Sam Keller's TEC Blog

Thursday, December 27, 2012

An Engineering Approach to Risk Analysis

Instead of reflecting on the unlikelihood of rare catastrophes after the fact, Elisabeth Paté-Cornell, a Stanford professor of management science and engineering and risk analysis expert , prescribes an engineering approach to anticipate them when possible, and to manage them when not.

Kelly Servick is a science-writing intern at the Stanford University School of Engineering.  In a recent article, she reviews the work of Elisabeth Paté-Cornell in this subject area. Click here for Ms. Servick's article.  Click here   for the link to Elisabeth Paté-Cornell's paper on the subject.

Ms. Paté-Cornell argues that a true 'black swan' - an event that is impossible to imagine because we've known nothing like it in the past - is extremely rare. (Reference "The Black Swan" by Nassim Nicholas Taleb.) The terms "black swan" and "perfect storm" have become part of the public vocabulary for describing disasters ranging from the 2008 meltdown in the financial sector to the terrorist attacks of Sept. 11, 2001. But using these terms too liberally in the aftermath of a disaster is really just an excuse for poor planning.

Her research on risk analysis was published in the November issue of the journal Risk Analysis.  Here she suggests that other fields could borrow risk analysis strategies from engineering to make better management decisions, even in the case of once-in-a-blue-moon events where statistics are scant, unreliable or even non-existent.

A true "black swan" – an event that is impossible to imagine because we've known nothing like it in the past – is extremely rare. The AIDS virus is an example. More often, there are important clues and warning signs of emerging hazards (e.g., a new flu virus) that can be monitored to guide quick risk management responses.
The 9/11 attack was not a black swan as the FBI knew that questionable people were taking flying lessons on large aircraft. 

Similarly, she argues that the risk of a "perfect storm," where multiple forces join to create a disaster greater than the sum of its parts, can be assessed in a systematic way before the event because even though their conjunctions are rare, the events that compose them – and all the myriad events that are dependent on them – have been observed in the past.

An engineering risk analysis is based upon systems, their functional components and their dependencies. For instance, many plants require cooling, generators, turbines, water pumps, safety valves and more all contributing to making the system work. Therefore, the risk analyst must first understand the ways in which the system works as a whole in order to identify how it could fail. The same methods can be applied to medical, financial or ecological systems.

Paté-Cornell says that a systematic approach is also relevant to human aspects of risk analysis.
"Some argue that in engineering you have hard data about hard systems and hard architectures, but as soon as you involve human beings, you cannot apply the same methods due to the uncertainties of human error. I do not believe this is true," she said.

In fact, she and her colleagues have long been incorporating "soft" elements into their systems analysis to calculate the probability of human error. They look at all the people with access to the system and factor in any available information about past behaviors, training and skills. by doing this, she has found that human errors, far from being unpredictable, are often rooted in the way an organization is managed. "We look at how the management has trained, informed and given incentives to people to do what they do and assign risk based on those assessments." 

Paté-Cornell has successfully applied this approach to the field of finance, where she has estimated the probability that an insurance company would fail given its age and its size. She has found that companies need forward-looking models that their financial analysts generally did not provide. Traditional financial analysis is based on evaluating existing statistical data about past events - like trying to drive by only looking in the rear view mirror.

In her view, analysts can better anticipate market failures – like the financial crisis that began in 2008 – by recognizing precursors and warning signs, and factoring them into a systemic probabilistic analysis.

Medical specialists must also make decisions in the face of limited statistical data, and Paté-Cornell says the same approach is useful for calculating patient risk. She used systems analysis to assess data about anesthesia accidents. Based on her results, she suggested retraining and recertification procedures for anesthesiologists to make their system safer.

"Lots of people don't like probability because they don't understand it," she said, "and they think if they don't have hard statistics, they cannot do a risk analysis." In fact, we generally do a system-based risk analysis because we do not have reliable statistics about the performance of the whole system.


Sunday, November 4, 2012

Economic Outlook

TEC Midwest relies on the economic forecasting of Brian Beaulieu with ITR Economics.  Why?  Because he has been so often right.  On September 25, 2012, he spoke to a group of TEC Chairs, TEC members and others at the annual Baird – TEC Luncheon in Milwaukee.

Here are my notes from that presentation.


  1.   If there is a new market for your company, go for it.
  2.    Be very cautious about hiring except to support your new market initiative.
  3.    Look at China as a potential market, but seek competent advice before entering.
  4.    The election will not impact the 2014 recession – the stage is already set.
  5.   Obama will most likely win so “deal with it”.
  6.   Your imagination and personal energy are the only things holding you back, not the government or the economy.  

US Economy as a percent of the World’s GDP (~$70 trillion) is still the largest though down to 21.7% from 25% a few years ago.

US employment is on the rise as companies have finished “right sizing”.  However, there is a 6% structural unemployment as a result of people not possessing the right skills to fill open jobs. 

We will have a mild recession in 2014 beginning 4 quarters after mid 2012 regardless of who wins the election.  Our election will not be an economic game changer regardless of who wins

Housing is doing better than Brian's forecast of a year ago.  He expects it will be flat to up slightly during the 2014 recession.  First time buyers are being held back by student loan debt.

Leading indicators are up suggesting 2 to 4 more quarters of growth.

Liquidity is not a real issue with $2 trillion on corporate balance sheets.  The will contribute to a solid recovery in 2015 through 2017.  China is also building liquidity so the 2014 recession should be soft.

Brian sees a substantial downturn after 2017.

QE3 will continue to keep interest rates low and bond prices up – but beware, a bond bubble is being built.

Banks lending is up strongly but only to clients with good credit.

Retail sales are up 25% year over year and the Christmas buying season is expected to be good assuming retailers don’t skimp on inventory.

Deficit spending continues as sequestration of funds merely slows the rate of growth in government – no true cuts.

Bush tax issue will be pushed off until April to let the next Congress deal with it.

Taxes will go up but question remains “on whom?”

Oil in 2013 will reach $120 per barrel if Iran should turn into an open conflict.

Food prices will continue to go up.  Meat prices are currently low as farmers send their life stock to slaughter because of high fed prices.  They will go up once this herd culling is concluded.

Energy and food prices won’t impact Fed policy.

Health care has become a social right regardless of who is elected our next President.  The issue that 80% of a person’s life time health care cost is incurred in the last two years of life will have to be dealt with. 

The deficit as a % of GDP is a “train wreck” coming and will be exacerbated by the growth is health care costs.

The stock market will have a significant downturn in 2014.

The EU will find a way to survive.

Our dependence on foreign oil continues to decline even without a clear energy policy.  And about half of the 45% we now import comes from Canada.

Energy distribution is a growth area – getting energy from its source to population centers.

US productivity continues to improve due to capital investment, which remains cheap due to low interest rates.

Manufacturing as a percent of GDP is now 12.2% up from 11% in 2009 and is expected to continue to grow.

Interest rates will remain low through the 2014 recession.  Then rates will go up and the bond bubble will burst.