The Butterfly Defect: How Globalization Creates Systemic Risks, and What to Do about It - Hardcover

Goldin, Ian; Mariathasan, Mike

Hardcover

ISBN 10: 0691154708 ISBN 13: 9780691154701

Publisher: Princeton University Press, 2014

Synopsis

How to better manage systemic risks―from cyber attacks and pandemics to financial crises and climate change―in a globalized world

The Butterfly Defect addresses the widening gap between the new systemic risks generated by globalization and their effective management. It shows how the dynamics of turbo-charged globalization has the potential and power to destabilize our societies. Drawing on the latest insights from a wide variety of disciplines, Ian Goldin and Mike Mariathasan provide practical guidance for how governments, businesses, and individuals can better manage globalization and risk.

Goldin and Mariathasan demonstrate that systemic risk issues are now endemic everywhere―in supply chains, pandemics, infrastructure, ecology and climate change, economics, and politics. Unless we address these concerns, they will lead to greater protectionism, xenophobia, nationalism, and, inevitably, deglobalization, rising inequality, conflict, and slower growth.

The Butterfly Defect shows that mitigating uncertainty and risk in an interconnected world is an essential task for our future.

About this title

About the Author

Ian Goldin is director of the Oxford Martin School and professor of globalization and development at the University of Oxford. Mike Mariathasan is assistant professor of finance at KU Leuven.

From the Back Cover

"Globalization is the girl with the curl: when it is good, it is very, very good, but when it is bad it is awful. It generates a world at the same time both robust yet fragile--economically, financially, environmentally, and socially.The Butterfly Defect explains why this opportunity-cum-threat calls for a radical new approach to the setting of public policy--an approach which to be successful needs to be every bit as hyperconnected as the world it is operating in."--Andy Haldane, Bank of England

"The Butterfly Defect is remarkable. Never has globalization, in its dramatically increased interconnectedness, been looked at so completely and clearly. For policymakers in particular, the book's analysis of the systemic fragility associated with globalized interconnectedness and the need for systemic resilience are of utmost interest."--Jean-Claude Trichet, former president of the European Central Bank and current chairman and CEO of the Group of Thirty

"A vital and timely book, The Butterfly Defect is the first to show why systemic risk threatens us all and how it can be managed. It is a must-read for anyone concerned about our rapidly integrating peoples and businesses, and the future of our hyperconnected world."--Pascal Lamy, former director-general of the WTO

"This fascinating and useful book provides interesting examples and connections across a range of fields and areas of study."--Danny Quah, London School of Economics and Political Science

"This interdisciplinary and far-reaching book brings together diverse research to highlight the increase in systemic risk that accompanies the interconnectedness associated with globalization. No other book has summarized these issues for the general public, and The Butterfly Defect will benefit a broad audience."--David Colander, Middlebury College

"Filled with striking examples, this ambitious book offers a new perspective on globalization--in particular, the need for policy responses that recognize the challenges presented by the globalization of many domains, from health to finance. The message about the need for coordination to overcome systemic problems will strike a chord with readers."--Diane Coyle, author ofThe Soulful Science: What Economists Really Do and Why It Matters

From the Inside Flap

"Globalization is the girl with the curl: when it is good, it is very, very good, but when it is bad it is awful. It generates a world at the same time both robust yet fragile--economically, financially, environmentally, and socially.The Butterfly Defect explains why this opportunity-cum-threat calls for a radical new approach to the setting of public policy--an approach which to be successful needs to be every bit as hyperconnected as the world it is operating in."--Andy Haldane, Bank of England

"The Butterfly Defect is remarkable. Never has globalization, in its dramatically increased interconnectedness, been looked at so completely and clearly. For policymakers in particular, the book's analysis of the systemic fragility associated with globalized interconnectedness and the need for systemic resilience are of utmost interest."--Jean-Claude Trichet, former president of the European Central Bank and current chairman and CEO of the Group of Thirty

"A vital and timely book, The Butterfly Defect is the first to show why systemic risk threatens us all and how it can be managed. It is a must-read for anyone concerned about our rapidly integrating peoples and businesses, and the future of our hyperconnected world."--Pascal Lamy, former director-general of the WTO

"This fascinating and useful book provides interesting examples and connections across a range of fields and areas of study."--Danny Quah, London School of Economics and Political Science

"This interdisciplinary and far-reaching book brings together diverse research to highlight the increase in systemic risk that accompanies the interconnectedness associated with globalization. No other book has summarized these issues for the general public, and The Butterfly Defect will benefit a broad audience."--David Colander, Middlebury College

"Filled with striking examples, this ambitious book offers a new perspective on globalization--in particular, the need for policy responses that recognize the challenges presented by the globalization of many domains, from health to finance. The message about the need for coordination to overcome systemic problems will strike a chord with readers."--Diane Coyle, author ofThe Soulful Science: What Economists Really Do and Why It Matters

Excerpt. © Reprinted by permission. All rights reserved.

THE BUTTERFLY DEFECT

How Globalization Creates Systemic Risks, and What to Do about It

By IAN GOLDIN, MIKE MARIATHASAN

PRINCETON UNIVERSITY PRESS

Copyright © 2014 Princeton University Press
All rights reserved.

ISBN: 978-0-691-15470-1

Contents

List of Boxes, Illustrations, and Tables, ix, 
Preface, xiii, 
Acknowledgments, xvii, 
Introduction, 1, 
1 Globalization and Risk in the Twenty-First Century, 9, 
2 The Financial Sector, 36, 
3 Supply Chain Risks, 70, 
4 Infrastructure Risks, 100, 
5 Ecological Risks, 123, 
6 Pandemics and Health Risks, 144, 
7 Inequality and Social Risks, 168, 
8 Managing Systemic Risk, 198, 
Notes, 221, 
References, 257, 
Index, 285, 

CHAPTER 1

Globalization and Risk in the Twenty-First Century

In recent decades we have entered a new era of connectivity and integration. Globalization not only affects multinational corporations and their global supply chains or banking conglomerates and their international investment portfolios. It also shapes the life of virtually every individual alive, every day. Transnational interactions have become the norm, and social networks are global. The connections between people around the world have grown at an astounding pace. "Right now a Masai warrior with a cell phone has access to better mobile phone capabilities than the President of the United States did twenty-five years ago. And if he's on a smart phone with access to Google, then he has better access to information than the President did just fifteen years ago."

This interconnectedness manifests itself in every aspect of our lives, even when we do not consciously choose it. We are so accustomed to globalization that we take for granted the products and services we consume from around the world.

In the twenty-first century, trade is no longer primarily physical. Electricity, media, money, and ideas cross borders at speeds that make traditional trade, such as that in meat from Argentina or bananas from the Caribbean, appear almost anachronistic. We all depend on technologies, as well as on products and services from across our borders. For example, our information technology (IT) services may run on Israeli software provided from Mumbai as we consume entertainment from Los Angeles filmed in South Africa on computers manufactured in China or Taiwan assembled from parts from more than 20 countries. A German loan bails out the Cypriot government as the EU shapes the fiscal policy of the Greek exchequer. The fiber cables that enable the World Wide Web form a web across our oceans' floors, with the servers providing the necessary computing power located around the world and as likely to be in advanced economies as in what was once termed the "third world."

The traditional boundaries between the "developed" and "developing" worlds are fading. Although laws, borders, and restrictions separate countries, virtually all our activities and ideas have cross-border dimensions. Individual and local choices have global impacts and vice versa: what happens outside our borders has direct daily consequences for each of us, every day. These connections are complex, frequently opaque, and often beyond our control. Yet together they are shaping how the world develops. As we will see, there is a growing likelihood that events in one place will have cascading effects in other areas, jumping across national borders and sectors as well as the traditional divisions of different types of risk.

In this chapter we establish a framework for understanding this complex web. The defining characteristic of our age is increasing connectivity. We start by seeking to better understand the driving forces of growing connectivity. We then link this growth in connectivity to the concept of complexity and show how this link inherently implies instability. We also build on work in risk analysis to link this instability with uncertainty and systemic issues on the one hand and with the loss of individual and institutional responsibility on the other. Finally, we argue for reforms to promote a more transparent and a more resilient globalization.

GLOBALIZATION AND INTEGRATION

Globalization can generally be understood as the process driven by and resulting in increased cross-border flows of goods, services, money, people, information, technology, and culture. These flows are multi dimensional, and the number of connections between them is unprecedentedly large and growing exponentially. It is becoming deeper in that these connections penetrate a growing range of human activities. Increasingly not only people but also things are being connected—cars, phones, merchandise, and a rapidly widening range of inanimate objects and sensors.

The current period of integration is revolutionary in that a larger set of changes have occurred with a pervasively wider influence than over any comparably short time in previous phases of globalization. We consider, in turn, two additional examples of global connectivity that we feel are unique and have significantly lowered the transaction costs of economic integration. The first is innovation and technological progress, particularly with respect to computing power and information technologies. In the late 1960s Douglas Engelbart, a computer scientist at the Stanford Research Institute, gave a demonstration of the new technological opportunities emerging with the advent of personal computing. His ideas on the user experience constituted a milestone in personal computer usage and inspired many of the breakthroughs that have gone on to transform the world. Today personal computing and Internet usage have entered a new paradigm. When Intel cofounder Gordon Moore first suggested in 1965 that the number of transistors on a chip would continue to double every year, he could not have anticipated the implications of his prediction. Today "technology has ... permeated through our normal daily routines, changing the way we cook and eat, the way we travel from A to B and the way we work and interact with one another." Almost 50 years later, "Moore's Law" is still firmly in place, and it will underpin changes in the coming decades that will be at least as radical as those of the past two decades. Affordable IT and telecommunication devices have allowed us to create a virtual world that transcends national borders as well as traditional industry boundaries. They have enabled unprecedented degrees of global integration, and—by providing a platform for the exchange of information and skills—they continue to generate potential conduits for further globalization. Communication also allows the world to take advantage of its most valuable resource: the growing numbers of human beings who are increasingly educated and literate.

The second example of global connectivity relates to the political and ideological changes that have both defined and facilitated the latest wave of globalization. The political revolutions that tore down the Berlin Wall and ended the Cold War were fundamental. In the same decade that the Berlin Wall fell and the Soviet Union splintered, the West normalized relations with China's 1.3-billion-person economy. Authoritarian regimes collapsed in more than 65 countries in Latin America, Asia, Africa, and Eastern Europe and were replaced with democratic systems that were more open to global trade, finance, and ideas. In many but clearly not all countries, along with open borders came democratic institutions, intellectual property rights, and an economic paradigm shift toward market capitalism and more open economies. The Uruguay Round of trade negotiations and reforms of macroeconomic policy brought more countries and people than had any previous wave of globalization into the global exchange of goods, services, and ideas. Cross-border capital flows have increased dramatically since the 1990s (from $1.5 trillion in 1995 to $6 trillion in 2007) and have recovered strongly in the wake of the financial crisis of 2007/2008 (reaching $4.4 trillion in 2010 following two years of volatility and decline). Since the turn of this century, China (2001), Taiwan (2002), Saudi Arabia (2005), Vietnam (2007), Ukraine (2008), and Russia (2012) have joined the World Trade Organization (WTO). There are now 154 member states, and all major global economies have bound themselves to the WTO's rules.

The liberalization of world capital and trade flows has not generally been accompanied by the removal of restrictions on the movement of labor and people across national or regional borders. Despite these restrictions, the extent and scope of globalization across labor markets are remarkable. Since 1980 the number of migrants has doubled to well over 200 million globally. The pattern of migration has also changed. The period 1840–1914 was mainly one of trans-Atlantic migration, whereas the movements that followed the aftermath of the Second World War and accelerated during the 1980s have spanned the entire globe.

The global movement of goods and people has been facilitated by the expansion and development of an increasingly complex system of roads, railways, shipping routes, and air traffic. In 2008 world container port traffic surpassed the threshold of 500 million TEUs (twenty-foot equivalent units) for the first time and was seven times greater than in 1988. World air travel has more than doubled since the mid-1990s (see figure 1.1). Over the same period, the real value of world trade has more than quadrupled as the demand for high-value traded goods has risen more rapidly than incomes, and production processes have fragmented geographically with the rise in global value chains, facilitated by more efficient logistics.

What most distinctively separated recent decades from previous ones was the coincidence of dramatic political, economic, and technological change. The end of the Soviet Union and the integration of China and many former autarkic regimes into the world community coincided with the technological revolution that brought us Amazon (in 1994), eBay (in 1995), Google (in 1998), and Facebook (in 2004). These political and communication upheavals significantly increased the tempo of globalization.

GLOBAL CONNECTIVITY AND COMPLEX SYSTEMS

In this section we illustrate what we mean by increased connectivity and show how the concept of complexity relates to the integrated systems created by globalization.

Connectivity

Accessing the Internet through mobile devices is an example of a relatively recent innovation. According to the Cisco Visual Networking Index, global mobile data traffic in 2010 was three times greater than total global Internet traffic in 2000. In 2010 mobile traffic tripled for the third year in a row, and the average connection speed doubled between 2009 and 2010. Smart phone usage also doubled over this one-year period. By 2015 global mobile traffic is expected to increase 26-fold over 2010 levels, and it is expected that there will be nearly one mobile device per person—7.1 billion mobile connected devices for 7.2 billion individuals. The transformative potential underlying these numbers is best understood when we realize that 48 million of these individuals will live with mobile Internet access but without electricity. In other words, there will be 48 million people with access to Google but not to artificial light. The Web will be more worldwide than light bulbs.

Although the mobile Internet requires a significant physical infrastructure in terms of Internet exchange points, mobile phone masts, and backbone cables, individuals seeking to establish mobile connections have to make a far smaller investment than is required to access the Web through cabling and fixed connections to the physical Internet. In fact, provided that a suitable system is in place, consumers now simply require a capable mobile phone and a nearby outlet for charging the battery. Not surprisingly, the growth of mobile Internet connections has been strongest in some of the world's poorest regions. These developments enable those with relatively poor physical infrastructure to access information and education. Figure 1.2 provides a visual map of a sample of 10 million Facebook "friendships" in 2010. We see that, for the moment, the Middle East, China, and most of Africa remain relatively unconnected. This isolation is the result of missing physical connectivity as well as the development of alternative social networks spurred, in some countries, by political restrictions on Facebook's activities. The revolutionary potential of mobile Internet devices is that they can play an important role in information sharing and political mobilization. The "Arab Spring" is one manifestation of this potential; the global protests surrounding the treatment of dissidents in Russia and China are others.

The relationship between the virtual and the physical can be further explored by comparing figure 1.2 with figure 1.3, which shows global civilian air traffic. One implication of this comparison is that virtual integration not only is a reasonable proxy for real-world interaction but also might act as an accelerator. Virtual connectivity allows users to learn about places and opportunities in other countries. Virtual friendships make long-distance journeys not only more desirable but also easier to organize. Virtual communication enables companies to maintain and develop contacts and manage employees and operations in far-flung parts of the world. Despite the many remaining barriers to international migration, the labor market is becoming globalized and the economy digitalized. Job vacancies are searchable from anywhere, and as work processes and cultures become more widely understood through improved communication, skills are becoming more transferable across continents. As a result of these developments, as shown in figure 1.1, there is a correlation between the travel patterns of people and the transport of goods. We see accelerated growth in both sectors since the 1950s, which reached totals of more than 4,500 billion passengers and upward of 170 billion tons transported per kilometer in 2011.

Figure 1.4 shows how domestic air travel in China and Europe increased between 1990 and 2010 in both volume and intricacy as more flights went to more destinations. Although the two regions started at comparable levels, growth in China has been most rapid, with a 1,745 percent increase in available seat-kilometers. The growth in airline activity has been part of a broader pattern of rising connectivity that has led to the emergence of China as a hub for global trade and to the development of a domestic trade web for goods sourced in China, as depicted in figure 1.5.

Finance, too, has seen a rapid expansion in connectivity and integration. An illustrative measure of volume is the interbank market activity conducted through the Federal Reserve System's Fedwire interbank payment network. Figure 1.6 represents this activity. On the left-hand side we see an extraordinary 70,000 links in just one day. The right-hand side depicts the core links at 75 percent of the day's activity.

A more global picture of integration in the financial sector emerges when we consider finance at the multinational level (figure 1.7). As well as increased linkages within nations, in the figure we see the corresponding evolution of foreign direct and portfolio investments (figure 1.8). The picture that arises from these graphs is one of cross-border capital flows increasing from the late 1980s onward. This increase was particularly pronounced in industrial countries during the late 1980s and early 1990s, suggesting that a new wave of globalization occurred as former "less economically developed countries" started to take advantage of global integration.

Complexity

Global integration has been a key contributor to recent improvements in living and health standards, but these improvements have for a long time also concealed a mutual interdependence. More than simple connectivity, our increasing interdependence represents complexity.

Complexity describes "phenomena generated by interacting parts, all of whose causal connections are not easily discernible, [and] whose behaviour over time exhibits disorder and behaves unpredictably or chaotically." We can further break down this broad definition into three levels: "small-tent" complexity, "big-tent" complexity, and meta complexity. The first of these, small-tent complexity, is widely known as "Santa Fe complexity" and is the most commonly used in complexity research (see box 1.1 on the following page). This is the concept of complexity adopted in this book.

The second level of complexity, big-tent complexity, is broader and encompasses small-tent complexity as well as cybernetics, catastrophe, and chaos (with complexity as the first of these, the four Cs). In other words, it is concerned with complex and unstable dynamics. The third level, metacomplexity, includes everything else and, in theory, can cover several distinct definitions. Our discussion of global connectivity leads us to the conclusion that, as a result of globalization, the world today should be defined as a complex system.

(Continues...)

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Edition details

• Publisher: Princeton University Press
• Publication date: 2014
• Language: English
• ISBN 10: 0691154708
• ISBN 13: 9780691154701
• Binding: Hardcover
• Number of pages: 320