Redeveloping economics on a new mathematical foundationi (?)

Mark Buchanan, How ergodicity reimagines economics for the benefit of us all, berfrois, Sept. 28, 2019:

Everyone faces uncertainties all the time, in choosing to take one job rather than another, or deciding how to invest money – in education, travel or a house. The view of expected utility theory is that people should handle it by calculating the expected benefit to come from any possible choice, and choosing the largest. Mathematically, the expected ‘return’ from some choices can be calculated by summing up the possible outcomes, and weighting the benefits they give by the probability of their occurrence.

But there is one odd feature in this framework of expectations – it essentially eliminates time. Yet anyone who faces risky situations over time needs to handle those risks well, on average, over time, with one thing happening after the next. The seductive genius of the concept of probability is that it removes this historical aspect by imagining the world splitting with specific probabilities into parallel universes, one thing happening in each. The expected value doesn’t come from an average calculated over time, but from one calculated over the different possible outcomes considered outside of time. In doing so, it simplifies the problem – but actually solves a problem that is fundamentally different from the real problem of acting wisely through time in an uncertain world.

Expected utility theory has become so familiar to experts in economics, finance and risk-management in general that most see it as the obvious method of reasoning. Many see no alternatives. But that’s a mistake. This inspired LML efforts to rewrite the foundations of economic theory, avoiding the lure of averaging over possible outcomes, and instead averaging over outcomes in time, with one thing happening after another, as in the real world. Many people – including most economists – naively believe that these two ways of thinking should give identical results, but they don’t. And the differences have big consequences, not only for people trying to do their best when facing uncertainty, but for the basic orientation of all of economic theory, and its prescriptions for how economic life might best be organised. [...]

Of particular importance, the approach brings a new perspective to our understanding of cooperation and competition, and the conditions under which beneficial cooperative activity is possible. Standard thinking in economics finds limited scope for cooperation, as individual people or businesses seeking their own self-interest should cooperate only if, by working together, they can do better than by working alone. This is the case, for example, if the different parties have complementary skills or resources. In the absence of possibilities for beneficial exchange, it would make no sense for an agent with more resources to share or pool them together with an agent who has less. The standard economic approach, by nature, tends to come down in favour of splintering society into individuals who see only their own interests, and it suggests that they do better by this approach.

Things change dramatically, however, if one considers how parties do when facing uncertainty and repeatedly undertaking risky activities through time. As Elsberg illustrates in his novel, such conditions greatly expand the scope for pooling and sharing resources to be beneficial to all parties. From a basic point of view, pooling resources provides all parties with a kind of insurance policy protecting them against occasional poor outcomes of the risks they face. If a number of parties face independent risks, it is highly unlikely that all will experience bad outcomes at the same time. By pooling resources, those who do can be aided by others who don’t.

H/t 3QD. On ergoticity, HERE.