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Ping Chen China Center for Economic Research, Peking University pchen@ccer.pku

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@ccer.pku.edu.cn Center for New Political Economy, Fudan University http://www.cnpe.org.cn/

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Ping Chen China Center for Economic Research, Peking University pchen@ccer.pku

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  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@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@physics.utexas.edu • Nov.11, 2004 at China People’s University

  2. 参考书: 陈平,文明分岔、经济混沌、和演化经济动力学，北京大学出版社 (2004)。 • 正象达尔文发现有机界的发展规律一样，马克思发现了人类历史的发展规律，即历来为繁茂芜杂的意识形态所掩盖着的一个简单事实：人们必须首先吃，喝，住，穿，然后才能从事政治，科学，艺术，宗教等等；所以，直接的物质的生活资料的生产，因而一个民族或一个时代的一定的经济发展阶段，便构成为基础，人们的国家制度，法的观念，艺术以至宗教观念，就是从这个基础上发展起来的，因而，也必须由这个基础来解释，而不是象过去那样做得相反。 • - 恩格斯， “在马克思墓前的讲话“ • 马克思恩格斯选集，第3卷，574页， 人民出版社，北京1972年版

  3. Is Economics a Science? • Conflicting doctrines: • Man’s nature is selfish and greedy (classical) • Man’s nature is free and social animal (Marx) • Bounded rationality (behavioral economics) • Conflicting Nobel prizes: • 1974 Gunnar Myrdal, Friedrich August von Hayek

  4. From Ilya Prigogine:Order Out of Chaos (1984) • Whitehead wrote that a “clash of doctrines is not a disaster, it is an opportunity.” If this statement is true, few opportunities in the history of science have been so promising: two worlds have come face to face, the world of dynamics and the world of thermodynamics. • Where classical science used to emphasize permanence, we now find change and evolution.

  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, worker’s number multiplied three times, but production output is only about one third of design capacity, WHY? • Economy of scale, market extent, and diversified pattern in division of labor

  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 China’s history favors self-sufficiency while West prefers division of labor? • [Classical economics] • Rational choice under scarcity (What shapes people’s preference?) • Optimal equilibrium under non-scale economy • Wallerstein Paradox and Needham’s Question: China lacks man while Europe needs space? • Marthus: ecology (resource limitation) • Max Weber: culture (Protestant/Confucius) • Marx/Mao: class struggle is the driving force of production? • New classical/anthropology: irrationality?

  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 China’s policy based on agriculture (grain production) while Europe based on commerce? • [Question 1c] Why spice trade in the West had different impact than silk/tea/china trade in China?

  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” > perfect competition > many small firms • Smith Theorem: Division of labor is limited by market extent > monopoly > few large firms • How small and large firms could coexist? • [中国国企的改革战略]抓大放小，与集团作大？

  15. Re-Understanding Chinese Society • Ecological crisis and peasant wars • Small-scale farming and population mechanism: 按效分配，按劳分配，与按势分配。 • [中国问题应用]： • 三农问题与乡镇机构的过度扩张 • 奖励生育，粮食自给，过度恳荒，与生态危机 • 趋同教育，恶性（完全）竞争，与就业危机 • [中国前途]： • 保护生态（小康社会），发展劳动分工与规模范围经济，鼓励创新（适度竞争），可持续协调发展 • 质疑过度个人主义（过度消费，福利社会，大政府，过度法制），均衡陷阱，过度/垄断竞争

  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 (Schumpeter’s Constructive destruction)?

  18. Question #2: Market Economy Is Inherently Stable? (macro-finance- micro-econometrics) • Equilibrium thinking in economics: • Negative-sloped demand curve (Marshall) > convex function > fixed point theorem in Arrow-Debreu model in microeconomics • Econometrics: Frisch model of noise-driven harmonic oscillator • Friedman’s monetary shocks • Real Business Cycle School (Prescott & Kydland): technology shocks • Fama’s efficient market hypothesis and Brownian motion model in finance theory • Friedman spirit and arbitrage-free theory in asset pricing

  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) > implication for Austrian school • HP filter and time-frequency analysis (1994) > 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- ) > perpetual motion machine of the second kind • Reject Lucas model (1999-2002) > against the law of large numbers • Find better measurement > relative deviation > meso economy, trivial result of consumption smooth • Reject random walk and Brownian motion model > fever birth-death process

  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) (Osborne1959, Black & Scholes 1973) • Microeconomics – Friedman’s thought experiment of arbitrager against speculator in an efficient market (1953) > Equilibrium illusions through a short-time window and representative agent

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

  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 marketin 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 througha WhiteningLooking Glass (FD) X(t) = FD[S(t)]=S(t+1)-S(t) • Frequency response for the FD filter

  27. S&P500 Stock Price Indexwith log-linear (LL) and HP growth trends (VHPfilterforvon 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 Space:Linear 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 4~10 years!

  42. Natureof the Frisch Fantasy:A 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). • Frisch’s Informal conference paper: R. Frisch, “Propagation Problems and Impulse Problems in Dynamic Economics”, in Economic Essays in Honour of Gustav Cassel, George Allen & Unwin, London (1933). • Frisch's promised paper, "Changing harmonics studied from the point of view of linear operators and erratic shocks," was advertised three times under the category"papers to appear in early issues" in Econometrica, including Issue No. 2, 3, and 4 of Volume I (April, July, and October 1933) but never appeared in Econometrica since 1934. • Frisch never mentioned a word about his prize-winning model in his Nobel speech in 1969 (Frisch 1981).

  44. The Principle of Large Numbersfor Positive Variables • SN=X1+X2+ . . . . . . +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 micro–macro 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 inlabororproducer market Implication > Three layerstructure (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 outinter-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.

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