Duncan Green — Please help me answer some scary smart student questions on Power and Systems

Uncertainty and emergence in huge complex adaptive systems.

To what extent can reflexivity anticipate emergence anticipated and reduce uncertainty by applying creative and critical thinking?

Oxfam Blogs — From Poverty to Power
Please help me answer some scary smart student questions on Power and Systems
Duncan Green, strategic adviser for Oxfam GB

Econolosophy — New Research is Looking Very Polanyi-Like

I attended the annual INET conference in Toronto a few weeks ago. Many interesting ideas were discussed, and it was great to hear what is at the cutting edge of econ these days. In particular, two ideas were stressed that really cut into the core of neoclassical thought, and I want to take the time to describe them and what they imply for our understanding of the modern (political) economy.

The first is George Soros’s idea about reflexivity in financial markets. This idea is not new, as Soros has been talking about reflexivity for the better part of at least two decades. But what is new is that the philosophical foundations of reflexivity were recently spelled out in detail in a special edition of the Journal of Economic Methodology.

The punch line is to say that there is seemingly an inherent feedback loop between the actions that fallible individuals make based on their assessments of fundamental value and the fundamental value itself. These feedback loops, moreover, can often lead to boom-and-bust cycles...

The other big idea that was discussed at the INET conference relates to what the complexity economists have been doing lately. The seminal paper in this movement is by Brian Arthur, who highlights the key findings that complexity economists have discovered in recent decades. In short, complexity has gone hand in hand with the advances we have seen in computer science over the past few decades, particularly with respect to machine learning....

Taken together, these two ideas – Soros’s elaborations on reflexivity and the findings by the complexity folks on interactive systemic instability – suggest that markets may be inherently volatile, in a vicious and destabilizing sort of way. If true, this has vast implications for the political economy. It would essentially mean that Karl Polanyi’s central hypothesis has merit: that the dream of the market as a self-regulating and stable system is just that, a utopian dream, which, if followed, will inevitably lead to war, conflict and strife....

Labor, on the other hand, has a notoriously difficult time dealing with market-induced adjustments. Economic shocks may force workers to either abruptly accept much lower wages than what they feel they are worth – which could inflict severe psychological harm – or the shocks may force workers to move to a new place where economic prospects are better, perhaps one where the local culture is very different from what the exposed workers are used to. All of this means that workers may get very angry when they are forced to adjust their prices or living styles to the market. And when workers get angry, they vote for change, primarily against the very liberalization that has inflicted suffering upon them. The populist resentment may even turn racial or nationalistic: when workers don’t have anyone to blame, they typically blame those who simply look and speak differently than they do....

The adjustments that the European Monetary Union has inflicted on people are so vast that the citizens of Europe are unwilling to go through with them; and indeed they are pushing strongly against them, voting for populist, anti-euro parties all across the continent.[2] And do you blame the citizenry for revolting? Workers are being forced to either accept rampant wage cuts (in Greece and Spain) or leave their families and friends to move to entirely different cultures where they are not accepted.

What’s going on is that we may fundamentally have the wrong model of markets in economics....

This suggests that the path forward may be to either take a step back and fundamentally rethink our liberalization projects and what we hope to accomplish with them, or make certain that, prior to embracing the market solution, we have the appropriate safety nets in place to shield people from the extreme adjustments that the market will inevitably force upon them.
In other words, the market often moves too fast, and we should slow it down lest it destroys our cultures and our people, as Polanyi stressed ...

New Research is Looking Very Polanyi-Like 
Econolosophy

Econolosophy — Complexity Economics, Bots, and All That

This is an important post in that it identifies the fundamental characteristic of biological system as self-referential which mechanical and cybernetic systems are not. In addition, human being are self-referential and self-reflective to a greater degree than any other known organisms. This puts them in a different ontological, epistemological, ethical, aesthetic, and social category from other species.

The result is that human beings are individually complex and their interaction socially is therefore even more complex. Any economic theory that does not take this sufficiently into account will be too simplistic to model a society and its economy representationally other than superficially.

Those familiar with the disciplines of  philosophy, history, anthropology, sociology, psychology, and other disciplines involving human reflexivity know that there is no general agreement about theory in any of them such as there is in the physical sciences and even the life sciences. One could trace this to the absence of a theory of consciousness, let alone one that is agreed upon. The level of complexity is too great to get a handle on in terms of a single overarching model. What expect anything different of economics?

Complexity Economics, Bots, and All That
Econolosophy

Alan Kirman & Dirk Helbing — Why mainstream economic models are unreliable

Economics has long had the ambition to become an “exact science”. Indeed, Walras, usually recognised as the father of modern economic theory, said in his Lettre no. 1454 to Hermann Laurent in Jaffe (1965):

“All these results are marvels of the simple application of the language of mathematics to the quantitative notion of need or utility. Refine this application as much as you will but you can be sure that the economic laws that result from it are just as rational, just as precise and just as incontrovertible as were the laws of astronomy at the end of the 17th century.”Furthermore his successors openly declared themselves as having the same goal...

This model of “perfect competition” is considered a useful idealization, and features such as the aggregate effects of the direct interaction between individuals are thought of as inconvenient “imperfections”. However, deviations between economic theory and reality may be of crucial importance in practice, and the consideration of the links between individuals and institutions cannot be written off as being of little relevance to the behaviour of the system as a whole. This is a lesson that is clear to all those, who are familiar with the analysis of complex systems.

In a comment on a previous post, Unlearning Economics observed that creating idealized models that are perfect and considering deviations from perfection to be "imperfections," misrepresents the reality of markets, which are not perfect and for a variety of reasons cannot be perfect. So it is incorrect to call these supposed phenomena "imperfections."

This is an important point not only with respect to models as representational but also rhetorical. When a phenomenon is labeled an "imperfection" rather than simply a phenomenon that is a regular feature of such conditions, the implication is that the situation can be improved by removing or reducing the "imperfection." However, this may not be the case, or the whole enterprise may be futile due to its construction.

As Paul Meli has observed, arguing about "imperfections" on the basis of an idealized perfect market is similar to considering friction an "imperfection" in physics and attempting to eliminate it, which is the goal of those who have sought to create a perpetual motion machine. This, of course, is ruled out by the laws of thermodynamics.

So modeling economics on physics must also take the laws of thermodynamics into account, so to speak, which implies that perfect models are necessarily non-representational.

It may be argued that an objective in engineering is to reduce friction in order to improve efficiency and this holds in economics, too, where friction is often called "drag." However, to suggest that this phenomenon can be eliminated  in the actual world is wishful thinking, since idealized models can only be rough approximations of the behavior of a limited number of variables rather than the basis for laws that apply generally.

Moreover, attempting to model what is complex, adaptive, and emergent, that is, determined by system relationships that are flexible rather than fixed, makes social science quite different from physical science, where simple models (however complicated) can be employed in that physical motion is regular across time. While ergodic modeling is appropriate in the natural sciences, it is not in the life and social sciences, where organisms are not simple stimulus-response mechanisms following general laws, as behaviorists had assumed. Reductionism did not work in psychology; it has not worked in social science, and it will not work in economics, and we know precisely why.

Why then do economists persist in their folly? The reason appears to be ideological, especially when buttressed by special interests promoting a status quo that favors these interests. For example, according to neoclassical economics and its offspring, the primary source of market "imperfection" is government "intrusion." Granting that government policy can create drag, it does not follow that reducing government also reduces drag automatically, as often assumed. 

The answer might be, and often is according to heterodox economists, that changing policy to reduce drag or improve performance might involve more government in some cases and less in others, depending on context such as the business cycle and the financial cycle. It is becoming clear from evidence that "expansionary fiscal austerity is not working as projected, just as heterodox economists warned would be the case when applied at the trough of a cycle, where more government is needed rather than less to offset the drag of flagging demand during a period of deleveraging at the culmination of a financial cycle.

Of course, conventional economists also realize the importance of government policy even though they may not admit it. For instance, they call for government to increase activity when and where it benefits ideological interests, such as military and security in protection of private property, to access resources, and to extend market reach through intimidation of weaker parties.  The type of policy recommended or pursued is based on ideological bias, based either on purely ideological considerations or special interests that are promoted by the ideology. 

For example, for the right government support of labor by legislating collective bargaining is an "intrusion," while supporting military Keynesianism is a requirement of national security, even when the military does't want the weaponry being appropriated. The left would take up the opposite position.

These are normative, ideological issues that should be argued as such rather than using the rhetorical sophistry of complicated mathematical (econometric) models to bias the debate on the basis of pseudo-scientific claims that do not pass the smell test.

Lars P. Syll
Why mainstream economic models are unreliable
quoting Alan Kirman & Dirk Helbing

Dirk Ehnts and Miguel Carrion Alvarez — The Theory of Reflexivity – A Non-Stochastic Randomness Theory for Business Schools Only?

Abstract:

According to George Soros (1987) – the author of “The Alchemy of Finance”, a book on the workings of financial markets -
“has found a place in the reading lists of business schools as distinct from economics departments. (2003, 4)"

The theory of reflexivity, which is at the center of the book, states that interdependence exists between the cognitive and manipulative functions of market participants. While Soros claims that imperfect knowledge rules on financial markets, academic orthodoxy assumes perfect knowledge and hence displays – in the absence of external shocks – financial markets as efficient.

Reviewing the published work of George Soros on both reflexivity and the Great Financial Crisis (GFC) we find that his theory can be interpreted as a rough theoretical edifice not too different from the (Post-)Keynesian perspective. Using the GFC as a background we explore the explanatory power of the theory of reflexivity. In our conclusion we make the argument that economic theories build on non-stochastic randomness should form the basis of a new discipline that should be taught at both business schools and economics departments.

Global Economic Intersection
The Theory of Reflexivity – A Non-Stochastic Randomness Theory for Business Schools Only?
Dirk Ehnts, Berlin School of Economics and Law, and Miguel Carrion Alvarez, Miguel Carrion Alvarez, Senior Risk Analyst, Grupo Santander (Math PhD)

Important. Basically, perfect knowledge that is time-dependent is impossible when feedback influences the future. Open complex systems are non-ergodic. Conventional economists pretend (assume) this is not the case in creating ergodic models as a methodological convenience. Alvarez is an expert in complex systems. This article is not wonkish however.

Greg Fisher — Social versus natural complex systems

Emergent principles, imagination, reflexivity in social vs natural systems.

Synthesis
Social versus natural complex systems
Greg Fisher

David Hales comments:

I think you’ve put your finger on a major issue here that is often not made explicit when ideas from complexity are applied to social systems. This has created a lot of confusion and miscommunication and we need more discussion at this level to clarify the issue. I think it was Popper who noted that since our actions in the world are strongly affected by our view or model of the world – and this changes with experience – then strongly predictive theories of the social world are logically inconsistent since they imply we can predict now how we will view the word tomorrow. Or to put it another way: if we can know now how we will view the world tomorrow then why are we not viewing the world like that now? Or to put it even more starkly – if you could produce a model that predicted the next theoretical breakthrough in physics then you’ve already made that breakthrough.

On the subject of coherent theories of collective action – well, there was the old classic by Mancur Olson “the logic of collective action” but that was from a purely rational action perspective. I would say that the more recent classic by Eleanor Ostrom “governing the commons” is the good start on this enterprise – based as it is on empirical work and self-organisation principles. What is true of both through is that importance of the group, how it is defined, where its boundaries are and how the behaviour of some relate others.

Greg Fisher recommends The Romantic Economist: Imagination in Economics by Richard Bronk. Here is some information at Amazon:

Since economies are dynamic processes driven by creativity, social norms, and emotions as well as rational calculation, why do economists largely study them using static equilibrium models and narrow rationalistic assumptions? Economic activity is as much a function of imagination and social sentiments as of the rational optimisation of given preferences and goods. In this 2009 book, Richard Bronk argues that economists can best model and explain these creative and social aspects of markets by using new structuring assumptions and metaphors derived from the poetry and philosophy of the Romantics. By bridging the divide between literature and science, and between Romanticism and narrow forms of Rationalism, economists can access grounding assumptions, models, and research methods suitable for comprehending the creativity and social dimensions of economic activity. This is a guide to how economists and other social scientists can broaden their analytical repertoire to encompass the vital role of sentiments, language, and imagination.

David Colander likes it, too: "The book is superb-a wonderful blend of common sense, erudition, and imagination." - David Colander, Christian A. Johnson Distinguished Professor of Economics, Middlebury College

Here is an Amazon review:

Yes. The problem is that " modern " economics is just old Benthamite Utilitarianism in new mathematical garb 

 By Michael Emmett Brady VINE™ VOICE

The author has,in general,put his finger on the fundamental problem facing economics today as it is taught to undergraduate/graduate students in the average college/university economics class. The problem is that economics is just the latest use of cribbed mathematical and statistical techniques shoehorned to fit the latest version of Benthamite Utilitarianism,which is what all variants of neoclassical and Austrian economics are. The author correctly points out that the " Romantics " rejected Benthamite Utilitarianism He recommends their writings as a counter weight to Benthamite Utilitarianism. However,a more powerful antidote , in my opinion,would entail going back and digesting what was written in the Old and New Testament, as well as in the works of Aristotle, Plato, Augustine, Thomas Aquinas and Adam Smith. Smith ,for instance completely rejected both libertarianism and Benthamite Utilitarianism in Part V of The Wealth of Nations (1776). Unfortunately, Part V of the Wealth of Nations is not taught /covered in any undergraduate/graduate level course at any college /university in the world .

Lars Syll — The nodal point of the macroeconomics debate

Microfoundations today means more than anything else that you try to build macroeconomic models assuming “rational expectations” and hyperrational “representative actors” optimizing over time. Both are highly questionable assumptions.

Read it at Lars P. Syll's Blog
The nodal point of the macroeconomics debate
by Lars P. Syll | Professor, Malmo University

To deliver macroeconomic models building on rational expectations microfoundations the economists have to constrain expectations on the individual and the aggregate level to be the same. If revisions of expectations take place they typically have to take in a known and prespecified precise way. This squares badly with what we know to be true in real world, where fully specified trajectories of future expectations revisions are no-existent 

Further, most macroeconomic models building on rational expectations microfoundations are time-invariant and so give no room for any changes in expectations and their revisions. The only imperfection of knowledge they admit of is included in the error terms, error terms that are assumed to be additive and to have a give and known frequency distribution, so that the models can still fully pre-specify the future even when incorporating these stochastic variables into the models.

This is also the basis of George Soros's general theory of reflexivity. IN The Alchemy of Finance, for example, Soros views economics and finance as a complex information system in which feedback is a principal determinant. 

Feedback is a reflexive information flow alters dependent information flows in ways that cannot be anticipated any more than actual events can be known advance. There are not only known unknowns but also unknown unknowns affecting complex information systems, and social sciences have to take this into account in their theories and modeling. To the degree they don't they will produce insufficient explanations and this will be revealed by failed predictions. 

This is basically an epistemological problem with implications for probability and statistics, as Lars points out. The present approach to microfoundations glosses over the epistemological issues since it is essentially static with respect to information in presuming both a representational agent and rationality in the way it does. Understandable methodological choice in light of model tractability, but inadequate to model complex information systems.

For an investigation of the epistemology see How George Soros Knows What He Knows: Towards a General Theory of Reflexivity by Flavia Cymbalista, Ph.D.

Reflexivity In Social Systems: The Theories Of George Soros by Stuart Umpleby, George Washington University

Mathematical analysis of Soros’s theory of reflexivity by C.P. Kwong

George Soros on Hayek

GS: "Friedrich Hayek is generally regarded as the apostle of a brand of economics which holds that the market will assure the optimal allocation of resources — as long as the government doesn’t interfere. It is a formalized and mathematical theory, whose two main pillars are the efficient market hypothesis and the theory of rational expectations.

"This is usually called the Chicago School, and it dominates the teaching of economics in the United States. I call it market fundamentalism.

"I have an alternative interpretation — diametrically opposed to the efficient market hypothesis and rational expectations. It is built on the twin pillars of fallibility and reflexivity.

"I firmly believe these principles are in accordance with Hayek’s ideas.

"But we can’t both be right. If I am right, market fundamentalism is wrong. That means I must be able to show some inconsistency in Hayek’s ideas, which is what I propose to do."

Read the rest, Why I agree with (some of) Hayek, at Politico.

This is an eloquent and well argued presentation that George Soros made at the Cato Institute, a Libertarian bastion. I have followed this line of thought since Soros began elaborating it some time ago, and I am in accord with it on philosophical and cognitive grounds. Hayek was a good thinker, too, but his animosity for Communism made him a bit irrational, as Soros observes.