Soros and Economic Analysis

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KYKLOS, Vol. 50 - 1997 - Fasc. 4,561-574

On George Soros and Economic Analysis

Rod Cross and Douglas Strachan*

‘Economic theory needs to be fundam entally recon-

sidered. There is an element o uncertainty in economic

pro cess es that has been largely left unaccounted fo r.

None of the social sciences can b e expected to yield firm

results comparable to the natural sciences, and eco-

nomics is no exception. W e must take a radically dif er en t

view of the role that thinking pl ay s in shaping events’

George Soros (1995, p . 67)

There is more than a touch of Renaissance Man about George Soros. Whilst

completing an undergraduate degree in economics at LSE he came under theinfluence of Karl Popper. After a spell working as an analyst specialising in

arbitrage opportunities between US and European financial markets, he pro-

duced a Popperian treatise on philosophy, ‘The Burden of Consciousness’

( 1 96 I /2). The Quantum Fund operated by Soros came to be possibly the most

prominent investment fund on the world stage. Operating on the basis of

leverage, the Quantum Fund earned an average annual yield of 35%, if profitshad been reinvested, over the twenty-five years from 1969 (Soros 1995). Soros

himself became a major media figure in Europe after the Fund made $1 billion

from taking a short position on sterling before the exit of the C sterling from theERM on 15 September 1992. Not content with just making money, Soros

regarded the operations of the Quantum Fund as a series of tests for his theories

of how the players in financial markets interact with the economic systems in

* University of Strathclyde and ICMM. Correspondence: Department of Economics, University of

Strathclyde, Curran Building, 100Cathedral Street, Glasgow G4 OLN, Scotland, UK, Tel: 0141-

548-3855/3856/3840, Fax: 0141 -552-5589, E-M ail: economics@ strath.ac.uk.

56 1



ROD CROSS AND DOUGLAS STRACHAN

which they participate, publishing the results of his ‘real-time’ exp erim ents in

The Alchemy of Finance (1987, 1994). In recent years So ros has become o ne

of the wo rld’s leading philanthropists by w ay of the funds provided by the Soro s

Foundation to pro mote reconstruction in his native Hun gary and elsew here in

Central and Eastern Europ e (see Soros 1995 and Slater 1996 for autobiographi-

cal and biographical details).

I. WHY SOROS‘?

Th e focus in the present essay is on the Soros view of economic analysis . This

is interesting for several reasons. Practitioners often upbraid ec ono mic theorists

with the jibe , ‘if you ’re so smart, why aren’t you so rich‘?’.Soros, despite some

spectacular losses, has managed to sustain high returns on his investment

strategies over too many years fo r the possibility that he w as jus t plain lucky to

loom large. Thus there is a prima ,facie case for taking seriously the Soros

account of how economic actors interact with the economic systems in which

they participate. Here there is maybe a parallel with John Maynard Keynes,

whose investment strategies, albeit on a much smaller scale, were, a few

disasters apart, successful en oug h to convince practitioners that his economic

analysis was worth taking seriously.

It is also intriguing that Soro s was not only traine d in econ om ic analy sis but

has also published, d uring his working life as an inv estm ent practitioner, a major

treatise on economic analysis (Soros 1987, 1994). Although his formal eco-

nomics education took pla ce in the early 195Os,So ros has clearly kept up with

dev elop me nts in area s such a5 the theory of efficient markets. Practitioners often

dismiss eco nom ic ana lysis as being ‘okay in theory bu t not in practice’ without

bothering to articulate a theory that would be ‘oka y in both theory an d practice’.

Soros has done both.

Finally, Soros is unusual in having a sophisticated understanding of the

philosophy of science. M any criticisms of e con om ic theory a re based on false

epistemological premises. A popular one is that economic theories are fun-

damentally flaw ed because they hav e not been, and could not be, dem ons trated

to be true. Exposed to Pop per e arly on, So ros understands that no theory can be

demonstrated to be true, be it in the p hysic al, natural o r social sciences. Instead

theories can only be assessed indirectly vi a attem pts to falsify th em . Th us the

Soros assessment of standard econo mic analysis avo ids false epistemological

premises a nd raises issues that are possibly valid.

A telling criticism of some alternative schools of thought in economics is

that they are more ‘attitudes of mind’ than fecund in the sense of producing

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ON GEORGE SOROS AND ECONOM IC ANALYSIS

substantive b od ies of analysis. In the rest of this essay we w ill argu e that So ros,

suitably reconstructed, is imm une fro m this criticism.

11. THE SOROS CRITIQUE

The starting point for Soros is the fallibility of knowledge about the external

world. As Popper pointed out, the logic of modus ponens cannot be applied to

scientific hypotheses, which leaves the logic of modus tollens. Th us scientific

hypotheses are conjectures that can be dem onstrated to be false, but ca nno t be

demonstrated to he true. Th e fallibility of hum an know ledge about the external

world provides the corne rstone for the Soro s philosophy of life:

‘ ._ .we cannot live without a set of reasoned beliefs ... the question is, can we have a set of

beliefs based on the recogn ition that our beliefs are inherently flawed? ... believe we can and,

in my own life, I have been guided by my own fallibility’ (Soros 1995,p. 212).

According to Soros, the central problem w ith standard econ om ic theory is that

it assu me s that econ om ic age nts hav e perfect, in the non-reflexive sense to be

defin ed later, knowledge about their econo mic world. This is inconsistent w ith

the inherently fallible nature of human knowledge, and hence standard eco-

nom ic theory is based on false premises abou t what it is possible fo r eco nom ic

agents to know.

The Soros alternative account of the behaviour of economic agents was

deriv ed from his analysis of the logical problem of self-reference. T his can be

illustrated by the liar’s paradox. Co nside r the claim: ‘all short statem ents in

economics are false’. If this claim is true i t must also be false, because of the

self-reference to the present economics essay. This type of self-referential

problem provided the background to the Soros articulation of why knowledge

of economic and social systems is different to that of physical systems. The

problem is that the agents who are trying to acquire know ledge of econo mic

and social systems are themselves participants whose behaviour affects the

eco nom ic or social environment they are trying to understand. T his gives rise

to the Soro s notion of reflexivity in econo mic behaviour:

‘ ...on the o ne hand , reality is reflected in people’s thinking - call this the cognitive func tion;

on the other hand reality i a affected by people‘s decisions - call this the participating fun ction

-the se events have a different structure from the events studied by natural acience - hey need

to he thought about differently ... call these events reflexive’ (Soros 1995,p. 214).

A basic problem with this argum ent is that observations in the natural sciences

are also theory dependent: observations of, say, su b-ato m ic particles are gener-

563




ated by theories speculating that such particles exist. Th e Soros response is that

theories in economics can change the behaviour of the reality observed in a

sense that, say, Heisenberg’s uncertainty principle does not change the behav-

iour of quantum phenomena.

Thus emerges a trichotomy between true, false and reflexive statements.

Economics can generate true statements, but only in the context of purely

axiomatic models. Economic propositions about empirical phenomena can be

expressed as the implications of hypothetico-deductive models, as with the

Popper characterisation. Such propositions are refutable, but, according to

Soros, they are inconsistent with the evidence. The problem is to model how

thinking and participating agents interact with historical events. If economic

agents cannot do o ther than act on the basis of reflexive beliefs or statements

about the world, the truth value of such statemen ts is inherently uncertain. A nd

so, therefore, is economic knowledge.

At first pass this position appears nihilistic a bout the possibility of economic

knowledge. Non-reflexive economic theories are going to be falsified in situ-

ations where reflexivity ‘plays an important role’. This is taken to be the case

in financial markets:

‘ ... the theory of rational expectations and efficient markets is highly misleading ...I believe

that the performance of the Quantum Fund alone falsifies the random walk theory’ (Soros 1995,p. 219).

This leaves reflexive statements, which can be considered as similar to the

incantations involved in alchemy:

‘ ... he alchemists made a big mistake trying to turn base metals into gold by incantation ...with

chemical elements alchemy doesn’t work ... but it does work in the financial markets, because

incantations can influence the decisions of the people who shape the course of events’ (Soros

1995, p. 221).

Thus neo-classical economists, rather than drawing their metaphors about the

workings of economic systems from Newtonian mechanics (see Mirowski

1989),would hav e foun d more appropriate m etaphors from Newton’s writings

on alchemy. Hence the title of the major Soros treatise on economics, The

Alchemy of Finance (1987, 1994).

The apparent nihilism of The Alchemy o j Finance, however, is partly

dispelled by the subsequent clarification in Soros (1995).Here the distinction

drawn between near-equilibrium and far-from-equilibrium conditions is given

greater significance. In near-equilibrium conditions, which might be con-

sidered to be ‘the normal situation’,

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O N GEORGE SOROS AND ECONOMIC ANALYSIS

‘ ... the discrepancy between thinking and reality is not very large and there are forces at play

that tend to bring them close together, partly because people can learn from experience, and

partly because people can actually change and shape socialconditions according to their desires’(Soros 1995,p. 69).

In such situations economic theories that ignore reflexivity might not be toowide of the mark. In far-from-equilibrium onditions, however, which might

be thought of as circumstances in which major changes in the economic

environment take place,

‘ _..he prevailing bias and the prevailing trend reinforce each other until the gap between them

becomes so wide that it brings a catastrophic collapse’ (Soros 1995,p. 70).

An example of a bias that can generate far-from-equilibrium conditions is

provided by errors in valuation.So, in the international lending boom beginning

in the late 1970s,for example, banks judged the borrowing capacity of debtor

countries by looking at debt-GDP or debt service-export ratios. The problem is

that such ratios are reflexive, in that they reflect the lending activities of the

participant banks as well as any ‘fundamentals’ affecting borrowing capacity.

Thus trends of increased lending were established on the basis of reflexive

valuations. Eventually the gap between beliefs about borrowing capacity and

the reality of actual borrowing capacity became so large that the bias underlying

the beliefs came to be realised, and lending collapsed.

Thus reflexivity in economic behaviour is capable of bringing about far-

from-equilibrium situations and regime changes. This, far from being nihilistic,

is an intriguing account of endogenously-generated regime changes. In terms

of economic analysis the suggestion is that the behaviour of economic agents

using rules of thumb such as valuation ratios, and of economic modellers

themselves, need to be introduced into economic models in order to capture the

interaction between thinking and reality. The way forward, then, is to eschew

the reductionist search for finer-grain microfoundations and instead study how

complex economic systems can emerge from the interactions between agents

operating both as thinkers and actors (Soros 199.5,p. 220).

111. RATIONAL EXPECTATIONS AND EFFICIENT MARKETS

From the foregoing discussion it is clear that Soros views the postulates ofrational expectations and market efficiency that have dominated the economics

literature on financial markets in recent years as implausible descriptions of

behaviour.

56.5




The rat ional expectat ions hypothesis has two components: each agent

maximises an objective function subject to some perceived constraints; and

the constraints perceived by the agents in the syste m are mutually con sistent.

Thus

‘ ._.he decisions of one person form parts of the constraints upon others, so that consistency,

at least implicitly, requires people to he kxming beliefs ahout others’ decisions, about their

decision processes, and even about their beliefs’ (Sargent 1993,p. 6).

If agents were not behaving in such a way there would be unexploited oppor-

tunities for profit, which would be inconsistent with the neo-classical con cep -

tion of market equilibrium. Rational expectations in this sense are clearly

inconsistent with the S oros first principle that hum an k now ledg e is fallible. If

the rational expectations hypothesis were true, agents would be able to know

the equilibrium probability distributions for the eve nts abo ut which they fo rm

expectations. Economists themselves do not know what such probability dis-

tributions are, and are obliged to use econometric techniques to attempt to

estimate probability distributions and ‘laws’ of motion. Such inferences are

inevitably fragile and fallible, as is apparent from the disagreements amongst

econo mists and econometricians. Th us th e rational expec tations hypo thesis is

implausible both because i t attributes know ledge to econ omic a gents that even

economists and eco nom etrician s do not have , and in that it igno res the inevitably

fallible and conjectural nature of any body of scientific knowledge.

The implication of efficient markets drawn from the rational expectations

hypothesis is also inconsistent with the S oro s view. In its weuk form th e efficient

markets hypothesis say s that market prices reflect any ‘laws’ of motion evident

in prices, so that any correlation between the present price and past prices is

eliminated; in semi-strong form the hypothesis says that market prices also

reflect any publicly available information about the processes determining

market prices; in strong form the hypothesis has mark et prices retlecting or

discoun ting insider information as well (se e Shiller 1996). n a world of efficient

markets, changes in market prices should be random in the sense of being

uncorrelated with past prices and publicly or privately available information.

This would leave no room for the investment strategies pursued by Soros and

the Q uantum Fund to be consistently more successful than the rest of the market.

T he Qua ntum Fund cou ld have been amazingly lucky, but it is more plausible

to agree with S oros that

‘ ... the performance ofthe Quantum Fund alone falsifies the random walk theory’ ~S or os 995.

p. 2 19).

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ON GEORGE SOROS AND ECONOM IC ANALYSIS

IV. KEYNES AND SOROS

In rejecting the idea that the uncertainties su rroun ding econo mic behav iour canbe tamed by assum ing that agents have perfect knowledg e of some objective

equilibrium probability distributions, Soros is in the same camp as John

Ma ynard Keynes. Th e untractable nature of the uncertainty surrounding eco-

nom ic decision-taking was stressed in the General Theory (Keyn es 1936, ch. 12)

and in Keynes’ response to his reviewers (Keynes 1937):

‘ .,. the outstanding fact is the extreme precariousness of the hasis of knowledge on which our

estimates of prospec tive yield have to be made . . _ou r nowle dge of the factors which will gov ern

the yield of an investm ent some years hence is usually very slight and often negligible ... if we

speak frankly, we have to admit that our basis of knowledge for estimating the yield ten years

hence of a railway, a copper mine, a textile factory, the goodwill of apatent medicine, an Atlantic

liner, a building in the City of London amounts to little and sometimes to nothing ... in fact,

those who seriously attempt to make any such estimate are often so much in the minority that

their behaviour doe s not govern the ma rket’ (Keynes 1936, pp. 149-150).

Ke yne s then proceeds to point out that the existe nce of securities markets mea ns

that the underlying physical investments

‘ .. _ re governed by the average expectation of those who deal in the Stoc k Exchange as revealed

in the price of shares, rather than by the genuine exp ectations of the professional entrepreneur’(1936, p. 151).

How , then, are the expectations of those dealing in securities d etermined ?

He re there are several similarities between Soro s and K eynes. A first is that,

in both So ros and Keynes, investors follow conv entions or rules of thu mb . In

So ros this is the trend-following behaviour pursued by investors, particularly

prevalent in funds whose performance is measured relative to the rest of the

market, rather than in absolute terms. The expectation implicit in such an

inve stme nt strategy is that the present trend will continue. In K eyn es the trendis called a convention, wh ose essential featu re is the assumption

‘ ... hat the existing state of affairs will continue indefinitely’ (193 6, p. 152).

Such conventions can survive in what Soros would call near-equilibrium

cond itions, and a re comp atible with

‘ ... a considerable measure of continuity and stability in our affairs’ (Keynes 1936, p. 1 52).

Such co nvention s, however, as in Soros, rely o n expectations for which there

is no secu re epistemological foundation:

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RO D CROSS AN D DOUGLAS STRACHAN

‘ ...we are assuming, in effect, that the existing market valuation, however arrived at, is uniquely

correct in relation to our existing knowledge of the facts which will influence the yield of the

investment, and that it will only change in proportion to changes in this knowledge; though,philosophically speaking, it cannot he uniquely correct, since our existing knowledge does not

provide a sufficient basis for a mathematical calculation’ (Keynes 1937, p. 152).

A second area of similarity conc erns what happens in what So ros calls far-from -

equilibrium conditions. In such circum stances trends are broken, and conv en-

tions regarding the correctness of existing market valuations are no longer

tenable. In Keynes such circumstances arise inevitably in systems where

valuations are established as

‘the outcome of the mass psychology of a large number of ignorant individuals’

because there are

‘ .. _no strong roots of conviction to hold it steady’

Keynes’ ‘abnormal times’ correspond to Soros’ ‘far-from-equilibrium condi-

tions’ in which perceptions and reality a re far from being syn chro nised . Fo r

Keynes such chan ges occur

‘ ,.. when the hypothesis of an indefinite continuance of the existing state of affairs is lessplausible than usual even though there are no express grounds to anticipate a definite change’.

Th e implication is that

‘ ... the market will be subject to waves of optimistic and pessimistic sentiment, which are

unreasoning and yet in a sense legitimate where no solid hasis exists for a reasonable calcula-

tion’ (Keynes 1936,p. 154).

A third are a where Soros an d K eynes a re close is in relation to reflexivity. In

Soros the theories which econo mic ag ents use to attempt to understand theirenvironment also change the environm ent when used as a basis fo r decision-

taking. In Keynes this sort of self-referential beh avio ur arises beca use investors

are inevitably invo lved in a gam e requiring each participant to gues s what the

basis of conventional valuation will be in the future. The con ven tiona l valuation

that emerges will depe nd o n a particular participant’s ow n gu ess about wha t

other participants will be guessing, who in turn will be guessing about the

particular particip ant’s guess. Thu s the m arke t valuation will be reflexive. T his

is the basis for Key nes’ striking beauty contest metaphor:

‘professional investment may be likened to those newspaper competitions i n which the

competitors have to pick out the six prettiest faces from a hundred photographs, the prize being

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ON GEORGE SOROS A N D ECONOMIC ANALYSIS

awarded to the competitor whose choice most nearly corresponds to the average preferences of

the competitors as a whole; so that each competitor has to pick, not those faces which he himself

finds prettiest, hut those which he thinks likeliest to catch the fancyof

the other competitors,all of whom are looking at the problem from the same point of view ... t is not a case ofchoosing

those which, to the best ofone’s judgement, are really the prettiest, noreven those which average

opinion genuinely thinks the prettiest ...we have reached the third degree where we devote ou r

intelligence’s to anticipating what average opinion expects the average opinion to be ... and

there are some, I believe, who practice the fourth, fifth and higher degrees’ (Keynes 1936,

p. 156).

V . HOW TO DO ECONOMIC ANALYSIS

Keynes’ remarks about the untractable uncertainty surrounding at least some

econo mic de cisions led som e of his fo llowers to a form of analytical nihilism:

‘... since certainty is not attainable, neither is knowledge ...’ (Coddington 1983, p. 58)

Keynes, howev er, did construct framew orks with which to analyse economic

systems, and

‘...even the most cursory acquaintance with the facts of his life shows that he was not reduced

to the state of puzzled indecision that a wholehearted adoption of ... unattainable standards for

beliefs to qualify as knowledge ...would entail’ (Coddington 1983, pp. 58-59).

The Soros point of dep arture is the fallible, conjectural n ature of any fo rm of

scientific k nowledge, so unattainable standards for knowledge are not used as

yardsticks. Instead, for So ros the key distinction is that econ om ic kno wle dge is

necessarily reflexive, with economic agents being both thinkers and actors in

relation to their economic environment. This then raises the question of the

appropriate form for economic analysis to take in such circumstances. The

follow ing aven ues of inquiry look promising in this respect.

1. Bounded Rutionulity

An ob viou s first step is to drop the strong rationality as sum ption s em ploy ed in

the rational expectations hypothesis, and use Herbert Simon’s notion of

bounded rationality instead. Rational expectations models focus on outcomes,

not on the behavioural context of decisions, which if the rational expe ctation s

hypothesis w ere true would be characterised not jus t by individual op timisa tion

but also by the mutual consistency of agents’ perceptions about the world.

Boundedly rational models drop this restrictive characterisation and focus

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ROD CROSS AND DO UGLAS STRACHAN

instead on the heuristic devices agents use as decision rules, and how these

decision rules are updated or revised in the light of exp erience. Th e task of

modelling eco nom ic systems is then o ne of populating mo dels with age nts who

are boundedly rational in the sense that they d o not know what any aggregate

probability distributions or equilibria are. Th us instead of assuming that agents

have worked out how the complex system in which they participate behaves,

the way the system itself beh ave s is constructed from the heuristic dev ices used

by the agents.

This approach is pursued in Sargent (1993). Th e starting point is that

‘.._when implemented numerically or econometrically, rational expectations models impute

more knowledge to the agents within the model (who use the ryrtilibriurn probability distrihu-tions in evaluating their Euler equations) than is possessed by an econometrician, who faces

estimation and inference problems that the agents in the model have somehow solved’ (p. 3).

Instead the boundedly rational m odels

‘... expel rational agents from o u r model environments and replace them with ‘artificially

intelligent’ agents who behave like econometricians ... these ‘econo metrician s’ theorise,

estimate and adapt in attempting to learn about probability distributions which, under rational

expectations, they already know’ (p. 3) .

Taking e cono mic agents to behave like econom etricians migh t appear absurd

until it is realised that

‘... n economics, procedures for revising theories in light of data are typically inform al, diverse

and implicit’ (p, 22).

Thu s the distinction b etween e conom ic agents and economists/econometricians

is blurred a nd the So ros self-referential notion of reflexivity is introduced:

‘... uch a system can contain intriguing self-referential loops, especially from the standpointof macroeconomic advisers, who confront the prospect that they are participants in the system

that they ar e mod elling, at least if they believ e that their advice is likely to be conv incing’ (p, 23).

2 . Complexity

In m any sciences the traditional emp hasis has been on searching for finer grain

explan ations of phenom ena. Thu s in 20th century physics there has been an

emp hasis on attem pting to understand the nature an d structure of sub-atomic

particles. In econo mics, albeit a form of alchemy according to So ros, this trait

has been evident in the insistence on micro foundations for macro models.

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ON GEORGE SOROS AND ECONOMIC ANALYSIS

During the last decade this emphasis has been countered by an increase in

interest in models of complexity, wherein the problem is to work out how

complex systems can be constructed or emerge from basic elements that are

taken as in som e sense irreducible (see Anderson, A rrow and Pines 1988 for

discussion of this approach to economic systems).

Sor os clearly sees this as the way fo r economic analysis to go:

‘... i t is high time to liberate social pheno mena from the straitjacket of natural sc ience, especially

as natural science itself is undergoing a radical change ... analytical science is superseded in

certain fields by the study of complex ity .,. he science of complexity studies open, evolutionary

systems ... all it seeks to do is build models or run simulations ...hut even here I find that the

difference between social and natural phenomena is no t sufficiently recognised ... mostcomputer programm es deal with the evolution of populations ... o study the interaction between

thinking and reality, we need a model of model-builders whose models, in turn, must contain

model-builders ud infinifurn _.. the infinite nesting of models must be brought to closure

some where if the mod els are to serve any practical use ...as a result, the models cannot retlect

reality i n its full complexity’ (Soros 1995,p. 220). ’

Th us although models of complexity are proposed, there is inevitably a deg ree

of arbitrariness surrounding the way such models avoid the infinite regress of

self-reference.

Models of complexity have come to be seen as promising ways to resolve

some of the anomalies surrounding the rational expectations-efficient markets

paradigm regarding financial marke ts. Simp le technical trading rule s of the type

stressed by Keynes and Soros have been shown to out-perform investment

strategies based on the standard paradigm (Brock, Lakonishok and Le Baron

1992, for example). And the standard paradigm implies that no trade should

take place in rational expectations equilibria (Tirole 1982), whereas trading

volumes remain significant even in quiescent financial markets. In models of

complexity these anomalies are resolved by specifying agents who are het-

erogeneous in the sense of using different trading rules. Thus som e traders may

extrapolate trends, others make buck trends thinking that what goes up must

come down, some agents may believe that market prices are determined by

‘fundamental’ economic forces, and yet others may see market prices as

reflecting the weights of the different belief system s of other traders (B rock and

Ho mm es 1996). The heterogeneous agents in such a system are then en dow ed

with a form of artificial intelligence which allows them to ch ange their beliefs

in light of how their initial hunches fare in terms of generating trading profits

(Arthur, Holland, Le B aron, Palmer and Taylor 1994). Thu s trading profits act

as a ‘fitness’ function, and beliefs, and therefore m arket prices, evo lve accord-

ing as to whether particular belief systems allow the traders adopting them to

57 1




survive in the market place. Thus the Soros view of reflexivity in financial

markets is at least partially reflected in this ac tive research area.

3. Heterostusis

Standard ec onom ic analysis assumes that econ om ic systems are homeostatic or

self-adjusting, in the sense that sho cks that mov e econ om ic systems a wa y from

equilibria are follow ed by a return to the initial eq uilibria once the shocks abate

(see Arrow 1988). Th is assumption is broadly consistent w ith the So ros account

of what happens in near-equilibrium con dition s, but not with his acc oun t of

what hap pens in far-from-equilibrium cond itions. In the S oro s exam ples of the

latter conditions (199 4, 1995) it is reasonably clea r that the reflexive processes

brought into play in far-from-equilibrium conditions cha nge eco nom ic equi-

libria rather than being accompanied by a return to the status quo ante once the

shocks abate.

The heterostasis involved in the alternative postulate that out-of-equilibrium

behaviour can c han ge the equilibrium attractor, how eve r, ha s been recognised

by som e o fth e leading proponents of econom ic analysis. Marshall, for exam ple,

recognised that temporary shocks to dem and or supply could be accompanied

by c hange s in demand or supply cond itions that would rema in once the shocks

abated, so changing market equil ibria (Marshall 1890, pp. 4 2 5 4 2 6 ) . And

Keynes answered his own question

‘are economics systems self-adjusting?’

in the negative (Keynes 1934).

One way of capturing the way economic equilibria are shaped by out-of-

equilibrium conditions is to allow for self-organising behaviour (Rak, Chen,

Scheinkman and W oodford 1993, for example) . Another approach is to allow

economic systems to be hysteretic. Hysteresis models are populated by hete-

rogeneous agents with heterogeneous beliefs who respond discontinuously or

in a non-linear m anner to sho cks. Th e outcom e is that econ om ic systems display

remanence, in that they do not return to the stutus quo ante if a sho ck is applied

and then removed. This means that each new extremum value of the shock

variable creates a new eq uilibriu m, and that econ om ic equilibria ev olve accord-

ing to the sequ ence of non-dominated extremu m values of the shock s experi-

enced (see Cross 1993, 1995 and Amab le, Henry, Lordon and Top ol 1995). It

does not require too great a leap of the imagination to connect this notion of

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ON GEORGE SOR OS AND ECONOMIC ANALYSIS

hysteretic or heterostatic equilibria with the Soros account of the power of

reflexivity in far-from-equilibrium conditions.

VI. SOME CONCLUDING REMARKS

A not uncommon criticism of economic theories is that they are out of touch

with practice, by wh ich is presumably meant reality. Geo rge Soros, unlike many

of the other critics, has made a constructive contribution by articulating a

method of analysis which could put economic theory into closer contact with

reality. In this essay we have argued that, although approaching the issues from

a Popperian background, the Soros approach is resonant with Keynes oneconom ic behaviou r in the face of uncertainty. Thi s line of thought is sometimes

depicted as being nihilistic about the possibility of economic knowledge. We

have argued, on the contrary, that foundations of the Keynes-Soros type are

analytically fecund, as can be seen in recent work on bounded rationality,

com plex econ om ic systems and heterostatic equilibria selected by self-organi-

sation or hysteresis.

RFFERENCbS

Amable, B., J. Henry, F. Lordon and R. Topol (1995). Hysteresis Revisited: a Methodological

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S U M M A R Y

This essay considers the Soros critique of the epistemological and analytical foundations underlying

theories of rational expectations equilibria and efficient m arkets. Sim ilarities between S oros and

Keynes are found. It is pointed ou t that Soroa is guarded rather than nihilistic about the possibilities

of economic knowledge, and developments in econ om ic analysis that resonate with the Soros view

are discussed.

LIJSAMMENFASSIING

Dieser Aut’ssatz unterwirft die Kritik von Soroa an den epistomologischen und analytischen

Grundlagen, die den Theorien der rationalen E rwartungen und effizienter M iirkte zugrunde liegen,

einer nlheren Betrachtung. Dahei werden Ahnlichkeiteo rwischen Soros und Keynes deutlich. Es

kann gezeigt werden, dass Soros den Anwendungsmijglichkeiten okonomischen Wissens nicht

nihilistisch gegenuhersteht, sondern sich von ihnen leiten Iiisst. Dariiber hinaus werdcn Entwick-

lungen der okonomischen Analyse diakutiert, die mit der Meinu ng von Soros ubereinstimmen.

Cet essai considkre la critique Sorosienne des bases CpistLmologiques et analytiques des thCories

des Cquilibres des prkvisio ns rationne lles et des rnarchCs efficients. Des similitudes entre Soros et

Ke ynes sont dCcelCes. II s’avkre qu e Soro s est circonspect plut8t que nih iliste quant aux possihilitCs

de laco nnai ssanc e Lconomique. De s dkveloppements dans I’analyse Cconomique compatibles avec

I’optique de Soros sont disc uds .

574

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Soros and Economic Analysis