Getting Risks Right: Thoughts about Increasing the Resilience of the Global Social & Economic System

The extraordinary extent of the financial crisis has inspired deep systemic reforms world-wide, rethinking financial stability, the resilience of our economic systems, and the role that national and international institutions play. While most of the ongoing activities are understandably centred on banks and the banking sector – the origin and centre of the crisis – other important elements have been relegated into secondary roles and fundamental democratic processes have been sidelined. Financial issues have crowded out real economic issues as policy-makers and politicians spend more time on the financial than the substantial (i.e. the real economy) and the democratic. Two fundamental concerns need to be addressed proactively: 1. A comprehensive approach to deal with both financial and real world risks on this planet, and 2. The global governance system based on democratic principles to follow globalisation of the business (and particularly the financial) sector.

1. Introduction
Since 2007, our global economic and financial systems have been in a higher degree of turmoil than at any other point in living memory. The last few years were extremely challenging and busy especially for all those concerned with the well-being of the financial system. Suddenly, highly sophisticated financial issues became the subject matter of a heated political debate in public as well as private discussions. Actions taken in the midst of the soaring financial crisis to combat specific problems took on a life of their own. They also inspired many of the systemic reforms undertaken recently world-wide, causing a deep rethinking process about financial stability, the resilience of our economic systems, and the role that different (national and international) institutions play and would play in the future. This regulatory explosion which often appears following major failures in an existing infrastructure and which seems to be challenging the existing regulatory paradigms is actually nothing new. As Jan Monkiewicz and I pointed out in our book The Future of Insurance Regulation and Supervision — A Global Perspective, it happened many times before.1 The bigger the failure, the more sweeping the reforms that are proposed and later implemented. The important new element this time is (besides a particular intensity of the debates and hence generally a larger scope of actions) arguably the global reach of the current considerations indicating a high degree of interdependence of various local solutions. This demonstrates how much contemporary economies are inter-linked and dependent on the well-being and proper functioning of the global system. This includes its constituent parts and its regulatory and supervisory framework, which are supposed to provide the necessary preconditions that allow a proper functioning.

Most of the on-going discussion and activities on current and future framework are centred on banks and the banking sector. This is not a surprise as this is where most work to improve our current systems has to occur. What is surprising though is how many other elements have been relegated into secondary roles in the process and how some fundamental democratic processes have been sidelined. It seems that financial issues have not only crowded out real economic issues, as policy-makers and politicians spend more time on the financial than the substantial (in which I would mean the real economy), they have also sparked a way to deal with these issues that are based less on democratic processes which would create legitimacy through direct participation and empowerment, but have propelled a mix of well-intentioned self-appointed groups and particular interests into positions of power with only indirect links to the wider population or in some cases very direct links only to minority subgroups of activists.
At this stage, there are two fundamental concerns that we ought to address more proactively: 1. A comprehensive approach on how to deal with both financial and real world risks in this planet does not exist, and 2. The global governance system based on democratic principles has not been able to follow the globalisation of the business (and particularly the financial) sector.
In the following contribution, we hope to develop some thoughts that are aimed at increasing the resilience of the global social and economic system while safeguarding basic democratic principles. Hopefully others might take this thinking further.

2. Starting Observations
The following are some fundamental observations that, subject to falsification in the best of Popper’s tradition, provide a background for the tasks at hand:
− A lot of the current problems in financial markets seem to stem from the fact that finance and real economics have drifted apart. The world of finance and the interested stakeholders controlling it have found ever more intricate ways of diverting a larger share of the value produced into their direction. The result has been an increasingly weaker link between, on the one hand, the finance that is truly needed to make complex projects happen over long periods of time and to guarantee that savings, investment and payment processes function at all times and, on the other hand, the finance that serves its own purpose. We will have to find better and more efficient ways to link the two parts of our economic system closer together again.
− We are experiencing a deeply rooted problem with our global governance, the existing global institutions and the failure of our systems to be able to project the will of the citizens fully onto the globalized stage. While business has globalized, democracy has not. Therefore, we lack functioning mechanisms to help steer what is socially desirable and desired for our planet. As any economist knows, there are some necessary preconditions for functioning markets. However, while there is a strong focus on getting the economic variables right – following the disaster of the financial crisis triggered by more of a laissez-faire approach than was good for the world – this has been less the case for the social variables. However, functioning social systems also need a proper framework and the (relative) best social governance system we have come up with so far is democracy. Making the economic and financial systems ever more global while keeping the social national or at best regional will create further tension as popular outbursts of dissatisfaction and anger have shown. Civil unrest will only increase if this chasm is not narrowed or, worse, continues to widen.
− The collapse of the communist block and indeed socialism as an alternative to unrestrained capitalism has deprived the capitalistic concept of what some consider an important corrective factor for its systemic problems. Many elements that anchor the capitalistic system in societies today (social security, old-age and accident protection, sharing in production factors etc.) are in effect based on non-capitalistic ideas. It has been a great strength of the capitalistic system to be flexible enough to integrate these ideas in an efficient way, providing more stability and social acceptability in the process. Today, unfortunately, it seems that the only rival to capitalism is a new form of state-controlled economic system (maybe to be understood as a combination of reformed and adapted neo-mercantilism) by often authoritarian regimes.
− Another issue is the penetration of the bureaucratic. The current economic performance of the advanced economies is to no small degree the result of a financial system being pumped with cheap liquidity based on government debt – never before has so much money been pumped into financial markets so rapidly. Indeed, the result of the public interventions in financial and real economy markets has led to an explosion of government debt that is historically only comparable to the levels reached in times of war. Economic history suggests that massive peace-time increments in government debt levels tend to prove enduring and are seldom reduced in an orderly fashion. They tend to create a lot of financial stress and political instability, depressing future growth rates and tying future performance to governmental decisions rather than the force and efficiency of markets. At the same time, the level of government penetration in the financial sector has increased notably. Governments not only have direct stake-holdings in so many financial institutions, which somehow will need to be wound down, but they are also linked with the explosive growth of central bank balance sheets. This is coupled with an apparently new doctrine that more micromanagement, if not direct containment, of the entrepreneurial spirit in the economy is the right answer to the crisis. However, it would be remarkable indeed if historic experience were suddenly to reverse and governments turned out to be more efficient generators of growth and prosperity than functioning markets.
− What is still absent from the macro level and indeed the governmental process to provide a stable, resilient and sustainable framework for the globalised society is a larger focus than simply on the financial. Real risks ought to be considered and worked with deploying the same energy and similarly sophisticated instruments. Currently, unfortunately, there are not enough attempts to create true risk management systems at the global level that would embed the full cost of consequences early in the process and factor in all monetised and non-monetised aspects, according equal weight and importance to the economic and the non-economic. As insurance specialists can only too readily testify, the indirect costs of any large disaster tend to be a multiple of the direct costs – and of those only a fraction are fully insured providing a special layer of protection for those affected. At the same time, the temptation to push more and more risks into the tail of the distribution (ecological, economical, financial etc.) has to be resisted, otherwise we will continue ending up too often in similar predicaments as now.

1. Patrick Liedtke and Jan Monkiewicz, The Future of Insurance Regulation and Supervision — A Global Perspective eds., (London: Palgrave Macmillan, 2011).

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