Young Economics.

The Changing Nature of Perception

with 2 comments

Here’s an article on the evolutionary nature of our economic system and understanding (link).

This type of thinking really fascinates me.  In general, each day we step out into the world with pre-formed beliefs and values that lead to our perceptions of truth and the actions we take.  But that night when you go to bed, you think about your experiences that day and process all the new things you’ve learned.   You re-evaluate how you see the world and yourself, and your idea of truth shifts.

It’s hard to see this happening on a day-to-day basis, but think back a few years.  Don’t you have a bunch of memories of behaving in a way that just seems so stupid now?  Don’t you wish you could go back and do it again knowing what you now know?

This is the essence of our species; we learn.  But this is also what makes predicting where we’re all heading that much harder.  When an economist comes out with an insightful explanation about how the world works, he’s celebrated for giving us a better understanding of what society is all about.  The only problem is everyone takes this new piece of information, processes it, and begins to behave differently than they did before.

Here’s a nice excerpt from the article:

The problem is that, no matter how “scientifically” these new beliefs were formulated, they are still false. Capitalism is, among other things, a struggle between individual people over the control of scarce resources. Like boxing and poker, it is a soft, restrained, private form of warfare.

Military strategists have known for centuries that there is, and can be, no final science of war. In a real struggle over things that actually matter, we must assume that we are up against thinking opponents, who may understand some things about us that we don’t know about ourselves. For example, if profit can be made by understanding the model behind a policy, as is surely the case with the models used by the United States Federal Reserve, sooner or later so much capital will seek that profit that the tail will begin to wag the dog, as has been happening lately.

The truth is that such models are most useful when they are little known or not universally believed. They progressively lose their predictive value as we all accept and begin to bet on them. But there can be no real predictive science for a system that may change its behavior if we publish a model of it.

Markets might once have been fairly efficient, before we had the theory of efficient markets. If investing is simply a matter of allocating money to an index, however, liquidity becomes the sole determinant of prices, and valuations go haywire. When a substantial fraction of market participants are simply buying the index, the market’s role in ensuring good corporate governance also disappears.


Written by jk

April 5, 2009 at 11:24 am

2 Responses

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  1. Wow, so maybe I’m a bit hung-over, but I thought Mr. Cloud’s article was terrible. First off, the author’s a Philosophy teacher at Princeton who has worked at some hedge funds. His article is generally factless and ill-defined. It reminds me a Phil undergrads that would ask “but why does 1+1=2?”.
    -On the broad arch, he’s beating a straw man. Who really thought that we had “finally devised a set of scientific tools that could really predict human behavior”? Nobody that I’ve met, read, or heard about.
    -He makes baseless and unsupportable claims such as, “almost every observation that economists make turns out in a way that wasn’t predicted”.
    -When he says “models are most useful when they are little known or not universally believed”, I must refer him to any basic textbook on monetary theory since 1980 where the government tries hard to tell people how it does and will react. You’ve got a weak model if it only works in obscurity.
    -“Moral hazard, we thought, could safely be ignored, because it is “moral,” which, as every true scientist knows, just means “imaginary.”” The government is quite aware of moral hazard, and it would be remiss to not weigh it against other issues.
    -“The banking system is probably already past saving.” Yes I too think that all of capitalism has come to end. Good thing I’ve been cultivating my beet farm.

    On the whole I don’t think he knows that Economists already understand that models, by definition, are false (thought useful).


    April 5, 2009 at 7:59 pm

  2. I’m with you in some respects Brian.

    I think he is way off in his criticism of economic modeling. I agree that no economist thinks their model will solve the world. It seems like this is the complaint I see most often about economists, and the one which holds the least water.

    But I think there is some truth to his idea that obscure models work better. You’ve got to remember this guy is coming out of the hedge fund industry. Imagine you are some hotshot and find some new mathematical algorithm that directs you towards an asset class primed for high returns. With one user, the model lets you enjoy great results. But if everyone got their hands on the methodology, then everyone would see the opportunity at the same time, pour their money in earlier, and take away the chance of the abnormal profit.


    April 5, 2009 at 9:13 pm

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