So I got pulled into economics in 2007 because
of the 2008 economic crisis.
Mike Brown who had been the first CFO of Microsoft,
Chief Financial Officer of Microsoft and treasurer
of Microsoft, he came to Toronto in 2007 and
took my wife and I out to dinner and said
he was trying to put together a research group
to work on economics and he would like me
to be involved.
And I said, "I don't know anything about economics."
And he said, "That's okay because nobody does
and the whole system is about to collapse."
He said, "The balance sheets of all the big
investment banks -- it's like they have cancer.
They're full of holes."
And I remember being very struck by this because
this was before anybody was talking about
this.
And so I started to meet with a group of people
that he was pulling together to understand
what was gonna happen and to understand if
there was any way to save the situation.
It was a very ambitious thing and, of course,
we failed.
But along the way I was motivated as a kind
of public service to get interested in economics.
And what I found . . . economics, in a way,
is very easy for a physicist to understand
because it's very mathematical.
And the mathematical models that they use
are very clean.
They're based on assumptions and hypotheses,
and you can study them.
And as I studied it I began to understand,
some for myself and more from just reading
around because the faults with the standard
economic models, with the standard models
of finance, are well known.
They have been in the literature for decades
and decades.
So let me give some examples.
The standard model of economics is called
the neoclassical model and it assumes that
markets or systems where trading happens between
consumers and firms and there's certain simple
models of how that goes on.
And the ideas that these come to equilibrium.
Equilibrium not in the physical sense but
in special economic sense in which you reach
a point at which the prices are fixed such
that market forces fix the prices such that
you maximize the happiness of the consumers
and maximize the profits of the firms.
And in so called equilibrium nobody can become
happier or more profitable without somebody
else becoming less happy or less profitable.
And the ideology behind this -- not behind
the mathematics because mathematics doesn't
have an ideology -- but behind the arguments
that were made and still are made from this
model is that markets don't need regulation
because they have these natural equilibria
where everybody benefits to the maximum possible.
And if you're in equilibrium you can't do
better.
Now there's a fault with this and it's an
obvious fault and it's been known since the
1970s from some theorems proved by some economists
including some of the founders of this field
of mathematical economics, which is that there's
not one equilibrium, there are many equilibria.
In fact, there's a vast number of equilibria.
And so which equilibria, even assuming that
this is a decent model of the economy which
is not clear, but even assuming it's a good
model, which equilibria you're in depends
on the past history, it depends on regulation,
it depends on politics, it depends on taste,
it depends on changing taste, changing preferences.
And so history matters and what's called path
dependence matters.
This takes us outside the neoclassical model
of economics but it doesn't take us outside
of economics because some wiser economist,
for example, Brian Arthur had for years been
developing models and theories of path dependent
economy where the history does matter.
People from the area of complex systems like
Stu Kauffman, Prubac in developing models
of markets where the history matters, where
there's not a single equilibrium, where there
are many equilibria.
And where change is paramount.
Another symptom of this is the idea that arbitrage
isn't, I mean, in these neoclassical models
when you go to equilibrium, arbitrage is impossible.
Arbitrage is making a profit from trading
around a circle of goods or a circle of currencies
without actually producing anything.
And in equilibrium that's supposed to be impossible
but lots of firms and investment banks made
fortunes off of currency trading, so why is
that?
It turns out because you're never really at
equilibrium.
So why is the notion of equilibrium so powerful?
I think part of the answer is this idea of
physics envy, that economists thought that
what they're doing was more scientific, hence
more correct, if it looked like physics.
And physics had this timeless picture in which
what really mattered, as we were saying before,
is the whole history of the system.
And in physics there's also a big notion of
coming to equilibrium which is, although however,
it's important to say, a different notion
of equilibrium.
And somehow people in economics got seduced
into this model which again works in the small
-- if you have a small little corner of the
economy, a small market -- it may work for
a while to characterize approximately what's
going on.
Arbitrage is not always there.
It's not always, I mean, arbitrage, arbitrage
does get eaten up.
There are market forces which do push you
towards equilibria.
There's some truth in it.
But the whole thing is a disaster if I can
say that as an outsider.
And it led indirectly -- it wasn't the only
reason why regulations were lifted on markets
and trading through the decades, but when
people were making arguments to Congress,
to the President's office that the economy
would be better off without regulation, this
was the "scientific rationale for it" and
led to the very unstable situation of the
last economic crisis.
And indeed there's still a very dangerous
and unstable situation in the world economy
because -- well, I'm not an economist.
I'm not gonna pontificate about the problems
in the economy, but one could see how the
idea of timelessness gave false comfort to
an unsuccessful scientific theory in the realm
of economics.
