Reviewing the predictions made at the beginning of the year by the world’s leading analysis institutions on the most important risks facing the planet in 2020 is a saddening exercise in these times of Covid.
For example, in its widely read Global Risk Report, the World Economic Forum (the institution behind Davos) highlighted climate change as the main threat to the planet in 2020. In fact, of the 10 most likely risks, the first five were related to the environment. They were as follows:
Clearly, a global pandemic resulting in hundreds of thousands of deaths and the biggest economic crisis in recent history was not among the most likely risks…
There seems to be no doubt that no one saw this coming. This is what is known as a “black swan”: a metaphor from Lebanese philosopher Nassim Taleb that describes surprising and unexpected events, with major socioeconomic impacts, and which are, rationalized after the fact with the benefit of hindsight (making what no one predicted seem predictable or explainable).
The 2020 global risk map in the January MAPFRE Economics Outlook Report also did not include a global pandemic as one of the threats to growth. However, MAPFRE Economics has just published its quarterly update of the Outlook report, which reviews the main risks to the economy. They remain the same, although Covid now affects most of them.
If, in January, a series of risks could jeopardize the period of global economic growth experienced in the last decade, the threats to the economy could now cause the recovery from the recession to be L-shaped rather than U-shaped. Below, we review the main risks, according to MAPFRE Economics.
The Covid-19 pandemic, coupled with its effects on economic activity, may generate increased tension over governance in the world, especially in regions (emerging countries) where health systems are weaker and less prepared to deal with the emergency.
Moreover, in the eurozone, an insufficient response to the magnitude of the challenge could entail a before and after in terms of greater political fracturing and a strengthening of populist movements.
The disruption in cash flows could ultimately lead to solvency problems that are assumed on banks’ balance sheets, turning the Covid-19 crisis into a systemic crisis. In turn, in their attempts to stimulate the economy, governments are going to incur larger deficits, resulting in potential market stress.
As well as the heightened tension inherent to the current situation, the unstable relationship between oil producers in their attempt to rebalance their market shares has led to historically low oil prices.
Macro-financial adjustment in China
The Chinese economy is gradually returning to normal. However, the “world’s factory” is still dependent on the performance of the global economy and its consumption needs, and domestic consumption that continues to be in shock. The risk of a macro-financial adjustment in China remains equally probable and severe as it did.
In an increasingly interconnected world, the rapid spread of shocks (sparked locally) to the rest of the world once again underlines the vulnerability and nascent state of coordinated response mechanisms and the global institutional network through which they are handled. In this sense, the unexpected emergence of tail events and their necessary global coordination brings to the fore the urgent need to address climate risk. The response to this involves all economic agents, specifically the insurance sector due to its fundamental role covering risks. The sector needs to play a more prominent role and actively manage financial and non-financial risks arising from tail events, which are nevertheless becoming more frequent and are having a major impact and resulting in extremely high losses.
Economic policy in the US
The effort by central banks around the world dwarfs what was seen in the aftermath of the 2008 crisis, which is a key part of alleviating the global shock of the pandemic. In spite of this, it may not be enough and could open the door to highly unorthodox measures –such as deficit monetization in all its forms – being rolled out without considering current debt and deficit levels, laying the foundation for the return of high inflation in the future. Nevertheless, for the time being, the risk of a global systemic effect stemming from a greater misalignment in US economic policy seems to be less likely.