Thought for the day

Kenneth Rogoff at Project-Syndicate:

The parallels between the oil spill and the recent financial crisis are all too painful: the promise of innovation, unfathomable complexity, and lack of transparency (scientists estimate that we know only a very small fraction of what goes on at the oceans’ depths.) Wealthy and politically powerful lobbies put enormous pressure on even the most robust governance structures. ...

The oil technology story, like the one for exotic financial instruments, was very compelling and seductive. Oil executives bragged that they could drill a couple of kilometers down, then a kilometer across, and hit their target within a few meters. Suddenly, instead of a world of “peak oil” with ever-depleting resources, technology offered the promise of extending supplies for another generation.
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The basic problem of complexity, technology, and regulation extends to many other areas of modern life. Nanotechnology and innovation in developing artificial organisms offer a huge potential boon to mankind, promising development of new materials, medicines, and treatment techniques. Yet, with all of these exciting technologies, it is extremely difficult to strike a balance between managing “tail risk” – a very small risk of a very large disaster – and supporting innovation.
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Economics teaches us that when there is huge uncertainty about catastrophic risks, it is dangerous to rely too much on the price mechanism to get incentives right. Unfortunately, economists know much less about how to adapt regulation over time to complex systems with constantly evolving risks, much less how to design regulatory resilient institutions. Until these problems are better understood, we may be doomed to a world of regulation that perpetually overshoots or undershoots its goals.

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