A chaotic hunt for the beast's lair

Howard Davies assays a non-Traditional way to riches

Do not mention it in the senior common room, but I am beginning to feel sorry for economists, or at least for those whom Eric Beinhocker, with pointed use of the upper case, calls Traditional Economists. Their rational-choice models are in tatters, their general equilibria never seem to settle any more and some argue that they ought to be talking about happiness, not wealth, anyway, because gross domestic product per head is such a poor proxy for wellbeing.

They are, indeed, on a random walk to nowhere - not that there are any random walks any more: all that efficient markets nonsense has been killed off by Mandelbrotian complexity wallahs or by chaos theorists. Paul Ormerod, with Nietzschean overtones, famously pronounced the death of economics a few years back. All that is left in the wreckage is game theory, an endless series of prisoner's dilemmas, in which two rational-choice economists are tortured by physicists into confessing the error of their ways.

Beinhocker, a "senior adviser" to management consultants McKinsey (even those big corporate fleas have little fleas it seems) lays into the poor prisoners with gusto. His first 70 pages include a breezy history of economic thought from Adam Smith via Walras and Pareto to Samuelson - good revision material for that "history of economic thought" paper - while the 380 that follow take the whole edifice apart brick by brick.

He writes fluently in an Economist magazine sort of way. But there must be an editorial school somewhere that teaches that the way to capture the reader's attention is to begin each chapter with down-home references to ordinary people, perhaps real or perhaps not, who play no part in the argument. So the section on economic modelling begins: "Maria Luz Ochoadra lives on one of the world's largest garbage dumps, a place incongruously called the Promised Land, just outside Manila."

Indeed, the book begins and ends, for no clear reason, with our hero in "a thatched hut belonging to an elderly Masai tribesman".

This reader's attention is distracted, not attracted, by these devices. But if you can get past the artifice, what do you find?

The body of the book is an interesting, if a touch overwritten, review of complexity economics and of the lessons for economics that have emerged in the past three decades from mathematicians, physicists and evolutionary biologists in particular.

But Beinhocker is nothing if not ambitious. He takes the argument further, in interesting directions. He asks what all this means for corporations in devising their strategies. If the economy is far less predictable than we once thought, and if equity market gyrations are more extreme than the efficient market theories imply, then how should companies plan?

Cautiously, might be a one-word answer. Hedging their bets is the amplification if three are allowed.

He asks how finance directors should think about their cost of capital in a post-capital asset-pricing model world. By putting a finger in the air like Warren Buffet, is the slightly disappointing recommendation.

"Unfortunately, while Traditional methods for calculating the cost of capital are flawed, better alternatives have yet to be developed."

Indeed, Beinhocker is frank about the work to be done before complexity economics can give us a useful alternative method of measuring risk. So a corporate finance director will not find a new tool book, but she will be convinced that she should view her current models with some scepticism.

Finally, he asks what all this means for public policy.

Once again, it is work in progress. "Complexity Economics" (he likes capital letters) "may not help us better forecast inflation but... it can potentially help us manage macroeconomic policy more effectively by giving us new insights into the dynamics of the business cycle."

I wonder. It's a deuced elusive beast, the business cycle, and I doubt that Beinhocker has tracked it to its lair. More promising, perhaps, are his observations on the importance of social capital and what he categorises as "social technologies", in a thoughtful and provocative coda about why some societies generate wealth more consistently than others.

In spite of the iconoclastic packaging, Beinhocker's approach is in many respects conventional. Wealth creation is his objective function - none of this wellbeing nonsense.

And his central thought is that we need a new definition of what wealth creation means. This has three parts: irreversibility, entropy and fitness.

The first and third are fairly straightforward. The second is the most intriguing: "All value-creating economic transformations and transactions reduce entropy locally within the economic system, while increasing entropy globally."

It is a little while now since Gordon Brown, the Chancellor, inserted neoclassical endogenous growth theory into one of his speeches, provoking Michael Heseltine's memorable rejoinder - "that's not Brown's, it's Balls".

Beinhocker's definition could be an excellent encore at the next Confederation of British Industry conference. It will bring the house down, I'm sure.

Sir Howard Davies is director, London School of Economics and Political Science.