This article first appeared in Forum, The Edge Malaysia Weekly on March 18, 2019 - March 24, 2019

If the present neoclassical economic paradigm is more or less broken, what is the new paradigm?

We are entering a period of great competition. Just as Western economics and science have been dominated by Anglo-Saxons (Great Britain and the US) for nearly 250 years, the shift from a unipolar to a multilateral order means that there will be many paradigms competing to be top dog. In other words, we are moving from a uni-paradigm to a multi-paradigm world.

Remember 2009, when the Queen of England asked the Royal Academy (comprising the best minds in the UK) “why had no one noticed that the credit crunch was on the way?” In reply, the Royal Academy said “the failure to foresee the timing, extent and severity of the crisis, and to head it off, while it had many causes, was principally a failure of the collective imagination of many bright people, both in this country and internationally, to understand the risks to the system as a whole”.

In short, the brightest experts failed in their collective imagination to lift their heads out of their specialist areas and look collectively at the bigger picture. This remains the failure of the economics profession because economic events are inextricably tied up with political issues, involving new technology, social inequality, religion, climate change, national security and all other factors. These messy subjects are usually excluded from economic models of how the economy works, mainly because “other unmeasured factors” are excluded under the “other things being equal” or “ceteris paribus” assumption.

In other words, the most interesting issues have been excluded from economists’ imagination, but that is where the problem lies.

To understand the past, appreciate the present and look into the future require huge imagination because things — or entropy, as the Second Law of Thermodynamics says, will keep on increasing all the time — namely, it will always get more complex.

To deal with complexity, classical Western science, starting from the French mathematician Descartes to the English astronomer Isaac Newton, created a rational, linear and mechanical view of the world in which humanity was essentially excluded. This neoclassical view is fundamentally reductionist. Its advantage is that everything is reduced to theory. By simplifying complexity into simple rules (or physical laws) of nature, you achieve elegance and “optimal” solutions — such as perfect information leads to perfect markets and optimal resource allocation. You do not need messy governments or human intervention in a self-regulating market mechanism that always reverts to equilibrium.

But life is not really that simple. If the Walter Lippman rule that “simple and neat solutions are likely to be wrong”, what is the right answer? Even Albert Einstein, who reduced the space-time problem into a single elegant equation e = mc2, wisely said that “everything should be made as simple as possible, but not simpler”.

To sum up, where mainstream economics went wrong is that despite moving into heterodox areas such as behavioural, environmental, law and other sub-fields, the core remained essentially quantitatively classical physics and mathematics. It ignored the major breakthroughs in cutting-edge quantum physics and relativity thinking, as well as the biological sciences, which realise that life is complex, becoming more so over time, as humans evolve and adapt. The complex, non-linear life and consciousness is about “emergence”. Biologists essentially say that living cells adapt or “emerge” through change, with the biggest breakthrough coming from Darwin’s evolutionary theory through natural selection.

In other words, economics needs to absorb major new thinking “outside the box”, coming from physics, biology, history, sociology, politics and other fields. This has not been achieved because the mainstream economics profession is stuck inside its “comfort zone”.

We now know that theory, just like history, is written by the victors because the victor uses theory to justify or legitimise why they became victorious. Economic theory, by forgetting the political economy, failed to see that while economics reinforce power, ultimately, it is politics that determine how the economy is shaped.

Consequently, in moving away from a unipolar world, we can identify many challenger paradigms to the Western worldview — Chinese, Japanese, European, Russian, Islamic (at least two variants in Sunni and Shia), Latin American and African. This contest of paradigms — “letting a thousand flowers bloom” — exists because within each continent, there are further variants of paradigms.

In the search for the truth, the fictional detective Sherlock Holmes put the issue very well, “Once you eliminate the impossible, whatever remains, no matter how improbable, must be the truth.”

In this age of fake news and political lies, what is the truth?

As usual, Einstein had thought about this better than anyone else. He went beyond classical physics because he had a great imagination. He said, “Imagination is more important than knowledge. For knowledge is limited to all we now know and understand, while imagination embraces the entire world, and all there ever will be to know and understand.”

This, at the heart of the impossible relationship between mind and matter, the physical and human consciousness, is where we failed in our imagination. Neoclassical economics still treats goods and services as real (physical) things, whereas human imagination has already moved into the “virtual”.

If we do not appreciate that the great powers have already moved into a contest of “virtual minds” — namely, artificial intelligence — and still think in terms of bricks and mortar, then we simply cannot compete. This is not about guns versus butter, but about the contest of minds and skills — imagination.

The breakthrough in quantum mechanics, biology and information is that there is an entangled relationship between the physical (matter) and the non-physical (anti-matter). To put it simply, we cannot look at the world only like drunks looking under the lamplight — much of what really happens occurs in the dark. Thus, if matter simultaneously exists with anti-matter, then anti-matter is like imagination, completely free, whereas the physical matter is confined to what we can measure.

In other words, the answers to the mysteries of the world, human or natural, lie in not what we can see, but what we cannot. It is lack of imagination that constrains our inability to see in the dark or the other side of reality.

The risk manager Nassim Taleb got it right: it is not about fragility that risk managers should think about, we should be focusing on “anti-fragility”.

The simplest way to express this is understanding the essence of money. Money is a derivative of the real economy and is actually the corresponding liability of real goods and services, often represented in terms of gold. Most of us still think about the economy as real goods and services, and we have difficulty understanding finance because it is trading in the liabilities that are derivatives of real assets. Finance trades in more and more complex derivatives. Modern money has become a fiction that has been legalised. Cyber-currencies exposed this fiction, and now there is dark money because cyber-currencies seek mostly to hide from official taxation and legality.

How we use this new paradigm to explain what is happening in the economy, politics and finance will unfold in this column in the coming weeks.

Tan Sri Andrew Sheng writes on global issues from an Asian perspective

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