The Next Big Thing
Posts about next generation technologies and their effect on business.

Economic Decisions Should be Based on Models

At the root of the current economic crises is a failure of financial institutions to properly manage risks. There also exists a lack of understanding by government leaders and others, of the complex implications of these risks to the national and global economies. This reflects both a failure to learn from history and a failure to make effective use of models to understand and control the dynamics of the economic system.

In 1993, Roderick MacDonald and Ann Dowling presented a paper on "The Savings and Loan Crisis: A System Dynamics Perspective" at the 11th International Conference of the System Dynamics Society. This paper presents a system dynamics model of the United States savings and loan industry in the 1980s. System dynamics modeling tools support simulation of the behavior of such a system over time. The paper demonstrates how unintended consequences of government actions exacerbated the problem leading to the extensive failures of savings and loan associations at a cost of over $300 billion to taxpayers. I've not seen any evidence that such techniques are being used to analyze the current economic crisis.

System dynamics was developed in the 1950s by Jay Forrester at MIT. A book by Craig Kirkwoond of Arizona State University, System Dynamics Methods: A Quick Introduction, is available on the internet. Modeling tools, such as iThink and Vensim, are available to develop system dynamics models on personal computers.

Such models should be a basis for decisions about bailouts, taxes and regulations to resolve the current economic crisis and minimize the risk of future crises. In addition to managing complexity and providing automated simulation, modeling provides a basis for development of consensus about the interdependencies of the system under consideration. A good model would help remove superstitions from the discussions. It might even help resolve the philosophical debate about the impact of raising or lowering taxes on the economy.

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  • Steve Simske is an HP Fellow and Director in the Printing and Content Delivery Lab in Hewlett-Packard Labs, and is the Director and Chief Technologist for the HP Labs Security Printing and Imaging program.
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