Decades of crises reveal how little we understand

Yet decision makers must find the right measures.

I experienced my first crisis in the 1970s, when an OPEC embargo quadrupled prices and caused inflation and unemployment to skyrocket. At the time, I had just finished my PhD, and participated in the first round of research seeking to understand why the consequences of the crisis were so large.

In the 1990s followed bank crises and currency crises, culminating in the Asian financial crisis of 1998. Ten years down the line came the global financial crisis in 2008, with consequences reaching all the way into the present.

A commonality of all these crises is that seemingly small events have had enormous consequences. From a global perspective, the oil sector was relatively small in 1973. The same was true for the American housing market in 2007. Yet both crises turned the world upside down.

Another commonality is that we experience each crisis as something new. In the 1970s, macro economists were baffled as inflation and unemployment increased simultaneously. In 2008, they learned once and for all how important financial markets are.

Now we are learning how badly prepared we are for a pandemic, despite decades of research on health economics. We struggle to fit the crisis into the textbook example of supply shocks and demand shocks.

As we did during the financial crisis, we are also learning that our greatest problem seems to lie in how dependent we are on each other. This applies to supply chains just as much as it does to financial markets. In fact, it applies to modern society as a whole. With studies and friends abroad, holidays in Spain, Thailand or the Himalayas and the global spread of real and fake news.

This network of interdependencies works quite well in ordinary times, with no coordination of leadership other than the invisible hand of Adam Smith. When it starts falling apart, however, the road to complete collapse is short.

The greatest lesson is perhaps how little we in fact understand about the workings of modern society. We can create sophisticated computer models, as I myself did during the American energy crisis. These models could explain the newly discovered relationship between oil prices, inflation and business cycles – or so we thought. Just a decade down the line, the models no longer corresponded with reality.

After the 2008 financial crisis, both the EU and the US spent enormous resources building a new financial architecture capable of withstanding crises without government intervention. Now, only ten years later, this system has crumbled.

This is not a result of poor workmanship. Rather, it testifies to how difficult it is to understand the complexity of the social and economic forces governing the modern world. We must admit how little we in fact know. At the same time, governments need to make decisions when crises hit. They need to do so quickly and without long discussions about costs and benefits, solving the most important problems first.

During the energy crisis in the 1970s, mass-unemployment had to be dealt with before we could start looking for new energy sources. Today the reverse is true: health policy must come before everything else, otherwise there may be no economy to stimulate in the end.

In one way, this makes economic stimulus meaningless, as it is neither possible nor desirable to stimulate activity we currently want to reduce to combat infection rates. At the same time, we must implement economic measures to avoid mass bankruptcy.

The debate about how wise measures have been has already started and is sure to continue for a long while. Open discussion is important. Still, those of us used to participating in such debates would be wise to recognize how difficult it is to find the right measures in situations like this.

As things stand, I feel inclined to admire the people in charge, rather than criticize them.

Published 2. April 2020

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