Resources on complexity economics

Following my posts last week on complexity and economics, Professor Leigh Tesfatsion of Iowa State University sent me this very useful website with links to loads of resources on the subject – including an introductory self-study course.

Prof Tesfatsion wrote to me that the complexity approach has real momentum but added: “In macroeconomics, however, bitter resistance has been encountered, particularly from those who have devoted themselves to mastering DSGE modeling.” However, there is also some work on agent-based macroeconomics.

One general book I spotted in this list, one I’ve not read, is Mark Buchanan’s . Nate Silver’s  doesn’t feature agent-based modelling but does talk about the macroeconomy as a complex (non-linear multivariate dynamic) system.

[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]

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Serendipity, complexity, and loneliness

No sooner (literally)  had I written about the complexity economics of the new book by David Colander and Roland Kupers, , than (in one of the many instances of serendipity in life) another book  on complexity turned up in the post, courtesy of its author, Peter Smith. The book is .

[amazon_image id=”0957069707″ link=”true” target=”_blank” size=”medium” ]The Reform of Economics[/amazon_image]

The book looks like it argues for a more realistic alternative to mainstream economics by actually developing it, using agent-based modelling. In a covering letter, Dr Smith says the intelligent agents: “learn by experience how to respond to market conditions. … They can engage in price exploration, and learn to manage their inventory, plant renewal and cashflow (or go bust), all starting from far-from-equilibrium states.” He also describes his research, and his search for a post-crisis renewal of economics as “a mite lonely.” I think it might be less lonely than he fears.

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Slow demise of the economist ex machina

A small number of economists have been interested in complexity theory and related approaches – agent-based modelling, network models – for a long time, and a growing number for a shorter time. Complex models in the technical sense of non-linear dynamic systems, with many inter-connections and feedbacks, can describe economic or financial data well. Their evolution over time is highly sensitive to initial conditions, and they are sometimes characterised by ordered states, a property known as emergence.

There are some very good books about complexity science, such as Mitchell Waldrop’s , or Philip Ball’s . Albert Laslo Barabasi’s  sets out the related network approach. There are also quite a few books specifically about complexity in economics. The Santa Fe Institute has long been involved in complexity models, and Brian Arthur and Herb Gintis have applied them to economics. Paul Ormerod’s ,  and  are all very accessible introductions to complexity in economics. Eric Beinhocker’s  is another. Alan Kirman more recently published .

A new book  by David Colander and Roland Kupers is therefore not introducing a new area of research. But it is nevertheless doing two very interesting things.

[amazon_image id=”0691152098″ link=”true” target=”_blank” size=”medium” ]Complexity and the Art of Public Policy: Solving Society’s Problems from the Bottom Up[/amazon_image]

First, it locates complexity models in the context of the history of economic thought, explaining why and how economics turned away from the intuitively complexity-based approach of the classical economists (and the also both Hayek and Keynes ). There is a nice anti-reductionism quotation from Keynes: “Once the complexity of reality is carefully considered, the argument that applied policy concerns can be reduced to economics becomes so unreasonable that only an academic would dare consider it.” Colander and Kupers argue instead for what they describe as ‘activist laissez faire’, an approach which still leaves room for disagreement – as between Keynes and Hayek – but about empirical judgements and tactics rather than completely polarised, mutually exclusive approaches.

The authors link the turn in economics away from messy reality, towards sterile abstraction, to the work of Abba Lerner in the 1930s. They argue that his  was one of the founding texts of the viewpoint that came to dominate the discipline, the standard state control economic policy framework. This caught on because it was simple, clear, and cast economists as the experts who could identify what policies were needed to maximise social welfare with their analytically soluble models. State intervention was only needed when laissez faire markets failed – but one could argue that that was almost always. This is the attitude so brilliantly described in James Scott’s . Thus the stage was set for the dualism between interventionism and free market-ism, between ‘Keynesians’ and monetarists. The account in this book sets the reductionist turn in economics earlier than the conventional wisdom has it – others locate it in the 1940s and 1950s.

[amazon_image id=”0300078153″ link=”true” target=”_blank” size=”medium” ]Seeing Like a State: How Certain Schemes to Improve the Human Condition Have Failed (Yale Agrarian Studies)[/amazon_image]

Aside from the discussion of the history of economic thought, the main contribution of this book is that it discusses the implications of the ‘complexity framework’ for the way we should think about public policy, arguing that it will get us away from the sterility of the markets versus states dualism. Instead, the role of both has to be respected – government in setting the rules and conditions, markets in delivering bottom-up choices in an efficient way. The policy intervention is  itself inside the system.

As the book points out, this is not consistent at all with the standard frame of economics, in which the economist is a deus ex machina calculating the optimal policy and implementing it – a command-and-control framework of thought that has spread far wider than economics to capture all of public policy and even business decision making.This has extracted a high price and I think is certainly at the root of the present dissatisfaction with economics.

The authors argue that the problem in economics itself is mainly with macro and theory, as the applied micro areas of the field have been steadily moving away from assumed rationality, linearity, static equilibrium etc for some decades now – behavioural economics being the obvious example. In 2000, this led Paul David to declare that ‘neoclassical’ economics was dead. The exception, however, is the one bit of economics that all normal people know about because it’s in the news all the time, not least because of the financial crisis and its aftermath. As the authors write: “Issues of morality, the market and the constitutional order should have been central to the policy debate about macroeconomics. They weren’t. The standard frame eliminated them from discussion.” They are wonderfully scathing about modern DSGE macro, a view with which I wholeheartedly agree. “While microeconomics has evolved considerably in the direction of complexity, progress in macro has been very limited.” What students are currently taught in their macro courses is not useful and in fact inconsistent with empirical reality.

Outside economics, in the wider influence the subject and its approach have had on public policy, reductionism still reigns, and probably will until future generations of people who have studied economics have experienced a different kind of curriculum. Colander and Kuper end with a curriculum reform proposal – economics education is a longstanding interest of David Colander, who contributed a chapter to . Role on the roll-out of INET’s CORE curriculum!

However, I think this book is more useful for people in the policy world rather than universities. It could start to chip away at the damaging idea that policy makers are deus ex machina, outside the system (something I spoke about in my Pro Bono lecture The Economist As Outsider), and focus attention once again on the importance of the institutional, cultural and ethical framework within which people make economic decisions.

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Butterflies and hurricanes

I received a copy in the post this weekend of , and what to do about it by Ian Goldin and Mike Mariathasan. I’d read the book in draft and it’s a thought-provoking and rather alarming account of some of the vulnerabilities arising from interconnected global systems. Exhibit number one is the financial crisis, I suppose, made significantly more severe by the criss-crossing and largely unmonitored links between banks and shadow banks in many countries. The book also discusses global supply chains, infrastructure, ecology, public health and the social risks arising from inequality (this last obviously written well before Piketty-mania).

The growing complexity in each if these areas is well-documented. The title is a riff on the well-known butterfly effect whereby a small initial disturbance in a complex system with feed-back loops can rapidly lead to large and unexpected results – the flap of a butterfly’s wings in one place leads to a hurricane somewhere else entirely. It has become a defect because our governance systems haven’t remotely kept pace with the changes of the past 25 years. Connectivity has led to complexity has led to systemic risks – but policies address only local risks.

The final chapter asks how to start managing the new risks, without wholly answering it – although to be fair it would take a new book for each of the previous chapters to set out ay detail about what to do. The authors do not want to reverse the interconnectedness, although they acknowledge that some people might prefer that. They call instead for more global management of risk, more awareness of the new kinds of risk on the part of all policymakers and businesses everywhere – better risk measurement, transparent communication about the dangers and the policy uncertainties, gearing economic policies towards giving people incentives to take more account of the personal risks they face, clear definition of legal responsibilites, and contingency planning.

This all seems perfectly sensible. Will it happen? I think the most sobering section of the book talks about the way the post-World War II global governance changes, the ‘Bretton Woods moment’, came about as a result of the cataclysm of total war. The book ends on a very optimistic note:

“With better management, there is the potential for all citizens to share in our world’s magnificent achievements, the most impressive of which could be yet to come.”

But I ended up feeling daunted. Anyway, both pro- and anti-globalizers should read it.

[amazon_image id=”0691154708″ link=”true” target=”_blank” size=”medium” ]The Butterfly Defect: How Globalization Creates Systemic Risks, and What to Do about It[/amazon_image]

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Vulnerability and sustainability

John Naughton’s column in today’s Observer about governments’ online spying sent me to Cory Doctorow’s essay of a few days ago about the parallels between a secure internet and public health. Both are worth a read.

They set me thinking about the meaning of sustainability. My last book, , was about sustainability defined broadly to include not only environmental issues but also economic assets including human capital and infrastructure and social sustainability (hence inequality). All matter for the fundamental question of whether or not future generations will be able to have at least as high a standard of living as we do. Many people in the developed economies think the answer is ‘no’ when they look at what’s happening to house prices, pensions, student debt and a lacklustre economy with no real wage growth. It’s hard to separate the effects of cycle and trend & I think it’s too soon to lose hope, but the idea of ‘secular stagnation’ is around.

[amazon_image id=”0691156298″ link=”true” target=”_blank” size=”medium” ]The Economics of Enough: How to Run the Economy as If the Future Matters[/amazon_image]

Anyway, I thought about the question of changes in assets of all kinds as an indicator of sustainability. The two columns made me realize I didn’t think enough about risk questions in that book. No doubt this features prominently in the environmental literature. But when you think about various examples – the effect of floods or unrest in Thailand or the Japanese earthquake on auto industry supply chains, the vulnerability of the UK’s west country to one train line right next to the coast being washed away in storms, or indeed the extraordinary vulnerability of the whole of the global economy to malign activities affecting the internet – the sustainability of the economy is obviously in question.

I find the Doctorow/Naughton parallel with public health persuasive. How would we react if we learned that the government was dealing with the threat of bird flu by secretly developing particularly virulent strains of the virus to use on – well, on whom exactly? –  rather than working on a vaccine.

Ian Goldin’s new book, , out in May, looks at exactly this kind of question. One to look out for. He’s talking about it in Oxford soon.

[amazon_image id=”0691154708″ link=”true” target=”_blank” size=”medium” ]The Butterfly Defect: How Globalization Creates Systemic Risks, and What to Do about It: How Globalization Creates Systemic Risks, and What ot Do about it[/amazon_image]

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