Science - February 25, 2016

‘See the financial world as an ecosystem’

Rob Ramaker

Economists should learn from ecology, climatology and other sciences which study complex systems. This can provide them with greater insight into the origins of the bubbles and crashes which cost society a lot of money. So say Marten Scheffer, professor of Aquatic Ecology at Wageningen University, and other scientists in Science.

Photo: Scott Beale

Over seven years ago, Lehman Brothers bank went bankrupt and very nearly took the global financial system with it when it fell. Such disastrous crashes are often not seen coming, yet they cause tremendous damage – the crisis of 2008 is estimated to have cost 14 trillion dollars. Not surprising that policymakers and central bankers want to gain a better understanding of how crises arise and how you can prevent or assuage them.

To this end economists should learn from other ‘complex’ sciences, says Cars Hommes, professor of Economic Dynamics at the University of Amsterdam. One of the lessons is the importance of network structures. Even when individual banks are stable, that is not automatically true of the banking system as a whole. This financial network played a role in the crisis of 2008 too. ‘The fall of Lehman Brothers set a domino effect in motion,’ says Hommes.

Another source of inspiration is the work of Marten Scheffer. The Wageningen ecologist discovered that lakes can be murky for a long time, only to ‘tip over’ suddenly into a new, clear state. Such tipping points are found in all kinds of contexts, such as migraine attacks and rain forests. Or banking systems. ‘We would like to have generic indicators of the resilience of such systems,’ says Scheffer. ‘An indicator that is generally applicable, which shows when the system is approaching a tipping point.’ Systems seem to be weaker at such points, and to respond to disturbances more slowly. Scheffer warns of one peculiarity of financial markets compared with other complex systems. ‘People are constantly trying to predict markets, because you can make money that way. That is not something trees in the Amazon do.’