Leanne Ussher and Sorin Solomon - Financial Fragility in a Network of Trade Credit

About the Interview

The physicist Sorin Solomon begins to feel dizzy when the economist Leanne Ussher talks econ lingo. Yet he listens, because the two of them have found a productive area of collaboration: some economic phenomena, they find, can be explained without recourse to the quirks that feed into human decision making. Sometimes, they say, we can model people as if they were particles, and explore consequences of the social structure that constrains their possible actions. Ussher and Solomon set up a model of Italian industry, stock-flow consistent and grounded in firm-level data on trade credits, to trace out the relation between network structure and financial fragility -- this is new economic thinking.

About Leanne Ussher

Leanne Ussher is Assistant Professor of Economics at Queens College, City University of New York. Her research is broadly focused on money, banking, trade credit, international financial reform and the macro-microstructure of financial markets. Full profile

About Sorin Solomon

Sorin Solomon holds a PhD in theoretical physics from the Weizmann Institute of Science. He is a professor at the Racah Institute of Physics of the Hebrew University of Jerusalem and was previously a Bantrell Research Fellow at Caltech and held a Career Development Chair at the Weizmann Institute. Full Profile

Comments

0

"--this is new economic thinking."

No, this is not new economic thinking. This is old economic thinking.
This is another attempt by economists to garner some of the respectability of the physical or natural sciences.
These two charming, well-meaning and incredibly bright people should really know better. After all, Robert Skidelsky, among many, many others, has been talking about the problem of "physics envy" in economics for years.
The failure of DSGE models, the utter uselessness of mainstream, heavily mathematized academic economics should be some kind of warning or sign that these kinds of projects are hopeless.
Anyway, I suspect or hope that this kind of thing is no more than a sideshow to INET's agenda.
A dose of Wittgenstein's Tractatus is called for here, I think. Clears the head right out.

Sincerely,
Ed Beaugard

0

Mathematics, statistics, and engineering techniques like those used by physicists are tools. Such tools can and should be applied in a variety of ways to all types of social science projects to the extent they give one a NEW, or validate an old, understanding of a particular phenomenon. The problem with economics as a science has been the dominance of some very narrow and specific types of tools that come under the heading of classical mechanics (see Mirowski’s (1989) More Heat than Light). This equilibrium approach, coped from Newtonian physicists and in particular their Hamiltonian equations, have come to dominate economics in describing ‘dynamics.’ Such tools underpin the DSGE macro models, which also have some random shocks based on historical data thrown in for good measure. Such ‘dynamic stochastic processes’ that DSGE models used for prediction, can be described as arbitrary at best, and represent the desire of scientists to find solutions that fit their specific type of economic thinking – one of preconceived notions of equilibria and steady states.

However, these methods are just mathematical and statistical tools, they cannot be blamed in of themselves. It is the application of these very specific tools, to the exclusion of all other methods, and the restriction of a pluralistic approach, that has made economics such a narrow and doctrinaire science – dominated by equilibria and representative agents.

In economics, using methods from other sciences, be that biology, physics, mathematics, statistics, engineering, psychology, anthropology, history or what have you, is ultimately an art, though combined with validation methods through experiments and statistics can help to make it a science. Using methods from physics can be used to offer a NEW way of thinking about economics, which opposes the current neoclassical or rational expectations regime.

As long as a pluralistic approach within the economic field is embraced, then we have a science that will benefit from the competition of ideas. It is when pluralism is banned, when specific methods and tools are excluded, or when outcomes are forced to satisfy certain conditions, that science becomes a backward art dominated by fad and fashion rather than progress.

Our approach is along the lines of complexity in economics and it is definitely NEW within the schools of economics, though it has parallels with Economic Institutionalism and Evolutionary Economics which emphasize institutional structure, interaction and demographics rather than with DSGE equilibrium macro models which are based on the psychology of a representative agent. A description of the complexity or emergent order approach within the field of economics can be garnered from an INET conference session earlier this year:

http://ineteconomics.org/net/video/playlist/conference/bretton-woods/K

Skidelsky and most economists are not opposed to the use of mathematics or physics in economics. It is rather the manner in which it is used to pursue a narrow line of thought and its dominance in the field that has led to the exclusion of a pluralistic approach.

0

One of the advantages of physics methods is that they offer an objective criterion for judging scientific work: according to the Popperian paradigm a theory must make falsifiable predictions and then one has to validate (or disproves) them through empirical measurements.

We have done just this in a long series of refereed journal papers in which, non-trivial and sometimes surprising economics predictions based on complexity / physics concepts and theory were validated by empirical quantitative measurements.

As a representative sample I suggest the list below:

1-            We predicted the equality between the Pareto exponent and the fractal market fluctuations exponent and verified it empirically in various economies:

Pioneers on a new continent: on physics and economics

Sorin Solomon and Moshe Levy 

Quantitative Finance Vol 3, No 1, C12 2003  http://shum.huji.ac.il/~sorin/ccs/QF.pdf

The Forbes 400, the Pareto power-law and efficient markets

O.S. Klass, O. Biham, M. Levy, O. Malcai, and S. Solomon;  Eur. Phys. J. B 55(2),143–147 (2007)   http://shum.huji.ac.il/~sorin/ccs/EPJB-Klass.pdf

The Forbes 400 and the Pareto wealth distribution

O S. Klass, O Biham, M Levy, O Malcai and S Solomon, Economics Letters  Vol 90, No 2, 2006, pp 290-295

http://shum.cc.huji.ac.il/~sorin/ccs/Econ-Lett-Klass.pdf

2-            We predicted long before 2008 the relation between trade globalization, wealth localization and economic instability.

World-Size Global Markets Lead to Economic Instability

Louzoun. Y. Mazurski. D., Goldberg. J. Solomon. S. Artificial Life (2003) 4(9) 357 – 370

http://shum.huji.ac.il/~sorin/ccs/Glob-Loc-AL.pdf

Finite market size as a source of extreme wealth inequality and market instability

Zhi-Feng Huang and Sorin Solomon

Physica A , 294 (3-4) (2001) pp. 503-513

http://xxx.lanl.gov/abs/cond-mat/0103170

3-            We predicted that as opposed to previous studies on economic convergence / divergence, it is the growth *rate* that converges when various economic regions, countries or sectors approach a stationary regime. We verified it in a large number of empirical measurements: 

Do all economies grow equally fast?

Dover Y., Moulet S., Solomon S. and Yaari G;

Journal Risk and Decision Analysis, 2009 Vol. 1/3,

special issue on Black Swans, Rare and Persistent Events and the Modelling of Uncommon Risks.

http://shum.huji.ac.il/~sorin/ccs/gae.pdf

Microscopic Study Reveals the Singular Origins of Growth, Yaari G., Solomon S., Rakocy K. and Nowak A. (2008)  European Physics Journal B, Vol. 62(4), 505-513. http://www.er.ethz.ch/teaching/Solomon_Nowak_NLgrowthEq_validation08.pdf

Intermittency and Localization,

Yaari G., Stauffer D. and Solomon S. (2009) 

in Encyclopedia of Complexity and Systems Science, edited by R Meyers, Springer, 4920-4930. http://arxiv.org/abs/0802.3541

4-            The same theoretical model predicted a universal shape that governs the dynamics of economies after a shock. This was verified empirically in tens of different cases:

The Universal Shape of Economic Recession and Recovery after a Shock

Damien Challet, Sorin Solomon, and Gur Yaari

Economics No. 2009-36 | September 29, 2009  http://www.economics-ejournal.org/economics/journalarticles/2009-36

-              For more popular coverage see

Ordinary miracles ;

Cover story of New Scientist magazine, 06 May 2000. http://shum.cc.huji.ac.il/~sorin/ordinary/ordinary.html

Stock market shock explained; Physicists model recent trading frenzy.

Published online 1 October 2002 | Nature |

http://www.nature.com/news/1998/020923/full/news020923-18.html

Microscopic Simulation of Financial Markets: from investor behaviour to market phenomena,

Levy M., Levy H. and Solomon S. (2000)  Academic Press. http://www.amazon.com/Microscopic-Simulation-Financial-Markets-Phenomena/dp/0124458904

a self-advancing and sound commented ppt presentation in http://shum.huji.ac.il/~sorin/ccs/ICCS-last.ppt

and see a video presentation in http://videolectures.net/ccss09_solomon_hdeg/

0

Prof. Solomon,

In the paper, "The Universal Shape of Economic Recession and Recovery after a Shock" there is a sentence:

"where [tau] is the typical speed at which the shock propagates throughout the economy."

The variable tau, a number, is supposed to represent an endless, infinitely complex process, one that should be considered an organic unity. How does one estimate a value for this parameter in a way that could possibly capture the infinite "feedback-loops" that are occuring as an economic shock propagates through an economy? I suggest that this is impossible for anyone to do in a way that's realistic or doesn't simplify a model to the point of irrelevance.

In my opinion, economic processes are not physical processes. A heat diffusion or fluid dynamics equation should not be used to describe the propagation of an economic shock since economic or social events are non-ergodic. The two, economics and natural science, are in entirely different realms.

So after all this work, the paper declares(if I understood it correctly), that:

"We therefore claim that shock therapies are unadapted to economies in crises as regards GDP. Patience and gradualism are better solutions in this kind of situations."

A conclusion I agree with wholeheartedly.

But the conclusion again if I'm understanding correctly, that "shock therapy" would not produce the best chance for solid economic growth, was obvious or should have been obvious to anyone who thought even for a moment about the situation in the former Soviet Union or Eastern Europe at that time.

So what was the purpose of all the mathematics?

My point: the maths and the back-testing in this paper do not "prove" anything. They don't demonstrate the correctness or falseness of the ideas of the authors, it's merely a "lucky accident"(Wittgenstein) that the back-testing worked. The is because it is mathematically and computationally impossible to really model the economic phenomena the paper is discussing. Or -  the economic thought or insight that went into to creating this simplified model produced the correct result.

At the end, I believe that the reasoning could have been done without maths and the same conclusions would have been reached.

In the paper titled, "The Forbes 400, the Pareto power-law and efficient markets", it seems that the efficient markets theory is taken seriously. I realize this paper was published in 2006, but now that the EFM is completely discredited along with all of mainstream, academic economics, have you given any more thought to this? Again, it appears that the paper comes up with an argument that supports the efficient markets hypothesis(as the authors write), a result that should be cause for some reflection, in my view.

Chomsky, in his role as a philosopher of science talks about similar problems in linguistics:

http://www.youtube.com/watch?v=yJp1-Od67-U

http://www.youtube.com/watch?v=_tvPkSveevA

----a very interesting part starts at 01:05:00.

Paul Davidson's paper that has been posted on INET discusses how economic processes are not ergodic. Since Mr. Davidson is correct in my view, this means that the physics of "phase-state transitions" will not work when applied to economic phenomena.

 

Prof. Ussher,

I read over my first reply and don't see anything that calls for a limit on ways of studying economics. I simply wonder why INET, whose project is the reform of mainstream, academic economics, would support work that repeats the error(the assumption of ergodicity) of economists like Samuelson, Cochrane, Solow and the rest.

A source for,

"Skidelsky and most economists are not opposed to the use of mathematics or physics in economics"

would be appreciated.

By the way, who exactly are most economists? Yes, mainstream, academic economists are all in favor of maths and physics in economics, and see where that's got us. But who else? My point is that of course, people are going to use maths, physics(perhaps) and statistics, it's the goal of seeking the certainty of the natural sciences in economics that is profoundly misguided.

My understanding is that Lord Skidelsky is opposed to the attempt to make economics more like a natural science. If he's changed his view on this, that would be interesting.

But I'm almost certain that he would be opposed to the use of maths and physics in the way discussed in this interview. Which is why it's so puzzling to see INET lend its support to this kind of work.

Thanks,

Ed Beaugard

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