The World Development Report (WDR) 2014 focuses on the process of risk management, addressing these questions: why is risk management important for development, how should it be conducted, what obstacles prevent people and societies from conducting it effectively, and how can these obstacles be overcome? It suggests five principles of public action for better risk management:
- Do not generate uncertainty or unnecessary risks: The state’s policies and actions should strive to reduce risks and lessen uncertainty. At a minimum, the state should not worsen them. How or why would a government do that? First, through its policies, it may perpetuate social norms that discriminate against certain groups and make them more vulnerable. For example, state policies that promote gender inequality or ethnic favoritism harm, rather than help, household and community resilience. Second, the government may favor the group that supports it politically, whether a small elite or large constituency, against the legitimate interests of others. Third, an internally fragmented government that lacks organization and coordination may end up with ambivalent policies or ineffective implementation. Finally, the government may be guided by ideology, wishful thinking, or simple desperation when confronting difficult and genuine problems, instead of relying on measures based on good evidence and analysis.
- Provide the right incentives for people and institutions to do their own planning and preparation, while taking care not to impose risks or losses on others: The challenge for public policy is to create incentives for people to do their own risk planning and preparation, avoiding circumstances in which benefits are privately appropriated but losses are imposed on others. Consider financial bailouts. They are detrimental not only because they can produce a large fiscal burden but also because they provide incentives for excessive risk taking. Yet bailouts are sometimes necessary to prevent a systemic collapse of financial intermediation. In a very different realm, social protection can be criticized for not encouraging personal self-reliance and being an unsustainable burden to the state. The evidence, however, demonstrates that these problems can be avoided by a design that takes people’s incentives directly into account. In all cases, to manage risks effectively, two changes in people’s mindset related to individual and social responsibility are critical: moving from dependency to self-reliance, and from isolation to cooperation. Providing the right incentives can contribute in both regards.
- Keep a long-run perspective for risk management by building institutional mechanisms that transcend political cycles: A major challenge for public action is to establish institutional mechanisms that induce the state to keep a long-run perspective that outlasts volatile shifts in public opinion or political alliances. For instance, the state’s provision of education and health services is a large investment in risk preparation for families and communities that must be funded on a continuous and sustainable basis to succeed: that entails long-run planning. For the financial system to support risk management, it is essential to strike the right balance between inclusion and stability. This balance can be assessed only through comprehensive long-run planning. Counter-cyclical monetary and fiscal policies also require a long-run perspective, which allows them to manage the business cycle by using resources built over a prolonged time and in different scenarios. Best practice suggests targeting a long-run budget balance, as Chile, Colombia, and Norway, among others, are doing. Institutional mechanisms that transcend the political cycle— such as a national risk board and an independent fiscal council—can help maintain a long-run focus on risk management.
- Promote flexibility within a clear and predictable institutional framework: Flexibility in adjusting to new circumstances is essential to promoting resilience and making the most of opportunities. Prime examples include household migration in response to shifting economic trends, rural communities’ adaptation to climate change, and enterprise renewal in the face of technological and demand shocks. Flexibility should not imply arbitrary discretion or haphazard responses, however. A challenge for the state is to promote flexibility while preserving a sensible, transparent, and predictable institutional structure.
- Protect the vulnerable, while encouraging self-reliance and preserving fiscal sustainability: The harsh reality is that throughout the world, many people do not have the material resources and information necessary to confront the risks they face. The everyday struggle to eke out a living can make planning ahead hard for the poor. The challenge for the state is to protect the vulnerable while preserving fiscal sustainability—and encouraging self-reliance. For households that remain highly vulnerable to shocks, the state can provide safety nets to replace the costly coping mechanisms that undermine consumption, human capital, and productive assets. Safety nets are possible even in low-income countries, provided the support is targeted to vulnerable populations and is designed to incentivize work effort.