There is also a good book of George Soros called “Alchemy of Finance” , where he specifies his reflexivity theory.
I can state the core idea in two relatively simple propositions. One is that in situations that have thinking participants, the participants’ view of the world is always partial and distorted. That is the principle of fallibility. The other is that these distorted views can influence the situation to which they relate because false views lead to inappropriate actions. That is the principle of reflexivity. For instance, treating drug addicts as criminals creates criminal behavior. It misconstrues the problem and interferes with the proper treatment of addicts. As another example, declaring that government is bad tends to make for bad government.
Both fallibility and reflexivity are sheer common sense. So when my critics say that I am merely stating the obvious, they are right—but only up to a point. What makes my propositions interesting is that their significance has not been generally appreciated. The concept of reflexivity, in particular, has been studiously avoided and even denied by economic theory. So my conceptual framework deserves to be taken seriously—not because it constitutes a new discovery but because something as commonsensical as reflexivity has been so studiously ignored.
Recognizing reflexivity has been sacrificed to the vain pursuit of certainty in human affairs, most notably in economics, and yet, uncertainty is the key feature of human affairs. Economic theory is built on the concept of equilibrium, and that concept is in direct contradiction with the concept of reflexivity. As I shall show in the next lecture, the two concepts yield two entirely different interpretations of financial markets.
The concept of fallibility is far less controversial. It is generally recognized that the complexity of the world in which we live exceeds our capacity to comprehend it. I have no great new insights to offer. The main source of difficulties is that participants are part of the situation they have to deal with. Confronted by a reality of extreme complexity we are obliged to resort to various methods of simplification—generalizations, dichotomies, metaphors, decision-rules, moral precepts, to mention just a few. These mental constructs take on an existence of their own, further complicating the situation.
The structure of the brain is another source of distortions. Recent advances in brain science have begun to provide some insight into how the brain functions, and they have substantiated Hume’s contention that reason is the slave of passion. The idea of a disembodied intellect or reason is a figment of our imagination.
The brain is bombarded by millions of sensory impulses but consciousness can process only seven or eight subjects concurrently. The impulses need to be condensed, ordered and interpreted under immense time pressure, and mistakes and distortions can’t be avoided. Brain science adds many new details to my original contention that our understanding of the world in which we live is inherently imperfect.