The Economy: An Ecosystem

Much of economic thought seems based on an almost unconscious fundamental analogy: The economic system is thought of as if it were a huge, complicated machine; at its center is a sort of reciprocating engine in which enterprises on one side and households on the other exchange money, goods, services and labor back and forth. Since economics as a science developed largely during the industrial era, it was perhaps natural to adopt this analogy. Machines, from bicycles to locomotives to blast furnaces, and by extension machine-like institutions like assembly lines, in which humans served as essential working parts, were awesome both in potential and in reality, utterly transforming society and the quality of life and daily existence. That would get anyone's attention.

That analogy has proved serviceable to some degree, but it is far from perfect. It  encourages an expectation of predictability that is frequently disappointed. It implies a degree of precision in the system's operation that does not exist. It predisposes toward assuming there is some grand design. It also predisposes subordinating the parts of this "machine" to the whole, when the "parts" are in fact the human beings the economy exists to serve. Worst of all, it leads one to think that there is some set of controls that one can seize to operate the machine, and even to "fine-tune" it, and that it therefore is in need of an Operator. Naturally, government is often looked to as that potential or actual Operator.

Basically, this analogy is fundamentally incorrect.

A better analogy would be to look at the economy as like an ecology. In a natural ecosystem, all the plants and animals in it act independently, albeit sometimes in symbiosis and sometimes as antagonists, seeking to survive and flourish, and they evolve together in light of each others' behaviors and nature and the resources available to the ecosystem, and the conditions under which it exists. The result rising out of apparent chaos is an ad hoc order that increasingly serves its components and that is simply the result of Darwinian natural selection - that which works tends to persist and increase and that which does not tends to decrease and die out. It is constantly evolving. The interrelationships among its components are sometimes extremely complex, and alterations of the ecology can therefore produce unexpected, even counterintuitive, results.

Similarly, the economy is the evolved product of the independent actions and decisions of everyone who comprises it and has comprised it, together with the resources they have available to act with. Everything said above about natural ecosystems is true of human economies.

In the United States, for instance, that means there are 320 million "operators," the vast majority of them making decisions for themselves under continually varying circumstances that affect the system in which they are acting to greater or lesser degrees. It is true there is often some degree of predictability to people's actions, which enables economists to make predictions about future results that prove close enough to actual outcomes to be of some use. Most often, these predictions are made by observing past trends and projecting them forward, as if anticipating machine-like predictable behavior, with some tweaks to adjust for known current circumstances. It is famously also true that most economic predictions and models fail at the times when they are most needed - at "points of inflection," moments when the performance of an economy departs significantly from trend or even reverses. That is because the economy is not actually a machine. Human behavior changes, sometimes on a large scale, and the overall economy inevitbly changes with it.

An example is the financial crisis of 2008-09. While a few warned of a possible recession (mostly people with reputations as "perma-bears"), no serious economist saw anything like this crisis coming, nor did virtually anyone who relied heavily on economists' analyses - including commercial bankers, stockbrokers, central banks, all of whom had an obvious institutional need to anticipate such an event if it were in the offing.

There were a small handful of speculators who did anticipate a collapse of some sort, and who profited almost beyond imagining by acting on that anticipation. The motion picture The Big Short entertainingly sets out how one such speculator foresaw and acted, to his vast profit. And how was this remarkable feat accomplished? By setting aside the equations and "econometrics" of economists and by adopting the methodology of those who seriously study the ecology - going out into the field and finding out what people were actually doing and what was going on. They discovered a deranged housing sector, full of "liar loans" to manifestly unqualified mortgagees being made by utterly irresponsible banks and other lenders banks and sold immediately to Wall Street "aggregators," who made no effort to verify the soundness of the loans before packaging them in mortgage-backed securities being held as assets amounting to many,  many billions of dollars on the assumption that their income streams would continue when in fact they would not. In short, the rise of packaged mortgages had short-circuited the traditional moral and practical constraints on mortgage lenders that had forced due diligence and accountability. As a resut, much of the mortgage and investment industry went haywire. Key motivations to ethical behavior were gone, and economists did not pick that up from their statistics and equations because they made no such investigation.

Perhaps it would be wiser for economists to augment the methodologies of mathematicians and engineers to the methodologies of those who study natural ecologies, with their enormously complex interrelationships and their sometimes surprising reactions to changed circumstances. Perhaps they should recognize that they are dealing with an economic ecology of independently acting organisms that can change in unanticipated ways and not with a basically predictable machine.