Summers at the IMF with Diamonds

1332897533_lucy in the sky with diamondsLast November 8th, Larry Summers talked before the IMF on the danger that the U.S. and Europe are turning Japanese, i.e., about to repeat Japan’s ongoing post-1991 episode of secular stagnation. After praising the quick and successful reaction to contain the financial panic and avoid a much worse scenario, his conclusion is not so optimistic:

My lesson from this crisis is that it is not over until it is over and that is surely not right now and cannot be judged relative to the extent of financial panic and that we may well need in the years ahead to think about how we manage an economy in which the 0 nominal interest rate is a chronic and systemic inhibitor of economic activity holding our economies back below their potential

This talk has got a lot of attention and even provoked a jealous rage in some of his professional colleagues who are now claiming they cried wolf first. For all the hype, there is no single clue in Summers’ talk about why this is happening now. Is it demography? Is it Bob Gordonesque decline in innovation (as Krugman put it in this seminal me-too post)? No idea.

The debate is absolutely engaging for someone with a math inclination. From a macroeconomist’s point of view, the market seems to demand a strongly negative real interest rate, and monetary policy is simply unable to deliver such a rate (liquidity trap). A negative interest rate seems the most stupid thing from an individual perspective. It means that I would like to deposit my money in the bank to be charged instead of paid for it, because I prefer a future dollar (or euro) than a present one. Phew! Hard to imagine, even after having a look at current film premieres!

Sooner or later, a macroeconomist will end up discovering an interesting imaginary variable somehow related to the square root of that crazy negative real interest rate. A Nobel Prize is just awaiting. While that comes, let’s have a look into another direction: What happens if we have hit a complexity ceiling?

Complexity is a topic management gurus like to talk about. On November 14th and 15th some of them met in Vienna to debate about the topic, and according to The Economist, they were preoccupied by two points: that business is more complicated than ever before; and that managing complexity is at the top of business people’s agenda. Further than this there does not seem to have been conclusions worth mentioning. No surprise here: complexity science is a complex thing, far from well understood and far from having produced any practical result yet, and yet maybe key to solve Summers’ conundrum.

For quite a few years, some people have been putting forward the idea that the economy is best described as a complex adapting system and that complexity and wealth might have a much closer relationship than we are ready to accept.

Wealth must be a product of evolutionary processes. Just as biological evolution summoned complex organisms and ecosystems out of the primordial soup, economic evolution has taken humankind from a state of nature to the modern global economy, filling the world with order, complexity, and diversity along the way (Eric Beinhocker, “The Origin of Wealth“)

Economic complexity matters because it helps explain differences in the level of income of countries, and more important, because it predicts future economic growth. Economic complexity might not be simple to accomplish, but the countries that do achieve it, tend to reap important rewards. (Ricardo Hausmann, César Hidalgo, et. al. “The Atlas of Economic Complexity”)

Dealing with complexity demands intelligence(1,2) but very likely our collective intelligence is not increasing. There is no evidence of something like a Flynn effect in our aggregated collective IQ because, to begin with, we do not even know how to measure that collective IQ. Our institutions –corporations, governments, markets– remain barely the same since the end of World War II, and in many cases are plummeting under the weight of their missions. If our intelligence is not increasing, we could have reached the limit of complexity we are able to deal with and, therefore, somehow a limit for the wealth growth our economy is able to generate. Maybe Japan hit their complexity ceiling in the 90’s. (Notwithstanding they were the smartest country in the planet for a time.) And now USA and for sure Europe might be hitting or have hit their complexity ceiling.

Worse, our efforts to solve the apparent problems might be disrupting the system and the best chances to increase wealth. Coming back to Summers again:

Most of what would be done under the aegis of preventing a future crisis would be counterproductive.

The problem with living within a system we do not understand is that we do not know whether we should try to counterbalance certain effects or they are just the effects we would expect along the most desirable path, even if we are talking about extreme inequality, bouncing market bubbles or uncanny negative interest rates.

As I am writing this I am beginning to feel a little dizzy and I am thinking of Larry Summers in a boat on a river with tangerine tress and marmalade skies. And everyone smiles as he drifts past the flowers that grow so incredibly high…

(1) “Complexity can be defined as intellectual un-manageability”; Nancy Leveson, “Engineering a Safer World”
(2) “The general factor of intelligence, g,
 is essentially the ability to deal with cognitive complexity, in particular, with complex information processing”; Linda Gottfredson, Why g Matters: The Complexity of Everyday Life”

Featured Image: Lucy In The Sky With Diamonds by lollipupgirl Art with a creative twist

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