Risk and Complexity

• Author: Ian Goldin and Chris Kutarna

Risk and Complexity Finance & Development, September 2017, Vol. 54, No. 3

Ian Goldin and Chris Kutarna

  Global integration and new technology mean rapid progress—but also higher risk

Today’s integration of economic systems and increased flow of ideas expands our choice, broadens our horizons, and is a catalyst for creativity, innovation, and growth. But it also dramatically changes the nature of risk.

The integration of complex systems leads to unintended and sometimes unknown consequences. The pace of change means that economies now face significant new challenges for which national and international governance systems are poorly prepared.

One of these risks is growing complexity—in global air travel, cross-border financial investments, and Internet infrastructure. Economic development and the integration of economies amplify this complexity by raising the volume of traffic that flows across these many and diverse connections and by adding new nodes—cities, industrial zones, ports, computer network or logistics hubs, power stations, labs, conferences, and journals. While global integration through economies of scale and harmonization of consumer preferences or global rules and regulations (such as those of the World Trade Organization) may reduce complexity, the fragmentation of supply chains, proliferation of rules, and growth in the number of participants and governments overwhelm the potential for simplification.

Complexity can be a good thing. The greater variety and volume of connections and flows provide a springboard for accelerating innovation and have produced a more dynamic and distributed global economy. It also creates resilience. The diversification of global growth has lifted and produced more stable global growth. Increasing trade integration may lead to higher business cycle synchronization between advanced and emerging market economies. However, the growing diversification of emerging markets away from advanced economies and the growth of trade between emerging markets build resilience. So too does the development of their domestic markets and regulatory and supervisory capacity. Systems design and competition and other regulations can contribute to resilience in complex systems. Beyond finance, this can ensure, for example, that if one link on the Internet goes down, its traffic reroutes to alternatives. Similarly, when one ATM goes down, another can be tapped, provided the alternatives are served by independent companies or operating systems.

But growing complexity poses a severe challenge for risk management. The more complicated our interactions become, the harder it is for us to see relationships of cause and effect. We develop cognitive blind spots in our vision of the events around us. How can we make good decisions when we can’t foresee the consequences? More complex systems also provide more scope for interdependent relationships...