Accounting for the creation of wealth has long challenged humanity's best minds. For business readers and academics, Beinhocker is a zealous and able guide to the emerging economic paradigm shift he calls the "Complexity Economics revolution."
A fellow of the economic think tank McKinsey Global Institute, he rejects traditional economic theory, based on a physics model of closed systems, in which change is an external disruptive shock. Instead, he outlines an open, adaptive system with interlocking networks that change organically, reflecting the interaction of technological innovation, social development and business practice.
Wealth is created to the degree that this interaction decreases entropy in favor of "fit order" that meets human needs, desires and preferences. Beinhocker is sufficiently comfortable with this evolutionary model to advocate a comprehensive redesigning of institutions and society to facilitate it. He argues for corporate policies that favor many small risks over a few big ones and recommends restructuring financial theory to favor growth and endurance rather than short-term gains.
Though he asserts that complexity economics can reduce political partisanship and increase social capital, Beinhocker stops short of saying that it cures sexual dysfunction. By the end, the concept emerges as a great idea that the author tries to make a panacea.
Excerpts
On Wealth: "...new answers to these fundamental questions are beginning to emerge from work carried out over the past few decades. These new answers come not just from the work of economists, but also from biologists, physicists, evolutionary theorists, computer scientists, antthropologists, psychologists, and cognitive scientists."
"The economy is a marvel of complexity. Yet no one designed it and no one runs it."
"...cooperative trading between nonrelatives is a uniquely human activity. No other species has developed the combination of trading among strangers and a division of labor that characterizes the human economy."
"...over 97 percent of humaity's wealth was created in just the last 0.01 percent of our history."
"...wealth creation is the product of a simple, but profoundly powerful, three-step formula - differentiate, select, and amplify - the formula of evolution."
"...cooperation is as vital an ingredient in economic development as "survival of the fittest" individualism."
"Evolution creates designs, or more appropriately, discovers designs, through a process of trial and error."
On complex adaptive systems:
"The most obvious characteristic of economies is that they are collections of people interacting with each other in complex ways, processing information, and adapting their behaviors."
"Evolution is thus a process of sifting from an enormous space of possibilities. It tries a bunch of designs, sees what works, and does more of what works and less of what doesn't, repeated over and over again. There is no foresight, no planning, no rationality, and no conscious design. THere is just the mindless, mechanical grinding of the algorithm."
"...there will also be at least a few outliers providing a chance of finding some new ways to higher ground."
"...evolution manages (...) the tension between exploration and exploitation."
"Markets win over command and control, not because of their efficiency at resource allocation in equilibrium, but because of their effectiveness at innovation in disequilibrium."
"Evolution is a knowledge-creation machine - a learning algorithm."
"Wealth is knowledge and its origin is evolution."
"But the frequent occurence of "stable" periods between punctuation points only gives us a false sense of predictability - there is nothing more dangerous than a "stable" industry."
"The company is now in the middle of a punctuation point, and the management suddenly finds itself in a new game and stuck with the wrong mental models, the wrong assets, and the wrong skills."
"...change in the economy is driven more by the entry and exit of firms than by the adaptation of individual companies."
"...the long-term survivors in the S&P 500 underperformed the average. It is the constant entry of newcomers that keeps the average up."
"Companies have an inherent disadvantage in that they can never have the same diversity of Business Plans as contained in the market as a whole."
"...admit the inherent uncertainty of the future, and emphasize learning and adapting over predicting and learning."
"...organizations are often too risk averse for ssmall bets made at lower levels of the hierarchy, and insufficiently risk averse for large bets made at the top levels."
"Our mental models thus tend to settle over time."
"Finance is one of the few areas of economics in which theories and equations come straight out of academia and are almost immediatly applied in the real world."
"The equilibrium view of Traditional finance simply assumes that everything happens all at once, and thus it hides these dynamics."
"Bachelier was wrong. Markets do not follow a random walk. (...) market data has considerable structure which has all the signature characteristics of a complex adaptive system."
"...financial markets are an evolving ecosystem of competing trading strategies."
"Traditional Economics tells us that stock prices move when a piece of news hits the market. (...) They found that, typically, there was really not much news to speak of on the days around the biggest crashes."
"Power laws, along with oscillations and punctuated equilibriums, are another signature characteristic of complex adaptive systems."
"...financial markets are far more volatile than Traditional Economics leads us to believe."