Beezer of beezernotes.com, posting on The Economist’s View, left a short reply to the posting, “Goodbye Homo Economicus.” I wanted to capture it because it’s both simple and accurate but also inverted and erroneous. And I do not mean that as a criticism. It is just an example of how even those people who understand that mathematics is a significant problem fail to understand that the natural processes and human processes – physics and economics – are both explanatory, not predictive.
We use prediction to test our understanding of physical processes, partly because the physical world is quite simple and comparatively slow. Humans are vastly more complicated and operate much faster. That’s the whole point of thinking: to defeat time’s arrow. But more importantly, it just so happens that the physical world isn’t heuristic – it doesn’t learn. We have an easy way of testing our reasoning in the physical world. Through this lens, we can test our REASONING in repeating a test in the physical world, and through observation improve our reasoning and retest it. This is a very simple, iterative process by which we can learn. But in the economic world, we cannot so easily perform tests by replicating them as we can by constantly improving our ability to produce results in the form of PARTICULAR OUTCOMES. Our problem is that we use politics, policy, credit, and law to try to test our theories.
The first test, however – the economic equivalent of Occam’s razor – is to say: if we need to force people to adopt something by violence, then it is certainly false. If we need to use political processes to get a lot of people to agree to something that they view as counter to their interests, then it is probably false. If we, instead, can issue them credit and shared risk and an idea to pursue and they flock to exploit it, then it is probably true.
In its present form economics not only fails to explain current events, it totally fails to provide predictive value.
[In pursuit of] certainty, [economists] focused on math to provide a comfortable framework. The math used appears to be flawed, to be kind. Gaussian techniques showed outlier results were so rare as to be insignificant. Mandlebrot argues these very outliers can be the most significant events, and not as rare as Gauss would have one believe.
But that’s just the math. Explaining human behaviour is a hundred knots within a maze. Economics will be studying this area more thoroughly, and forever. The predictions of human behaviour are most often “fuzzy,” but understanding them will allow for more accurate explanations and predictive value.
I’m going to use this little bit of thinking as a jumping-off point.
1) Economics as we conceive of it will never have predictive value. It will have explanatory value. It will only provide us with information to use in predicting our individual actions, not the result of our collective actions. More often the only value we can obtain from prediction is in profiting from arbitrage, which is not of any real value to society anyway, just to traders.1 And if, for policy, it is the policy of negotiating with foreign governments over trade barriers, or at its worst, an attempt to use law and credit for politicians to buy off factions, then they are simply engaged in a vast game of profiting from class warfare that they themselves, despite their good intentions, have specifically created. So there is no good use of equilibrial economic theory, and no good use of equilibria.
2) We cannot use economics and its resulting information to develop a steady state. We can use this information to search for events that will break the steady state. We have it backwards. If Taleb and Mandelbrot have not convinced enough people yet, then the current crisis should do so: quantitative economics is a religion and nothing more. It seeks answers in mystical scripture revealed by the magic of numbers, in the hope of deducing human behavior so that it can influence human behavior. But it seeks, unintentionally, an ideal that is an analogy to an agrarian, egalitarian, steady state. There never was one. There never will be one. The only steady state is found in endemic poverty.
3) There is no equilibrium. And Samuelson erred. Humans semi-randomly innovate, those innovations create opportunities, and those opportunities are exploited and consumed until the opportunity is gone or systemically adopted and turned into a habit by some part of the population. That is not a process of equilibrium. It is a process of discovery, adoption, consumption, discarding, and forgetting. In other words: it is a process of evolution.
This means that our concept of DEMAND is simply FALSE. I’ll say that again. Our concept of DEMAND is FALSE. Demand is simply the aggregate of the result of opportunities. It is not CAUSAL, it is DESCRIPTIVE. A demand curve is a description that FOLLOWS a set of opportunities.2 A demand curve is a remnant of agrarian society’s minor differences, long production cycles, and high risk. It is a statement of minor variations, of noise in an apparently static world, rendered as static by its slow rate of change.
I talk about this all the time, but one of the biases that we do not refer to in behavioral economics is the one that the profession employs all the time: the “Assumed Point of Reference.” Despite its emphasis on calculus, equilibria, and other multi-dimensional problems, and the fact that economics is a subjective science consisting of individual marginal differences in the perception of utility, the art of economic mathematics and reasoning as it is practiced does not include its own assumptions in that model of constant subjective relativism: that solving for an equilibrium of any kind is in fact creating a point of non-subjective, fixed reference. When in fact, economic productivity has no norm except starvation and poverty. It’s a spring that keeps expanding OUT from that poverty and starvation, by virtue of a rate of innovation. There is no steady agrarian state. The agrarian state (which simply means a simple one that doesn’t change much or fast) assumed by equilibrium theory is a contrivance to make calculation easier. In fact, life is a multidimensional fractal process whose dimensions are enumerable, but so vastly more than the nine or ten that string theory proposes that the very structure of it is nearly, and I emphasize nearly, impossible to discern.3
The world turns faster. The spring extends farther. The fractal sphere of our knowledge reaches a new diameter with spikes of innovation. But that sphere is held together by a of form of gravity: opportunity. We live in an opportunity economy FIRST and FOREMOST. Not a monetary one.
Our job, as makers of policy, if there is to be a government, is to make sure we provide enough redistribution of liquidity in the form of credit so that we create the largest number of innovations and consequential opportunities. We must provide the lowest friction to opportunity exploitation that we can. This is NOT an agrarian model of society based upon the productivity of land, which is what our entire banking system, unknowingly, runs on. It is not a system of efficient equilibrium, which is the purpose of economic reasoning in an agrarian model of society based upon the productivity of land and factories. Those were different problems. We live in an urban society where economic productivity comes largely from the satisfaction of aesthetic preferences.
We live in a world where there are vast cities, and they are not houses of wealth, but vast slums with a few inspiring, small, prosperous enclaves.4 The inverse is happening. Our poor live in cities without property or opportunity, and they are still breeding as if they were farmers because they lack property and opportunity. 5
3) Humans behave rationally, at least for humans, but not computationally. In other words, they do not seek probabilistic outcomes that produce efficiently profitable results. This is because humans do NOT CALCULATE. They can’t calculate in real time. They habituate instead. They form habits individually, and cooperatively as networks, and calculate only small variations within those habits, seeking to exploit opportunities to create the greatest number of opportunities to exploit, and hope that their FACTORY OF HABITS produces a profitable result. They use quantitative calculation to assist them in refinement of the asset they value, which is their habits, computationally, in real time, in order to create a sufficient number of opportunities, in order to reduce their risk, because computationally, manufacturing, testing, and accumulating their habits is extremely complicated, risky, costly, and, frankly, just HARD.
If their habit factory fails them repeatedly, they will make minor revisions to it. But their habits are assets, just like physical assets. And they will abandon them only when they no longer have a choice not to: when they are expended. Or, put better, when the cost of doing so is less than the opportunity cost of not doing so. Habits, domain or process knowledge, and relationships are as important as are explicit technical knowledge, money, and property. You can borrow money and property. You cannot easily borrow relationships and habits. Money makes it possible to buy relationships if you have enough of it. But even then there is a limit on the number of people one can interact with to put it to use.
Contracts are an extension of people’s habits, not the other way around. They are a form of registration of their habits. We are overly concerned with contracts, because they are evidentiary. But they simply codify habits. It is our habits that cause the stickiness of prices that was a behavioral economist’s surprise. The network of habits is a factory. And looking at the network of habits as a factory with real costs and real investments, capable of low cost production, is how we will best understand human behavior in an economy, and, in turn, best understand how we should measure human activity.
Homo Economicus (Economic Man) should instead be called Homo Economicus Usitor:6 Economic Habit Man. And he is so because computation, in any form, of any network, sufficient to create and exploit niche opportunity is extremely expensive. We have managed to not make it so expensive in the expenditure of physical labor, but it is terribly expensive in risk in time.
Humans calculate in this priority: a) Habits + b) Property+ c) Money. In that process, I use the term “habit” because it is an action-oriented term that is intentionally very different from the term “knowledge,” which is not action-oriented and implies the use of thorough revisitation of that knowledge in decision-making. Habit is a more accurate term.
The reason that they rely on those habits is the problem of the scarcity of time, and more importantly, because it is ONLY WITHIN THOSE HABITS that monetary calculation is of any value in increasing the precision of actions. Habits and one’s habit factory determine the set of opportunities which one can exploit. One uses monetary calculation to test or improve expansion of that habit, or refinement of micro-decisions that supply one’s habit factory.
Most decisions, which we must understand are between taking one action or set of actions or another set, are not clear or calculable. We need external information in order to break ties. Most of the decisions we make during the day are tie-breakers. We cannot ruminate on all the decisions we make in a day.
The study of economics, or the measurement of human cooperation, will be fraught with error until its practitioners begin to understand that they are working with a subset of data that is only questionably relevant. In particular, the field, because it exists post 1870, and possibly, post-Marx, as a tool for the purpose of developing policy, overestimates the importance of money and interest and the process of trading commodities and securities. This data is, at least to an economy, probably largely the record of nothing more than an expression of human fashionability, a side effect of Europe’s expansion into the American continent and the subsequent conversion of the rest of the world to institutionalized, individualist capitalism. Within that process, all activity is simply noise. That’s right. It’s just noise. There is nothing to “predict.” It’s just noise explaining the demographic migration and the chaotic nature at which humans of different knowledge bases and different ages transform from localized socialist farmers to globalized capitalist industrialists.
I’m exaggerating, of course, but only a little, and only for illustrative purposes.
We need to understand that quantitative economics is never predictive. It is explanatory. Only human beings are predictive, because the information necessary to predict is absent from, and not deducible from, the monetary record of human activity. Innovation, or human pattern-recognition and re-application of those patterns to seemingly unrelated problems so that opportunities can be either created or problems exploited, ensures that ALL CAUSAL ACTIVITY IN ECONOMICS IS FOREVER HIDDEN FROM US.
This is why any probabilistic study of human economic activity is impossible. An equilibrium is a device for compensating for our lack of ability to measure adaptation, expressed as innovation. As such it is a HORRIBLY ERRONEOUS device, because with it we cannot create meaningful categories by which to make quantitative comparisons.
We should, instead of trying to be predictive and trying to achieve an efficient equilibrium and universal employment, seek, using POLICY in the form of CREDIT, to identify opportunities for “black swans,” for “M factors,” and to pursue and to exploit every possible one of them that we can. In this world, we can satisfy policy makers, but they must seek constant opportunity for disruption instead of constant opportunity for efficiency. This means remaking the state from an attempt to return us to predictable agrarianism and a bureaucracy of laws, to one of innovation and entrepreneurship of unpredictability from which we have the greatest opportunity for constantly changing employment, using a market of bankers, whose profits in terms of interest fund the state, rather than taxes.
We should not seek predictability from which some body of people can exploit marginal profitability due to the ignorance, in time, of another. That is the fundamental quest that current economic reasoning seeks to develop into a science: a science that is no better than the socialism and justification of government jobs that inspires it, or the Veblenian7 madness of the public intellectual or politician who seeks personal affirmation through his management of society – an extension of and unnatural bias created by a theocratic-cum-secular public education.
It is our quest to make the world constant by making it free from change that is the fundamental human error. We must instead reduce the risk of change for any individual by remaking policy and society so that change is its defining factor. Only then are we masters of nature, time, and ourselves. It is in this world of constantly expanding, vast opportunities that we reduce the cost of any one of them.
This is, in effect, a call for the state to use credit to transform the purpose of government from one of agrarian universalism to the research and development state.
Of course, there will be just as radical a separation of rewards in that system as there is today. The difference is that we can capture a lot of that wealth for use in funding basic human services.
I won’t go into it here, but we don’t have a lot of choice really. If we don’t solve this problem, very soon – because of our vast cities – a lot of people are going to have to die. This isn’t an aesthetic preference. And I will leave some social scientist the job of doing the rough calculations on opportunity and population. It is roughly an analog of the logarithmic expansion of knowledge in relation to population over historical time.
Stop trying to create the pastoral Garden of Eden: the equilibrial agrarian economy served by industry. Create the entrepreneur economy for the world we live in: suburbs and cities where freely-moving assets and information are easily brought together to exploit opportunities toward rapid success and then broken apart and resold or retooled for the same.
Stop trying to build a portfolio based on risk that is understood as collateralized assets, so that the state and its bankers act as loan sharks. Instead, build a state, if you must have one, that starts taking risks that create competitive opportunity for your citizens, by putting credit behind ideas. Create a collective credit economy over the top of the private-money economy, and fund public services from the interest. Right now you’re just engaging in reverse inter-temporal redistribution. We have it backwards.
Seek not to build an even, predictable equilibrium but instead rapidly disrupt all steady states and train society to adapt to it. Simply help in the process of habituating people from an agrarian set of values and ambitions to an urban set of values and ambitions. We have to do it and we have killed a few dozen civilizations trying to do it in the past. We need to solve the problem of urbanized man: politically, economically, socially, and philosophically. Economic reasoning in the form of equilibrium studies and efficiency is part of the problem, not the cure.
We have been trying for millennia to distance ourselves from the chaotic randomness of nature and put man’s destiny in his own hands, depending on his own success or failure rather than nature’s vagaries. Converting the world to credit and opportunity, rather than fixed assets and risk, or, for that matter, tribes and territories, is simply one more step in that process.
If we don’t solve it we are just doomed to continue our extended adolescence. As children we were hunter-gatherers. As adolescents we were farmers. As adults we become urbanites. I do not know what old age will bring but hopefully we make the transition, and with it will find the peace we have sought for so long.
And, in simple terms, the carrot of credit it is far better than the stick of law for that purpose.
(I’ll explain how we do that later on. And the simplicity of it will surprise you.)
If politicians want to increase revenues, they should identify a local market opportunity and go find a small group of low-level young people to fund in pursuit of it. Repeat the process infinitely until you have mature people who can do bigger things and fund them. Repeat until you have a nation of people who are not easily corrupted. And if they are corrupted, if you have to in some sub-Saharan family fashion, then simply make an example of them that is so horrific that your point is made. This gets politicians out of the office managing corruption and interest groups and out building new interest groups and prosperity for your society. Start at the universities and work out from there. This process is a lot easier to implement if you’re a king than it is if you’re an elected official. Yet another reason I will always support parliamentary monarchy as the best form of government. ↩
I can almost hear Peter Klein, whom I greatly admire, telling me that it’s the same thing either way. But it’s NOT the same thing if what the other person DEDUCES from a statement is different from what you intend to describe by that statement. This is yet another lesson in causality writ as the exasperatingly obvious. ↩
It is possible to construct a geometry in space and time of this nature, a manifold of sorts, if time is variable and space is not uniquely occupied. And no, I’m not going to get into that stuff here. Economic philosophy is hard enough and if I get into another subject my editor and business partners will chastise me. ↩
For example, Paris, New York, Moscow, and Vienna have gorgeous cores, surrounded by rings of urban concrete, cinderblock, and brick-faced slums. The US is beautiful deserts, forests, and farmland, coupled with the twin cities of New York and San Francisco, and everything in between is industrialized wasteland encircled by heat-consuming, 3500 square foot individual family enclaves connected to a series of shops and businesses by personal transportation systems we call automobiles. ↩
It takes a king, 1000 armed men, the money to keep them well-fed and training constantly with current equipment, 500 decent MBA’s, and 50 decent small company CEO’s to take over any country of less than 10M people and make it prosperous in a generation. You might notice I didn’t put a lawyer or judge in that list anywhere. ↩
My Latin is terrible so if it’s more appropriately Homo Economicus Usitor, or Usitor Economicus I am not sure. ↩
Thorsten Veblen’s doctrine that intellectuals kill their society. ↩