Economics focus

Agents of change

Conventional economic models failed to foresee the financial crisis. Could agent-based modelling do better?

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Readers' comments



While ABM does indeed potentially have much to offer, it is important to realise how much investment must be made in both building, analysing and validating models before we are able to reap the rewards. The danger with ABM is that it is deceptively simple - rules in, magical emergent behaviour out. But to truly understand a system we must ask deeper questions: Which rules are truly necessary and/or sufficient? Under what conditions do these rules work? ABM can only deliver success with the buy-in of an integrated team of domain experts and data analysts.


Economists are said to have Physics Envy.

Physicists can take a simple mathematical expression derived from pure reason, perhaps fitted with some constants taken from terrestrial observations, and project the motion of heavenly bodies forward and backward thousands of years in time with stunning precision.

Meteorologists are bound by the same laws of physics (including chemistry) but they are stymied by “complexity” - extreme sensitively to initial conditions. The flap of a butterfly’s wing in California may trigger a tornado in Kansas days later. They can estimate the probability of tornado in a given region but the exact time and place of a strike can be known only after the event.

Economics is, by definition, the work of man through his laws, vices, foibles and Darwinian Instincts. Man cannot command the tides to cease their motion or the climate to change or unchange. But almost every one of his laws commands someone to stop a profitable activity or to incur costs that they otherwise would avoid. When others gain a competitive advantage by taking their economic activities to another jurisdiction, they profit at the expense of the enterprise subject to the rules. Thus the People’s Republic of China annually moves a half trillion dollars of economic gain – and this is small fraction of the retail value – from the US to their economy by avoiding costs for minimum wages, worker safety and employer funded health care, environmental protection etc. and (coming soon) carbon taxes.

Economics can never be as pure and simple as physics because of the number of unobservable hidden variables and the irrational behavior of at least some people. But economics should not be as complex as meteorology as there are only a countable number of “players” and “tokens” in the game. And, even meteorology gains useful information from the laws of physics at the “system” level – energy must be conserved, the number of carbon atoms is constant, the total radiation from the sun that reaches the earth must be accounted for. Similar laws could do much to inform the current debate on economics but they are rarely acknowledged (or accepted) – a few examples:

1. An economy has two functions – to create wealth and to distribute it. Wealth is created by agriculture, extraction and manufacturing and distributed by services, the financial markets and governments at all levels.

2. Once created, wealth circulates through the economy and its effect is “multiplied” in form of jobs and tax revenue until it is ultimately dissipated or until it “leaks-out” to buy imported goods or commodities.

3. Every dollar collected in taxes is no longer available to be spent to buy goods and services in the greater economy and results in correspondingly reduced revenue for governments at all levels.

4. Every dollar not borrowed or spent by the government eliminates someone’s employment and spending, and produces corresponding reductions in tax receipts.

5. The average investor in a financial instrument that does not include the distribution of gains from agriculture, extraction or/and manufacturing, will only get his original investment back – less his share of the ludicrous “vigorish” extracted by the instrument’s perpetrators (c. f. Ponzi, Madoff,...).

6. The present value of the US balance of payments deficit is equal to the sum the Federal Debt, Consumer Debt and Immigrant Payments to within the measurement error.

7. Health care costs what it costs and the only way to reduce that cost is to either reduce the amount of care health delivered or to reduce the profits of folks involved in its delivery.

8. The ability to unchange the climate increases linearly while the population and consequent (putative) anthropogenic forcing increases geometrically. Trying to fund this effort without compensating tariffs or factoring it into the immigration debate is at least irrational.

The economists can practice their modeling and forecasting skills by following the meteorologist’s example rather than the physicist’s. Take the abundant data from (say) 1965 to 1995 and try to identify the “Conservation Laws” and “sensitivity to initial conditions” and then build a series of “System Level” models to see which (if any) fits the observed results for 1995 to 2010.

Probably won’t have much luck with the impact of 9/11, the Internet Bubble (and Mr. Clinton’s lucky surplus) or any of the more recent disasters. But, the fallacy that trade is “free” when the mandated costs apply only to our enterprises, should be as prominent as a supernova.

If any of the models come close to reproducing the observed results, then it could be seen how it might inform future policy and law making. Otherwise, economists should be sent back to their schools for more research or for some classes in the physics of meteorology.


Robert North wrote:
This is precisely the kinda optimism I expect from this magazine. WE just wire the whole earth and contents into the giant mainframe, there you have real data flowing continously updating forecasts.

Actually, you may be on to something. The majority of people involved in the economy in any significant way would have internet. So why not create a new financial facebook, where people input their feelings and dealings on a daily basis. You could make it mandatory for business owners, traders, mutual funds, government employees, or everyone if you really wanted to.


Friedrich Hayek received the Nobel Prize for telling us (among other things) that useful models of the economy at large (or significant subsets such as the stock market) are impossible. Many of the above comments agree with this.

Any true model of the economy would have "unemployment rate" as an output, not an input.

Agent based models are still models. You trade one large model (impossible to make) for a lot of smaller models (a questionable proposition at best) AND a (questionable) statistical model for their interactions. The uncertainties in the underlying data, the chaotic nature of the system, the irreducibility of the system and the emergent effects - none of these "problems" are significantly reduced by switching to agent based modeling. All "black swan" and "fat tail" effects remain. You run your simulation 1000 times and what do you have? A number of results to treat statistically. You run it one more time and you hit a "black swan" result that throws off the curve by a factor of a million. Now what? Yes, reality is like that and you may be happy to learn from your simulations that predictions about the economy are impossible. But we already knew that.

And you don't even learn much from these experiments. Simulations don't provide the closed and compact models that reductionist science in general demands and expects. You get simulation data; Interpretations are iffy.

Anyone attempting to use statistics on a chaotic system is living in sin. But the economy is not only chaotic, it is "Bizarre" in the technical sense discussed at .

Better to lower your expectations and use Model Free Methods. These can be used in Bizarre Domains. See for several videos that discuss these issues.

And Avigandhi has it backwards. The Life Sciences, headed by Genomics, have made the necessary transition to Model Free Methods, whereas the more Reductionist disciplines such as Physics have not.

Another Innocent Bystander

So a new elegant model with brand new hidden assumuptions? Just what the world wants to lead it slap into the next surprise crash.

I'm with Mica10 we need more models not a single "answer to everything"; keep monitoring several sets of assumptions and check the worst performing under current conditions to find what is driving the dangers... also has benefit of keeping more economics graduates off the streets.


I may be completely off on this, but since when was nobody predicting any sort of economic collapse? Even taking basic econ classes in 2004, when they talked about the balance of payment deficit being funded by other countries investing in our credit, it was pretty much assumed that this would come to a head. When real-estate prices went up several times over without anything close to income increasing by those levels, (or at all) most people rightly referred to it as a bubble. When short term interest rates generate higher returns than long term ones, (as happened before the crisis) traditional models suggest a recession is imminent. When the median income is stagnant but consumption is rising and house prices skyrocketing, most traditional models would suggest that bad times are coming. When the financial laws that had governed the country for the 70 years since the last depression are shredded, maybe people will remember why glass-steagall was put in place to begin with. I don't mean to sound too populist and I actually believe that many of the innovations in finance have a lot of value and growth is more important than balanced budgets, but it seemed to me that every traditional model was predicting a collapse and that the counter-argument was that those models didn't understand the sophistication of our modern economy. As has been noted by this publication, leaders (or at least a great deal of the population) often know what to do, they just don't know how to get re-elected after they do it.


What ever happened to those government policies promoting home ownership? Might that distort the market a bit and produce something less then desirable?


economic and financial models are quite simple with no more than a couple of varibles, they are usually over simplified, hence deviate from reality, but you can apply mathmatics to get the results. the agent based model is too complicated, you cannot deduce anything useful from it.


The reason for the failure of the conventional economic models is the rising greed and irrational risktaking by certain parties. Strong attempts hence, should be made to penalise such parties rather than providing cushioning support. The behaviour of certain economic agents will need to be curtailed to avoid any future crisis...


Not to provide excuses for economists, but as the article reports, the major obstruction in constructing good models is the obstinate and defiant nature of people. Hard scientists can crush and test rocks and chemical compounds to their hearts content without the physical objects complaining or protesting the rough treatment. People, on the other side of the coin, are remarkably fussy about exposing their economic behavior.

Yes, if it wasn't for people, economics would be simple and easy to understand and model.

Like I was saying...

It all sounds like they are trying to wipe the windows to start up a car with crappy starter. Since wiping the windshield vertically, like we have done for the last decades, hasn't worked too good, they are thinking they should start wiping it horizontally.

Someone else wrote:

"... this discipline [economics] will remain a pure masturbatory academic pursuit."

Please, that's an insult to masturbation.

Robert North

This is precisely the kinda optimism I expect from this magazine. WE just wire the whole earth and contents into the giant mainframe, there you have real data flowing continously updating forecasts. The nirvana of real time real view achieved. Was there a sequel to the lawnmower man? Of course anything less and you have just a ho hum behavioural model which requires inputs, assumptions, etc....etc.

J. Kemp

It is entertaining to see quantitative academics attempt to wrestle the world economy into various modeling techniques. One is reminded that it has been some decades since vast, simultaneous, non-linear, simultaneous equation modelling of even single-country economies was found to be rather wanting.

If the goal is to "forecast" the likelihood of a bubble or crisis, here is a shockingly simple way to go about it which actually works:

1. conduct a systematic audit of all sectors and types of transactions in an economy which are either (i) significant in terms of size, or (ii) reflecting significant "growth" in size or number of transactions;
2. in this "audit", look for any and all signs of, or emerging rewards to: misrepresentation of any type, including in particular, mis-valuation (over- or under-valuation);
3. drill into all sectors and parties where there are indicactions that a new form of "scam" may be afoot;
4. intervene swiftly against all identified cases.

That folks, is really all it takes. Consider the fiascos of the U.S. economy over recent decades:

- crash of 1987 from LBO craze
- LTCM derivatives crisis of early 1990s
- dot-com crash
- sub-prime lending linked crash
- massive scale indebting of Americans with 29% per year interest rate charging "credit" cards

Proper ground-level "honesty" audits of what was going on among wel identified enonomic parties in America at that time, could have prevented each of these crises.

Within companies, similar methods are used to catch early, and head off problems occasioned by employee dishonesty.

It is really, truly this simple folks. Chase down the foul odors produced by any economy, and these will lead you to those pofiting by churning out sewage. Shut down the sewage-producers early, and you avoid allowing them to profit by turning an entire economy into a sewer.

Models are not needed. Examination of conduct is needed.


As Quodomine said above, a model, any model, is just a tool of analysis, let's not all follow it blindly.

That is, a model is just an "agent" of analysis, it cannot replace the analyst or consultant agent, and much less the decision making principal.

And two models are probably better than one.


Economic theories give economists enough tools to foresee events such as the financial crisis. Corporate greed and a grey regulatory framework, in conjunction with information asymmetry, is a time bomb in the waiting.

It is not that the models fail to foresee where things could go wrong. It is just that economists, especially those with a something to lose or who think they know too much and want a Nobel price, don’t want to be tagged with names such as 'anti-market economic policy advocator'.

Economists should take responsibility for their profession and understand that those with no understanding of how the market works are relying on their skills to give them the right advice at the right time. Economists and not economic theories are the real failure.


...btw: The accompanying beautifully coloured sketch is imaginative and yet highly relative - above all enjoyable! Thanks..


Conventional economic models fail to see the purpose of the union for which the US flag stands, and why in Article one section eight, the US Congress must regulate commerce to establish the justice refered to in the US Constitution's preamble, which is essentially an agent based model culturally dependent upon agents (people) to live in agreement with a socio-economic-ecological balance of tranquility, heart, and equality.


Why not do the same for the economy? .... well Mr Stalin Gosplan, your name alone should be enough to stop this little project in its tracks.


It would be wrong to depend on economic models even agent based to strategize and perform without taking into account the volatility of market and rapidly changing economic and political scenerio as well as consumers expectations and behaviour patterns. In this fast changing world it would be wise to remain on guard at all times and adopt flexible policies so that quick change of track is feasible to counter any imminent change in market behaviour.


What kind of statistics is needed for agent-based modelling? Is it existing or must it be created?


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