Taking Risks: The World Bank Way

World Bank economist Dr Norman Loayza says the world’s poorest people are being held back by a reluctance to take calculated risks with their life strategies

Norman Loayza is in Bangkok for less than 24 hours when we meet in a nondescript corner of this sprawling urban environment. The Peruvian national, who heads up the Development Economics Research Group at the World Bank, wants communities, corporations and governments to think seriously about risk. It’s a global message tailored for an Asian audience.  He is on a whistle-stop tour of the region, promoting the findings of the World Development report Managing Risk for Development.

A Harvard graduate and lead author of the report, Loayza pulls no punches. Risk is not to be avoided, it is to be managed, his opus concludes. “The consequences of mismanaged risks may destroy lives, assets, trust, and social stability. And it is often the poor who are hit the hardest,” says the study.

The report warns that as world economies return from the brink of disaster resulting from the financial crisis, the solution is “not to reject change” in order to avoid risk but to “prepare for the opportunities and risks that change entails”.

“Managing risks responsibly and effectively can save lives, avert economic damage, prevent development setbacks, and unleash opportunities. It has the potential to bring about security and a means of progress to people in developing countries and beyond,” says the study. Before he departs Thailand, a country no stranger to political and environmental risk and the resulting crises when it is poorly managed, he takes time out to go deeper into the issues with PublicAffairsAsia.

He concedes that he was “rather gloomy” when he started to research and draft the study. But the more his team dug into the issue, the “stronger connection between risk and opportunity became clear to me”.  “We conclude in the report that risk management can be a powerful tool for development. Number one it can save lives, for instance, in the case of natural disasters. Number two it can prevent crises and avert economic costs, such as in the case of the international financial crisis. It can unleash opportunities especially for people who feel secure in taking new risks.  If you take all three: saving lives in natural disasters; preventing crises; and, opening opportunities then you have the path to more prosperity and drive forward growth,” he contends.

Poor ‘not taking risks’

Loayza challenges the notion that under-developed nations are suffering because of excessive short-termism or over exposure to risky behaviour: either by citizens, corporations or domestic governments. “Many people think that in developing countries there is an excess of risk-taking but I think this is not the case. The truth is that many people, and many poor people, don’t take necessary risks. They prefer stagnant but stable life strategies because they feel insecure. Richer people take risks and institutions like banks they take risks, sometimes excessively, because they think, with good reason, that if they fail they will be rescued.”

He says that effective risk management can “help communities face shocks and recover quickly from the losses” and benefit from the upsides which occur when risks are taken.
While his report offers advice for all levels of society: from householders up to multilateral international institutions, he hones in on the work that national governments can do to assess and deal with the risks which, if badly managed, can send shockwaves through societies and economies.

Says Loayza: “For governments we provide a set of policy recommendations and these have to follow five guiding principles. The first guiding principle is that governments should not increase uncertainty and produce unnecessary risk – the do no harm principle if you like.  Secondly they should avoid imposing risks on others. Thirdly they should promote flexibility. Flexibility is the capacity to adjust to new events. If there is any area of society which is too rigid it is not going to adapt well to the challenges of the modern world. Public policies should be addressing those rigidities and improving flexibilities.

“Fourthly government should think about the long-run: they should pursue long-term policies. A key factor for effective risk management is that it is proactive and forward looking. Long- term preparation is key to providing institutional mechanisms that transcend political cycles. Fifthly, it is a harsh reality that many who find themselves in poverty find planning ahead very difficult. This is where governments can play a supportive role. Governments need to support vulnerable populations but do it in a way which encourages self reliance and following programmes which are sustainable over time.”

Looking to Asia, he fears a lack of cohesion between regional agencies and governments could hamper risk management when dealing with common natural disasters. “Asia is a very diverse region. But there are natural disasters that are common to many countries in the region. One of the recommendations in the report is to build enough infrastructure to deal with natural disasters, such as flooding or drought.”

“But equally as important is to provide insurance mechanisms that can pool this sort of risk – creating a system where countries cooperate with each other and provide insurance in case one of them suffers from a natural disaster.

The truth is that we cite East Asia as a region of good examples where important transformations in risk management have taken place, for example, in health related risks which have decreased quite substantially,” he adds.

Looking to the region’s economy he is confident that having learned harsh lessons when the Tiger economies came crashing down in 1997, the region is on a path of economic stability and sustainability. He says far reaching financial policy reform has put the region on solid ground. “Asia is much less vulnerable following the 1997 crisis. Many people thought that it was the end of run for the East Asian tigers. But countries of the region proved these people wrong. They were able to take the right measures very quickly afterwards and they recovered strongly. But every time the region is faced with a crisis it not only faces the crisis, but it implements reforms which make it less vulnerable to a similar situation in the future. These countries learn from their experiences: whereas some others don’t learn from their mistakes,” says Loayza.

Tackling risk
Loayza does not want government or society to avoid risk: he simply wants them to better manage it. We want risk management to be at the top of the agenda when strategic decisions about development are being taken. Risk management needs to be integrated. The silos need to broken down: where the health ministry is only dealing with health issues and the central bank is only dealing with monetary policy. To tackle interconnected risks, the World Bank is recommending that governments form National Risk Boards to drive the issue throughout corporations, civil society and through government agencies.

But as he concludes, Loayza turns back to the inherent balancing act he is pressing for. “We need to, on the one hand, diminish the risks that the banking institutions are taking by not bailing them out when they fail,” he says. “And at the same time, we need to encourage people, and especially poor people, to take necessary risks. To do this we need safety nets for the poor. Secondly, we need reforms which make the enterprise sector more flexible, more formal, and larger.”

Closing he sets out three final fundamental messages he wants Asia to take on board. “Number one: We must mainstream risk management into the development agenda – taking into account the risks and opportunities that countries face. We don’t want risk management to be seen as foreign to governments and institutions any more.  Number two: The goal is not to eliminate risk, but to manage it. Risk is necessary to pursue opportunities and that is, in fact, the way to grow.

Third, and finally, to be effective, risk management has to be integrated. It has to break out of the silo where a health ministry only deals with health issues or the finance ministry only deals with finance issues.”

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