The economy is an elm
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Once upon a time, there was a group of people who hoped — under an elm — that pears would fall from the tree. Some did nothing, they just hoped. Other people, more active, pruned the elm, discussing endlessly on which branch to chop. Others performed rituals. Nothing worked, because an elm is an elm: it does not produce pears. It is not “structured” to produce pears.
In Spanish, when someone asks for something impossible, we use the proverb “no le pidas peras al olmo”, which means: “don’t ask the elm for pears”. This proverb illustrates, in my personal opinion, the current situation in which we expect social justice and environmental sustainability — the pears of the proverb — from an economic system not really structured for this purpose.
In any system, a behavior that persists and repeats itself over time is most likely due to its structure. These behaviors reflect the objectives of the system; even if these objectives are different from the ones we would like to achieve, or the ones we claim to be seeking.
Donella Meadows — lead author of the book Limits to Growth — argues that the objective of the current economic system is to increase the size and scope of firms, by increasing the wealth of those who contribute to capital: the shareholders. Not out of malice, conspiracy against the people, or “human nature”; but out of structure.
To stay in the game, she says, there is a golden rule: to make profits. The more profit to be distributed to the shareholders, the more their wealth increases, the more they will be able to invest in capital, and the more their market share will increase.
Profit is obtained when the total costs of production are lower than the revenues earned from the sale of products. In the current system, profit is the financial reward for taking investment risks.
Profit per se — the difference between costs and revenues — is not problematic. On the contrary, it is necessary for a company to be able to operate over the long term. It is the use (i.e., the way it is distributed) as well as the unlimited desire for profit that may be getting us into trouble.
Profit can be increased in three ways: (i) by increasing the number of products sold; (ii) by reducing costs; and/or (iii) by increasing the selling price (Figure 1). This article summarizes insights from the book The Limits to Growth and this paper by Jennifer Hinton, which point to how the first two strategies to increase profits can lead us to environmental degradation, growing inequality, and political capture by capital owners.
The key message of the analysis is the following: the undesirable outcomes that are observed are not errors or market failures (as so often said), but the logical outcome of a system structured around profit maximization.
Let’s look at these results in detail.
- Environmental degradation
To increase the number of products sold, companies invest in capital (e.g. machinery) (1) to increase production (2), to sell more (3), and thus increase profit (4). The more profit, the more can be distributed to shareholders (5) who — motivated by the desire for profit — may invest in the company again (6). The firms more successfully making profits would have new resources to invest (1), which allows producing more (2), and so on (Figure 2).
Sales (3) — one of the variables in the loop in Figure 2 -do not depend entirely on the firms. If there is no demand for the products offered, even if firms increase production, profit does not increase. The loop decelerates and may even stop for some products, reducing or eliminating profits (Figure 3).
Companies — to some extent obliged by the rules of the game — use two mechanisms to ensure that this is not the case: advertising and planned obsolescence (disinformation could be added here, see for example this documentary, or this article).
Investment in advertising (7) plays a crucial role in promoting consumerism, which increases sales (8), and thereby increasing profits. The purpose of planned obsolescence is to encourage the purchase of new products and services that would not otherwise be needed, thereby increasing sales (9) and profit (4) again.
What has just been described — and illustrated — are positive feedback loops. This technical term refers to a cause and effect mechanism in which “the more there is, the more there will be” (or vice versa). In common terms, this is often referred to as vicious or virtuous circles, depending on whether the outcome is desirable or not. COVID’s contagions, for example, follow this mechanism. The population, the number of bikes on the street, the level of irritation in a traffic jam (or in a couple’s discussion) are positive feedback loops: the more there is, the more there will be.
The result of this mechanism is an exponential increase (or reduction) (Figure 5). The analysis in this article focuses on the exponential increase in production output, which is generally referred to as economic growth.
Because of the physical laws of our planet, exponential economic growth is unsustainable, i.e. it cannot last, due to the impact it inflicts on the environment (10). The environmental impact is inevitable and is not exclusive to humans: a fly also has an environmental impact. Life would not exist without environmental impact.
Environmental impact becomes a problem when it exceeds certain thresholds: the planetary boundaries. Exceeding these thresholds endangers the maintenance of human life, as well as of other species (many of which have already gone extinct or are in danger of extinction). More details on this subject can be found here.
According to the authors of the analysis described in this article, the structure of the current economic system would lead inexorably to the exceeding of planetary boundaries. This because the companies that succeed (and therefore grow) today are those that accelerate the production loop, which in turn accelerates the impact on the environment. And an exponential acceleration of environmental impact is not compatible with the physical reality of our planet.
— Don’t forget about technology! May be the next thing you tell me if we were having a coffee together and we could interact.
Technology can, indeed, play a key role in reducing the environmental impact of our activities. I will argue, however, that for technology to play that crucial role, there is a need for a paradigm shift on how technology is used, on what technology targets.
A key insight of systems thinking is that the potential for change in complex systems lies in its structure, in its feedback loops, at the source of the results that we observe, and we may be aiming to change. Most technological efforts target, however, parts (e.g. products), rather than systems’ structure. Said differently, most technological efforts do not lead to new systems, and without new systems there likely not be new results.
Technology has a key role to play to reduce the environmental impact of our activities. Its potential is, however, largely untapped until technological innovation becomes systems innovation. More on this here.
2. Cost reduction and inequality
Going back to the analysis and Figure 1, we have seen that one of the mechanisms to increase profit is cost reduction. And salaries are a cost for a company. With the objective of maximizing the return on investment — that is, the amount of money distributed to shareholders — the authors argue that it is perfectly rational to want to reduce the cost of wages (11) and try to prevent any mechanism — such as unions or increases in minimum wages, for example — blocking this reduction (Figure 7). It is also perfectly rational: i) to automate production when that is profitable (which may lead to less jobs and a potential increase in inequality); ii) to externalize — a fancy term to say “not pay” — environmental or social costs; and iii) to try to stop any public policy that would prevent that externalization (more on why cost internalization may not be a feasible solution to the environmental crisis here).
Donella Meadows argues that the search for profit by shareholders encourage firms to adopt aggressive growth strategies, with the aim of eliminating competition and gaining a larger share of the market. She identifies this as the main objective of the current system. Growing and concentrating market share is, according to Meadows, the behavior encouraged by the current system’s structure, and the most rational at an individual level. The bigger the company, the more ways to increase profit, such as economies of scale, lobbying power, increasing the visibility of products through greater investments in advertising, access to accounting mechanisms to take advantage of tax havens, the possibility of relocating production where labor costs are lowest and where the possibility of outsourcing (not paying) the environmental costs of their activity is highest, the financial capacity to wage price wars to eliminate competition, etc.
If successful firms are those that distribute the most profit to shareholders (5), and reducing wages is a mechanism to allow this, it is not surprising if shareholders accumulate capital (12) and wages stagnate or fall. The increase of inequality (13 and 14) and the concentration of capital — already high, largely for historical reasons — is, according to the authors, a logical result of the system’s structure. This implies that the concentration of wealth and the growth of inequality are not side effects of the economic system but the product of its structure. They are the fruits of the elm tree.
3. Political capture
If you have gotten this far, you may be wondering about the role of the Government. If the right incentives were there, if politicians had the courage to take ambitious political decisions for the common good, then we wouldn’t be in this situation. Except…that we are, and it’s not by chance.
To reduce environmental impact in a finite planet, policies and laws ensuring that companies pay the cost of their activities and limit their production to sustainable levels, are likely needed. To reduce inequality in a finite planet, and given the current level of wealth concentration, re distributive policies are likely needed.
These policies , however, either because they increase costs or because they reduce the number of products to be sold, run counter the objective for which, according to Meadows, the system is structured, and are thus fiercely resisted.
Courageous politicians and ambitious environmental and social policies could be part of the pears that the elm tree cannot give us. More on this here.
In a nutshell, the authors argue that an unlimited search for profit encourages an increase in production, which leads to the exceeding of planetary boundaries, because an infinite increase in production is not compatible with the physical laws of the planet. Inequality rises due to the distribution of ever more profit to the owners of capital, and due to the reduction of wages, in order to reduce costs. The desire for profit in a context of growing inequality leads to political capture, which limits the regulatory role of the Government, thus further intensifying the dynamics here described (as the regulatory mechanisms that could slow down the production loop are weakened or eliminated).
The undesirable results we observe are not, as often presented, market failures, but the logical results of an economic system structured around profit maximization and accumulation. To go back to the metaphor, these results are the fruits of the elm, not the effect of a fungus attacking the tree (which could be eliminated if only the right techniques were used).
The good news — because an article of this length deserves one — is that social systems — unlike physical laws — can be transformed. We have the ability — as a society — to collectively decide to organize ourselves following different rules. We can tell ourselves that an economic system whose objective is the accumulation of resources in the hands of an ever-smaller group of people — with all the consequences that implies — is not good enough. That an economic system that grows at the expense of the environment upon which life depends is not good enough.
And we could then try to collectively understand what we want to achieve as a society, what are the pears, and how do we make the economy a pear tree.
Keep reading to explore that ‘how’.
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This article is part of a series, available here.