Old Economics vs. New Economics
The New Economics that we need cannot be built. It has to be created by the people, through the choices they make and can only be observed by the scientists. The power and the responsibility for creating a new world with no recessions or slow downs cannot be given to those who are trained to record, not to lead. Asking those who were part of the teams that created the problem to clean up the mess is easier than asking them to create a new system.
Currently, business economics seems to operate like a slightly more complex version of the game of monopoly – where you start off with some money, buy and sell assets, milk the assets for what they are worth based on the demand that lands at your doorstep and then try to win by monopolising the entire board. Sometimes you borrow and you lend, some of us add some leverage, bets and options to make it more interesting – as we do in real life. And yet we know that the game of monopoly works if you keep getting hand outs for going round and round – each time you pass go, you receive a hand out. We may argue this point, but players know how many times the handout has saved their play. The objective of monopoly is to bankrupt other people. Maybe in business too. In real life, as a society, we aim to ensure that nobody is bankrupt, if possible. Or do we?
Herein lies the essential dichotomy in our current way of doing business. We operate on the principal of personal competition. It is almost a Darwinian struggle, though this time it is not about survival but about winning. We find ourselves trying to squeeze all value out of other players, not seeking to partner with them but to almost bankrupt them.
And we have seen, that doesn’t work.
If half the people were bankrupted every year (assuming the zero sum game, for every winner there would be a loser) the game would stop. Finito. Unless there were handouts.
And that is not possible, let alone sensible. Where does an infinite supply of handouts come from? From the great balloon in the sky? The ever expanding universe?
Competitive living can only create chaos. We are witness to that. As is our reason. New economics has to be built on collaboration. If we want it to be sustained, want us to be sustained. The tribes of legend may have figured out sustainability better than we post-industrial era people. But does sustainable have to mean small? Is it at the cost of growth, of improvement, and dare I say it – of innovation? To rephrase, is collaborative growth not possible? Not in our current models, not in our current mindset.
Let us take trading in financial markets:
In place of buying and selling what is real today, we trade in possibilities and probabilities. We have moved on from trading reality to trading vision. What is value in the present is dismissed as already in the past and we seek the Net Present Value (NPV) of the future.
When you are trading on visions of the future, you are trading on something that does not exist – it is a possible future. This scenario changes as reality evolves – as we traverse time. The changes in present information then changes the vision of the future – and thus their valuation. As the valuation changes, the price at which it is traded changes. It is like saying – ohoh.. we realise that we got that wrong (based on new information) – let us write off the wrong and replace it with another estimate. Which of course, naturally, will be proved wrong as new realities emerge. This is how the market is designed, is structured. It is designed to trade in error margins.
This is what we have been dealing in for years – margins of error. And playing for who gets to guess this right.
Let us now take advertising – a multi billion dollar industry (or service):
The service is real and does provide value to its clients. It does increase sales – and all the other things that we discussed at school. About how advertising does give information, increase reach of innovation. All the good stuff.
Advertising also deals in aspiration. It helps create aspiration, and shows ways of filling that hole (one that the advertisement dug) via the product.
It is a smart business, for all it really does is dig deep into our true nature and show it to ourselves. Do not blame the advertisers, or the agencies. But do reflect on the fact that we purchase aspirations, not only products. Again, we are buying and selling value that we think will make us feel better. Value that we have created in our minds and for our minds. We begin to question reality now, and wonder whether our transactions are in the realm of reality. Is this a part of the real economy? Is this the economics that collapsed? (Begs the question – if it was not real, how could it collapse?
Let us take agriculture:
As rooted and as solid as possible. Our current economics seeks to produce and feed the poor – the stated goal being to resolve world hunger. The same economics (albeit a different branch, since we are such ivory people) says that it makes sense to pay farmers to keep their fields uncultivated. When fine logic trumps common sense, then the meta logic must be questioned. Unquestionably either got carried away, or we did not think it through enough.
When the good science determines that we add value by letting people starve, letting fields lie fallow and by overcrowding other farms, then something is wrong with the science. When we grow by poisoning our produce and progress by changing the seeds so that they cannot propagate – there is reason to accept that this is not a good science. The old nomer of dismal science may have been more apt than we knew.
Maybe we went wrong somewhere in defining the terms, in understanding the concepts of utility and value. We saw that value came from exchange. But we forgot that exchange was more than receiving, it was giving too. Economics was designed from the point of view of the receiver first – “what can you get out of it?’ was the question that was being asked. But exchange, even at its simplest is a two way multi layered beast – how can we splice a piece of it and pretend to understand the whole? There has been much work done on value – on how we gain by giving too. On how happiness does not depend on gaining wealth. On the satisfaction of creating social connect. On the social contract and its marketplace. Some of this has trickled into economic theory, little into the constructs that design businesses. Or negotiate trade terms.
The new economics that we create will not be an invention in ivory towers – it never was. The ivory towers are mere distillation machines, they seek to measure what they observe. Economics is always created in the market place. And any social science is distilled from observations. Think pixellation, and you will know how difficult it is to create theory. The more the pixels, a swift change of filters and you create a completely new theory – a new reality mapped. Or missed.
Take, for example, the simple but solid concept of the money multiplier, which makes so much sense in theory – each time money changes hands, it has been used like new money. Put it together with the another part of the transaction – say, a chain of trades, where people buy and sell for profit. I visualise it as a pass the hot potato game – at first too hot to hold, it gains value as it cools down to the perfect temperature. The value is realised in the eating, not in the trade. If not eaten it loses value. Both because it has been passed around too many times for anyone to be interested in it but also because it is a cold potato now. We defined utility and value as the same – maybe it is not. We defined value upto the point of exchange, we sought the point of equilibrium where value equalled price. Where the temperature of the potato and the desire to eat it meet. What happens next? How much value has been transacted here? See the challenge? The intermediaries added little or no value, yet the economy thrived via transactions.
It is equally true that the act of observation did distort the marketplace. Since only a partial view was valued and that is where value began to be traded and inflated each time it changed hands. (See the hot potato game). For each transaction, the dollar value, which was just one part, inflated and deflated with the markets, the others tagged along unseen. Doing their own thing. In the hot potato game, the traders had no use for the product and traded it on. Though tangible, there was no consumable value till the potato reached the right temperature. Yet there was trade and valuation. This valuation is a man made process and we seem to have not got it right. The hot potato is a simple example, easily refuted as a single case. Other examples abound.
There were socio-economic forces at play even in the hot potato market. Changing the balance. Unmarked, unmeasured, unremarked upon. For example – why did the potato pass through that route and not another? Were there friendships involved, or foes? Game theory tackles that, but is not a part of mass economic analysis, nor macroeconomics. Or, did perfect information prevail? A core assumption made on behalf of markets that is rarely borne out in the real world. In the real world a major trader might be home because of a fever, or a vital piece of information is later revealed to be less than accurate. Pressures are exerted on the market that are not listed in classic definitions of rationality. Yet these pressures unleash a force to be reckoned with, especially in times such as now. Since it seems to be running or ruining the show.
The sad truth is that we do not know what forces we are dealing with, so we cannot build the tools to fix the market. It is also true that a unified theory of the firm was never created – economics could not reconcile its internal differences. This gap was more of a crack in the social science that more or less rendered it a contrarian ruler, or an unresolved quest. In that, economics is really a set of conundrums, certainly not a science. We can play with the old tools of taxation, subsidy, welfare programs, government spending, money flows and prices and hope we find a place where the hot potato game can resume. Where the forces are in balance again (we will still call it equilibrium) and the merry go round can resume. But this too will collapse like the game of monopoly – Once somebody wins and others lose, the game ends.
To create a game that never ends, one has to redefine the endgame (pardon the wordplay, but it helps). If the objective is to gain, to gather and to hoard value, then use it as a source of power, then we will perennially be stuck in the kind of messes we have seen every decade for over a century. Value, that what we pay for in any exchange, has to be defined differently and must be rooted in sustainability.
Solutions? The post after the next one. Oops! That sounds arrogant. Or is this willingness to collaborate?
Next Post: The alignment of Value