Wednesday, 3 July 2013

What Future For The Euro And For Europe?


Given the chance, complexity will always increase. Life, in general, gets more complex, not simpler. It is ironic that it was the ancient Greeks who discovered that each generation leaves behind more chaos than the previous one. This logic can be applied to our individual lives, to our societies or even to larger systems such as the EU.

Europe, on the one hand, lacks both political and economic union and, at the same time, is exposed to forces of disintegration. There are many more states in Europe today than after WW II and in the near future the list may grow. From this perspective alone the situation is getting more complicated and at the same time more complex. While complicated stands for intricate, complex means chaotic and able to surprise and this is precisely why highly complex scenarios are not only difficult to govern, they are also difficult to understand. Fortunately, complexity is bounded. The so-called critical complexity represents a sort of physiological limit and each system possesses such a limit. This includes the EU. For over two years we have been measuring the complexity of the EU on a quarterly basis. We are observing an alarming but steady trend - every quarter the EU as a system is approaching its own critical complexity limit. The most recent analyses, illustrated below, indicate a complexity of 390, while the upper limit is only 426. Not only does this leave little room for manoeuvre and error, it also means a very low resilience (one star). This means the system is like a slab of notched glass - unable to withstand shocks.

The point, however, is not to analyze the fragility of the Eurozone - this has been illustrated in our previous blogs. The idea is to apply our knowledge on complexity and its dynamics to answering the following question: What is the most probable scenario for the Euro and for Europe? Evidently, without the Euro it is difficult to imagine a European Union, so the two are inextricably linked.

There are two fundamental points to consider when it comes to answering similar questions:

  • As a system approaches its own critical complexity, it becomes very fragile and can collapse due to a small perturbation (e.g. the default of one large bank).
  • The higher the complexity of a system and the greater the number of players (parameters) the more possible outcomes (attractors) the system can tend to.

Extreme fragility (almost) inevitably equates to collapse. A small endogenous or exogenous perturbation can bring a huge system to its knees and it is a question of time when it comes. Today, the EU as a system is so fragile that a click of a mouse can cause its collapse. The downgrading of a country by a couple of notches may cause panic on the markets and this can cause an avalanche. Rating agencies have recently been busy doing just that by issuing strings of unsolicited ratings of EU economies, forcing them more into a downward spiral.

The second issue is what makes it difficult to make predictions. Using only 24 macro-economic parameters to reflect the economy of each of the 27 member states leads to a space with 648 dimensions! This means that the complexity of the problem is of cosmological proportions. The number of (more or less robust) attractors for such a system is very large and there is no way we can produce a complete list. This is because the system can't  be described by PDEs and analyzed in a classical sense.

Where, then, is the EU going? Let's see what we have on the table.

  • The EU doesn't have a government, it lacks leadership and unity.
  • Politicians are unable to come up with a credible roadmap to get the EU out of the mess. Placebo-generating measures is all politics is able to propose.
  • The same finance that has contributed so significantly to the crisis, and which has been bailed out by already crippled economies is now dictating agendas and stripping nations of their sovereignty. This may actually help explain the previous two bullets.
  • The entire system is approaching steadily its critical complexity hence it will be even more difficult to comprehend and manage.
As may be see in the figure below, the situation is getting more uncertain and chaotic. I actual fact it has been getting more uncertain since the mid 1990s when the rate of entropy production has increased very significantly. This means that the system is increasingly rich in noise. There are many causes of this increase of entropy and we will not analyze them here (excess entropy in an economy/society is, essentially, the equivalent of ballast). However, what this means is that understanding and governing an increasingly uncertain system such as the EU is going to be increasingly difficult. The plot below is result of time-domain analyses of World Bank's data, which incorporated close to 1000 parameters.

What does this lead to? What kind of future attends the EU? Given the enormous dimension of the problem there is no straightforward answer but it is possible to speak of trends:

  • Today finance controls the agenda. It will seek to do so in even greater measure as this guarantees more control and profits.
  • As a consequence of the above, nations will continue to lose sovereignty. A process of Balkanization may emerge, whereby richer areas will "separate" from the poorer ones. This will, de facto, end the Euro, although the richer nations may continue to embrace it.
  • Politics will become increasingly complex and under the control of finance. This means it will become an increasing burden for society.
  • The poorer regions will experience social unrest. Society won't be able to absorb the enormous entropy (inefficiency, wasteful and obese states, politics, corruption, crime, etc.) without traumas. This may lead to the erosion of important chunks of social structure.
  • The complexity and fragility of the EU will increase. At present rates, the peak will be reached towards the end of 2013. This will make it increasingly more difficult to govern. More unpopular measures will be needed to keep the system afloat.
Based on the above it seems that the EU will collapse. What must be done in order to avoid this is to radically simplify the system by dumping huge amounts of entropy. How much? The above plot hints a massive 20-25%. If governments don't do it, Nature will. Nature's most efficient simplification mechanism is collapse.