The Drachma and the Euro as a Cybernetic Question

When people suggest that human ingenuity will find a way out of the various predicaments we have wandered into, they base this optimism in part on extrapolation. History shows what the British call “muddling through”, adding a bunch of ad hoc rules and policies to adapt gradually to changes. The trouble with this is familiar to any software developer. You end up with a system that is overly complex, poorly understood, fragile, and increasingly difficult to muddle with. This is the usual dynamic of failed software.

The other basis for such confidence is the history of ingenuity itself, which is actually an impulse toward elegance and informed design. If you delegate well-defined technical problems to appropriate experts, they generally find a way out. The delegation process is fraught, of course. So where possible, you let anyone willing and able to declare themselves expert, and set up a competition between them. The competition can in many cases solve the delegation process – whoever succeeds in solving the problem is rewarded.

Feedback appears twice in this sort of solution. The first is obvious – you solve the delegation problem by mapping it onto a marketplace problem, and reward the winner, that is, the outfit or outfits that best solve the problem, handsomely. Demand for the product measures the fitness of the product for the problem at hand. Then perhaps, you may choose to muddle things. You modify policies to encourage the further progress of the new solution.

But there’s another place feedback enters – within the individual solutions at hand: say, mining systems, power plants, bridges, pharmaceutical plants, etc. When you look at the actual technical solutions that constitute the real basis of modern civilization, you find explicit, mathematically elegant feedback loops wherever you look. My prior brief essay was intended to introduce people to the rudiments of feedback and control theory. It’s not that I expect conversation here to proceed in the Laplace Transform Domain. However, I would like it if people understood that there is a whole domain of expertise about feedback systems that touches on predictability, stability, and communication, key concepts for coping with the Very Big Problem.

Norbert Wiener, a pioneer in this domain who coined the term “cybernetics” to identify it, failed to get very far beyond the engineering problems which so advanced the practice of engineering in the mid-twentieth century. But he did note that many problems of governance had analogous structures. In addition to his well-known early dabbling in Artificial Intelligence (which gave us the vernacular meaning of “cybernetic” in use today) Wiener also was very concerned with the relationship of employment to the larger structure of society. He was deeply concerned as to what would happen as a consequence of the” automation” of manufacturing processes leading to a decrease in demand for low to medium skilled labor. (How this was avoided for a half century, and why it is finally rising to bite us now, is something on which I have some speculative hypotheses, but I’ll stick here to what I’m pretty certain of).

All the talk of “feedback” in the climate system also relates to these concepts, even though the climate is not (as yet) an engineered system.

So we can start with natural homeostasis. A “homeostatic” system is one which has a tendency to return to a given state when preserved. The short term temperature (assuming fixed atmospheric concentration) of the earth’s surface is roughly homeostatic. If a perturbation occurs that warms the surface, more infrared radiation is emitted from the surface, allowing the surface to cool. Cloud albedo, notoriously, makes this process more complex but not so much as to run it backwards – that would make the process unstable as opposed to homeostatic. To fully characterize the system leads to mathematics far more complex and less tractable than that in an engineering situation, but the presence of the key features of homeostasis are there.

One key feature of such systems is the dominant time constant – how long it takes a perturbation to go away. One of the key design goals of engineered systems is often to minimize this time (though with systems like shock absorbers, it is to extend it). It can be of the order of seconds or even much shorter. In a natural homeostasis, a key objective is to discover that time. (For technical reasons the “time constant” is typically about a third of the time it takes a perturbed system to settle back into the noise – it’s the inverse of the rate of the decaying exponential, sometimes called the “e-folding time”.)

Economic systems are artifacts, but they are not properly considered engineered systems. What is or isn’t privately owned  (surface water, highways, airports, schools, land, air, music, pictures of mice with big round black ears) is contextual, and is decided by the political process of “muddling through.” Economic theory, to my limited understanding, tends to divorce itself from all this messiness and focus on theoretical aggregations of exchanges among free agents. If my understanding is right, this is one of the points where it suffers badly from its lack of overlap with other sciences. It’s as if a climate model were to ignore the surface boundary level altogether, for instance. You’d end up with a much simpler abstraction, and one not entirely without utility (see “quasigeostrophic”) but you would not have a complete theory of climate or a model that could be integrated indefinitely to replicate the gross features of climate.

This makes economics hard, because if viewed as a science, it includes politics as a key system. Climate projection can factor this out into “emissions scenarios”, based on a few large decisions that we will eventually make, even if only by default. The relationship of economics to policy is far more tightly coupled. And predicting politics is surely beyond foreseeable human capacity, Asimov’s Foundation notwithstanding. (I mean, even though I read the trilogy at 14, I knew he was desperately handwaving.)

But there is no question that there are homeostatic subsystems within economics. These have, perhaps, emerged to some extent in a competition among social structures. Some of them, perhaps, were built in to the very idea of a market. If people won’t buy my product at my price, I have to change my product, or my price, or the way I market it. My failure in the marketplace feeds back on my behavior. Then, when people do start buying, I get feedback that I am doing something right, and can start to scale up.

There is homeostasis at a macroeconomic level as well. A particularly important one was discovered by Jane Jacobs, and explained in her book “Cities and the Wealth of Nations”. Her thesis in that book is “one city, one currency”. She illustrates how currency forms the feedback mechanism in a healthy homeostasis in world trade. In short, if an economic zone is doing well, it can export, causing the value of its currency to rise, and allowing increased value of imports. Conversely, if a zone is in decline, its currency will fall, and it is obliged to rely more on local resources, building up local skills and services, and eventually allowing it a position in export again. She points out that most nations are larger than a single economic zone, and this is what encourages the formation of economically dominant regions in a currency zone, whose interests are best represented by that currency: London, Toronto, Madrid, Milano, the Ruhr.

Just as physics is both the greatest of the sciences and a poor paradigm for the rest, the USA is the greatest of the economies and also a poor paradigm. On the whole, the American people are immensely mobile and willing to move for employment, far more than people in other countries who tend to be rooted to their ancestral region. The country is so vast, so naturally wealthy, and so young, that a dominant region has not emerged since the relative decline of New York. Both conurbations in California, Chicago, the Texas triangle, and even swaths of the southeast and northwest are competitive. Many people are willing to move between them. So in Jacobs’ sense, America manages to be more like an enormous city than like a large nation.

This fact was an enormous distraction for the Europeans. Nowhere else on earth are national boundaries as important as in Europe, especially western Europe, which has long been sorted into linguistic and cultural affinity zones. The idea of creating a common currency was meant largely to be competitive with American industrial might but also with America’s geopolitical influence. The trouble is, Europeans are not fungible. While there may be important exceptions, on the whole a Greek fellow cannot function very well in Dusseldorf. And the Greeks maintain their own parliament, their own electoral rules, their own laws, and their own political traditions.

What this does is break the cybernetic loop that Jacobs defines (without actually getting into cybernetics jargon). The performance of the Greek system does not affect the Greek currency, because the Greek currency is dominated by what happens in Dusseldorf. So the process of import-substitution does not take place, because what money does end up in the hands of a Greek can equally purchase goods and services from Paris or Dusseldorf as from Athens. But Athens does not become a provincial city ancillary to Dusseldorf because the Athenians have not conceded control of their governance along with control of their currency. Consequently, the system becomes unstable.

(When the Euro idea first came along, I thought it would fail along these lines. I should say what I think even if it’s unorthodox, I guess. Jane Jacobs lived until 2006. I wonder if she said anything about the Euro.)

The lesson here goes beyond the Euro crisis. There is a key generalization here, one which is fairly obvious but somehow not widely perceived. A homeostatic system requires feedback. Break the feedback loop and you lose control.

You cannot control what you don’t measure. This is so obvious in an engineering worldview that it isn’t even mentioned, yet the whole of Europe somehow missed the point, (Admittedly, Jacobs’ import-substitution model is not mainstream economics. More’s the pity, apparently.)

And this is the context in which I want to consider how the economic systems we have deal with sustainability (badly). The reason that the system is off the rails is only crudely because “we don’t account for externalities”. That would, of course, be better than what we have. But the question is how the accounting should take place.

Comments:

  1. That's a nice play in to the Greek Drama. The idea that there could be such an insane set of events that could cause such a mess in Europe was never taken seriously as the Euro euphoria set in. The anti-globalization movement seemed to know it. The Serious Economists didn't. Molotov cocktails over calculators? Not quite. A good ideological guess - probably more apt. But would it have been based on uncertainty and risk, or a real mathematical argument?

    If we look at the factors and try to unwind it, you can see why it got so bad. Was it really the banks that lent Greece so much money? Or the center-right-left government that used derivatives to hide it? Was it really the tax system that allows the upperclass to take advantage of value-added and evade? Is it the lower class that is not willing to go through the equivalent of economic blackmail and torture? Is it Germany's unwillingness to compromise on austerity? The housing crisis? The inability to understand the contagion problem of global finance?

    The point being that those who screamed that uncertainty about the economics of the Euro were going to hurt the European population got it right. There really is no way to produce a fiscal union over politics. Even though all the powerful countries in the Euro tried to force it, a single election by a small country blew it up. You can't model politics and that is beauty of democracy.

  2. "that a dominant region has not emerged since the relative decline of New York"

    All dominant regions will decline because of the constraints on capital. Two important constraints are 1) the size of the labor pool and the ease at which it is exploited and 2) land use and capital it takes to remake a finite resource as it declines in value. This is why trade agreements and military might are useful to the west and not, say, Africa. Remember, capital must keep growing at about 3% compound to keep up with historic growth. If not, crisis and it begins to eat itself.

  3. Not really importnat, but I don't believe a dominant region will maintain itself in the current economic climate. Different emergent economies will share that title over the decades to come. The ability for a single economic region to maintain it's level economic domination is constrained by its finite resources. Land, an important destination for surplus capital, can be remade, and this is the usual practice in expanding cities. This is why gentrification exists. THis is time and resource specific.

    As another way to get the needed growth, labor also takes a loss. As labor loses, put productivity maintains due to technological advancement, demand decreases. To maintain growth, capital either moves to another region to exploit land and labor, or face a loss on demand. This is replaceable by credit, but as we know, this is not a sustainable option.

    The important question being - is this desirable?

  4. +1 Jacobs. She da man, so to speak. Jacobs' metaphor for currencies is the best thing I've come across for thinking about it. From Cities...

    "Imagine a group of people who are all properly equipped with diaphrams and lungs but who share only one single brainstem breathing centre." [161]

    "Nations include... differing city economies that need different corrections at given times, and yet all share a currency that gives all of them the same information at a given time. //

    Wrong on two levels: "bad specific information for them with respect to their foreign trade, and it is no information at all with respect to their trade with one another." [162]

    The 'shared lungs' thing is a perfect metaphor: I can imagine Germany pumping ahead on the gym treadmill at a quick jog. Everyone else gets the same oxygen input, regardless of their actual rate of exercise.

  5. > What this does is break the cybernetic loop... The performance of the
    > Greek system does not affect the Greek currency... So the process of
    > import-substitution does not take place... But Athens does not become
    > a provincial city ancillary to Dusseldorf because the Athenians have
    > not conceded control of their governance along with control of their
    > currency. Consequently, the system becomes unstable.

    Errm hold on. Where did "Consequently, the system becomes unstable." suddenly come from? I know its the conclusion you want to reach, but you can't just append it to a paragraph and call it QED.

    What has actually forced the crisis is that Greek debt levels are unsustainable given todays market rates. That is partly because rates have risen since 2007, and partly because people don't trust Greece not to fall apart.

    > When the Euro idea first came along, I thought it would fail along these lines.

    Bit of a shame you didn't say so at the time. OTOH, many mainstream economists did indeed point out that the Euro had many more of the hallmarks of a political project than an economic one (which was their way of saying the same thing) (don't force me to actually dig up references; you know I'll struggle). This makes G's The anti-globalization movement seemed to know it. The Serious Economists didn’t incomprehensible.

  6. The instability within Greece is very much along the lines of Jacobs' analysis. A declining economy without a declining currency will go into debt. No import substitution occurs. No skills are developed. A satellite economy (in this case as in many others, tourism-oriented). Further decline or other pressures weaken the tourism as well. Germans and Dutch do not retire to Greece the way Chicagoans retire to Florida. Yet benefits and social safety nets are priced in the equivalent of D-Marks.

    How it would propagate to the Euro depends on intricacies of the Euro treaty, about which I know nothing. I am guessing that no country signed away its sovereignty under any contingency. So something has to break - for some reason expulsion from the economic union seems to terrify everybody, even though the Slovaks broke off from the Czechs nicely enough which would seem to show the way.

    I also don't know how Euro-based banks are structured. So I don't know anything about the dynamics post-failure. But exactly the failure I anticipated based on Jacobs' ideas has occurred.

    I had thought I had mentioned it on usenet in the 90s but I can't dig up any evidence. Possible I couldn't bring Jacobs' name or book title to mind, which would make it hard to write about and even harder to find. Pre-Google you know. Anyway I am not going to personally take the blame for the existence of the ill-conceived Euro idea.

    (I had even less influence in the 90s than I do now. For instance, now I say we should phase out coal immediately and buy off the owners. The number of people who like this idea, insofar as I know, is approximately 1. I may get a told-ya-so out of it someday. But I'm not accepting blame that I'm not more widely quoted or considered on these outre ideas.)

  7. The view of European mainstream economists was that the fixed exchange rates was not compatible with free capital flow, and it saw the Euro as a monetary union to overcome that. Where were the economists that predicted the current situation or anything similar? And why didn't they win the argument back then?

  8. G: http://en.wikipedia.org/wiki/History_of_the_euro#US_economists_on_the_euro.2C_1989.E2.80.932002 is the best I can easily find. But since you've provided no refs at all, I'm one up on you.

    > And why didn’t they win the argument back then?

    Because it was a political project not an economic one. What makes you think that sound rational economics wins political arguments?

    > A declining economy without a declining currency will go into debt

    Yes. But what you're missing is that Greece (and Spain, and Italy, and...) was happily in debt for ages. Only after 2007 did this become a problem.

    > Further decline or other pressures weaken the tourism as well

    What weakened tourism was civil unrest. Not the decline in their economy.

    > Germans and Dutch do not retire to Greece the way Chicagoans retire to Florida. Yet benefits and social safety nets are priced in the equivalent of D-Marks.

    Its worse than that. Greeks retire earlier and on higher benefits than Germans do. The Greeks are living in a fantasy world, but the real world is breaking in. This is in the end the source of their troubles. If they were out of the Euro they could indeed drift off into banana-republic land of sitting in the sun all day. That wouldn't be good either.

    > for some reason expulsion from the economic union seems to terrify everybody,

    For a whole pile of reasons. This is a political dream. No-one wants harsh reality to intervene. Any Greek leader who does so is likely to get pilloried. There is no mechanism to leave the Euro - this is completely unknown ground. An obvious worry is that all mobile money leaves Greece before the break - you'd be mad not to take your money out. There are a whole pile of contracts of uncertain status if Greece leaves. Etc etc. The Greeks associate being in the Euro with being a first world country, so they don't want to lose that. Polls show that although they have voted to reject austerity they're still in favour of being in the Euro - in other words, they are clueless.

    > even though the Slovaks broke off from the Czechs nicely enough which would seem to show the way.

    Not a good example I think. It wasn't done in the midst of a crisis, it was only a small country, etc etc.

    But we (I) seem to have wandered away into details. Let me try to return to the main argument. the mainstream economic (not political) view is that the Euro in Greece (and elsewhere) is tricky due to optimum currency area (http://en.wikipedia.org/wiki/Optimum_currency_area) problems. I think (putting words into their mouths) that they would say that, plus the debt-bubble stuff, is enough to explain Greece's problems.

  9. Here's a BBC World Service series that discusses the setting up of the Euro zone. Obviously it won't cover it as much as a scholarly book, but as they interview some people involved in the process, it may be of use:

    http://www.bbc.co.uk/programmes/p00p5qv6#synopsis

    - (see the rhs for link to part 2, and from there there will be a link to part 3). I don't know whether it's available outside the UK, but as it's World Service, hope so.

    Also, on the issue of the Greeks and the Germans, this is partly useful in that it refers to their Greek/German comparison, though that programme is no longer available:

    http://www.bbc.co.uk/programmes/p00rrvw9

  10. "Because it was a political project not an economic one. What makes you think that sound rational economics wins political arguments?"

    I don't, but that was my point in my comment. Did you see how I said that the "ideological guess" was better than the serious economists solution? I give in on the economists who were skeptical (this doesn't constitute predicting what has happened) point, they were out there, but I was really pointing out that following the currency scare in Europe, that the Euro was the economist's answer to the problem of capital flow. It wasn't really an "experiment", it was a major economic change that effected the lives of the entire planet. Economists couldn't predict the outcome because, as I said, you can't model politics. That's the point of the article, I believe. Politics over economics. This won't change, and it shouldn't. We are not a technocratic people where there is a one size fits all economic solution.

  11. The Optimum Currency Area stuff is remarkably like Jane Jacobs, except that in practice Jacobs thinks the OCA is a large city, not a region of subcontinental size. She supported Quebec separatism on economic grounds, thinking this would enable Montreal to re-emerge as a major economic center outside the shadow of Toronto.

    Anyway it seems clear that the Euro zone didn't rise to the occasion and fill in the weaker aspects of the criteria as applied to Europe. And whether you buy her argument as applied to cities or not, you do have to agree to a commonality of destiny. But nobody really thinks about the future of Europe, I would bet. The Spanish may think about the future of Greece within Europe and similarly the Dutch and the Czechs and the Greek. But (guessing from a distance, I admit) nobody thinks about a Europe in which you can get by speaking Spanish in Rotterdam or Dutch in Brno, and nobody (and here as a Montrealer I speak from experience) wants their own language to become extinct in their own home. Whence the inadequate cession of sovereignty and whence further the broken-loop currency.

  12. > But nobody really thinks about the future of Europe, I would bet.

    WTF!?! You can't say that. There are piles of folks in Brussels and Strasbourg who do nothing else. Plenty of the top pols in Germany or France obsess about the future of Europe.

  13. Okay, nobody much outside the Brussels bureaucracy anyway. I would guess that even the most pro-union politicians in Germany and France think about Europe as a vehicle for the advancement of their own cultures on a regular basis. Anyway, again with my Montrealer had on, if they don't they will have trouble getting anything done.

    The point is that few people self-identify as "European" the way they might as "American".

    PERSONAL SIDEBAR

    I don't have a clear identity in this way, by the way, though it amuses me to self-identify as "Texan". In fact I am "North American/Canadian/Quebecois/Anglo-Quebecois/Judeo-Anglo-Quebecois/Hungaro-Judeo-Anglo-Quebecois", that last still a sizable community of some ten thousand people or so. My loyalty is divided and messed up. But despite it all I definitely identify as English speaking, so the gradual decline of the English language on the island of Montreal is a sad thing for me.

    Something somewhat resembling North American English and mutually comprehensible with English is still widely spoken there, but the vocabulary, syntax and rhythms are increasingly bizarre and more like a Creole (or a bouillabaise) than a pure language. Much expressiveness is lost, compensated by grunts and squints and gestures.

    It's amazing that Leonard Cohen emerged from this ill-composed word salad, but he didn't entirely. A very rich formal English-language culture was vibrant on the island in his youth and, though I'm no Leonard Cohen of course, in mine. It's almost disappeared. But anyway the contrary themes of endangered French in North America and endangered English in Montreal are constant motifs for us in the English-adopting immigrant groups who now dominate "Anglo" Montreal. And though we English and "Anglos" all grew up together under the same laws and the same currency and the same streets and the same (brr...) skies with the French-speaking Quebecois, we do not share and have never shared a common vision of a common destiny.

    So I guess that's another aspect of my experience that has me looking at the Euro with a baffled sense of WTF-ness.

  14. A Greek fellow can function quite well in Düsseldorf. We have that since many decades. Greek, Spanish, Italian, and mostly Turkish "guest workers" (German Gastarbeiter). Now for a new wave. Germany has a skilled worker deficit again (Fachkräftemangel - well deserved I say) and would be happy about any Spanish or Greek IT expert.

    Methinks most of the crisis is due to excessive debt turned into a death spiral after 2007. And yeah, me German envied the Greek for their early retirement age (and their large assortment of islands and beaches where to retire).

    Somehow the current crisis doesn't scare me. Greece will be totally f'ed only in a few decades, when the last olive tree had burned off and the water stopped dripping. Look at the climate predictions. Retirement in Greece is no longer an option due to coming desertification.

  15. Hmm. I think it was Eric Hobsbawm who made the useful observation that "identies are not like hats - you can wear more than one at a time". A good many people in Europe do - according to surveys - identify as "European". At the same time they also identify as German/French/Danish and as also Breton, Ossi, Welsh or whatever (and, of course, as upper class or Catholic or...).

    You don't have to look far in the US to find areas that have lost much of their ability to support their populations at a first world standard. They live on transfers from wealthier areas. Often they are called "red" states. Europe lacks many of the mechanisms that enable such transfers - most notably a large central government.

    It also helps, in looking at this unfolding crisis, to remember that it started in Ireland, which was fiscally conservative, when the Irish government chose to tale on the debts of the banks - with German/French/British prodding. Spain is similar - government spending was under control, but bank lending wasn't. In this regard, this is more like the US vs Mexico/Thailand/Argentina than a a crisis of governance. The banks line is - look, we lent those foreigners much more than could pay, who could have known they could not pay, they must be feckless, lazy (and probably black), their government must pay us and then make them all work harder.

    It helps to remember that economics is, where it is not accounting, a branch of politics. And the political question is always - who gets the short straw?

  16. A few points in response to that interesting comment:

    1) I agree (obviously, considering my confession) that we can have multiple identities. But I also assert that there is a natural boundary across mutually unintelligible languages that is very hard to break. It's easy for me to just support English-language hegemony. After all, my parents took the plunge for me, deliberately speaking only broken English around me in my early childhood. But I've been around enough less-popular languages that I understand how much would be lost. Meanwhile, different language groups come to different understandings of the world and their role within it.

    2) Although there is, ironically, some wealth transfer from the social-democracy-leaning blue states to the libertarian-leaning red states, it is the sort of error one might make from a distance to suppose the red states are not self-supporting. Military pensions and benefits, along with direct military expenditures, are probably the main channel for this. Other transfers, while ironically red-ward on net, are small. Welfare benefits and such are administered at the state level.

    Canada has been propping up the Atlantic provinces for decades. Nothing like that occurs in the US.

    The red/blue divide is largely rural/urban. And you have to wonder, if the various beltways and ring roads were made into walls, how quickly it would appear that the dependency goes the other way. This ties into one of my key questions - what is wealth anyway? How is it that lawyering and moviemaking counts for more than growing food and sawing lumber? Who really needs whom in this situation?

    3) I agree that "economics is a branch of politics" for some sense of "economics", but it's starting to appear that the word "economics" has no sensible accepted definition. I predict people will object. To phrase it a bit more clearly, I would claim that the economy can't be understood independent of government, and that pure abstractions that ignore active intervention from the political sector are inherently incomplete.

    I also agree that banking and finance is clearly part of the problem. I freely admit that my head starts to spin when I try to think about it.

    It's interesting that economic theory tends to ignore finance as well as government. Climatology would be easier if it weren't for those nasty clouds. What if we just ignore them, then?

  17. Here is what is supposed to be a primer on the situation from USA Today.

    It makes essentially no sense to me. All I can see is that there are two camps disagreeing on how to promote growth. I do not know what is the right way out of this mess, but I am very worried about the only aspect of the situation that every viable party seems to be agreed upon.

  18. I don't know too much about the composition of the flows that are commonly characterized as Blue-state subsidies for Red states. However I think that the idea that it is primarily a rural-urban divide - at least today - is somewhat misleading, since hardly anyone is really "rural" anymore. But certainly the rural history of the South (including slavery) and the Rocky Mountain west does contribute to the cultural history that has left the patterns the way they are.

  19. A little late to the party here but I wonder how one would fold completely false instrumentation readings into this way of thinking of national economic behavior?

    Greece is a corner-case, possibly useful because it's so extreme. See this breathtaking article:

    Beware of Greeks Bearing Bonds

    BTW, there's an embarrassment of good writing here at Planet3-dot-oh. Please keep plugging away.


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