Textbook teaching in economics is not consistent with life processes and physical laws
from James Galbraith and RWER current issue
An economic theory that is consistent with life processes and physical laws is necessary for a simple reason: the economic theory that underlies modern “mainstream” economics and practically all textbook teaching in economics is not consistent with life processes and physical laws. And this is a problem.
Human beings are living organisms. All human activities, including mental activities, are consistent with physical laws. It is natural to build an economic theory on the foundation of biology and physics. In my forthcoming book with Jing Chen, Entropy Economics, we undertake this task, for two foundational elements of economics: the theories of value and production.
Modern mainstream economics is a theory of balance, or equilibrium. The basic terms of reference are the concepts of supply and demand, which interact in a market and come to rest at certain prices and quantities. There are a thousand different ways in which this process may be disturbed, by “imperfections” and “shocks.” But at the heart of the matter lie the concepts of balance and equilibrium – the immanent order toward which a market system is supposed to tend. This immanent order is sometimes called a “steady state.” This is a very comforting idea, compatible with such notions as the “end of history” and the triumph of market capitalism over competing social systems.
In real life, there is no such thing. In real life, time moves from the past, through the present, to the future, in an unceasing process of change. The changes take many forms, including birth, growth, decline, death, and the rise and fall of societies and civilizations. All of them occur under the influence of physical and biological laws, including especially the second law of thermodynamics and the laws of biological evolution. In our view, economics should adhere to the same broad principles. It should not rest on the illusion of an underlying steady state.
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Real-World Economics Review Blog 
The reason conventional economics ignores the importance of physical processes – and we agree that it does – is not to do with equilibrium theorising. It is because production in economics is not of gross product but of “value added”. Inputs that are not paid for are not counted and outputs that are not sold or not charged for are not counted. A strict separation is assumed between the “value” sphere and the physical processes underlying it.
That approach treats natural resources as inexhaustible and the earth as an infinite sink that will absorb all pollution. No feedbacks on economic activity are considered. This was a serviceable approximation in the earlier phases of industrial activity but evidently it is so no longer.
At present the neglect of unwanted outputs seems of greater concern than neglected inputs. Emissions of greenhouse gases that alter the climate and the effects on natural systems of pollution by insecticides, fertilisers and weedkillers, not to mention microplastics, require urgent attention. The first step is to amend economic accounting to include pollution, not just the costs of clearing it up but the implicit costs for the future of that pollution that is not ameliorated now. That requires accounting not just for current flows but for “stocks” of pollutants that will affect the future. Once all the costs of economic activities are brought into consideration more sensible choices can be made.
There is currently a lively debate among economists specialising in these questions about how far it is possible to economise on energy at current levels of economic activity given existing technology but these debates do not get into text books and don’t influence economic policy-making half as much as they should.
In the model of the social system of macroeconomics that I have presented, the cost of proper disposal and treatment of the unwanted by-products mentioned above, can easily be included (in the production cost), and should be too.
Gary,
as James Galbraith argues, “Modern mainstream economics is a theory of balance, or equilibrium,” and it is necessary to oppose to this framework. But, it is not the reason why economics (in general, including most of heterodox economics) “ignores the importance of physical processes,” as you pointed it.
One of the reasons of this negligence is, as you point it, due to the fact that “production in economics” in statistics is accounted in value terms or more precisely value-added terms. However, even if we go back to gross production framework, it is not easy to take into account waste heat and other materials.
For example, even if we see production as a process of input and output (as I do normally in my formulation), in other words, even if we formulate the production as a process
x = (x1, x2, … , xN) = yA => y= (y1, y2, … , yN),
this does not include waste heat and entropy increase. Generally speaking, if we measure input vector x and output vector y by weight, say by a weight coefficient vector w = (w1, w2, … , wN), normally we have the inequality
= Σ xi wi < = Σ yi wi,
which means there are normally some materials that are not taken as valuable goods. I believe Chester is not aware of this fact.
In my post above (on January 7, 2024 at 5:58 am), I wrote that
if x = (x_1, x_2, … , x_N) and y = (y_1, y_2, … , y_N) are respectively the input vector and the output for all productions in an economy, and if w = (w_1, w_2, … , w_N) the weight per units of goods, then we generally obtain the inequality
<x, w> = Σ xi wi < <y, w> = Σ yi wi. (1)
(Please ignore “=” in my original expression. It is simply a typo.)
The inequality (1) means that the total weight (measured in Kg or other units) of the input is smaller than the total weight of the output. In other expression, the total mass of the output is greater than the total mass of the input.
At a first glance, this is quite strange contention. Readers may have considered that I went mad. But, this only means that we are so blind about what is happening in production process.
Take a simple example. Let A = (aij) be input coefficient matrix (à la Leontief or Sraffa). It is often assumed that there exists an eigenvector z = (z_1, z_2, … , z_N) such that
x = z A = λ z = y. (2)
When A is productive, i.e. if it is possible to give a positive price vector p that satisfies
A p < p,
the eigenvalue λ of A is smaller than 1. For simplicity, we may assume that A is irreducible.
If we substitute this fact in the equality (2), we easily obtain
x < y (3)
for a production that is near to the eigenvector of the matrix A. For the case of x and y, it is evident that we have inequality (1).
The inequality (1) holds for much more general vectors that are not eigenvectors of the matrix A. I expressed this fact that “normally we have the inequality (1).” Of course, we cannot say that inequality (1) holds for all couples of x and y.
Inequality (1) has a serious consequence for environment economics. Market economy (an economy that is driven by price information) necessarily contain materials that are not accounted as useful resources having positive prices.
When useful work is performed there is no necessary connection with the amount of mass nor quantity of the produce, but basically and initially there is a certain amount of the raw or natural resource that needs to be extracted or occupied. This action stops other producers from using it, unless it is so plentiful and easily reached that its right of access has no initial value. When it does have value, this benefit should be properly seen as comprising the actual ground-rent. The measure of this is a rate of value in use, just as are all macroeconomics quantities that go into continuous production.
The better order or arrangement of the produced articles correspond to a locally reduced entropy, but due to the Second Law of Thermodynamics, the surroundings will become more disordered with a growth in their total entropy, even when the whole system includes what has just been made. This includes the by-products and pollution that are a resulting feature of human industry.
Equilibrium theorizing (noted above) should be based on the way these rates can be balanced, but since changes are continuously occurring the system hardly ever gets to an equilibrium state. However, since the degree of variability of the sample of the quantity being examined for equilibrium, greatly depends on the length of time being covered, an aggregate rate is needed to obtain what could be regarded as it reaching a possible equilibrium state. Even this makes the equilibrium concept very difficult to apply and what should be used to replace it is a stability criterion for the whole system acting together, without the duration of the action being so very significant.
The degree of stability is the rate at which the rate of change of the aggregated variable tends toward an (imaginary) equilibrium condition. In our social system, stability is maintained most of the time, due to negative feed-back. This feature is inherent within the nature of the system, but it is not always sufficiently effective without some deliberate changes being introduced through governmental control. The choice of how and when the government should do this is what professional macroeconomists should discuss and try to understand.
I will not argue anymore about methodological question of equilibrium. It will be insurmountable obstruction for those who live in equilibrium world, because he or she never walked out of that world.
However, we can argue more concrete questions. An example is the remark that David Harold noted probably without serious reflections (because it the the common sense for equilibrium analysis):
David does not acknowledge that this argument is based on equilibrium framework. In equilibrium, all resources are used up to the maximum. Let k be the kind of resources among many and let the demand for k be d_k(j) for an activity j, and finally q(k)be the amount of resource k. Then in equilibrium the equality
d_k(1) + d_k(2) + ・・・ + d_k(N) = q(k)
holds for N the number of all activity that demands resource k.
If d_k(i) increases, then some other activities must be decreased if we compare two equilibrium states.
This implies that in equilibrium all resources are fully employed and there is no resource k‘ that is used less than q(k‘) unless k‘ is a free good (i.e. the price of which is zero).
Keynes’s theory of unemployment is famous. It is a theory that unemployment occurs while the wage remains positive. Similar situations are repeated for many (natural) resources.
The standard argument of equilibrium theory is that the full employment is regained because input substitution occurs. In reality such input substitution is not powerful enough to return the disequilibrium back to an equilibrium. This is one of important arguments for neoclassical economics. Those who claim such propositions do not aware that they are a victim of equilibrium thinking.
Citing a part of James Galbraith’s paper, I posted a supplementary comment https://rwer.wordpress.com/2023/12/14/book-review-real-world-economics-for-whom-and-for-what/#comment-201186 on my book review of Komlos (2023) Foundations of Real-World Economics. It is easy to compare neoclassical economics with a new alternative economics. The difference lies in a deep level of the theory.
The economic theories are not physically embedded. Economic theories are not physics, they are called social sience or something else, which is, by definition, not exactly measurable, not precisely defined.
Any physically based economic theory must be based on a as precise as possible kind of definition of the subject of the discussion.
So, a precise definition – noteably and inevitable in physical terms, in physical characteristics – of “GDP” is necessary.
So, the real question to start the discussion of interlinking economic theories with physical world is:
What is the general real world physical characteristic of any kind of each single part of the sum of all new products, new services?
And the answer is close. The coalition of energy consumption and total economic size is widely known.
Money is not the real world unit for measuring economies.
Money is a relative dimension meter, without any real world stable dimension.
Money is not the meter of measuring the bubble in its total size, since it is not physically defined.
There is no “one unit” of a GDP defined with a physical measurable characteristic used to define “one money unit”.
That is the flaw of any kind of existing economic theories.
The theory itself is not physically embedded.
That is necessary to interlink real world with economics.
The equilibrium is a static condition, but our social system is dynamic and continuously being changed by disturbances. So to use a theory about directly achieving an equilibrium condition cannot be correct. What should replace it is the concept of stability. This term applies to the amount of negative feed-back a particular variable experiences, so that it tends to return to the theoretical equilibrium condition. Even though we don’t know the amount that this condition really obtains, we are still able to see how fast our variable approaches it, especially due to the need (below) for taking aggregate quantities.
I am thinking in terms of money, even though this is an unsatisfactory medium but we don’t have any other kind of seamless measure that generally is applicable to all of the variables. All of these variables are rates of flow of the values of goods, services, etc., of different kinds, and the stabilizing effect is expressed as a rate of change of these quantities. They are very sensitive to change so it is better to take an average (aggregate) of the trend of the stabilizing effect over a time period, rather than a single value at a specific time.
Even with these complications I find that to think in terms of stability is much better than to try to show more directly how equilibrium is reached.
energyasnumeraire is right in much of what he says but misses the point of economic activity. Please see my response to his comment on the “with one word…” thread.
The crux is that social studies are concerned with human welfare, which while wholly dependent on physical entities is not the same thing as those entities and cannot really be measured in physical units. Take energy. Early steam engines had an energy efficiency of 2-3 per cent. Current internal combustion engine might manage 25 per cent. Future engines might achieve 50 per cent. With such enormous variation, energy is no more an absolute measure of human welfare than is peanut consumption. If we only used the same energy per head as the 18th century we would still be a lot better off. Money has no intrinsic value, we agree. It is simply an arbitrary unit of account. Economics is a subject where ordinal comparisons are often possible but cardinal measures over time and space are always highly suspect. Physics is easier and much more precise but it doesn’t answer all the questions about society that we want to ask.
ghholtham, I see your point with the welfare.
But even that is … of relative dimension. I mean: what “really” is welfare? Somethins like a feeling of someone.
My point is, that to measure a bubble from inside with a relative meter … is always as well of relative dimension.
The only way is the true real har metered fact that any of all production factors is and ever will be determined to 100% by energy.
For any existing process, there is no “easy efficiency wizard stick”. Try to make iron casting more energy efficient … (switching out the lights at everning, tell iron to melt with lower temperature?)
Any inefficiency is “build into” the current existing processes. A long story of technological evolving process is necessary of … getting more output from the same amount of energy or investing even more, if you find someone wanting more pyramids per year (to find such pharaos, you need marketing specialists … but to produce more pyramids, … you need energy, much more energy. As slaves or as external energy driven machinery.
Efficiency is irrelevant for the real world size energetic of the GDP. It is just nice to get one (or maybe more) pyramid per year for the pharao instead of waiting twenty years for only one.
energy…I am not sure where we disagree or even if we do. The importance of energy to economic activity is freely conceded. Its neglect in production theory is indeed a serious flaw. My points that energy does not measure welfare, though important to it, also stands. Reducing GDP to physical units can answer some questions but ignores others. Economic metrics are imperfect but you choose the one appropriate to the question you are asking.