Economic complexity beyond rational management

The economic crisis is a global crisis and although there has been much to-and-fro on the proper response one thing we all surely agree on is that a global crisis requires a global solution. Most of the attention has been given to short-term responses such as relaxed monetary and fiscal policies. These responses seem to be appropriate, although the focus here is on long-term solutions. For Australia the economic crisis has once again brought to relief a perennial structural defect in the economy, which neoliberal reforms were supposed to eliminate.

An interesting sub-text in all of this is the status of economics as a rigorous intellectual discipline.

Much of the neoliberal reforms were justified on the basis that economic theory amounted to an empirically well grounded physical science. It is revealing that the leading critic of Australia's debt fuelled binge, Steve Keen, just so happened to also write a book puncturing the scientific pretensions of standard economic theory.

In order to develop solutions like any good doctor we need to understand why the crisis first arose. We may divide this into two components, namely at the global level and the specifically Australian aspects. Let us start with the crucial global component.

When Sir Nicholas Stern delivered his major report on the economics of global warming he pointed out that the global ecological crisis was the most severe instance of market failure in human history. This observation on Stern's part is a fact of great moment. This is because the economic crisis itself is a vast example of market failure of exactly the same type: what economists would call market failure due to negative externalities.

That most economists did not see that this type of market failure was coming seriously dents their status as objective observers of economic processes. Deregulated markets are prone to failure, a conclusion that is not made clear from the efficient markets hypothesis which is only now the subject of much critique.

In pointing this all out we should be mindful of the observation of the political economist Karl Polanyi, in his classic The Great Transformation, that "the idea of a self-adjusting market implied a stark utopia. Such an institution could not exist for any length of time without annihilating the human and natural substance of society; it would have physically destroyed man and transformed his surroundings into a wilderness."

Negative externalities arise when the social costs of economic activity are not reflected in market prices. In the case of the financial system the price can be measured in terms of risk. The reason why financial corporations such as Lehman Brothers engaged in such reckless conduct was because liberalised financial markets under-priced risk. The risk to finance companies when they engaged in complex mortgage-backed securities trading was less than the risk that such trading would lead to systemic collapse. Because systemic risk is something external to the company reckless behaviour becomes rational.

The crisis is more than just a grand failure of markets. It is also a form of institutional and political failure. Corporations, which dominate our basic social categories, are profit maximising entities. Ours is a system that has profits right at the core. The way in which the corporate form has evolved means that it is short-term profits that matter.

A result of finance liberalisation has been the rise of what is called the "dual constituency conundrum" whereby governments became accountable, or perhaps more accountable, to financial markets in addition to the electorate given the possibility of large capital strikes. This has led to finance corporations attaining great political power which they have parlayed into compelling the state to deregulate financial markets, enabling short-term, systemically risky, profit making.

When highly risky and potentially truly catastrophic actions turn into a form of perverse rationality disaster is all but inevitable.

A very important feature of the crisis can also be found in the science of complexity. The theoretical biologist Stuart Kauffman put complexity on the map through his ground breaking work on complexity and evolution, which promises to enrich our understanding of evolution in ways that go beyond adaptation and natural selection. The industrial sociologist Charles Perrow has shown that complex technological systems are prone to systemic failure, what he called "normal accidents". Perrow demonstrated, convincingly, that complex systems are prone to failure of a type that engulfs the entire system. In fact such failures are inevitable hence "normal".