The Economy as an Ecosystem

A production-centered economic paradigm

Most of the explanations that you probably hear about the economy are wrong. They are not just wrong, the explanations lead to solutions that do exactly the wrong thing. No wonder we have an economy that doesn’t work for most people, even though every year technological innovation makes the current moment the wealthiest in human history.

No amount of criticism of current economic thinking will lead to different policy outcomes. Only a different economic theory can lead to new policies that will prevent the American and global economy from going over the cliff. I will present my own modest attempt to create a new economic paradigm below. I will call this a production-centered theory of political economy.

This paradigm leads to several policy conclusions that are completely at odds with reigning conventional wisdom: 1) Manufacturing is the most important part of an economy,; 2) The state (government) is more important than the market in a capitalist economy; 3) Globalization is very inefficient, and should be replaced by a set of regional (continental or subcontinental) trading blocks; 4) Firms should be employee-owned-and-operated, not owned by shareholders; 5) The government can create infrastructure using technologies that will eliminate the causes of global warming, rather than depending on the market to mitigate climate change; 6) Most banking should be done by public agencies; 7) The government should print money instead of borrowing it, and should only tax the wealthy and corporations, not the middle or lower class and 8) The government should provide a guaranteed middle class job, income, and health services to everyone.

What kind of theory, or framework, or what I will call a paradigm, will help us arrive at these conclusions? What we need, first of all, is a more encompassing conception of the economy. We need to talk about what used to be called a political economy, that is, we need to include the state as an integral part of the description of the economy, not as an add-on as in conventional economics. Next, we need to focus more on production, as in manufacturing and other sectors such as agriculture, than on exchange, as again occurs in conventional economics. We also have to consider what is clearly the foundation of any economy, the environment, as an integral part of an economic system, not as some external factor, as in conventional economics. Finally, we have to discuss the internal operation of the firm, as opposed to the “black box” that it is considered in mainstream economics.

So our framework has to include 1) production, 2) the state, 3) the environment, and 4) the internal governance of the firm. But we need to do this in a simple, comprehensible way so as not to make things so complicated that nobody can follow it.

The Economy is an Ecosystem

The central idea that I want to communicate is the idea that the political economy is an ecosystem. This rather simple idea has profound differences with mainstream economics. An ecosystem, such as a forest or meadow, is composed of different parts which are niches. A niche represents a certain function that the occupier of that niche performs. So, the trees in a forest provide the function of converting sunlight, carbon and minerals into food, while the small animals provide the function of eating some of that food, while the carnivores provide the function of eating the small animals, and what are called the detrivores, such as worms and fungi, recycle all the dead materials so that the trees can use the minerals again.

This concept of function might sound antiseptic and passionless, but it is actually quite revolutionary. If the concept of function as a part of the economy was accepted, it would destroy the policy-making authority of most economics — except for Keynesian economics, about which more later. If there was a consensus that function was important in thinking about the economy, it would be like throwing water on the Wicked Witch in the Wizard of Oz.

The concept of function is so important because if there really are certain functions that the economy has to fulfill, then it is the government’s responsibility, as the expression of the will of the people, to make sure that those functions continue to exist and thrive. Most importantly, if manufacturing is a necessary function within a political economy, then it is the government’s responsibility to make manufacturing thrive, whether or not manufacturing is doing well as a consequence of the operation of the market. Therefore, is the economy is indeed an ecosystem and manufacturing is a crucial function within that ecosystem, then the number one priority of governmental policy is to revive the manufacturing sector.

Of course, there are other functions besides manufacturing, probably the most important being the encompassing environment, the set of natural ecosystems that is part of the political economy ecosystem.

The self-destructive nature of the market

The mainstream economist might interject at this point that the beauty of the market is that it determines, automatically and without conscious human intervention, what functions are necessary and what are not, which should go away and which should arise. Trade theory is built on the idea that the functions of the world economy should automatically go to the nation or area which most cheaply carries out a particular function. There are several problems with this approach

First, the historical and empirical record show that the market does not efficiently allocate functions. There are areas of the world that are grindingly poor, and areas that have small groups that are super-wealthy. In other words, the level of inequality is so gross, and getting worse, that something is clearly wrong. Most countries never industrialized, which was the policy for most of the post-WWII period, and those countries are still very poor. Countries that have industrialized, such as China, did so with massive government intervention and focused in particular on a specific function, manufacturing.

Second, the market has an inherent tendency to destroy itself (as Karl Polanyi pointed out 70 years ago, and of course as Marx argued). Again, the historical record of depressions and recessions shows this tendency, but there are important internal dynamics as well. Most importantly, markets operate in the short-term. Because they operate in the short-term, they tend, over the long-term, to centralize power in the financial system. Since money can be moved around at such a high speed (down to nanoseconds), it is easier to accumulate more and more economic power at a higher speed than any other part of the economy, and certainly much faster than in the industrial sector, which can take years to build a factory, not nanoseconds. As we see now, the financial system turns into a vortex that sucks all the economic resources of the country into it, which eventually leads to collapse. The financial system is like an economic black hole, it sucks in wealth, never to return to the larger economy.

The second problem with the short-term nature of the market is that the market tends to destroy capital, that is, the wealth generating parts of the economy. The market has a tendency to destroy capital because the easiest way to get money is to liquidate, or milk, capital, and once one has the money from turning capital into money, then one can buy other companies and do all the things that the financial system is good at to quickly gain more and more power. In other words, capitalism has a tendency to destroy the very root of its existence, capital. This is why I said at the beginning that the state is more important than the market in a capitalist system; only the state can prevent the market from destroying itself, although that does not mean that the state will prevent the market from destroying itself; as we can see, if the state is captured by big corporations it will help them to destroy themselves.

This process of liquidating capital explains the terrible shape of infrastructure in the United States. The big corporations have collectively decided that they would prefer to let the most important part of the capital of a country, the infrastructure, deteriorate rather than pay for its upkeep. This increases their short term profit, but will eventually lead to their decline, insofar as they stay dependent on the United States economy. On the other hand, China is vastly expanding its infrastructure because the government there is still in control — as the government in the United States was in control when, for example, the US built the Interstate Highway System.

Indeed, there is no other way for a corporation to operate than to increase its profits and revenue, even if by doing so, sometime in the future, it would cease to exist. Its sole reason for existence is to make more profits, even if it kills and maims people in that pursuit, and destroys everything that makes its existence possible. It is like a run amok robot, or zombie; it is incapable to acting in the long-term and for the benefit of the society as a whole.

The government builds the economy

Only the government, as the expression of the needs of the society as a whole, can counter this psychopathic behavior, and only the government can consciously plan and design the political economy so that all its functions are working properly, and working together. I don’t say this because I have some mystical love for government; I think that the least government is the best government, however, the least government is much more than we have now, in my opinion. Since the 1960s, the progressive forces in the US have been very suspicious of the Federal government because the national security function has grown completely out-of-proportion to where it should be, including the spying capabilities and the military proper. In addition, since money has become so important for effectively buying political office, the government is seen to be a creature of the very corporations it is supposed to be countering. But the reality is that the government is still amenable to some democratic control, and to completely reverse the meaning of the famous phrase of Margaret Thatcher, “there is no alternative” to a very large role of the government in the economy.

Thus, if function is in reality a critical aspect of the economy, then government intervention in the economy is necessary, not “part of the problem”, to quote Ronald Reagan. The government must make sure all of the functions are operating well, because the market will destroy those functions if left to its own devices. But there is a further necessary aspect of government intervention then simply preventing corporations from behaving badly.

The government is actually a part of the production process, not by operating factories or farms, but by 1) building infrastructure, 2) human capital, 3) scientific and engineering knowledge, and 4) protecting the natural capital of the environment. Each of those productions processes are critical parts of a society’s production capital, the very things the corporations have an incentive to liquidate and destroy.

First, civilization was created by infrastructure; infrastructure is the defining characteristic of civilization, as mundane as much of it might seem. The first civilizations in the Middle East were created by building infrastructure for irrigation. Since then, water infrastructure and roads, ports, then sewage systems, electrical networks and myriad other infrastructural systems have tied together economic systems. Trade itself is only possible because of infrastructure.

Second, government has historically provided whatever education is provided to the bottom 99% of the population. The current efforts of so-called school privatization are simply ways to funnel public money into private pockets, because the costs of education are still provided by the government. ‘Human capital’, that is, the skills needed to operate a complex technological society, are perhaps the most important capital that a society possesses. When the Allies pulverized the manufacturing assets of Germany and Japan in World War II, they still came back to be the current manufacturing leaders because they retained their human capital.

Third, the scientific and engineering pool of knowledge that the people who possess human capital use is, for the most part, provided by the government.

Fourth, the environment serves myriad important and necessary functions for the economic ecosystem. Many civilizations have collapsed because of mismanagement of the environment (as Jared Diamond shows in his book “Collapse”), and now we have a global civilization that is in real danger of doing the same, threatened by climate change, ecosystem destruction, destruction of water and soil resources, and dependence on nonrenewable resources. The infrastructure has be be designed in such as way as to retain the capital in natural ecosystems, so there has to be a cooperative aspect between the infrastructure and environment.

These four critical pools of capital are provided by the government because for a corporation to provide these would require that it “tie up” too much of its money somewhere for too long, and it would therefore risk that another corporation would use its money to grab more economic power away from the longer-term thinking corporation. In addition, these pools of capital, as economists point out, cannot have their output captured only by the the company building it, so a private company will not undertake these tasks (they call this ‘public goods’, a rather broad category that has very little dynamism or explanatory power).

Thus the government must directly provide for several critical functions in a society: infrastructure, human capital, and scientific/engineering knowledge and protection of the environment. The market, which for all intents and purposes generally means the large multinational corporations (MNCs), does not want to pay for these things. In their quest to not be countered by the government and not have to pay for anything, they also throw the baby out with the bathwater and fight against spending on these critical sources of long-term capital.

The only long-term solution to the constant battering of the barbarian corporations at the gates of civilization is to change the way corporations are governed, that is, to make them employee-owned-and-operated, instead of being owned and operated by outside shareholders and upper management. In other words, corporations (most businesses) need to become democracies, not tyrannies. This would have two other important consequences, about which more later: they would actually be more efficient, and their employees would lead happier and healthier lives.

A democratic business would have other incentives besides maximizing profit. While it would still have an incentive to improve its products, it would also be motivated to stop fighting the government to improve society as a whole. Since it would be run by people who were not obsessed with increasing their personal power — as the top management and top shareholders of any firm are — then such a business would even cooperate with the government to insure that the long-term future of the society was improved. Instead of corporations being people, we would have people controlling corporations. The corporation would be humanized, dare I say even civilized.

Thus if we widen our view of the economy to include the political — the government — and the internal governance of the firm, and we look at the economy as a set of critical functions, we see how many of the problems we encounter can be explained, and how solutions can be found. If the economy is simply seen as a set of firms, without function or internal governance, and without the allegedly stultifying hand of the government, then we miss most of what is important in the economy.

The structure of the production economy

So we are beginning to understand what this ecosystem is all about. There is a production system that is part of this ecosystem, which is the goods and products produced by the myriad businesses, and this production system is connected to the infrastructure system that the government creates, as well as human capital and scientific systems, also provided by the government, all working cooperatively with the natural ecosystems. If we peer into the production system, we see that it too has several component parts — services, industry, and agriculture.

Services are the biggest part of the economy, and constituted about 2/3rds of output. But services have a peculiar characteristic — they are generally the act of using a manufactured good. Think of buying something in a store, or flying a plane, or even buying a house, listening to music, talking on a phone, or any of the other myriad services. They are almost all dependent on manufactured goods. In fact, even the technological advancement in the services sector are dependent on the technological advancements in the manufacturing sector. The computer revolution is only the latest installment of this story.

Since services are the act of using a good, the vast bulk of trade in the world is in goods, not services — 80% in goods, and 20% in services, to be precise. Therefore, normally, a country can’t run a trade deficit in goods for very long. In other words, a country can’t buy many more manufactured goods than it sells for a long period of time. If it does, usually the currency has to decline until the trade is balanced. But this hasn’t happened to the U.S. yet, even though the U.S. runs about a half trillion dollar deficit each year, and the total imbalance is now well over $10 trillion. This is because the world uses the dollar as a kind of global currency, and in particular countries only buy and sell oil in dollars. If oil were to stop being a critical resource, the value of the dollar would plummet.

If we look more closely at this manufacturing part of the economic ecosystem, we can see further subcomponents. In particular, we can see that there is a critical sector, which we can call production machinery, that manufactures the machinery used in the factories (or outside when constructing buildings). Innovation in these sectors leads to innovation in manufactured goods, and from manufactured goods innovation spreads to the service sector. But within the production machinery sector there is yet another sector, which I call the reproduction machinery sector. Here we find very specific kinds of machinery, such as machine tools, that collectively make the parts that make more of themselves (with human assistance, of course). These kinds of machinery are then used in the production machinery sector, and so any innovations in these industries will have a very amplified effect on the entire economy. For instance, semiconductor-making equipment is used to make the semiconductors that then go into more semiconductor-making equipment, into other reproduction machinery such as machine tools, and into myriad products throughout the economy. Innovation in the semiconductor-making equipment industry lead to basic kinds of innovation like the smart phone.

Growth and trade

The reproduction part of the reproduction machinery sector is what accounts for most of economic growth. Like the growth of an animal population such as rabbits, reproduction machinery reproduces itself, which can lead to very quick bursts of economic growth.

This economic growth can happen in two different ways. The sheer quantity of goods can multiply, which leads eventually to a depletion of resources and ecosystems. Or it can happen by increasing the efficiency and precision of the reproduction machinery sectors, so that quality improves instead of quantity going up. This is the challenge of creating a sustainable society: can we grow qualitatively, instead of quantitatively?

If growth mainly occurs, either directly or indirectly from within the manufacturing sector, then what does this mean for trade? According to the reigning economic worldview, won’t the world be a better place when global trade is utterly and absolutely free? Well, no. In fact if we conceive the economy as an ecosystem, we can see that trade not only does not have much bearing on economic growth, it can be very harmful to it.

The manufacturing sector, and with it the other sectors of the economy, need to have some proximity to each other, that is, the closer the parts of the economic ecosystem are to each other, the better. The closer they are together, the easier it is for the various niches of the economy to interact, and thus decrease costs (transaction costs in mainstream economics), but perhaps more importantly, innovation is encouraged the closer the economic parts are to each other, because the engineers and other workers who do the innovation have a chance to experience the various processes going on in the economy, and to see what the effect of their changes and innovations have on the production process. They can all ‘kick the tires’ of the factory machinery. It has become clear that when engineers can visit the factory, they have a better chance of understanding what is going on, and innovations thereby are made and spread more rapidly.

If, as in Ricardo’s ideal world, every country specializes in one industry (or set of industries) and they all trade with each other, all of this cross-fertilization and innovation enhancement goes away. In particular, the links between the production and reproduction machinery sectors, on the one hand, and the final production and service sectors, on the other, are broken, or are made much more difficult, and so they all suffer from this lack of feedback, serendipity and support that an economic system with a full suite of industries retains.

For example, one of the reasons that Apple produces so many iPhones in China, besides the lower wages, is that there are so many different kinds of factories there, and they output such an enormous quantity and variety of products, that if Apple wants to use different components, they can literally walk down the street, whereas if they produced iPhones in the US, because of the paucity of various kinds of manufacturing, they would have to wait weeks while something was designed and manufactured from somewhere around the world.

So Ricardo got it exactly wrong — the long-term growth of economies is encouraged by a regional trading block that encompasses an easily navigable area, such as a continent or subcontinent, and is discouraged by the current globalization mania.

Conclusion

So if we look at the economy as an ecosystem, we can look at economic policy debates in a whole new way. The government is no longer an impediment to equitable and sustainable economic growth, it is the most important cause of it. The tyrannical nature of the firm is not just some unfortunate consequence of a market system, it is a cause of its long-term destruction. Manufacturing is not something that countries ‘go through’ on their way to service-industries utopia, it is the basis of services and a wealthy economy. The environment is not something getting in the way of greater economic growth, it must be managed by the government with a well-designed infrastructure and manufacturing sector.

So now we can return to the current mess that is our world, and see what a way out might be. No longer shackled to the necessity of solving everything through the market, we can figure out how to set things right — how to revive manufacturing while at the same time preventing ecological catastrophe, and at the same time creating an equitable, poverty-free society. All of these goals can be achieved by a program of economic reconstruction, which in the United States would involve spending about two trillion dollars per year on the rebuilding of the infrastructure, which would then provide a market for a rebuilt manufacturing sector, would provide enough jobs to lift everyone into the middle class, and would allow the country to produce and do everything they needed without emitting greenhouse gases or destroying the environment (for more, see Green New Deal Plan website)

Jon Rynn, 5/24/2015

explanation of the animation model at the top

This model shows how the economy produces wealth, focusing on the manufacturing sector. The production system is divided into three stages here: the reproduction machinery stage, the production machinery stage, and the final production stage. Each stage is composed of a fixed capital section, and a circulating capital section. Each of these sections is what is known in economics as an input-output table, as first developed by Wassily Leontif. The fixed capital table is what Leontief called a "B table", composed of assets. Most economists ignore this kind of table, and focus on what Leontief called an "A table", composed of the circulating capital. This model shows how the fixed capital of one stage is composed of the machinery output of the previous stage, except for the reproduction machinery stage, which consumes its own output (as well as being used by the next stage, the production machinery output).

Each stage is composed of four categories of production: structural, material, energy-converting, and information processing. Each of these constitutes a column and a row in each table. Each category contains machinery, or fixed capital, as well as circulating capital. The circulating capital is used as inputs into the fixed capital section, and the output of the fixed capital either goes back into the circulating capital for that stage (often called intermediate goods), or if the good is complete, it goes on to the next stage.

The reproduction machinery creates the machinery which it then used to create more of its own machinery, that is, reproduction machinery. Machine tools, steel-making equipment, electricity-generating turbines, and semiconductor-making machines are examples of reproduction machinery. Collectively, they all reproduce each other. For instance, machine tools are used to make more machine tools, and in order to reproduce themselves they use electricity generated by turbines, steel produced by steel-making machinery, using controls created by semiconductor-making machinery. Steel-making machinery is created using parts made by machine tools, electricity made by turbines, used by semiconductor-making machinery, and so on.

The production machinery uses the output of the reproduction machinery, such as machine tools, to create the machinery which will actually be used to create the final goods. For instance, the production of construction machinery and textile machinery uses machine tools, electricity, steel-making, and computer controls generated by the reproduction machinery stage. These pieces of machinery compose the fixed capital section

The final production is created using the machinery generated by the production machinery stage. The machinery generated by the production machinery stage, such as construction machinery or textile machinery, composes the fixed capital section of the final production stage. Once the final output is created, whether infrastructure (public goods) or consumer goods (private goods), the distribution subsystem of the economic system is used.