The ‘living, breathing’ economy
New views of the economic bust consider finance as a dynamic ecosystem.
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One modeling approach succeeds in reproducing these bubbles quite well. So-called agent-based models – a simulation of a self-assembling system – tend to produce bubbles and wild swings as a matter of course, says Blake LeBaron, a professor at the International Business School at Brandeis University in Waltham, Mass.Skip to next paragraph
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“Across the agent-based financial models, one thing you definitely notice is the idea that crisis ... is sort of generic,” he says. “You have to work hard to get rid of these instabilities.”
Instability as a constant
In fact, instability may be an inescapable part of any complex, self-organizing system, he says. Ecologists note that ecosystems go through cycles of growing complexity, only to collapse, simplify, reorganize, and begin the cycle again.
Some ants illustrate another aspect of this principle. Army ants are famous for operating as if directed by an all-seeing intelligence when there is, in fact, no central command. They sweep through ecosystems and devour everything in their path – snakes, birds, even cows. They create living ant bridges to ford creeks, aggregate into balls that hang from trees, and carry out other seemingly top-down directed activities. They exemplify the magic of a self-organized system.
But sometimes, army ant foragers get caught in what’s known as a “circular mill.” After picking up their own trail of pheromones, they begin marching in a circle until they die of starvation.
Here’s the lesson: Self-organizing systems seem to be vulnerable to self-reinforcing cycles that lead to their own collapse. Because of how they interact – in this case, ants following pheromones and laying down more “follow me” pheromones along the way – the mistake of a few individuals can propagate, amplify, and bring down the whole structure.
Worker ants vs. free market
We are not ants, of course – although free markets do operate along the same principles. Unlike ants, we have the capacity to foresee and stave off “circular mill” situations, at least theoretically, through regulation. However, the anxiety, usually expressed by the political right, is that too much meddling will quash a self-organizing system’s exuberance. Let the system self-correct, they argue. Let the unfit die off, and the fit survive. We’ll be left with the strongest of all possibilities.
The counterargument, is that without guidance and occasional intervention – such as the $700 billion stimulus plan – market fluctuations can break the whole system. An ecosystem approach to economics supports this notion.
Arthur puts it this way: “The market does pretty well. It does pretty well like any other game, if there are set rules and a bunch of referees.”
Creating a resilient economic ecosystem
The recent collapse highlighted the extreme, and unprecedented, interconnectedness of modern financial institutions. “Before the crisis, people talked about ‘too big to fail,’ ” says Eric Beinhocker, author of “The Origin of Wealth.” “After the crisis, we talk about ‘too connected to fail.’ ”
While this interconnectedness enables efficiency and wealth creation, it also permits failure to spread more quickly than ever before, such as the ripples after people couldn’t pay their mortgages. If we accept that instability is an inherent quality of any self-organized system, one way to make economies more resilient is to sever some of that connectivity.
Miller uses the analogy of firebreaks in a forest. The gaps prevent conflagrations from consuming everything. In an economy, that means identifying the links – transparency, or knowing who owes what to whom – who can lend to whom. If one or two institutions fail, he says, the failure can’t spread.
Arthur has another idea: the financial equivalent of an environmental impact assessment. Financial innovations, such as derivatives, inevitably open up new ways to “game” the system, he says. Every innovation should therefore be assessed before implementation, its potential impact on the market “ecosystem” thought through by economists, and even Congress, in advance.
“If we had had that before,” he says, “we wouldn’t have gotten into this mess.”