If we’re lucky, 2010 could be a lousy year. If we’re unlucky, 2010 could be a disastrous year, worse than 2008, because there are potential nasty surprises lurking out there. Such surprises could precipitate another, even worse financial crisis, and dump us into a global depression, instead of the recession from which we are now emerging. I’m going to deal with the issue of the nasty surprises in a later blog, so just for the moment, I’m going to assume that none of them will happen, and the economic future will unfold about as it looks now. And, although I’m looking out to the year 2020, I’m going to start by looking at 2010 on its own before moving beyond there.

The Prospects for 2010

America is out of its recession, but I would hesitate to call what we have now a recovery. It’s true, U.S. GDP grew by a reported 3.5% in the third quarter of 2009, but that was, in many ways, misleading. In the first place, it was heavily influenced by government stimulus, especially the “cash for clunkers” program. Since government stimulus will be tapering off in 2010, and the car incentives are finished, this source of economic strength will be missing. But even more revealing, barely was the ink dry on the reports of 3.5% GDP growth when they were revised downwards to 2.8% – an unusually large and rapid downward revision.

To see what’s ahead for the U.S. economy, let’s start with public sentiment. One of my favorite indicators of economic strength is the frequency with which the word “recession” appears in the mainstream media (“MSM”). This indicator has been known and used for decades, but before the Internet, you had to be in the MSM to have the ability to perform this count. In 1995, I realized that I could do it myself using Googles’ news website, and since September of 1995, I’ve done just that every week, and then graphed the results. Here’s how this graph looks today (the X-axis has been inverted since “recession” is inherently a negative idea):

© Copyright, Richard Worzel, December 2009.

One of the interesting things about this indicator is the date when it said we felt the best about the world, which was July 30th, 2007. This was just five months before the indicator dropped suddenly at the beginning of 2008, indicating that concerns were rising. This subsided in the Spring of 2008, but then collapsed in earnest in October of last year – a trough from which we haven’t yet recovered. Clearly, we were all feeling fat, dumb, and happy in mid-2007, without realizing how bad the underlying fundamentals were. And the most important lesson to draw from this is that sentiment indicators are not good predictors of problems, only feelings.

Yet sentiment is important. It embodies what economists call the “animal spirits” of an economy, being the courage to go out and do things, like take risks to make and spend money, and the willingness to trust that the other side of a transaction can and will fulfill their part of an agreement. Without these feelings of courage and trust, people hunker down in a hole, don’t spend money, and the economy’s heartbeat stops, which pretty much describes what happened last year.

Now, looking at the chart again, we can see that although our “animal spirits” have recovered from the depths, we are nowhere near where we were at the beginning of 2008. We’ve climbed back, but seem stuck halfway – and that’s a pretty fair estimate of what I expect for 2010. The economy will grow – but slowly. Unemployment will stop exploding, but employment will be painfully slow in coming back. Indeed, employment typically is slow to return at the beginning of a recovery because business owners are still wary of potential problems, and because they can increase working hours, through additional shifts and overtime, without hiring additional staff. This increases productivity and profits without increasing risks – a good bet in perilous times, but tough on those out of work. So, the prospects for America’s economy in 2010 are weak, at best.

Despite this, the outlook for inflation is dismayingly bad. I consider the price of oil to be the bellwether of rising prices, because of its pivotal position in the global economy. The price of a barrel of oil dropped from $147 to $30, and has bounced back to over $70. Now, it’s true that $30 a barrel was clearly an overreaction by a market that was wondering if the world was coming to an end, but you still have to ask why it would bounce back so far and so fast. The answer, as it often is in this day and age is simple: China, India, Brazil, and the other Rapidly Developing Countries (RDC’s). They barely went into recession, or merely experienced growth slowdowns, which were over relatively quickly. As their economies bounced back, their thirst for oil began growing again. And when the developed country economies begin growing again, all of the bottlenecks that caused the price of oil to spurt upwards in 2006 & 2007 will come into play again, and the price of oil will, once again, spurt upwards, stoking the next inflation cycle. And because of the growing relative importance of the RDC’s in the global economy, we will all experience more inflation much earlier than we would normally expect in this economic cycle.

This same combination of RDC growth and developed world recovery will play out again and again beyond oil. Food will be one of the next places it will happen, followed by other commodities and resources. The net result is that we will start hearing about an indicator that went out of fashion in the 1980s: the “Misery Index.” The Misery Index is the unemployment rate plus the inflation rate, and reached an annual high of 20.76% in 1980[1]. For comparison, it reached a modern low in 1998 at 6.05%, and its post-World War II low was in 1953, when it was 3.74% If America’s unemployment rate sticks somewhere around 10%, which I expect it will, and inflation reaches 5%, which it might despite the weak U.S. economy, then the Misery Index will reach 15% – a level not seen since 1982 when Ronald Reagan was president. All of which is why I say that if we’re lucky, 2010 will be a lousy year.

Canada’s 2010 – Canada will have an uneven year, which is to say that some parts of Canada will do quite well, while others will continue to suffer. Most of the suffering will be done in Central Canada – Ontario & Quebec – because of their reliance on manufacturing, especially in cars, their overwhelming ties to the United States, and the strength of the Canadian dollar. All of these mean that the two former powerhouses of the Canadian confederation will now lag most of the rest of the country in recovery. Indeed, if the loonie continues to strengthen against the greenback, Central Canada could have an even worse year than the United States.

Meanwhile, those provinces that supply natural resources, particularly Alberta and Saskatchewan, and to a lesser extent B.C. and Newfoundland, will do much better. With oil strengthening, and food following, the two Prairie provinces will build on their previous strengths and outperform the rest of Canada, as well as the United States, and their strength could continue to boost the price of the loonie. The resource provinces will also increase their trade with the developing countries of the world, notably China. Indeed, I would suspect that we will see a return of corporate takeovers of Canadian resource companies that could cause the Toronto Stock Exchange to outperform most developed world counterparts in 2010.

All of this will add political friction between the new “have” and “have-not” provinces that will make life testy and interesting in Parliament in Ottawa.

RDCs – Meanwhile, the RDCs, again lead by China and India, but also including Brazil and to a lesser extent Mexico, Malaysia, and Indonesia, are bouncing back from a fairly traditional inventory-led recession or growth slowdown.

There is more to RDC growth than China. Everyone has heard of India, and India will continue to try to accelerate its growth. However, watch Brazil as well, which is becoming the next powerhouse after having settled its long-standing problems of political and economic stability. We will be hearing more and more about the giant emerging in South America.

China’s ambitions – One particularly important issue for the future is China’s pegging of its currency to the U.S. dollar, which means that it has effectively executed a competitive devaluation against the Euro, Yen, and other currencies while maintaining its undervalued status against the greenback. This will cause the U.S. trade deficit to continue to run unsustainably high, and will inflict even more damage on other developed country economies. This is not the behavior of a player concerned about its image in the world, or even in its own long-term enlightened self-interest, but it does accord with my beliefs about what motivates China.

I believe that China has two primary objectives that trump all other concerns; one immediate, and the other long-term. The immediate one is the Chin’s leaders are desperate need to keep economic growth high in order to keep employment growing. If they aren’t able to achieve at least 8% growth in real GDP per year, then by their own reckoning, unemployment will rise, and with it, social and political unrest. And, from what I’ve seen, China’s leaders are more concerned about hanging on to their political power – which means political stability – than anything else. The welfare of its trading partners pales into insignificance in comparison to this critical domestic need, especially when you consider that in 2007 – the last year of strong global growth – China experienced a reported (but unverified) 10,000 spontaneous demonstrations about economic and living conditions around the country. The Red Army may be large, and it may be strong, but it can’t be everywhere, so political instability scares China’s leaders like nothing else. Accordingly, if China’s economy needs exports for strong growth, then it will contrive to have exports at any cost, especially if someone else pays that cost. China is not the first country, or the only country to play the trade game entirely selfishly. Indeed, you could say they’ve stolen Japan’s playbook from the post-war era. But China is playing it very well, if cheating for narrow self-interest is your yardstick.

The second motivation is long-term: China wants to dominate the world, replacing America as the only superpower. This again is supposition on my part, but is, I think, pretty obvious. And if they want to supplant the U.S. as the only global superpower, than inflicting economic damage on your principal geopolitical competitors is not a bad long-term strategy, even if it costs you something in lost trade along the way. It reduces the amount of money your competitor has for military and diplomatic strength. It focuses their attention on domestic issues. And it creates friction between domestic political parties. All of these are helpful to a China that is eyeing the top spot, and would prefer to get there without military conflict.

Beyond 2010

If we assume, once again, that none of the terrible “what-if” scenarios happen, then what happens after 2010?

America’s economy will continue to recover, but more slowly than desirable, and more slowly than in earlier recessions. This was not a typical recession, but was precipitated by too much debt accumulated by consumers, state governments, and, ultimately, the U.S. federal government. It takes time to pay off debts and recover spending power after the excesses of the last 25 years, which is why this recovery will be so anemic. Moreover, with so much of the U.S. housing market still under water, with mortgages bigger than current property values, it will take a long time for home owners and mortgage lenders alike to recover from the scars. This means that 2011 and 2012 are likely to continue to be less than robust.

Beyond 2012, I expect that the U.S. economy, pulled along by the global economy, the Rapidly Developing Economies, and American ingenuity and grit, will begin to pick up speed. And unless some additional shocks or surprises occur, I would expect the economy to continue to grow, and prosperity to return, through the balance of the 2010′s. It will also be accompanied by persistent high inflation – perhaps not high by 1970s standards, but higher than we’ve been used to in the past 20 years or more. This may make it tempting, beyond 2012, for central banks, lead by the U.S. Federal Reserve Bank, to put on the brakes, raising interest rates significantly in order to slow inflation. However, higher interest rates will actually have relatively little effect, because this bout of inflation will be driven primarily by bottlenecks and shortages, particularly in oil production and food, as mentioned earlier. This is going to pose a real quandary for central banks: How can they temper inflation when it’s mostly caused by too little supply rather than by too much money? The only way to lower inflation in that kind of environment is to lower economic growth – and that won’t be very appealing to any central government after years of soft growth.

All told, then, this is going to be a fragile decade for America and her mature trading partners, and the potential for bad things to happen will remain high for quite some time.

RDC’s – The RDCs will continue to grow rapidly, boosting each other’s growth, and gradually pulling the rest of the global economy with them. They will be the principal drivers of the global economy this time around, not the U.S. The bigger question, and one worth watching carefully, is whether their consumers begin to increase their consumption, taking the place of consumption-happy Americans. And how the RDCs deal with the challenges of rising, and persistent, inflation will also tell a great deal about how mature their governments and central banks are.

Canada – Canada’s economy will continue to be uneven, with Ontario and Quebec lagging behind, and the resource economies moving forward with the prices of their resources. However, both Ontario and Quebec are committing significant resources to capture some of the new industrial strength of the green economy. This, along with the slowly improving automotive market, will gradually allow Central Canada to begin strengthening with the advent of the ‘teens of this decade. Meanwhile, low interest rates, kept in place to stimulate economic growth, may produce a bubble in real estate prices in Canada, especially in the major cities, that may threaten Canada’s stability. It would be ironic, indeed, if Canada dodged the bullet that knocked off the American economy in the financial crisis of 2008, only to get hit by it in the next economic cycle. And yet, that is, implicitly, what Mark Carney, the Governor of the Bank of Canada, has been warning for some time. As well, the leading edge of Canada’s baby boom will be entering their 70s by 2020, and that will lead to lower economic growth, and shortages of skilled labor in many areas of the economy. The next 10 years will be a decade of real potential combined with real challenges for Canada.

Europe – In theory, Europe should be the strongest region of economic growth in the developed world. Yet, it is going to struggle at least as much as America, if for different reasons. Britain’s housing market and mortgage market went through pretty much the same wringer as America, and it’s government ran persistent deficits through the fat years that leave it without much ammunition to face the challenges ahead. China has instituted what amounts to a competitive devaluation by pegging its currency to the U.S. dollar, which has been persistently weak compared to the Euro, and will make it harder for Europe to compete with China in world markets. But the clincher really is that Europe is old, and the labor forces of its member countries offer either no-growth or are shrinking. Since, simplistically, GDP growth is composed of labor force growth plus productivity growth, this means the either Europe must massively improve its productivity, or it is going to see its economic growth stagnate, and its share of global output shrink throughout the next 10 years.

Let me start by defining risk management as the process of asking the right questions about what might happen in the future, and then preparing the best plans you can to deal with events that might occur. Hence, if there’s a major pandemic, and if you’ve considered that possibility, have a plan prepared to deal with it, and the plan works reasonably well, then you have adequately managed that risk.

And yet, I very much doubt that any contingency plan, no matter how well you prepare it, will deal with everything that happens – you will still be caught by surprise in some regards. This is why you always need to do a “lessons learned” assessment after each crisis. Your task in risk management, though, is to both to be able to cope with problems as they arise, and to be prepared to change your plans when new, unexpected developments occur.

I’m going to approach risk management from a futurist’s viewpoint, not from the body of risk management literature, so my view will be different from the risk management texts that are out there.

And let me start by making three comments about risk management. First, the best kind of risk management is where you forestall problems rather than cure them. Hence, successfully promoting the use of condoms for safe sex is better than being prepared for a widespread outbreak of AIDS. Second, risk management can’t always allow you to stop problems from happening. You can’t stop a plane crash, because that’s out of your control, so the appropriate response then becomes containing the problems, keeping difficulties to a minimum, and producing the best possible corporate outcome in the most cost-effective manner. Hence, while you may not be able to stop a plane crash, you can make sure that you don’t allow too many key corporate leaders to fly in the same plane. And third, not all risks are negative. This last point is often not considered at all, or is considered to be outside the purview of risk managers, but I contend it is critically important to proper risk management.

Suppose, for instance, in-house research allows you to cut carbon emissions, reduce costs, and improve customer satisfaction (which, by the way, is not that far-fetched as it might sounds as it has been the focus of work I’ve done for number of clients). Or consider a significant increase in productivity, due to new technological tools. Does your organization have the awareness and ability to capture the benefits of such improvements, or will you waste the opportunity? I know that, for many groups, this has more to do with the responsibilities of senior management; my point is that not all the changes we face in future are negative, and managing positive outcomes can be just as important as managing negative ones – they just don’t get as much attention. I call this the “lottery effect”; if improperly managed, positive outcomes can be frittered away, as often happens when someone wins a lottery and blows all the money.

Three fundamental types of risk

Next, I believe there are three fundamental kinds of risks to be concerned about: Rapid onset, gradually developing, and unexpected.

Typically with rapid onset risk, you will have considered a catastrophic event, but when it happens, it’s still a shock because of the speed with which it occurs. Examples include SARS, a flu pandemic, a plane crash with senior management on board, or a major product defect that causes harm to customers or clients.

With a gradually developing risk, you can see it coming, but because it happens over a long period, no one day seems that urgent and you can usually justify deferring action. Examples include the rising level of financial stress due to an aging population, and the growing abuse of mortgage financing in the States from 2000 and before. Eventually such gradually developing situations reach a tipping point where they become a crisis. At that point, if you haven’t prepared for it, you can look awfully foolish. After all, after the fact, everyone saw it coming, so why didn’t you? This is precisely what happened with the financial panic of 2008.

Finally, let’s consider the unexpected. The unexpected risk is something that happens that you haven’t foreseen or considered, and to which you must respond. Among the more recent classic examples are the terrorist attacks of 9/11, the south-Asian tsunami of 2003, or a tornado hitting downtown Chicago.

The classic responses to these three kinds of risk also tend to vary, according to the type. The classic response to rapid onset risk is to deploy the contingency plans you’ve prepared, if they exist; otherwise people will treat it as they will an unexpected risk. With a gradually developing risk, the classic response is to ignore it, and hope for the best. With an unexpected risk, the classic response is panic.

You need to think through all three kinds of risk, and have plans to deal with them. Most of the effort devoted to risk management is spent on the first category, rapid onset risk, but you can be devastated by all three. It can be argued that the second category, gradually developing risk, actually falls more into the area of corporate management rather than risk management. That may or may not be appropriate, but however you define it, you still need to manage it. And, of course, managing the unexpected is, by definition, hard to do, but you can try to whittle down the types of things that are unexpected. I’ll return to this later.

Environmental scanning

Next, I’m going to discuss risk management in two parts. First, I’m going to survey the future, which is also called “environmental scanning,” and talk about some of the risks I see ahead of us at this time. Then, I’m going to talk about a particular approach to risk management. I’m also going to give you some tools to take home and use, and discuss how you can use these tools to improve your strategic foresight and develop appropriate contingency plans to cope with all three kinds of risk. So let’s start by talking about what risks are out there that we can see

Let’s start big, first with global health, and then the global economy.

We know we are experiencing a flu pandemic, but what we don’t know is how bad it will be. Although there have been deaths from the H1N1 strain, the number of deaths in the Southern Hemisphere was significantly lower than for the normally expected seasonal flues of recent years. However, this was also the pattern we experienced with the Spanish flu of 1918-20, so let’s review that pandemic. We don’t really know how bad it was, because there weren’t as accurate global statistics as there are today. However, the estimates I’ve read indicate that roughly one-third of the world’s population, or about 500 million people, caught Spanish flu, and between 10 and 20% of that third died from it. This death rate is between about 3 and 6 times normal, and would overwhelm our health care system.

Now transpose these sickness and death rates to your own staffs. Imagine having 12% of your staff sick at any one time, and having 5-10% of your staff die from a pandemic. What would that do to your company’s ability to operate? Probably decimate it, regardless of any contingency plans you’ve made – but the real issue becomes how badly you are affected, and how quickly and well you recover.

Of course, global pandemic plans aim to break the cycle of infection and transmission, so it’s quite possible that isolation and inoculation could keep these numbers down. But in your plans, this is the kind of rapid onset risk you need to be considering. So far, this kind of killer flu pandemic has been a once-a-century risk – but we’re due, and there is, now, a potentially nasty pandemic that we know is happening.

By comparison, there’s another pandemic that is also happening, but as a gradual onset risk, which is why you haven’t heard much about it. The rise of antibiotic-resistant bacteria represents a very real threat to public health, but its rise has been relatively slow and steady, so we’ve tended to ignore it. We know it’s happening, but there isn’t the same kind of outcry about it – it doesn’t get the media or political attention, even though it may ultimately claim more lives than the H1N1 flu.

Now let’s step back and consider a more complex probable risk. Suppose we get hit by a combination of events, such as the emergence of a hyperbug – resistant to all known antibiotics – while we are fighting the flu pandemic. This is not an improbable scenario: if health professionals are overworked and tired, or overwhelmed with patients even after triage, as might well happen in a flu pandemic, then they may get sloppy with protection procedures. Then, add to this the inevitable overcrowding of hospital facilities and there is a real increase in the probability of the emergence of a hyperbug, leading to substantially higher death rates, and a dramatic decrease in the effectiveness of health care facilities and practitioners. Have you thought about or planned for these kinds of combined risks?

The potential for nasty economic surprises

Now let’s turn to the economy. At this stage of the cycle, when the economy is starting to grow again, it’s easy to assume that things will continue to get better. That’s probably the case, but the economy and the global financial systems are still fragile, so we could be shocked by new nasty surprises that still might happen. I’d like to mention three possibilities, although there are others.

The first is that the American banks – and others – are now starting to register significant losses on commercial real estate loans. If things go badly, this could push more banks into insolvency, trigger a new run on banks, reigniting a financial crisis. These aren’t the same big, money-center banks, by and large, but a lack of confidence in some banks could easily spread throughout the system, as we saw last October.

The second is one we’ve all rather conveniently forgotten: toxic debt. It was lack of due diligence on the part of all the financial players in the States – and elsewhere – that led to the creation of all of the toxic, asset-backed securities in the first place, and there are trillions of dollars of this stuff still out there. At some point, someone has to figure out how to value these securities – which may be impossible – or write them off entirely. However they are dealt with, someone is going to have to take big losses – and taxpayers are almost certain to figure prominently in this group.

And the third, and potentially most dangerous, is a wild card: the possible insolvency of the government of the United States. Let me cover this with a quote from the blog I posted on my website in June, 2009, “Is America Too Big to Fail?”:

“… the U.S. federal government, unless it makes a Herculean effort to change direction, will fail. … With the U.S. already the biggest debtor nation in the world, with its biggest [external] creditor, China, already musing publicly about whether the U.S. government is capable of supporting the debt loads projected, and with market players musing about whether the U.S. government will lose its AAA credit rating, who is going to want to step up and buy more U.S. securities than have ever been sold before? Why would any sane investor want to take that kind of risk? … If the American government tries to sell all of this new debt, and doesn’t find enough takers, than the U.S. government won’t have enough money to pay the bills it is so freely running up. Its checks (or cheques) will start to bounce; it will be functionally bankrupt.”

Am I sure that these things will happen? No, and I clearly hope they don’t. But the difference between a crisis and an opportunity is foresight, and foresight implies taking a hard look at reality, whether you like it or not. And just as clearly, you need to have a Plan B ready to deal with these kinds of possible shocks. I would classify a possible default by the government of the United States as a gradual onset risk – and, as such, one that we all tend to ignore.

The aging of the population: another gradually developing risk

Now let’s turn to one aspect of demographics that is clearly defined and falls into the gradual onset category of risk: the aging of the population. Average per-capita health care costs tend to remain reasonably stable from about age 2 until around age 55 – but then they start rising almost exponentially. The baby boom – the biggest generation in history – is entering the high-rent district of health care. They were born between 1947 and 1967, so the leading edge is turning 62 this year. This is inevitably going to push up spending on health care, as will happen not only in America and Canada, but throughout the developed world.

Three things will happen as a result: First, program spending in every other area will have to be cut to allow for greater health care spending – which will make for uncomfortable choices, acrimonious cabinet meetings, and unhappy users of government services. Next, governments and corporate payers will try to cut back on the things that government- and corporate-sponsored health insurance covers (you can already see this happening), with the result that there will be pressure from unhappy voters to spend even more on health insurance. And finally, there is a high probability, in my view, that taxes will rise, and might rise significantly.

This is clearly an example of a gradual onset risk – and yet, it’s one that governments and the private sector alike are ignoring, but which will have significant, even dire, consequences. There is a very real risk that these problems could bankrupt not only American and Canadian national, state, and provincial governments, but the governments of developing (and rapidly aging) countries around the world as well. I’ll bet that very few organizations here have even considered this in their risk management planning

Unexpected risks

Now we come to unexpected risks.

There are positive risks ahead of us that are highly probable, but hard to anticipate. There are going to be immense new opportunities opening up to do things that have never been done before – but they are difficult to forecast precisely because we have no experience with them. For example, I worked on one of the first applications for cellphone licences in the early 1980s. Our group (which did not get a license) did a feasibility study of the potential demand for cellphones, and concluded that it had money-making potential because almost 8% of consumers said they were likely to use a cellphone. This was good enough to establish a business case, but our projections were wrong by almost a factor of 10. Neither we, nor anyone else, expected the extent of the market penetration of cellphones at a time when they cost over $2,000 each, and were so heavy that you had to store them in the trunk of your car. The reality turned out to be much better than we had projected – and could have bankrupted us if we had won the license, but had not had the necessary working capital to fill demand.

Next, have you considered the risk to your business of someone you don’t know applying technology in novel ways? Let me use as an example a prognostic test for cancer, for instance, that is about to be submitted to the Food & Drug Administration for approval. (And pause for disclosure: I’ve worked with this company, and hold shares in it, but it’s not publicly traded, so you couldn’t buy shares in it anyway.) This test has been produced by a young upstart of a company that applies patented, problem-solving computer software to come up with tests and treatments for cancer. The test promises to be significantly more effective than current techniques in telling patients who have had surgery for colorectal cancer whether they should have follow-on therapy or not.

Now suppose you were a pharmaceutical company that had just come up with a new drug to treat Stage III colorectal cancer, only to find that this young upstart could tell half of your market that they don’t need any additional cancer treatment, and a third of the remaining market that they can get results that are as good, or better, with a cheap, out-of-patent drug? Tufts University estimates that in 2006 it cost $1.2 billion to develop and market a new drug, and suddenly you find that market for your drug has just been scooped by a company offering two tests that cost about one-tenth of a course of your new drug. Where were the risk managers in your organization while this was happening?

Governance risks

Which leads, rather naturally, into governance, both corporate and public sector. I would suggest that a number of the things I’ve characterized as risk most organizations tend leave to senior management, particularly gradual onset risks, and positive risks. But what about management itself as a risk?

Looking back at last year’s financial collapse, it’s clear that the interests of the organization and the interests of management don’t always coincide. What happened in the U.S. financial system (and elsewhere) was that senior managers were chasing the prospect of enormous bonuses by pushing their organizations into taking unreasonable risks. This is a classic case of “heads I win, tails you lose”, because all that could happen to the executives would be that they were fired, whereas many corporations lost everything, either by being taken over (Bear Sterns, Merrill Lynch) or going to the wall (Lehman Brothers, AIG).

The problem is only partly recognizing these risks; the other part is how do you deal with someone to whom you report who is putting the corporation at risk? Especially if the Board of Directors is involved as well? I would suggest that you’ve already lost if you encounter a situation where you are trying to change the behavior of senior management that is pursuing personal gain at corporate expense. Instead, this is the kind of risk that, probably, can only be dealt with by anticipating it. In particular, you should seek to have corporate policies in place that identify such behavior, and provide an accepted means of blowing the whistle if it happens. Even then it’s dicey – which only heightens its importance.

Next let’s consider external governance risks. We’ve already talked about two potential government risks: rising taxes because of health care costs; and over-reaction because of privacy violations. I think you should also consider what happens when governments are faced with a world where they have less and less influence at a time when their constituents are feeling more and more anxious. You are likely to get governments that act irrationally, and look for scapegoats and whipping boys. And if your company happens to be handy for that purpose, it may be your turn in the barrel. I would strongly suggest that one of the risks you should consider preparing for is arbitrary government actions. You should watch for it, and have contingency plans in place for dealing with it. And remember; it’s easier to head off such developments than to undo them once they’ve become law. This also argues strongly for working together as a group, both here, and within your own industries, because an industry has more chance of influencing outcomes than a single company.

The balance of this article, dealing with techniques for risk management, will appear next week.