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Posts Tagged ‘economic theory

“We have always known that heedless self interest was bad morals, we now know that it is bad economics.”*…

 

Economics

The World Clock in Alexanderplatz, Berlin

 

The set of ideas now called ‘Ergodicity Economics’ is overturning a fundamental concept at the heart of economics, with radical implications for the way we approach uncertainty and cooperation…. starting with the axiom that individuals optimise what happens to them over time, not what happens to them on average in a collection of parallel worlds.

Much of this view rests on a careful critique of a model of human decisionmaking known as expected utility theory. Everyone faces uncertainties all the time, in choosing to take one job rather than another, or deciding how to invest money – in education, travel or a house. The view of expected utility theory is that people should handle it by calculating the expected benefit to come from any possible choice, and choosing the largest. Mathematically, the expected ‘return’ from some choices can be calculated by summing up the possible outcomes, and weighting the benefits they give by the probability of their occurrence.

But there is one odd feature in this framework of expectations – it essentially eliminates time. Yet anyone who faces risky situations over time needs to handle those risks well, on average, over time, with one thing happening after the next. The seductive genius of the concept of probability is that it removes this historical aspect by imagining the world splitting with specific probabilities into parallel universes, one thing happening in each. The expected value doesn’t come from an average calculated over time, but from one calculated over the different possible outcomes considered outside of time. In doing so, it simplifies the problem – but actually solves a problem that is fundamentally different from the real problem of acting wisely through time in an uncertain world.

Expected utility theory has become so familiar to experts in economics, finance and risk-management in general that most see it as the obvious method of reasoning. Many see no alternatives. But that’s a mistake. This inspired [the Ergodicity Theory creators’] efforts to rewrite the foundations of economic theory, avoiding the lure of averaging over possible outcomes, and instead averaging over outcomes in time, with one thing happening after another, as in the real world. Many people – including most economists – naively believe that these two ways of thinking should give identical results, but they don’t. And the differences have big consequences, not only for people trying to do their best when facing uncertainty, but for the basic orientation of all of economic theory, and its prescriptions for how economic life might best be organised.

Of particular importance, the approach brings a new perspective to our understanding of cooperation and competition, and the conditions under which beneficial cooperative activity is possible…

Economists and mathematicians at the London Mathematical Laboratory, together with collaborators including two Nobel laureates from the Santa Fe Institute, propose something altogether different: “How ergodicity re-imagines economics for the benefit of us all.”

* Franklin Delano Roosevelt

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As we consider alternative accounts, we might recall that it was on this date in 2007 that Dodger infielder Chin-Lung Hu, recently acquired by the team, singled in a home game… allowing legendary Dodger announcer Vin Scully remark on-air, “shades of Abbott and Costello, I can finally say, ‘Hu is on first base.'”

HU

Hu, on first

source

 

“Economic theory is the art of pulling a rabbit out of a hat right after you’ve stuffed it into the hat in full view of the audience”*…

 

economic-crisis

Many critics were disappointed the 2008 crisis did not lead to an intellectual revolution on the scale of the 1930s. But the image of stasis you’d get from looking at the top journals and textbooks isn’t the whole picture — the most interesting conversations are happening somewhere else. For a generation, leftists in economics have struggled to change the profession, some by launching attacks (often well aimed, but ignored) from the outside, others by trying to make radical ideas parseable in the orthodox language. One lesson of the past decade is that both groups got it backward. Keynes famously wrote that “Practical men who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist.” But in recent years the relationship seems to have been more the other way round. If we want to change the economics profession, we need to start changing the world. Economics will follow.

From J.W. Mason‘s helpful survey of economic thought since the Crash of 2008: “How a Decade of Crisis Changed Economics.”

* Joan Robinson

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As we contemplate counting, we might send revolutionary birthday greetings to Alexander Hamilton; he was born on this date in 1755 (or 1757, there is some scholarly debate about the year, but not the date).  A Founding Father of the United States, Hamilton created the Federalist Party (proponent of stronger national government than provided by the Articles of Confederation), the United States Coast Guard, and the New York Post newspaper.  But he was probably most notably the creator of the new nation’s financial system.  The main author of the economic policies of George Washington’s administration, he took the lead in the Federal government’s funding of states’ debts, and established a national bank, a system of tariffs, and friendly trade relations with Britain.  His vision included a strong central government led by a vigorous executive branch, a strong commercial economy, a national bank supporting manufacturing, and a strong military…. in all of which he stood most frequently opposed to Thomas Jefferson, who favored agrarian and small government policies.

220px-alexander_hamilton_portrait_by_john_trumbull_1806 source

 

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