Finding a Framework for a New Economics

[In preparing a pitch to some possibly supportive people, I realised I have not spelt out in brief form the argument that economies are complex self-organising systems.  There is a straightforward logic, it is not simply a preference pulled out of the air, or the depths of my psyche.]

Many economists, and more non-economists, agree that economics needs new ideas, given the comprehensive failure of the mainstream to foresee the Global Financial Crisis and its continuing failure to lift the US and Europe out of deep recession or depression.  Yet few seem to know where to start, and there seems to be little agreement on how much the subject needs to change.  When proposals appear that might begin to address fundamental problems, many economists seem to recoil, and others seem simply to fail to recognise that the proposals have any relevance.

I argue that a broad framework for a new theory of market economies can be arrived at rather readily by combining modern ideas of systems with well-known observations of modern economies.  Briefly, there are some readily identifiable sources of instability that are at work all of the time, not just during market crashes when their presence ought to be undeniable.  (Examples at end.)  There are also stabilising forces, of the kind described by the invisible hand metaphor, though they are far from dominant.  Thus the economy has both invisible hands (stabilising) and invisible feet (destabilising) driving its behaviour from the inside.

These characteristics describe a self-organising system, and one that is not close to equilibrium.  It is reasonable to argue further that the system is in fact far from equilibrium all of the time.  In that case the system is either in a state of deterministic chaos or in a state called complexity.  Although the system is sometimes very erratic, mostly it displays recognisable patterns of behaviour, though with continuous fluctuations and occasional large shifts.  Such behaviour is characteristic of complexity rather than chaos.  By this logic, modern economies can be identified as complex self-organising systems, or complex systems for short.

Fundamental conclusions follow immediately.

A complex system has many possible states that cannot be readily ranked by efficiency or any other criterion, rather than one global optimum as in the near-equilibrium neoclassical theory.  This means there is not just one best way to organise an economy.  There are many more acceptable ways than there are societies and cultures.  It is for each society to organise its economic system to support the kind of society it chooses to be.  Thus economies are relegated to their proper place, which is to support the society of which they are a part.  Thus also economic and cultural diversity can thrive again.

Living systems are also complex systems.  Therefore there is no fundamental reason an economy cannot be made compatible with living systems, so that the natural living world can thrive around it.  In contrast, the present system is incompatible with living systems at a fundamental level.

Without a global equilibrium there is no basis for the claim that free markets are the optimal way to organise an economy.  The global optimum predicted by neoclassical theory is an unrealistic abstraction.  Markets are clearly powerful, but if they cannot be relied on to deliver a useful result then they need to be managed.

To manage a market economy we need to understand it.  The guiding principle in seeking such understanding is the same as is used in dealing with living things.  Although the moment-to-moment behaviour of a dog or a horse cannot be predicted with certainty, a good trainer works with the character of the animal to manage its behaviour.  At present our economies are more like wild horses.  They need to be tamed, and harnessed to the urgent demands of humanity’s current precarious situation.  Thus we arrive at a vision of markets managed, through incentives, to deliver the things we want.

The framework thus outlined can accommodate many of the issues addressed by the less doctrinaire economists, such as our so-called non-rational behaviour, the herding behaviour and “reflexivity” evident in financial markets, the roles of institutions, and social behaviours like fashion-following, and so on.  Cooperation can stand with competition as being fundamental to the human condition (and the whole living world).

Some pre-existing parts of economics will presumably carry over into this framework, but some will not.  The neoclassical notion of equilibrium, and its associated free-market optimality, must be abandoned.  Neither is the Marxist conception of a managed non-market economy compatible with how a complex system like an economy works.

There are other important and fundamental misconceptions or malfunctioning aspects of modern economies that also need to be addressed.  For example, the GDP is not a measure of material well being, it is only a measure of activity involving money.  The obsession with ever-increasing GDP needs to be abandoned.  The banking system, in conjunction with financial markets, currently generates grossly excessive levels of debt, and these are fundamental to the so-called business cycle and its excesses, in the form of crashes and depressions.  More stable banking systems are possible.

To properly address the deficiencies of modern economics and economic management we must be willing to address such fundamental issues.  But perhaps the central issue, psychologically, is the notion that the economy is never far from equilibrium and can be relied upon to sedately restore itself if perchance any small disturbance should ever come along.  This belief underlies the widespread faith in free markets, but it is ideology, not science.

If economists, or some economists, or some people who want to define a new economics, are willing to contemplate such possibilities, then we can have a constructive debate.

Examples of instabilities in modern economies:

Increasing returns to scale are pervasive, and they allow large firms to grow at the expense of smaller firms, leading to widespread monopoly or oligopoly.

Financial markets are prone to herd behaviour that amplifies trends, often dramatically.

During the 1987 market crash, valuations changed by 30-40% in one day, though there was no change in the physical world:  30% of factories had not been bombed overnight.

Wealth tends to aggregate to the already wealthy, an instability in the distribution of wealth.

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4 thoughts on “Finding a Framework for a New Economics

  1. Kevin Cox

    Markets are meant to regulate prices by increasing prices when there is a shortage and decreasing prices when there is too much supply. Of course markets do not behave as this simple theory predicts but is an easy “cause and effect” that people cling to even in the face of overwhelming evidence. For example, the so called stock market operates exactly the opposite to the theory of markets. When prices go up demand increases because people hold on to their stocks in the hope of higher prices and so prices continue to go up.

    However, the main cause of “market failure” or a better term would be failure of feedback to stabilise the system are the rules and regulations put in place to try to make the markets behave as they are supposed to behave. We have the ridiculous situation with stock markets where companies cannot buy and sell their own shares without jumping through many hoops. This means that the feedback mechanisms cannot work because the most obvious way to increase the supply of stock when it is in great demand is to create more of it.

    We put in rules and regulations to try to stabilise systems but in many cases the emergent properties of changes destabilise the systems. Economics should be a empirical science with constant testing and monitoring of the system to see it is working as it is expected. Rather what we do is build the system based around outdated and incorrect models of the economic system.

    The sad part is that it is actually easy to fix because economic systems are “software” and we all know that software is easy to change if designed well.

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  2. DJC

    There isn’t “a system” or an “Economy” and there aren’t rules set in our DNA. There is just behaviors based upon environment and inclination. and as Geoff says this is a complex system of feedback loops and randomness. I think the most beneficial way to structure an economy is to have an umbrella of monetary support, a flow siphon flat payment http://iwillknow.jesaurai.net/?page_id=316 with a minimal rules and encouragement of leisure. this should encourage thoughtful – long term – value choices and move money and power to those that can best sustain a stable future. This I call fluidity or fluid pluralism. http://iwillknow.jesaurai.net/?p=561

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  3. Pingback: Finding a Framework for a New Economics – Expanded | Better Nature: commentary by Geoff Davies

  4. Pingback: Decoding Complexity [video]: The Organizing Principles Behind our Economy « Get "fit for randomness" [with Ontonix UK]

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