COMPLEX ECONOMICS

Abstract: Conflicting agendas in corporate governance show the limits of the transaction costs approach and property rights theory. A top-down approach of control and monitor may have negative effect on the competitiveness of the firm. The mechanic picture of transaction costs and agency costs is rooted in reductionism of firm theory. The Coase world of zero-transaction costs is contrary to the law of thermodynamics and historical trends of industrial economies. Diversified patterns in corporate governance and corporate culture can be better explained by the creative nature of the firm in evolutionary economics. China’s experiments under mixed property rights during economic transition shed new light on life cycles in changing ownership and corporate governance. The survival of a firm is more associated with the emergence of selective mechanisms and adapting ability.

Keywords: transaction costs, corporate governance, selective mechanism, life cycles,evolutionary thermodynamics.

*Chen, Ping. “Complexity of Transaction Costs and Evolution of Corporate Governance,” Kyoto Economic Review, 76(2), 139－153 (2008). Also, Chapter 14, pp.270-282, in Chen (2010).

Chen, Ping. “Disillusion in Utopian Capitalism and Lessons to the Development of China,” World Review of Political Economy, 5(3), 414-429 (2014).

Abstract：The principle of large numbers shows that the relative deviation for a macro system with independent elements is of the order of Lucas’ approach to a microfoundations for macroeconomic fluctuations is thus not capable of explaining the magnitude of observed macroeconomic fluctuations. Arbitrage activity would largely eliminate correlations created by rational expectations among economic agents when they face counter movements in relative prices. The complex nature of many-body problems and the statistical feature of aggregate indexes cannot be ignored in a micro–macro modeling. Intermediate structures, such as fifinancial markets and industrial organizations, are more important than households and fifirms in generating business cycles.

Keywords: Large numbers; Microfoundations; Arbitrage; Relative price movements; Rational expectations;Intermediate structure

Ping Chen,  “Microfoundations of Macroeconomic Fluctuations and the Laws of Probability Theory：the principle of large numbers versus rational expectations arbitrage,” Journal of Economic Behavior & Organization, 49, 327-344 (2002). Also, in Chen (2010), Chapter 13, pp. 251-269.

Tang, Yinan, Wolfram Elsner, Torsen Heinrich, and Ping Chen, “Trend, Randomness, and Noise: Exogenous vs. Endogenous Explanation in Complex Heterodox Analysis (A Note on Nicolas Bouleau in RWER 60)”, Real World Economics Review, no.62 (2012).

Abstract：The Washington Consensus failed to recognize the need of the developing world and the limits of the western mode of industrialization. In last three decades, China experiments a new approach with self-determination, open-minded learning, decentralized experiments, and dual-track reform to simultaneously achieve high speed growth, social stability, and international partnership in peaceful evelopment.

Chen, Ping. “China Approach in a Changing World,” Invited Keynote speech at 6º. FORUM DE ECONOMIA DA FUNDAÇÃO GETÚLIO VARGAS, Sao Paolo, Brazil, Sept.22, 2009. In Bresser-Pereira, Luiz Carlos, ed. Depois da Crise. A China no centro do mundo? (After the Crisis, China in the Center of the World?), Rio de Janeiro: Editora FGV (2011). 

Introduction：A central issue in business-cycle theory is the nature and origin of persistent business cycles. There are mainly two lines of economic thinking: the endogenous school and the exogenous school (Zarnowitz 1992). Schumpeter considered business cycles as the life rhythm of an economic organism (1939).Goodwin introduced the nonlinear and chaotic oscillator to describe persistent business cycles (1951, 1990). However, early evidence of economic chaos has received little interest in mainstream economics, because the existence of economic chaos may imply serious challenges to the foundations of equilibrium theory and parametric econometrics (Barnett and Chen 1988; Chen 1988a, 1993a, 1996a, 1996b; Brock and Sayers 1988). In contrast, the exogenous school represents mainstream economics since the 1930s; whose founder was Ragnar Frisch (Kydland 1995).

Hayek realized that empirical features of business cycles were difficult to understand by equilibrium theory (Hayek 1933). However, Frisch suggested that a noise-driven damped oscillator might explain both market stability and persistent cycles, which he claimed in an informal paper in 1933 (Frisch 1933). Contrary to Frisch’s belief, physicists had known since 1930 that a harmonic oscillator under Brownian motion could not produce persistent oscillations (Uhlenbeck and Ornstein 1930; Wang and Uhlenbeck 1945). Today Frisch’s belief is still widely held among economists and econometricians. Indeed, it is a mystery as to why Frisch never published his promised paper, and why the first Nobel Prize in economics was awarded to an unproved and wrong idea. Reexamining the Frisch model will help us to understand the origin of equilibrium belief in economic thinking.

In this chapter, we will give a brief history of the Frisch model, and then discuss its theoretical and empirical implications. We will show that the linear deterministic model of business cycles has structural instability. The effect of external noise to a linear oscillator can be studied by the Langevin equation and the Fokker–Planck equation. We may obtain the analytical solution for a harmonic oscillator under Brownian motion. Its exponential decay in amplitude and autocorrelations indicate that white noise is not capable of producing persistent cycles. We can directly estimate the intrinsic frequency and friction coefficient from real US GDP data. We then will discuss the main implications from the Brownian motion of a harmonic oscillator, and basic problems of the linear model of business-cycle theory.

Chen, Ping. The Frisch Model of Business Cycles – a Spurious Doctrine, but a Mysterious Success (1999), Also, in Chen (2010), Chapter 12, pp.239-250.

Instability, Complexity, and Bounded Rationality in Economic Change

Ilya Prigogine, Ping Chen, and Kehong Wen

In Cooper, W.W., S.Thore, D.Gibson, and E.Phillips Eds. Impact: How IC2 Institute

Research Affects Public Policy and Business Practices, Quorum Books, Chapter 11,

pp.209-218, CT: Westport (1997).

Abstract：Economic order and structural change can be better understood from the perspective of self-organization under non-equilibrium constraints. The constructive role of instability, prevalence of complexity, and source of bounded rationality are demonstrated by examples of traffic flow, complex business cycles, economic crisis, division of labor, and economic development. The socioeconomic order can only be maintained by self-organization processes.

Abstract ：The random-walk (white-noise) model and the harmonic model are two polar models in linear systems. A model in between is color chaos which generates irregular oscillations with a narrow frequency (color) band. Time-frequency analysis is introduced for evolutionary time series analysis.The deterministic component from noisy data can be recovered by a time-variant filter in Gabor space. The characteristic frequency is calculated from the Wigner decomposed distribution series. It is found that about seventy percent of fluctuations in Standard & Poor stock price indexes, such as the FSPCOM and FSDXP monthly series, detrended by the Hodrick-Prescott (HP) filter, can be explained by deterministic color chaos. The characteristic period of persistent cycles is around three to four years. Their correlation dimension is about 2.5.

The existence of persistent chaotic cycles reveals new perspective of market resilience and new sources of economic uncertainties. The nonlinear pattern in the stock market may not be wiped out by market competition under nonequilibrium situations with trend evolution and frequency shifts. The color-chaos model of stock-market movements may establish a link between business-cycle theory and asset-pricing theory.

Ping Chen, “A Random Walk or Color Chaos on the Stock Market?Time Frequency Analysis of S&P Indexes,” Studies in Nonlinear Dynamics & Econometrics , 1(2), 87-103 (1996). Also, in Chen (2010), Chapter 6, pp.151-172.

Chen, Ping. “Three Dimensions of Current Economic Crisis,” in Looking for Solutions to the Crisis: The United States and the New International Financial System, Conference Proceedings, New York, Nov. 14, 2008, EPS (Economists for Peace and Security) and IRE (International Initiative for Rethinking the Economy), Published in Clamecy, France (2009).

Washington consensus and shock therapy forgot Keynesian lessons from the Great Depression: market instability and the active role of government in promoting growth. The severe output decline in East Europe and former Soviet Union (EEFSU) was triggered by simple-minded policy of liberalization and privatization, which ignored economic complexity and multiple equilibriums under division of labor. New fundamental issues, such as chain reactions between macro instability and micro behavior, the government role of creating learning space in development, interactions among economic openness, sustainable growth, social stability, can be revealed from comparative experiments between China and EEFSU, including exchange rate regime, price dynamics, trade policies, and reform strategies. The tremendous cost of the Transition Depression sheds new light on theoretical limitations of demand-supply analysis, hard-budget constraints, microfoundations theory in macroeconomics, and property right school in institutional economics. New development policy based on learning, innovation, and decentralized experiment will broaden our scope of economic thinking.

Chen, Ping. “Market Instability and Economic Complexity: Theoretical Lessons from Transition Experiments” in Yang Yao and Linda Yueh eds., Globalization and Economic Growth in China, Chapter 3, pp.35-58, World Scientific, Singapore (2006). Also, Chapter 15, pp.285-300, in Chen (2010).

A new analytical tool of time-frequency analysis, based on the symmetry principle in frequency and time, is introduced for studies of business cycles. The Wigner-Gabor-Qian (WGQ) spectrogram shows a strong capability in revealing complex cycles from noisy and nonstationary time series.

Competing detrending methods, including the first difference (FD) and Hodrick-Prescott (HP) filter, are tested with the mixed case of cycles and noise.FD filter does not produce a consistent picture of business cycles. HP filter provides a good window for pattern recognition of business cycles.

Existence of stable characteristic frequencies from economic aggregates provide strong evidence of endogenous cycles and valuable information about structural changes. Economic behavior is more like an organism instead of random walks. Remarkable stability and resilience of market economy can be seen from the insignificance of the oil price shocks and the stock market crash.Surprising pattern changes occurred during wars, arm races, and the Reagan administration. Like microscopy for biology, nonstationary time series analysis opens a new space for business cycle studies and policy diagnostics.

The role of time scale and preferred reference from economic observation is discussed. Fundamental constraints for Friedman’s rational arbitrageurs are eexamined from the view of information ambiguity and dynamic instability. Nonlinear economic dynamics offers a new perspective in empirical measurement and theoretical analysis.

Chen, Ping. “Trends, Shocks, Persistent Cycles in Evolving Economy: Business Cycle Measurement in Time-Frequency Representation,” in W. A. Barnett, A. P. Kirman, and M. Salmon eds., Nonlinear Dynamics and Economics,  Chapter 13, pp. 307-331, Cambridge University Press (1996). Also, in Chen (2010), Chapter 7, pp.173-197.

Abstract：This paper argues that the success China’s economic reform, contrasted with the difficulties of Eastern Europe and Russia, stems mainly from China’s willingness to tolerate decentralized experimentation and a gradual evolution of new institutions, whereas in Eastern Europe and Russia a sense of urgency led to wholesale importation of foreign institutions. This contrast in turn has implications for the usefulness of non-linear, dynamic analysis over the traditional neoclassical paradigm.

Chen, Ping. “China’s Challenge to Economic OrthodoxyAsian Reform as an Evolutionary, Self-Organizing Process,” China Economic Review, 4, 137-142 (1993). Also, in Chen (2010), Chapter 11, pp. 231-235.

INTRODUCTION：Neoclassical models in microeconomics often describe an atomized society, in which every individual makes his or her own decision based on individual independent preference without the communication and interaction with the fellow members within the same community.1 Therefore, static economic theory cannot explain collective behavior and changes of social trends, such as fashion, popular name brand, political middling or polarization.

Physicists have been interested in collective phenomena caused by the success of ferromagnetic theory in explaining collective phenomena under thermodynamic equilibrium. The Ising fish model2 and the public opinion model3 represented the early efforts in developing complex dynamic theory of collective behavior. However, the human society is an open system, there is no ground to apply the technique of equilibrium statistical mechanics, especially, the Maxwell-type transition probability, to social behavior. Therefore, these pioneer models have been discussed in physics community, but received little attention among social scientists.

However, the development of nonequilibrium thermodynamics and theory of dissipative structure open new way to deal with complex dynamics in chemical systems and biological systems,4,5,6 that have many similarities with the behavior of social systems. In this short article, we will introduce new transition probability into master equation from the consideration of socio-psychological mechanism. The model may shed light on social behavior such as fashion, public choice and political campaign.

Chen, Ping. “Imitation, Learning, and Communication: Central or Polarized Patterns in Collective Actions,” in A. Babloyantz ed., Self-Organization, Emerging Properties and Learning,  pp. 279-286, Plenum, New York (1991). Also, in Chen (2010), Chapter 9, pp.210-216.

Abstract：Joseph Needham’s question Why did capitalism emerge in the West and not in China is discussed along with the sources to form a centralized state and the mechanism for perpetuating the Chinese bureaucracy. The relationship between the stability and complexity of socio -ecological systems is also analyzed. The potential application of nonequilibrium thermodynamics and nonlinear dynamics to social evolution in China is introduced. A brief survey of historical and contemporary issues relating to the transition of agricultural structure in China and the recent crisis in economic and political reform is given.

Chen, Ping. “Needham’s Question and China’s Evolution – Cases of Nonequilibrium Social Transition,” George Scott ed., Time Rhythms and Chaos in the New Dialogue with Nature, Chapter 11, pp.177-198, University of South Dakota at Vermillion, Iowa State University Press (1990). Also, in Chen (2010), Chapter 10, pp.217-230.

Chen, Ping. “The Aggregation-Theoretic Monetary Aggregates are Chaotic and Have Strange Attractors: An Econometric Application of Mathematical Chaos” (co-authored with William A. Barnett), in Dynamic Economic Modeling, W. A. Barnett, E. Berndt, and H. White eds., Chapter 11, pp.199-245, Cambridge University Press, Cambridge (1988 ).