Wednesday, February 08, 2012

Economic bobbles are like traffic jams

I don’t usually listen to podcasts twice, but this one I did. 16 minutes.

One of the grand old men of complexity theory, Brian W. Arthur, gives a brief overview of why economics seen from a complexity point of view is different than neo-classic economics.

Brian Arthur mentions cars in traffic as an example of a complex, dynamic system.

“Traffic forms some sort of pattern at a given instant and the cars react locally to what ever that pattern is for them, and so in reacting they are recreating anew the pattern to which they further react. There is a beautiful causal loop”.

Arthur’s point is that the patterns and events in the economy arise in much the same way, but he argues that the models used in classic economic theory make a shortcut by assuming that the economy tends towards some equilibrium state as all players rationally adjust their behavior to balance demand and supply.

To Brian Arthur this type of top-down modeling is a simplification, which hides a lot of the important events and causes that determine how the economy actually develops.

As he explains it:

“In an equilibrium theory model of traffic flow, traffic would move along nicely, and settle at some equilibrium flow. But you can’t see phenomena in time, such as traffic jams. Traffic jams happen when there is a fair amount of density of traffic, and they happen spontaneously. Some small event, perhaps a dog running into the road causes a car to slow, that causes another car behind it to slow also, and very quickly you get this emergent structure of a traffic jam.

But you will not see it in an equilibrium model. And then the question arises; if we have put a massive filter in front of economic theory, if we took that filter away what else would we see? I think we would see something different and more realistic.

What you lose sight of, says Brian Arthur, are positive feedback, increasing returns, network effects, structure determined by accidents shaping the future as very small events will lock things in.

Complexity theory sees “an economy that is organic, one layer builds on top of what’s already there. It’s self constructing, the economy arises out of itself, forms of itself, gives new structures and new challenges, it's always boiling and roiling with change and opportunity. History matters, outcomes are historically contingent and that sets the scene for further outcomes that are historically contingent. It’s imperfect, it’s messy, but it’s realistic”

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