In listening to discussions about markets and economics you seldom hear the word complexity. Most economic theory tends to be linear in construction. Markets, however, consist of very complex systems. Because of its importance in understanding markets, I want to offer a brief introduction to the concept of complexity. I will get back to this subject many times in the future. At this time, I want to address some basic concepts to encourage you to keep the complex nature of the markets in mind.
Definition of Complexity
You can sum up systemic complexity by the phrase “the whole amounts to more than the sum of the parts.”
This means that something happens in the relationship between the parts of a system that give it more and different characteristics than the aggregation of the parts in the system. Thus, whenever you hear comments about a system you should ask yourself, “how to the parts of the system relate to each other and how that relationship makes the whole different than the sum of the parts?”
Complex systems are generally divided into two types:
- Complex Physical Systems
- Complex Adaptive Systems
Complex Physical Systems
Certain fixed rules define the relationships that make a physical system complex. Machines epitomize complex physical systems. The rules of leverage, for example, apply in all applications of machine systems.
Given knowledge of the initial conditions of a physical system and the external forces applied to it, a person can predict the response (effect) with reasonable certainty.
Complex adaptive systems, however, do not have that level of predictability.
Complex Adaptive Systems
Unlike complex physical systems, complex adaptive systems have the capability of adjusting their own behavior. They can rewrite some of the rules. The behavior of human systems — i.e. complex adaptive systems with a human component, including markets — tend to have a range of unpredictability.
Similar to physical systems, a person can measure the initial conditions and the external forces applied to adaptive systems. But, unlike physical systems, the response of an adaptive system remains unpredictable.
Complex adaptive systems watch the results of their own behavior (self-referencing); they adapt their behavior based on prior results; and they create unpredictable results. In the simplest terms we can refer to this adaptability as learning.
The word emergence refers to the manner in which the characteristics of the whole system develop from processes. The characteristic of wetness emerges from the process of combining hydrogen and oxygen in the proper proportions. The characteristic of “automobile” emerges from the process of assembling the component parts. And, the characteristics of markets emerge from the processes of production, consumption, and exchange.
In the first two examples the same characteristics will emerge with each iteration of the process. In the case of markets (complex adaptive systems,) new characteristics emerge with each iteration. The market continues to display the capability of learning as time progresses.
Counting the number of dollars changing hands in an economy provides little information about the emerging characteristics of the economy as a whole. Thus, the validity of economic statistics must continually remain the subject of doubt.
When you hear people making definitive statements about the behavior of markets, keep in mind that markets represent complex adaptive systems.
An extremely larger number of interactions come together and emerge as the new characteristics of the market. As a result of information conveyed through the pricing mechanism, the various parts in a market will adjust their behavior and a whole new system will emerge.
Because of their complex adaptive nature, no one can predict the results of any intervention into a market system.