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. This New Scientist ‘Science in Society’ Briefing examines the issues.

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 destabilising, says physicist Len Fisher at the University of Bristol, author of Crashes, Crises and Calamities: How we can use science to read the early-warning signs.

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, Fisher says computer models of the system can still show how the system can change. Yet leading economics journals, he says, do not accept computer-modelling studies. “Mainstream economists have not considered these non-linear effects,” agrees Oonsie Biggs of Stockholm University’s Stockholm Resilience Center in Sweden.

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. “Cascades of failure may be controlled by changing the nature and strength of the links between various parts of the networks,” says Fisher. Much current research in complex systems focuses on assessing connectivity correctly to enable that. Other work aims to detect behaviour that indicates an imminent collapse.

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?

Complexity theory shows what went wrong. Yaneer Bar Yam of the New England Complex Systems Institute in Cambridge, Massachusetts, says his still-unpublished studies show that investors profited by driving down the value of Greek government bonds, triggering the crisis. If instead of national bonds issued by sometimes weak economies, the eurozone had one common bond backed by powerhouses such as Germany, such an attack could not have happened.

Germany rejects eurobonds. But, says Bar Yam, 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. “Biology has solved this problem several ways,” says Bar Yam.

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 develop ways to make systems more stable, such as pruning connectivity or paying for defence measures. “We now have the quantitative, analytical tools to do that,” says Bar Yam. Such models may also show when short-term costs that reduce a system’s efficiency may be warranted because of the long-term benefits of increased system resilience.

Some connectivity problems could be hard to prune, though. Biggs says close coupling between major global hubs, such as the eurozone and the US, is a big source of instability that which may threaten strong contributors in future, like France and Germany.

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. Such forests accumulate deadwood fuel and lose patchiness, increasing connectivity. When a fire eventually breaks out, it becomes huge. That’s why forest managers now encourage regular, small burns. Similarly, banking networks may need low-level failures to prune connectivity and risk.

Systems-based thinking has even reached the Bank for International Settlements in Basel, Switzerland, which sets global rules for the capital a bank must hold to back loans. It announced this month that the risks posed by banks depend on their “size, interconnectedness, complexity and global scope”. So from 2016, “global systemically important banks” – initially 29 of them – will be required to keep more capital on hand per dollar loaned than less vital banks. This is partly to “discourage banks from becoming even more systemically important” – in other worlds, too big to fail.

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.

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Join the conversation! 6 Comments

  1. Very nice essay! The points about common defenses being commensurate with common risk-level and about allowing small fires to burn to prevent the build-up of deadwood (I was at the Tetons during the 1988 fire at Yellowstone in Wyoming) are excellent. I would add the following point: In an ecosystem, the ecologizing constraint of the ecosystem can be broached if a species acts as a maximizing variable within. That is, a schizogenic variable can breach the viability of a homeostatic “normative” constraint. What is the maximizing variable in the “euro zone”? Runaway government debt? What is the “ecologizing” constraint? Pressure from the E.U. political elite on “wayward” state leaders? On this point, please see my essay at http://thewordenreport.blogspot.com/2011/11/popular-sovereignty-eu-bailout-or.html

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  2. noticed the current format for the tag cloud on the economist? Interconnections are becoming part of our mind set and communications, especially in financial discourse:

    http://www.economist.com/conversation-cloud?days=14

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  3. Up to now I felt like and egocentric megalomaniac. I did my PhD in Biomedical Engineering and have spent my professional life looking at complex networked systems, to understand them to the point of being able to predict which interventions would be positive for humans, before my company spent millions in Clinical Trials. Thus when I came to the world of economics and the financial markets I was flabergasted by the level of the mistakes being made by our leaders in managing the economy. For instance excess liquidity as has been created worldwide, makes the system EXTREMELY unstable by increasing the gain of all the feedback systems. Further increases in liquidity will assure that the system will reach metastability, where any small perturbation can trigger chaotic behavior. Chaos will be quickly stablished and the attractors will be several different, and predictable states. At this point the system will start oscillating faster and faster between those states (you can observe this type of attractors already occurring and being called “Ranges”) until the whole system burns and crashes when people and institutions can’t handle the level of volatility that this will create.
    At the same time if is fascinating how careful we are in Clinical Trials to test new interventions, due to our awareness of the complexity of the system we are trying to intervene on. And how casually people like Bernanke are allowed to experiment with the well being of hundreds of millions of people with complete and total impunity. In our world what they are doing with the economy is equivalent to “Alchemy” in its degree of sophistication.

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  4. […] What does the new atlas of economic complexity tell us about development? Potentially a huge amount – I think this is probably v important, but while I’m trying to digest it, have a look at Ben Ramalingam’s post. And while we’re on complexity, what does managing forest fires and other ecosystems tell us about how to solve the Euro crisis? […]

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  5. Thanks for this essay. It is obvious that biomimicry is becoming a source of inspiration in many fields, as diverse as design, ingeneering, architecture, now finance and more. I especially liked the part about the importance of small scale crises in order to prevent global collapse. See Per Bak’s sandpile experiment about this: our (still very little) understanding of systems allows us to monitor them and to prevent small system collapse by shifting the load to other systems, thus creating a network of “near break-point” systems, waiting for global collapse. Could we one day see small scale collapses as a healthy systemic behaviour? Is the human dream of total control (understanding) coherent with complexity, or should we learn the importance of imperfection and unpredictability?

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  6. […] on aidontheedge.info Share this:CondivisioneFacebookTwitterDiggLinkedInRedditStumbleUponEmailStampaLike this:Mi piaceBe […]

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About Ben Ramalingam

I am a freelance consultant and writer specialising on international development and humanitarian issues. I am currently working on a number of consulting and advisory assignments for international agencies. I am also writing a book on complexity sciences and international aid which will be published by Oxford University Press. I hold Senior Research Associate and Visiting Fellow positions at the Institute of Development Studies, the Overseas Development Institute, and the London School of Economics.

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Biology, Economics, Financial crisis, Innovation, Institutions, Knowledge and learning, Networks, Public Policy, Technology, Trade