Ubiquitous Instability

A fascinating piece from New Scientist highlights an important new paper that examines the network of firms that “runs the world.”  The thesis of the paper is that these highly connected finance networks “form a giant bow-tie structure and that a large portion of control flows to a small tightly-knit core of financial institutions,” causing the entire structure to be extremely and inherently unstable. The architecture of global economic power and the concentration of that economic power combined with such super-connectedness is highly problematic and dangerous.

Coincidentally, The New York Times has a beautiful (and terrifying) new illustration of the various debt connections among Eurozone nations that shows how “problems in one part of the world can reverberate almost everywhere else – risking a cascade of default, contagion, contracting credit and collapsing economic activity.”  It isn’t hard to make a connection.

Per New Scientist:

An analysis of the relationships between 43,000 transnational corporations has identified a relatively small group of companies, mainly banks, with disproportionate power over the global economy.

“The study’s assumptions have attracted some criticism, but complex systems analysts contacted by New Scientist say it is a unique effort to untangle control in the global economy. Pushing the analysis further, they say, could help to identify ways of making global capitalism more stable.

“The idea that a few bankers control a large chunk of the global economy might not seem like news to New York’s Occupy Wall Street movement and protesters elsewhere (see photo). But the study, by a trio of complex systems theorists at the Swiss Federal Institute of Technology in Zurich, is the first to go beyond ideology to empirically identify such a network of power.”   

As one of the authors states, “[i]n effect, less than 1 per cent of the companies [mostly financial institutions] were able to control 40 per cent of the entire network.”  Because of this tight interconnectedness, “[i]f one [company] suffers distress, this propagates.”

Barry Ritholtz suggests that the proper concern ought to be less about influence than about having massive amounts of capital. Thus he sees Goldman Sachs (#18 on the list) as far more influential than Vanguard (#8). Accordingly, he isn’t sure what conclusions to draw from the study.  I would suggest that influence and capital are inter-related and that the list is a very good start.  The study is particularly significant in that it relies upon data for its conclusions rather than ideology.  OWS and the Tea Party Movement alike should benefit from its insights.

Nassim Taleb frequently points out the dangers of efficiency and the corresponding benefits of redundancy, especially to complex systems.  This new research supports that notion – concentration may provide efficiencies, but they come at a high cost.  Similarly, Mark Buchanan’s Ubiquity makes the case that applying nonequilibrium physics to the complex systems that affect various cataclysms in human history yields illuminating and fruitful results.  A very small shock may trigger a disproportionately huge response.

From studying the physics of sand piles, scientists have learned that an astonishing range of things, including the Earth’s crust, cars on a highway, financial markets, the spreading of epidemics and the networks of human society all have a natural tendency to organize themselves into a “critical state” in which they are poised on what Buchanan describes as a “knife-edge of instability.” Indeed, as Buchanan argues, “[t]he peculiar and exceptionally unstable organization of the critical state does indeed seem to be ubiquitous in our world.”  

The study highlighted by New Scientist supports Buchanan’s view and offers an interesting concept — that it’s the inherent nature of these super-connected networks that breeds instability and crisis.  If that doesn’t scare you given the daily headlines, I’m not sure what will.

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