[Big Ideas – Special] Understanding Markets via “Narrative Economics”

The secret of effective market game-playing is to recognize that the market game hinges on the Narrative, on the strength of the public statements that create Common Knowledge.

Epsilon Theory Manifesto

Nobel-winning economist Robert Shiller recently published Narrative Economics, a book on “How Stories Go Viral and Drive Major Economic Events“. Shiller gave a talk at LSE on the big ideas (video, audio, related 2017 paper).

Context: This article is part of the Big Ideas series, where I synthesize takeaways from the world’s best experts in multiple disciplines. This article is a special in the series, because unlike other articles that are synthesized from Discover magazine expert interviews, this piece is largely inspired by a public lecture.

What is a Narrative?

Let’s start with definitions. According to Shiller:

  • Narrative = a telling of a story that attaches significance, meaning or emotions to it;
  • Story = a chronology of events.

What is Narrative Economics?

Shiller makes a key distinction between narrative economics as defined in the dictionary vs. defined by himself. The textbook definition of narrative economics is “economics research that takes the form of telling a narrative about economic events”.

For Shiller, narrative economics should have a narrower focus, i.e., only investigating popular economics narratives that “went viral”, “changed things” and “became contagious”.

Shiller thinks economics narratives are powerful in affecting (& shaping) economic decisions. He identifies 9 perennial economics narratives:

  1. Panic vs. confidence narratives – e.g., the Big Depression is a panic narrative;
  2. Frugality vs. conspicuous consumption – e.g., Trump’s book “Think Like a Billionaire”;
  3. Monetary standards – e.g., the Gold Standard vs. Bimetallism debate;
  4. Technical unemployment, i.e., labor-saving machines replace many jobs;
  5. Automation & AI replace most jobs;
  6. Real estate booms & busts;
  7. Stock market bubbles;
  8. Boycotts, profiteers & evil business;
  9. The wage-price spiral & evil labor unions.

Broadly speaking, the 9 narratives above focus on the macro economics momentum / “culture” (1-3), employment (4-5), investment (6-7) or actors in power (8-9).

Shiller argues that data sources are at the root of economics evolutions. He believes the recent “digitization of search” is and will bring shifts to narratives. Moreover, Shiller claims that big events occur often not because of a single narrative, but because of a “confluence of narratives“, i.e., as a result of the chemical reaction of multiple narratives.

With an interesting twist, the word “narrative” appears less frequently academic articles in economics & finance compared with other subjects – see this analysis of JSTOR articles below:

Studying Narrative Economics via the Virality Model of Epidemics

If we think of a narrative as a disease, then we could study its spread by borrowing patterns from research on epidemics. In other words, we could leverage research on how viruses “go viral”, and try to figure out how narratives get popular.

The Kermack-McKendrick (1927) mathematical theory of disease epidemics is a breakthrough in medicine, because it “gave a realistic framework for understanding the all-important dynamics of infectious diseases” in the words of Shiller.

The Kermack-McKendrick model divides the population into three groups: susceptibles, infectives, and recovered. Importantly, the model suggests the curve of the number of infectives to take a “humpback” shape, i.e., rising sharply before declining at a similarly fast speed:

We could see similar “humpback” shaped curves in data that could serve as proxy measurements for how popular an economics narrative is.

Here’s an example on how frequent the phrase “stock market crash” appears in news & newspapers:

Here’s another example on how frequent the phrase “Great Depression” appears in news & newspapers:

The Future of Narrative Economics

Shiller is hopeful that ” the advent of big data and of better algorithms of semantic search might bring more credibility to the field”.

Meanwhile, narrative economics faces challenges, including:

  • On data collection, we need to move beyond “passive collection of others’ words, towards experiments that reveal meaning and psychological significance”, e.g., via focus groups or social media – though the proper design & implementation of such experiments is not easy;
  • Dealing with the overlap & “chemical reactions” of multiple overlapping narratives is difficult;
  • Causality is tricky. As Shiller says, one challenge is in “distinguishing between narratives that are associated with economic behavior just because they are reporting on the behavior, and narratives that create changes in economic behavior.”

Nevertheless, the challenges make the field more interesting. I am particularly interested in predicting which narratives will gain momentum. Perhaps the narrative machine will serve, to some extend, as a crystal ball that offers a narrow glimpse into the future.

Life Is The Ultimate Imitation Game (René Girard reading notes 1)

Man differs from the other animals in his greater aptitude for imitation.

Aristotle, Poetics, 4

This article is inspired by “Things Hidden Since the Foundation of the World” by René Girard – Book I: Fundamental Anthropology, Chapter 1: The Victimage Mechanism as the Basis of Religion. All Girard quotes below are from this chapter unless otherwise specified.

Imitation is A (The) Portal Onto the Past, Present & Future

Mind-blowing.

If I could only describe René Girard’s model of the world in one word, “mind-blowing” is my pick, and even that may be an understatement.

I first heard about Girard in an interview with Peter Thiel, where he spoke highly of Girard’s Mimetic Theory on the role of imitation:

It’s a portal onto the past, onto human origins, our history.

It’s a portal onto the present and the interpersonal dynamics of psychology.

It’s a portal onto the future in terms of whether or not we’re going to let these mimetic desires run amok and lead us to apocalyptic violence.

Peter Thiel commenting on Girard’s Mimetic Theory, The Portal podcast

Understanding imitation is a portal – perhaps THE portal – to understanding the one big question in the “science of man”:

[T]he precise domain in which the question of man will be asked…is that of the origin and genesis of signifying systems…it is the problem of what is called the process of hominization.

René Girard

Let us dissect the question of hominization from multiple angles below:

The Evolutionary Biologist: Survival is the “Who-Creates-More-Imitations” Game

Let us go back in time and look at the rules of the game that govern the evolution of species.

In a highly entertaining book on evolutionary biology, “The Ape that Understood the Universe: How the Mind and Culture Evolve” (with its entertaining feature evident from the entertaining title), Prof. Steve gives a concise summary of key ideas behind gene selection:

Genes are selected to the extent that they propagate themselves in the gene pool. Often, they do this by helping their owners to survive and reproduce, or by helping their owners’ kin to survive and reproduce.

…adaptations are designed to pass on the genes giving rise to them. And human beings, along with all other organisms, are gene machines.

Steve Stewart Williams, “The Ape that Understood the Universe: How the Mind and Culture Evolve

The highest & sole purpose of existence of a gene is to propagate copies of itself – to create imitations. Interestingly, in the case of humans (& many other species that mate to reproduce), the reproductive process creates genes (children) that are close imitations of either parent, instead of exact replicas. It is an imitation, not a 100% copy, in the truest sense of the word.

More interestingly, at the start of time, cells reproduced without mating and simply replicated an exact copy of itself – 100% original, 0% room for experimentation. However, this copy-and-paste approach – while efficient (saves time of finding a mate) – is detrimental to the propagation of the original gene in the long run. In other words, 100% cloning limits the ability to create more imitations (replicas) as time goes on:

…while clonal reproduction helped bacteria pass on beneficial mutations, it also left some entire colonies at risk when dangers such as bacteria-infecting viruses arose, because the cloned bacteria possessed too many of the same inadequacies in their defense mechanisms. Sexual reproduction changed that in a big way.

…Organisms that reproduced sexually had more genetic losers that their clonal forebears, but they also had a far greater possibility of evolving genetic winners.

Jamie Metzl, “Hacking Darwin: Genetic Engineering and the Future of Humanity

Being too predictable in the Survival Game (reproducing via clones that are 100% replicas) makes a species hack-able – what kills one in your species could, in theory, wipe out the entire species. Predictability kills at times. The hack to that is to create imitations – close enough but not entirely the same. The cost of hack is the reproductive process is more time-consuming. Nature is fair with trade-offs.

The Philosopher: Identity is the “Who-Should-I-Imitate” Game

“What is my identity” is a trendy way of phrasing the questions:

  • Who am I?
  • Who do I want to be?
  • Who do I see myself becoming?

Identity is not just a static question of who I am at present – identity creates the drive to change, to move dynamically towards an ideal persona we see ourselves becoming. The process of finding our “identity” is the process of finding what type of person we want to imitate. The act of staying true to our identity is the act of not deviation from the imitation game we are playing to mimic the perfect, model persona in our minds.

When we say we “identify with” someone or something, we mean we see the similarities – we see the other side as imitations of ourselves, and we want to imitate them in return.

Identity politics is the product of us carving out individuals or groups that we see more closely resembles ourselves. And on that note, let’s turn to the politician’s point of view.

The Politician: Campaigning is the “Freedom-To-Imitate” Game

When a gay couple fight for their right to marriage, they are effectively saying is: I don’t want to be forced to imitate the conventional marriage structure of others.

When some people oppose gay marriage, they are effectively saying is: You should imitate us – our way of living, our understanding of marriage.

When politicians promise on a campaign to protect the rights of homosexuals, what they are effectively saying is: I will let you freely choose who or what behavior you want to imitate.

Almost all political campaign messages boil down to this promise: I will give you what you want. Let’s translate that into: I will let you choose who or what you want to imitate, or you let others imitate. Or perhaps we can call this type of freedom of choice: “freedom to imitate”.

The Economist: Decision-Making is the “Mind Imitation” Game

Speaking of choice, the economists will definitely not miss out on the chance to have a say on decision-making.

In the Prisoner’s Dilemma, the two equilibrium outcomes have one thing in common: both prisoners imitate each other, i.e., they arrive at the same decision to either remain silent or frame the other person. This symmetry is a delicate balance.

In Game Theory and decision-making in daily life, we frequently decide based on what we think other people are thinking. We can think of it as a “mind imitation” game – trying to mimic the thought process of the other party. Thinking out of the box is when your mind is hard for others to imitate – hence you surprise them. The “box” is the set containing all the copies of your mind the other imitators have drawn up.

This quote aptly describes the “mind imitation” game:

I am not what I think I am, and I am not what you think I am.

I am what I think you think I am.

Charles Horton Cooley

The Engineer: AI is the “Create-The-Best-Imitation” Game

Since we started with a look at the evolutionary history of species, let us conclude with a look at an exciting topic that could shape the future of mankind: Artificial Intelligence (AI).

The very definition of the phrase AI already reveals that imitation sits at its core:

Definition of artificial intelligence

1. a branch of computer science dealing with the simulation of intelligent behavior in computers

2. the capability of a machine to imitate intelligent human behavior

Merriam-Webster Dictionary

When literature & media discuss (or predict) potential dangers of AI, they most often point to the possibility of AI breaking free of the imitation game it is wired to play – instead of imitating human beings, AI achieves a level of transcendental intelligence that we human beings are incapable of imitating (or controlling) in return.

This paragraph below captures the fear of this type of danger:

Let an ultra-intelligent machine be defined as a machine that can far surpass all the intellectual activities of any man however clever…and the intelligence of man would be left far behind.

Thus the first ultra-intelligent machine is the last invention that man need ever make, provided that the machine is docile enough to tell us how to keep it under control.”

I. J. Good, “Speculations Concerning the First Ultra-intelligent Machine

Life is The Ultimate Imitation Game

We are all “game theorists” – playing the Ultimate Imitation Game of Life. To borrow (& tweak) the words of Shakespeare: to imitate or not to imitate, that is the question. Every decision we make in everything we do is boiled down to whether we imitate, who we imitate, and what we want others to imitate about us.

If life were a grand game of chess, then we are all studying & imitating the moves of other players, while being imitated in return. Each “genius” move is born to be unique, unparalleled & unprecedented, while at the same time born out of imitation.

The winner emerges out of imitating the winning; the loser falls out of being out-imitated. Contrary to conventional belief, victory belongs to the best imitator, not the best creator – as there is no such thing as creation without imitation.

So imitate wisely and take on the game of life victoriously. But when you win, know that the victory is yours but not yours alone – it belongs to the collection of countless imitations that have happened before your time, happening at your time, and will continue to happen in the time to come.