The Economics Book

278

THE ECONOMY IS

CHAOTIC EVEN WHEN

INDIVIDUALS ARE NOT

COMPLEXITY AND CHAOS

N

o system yet discovered

guarantees a good return

in the stock market. One

might have hoped that economics,

with its theoretical models in which

the economy always reverts to an

equilibrium, would give us such a

tool. Most economic theory is

modeled on the laws of motion

developed in the 1680s: every

action leads to an outcome, and

every event is linked in a causal

chain backward and forward in

time in what is called a “linear”

process. Standard economics

builds its large-scale predictions—

the equilibrium that an economy

will arrive at—from the combined

effect of the behavior of rational

individuals reacting to prices.

Looking for complexity

If the real world does indeed

behave like this, why do we find it

so hard to predict stock market

crashes? Some economists feel

the entire linear approach is

obsolete. Austrian economist

Friedrich Hayek (p.177) believed

that economics is far too complex

to model in the same way as

physics. One response to such

doubts is complexity theory,

which emerged from the work

on thermodynamics of Russian-

Belgian chemist Ilya Prigogine

(1917–2003). Unlike standard

economics, this approach

recognizes that predictable,

regular actions by individuals

do not necessarily lead to a

stable, predictable economy.

In 1975, French economists

Jean-Michel Grandmont and Alan

Kirman argued that economies are

“complex systems.” In standard

economic models of perfect

competition individuals do not

Tiny changes in initial conditions can

cause large changes in outcomes. This

is known as the “butterfly effect:”

Edward Lorenz’s suggestion that a

butterfly flapping its wings in Brazil

could lead to a cyclone in Texas.

IN CONTEXT

FOCUS

The macroeconomy

KEY THINKERS

René Thom (1923–2002)

Jean-Michel Grandmont

(1939 – )

Alan Kirman (1939 – )

BEFORE

1887 French mathematician

Henri Poincaré’s analysis

of the interaction between

three bodies orbiting each

other lays the foundation

for chaos theory.

1950s French mathematician

Benoît Mandelbrot finds

recurring patterns in the

variation of cotton prices.

1960 US mathematician and

meteorologist Edward Lorenz

discovers the butterfly effect

in meteorology.

AFTER

1980s Northern Irish

economist Brian Arthur

develops complexity theory.