Making Sense of Chaos: A Revolution in Economic Theory

In Episode 374 of Hidden Forces, Demetri Kofinas speaks with J. Doyne Farmer. Dr. Farmer is a complex systems scientist and entrepreneur who pioneered many of the theories and applications that we discuss today, including chaos theory, complexity science, artificial life, and wearable computing.

We live in an age of increasing complexity, accelerating technological change, and global connectivity that holds more promise and peril than arguably any time in human history. Successfully navigating these changes will depend immeasurably on the quality of our economic models because, at their heart, all these changes—the changes associated with trends in automation, digitization, demographics, and financial markets—are rooted in the economy and the network of systems that keep us alive.

For the first time, using big data and ever-more-powerful computers, we are now able to apply complexity science to economic activity, building realistic models of the global economy and financial markets that promise to vastly outperform in terms of verisimilitude and predictive power anything that we have seen in human history.

This episode is divided into two parts. The first hour is meant to provide you with a foundational understanding of complexity science and its application to economics. We discuss chaos and volatility and compare the explanatory and predictive power of agent-based simulations to the standard economic model.

The second hour is an exploration of economic frameworks that treat the economy as an ecological network and series of metabolic processes. We also apply the lessons of the first hour to specific economic and financial questions related to investment styles, risk management, technological disruption, and policymaking.

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00:00 - Introduction

04:30 – Background

06:03 – What Is Complexity?

07:01 – Origins of Complexity

08:40 – What Is Chaos?

09:47 – The Predictability of Roulette

11:06 – Sensitive Dependence on Initial Conditions

14:29 – Laplace’s Demon

15:55 – Heisenberg’s Uncertainty Principle

16:36 – Complexity vs. Complicated

17:33 – Order From Chaos

19:37 – What Are Attractors?

21:40 – Dynamical Systems

23:13 – Linearity vs. Non-linearity

24:45 – What Are Heuristics?

25:37 – Inductive vs. Deductive Reasoning

26:35 – Complexity Economics

28:00 – Economic Theory & Econometrics

30:09 – Theory vs. Statistical Regression

32:36 – What Is Equilibrium?

33:47 – What Are Rational Expectations?

35:48 – Utility Functions & Behavioral Economics

37:23 – Informational vs. Allocational Efficiency

38:49 – Efficient Markets Hypothesis

40:31 – Engogenous Motion & 1987 Crash

41:08 – Agent-Based Simulations & Diversity

42:47 – Plausibility of Assumptions

44:51 – Financial Volatility

47:03 – Topics in the Second Hour

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Producer & Host: Demetri Kofinas

Editor & Engineer: Stylianos Nicolaou

Follow Demetri on Twitter at @Kofinas

Episode Recorded on 08/02/2024

Making Sense of Chaos: A Revolution in Economic Theory | J. Doyne Farmer