Complexity Economics studies economies that operates in a two dimensional space — one dimension is obviously “Trade + Investment”, but the other is “Innovation + Complexity”.
Trade is the dimension that gets the most press, for it is the short-term dimension of GDP numbers and current economic activity; but complexity is far and away the more important dimension for it is the long-term dimension of progress and innovation — the dimension that both, makes an economy more interesting and diverse, and increases the economy’s international competitiveness, all through the work of the “Invisible Hand”…
Anyone who has studied even a little bit of economics will have learnt early on that free markets are driven by the competitive forces of supply and demand. In 1776 Scottish Philosopher Adam Smith, the so-called “Father of Economics”, published “An Inquiry into the Nature and Causes of the Wealth of Nations”. In this classic work Smith told us how the most efficient economies are the one which self-organize themselves; pulled, as if by an “invisible hand”, to the optimal economic equilibrium by the competitive forces of supply and demand. Despite the brilliance of this inspired work, and the work of many other great economists over the last two and half centuries, economics is still often considered more art than science!
Much of the reason for this “lack of full scientific status” is that there has never been a proper framework for the scientific study of economics. Complexity Theory potentially fills that gap. Complexity theory explains economic behavior as the typical but complex mathematical behavior of a “Complex Adaptive System”.
A CAS is a self-organizing system of interacting parts – something akin to a system which has an “invisible hand” of internal self-organization. But before we address the idea of the economy as a self-organizing system, spontaneously self-organizing to an economic equilibrium; let us first examine the concept of equilibrium in general…
The concept of equilibrium is well known to the science of physics, where it crops up a lot; but most prominently in mechanics and thermodynamics.
In mechanics, there is the concept of a “Body at Equilibrium”. Isaacs Newton described a body to be at equilibrium if any and all forces, which may be acting on the body, net out to zero, (and as a result the behaviour of the body is unchanging).
In thermodynamics, there is the concept of “Thermal Equilibrium”. Thermodynamics deals with “systems” moving to, and being “at equilibrium”. Thermodynamics describes a system to be at thermal equilibrium when the macroscopic state of the system is, to all intents and purposes, unchanging.
The Second Law of Thermodynamics (SLOT) is the law of physics that deals with how the spontaneous distribution of energy unrelentingly pulls a thermal system to thermal equilibrium. In everyday terms the SLOT is simply the fact that cold milk and hot coffee, if left unstirred, will spontaneously mix themselves…
Despite the fact that this seems to be rather common innocuous everyday behaviour, the SLOT is nevertheless considered to be one of the most important laws of physics (if not the most important); and the reason for this exalted status is that the SLOT is both a “Probabilistic Law” and also the “Law of Maximum Entropy”!
Entropy is a concept that deals with amount of disorder in a system. It is widely understood that the spontaneous gravitational pull to maximum entropy is not restricted to simple thermal systems. Due to its underlying probabilistic nature, the SLOT has led to the universal understanding that all spontaneous change (in any system of whatever type) ultimately leads to maximum disorder. This of course beggars the question that if the SLOT applies to all systems of any type, then “how can a complex economy arise and sustain itself without some external organizing force?”
Complex Adaptive System
Oddly enough, some 74 years before the concept of the entropy and the SLOT had even come into existence, Adam Smith had already answered this question by suggesting that an economy could self-organized itself into existence. Smith more or less described how, in a free market economy, an “invisible hand” – operating from within the economy itself – can pull a system away from a thermal equilibrium to an equilibrium of ever increasing complexity.
At its most simple, the human race is nothing more than a system with a large number of individual parts. If every human being (within this system) acted totally independently of every other human being, then the human race as a whole would behave very much like a thermal system. People however, in general, do not behave independently of each other, but have a tendency to co-operate and compete, and it is this tendency to adapt to each other, that causes the human race to behave less like a thermal system, and more like a Complex Adaptive System.
Adam Smith and the Invisible Hand of Innovation
In their simplest form, free markets ensure that competition among producers will bring forth the lowest price (at given quantity) for consumers, and similarly competition among the consumers will bring forth the highest price (at given quantity) for producers. Thus, in its simplest form, a free market will self-organize a balancing equilibrium between supply and demand and, in so doing, thus brings forth the best available price for both buyers and sellers.
But the real juice of free markets is not in its ability to identify “the best equilibrium price” but its motivation towards productivity and innovation. In free markets, it is the “competition of ideas” that ultimately spurs “innovation” (in both products and production); which, as Adam Smith identified, acts like an “invisible hand” to the benefit of society as a whole!
Complex Adaptive Economy
“Chaos Theory“ has shown us that there is more to equilibrium than meets the eye. Chaos Theory introduced us to the idea that there can be many different forms of equilibrium, showing us that equilibrium can, in reality, be a multi-dimensional space!
In economics, equilibrium is fundamentally a 2-dimensional space. Markets are the price and quantity exchange dimension of equilibrium (how diversity in the economy is integrated through trade), and the economy as a whole is the complexity dimension (how the constant interplay of innovative emergence and upheaval, evolves the “micro-economic structure” of the economy to ever greater complexity).
When Adam Smith described the economy as a naturally self-organizing system, he was essentially talking about the complexity dimension of a Complex Adaptive System. And when he talked about an invisible hand, what he had essentially identified was that individuals acting in their own self-interest adapt to each other, and, in so doing, the economy as a whole self-organizes itself away from a thermal economic equilibrium to a more structural, more complex economic equilibrium.
In the concept and use of the phase “invisible hand”, Adam Smith had essentially identified how structure and complexity emerges and grows in the “Complex Adaptive Economy” (CAE).
[Click here for a more detailed explanation of what drives the emergence of spontaneous order in a Complex Adaptive System.]
Spectrum of Equilibrium
Left to itself a CAE will self-organize itself to some form of economic equilibrium; but this is not an equilibrium in the price dimension (dealing with the supply and demand of goods); this is an equilibrium in the complexity dimension (dealing with the emergence and upheaval of innovative diversity).
This complex equilibrium is an evolving, dynamic equilibrium, which might sound to some as a contradiction in terms, but Chaos Theory has shown us that the “structure” of equilibrium need not be restricted to the dull and boring, there is in fact is a whole spectrum of possible equilibriums ranging from thermal to chaotic, and the “optimal” complex equilibrium lies somewhere in between…
“Complexity Theory“ is essentially the study of the structure of complex equilibrium. Complexity Theory shows us that a complex equilibrium is actually a coarse version of thermal equilibrium. Complexity is essentially “Coarse Entropy”!
A thermal equilibrium we know is a dull uninteresting featureless affair. A complex equilibrium on the other hand is far from dull and boring; it is an intricately layered structured equilibrium that has self-organized itself into existence.
A complex equilibrium is a progressive structure of integrated emergent diversity (that emerges, layer upon layer, from the bottom up), self-organized and fine-tuned by mutually adaptive, symmetry-breaking, co-emergence. Progress in a CAE is driven by the constant balancing interplay of innovation and upheaval; innovation brings forth the new at the expense of the old!
The economy is a Complex Adaptive System (CAS) and the “Micro-economics” of this CAS operates in 2 different dimensions, that are normally confused as being one and the same!
In micro-economics, equilibrium is fundamentally a 2-dimensional space. Trade is one dimension, the economy (or more accurately economic structural complexity) is the other. When Adam Smith talked about the “Invisible Hand”, what he was really talking about was the complexity dimension; how in a CAE some form of “Invisible Hand” guides the “micro-economic structure” of the economy to an ever more complex economic equilibrium…
Economics is often considered the “Dismay Science” because of its enduring focus on the competition for scarce resources. But the progression away from this most basic of economic equilibriums – to more complex economic equilibrium structures – first occurred, and continues to occur, when innovation “replaces” direct competition…
Complexity Theory shows that the “Invisible Hand” is more about competitive and complementary innovation, than competitive fighting over scarce resources. A CAE is a driven-damped system; driven by innovation and damped by natural entropic decay.
In this driven-damped system it is the constant “interplay” – of diversification and integration, of upheaval and rejuvenation, repeated over and over, at every level of scale – that acts like “an invisible hand” both driving and fine-tuning Spontaneous Economic Self-Organization and the Emergence of Every Greater Economic Progress and Complexity!
And so it would appear that Complexity Theory applied to the CAE confirms what Adam Smith suggested back in 1776 “Free Markets and Competition lead to Innovation at the Cheapest Possible Price to the Benefit of All”.
But, as serendipitous as all this might seem, this natural unfolding of a bountiful economy still relies heavily on the “efficient” guidance of the invisible hand – but unfortunately efficiency is not always guaranteed!
The “Micro-economic Structure” of the self-organized economy may well be driven by the constant fine-tuning interplay of innovation and upheaval; but if this “Macro-economic Behavior” (of this fine-tuning interplay) is somehow disrupted then,
The self-organized, economic equilibrium – like any other driven damped system – can still be vulnerable to “coarse synchronicity and chaos”…