Fractal Economics is the New Economic Paradigm

Fractal Economics is giving economics it’s “Copernican Moment.”

Two things are historically clear: 1) We use tools to help us control the world around us.  2) The tools we use are constantly evolving into better tools.  The hammer evolved into the power nailer.  Telescopes evolved from a single lens to multi-mirrored space platforms.  Communication tools evolved from storytelling, to cave paintings, to clay tablets, to paper, to the printing press, and to the Internet.  Computing tools evolved from the abacus to quantum computers.

It is not so much that the prior tools did not do the job anymore.  Rather, the new tools do the job better, faster, and/or cheaper.  The change always starts out slow in the beginning but rapidly accelerates when it finally becomes clear that the current ways of thinking are inadequate and a new way of thinking enables us to make much better make better predictions of our world.

The great thing is we have a lot of documentation about how this change occurs.  Books have been written about it and thinkers have been writing about it from the beginning.

Perhaps the best historical quote I could offer is Macheville: “It must be remembered that there is nothing more difficult to plan, more doubtful of success, nor more dangerous to manage, than the creation of a new system. For the initiator has the enmity of all who would profit by the preservation of the old institutions and merely lukewarm defenders in those who would gain by the new ones.”

Copernicus and the Change from Earth-Centered to Sun-centered solar system

While there are many examples I could use to illustrate the evolution of the tools we use to see the world, (the printing press, gunpowder, the internal combustion engine), I chose to use the evolution from an earth-centered solar system to a sun-centered solar system.  This was the evolution from Aristotle’s cosmology and Ptolemy’s astronomy, to Copernican astronomy.

Here is the way Dennis Snower describes it in his essay “Economics Nears a New Paradigm.”

Up to the 16th century, the conventional wisdom on astronomy conformed to Aristotle’s cosmology and Ptolemy’s astronomy. In Aristotle’s system, the earth is the center of the universe and the heavenly bodies are part of spherical shells of aether. These shells fit around one another in a clear order: Moon, Mercury, Venus, Sun, Mars, Jupiter, Saturn, and the fixed stars. All these spheres are put in motion by the Prime Mover. By the 16th century, Ptolemy’s astronomy was regarded as in accord with the conventional reading of the Bible, the ultimate source of all knowledge.

Ptolemy’s system encountered endless difficulties in accounting for the empirical evidence, which were addressed through the repeated application of geometric “fixes” (eccentrics, epicycles, and equants). The underlying methodological requirement was to retain the Aristotelian system as the foundation for our understanding of the universe and then to depict each “fix” as a divergence from this accepted foundation. Thus, to be taken seriously as an astronomer, it was necessary to master the Aristotelian and Ptolemaic systems and to develop superstructures on them. Copernicus did not follow this intellectual path, but he did not dare to publish his heliocentric theory until the year of his death, in 1543. In 1632 Galileo published a book supporting Copernicus’ heliocentric theory, was summoned before the Inquisition, and recanted. The Church had the hard power of the Inquisition and the soft power of scholastic theology on its side.

Current Economic Thought

(From Economics Nears a New Paradigm.)

  • Microeconomics:
    • Individuals are the only units of functional organization relevant to economic decisions. The economic activities of social and political groups are merely the sum of their members’ activities. Thus individuals are the only unit of selection, i.e. the success of an individual depends only on the characteristics of that individual. Methodologically, we have the claim that social phenomena must be explained by individual actions, which in turn must be explained by the decisions of individuals. This is the doctrine of methodological individualism.
    • In neoclassical economics, consumption is the ultimate source of wellbeing. In other words, the “utility” of individuals depends, either directly or indirectly, on what they themselves consume. In behavioral economics, this axiom has been relaxed to allow for “social preferences,” whereby an individual’s utility may depend on the consumption of others.
    • Individuals are “rational actors.” This means that each individual’s decisions can be explained in terms of maximizing utility subject to constraints (such as a budget constraint).
    • This utility can be represented by a preference function that is complete (it covers all the individual’s objects of choice) and transitive (if A is preferred to B and B is preferred to C, then A must be preferred to C). The individual’s choices “reveal” her preferences, which implies that the preference function must be temporally stable at least for long enough for such preference revelation to take place. Behavioral economics relaxes this axiom to allow for preferences that depend on reference points (such as the status quo), loss aversion (more weight given to losses than gains), and differences between experienced utility (the source of wellbeing) and decision utility (the objective of decision making).
  • Macroeconomics:
    • An economic market can be understood in terms of the demand for and the supply of goods in that market, which depend on the prices of these goods. In “perfect” markets (characterized by perfect information, perfect competition and no externalities), the price adjusts to equate demand and supply.
    • Once this adjustment has taken place, the market is in “equilibrium,” which means that there is no tendency for any further change.
    • Under “market imperfections” (imperfect information, imperfect competition, and externalities), markets may tend towards an equilibrium in which they do not clear. In such an equilibrium, for example, labor supply may permanently exceed labor demand.
    • When all markets have reached their equilibrium, then the economy is in a state of “general equilibrium,” in which the entire economy experiences no further change.
    • Macroeconomic activities can generally be understood as aggregates of market activities in the general equilibrium.
  • Knowledge:
    • Individuals understand their environment imperfectly. Rational agents obey the axioms of probability. This means that they know the set of all possible events; they can assign a probability to each event; every event has a probability of at least zero; the probability of all events is 100%; and if the events are unrelated, then the probability that either of the events happens is equal to the sum of the probabilities that each event happens.
    • Economic events can be understood through the application of econometrics (i.e. statistical theory, based on probability theory).

A major implication of these axioms is that under “perfect” market conditions, the general equilibrium is efficient, so that no one can be made better off without making someone else worse off. This is the basis for understanding Adam Smith’s Invisible Hand, whereby the selfish activities of uncoordinated market participants serves the public interest. It is also considered the basis for understanding why the capitalist system has been so successful in delivering high and growing living standards.

Unless you accept these basic axioms and the Invisible Hand implication, you will not be taken seriously as an economist. This is important since economics is particularly influential among policymakers, economic commentators, and the general public — far more influential than the other social sciences.

Fixes That Fail

As with the Ptolemy “fixes” economists “fix” the discrepancies, between the predictions of this system and their empirical observations,  as a divergence from the accepted foundation.

They recognize that the paradigms they suggests results that differ from empirical evidence.

Snower says it this way:

Behavioral economics began as a compendium of “anomalies” that the neoclassical system could not explain. Some of these anomalies have been addressed by behavioral theories such as prospect theory or social preference theory, but many have not. Different theories explain different anomalies; there is no overarching theory to explain them all. And since behavioral economics is devoted primarily to individual fixes, it has retained many of the basic axioms above, such as methodological individualism, consumption as central for wellbeing, understanding economic events in terms of probability theory and the tendency toward equilibrium. However, these axioms are also open to question.

Regarding methodological individualism, who says that the individual is the only level of selection? After all, Homo Sapiens owe their evolutionary success largely to their ability to cooperate with one another, in larger number than other mammals.

Regarding consumption as central to wellbeing, who says that our material appetitive needs dwarf our social needs, such as the need to care and be cared for, or the need to belong to a community, or the need to shape your fate through your own efforts?

Regarding our ability to understand economic events in terms of probability theory, who says that we can imagine all conceivable future states of the world and that we can assign probabilities to each of them? After all, many of the most important events that young people look forward to in the future — whom they will marry, where they will live, what jobs they will get, how much they will earn, what their state of health will be, when they will retire, how long they will live — are simply unknown unknowns.

Not only has the neoclassical system encountered endless discrepancies between predictions and evidence and thus has accumulated endless fixes, but it also has had little success in addressing the great economic questions of our time. For example: If the free-market system is meant to satisfy our needs efficiently, why is it despoiling our environment? Why is it generating inequalities and other inequities that threaten the social cohesion of our societies? Why does it leave so many people economically insecure, vulnerable to unemployment and trapped in dead-end jobs? Why does it not correct for the excesses of consumerism, workaholism and digital addictions, frequently leading to anxiety, depression, burnout, substance abuse and crime? Why is it giving us so little guidance in promoting public compliance with social distancing rules during the Covid-19 pandemic, even though such compliance has economic causes and consequences? Why does it keep so many businesses focused on short-term profit and shareholder value, even though so many business leaders are genuinely concerned about the environment and the wellbeing of their customers and employees?

Fractal Economics

For those that are paying attention, there is a new world view – Fractal Economics.  Fractal Economics is Economics Copernican Moment.

We are gradually reaching the same sort of stunning realization that Copernicus must have reached before writing his revolutionary book “On the Revolutions of the Celestial Spheres”:  All the “fixes” needed to make Ptolemy math explain empirical observations, can go away if you use Copercian math.  Additionally, using Copercian math allows for a major new leap in our understanding?

Fractals suggests our natural world can be understood in terms of variation, replication, and selection.

Snower suggests the following:

The evolution of ideas can be understood in such terms as well: new ideas keep cropping up; they are transmitted from person to person; and the ideas that get selected to survive are often to be ones that enable us to navigate our environment most effectively. Selection can act not only on individuals, but also on groups. “Selfishness beats altruism within groups. Altruistic groups beat selfish groups. Everything else is commentary.”(E.O. Wilson and D.S. Wilson (2007), “Rethinking the Theoretical Foundations of Sociobiology,” Quarterly Review of Biology, 82(4), 327-348) The level of functional organization thus depends on the relative strength of within- and between-group selection.

This is a different starting point from the one underlying mainstream economics. The discipline of economics is based on classical physics, i.e. the inanimate world. Evolution, by contrast, is appropriate to the animate world. Not a bad point of departure for economics. After all, humans are living creatures. If we choose this path, economics will be reaching its Darwinian – not Copernican – Moment.

This is why now is probably the most exciting and fruitful time ever to become an aspiring economist. The Dutch philosopher Erasmus famously said, “At the end, you will ask yourself: What have I made of my life? That wish you wish to answer then, do now.” Who would not wish to be alive and active at such a moment, when a great contribution is waiting to be made and there is no one around to execute you for it?