The turmoil that erupted on many of the world’s financial markets in the past days is a timely reminder of risks and vulnerabilities. Global growth may be back at pre-2008-crisis levels, but the worst risks we are facing don’t come from stock-market volatility. Rather, they are related to increasingly complex interconnections between technology, the environment, cyberattacks, and political trends that include a heightened possibility of protectionism.
Looking at the results of the World Economic Forum’s annual risk-perceptions survey in the Global Risks Report, it has been striking to watch global economic and financial risks fade from prominence over the past 10 years. This year they scarcely even registered. Some of that shift reflects a healthy focus on other pressing issues now that dealing with the aftermath of the financial crisis is taking up less bandwidth. But arguably some of it reflects hubris about the robustness of all our systems.
This week’s market gyrations have been severe, but they do not (yet) amount to a systemic problem. After sharp selloffs on both Monday and Thursday, both the Dow Jones Industrial Average DJIA, +1.38% and the S&P 500 SPX, +1.49% moved into “correction” territory having dropped more than 10% from their peak.
While this has led to frayed nerves among many market participants, and an expectation that further volatility is inevitable, there has been a notable degree of confidence that developments this week represent a “traditional” selloff rather than the kind of systemic unraveling that loomed when the subprime mortgage market collapsed 10 years ago. This underscores the fact that a lot of work has been done to bolster the global financial system in the years since the crisis.
And yet it was also striking that the stock-market selloff was focused on the ecosystem of financial engineering that has built up around the VIX VIX, -9.64% in recent years— a measure of volatility and hardly an obscure corner of the market to which no one has been paying attention. The lack of volatility during much of the current bull run has been unmissable, and has prompted countless notes and commentaries about the inevitability of some kind of shakeout when it does return. So this was a wave of disruption that shouldn’t surprise us, particularly at something of an inflection point for global monetary policy.
But if we shouldn’t be surprised by risks crystallizing around the VIX, what about other elephants in the room that could be triggers for problems? In this year’s Global Risks Report, we highlighted two longstanding vulnerabilities.
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The first was a potential asset price correction: we’ve clearly seen some of that risk wash through the financial system this week, but it would be a brave person who suggests there are not still areas where valuations look stretched. We remain in potentially volatile territory.
The second of these red flags we raised was on indebtedness, where vulnerabilities have in many cases intensified since the 2008 financial crisis. Across the G-20 nations, non-financial-sector debt increased from $80 trillion in 2007 to $135 trillion in 2016. Corporate debt issuance has surged in many countries, and one measure suggests that U.S. corporate debt-to-equity ratios have doubled since the crisis. Meanwhile many emerging economies are particularly exposed to increases in global rates. For example, in October last year the governor of the Central Bank of Kenya cautioned that public debt levels in many African countries has reached levels at which an external shock “could push us over”.
New fractures and fragilities
Asset prices and debt levels represent potential triggers for short-term disruption, but there are also more deep-seated risks to consider. The world is undergoing a number of simultaneous transformations that have introduced fractures and fragilities to the prevailing economic models.
Technology is the obvious example here. The depth and pace of changes that are unfolding have the potential to upend many of our basic economic assumptions, particularly in relation to the functioning of labor markets.
The growing prospect of a revival of protectionism is another potential source of long-run economic and financial instability. Consensus among leading global powers has broken down about the prevailing rules of globalization, and the spillover effects in domestic economic policy-making risk pushing us into a precarious zero-sum approach to trade. All of this is closely related to developing patterns of inequality in many countries—and once again this year, disparities of wealth and income were ranked in the top three in our survey as a driver of global risks over the next 10 years.
A further transformation with the potential to unleash havoc relates to the environment, and the profound changes we are likely to have to make to mitigate and adapt to climate change. In the financial sphere, a growing chorus of voices in both the public and private sectors is calling for action on the potential “transition risks” that will crystallize if and when our move to a low-carbon and environmentally sustainable future develop traction.
But concerns about the disruptive financial potential of stranded fossil-fuel assets are only the tip of the iceberg. The structural changes faced by the countries and regions most affected by energy and environmental transitions—such as in the Middle East, where tensions are already running high—will lead not just to economic financial dislocation, but to profound societal and geopolitical challenges and disruptions.
The potential for runaway collapse, not just incremental damage
And here we start to consider the complex or systemic risks that have the potential to hit us not just with incremental damage but with runaway collapse or an abrupt shift to a new and suboptimal status quo that becomes difficult to escape. We live in a world characterized by increasingly dense networks of interconnections. The potential paths along which risks can cascade have proliferated, and the pace has accelerated. Technology has been a powerful conduit for these systemic vulnerabilities.
Consider the step change in cyberrisks that we witnessed in 2017, with previously extraordinary attacks becoming increasingly commonplace. An attack like WannaCry saw geopolitical tensions feed through to a technological breach which in turn had immediate societal and economic impact, with disruption recorded in banks, hospitals, government ministries, energy suppliers and transport networks. If a “kill switch” hadn’t been found to shut the attack down, the damage and disruption caused could have been much, much worse.
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There is every reason to guard against complacency about purely financial risks, but increasingly it is complex systemic risks that we need to worry about. Humanity has become remarkably adept at learning how to manage conventional risks that are reasonably easy to isolate and to tackle with standard risk-management techniques. But we’re much less successful when it comes to complex risks in the global systems we rely on that are characterized by feedback loops, tipping points and opaque cause-and-effect relationships that make assessment and intervention problematic.
We should be vigilant for further episodes of volatility like the one that saw trillions of dollars wiped off equity markets this week.
Some of the vulnerabilities we need to guard against are clear. But we should also be scanning the horizon for unexpected disruptions, and redoubling our efforts to build in as much resilience and adaptability to all of the global systems we rely upon.