Book of the Day: How Networks Can Revolutionise the World

Network effects, the fact that a person can and often does decide to change his or her preferences simply on the basis of what others do, pervade the modern world.

* Book: Positive Linking: How Networks Can Revolutionise the World. By Paul Ormerod. Faber and Faber, 2012.

Here is the publisher’s summary:

‘According to Paul Ormerod, author of the bestselling Butterfly Economics and Why Most Things Fail, the mechanistic viewpoint of conventional economics is drastically limited – because it cannot comprehend the vital nature of networks. As our societies become ever more dynamic and intertwined, network effects on every level are increasingly profound. ‘Nudge theory’ is popular, but only part of the answer. To grapple successfully with the current financial crisis, businesses and politicians need to grasp the perils and possibilities of Positive Linking.

Our social and economic worlds have been revolutionised by a massive increase in our awareness of the choices, decisions, behaviours and opinions of other people. For the first time in human history, more than half of us live in cities, and this, combined with the Internet, has transformed communications. Network effects – the fact that a person can and often does decide to change his or her behaviour simply on the basis of copying what others do – pervade the modern world.

As Ormerod shows, network effects make conventional approaches to policy, whether in the public or corporate sectors, much more likely to fail. But they open up the possibility of truly ‘Positive Linking’ – of more subtle, effective and successful policies, ones which harness our knowledge of network effects and how they work in practice.”

Paul’s colleague at the Synthesis think thank, Greg Fisher, discusses the importance of the book:

“Modern economic theory was first set out on a formal basis in the late 19th century. There have certainly been developments since then, but at heart the basic view in economics of how the world operates remains the same. Economics is essentially a theory of how decisions are made by individuals, of what information is gathered and how it is used by the decision maker.

All scientific theories, even quantum physics, are approximations to reality. Theories involve making assumptions, simplifications, to enable us to understand problems better. A key feature of a good theory is that its assumptions are a reasonable description of the real world.

In the early 21st century, just as it did in the late 19th, economics in general makes the assumption that individuals operate autonomously, isolated from the direct influences of others. A person has a fixed set of tastes and preferences. When choosing amongst a set of alternatives, he or she compares the attributes of these alternatives and selects the one which most closely corresponds to his or her preferences.

At first sight, this may seem quite reasonable, indeed even ‘rational,’ as economists choose to describe this theory of behaviour. But there is a serious problem with the assumption that individuals operate in isolation from each other, that their preferences are not affected directly by the decisions of others. If I am interested in buying a product which many people want, the price may go up. So their choices affect me indirectly through the workings of the market. But my preferences remain unaltered.

The social and economic worlds of the 21st century are simply not like this at all. We are far more aware than ever before of the choices, decisions, behaviours and opinions of other people. In 1900, not much more than 10 per cent of the world’s population lived in cities. Now, for the first time in human history, more than half of us live in cities, in close, everyday proximity to large numbers of other people. In the last decade or so, the internet is revolutionising communications in a revolutionary way not experienced since the invention of the printing press in the late 15th century.

The assumption that people make choices in isolation, that they do not adopt different tastes or opinions simply because other people have them, is no longer sustainable. Perhaps – perhaps, and it is a big ‘perhaps’ – over 100 years ago this might not have been a bad assumption to make. But no longer.

The choices which people make, their attitudes, their opinions are influenced directly by other people. The medium across which this influence spreads is social networks. Often, social networks are thought of as purely a web-based phenomenon, sites such as Facebook. These indeed can influence behaviour. But it is real-life social networks, family, friends, colleagues, which are even more important in helping us shape our preferences and beliefs, what we like and what we do not like.

Network effects, the fact that a person can and often does decide to change his or her preferences simply on the basis of what others do, pervade the modern world.

Network effects have in fact been pervasive throughout human history. A crucial feature of human behaviour is our propensity to copy or imitate the behaviours, choices, opinions of others. We can see it in the fashions in pottery in the Middle Eastern Hittite Empire of three and a half millennia ago. And we can see it today in the behaviour of traders on financial markets, where the propensity to follow the herd can lead all too easily to the booms and crashes we have experienced. Scientists such as Robin Dunbar have argued that our anomalously large brain, compared to other mammals, evolved precisely because copying is a very successful strategy to follow from an evolutionary perspective.

This concept is just as crucial for companies and markets as it is for people. In September 2008, Lehman Brothers went bankrupt, precipitating a crisis which almost led to a total collapse of the world economy and a repeat of the Great Depression of the 1930s. It was precisely because Lehman was connected on a network to other banks that made the situation so serious. Lehman’s bankruptcy could easily have led to a cascade of bankruptcies across the world financial network, first in those institutions to which Lehman owed money, and spreading wider and wider from these across the entire network. Incredibly, neither the systems of financial regulations which were in place, nor the thinking of mainstream economics which influenced policy so strongly, took any account of the possibility of such a network effect.

A world in which network effects are a driving force of behaviour is completely different from the world of conventional economics, in which isolated individuals carefully weigh up the costs and benefits of any particular course of action. A world in which network effects are important is a much more realistic description of the human social and economic worlds which actually exist in the 21st century. It is the implications of this world which I explore in this book.

Incentives have not disappeared as a driver of human behaviour. It is still the case that if, say, Pepsi raises its price compared to Coke, more Coke and less Pepsi will be sold. This is the world which economic theory describes. It is not wrong. But it is often misleading. For it offers only a very partial account of how decisions are made in reality. Network effects can be far more powerful than incentives, and we will see many examples in which network effects have completely swamped the impact of incentives, leading to outcomes completely different from those intended by the policy makers when they altered the incentives.

Network effects require policy makers, whether in the public or corporate spheres, to have a markedly different view of how the world operates. In part, they make successful policy much harder to implement, and they help explain many of the failures of policies based on that incentives and not network effects are the key drivers of behaviour. But they open up the possibility of much more effective and successful policies, ones which harness our knowledge of network effects and how they work in practice.”

Finally, here is a review by Rhett Gayle:

“Paul Ormerod, economist and bestselling author of Why Most Things Fail and Butterfly Economics and co-director of Synthesis, points out in his new book Positive Linking, that governments operate on the notion that offering right incentives will produce the outcomes that the government thinks are good, and that when the desired outcomes aren’t forthcoming the incentive scheme is in need of adjustment. Ormerod argues, that the problem is that governments, and economists, are committed to a model of human beings that leaves out the “everyone” that was so important to me as a child. We all operate in the context of networks (the relevant “everyone”) and networks can lead to all kinds of behaviours that amount to jumping off bridges from the perspective of someone outside the network. One of the examples of this offered in the book is people choosing to be Protestant in Britain under Mary Stuart, a decision that could easily result in being burned to death. We cannot really make sense of this from a rational agent perspective. People copy other people in their network, sometimes even when it is not rational in an economic sense to do so.

Contemporary technology amplifies the power of networks to create or inhibit change. The events of the Arab Spring bring this point home. The technology-enabled network of connections encouraged people to ignore incentives (government troops firing on them, for example). Ormerod argues that policy makers and their advisors need a model of economics, and hence decision making, that includes network effects. If not, the current model in use will lead to greater disconnection from reality and hence from the possibility of being effective.

The book is not merely an attack on neoclassical economics and the strategies of governance that flow from it. Instead it offers a clear way to understand how to include networks in our thinking and what some of the consequences of that inclusion are. Network effects do not dominate in all situations; Ormerod offers a good heuristic for being able to tell when networks must be taken into account. He also points out practical ways that networks can be used to create positive change.

From the point of view of neoclassical economists, the introduction of networks is bad news (I suspect Paul won’t have a problem with that, he also wrote a book called The Death of Economics). The idea that a centralized decision making body, aided by a market composed of rational actors, could get the incentives right in some general sense and hence that there is some silver bullet scheme that will solve all our problems must be consigned to the flames. The good news is that in its place is the idea of a less ambitious, more decentralized, more experimental set of strategies for governance. Ormerod argues that in an age dominated by network effects, the principle of subsidiarity is strengthened. Centralization works well when citizens can be treated as atomized individuals, who are basically the same. Network effects mean that this assumption is often wrong, and hence devolving authority and responsibility will allow decisions and actions to be more attuned to reality and hence more effective.

Positive Linking provides a clear and practical introduction to understanding networks and how that understanding can effectively play into good governance and policy making. It does not claim that network theory is the silver bullet that solves all problems but effectively shows that without “everyone” (networks), our thinking about changes in social world are hopelessly flawed. People who are interested in policy, good governance, better economics and advancing the social good will all benefit from reading this book.”

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