Butterfly Economics

A New General Theory of Social and Economic Behavior

by Paul Ormerod
Pantheon 2000
217 pages

Focus
Leadership
Strategy
Sales & Marketing

Take-Aways
Human behavior has always defied economic theory.
Economics depends on arbitrary laws.

Corporate Finance
Human Resources

Human society isnt predictable or controllable.

Technology
Production & Logistics

Society can only be understood by looking at its complex interactions.

Small Business
Economics & Politics

All human societies are like living organisms.

Industries & Regions

Career Development
Personal Finance
Self Improvement
Ideas & Trends

Economic theories must change to reflect human behavior.

Economics should be similar to the science of biology.
Governments will be more effective if they accept that society is not mechanistic.
Business cycles are natural and normal, and usually dont require intervention.
Butterfly economics recognizes that people are influenced by the actions of others.

Rating
Overall

(10 is best)

Applicability

Innovation

Style

10

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Relevance
What You Will Learn
In this Abstract you will learn: 1) The basic principles of complex systems theory; 2)
How complex systems theory applies to the economy and society in general, and 3) How
businesses and government policy makers can apply the concepts of complex systems
theory to improve their results.
Recommendation
Paul Ormerods critically acclaimed work pinpoints the failings of traditional economics
and government policy making by demonstrating the complex nature of economies and
societies. You wont find a single dry, dusty page in this dazzling book, which serves as
a primer to the latest thinking in 21st-century economics. Ormerods premise: Standard
economic theory fails to take into account the fact that people are influenced in their
decision making by other people. This interaction forms the foundation of his butterfly
economics. Ormerod keeps you turning the pages and brings the subject vividly to life.
getAbstract.com recommends this newly penned classic to all readers.

Abstract

The ability to
develop models in
which the behavior
of individuals is
directly affected by
the behavior of
others represents
a very important
intellectual advance for the
social sciences,
and offers a more
powerful explanation of a wide
range of phenomena than does
conventional thinking.

Short-term predication and control,

on which so much
of public policy is
based, is inherently difficult and
sometimes literally
impossible.

Butterfly Economics
Human behavior has always defied time-honored economic theories. If economists
want to improve the accuracy of their predictions, its their theories that will have to
change, not human behavior. Economics must become a science similar to biology, less
dependant on so-called laws and forces that provide unreliable predications, and more
open to the fact that people are influenced by what others do.
The interconnected nature of human behavior is evident in all areas of the marketplace.
Some common phenomena prove this point. For example, every Christmas season,
everyone clamors for one particular toy, and every year, some big-budget movies die at
the box office while other, low-budget films become surprise, runaway hits.
Economics is rooted in the workings of human society, with all its chaos and
unpredictability. Human society isnt a predictable, controllable machine; its more like
an organism, a living creature, whose behavior can only be understood by looking at the
complex interactions of its individual parts. This concept and all of its implications form
the foundation of butterfly economics.

Why Butterfly?
The fundamental view of society as a living creature that adapts and learns can be
compared to the butterfly. The image of the butterfly draws upon sciences chaos theory,
which maintains that the beating of the wings of a butterfly can, in principle, cause a
tornado on the other side of the globe. Modern economics and societies express this
scientific view, since both are complex systems that hover on the brink of chaos. The
behavior of the system as a whole can never be understood by mechanistically adding
together its component parts, just as a living creature is more than the sum of the
individual cells that make up its body. The economy and society are more than the sum
of the individuals who inhabit it.
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An economy can
only grow at the
overall level if the
individual firms of
which it is composed grow. So
any theory of
growth should be
based upon the
activity and behavior of individual
companies.

The problems are

compounded in
economics by the
fact that it is usually impossible to
repeat an experiment. After all,
America has only
one history, so we
only have one data
series for economic growth over
the years in the
United States. We
cannot, by whatever means, construct another.

The idea that the

behaviour of
others can influence an individuals decision in
financial markets
is by no means
new.

In constantly changing economic and social worlds, the connection between the size
of an event and the magnitude of its effects must no longer be viewed as routine
and mechanical. Small changes often have small consequences, but sometimes they
have rather large consequences, and on occasion even dramatic impact. Large changes
certainly sometimes have large effects, but they also often make surprisingly little
difference to the eventual outcome.
It is almost as impossible to predict with any degree of accuracy the immediate effects
of any event. Even so, in the longer run, there is considerable regularity of behavior.
The often-unpredictable interactions between individuals lead to a certain kind of selfregulation in the behaviour of the system as a whole. At the root is the basic truth
that people see what others do, and may be influenced by it. By contrast, orthodox
economics is arbitrarily forced to assume that the tastes and preferences of individuals
are completely fixed, which in practice does not hold up.

Illusory Control
While it may appear sophisticated, the machine-oriented approach to human behavior
as represented by the mathematics of orthodox economics cannot cope with situations
in which peoples tastes and preferences can change according to how others behave.
Systems in which people copy each others behavior require different analytic techniques
than those used in standard economics. These mathematical techniques have only been
available during the past 10 to 15 years, and require computers to artificially simulate the
behavior of such societies.
The apparently obvious assumption that individuals dont live in a vacuum and, in fact,
live in a society in which they could be influenced directly by the behavior of others, also
has profound implications for the conduct of public policy. Once you view the economy
and society as a complex, living system, youll quickly understand the frequent failures
of public policy. Much of the control that governments believe they exercise over the
economy and society is illusory.
With their faulty, mechanistic view of society, polices makers have long been encouraged
to believe in the checklist mentality, which lies at the heart of conventional economics.
This mentality lends itself to the belief that if you do A, B and C, the consequence will
be X. But such thinking offers merely the illusion of control. It may sound manageable
on paper, but in practice, a complex, living system simply doesnt work this way.

The Ant Colony

People arent the only creatures who are influenced by the behavior of others. By
studying the behavior of ants in an ant colony, you can see parallels to human behavior.
Once an ant has found food, it will usually go back to the same site, over and over. When
an ant that has found food returns to the nest, it physically stimulates another ant to
follow it to the food source by chemical secretion. Some varieties of ants even get entire
groups to follow them by laying a trail of secretions. So an ant emerging from the nest
for the first time would be influenced in its decision by the trails of the ants it encounters
on its journey.
Thus, a particular site will become the favored destination for more and more ants. With
other sites to choose from, things really get interesting. Given two food sites to choose
from, an ant coming out of the nest follows one of three courses: 1) It returns to the
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food pile it previously visited; 2) It is persuaded by a returning ant to visit the other food
source, and 3) Of its own volition, it decides to try the other food source itself.

As more people
choose one rather
than the other, it
becomes increasing likely that
others will subsequently choose the
successful version
of the product.

Its easy to recognize the parallels to humans making social and economic choices and to
business cycles. At any point in time, an individual agent, whether its an ant, a person,
a company, or anything else, faces three courses of action: 1) To stay with its previous
decision; 2) To select an alternative of its own accord, and 3) To be persuaded to switch
to the alternative by the actions of others.
The consequences of this kind of human behavior have deep implications for the human
colony as a whole. Many important social and economic issues in human society share
the fundamental characteristics of ant behavior: short-term unpredictability merging
imperceptibly over time into a form of regularity, of complex systems living at the edge
of chaos.
This behavior helps explain market volatility and unexpected economic outcomes, such
as a technologically inferior product beating out a superior rival. It also accounts for
social behavior, from crime and family structure to education and fashion.

The most striking

feature of the
annual rate of
growth of American national
income is that it
is always changing. It is never
the same from one
year to the next.

Less Can Be More

Generations of policy makers have been trained in the mechanistic methodology: To
achieve a particular set of aims, draw up a list of policies and simply tick them off. While
this may seem like a comfortable, dependable, predictable and controllable environment
in which to live and work, it doesnt translate from theory into practice. The complex
systems approach makes policy-makers uncomfortable, since it requires them to accept
their lack of control and the cold hard truth that life and everyone in it is unpredictable.
As demonstrated by the ant colony, short-term results are unpredictable and
uncontrollable: You dont know which food site an individual ant will choose to visit. But
over a long period of time, the structure of that outcome is open to influence.
Governments can be effective if they begin by accepting this complexity and its attendant
policy implications: That governments should do much less in terms of detailed, shortterm intervention and spend much more time thinking about the overall framework of
whatever particular problem is at issue.

The Business Cycle

Governments should accept the fact that inflation increases and decreases over the
course of business cycle, but provided that the conditions for a low-inflation environment
remain in place overall, the dynamic is nothing to worry about. Governments rarely
seem to learn from their mistakes, as time after time attempts to intervene and hit precise
targets actually end up doing more harm than good.
Attempts to
account for the
existence of business cycles have
been a key theme
in economic theory
for the past two
hundred years.

Interventions to try and control the movements of the business cycle itself are also
misplaced. Its simply not possible to forecast with sufficient precision the state of the
economy in, say, one years time in order to decide which measures to take now to
bring out the desired outcome. Such precision would be impossible even if the impact of
measures such as changes in taxation or public expenditure were known with sufficient
accuracy, which they are not.
At times like this, governments should see that the periodic ups and downs of the business
cycle can never be abolished, but are an inherent feature of market economics. The
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Studies showed
quite clearly that
by far the biggest
contribution to
Western economic
growth, according
to the growthaccounting approach, was made
by technology.

Our model of
growth is certainly
based upon general principles,
rather than on
knowledge of how
any particular
economy operates
in practice.

market consists of individuals, organizations, groups and companies making decisions

in situations of uncertainty. The role of government in the business cycle should be
confined to trying to mitigate the consequences of the cycle rather than to try to smooth
it out or eliminate it.
For example, governments should not attempt to control unemployment, which fluctuates
fairly regularly during the course of the business cycle, falling during booms and
rising during slumps. Occasionally a sharp recession occurs, leading to a spike in
unemployment. This need not be a major concern. As the economy recovers during the
next upswing of the cycle, unemployment always falls. Problems with unemployment
arise only when it moves into a different, higher path, when a recession precipitates an
unemployment increase that is greater than expected, given the size of the economic
slow-down.

Inherent Chaos
Many government and academic economists do not have an intuitive understanding of
the complexity of the world. Business people realize that it is futile to search for the
perfect plan, since the future is to a large extent unpredictable. They learn this from
direct experience with reality, as opposed to the wishful thinking thats often inherent
in theories derived by academicians and clung to by bureaucrats and politicians whove
never been in the business trenches.
Companies should not place too much emphasis on the state of the overall business
cycle, and, by and large, they do not. Their main focus should be on their competitors
and their long-term strategy. Naturally, a boom or a slump affects companies, but
these always come and go, whereas rivals who steal a strategic advantage can inflict
permanent damage.
Orthodox economics is not a completely empty box, and neednt be completely rejected.
It must be extended to include the fundamental fact behind butterfly economics: that
people are influenced directly by the behaviour of others.

About The Author

Paul Ormerod has been head of the Economics Assessment Unit at The Economist and
a visiting professor at the University of London and the University of Manchester. He
lives in London.

Buzz-Words
Business cycles / Butterfly economics / Chaos / Complex systems

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