Wednesday, April 23, 2008

Soros on Historical Time

The New York Times a couple of weeks ago profiled George Soros, the billionaire financial speculator, philanthropist, and student of Karl Popper's ideas. According to this profile, Soros would like to have an impact on the discipline of economics:
"Now in his eighth decade, [Soros] yearns to be remembered not only as a great trader but also as a great thinker. The market theory he has promoted for two decades and espoused most of his life - something he calls 'reflexivity' - is still dismissed by many economists. The idea is that people's biases and actions can affect the direction of the underlying economy, undermining the conventional theory that markets tend toward some sort of equilibrium." -- Louise Story (2008)
Stiglitz is quoted as saying that Soros might become successful at his goal:
"But Joseph E. Stiglitz, a professor at Columbia who won the Nobel for economics in 2001, said Mr. Soros might still meet success. 'With a slightly different vocabulary these ideas, I think, are going to become more and more part of the center,' said Mr. Stiglitz, a longtime friend of Mr. Soros." -- Louise Story (2008)
I suppose one could debate about whether mainstream economics is as open to these ideas as Stiglitz suggests.

About a decade ago is the first time Soros put these ideas into print, as far as I aware. Here is his then definition of reflexivity:
"In the case of scientists, there is only a one-way connection between statements and facts. The facts about the natural world are independent of the statements that scientists make about them... If a statement corresponds to the facts, it is true; if not, it is false. Not so in the case of thinking participants. There is a two-way connection. On the one hand, participants seek to understand the situation in which they participate. They seek to form a picture that corresponds to reality. I call this the passive or cognitive function. On the other hand, they seek to make an impact, to mold reality to their desires. I call this the active or participating function. When both functions are active at the same time, I call the situation reflexive...

...When both functions are at work at the same time, they may interfere with each other. Through the participating function, people may influence the situation that is supposed to serve as an independent variable for the cognitive function. Consequently, the participants' understanding cannot qualify as objective knowledge...

...Our expectations about future events do not wait for the events themselves; they may change at any time, altering the outcome. That is what happens in financial markets all the time... But reflexivity is not confined to financial markets; it is present in every historical process. Indeed, it is reflexivity that makes a process truly historical...

A truly historical event does not just change the world; it changes our understanding of the world - and that new understanding, in turn, has a new an unpredictable impact on how the world works."-- George Soros (1998: 6-8)
And Soros uses these ideas to criticize the use of equilibrium models in economics.

To me, Soros is expressing the same concept that Post Keynesians call historical time. Post Keynesians reject neoclassical economics. In the failed neoclassical approach, the economy tends towards an economic equilibrium pre-determined by the objective data of tastes, technology, and endowments. Both Soros and the Post Keynesians, with their emphases on expectations, question the objectivity of the data. Today, I turn to Jan Kregel for a statement of the Post Keynesian position:
"There can be no tendency to equilibrium based on a relation between expectations and the objective data of what the consumer will demand and the price he will pay which describes the conditions of equilibrium because the incomes available to consumers will be determined ultimately by the very decisions taken by entrepreneurs on the basis of these expectations.

The post Keynesian approach is thus influenced by Keynes' insistence that the level of output and employment cannot be considered as objective data determining the conditions of equilibrium because they will be endogenously determined by entrepreneurs' decisions... Keynes is concerned with the role of expectations in the coordination of individual production plans in a society consisting of several independent producers whose expectations determine the means available to satisfy an uncertain multiplicity of future demands. Expectations themselves determine the objective facts of the conditions of equilibrium... The problem is not whether the objective data necessary to achieve equilibrium will be reflected in subjective data available to the individual, but the very definition of the objective data. Indeed, even its objectivity is questioned." -- Jan Kregel (1986).
And these ideas accompany an concern with processes set in history. (I have previously mentioned Paul Davidson's use of the concept of non-ergodicity in a formalization of the idea of a process set in history.)

Soros and Post Keynesians like Davidson draw similar practical conclusions from developments of these ideas. The financial system, including internationally, can be a source of economic instability. We need to design new international institutions and conventions to govern finance. The system that has evolved since Richard Nixon abolished the Bretton Woods system doesn't work, as international economic crisis succeeds international economic crisis.

  • J. A. Kregel (1986). "Conceptions of Equilibrium: The Logic of Choice and the Logic of Production", in Subjectivism, Intelligibility, and Economic Understanding: Essays in Honor of Ludwig M. Lachmann on his Eightieth Birthday (ed. by Israel M. Kirzner), New York University Press.
  • George Soros (1998). The Crisis of Global Capitalism: Open Society Endangered, Public Affairs
  • Louise Story (2008). "The Face of a Prophet: Soros Craves Respect for His Theories, Not Just His Money", New York Times (11 April) Business, p. 1


Gabriel M said...

A question for those that happen to know both literatures... How is this different from the Farmer-Gao results (Farmer's "The Macroeconomics of Self-Fulfilling Prophecies")?

Or from the "coordination failure", game-theoretic results of say Cooper?

Or multiple equilibria in linear R.E. models?

Farmer shows, IIRC, that an i.i.d. sunspot in investors' expectations can cause fluctuations comparable with those in the data (it gives as good answers as RBC and NewKeynesian models of that vintage).

That being said, I fail to see how restricting attention to equilibrium outcomes in itself, to close the model (rather than say by other, potentially ad hoc means) is a liability.

It's just a matter of a no-arbitrage condition holding, in the end, no? A modeling strategy.

That (financial) crises are, in a vast majority of cases, associated with innovations of sort is also worth mentioning.

That plus the fact that it's difficult to get any quantitative hypotheses out of these things discussed here.

The PostK. quote seems hand-wavy to me. You either get a fixed point in the mapping from expected state to realized state or you don't.

Gabriel M said...

What the mainstream is doing (from a 2003 review by Farmer):

This book consists of a collection of ten papers by Roger Guesnerie and his co-authors, all of which are concerned with the idea that business cycles maybe driven by self-fulfilling expectations in economies in which there exist multiple rationale expectations equilibria.

Two concepts have been important in the area of endogenous fluctuations. The first is that of "sunspots,"a term first used by David Cass and Karl Shell to refer to the idea that general equilibrium models may contain equilibria in which allocations may differ across states of nature that are identical with respect to all economic fundamentals. The second is that of "indeterminacy," the idea that dynamic economic models often contain a continuum of equilibria. The combination of models that display both indeterminacy and sunspots has proved to be an extremely powerful tool for modeling the idea that dynamic economic models may generate stationary stochastic business cycles that are generated purely by the self-fulfilling beliefs of agents in the models.

Unknown said...

I can't comment on orthodoxy or post-Keynesianism, since I know almost nothing about them. But I think Soros first put forward his 'reflexivity' idea in 'The Alchemy of Finance' (1988, revised 1994). Soros there argues that that markets (though he focusses on financial markets) have no tendency to move towards equilibrium - no equilibrium at all, really - but rather move in boom bust waves that are largely produced, as you say, by expectations. He stresses the self-reinforcing nature of these expectations, and the impossibility of predicting the 'tipping point' at which self-reinforcement first stops and then is re-established in the opposite direction. As you say, he lays heavy stress on the impossibility of separating 'fundamentals' from speculative 'noise'.

Anonymous said...

In the sociology of finance literature [Donald Mackenzie et al] the issues Soros raises are called "the performativity of economics" problem.

See "An Engine not a Camera" by Mackenzie, MIT Press

Robert Vienneau said...

Praxis, thanks for the correction.

Post Keynesians debate among themselves how much various approaches are in historical time. They also recognize that mainstream economists have recently come some way towards such models. See, for example A. K. Dutt's "Robinson, History and Equilibrium", in Joan Robinson's Economics (ed. by Bill Gibson, Edward Elgar).

I have enjoyed MacKenzie's earlier book on computer-assisted proofs. Given that I've read many of the papers that apparently became chapters, I have yet to read An Engine, Not a Camera. I do not see, however, how MacKenzie's performativity leads to an analogous critique of equilibrium. So I still prefer my mapping of Soros' reflexivity to the Post Keynesian's historical time.

YouNotSneaky! said...

Quiet honestly, I think you're giving Soros way too much credit.

Curt said...

" Soros too much credit."

well, Soros is just more populist.

There are (as we can see from the postings here) people exploring this problem in many fields: philosophy, mathematics, and economics, as well as in history and finance.

When someone comes across the general pattern (the relationship between fractal knowledge expansion: imagination subjectivity, calculability and time) they label it with whomever they heard the pattern from that was relevant enough to them that they could grasp it.

Darwin and Edison are people we remember because the won the contest, but neither was unique, or even first.

Soros has a legitimacy problem largely because he is considered, probably justifiably, as an immoral man. But he is not particularly innovative. These conceptual wars have been going on for a very long time. And they will go on until we solve 'Hume's Problem" the problem of induction, or what it is that we can know. Soros certainly isn't smart enough to solve it, but he's smart enough and popular enough to popularize the nature of the problem.

But him aside, there are many people in many fields that are working on it, and we're deceptively close I think to solving it. And when we do, we'll call it by whatever name that may be.

Winner takes all in history.