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Economics

Been there, done that, bought the T-shirt

Continued from Scylla & Charybdis

The guilty secret shared by many disciples of these two schools is that they are well aware that theirs is very much a busted flush, as is made plain by the procession of very public breast-beatings and existential re-examinations which they have conducted in the years of post-Lehman purgatory by way of atonement for their failures. Indeed, one measure of the dissatisfaction felt at the failings of these Terrible Twins – the money illusionists and the flushing-toilet hydraulicists – lies in the attention now being focused on the work being done by my third opponent and his peers under the guise of the ‘complex adaptive system’ approach.

To an Austrian, in truth, there is much about this last that seems thoroughly unobjectionable, so much so that it is hard to resist an invocation of Gunnar Myrdal’s trenchant dismissal of Keynes’ for his linguistically-challenged commission of the sin of many a monoglottal, English-speaking economist – that of ‘unnecessary originality’.

I say this because in many ways the Complexity guys are simply putting a computer-age spin on concepts we have been trying to articulate for the past three generations.

We, too, start from the bottom-up by focusing on the individual – or the ‘agent’ as he is now known. We, too, believe that order is emergent, knowledge is dispersed, network effects are key, and that the attainment of equilibrium is a mirage.

Where I suspect we differ is that we are more radically subjectivist in a way that it cannot be possible to capture in a mathematized ‘model’. One might also be dubious about the degree of ‘scientism’ involved – i.e., the extent to which there has been an invalid application of the precepts of physics to what is after all a social phenomenon. One might also be wary of the inherent dangers of being too prescriptive in laying out what the ‘agents’ may or may not do.

Among the caveats is the fact that we Austrians hold that scales of preference and utility are ordinal, not cardinal, and so are not arithmetically tractable. Moreover, we cannot see it as a complete solution to go to the trouble of atomizing what was formerly a faceless, monolithic ‘aggregate’ only to have to deny the atoms their own individuality, however capricious their expression of this property may be. We must be wary therefore of driving out the ghost and leaving only the machinery behind.

Nor do we then want to thrust our poor little cellular automata into a Game of Life whose inevitably arbitrary choice of rules is predicated on the very same contradictory framework from which we are trying to free ourselves – namely, the one prescribed by the traditional schools of macromancy. Not only would we wish to avoid our agents’ freedoms being prejudiced by the suppositions of the mainstream, we would also wish them to do more than play out a mere financial simulation, however rich it might be in revealing the structural flaws in our existing institutional architecture and in warning us of its proclivity to the negative feedbacks, price cascades, and other malign outcomes which have come to plague it.

For us, a better imagined microcosm would include scope for the real-world action of entrepreneurs, those principal vectors of eco-genetic adaptation and selection, those drivers of change and arbitrageurs of profitable possibilities, the men and women who are constantly seeking out new combinations of action and innovative mixes of things in order to deliver more value at lower cost to a wider range of customers. Any toy universe which leaves out a reasonable representation of entrepreneurial endeavour – and the fact that this quintessential force for betterment thrives best in conditions which lie outside the bounds of equilibrium, yet away from the ragged edge of chaos – is likely to produce a poor facsimile of the real economy.

Our stipulation for an improved virtual landscape would also insist it addresses a major failing of mainstream macro, viz., its poor handling, if not outright neglect, of the role of capital – a critical construct which is neither a financial variable (despite the unfortunate overlap of terminology with the world of book-keeping) nor, strictly, a mere physical entity like a factory or a machine tool, but which is rather a hybrid which includes both the use of the Thing and the process by which it is employed such that ‘capital’ becomes as much a verb as a noun, if you will.

It may be that we do a disservice both to the judgement and the ingenuity of our Complex System friends, but it does seem questionable that the kind of ‘experts’ they are likely to have consulted would have advised them to incorporate such features when writing their programs just as it is beyond our ken as to exactly how they would go about doing so, even if asked.

If it really is the case that either they have not or they cannot, theirs must very much still be considered a work-in-progress and not yet a fully-formed tool of analysis.

This article is the third in a series. Continue to Part 4: Et in Arcadia ego.

2 comments to Been there, done that, bought the T-shirt

  • John Phillips

    I think the rejection by mainstream economists of the fact that people have ordinal preferences vs cardinal is their most significant error and could even be considered the root of many of their errors. Ordinal preferences implies non-linear micro and macro-economic variable relationships. In other words, it implies a much more complicated reality than their relatively simpleton macro-economic formulas suggest.

  • Sean, I’m afraid you have been sadly misled by Professor Doyne Farmer on the concept of complex systems as applied to economics. I’m aware of his work and it is a nonsense. He tries to create models of complex systems – this is an oxymoron – by definition complex systems are too complex to model.

    However complexity and chaos theory can be applied in a general sense: to provide a useful understanding of an economic system. For example, complexity theory tells us that a complex system will alway tend towards a stable state depending upon the factors and conditions that effect them. These influences can change quite a lot without changing the stability too much. But, If an influencing factor changes by a critical amount, the system will become unstable and will jump into a new and quite different (and unpredictable) new state of stability.

    Applying this to the current economies of the western world would see a stable state having emerged based upon a continuous supply of credit. When this credit ceases, the system becomes unstable (chaotic) as it tries to find a new steady state where there is no credit entering the system. This chaos and change is inevitable if credit is stopped or even reduced. Is it any wonder then that the only solution governments and their economists can see is to keep up the supply of credit?

    Of course, credit cannot be fed into the system indefinitely: so the system is bound to become unstable at some point in time. There is no answer to it and no amount of modelling will either provide a solution or be able to predict how the system will behave.
    This is what complexity theory tells us.

    An economy is a complex system and over the last two or three decades much has been learnt about how such systems behave. Firstly, complex systems have a strong tendency to self organise. That is, if you leave them alone they will settle down into a steady stable state. This stable state is very resilient to much change but if changes exceed a certain critical amount the system becomes unstable and reorganises itself into a new and quite different stable state which is completely unpredictable (this is described mathematically by chaos theory).

    The banking crisis was the first sign that the economies of the western world had entered a chaotic phase, where the changes are likely to be far reaching and dramatic.

    Prior to the banking crisis, the system had stabilised around a situation that saw money, in the form of debt, being created at an ever increasing rate. This cannot go on indefinitely, the time comes when it is realised that this reliance on increasing debt is unsustainable. This leads to a tipping point, where the system loses its stability and goes into a chaotic mode while trying to adjust itself to the new conditions.

    This can be visualised by imagining a family boosting their income over a number of years by using credit cards. They can enjoy luxuries and a higher standard of living for a while, but then as interest mounts up they have to get increasingly further into debt to be able to maintain this standard of living. At some point they are no longer able to get credit. Not only do they lose the extra income they have enjoyed from the continuous credit, they also have to start repaying the debt. Quite obviously, their life style will have to change and if the debt has got out of control there will be a breakdown and their life will go chaotic until they find a new stability as it adjusts to their changed circumstances.

    A similar situation has happened with most western economies. For many years the system adjusted to the continuous input of vast amounts of debt creation. Now this is coming to an end and the system is going into a chaotic mode as it tries to settle into a new, and probably quite different, kind of stability.

    This situation cannot be handled by economic theory. Economic theory relies on cause and effects – and in a chaotic situation causes and effects are totally unpredictable. Politicians have no answers because they rely on individual voters for election and must consider the situation from the point of view of individual reactions rather than deal with the system itself.

    Now consider the economy prior to the banking crisis of 2008: the excess of debt created money coming into the system allowed all kinds of bureaucracies, extravagances and inefficiencies to become part of the economy. These cannot be removed without further substantial imbalances, which will further destabilise the economy. Yet they cannot continue. This is the crux of the politicians’ problems.

    The solution many economists come up with is to try to revert back to the previous stable state by carrying on with introducing more and more debt – governments do this either by openly borrowing more money or, covertly, by creating more fiat currency. These solutions are favoured by politicians because it saves them from having to make unpopular decisions that might reduce their future electability. The various ways politicians find to disguise these solutions are ingenious in the extreme – but however successfully they fool the electors, the consequences will still result in an unavoidable catastrophic outcome at some future date.

    This is no longer a viable option. This means that chaos is unavoidable and the current economic system will become unstable: possibly leading to a complete breakdown.

    The only solution is for politicians to risk their popularity and take decisions that will remove the bureaucracies, extravagances and inefficiencies that have been financed through debt. They must also find ways to establish a viable ratio between productive and non productive members of the population. For this I think Keynes has the better solution – as long as his conceptual framework is taken into account

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