Monday, August 16, 2010



In previous blogs I have piled opprobrium upon Neoclassical economists, the high priests who whisper in the ears of our politicians and corporations. In my attempt to try to tease out the influence of these priests , I have discovered some surprising historical facts from the early days of economics. In my previous blog I provided some of this early historical background, as well as mentioning some of the concepts underpinning neoclassical economic theory, the theory governing our contemporary political and economic life. There are of course many variations upon what passes for neoclassical economics and my tacit if poorly expressed assumption is that my perception of neoclassical economics is of a linear construct. The laws and assumptions of neoclassical economic theory rest upon that assumption. George Sugihara, a biologist at Scripts Institute who has an interest in Chaos Theory writes:"A nonlinear system can exist in one configuration for a long period of time during which it is well understood, but it can switch gears suddenly, due to the interdependence of a multitude of shifting variables, and seem to become a totally different system governed by new laws. Superficially, everything has changed, but on the deepest level,nothing has."                                                                                                                 Hyman Minsky, an economist who studied the nature of financial crises had a famous expression"stability breeds instability." I have not read any of Minsky's articles in which he stated whether he thought of economics as a linear or a non linear discipline but I have concluded that his famous quote implies that economics is anything but linear.

Chaos theory was first described by Henri Poincare in the 19th century when he was grappling with what was called the “Three body Problem.” In physics, the problem refers to measuring position, mass, velocity, momentum of certain particles or masses and then trying to devise a method to calculate the position of these particles in the future thought to be governed by classical Newtonian laws and laws of gravitation. He was unable to devise a successful method.

Chaos theory as I understand it, deals with the observation that small differences in initial conditions can have widely varying outcomes in chaotic systems. In a stable, linear system which can reach equilibrium, such widely varying outcomes would not be expected to occur. The existence of chaotic outcomes appears to have begun with Henri Poincare in 1870 and references to the chaotic outcome phenomenon cropped up over the next 90 years. In 1961 a meteorologist by the name of Edward Lorenz working on an early digital computer was trying to develop a weather simulation. He inputted his data , ran his simulation over 7 days and printed out his results. He ran the simulation again and decided to run his simulation in the middle of his time period. To save time running the simulation again he used his printout data. To his surprise his results were totally different. This puzzling result made him look at his methodology. He noticed that his inputs were to 6 digits after the decimal but his printer would round off the inputs to only 3 decimal places . Why would that make any difference? In a linear system capable of reaching equilibrium, it wouldn’t have but it became apparent to Lorenz that weather was not operating under those rules..He3 dubbed it the Lorenz attractor operating under rules termed the Lorenz Oscillator which was a description of system which evolved over time spitting out data in a chaotic non repeating pattern. This was later referred to as the “Butterfly effect,”. This was a metaphor for chaos theory and referred to the title of a paper given by Lorenz at the American Association for the Advancement of Science in 1972 entitled” Does the flap of a butterfly’s wings in Brazil set off a tornado in Texas?”. It referred to the notion at the flap of a butterfly’s wings might be enough of a disturbance in the atmosphere to change distant atmospheric outcomes. Chaos Theory was initially confined to the fields of physics and mathematics but has been expanded not without controversy into widely varying fields including medicine, meteorology, evolution and even politics, economics and finance.

I have stated in previous blogs, the abject failure of most economists to predict accurately the behavior of markets despite dazzling mathematical models. In my mind, the reasons for this failure must lie with a failure of their assumptions, methodology and their models. This failure may be occurring because the system they are trying to model is not the system they think they have been dealing with. If the system is a non linear complex system, their results and predictions are doomed to failure. It is my contention after reviewing the opinions of economists writing outside the mainstream that neoclassical models and methodology need to be modified or abandoned. These new ways at looking at economics include names such as ecological economics, biophysical economics and complexity economics. I am just a humble beginning student struggling to wrap my mind around this problem but here is my current notion: The economy is an example of a complex, adapting, dynamic, non-linear system subject to both positive and negative feedback. Seemingly random changes in variables, however small can lead to widely different outcomes. The bad news from a policy making standpoint obviously is that if economics is a chaotic system, predicting its future behavior may be a fool’s errand. The good news is that if this notion becomes accepted, a lot of the high priests, fools and dimwits spouting nonsense and misinformation might eventually be discredited and disappear.

No comments: