Disruption risks in adaptive inter-firm networks

Célian Colon, of the Ecole Polytechnique, France, examined how the behavior of companies connected by trade links can affect the risk of economic crash, showing that targeted regulations or incentive schemes have the potential to increase stability.

Célian Colon

Célian Colon

Introduction

The interconnectedness of economic activities generates new types of risks, termed systemic risks. Localized perturbations interrupting production or supply delivery by one firm can disrupt customers and cascade further down the supply chain. Such propagations can yield sizeable indirect economic losses. Firms can take several measures to mitigate these risks (e.g., diversifying suppliers, stockpiling). However, because of their interconnectedness, measures taken by one firm influences the risk exposure of other firms, as well as the overall level of risk in the economy. Do individualistic strategies, aiming at profit maximization, lead to the highest economy-wide performance under risks? Within a supply chain, which firms can most effectively mitigate systemic risks? From a regulator’s perspective, what kind of regulation and incentive scheme could be envisioned?

Methods

We formulate and analyze a stylized agent-based model, which is dynamic and evolutionary. Supplier–buyer interactions are represented by acyclic random networks. Firms produce to meet intermediary and final demand from consumers. Firms can be affected by some random perturbations, which temporarily disrupt production. To mitigate supply disruption, firms over-order from their suppliers. Through an evolutionary process, individualistic firms adjust their over-ordering rate to maximize profit; altruistic firms adjust their over-ordering rate to maximize the economy-wide gross domestic product (GDP).

Results

Altruistic strategies lead to higher over-ordering rates than individualistic strategies. The distribution of over-ordering rates is highly heterogeneous: downstream firms tend to over-order more than upstream firms. In the altruistic case, the profits of downstream firms are usually lower than in the individualistic case, while profits of upstream firms are always higher. Altruistic strategies always yield higher GDP. These results are robust across changes in failure rate and productivity. For moderate failure rates (i.e., less than 0.2) altruistic strategies decrease GDP volatility. However, for larger failure rates, altruistic strategies lead to higher GDP volatility. Finally, firms contribute asymmetrically to systemic risk.

Conclusions

Under stochastic perturbations, the economy-level optimal performance cannot be reached by profit-maximizing firms. Supply chain linkages impose coordination of over-ordering efforts. These results will be tested against a wider class of production functions and a dynamic price mechanism. The contribution of firms to systemic risks is heterogeneous, and the strategies of downstream firms can significantly reduce systemic risks. This suggests that there is a potential for the implementation of targeted regulations or incentive schemes. The model will be used to test the validity of such policies.

Supervisors

Åke Brännström, Evolution and Ecology Program, IIASA

Elena Rovenskaya, Advanced Systems Analysis Program, IIASA

Note

Célian Colon, of the Ecole Polytechnique, France, is a citizen of France. He was funded by IIASA and worked in the Evolution and Ecology Program during the YSSP.

Please note these Proceedings have received limited or no review from supervisors and IIASA program directors, and the views and results expressed therein do not necessarily represent IIASA, its National Member Organizations, or other organizations supporting the work.


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Last edited: 02 February 2016

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