The network effect

And what it means for policy

Economics assumes that individuals operate autonomously, isolated from the direct influences of others. But today’s social and economic worlds are not like this. The choices people make are directly influenced by others through "social networks" – not merely Facebook but, more importantly, real-life social networks such as family, friends and colleagues.

Network effects have been pervasive throughout history. Humans, whether Hittite potters three and a half millennia ago or traders in financial markets today, have a propensity to copy the behaviour of others around them. On the financial markets, this herd mentality can lead all too easily to the booms and crashes we have experienced in recent years.

Networks are especially important in finance. When Lehman Brothers went bankrupt, it precipitated a crisis that almost led to a total collapse of the global economy, and it was precisely because Lehman was connected into a network of other banks that the situation was so serious. Incredibly, neither the system of financial regulation that was in place, nor the thinking of mainstream economics that influenced policy so strongly, took any account of the possibility of such a network effect. Ironically, policy makers and the financial establishment thought that risk could be mitigated by spreading it across the system. They misunderstood completely the dynamics of financial networks and the possibility that such networks might not reduce risk but could create upheaval.

A world in which network effects drive behaviour is completely different from the world of conventional economics. Network effects require policy makers to have a markedly different view of how the world operates. They make successful policy much harder to implement but they also help explain many policy failures.

The intellectual underpinning of the burgeoning activity of the state has been provided by mainstream economics. Paradoxically, a theoretical construct that purports to establish the efficiency of the free market has been used to justify an enormously enhanced role for the state. The concept of "market failure", at first sight a critique of free market economics, has provided powerful backing to state intervention. When markets have not functioned in the real world as the theory suggests they should, then regulation, taxes, incentives of all shapes and forms have been used in an attempt to make the imperfect world conform to more closely to the perfect one of economic theory.

We have now had over sixty years of this vision. Yet the stark fact is that the combination of large- scale state activity and a mechanistic intellectual approach to policy-making has not delivered anything like the success hoped for. Deep social and economic problems remain. For example, the average unemployment rate in the UK in the six decades before the Second World War was 5.5 per cent – virtually identical to the average rate for the six decades since. Rational planning and clever regulation did not prevent the biggest economic recession since the 1930s from taking place in 2008/9.

It is time for mainstream economics to adopt a model of the world that more closely approximates the reality of networks.  A fundamental feature of any system in which network effects are important is that it is ‘robust yet fragile’. Most of the time, the system is stable and resilient to shocks. But every so often a particular shock can have a dramatic effect and the behaviour of individuals across the network will be altered. These events are extremely difficult to anticipate, and hard to control when they do occur.

But the network view highlights the importance of social norms in determining the success of legislation. When network effects are present, the most effective policies are unlikely to be generic changes to incentives, as per the mainstream view. Careful analysis and targeting become the order of the day. Fewer resources used more intelligently can potentially lead to much more effective strategies. The silver bullet of this approach is that there are no silver bullets. Instead, we need to rely much more on the processes of experimentation and discovery.

The focus of policy needs to shift away from prediction and control. We can never predict the unpredictable. Instead we need systems that exhibit resilience and robustness on the one hand, and the ability to adapt and respond well to unpredictable future events on the other.

Paul Ormerod is an economist and author of Positive Linking: How networks and nudges can revolutionise the world.

This is an edited version of a chapter from IPPR’s forthcoming book, Complex New World: translating new economic thinking into public policy. For more see http://bit.ly/IPPR9499

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Theresa May could live to regret not putting Article 50 to a vote sooner

Today's Morning Call.

Theresa May will reveal her plan to Parliament, Downing Street has confirmed. They will seek to amend Labour's motion on Article 50 adding a note of support for the principle of triggering Article 50 by March 2017, in a bid to flush out the diehard Remainers.

Has the PM retreated under heavy fire or pulled off a clever gambit to take the wind out of Labour's sails while keeping her Brexit deal close to her chest? 

Well, as ever, you pays your money and you makes your choice. "May forced to reveal Brexit plan to head off Tory revolt" is the Guardian's splash. "PM caves in on plans for Brexit" is the i's take. "May goes into battle for Brexit" is the Telegraph's, while Ukip's Pravda aka the Express goes for "MPs to vote on EU exit today".

Who's right? Well, it's a bit of both. That the government has only conceded to reveal "a plan" might mean further banalities on a par with the PM's one-liner yesterday that she was seeking a "red white and blue Brexit" ie a special British deal. And they've been aided by a rare error by Labour's new star signing Keir Starmer. Hindsight is 20:20, but if he'd demanded a full-blown white paper the government would be in a trickier spot now. 

But make no mistake: the PM didn't want to be here. It's worth noting that if she had submitted Article 50 to a parliamentary vote at the start of the parliamentary year, when Labour's frontbench was still cobbled together from scotch-tape and Paul Flynn and the only opposition MP seemed to be Nicky Morgan, she'd have passed it by now - or, better still for the Tory party, she'd be in possession of a perfect excuse to reestablish the Conservative majority in the House of Lords. May's caution made her PM while her more reckless colleagues detonated - but she may have cause to regret her caution over the coming months and years.

PANNICK! AT THE SUPREME COURT

David Pannick, Gina Miller's barrister, has told the Supreme Court that it would be "quite extraordinary" if the government's case were upheld, as it would mean ministers could use prerogative powers to reduce a swathe of rights without parliamentary appeal. The case hinges on the question of whether or not triggering Article 50 represents a loss of rights, something only the legislature can do.  Jane Croft has the details in the FT 

SOMETHING OF A GAMBLE

Ministers are contemplating doing a deal with Nicola Sturgeon that would allow her to hold a second independence referendum, but only after Brexit is completed, Lindsay McIntosh reports in the Times. The right to hold a referendum is a reserved power. 

A BURKISH MOVE

Angela Merkel told a cheering crowd at the CDU conference that, where possible, the full-face veil should be banned in Germany. Although the remarks are being widely reported in the British press as a "U-Turn", Merkel has previously said the face veil is incompatible with integration and has called from them to be banned "where possible". In a boost for the Chancellor, Merkel was re-elected as party chairman with 89.5 per cent of the vote. Stefan Wagstyl has the story in the FT.

SOMEWHERE A CLOCK IS TICKING

Michael Barnier, the EU's chief Brexit negotiator, has reminded the United Kingdom that they will have just 15 to 18 months to negotiate the terms of exit when Article 50 is triggered, as the remaining time will be needed for the deal to secure legislative appeal.

LEN'S LAST STAND?

Len McCluskey has quit as general secretary of Unite in order to run for a third term, triggering a power struggle with big consequences for the Labour party. Though he starts as the frontrunner, he is more vulnerable now than he was in 2013. I write on his chances and possible opposition here.

AND NOW FOR SOMETHING COMPLETELY DIFFERENT

Emad asks if One Night Stand provides the most compelling account of sex and relationships in video games yet.

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Stephen Bush is special correspondent at the New Statesman. His daily briefing, Morning Call, provides a quick and essential guide to British politics.