Guest Post 2: Blue Aurora on Econophysics

This is Blue Aurora's second installment. It's worth pointing out that his first post elicited some other commentary in the blogosphere. Gene has a humorous treatment of uppity physicists here. Jonathan goes into some Austrian critiques of economics as a predictive science, and the relevance of this point for econophysics . Regular readers know I agree on this point - that I like to think of economics primarily as an explanatory science, just like any study of a complex system.

There was some comment section discussion of statistical distributions that I was unfortunately not able to participate in. I think the point that a lot of people who criticize assumptions of normal distributions miss is that a lot of what they're talking about are assumptions about normally distributed parameter estimators. As far as I am aware, we can assume these estimators are normally distributed - they are random variables themselves, after all. That's a very different proposition from assuming that whatever distribution these parameters contribute to are normally distributed. An estimator for a mean is going to be normally distributed regardless of whether the distribution that generated that mean is normally distributed or not. Anyway - on to Blue Aurora

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MOVE OVER, MANKIW, KRUGMAN, AND BERNANKE

Why do I list this cast of economics characters? Because whatever your strand of economic thought, be it Austrian, Feminist, Old Institutionalist, New Institutionalist, Market Monetarist, Neoliberal, Post-Keynesian—do call yourself what you like—but the bottom line’s the same: There’s a new show in town, and it’s dangerous.

Picture, if you will, the orthodox citadel under assault by a bunch of physicists armed with a concentration in statistical mechanics (not to mention a knack for “non-stationary increments”) and Mandelbrot’s fractal geometry. Robert Lucas attempts to draw out his eponymous Critique. It proves futile, as the econophysicists point out that Lucas had erred in his conclusion from a “scientific standpoint” (see page 224 of “Dynamics of Markets: The New Financial Economics” by Joseph L. McCauley). Bernanke doesn’t take long to bow thereafter. Why hasn’t this scenario happened yet? Two simple reasons—the lack of widespread knowledge, and the fact that the econophysics project hasn’t grown that strong just yet.

So far as I have been able to tell, the econoblogosphere hasn’t commented extensively on the so-called “econophysicists”. This is in spite of the fact there is a dedicated blog on econophysics at an econophysics forum, econophysicists who are based at respectable institutions (for example, Jean-Philippe Bouchaud teaches at École Polytechnique), and even the occasional media mention in the movement’s fifteen years—for instance, in a 2005 article on The New York Times and in the Sept/Oct 2009 issue of Adbusters. Okay, there’s Cosma Shalizi’s little rant at Three Toed Sloth, the Gallegati-Keen-Lux-Ormerod “Worrying Trends” paper in Physica A, and Jean-Philippe Bouchaud’s article in Nature. Leading econophysicists Imre Kondor and Rosario N. Mantegna have received grants from the Institute for New Economic Thinking. The Austrian School-sympathizing scholar of quantitative finance, Nassim Nicholas Taleb, has referred to leading econophysicists Dr. Didier Sornette and Dr. Jean-Philippe Bouchaud, in his popular works. Of course, with the instrument that is the World Wide Web, in due course the econophysics project will receive more attention—but for the moment, they have not.

Here and there, they have been referred to on the blogosphere—see the March 3, 2011 entry on online blogger Lord Keynes’s website, “Social Democracy for the 21st Century: A Post Keynesian Perspective”, for instance, and Robert Vienneau’s July 13, 2006 entry. I’ve also encountered some comments on the forum of the Ludwig von Mises Institute. Why is the commentary so dispersed and not so frequent, despite the World Wide Web? A culture clash between the econophysics project and the economics profession is one reason. So would the youthfulness of the econophysics project (only being fifteen years old!), the fact that the natural sciences and social sciences have been interacting for the past two centuries aside—Jan Tinbergen studied physics at the undergraduate level, and so did Paul Samuelson, but there is something different from these previous translations of phenomena in the natural sciences into the social sciences. I figured there was something different to them once I read the article referenced in the bibliography of a post written by Lord Keynes of Social Democracy for the 21st Century.

Lord Keynes refers to a July 2009 article published in Elsevier-owned “Physica A: Statistical Mechanics and its Applications” called “Economic Uncertainty and Econophysics”, written by one Christophe Schinckus. Three renowned economists that touched upon uncertainty covered in the subject of the article were none other than John Maynard Keynes, Friedrich A. Hayek, and Frank H. Knight. Schinckus claims in his article abstract: “By presenting econophysics as a Knightian method, and a complementary approach to a Hayekian framework, this paper shows that econophysics can be methodologically justified from an economic point of view.” I strongly feel that the econoblogosphere needs to discuss this issue in much greater frequency.

Thus far, it has been rather dispersed and all over the place. However, in my quest to learn how my fellow bloggers would make of econophysics, I prodded around and linked to the econophysics forum. One blogger had an initial reaction that indicated some amusement and flippancy: “What does economics have to do with physics? Sounds like a revival of Comte.”

Not taking it seriously initially, I then linked to Jean-Philippe Bouchaud’s article in Nature. He
proclaimed that “In short, [Bouchaud] doesn’t know what he’s talking about.” Then he cited “The Epistemological Problem in Economics”, an essay by Ludwig von Mises, to counter Jean-Philippe Bouchaud’s essay. I countered that the econophysicists have listened to outside criticism referring to the Gallegati-Keen-Lux-Ormerod paper) and have made an impact on finance. As of this writing Jean-Philippe Bouchaud is still the editor-in-chief of the journal Quantitative Finance. Dr. Bouchaud’s methods have set a precedent. Future financiers will have to listen—and
following the example of the econophysics project, adopt an empirically-based approach that rejects a priori theorizing, but stand up in the face of a financial crisis.

It was at this point In the following interactions I had with him, the Austrian School disciple, Jonathan Finegold Catalan, pointed to the “lack of controlled experiments” that “distinguishes physics from economics”. But there is a lack of controlled experiments in astrophysics and geophysics, and they are considered empirical sciences! Observation, as Catalan should know, is a part of the scientific method. Going by Catalan’s logic, astrophysics and geophysics would be unscientific. What makes econophysics scientific? The techniques of the econophysics project have yielded solid results. While predictive power is obviously secondary to explanatory power, what Dr. Bouchaud, Dr. Stanley, and their colleagues have been doing seem to hold up! The techniques of statistical mechanics are designed to analyze and describe non-linear, random processes. Human decision-making processes are non-linear and non-additive, as demonstrated
by the works of cognitive psychologists and countless other scholars. The techniques of statistical mechanics so far, hold up. The explanatory power of the econophysics project may well prove more fruitful than current methods. But enough with the turf wars over method. I suspect that economists could use an even bigger toolbox if they are to avoid being completely falsified by the
econophysics project.

Heterodox economists Mauro Gallegati, Steve Keen, Thomas Lux, and Paul Ormerod are a few economists who have engaged the econophysics project. All four of them have published in Physica A. But engagement of the econophysics project doesn’t have to begin at the fringe (see the special issue in the Journal of Economic Dynamics and Control mentioned above). John Sutton, a scholar at the London School of Economics and Political Science, is one of the few orthodox economists aware of the econophysics literature. So there is still time for the economics
profession to cooperate with the econophysics project and ultimately, learn. Unless of course, Dr. McCauley and Dr. Bouchaud have their way, Brad DeLong and Scott Sumner wouldn’t be debating estimates about the multiplier effect anymore. There wouldn’t be debates between the New Classicists and the New Keynesians. Instead, according to the world of Dr. McCauley and Dr. Bouchaud, both Sumner and DeLong shall be relegated to the role of Ptolemaic astronomer. Dr. McCauley accuses Keynesianism and Monetarism of becoming “ideologies”.) And it seems that the econophysicists—with their Mandelbrotian-Osbornian-statistical mechanical analysis—have the tools to potentially falsify virtually all of economics. One way to deal with this problem would be to take all of the Great Moderation Consensus to aggressively critique and attack the econophysics project. But I feel that reaching out to the econophysics project en masse will have a far more positive effect, and prevent economics from being falsified completely.

For somewhere beneath the acerbic stance taken by the more outspoken econophysicists like Dr. Bouchaud and Dr. McCauley, there just might be a point lying somewhere from which a new economics can evolve.