Complexity economics

Brian Arthur talks about complexity economics.

Cultural migration and the Scottish independence referendum

Maximilian Schich has created a video showing patterns in cultural migration across hundreds of years by showing the places of birth and death of notable individuals. Places of birth are shown in blue while places of death are shown in red.

The commentary for the video indicates that migration in France has been towards a single hub (Paris) whereas migration in Germany has been to several competing hubs (see around 2:00 in the video). The UK is not mentioned in the commentary but London is clearly shown as the dominant migration hub in the UK.

This level of centralisation can become unhealthy both for the rest of the country and for the hub itself. It is normally the young and energetic who look most widely for better opportunities. For the rest of the country, the continuous loss of economic energy can lead to alienation from the hub and even, as in Scotland today, to referenda on independence from the hub. For the hub itself, it can lead to problems of success such as overcrowding. For example, the ten most overcrowded train services in England and Wales all involve journeys to or through London.

The relative success of Germany compared with France and the UK might suggest at least the possibility that a country dominated by a single migration mega-hub is far from the optimal design.

When the herd turns

Home for the holidays

An economics student talks to his mother about what he has learned on his course.

Debt: The good, the bad, and the ugly

Dirk Bezemer has an excellent series of four videos on debt.  The videos are a great example of high-quality accessible academic economics!  Watch the first episode below and the others after the jump.

Economics and aliens

Do economists come from outer space? Are they inhabitants of the planet Economania? Unfortunately not. Here’s why.

Economists live in tribes. Noah Smith has a recent post EconoTrolls: An Illustrated Bestiary which pokes fun at the various economic tribes. Noah also pokes fun at himself (he’s a mad scientist), although he stops short of lampooning his economic heroes. Perhaps he sees his heroes as Very Serious People who have no sense of humour. Still, that is a minor quibble. The key points are that Noah’s post is funny and that, importantly, modern economics is split into many incompatible tribes with minimal cross-tribal collaboration.

An economist

As a non-economist studying the behaviour of economists, this is an important insight. The various tribes approach economics in different ways. They have different starting points; use different methods; make different assumptions; quote different ‘facts’; cite theories of different dead economists; and tell different stories. Some tribes agree on their descriptions of how the economy works but differ on how the economy should be managed. Some tribes agree on how the economy should be managed but differ on their descriptions of how it works. Most tribes seem to disagree with other tribes as a matter of principle.

This tribalism presents little problem for economists. Each economist lives in one of the tribes and assumes that all of the other tribes are crazy. For a sceptical non-economist, however, this presents a major obstacle to any coherent understanding of economics. Which tribe, if any, should a sceptical non-economist join? What criteria should a sceptical non-economist use to make this decision?

I’ve been thinking about this for a while, and the most obvious answer seems to be to re-invent economics from scratch; compare that knowledge with each of the original tribes; and then decide which original tribe to join. I can see only two problems with this plan. The first is that I don’t have the time, inclination, skill or insight to re-invent economics from scratch. A minor obstacle! The second is that if I went to the trouble of re-inventing economics, I would, in effect, be inventing yet another tribe and making the multi-tribe problem even more difficult for future non-economists.

I was reminded of this problem this week while watching QI (and here). The programme showed a tribe of fire ants crossing a pond. The ants form their own bodies into a raft, and then use the raft to cross the pond. At each stage, some ants appear to form the raft while other ants move across the top of the raft. Eventually, the raft reaches the other side of the pond and the ants disembark onto dry land.

A raft of fire ants

This is an amazing natural phenomenon. There are a number of questions one might ask about this phenomenon.

• How (and why) do the ants decide to cross the pond?
• How do the ants know that they should form a raft and how do they steer the raft?
• How does each ant know when to move and when to stay in position?
• Why does the raft not sink?
• What would happen if some ants rebelled in the middle of the pond and decided they wanted to change direction?
• What would happen if all of the ants decided to move in tandem when they caught sight of their destination? Would this result in a tsunami-like phenomenon?
• Do some ants position themselves on the raft so that they will be at the front of the raft when they reach their destination?

The interesting thing is that we do ask some of these questions and answer them using a scientific approach. For example, here is a QI video showing why the ant raft doesn’t sink. However, there are other questions that we neither ask nor answer. They are too hard. For example, we don’t ask questions about an individual ant’s motivation or decision-making skills in order to work out why and how each ant decides whether or not to move. And we don’t try to link the behaviour of an individual ant to that of the entire tribe.

What does this have to do with the tribes of economists?

Compare the study of the behaviour of ants collaborating to move across a pond, and the study of the behaviour of humans collaborating to improve their individual and collective well-being. In one case, scientists observe the behaviour from a detached perspective and use the scientific method to focus on the observable behaviour of the tribe rather than the imagined motivation of an individual. In the other case, economists observe the behaviour from alongside the tribe and see themselves as part of the tribe. Mainstream economists decide that it is vital to focus on the behaviour of an individual “representative agent” to determine the apparent motivation of individuals in the tribe and then, somehow, to link the behaviour of an individual to that of the tribe.

It strikes me that economists are making economics far too difficult and are causing many of the major tribal divergences of opinion through this approach. A much easier, and more scientific, way to study economics would be to hire a set of aliens to carry out the study on our behalf and then tell us of their findings. They would study us with a scientific approach similar to our approach to the study of tribes of ants.

What would these aliens conclude?

Firstly, they would see that ant-people are divided into many tribes. They would see that individual ant-people combine into teams of various sizes to collaborate with each other using a process of exchange to the apparent benefit of each individual and team. They would also see that ant-people tribes collaborate with each other through a process of exchange to the benefit of each tribe.

Secondly, they would see that some individuals, teams and tribes are much more productive than others. They would see that the process of exchange works best in a stable environment but that, for all tribes, there are some periods when the environment becomes unstable. They would see that the periods of instability often arise when the ant-people display herd-like behaviour similar to that of stampeding alien-cattle.

Finally, they would observe several mini-tribes of ant-people who stand at the edge of each main tribe and shout instructions to the main tribe to tell them how to collaborate more effectively. Unfortunately, each of the mini-tribes shouts incompatible advice, so the main tribes ignore them and behave mostly as though the mini-tribes don’t exist. The aliens would give the mini-tribes a name. They would call them ant-economists.

Afterwards, the aliens would retire to watch alien television. They would watch alien-QI and marvel at videos of the normally miraculous achievements of the ant-people; they would show concern when the ant-people appeared to stampede towards (or away from) what they imagine to be an economic cliff; and they would laugh at the behaviour of the ant-economists. They might ask themselves why the ant-economists thought they could advise the main tribes on how to collaborate more effectively when the ant-economists themselves showed little or no ability to collaborate effectively with other ant-economists in different mini-tribes. They would probably conclude that some questions are too difficult to answer and that they should concentrate their pursuit of knowledge on readily observable phenomena.

It is likely that my plan to use aliens to help us understand economics has more chance of success than trying to decipher the incompatible thoughts of the various economic tribes in Noah Smith’s post. However, in the absence of friendly and willing aliens, there is no practical alternative to the latter approach. I will start my journey to the metaphorical planet of Economania in an upcoming post.

A non-economist ponders a journey to the metaphorical planet of Economania

An economist reassures the non-economist that he will come to no harm on his journey

Money is debt

97% Owned is a two hour, UK-focused video on money and monetary reform. It was made by Queue Politely and includes contributions from, amongst others, Positive Money, New Economics Foundation, Money Reform Party, Bank to the Future and Ann Pettifor.

The video is strongest when it describes the mechanics of the existing monetary system and the problems associated with the existing system. Perhaps inevitably, it is not as strong when it attempts to define solutions and, in some places, it is overtly party political.  Nevertheless, it is essential viewing for anyone with any interest in economics or 21st century politics.  If it doesn't make you mad you're not paying attention.

Crises of capitalism

A visual presentation from The RSA of some of the reasons for the current economic crisis. The animation is by Cognitive Media.

Ten principles of economics

Yoram Bauman (and here) is an environmental economist who works at the University of Washington. He is also a stand-up comedian.

Evolution of the wealth of nations

One of the biggest tensions in economics is between a top-down macro view of the economy and a bottom-up micro view of the economy. César Hidalgo (and here) is pursuing a very visual and data oriented approach to economic thinking which allows him to get the best of both worlds.

We have always had this tension of understanding the world, at small spatial scales or individual scales, and large macro scales. In the past when we looked at macro scales, at least when it comes to many social phenomena, we aggregated everything. Our idea of macro is, by an accident of history, a synonym of aggregate, a mass in which everything is added up and in which individuality is lost. What data at high spatial resolution, temporal resolution and typological resolution is allowing us to do, is to see the big picture without losing the individuality inside it. I believe that in the future, macro is going to be something that is going to be in high-definition. You're going to be able to zoom in into these macro pictures and see that neighborhood, and see that person, and understand that individual, and to have more personalized interactions thanks to the data that is becoming available. I think that in some sense, big data can help recover the humanity of a world in which the scientific representations of people have become dehumanized, because of our need to simplify.

César Hidalgo

César talks about his work here. The Observatory of Economic Complexity is here. His TED talk from 2010 is also very interesting. Watch his TED talk after the jump. It's all about lego and putty.

Reclaiming the Laffer curve from the propagandists

The Laffer curve explains why increases in the rate of income tax do not always generate more revenue for the government.

Consider the income tax system:

1. The government is free to set the rate of income tax anywhere between 0% and 100%
2. If the government chooses to set the rate at 0%, it will generate no revenue. 0% of anything is nothing
3. If the government chooses to set the rate at 100%, it will also generate no revenue. If an individual does not profit from working then there is no incentive to work at all. If no-one works then revenue from income tax will be nothing
4. In the real world, governments set the rate of income tax somewhere between 0% and 100%, and they do generate revenue
5. We can conclude, therefore, that there must be one (or more) rate(s) of income tax that will generate the maximum income tax revenue.

This is a great example of a thought experiment in economics. However, it is also an example of why economics is not a science, or at least why most economists (and almost all politicians) do not appear to be scientists.

What is missing from this description of the income tax system is a very obvious question. What is the optimum rate of tax which will generate the largest amount of revenue?

It seems to me that there are four possible answers to this:

1. A specific number. For example, perhaps 42% is the optimum tax rate. We’d need to be clear whether this rate included or excluded related taxes such as National Insurance, but this would be a really useful answer. The government could set the tax rate to this optimum rate and then watch the revenue flow in
2. Two or more specific numbers. For example, perhaps 32% and 52% both generate the same maximum amount of revenue. The government could then choose between these two rates depending on its political beliefs
3. It depends. Perhaps there is no universal optimal tax rate and the optimum depends on circumstances. For example, maybe culture is an important factor; maybe the optimum varies depending on the wider state of the economy; maybe it depends on political and religious beliefs; maybe it depends on age; maybe it depends on the government's spending plans. If this is the case, a scientist would want to explore this further before drawing any conclusions. Without further research, the government would have no clear cut method for using the Laffer curve to set the optimal tax rate
4. We don’t know. Although the Laffer curve is an interesting and useful thought experiment, there is no practical way of knowing the optimal rate in all circumstances.

This defines the dividing line between science and politics. Scientists would ask this very obvious additional question and demand an answer. Politicians would be happy to use the thought experiment to generate political propaganda. I’m not sure where economists sit in relation to this division.

Here is a typical diagram of the Laffer curve.

Laffer curve as political propaganda

This is an example of political propaganda. There is no scale indicating different taxation rates. There is an assumption that there is one peak taxation rate. There is another assumption that the current taxation rate is higher than the peak rate. This is propaganda for a politician who believes in tax cuts. The diagram could equally be drawn with the current tax rate to the left of the peak. With that minor tweak, the diagram would become propaganda for a politician who believes in tax increases.

The Laffer curve originated in the 1970s. At that time, income tax rates in many countries were above 90%. It’s not hard to imagine that this level of tax was a major disincentive. It’s almost certain that 90% is to the right of the optimum tax rate. However, that does not mean that we can conclude that any current tax rate is to the right of the optimum rate.

There are three key points arising from this argument.

Firstly, let’s assume that, when the governments in the 1970s set very high rates of tax, they were being self-interested, intelligent and rational. Mainstream economics assumes that all economic actors are self-interested, intelligent and rational, so that must include these governments. However, at best, these governments were only “intelligent and rational” from their own perspective.

If we increase the rate of tax then we will generate more revenue. Let’s increase the rate of tax as far as we can
An "intelligent and rational" government

The problem with this logic is that tax payers are also intelligent and rational, and many tax payers reacted to the higher rates by leaving the country, by closing their businesses, or by looking for loopholes in the tax laws.

Secondly, the Laffer curve is likely to apply to all exchanges in economics. The peak in the middle arises precisely because it is the most intelligent and rational compromise between the self-interest of the two actors involved. Not all exchanges take place at the peak, though, because it is in the self-interest of both parties for the exchange to take place away from the peak. If I can sell you a sandwich for £1,000 then that is a good deal for me but a bad deal for you. In that case, I have a better self-interest optimising strategy than you, but that doesn’t preclude the exchange from taking place if you are starving and I am a monopoly supplier, or if you are a fool.

Thirdly, economists need to decide where they sit in the science versus political propaganda divide.

In the meantime, non-economists should reclaim the Laffer curve from the political propagandists and challenge the economics profession to become scientists. The smartest people are the ones who ask the best questions, not the ones who think they have all the answers.

What do we mean by “economics”?

Paul Krugman is one of my favourite economists. In 1996, he gave a talk entitled “What economists can learn from evolutionary theorists”. During the talk, he gave his own definition of economics. He also talked about how economists could learn from evolutionary theory, using an example about the behaviour of frogs. Here are the relevant extracts.

Paul Krugman on the definition of economics:

Let me give you my own personal definition of the basic method of economic theory. To me, it seems that what we know as economics is the study of those phenomena that can be understood as emerging from the interactions among intelligent, self-interested individuals. Notice that there are really four parts to this definition. Let's read from right to left. Economics is about what individuals do: not classes, not "correlations of forces", but individual actors. This is not to deny the relevance of higher levels of analysis, but they must be grounded in individual behavior. Methodological individualism is of the essence. The individuals are self-interested. There is nothing in economics that inherently prevents us from allowing people to derive satisfaction from others' consumption, but the predictive power of economic theory comes from the presumption that normally people care about themselves. The individuals are intelligent: obvious opportunities for gain are not neglected. Hundred-dollar bills do not lie unattended in the street for very long. We are concerned with the interaction of such individuals: Most interesting economic theory, from supply and demand on, is about "invisible hand" processes in which the collective outcome is not what individuals intended.

Paul Krugman

Paul Krugman on the behaviour of frogs:

William Hamilton's wonderfully named paper "Geometry for the Selfish Herd" imagines a group of frogs sitting at the edge of a circular pond, from which a snake may emerge - and he supposes that the snake will grab and eat the nearest frog. Where will the frogs sit? To compress his argument, Hamilton points out that if there are two groups of frogs around the pool, each group has an equal chance of being targeted, and so does each frog within each group - which means that the chance of being eaten is less if you are a frog in the larger group. Thus if you are a frog trying to maximize your choice of survival, you will want to be part of the larger group; and the equilibrium must involve clumping of all the frogs as close together as possible. Notice what is missing from this analysis. Hamilton does not talk about the evolutionary dynamics by which frogs might acquire a sit-with-the-other-frogs instinct; he does not take us through the intermediate steps along the evolutionary path in which frogs had not yet completely "realized" that they should stay with the herd. Why not? Because to do so would involve him in enormous complications that are basically irrelevant to his point, whereas - ahem - leapfrogging straight over these difficulties to look at the equilibrium in which all frogs maximize their chances given what the other frogs do is a very parsimonious, sharp-edged way of gaining insight.

Paul Krugman

I’ve been looking for a definition of economics for some time. The current economic crisis suggests that there is something fundamentally wrong with economics (or certainly with economists), so I thought it might be a good idea to go back to basics and look for an effective definition. I tried Wikipedia and a number of other sources, but it was Krugman’s definition that struck me as most interesting, and the fact that he gave his definition during a talk in which he contrasted economics with evolution suggested a link with complex systems.

Nevertheless, I have a problem with Krugman’s definition. A one word summary of his strap line is that economics is about “interactions”. His phrase “among intelligent, self-interested individuals” is merely delimiting the interactions. I agree with the focus on interactions. However, he then breaks his definition into four bullet points. The first three of these bullets are about individuals. Only the fourth is about interactions. This balance feels wrong.

When Isaac Newton saw an apple falling from a tree, he had the opportunity to think further about the apple or to think further about the movement of the apple. There are lots of things he could have thought about the apple: the way it grows, its shape, its size, its colour, its taste, the recipes through which it can be transformed into food and drink, how any of these things could be improved. Instead, Newton thought about the movement of the apple. In many ways, it would have been easier to think about the apple. For example, he would not have had to go to the trouble of inventing calculus. However, he thought about the movement of the apple and realised that the apple was not really important to his thinking. It could have been anything falling from the tree: a leaf, a branch, an animal or even Isaac himself. Incredibly, he realised that he could replace the apple with the moon, even though the moon doesn’t fall from a tree and the moon never hits the ground. Newton was smart but one of his most immense skills was the way he framed this problem and defined his area of study.

I don’t think that Newton would have defined his subject with a strap line about movement, and then expanded his definition with four bullet points, the first three of which were about apples.

This is what troubles me about Krugman’s definition of economics. Why are individuals so important that they warrant three bullet points? Surely the individuals are the equivalent of Newton’s apples. Individuals are not even the only actors in the economy. What about businesses, banks and governments? And why do the individuals need to be intelligent? When Krugman discusses frogs, he doesn’t indicate that they need to be intelligent, even though they display “intelligent” behaviour by arranging themselves in groups to protect themselves from the snake. And why does Krugman not say anything interesting about interactions if that is what he thinks economics is about? It would be better if he had said something like this.

Let me give you my own personal definition of the basic method of economic theory. To me, it seems that what we know as economics is the study of those phenomena that can be understood as emerging from the exchanges and interactions among self-interested economic actors. There are really five parts to this definition. Economics is about individual exchanges between actors. For example, I buy a bicycle from you for £20. The exchanges may involve assets, products or services. The actors may be individuals or businesses. Economics is about the exchanges themselves but also about the strategies used by the actors to promote their self-interest Economics is about the money used to facilitate these exchanges and related interactions. This includes physical notes and coins but also credit-based money. The inclusion of money also means that economics is about the banks who issue money and who manage money on behalf of other economic actors. As the banks are themselves involved in exchanges, they are also economic actors Economics is about the emerging properties of the totality of these exchanges and related interactions. When exchanges are viewed from the perspective of assets, products, services and money, we talk about markets. When exchanges are viewed from the perspective of the actors, we talk about wealth and debt, surpluses and deficits, profits and losses, winners and losers. When exchanges are viewed from the perspective of geography and government, we talk about international trade and exchange rates between currencies Economics is about the rules and regulations used in these exchanges and related interactions, and how these rules and regulations impact on the behaviour of the actors. The inclusion of rules means that economics is about the governments and other institutions which set the rules. As these institutions are themselves involved in exchanges, they too are economic actors Economics is about the emerging properties of this entire system, including the study of observed behaviours such as booms and busts of the entire economy; booms and busts in the prices of specific assets, products or services; and economic wealth and debt of individual actors. Economics is about the tools for managing this entire system in order to promote economic well-being, and to prevent and cure observed economic pathologies.

Jamie

Why do I believe that this would be a better definition, and that interactions are so much more important than individuals? There are two main reasons.

Firstly, as Krugman says in the fourth bullet point of his definition, many of the most interesting, and certainly the most destructive, phenomena in economics are about interactions:

1. If an individual buys shares, there is no problem. If everyone buys shares, there is an asset bubble. If an individual sells shares, there is no problem. If everyone sells shares, there is market panic
2. If an individual takes his money out of the bank, there is no problem. If everyone takes their money out of the bank, there is a bank run and the bank collapses
3. If an individual decides to stop spending and instead saves his income, or uses it to pay back his debt, there is no problem. If everyone does this at the same time then no-one is spending their income, so there is no demand for products and services, and the economy collapses. Keynes called this phenomenon “the paradox of thrift”. Why did he see it as a paradox though? It is only a paradox if you start by thinking from the perspective of an individual but not if you start by thinking about interactions
4. When Japan has a major earthquake not only does it disrupt the Japanese economy, but there are contagions to other regions. For example, when the earthquake generates a tsunami which overruns sea barriers and floods a single nuclear power station, Japan turns off all of its nuclear power stations and uses other energy sources instead. As a result of this, world demand for other types of energy increases. This increases the price of energy for everyone. In addition, other countries respond to the Japanese nuclear accident by re-considering their own use of nuclear power. This has further implications for energy prices and also for the employment of people in the nuclear industry in those countries.

Secondly, conventional macro-economic models focus on the behaviour of a single individual: a single, rational, representative agent. How do these models incorporate interactions? If there is only one individual then with whom does he interact? How do these models predict pathologies such as depressions and bank failures when these phenomena relate to interactions? Based on our experience in the current economic crisis, they don’t. Even though Krugman’s strap line emphasises interactions, mainstream macro-economic models seem to focus on the three bullet points about individuals.

One of the problems for a non-economist in trying to understand much of modern economics, and in trying to understand most modern economists, is that a lot of this economic thinking appears to be insane. As a result, a rational non-economist is tempted to conclude that it must be him who is insane. Surely, any sane economist would realise that models based on individual behaviour are unlikely to predict pathologies caused by interactions?

Here is a presentation (and slides) by Joseph Stiglitz, Nobel prize winner, at the 2010 INET conference, making similar points about the limitation of mainstream macro-economic models, particularly from 17:00 to 19:30 in the video. At least it’s comforting to know that if a sceptical non-economist is insane then so is Joseph Stiglitz.

When you start by thinking about interactions then some aspects of economics become obvious. For example, in world trade, when one country runs a trade surplus then some other country must have a deficit. The sum of all imports into all countries must equal the sum of all exports out of all countries. When many countries run a trade surplus at the same time then at least one country must act as “deficit of last resort”. If a country running a deficit decides to close its trade gap then the easiest way to do this is to stop importing goods from other countries. As a result, those countries’ trade surpluses will be threatened. You might suggest that this is obvious. I couldn’t possibly comment except to say that I’d expect to learn this in the first couple of weeks of an elementary economics course if that course were based on interactions. I cannot buy a product unless you sell it. I cannot borrow money unless you lend it. I cannot collect taxes unless you pay them.

What about mainstream economists though? Do they think this is obvious? Here is another presentation (and slides) by Joseph Stiglitz, this time at the 2012 INET conference where he makes precisely these same points. Good man! However, remember this is a Nobel prize-winning economist presenting to some of the world’s leading economists on state of the art economics. Stiglitz does include a number of more sophisticated points in his presentation, including some political points about possible solutions to current problems in international trade. However the key messages, particularly in his slides, are blindingly obvious to anyone who thinks about interactions.

It is a good job that it was Isaac Newton who saw the apple fall from the tree, and not an economist. The economist would have focused on the price of the apple and claimed that its movement was caused by an “invisible hand” which injected “animal spirits” into the apple! If only Newton had decided to sell the apple to a friend and used the proceeds to buy a new notebook. He might then have thought about that as well.

High Anxieties: The Mathematics of Chaos

High Anxieties: The Mathematics of Chaos is a documentary film made by David Malone on the origins of chaos theory and its implications for our political and economic systems. It describes how advances in mathematics and physics have led to an understanding that we don’t live in a Newtonian ‘clockwork universe’ governed by simple rules of cause and effect. It concludes that there are practical limits to our individual and collective abilities to predict and control complex natural systems and man-made systems. Any observed instabilities and breakdowns of such systems may be inherent in the systems themselves and are not necessarily the result of an external shock. The programme was first broadcast by the BBC in 2008.

The programme provides a good introduction to chaos theory and to well-known concepts such as tipping points. It makes a number of good points particularly on economics. However, a few segments seem to push the concept of chaos too far. For example, it suggests that chaos was a major cause of our inability to plan the course of the First World War, and it somehow seeks to relate chaos to the development of nuclear weapons. Also, it ends with some conclusions about the inevitability of disastrous outcomes arising from man-made climate change, which I don’t think are warranted by the preceding arguments. The key point surely is that chaos theory suggests that phenomena such as climate change are unpredictable, and that the risks they represent should be taken seriously, but not that such phenomena will inevitably lead to disaster. Nevertheless, the programme is worth watching.

Watch High Anxieties, split into nine segments, below.

Segment
High Anxieties: Part 1 of 9
High Anxieties: Part 2 of 9
High Anxieties: Part 3 of 9
High Anxieties: Part 4 of 9
High Anxieties: Part 5 of 9
High Anxieties: Part 6 of 9
High Anxieties: Part 7 of 9
High Anxieties: Part 8 of 9
High Anxieties: Part 9 of 9

The programme mentions people such as Henri Poincaré, Aleksandr Lyapunov and Edward Lorenz. Interviewees include David Ruelle, Paul Ormerod, James Lovelock, June Barrow-Green, Peter Cox and Linda Gask.

Metronomes, people and starlings

The essence of a complex system is the interaction between its component parts. The fascination of a complex system is that apparently simple interactions can produce unexpected behaviours. Here are three examples featuring, in turn, metronomes, people and starlings.

When several metronomes are set up on a single moveable surface, such as a board on two rollers, and when they are set in out-of-phase motion, they will gradually synchronise with each other. This process is called entrainment. The scientific explanation is that the metronomes interact with each other through small vibrations in the moveable surface.

The Nobel prize-winning economist Thomas Schelling asked himself why racial segregation occurs in human populations. He could equally have asked about segregation based on nationality, caste, religion, ideology or any of the many other ways in which people identify themselves. He carried out an experiment using counters on a chess board and saw that, even with a very mild preference for the colour of a neighbouring counter, the ‘society’ of counters segregated fully into black and white. Even though individuals are rational and fairly tolerant, the societies we produce together may be neither rational nor tolerant.

Flocks of birds and shoals of fish often move in unison to create complex and beautiful patterns without any leadership and without any obvious rationale. For example, scientists have studied the behaviour of murmurations of starlings. Explanations (pdf) (and here) of their collective behaviour suggest that it may help protect the birds from predators.

Watch demonstrations of each of these three phenomena after the jump.

Franklin’s Gambit and political decision making

John Kay has written an excellent article on decision making in business and politics. His main point, which he refers to as Franklin’s Gambit, is that, even when we appear to follow a rational process for making a decision, we are often looking merely to justify a decision we have made already.

A typical rational decision-making process would be:

1. Scope problem
2. Decide options for solving problem
3. Decide evaluation criteria and relative weightings of these criteria
4. Establish facts
5. Evaluate options based on facts, criteria and weightings
6. Make decision.

In fact, what can often happen is:

1. Scope problem
2. Make decision
3. Decide options for solving problem
4. Establish facts
5. Decide evaluation criteria and weightings which support decision made in step 2
6. Evaluate options based on facts, criteria and weightings
7. Confirm decision made in step 2.

In particular, the weightings of evaluation criteria are always subjective, so they can be chosen, or adjusted after the fact, to produce any desired outcome.

The Civil Service prides itself in its neutrality, and I have worked with many Civil Servants with impeccable ethics. They produce rational reports to support government decisions. Nevertheless, the conclusions of these reports almost invariably support the ideology of the government of the day, and, when the government changes, the conclusions change as well.

In business decision making, reports have an uncanny ability to reflect the views of the Chief Executive and other senior managers. On-message reports can result in promotion. Off-message reports can end careers.

In personal decision making, we often interpret new facts as confirmation of an existing bias. This extends from major decisions through to the trivial. For example,

• When we cast a vote in an important election, we may choose the candidate with the same background or ideology as ourselves irrespective of the merits of the debate during the election campaign. Alternatively, we persuade ourselves that the candidate who offers us the biggest cut in taxes, or increase in benefits, or the ability to buy our council house at a knock-down price, has the best policies for the broader community
• When a player from our favourite football team dives in the penalty area, we see an obvious penalty. However, when a player from an opposing team dives in the same situation, we see a cheat.

We exhibit this type of behaviour in making even routine decisions, so what happens when we have to make an important decision relating to a complex system which we don’t fully understand, such as the climate or the economy?

A 2011 report (pdf) shows that there is a strong correlation between views on climate change and political ideology. If significant future man-made climate change could be proven beyond doubt, we might require expensive new government interventions and many new regulations on private sector businesses. Of course, it is not possible to prove, beyond doubt, the extent to which the climate will change over the next 50 or 100 years. Neither is it possible to prove, beyond doubt, the impact of specific changes in human behaviour. As a result, people on the right of politics, who don’t like the political implications, are mostly sceptical of climate change, while people on the left, who are more comfortable with the implications, tend to be believers.

Correspondingly, in economics, politicians on the right have decided that the solution to the current economic crisis is for government to spend less, while politicians on the left have decided that the solution is for government to spend more. Despite the fact that economists provide conflicting advice on both the causes of, and solutions to, the crisis, the political left and right agree on two things:

• The correct policies are clear and beyond doubt
• The correct policies are the ones which are consistent with their existing ideological beliefs.

The most interesting aspect of this is that there are at least two conflicting aspects of any solution to the economic crisis: the need to create jobs and the need to reduce debt. Policies to create jobs include increasing government spending to provide a stimulus to the economy, and reducing taxes to encourage entrepreneurs and to stimulate demand. Policies to reduce debt include decreasing government spending and increasing taxes. The policies required to solve one of these problems are the opposite of those required to solve the other. Solving both problems at the same time is anything but clear and beyond doubt.

As a result, both left and right justify their policies mostly by pointing out the flaws in their opponents’ policies:

• The right says that the left prioritises jobs over debt. Increasing government spending in the hope of creating jobs will increase the debt further. This will lead to disaster. Look at Greece!
• The left says that the right prioritises debt over jobs. Reducing government spending in the hope of reducing the debt will increase unemployment further. This will increase the level of unemployment benefit payments, so might not even reduce the debt (or the annual deficit). Austerity leads to more austerity!

Both sides argue convincingly that their opponents’ policies won’t work, so their own policies are the best ones. This is false logic. It doesn’t occur to either ideological wing that they may both be correct in assessing that their opponents’ policies won’t work, and that we may be facing a Sophie’s Choice where there are no good outcomes.

Richard Feynman would point out that a search for the truth, in the face of complex systems which we don’t fully understand, should involve both humility and doubt. These qualities appear to be entirely absent in our politicians and their ideologies.

More on economics models

When you are trying to diagnose and cure a problem in a business or a government organisation, business models are extremely useful. There are all sorts of ways of modelling a business. However, they can be divided into two main classes: top-down models and bottom-up models. Top-down models aim to give a management perspective on a problem while bottom-up models give a shop-floor perspective.

Economists use a similar distinction between top-down macroeconomic models and bottom-up microeconomic models. A key issue in both business analysis and economics is the relationship between the top-down and bottom-up models, and the level of consistency between them. Business analysts have debated these issues for many years, so what does business analysis have to contribute to the current modelling debates in economics?

Most people have no interest in, or experience with, either business models or economic models, so I’m going to use a more familiar set of models to make some relevant points, although I learned these lessons through developing business models.

Let’s start with a top-down view of the geography of the earth. Here is a photograph taken from Apollo 17. It’s known as the Blue Marble.

The Blue Marble

At this scale and perspective, we can see that the earth is round, and we can identify feature such as continents, the sea, the snow-covered poles and large areas of cloud. A second model, at a similar scale, might help us understand that the earth orbits the sun with its polar axis at an angle of around 23 degrees. This model would allow us to explain the seasons of the year.

When we change scale to look at the earth in greater detail, we move to atlases and maps. As these models show a round object on a flat surface, we need to use projections such as Mercator, Gall-Peters and Mollweide to produce these models. Projections distort the relative size and position of different objects on the earth. Different projections distort the earth in different ways. At this scale, and subject to the rules of any specific projection, we can use these models to see the relative size and positions of countries, and large features such as mountain ranges, large lakes and the biggest rivers.

When we change scale again to look at an individual country, the distortions of different projections become less pronounced, particularly for small countries. At this scale, we can use different maps to see more detail. For example, we might see geographical and political boundaries, towns and cities, and major road and rail networks. Even if we are unfamiliar with a country, we can ask interesting questions which can help expand our knowledge: why are the states in the north-east of the USA often small while the states elsewhere are much larger; why do some states have regular boundaries while others have jagged boundaries? If we are not familiar with the distortions in the map, we may misunderstand the picture we are viewing: is Alaska really an island off the south-west coast of Texas; and what happened to Canada and Mexico?

Map of US States

Finally, when we change scale again, we can use street maps to navigate around a single town or city. We can also use highly stylised maps to navigate tube and subway networks. In these latter maps, we may even lose a sense of the physical distance between stations. However, these maps are still useful in helping us to select the correct train line and to understand when we need to change from one line to another.

What general rules can we take from these geographical models which could also be applied to business and economic models?

General Modelling Rules

Rule	Description
1	Models can be developed at different scales and with different perspectives
2	All models are simplifications of reality
3	Models should be judged as useful rather than correct. Models which distort reality can still be useful as long as the reader understands the distortion and its limitations
4	It is vital that any model helps you answer specific questions. It is often better to develop several simple models, with different perspectives, to answer different questions. A model which helps you understand the seasons of the year may not help you find your way round the London tube network, and vice versa
5	It is essential to develop models which provide insights for the layman into the complexities associated with the questions he is asking, and into the answers to these questions. This does not preclude the use of expert-only models but such models cannot, and should not, be used to communicate with non-experts
6	A model presented as a diagram is normally easier for a layman to understand than an equivalent verbal description
7	Different people may need and expect to see the same situation from different scales and perspectives, so multiple models may be needed to communicate with different audiences
8	It is not always possible to develop top-down models simply by combining bottom-up models. You cannot tell that the world is round from a city street map.

In general, business analysts have recognised these characteristics in their use of models. Perhaps that’s because their customers hold them to account in providing useful answers to specific questions, and because they insist on models that reflect the facts as they understand them. In contrast, the debates in economics seems to focus more on the correctness and consistency of economic models rather than their usefulness in solving problems or in explaining problems and solutions to non-experts.

Paul Krugman and economics models

During my quest to understand the mental models used by economists, I came across a fascinating 20 year-old article by Paul Krugman. The article’s title is ‘How I Work’ and it outlines Krugman’s basic rules for conducting interesting research. The reason the article is fascinating to me is that it provides a rare insight into how a leading economist thinks about economics rather than merely what he thinks.

The article includes a number of interesting insights into Krugman’s background. For example, he makes the following observation about what distinguishes the way he thinks, and his attitude to models, from most other economists.

Most young economists today enter the field from the technical end. Originally intending a career in hard science or engineering, they slip down the scale into the most rigorous of the social sciences. The advantages of entering economics from that direction are obvious: one arrives already well trained in mathematics, one finds the concept of formal modeling natural. It is not, however, where I come from. My first love was history; I studied little math, picking up what I needed as I went along.

Paul Krugman

Economics and models

The development of mental models is one of the most important ways through which we make sense of the world around us. That’s true of everything from the earth orbiting the sun to the internal workings of a jet engine, and from the maps that help us navigate to our political systems. When we have good models, we call them scientific and, when we don’t, we think in terms of belief and ideology. When we share a common model, it is easy to debate how to improve the model, and when we don’t we tend to struggle to make any advances.

The image of the world around us, which we carry in our head, is just a model. Nobody in his head imagines all the world, government or country. He has only selected concepts, and relationships between them, and uses those to represent the real system.
Jay Wright Forrester

In order to work out what is wrong with economics, and economists, I wanted to understand the mental models that economists use to drive their thinking. What does the economy look like? Who are the main participants e.g. banks, businesses, households? How do they interact with each other?

When I looked for this type of insight, one of the first surprises I found was that economists seem to make little use of diagrams. Although this might seem trivial, it means that it is very difficult for a layman to envisage how economists picture the economy, why they expect a particular policy change to improve the economy, or how the view of one economist differs from that of another.

A picture is worth a thousand words, except in economics.
Jamie

A verbal description is the next best option. The economics profession set up the Institute for New Economic Thinking (INET) to promote novel ideas following the advent of the current economic crisis. It held an inaugural conference, attended by many of the world’s leading economists, in April 2010. At this conference, Joseph Stiglitz gave an excellent presentation (including 23 slides with, of course, no diagrams) where he discussed many of the limitations of the models and methodologies used by mainstream economists prior to the crisis. He also proposed some areas for research to improve these models. Here are just a few key points.

Stiglitz began by discussing some of the mainstream economic beliefs which had turned out to be wrong. One of these was incredible.

There is no such thing as a bubble.
The mainstream economics profession

Now, bubbles have been known since Tulip Mania in the 1630s, and the Internet bubble burst only a few years before the current crisis. As a result, this statement, on its own, seems to be sufficient evidence to discredit the entire mainstream economics profession.

Stiglitz then discussed some of the assumptions that mainstream economists use in their models. These include an assumption that all people are identical and can be modelled as a single representative agent, and a further assumption of rational expectations which suggests that the representative agent always behaves rationally and with perfect information on the state of the economy. Again, these statements seem to discredit the entire profession. As Stiglitz indicated, if there is a single representative agent then how do financial markets work e.g. who sells to whom, who lends to whom, how can bankruptcies happen, who causes a run on the stock market? Most importantly, these assumptions preclude the current crisis.

One of Stiglitz’s main overall points was that there is no possibility of interactions between agents in these models. He concluded that one of the biggest modelling challenges for the profession is the inclusion of various types of interaction. These include regulation and control interactions as well as the transactional interactions which drive markets.

One of my initial observations on this blog concerned double pendulums. A single pendulum is the equivalent of the economic vision of a rational agent with very predictable behaviour. A single pendulum has perfect information on the influence of gravity on its behaviour. However, when two pendulums interact, the resultant system can produce unpredictable and unstable behaviour. It seems that the vast majority of the economics profession is oblivious to this type of behaviour.

Taking these points together, the pre-crisis economics profession resembles a religious cult more than a group of professional experts investigating the behaviour of a complex system. At the very least, they come across as a closed community with limited ability to draw analogies, and inspiration, from similar fields of study such as meteorology. As a pseudo-scientific endeavour, pre-crisis mainstream economics resembles a modern equivalent of alchemy.

How did economists get it so wrong?

In 2009, Paul Krugman wrote an article for The New York Times entitled How Did Economists Get It So Wrong? It is an excellent summary of mainstream economic thinking from Keynes to the present day (albeit from a very US-oriented perspective). It is also very good on the deficiencies of the economics profession in predicting the current economic crisis. I particularly like his analogies about baby-sitting and the price of ketchup.

Wanted – useful economists

There seem to be few hard and fast rules in economics. Take the concept of division of labour. We are all better off when we each take a specialist role and then trade with each other. This works well almost everywhere for all manner of goods and services. However, it doesn’t work when asking and answering big questions on economics.

Suppose I want to know the likely impact on inflation of current government policies. As it happens, I have been asking this question and doing some internet research. Economists are the specialists in this area and they have been working on this question for some time. According to economists, the answer is that hyperinflation is likely; or mild inflation; or no inflation; or prolonged deflation. The economics professional does not speak with a single voice on this question. I am left with the task of deciding for myself which, if any, of these answers is correct. Of course, in order to do this, I will first need to teach myself economics to the level of a Nobel prize-winner and then work through the pros and cons of the arguments for each answer. I may be some time.

I’m being a little unfair here, but only a little, so I have a dilemma. In order to make any progress, I need to use the knowledge of ‘the best’ economists, but it’s not at all clear to me which economists are ‘the best’. I need some criteria.

I have set out some criteria, including basic reasoning, below. I have not made any attempt at balance in these criteria. I do not know enough about the many schools of economic thought to achieve political, ideological or methodological balance.

Criteria for 'useful' economists

Criterion	Description
Mainly macroeconomics	Economics is made up of top-down macroeconomics and bottom-up microeconomics. The questions I want to answer seem to be mostly macroeconomic questions.
Prediction track record	Economists who predicted the current crisis are more likely to have mental models that are consistent with the facts. Of course, they could have predicted the crisis through luck, so a longer track record is desirable.
Recognition of failings	Economists who have acknowledged openly the economics profession’s failings are more likely to be open to identifying problems and making improvements.
Good communications	Economists who talk in plain English are easier to understand than those who use abstract jargon.
Flow diagrams	Economists who use diagrams to demonstrate the flows of goods, services, information and money between the various stakeholders in the economy, are likely to be easier to understand than those who use only words.
Complex systems	Economists who use the language of complex systems are more likely to fit my own beliefs.
Trial and error	In the face of a complex system which demonstrates unpredictable behaviour, economists who advocate the use of experimentation, trial and error, and controlled experiments, are more likely to fit my own beliefs.

I’ve been looking for economists who meet at least some of these criteria for a while. Here is my initial list of the economists from whom I’m hoping to learn:

First cut set of 'useful' economists

Name	Country	Website/Blog	Wikipedia	Twitter	Other
Ha-Joon Chang	South Korea	Website/Blog	Wikipedia
Tim Harford	UK	Website/Blog	Wikipedia	Twitter	More or Less
John Kay	UK	Website/Blog	Wikipedia	Twitter
Steve Keen	Australia	Website/Blog	Wikipedia	Twitter
Richard Koo	Taiwan		Wikipedia
Paul Krugman	USA	Website/Blog	Wikipedia	Twitter
Paul Ormerod	UK	Website/Blog	Wikipedia	Twitter
Joseph Stiglitz	USA	Website/Blog	Wikipedia

As most of these economists have blogs and use Twitter, it’s easy to find their views. Some of them have boisterous arguments with their ideological and methodological opponents, so it’s easy to find alternative views as well.

There are lots of financial blogs on the internet. Here is Time magazine’s list of the 25 best financial blogs.