On how to advance
the cognitive power of free market

This post continues the one entitled “Roubini’s conceptual apparatus […]”.

1. Computational power as a kind of cognitive power

Had Adam Smith lived in our times,  instead of  “market’s invisible hand” he might have  preferred the phrase  “market’s invisible computer”.  For it is an axiom of classical economics that the free market  functions like a device to calculate an optimal state of economy.  Such an analogy has become popular due to the long Friedrich Hayek’s  dispute with Oskar Lange.  The latter was the Polish socialist economist,  who believed that the central socialist planning will  prove efficient owing to computer simulations of free market, while Hayek was aware  that  such a tricky virtual   market  could not match  the real one in its computational power.

Following  this metaphor, let us ask the question: does such computer need a programmer?  In Smith’s perspective, the answer would be, presumably: “yes it is  the  good Lord himself  who has programmed it”. If  you dislike  invoking God’s name in vain,  you may replace it with the phrase “self-organizing Universe”. In either case the question arises: does  the executing  of program need a human assistance?  There appears an illuminating analogy with automated reasoning: often it succeeds when being  executed by computer alone,  but in  most  complex cases  it needs prompting  or controlling  by a  human reasoner.

I resort here to the ideas of computational power and computability, though they belong to very sophisticated concepts of mathematical logic and theoretical computer science; hence their definitions, should they be duly precise, would require many preparatory steps.  However,  with  referring to our everyday experience with computers, we can approximate these ideas  to  some  extent  – to use them as useful metaphors, or models, also  in  the field of economy.

For instance, with successive upgradings of the softeware, my computer ever more knows how to  perform ever more complex tasks. In this sense,  there increases its  power which we call  computational,  for all  such  tasks are being performed by computing.  Since  my computer may be thereby said  to  “know more”,  its computational power turns out a kind of cognitive power.

There are other kinds of  cognitive power, not being computational.  To see the difference, let us compare two kinds of  mathematical cognition. If one computes the  circumference of a circle according to an algorithm (capable of being  rendered as a program), then he  uses his brain’s computational power. However,  when he accepts  intuitively,  as being obvious,  the axioms of arithmetic and geometry (from which there follows the algorithm in question),  he makes use of a cognitive power different from the ability of computation; this power is ofted called  intellectual intuition.

In economic matters, both  varieties of cognitive power come into play. There are calculations, and there are intuitive acts  of cognition. The latter  include seing  significance of  certain problems, accepting certain assumptions,  recognizing  some mathematical models as  useful for predictions, etc.

Cognitive power is enjoyed not  only by individual market agents but also by free market as an overall system of information processing. Its main job consists in computing  prices, each price as the function of  a set of variables,  especially  demand and supply.  In this sense Smith’s dictum may be paraphrased as “invisible action of a computer”.  However,  let  us return to the question posed above (see the second paragraph):  given the fact that complexity of some computations needs a support from an intuitively reasoning agent,  one may ask about the following analogy.  May it be so  that  the complexity of social life (which involves supply-demand relationship) needs deliberate state intervention to protect public interests, apart from  market’s mechanisms? In other words: are there any circumstances in which state control over prices would be a smart strategy to advance public interests? On this point there are divergent appoaches, one of Keynes, the other one of the Austrian Economic School,  brilliantly represented by Hayek.

2.  The interplay of spontaneous market and state’s economic control

To take a well considered  stance toward the  Hayek-Keynes disagreement, that concerning market’s and government’s  impact on  the demand-supply relations,  we should link this controversy with the idea of computability;  it is the latter which plays the key role in the Hayek-Lange dispute.  The free market is a reliable device to compute optimal prices, optimal strategies etc., provided  that all its agents are fully rational and fully honest. Any deviations from these ideal  conditions result in errors of computing.   The more complex  become economic  processes,  the  less  there  is likely  to attain a perfect rationality.  The grater gains are at stake, the more people happen to be drawn away from the virtue of honesty. To become free from such deviations,  the market needs a control by  competent authorities, smart enough to establish reasonable  rules of market game.

Moreover, such a control may be needed because of  interference of various social interests,  and of multiple government strategies,  as  to protect  the poorest parts of population,  to support  export and reduce import, etc.  These purposes may be attained with such instruments as subsidies, tariffs, loans, taxes etc. Such measures can be directed towards definite sections or sections,  e.g. subsidies for food production,  highly advantageous loans for housing,  tariffs on definite kinds of goods, etc.

There is the extreme view (sometimes called libertarian) which denies  governments any right to interfere with markets. To  support  such a contention, one should prove that market agents always  are fully rational, that is, doing correct computations, and  invariably respecting moral  claims. However,  neither is the case.  Market agents happen to commit various errors: sometimes they use false premisses in their predictions   (e.g. some years  ago  they superestimated the potential of Greek economy),  yield to the panic,  have a propensity to engage in speculative bubbles, etc. These are  intellectual errors,  to wit lapses in calculation.  Morever,  market agents happen to  transgress moral standards when their self-interest blinds them to public interest, when they tend to monopolistic power, when they do selfish lobbying, etc.

In such state of affairs there are at least three reasons for  the interaction  of political power with  market forces.  First  of all, there  is the absolute need of legal system to enable the very existence of free market in modern societies.  No economic  action would be possible,  if the state failed to create  a system of economic law  including  financial and banking law, law of companies etc.  This is  an essential state’s contribution to making economic processes predictable and transparent,  and thus obtaining the trait  of computability.

Another reason  amounts to the mentioned above vices, either moral or intellectual, of some free market agents. These diminish the computational power of free markets, hence should be remedied in order to restore a desired level of agents’  computational power and market’s  computability.

At last state, authorities,  mainly governments and central banks, in a period of acute crisis become the lenders of last resort,  necessary to prevent an irreversible economic disaster, as  there argues Roubini in his “Crisis Economics”; see post on Roubini’s conceptual apparatus. 

3. Economic crisis:  either a disaster  or a harsly challenging opportunity

This Section will be continued in more detail to inquire  into the  ideas of  Keynes and of Austrian School, and specially of  Joseph Schumpeter, as discussed by Roubini (see link above).  This issue is worth our careful  attention in  the debate on European integration strategy when  considered in a long run. To avoid economic desintegration, should Europe base on the Austrian or rather the Keynesian strategies? This appears as  the question of  the United Europe’s  to be or not to be.

To be continued.

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