Economic complexity beyond rational management

Complex systems may be characterised by tight-coupling and linear interactions. A small perturbation in such systems can cascade through the entire architecture precisely because these systems are so tightly coupled. We are starting to understand that large-scale social systems can also be complex in the above terms. This was first really developed in a major way by Joseph Tainter who, in a path-breaking study, argued that the collapse of ancient societies occurred because they became too complex. These collapses were normal accidents.

Because of financial liberalisation the global financial system became particularly complex and it began to take on a high degree of tight-coupling because liberalisation led to financial globalisation. It only took the downturn in the US real estate market to reverberate its way in a dimly understood fashion through the coupled global system to bring the entire edifice towards the cusp of systemic collapse, that is, a normal accident. The property market dip acted in much the same fashion that failure in an electricity sub-station leads to massive systemic blackouts.

One feature of economic complexity is that it has led to financial crises of ever increasing frequency and scale. This makes the system poorly disposed towards rational management. The intriguing bit about that is that it seemingly turns Friedrich Hayek’s arguments, a noted free market philosopher, on their head. Hayek wrote at the same time as Polanyi.

Hayek, justly in my view, famously developed an epistemic argument against central planning as exhibited in the Communist bloc. He argued that no central planning agency could possibly allocate resources efficiently because such a task assumes impossible amounts of knowledge on the part of the central planner. Yet we observe that financial liberalisation has led to a system that is so complex that it is beyond rational management.

If we are to deal with the prospect of systemic risk it would require the fashioning of a system that is less complex and thereby more prone to rational management. Clearly, this requires putting financial liberalisation in reverse gear. In this sense Hayek's epistemic argument can be, sort of, applied in the other direction. One makes this point especially for those who appreciate irony. This is doubly ironic given that Hayek was the intellectual godfather of Alan Greenspan.

The global solution to the current crisis will require co-ordination by governments the world over to fashion a new regulatory regime that helps to internalise systemic risk, thereby obviating the problem of negative externalities, and to develop a financial system less complex and globally integrated. That means reversing the trend towards the greater liberalisation of finance capital. Greater regulation and control over the movement of finance capital will also constrain the institutional and political power of financial corporations.

At the beginning of last year a lot of emphasis was placed on what was called "de-coupling". It was argued that there appeared a measure of de-coupling between the growth rates of the emerging economies of Asia, especially China, and the United States.

The Chinese economy has begun to cool off. However, de-coupling, in fact, is worse because the US economy is in deep recession. It is indeed true that China's economy is now no longer growing at supercharged levels but nonetheless the growth rate differential is actually bigger and may increase.

We mention this because we may depend on this de-coupling to help get ourselves out of the mess we currently find ourselves in. What China is not de-coupled from is a highly liberalised and integrated global financial system. This would be the causal link accounting for the observed correlation between the decrease in Chinese growth and the September 2008 financial meltdown.

This again brings to relief the issue of complexity. We may have to rely on the relatively de-coupled aspect of the global economic system to help kick-start the global economy. If the real economy was as tightly coupled as the financial economy then we would now be in a deeper global economic recession that would be very difficult to get out of. As it is the core economies of the European Union, the US and Japan are in simultaneous downturns. This has not been seen since 1945.

This demonstrates the folly of globalisation. It is crucial that we understand that a degree of de-coupling in our economic and financial architecture is vital and we must impose limits to globalisation.

We mention China for it is a natural place to bring Australia into the picture. The relative downturn in China has resulted in large falls in commodity prices. In Japan, our leading trading partner, GDP growth is declining at significant levels and industrial production is declining at a whopping 20 per cent. If these trends continue Japan could be heading for something similar to the Soviet and Russian crises of the 1980s and 1990s.