what future for OR/IE?

1. whatfuture for OR/IE? çağlar güven may 2013 what future for OR/IE?

2. outline • planning for resource allocation • market failure • climate change • complexity • systems thinking • the challenge for OR/IE what future for OR/IE?

3. most problems in OR/IE are problems of resourceallocationin human-activity-systems • resource allocation is central to alleconomic decisions • several questions can be posed about allocation: • whois going to allocate resources? • howare resources to be allocated? • what is themechanismand the scope of allocation? • allocation is a two-stage process: • planning • implementation what future for OR/IE?

4. OR/IE is concerned both with planning and implementation • however our primary contribution is planning • forplanning OR/IE depends on: • mathematical modelling in general • operational research • statistics • engineering sciences • microeconomics • ... • planning has to answer the questions: • whatto do? • how to do? what future for OR/IE?

5. whatshould be done to realise the long-term goals of the human-activity-system? the aim is effectiveness →doing the right thing concern is about morality, ie, the what-question is a moralquestion • howshould it be done without wasting resources? the aim is efficiency→doing things right concern is about techniqueand technology, ie, the how-question is a technical question • these questions come up in different contexts what future for OR/IE?

6. type-1 planningtakesplace at the micro-operationallevel; for example: • production and inventory management • supply chain management, etc.. type-2 planning takes place at the micro-strategiclevel; for example: • business planning • valuechain analysis • strategic planning • investment planning, etc.. type-3 planning takesplace at sectoral or the macrolevel; for example: • energyplanning • industrial policy • sectoral planning • regional planning, etc.. what future for OR/IE?

7. the how-question primarily appears in type-1 planning • the what-question appears in type-2 and type-3 planning • the what-question comes first; it is crucial for resource allocation in all human-activity-systems • but in the last 30+ years, it was commonly accepted that only free markets could tell us what to do • hence industrial engineers have had to forgetaboutthewhat,and focus on thehow • as a result, OR/IE was generally excluded from (type-2 and type-3) planning what future for OR/IE?

8. this has weakened and marginalised the contribution of OR/IE to critical and strategic debate about resource allocation • as a result, the OR/IEprofession has become almost irrelevant for a wide range of issues facing society • why did this happen? • to explain why, we have to consider how resource allocation works • let us consider the following two questions: what future for OR/IE?

9. whois going to allocate the resources? • a centralauthoritysuch as the government, • or consumerchoice? • by what meansare resources to be allocated? • by planning and governmentdirectives, • or by letting the marketmechanism to decide? • the practice of the last 30+ years has been: • allocation by consumer choice • free-market policiesand, • no need for type-2 or type-3 planning • how can we justify this, isthereascientifically-basedargumentfor free market policies? what future for OR/IE?

10. market policies are often said to be rational, efficient or optimal; implying such policies are ‘scientifically’ grounded • this claim is founded on two fundamental theorems in microeconomics, the welfaretheorems: • the first welfare theorem says: “ if every good is traded in a market at known prices and if households and firms act perfectly competitively, then the market outcome is Pareto optimal;ie. when markets are complete, any competitive equilibrium is necessarily Pareto optimal” • which means that the invisible hand of the market makes sure that marginal costs equal marginal benefits (MC = MB)in perfectlycompetitive markets what future for OR/IE?

11. the second welfare theorem says: “if household preferences and production sets are convex, there is a complete set of markets with known prices, and every agent acts as a price taker, then any Pareto optimum can be achieved as a competitive equilibrium if appropriate lump-sum transfers of wealth are arranged.” • in effect, the first theorem is telling us that all perfectly competitive market equilibria are efficient, and, • the second theorem is saying that economic policy can lead us to anydesired equilibrium, thus ensuring maximumwelfare what future for OR/IE?

12. but these are just two theorems in mathematics, • they have strong internalvalidity • but almost no external validity • external validity is weak because the assumptionsmade are very strong: • an infinity of producers and consumers, perfectly elastic demand for goods and factors • perfect information • homogeneous products • free entry, free exit • constant returns • ... what future for OR/IE?

13. in reality perfect competition is never achieved and markets fail to provide either efficiency or optimality • there is cause for market failure: • many agents are not price takers; this leads toimperfect competition • some goods cannot be priced by markets because the relevant market is missing; this causes externalities • all goods are not private, there are publicgoods(and bads) that are accessible to shared consumption by several agents • not all agents have perfect information; information asymmetry is common what future for OR/IE?

14. externalities and public goods are particularly common: • transactions of the externality take place outside the market • total marginal cost becomes MSC = MC + MEC • but there is no market that prices the MEC • so the optimality rule MSC = MB fails to hold • market failure is a result of the nature of things, it cannot be avoided and is common to all economies • but if this is so, then the promise of free markets will not be realised • so why should we stick with free market policies? what future for OR/IE?

15. free market supporters claim that: the closer an economy comes to realise the conditions of a free market, the closer to optimum will be the allocation • however this claim has no proof even in mathematics, under assumption of an idealised free market, this means that: • pursuing market policies is a political choice • free market economists claim • that failures exist but only as exceptions that can be put right and, • that the government’s only business is to prevent or repair market failure what future for OR/IE?

16. in fact there are conflicting views on what to do about failures: • neoliberals say that market failure is the exception and markets can correct such failure in time • liberalssay that market failure is the exception and government action may be needed to address the failure • Keynesianssay that market failures are common and governments have to take care of failures • Marxistssay thatfailures are the rule, not the exception, and central planning is necessary • but something is happening now, that effectively puts an end to this debate: what future for OR/IE?

17. climate change is causing externalities at a global scale; it is no longer possible to treat market failure as an exception; it has becomethe rule in all economic activity • theIPCCas well as bodies like the "National Climate Assessment and Development Advisory Committee" of the US Congress now agree that: • climate is changing fast and global warming is real • change is man-made, and • it will cause catastrophic results • change is mainly caused by CO2 concentration • all economic activity consumes energy and emits CO2 what future for OR/IE?

18. hence all economic activity now causes an external cost • there are no market signals telling us what that cost is • market failure is therefore universal all markets have now failed(witness markets since 2007) • we can no longer expect markets to function effectively on their own; (type-2 and type-3) planning is needed to ensure that MSC = MB holds • mainstream economists do not dare to admit this, but there is no escape from reality • most messes we are facing today are caused directly or indirectly by the failure of market policies • planning is back in force at every level of economic activity what future for OR/IE?

19. even a bigger cause for messes is our failure to recognise the complexity of nature and of human-activity-systems • the Newtonian paradigm that continues to dominate scientific inquiry assumes that, • the world is knowable; objective knowledge is possible and subject-object duality holds • cause and effect act linearly • nature is deterministic or predictable • reduction and analysis works • the new realisation however, is that many of the systems that surround us are complex, and that the metods of Newtonian science are incapable of dealing with complexity what future for OR/IE?

20. the complexityparadigm tells us that, • systems contain many constituents interacting nonlinearly • there is constant interplay between chaos and nonchaos • systems have emergent properties, analysis fails • objective knowledge is not possible; subject-object duality is false • allhuman-activity systems are complex, exhibiting technical, stochastic and purposive complexity • complex systems can be characterised by thermodynamicsconcepts • a gradient must be imposed on a system if work is to be done • work can be done if a system is not in thermodynamic equilibrium, ie. when a boundaryseparates the system from its environment • complexity is the degree to which asystem maintains thermodynamic disequilibrium; whereas a total lack of complexity is randomness, a state of maximum entropy, or a state of total disorder and disorganisation what future for OR/IE?

21. systems maintain disequilibrium by dissipating gradientsin a locally reduced entropy ­state; all human-activity system are dissipative • dissipative systems self-organise into structures that dissipate gradients • life itself is a dissipative structure that has emerged to counter the gradient imposed by the sun, mainly through photosynthesis • markets, when left to their devices, act as self-organising systems that dissipate (chemical, physical, kinetic etc..) gradients generated by the world’s resource-base, thus accelerating the progress towards disorder and disorganisation • planning is necessary to counter this tendency of markets in order to keep our distance from thermodynamic equilibrium • all the messes we face are caused by failure to recognise the complexity of human-activity systems, complexity of the highest order what future for OR/IE?

22. how can we deal with complexity, how should we conduct inquiry? • the mathematical results of complexity studies cannot easily be applied to human-activity systems • there are two main strategies that can help us in inquiry: • boundary setting • separating scales • changing boundaries and scales as needed • these are the basic topics of systems thinking, a meta-methodology that aims to deal with complex human-activity systems • for example soft ORextends the methodology of OR to deal with systems in which purposive complexity is predominant • in general the soft systems approaches are essential in dealing with messes what future for OR/IE?

23. a world in which neither the methods of science nor the market mechanism is effective, presents new opportunities for the OR/IE profession: • resource allocation is no longer possible without planning, without operational research • this opens up new areas for OR/IE, like: • policy analysis • strategy analysis • value chain planning • complex systems design • ... • which calls for competence in: • systems thinking • microeconomics • cge modelling • sustainability analysis • transdisciplinary team work • ... what future for OR/IE?

24. in conclusion, the challenge for OR/IE is • to stop doing what it has mostly been doing in the last 30+ years • to accomplish a paradigm change, and shift its attention from the how-question to the what-question • if this challenge cannot be met, the threat for OR/IE is • further marginalisation, and even • irrelevance • first resposibility lies with universities who are primarily to blame for the present state of the profession what future for OR/IE?