There are these two young fish swimming along, and they come across an older fish swimming the other way, who nods at them and says, “Morning, boys, how’s the water?” And the two young fish swim on for a bit, and then eventually one of them looks over at the other and goes, “What the hell is water?” David Foster Wallace

A physicist, an engineer, and an economist are stranded on an island with nothing to eat. A can of beans washes ashore. The physicist says, “Let’s build a fire and heat the can, the pressure will make it pop open, and we can eat the beans.” The engineer says, “The can will explode and beans will go everywhere. Let’s smash the can open with a rock.” The economist says, “Lets assume that we have a can-opener…” _ Original author unknown

Do economists really understand the essence of what’s going on in the economy, or are they like fish who don’t know what water is, assuming can openers to solve what ails it?

Vox had an article on what Pokémon Go says about capitalism.

The gist: all the money from the digital economy goes to a few people in large companies like Apple and Nintendo, and the rest of the world is in a brutal race to the bottom.

Now, that’s not 100% true…Pokémon Go creator Niantic is a startup, if an unusually well-heeled and well-financed startup.

But it feels essentially true.

The reason I started writing this long and digressive rant, is that I posted the Vox story about Pokémon Go in an economics forum, and it got banned for not contributing to the economic discussion. The notion that there could be secular stagnation, and it could have to do with income distribution, and there might be policy implications, was, to some folks, not even a proper subject for analysis and debate.

We’re in a world where something like Pokémon Go can achieve global scale, and the results accrue to relatively few. Lower income folks who receive an additional dollar of income immediately spend two or three times as much wealthy folks. So, if growth in personal income goes mostly (or entirely) to the wealthy, it doesn’t boost demand as much.

In a digital winner-take-all land grab economy, with the returns accruing to fewer people…the spending multiplier doesn’t ripple through the economy, except in $10,000/sf NYC apartments in the sky…The literal land grab for people lucky enough to have acquired NYC/SF real estate before it took off.

These days, you don’t need to build big factories and infrastructure to create a tremendous amount of value. Messaging company WhatsApp had 55 employees when they were bought by Facebook for $19b!

Meanwhile old-world messaging company Verizon is for all intents and purposes exiting land lines, not rolling out FiOS to compete in competitive markets like e.g. NYC, laying off employees who picket stores, while spending big on mobile, digital, content like Yahoo. (Verizon snookered an NYC franchise out of Mike Bloomberg with a promise to roll out FiOS — don’t get me started on their non-competition/collusion with cable companies, and FCC net neutrality shenanigans.)

Invest in FiOS, or a restaurant, or a hotel, or a transportation fleet, be lucky to earn any risk-adjusted real return…meanwhile Seamless, Airbnb, Uber take 15%+ off the top line and earn huge returns on equity and make billionaires of a lucky few big winners.

The phone is the new car, the totemic identity-defining product that drives the economy. If you want your teenager to stay in line, threaten to take his or her phone away. Or is that now considered child abuse?

In the old days the threat would have been to take way TV privileges, or car privileges. The phone is now the teenager’s passport into an independent social life away from parents’ watchful eyes.

But when kids drove cars, they would drive to the mall, spend money, or at least get exposed to the mindset of expressing themselves through consumption within their own generational subculture. They would buy records and CDs and go to movies…now they download and share on social media all day, watch YouTube and Netflix and listen to Spotify for much less money.

Mass media, car culture, consumer goods, they all came of age in the postwar era. Is it possible that, without a new social contract, they will all decline in tandem, as Ben Thompson has suggested?

Capital utilization becomes more and more efficient. In our lifetimes, trains of driverless trucks will be dispatched by central software, making whomever develops it rich, drafting to avoid air resistance, taking up less road, needing less fuel, fewer gas stations and truck stops, and of course drivers.

Map the most common job in every state, drivers is at the top of the list…what is it going to be in 30 years? I’m not too sure ‘app developer’ is a good candidate.

The more the economy develops, the more abstract it gets. Instead of being constrained by labor, capital, energy, everything becomes a land grab for screen real estate, network effects, or mind-share (branding being a franchise in brain real estate).

When you’re buying a stock, a McDonald’s franchise, a piece of real estate, what are you buying, exactly? You’re buying the cash flows from ownership. But what are the cash flows from ownership? The course of the economy, the competitive landscape determine that. But so do regulation, taxes. Either way, what you’re buying is a story.

You may not like it, but when you buy a stock, you’re buying a story about why it’s going to grow and be a strong brand, and the value will change depending on how the HQ grows the brand, changes the rules about how revenues and profits get allocated.

When you buy a bond, you buy a defined cash flow, modulo credit risk, but you’re buying a narrative about whether the Fed and the economy will keep the value of that cash reasonably stable.

The more we evolve, the more we climb the abstraction layer from sweat to clever invention, to stories and viral media land grabs. The new world smells like buzzword globaloney. But that’s what it is…the job of the powers that be is to keep the story machinery humming because the business of the world is manufacturing self-perpetuating stories, i.e. bubbles. We are all Lloyd Dobler now.

If you don’t buy into one of those narratives you end up holding cash and gold, but in the long arc of history the stock and bond narratives have more or less worked out most of the time, so you end up losing out.

We’re all in a Thorstein Veblen world now. Except there’s no leisure class. There’s a work-like-crazy-for-status class, a work-like-crazy-to-survive class, and an underclass.

Economics has things to say about this game of stories and bits, where every bit strives to be the high-order bit. But it’s not the economics of competitive markets and supply and demand.

Consider Apple iOS. No Apple phone is the most leading-edge hardware, the teardown cost of the iPhone is always lagging e.g. the latest Samsung Galaxy. But the software and ecosystem are why the ASP of iPhone is in the $600s, while Android is in the $200s.

The iPhone platform is more of a mini-state of law than a product. The US has to go begging for access (or hire people Apple would consider outlaws to hack it).

I cry a little inside over Twitter’s harassment issues, which represent a loss of innocence. There was a time when I thought anonymous/pseudonymous public speech was OK, but it just hasn’t worked out. People suck and that’s why we can’t have nice things. You can only have freedom to the extent there’s virtue a/k/a social capital. Neither Milo nor ‘Help! Help! I’m being repressed’ activists should be able to hound people and shut anyone down. But no one asks the government for rules (well, at least, not most reasonable people). They ask Twitter to put something in place…presumably in the not too-distant future users will be able to only see approved or verified folks in their stream and not have trolls calling them out all day (and maybe live in their own left- or right-wing bubble of stories).

The economic holy grail is carving out a platform with increasing returns to scale and a massive moat_not being the low-cost producer, market leader, etc. It’s seizing the commanding heights, making the rules, not making the product. It’s not the game you learn in Micro 101.

I don’t think you can treat these companies as monopolies like Elizabeth Warren suggests. Well, you should probably rein in some of the most egregious behavior. But Microsoft would have argued that splitting their OS from the apps business would have done more harm than good by making it harder for apps and OS to co-evolve, and they were probably right.

This is where I think some economists and some libertarian types miss the boat.

Here’s a thought experiment…how much of your brain do you think is devoted to social processes, and how much to utility-maximizing processes?

I don’t have a link, but I’m quite sure the answer is the former. If you’re a business person or policy person, you may spend a lot of time thinking about markets and incentives. But only a small percentage of our interactions work that way. Economics is the tip of the iceberg, the point of the spear. Marginal thinking and incentives may be decisive in important interactions. But they only allow you to act within a framework of social conventions and laws which is more determinative.

Coase’s theory of the firm is that markets are inefficient coordinators… they excel at high level allocation of resources, but for the last mile of complex processes you need a hierarchical, organization with command and control…and culture.

In a physics sense, the market economy is incredibly inefficient. People massively duplicate effort. You have multiple competing gas stations at every big intersection. Huge amounts are spent on marketing, products with questionable social value.

In a computer science sense, however, it is highly distributed, highly parallel at exploring the search space for best practices, technological evolution.

The market economy is like sexual reproduction. It makes animals waste a huge amount of energy searching for mates and creating courtship displays. But it powers a constant search to mix and match the features that allow survival and drive improvement. In the words of Darwin, “It’s not the strongest of the species that survive, nor the most intelligent, but those that are the most responsive to change.” The meta-feature of adaptability is more crucial than efficiency narrowly defined.

Marx viewed economics and relations of productions as the base, and politics and political relations as the superstructure. I think it is much more correct to view social/political and market structure as highly co-evolved, and they together define the ‘water.’

I think if you want to understand human behavior, study social psychology, anthropology, zoology, not economics. Most of human behavior is social psychology, seeking the hierarchy of needs, which mostly boil down to social status…if you have that all your other needs are taken care of. And economics is a game or a collections of games or market designs humans have created to coordinate activity, and by winning them you gain one component of social status. But social behavior comes first, and economics is the game within the game. You optimize your economic choices, but only within the choices society makes available, and the point of economic choices is, once you get past survival, to win a social game, that in turn gives you mating choices, propagates your genes, etc.

You go to a store, you pick something out, you hand over cash, you get a receipt. How long would it take to explain that to an alien? In fact economists can’t even agree on why things like money and gold have value, and why they fluctuate (for instance whether monetary easing right now lowers or increases inflation).

When you get to something like iOS, it’s not so much a product as its own nation of people and laws, its own ecosystem, its own market structure. The product is not the phone, it is the platform, the standards, the ecosystem. The market structure and ecosystem is the product. Same with Pokémon Go…there is no product, all there is is a set of rules that create its own social and economic ecosystem.

Thinking about massively multiplayer game play is essentially the same as thinking about economics. Not for nothing do game companies hire real economists… they are our most empirical economists, market planners, ecosystem engineers.

There’s a brand of economist that thinks everything fixes itself. It exists, therefore it is optimal (unless government is involved). There can’t be any problem with existing market economic structures that could fail to adapt. It’s like the guys who said when Saddam Hussein is deposed in Iraq, it will evolve into a social democracy.

It’s assuming this whole can opener of soft infrastructure, social capital, a legal system, a state that can enforce its will and a political infrastructure that can evolve over time.

Market structure is everything, and social capital that enables market structure is everything. They are the water. You can’t say, just let everyone be free, and a working capitalist system will spontaneously emerge. You want market structures that maximize freedom to trade and innovate. But markets don’t exist without complex social contracts, virtuous people who abide by them a/k/a social capital, explicit laws, and a strong government that enforces them.

Returning to the implications of Pokémon economics, possibly this is the new world we live in, with lower GDP growth, lower population growth, more efficient capital utilization via e.g. Uber which direct capital utilization and control the commanding heights and mean we don’t need a car in every driveway. And everything will be OK.

Maybe machine intelligence is just a latter-day John Henry man vs. machine story, and it will free people from rote work. But, a thought experiment: suppose capital took the form of perfect human robots … what would the economy look like? Would it fix itself, or fall into a Piketty singularity leading to an economy of a lumpenproletariat, robots plus overclass? At what point does the social contract break?

Maybe negative interest rates are post-capitalism, or post-capital, the end of capitalism.

The financial system is totally broken if negative interest rates are a long-term state of affairs, a lot of banking business models are borked, government may have to step up to invest in a lot of infrastructure that doesn’t pay huge returns.

This would make sense. If we’re paying Switzerland to take our money for 30 years, they might as well take it and tunnel the Alps til they’re Swiss cheese. But most countries aren’t doing it.

But if all the income goes to firms that don’t need massive investment, and you use the infrastructure far more efficiently, and government doesn’t step up to invest…you get zero interest rates which lead to financial crisis, and you get Milanović’s elephant chart, which leads to political crisis, Trump, Brexit, etc.

Rethinking investment and the financial system to work in this environment won’t happen without another massive financial crisis, and restructuring of the financial system and even social contract. Hopefully not along the lines of Trump/Brexit/de-globalization and conflict.

People can only absorb so much change. Globalization has been pretty intense for a lot of people, and intelligent machines will throw more over the edge.

The economy is like the human body. We know broadly what will kill it (cough) and broadly what it needs to stay healthy, but we can’t predict everything it does, and sometimes it gets sick for inexplicable reasons.

Something is pretty broken right now. Maybe it will fix itself. But assuming everything is self-healing is a bit like a fish, who doesn’t know what water is, assuming a hammer. The big errors, like the financial crisis, happen when you keep applying old models, when the assumptions they were built on have changed. How can you be so sure they haven’t?

The transition from agrarian to manufacturing economy didn’t happen without massive crisis, depressions, wars, a long culture war between capitalism and communism. Seems like a bad idea to be complacent that models that worked in the past won’t need updating, that problems will solve themselves. Have a little humility. How could we possibly know? What would change your view? If nothing in reality will change your view, then your view isn’t based on reality.

There aren’t a lot of people who understand systems well enough to fix them from first principles, let alone build them, be they economic systems, ecosystems, human bodies, climate. Fortunately, systems that have been around a long time have evolved complex, highly redundant ways of adapting, maintaining equilibrium, and surviving. But they all have their breaking point. There’s an arrogance to thinking humans can understand and control everything, and an arrogance to thinking everything that exists is for the best and will always fix itself.

If you keep making bigger changes to a model, quantitative change becomes qualitative change to the dynamics of a model. When you perturb a system, maybe nothing changes, maybe it starts to oscillate and return to equilibrium, or it breaks/explodes.

Economics is not the study of models, it’s the study of the real world. The map is not the territory. You don’t get to say, what you’re talking about falls outside my model, so ipso facto it is not economics.

We may be bad at forecasting the future, but you still have to act and your actions determine the future, so you have a moral obligation to think about reality, and not just a closed model.

How is the water?