Preface to the Italian edition of
Forecast: What Physics, Meteorology, and the Natural Sciences Can Teach Us About Economics by Mark Buchanan, Bloomsbury USA; Reprint edition (June 3, 2014)
Francesco Sylos Labini
This book, written by a physicist, discusses the ideas and concepts that are at the basis of that branch of economic theory generally called neoclassical – at the foundation of the neo-liberist doctrine – that appears to be culturally and politically dominating in these difficult times. It may seem strange that a physicist, whose object of study is usually represented by atoms, molecules, planets or galaxies, has anything relevant to say about the queen of social sciences: economics. Human beings, contrary to elementary particles or stars, are endowed with free will and, more important, the laws that rule the ways in which an individual makes his own choices end by which different individuals establish relations among them, developing a social behaviour, are unknown to us. Rather, it seems legitimate to doubt that such laws are well defined. In fact, we know the fundamental laws that rule, for instance, the interactions between electrical charges, or between the planets and the Sun: such laws, like, e.g., gravity, are universal and are the same at different points in space and at different times.
For sure, we cannot say the same about the laws ruling economy: it is enough to jump back in time a hundred years, or rather to consider the present situation in underdeveloped countries, to immediately realize that the laws of economy, that we do not know to the same extent as we can write the equation describing the gravitational force that exists between the Earth and the Sun anyway, change in time and space, according to the historical, social, and legislative conditions of different countries. Indeed, time in a physical theory lacks a historical perspective, whereas time in economics is, or should be, historical time. As Mark Buchanan points it out, the cost of an apple nowadays has nothing to do with the cost of an apple during World War II, etc.
Furthermore, the differences are not limited to this aspect. Precisely by virtue of the universality of natural laws, in physics we can repeat an experiment to ascertain the causal relation within a certain series of processes. Moreover, thanks to our knowledge of the natural laws that rule the dynamics of some phenomena, we can make predictions, to be tested against experiments carried out under controlled conditions, so as to rule out or minimize the effect of external factors (not included in the theory). The results of these experiments must be repeatable, given the same conditions, in every other place on earth, at any other time. Validation of a theory through reproducible experiments stands, indeed, at the basis of the scientific method.
Given this situation, one may be led to conclude that economics is a discipline far different from a natural science, like physics, and therefore, exactly the same way an economist does not possess technical and conceptual instruments apt to contribute to a physical problem in a significant way, a physicist undertaking problems so different, and in some sense more circumscribed, but methodologically more defined, has nothing interesting to say about the economic dynamics, because incomparably more complex. This, exactly in virtue of the fact that the objects of study in physics are inanimate, the laws of nature are universal and the experiments are reproducible.
Notwithstanding the huge differences between the two sciences, there are some concepts and methods that have been developed in physics – and more generally in natural sciences in the last century – that may and must be a patrimony common to social scientists and economists too. This book aims indeed at providing a guideline apt to highlight the impact of these concepts on neoclassical economics.
Mark Buchanan recalls and discusses deterministic chaos, that is at the basis of the behaviour of systems with nonlinear interactions, such as the Earth-Moon-Sun system, or the atmosphere, in which small perturbations may cause enormous and surprising effects; scale-invariant systems, like fractals, for which the customary notions of statistics, like mean and variance, must be abandoned to focus on scale exponents; systems characterized by large fluctuations, in which extreme events are fare more probable than usual; systems out of equilibrium, that are intrinsically unstable and for which the stable equilibrium state becomes irrelevant; systems that self-organize in “critical” states, characterized by scale-invariant dynamics, and subject to sudden and dramatic changes; systems in which adaptation and diversification are the crucial dynamical elements, and many others, have been studied, by now customarily, in physics, meteorology, geology, biology.
The author compares neoclassical economists with meteorologists that insist in forecasting the weather neglecting storms and hurricanes: the analogy between economics and meteorology provides one of the guidelines of the book, precisely because atmospherical turbulences seem to have much in common with the ups and downs of financial markets and offer interesting ideas to understand the limitations of the hypothesis of economic stability. Moreover, this parallel clarifies the sense in which we may conceive the concept of forecast for a complex systems and how the progresses achieved in the last century allowed improving the predictive power of meteorologists.
One century ago, weather forecasts were based on the analogy with the regularity displayed by several physical phenomena: the idea was simply to try and find in the past a situation sufficiently “close” to the present, and from this draw a forecast for tomorrow. The results of such forecasts were rather disastrous for a reason we now know very well: the atmosphere behaves in a chaotic manner and tiny variations in the physical parameters may induce huge changes in the weather. A breakthrough in weather forecast was achieved thanks to the intuition of the physicist Lewis Richardson, who proposed to employ the equations of the well-known physical laws that rule the dynamics of fluids. Thanks also to the development of computers that allow for the numerical solution of systems of equations and to the monitoring of the atmospheric conditions through a vast network of satellites, Richardson’s ideas have come true and the quality of weather forecast steadily increased in time since the eighties onwards. For instance, making sufficiently reliable seven-day forecasts has become possible starting from the year 2000, while five-day forecasts have nowadays the same reliability as three-day forecasts had in the early nineties.
A recent study has shown that the major economic analysts and the official national and international organizations, besides agreeing all the time, have not been able to foresee, one year in advance, almost none of the 88 recessions (decrease of the real GNP on the yearly basis) that took place in the lapse 2008-2012 in developed countries, so that the authors concluded that “the record of failure in the prevision of recessions is to all extent spotless”. This means that nowadays – exactly as in the days before the crisis of ’29 – it is a good rule to consider that the contrary of official forecasts, as well as of those of the major analysts, is very likely what will happen. In any case, more likely than a decision based on tossing a coin. Therefore, it is not surprising that those very same economic models that did not even take into account the possibility of a historical crisis, like that of the year 2008, are not sufficiently reliable to foresee the recessions: in other words, they do not withstand the basic test of every scientific theory.
Neoclassical economics is nowadays equipped with a mathematical guise, as it were a natural science, but is not apt to describe reality, as the failure of all previsions clearly shows: to remedy they say, obviously a posteriori, that the failures are due to external shocks (e.g., political crises, earthquakes, and so on) that are not included in the models. Nonetheless, comparison with reality is the strength of the scientific method. In physics, for example, several examples can be found of theories that were mathematically correct but completely irrelevant, as they were based on wrong hypotheses. Therefore, such theories yield formally correct results that are contradicted by the experiments. But if an experiment disagrees with a theory, one cannot conclude that this disagreement discredits the quantitative method, rather the hypotheses upon which the model is based should be analysed and those that are wrong must be identified. And obviously, the model is changed: more than mathematical accuracy, what matters is physical relevance that is comparison with reality.
The most important conceptual step discussed by Buchanan and not incorporated in neoclassical economics is that that gave birth to the interdisciplinary field of complex systems. Phil Anderson, Nobel Prize laureate in physics, synthesized this conceptual revolution in an article of 1970, entitled “More is different”. The basic idea is described hereafter. The traditional approach in physics considers the simplest systems and studies them in detail. This approach, called reductionist, focuses on the elementary building blocks constituting matter and is successfully applied to several phenomena. Thence, it was possible to derive general laws that extend from the scale of the atomic nucleus to the scale of galaxies. However, it is easy to realize that, as soon as the degree of complexity of the structures and systems increases and when these are composed of several interacting elements, one is faced with new situations, in which the knowledge of the properties of individual constituents (for instance, particles, atoms, planets, and so on) is not sufficient to describe the structure as a whole.
The point is that, when these constituents combine nonlinearly, they form complex structures and support collective motions that have little to do with the properties of the isolated constituents. We can represent this situation as the study of the “architecture” of matter and nature that depends one way or another on the properties of the building blocks, but possesses peculiarities and fundamental laws that cannot be directly connected to those of the single constituents. According to Anderson, reality then has a hierarchic structure and at every level of the hierarchy concept and ideas have to be introduced that differ from those employed at the underlying level. In simple words: from the knowledge of the fundamental laws that rule the interactions between elementary particles is not straightforwardly possible to understand the formation of many phases of condensed matter, etc. The study of complex systems concerns the emergence of collective properties in systems with a large number of constituents in mutual interaction. If this approach is fundamental in the study of many physical problems, several examples in the last thirty years have shown that understanding some problems specific in a certain field can give rise to a new methodology, possibly applicable to other disciplines, among which, for sure, economics. The study of complex systems thus provides a variety of new and refined methods, that allow for new questions to be formulated and framed in a different and original manner.
An economic theory that does not take into account the way in which the collective behaviour of agents arises or neglects the considerable dependence on small perturbations – as indeed does neoclassical economics – is not apt to explain how important crises or sudden fluctuations, that are seen every day on financial markets, occur. The very idea that an interconnected and tightly interdependent system, as modern financial economy, may tend to some form of stability must be called into question in a laic and pragmatic manner.
To understand the reach of the theoretical ideas developed about nonlinear phenomena (far) off equilibrium, it is enough to consider that neoclassical economists have interpreted the crisis of 2008 by means of the ideological prejudice according to which the financial crisis was triggered by unforeseeable causes, the bankruptcy of Lehman Brothers, but, since the free markets tend to stability, there would not be consequences on real economy. This interpretation – that influenced the public opinion and the subsequent political choices of the governments of several countries and of the main international institutions – stems from the very theoretical belief according to which deregulated markets should be efficient and rational agents should rapidly adjust every price that is not fully appropriate and every evaluation error. The price should therefore faithfully reflect the underlying reality and ensure the optimal allocation of resources. These “balanced” markets should be stable: therefore crises can only be triggered by large exogenous perturbations, like hurricanes, earthquakes, or political unrests, but certainly not caused by the market itself.
These theoretical prejudices stem from an oversimplification of the problem, so that the idealization not only is unlike reality, but actually is completely inadequate to its understanding. As Buchanan explain in detail, physicist who deal with complexity study since about twenty years systems that display intermittent behaviours much alike those of financial markets, in which the nontrivial nature of the dynamics stems from intrinsic collective effects – not external shocks or causes. The individual parts behave in a relatively simple way, but the interactions lead to new emergent phenomena, so that the behaviour of the whole system is fundamentally different from that of its elementary constituents. Even if an equilibrium state exists in theory, this may be totally irrelevant to all practical extent, because the time needed to reach it is too long and because these systems may be intrinsically fragile with respect to the action of tiny fluctuations, and evolve in an intermittent way, with a succession of stable epochs spaced out by sudden and unforeseeable changes. Within this perspective, it is natural to conclude that other crises like that started in 2008 may happen again, without any forewarning and, alas!, rather often, as long as a regulation of financial market is not enforced, acting on the endogenous causes of crises and on the theoretical prejudices at the basis of the ineffable equilibrium of free markets.
The relevant question that should be asked is the following: are the fundamental axioms employed in neoclassical economic theory subject to empirical tests? For instance: do the free markets tend to equilibrium, or do they fluctuate wildly? Does the answer to this question come from observations or is it an indisputable assumption? This is a crucial point, since those who think that free markets are efficient and self-regulate toward stable equilibrium will be led to propose an ever more important role of markets and to “starve the beast”, the State, corrupted and nepotistic, as indeed happened both in the United States and in Europe in the last twenty years. Those who instead think that free market are dominated by wild fluctuations and are intrinsically far from a stable equilibrium, generating dangerous unbalances and inequalities, will be led to propose a more important participation of the State, trying to improve the efficiency of this latter.
Analogously, those who believe in the stability of deregulated economy will obviously be led to consider every fluctuation in financial markets as an uninflected perturbation of the equilibrium condition: a devastating crisis cannot be foreseen because it is not even conceived in the fairy-tale world of efficient markets.
When a paradigm becomes so strong to replace whatever empirical observation, it becomes a dogma and the scholar ends up living in the model, without being aware of what happens in real world. As it is well experienced nowadays, there is no stability in real economy: the acceleration toward financialization, with the introduction of derivatives in the market, has made the situation even more potentially explosive. The contrary of what the neoclassical economists do believe.
Queen Elizabeth was then completely right when – during a visit to the London School of Economics in November 2008 – asked why the overwhelming majority of economists, those who work in the national and international institutions, and those who write every day on the major newspapers across the world, had not understood that the crisis was going to burst out. Two notorious British economists answered the “Queen’s question” with a letter to the Queen, summarizing the positions that had emerged during a forum promoted by the British Academy: “To conclude, in short, Her Majesty, the ineptitude to foresee times, magnitude, and seriousness of the crisis, and to prevent it, although having several causes, was mainly a failure of the collective imagination of many brilliant persons, in this and other countries, to understand the risks for the system as a whole”. More explicitly, another group of British economists emphasize that “in the last years economy became almost entirely a branch of applied mathematics, and got separated from the institutions of the real world and from the events”. The problem does not stand in the question whether economics is or is not an exact science (and sure it is not), or in the fact that the use of mathematics provides a solid scientific appearance, rather it is methodological.
Biology (which is not an exact science too) has made significant progresses in the last years, thanks to a systematic analysis of experiments and data, advancing in a pragmatic manner, and not being guided by indubitable ideological assumptions.
The economic crisis initially busted out as a banking and financial crisis, triggered by a crisis of the private debt, due to an uncontrolled creation of “money out of nothing” in the form of derivative bonds on the banks’ side, both in Europe and America, justified by the belief that they would more effectively stabilized the markets. When this house of card crumpled, with enormous costs for millions of individuals, the American government upheld the banks with almost thirty trillion dollars, in the form of credits and guarantees, some returned back, some not, while at the end of 2010 the European Commission authorized support to the banks for more than four trillion dollars. With these interventions the financial crisis, that until the beginning of 2010 had been a crisis of private banks and had not turned into a worldwide catastrophe, was charged onto the public balances. At that moment, the leitmotiv, diffused by the major media, often by the same neoclassical economists that had supported in the past every choice of deregulation and liberalization of the markets, turned different: excess of indebtment of the United States, excess of public expenditure, unbearable pensions, expenses for education that “we can no longer afford”, and so on. As a consequence, also to follow the new measures, first of all the unbelievable rule of break even balance, inserted in the Constitution without any public discussion by a Parliament at least inattentive, without great difficulty the message was put forward that the State spends too much and therefore it is necessary to cut the public expenses: kindergartens, schools, healthcare, education, research, pensions, etc.
This incredible and unacceptable mystification has been made possible thanks to a surprising and pervading cultural hegemony, that developed not only by means of the conquest of dominant academic positions achieved by neoclassical economists, but also, mainly, by means of the superposition of their academic, political, and opinion-making roles, as many of them were columnists of major national newspapers or the prince’s advisors. Buchanan’s books shows, indeed, that some theoretical ideas that appear to be innocent cogitations of some eccentric scholar, have become powerful means of political and cultural brainwashing. The Nobel laureate in economics Paul Samuelson writes: “I do not care about those who write the laws of a nation or elaborates her treaties, as long as I can write her textbooks of economics”. The way out of the economic crisis passes first of all through a change of cultural perspective that the new concepts of natural sciences, together with their methodologies, can contribute to economics.
To conclude, Buchanan discusses in many points about the intellectual honesty of neoclassical economists as related to the way in which they argue and uphold the unbelievable hypotheses at the basis of model as yet employed by political and institutional decision-makers. To complete the discussion, hereafter we report the illuminating lecture of the Nobel laureate in physics Richard Feynman about the meaning of science and scientific ethics. Feynman clearly explains the methodological flaw of neoclassical economics:
“In the South Seas there is a cargo cult of people. During the war they saw airplanes with lots of good materials, and they want the same thing to happen now. So they’ve arranged to make things like runways, to put fires along the sides of the runways, to make a wooden hut for a man to sit in, with two wooden pieces on his head to headphones and bars of bamboo sticking out like antennas – he’s the controller – and they wait for the airplanes to land. They’re doing everything right. The form is perfect. It looks exactly the way it looked before. But it doesn’t work. No airplanes land. So I call these things cargo cult science, because they follow all the apparent precepts and forms of scientific investigation, but they’re missing something essential, because the planes don’t land. Now it behoves me, of course, to tell you what they’re missing. But it would be just about as difficult to explain to the South Sea islanders how they have to arrange things so that they get some wealth in their system. It is not something simple like telling them how to improve the shapes of the earphones. But there is one feature I notice that is generally missing in cargo cult science. That is the idea that we all hope you have learned in studying science in school – we never say explicitly what this is, but just hope that you catch on by all the examples of scientific investigation. It is interesting, therefore, to bring it out now and speak of it explicitly.
It’s a kind of scientific integrity, a principle of scientific thought that corresponds to a kind of utter honesty – a kind of leaning over backwards. For example, if you’re doing an experiment, you should report everything that you think might make it invalid – not only what you think is right about it: other causes that could possibly explain your results; and things you thought of that you’ve eliminated by some other experiment, and how they worked – to make sure the other fellow can tell they have been eliminated. […] We’ve learned from experience that the truth will come out. Other experimenters will repeat your experiment and find out whether you were wrong or right. Nature’s phenomena will agree or they’ll disagree with your theory. And, although you may gain some temporary fame and excitement, you will not gain a good reputation as a scientist if you haven’t tried to be very careful in this kind of work. And it’s this type of integrity, this kind of care not to fool yourself, that is missing to a large extent in much of the research in cargo cult science. […] So I have just one wish for you – the good luck to be somewhere where you are free to maintain the kind of integrity I have described, and where you do not feel forced by a need to maintain your position in the organization, or financial support, or so on, to lose your integrity.
May you have that freedom”.
Feynman’s “cargo science” is therefore a perfect metaphor of the neoclassical theory: the runways, the fires and the bars of bamboo are much alike the invisible hand, the rational expectation and the efficient markets. The same way as the “cargo people” are there waiting for the airplanes to land, the economists wait for the markets to stabilize. Unfortunately for the South Seas islanders and for us consumers and citizens the airplanes are not landing and the crises keep on raging. Neoclassical theory probably lacks something essential: complexity is certainly one of the most promising attempts to provide scientific instruments, and reformulate from the very foundation the methodological approach.