The Fundamentals of Economics
I'd like to examine the political economy from the perspective of systems science. Specifically I want to put biophysical economics together with the theory of hierarchical cybernetic systems to see if we can't find some guidance to developing a model of a well regulated, functional, and maintainable economic system. Political economy is the study of the intersection between the system of governance and the economic system that supports those participating in the society. There are quite a few political theories regarding this intersection, from strict forms of socialism to anarchy (no governance) wherein the free markets will self-regulate. But these political theories are inevitably based on ideological frameworks. In the end they are supported not by evidence or even logic, but by emotions and “gut feelings.” Here I want to do an analysis of a biophysical economic system, i.e. one based on the scientific realities of energy, work, wealth, and the laws of thermodynamics, that asks what might we find as scientifically based models of regulation that, in particular, keep the system in balance with the Ecos and maintained over an indefinite period of time.
My analysis begins with the fundamental components of any economic system, the individuals that participate in a social contract involving specialization of work skills and trades of wealth. One might be tempted to think of this as the ultimate microeconomic framework.
To be clear, economics involves the control of behaviors that contribute to the obtaining of resources needed to maintain a biological system, including those needed to extend the system into the future, e.g. reproduction. The biological mandate to continue to exist and reproduce is paramount. Every human being is bound by this mandate and all economic decisions are subject to its dictates.
In spite of all the seeming complexity and sophistication of human behavior, ultimately it is all directed at fulfilling this mandate. We can more easily see this by looking at human evolution. What were we when we evolved to our current form? What were our behaviors as creatures of nature? The exposure of our basic biological heritage can be gleaned from this background.
Figure 1, below, depicts this unit of economic activity, an individual. I've chosen to start with an individual from a pre-agriculture time to show how this is basically a biological entity. Energy flows from the sun to plants and from there to animals and humans (some via animal protein). Humans can then do physical work using resources from nature to produce various tools, such as stone cutters and scrapers, wooden digging sticks, and clothing, that all give the human leverage in obtaining the natural resources.
Figure 1. Early Homo sapiens obtained life support through hunting and gathering getting energy from plants and animals. Human labor, in the form of fashioning useful tools allowed humans to more efficiently obtain the energy, which was a major evolutionary advantage.
By contrast consider the modern state of affairs. Each individual human is now amplified in their work capacity by the burning of fossil fuels for 80%+ of their high-power work needs. Figure 2 depicts this situation. Humans, by virtue of producing power tools can do considerably more work than they could by hand. So they produce more product (or service) per unit of time and wealth (the aggregate of products and services) accumulates. Some of those power tools increase the human effort efficiency (not necessarily the work efficiency), which is called “productivity”, a seemingly good thing. When humans were few in numbers, even after having mastered water and animal power to improve their productivity, there seemed to be enough energy and material resources so that the economic activity of individuals could expand giving rise to accumulation of wealth. Surely that was a good thing!
Figure 2. The use of external high-power fuels to drive automation amplifies the human capacity for work many fold.
The individual unit as depicted in figure 2 will be the one we will use later. Returning to the early human situation, consider figure 3 below. This is the fundamental unit of social economics. The basic idea was recognized by Adam Smith as the inherent capacity for certain individuals to become specialized in one kind of work wherein they are very efficient. The products so produced, however, have wider appeal and so two (or more) individuals producing excesses over their own needs may enter into a trade relation in which they negotiate an exchange based on some perceived relative value per unit of their products. That is they barter.
Figure 3. A simple model of specialization and trade. One human produces product A and needs or wants product B. The reverse is the case for the second individual. They negotiate a trade on the basis of some perceived unit value of each product.
Incorporated into figure 3 is the now more prominent material resources such as wood and fiber as well as rocks and, later, bronze metal. The situation represents, roughly, the transition period from the Paleolithic to the early Bronze Age. Humans were in the process of mastering building and shaping arts, becoming proficient in agriculture and animal husbandry, and engaged in trade on an inter-individual and inter-group basis.
The figure shows the flows of matter, energy, and influence (messages). Each individual human is responsible for applying control to the work process (e.g. farming, making tools, etc.)
The cybernetic element in this model is the individual, an adaptive agent capable of making hierarchical cybernetic decisions and learning to change economic behaviors based on experience in various situations.
Every human individual must make a range of decisions that guide their economic behavior. These range from purely operational level decisions (plant the seeds in this plot of land), to logistic (save enough seed from this harvest to plant next year), to tactical (obtain some new seeds from the tribe over the hill) to strategic (find a way to expand my territory). The individual agent thus embodies the whole hierarchy of cybernetic management with respect to their own individual behaviors. Some individuals were particularly good at different levels in this hierarchy. Some (a few) particularly good at strategic and tactical thinking were able to organize the activities of many members of a social unit. We will examine this tendency later.
In figure 4 I have provided a simple representation of an adaptive agent that will be developed as the fundamental economic agent. Bear in mind that all that motivates this agent is the biological mandate. Ultimately all decisions are directed toward maintenance and reproduction. But because the agent is adaptive and also under the mandate to maintain life at the least cost, it will find creative ways to accomplish its mission with the least risk while conserving energy.
Figure 4. An economic agent (an individual) is modeled as a decision maker with an ability to consider operational, tactical, logistical, and strategic decisions.
The human brain is a hierarchical cybernetic system that evolved in response to the increasingly complex world it had to survive in.
Things Get Complicated
I will start with a refresher on hierarchical cybernetics as realized in the human brain (the agent) and with examples form meta-biological social systems, especially commercial enterprises. All humans do some kind of work and produce things that they and others can use in carrying out the biological mandate. Figure 5 shows a work process in which an operational-level controller maintains the quality of the product through a feedback loop. If the product being produced gets out of specs, the operator (agent) generates a control signal or action that brings the product quality back into alignment with the desired values. Those values are, of course, determined by what the “customer” wants.
Figure 5. Work processes produce a product that is desired by a customer. The quality and quantity of the product requires close monitoring by the operational level management of the human agent.
The next higher level in the cybernetic hierarchy is the coordination level. Figure 6 shows the agent performing both feedback and feed forward control. The coordination level serves two basic purposes. The first is to coordinate the behaviors of some number of internal sub-processes within the basic work process (shown later). The second is to coordinate the overall behavior of the work process with the external environment, in particular, the sources of inputs and the sinks for outputs. In this figure I show a simple version of a coordination level controller using the beginnings of a tactical (pre-tactical) model and feed forward information from the input flows to send commands to the work process in order to modulate the input flows appropriately, for example by using internal buffers to store excess in times of plenty and supply internal sub-processes in times of want.
Figure 6. Coordination with the external world begins by monitoring the input flows against their desired values and modulating them to be within the desired ranges.
Logistical control handles coordination between internal sub-processes when a work process is complex. It is broken up into sub-processes, each of which has its own operational control and an overseer logistical controller.
Figure 7. Coordination of internal sub-processes involves logistical controls. The controller receives messages from the operational level controllers regarding time-averaged behaviors of the processes. It uses a balancing or optimization model to determine the best mix of operational control settings so that all of the sub-processes operate in synchrony (harmony).
In many situations (many different kinds of systems) the logistical control is somewhat automatic, requiring little in the way of “conscious” decision making; this is the case for the human brain, for example. Most of the regulation of internal subsystems is under non-conscious control, e.g. heart rate and breathing when exercising. In most large organizations (e.g. corporations) the routine procedures that are followed (codified in procedures manuals) are similarly automatic and senior management does not concern itself with the details of middle management's work until the profit and cost center numbers come in, say, at the end of the month. Even then they do not worry about the details but rather just reward or punish performance.
When a complex system is operating in a complex environment the demands on tactical control are great. The system must advance from merely checking flows in and out, but must actually have more information about the sources and sinks themselves. From the pre-tactical coordination to a fully tactical form we need new kinds of message processing that collects data from the external world and provides this to a full tactical controller. Whereas pre-tactical involves relatively simple real-time sensing, the tactical controller works over much longer time scales relative to the operations. It includes anticipatory models of the environment that can be used to predict future behaviors that could lead to variations in the resource inflows or customer demands, etc. Figure 8 depicts this situation.
Figure 8. A full tactical controller (evolved from the workings of the pre-tactical version) is able to sense the behaviors of external entities of importance to the system and use models of those behaviors to anticipate the near future, thus being able to devise tactical moves to minimize negative impacts or maximize positive ones for the whole system. The tactical and logistical controllers still need to communicate with one another to provide complete coordination, within and without.
Once again, the human brain is a wonderful example of this capacity. Our external sensory system is constantly taking in data about the state of the world while we are not sleeping (or daydreaming). It processes this data into percepts based on our memory system's images, which, in turn, feed into the concept processing areas of the brain. We are continually processing lower-level concepts, e.g. there is a wall in front of me, which we have learned to handle without much conscious attention (turn to avoid the wall). Our interactions with our social world takes much more processing and not a small amount of conscious attention since people are generally always surprising us to some degree or another. We have to have models of them to help us react to or anticipate their behaviors. Many brain scientists think this is the basis for the evolution of our larger brains, that our social interactions are so much more complex than those of our nearest relatives (apes) that we need much more processing capacity to interact tactically with other people.
Organizations, too, invest considerably into tactical coordination. The purchasing department, the sales department (with marketing), the shipping department, etc. are all examples of complex operations that deal with the external environment, attempting to maximize benefits to the organization (get the best price). Marketing departments in particular are a lot like the social tactical facilities in the brain (and this is actually not just an analogy) representing some very conscious considerations with respect to getting customers to want the products and be willing to pay good money to get them.
Tactical decisions are about how to win the battle; they are relatively short-term in scope. But decisions about which wars to wage, that is strategic, longer-term, and involving the likely changing of behaviors to achieve a strategic opportunity or avoid a threat. For this a new level of cybernetic management is needed that can process long-term plans and direct modifications to the internal structure or tactical models such that behaviors of the system change to accommodate long-term changes in the environment. This involves extending the time horizon and scope of the world models associated with tactical control. The new level is strategic/planning.
Figure 9 depicts the larger scope of strategic control. The strategic decision maker is receiving information from the tactical (and logistical) controllers but also receives information from the larger world, those entities with which it might not have direct interactions (clouds), but whose behaviors might impact the sources and sinks with which the system does interact (e.g., influence arrows from clouds to sources). This is more than just tactical control; it evolves from tactical control when the larger environment is highly dynamic, complex (e.g., bi-directional arrows between clouds), and non-stationary giving rise to a need to understand how the future will shape up in order to avoid new dangers and exploit new opportunities. Not shown in the figure, the strategic controller has the ability to “pre-adapt” functions and processes within the system such that new behaviors can emerge to make the system more competent in the future state of the world. The strategic control is responsible for long-term planning based on its best estimate of what that future world will be like.
Figure 9. Strategic control obtains information not just from the tactical level (based on the behaviors of sources and sinks) but also from other factors in the environment that may impact those sources and sinks. It looks at general models of these factors to try and set plans for changes the system need to make internally to take advantage of opportunities and avoid threats in the long-run.
Certain areas of the prefrontal cortex in the human brain perform this function. Most human beings do have a limited capacity to think about the future and lay plans. The brain certainly has the capacity to learn about the behaviors of other entities in the world that do not have a direct influence on the individual, but are part of a larger stochastic dynamic that could come to have an impact. The brain does have the ability to do some limited strategic planning and control, but whether the majority of people fully use this facility is an open question.
Organizations, similarly, have a strategic thinking function and tend to try to use it explicitly. However, because these functions are carried out by people, the true efficacy of such functions is subject to how well the individuals think strategically.
One key difference between strategic and tactical control involves the capacity of the system to make alterations to its sub-processes or even gain new sub-processes that will be used in the future. Human beings cannot do much to change their individual selves, for example they cannot ‘learn’ to digest a poisonous plant that might become food. Biological evolution is needed to alter physiological and physical aspects of the body. Humans can adapt within narrow ranges of tolerance to changing environments, but not change their fundamental ways of interacting with the environment.
They can, however, change their tactical models, or in other words, learn to behave differently with respect to the world. For example, humans learned to construct and wear clothing to increase their tolerance to cold conditions, something necessary during the periods of glaciation in Europe and Asia. This was not a strategic decision but a tactical move that had strategic consequences for individuals and for the species. The only internal sub-processes that humans can alter or acquire are concepts encoded in engrams in the brain. Strategic decisions generally involve changing sub-processes, so an example of a strategic decision would be when deciding on what in the world should be attended to and be a source of learning. For example, when someone thinks about what career they would like to pursue they are making decisions that will result in changing their own brains (the engrams) one way as opposed to another.
Organizations, on the other hand, have tremendous ‘morphing’ abilities (called evolvability). They can alter, gain, or discard sub-processes at will (of the strategic thinker) providing they have the resources (i.e. financial) to do so. An organization's behavior can be radically altered in the sense that it becomes capable of doing something entirely new vis-á-vis its tactics and logistics. But organizations are limited by the cognitive capabilities of their strategic managers (CEOs). Unless they possess real vision and knowledge of the world, they may not be able to take advantage of their evolvability. Most organizations change as a result of experimentation and muddling through rather than planning and executing. It is tempting to wonder what might happen if an organization actually did do a good job of strategic planning and execution. I think there are a few examples in history, but since those successes depended on visionary individuals, after they retired or moved on, the organization generally fell back into the muddling mode.
The Trouble with Markets
Really complex systems, those with many various kinds of sub-processes that must work together to be successful in a complex environment, require a cybernetic hierarchy in order to do so. One of the reasons this is so is that inevitably communications break down between more distant sub-processes when the information must be relayed across many such intervening sub-processes as is the case in a highly connected but sparse network such as depicted in figure 10. Here all nodes, representing sub-processes, are fully connected through interactions (abstractly represented by links between nodes). Any behavior changes in any one of the sub-processes can be propagated throughout the network eventually impacting all the other nodes and probably with reverberating effects at that.
Figure 10. In a network of interactions, even if sparsely connected, the propagation of effect due to one node may affect every other node.
There will be time delays inherent in the system since it takes time for information to propagate. Add to this the notion that active (thinking and deciding) agents can exert local control over how and when (or even whether) the process can propagate the information to other nodes and you have the potential for the introduction of noise and distortions. The results can be disastrous when time delays and positive feedback loops (amplification) are involved.
It turns out that markets are really like this situation. Markets are systems in which aggregates of agents transact (trade) through links. Such transactions can be simple exchanges such as barter or more complex, involving tokens of value that are exchanged along with the movement of goods or performance of services. When markets as systems are relatively simple, e.g. the outdoor markets where food and trinkets are traded the possibility for establishing connections between agents for the purpose of establishing the relative value of what is being traded makes it possible for the market to establish consensus values in the form of fair prices. Each seller knows what effort and costs went into the production of their products and each buyer can attempt to keep the sellers as close to those costs, i.e. not expect to make a huge profit at the buyer's expense. Through the jostling of buyers and sellers haggling the magic of a market mechanism for setting prices is pretty much what John Smith described in Wealth of Nations.
Unfortunately as trades become more complex, for example involving transporters and middlemen, as the separation between buyers and sellers increases in time and space, as products and services become more complex and specialized, the information flow needed to allow that magic to work is increasingly subject to distortions (including false or misleading information). Prices fail to reflect any real costs (plus fair profit) and the system becomes vulnerable to crashes and bubbles — exactly what we see in the modern world.
Even though libertarian ideologues clutch onto their cherished Randian notion that the market is the best mechanism for establishing prices and, through competition, generate greater goods and services, systems science shows us this is not the case. Market mechanisms are good for small-scale and simple systems. But as the system becomes much more complex they are incapable of providing the needed information flow to ensure all sub-systems are working optimally.
Throughout the history of life on Earth, from its origins to the present time, nature's answer to emerging complexity has been the same over and over. At a certain point in a system's evolution, hierarchical control evolves so as to stabilize and maintain the system. If it does not, the system fails to survive and therefore cannot compete against those that do. The latter are the survivors (and replicators) and live on to undergo further evolution and participate in further complexification. Societies and their economic systems are no different. Governments have always developed ways to regulate flows in systems through various supra-economic mechanisms (e.g. taxes and policies). They are (usually) unwittingly carrying out the natural emergence of hierarchical control, albeit messily. Evolution does not work by producing perfect systems, in the sense of engineering for a purpose. It experiments. It is a massively parallel search through a possibility space of options and only some of them work. The history of humanity is full of multiple attempts to find some mechanisms of regulation (operational, coordinational, and strategic) that suit their societies given the technologies and beliefs held by those societies.
None of the societies to date have gotten the formula right and that definitely includes the western democracies. The combination of republican governance (i.e. representative democracy with evolving inclusiveness) and capitalism, along with, as it turns out, foolish beliefs in the role of greed and profit taking, were bolstered in the late 19thth centuries by the unprecedented influx of high power energy in the form of fossil fuels that were abundant and relatively easy to extract. These interacting aspects reinforced one another to produce copious material goods and services, what I would call ersatz wealth. Those agents who benefited most from this explosion of production naturally looked upon the ideologies behind the aspects and concluded that it was good to let capitalism and free markets flourish in a society of free individuals. They didn't think twice about the role of energy, so distanced were they from the realities of existence (Figure 1) that it never occurred to them that wealth was not a product of capitalism and free markets, but in reality a product of energy flow. It wasn't until the latter half of the 20th century that some people started questioning this situation. What would happen when the finite resources of fossil fuels became depleted? The modern meme holds that technology will figure out a replacement.
In my next post in this series I will address the issues involved in designing an intentional political economy based on hierarchical cybernetics and biophysical principles. Where this goes involves recognizing that the biological mandate, as described earlier, must be regulated in such a way that agents can be free to act in manners that maximize their well-being but also do not jeopardize the well-being of the society (indeed the species). It is hard to imagine that a governance system comprised of human agents, with their faults and foibles and also driven by the biological mandate, could achieve the right combination of benign oversight and non-coercive regulations needed for the complexity of modern human societies. But it seems a worthy challenge to me to at least ask the questions.