Monday, January 4, 2010

Mixing economics, thermodynamics, and heterogeneity

... or METH, as some call it. And if you want some more drug innuendo, read on.

On Brad DeLong's blog, a commentator named "MJ" deftly applies insights from thermodynamics to the issue of heterogeneity of goods in economics:

What would statistical mechanics be without a quantitative model of heterogeneous vs. homogeneous distributions? Such a statistical mechanics would miss a few subtle but crucial concepts. Such as entropy.

Note how the negentropic development of increasingly heterogeneous capital allocations over the past decade was accomplished through entropy production: bundling good with bad, compromising tranches, etc... Goldman Sachs made a killing, basically, off of knowingly producing entropy. The entropy production, of course (2nd law), far exceeded the negentropy production of their wealth aggregation- as reflected in the order of magnitude between financial industry's gains and the over all loss.

We're now learning Fannie and Freddie also engaged in entropy production, obscuring the distinction between scores over and under 660.

I can vouch for that as showing a good understanding of entropy, and it gives a good perspective for viewing economics:

1) An efficient economy produces as little net entropy as possible: the entropy it generates (destruction of heterogeneity) should be offset by the entropy it destroys in organizing inputs for their uniquely optimal roles.

2) A sign of inefficiency is when economic actors destroy distinctions (like in MJ's example of very different tranches and borrowers being made indistinguishable) without making a corresponding useful distinction or organization.

Definitely some issues worth fleshing out. I know I've seen papers that try to view economics from a thermodynamic perspective, but they invariably have me rolling my eyes.

1 comment:

Doc Merlin said...

I've been wondering for a long time how to better quantify entropy in the macroeconomy.