Equilibrium vs. Nonequilibrium Views of Recovery: Complexity Economics Series Part 2

Published on INFORMS Analytics Magazine (Joseph Byrum)

Author’s note: This series Seeing Economic Collapse and Recovery Through the Lens of Complexity Economics will look at the pandemic-related economic problems we currently face and how we might apply important concepts of complexity economics to better understand how to move forward. Read Part One about the complexity economics view on pandemic recovery.

The “long-tail” shape of recovery from the 2008 financial crisis has prompted some economists to doubt the wisdom of equilibrium models and to support a different view. In a 2019 paper published in Nature, Klimek, Polednik and Thurner noted that “supply-demand equilibria do not exist during recessionary shocks” [1].

In studying the aftermath of the 2008 crisis, the authors focused on “resilience as a nonequilibrium property of networked production systems.” They looked at 56 industrial sectors in 43 countries between 2000 and 2014 and found that the susceptibility of individual industrial sectors to economic shocks greatly varied across countries, sectors and time. By not trying to fit the data into a preconceived econometric model, but letting it form its own patterns, this study took a nonequilibrium approach with some success. “We show that susceptibility-based growth predictions that take sector- and country-specific recovery into account, outperform – by far – standard econometric models,” the authors explained [2]. 

Equilibrium or Nonequilibrium Approaches?

Despite such approaches, equilibrium remains a dominant mode of economic thinking. For example, the U.S. Federal Reserve Bank has more than 2,000 resources that discuss “equilibrium” condition [3] but only two that mention “nonequilibrium” conditions [4]. As the term suggests, equilibrium economics sees the economic system as being in some kind of balance, much like the physical world described in Newtonian physics. Indeed, Adam Smith’s “Wealth of Nations,” one of the world’s most influential economic treatises, can be seen as a search for the laws of economics inspired by Isaac Newton’s search for the laws of physics [5].

In physics, equilibrium is “the condition of a system when neither its state of motion nor its internal energy state tends to change with time” [6]. A system’s equilibrium can be stable, when exogenous displacements produce forces that oppose the displacement and return the system to the equilibrium state, or unstable, when such displacements, no matter how small, produce forces that increase (rather than balance) the displacement. Mainstream economics today recognizes the nonequilibrium case, but still sees equilibrium, or balance, as the driving force of a system.

According to the equilibrium view, economies act much like the physical realm that we can see with our eyes. In this realm, certain truisms are common: what goes up must come down, there are no free lunches, and to pay Peter one must rob Paul. Of course, equilibrium economics admits that there are times when a system is disrupted, out of balance. But the equilibrium view says that the system will always seek to balance itself out.

The nonequilibrium view is quite different. Its analogies are more often derived from advanced thinking on the behavior of subatomic particles than from more traditional areas of physics. Complexity economics uses agent-based models to see how the economy indirectly emerges from the actions of heterogeneous individuals who are allowed to interact and influence each other’s action, much like the behavior of quantum particles [7]. As W. Brian Arthur stated in a seminal 1999 paper, while economic patterns sometimes simplify into the simple, static, equilibria of standard economics, more often they are “ever-changing, showing perpetually novel behavior and emergent phenomena” [8]. While they will show a pattern, it will not be a predictable one from a closed system, but something emergent [9].

This ability to look at systems through their agents can give rise to new kinds of thinking. A paper by Weyl and Sethi points out that the current situation is not like the typical “endogenous” recession arising from internal failures of the economy but rather from an external (or exogenous) threat [10]. A Santa Fe blog based on the paper (and showing more influence from complexity economics) finds that a “mobilize and transition” strategy could “reduce COVID-19 mortality while cushioning the economic decline” [11].

While the Weyl and Sethi paper does propose any particular economic theory (much less nonequilibrium economics), its main idea rests on agent-based modeling – one of the hallmarks of complexity economics – as it analogizes to a stop-and-search process. Their idea for recovery basically involves two programs – one called “find the safe” and the other called “find the virus.” The authors demonstrate a “game theory” type of thinking (thinking based on patterns) that draws an analogy to nondiscriminatory police stops and searches. “Translating this to the case of testing, the targeting of individuals should be such that the likelihood of testing positive is roughly equalized across locations, occupations and demographic groups, at least among those who have been recently tested. If a location is turning up more positives than another at the margin, resources would be better used by shifting to the former at the expense of the latter. Such adjustments require extensive mobile testing capability.” Interestingly, the Trump administration in the United States is considering a similar strategy with red and green zones [12].

Brief Reflection on COVID-19

It might be useful to look at COVID-19 and its spread as a complex adaptive system that is acting as a nemesis to our economy. Up until early 2020, we had a healthy global economy operating like a living system. Then the quasi-living phenomenon called COVID-19 began killing the main players of our economy (people) and in turn, the economy. Scientists are rightly focused on the virus – where it is, where it is going, what can kill it. Others are focusing on our economy – where it is, where it is going, what can revive it. Can the two efforts learn from one another?

In our next installment, we’ll apply 12 key lessons of complexity economics to the prospects for recovery.

References & Notes

1. Klimek, P., Poledna, S., and Thurner, S., 2019, “Quantifying economic resilience from input–output susceptibility to improve predictions of economic growth and recovery,” Nature Communications, Vol. 10, No. 1677, https://www.nature.com/articles/s41467-019-09357-w.
2. Ibid.
3. Search for “equilibrium” on April 4, 2020, https://www.fedsearch.org/board_public/search?source=board_pub&text=equilibrium&submit=Search.
4. One paper is Grundl, S., and Zhu, Y., 2019, “Robust inference in first-price auctions: experimental findings as identifying restrictions,” about an “overbid puzzle” (why people overbid), https://www.federalreserve.gov/econres/feds/files/2019006pap.pdf; the other paper is King, R.G., and Wolman, A.L., 2003, “Monetary discretion, pricing complementarity and dynamic multiple equilibria,” about a “sunspot” problem, https://www.federalreserve.gov/events/conferences/irfmp2003/pdf/Revised/KingFinal.pdf.
5. Diemer, A., and Guillemin, H., 2011, “Political Economy in the Mirror of Physics: Adam Smith and Isaac Newton,” Revue d’histoire des sciences, Volume 64, https://www.cairn-int.info/article-E_RHS_641_0005–political-economy-in-the-mirror-of.htm.
6. Hosch, W.L. (editor), undated, “Equilibrium,” Encyclopedia Britannica, https://www.britannica.com/science/equilibrium-physics.
7. Orrell, D., undated blog, “Economics Is Quantum,” https://aeon.co/essays/has-the-time-come-for-a-quantum-revolution-in-economics.
8. Arthur, W.B., 1999, “Complexity and the Economy,” Science, Vol. 284, http://tuvalu.santafe.edu/~wbarthur/Papers/Science%201999.pdf.
9. Wolchover, N., 2013, “In Mysterious Pattern, Math and Nature Converge,” Quanta Magazine, Feb. 5. There is a “universality” pattern in nature that shows a precise balance of randomness and regularity. This has been observed in measured aspects of many complex, correlated systems – both natural and economic. In such cases “a mathematical formula called the ‘correlation function’ gives the exact probability of finding two lines spaced a given distance apart.”
10. Weyl, G., and Sethi, R., 2020, “Mobilizing the Political Economy for COVID-19,” White Paper, March 26, https://ethics.harvard.edu/files/center-for-ethics/files/white_paper_3_mobilizing_the_political_economy_for_covid-19_3.26.20.pdf.
11. Allen, D., Weyl, G., and Sethi, R., 2020, “A ‘mobilize and transition’ strategy could reduce COVID-19 mortality while cushioning the economic decline,” SFI Transition: Complexity Science for COVID-19, April 6, https://sfi-edu.s3.amazonaws.com/sfi-edu/production/uploads/ckeditor/2020/04/05/t-007-allen-weyl-sethi.pdf.
12. Jacobs, J., and Sink, J., 2020, “Trump Health Team Crafts Plan to Open Economy if Virus Crests,” Bloomberg News, April 8, https://www.msn.com/en-us/news/politics/trump-health-team-crafts-plan-to-open-economy-if-virus-crests/ar-BB12l7YP?ocid=spartandhp.