This is the third post in a six-post series on impact by ACS Associate Will Nielsen.
Spoiler Alert: The importance of imperfect information becomes even more important within the context of the interconnected nature of all aspects of economies. Different economic philosophies demonstrate the importance of interconnectedness. They also clarify how our current capacity to understand interconnectedness limits the total net benefits that can be generated.
Interconnectedness of Economies
When viewed from a systems perspective, the interconnectedness of the economy, of all economies, becomes readily apparent. The smallest of microeconomic decisions lead to shifts in personal-level and firm-level actions, which lead to industry-level shifts, which lead to regional changes that, upon aggregation, form the macroeconomic trends of entire nations—which are all derived from these small beginnings, sometimes referred to as microfoundations. The speed and ease of moving almost everything (e.g., products, money, people, ideas, and news) only amplifies this interconnectedness as decisions made in one part of the world can quickly flow through a range of economic players around the world. Deep, I know.
In Adam Smith’s idea of the invisible hand and its distribution of unintended social benefits, the importance of the interconnectedness of the economy and the people in it also becomes readily apparent. However, the metaphor of an invisible hand only rings true for people pursuing economic opportunity they can see—they can recognize and take advantage of. For all the opportunities we cannot yet see, there is no invisible hand to distribute social benefits. More so, for many, these unseen opportunities cannot be recognized because the working of the invisible hand depends on our ability to place economic value on all resources used.
Thus, the invisible hand of free markets can serve society only as far as our current understanding of resources and their scarcity exists. An inability to effectively value many resources known to be valuable (e.g, freedom and clean air) is an example of the invisible hand’s limitations. This conundrum was famously described in the tragedy of the commons (sounds like the name of an ancient Greek play, but really it’s a theory that public resources get overused if we all act only in our own self-interest).
An alternative perspective is Alexis de Tocqueville’s idea of self-interest properly regarded and enlightened self-interest. It essentially claims that by serving the interests of others will end up serving your own. While sounding noble and altruistic, it still requires knowing what everybody else’s interests are. Figuring that out is not always so easy.
There are many connections we still do not understand fully and in a market of imperfect information (see Part 2), unforeseen risks will persist and negative externalities will propagate — no matter how efficient the invisible hand is working. The simple, sole pursuit of money could push us down a path of warring kingdoms, where power accumulates to the few and democracy is tested. While many of us enjoy Game of Thrones, it’s not a particularly effective vision for maximizing the well-being of the masses. While an enlightened self-interest shows promise, we need to know more about impacts to know how enlightened our decisions really are.
With all of these economic philosophies, there is an interconnectedness that impacts everyone and everything in the economy. To better understand these complex connections, we need a holistic frame of thinking. Conveniently, systems thinking is the subject of Part 4. Isn’t it nice when things just work out like that.