By Dr André Haughton
What is risk management and why is it relevant?
MANY PEOPLE around the world in developing countries, including Jamaica, are classified as poor or are very close to poverty due to circumstances.
Currently, more than 20 per cent of the population in developing countries live on just US$1.20 per day (broad measure of extreme poverty); more than 50 per cent live on just US$2.50 per day (extreme poverty in Latin America and the Caribbean) and more than 75 per cent of these live on less than US$4.00 per day.
These people face the risk of becoming even poorer if the country is hit by negative shocks. These risks, including joblosses, diseases, crime and violence, financial crises and natural disasters such as hurricanes, flood and earthquake must be managed properly if a country wants to develop sustainably.
The World Development Report 2014 focuses on effective risk management and opportunity for developing countries. The report explains that risks can be burdensome, but can provide opportunities if managed correctly - highlighting that good risk management can be a powerful tool for development.
What is the approach to good risk management?
The report explains five key elements in the process of risk management. First, a country must confront risk if they expect to find opportunities for development.
The risks associated with doing nothing is far worse than the risks associated with doing something. Second, to effectively overcome risks, countries must move away from the usual ad hoc unplanned approach to risk management and become proactive, systematic and incorporate integrated risk management in their approach.
The benefits of risk management far outweigh the costs. Third, simply identifying risk alone is not enough; private and public sector must also identify, prioritise and address the trade-off between obstacles and risk management. Fourth, some risks are beyond the individual, as such, risk management require collective action from all members of society.
Sharing risk with others can reduce the burden and help everybody to overcome the risk. And fifth, Government plays a vital role in creating an environment that is equipped to manage systematic risks and channel support to the most vulnerable people.
What are the components of good risk management?
Good risk management combines Jamaica's ability to prepare for risks with our ability to cope with risks after a shock, taking into consideration how the initial cost associated with preparation lead to benefits.
According to the World Development Report, strong risk management contains the following key components of the preparation phase: knowledge, acquiring protection, obtaining insurance and coping after the crisis has occurred.
For example, better knowledge will result in better allocation of resources after the shock. Countries must have the knowledge to understand shocks, internal and external conditions and potential outcomes, thus reducing uncertainty. Protection to reduce the size and probability of losses and increase the benefits, insurance to transfer resources across people and, over time, from good to bad states of nature.
And finally coping, which is the ability to recover from losses and make the most of benefits. There are, however, obstacles to effective risk management that a country must work hard to overcome. The index of risk preparation across countries show that Jamaica is among the countries that is least prepared to deal with the risks associated with negative external shocks.
How can Jamaica overcome these obstacles to risk management?
Lack of resources, lack of information, cognitive failures where people are unaware of risks, as well as behavioural failures are some of the main obstacles to effective risk management. Other obstacles out of the control of individuals include missing markets and failure to provide sufficient public goods.
Credit, insurance and jobs are often missing in developing countries, as well as public goods essential for risk management. Good risk management can be achieved by assessing the following; risk, incentive, information, behavioural and resource assessment which will facilitate good policy design.
The practical approach includes two important factors to effective risk management; first, Jamaica must be realistic in its approach and build a strong foundation or effective risk management overtime. Jamaica must take a holistic approach to overcome the obstacles to good risk management.
The household, the community, enterprises, the financial sector, the Government and the international community must play their role to help Jamaica overcome any obstacles to good risk management.
The Government must provide sufficient social protection, public goods and public policy. Civil society and the private sector must play their role, and the international community must provide additional resources, expertise, global rules and coordination.
Dr André Haughton is a lecturer in the Department of Economics on the Mona campus of the University of the West Indies. Follow him on twitter @DrAndreHaughton; or email email@example.com.