Evolving Our Economics

Economics is evolution, but we don’t recognize it.

Look at the coverage of the economic recovery. Listen to the language that we’re using: “Things are getting back to normal.” We expect things to continue the same way they always have – even though it never does.

Media industries are another example of this. From printed sheet music, to radios, to MP3s, the music industry has tried to stop the evolution of production. The movie industry originally fought VCRs – but ended up profiting (think of direct-to-video movies, folks). Print publishers originally (and still, to some extent) fought e-books. DRM and draconian anti-piracy measures are all attempts to keep their businesses running exactly the same way as before.

When it’s pointed out, recognizing that evolution isn’t difficult (corporate CEOs notwithstanding). The problem now is realizing that economics is even more like evolution than we thought.

Our understanding of biological evolution has changed relatively recently. We used to think that evolution was a gradual process, with slow changes accumulating over time. It’s only recently that the “punctuated equilibrium” (or “punk-eek”) model gained acceptance. Briefly, this says that things stay pretty much the change for a while, and that biological change occurs rapidly. When there’s a new niche, a change in environment, whatever – that trigger causes much more rapid and radical change than previously thought.

The housing crisis of the 2000’s is an example of punctuated equilibrium in economics. New instruments and deregulation combined to rapidly change the world of mortgages and finance. CDOs, sub-prime lending, and debt swaps were seen as relatively innocuous innovations, but led to massive changes (and exploits) that regulators – and in many cases, outside observers – were unable to keep up with.

This implies that we can expect further economics changes to be rapid and radical. Some of this is due to the increased speed of feedback and information loops, but I believe we’ve been seeing punctuated equilibrium in the economic world for quite some time. This has huge implications for all economists. Neo-Keynesians (like myself) will have a much harder time reacting to economic change. This model implies that it may even be impossible to create a steady economy.

But we still have to try. The Chicago school of economists claim that the market will take care of itself and return to equilibrium. I think a punctuated equilibrium economic model does imply that equilibrium will return. But that’s not the same as everything going back to “normal”. I think the evolutionary model fits here as well.

An equilibrium is reached after an evolutionary event – but it’s a new equilibrium. It does not imply anything about how good that new equilibrium is for the organisms that used to thrive. Or put another way, I don’t think humans can “kill” the Earth. Life will persist on this planet, even if we pollute the hell out of it. That doesn’t mean that humans will.

The Great Recession seems to be achieving a new equilibrium. The “moral hazard” bankers succumbed to (from deregulation and “innovative” financial instruments) are still thriving. Maybe the bank isn’t – but the individuals who made those decisions are.

It’s the rest of us who are suffering and paying the cost for their sins. The question now is this: Will we ensure that the financial system evolves to support them… or us?

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