May's instability in large economies.

Area of Science:

• Complexity Economics
• Network Theory
• Ecosystem Dynamics

Background:

• Economic systems, like large ecosystems, may face inherent stability challenges as they grow.
• Previous work by Robert May suggested ecological systems tend towards marginal stability.
• Real-world supply chains often feature firms with non-substitutable production inputs.

Purpose of the Study:

• To investigate whether large economic networks tend towards marginal stability.
• To explore the impact of network size, firm heterogeneity, and input substitutability on economic stability.
• To explain the 'small shocks, large business cycles' puzzle.

Main Methods:

• Modeling firm networks with non-substitutable production inputs.
• Applying results from random matrix theory to analyze network dynamics.
• Analyzing the distribution of firm sizes and output losses under stress.

Main Results:

• Economic networks become dysfunctional with increased size, high firm heterogeneity, or reduced input substitutability.
• At marginal stability and high heterogeneity, firm size distributions exhibit empirical power-law tails.
• Small, idiosyncratic shocks can trigger cascading defaults ('avalanches') with power-law distributed losses.

Conclusions:

• Evolutionary and behavioral forces may drive large economies to a state of marginal stability.
• This marginal stability, coupled with heterogeneity, creates vulnerability to small shocks, leading to large-scale crises.
• The model provides a theoretical explanation for the observed 'small shocks, large business cycles' phenomenon.