Wanted: a better economic framework for resilience

NPC Commissioner Helene Galy, Director, Willis Research Network, Willis Towers Watson has written this article for the NPC, which brings in wide ranging examples, including tackling the increasingly pressing issue of managing space debris, and the humanistic branches of economics and the principles of Doughnut Economics to explore what a better economic framework for resilience could look like.

Introduction: Resilience is a product of the choices we make

Resilience is clearly desirable – a good idea that is difficult to disagree with – yet its goals are often vague and undefined. Even the interpretation of the word ‘resilience’ can be complex and subjective, and different stakeholders will have their own resilience needs, which may be in tension with one another.

One key question revolves around the economics of resilience. Who benefits from it? Who decides who benefits from it? Who pays for it? And how do we measure it (to decide if it is worth the investment or assess progress)? If those seem like tricky questions to answer, we may need to be clearer when defining what we mean by resilience in the first place.

The question: ‘resilience to what?’ may be a good place to start: Known risks, or unknown risks?; Risks to the organisation or to its suppliers aswell?; Slow onset (chronic) risks or sudden shocks (acute risks)?…the list goes on. Depending on our ambition, we may aim for passive resilience (minimising the impact of a shock and bouncing back to where we were before) or active resilience (absorbing a shock and bouncing forward – in effect, transforming to come out stronger after the crisis) (see NPC Report Building Better Resilience (2020)).

The level of resilience we can achieve therefore (whether in a system, a service or a country) depends on the choices we make. Clearly those choices have implications, often beyond the geographical, temporal or responsibility boundaries of the decision-maker themselves. How then, to handle the choices we’re faced with?

Can we leave it to pure economics, commerce and finance?

One strategy is to leave these choices to the market economy, and hope for the best. However, market economics may be limited in their utility. The hopefulness underlying classical economics described in Adam Smith’s The Theory of Moral Sentiments (1759) is symbolised by what we call the ‘invisible hand’. In a free market economy, unintended greater social benefits and public good are brought about by individuals acting in their own self-interests through a system of mutual interdependence.

Following free market economics has certainly resulted in growth and development, but when it comes to sustainability and resilience, there is cause for concern, not least because of the concept of the ‘commons’ – those goods and resources that benefit all of us if used judiciously by each of us. A so-called ‘tragedy’ of the commons occurs when the capacity of the good or common resource is far outweighed by the level of use being made of it – exacerbated by the fact that ‘commons’ frequently have insufficient or no governance or stewardship arrangements.

To use a more modern illustration than that of sheep grazing on common land, we can use space as a case study of how unfettered economics does not always lead to the most resilient outcomes.

Space (defined as anything higher than 50-60 miles above sea level) exhibits all the hallmarks of a commons, or common good, although unrecognised by international law or the US as such. It is shared, hard to exclude users from, and can easily be depleted or degraded without recourse. In 2011, the US National Security Space Strategy described outer space as “congested, contested, and competitive.” Once dominated by the two Cold War superpowers, space today counts more than 80 actors, including commercial ones. Of 15,070 satellites launched, 7,200 are still in orbit, and such increased usage of space has a range of unintended consequences. The congestion is making it increasingly difficult to plan launches and orbits, and constellations can interfere with geostationary satellites as they fly through their beams.

Problematic this might be, but even more concerning is the issue of space debris, as described by the Kessler syndrome: In 1978 NASA scientist Donald Kessler warned that space would become so crowded with active satellites and detritus of past missions that it would be extremely difficult for mankind to launch new satellites. The European Space Agency estimates that there are more than 36,500 items larger than 10 cm in space today, and even debris smaller than 1cm can cause considerable damage to a satellite – and there may be 130 million of those (see this article on space debris by the European Space Agency (ESA)).

Crowded space gives rise to other risks, including collisions. In 2009 the derelict Russian military communications satellite Kosmos 2251 collided with the active commercial Iridium 33. The problem of accidental collisions is compounded by rogue behaviour from certain actors. In 2007 China intentionally destroyed an old, malfunctioning weather satellite with a missile, whilst in 2021, it was Russia’s turn to use an anti-satellite missile to destroy Soviet-era Cosmos 1408, forcing the International Space Station into an avoidance manoeuvre.

The real cause for concern lies in the fact that satellites are essential to modern life on Earth – for example in GPS navigation and the internet. Reliance on essential services in an unregulated, free-for-all space is one of the great vulnerabilities for modern society – yet it rarely makes the headlines beyond the space community. Potential for a so-called ‘tragedy of the commons’ is high.

To avoid a tragedy of the commons, we habitually resort to either innovative technology and/or increased governance. Innovation will doubtless help in the long run and space traffic control systems and propulsion technologies (to avoid debris) are in increasing demand. In 2021 a private company even tested commercial a spacecraft, which, by 2024, could become the world’s first space garbage truck designed to remove defunct satellites.

Increased governance in the not-so-distant future would also be a good idea. Space regulation is out of date, struggling to keep pace with the increasingly rapid innovation and diversification of space activities, and any improvements will need time to take effect. ‘Advancing the peaceful and sustainable use of Outer Space’ will be one of the objectives of the UN Summit for the Future in 2024. But self-regulation, accepted norms of behaviour, and codes of conduct driven by a sense of responsibility, can make a big difference much more quickly and are more flexible than regulation. For example, some decisions by operators could decrease the risk of collision with space debris: using mildly eccentric orbits would spread the constellation mass over a much larger volume of space, thereby lowering the collision risk. Actuarial calculations by the insurance sector, with lower premiums for operators adopting such risk mitigation strategies, might help to encourage such behaviours.

What role does politics play in economics?

In Ancient Greece (4th century BC) Xenophon created the term ‘economics’ to describe “the practice of household management”. Today, it can apply to our planetary household.

Classical economists such as James Steuart and Adam Smith considered political economy to be a goal-oriented science, espousing the concept of value-driven choices. Too soon, however, economists moved away from goals towards a discovery of the mechanics of economics, turning the emerging discipline into a value-free zone.

Goals and trade-offs between stakeholders can be made more explicit through politics. Politicians are expected to balance the will of the electorate, advice from experts (including economists), and moral judgment. CEOs walk the same tightrope in the corporate world.

Left to its own devices, pure economics optimises for efficiency rather than resilience; for just-in-time rather than just-in-case (the latter having an opportunity cost). Extra capacity (e.g., extra beds in a hospital), redundancy in a system (e.g., a generator on standby) or diversification of suppliers (rather than always opting for financial economies of scale through a single wholesale supplier) are all deemed sub-optimal solutions in purely economic terms.

Yet all of these strategies can play a part in building resilience. One way of resolving the apparent dilemma is to use governance methods (for example, regulation) to mandate such measures. In the early 1990s, the resilience of the insurance sector was seriously tested by a number of large losses, and US insurance company insolvencies peaked at 50 in 1992 alone (exacerbated by Hurricane Andrew, which resulted in $27.3bn damages that year). A drastic overhaul of the risk modelling methodologies (physical-based models rather than actuarial models extrapolating from the past) and one of the tightest regulation frameworks (Basel I in 1988, Basel II, III and then Solvency II from 2016 – which requires insurers to hold capital to withstand shocks with a 0.5% probability) has made that sector more resilient.

Yet regulation should not be regarded as a panacea. A resilient insurance sector is good news for all policy-holders who may one day have to file a claim, but the insurance sector is only one component of the system whose resilience we are concerned with. If the price of this resilience is an increasing insurance protection gap (meaning that insurance becomes increasingly unavailable or unaffordable for certain risks, e.g., cyber risk) are we really better off?

Within the existing rules of the game, the economics make it unprofitable for insurers to offer protection against risks that are seen as increasingly systemic. Cyber risks are the oft-cited obvious example here, due to the unprecedented connectedness of IT systems worldwide. The situation is exacerbated by geopolitical tensions which make this relatively cheap form of ‘greyzone’ aggression more likely as a persistent tactic. As a result, Swiss Re estimates the cyber insurance gap at 90% (i.e., 90% of the losses are not insured). Ultimately, the risk rests with individuals and organisations unable to get insurance, even if they take some steps to prevent or mitigate the risk. Even in cases where the state has been seen as the insurer of last resort (e.g., the furlough system during the Covid-19 pandemic), the cost is ultimately borne by all tax payers – now and for the foreseeable future.

Another lever for better resilience is to assign some value to those extra beds that make a hospital resilient, or to that emergency generator or supplier diversification. Assigning value enables a fuller cost-benefit analysis which can augment the purely financial cost of investment in resilience. Recognition of both tangible costs and intangible value can help us to understand resilience as an asset, which has both a cost and a benefit.

However, assigning value is a complex and often largely subjective task. It is not politically neutral, but involves choices made by stakeholders, who can have diverse (and often conflicting) objectives. Initiatives designed to build or retrofit resilience to a system are often developed with input from one (or a few) dominant stakeholders. Increased resilience for one group may not automatically increase resilience for all the others. Ultimately, there will always be choices or trade-offs to consider and two in particular can serve to illustrate how resilience decisions are inevitably influenced by political (small ‘p’) choices:

Choices between the individual and the group: during the Covid-19 pandemic, lockdowns and track-and-trace systems were imposed in most countries as necessary measures to slow down the transmission of the virus, while more long-term mitigation measures (e.g., vaccines) were being put in place. This decision demanded the temporary curtailment of civil liberties (freedom of movement) in favour of public health imperatives. Societies with strong individualistic cultures experienced a lot more opposition to these measures, with some needing more stringent governance to enforce them, compared to societies where the collective has a larger place. A study of Covid-19 across 69 countries covering 75% of the world population found that the more individualistic (vs. collectivistic) a country was (based on cultural preference surveys), the more Covid-19 cases and mortalities it had.

Choices between current and future generations, or between different regions of the world: although the drivers of Climate Change have been known for almost 167 years, the politics of Climate Change only gained prominence in the 1970s, and a coherent action plan that will ensure the long-term resilience of all our societies on Earth is far from being agreed upon. Mark Carney’s words in 2015, when still Governor of the Bank of England, finally spurred the financial sector to consider Climate Change as a major risk. Those words are still a poignant summary of the intergenerational trade-off we face: “Climate Change is the tragedy of the horizon. We don’t need an army of actuaries to tell us that the catastrophic impacts of Climate Change will be felt beyond the traditional horizons of most actors – imposing a cost on future generations that the current generation has no direct incentive to fix.” Climate Change presents clear intergenerational and inter-regional equity challenges: consumption now creates costs for future generations; consumption in developed countries creates costs in developing countries.

A difficult balancing act it may be, but there is hope that a more humanistic branch of economics could be leveraged to support leaders in their daunting task. In 1819, Jean Sismondi, a Swiss economist, prioritised human welfare as the goal of political economy, rather than wealth accumulation. More have followed suit, including John Ruskin and Amartya Sen.

The need to account for resilience

Most people would agree that improved resilience is a worthy goal, yet – just as in the age-old model of the ‘commons’ – we still struggle to understand how to measure, account or be accountable for it.

Objective comparable metrics and a resilience accounting model would make it easier to track changes in resilience (hopefully improvements) and to compare options when decisions or investments are required. We are regularly reminded that an investment strategy based on regular modelling increases performance, efficiency and resilience, however we do not possess a shared understanding of how to account for resilience.

For something that affects us all, risk and resilience are conspicuously absent from our national statistic sets. It may prove trickier to encapsulate resilience and preparedness in a few objective metrics than for the current growth-related metrics (GDP, inflation, interest rates), but that should not prevent us from trying. British economist Kate Raworth, in her book Doughnut Economics (2017), has identified the crux of the matter – it seems we may have been chasing the wrong goal. Isn’t GDP growth a misleading indicator of economic health if that growth is neither sustainable nor resilient?

Economics on its own will not provide better resilience. Resilience is a product of our choices, and will be determined by our values, behaviour and judgement. Political and business leaders will always need to make trade-offs, but we should continue to look for ways of making those choices more informed. We need a new way of valuing resilience that enables choices between economic growth at any cost and resilience at any cost – the answer lying at some elusive point between the two. Perhaps a priority of Government should be to work across boundaries in search of a set of metrics that translates into both domains and that can support a more open national discussion on risk and resilience?