Customer Reviews

Origin of Wealth: Evolution, Complexity, and the Radical Remaking of Economics

5 star:		(48)
4 star:		(7)
3 star:		(8)
2 star:		(5)
1 star:		(0)

 

 

Eric Beinhocker's The Origin of Wealth provides a compelling synthesis of recent advances in the application of complex systems to economic phenomena and proposes that classical economics with its assumptions of perfect rationality, perfect information and equilibrium are fundamentally wrong. Much of this will be obvious to those who have been following the work of the Santa Fe school - Holland, Kaufman, etc., but there is enough new here to make the book well worth the investment in time.

Beinhocker proposes that economies are best understood as dynamic systems, composed of agents, acting in networks, that support emergent behaviors with selection operating to drive evolution. He simplifies the evolutionary algorithm to differentiate-select-amplify, and those who are seriously interested should probably read through Dawkins books to get a deeper understanding (I find The Extended Phenotype particularly useful in thinking about organizations). I have two quibbles and one more serious question about his approach, which in general I find useful and applicable to my own work of designing knowledge based systems (I actually work for a competitor of his employer McKinsey & Co.).

The quibbles. Beinhocker describes `primitive' and certain other societies as being dominated by a `Big Man.' This is simply wrong for most primitive societies which are generally governed by a form of consensus hierarchy in which no one person can take unilateral action. Another quibble, Beinhocker has accepted Steven Pinker's silly characterization of music (and by implication other aesthetics) as mental cheesecake. For a more useful approach see Steven Mithen's new book The Singing Neanderthals (`Steven' seems to be a popular name in this field, and a good name it is too).

But these do not concern his main argument. I have more questions around his formulation of business plans as constituting a design space and the notion that a `management team' is a reader of `business plan schema'. There are several problems here. There is no language by which to define the design space of business plans. Beinhocker gets around this with a Borgesian approach of defining a library of all possible texts and then providing a filter to determine what is a business plan. I am less than convinced that any such filter could exist. If there is no language of business plans and no filter to determine what is and is not a business plan I do not see how the design space exists (and I have made effective use of the notion of design space and design space exploration in many projects). Take this away and the precise mechanisms proposed for understanding economic and business processes are on shaky ground. It may be more useful to think of business plans as simply another form of social technology that exist in the larger design space of social technologies. Given the difficulty involved in filtering out what is a business plan and what is not, this may be a more general and effective approach. Perhaps only a person from a management consulting firm could imagine that business plans are so clearly differentiated from the other apparatus of business and that they deserve to be called out as a first order construct.

That said, complexity economics as described in this book represents a paradigm shift from classical and neo-classical approaches and for my purposes anyway offers more actionable models.

Scattered throughout The Origin of Wealth is a five star survey of new ideas in economics, incorporating discoveries from science and psychology. Unfortunately, in the end, the book is undone by Beinhocker's unfortunate habit of stating hypotheses and non sequiturs as facts, and his continuous harping on "Traditional" economics (and "Traditional" finance) as obsolete and irrelevant. Also, the book is quite uneven in the amount of detail presented; there's too much sometimes (which is tedious), and too little other times (which is frustrating). I really wanted to be able to give the book three stars because of its broad scope and entertaining analyses, but just cannot do so after a few days of mulling over the entirety of its content. If you can separate the wheat from the chaff, it's a decent read; but if you are not already familiar with the subject matter discussed, caveat emptor (buyer beware)!

Some examples of the unevenness of detail: Several times the author described computer simulations, but did not include enough detail for the reader to fully understand how they were set up. For example, in one simulation of evolution, 1's and 0's were referenced as having been strung together to represent strategies in the "prisoner's dilemma" game. Unfortunately, the author did not bother to explain how the strings of digits corresponded to the strategies; therefore there was not enough information to figure out how the simulated evolution actually worked. In another case, over a page is consumed in an unnecessary blow-by-blow description of how a factory manager might increase production capacity, only to see the demand cycle slowing due to a feedback lag.

A distracting aspect of Beinhocker's presentation is the way that he repeatedly refers to mainstream economics as "Traditional Economics" with a capital T, indicating that it is not progressing, is resistant to change, and is obsolete. Of course, like any science, mainstream economics evolves slowly, but I don't think that a neutral observer could say that economists as a whole have not been open to new ideas over time. "Traditional" economics is actually in the process of absorbing some of the results he relates -- for example those from behavioral economics -- but you wouldn't know it from the text.

There are many statements in the book that seem questionable, but are stated as if they are incontrovertible facts. For example: that punctuated equilibrium is a fully accepted part of standard evolution theory (it's still under debate), that success in evolution can be fully defined by a "fitness function" (success in evolution is ultimately defined by success itself), that the second law of thermodynamics applies to the interactions between people (just because something applies to atoms doesn't mean that it applies to people -- consider the strong nuclear force).

The main part of Beinhocker's thesis is that the economic system can be equated to an evolutionary system, with companies consisting of a set of "businesses" that interact with each other in the economy. Businesses that are "fit" replicate, and those that are not disappear. He creates the concept of a hypothetical, written business plan that corresponds to DNA in evolution. This is a neat concept, but the parallel doesn't quite work. DNA "describes" the organism in a condensed, holistic manner. A business plan fully describing a business would have to be as complicated as the business itself.

In the final section, Beinhocker presents implications of his new complexity-based, evolutionary economics for business and policy.

For business, a major implication is that a company should not try to determine up front what strategy will work, but should set up different parallel businesses with different strategies and see how things go before betting on a single strategy. Ignoring the issue of when a company should stop providing capital to a business, -- What if the "fittest" business takes the longest to succeed? -- this is precisely what is suggested by such strategic frameworks as the BCG matrix, which were developed well before complexity economics. Basically the concept comes down to the old saw of not putting all ones eggs in one basket. It's also an implication of CAPM, "Traditional Finance", that diversification is optimal. (By the way, according to the book, "Traditional Finance" is obsolete also!)

(Beinhocker also finds an "implication" that companies should take a stakeholder approach and favor growth over return to shareholders. I cannot see how this follows from the theory, but I'll let it go.)

In terms of policy, The Origin of Wealth gets really crazy. Somehow Beinhocker comes to the conclusion that Behavioral Psychology favors universal health care coverage and a "minimum living wage." (In all fairness, Beinhocker is relating the proposals of a Matt Miller; however, he strongly supports them also.) The text presents these policies as if they are consistent with Strong Reciprocity, but how can these benefits be reciprocal when they apply to everyone regardless of behavior? (He also conveniently ignores moral hazard, and politicians' strong incentives to manipulate programs to benefit themselves.) It's not so much the conclusions -- e.g., no one can argue that the proposed strong elementary education for all is a bad idea -- but the fact that they don't follow logically from the premises.

The bottom line is that describing economics as an evolutionary system is fine, but there is really nothing that you can draw from the resulting model prescribing any particular strategy or policy. In order to see what will happen to the economy as the result of a new policy, one would have to create a simulation as complex as the economy itself -- in essence one would have to create an entire, new economy; or one could just try the policy and wait and see what happens. On the other hand, "Traditional Economics" gives us such theories as the law of supply and demand and interest rate parity. The law of supply and demand may not be perfect, but at least it predicts that a business will reduce sales if it raises prices. Interest rate parity isn't perfect, but at least it predicts that if a central bank raises rates, it should see a strengthening of its currency. Don't give up on mainstream, "Traditional," economics yet!

(If you are considering this book, you should check out "More Than You Know: Finding Financial Wisdom in Unconventional Places" by Michael Mauboussin, which applies some of the same theories of science and psychology to investing; and "Knowledge and the Wealth of Nations: A Story of Economic Discovery" by David Warsh, which presents a history of the development of mainstream growth theory.)

Wealth creation is central to any understanding of economics. What is it? How is it created? How is it increased? These questions are essential to most of us. They dominate our daily working lives. They dominate our political lives.

In "The Origin of Wealth" Eric D. Beinhocker argues wealth creation is the product of a "simple, but profoundly powerful" three step process:

1. Differentiate.
2. Select.
3. Amplify.

The same process that drives the order and complexity of life, the author says, drives the order and complexity of the economy. Borrowing from Darwin's theory of natural selection - which incidentally was borrowed from the economist Richard Malthus - the senior advisor to McKinsey & Company argues the economy evolves. It is a "design without a designer."

If the economy is a complex, adaptive system, the author argues, there are four implications:

1. Equilibrium, and with it much of the economic thinking that has dominated the past century, is out.
2. A new tool set with its own techniques and theories are available to explain economic phenomena.
3. Wealth is a product of evolutionary processes.
4. Changes in economic thought foreshadow tremors. Adam Smith begat free trade. Karl Marx begat revolutions and socialism. Neo-classical economics begat the rise of global capitalism.

Whether you are an investor, business or political leader, this well-written, readable book offers a thought-provoking tour of the latest in economic thinking. If the author is right, we are standing on the threshold of an economic revolution. Eric D. Beinhocker's book provides insight into how this changing view of wealth creation will change business strategy, finance, politics and policy.

Time spent reading and understanding its implications will be well-spent.

About 40% of Eric Beinhocker's (EB's) book contains some very worthwhile observations and advice. This material is concentrated into the first and last of the book's four parts. Part One is a critique of traditional, neoclassical economics (NCE), which borrowed metaphors from mid-19th Century thermodynamics and a rigorously non-empirical aesthetic from Bourbakist mathematics. As the author ably describes, NCE just doesn't have much to do with reality. Part Four contains some very good insights about a portfolio approach to strategy and about the right amount of hierarchy in organizations, in particular. You can find most of these insights elsewhere -- in the writings of other business writers cited by EB and in the business practices of good companies, should you be lucky enough to work for one, as I was. But that doesn't diminish the value of EB's message.

The other 60% is devoted to the author's vision of complexity economics, which regards the economy as a type of "complex adaptive system" (CAS). It's a possible successor to NCE that's based more on modeling, empiricism (a dash, anyway) and metaphors from evolutionary biology and other scientific fields. (More on metaphors below.) As for this part of the book, there's good news and bad news. The bad news: a lot of it is sloppy, garbled, misleading or even wrong. The good (and ironic) news: the author fails to show that the other 40% of the book logically depends on this imaginative but mushy 300 pages.

If you've never read a critique of NCE before, never heard of CAS theory, and/or never worked in an entrepreneurial environment or read books like "Built to Last" or "The Balanced Scorecard" you can learn a lot from reading this book. If you're wondering why I give it only three stars anyway (2.5, actually), you can read the rest of this review. Here is a very abbreviated list of my irritations and disappointments with this book:

1. Unduly half-hearted critique of NCE:

Compared to earlier critiques of NCE by Mandelbrot, Osborne, Ormerod, Keen, and McCauley, among others, EB wimps out. E.g., despite his description of the totally unempirical nature of NCE, he persists in regarding NCE economists as scientists (at 75). He also says "It would be hard to believe" a model of economics that doesn't include the law of supply and demand (at 95). But take a look at M.F. Osborne's "The Stock Market and Finance from a Physicist's Viewpoint" for a demonstration that this "law" is vaporware.

EB doesn't cite Osborne, but he does include Philip Mirowski's "More Heat than Light" (1988) and "Machine Dreams"(2002) in his bibliography. The latter book -- an exhaustively documented, slam-dunk withering indictment of NCE based on the NCE economists' own words -- seems to have made little impression on him; it's only cited once, for a small point. You should read it if you're going to read "Origin of Wealth". In addition to the criticism of NCE, you'll get a thorough historical context for the mathematical modeling that underpins EB's arguments in Parts Two and Three of his book.

2. Ambiguous or careless citation of sources:

A. EB provides an extensive set of footnotes and an impressive bibliography, but checking the citations can be a frustrating task. EB frequently cites to edited volumes of articles or essays -- but almost always to the entire volume, rather than to the specific article that might support his point. Page numbers are rarely included in the cites, so his sources often remain cloaked in ambiguity.

B. More troubling is a discussion of "punctuated equilibrium" (PE) at 173-175. Here EB discusses at length two papers by Jain & Krishna from 2002 -- but neither one mentions PE at all. In fact, no grammatical form of "punctuate" or "equilibrium" appears in either paper, but for one exception that is not relevant to EB's point. This left me concerned that other of his cites relate only tangentially -- or perhaps not at all -- to the points he claims they support.

C. Sometimes the cites even negate his point. In his blog about Adam Smith, Gavin Kennedy has noted a case in which EB misstates the position of Prof. Herb Gintis and his colleagues by 180 degrees (EB at 121, and Kennedy entry for 2006/8/26). (BTW, Prof. Gintis, whose encomium of the book appears a couple of reviews below this one, is affiliated with the Santa Fe Institute (SFI) and is cited approvingly in several places in the book.)

3. Opinions presented as more unified than they are:

A. Why did I just mention SFI? Because it's one of the leading think tanks for complexity theorists, and the homeland of CAS theory. Also because it's financially underwritten by, among others, EB's employer, the consulting group McKinsey & Company. EB is very up-front about disclosing this relationship. Nonetheless, he omits mention of most alternative points of view about complex systems, producing what amounts to a brochure for SFI, and giving the impression that complexity theory is CAS theory. For example, you won't encounter even a paragraph about the philosophy or techniques of the Brussels School (of Nobel laureate I. Prigogine et al.), nor about the attempts of Ralph Stacey and others to integrate these into management theory and practice. (See, e.g., Stacey, Griffin & Shaw's "Complexity and Management" (2000) and related volumes, which focus far more on people and organizations, and far less on computer modeling, than EB.)

B. In other cases, EB uses ambiguous quantifiers to suggest that opinions are more widely-held than they may be in actuality. Consider this statement (at 12): "Modern evolutionary theorists believe that, like gravity, evolution is a universal phenomenon, meaning that no matter whether the algorithm is running in the substrate of biological DNA, a computer program [or] in the economy ... evolution will follow certain general laws in its behavior." Logically, this means that there exist *some* theorists who believe all these things, but rhetorically the statement is made to sound as if their number is legion --despite the fact that the statement concatenates a number of potentially contentious notions. So who are these theorists? Biologists? Cosmologists, even? Checking EB's footnote shows that 4 out of 5 of the cited "modern evolutionary researchers" are computer scientists. So it's not surprising they take this abstract, algorithmic point of view. (The fifth cite is to an edited volume of SFI proceedings, cited as a whole.)

C. A more direct example of misrepresented consensus is the statement "[M]ost researchers believe that the brain is a Boolean network" (at 148). According to one Stanford neurobiology professor with whom I checked, this statement is simply false. While some researchers may believe it's Boolean, more believe the brain is closer to a Bayesian network, and others believe that it's neither Boolean nor Bayesian. (Caveat: Her reply was based on researchers who actually study *the brain* professionally -- researchers who study computers, rocks, etc. may have their own ideas.)

4. Unexplained disunity in EB's own opinions

At times I had the feeling that EB was speaking out of both sides of his mouth. This first came up in connection with hierarchy, which seemed at first to be bad, then good, all within 4 pages. One has to wait about 200 pages for a resolution of this dialectic (compare 152-155 and 356 with 364-367).

Unfortunately, not every contradiction has such a happy ending. EB disses econometrics because it provides only statistical correlations, not causal explanations (at 59). His attitude is quite the opposite when it comes to CAS-based computer models, however. Shortly after noting that it's impossible to predict a model's output without running it (at 232), he goes on: "We may then be able to say things like `For parameter settings of X, there is a 60 percent chance that a high-profit environment will emerge and a 40 percent chance of a collapse into low profits.' Thus, while we may not be able to forecast the model's specific outcomes, by exploring the parameter space and collecting statistics, we can learn a good deal about the model's behavior. In many ways, a deep understanding of how the system works may ultimately be more valuable than being able to make forecasts" (at 233).

Shades of "It's not a bug, it's a feature" -- how did statistical correlations become cool again? And why do they now constitute "deep understanding"? It's a shame for such mysteries to surround one of the key practical points of the whole book.

5. Sins of definitional omission and commission:

A. Try as I might, I couldn't find a definition of "complexity" in this book. EB's reticence to define the term, however, doesn't inhibit him from making quantitative statements incorporating it, such as "[T]he global economy is orders of magnitude more complex than any other physical or social structure ever built by humankind" (at 6), or "The number of SKUs added by an innovation climbs exponentially with the complexity of the artifact" (at 248).

The lack of a definition perhaps gives me no excuse to be surprised to read that "complex designs are inherently modular" (at 197), but I admit this remark made me shout out loud. If you're familiar with definitions of complexity that rely on some monotonically increasing function of the minimal number of binary digits needed to characterize a system (e.g. Kolmogorov complexity, algorithmic complexity, etc.), you will sense that EB got it totally backwards. By such a measure, a messed up pile of papers is more complex than the same papers organized modularly into file folders, chapters etc. EB cites Herb Simon's 1962 paper "The Architecture of Complexity" as support for his comment. Simon's notion of "complexity" was based on his deep interest in hierarchy in organizations; more hierarchy meant more complexity for him. (See Philip Agre's insightful 2003 critique, available on the Web, for the historical context of Simon's essay.) However, most natural scientists, mathematicians and computer scientists haven't followed Simon in their usage of the term. In fact, even SFI tends to ignore Simon (you won't find him mentioned or cited even once in the 700-plus page SFI conference proceedings volume "Complexity: Metaphors, Models and Reality" (1994), nor in SFI guru Brian Arthur's 1996 seminal "Complexity and Economics" paper) -- leaving EB deserted by his homies on this issue. EB's implicit reliance on Simon while attempting (as I discuss below) to ground his own theory directly in thermodynamics and biological evolution thus sets up a kind of culture clash, if not outright confusion, when it comes to understanding this fundamental bit of terminology.

B. EB's use of the phrase "punctuated equilibrium" seems willfully to depart from the usage of biologists and eventually veer out of control. For biologists, PE is a term of art describing sudden appearances of new species in the fossil record; moreover, PE is not evidence against gradual evolutionary change, which inevitably is imperfectly displayed in rocks. (See, e.g. the book by EB's favorite non-scientist philosopher of evolution, "Darwin's Dangerous Idea" by D. Dennett, at 282-299.) As for EB, after dutifully citing the original PE papers by S. Gould and N. Eldredge, he faults Gould for misusing the term (at 173). I mentioned a minute ago how he finds PE in sources that don't use the term at all. As the book progresses, EB begins to apply the term to situations of alternating stasis and *sudden* change (e.g. at 328-329), and eventually uses it to characterize changes in the *environment*, rather than changes in the things the environment is acting on (at 363).

C. EB defines knowledge as "fit" information, i.e. "information that is useful" (at 317). He goes on: "Evolution is a knowledge-creation machine -- a learning algorithm. Think of all the knowledge embodied in the ingenious designs of the biological world. A grasshopper is an engineering marvel, a storehouse of knowledge of physics, chemistry and biomechanics -- knowledge that is beyond the bounds of current human ability to replicate." (Id.)

Question is, *to whom* is such knowledge "useful"? EB doesn't tell us. Any hints? Well, he never suggests that the goal of all biological evolution is to increase humans' knowledge; and although he insists that biological life is "designed" he also insists that there isn't any designer (see 187-188). So that leaves the grasshopper. Is the leg of a grasshopper useful to it qua information, or qua matter? One could argue that it's useful to the grasshopper as matter, not as information, since it seems unlikely that the grasshopper has any awareness of his leg as information. (Similarly, humans didn't have any awareness of DNA until a bit more than 60 years ago.) But suppose we insist that the leg is useful to the grasshopper as information, and we insist the same regarding DNA for humans in, say, year 1800, even though neither subject would have any awareness of this information. I submit that this stretches the term "knowledge" way beyond all usual usage of the term, leading to the question of *what insight* do we win from EB's peculiar definition? (Smarter people than I can also ponder whether it makes sense for the goal of evolution to be creating something useful for an individual, when genes, not individuals, are the unit of selection (at 279).)

6. The good, the bland and the ugly:

Throughout the book, EB insists that when he speaks about economics, evolution, thermodynamics and such stuff, he is *not* speaking metaphorically. E.g., "Economic wealth and biological wealth are thermodynamically the same sort of phenomena, and not just metaphorically" (at 317). However, at times this no-metaphor commitment seems to paint him into a corner from which the only escape routes are triviality or sticky-footed retreat.

A. Throughout the book, EB develops a theme based on thermodynamics. He frequently repeats the mantra of "matter, energy and information," as in: "A business is a person, or an organized group of people, who transforms matter, energy, and information from one state to another with the goal of making a profit"(at 280), or "[I]n economic systems, entropy reduction requires flows of energy, matter and information" (at 410). But this mantra is a bit like listing "concrete, asphalt and streets" (albeit there isn't any E=mc2 for asphalt and concrete) -- it rests on a category confusion. As Rolf Landauer says in the opening sentence of his landmark 1996 paper on information, energy and computation (reprinted in Leff & Rex, "Maxwell's Demon 2" at 341), "Information is inevitably tied to a physical representation, such as a mark on paper, a hole in a punched card, an electron spin pointing up or down, or a charge present or absent on a capacitor." You can't transform information without also transforming matter or energy somehow.

Too bad EB didn't read that sentence. (EB explains the broad gist of Landauer's paper but cites to a secondary source (at 305 and n. 27).) It might have helped him to rethink his no-metaphors commitment when he made remarks like "[I]rreversibility is a necessary ... condition for value creation" (at 306). When two people swap Babe Ruth and Hank Aaron baseball cards, this is "irreversible in a thermodynamic sense" because the traders "would not want to immediately undo their deal" (id.). (How do we know this? Because we could get a market researcher to survey the traders before the trade (id.). How does EB know the outcome of this survey? He doesn't say.) In later chapters, EB gets more deeply into the mess. In the chapter on strategy, he notes that "truly strategic choices are difficult or costly to reverse once made" (at 325) and that "without irreversibility, there is no wealth creation" (id.). A bit later, after narrating the rise and fall of Westinghouse (at 349), he declares "[O]rganizations carry out thermodynamically irreversible transformations on matter, energy and information, converting high-entropy inputs into lower-energy outputs" (at 352).

Where's the mess? If we accept EB's statements about irreversibility and Hank Aaron literally, the result is trivial. The physical process of swapping cards (including friction as they slide across the table or schoolyard playground), and the sloshing around of molecules in each trader's brain may indeed be physically irreversible. But what insight do we get from that? On this basis, all human activity, not just economic activity, is "irreversible in a thermodynamic sense."

For EB to be making a deeper point, he must be trying to address some different level of organization. He seems to want to treat information -- the trader's preferences -- as something different from matter or energy. But Landauer's comment shows that you can't do that. Moreover, if we ignore the physics and chemistry of the deal, then irreversibility becomes much more questionable. What's so impossible about a trader changing his mind? Does it require energy to do this? If this is literal energy, mazel tov -- we're back to the banal interpretation of "irreversible". And if it's some kind of metaphorical energy, there goes our no-metaphors promise.

Similarly, in what sense is a strategic decision irreversible? In the sense that it takes energy and money to reverse it? But in the literal sense, you need the same to reverse any business decision. The difference is only one of degree, not kind. Once you start to make distinctions such as tactical decisions are reversible and and strategic decisions "irreversible", you're in metaphor territory. Moreover, as EB's fable of Westinghouse shows, value created can easily be turned into value destroyed -- nothing irreversible about that.

B. Finally, what is the origin of wealth? The answer is a bit of an anticlimax: It is knowledge -- only treated as an endogenous variable in a CAS model, rather than as an exogenous variable in an equilibrium (NCE) model (at 317). Even EB finds it hard to warm up to this. The real punch line for him seems to come two paragraphs earlier, when he notes "[T]he fitness function of the economy -- our tastes and preferences -- is fundamentally linked to the fitness function of the biological world -- the replication of genes. **The economy is ultimately a genetic replication strategy**"(at 317, emphasis in original).

Here EB makes good on his commitment not to speak metaphorically. But despite his italics, one again has to wonder: so what? Couldn't the same explanation apply to lots of other human behaviors such as art, music, sports and, per Messrs. Dennett and Dawkins, even religion? What new insight should we get from this revelation about economics? Why should we have expected otherwise? The bigger surprise might be if economics were *not* linked to genetic replication. (BTW I ignore for the moment (i) the question of whether evolution really is only about genes, and (ii) EB's failure to mention anything about evolutionary neutrality in his book.)

I'll end here. There are a host of other things that bug me about this book (ambiguities about fitness landscapes for physical technologies; the omission, contrary to my own limited personal experience as patentee, of intuition as a cognitive process in innovation; garbled discussion of Nash 1950 bargaining paper (see also Gavin Kennedy blog); attribution of realization of business plans solely to "management teams", and analogy between such teams and implanted fertilized mammalian eggs (compare pp. 194 & 236); frequent anthropomorphizings, reifications, shifts in who are the agents and patients of evolution, etc. etc.), but I will bite my tongue. As I've noted, the book does have some true virtues. But surely when someone as sharp as Prof. Gintis calls this the most important book on economics in years, he is using a blurbista's hyperbolic license to help out a pal. At least I hope so -- because if intended at face value, it would be a deeply, deeply sad statement about the economics profession.

Beinhocker has created a tour de force that reviews the history of economic thinking from Adam Smith, and uses this histiory as a way to introduce the next wave of economic thinking, complexity theory, etc.

In following this approach, the book is very long with its arguement scattered throughout. If Beinhocker really wanted to acheive his objective -- to say that traditional economics are broken and new economics will change the way we think about business, he could have done that with fewer pages.

The book is a great read for people who understand classical and neo-classical economics. This is the book's greatest strength but also its weakeness because without an understanding of what has come before its difficult to recognize the value. So knowiing what is in the ECON 101 College textbook that Beinhocker derides actually is essential to getting the most value from this book.

In many ways this book is like Jostein Gaarder's Sophie's World -- tour of philospohical thinking that was a great refesher.

Beinhocker, gives a journalistic survey approach to the subject which is fine, provided you know what they are surevying but of less value for the un-initiated -- so if you were an ECON major read this book and open your mind.

If not, still read this book, but you may need to read some other stuff to get the most out of it.

The biggest idea of the book is pretty simple: The idea of equilibrium in economics doesn't stand up to empirical observation, but if you think of the economy as a subest of evolution, a lot of economic phenomena can be explained.

Beinhocker lays out quite a meticulous case and presents some startling implications. He is very careful to say that it is still very early in the game to speak with full certainty about what can happen, and indeed, giving up the concept of certainty is one of the themes of the book. It is one of those books that will have you start looking at the world in a very different way. It is sure to be one of the best economics books of 2006.

I bought the book initially because the economist issued an article commenting it which draw my interest. Quite honestly, I was surprised to see that it is basically a compilation of works, essays and academic papers defying orthodox finance and economics viewpoints rather than groundbreaking material. Throughout the book, the author cites many heavyweights in different sciences to augment his thesis of a new paradigm in economics along with the typical historical retrospective on economics, from Adam Smith to Samuelson and beyond which serves the purpose of claiming economics is locked in its own on intellectual embargo.

Now, for anyone already exposed to the current thesis in this area, the book might not add as much as it would for someone that is still green on the subject. Notwithstanding this, I would recommend the book to anyone, since the author call has merit, the book is extremly well written and very well structured too while the ideas presented are solid and backed by various authorities in the field.

Slowly but steadily, complex adaptive systems theory is working its way into the mainstream. I have studied it for years, and applied its concepts in public policy, business and finance. This real world experience has made me a believer in CAS' long-term importance, and ability to fundamentally change our understanding of multiple fields. Unfortunately, many written treatments of complex adaptive systems theory are either too technical for the general reader, or too simplistic -- either high math or squishy analogy. Beinhocker's book is a shining exception to this rule, and for the first time makes this subject accessible in rigorous yet understandable way. I highly recommend it whether you are in business, government or finance.

To be honest, I haven't finished reading this book yet, but I have been stunned by the depth and originality of the work described herein. Eric Beinhocker is a senior advisor at McKinsey and the quality of his analysis of the profound paradigm shift that has begun in economic theory is quite simply stunning. Superbly researched with complete references (always the mark of superior scholarship even in what is targeted as a general business book). His treatise is that economic systems are a subset of a larger set of evolutionary systems subject to the forces of differentiation, selection and amplification. Exceedingly appropriate for investors and money managers seeking long term strategic advantage in the capital markets. I am sure this will be a future classic.

Beinhocker's goal in this book is to conceptualize and defend a vision of the
economy that differs radically from the general equilibrium framework of
Traditional Economics. His vision is that of the economy as a complex
adaptive system. The theory that explains the operation of the economic
system he calls Complexity Economics.

The Origin of Wealth disabused me of an opinion that I probably shared with
most economists, which is that to call a phenomenon a "complex system" was
just another way of saying that we do not understand it. In fact, it is a
factual assertion, it is almost certainly true when applied to the economy of
an advanced society, and knowing this materially alters the tools we have
available to us for understanding the economy.

Beinhocker is a quick and subtle thinker who is intellectually comfortable
with several natural and behavioral science disciplines, including physics,
economics, evolutionary biology, and anthropology. His ideas range broadly
and penetrate deeply. I did not find a single error in the book, even in the
treatment of the most complex and error-prone areas of modern science. In the
Preface, Beinhocker says that the goal of the book "is not to tell you what
to do, but to change the way you think." He does just that.

Beinhocker characterizes the modern economy not simply as a complex system,
but one endowed with an evolutionary dynamic (this is the meaning of the term
"adaptive" in "complex adaptive system"). Beinhocker argues that not only do
genes evolve, but also firms, technology and the culture of cooperation and
exchange in a modern economic system.

Beinhocker's critique of Traditional Economics is nuanced, insightful, and
above all, powerful. He recognizes its accomplishments, but locates them
squarely in the past. "Economics can do better," he says, "it's time to move
on." Beinhocker's critique lies outside the Left-Right continuum. Complexity
Economics supersedes this continuum altogether: the laissez-faire
predilections of the Right are akin to the notion that one can grow a
beautiful garden by throwing out a bunch of seeds in the Spring and refrain
from further interference. The state-centered predilections of the Left are
akin to attempting to create new plant varieties by legislative fiat. In 1998
President Clinton was widely criticized when, in a speech delivered in
Beijing, he spoke of "the goal of growing your economy." Yet, this is
precisely the appropriate notion in Complexity Economics.

Beinhocker's critique of Traditional Economics (TE) is very simple. The economy is
a complex adaptive system, but TE models it as static equilibrium system. TE
does this because the math is easier. But, he notes, we have gone as far as
we ever will go with the easy math. It's time to get serious.

In contrast with getting serious, TE theorists have turned solving the wrong
problem into a professional standard of ethical behavior. It is good to do
theory, most will profess, without regard to empirical verification. Whereas
in the natural sciences, theorists love experimentalists because they provide
the data that facilitate distinguishing among models and developing more
refined theories. TE theorists are indifferent to those who gather and
analyze data unless their results cast doubt on their theories, in which case
they turn hostile.

This sorry situation became clear to me in the summer of 2001, when I
happened to be reading a popular graduate text in quantum physics, as well as
a leading graduate text in microeconomics. The physics text began with the
anomaly of black body radiation which was inexplicable using the standard
tools of electromagnetic theory. In 1900, Max Planck derived a formula that
fit the data perfectly, assuming that radiation was discrete rather than
continuous. In 1905, Albert Einstein explained another anomaly of classical
electromagnetic theory, the p effect, using Planck's trick. The text
continued, page after page, with new anomalies (Compton scattering, the
spectral lines of elements of low atomic number, etc.) and new, partially
successful models explaining the anomalies. This culminated in about 1925
with Heisenberg's wave mechanics and Schroedinger's equation, which fully
unified the field.

By contrast, the graduate microeconomics text, despite its brilliance, did
not contain a single fact in the whole thousand page volume (or, rather,
there were two references to facts, both in footnotes). Rather, the authors
build economic theory in axiomatic fashion, making assumptions on the basis
of intuitive plausibility or consonance with the principles of "rational
action." This is what I term sui-generis theorizing.

Complexity Economics (CE) is in a sense a mirror inversion of Traditional
Economics (TE). Beinhocker favorably quotes Axel Leijonhufvud, who remarks
that TE models "incredibly smart people in unbelievably simple situations,"
while the real world involves "believably simple people [coping] with
incredibly complex situations."

What is the Complex Economy? For one thing, it is never in, and usually not
very near, equilibrium. It suffers frequent local resonances (complex
nonlinear resonances) that lead to significant deviations of economic
variables (prices, quantities, wages, asset prices) from their equilibrium
values even in the absence of strong perturbations on the input side. We see
such deviations (often called "fat tails" in the literature on the power laws
of complex system as compared with the Gaussian distributions of Traditional
Economics) in many available time series.

Beinhocker stresses a second characteristic of the complex economy: the Law
of One Price fails. For instance, Beinhocker notes that in the European
Union, the standard deviation of prices rose from 12.3% in 1998 to 13.8% in
2003, despite the extensive dropping of trade barriers and movement to a
common currency over this period.

A third characteristic of the Complex Economy is that it cannot attain the
sort of optimality that can be attained in noncomplex nonadpaptive systems.
For instance, since economies are rarely in equilibrium, most production,
trade, and consumption takes place out of equilibrium, and hence is
inefficient, at least when measured against a complete information Walrasian
economy that has somehow attained equilibrium.

Beinhocker offers the following useful summary of the differences between
Traditional and Complexity Economic.

Dynamics: The complex economy is thermodynamically open, dynamic, nonlinear,
and generally far from equilibrium, whereas the Walrasian economy is
thermodynamically closed, static, and linear in the sense that it can be
understood using algebraic geometry and manifold theory.

Agents: In the complex economy, agents have limited information and face high
costs of information processing. However, under appropriate conditions, they
evolve non-optimal but highly effective heuristics for operating in complex
environments. There is no assurance that when faced with novel environments,
individuals will shift efficiently to new heuristics. In the traditional
economy, by contrast, agents have perfect information and can costlessly
optimize.

Networks: Agents in the complex economy participate in sophisticated and
overlapping networks that allow them to compensate for having limited
information and facing formidable information processing costs. In the
Walrasian economy, agents do not interact at all. Rather, each agent faces an
impersonal price structure.

Emergence: In the complex economy, macroeconomic patterns are emergent
properties of micro-level interactions and behaviors, in the same sense as
the chemical properties of a carbon molecule, such as carbon, is an emergent
property of its nuclear and electronic structure, or that thermodynamics is
an emergent property of many-particle systems. In such cases we cannot
analytically derive the properties of the macro system from those of its
component parts, although we can apply novel mathematical techniques to model
the behavior of the emergent properties. In the case of the complex economy,
these higher level modeling constructs are currently largely absent, although
agent-based modeling may provide the data needed to develop the appropriate
mathematical tools. By contrast, the Walrasian economy has no macro
properties that cannot be derived from its micro properties (for instance,
the First and Second Welfare Theorems).

Evolution: In the complex economy, the evolutionary process of
differentiation, selection, and amplification provides the system with
novelty and is responsible for the growth in order and complexity. In the
Walrasian economy there is no mechanism for creating novelty or growth in
complexity.


Imitation is at the very epicenter of biological evolution, since offspring
inherit the genes of their parents. Imitation is also at the very heart of
cultural evolution. Indeed, the replicator equations for cultural
evolution---the very same equations that hold for genetic evolution---are
derived by assuming individuals with low-payoff strategies switch with some
positive probability to the strategies of more successful agents, with a
probability that is increasing in the difference of the payoffs (Gintis,
2000a). While there have been a few contributions to the economic literature
on behavioral change through imitation (Conlisk, 1988, Bikhchandani et al.,
1992), and technological diffusion is included in macroeconomic modeling,
Traditional Economics considers the notion completely non-standard. Rather,
economics has traditionally treated learning as process of individual data
gathering and experimentation The most plausible explanation of this bizarre
prejudice is simply disciplinary cultural inertia, but I cannot imagine why
this persists, given that the capacity to imitate is likely one of the most
important aspects of human cognitive capacity accounting for our cultural
advance over other primates. "Imitation," notes Beinhocker, "is the sincerest
form of flattery."

Imitation acquires its importance from the fact that most mutations are
deleterious. An agent is thus more likely to improve his position by
imitating a successful other, rather than experimenting personally.
"Technological evolution," says Beinhocker, "is not a mere metaphor. It is
the result of humandkind's deductive-tinkering search through the near
infinite possibilities of Physical Technology space. The nature of the
process of differentiation, selection, and replication in this substrate is
different from that of biology, but is an evolutionary process nonetheless."


TE has a genius for hijacking terms from everyday economic discourse and
turning them analytically into their virtual opposites. Consider, for
instance, the term competition. There is no competition at all in the
Walrasian economy. However TE redefines the term to mean a situation in which
individuals have no effect on market outcomes. How perverse!

Similarly, a market in the Walrasian model is precisely not a market in the
ordinary sense of an institution mediating the exchange of goods. Rather, the
Walrasian market consists of a centralized pricing agent (the "auctioneer")
who calls out prices, determines how much of each good would be forthcoming
given these prices, and adjusts the prices until excess supply in all markets
is zero. In no sense, then is the "market" of TE akin to the markets in which
agents engage in face to face competition and exchange, and in the Complex
Economy.

"An evolutionary view of the economy leads one to agree," says Beinhocker,
"that markets are good, but for some very different reasons [from those of
TE]." Markets are, in his view, "an evolutionary search mechanism. Markets
provide incentives for the deductive-tinkering process of differentiation.
They then critically provide a fitness function and selection process that
represent the broad needs of the population they provide a means of shifting
resources toward fit modules and away from unfit ones, thus amplifying the
fit modules' influence." He explicitly recognizes that the differentia
specifica of markets cannot be captured by Traditional Theory: "Markets win
over command and control, not because of their efficiency at resource
allocation in equilibrium, but because their effectiveness at innovation in
disequilibrium." (p. 294)

Throughout much of the world, the pitched ideological and political battles
between Right and Left over economic policy are a thing of the past. On the
Left, there is no serious movement for the abolition of private property or
even the nationalization of basic industries. Liberal Keynesianism is dead in
an era where conservatives are prone to run deficits and liberals to piously
admonish such policy as reckless and short-sighted. On the Right, the notion
that the state should be restricted to protecting private property is
maintained, against all evidence, only by a radical fringe. Complexity
Economics was hardly responsible for defusing Right-Left polarities in policy
circles. Old age and boredom were probably the real culprits.

Nevertheless, as Beinhocker stresses there remain deep ideological divides of
a Right-Left nature that are affected by the considerations analyzed in The
Origin of Wealth. One concerns human nature. "If one digs deeply into the
Left-Right divide...one finds two conflicting views of human nature. On the
Left is the view that human beings are inherently altruistic; that greed and
selfishness stem...from the construction of the social order; and that humans
can be made better through a more just society....On the Right is the view
that human beings are inherently self-regarding and that the pursuit of
self-interest is an inalienable right. The most effective system of
government is one that accommodates rather than attempts to change this
aspect of human nature." Beinhocker asserts that behavioral game theoretic
findings defuse this polarity by showing that both sides are wrong, and give
us the materials for a far more nuanced and effective set of policy options
than are envisioned in the Left-Right dialogue.

The second Left-Right divide is over the proper weight to be afforded to
markets versus state intervention, the Left stressing market failure and
favoring widespread state intervention, the Right stressing state failure and
favoring strict constraints on intervention. The historical fact that strong
states and strong market economies have coevolved suggests that state
intervention is an aspect of the economy as a complex adaptive system, and
the idea of a minimal state is simply a conservative fantasy. Conversely, the
notion that the state can successfully supplant the market is incompatible with the
importance of competition in the economy's evolutionary dynamic. However, a
proper understanding of economic dynamics and human nature hold out the
possibility of rendering state interventions, for instance in addressing
poverty and environmental problems, considerably more effective and
politically popular than hitherto possible.

Behavioral economic research, in work pioneered by Fehr and Gaechter (1998),
extended by Henrich et al. (2004), and summarized in Gintis et al. (2005) and
Henrich et al. (2005), supports the notion that most individuals are not
self-regarding in their social interactions within a group, but rather are a
combination of conditional cooperators, who prefer to sacrifice personally on
behalf of other group members, and altruistic punishers, who prefer to punish
other group members who violate the group's cooperative norms. The case of
both cooperation and punishment, individuals are willing to so behave even
when there is no possibility of future material reward stemming from their
actions---as is the case, for instance, in one-shot anonymous games in the
laboratory and in the field. This has come to be known as strong reciprocity.
the theory of repeated games.

The prevalence of strong reciprocity effectively undermines the Hobbesian
view of human nature so dear to conservatives. But it conflicts with the
notion of unconditional altruism favored by liberals on two counts. First,
strong reciprocators are conditional cooperators who, in repeated but
anonymous interactions, will generally withdraw cooperation if it appears
that others are not reciprocating. Second, strong reciprocators will
generally revert to self-interested behavior if the cost of cooperation
becomes sufficiently high (Andreoni and Miller, 2002, Gneezy, 2005).
Moreover, both Left and Right have generally ignored the altruistic
punishment aspect of strong reciprocity. Indeed, only carefully controlled
laboratory studies have succeeded in isolating altruistic punishment as a
"pure" motive rather than simply a statistical aberration or an attempt to
establish a reputation as a hard bargainer. These studies suggest, by
contrast with traditional political philosophies of both Right and Left that
altruistic punishment may be the most potent enforcer of prosocial norms,
both in the evolution of our species and in contemporary social life.
Informal, decentralized sanction will normally be more effective in
motivating prosocial behavior than bureaucratic juridical sanctions. "Leges,"
wrote Horace in the Third Ode, "sine moribus vanae" (laws without morality
are useless).

Turning to the question of market vs. state, we should note that there are
three philosophies of state intervention in America. Liberals generally
believe that markets wreak havoc with people's lives and generate extreme
income inequality, state intervention being the appropriate remedy.
Conservatives believe that the market almost always produces efficient and
just outcomes, so the state should be limited to protecting the rules of the
game. Economists generally believe that both market and state failure are
serious problems, and any proposed intervention must be thoroughly analyzed
in terms of costs, benefits, and feasibility. Beinhocker argues that
Complexity Economics offers a philosophy of state intervention that is
distinct from all of the above.

"A complexity perspective," he asserts, "would distinguish between two types
of government action. Policies that get the government involved in
differentiating, selecting, and amplifying Business Plans would be seen as
interfering in economic evolution...In contrast, policies that shape the
fitness environment while leaving Business Plan selection and amplification
to market mechanisms" are useful and even necessary (p. 426). This position
is probably closest to that of the traditional economics view, except that
Beinhocker's approach is mo ecological in that many of the parameters
involved in assessing the effect of an intervention on the fitness
environment of the economy are interdependent and difficult to measure. He
conclusion that the "economic role of the state is to create an institutional
framework that supports the evolutionary workings of markets" suffers from a
certain vagueness but may be workable in practice.