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Professor R. Quentin GraftonCrawford School of Economics and

Governmentquentin.grafton@anu.edu.au

18 February 2010

Resilience Thinking and Economics

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Failure to Understand Resilience

“Just when risk seemed most remote on the basis of market indicators and complacency was at its highest, the system was most fragile”

Jaime Caruana, General Manager of Bank for International Settlements (quoted by Alan Mitchell in Aus. Fin. Review 13-14 February 2010)

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Failure to Understand Systems“And the human intellect, without no inkling of the immense variety and complexity of circumstances conditioning a phenomenon, any one of which may be separately conceived of as the cause of it, snatches at the first and the most easily understood approximation, and says here is the cause ”

Leo Tolstoy (1869), War and Peace Volume IV, Part XIII, Chapter 1 (translated by Constance Garnett)

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Economic Thinking

• Efficiency: a competitive market equilibrium is efficient such that all gains from trade are exhausted

• Equity: how much everyone consumes should not only be determined by resources owned by or inherent in each person.

• Market Failure: externalities in production & consumption generate inefficiencies

• Government Failure: interventions create distortions that generate inefficiencies

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Mistaken ‘Orthodoxy’• False dichotomies (markets versus

regulation; economy versus environment etc.)

• Current economic state is what matters most, not trajectories to future states (Nauru in 1980, 2000 dot com crash)

• Rules/methods successful in the past or a specific situation can be applied in general (managing the GFC)

• Linear thinking (unjustified extrapolation of past trends)

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Resilience-Economic Thinking

Economy as a complex system:

- trade-off in goals;

- actions will have unexpected consequences;

- multiple levers needed to ensure success in different states of the world;

- structure/connections matter, etc.

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Resilience-Economic Thinking

Economy as a dynamic system:- linkages across economy affects its

current & future state;- recognise the critical variables the interact

and affect many components of the system;

- current actions have long-term consequences;

- cause & effects come in loops, etc.

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Networks as Systems

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Resilience and Connectivity

# of links in trading network

1 101

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100

Pim

m

Resilience

resilience decreasing

resilience increasing

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Connectivity & Contagion

Source: Gai and Kapadia (in press)

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Remarks• Resilience thinking using networks as an

underlying framework, provides valuable understanding about phenomena: asset bubbles, financial collapses, trade, productivity, etc.

• Systems thinking using simulation as an underlying framework, provides valuable insights about policy: robustness of policy models, critical variables and policy levers, feedbacks and lags, etc.