Irving Wladawsky-Berger

Economics After the Crisis

Last month, David Brooks wrote an OpEd in the New York Times on the evolution of modern economics: The Return of History.  Like so many of us, Brooks is trying to come to grips with the failure of economists, - many of whom have been so publicly famous and influential over the past several decades, - to anticipate a financial crisis of this magnitude.  “Some brilliant scholar has to write a comprehensive history of modern economics because the evolution of this field is clearly one of the most consequential things happening in the world today,” he says.

Brooks speculates that this modern history of economics will consists of five acts, starting with “ . . . the era of economic scientism: the period when economists based their work on a crude vision of human nature (the perfectly rational, utility-maximizing autonomous individual) and then built elaborate models based on that creature.”  Paul Krugman called such models, an “idealized vision of an economy in which rational individuals interact in perfect markets . . . gussied up with fancy equations” in a recent NY Times Magazine article, How did Economists get it so Wrong?

Act II is when “brave economists” started to question this idealized, abstract view of economics.  Such brave economists started to point out that people are not really perfectly rational and do not always make totally objective decisions.  Some human behaviors cannot simply be explained in terms of narrow self-interest, like having children and behaving altruistically.

Act III is the ongoing global economic crisis.  “This act is a climax of sorts because it exposed the shortcomings of the whole field.  Economists and financiers spent decades building ever more sophisticated models to anticipate market behavior, yet these models did not predict the financial crisis as it approached.  In fact, cutting-edge financial models contributed to it by getting behavior so wrong - helping to wipe out $50 trillion in global wealth and causing untold human suffering.”

This then brings us to Act IV, “the period of soul-searching that we are living through now.  More than a year after the event, there is no consensus on what caused the crisis. Economists are fundamentally re-evaluating their field.”  Brooks, then gives his prediction for how the story concludes:

“In Act IV . . .  economists are taking baby steps into the world of emotion, social relationships, imagination, love and virtue.  In Act V, I predict, they will blow up their whole field.  Economics achieved coherence as a science by amputating most of human nature . . . [but] the moral and social yearnings of fully realized human beings are not reducible to universal laws and cannot be studied like physics.  At the end of Act V, economics will be realistic, but it will be an art, not a science.”

I very much liked David Brooks’ OpEd, but I don’t quite agree with his Act V epilogue.  In my opinion, the moral of this story is not that economics is more art than science.  What we are seeing here, is another manifestation of the arrogance of power that we all have to guard against because it inevitably leads to trouble.  We have often seen that if we are not careful, power will invariably lead us humans to arrogance and pride, whether we are successful business executives, politicians, athletes, academics . . . or economists.

"Innovation in New York" Revisited

In June of 2008 I participated in a panel, “Is New York a Center of Innovation?,” which was jointly sponsored by SUNY’s Levin Institute and the New York Academy of Sciences, and moderated by Levin Institute’s president Garrick Utley.  Since that time, the same two institutions have partnered with the Sloan Foundation and organized Innovate New York - Envisioning an Inventive City , - which has held a series of panel discussions to explore how to foster innovation in such diverse areas as finance, media, services, life sciences, arts and culture.

I joined the Levin Institute as Senior Fellow in the Fall of 2008.  Innovation in large urban regions like New York has been one of my key areas of interest.  This coming June the Levin Institute will revisit our original panel, and to better prepare for the event, I want to reflect on how much progress we have made in the intervening two years in our quest to help make New York one of the premier world centers of innovation in the 21st century.

Few will argue that the still ongoing financial crisis, has been the dominant story for the past two years in New York City, the US and the world.  For many, survival, not innovation, has been paramount in their minds.  In April of 2008, the unemployment rate in New York City was only 4.4%.  By February of 2010, the NYC unemployment rate had climbed to 10.2%, higher than the 9.7% national unemployment rate.  There are now over four hundred thousand unemployed city residents, many of them having lost their jobs as a result of the major layoffs in the financial industry caused by the crisis. 

Two years ago we could not have foreseen JumpStart NYC, one of the major programs at the Levin Institute over the past year.  The key objective of JumpStart, which I have personally been involved in as an instructor and a coach, is to help city residents who lost their jobs on Wall Street and other industries explore new career paths and opportunities in small, entrepreneurial firms in the New York area. 

But, as is often the case, out of great pain comes great opportunity.  Innovation is now even more important to New York.  We need to help create all kinds of new, well paying jobs so the NY area can dig its way out of the crisis.  But, the innovation environment now feels quite different from what it was just a very short two years ago.  Let me discuss some of those key differences.

The Power of Pull

Last summer, John Seely Brown (JSB), John Hagel and Lang Davison published the results of a major research project they have been conducting at Deloitte’s Center for the Edge.  The Big Shift, as they called the project, refers to the long-term transformations in the global business environment over the past several decades that have been primarily, but not exclusively, caused by the remarkable advances in digital technologies over that period.

Their research uncovered a number of major, somewhat paradoxical findings.  For example, the return on assets (ROA) of US companies, - a general indicator of profitability, -  has been progressively falling and is now almost one quarter its 1965 levels.  But, labor productivity has been steadily rising, and is now nearly double what it was in 1965.  Where have the benefits of these productivity gains gone?  Certainly not the bottom line of companies which have seen their profitability drop so much during the same period.

To help them make sense of their various findings, the Deloitte research team came up with 25 different metrics which taken together helped them understand the rate and magnitude of the long-term changes they kept uncovering.  The result is The Shift Index, an extensive report that explains each of the 25 metrics, as well as their overall ideas and methodologies.

Now they have turned their attention from analysis to prescription.  What should we be doing to cope with the growing performance pressures being experienced by individuals and institutions?  To answer this question, JSB, Hagel and Davison have written The Power of Pull: how small moves, smartly made, can set big things in motion, which is being published this coming week.

A 21st Century Magical Mystery Tour

Isaac Newton laid down the foundations for what we now call classical mechanics with the publication of his Principia Mathematica in 1687, where his Laws of Motion, where first articulated.  Ever since, our scientific understanding of the world around us has been based on classical mechanics, - “a set of physical laws governing and mathematically describing the motion of bodies and aggregates of bodies geometrically distributed within a certain boundary under the action of a system of forces.”

Classical mechanics works exceptionally well for describing the behavior of objects that are more or less observable to the naked eye.  It accurately predicts the motion of planets as well as the flight of a baseball.  It formed the scientific basis for the technology and engineering underlying the Industrial Revolution. 

The elegant mathematical models used in classical mechanics depict a world in which objects exhibit deterministic behaviors.  The same objects, subject to the same forces, will always yield the same results.  These models make perfect prediction within the accuracy of their human-scale measurements. 

But, this stable world that could be perfectly described given enough information and scientific knowledge began to fall apart in the early 20th century.  Classical mechanics could not explain the counter-intuitive and seemingly absurd behavior of energy and matter at atomic and subatomic scales.  Neither could it explain the behavior of bodies traveling near the speed of light or the vast scales of the universe. 

To do so, physics had to wait for quantum mechanics and relativity.  Compared to the pastoral worlds that classical physics had been traveling through, the new theories that quantum mechanics, special relativity and general relativity were now spinning often had the feel of some sort of 20th century magical mystery tour.