Sunday, August 26, 2012

Why the Market Must be Governed


This is a presentation I have been playing with the ideas are still very rough, but I think they should be shared if they are to be improved. :)

The thesis is simple – challenge a fundamentalist neo-classical concept of ‘free market’ economics – the concept of Equilibrium – which is based on the 19th Century physics of a closed system of atomistic, isolated entities.

What I want to propose is the political-economics represent living/complex systems. And these types of systems are now well established as existing 'far from equilibrium'. And so the necessary concept is not equilibrium but rather is Homeostasis.

Equilibrium applied to political economics and social dynamics represents a fundamental epistemological pathology (e.g. Gregory Bateson’s Mind & Nature).

I want to explore some of the Entailments of these concepts as metaphors from 19th Century physics versus metaphors from 21st Century biology – including:          Corresponding Distributions and Implications for economic policy/theory

The real voyage of discovery consists not in seeking new landscapes, but in having new eyes
Marcel Proust


While economists were pursuing their vision of the economy as an equilibrium system, during  the latter half of the 20th century, physicists, chemists, and biologists became increasingly interested in systems that were far from equilibrium, that were dynamic and complex, and that never settled into a state of rest. ...refering to these types of systems as complex systems. ...a complex system is a system of many dynamically interacting parts or particles. In such systems the micro-level interactions of the parts or particles lead to the emergence of macro-level patterns of behavior. (p.17-18)
Beinhocker, Eric D. 2006.
The Origin of Wealth: Evolution, Complexity, and the Radical Remaking of Economics. Harvard Business School Press.

The concept of equilibrium (as applied in modern [liberal, neo-classical economics) arose from the 2nd Law of Thermodynamics. This could be defined as the tendency that over time, for differences in temperature, pressure, and chemical potential to equilibrate in an isolated physical system.

The Oxford Dictionary of Physics defines it as: a State of a system where forces, influences, reactions, etc. balance out until there is no net change. In essence, it sees the economy as or a rubber ball rolling around the bottom of a large bowl. Eventually the ball settles into the bottom of the bowl, to its resting equilibrium point... or lowest Entropy

In this way:

The ball will stay there until some external force shakes, bends, or otherwise shocks the bowl, sending the ball to a new equilibrium point. Since the late 19th Century the organizing paradigm of economics has been the idea that the economy is an equilibrium system, essentially a system at rest. ...the primary inspiration for economists from the late 19th through the mid-20th centuries was not biology, but ...the physics of motion and energy. Traditional economic theory views the economy as being like a rubber ball rolling around the bottom of a large bowl. 

Eventually the ball will settle down into the bottom of the bowl, to its resting, or equilibrium, point. The ball will stay there until some external force shakes, bends, or otherwise shocks the bowl, sending the ball to a new equilibrium point. The mainstream paradigm of economics over the past 100 years has portrayed the economy as a system that moves from equilibrium point to equilibrium point over time propelled along by shocks from technology, politics, changes in consumer tastes and other external factors.

While economists were pursuing their vision of the economy as an equilibrium system, during the latter half of the 20th century, physicists, chemists, and biologists became increasingly interested in systems that were far from equilibrium, that were dynamic and complex, and that never settled into a state of rest. ...referring to these types of systems as complex systems. ...a complex system is a system of many dynamically interacting parts or particles. In such systems the micro-level interactions of the parts or particles lead to the emergence of macro-level patterns of behavior. (p.17-18)
Beinhocker, Eric D. 2006. 
The Origin of Wealth: Evolution, Complexity, and the Radical Remaking of Economics. 
Harvard Business School Press.

Homeostasis, on the other hand is the ability of an open system, especially living organisms, to actively regulate its internal environment. Unlike equilibrium as a path of least resistance – the ball in the bowl, Homeostasis is an active ‘intervention’ against equilibrium & entropy, to dynamically maintain a ratio of forces, factors, influences, reactions integral to the a systems. An ‘identity’ which is constituted through its processes and structure.

Homeostasis, therefore is different from equilibrium. Where equilibrium is the tendency  to a path of least resistance - a coming to a natural balanced distribution - something that will or should happen of itself (e.g. the ball in the bowl). Homeostasis, is an active 'intervention' against equilibrium and entropy, in order to dynamically maintain a necessary ratio of forces, factors, influences, reaction.... that are integral to a system's 'identity' - its fundamental processes and structure (autopoiesis). 

Homeostasis, is enabled by a 'governance' system or mechanism of an organism, whereby the entirety of its existence is self-regulated. This is done to maintain he integrity of its identity. 

The entailment of equilibrium then is: 
  • A natural phenomena arising out of a balance where all should be equal 
  • Suggestive of a 'normal' distribution


Wikipedia explains that in probability theory, the normal distribution is a continuous probability distribution, that has a bell-shaped curve - the 'bell-curve'. The logical conclusion from this concept of equilibrium is that a 'free market' will 'average' difference in a way the creates a large middle class. Thus, an ungoverned market will distribute the gains of productivity in a way that theoretically distributes/allocates resources and benefits in an efficient normal distribution.

However, equilibrium can only arise in conditions of a 'closed system' (which made a logical sense in the age of independent, isolated nation states composed of equally independent and isolated 'rational, atomistic beings'. Another condition is that normal distribution only applies to certain measurable characteristics.

The most fundamental criticism of the 19th century physics adopted by modern economics is that many natural phenomena are not distributed in a 'normal', bell-type-curve, the are distributed in a power-law curve - the '20-80' rule. For example, 20% of the books published constitute 80% of the profits, 20% of the earthquakes create 80% of the damage - this applies to craters on the moon, solar flares, foraging patterns of many species, the sizes of activity patterns of populations, the frequency of words in most languages, frequencies of family names, the sizes of power outages, and so much more. 













Some of the entailments of a Power-Law relationship include, the exponential acceleration of comparative advantage
  • The more connected you are - the more likely you are to be able to form new connections
  • Wealth Concentration, Condensation, where created wealth tends to become concentrated in the possessions of the already wealthy (the more money you have the easier it is to make more money)
The long tail of Wealth distribution - or the 'Trickle-up Economy'. Thus, what we see in an unregulated, 'free-market' is the 'normal' long tail of wealth distribution. But, in these conditions of de-regulated market-systems, where is the 'middle-class' of the 'normal' distribution? The engine of consumption & exchange that powers a market system to be able to consume its own products.

What happens is the reversion to a power-law distribution of a feudal society - of a landed (ownership) nobility/aristocracy and rabble - the cancerous erosion of what a real market system must be founded on.













However, the entailment of a concept of homeostasis suggest that an active intervention is necessary to maintain a chosen homeostasis that dynamically balances a societies chosen values. For example, from 1945 to 1980: the bottom 90% of the population had almost 70% of the wealth, while the top 1% had 10% of the wealth.

This began to change dramatically after the advent of the Reagan, Thatcher, Mulroney governments shifted to monetarist economic philosophies. The result was that by 2005, the bottom 90% of the population had only 50% of the wealth and the top 1% had over 20% of the wealth.


The Homeostically Governed Market


The establishment of perfect justice, of perfect liberty, and of perfect equality, is the very simple secret which most effectually secures the highest degree of prosperity to all...
Adam Smith “The Wealth of Nations” p.726


In 1776 two documents were published – The Wealth of Nations and The Declaration of Independence. Both were presupposed on Responsible Autonomy – the necessary belief that individuals were capable of pursuing what interested them as necessary conditions for their own flourishing. 

Both concepts – democracy and a market-system, required justice, equality and freedom from domination. According to Philip Petit, political thinkers of the day thought this initial interpretation of liberty/freedom was thought to be too difficult to actualize and thus came to be understood as a less effective ‘freedom from interference’. In fact, an understanding of liberty as ‘freedom from domination’ is also more consistent with creating social conditions that support an effective application of ‘equality’.

Therefore, another way to view of Smith’s three necessary (system design) principles, is as guides to:
  • Create and sustain a system that enables the maximization of both individual liberty and prosperity
  • Minimize the Gini coefficient, representing robust conditions of an equality of social wealth and productive capability – e.g. an optimal middle-class
  • And a way to protect the commons and other necessary public goods as the foundations of social prosperity (since the profit motive cannot adequately provide for such commons).
The Gini coefficient is a measure of the inequality of a distribution – a value of 0 expressing total equality and a value of 1 maximal inequality. It is commonly used as a measure of inequality of income. Worldwide, Gini coefficients for income, range from approximately 0.23 (Sweden) to 0.70 (Namibia) although not every country has been assessed.

The Principles of Market Homeostasis 

Homeostasis is the dynamic regulation of a system based on the shifting states (gradients) of key values that determine the ‘identity’ and integrity of the system. The values outlined by Smith are not only orthogonal but are generally in conflict with one another

For example, Communism/Socialism focuses primarily on conditions for equality (and perhaps as a consequence, also emphasized centralization of decisioning/control). On the other hand, ‘laissez-faire’ free-market capitalism focuses primarily on liberty (freedom from interference of individuals, which perhaps is why corporation have needed to be seen as ‘persons’, an interpretation of liberty as freedom from domination would have dramatically different consequences). Thus:
  • Primacy on Equality eliminates incentives to excel
  • Primacy on Liberty – privileges ‘might’ & Long-Tail income distribution
The cure to this is not related to the size (e.g. small) government, (the smaller the government the easier it is for a small group to control), but rather on the effectiveness and agility in establishing appropriate ‘course correction’s for the homeostatic balancing of a political economies core values (e.g. justice, liberty, equality) that form its identity. The cure is agile regulation based on fundamental values integral to democratic/market identity through ongoing process of negotiation – something that the life-work of Eleanor Ostrom has well established.

The aim of a homeostatically governed market-system is the same – establishing a robust democracy that supports the responsible autonomy. This means an ‘equal’ playing field with incentives for competition and cooperation for excellence & innovation to increase the Wealth of People and human flourishing and consistent with a self-governing political-economy.