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Myopia and (dis-)incentives - The political economy of managing risk

Jun Erik Rentschler's picture

The following post is a part of a series that discusses 'managing risk for development,' the theme of the World Bank’s upcoming World Development Report 2014.

It is an old and well known criticism of electoral politics: the conflict between short political mandates and long term objectives. To galvanize political support, policy makers not rarely resort to “benevolent” political measures, such as short-sighted tax reductions or infrastructure investments, which are often more beneficial to their own election polls than to their electorate. Such political myopia is alarmingly common, and stands in the way of effective policy making in the long term interest of people.
Risk management is one of the fields in which effective action tends to be impaired by political myopia. For instance, implementing comprehensive regulation in the financial sector, or imposing stringent environmental requirements on certain industries, would help managing the risks of financial or environmental crises. Similarly, the installation of early warning systems for tsunamis or hurricanes could provide decisive information for preparation and timely evacuation. 

However, such public risk management measures often fail to be implemented – partly because they often come at considerable upfront costs (e.g. installation costs of early warning systems, or job losses following the regulation of risky industries). Such costs are likely to be observed closely (and critically) by the public and political opposition – which may underestimate the risk of a contingency. Even when necessary resources for such measures are available, policy makers are often reluctant to devote them to risk management, since benefits are likely to materialize only long after the end of their mandates. Furthermore, benefits are difficult to be observed and recognized: For instance, successfully regulating the risks of oil extraction may simply result in an environmental catastrophe not happening 25 years down the road.

This non-observable quality also means that it is very difficult to monitor and measure good risk management and its results, and for policy makers to be held accountable for their risk related decisions. As a consequence, policy makers tend to not manage risk ex ante, but are biased towards less effective but more visible ex post action, i.e. only once a contingency has occurred. For instance, between 1980 and 2009, only 3.6% of disaster related development assistance was spent on disaster prevention and preparedness, whereas the rest was spent on post-disaster response and reconstruction (see the Sendai Report for details).

In addition, policy makers will bear in mind the political stakes of risk management measures, e.g. when regulating influential industries. The existence of powerful lobbies and interest groups, which naturally oppose the regulation of their industries, can prevent risk management measures even in the presence of strong scientific evidence (e.g. tobacco or financial regulation). This is not least due to opposing interests: stricter regulation in favor of managing risks may result in the loss of revenues or jobs in industries where risk management was previously suboptimal.

Despite such seemingly bleak incentives for bold action on risk management, the upcoming World Development Report 2014 on ‘Managing Risk for Development’ argues that such challenges of the political economy must and can be overcome.
In order to establish a systematic and integrated approach to coordinating and monitoring risk management, the creation of National Risk Boards could bring significant progress. The driving impulse for such an institutional arrangement may initiate from reformist political leaders, the international community, or also from the direct experience of a crisis, which may increase public awareness and support for risk management in its aftermath.

By mandating such a single oversight body with the assessment of risks, governments can coordinate policy measures across ministries and prioritize action. The UK and the Netherlands have conducted such National Risk Assessments for several years in order to prevent and plan for crises and emergencies, regardless of the nature and origin of the risk (such as natural, technological or terrorist risks). Such a systematic and clear definition of risks helps explicitly spelling out the need for risk management, and may deter policy makers from only addressing selected risks with the potential for visible short term benefits.

Using such risk assessments, national risk boards can also make progress in the assessment of the quality of risk management, by developing indicators that reward risk-sensitive policy making. Continuous risk monitoring and policy assessment can also help to ensure that risk management is consistent across time and changing cabinets. Only when the importance of effective forward looking risk management with long term time scales is fully and publically recognized, will policy makers devote resources to such measures – even with election polls in mind.
 

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