It is by now common wisdom that our current financial crisis is due in large part to misplaced incentives in our financial system. Analysts and fund managers were rewarded for short-term thinking and risk-taking. If we can rework our financial system to reward long-term, careful planning, it is often argued, we can avoid collapses like this in the future.
While I agree that misplaced incentives were a fundamental problem, the question of how to change this is rather more deep and complex than I think many people realize.
Our economy is, of course, an evolutionary system. Successful businesses grow in size and their practices are imitated by others; unsuccessful businesses vanish. This process has led to many good business practices, even in the financial sector.
However, evolution does not always yield the best outcomes, in biology or in economics. Our recent crisis illustrates two key limitations of evolutionary systems, limitations which allow bad ideas to evolve over good ones.
The first problem has to do with time lags. Suppose Financial Company A comes up with an idea that will yield huge sums of money for five years and then drive the company to bankruptcy. They implement the idea, obfuscating the downside, and soon the company is rolling in cash. Investors line up to give them money, magazines laud them, and other companies begin imitating them.
Not so Company B. Company B believes in long-term thinking, and can see this idea for the sham it is. They persue a quiet, sound strategy, even when their investors begin pulling money out to invest in A.
We would like to think that in the end, Company B will be left standing and reap them benefits of their foresight. But there is a fundamental problem of time-scales here: by the time A folds, B may already be out of business, due to lack of interest from investors. In theoretical terms, there is a fundamental problem when the evolutionary process proceeds faster than the unfolding of negative consequences. In these situations, good ideas never have a chance to be rewarded, evolutionarily speaking.
One might argue that investors, not to mention government regulators and ratings agencies, should have forseen the flaw in A's plan. But this highlights a second limitation of the evolutionary process: it favors complexity. Simple bad ideas can be detected by intelligent agents, but complex ones have a chance to really stick. If Company A's idea was so complicated that no one aside from a few physicists could figure it out, investors and regulators could easily be fooled.
It's not clear to me how to patch these flaws in the evolutionary system. Increased transparency and oversight will help, but unless we can somehow cap the complexity of financial instruments (difficult) or slow down the evolutionary process (impossible), I'm not sure how we'll avoid similar crashes in the future.
Field of Science
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Change of address1 year ago in Variety of Life
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Change of address1 year ago in Catalogue of Organisms
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Earth Day: Pogo and our responsibility1 year ago in Doc Madhattan
Showing posts with label Economy. Show all posts
Showing posts with label Economy. Show all posts
Two great links about the economy
1. Eduardo Porter has an excellent Op-Ed in the New York Times comparing the evolution of huge bonuses for bankers to the evolution of excess blubber on bull elephant seals--good for the individual seal (bank) but bad for the species (financial sector.) I couldn't agree more.
2. The collaboration between This American Life and NPR news that brought us the excellent show about the mortgage meltdown are back again with the clearest explanation I've heard to date on how our banking system is screwed.
2. The collaboration between This American Life and NPR news that brought us the excellent show about the mortgage meltdown are back again with the clearest explanation I've heard to date on how our banking system is screwed.
Evolution and Interdependence
So President Bush has finally taken a complex systems view of the economy:
Stupidity aside, he's entirely correct: our economy is highly interdependent. We discussed this situation last post, now I'd like to give some perspective on how interdependence comes to be.
Our economy, like life, is an evolutionary system, featuring competition, innovation, and adaptation to internal and external challeges. And I think some of the difficulty in understanding the current financial crisis comes from a misconception about evolution.
We usually think of (biological) evolution as a species-level process: each species makes its own incremental improvements in search of competetive advantage. But this is too simple a picture. Species do not evolve in isolation; theyco-evolve in concert with all they interact with: plants, animals, microbes, and even minerals. In this co-evolutionary process, species develop relationships with each other; sometimes competitive, but often symbiotic or mutually beneficial in some way.
In the long run, co-evolution seems to produce increasing interdependence. Consider that all life started out as single-celled organisms, and that the co-evolution of these organisms led to multicellularity, which is a form of indterdependence so advanced that the component cells can no longer live on their own. On a larger scale, multicellular organisms co-evolved to form ecosystems. While not as interdependent as a multicellular organism, an ecosystem still has the property that if you remove enough vital components, the whole system fails.
An interesting thing happens now. As interdependence grows, so does the scale at which evolution occurs. Life started with cells competing against cells, grew into organsims competing with organisms, and now, in a sense, we also have ecosystems competing with ecosystems. The rainforest, for example, is competing with the desert in Africa. If the rainforest fails, so do all species that live there.
A similar process happens with economies. They begin with small, relatively self-suffient businesses. These businesses develop relationships with each other, co-evolve, and grow webs of interdependence. In the US, the webs have become so complex that an obscure industry known has mortgage-backed securities has sunk our entire economy.
So here too, evolution has "scaled up." It's no longer just companies competing against companies, it's also our whole nation's economy competing against those of other nations, and indeed the whole world's economy competing against, well, itself.
I don't think interdependence can be avoided, but it certainly needs to be understood. When people speak of the "free hand of the market" correcting our economy's mistakes, they're thinking of individual companies competing idependently, and failing to grasp the reality that, to some extent, our economy lives or dies as a whole.
Stupidity aside, he's entirely correct: our economy is highly interdependent. We discussed this situation last post, now I'd like to give some perspective on how interdependence comes to be.
Our economy, like life, is an evolutionary system, featuring competition, innovation, and adaptation to internal and external challeges. And I think some of the difficulty in understanding the current financial crisis comes from a misconception about evolution.
We usually think of (biological) evolution as a species-level process: each species makes its own incremental improvements in search of competetive advantage. But this is too simple a picture. Species do not evolve in isolation; they
In the long run, co-evolution seems to produce increasing interdependence. Consider that all life started out as single-celled organisms, and that the co-evolution of these organisms led to multicellularity, which is a form of indterdependence so advanced that the component cells can no longer live on their own. On a larger scale, multicellular organisms co-evolved to form ecosystems. While not as interdependent as a multicellular organism, an ecosystem still has the property that if you remove enough vital components, the whole system fails.
An interesting thing happens now. As interdependence grows, so does the scale at which evolution occurs. Life started with cells competing against cells, grew into organsims competing with organisms, and now, in a sense, we also have ecosystems competing with ecosystems. The rainforest, for example, is competing with the desert in Africa. If the rainforest fails, so do all species that live there.
A similar process happens with economies. They begin with small, relatively self-suffient businesses. These businesses develop relationships with each other, co-evolve, and grow webs of interdependence. In the US, the webs have become so complex that an obscure industry known has mortgage-backed securities has sunk our entire economy.
So here too, evolution has "scaled up." It's no longer just companies competing against companies, it's also our whole nation's economy competing against those of other nations, and indeed the whole world's economy competing against, well, itself.
I don't think interdependence can be avoided, but it certainly needs to be understood. When people speak of the "free hand of the market" correcting our economy's mistakes, they're thinking of individual companies competing idependently, and failing to grasp the reality that, to some extent, our economy lives or dies as a whole.
Too Important to Fail?
The federal government is set to take over mortgage companies Fannie Mae and Freddie Mac. Earlier this summer, the government rescued the investment bank Bear Stearns. In each case it was decided that, even though the companies were in trouble of their own making, the damage caused by their failure would be too great for the economy to bear.
Strictly speaking, this isn't how our economy is supposed to work. It's supposed to be survival of the fittest: the companies that make the best decisions survive, and others fail. In this way good practices are rewarded, better business models evolve, and society progresses.
The problem is that, as part of this evolutionary process, the US economy has become increasingly interdependent. Companies need each other to survive, so that if a big one goes down it could take others with it. In the cases of Fannie Mae, Freddie Mac, and Bear Stearns, it was deemed that the failure of these companies would take out entire sectors of the economy, and as a country we couldn't let that happen.
I won't argue the merits of these decisions, but I'm interested in what they say about our economy. We're accustomed to thinking of our economy in terms of a system of competing animals. If one dies, others arise to take its place. But it may turn out our economy is more like another system: the human body, wherein if one part fails, the system suffers as a whole.
If this is true, then the whole of economic theory is based on an incorrect assumption. We may have some fundamental rethinking to do about how our economy works and why.
Strictly speaking, this isn't how our economy is supposed to work. It's supposed to be survival of the fittest: the companies that make the best decisions survive, and others fail. In this way good practices are rewarded, better business models evolve, and society progresses.
The problem is that, as part of this evolutionary process, the US economy has become increasingly interdependent. Companies need each other to survive, so that if a big one goes down it could take others with it. In the cases of Fannie Mae, Freddie Mac, and Bear Stearns, it was deemed that the failure of these companies would take out entire sectors of the economy, and as a country we couldn't let that happen.
I won't argue the merits of these decisions, but I'm interested in what they say about our economy. We're accustomed to thinking of our economy in terms of a system of competing animals. If one dies, others arise to take its place. But it may turn out our economy is more like another system: the human body, wherein if one part fails, the system suffers as a whole.
If this is true, then the whole of economic theory is based on an incorrect assumption. We may have some fundamental rethinking to do about how our economy works and why.
Sub-Prime Mortgage Crisis Part II: Lessons for Complex Systems
Last time, we talked about what went wrong in the US mortgage market, based on the explanation given by NPR and This American Life. What does this debacle tell us in general about how complex systems can go wrong?
The main problem, in a theoretical sense, is that a feedback loop got too long and complex.
A feedback loop is the process by which an action leads to a consequence for the actor. Let's look at the old mortgage system:
Under this system, if the bank made a bad loan, they'd lose their money. So there was a very direct link between action and consequence. Banks have been dealing with this feedback loop for centuries and have gotten pretty good at making only loans that will get repaid.
But in the early 2000's, the system was replaced by this:
There's still a feedback loop here, but it's longer and more complex. Long, complex feedback loops are dangerous because they can fool people into thinking they're making good decisions, when really their bad decisions haven't caught up with them yet. The investors were pouring yet more money into the broken system, because their actions hadn't caught up with them yet, and they were too far removed from the homeowners to see what terrible shape they were in.
We moved essentially from
bad action ---> bad consequence
to
REALLY bad action --- (long time delay) ---> REALLY bad consequence
It's unlikely that investors will make this same mistake again, because they understand much better now how the mortgage market works. But the general mistake of stretching out a feedback loop, and assuming that you're doing well just because nothing's gone wrong so far, will probably be repeated many, many times.
The main problem, in a theoretical sense, is that a feedback loop got too long and complex.
A feedback loop is the process by which an action leads to a consequence for the actor. Let's look at the old mortgage system:
Under this system, if the bank made a bad loan, they'd lose their money. So there was a very direct link between action and consequence. Banks have been dealing with this feedback loop for centuries and have gotten pretty good at making only loans that will get repaid.
But in the early 2000's, the system was replaced by this:
There's still a feedback loop here, but it's longer and more complex. Long, complex feedback loops are dangerous because they can fool people into thinking they're making good decisions, when really their bad decisions haven't caught up with them yet. The investors were pouring yet more money into the broken system, because their actions hadn't caught up with them yet, and they were too far removed from the homeowners to see what terrible shape they were in.
We moved essentially from
bad action ---> bad consequence
to
REALLY bad action --- (long time delay) ---> REALLY bad consequence
It's unlikely that investors will make this same mistake again, because they understand much better now how the mortgage market works. But the general mistake of stretching out a feedback loop, and assuming that you're doing well just because nothing's gone wrong so far, will probably be repeated many, many times.
Sub-Prime Mortgage Crisis-Explained!
Recently, my favorite radio show teamed up with NPR news to do an in-depth collaboration on exactly what went wrong with the US sub-prime mortgage crisis. It turns out to be a perfect example of how a complex system can go wrong. So I thought I'd give a summary of what they found, and discuss how it relates to what we know about complex systems in general.
The whole thing started with what our radio hosts call "the global pool of money." In the early 2000's, there ended up being a whole lot of people around the globe with lots of money to invest. The amount of money looking to be invested had doubled in the past xxx years, due in part to growing economies in other countries.
The wealth holders of this money needed somewhere to invest this money, to keep it safe and growing. A large subset of them wanted safe investments, where the return on their money would be moderate but reliable. So they and their brokers looked around for safe investments to make.
While this was happening, Alan Greenspan was trying to help the US economy out of the post-internet bubble slump. He did this by setting interest rates extremely low: around 1%. This means that US treasury bonds, one of the safest investments historically, would be getting extremely low returns for a long time. So the pool of money had to look elsewhere.
The lack of traditional safe investment options meant that the brokers had to get creative. So they looked around and they saw this:
All over the country, retail banks (the kind of banks you and I use) were loaning money to homeowners, who were repaying the money with interest. These were safe investments on the banks' part because historically, very few homeowners default on their mortgages. The brokers wanted to get in on this action, but mortgages are too small and detailed to get involved with on an individual level. So they set up a system like this:
The retail banks would lend money to homeowners, and then sell these mortgages to investment banks. The investment banks would buy tons of these mortgages and organize them into "bundles" of hundreds at a time. These bundles would be sold to Wall Street firms, who would create "mortgage-backed securities" out of the bundles, and sell shares in these securites to the global pool of money.
This system worked fine for a while. But by 2003 or so, virtually every credit-worthy indvidual with a home had already taken a mortgage. There were no more mortgages to be bought. But the global pool of money had seen how effective these mortgage-backed securities were, and they demanded more. This sent an echoing voice all the way down the chain saying "GIVE US MORE MORTGAGES!"
To fill this incredible demand, the retail banks started relaxing the standards for who they loaned to. The radio show tells the fascinating story of how every week, one requirement after another was dropped, until they reached rock bottom: the NINA loan. NINA stands for "No Income, No Asset." It means you can get a loan without even claiming to have a job or any money in the bank whatsoever. In the words of one former mortgage banker "All you needed was a credit score, and a pulse."
In the old system, no bank would ever think of giving a loan without verifying the borrowers income and assets. This is because the bank had an interest in seeing that it got its money back. But under the new system, the banks would just sell the mortgage up the chain and wash their hands of it. If the borrower defaulted two months later, it would be someone else's problem.
Still, you would think that someone would realize that an investment system built on no income, no asset loans was bound to fail. And indeed, many people did realize it. But the money kept flowing in from the global pool, and everyone in the chain was getting rich in the process. Saying "no" to the system seemed like ignoring a pot of gold right in front of your face.
Two additional factors prevented reason from prevailing. First, the computer models used by the investment banks and Wall Street firms were telling them that everything was going fine. No one made the connection that the models were using data from pre-2003, when loans were made on the basis of actual assets. Second, housing prices in the US were going up. If a borrower defaulted, then the bank would own the house, which as long as prices were rising would be worth more than the bank loaned originally.
Of course, housing prices didn't keep going up. And the Wall Street firms noticed at some point that some of the mortgages they were investing in were defaulting on the very first payment. So they stopped buying these bundled mortgages. At that point, the middlemen in the system (the retail and investment banks) were left holding mortgages that no one up the chain wanted, and that would almost certainly be defaulted from the bottom of the chain. And they went bankrupt en masse.
That's enough writing for today. Next time we'll use this crisis as a case study for some general complex systems principles.
The whole thing started with what our radio hosts call "the global pool of money." In the early 2000's, there ended up being a whole lot of people around the globe with lots of money to invest. The amount of money looking to be invested had doubled in the past xxx years, due in part to growing economies in other countries.
The wealth holders of this money needed somewhere to invest this money, to keep it safe and growing. A large subset of them wanted safe investments, where the return on their money would be moderate but reliable. So they and their brokers looked around for safe investments to make.
While this was happening, Alan Greenspan was trying to help the US economy out of the post-internet bubble slump. He did this by setting interest rates extremely low: around 1%. This means that US treasury bonds, one of the safest investments historically, would be getting extremely low returns for a long time. So the pool of money had to look elsewhere.
The lack of traditional safe investment options meant that the brokers had to get creative. So they looked around and they saw this:
All over the country, retail banks (the kind of banks you and I use) were loaning money to homeowners, who were repaying the money with interest. These were safe investments on the banks' part because historically, very few homeowners default on their mortgages. The brokers wanted to get in on this action, but mortgages are too small and detailed to get involved with on an individual level. So they set up a system like this:
The retail banks would lend money to homeowners, and then sell these mortgages to investment banks. The investment banks would buy tons of these mortgages and organize them into "bundles" of hundreds at a time. These bundles would be sold to Wall Street firms, who would create "mortgage-backed securities" out of the bundles, and sell shares in these securites to the global pool of money.
This system worked fine for a while. But by 2003 or so, virtually every credit-worthy indvidual with a home had already taken a mortgage. There were no more mortgages to be bought. But the global pool of money had seen how effective these mortgage-backed securities were, and they demanded more. This sent an echoing voice all the way down the chain saying "GIVE US MORE MORTGAGES!"
To fill this incredible demand, the retail banks started relaxing the standards for who they loaned to. The radio show tells the fascinating story of how every week, one requirement after another was dropped, until they reached rock bottom: the NINA loan. NINA stands for "No Income, No Asset." It means you can get a loan without even claiming to have a job or any money in the bank whatsoever. In the words of one former mortgage banker "All you needed was a credit score, and a pulse."
In the old system, no bank would ever think of giving a loan without verifying the borrowers income and assets. This is because the bank had an interest in seeing that it got its money back. But under the new system, the banks would just sell the mortgage up the chain and wash their hands of it. If the borrower defaulted two months later, it would be someone else's problem.
Still, you would think that someone would realize that an investment system built on no income, no asset loans was bound to fail. And indeed, many people did realize it. But the money kept flowing in from the global pool, and everyone in the chain was getting rich in the process. Saying "no" to the system seemed like ignoring a pot of gold right in front of your face.
Two additional factors prevented reason from prevailing. First, the computer models used by the investment banks and Wall Street firms were telling them that everything was going fine. No one made the connection that the models were using data from pre-2003, when loans were made on the basis of actual assets. Second, housing prices in the US were going up. If a borrower defaulted, then the bank would own the house, which as long as prices were rising would be worth more than the bank loaned originally.
Of course, housing prices didn't keep going up. And the Wall Street firms noticed at some point that some of the mortgages they were investing in were defaulting on the very first payment. So they stopped buying these bundled mortgages. At that point, the middlemen in the system (the retail and investment banks) were left holding mortgages that no one up the chain wanted, and that would almost certainly be defaulted from the bottom of the chain. And they went bankrupt en masse.
That's enough writing for today. Next time we'll use this crisis as a case study for some general complex systems principles.
On Capitalism
Like it or hate it, there's no denying that capitalism is the dominant economic system on the globe. In countries which established capitalism on their own terms (i.e. not the ones where capitalism was forced by intervention from other countries), productivity and average (material) quality of life have grown consistently, far outperfroming countries with other economic systems. What is behind this success? How can a system which is (in some sense) based on inequality provide better for its citizens than systems which explicitly try to provide for everyone?
Let's take a closer look at how capitalism works. Ideally, people provide goods or services which are useful to society, and if other people value these goods or services, they give money in exchange for them. Money is a powerful incentive, thus people have a motivation to provide things that other people want. If any particular need of society is not being taken care of, there is especially high incentive for some entrepreneur to come along and start providing it. Eventually, people evolve different strategies of providing good and services: they organize themselves in different ways and experiment with new products and methods of distribution. In theory (there's that word again!) the people and organizations that are successful are those that most effectively provide what other people want.
Broadly speaking, this is exactly how a complex system should be run. The incentives are in place for people to do things that are good for other people. Those who "run" the system (i.e. the government) do not dictate exactly what we should do, but instead make sure the incentives work correctly in encourage us to be useful. Creativity and experimentation are allowed, even encouraged. The final result is unpredictable, but the market works in delivering to most of us the things we need.
Of course, there are many, many problems with capitalism. Too many for me to list exhaustively, though I will highlight a few major ones:
Let's take a closer look at how capitalism works. Ideally, people provide goods or services which are useful to society, and if other people value these goods or services, they give money in exchange for them. Money is a powerful incentive, thus people have a motivation to provide things that other people want. If any particular need of society is not being taken care of, there is especially high incentive for some entrepreneur to come along and start providing it. Eventually, people evolve different strategies of providing good and services: they organize themselves in different ways and experiment with new products and methods of distribution. In theory (there's that word again!) the people and organizations that are successful are those that most effectively provide what other people want.
Broadly speaking, this is exactly how a complex system should be run. The incentives are in place for people to do things that are good for other people. Those who "run" the system (i.e. the government) do not dictate exactly what we should do, but instead make sure the incentives work correctly in encourage us to be useful. Creativity and experimentation are allowed, even encouraged. The final result is unpredictable, but the market works in delivering to most of us the things we need.
Of course, there are many, many problems with capitalism. Too many for me to list exhaustively, though I will highlight a few major ones:
- Inequality: In any incentive-based system, some people will get more of the incentive and some will get less. This is just how incentives work. Under capitalism, however, money is tied to our basic ability to survive. If we want to avoid people starving to death, or living homeless, just because they are bad capitalists, the best solution is a strong social safety net that provides basic necessities for everyone.
- Unfair competition-If you have a good idea and a good way of delivering it, you should be able to make money from it under capitalism. Unfortunately, established corporations have ways of squelching efforts by upstarts. These unfair practices should be illegal, but combatting them requires a strong, independent government, and for this we probably need publicly financed elections.
- Harming the public-This is a broad category, including things like deceiving your customers out of money (think credit card companies) and using up resources that should belong to all of us, like the environment. Again, a strong, independent government is necessary, though citizen activists also have an important role in protesting these abuses.
- Money "becomes" morality-I've been thinking a lot about this point lately. It seems that in any incentive-based system, people have a tendency to internalize the incentives to the point where they bleed into their notions of right and wrong. For capitalism, this means that some people seem to think anything that makes them money must be "right"--a point that mundane turbulence made earlier. This is a serious issue for capitalism because it feeds into all the other negatives above ("The love of money is the root of all evil.")
I think the overall message is that capitalism is very good at providing for the needs and wants of individuals, because the incentive (money) comes from individuals. It is much worse when it comes to providing for our collective needs (e.g. a clean environment.) We need to think creatively about how to make captitalism and democracy work for our needs as a whole, and not just as individuals.
On Communism
Communism was always a mystery to me. Why was it that all the countries supposedly founded on the egalitarian ideals of Marx ended up as repressive police states? Was it just a historical accident, or is there a deeper reason?
In this post I will argue that the failure of communism was the inevitable result of a failure to manage complexity. I expect this thesis to be somewhat controversial--chime in if you have an opinion. Also, I am not a history expert, so please forgive and correct any errors I make. As in many other areas, my thinking on this issue owes a large debt to Yaneer Bar-Yam.
Let's start with Marx's principle: "from each according to his ability, to each according to his need." According to this principle, everyone performs the tasks they are good at, and the goods and services produced are redistributed to those who need them. If this process runs smoothly, the needs of the entire society are taken care of.
However, as we all know from personal experience, it's complex enough to figure out what one person's abilities and needs are. Imagine trying to discern the needs and abilities of an entire country, and how best to match the needs and abilities with each other. To do this in a way which takes the idiosyncasies of each individual into account would be a massive complexity overload; it would take practically every individual in the country just to do the planning, with no one left to do the actual work.
So how did the USSR and other communist societies deal with this problem? Recall from last time the only way to control a complex system is to coercively reduce the system's complexity. This is precisely what happened in communist countries: they turned into permanent police states. In order for the leaders to control the economies they were trying to plan, the populace had to be forced into conformity and regimentation, i.e. lower complexity. People were forced into occupations that were not the best match for their talents, and governments made the simplifying assumption that everyone's needs were pretty much the same. It was the only way the organizational problem could be solved.
These simplifications worked, for a time. Eventually, in the USSR, people grew tired of the coercion and the economy stagnated. Gorbachev sought to reinvigorate the nation by allowing some economic and political freedoms, not realizing that the lack of freedom was precisely what was made the organizational system possible. No longer able to control the recomplexified system, the government fell.
So could communism ever work? Not, in my view, on the scale of a whole country. The principle of need and ability could be applied to smaller groups, where the organizational challenges are less severe. We see this, for example, in cooperative communities such as the kibbutzim of Israel (though even these are suffering from complexity management challenges.) In these smaller communist societies, you miss out on the efficiency provided by economies of scale, and there is no opportunity for highly specialized professions such as neurosurgeon or theoretical physicist. But the upside is the possibility of a society where everyone's needs are taken care of. Not such a bad deal.
Join us next time when we ask, "Does capitalism do any better?"
In this post I will argue that the failure of communism was the inevitable result of a failure to manage complexity. I expect this thesis to be somewhat controversial--chime in if you have an opinion. Also, I am not a history expert, so please forgive and correct any errors I make. As in many other areas, my thinking on this issue owes a large debt to Yaneer Bar-Yam.
Let's start with Marx's principle: "from each according to his ability, to each according to his need." According to this principle, everyone performs the tasks they are good at, and the goods and services produced are redistributed to those who need them. If this process runs smoothly, the needs of the entire society are taken care of.
However, as we all know from personal experience, it's complex enough to figure out what one person's abilities and needs are. Imagine trying to discern the needs and abilities of an entire country, and how best to match the needs and abilities with each other. To do this in a way which takes the idiosyncasies of each individual into account would be a massive complexity overload; it would take practically every individual in the country just to do the planning, with no one left to do the actual work.
So how did the USSR and other communist societies deal with this problem? Recall from last time the only way to control a complex system is to coercively reduce the system's complexity. This is precisely what happened in communist countries: they turned into permanent police states. In order for the leaders to control the economies they were trying to plan, the populace had to be forced into conformity and regimentation, i.e. lower complexity. People were forced into occupations that were not the best match for their talents, and governments made the simplifying assumption that everyone's needs were pretty much the same. It was the only way the organizational problem could be solved.
These simplifications worked, for a time. Eventually, in the USSR, people grew tired of the coercion and the economy stagnated. Gorbachev sought to reinvigorate the nation by allowing some economic and political freedoms, not realizing that the lack of freedom was precisely what was made the organizational system possible. No longer able to control the recomplexified system, the government fell.
So could communism ever work? Not, in my view, on the scale of a whole country. The principle of need and ability could be applied to smaller groups, where the organizational challenges are less severe. We see this, for example, in cooperative communities such as the kibbutzim of Israel (though even these are suffering from complexity management challenges.) In these smaller communist societies, you miss out on the efficiency provided by economies of scale, and there is no opportunity for highly specialized professions such as neurosurgeon or theoretical physicist. But the upside is the possibility of a society where everyone's needs are taken care of. Not such a bad deal.
Join us next time when we ask, "Does capitalism do any better?"
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