OXFORD – Recent evidence suggests that much of the world has entered a period of low financial-market volatility. But this is no time for complacency; more turbulent times are likely to lie ahead.
Over the last quarter-century, rapid technology-driven globalization – characterized by the physical and virtual integration of the global economy, including the opening of world markets – has contributed to the fastest increase in incomes and population in history. But, while globalization has created unprecedented opportunity, it has also unleashed a new form of systemic risk – one that threatens to devastate political institutions and national economies.
Systemic risk is intrinsic to globalization. Greater openness and integration necessarily increase the potential for cascading crises and amplification of shocks.
As individuals and societies become richer, they come into closer contact with one another – virtually, through communication technologies, and physically, through population growth, urbanization, and travel. Meanwhile, rising consumption of products like food, energy, and medicine enhances the externalities, or spillover effects, of individual choices, with the connectivity of global systems increasing these effects’ range and impact.
For example, taking an antibiotic may be a rational individual decision. But when billions of people take antibiotics, and livestock producers use them to boost efficiency, they often become ineffective. The same paradox applies to energy use, owing to the destructive impact of large-scale carbon emissions. Even the consumption of basic necessities like food (production of which can have major environmental consequences) and water (given limited supplies) is not exempt.
Furthermore, increased openness and market integration, driven by rapid technological change, is exacerbating divisions within and among societies. Those who miss the globalization train at the start often are unable to catch up later.
Nowadays, the world’s most pressing challenges – from climate change to cyber-crime – increasingly transcend national borders, making them extremely difficult to address effectively. Worse, they can have a cascading effect, with, say, a pandemic or cyber-attack provoking a financial or political crisis and imposing costs disproportionately on those who can least afford them. The vectors of connectivity – such as the Internet, financial markets, airport hubs, or logistics centers – facilitate “super-spreading” of globalization’s effects, both positive and negative.
Though the systemic risks brought about by globalization cannot be eliminated, they can be mitigated, if world leaders work together and learn from past mistakes. Unfortunately, neither appears likely.
For starters, national politics in key countries is largely moving away from cooperation, with rising inequality and social fragmentation making it difficult for governments, especially in democracies, to make tough decisions. At the same time, populations are rejecting regional and global institutions. Europe, for example, is witnessing an upsurge in support for nationalist parties, like Britain’s UK Independence Party, and increasingly loud calls for self-determination, such as in Scotland and Catalonia.
Equally problematic, the world has largely failed to learn from globalization’s most obvious and far-reaching consequence yet: the 2008 financial crisis. While it is impossible to safeguard the system fully, sound regulation and effective oversight could have prevented the crisis, or at least reduced its impact on millions of people’s livelihoods. The problem was that central banks, finance ministries, and multilateral organizations like the International Monetary Fund – the pillars of the global economy’s institutional framework – failed to grasp globalization’s emerging characteristics and effects, owing partly to the difficulty of discerning structural shifts in the huge mass of data now available.
In this sense, the crisis should have served as a wake-up call, spurring the financial sector, policymakers, and multilateral organizations to take action to enhance systemic stability. But, despite employing tens of thousands of highly educated economists whose primary job is to determine how best to protect the financial system from globalization’s destabilizing effects, these institutions seem to be even less willing to act now than they were before the crisis.
This is particularly true in the advanced economies, where depleted financial reserves and political paralysis are preventing constructive investments in areas like infrastructure and education, which can enable citizens to take advantage of globalization’s benefits. Making matters worse, some of these countries have reduced their contributions and commitment to the reform of regional and global institutions, which are essential to managing systemic risks.
In this context, it is not surprising that ordinary citizens feel uncertain about the future and frustrated with their governments, which have so far failed to protect them from globalization’s fallout. But wresting power back from regional and international institutions – however shadowy and distant they may seem – would only compound the problem, for it would reduce the ability to guide the supranational trends that are shaping the world’s future. More, not less, cooperation is necessary to manage growing complexity and integration.
It is time for our leaders to recognize new systemic risks and work together to mitigate them. Otherwise, the recent past will be prologue, with those risks likely to get the better of the global economy.