The economy as an adaptive system

The organisation of ants – The nature of adaptive systems –
New goals for new economies – Water Rewards – Rewards as a system

How is it that ants are so good at finding food? If a single ant finds a food source (such as that not-quite-closed jar of honey in the pantry), why does a trail of ants immediately appear to help carry off the food? And if you try to disrupt the trail by putting obstacles in the way, why do the ants still seem to find their way to the honey?

How do they manage to do this given their limited information processing capabilities and relatively uncomplicated behaviour patterns? An ant cannot reason and cannot plan, but it can communicate with other ants through the use of pheromones or scents. It is this that enables complex group behaviour to emerge even though the ant interactions remain simple.
An ant colony sends out ants to randomly search the environment for food. When an ant finds food it loads itself up and finds its way back using landmarks, the position of the sun and in some cases the earth’s magnetic field. On its way home it leaves a scent trail. The scent evaporates over time and gets weaker but before it can disappear, other ants from its colony will find the trail and start to follow it – regardless of whether they are coming home or are on their way out searching for food. Ants, you see, only lay down pheromones when they have food and are on the way home.

If you were an ant and came across such a trail, you could be guaranteed that there was food at one end and home at the other. The stronger the scent, the more ants that would have already traversed the path home laden with food. When the food source runs out, your fellow ants will search the immediate vicinity to look for more food. If they find it they will scurry back home by the shortest path they can find.

The result of this simple behaviour pattern is that ants find a near optimal solution to discovering and harvesting food sources for the colony. Humans with all their technology would find it difficult to devise a better strategy and only with more information than the ant possesses. The critical parts of the strategy are that the ants have a goal – find food and carry it back to their nest – and they have a behaviour pattern that says “leave a scent when you have food” and “follow a scent trail”. Out of these actions the ant system repeatedly discovers optimal solutions for an ever-changing environment. Note that ants do not plan how to find the shortest path from their nest to food sources. That solution is an emergent property arising naturally from the rules of behaviour.

The structure and organisation we’ve just described is an example of a complex adaptive system. It is complex because it is made up of a number of diverse elements and it is adaptive because it is self-adjusting, constantly modifying behaviours in order to adjust to the changes going on around it. Remarkably organised though the ants may be, there is no overall guiding hand determining how their system should operate. Each ant obeys relatively simple rules that govern its reactions to immediate stimuli and to other ants. Behaviour of the total ant colony 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 way that you might plan a great building. Humans have not become more intelligent in the sense of an increase in innate ability, yet we have created the modern world through our own complex adaptive system.

Other examples of such systems include the climate, the brain, the ecosystem and cities. All are comprised of multiple elements; follow a set of rules; involve inter-activity, cooperation and communication; and are capable of modifying or responding to change. Specialisation is another property, whereby agents within the system take on roles dedicated to particular tasks. The behaviours produced by these systems are described as emergent properties because they arise (or emerge) naturally as a result of activity within the system. Due to the need to adapt to change, they can not be predetermined.

In recent years the idea of complex systems has also been applied to our monetary systems, creating the theory of complexity economics. This school of thought proposes that rather than being a closed system seeking equilibrium, the world economy is actually the end result of an adaptive system designed and planned by no one. It has emerged and continues to develop through the activities of individual entities who are involved in mutually beneficial trading and who operate with relatively simple trading rules[1].

Put another way, the economic world that we know has emerged out of a system that has at its core the idea first expressed by Adam Smith; that wealth is created when people specialise in an activity and hence become good at doing that task[2]. People benefit from their activity by trading some of their output with others who have specialised in other activities. The result is an economy based on individuals seeking to maximise their own wealth and looking to conduct their trades in ways that will work.

For the system to work it requires rules and underlying those rules, it demands trust: if you can’t trust your trading partner to obey the same rules, the trade will fail. Thus successful trading economies evolve where both parties benefit and where the rules are enforced. First and foremost of those rules is that the trade should be “fair”.

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. Like the ant colony, we cannot understand nor predict exactly what will arise from this loop, but we do observe that it works and – for humans at least – it increases wealth.

What would happen 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.

Water trading is an example of this kind of tinkering. Here the goal is to increase the water supply through more efficient use and by creating more available water. To achieve this governments create the right to consume water and allocate this right to different people. Ideally, the quantity of available rights should equal the reduced consumption level that the government is targeting. If not, the next step is to begin a gradual decrease in the number of water rights until the target consumption level is reached. Unfortunately this is extraordinarily difficult to do, not least because it is politically unpopular and it inevitably drives up the cost of water. As a result it is unlikely to achieve the required decrease in the desired time

Water Rewards

A more successful alternative is to follow the ants’ example and create a means of harnessing our collective endeavours to achieve an objective. Rather than inventing water rights or allocations, why not channel the power of the market to favour those who become more efficient in their water consumption?

We’ll call this system “Water Rewards”. Given we are the ones creating the goals and we are the ones who will have to buy the water, let’s demand that the primary objective of the system must be to provide us with H20 at the lowest reasonable cost. The secondary objective should be to increase the supply of water through more efficient use and by creating more available water.

To support these goals we set in place a system of Rewards – a form of financial incentive – for people who reduce their water consumption. Or perhaps we provide Rewards to those who use less than a predetermined household allocation. The parameters are a starting point and they need to be fair to encourage participation, but it’s not essential to get them right immediately as the whole idea of the system is to continue tweaking until we get to the desired result.

The Rewards could be funded by a small increase in the price of all water. Anyone who meets the goals would then have the extra cost of water reimbursed through the Rewards. Those who use more than their allocation or who don’t support the goal will end up paying slightly more for their water, but this is still likely to be seen as fair because people are used to the idea that prices increase when a resource is scarce.

Given every system has to have rules that support the goals, our next step is to decide that the money given as Rewards must only be used for goods or services that increase the supply of water. Depending on how high we want to aim, this could range from a new dam for a city through to water tanks in every back yard or water-efficient shower heads in every home. It’s the kind of limitation that people aren’t generally used to with money, but if we think of Rewards as tagged money – a kind of frequent buyer incentive – the expenditure rules make sense. It is also important to understand that within this system we are appointing money not merely our currency, but also our method of communication. The choices we make relating to our willingness to work towards the goals and the solutions that we think will work best are communicated by the way we spend our money.

To achieve cooperation we make the system voluntary. Those who don’t want join will still be able to buy water as normal, but they won’t be eligible to receive Rewards. If a seller abuses the system or does not want to participate, they will be excluded from Rewards redemption.

What we’ve created is a complex adaptive economic system. It has a purpose; it has numerous diverse elements; it has rules that can be used to adjust the system and modify behaviour. There is no single controlling agent setting direction for the system and we can’t be sure how it will end, but once we set it going, Water Rewards will begin to modify and adapt until it finds the optimal solution to its goal.

Rewards as a System

We started this book by stating that Rewards is an alternative approach to the management and allocation of any resource. We’ve given the examples of water and greenhouse gases, but it can equally be applied to any economic system with a clearly defined objective.

The main purpose for the invention of a special purpose or limited currency is to direct expenditure towards the defined objective. In the case of Energy Rewards our goal was to reduce greenhouse gas concentrations. With Water Rewards we were seeking to conserve a resource. In systems terminology what we have done is:

• create a new economic system defined by a new currency (Rewards);

• state the objective of the system;

• 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.

It is deceptively simple. 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.

One question that has to be answered is why, when we are attempting to introduce a new approach, should we continue to look to the markets for our answer to resource allocation? Why not throw away the markets and create a system that is completely new and different?

The short answer is that markets work. They have proven their attractiveness and value to humans for centuries. An economic system is something that that allows the transfer of value and markets are very efficient subsystems for achieving this transfer.

What happens in a market is that sellers adjust their behaviour depending on the actions of buyers. Prices go up and down while other behaviours – like advertising – influence the decisions made by the buyers. Whether describing the market for health products, entertainment, energy, education, or even the interaction of markets known as the market economy, buyers will typically try to minimise the amount of money they spend to satisfy their needs, while 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, or in other words, producing 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 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, something that typically occurs where there are natural monopolies such as water reticulation systems, sewage infrastructure and transport routes.

One of the most critical elements within a market is its currency. The currency and rules surrounding it help to define the system and influence the outcomes of each market. Just as there are many markets there are also many currencies, the majority of which are based on geographic areas. There are also private currencies such as frequent flyer points, and electronic currencies such as telephone minutes on prepaid phones. Depending on the rules of each of these systems, the currencies may or may not be allowed to be transferred one to another, enabling value to move from one market to another.

What Rewards does is enable us to subdivide the economy by creating new limited purpose currencies that define separate systems. It delivers a mechanism to control and define different objectives for each market.

The potential for such restricted currencies and market implications are what we now need to explore.

[1] For detailed information on this theory see Beinhocker, Eric D. 2005 The Origin of Wealth. Random House Business Books,

[2] Smith, Adam. 1776 An Inquiry into the Nature and Causes of the Wealth of Nations

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