Orthodox Economics Is Broken. How Evolution, Ecology, and Collective Behavior Can Help


Kate Douglas in Evonomics:

Using a mathematical model of price fluctuations, for example, Bell has shown that prestige bias – our tendency to copy successful or prestigious individuals – influences pricing and investor behaviour in a way that creates or exacerbates market bubbles.

We also adapt our decisions according to the situation, which in turn changes the situations faced by others, and so on. The stability or otherwise of financial markets, for instance, depends to a great extent on traders, whose strategies vary according to what they expect to be most profitable at any one time. “The economy should be considered as a complex adaptive system in which the agents constantly react to, influence and are influenced by the other individuals in the economy,” says Kirman.

This is where biologists might help. Some researchers are used to exploring the nature and functions of complex interactions between networks of individuals as part of their attempts to understand swarms of locusts, termite colonies or entire ecosystems. Their work has provided insights into how information spreads within groups and how that influences consensus decision-making, says Iain Couzin from the Max Planck Institute for Ornithology in Konstanz, Germany – insights that could potentially improve our understanding of financial markets.

Take the popular notion of the “wisdom of the crowd” – the belief that large groups of people can make smart decisions even when poorly informed, because individual errors of judgement based on imperfect information tend to cancel out. In orthodox economics, the wisdom of the crowd helps to determine the prices of assets and ensure that markets function efficiently. “This is often misplaced,” says Couzin, who studies collective behaviour in animals from locusts to fish and baboons.

By creating a computer model based on how these animals make consensus decisions, Couzin and his colleagues showed last year that the wisdom of the crowd works only under certain conditions – and that contrary to popular belief, small groups with access to many sources of information tend to make the best decisions.

That’s because the individual decisions that make up the consensus are based on two types of environmental cue: those to which the entire group are exposed – known as high-correlation cues – and those that only some individuals see, or low-correlation cues. Couzin found that in larger groups, the information known by all members drowns out that which only a few individuals noticed.

More here.