But how does it maintain itself? How does it evade collapse? Traditional economics tended to believe the economy had a natural equilibrium. But you can't just assume stability (as if we could doubt that when we look at the current economic situation.) Natural systems continually have to adapt to change. They can and do collapse. And so Jacobs, in her evocative dialogue, looks at how that happens.
The economy is not a static entity. It a dynamic system, and , says Jacobs, there are four main methods by which dynamic systems evade collapse: bifurcations, positive-feedback loops, negative feedback controls, and emergency adaptations. They do not exclude each other. All four can be used at the same time.
A bifurcation, she says , is a term from chaos theory. It literally means a fork in the road. It is when
For example, when Rome outgrew its water supply the Romans built aqueducts. A small business may evade collapse by finding a new market or producing a new product. Bifurcations change the very systems that gave them birth.
A system's instabilities of some sort have become so serious that for it to continue operating as it has been is not a practical option. It must make a radical change - take a fork in the road, travel into new territory.p87
But they often have unintended and even unforeseeable consequences.
Sometimes the only way to survive is to change - to find a new niche, to adapt.
We live on an eternally restless planet. .. Its very creativity and fecundity require endless further corrections. No help for that. Pessimistically, we can despair at being trapped in economic and social systems impossible to perfect or even to make tolerably secure except, at best , for the time being. Or optimistically, we can take zest in the fact that the world affords, among its riches, endless streams of interesting and constructive opportunities to correct and correct and correct what we do. (p92).
FeedbackFeedback is at the heart of maintaining stability. First, positive feedback loops:
Ecosystems are crammed with loops... Plants support animals that help fertilize plants; luxuriant plant growth supports more animals , and so on. It's impossible to imagine how either ecosystems or economies could fend off collapse in the absence of beneficent loops... Positive-feedback loops are the very structure, the very context within which bifurcations and diversity can emerge. (p94)
The emphasis on feedback is very interesting. It is a more generalized and fruitful way to look at a wide range of economic and business behavior.
Feedback refers to information regarding a system that the system reports and responds to. This information can be carried by any medium - monetary, demographic, mechanical, chemical, electrical, whatever. The feedback triggers an effective response to its information. (p95)
This is no doubt what is going on when a lot of more advanced companies search for "metrics". It's a matter of finding information that can be responded to to keep a balance. And that is what the price system does as well for the economy. There certainly was little emphasis on feedback as such in my economics textbooks at college.
It is not all good news, however. Positive feedback loops can sometimes turn into vicious circles of one problem reinforcing itself. In the wrong circumstances positive feedback intensify instability, she says. For example, overfishing led to investment in larger trawlers to maintain the value of the catch and employment, and the Grand Banks ecosystem collapsed.
Incidentally, "positive" and "negative" just refer to a tendency to reinforce or cancel out information, not any kind of value judgement.
That brings us to negative feedback. In fact, in her view Adam Smith was far ahead of naturalists in seeing prices as feedback information, although he didn't use the term. High prices stimulated production. Continual adjustments in negative feedback loops "created order out of volatile, uncoordinated confusing conglomerations of countless different enterprises and individuals, narrowly pursuing countless picayune opportunities and their own interests."
But, she argues, "economics failed to progress much further as a science", because it tried to make this one negative feedback concept explain too much.
Smith overemphasized economic specialization rather than diversification. Economics in general paid no attention to self-refuelling cycles. But high prices stimulate substitutes - differentiation - as well as more supply. The system changes. That element of innovation and new niches did not get enough attention.
However, Jabobs says, Smith was brilliant in realizing that feedback is only as good as the accuracy of the reporting of its information. So distorted prices - and inflation - are still seen today as fundamental problems for the economy.
In fact, as a sidenote, this is one of the paradoxes of central banking. It is hard to demonstrate that inflation causes as much damage as the public (or central bankers) believe, at least at steady rates in the single digits. The main avenue is to argue that inflation distorts price signals and hence reduces allocative efficiency. But this does not produce much actual evidence of problems. People and institutiions. easily adapt to that. In fact, the real reason for public hatred of inflation likely has more to do with the credibility and legitimacy of government, and the distribution of costs between creditors and debtors.
In any case, money is the main feedback mechanism in the economy. But it is not the only feedback mechanism that can or should exist.
I completely agree with this. We tend to reify money, but it is a tool, an institution which is constantly changing. We looked at some of the history of money here.
Nature says money is a feedback-carrying mechanism.. Money is useful to economic self-regulation in the process we've come to call negative feedback control. But the usefulness of money is far from enough to explain how economies work. p12
Crisis - and non-crisisFinally, the fourth category of corrections are emergency adaptations to address temporary instabilities. For example, animals hibernate, plants adapt to survive droughts or forest fires or hurricanes. Bodies fight disease through fever.
But such crisis reactions can be damaging if kept on after the end of the crisis, as often happens. Keynes' deficit financing, she says, was intended to be a new negative feedback control which would keep the economy on course like a steersman correcting the course of a ship. But most governments hung on to it in good times as well, which created a "vicious circle of intractable indebtedness."
These four factors, she says, round out the key processes that maintain stability. There may be others, but it's not clear what they would be.
So to understand how economies work, don't think so much about fiscal policy in isolation, or quantitative easing. Think about feedback and loops and ecology.
I think this is highly persuasive, and at a generalized level ought to be applied to any ideas about how the economy ought to work better. It is also something else to bear in mind when we think about incentives. Incentives ought to be seen as part of those four mechanisms, not in isolation.
There's just a little more to say - about niches and fitness.