Fool Special
[ January 4, 2000 ]
Book Review
Butterfly Economics, by Paul Ormerod
[Buy this book from the Fool's Bookshop]
By Alan Oscroft (TMFAlan)
Author of the best selling book, The Death of Economics, Paul Ormerod has done it again; he's produced another cracking good read. Riveting reads on the subject of economics are not exactly common, and this reviewer's usual measure of a good treatise on the subject is one that doesn't send the reader immediately to sleep.
But this isn't an ordinary economics book. Instead of the hackneyed old economics theories that for decades have led gullible formula followers down the garden path of mathematical prediction, Ormerod introduces a much needed shot of common sense to the arena.
To quote from the book's introduction, "The conventional ways of thinking in the social sciences, and in economics in particular, offer at best a partial and at worst a misleading view of how the world operates. In essence, the world is seen as a machine. The machine may be very complicated, but in principle it can be understood completely, and the consequences of using it in various ways can be predicted. A lever pulled here or a button pressed there will have entirely predictable consequences."
Let's put this book into context. Firstly, it isn't an investment book, and so might seem like a strange subject for a Foolish review. And secondly, for Fools to get the most out of it, some prior understanding of economics and some interest in the subject is pretty much a necessity.
But there is a connection with Foolishness, and it is a pretty fundamental one. Most Fools are firmly convinced that forecasting the short term movements of the stock market is not possible, and that academic theories along the lines of the perfect markets theory are just that; they are interesting economic theories, but they bear little relationship to the real world. And guess what? Economics pundits are no better at predicting the short term direction of the economy than their Wise brethren with the wide braces are at predicting the stock market.
And the reason is identical. People. As individuals, we don't obey economic theory when making our day to day buying decisions any more than we weigh up all available information and arrive at the identical logical investment decisions that perfect markets theorists delude themselves into believing.
Now, no book is perfect, and Ormerod goes a little over the top in early chapters when promoting his ideas. He has a tendency to tilt at windmills a little, and to paint himself a portrait of a conventional economist at which to direct his lance. And that portrait is a charicature of a real economist; one who believes that all economic theories are perfect and accurately model the real world.
Such an approach is a little misplaced though, because the thrust of his argument is convincing in its own right and he has no real need to set up any stylised opponents to knock down. His arguments are compelling, his evidence is convincing, and his research looks to be pretty thorough. Many of his examples are so simple and so obvious too, that the one could be forgiven for slapping one's forehead from time to time and exclaiming "Of course the economists are wrong, it's so obvious!".
Here's a simple one. Classical economics theory tells us all about the price mechanism that links supply and demand. If more people want to buy something than can be supplied at a particular price, then the price will rise. That rise will suffice to decrease the demand and, at the same time, induce suppliers to make more of whatever it is, so that supply and demand balance nicely. But there are two things wrong with that. The theory (and most of classical economics in fact) takes a fixed snapshot of how things are and assumes that that will accurately describe the future. No allowance is made for changing tastes or fashions, for example. The other failing is that, by this mechanism, individuals are only influenced by their own fixed preferences and by the price, and can only affect the purchasing patterns of others through the effects that their own purchasing has on demand.
But can't we individuals influence each other directly? Well, of course we can, and we do. All the time in fact. Why is there a shortage of certain Christmas toys every year? Demand for teletubbies one year, and Star Wars toys or whatever the next, doesn't come from a mechanistic combination of supply and price. Such demand comes from fashion, and individuals' desire for those goodies stems directly from the desires that other individuals have for the same things (and that's something that happens with share prices too, though they don't get a mention in the book).
Economists' attempts to predict business cycles come in for a bit of a bashing too. We all know that business and economic growth tends to be cyclical, and that there are good periods and bad, booms and busts. But predicting the length and the timing of such cycles is a challenge that continues to defeat us. But why? One obvious possibility, and one that seems to have escaped mainstream detection, is that business cycles are inherently unpredictable. They are not mechanistic and instead, behave partly chaotically, and that chaos comes from the unpredictability of people.
And chaos is where the butterfly of the title comes in. You know the old one that says if a butterfly flaps its wings in a remote rainforest, then a million Chinese will jump off their chairs simultaneously (or something like that).
Ormerod is rather fond of ants too, and early on introduces the problem of predicting the behaviour of a colony of ants that is presented with two identical food sources situated at identical distances from the nest. How will they distribute themselves? All at one source or another, or equally between the two? And can we apply a mechanistic approach to the problem at all? I won't attempt to steal the author's thunder by revealing the answer, but you can guess that it isn't simple.
Conclusion
You can probably deduce that I like this book. There are many people to whom it will not appeal, and it isn't a light casual read. But if you have any interest in a real world approach to economics and think that the conventional approach needs shaking up a bit, and if you want something that will help shake those grey cells round a bit, then you might just enjoy it. And once you've read it, the chances are that you won't spend any more time trying to outguess future stock market movements.
Scores below are out of five. As this isn't an investment book and does not deal directly with personal finance, trying to give it a Foolishness score is probably inappropriate, so I won't try.
If you are interested, the recently released paperback version is available from Amazon at a reduced price. Just follow this link.
Ratings (out of five Jesters caps):
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Readability:
Foolishness: n/a
