The Butterfly Defect: How globalisation creates systemic risks, and what to do about it, by Ian Goldin and Mike Mariathasan, Princeton University Press, 320 pp, $35, ISBN: 978-0691154701
“One flap of a seagull’s wings could change the course of weather forever,” concluded Edward Lorenz, the American meteorologist and mathematician, in his research into the origins of weather patterns. Perhaps guessing that the image of a flapping seagull was unlikely to take root in popular understanding Lorenz wisely adapted his image to that of a butterfly. The “butterfly effect” is the concept that a minor change in circumstances can have a major impact at another location or at another time.
Interdependence is an essential element of the concept. It is the link through which disparate events influence each other. Connectivity is a defining feature of modern life. By 2015 global mobile phone usage is predicted to multiply twenty-six-fold over 2010 levels. Global mobile data traffic in 2010 was three times greater than total internet traffic across the globe in 2000. It is expected that there will soon be nearly one mobile device for every person in the world, 7.1 billion devices for 7.2 billion individuals.
Globalisation refers to the pervasiveness of this interdependence and the profound consequences on our daily lives, opportunities and prospects. Ian Goldin and Mike Mariathasan argue that “Globalisation has shaped our lives and options for the future … The defining characteristic of our age is increasing connectivity.” In Goldin and Mariathasan’s study, defect takes the place of effect as they argue that deeper connectivity ensures that contact and contagion are now two sides of the same coin. This is elaborated in the subtitle “How globalisation creates systemic risks, and what to do about it”.
They begin by developing a framework to explain how deep connectivity has triggered higher levels of risk, a framework which explores different aspects of globalisation, from global supply chain integration to worldwide epidemics. The conclusion is a set of principles designed to better manage the systemic risks inherent in a more interconnected world.
A valuable addition to the growing and already substantial canon of literature on globalisation and similar to works such as Nudge by Thaler and Sunstein and the earlier The Tipping Point by Gladwell, the authors convincingly argue that small changes can have huge implications and suggest that those changes can, and do, come from risks that are inherent in the systems that mediate our economy, our public health systems and even our physical supply of goods. These risks regularly lead to system failure.
The authors acknowledge and analyse the quantum of benefits due to globalisation. Higher standards of living, step-changed levels of technological innovation and wider horizons are all given their due. The economic consequences of this connectivity are immense: “Even among those who are doubtful about the benefits from globalisation it is recognised that, on average, poverty has decreased during decades of global integration.” Research by the World Bank concludes that the number of people in the developing world living on less than $1.25 per day has dropped by just over 600 million between 1990 and 2008. This period of deeper trading and financial integration has facilitated the expansion of a larger global middle class, with positive consequences for health and education levels.
The book’s horizon stretches beyond an exclusive focus on financial integration, which is welcome: the financial crisis between 2008 and 2009 brought the systemic risks of deepened interdependence into sharp focus. It does not however cover the full spectrum of the consequences of globalisation, yet the book has a wide focus: the impact of shipping containers is recognised, not just the effect of currency markets. Contagion is recognised as a disease, not just as a metaphor for the woes of interconnected national economies.
This breadth of analysis leads the authors to conclude that “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.” This complexity also conjures up deeper levels of risk and contingency. The German sociologist Ulrich Beck described this phenomenon as the “might” society; what might happen if a crisis strikes or if the financial markets collapse and the unthinkable happens? The not-knowing, he suggests, “washes all known landmarks away”. The authors propose principles for managing this upheaval.
Reference to scientific research into evolving and dynamic systems allows the identification of two strategically important developments. First, the sources of influence on individual behaviour have exponentially increased: “[b]ecause more people and persons from different backgrounds and cultures are now able to interact, their behaviours, cultures and, and risks will evolve”. Second, this work raises the difficulty of attribution with the “erosion of responsibility that occurs because our actions lead so indirectly to their effects”.
The authors pose the issue of a natural disaster disrupting a global supply chain and ask how responsibility or causality can be attributed. Is the manufacturer responsible for not taking precautionary measures or the policy-maker for not reducing the possibility of natural disasters? “Our actions,” they write, “are bound to have systemic consequences that we cannot foresee before they occur and often fail to understand afterwards.”
This radically enhanced connectivity changes the nature of risk facing individuals and policy-makers. The management and understanding of risk requires that casual links between actions be understood. The difficulty in so doing leads Goldin and Mariathasan to argue that the concept of “systemic risk” better describes the challenges of globalisation where there is the prospect of a breakdown in the entire system as opposed to the breakdown of constituent parts. This risk is demonstrated by practical examples in different policy areas.
A telling example in the energy sphere are the unintended consequences of a falling tree. At 1.58pm on August 14th, 2003 an electricity generation plant in the American Midwest was shut down due to damage caused by a fallen tree. This triggered widespread grid failures, resulting in the tripping of multiple power generators. By 4.10pm blackouts began, first in Michigan, followed by the East Coast. Fifty million people were left without power, some for more than thirty hours. The financial cost of this was estimated at between $6 billion and $10 billion.
The book analyses the dynamics of global supply chains. It suggests that accountability may be inherently stronger when success (the delivery of the product on time) is easier to measure than the performance of a stock portfolio that is subject to the vagaries of financial markets. However the very interdependence of these global supply systems is now the source of their vulnerability. For example, “just in time” delivery of components for Toyota, helping the company minimise storage costs, also made it extremely vulnerable to breakdowns in supply from outside contractors. According to the authors this meant little or no reserve stock at all. A poorly fitted floor mat and “sticky” accelerators, with little back-up stock, led to the recall of over two million cars in 2009 and 2010.
Goldin and Mariathasan develop these themes for other parts of the global economy. The provision of physical infrastructure is at risk with, for example, Heathrow operating at 98 per cent capacity and the Icelandic volcano eruption in 2010 costing the world economy $5 billion due to the disruption in trade. Similarly, reliance on the internet means cyber-crime has the potential to disrupt entire systems of government, with Estonia having suffered waves of “cyber aggression”, flooding the country with internet traffic and crashing the websites of the president, his ministers and two of the country’s biggest banks.
The authors remind the reader that the concept of contagion has a biological provenance with the risk of global pandemics. On February 17th, 2003, Liu Jianlun, a sixty-four-year-old doctor, checked into Hong Kong’s Metropole Hotel. Dr Jianlun had treated patients in the Guangdong province of China. These patients were subsequently diagnosed with Severe Acute Respiratory Syndrome ‑ Sars. While staying at the hotel, Dr Jianlun came into contact with fellow patrons who subsequently travelled the globe. This, and similar episodes, led to the diagnosis of 8,400 cases in thirty countries. By June of that year Sars was diagnosed on all continents. Connectivity enables the most virulent form of contagion. Recent and continuing fears in relation to the spread of Ebola provide a sharply current emphasis of this risk.
All of these deep opportunities and challenges are created by a transformation that is intrinsically global. The authors, therefore, advocate a global response, arguing that “the primary lesson of our analysis is that sustainable globalisation requires careful management, ensuring transparency, inclusivity and resilience as guiding principles” and that “systemic risk is no longer an abstract concept but is now something that every investor, every small business in search of funding, and every person with a savings account can relate to”.
This begins with the promotion of sustainable, resilient globalisation that builds in accountability at every stage of the physical or virtual production line. Disintermediation is continually identified as a defining policy hazard of globalisation. Complexity makes it difficult to establish political, economic or social causation. Greater focus on responsibility should foster a broader awareness of risks and more focus on their mitigation.
This continues with the fostering of transparent communication of the choices, risks and uncertainties about policy alternatives so that electorates and shareholders are, at least, aware of the potential downsides of the decisions they are making, or which are being made for them. Next, risk measurement must be improved so that we can drill through the vast amount of data and information available to us and properly plan for what may happen if those downsides come to pass. “Big data” must be harnessed to measure and then understand complex trends. Armed with these measurements, systems of incentives that encourage risk and bad choices must be recalibrated, from tax incentives from governments or bonus structures to employees. After this, we prepare for contingencies and use the wealth created by globalisation when it works correctly to create systems to respond to the problems created by the sharing of risk and complexity. Contingency planning is vital.
Finally, we must define and enforce unified legal responsibilities so that everyone knows the role they play and the blame they share should systems break down. This could see businesses and governments coming together in coalitions of the willing designed to share information, agree codes of practice and end the search for “international unanimity” that has left us ill-prepared for local changes of circumstance caused by global trends.
A crucial strength of this work is the balance afforded to both the benefits and costs of globalisation. Increases in living standards and the consequent social advances are detailed, to the likely discomfort of critics from the traditional left. Equally, the dislocations of globalisation are plainly laid out. The massive challenges of environmental risk, exacerbated inequality and the acute challenges posed by global and regional health risks are clearly articulated ‑ challenges that are not acknowledged by those who argue that deeper market-led integration is the best response to the problems created by current levels of integration.
The authors convincingly demonstrate that globalisation is at the very centre of many of the governance challenges we now face. These challenges are summarised accurately by David Held in his work on global governance when he refers to the paradox of governance as “the fact that collective issues with which we must grapple are of growing extensity and intensity, and yet the means for addressing these are weak and incomplete. Global public goods seem to be chronically undersupplied, and global bads build up and continue to threaten livelihoods.”
The principles of response advocated by the authors are of value. The tone is neither breathless in praise or handwringing in despair. Rather the authors advocate a policy framework for effective cooperation to make the best of the opportunities created by globalisation and mitigate the worst of its consequences. However their paradigm does raise two questions that are central to the political and social response to this deep change. These are the degree of irreversibility of globalisation and how individual countries, particularly, smaller countries, can respond to these global forces. The latter question is perhaps the key one facing Irish policy-makers.
This challenge must be addressed in a more volatile context. The inevitability of globalisation needs to be considered. The authors assume this is a given, and that future scenarios will involve at least the maintenance of the current levels of economic and political integration. However, at both domestic and international level, strong tides of public opinion appear solidly in favour a retrenchment of the globalist model.
In a recent article in the Financial Times, Philip Stevens argued:
The frontiers of globalisation are being rolled back … The crash of 2008 read the rites over what was to have been a seamless melding of the world’s capital markets. Banking has been renationalised as governments repudiate responsibility for anyone else’s debts … The internet faces the same process of Balkanisation … Trade multilateralism has been replaced by bilateral dealmaking and regional pacts. There is a symmetry here. China, India and the rising rest are jealous guardians of their national sovereignty. A world-weary ‑ and wary ‑ US no longer has the capacity for, or self-interest in, writing and enforcing universal rules. Vladimir Putin has delivered the most abrupt shock to those 1990s assumptions about values and interests being shared across state borders.’
Support for the theory that the high watermark of globalisation has passed can be seen elsewhere. The rise of Ukip, the Front National, the Five Star Movement in Italy and the rapid development of Podemos in Spain all point to a growing disenchantment with the distribution of costs and benefits by globalisation. Other scenarios, such as the possibility of a British exit from the EU, show that countries apparently thriving from the economic consequences of integration may still be unwilling to tolerate its political constraints.
The economic symptoms of this strain are apparent. For the first time since the end of World War II global trade growth is lower than global Gross Domestic Product growth. In the immediate aftermath of the economic crisis governments across the world implemented more than two thousand protectionist measures. Estimates indicate that approximately ten per cent of these measures were unwound. A recent analysis concluded that “Trade talks are no longer global but regional and local, threatening a destructive so-called spaghetti bowl of competing economic alliances.” By 2013, cross-border capital flows averaged sixty per cent of the pre-crisis peak, with national economies placing increasing focus on their domestic capital formation. These trends have led to the use of terms such as deglobalisation or globalisation in reverse.
Such developments should be seen in a historic context. We have been here before. Prior to the First World War, the major economies of the globe were all moving inexorably towards integration, powered by communications technology that made New York seem a lot nearer to London with the deft magic of statesmen and monarchs always seeming to co-ordinate and resolve competing political prerogatives. The British journalist Norman Angell, infamously argued in The Great Illusion in 1910 that war was futile and prohibitively costly due to trading links between developed countries.
The outbreak of war changed this utterly. With nationalism taking hold, a way through for global economic integration seemed stymied. Nations turned inwards, closing the door on globalisation and making another war inevitable. The path of history changed again, however, in the aftermath of World War Two. The Marshall Plan saw Europe rebuilt with American money and the United Nations establish far deeper roots than the League of Nations ever did. Similarly, the smooth global economic integration and growth of the 1990s would have looked unthinkable in the 1970s and 1980s when governments grappled with the consequences of the breakdown of the Bretton Woods currency agreement, two oil price shocks, stagflation and various Latin American debt crises.
This all gives rise to questions about the stability of the current equilibrium of globalisation. Stability can give way to upheaval; calm can precede a storm. These concerns in relation the apparent robustness of current levels of integration were summed up famously by Joseph Stiglitz in 2003 in his book Globalisation and its Discontents when he wrote that “If globalisation continues to be conducted in the way that it has been in the past, if we continue to fail to learn from our mistakes, globalisation will not only not succeed in promoting development but will continue to create poverty and instability. Without reform, the backlash that has already started will mount and discontent with globalisation will grow.”
Given the sudden nature of the global economic crisis from 2007 this appears an obvious risk, and it is one that could have been given more emphasis by Goldin and Mariathasan. While they do point to the need for a more resilient globalisation and do offer strategies that would make more progress towards it there is not enough focus on the risks to the current levels of political and economic integration.
This matters to Ireland, as we are one of the most globalised countries in the world. A globalisation league table , prepared by the Foreign Policy journal and AT Kearney, measures the social and economic integration of countries. It has consistently indicated that Ireland tops, or nearly tops, the globalisation league table. A separate study by the Economist Intelligence Unit and Ernst & Young indicated that Ireland was the world’s third most globalised nation as measured by GDP, and that it is the most globalised nation in the Western world. Their index has five measurements to assess a country’s individual global ranking including: openness to global trade, global capital movements, global exchange of technology, global labour movements and cultural integration. The report, drafted in collaboration with the Economist Intelligence Unit (EIU), confirms that Ireland is the second most globalised economy in culture and joint third, with Singapore, in the global movement of finance and capital.
Primary reasons for this include our open borders, the magnitude of our export performance, the importance of financial services to our economy and our absorption of foreign direct investment. Despite our recent trauma, our interdependence with external forces has not substantially lessened. A further measurement system, the KOF Globalisation Index by the Swiss Economic Institute, yielded similar insights earlier this year. It ranked Ireland as the most globalised country in the world (with Somalia as the least). This calibration also included measures of social integration. Personal cross-border contacts and the size of foreign communities were measured. Focus was placed on tourism and proximity to the global mainstream of goods and services, also the number of McDonalds restaurants and Ikea branches. Despite changes in this measurement system, Ireland has always ranked near the top in this index too.
Coincident with this consistent performance in indices of integration is a healthy long-term performance in many medium-term measures of national performance. Ireland is seventh in the World Bank’s Human Development Index league table. Despite our ongoing economic difficulties many analyses of national economic development place Ireland as one of the richest countries in the world. This level of economic performance, combined with exceptional levels of economic integration, poses the key strategic challenge for Ireland ‑ how can a small island off the coast of mainland Europe prosper within, and respond to, a globalised world? Michael O’Sullivan framed this challenge in his book Ireland and the Global Question, published in 2006. He articulated the concept of a new national question as “a desire to maintain the sovereignty and independence of the nation in the face of powerful external forces”. The key factor in maintaining this autonomy was “whether the state has a framework for dealing with the effects of globalisation on Irish society and social life”. Goldin and Mariathasan, however, write little of the challenge facing individual nation states. Their strategies for response are best suited to multilateral organisations or models of global governance. They write that “we can no longer hope to rely on national governments alone to manage global challenges”. That may be true ‑ but they will still have a vital role.
The conventional narrative would point to powerlessness by a small island nation in the face of overwhelming global forces. An expectation is that small countries have little choice but to bend in supplication to forces over which they have little control. Recent and vital debates about how Ireland entered our bail-out programme and the role of the European Central Bank and International Monetary Fund in our national fortunes point to the relevance of this debate. The clustering of small countries at the apex of different measurements of globalisation affirms the necessity of this inquiry.
However an intriguing alternative view is developing – suggesting that small countries might actually be more successful in navigating the ripples and storms of globalisation. This narrative is supported by the strong long-run economic performance of the very small states that cluster at the top of most measurements of globalisation. The “Success of Small Countries”, a recent report published by the Credit Suisse Research Institute is an example of this argument. It adds to the collection of indices and league tables by creating a further measurement system. This system integrates measures of governance, human development and economic volatility. This work leads to the creation of a “Country Strength Index”: thirteen of the top twenty leading countries in this index are small states. The leading small country is Switzerland, followed by Singapore, Hong Kong, Denmark, Ireland and Norway. Other well-performing small states include Finland, Austria and New Zealand.
In their consideration of the factors underlying this performance, the report’s authors develop the concept of “intangible infrastructure”. This is “the set of factors that develop human capability and permit the easy and efficient growth of business activity”. Factors include the quality of education and healthcare and the level of development of finance, business services and technology. The authors argue that “[i]t seems that excellence in intangible infrastructure is a small country speciality”. Of the ten countries with the strongest intangible infrastructure seven of them are small states. The conclusion of this report is that the “secret sauce of developing small countries” is “a sense of strategic planning and an awareness of the impact that outside forces (markets, trade and immigration) can have on a small state as well as the institutional ability to implement policy in these fields”.
This analysis does not ask the deeper question of why economic institutions are successful in these smaller countries, or where this “secret sauce” comes from? The nature of the ingredients are the subject of continuing research by political scientists. The Origins of Political Order by Francis Fukuyama is an example of the analysis of the success or decay of economic and political orders. Why Nations Fail by Daron Acemoglu and James Robinson is another: it argues that inclusive political institutions are the bedrock of economic sustainability. Perhaps such political inclusivity is easier to achieve in smaller societies, where the relative intimacy created by smaller and less fractured communities creates a consensus that is necessary to manage constant change. It may seem foolhardy to advance such a thesis at a time of social protest and strong political challenge. However the magnitude of Irish economic development over the last fifty years, and our successful engagement with the structural forces of globalisation, has long term political roots and support. We overlook this at our risk.
Despite the many other virtues of their analysis, Goldin and Mariathasan are silent on such questions. They acknowledge that systemic risks “would also mean that our societies would become more divided because risk affects people differentially. The lack of cohesion would make the political challenge more difficult.” However they have little to say about how governments in nation states can rise to this political challenge. This is a weakness, particularly given that the ability of national political leaders to meet the challenge is a prerequisite for creating the resilient globalisation the authors wish to see.
These challenges matters to Ireland. It is not a matter of purely academic interest or one confined to the interpreters of sophisticated indices. The efforts and skill of our farmers are the reasons that the leading Chinese baby food brands are Irish. Multinationals employ 256,000 people in Ireland; Irish companies employ nearly the same number, 246,000, in other countries. How can we best answer the new national question as posed by Michael O’Sullivan in 2006 ‑ of making the smartest use of our sovereignty as a small country in a globalised world.
The answers to this question are many and varied, stretching across all spheres of Irish public life. However some crucial principles do emerge, in my view, from our crisis and also from the huge challenges that Europe and the euro zone faced and still face. First, that a country must be able to pay for the public services that it wants from the tax yield that it generates, now and in the future. We cannot rely on the savings of other countries to achieve this, because at some point other countries might chose not to make their surpluses available to fund our schools, hospitals and social welfare payments. This is counter-intuitive, arguing for economic sufficiency at a time of deep integration. But this very integration does not diminish the searing truth that this equation must balance, and that this rebalancing can become a national trauma.
Second, that economic growth must have many engines. This should be more achievable due to the consequences of globalisation as the development of national competitive advantage is facilitated by the mobility of people, capital and ideas. This priority and the sustainability of funding for the required level of public goods for a country are inseparable. Healthy tax yields require a healthy economy; this in turn requires multiple sources of growth. Third, national cultural ease with a permeable world is essential. Making the most of freedom of movement and allowing others to do the same within your national boundaries is an antidote to the angst that can gnarl national confidence. This is essential for Ireland. It encourages our youth to acquire and develop skills elsewhere. This cultural ease welcomes others to our communities to allow them to do the same, hopeful that we can benefit from their productivity and work.
Finally, confidence that shared sovereignty is not the same as lost sovereignty. Again, Phillip Stephens, in a lecture in Dublin, noted that “sovereignty is increasingly prized but even as it is prized this sovereignty is increasingly ineffective”. Through Irish membership of the European Union we have both developed markets and deepened national access to them. Irish levels of success in aviation, financial services and technology would have been extremely unlikely occurrences without active membership of the European Union. As the enthusiasm of others for this project ebbs and flows, our solid participation offers the best way of navigating a globalised world.
This very embedding of our national economy and fortunes into global economic and political fortunes ensures that The Butterfly Defect is an analysis that is very relevant to Irish prospects. While overstating the stability of current levels of globalisation and understating the lessons for national governments, it still offers valuable strategies for creating a resilience that is in the interest of all. Whether the political centre can hold to oversee their delivery and deliver a dividend back to those who feel threatened by the fracturing change of globalisation is now a question of strategic relevance in Ireland and beyond.
Paschal Donohoe is a TD for Dublin Central and Minister for Transport, Tourism and Sport.