Economics as events

  ``Every heat engineer knows he can design his heat engine reliably and accurately on the foundation of the second law [of thermodynamics]. Run alongside one of the molecules, however, and ask it what it thinks of the second law. It will laugh at us. It never heard of the second law. It does what it wants. All the same, a collection of billions upon billions of such molecules obeys the second law with all the accuracy one could want.''

-- John Archibald Wheeler

We construct aggregates to approximate the behaviour of large numbers of discrete interactions. Sometimes they are useful, as in thermodynamics. Often they aren't, as with most macroeconometric measures. Wheeler suspects that all our laws of physics describe approximate behaviour of aggregates of observations; that the fundamental quantum event is all that really exists. Most of physics does not attempt to understand why these quantum events occur but simply describes the aggregate behaviour of large numbers of events. As we begin to understand the low-level mechanisms, we will get to the true physics beneath the aggregates. Similarly, in economics we try to predict behaviour of aggregates of individual transactions. Only the transactions are real; all the rest is the work of man. One may not be able to understand what drives the transactions by theorising based upon aggregates.

Parallels exist between markets and quantum mechanics. The electron has no position or momentum until you measure it. When you measure its position, you disturb it, foregoing accuracy in measuring the momentum. A share of General Motors has no price until a buyer and seller exchange it, a discrete event. This transaction/measurement affects the price of subsequent transactions. Prices are undefined until a transaction occurs, whether the purchase of a loaf of bread or the takeover of RCA by GE. Prices in a large liquid market can be predicted quite well since the effect of a single transaction is minuscule; prices in blockbuster transactions can barely be predicted at all. Similarly, you can predict interference fringes to many decimal places but which detector an individual electron will trigger in a dual slit interference experiment is unknowable in principle.

``The market was up 15 points today'' is meaninglessness layered on meaninglessness. The market is neither up nor down. The market is a place where discrete transactions occur--a surging organic sea of buyers and sellers with different goals, opinions, and strategies, who momentarily and unpredictably agree to exchange specific assets. We aggregate these transactions into the abstraction of a continuum of price. We aggregate a selection of these abstracted continua into an average price. We then assign meanings to the action of this average, and impute its behaviour as being representative of the market.

Thermodynamics works because the number of particles is a statistical universe. Economics may not work because the number of players and events is too small. Perhaps the fundamental difference between people in a market and gas molecules in a jar is not that people have free will and gas molecules don't, but just that there are a lot more gas molecules.

The further you are removed from the events, the less you're able to see what is really going on. MBAs and investment bankers are trained to look only at aggregates: ``Well, if they're putting 10% of sales into R&D, that will translate into a 30% sales increase in 2 years'' or ``Their margins are eroding, and therefore...''. Local governments work pretty well because the people who run them are actually aware of the sewers, potholes, and running dogs. Large national governments can deal only with totally abstract aggregates and consequently are less effective. Decision making must, to be effective, be based upon accurate information regarding events. To the extent that government or business managers see and adjust only aggregates, their actions become increasingly ineffectual. As those governed or the customers of a business perceive consistently ineffectual or counterproductive actions, the legitimacy of the institution wanes.