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Episode 4: Brian Arthur

Schumpeter Prize Winning Economist Dr. W Brian Arthur on Becoming a Complexity Thinker

In Episode 4 Host, Michael Hanson speaks with noted economist and professor Dr. W. Brian Arthur on the show, discussing his book Complexity and the Economy. With a list of accomplishments too long to list—the 1990 Schumpeter Prize in Economics among them—Dr. Arthur’s wide-ranging career spans numerous books and publications, over a decade teaching at Stanford, and currently he’s an External Professor at the Santa Fe Institute and a Visiting Researcher at the System Sciences Lab, at the Palo Alto Research Center for technology. He’s not only a deep thinker, he’s been a great ambassador. Part of that is the warmth and regard for real people in Dr. Arthur’s work, you’ll notice throughout the interview. You can read more about Dr. W Brian Arthur at https://www.santafe.edu/people/profile/w-brian-arthur, and you can find his book Complexity and The Economy on Amazon.

Full Episode Transcript

Michael Hanson (intro):

Hello! Today is July 29th 2020, and welcome to another episode of The Well-Read Investor, the podcast that profits your mind and your money.

Today we’re truly delighted and honored to have noted economist and professor Dr. W. Brian Arthur on the show. With a list of accomplishments too long to list—the 1990 Schumpeter Prize in Economics among them—Dr. Arthur’s wide-ranging career spans numerous books and publications, over a decade teaching at Stanford, and currently he’s an External Professor at the Santa Fe Institute and a Visiting Researcher at the System Sciences Lab, at the Palo Alto Research Center for technology.
 
Dr. Arthur is best known for his foundational and iconoclastic work on Complexity Economics, which he began in the 80s, and continues today. Listeners have heard us discuss this term, “complexity”, before. Standard economics, as still taught widely today, is based on the idea of super-rational people operating in a static world of constant equilibrium; complexity economics, rather, sees a world which produces perpetual novelty and newness where market systems and people adapt to each other in real time. In this worldview, decisions are made with incomplete information, often distorted by behavioral and cognitive biases—yet the sum of it all still frequently produces reliable price signals. Might seem like an obvious description of the markets today, but it wasn’t 40 years ago.

Dr. Arthur is something of a personal hero of mine—as his ability to synthesize the topics of economics with technology, complexity, physics, and so much else is only matched by his ability to communicate those things clearly to others. He’s not only a deep thinker, he’s been a great ambassador. Part of that is the warmth and regard for real people in Dr. Arthur’s work you’ll notice throughout the interview, and in true Well-Read Investor archetype, his wide-ranging literacy is quite evident. 

Today we’ll focus on his book, Complexity and the Economy, from 2014—a compilation with commentary of his most famous and influential papers, as well as his widely lauded 2011 book, How Technology Works. Both contain ideas investors will be very much interested in.

This interview was conducted via Skype in February of this year with Dr. Arthur in Palo Alto. Here’s our conversation with Dr. Brian Arthur. Enjoy!

 

INTERVIEW

Michael Hanson (00:00):

Brian, we always ask our authors, why should every well-read investor read your book?

Brian Arthur (00:06) :

The economy, isn't a set of equations. It's not quite a mechanistic entity. It's not like big power station. The economy, if you look at it is, I think best described as a story of events, triggering other events, people intervening. And I think that the people who do very well in investing happened to be very highly trained and thinking of narratives, thinking of stories and understanding human behavior. I think that there's a lot to be said for understanding human nature, understanding human stories and thereby understanding the story of the economy, the narrative that's playing out as the economy changes and evolves and unfolds.

Michael Hanson (00:55)

Now. And so, but when you were thinking about all these issues, it's not as if complexity was a main topic or a mainstream topic by any stretch. So how did you start to think about this and how did all that begin?

Dr. Brian Arthur (1:05)

Well I got curious and I was very much interested in tech and technology. So, I’ve been very interested in a technological phenomenon that, as we point to say Facebook or Google, if something gets far enough ahead, if all your friends are on Facebook and its year 2005 or whatever my space is available, most of your friends start being on Facebook. So, I noticed that tech companies, or the technological economy worked according to positive feedbacks. If something gets ahead, it could further ahead. All the economics I learned was this, something that gets far enough ahead, it would run into diminishing returns, higher costs, more difficulties, more regulation of whatever, and everything would reach a balance and equilibrium. I started to look at systems or see systems that didn't have a balance or equilibrium, very unstable, the more something that happened, the more it happened. And the companies that emerged as huge companies, Google, or Microsoft, or Facebook might not have emerged. Had it not been for either a really good strategy early on, or a lot of luck. I wrote this up, in 1983. And it was considered the horror because this is the marriage of the cold war. I was basically saying a lot of the economy emerges by luck. I was not very popular in the 1980s. Now this is considered gospel here in Silicon Valley, and it all worked out that I got a lot of credit for this, and blame as well.

Michael Hanson (03:01)

Now, the sort of the mid to late eighties, you get started at the Santa Fe Institute. And some of that comes together with putting together prominent economists, including people like Kenneth arrow, of course, but then also ironically, uh, physicists and for all the talk about narratives and, and all of that, you know, you bring together the physicist. So how did that go? And, and, and what were the difficulties with that?

Dr. Brian Arthur (3:20)

Well, in sometime around 1987, Kenneth arrow, A Stanford Economist, and a mentor of mine, asked me to go to a meeting at the Santa Fe Institute.  Santa Fe Institute in 1987 was barely starting Physicists and scientists, were going to meet economics scientists for about 10 days and have a, an enormous exchange of ideas. We did. That meeting turned out to be very significant. And Santa Fe Institute decided that the first research program they wanted to have was on the economy as an evolving complex system. I was asked to be in charge of that, so I was in charge of this first program at Santa Fe.

Michael Hanson (4:10)

And so, what was the reaction of those types of ideas meeting each other for the first time?

 

Dr. Brian Arthur (4:16):

That's a really excellent question. I think that we came together, and our ideas have been largely ignored in standard academia. We all discovered each other. And it was like a bunch of Cinderella's being excluded, discover that there are other people just like them. So, I felt that going to Santa Fe was worth five years of intensive therapy. All the horrors I'd been through and others had been through, were vindicated that I was meeting people just like me. One of the things I really enjoyed in the Fe was there were no boundaries. So, I found Santa Fe Institute to be wild, we were all strange and weird, but we got along extremely well. We were doing things that I thought were groundbreaking or at least interesting at the time.

 

Michael Hanson (05:13):

Now, one of the most fascinating, I think insights about some of your work is that when you talk about people and people having their own stories and subjectivities, in fact, they have their own stories and their ways of seeing the world. And when they work together often what you might call efficient outcomes or relatively efficient outcomes can happen with people by process, just by going through process. And so, you worked on something called the El Faro problem, which sort of illustrated some of this is that right? Yeah.

Dr. Brian Arthur (05:41): 

Yeah, talking about a story. There’s a bar in Santa Fe called El Farol, I used to go there on a Wednesday night and they had Irish music on a Wednesday night and it occurred to me, having gone to this bar dozens and dozens of times that if you went there and it was horribly crowded, it was very unpleasant. But, if there were very few people there, there were plenty of music. It was great place to be. So, I asked this question. Suppose there was a bar somewhere called El Farol and 100 people independently were trying to figure out, should the y go to the bar that night, how should they figure this out? Standard Economics said they would all come to a similar conclusion but that wasn’t what I was seeing. So, this presented a kind of paradox. if everybody had a little forecasting machine on their desk and the forecasting machine said, there's going to be 95 people tonight at El Farol, they would all decide not to go. So that forecasting machine would be ruled out.

Dr. Brian Arthur (07:07)  

The economists were a little bit slow to recognize this when I published it in 1994, but the problem became famous in physics. It became one of these little toy problems. Like the prisoner's dilemma. There was the El Farro bar where if you got the problem and it was a bit like getting the joke, you know, everybody wants to go to this bar. Nobody will go because they think everybody else, et cetera. So, um, so I really invented this problem because of came on reality. If everybody wants to invest in a stock, uh, then that might be good or bad, but you have to sort of think this is actually investing as based upon expectations and forecasts. Sometimes those expectations be self-reinforcing or sometimes they can be self-negating. And that's what fascinated me.

Michael Hanson (08:05):

Now, there seems as if there's a lot of work going on in a narrative analysis, certainly in the behavioral sciences and economics. Do you think that the direction of that is good? Are you excited by the direction that's going?

Dr. Brian Arthur (08:16)

Well, there's a new field. That's very much taking over the center of economics called behavioral economics. Not so much how rational, perfect, platonic people, cyborgs or whoever they are should behave, but how human beings actually behave. And I think that's very healthy. But what's missing is an overall logical framework. If you want to view the economy more as a story and less as a machine or more as an organic, highly connected entity, that's unfolding and playing out, you need a new framework. And that's what we, my group in Santa Fe been trying to provide.

Michael Hanson (9:00)

So, what is the real difference between standard economics and complexity? Economics

Dr. Brian Arthur (09:06)

Standard economics views the economy as a well-balanced machine. And occasionally it gets a bit out of balance. You have to tweak it and it goes into equilibrium or better balance. And complexity economics has a different point of view saying there's all kinds of different parties in the economy.   There are investors, there are entrepreneurs or startups, there's their consumers, there's government agencies, there's banks, and the various different problems that we're looking at, We don’t look at that particular situation not as a machine, we're looking at it more as an ecology, But, as different groups or species of players or entities that are companies or technologies that are vying to survive and to thrive in a situation that's created by other entities and technologies that are vying to survive. It's a shift, it's a shift in point of view. And given that that's complicated, normally we use computers to work out the implications. And one of the things that fascinates me at the moment is that science is not so much looking at how things are, it's looking, it's changing, now looking at how things become. So, complexity is very much part of that, complexity science doesn't ask how systems are. If you're looking at the formation of a galaxy, you're asking, how does subsystems come in to being, how did they form? That's also thing that fascinates me.   

Michael Hanson (10:19)

One of the things that's important, it seems to me about your ideas is the idea of pretty constant, if not perpetual novelty. And I, and I want to ask you about that in relationship to your theories   about technology. One of the things that really changed my thinking about how you look at technology and how it emerges is, was from your book. Could you explain a little bit about your ideas on combinations of technologies and when things are ready to emerge?

Dr. Brian Arthur (10:43)

I spent a long time, about 12 years or so, looking deeply at technology. I came to the conclusion that an economy or economic progress depends not so much on people, not so much on governance or investments or policies. It depends on technological change. The reason we're different from the economy in Britain, in the 1850s, we have completely new and different technologies. We’re not operating with steam engines any more. We've all sorts of novel technologies since that. So, an economy keeps changing. It forms from its technologies. And so, I started to ask my question – how do new technologies form?    And for me this was a revelation, I discovered that I wasn't the first to think about combination goes back to a guy called Thurston in 1880, talking about steam engines. So, there's a history of that idea. But what I did in my book, The Nature of Technology was to work out how novel technologies come into being, and the existing toolbox of technology keeps coming up with new combinations that are useful technologies. So, we have all these novel technologies, forming the toolbox to be for further combinations. So, it's all combinations forming from previous combinations.

Michael Hanson (42:21):

Yeah. Every time I look at an iPhone, I think of your ideas because an iPhone was just a, something that was ready to come together with the screen, such as they were in the batteries and the right time and the chip sets and all of that come together to make a new novel thing. And now they have their own ecosystem.

Dr. Brian Arthur(42:37):

That’s right, precisely better said than I could have.

Michael Hanson (11:32)

Through all of this, do you see people as fundamentally rational or irrational?

Dr. Brian Arthur (11:38)

Neither? I think in nearly all economic situations, rationality is not well defined. Let me explain why. Suppose I have a startup here in Silicon Valley and I know 19 other people are launching similar startups in the same space. I don't know what they're going to do. So, in that case, rationality is not well defined because we simply don't know, if you don't know what other people are going to do. If you don't know in the stock market what other investors are going to do, then the problem of being rational is ill defined. If the logical problem is not well defined, there's no rational solution. I'm not saying you throw darts. What do you do instead of being rational or irrational, you try to make sense of the problem.  So, what we see here in Silicon Valley in a fast-moving changing economy, is that people are trying to make sense of the situation and the people who make better sense earlier on do better, but as they make sense, the situation changes. So, the real stock markets - there's no rational solution. So, the game of the market is not to act rationally. That's not well defined. The game is to see if you can make sense out of what's the quite nebulous situation and make better sense than other people.

Michael Hanson (13:18)  

So, what other types of literature do you enjoy? You've mentioned that you, you are a literate person. What are some of your favorite books?

Dr. Brian Arthur (13:25)  

Gosh, I’ve got Blood Meridian obviously up there. Book by Halldor Laxness, the Icelandic author, called Independent people. He wrote it in Islandic and It's translated very beautifully engineering. I thought that's a staggeringly, good book. I read the Raj Quartet by Paul Scott, uh, two or three years ago -- beautifully, beautifully done. But I think that personally in my life, I'm fascinated by, not so much by literature per se or by writing per se, but what fascinates me and is deep in my Irish DNA is the idea of the story. And what I do in economics is I view anything I talk about as a story, a story gets told they being mathematically or algorithmically, but to me it's still a story. Sort of, imagine the following situation, imagine this, imagine that, and then you set all the pieces working. I'm concerned with where it's unconcerned with the stories that are told about the economy or about some aspect of systems.

Michael Hanson (15:51)

What's most exciting to you. Where's your work going to take you next?

Dr. Brian Arthur (16:06)

I think that as economics becomes more sophisticated, as it pushes ahead, this new wave of economics are seeing their economy as based on human behavior. And also based on groups of players vying and ecology. And it turns out that that point of view is not quite new political economists of 150 years ago looked at an economy that way they're comfortable looking at things that way. I'm thinking of people that have John Stuart Mill, ah, Ricardo, others, that era.  And so, I think economics is getting back to the idea of story, that every part is affecting every other part. That's the economy is open ended, that rational behavior and the generalist not well defined. So, the bottom line here is that as economic theory progresses and starts to see the world more in formation terms or more as the ecology of players in the economy, it's coming back to rediscovering the political economy of 150 years ago. For me, that's extremely exciting.

Michael Hanson (17:16)

I couldn't agree with you more. I mean, the prospect of getting back to a time when political economy was frankly, more literary and, uh, more erudite and, and so forth, it was a pretty good time. I thought as well. I'd love to see some more of it.

Dr. Brian Arthur (17:30)

I think it's coming, good for you.

Michael Hanson (17:33)

Well, my guest today has been dr. Brian Arthur. Brian, thank you so much again for joining us.

Dr. Brian Arthur (17:39)

Well, I'm delighted in particular, I'm delighted to talk to a literary audience. That's a thrill for me.

 

OUTRO

 

Michael Hanson:

Well, scratch that one off my bucket list. Thanks again to Dr. Arthur, and thank you again for listening. I always linger on Dr. Arthur’s idea of how technology is created: by combining existing things. You can quibble with some of the intricacies, but the idea explains so much in terms of how computers and smartphones came together.
 
Wherever you may be hearing the Well-Read Investor, please comment, like and subscribe—it really does help us. You can visit our website:wellreadinvestor.com or send us an email at wellreadinvestor@fi.com . And if you haven’t gotten enough podcast—may I suggest the Market Insights Podcast hosted by my friend and colleague Naj Srinivas for pithy and focused discussion on the biggest issues facing markets right now. Meet us back here in two weeks on August 12th, when we speak with Professor John Gaddis and his book Grand Strategy. Until then, may all your reading profit your mind and your money. Take care.

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