It’s often said by critics of economics that the problem is economists have physics envy: they want to describe the economy using models that are over-complicated in the mathematics, mimicking classical physics, and under-sophisticated in its understanding of how humans actually make choices. But in
[amazon_image id=”1408827379″ link=”true” target=”_blank” size=”medium” ]Forecast: What Physics, Meteorology, and the Natural Sciences Can Teach Us About Economics[/amazon_image]
He makes the argument in the context of financial economics and its discrediting by the financial crisis. I find it a wholly persuasive thesis. Rational choice theorising just cannot account for the data on financial markets – the numerous self-reinforcing large price movements without specific causes, the long persistence in the absolute size of price movements, the fractal character of the movements on annual, monthly, daily, hourly, nano-secondly timescales. However, models from statistical physics can do so. The empirics of financial markets are similar to those of earthquakes, for example, well described by power laws. Economists should be using these tools as their starting point for theorising rather than starting with theories that fit the data about as well as Cinderella’s glass slipper fits the feet of the Ugly Sisters. It astonishes me that so many economists are so resistant to believing the evidence of the data – as I wrote describing here last autumn’s ESRC symposium on macroeconomics and the reception physicist J.P.Bouchaud got from some of the other participants.
Forecast is a useful and very accessible guide to the physics models, although this is not untrodden territory in pop science. For example, Philip Ball’s
For the main point here is about the prevalence of disequilibrium in economies, and the consequent inappropriateness of equilibrium as the starting point for economic modelling; the inadequacy of comparative statics in a dynamic world; and the role of social influence in markets. There is a very interesting section on the way the ‘wisdom of crowds’ is valid for independent decisions but destroyed when people know what others think, when it is replaced by the ‘unwarranted confidence of crowds’.
The most intriguing point the book raised for me concerned the predictability of financial market prices. Markets seem to have two phases of behaviour, like water versus ice, and the transition from one to the other is particularly interesting. “When the number of participants is smaller than a certain threshold… the market always has some predictability in its movements,” Buchanan writes of some experimental research (by Yi-Cheng Zhang and Damian Challet, written up in the book
Economists who have already read about complexity economics – say in Paul Ormerod’s
How well does it take on the points so memorably made by Cosma Shalizi http://vserver1.cscs.lsa.umich.edu/~crshalizi/weblog/517.html?
I wouldn’t say it takes them on, but neither does it glaringly make the errors flagged up there – expect to the minor extent of shoving in other fashionable points such as the Sandel-type anti-market polemic, as I describe in the post. Buchanan doesn’t theorise about the economy, but rather says, here are well-known statistical tools and models that describe the data of financial markets – why isn’t financial economics building from them? To be clear, I don’t think more physics is all that’s needed, so much as more consistency with/interest in relevant work in all the natural and human sciences.
Great post and one that deserves wide currency. I have been blathering on about this since beginning blogging one way or another although not with the same expertise. Incidentally, posted today, Monday, on “The Leaving of Liverpool” which relates not only to containers but also complexity as implicit in what happened there. My first acquaintance in how to create chaos out of order easily was when moving an Armoured Division around.
You’re very kind thank you.
Ah yes, chaos from order. Just to spell it out for others, here is your ‘Leaving of Liverpool’ blog post:
http://www.thecynicaltendency.blogspot.co.uk/2013/04/the-leaving-of-liverpool.html
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