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Erwann Michel-Kerjan

Erwann Michel-Kerjan

Posted: October 26, 2010 10:23 AM

As recently as a decade ago, very few world leaders would have guessed that energy price volatility, unprecedented natural disasters or an historical financial crisis would be some of the biggest challenges in the foreseeable future. But one of the hallmarks of this new century will be more and more of such unthinkable events, previously unseen contexts, and pressure for individuals, private companies and the urge for government authorities to react extremely quickly.

Other concerns to add to the list are intercontinental pandemics, terrorism and new war configurations; major earthquakes and the impacts of much higher climate variability, to name a few. It's no coincidence then that this year's World Economic Forum on the Middle East and North Africa (MENA) in Marrakech, Morocco on October 26-28 will have a special focus on how to better manage global risks, including the launch of the forum's MENA at Risk 2010 report.

These risks, when they materialize, will be even more costly in the future. First, there has been a very rapid increase in population around the world, and most of the population now lives in urban areas. This is clearly the case in the Middle East and North Africa: 170 out of its 300 million inhabitants reside in urban areas. According to UN projections, the MENA population will reach 430 million by 2020, of which 280 million are expected to be in those urban areas. For instance, the population of Morocco tripled over the past 60 years alone to reach 32 million today. Second, many MENA countries have benefited from sustainable economic growth; assets at risk have significantly increased as well. This creates an unprecedented degree of human and economic concentration. As a result, many more people compete for limited natural resources and there is, mathematically, a much higher exposure to catastrophes of all types.

What can MENA leaders do to more effectively deal with future catastrophe risks? Below, I propose a six-step process which, if appropriately implemented, can create huge value.

  • First, determine the top 10 global risks your country faces. At first, it might seem overwhelming to consider an almost never ending risk landscape. This has often resulted in an "it will not happen to us" behavior or a "we will look at this later" postponing attitude. Unfortunately, playing ostrich, which I have witnessed in several countries, has had very costly consequences. One recommendation is that the head of the country might establish a special commission whose task will be over a 12-month period to determine the key sources of national exposure. Some of the forum's recent work on global risks in its annual Global Risks report series, and in the MENA region in particular, can help here: water scarcity, energy security and underinvestment in infrastructure were singled out as "crippling risks." Terrorism or natural disasters will certainly be added to the list. There will be others that are country-specific.
  • Second, a better understanding of risk interdependencies. Risks are too often treated in silo, but they are becoming more and more interdependent. For instance, a prolonged episode of flood would have major impact on agriculture, which in return can have serious economic, health and social impacts and can induce political risks as well. Just think of the earthquake in Haiti and the major floods in Pakistan this year. Furthermore, the flip side of economic and social globalization is that risks are also becoming more global. As such, a catastrophe in country-A can have serious effects in country-B. A better quantification of these effects ex ante is critical.
  • Third, what national strategy exists today, if any, at a government level to deal with these risks? How is the private sector involved? I recommend that a transparent account of the major local and national initiatives currently underway in your country to tackle risks be undertaken. Many MENA countries are active in trying to better manage risks, but these are often local or sectorial approaches only; to benefit from economies of scale they ought to be integrated into a coherent national strategy for risk management.
  • Fourth, monarchs, rulers, presidents and/or prime ministers in MENA countries should compare notes on how their risk management strategies measure up to others and what the best practices they can learn from are. As a benchmark, the G-20 countries working with the International Monetary Fund (IMF) have developed the G-20's framework for growth. Every year, the IMF leads a mutual assessment of how the G-20's respective national and regional economic policy frameworks fit together. This peer-review consists of a forward-looking analysis of whether policies pursued by individual G-20 countries are collectively consistent with more sustainable and balanced trajectories for the global economy. It allows finance ministers to compare notes and coordinate actions on important economic policy issues. A similar process could be developed in the MENA region on a selected number of global risks which would be considered priorities by top leaders.
  • Fifth, establish a cabinet member position for a national risk officer. Given that mismanaging global risks can be a serious impediment to sustainable economic growth and social balance, I recommend that countries establish, as new cabinet member position or advisor to the royal family, the role of national risk officer. Similar to a chief risk officer in the private sector, the national risk officer could serve as a national coordinator for forward-looking and comprehensive global risk management, along the four aforementioned tasks. Steps 1, 2 and 3 allow top decision-makers to ascertain their risk tolerance, the resources required to prevent and mitigate risks. Steps 4 and 5 were proposed on a broader level by a group of Young Global Leaders of the World Economic Forum as part of the Paris Initiative, in preparation of next year's French presidency to the G-8/G-20. These proposals would apply to the MENA region quite well.
  • Sixth, and this is a critical element, design the right financial mechanisms to hedge the economic consequences of futures extreme events. Here it is important to go beyond the view that your government will always have to pay for all and everything. Innovative financial solutions do exist today and can be leveraged effectively. If organized creatively across the MENA region, I envision they would provide the necessary safety net to those countries needing protection (e.g. dedicated post-disaster loans, regional pools and/or cat bonds), and at the same time guarantee a high ROI to dedicated investors. Ideally, richer countries might even join as institutional investors (e.g. Saudi Arabia, Kuwait, Qatar, Bahrain, Jordan, UEA). Regional solidarity in MENA is a wonderful asset which, to me, has not been fully articulated, yet.

Overall, we all face a similar choice vis-à-vis risks with potentially very high impact: we can either pretend they will not occur under our watch and remain passive, or we can start being very much proactive in dealing with them, collectively.

If the later trajectory is chosen, heads of states and leaders from the private sector will soon realize that there are also major political, social and economic benefits to it: creating sustainable value.

Erwann Michel-Kerjan is an authority on the management and financing of catastrophe risks. He teaches at the Wharton School of the University of Pennsylvania (USA), and is managing director of the Wharton Risk Center, which for more than 25 years has been at the forefront of research into extreme events. Honored by the World Economic Forum as a Young Global Leader, he currently serves as chairman of the OECD Secretary-General Board on Financial Management of Catastrophes, which advises its 32 member countries on these issues. He is the author, most recently, of At War with the Weather (MIT Press; with H. Kunreuther) and The Irrational Economist (PublicAffairs; with P. Slovic). More information at his website, http://www.erwannmichelkerjan.com.