Econ 101: The Problem of Time

Time represents a special problem for economic theory. It gets in the way. It makes things messy. It introduces … gasp … the possibility of uncertainty. This latter being the really big problem.

As those of you who follow my ongoing opposition to textbook economics realize I have a major beef with the notion of markets as specified in the standard texts. That beef being based on the ridiculously unreal assumptions – contortions would a more apt description – that standard theory has to go through in order to “prove” that free markets always clear, and that they represent a preferable mechanism for resource allocation than the major alternative known as central planning.

Those of you familiar with the textbook explanation will notice that in order to arrive at the “correct” solution economists have to rig their theory. They make astounding leaps of faith. They assume, for instance, that all the actors on the economic stage have equal and costless access to all the necessary information needed to make rational decisions. They assume we are all omniscient. Not only that, but they assume we can process all that information instantaneously. We are prodigious calculators in their eyes. They go on and assume that their definition of rational is the only one we would use. This is convenient because it implies that once we have acquired all that information, and once we have calculated what to do, we will act in exactly the same way that an economist would. They don’t expect us to behave this way in actuality, but they expect that our behavior mimics what an economist would have done.

Thus standard theory assumes a world full of super rational automatons acting as if they were all economics PhD’s.

Very realistic.

It gets worse.

That’s where time enters the fray.

The problem is that to “prove” that markets always produce a socially beneficial result standard theory can admit of no uncertainty. It would muddy the waters and complicate things. It would mean that there is no single configuration of the economy that provides the maximum welfare. And the search for the single point is what drives standard theorists. An economy riven through with uncertainties could have more than one acceptable solution. Were that the case it could nor be assured that the market was any better than central planning.

Sometimes standard theory goes to even more absurd lengths to protect the sanctity of the markletplace.

Economists are obsessed with equilibrium – that singular point at which everything settles and welfare is maximized. But to get to equilibrium a market has to go through the motions of getting stuff produced, moved and bought. These are things that take time. But as I said time introduces uncertainty. So it is eliminated. The production, movement, and purchase a of goods and services is assumed to be instantaneous. That way markets can discover the prices at which they can clear. In something called general equilibrium theory, which is still the cornerstone of modern economics even though it has been attacked for decades, the bidding process during which market clearing prices are fixed is carried out by a disembodied “auctioneer” who sits outside the system, but collects and distributes information to producers and consumers. The haggling of a rowdy market is thus reduced to an auction during which everyone knows everything all at the same time. Neat. For those of you who are asking about time: the modernized version of the theory assumes that there are futures markets that embody sufficient information that future delivery of goods can be compressed into a current decision making process. The future is discounted into the present. And the ugly prospect of uncertainty magically melts away.

Even neater.

This is, of course absolutely ridiculous. But it is necessary to jump through these hoops if you want to preserve the sanctity of market magic. What economists have done is to create a system so convoluted and silly that they hope you don’t notice. The mathematics are extraordinarily elegant. The creators of the model won the Nobel Prize. Their creation dominates theorizing to this day.

They saved market magic, and that’s all that counts.

As Milton Friedman argued: it doesn’t matter how crazy the assumptions are as long as the result is correct. That begs the question as to how we know if the answer is correct. His view was that if markets arrive at an optimal solution in the model, we know the assumptions are OK.

I have a heretical view of all this.

I think Keynes was right in arguing that uncertainty is endemic. Markets may or may not be good allocators of resources. We don’t know. They may or may not arrive at equilibrium. We don’t know that either.

But I go further than this: I don’t think time exists.

There is no such thing as time. It is not a property of the universe. It is simply a convention, a scorecard, with which we keep track of change.

My view is that we exist in states of the universe. Each state is unique. Each is a full configuration of the entire system. Think of each such state as a single point in an infinite space of similar points. When we move from point A to point B we experience change: the configuration is slightly different. Since the two points are sequential we denote the movement as the passage of time. But in fact we have simply changed configurations. A history is a long string of points connected by a common thread. That thread being the observer through whose eyes the universe is being observed. As the observer jumps from state to state he or she experiences change. The trajectory thus created follows a path through the state space of the universe. It is not time passing, it is the universe changing.

Now what makes things change?

Entropy and the laws of physics that dictate creativity.

Creativity is the elimination of information. That sounds counter intuitive. But it is simple. When we create something we specify it. By being specific we eliminate all the alternative things we could have done. We reduce the choices to one. Thus when we build something from a lump of iron we start with a huge variety of things we could do. But we end up with just one of those things. We have eliminated the rest. We have reduced the amount of information.

Conversely, when we use things we add back that information. We do this in two ways. The iron thing we just made wears out. The iron returns to its original state albeit via the process of rusting. The iron remains, but the thing we specified is “used up”. The amount of iron available in the universe remains. The thing created does not. This is an approximation. But it explains the principle. This loss of information through the use and consumption of things is the process of entropy at work.

Entropy is often called the “arrow of time” because it has profound implications. It says that any closed system – the universe, of your cup of coffee – will always move from an more organized state towards a less organized state. In other words we lose track of the order. We lose specificity.

Economies can be thought of as such systems.

They are constantly moving from one state to another. Each state is a full configuration of the system. Each is unique. Each has different information content. As entropy tears away at the specifics of our products, we produce more. In a system dependent upon human intentionality like an economy the role of the laws of physics is played by our innovative and productive capacity. We marshall knowledge in order to fend off entropy. We locate, gather, and deploy resources in order to meet our economic goals. Those actions are creative. They allow us to configure the economy in order to meet our requirements. We combine natural resources with energy and our know how to make stuff. that stuff is a specification. It implies the reduction of entropy in the universe. But as we consume that stuff entropy re-asserts itself, and the laws of physics are preserved.

This view of what an economy is doing does not require us to speculate about equilibrium. It requires us to speculate about the search for resources; about the impact of their location; about the way in which we learn to use them; about the way in which technologies are developed; about the level of knowledge in society and the institutional or cultural constraints on its use; and about the structure of the networks or processes through which resources are transformed into products and moved to consumers.

None of this requires us to muddy things with time. Instead we simply observe how the economy moves through its state space as the process of search drives it onward.

But enough.

Time represents a problem to standard theory. Just not in my world.