Introduction

Economists say that economic transactions are not “zero-sum”. Zero sum transactions have a winner and a loser such that the benefits of the winner are exactly offset by the detriments to the loser. Many folks don’t understand economics well enough to know that economic development and transactions are not zero sum; in fact, too many mistakenly believe that for every winner and advancement, others must loose. A nice treatment of this topic by Warren Meyer on his Coyote Blog. My intention is to discover exactly why economic growth can be positive or net-sum. This line of thinking may not be new, but it was so fun to think through that I wanted to share it:

Economic transactions and Information

A typical modern economic transaction consists of exchanging a good or a service for a sum of money. It’s easy to see that the party receiving the money obtains a net positive benefit, as long as the price is fair. It also turns out that the party receiving the good or service is also benefited – whether the purchase is for a tool, a luxury or a necessity, the purchaser will in general see a net improvement in quality of life. The first interesting thing that occurred to me is that most people would intuitively conclude that the party receiving the money was better off. It’s less likely that somebody will conclude the buyer as being better off; it takes more thought to realize this benefit. Upon reflection, the fact that money is recognized as valuable whereas purchases are not is interesting- because money is not an end to itself, but a means (forgetting capital markets for the moment). Remember that money has three roles: A store of value, a unit of account and a medium of exchange. Each of these three roles leverages the fact that money is a quanta of information. The store of value of money is exactly identical to the account it measures which is in turn equal to the exchange potential. During inflation, a $1 bill stores one dollar of value consistently, but the goods available for exchange at $1 diminish (e.g. $1 buys less food than it did previously). In this regard, the information content of the dollar remains constant, but the purchasing power (or exchange value) diminishes. Deflation does the opposite, increasing the exchange value of a given currency denomination.

So what does money store information “about”? Some folks have argued that there is a natural analog between money and energy. At first glance, this seems like a viable conclusion, since stored money represents a stored “potential” to buy or build a thing. A spent dollar is transformed into the labor of workers or the transport and assembly of a product, which takes energy. We can see then that a simple analysis could persuade us of the link between energy and money. However, significant problems arise if we think further about the issue. Going back to basic physics and the world’s most well known equation: E=mc² we can conclude that the energy content in a pound of cow pies or a pound of apple pie is absolutely identical. If the price were equal, based on the energy contained in one pound of mass, most people would still choose to buy the apple pie with their one-pound (or dollar) note. Now some might argue that the human digestive system is much more able to extract energy from the pound of apple pie, so its value is greater. I would point out though, that a pound of sugar has far more energy value than a pound of truffles – so shouldn’t the sugar be worth more? Clearly there are a couple of things at work here than just raw energy, as measured by physics. One issue concerns the idea of scarcity and the other concerns the idea of preference or demand. I won’t get into the scarcity discussion now, as that would take us too far afield. For the moment, let’s assume that given equal scarcity, there is still a reason to value different commodities and services differently based on their desirability.

A difference in value due to quality of energy has a very direct analog in physical science: entropy. Physics recognizes that not all energy is created (or destroyed) equally and indeed goes so far as to relate higher qualities of energy with ever increasing levels of organization and complexity. In general pure heat is the lowest quality energy source while chemical energy, the energy of uniform motion, light and potential energy are high quality. At an even more basic level, people are far more interested in higher-quality versions of goods and services – nobody wants to hire a service which cuts only random patches of grass in a lawn. People tend to be much more interested (e.g. demand) low-entropy, high-quality and highly-useful goods and services.

I’ve rather rushed through all this, and rounded off quite a few corners (it is after all a post, not a book). For the sake of summary let me propose that it’s far more reasonable to think of value as a measure of the combination of low entropy (which drives demand) and scarcity. In addition it is universally true that an object or system can be made more valuable by diminishing its entropy (e.g. building a house out of lumber, turning sand into glass or integrated circuits). Both of these quantities, scarcity and low entropy are in some real sense measured by the value of money. Which takes us to…

Money as a Guarantee of Future Entropy Decrease

This is the foundation upon which all net-sum economic theories must rest:
1) There must be confidence that Money received in a transaction is a store of value, or that it is persistent.

2) In most any case, adding complexity, or stated another way – diminishing entropy, will enhance the value of a material or process (an example of an exception is a weathered antique). Any act of manufacturing, building or inventing entails a diminution of entropy. Money facilitates bringing together the information, energy and raw materials required to construct a system or device with locally lower entropy. As such money is better represented as a potential for entropy decrease, or a negative-entropy store rather than as a unit of energy. This is semantically more appealing because entropy can be equated with information rather directly, and money is a conveyor of information; whereas there is no similarly direct mechanism for equating energy with information.

Positive Sum Economies

It’s time to return to the original question: How can a positive sum economy exist and be sustained? The simple answer is that the vast majority of fair economic transactions diminish entropy for all involved parties, whether immediately by virtue of a good or service, or in a delayed fashion by virtue of the confidence and capability of money. Even in the case where a raw material is being purchased, the raw material has been extracted from its natural, inert (e.g. underground, chemically bonded, rarified, etc.) state by the expenditure of energy and the corresponding decrease in entropy. A case where entropy is not diminished is when payment is made for destruction (e.g. war, demolition, incineration).

Basic physics tells us that the only way to avoid a continued increase in entropy over time in a closed system above absolute zero temperature is to have a constant flow of energy through the system. The Earth is essentially a closed system. Discounting space dust, the amount of matter in the word does not change over time. Instead it cycles over time from low to high entropy states. The only way to lower the entropy of a system is to put in usable energy from outside the system.

Energy is Economics

We see now that money is not a measure of energy, it is a measure of (lowered) entropy. We also see that for the promise of lower entropy to be realized, usable energy must be available. The inescapable conclusion is this: Net-sum economies are possible only so long as there is sufficient energy for the creative and “creative destruction” mechanisms of economics to continue.

Any thoughtful person who believes energy policy can be ignored, or that it is not the single most important aspect of our reality allowing us to be more than a planet of yeoman farmers is fooling themselves or woefully uninformed.

Friday, August 11th, 2006 @ 12:28 am Ecomomics and Thermodynamics
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