1. Old Europe – New Europe Implications for Risk Management Supply Chain Risk Leadership Council February 22, 2007 Daniel M. Hofmann Group Chief Economist Zurich Financial Services

2. © Zurich - 2 Chief Economist - February 22, 2007 The problem defined A definition of supply chain risk* includes risks due to -Unnatural disasters -Natural disasters -Health -Disruptions in the supply chain infrastructure It excludes the economic framework in which we are operating, a glaring omission in a time characterized by discontinuities. The answer to the question whether Europe can successfully deal with discontinuities arising from further integration is decisive for the treatment – and ultimate mitigation – of economic supply chain risk. *George A. Zsidisin, Business and Supply Chain Continuity, CAPS Research, January 2007

3. © Zurich - 3 Chief Economist - February 22, 2007

4. © Zurich - 4 Chief Economist - February 22, 2007 … and Fastest Growth Since the Early 1970s 0 1 2 3 4 5 6 7 8 1970197419781982198619901994199820022006 Growth in % World Output Average 3.7 A Global Boom... World OutputNIAE Developing AsiaAdvanced Economies 0 2 4 6 8 10 20032004200520062007 Growth in % Source: IMF

5. © Zurich - 5 Chief Economist - February 22, 2007 What went right in Europe? An excellent outlook for the short term No housing bubble 0 2 4 6 8 10 12 14 85 90950005 USEurozone Improved productivity 0 1 2 3 4 5 929394959697989900010203040506 USEurozone Lower inflation -2 0 2 4 6 97989900010203040506 USEurozone Diversified export structure 0 9 18 27 36 45 959697989900010203040506 USAccession 10, Asia ex Japan, Russia Source: Thomson Datastream Source: ABN Amro

6. © Zurich - 6 Chief Economist - February 22, 2007 Too good to be true? A Bubble in Commodities Oil Metal Food Signs of a liquidity-driven bubble economy… -7 -5 -3 1 3 5 7 Saving - Investment in % of GDP USA UK Euroland JapanNIAEDev Asia Global Saving / Investment Imbalances …or real factors at work? Growth of Global Derivative Markets (Notional Amounts Outstanding; USD trill.) 200 240 280 320 360 400 June 04Dec 04June 05Dec 05June 06 0 5 10 15 20 25 Total Contracts (lhs)Credit Default Swaps (rhs) Source: Thomson Datastream Source: IMFSource: BIS

7. © Zurich - 7 Chief Economist - February 22, 2007 Three more distinct risks Risk one Upside risks to inflation and interest rates Risk two Global imbalances and a disorderly correction Risk three Lagged impact of high oil prices and the US housing bubble

8. © Zurich - 8 Chief Economist - February 22, 2007 A big challenge not only for Europe: Governance gap in a time of discontinuity 1980199020002010 Change Market dynamics Technolog y pull Governance gap Institutional capabilities ;mindsets Time Discontinuities caused by 1989 and all that (e.g. CEE enlargement) Impacts of globalization due to  Rapid advances in technology  Financial engineering  Tight integration of capital markets  Doubling of global labor force Geopolitical risks, terrorism Climate change Discontinuities create frictions and a potential for political backlash (as seen in reaction to the perceived inequality of globalization). They are of particular concern in light of a widening governance and gap.

9. © Zurich - 9 Chief Economist - February 22, 2007 The big potential of the New Europe As seen through the lens of CEE enlargement Average 6.4 Average 4.3 GDP per capita of CEE members In USD 0 10000 20000 30000 EU Slovenia Czech Republic Hungary Estonia Slovakia Poland Lithuania Latvia Stock Market Capitalization 0 20 40 60 80 EU Slovenia Czech Republic Hungary Estonia Slovakia Poland Lithuania Latvia in % of GDP Rest of EU Germany Austria Value added through CEE enlargement 0 50 100 150 200 250 until 2006by 2012 in EUR billion Source: World Bank Source: BA-CASource: IMF

10. © Zurich - 10 Chief Economist - February 22, 2007 Pulling it together The medium term outlook for Europe and the global economy is excellent. Supply chain risk may derive from economic discontinuities unleashed, for example, by the forces of globalization and EU accession. An emerging governance gap points to potential frictions. Example are the growing resistance to trade liberalization within the framework of the Doha round and the recent political backlashes in Hungary and Poland. Economic forces driving globalization in general, and the further integration in Europe in particular, warrant closer monitoring.