The Evolution of Economics

Seneca 4BC–AD65:
“What difference does it make how much is laid away in a man’s safe or in his barns, how many head of stock he grazes or how much capital he puts out at interest, if he is always after what is another’s and only counts what he has yet to get, never what he has already You ask what is the proper limit to a person’s wealth? First, having what is essential, and second, having what is enough.”

There is much wisdom in the words of Seneca, written some 2000 years ago, on which the future of global economics may yet need to reflect. However, this discussion will start by making some attempt to understand how and why the global economy has become so complex and essential to the modern world.

In order to begin to understand this complexity, we might initially adopt the approach of ‘reductionism` and 'determinism`, where the former tries to reduce the overall complexity in terms of simpler underlying mechanisms, while the latter considers every event as being determined by a series of preceding events. As such, we will start with the initial question:

Where did the notion of an economy start?

In a sense, it might be argued that the basic concept of an ‘economy’ begins with any conscious exchange of goods and services, which can initially be perceived in terms of a ‘barter system’. However, the beginnings of such exchanges might well be traced back to even more primitive survival mechanisms, which pre-date human civilisation and certainly long before the creation of any formal financial institutions. Of course, somewhere along the way, the sophistication of today’s global economy has ‘evolved’ beyond all recognition.

So what drove this change?

While, at this stage, it would be premature to try to answer this question directly, we might recognise that the mechanisms of financing ‘the economy’ have undergone radical change over the last few hundred years or so. While the next cartoon may be unfair, it possibly reflects how many now perceive the ‘evolution’ of our financial institutions and the people that run them:

For what might have started out as an ‘exchange’ in a literal sense, i.e. you scratch my back and I’ll scratch yours, now appears to have evolved to encompass not only the idea of money and credit, but ever more abstract ideas, such as hedging and derivatives. While a full description of such concepts is not really the focus of these discussions, some initial outline might be useful for preliminary reference:

  • Asset: In the current context, an asset is simply something that has value, e.g. goods, services or commodity, which might be exchanged or traded. 

  • Money: Represents some equivalence of an asset, i.e. goods, services or commodity, which may then be more easily exchanged for another goods, services or commodity.

  • Credit: Allows one party to obtain an asset from another party in advance of needing to or even necessarily being able to immediately reimburse the another party, which then usually involves some additional payment by way of interest.

  • Hedging: Started as a way to reduce or spread risk. Today, people invest in managed hedge funds that can use a range of financial techniques over a wide spread of assets to generate a higher return for a given level of risk. There is also a perception of a hedge fund manager being yet another form of financial ‘parasite’ as suggested by the cartoons above and below, while the fund managers will probably see themselves as simply being astute investors. 

 

  • Derivatives: Are a financial agreement where a payment is agreed based on certain conditions. Many derivatives define options that can increase the gain or loss that result on maturity. For example, the buyer may make an initial small investment, which is also  a commitment for a much larger purchase by a certain date. Based on market movement, in the time period agreed, the buyer either makes a gain or loss, such that derivatives can be likened to a financial bet.

While the financial mechanisms outlined above have existed in some basic form for many hundreds of years, the sophistication, complexity and abstraction in today’s economy has increased exponentially. However, these basic definitions may also highlight the evolution of a global economy that now separates the world into those who produce things, those who provide services and those who simply trade things and services. While it may never have been more true that ‘money makes the world go around’, many now question whether the rewards extracted from the economy by financial traders and institutions is disproportionally high.

However, without going into too many details at this stage, it is clear that idea of physical goods and services, which initially underpinned most early economies has now been abstracted in terms of  ‘tradable assets or commodities’ , which can be bought and sold in many different ways. However, despite this apparent abstraction and complexity, it might still be said that what drives any economy is the desire to acquire ‘wealth’. In 1776, Adam Smith published The Wealth of Nations’ in which he described wealth in terms of the economy of a society, i.e. as the annual produce of the land and its labour. Of course, in the context of his time, Adam Smith’s definition of the ‘produce of the land’ was possibly orientated towards more basic human needs, e.g. food, land and other natural resources. However, the following definition might still be applied to an individual, institution or nation-state:

  • Wealth: Is defined as an abundance of valuable resources or material possessions, although today it may often be quantified purely in monetary terms.

While the idea of wealth is not directly mentioned in Maslow’s hierarchy of human needs , we might recognise that wealth may help to address many of our most basic survival needs, as well as inferring both esteem and power on an individual, institution or even nation-state. If so, the motivation to acquire wealth may have been a key factor in the evolution towards today’s global economy. However, there appears to be both a dichotomy and inequality within the present global economy that is characterised in the cartoon below:

So, in the context of reductionism and determinism, we might see the acquisition of wealth as a fundamental factor that has driven the evolution of the economy, both in scope and complexity. However, while the desire for wealth might help explain the ‘why’ economies have evolved, it does not necessary explain ‘how’.

So what might be described as a fundamental mechanism of economic growth?

Again, from a simplistic starting point, it may be argued that all economies depend on the mechanism of a ‘transaction’ in some form or another; where the growth in the sum total and complexity of all financial transactions helps to explain the evolution of the global economy we see today. Let us add the basic idea of a transaction to the growing vocabulary of economic terminology:

  • Transaction: Beyond the basic idea of barter, a transaction can be introduced in terms of a buyer giving money or credit to a seller and the seller giving an asset, i.e. goods, service or commodity, to the buyer in exchange.

Today, most transactions take place in the context of a specific ‘market’ that categorises the commodity being bought or sold and helps define the normal terms and conditions applying to the transaction in question. So while the nature of the ‘market’ may add to the complexity of our overall introduction, all economies are still built on the basic idea of a ‘transaction’, i.e. trade. Of course, if it were really this simple, we might wonder why history is littered with so many ‘boom and bust’ cycles of economic growth and collapse and why economists continually debate the reasons for these cycles in terms of both ‘cause and effect’. However, as stated, this opening discussion is only meant to be a ‘starting point’; although we might still make an initial guess as to some of the fundamental causes of economic instability:

  • Human nature, i.e. greed, can lead to irrational and fraudulent transactions.
  • The scope and total number of transactions is almost impossible to control.

Again, while it is recognised that the possible causes cited above are very simplistic in scope, they may still serve to highlight some of the most basic problems that future discussions will need to consider in more detail.

2008 Financial Crash

By way of an example, the global ‘crash’ of the economy in 2008 might be attributed to the two bullets above, while being explained in the following terms:

  • In search for ever greater profits, US and other global financial institutions created products based on ever riskier mortgages, while finding ways to sell them as secure investments.

  • Supposedly independent rating agencies appear to have endorsed the risky mortgage assets with AAA ratings, which were then sold on to global buyers. Many of these agencies subsequently blamed the failure of their ratings on computer automation, possibly suggesting that nobody was personally to blame.

  • Having sold on the risk, original lenders were no longer concerned as to whether any borrower could actually afford  to pay their mortgages. Equally, when freed of this risk, lenders used ever more dubious tactics to convince home buyers to take out mortgages without concern of the consequences from which they appeared immune.

  • In a growing credit-driven market, possibly better described as debt laden, the home buyers accepted these mortgage loans without fully understanding that the equity of their homes could fall. When confidence in the house market collapsed, many home buyers lost everything.

  • Faced with the prospect of the economic collapse of its financial institutions, governments stepped in and passed on the cost/losses to its tax payers, thereby creating a debt burden that may take generations to repay.

  • In the midst of this crisis, much of the tax payers’ money effectively ended up in the pockets of the executives of the financial institutions responsible for  the crash in the form of bonuses and gold handshakes.

However, should you believe that the 2008 collapse was an extreme one-off event or possibly a once-in-a-lifetime event, the following extract taken from the Wall Street Journal might make you more cautious in your optimism:

I have witnessed the 1980s savings-and-loan crisis, the 1987 stock-market crash, the 1997 Asian financial crisis, and the 1998 collapse of a hedge fund called Long-Term Capital Management that had to be bailed out before it took down the global economy. Then came the 2000 dot-com bust. Then, the 2008 financial crisis and the muck our economy has been stuck in ever since. Every crisis is different in detail, but the cause is always some variation of the same game: High rollers amass debt until they can't pay it off, and then they default, setting off a string of insolvencies that can be stopped only by putting taxpayers at risk. Systemic fraud is exposed in every crash, but little is done about it. Big business, big government and big bankers are too often from the same self-dealing clan. The most culpable among them will claim no one could have possibly seen the big crash coming, even though plenty of warnings went unheeded. Economists working for the looting class often compare the economy to the weather. They claim that unavoidable cycles cause crashes, as if the economy were a natural phenomenon, existing apart from humanity. But humans create economies, and humans cause financial disasters. Financial crimes are tolerated in the name of free-market capitalism and the comforting pretension that another economic crash could never happen again.”

This initial discussion has been  entitled 'The Evolution of Economics ’ for two reasons. The first by way of a direct analogy to the evolutionary idea of  ‘survival of the fittest’, where  it would seem that most of the population do not appear to have the necessary ‘skills’  to survive without the protection of the rule of law. As a consequence, the second reason for the title of this discussion is the perceived need for further evolution of the global economic system, so that a degree of both moral and legal justice may one day ‘hopefully’ come to underpin the governance of those that seek to profit by it.

What is implied by the call for both moral and legal justice?

Any economic system, both local and global, clearly reflects the morality of men, and women. In the extract above, there is an implicit suggestion that large-scale systematic fraud, i.e. stealing, took place on a regular basis, which if committed in almost any other context would be classed as a criminal offence subject to a prison sentence. Therefore, knowing the limitations of human morality requires the addition of legal justice or accountability.

So how many people were held to account for the 2008 losses?

While there may be some mileage in the analogy of the global economy being similar to a chaotic weather system, the chaos was still man-made and little effort appears to have been made to correct its fundamental weakness, i.e. the human condition. As such, the 2008 economic crash should not be likened to a natural disaster, but possibly likened more to global warming, i.e. problem effectively ignored. To-date, no senior official or banker has even been charged, let alone sentenced for the wholesale financial fraud that took place over the many years leading up to the 2008 crash.

OK, but did the losses essentially amount to a victimless crime?

To give some scale to these losses in the US alone, it has been estimated that homeowners lost something in the order of $3.3 trillion in home equity during 2008, while 1 in 6 still remain in negative equity relative to their mortgage debt. It is also estimated that shareholders lost about $6.9 trillion in share value in 2008. While these losses amounted to almost 1/5 of the GDP of the entire world, the real impact was, and still is, felt by those who lost their homes, their jobs, their life saving and pensions as a direct result of fraud or as an consequence of the government cutbacks needed to address a growing national debt and the knock-on downturn this caused to the global economy. In the description above, the losses in the US, attributed to the 2008 financial crash, have been estimated to be in the order of $10 trillion, i.e. 10*1012. If we divide this figure by a US population of 320 million, i.e. 320*106, it would suggest a loss of over $30,000 per person, although we need to question whether this figure has any meaning as the ‘value of money’ has not been quantified. Therefore, let us table another question for consideration:

What is the value of money?

It has been stated that money represents some equivalence of an asset, which can be exchanged for goods, services or commodities. However, it might be realised that money has no intrinsic value in itself and the history of German hyperinflation may also suggest that the perceived value of money can quickly evaporate given a precariously dependence on market confidence. Today, the value of money is also affected by general inflationary effects, market devaluations and other financial mechanisms, such as quantitative easing. Therefore, changing the value of money can also change the perception of the wealth of a nation, such that it has ultimately to be quantified in terms of its assets, i.e. goods, services and other commodities. So, given this note of caution, the following table only provides a somewhat arbitrary monetary comparison as the basis of further discussion, which will be out of date before you read it:

Global GDP $72 trillion
Global Population 7 billion
Global Millionaires 10 million
Global Billionaires 1500

Again, if we simply divide the global GDP by the global population, the figure might suggest a distributed wealth amounting to $10,000/person. However, in reality, nearly 50% of the global population earn less than $2/day, while the top 1% control nearly 50% of all wealth.

But does this distribution of wealth simply reflect the entrepreneurial skills of the few?

While this may be true in a few cases, it would not necessarily imply that it is fair, while history would suggest that the distribution of wealth might be better described in terms of the survival-of-the-fittest. However, this form of natural selection is possibly best described in terms of the evolution of political power as seen across all geographies of the world. Today, the nature and scope of this ‘power’ can take many forms, but invariably seeks to control or manipulate both the legislative and judiciary branches of government to the benefit of the few rather than the many, while often ignoring the long-term interests of the planet as a whole.

While repeated reference has been made to the idea of a 'global economy’ based on trade between nation-states, it is clear that many of these nation-states have adopted different ‘economic ideologies, which we might initially separate in terms of ‘socialism’ and ‘capitalism’. For, in many ways, the central argument within the socialism versus capitalism debate are anchored in the issue of economic equality and the role of government. From an ideological perspective, rather than its practical implementation, we might define these two positions as follows:

  • Socialists: believe that too much economic inequality undermines a society and therefore governments must legislate policies to protect and benefit the poor in terms of the distribution of wealth.

  • Capitalists: believe that government does not use economic resources as efficiently as private enterprise and therefore society is better off with the free market determining economic winners and losers.

However, while these positions might be described as different economic ideologies, in practice, the situation is often ‘muddied’ by the political ideology in which they are implemented, e.g. democracy versus communism. While the debate surrounding these political positions will be deferred, it might be said that the pairing of ‘socialism-communism’ often appears to lead to an unelected political elite ignoring the plight of the poor. While the pairing of ‘capitalism-democracy’ may seem to require the political elite to take ‘some note’ of the poor in order to be re-elected, in practice, the self-interest of the ‘rich and powerful’ may still be  prioritised.

But is either pairing really capable of solving the world’s problems?

Today, political correctness can often suppress public discussion of certain topics that may appear to conflict with the growing demand for human rights. However, although this position is both understandable and commendable, there comes a point where such rights and freedoms have to be seen as ‘self-interest’ that has to be reconciled with the ‘collective-interest’ of society as a whole. Therefore, the suppression of debate, because it may appear to conflict the new norms of political correctness does not necessary make the underlying problems go away. So let us table a question that few honestly discuss in open debate:

Are there too many people surplus to requirements?

In most economies, there is a supply and demand for job skills, which may ultimately define the separation between the rich and poor. However, on a more uncomfortable note, evolution in the form of the ‘survival of the fittest’ will not only determine who prospers, but who lives and who dies. Based on the earlier figures above, it would seem that a true democracy of the majority would simply be representative of the poor in society rather than its rich minority. If so,

What economic policies would such a majority demand?

One might reasonably assume this majority would simply demand ‘more for the poor’ as it would be in their ‘self-interest’ to do so. However, the next graph might, in part, provides an alternative insight as to how the answer to this question is currently evolving. For it suggests that wealth distribution between the rich and poor in the US, as in most developed economies, has continued to widen over the last 30 years, despite a conceptual democratic majority being dominated by the poor or, at least, the non-rich. One can only assume that the wealth distribution in Russian in respect to the emergence of its financial oligarchs and the rapid increase in Chinese millionaires would only lead to an even more mark separation between the rich and poor on a global basis. However, this situation may also tell us something about how self-interest may play its part in a world of increasing resource shortages.

So, in some respects, it would seem that the rich and powerful can still manipulate the economy to their advantage, irrespective of whether the political system is autocratic or democratic. However, there is possibly a bigger problem associated with the distribution of wealth, when considered in terms of the sum total of natural resources. Today, the global population is approaching 7 billion and projected to be in the order of 9-10 billion by 2050, possibly peaking to 15 billion by 2100. While the ecology of planet Earth already appears to be under threat, even with current population levels, it might be possible for further efficiencies  to support a doubling of the global population. However, this optimism ignores the 50 fold variation in resource usage between the top rich 1% in comparison to the bottom poor 1% of the global population. Should the bottom 50% of the global population ever aspire to use just half of the resources of the top 1%, this could equate to a 10-20 fold increase in global resource usage, even if the population remained static. Possibly, in the face of this stark reality, we might begin to understand why the question previously tabled has so many unpalatable implications, which few politicians appear to want to discuss in open public debate. Unfortunately, this problem will not go away, although the idea of the survival-of-the-fittest’ can always provide a very brutal solution, such that future generations may not be able to ignore the fundamental question:

Are there too many people?

If so, then the workings of global economics may also tell us something much more profound about how our world may evolve and some of the possible consequences that future generations may be forced to address. Hence the debate will be expanded to include 'The Growing Storm' plus The Limits to Growthand The Future of Eco-nomics?in the series of discussions to follow.