Division of Labor, Technology Metabolism, and Business Cycles - A Constructive Criticism of Mainstream Economic Principles Ping Chen China Center for Economic.

Division of Labor, Technology Metabolism, and Business Cycles

- A Constructive Criticism of Mainstream Economic Principles

• Ping Chen• China Center for Economic Research, Peking University

• [email protected] for New Political Economy, Fudan University

http://www.cnpe.org.cn/• Ilya Prigogine Center for Studies in

• Statistical Mechanics and Complex Systems, University of Texas at Austin• [email protected]

• Nov.11, 2004 at China People’s University

参考书 : 陈平 ,文明分岔、经济混沌、和演化经济动力学，北京大学出版社 (2004) 。

• 正象达尔文发现有机界的发展规律一样，马克思发现了人类历史的发展规律，即历来为繁茂芜杂的意识形态所掩盖着的一个简单事实：人们必须首先吃，喝，住，穿，然后才能从事政治，科学，艺术，宗教等等；所以，直接的物质的生活资料的生产，因而一个民族或一个时代的一定的经济发展阶段，便构成为基础，人们的国家制度，法的观念，艺术以至宗教观念，就是从这个基础上发展起来的，因而，也必须由这个基础来解释，而不是象过去那样做得相反。

•  

• - 恩格斯， “在马克思墓前的讲话“• 马克思恩格斯选集，第 3 卷， 574 页， 人民出版社，北京 1972 年

版

Is Economics a Science?

• Conflicting doctrines:• Man’s nature is selfish and greedy (classical)• Man’s nature is free and social animal (Marx)• Bounded rationality (behavioral economics)

• Conflicting Nobel prizes:• 1974 Gunnar Myrdal, Friedrich August von

Hayek

From Ilya Prigogine:Order Out of Chaos (1984)

• Whitehead wrote that a “clash of doctrines is not a disaster, it is an opportunity.” If this statement is true, few opportunities in the history of science have been so promising: two worlds have come face to face, the world of dynamics and the world of thermodynamics.

• Where classical science used to emphasize permanence, we now find change and evolution.

Observation, Question, Theories, Evidence

• How to start from an observation of “real world”?

• Any observation implies an implicit theory, the question is judging competing theories

• Pay equal attention to supporting evidence and counter examples

• Find hidden assumption in existing theory and alternative perspective

A Good Question Is Half-Done

• [Observation No.1] at Taiyuan Heavy Machine Co.:

• After more than 10 years, worker’s number multiplied three times, but production output is only about one third of design capacity, WHY?

• Economy of scale, market extent, and diversified pattern in division of labor

From Cybernetics to Complex Systems

Wiener (cybernetics) – negative feedback mechanism for dynamical stability;

Schrödinger (quantum biology) – meta-stable state, non-periodic crystal, and negative entropy flow;

Prigogine (non-equilibrium physics) – positive feedback, catalytic reaction, and order out of chaos.

Question #1: Why China’s history favors self-sufficiency while West prefers division of labor?

• [Classical economics] • Rational choice under scarcity (What shapes people’s

preference?)• Optimal equilibrium under non-scale economy• Wallerstein Paradox and Needham’s Question:

China lacks man while Europe needs space?• Marthus: ecology (resource limitation)• Max Weber: culture (Protestant/Confucius)• Marx/Mao: class struggle is the driving force of

production?• New classical/anthropology: irrationality?

Quantitative Counter Evidence and Historical Puzzle

• [Question 1a] Is there any empirical evidence than landlord system and small-farming is more productive in history? (Answer: No).

• [Question 1b] Why China’s policy based on agriculture (grain production) while Europe based on commerce?

• [Question 1c] Why spice trade in the West had different impact than silk/tea/china trade in China?

Equilibrium & Non-equilibrium Order in Evolutionary Thermodynamics

From Non-equilibrium Thermodynamics to Cultural Anthropology

• Why spice trade? Animal husbandry vs. grain production

• Why China developed labor-intensive but resource-saving technology while Europe developed labor-saving but resource-intensive technology?

• Geography and climate shaped the initial condition of technology and culture

Individualism (Risk-Taking) & Collectivism (Risk-Aversion) Behavior

Challenge to Microeconomics• What is the nature of competition?• Price competition vs. market-share competition

• What is the ideal state of competition?• Perfect/monopoly/proper competition?

• What is the social outcome of competition?• Positive or reverse selection?• Increasing/decreasing division of labor?

Smith Dilemma (Stigler 1951) and Trade-Off between Stability & Complexity

(Chen 2002)

• Adam Smith Theory: “Invisible hand” > perfect competition > many small firms

• Smith Theorem: Division of labor is limited by market extent > monopoly > few large firms

• How small and large firms could coexist?• [ 中国国企的改革战略 ] 抓大放小，与集团作大？

Re-Understanding Chinese Society

• Ecological crisis and peasant wars

• Small-scale farming and population mechanism: 按效分配，按劳分配，与按势分配。

• [ 中国问题应用 ] ：• 三农问题与乡镇机构的过度扩张• 奖励生育，粮食自给，过度恳荒，与生态危机• 趋同教育，恶性（完全）竞争，与就业危机• [ 中国前途 ] ：• 保护生态（小康社会），发展劳动分工与规模范围经济，

鼓励创新（适度竞争），可持续协调发展• 质疑过度个人主义（过度消费，福利社会，大政府，过度

法制），均衡陷阱，过度 / 垄断竞争

Specie Competition, Technology Metabolism, Product Cycles, and Growth Wavelets

0 100 200 300 400 5000

0.5

1

1.5

2

2.5Logistic Competition

time

popu

latio

n

Challenge to Growth Theory and Transaction Cost School

• Convergence (Solow)?• South-North Gap (Endogenous growth, Romer,

Lucas)?• Decreasing transaction cost (Coase)?• Independent of initial condition (Coase Theorem)?

• Convergence equilibrium (Stalin/Coase) vs. Diversity development (Schumpeter’s Constructive destruction)?

Question #2: Market Economy Is Inherently Stable? (macro-finance- micro-econometrics)

• Equilibrium thinking in economics:• Negative-sloped demand curve (Marshall) > convex

function > fixed point theorem in Arrow-Debreu model in microeconomics

• Econometrics: Frisch model of noise-driven harmonic oscillator

• Friedman’s monetary shocks• Real Business Cycle School (Prescott & Kydland):

technology shocks• Fama’s efficient market hypothesis and Brownian motion

model in finance theory• Friedman spirit and arbitrage-free theory in asset pricing

Historical Events: Great Depression and Financial Crises

• Keynesian Revolution: Insufficient macro demand• Austrian school: internal instability in financial

market• Neo-classical synthesis: a compromise to classical

economics

• Lucas: New classical counter-revolution: micro foundations and rational expectations

Question 2a: Can We Test Competing Economic Theories by Quantitative Analysis? (Testing noise versus chaos from macro & financial time series)

• Equilibrium model:• Steady state + random noise

• Keynesian school: damped oscillation

• Schumpeter (evolutionary) school: persistent cycles (limit cycle or deterministic chaos)

Test #1: Monetary and Macro Chaos or Noise?Economic Chaos: Copernicus Problem in

Macroeconomics (1984-1996)

• Discovery of monetary chaos (1985) > implication for Austrian school

• HP filter and time-frequency analysis (1994) > wide evidence of color chaos in macro and stock indexes

Re-Examine Empirical and Theoretical Foundations of Equilibrium Economics (1999-2002)

• Reject Frisch model (1999- ) > perpetual motion machine of the second kind

• Reject Lucas model (1999-2002) > against the law of large numbers

• Find better measurement > relative deviation > meso economy, trivial result of consumption smooth

• Reject random walk and Brownian motion model > fever birth-death process

Re-Examining Empirical and Theoretical Foundations of Equilibrium Economics

• Econometrics – Frisch model of noise-driven damped harmonic oscillator (1933)

• Macroeconomics – Lucas model of microfoundations and rational expectations (1972)

• Finance –geometric Brownian motion (diffusion model) (Osborne 1959, Black & Scholes 1973)

• Microeconomics – Friedman’s thought experiment of arbitrager against speculator in an efficient market (1953)

> Equilibrium illusions through a short-time window and representative agent

Physics Selects Better Alternatives

• Frisch model – against the second law of thermodynamics (Unlenbeck & Orstein 1930, Chen 1999,2003) > nonlinear oscillator (color chaos)

• Lucas model = disguised representative model – against the law of large numbers (Schrödinger 1940, Chen 2002) > statistical mechanics

• Brownian motion – explosive in time (against economic coherence) (Chen 1999, 2003) > birth-death process

• Friedman argument = Maxwell demon – perfect information against the uncertainty principle in information theory (Brillouin 1951, Chen 1999, 2003) > economic complexity

Why Strong Resistance to Economic Chaos

• Logistic curve and multi-humped function is excluded by utility theory in microeconomics (multiple equilibrium against unique equilibrium)

• Non-integrable system implies the failure of regression approach in econometrics

• Chaotic pattern against the belief of efficient market in finance theory, rational expectations and fine-tune by government interference in macroeconomics

• Difficulties in empirical tests: non-stationarity, strong noise, short time series

Equilibrium Illusion through a Whitening Looking Glass (FD)

X(t) = FD[S(t)]=S(t+1)-S(t)

• Frequency response for the FD filter

0 0.1 0.2 0.3 0.4 0.50

0.05

0.1

0.15

0.2

0.25

0.3

0.35

0.4FD Whitening Filter

f

Fre

q R

esponse R

(f)

S&P500 Stock Price Indexwith log-linear (LL) and HP growth trends

(VHP filter for von Neumann-Hodrick-Prescott)

1950 1960 1970 1980 1990 20002

3

4

5

6

7

8

X(t

) =

Ln

SP

X

XLLHP

Detrended Cycles with Different Images

1950 1960 1970 1980 1990 2000-0.8

-0.6

-0.4

-0.2

0

0.2

0.4

0.6

Cyc

les

FDHPcLLc

Different Images of Auto-Correlations

0 10 20 30 40 50-1

-0.5

0

0.5

1

AC

(n)

HPcLLcFDs

Copernicus Problem in Choosing Proper Observation Reference

FD (First-Differencing) – Observing rate of changes in a time unit – ignoring (low-frequency) long-term growth trend + amplifying high-frequency noise

• Gaussian random noise for monthly to annual macro data (mainstream econometrics)

• Fractal Brownian motion for high frequency (minutes) financial data (econophysics)

HP (von Neumann-Hodrick-Prescott) filter for weekly to quarterly data– Observing business cycles around a smooth trend in a medium time window (~ years) – mainly (continuous-time) color chaos (strange attractor) + some white noise

Uncertainty Principle in Signal Processing

Gabor (Gaussian) Wavelet with Minimum Uncertainty

)exp()2

exp()1

()(2

24

1

2ti

tth

The Coherent State (Gaussian Packet, Gabor Wavelet)

The Uncertainty Principle in Quantum Mechanics & Information Theory

t f (1/4)

WDb (t, ) = 2 exp{- [ (t/)2 + ()2 ] }

Gabor Space (1946) in discrete time-frequency space

• Minimum uncertainty in time-frequency space

• Un-orthogonal base function

Wigner Distribution (1932)

• Probability representation in quantum optics• Fourier transform of autocorrelation in a

symmetric time window

ditststWD )exp(*)2

()2

(),(

Stationary (Discrete Fourier Transform) vs.Non-Stationary (Joint-Time-Frequency Analysis)

Time Series Analysis

Separating signals and noise in Gabor (time-frequency) space

Unfiltered & Filtered Gabor Distribution

Evidence of Strange Attractor in Stock Market Obtained by WGQ (Wigner transform + Gabor space + Qian algorithm) Time-Varying Filter

-0.3

-0.2

-0.1

0

0.1

0.2

0.3

X(t

+T)

-0.3 -0.2 -0.1 0 0.1 0.2 0.3X(t)

FSPCOM Raw HP Cycles

-0.3

-0.2

-0.1

0

0.1

0.2

0.3

-0.3

X(t

+T)

-0.2 -0.1 0 0.1 0.2 0.3X(t)

FSPCOM Filtered HP Cycles

Stock Price Indexes (Standard & Poor 500)Correlation dimension = 2.5

Variance of color chaos = 69 %

-4

-2

0

2

4

1945 1955 1965

S(t

)

1975 1985 1995t

FSPCOM Original & Filtered Cycles (H=0.5)

SoSg

Structural Stability in Parameter Space:Linear vs.nonlinear models

Stability pattern of Samuelson model in parameter space. Here, ST denotes the steady state; DO, damped oscillation; EO, explosive oscillation; EP, explosive solution; PO, linear periodic oscillation.

Test #2: Frisch Model Failed to Generate Persistent Business Cycles (Chen 1999)

• The observed auto-correlation will be damped exponentially (Wang and G. E. Unlenbeck 1945);

• For the Frisch model of the U.S.business cycles, American business cycles would be ceased within 4~10 years!

2 2( ) exp( )[cos( ) sin( )]

2r

r r

T

T T T T

Nature of the Frisch Fantasy:A Perpetual Motion Machine of Second-Type

• The relaxation time T is 2 yrs for FD, 5 yrs for HP, 36 yrs for LL. No persistent cycles in Frisch model of US GDP.

• The variance of external shocks should be 75% larger than that of US real GDP for FD!

• HD is better than FD and LL in applying Frisch model to GDP series.

Table I. The Frisch Model for US Real GDP Cycles (time unit is year)

Detrending 1 T T1 T g

FD 1.02 1.79 1.86 3.4 3.5 2.0 0.010 0.57 HP 0.41 1.30 1.32 4.7 4.8 4.9 0.018 2.8 LL 0.055 0.11 .015 42 57 36 0.021 1600

where, g is the variance ratio of the observed residual to the external noise.

Myth about the Frisch Model

• Frisch was not the FIRST: G.E.Uhlenbeck and L.S. Ornstein, "On the Theory of Brownian Motion," Physical Review, 36(3), 823-841 (1930).

• Frisch’s Informal conference paper: R. Frisch, “Propagation Problems and Impulse Problems in Dynamic Economics”, in Economic Essays in Honour of Gustav Cassel, George Allen & Unwin, London (1933).

• Frisch's promised paper, "Changing harmonics studied from the point of view of linear operators and erratic shocks," was advertised three times under the category "papers to appear in early issues" in Econometrica, including Issue No. 2, 3, and 4 of Volume I (April, July, and October 1933) but never appeared in Econometrica since 1934.

• Frisch never mentioned a word about his prize-winning model in his Nobel speech in 1969 (Frisch 1981).

The Principle of Large Numbersfor Positive Variables

• SN=X1+X2+ . . . . . . +XN

Relative Fluctuation (RD) and the Implied Number from Empirical Observation

• Relative fluctuation

• Implied number

N

1~

NN

NST

2

2

2

1*

macro

macro

macro

N

Relative Deviation (RD)Under Different References

• HP – upper bound for the number of micro agents• ST – Static time window of 10 years, lower bound• LL – middle range figure• FD – useless in studying micro–macro relation caused

by negative mean.

Data GDPQLn(HP) GDPQLn(LL) GDPQLn(ST) GDPQLn(FD)

(%) 0.2 0.4 1.2 140

N* 200,000 70,000 7,000 0.5

The Relative Deviation and Implicit Number For Macro Indexes under ST and HP Methods

• GDPQ – US Real GDP quarterly

• GCQ – US Real Consumption quarterly

• GPIQ – US Real Investment quarterly

• LBMNU – US Non-Farm Business Hours quarterly

(%) [N*] GDPQLn GCQLn GPIQLn LBMNULn

ST 1.2 [7,000] 1.4 [6,000] 2.2 [2,000] 1.1 [8,000]

HP 0.22 [200,000] 0.16 [400,000] 1.3 [6,000] 0.43[50,000]

Numbers of Households and Firms in 1980 of the US Economy

• Realistic Number and Potential Relative Deviations

Micro-Agents Households Corporations* Public Companies

N 80.7(million) 2.9(million) 20,000

(%) 0.01 0.05 0.7

*Here, we count only those corporations with more than $100,000 in assets.

Test #3: Weak microfoundations in labor and producer market

The observed implied numbers predicted by the Lucas model is 400~ 500 times smaller (RD is 20 times larger ) than in US real economy.

Possible microfoundations in financial markets and industrial organizationnot in labor or producer market

Implication > Three layer structure (micro, meso, macro) rather than two layer structure (micro, macro) in economies

Failure of the Lucas Model of Rational Expectations and Inter-temporal Substitutions

• Relative prices move in opposite directions: Rising demand of leisure will raise leisure prices, which would induce arbitrage activities

• Arbitrage activities by rational agents would cancel out inter-temporal substitution.

• Rational expectations hypotheses is a self-defeating mechanism as Lucas critique in forecasting market movements.

• Lucas model of island economy (1972) is a disguised model of representative agent, which ignored statistical effect under the Principle of Large Numbers.

Stable RD in US Macro Indexesobserved under VHP filter

1950 1960 1970 1980 1990 20000

2

4

6

8

rel

de

v (

%)

gdpc1

gpdic1

pcecc96

Test #3: Persistent Fluctuations in Financial Market

• Random walk is damping over time• Brownian motion is exploding over time• Only the Birth-death process is stable in time, which is a

statistical model of endogenous fluctuations

Order Brownian motion Birth-Death Random-Walk Mean )exp(~rt )exp(~rt t Variance }1){2exp(~

2

tert )1(~rtrtee t

RD )1(~2

2

2 t

tee

0

1~N

t

1

Test #4: Failure of Friedman Spirits (~ Maxwell Demon) for Efficient Market

• Arbitrage risk (De Long et al 1990)• Information cost (Grossman and Stiglitz 1980)• Information ambiguity (limited data, time

delays, dynamical uncertainty)• Limited replication of winner’s strategy under

complex dynamics

• Complex patterns in resilient market

Understanding Resilient Market (Order & Changes) by Economic Biophysics

• Viability (survival zone) at micro: Non-convex utility of individual behavior

• Diversity at meso (finance and industrial organization): Lotka-Volterra competition for market niches

• Persistent cycles at macro: Birth-death process (economic metabolism) in growth fluctuation and nonlinear oscillator (biological clock) in business cycles

Policy Implications

• Source of innovation & crises: Meso economy in three layers of economic organism (Schumpeter, Keynes, Minsky):

micro - financial intermediates – macro

• Policy change: from demand side to supply side, from managing monetary shocks to technology waves (Rostow)

中国问题的新思考：非均衡的现实与多样的发展

• 如何解决就业问题？• 宏观调控的措施？• 房地产泡沫与金融改革• 效率与公平的悖论：土地，教育，医疗，

社保• 世界工厂与外向政策

Toward a General Synthesis of Smith, Schumpeter, Keynes, and von Neumann

• Keynes’s Goal of his General Theory (disequilibrium framework) and Einstein’s General Relativity

• Retreat of neo-classical synthesis (equilibrium framework) by Hicks and Samuelson

• Construct a general framework based on evolutionary (non-equilibrium) perspective

从均衡经济学到复杂经济科学

• 老子，道德经：“道生一，一生二，二生三，三生万物。”

• 市场 - 政府 - 与社会的互动• 微观 - 中观 - 宏观的结构演化• 演化经济学的兴起• 新政治经济学的整合：可持续协调发展与效率，

公平，创造的兼顾• 看不见的手，帮助的手，掠夺的手，还是规制

的手？• 保护产权还是保护创新？