The 2008 Crisis has more to do with the Apple iPhone than with economics. I know. To an expert, that probably sounds ridiculous. Suzuki might say, though, that it is one of the “many possibilities.” Why not have beginner’s mind about it? It would, I think, improve the design of our financial system, and make it safer for most of us.
The iPhone happened to launch right around the time the Crisis got started. One thing didn’t lead to another; I’m not saying that. I am saying that the iPhone is symbolic of the Network Age we live in. Mobile technology has connected us as never before. It happens that the behavior of connected networks is different than that of independent parts. This dynamic defines our time. Economics needs to awaken to its dominance. This is not a “crystal crunchy” thing to say, but a statement based on science: specifically, on physics, and more specifically, on the physics of sand piles.
Per Bak was a Danish theoretical physicist who researched the science of phase transitions — like the abrupt shift of water from solid to liquid. His 2002 obituary in Nature stated he was one of the world’s most cited physicists. He also spent a long time looking at sand piles.
The financial system, an interconnected network, behaves like a sand pile, Bak argued. He actually invited some of the leading economists in the world to his laboratory to explain why. One of them, Kenneth Arrow, briefly dallied with Bak, but ultimately orthodoxy turned its head away. The problem was that Bak’s sand pile physics foiled the neat equilibrium physics at the heart of economics and finance. In short, Bak’s “possibilities” threatened the economists’ expertise.
Bak’s sand pile metaphor is simple to apply. Risk grows as traders pile on bets on the system like sand, and the piles grow higher. Regulators, wary of slides, try to shore them up with some of that orange plastic netting — i.e., a promise to intervene and bail out traders. Of course, once the netting is in place, traders just pile up more sand (bets) on the pile. Eventually even the netting is not enough to stop a slide, and the regulators shore up the pile even more, which results in more trader bets, which causes bigger potential slides.
Bak argued that the sand pile system always ‘seeks’ a hypercritical state, the point at which it is poised for a slide. Intuitively, this means traders will take whatever promise of stability regulators give them and use it to make even riskier bets. This is not a happy message for regulators. It implies much of their work is, well, worse than useless. Combine this with the clash between economics’ equilibrium physics and networks, and one can understand why the experts would press the ‘ignore’ button when someone brings up Bak’s work. To many of us, though, the sand pile metaphor fits with our intuition: We sense that we live in the shadow of the looming pile of risk that is our interconnected financial system. We sense also that repeated bailouts are making the pile grow larger and larger.
Unfortunately, economics is in the vanguard of the reductionist war on intuition. That sounds a little freaky, I realize. What war on intuition? I suppose it’s an unseen one, like Nixon’s Cambodia bombings — I know, I’m dating myself here. Most economists, I think, not only assume rationality and autonomy in our decision-making; they value it. This sets up a conflict between two camps: evolutionary biologists and psychologists on the one hand, and economists on the other. The former argue that our connections and intuitive/emotional apparatus are critical adaptations, the keys to our success as a social species. Economists seem to hold the view that they hold us back from progress. In fact, the field’s newest branch, behavioral economics, shouts this from mountaintops.
The Apple iPhone, as a symbolic artifact, weighs in on the evolutionary side. As we progress, our connectedness matters more, and the chance that we act like independent automatons falls. The financial system is just one place where connectedness and our subconscious minds combine to create emergent behavior. This is a very different place from the one the experts imagine in their equations, and in the design those equations produce.
For financial system designers, Bak offers a different way of seeing, one that incorporates network feedback. Beginner’s mind requires us to put on different ways of seeing like reading glasses we have stashed away in drawers. In regulators’ case, those glasses could allow them to glimpse, more than intuitively, the interconnected behavior of sand piles, of which they form a part.
That would be a good thing for all of us living at the base of the sand pile.
