Tuesday, June 23, 2009

Act of God

When studying contract law, or when signing any formal contract, you may come across the clause Force Majeure. It means superior force. The lecturer said it refers to act of god. This clause is included in contract in order to avoid some liabilities. It is bad news for the damaged party in the contract. One cannot sue the other party for damages arising from act of god. Definition of act of god is normally stated in the contract, but the description is not exhaustive. Usually such events include natural disasters such as flooding, earthquake, volcanoes and also man-made disasters such as war, strike, riot, crime. The general principle is that events which cannot be controlled by the contracted parties are acts of god.

While natural disasters with causes beyond human comprehension temporarily can be regarded as acts of god, it may a shame to label those human evil deeds as acts of god. On the other hand, on the face of the almighty, all good and evil things we cannot controlled should be attributed to god. This thinking prompts an article in Mckinsey Quarterly entitled What Natural and Economic Disasters have in Common. The author draws parallels between the failures of man-made systems, such as the economy, and of similarly complex natural ones. Please take a look at the article if you are interested.

Economists, financial experts and the like are somewhat disappointed for not foreseeing last year's global credit crisis. They turned to the lexicon of natural disasters, describing the shock as a tsunami hitting markets and as an earthquake shaking the world economy’s foundations. Such reaction reflects the extreme and unexpected nature of the circumstances. In fact, the parallels between the dynamics and failures of man-made systems, such as the economy or the electricity grid, and similarly complex natural ones are bringing new ideas to economic forecasting, strategic planning, and risk management.

Scientists in cooperation with economists are applying complexity theory to economic research, rejecting the traditional view of the economy as a fully transparent, rational system striving toward equilibrium. The geophysics professor and earthquake authority Didier Sornette, for example, leads the Financial Crisis Observatory in Zurich, which uses concepts and mathematical models that draw on complexity theory and statistical physics to understand financial bubbles and economic crises.

Sornette aims to predict extreme outcomes in complex systems. Many other scientists in the field of complexity theory argue that earthquakes, forest fires, power blackouts, and the like are extremely difficult or even impossible to foresee because they are the products of many interdependent “agents” and cascades of events in inherently unstable systems that generate large variations. One symptom of such a system’s behavior is that the frequency and magnitude of outcomes can be described by a mathematical relationship called a “power law,” characterized by a short “head” of frequently occurring small events, dropping off to a long “tail” of increasingly rare but much larger ones. The economy, like other complex systems characterized by power law behavior, is inherently unstable and prone to occasional huge failures.

Act of god is being studied and understood and the focus is on early warning. Similar to the early-warning systems for earthquake, volcano eruption and tsunami, strategists could monitor potential indications that economic stress might be building in their industries. Other lessons to be learnt from nature's complex systems include flexible business models incorporating some slack and flexibility, and examples like controlled damages of small forest fires to avoid large-scale fires.

2 comments:

  1. I heard about the term "Act of God" when I studied Law of Contract many years ago. At that time I was fasinated by this term for quite a while.

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  2. My first reaction to the Act of God clause is that men are putting the blame of failed contract to God, and thus avoiding their own responsibilities.

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