Equilibrium Illusion, Economic Complexity and Evolutionary Foundation in Economic Analysis
Introduction：It is widely believed that the idealized world without friction is a unifying foundation for equilibrium economics. This belief faces fundamental challenges from new findings in complexity science, which will lead to a paradigm shift in economic thinking and quantitative analysis.
Two basic models in equilibrium economics are the optimization model and the representative agent, which are based on a Hamiltonian framework in economic theory. The Hamiltonian approach is valid only for a conservative system without friction, i.e., no energy dissipation in the form of heat. Notable examples in physics are planetary motion and harmonic waves, including electromagnetic waves and the atomic spectrum. Two economic features go beyond the scope of the Hamiltonian system: business fluctuations and economic growth. Specifically, the building block in econometrics is random noise, which is the typical feature of energy dissipation or entropy production. In other words,an economic system is more like a biological system than a mechanical system,since they are dissipative systems not Hamiltonian systems in nature.
According to nonequilibrium physics, potential function no longer exists under far from equilibrium conditions, which indicates the limit of the optimization approach (Prigogine and Stengers 1984). Nonlinear dynamics told us that nonlinear interaction is the internal deterministic cause of seemingly random movements, an alternative mechanism for external explanation of business cycles. Positive feedback is a constructive force for growth and innovation, which is outlawed by equilibrium economics under the equilibrium condition of non-convexity. The many-body problem (such as social behavior) is essentially different from the one-body (in a representative agent) and two-body (in bilateral bargaining) problems. If we accept these new understandings in complexity science, we will easily realize that many doctrines in mainstream economics are simply equilibrium illusions, which are equivalent to perpetual motion machines against the laws of physics and the history of division of labor.
In this review chapter, we will examine two central beliefs in equilibrium economics: the self-stabilizing market and institutional convergence. We will see that both computational and natural experiments demonstrate the limits of the equilibrium approach and the potential of an evolutionary perspective based on a nonlinear and nonequilibrium approach.
In section 2.2, we give a brief review of how technical progress in complexity science led to a paradigm shift in economic thinking. In section 2.3, we discuss equilibrium illusions in economics and econometrics. In section 2.4, we demonstrate the main results of computational experiments in testing competing economic theories. In section 2.5, we study transition economies and their implications to economic theories. In section 2.6, we address fundamental issues to be solved by the next generation of economists. We hope that a new dialogue between scientists and economists will be fruitful in bridging the gap of two cultures, i.e., the mechanical and living world.
Ping Chen, “Equilibrium Illusion, Economic Complexity and Evolutionary Foundation in Economic Analysis,” Evolutionary and Institutional Economics Review, 5(1), 81-127 (2008). Also, Chapter 2, pp.11-52, in Chen (2010).
