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Econophysics: When Physicists Do Economics They Do It Late And Badly

by | 25th, February 2014

THERE’S a whole new field out there called “econophysics”. It comes from the brainboxes in physics noting that they deal with chaotic systems a lot and so does economics: therefore we can apply what we know in one field in the other.

It does rather fail in one sense, for absolutely none of the physicists would agree that an economist knows damn all about quantum theory but they’re absolutely certain that a physics guy can know all about minimum wages. Odd that.

But there’s another way in which it fails and that’s in the way that anyone from outside a discipline is likely to. That is, given that they don’t know the intricacies of the field they’re likely to produce a recommendation that either everyone has already considered and rejected, or perhaps worse, something that’s so obvious that everyone’s already doing it. A nice example is this:

In a new paper, complex-system specialists Sebastian Poledna and Stefan Thurner offer a relatively simple idea: Make banks recognize systemic risk by charging them for creating it. Currently, lenders worry only about the risk they face from a default by the borrower, as opposed to the risk the loan may present to the larger financial system by making cascades of default more likely. Poledna and Thurner suggest that a small tax, proportionate to the systemic risk a loan entails, could help rebalance the incentives.

OK, so, the riskier loans then get charged a higher insurance premium by the government for increasing the possibility that the loan will go bad and thus require the bailout of the entire financial system.

Excellent, what could be wrong with this?

Well, actually, everything.

For it’s not who a bank lends money to that creates systemic risk in the banking system. It’s who it has borrowed that money from in the first place to make the loan that does. That is, it is the funding of a loan which creates that risk: and thus the insurance premium should be higher for people who fund their lending through short term borrowing than it will be for those who fund it through a long term bond issue. And then lower again if the bank is actually lending out its own equity. So the proposal is looking at the wrong part of the equation as to where the risk is.

Which is bad.

And then, even better, this is so obvious that it was actually passed into law several years ago. This is what the “bank levy” does. A bank which funds its lending through short term borrowing pays a higher bank levy than one that has issued long term bonds to do so etc. Even George Osborne has managed to get it right and earlier than our physicists.

Late to the party and wrong just isn’t a good advertisement for econophysics really.



Posted: 25th, February 2014 | In: Money Comment | Follow the Comments on our RSS feed: RSS 2.0 | TrackBack | Permalink