Making a market for acts of God

How is the damage of major global disasters paid for? And who by? Dr Rebecca Bednarek, Senior Lecturer in Management at Birkbeck, explores this in new book Making a Market for Acts of God, now available from Oxford University Press. 

acts-of-god

Catastrophic events appear to be increasing in both frequency and severity globally. The financial cost of their losses can be sudden and huge – but who pays the insurance bill for such massive events? Who paid for Hurricane Katrina, or 9/11, or the 2011 Tohuku earthquake?

It all comes from the ‘Reinsurance’ industry – a financial market that trades in the risk of major disasters. This means reinsurance is a crucial social and economic safety net that helps to mitigate some of the effects of disasters, both financially and in terms of allowing for a swifter rebuilding of people’s day-to-day lives following destruction or damage. Dr Rebecca Bednarek, Senior Lecturer in Management at Birkbeck uncovers the everyday realities of the reinsurance market in her book, Making a Market for Acts of God, co-authored with Professor Paula Jarzabiwski and Dr Paul Spee. They get to the bottom of how the risk of such disasters can be calculated and traded in a global market.

rebecca-bednarek_photoIn a recent interview for BBC Radio 4’s programme Thinking Allowed, Bednarek explains: ‘In the reinsurance industry, the increase and frequency of weather related events are put in the context of climate change. In addition, what is also happening is increased urbanisation; as cities get bigger, the losses and expenses of these events become more expensive, as more people are insured in localised settings.’ Further, increasingly, a natural disaster in one country could affect significant losses to supply chains in businesses around the world, and it is against this backdrop of increased globalisation that we must attach more significance to understanding the market of reinsurance.

The sheer scale of the claims means risk must be spread further in order to mitigate its effects – the attacks on the World Trade Centre in 2001 insured losses of $35.5 billion, for example, and for Hurricane Katrina in 2005 the payout was $46 billion. But as Bednarek says: ‘It’s not just the scale of this loss, it’s the fact that you couldn’t predict them. The reason reinsurers are able to themselves survive and to weather such large claims is because for each individual insurance deal, multiple reinsurers take a small part of this deal. No one reinsurer is exposed themselves to a single risk.’ The book also explains how long-term trust-based relationships between insurers and reinsurers are crucial to enabling and stabilising capital flows before and following these large-scale events. These relationships also enable reinsurers to build up deep contextual knowledge of specific risks; something which remains crucial in informing their judgement about risk even as they also use highly technical vendor models and actuarial techniques.

acts-of-god-book-cover

Bednarek and her co-authors shadowed underwriters from various different countries for over three years, gathering ethnographic observations from reinsurers in Bermuda, Lloyd’s of London, Continental Europe and South East Asia, studying their trading activities across many disaster situations.

There may be some developments in the reinsurance industry which could cause future problems, however. Bednarek says: ‘What we found was a whole milieu of long-standing social practices that had ensured that this industry had worked’ and provided capital to underpin large scale catastrophes for centuries. However towards the end of their period of engagement, the researchers began to observe ‘a period of rapid change; things like collatorised forms of finance, different kinds of deals that were changing the industry in certain ways. We wonder what these changes might do to some of these long existing practices that we identified as integral to this market and how it works.’

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What does the retreat of public research mean for welfare and innovation?

This article was written by Professor Daniele Archibugi and Dr  Andrea Filippetti, from Birkbeck’s Centre for Innovation Management Research

research-and-developmentAn increasing proportion of knowledge is generated in the private sector, rather than in public research institutions like universities.  For many, this is cause for concern; public research and private research differ economically in terms of public access, potential for future technological innovations and in the criteria of resource allocation. Does it matter whether research is conducted by  private business rather than in universities or government research centres? And will the retreat of public research have negative effects on welfare and innovation?

These are just two of the questions we considered in our recent research . While science and innovation policy in the last decades has focused on exploring the relevance of the interconnections between public and business players in enhancing knowledge-based societies, we argue that a major trend has been ignored: both the quota of public Research and Development (R&D) and its share over the total R&D investment has shrunk in most OECD countries.

The shift from public R&D to business R&D

The evidence for a shift in R&D is reflected in the most visible and measurable component of knowledge creation –  the resources allocated to R&D. In most OECD countries a significant shift in the effort to finance public R&D has occurred: as shown in the tables below, from 1981 to 2013 the share of public-financed R&D to GDP has been reduced from 0.82 per cent to 0.67 per cent. By contrast, the industry-financed R&D has increased from 0.96 per cent of GDP in 1981 to 1.44 per cent in 2013.

Gross R&D (GERD) expenditure as a percentage of GDP by source of funds (G-7 countries plus South Korea and OECD average), rate of change 1981-2013

Industry-financed GERD as a percentage of GDP Government-financed GERD as a percentage of GDP
rate of change 1981-2013 rate of change 1981-2013
Canada 53.06% -6.56%
France 63.16% -21.21%
Germany 38.81% -13.27%
Italy 33.33% 38.46%
Japan 85.82% 15.38%
South Korea* 86.90% 126.19%
United Kingdom -19.15% -59.26%
United States 48.21% -29.63%
OECD – Total 50.00% -18.29%

Source: OECD Main Science and Technology Indicators (MSTI).

*  Data for South Korea refer to 1995 instead of 1981.

 

Table 2 – Percentage of Gross R&D (GERD) expenditure by source of funds (G-7 countries plus South Korea countries and OECD average)

 

Percentage of GERD financed by industry Percentage of GERD financed by government
year 1981 2013 rate of change 1981 2013 rate of change
Canada 40.77 46.45 13.93% 50.61 34.86 -31.12%
France 40.92 55.38 35.34% 53.4 34.97 -34.51%
Germany 56.85 65.21 14.71% 41.79 29.78 -28.74%
Italy 50.08 44.29 -11.56% 47.21 42.55 -9.87%
Japan 67.71 75.48 11.48% 24.91 17.30 -30.55%
South Korea* 76.26 75.68 -0.76% 19.04 22.83 19.91%
United Kingdom 42.05 46.55 (70)** 10.70% 48.1 26.99 -43.89%
United States 49.41 60.85 23.15% 47.8 27.75 -41.95%
OECD – Total 51.64 60.76 17.66% 44.19 28.28 -36.00%

Source: OECD Main Science and Technology Indicators (MSTI). Data for South Korea refer to 1995 instead of 1981; the sum of the shares does not add up to 100% since there are other minor sources that are not considered, namely “other national sources” and “abroad”.

* Data for South Korea refer to 1995 instead of 1981.

** In the UK a significant higher proportion of R&D funding comes from overseas. When this is taken into account the share of private-funded R&D stands at 70% (Economic Insight, 2015, p. 7)

 

This data also indicates significant differences across countries. Japan and South Korea exhibit a virtuous trend where both  business and  government have increased their R&D expenditure; in South Korea, particularly, government expenditure increase has been spectacular. In the US, the UK, Canada, France and Germany, by contrast, we see simultaneously the growth of industry-financed R&D and  the decline of government-financed R&D.

Beyond the knowledge-as-a-public-good view

The current privatisation of research activity and knowledge (which is often praised) can have major consequences on innovation and, ultimately, on long-term economic growth and social welfare. But why is the threat to knowledge largely ignored or under-estimated?  We believe that it is due to an unclear understanding of the economic characteristics of knowledge. Historically, knowledge has been considered to be a public good; Nobel Prize winner in Economics, Kenneth Arrow, is cited arguing that knowledge is costly to produce but could be disseminated as information at zero or very low costs. While this view recurs frequently in literature, and is repeated by another authoritative Nobel Prize winner, Joseph Stiglitz, a great body of research has demonstrated that knowledge has both public and private components.

Public-generated knowledge and private-generated knowledge have different economic characteristics, which will shape future knowledge-creation and innovation. The way in which knowledge production is funded – public or business – matters for subsequent application for innovation, particularly in:

  1. Resources allocation
  2. Excludability in consumption
  3. Excludability in production
  Private-generated knowledge Public-generated knowledge
A.

 

Resources allocated through market mechanism.

The main purpose is to contribute to profits though knowledge-based products, services and processes.

Resources allocated through political process.

The main purpose is to contribute to the advancement of knowledge and social welfare.

B. Excludability in consumption pursued through active strategies such as industrial secrecy and proprietary forms of intellectual property. Non-excludability in consumption implemented through technology transfer policies and full disclosure (e.g. open science and non-proprietary forms of intellectual property).
C. Excludability in production associated to firm-specific technical knowledge and tacit knowledge. Non-excludability in production actively sought reducing tacit knowledge.

Our research suggests that, up until now, little attention has been given to the major shift from public to private consequences. We are calling for a change: while the long-term consequences of this shift have not yet been discussed at length, they have the potential to be extremely relevant to long-term technological opportunities, the role of major scientific breakthroughs, and vital knowledge exchange from basic research in the public sector.

Further reading:

  • Archibugi, D. and Filippetti, A. (2016) ‘The Retreat of Public Research and Its Adverse Consequences on Innovation’. CIMR Research Working Paper Series Working Paper No. 31.
  • Archibugi, D. and Filippetti, A. (2015) The Handbook of Global Science, Technology, and Innovation, John Wiley & Sons.
  • Mazzucato, M., 2013. The Entrepreneurial State: Debunking Public vs. Private Sector Myths. Anthem Press, London.
  • I.T., 2015. The Future Postponed. Why Declining Investment in Basic Research Threatens a U.S. Innovation Deficit. M.I.T. Washington Office, Washington D.C.

Further information:

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Peace-making in Colombia beyond the ratification of the peace agreement: political or market solutions to peace-making?

This post was contributed by Dr Olivier Sibai, lecturer in marketing in Birkbeck’s Department of Management. Dr Sibai recently published a paper entitled ‘Marketing as a Means to Transformative Social Conflict Resolution: Lessons from Transitioning War Economies and the Colombian Coffee Marketing System‘ in the Journal of Public Policy and Marketing

Colombian peace agreement: is it really the end of the longest civil war?

After four years of negotiations, the Colombian government and the representatives of the FARC signed a historical peace deal this summer. The deal was ratified by the house of representative on the 30th November, officially ending 52 years of a civil war which has left up to 250 000 people dead and over 5 million people displaced. The peace deal was hailed by the international community as a major achievement. High Commissioner for Peace Sergio Jaramillo described it as a miracle and the country’s President, Juan Manuel Santos, received the Nobel Peace Prize for his role.

While the peace agreement is clearly a great achievement, voices are already raising concerns about the risks of ex-fighters joining criminal gangs. Clearly, the agreement is only the first step of a long peace-building process. As long standing civil war deeply changed Colombian society, peace-building will be a challenging process, necessitating the overcoming of many hurdles over many years.

Peace-making: a political challenge with a political solution?

Peace-making in Colombia is clearly a political challenge. Civil wars developed because, 50 years ago, the state was dysfunctional to the extent that it failed to provide certain public goods required for societal well-being. In particular, security manifested as physical safety, wealth, and welfare was limited to small segments of society – typically affiliated with the ruling party or class. In the wake of this situation, rebel parties emerged, fighting the state to implement a different political order.

Peace-making, therefore, typically involves achieving three objectives: restoring the ability of the state to provide public good,  undermining the ability of the rebel parties to challenge the state through war-making, and facilitating reintegration of the actors actively engaged in the war in a state-centered society. The peace agreement ratified in Colombia addresses those three political issues through political solutions. The Colombian state will redistribute land and invest in rural development, set up of a transitional justice system to judge and formally reintegrate the former rebels, and guarantee the FARC a place in democratic debates as a political party. International political organisations will also be involved, with, for example, the United Nations overlooking disarmament in the coming months. Civil society is already contributing to peace-making, facilitating community dialogue and communicating the benefits of citizenship and law-obedience within sensitive communities.

Peace-making: a market problem – with political or market-based solutions?

While political issues must undoubtedly lead the peace-making process, markets will also necessarily play a significant role in turning the peace-making initiative into a long-term success or a failure. As the civil war continued, the Colombian economy transformed into a war economy – an economic system adapted to the context of violent conflicts and functioning largely outside the rule of law. As the war economy itself continued, it stabilized itself as the new economic order, making it difficult to return to a peace economy. The markets of the war economy became institutionalized and business actors became dependent on the continuation of war to sustain their livelihood, producing short-term economic interest in perpetuating the war economy. The actors of the combat market accumulate their wealth from trade activities that directly fund the war (e.g. trade of money, arms, equipment, and fuel; taxation of licit and illicit economic activities). The actors of the shadow markets accumulate theirs from lucrative entrepreneurial activities on the margin of it (e.g. drug trafficking, smuggling, mass extraction of natural resources, currency exchange, and manipulation of aid resources). The actors of the coping markets (e.g. wage labor, petty trade) depend on the combat and shadow markets to eke out a living and reimburse their loans.

As business actors are embedded in the war economy, they are often viewed as a significant force working against peace-making. Typical approaches to fostering the transition from a war economy to a peace economy are therefore political, involving policies and interventions aimed at controlling market actors. The peace agreement for example foresees the states collaborating with the international community to crack down on narco-traffickers.

Yet, in the past 15 years, governmental institutions in countries afflicted by civil wars have been criticized as kleptocracies manipulated by elites embedded in the war economy to retain power and wealth. Markets, by contrast, have increasingly been recognized as including the potential to be the pro-social forces contributing to peace-making in such contexts, promoting cooperation, inclusion, security, social justice, and sustainable prosperity. Some have argued that business people have more interest in building a deeper peace than transitory international peacebuilding officials as they have a long-term personal investment in the country. Others have depicted business sites, such as plantations or large mines which remained “islands of civility” in times of war, as representing spaces in which trust and hope can redevelop in post-war periods.

Envisioning market-based solutions to peace-making

If market-based solutions can complement political solutions to peace-making in Colombia, we still need to understand how markets can contribute to stabilizing Colombia into peace rather than destabilize it back into war. And today, we still know very little about that.
My colleagues and I argue that, for markets to contribute to transforming the war economy into a peace economy, marketers need to shift their perspective. They need to view themselves not solely as economic agents guided by profit but as policy agents or corporate diplomats, equally interested in promoting social wellbeing through the market. From this perspective they must design peace-making markets rather than just design marketing tactics in existing war markets.

Now, what would a peace-making market look like? To get a first picture of this, we investigated the fair-trade coffee market system in the Colombian civil war. Overall our analysis shows that promoting individual empowerment, communication, community building, and regulation within markets represented useful anchors for marketers to design a peace-making markets, contributing altogether to legitimizing the government as a provider of public good, weakening rebel forces and helping market actors from the war economy to transition to a peace economy. Let us look at each anchor in turn.

  • First, the Colombian fair-trade coffee market system has empowered individual actors from the shadow markets engaged in illegal entrepreneurial activities on the margin of the war, providing them with the necessary resources and capabilities to reintegrate into the peace economy. For example, it has given farmers a viable “way out” of cocaine production.
  • Second, it has fostered the development of resourceful communities that incentivize actors from the coping markets, struggling to eke a living, to embrace the peace economy. For example, fair-trade coffee certification came along with training, increasing poor farming communities’ knowledge and expertise and the provision of education and health care for communities.
  • Third, the marketing system promoted communication between/among market actors and government bodies, enhancing the legitimacy of the state. For example, governmental methods to eradicate cocaine fields which damaged crops pitted the government against coffee farmers suffering from it, breaking ties between them. The democratic requirements of decision-making in fair trade coffee cooperatives motivated negotiations with the governments which successfully led to developing less destructive ways of eradicating cocaine plantations, relegitimizing governmental activities.
  • Finally, the fair trade coffee marketing system promoted the development of self-imposed market regulations that promote the view that prosperity can be attained through the peace economy. Governmental support of such regulations further legitimized the state as a provider of public good.

We do not contend that the anchors identified will necessary be the same in different contexts as there is no one-size-fits-all approach to peace-making. We do not contend either that market-based solutions to peace-making are alternatives to political solutions to peace-making. However, they represent a useful and necessary complementary approach. Markets will play an important role in the actual long-term pacification of Colombia and it seems unlikely that the war economy will transition in a peace economy without peace-making initiatives from market actors themselves. It is therefore essential that the Colombian government and the international communities consider carefully how they can promote and leverage market-based peace-making initiatives when working towards peace-making.

 

Further information:

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Rio 2016: Predicting Success

This post was contributed by James Fisk, graduate administrator at the School of Business, Economics and Informatics. This article relates to new a new study by Professor Klaus Nielsen, of Birkbeck’s Sport Business Centre and Department of Management. Prof Nielsen’s study uses novel measures to predict countries’ success in the approaching Rio 2016 Summer Olympic Games.

A hand with the Brazilian logo and the five Olympic ringsWith the opening ceremony of the 2016 Olympic games due to take place in a few days (6th August, to be precise) athletes throughout the world will be making their final preparations for the biggest sporting event of their lives.  It won’t just be anxious athletes arriving in Rio de Janeiro this week; the international press, hopeful fans and governments will all be alighting for the competition, whose roots famously stretch back to antiquity. The Olympic Games appear as a focal point not just for athletes, but also for governments throughout the world, for whom huge investments have been made in the pursuit of the coveted Gold medals. So, who will come out on top? Fortunately for us, Birkbeck’s Dr Klaus Nielsen, Professor of Institutional Economics, has written a paper that should give us a good idea. Using a combination of results from recent world championships in Olympic sport disciplines, world rankings, taking into account banned or absent athletes and historical comparisons, Dr Nielsen has predicted the winners and losers of the forthcoming tournament.

The Top Three

The top three may not come as a huge surprise to many, they are: the United States of America, China and Russia.  However, it’s not all static at the top, as Dr Nielsen’s paper predicts the overall medal share for the three giants to reduce from 30% in 2012, down to 25% for 2016. A reduced share of the medals for Russia are a direct consequence of many of its athletes being banned or suspended, particularly in disciplines for which Russia has traditionally been dominant, such as weightlifting. The USA, meanwhile, face reductions in their predicted tally following a disappointing showing from their Track and Field team at last year’s world championships, although overall, the USA is still predicted to come out on top.  China are also set to see their tally drop from 2012, from 88 medals to 83, with Dr Nielsen citing a lack of diversification in the sports they actively compete in. So, with the big three seeing a 5% drop in success shared among them, where will the extra medals go?

Great Britain

Four years after successfully hosting the tournament, in which they won 65 medals, Great Britain return with momentum. Although funding has not dropped below the level it received in the build up to London 2012, the ambitious previous target of becoming the first nation to win more medals in the tournament immediately after hosting, has recently been replaced with a more modest one of winning at least 48 medals – which is more than its hitherto most successful overseas Games in Beijing 2008. Professor Nielsen believes that this target will be achieved in Rio. Recent performances at world championships suggest that a figure of 51 medals is likely. Great Britain is predicted to end up as the fourth best nation so although the top three look set for diminished returns, Great Britain are not poised to use this to their advantage and interfere with the dominant triumvirate.

The beautiful coastline of Rio de Janeiro

Movers and Shakers

Rio looks set to witness changes to the top 10 medal-winning countries. Italy look set to drop out of the top 10 and Brazil, the Netherlands and, rather surprisingly, New Zealand will be vying to shoot up the table.  New Zealand will be hoping to use a phenomenally successful London 2012 showing (where they won 13 medals) as a platform for increasing their share of medals to 20. Although investment plays a significant role in this upward trajectory, Dr Nielsen highlights their dominance in 3 of the 4 new events due to debut at the Olympics. Rugby 7’s, as well male and female Golf, will see New Zealand continue their ascendancy into the higher echelons of sporting achievement.

Whilst the Olympics has always cherished its surprises, such as Abebe Bikele  in 1960 or Billy Mills in 1964, Dr Nielsen’s work should put some anxious minds to rest, whilst others – such as Russia and Italy –  will perhaps be hoping for more Olympian surprises.

Read Professor Klaus Nielsen’s study: “Medal predictions for the Rio Games – the competition between national elite sport systems

Find out more

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