By Paul Ormerod
I have been interested in this for some years, and here is a paper I published on Keynes, Hayek and complexity.
Both Keynes and Hayek retained the concept of equilibrium in their models. But their theories describe what happens when – which is most of the time – the economy is out of equilibrium, possibly a considerable distance, as happened in the Great Depression of the 1930s.
Complex systems have several key features:
Emergence means that observable properties of a complex system at the aggregate, overall level emerge from the interactions of its constituent parts. So the theory of any complex system requires a theory of how the individual component parts behave.
Hayek’s major general contribution to social science was to emphasise the limits to knowledge in social and economic systems – the limits to knowledge of all agents, including finance ministries and central banks.
His 1974 Nobel lecture, for example, is entitled ‘The Pretence of Knowledge’. In it he writes, along with much else, that ‘the social sciences, like much of biology but unlike most fields of the physical sciences, have to deal with structures of essential complexity, i.e. with structures whose characteristic properties can be exhibited only by models made up of relatively large numbers of variables’.
In essence Hayek’s view as to why the business cycle exists is first, that agents have different expectations about the future; and, second (partly in consequence of the first) agents find that outcomes differ from their expectations, and revise their actions as a result.
So in his 1937 article ‘Economics and Knowledge’, for example, Hayek writes that ‘It appears that the concept of equilibrium merely means that the foresight of the different members of the society is in a special sense correct. It must be correct in the sense that every person’s plan is based on the expectation of just those actions of other people which those other people intend to perform and that all these plans are based on the expectation of the same set of external facts, so that under certain conditions nobody will have any reason to change his plans’.
He argued that such individual plans might indeed have to be revised by external shocks. But, more importantly, the individual plans may not have been, indeed are unlikely to have been, compatible from the outset, so that revisions are inevitable. This relates to the concept of reflexivity and the inherent inability of agents to co-ordinate their actions and expectations.
It is the interactions between agents, this time in terms of the incompatibility of their individual plans, which brings about the particular macroscopic outcome for the system as a whole – the business cycle and recessions.
Hayek was a true precursor of modern complex systems theory.
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