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Managing Risk for Development

Kaushik Basu's picture

Suppose a political leader implements a policy that results in an economic crisis in the sense that, had he not implemented the policy in this instance, the crisis would not have occurred. In such a situation we are inclined to come down heavily on the leader’s policy and castigate the decision. This would however be a mistake.

To see the mistake—as to see so many things in life—it is worth converting this to a more abstract problem. A (fair) dice is about to be rolled; but before that you have to choose between A and B. If you choose A and the dice outcome is 1 or 2, or you choose B and the dice outcome is 3, 4, 5 or 6, all will be well. Otherwise, there is a major food crisis. What should you do? A little thought makes it clear that you should choose B. If after that the dice shows up on 1, there will of course be a crisis, but that disastrous outcome would not render your decision wrong. Indeed, if you had to play the game again, you should make the same choice.

It is the existence of risk (in the above example the rolling of the dice) that drives the wedge between a good decision and a good outcome, thereby illustrating how risk complicates not only the making of policy but also the retrospective evaluation of policy. 

At the same time, risk permeates life and so there is no getting away from it. How we handle this ubiquitous feature of our existence can make a big difference to how we lead our lives. This is nowhere more evident than in crafting development policy. With this in mind, the theme of the World Development Report 2014 will be managing risk for development. This is an apt choice given the series of economic shocks, global crises and major natural disasters the planet has grappled with over the past four years.

The role that risk management plays in development and poverty reduction has not been studied adequately at the World Bank and maybe everywhere. Many people tend to focus on specific risks like financial crises, droughts or natural disasters when they arise, rather than on the process of risk management. The team working on the Report is starting out from the premise that responsible and efficient risk management is crucial not only to mitigate the effects of shocks and hazards but also to enable individuals, households, and entrepreneurs to pursue new opportunities for growth and prosperity.

It has to be kept in mind that risk management must not be equated with risk avoidance. Excessive risk avoidance can stunt growth and progress. It is arguable that if a person is old, a frequent traveler, and has never missed a flight, he or she has been going to the airport too early and has lost a lot of time. I should warn the reader that this does not mean that you should quickly miss a flight and set the record right. It simply highlights that, in an environment with risk, it is wrong to be single-minded in avoiding bad outcomes. The secret is to manage risk right and this is of course easier said than done.

Not surprisingly, it will be a challenging task to develop clear and implementable policy recommendations for a range of development actors, including international financial institutions, the donor community, governments, NGOs, and civil society.

Devising practical steps for improving risk management at the individual, family, enterprise, national and global levels is both worthy and essential, particularly when risks may lead to irreversible and long-term losses, but a single-minded avoidance of risk could, in turn, blight opportunities.

The production of the Report is still in the early stages, but the team has already undertaken an initial set of consultations both internally and externally, including with the Global Network of Civil Society Organizations for Disaster Reduction, the Red Cross and Red Crescent Societies, the Japan International Cooperation Agency; the OECD, the ILO, the World Economic Forum and various governments.

Norman Loayza, the report’s director, is gearing up to launch a website and open online consultations on the WDR in the New Year and readers of Let’s Talk Development should watch this space to hear an update from him soon.

Comments

Public policy outcomes can be measured in terms of Equity, Efficiency, Liberty and Security. Last two are not measured in numbers. A natural hedge : roll both the dice or use a fair dice.

Kaushik Basu wrote, "Suppose a political leader implements a policy that results in an economic crisis in the sense that, had he not implemented the policy in this instance, the crisis would not have occurred. In such a situation we are inclined to come down heavily on the leader’s policy and castigate the decision. This would however be a mistake." Is it not more accurate to say that it may be a mistake, depending on the information available to the leader in the first place? In the case of the financial crisis, the vast majority of macroeconomists failed to take account in their inferences from spending to prosperity the, to some, obvious fact that spending was to a highly significant extent financed by debt, not prosperity. Kaushik Basu wrote, "The role that risk management plays in development and poverty reduction has not been studied adequately at the World Bank and maybe everywhere. Many people tend to focus on specific risks like financial crises, droughts or natural disasters when they arise, rather than on the process of risk management." Yes - and many people warned economists before the financial crisis that there was something wrong with the concept of "growth". And there is still a risk from using spending statistics to infer prosperity for the "extremely poor" without looking at needs - which is why I have asked both you and Dr Ravallion questions that so far have, in Dr Ravallion's case after several inquiries, failed to yield answers: http://blogs.worldbank.org/developmenttalk/perspective-from-a-new-world-bank-chief-economist#comment-1698 http://blogs.worldbank.org/developmenttalk/perspective-from-a-new-world-bank-chief-economist#comment-1754 http://blogs.worldbank.org/developmenttalk/should-we-care-equally-about-poor-people-wherever-they-may-live#comment-3235

Submitted by Anonymous on
The idea behind risk is encouraging.A complication arises as how to make people convince for an effective risk management.people may be excited or obsessed about the possible negative outcome.

Submitted by Rajeev Gopal on
We are often so taken up by the issue of risk management that we do not stop to think about the need for taking risk. The need for risk management should arise only when risk exists and where it is possible to manage the risk. Risk exists either because of natural phenomena or due to human action. Leaving the natural phenomena aside, let us focus on risk created by human action. Take financial management or investing. Or for that matter driving on a road. The level of risk is determined largely by the attitude of the investor/ driver. Would the risk not be low if the driver is careful and avoids a rash driving style. Similarly would the risk not be low if the investor targets a moderate level of return - sticks to growth linked returns and avoids exotic, synthetic and speculative instruments with the sole objective of 'beating' the market and earning more than what can be legitimately expected. If the majority of investors were to adopt a 'reasonable return' approach, would the incidence of financial crises not be lower. However, instead of promoting a low risk approach we encourage risk taking by trying to come up with risk management strategies. If any risk management strategy had any ability to reduce risk there would not have been multiple crises in this world - either developing or developed. But most of us cannot avoid the attraction of studying and preaching on risk management. Whereby a simple mantra of 'live within your means' would suffice, we tend to develop all kinds of mathematical jargon around risk management with the hope of reducing risk. Indeed one of my disappointment with risk management is the lack of use of simple language. To me risk management is largely common sense. I believe there is no such thing as risk reduction or risk management. If you indulge in risky behavior, sooner or later the hand of chance would deal you a fatal blow. My belief is taking risk where it is not needed is foolish. e.g. driving or investing rashly. Risk management vs risk avoidance. I believe the focus should be risk avoidance. A majority of situations should be handled by risk avoidance and only a small fraction should need risk management. Let me also clarify that taking risk in exploring new territory is not foolish - e.g. exploring for new lands or going to the moon. Or creating a safer explosive. Or creating gadgets to reduce drudgery. These are legitimate ventures. Man is curious by nature and will indulge his curiosities. By risk avoidance I do not mean curbing your curiosity. Instead I would avoid risk driven by greed or carelessness, e.g. investing in junk bonds. There is no need for junk bonds to exist and by extension there should be no need for people to invest in junk bonds. This is risky behavior which cannot be mitigated. Indeed there cannot be risk mitigation for greed. Only avoiding the risky behavior can help. Coming to risk management for development. I am not sure what the risk in development is. Is it whether your development project will fail due to (i) natural phenomena - e.g. lack of rain, (ii) political action, e,g, an arab spring, or a coup, (iii) poor project design or implementation, e.g. lack of stakeholder buy-in. The first two are beyond anybody's control and the only risk mitigation available is to go step by step and diversify. The last one reflects a poor effort by the project developers and should not happen at all. But maybe they do. We are not perfect and there are numerous instances of poor project development and implementation. So perhaps risk management for development means how to plan and execute projects properly. How to get stakeholder buy in. How to allocate adequate resources for a smooth implementation. How to retain flexibility in project scope, funding and staffing. How to have responsive and proximate management structures which can respond quickly. I look forward to the 2014 WDR to understand this better. I also hope it focuses on specific projects, situations etc and less on generalities.

Submitted by Jimmy Janssens on
Risk assesment in the means of reducing the risks , probability and possible damages is a very effective way to decrease risks and accidents. However in industries where risk assessment is used daily for every non standard job or after every incident as corrective actions, these actions sometimes start living there own lives where people has to change without knowing the correct reason and for which purpose. Feedback is rarely requested and many items become obsolete or besides the point after a while. Many simple things become difficult . Therefore we should learn from failures of used risk assessment and make sure to review regularly after implementation whether it is still as effective from the beginning on.

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