Foreign direct investments in Eurasia: too little and from the wrong places?

By Peter Havlik, senior economist and former deputy director at the Vienna Institute for International Economic Studies.

Foreign direct investment (FDI) has been the main driver of restructuring and modernisation of many countries’ economies. In Central and Eastern Europe, FDI has been instrumental in both privatisations of state-owned enterprises and in launching new investment projects. FDI flows in manufacturing have created modern, competitive, export-oriented industries and generated export revenues. However, FDI flowing into the services sectors (including finance and insurance but especially retail trade and real estate) have been more controversial since they boost import demand rather than create new export opportunities.

Global FDI flows are highly volatile and there is no straightforward explanation for such fluctuations. In 2016, FDI to Russia went up sharply, partly because of a single large transaction related to the oil company Rosneft; flows to Kazakhstan recovered as well. FDI flow into Ukraine also increased in 2016, primarily due to bank recapitalisations (reorganization of how a corporation finances its assets) and the privatisation of some companies with the participation of institutional investors such as the European Bank for Reconstruction and Development. FDI flows to Georgia were relatively high in 2014-2016, presumably thanks to the implementation of the Deep and Comprehensive Free Trade Areas (DCFTA), three free trade areas established between the EU, and Georgia, Moldova, and Ukraine. A similar trend, albeit at a much smaller scale, was observed in Moldova.

© Number1411

DCFTA countries have been laggards with respect to attracting FDI, largely due to ‘frozen’ conflicts over disputed territories and a poor investment climate in general. Moreover, FDI in the DCFTA countries, similarly to Russia, have a skewed geographic origin: in Ukraine, for example, more than 30% of FDI stocks originate in Cyprus; the share of FDI from Western Europe was just 36% of total FDI stocks in 2016. The extremely high shares of Cyprus and other offshore destinations indicate that this kind of FDI most likely just represents a recycling of domestic capital flight— when assets or money rapidly flow out of a country—and possibly also tax evasion. One can probably safely assume that this kind of FDI is also not particularly conducive to upgrading and modernising the economy. Progress towards institutional reforms in general would therefore instead result in diminishing the shares of FDI that originates from offshore.

The experience of EU countries in Central and Eastern Europe (EU CEEs) indicates that FDI inflows have significantly contributed to the modernisation and restructuring of their economies (about 80% of FDI there originates from Western Europe in contrast to less than 40% in Russia and Ukraine). FDI in the manufacturing industry, business services such as IT, software development, and logistics, has been especially beneficial. Such investments have been particularly welcome as they help to establish competitive export-oriented industries (the successful German-CEE automotive cluster is a case in point). After EU accession, foreign investors have to be treated as domestic ones. Recently, though, a renewed economic nationalism in some countries, such as in Hungary and Poland, has resulted in selective treatment of investors by economic sectors, causing a de facto restriction of foreign investment in banking, trade, etc.

However, it is not just the volume of the registered FDI and its origin that matter; its sectoral composition, investors’ motives, and other FDI structural and ‘quality’ characteristics are also important. In EU CEEs, the bulk of FDI has been concentrated in manufacturing, trade, and financial services: each of these three broad sectors account for about 20-30% of total FDI stocks. In this respect, the DCFTA countries are not very different from Hungary, Poland, Romania, or Slovakia. As far as Eurasian Economic Union countries are concerned, most FDI has been concentrated in energy and mining sectors (especially in Kazakhstan and Russia). In Moldova, Ukraine, and Romania, there are some (small) foreign investments in agriculture. The energy sector is an important FDI target in Georgia, Moldova, and Romania (there are no comparable data for Belarus).

How to explain the huge differences in various FDI structural characteristics across individual transition countries? A number of factors definitely play a role: geography, size of the country, resource endowments, costs and skills of labour, government FDI policies and the investment climate in general. According to the latest World Bank Ease of Doing Business survey for 2018 (published on 31 October 2017 and registering big shifts in ranking scores), Eurasian Economic Union and DCFTA countries received the following ranking (out of 190 countries surveyed): Georgia (9), Poland (27), Russian Federation (35), Kazakhstan (36), Belarus (38), Slovakia (39), Moldova (44), Romania (45), Armenia (47), Hungary (48), Azerbaijan (57), Ukraine (76) and Kyrgyzstan (77). Russian Federation, Kazakhstan, Belarus and Georgia were among the top 10 countries which have managed to improve their ranking recently.

In conclusion, the analysis from the forthcoming IIASA Fast Track FDI study implies that Eurasian Economic Union and DCFTA countries have not been particularly attractive for foreign investors; and if ‘round-trip’ inflows from offshore are excluded this issue is even more evident. This goes a long way to explaining why restructuring in the region has stalled. This pattern can change only with marked improvements in the domestic regulatory environments and investment climates. FDI inflows should also be promoted by pro-active government policies (at national and regional levels) which focus on attracting FDI in manufacturing and business services in order to assist restructuring and modernization.

Note: This article gives the views of the author, and not the position of the Nexus blog, nor of the International Institute for Applied Systems Analysis.

Myths are not true… or are they?

By Gerid Hager, IIASA Ecosystems Services and Management Program

©Gerid Hager | IIASA

In July, Miranda Lakerveld, a music drama artist and founder of the World Opera Lab, visited IIASA to run two storytelling workshops with young actors in civil society and youth policy, as well as with YSSP students and IIASA staff. Miranda first came to IIASA in September 2016 as part of the Citizen Artist Incubator.

After the workshops in July, Miranda and I sat down for a chat.

Gerid: Miranda, in the workshop you shared how you approach storytelling in your artistic practice. You said: “I’m looking for moments that feel true, I pick them up and weave them together into new stories.” Then, a participant exclaimed: “Stories are not true!” It seems a contradiction, but possibly this is the very nature of stories. They might not be true, giving accurate accounts of past events, but they carry truths in them, which we so often can’t capture otherwise. You’ve been working with myths for a long time: What value do you see in them today, as we’re trying to navigate between “alternative facts” and often incomprehensible scientific writing?

Miranda: Yes, this was a short reflection on the methodology I have developed and applied in many different contexts over the last eight years. It uses comparative mythology as a starting point. The aim of the method is to create a meaningful creative exchange that can involve people from all walks of life. Myths are examined from the perspectives of different cultures, and through this intercultural lens, we find symbols and archetypes that resonate as ‘true across cultures.

The ‘post-truth’ era made us extra aware of the divides between communities and I believe such an embodied practice of mythology can be an inspiring place for people to meet. I think the renunciation of facts and scientific insight is a symptom of people feeling left out and angry. Using myths and stories can be one way to bring people together and find common truths.

This workshop was part of the Systems Thinking for Transformation project and we wanted to search for “systems stories” in ancient narratives. We arrived at a very personal story of endurance and adaptation, pondered the power of great nature and cyclical behavior on a very large scale, and discussed economic justice and its relation to sustainable development. How does one story from Greek mythology – the Hymn to Demeter – lead to such diverse considerations?

The development of myths and folk stories has very specific characteristics, which I like to compare to ecosystems. Symbols and characters create organisms in constant interaction with their environments. Through time, myths change, in fertile circumstances the stories flourish, and layers of meaning are added.

Participants relate the Greek myth to myths from their own cultural backgrounds, and then to their personal histories. Interestingly, in the encounter between the myth and a group, some deeply felt preoccupations spring up from under the surface. I am still not sure how this happens. It probably has to do with a combination of embodiment of the characters, the richness of the archetypes, and the mise en scène, which represents the people inside the larger system.

Majnun & Leyla- World Opera Lab 2016- photo by Fouad Lakbir

One integral part of systems thinking is to be able to consider and explore multiple perspectives on a problem or situation. How does the embodiment exercise come in to this?

Slipping into different characters from the story is an essential part of the process. It unlocks the creative imagination and is related to action in society. The Greek root-word for drama is “dran”, which means “to act”. Through embodiment we can take the position of another character or force in the system. The performing arts make this possible: we can take on different roles, understand new parts, and at the same time experience the whole system from a new perspective.

There are other examples of how art and science meet through storytelling. A researcher at Berkeley University teamed up with story artists from PIXAR to help researchers create better stories about their research. What interests you in working with scientists and what is the role of storytelling?

I think the collaboration between art and science could go far beyond creating stories about research. We see very different approaches of creating and transmitting knowledge. So we have to deal with this tension but an inclusive society also means we should value these differences. The academic world has created an intricate system of validating knowledge leading to very specialized fields of research. Artists work on larger ideas, but the output cannot necessarily be validated. We are trying to grasp truths about the same river, but we work from opposite river banks. I think we can build bridges and increase our ability for insight and action by telling stories together.

This article gives the views of the author, and not the position of the Nexus blog, nor of the International Institute for Applied Systems Analysis.

Interview: An empirical view of resilience and sustainability

University of Tokyo researcher Ali Kharrazi credits the 2012 IIASA Young Scientists Summer Program (YSSP) with strengthening his passion, and giving him the research skills, to make a positive impact on humanity and sustainable development. He continues to collaborate with the institute as a guest researcher.

Ali Kharrazi

What is your research focus?
I’m currently examining both theoretical and empirical dimensions related to resilience and the wider application of sustainability indices and metrics. Towards this end, I have lately completed a literature review of empirical approaches to the concept of resilience, examined the resilience of global trade growth, and examined the resilience of water services within a river basin network.

My future project includes the examination of the application of modularity for resilience and its impact on other system characteristics of resilience, such as redundancy, diversity, and efficiency. In addition, I am collecting more data on the water-energy-food nexus, to empirically examine the resilience of these critical coupled human-environmental systems to various shocks and disruptions. I am working with other researchers towards channeling the emergence of urban big data towards practical research in sustainability indices and metrics, especially those which are related to resilience. Finally, I am engaged in what may be called ‘action research’ towards better teaching and engaging the concept of resilience to students.

How do you define resilience for a layperson or a student?
At its simplest, resilience is the ability of a system to survive and adapt in the wake of a disturbance.

The concept of resilience has been dealt by various disciplines: psychology, engineering, ecology, and network sciences. The literature on resilience relevant to coupled social-environmental systems therefore is very scattered,  not approached quantitatively, and difficult to rely upon towards evidence based policy making. There are few empirical approaches to the concept of resilience. This makes it difficult to measure, quantify, communicate, and apply the concept to sustainability challenges.

In a recent study, Kharrazi explored the resilience of the Heihe river basin in China ©smiling_z | Shutterstock

What is missing from current approaches of studying resilience?
There is a need for more empirical advancements on the concept of resilience. Furthermore, empirical approaches need to be tested with real data and improved for their ability to measure and apply in policymaking. If you look at the Sustainable Development Goals (SDGs) the concept of resilience is used numerous times, however the indicators used to reflect the concept need to be improved to better reflect the elements of the concept of resilience. This includes the ability to consider adaptation, the ability to integrate social and environmental dimensions, and the ability to evaluate systems-level trade-offs.

We need to apply the different empirical approaches to the concept of resilience towards real-world sustainability challenges. With the emergence of big data, especially urban big data, we can better apply and improve these models.

How did you personally become interested in this field of research?
I always wanted to make a positive impact for humanity and our common interest in sustainable development. When I first started my PhD, my PhD supervisor at Tokyo University, Dr. Masaru Yarime, told me to always set your sight on the ‘vast blue ocean’ and how as researchers we should dedicate our time to  critically important yet less researched areas. Given the global discussions of SDGs and the Agenda 2020 at that time I became interested in the concept of resilience, its relationship to common sustainability challenges, and our inability to measure and quantify this importance concept. My research stay at IIASA and YSSP and especially my experience with the ASA group strengthened my passion to contribute to this area and therefore since my PhD I have continued to research in this area and apply it to various domains, such as energy, water, and trade.

How would you say IIASA has influenced your career?
Without IIASA and especially the YSSP in the Advanced Systems Analysis program, my academic career would have never taken off. I am truly indebted to the YSSP, where I learned how to engage in scientific research with others from diverse academic and cultural backgrounds and most importantly had the chance to publish high quality research papers. IIASA also gave me the chance to get experience in applying for international competitive funding schemes and truly believe in the importance of science diplomacy and influence of science on global governance of common human-environmental problems in our modern world.

Follow Ali Kharrazi on Twitter

Ali Kharrazi, second from left, received his certificate with other participants of the 2012 YSSP

References
Kharrazi A, Akiyama T, Yu Y, & Li J (2016). Evaluating the evolution of the Heihe River basin using the ecological network analysis: Efficiency, resilience, and implications for water resource management policy. Science of the Total Environment 572: 688-696. http://pure.iiasa.ac.at/13594/

Kharrazi A, Fath B, & Katzmair H (2016). Advancing Empirical Approaches to the Concept of Resilience: A Critical Examination of Panarchy, Ecological Information, and Statistical Evidence. Sustainability 8 (9): e935. http://pure.iiasa.ac.at/13791/

Kharrazi A, Rovenskaya E, & Fath BD (2017). Network structure impacts global commodity trade growth and resilience. PLoS ONE 12 (2): e0171184. http://pure.iiasa.ac.at/14385/

This article gives the views of the author, and not the position of the Nexus blog, nor of the International Institute for Applied Systems Analysis.

Boosting resilience for African cities

Chibulu Luo, PhD Student in the Department of Civil Engineering at the University of Toronto, and a 2016 participant in the IIASA Young Scientists Summer Program

We cannot think about sustainable development without having a clear agenda for cities. So, for the first time, the world has agreed – under the UN’s Sustainable Development Goals (SDGs) and the New Urban Agenda  – to promote more sustainable, resilient, and inclusive cities. Achieving this ambitious target is highly relevant in the context of African cities, where most future urban growth will occur. But it is also a major challenge.

Of the projected 2.4 billion people expected to be added to the global urban population between now and 2050, over half (1.3 billion) will be in Africa. The continent’s urban communities will experience dramatic shifts in living and place significant pressure on built infrastructure and supporting ecosystem services. As many cities are yet to be fully developed, newly built infrastructure (estimated to cost an additional US$30 to $100 billion per year) will impact their urban form (i.e. the configuration of buildings and open spaces) and future land use.

In order to realize the SDGs, African cities, in particular, need an ecosystem-based spatial approach to urban planning that recognizes the role of nature and communities in enabling a more resilient urban form. In this regard, more comprehensive understanding of the dynamics between urban form and the social and ecological aspects of cities is critical.

Unfortunately, research to investigate these relationships in the context of African cities has been limited. That’s why, as a Young Scientist at IIASA, I sought to address these research priorities, by asking the following questions: What is the relationship between urban form and the social and ecological aspects of African cities? How has form been changing over time and what are the exhibiting emergent properties? And what factors are hindering a transition towards a more resilient urban form?

Fundamentally, my research approach applies a social-ecological system (SES) lens to investigate these dynamics, where resilience is defined as the capacity of urban form to cope under conditions of change and uncertainty, to be able to recover from shocks and stresses, and to retain basic function. At the same time, resilience is characterized by the interplay between the physical, social, and ecological performance of cities.

Resilient urban forms are spatially designed to support social and ecological diversity, such as preserving and managing urban greenery Photo Credit: Image of Lusaka, Zambia, posted on #BeautifulLusaka Facebook Page

Resilient urban forms are spatially designed to support social and ecological diversity, such as preserving and managing urban greenery
Photo Credit: Image of Lusaka, Zambia, posted on #BeautifulLusaka Facebook Page

Currently, Africa’s urbanization is largely unplanned. Urban expansion has led to the destruction of natural resources and increased levels of pollution and related diseases.  These challenges are further compounded by inadequate master plans – which often date back to the colonial era in many countries – and capacity to ensure equitable access to basic services, particularly for the poorest dwellers. Consequently, over 70% of people in urban areas live in informal settlements or slums.

My summer research focused on the specific case of Dar es Salaam, Tanzania, and Lusaka, Zambia – two cities with very different forms, and social and ecological settings. I used the SES approach to develop a more holistic understanding of the local dynamics in these cities and emerging patterns of growth. My findings show that urbanization has resulted in high rates of sprawl and slum growth, as well as reductions in green space and increasing built-up area. This has ultimately increased vulnerabilities to climate-related impacts such as flooding.

Densely built slum in Dar es Salaam due to unplanned urban development Photo Credit: tcktcktck.org

Densely built slum in Dar es Salaam due to unplanned urban development
Photo Credit: tcktcktck.org

Using satellite images in Google Earth Engine, I also mapped land cover and urban forms in both cities in 2005 and 2015 respectively, and quantitatively assessed changes during the 10-year period. Major changes such as the rapid densification of slum areas are considered to be emergent properties of the complex dynamics ascribed by the SES framework.  Also, urban communities are playing a significant role in shaping the form of cities in an informal manner, and are not often engaged in the planning process.

Approaches to address these challenges have been varied. On the one hand, initiatives such as the Future Resilience for African Cities and Lands (FRACTAL) project in Lusaka are working to address urban climate vulnerabilities and risks in cities, and integrate this scientific knowledge into decision-making processes.  One the other hand, international property developers and firms are offering “new visions for African cities” based on common ideas of “smart” or “eco“ cities. However, these visions are often incongruous with local contexts, and grounded on limited understanding of the underlying local dynamics shaping cities.

My research offers starting point to frame the understanding of these complex dynamics, and ultimately support more realistic approaches to urban planning and governance on the continent.

References

Cobbinah, P. B., & Darkwah, R. M. (2016). African Urbanism: the Geography of Urban Greenery. Urban Forum.

IPCC (b). (2014). Working Group II, Chapter 22: Africa. IPCC.

LSE Cities. (2013). Evolving Cities: Exploring the relations between urban form resilience and the governance of urban form. London School of Economics and Political Science.

OECD. (2016). African Economic Outlook 2016 Sustainable Cities and Structural Transformation. OECD.

The Global Urbanist. (2013, November 26). Who will plan Africa’s cities? Changing the way urban planning is taught in African universities.

UNDESA. (2015). Global Urbanization Prospects (Key Findings).

Watson, V. (2013). African urban fantasies: dreams or nightmares. Environment & Urbanization.

Note: This article gives the views of the author, and not the position of the Nexus blog, nor of the International Institute for Applied Systems Analysis.

 

Challenges for marine decision making in the Arctic

By Melina Kourantidou, MSA 2015 participant, PhD student, Department of Environmental and Business Economics, University of Southern Denmark

In summer 2015 I participated in the Summer Academy on Economic Growth and Governance of Natural Resources  in Lomonosov Moscow State University. I was inspired by the interdisciplinary lectures there as well as by recent developments in Arctic marine governance to propose a game-theoretical model for Arctic fisheries management.

© Fernbach Antal - Fotolia | Dollar Photo Club

While commercial fishing in the central Arctic Ocean is unlikely to become common anytime soon, fisheries management in the region includes complex decision making challenges. © Fernbach Antal – Fotolia | Dollar Photo Club

In July 2015, representatives from the five Arctic Ocean coastal states (Canada, Denmark, Norway, Russia and the United States) signed the Declaration Concerning the Prevention of Unregulated High Seas Fishing in the Central Arctic Ocean. In the declaration text it is clearly stated that “commercial fishing in the high seas portion of the central Arctic Ocean is unlikely to occur in the near future.” This approach increases the stature of the Precautionary Principle, a strategy that copes with possible risks in cases where scientific information is limited. The declaration is the first official attempt to regulate international waters of the Central Arctic Basin. While commercial fishing in the central Arctic Ocean is unlikely to become common anytime soon, fisheries management in the region includes complex decision making challenges, while it is also complicated by multiple factors, including transboundary fish stocks—those  crossing boundaries of Exclusive Economic Zones (EEZs) — and straddling stocks (those typically found  in the high seas adjacent to the EEZ) arising from the unsettled maritime boundary lines, thus often calling for the establishment of an effective bilateral or multilateral regime.

The contentious and divisive issue of how to handle Arctic fisheries has mostly been discussed so far in literature from a biodiversity standpoint rather than an economic one. Yet looking at the problem from an economic standpoint could help provide information that could prevent optimal use of resources and thus contribute to preventing irrational behaviors that may lead to the collapse or disruption of the ecosystem. Optimization theory provides critical insights for individual fishers or countries pursuing the most profitable strategy (higher payoffs). At the same time it can also prove useful for broader decision-making processes whereby all interested parties cooperate on the management of Central Arctic fish stocks.

 

A map of the Central Arctic Ocean ©Shephard et al., 2016

A map of the Central Arctic Ocean shows the many countries that border the ocean. © Shephard et al., 2016

Game theory can potentially contribute in a more complex setting, with two or more actors—states in our case—involved in fishing resource management and with each state being able to choose among a set of available options, with their payoff dependent on other states’ choices.

There are a number of different types of games available in the game theoretical framework. Given the existing risks and uncertainties over Arctic marine resources I would propose a differential game setting as a baseline scenario. A differential game is a mathematical formulation used for either conflict or cooperation where players’ strategies are changing over time.

A differential game seems suitable since there is an underlying assumption that the “Arctic players” involved make decisions at all time points and not necessarily in specific time intervals. Furthermore a repeated static game (players deciding simultaneously with no prior knowledge of other players’ choices), such as the Prisoner’s Dilemma, would probably not work as well here, since the payoff functions of our players would not be time-dependent.

If we are looking for a solution where all involved Arctic states agree to cooperate on the management of marine resources in the Central Arctic, we would probably need to solve it as a standard optimal control problem, through the use of maximum principle or dynamic programming. In other words the outcome of optimizing a joint welfare function should be examined regarding its efficiency, which brings together the different Arctic players in a joint effort to maximize their average individual welfare.

Another theory known as Nash equilibrium could provide useful insights with regard to incentives and motivations, especially in cases, like the one described here, where it is rather daunting to predict how different players will behave in a game. A Nash equilibrium comes down to a set of different strategies for each one of the players included in the game, indicating that neither player has incentive to change their choice (taking others’ choices as given) since their payoffs are not improving anyway.

An open-loop solution that gives Nash equilibrium would result in all players having absolutely no incentive to deviate from their specific strategic path, given the path of other players or in other words having the players at a Nash Equilibrium would make them unwilling to act differently, since they would be worse off if they did.

An Open Loop Nash Equilibrium can be examined where there is exclusive dependence on the time variable; if a player deviates from the equilibrium control, even if briefly, and decides to return to its former behavior, the equilibrium is broken. Conversely, in a feedback (or closed-loop) Nash Equilibrium which is strongly time consistent, the dependence lies on the current state of the system. Differential games can generally help towards answering whether a potential cooperative solution can be achieved through a Nash equilibrium of a non-cooperative game.

Yet another question is whether countries would prefer to cooperate instead of competing for fishing in the Central Arctic. A cooperative scenario would require a Net Present Value (sum of benefits minus sum of costs, both in present values) larger than the non-cooperative scenario, thus covering the opportunity costs arising from the cooperative case. If this condition is not satisfied we will have to accept that there will be a non-cooperative behavior up to the point that cooperation turns lucrative for all players.

Game theoretic approaches with regard to stock management have provided useful insights and directed new lines of inquiry, but the dynamically changing Arctic raises issues that call for coordinated responses, for example through the use of more robust tools such as evolutionary game theory. Given that many species are expected to expand to yet unexploited parts of Arctic waters, one major concern is the consequences of coastal states’ harvesting activities on society’s wellbeing, and the ways in which it will be made possible to leave a positive legacy for future generations.

Looking at the interplay of ecology and economic behavior is one way that scientists can begin to answer these questions. Meticulous research on strategies of defection, cooperation and enforcement can be a cornerstone for establishing and managing effective ways to protect the Arctic marine environment, taking into account the current dearth of research in existing and future biodiversity.

Read my full report on the MSA 2015 Web site (PDF)

Note: This article gives the views of the author, and not the position of the Nexus blog, nor of the International Institute for Applied Systems Analysis.

How coordination can boost the resilience of complex supply chains

By Célian Colon, PhD student at the Ecole Polytechnique in France & IIASA Mikhalevich award winner

How can we best tackle risks in our complex and interconnected economies? With globalization and information technologies, people and processes are increasingly interdependent. Great ideas and innovations can spread like wildfire. However, so can turbulence and crises. The propagation of risks is a key concern for policymakers and business leaders. Take the example of production disruption: with global supply chains, local disasters or man-made accidents can propagate from one place to another, and generate significant impact. How can this be prevented?

Risk propagation is like a domino effect. Credit: Martin Fisch (cc) via Flickr

Risk propagation is like a domino effect. Credit: Martin Fisch (cc) via Flickr

As part of my PhD research, I met professionals on the ground and realized that supply risk propagation is a particularly tricky issue, since most parts of the chains are out of their control. Supply chains can be very long, and change with time. It is difficult to keep track of who is working with whom, and who is exposed to which hazard. How then can individual decisions mitigate systemic risks? This question directly connects to the deep nature of systemic problems: everyone is in the same boat, shaping it and interacting with each other, but no one is individually able to steer it. Surprising phenomena can emerge from such interactions, wonderfully illustrated by bird flocking and fish schooling.

As an applied mathematician thrilled by such complexities, I was enthusiastic to work on this question. I built a model where firms produce and interact through supply chain relationships. Pen and paper analyses helped me understand how a few firms could optimally react to disruptions. But to study the behavior of truly complex chains, I needed the calculation power of computers. I programmed networks involving a large number of firms, and I analyzed how localized failures spread throughout these networks, and generate aggregate losses. Given the supply strategy adopted by each firm, how could systemic risk be mitigated?

With my collaborators at IIASA, Åke Brännström, Elena Rovenskaya, and Ulf Dieckmann, we have highlighted the key role of coordination in managing risks. Each individual firm affects how risks propagate along the chain. If they all solely focus on maximizing their own profit, significant amounts of risk remain. But if they cooperate, and take into account the impact of their decisions on the risk profile of their trade partners, risk can be effectively mitigated. Reducing systemic risks can thus be seen as a common good: costs are heterogeneously borne by firms while benefits are shared. Interestingly, even in long supply chains, most systemic risks can be mitigated if firms only cooperate with only one or two partners. By facilitating coordination along critical supply chains, policy-makers can therefore contribute to the reduction of risk propagation.

Colon's model analyzes how firms produce and interact through supply chain relationships. Credit: Jan Buchholtz (cc) via Flickr

Colon’s model analyzes how firms produce and interact through supply chain relationships. Credit: Jan Buchholtz (cc) via Flickr

Drawing robust conclusions from such models is a real challenge. On this matter, I benefited from the experience of my IIASA supervisors. Their scientific intuitions greatly helped me focusing on the most fertile ground. It was particularly exciting to borrow techniques from evolutionary ecology and apply them to an economic context. Conceptually, how economic agents co-adapt and influence each other shares many similarities with the co-evolution of individuals in an ecological environment. To address such complex issues, I strongly believe in the plurality of approaches: by illuminating a problem from different angles, we can hope to see it more clearly!

Note: This article gives the views of the author, and not the position of the Nexus blog, nor of the International Institute for Applied Systems Analysis.