Global Risk Management in a World Out of Balance

Date July 11, 2005
Speaker Paul LAUDICINA( Managing Director, Global Business Policy Council, A.T. Kearney)
Moderator Andrei HAGIU (Fellow, RIETI)


Summary Transcript of Extraneous Remarks

Looking at economic history from the beginning of time, there was virtually no change in GDP per capita from the beginning of recorded history until the Industrial Revolution. Then, as human power was substituted for by machine power, there was a quantum leap not only in GDP, but in the amount of data available about the world. Innovations in information technology have enabled the storage of massive amounts of data, transforming the information environment. However, the question arises as to whether having all this data really makes people smarter about the world.

In fact, the common man increasingly prefers to tune out this constant bombardment of information, rather than try to pick through the data smog to understand the world. Particularly since the demise of the "old world order," in which at least there was a certain simplistic sense about the global architecture, and in which people could place facts and figures in terms of the good guys and the bad. This is not the case today. The "new world order" is not an ordered situation at all. It is a world that is out of balance, best characterized by complexity and paradox. While people are now better educated, healthier, richer and better informed, they are nonetheless more apprehensive than ever before.

My suggestion is that this is so, not in spite of globalization but because of it. The same forces of global market integration and technology that have enhanced competitiveness are also the ones that drive anxiety about one's security, physical as well as financial. For example, the same low-cost air carrier that permits enjoyment of more travel and leisure than ever before can become an instrument of terror, transporting not just businessmen and tourists, but viruses, diseases and terrorists. The same high-speed Internet system that has made more information available faster and more efficiently can also steal our identities, pick our pockets, transmit hate, and be used to direct a global campaign of terror. There has been a radical transformation in public consciousness as a function of this very rapid change in society. The heightened integration, economic expansion and popular optimism of the 1990s gave way in the late 1990s to the post-Asian Financial Crisis, post-tech bubble implosion, post-9/11, post-Enron/WorldCom global scandals and the erosion in public confidence, heightened anxiety, and heightened risk aversion.

As for businesses all around the world, what they are most concerned about is how to grow. Many are sitting on mountains of cash, afraid to invest it because during the 1980s and 1990s, they invested too quickly were not sensitive enough to risk. Since the turn of the century, because of all of these things that have happened, from 9/11 to corporate scandals and global recession, they are afraid to act.

The book World Out of Balance is all about how to make the decision to grow by doing things cross-border in an environment of chronic volatility and instability. All the unsettling conditions of the world today will continue to manifest themselves, so the book is about how to look at the future and how to try to find the signals for future developments so as to gain insight on making the right decisions. The research conducted at A.T. Kearney suggests that the most successful companies and countries are those that make the decision to grow beyond their borders and to do so continuously.

As for the methodology with which A.T. Kearney helps its clients to understand how to get a better handle on future global developments, we consider the propensity of integration to create risk as well as opportunity. All the forces of global integration - technological, economic, political and social, the fact that trade barriers have declined steadily, the fact that capital flows have increased- all of these support improved opportunities for growth. At the same time, however, those same paradoxical forces of integration are accompanied by a growing number of terror incidents and computer viruses. This has led to growing insecurity about employment, health and public safety.

In trying to understand the future, there are five key drivers, all with a very important leveraging effect on technology and innovation. These are globalization, demographics, changing consumer patterns, natural resource and environment issues, and increasing government regulation and consumer/shareholder/stakeholder activism at every level. These drivers are overlain by wildcards, or the kinds of disruptive events that can dislodge even a well-constructed view of the future.

The A.T. Kearney Global Business Policy Council aims to estimate certain conditions prevailing in the year 2015, for the purpose of getting a sense of the direction in which the world is moving, to inform the present. As such, a given driver is plotted and an econometric forecast is conducted on each in terms of the most optimistic and pessimistic outlook; growth prospects; effects on market segment, customers, geography and industry; and so on. For each of the five drivers there is a series of indicators to derive some level of detail useful for discussion of each driver and its component parts. These indicators are further used to build sub-scenarios from which macro scenarios are developed, spanning across the entire continuum of future prospects.

All this is used by management to prepare risk and action plans for different scenarios, to align the organization and its thinking about the future, or to make decisions on which markets to enter or depart. Finally, this is incorporated into a master scenario plan for a "powerfully imagined and rigorously researched" future.

The first driver, globalization, is something that means something very different to different people. In terms of the A.T. Kearney Globalization Index, the focus is on economic, political, social and technological integration in objectively measurable, universally available facts that come from reliable sources and can be put together to raise questions about the convergence of these forces and various countries. While a few years ago globalization may have been viewed as an irreversible, immutable and irrefutable force in everyone's best interest, looking at the last golden era of globalization (1870-1914) with great technological progress, the greatest migration of people and more trade and finance crossing borders, it all came to a screeching halt because of one act of terrorism that led to World War I. This was followed by an era of protectionism, and that led to a global depression. What this leads to is the conclusion that globalization should not be taken for granted. It should not be assumed that economics trump politics because history is replete with examples where in fact they have not.

The second driver is demographics, which presents a familiar picture to many. The world population has trebled in the last century with the great advances in life expectancy. Global population growth is now down to about 1.2% per year, not only due to population decline in developed countries, such as throughout Europe and Japan, but because the 750 million people in sub-Saharan Africa over the last decade have seen their life expectancies decline, largely due to HIV/AIDS. Developing countries are experiencing strong growth in the 15-39 year-old cohort, while the industrialized world is experiencing an aging population. There are also huge changes in population and demography, with 95% of the global population now living in the developing world. In addition, the locus of population growth has shifted to urban areas. In cities ill-prepared for this shift in urban concentration there will be huge instability. These changes both within and between societies are going to have a tremendous impact on economics.

In addition to the demographics, there have been changes in the global labor environment. First, since the end of the Cold War there has been clear integration of global labor markets and an environment in which the digitization of data and low-cost telephony have made outsourcing possible. At the same time, a radical restructuring of economic power is occurring now as we shift from a manufacturing- to a services-based economy. In fact, in 1995-2002 there was a net decline in manufacturing jobs globally of 11%. In 2002, China had 15% fewer manufacturing jobs than in 1995. At the same time, it doubled factory output as a function of technology-driven innovation and productivity improvements. Dealing with a shortage of labor coupled with depopulation could mean importing labor (immigration) or exporting jobs (outsourcing). While manufacturing jobs were declining from 1995-2002, the youth population in the developing world grew by 18%. That is an important dynamic to consider when thinking about future global demographics.

A third driver is consumer power and preferences. Drawing a map of the world to scale and considering only those people earning U.S.$10,000 per capita adjusted for purchasing power parity, the world population in 2000 is reduced from 6 billion to 1 billion people. In 2015, the situation is completely different in that this population doubles to 2 billion, with 900 million in the developing world (626 million in China). This is why investors are most likely to invest in China - because of the potential for burgeoning new markets. It is also important to note that while Japan and Europe are in decline, their concentrations of upper-income consumer groups actually grow.

This leads to talk about more consumers in the industrialized world wanting to buy "experiences" (such as high-end luxury goods, customized features, entertainment, travel, tourism, higher education, wellness, better health) rather than "stuff". Thus, the homogenization of markets, which was discussed years ago, seems unlikely to happen, in part because when people fear that the world is crowding in on them, they look to "comfort products" that they can somehow relate to rather than broad, global, homogenized products. As people react and push back against globalization, they actually gain a preference for local brands that they think help define who they are and what they are, assuming such brands offer roughly equal quality as well as price.

The fourth driver is natural resources. Experience has shown that most forecasts on oil reserves have been wrong. For example, instead of depleting oil and gas reserves in the energy sector, a million times more computing power is being used today than in 1970. This suggests that we have added to reserves in ways previously unforeseen. New sources of hydrocarbons have also been found. Therefore, to understand the future of energy, the politics of the supplying countries come into play, particularly the former Soviet Union/CIS countries as well as OPEC, and the demand side of Asia in general, and in China, in particular.

The natural resource situation depends not only on politics and economics but also on the environment and what is likely to happen in the future on the issue of climate change and availability of natural resources other than energy. One of the most problematic resources is water and the fact that in 2050, 42% of the world is expected to be in a water-scarce or shortage situation. With population growth, the consumption of water for agriculture, food and manufacturing has increased without being replenished. Clearly, availability of water has been acknowledged as a problem and the Intergovernmental Panel on Climate Change has come to publicize that this issue as no longer one of mitigation, but of adaptation.

The last driver is related to activism and regulation. If it is assumed that people feel more vulnerable than ever before, they will look to government for protection. At the same time, because people are feeling more threatened and activist groups are enabled by technology, there is more power to be leveraged by shareholder/stakeholder activism at every level. At the same time, more will be demanded from government in the future. The policy issues on which government must pronounce are becoming more complex, related to privacy and digital technology, biotechnology, stem cell research, et cetera. In the United States, nearly half of the senior executives in the U.S. government workforce are eligible to retire this year, which will mean fewer experienced people within government.

All of this leads to a certain view of the world with the A.T. Kearney future scenario being one of "Open Borders, Lingering Fears," which holds that the U.S and Chinese economies will be dominant and the other economies will be fulcrums, leveraging power between the two.

Finishing up the scenario plan is the discussion about "wildcards." These are low-probability, high-impact events that are going to affect the human condition, are potentially disruptive, and could be positive (for example, the Green Revolution) or negative (for example, avian flu) and beyond anybody's control. This would suggest that there will be much more intense resource competition and price escalation, or perhaps new and more efficient uses of natural resources.

In looking at the risks that concern business leaders, while traditional risks remain, such as country financial risk and civil disturbance, there are also new, emerging risks that have to do with security threats, terrorist attacks, theft of intellectual capital and IT disruption. In fact, top business leaders' greatest fear is that they are unable to properly monitor risk and guide strategy. It is this strategic assessment and risk mapping that makes companies reluctant to invest. Some obstacles executives identify as impediments are the lack of tools to make out early warning signs, and the lack of information necessary to make strategic decisions. Unless they have independent, third-party assessments, executives cannot discharge their responsibilities.

In conclusion, after constructing the scenarios that give the corporate client an opportunity to envision the future, the risks are mapped by, first of all, prioritizing the most important factors in terms of generating earnings for the corporate operation; then identifying the critical infrastructure, locating vulnerabilities and developing responses by creating flexibility or redundancy to prepare for disruptions; and finally, implementing a system to monitor changes in the conditions. Most importantly, everyone in the company at the senior executive level must understand who has responsibility for each risk, the severity of the risk, the impact on profitability, the action to be taken, and who to approach for managing that risk as well as putting the risk abatement plan in place.

In short, the view at A.T. Kearney is that the only way companies can do what they need to do to grow is to have a more dynamic view of the world by rigorously researching and powerfully imagining the future, and putting in place a risk-mitigation strategy so that as the world continues to manifest volatility and change, there is room to move forward and act responsibly for shareholders and stakeholders at every level.

Questions and Answers

Q: It seems to me that your Globalization Index may lack a historical perspective and therefore is biased in its selection of indicators. Is it purely quantitative, or is there a qualitative aspect as well?

A: We purposely focused only on those elements of globalization which would allow broad statistical assessment across many years going back to 1980, looking at the data available for the largest sample of countries from the IMF, the World Bank and the World Tourism Association. This is not the end-all and be-all of globalization. The purpose of the Globalization Index is to look at the four characteristics (economic, social, technological and political integration) and plot the trajectory of countries. The countries that have integrated across these measures most rapidly register better income distribution, higher investment and social overhead, and score higher on the U.N. Human Development Index. Based on this limited but objective assessment, globalization is seen as a net positive, even among the least-developed countries. While we acknowledge that cultural issues are important, we do not have a way of getting a handle on them, so we just look at factors that we consider objectively measurable.

Q: How do you evaluate the general capability of companies to digest your vision and reflect it in their strategies? Do you think they are doing a good job?

A: Most Western companies decommissioned their internal planning capability sometime in the 1980s because of cost-cutting or because plans did not prove fruitful. Western companies in general and U.S. companies in particular are in worse shape right now in trying to digest and understand the new world because they do not have the capability, other than lines of business leaders out there in the field saying that they should or should not do this or that. Now that CEOs, because of Sarbanes-Oxley and other changes, are feeling more vulnerable about the decisions they make, they are looking for more controls and ways of understanding. For this, they come to us to help them construct a view of the future that will give them some clarity. Japanese companies, on the other hand, did not really decommission their central planning capability. Therefore, they are well-positioned to use better methodologies to absorb all the data.

Q: Risk management really seems to depend on the situation. In Japan civil society is, in a sense, underdeveloped and the risks perceived by companies are very low compared to their foreign counterparts. What do you think about this?

A: Different companies come at the whole corporate social responsibility (CSR) debate in different ways. There is almost nothing that companies can do to satisfy some of the more radical activist groups. How one defines CSR is not a new debate. Years ago, CSR was often considered mostly in terms of community development activities that might be regarded as self-serving. This is a narrow gauged form of CSR. The issues that I urge companies to get involved in relate to the big policy issues of the day. Companies cannot afford to be silent on questions that relate to eliminating agricultural subsidies, the liberalization of trade or environmental degradation and the Kyoto Protocol. To me, the power of a given corporation to make a substantial difference in terms of social performance is probably less than its power to change the policy environment and to create a receptive public environment for defining the right policy options.

While the benefits of globalization are out there and ultimately are positively affecting everybody, the pain associated with the disruptions of globalization is immediate and palpable. There is an asymmetry at work in which the benefits associated with globalization are longer term, more diffuse and more in the social interest at large, but the dislocation associated with globalization is immediate. It is that dislocation that drives the political calculus. A new compact is needed between business, the public, labor and government. I define CSR as being able to speak up and being involved in the policy environment through which all of these issues ultimately have to make their way. If businesses can get involved in the policy debate, then everything else will follow.

Q: What are some of the reactions from political leaders to your theory?

A: I addressed the National Congress of Brazil a few weeks ago as well as the National Assembly in Korea and, of course, I have spoken to my own government many times. What I have found is that all politicians have the same fears: They know the world is radically transforming but they cannot quite understand it and move the policy machinery fast enough to respond to these things and, most importantly, they have not found a compelling way to communicate this with their constituents. Enlightened politicians everywhere are looking for a formula to understand the underlying needs and to promote solutions to those needs.

I am encouraged by the fact that there are more political figures who understand the stakes and are trying to figure out the mechanisms. But they cannot do it alone. That is why, in talking about CSR, it has got to be a joint effort. As in those societies that have been able to transform themselves, there needs to be agreement among all political parties, not differences in opinion on the basic issues that surround the future of global integration. There is a growing group of politicians out there that is seeking this common ground, and we are here to help them come up with the right answers.

Q: Increasingly in economic research, happiness research shows that more wealth does not necessarily make people happier in general. With globalization increasing global income, have you looked at the policy implications associating growth with happiness?

A: When we did this comparison, it turned out that the Irish were at the top of the Happiness Index and also the Globalization Index. One assumes that the U.N. Human Development Index, which is a quality of life index that looks at a lot of factors, is another proxy for satisfied people. Those countries that integrate and are open societies tend to have more satisfied citizens. One curious fact about polling data of industrialized societies is that there are increasingly large pluralities who believe that globalization is more negative than positive. In India and China, however, an overwhelming majority of people believe that globalization is positive.

That means they believe the benefits derived from their current trajectory are yet to come or are coming, whereas more mature societies that have already experienced the benefits are now seeing the risks and they are pushing back. The real issue is the gap between the "mobile minority" who have benefited immeasurably from globalization and the "immobile majority" who have benefited only incrementally. While everybody is better off, the gap is much greater and the difference today is that it is all transparent. People are not content to see this kind of bipolar world and we need to do something to encourage those who have been left out of the globalization equation.

Q: How do you think the division of labor between government and business will change in the next 20-30 years?

A: It has to change because there are lots of government services that governments in the future will not have the personnel to carry out. I think there is going to be more and more efficient privatization of government services to the private sector. The extent to which government is not able to address, to the satisfaction of industry, questions that have to do with vocational training and education, the private sector will have to handle it. Industry and government will be forced to work together because industry cannot be successful without some government response to the basic issues that industry is trying to deal with; and government cannot discharge its responsibilities effectively unless it has a vibrant industry that is contributing to improvements in national income. It is that enlightened self-interest that will get the two working together, not some sort of social responsibility instinct.

Q: A response such as redundancy has a tradeoff with efficiency. In that respect, is there any methodology to enumerate the costs and benefits of redundancy?

A: We have a rigorous numerical representation of risk, probability of risk, risk routing, the cost of the risk manifesting itself, and the range of costs of various redundancy schemes. A cost-benefit analysis could be developed from this to determine how likely a risk is, how severely it would affect the bottom line, and how much it would cost to build in the redundancy into protection, especially with respect to the competition.

Q: In comparison with other sectors, the government in Japan has maintained its position in recruiting good students, but policymaking is becoming more difficult because of the political complexity of issues.

A: It is good to know that the best and the brightest are still going into government because it is less true in Europe and the United States.

Q: Given the good business relationships between Japan and China, most businesspeople in Japan view the political issues arising with China as an impediment. Is there a way to raise the threshold so that politics do not trump the good economic foundations that have been built?

A: There are some recent examples, such as in the tensions between India and Pakistan, where the business community reportedly convinced the Vajpayee government in India not to act in a way that a previous government might have acted because it would destroy the economic momentum from which India was benefiting. A moderating influence was thus placed on the government's instincts to act politically in one way because of what was judged to be negative economic consequences that might come out of it. I presume that the Chinese government was surprised by the intensity of the recent demonstrations against Japan and is making efforts to figure out how to handle this. In many areas of geopolitical friction, I believe that economics presents a buffer to a negative political outcome.

*This summary was compiled by RIETI Editorial staff.