THE BUTTERFLY DEFECT
How Globalisation Creates Systemic Risks, and What to do About it
Ian Goldin and Mike Mariathasan
Princeton University Press, 2014
296 pages
The authors of The Butterfly Defect have written a long book to make a short point. We live in a large interconnected world, and the interconnection brings to the fore its own risks. These risks are not to be wished away; the interconnection makes it increasingly difficult to isolate and insulate problems. In the interconnected world, physical borders do not matter; an event in one corner of the world can affect some other part of the world really fast. We are indeed living in a risky world. This world has its efficiencies, economies of scale, even a certain subversive tendency, but the downside is also enormous.
The authors have chosen multiple sectors to illustrate their point. To start with, they lay down the basic argument in the first chapter, which shows the linkages and the interconnectedness, and then describes the nature of risks. The second chapter focuses on a trend that we continue to experience: the effect of events in the financial sector and how it affected the world at large. The chapter is not just about the United States; it also looks at events in Iceland and later in Greece. The ripples are still being felt elsewhere in the world; even the governor of the Reserve Bank of India talks about the US taper when he announces the credit policy.
In addition to the financial sector, what sharply illustrates the risk of interconnectedness is the health sector. A few years ago, we experienced a global scare over severe acute respiratory syndrome (SARS). There have been instances of large scares owing to the outbreak of swine flu and economic losses due to bird flu. Such scares show how pandemics can put the global community at risk, clearly a result of increased mobility across borders.
The authors illustrate other risks too. Free movement allows the world to achieve economies of scale and establish clusters of specialisation, thereby leading to very high productivity. This could happen not only in services like software, but also in the manufacturing sector; the dominance of China, Korea and Taiwan in the manufacturing sector based on a cost advantage is well known. Such super-efficient clusters often expose themselves to supply chain risks. In this regard, the authors illustrate how a flood in Thailand had an impact on the production of hard disk drives across the world.
In addition to supply chain risks, there are infrastructure-related threats: for instance, gas pipelines, undersea fibre optic cables and satellites add to efficiency, but also expose us to great risks. Then there are environmental hazards: for example, local processes that may lead to global warming, a larger carbon footprint and a depleting ozone layer. The authors discuss this aspect in detail.
Of particular note is the seventh chapter. It discusses the risks associated with rapid growth and the concomitant development and increased inequality. That in itself could be a matter of tension, but the social risks that emanate from homogenisation resulting from the existence of a dominant culture are another cause for concern. It is when the authors move from the very obvious risks of growth and economic development to the much more subtle risks of inequality and social risks that their argument gets weaker. Effectively, the authors are unable to communicate the immense risks that inequality brings. Therefore, through this chapter, they lend themselves to Jagdish Bhagwati and Arvind Panagariya for easy target practice.
Each chapter includes a section on how to cope with these risks. The suggestions look obvious and are not backed by a concrete framework for implementation. These solutions could be offered to the world at large, irrespective of whether the problem resulted from interconnectedness or globalisation. Here are some of the lessons.
One, the current global financial regulation framework is inadequate. The solution: “Independent and yet accountable national and supranational agencies are required and these must have the necessary authority and ability to oversee and promote the stable evolution of the global financial system” (pages 65-66).
Two, simplicity, not complexity, will allow global institutions to manage local issues (page 67).
Three, when it comes to supply chain risks, negative externalities, such as counterparty risk, need to be recognised and addressed (page 96).
The last chapter is devoted to managing systemic risks. The solutions are couched in generalities. So the book tells us what we already know: that the globalised, interconnected world is risky. It also brings together the nature of risks in diverse sectors that we possibly saw as independent and unconnected events. These could be traced to a common cause: globalisation. The book identifies the obvious problem well. It does attempt to look at the not-so-obvious problem of inequity and social risks, but does not analyse it in detail. Nor do the authors offer a framework to deal with the problems that they identify. The net effect is that the world in general – and the book in particular – leaves us with an unsettling feeling.
The reviewer is a visiting faculty member at the Centre for Public Policy, Indian Institute of Management, Bangalore
How Globalisation Creates Systemic Risks, and What to do About it
Ian Goldin and Mike Mariathasan
Princeton University Press, 2014
296 pages
The authors of The Butterfly Defect have written a long book to make a short point. We live in a large interconnected world, and the interconnection brings to the fore its own risks. These risks are not to be wished away; the interconnection makes it increasingly difficult to isolate and insulate problems. In the interconnected world, physical borders do not matter; an event in one corner of the world can affect some other part of the world really fast. We are indeed living in a risky world. This world has its efficiencies, economies of scale, even a certain subversive tendency, but the downside is also enormous.
The authors have chosen multiple sectors to illustrate their point. To start with, they lay down the basic argument in the first chapter, which shows the linkages and the interconnectedness, and then describes the nature of risks. The second chapter focuses on a trend that we continue to experience: the effect of events in the financial sector and how it affected the world at large. The chapter is not just about the United States; it also looks at events in Iceland and later in Greece. The ripples are still being felt elsewhere in the world; even the governor of the Reserve Bank of India talks about the US taper when he announces the credit policy.
In addition to the financial sector, what sharply illustrates the risk of interconnectedness is the health sector. A few years ago, we experienced a global scare over severe acute respiratory syndrome (SARS). There have been instances of large scares owing to the outbreak of swine flu and economic losses due to bird flu. Such scares show how pandemics can put the global community at risk, clearly a result of increased mobility across borders.
The authors illustrate other risks too. Free movement allows the world to achieve economies of scale and establish clusters of specialisation, thereby leading to very high productivity. This could happen not only in services like software, but also in the manufacturing sector; the dominance of China, Korea and Taiwan in the manufacturing sector based on a cost advantage is well known. Such super-efficient clusters often expose themselves to supply chain risks. In this regard, the authors illustrate how a flood in Thailand had an impact on the production of hard disk drives across the world.
In addition to supply chain risks, there are infrastructure-related threats: for instance, gas pipelines, undersea fibre optic cables and satellites add to efficiency, but also expose us to great risks. Then there are environmental hazards: for example, local processes that may lead to global warming, a larger carbon footprint and a depleting ozone layer. The authors discuss this aspect in detail.
Of particular note is the seventh chapter. It discusses the risks associated with rapid growth and the concomitant development and increased inequality. That in itself could be a matter of tension, but the social risks that emanate from homogenisation resulting from the existence of a dominant culture are another cause for concern. It is when the authors move from the very obvious risks of growth and economic development to the much more subtle risks of inequality and social risks that their argument gets weaker. Effectively, the authors are unable to communicate the immense risks that inequality brings. Therefore, through this chapter, they lend themselves to Jagdish Bhagwati and Arvind Panagariya for easy target practice.
Each chapter includes a section on how to cope with these risks. The suggestions look obvious and are not backed by a concrete framework for implementation. These solutions could be offered to the world at large, irrespective of whether the problem resulted from interconnectedness or globalisation. Here are some of the lessons.
One, the current global financial regulation framework is inadequate. The solution: “Independent and yet accountable national and supranational agencies are required and these must have the necessary authority and ability to oversee and promote the stable evolution of the global financial system” (pages 65-66).
Two, simplicity, not complexity, will allow global institutions to manage local issues (page 67).
Three, when it comes to supply chain risks, negative externalities, such as counterparty risk, need to be recognised and addressed (page 96).
The last chapter is devoted to managing systemic risks. The solutions are couched in generalities. So the book tells us what we already know: that the globalised, interconnected world is risky. It also brings together the nature of risks in diverse sectors that we possibly saw as independent and unconnected events. These could be traced to a common cause: globalisation. The book identifies the obvious problem well. It does attempt to look at the not-so-obvious problem of inequity and social risks, but does not analyse it in detail. Nor do the authors offer a framework to deal with the problems that they identify. The net effect is that the world in general – and the book in particular – leaves us with an unsettling feeling.
The reviewer is a visiting faculty member at the Centre for Public Policy, Indian Institute of Management, Bangalore