Complexity in Markets: a few random thoughts

20130318-174856.jpgI was just checking out an article by Mark Buchanan on Bloomberg about the need to abandon the idea of economic markets as being inherently stable.

For several decades, academics have assumed that the economy is in a stable equilibrium. Distilled into a few elegant lines of mathematics by the economists Kenneth Arrow and Gerard Debreu back in the 1950s, the assumption has driven most thinking about business cycles and financial markets ever since. It informs the idea, still prevalent on Wall Street, that markets are efficient — that the greedy efforts of millions of individuals will inevitably push prices toward some true fundamental value.

Problem is, all efforts to show that a realistic economy might actually reach something like the Arrow-Debreu equilibrium have met with failure. Theorists haven’t been able to prove that even trivial, childlike models of economies with only a few commodities have stable equilibria. There is no reason to think that the equilibrium so prized by economists is anything more than a curiosity.

It’s as if mathematical meteorologists found beautiful equations for a glorious atmospheric state with no clouds or winds, no annoying rain or fog, just peaceful sunshine everywhere. In principle, such an atmospheric state might exist, but it tells us nothing about the reality we care about: our own weather.

This is true. Markets are inherently unstable beasts,as was proven by the crashes of 2000 and 2007/8. Personally, I am an advocate of free markets. The trouble is that no one can agree on what a free market is.

I recently watched a compelling lecture by development economist Ha Joon Chang, where he pointed out (rightly) that “free markets” are truly in the eye of the beholder, pointing out that even the most ardent of free market supporters in 2013 wouldn’t support the free marketers and libertarians who complained of the implementation of child labor laws in the early 20th century.

I should say, then, that I’m an advocate of the “freeest markets within reason” or “the freest markets as will support the moral ideals I hold to be important.” That is, the freeest markets as will support the protection of individual rights to freedom of expression and political thought, the preservation of equal opportunity through education and health, access to capital and social mobility.

Mr. Buchanan points put that where other sciences have accepted that there is no such thing as stability in the rest of the universe, desperate economists and their politically backward fans stick to the idea that, despite evidence of the irrationality of humans in every other space, markets are “self stabilizing.” That humans are rational (they are not) and customers can democratically select optimal prices vs. availability (untrue).

First, I am drawn to the incredible volatility of prices in areas that have the least power to influence them (developing countries).

If there were ever an example of the undemocratic nature of unbridled markets, food in developing countries would be it. Buyers and sellers are legion, yet bodies across the sea set prices with little regard to the demands of the many. In Sub Saharan Africa, stability is a fantastical dream.

Second, I am thinking of the work being done on complex systems in finance, specifically that coming out of Princeton at the moment.

SOME people aren’t waiting around with their heads in the sand, but rather are working to describe the phenomena of finance volatility, noting the increased complexity of financial markets in 2013. It would seem that deeper linkages between financial systems, though necessary, induce the very real problem of volatility. Ignoring it or pretending it doesn’t exist won’t make it go away.

Blaming government regulation and calling for a return to 19th century finance doesn’t work well either.

But that’s enough….


About Pete Larson

Assistant Professor of Epidemiology at the Nagasaki University Institute for Tropical Medicine

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