What is an economy?

It seems a basic question with a not-obviously important answer, but in fact, answering it is critical and completely changes our perspective on how economic systems work.

What is an economy? It seems an innocuous question right? As in, “surely we’d know, and by the way, how could that possibly be important?”

Well… Actually, no, it’s not an easy question to answer, we economists haven’t ever really answered it or really even given it that much dedicated thought (on the whole), and the answer is really important.

If business doesn’t know the nature of the system it’s doing business in, it stands to lose a lot of money. If the government doesn’t know the nature of the system it’s trying to work with, it stands to create a lot of problems for a lot of people.

The economy is a complex evolving network of individuals acting on the basis of their psychology and social position. Outcomes are contingent on position, behaviour is complex and intricate, both mutable and immutable because it’s driven by psychology, and small local changes can multiply across the network into massive global ones. Pretending the economy is “as if” it’s simple without particular regard to what “it” actually is is a hubris which can lead to spectacular nemesis.

Tony Lawson and Ludwig Wittgenstein: get your picture right or you won’t see clearly

Tony Lawson, an academic at the University of Cambridge (the birthplace of modern economics) made himself quite a name by pointing out a rather significant elephant in the room. He espoused, and proceeded to act upon, what is actually, once you think about it, a really rather common sense idea: economists should study what the economy actually is in order to understand it.

Isn’t that what economists do? Well… no, not really. When it comes to the economy, we think a lot about how to model it, but don’t really give much consideration to the nature of the “it” we are modelling. For very good reasons (namely, we didn’t used to have the tools to do otherwise), we study the economy not as it actually is, but as if it were something else. Economists on the whole actually study the economy as if it were a physical system.

“Neoclassical” models of economies are all derived from literally the mathematics of eighteenth-century physics applied to modelling economic systems. “Energy” becomes “utility”, “spacetime” becomes “commodity space”, a particle minimising its energy gradient in space becomes a human maximising their utility in their choice of commodities and so on… The model derived thus gives the impression the economy is like one big machine settling into an equilibrium flow of water/electricity between two chambers/diodes (goods and services flowing between supply and demand).

There’s a problem with this. The great French thinker Michel de Certeau taught us that language, language like a mathematical model, constrains the very way we “read” (“make sense of”) the world. Wittgenstein showed us why in the core of his philosophy: symbols and their relations present to us a “picture” of the world. Language presents us with a picture of the world — the objects in it and their relation — much in the way as does a piece of art or a photograph.

If our picture doesn’t represent what some “A” actually is, but only represents it in terms of some “B” it is thought to be like, it must obscure the aspects of A which aren’t like B. If the economy isn’t just like a physical system, neoclassical models of economies which represent it as such will obscure from our vision any aspects of an economy which aren’t just like a physical system.

The Brisbane Club: economies are complex evolving network systems

The economy clearly isn’t just like a physical system. Human beings have internal motivations, they have agency, and they aren’t all directly connected to each other in a space akin to an electromagnetic field. But then, what exactly is the economy?

One of the singular contributions of the “Brisbane Club” of economists clustered around John Foster and Jason Potts at the University of Queensland in the first decade of the 21st century was to develop a remarkably coherent and intuitive answer to the question “what is an economy”:

An economy is a complex evolving network of individuals following behavioural rules.

That isn’t obviously profound to the uninitiated so let’s break it down a little more. An economy is a network, in which the nodes are individual people, and the connections between them the exchange of goods and services and money and information. If you ever want a really great exposition of the idea you should read Herbert Simon’s classic (non-technical) paper: “Organisations and Markets”.

This network is clearly complex (just think, 7 billion people, all forming connections with each other), and it’s clearly evolving (because we tend to change our behaviour over time). And our behaviour is not like a particle minimising its use of energy, but rather much more like a computer checking off a list of questions before performing a task: “I’m going to the shop, I need to buy milk, bread and eggs”.

The vision was developed more at length in Kurt Dopfer and Jason Potts’ classic book The General Theory of Economic Evolution, and John Foster’s classic paper From Simplistic to Complex Systems in Economics. But to see why it’s important to understand that idea would take the development of a language, a language like a mathematical model, to give us a picture of the economy as a complex evolving network of individuals following behavioural rules.

The “UQ model”: painting the Brisbane Club’s vision

I am, in some ways, the last of the Brisbane Club. I’m not really even “of” the Brisbane Club, I’m really their student. But it fell to me to build the mathematical model, the language, which presents us a picture of the economy as it is. This is what I did, in the course of my research at the University of Queensland.

I made one refinement to the Brisbane Club vision, for while Kurt Dopfer makes a good argument that all human thought is about rule-following, I find it easier to think of it as simply psychology. So we ended up with a picture based on the reality that:

An economy is a complex evolving network formed by individuals acting on the basis of their psychology and social position.

What happens in an economy then, is that we find ourselves (for it is “we” who make up the nodes of an economic system) in a social environment (including economic networks) where we face a wash of information. Our psychology “filters” this information, literally sets electrical signals from our senses whirring off through our neural networks, to form our thoughts about our environment: conscious or subconscious.

It is these thoughts, either the application of rules or the constructing of mental “sentences” which comprise our knowledge, our understanding, of the environment we are in, and inform our actions by expressing our beliefs of how and why we ought to act in a particular way. Our actions of buying, selling, and making, the exchanging of goods, services, money and information form the connections which comprise the economy. Because our knowledge evolves, the network does too.

That is what an economy is, that is how an economy works.

Why it matters to get your picture right: you can lose a lot of money, and hurt a lot of people

All of a sudden, when we build a picture of what the economy actually is, we don’t see something like a big machine settling into an equilibrium flow of water/electricity between two chambers/diodes. We see a complex, intricate, at times violently chaotic network system where evolution is the norm, where equilibrium is the exception.

This matters. And it matters a lot.

For instance, the outcomes of actions depend on position. It is not enough to provide a good quality product at a reasonable price, a business or a person has to have a good position in the network to be able to access a lucrative cluster of economic connections.

The Australian financial service industry provides a good quality product at a reasonable price, but it is headquartered in Sydney, an eight-hour flight even from Singapore. A business plan or a policy which aims only to ensure a good quality product at a reasonable price without a (literal) positioning strategy is left to the vagaries of chance.

For another instance, human behaviour is complex and intricate, there is no getting around this. The complexities and intricacies of the way that human beings think means that behaviour is both mutable and immutable. In some respects human beings will change their behaviour drastically in response to the slightest change of environment, while in others they will cling to their habits in the face of the direst consequences.

Some people keep smoking and drinking in the face of exorbitant taxes and massive information campaigns who would stop eating vegemite or drinking Coca-Cola over a few cents price rise or a slight change of packaging. To pretend otherwise is as sure-fire way to lose money (by a misjudged pricing/branding campaign) as it is to implement policy with unintended consequences (taxing the poorest without changing their behaviour).

For one final instance, small changes in one small locale of an economic system can quickly multiply across the network into violent changes all across the system. A small change of behaviour on the part of a single individual can change their neighbours’ behaviour, which affects their neighbours’ behaviour and so on until the whole economic system sees a surge of connections made or an utter collapse and withdrawal. This is sometimes called the “butterfly effect”.

Some loans not being repaid in Florida can cause a near wholesale collapse of the entire global economy. A university dropout can build a service in his dormitory to which one billion people will eventually subscribe. If this aspect of the economy is obscured by our models, one cannot honestly claim to understand the Global Financial Crisis or the rise of Facebook.

And this is actually only scratching the surface.

That is why it matters to know what the economy is. Knowing that with which one deals is not a philosophical question for pondering after supper before bed, it is a desperately practical question upon which hinges the success or failure of all forms of human enterprise.

Brendan Markey-Towler

Written by

Researcher in psychological and technological economics at the School of Economics, University of Queensland, Australia

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