What Complexity Economics Can Add to Our View of the World

Tracy Alloway (0:10)

Hello, and welcome to another episode of the Odd Lots Podcast. My co-host, Joe Weisenthal, is away today, so it's just going to be me for a bit.

And one of the discussions we've been having on Odd Lots over the past year or so is this idea that traditional economics doesn't actually do a great job of taking into account a lot of important parts of the world economy right now. And what I mean by that is, if you look at something like the supply chain issues we've been having in the market, we've been talking a lot about the shortage in semiconductors, or if you look at things like transportation gridlock, we've spoken tons about the chaos in container shipping this year, a lot of those sort of factors or complexities don't actually make it into traditional economics. So for instance, one of the things I learned this year was that the sort of classical definition of comparative advantage where one nation is very good at making guns and the other nation is very good at making butter or wine versus cloth, something like that. And so they're supposed to trade with each other. That classical model doesn't actually take into account transport costs, or at least it didn't when it was first proposed. So if economics is all about simplifying assumptions in order to make it useful, you kind of have to ask about the trade off between simplifying everything and then overlooking quite important things that are impacting the economy. So it's something that both Joe and I have been thinking about this year. We've been exploring alternative types of economics. We had Professor Steve Kean on, on a recent episode where he was talking about how economics doesn't actually do a very good job of taking into account things like energy costs.

And we are going to be continuing that discussion today. So I'm very, very excited to introduce Brian Arthur. He's a economist who specializes in something called complexity economics, which automatically kind of sounds like something that we need to talk about in the current environment. He's a professor at the Santa Fe Institute and also a visiting researcher over at PARC in Palo Alto. So Brian, thank you so much for coming on.

W. Brian Arthur (2:29)

Thank you indeed. I'm really looking forward to this.

Tracy Alloway (2:33)

So I guess my first question has to be, what is complexity economics?

W. Brian Arthur (2:39)

Yeah, I'll have to take a deep breath here.

Economics has a lot of simplifying assumptions. I'm a theorist in economics, meaning I like to look at the economy theoretically or formally. And we use a lot of mathematics to do that. Standard economics, it's called neoclassical economics, brings in a lot of simplifying assumptions that have particular questions. It's like clearing the clutter and just saying, we want to get right down to the nitty gritty in any problem.

And to do that, in standard economics, we assume that all the problems that the players in the economy face, they might be investors or banks or shipping companies, we assume that they're all facing well-defined problems, that they're all optimizing, meaning they're doing the best that any mathematician could, they're hyper-rational. And the solutions they come up with are to be in equilibrium. So the pattern is in equilibrium, nobody in these solutions has an incentive to change. Complexity economics, not so much deliberately, but we were motivated by the whole idea of looking at the economy much more realistically. And so we might start by assuming that the banks or government departments or companies are different. They're not all identical. But once you assume they differ, then they don't quite know that other companies, other companies obviously aren't the same as them. They don't quite know what they might do, how much resources they have, what technologies are available to them. So generally speaking, when you don't know about other people or other players, you're subject to what economists call fundamental uncertainty. It's not just that you can't put probabilities on things, you simply don't know. So it turns out then, you get yourself very quickly into a mess. The problems then that any individual agent is facing are not well defined. They're not subject to logic. You don't quite know what situation you're in. It's like quite often landing in a country. You might be a very skilled negotiator, but you land in some East Asian country you've never been in. You don't know what procedures are, what the customers are, or how business operates there. So the situation generally for agents, to quite some degree, subject to uncertainty and not well defined. You're in not so much a mathematical problem then, you're in an ill-defined situation. So in complexity economics, part of the economy we're looking at, they're in some situation, it isn't well defined, but they're not helpless.