March 1, 2003

We may think economics the most scientific among all social sciences, but at best most economic theories could be described as profound philosophical ideas rather than proper scientific knowledge. The goal of science is to search for laws of nature to understand the workings of our universe. However, most economists do not believe that there are such a thing called "laws of nature" in economics, because human economic behavior is too random to be guided by any law. But like any other biological entity, human beings also need to follow certain rules and laws. Making random decision without following any law comes with great price – war, famine and destruction to the ecosystem. On the other hand in a free and democratic society every economic decision of an individual should not be controlled by the government. But there should be a limit for every economic decision made by individuals and the limit is based on law of nature in economics that contain a permanent solution.

Why is it necessary to find the laws of nature in economics? Assume a modern society where people are not aware of the law of gravitation. In this society a man wants to fly like a bird and jumps from a thirty foots cliff injuring himself. The doctors in the emergency room treats his wounds and send him home, without being able to explain to him the physics of flying.

Economists are like the doctors in that emergency room. Every time the economy injures itself, they try to fix it and they are relatively good at it. But, like the doctors, they do not understand why someone should fall downward if he jumps, at what rate he would fall and what to do to prevent falling. They cannot explain these concepts because they do not understand the law of nature.

Law of nature in economics could be described by permanent economic models that are made of equations of time-invariant variables. Economist Milton Friedman first empirically verified and used a time-invariant variable in his equation: Price x Quantity = V x M2, Friedman showed that the Velocity of Circulation (V) of the Broad Money Supply (M2) is a time-invariant variable. Therefore, while "V" is a law of nature in economics and remain relatively constant over time, the other variables change according to need of the economy.

While we are beginning to understand the cause and effect of our behavior on nature, we have completely failed to recognize that there could be some underlying laws of nature at work in our economic life that need to be consider. For example, it could be suggested that whenever there is a stock market crash or an economic depression, we are violating one or several natural laws of economics.

It is becoming more evident to the economists that modern scientific approach that helped physicists to unveil the secrets of the universe is not adequate to solve and find laws of nature in economics. In this essay I have described a probable law of nature in economics, namely Infinite Spreadsheet, invented by mathematician, physicist and philosopher Dr. Hugh Ching. This invention employs a completely descriptive approach to science to solve the problems of simplistic and static models. It also pointed out the distinctions between physical science and social science.

Today economic theories are rendered by two different extreme approaches. Economist Frank H. Knight in the introduction of his book Risk, Uncertainty, and Profit pointed out these approaches:

After 80 years of the first publication of this book, we still have not seen many economists that have ventured into the path of descriptive science. Instead of trying to establish economics as a separate science with its own traits, economists are more interested in imitating natural science - knowing in economics we can not perform laboratory experiments to produce deterministic solutions of a model. Prime examples are last year’s Noble laureates Daniel Kahneman and Vernon Smith. Kahneman and Smith integrated psychological research into human decision making processes under conditions of uncertainty. However, by doing so both of them seriously undermined the power of human reasoning and portrayed human beings as only an emotional being with no distinction between humans being and other animals.

One may argue that there is nothing wrong with imitating a natural science like physics as long as the validity of an economic model could be tested by rigorous statistical methods (econometrics). Economists are mostly interested on building complex models and eloquent proofs. More often they act like mathematicians without conviction towards their original role as a social reformer. But economic models that try to explain complex social behavior through some mathematical formulas in a controlled experiment (the buzzword is Econophysics) are questionable at very best. Firstly, most of these models use add factors to increase it’s predictive capability. Secondly, a major component of the study of econometrics, time series analysis uses time variant variables (see Ching 2001) to predict future.

However, in an effort to support their position on Experimental Economics economists like Kagal and Roth, devised methodology to compare their laboratory results with natural experiments. But the rationality, outcome and effectiveness of this method is yet to be seen.

Economists such as Edmonds and Moss are talking about shifting our direction from laboratory experiment of economic models to observation and description of the economic agent to understand their behavior. In other words, while constructing a model they reject most of the a priori assumptions and try to understand the underlying process by observing and describing – more like the science of Biology. This technique would probably help us to build a better model, but it is very unlikely that this would yield a perfect relationship between the dependent and independent variables of the model.

From past experience it is observed that long run economic models are unable to keep an exact relationship between the input and the output – because unlike the Physicists, the Economists cannot repeat their experiments to get rid of the error term from their equations and find a universal constant that can be used repeatedly in their model.

We can determine universal constants (time invariant quantities) in physics by past data and repeated experiments, because a physical phenomena takes place in a finite time frame. However, an economic output like price (policy, decision etc.) cannot be determine by using past data, because today’s price depends on future expected resale price, not past. The continuous nature of economic variables (time-variant quantities) does not allow for the formation of a static model. In other words an economic phenomenon is a dynamic process spread over infinite past and future and cannot be quantified through physics-like experiment.

Temporal dependence of the variables in a model is a challenge for economist. Economist Gerard Debrau, in his book The Theory of Value An Axiomatic Analysis of Economic Equilibrium first tried to address this issue. According to Debrau, the price of a commodity is the amount which has to be paid now for the future availability of one unit of that commodity. And a commodity is characterized by its physical properties, the date at which it will be available, and the location at which it will be available [1]. So, the only way to determine the price of a certain commodity, is to disclose all the future dates and locations with certainty.

In order to accomplish this, the question of uncertainty or randomness of an event has to be solved. Economist Frank Knight pointed out that randomness is not an objectively measurable phenomenon but rather a knowledge phenomenon (Knight 1921). He argued that if knowledge is complete then there is no probability but certainty [2]. Later Kenneth J. Arrow (1953) and Gérard Debreu (1959) introduced the state preference approach to uncertainty. According to Debreu under uncertainty "a commodity specifies to its physical properties, its location and its date as well as an event on the occurrence of which the transfer is conditional." (Chapter 7) In other words a bushel of wheat when it is raining and when it is sunny are two different products and the economic agents could ask different prices for them.

The need for the full disclosure of an economic model (spreading over infinite past to present) was again stressed by economist Frank Knight: "But theoretical economics has been much less successful than theoretical physics in making the procedure useful, largely because it has failed to make its nature and limitations explicit and clear." (Chapter 1) An experiment in physics although a controlled study (within finite space and time), is still a practical solution because a physicist is always aware of the finite nature of the experiment and knows how to discount its incompleteness from a broad and more practical situation. But economic models without full disclosure are not adequate to explain the changing nature of the human experience between time and place.

In an attempt to answer this question, Dr. Hugh Ching invented Infinite Spreadsheet. The notion Infinite Spreadsheet introduced by Dr. Ching (Ching 2002), is basically a spreadsheet which fully disclose all the future expected consequences of an investment (or any other economic variable) decision in a mathematically consistent manner. The description of the Infinite Spreadsheet, which is more than 100 pages long and consists of flow charts and mathematical deductions, can be found at the office of United States Patent and Trademark (Patent No. 6,078,901).

According to Dr. Ching, empirical verification is possible only when a deterministic event, described by an equal number of equations and unknowns, occurs within finite time duration; scientific predictions rely on the possibility of fitting deterministic future phenomena into deterministic past phenomena. But value, the foundation of social science, is defined as the sum total of all the expected benefits and losses to infinity in time. Therefore, it requires different treatment.

Only the deterministic (or non-arbitrary) solution to price can quantify value. The solution to price could be found by using the infinite spreadsheet described by an equal number of equations and unknowns-between the price and all the factors affecting the price in an expected time space extending from now to the infinite future.

It should be noted that although deterministic solution to price contradicts Walrasian concept of price theory, it does not profess against free market theory, rather only ascertain the limit of freedom. Also it is important to understand that the inputs used in infinite spreadsheet are still determined by quantitative supply and demand model.

In the Infinite Spreadsheet, the inputs are expressed as approximate time-invariant variables, because only time-invariant variable can capture infinity. Further the term "infinity" is not defined as indeterminable time in future but as very long period of time which is more close to reality.

In economics, it is impossible to find absolute time-invariant variables, because of the changing nature of human behavior. So we settle for the second best - approximate time-invariant variables. The method for creating approximate time-invariant variables is to express the inputs in dimensionless terms, such as a percentage of price or income. For example, instead of using net income as an input we could use percentage increase of net income. Unless there is an inflationary pressure or economic boom this percentage would not vary too much over time. However, if and when there is a drastic economic change, we need to recalculate our approximate time-invariant variable. But this would not affect the integrity of Infinite Spreadsheet, because it is a complete model that includes all the factors affecting the output (time-variant quantity) from now to the infinite future.

It is important to empirically survey each potential time-invariant variable before including them into the Infinite Spreadsheet.The deterministic method is necessary for empirical studies in social science because it is needed to identify the factors to be used as inputs and to provide the analytic relationships among all the factors.

Also it is important to understand why some economic variables like price are time-variant and can never be used as inputs of a model. For this reason, most time series analyses of prices will not produce useful results because price is a time variant, even after being made dimensionless using its own rate of appreciation.

Infinite Spreadsheet could be used to create any economic model to find practical solutions. Presently there are two types of software (Stock Valuation Software and Real Estate Valuation Software) available in the market, based on Infinite Spreadsheet. The general description of Stock Valuation Software is as follows:

Final thoughts:

Deterministic solutions to price are not synonymous to cost theory of price, which is at the center of Marxist economic system. It is because Marxist planning system is incomplete and based on finite spreadsheet.

The socialist regimes in Eastern Europe fell because Marxism failed to introduce a viable socialist democracy. Socialism resorts to totalitarianism because of its inability to define the extent of freewill. On the other hand, the deterministic solution to price defined by Infinite Spreadsheet express the extent of free will, to freely choose any values for all variables except that of the final variable. So, it could be said that if human behavior is a squiggling line (unlike a sine curve), then law of nature of economics is a straight horizontal line that provides upper and lower limits for the squiggling lines. The stock market would be much more stable only if the investors had understood the limits of their investment behavior.

Over the years Austrian, Post Keynesian and Evolutionary school of thoughts have addressed the different components of Infinite Spreadsheet. However, they failed to address why economics should be treated as a separate knowledge base, instead of an extension of the existing scientific knowledge especially Physics. They also failed to address why past data cannot be used to predict the future economic incidents. Now, economists are using Chaos Theory to explain future economic trends. They have concluded that our economic system is a fractal and future of this dynamic system cannot be predicted because we can never accurately predict the current situation. However, the Infinite Spreadsheet avoided this entire dilemma and showed us a different angle of this problem.

Infinite Spreadsheet pointed out that the major distinction between science and social science is that scientific experiments are empirically verifiable and economic variables cannot be verified in the same manner. Economic output like price is empirically non-verifiable and time-variant and should be determined by infinite spreadsheet and time-invariant variables.

Regardless of what our policymakers think, it is reasonable to argue that a practical economic system for 21^st century should pursue to find the laws of nature of economics, in order to develop more rational and permanent economic models and Infinite Spreadsheet is one of the solutions for those models.

[1] During a private discussion with economist Dr. Kenneth Arrow Dr. Ching, mentioned, "Although Dr. Debreu solved the special dependence of price, but on page 34 of his book on Theory of Value he incorrectly solved the temporal dependence of price." Dr. Arrow asked one crucial question, "What is wrong with the method of discounted cash flow?" Dr. Ching replied, "The discounted cash flow method or the present value calculation is incorrect because the average rate of return depends on the investment period which is generally different from the time to maturity or the actual holding period. The investment period should be a reasonably finite hypothetical time period chosen along with the investment return as the investment criterion. This error is made, for example, in the classical book Theory of Value by Gerard Debreu, where an infinite investment period is used in the calculation of the rate of return. The infinite investment period is unrealistic and will make market comparison difficult. In reality the investment period is almost never infinite."

[2] If we know the shape and weight of the coin, the strength of the tosser, the atmospheric condition of the room in which the coin is tossed, the distance of the tosser’s hand from the ground etc., then we could predict with certainty whether it would be head or tail.

Arrow, K.J. "The Role of Securities in the Optimal Allocation of Risk-Bearing." Econometrie (1953) as translated and reprinted in Review of Economic Studies 31 (1964) : 91-6

Ching, Hugh. "Quantitative Supply And Demand Model Based On Infinite Spreadsheet." (Patent No. 6,078,901) PO Box 461, Berkeley, CA 94701, USA

Debrau, Gérard. The Theory of Value An Axiomatic Analysis of Economic Equilibrium. New Haven and London : Yale University Press, 1959.

Edmonds, B. "Complexity and Scientific Modeling," paper presented at the 20^th Wittgenstein Symposium, Kirchberg am Weshel, Austria, August 1997.

Kagel, John H. and A. E. Roth, "The dynamics of recognition in matching markets: A laboratory experiment motivated by a natural experiment," Quarterly Journal of Economics (February, 2000) : 201-235.

Knight, Frank H. Risk, Uncertainty, and Profit. First edition. Boston and New York : Houghton Mifflin Company, The Riverside Press, 1921.

Moss, S.J. and B. Edmonds, "Modelling Economic Learning as Modelling," Cybernetics and Systems 29 (1998) : 5-37.