Non- Linear See Saw Effects and Consequences

July 17, 2016

 

Often we believe in linear and proportional impacts among the cause and effect relationships. Say for example, 5% (X%) increase in demand will result in 10% (Y%) hike in price and vice versa. Or 10% decline in consumption of a commodity will cause proportionate level of impact in the price, profitability or industry output. Or presuming that a 1000 point rise/decline in stock market index roughly corresponds to proportional respective increase/decrease in size of GDP or economic output.  Such a presumption of proportionality or linearity has become not only a myth in many contexts, but it can be a major cognitive bias affecting many of our decisions. The proportionality and linear assumptions can engender unimaginable consequences in many socio-economic and business contexts.

 

The relationship between demand for gasoline and price at the pump is a good example to illustrate the dis-proportionate and non-linear effects. Say for example, 5% increase in global fuel demand can cause (in the absence of price controls and production increases) unimaginable rise in price of gasoline at the pump elsewhere due to critical nature of the commodity and the dependence of the global economy on energy and oil derived from petro-resources.

 

If we look at the 2008 economic crisis and the years between 2008 to 2013, the rise in oil prices could have been one of the primary factors costing nearly 20% the global economy (of  75 Trillion dollar global economy nearly 15 Trillion dollars and more could have been stunted due to rising oil prices). From 2000 to 2010, while oil companies made huge profits, most of the companies in Airlines, Transportation, Tourism, and Automobiles industries suffered huge losses. The airlines, transportation, tourism, and automobiles have been the backbones of the global economy and their growth suffered due to consumers feeling the pain at the pump and reduced purchasing power.

 

Sub-Prime mortgage crisis is another example of non-linear and dis-proportionate impact on the whole system caused by changes in a few variables. Subprime mortgage crisis was a nationwide banking emergency that coincided with the U.S. recession between 2007 and 2013. The crisis was triggered by a large decline in home prices after the collapse of a housing bubble, leading to mortgage delinquencies and foreclosures and the devaluation of housing-related assets and securities. Declines in residential investment preceded the recession and were followed by reductions in household spending and then business investment.

 

Although only a 5% of home ownership lost due to default mortgage payments (most affected by the higher sub-prime rates), but the crisis triggered a multi-trillion dollar global economic crisis. 

 

Now, the globalization is another phenomenon triggering more volatile and non-linear effects on many economic and business systems. As globalization increased in the last 3 decades, as markets have become border-less, companies are also becoming border-less. Although some pandits would pursue an exaggerated view of globalization phrasing it as "world is flat", world is not flat yet, albeit there is a small flat world within; Still 60% and more of the global population are quite domestic and "ethno-geo-centric". Some proponents of globalization, otherwise, argue that both perceptions of opportunities and threats of globalization are exaggerated claims and mere "globaloney", and only less than 25% of Global GDP is globally derived and still have a long way to go to be euphoric or fearful about it.

 

Although, it is agreeable that globalization has become inevitable, - in the absence of safety net, currency stability, corporate and capital gains taxes, isolating financial structures, visa/ passport/ travel permissions, synchronization of labor value and standards, - the impact of globalization on economic and business variables can be much greater with potential to cause political turmoils and economic crises. In a sense, without safeguards and safety-net at the global and local systems, globalization can cause real "globalooney" or "globanoea".  This can cause the existential crisis for many governments as to whether governments have any role to play or not, and anarchy would become a regular feature of many economies. 

 

Some critical factors said to be causing these crises...Firms under undue pressure to maximize wealth but investors are ever-ready-to-flee with short-term goals; Dynamic technological changes, technology convergence; Volatile markets; Interdependence of global markets and firms, Currency fluctuations; Excessive investment risk; Increasing Middle-class capital (derived from retirement savings), Lack of financial regulations, greed, lack of safety-net, lack of living wages and labor standards.

  

For other related articles, check my LinkedIn blog posts. Please share if you like... 

 

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