Sunday, June 24, 2012

When is an economy not an ecosystem

In the previous part of my reply to Jason's most recent volley in our bout of blog tennis, I described the essay "I, Pencil," by Leonard Read, with its description of how an economy works that sounds an awful lot like how an ecosystem works, as far as being self-organized and unplanned.

The more famous economist Friedrich Hayek provides a different phrasing of that same vision, in this case emphasizing the role of the price system in making that self-organization possible. Hayek distinguishes between what might be called the "textbook" economic problem and the real problem. The textbook problem is to have equal marginal rates of substitution for all items in all uses. That is, if a piece of coal would be worth 20¢ in one use and 15¢ in another, it should be moved from the second use to the first. You lose 15¢ in the second application, but gain 20¢ in the first. And because you now have a bit more coal in the first application, the value of the next piece of coal is presumably a bit lower, and since you have less coal in the second application, the value of what's left should go up a bit. As you keep moving coal from the second use to the first, the marginal values keep moving closer together, and when they meet, you've achieved efficiency in coal for those two uses and you should stop. Do it for every use of every good in the economy, all at the same time, and you've solved the "textbook" problem.

Hayek's point (and it's an excellent one) is that this isn't the real problem. The real problem is that no single mind has all the info needed to solve the textbook problem.
The peculiar character of the problem of a rational economic order is determined precisely by the fact that the knowledge of the circumstances of which we must make use never exists in concentrated or integrated form, but solely as the dispersed bits of incomplete and frequently contradictory knowledge which all the separate individuals possess. The economic problem of society is thus not merely a problem of how to allocate “given” resources—if “given” is taken to mean given to a single mind which deliberately solves the problem set by these “data.” It is rather a problem of how to secure the best use of resources known to any of the members of society, for ends whose relative importance only these individuals know. Or, to put it briefly, it is a problem of the utilization of knowledge not given to anyone in its totality. [Hayek, The use of knowledge in society, American Economic Review 35(4):519-530; pp. 519-520]
Hayek also distinguishes three types of planning: the centralized planning that most people think of when they hear the word; decentralized planning by many separate persons (better known as “competition”); and a “halfway house” of planning organized by whole industries, otherwise known as “monopoly”). And he says that the best form of “planning” is the one that will best gather information about what needs to be done and can be done, and best distributes that information back to those who will actually do the work. 

In this context, the important thing about the price system is that it is the mechanism by which the decentralized form of planning handles the information problem:
Fundamentally, in a system where the knowledge of the relevant facts is dispersed among many people, prices can act to coordinate the separate actions of different people in the same way as subjective values help the individual to coordinate the parts of his plan. [526]
It is more than a metaphor to describe the price system as a kind of machinery for registering change, or a system of telecommunications which enables individual producers to watch merely the movement of a few pointers, as an engineer might watch the hands of a few dials, in order to adjust their activities to changes of which they may never know more than is reflected in the price movement. [527]
At least in this particular article, Hayek is talking about relatively transitory changes--things like temporary outages and shortages--but the argument applies with even more force to change that could be described as "evolutionary," the emergence of new technologies and new social arrangments that in their turn create difficulties and opportunities that no planner can foresee. Indeed, Hayek makes a similar point regarding the price system itself. He describes it as a marvel, which doesn’t get the respect it deserves because
it is not the product of human design and that the people guided by it usually do not know why they are made to do what they do. But those who clamor for “conscious direction”—and who cannot believe that anything which has evolved without design (and even without our understanding it) should solve problems which we should not be able to solve consciously—should remember this: The problem is precisely how to extend the span of our utilization of resources beyond the span of the control of any one mind; and, therefore, how to dispense with the need of conscious control and how to provide inducements which will make the individuals do the desirable things without anyone having to tell them what to do. [527]
Curiously, Hayek describes this development as what allowed us to have a form of social organization different from that of the "termite ants" (see p. 528), whereas from my perspective, the fact that money allows us to act in a decentralized yet coordinated fashion actually makes us rather similar to ... termites. But I think I understand why Hayek misses this.
It seems to me that many of the current disputes with regard to both economic theory and economic policy have their common origin in a misconception about the nature of the economic problem of society. This misconception in turn is due to an erroneous transfer to social phenomena of the habits of thought we have developed in dealing with the phenomena of nature. [p. 520]

Well, yes and no. We’ve transferred our thinking about physics, engineering, and technology, but we haven't grounded enough of our economic analysis in ecology, both from the standpoint of the use of resources in the economy and in terms of the ways that an economy is itself a kind of ecosystem in how it organizes itself and how it changes. The self-organizing and adaptive properties of economies that Hayek emphasizes are key elements of the phenomena of nature, hardly unique to social phenomena..

In an ecosystem, there is no particular “desired” end. We can put “success” criteria on an ecosystem as a whole, such as its resilience (ability to return to it status quo ante after a shock), or biodiversity, or the number of times some quantity of energy is passed from one organism to another before being fully dissipated. But those are human-imposed criteria. There’s nothing in the ecosystem itself that cares, or that is measuring success. The ecosystem simply is and does, until it doesn’t. If an asteroid crashes to Earth and destroys myriad species and niches, life will reconstitute itself in new forms: So long, T. Rex, hello, mammals!.

Or there could be an island with an ecosystem that is functioning well by some criterion (say, the quantity of solar energy captured by photosynthesis), and some new species comes floating in on a piece of driftwood and quickly gains a foothold. It’s got no predators in this new environment, and so it soon wreaks havoc, over-consuming some key part of the existing system, leading to a decline in the productivity of the plants on the island. From one perspective, a catastrophe. But given enough time, life on the island will adapt. Species will evolve that are resistant to the newcomer, and others will evolve that eat it. More productive sets of relationships will supersede less productive ones, and the “invader” itself will eventually become a native of the new arrangement—“in the fullness of time,” a phrase I heard often from my grad-school advisor, Gardner Brown.

Evolution always “works,” because evolution doesn’t care one whit about any particular species. It merely favors species that successfully reproduce under given conditions. Those “given conditions” are partly geological and climatological (Are you in a frozen-over sea? A tropical rainforest? A hot desert?), and they’re partly a function of the other species that live there. Since geology and climate are always changing (even if slowly), and since your neighbors are always evolving (sometimes quite quickly), you yourself had better be changing all the time. And as you can read in any mutual-fund prospectus, past performance is no guarantee of future results. The dinosaurs were successful for 150 million years, paragons of evolutionary success. And then they were gone, and mammals came into their own, new paragons of evolutionary success. From our perspective, this was a wonderful development. From the dinosaurs’ “perspective,” it was a disaster. And evolution didn’t care one way or the other; it just kept right on going, nudging whatever genetic material it could find into forms that were better suited to the environment at hand.

And this is where we have to be careful not to push the economy/ecosystem parallel too far, because the economy is the ecosystem of us, and we do care about particular outcomes.

All that evolution guarantees is that there will be an outcome. But we humans are picky, and we like some outcomes better than others. Perhaps the “natural evolutionary outcome” of a human economy is widespread deforestation, or heedless combustion of fossil fuels leading to climate change that reduces most humans’ quality of life. Or maybe the “natural evolutionary outcome” is ever-increasing concentration of wealth and political power, with a healthcare system that delivers inferior results at excessive cost, but that "thrives" because it supports the further concentration of wealth. Or maybe they’re both natural outcomes: neo-feudalism in a radically altered climate regime (Hel-lo-o-o, Mad Max). Certainly the natural outcome regarding postal service is not flat-rate deliveery to every corner of the country.

Hayek is right that the economy is far too complex to be planned in every detail, in the way that the Soviets and Chinese tried and failed. He’s right that money is a remarkable tool that allows societies with millions of people to meaningfully coordinate their actions, despite the fact that each person, even each group of people, knows only a tiny fraction of all the information that needs to be taken into account. But he also puts a normative value on the outcomes of the decentralized system: Anything that results from the decentralized economy is presumed good; anything that results from “government intervention” is presumed inferior. And in this he is simply mistaken.Governments are certainly capable of screwing things up. They can be tyrannical, corrupt, obtuse, inefficient, … But they can also do useful things which are beyond the magical abilities of the market. In making use of government, we shouldn’t throw all caution to the wind. But if I’m right to see the economy as a particular kind of ecosystem, an ecosystem for and by us, where we care about particular ecosystem results, then we have no choice but to make intelligent use of government. And for more than merely the enforcement of property rights and contract law allowed by the Austrian school from which Hayek emerged.

Government itself is an evolved social institution. It's not the antithesis of "the market," some alien imposition on some otherwise pristine interaction of economic free agents. Markets and states are co-evolved systems--or rather, economies are evolved systems that include governments as well as markets. When that system is in the path of a metaphorical asteroid, and we think a changed role of government would be useful, we can try to get our fellow-citizens to agree. We don't have to just stand there and "let nature take its course." If some piece of the economy (Ahem, banks) is in private hands and is making a hash of its job, we should look at different ways of getting that job done.

We have more foresight than the dinosaurs and, after all, even our foresight is a product of evolution. We should consider using it.

Next time: Actually addressing Jason's post ... I promise!


  1. Hi Karl,
    Enjoyed reading this, although I have to admit I'm getting anxious--are these two prefatory posts just a set-up for when you thoroughly rip into my Expropriate Goldman-Sachs: Jumpstart jobs for a green economy? But the tone leaves me hopeful!

    I really like what you have to say about markets and states as "co-evolved systems." It's a very important point. My only issue with the terminology of evolution is how it may lead to thinking that markets and states conform to some sort of natural selection mechanism. That's not necessarily even true about biological evolution--as you put it, evolution always "works" because there is always an outcome. Or in some sense, the idea of "survival of the fittest" was always tautological.

    So, long way of staying that markets and states have always shaped each other historically, and have always been shaped by people trying to get other people to agree with them, sometimes of course by quite coercive measures.

  2. Fine, you call them "prefatory posts," I call it "stalling." Two weeks ago, or whenever it was that you put up "Expropriate," I had a sense of where my answer was going to go, but working out the logical structure of it has proven trickier than I expected (that shouldn't surprise me at this point, but I'm a slow learner).

    I suspect that there _is_ some sort of natural selection mechanism at work among economies, in an almost tautological sense. There are elements of chance in the survival of societies, and elements of changed resource availability raising a society up at on time and crushing it at another. But among that "noise," shouldn't there also be a signal? If an economy is effective at feeding and clothing (and arming) the people who constitute it, shouldn't it be more likely to have a growing population, or at least a sustained one? And be more able to support culture? And be more likely to prevail in armed conflict, whether acting in defense or in conquest?

    That veers in a very social-Darwinist direction, except for two things. There's nothing inherently social Darwinian about it as far as domestic policy. A through-and-through social Darwinian hates the social safety net because he thinks it helps the "inferior" members of society survive and thus weakens society (or rather, the "race"). But a Darwinian process of selection _among_ societies could well favor an intelligently run social-welfare state.

    That still leaves Darwinian international relations, and ... I don't have as good an answer on that. The best I've got at the moment is the idea that coalitions of states that cooperate may thrive more than those always picking fights, but that doesn't feel like much of an answer.

    Anyway, I won't be "thoroughly ripping into" your "Expropriate" post. I hope to write on Friday; right now I'm in the throes of getting a draft of a working paper finished.