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October 05, 2009


Steve Flinn

In my view many of the current crop of market critics are actually falling into the same trap as the economists of the past that they criticize -- they are artificially bounding their "models," ignoring the exogenous variables as if they don't exist, but still exuding confidence that the models have reasonable predictive power.

This error in thinking is manifested by on the one hand rightly viewing markets as a complex adaptive system, but then somehow viewing government as a fixed, exogenous variable that will constitute that eminently rational "economic man" that we desire. That's foolhardy thinking. The reality is governments are also complex adaptive systems, and it cannot be predicted exactly how they will evolve any more than we can predict business cycles with any accuracy (although couched in different terms, this was Friedman's key issue).

Rather than artificially focusing just on the economy per se, and on short-term events, I think history is much more instructive when looking holistically at the dynamics of government plus economic performance over long periods of time. So throw in the experiences of the Soviet Union, Latin America, Britain, Sweden, etc., as well the USA, and over a century or more to get a sense of the relative merits of combined complex adaptive system of government plus markets.


That's as good a summary, interpretation and presentation of Krugman's article and the debates as I've read. Well done. That's both as someone with an MA in economics and who's been publishing a newsletter which covers the economic situation for almost five years now with a track record of being reasonably accurate. Forgive the ad hominem appeal to authority but at the end of the day the question is what works. The key here is understanding business cycles and the the role of financial markets therein. Unfortunately while a rich area of research the profession came up to the cusp point in the late '70s where it was recognizably dealing with a complex, dynamic system that was out of equilibrium and needed new concept,tools and math to analyze. After trying, failing and giving up they fell back on pure micro-foundations and stunted macro to fit aggregable models; which don't work. One of the pillars of Keynes thinking was that macroeconomies don't follow the simple rules of local behavior - an insight which dates back to Marshall, Robertson, et.al. Marshall in fact compare economics to a biological science. Some good, pragmatic reading is Ellis' Ahead of the Curve, Mike Lehman's Guide to Being Your Own Economist and Mankiw's Intermediate Macro text is outstanding. And a saltwater synthesis for students. My bittersweet joke about economics and its mothership is that they are the largest experimental sciences around because they use whole societies for field test; a sort of agricultural experiment station. The implicit point is that getting this right is important.
NB: on Steve's point about institutional arrangements cf. Douglas North, particularly his earlier work on Structure and Change combined with Mancur Olson's Power and Prosperity.
Keep up the good work and keep proselytizing - we are literally debating the future course of society on the planet, at least IMHO.

Kymus Ginwala

Having studied economics only as an engineering student with Samuelson as the textbook, I became a fan of the subject after after I read Levitt. It seems that the subject should be taught as "behaviorial economics" or no other?

Henry Engler


Thanks very much for your insightful thoughts and summary of economic thinking over the years.

In this latest episode I think what is at stake is an understanding of what our financial system should and should not do -- in other words, as a key service sector of our economy, it's primary role should be to faciliate the flow of capital between those who have it and does who need it. This is a very traditional -- some might say antiquated view of modern finance -- but in essence the intermediary role of finance, bringing owners of capital with borrowers is the core of this business.

Unfortunately over time, as technology has made this intermediary role less profitable -- computers can now match buyers and sellers almost immediately -- the traditional "agency" role of financial firms, particularly among the larger ones, became less attractive.

What emerged was a diversification strategy into more speculative, or shall we say, proprietary business models. Put simply, many large institutions diversified their business models into areas where both leverage and risk was enhanced and allowing their fiduciary responsibilties to take a back seat.

I think one of the core lessons in this latest crisis is perhaps understanding why there was a Glass-Steagall Act to begin with -- the separation of banking from these more risky activities.

I also think, and would certainly welcome your thoughts, on what role you think non-financial institutions should play in lobbying Congress for better regulation of this important sector. We have heard time and again of the influence of Wall Street because of its deep pockets and ability to steer legislation to its liking.

What we do not hear, however, is how large and small non-financial firms, who ultimately bear a cost from such financial engineering, might have a voice if they acted together. Let's not forget that this current recession was manufactured largely by the business decisions on Wall Street. It's ramifications to non-financial companies has been considerable and I believe collectively they should make their case before Congress, underscoring the need for a financial system that is there for the collective good of the larger economy.

Best regards

Henry Engler


Small Business owners are largely forgotten. Thats why I only focus on them. I have experience several members of my family file bankruptcy due to small business failures. I also I suffered through 2 destroyed businesses due to failure however, in my failings I have learned some of the secrets to success. (Who can say they know it all?)


cabernet reserve

A year's output is the value of goods and services produced over that year, while equity values reflect the (discounted) value of all future streams of profits. If you are comparing the two, you must at least have a sense of what a decent benchmark for comparison would be.

So if, say, half of GDP originates in the corporate sector and profits are one-third of value added, the present value of profits discounted at a continuous rate of 8% amounts to 208% of GDP (=0.5x0.33/0.08). This suggest that the value of stock markets should be more than double that of annual output, not the mere 10 percent extra that the above numbers suggest. Planet Finance is not all that huge after all--at least given the numbers we are presented.

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