Doughnut economics #5

Key idea #5: the real world economy is a complex network of interrelated systems.

Thanks to Rob Liu for granting permission to reprint this from the Conscioused website.

Buy Kate Raworth’s Doughnut economics  at Fishpond (New Zealand)

“Supply and demand” is a famous phrase. Open up any entry-level economics textbook, and you’re likely to find a simple diagram explaining how it works. On one side, there’s an ascending line. On the other, a descending line. They overlap at the point where prices align with what consumers are willing to pay. Economists call this the equilibrium point.

In the same way that a swinging pendulum is governed by the equilibrium-seeking laws of physics, so markets are governed by economic laws. Or that’s the theory at least. Unfortunately, equilibrium doesn’t work like that in the real world. In fact, the models used by economists often only make sense because they’re over-simplified. That’s because they often search for models that look like those used by scientists, such as physicists.

But ironing out the messy reality of the world means making simplistic assumptions that don’t mirror the way things actually work. A representative consumer responding to events in predictable ways is one of those assumptions, and that’s dangerous because it overlooks the unpredictable boom-and-bust cycles of the market.

Take the 2008 financial crisis. Because mainstream economists were convinced that markets naturally stabilize themselves, they overlooked the warning signs. They ignored the banking sector and failed to analyze its unique complexities and vulnerabilities. The US Federal Reserve didn’t even include private banks in its models!When the crash came, they were caught out. They hadn’t seen it coming.

So how can future disasters be avoided?

Economics in the twenty-first century needs to change. That means dropping mechanical metaphors and thinking about economies as systems. To do that we have to see economies for what they are – massive systems of interconnected variables. Equilibrium isn’t likely in these kinds of systems. Instead, individual components interact, reinforcing one another. To understand this, it’s a good idea to use the tools of system thinking.

Take feedback loops. These can have two effects: In the first case, positive loops encourage something in a system. In the latter, balancing loops discourage something. You can understand how this works by imagining a flock of chickens living next to a road. There are two things chickens love to do: cross roads and lay eggs. The more eggs they lay, the more chickens there are. That, in turn, means more road crossings. That’s a positive – or reinforcing – loop.

But say the road’s a busy one. More crossings mean more chickens being run over, sinking the total number of the flock. That’s a balancing loop. Thinking in terms of feedback loops lets us monitor the complex interactions of an economy, and that’s a much better approach than blind faith in the market’s ability to balance itself!