Complexity Economics: A Path Beyond Neoclassical Dogma

1. Sami Al-Suwailem IRTI - IDB

2. Coined by Brian Arthur (1999) • Attracting more attention • Promising with great potential • Still needs more precise characterization

3. Probably the most fundamental property of Neoclassical Economics (NE) • Convexity can be viewed as an organizing principle of the comparison between NE and CE • Any combination of two points in the set belongs to the same set

4. Convexity precludes novelty by design: combinations always belong to the same set • No innovations or creativity • No learning or R&D • No entrepreneurship

5. Convexity allows only negative feedback; positive feedback is not allowed • Equilibrium, static system • No dynamics, no self-organization

6. Maximization requires convexity • Path-independence: Choice process or act of choice is ignored • No place for emotions, ethics, values, and social relations

7. NE assumes perfectly divisible commodities • Real numbers exclude Diophantine problems • But if commodities are indivisible, we cannot use real numbers • Rational numbers are non-convex • Diophantine problems are not decidable

8. Neoclassical Economics Complexity Economics • Novelty not allowed • Negative feedback • Maximization • Path-independent • Decidable • Perpetual novelty • Negative and positive • Satisficing • Path-dependent • Undecidable

9. Institutions can be seen as factors for “convexifying” the choice set • Convexity might not be always bad! • A promising line of research

10. Self-organization—structure • Emergence—function

11. Global order via local interactions • Implies positive-feedback—excluded by convexity • Examples: • Bird flocks • Fireflies

12. “The whole is greater than the sum” • Self-organizing system is able to perform functions the sum cannot • Implies novelty—excluded by convexity

13. “Swarm Intelligence” • “Group Genius” • “Wisdom of the Crowds”

14. Both exhibit nonlinear dynamics and universality • Different nature and properties

15. Chaotic Systems Complex Systems • Indistinguishable from random behavior • Ergodic • Non-adaptive • Basin of attraction computable • Not capable of universal computation • Path-independent • Recognizable patterns and order • Non-ergodic • Adaptive • Basin of attraction not computable • Capable of universal computation • Path-dependent

16. Fireflies, bird flocks, fish schools, … • Agents react to two sources of information: • Environment—exogenous variables • Local neighbors—endogenous variables

17. Each agent has a piece of knowledge regarding target or objective • Relative variables communicate the knowledge to neighbors • As each agent adjusts to its neighbors, the whole group synchronizes to the environment • Knowledge therefore becomes integrated

18. “The problem is thus in no way solved if we can show that all of the facts, if they were known to a single mind … would uniquely determine the solution; instead, we must show how a solution is produced by the interactions of people, each of whom possesses only partial knowledge”

19. Dispersed information zi must be consistent • An aggregator function must exist: • Fneed not be computable • Agents need not know F but they need to know it does exist

20. If independent variables dominate: stagnant order • If relative variables dominate: chaos • Complexity lies at the edge between order and chaos

21. Relative variables: the “self” part • Independent variables: “organization” part

22. Missing from mainstream NE • Supported by behavioral and social studies • Also by physical sciences (spin glass) • A point of departure of CE from NE • But can be a point for extending NE

23. Consumption is presented as a function of income (and wealth) • How about consumption of local neighbors? • “Social capital” • “Social multiplier”

24. As agents get different incomes, they cannot have equal consumption • How to react to “consumption gap”? • Move to different neighbors—Schelling model • Trade—labor market • Borrow—different modes of finance • Donate—philanthropic institutions

25. Simple (NE): • Complex: • How this affects economic variables?

26. NetLogo 3.1.4 • 1225 patches (agents); 8 neighbors • 1500 periods • 30 runs • Income is exogenous, uniformly distributed across agents; normally distributed across time • Gap is closed using interest-free lending

27. Surpluses are managed centrally • Deficits are financed from accumulated surpluses • Loans are extended based on available funds

28. Total assets = total cash + total credit • Total cash = cum (total-surplus + total-principal-payment – total-loans) • Net wealth (i) = share in total assets – debt • Share (i) = (acc. surplus) / sum (acc. surplus) • Total credit = total debt

30. Desired Consumption surplus deficit Loans Loanable funds Consumption, wealth

31. Sum (net-wealth) = total cash • Sum (shares) = 1 • Income + loan – consumption – surplus – installment = 0

33. Smoother consumption • Higher wealth • More efficient fund utilization

34. Consumption

35. Net-wealth

36. Wealth and Debt

37. Flow of Funds

38. Relative behavior smoothes out consumption • Smoothing reduces excessive consumption, thus adding to wealth • Connectedness facilitates channeling funds to deficit agents • Higher net-worth and higher efficiency

39. Relative behavior deserves more attention • Agent-based simulation provides a rich environment for research • Extensions to investment and capital markets