Friday, 19 July 2013

How to Best Breakup The Eurozone?

The Eurozone is in an extremely fragile situation with a one-star resilience rating for the past year and a half. The system is reaching critical complexity very quickly and inexorably (current complexity is approximately 390, the critical value at which breakup is inevitable is around 426).

First of all, highly complex systems, such as today's economy, are basically out of control - the current crisis is sufficient empirical proof - and their dynamics is beyond our comprehension. There is no way we can describe such a system using traditional mathematics. No model will work here. Secondly, politics is not only unwilling to intervene, it is incapable of any form of intervention because of the immense complexity of the problem and, if that were not enough, political agendas are imposed by finance. Governments are giving up sovereignty whether they like it or not. This compounds the problem further. It appears the system will break up.  There is talk of establishing a two-speed EU.

We have performed an analysis of a set of hypothetical scenarios, in which the system would be "split" into clusters of countries with a certain degree of affinity. We have measured the resilience of each cluster. The following groups of countries have been analyzed:


EU 15 (this is the entire system):
Complexity = 167.1, Resilience = 56%

G7 (France, Germany, Italy and UK):
Complexity = 52.7, Robustness = 66%

G7 - UK
Complexity = 38,7, Robustness = 67%

PIGS (Portugal, Ireland, Greece and Spain)
Complexity = 57.6, Robustness = 58%

MED (France, Greece, Italy, Portugal and Spain)
Complexity = 72.1, Robustness = 59%

MED - Greece and Portugal
Complexity = 41.9, Robustness = 59%

EU 15 - G7
Complexity = 116.8, Robustness = 55%

Northern Countries (UK. Sweden, Finland, Denmark, Netherlands)
Complexity = 76.1, Robustness = 66%

EU15 - G7 - Northern countries
Complexity = 86.6, Robustness = 56%

The following conclusions can be drawn:

  • The entire system (EU15) has a low robustness - 56%
  • The G7 countries as a group have a robustness of 66%, that is 10% higher than the entire system
  • The G7 group, excluding the UK (which hasn't adopted the Euro) is slightly more robust - 67%
  • Placing Italy in the MED group would make little sense because the robustness would be only 59%
  • The Northern countries enjoy a robustness of 66%
  • The remaineder of EU15 - the G7 and Northern countries would have a robustness of 56%, equal to that of the entire system today

The point is now this. Since trying to manage a huge, higly complex and fragile system is risky business, it is better to break it up into less complex and more robust sub-systems, attempting to fix each one. This does not guarantee that the whole will perform better. However, the fact is that today the entire system is extremely vulnerable. Before we start to fix the problem we must cast it in a form in which a fix may be attempted and with better chances of success. We therefore suggest to "break up" the EU15 into the following clusters of countries:

  1. Germany, France and Italy - the robustness of this group is 67%
  2. UK, Sweden, Finland, Denmark and the Netherlands - the robustness is 66%
  3. All remaining countries - robustness is 56%

The idea is not to institute different currencies in these groups. The idea is to cluster countries into more homogenous groups, so that a more specific cure can be deployed in these groups, not in single countries. Italy, for example, does not belong to the PIIGS, as it has a solid banking system and the EU's second largest manufacturing industry, not to mention that it has a low level of private debt. Imposing severe austerity measures on a country like Italy is counterproductive. The recent tax increases are contributing to the destruction of the real economy, favoring only the speculators.

Austerity measures and other policies should be applied in a coordinated fashion and, most importantly, to "homogenous" groups of countries to be most effective. This will avoid weakening countries that can help those in trouble and will allow to treat the system in a way that takes into account its natural structural properties. Trying to fix the problem based on uncoordinated ad-hoc interventions, focusing on one country at a time and strangling its economy, is going to favor the domino effect which everyone wants to avoid so badly (really?).