Division of Labor, Technology Metabolism, and Business Cycles - A Constructive Criticism of Mainstream Economic Principles

1
Division of Labor, Technology Metabolism, and
Business Cycles - A Constructive Criticism of
Mainstream Economic Principles

• Ping Chen
• China Center for Economic Research, Peking
  University
• pchen_at_ccer.pku.edu.cn
• Center 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
• pchen_at_physics.utexas.edu
• Nov.11, 2004 at China Peoples University

2
??? ??,??????????????????,??????? (2004)?

• ?????????????????,???????????????,????????????????
  ???????????????,?,?,?,????????,??,??,??????,????
  ?????????,?????????????????????,??????,???????,???
  ?,????????,?????????????,??,???????????,??????????
  ???
•  
• - ???, ?????????
• ????????,?3?,574?, ?????,??1972??

3
Is Economics a Science?

• Conflicting doctrines
• Mans nature is selfish and greedy (classical)
• Mans nature is free and social animal (Marx)
• Bounded rationality (behavioral economics)
• Conflicting Nobel prizes
• 1974 Gunnar Myrdal, Friedrich August von Hayek

4
From Ilya PrigogineOrder 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.

5
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

6
A Good Question Is Half-Done

• Observation No.1 at Taiyuan Heavy Machine Co.
• After more than 10 years, workers 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

7
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.

8
Question 1 Why Chinas history favors
self-sufficiency while West prefers division of
labor?

• Classical economics
• Rational choice under scarcity (What shapes
  peoples preference?)
• Optimal equilibrium under non-scale economy
• Wallerstein Paradox and Needhams 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?

9
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 Chinas 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?

10
Equilibrium Non-equilibrium Order in
Evolutionary Thermodynamics
11
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

12
Individualism (Risk-Taking) Collectivism
(Risk-Aversion) Behavior
13
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?

14
Smith Dilemma (Stigler 1951) and Trade-Off
between Stability Complexity (Chen 2002)

• Adam Smith Theory Invisible hand gt perfect
  competition gt many small firms
• Smith Theorem Division of labor is limited by
  market extent gt monopoly gt few large firms
• How small and large firms could coexist?
• ?????????????,??????

15
Re-Understanding Chinese Society

• Ecological crisis and peasant wars
• Small-scale farming and population mechanism
  ????,????,??????
• ??????
• ??????????????
• ????,????,????,?????
• ????,??(??)??,?????
• ????
• ????(????),?????????????,????(????),???????
• ????????(????,????,???,????),????,??/????

16
Specie Competition, Technology Metabolism,
Product Cycles, and Growth Wavelets
17
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 (Schumpeters Constructive
  destruction)?

18
Question 2 Market Economy Is Inherently Stable?
(macro-finance- micro-econometrics)

• Equilibrium thinking in economics
• Negative-sloped demand curve (Marshall) gt convex
  function gt fixed point theorem in Arrow-Debreu
  model in microeconomics
• Econometrics Frisch model of noise-driven
  harmonic oscillator
• Friedmans monetary shocks
• Real Business Cycle School (Prescott Kydland)
  technology shocks
• Famas efficient market hypothesis and Brownian
  motion model in finance theory
• Friedman spirit and arbitrage-free theory in
  asset pricing

19
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

20
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)

21
Test 1 Monetary and Macro Chaos or
Noise?Economic Chaos Copernicus Problem in
Macroeconomics (1984-1996)

• Discovery of monetary chaos (1985) gt implication
  for Austrian school
• HP filter and time-frequency analysis (1994) gt
  wide evidence of color chaos in macro and stock
  indexes

22
Re-Examine Empirical and Theoretical Foundations
of Equilibrium Economics (1999-2002)

• Reject Frisch model (1999- ) gt perpetual motion
  machine of the second kind
• Reject Lucas model (1999-2002) gt against the law
  of large numbers
• Find better measurement gt relative deviation gt
  meso economy, trivial result of consumption
  smooth
• Reject random walk and Brownian motion model gt
  fever birth-death process

23
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 Friedmans thought experiment of
  arbitrager against speculator in an efficient
  market (1953)
• gt Equilibrium illusions through a short-time
  window and representative agent

24
Physics Selects Better Alternatives

• Frisch model against the second law of
  thermodynamics (Unlenbeck Orstein 1930, Chen
  1999,2003) gt nonlinear oscillator (color chaos)
• Lucas model disguised representative model
  against the law of large numbers (Schrödinger
  1940, Chen 2002) gt statistical mechanics
• Brownian motion explosive in time (against
  economic coherence) (Chen 1999, 2003) gt
  birth-death process
• Friedman argument Maxwell demon perfect
  information against the uncertainty principle in
  information theory (Brillouin 1951, Chen 1999,
  2003) gt economic complexity

25
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

26
Equilibrium Illusion through a Whitening Looking
Glass (FD) X(t) FDS(t)S(t1)-S(t)

• Frequency response for the FD filter

27
SP500 Stock Price Indexwith log-linear (LL) and
HP growth trends (VHP filter for von
Neumann-Hodrick-Prescott)
28
Detrended Cycles with Different Images
29
Different Images of Auto-Correlations
30
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

31
Uncertainty Principle in Signal Processing
32
Gabor (Gaussian) Wavelet with Minimum Uncertainty
33
The Coherent State (Gaussian Packet, Gabor
Wavelet)The Uncertainty Principle in Quantum
Mechanics Information Theory
34
Gabor Space (1946) in discrete time-frequency
space

• Minimum uncertainty in time-frequency space
• Un-orthogonal base function

35
Wigner Distribution (1932)

• Probability representation in quantum optics
• Fourier transform of autocorrelation in a
  symmetric time window

36
Stationary (Discrete Fourier Transform)
vs.Non-Stationary (Joint-Time-Frequency
Analysis)Time Series Analysis
37
Separating signals and noise in Gabor
(time-frequency) space
38
Evidence of Strange Attractor in Stock Market
Obtained by WGQ (Wigner transform Gabor space
Qian algorithm) Time-Varying Filter
39
Stock Price Indexes (Standard Poor
500)Correlation dimension 2.5Variance of
color chaos 69
40
Structural Stability in Parameter SpaceLinear
vs.nonlinear models
41
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
  410 years!

42
Nature of the Frisch FantasyA Perpetual Motion
Machine of Second-Type

• The relaxation time Tb 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.

43
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).
• Frischs 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).

44
The Principle of Large Numbersfor Positive
Variables

• SNX1X2 . . . . . . XN

45
Relative Fluctuation (RD) and the Implied Number
from Empirical Observation

• Relative fluctuation
• Implied number

46
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 micromacro relation
  caused by negative mean.

47
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

48
Numbers of Households and Firms in 1980 of the
US Economy

• Realistic Number and Potential Relative
  Deviations

49
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 organization
• not in labor or producer market
• Implication gt
• Three layer structure (micro, meso, macro)
• rather than two layer structure (micro, macro)
• in economies

50
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.

51
Stable RD in US Macro Indexesobserved under VHP
filter
52
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

53
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 winners strategy under
  complex dynamics
• Complex patterns in resilient market

54
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

55
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)

56
????????????????????

• ?????????
• ????????
• ??????????
• ??????????,??,??,??
• ?????????

57
Toward a General Synthesis of Smith, Schumpeter,
Keynes, and von Neumann

• Keyness Goal of his General Theory
  (disequilibrium framework) and Einsteins General
  Relativity
• Retreat of neo-classical synthesis (equilibrium
  framework) by Hicks and Samuelson
• Construct a general framework based on
  evolutionary (non-equilibrium) perspective

58
?????????????

• ??,??????,???,???,?????
• ??-??-??????
• ??-??-???????
• ????????
• ???????????????????,??,?????
• ?????,????,????,???????
• ???????????