Why crisis happen, and how systems react to turbulence: A manifesto for economic research

A tiny virus, emerged apparently from nowhere, raged the world shaking the world societies at all the levels and in all the systems. While the book

“The Rise and Fall of Business Firms”

was completed before the Covid19 crisis, the pandemic could be well considered a perfect example of the “unstoppable turbulences” that, often unforeseen, strike economics systems. How to analyze their effects on the decline and growth of economy, and how to possibly foresee and “prevent” the coming crises is the subject of the new book co-authored by

Massimo Riccaboni

, full professor at

IMT School for Advanced Studies Lucca

, and recently released by Cambridge University Press.

Echoing in the title the “rise” and “fall” of many human enterprises – from empires to civilizations – the authors provide a theoretical framework of how innovation and competition shape the growth and decline of companies.

The book, whose subtitle is “A Stochastic Framework on Innovation, Creative Destruction and Growth”, is the result of fifteen years of work and intense exchange between two American physicists (Gene Stanley of Boston University, and Sergey Buldyrev of Yeshiva University of New York) and two Italian economists (Fabio Pammolli, now at the Milan Polytechnic, and Massimo Riccaboni).

The theoretical premise on which the volume is based is that forces that act on economical systems are similar to those of the physical systems, with which they share many properties. One example is the climate, which we have only partially recently learned to understand, and that for sure you do not know how to govern. Another one could be an ecosystem, where the decline or the growth of a single species can trigger a chain of consequences difficult to foresee.

Combining the analysis techniques of statistical physics and economics, and analyzing various data sources, including a database of historical data on the sale of more than 3,000 companies and 50,000 products in twenty countries, the scholars propose their analysis and forecasting model of the evolution dynamics of firms, which often has counter-intuitive results compared to those of classical economic theory. While, for example, classical economic theory predicts that in the economic systems of industrialized countries the fate of individual firms has little influence on the stability of the system as a whole, the authors’ approach is able to estimate that, when a shock affects some “key” companies, the repercussions can have a large-scale impact. On another level, the model is able to predict which leaps forward an economic system is able to make by producing innovation or, vice versa, in which situations it is at risk of sudden collapses.

Although the model and the mathematics behind the analyses are complicate to understand for non-specialists, the view in the book is clear: each economic aggregate is made up of elements of different sizes: large companies like Amazon and small merchants; products with millions of customers and others that sell only a few items. The growth of each element responds to some fundamental and general rules that can determine its success or extinction. When all these elements combine to form complex economic systems, the fate of the individual units has vast and profound repercussions on the aggregate dynamics of collective economic progress and on the capacity for renewal of modern economies. The book helps to better understand the origin and fate of individual organizations, large and small, and their prospects for a restart.

“On the cultural level, the book stems from the profound dissatisfaction with the ability of modern economic theories to understand, and foresee where possible, the reasons for the turbulent growth and the intrinsic fragility of economic systems”, says Riccaboni. “From this point of view it is proposed as a real manifesto of a new study perspective or even, of a model for doing economic research in the future. The method starts from consolidated evidence, or stylized facts, to propose a theoretical approach whose predictions and assumptions are to be tested, in search of the best possible synthesis”.

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Massimo Riccaboni is professor of Economics at IMT School for Advanced Studies Lucca. His main research interests are industrial organization, network analysis and the economics of science, with particular reference to the life sciences.