superbus: proud (Latin)

During the past week I have been in Frankfurt, where I participated in a Strüngmann Forum Complexity and Evolution: A New Synthesis for Economics. The basic premise that motivated the discussions among the 40 scientists at the Forum was that the field of economics is mired in two deeply flawed paradigms: rational agents and a focus on equilibrium.

The core models that inform economic theory (and the advice economists give to policy makers) assume that people are rational agents, who only care about maximizing their ‘utility function’ (using the jargon of economists). In plain language it means that humans only care about getting material rewards and avoiding punishments. Considerations such as morality, honor, and concern for the welfare of others do not affect the choices people make.

The focus on equilibrium means that economists typically ignore the dynamics. Although the economy is constantly in flux, mathematical economists imagine what would happen if the conditions were constant for a sufficiently long time. This assumption allows them to generate powerful mathematical insights about such things as price formation, adjustment of production to demand, and so on. The problem with this assumption is not only that no economy is ever in equilibrium, but that the economic theory tends to ignore such intrinsically dynamic events, like, for example, the Great Recession of 2007­-8.

So our charge from the organizers (disclosure: I was on the advisory committee that helped to plan the meeting) was to brainstorm about ways that insights from evolutionary theory (which has a lot to say about what really motivates people, apart from desire for gain) and complexity theory (which has a lot to say about complex dynamics, such as cycles, chaos, and sudden collapses) can be incorporated into the thinking of economists.

At this point, hopefully, those readers of my blog who are professional economists (and those non-economists, who, like me, have been following how economics has been transforming itself in the last couple of decades) are boiling with frustration. Of course, everything I said in the beginning paragraphs of this blog is a caricature. There are many economists who have been using evolution or complexity science (or both) in their research. One of the most significant developments in Economics recently (in the last two-three decades) is the rise to prominence of the field of Behavioral Economics. Many economists have been looking to evolution for insights for quite a time (for example, Friedrich Hayek).

Economists who attended the Forum (where they were a minority outnumbered by psychologists, anthropologists, political scientists, and biologists) repeatedly complained against being mischaracterized in this fashion. In fact, the economists who were at the Forum all use evolution and complexity in some fashion (which is why, of course, they were invited).

Indeed, economics is evolving, and there are many economists who don’t need to be preached to about the shortcomings of the homo economicus model or the need to embrace the complexity theory. Yet, any good caricature, while being a gross exaggeration, carries a seed of truth in it.

First, some of the economists who push the envelope are considered to be ‘heterodox’ by the majority of their colleagues, who continue to churn out equilibrium models of homines economici interacting in idealized free markets.

Second, and more important, the policy advice that economists give has hardly changed as a result of new economic thinking that embraces complexity and evolution. In fact, I find it difficult to discern any appreciation for evolution or complexity in what the economists tell policy makers or newspaper reporters. It’s the same litany that markets must be opened, governments’ role reduced, taxes cut, government provision of public goods cut, and social norms substituted with monetary incentives.

That this is bad advice is one of the major insights we get from evolutionary and complexity theories-informed research, both theoretical and empirical. And it often leads to disasters.

Remember that rare moment of self-doubt in the economic profession following the financial debacle of 2007? No mainstream economist predicted it. Worse, the advice they gave in the years before the crisis contributed to creating the crisis.

Similarly, the advice that economists gave to the Russian government during the 1990s massively contributed to the collapse of the GDP in Russia by half and a deep immiseration of the majority of the population. (It did, however, enrich a few oligarchs and, interestingly enough, quite a few of the economic advisers). More recently, a large dollop of blame for the mess in which Iraq currently finds itself is due to the disastrous decision of the Bremer vice-regency to throw untrammeled markets on the fragile Iraqi economy.

I know that economists will tell me that they perfectly well understand the limitations of homo economicus and equilibrium approaches. In fact, three of them did during the private interactions at the Forum. (One was so emphatic in denying the charge that he characterized it as “bullshit.”)

Yet I stand by the following formulation of what is wrong with economics: the policy advice that economists give 99 percent of time is based on the core theory that is almost entirely ignores the new developments in behavioral and evolutionary economics, as well as new non-equilibrium economic theories.

[to be continued]