question is how do you put together a joint solution to the overheating of the Chinese economy and what is going on in the rest of the world right now?" The answer is global interdependence.
From Global Risks to Global Growth
As I mentioned above, with growing interdependence of social and economic activities worldwide, what occurs 5,000 miles away can impact your organization or country tomorrow. Likewise, your actions are more likely than ever to have multiple ripple effects. From these actions have emerged global risks which no one knows how to address nor has the energy, financial and human resources to do it. Global events such as pandemics, international terrorism, financial crises and large-scale natural disasters, to name a few, require a new type of collaboration.
That is true both for risks and new opportunities. Many organizations and governments are still supporting their decisions and actions using risk and crisis management tools developed over the past 20 years. Unfortunately, these tools are based on the outdated assumption that risks are mainly local and always formatted -- that it is possible to list all untoward events that could happen, determine their probability based on past experience, measure the costs and benefits of specific mitigation measures and implement them for each one of these risks. Surprise was not a factor, nor was failure. As a result, these organizations do not have any flexibility to quickly respond to surprises. This is no longer a sustainable posture. Quite the opposite: The hallmarks of this new century include more and more unthinkable events, previously unseen contexts, and pressure for private companies and government authorities to react extremely quickly, even when they cannot predict the impact their actions will have.
A radical change is occurring, however. If five years ago, most companies looked at risks in isolation, more and more of them have now started to recognize their interdependent features when mapping their vulnerabilities. The challenge of such global risks, however, lies in the need to adopt a unified coherent strategy across all divisions of an organization operating worldwide, and/or relying on other organizations in other parts of the world. An increasing number of companies and governments have turned to global risk experts to do just that. A much broader effort toward collaborative actions allows not only increased sharing of information and fast learning about these risks, but also sharing the costs of managing these risks on a broader scale and collectively benefiting from new growth opportunities.
A perhaps even bigger risk to the global economy discussed in Dalian is the market turmoil of the past few months and the potential for an economic slowdown. This might exacerbate growing protectionist impulses among politicians catering to misgivings among middle-class voters that the gains of globalization are being enjoyed primarily by the very rich and the very poor. With Europe regaining dynamism under the joint leadership of German Chancellor Angela Merkel and newly-elected French President Nicolas Sarkozy, retrenchment from globalization by the U.S. public was identified as a serious and likely risk to global growth at the September meeting.
Samuel DiPiazza Jr., CEO of PricewaterhouseCoopers, cited the 2007 edition of the World Economic Forum's annual Global Risks Report, released in Davos in January of this year, which was undertaken in partnership with Citibank, Marsh MacLennan, Swiss Re and the Wharton Risk Center. Several of us work on that project on an ongoing basis, including professors Howard Kunreuther, Steve Kobrin and Witold Henisz. In that report, we identified this very risk as becoming increasingly prominent.
As Neville Isdell, chairman and CEO of the Coca-Cola Company, noted in one session at the World Economic Forum in Dalian, "We have to take a much more holistic approach, and businesses have to engage on a much broader front.... The problem is that there are a large number of people who are trying to find simple solutions to complex problems; and those simple solutions are driving people to take protectionism measures that are not to the benefit of the world." A new era calls for a new model.
The Forum of the Young Global Leaders (YGLs)
Dalian was also the venue of the annual meeting of the newly-formed Forum of the Young Global Leaders, a community of young leaders who "share a commitment to shaping the global future." Each year, the World Economic Forum identifies 250 extraordinary individuals, drawn from every region of the world and from a myriad of disciplines and sectors.
Among other YGLs living in the U.S. (about one-fifth of the entire group), are Larry Page and Sergey Brin, co-founders of Google; Madhu Kannan, vice-president, NYSE; Jimmy Donal, founder of Wikipedia; Terence Tao, professor of mathematics at UCLA (Fields medal 2006); Steven Levitt, professor of economics at the University of Chicago and author of Freakonomics;, Adrian Fenty, mayor of Washington, D.C.; Joshua Bell, Grammy Award-winning violinist; Yao Ming, Chinese professional basketball player, and Maria Bartiromo, anchor of CNBC's "Closing Bell."
The Young Global Leaders (YGLs) are engaged in the "2030 Initiative," a comprehensive endeavor to jointly define a vision for a better future. The community will then develop innovative global strategies that can be translated into decisions and actions.
The YGL Task Forces focus on five areas: health, environment, development and poverty, education, and global governance and security. Already a series of concrete initiatives is being undertaken. One new initiative, launched by the Health Task Force during the Young Global Leader Annual Summit in Dalian, is "Table for Two." With one billion people suffering from hunger and another billion suffering from obesity, the "Table for Two" initiative aims to tackle both at the same time. It offers a unique and simple scheme to address hunger in the developing world, and obesity and other life-style-related pathologies in the developed world.
"Every time someone eats a healthy meal at participating company cafeterias, restaurants and events, 20 cents is donated to fund a healthy school meal in developing countries," said James Kondo, president and vice-chairman, Health Policy Institute, in Japan and a Young Global Leader. The aim is to spread the initiative worldwide. To date, 32 companies have announced their commitment to offer healthy meals to their employees and customers. It is a simple and positive example of the fantastic benefits made possible by globalization.
As Klaus Schwab, founder and executive chairman of the World Economic Forum and initiator of the Young Global Leaders community, noted at the end of the event: "In this meeting, we were all bound together by the same spirit -- the spirit of entrepreneurship and the spirit of social engagement."