Economics and Ethics

Two book reviews in economics and ethics from the Erasmus Journal for Philosophy and Economics

Mark D. White

Thanks to the indispensable Heterodox Economics Newsletter (latest issue here), here are two recent book reviews that may interest our readers, both from the latest issue of the Erasmus Journal for Philosophy and Economics (6/1, Spring 2013). [In the interest of full disclosure I must note that I blurbed the first book and the second was published in my "Perspectives in Social Economics" series from Palgrave Macmillan.]

Economics as Applied Ethics: Value Judgements in Welfare Economics, by Wilfred Beckerman (Palgrave Macmillan, 2011), was reviewed by our own Jonathan B. Wight, who finds it "a well-written textbook geared to advanced undergraduate or graduate students of economics, many of whom are largely and regrettably innocent of the ethical problems inherent in conventional economic analysis." After a detailed critical breakdown by chapter, Wight concludes that:

Overall, this book is highly recommended. It covers the selected topics with depth and sensitivity. The writing is generally excellent, but there are occasions of repetition and unevenness, as if the chapters were compiled separately and merged later. A student reader who is not already familiar with basic ethical theories could benefit from a primer in some places. For example, the book discusses Amartya Sen’s theory of commitment, however it does not dig very deeply to explain or defend that notion, whether from a deontological or virtue ethics approach.

The book devotes a lot of attention to questions of equality and justice, particularly on the work of economist philosophers such as John Broome, Partha Dasgupta, Ian Little, and Amartya Sen. This is
appropriate, interesting, and relevant. However, the book does not appear to address research in experimental economics, biology, and psychology that might be relevant to some of these questions, such as the work in neuroeconomics by Paul Zak, experimental work by Vernon Smith, or recent philosophical work on virtue ethics by Deirdre McCloskey. This is the normal limitation of any text that strives to be concise, yet students should understand there is much more to ethics and economics than can be conveyed in this book.

Approximating Prudence: Aristotelian Practical Wisdom and Economic Models of Choice, by Andrew Yuengert (Palgrave Macmillan, 2012), was reviewed by Ricardo F. Crespo. According to Crespo, 

Yuengert shows in this book that economic modeling undertakes only a partial analysis of economic action, because it ‘puts away’ interesting features of its subject that deserve to be taken into account. He proposes adopting the Aristotelian account of human action—more specifically, of practical wisdom—as the benchmark against which to consider economic modeling. He maintains that “economics can learn much about its limits from Aristotle, who describes aspects of choice behavior that cannot be precisely modeled” (p. 3). Thus, the aim of the book is to determine what aspects of human behavior cannot be captured by the economists’ models.

After a careful analysis of the book's structure and arguments, Crespo concludes that it

provides the useful service of identifying the characteristics of human action that economic models cannot take into account. It is useful because it explains the challenge to positive economists of trying to incorporate these characteristics into their approach, and because it highlights the features that economists must consider in their normative work. The contribution of the book lies in its originality. Economics books are not usually about what economics cannot do.

Both the author and the reviewer are Aristotelian economists, and readers benefit greatly from Crespo's detailed analysis of Yuengert's use of concepts such as eudaimonia  and contingency (the latter is comparison to Knightian uncertainty). (See Crespo's Academia.edu page for his own work on Aristotle and economics.)

Our Children’s Economics

Jonathan B. Wight

What is the future of economics? Barry Eichengreen posted his ideas in "Our Children's Economics" in The Economist.

According to one view, the economics of 2030 will have marginal improvements, adding a bit of behavioral economics here, a spice of institutional theory there, perhaps even a re-writing of Adam Smith's ethics and a reinterpretation of the invisible hand that is not based on greed.

Eichengreen argues that the marginalist view is likely wrong. We are heading for major rifts and breakthroughs, similarly to the Keynesian revolution of the 1930s. What these are he cannot say.

My own pet theory is that economics will merge with biology to make BIO-ECONOMICS. Both fields try to understand survival and procreation in particular habitats with innovation and adaptation to changing environments.

Eichengreen notes that the mechanism by which knowledge is transferred from generation to generation will radically change. The old model is of a great authority who writes a definitive textbook that lasts for a generation: think of Smith and Wealth of Nations in late 18th century, Ricardo and his Principles in the 19th century, Marshall's great fusion at the end of the 19th and early 20th century, and Samuelson's great synthesis of Keynesian economics in the 1950s and on.

In the future, Eichengreen argues that textbooks will no longer be written by big-name authors, but through a wiki-process, electronically built from the bottom up. The result will be different to be sure:

"The outcome will be messy. But the economics profession will also become more diverse and dynamic – and our children's economics will be healthier as a result."

[Thanks to Pam Thomas for this link.]

Has neoclassical economics led to ecological disaster?

Mark D. White

Here's an interesting and provocative talk, upcoming at the University of Greenwich on March 6, 2013 (register your place here):

"How Neoclassical Economic Thinking Has Led to Ecological Disaster?"

We are facing several crises at once: the near collapse of the world banking system in 2008 (and its consequences), the loss of biodiversity (the fifth extinction), world-wide pollution of land, water and air, and apparently escalating climate change. I shall discuss how neoclassical thought has justified the actions and behaviours that have led to these crises. Traditional economics (i.e. neoclassical use of calculus, network and game theory) has an emphasis on individual utility, rationality and market equilibrium. This approach with the use of market discount rates, the lack of reflexivity, the conversion of altruism into money, and the absurd separation of issues of equality from those of economic growth and welfare, has turned people into commodities (in the theory), played down our love of nature, and coarsened those who teach it. The greed and self-serving behaviour of the global banks, and the clients they advise, demonstrates the end result of worship of so-called free markets and pursuit of deregulation to achieve more profits.

About the speaker:

Dr Barker is the Chairman of Cambridge Econometrics, having founded the company in 1985. He is also Senior Departmental Fellow at the Cambridge Centre for Climate Change Mitigation Research (4CMR), Department of Land Economy, University of Cambridge. He is a member of the Editorial Board of Economic Systems Research, the International Journal of Climate Strategies and Management, the International Journal of Global Warming, and the Scientific Advisory Board of the World Wide Views on Global Warming. He was a member of the Scientific Committee of the Climate Change Congress, Copenhagen, March 2009, and was on the Writing Team of the Synthesis Report of the Congress. He received the Distinguished Guest Lecturer Medal for 2008 from the Royal Society for Chemistry, Environmental Chemistry Group.

He was a Co-ordinating Lead Author (CLA) for the the Intergovernmental Panel on Climate Control (IPCC)’s Fourth Assessment Report, 2007, for the chapter on cross-sectoral mitigation. Previously he was CLA in the Third Assessment Report, 2001, taking responsibility for the chapter on the effects of greenhouse gas mitigation policies on the global energy industries. He was a member of the core writing team for the Synthesis Report Climate Change 2001. He contributed to the IPCC's Scoping Meeting for the Fifth Assessment Report, held in Venice 13-17 July, 2009.

From 2000 he instigated and worked on projects building a global E3 model (E3MG) with initial emphasis on modelling the E3 structures of China and Japan. Since 2004 he has been working as member of a UK Tyndall Centre project to develop E3MG as a 20-region world model, designed to analyse GHG mitigation policies under endogenous technological change. He is now leading the research of a team in 4CMR developing and using E3MG for studies of the decarbonisation of the global economy, funded by the Three Guineas Trust, one of the Sainsbury Family Trusts. In the 1990s he was appointed the Project Co-ordinator of the pan-European project developing and applying the E3 model for Europe (E3ME), partly funded by the European Commission, analysing energy and fiscal policies including the equity effects of environmental fiscal reform. Previously he was Principal Investigator on projects funded under the ESRC’s Global Environmental Change Programme ‘Developing an E3 model of the UK economy’ and ‘Greenhouse gas abatement through fiscal policy’; the independent evaluators rated the outcome of the first of these projects as an outstanding contribution to knowledge. He worked with Professor Sir Richard Stone, the Nobel Laureate, in the Department of Applied Economics, becoming the Director of the Cambridge Growth Project 1983-87, a team of 8-10 economists that originally developed the (MDM) structural model of the British Economy.

The Illusion of Mathyness

Mark D. White

Kevin Drum at Mother Jones recently highlighted a new paper by Kimmo Eriksson (Mälardalen University and Stockholm University) published in Judgment and Decision Making titled "The Nonsense Math Effect" (7/6, November 2012). Here's the abstract:

Mathematics is a fundamental tool of research. Although potentially applicable in every discipline, the amount of training in mathematics that students typically receive varies greatly between different disciplines. In those disciplines where most researchers do not master mathematics, the use of mathematics may be held in too much awe. To demonstrate this I conducted an online experiment with 200 participants, all of which had experience of reading research reports and a postgraduate degree (in any subject). Participants were presented with the abstracts from two published papers (one in evolutionary anthropology and one in sociology). Based on these abstracts, participants were asked to judge the quality of the research. Either one or the other of the two abstracts was manipulated through the inclusion of an extra sentence taken from a completely unrelated paper and presenting an equation that made no sense in the context. The abstract that included the meaningless mathematics tended to be judged of higher quality. However, this "nonsense math effect" was not found among participants with degrees in mathematics, science, technology or medicine.

It's a short paper and well worth the quick read (or read Drum's post, which summarizes it well). Eriksson reports that humanities/social science readers tended to be enchanted by the irrelevant equations, with 60-65% rating the adulterated abstract higher, but economists are not broken out of that very broadly defined group (which only includes 84 people as it is). Given some (most?) economists' predilection for mathyness, though, I would not be surprised at some degree of unconscious bias for research that promises greater mathematical sophistication (though I assume any such bias would melt away once the paper was read).

But I think many other economists, especially heterodox economists who are more skeptical about the benefits of mathematical modeling, might go the other way. I know that when I read an interesting abstract and then skim the paper, my eyes glaze over when I hit math--not because it doesn't add anything to support the author's thesis but because I'm afraid it will leave out many things in the interest of abstraction and simplicity, such the very nonquantitative aspects of the model that I found fascinating in the first place! Some things must be left out of a model, of course, but these factors should be omitted because they are relatively unimportant, not because they're don't fit into the modeling framework.

As Eriksson writes in his introduction to the paper,

In areas like sociology or evolutionary anthropology I found mathematics often to be used in ways that from my viewpoint were illegitimate, such as to make a point that would better be made with only simple logic, or to uncritically take properties of a mathematical model to be properties of the real world, or to include mathematics to make a paper look more impressive.

He very well could have included economics in there as well--I'm curious if his exclusion of it was intentional or random. Gee, I'll bet we could model that...

Have economists ignored clinical depression?

Mark D. White

A recent issue of Science (October 5, 2012) is a special issue on depression, and senior editor Peter Stern's introduction lays out the reason for it (emphasis mine):

Depression is a devastating disease. It affects not only the directly afflicted but also the people around them, their families, and their closest relations. It indiscriminately hits all strata of society, no matter one’s intellectual background, age group, or economic situation. There are many cases of highly successful and widely admired individuals who have been struggling with depression for years. Unfortunately, for reasons we still do not fully understand, this condition has been on the rise over the past decades. Considering its impact on an individual’s quality of life and subsequently on the economy and society in general, gaining an understanding of what causes depression and trying to develop effective therapies is of utmost importance. Hence, this year’s Neuroscience Special Issue is devoted to different aspects of depression.

I've long wondered why economists don't look more at both the microeconomic and macroeconomic effects of clinical depression. (I'm careful to add the modifier "clinical" because economists do, of course, spend a lot of time thinking about depressions, Great or otherwise.) Behavioral economists identify, quantify, and model the cognitive biases and dysfunctions that affect the choices of the average person, but have not yet (to my knowledge) looked into how depression affects decision-making. As Dr. Stern recognizes, choices affected by depression--given reported high rates of incidence of the disease--have potentially tremendous economic effects, not only on personal well-being but also on market outcomes, aggregate economic performance, and government policy.

There are many theories of depression in psychology, but one that seems extraordinarily well-suited to incorporating the effects of depression into economic models of choice is cognitive psychology, as typified by the work of Aaron Beck. Beck maintains “the individual’s problems are derived largely from certain distortions of reality based on erroneous premises and assumptions” (Cognitive Therapy and the Emotional Disorders, p. 3). Examples of this negative thinking include: dichotomous reasoning (everything is either black or white, failure or success), selective abstraction (focusing on failures and glossing over successes), and overgeneralization (exaggerating the importance and incidence of failures). In economic terms, these have obvious effects on beliefs and preferences, the foundation of decisions in the mainstream model of choice.

Depressives also report a lack of motivation or "paralysis of the will" that makes them less likely to act decisively to further their goals. In the mainstream economic model of choice, this can be be regarded once again as a result of distorted perceived benefits and costs (downplaying the former and emphasizing the latter) which result in a bias toward inaction (or at least decisional inertia).

This is just one possible framework, and there are many others. I believe that behavioral economists could work within such a framework to refine the cognitive and conative effects of depression on decision-making. Behavioral economists have already told us that we're "presumably irrational"--now it's time to turn to the members of society who are "presumably depressed."

Which is "harder": social science or physical science?

Mark D. White

Yesterday, Kevin Drum at Mother Jones spoke up for social science following an editorial in Nature arguing against the NSF's proposed defunding of research in political science. Here's a bit of the op-ed:

Part of the blame must lie with the practice of labelling the social sciences as soft, which too readily translates as meaning woolly or soft-headed. Because they deal with systems that are highly complex, adaptive and not rigorously rule-bound, the social sciences are among the most difficult of disciplines, both methodologically and intellectually. They suffer because their findings do sometimes seem obvious. Yet, equally, the common-sense answer can prove to be false when subjected to scrutiny. There are countless examples of this, from economics to traffic planning. This is one reason that the social sciences probably unnerve some politicians, some of whom are used to making decisions based not on evidence but on intuition, wishful thinking and with an eye on the polls.

...As Washington Post columnist Charles Lane wrote in a recent article that called for the NSF not to fund any social science: “The 'larger' the social or political issue, the more difficult it is to illuminate definitively through the methods of 'hard science'.”

In part, this just restates the fact that political science is difficult. To conclude that hard problems are better solved by not studying them is ludicrous. Should we slash the physics budget if the problems of dark-matter and dark-energy are not solved? Lane's statement falls for the very myth it wants to attack: that political science is ruled, like physics, by precise, unique, universal rules.

And here's some of what Mr. Drum added to it:

The public commonly thinks of disciplines like physics and chemistry as hard because they rely so heavily on difficult mathematics. In fact, that's exactly what makes them easy. It's what Eugene Wigner famously called the "unreasonable effectiveness" of math in the natural sciences: the fact that, for reasons we don't understand, the natural world really does seem to operate according to strict mathematical laws. Those laws may be hard to figure out, but they aren't impossible. ...

Hari Seldon notwithstanding, the social sciences have no such luck. Human communities don't obey simple mathematical laws, though they sometimes come tantalizingly close in certain narrow ways — close enough, anyway, to provide the intermittent reinforcement necessary to keep social scientists thinking that the real answer is just around the next corner. And once in a while it is. But most of the time it's not. It's decades of hard work away. Because, unlike, physics, the social sciences are hard.

Bonus points for the Foundation mention!

(I don't have much to add; I made a similar point in this post, comparing the complexity of marcoeconomic forecasting models to meteorological weather-forecasting models.)

Decision-making is not math: A lesson in the subjectivity of value

Mark D. White

Last month, The Economist published an article (based on research published in Journal of Marketing) on consumers' irrationality when compared discounts and added content:

Consumers often struggle to realise, for example, that a 50% increase in quantity is the same as a 33% discount in price. They overwhelmingly assume the former is better value. In an experiment, the researchers sold 73% more hand lotion when it was offered in a bonus pack than when it carried an equivalent discount (even after all other effects, such as a desire to stockpile, were controlled for).

In a recent issue, the magazine printed a letter by Rory Sutherland of Ogilvy & Mather UK, succinctly and humorously pointing out the problem with attributing irrationality to such consumers:

You mentioned research which revealed that shoppers often prefer “50% extra free” to a notionally more generous 30% reduction in price, and you cited this as evidence of irrationality or poor mathematical ability on the part of consumers. I think you may be wrong and consumers may be right.

There is, as the advertising sage Jeremy Bullmore observed, a significant difference between a bonus and a bribe. A price tells you much more about a product than merely what it costs. A price cut may be sensibly perceived as a mark of mild desperation on the part of the seller and it is not unreasonable to infer from a price cut that a product is an inferior good. Charging the full price but adding something extra does not convey the same desperation. In any case this whole debate is silly.

If people value 50% extra free more highly than 33% off, then that is an end of the matter. Since all value is subjective, what you are doing by offering the former is simply creating more perceived value at a lower cost. Whether or not the resulting behaviour conforms to some autistic neoclassical idea of rationality is irrelevant.

If the sole purpose of life was to be rational, we would have banned golf years ago.

Mr. Sutherland said it better than I ever could--and I've tried, in many places and many contexts, including previous posts (such as here), book chapters, and my forthcoming book, The Manipulation of Choice: Ethics and Libertarian Paternalism. Economists--of both mainstream and behavioral varieties--all too often see irrationalities where none exist because they insist on interpreting choice through the lens of their narrow understand of decision-makers and the overly simplistic choices they assume on consumers' parts.

The factors that consumers take into consideration when make choices are much more complicated than economists recognize--as Mr. Sutherland points out. And while behavioral economists are making headway in identifying some of these factors, they still don't account for qualitative ones like principles and ideals. Nor do they consider the complex and subjective interests of consumers (and all decision-makers), choosing instead to assume simple unitary goals like wealth-maximization. Until they take these common influences on choice into account, they will see irrationalities wherever they look--which reflects more on the shortcoming of their models than on the decision-makers themselves.

On Barry Schwartz's "The Danger of Too Much Efficiency" in The New York Times

Mark D. White

In the New York Times, psychologist Barry Schwartz (author of The Paradox of Choice: Why More Is Less) warns us of "The Danger of Too Much Efficiency," in which he argues that, while efficiency is generally a good thing and enables increases in standards of living, more efficiency is not necessarily better. The first half of his piece is an excellent summary of the benefits of efficiency, which he illustrates using the concept of friction:

...firms compete to become more efficient, and we as consumers, along with Bain and its like, benefit from this competition.

What stands in the way of efficiency is friction. When automobile manufacturers struggle to squeeze as many miles per gallon as possible out of their car designs, friction is the enemy. Their aim is to design a vehicle that uses every ounce of fuel to move the car forward.

And so it is in the world of finance. As the historian Niall Ferguson reminds us in his book The Ascent of Money, hard as it is to imagine, people didn’t always have money. The invention of money went a long way toward reducing the friction, the inefficiency, in financial transactions. No longer did the farmer have to bring sacks of potatoes to the marketplace to trade for eggs and milk. Money was a medium of exchange that greatly reduced what some have called the financial coefficient of drag.

But Schwartz recognizes that increasing efficiency by reducing friction is not the only important concern to individuals or society. After summarizing the efficiency gains from securitizing mortgages and increased access to consumer credit, he turns to the downside:

All these examples tell us that increased efficiency is good, and that removing friction increases efficiency. But the financial crisis, along with the activities of the Occupy movement and the criticism being leveled at Mr. Romney, suggests that maybe there can be too much of a good thing. If loans weren’t securitized, bankers might have taken the time to assess the creditworthiness of each applicant. If homeowners had to apply for loans to improve their houses or buy new cars, instead of writing checks against home equity, they might have thought harder before making weighty financial commitments. If people actually had to go into a bank and stand in line to withdraw cash, they might spend a little less and save a little more. If credit card companies weren’t allowed to charge outrageous interest, perhaps not everyone with a pulse would be offered credit cards. And if people had to pay with cash, rather than plastic, they might keep their hands in their pockets just a little bit longer.

Rather than focus on his policy recommendations (with which I have much disagreement, as regular readers of this blog can easily imagine), I want to address his normative analysis of efficiency, which with I have much sympathy. I do think, however, that the particular way in which he criticies the emphasis of efficiency is strange, and obscures his greater point to some extent--a point with which, again, for the most part I agree.

Using the Aristotelian language he adopted in his more recent book (written with Kenneth Sharpe), Practical Wisdom, Schwartz recommends finding the "golden mean" of efficiency rather than simply purusing its maximum level. While I don't disagree with this in principle, I do think it is an odd way to put the problem, since it suggests that we can find the optimal level of efficiency without consideration of other values. If there is a golden mean of efficiency, the only way to find it is to determine how much efficiency is consistent with other values we want to promote (such as justice, dignity, and equality). This is really no different from the Aristotelian determination of the golden mean of characteristics like courage, in which the extremes of foolhardiness and cowardice offend other values and ends, as opposed to being internally inconsistent.

But I find the golden mean analysis to be misleading in a deeper sense when applied to efficiency. The reason we can't determine the optimal level of efficiency is because it is an empty value--it's a mean to an end, not an end in itself. And as such, it should be maximized in order to provide the means to pursue valuable ends, except insofar as it conflicts with those ends themselves. In other words, the pursuit of efficiency must be limited, but out of recognition that other values are more important, not that there is something inherently bad about a certain level of efficiency. The only "danger with too much efficiency" is that it implies that important values have been neglected in its name.

To a large extent, this all cashes out the same way; my disgreement with Schwartz on this issue is largely rhetorical rather than substantive. He emphasizes the excessive attention given to efficiency, and then recommends that it be frustrated (by increasing frictions through regulation) in order to correct the resulting problems. But as I said above, the issue is not an excessive focus on efficiency, but on neglect on other values which should temper it. It is as if we said that, if people neglect their families to spend time at the gym, then we should discourage gym use by raising membership fees or reducing hours of operation. But exercise--also a good thing in general, though it can be taken too far in many ways--is not the problem here. The neglect of family is the problem, and it is that neglect that should be addressed. In general, our focus should be placed directly on the neglected values (justice, equality, and so forth) rather indirectly on limiting the threat to them (too much efficiency).

Indeed, Schwartz does emphasize the importance of corrective norms, although he resorts to regulation to bolster them:

Perhaps we can use the criticism of Bain Capital as an opportunity to bring a little friction back into our lives. One way to do this is to use regulation to rekindle certain social norms that serve to slow us down. For example, if people thought about their homes less as investments and more as places to live, full of the friction of kids, dogs, friends, neighbors and community organizations attached, there might be less speculation with an eye toward house-flipping. And if companies thought of themselves, at least partly, as caretakers of their communities, they might look differently at streamlining their operations.

True, increased observance of these norms would increase friction and reduce efficiency, but that shouldn't be the goal--the goal should be increased observance of the norms themselves! Again, the result is the same, but I worry that focusing on efficiency as the "target variable" risks obscuring the more important issues behind it.

I think Schwartz would agree with me that, in the end, the best way to conceptualize of efficiency is as a means to an end, in which the values we hold individually and collectively are promoted by it at the same time that they temper its pursuit.

Positive signs regarding "The Future of Economics" from Davos

Mark D. White

As pointed out by Lynne Kiesling at Knowledge Problem, Nobel laureates Peter Diamond and Joe Stiglitz, along with (this year's ASE/ASSA keynote speaker) Robert Shiller and Brian Arthur, discussed "The Future of Economics," which moderator Martin Wolf summarizes at the Financial Times' The World blog. Kiesling condenses Wolf's summary (as reproduced below):

1. First, orthodox economics had, in the years leading up to the crisis, become more a cult than a science, particularly with the assumption that what exists in competitive markets has to be the best possible outcome, since, if it were not, it could not exist.
2. Second, let a thousand flowers of thought bloom.
3. Third, the sociology of the profession – the need to define and defend a core discipline that can be taught to students and so determines what it means to be an economist – militates against such heterodoxy.
4. Fourth, human beings are not rational calculating machines.
5. Fifth, time matters in economic processes, which are, in general, not reversible and not characterised by any sort of equilibrium.
6. Sixth, the world is not computable.
7. Seventh, being a study of complex human behaviour, in which the world is created by human understand [sic] and motivations, economics is hard.
8. Eighth, in theory it is right and proper to abstract in order to focus on a specific phenomenon. In addressing policy, this is irresponsible.
9. Ninth, even though economists get much wrong, they still have much to offer to non-economists who tend to assume that economic problems are far more simple than they actually are.
10. Tenth, there is a great danger that in rejected the most simplistic pro-market mantras, economists and policymakers will embrace even more dangerous and naïve statism.

In my opinion, these are fantastic, especially 4, 6, 7, and 9 (concerning the complexity of economics as a social science and popular misunderstandings of that), 8 (about the responsible conduct of policy analysis), and 10 (cautioning against extreme reactions to the crisis). I just hope people are listening.

Another pointed critique of mathematical modeling in finance and economics

Mark D. White

In today's Wall Street Journal, there is a book review by Burton Malkiel of Models. Behaving. Badly., a critique of excessive reliance of mathematical modeling in finance and economics, written by Emanuel Derman, a key player in developing the very techniques he now criticizes. Judging from Malkiel's review, Derman's book echoes themes which are familiar by now, but are no less welcome for that. Some excerpts from the review:

Mr. Derman's particular thesis can be stated simply: Although financial models employ the mathematics and style of physics, they are fundamentally different from the models that science produces. Physical models can provide an accurate description of reality. Financial models, despite their mathematical sophistication, can at best provide a vast oversimplification of reality. In the universe of finance, the behavior of individuals determines value—and, as he says, "people change their minds." ...

"In crises," Mr. Derman writes, "the behavior of people changes and normal models fail. While quantum electrodynamics is a genuine theory of all reality, financial models are only mediocre metaphors for a part of it." ...

The basic problem, according to Mr. Derman, is that "in physics you're playing against God, and He doesn't change His laws very often. In finance, you're playing against God's creatures." And God's creatures use "their ephemeral opinions" to value assets. Moreover, most financial models "fail to reflect the complex reality of the world around them."

And my favorite:

He sums up his key points about how to keep models from going bad by quoting excerpts from his "Financial Modeler's Manifesto" (written with Paul Wilmott), a paper he published a couple of years ago. Among its admonitions: "I will always look over my shoulder and never forget that the model is not the world"; "I will not be overly impressed with mathematics"; "I will never sacrifice reality for elegance"; "I will not give the people who use my models false comfort about their accuracy"; "I understand that my work may have enormous effects on society and the economy, many beyond my apprehension."...