Our thinking habits are often based on simple cause-effect relations as can be seen in Newton’s mechanics, engineering and economics. However, with the coming of quantum-mechanics, interconnected computers and global interrelated economies maybe our standard cause – effect need to be replaced by systems thinking.
Systems thinking is the process of understanding how things, regarded as systems, influence one another within a whole. In nature, systems thinking examples include ecosystems in which various elements such as air, water, movement, plants, and animals work together to survive or perish. In organizations, systems consist of people, structures, and processes that work together to make an organization “healthy” or “unhealthy”.
In a recent blogpost, “Training in economics is a serious handicap” we shared David Orwell’s opinion that neo-classical economics is a dangerous doctrine. Doctrine is a codification of beliefs or a body of teachings or instructions, taught principles or positions, as the body of teachings in a branch of knowledge or belief system. He proposes a systems approach to economics, in order to avoid system risk.
Systemic risk, the risk of collapse of an entire financial system or market, as opposed to risk associated with any one entity, could be reduced by introducing the concept of robustness. It can be defined as “financial system instability, potentially catastrophic, caused or exacerbated by idiosyncratic events or conditions in financial intermediaries”. It refers to the risks imposed by interlinkages and interdependencies in a system or market, where the failure of a single entity or cluster of entities can cause a cascading failure, which could potentially bankrupt or bring down the entire system or market. It is also sometimes erroneously referred to as “systematic risk“.
To make the economy more robust David Orwell in his book Economyths – How the Science of Complex Systems is transforming economic thought – proposes:
- Modularity. Modularity is the degree to which a system’s components may be separated and recombined.
- Redundancy. Redundancy is the duplication of critical components or functions of a system with the intention of increasing reliability of the system, usually in the case of a backup or fail-safe.
- Diversity. A degree of diversity in a system can help it adapt to change.
- Controlled shut-down. If entities (banks, companies) are damaged beyond repair, they must be taken apart from the system, before it infects the whole.
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