Managing Risk for Development

WDR 2014 Managing Risk for Development Norman Loayza Berlin Workshop December 2012

Context and Objective 2

The topic is timely! Why a WDR on Risk? Ongoing global food / fuel crisis Global financial crisis well into its 5 th year Increased frequency and intensity of natural disasters Growing concerns about global warming/climate change 3

Why a WDR on Risk? The topic is timely! Ongoing global food / fuel crisis Global financial crisis well into its 5 th year Increased frequency and intensity of natural disasters Growing concerns about global warming/climate change An environment packed with risk and uncertainty, with key implications for growth and poverty 4

WDR 2014 focuses on: Improving the management of risks that matter to people in their struggle for development Clear, useful, and implementable policy recommendations Systematic risk management is key to resilience against adverse events key to pursuing development opportunities Systematic risk management is a shared responsibility from the household to the international community overcoming obstacles to risk management dealing with both idiosyncratic and systemic risks 5

WDR 2014 focuses on: Improving the management of risks that matter to people in their struggle for development Clear, useful, and implementable policy recommendations Systematic risk management is key to resilience against adverse events key to pursuing development opportunities Systematic risk management is a shared responsibility from the household to the international community overcoming obstacles to risk management dealing with both idiosyncratic and systemic risks 6

WDR 2014 focuses on: Improving the management of risks that matter to people in their struggle for development Clear, useful, and implementable policy recommendations Systematic risk management is key to resilience against adverse events key to pursuing development opportunities Systematic risk management is a shared responsibility from the household to the international community overcoming obstacles to risk management dealing with both idiosyncratic and systemic risks 7

Risk and Opportunity 8

Risk A burden but also an opportunity Risk as a burden Natural hazards (earthquakes, droughts, hurricanes ) Epidemics, illnesses Economic/financial crises Risk and opportunity Farmers trying new crops in search for higher yields Migration to the city to seek better paying jobs Opening borders to international flows to enhance growth.. Actions are taken in the search for improvement but results are seldom guaranteed 9

Drought in Northern Kenya

Visible and invisible risks in Mukuru slum, Nairobi

Risk A burden but also an opportunity Risk as a burden Natural hazards (earthquakes, droughts, hurricanes ) Epidemics, illnesses Economic/financial crises Risk and opportunity Farmers trying new crops in search for higher yields Migration to the city to seek better paying jobs Opening borders to international flows to enhance growth.. Actions are taken in the search for improvement but results are seldom guaranteed 12

New crops introduced in East Timor Source: World Vision

Risk A burden but also an opportunity Risk as a burden Natural hazards (earthquakes, droughts, hurricanes ) Epidemics, illnesses Economic/financial crises Risk and opportunity Farmers trying new crops in search for higher yields Migration to the city to seek better paying jobs Opening borders to international flows to enhance growth.. Actions are taken in the search for improvement but results are seldom guaranteed 14

Risk Management 15

Why focus on risk management? Lack of systematic risk management has led to many recent crises has perpetuated poverty traps WDR 2014 focuses on risk management because it can make a difference for development outcomes: saves lives saves costs averts damages & setbacks unleashes growth & opportunity 16

Why focus on risk management? Lack of proper risk management has led to many recent crises has perpetuated poverty traps WDR 2014 focuses on risk management because it can make a difference for development outcomes: saves lives saves costs averts damages and protects gains unleashes opportunity and fosters growth 17

1. Risk management saves lives Deaths from disasters have been falling, in part due to preparedness and response systems over the last 30 years Haiti earthquake vs. Chile earthquake (2010) Haiti: more than 200,000 fatalities Chile: 500 fatalities 18

Earthquake in Haiti

Earthquake in Chile

2. Risk management saves costs An ounce of prevention is worth a pound of cure Estimates suggest benefits of preparation/prevention exceed costs many times nutrition interventions immunization disaster risk reduction financial monitoring macro prudential 21

2. Risk management saves costs An ounce of prevention is worth a pound of cure Estimates suggest benefits of preparation/prevention exceed costs many times nutrition interventions immunization disaster risk reduction financial monitoring macro prudential Sadly, more resources are spent on relief compared to 80 70 60 50 40 30 20 10 Total donor development assistance for disaster-related activities 1980-2009s % allocated to: prevention or preparation 0 Emergency response Reconstruction Disaster prevention and preparedness 22

3. Risk management avert damages and protects gains Mismanagement of risks and resulting crises/disasters, have slowed down progress toward poverty reduction and attainment of the MDGs However, when preparation is effective, losses can be mitigated Poor and emerging-market economies more resilient in the aftermath of latest global crisis 23

3. Risk management avert damages and protects gains Mismanagement of risks and resulting crises/disasters, have slowed down progress toward poverty reduction and attainment of the MDGs However, when preparation is effective, losses can be mitigated Poor and emerging-market economies more resilient in the aftermath of latest global crisis 24

Better macroeconomic preparation leads to lower growth contraction in the face of global economic crises sample of low-income countries 12 10 8 Period prior to global crisis in the past Period prior to 2008 global crisis 0.0 Change in GDP per capita growth after global crisis Past global crisis 2008 global crisis 6 4 2-1.0 0 Inflation (%) Current account deficit (% GDP) Fiscal deficit (% of GDP) Reserve coverage (months of imports) -2.0 Source: Staff calculations based on data from World Development Indicators and International Financial Statistics.

4. Risk management unleashes opportunity Effective risk management enables people and countries to take advantage of development opportunities breaking poverty traps fostering growth A few examples, Stronger school attendance if community is safe Larger international trade when payments are secure Higher agricultural investment when rainfall insurance is available 26

4. Risk management unleashes opportunity Effective risk management enables people and countries to take advantage of development opportunities breaking poverty traps fostering growth A few examples, Stronger school attendance if community is safe Larger international trade when payments are secure Higher agricultural investment when rainfall insurance is available 27

Rainfall insurance encourages Indian farmers to increase their investments 60% % of households that invest more % of households that invest less 50% 40% 30% 20% 10% 0% Amount of fertilizer Amount of seeds Amount of pesticides Amount of bullock labor Amount of hired labor Amount borrowed for inputs Source: Cole, Gine, and Vickery 2011.

In brief Risk as threat to development Risk management as an instrument for development 29

Principles and Obstacles 30

Systematic risk management The process of Preparing (ex ante RM) Confronting and taking on risks Coping (ex post RM) 31

Principles of risk management EX ANTE KNOWLEDGE of shocks, exposure, and potential outcomes INSURANCE to transfer resources from good to bad times RISK MANAGEMENT PROTECTION to reduce the probability and size of losses and increase those of benefits EX POST COPING to recover from losses and make the most of benefits 32

Obstacles to efficient risk management Internal constraints Lack of resources Lack of information Cognitive failures Behavioral failures External constraints Missing markets, Missing public goods Externalities / Moral hazard Exclusion 33

Obstacles to efficient risk management Internal constraints Lack of resources Lack of information Cognitive failures Behavioral failures External constraints Missing markets Missing public goods Externalities / moral hazard Exclusion 34

Well-functioning social and economic systems can support people to overcome these constraints International community Nation Financial system Enterprise sector Community Household 35

Risk management a shared responsibility People s Risk Management The State Social protection health, old age, and unemployment insurance assistance and relief Public goods infrastructure law and order national defense Public policy macroeconomic mgmt. regulatory framework Households family ties/primary support Communities collective action Enterprise sector jobs and income Financial system insurance, credit, savings National economy macro stability and resource mobilization The International Community expertise, coordination, resources 36

All suffer from shortcomings Households gender and age biases? Communities collective action problems, conflict? Enterprise sector inefficient allocation of resources? Financial system source and propagation of shocks? State capacity constraints? policy uncertainty? predatory? International community inaction? loss aversion? 37

All suffer from shortcomings Households gender and age biases? Communities collective action problems, conflict? Enterprise sector inefficient allocation of resources? Financial system source and propagation of shocks? State capacity constraints? policy uncertainty? predatory? International community inaction? loss aversion? Recognize potential, identify pitfalls, provide useful recommendations 38

Outline 39

Structure of the WDR 2014 THE HOUSEHOLD THE COMMUNITY THE NATION THE ENTERPRISE SECTOR THE STATE GLOBAL COMMUNITY THE FINANCIAL SYSTEM THE CONSTRAINTS AND THE ROLE OF SUPPORT SYSTEMS RISK MANAGEMENT: PRINCIPLES AND MEASURES 40

Preliminary messages and conclusions 41

Main (preliminary) messages Effective risk management can open doors to opportunity especially for the poor For this purpose, it is essential to move from ad hoc responses to risk toward systematic risk management To be successful, risk management should involve shared responsibility and action by households, the private sector, and public organizations 42

In conclusion The WDR 2014 will argue for systematic risk management for development by: Outlining benefits Providing frameworks and principles Identifying most relevant constraints Recommending best practices and policies tailored to specific country/system characteristics Calling for operationalization and action 43

WDR 2014 Managing Risk for Development Norman Loayza Berlin Workshop December 2012

Additional Slides

HOUSEHOLD Primary instance of support Sharing resources to care for the vulnerable: Young, old, ill Building resilience while taking development decisions 46

COMMUNITY Pooling idiosyncratic risks using informal networks Collective action - combining efforts and assets to confront common risks natural disasters crime and violence 47

ENTERPRISE SECTOR Absorbing and transforming economic shocks Helping stabilize people s income, employment, spending Doing so through innovation competition resource reallocation 48

FINANCIAL SYSTEM Providing financial risk management tools and services insurance credit Avoiding being a source of instability or systemic propagation of shocks 49

NATIONAL ECONOMY Providing macro stability Ensuring effective state resource mobilization for social protection public goods & services 50

GLOBAL COMMUNITY Providing global expertise and knowledge Facilitating international policy coordination Pooling international resources 51

The risk chain (I) Shocks / Trends An imposed risk derived from a negative shock Exposure Outcomes Resilience External Environment A Changing World Negative Shocks / Trends Internal Ex-ante Conditions Risk Mgt. Confront Risks Loss Ex-post Risk Mgt. Crisis/ Disaster 52

The risk chain (II) A voluntary risk taken on in response to a positive trend Shocks / Trends Exposure Outcomes Success Benefit External Environment A Changing World Shocks / Trends Internal Conditions Ex-ante Risk Mgt. Pursue Opportunity & Confront Risks Ex-post Risk Mgt. Resilience Loss Crisis/ Disaster 53

Basic risk management strategies Risk Management Strategies (Actions taken to reduce negative impacts of risk or enhance benefits ) Ex ante Risk management Ex post Risk management Risk mitigation (Reduce the potential impact if risk were to materialize Risk prevention/reduction (Reduce the probability of occurrence) Coping (Recover from the impact of risk once materialized) Market/informal/social insurance (risk pooling) Self insurance (risk retention) Self-protection (risk avoidance/reduction) Form and extent of coping actions depends on ex ante actions taken and availability of social and informal protection 54

Risks are diverse in origin, characteristics, outcomes Different tools to manage Origins of risk Voluntary or imposed? Origins based on gender, income level, geographies? Characteristics of shocks Idiosyncratic or covariate (systemic)? Slow or rapid onset? Rare or frequent? Different outcomes associated with risks Temporary or permanent? Localized or widespread? Impact based on age, gender, geography, income level? Stylized facts on risks, origins, characteristics, consequences 55

Timely Value added Shifting focus from crisis response to risk management many recent crises stemmed from mismanagement of risk, undermining progress toward MDGs Risk as intrinsic to development Risk not be avoided at all cost, but managed well to avoid large losses /crises Risk management can then be an instrument for development Holistic perspective Resilient development requires action by all the major social and economic actors and systems, and considering multiple risks together Integrated approach to risk management From shocks to exposure; from preparation to coping and crisis management (Preparation for crisis management and coping) within ex ante RM Balanced view of government and other support systems They can enhance but may also hinder people s efforts in managing risk Political economy, incentives, capacity Address to improve RM 56