What ecology can teach us about economy & politics

Over the last few years it has become increasingly common to look at the state of the world and to throw one’s hands up in disbelief, dejectedly exclaiming something along the lines of:

“The system is broken. America is broken. Everything is broken.”

Many of us have, at least on occasion, shared this sentiment. It’s hard to look at a system suffering from growing income inequality and political upheaval without feeling it’s all coming apart at the seams. This feeling can however be hard to reconcile with the more-objective observation that the US—on the whole—remains a decent place to live. (Because poverty is relative, being poor in America affords you absolute riches on a global scale.) Altogether, these discrepancies raise the interesting question why all of this is taking place: Why does it feel like America is so broken (when there are so many worse places to live)?

Strangely, ecology might hold the answer. To understand this, we must however first take a detour into physics. When it all comes together in the end, we’ll have a more-productive framework with which to interpret what’s going on in the American system, including the economy and its contemporary politics. 

(I’ll be simplifying a bit in the following, in the interest of space. If you want to skip straight to the conclusion, scroll down to ‘Why does the (American) system feel so broken?’)

Complex systems are organised by energy flows

In thermodynamics (or non-equilibrium thermodynamics, to be precise) there is a concept that has been popularised as “Nature abhors a gradient”. What this means is that whenever a gradient arises, it will be dissipated. If the gradient is strong enough, a self-organising system will result, actively feeding off the birthing gradient until it has been dissipated. In other words, whenever a gradient arises, a system will arise to feed off the gradient to dissipate it. The stronger the gradient, the more complex the system. The more persistent the gradient, the more persistent the system.

Companies are examples of complex, dissipative systems, only that they self-organise where there is a money-gradient to exploit and diffuse. Several companies (and other money-gradient-diffusers) working together in an interconnected network is what we refer to as an ‘economy’. 

Economics is the study of such money-powered systems, just like ecology is the study of organisms (energy-powered systems) as they organise into ecosystems. Seen from this perspective, economics and ecology are sub-disciplines of the branch of non-equilibrium thermodynamics that concerns itself with the study of these self-organising, gradient-dissipating systems. As such, many of the tools developed for use within either economics or ecology can be adapted for use also within the other sub-discipline (and indeed, such cross-fertilisation of tools and ideas has happened very productively in the past). 

Altogether, this provides us with the first part of the framework that we’re building in this post: Economies are ecosystems assembled from money-gradient dissipative systems. 

Next, let’s learn a bit about ecology: How ecosystems are organised and how they function. (If you want to learn more about this, and beyond what I’m offering in this blog post, I really recommend Eric Schneider and Dorion Sagan’s book Into the Cool [link].)

Ecosystems are supported by energy-capturing producers

The best illustration of how an ecosystem is organised is a ‘food pyramid’. These pyramids show how organisms organise into (trophic) layers and how these layers organise into hierarchies.

The supporting layer of a trophic hierarchy is that of the producers. Importantly, the producers in an ecological hierarchy are not the source of the energy. Rather, the producer-layer is the layer where the energy (which comes from outside the system) is first captured and brought into the system. In a biological ecosystem, the producers would (typically) be plants, which capture energy (sunlight) through photosynthesis. Herbivores would then consume the energy captured by the plants, while carnivores consume the energy consumed by the herbivores.

The pyramid-shape of these trophic hierarchies results from the energy transfer between layers not being perfect. This causes energy to be lost from and between layers, reducing the amount of energy available to flow and support successive ones. As a result, most ecosystems are made up of no more than five or six trophic layers. The more mature the ecosystem is, the better it is at capturing and retaining energy within the system, allowing it to support more layers.

Because the producers make energy available to the rest of the system, the size of the producer layer (which is itself determined by its ability to capture energy) becomes a proxy for the size of the overall system. As a result, an ecosystem with producers that can capture a lot of energy will have more energy available to it than an ecosystem where the producers capture less energy.

Altogether, the ecosystem is a networked system of individual gradient-dissipators (organised into layers) where the system as a whole acts as a better gradient-dissipator than any individual organism or layer would be on its own. The more tropic layers the ecosystem contains, the more efficient the ecosystem becomes at both capturing and retaining energy within the system. These ecosystems would be ‘mature’; operating at the very peak of their gradient-dissipating potential

Ecosystems mature through a process of increasing specialisation. When a new niche (source of energy) opens up, ‘pioneer’ species will migrate into the niche to dissipate the energy gradients. (Consider, for example, the emergence of a new island from the sea and how the first species to take root will be producers like plants which only later attract animal-consumers.) This newly-colonised ecosystem is immature and less able to dissipate (capture and retain) energy than a more mature ecosystem. The pioneer species however create niches for more specialist species, allowing these to take root and the ecosystem to mature further. The ecosystem will be fully mature at the point where it reaches a steady-state of sorts, where it dissipates gradients as efficiently as possible given the continued influx of energy (at the producer layer) and in the absence of any external disruption or stressors (like the introduction of an invasive new species or a catastrophic, destabilising event).

This provides us with the second piece of the framework we’re building: More energy means greater complexity.

Stressed ecosystems lose energy and grow more immature

Mature ecosystems operate at a high level of complexity, with the complexity supported by the system’s high capacity for capturing and retaining energy within the system. Whatever energy is lost as energy is passed from one trophic layer to the next (or from the activities happening within each layer) will be replaced by more energy being captured at the producer-layer. This is what allows the ecosystem to operate at a stable state. At this state, the amount of energy flowing through the system is stable.

The introduction of a stressor will however upset this delicate balance. An invasive species is ‘invasive’ because it is (for some reason or another) better-able to capture or make use of energy to support itself than other organisms in the system (perhaps because there are no predators to keep it in check). This dynamic allows the invasive species to thrive in the invaded ecosystem, capturing and diverting energy away from other layers. This causes a disruption to the flow of energy through the system, which stresses it. A catastrophic event (like a flood or a forest fire) will similarly reduce the amount of energy flowing through the system.

With less energy available to it, the ecosystem will then revert to a more immature state. As a result, the stressed ecosystem will cause energy to ‘leak’ out of it, reducing the system’s ability to dissipate the original energy gradient. These stressed ecosystems are no longer stable at the high level they were at previously. Rather, the systems regress as they oscillate towards a new, lower-energy state that better represents the amount of money flowing through it.

This provides us with the third piece of the framework: Stressors cause complex systems to grow less complex or collapse.

To make this ecosystem analogy more relevant to economics or finance, let’s paint the picture again, but replacing organisms with companies and niches with industries.

Economies are organised much like ecosystems

In the money-powered ecosystems we know as economies, niches are populated by companies that compete on their ability to dissipate money-gradients and to use the captured energy (cash) to grow and maintain their internal organisation. It’s this dynamic that we measure when we look at company-specific metrics like, for example, revenue growth (their ability to consume more money-energy) and ROIC (their ability to capture more money-energy to support themselves).

The economy per se is the product of many interconnected companies and niches, feeding off and supporting each other, much like organisms in nature. From this perspective, the organisation of an economy is fractal: Regardless of what level you look, you’ll see the same layers of organisation of producers supporting layers and layers of consumers (within companies, within sectors, within industries, and within economies). 

As a niche (a sub-economy) matures, the system goes through the same progression from pioneers to specialists as biological ecosystems do. By way of example, we can consider something like the Internet (which represented the emergence of a new niche). This new niche was colonised by pioneers like Amazon and Facebook and Google; generalist-producers whose presence attracted consumers to the niche.

As the Internet-economy ecosystem has matured as it is able to capture more and more money-energy, it has also been able to support more and more trophic layers; allowing the ecosystem to grow increasingly complex. Today, this system is growing increasingly mature, and increased money-gradient dissipative efficiencies are added at the specialist fringes (for example in the form of direct-to-consumer brands powered by producers like Amazon/Google/Facebook).

From this perspective, it wouldn’t be possible to find something like ‘the next Amazon’, as that part of the ecosystem (niche) is already populated. Instead, it makes more sense to look for companies that can find money-gradients that remain to be dissipated (e.g. similar to how the relative Internet late-comer Shopify identified the money-gradient created by the direct-to-consumer businesses enabled by producers like Google and Facebook). As the ecosystem is growing more mature, any remaining money-gradients will however grow increasingly hard to find. More fruitful areas to scour would be wholly new niches with the potential to evolve into bona fideecosystems. 

All of this is not to say that a mature ecosystem (or economy) is in any way stable. ‘Stability’ implies something fixed and unchanging, but that’s not the dynamic that’s at play here. No, rather, an ecosystem can be mature at the system level, even as that system (and its maturity) is formed by many small fluxes happening within the system as new organisations rise and fall. In this way, the top-level stability of an ecosystem or economy is much like that of the stock market, where there ‘market price’ is the product of the rising and falling stock prices of the thousands and thousands of companies within. In other words, even as the emergent system is itself stable, the organisation within is anything but. 

Just as ecosystems are supported by the flow of energy within them, with greater energy-flows translating into more complex ecosystems able to support increasingly specialised organisms, so economies are supported by money-flows. Because of this dependency on flow, economies can—just like ecosystems—grow stressed. In economies, this stress is the result of diverted or reduced money-flows that cause less money to flow through the economy overall. These reduced money-flows are less able to support the economy at a given level of complexity, causing the economy to regress to a more primitive state. In other words, stressed economies will regress to a more primitive state. 

By replacing ‘ecosystems’ with ‘economies’, our framework is complete:

• Economies dissipate money-gradients (through the action of its component organisations).
• Greater money-flows translate into more complex and mature economies.
• Stressors reduce money-flows, which causes economies to regress.

Armed with this framework we can now (finally!) begin to answer the original question:

Why does the (American) system feel so broken?

The short answer to this question is that the American economy is stressed. As such, the system is in the process of reverting to a lower-energy stable state. This process will be painful and disruptive until the system has settled into the state that will be the most stable for its current level of money-flows. 

The longer answer is, well, longer.

A booming manufacturing sector grows the American economy-pie

Up to the final decades of the 20^th century, the American economy was growing; powered by an unprecedented burst of technological innovation and manufacturing prowess. (I like Robert J. Gordon’s The Rise and Fall of American Growthfor an in-depth overview of this process [link].) With increasing productivity in the manufacturing sector, the people employed therein, in the foundational—productive—layers of the economy, saw their incomes rise as a result. This great wave of newly-created wealth propelled the economy forward as people employed in manufacturing spent their earnings, sending money-energy flowing through the economy. Some of this energy was captured by the managerial (service)-based layer higher up in the hierarchy, allowing the primary service-based sectors to grow. This layer, in turn, fuelled the growth of further service-based layers above. The net result was that the total economy-sized pie was growing bigger, allowing everyone to capture a bigger share. Times were good. The economy was booming. Importantly, this growth was however fuelled by the growth of the productive layer of the economy: The manufacturing sector.

(We’ll look further into the debate whether manufacturing or services is the main source of wealth in a future blog post, but for now, let’s suffice to say that money-energy is captured by the producer layer, while the higher-up service-based layers only consume the money-energy flow in the form of zero-sum transactions.)

Globalisation has reduced the money-energy capture of the manufacturer-producer layer

Globalisation (a disruptive event) happened in the 1950s and 1960s with incremental parts of the global logistics machine falling into place. (I like Mark Levinson’s The Box for a digestible overview of the history of shipping and globalisation [link].) As globalisation grew more dominant, more and more manufacturing moved off-shore. While this allowed goods to be manufactured at lower cost (reducing the cost of finished goods to the benefit of retailers and consumers), this also gutted a large part of the domestic producer layer (as the producer layer went global). The people employed in the manufacturing sector found themselves on average making less (if lucky enough to hang on to a job). In other words, globalisation caused the producer layer to shrink. As a result, less money-energy was being captured by this foundational layer of the economy. This caused the ecosystem to grow proportionally heavier at the top. In other words, the economy grew imbalanced. It grew stressed.

(It is worth noting here that economies like Germany avoided the globalisation-induced stress by allowing the manufacturing sector to evolve as the manufacturing workforce grew more skilled. Low-skilled jobs were exported with globalisation while high-skilled manufacturing jobs were retained. This allowed the producer layer to keep growing; supporting the economy; allowing it to keep maturing. The mistake the US made was in allowing so much of its manufacturing to move off-shore, making little distinction between high- and low-skilled manufacturing jobs. [I think Dan Wang [link] writes very well on this topic and its implications for the manufacturing sector.])

For individuals, the producer-consumer dynamics are very similar, and best expressed using Maslow’s Hierarchy of Needs. In this hierarchy, the supportive needs (survival and belonging) need to be satisfied before self-actualisation becomes possible. If a person is struggling economically, they will revert back to a lower level in the hierarchy, showing an increased focus on satisfying those more basal needs. If an economy is to be as productive as possible, we want everyone in the economy to operate at the level of self-actualisation, since this allows them to be friendly, proactive, cooperative, and innovative. 

The contemporary American economy is very stressed

The economic stress caused by the gutting of the money-capturing capacity of the productive layers of the American economy has likely been further exacerbated by the Baumol effect and the asset-price inflation that I wrote about in a previous post [link]. Let’s quickly look at each, in turn.

First, as the price of manufactured goods started dropping (because of the positive impact of globalisation and continued technological innovation in the consumer-goods sector), the proportion of the household budget spent on goods went down. In other words, as less money bought more goods, more goods would be needed to buy a fixed amount of services. This is the Baumol effect. (I find this publication [link] to be a good introduction to and discussion of the Baumol effect.)

Second, as more money (in dollar-terms) has been flooding into the economy following the Great Financial Crisis, the total value captured by each dollar has been going down. Now, if this was happening on an economy-wide level, nobody would be any wiser; we’d just call this good old-fashioned inflation. However, if this inflation is happening in a specific asset classes (like, say, US stocks), it would seem (from the level of the economy) as if the price of that asset class was going up. This means that people whose incomes were tied to these rising prices would see their incomes go up. Conversely, people without incomes tied to this price-inflation would see their incomes go down.

Putting all this together, we now have a situation where the producer layer in the American economy is less productive (because so much manufacturing has moved off-shore). This has led to less money being captured by the producer layer, which would otherwise flow from there to support the rest of the economy. In addition, asset-price inflation has seen more wealth get concentrated at the top layers of the economy, from where very little trickles down. (There is a limit to how much money someone like Jeff Bezos can spend on what they actually need, causing money to pool and not being spent. As a result, the money-flows coagulate.) Altogether, this creates a topsy-turvy distribution of money-energy in the economy, effectively standing the pyramid on its head: Where a lot of money-energy has pooled in the upper layers with very little of it flowing to support the rest of the economy. 

Altogether, this is why it feels like the American system is broken. The flow of money through the system has been interrupted, and with less money-energy flowing, the gradient that supports the system has been depleted. There is less money-energy to support the system. The system is stressed, and it’s reverting back to a more primitive, immature state (which is more appropriate for its current level of money-flows). While this process is happening, it feels like everything is going wrong when, in fact, it’s just a system re-tracing its path back into a state that it had previously left behind. It’s a bit like the air going out of a balloon. 

If you understand the underlying logic, all of this makes sense: Everything that’s happening in America is part of a greater, predictable process, rooted in thermodynamics and how energy gradients give rise to complex systems.

Importantly, not only does this mean that we know what is likely to happen (the system’s progression is predictable), it also means that we have the tools required to understand how to stop the process and to set the economy back on its original path. Everything that’s required is a bit of political will and enough sensible people in government to recognise that what’s needed is to rebalance the Great American Pyramid to make the American economy less stressed. The sooner we do this and set the economy back on its original path, the less time it will take to get back to where we started—50 years ago. 

Failing this, we’ll see more economic and political upheaval and increased polarisation of the political discourse. This, however, is all part of the process. A stressed economy will see more and more of a push to revert to equilibrium, where the money-energy is evenly distributed throughout. The have-nots will cry louder that we need to eat the rich to survive, and the rich will seek increasing protection behind lenient bodies in Senate and Congress, hoping to protect what they have. Ultimately, a government that promises a more forceful and authoritarian redistribution of wealth is likely to be favoured. We might not like this, but it will re-balance the economy and set the machine chugging forward once again. The more socialist economies of Scandinavia offer good examples: While their manufacturing has moved off-shore, they are much more principled in using taxation to redistribute the wealth. Ultimately, it’s up to each individual economy and political system to decide how they want to re-balance the pyramid. The path chosen is less important than the ultimate result.

At the end of the day, people need very few things to be happy. Among these is the need to earn a not-too-small proportion of the income of the very richest in society. This balances the distribution of wealth in the economy, allowing more of the money to flow. When the money flows, the economy is stable (and people are happy). Happy people will also go out and happen to things, which is how innovation happens. Innovation causes the economy-pie to grow. America knows how to do this part very well. For America to stop being broken, we need to let the money flow once again.