Systems thinking, exogenous shocks and the temptation to keep on dancing

Systems thinking – an understanding of society which acknowledges the interdependencies and feedback loops of multiple actors and markets -  is without a doubt a better representation of the economy than the isolated (partial equilibrium) models that economists often resort to using. And to be fair, economists will readily admit as much, but defend the use of simplified models on the basis that it’s impossible to model the complexity of the world around us in any manageable way otherwise. The trend over the past 50 years to use increasingly sophisticated mathematics is a symptom of this wish to distil complex economic interactions into neat equations and solutions. Kate Raworth, the author of Doughnut Economics, puts it this way: ‘Craving the authority of science, economists mimic the laws of physics and use mathematics to ‘prove’ their theories’. Many interdependencies have to be left out when relying on the language of the natural sciences to explain human behaviour. And many events that economists typically model as exogenous shocks can be better understood as arising from endogenous forces within such complex systems. The financial crisis which erupted in 2007 was not a shock but rather the result of a long-term build-up of risk in the sub-prime mortgage market.  The fact that almost everyone was ‘shocked’ by it and failed to see it coming is perhaps a symptom of the lack of the right set of tools for understanding the systemic, endogenous and dynamic features of the financial world at that point in time. Another explanation is that most of us, with or without the use of models, were incapable of understanding the complexity of the financial products being transacted. Some, however, definitely saw it coming but decided to pretend it wasn’t happing or that it wasn’t their job to change course. Chuck Prince, CEO of Citigroup at the time, acknowledged the risk of the US sub-prime mortgage market, but said ‘you have to keep on dancing as long as the music plays’ (Financial Times, July 10 2007).  Against this backdrop, it is heartening to see the recent developments of more complex systems thinking in the economics profession, including a more broad-based curriculum (CoreEcon) offered in some universities. But I still think we have a long way to go before the developments in academia translate into the spheres of politics and public policy decision making. Not to mention to the world of Chuck Prince and everyone else who prefer to keep on dancing.