Sunday, May 04, 2008

Letters From Soros

Last month, I noted resemblances between Soros' concept of "reflexivity" and Davidson's use of non-ergodicity to formalize the notion of a model economy set in historical time. Davidson drew this point to Soros' attention over a decade ago. Soros has commented on this resemblance.

The following letter has an Open Society Institute letterhead:
February 28, 1997

Professor Paul Davidson
Holly Chair of Excellence in Political Economy
The University of Tennessee Knoxville
College of Business Administration
Department of Economics
Stokely Management Center
Knoxville, Tennessee 37996-0550

Dear Professor Davidson,

Thank you for sending me your book Economics for a Civilized Society. I found your comments on Samuelson's ergodic hypothesis very pertinent.

Yours Sincerely,

George Soros
From the 15-21 March 1997 issue of The Economist:
Sir - In "Palindrome repents" (January 25th) you accuse me of ignorance of economic theory. In particular, you say that my "claim that economics is inherently flawed on some deep epistemological level is just embarrassing." Is it?

Economics aspires to the status of a hard science. Specifically, it seeks to establish universally valid laws similar to 19th-century physics. For this purpose it relies on the concept of equilibrium, similar to the resting place of the pendulum, which is the same irrespective of any temporary perturbation. Paul Samuelson, an economist, called this the "ergodic hypothesis" and considered it indispensable to making economics a hard science.

The trouble is that economics cannot be made into a hard science, because of the reflexive interaction between the participants' thinking and the actual state of affairs. The interaction does not have a determinate outcome, because the outcome is contingent on the participants' expectations, and the participants' decisions do not merely passively discount the future but also actively help to shape it. There is a two-way feedback mechanism that does not lead to a predetermined resting place, but keeps a historical process in motion. Economic theory can protect the false analogy with 19th-century physics only by eliminating reflexivity. It does so by assuming demand and supply as independently given. The result is an axiomatic system that has little relevance to the real world.

You are correct to claim that, in practice, economists have learnt this, in order to deal with the real world. Alan Greenspan's recent Humphrey-Hawkins testimony is a brilliant exercise in reflexivity. But the theory has never been discarded and it serves as the scientific underpinning for the prevailing belief in the magic of the marketplace.

You are also right to claim that markets do not reign supreme; but you cannot deny that there is a powerful body of opinion that passionately believes that they should. You are plain wrong in asserting that I do not know the "big difference" between laisser-faire and totalitarian ideologies. I stated it explicitly in my Atlantic Monthly article and have been guided by it in my philanthropic activities. I can tolerate personal attacks but I must object when they are used to obfuscate valid arguments.

New York
George Soros


Gabriel M said...

What is "participants' decisions do not merely passively discount the future but also actively help to shape it" supposed to mean?

Anonymous said...

Gabriel: This means that in orthodox economics where the ergodic hypothesis is applicable, ther future is already cdetermined and today's participants merely use the discount rate to evaluate the already preprogramed future b enefits and costs; while with nonergodicity (or Soros's reflexivity) the decisiond that people make today affect (create) future outcomes.