The one feedback loop he mentions explicitly – falling sales lead to layoffs which decrease money available to make purchases, etc. – was thoroughly analyzed in Keynes’ seminal 1935 book. The solution is for government to use its borrowing power (deficit spending) to inject more money directly into the market (subsidized credit) and/or to create jobs, damping the downward spiral.
As Keynes also pointed out, government can and should regulate securities markets to slow or, in extreme cases, stop the speculation-powered upward cycles that increase vulnerability to and consequences of the eventual downturn.
This all works pretty well until someone finds a way around the controls. This time, it was the inflated credit and housing markets. Most
governments now understand not to invoke the second-level feedback loop: as economic activity falls, government tax revenues fall, so there’s an impulse to raise taxes to balance the budget, and to tighten the money supply to reduce the now-irrelevant speculation. That’s what governments did in 1929-1932, producing the Great Depression.
The missing point in most macroeconomic analyses is that where the government injects money and jobs does make a difference. Keynes said that “paying people to dig holes and fill them up again” would be better than doing nothing, but that doesn’t mean that’s the best choice. Economics focuses on revenue - expenses accounting. If you spend $200,000 to build a house, then spend $50,000 to tear it down and throw the debris into the river, you’ve contributed $250,000 to GNP. Competently run businesses focus on assets - liabilities accounting. By that reckoning, we note
correctly that the example here simply converted useful resources into trash and pollution. The point is that government efforts to stimulate the economy work better when they are directed to increasing asset value: roads, parks, information infrastructure, scientific research, health care, education, mass transit, for example, on the jobs side, and financial aid to individuals, especially entrepreneurs, rather than big badly-run institutions, on the money supply side.
SD has already alienated many economists by proposing solutions without showing understanding of what economists already know. Let’s not go there again.
– Doug Samuelson
···
From: SDMAIL Fred Nickols
nickols@att.net
To: System Dynamics Mailing List sdmail@lists.systemdynamics.org
Cc: System Dynamics Mailing List sdmail@lists.systemdynamics.org
Sent: Saturday, December 6, 2008 6:54:31 AM
Subject: ANNOUNCE PCT and an economic emergency (SD7264)
Posted by “Fred Nickols” nickols@att.net
Bill Powers, creator of Perceptual Control Theory (PCT), a feedback or control
loop based view of human behavior, has grown concerned about some positive
feedback loops in the economic system and wrote a letter which I am passing
along. My guess is that the folks on the SD list have also spotted the same
loops. Anyway, I thought I¢d check reactions to Bill¢s letter on this list.
Regards,
Fred Nickols
Managing Partner
Distance Consulting, LLC
Control Systems Group Network (CSGnet)
[mailto:CSGNET@LISTSERV.ILLINOIS.EDU] On Behalf Of Bill Powers
[From Bill Powers (2008.12.05.0444 MST)]
This is a letter that needs to be conveyed to as many people who make
economic
decisions as possible. OUR ECONOMIC SYSTEM CONTAINS DESTABILIZING FEEDBACK LOOPS
THAT CAN DESTROY IT. WE NEED TO FIGURE OUT HOW TO REMOVE THEM AS QUICKLY AS
POSSIBLE.
This is a true time bomb. It is perfectly obvious, and it is to my shame and
that
of everyone who understands the dynamics of control systems that it was not
noticed, publicized, and corrected long ago. It is very simple and we are
watching it operate every day that this recession deepens.
Its cause is some set of policies or principles that are thought to be necessary
to maintain the viability of a business, but which, when generally adopted, have
the effect of exaggerating swings in the market and, if widespread enough, throw
the market into a state of dynamic instability that feeds on itself. Increases
in
market activity cause a piling-on effect which drive the increases even further
and induce more frenzied market activity.
The same underlying relationships work
the other way, too: when the market peaks and starts downward, this cause the
enthusiasm to wane and the market activity to slow down, and the slowdown causes
an even more dampening effect, which makes the slowdown accelerate. Whichever
way
the market tends to change, the change is exaggerated by this feedback effect.
The initial result when the amount of feedback is small is that the economy
displays “boom-and-bust” cycles of relatively small amplitude, which die out
after a time. When the degree of this effect becomes large enough, the swings
start to get larger and can enter a region in which a runaway effect occurs.
Then
the only way to stop the growing oscillations is for something in the system to
be damaged enough to reduce the feedback effect below the fatal threshold of
sensitivity.
One obvious destabilizing effect we are seeing right now is that
companies faced
with falling sales are laying off parts of their workforces to reduce costs and
preserve their net income. As the number of employed persons decreases, the
total
income of the average consumer falls, so there is less money to spend on goods
and services – the very spending that is the source of income for the companies
who are laying off workers (and each others’ customers). So we have the
situation
in which the attempt of companies to reduce expenses and restore their income to
profitable levels has the effect of reducing, not increasing, the total net
income of all companies. That leads to an increase in the attempts to reduce
expenses, and so on. If enough companies follow the same policy, there can be
only one outcome: total collapse.
This is probably not the only destabilizing feature in the basic relationships
that make up our economic systems. It is only one obvious feedback loop with
the
wrong sign. This is known technically as a positive feedback loop, one in which
small changes lead to larger changes, in contrast with the negative feedback
loop
in which small perturbations are negated by feedback effects and are immediately
smoothed out. In popular usage “positive feedback” means encouragement and
approval, but if encouragement occurs only when one is doing better and is
withdrawn when one begins to do less well, the seeds of true positive feedback
have been planted; at the first sign of doing less well, approval will decrease,
and the resulting lessening of encouragement will cause performance to decrease
even more, and so on to disaster. What works on the way up continues to work on
the way down. Changes in either direction are exaggerated by positive feedback,
and the result is instability. If there is enough instability, the system will
destroy itself.
The cure for positive
feedback and its destructive effects is to ferret out and
remove all the positive feedback loops. There should be little resistance to
doing this, because what will be revealed is the clear fact that actions
intended
to improve matters are actually making them worse. Any sane person will cease
such actions even if their undesirability is not immediately explained or
understood. Once we step back and look at the overall relationships, the
instability that is caused by a wrong response to problems becomes obvious. Then
the main issue is seen clearly: what do we need to change to prevent this sort
of
destabilizing feedback from occurring?
Stabilizing the economic system does not require telling people what to buy or
what to sell, or for how much, or to whom. It requires intervention only when a
reaction to a change in economic activity, either upward or downward, results in
amplification of the change rather
than smoothing it out. Just why this
amplification occurs has to be studied so the correct adjustment can be made. It
could be only that there is too much reaction to a change. It could be that the
reaction is too much delayed, so what would have been a stablizing reaction if
it
had occurred right away becomes destablizing when applied too late. Or it could
be that the intuitive reaction to a problem is exactly the reaction that will
make it worse, showing that there is a mistaken understanding of how one part of
the system affects other parts.
Reaching an understanding of instability in the economic system is no longer an
abstract goal of only academic interest. It is a necessity for our survival. It
requires a massive investigation and the efforts of many competent scientists
who
know how to analyze and model large systems – a Manhattan Project that will
finally unravel the mysteries of how the economic
system works. We need to
understand exactly what kind of technical public-sector interventions can be
brought to bear when the free market goes into free fall, without infringing on
rights or imposing micromanagement on individual entrepreneurs and consumers.
The
answer, at times, could be as simple as a slowing of changes similar to what the
stock market imposes when panic threatens an individual stock. Sometimes it
could
require rulings about policies which, if followed by enough transacting parties,
threaten the entire system. Some existing regulations might prove to cause more
of the problems they were intended to lessen.
The only way to find the answers we need is to construct a working model of the
economy, which requires studying it in sufficient detail to construct that
model,
and then, once consensus is reached, using the model first to reproduce the
economic events that are so troublesome to
everyone, and then looking for the
minimum changes required to prevent them from ever happening again.
Please forward this letter wherever you think it might do some good.
Bill Powers
Posted by “Fred Nickols” nickols@att.net
posting date Fri, 5 Dec 2008 07:30:54 -0700