OPINION
Networks Science
P
aul Volcker, the former Federal Reserve Chairman, declared a couple of years ago that the only significant innovation in finance over the past two decades was the ATM. Were he to ask the same question of the economics profession, the conclusion would be even more damning.
Economic theory has failed to yield any substantial breakthroughs in recent memory. The obsession of the 1990s, Efficient Markets Hypothesis, was fatally undermined by the financial crisis. The latest fad, behavioural economics, is at heart really just a reprise of a notion propounded by Adam Smith and John Maynard Keynes – that human beings often behave irrationally. Political economics has regressed back to the 1970s, so we are once again playing out the battle between Keynesians and Supply-siders.
A year ago I went to Harvard to study, searching in particular for new ideas which might change economics. For most of the year, it was a fruitless quest. I took a course with renowned economist Dani Rodrik, who told me that the future of the international monetary system would involve reprising something akin to the Bretton Woods system of the post-war era. I took a course with former Obama advisor Larry Summers who told me that when the White House decided how much it would spend on the fiscal boost, it did so with the help of Okun’s Law, an equation produced back in the 1960s.
Everything, in other words, was about regression rather than progression. Then I happened across a course on networks science given by a young MIT professor who said he might just have the answer. I wondered at first whether the prof, a Chilean called Cesar Hidalgo, had sold me a pup. Networks as a new kind of mathematical science was certainly fascinating, but it wasn’t immediately clear how relevant it was. At its core, and with the help of powerful computers, lies our ability for the first time to analyze complex networks, whether they be social, biological, the Internet, neural or metabolic networks – any kind of connected system.
It’s when you consider what this means for economics that things get interesting. Until now, economics has been an essentially reductionist science – most economic theories rely on some degree of simplification in order to derive findings.
30 // JULY/AUGUST 2011
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Edmund Conway says economic theory is intellectually bankrupt, capable only of recycling tired old ideas dressed up in shiny new wrappers. But he says there is hope that
the dismal science may be able to find new tools to measure our increasingly complex financial world: in networks.
Microeconomics ignores the big picture; macroeconomics oversimplifies significant detail. The most important statistic in economics is gross domestic product, but this in itself is a gross oversimplification: China and Japan have similar levels of GDP but extremely different economies.
If however you use a network to map out a country’s products and capabilities – a kind of web of its economic activity – you arrive at something which is similar to GDP, in that it represents a country’s economic performance, but vastly more sophisticated, in that it maps out links between products a country currently produces and those which, by implication, it could subsequently produce. According to Hidalgo, looking at a country’s ‘product space’ – the name he gives these networks – allows you to make a pretty good stab at its likely economic performance over the following 15 years or so.
For example, back in 1970 Peru was twice the size of South Korea in GDP terms, and yet by 2003 the Korean economy had grown more than sevenfold while Peru had stagnated. GDP, or for that matter export statistics, offered little explanation for this dramatic leapfrogging. Examining the respective countries through the lens of the product space would have revealed that, even in 1970, Korea had diversified its economy to a large degree, towards specific product areas that were associated with higher returns.
Networks, in other words, provide a kind of economic crystal ball of a country’s long-term prospects – one that could help guide struggling nations towards prosperity. Granted, this isn’t exactly a revolution in economic thought, but perhaps it represents the first taste of how economists might borrow from technology to improve their prescriptions. Indeed, another MIT scheme, the Billion Prices Project, has created an entirely new real-time inflation index based on prices sourced from the Internet.
So, reassuringly, there are new ideas out there. Networks science may even help provide a better map of the financial system, helping mitigate future crises. This might not be good enough to satisfy Paul Volcker, but it is at least a start.
Source: Edmund Conway is the Economics Editor of Sky News and is the author of 50 Economics Ideas You Really Need To Know (see previous page)
edmund.conway@
gmail.com
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