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Mathematicians Develop Stress Test For Global Economy

If China suffers a recession, how badly will the rest of the world be hit? Mathematicians have used network theory to calculate the answer

One of the rapidly growing applications of network science is the simulation of change in the real world. Ecologists, for example, are acutely interested in food webs and how the extinction of one species can have dramatic consequences for others.

The consequences of an extinction can be highly counterintuitive, such as triggering extinction cascades that wipe out many species, like an avalanche. This kind of phenomenon is impossible to test in the real world but it has recently become possible to study the consequences in silico, as we saw just a few weeks ago. .

What’s more, biochemists are using the same process to see what happens when a protein is removed from a protein or metabolic network while computer scientists use it to measure how the world wide web would stand up to targeted attacks which remove certain nodes. It’s an approach that has been remarkably successful

So it should come as no surprise that economists might want to get in on the act. Today, they are beaten to this goal by a group of mathematicians at Dartmouth College in New Hampshire. Dan Rockmore and a couple of pals have recreated the world trade network from between 1870 and 2006 and then simulated what happens to it when certain countries become less active as might happen during a period of internal strife, or when they disappear entirely. They’ve also looked at what happens when the trade links between certain countries become broken as might happen during a war.

Theses simulations are a kind of stress test of the world economy. They allow Rockmore and co to see what might have happened to the world economy if history had been different and what might be in store for us if certain events were to occur in the near future.

The results give a unique insight to the state of the global economy both now and in the past. For example, it’s possible to work out the most important trade links in the world by asking what effect they would have elsewhere if they were cut.

By this measure, this most important link turns out to be the one between the US and Canada; cutting this link would cause a 4 per cent drop in global income. That’s not entirely surprising but many of the other important links are. For example, the second most important trade link is between the US and Mexico. Cutting this link would reduce global income by almost 3 per cent. Then comes the link between Germany and the Netherlands, which would cut global income by over one per cent.

(Rockmore and co do not say whether there are any trade links that, if broken, would increase global income but it’d be interesting to know if these existed.)

They also study how changes in a single economy can influence the rest of the world. This analysis provides an important insight into one of the big economic questions of our time: how important is the continued growth of the Chinese economy?

Rockmore and co simulate what would happen to the global network if China were to decrease its exports by only 5 per cent while decreasing its imports by 30 per cent. They say that if this happened, 94 per cent of the countries in the world would suffer a drop in income of at least 1 per cent. That’s a global recession.

If China sneezes, the rest of the world had better be prepared for a serious bout of flu.

The Dartmouth study also makes some unexpected finds. Most puzzling is the discovery that at various times the robustness of the world economy has increased sharply, such as in the mid 1970s, when the average number of trade partners per country increased. That makes the global economy stronger because it gives countries alternative trading partners if one partner should suffer.

However, the simulations show that after this sudden transition, the robustness slowly decreases over time. Just why this happened isn’t entirely clear. Further tests should provide more insight.

Overall the process of stress testing the global economy in this way looks to have great value (provided the model is well conceived). It looks to be a powerful way of identifying and evaluating potential threats.

That’s got to be an improvement on the kind of forecasts that economists currently rely on, which generally do not admit the possibility of nonlinear change. By contrast, the Dartmouth approach thrives on it.

Let’s hope we see more of it.

Ref: Stability of the World Trade Web over Time - An Extinction Analysis

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