If you ask a random person what economics is, you're likely to get an answer having to do with money. But when you go into your first day of economics class, you might be told that, sure, money is involved, but that economics is about a lot more than money. It's a social science, one of the ways of studying how people make decisions. It's the science of how people allocate scarce resources toward competing ends.
"Resources" can include things like oil, clean water, or fish, but usually economists focus on a much broader conception that takes in labor and capital (that is, things like productive machinery). Resources in the sense of natural resources are there, too, but the study of their role in the economy is a pair of specialized sub-disciplines, resource economics and environmental economics. Labor and capital are treated as the really interesting things, and economists argue over how to make sure there's more capital, what makes labor productive, why labor is or isn't being used at different times.
So that's economics, the study of the economy. But what about the economy itself? What does an economy do? Here's a really good way of thinking about it, taken from a paper by Charlie Hall at SUNY's College of Environmental Science and Forestry:
Energy comes from the sun, from geothermal activity, and from the breakdown of radioactive isotopes. Some of the sun's energy gets bound up with matter in the trees of a forest or in the crops of a farm, and from there gets passed to animals. Other solar energy millions of years ago got bound up with organic matter that was trapped and turned into fossil fuel.
Humans cut trees, harvest crops, mine fuels and metals; we process the things we've harvested and extracted; we manufacture goods out of what we've processed; we use the goods along with some more of our labor to provide services (either for ourselves or as our business).
All along the way, matter is rearranged from one form to another. What drives that rearrangement is energy, which is getting dissipated all along the way. Some of the energy itself is transformed, from petroleum to gasoline, or from sugar cane to ethanol, or from grass to cow to hamburger meat. The transformed energy ends up in the tank of the consumer's car, where it makes the car go, or in the consumer's stomach, where it makes the consumer go. Once it's done that, it too is dissipated to the environment.
The matter doesn't dissipate, but moves through the economy from extraction to consumption. At each stage, some of it leaves the economy as waste, including after consumption (the pizza box from dinner last night, the styrofoam that protected your computer on its journey to your house ... the computer itself after a few years).
The diagram doesn't show it, but there is some circulation of the matter: paper and glass that get sent back into the processing stage of the economy; organic materials that decompose and find their way back to the soil. With that little addition, we've got a situation an awful lot like an ecosystem, where matter circulates in a series of rearrangements, driven by energy, which is dissipated to the environment.
A situation an awful lot like this one from the previous part of this series. With a little relabeling and tweaking, we can represent the economy in similar terms:
Like an ecosystem, the economy needs to capture and reduce thermodynamic gradients, it's just that it makes use of different ones. The dominant gradient in ecosystems is the solar gradient captured by plants, and this was true for preindustrial economies as well, where almost all the energy could be traced back to crops or trees growing somewhere. Preindustrial economies made use of the solar gradient in other forms as well, such as power from wind when different parts of the Earth heat up differently or from water when the sun evaporates water from the ocean and drops it on
mountains as rain or snow. Modern economies still use those gradients, though in updated forms, such as hydroelectric power stations on wind turbines.
There's an irony in this development. In ecosystems, the key breakthrough was the "invention" of photosynthesis, which made a vast new source of energy available to life on Earth. The comparable breakthrough for human economies was the discovery of how to use fossil fuels for more than just heat: first as a replacement for wood in the making of iron and steel, then as a replacement for wind and horses in moving things around.
Once we figured that out, we made ourselves ever more dependent on the large gradients available from fossil sources. But that same change has lessened our dependence on the sun and on photosynthesis, that innovation that had been so important to all that came before us. Still, economic processes, just like the functioning of ecosystems, depend on finding, capturing, and utilizing (reducing) thermodynamic gradients.
The similarity between ecosystems and the physical structure of the economy goes well beyond these considerations of energy. Different species play roles in ecosystems, much like different industries and occupations play roles in economies.
You might think that trade is uniquely human, but it too has its counterparts in ecosystems. There are nitrogen-fixing bacteria that live on the roots of legumes (beans and peas). The bacteria take nitrogen from the air, turn it into a form that the plants can use, and make it available to the plants; as if "in return," the plants provide the bacteria with some of the sugars they have produced using photosynthesis.
Or you could point to innovation. We didn't always know how to make computers, or steel, or bronze. "We" had to figure out how to make stone blades, then metal ones. Humans went from being hunter-gatherers to pastoralists and farmers. And we changed from depending exclusively on solar-driven sources of energy to running our economies mostly on fossil fuels.
But this last example points to the obvious similarity in ecosystems, which is evolution. Ecosystems didn't always "know" how to perform photosynthesis, but some genes changed, and then they were able to do it. And there's actually a whole perspective on economics known as "evolutionary economics," which applies Darwinian insights to economic processes, as with Nelson and Winter's An evolutionary theory of economic change. And there's the relatively new application of "agent-based modeling" to economics, drawing on similar ideas to create things like the Sugarscape model of societies.
Strictly speaking, it's probably best to say that ecosystems and economies are both instances of a broader concept, that of a complex adaptive system. In ecosystems as in economies, there is complexity, with the properties of the whole system arising from the interaction of lots of individual "agents." And both types of things are adaptive, with diversity among the agents, selection according to some criterion of success, and amplification of whatever is "successful."
My first exposure to this idea was in the book, The nature of economies, where Jane Jacobs lays out the structural similarity between an economy and an ecosystem. And it's only stretching the usage a little bit to say that an economy is an ecosystem, just one created by humans.
Yet there's a key difference, and it has to do with the success criterion. Success in an ecosystem is tied to reproduction, getting your genes into the next generation. In an economy, it's about creating and getting your hands on value, which leads in turn to money and the financial system. But that's taking us beyond the physical structure of the economy, so I'll stop here for now.
Next: The sweet smell of success