How to develop economic resilience

Economic resilience by design and by intervention

In this commentary Hynes et al. discuss how to strengthen systemic resilience within our economies, in other words, the capacity of a system to anticipate, absorb,  recover from and adapt to a wide array of systemic threats. They argue that there have been only a few studies that have examined how low-level market disturbances can escalate into sectoral disruption in such a way that exogenous shocks are responsible for the stochastic evolution of the economy.

So far economic recovery and or resilience is achieved through intervention, with sizable capital outflows via government stimulus, such as those to preserve financial liquidity and backstop threatened economic sectors. Such interventions may offer considerable lasting benefits to national and international economic health, but they suffer from two limitations:

• The cost of intervention may rise above and beyond the political or market capacity or willingness to sustain the debts incurred;
• The success of interventionist policies depends on impeccable timing and a precise identification of when and where to intervene.

In addition, one of the principal problems in trying to act on and improve one component of a complex system is that this will often have unexpected consequences for the rest of the system. The authors argue that structuring systems in a manner that promotes their self-organization around post-disruption recovery will ultimately better position the economic system to minimize the resources required to rebuild affected systems, and simultaneously generate greater system stability. For example, when governments allocate vast amounts of capital to preserving everything from household mortgages to payroll and labor, food and utility assistance, and various other core essentials, the intention is to aid a failing system by conferring enough resources not only to stave off systemic collapse, but also to stimulate a more robust recovery.
It is important therefore to strike a balance between systemic resilience by design (RBD) and by intervention (RBI). The differences between the two approaches is outlined below:

Systemic resilience in economics
Authors: William Hynes, Benjamin D. Trump, Alan Kirman, Andrew Haldane, Igor Linkov
From: OECD, University of Michigan, Ann Arbor, The Royal Society of Arts, Manufactures and Commerce, Carnegie Mellon University

How should public policy promote resilience

As noted in the paper above, a resilience-focused policy has to a) minimize the potential harm inflicted by unexpected shocks; and b) maximize the opportunities and capabilities to adapt and bounce back following shocks. The policy question then is how to use various policy instruments, including public investments in various stocks of capital, to achieve these aims. How can one operationalize such an approach to public policy?
Towards this goal the authors propose the use of Viability theory, an area of mathematics that studies the evolution of dynamical systems under constraints on the system state. Within a dynamic economic context, viability theory implies that the policymaker instead of looking for optimal paths, he is looking for a feasible policy (possibly a vector policy) that could maintain  economic, environmental and social variables within a closed set of constraints. Such a policy, called viable, can be obtained as a solution to a viability problem.

Policy problems are typically formulated as optimization problems. Governments are conceptualized as optimizing agents. Risky situations are modelled as outcomes with known probabilities. Under ‘radical’ uncertainty, this model collapses because possible outcomes and their probabilities are unknown. Public policy must then build resilience to ‘unknown unknowns’. Viability theory offers a superior tool for such situations than optimization. The width of the viability kernel represents a mathematical expression for the degree of resilience to unknown shocks. Policy then aims at suitable investments that expand the viability kernel. We demonstrate the design of policy using viability theory with a simple model.

Public policy, systemic resilience and viability theory
Authors: Girol Karacaoglu, Jacek B. Krawczyk
From: University of Wellington, The University of Sydney