Every year when the Central Bank of Sweden hands out its “Nobel Memorial Prize in Economic Sciences”, there are always snorts of derision and cries of protest that this is “not a real Nobel Prize” and economics is “not a real science”…

The Oxford Dictionary definition of science is “the systematic study of the structure and behaviour of the physical and natural world through observation and experiment”.

Economics is sort of unique among the “social sciences” in that it attempts to apply mathematical rigor to the study of human behaviour.  This would seem to imply that economics is an exact science, like physics or chemistry; which further implies that economists are in the business of discovering “fundamental truths”…

Critics of “economic science” argue that the use of the paraphernalia of physics, like dense mathematical models, is in reality, purely “for show”; a vain attempt to give economics the elevated aura of physics (without unfortunately the same power of prediction). In fact some people would go so far as to say that “economic science” is really about as scientific as astrology and voodoo.

A bit Harsh Maybe !?…

Linear Dynamics

Physicists like to describe their science as the hardest of “hard science” because physics can claim to be governed by hard and fast scientific “Laws”.  This of course would seem to imply that many of the so-called “soft sciences” are in some way not quite as elevated, not quite as good.

In truth however we could say that physics is an “easy science”, and the soft sciences are “difficult” because the “laws” of physics only really work in the absence of “noise”, and yet the everyday world of the soft sciences is full of noise because most everything is continually battered and buffeted by “constantly changing feedback” which can generate wild “nonlinear dynamics”.

In reality all dynamics have feedback (and resultant nonlinearity), it is just that some dynamics have much less feedback than others.  Physics is, in a sense, the science of “dynamics with negligible feedback”, the science of “linear dynamics” — or in other words it is the science of the nonlinear stuff that can be safely “compressed” into neat linear differential equations which express neat linear “cause and effect”.

All the mathematical laws of physics are linear approximations of nonlinear behavior.  In fact the reason that these “Laws of Physics” are actually considered to be “Universal Laws” is precisely because the dynamics behind these laws can be linearized (which then allows us to repeat experiments over and over again, with the same initial conditions, and always get the same predictable result).

Nonlinear Dynamics

Ironically, it is our inability to express the dynamics of a system in a linear form that results in us referring to that system’s behavior as being “nonlinear dynamics”.  In the simplest possible terms, linear dynamics are dynamics where the effect is proportional to the cause, and nonlinear dynamics are where the effect is disproportional to the cause.  In any system of any type, the universal causes of nonlinearity are

1. The inability to damp down constant adaptation causes the emergence of diversity (i.e. deviations from the uniformity of equilibrium).
2. The inability to damp down positive feedback causes the emergence of bias or “skew” (i.e. some random things can arbitrarily get reinforced).

Economics is highly nonlinear and subject to both incompressible adaptation and incompressible feedback.  This means that there are no, and never will be any “fundamental laws of economics”.  Even  the slightly move away from linearity is akin to moving away from a “law” to a “strong probability”; and economics has moved a long way away from linearity.

Economics is highly nonlinear because economies and economic activity are riddled with adaptation and feedback, which means that even probabilistic predictions can become difficult; but this is not necessarily a bad thing, because this unpredictable nonlinearity can lead to “the emergence of unpredictable complexity”…

The Nature of Emergence

In an economy it is innovation that drives adaptation, and it is investment that drives positive reinforcement.

In any nonlinear system, it is hard to know what adaptations are going to occur and which of them will get reinforced through investment; and the more nonlinear the system is, the less amenable it will be to even probabilistic prediction. However this lack of predictability does not mean that we cannot have a “Qualitative Understanding” of the potential behavior of the system.

Both adaptation and positive reinforcement can independently drive emergent behavior, but it is the interplay between the two that determines “the nature of emergence”.  While diverse innovation without positive reinforcement can lead to the emergence of chaos, and reinforcement without diversity to the emergence of a bubble, the right balance between the two will always drive “the emergence of complexity”.

Aggregated Behaviour

Economies are effectively aggregated behaviour.  Some would argue that, left to its own devices, a society’s aggregate behaviour will self-organise the optimal economic equilibrium; but this is obviously not true, for without laws society’s aggregate behaviour can often disintegrate into chaos.

Okay, you might say, we need laws but we don’t need government nor bureaucratic interference in the economy; but this is not true either.  When it comes to financial matters, in general humans (and banks for that matter) can often behave like complete idiots, displaying a herd-like follow the crowd mentality.

The raison d’être of rational capital markets is that valuable investment funds are allocated to a diverse number of innovative business ideas, thereby generating economic complexity to the benefit of society as a whole.  But with the emergence of herding these funds (and even borrowed funds) are often almost blindly redirected and allocated into one particular area or asset class thereby generating a financial asset bubble to the detriment of society as a whole.

So when it comes to managing the economy, a hands off approach is not always the greatest idea….

Managing an Economy

When it comes to managing an economy, the question that needs to be asked is not what are the driving forces unique to economic systems, but “what the universal forces that drive all complex systems?…”

All complex systems are driven by an interplay of diversity and combination, or in other words, “complexity emerges” as a result of “the diversification of uniformity and how this emergent diversity best fits together”.

So in reality, it is not really possible to truly understand economics without understanding complexity, and it is not possible to understand complexity unless we understand the interplay between  order and chaos.

Managing an economy, like managing any other complex system, is an art, or more aptly a talent, like cooking, and like cooking it needs a good chef.  A good chef knows how much of each thing he needs and how long to cook it for (to achieve optimal integration).

Too much reinforcement without diversity of innovation and we get inequality and lock-in. Too much innovation and no reinforcement and we get the chaos of many fragmented ideas (that can quickly form, but just as quickly disappear).

What we need is to ensure that “the demand for investment opportunities is, as much as possible, always in sync with the supply of good ideas”; we need to ensure just the right mixture between innovation and reinforcement to achieve the perfect dish of integrated diversity…

Economics vs. Physics

Both physicists and economists need to realise that economics is indeed a science, just not a linear science; which means it cannot rely on linear mathematics, and thus is not amenable to mathematical prediction.

Economics is a nonlinear science, a “complex system science”, and so although not predictable it is still deterministic, governed by the same universal forces that drive all complex systems.

Economics as a disciple should cease attempting to be like Physics, because although natural systems are predictable, economics systems have vast potential for “unpredictable creativity”, and with the right complexity management we harness this potential, to the benefit of all…