An opportunity for reformA cyclical recovery in global economic growth masks structural weakness

Global Risks InsightsEconomic Risks

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GLOBAL RISKS INSIGHTS ECONOMIC RISKS

CONTENTS.

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High or low growth: both present cause for concern

Global economic growth is currently on the upswing. The International Monetary Fund (IMF) has raised its global GDP growth forecast to 3.5 percent for 2017 and 3.6 percent in 2018 after a disappointing 3.1 percent in 2016. Global trade is also showing improvement. But with underlying economies remaining structurally weak and vulnerable to the next downturn an improvement may be only a cyclical development. Nine years after the 2008 financial crisis investment rates in all but China remain relatively low. Productivity growth for advanced countries remains flat, well below the levels of the past two decades.

An opportunity for reform A cyclical recovery in global economic growth masks structural weakness

GLOBAL RISKS INSIGHTS ECONOMIC RISKS

In a current, positive growth environment, policymakers must seize the opportunity to bolster their economies and create a higher quality and more sustainable growth dynamic for the longer term.

Source: OECD, Consumption/Investment shown for OECD only. Recovery tracked from Q1 2008. http://www.oecd.org/eco/outlook/Will-risks-derail-the-modest-recovery-OECD-Interim-Economic-Outlook-March-2017-presentation.pdf.

Source: OECD, http://www.oecd.org/eco/outlook/Will-risks-derail-the-modest-recovery-OECD- Interim-Economic-Outlook-March-2017-presentation.pdf.

Labor productivity growth (%)

Consumption Investment

Source: OECD, http://www.oecd.org/eco/outlook/Will-risks-derail-the-modest-recovery-OECD-Interim-Economic-Outlook-March-2017-presentation.pdf

Consumption Investment

Pre-recession peak

140 -

130 -

120 -

110 -

100 -

90 -

10 2 3 4 5 6 7 8 9 10

Years after peak

- 140

- 130

- 120

- 110

- 100

- 90

10 2 3 4 5 6 7 8 9 10

Years after peak

Current recovery

Average previous 3 recoveries

% %

OECD

3.0 -

2.5 -

2.0 -

1.5 -

1.0 -

0.5 -

USA

1990-2000

2000-2007

2007-2015

Labor productivity growth (%)

Source: OECD, http://www.oecd.org/eco/outlook/Will-risks-derail-the-modest-recovery-OECD-Interim-Economic-Outlook-March-2017-presentation.pdf

Euro area Japan

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Productivity gains at the expense of jobs may fuel populism

Without underlying growth, it’s questionable whether the global economy can pay down excessive levels of outstanding debt, substantially raise wage levels, or generate better-quality jobs1. Since the financial crisis, companies have largely refrained from productivity-enhancing investment.

Lack of consumer buying power and excessive productive capacity in many emerging market economies has contributed to this reluctance. But rising employment rates are now lifting consumption, reducing economic slack, while business and consumer confidence have risen significantly in both developed and emerging economies. Ideally, this could translate into higher investment spending, which might extend the period of economic expansion.

But boosting productivity would in all likelihood include more automation increasing concerns about job security among less skilled and less educated workers. This could engender populist sentiment among the broader population, unless the workforce is equipped to face impending technological changes through education and other means.

Technology offers higher productivity, but it comes at a price

While parts of most jobs will be automated in future, jobs held by less skilled workers are particularly susceptible to being completely eliminated. Automation could provide the much-needed productivity boost – anywhere from 0.8 to 1.4 percent annually of increased global growth2 – and address concerns about a dwindling workforce in aging populations, particularly in advanced countries.

However, the transition to gaining the benefits technology offers poses a problem. In the past couple of decades, the vast majority of information and communications technology (ICT) productivity gains in the U.S. went to the top 20 percent of the population in terms of income. The wealthiest tier saw similar gains in other advanced economies.

The most vulnerable to technological change – including less-skilled workers – are typically those most ill-equipped to adapt. Many of these workers have spent many years at their jobs and lack skills needed to find employment in an environment where technology requires new types of expertise. However, it is no longer just those employed in ‘low-skilled’ jobs that are at risk. Increasingly, many mid-tier and even high-tier knowledge workers are facing similar concerns.

Educational institutions aren’t adequately preparing young people for these new job opportunities. In any case, this is no easy task given the rapid pace at which the job market is changing. But if the problem is not addressed, job insecurity among current and prospective jobholders could foster more populist sentiment. This is all the more worrying in an environment in which the public is losing faith in the government’s ability to tackle such issues.

GLOBAL RISKS INSIGHTS ECONOMIC RISKS

While parts of most jobs will be automated in future, jobs held by less skilled workers are particularly susceptible to being completely eliminated.

Source: Bloomberg, Eurostat

01 http://www.ilo.org/wcmsp5/groups/public/---dgreports/---dcomm/---publ/documents/publication/wcms_541211.pdf.

02 A Future That Works: Automation, Employment and Productivity,’ McKinsey Global Institute, January 201, p. 1, file:///C:/Users/mburrows/Downloads/MGI-A-future-that-works_Full-report%20(2).pdf.

Eurozone employment has been slow to recover, with structural challenges still evident

Source: Bloomberg, Eurostat

Eurozone youth unemployment rate (%, RHS)

25 -

20 -

15 -

May 2007 May 2008 May 2009 May 2010 May 2011 May 2012 May 2013 May 2014 May 2015 May 2016

%

Productivity and technological progress

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Long-term growth prospects are highly uncertain. Government, corporate and household debt levels are extremely high in most economies, while global trade is now under threat. Frustrations with the slow pace of recovery following the 2008 financial crisis have increased, and this has had repercussions.

The World Trade Organization (WTO) and Group of 20 (G-20) have tracked the growth of ‘trade restrictive measures’ since 20143. Among the concerns are that more trade restrictive measures could have a domino effect, undermining the entire global economy. With the spread of global value chains, increased trade barriers would hurt many domestic manufacturers as much as protect them. A scenario of mutual retaliation between U.S. and China, for example, would be particularly destructive.

All signs point to emerging economies continuing to be the biggest drivers of global growth, but their performance has been uneven. Without further structural changes, they will remain vulnerable to external developments. Absent higher growth, members of the emerging middle class in these countries, most of whom joined it in the past couple decades, could slip back below the poverty line again.

GLOBAL RISKS INSIGHTS ECONOMIC RISKS

Latin America in focus

Latin America is a case in point. In the first decade of 2000, growth outstripped the OECD average, generating a dramatic drop in the poverty rate and a huge number of people joining the middle class. But this largely came about due to booming growth in China, and buoyant commodity prices. No effort was taken to re-structure and reposition economies in anticipation of the day when these positive factors would fade. Today, two hundred million people, or one out of three in Latin America, is considered middle class.

If Latin American countries want to move forward and regain their former rapid pace of growth, they will need to substantially boost productivity. Yet, on the World Bank’s ease of doing business index, Latin America is falling further behind developed economies on every metric, from starting a business to getting credit and resolving insolvencies4.

Education levels in Latin America are still subpar compared with advanced economies. While the region has achieved universal access to primary education, enrollments remain low in pre-primary as well as secondary and tertiary schooling. Quality remains a problem.

The Latin American results from the 2016 Program for International Student Assessment

(PISA) exams show the region, on average, is 2.5 years of schooling behind the OECD average, with low rankings in science, math and reading. Some 46 percent of students in reading and 63 percent in math are not even at the most basic level5.

The OECD believes Latin American companies in the formal economy are three times more likely than South Asian firms and thirteen times more likely than Asia Pacific counterparts to ‘face serious operational problems due to shortage of human capital’.

Today, two hundred million people, or one out of three in Latin America, is considered middle class.

GDP

Global GDP reduction by a cumulative USD 35 trillion,

leading to

If China and the U.S., were to reduce trade, by 2035 it would

lead to:

20m additional people living in extreme poverty and

45m more people living on less than USD 3.10 per day

Source: Our World Transformed: Geopolitical Shocks and Risks, 2017

03 https://www.wto.org/english/news_e/news16_e/g20_wto_report_june16_e.pdf.

04 ‘Where Will Latin America’s Growth Come From?’ McKinsey Global Institute, April 2017, p. 12, file:///C:/Users/mburrows/Downloads/MGI-Discussion-paper-Where-will-Latin-Americas-growth-come-from-April-2017.pdf. January 2017, p. 1, file:///C:/Users/mburrows/Downloads/MGI-A-future-that-works_Full-report%20(2).pdf.

05 Matias Busso and Steven Ambrus, ‘Latin America, the Caribbean and PISA: The Long Road Ahead,’ IDB, December 13, 2016, https://blogs.iadb.org/ideasmatter/2016/12/13/latin-america-the-caribbean-and-pisa-the-long-road-ahead/.

06 Mario Pezzini and Andreas Schleicher, ‘Jobs in Latin America: where there’s a skill there’s a way,’ Guardian, January 30, 2015, https://www.theguardian.com/global-development/2015/jan/30/latin-america-jobs-employment-education.

Risks to global growth are increasingly interlinked

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GLOBAL RISKS INSIGHTS ECONOMIC RISKS

The actions taken in many countries to mitigate the consequences of the 2008 credit crisis, such as austerity budgets and ultra-loose monetary policy, combined with other societal and geopolitical risks and trends such as migration and increasing longevity, have contributed to a rise in nationalist and populist sentiment and a backlash against globalization.

This was reflected in the latest World Economic Forum’s Global Risks Report, which is in many instances based on the Global Risks Perception Survey.

The 2016 Survey results indicated that economic risks, while not among the top five risks ranked by impact and likelihood, strongly underpin the global risk landscape. Besides asking respondents to assess the impact and likelihood of individual risks, the survey asked them to consider the influences and interconnections that shape the risk landscape.

The economy is a paramount factor: respondents saw ‘growing income and wealth disparity’ as the trend most likely to determine global developments over the next 10 years.

When asked to identify interconnections between risks, the most frequently mentioned pairing was that of

Takeaways from the Global Risks Report 2017

Most important risk interconnections

01

Unemployment and underemployment.

Profound social instability.

02

Large-scale involuntary migration.

State collapse or crisis.

03

Failure of climate-change mitigation and adaption.

Water crises.

04

Failure of national governance.

Profound social instability.

05

Interstate conflict with regional consequences.

Large-scale involuntary migration.Source:

World Economic Forum Global Risks Perception Survey 2016.

Concerns about social stability

While low interest rates are traditionally considered to encourage consumption and investment, in a period of sustained low interest rates, debt burdens still could conceivably weigh on growth by reducing the incentive to pay down borrowing and make new investments. A sudden re-pricing of risk would also hurt especially high-deficit countries and could have significant economic and political consequences. Productivity growth has also been slow to recover from the financial crisis.

Structural unemployment remains high, with especially devastating consequences for young jobseekers. At the same time, many emerging markets are struggling to adapt to the end of a commodities super-cycle. Economic inequality and political polarization could heighten risks, increasing fears of social unrest. A response is urgently needed to address these problems, allowing people to benefit from technological change; better public support for the world’s growing middle class; and to find better ways to empower individuals at the local level without sacrificing the many benefits of globalization.

Source: OECD Quarterly National Accounts Dataset

The place of global recoveries

Source: OECD Quarterly National Accounts Dataset

140 -

130 -

120 -

110 -

100 -

90 -

The pace of global recoveries since 1975OECD real GDP; seasonally adjusted; rebased to 100 at trough of each slowdown

10 2 3 4 5 6 7 8 9 10

Number of quarters after trough

1975

11 12 13 14 15 16 17 18 19 20

1991

1982

2001

2009

%

For the full Global Risks Report, see:www.zurich.com/en/knowledge/articles/2017/01/global-risks-report-2017

View the top five trends that determine global developments

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GLOBAL RISKS INSIGHTS ECONOMIC RISKS

We used the Zurich Risk Room – a global risk analysis tool, designed to help illustrate the impact of multivariate risks on individual countries and regions to model an economic risks scenario. We chose to contrast the level of economic risk facing G7 countries compared with BRICS (Brazil, Russia, India China and South Africa), highlighting the countries that are better positioned to exploit economic changes.

We examined eight drivers of economic growth and plotted them against six drivers of economic and social stability.

The eight business risks comprised:

01 Exposure to a slowdown of Chinese economy 02 The extent of non-tariff barriers limiting the ability of imports to compete in the domestic market 03 Weighted average of all tariffs 04 The risk of needed fiscal austerity 05 The wastefulness of government spending 06 The domestic savings rate 07 The quality of labor, as measured by how well the country’s education system meets the needs of a competitive economy amongst others 08 R&D intensity

The six economic and political risks comprised:

01 Employment of working-age population 02 Inflation 03 Income inequality as measured by the ratio of income shares held by richest quintile versus poorest quintile 04 Social mobility 05 Financial market development as measured by availability and affordability of financial services amongst others 06 Safety net protection in event of job loss or disability

It is noteworthy that the BRICS show great risk, reversing what had been a stellar economic performance in the first 10 years of this millennium. Geopolitical risks, local failure to address governance issues, bribery and corruption scandals and the emerging markets foreign exchange vulnerability to rising U.S. interest rates have all played a role.

Brazil is expected to barely emerge from recession in 2017, after a debilitating political crisis and corruption scandals that are still playing out. With commodity prices falling to earth, Brazil needs to diversify its economy, and rebuild its manufacturing sector. South Africa also needs economic reform which the government of Jacob Zuma has been hesitant to initiate. Russia’s heavily energy-dependent economy has been hit by both relatively low oil prices (despite OPEC production cuts) and Western sanctions.

Among the Group of Seven countries, Italy is the only one with elevated risk. With the country facing a general election later this year, the economy is weighed down by accumulated government debt, equivalent to 130 percent of GDP, a struggling banking sector and near stagnant growth. For businesses operating in those markets, it is crucial to look after the risks connected with the recession and to proactively mitigate or hedge those.

LOW

RIS

K

HIG

H RISK

DRIVERS OF ECONOMIC GROWTH

HIGH

LOW

Economic and social stability

EURO

PE

FRANCE

NETH

ERLA

NDS

SWED

EN

GER

MA

NY

LUXE

MBO

URG

SWIT

ZERL

AND

IRELA

ND

DENM

ARK

NORWAY

FINLAND

AUSTRIA

BELGIUM

SPAIN

KOREA

SOU

TH

RUSSIA

ITALY

PORTUGAL

UNITED KINGDOM

UKRAINEAUSTRALIA-PACIFIC

NEW ZEALAND

AUSTRALIA

HONG

KONG

S.A.R.

U.A

.E.

JAPA

N

MA

LAYS

IA

LEBANON

PHILI

PPIN

ES

QAT

AR

TURK

EY

ISRA

EL

INDONES

IA

SAUDI A

RABIAINDIA

BAHRAINCHINA

KUWAIT

OMAN

PAKISTAN

SOUTH AMERICA

NORTH AMERICA

CANADA

UNITED STATES

MEXICO

PERU

COLOMBIA

ARGENTINABRA

ZIL

AFRIC

A

SOU

TH A

FRICA

VENEZU

ELA

ASIASINGAPORE

TAIW

ANTH

AILA

ND

CHILE

EGY

PTEconomic and social stability

After 10 years of stellar economic performance, BRICS show great risk.

View the economic growth and social stability chart

Insights from the Zurich Risk Room

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GLOBAL RISKS INSIGHTS ECONOMIC RISKS

Economic risks demand companies to adopt a holistic risk management approach.

Ways to mitigate risk

Companies should keep in mind that economic risks are likely going to drive global development in the next decade. Those risks are interrelated, so understanding connections is a vital step in managing them and avoiding surprises.

• Boards and risk managers must consider the potential impact of economic risks on their assets, operations including supply chains and people.

• Effective risk management requires companies to take into account the interdependencies between risks, and more than ever demands a truly holistic risk management approach.

Era of dynamic workforce

To counter the rising tide of populist sentiment, of which worries about job security play a major part, much more needs to be done.

The workforce must become more dynamic, more flexible and get the right education. Achieving this requires both public and private sectors to commit to life-long learning, training initiatives and efforts to make the job force more productive. Rapid aging in the biggest economic powers means a shrinking workforce, lower growth potential and lower tax revenues. Ensuring immigrants a place in workforce could help to mitigate that trend. Increasing the proportion of women in the labor force can also help to maintain workforce strength. Encouraging women to stay in jobs requires removing obstacles to their success. It’s unlikely that automation in and of itself will address inequality.

We have observed that productivity gains tend to go to the highly skilled and those who already have accumulated wealth. This trend will no doubt continue, if not deepen, as the pace of technological change accelerates.

To ensure parts of the populace are not left behind, educational and employment opportunities for the disadvantaged and displaced need to be given more emphasis.

Better coordination needed

Over the past decade, central banks had to bear too much of the burden of economic stimulus. It’s now time for fiscal and monetary policymakers to better coordinate their actions, so as to mitigate the impact of the next economic downturn.

Areas for public and private sector collaboration include:

working to foster greater solidarity and long-term thinking in market capitalism finding ways to revitalize global economic growth recognizing the importance of identity and inclusiveness in healthy political communities mitigating the risks and exploiting the opportunities of the ‘Fourth Industrial Revolution’ strengthening our systems of global cooperation

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Zurich Insurance Company Ltd Mythenquai 2 8002 Zurich Switzerland

173003593 (06/17) TCL

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