How We Got Here

Two recent articles I read have me thinking about path dependence.  For those who don’t know, path dependence basically means that we (either individuals or institutions) are the sum of historical experiences – history matters.  A corollary is that small events can build up over time to have large historical impacts (read the Wikipedia entry above for the story of VHS vs. Betamax).

The first article comes from the New Yorker and is about how we arrived at the current U.S. healthcare system (The author, Atul Gawande, is a pretty fascinating guy – read his recent NEJM paper on how simple checklists can significantly improve patient outcomes).  The synopsis could be: nobody designed this system, rather many little decisions have now led us to what it is.  This is classic path dependence (and his article calls it out).  Anyone who wants to change the system is going to have to accommodate this and show that their solution is able to deal with all the challenges that got us here in the first place.

The same dialogue is going on right now in the world of finance.  Check out Alan Blinder’s recent article in the New York Times.  He outlines the six retrospectively obvious mistakes that we made to lead us into the current financial crisis we’re in.  This again, is classic path dependence: a few independently made mistakes combines to create one massive mistake that was much great than the sum of its parts.

You might be thinking that path dependence is a bad thing, but that’s not true.  In fact, it can lead to great outcomes.  Before the Euro, one of the reasons that Germany consistently had a high standard of living was the Bundesbank’s focus on low inflation.  They were adamant about keeping inflation low as the Bundesbank’s early governors had lived through the hyperinflation of the Weimar Republic and were obsessed with making sure that it never happened again.