The Queen, emergence and systems theory

A group of economists at the London School of Economics have felt impelled to write to the Queen in response to her question posed a year ago when she was on a visit to the university as to the cause of the banking collapse.The Queen

The letter explains that there was a ‘psychology of denial’ affecting all those concerned, and in a touching note of humility drawing attention to the fact that many very intelligent people were caught up in this collective denial, the letter goes on to explain that  “it is difficult to recall a greater example of wishful thinking combined with hubris”.

“Everyone seemed to be doing their own job properly on its own merit. And according to standard measures of success, they were often doing it well,” they say. “The failure was to see how collectively this added up to a series of interconnected imbalances over which no single authority had jurisdiction.” (my emphasis added)

Perfectly put.

A number of processes are at work here which we have investigated on this blog. The first is the belief in the intelligent, rational actor, who, in collaboration with other intelligent, rational actors can identify all possible risks and do their best to ameliorate them. Unfortunately, as Donald Rumsfeld observerd with his famous indentification of the ‘unknown unknowns’ , there is a difference between risk and uncertainty. With risk we are working with factors we have identified: with uncertainty we have no way of knowing what we might encounter which might just be an unusual cofiguration of what we already know. Emergence, to use the definition of the analytic sociologist Peter Hedstrom, is the uncommon combination of common events and circumstances.

Secondly, the letter to the Queen seems to be an implicit admission that targets and performance measures could actually have contributed to the crisis. If financial brokers were being rewarded for the number of deals that they are making rather than for the nature and quality of those deals, then there was no incentive for them to reflect upon what it was they were doing. We have explored this phenomenon recently in a recent posting on John Seddon’s critique of performance measures . The setting of targets distorts people’s day to day work: what gets measured gets done, even if this is counterintuitive to a broader measure of success, or even simply what the client requires. Professor Luis Garicano of the LSE put it like this:

‘I think the main answer is that people were doing what they were paid to do, and behaved according to their incentives, but in many cases they were being paid to do the wrong things from society’s perspective.’

The interesting phenomenon that we are talking about here seems to be of intelligent, rational people acting rationally from one set of criteria and irrationally from another. Paradoxically, rationality and irrationality arose together. The signatories to the letter do seem alive to this paradox as well as to the fact that there were many, many contributory factors to the crisis happening.

‘There was a very complicated, interconnected set of issues, rather than one particular person or one particular institution.’

This does not prevent just a hint of a suggestion that it might be possible to prevent something similar happening in future, if only one could get ‘the whole system’ in the room:

‘In summary, Your Majesty, the failure to foresee the timing, extent and severity of the crisis and to head it off, while it had many causes, was principally a failure of the collective imagination of many bright people, both in this country and internationally, to understand the risks to the system as a whole.’

The financial crisis clearly arose from a variety of  factors and it is of course worth reflecting on what these could have been. It is also valuable to think about the perverse incentives that drove a variety of people to act as they did, and even to raise moral questions about wealth creation and how much money is enough. With bankers receiving millions in bonuses in addtion to their salaries one would have to point to an usustainable level of acquisitiveness. However, given that financial activity takes place as the many many daily interactions between many people in many different countries, to what extent does it make sense to think of this as a ‘system’? How would it ever be possible to imagine the risks to ‘the system as a whole’?

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One thought on “The Queen, emergence and systems theory

  1. sbilling

    From your post, it seems to me that the letter to the Queen is saying that “It was caused by many things. We were all incented to do things that turned out to be detrimental from the perspective of society. If only we had all got together as a society we could have found a way to stimulate the collective imagination of the bright people in banking and then we could have understood the risks to the banking system as a whole.”

    As you mention in your post, this implies that the rational intelligent actor could identify all the risks and then work out how to mitigate them.

    You also question whether financial markets are a system, and I am in agreement with you that it is not. In a system, the parts are defined in terms of their relationship to each other and their purpose for the whole. For example, the cogs that make the wheels go round, or the leaves whose purpose is photosynthesis. In financial markets the actors are human beings with consciousness and some degree of choise, unlike the parts of a system like cogs or leaves.

    Great post Chris.

    Cheers, Stephen http://www.changingorganisations.com

    Reply

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