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FromRationalChoicetoReflexivity:LearningfromSen,

Keynes,Hayek,Soros,andmostofall,fromDarwin

Abstract:

Thispaperidentifiesthemajorfailingsofmainstreameconomicsandtherationalchoicetheoryitreliesupon.Thesefailureswereidentifiedbythefourfigures

mentionedinthetitle:economicstreatsagentsasrationalfools;bythetimethelongrunequilibriumarrives,wearealldead;thesocial,politicalandeconomic

institutionsthatmeetmosturgenthumanneedsmosteffectivelycouldnothave

beentheresultofrationalchoice,buttheir"spontaneousorder"needstobeexplained;humanuncertaintyandreflexivityprohibitapredictivelyusefulrational

choiceapproachtohumanaffairs,andevenlimititsroleininstitutiondesign.Whatunifiestheperspectivesofallfourofthesecriticsofneoclassicaleconomics,

however,istheirimplicitrelianceoronneedforaDarwinianperspectiveonhuman

affairs.

1.Introduction

2.SensProblemofRationalFools.3.Keynesproblemofthelongrunequilibrium

4.Hayeksproblemofspontaneousorder5.FromHayektoSoros,viaDarwin

6.SorosianUncertaintyandReflexivity

1.Introduction.RationalChoicemodels(hereafterRCTorforfun,Rat

Choice),andthemicroeconomistsapproachtoemployingthemareinthe

ascendancyamongsocialscientists.Politicalscientistshavebeenexpoundingitfor

25years.Inthelastdecadeorsoitsapplicationhasextendedtoexperimentalsocial

psychologyandevenneuroscience.Amongeconomistsrationalchoicemodelshave

beentheonlygameintownforatleastacentury.

Asissooftenthecaseinthesocialsciences,thisinfluencehegemonymight

beabetterword,ismoreamatteroffashionthanachievement.Itismostlythe

resultoftheoreticaltractability,mathematicalelegance,andideologically

convenientrationalization.Itcertainlyisnotowingtothepredictivesuccessof

theoriesandmodelsinspiredbyrationalchoicetheoryandthewayinwhich

economistsemployit.WhyisitthatRatChoiceissoappealingdespitetheabsence

ofmuchofapay-offtousingit?

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ThestrengthofthetemptationtoadopttheRCTapproachestoexplain

humanaffairsisoverwhelming.Introspectiontellseachofus,youandme,thatwe

arerationalcreatures,whochooseamongalternativesonthebasisofourbeliefs

anddesiresinRatChoicespeakourexpectationsandpreferences.Similarly,we

explainotherpeoplesbehaviorbyinterpretingit,thatis,makingguessesabout

whatdesiresandbeliefstheymusthavehadthatworkedtogethertobringabout

theirbehavior.RCTisjustfolkpsychologyformalized.Sincewecantshakefolk

psychology,wearesuckersforRatChoice.Ithasalltheallureofourmost

psychologicallysatisfyingstories.Thesternadmonitionofsciencethatthemere

reductionoffeelingsofcuriosityisnomarkofexplanatorypowerfallonourdeaf

ears.Butwehadbetterbeabletogiveitup,ifwewantausefulsocialscience.

TheproblemsofRCTarefourfold:Sensproblemofrationalfools,Keynes

problemaboutthelongrun,Hayeksproblemofspontaneousorder,andSoros

problemofreflexivity/uncertainty.

2.SensProblemofRationalFools.ThisisAmartyaSens(1977)labelfor

thechargethatRCTisnotonlyincapableofexplainingagreatdealofthemost

characteristicofhumanbehaviors.Whatisworse,Senargues,itwouldbefoolishto

substitutethechoicesRCTdictatesfortheonesweactuallymake.

Ratchoiceissurprisedbythedegreetowhichpeoplecooperate,mutually

providepublicgoodsonesthatarenonexcludableandnon-rivalrous.RCTalmost

alwaysrecommendsfreeriding,andotherstrategiesthatunravelcooperative

institutions.Buttheseinstitutionspersist.Inordertoreconcileitselfwithreality

RCTmustmakeunreasonableadhocassumptionsabouttheshapeofpreference

curves,andequallyadhoconeaboutprobabilisticexpectations.RCTcontinuesto

struggleinthequesttoexplainawaythreefacts:thefrequencywithwhichwe

succeedinprovidingourselveswithpublicgoods,andthefrequencywithwhichwehonornormsthatinhibitself-interest,andthenet-costswewillinglyimposeon

ourselvestopolicetheirviolation.

EconomistsdidntstarttotakeSenscritiqueseriouslyuntilitbeganto

emergefromcomputersimulationsingametheoryandhumanexperimentsin

cognitivesocialpsychology.Evennowthesetwosourcesofevidencearemetwith

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muchresistancebymainstreameconomists.Sensinsightwastheneedforaricher

psychologythanRatChoiceallows,onethathasroomforcommitment,amongother

features.AdecadeafterSensoriginalpaperRobertFrank(1988)advancedthis

insightindetail.InPassionwithinReasonhearguedthatthereareavarietyof

crucialsocialinteraction-problemspeopleregularlysolveinwaysRCTcannot

accommodate.Rationalchoicetheorymakeshonestythebestpolicy,exceptwhere

youcangetawaywithdishonesty.Inastraightcontestbetweenunconditional

honestyandRCTsqualifiedhonesty,thelatterwinsandunravelsmostofoursocial

institutions.IfwereallywereRatchoosers,wedstillbeinHobbesstateofnature.

Wearent,soRCTmustbewrongaboutthemostfundamentalfactsofhuman

psychologyandsociallife.Sen,Frank,andagenerationofcognitivesocial

psychologistsfollowingthem,haveshownthathumanaffairsaredrivennotbyRat

Choicebutbyemotionsharnessedtonormsoffairness,equality,andrealnon-

opportunisticaltruism.

Thisworkhascombinedwithanotherlineofresearchtoundermineifnot

unravelRCT.StartwiththemostprofoundregressproblemRatchoicefaces,one

firstidentifiedbySidneyWinter(1975)andJonElster(1978):tomakearational

choiceyouneedtohavecorrectexpectationsaccurateinformationabout

alternatives.Acquiringknowledgeaboutalternativescostsresourcesandpresents

anoptimizationproblem.Howmuchshouldyouspendtoacquiretheinformation

youneed?ThisisaproblemforRCT.Howtosolvetheproblemoffiguringouthow

muchtospendinaparticularcase?UseRTC?Howtosolvetheproblemoffiguring

outhowmuchtospendtofigureouttheproblemofhowmuchtospendtoacquire

theinformationinthefirstplace,andsoon

Howinfactdoesthisregressgetcutshort?HerbertSimonansweredthe

questioninthegeneralcaseevenbeforeWinterandElsterarticulatedtheproblem.Humansdontmaximize,asRCTrequires.Theysatisfice.ThisisaninsightTversky

andKahnemann(2011)developedintoaNobelPrizewinninginsightabouttherole

ofheuristicsindecisionmaking,whatGigerenzercallsfastandfrugalcognitive

strategiesformakingchoices.Humansareasfullycommittedtothesecognitive

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normsastheyaretotheemotionallydrivenmoralnormsthatpreventusfrom

makingrationalfoolsofourselves.

RCTstartedoutlifeasapsychologicaltheory,anaccountofhowpeoplemake

choices.JustaskJevons(1877)orEdgeworth(1895,2003)orWicksteed1910).By

thetimeMiltonFriedmanwroteThemethodologyofpositiveeconomicsheand

hismorefarsightedcolleagues(forexampleGaryBecker)hadrecognizedthey

neededquiteadifferentrationalfortheirattachmenttoitthanitsadequacyasa

theoryofindividualhumanbehavior.Sotheysurrenderedanyinterestinthe

projectofexplainingindividualbehavior.TheyinsistedratherthatRCTwasa

powerfultoolforexplainingandpredictingthebehaviorofmarkets,industries,

economies.ThisbringsustoJohnMaynardKeynes.

3.Keynesproblemoflongrunequilibrium.LordKeynesfamouslysaid,

Inthelongrunwearealldead.Thefullquoteisworthreproducing:The long run

is a misleading guide to current affairs. In the long run we are all dead. Economists set

themselves too easy, too useless a task if in tempestuous seasons they can only tell us that

when the storm is past the ocean is flat again. [1923, Ch. 3.] Thelineisprobablyhis

mostfamousinalifeofbonmots.Keynespointwasthatatheorythatcouldenable

ustopredictonlylongrunoutcomeswasoflittleuse,evenifitwascorrect.One

couldgofurtherandargue,withPopperandSoros,thatthereisnowaytotellif

suchatheoryiscorrectandsoitisnotreallyascientificallyrespectabletheoryatall.

AdamSmithfirsthypothesizedthatRatchoicewould,viatheinvisiblehand,

exploitselfseekingtoproduceanoutcomethatmakeeveryonebetteroff.

EconomistssoughttoconvertSmithshypothesisintoamathematicaltheoremfor

thenext150years.Theysucceeded,butatgreatcost.

SeveralfactorsconspiredwithSmithsinsighttodriveRCTtoanunshakeable

commitmenttotheexistence,uniquenessandstabilityofamarketclearinggeneralequilibrium.TobeginwiththetoolsofdifferentialcalculusWalrasandother19th

centuryeconomistssharedwithphysicsand(lateralsoevolutionarybiology)made

itnaturaltosearchforequilibriumsolutionstosetsofsimultaneousequations.

Moreimportantwastheevidentfactofpricestabilitychangeonepriceandthe

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resultisnotamarketspiralingoutofcontrol,butwhatlookslikeasmooth

readjustment.Over-generalizeandtheresultisoneseesequilibriumeverywhere

Equilibriumoutcomes,ifwecangetthem,provideseveralthingseconomists

wanted:first,likeallsocialscientistseconomistsseekexplanatoryregularitiesinthe

chaoticswirlofhumanaffairs.Ifunderneaththeboomingbuzzingconfusion,there

areequilibriaamongsignificantsocialforces,thentherearegeneralizationsabout

themthatwecandiscover:tostartwith,thelawsofsupplyanddemand.Ifthereare

noequilibria,theprospectofuncoveringlawsgoverninghumanaffairsismuch

reduced.Second,theequilibriumoutcomesoftheinteractionofrationalchoosers

areprobablyallocativelyefficienttheydirectinputstotheiroptimalusein

meetingtherealattainablewantsofeconomicagents.Assuch,equilibriumanalysis

providesguidancetopolicypublicandprivateabouthowtoarrangemattersto

attainthebeneficentoutcomeSmithsinvisiblehandhypothesisenvisions.Ofcourse

thefactthattheequilibriumisuniqueandstablemeansthatusuallynothingneed

bedonebygovernmenttoattainit.Laissez-faire:Lefttoitselftheeconomywillget

there.

Asnoted,becauseoftheirattractiontoequilibriumanalysis,economists

spentabout150yearstryingtomakeamathematicaltheoremoutofSmiths

metaphoroftheinvisiblehandmakingusallbetteroffthroughtheselfseekingof

eachofus.Theysucceededandcongratulatedthemselvesbyawardingoneoftheir

earliestNobelPrizetotheeconomistwhodidit(ArrowandDebreu,1954).What

theyprovedwasaweakerresultthantheywanted,butitwasthebestRatchoice

coulddo:Inaperfectlycompetitivemarketofrationalagents,thepricesofallgoods

andserviceswillarriveatauniquestablegeneralequilibriumthatisallocatively

(Pareto-)efficient.Butthecostofprovidingtheproofwasdraconian:theexistence

oftheuniquestableallocativelyefficientequilibriumrequiredsomanyfalseandimpossibleassumptions(fiveofthem)besidesthoseofRCTthattheproofmainly

explainswhyactualeconomicoutcomesareneitherwelfaremaximizingnor

allocativelyefficient.

Observationsuggestsstronglythathumanaffairsarerarelyinequilibrium.

Atmostpatternsinhumanaffairsareverylocal,temporaryequilibria,brokenup

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annually,monthly,daily,indeedsometimeshourly.RatChoicetheoristsbidus

disregardordeprecatethisinconvenientfact.Mostchanges,theyargueare

temporarystochasticdeparturesfromtheuniquestablelong-termequilibriumthey

haveprovedtoexist.Thesetemporarydeparturesarefatedtobecanceledoutby

equallyrandommovementsbacktowardstheuniquestableequilibrium.

ItsrationalityofthesortRCTassertstobewidespreadthatassuresusofthe

existenceofthishappyoutcome.Rationalagentschooseunderconditionsnotof

certainty,butofrisk.Riskistheconditionunderwhichagentscanassign

probabilitiestoallalternativeoutcomesinaccordancewiththreerelativelyweak

axiomsofprobabilitytheory.ItsadirectimplicationofRCTthatagentsoptimally

allocateresourcestothesearchforinformationtheyneed.Recalltheregress

problemofWinterandElster.)AnequallyobviousimplicationofRCTisthatthey

employthisinformationoptimallytomaximizetheirexpectedutility.Ifagentsobey

thelawsofprobabilitynewinformationisalwaysincorporatedintotheir

expectationsinaccordancewithBayestheorem.Twostartlingimplicationsfollow

fromtheseassumptions:first,underthesecircumstancesinthelongruneveryones

probabilityassignmentswillconvergeonthesamesubjectiveprobability

assignmentstoallalternativesnomatterwheretheystartout.Second,becausethe

errorspeoplemakearerandomlydistributedonabell-shapedcurve,theaverage

valueoftheirprobabilityjudgmentswillalwaysbeclosetotheobjective(i.e.correct,

actual)probabilities.Everyindividualsexpectationsmaybewrongallthetime,but

theaggregateaverageofthesewrongexpectationswillbetherightexpectation.

Thus,inthelongrunthemarketsexpectationsaboutoutcomesarealwayscorrect.

Thisisthebasisofthecontinuedconfidencethatmarketsreallyareallocatively

efficientbecausetheyareinformationallyefficienttheefficientmarkets

hypothesis.Keynesfamousepithetreflectsseveralcriticismsofeconomicsattachment

toequilibrium.MosthavetakenInthelongrunwearealldeadtomeanthat

laissez-fairesolutionstoeconomicproblemsarrivetoolatetohelpthepeoplewho

needit,iftheyarriveatall.ButKeynesfamouslyarguedthatinsteadofoneunique,

stablemarketclearing,allocativelyefficient,equilibrium,therearemanylocal

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equilibriawhicharefarfromallocativelyefficient,andthatgovernmentscan

actuallymoveeconomiesoutoftheselocalequilibriaintheshortandmediumrun.

Finally,andmostsubversively,hegaveareasontothinkthateconomiesarenever

reallyonthemovetowardsthelongrunequilibriumofwhichtherationalchoice

theoristdreams.Thereasonhegavewasthathumansoftencannotactin

accordancewiththerequirementsofRCT.Thisfactdepriveseconomicsevenofa

theoreticalassuranceoftheexistenceofanequilibriumthatobservationnever

detects.

TheheartofKeynescritiqueofmainstreamequilibriumthoughtwashis

diagnosisofwhatRCTgetswrongandwhy.Thediagnosiswasperhapsnot

completelyoriginalwithKeynes(FrankKnight(1921)prefiguredKeynesand

GeorgeSoros(2003)cameatthesamepointperhapsindependently).Itbeginswith

adistinctionbetweenriskanduncertaintyandexplainsthecrucialroleofmoneyin

theeconomy.Agentsfaceconditionsofriskifthealternativesfacingthemcanbe

assignedprobabilitiesthatbehaveinaccordancewiththethreeaxiomsof

probabilitytheory,andwhichtheycanupdateinaccordancewithBayestheorem.

Agentsfaceconditionsofuncertaintywhenitisimpossibletoassignprobabilitiesto

alternativesinthisway.

Equilibriumeconomicsispredicatedontwoassumptions:thatriskistherule

anduncertaintytheexception,andthatprobabilisticexpectationsofagentsare

distributednormallyaroundtheobjectiveprobabilitiesofevents,cancelingout

individualerrorsandmakingmarketsallocativelyefficient.Forthisreason,thereis

noroominmainstreameconomictheoryfortheexistenceofmoney,aremarkablefact

onwhichmostmicroeconomistsaresilent.

Infact,humansgenerallyfaceuncertainty,notrisk.Thedifferencebetween

riskanduncertaintyisthedifferencebetweenthecasinoinwhichallprobabilitiescanbecalculated,andlivingonanearthquakefault-linewherenoonehasthe

slightestideawhenthebigonewillhit.Exogenousoutsideevents,bigandsmall,

interveneinalmostallsocialprocessesalmostallofthetime.Agentsdont,cant

probabilifytheseevents.Evenifthereareequilibriaaroundwhichoutcomesare

moving,theseexogenouseventsdestroythem,substituteothers,anddestroythem

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tooinacontinualprocess.Itisaprocessthatothergreatopponentofequilibrium

thinking,Schumpeter(1942),calledcreativedestruction,thoughheshouldalso

haverecognizedtheprocessofdestructivedestruction.Intheenditsthis

continualdestructionofgeneralequilibriumtrajectoriesbeforetheyreachtheirend

pointsthatKeynesspithyobservationdrawsourattentionto.

UncertaintywasthekeytoKeynesexplanationofwhymoneyexistsand

whatitsrealroleinaneconomyis.Theprevalenceofuncertaintyisonereason

humansemploycognitiveheuristicsindecisionmaking,insteadoftheRCTtools

suitedonlytoquantifiablerisk.Uncertaintyandthewayhumansdealwithit

producemultiplestableandunstablelocalequilibria,noneofwhichareallocatively

efficient,andallofwhichobstructtheeconomysmarchtothemainstream

economistsnirvana,generalequilibrium.

So,socialscientists,especiallyeconomists,commitmenttoequilibriais

equalpartswishfulthinkingabouttheinvisiblehand,attractiontomathematical

eleganceandtractability,andoverconfidenceintherationalityofhumanbeings.Its

arecipeforretrospectiverationalizationandprospectiveimpotence.Thereare

however,manylocalequilibria,somerelativelylonglasting.Theexistenceofmoney

isonesuch,anditraisesanotherfundamentalproblemforRCT.

4.Hayeksproblemofspontaneousorder.ItsnotjustthatRatChoice

doesnotexplainseveraloftheimportantfeaturesofhumanlife.Itcannotdoso.This

NobelPrizewinninginsightisduetoaneconomistreveredbymanymainstream(i.e.

Chicago-school)economists,FriedrichHayek.Herearethreeexamples,allfrom

economics,whereyouwouldassumerationalchoicehasanexplanatoryrole:the

firm,money,andtheprice-system.Eachoftheseinstitutionsfulfillsanimportant

needindividualshave.Noneemergedfromarationalchoiceprocess.Hayeks

problemwastofigureouthowtheycouldhaveemergedandwhytheypersist.Hecalledthemcasesofspontaneousemergence,persistenceororder.Butthatisjust

tolabeltheproblem,aswellsee.

Inthecaseofthefirmthehumanneedistosolvetransactioncostproblemas

RonaldCoasefirstnoticed.Withoutasolutiontothisproblem,thedivisionoflabor

mustcometoastandstillandwithitalmostalltheproductivityincreaseshumans

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havecontrivedsincethemiddleages.Norationalagentrecognizedwhatthe

problemeveryonefacedwas,noonedecidedtoinventthefirminordertosolve

thisproblem.Itemergedspontaneouslytoorderexchangesbetweenindividuals

thatsolvedatransaction-costproblem.Thefirmisanexampleofspontaneous

order.

Moneysolvesthebiggestproblemofbarter:whattheeconomistscalldouble

coincidenceofwants.WithoutmoneyifIwantorangesandhaveonlybanana,Ineed

tofindsomeonewhowantsbananasandhasoranges.Whatsmore,ifwecant

divideandstorebananasandoranges,Illneedtofindsomeonewhowantstotrade

inexactwholenumbersofbananasandorangesthatmatchupwiththeamountsI

ampreparedtotrade.Thisisaproblemthatbecomesintractableveryearlyin

humanexchange.Howdoesitgetsolved?Severaltimesindistantculturesthesame

solutionwashitupon:theemergenceofacommoditywithcommonfeatures:

portability,divisibility,durability,utilityorwidespreaddesirability,andshortterm

limitsonitsquantity.Whenmoneyemergednoonearoundconsciouslyrecognized

thatmoneywouldhavetohavethesefeatures.Noonerationallyadoptedsome

commodityinordertosolvetheproblemofthedoublecoincidenceofwants.Rat

choicecantexplainhowithappened

Theemergenceofmoneyrequiresthatagentssolveanotherproblem,oneof

coordination.Soonerorlatertheymustallconvergeonthesamecommodity.People

mustsolveacommonknowledgeproblem.Somehoweachagentmustbewilling

toadoptacertaincommodityasmoneyandmustcometobelievethateveryone

elsewilladoptthesamecommodity,andmustbelievethateveryoneelsewillbe

confidentthateveryotheragenthasadoptedthesamecommodity.Youcanseethat

thisisasetofproblemsthatcantbesolvedbyindividualrationalchoice,thatwere

notsolvedbysomeexplicitsocialcontract.Theinstitutionofmoneyisanotherexampleoforderemergingwithoutanyoneintendingitortakingstepstobringit

about.Ofcoursetosaymoneyemergedspontaneouslyissimplytolabelthe

problemandexcludeanobviousRatChoiceexplanationofhowitemerged.

Thethirdexample,Hayeksexample,thesystemofmarketprices,isthemost

importantbutthemostdifficulttounderstandoftheseproblemsofspontaneous

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order.ItwasthisrealizationthatearnedHayekhisNobelPrize,nothisfreemarket

rapvideoonYouTube.

Theunsolvableproblemofsocialistcentralplanningisinformational.Central

planningfacesthemathematicalproblemofconvertingalistofavailableinputsand

alistofdesiredoutputsintoalistofproductionorders,andthencontinually

updatingthislistasinputavailabilitychangesanddesiredoutputschange.Central

planningfacesthefurtherproblemofsendinginformationabouteachofthe

changesininputsandoutputsonlytothosewhoneedtohavethisinformationin

ordertochangetheirproductionplans.Thecentralplannercantsendthechanges

toeveryone:wedhavetspendthebetterpartofeverydayjusttryingtofindthe

informationweneedfromadailymassivedatadump.Butthecentralplannercan

nomorefigureouttowhomexactlytosendtheupdatedinformationthanitcan

figureouttheinitialproductionorder.TheseareallwhatmathematicianscallNP-

hardproblems(Nondeterministicpolynomial-timehardproblems).Thereisno

knownalgorithmic,computerizablesolutiontosuchproblems,andagoodchance

thannoneexists.Yettheproblemsareallsolvedalldayandeveryday

instantaneouslybythesystemofmarketprices.Themarketpricesystemisan

informationstorage,retrievalandcalculationsystemavastvirtualcomputer

thatprovidestheclosestapproximationtomathematicallycorrectsolutionstothe

centralplannerscalculationproblemsandatnocostwhatever.

Themarketpricesystemperformsafunctionindispensiblenotjustto

modernlifebuttoallhumanlifebeyondthePleistocene.Itisafunctionmeetinga

needthatcannothavebeenforeseenbyhumans,nomatterhowrational;Itisa

solutiontothatneedthatnohumanorcoalitionofhumanscouldhaveintentionally

contrived.Indeeditisasolutionthatrationalchoicewouldhaveledindividualsto

trytoundermineorsubvertintheirowninterests.Itisasolutiontotheproblempeoplefacethatissoingeniousitautomaticallyandsuccessfullyrespondstosuch

subversionattempts.

Themarketpricesystemoperatescontinuallytomeetaneedthatnohuman

orsetofhumanscouldbyintentionalanddeliberateactionfulfillthefunction

servedbythemarketpricesystem,nomatterhowrationaltheyare,andnomatter

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howpowerfulandinexpensivetheirinformationstorage,retrievaland

computationalresourcesare.Andthemarketpricesystememerged,likemoney,

spontaneously,independently,repeatedlyandwithoutmaliceofhumanforethought

throughouthumanaffairs,acrosstheglobe.

Thesethreeexamplesofspontaneousorderhighlighttheeconomists

versionofaproblemfacingallsocialsciences,aproblemRatchoiceisincapableof

dealingwith.Theproblemisdeep,andpervasive.

First,whypervasive?Becausethethreecasesidentifiedherearejustthetip

ofaniceberg.Almosteveryphenomenonofinteresttothesocialscientistmanifests

theproblemofspontaneousorder.Almosteveryhumaninstitution,almostevery

long-standingsocialpractice,almosteveryorganizationofindividuals,andoftheir

coalitions,fulfillsafunction,solvesaproblem,confersabenefitoradvantageon

somethingorother.Thinkofanyofthevariablesofmacroeconomics-theinterest

rate,therateofinflation,themoneysupply,thefiscaldeficit.Theseareinstitutions,

orthepropertiesofinstitutionswithfunctions.

Unbeknownst to the agents who participate in them, the macroeconomic

institutions fulfill important functions for the economy, for industries, for markets, and

for their individual participants. Most of these functions are unrecognized, unintended,

unforeseen most of the time by most of their participants. But the functions fulfilled by

these institutions are crucial to their emergence, persistence, change over time, and to

their eventual disappearance. In this respect economic institutions are no different from

almost all the political, social, cultural institutions, organizations, and practices that

order the behavior of individuals and groups. That means all social sciences face the

problem of spontaneous order, not just economics. No social institution, organization or

practice could exist long enough even to be noticed by social scientists unless it had a

function. Since most of the functions of most of the institutions that make human affairs

possible go unnoticed, as well as unintended and undesigned by their participants, they

all raise the problem of spontaneous order that Hayek noticed and that confronts the

economist.

Almost everything of interest to the social scientist has a function, usually

untended and unforeseen and continually unrecognized. This observation was recognized

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dimly and imperfectly by functionalist social scientists, like Durkheim (1895) and

Parsons (1951), in the first half of the 20th

century. They recognized that most functions

of most institutions escape the notice of their participants. These they called 'latent'

functions, by contrast with the 'manifest' functions recognized and often designed,

intended, and sustained by conscious deliberation and perhaps even by something

approaching rational choice. The written US Constitution has manifest functions, some of

them quite different from those of the unwritten British constitution. The former fulfills

important latent functions not intended and not widely recognized. One reason British

people are in certain respects--e.g. health care--far better off than American people is

because the British constitution fills latent functions the US constitutions does not.

The 20th century functionalists were right about the functional character of almost

all social institutions. But a serious oversight in their analysis condemned it to

implausibility, and it went into eclipse long ago. The simple error functionalists made,

which made their view sound so implausible, was to mis-identify the beneficiaries of the

functions that institutions, practices, and organizations fulfilled. They assumed, quite

myopically and wrongly, that the function of institutions, practices, organizations, was to

fulfill the needs of people, of human beings. But it was obvious that many institutions,

practices, organizations are in fact are harmful to people, confer no net advantage on

them, for instance most religions, or Chinese foot-binding, or tobacco smoking. This

Panglossianism about all social institutions made functionalism a laughing stock when it

was not pilloried as an invitation to complacence and conservatism: if almost all human

institutions fulfilled functions for us, then it is tempting to reason that we should not

change them lest we deprive ourselves of the benefits they confer on us. Whence the

charge of complaisance.

Only in the late 20th

century did it become apparent that in these and other

cases, a change in perspectivea Gestalt switch-- would enable us to see what was not

previously apparent: the relevant beneficiary of those features of institutions, practices,

organizations harmful to people were the institutions, practices, organizational structures

themselves, that parasitize people, that treat people as niches, environments to be

exploited. Think of people as the environment and think of types of institutions, practices

and organizations as the things that survive, replicate, and spread or recede and become

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extinct owing to the degree their features exploithuman characteristics. Then the

functionalist perspective becomes irresistible: many socially significant institutions,

practices, organizations, confer huge net benefits on peoplemoney, the firm, the market

price system. Many others confer huge net harms on people, but in so doing ensure their

own persistencethink again of foot binding or tobacco smoking or heroin addiction.

Other institutions confer benefits on some people, and harms on othersslavery for

example. Most institutions--religions, for example-- confer a mixture of harms and

benefits on different mixtures of persons over time.

One way to effect thegestalt switch necessary to accept thorough-going

functionalism about human affairs is to employ the game theorist's notion of a 'strategy.'

A 'strategy' is simply a rule, norm, procedure, of the form 'Under condition X, do Y.'

Strategies may be reflexive or voluntary, moral, or ritual, matters of fashion or style,

short-lived or not, obligatory or optional, complex or simple, consciously followed or

not, beneficial to the agent employing them or harmful to him or her. People's

behaviors are determined by strategies they internalize. These strategies are traits, like

left-handedness, or speaking French, or wearing miniskirts, that can come and go. They

are acquired, by social learning, by imitation, by unconscious classical and operant

conditioning, and transmitted from person to person, and they interact with other

strategies, cooperating with them, competing with them, subordinated to them, or

subordinating them. Human social institutions, from a book club to Feudalism, are nested

sets of coordinated strategies. Think of practices like patrilateral cross cousin marriage or

purdah or the incest taboo, Think of organizations like the free masons or the parish

council. Human affairs is a matter of nested institutions, organizations, practices, all

composed of the strategies individuals employ. Then there are the strategies each

individual employs to navigate through these institutions, organizations, practices. The

institutions, organizations, practices have functions. They thrive or perish depending on

how well the strategies they impose on people enable the institutions, organizations and

practices to fulfill these functions for their beneficiariesoften themselves.

To repeat: almost everything of interest to social scientists has a function,

fulfills a need, confers a benefit, or is the direct consequence of something with a

function. The pervasiveness of this feature of human affairs makes Hayeks problem of

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spontaneous order much more serious than even he supposed. Recall that problem: how

do cases of spontaneous order emerge and persist? Rat choice is not an option here. The

institutions, practices, organizations that mainly interest us in social science have

functions, attain ends, goals, confer advantages. Yet almost none of them were designed

by men or gods. Hayeks achievement was to show that the economically most important

of them could nothave been the intended, designed, foreseen result of intentional action

by rational agents. The problem of spontaneous order is where did all these apparently

well designed (but not actually designed at all) institutions, practices and organizations

come from and why do they persist?

Hayek had the answer.

5.FromHayektoSoros,viaDarwin.Wherevertheappearanceofdesignis

tobemetwith,innatureornurture,inthebiologicalrealmorthesocialrealm,on

thewatchmakersworkbenchornatureslaboratory,thesourceisneverreal

foresight,butalwaystinkeringblindvariationandenvironmentalfiltration.Thisis

alessonalreadywellestablishedinbiology.Butitisequallyinforceforthesocial

andbehavioralsciences.Thelessonisresistedonlybecauseofthesamemistake

thatobstructedthefunctionalistsocialscientists,combinedwithanequally

egregiouserrorofsupposingthatDarwinianprocessesarerestrictedtothedomain

ofgeneticallyhardwiredfunctions.Everysignificant(unintended)featureofsociallifethathasafunction(and

theyalmostalldo)hasbeenbuiltbyaDarwinianprocess.Why?Becausethereisno

otheralternative.Longagoscience,especiallyphysicalscience,excludedthe

possibilityofrealgoals,ends,purposesinnature.Itrevealedthatfuturestates

couldntreachbackintothepastandpulleventsinitsdirection.TheAristotelian

conceptionthatpurposesexplainanythingatallhasbeenprogressivelyreadoutof

everyscientificdomaintillitisleftonlyinfolkpsychologyanditsRatChoice

formalization.(Theideaisthatcorrectexpectationsaboutthefuture,togetherwith

attainabledesiresaboutthefutureproduceachievedfutures.Thesefuturesare

thereforepartoftheexplanationoftheprocessesthatbringthemabout).Purposeis

hardforhoipolloitoshake.PartofthegripofRCTtradesonitsformalizationof

commonsensepurposiveexplanation.

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Ittook200yearsafterphysicsexpungedpurposefromitsdomainbeforeit

wasbanishedfromthebiologicalrealm.Until1859thehandofthebenevolent,

omnipotentdesigner,God,wasthefavored,indeedtheonlyexplanationofthe

appearanceofdesigninthedomainoflivingthings.Thisineffectmadebiology

incompatiblewithphysicsandchemistry,sciencesthathadnoneedforthedeity.

ThesolutiontotheinconsistencywasDarwinsdiscoveryofthepurelynatural

causalprocessthatproducetheappearanceofdesignwhileshowingthatthe

appearanceisnotareality.Heshowedbiologyhadnomoreneedofthedeitythan

physics.Therearenopurposesatworkinthebiologicalrealm.Allbiological

functionsarejustadaptationsproducedbyblindvariationandpassive

environmentalfiltration.

Thereisnounderestimatinghowpowerfulthisresultwasandremainsfor

reorderingallthenonphysicalsciences.Itreconcilesthemwiththemost

fundamentalfactsaboutnaturephysicsdiscoveredthattherearenopurposes,

goals,ends,designsouttherewaitingtoberealizedandplayingaroleinbringing

abouttheirrealizers.OnceDarwinshowedhowpurelycausalprocessescouldbring

abouttheappearanceofdesign,biologistssetaboutshowingexactlyhowcausal

processesdidbringthemabout:a150yearsofthisworkproducedgeneticsandthe

molecularbiologyofthegene,protein,enzyme,neuron.Itmadethoroughly

mechanicalreproduction,respiration,development,andcognition.

Ifsocialprocesses,andalltheinterestingaspectsofhumanaffairsfulfill

functionsforus,forthemselves,forsomethingelse---,iftheyshowtheappearance

ofhavingbeendesignedtodeliversomebenefittosomethingorother,thenthey

havetobetheproductofaDarwinianprocessofblindvariationandpassive

environmentalfiltration.Why?Becausethatistheonlywaythingswithfunctions,

adaptedtraits,cancomeabout.Recallthesuggestionabovethatweneedtotreathumaninstitutions,groups,

practicesaspackagesofstrategiesemployedbypeople.Thefeatures,characteristics,

traitsofinstitutions,organizations,practices,arecomposedofthesepackagesof

strategies.Atthebasementlevelofindividualagents,thestrategiestheyemployare

theirownindividualadaptationstraitsthathavepay-offsforthemorforsomeone

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elsethatresultinthesestrategiespersistingbeingusedoverandover,and

spreadingbyimitationorinstruction,reinforcementorcoercion,orrecedingby

operantpunishment,orlegalsanction,etc.Individualstrategiesaretraitsof

individualpeople.Theircognitiveequipmentiswhatpassesthemon,modifiesthem.

Thehumanenvironment,includingallthenestedpackagesofstrategiesthat

constituteinstitutions,organizationsandpractices,selectamongthesestrategiesin

waysthatresultintheemergence,persistence,andchangerapidandslowof

individualstrategies,andnestedgroupsofthem.

Heregametheory(thescientificstudyofstrategicinteractions)isa

pedagogichelp.Typesofgamesarecharacterizedbypay-offsandstrategies

availabletobeplayed.Intheprisonersdilemmaonecancooperateordefect.The

rationalstrategyistodefect.Biggerinstitutions,practices,organizationsare

composedofstrategiesplayedbytheirsmallercomponentinstitutions,practices

andorganizations,andintheendbytheindividualparticipants,people,whose

interactionproducestheselargersocialunitsandtheirfeatures,astheunintended,

unforeseenresultoftheirindividualstrategies.(Studentsofthephilosophyofsocial

sciencewillrecognizethisclaimasthethesisofmethodologicalindividualism,a

thesisfamiliartoeconomistsandPopperians).

Giventhepay-offscostsandbenefits--thatinstitutions,practices,

organizationsimposeontheuseofvariousstrategies,thereisselectionforthose

thatdobetter,regardlessofwhetherthepeoplewhoplaythemrecognizethepay-

offsoraremotivedbythem.Whodecidesonthepay-offstovariousstrategies?

Almostalwaysnoindividualdoes.Itsnaturethatdecidesintheearliest,simplest

institutions.Forexample,thestrategiesofmalesandfemalesinthehunter-gatherer

domesticdivisionoflabor,wereselectedforbytheirimpactonoff-springsurvival.

Asinstitutions,practices,andorganizationsemerge,theyincreasinglysetthepay-offstoparticipatingstrategies,tootherstrategiesthatmayundermineorunravel

them,andtostrategiesthatcompetewiththem.Ofcourseinstitutions,practices,

roles,spawnnewinstitutions,groups,andpractices,oftenbycombiningintolarger

unitswithnewfunctions,andalsobyselectingforsmallercomponentunits,

cooperativeones,andexploitativeones.

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Inbiologicaladaptationbynaturalselectionthereisawell-understood

processthatoperatesthroughadaptationtoproducebothincreasingcomplexity

anddiversity.Thesameforcesoperateinhumanaffairs.Thepersistentprocessesof

randomvariationandpassivefiltrationproducecomplexanddiverssocial

institutions,practicesandorganizations,oneswithnewadaptations,newfunctions.

Thinkaboutstrategiesthatpeopleemployasthetraitsoutofwhichthe

traitsofalltherestofsocialprocessesarecomposed.Thinkaboutthesestrategies

andpackagesofthemthatconstituteinstitutions,ashavingtraitsthatenablethem

tocolonizehumans,tospread,tocompete,tocooperate,tosynergizeandsupport,

orsubvertandexploitoneanother.

HayekrealizedthatthisDarwinianapproachtothedomainofthesocial

sciencesisnotmerelyausefulmetaphor,asuggestivetrope,awayoflookingat

thingswehadnotnoticedbefore.TherearetworeasonsaDarwiniancultural

mechanismisanunavoidablerealityinhumanaffairs,andthereforean

indispensibletoolforunderstandingthem.

First,asnotedabove,aDarwinianapproachtohumanaffairsistheonly

gameintown.Weknowwithgreatconfidencethatthereisonlyonewaythat

functions,adaptations--theappearanceofpurposeordesign,canemergeinaworld

likeours:thewayDarwindiscovered.Unlesswearepreparedtodenythatsocial

institutions,practices,organizations,havefunctions,wearestuckhavingtoapply

Darwinsdiscoverytohumanaffairs.ApplyingtheDarwinianapproachrequiresa

lotofwork.WecannotexpecttosimplyapplythedetailsofhowDarwinianselection

worksinbiologytohumanaffairs.Darwinianculturalprocesseswillnotemploythe

mechanisms(especiallythegeneticones)Darwinianbiologicalprocessesdo.The

Darwinianapproachtohumanaffairsdoesnotrequiregeneticdeterminismof

humandifferences,theinnatenessofimportanthumantraits,thehard-wiringofhumanculture,oranevolutionarypsychologyabouthumancognitiveandemotional

traits.Blindvariationandpassiveenvironmentalfilteringareasmuchmattersof

cultureasmattersofnature.

Second,andforpresentpurposesmoreimportant,recognizingtheDarwinian

characterofallprocessesinthedomainofthesocialscienceshelpssolvethethree

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problemsthatdauntRCT,theproblemofrationalfools,theproblemthatbythetime

equilibriumarriveswearealldead,andthemysteryofspontaneousorder.Andit

doesallthesethreethingsinawaythatvindicatesanimportantinsightGeorge

Soroshasbeenarticulatinginlectures,papersandbooksforabout30years.

Sensproblemofrationalfoolsistwofold.Ontheonehand,rationalagents

wontprovidethemselveswiththefruitsofcooperationsincecooperationisjusta

setofstrategiesthattherationalagentcanfreerideupon.Evenwhencooperationis

aNashequilibriumstrategy,therationalagentwillcontinuallyseekopportunitiesto

changethepay-offs,takeadvantages,free-ride,securerents.Enduringcooperation

robustenoughtowithstandthreatsrequirescommitment,usuallydrivenby

emotions,thatoverriderationalchoice.Thisisthelessonofmuchoftheresearchon

theevolutionofcooperation,researchthatexplicitlyemploysDarwinian

dynamicsmechanismsofrandomvariationandnaturalselectiontoidentify

strategiesthatmaximizefitness.ThesestrategiesarerarelyonesRCTrecommends.

Thesecondrationalfoolsproblemisthecalculation/implementation

problemthatfacesRCT.Besidestheregressinapplyingittodecidehowmuchto

investinacquiringinformation,theabsenceofrisk/presenceofuncertaintyin

choice,makeRatChoiceoftenmaladaptiveasarealworlddecisionstrategy.What

weemployinsteadareheuristicsrulesofthumbandrulesofthoughtthatprovide

quickanddirtysolutionstoreal-timeproblems.Ourhardwiredcognitivestrategies

aretheonesnaturalselectionfoundthroughgeologicaleonsoftinkering.Our

learnedcognitivestrategiesareonesDarwinianculturalselectionhasproducedby

trialanderrorandtransmittedbyteaching.InHerbertSimons(1955)terms,

humansdontoptimize,theysatisfice,justasDarwiniannaturalselectionthe

satisficingprocessparexcellence--wouldhavethemdo.

Darwinianculturalselectionenablesusfullytounderstandbothspontaneousorderandtherealroleofequilibriainhumanaffairs.Onceweseehow

itdoesthesetwothingswewillbeinapositiontoappreciateSorosconceptionof

reflexivityandhowpervasivelyitinfluencesallaspectsofhumanaffairs.

TurnforamomenttoDarwinianprocessesinthebiologicalrealm.Here

thereisaconsiderableroleforequilibriumanalysisanditisanimportanttoolin

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boththemathematicalmodelingofbiologicalprocessesandintheexplanationof

biologicalregularitiesorlaws.

Anillustrationwillhelpgreatly.Itisaregularitythatinalmostallvertebrate

species,indeedinalmostallsexuallyreproducingspecies,thesexratiois1:150%

males,50%females.Thatthereisalmostalways,almostexactlythesamenumber

ofmenaswomen,waslongtreatedasstrongevidenceofthebenevolenceofGod.

The20thcenturyBritishgeneticist,R.A.Fishershowedthatthe1:1sexratio

generalizationisastableequilibriumwhichresultsfromaDarwinianprocessof

blindvariationandpassiveenvironmentalfiltration.Womenhavevarying

hereditarypredispositionstogivebirthtomalesortofemales.Wheneverthesex

ratiodepartsfrom1:1infavorofmorefemales,thosemotherswho

disproportionatelybaremalechildrenwillhavemoreandfittergrandchildren,

sincetheirsonsarescarcerrelativetofemalesandcanbechoosier.Moregrand

childrencarryinggenesthatfavorhavingboysresultsinmoreboysandsomoves

thesexratiobackto1:1.Whenratiobeginstofavormalesoverfemalesthesame

processinreverseshiftsitbackto50%ofeach.Whencethestableequilibriumand

thebiologicallawthatsexratiosremainthesameandinbalance.

Actuallyitsnotalaw,becauseitisfalseforasmallnumberofspecies.In

humansthelongrunequilibriumsexratioatbirthis1.05to1,slightlyfavoringmale

births.Why?Becauseboysmortalityratesarehigherthangirls,oratleastwere

higherintheenvironmentthatselectedforhomosapiens.Darwiniannatural

selectionhadtofinetunethesexratiotomakeit1:1atsexualmaturity.Doingthat

requiredmoreboysatbirththangirls.Additionally,thereareseveralspeciesof

insectsinwhichthesexratioisheavilybiasedtowardsfemales.

Howdoesthefine-tuningontheonehand,andthecasesofcomplete

abrogationoftheapparentbiologicallawontheother,happen?Therearemanyexamplesoffine-tunedequilibriainthebiologicalrealm.TheFishersexratioisbut

oneveryeasilyunderstoodexample.Anytwotraitsoforganismsthatworktogether

well,suchasflyingandgoodeye-sightinbirds,orsymbiotictraitscleanerfishand

cleanedshark,remaininequilibriumforalongtimeonceestablished.Competing

traitsdosoaswell:thinkofpredatorandpreyspeciesthatmaintainalongterm

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relationship,neitherbecomingtoorareortonumeroustomaketheotherextinct.

Andofcoursethetraitsofparasitesandhostsshowthesameprocessoffitness

maximizingequilibriationovertime:aparasitesovirulentthatitkillsahostbefore

itcanjumptothenexthostbecomesextinct,leavingthelessvirulentformtospread,

andsoitgoesuntilparasiteandhostcanjustlivewitheachother,asintheSimian

versionoftheAIDSHIV.

Theseareallcasesoflocalequilibrium.Butunderneaththeappearanceof

changelessness,balance,calmstasisinthefixedrelationshipbetweentraits,thereis

anundergroundguerillawartakingplace.Eachpopulationoftraitsamong

cooperativeonesorcompetingones,inthesamespeciesorindifferentinteracting

ones,isinconstantvariationrandommutation.Almostallofthesemutationsare

ofcourseunfavorableintheirlocalenvironmentsthecombinationofthe

competingorcooperatingtraitandtherestofthenicheinwhichthemutationfinds

itself.Veryrarely,oneoftheserandomvariantsconfersanadvantagetoatraitand

theorganismthatbearsit.Thenewtraitenablestheorganismtoexploititshitherto

cooperatingpartner,ortosuddenlyachieveanadvantageoveritshithertoequally

fitcompetitor.Atthispoint,thelocalequilibriumbeginstobreakup.Theonlything

thatcanpreventitfromeventuallyunravelingcompletelyisacounter-variationin

thetraitsthathithertocooperatedorcompetedeffectivelyenough:acounter-

variationfitenoughtopreservetheequilibrium.Forobviousreasonstheprocess

thatensueswhenlocalequilibriabreakuparecalledarmsraces.

Thenaturalhistoryoftheplanetisahistoryoflocalequilibriabrokenupand

followedbyarmsracesinthebiologicaldomain.Thelocalequilibriaareimposedby

naturalselectionoperatingthroughverysmallvariationsoverenormoustimescales

inveryslowlychangingenvironments.Theyproduceregularitiesthatshortlived

creatureslikemistakeforfixedlawsofnature:giraffeshavelongnecks,polarbearsarewhite,Australianmammalsaremarsupial.Andwhenenvironmentsareconstant

forlongenoughsomeoftheregularitiesreflectequilibriathatapproachfitness

optimaveryclosely,forexamplethe1.05to1sexratioinhumans.

Sometimestheselocalequilibrialastforonlyabrieftimeandarebrokenup

quickly.Thebestexamplesofsuchrapidevolutionarychange,wherearmsracesare

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theruleandequilibriaaretheexceptions,istheevolutionofbacterialdrug

resistance.TheAIDSvirusvariessorapidly,owingtoinstabilityofitsRNAgenome,

thatitcanquicklydefeatanysingleretroviralagent.Forthisreasontheonly

effectivetreatmentofAIDSrequirestheuseofthreedifferentdrugsincombination

whichreducestheprobabilityofavariantarisingtoalowenoughleveltoprevent

resistancebuildingup.

So,naturalselectionproducestraitsthatarelocallyadapted,i.e.thatperform

functions,confernetbenefitstowhateverbearsthesetraits.Naturalselection

packagesthesetraitstogetherintolocalequilibriathatendureforvaryingtime

periodshundredsofmillionsofyearsinsomecases,dependingontheconstancy

oftheenvironment.Buttheseequilibriaarealwaysliabletobeendedwhen

environmentschangeorwhenpersistentthoughblindvariationsthataddorchange

traitsinwaysbetterabletoexploitorevendestroythelocalequilibrium.Since

environmentschangeslowly,manylocalequilibriaemergeandincreasingly

approachlocaloptimas.Thereforetheyresistunderminingbyrandomvariations,

andtheresultingbiologicalregularitiesusuallyendureforeons.Butwhen

environmentsbegintochangerapidly,thegeographicrangeandthelife-timesof

localregularitiesbeginstoshorten.Bythetimeyougettodisease-causingbacteria

andhost,thelocalequilibriaareveryshortlived.

Theapplicationofallthistohumanaffairsisobvious,directandhighly

significant.Tobeginwith,itsolvesHayeksproblem.Spontaneousorderisrelatively

longlastingandwidespreadlocalequilibrium.ItistheresultofDarwiniancultural

selectionoperatingonstrategies,packagingthemtogetherinwaysthatpayofffor

participantsoftencooperatingorcompetingindividuals,sometimescoalitionsof

them.Othersofthesestrategiesthatgetpackagedtogetherintoinstitutionsthat

parasitizealltheirparticipantsoronlysome,symbioticallybenefitingothers,ormorelikelydoingbothatthesametimetodifferingdegreestoallparticipants,

practitioners,groupmembers.

Considerthethreeexamplesfromeconomicsdevelopedabove:money,the

firm,andthepricesystem.Wecouldhavepickedothers,examplesofpolitical

institutionsparliamentarydemocracy,socialpracticesliketheIndiancastesystem,

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complexcross-cousinmarriagerulesanthropologistshaveuncovered,historically

longlivedpracticessuchasprimogenitor,orthefashionabilityofaninnovation,like

theIphone.Eachofthesereflectsalocalequilibrium,someverylonglivedsuchas

thecastesystem,somenotquiteasold,suchasparliamentarydemocracy,others

fleetingreflectionsofSchumpeterscreativedestruction.Ourthreeverylonglived

examplesthefirm,money,andthepricesystemhavebeenaround,andwill

continuetobe,owingtotheimportanceofthefunctionstheyfulfill,andthelow

probabilityofenvironmentalchangeorvariantsemergingthatcouldunravelthem.

Overtheeons,peoplehaveconsciouslyandunconsciouslyadoptedstrategiesthat

attempttotakeadvantageofeachofthemrentseeking--bycounterfeiting,or

currencydebasementinthecaseofmoney,byarangeofbusinessfraudsinthecase

ofthefirm,bymarketcornering,orpricecontrols,orinsidertradinginthecaseof

thepricesystem.

Ineachcasetheinstitutionhasresponded,throughnewvariationsinthe

strategiesthatcomposeit,inwaysthatsuccessfullyresistedsubversion.Thelocal

equilibriumeachofthemconstituteshaspersisted,astheinstitutionshavefound

waystoadapttochangesintheirenvironments.Institutionslikemoney,thefirm,

thepricesystemlastlongenoughtoprovideanenvironment,aframeworkwithin

whichmanymorelocal,moreshortlivedequilibriacomeandgo.Thesemorelocal

equilibriaemergeasindividualenvironmentaladaptations,andco-adaptations,

temporarilywellmatchedcompetitors,orcombinationsofthem.Theenvironments

withinwhichthesepackagesofstrategiesareco-adapted,areonescreatedby

institutionsandpracticessuchasmoney,thefirm,andthemarketpricesystem.

Keynesslongrunequilibriumhasarrivedforafewlong-livedfundamentalhuman

institutions.Localequilibriaarenestedwithinthem,andthemorelocaltheyare,the

easiertobreakup,tillatsomelevelofstrategicinteraction,therearenolocalequilibriaornonelastinglongenoughtoexploit.

6.SorosianUncertaintyandReflexivity.Theimpermanence,instability,

multiplicityandindeedtheabsenceofequilibriainday-to-day,orevenmonth-to-

monthhumanaffairsbringsustoSoros,andhisinsights.Theseinsightsdotwo

things:Mostimportant,theygiveusthemechanismthroughwhichtheDarwinian

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processesoperatetomakeandbreakspontaneousorders.Lessimportant,they

vindicatePoppersthesisoftheunityofscience,theonedoctrineofSirKarlthat

Sorosrejects.

Sorosmakestwotwoclaims:

Thehumanuncertaintyprinciple:humansarefallible,infactusually

mistakenintheirexpectations,includingtheirprobabilisticones.They

predictinaccuratelyandthesepredictionscannotbeimproved,forexample

byhonoringtheprinciplesofprobabilitytheorymorefully.

Reflexivity:Agentsearlierexpectationsaboutfutureoutcomescombinewith

theirpreferencesinwaysthatchangethefutureoutcomes,oftensogreatly

astobearnoresemblancetotheirearlierexpectationsandtofailtosatisfy

theirpreferences.

InTheAlchemyofFinanceSorosusesthecombined,iterated,andcyclicaloperation

ofthesetworegularitiestounderminetheconfidenceeconomistshavethatweare

evernearthelong-run-all-deadgeneralequilibrium.Heusesthemtoexplainhow

severalobviousfactsabsurdlydeniedbyRCT-dominatedeconomictheoryinfact

obtaine.g.bubblesandbusts.AndSorosemploysthemtoshowthatpredictionis

impossibleinfinancialmarketsinparticular.

Anexampleillustratestheuncertainty/reflexivenessprocessatitsstarkest,

whereitproducesbubbleandbustsinthestockmarket.Inthinkingaboutthe

extremecasesitisimportanttokeepinmindthattheprocessoperateseverywhere,

andproducesroutinechangesaswellasnon-routineones.

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Figure1.Stockpricestrackearningsandviceversai.e.reflexively.

ThegraphisbasedononeinTheAlchemyofFinance,p.56.Inbrief,thered

curveofstockpricesreflectsthestrategiesofagentsmutualfunds,hedgefunds,

individuals,etc.Thiscurvereflectstheaggregateofagentsuncertain,unforesighted

expectationsaboutcompaniesfutures.Thebluelineimperfectlyreflectsthe

businesssuccessofcompanies,i.e.theequallyuncertainstrategiesandpackagesofstrategiesofCEOs,managers,salesreps,andtheshop-floorworkers,andconsumers,

whoeffectthecompaniesactualearningspershare.

FollowingKeynesandKnight,Sorosinsiststhatthescopeforprobabilityis

extremelylimited:errorsdonotfallonabell-shapedcurvearoundthetruth,and

newevidencedoesnotdriveitinthatdirectioneither.ForthatreasonRCTs

substitutionofriskforcertaintyisnotasignificantimprovementonthestandard

assumptionofcompleteinformation.Equallyimportant,infigure1.theshapesof

thetwocurvesreflectthefactthatearlierstockpricesinfluencelaterearnsper

share,andviceversa.Peoples(fallible)expectationsaboutfuturestatesofaffairs

haveeffectsonhowthosefuturestatesturnout,andthesefuturestateseffect

peoplelater(andalwaysfallible)expectations.Thecombinationofreflexivityand

uncertainty,whennotheldincheck,produceswingsintwo(ormore)factorslocked

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inareflexiverelation,andusuallymuchwiderswingsontheexpectationssideof

therelationship.

Expectationsbythemselveswonteffectanything.Theyneedtobeacted

upon.(SometimesSoroscallsthisthemanipulativefunctionofthinking,sometimes

hecallsittheparticipatingfunction.)So,reflexivenessisarelationshipbetween

strategies.Butstrategiesaredrivenbyexpectationsthatlackforesight.Theyare

almostalwaysindividuallywrong,veryoftenalsowrongonaverage,andwhenthe

expectationsarerightanddrivesuccessfulstrategies,theyarerightbyaccident!

Now,thecombinationofstrategy-uncertaintyandstrategy-reflexiveness

doesnotsimplyproducewildswingsinfinancialmarketsbubblesandbubble-

bursts.Itoperateseverywhereinhumanaffairs,becausereflexivityistheruleand

nottheexceptionintheseaffairs.Strategiesthatonesetofagentsandorganizations

employtoexploitotherpeoplesandotherorganizationssetsofstrategieseffectthe

secondsetofstrategiesandtheseinturneffectthesuccessandthusthespreadand

persistenceofthefirstsetofstrategies.Thismakeshumanaffairsunpredictableto

participantsowingtotheineliminablecombinationofuncertaintyandreflexivity

thatdrivesthechoiceofstrategiesreflexivelylinked.

ContrastthepictureofSorosianreflexivity/Uncertaintywiththemainstream

economistspicture:RatChoiceeconomictheorywouldhavethesecurvesmove

verycloselytogether,sinceallpartiesarehypothesizedtoemployprobability

theoryandtheaverageoftheirexpectationscancelouttotheactualobjective

probabilities.Thetwocurvesshouldmoveinlock-step.Thisistheefficientmarkets

hypothesis,reflectedinfigure2.

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Figure2.stockpricestrackearningsovera120yearperiod.

IfSorosiscorrectthecombinationofreflexivityanduncertaintymakes

mainstream,generalequilibrium-oriented,economicsimpossible.

HowdoweknowSorosiscorrectandmainstreameconomics,Ratchoiceand

themicroeconomicparadigmtheydriveiswrong?Whichgraphaboveiscorrect,

figure1.,theSorosboom/bustcurve,orfigure2.the120yearsofefficientmarkets?

Theempiricaldatabythemselveswontdecide.Therearemanyreasonstheycant

decide.Butthemainreasonitcantisthata)itisequivocal,b)datacollectionis

theoreticallydrivenanddoesntpointinthedirectionofanytheorywithoutagreat

dealoftheoreticaladjustmentandinterpretation.WeknowthatSorosinsights

aboutuncertaintyinexpectationsandreflexivityintheireffectsarerightbecause

thesetwoprocessesaredrivenbytheDarwinianprocesses.ThesameDarwinian

processespreventusfrombeingrationalfools,makeususersoffastandfrugal

heuristics,producespontaneousorder,andshapetheinstitutions,groupsand

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practicesthroughwhichhumansnavigate.Sorosianreflexivityanduncertaintyisa

matterofDarwinianforcesactinginhumanculture.Letsseeexactlywhy.

Thegraphbelowrepresentsatypicalpredator-preypopulationcycleover

time.Inthiscaselynxandharepopulationscyclebetweenlimitswithaconstantsix-

monthlagbetweenpopulationmaximaandbetweenpopulationminima.

Thecauseofthispatternisacombinationofreflexivityanduncertainty.Lynx

survivebyemployingthestrategyofpreyingonhare.Lynx-predatorystrategies

selectforharestrategiesthataregoodatavoidinglynx-predation.Successfulhare

huntingstrategiesincreaseslynxpopulations,butthisreduceslaterhare

populationsandsoevenlaterreflexivelyreduceslynxpopulationsbyreducingthe

pay-offstotheirpredationstrategies.

Thereflexivenessoftherelationshipbetweenlynxandharestrategiesiswell

understoodinevolutionarybiology:eachsetofstrategiesissubjecttolinkedfrequencydependentselectionwithalag.Eachismaintainedwithinacertain

minimalandmaximalrangebystabilizingselection.Underneaththisstablecycle,

bothlynxandharesarevaryingtheirbehaviorsrandomly,withoutforesight.

Mothernaturefacesthesamekindofuncertaintywehumansface.

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Now,comparethiscurvetotheSorosboom/bustcyclecurve.Itsthesame

curveoflaggedreflexivenessofstockpricestoearningspershare,thesame

relationshipbetweenstrategiesofstock-pickersandstrategiesatworkinfirms

reflectedintheirearningspershare.Thedifferenceisthatthepredatorpreygraph

covers4cycles,andSorosscoversjustone.

Figure1.again.Thepointisnotsimplythatthecurvesineachgraphsharethesamerelationship.

Theprocessestheydescribearethesame.AndtheDarwinianselectiveprocessthat

givesrisetothemisthesametoo:reflexivenessanduncertainty.Inbiological

contextsreflexivenessisthelinkedfrequencydependentselectionofstrategiesthat

compete,cooperate,areparasiticalorsymbiotic.Inthebiologicaldomainthe

uncertainty,thelackofforesightinstrategy-choice,isreflectedintheirpersistence

coupledwiththeblindnessofvariationsamongthem.BothoperateinDarwinian

culturalprocessestoproducethesamephenomena.

Thedifferencebetweenthebiologicalandtheculturalisadifferenceof

degreethetempoandmodeofevolution..

Inthebiologicaldomainreflexivityanduncertaintyareusuallykeptin

boundsthatproducestablecycles,onesthatevenvindicatesomelimitedconfidence

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inpredictionsamongecologists,agriculturalscientists,evensomeepidemiologists.

Thetworeasonsareobvious.Reflexivitychangestheenvironment.Butitrarely

changestheenvironmentwithinwhichastrategyisplayedsomuchthatitdrives

itselftoextinction,ortocompletedominancefixationinthebiologists

terminology.Extinctionsarewellunderstood.Fixationslessso.Abouttheonly

exampleofastrategythatinnaturehasachievedcompletedominationisthe

strategyofcodinggeneticinformationinnucleicacids.Somewhatlessdominantbut

almostuniversalisthe1:1ratiobetweenstrategiesofbearingmalesvs.females

withintheenvironmentcreatedbysexualreproduction(thoughwedontyet

knowwhatenvironmentaldesignproblemselectedforthestrategyofsexual

reproductionitself).Thesecondconstraintthatkeepsreflexivestrategiescyclingin

balanceisthattherangeofrandomvariationislimited,thedifferencesinpay-offsto

thevariantsissmall,andtheirratesofreplicationareslow,requiringageneration

orso.Allthismeansthatsomelocalequilibriainbiologylastlongenoughthatitis

worthwhilelocatingthemandtryingtoexploittheminappliedscience.

InDarwinianculturalprocesses,noneoftheseconstrainsoperate,andthey

produceSorosianphenomenaeverywhere.Therateatwhichstrategiesreplicate

(throughimitationaswellasinstructionandenforcement)hasbeenaccelerating

overtheentire50,000yearsofhumanculturalevolution,andtherangeofvariations

inthesestrategieshasalsoproliferated,thoughitiscrucialtobearinmindthatthey

areaslackinginforesightasever.Whatismore,owingtothenestedcharacterof

humaninstitutionswithfunctions,andthespeedwithwhichtheychange,therehas

beenverystrongselectionforstrategiesthattrackchangesinotherstrategiesand

influencethemaswell,thatis,forreflexivestrategies.Finally,environmentschange,

andoncehumancultureanditsinevitablereflexivitycrossesathreshold,most

selectiveenvironmentsneverremainstablelongenoughtoallowfortherepetitionofthesameboom/bustcyclesthatmakethemofanypredictiveuse.Theefficient

marketscurveabovelooksregularandreliableuntilyoulookatthetimescaleon

thebottomofthecurve.Its130years!Spreadoutthecurveanditprovidesno

guidanceanyonecanuseinday-to-day,week-to-week,month-to-monthstrategy

selection!

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Inthebiologicaldomainuncertaintyandreflexivityareheldincheckby

environmentsthatchangewithgeologicalslowness.Thisproduceslong-livedlocal

equilibriumoutcomes.Inthehumandomain,theenvironmentiscultural.Itis

composedofnestedsetsofstrategiesthatareallaffectedbybothreflexivityand

uncertainty.Theresultoftheiroperationisatmostshort-livedlocalequilibria,

brokenupbyradicalenvironmentalchange.Thesourceofthisradical

environmentalchangeinhumanculturalprocessesisobvious.Itistheiterated

unsynchronizedcombinationsofreflexivityanduncertaintyinstrategyvariation.As

therateofchangeintheculturalenvironmentincreases,thelifetimesoflocal

equilibriashortenuntilinmanycasestheydisappearaltogether.Humanaffairs

appearchaoticbecausemanyofthemarefarfromequilibrium,evenifthereareany

equilibriatowhichtheymaytemporarilybeheading.

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Theproblemreflexivitymakesforallhumanagentsisthatalmostalllocal

equilibriaofinteresttousaretooshortlivedtobeexploited.Owingtoreflexivity

manyequilibrialastforanhouroradayoraweekoramonth.Bythetimepeople

havenoticed,andfiguredouthowtoexploitthemtheyhaveevanesced,disappeared,

beenbrokenupbyanewvariantthatbreaksthemupandsubstitutesanewequally

shortlivedequilibrium,orperhapsanarmsrace,rapidlysearchingthoughthe

spaceofstrategy-variationsforanewimpermanentequilibrium.Whensome

innovationanewfashion,gadget,politicalslogandoesmanagetoexploitalocal

equilibrium,wecanbeconfidentthatitarosewithoutforesight,andthatitwill

probablydisturbthelocalequilibriumimmediately,eventuallybreakitup

completely,andthenitselffallvictimtosomenewerstrategy.

Thereareofcoursemanyverylonglastinglocalequilibriainhumanaffairs.

Mostofthempersistowingtobebenefitstheyaccordpeople,someexistinspiteof

thenetcoststheyimposeonpeople.Theycanbeexploitedbypolicydesignand

implementation;someofthemcanevenbeunraveledbypolicy,forexample

considerthefateofthetobaccosmokinginwesternsocietyoverthelasthalf-

century.Mostlong-livedwidespreadlocalequilibriaarehardforsmallnumbersof

individualstoexploitorundermine.Itstheshort-livedlocalequilibriathatarethe

targetsofrent-seekinginbusinessespecially.Andtheyaretooshortlivedforany

simplerecipeforsecuringsuchrentstosucceedforlong.

AlexRosenberg

DukeUniversity

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Youtube: Hayek v Keynes, http://www.youtube.com/watch?v=d0nERTFo-Sk