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

Photograph: Getty Images
Picture: ANDRÉ CARRILHO
Show Hide image

Leader: Boris Johnson, a liar and a charlatan

The Foreign Secretary demeans a great office of state with his carelessness and posturing. 

Boris Johnson is a liar, a charlatan and a narcissist. In 1988, when he was a reporter at the Times, he fabricated a quotation from his godfather, an eminent historian, which duly appeared in a news story on the front page. He was sacked. (We might pause here to acknowledge the advantage to a young journalist of having a godfather whose opinions were deemed worthy of appearing in a national newspaper.) Three decades later, his character has not improved.

On 17 September, Mr Johnson wrote a lengthy, hyperbolic article for the Daily Telegraph laying out his “vision” for Brexit – in terms calculated to provoke and undermine the Prime Minister (who was scheduled to give a speech on Brexit in Florence, Italy, as we went to press). Extracts of his “article”, which reads more like a speech, appeared while a terror suspect was on the loose and the country’s threat level was at “critical”, leading the Scottish Conservative leader, Ruth Davidson, to remark: “On the day of a terror attack where Britons were maimed, just hours after the threat level is raised, our only thoughts should be on service.”

Three other facets of this story are noteworthy. First, the article was published alongside other pieces echoing and praising its conclusions, indicating that the Telegraph is now operating as a subsidiary of the Johnson for PM campaign. Second, Theresa May did not respond by immediately sacking her disloyal Foreign Secretary – a measure of how much the botched election campaign has weakened her authority. Finally, it is remarkable that Mr Johnson’s article repeated the most egregious – and most effective – lie of the EU referendum campaign. “Once we have settled our accounts, we will take back control of roughly £350m per week,” the Foreign Secretary claimed. “It would be a fine thing, as many of us have pointed out, if a lot of that money went on the NHS.”

This was the promise of Brexit laid out by the official Vote Leave team: we send £350m to Brussels, and after leaving the EU, that money can be spent on public services. Yet the £350m figure includes the rebate secured by Margaret Thatcher – so just under a third of the sum never leaves the country. Also, any plausible deal will involve paying significant amounts to the EU budget in return for continued participation in science and security agreements. To continue to invoke this figure is shameless. That is not a partisan sentiment: the head of the UK Statistics Authority, Sir David Norgrove, denounced Mr Johnson’s “clear misuse of official statistics”.

In the days that followed, the chief strategist of Vote Leave, Dominic Cummings – who, as Simon Heffer writes in this week's New Statesman, is widely suspected of involvement in Mr Johnson’s article – added his voice. Brexit was a “shambles” so far, he claimed, because of the ineptitude of the civil service and the government’s decision to invoke Article 50 before outlining its own detailed demands.

There is a fine Yiddish word to describe this – chutzpah. Mr Johnson, like all the other senior members of Vote Leave in parliament, voted to trigger Article 50 in March. If he and his allies had concerns about this process, the time to speak up was then.

It has been clear for some time that Mr Johnson has no ideological attachment to Brexit. (During the referendum campaign, he wrote articles arguing both the Leave and Remain case, before deciding which one to publish – in the Telegraph, naturally.) However, every day brings fresh evidence that he and his allies are not interested in the tough, detailed negotiations required for such an epic undertaking. They will brush aside any concerns about our readiness for such a huge challenge by insisting that Brexit would be a success if only they were in charge of it.

This is unlikely. Constant reports emerge of how lightly Mr Johnson treats his current role. At a summit aiming to tackle the grotesque humanitarian crisis in Yemen, he is said to have astounded diplomats by joking: “With friends like these, who needs Yemenis?” The Foreign Secretary demeans a great office of state with his carelessness and posturing. By extension, he demeans our politics. 

This article first appeared in the 21 September 2017 issue of the New Statesman, The revenge of the left