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Economics And The Complexity

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  • 1. Pratt 1 Economics and the Complexity Vision 2009 Summer Project Greg Pratt Mesa Community College The static neo classical model of economics typically found in the economics classroom (and professional journals) belies the reality of human interaction. While models demand a set of simplifying assumptions, the quantitative approach that swept economics in the post WW II era to dominate the profession does as great a disservice to society as a service. However, looking back to classical economics as well as the Austrian school a small group of scholars have begun to examine what has been called economic behavior from another perspective. While these scholars are a tiny part of the profession, their view has more than passing importance. David Colander in The Complexity Vision and the Teaching of Economics observes: “ . . . the field of economics displayed many of the characterize a complex system. It had a self-organized quality to it, and it dealt with interdependent agents. Indeed it has along history of explanations involving the invisible hand and spontaneous order. “(4). So the examination of the emerging work in complexity, centered at the Santa Fe Institute (SFI), is an appropriate and compelling allocation of time. The Santa Fe Institute is a private, not-for-profit, independent research and education center founded in 1984, for multidisciplinary collaborations in the physical, biological, computational, and social sciences. Understanding of complex adaptive systems is critical to addressing key environmental, technological, biological, economic, and political challenges. (http://www.santafe.edu/about/ ) Colander’s edited work in The Complexity Vision and
  • 2. Pratt 2 the Teaching of Economics is based upon the work of SFI scholars and covers a series of topics ranging from bioeconomics to the Austrian school of economics. This complexity work is tied to two of the giants in Austrian thought – Ludig von Mises and F. A. Hayek as well as Adam Smith. The major problem for any economy Hayek argued, is how people’s actions are coordinated. He noticed, as Adam Smith had, that the price system—free markets—did a remarkable job of coordinating people’s actions, even though that coordination was not part of anyone’s intent. The market, said Hayek, was a spontaneous order. By spontaneous Hayek meant unplanned—the market was not designed by anyone but evolved slowly as the result of human actions. Roger Koppl writes of the connection between Austrian and complexity: Austrian economists (of the Hayekian variety at least) share common elements and a common past with complexity theory. Complexity theorists trace their origins in part to Ludwig von Bertalanffy’s work on systems theory and Norbert Wiener, creater of the related field of cybernetics. Hayek had a series knowledge of and interest in systems theory and cybernetics. . . . The most characteristic feature of Hayek’s system of thought is probably his notion of ‘spontaneous order. . . A spontaneous order is a complex adaptive system. It is Adam Smith’s idea of the ‘invisible hand’. (Colander 139-140) The tie then between classical economics, modern Austrian thought and complexity theory can be found both in the work the SFI as well as the sources of classical and modern economic thought. This tie between complexity theory and the Hayekian notion of spontaneous order (1) is not widely communicated in social sciences and is arguably one of the most important contributions that is lacking in contemporary social sciences education. The connection between the two is both clear and compelling. Koppl goes on to clarify this connection when he points out: “ . . . they are complex; for spontaneous orders, the
  • 3. Pratt 3 ‘degree of complexity is not limited to what a human mind can master. Second, they are abstract . . . Third, they have no purpose, ‘not having be made’ by any designing minds,”(140). This final point is critical, complexity is adaptive, emergent and evolutionary and the work of the Austrians builds on the insight of Adam Smith to indicate the implications of these set of conditions which seem to inform behavior. (2) Harvard economist and former Harvard University President Lawrence Summers explains Hayek's place in modern economics this way: quot;What's the single most important thing to learn from an economics course today? What I tried to leave my students with is the view that the invisible hand is more powerful than the [un]hidden hand. Things will happen in well-organized efforts without direction, controls, plans. That's the consensus among economists. That's the Hayek legacy.quot;(quoted in The Commanding Heights: The Battle Between Government and the Marketplace that Is Remaking the Modern World pp. 150-151.) While Hayek is neglected or often unknown in current economic education, Adam Smith remains a central, if misunderstood, element of both instructor generated instruction and textbook analysis of the markets. His invisible hand (mentioned only 3 times in his collected works) is frequently emphasized although misinterpreted. Vernon Smith, an advocate of the constructivist or complex vision points to Smith’s contributions to his work in experimental economics. He writes that this vision is: an undesigned ecological system that emerges out of cultural and biological evolutionary processes: home grown principles of action, norms, traditions, and morality. Thus, quot;the rules of morality are not the conclusions of our reason.quot; According to Hume, who was concerned with the limits of reason and the boundedness of human understanding, rationality was a phenomena that reason discovers in emergent institutions. Adam Smith expressed the idea of emergent order in both The Wealth of Nations and The Theory of Moral Sentiments. According to this
  • 4. Pratt 4 concept of rationality, truth is discovered in the form of the intelligence embodied in rules and traditions that have formed, inscrutably, out of the ancient history of human social interactions. (Vernon Smith) Vernon Smith argues for the view that Adam Smith in both the well known Wealth of Nations and virtually unknown Theory of Moral Sentiments finds the emergent and evolutionary view of human activity persuasive. Thus, the invisible hand metaphor acquires a deeper meaning as a symbol for what Hayek would call spontaneous order that is emergent, in the words of Vernon Smith, over the extended period of the “ancient History of human social interactions. These interactions are the informal institutions – norms and conventions that Douglass North sees shaping formal institutions and incentive structures that impact behavior. This process is one that is complex in nature, has not been fully understood or modeled, in spite of the impression given by introductory texts in economics that see markets and outcomes as fait accompliat. North writes: Informal constraints (norms, conventions and codes of conduct) favorable to growth can sometimes produce economic growth even with unstable or adverse political rules. So North agrees with Vernon Smith and writes: “It is necessary to dismantle the rationality assumption underlying economic theory in order to approach constructively the nature of human learning. History demonstrates that ideas, ideologies, myths, dogmas, and prejudices matter; and an understanding of the way they evolve is necessary for further progress in developing a framework to understand societal change.”(Nobel Lecture) As Douglass North reminds us, the complicating factor in our study and instruction of economics is change. In works ranging from Structure and Change in Economic History toUnderstanding the Process of Economic Change North reiterates the
  • 5. Pratt 5 centrality challenge of understanding the forces that lead to change. In his 1993 Nobel lecture North explicates what he calls the non ergodic nature of change. “increasing our understanding of the historical evolution of economies” can “contribute to our understanding of the complex interplay between institutions, technology, and demography in the overall process of economic change.” He concludes much of his recent work with the twin observations that it is “adaptive rather than allocative efficiency that is key to our understanding of complex economic process and path dependence, one of the remarkable regularities of history. . . . Pioneering work on this subject is beginning to give us insights into the sources of path dependence (Arthur, 1989 and David, 1985). But there is much that we still do not know.” (Nobel) In a subsequent Nobel ceremony, Vernon Smith recognized this limitation in his banquet toast. (3) So the line of thought from Smith to Hayek to North is clear – there is much we do not know, the modern models used in economics mask or ignore this ignorance and complexity theory is a vision or prism that can allow a more realized view of human behavior. All three provide a rationale for their vision; the economic growth or change has allowed humanity to dramatically increase the standard of living in the 21st century. While an understanding of the limitation of contemporary quantitative economic modeling, institutions such as the Santa Fe Institute seem to argue for a Hayekean recognition of the limits to understanding of spontaneous orders or complex systems.
  • 6. Pratt 6 Notes (1) Because it is undesigned and not the product of conscious reflection, the spontaneous order that emerges of itself in social life can cope with the radical ignorance we all share of the countless facts on knowledge of which society depends. This is to say, to begin with, that a spontaneous social order can utilize fragmented knowledge, knowledge dispersed among millions of people, in a way a holistically planned order (if such there could be) cannot. “This structure of human activities” as Hayek puts it “consistently adapts itself, and functions through adapting itself, to millions of facts which in their entirety are not known to everybody. The significance of this process is most obvious and was at first stressed in the economic field.”34 It is to say, also, that a spontaneous social order can use the practical knowledge preserved in men's habits and dispositions and that society always depends on such practical knowledge and cannot do without it. http://oll.libertyfund.org/?option=com_staticxt&staticfile=show.php %3Ftitle=1305&chapter=100481&layout=html&Itemid=27 (2) One idea propounded by Hayek is central for the understanding of the Social Sciences: the notion of complex phenomena. This notion was originally introduced in his paper “The theory of the complex phenomena” published in Studies in 1967. He proposes that the degree of complexity of a phenomenon depends upon “the minimum number of elements of which an instance of the pattern must consist in order to exhibit all the characteristic attributes of the class of pattern in question…” http://evolucionismoycomplejidad.wordpress.com/2008/09/18/discussion-on-the- theory-of-complex-phenomena/ (3) Vernon L. Smith's speech at the Nobel Banquet, December 10, 2002
  • 7. Pratt 7 Copyright © Nobel Web AB 2002 Photo: Hans Mehlin Toast I wish to celebrate: • The Royal Family for their grace and charm in this magnificent affirmation of the dignity of humankind. • Daniel Kahneman for his ingenuity in the study and understanding of human decision and its associated cognitive processes demonstrating that the logic of choice and the ecology of choice can be divergent. • The pioneering influence of Sidney Siegel, Amos Tversky, Martin Shubik, and Charles Plott on the intellectual movement that culminated in the economics award for 2002. • Humanity's most significant emergent creation: markets. • Mandeville who said: quot;The worst of all the multitude did something for the common good.quot; • The ancient Judeo Commandments: Thou shalt not steal or covet the possessions of thy neighbor, which provide the property right foundations for markets, and warned that petty distributional jealousy must not be allowed to destroy them. Neither shalt thou commit murder, adultery or bear false witness, which provide the foundations for cohesive social exchange. • David Hume who declared the three laws of human nature: The right of possession, its transference by consent, and the performance of promises, and taught that the rules of morality are not the conclusions of reason. • F.A. Hayek for teaching us that an economist who is only an economist cannot be a good economist; that fruitful social science must be very largely a study of what is not; that reason properly used recognizes its own limitations; that civilization rests on the fact that we all benefit from knowledge that we do not possess (as individuals). • Benjamin Franklin who said quot;Tell me and I forget, teach me and I remember, involve me and I learn.quot; • And to Kahlil Gibran who reminds us that work is love made visible. Copyright © The Nobel Foundation 2002
  • 8. Pratt 8 Bibliography Colander, David. The Complexity Vision and the Teaching of Economics. Edward Elgar, Northampton, MA, USA. 2000. Hayek, FA. -----The Constitution of Liberty. Chicago: University of Chicago Press. -----Economics and Knowledge A presidential address to the London Economic Club, 10 November 1936. First published in Economica (February 1937). ----- Individualism and Economic Order. Chicago: University of Chicago Press. 1952. -----The Counter-Revolution of Science: Studies on the Abuse of Reason. Glencoe, Ill.: Free Press. 1960. -----Law, Legislation, and Liberty. Chicago: University of Chicago Press. 1973. ----“The Use of Knowledge in Society.” American Economic Review 35 (September): 519–530. Available online at: http://www.econlib.org/library/Essays/hykKnw1.html. North, Douglass. Nobel Prize Lecture, 1993. http://nobelprize.org/nobel_prizes/economics/laureates/1993/north-lecture.html -----Structure and Change in Economic History, 1981 -----Understanding the Process of Economic Change Smith, Adam. 1776. An Inquiry into the Nature and Causes of the Wealth of Nations. Edited by Edwin Cannan. Chicago: University of Chicago Press, 1976. Available online at: http://www.econlib.org/library/Smith/smWN.html -----1759. The Theory of Moral Sentiments. Edited by D. D. Raphael and A. L. Macfie. Oxford: Clarendon Press; New York: Oxford University Press, 1976. Available online at: http://www.econlib.org/library/Smith/smMS.html
  • 9. Pratt 9 Smith, Vernon. What is Experimental Economics? http://www.ices- gmu.net/article.php/368.html Yergin, Daniel and Joseph Stanislaw The Commanding Heights: The Battle Between Government and the Marketplace that Is Remaking the Modern World, New York: Simon & Schuster. 1998. Warch, David. The Idea of Economic Complexity. New York: Penquin. 1984.