Complexity Fetishism, the Euro Crisis and a worthy challenge for 2012: Part B

Part B: The lure of naive models in the era of financialisation (*)

[(*) For the rationale of this four-part series of posts, as well as for Part A of the series, click here.]

Preface: Part A of this four-part series of posts began by focusing on the problematic application of the analytic-synthetic method to socio-economic interactions. It argued that the economists’ penchant for ‘analysing’ complexity (through a process of breaking it down to its ‘constituent parts’, before synthesising the knowledge of those parts into a macro theory of the whole) delivers logically incoherent insights regarding the phenomena under study. But, remarkably, because the analysis itself is so complex (from a mathematical perspective), few can see through these models and realise their inanity. And given that the economists’ models have a great deal of utility for politicians and financiers, they become established as ‘conventional wisdom’.

B1. Is it a matter of dishonesty? On the process by which the economics’ profession becomes ‘captured’ by its theoretical artefacts

If I am right (that the analytic-synthetic approach of mainstream economics produces logical incoherence of untold complexity), how come so many smart economists pursue this practice, building on it fabulous careers in the best universities? Is there a conspiracy? No and no, is the simple answer. There is no conspiracy and it would be absurd to think that the economists involved knowingly indulge in theoretical subterfuge. So, what is going on? Here is what I think the answer is:

Economists are, by and large, an exceptionally open-minded people, willing to countenance any proposition, however farfetched, weird or even… leftwing. All they ask for in return is that the said proposition is embedded within their models. This ‘openness’ is made all the more significant by the fact that, undoubtedly, any conceivable ‘story’ can be told by tinkering with the economists’ axioms and hypotheses. Enticed by the prospect of unbounded theoretical possibility, the aspiring young economist delights in tinkering her way into the infinite vistas of potential economic narratives of everything and anything; she even revels in sailing the oceans of indeterminacy stirred up by her tinkering.

At some point, however, the fun must give way to publications, appointments and full induction into the profession. At that point, the lurking gatekeepers (supervisor, referees, Head of Department etc.) present her with a fresh condition: To be allowed into the priesthood, her models must have first achieved ‘closure’ (i.e. a restricted set of solutions, or ‘equilibria’ as economists call them); she must, in effect, submit them to the merciless tightening of her axioms in order to produce an ‘orderly’ narrative on what her model actually predicts.

The problem with squeezing a determinate solution out of her models is that to do so she must tighten her axioms in a manner that, at some level, defies logic. In the example mentioned in Section A2 of Part A the hapless economist must assume that certain unknowable probabilities are not only known but that everyone shares precisely the same estimate of them. But how can the unknowable be commonly known? The only answer the economist has is that, if the unknowable is not commonly known, then there can be no solution to her model (and no prediction of what will transpire). The honest retort, at that point, is to say: So what? If this is how things are, then clearly the model cannot predict anything.

Alas, the cost of admitting this is too great. Having already invested great energy and hope in her modelling, it takes a brave and tragic theorist to make this confession and call it quits. For if she does make this admission, her model will not be ‘closed’ neatly, her paper will not be published and her career will not take off. What tends to happen in the economics’ profession is the following:

  • a tiny minority of practitioners ‘close’ their models reluctantly, tucking critical comments away in their papers’ footnotes, biding their time and, once tenured, turn into resident critics.
  • some ‘close’ their models and steer clear of any controversy but, nonetheless, manage to retain the memory of how their profession’s imperatives whipped them back, from a complex and rewarding inquiry, to a paradigm devised for arid theorizing in the context of which a sophisticated theory of behaviour, of price formation, of crises etc. is as viable as a fire under a mighty waterfall
  • the vast majority not only leave no stone unturned to ‘close’ their models, often with moral enthusiasm, but also sweep under the emotional carpet any memory of how their models’ ‘closure’ was bought at the price of a ‘haircut’ on logic.

Once young economists have compromised themselves in this manner, in order to become established in the academic profession (usually at Graduate School), they soon discover that they must do so again and again and again, if they are to stay the professional course. For once they are called upon to impart their wisdom in the amphitheatres, or to ‘advise’ government, business etc., their audiences demand a nuanced story of how their ‘closed’ models apply to the real world. Telling them that you can have either such a nuanced narrative or determinate models but never both requires the combination of intellectual honesty, mathematical acumen, and secure academic employment that only exceedingly rare birds have ever possessed. In their absence, the vast majority sustain the illusion of a nuanced, determinate theory by keeping shifting backwards and forwards between (A) ‘closed’ oversimplifications and (B) complex-yet-indeterminate models; and, last but not least, by (sub-intentionally) hiding all this under a rhetorical cloak which gives (even to themselves) the impression of a serene, unchallenged scientific authority.

B2. How the failed models became functional to the most toxic aspects of politics and financialisation

It is of course true that the very sight of a system of equations inspires a natural urge to solve it (and a feeling of disappointment when it proves over-determined). However, the economists’ zeal goes beyond that natural urge. The reason they are so hell bent on the endogenous determination of all variables (prices, quantities, wages, profits, but even social norms, moral entitlements, psychological utilities) exclusively on the basis of the initial, primitive data of their mathematical model, is that they understand the great rewards they have been receiving in the universities from having convinced the powers that be that they, the economists, are the only genuine social scientists. They have tasted the large rewards from ‘going it alone’; from appearing to be self-sufficient social scientists; ‘scientists of society’ who need no help from historians, psychologists, anthropologists or, God forbid, sociologists.

In this sense, economics’ closed-model approach is enforced by the invisible hand of academic rent seeking. This is how the (unseen to most) logical incoherence of their models (which is necessary in order to close them) is compensated for: By large academic research projects, salaries well above those of other social theorists and, importantly, an open communications’ channel with those in authority both in the financial sector and in government. Let us focus on these two channels: the one linking economic theorists to the world of political authority and the one connecting them to Wall Street et al.

Starting with the link between the economists’ models and financialisation, have you ever wondered where the financial engineers found the courage to argue that their own models could value the toxic derivatives that they were creating? The answer is devastatingly simple: The pricing models they used could only work (i.e. come up with a number denoting the ‘value’ of the CDO under construction) if their author imposed upon them the sort of tight axioms (or farfetched hypotheses) which the economists had learnt to adopt (against logic and reason) in order to ‘close’ their own economic models (in pursuit of academic success). Thus emerged a commonality of purpose: The most highly regarded mathematical economists, who turned a blind eye to the lack of logical coherence of certain assumptions necessary to ‘close’ their models, discovered that financial engineers who adopted these same assumptions made a bundle of money (by managing to turn their CDOs into tradable commodities). And the financial engineers, when needing to justify their models, pointed to the similar assumptions made by the best economists in the universities; indeed, by Nobel Prize winners…

Suddenly, economists bending the rules of logic in order to ‘close’ their models (for the sake of deriving determinate economic forecasts from them) entered into a loop of positive mutual reinforcement with the financial engineers who copied the economists’ axioms to compute the value of their financial products, and thus to enrich themselves and their employers. This feedback effect between economists and financial engineers proved exceedingly strong and highly lucrative for both. The economists involved, significantly, became all the rage in Wall Street. Guess which type of economist (the latter or those who kept questioning the logic of the said axioms) got all the perks, the large research budgets, a free pass to come-and-go between their University and some great bank at will and, lastly, the kudos within academia: Yes, the ones with a greater propensity to turn a blind eye to the logical flimsiness of the axioms necessary to ‘close’ the models.

Turning now to the link between these economic models and the political currents of the era, it is helpful to begin with an observation: Politicians who wanted to ride the wave of financialisation had a natural tendency to suggest to the electorate that what was going on was natural, that there were no risks involved of some Crisis (like that which, eventually, hit us), that even observed unemployment was OK, natural, part of the adjustment process that the labour market must go through. In technical language, mainstream politicians who posed as Wall Street’s blue eyed boys, had an interest in presenting current prices and interest rates are sufficient statistics by which to estimate the future as a linear extrapolation of the present. Financial markets were, thus, axiomatically conceived of as efficient mechanisms for spreading risk and distributing capital that no humble intellect could plausibly doubt or second-guess.

In all this, any serious discussion of the possibility of some Crisis was dismissed as non-sensical. And when one asked “Why is it non-sensical?” the answer took the form of a recapitulation of the models on which the forecasts and the valuations were predicated, without of course ever delving into the logically incoherent assumptions that most could not even discern.

In this sense, the economics profession’s ostracism of any analysis that ventures beyond the economists’ hidden axioms was tantamount to a subconscious strategy that brought great rewards to the economists involved, wonderful profits for the financial engineers that copied the same hidden axioms into the formulae that priced their derivatives and, lastly, re-election and long terms in office for the politicians whose policies were based on these models.

While the world is currently struggling to make sense of the tumult visited upon it by a particular strand of globalising capitalism, the latter’s best defence comes in the form of thousands of young economists being quickmarched headlong into academic obscurantism and socio-economic irrelevance. Instead of acting as the avant guard that will prise out the truth about the causes and nature of the current crisis, they are conscripted to this perpetual feedback mechanism which mutually reinforces (a) the current economic order and (b) the core of mainstream economics. Future historians undoubtedly will mark this out as our era’s most fascinating, and most tragic, evolutionary social dynamic.

B3. Epilogue: The curious success of theoretical and practical failure

Perhaps the greatest puzzle for our post-2008 times concerns the curious fact that nothing succeeds these days like grand failure. Economists draw their immense narrative power from an audaciously circular process of mutual reinforcement: faithful to its constitutive analytic method, which they juggle continuously in a manner that hides their implications (and, often, their logical incoherence), toxic economics retains its hold over the economics mainstream and rules itself out of engagement with the logic of really existing capitalism. Then, those who manage the latter supposedly on our behalf (politicians, bureaucrats, Wall Street), supra-intentionally, reward toxic economics with institutional power which helps it maintain a strict embargo on any serious scrutiny of either its own foundations or of really-existing capitalism.

It seems almost indelicate to point out that, while this feedback mechanism remains opaque and unexamined by the rest of us, the crony capitalism we live under and the toxic economics that supposedly sheds light on it will remain strangers who reinforce each other’s dominance as long as (a) economics remains, courtesy of its ‘closed’ model methods, innocent of the logic of crony capitalism and (b) the logic of crony capitalism spreads faster and deeper when economics’ method help it remain toxic.

NEXT:  The next part in this series, Part C, will be entitled “Crisis and the temptation of Complexity Fetishism: The eurozone case.

Further reading:

  • Yanis Varoufakis (2008). ‘Game Theory: Can it unify the social sciences?’, Organisational Studies, 29, 1255-77 
  • Yanis Varoufakis (2006). ‘Rational Rules of Thumb in Finite Dynamic Games: N-person backward induction with inconsistently aligned beliefs and full rationality’, American Journal of Applied Science, 2 (Special Issue), 57-60
  • Shaun Hargreaves-Heap and Yanis Varoufakis (2004). Game Theory: A Critical Text, London and New York: Routledge
  • Abstractions and morality in modern finance, Posted by Lisa Pollack on 23rd December 2011, FTAlphaville


  • “The invisible hand of academic rent seeking” has been assaulting academe for quite sometime, yet she remains -mostly- silent.

    Your description of naive models reminds me of Vandana Shiva’s “reductionism” and of Jacques Ellul’s “technique”.

  • . . . have you ever wondered where the financial engineers found the courage to argue that their own models could value the toxic derivatives [CDOs] that they were creating?

    Yani, wasn’t it simply a scam from the start? These CDOs, unlike the original mortgage-backed bonds when first introduced, were not well-diversified pools of mortgages. Far from it — They were subprime, high-risk mortgages; in other words, and please excuse the phrase as it comes from an internal Bear Stearns e-mail, a “sack of shit.” I mean, when you’re dealing with “shit” from the start, can you sincerely pretend that you can categorize said “shit'” into tranches in which some “shit” is more valuable than the other “shit”?

    And, as Matt Taibbi in a recent aritcle for RollingStone states, investors turned a blind eye, or were unsuspecting, because the likes of Bear Stearns wrapped these toxic derivatives — “sack of shit” — in bond insurance (unbeknownst to the insurers, of course, and hence the pending lawsuits).

    Btw, I wonder who the clever financial engineer was who came up with the synthetic CDO? 😉

    Guess which type of economist (the latter or those who kept questioning the logic of the said axioms) got all the perks, the large research budgets, a free pass to come-and-go between their University and some great bank at will and, lastly, the kudos within academia: Yes, the ones with a greater propensity to turn a blind eye to the logical flimsiness of the axioms necessary to ‘close’ the models.

    Ok, I’ll take a wild guess and say the neoclassical type a la Paul Krugman (that toady for theClinton push for NAFTA).

    Here’s one. Guess who said this (from recently released FOMC transcripts, from a Dean Baker article in

    “I’d like the record to show that I think you’re pretty terrific, too. And thinking in terms of probabilities, I think the risk that we decide in the future that you’re even better than we think is higher than the alternative.”

    Wow! There is sucking up and there is SUCKING UP. 😉

    • So was my wild guess correct — It was the neoclassical type of economist?

      Ron Paul, for example, is from the Austrian school. I like that he is against the wars, but, because of his Austrian beliefs, he advocates free-market policies (socialism very bad). And that is all I need to know because something so important as single payer universal health care would be anathema to him. If you’re seriously ill and you don’t have health insurance, and you can’t afford to pay, then it’s your tough luck: Die.

  • Mr Varoufaki , i would like a comment from you about the accusations concerning ELSTAT, Georgiou , Papakostantinou and Papandreou .
    I understand that it’s a complicated case . I understand that what is going to happen is highly unpredictable . Our MPs can refuse to proceed . The most possible outcome is a parody in the parliament .
    Nevertheless , for such serious accusations , whoever can stand next to the truth , has to do it , for the simple reason that if no one dares to claim the truth , those who are unjust and deceitful will prevail without a fight .

    • This is the tragedy of our judicial system. Its incompetence (i.e. the complete absence of an investigative arm) and corruption means that no politician can ever be proved guilty. And this means that no one can be thought of as innocent – including those who are. On the specifics of this case, I cannot pass judgement (i.e. be investigator, judge and jury). but I do know that the Papandreou-Papakonstantinou duo are guilty of gross political failure which they invested with the most astonishing arrogance. I think the nation’s overwhelming contempt is a fitting sentence.

    • I think the nation’s overwhelming contempt is a fitting sentence.

      Yes, I know justice will probably not come — and by justice I mean the convicted each get some serious prison time in a cell shared with a guy named “bubba” (sorry, don’t know the Greek equivalent) — but I don’t think they care what the nation thinks of them, Yani. I mean, you have to have pretty thick skin to get into politics; it’s obviously not for the sensitive type.

      Matt Taibbi, in a column for Rolling Stone, has called Jeffrey Verschleiser (of Bear Stearns “sack of shit” notoriety) ” one of the biggest assholes in the entire world!” I am sure JV is aware of it. Does he care? Doubt it. Thanks to all the millions he’s stolen, he and his family are living the high life. He’s decided to rent for 3 days all 94 rooms of a luxury hotel for his duaghter’s Bat Mitzvah — with other
      people’s money, of course.

  • Articles like this indicate that there might be some hope after all, because what was most depressing post-2008 was the way the basic paradigm remained intact. Kuhn nicely described the resistance to paradigm shifts – the way that contradictory data can be ignored – I am sure he would have been dumbfounded to see the way the cataclysmic events of 2007-2008 could be brushed under the paradigmatic carpet.

    A quibble though: You say repeatedly that toxic economics is illogical. Surely the problem is not a lack of logic, but a failure to recognise that the thing being theorised (social life) cannot be reduced to a set of equations? It can also not be expressed as a set of logical propositions. Indeterminacy is inherent in social life (why here among the Greeks is it the girls who wear the lipstick while among the Massai it is the boys?). I assume that economists are wise enough to see that there cannot be a science of all social life (e.g. there cannot be a science of love – of sex, perhaps, but not of love in all its interesting details, like the details of facial adornment and courtship), and yet they clearly want to insist that one aspect of life – economic life – can be considered in isolation and identified with a mathematical model.

    I am off now to read Lisa’s article on morality, because that is surely the nub of the issue, and it is the destruction of ethical life by crony capitalism that makes it seem less and less ridiculous to construe one part of social life (the economic) as utterly mechanical.

    • “You say repeatedly that toxic economics is illogical. Surely the problem is not a lack of logic, but a failure to recognise that the thing being theorised (social life) cannot be reduced to a set of equations?” One and the same thing, I am afraid. Because (as you say) “the thing being theorised (social life) cannot be reduced to a set of equations”, the only way of doing this is by means of axioms that are logically incoherent; e.g. assuming that people will behave in particular ways in parts of the social game that the same theory concludes they will never reach…

  • With a change in vocabulary it would be a good description of the famous “climate science” cronyism and academic advancement. The hubris of thinking that one can make a deterministic closed system out of what is deterministic chaos.

  • This is a brave article. I’ve been following your commentary, posts, etc. with enthusiasm ever since you argued against B. Papadimitriou and M. Xafa on “Neoi Fakeloi” (a couple of years ago when everything started) that we shouldn’t take for granted that the private sector in Greece consists of good entrepreneurs – again, a simple and bold argument which voiced out what many people were silently sharing as a concern. Your current argument then, against academic reasoning, is anything but familiar in my sector: I teach architectural design. And in architecture, reasoning with complexity through a narrative is a fundamental gesture and most usually the generator of whatever construction of a new reality we actually produce. It seems like in economics, which I know very little of, as well as in architecture, the outcome of our efforts as proffessionals is really hard to hide under the carpet! But then, we can always rely on theory to settle our blindness in once more…

    Thanks again for all your efforts to voice out so many of our concerns! (and in a way we can understand them)

  • Yanni,

    I would like to suggest this.

    The economy is a chaotic system, but that doesn’t mean it cannot be predicted with modeling methods. The problems is that the models that current Economist use are incomplete, based on empirical data, little actual science and more historical pattern matching rather than actual correlation.

    If the numbers to tell you the truth, you are looking at the wrong numbers.

    I would suggest to get a student to do some PhD research on Finite Element Analysis methods for full economic modeling.

    Remember the days when they could hardly predict next days weather. Then with modeling they managed to get 2-3 days of prediction and now with supercomputers they can get 15 days of weather prediction.

    The same can be done with economics… but you have to get engineers, mathematician and economist all in the same room and cross-pollinate..

    • Dear Jason,

      I beg to differ. Weather prediction is difficult, because of the non-linearities involved (the ‘chaos’ theory aspect of it). But it is not insurmountable. In sharp contrast, economic phenomena are not just hard to predict. Their prediction is impossible. Why? Because human economies (quite unlike those populated by automata) are subject to something worse than the worst non-linearities: infinite regress. This was my point: When our theories of a phenomenon under study are an instinsic part of the phenomenon, no ‘closed’ model-theory can explain the phenomenon. Metereologists would be facing exactly the same conundrum if, say, the weather responded to average human predictions of the weather.

    • NOW I understand. I am left wondering, though, how you are going to pan out the political implications of the limits of economic theory, because I read that (equally brilliant) Lisa Pollock article and read some of the details of the disturbingly bizarre things going on in the world of finance, and now I wonder what the reaction would be if I rushed into one of those offices clutching your posts, and I said: “Guys, Wait a minute! Those theories you are using for pricing stuff, they aren’t valid?” “Why?” they ask. “Because people know about them and so they are going to act differently. It’s like Heisenberg, but worse,” I tell them. But I just see them shrugging their shoulders. So I explain about the crashes and the economic devastation and the economic suicides of farmers and small businessmen too deep in debt, and again they just shrug their shoulders. “We make money on the way up. We make money on the way down.”

    • Jason,
      You’ve demonstrated your faith-in-science belief that if just enough science is brought to economics it will be solved. That is exactly what economists have been doing for over a century – taking a leap of faith that making the ‘right assumptions’ will not only solve the chaos, but somehow explain all the vicissitudes of human psychology.

      The faith-based economics of mainstream theory has largely become a political tool for transfer of wealth from poor and middle class to the rich. That’s all.

  • Although this is not the first time that Mr Varoufakis talks about the nature and politics of “modern economics” , it is more than evident that such critique becomes possible due to the fact that the bubble has exploded . Such criticism was unthinkable 15 years ago .

    My wish is that such realization as the one of Mr Varoufakis in economics , is also made in other sciences as well . Environmental science for instance . Biology and genetics . Pharmaceutical companies . The almost eclipse of anthropological sciences and philosophy . The “profit is above all” mindset has created bubbles in other fields as well . Let’s hope that we won’t wait for absolute disaster in these areas before we make our criticism and act .

    • Such criticism was unthinkable 15 years ago.

      There was criticism, all right. Unfortunately, in teaching, in research, and in public policy, all non-neoclassical economic ideas were purged. And according to Steve Keen, these purges were “aided and abetted by developments in the economy”; that is, things were going well enough that neither the public nor media questioned neoclassical thinking.

      Get a copy of Steve Keen’s Debunking Economics: The Naked Emperor Dethroned. It makes an excellent complement to Yani’s The Global Minotaur. (Btw, since I won’t be going to the beach any time soon:-(, and TGM has whetted my thirst to learn more, I look forward to reading the more detailed Modern Political Economics: Making Sense of the Post-2008 World by Yani, Halevi, Theocarakis (2011).)

  • Professor while I generally agree with your argument I have to wonder this….if said economists actually stepped up and admitted defeat as far as the predictive power of their models would this make economics’ practical use ultimately irrelevant?

    I mean they could argue that even Adam Smith made some pretty ludicrous assumptions to make his ideas work.

    • I only wish economists’ models were made irrelevant. Presently they are poisonous. As for Adam Smith et al, all theory requires assumptions, even simplistic and silly ones. The problem with modern economics is that to close the maths we need crucial assumptions that are (a) hidden and (b) logically inconsistent. The latter is not the same as ‘silly’. It is like assuming at once that A is equal to B and A is never equal to B. Adam Smith can never be accused of that…

    • Thank you for your reply professor.

      I was wondering if you could point me towards a model that is a blatant violation of human logic, such as what you described in your reply.
      If the mathematics are not too alien I would appreciate it (it’s been a while since the basement of Aristeidou). If not it’s okay, I’ll figure it out.

      Thanks in advance.

      PS. With your busy schedule do you find the time to teach at Oikonomiko? Game Theory especially!

  • Regarding complexity fetishism,

    Glass–Steagall Act of 1933 —> only 34 pages long

    Dodd–Frank Wall Street Reform Act of 2010 —> 2300 pages long!

    Regarding failed models,

    Excerpt from the 2008 Congressional hearing on the role of financial regulators in the financial crisis:

    REP. WAXMAN: Do you feel that your ideology pushed you to make decisions that you wish you had not made?

    MR. GREENSPAN: Well, remember that what an ideology is, is a conceptual framework with the way people deal with reality. Everyone has one. You have to — to exist, you need an ideology. The question is whether it is accurate or not. And what I’m saying to you is, yes, I’ve found a flaw. I don’t know how significant or permanent it is. But I’ve been very distressed by that fact. But if I may, may I just answer the question —

    REP. WAXMAN: You found a flaw in the reality —

    MR. GREENSPAN: Flaw in the model that I perceived as the critical functioning structure that defines how the world works, so to speak.

    REP. WAXMAN: In other words, you found that your view of the world, your ideology was not right. It was not working.

    MR. GREENSPAN: Precisely. That’s precisely the reason I was shocked, because I had been going for 40 years or more with very considerable evidence that it was working exceptionally well

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