Synthetic Markets

and the Design of

Economic Institutions

Juan Pablo Pardo-GuerraLondon School of Economics June 2014

Markets envelop ……….

every aspect of our lives

………they constitute the

fabric of modernity

But markets are also at

the crux of most social

problems

How can we domesticate markets

for the 21st

century?

A provocation, to move from the

metaphors of physics and biology

to those of engineering life

Steps

1. Beyond ‘the natural’

2. Engineering nature

3. Three consequences

1. Beyond

‘the natural’

1. Natural markets?

To the question of where markets come from, we are told:

“[Economic organization and industry] from which so many advantages are derived, is not originally the effect of any human wisdom, which foresees and intends that general opulence to which it gives occasion. It is the necessary, though very slow and gradual consequence of a certain propensity in human nature which has in view no such extensive utility; the propensity to truck, barter, and exchange one thing for another.”

1. Where do markets come from?

• Conventional account of the origin of markets (e.g. Hayek):

– Asymmetries in production/consumption emerge naturally, providing conditions for barter;

– Unstructured, ad-hoc barter leads to regular trade

– As trade evolves and consolidates, a market emerges (Barter >> Trade >>Market)

– Ontologically, markets are natural emergent phenomena, they are ‘natural’ kinds

Gomez and Boesch, 2009. “Wild chimpanzees exchange meat for sex on a long term basis”, PLoS

1. The domestication of what?

• Of course, markets don’t just ‘happen’:– They require, for instance, rules and social

institutions (c.f. Polanyi)

– They reflect social structures (e.g. culture, interactions c.f. Baker, Zelizer, etc.)

– They are enacted in history (c.f. Agnew)

– They require things (c.f. Callon)

• Markets are fabricated, they are artificial kinds

1. Let’s take economists at face value

If markets are ‘natural’, what can we do?

• Option 1: Study them, to then intervene; as we do with other natural kinds (e.g. plants, climate). – Respects the ‘purity’ of natural kinds (e.g. monetary

systems obey a particular ‘logic’ that is internal to money)

• Option 2: Re-design. Re-engineer. Re-fashion. – Nature has never been natural. Everything is an

artificial kind. Laws are made, not discovered.

1. Thinking like an engineer

• If markets are fabricated, why not make them according to some principles?

• Design according to fundamental building blocks.

• Alvin Roth (+Paul Milgrom):

– Nobel prize-winning economist;

– One of the key figures in market design;

– Market design emphasizes the metaphor of the economist as an engineer.

– But engineering based on physics….

1. Meet market/auction design

‘Consider the design of suspension bridges. The simple theoretical model in which the only force is gravity, and beams are perfectly rigid, is elegant and general [cf. neoclassical economics]. But bridge design also concerns metallurgy and soil mechanics, and the sideways forces of water and wind. My questions concerning these complications can’t be answered analytically, but must be explored using physical or computational models […] Engineering is often less elegant than the simple underlying physics, but it allows bridges designed on the same basic model to be built longer and stronger over time, as the complexities and how to deal with them became better understood’.

2. Engineering

nature

2. Engineering nature

• Engineering metaphors abound, e.g. in synthetic biology

• One radical interpretation of synbio refers to the re-engineering of life itself

• Can we deconstruct natural kinds into their key components and, on the basis of such modularization, create new forms of previously impossible life (e.g. XNA)?

• Nature as an artificial kind

Synthetic biology should give

“undergraduates and high school students, without prior training in biology or laboratory engineering, [the ability to] design synthetic biological systems of their own invention comprised of several dozen pre-existing standard biological parts, order and receive the DNA encoding the system, and show it to work.”

(Endy 2005)

2. Divergent epistemologies

• Synbio is democratic: a developer in every garage / DIY-bio

• Market design is technocratic: economists as design experts / auction design

• Can we democratize markets by learning from synbio?

2. Modularized markets

• Synbio is predicated on the idea of modularization: what are the ‘parts’ of natural entities?

• Is there an equivalent for markets?

• Arguably, yes…

• Philip Mirowski:

– Economist;

– Historian of economic thought;

– Criticizes the idea that economics ought to be like physics (i.e. model-based and universalizing);

– Advocates a evolutionary computational approach to the study of the economy;

– Defines the market as a ‘formal automaton’

2. What are the components of the market?

• Automaton:

– Self-operating machine

– Driven by a set of inputs that define possible outputs

– e.g. Turing machine, the theoretical generalization of any computer (a Turing machine can simulate any computer)

2 What are the components of the market?

• Markets are specialized pieces of software that perform these functions:– Data dissemination and communication;– Rules of execution– Order routing– Order queuing and execution– Price discovery and assignment– Custody and delivery– Clearing and settlement, with re-allocation of

property rights– Record-keeping

2 What are the components of the market?

The metaphor of markets as software is, indeed, consistent with market design:

“a great deal of market design is going to be done by computer programmers.”

(Roth 2002)

FINANCIAL TIMESMONDAY MARCH 19 2007

COMPANIES INTERNATIONAL

‘Millisecond’ trading arrivesEXCHANGES

By Anuj Gangahar in New York

Some of the largest participants in

US capital markets are to start using

a new system that dramatically cuts

the time it takes to trade and

communicate with each other, as

they respond to the greater demand

for speed from hedge funds and

other traders.

It will reduce transaction times to

just 1 millisecond from about 10

milliseconds at present, in the New

York metropolitan area.

Hedge funds and other traders who

employ complex strategies, are

putting ever greater emphasis on the

speed at which they do business, as

competition to eke out the best

returns intensifies.

The system, known as Radianz

Ultra Access, offered by BT

region.

Institutions that have signed up to

use the system already include the

NYSE Group, Nasdaq, Boston

Options Exchange, BATS electronic

communications network, and the

International Securities Exchange,

among others.

The uptake of the new system

comes just weeks after the

introduction of Regulation National

Market System, a controversial set

of rules aimed at levelling the

competitive field in the US equity

market, meaning trades must be

routed to the exchange that offers

the best price.

During the recent market sell-off, a

week before the introduction of Reg

NMS, a spike in trading volumes

caused some systems and servers to

go down, leading to widespread

concerns about technology

BT Radianz developed the new

system in response to the growing

use of algorithmic and black-box

trading strategies by broker-dealers,

asset managers, prime brokers and

hedge funds. Tom Price, senior

analyst in the securities and capital

markets practice at the Tower Group

consultancy, said: “Speed is a

competitive differentiator for market

participants using advanced trading

strategies. The ability to consume

massive amounts of data, translate it

into opportunity, and get orders to

the appropriate execution venue

ahead of the competition, is key to

success.”

3. Three

consequences

3. Financial, by design

• What happens when we think of designing financial markets?1. Markets as ecologies: beyond equilibrium, and

towards complexity, diversity, linkages and life-cycles. E.g. Non-continuous financial markets.

2. Beyond oppositional logics: generalizing Polanyi: if markets can only exist with states, redesigning markets requires redesigning state institutions. E.g. regulation as cyclical, recognizing organizational logics

3. Expansion of market expertise – against economists. Not only vernacular economics

3. Markets as ecologies

• How are stock markets organized?

– Primarily, through time-price priority

– Order-book dynamics depend on continuous trading

– This makes space relevant, and leads to a arms-race-like incentives for innovation

• But, do markets have to be driven by price-time priority?

3. Markets as ecologies

• No: e.g. auctions (Arizona Stock Exchange)

• (They are also ‘moral’ ecologies)

• Better models of market design may show the advantages of diversification in over

• (see Budish, Cramton and Shim, ‘The high frequency trading arms race’)

3. Markets and states

• Animals die, environments change. Regulators stay the same?

• Should regulators have an expiry date?

• Securities and Exchange Commission:– Created as a New Deal institution

– Organizational logic emphasizes on auditing, disclosure and accountability

– 1934-2012, 40 topic models, only 1 on market structure

3. Markets and states

• 62,000 Comment letters (1995-2014):

– Key preoccupation with market structure

• But the SEC does not ‘see’ market structure

• The question is not ‘is it a wise regulator’ but rather: should it be a regulator at all?

• Institutions as life-forms: they also must come to an end (fitness to the environment?)

3. Democratizing markets

• Are economists ‘the experts’?

• 2010 Flash Crash: no conclusive explanation

• The theoretical toolkit of economics fails to explain the market

• Yet, non-expert HFT programmers and infrastructural workers have a coherent narrative

• Theorizing beyond economics? An open question

Some concluding thoughts

• Changing metaphors as a way of re-engaging with markets

• Three roles for social scientists: – not oppositional (e.g. economic sociology) but

contributory; but showing markets as constructed and drawing alternative designs;

– Not only ‘ontological’ critique but also ontography: emphasis on how markets evolved;

– Innovating markets: how best to involve publics in the construction of markets? (e.g. responsible innovation)