Rewards for low cost policy outcomes

The nature of economies and adaptive systems;
Creating new goals for new economies;
Rewards as the least-cost solution to achieve agreed social outcomes

Adaptive systems and complexity economics

The Macquarie Dictionary defines “humanism” thus: ” any system or mode of thought or action in which human interests predominate.” In adopting a humanist approach to public goods provision, our primary aim is to remove the divide between private and public benefit, creating a system that works for the good of all at the same times as offering individual incentive and reward.

Demanding benefits to multiple parties does increase complexity, creating new relationships within the system along with a need to somehow predict and manage the results of those interactions. It requires what is known as an “adaptive system”, one that is never static, modifying its behaviour in order to adjust to the changes going on around it. Such a system can be seen in the behaviour of a termite colony. Remarkably organised though the colony may be, there is no overall guiding hand determining how the system should operate. Each ant obeys relatively simple rules that govern its behaviour, reacting to its immediate stimuli and its interactions with other ants. The termite colony behaviour is an emergent property of the sum of the individual interactions.

Human society is much the same except we have the advantage of being able to change the rules under which we individually act. Over the past 5,000 years humans have evolved an amazing society yet it was not planned in the sense of planning a building. Humans have not become more intelligent in the sense of an increase in innate ability, yet we have created the modern world. This world has happened because we have been able to communicate and because we have worked out the economic system called trading that enables individuals to specialise and so become more productive.

In his book “the Origin of Wealth” Eric Beinhocker outlines the theory of complexity economics, proposing the idea that the world economy is the end result of an adaptive system designed and planned by no one. It has, he suggests, arisen through the activities of individual entities operating with relatively simple “trading rules” and who are involved in mutually beneficial trading. Complexity economics or adaptive economics explains the rich world of economics as an emergent property of a system that has at its core the idea first expressed by Adam Smith in “An inquiry into the nature and causes of the wealth of nations”. Wealth is created when people specialise in an activity and hence become good at doing that task. They benefit from their activity by trading some of their output with others who have specialised in other activities. The economic world as we know it is an emergent property of this system of trading where individuals each seek to maximise their own wealth and to conduct their trades in ways that will work.
The underlying rules of trading depend on trust that the others with whom one trades will obey the rules of the trade. Thus successful trading economies evolve where both parties benefit and where the rules are enforced. First and foremost of those rules is that both parties should benefit and the trade should be “fair”.

A review of Beinhocker’s book in the Economist http://www.economist.com/finance/displaystory.cfm?story_id=7189617 gives a summary of the main ideas in the book and ends with the following.

For the moment, then, evolutionary economics remains a niche pursuit, not the intellectual revolution Mr Beinhocker predicts and hopes for. It is ironic that evolutionists, of all people, should have such trouble reproducing themselves.

This book gives a way for the ideas to be reproduced in economic systems and for Beinhocker’s vision to become a reality.

New goals for new economies

All adaptive systems require a purpose. In economic systems this goal has been to increase the wealth of communities. At present wealth is measured by consumption, or the monetary value of the output of goods and services. As consumption increases, wealth multiplies and our capacity to create more wealth also grows. The system is built on the idea that each entity within the system will attempt to increase its own wealth.

This positive feedback loop has been the driving force behind economic development. We cannot understand nor predict exactly what will arise from it but we do observe that it works and it increases wealth. We can also estimate what will happen if it continues. In the case of the generation of energy we know that if we continue to produce energy by burning fossil fuels we will radically change the environment under which we live ā€“ almost certainly for the worse.

What would happen however if we modified an economic system to include goals other than consumption as the measure of success? If we change some of the rules under which we trade it may be feasible to alter the outcome of the system in ways that are more benign. In fact it becomes possible to build economic systems with goals other than wealth generation.

Emissions trading is an example of this kind of tinkering. The goal is to reduce greenhouse gas emissions, so we invent the concept of a right to create emissions and allocate this right to different people. Next we need to reduce the number of emission rights until we reach the desired result. Unfortunately as outlined earlier, this is extraordinarily difficult to do and it is unlikely to achieve the result we want in the time needed.

The humanist approach suggests an alternative set of changes to the trading system; changes that are more likely to succeed because they create a way of harnessing the market’s collective endeavours to achieve an objective. Rather than creating rights to emissions, for example, the humanist approach first requires changing the rules of trade to favour the goal which in this case is the production of non-polluting sources of energy. As is essential for trade to succeed, these rules have to be equitable for all participants in the market.

It can be done in the following way. People who generate greenhouse gases could pay extra for the privilege. This extra money can now be used to reward those who, through their behaviour, generate fewer greenhouse gases. One of the rules applied to this money however, is that the rewards must be used to invest in ways of further reducing greenhouse gases. It’s an approach that is not all that different to existing frequent flyer and frequent buyer marketing models. The person supporting the desired behaviour is rewarded. The difference is that those contributing to the problem (or using the resource) provide the funding to reinvest in alleviating the problem.

As these new rules work towards the goal of the economic system, participants will recognise them as fair and will be prepared to abide by them. The regulations can be enforced by inventing a special currency to record the results of these trades and excluding any rule-breakers from the arrangement. The system is guaranteed to reduce greenhouse gas emissions because it has set in process a positive feedback loop that people will abide by. It will not cause any economic dislocation.

We call this approach Rewards. Rewards can be applied to any economic system with a clearly defined objective. The main prerequisite is the invention of a special purpose or limited currency which can then be used to measure the success of our objective. In the case of Energy Rewards the goal is to reduce greenhouse gas concentration. In systems terminology we:

  • create a new economic system defined by a new currency ā€“ Energy Rewards;
  • state the objective of the system – to reduce greenhouse gas emissions for minimum cost;
  • establish the rules of the system which are the rules placed on the creation and use of the currency, all of which are designed to achieve the overall goal.

The system is adaptive because it has rules that can be varied, such as: who gets Rewards, who pays for Rewards and where the Rewards are spent. Past experience has proven the ability of adaptive systems to attain their goals so we can be assured that this system will achieve its objective of reducing greenhouse gases in the atmosphere.

We can solve the problem of the commons by building targeted economic systems that address new goals and which can be measured on criteria that are more inclusive than wealth generation.

Rewards as a Restricted Market

We can define an economic system as a system that allows the transfer of value. Markets have proven to be efficient at achieving this when value is defined within the system and by the rules associated with the method of exchange or the currency. In a market we have something to sell, a set of sellers, a set of buyers and we have something called money as the way of choosing a preference. Markets are adaptive learning systems and a market will learn to produce goods and services for the lowest cost.
What happens in a market is that sellers adjust their behaviour depending on the actions of buyers. That is prices go up and down, and other behaviours – like advertising – influence the decisions made by the buyers. A typical objective of buyers is to minimise the amount of money they spend to satisfy their needs while the sellers attempt to maximise the money received. Markets work when there are many buyers and sellers, and where the buyers are free to choose. The total system has the goal of supplying the most goods for the least amount of money. That is we produce the most goods for the least cost. Sellers are driven to supply goods for lower and lower costs or to supply more for the same. Complications arise when the buyers have different criteria for choosing amongst the different offerings and the sellers vary what it is they are selling. But this is also the “magic” of the market. Markets work because there is variety in the system and because buyers and sellers can vary the criteria for how they value the goods being sold without necessarily telling the other party.
Markets become inefficient when they are constrained in ways that prevent the freedom of choice and reduce the need to innovate. Examples are not enough buyers, not enough sellers and not enough money to allow choice and innovation. Difficulties also arise when choice is restricted through rules and regulations. The most common market restriction with public goods is the restriction in the number of buyers or in the number of sellers. This commonly occurs where there are “natural monopolies” such as water reticulation systems, sewage infrastructure and transport routes.
A market requires a method of measuring value. This measure of value or currency is a critical part of the market system and how it is defined and its meaning will greatly influence the outcomes of the market system. When we talk about a market economy we are really talking about many markets. There is a market in health, a market in energy, a market in entertainment. These markets overlap and by using a common currency for all markets we enable wealth in one area to move between markets. However there are many currencies and these are most commonly based on geographic areas. We have a currency for Australia and another for Japan. We also have private currencies such as frequent flyer points and we have many electronic currencies such as telephone minutes on prepaid phones. These currencies may or may not be allowed to be transferred one to another, enabling value to move from one market to another.
A modern problem with currencies is that some of them have taken on a new role which has become intertwined with the old role of measuring value. This new role entails having value itself. That is, money has become wealth itself and trading in money now competes for trading in other goods and services. The implications of this are explored in the next chapter but the fact that the measure of value now has value can cause inefficiencies for a particular market. That is, the definition and rules surrounding the currency used for trading is are an important part of any market.
The approach advocated in this book to overcome some of the difficulties that restrict, constrain or interfere with the working of markets is to create new limited-purpose currencies for markets where the use of a general currency is in some way prevents achieving multiple goals. We believe that restricting currencies for a given market allows that market to deliver the most economically efficient solution to a given problem.
The full details of Energy Rewards are given in a later chapter but in summary, the goal of greenhouse gas reduction can be solved by creating our own adaptive learning economy. We start by defining a market that encompasses infrastructure to produce energy with low greenhouse emissions and infrastructure that reduces the need for energy. This market place does not include infrastructure that produces energy with unacceptable greenhouse emissions. This approach will result in infrastructure that produces the most energy for the least cost. Adding a cost to the price of energy when emissions occur will also result in the lowest cost solution to reducing emissions for Energy production. This will happen because supply and demand within the Energy Rewards market place will work just as it does in any other market, driving towards maximum value for lowest cost.
A Rewards approach allows markets to generate desired goods and services but with multiple goals. For Energy Rewards one goal is the least cost and another goal is low greenhouse emissions. In an unconstrained market the least cost will always win and with current technologies this will have high greenhouse emissions. By constraining the currency for trading in energy infrastructure we can achieve multiple goals efficiently. Using Energy Rewards does not preclude other methods of directing trading (such as the trading of emissions permits) but rather it complements and enhances the effectiveness of cap and trade systems.

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