What’s happening and what’s new? For many years we all celebrated globalization and its fantastic benefits. But we may have underappreciated its flip side: risks are becoming more global too, so that each one of the aforementioned events had major ripple effects on other parts of the world than where it originated. Managing these risks alone, as the CEO of a business and the head of state, has become a ‘mission impossible’.

What can be done? The World Economic Forum last week issued its 7th Global Risk Report (GRR). It aims at helping top decision makers better understand the perceived likelihood and severity of a number of global risks which could materialize, or become more severe, in the coming ten years. It also shed some light on the level of interdependence among those risks and what unintended consequences they could have. The GRR 2012, which will be widely discussed in Davos next week, focuses on 50 global risks and rank them based on the response gathered from a survey of nearly 500 top decision makers in the public and private sectors and experts from leading research institutions.

What tops the list this year? Income disparity. Today we have reached a 50/1-1/50 situation: the poorest 50% of the global population owns barely 1% of the global wealth, while the planet’s top 1% owns close to half of the world’s assets. If this gap continues to rapidly stark, this will have serious consequences. Indeed many governments don’t have the financial strength to support large welfare programs and counter-cyclical spending anymore.

Don’t think this is only Occupy Wall Street… A live example is China. The income disparity in China has been slowly on the rise since the late 1970s when Deng Xiaoping started his market-oriented reforms. In addition to the differentials between the rich and the poor in general, the income disparity in China also manifests itself in regional income gaps and urban-rural income gap.

For example, while the eastern/coastal provinces have always been economically more developed than the western/inland provinces, the differential has grown over the years. In 1980, the per capita GDP of the coastal provinces was about 80% higher than that of the inland provinces, and in 2008, that number grew to 144%. Similarly, data released this week by the National Bureau of Statistics of China (NBSC) indicated that the average income of a Chinese urban resident was 313% of a rural resident, compared to 186% in 1985. In the late 1970s before the reform started, very few Chinese citizens had any quantifiable personal assets, but in 2010, China had 271 known billionaires, second only to the US.

This multi-faceted income disparity has far-reaching implications to the Chinese economic, social and political dynamics, and presents a serious risk. The most obvious example is related to migrant workers. NBSC estimated this week that, in addition to about 100 million rural laborers who work in nearby cities, there are currently 150 million migrant workers in localities far from their rural homes. These rural labors migrate to other cities or provinces in search of better economic prospects. In their new urban homes, however, they frequently face long work hours, substandard work conditions, severe restrictions about what types of jobs they can do and where they are allowed to live, lack of education opportunities for their kids, and lack of credible mechanisms for labor disputes, among other problems. The widely reported 18 attempted suicides during a ten-month period in 2010 at Foxconn, a primary manufacturer of iPad and other products for Apple, Dell, HP, Motorola, Nintendo and Sony, highlighted the level of despair migrant workers might have been facing.

These risks have not gone unnoticed by the ruling Communist Party. As early as 2005, the Party started to list ‘harmonious society’ as a strategic objective. The Twelfth Five-year Plan that was launched last year placed a heavier focus on the quality of life and resident income over GDP growth.

In the long term, how these measures would reduce the risks in China, and impact the rest of us, remain to be seen. In the short term for China, the 2011 economic data that was just released yesterday by NBSC offered some ground for cautious optimism. For the first time in China’s thousands of years of history, more Chinese people live in cities than in rural areas, reflecting a continued urbanization process through which more people move to cities with better living standards. The urban-rural income differential dropped slightly from 333% two years ago to 313% for 2011. NBSC data also showed that, after two years of various policy measures, the housing prices in most Chinese cities start to drop, making housing more affordable to the Chinese.

In Davos next week, several panel sessions are set up to discuss global risks. Many crises in the past were triggered by stand-alone and disruptive catastrophes. In the crisis-fatigued, just-in-time and interdependent world today, what risks are more likely to cause the next shock to the world? Would they be the risks you manage everyday that you think could destabilize your organization or your country, or would they be those you decide to ignore, conscientiously or not, because you believe they do not matter much? Would they be stand-alone, sudden and disruptive traditional risk events as we saw in the past, or would they be interconnecting and slow-building trends that people take for granted, for a long time until the time they actually cause a crisis?

Is income disparity slowly bleeding the world into the next crisis?

This op-ed was published by the Wall Street Journal on Januray 21, 2012, four days before the opening of the EWorld Economic Forum’s Annual Meeting in Davos. About the authors: Erwann Michel-Kerjan is Managing Director of the Center for Risk Management at the Wharton Business School and a contributor to the GRR 2012. Kevin Lu is Director of the Multilateral Investment Guarantee Agency (MIGA), the private sector investment guarantee arm of the World Bank Group, and a Council Member of the Emerging Markets Advisory Council at the Institute of International Finance (IIF) based in Washington, DC. This column focuses on policy issues related to international finance and political economy, especially those relevant to the emerging economies. It also examines many fundamental changes that are occurring in the advanced economies, in the context of the significant shifts of economic weight towards emerging markets.The opinions are their own.

What are the top 50 risks this year?

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Take natural disasters. Hundreds of thousands of people lost their lives; millions were displaced; billions were severely economically affected. Direct physical losses from natural disasters between 2000 and 2010 were more than $1 trillion. Whether they hit some of the richest (Japan) or poorest (Haiti) countries, these disasters had severe and enduring social, economic and political impacts.

Our vulnerability to future catastrophes is not slowing down, but rather growing very fast. Why? Increasing population, concentration of asset and interdependence are to blame here. This year we reached 7 billion people on planet Earth, a billion more than we were in 1999. In the next 10 or 15 years, we will be 8 billion. A large portion of this massive increase lives in large cities, many of which are located in vulnerable areas. Unmanaged concentration of individuals and assets over a few kilometer-squares will be prone to large concentrated loss (think of a pandemic for instance). Finally, we continue to push for always more social and economic globalization such that we have now reached a degree of interdependence not seen before in human history. But in doing so we might have forgotten that there is flip side: risks are becoming more global, too. A catastrophe occurring today in one continent will likely have ripple effects on the others tomorrow.

So, unless we undertake concrete actions with measurable output to collectively make our countries more resilient to extreme events, many more will come, and soon to follow. More firms around the world have now recognized the importance of addressing the challenges associated with better assessing, preventing and managing such extreme events. Most governments have not, however. In the best case, risks continue to be managed in silo (when they are at all), each ministry feeling in charge of “its” risks, but not necessarily getting the big picture of more global interdependent risks, nor the impact that their decision in how manage one type of risk can impact others. This is surprising because governments’ exposure to catastrophes over the coming decades is in trillions USD, a worrying figure if your country is already running a large deficit or is virtually on the edge of bankruptcy. That’s precisely the worst possible time to have to manage another disaster. Moreover, the mismanagement of these risks has already proven to impact election results, too, which should be of concern for political leaders.
But it does not have to be that way. Every year, working with the World Economic Forum and several colleagues we prioritize 30-to-40 global risks with the potential to cause major human suffering and upwards of at least US$10bn in economic damage. We discuss these risks in the now widely disseminated WEF Global Risks Report, which has correctly identified the risks arising from an asset price collapse (January 2007) and from food crises (January 2008) before these events materialized, demonstrating that it is possible to think strategically about global risks.
Could the G20 have a constructive role to play here? I think it has. So what can be done? Along with several fellow Young Global Leaders we have proposed two concrete steps which could be implemented in the next 2 years if supported by enough political will.

Proposal 1: Establish a new National Risk Officer (NRO) within each G20 government.
This role would be similar to the Chief Risk Officer in the private sector. The office of the NRO would coordinate country-wide for forward-looking and comprehensive risk management. Specifically, the role spans:

• Identifying potential risks, particularly those that affect multiple government departments, in collaboration with experts and the private sector.
• Creating a National Risk Map that quantifies and prioritizes risks according to severity, uncertainty and inter-connectedness with other domestic and global risks.
• Facilitating dialogue between government entities and the public at national and international levels to ensure that major risks and the trade-offs between them are understood and appropriately incorporated into decision-making and policy.
• Making CEOs of top companies accountable for identifying risks and proposing solutions, facilitating exchange of information and people between the public and private sector.
• Fostering innovations from business and academia in order to develop solutions to reduce the probability of those global risks and their consequences.
• Coordinating governmental response in the event of a major catastrophe whose impact straddles the responsibilities of multiple departments.
• Develop ex ante a national strategy for catastrophe financing.

The role of National Risk Officer could initially be assumed by a senior staff member within a country’s finance ministry or in the president or prime minister’s cabinet. The NRO should have direct access to the leader of the government, potentially assuming a cabinet member position in the future. Several countries are currently considering this concept. We also suggest that 20 NROs formally meet as part of the G20 Summit process.
Proposal 2: Incorporate National Risk Mapping into the IMF’s Mutual Assessment Process.
The IMF‟s Mutual Assessment Process focuses primarily on economic and financial policies. As other global risks need to be addressed, a holistic approach to policy measures needed to better anticipate and manage those risks will become increasingly important for both national governments and the G20. The G20 can play a central role in sharing good practices, which could then be used in many other countries as well.
The Cannes summit has the potential to be remembered as an important one, not only by what is actually achieved there, but also by what novel ideas are introduced there. No question that it will also be seen by many top leaders in the government and industry alike, and by civil society, as a test for our capacity to redesign global governance, step by step. Not one single initiative will be able to achieve this, but the combination of several good ones could. Establishing NROs and building on the IMF mutual assessment process should help.

The idea can be further developed this coming year in collaboration with the government of Mexico, which will then assume the G20 presidency. 2012 will likely see important changes in the international political landscape, with national elections in China, France, India, Mexico, the US, and Russia, all members of the G20. But the clock is ticking. I predict that several other large-scale disasters will likely have hit us by the autumn of 2012.

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NROs for Global Risk Management is one of the nine proposals that were developed for the French presidency, this year’s G20 Chair, by the ‘G20 Paris Initiative Task Force’ of the World Economic Forum’s Young Global Leaders community. Jill Otto (JP Morgan) and Kevin Lu (World Bank Group) also contributed to the proposal.

This column focuses on the emergence of large-scale catastrophes and crises and some of the policy issues related to how better manage them collectively. It proposes the creation of national risk officer positions in G20 governments to help coordinate national and international management of global risks.

“The world has entered a new era of catastrophes. Economic losses from hurricanes, earthquakes and resulting tsunamis, floods, wildfires and other natural disasters increased from $528 billion (1981-1990) to more than $1.2 trillion over the period 2001-2010. The 9.0 earthquake and massive tsunami in Japan this past spring caused hundreds of billions of dollars of direct and indirect costs. It has affected the Japanese macroeconomic forecast and resulted in the departure of the then-prime minister. And before this, massive earthquakes in Haiti, Chile and New Zealand inflicted record human and financial losses as well.

Despite being the richest country in the world, America is still highly vulnerable to natural disasters. Two principal socioeconomic factors directly influence the level of economic losses due to catastrophic events: exposed population and value at risk. Florida, for example, has seen its population grow from 2.8 million inhabitants in 1950 to 18.8 million in 2010 (+570%). Increased population and development means an increased likelihood of severe economic and insured losses in Florida and other hurricane-prone regions unless cost-effective mitigation measures are implemented and the risk properly hedged.

So, when an unexpected earthquake was felt on the East Coast, followed by Hurricane Irene, those of us who have been tracking extreme events for years knew what would likely happen.

First, the Administration in Washington would have learned the lessons from the 2005 Hurricane Katrina debacle. Evacuation would have to be required and enforced. The president, the heads of FEMA and DHS, along with local, state and federal officials in charge of disaster management would have to be on the front line very early. The presence of true professionals would matter a great deal. Furthermore, this effort and a well-articulated crisis management strategy would have to be relayed and clearly explained by leading media outlets.

That is the way it happened…..”

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This year award will be given to the authors of the book At War with the Weather: Managing large-scale Risks in a New Era of Catastrophes (MIT Press) (H. Kunreuther and E. Michel-Kerjan) on August 7-10 in San Diego, California.