Read Part 1 here.
How did we get into this mess? How did we go from using capitalism as a way of escaping dictatorial doctrines to a society that was wasteful, indifferent and voracious? How did we not see this cultural change in which having more and consuming became paramount to anything else? The more money, freedom, leisure and luxury we got, the more we wanted.
One of the main reasons for this was the overall acceptance of contemporary free market capitalistic theories and the policies and models that were based on these theories. Free market economic models (and the policies that are based on it) are based on two main theories – the Rational Expectations Theory (RET) and the Efficient Markets Hypothesis (EMH).
These two theories work in conjunction. The RET states that the expectations of players in a market are formed on the basis of the information that they have and their past experiences. According to this theory, stock prices reflect all the information regarding a stock. Thus, by using the stock price as a proxy, we have access to all the information regarding a stock on the market, and can make rational decisions based on our expectations.
If someone makes a bad decision, then it is offset by someone who makes a good decision. The market is thus in a constant state of efficiency where the price of a share intrinsically incorporates all the relevant information. As a consequence, markets are in a state of equilibrium (EMH). We might have a shock now and then but the market always goes back to its natural state, which is that of equilibrium.
Our faith in these theories has resulted in accepting that the bad actions of one economic agent would be offset by the good actions of another. As more debt was offered to us, we accepted it as it was now the norm. In the process of handing over responsibility to the ‘other’, we believed in the banks, bought their complex debt-based financial instruments (CDOs, CDSs, etc.) and listened to the bastions of the system as they preached about its benefits from their pulpits.
“These increasingly complex financial instruments have contributed to the development of a far more flexible, efficient, and hence resilient financial system than the one that existed just a quarter-century ago. After the bursting of the stock market bubble in 2000, unlike previous periods following large financial shocks, no major financial institution defaulted, and the economy held up far better than many had anticipated”
-Alan Greenspan, the Chairman of the Federal Reserve, (2005).
Those who challenged the status quo were ostracized from academia and markets, while the players in the economy were happy to go on taking debt and serendipitously advance towards a false sense of prosperity, leaving the hard business of understanding the macroeconomics of the system to people who were elected to do so.
But following the crisis, we need to take a step back and question this reality and the abilities of these economic bastions. We need to ask ourselves if the entire structure of analysis and the level of understanding of the experts needs to be questioned. This statement was best summarized by the Queen of England when she visited the LSE in 2007 and asked the economists in the room a very simple question,
“Why did no one see this coming?”
Thus, conducting a review of economic dogmas necessitates a review of the very basics, i.e., RET & EMH. More importantly, it requires a change in mindset and asking the right questions. Consider this – If our economy is supposed to be based on patterns of equilibrium, how does it explain a capitalistic system’s obsession with constant growth? Think about it – If you work in a company or are creating one, then the primary objective is to grow. Every company is constantly trying to expand, or buy out or merge with another company. It seems that it is never happy where it is and even if a company wishes to remain constant, its competitors will force it to move.
So if this state of entropy is the natural state of affairs, then why do we use equilibrium-based economic models to witness economics and pass public policies (monetary and fiscal)? We can extend that line of questioning and even challenge the RET – If all decisions are rational, then why do people engage in philanthropy? From a personal objective perspective, it would seem to be the most irrational thing to do.
In spite of these abhorrent divergences from reality, we continue to pass policies and enact measures based on analyses done using DSGE (Dynamic Stochastic General Equilibrium) models. It’s like the equivalent of bringing a turtle to a rabbit race.
Not questioning these fundamentals has been one of the primary causes of our addiction to debt and our laissez-faire attitude that has allowed banks to get bigger and more entrenched in every aspect of policy making. Therefore, what is required is a revisit to the very fundamentals on which we base our understanding of the economy.
We need to move from equilibrium-based models to entropy-based ones. Equilibrium can exist in an economy, but it is a temporary state. The natural state of an economy is entropic due to the constant exchanges and decisions being made by agents and actors in the economy. In short, we need to move towards complexity economics.
Complexity economics was devised based on this understanding of entropy and is a field that is gaining increasing prominence today. In a recent speech, Andy Haldane, the Chief Economist of Bank of England stated it is necessary for the bank to base its models on complexity science as it allows us to integrate complex, adaptive networks. Using these kinds of models, economic policy would be based on dynamic complex network analysis and behavioral modeling, thus giving us a template that is more suited to modeling reality.
The blockchain’s role in all of this
In the past few years, commercial and central banks have been toying with the blockchain owing to its operational efficiencies. In a recent report, the Centre for International Governance Innovation (CIGI) stated that G20 countries should create a central bank blockchain consortium, a la R3CEV.
The blockchain is many things to many people. But at its heart, it is an engine of transparency. While it is irrational to think of the blockchain as some kind of panacea that will be the solution to our current economic malaises, it is nevertheless a useful tool that can be used with other financial technologies to offer us more clarity of our capitalistic system. And this clarity is required today if we are to use capitalism to escape from a coterie of rulers, as we did in the 17th century.
This issue needs to be discussed today as enter an era where banks, academics and public institutions push us towards a cashless economy. Becoming a digital economy comes with benefits, but also comes with increased risk, owing to the speed, size and interconnectedness of the financial system. And one of the ways we can ignite this conversation is by leveraging the transparency that is provided by new financial technologies, especially the blockchain.
Transparency is a lop-sided issue in today’s financial markets, for as we transition to a cashless economy transparency seems to be a one-way street. As customers and citizens become digital avatars, banks and government institutions now have greater amounts of highly granular data with stark levels of detail.
But peculiarly, consumers, on the other hand, are not privy to the same amounts of transparency when it comes to the financial operations of banks and public governing bodies. A review of some of the scandals that have unfolded in the past three months highlights the need for two-way transparency:
- In February 2017, the Trump administration began dismantling Dodd-Frank, rolling back years of progress.
- Undoing Dodd – Frank throws a monkey wrench into the process of breaking up the banks.
- Shortly after this move by the Trump administration, US banks lobbied to ease of money laundering rules.
- According to the IMF, almost 5% of the world’s GDP is laundered while only 1% gets any attention.
- Considering the size of these markets, and the fact that the biggest money launders are banks necessitates a conversation in the direction of transparency prior to moving to a cashless economy.
It is, therefore, urgent that we ascertain what kind of an economic reality we are headed towards before any infrastructural changes are put in place. Or else, the spread of a crisis in a hyper-connected digital economy will be faster and more violent than before.
The blockchain’s transparency is however only part of the equation. Transparency can be illuminating, but to transform transparency to clarity still requires effort. While the blockchain allows us to see what is going on, it would make no sense to use this information as an input to models based on equilibrium. If we are to truly leverage the potential of the blockchain and use it to define macroeconomic policies that are more representative of reality, it has to work in conjunction with complexity economics:
(Blockchain’s Transparency) + (Economic models based on Comp. Economics) = Clarity of Capitalistic system.
As we move into a more digital world with faster technological evolution providing strong headwinds of change, it is important to realize that adapting to this change will not simply be a case of investing in the new tool or updating one’s skillset. Capitalism has always been a renegade, whose greatest impacts have been born out of conflict and change. At every turn, this has required that tough questions be asked, and our notions and conceptions be rewritten.
If we are to continue growing with hedonistic sustainability, we need to better understand capitalism. The unison of complexity economics and the blockchain is a step in that direction and will entail the creation of new cultural forms, institutions and a new vocabulary for education. But with a better understanding of capitalism, people in democracies can play a much more positive and vigorous role in shaping their economic institutions.
There would be no capitalism without a culture of capitalism and there would be no culture if the existing ideologies were not challenged and overcome. At a time when information is so abundant that we can get the answer to any question, the real responsibility becomes asking the right question. If we fail to ask these questions and leverage the power of decentralization and transparency, we risk starting a conversation with the next generation by beginning with an apology.
Disclaimer: This article contains extracts from the author’s new book, 'The Blockchain Alternative' (2017)
Kary Bheemaiah is the author of 'The Blockchain Alternative: Rethinking Macroeconomic Policy and Economic Theory’ (2017). Available now on Springer and Amazon.
Complexity and the Economy, W. Brain Arthur (2014) Rethinking Economics Using Complexity Theory, Kirman, D. H. (2014) Reconstructing economics: Agent-based models and complexity. Kirman, M. G. (2013). Complexity Modelling in Economics: the State of the Art. Economic Thought, Vol 5, Number 2, 29-43. Bruno et al. (2016). Why Information Grows, Hidalgo, C. A. (2015).