The Insupportable Equilibrium of Economic Thought; In one form or another, positive feedback lies behind almost everything that makes our world rich and surprising, changeable and dynamic, lively and unpredictable

The Insupportable Equilibrium of Economic Thought

Conjure an image in your mind: a pencil resting on a small table, perhaps next to a notebook. In what position did you imagine the pencil? Lying on its side, right? Why not upright, with either the eraser or the graphite tip touching the table and the rest pointing into the air?

In terms of strict physical forces, it’s possible to position a pencil this way. We never see it happen because even the tiniest vibration, from the rumble of someone tapping the table to a slight shift in air currents, will knock it over.

The upright pencil is in what’s called unstable equilibrium, a state of being that can exist if unperturbed, but that will change rapidly if given the tiniest shock from the physical world. By contrast, a pencil lying on its side is in stable equilibrium. Blow on it, even slam your fist on the table, and the pencil will stay in that position or bounce around momentarily and then go back to it.

Stable equilibria are generally more important than unstable, because things in such states stay there. Whether we’re thinking of forces affecting a pencil or the Dow Jones Industrial Average, we can expect something to remain near a stable equilibrium but to wander away from an unstable one. So whenever we consider a state of equilibrium, we’ve got to ask whether it’s stable.

Elegant Mathematics

For several decades, academics have assumed that the economy is in a stable equilibrium. Distilled into a few elegant lines of mathematics by the economists Kenneth Arrow and Gerard Debreu back in the 1950s, the assumption has driven most thinking about business cycles and financial markets ever since. It informs the idea, still prevalent on Wall Street, that markets are efficient — that the greedy efforts of millions of individuals will inevitably push prices toward some true fundamental value.

Problem is, all efforts to show that a realistic economy might actually reach something like the Arrow-Debreu equilibrium have met with failure. Theorists haven’t been able to prove that even trivial, childlike models of economies with only a few commodities have stable equilibria. There is no reason to think that the equilibrium so prized by economists is anything more than a curiosity.

It’s as if mathematical meteorologists found beautiful equations for a glorious atmospheric state with no clouds or winds, no annoying rain or fog, just peaceful sunshine everywhere. In principle, such an atmospheric state might exist, but it tells us nothing about the reality we care about: our own weather.

Outside economics, in areas such as meteorology, the biggest shift in scientific thinking of the last 50 years has been the movement to understand “out of equilibrium” systems. Consider tornadoes. The state of Kansas alone sees hundreds of them every year, and they come about through perfectly ordinary atmospheric processes. Warm, moist air sweeps in from the Gulf of Mexico, cold air descends from the Rockies, surface winds blow. All these events build on one another, and soon an ordinary gray sky becomes a violent, memorable twister.

More technically, we could say that the atmosphere is prone to positive feedbacks, which prevent it from settling into a nice equilibrium. As humans, we’re terrible at imagining how such processes work. Take a piece of paper and fold it, and then take that doubled paper and fold it again, and then again, 30 times in all. Actually, don’t waste your time. You’ll find you can’t do it because the result, if you did, would be about 70 miles thick. This is the power of positive feedback: Each step not only makes things bigger, but also makes them bigger more quickly. This leads to consequences far beyond our expectations.

Blind Spot

In one form or another, positive feedback lies behind almost everything that makes our world rich and surprising, changeable and dynamic, lively and unpredictable. It makes seeds sprout and grow into trees, matches burst into flame, and single cells divide and proliferate into living, thinking human beings. It drives political revolutions and new religions. Yet outside of these areas, an intellectual blind spot to the power of positive feedbacks still holds us back. Nowhere is this truer than in the science of human systems, in social science, and especially in economics and finance.

We’ll never understand economies and markets until we get over the nutty idea that they alone — unlike almost every other complex system in the world — are inherently stable and have no internal weather. It’s time we began learning about the socioeconomic weather, categorizing its storms, and learning either how to prevent them or how to see them coming and protect ourselves against them.

(Mark Buchanan, a theoretical physicist, is the author of “The Social Atom: Why the Rich Get Richer, Cheaters Get Caught and Your Neighbor Usually Looks Like You.” This is the first in a series of three excerpts from his new book, “Forecast: What Physics, Meteorology and the Natural Sciences Can Teach Us About Economics,” to be published March 26 by Bloomsbury. The opinions expressed are his own.)

To contact the writer of this article: Mark Buchanan at buchanan.mark@gmail.com.

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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