Notes on a lecture by Eric Beinhocker on ‘The economy as a complex and evolving system’
The income of the bottom 90% of earners in the US has stagnated from 1973 onwards.
Pre-1973 growth was more inclusive – the bottom 90%’s income grew faster than the average. Now the reverse is true, with the top 1 and 0.1% growing much faster.
Productivity gains stopped following to workers and started flowing to owners of capital.
A shift from constructive to extractive capitalism.
This has weakened the post-war social contract.
Beinhocker sees this as caused by the rise of neoclassical economics and neoliberal ideology and the associated structural changes driven by this dominant way of thinking about the economy and society.
The breakdown of Western capitalism
The rise of neoclassical economics and neoliberal ideology led to these structural changes:
- Globalisation of finance
- Shareholder value revolution (focus on stakeholders as the only legitimate interest in a company)
- Neoliberal public policy agenda
- Shift from virtue ethics to selfish utility maximisation
This shifted power in the economy, increased power of capital versus labour, and shifted rents to the top of the system. These rents were used to capture the political system.
Rethinking economics
To change the system, we need to revisit the ideas and assumptions behind it.
Neoclassical economics assumes:
- Micro – individual behaviour
- People are rational utility maximisers
- People are self-interested and atomistic
- Meso – social structures
- Markets are efficient in allocation
- Markets are self-correcting
- Firms are optimally run
- State ‘interference’ causes welfare loss
- Macro – system level behaviour
- Macro is a linear adding up of macro
- Natural state is full-employment equilibrium
But the underlying assumptions don’t match with reality:
| Neoclassical Theory Assumptions | Real World Empirical Data |
| Individuals maximise utility, preferences are consistent | Utility functions are not stable; play no role in decision making |
| Individuals behave ‘rationally’ and deductively | Individuals behave heuristically and indictively |
| Individuals have perfect information | Individuals have highly limited and asymmetric information |
| Individuals are self-regarding and asocial | Individuals are other-regarding and highly-social |
| Markets are complete | Markets are incomplete |
| Micro adds linearly to macro | Macro emerges from non-linear micro interactions |
| Markets always find equilibrium | Markets can be out of equilibrium for significant periods of time |
Hence the following incorrect policy memes:
- Markets are always self-correcting
- Inflation is always and everywhere a monetary phenomenon
- You can either have growth or equality
- Trade is always welfare-increasing
- Raising wages reduces the demand for labour (e.g. minimum wage)
- The goal of business is maximising shareholder value
- Tackling climate change will cost growth and jobs
… and the incorrect belief that equilibrium systems cannot:
- endogenously grow
- create novelty
- generate spontaneous order
- spontaneously crash
New thinking: the economy is a complex adaptive system
- Complex: Many interacting agents and organisations of agents
- Adaptive: Designs and strategies evolve over time
- System: macro patterns emerge non-linearly from micro-behaviour
So in this way of thinking the economy is:
- An unfolding process
- Dynamic
- Non-linear
- Distributed
- Heterogeneous
- Networked
- computational
- Autopoetic (self-creating)
- Self-organising
- Evolutionary
- Reflexive
- A social phenomena
- A cultural phenomena
- A physical phenomena
Reimagining capitalism
Capitalism isn’t great at efficient allocation, but it’s good at getting people to cooperate at innovate and solve problems. Beinhocker is happy with capitalism in general, just not the current implementation.
Prosperity isn’t money – it’s the accumulation of, and access, to solutions to human problems.
So we can redefine capitalism:
- The purpose of capitalism is to provide solutions to human problems.
- Wealth is the accumulation of solutions to human problems
- Growth is the rate at which new solutions are created and made available
- Prosperity is the set of solutions plus access
- Goal of business and investment is to create new, better solutions and make them more widely available
- Markets and governments together create an interdependent evolutionary ecosystem for solution creation and access.
Traditionally we’ve assumed that price is the measure of value. But that doesn’t help us measure between good and bad economic activity. (e.g. cigarettes or polluting activities. Or creating a fancy derivative product that ultimately makes the economy more unstable.)
The redefinition of capitalism above helps us distinguish between good and bad economic activities. Ask these questions:
- Is my solution creating a problem for someone else?
- Is my solution creating problems for society (e.g. derivatives)
- Is my solution today creating problems for the future?
- Am I solving a real human problem or just rent seeking? (e.g. high-frequency trading isn’t)
Human cooperation is fundamental to problem solving.
To demonstrate this, Thomas Thwaites tried to build a toaster from scratch.
Because cooperation is crucial, and because capitalism exists to solve human problems, then inclusion and a fair social contract are fundamental to capitalist prosperity.
Fixing capitalism
We need to shift our thinking
| From | To |
| Left vs right | How best to foster inclusion, fairness and trust |
| Market vs state | Effectiveness of market and state ecosystem |
| GDP | Solutions to human problems |
| Market efficiency in allocation | Market effectiveness in innovation |
| Purpose of firms is to maximise shareholder value | Purpose of firms is to make products and services that solve human problems |
| Labour is a cost to be minimised | Employment is a key means of inclusion |
| Markets are amoral | Moral fairness underpins capitalism |
| Economy is separate from society and environment | Economy is embedded in larger complex system of society and environment |
So we need a broad set of reforms to support:
- Inclusion:
- Economic
- Social
- Political
- A fair, reciprocal social contracts
- Effectiveness in problem-solving innovation
- Demand for, and access to, new solutions
- Problem-solving vs problem creating (e.g. the environment)