Real-Life Economics: Rational or Complex?

Doyne Farmer’s recent conversation with EconTalk’s Russ Roberts has given listeners reason to reflect on the state of economics and the way mainstream economists model market behaviors and use their models and tools to predict behaviors and identify trends.  After listening to the EconTalk episode “Chaos and Complexity Economics (with J. Doyne Farmer),” would you agree? 

In this podcast, Roberts and Farmer dove into the realm of complexity economics, with Farmer making a strong case for its potential to significantly enhance the way economists model and predict market behaviors and trends. Farmer argues it only makes sense to move away from the all-too-simple rational expectations model. He advocates turning to the messy, interconnected realities of the economic world.  Yes, it does sound like a heavy lift.  But Farmer makes a compelling case for complexity economics and using its agent-based modeling.

Roberts and Farmer make complexity economics digestible for outsiders of Farmer’s specialized field, especially for those outside of the economics discipline and for those fancying themselves as armchair economists. 

Around 22:26 in the podcast, Farmer explains how complexity economics can incorporate more realistic and nuanced aspects of human behavior into agent-based modeling.  He provides an example to illustrate using the way housing prices are set through aspiration-level adaptation. Complexity economists acknowledge the heterogeneity of individuals, and the multiplicity of their decision-making strategies. Which is starkly different from the rational expectations assumption of homogenous actors seeking utility maximization in neoclassical models with identical constraints of income. 

This shift makes the work of complexity economists seem capable of bringing the discipline of economics closer to the nuances of real-life and capable of systematically introducing rules of thumb and social institutions into decision-making, something that has been difficult in most economic models. Around 24:00, some of the differences between the work of complexity economists and econometricians are discussed by Farmer and shared with Roberts. It is here that Farmer describes the advantages of using complexity economics to breakdown the 2008 Financial Crisis, highlighting the possible advantages of using complexity economics to inform policy responses to thwart the aftermath. Roberts pushes back, encouraging Farmer to consider other possibilities. Farmer appears firmly committed to using centralized policy rather than trusting decentralized markets and the people who make them up. 

Complemented by using big data and through powerful advanced computing, Farmer moves on to make a compelling case for taking the heterogeneous approach of complexity economics and its real-world dynamics to supercharge economics and, perhaps, help mainstream economics recalibrate the way they model consumption, savings, and investment behaviors. To this point, explain why Farmer argues that this heterogeneous approach is a huge advantage, especially when considering demographics, income differences, random behavior adjustments, and other factors.

From Farmer’s perspective, complexity economics could serve as a pathway towards a future in which economic models become clearer, more widely applicable, and adept at examining both the direct and indirect consequences of various policies, equipping economics to better navigate the complexities of societal and global events.  Yes, this creates a compelling vision, especially if it is accompanied by improved predictive power and offers a framework that significantly improves how we understand economic dynamics. As an example, Farmer discusses how he and his team approached introducing an unexpected global crises like recent pandemic into predicting how consumers, businesses, and industries would respond. He cites his team’s experiences with COVID in the United Kingdom. 

The integration of complexity economics indeed creates a fertile ground for interdisciplinary collaboration and potentially provides a playground for new institutional economics, fortifying the models with empirical evidence and potentially leading to a paradigm shift in economic thought. The aspiration for a more inclusive and comprehensible economic science is applaudable and aligns with a broader desire across the discipline to make economics more accessible and actionable for wider audiences across disciplines. Indeed, this is all very appealing.  But, there is always a but, especially in our circles committed to the ideal of a society of free and responsible individuals.

There is definitely potential for a serious clash when free-market economists take a deep dive into how Farmer advocates using the fruits of complexity economics to inform policymakers. Yes, there always is potential for this clash.  But Farmer appears unfamiliar with F.A. Hayek’s work. From cover to cover, Hayek is not mentioned in his book nor is he discussed in this or other popular podcasts.  Plus, he appears not to fully understand Milton Friedman’s position on the impressive records of self-interested individuals navigating through markets versus the disastrous records of “benevolent” government officials and policymakers. In fact, he appears somewhat hostile to Friedman and his cadre of Chicago School of economists.

Yes, Milton Friedman – or F.A. Hayek who is not mentioned by Farmer – are notable for their advocacy of free market principles.  How might they respond to Farmer’s claims? One could only assume that they would react but they would respond differently. Both would likely be intrigued by his scientific approach and its ability to use “decentralized” rules of thumbs as a key part of decision-making behavior.  However, would you agree that Friedman would advocate for incorporating minimal government intervention and the self-regulatory strengths of the free market into the modeling scenarios used by Farmer to offer a balanced perspective?  Or do you think he’d push for something else? Now, turn to Hayek with his emphasis on the dispersed nature of knowledge and the potential hazards of central planning. How would you imagine he would critique Farmer’s approach?  What suggestions would he make to Farmer? 

If Farmer’s primary use of this agent-based model seeks to only design policies to address significant social issues, Friedman and Hayek might question its efficacy. However, if it is possible to use his model to explore the net effects of securing property rights, improving legal systems, advancing stable money, improving capital markets, and more can we see Friedman and Hayek leaning into Farmer’s model? Might advocates of minimal intervention might nudge complexity economists like Farmer to explore the natural equilibrium a dynamic economy gravitates toward through free interactions to compare the findings to those generated by the more policy-oriented Keynesians? 

This leads me to ask one last question.  Can complexity models provide valuable insights to settle the debate about which serves society better – free markets with limited government or a government that tries to engineer policies? Making progress toward settling this debate would make great strides in helping reconcile different economic paradigms and highlight the need to understand how society is harmed or hurt by both market forces supported by decentralized systems as well as government policies produced in centralized systems.

 

Let’s hear what you think. Consider the following questions, and share your responses with us today.

1. After listening to the episode, do you agree that Farmer’s conversation with Russ Roberts give us reason to seriously reflect on the current state of economics, particularly how mainstream economists model and predict market behaviors and identify trends?  Explain your answer.
2. At around 22:26 in the podcast, Farmer illustrates how complexity economics integrates more realistic and nuanced aspects of human behavior into agent-based modeling (ABM), as seen in the setting of housing prices through aspiration-level adaptation.  Contrast this ABM approach with the representative-agent decision-making used in instantly clearing market adjustments in response to disturbances or disequilibrium.
3. At around the 24:00 mark, Farmer discusses with Roberts the differences between the work of complexity economists and econometricians; how do the advantages and disadvantages of each approach compare and contrast, particularly in the context of the 2008 Financial Crisis?
4. Why does Farmer argue that the heterogeneous approach of complexity economics, complemented by big data and advanced computing to capture real-world dynamics, represents a significant advantage for mainstream economics in recalibrating how consumption, savings, and investment behaviors are modeled, particularly when taking into account demographics, income differences, random behavior adjustments, and other factors?
5. Considering the claimed benefits of complexity economics in making economic models more clear, widely applicable, and capable of assessing the direct and indirect effects of policies, how did this approach prove useful during COVID in the United Kingdom?  Take a look at the skepticism expressed in the posted comments on this topic. In light of this model’s experience with the U.S., what would your response be to further the discussion? 
6. Complexity economists like Farmer places considerable trust in the government’s ability to strategize and implement policies without falling prey to special interests, shortsightedness, or low-information voting. Can this framework be used to take into account and investigate policies that increase economic freedom? 
7. To what extent can the complexity economics approach to modeling the world be used to help settle the debate on which is better for human flourishing – economic freedom or central-planning through policies?

 

[Editor’s note: Don’t miss Ferrarini discussing Farmer’s book with David Henderson and Arnold Kling in this episode of our From the Shelf series.]

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