Opinion (from New Scientist): “The eurozone, like the rest of the world economy, is a complex networked system. That gives it properties economists rarely consider but which could help us understand the current crisis.
“What is a complex network?
“Complex networks have many interconnected components which influence each other’s behaviour. These changes then feed back on each other. A famous example is the numbers of predators and prey in a given environment, which vary in a complex interdependent way. The eurozone – the 17 countries that share a common currency, the euro – is similarly interdependent, with similar feedback mechanisms.
“All complex networks are governed by a balance between negative feedback, such as interest rates, which is stabilising, and positive feedback, such as the self-reinforcing erosion of trust in markets, which is destabilizing.
“How does that help us understand economic crises?
“In certain circumstances, one type of feedback can end up dominating the system, causing it to change so dramatically that it flips to another state. Examples include the way animal populations can suddenly collapse or the way economies can slip into recession.
“These tipping points tend to be highly unpredictable. Even so, computer models of the system can still show how the system can change. Yet leading economics journals, he Len Fisher at the University of Bristol, author of Crashes, Crises and Calamities: How we can use science to read the early-warning signs] says, do not accept computer-modelling studies.
“Can we understand complex systems well enough to control them?
“Maybe. The diversity of a network’s components and the density and strength of its connections – called its connectivity – affect the system’s resilience, or resistance to change. More connections make a system more resilient: if one component fails others can fill in. But only up to a point. Go past a certain threshold and more connectivity makes the system less resilient because a single failure can cascade to every other component.
“The trick is to get the balance right.
“So turning 17 separate currencies into one eurozone was a cascading failure waiting to happen?
“Yes. That is why Greek debt is a crisis, even though Greece accounts for only 2.5 per cent of the eurozone’s GDP. News of its debts caused the trust that markets placed in Greek government bonds to plummet. Its creditors are mainly in the eurozone, so a Greek default is causing markets to lose confidence in other members, such as Italy – which is too big to bail out.
“Could the crisis have been avoided?
“Germany rejects eurobonds. But, says Bar-Yam [of the New England Complex Systems Institute in Cambridge, Massachusetts], complex systems such as multicellular organisms show that ‘if you are going to accept common risk, you have to invest in defences that extend to the weakest member.’ Either that or make sure an attack on a weak member cannot spread, a technique that ant colonies have perfected: the death of a single ant has little effect on the colony as a whole.
“If connectivity is a risk, why create the euro?
“Connectivity is also profitable as it makes economic production much more efficient. And it can adapt to problems: connectivity allows other eurozone countries to help Greece, and to build better common defences.
“Trade-offs between efficiency and resilience may mean we need to sacrifice efficiency to make systems more stable, by pruning connectivity or paying for defence measures.
“Some connectivity problems could be hard to prune, though. Close coupling between major global hubs, such as the eurozone and the US, is a big source of instability; strong contributors to a network, like France and Germany in the eurozone, can be as well.
“Why don’t economists know this?
“They are starting to. Some economic theorists have drawn parallels between financial networks where bank failures are prevented, and forests where small fires are always put out… This recognition of the importance of complexity has been largely confined to banking, however. The eurozone is a network of governments. It is not clear how eagerly they will adopt a way of thinking that truly puts collective interests first.”|