RUTHFULLY YOURS

— James Grier Miller
(The relevance of this quote from the author of the defining treatment of “living systems” will become clear as I argue that capitalism is the only economic system capable of resisting the second law of thermodynamics and sustaining economic prosperity in a finite world.)

Is it possible to have endless economic growth in a finite world? Dick Smith thinks it is absurd, as he explained in August to the National Press Club. He largely blamed economists for propagating and nourishing this self-evident absurdity.

Mr Smith is not alone. Environmentalists would concur, as would a number of other successful business tycoons who have turned to Gaia in their reflective years. The Club of Rome might have over-egged the imminent depletion of key resources in the 1970s but to the faithful it is simply a matter of time. And, really, within fairly expansive limits, wrong timing is a minor fault in the scheme of things.

On its face, the case seems to be unanswerable. If you keep taking bite-size chunks, and increasingly bigger ones at that, out of an apple it will dwindle and vanish or at least only the unappetising core will remain. Liken the Earth to a large apple. Ergo, the enjoyment of the fruits of the Earth is eventually bound to result in a depleted wasteland. Isn’t it? Well, no, actually, it isn’t.

What seems like a no-brainer to environmentalists is a myth—a brainless no-brainer no less. It is as ill-founded as was Malthus’s dismal theory that “population is always pressing against food”. But it has nevertheless flourished in the hands of those who despise capitalism and the economic abundance it brings and who, given half a chance, would put industrial development on hold or into reverse.

From the Keystone Pipeline in the United States to nuclear power in Germany to fracking in Australia, hampering economic development in the name of sustainability is de rigueur. I doubt there is now any major company which does not pay homage to sustainability in its mission statement. Global warming alarmism has added an extra twist but, make no mistake, just as the sustainability movement began before the planet began its recent short period of warming, it will not miss a beat if the planet starts cooling.

To be sure, environmental zealots don’t want to drive us back to the seventh century, as do the clownish Islamists; too many open fires, I suppose. They do however want us in the West to stand still. Mr Smith put it succinctly. If you already have five flat-screen televisions, he said, do you really need seven? I will return to this implied admonishment. It is instructive.

Standing still is a chimera. Its mere pursuit, presumably by government, would lead to economic sclerosis; to entropy (as I will come to) and to regression and poverty. This has nothing to do per se with burdensome green tape or the subsidisation of inefficient renewal energy; even though both fall out of a sustainability agenda. It is to do with there being an intractable contradiction between capitalism and standing still.

Capitalism and growth are inextricably linked. Embracing capitalism means ineluctably embracing economic growth. But if this is true, as I will show, what implications does it carry for a planet whose resources are by definition finite?

The finiteness of resources in a world of economic growth frightens environmentalists. I imagine it keeps them awake at night and, in all likelihood, is the inspiration for much of their impoverishing agenda. So, perhaps, if their fears can be dispelled their agenda might become more rational, reasonable and growth-friendly. You don’t think so? You’re probably right. Environmentalists, like religious fundamentalists, are fanatics and won’t be swayed by any kind of sweet reason or logic. But that is no reason to shy away from the argument. Truth, after all, will eventually win out. Hmm, there I go again, as President Reagan might have phrased it.

I will break the argument into three parts. First, I will consider the relationship between capitalism and economic growth. Second, I will consider the relationship between capitalism and the exploitation of resources. Finally, I will come to “living systems” and the genius of capitalism. I will show that capitalism has the characteristics of a living system and, accordingly, far from being inimical to sustainability, is the only economic system capable of safeguarding Earth’s resources into the far-flung future. I will also make a few remarks about the way in which social costs (such as pollution) and population growth fit into the picture.

Capitalism and growth

In 1953, or thereabouts, in provincial England, the father of my boyhood friend bought the first television in our street. It had a nine-inch screen fronting a deep cathode-ray tube. After a little while he fixed a curved thick magnifying glass, hung by straps, to the screen to increase its viewing size. However, this distorted the picture unless you sat more or less directly in front.

Now let me patch Dick Smith’s view that enough is enough into our street in 1953. My friend’s house had one small living area and two small (usually cold) upstairs bedrooms. His father really didn’t need two televisions. Where would he have put the second one? And, anyway, having acquired one television in the 1950s, what in the world did he need another one for? It would have been unthinkable. So, maybe the economy should have been put on hold at that juncture; at least for my friend’s father. Presumably, if he were alive, he would be peering still at his nine-inch television through its magnifying glass; happy as Larry.

As I have said, Dick Smith is simply one among a number—Warren Buffett and Bill Gates come immediately to mind—who, having made their pile, have become focused on environmental and social issues. But the irony is telling. Mr Smith didn’t stop at five shops and undoubtedly he made sure they were always selling the latest gadgetry.

The point of course is not whether having five flat-screen televisions is enough; though it may not be if you own a mansion. It is whether flat-screen televisions as currently made will become anachronistic. It is simply silly to choose one point in time and say well, that’s it; no more growth is needed. Flat-screen televisions, DVRs, the internet, personal computers, laptops, iPads, iPods, mobile phones, smart phones, air-conditioned cars, jumbo jets, communication satellites and many, many, other things were simply not around when my friend’s father was watching his nine-inch television. Growth begets innovation and innovation growth. Growth and innovation are indivisible. Both are derivatives of capitalism.

Capitalism can be defined as the private ownership of the means of production, distribution and exchange. However, that provides little insight into its nature. It is like describing Albert Einstein or Marilyn Monroe as a people with two arms and legs and other requisite body parts. Capitalism epitomises creativity.

Socialism puts production, distribution and exchange under the ownership and control of government. From there on we know from experience that stagnation ensues, as do endemic mismatches between the availability of particular goods and services and the demand for them. If zero or negative growth is required, socialism can certainly deliver it; and on a continuing basis. Socialism can make do with a snapshot of the economy. Capitalism can’t. The nature of capitalism is that it produces a changing and ever-modernising moving picture of production, distribution and exchange.

Companies would have gone broke continuing to make nine-inch televisions in the mid-to-late 1950s, never mind in today’s market. There is no sustainable snapshot in capitalism because competitors are always looking to produce better and cheaper products and to grow their market and their profits. People who believe that growth can be stopped to preserve resources do not understand capitalism. The only way to stop growth is through government ownership and control. Only then can attempts be made to keep production the same year after year; the same in quantity and, because commissars are not much good at innovation, the same in kind.

Individual entrepreneurs like Dick Smith and Bill Gates are always looking to develop and grow their businesses, or at least they were when younger, before their reflective years set in. Reflective years are full of delusional regrets. You know the kind of thing: I wish I’d spent more time with my children when they were young. Fortunately new young entrepreneurs are always springing up to take the place of the old.

Multiply the young Smith and Gates by countless numbers of others; including those of more modest ambitions. There is no stopping them. Together they introduce new and better products and services and make us all richer (and richer into the future). To suggest that some collective cap can be put on their ambitions is totally to misunderstand the game. It is not a team game. They are all unruly independent individuals jockeying for position; always striving to grow. Left relatively unencumbered by government, no other result is conceivable out of this process—except for short periods of dislocation—other than continual aggregate growth. Growth is capitalism’s norm.

The nature of capitalism (its genius I will come to) is that it makes societies ever richer. It can do no other unless it is totally hamstrung by restrictions, rules and regulations. Economists are not responsible for growth. It is useless pointing the finger at them. In fact, in government service, they have generally conspired, albeit unintentionally, to undermine growth by implementing interventionist Keynesian policies. But, that aside, their allegiance to economic growth simply pays due heed to the nature of capitalism and to man’s innate desire to acquire earthly riches. And, if we can judge by a literal reading of the Parable of the Talents, to God’s regard for those who go forth and make profits.

Exploiting resources

Making profits means exploiting resources. There’s the rub, or so it seems. English economist E.J. Mishan was the first economist of note to set out some of the problems of economic growth in The Costs of Economic Growth (1967). However, his concentration was on adverse externalities like pollution, congestion (which he particularly disliked), urban violence, and the effect of commercialism on moral standards.

It is hard to disagree entirely with Mishan. He made out a good case. But he was stuck in his time. He didn’t foresee the dynamic possibilities of continued growth providing the wherewithal to mitigate the very social ills which he observed growth had caused. Nor did he explore whether any conceivable alternative would be worse. Life was mean and short before industrialisation and growth started taking off in the eighteenth century, and stagnation didn’t work out too well in post-war Eastern Europe. In any event, Mishan did not focus on the impact of growth on the usage of finite resources.

The focus on the usage of resources came later, in 1972, with a study (The Limits of Growth) commissioned by the Club of Rome, a global think-tank. This study echoed both Malthus, in suggesting that the world’s population would outrun the food supply, and Mishan, in warning of the serious effects of pollution. However, its main thesis was that the world would soon run out of key resources unless economic growth was curtailed. How was this conclusion reached? A complex computer model was employed.

Computer models are like guns. In the wrong hands they can be deadly. They become deadly when they become inviolable; when they are thought to mirror the complexity of real life; when they replace rather than aid thinking and common sense; when the predictions they produce are preferred over evolving facts; and when any sceptical sniff tests are derided as being unscientific.

The climate models relied upon by the IPCC are currently the most egregious example of computer models in the wrong hands. But the IPCC is not alone. After the 2009 financial meltdown, computer models were used to predict that Keynesian stimulus spending would create massive numbers of jobs. When the jobs failed to materialise the facts were contorted to fit the predictions. “Jobs created” became the (unfalsifiable) “jobs saved”.

The Club of Rome was simply an early mover in misusing computer models. Its immediate influence was short-lived. Maybe the age was less gullible. In any event, classically-minded economists were not hoodwinked.

The basic problem with the Club of Rome’s model was that it failed, and extraordinarily so, to take proper account of the price mechanism; the responsive steering gear of capitalism. Prominently, among a number of economists, Wilfred Beckerman (“Economists, Scientists and Environmental Catastrophe”, Oxford Economic Papers, 1972, and Two Cheers for the Affluent Society: A Spirited Defence of Economic Growth, 1975) pointed out the obvious flaws in the model.

A change in the balance between the supply of and demand for any raw material results in price changes which steer markets into a different direction. Forward markets provide advance warning of any impending shortages. Impending shortages lead to rising prices. Mitigation results: exploration and extraction intensify, substitute materials are brought into play, and new technologies and products are developed which rely less or not at all on the materials whose supplies are tightening. All of this is transparent and comforting to those who understand market economics—while unrequited alarm continually besets those who don’t. As Beckerman puts it:

History is full of dire predictions that if the demand for a certain product continued to grow as before the known resource would be used up in x years time, and all of them have been shown by events to have been absurd.

Free market prices guide the economy around obstacles without any long-lasting slackening of pace. But this tells only the beginning of the story. The completely told story of the genius of capitalism is that it is the only economic system which is sustainable in a finite world. It is the only economic system which can continually enrich mankind over the millennia ahead. The reason for that is that it has the characteristics of a “living system”.

Living systems

Living systems are systems which self-organise and interact with their environment. Living Systems by James Grier Miller (1978) is the defining work on the subject. It is heavy going and, at around 750,000 words, very long. Thankfully, however, Miller sets out the characteristic of living systems in a summary and digestible form. Moreover, for my purpose, I need concentrate on just two inter-dependent critical characteristics of such a system. The first is that the system resists entropy; in other words, it resists falling into disorder and therefore remains viable. The second, on which the first depends, is that the system is “open”.

Only open systems have the capacity to survive in a viable state. The second law of thermodynamics has its way with all “closed systems”. Entropy eventually undoes them. According to Miller, an open system must have both inputs and outputs. And, more than this, its inputs must be higher in complexity (lower in entropy) than its outputs. Among other things, this gives it the capacity to forestall decay and undertake repairs. Additionally, an open system must have a minimum level of complexity and a “decider” which causes its components to interact. In the area of economic systems—almost by definition and without exception—only capitalism meets the requirement of an open system.

Capitalism draws in inputs from the natural world in the form of materials; it draws in physical and financial capital; labour and skills; ingenuity, invention and innovation; and, crucially, entrepreneurship. It produces outputs in the form of goods and services. Its inputs are much more complex than its outputs. Consider the engineering that goes into producing computers compared with the finished article. Consider the minds, ingenuity and the entrepreneurship which form part of the inputs. Capitalism is a highly complex system; much too complex to be centrally organised. However, it has a “decider” in the form of market prices which govern its internal interactions and which guide the application of its inputs to the purposes of repair and renewal.

Now compare capitalism to its alternatives, all of which embrace public control of economic activity. This might include public ownership, onerous and discriminatory taxation, strangulating red and green tape, wage and price controls, and/or enervating income and wealth redistribution. The economic system is effectively walled off in one way or another. The system is not as welcoming and rewarding of complex inputs. Entropy increases, as it did in Eastern Europe. It is best that I quote Miller:

In living systems many substances are produced as well as broken down; gradients are set up as well as destroyed; learning as well as forgetting occurs. To do this such systems must be open and have continual inputs of matter-energy and information. Walling off living systems to prevent [free] exchanges across their boundaries results in death by confinement … entropy will always increase in walled-off living systems.

Of course there are no absolutes in real economic life. It is not a question of there being walls or no walls. The question is how high and extensive and impermeable are the walls. What we are seeing in Europe, for example, with an unemployment rate in August of 11.5 per cent, measured across the eighteen Euro-area countries (OECD Stat-extract), is that the walls there are seriously interfering with capitalism’s ability to repair and renew economies. Entropy is winning. And, only tearing down the regulatory and restrictive walls, or at least some of them, will solve the problem.

Capitalism evolves, as do living systems. It changes course in response to stressors and to changing conditions of supply and demand. Constraining its ability to do that puts prosperity at risk; and it can, if taken too far, put economic survival at risk.

A living system is geared to self-preservation. Similarly, capitalism is geared to keep on finding ways to grow the economy. When you consider that mining has still only made small inroads into the Earth’s crust, there is a lot of materials and energy to find. But that is beside the point. For example, the US Geological Survey estimates that iron ore mined in 2013 was close to three billion tonnes, against known world reserves of 170 billion tonnes. So, it seems that even standing still won’t do it for our grandchildren and their children. Iron ore will run out in about fifty-seven years. We either have to go rapidly into reverse or a return to the Bronze Age; that is, if there is enough copper and tin to go around.

There are lots of things wrong with that story, including that “economic demonstrated resources” across all minerals will undoubtedly grow through discovery and improved methods of extraction. But the main thing wrong with it is that we have no idea where capitalism will have taken us in fifty-seven years. We don’t know what new materials will be developed, how the pattern of usage of materials and goods produced will change, and what new technologies will overthrow existing technologies. For example, nuclear fusion, on which Lockheed Martin has recently announced a breakthrough, might eventually make other forms of energy redundant. No one knows.

What we know is that human ingenuity combined with the market price mechanism and competitive forces will find ways through obstacles and go on producing more from less. Think of Moore’s Law and the exponential increase in computer performance as a result of technological innovation and competition. Of course, nothing in this physical domain lasts forever. The sun will eventually explode. However, unless capitalism is completely hamstrung by government intervention, by cronyism or by misguided social agendas (like the inequality agenda) it will sustain ever-growing prosperity without ever using up the available supply of whatever changing pattern of resources are needed to underpin the changing pattern of production.

None of this is to say that capitalism is the complete answer. Capitalism doesn’t adequately take account of social costs like pollution and congestion. That is because it would be self-destructive for it to do so, and living systems don’t normally commit suicide. Businesses that tried to configure their operations to take account of social costs—to internalise externalities—would find the task impossible and would likely go out of business trying. Market prices would no longer provide a guiding determinant of resource allocation. Undoubtedly entropy would ensue as resource usage became unhinged from market forces.

Some capitalists like John Mackey (Conscious Capitalism, 2013) preach the need for businesses to balance the needs of all of their stakeholders, including those of the community within which they operate. But, he is a founder of the company Whole Foods Market in the USA which sells environmentally sound foodstuffs. Being particularly sensitive to social costs fits this business model. Sensibly, most businesses pay little more than loudly-promoted lip service to social costs outside of meeting regulatory requirements. They know that competitors would rise up to “kill” them if they got too “caring”. Selling upmarket organic vegies and ecologically sustainable fish is not like selling raw materials, intermediate goods, and the general run of groceries, household goods, clothes and family cars.

The only way to tackle social costs effectively is for government to set rules (limits on particular emissions, for example) within which the free market can operate and, where necessary, to make public investments in infrastructure. The onus is on government to set achievable goals and spend sensibly. In the main this has worked tolerably well, despite some stark examples of government overreach of which attempts to curtail carbon dioxide emissions is the latest. Pollution of air and water is far less in the modern world than it was, say, fifty years ago. Traffic congestion is also much less acute than Mishan might have imagined if he had drawn a straight line through vehicles on the road in 1967 and now.

Whatever steps are taken to reduce pollution and congestion, having fewer people contributing to the problem is beneficial. Environmentalists should therefore be delighted by the ability of capitalism to curb the planet’s “biggest scourge”; to wit, population growth. Capitalism produces prosperity and as Jones, Schoonbroodt and Tertilt point out in their paper “Fertility Theories” (Demography and the Economy, NBER, 2011): “Empirical studies find a clear negative relationship between income, or wages, and fertility”. The reasons for this negative relationship are admittedly less clear cut than the fact of it.

Economists assume children are “normal goods”; and the demand for normal goods (as distinct from “inferior goods”) should increase as income grows, not fall. The usual explanation for the (apparently) inconsistent decline in the demand for children is that as family income grows, the sacrifice of having a child in terms of income forgone—particularly when women form a large part of the workforce—overwhelms the positive effect of growing income. Another view is that as income grows there is a tendency to invest heavily in quality (through education, for example) at the sacrifice of quantity. Whatever the definitive explanation, the effect is profound. Richard Easterlin puts it starkly in “Fertility” (The New Palgrave, 1987):

Over the long term, growth in real per capita income has everywhere been accompanied by a decline in child bearing from levels sometimes averaging as high as six or more births per woman to around two or less.

Without much doubt, reducing fertility is a good thing taking the world as a whole. The world’s population is around 7 billion. It is set to go on growing to perhaps 10 to 11 billion before it stabilises. Though, that is by no means certain. Some outlying predictions have it rising well beyond 11 billion (UN DESA).

It might be comforting to know that in 1679 Antoni van Leeuwenhoek (apparently the father of the use of microscopes in biology) calculated that over 13 billion people could live on the earth. Leeuwenhoek based his calculation on the population density of Holland at the time. (This can be found in a fascinating book by I.B. Cohen, The Triumph of Numbers, 2005.) My senses nonetheless tell me that it would be desirable if the world’s population could be contained to a considerably smaller number than 13 billion. The best way to ensure that happens is to make people better off.

The mission has been accomplished in the developed world. In fact, it has undoubtedly gone too far. For example, in Europe in 1960 all but one or two countries had fertility rates well over the replacement rate of 2.1 children per woman. By 2012 these rates had all fallen below the replacement rate; some markedly so. Take Italy, where the progressive decline has been from 2.37 to 1.43 (EC eurostat). The situation is very different in the developing world, where populations continue to grow much too strongly. According to the UNFPA:

Between 2013 and 2100, the populations of 35 [least developed] countries could triple or more. Among them, the populations of Burundi, Malawi, Mali, Niger, Nigeria, Somalia, Uganda, United Republic of Tanzania and Zambia are projected to increase at least five-fold by 2100.

Ideally a re-balancing of population growth needs to occur between developed and developing countries. That might require financial incentives to encourage a modest increase in fertility in developed countries. More critically, it will require developing countries to lift themselves out of poverty by establishing the conditions under which capitalism flourishes. As these conditions include an enlightened and free society, the rule of law, property rights and the absence of entrenched corruption, their extensive establishment looks to be a fair way off. Nevertheless, there are no other good options. Capitalism is the key to overcoming poverty and, as a by-product, to controlling population growth.

Capitalism combined with sensible controls of social costs is the route to rising and sustainable prosperity. And it is not just the best route; it is the only one. All else will eventually produce impoverishment. Closing up economies by imposing limits on growth or a range of other onerous restrictions will cement patterns of resource usage and lead inevitably to shortages, collapses and chaos; in other words, to entropy. We have stumbled, via Enlightenment thinking and industrialisation, onto an economic system that can overcome shortages by developing new materials and new technologies. There is no conceivable limit. Can this be proved? It can’t be proved. However, so far, history is well onside.