Why economic complexity is the root cause of the polycrisis

Why economic complexity is the root cause of the polycrisis
Photo by Brian Jones / Unsplash

There is consensus on the narrative that we have a systemic crisis, that our current 'economic system' is in overshoot. In targeting this crisis, the most intuitive way is to address the behavior of agents/actors/individuals in this system, with legal and regulatory measures, such as curbing CO2-emissions. After all, that is a simple, understandable approach, and follows the human perception that we can, to some extent, control the behavior of entities. That is what the legal and regulatory frameworks are for. This works in normal situations.

But not in this situation; not in a systemic crisis. In a systemic crisis the problem is not caused by the actors behavior, but it is caused by how the system facilitates their behavior. It is very difficult to have arguments about this. I often get the reply that the actors ARE the system, so we still have to address individual actors. Again, in domain-specific crises: yes, but we are in a systemic crisis, and we now have a system that is fully unprecedented in its complexity and its scale. At that level of abstraction, actors do not really exist. It is more like a single, continuous, dynamic. There is no actor.

In my opinion, therefore the way the system facilitates behavior is much more important than how our regulatory and legal frameworks facilitate behavior, especially because, over the last few decades, the amount that the system facilitates unwanted behavior has increased dramatically.

A fractal market

I am incredibly sorry for getting a bit boring right now, but this change has everything to do with the infrastructure of our markets. Thanks to the IT-revolution, existing markets have become much more complex, and all kinds of so-called 'synthetic' markets have emerged, all kinds of intermediate markets. The most trivial example is agents like booking.com that started to sit in between consumer and producer. Today, there are even extra layers in between, service providers that provide connectivity to booking.com instead of a direct connection. The financial crisis of 07/08 was purely caused by the existence of these intermediate layers between primary supply and demand. In fact, most of our economic value is now being created in these intermediate layers, instead of 'primary' or 'organic' economic activity. In my previous piece I called this 'the bullshit economy'.

Note that the 'actor' booking.com is not relevant here, but the emergence of an intermediate layer of market-structure is.

In this piece I would like make a deep-dive into this aspect, and try to explain why I think it is the primary driver of practically every crisis we perceive today.

The interesting aspect of these intermediate layers between primary supply and demand (I need bread, I want a new TV, I need a mortgage to buy a house, etc) is that they, in their slipstream, increase what I would like to call the settlement-surface.

In this piece I explain that these intermediate markets can be seen as a fractal: the more of these intermediate layers are inserted, the more complexity is made available for the settlement of supply and demand. Some actors then only have to inject artificial supply and demand into the system, and they can make profit off transaction fees. Within a hugely complex and extremely biodiverse ecosystem of actors (high frequency traders, banks, investment vehicles, ETF-providers like BlackRock, etc), the total potential of settling transactions is huge. The financial crisis of 07/08 is well-known for its association of financial derivatives, chopping up individual mortgages a repackaging them into new synthetic products, for which other parties would offer insurances etc etc, which is actually an increase of the resolution of the transactionality. If you would pick out all those intermediate, high-resolution-transactional layers and spread them out and put them next to each other, it would show you how big the total 'transactional settlement-surface' actually is.

That is because, as stated, this market-structure is actually FRACTAL. Let me illustrate this with the following animation, a so-called (increasing) Koch-curve:

Every step indicates a new extra synthetic market-layer in between primary supply and demand (e.g. booking.com and its service providers, or banks and ETF-providers and the whole chain of liquidity-providers, etc).

(For a mathematical definition of economic entropy and a proof of its increase, refer to my publication below).

The total LENGTH of the line INCREASES every step: if you would cut it somewhere to spread it out towards a single, straight line, that line would increase in length, every step.

This line can be understood as the transactional surface of total supply and demand (visualize supply at the top, and demand at the bottom of that line, and crossing it is settlement).

So an increase in market complexity results in an increase of transactional surface.

In another piece I have explained what our economic system wants: to settle existing supply and demand as fast as possible. It continuously finds the paths of least resistance to settle supply and demand (just like our climate-system is driven by the changing of paths of least resistance to dissipate heat).

A larger transactional surface provides:

  • more paths of least resistance
  • lesser resistance overall

This is the only thing that 'drives' economic activity (and in corollary, CO2-emissions).

Waterbed effects

Targeting an extremely small group of actors to reduce settlement will therefore ONLY result in forcing the rest of the actors to absorb the resulting excess on the existing surface. The system cannot do anything else but settle supply and demand as fast as possible using the full capacity of the surface. If the surface provides more settlement-capacity than the system needs, curbing settlement at one place will just increase settlement elsewhere, by natural law, by statistical inference, by thermodynamic irreversibility. One does not defy this principle. Mankind cannot defy this logic. Humans cannot defy the natural universe. Policy-making cannot get away with ignorance of this physical fact.

We cannot control individual behavior, it is determined by systemic market microstructure. Transactional space at current complexity-levels incentivizes behavior much more than legal and regulatory frameworks

This makes it completely obvious that we should NOT try to target unwanted individual actor behavior (because, at best, it will just instigate waterbed effects), and instead we should reduce transactional surface (the enabler of this unwanted behavior), and therefore, by proxy, unwind economic market complexity that yields this surface.

A complexity-based, systemic point of view

This might sound crazy abstract and complicated, but this is totally possible within existing empirical frameworks as employed in, for example, quants are doing with econophysics, and methodologies like the Cynefin framework. This empirical approach is opposite to the mainstream analytical approach, in which we think of discrete solutions for an understandable problem. But the level of complexity of our systems is beyond this understandable, and beyond a traditional analytical approach.

So it requires a fundamental paradigm shift in policy-making when looking at our systems, an increase of diagnostic depth of our collective, wicked problems. And it requires targeting policy towards at max a 'desirable direction' for our chaotic system, with all its associated Knightian uncertainties, instead of believing we can come up with deterministic solutions: our globalized, excessively complex and hyper-efficient system simply does not allow for those anymore.