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"COMMITTED TO IMPROVING THE STATE OF THE WORLD Middle East@Risk A Global Risk Network Briefing in collaboration with the Gulf Research Center This work was prepared by the Global Risk Network of the World Economic Forum and the Gulf Research Center The views expressed in this publication do not necessarily reflect the views of the World Economic Forum. World Economic Forum 91-93 route de la Capite CH-1223 Cologny/Geneva Switzerland Tel.: +41 (0)22 869 1212 Fax: +41 (0)22 786 2744 E-mail: charles.emmerson@weforum.org www.weforum.org ©2007 World Economic Forum All rights reserved. No part of this publication may be reproduced or transmitted in any form or by any means, including photocopying and recording, or by any information storage and retrieval system. REF: 100507 Contents Foreword 4 Introduction: The Global Risk Outlook for the Middle East 5 Executive Summary: Global Asset Price Collapse 8 Executive Summary: Chinese Economic Hard Landing 10 Executive Summary: Retrenchment from Globalization 12 Executive Summary: Geopolitical and Geostrategic Instability 14 3 Foreword This briefing, in collaboration with the Gulf Research Center, builds on the global work undertaken by the Global Risk Network of the World Economic Forum. The Global Risk Network (GRN) is an unparalleled network of industry, risk and regional experts working with business leaders and policy-makers to: • Create a framework for assessing and prioritizing existing and emerging risks to global businesses over the short and long term • Alert key decision-makers to the impact these risks may have on their environments • Assist leaders in their reflection on how risks may be mitigated at the global, regional, industry and company levels • Transform these global risks into opportunities The GRN was set up in 2004 in response to concern over the rapidly changing nature of the global risk landscape, with six defining features raising particular concern in the business and policy environment. • What Are Global Risks? Our definition: non-business risks that affect business (i.e. not operational, project or financial risk) • that can be strategic, exogenous and systemic • that are highly interdependent (i.e. do not manifest in isolation) • that are characterized by uncertainty, sharp discontinuities, non-linearity (power law distributions) and lack of proportionality • that can’t be predicted (but can be managed) • • • • • Interconnectedness: Opportunities for contagion of risk across geographies and categories make them harder to manage, and their consequences harder to predict. Risks that occur in discrete geographies and with well-known proximate causes – such as Hurricane Katrina – can cause unpredictable results elsewhere. Asymmetry: Partly as a result of contagion, apparently small At the regional level, the Global Risk Network has undertaken events can have increasingly disproportionate effects. This work on regional risk exposures for World Economic Forum is particularly true of geopolitical risk. meetings in Turkey, India and Latin America. The purpose of this Time compression: Some risks can develop within the work has not been to create a final list of top risks for any region, decision cycle of decision-makers. The secondary impacts but to draw together an understanding of global risks with their of financial or geopolitical crises can begin to take effect impacts at the regional level, building up a wider picture of before businesses and governments have adequately global interdependence and a broader case for multistakeholder responded to the initial risk event, allowing a limited crisis thinking and action to manage and mitigate global risk. to expand into a systemic one. Just-in-time processes can leave little built-in resilience. Risk extension: Other risks are perceived to occur outside the decision cycle of decisionThe Correlation Matrix makers, giving rise to the “NIMTOF” (Not-in-MyTerm-of-Office) phenomenon, where mitigation Key: STRONGER costs are immediate and known, and mitigation CORRELATION benefits are long term and/or unclear. Climate change is a prime example of an extended risk. Current account Oil price shock deficit/ Fall in US$ Proliferation of WMD Noise: The profile of an emerging risk is rarely International terrorism clear before it occurs, with salient indicators Spread of liability regimes Pandemics hidden by surrounding “noise”. Loss of freshwater Rise of “infodemics”: The rapid and uncontrolled services Climate change spread of information – including inaccurate Breakdown of CII information from new, unreliable and uncontrollable Retrenchment from sources – can skew responses, generating globalization Coming information-driven impacts greater than those of fiscal crises the primary risk event. China economic Failed and failing states NatCat: Tropical storms Emergence of nanotech risks Asset prices/ excessive indebtedness Transnational crime and corruption Interstate and civil wars Developing world disease (HIV/AIDS, TB, malaria) NatCat: Inland flooding NatCat: Earthquakes Chronic disease in developed countries hard landing Middle East instability It is a central tenet of the work conducted by the Global Risk Network and its partners that global risks do not manifest themselves in isolation. This was apparent when the domino effects of Hurricane Katrina briefly shook the global system. More recently, the connections between two of the most pressing global issues for public policy and private enterprise – energy security and climate change – have reinforced the sense that many global risks share a common lineage. The correlation matrix below, drawn from the Global Risks 2007 report, shows expert views on correlation between a limited list of 23 core global risks. At the global level, the Global Risk Network has identified some 23 global risks to the international community over the next 10 years. It has advanced thinking on how to conceptualize their interaction and how to design strategies to mitigate them including the “5i” framework. The Global Risks 2007 report, released at the Annual Meeting 2007 in Davos, and other publications by the Global Risk Network, are available at www.weforum.org/en/initiatives/globalrisk. Source: World Economic Forum Global Risks 2007 4 Introduction: The Global Risk Outlook for the Middle East The Middle East is a focal point for global risk and its mitigation. This is particularly clear with geopolitical risk – with a high concentration of destabilizing geopolitical events having their origin in the wider Middle East region. But it is also true of two of the great intersecting global risks of the early 21st century – energy security and climate change – and of the risks relating to global economic imbalances: Middle Eastern external surpluses far exceed those of China. Some Middle Eastern economies (particularly those of the Gulf region) are heavily integrated into global trade and financial flows. Others, often the largest economies in the Middle East, have not yet overcome the dominance of the state sector and remain relatively unattractive to foreign investment. The vulnerabilities of these different economies – and of different political structures, geographies and religious compositions across the region – inevitably mean that global risks will play out differently. However, the Middle East shares a number of global risks, and a number of solutions to those global risks. The region is interconnected by webs of investment, of geopolitics of religious affiliation – as well as physical infrastructure of pipelines for oil and sources of water, an increasingly precious resource. Many of the possible mitigation measures to deal with the consequences of global risks stem from within the region. Indeed, many of the mitigation measures can only be managed and controlled by acting in frameworks of regional cooperation. This briefing does two things. First, it provides a brief overview of a range of 9 of the most salient of the 23 global risks extracted from Global Risks 2007, and outlines major trends as well as the impact on the Middle East region. Second, it provides a deep dive into four areas identified as being of particular interest: a global asset price collapse, a Chinese economic hard landing, retrenchment from globalization, and wider geopolitical and geostrategic instability in the Middle East. The intention is not to provide a prioritization of risks to the Middle East, but to highlight some of the common choices that the region faces and the common risks to prosperity and security, from the future of freshwater services to the future of the Middle Eastern currencies’ peg to the dollar. Raising awareness of common risks raises the bar for shared responsibility for action and opportunities that will derive from timely, proactive policies to prevent global risks overwhelming the Middle East region. 5 Middle East@Risk Matrix Risk Oil price shock/energy supply interruptions Description In the short term, a hydrocarbon price spike caused by geopolitical tension or terrorism – disruption to secure energy supply. In the longer term, a plateau of high hydrocarbon prices as the supply of products fails to keep up with demand, particularly from emerging markets – unsustainability of secure energy supply. Trends to watch Rapidly expanding demand, 80% driven by BRICS; fears that underinvestment in capacity (in the Middle East and elsewhere) will mean production shortfall. In gas, discussions of a possible producers’ agreement – including Iran, Russia and Qatar – remains complicated by internal differences and existing bilateral supply agreements. Increasing concentration of hydrocarbon resources driving geopolitical attempts to “lock in” future supplies. Debate over possible “peak oil”, including some doubts about official Middle Eastern reserves. Growing awareness of anthropogenic climate change. Models of future oil demand are subject to major uncertainties around China, including a possible decision to invest in nuclear power or coal-fired generation or any mandated improvement in vehicle emissions standards. Any movements towards effective hydrocarbon substitutes for transport. Impact on the Middle East Any short-term supply disruption – for example as the result of a terrorist attack – would undermine the economic foundations of current economic growth in the Middle East. Excess capacity needed to manage oil prices is low, and the resurgence of non-OPEC supply has led to some to question the ability of Middle East oil producers to achieve price targets. The growing concentration of future oil and gas supplies in the Middle East has strengthened NOCs compared to IOCs and may lead to renewed downstream NOC investments. But, in the long term, concentration of hydrocarbon resources in the Middle East may hasten the end of the oil era, as major Western countries cite geopolitical concerns. “The oil age will end long before the world runs out of oil.” Whether prices remain high or eventually fall back, economic diversification must remain a top priority. US current account deficit/fall in US$ Unsustainability of the US current account deficit, triggering a major fall in the US dollar, with impacts throughout the financial system. Global picture of high US current account deficit sustained by Asian savings and Middle Eastern petrodollars. US dollar remaining the global reserve currency; other currencies (e.g. the euro) playing an increased portfolio role or even acting as denominating currency for some commodities. Many Middle Eastern currencies are pegged to the US dollar and Middle Eastern investments are held in dollar-denominated assets. A sharp decline would import inflation, lead to questions about long-term viability of pegging to the dollar and denomination of oil prices in dollars. Chinese economic hard landing Sharp slowdown of China’s economy – potentially as a result of protectionism, internal political or economic difficulties. Debate around the long-term sustainability of China’s current growth given infrastructure constraints, environmental concerns and political risk. Evidence of some backlash against Chinese exports (in the form of anti-dumping duties); concerns about the stability of the Chinese financial system and the extent of potential defaults. See deep dive on Chinese economic hard landing below. Blow up in asset prices Collapse in house prices (e.g. in US and southern Europe) and other asset prices causing recession, with contagious effects globally. A correction in house prices is underway in the US, and in some European markets; questions over particularities of the US market compared to other markets. The rate of a US slowdown, and its wider global consequences are not yet known. Financial market volatility remains low and risk appetites high, despite minor correction in February 2007, but market complacency may not last the year. See deep dive on global asset price collapse below. Climate change Increased temperatures around the globe, with impacts on rainfall patterns. Increasing frequency of extreme weather events from man-made climate change with severe impacts on critical infrastructure, Consensus around climate change moving to a debate around impacts, possible mitigation or adaptation measures. Success or failure in involving major future emitters in any future post-Kyoto agreement over the next few years will likely determine the overall emissions pathway, and thus the extent of climate change. Besides indirect effects of reduced Gross World Product as a result of unmitigated climate change, the chief indirect impacts from climate change come from potential changes in rainfall patterns and the overall rise in temperatures expected across the region. 6 continued Risk Description agricultural yields and human lives. Trends to watch Leading indicators of the impacts of climate change in most affected regions, causing population movements, tension within countries and between countries. Any movements towards effective hydrocarbon substitutes for transport. Impact on the Middle East Agriculture in the Middle East is likely to become increasingly marginal; some inland regions may be no longer habitable; overall costs of living and doing business are likely to be increased with adaptation no longer a viable option. Climate change may encourage use of hydrocarbon substitutes, undermining the Middle East’s most valuable export. Loss of freshwater services Growing penury of freshwater supplies, partly as a result of climate change, partly as a result of increasing burden of overuse. The two main factors affecting future water scarcity in the Middle East are water use, and patterns of supply. Without greater public accountability, and without moves to reallocate water supplies, demand will increase as populations expand. If climate change patterns accelerate, freshwater service supplies are likely to become more erratic. MENA countries are already using more water than they receive each year; growing awareness of the need to manage freshwater throughout the cycle, as opposed to managing discrete portions of supply. World Bank suggests water available per person in the MENA region could fall by half by 2050. The Middle East is well experienced in managing water scarcity, but increased penury is likely to divert development funds to desalinization and water transport schemes, and promote geopolitical conflict between headwater and tributary countries. International terrorism Acts of terrorism (both internationally organized and inspired, and local) with the capacity to cause extensive physical damage, spread terror and undermine social cohesion. In addition to the spread of the Al Qaeda “franchise” – including to North Africa – there are fears Al Qaeda may be regaining organizational strength. This would imply the ability to carry out attacks beyond those which are locally planned and executed. Iraq has become a major recruiting and training ground for international terrorism; should the situation continue to deteriorate its role in international terrorism will most likely increase. The Middle East region suffers from international terrorism on multiple levels: as a direct victim of attacks, as a perceived centre of instability (reducing foreign investment appetites) and as a perceived source of terrorism in terms of personnel, training and ideological background (reducing opportunities for knowledge transfer and personnel exchange with Western countries). A number of Middle East regimes are specific targets of Al Qaeda as the “near enemy”. Proliferation of weapons of mass destruction Proliferation of weapons of mass destruction and the likelihood of their use, inviting major retaliation, furthering global insecurity and threatening globalization. Key short-term issue: the management of Iran’s alleged attempt to build a nuclear device. Key long-term issues: future of the Nuclear Non-Proliferation Treaty, expansion of the Proliferation Security Initiative, prevention of weapons’ capacity while allowing spread of nuclear power. Iran is several years away from being able to test a nuclear device, and denies that this is the purpose of enrichment. However, should international and regional pressure fail to bring greater transparency to Iran’s nuclear programme, several Middle Eastern countries will feel compelled to develop contingency plans, including boosting domestic understanding of nuclear technologies. The wider impact on the region would be disastrous, removing the prospect of a nuclear-free Middle East, potentially pushing Israel to declare nuclear status, and requiring massive funding which would otherwise have been spent on economic and social reform. Retrenchment from globalization A two-way risk: a protectionist impulse in developed countries and rising nationalism in developing countries (and evidence of global inequality), driving both to attempt to slow or reverse globalization. Failure to achieve agreement in discussions on world trade; growth of bilateral trade agreements. Increasing use of anti-dumping measures in the developed world; spread of nationalizations in key industries in developing countries. Rise of political populism in both the developed and developing world. See deep dive on retrenchment from globalization below. 7 Middle East@Risk COMMITTED TO IMPROVING THE STATE OF THE WORLD Executive Summary: Global Asset Price Collapse Will oil savings evaporate? How would an ensuing economic slowdown affect the economies of the Middle East? As the Global Risks 2007 report suggested, the financial markets are complacent as regards risk levels. Despite turbulence in the financial markets in February 2007, investors’ appetite for risk remains relatively high, volatility remains historically low, and market expectations seem to point to a benign economic scenario. Global market liquidity, including investments from Middle Eastern countries enjoying financial surpluses, may be one reason why investors remain confident. But risk factors around global asset prices and potential risks for the Middle East in particular cannot be ignored. In any future collapse, central bank capacity, diversification and the future of the US dollar will be key questions. Risk Prices for real estate, stocks, commodities and gold are all at, or near, historic highs, while global interest rates are low and bond markets are doing well. Historic correlations (such as those between high oil prices and falling equities, or high gold prices and inflationary pressures, rising interest rates, and lower bond and real estate prices) have weakened. There are two possible explanations: the market has fundamentally changed in nature, or many market participants have misread it. Many of these high asset prices ha..."

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