Subtle is the Lord

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Nov 24, 2017 - and science provides us with these limits. “Science is only possible because some things are impossible,” writes Oxford physicist John Barrow.
“Subtle is The Lord, But Malicious He is Not” Do Nature and Markets Have the Same Lord?

Sami Al-Suwailem November 24, 2017

Why social sciences are different from natural sciences? It is not the lack of controlled experiments ... It is not because of non-linearity ... It is not because of unpredictability ... All these challenges exist in natural sciences. So what is the difference then? Simple. Atoms do not cheat; they faithfully obey the laws of Nature. Albert Einstein famously remarked: “Subtle is the Lord, but malicious He is not.” He means that Nature is consistent but not trivial. In contrast, humans do cheat; they can be malicious. Why? Because they have free will. But our will is hosted within biological systems of Nature. So our will should ultimately be governed by natural laws. How is it possible then that we are able to evade the laws of Nature? Undoubtedly, we cannot evade the laws of Nature for so long. We can do so only in the “short run.” Sooner or later, however, someone has to pay. But how “short” is the “short run”? We don’t know! “In the long run, we are all dead,” J.M. Keynes declared in his General Theory. And herein lies the source of the problem. In the short run, one may be able to take advantage of someone else. Collectively, though, we cannot get away with it. Individually, however, we probably can. Or we think we can. If that “someone” is also playing the same game, we might end up with a disaster. The Global Financial Crisis was predominantly a consequence of our failure to understand how collective interactions can lead to the disaster. Queen Elizabeth II of England in 2008 asked the obvious question: “Why nobody noticed that the credit crunch was on its way?” The answer, provided by the British Academy, was: Everyone seemed to be doing their own job properly on its own merit. And according to standard measures of success, they were often doing it well. The failure was to see how collectively this added up to a series of interconnected imbalances … Individual risks may rightly have been viewed as small, but the risk to the system as a whole was

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vast.

Everyone knew they were playing a “musical-chairs game,” as the CEO of Citigroup in 2007, Chuck Prince, made it clear at the time. Each player however thought that he or she will be able to grab a seat at exactly the right time. The result: seats crashed when the music stopped, and (almost) everyone lost. ❋❋❋

Humans have the unique ability to imagine and predict the future. No other animal has this ability. We create our own worlds in our minds, which may or may not match the outside World. If they do, we obviously cannot cheat Nature. But if they don’t, then why not? The neoclassical approach seems paradoxical in this regard. At one level, neoclassical agents are supposed to hold a perfect view of the outside World. They know the exact model of the market or the economy, and thus are able to form “rational expectations.” Yet, no agent cares about the whole picture resulting from the collective interactions of agents. The model they hold is of purely individualistic agents. Somehow, they can see only one dimension but not the other. It is like the inhabitants of Flatland, who can see the world only in two dimensions. They are unable to envision the third dimension. For them, the Earth would look as an infinite plane. No matter how far they go on the plane, they will never reach an end. Similarly, neoclassical agents are able only to view their individualistic choices, whereby the world looks infinite. An agent may take advantage of another, and the other of another, …, ad infinitum. This is perfectly “rational” in the theory because the market is infinite, and thus agents can play the musicalchairs game forever. Nothing in economic theory says that this behavior is inherently unsustainable. Just like the Flatland, the neoclassical land looks infinite. The economy obviously is finite. And because of this mismatch between our image and the real World, we think we can cheat Nature indefinitely. ❋❋❋

So what are these laws of Nature that we can cheat but not forever?

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They are not the laws of “gravitation” or “electromagnetism.” They are more fundamental than that. They are grouped under the heading conservation principles. In Nature, you cannot get something for nothing. This simple and intuitive principle governs not only Nature, but human interactions as well. In fact, it is the first principle of economics: scarcity. So how could it be that economic theory violates its most basic axiom? The reason is another axiom: methodological individualism, which dictates that only the individual’s actions and consequences are considered for economic decisions. This is because, according to the theory, every individual, in pursuing only his own selfish good, is supposed to achieve the best good for all, as if by an “invisible hand.” Thus, the collective consequences of agents’ interactions are not at the core of the theory. They are external to it, and that’s why they are dubbed “externalities.” And few of us really care about these externalities. But Nature does. The “mother of all externalities” is the Climate Change Crisis. Mainstream economists are still struggling to find the evidence for climate change. And it is unlikely they will, for a simple reason. They usually apply reductive techniques to examine a complex phenomenon. It doesn’t work this way. ❋❋❋

Individualism is not an economic principle; it is an ideology, as Alan Greenspan, former governor of the Federal reserve, made it clear during the Crisis. As an ideology, individualism doesn’t belong to science. This is fine as long as it doesn’t contravene the laws of Nature. But once it does, it becomes a harmful superstition. It turns out that individualism and scarcity are incompatible. Scarcity is a global, system-level, property. Individualism is exactly the opposite. Scarcity prevents one from getting something for nothing. Individualism allows one to take advantage of others, as in social dilemmas and tragedy of the commons, not to mention musical-chairs games. The two principles therefore cannot get along easily. 4

Individualism has been invalidated by a large number of studies showing how herd behavior, imitation, and groupthink dominate human interactions. Modern theory of finance follows the footstep of the French mathematician, Louis Bachelier, in his 1900 Ph.D. thesis, Theory of Speculation. Bachelier assumes that speculators’ decisions at any moment of time are random and independent, which is the foundation of the Efficient Market Hypothesis today. The great mathematician Henri Poincaré, Bachelier’s advisor, was not very enthusiastic about this assumption. He wrote: When men are brought together they no longer decide at random and independently one of another; they influence one another. Multiplex causes come into action. They worry men, dragging them to right or left, but one thing there is they can not destroy, this is their Panurge flock-of-sheep habits. And this is an invariant. (Emphasis added.)

Scientists call something “invariant” if it is a conserved property of the system. Conserved properties are essential for proper scientific investigation. So, if we are to develop the science of social behavior, including economics, we ought to embrace group-behavior as a basic axiom of social interactions that puts limits on individualism. In this manner, we will be able to view the world in three dimensions, and, thus, give up trying to cheat Nature. ❋❋❋

There is no contradiction between free will and science. Free will has limits, and science provides us with these limits. “Science is only possible because some things are impossible,” writes Oxford physicist John Barrow. We are free to choose, but we are not free to have the cake and eat it. We may choose only one or the other. And this tradeoff is the essence of economics. Science and economics, therefore, have the same subtle, but non-malicious, Lord.

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