On the computerization of finance

Business Horizons, Nov-Dec, 1989 by Dudley G. Luckett

Today's technology not only affects the world's financial transactions; it may affect economic theory as well.

A funny thing happened on our way to the twenty-first century. Economists became respectable. Some 200 years ago, Edmund Burke (in his Reflections on the Revolution in France, 1790) expressed what was probably the prevailing sentiment of his time when he wrote, "The age of chivalry has gone. That of sophisters, economists, and calculators has succeeded... ."

Succeeded it has indeed. Not only are today's economists routinely called upon to advise princes on such arcane matters as futures options and trade-weighted currency baskets, but for almost 20 years now economists have been privy to that inner circle of artistic and scientific disciplines that receive Nobel Prizes.

How can we account for this rise to respectability? What have we been doing right? What we seem to be doing is grouping Burke's three classes of people-sophisters, economists, and calculators-into a single category. To say economists" and "calculators" would essentially be redundant. Some 50 to 60 years ago economists began a collaboration with mathematicians that has proven enormously fruitful. Flanked by calculus on one side and statistics on the other, economists have developed precision of description and a method of verification that, if only a pale imitation of physics, is nevertheless well beyond the capacity of other behavioral disciplines. In short, economists are called upon to proffer advice precisely because they have advice to proffer. And if sometimes the advice is contradictory and none too accurate, it is nevertheless vastly superior to the counsels of the untutored or the prejudices of the self-interested.

But if we must generally acknowledge the role played by calculators in the intellectual rags-to-riches rise of economists, what kind of claim can sophistry possibly have to forwarding the respectability of economics? Here I use the word sophistry in what I assume was Burke's meaning-a somewhat superficial view of the world, filled with narrow preconceptions and brittle logic. And one's reaction to this meaning is that the sophistic side of economics must surely cheapen it in the public eye must, that is, make it disreputable. I quite disagree. Rather, it seems to me that the sophister-economist is an indispensable adjunct to the calculator-economist; we cannot have one without the other.

Let me explain and at the same time honorably discharge Burke, who has served his purpose. The contemporary method in mainstream economics is the mathematical model coupled with econometric hypothesis-testing. This method has given the economist the ability to answer a small set of questions with reasonable rigor. What it has not done is give us anything profound to say about historical change. For although econometric models necessarily abstract from institutional change, it is the evolutionary nature of society's institutions that constitutes the bulk of economic history.

It is on this basis that I made the previous assertion that the sophister-economist is part and parcel of the calculator-economist. In opting for the econometric method we have chosen to forgo the big questions, which we cannot answer, in favor of small questions, which we can.

On the whole, I do not think it is a bad bargain. But now and then there comes along an economic event of such enormous historical importance that it is impossible to ignore. When this happens, the economics profession-though poorly equipped by both temperament and training-must willy-nilly try to deal with it. The advent of computerized finance is just such an event. It is increasingly clear that the application of the computer to finance is a revolution of the same significance as moving from a barter system to commodity money, from commodity money to paper money, and from paper money to deposit money. In each of these cases, sweeping institutional change followed in its wake, and electronic finance is proving-and will continue to prove-to be no exception.

AN ANALYTICAL FRAMEWORK

If, as has just been argued, using neoclassical economic theory to analyze the impact of computerized finance is like using a screwdriver when you need a chisel, the question arises as to what theoretical instrument would be more appropriate. The answer lies in the institutionalist economic theory of Thorstein Veblen, an American economist of the late nineteenth and early twentieth centuries. Veblen was an iconoclast of heroic proportions, and his view of the economic process is rarely discussed today except to amuse undergraduate students in courses on the history of economic thought. Nevertheless, it seems to me that the Veblenian method is an insightful tool to use for the topic at hand.

Veblen conceived of the economic process as evolutionary, a process of continuous institutional adaptation to a changing technological environment. More specifically, Veblen viewed economic history as the product of two continuously interacting forces, the institutional and the technological. The institutional, which includes tradition and custom as well as formal bureaucracies, he saw as static. That is, he saw institutions as having no internal dynamic that would induce spontaneous change. Institutions do change, of course, but they do so only under the external influence of changing technology. Technology, unlike institutions, is inherently dynamic, due largely to what Veblen called the "idle curiosity" of human beings.