Economics is failing

Yes, that’s right, traditional economics is failing, but then we knew that. We hear talk that we’re out of the recession, but for a lot of people that doesn’t seem to be true. Many businesses are out of the recession and the “market” seems to think we’re out of the recession. However, what does it mean when the market is out of the recession? A lot of the market runs on high frequency trading, so the market can make money without a lot of people participating. Based on traditional economics theory, these markets should behave in a specific manner and they aren’t.

Slate calls this the difference between salt water and freshwater economics. Where the freshwater economics is based upon a lot of the traditional neoclassical theories, while the salt water economics is what the market traders are using. They’re using physics or other sort of network models that aren’t included in traditional economics theories.

Many of them have begun to use various forms of evolutionary economics, because it works. However, there’s a disconnect between the market and many of the leading theorists in Academia. Why? because those economists have made a career out of developing these theories. I believe that economics is at the beginning of a paradigm shift and it’s going to be painful. A lot of things are going to be changing because of this paradigm shift.

We’re staring at the end of jobs within the next 40 years, not all jobs, but a huge amount of the works force is going to be automated. Google’s working on industrial robotics with Foxconn, multiple companies are working on driverless cars, a few companies have developed drag and drop software so you don’t need to know how to code to develop software which will automate work because you build in your process rather than building your process around the system. This is radically going to change work. In the Race Against the Machine book it’s clear we’re going to be seeing changes in how our society works.

We’re going to be entering a time period where traditional economics doesn’t work and neither does capitalism. A blog post I read the other day has an interesting discussion of how we can move beyond capitalism (based on Star Trek). By the way, when I’m saying capitalism isn’t working, what I mean is that it’s not going to work to fundamentally keep the majority of the people working or provide any realistic relief to non-working people. It will be working quite well for a subset of the population that figure out how to survive or thrive in that economy. The question at that point becomes not what we think our economy is or should be, but what we value as a society.

I’ve talked about this in other posts in the past, however, I think that when we are looking at the “market place of applicable ideas” and we see that the people that should be influenced the most by economic theory AREN’T using it, but our government is, we have a serious problem. People at banks making huge sums of money on trading should be influenced by economic theory because they deal with vast sums of money and are actively driving a huge portion of our economic activity (valuable or not is another question). If they don’t see value in using those theories, then our leaders that are still applying them need to seriously rethink what theories they are applying to “manage” our economy.

When the prevailing theory in a discipline is failing, for the discipline to survive it must move beyond it. Typically the new theories that save it come from outsiders and indeed in economics it has – from two sources, Biology and Physics. Hopefully our leaders and teachers can see it before our current economic theories destroy us all.

Evolution and Innovation

Apparently I published this before I meant too. Anyway, today in Techdirt, they published a discussion on copying, innovation and evolution. Basically, a biologist argued that we are evolutionarily predisposed to copy and use group learning to develop new tools. What this means is that instead of going out and developing something out of the blue we first have to see what someone else has done and then we copy whatever they did, then in a parasitic way, make marginal improvements on the original. We’re nothing but freeloading copiers that make things a little better.

Techdirt completely disagreed with this point of view. They argued that simply copying something or a part of something doesn’t mean you’re freeloading. You can add a great deal to something to the point that whatever you copied simply becomes a part of a larger whole.

Anyone should know from my writing that I support Techdirt’s perspective. This comes from several several different arguments. The first is from the evolution of technology. If you ignore some of the human motivation behind the changing technology itself and focus on the selection process, you can see that technology changes through incremental adjustments. These changes are selected by the market or in primitive societies by the end result of an improvement. Spears that last longer, less energy expended on making new spears, spears that can be thrown farther, less danger from the animal being killed, or sharper shovels, less energy spent gathering food – more food. This selection process is a very natural process. Additionally, there would be some specialization of skills even at this point in our history. Some people would have been better at making spears and in a collaborative environment, because there were no patents and sharing was for the best of everyone, many people could experiment with new spear designs. This innovation while based on copying is a very real form of innovation that likely lead to gradual improvement over a great deal of time.

The second argument that supports innovation after copying is the argument of Cesar Hidalgo, which argues that looking at what countries are currently producing you can see a relationship with their innovative ability. By looking to see what technologies they import and export you’re able to see how well they have developed scientifically and in the manufacturing world. For example you can expect to see more advanced products come out of a country if they got into producing fertilizer very early in modern times. This typically leads to a general chemical industry which can lead to pharmaceuticals and semiconductors. Why? Well developing a strong base in chemistry with fertilizers can be expanded into drugs and as a base for semiconductors.

How do new countries move into these fields? Essentially, they have a knowledge transfer from a country that is already doing it. This can be done in two ways, one is the easy way: have a multinational company set up a manufacturing then R&D facility in your country. This allows a direct flow of knowledge on how to manufacture the material, which increases the rate of copying. Would allow the country to be a fast follower but will still require significant time for them to eventually innovate on that technology. Having an R&D facility would increase this rate, because local scientists would have already been trained on how to innovate in that field. They would have already been doing research in that industry and would more easily be able to innovate if a spin-off was created (or if the state nationalized that part of the multinational). The second manner is much slower: repatriating of knowledge workers. This is essentially what has happened in Taiwan and India. Educated Indians or Taiwanese returned from the US and created spin-offs and became professors at the local universities. This isn’t always successful.

Saudi Arabia is trying to develop a third way, which is having some success. They are recruiting experts from around the world to develop their own universities and companies. This is having mixed results and education and industry needs to pay attention to these attempts to see how well it plays out in the long run.

Copying is extremely important in education and is required to develop new industries in a country. Technology evolves through copying previous technology, recombining with new learning from other fields and from experimentation within the current field. Without copying there cannot be innovation. The more people participating in an economy where innovation through copying is rewarded, the greater our culture and the greater or technological evolution will be. Biology needs to take a lesson from Evolutionary economics.

Economic Growth II

So, two days ago I started discussing two different paradigms for economic growth. The first is neo-classical growth, the second is evolutionary economics. I basically asserted that neoclassical growth methods are crap. Well, I should have been a bit more careful. There are situations where they do work and can work well. However, they require a great deal of work to make sure that they actually predict anything. Additionally, they also measure if the economy is going towards or going away from a steady state position.

First, it’s not entirely clear if there is anything as a steady state economy. By steady state I don’t mean no growth at all, it’s more like consistent growth at a specific level. The US supposedly was in a steady state economic condition during the late 90s and early 2000s. However, two recessions, in my opinion, have revealed how flawed this theory of steady state economy is.

So what is neoclassical economics good for? Well, it can be used to predict growth assuming that the economy is capable of absorbing new technologies and innovations. If the economy is able to absorb these and then create manufacturing centers or research centers based on these advancements then the neo-classical growth model can work fairly well. It would work well for most European countries, however, I would still be skeptical of these predictions.

Why? Well, these growth models only capture a part of the economy as I said on Sunday. It also doesn’t predict or deal with changes within the structure of economies. For example, the age of steel was an extremely long lasting period, however, based on neoclassical growth the city of Pittsburgh should not have worried about shifting to a new area.

So what is evolutionary economics then? Well, I’ll get to that tomorrow.