Preventing accidents in complex systems

The financial industry needs to learn lessons from other complex systems such as petrochemical plants and space exploration in order to lessen the danger of accidents, according to leading economist John Kay.

Writing in the Financial Times, Kay points to the nuclear incident at Three Mile Island in the United States in 1979 that led to an inquiry that made recommendations that would ensure an identical failure could not recur.

However Kay, a visiting professor at the London School of Economics, says there will be other, different, accidents at other stations – as indeed there have been, mostly recently at the Fukushima plant in Japan in 2011.

He cites the work of Charles Perrow, emeritus professor of sociology at Yale University, who coined the term “normal accidents” to describe the similar incidents that inevitably occur in all the complex systems he observes: marine transport, petrochemical plants and space exploration.

Kay writes that two features render complex systems vulnerable to complexity: interactive complexity that means everything depends on everything else; and tight coupling which means that there is little slack to permit self-repair or recovery.

He says attempts to design a financial system for zero failure are “impractical”. Instead it should look “shorter, simpler, linear chains of intermediation…and loose coupling that gives every part of the system loss absorption capacity and resolution capability”.

However he says that the development of the financial industry over the last two decades has been in the opposite direction. Interactive complexity has increased through the “explosion of trading between financial institutions” while shorter timescales and a drive to more efficient use of capital have meant coupling between institutions has become tighter.

“Finance needs to learn from engineers with experience of complex systems in the face of ‘normal accidents’,” he concludes.