The Financial Economics of Synthetic Catastrophe

The BP deep water oil catastrophe in the Gulf of Mexico is beginning to generate lessons from economists. Prof Kenneth Rogoff (2010) offers this early conclusion regarding the evolution and emergence of risk economics in an increasingly complex world:

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.

The regulation of risk is bound to expand in the coming years. However, the time has also come for society to improve its understanding of uncertainty and risk in the post-modern age. The financial economics of synthetic catastrophe are central to the future of capitalism in the new millenium.

Source: Ragoff, K (2010, June 1), The BP Oil Spill’s Lessons for Regulation, Project Syndicate.

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