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Globalisation brings immense benefits. As barriers to the movement of goods, services and capital have been lowered, many emerging economies have seen extraordinary improvements in living standards and incomes. Even more important than the physical flows across borders has been the rise of the internet over the past 15 years, which, together with improving literacy and education, is allowing ideas to spread faster than ever before. Yet growing integration and complexity has also resulted in new systemic risks that must be managed if we are to preserve the gains of recent decades.

The recent financial crisis was the first of the systemic crises of the 21st century but certainly will not be the last. At its heart were four critical failures. A mismatch developed between a system that had become global in its reach and a regulatory structure still rooted in national institutions. Revolutionary technological changes driven by the exponential improvements in computer power facilitated new financial instruments that were not understood by an older generation of supervisors. Management and regulators were blinded by the blizzard of data. Last, conflicts of interest were endemic in the system, and far from excessive risk-taking being curtailed, it was excessively rewarded. Politicians, chief executives and bank boards were seduced by lucrative incentives and the toxic mix of cheap credit, bonuses, and accounting and political systems that rewarded short-termism.

That the most highly supervised, institutionally well endowed and data-rich of industries could fail so catastrophically should provide a wake-up call for all of us. For the vulnerability of our interconnected global systems to the “butterfly effect” – in chaos theory, the potential for a ripple in one part of the world to be amplified and lead to major disturbances in another – is by no means confined to finance.

Increased mobility and population density has exacerbated the threat of a global pandemic. The virtual integration of global society and business over the internet has created a new threat of collapse due to cyber attacks or failures in the infrastructure. Meanwhile, rapid integration of the global economy is leading to rising greenhouse gas emissions, with the potential to trigger catastrophic climate change on the other side of our planet.

In all of these areas, a disconnect between an increasingly global world and the fragmented structure of nation-states – what we might call the “butterfly defect” – exacerbates systemic risks. At a time when in finance, as in many other areas, greater co-operation is required, international economic policy and governance is gridlocked. New ways of working are required, including through the establishment of creative coalitions of government, business, cities and civil society. Complexity cannot be fought with still more complexity.

Policies at the national and international level should aim to build resilience. In finance, this has implications for competition policy, for the geographical location of key institutions and for regulation, including to moderate short-term incentives. Fundamental reforms in global governance are required to harvest the upsides of globalisation and mitigate the systemic risks endemic to rapid economic growth and closer integration.

While systemic risks come from globalisation, they also pose the gravest threat to continued globalisation. The political and psychological response to growing complexity is to try to become more local. Protectionism, nationalism and xenophobia are on the rise, and there is a real danger that globalisation will be rolled back and that our societies will become more closed. This would be a terrible mistake, not least for poor people across the world who are yet to benefit from increased connectivity and growth. The way to manage the systemic threats arising from globalisation – financial, climate, pandemic, cyber and others – is to ensure we co-operate to address them.

Ian Goldin is director of the Oxford Martin School. He is co-author, with Mike Mariathasan, of the forthcoming ‘The Butterfly Defect: How Globalization Creates Systemic Risks, and What to Do about It’, which he will be discussing at the Oxford Literary Festival on Thursday 27 March. oxfordliteraryfestival.org

Copyright The Financial Times Limited 2017. All rights reserved.

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