Why system economics?
Because...
As a first blog here I want to explain the name. It is quite simple. We have a systems problem in our economic system. And we know it for a long time. Silent Spring, Limits to Growth report of the Club of Rome, IPCC report, SDGs IPBES on biodiversity. Nothing new. Also a last warning from scientists a few weeks ago.
The limits to growth’s main message was that continuous growth in industrial output could not be sustained indefinitely. Effectively, humanity can choose its limit or, at some point, reach an imposed limitation, at which time a decline in human welfare will become unavoidable. A vital point of the analysis was the plural of“limits”, in the analysis of the Club of Rome in the early 1970s with 66 “continuous critical problems”, which were all interconnected. Still, the root cause was growth: the exponential growth of energy use, material flows, food production and population against the earth’s physical limits.
Stating that the root cause is economic growth is still not a solution. It runs deeper. And we have a challenge that runs deep in economics.
In the realm of microeconomics, particularly for neoclassical economists, the 'growth problem' is not a concern. The narrative is rather straightforward. Economic players, such as households and firms, act to optimize their objectives—be it profits or utility. Consequently, through market transactions, the most extensive welfare emerges by aggregating individual preferences, yielding macro-optimality. Admittedly, market and government failures create challenges, constituting the core focus of most economists. The premise is that rectifying market failures, such as implementing carbon prices to curtail 'free' carbon emissions or reducing the market dominance of major corporations, can yield optimal outcomes. Scarcity has a price but not an inherent limit. Economic growth isn't a requisite in this analysis; it simply mitigates scarcity.
However, the macroeconomy operates differently. Maximizing profits, utility, and accumulating capital are pivotal aspects at the micro level, fostering an expanding economic system at the macro level. Capital accumulation, inherent to a market economy, inherently generates a distributional quandary between those earning from labour and those deriving income through investments and profits. For capital to accrue, profits must increase over time. Consequently, when capital accumulation necessitates rising profits, other income shares, notably labour income, must decrease, or the economy must grow. Productivity growth fuels innovation and progress but demands an expanding economy.
When (labour) productivity advances, unemployment tends to rise, sustaining escalating profits aligns with firms' interest to maintain, or ideally increase, employment. Firms are unlikely to channel productivity gains as income to wage earners due to the practical reality of capital accumulation. Consequently, both labour and capital rely on growth. Further growth is a mediator in the conflict between labour and capital within market economies. This encapsulates the concept of the growth machine (explained below).
How is economic growth achieved? It's through expanding the system. This involves increasing the labour supply, boosting capital (credit, essentially a claim on future growth), accessing more 'free' energy and nature, instituting more flexible institutions (allowing for a decrease in labour shares and facilitating capital accumulation), and the widespread commodification of nearly everything (bringing onto the market what was previously not, like elderly care, child care, data, and so on). These 'pockets of growth' serve to maintain stability within the system.
Consequently, we find ourselves in a system that heavily relies on growth. Yet, we also face limitations.
This, in essence, represents a systems problem—one that lies at the very heart of our economy.
This discussion addresses the issue at hand. I'll delve further into specific problems, and of course, explore potential solutions.
Nicolae Georgescu, a well-respected but very pessimistic economist who explained that natural resources degrade over time through economic activity and that earth’s carrying capacity to sustain human populations and consumption levels would ultimately decrease and lead to our extinction.
From what I remember from high school, the first law of thermodynamics says it is impossible to create something from nothing. All products we produce result from the transformation of natural raw materials using energy. Thermodynamics is part of physical science that deals with the relations between heat and other forms of energy, such as mechanical, electrical, or chemical energy, and, by extension, the relationships between all forms of energy.
All human-made products break down, wear out, and eventually fall apart, returning to the environment as waste. The extraction of raw materials from nature and the return of disordered waste is known as throughput. Maintaining existing stocks in the face of gradual decline requires continuous throughput flows, creating even more waste. This physical throughput is essential to nearly all economic processes, including electronic and digital transactions, which depend on some combination of power in the form of electricity or food and tools in the form of paper, pens, computers, or phones, all of which depend on throughput.
The simplest laws of physics and mathematics tell us that the exponential growth of any physical subsystem of a finite system is impossible. Since all economic production consumes raw materials and generates waste (Air, Water and Land), the economy is a physical system. If this is so, then our current economic system, which is capitalism, focussed on infinite growth and profit, is not sustainable when waste becomes so prevalent that it threatens the very people who participate in it, which is, after all, all of humanity.
Infinate growth is impossible. Trees don't grow to infinate height. It's all a balance. To achieve this a complete mind shift is required where natural resource scarcity and waste creation and making it harmless is priced in. The problem however is that our population is growing, creating even more pressure on consumption so something will have to give.
"For capital to accrue, profits must increase over time."
This feels like it ignores the mathematics of compounding that shows us how account balances can grow to infinity, exponentially, over time, if investment earnings are retained and reinvested, instead of being withdrawn for spending. Earnings do not have to increase for compounding to work its magic. They can be constant over time. What is important is that earnings are retained, and reinvested.
This tells us that a charge for the use of money obtained through financing can be a variable cost of doing the work of creating surpluses for sharing through exchange by enterprise, just like supplies, regulatory compliance, the depreciation of capital equipment, payroll, marketing and administrative expenses, all of which are costs of doing business that must be recovered through the selling price.
This shows us that the growth imperative does not come from financing based on sharing in enterprise cash flows. So where does it come from?
It comes from financing as ownership for resale that requires that the selling price go up in order for the financier to extract a profit on sale as its source of compensation for providing equity as ownership for resale.
Only one kind of financing works this way. That is financing through Exchanges & Funds, where large scale financing contracts are securitized into large numbers of legally equal shares that are owned through purchase and sold for a profit in markets for maintaining market clearing prices on such shares. These markets must be liquid in order to attract participants. Sellers must be able to sell. Buyers must be able to buy. No seller can ever get locked into a trading position they cannot get out of; no buyer can be boxed out of a trading position they want to enter into. Price can be uncertain, but availability cannot. To maintain liquidity, these markets rely on volatility and growth in market-clearing prices.
For debt instruments that amortize with interest, volatility is sufficient for market liquidity, because the holder of a debt instrument will be able to get out of that position over time through amortization and interest payments, even if the markets do not delver a buyer for early exit (subject, of course, to default, which causes a loss on the position but at least closes the position out).
For ownership instruments - like shares of corporate stock - that do not amortize and may or may not pay dividends, growth is required. Growth in share price is what lets current sellers sell at a profit to current buyers who expect to sell, in their turn, at a profit, through continued growth.
Without growth, buyers won't buy. Without buyers, sellers can't sell. They get trapped owning shares that are not paying dividends and have no selling price (even at a loss).
Stock markets cannot function if buyers won't buy, and buyers won't buy if prices don't go up.
This is the source and origin of the growth imperative that drives corporate gigantism, which becomes a special pleading for the special interests of market professionals for governmental policies to support GDP growth which drives NPV growth which drives NAV growth which drives AUM growth which drives growth in fees and profits for market makers and the vast ecosystem of related professionals (including economists) who support liquidity and growth in the markets for maintaining market clearing prices on securitized shares in large scale financing agreements.
These special pleadings of special interests are NOT a requirement of capitalism as participation in markets without the need to seek the permission of privileged and entitled aristocrats (or modern day autocrats). It is not a requirement of Finance, writ large, within capitalism.
And it is only a requirement of one modality of finance as a process that:
1. aggregates money set aside by others;
2. deploys those aggregations as money for use by enterprise in doing its work;
3. charges enterprise for the use of that money;
4. shares the charges collected from enterprise with the ultimate sources of the money it provides to enterprise.
The only modality of finance as aggregations for deployment is securitization for share price trading over Exchanges or through Funds.