Preface. I’m fascinated by system risks, so I’ve included this, though there’s no awareness at all of peak oil or limits to growth or that energy, not money, is the basis of civilization and foundation of every single widget made and transported. But since the next economic collapse may well be due to the financial system, and since money is how most people view the world, here are my Kindle notes. David Korowicz has the best articles about systemic risk, I review three of his publications here.
Alice Friedemann www.energyskeptic.com author of “When Trucks Stop Running: Energy and the Future of Transportation”, 2015, Springer and “Crunch! Whole Grain Artisan Chips and Crackers”. Podcasts: Practical Prepping, KunstlerCast 253, KunstlerCast278, Peak Prosperity , XX2 report
Ian Goldin & Mike Mariathasan. 2015. The Butterfly Defect: How Globalization Creates Systemic Risks, and What to Do about It. Princeton University Press.
We are so accustomed to globalization that we take for granted the products and services we consume from around the world.
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.
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
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. 2 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.
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.
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. 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.
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. There are an extraordinary 70,000 links in just one day. The right-hand side depicts the core links at 75% of the day’s activity. A more global picture of integration in the financial sector emerges when we consider finance at the multinational level. As well as increased linkages within nations, in the figure we see the corresponding evolution of foreign direct and portfolio investments. The picture that arises from these graphs is one of cross-border capital flows increasing from the late 1980s onward.
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.
Our actions are bound to have systemic consequences that we cannot foresee before they occur and often fail to understand afterward; this is true for us individually, but potentially even more so for policy makers and institutions seeking to provide guidance and management in this highly complex environment.
The potential for mutual influence leads us to the second important consequence of complex linkages, an erosion of responsibility that occurs because our actions lead so indirectly to their effects. If a natural disaster disrupts a tightly linked global supply chain, who is to blame for the resulting shortage of cars, computers, or customized machinery? Is the owner responsible for not taking sufficient precautions? Is the manufacturer to be held accountable for operating in a risky location? Is the distributor at fault for using the supply chain without backups? Did the local government fail in its urban management duties by licensing an exposed area for industrial use? Is climate change the reason the disaster occurred in the first place? In this area, as in the case of financial crises, pandemics, and other highly complex cascading risks, it is increasingly difficult to identify the root cause of a hazard or even the channels of its transmission. Increasing global integration is making this task harder.
Complex system researchers Dirk Brockmann, Lars Hufnagel, and Theo Geisel simulated the effects of a single individual infected with severe acute respiratory syndrome (SARS) placed anywhere in the world using data that accounted for 95 percent of the entire global civil aviation traffic and assuming virulence equivalent to that of SARS. 32 Whereas in previous centuries the insular nature of parochial communities would contain such an infection and give the authorities time to consider their options, now two plane journeys on average would require the vaccination of 75 percent of the world’s population to avoid a global pandemic. After three flights, global vaccination would be required.
Analogous patterns of infectious risks spreading throughout the world can also be observed within the economic and infrastructural spheres. By 2009 the global financial crisis that began in 2007 had triggered losses of $4.1 trillion, with its effects felt in every world market. 34 Earlier events exhibited the same pattern of system-wide failure. The widespread implications of the 1929 Great Crash and the more recent 1987 stock market crash show how, already in the twentieth century, world systems were integrated and highly sensitive to distant shocks. More recently the turmoil of 1997–98 that began with the devaluation of the Thai baht led to the financial contagion associated with the Russian loan default, the collapse of the hedge fund Long-Term Capital Management, and crises across Asia.
the specification of contingencies becomes progressively more difficult as transport, communication, and financial and other world systems become increasingly integrated. This is because we start to lose sight of the effects of individual actions, introducing uncertainty and hazard. Given the pace of change, the traditional concepts of risk have become increasingly inappropriate as a basis of modern global governance. This means that the notion of risk needs to be expanded to include nonstochastic elements that cannot be easily quantified or defined using traditional tools and formulas from probability theory and mathematics. The classical distinction between risk and uncertainty is beginning to unravel, in our view, due to rising complexity and the difficulty of classifying real-world phenomena as either of these two. Additional concepts are increasingly required to understand the “possibility” or risk of failure in an increasingly complex and connected world where assigning probabilities to risks is becoming more difficult.
Systemic risk refers to the prospect of a breakdown in the entire system as opposed to the breakdown of individual parts. Implicit in this definition is the understanding that risk and uncertainty become more virulent in systems as the number of linkages grows. A “systemic risk” is a risk of a “common shock which is not the result of direct causation but … [of] indirect impacts.” This distinction is crucial because it underlines the fact that it is increasingly difficult to identify direct causality for outcomes.
- A large shock or “macroshock” triggered when relatively modest tipping points, breaking points, or regime shifts hit their thresholds and produce large, cascading failures in most or all of the system.
- A shock propagated through a network via risk sharing (transferring) or contagion (transmission and amplification). The latter involves a cascading failure, that is, the “cumulative losses [that] accrue from an event that sets in motion a series of successive losses along a chain of institutions or markets comprising a system.” 46 3. A “common shock,” which is the result not of direct causation but of indirect effects. These indirect effects can be just as important as direct effects if not more so. 47 Systemic failure is also characterized by “hysteresis,” whereby the effects are much less resilient to recovery and are in some cases irreversible.
efficiency concerns rather than strategic political choices or logistical issues that determine the locations of production facilities, financial centers, and organizational hubs. These efficiency concerns have created a new class of geographical or spatial risk. We can divide this new type of risk into two categories: vector risk and density risk.
urbanization and heightened population density in cities. The risk that arises from these is illustrated best in the context of biological hazards and the transmission of viruses and diseases. One noteworthy study estimates that the breakdown of biogeographic barriers and the introduction of invasive species cost the world in excess of $120 billion annually. This cost includes that of the rise of pathogens that directly affect the health of humans, livestock, and animals.
second geographical risk, density risk, relates to the growing concentration of activities in solitary or a small number of world epicenters. The global financial system is effectively rooted in New York and London, and global electrical manufacturing is concentrated in certain regions of China and Hong Kong, while Thailand produces 40 percent of the world’s hard disk drives. Silicon Valley continues to be the central hub for most IT engineering and innovation.
When the Nock-ten typhoon hit Thailand in 2011, it affected car and computer manufacturers all over the world because profit-driven outsourcing had led many firms to the same cost-efficient location.
What these instances had in common is that the source of the economic hazard in each case was entirely geographical. Had the financial system been less concentrated in lower Manhattan, the impact of the 9/11 attacks would have been felt, but the financial repercussions would have been lessened.
There are numerous reasons to be concerned about globalization. Our focus is on the systemic risk that is embedded in the current wave of globalization and the complexity it engenders, which give rise to uncertainty and unintended consequences, including the erosion of the responsibilities of individuals and firms. These unintended outcomes are “externalities” because profit-maximizing agents do not incorporate these social costs in their cost–benefit analyses. Systemic risks may thus be considered a contemporary manifestation of the tragedy of the commons. Exploiting Ricardo’s comparative advantage creates efficiency gains but simultaneously fosters interdependence. Using the benefits of trade leads to output growth but also to inequality.
The Internet has increased transparency and the flow of information but equally has the potential to facilitate the spread of rumors and panics as well as cybercrime and aggression.
Container traffic accelerates the transport of goods but enables the proliferation of illegal trade in weapons and spreads viruses and diseases.
Efficiency promotes “monocultures” of products and production and removes the fat that provides a cushion against shocks. Although in agriculture it has long been understood that monocultures are particularly susceptible to disease and extreme weather conditions, these simple insights have been neglected in other domains.
The global financial system has become more interconnected than ever before over the past decade due to policy and regulatory changes that have opened markets combined with the massive surge in computer power described in chapter 1. The increase, however, comes at the expense of a much higher potential for cascading collapse,
It also has been associated with a higher level of dependence on computer systems, which increases the vulnerability of markets to technical failures, human error, and cybercrime. More computing power implies greater complexity in code, increasing the potential for breaches of cybersecurity and also the potential for bugs.
Errors occur not only due to poor programming or interfacing problems but also as the result of human interaction with computers. The most notorious of these mistakes are so-called fat-finger trades, which occur when a trader mistakenly enters the wrong amount for a trade, for example, by keeping a finger on the “0” key on the keypad and adding an additional order of magnitude. On 18 September 2012 a fat-finger trade caused major market volatility when the shares of Rowan Cos., National Oilwell Varco Inc., and other oil drillers and equipment manufacturers jumped between 3 and 9%. Relying heavily on computer systems carries the inherent risk of unanticipated errors and mistakes as well as increasing vulnerability to cyberfraud or cyberaggression.
Global financial concentration also increased. The share of the top three banks increased from 10% in 1990 to 40% in 2008 in the United States and from about 50% in 1997 to almost 80% in 2008 in the United Kingdom. Such significant increases in market concentration lead to implicit bailout guarantees by the state in the event of insolvency. These guarantees, as the 2007/2008 crisis shows, can quickly turn into explicit guarantees that erode market discipline and encourage the largest banks to take on excessive risks, safe in the knowledge that they will be rescued if something should go wrong. Moral hazard thus fuels systemic risk
Concentration as a source of systemic risk is not found just in the financial system, however. A number of studies show how concentration in commodity networks also enables firms to exert control over suppliers, “making them captives.”
Financial traders have invented new ways to trade and to gain access to credit. Though marginal at the turn of the century, credit default swaps, collateralized debt obligations and the resale market for capital had all become ubiquitous operations by 2008. In less than a decade the over-the-counter derivative market expanded to 10 times global GDP, or roughly $600,000 billion.
Until 2002, banks issued more corporate debt than asset-backed securities. In 2005, however, banks issued almost twice as much in complex asset-backed securities as in corporate debt. The same trend can be observed when looking at the global issuance of collateralized debt obligations, which increased by a factor of five between 2002 and 2006
Securitization is the process in which banks repackage a number of risky assets (for example, mortgages, credit card receivables, and student loans) and sell claims to different parts of the return stream. Although securitization in itself might not be destabilizing, excessive securitization has a number of detrimental effects, including excessive opacity and complexity. One important reason for the excessive transfer of risk through securitization was that this process was a convenient method to reduce the amount of capital required for a certain risk. The models on which regulatory capital requirements relied had a tendency to overlook tail risks. This loophole was exploited by banks that took $100 worth of loans for which they had to hold $8 of capital to generate a $100 security for which they had to hold much less, if any, capital. This regulatory and ratings arbitrage made it increasingly attractive for banks to engage in securitized lending. It also implied that the banks’ assets received favorable pricing.
With the endorsement of rating agencies, banks were able to combine small, risky individual mortgages into one large apparently riskless security.
When banks started issuing securitized assets they engineered a way to increase the share of highly rated assets and subsequently reduced the amount of capital they had to hold. In combination with light-touch regulation, securitization allowed banks to leverage up to unprecedented levels. Through securitization, risks could also be transferred to legal entities called special-purpose vehicles (SPVs). These vehicles in certain respects were like a bank, with the crucial difference that they were not subject to regulation. Moving risks to these SPVs was possible due to loopholes in the existing regulatory framework. And even if regulators had wanted to go after such SPVs they could not have done so because these legal entities were set up in places like the Cayman Islands, Liechtenstein, and other regulatory and tax havens. Banks then issued guarantees to the SPVs, which in turn enabled them to issue short-term liabilities (so-called asset-backed commercial papers) to outside investors.
These investors often were very large insurance companies or mutual funds that could not have invested in risky loans but were allowed to purchase these seemingly riskless securities. This apparently endless cycle resulted in a systemic maturity mismatch that ultimately led to a breakdown of markets once “the fuse was set on fire” and Lehman Brothers filed for insolvency. Securitization allowed banks to transfer large risks off their balance sheets, making credit available to investors with a seemingly insatiable appetite for allegedly riskless assets. When banks started leveraging instead of creating larger capital cushions, they were able to expand their balance sheets substantially. More and larger deals led to higher profits for the banks. Yet most of the profits from leveraging were not used to capitalize the banks but were paid out either as dividends or as bonuses, typically based on short-term successes such as revenue increases in a given quarter.
The maturity mismatch that ultimately led to a breakdown of markets once “the fuse was set on fire” and Lehman Brothers filed for insolvency. Securitization allowed banks to transfer large risks off their balance sheets, making credit available to investors with a seemingly insatiable appetite for allegedly riskless assets. When banks started leveraging instead of creating larger capital cushions, they were able to expand their balance sheets substantially. More and larger deals led to higher profits for the banks. Yet most of the profits from leveraging were not used to capitalize the banks but were paid out either as dividends or as bonuses , typically based on short-term successes such as revenue increases in a given quarter.
Bankscope, https://bankscope2.bvdep.com/ . A major contributor to instability was the fact that poorly designed remuneration schemes for senior executives and traders favored short-run profits and asset accumulation over prudence and stability. Bankers responded to these incentives, so it should not come as a surprise that they were primarily concerned with maximizing their returns (for example, through leverage) and minimizing each individual’s risk exposure. With the rise of securitization, bonuses on Wall Street tripled within six years, reaching an all-time high of nearly US$35 billion in 2006. The trend did not stop there, though. Even when bonuses were declining, generous dividends were still paid. In 2008, when the crisis reached its pinnacle when the insolvency of the U.S. investment bank Lehman Brothers was declared on 15 September, bonuses and dividend payments totaled about US$130 billion.
The rapid expansion of the sector was aided by a political culture that favored deregulation at the national level, along with resolute noncommittal to international regulation. Due to international competition among the various financial hubs around the globe, a race to the bottom led to the reduction in already weak regulatory standards. In the short term this provided more financial activity, higher revenues, more taxes, and more growth and explains why so many policy makers argued that their domestic financial system had to become “more competitive,” which they took to mean bound by less regulation.
The culture of deregulation became entrenched worldwide despite the efforts of groups such as the Basel Committee on Banking Supervision and warnings of a number of the world’s foremost economists. 3At the height of subprime lending in the United States, the attorneys general of all 50 states were seeking to investigate these risky practices but were “blocked by a coalition of major banks and the Bush administration,” which used the archaic National Banking Act of 1863 to prevent state-level action. In the United States, the world’s largest national financial market, legislation such as the Glass-Steagall Act had aimed to foster financial stability since the Great Depression. Commercial and investment banking activities were separated, reducing speculation and risk taking by stopping banks from “gambling” with savings. In the decades after Glass-Steagall’s ratification, however, administrations convinced of the merits of uncontrolled capital flow began to undermine such efforts. The repeal of the Glass-Steagall Act by the Gramm-Leach-Bliley Act in 1999 constituted the final removal of the divide between commercial and investment banking.
Now nothing prevented multiple claims from being made against debtors or the implicit extension of deposit insurance.
In order to remain competitive with the U.S. financial market, the European economies felt compelled to create matching opportunities for investors and similarly succumbed to deregulatory pressures.
National deregulation and an integrated market led to a global financial network that Andrew Haldane from the Bank of England has described as a “monoculture.”
At the same time that regulators were stumbling, the collapse of the U.S.-based hedge fund Long-Term Capital Management following the 1997–98 financial crisis signaled that banks deemed “too big to fail” could expect to be bailed out by national governments.
Implicit government guarantees had a substantial impact on banks’ funding costs. One estimate puts the yearly reduction in funding costs due to implicit guarantees at between US$70 billion and US$120 billion between 2002 and 2011. Implicit guarantees are effectively a transfer of wealth from taxpayers to the financial system.
In the buildup to the crisis, the global financial network could be likened to “the dynamics of ecological food webs” or “networks within which infectious diseases spread.” Within these networks an increasing number of nodes and links, along with the corresponding opportunities to trade and share risks, created the illusion of enhanced financial stability.
In a model of fire sales and market breakdowns, banks face an inherently uncertain environment when assessing counterparty risk. In a network of interbank lending the default risk of a bank depends on the default risk of all the banks’ counter parties. This, in turn, depends on the default risk of the counterparties of counterparties, and so on. It follows that complexity can make healthy banks reluctant to buy, which can lead to the evaporation of liquidity and the breakdown of markets.
Regulation itself has become increasingly complex. Whereas Basel I, the predecessor of the current Basel III agreement, had a total length of 30 pages in 1988, by the time Basel III is fully implemented in the United States it will take up to 30,000 pages.
The connectivity that had enabled rapid growth suddenly turned to amplifying and spreading systemic risks.
Haldane argues that connectivity is a knife-edge property. Up to a certain point, financial networks and interbank linkages serve as a form of mutual insurance of the financial system and thus contribute to systemic stability. Beyond this point, the same interconnections might serve as shock amplifiers and thus increase systemic fragility.
If a number of banks hold identical or similar assets, this correlation between their portfolios can give rise to a fire sale that is typically associated with significant losses for a large number of banks.
The main idea behind information spillovers is that the insolvency of a bank can increase the re financing costs of the surviving banks—especially in times of crises, when financial markets exhibit herding behavior.
Although a growing chorus of economists cautioned against unchecked deregulation, the mainstream of the profession saw the lowering of transaction costs as economically sensible. These economists provided cover for those in government and business who were un willing to curtail the flow of cheap credit that was driving consumers’ confidence and sense of good fortune. It is never easy to turn off the music or take away the punch bowl while a party is in full swing. Politicians who profited from the bubble in credit and expectations, along with bankers who were intoxicated by bonuses, not surprisingly resisted attempts to enforce tighter standards. Profit overtook reason and common sense. It was not simply the case that institutional procedures were too sluggish to respond to policy directives, or even that politicians and regulators simply ignored expert warnings.
Globalization has facilitated the widespread creation of extensive supply chains, defined as systems of organizations, people, technology, activities, information, and resources involved in moving a product or service from supplier to customer.
China used the power of its economic dominance in the production of this key commodity during a maritime conflict with Japan and blocked the exports of rare earth elements. This episode shows how supply chain dependencies can be exploited to achieve strategic geopolitical goals.
“Globalization requires greatly increased co-ordination of transport by road, rail, sea, air and now also by an entirely new route to market: the internet. This makes logistics vastly more complex. The job of ensuring that all these things work together is known as supply-chain management.”
Between 1951 and 2004, the average annual growth rate of world trade was 5.7 percent.
Declines in the cost of shipping and air transport now make it both possible and profitable for supply chains to operate across a wider range of countries. Companies today function transnationally, outsourcing everything from manufacturing to engineering as raw and processed materials flow from one continent to another.
There was an extraordinary eight-fold increase in China’s exports between 1999 and 2008.
The standardization of container size and freight technology made international transport easier by substantially reducing transaction costs, the virtual world experienced a parallel standardization with the invention of the Internet Protocol Suite, which significantly simplified communication between disparate networks and across borders. World container traffic was almost seven times as high in 2008 as in 1988; in the intervening period, the Internet fundamentally transformed our commercial habits. These two trends were not unrelated.
Toyota relied on efficient transportation platforms and data exchange networks to deliver parts when they were needed but not before. This “just-in-time” manufacturing helped to cut muda and was essential to the “Toyota Way.” Toyota also pioneered the practice of supply chain fragmentation, outsourcing the manufacture of various components to subsidiaries around the world. It was the first company to recognize that by leaving the production of individual parts to specialized suppliers it could optimize efficiency and operate more cost-effectively. This quest for efficiency moved Toyota to open multiple manufacturing facilities in over a dozen countries worldwide. The firm overcame geographic, linguistic, and cultural barriers to search out the most cost-efficient locations, balancing production costs, speed to market, and access to labor.
The prevailing logic of supply chain management today is that the production of goods, where possible, should be outsourced to the most cost-efficient provider.
The strategy of fragmenting supply chains into outsourced locations has proved so profitable that it is now a management standard in many manufacturing industries. The example of flooding in Thailand illustrates what can happen when centers for outsourcing experience problems or, as the Economist puts it, “when the chain breaks.” The reason that so many different industries were so severely affected by the floods was that cost-minimizing locations such as Thailand tend to be seen to address a range of efficiency concerns. Low taxes, low wages, liberal regulation, and other incentives make specific locations attractive across industries. Although one generally thinks of globalization as a process involving a multiplicity of locations, and thus a geographical diversification of risk, in practice it has also resulted in a concentration of risk and instability. By allowing these nexuses to arise, the world is literally putting all its eggs in one basket and leaving itself vulnerable to highly disruptive hazards.
It can be highly beneficial for an individual student or firm to learn from techniques and procedures that have proven to be successful in the past (the use of best practices). The standardization of management education, however, impairs the ability of graduates to draw from their diverse backgrounds and to react to unexpected circumstances. Uniform teaching of textbook techniques ensures efficiency during standard periods and thus responds well to standard tests. These techniques, however, are unprepared to respond to unexpected circumstances or to react to rare events. With the proliferation of management education, there is standardization and shared models of how to deal with risk. This means that when an event occurs that is not predicted by textbook analysis (and we know from our discussion of global complexity that this is increasingly likely), all managers will be similarly unprepared and will respond in a similar fashion. Systemic risk is, by its nature, surprising. In the face of unusual challenges, there is no manual or textbook response. Ingenuity and the pooling of different perspectives are required. Responding to systemic risk requires managers who can think originally and draw on a heterogeneous set of perspectives to come up with novel solutions to often uniquely testing circumstances.
Researchers at the WTO, for instance, have shown that there is a “resonance effect” between supply chains and monetary circuits. 38 They provide evidence of cross-sectorial systemic risk and identify international supply chains as potential conduits for the spread of financial shocks.
National Strategy for Global Supply Chain Security issued by the White House in January 2012 marks an important step toward containing supply chain risks.
it also raises awareness of the threat of an “adverse impact” on “global economic growth and productivity” that would result from natural disasters such as earthquakes, tsunamis, and volcanic eruptions.
As in the financial sector, it appears that highly interconnected firms lack the resources to appraise all of their risk factors. This is in part because such risks extend to their trading partners, subcontractors, suppliers, and others,
Here complexity not only interferes with the ability of companies to manage risks; it also, as in finance, affects the capacity of regulators to monitor instability.
The effects of outsourcing and subcontracting in global supply chains are in many ways comparable to the effects of securitization and secondary market trading in the financial sector. All of these innovations can diversify risk and may be profitable for individual firms, yet they also fail to account for their negative externalities and the creation of systemic risk. The result in both cases is that profit-driven firms inject unsustainable fragility into the global economy. Supply networks and financial networks are not independent of each other. Whenever a commodity is sold from a supplier to a retailer, the supplier faces the risk that the retailer will file for insolvency after obtaining the good but before making the appropriate payment.
Supply chain risks include everything from natural hazards, terrorism, pandemics, and data security to demand variability and supply fluctuations. Fierce competition and tight margins can further magnify the impact of a supply chain failure on a business…. Economic pressures exacerbate supply chain–related risks particularly in relation to supplier viability given tightening credit markets, downward pressure on costs, and shrinking consumer markets.
Because infrastructure underlies all other sectors, shortcomings in infrastructure spread to other domains with particular virulence—an electrical glitch can lead to a financial collapse, an airport closure can disrupt a global supply chain, and an Internet crash can destroy communications arrays, with infrastructure collapses quickly cascading across sector boundaries. Second, the growing complexity of infrastructure systems and the significance of a small number of increasingly connected nodes mean that particular pinch points in the system are sources of instability.
A few oil refining and transshipment centers account for most U.S. fuel. Power, communication, financial, and other systems are increasingly geographically concentrated, with little real option to relocate. The pace of population and economic growth and the rapid rise in connectivity and technological change mean that in much of the world the supply of infrastructure has lagged further and further behind demand. Many of the networks on which existing transport, water, and sanitation systems rely in the advanced economies are more than 50 years old and in some cases more than a century old and are operating well beyond their design capacity. With the economic crisis reducing the capital allocated to investment in new building and maintenance, a growing number of societies are suffering from increased aging of infrastructure.
Complexity and efficiency.
Today transport networks are operating at close to capacity, and choke-points such as airports (for instance, Chicago’s O’Hare) or junctures (for example, the Suez Canal) process significant shares of regional and even global traffic with wafer-thin margins of flexibility. Through economies of scale, key ports can process far more traffic than smaller competitors and can claim ever-larger regional shares. Similarly, cargo lines using larger and larger ships and planes to transport goods efficiently in bulk have managed to push smaller players out of the market. An over-reliance on critical nodes and lines means that natural disasters and human error are more likely to be amplified and become systemic failures. The second dimension of systemic risk in infrastructure is that, as well as creating a risk of cascading failures, globalization has increased the vulnerability of these critical nodes. As many infrastructure systems become outdated and are under-monitored, they become more vulnerable. High-volume traffic means that there is little time for maintenance. Meanwhile, the international nature of these nodes makes national regulation incomplete and less effective. These two risks can be illustrated simply: complexity means that a failure at one node (for example, an airport) is likely to have systemic consequences that could easily affect multiple sectors of the economy, multiple countries, and millions of only indirectly connected global citizens. Vulnerability means that this one node is more likely to
Environmental disruptions lead to extreme weather conditions and diseases that originate from the ecosystem and put vital systems (such as those for food and energy supplies, telecommunications, and manufacturing production) at risk. The two aspects of environmental risk are linked; as globalization creates risks to the environment, the resulting ecological disruptions cause risks from the biosphere.
Rising water levels resulting from melting ice caps put large numbers of people at risk. More than half of the world’s population lives within 60 kilometers of shorelines, and the rising tides are likely to bring flooding, the contamination of groundwater and crops, and the destruction of homes and livelihoods.