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					I II I HEN picking over the causes for the
 |; ; ' current economic crisis, we think
  M If we know where to point the finger:
it was them greedy bankers wot dunnit. It was
they who lent American house buyers more
money than they could hope to repay, and
sold on the risk in ever more complex, opaque
packages, rewarding themselves handsomely
in the process.
    While there is truth in that picture, it
ignores the complexities of a system that
                                                         ,
led the initially small perturbation of the
"sub-prime" mortgage crisis to morph into
systemic collapse. Moreover, concentrating
on the specific causes of that one event fixates
on the past at the expense of the future. When
the next crisis comes, the disturbance will
probably ripple out from another quarter of
the economy, taking us completely unawares.
    Can we prepare better? Perhaps - but only
if we fundamentally change our approach to
economics. Instead of making unrealistically
simplistic assumptions about human
behaviour and the properties of markets,
we can harness the number-crunching power
of modern computing, coupled with our
emerging understanding of the physics of
complex systems, to rebuild economic theory
from the bottom up. Extending that approach
to the social sciences more generally could
help us develop forecasting tools to assess a
whole range of problems threatening human
society - not just the ravages of the markets,
but wars, disease and demographic change.
    Investigating the roots of our recent
financial crisis using conventional economics
rapidly hits a problem: the theories deny
that such things ever happen. Economists
employed by central banks and government
treasuries favour using statistical models
fitted to past data or "equilibrium" models
that assume markets find stability if left to
their own devices, a quality characterised by
the 18th-century Scottish economist Adam
Smith as the "invisible hand". Such models
assume that markets never crash on their own.
                                                   ,r~



The Earth
simulator
Packing the world of human interactions
into a computer could help solve our planet's
woes, says Philip Ball

48 I New/Scientist [ 30 October 2010
                                                    Instead, speculative bubbles and catastro
                                                    crashes are caused by unpredictable event
                                                    the wider world, such as political upheava
                                                    technological innovations.
                                                       That's not the only convenient simplific
                                                    Individuals and institutions are also assu
                                                    to have access to all the information that e
                                                    on an object's price, and make the decisio
                                                    on whether to buy it in their own self-inte
                                                    according to a rational cost-benefit analys
                                                    That's like choosing to buy a chicken sand
         MedJwatch.........                         only after taking into account the current
  2                                                 of all other chicken sandwiches in the wor
         Vlercator Gold
 58                                                    "That is psychologically unrealistic," sa
         Messaging fntl...,,......034               Daniel Kahneman, an economics Nobel
G 1 ,:
                     intl Wts..,.,. 0.              laureate at Princeton University. Not only
.1*2
         Metairax.................... 5'2           we act on the basis of incomplete informa
35                                                  but we often make economic decisions ag
                                                    our rational self-interest. We pay more fo
                                             23     brand-name goods that are not necessaril
                                             33     superior to unbranded ones, for example,
                                                    and we sometimes buy a sandwich regard
                                                    of the price, just because we are hungry.
                                            i'vft
                                            •
                                                    Messy mathematics
                                                    The central characteristic of agents in an
                                                    economy, be they companies, banks, trad
                                                    or individual consumers like you and me,
                                                    Kahneman, "is not that they reason poorl
                                                    but that they often act intuitively". This is
                                                    the downfall of many attempts to model
                               w **                 economic and social interactions: the
             """a^^lKlulil^                         assumption that everyone behaves in
                                                    the same rational way. We clearly don't.
                                                       What's more, the number-crunching
                                                    power now at our fingertips means such
                                                    assumptions are no longer necessary.
                                                    Rather than solve mathematical models o
                                                    an economy, we can use computer model
                                                    simulate how people and institutions int
                                                    and how their actions combine to dictate
                                                    the ups and downs of markets. By feedin
                                                    whatever rules for human behaviour we li
                                                    into a model and letting it roll, we can see
                                                    consequences without worrying about ho
                                                    messy it makes the mathematics.
                                                       This approach, called agent-based
                                                    modelling, has its roots in the computer
                                                    studies of so-called cellular automata,
                                                    popularised in the igyos by the British
                                                    mathematician John Conway's "Game of
                                                    Here, individual cells in a grid interact wit
                                                    one another according to simple rules, for
                                                    example reproducing or dying depending
                                                    the number of neighbours they have. Suc
                                                    simple rules can rapidly give rise to comp
                                                    yet organised collective behaviour.
                                                       Agent-based economic models have a
                                                    similar starting point. Agents representi
"The idea is to create a predictive model of global
 social, environmental and ecological behaviour"

or just copy the most successful strategy             to atmospheric chemists, so any whole-           institutions. This would include previously
followed by others.                                   economy model would need to draw on              confidential details such as information on
   Crucially, they can also learn from                the knowledge of experts in finance, labour      individual loans and who underwrites the
experience and respond to one another's               markets, supply chains, marketing, retail        risk for credit defaults.
decisions. For instance, an agent might buy a         and perhaps even psychology and law.                Even with that data glut, we would
stock with a certain probability if its price falls      Vast computing power would also be            probably need many models to generate
below a threshold - a threshold which could           needed to run the actual model and follow        useful predictions. "There will never be a
differ between agents - but with an increased         the interactions of millions, or perhaps         correct and final model," says Silvano Cincotti,
probability if other agents are also buying           billions, of agents representing companies       a complex-systems engineer at the University
the same stock.                                       and institutions with diverse agendas            of Genoa, Italy, who attended the Virginia
   Just as in the Game of Life, complex               and decision-making rules. And just as           workshop. "Economics is a self-referential
behaviours soon emerge from such simple               climate models need a stream of data from        system - the model influences the system
beginnings. In 1998, economist Thomas Lux,            meteorological stations to provide a constant    you're studying." In other words, if people
now at the University of Kiel in Germany,             reality check, an agent-based economic model     get wind of predictions, they change their
 and physicist Michele Marchesi of the                would need colossal amounts of information       behaviour on the basis of those predictions,
University of Cagliari in Italy showed that           about market transactions, prices, consumer      quite possibly invalidating them.
a basic economic model containing agents              behaviour, employment and business growth,          All this would imply that real-world agent-
with various trading strategies could produce         government fiscal policies and interest rates.   based models won't be around any time soon.
realistic patterns of price fluctuation. Not          Basically, it would need everything concerned    In fact, a proof of the principle already exists.
only that, but they could also produce new            with business, banking, finance and day-to-      Called Eurace, this is the largest agent-based
phenomena alien to equilibrium models but             day economic behaviour.                          model of an economy developed so far and
familiar to real markets, such as bursts of              Right now we don't have that data, but we     was created by a European team, including
transactions separated by relatively calm             could do soon. In the US, for example, the       Cincotti, between 2006 and 2009.
periods (Nature, vol 397, p 498).                     Office of Financial Research, whose creation        Eurace simulates a fictitious economy
   Around the same time, economist Blake              was mandated by Congress in July 2010,           with several million agents, whose markets
LeBaron, now at Brandeis University in                will have unprecedented powers to demand         for labour, goods, credit and finance act as
Waltham, Massachusetts, and his colleagues            information on transactions by financial         the perfect place to test the effects of different
showed how a similar model could produce
business-as-usual fluctuations punctuated
by occasional big variations and even crashes
(Artificial Life and Robotics, vol 3, p 27).


 Lessons learned
These models show that Smith's invisible
hand is not so much invisible as non-existent.
Herding behaviour, panic selling and market
instability arise not just through uncontrollable
external events, but also through the way we
make decisions and the influences others have
on our decision-making.
   What can we learn from this ? In June
this year, scientists, economists, computer
modellers and policy-makers joined together at
a workshop in Warrenton, Virginia, sponsored
by the US National Science Foundation, to see
what lessons we might draw from agent-based
models of the recent crisis (see "Picking over the
debris", opposite). They also explored whether
they might help us prevent any future slumps.
   One central question emerged: is it feasible
to build an agent-based model on a scale
capable of simulating a nation's or indeed the
world's economy? Such a model would be a
huge step towards better understanding the
consequences of policy decisions before we
make them.
   It would also be a huge undertaking. Just
as modelling Earth's climate requires the
expertise of everyone from marine biologists

 50 I NewScientist I 30 October 2010
                                                               What turned the modest d ra n a i n       the debt on were faulty, and the
                                                               the US housing market in mid-2007         "derivatives" they created had
msly       economic policies. How, for example, should         into a global catastrophe? A new way      developed such byzantine complexity
non        we deal with the massive government debts           of modelling economies, bes=3 en          that it was almost impossible to
the        incurred as a result of the financial crisis? Is    the economic behaviour of individuals,    keep track of what risk went where.
           the answer fiscal tightening - reducing the         or agents, is supplying us with           As soon as the first bankruptcies
           debt with high taxes or low public spending -       fresh insights.                           were announced, the whole system
te         as pursued by the current UK government?               Whafs certain is that rising           froze because no one knew where
!a         Or quantitative easing, keeping taxes low           house prices and low interest rates       the debts lurked, and so couldn't
Incotti,   and plugging the debt by selling government         encouraged people to release the          tell who to grant a loan to.
versity    bonds, as has been favoured in the US?              equity on their house by refinancing,         An advantage of agent-based
lia        Eurace's simulations suggest that, in the long      while banks were falling over             models is that they can simulate
tial       run, the American approach boosts economic          themselves to offer such loans.           the web of interactions between
em         growth and employment levels more.                  But according to models developed         banks explicitly. Just as with
)le                                                            by Andrew Lo at the Massachusetts         power grids, computer viruses and
ar                                                             Institute of Technology, one crucial      disease epidemics, the topology of
ions,      Crisis observatories                                factor in causing the situation to        this web - what is linked to what else,
           More work is needed to prove that these and         spiral out of control was the tendency    and how many connections exist - is
igent-     other preliminary results from Eurace scale         of home-owners to increase their          thought to determine how it behaves
5 soon.    up to the size of a national or indeed the world    "leverage" - the ratio of their loan      under stress. Researchers at the
;xists.    economy, says Cincotti. But it looks set to be a    burden to their property value - in the    Bank of England, among others, are
iased      far more promising vehicle for understanding        good times but not decrease it in the     now trying to tease out the network
and        the niceties of economics than the old one-         bad times. When there was a critical      properties in financial markets,
ing        size-fits-all approach.                             fall in house prices, everyone was        in the hope of identifying generic
              Why stop there? If it is possible to simulate    caught short at once.                     vulnerabilities and dangers in
y          an entire economy using agent-based                    The problem also lay in the way the    the system. If they can find them,
kets       modelling, can we encapsulate more facets           debt was handled. The tools banks         agent-based models might help
 as        of human activities and impacts in a model?         used for calculating risk when selling    us to avoid a repeat of past crises.
'ferent    That is just what the researchers behind
                                                              the pan-European Future Information and          a gap in the knowledge landscape," he
                                                              Communication Technologies consortium            "We've invested billions each year in a
                                                              (FuturlCT) are planning. Coordinated by Dirk     such as particle physics, nuclear fusion
                                                              Helbing, a social scientist at the Swiss Federal and medicine, but just a fraction of tha
                                                              Institute of Technology in Zurich, they have     socioeconomic sciences. We have dire
                                                              recently submitted a proposal to the European our curiosity outwards, not towards th
                                                              Commission to develop a model that they dub living Earth."
                                                              the "Living Earth Simulator".                       Early next year, Helbing and his coll
                                                                 The idea is to plug a whole-economy model who include Cincotti, will find out if t
                                                              into models of other "Earth systems", such       convinced the EU sufficiently to award
                                                              as climate, transport, population and water      €1 million in development funding fr
                                                              resources, to create a predictive model of       Flagship Programme, which seeks to f
                                                              global social, environmental and ecological      large-scale, visionary initiatives. A dec
                                                              behaviour. It is an acknowledgement of           on footing the full bill for just two Fla
                                                              the fact that it is all but impossible to study  proposals is due in mid-2Oi2.
                                                              complex phenomena in isolation. The spread          With the know-how and the technol
                                                              of infectious disease, for example, is highly    make large-scale agent-based models
                                                              dependent on transport networks, from            now coming together, FuturlCT's advo
                                                              international contagion by air travel to         argue that €1 billion is a small amount
                                                              the small-scale details of local bus services.   gamble for our future security. "It is im
                                                                 By bundling all the relevant systems into     that this admittedly bold step be taken
                                                              one model, the hope is to create a "crisis       Joshua Epstein of Johns Hopkins Univ
                                                              observatory" that could help us to negotiate     in Baltimore, Maryland, a social scient
                                                              the challenges facing humanity: disease,         who pioneered agent-based models of
                                                              war, demographic changes such as ageing          and is now using them to study epide
                                                              populations and mass migration, the security After all, the credit crunch alone cost t

				
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