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September 02, 2010

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GaryA

Come on George...I have been away from your blog- any blog, any PC for 2 months while I moved house. Now what chance have I of getting to grips with a catch up agenda when you produce long-winded gems like this.(wink)
Gimme a break and slow down a little....

porge

Whew! That should have been a two parter! Some would even say it was prolix(I never get to use that word and is the main reason I threw it in ;).

Your depth and breadth across so many topics and how they relate never ceases to amaze me George.

I know one regular here that will have some interesting comments for this post since the subject is right up his alley and I can't wait for his insights to be added.

I have limited time right now to comment and I also want to read the post again but I will say that I have had debates on TOD over the last year and have defended just about every position that you take and especially agree that the almost living quality of the "market" to "learn" and adjust rapidly at the point of transaction is simply never going to have a substitute.
No type of planning is ever going to approach the real time efficiency of people acting and reacting in their everyday affairs to maximize utility.
Having said that the biggest Achilles heel of the market approach is the enormous blind spot to longer term unintended consequences........multiple current predicaments to wit.
I wholeheartedly agree that rather than contrive systems (economics, even law) we should look to nature as a model and base our processes on natural process and our laws on natural laws.
The answers are all around us if we just look for them.
I'll be Baaaack (terminator)


porge

correction:

Your depth and breadth of understanding of and across...........

Phil Henshaw

George,
It does seem I've pointed you to the escape from this tangle more than once. I don't know what to say, your obfuscation is magnificent, but doesn't correct for the common investment cycle of finance. People invest if they expect a return and to be able to add their return to the principle they are investing.

There are two and only two ways for that to stabilize. One is for investors to notice the point of diminishing returns approaching and choose to divest their earnings to maintain maximum returns.
The other is to wait around, as Keynes and Boulding and I have successively harped on till we are blue in the face, till returns on investment are zero. Market forces work perfectly with either solution.

Alan Renaud

Had to pause at the bit titled "Unfettered Competition in a Non-Growing Real Asset Economy."

Stoneleigh's contention, I believe, is that bubbles always self-destruct due to Ponzi dynamics...800 years of market bubbles (and their collapses) against a backdrop of growing in-flows of energy to would seem to suggest this interpretation has some truth to it.

In other words, our current world predicament could have been anticipated purely on the grounds that what started as a bubble and grew (thanks to globalisation) into the largest bubble ever seen by man, was surely going to end in a collapse--diminishing returns on available net energy, while seductive as a deep explanation to why we are where we are now [in 2010], may not, as it turns out, be strictly necessary...

That doesn't mean, however, that we are not facing real energy limits ... we could be looking at two monsters simultaneously: an ordinary (though extra-ordinary in size) Ponzi collapse, followed in the shadows by a lurking hulk, something darker and nastier, that our Western civilisation has never had to contend with, the spectre of limits to growth and the genuine end of a way of life...

porge

Phil,
Yeah, in a perfect world where everyone plays fair and with honor.
If you will notice, most "investment" is in pure financial instruments now which have no basis in anything tangible or productive.
All that we have now is a glorified casino with the gamblers playing zero sum games. Money is a pure abstraction that has become detached from the underlying real "wealth" (or whatever you want to call the sum of natural capital and value added due to technology and labor improvements).
I think one of George's main points is that first the currency needs to be linked to the underlying real world (I like energy as the initial measure of potential) then all the mechanisms start to make sense and operate toward the desired ends.( George correct me if i am wrong)
It is the tertiary economy becoming de-linked and taking on a life of it's own that has led us way off course and not the mechanism of the market itself.


George,
I think you hit the nail on the head by observing that China has a front end strategy that regulates and steers the big inputs into the economy and lets the market take it from there.
That hybrid system has worked a little better than the economic anarchy that we use.
Just linking the currency to a predetermined energy flow rate would be a decent start...now how to do that........is another matter.

ruralcounsel

I promise to go back and read the whole article, but the first thing that came to my mind was...How do we know whether something is actually an economic PROBLEM?

Seems like that should be the first issue to address, rather than whether free markets are a solution to all economic problems.

I treat warily any idea used to do something good for "humanity as a whole." How is that defined? Or even measured? We know global optimum is not the same as local optimum. We know that many horrific things have been done on the local level to achieve purported global justice.

Constraints are often imposed for the benefit of the constrainer, not the constrained.

porge

One more thing is that time based interest(AKA usury) needs to be abolished because it creates a false increase in the amount of currency on paper before the fact of production.
The only investment relationship should be equity share interest where the investor puts up the capital in energy based currency which represents the energy required for the venture and hence linked to the predetermined flow rates and of course the entrepreneur puts up the know how and creative idea (which is by far the most important part of the investment). The risk should be shred equally.
If you look at the history of usury you will find that the risk share aspect is the reason it was outlawed.
We need a system that prioritizes and rewards productive, creative ideas and discourages gambling.
Money should never be allowed to increase just because time passes and in fact it probably should decay like the scrip used in an Austrian town during the depression era.
We want to improve the human condition not increase the balance of the account statements of a few greedy usurers.

Jackl

Excellent analysis. One thing I think is also a contributing factor, but which isn't really covered in your post, is the role of advertising in modern markets. I would argue that modern advertising techniques serve to further obscure the intrinsic value of products through the psychological techniques of branding, causing people to overestimate the value of products, and to create artificial "bubbles" for products.

barbara

I will have to dissect this article slowly and carefully. Your article is impressive from what I understand so far. -- barbara

blagroll

If one doesn't accept as the basic predicate that markets are inherently natural, as in somehow existentially existing apart from human kind or its activities, then much of what you posit afterwards, although relevant to modern society due to its predominant belief system in so-called natural markets, can't be the basis for others to draw new conclusions or insights. This is not to say that many of your insights and conclusions aren't compelling, but they do lead to, from my prespective, a cul de sac. At best we can draw comparisons with biological or ecological systems (in as much as we understand such systems or processes), but this doesn't validate the notion that markets exists independently or that humanity somehow mimics other naturally occuring system without realising that it does so. We can only use other "naturally" occuring systems or processes through comparison analogies or metaphor. Do we mimic beavers when we build our homes? Do we somehow mimic cities/colonies of bacteria and fungi when we build Detroits and Manchesters? I would argue mostly no. We do these things because they benefit humanity, or subsets of humanity in dealing with our physical world. We do not do so through some innate biological or cosmically occuring ecological drive in which we'll eventually discover the underlying, pre-existing rules of the naturally occurring markets.

Yes, markets, where goods and services are exchanged, have a long and natural history in human involvement; especially in complex hierarchically constituted socities. There have been endless varities of markets, but there have also been societies that have thrived and endured without markets as we understand them in the West.

There are many common features of long established markets, or types of markets that have disappeared and only to reappeare later, that seem to indicate that market mechanisms have certain physical constraints such as location of primary resources, transportation, security concerns and so on that are common to many markets in different times and places. We shouldn't, however, confuse the physcial constraints of markets with the notion that these physical constraints somehow validate the notion that markets are cosmically constituted or would exist extant without human acitivity. They are merely physically limiting descriptive features of markets.

When we humans feel the need to trade goods or services, the notion of naturally occuring markets, imho, only serves to cloud the issue with regard to market outcomes. Rather, we should be asking a series of questions about how we use the earth's limited resources, how the finite resources are allocated via their initial condition and finished conditions, and how we can create markets that have satisfactory outcomes for our various societies and the world around us. What I see around me are mostly disfunctional markets where the vast majority of participants are merely consumers and market costs such as pollution, habitat destruction, population displacement, human ennui, are "externalised". They are conceptually allowed to be externalised because we think this is how markets naturally function or these are the natural outcomes of complex, modern markets.

Since so many people think markets exist apart from or are detachted from human direction, we do not ask how or why these outcomes occur or, if we do, we come up with a simplistic answer such as we have too many regulations (human intervention) which don't allow market to functionas they would naturally (without human intervention). Natural becomes it own justification for outcomes. Natural becomes tautological. No debate nor reconstitution of how we deploy markets is possible based upon the notion of cosmically and naturally occuring markets. Instead we are reduced and mis-directed into searching for the perfect way to employ markets. By way of analogy, we are reduced to searching for market atoms, and understanding how these atoms function, we can then discover how the market molecules form; eventually understanding how markets are "supposed" to function.

Btw, love your articles and insights. Always thought provoking.

George Mobus

GaryA,

The slowing down will most likely be happening. The school year is about to start and I have a great deal to do to get ready. The blogs will likely be fewer and further between for the next month or so!

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Porge

Having said that the biggest Achilles heel of the market approach is the enormous blind spot to longer term unintended consequences...

I didn't say much about the strategic level of management but, in theory, that would be tasked with trying to determine future scenarios so as to get some early warning of unintended consequences. That is likely a subject for another, prolixic, post!

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Alan R.,

Perhaps a question should be asked regarding why Ponzi schemes get traction in the first place. What is going on in the environment that induces people to get into these schemes. I would suggest that the scale and extent of the bubbles we have witnessed are a response to the real decline in net energy that meant a real decline in real wealth production. Inflating the values of certain assets (like houses), or calling pieces of paper backed by empty promises assets and then inflating those seem to me to be responses to the energy phenomenon. In order to maintain an illusion of growth it was necessary to allow the financial industry to create imaginary assets and sell them as if they were real.

It would be interesting to analyze past Ponzi (read financial) schemes to see what was going on in the surrounding market environments that might have made the schemes seem worthwhile. I realize the get-rich-quick motivation is operating in individuals, but surely there were those who could see through the illusions and sound a warning.

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ruralcounsel,

You make a good point re: defining something as a problem. However I think there are few doubts about whether our economy is suffering from problems right now. And this article addresses the claim that one often hears from libertarian types that a 'free' market solves all problems.

I think I did make it clear that the central objective of an economy is equitable (not equal) distribution of assets. Anything that fails that test would be, in my estimation, a problem.

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Porge (#3)

I suggest an across the board limitation on profit period. How much profit on a value-added activity is enough/too much? I suspect it will depend on the industry. Where profit is used to hedge against future uncertainties (like a bad crop year) the profit rate would depend on the risks involved.

That is the scheme I would have liked to see in a steady-state economy where the point is to maintain the very long-term viability of production processes that satisfy the needs of a non-growing population. But now with energy flow reduction on the scene, we are looking at a contracting economy. What does that mean as far as profitability is concerned? Tough question.

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Jackl,

You are so right about advertising. I did a side swipe by pointing out the susceptibility of buyers to see 'features' as more important than substance. If a man sees an attractive woman draped over a sports car... Its the psychological factors that make humans susceptible to advertising.

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Barbara,

Hope it continues to make some sense upon dissection!

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blagroll,

Am a bit uncomfortable with the distinction you seem to be trying to make between 'natural' and human-deployed markets. I have generally operated under the premise that humans are as much a product of nature as anything, and thus our 'systems' are natural. I don't see a dichotomy between what humans do and what so-called natural systems do, so the word nature should not denote such a dichotomy. There may be qualitative and quantitative differences between all previous market examples (e.g. an ecosystem) and human markets, but that is a result of the evolution of complexity and not some dualistic essence.

But maybe I misunderstood!

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George

Sam

George,
Sorry I’m coming late to the party here (it was either reading this blog post or my chemistry textbook, and unfortunately the latter had to take precedence). This is exactly what I was hoping for—much more, in fact. You touched on many of your key theses while constructing a very solid argument in favor of a more circumscribed approach to understanding the utility of markets in society. As much as some libertarians would find this hard to believe, Adam Smith would likely agree with many of your points. He extolled the idea that markets had to be governed first and foremost by human sensibilities, that we couldn’t let markets deteriorate our values. Markets only work smoothly when both parties behave in an ethical way, in a manner which upholds the values of honesty and fairness that you alluded to in your essay. Your argument also finds support among other early economic theorists, such as Alexander Hamilton, who noted the dangers of overspecialization. Hamilton worried that the U.S. would become too dependent on overseas imports if we lacked our own manufacturing base, and instead relied solely on commodity exports for foreign exchange—the price of which fluctuated with global demand that even in those days had little to do with the work involved in producing it.

The consequences of such dependency are clearly illustrated by the failure of many African countries to effectively develop. Countries that depend primarily on the export of food crops or minerals have seen their economies (and trade balances) plunge when commodity prices fluctuate. That’s not to suggest that these countries need to export goods in 50 different sectors to be competitive—that would simply be the problem of overspecialization manifesting itself differently. But a sustainable system cannot be based around the production of too few goods, each of which is ultimately dependent on the vagaries of nature for its existence, nor can it be based around the production of so many goods that specialization allows people to ignore physical realities and obscures information about the true cost of goods.

As much as I want to offer informed skepticism to this piece, I don’t think you have too many holes to fill. You’re right about needing to find effective ways to police markets and monitor the monitors, but I’ll wait to hear your thoughts on that in a further post.

You do assume that prices in an ideal market will be regulated to some extent. That is to say, buyers will pay roughly the cost of production, while allowing the seller to make a living. But this only works if the quantity demanded equals the quantity supplied. If the regulated price was lower than what people were willing to pay (despite the fact that the regulated price is more reflective of the actual cost), then shortages would result, and some wouldn’t be able to buy that product. The seller wouldn’t make excess profits, which is good, but on the other hand some people wouldn’t get the goods they desire. So an ideal market would have to have a regulator not only regulating the price of goods, but also how much is produced, to avoid creating shortages which could in turn generate a black market. Of course, regulating the quantity produced is difficult when goods produced ultimately come from nature, the whims of which are subject to change from year to year, while demand for many staple products holds roughly steady. The problem of excesses (too much of a good at a market-regulated price) seems to be more self-policing, that is, if farmers or craftsman produce too much of a good, it doesn’t sell and they produce less next time.

I guess the only thing I would add is that while the flow of energy and resources is important, it is not the only factor affecting the fate of market economies. Remember that in theory, knowledge is limitless unlike resources. And as with energy flows, knowledge flows have increased dramatically within the past few centuries. This knowledge hasn’t always been put into practice wisely, but it exists regardless. Such knowledge has enabled us to move beyond inefficient steam engines to more efficient sources of energy. Now as you know, correlation does not equal causation. Simply because higher energy flows are correlated with economic expansion does not make them a cause. So what specifically makes your causal argument any more compelling than the one libertarians make, that knowledge has increased in lock step with energy, and humans have used this knowledge to find ways to get around other resource limits in the past (after all, necessity is the mother of all invention, right?). So as we continue to increase our population, it seems like we’ll just have an easier time of finding solutions. What some dogmatic skeptics may ask is how are the problems you’re describing any different from the 1970s doom about resource depletion which occurred just prior to the Green Revolution—a triumph of human ingenuity over the perceived capacities of nature? You alluded to this in the piece, but drawing this out a little more couldn’t hurt.

But as I said, I’m not doing much more than grasping at straws, you made a very strong case and I hope this makes its way to a larger audience at the Oil Drum without too much delay.

porge

George,
I think that in a steady state economy that the main thing that needs to be monitored and controlled is resource use and not profit.
Profit can be(and has often been) from increases in efficiency. This type of profit should not only not be restricted but encouraged.
We need to get really good at getting the most from the least and direct all our resources and efforts toward quality of life improvements for all.

Capitalism is an astonishing belief that the wickedest of men will do the wickedest of things for the greater good.
John Maynard Keynes

mikkel

"For example, the rising price of, say, oil will not result in more investments in substitute fuels (like corn ethanol) or alternative energy sources like solar or wind, because these latter are not actually physically viable substitutes. They do not have the energy density potential that fossil fuels have, and on top of that, the energy capture and conversion capital needed to make them work at all is based on using fossil fuels to build them. If the price of fossil fuels goes up with reduction in supply, so does the cost of alternative energy capital. No market can change basic physics."

A more explicit extension is that in this scenario market failures are guaranteed even with highly accurate knowledge. Since price is based on supply/demand instead of any absolute amount, price for alternatives will be higher until the point in which demand exceeds supply but at that point the market has already failed and it'll be very costly to transition. Or as the people at the oil drum point out, in reality it creates a very volatile environment of price spikes and collapses, which continually destroys investment and thus productive capacity.

Because of desire for return on investment (or interest if borrowed money) it is mathematically impossible to provide a relative profit for undergoing the transition so markets won't do it. And that is assuming you actually convince people that the problem is real and to start transitioning in time! Once you add in uncertainties then the risk adjusted returns are highly negative.

The only way around this is to either get the government to provide policies of guaranteed ROI or [as mentioned above] to convince enough people that the future has negative ROI on all traditional investments that alternatives is the smarter play.

This is a really good post and I love the explanation. I am more skeptical about the idea that increased information will really solve many of the issues though because of the effects that information overload play. It's been well demonstrated that in general there is an optimal amount of information content to maximize rationality in a transaction and once it increases then people go back to irrational based methods. I am much more partial to having trade barriers that will guarantee as many basic necessities as possible are locally produced and consumed while long distance markets operate on luxuries.

George Mobus

Sam,

Welcome to the party!

So an ideal market would have to have a regulator not only regulating the price of goods, but also how much is produced, to avoid creating shortages which could in turn generate a black market.
[emphasis added]

I'm a little uneasy with the notion of an 'ideal' market. From a modeling standpoint we can pretend that such an entity exists and see how it performs. But from a realistic standpoint I prefer a closed-loop system (of regulation) that self regulates toward an 'ideal' goal, i.e. equitable distribution.

But I'm OK with sometimes having shortages and other times having surpluses. That is exactly where local markets can work to right the course. Similar to your last sentence in that paragraph.

Simply because higher energy flows are correlated with economic expansion does not make them a cause. So what specifically makes your causal argument any more compelling than the one libertarians make, that knowledge has increased in lock step with energy, and humans have used this knowledge to find ways to get around other resource limits in the past (after all, necessity is the mother of all invention, right?).

This relies on a deep understanding of dynamical systems and the role energy flow plays in emergent organization. Organization comes in two forms, there is the physical structure of a system (what parts are interacting with what other parts) and the internal 'knowledge' that maximizes dissipation of energy flows. Knowledge is a natural consequence of energy flows through systems far from thermodynamic equilibrium but not yet in steady state. I've often recommended Harold Morowitz's classic "Energy Flow in Biology" and, more recently, "Into the Cool: Energy Flow, Thermodynamics, and Life" by Eric D. Schneider and Dorion Sagan. I've covered this topic in my series on Systems Science, specifically #5: http://questioneverything.typepad.com/question_everything/2009/04/the-science-of-systems-5-.html

George

George Mobus

Porge,

Check Fig. 5 again. You'll see that resources are monitored. I didn't elaborate but I agree that there is a need to do so. I will be thinking more about this governance issue (if you didn't see my series on Sapient Governance here is the series index URL: http://faculty.washington.edu/gmobus/Background/seriesIndex.html#saient_governance )

As far as profit control is concerned, my thought was more along the lines of establishing a societal norm, informed by the science of resource depletion/recycling and energy, that represents a fair target (my own educated guess is 1-2%). Then the mechanisms of the transparent market can provide self-regulation. I mentioned in the piece about relative value in context - the two farmers changing their willingness to exchange at different rates depending on circumstances. No external coercion is needed, just a norm of fairness and transparency.

But profits need some kind of normalization in order to keep producer-sellers from cheating and, in the end using more resources than were necessary. I'll have to write this up in more detail some day.

George

George Mobus

Mikkel,

I am more skeptical about the idea that increased information will really solve many of the issues though because of the effects that information overload play.

This is a good point and probably a major factor in why the current situation is so bad! The information measure that you mention is likely a so-called objective measure, that is, independent of the observer, like channel capacity. There is an observer-dependent measure of information that is based on the observer's processing capacity, which is what I assumed. Overload depends on this version of information measure. And that is exactly why I claim that markets as practiced now have become opaque. The observer (potential customer) cannot grasp the value basis because they have not got the processing capacity to deal with so much potential information.

In the more limited sense of rational local markets (with the monitor in place) the information load would not be that high because the monitor takes on the job of processing to summarize a single price/value ratio or, alternatively, a profit margin report on products that are complex and beyond the knowledge of the buyer.

So, in a sense, this system actually produces less volume of information, but better targeted information. The catch, of course, is that it would require sellers to open their books to the monitor and expose what is now considered proprietary information. Probably not something most companies want under the current system of unfettered competition.

On your last point, my guess is that as transportation costs relative to prices that buyers are willing to pay, go up, the long distance trade in commodities will decline as we head down the slope of oil production.

George

porge

George,
If you want the benefits of the market you can't tell it what to do.
Just regulate the big inputs and leave the rest to the rest.
You are bordering on tampering my friend.

porge

More:

The best you/we can hope to do is educate the populace in the true spirit of science.
After that the natural progression will ensue.
I know it can be tempting to think that you might have the perfect solution(I know that I have been of that delusion more than once)but in the end nature will do what nature will do. Believe it or not most people are smarter than you think they are.

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