Risk management can avert future shocks: World Development Report

Nations can cushion themselves against financial crises and natural disasters through proper planning as opposed to ad-hoc responses, says World Bank’s annual report

 
By Jitendra
Published: Monday 17 August 2015

The economic liberalisation of the 1990’s helped many developing countries integrate with the global market but also exposed them to international shocks. These shocks can be managed through timely interventions so that millions of possible job losses, potential social unrest and environment damages can be minimised, says the World Development Report (WDR) 2014, released by the World Bank.

Events of the past decade form the backdrop to the report. These include the 2008–09 global financial crisis with consequent loss of employment and setbacks in efforts to reduce poverty; food prices spike in 2008 and riots in over a dozen countries in Africa and Asia. Concerns about the impact of climate change worldwide are growing, and so are fears about the spreading of deadly contagious diseases across borders.

The major economic crises and disasters that have occurred in recent years and those that may occur in the future underscore how vulnerable people, communities, and countries are to systemic risks, especially in developing nations, says the report. The poor are the most vulnerable. Mortality rate from illness and injury for adults under age 60 is two and a half times higher for men and four times higher for women in low-income countries, while the rate for children under age five is almost 20 times higher. Evidence shows health shocks, weather shocks, and economic crises play a major role in pushing households below the poverty line and keeping them there, it adds.

The report dwells on the economic liberalisation of the 1990s when most developing countries opened their borders to seek international integration and higher economic growth. Firms around the world made investments to upgrade their technologies and increase profitability, but the debt required to do so made them more vulnerable to changes in demand and credit conditions. From Brazil to South Africa, millions of families have migrated to cities to seek better job opportunities and health and education services, where they have also become more exposed to higher crime and benefit less from communal support. The motivation behind these actions is the quest for improvement, but risk arises because favourable outcomes are seldom guaranteed.

How risk management helps

The report elaborates how risk management can save lives, avert damage and provide opportunities. For this, it is essential to shift from unplanned and ad hoc responses to crises. As such, risk management can build the capacity to reduce the losses and improve the benefits.

The report cites Bangladesh’s example. Improved preparation for natural hazards has dramatically reduced loss of life from cyclones in the country. In the past four decades, three major cyclones of similar magnitude have hit Bangladesh. A cyclone in 1970 claimed over 300,000 lives, the one in 1991 claimed almost 140,000, and the one in 2007 claimed about 4,000. Casualties have been greatly reduced through a nationwide programme to build shelters—from only 12 shelters in 1970 to over 2,500 in 2007—along with improved forecasting capacity and a relatively simple but effective system for warning the population.

The report cites other examples. The Czech Republic, Kenya and Peru are more recent examples where macroeconomic preparation has shielded the economy from the negative effects of a global financial crisis. Having achieved lower fiscal deficits, disciplined monetary policy, and lower current account deficits, these countries experienced a smaller decline in growth rates in the aftermath of the 2008 international crisis than they did following the 1997 East Asian crisis.

The report also cites examples of how risk management can unleash opportunities. Risk management tools—such as improved information, crop insurance, and employment diversification— can help people mitigate risk. The ability to mitigate risk, in turn, can allow people, especially the poor, to overcome their aversion to risk and be more willing to undertake new promising ventures. Some farmers in Ethiopia, for instance, chose not to use fertilizer because they fear drought and other potential shocks and thus prefer to retain savings as a cushion rather than investing in intermediate inputs. In contrast, farmers in Ghana and India have been more willing to take on risk in search of higher yields—increasing their investments in fertilizer, seeds, pesticides, and other inputs—because they have rainfall insurance.

Cost effectiveness

The report also underlines cost-effectiveness of preparing for risk when compared to cost of coping with the consequences. The choice between these actions depends in part on how the (certain) costs of preparing for risk compare to the (often uncertain) benefits of doing so. For instance, a family living in a violence-ridden community faces safety, health, and property risks and must choose how to allocate its limited budget to protect and insure against each of these risks. Likewise, a small country prone to torrential rains and also exposed to international financial shocks must decide how much to spend in flood prevention infrastructure and how much to save to counteract the effects of financial volatility.

Risk management involves not only considering trade-offs but also taking synergies into account. These can make both preparation for and consequences of risk less costly. They can also diminish risks and increase expected benefits.

Investments in nutrition and preventive health, for example, make people more productive while reducing their vulnerability to diseases. Similarly, improvements in the business environment, such as streamlining regulations and improving access to credit, can induce the enterprise sector to become more dynamic and grow more quickly, while also making it more resilient to negative shocks.

Obstacle in risk management

The report also looks at the reasons why people and societies are not opting for risk management. The report highlights some obstacles and constraints faced by individuals—lack of information, cognitive and behavioural failures, missing markets and public goods, and social and economical externalities.

The report goes on to say that identifying risks is not enough but obstacles in risk management should also be identified, prioritized, and addressed through private and public actions.


World development report 2014: risk and opportunity - managing risk for development

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