Friday, August 19, 2011

A Soaring Economy

Every trained pilot knows that pulling back on the yoke causes the nose of the aircraft to pitch upwards. Sufficient airspeed and thrust will steadily increase the climb rate and altitude. If the airspeed is insufficient the aircraft will quickly stall, nosedive, and the plane can crash. The distinction is essential. Pilots understand the primary effects, side effects, interactions, and situational use dozens of cockpit controls. They master aerodynamics in theory and in practice.

Professional pilots train for years, practice in flight simulators, refresh their skills often, demonstrate new skills to expert instructors, practice a wide variety of emergency procedures, and constantly study flight theory and operation. As a result expert pilots skillfully manage the complexities of flight and  complete tens of thousands of flights safely each day.

Boeing 747 Cockpit
Controlling an economy is at least as complex as controlling an aircraft. Corporate and individual tax rates, interest rates, spending rates, money supply, subsidies, tariffs, international trade agreements, and regulations each have their primary effects, secondary effects, interactions, and situational applicability. Do we know what these effects are? Do we know how they interact? Do we know how they work in a wide variety of situations? Do we have an accurate and comprehensive macroeconomic theory that describes the system interactions?

Knowing what control to exercise in each economic situation is a complex skill best left to trained experts. Perhaps economies would soar more often than they crash if we learned more lessons from expert pilots.

Pilots study comprehensive and accurate aerodynamic models. They understand the four primary forces of thrust, drag, lift, and gravity. They study the characteristics of their specific aircraft learning precisely how it performs under different conditions of speed, load, weather, position, and configuration.  They master new maneuvers in simulators rather than subjecting passengers to ad-hoc experiments.

Perhaps we can begin by researching, developing, validating, and understanding a comprehensive and accurate macroeconomic reference model. We could use that model to understand, describe, and explore the many effects of each proposed change in the economy. For example, the effects a proposed tax cut would have on public sector jobs, private sector jobs, the deficit, and other aspects of the economy could be described together as the overall effect of a proposed change. We would always refer to the same reference model to fully describe the many effects of each proposed alternative rather than highlighting only one effect while ignoring all the others.
US Unemployment Rate, 1890-2009
The pilot and co-pilot agree, well before takeoff, on their destination. It would be reckless for the pilot to head toward Chicago while the co-pilot is determined to head toward Iowa. Perhaps leaders could agree on the overall goals of proposed economic policy for the long term and the short term before proposing specific maneuvers. Is the goal deficit reduction or jobs growth? What tradeoffs are we willing to accept? What is the flight plan—the economic trajectory we are proposing? Is there some set of controls that can be exercised to achieve that outcome for each of the important economic elements? Can we validate our economic proposals before subjecting the citizens to yet another ad-hoc economic experiment?

When a bird strike suddenly stopped both engines on US Airways Flight 1549, Captain Sully Sullenberger drew on his extensive expertise, wisdom, leadership, and courage to calmly and expertly land the plane in the Hudson River. He did not look at a single straw poll; it was a time to rely on a lifetime of experience rather than sound bites. Everyone aboard was saved in the January 15, 2009 “Miracle on the Hudson.” Sadly this contrasts with the tragedy of Colgan Air Flight 3407 which crashed near Buffalo New York when less experienced pilots reacted incorrectly during difficult weather conditions. All aboard were killed the night of February 12, 2009 when the plane stalled and crashed due to pilot error.

Complex systems require expert oversight. We must improve the expertise, wisdom, leadership, and courage of the people controlling our economy.

Perhaps a widely available tax policy simulator—let's call it TaxApp—could help us distinguish fact from fiction. Tax App would do for our understanding of tax policy what spaghetti charts do for hurricane forecasts. Imagine an application for the iPad and other platforms that allows the user to input tax policy proposals and then displays their consequences across the broad economic landscape. For example in simulating a specific proposal to increase tax rates for the wealthy TaxApp could forecast the impact on total tax revenues, deficit over the next 20 years, the amount I pay in taxes, the amount my business pays in taxes, the ratio of taxes collected from business to that collected from individuals, the number of people paying taxes, a profile showing what people at various income levels contribute to the tax revenue, employment levels, the degree to which such a change would be more or less regressive, and other important implications.

The economic models that form the basis for TaxApp could be designed by a panel of expert economists. Just as several different meteorological models each predict a unique path for each hurricane, there might be several different versions of TaxApp, each reflecting differing expert opinions on the most accurate economic model. When a hurricane is about to reach land, we look at each path predicted by the various meteorological models and from that spaghetti chart we can immediately see where the models agree and the extent to which they disagree in their predictions of the hurricane path. Similarly, we can look where the various versions of TaxApp agree and the extent to which they disagree about the impact of various tax proposals.

Hurricane spaghetti models help us understand weather forecasts. Perhaps TaxApp could help us understand the implications of tax policy proposals.
When a hurricane is about to come on shore we study a variety of expert opinions, rendered in the form of the spaghetti chart, to understand the most likely future outcome and degree of uncertainty. With TaxApp we can get similarly important information about tax policy proposals. Imagine a presidential debate where a candidate proposes a specific tax policy change. The moderator, or any viewer, can model that with TaxApp and immediately notice the full range of impacts and implications that policy would have. Specific follow-up questions could then be posed to the candidate. Injecting this level of reality into the dialogue would move us to a new level of understanding.

Generations of aspiring pilots enjoyed testing their skills on Microsoft Flight Simulator. Perhaps a new generation of aspiring politicians, or caring citizens, can enjoy testing their skills as tax policy proponents.

Sunday, August 7, 2011

Earth at One Billion

After a difficult transition the earth finally stabilized at a population near one billion humans. Now we clearly see the benefits and wisdom of this smaller population. It has been many centuries since the earth’s population reached its peak of more than 12 billion people back in the year 2050. Despite the dismal predictions of Malthus at the turn of the nineteenth century, publication of The Population Bomb in 1968 and The Limits to Growth books in 1972 and 2004, we all got swept up promoting the economic growth and relentless consumption that financial systems have relied on for millennia.

But eventually it became clear that Malthus and his disciples got it right. Drought, famine, global warming, overcrowding, deforestation, hoarding, violent conflicts, and depletion of: fertile soil, fossil water, fossil fuels, and essential minerals made it undeniable that we had already exceed earth’s ecological limits to growth by the beginning of the 21st century.  In addition economies at the personal, regional, national, and world levels were relying on increasing and crippling quantities of debt. The bubble finally burst, we finally got the message, and something had to be done. Enough!

Political, religious, business, and community leaders agreed to unequivocally advocate voluntary birth control. Many young couples went childless; others had at most one or two children. They spent more time with nieces, nephews, and neighbors. Adoptions, community care centers, and other social arrangements helped ease the loneliness during this difficult time. At the same time people were living longer so it took centuries for the population to decrease. Advances in genetic counseling provide more information for family planning. Now couples typically have two children, and the population is finally stable at a sustainable level.

Transition of the economy was equally essential and difficult. One key was a mental shift that allowed us to realize prosperity as flourishing—enjoying life more—rather than as opulence—buying more things. Eventually we began to see opulence and all of its excess as vulgar and not something to envy or aspire to. People learned to seek more enduring and authentic forms of gratification based on savoring possessions, events, and experiences that provide real and lasting value. A walk in the woods was soon enjoyed more than a trip to the theme park. Durable goods are now built to last by skilled crafts-people, and they are enjoyed for centuries.

Another key to transforming the economy was to fully internalize the various externalities that primitive accounting systems ignored. It had long been recognized that Gross Domestic Product was a narrow and inaccurate measure of productivity and value added. For example, the results of a fatal car accident perversely caused the GDP to increase because the costs to replace the damaged vehicles, hospital expenses, ongoing therapy, funeral expenses, and legal expenses are all counted positively, despite the tragedy they each represent. In addition it ignores the value of natural resources and ecosystem services. Eventually we were able to move to more comprehensive measures of human well-being, modeled after the Human Development Index, the Genuine Progress Indicator, measures of Gross National Happiness, and other measures that began to emerge early in the 21st century.

Because there are now fewer people, each person enjoys a greater share of earth’s bounty. Most of the world has become a nature preserve for all of us to enjoy. Forests cover much of the land, providing habitats to preserve and enhance biodiversity, sequestering carbon, and generating fertile soil. Only the most suitable arable land is used for agriculture, relying on rain water for irrigation and compost for nutrients. The oceans are once again teeming with fully grown fish in every species not yet extinct. Those that are caught represent only a tiny sustainable fraction of those that live and grow. Overfishing has become only a distant and painful memory.

As there were fewer people, the dignity intrinsic in each person became more fully recognized. It was no longer tolerable to watch as a billion people went without clean, safe drinking water, three billion were malnourished, and violent conflicts killed millions. The Universal Declaration of Human Rights finally took hold world-wide, and the rights of each person eventually prevailed over the last strongholds of tyranny.

Because of this bounty starvation has been eliminated, along with most resource conflicts. Peace finally prevails across the earth, eliminating the need for militaries, defense contractors, and so many other defensive drains on our time, energy, and natural resources. Many other jobs that did not add value have been phased out. The tobacco industry finally dwindled away as people became better informed of the dangers of tobacco use. Simplified tax codes eliminated the need for tax accountants, tax lawyers, and the entire tax interpretation industry. Simpler and more just laws reduced the need for lawyers, and reduced the number of people incarcerated. This reduced the size of prisons and the number of police and prison guards needed.

People only need to work two or three days per week to earn the income required to support their families. Most careers are in farming, engineering, teaching, art, and entertainment, in addition to the many hands-on trade and service jobs. Most of us enjoy a healthy balance between work and leisure time, while a few still choose all leisure or all work.

People eat healthier food and live healthier lives—spending more time exercising as a natural part of each day and encountering less stress. This leads to greater fitness and fewer health-related problems, thereby reducing health-care costs.

Education has evolved to become human-centered. We use our educations everyday to live better lives and improve our well-being. Illiteracy disappeared centuries ago.  Open education platforms modeled after Wikiversity and the Khan Academy make vast collections of learning resources freely accessible and are now the widespread norm. Life skills such as emotional competency essential to improving human interactions are now core elements in typical curricula. Developing a robust theory of knowledge allows us to carefully decide what to believe and what to dismiss. Educational institutions have successfully made the transition from imparting knowledge to promoting wisdom. People learn more than facts, they learn what is most important in life, how to become more creative, and how to make decisions that improve their well-being. We are finally learning how to cope with abundance.

The major cities that were so overcrowded at the time of peak population continue to be where most people choose to live. However now that fewer people share the space, housing, and cultural resources of a huge city, there is plenty for everyone to enjoy. Renewed emphasis on placemaking has transformed the cities into safe, comfortable, and intriguing living spaces. Some cities located in earthquake zones were abandoned rather than rebuilt after earthquakes occurred. Of course, many people still choose to live in the surrounding suburbs, and in rural areas. The shorter work week reduces commuting time and expense. Also, high speed rail lines connect each of the major cities allowing safe, fast, comfortable, and economical travel.

Quality of life is finally triumphing over incessant growth.  Virtue is finally prevailing over vice. Imagine!

Note: This fictional story was written for the Wikiversity course "Limits to Growth" to provoke thinking about one possible long-term outcome.

Thursday, March 3, 2011

Spending Strategies

When their grandmother passed away, four young adult brothers each inherited $1,000,000. The funds are each held by the same financial account manager who achieves 5% investment growth each year based on the available principal. Inflation and taxes are both negligible and are ignored in this analysis. The brothers are free to decide how much money they withdraw to spend each year.

Tom is thrifty and decides to withdraw only 4% of the principal each year. He received $40,000 the first year, and the principal continues to grow. After 20 years he has withdrawn a total of $929,568, the principal has grown to $1,220,190 and is still growing.

A graph, showing Tom’s annual withdrawals (shown in blue and scaled by the right-hand axis), the cumulative withdrawals, and the remaining principal (both scaled by the left-hand axis) over 50 years is shown below.

(Click to view full size)
Brother Sigmund was able to defer his spending somewhat, but then needed more money for a period of time. A graph, showing the annual withdrawals, the cumulative withdrawals and the principal over 50 years for Sigmund’s spending strategy is shown below. 

After 50 years he was able to withdraw slightly more than his brother Tom, ($2,644,313 for Tom and $2,667,823 for Sigmund) and the principal has been restored to the original $1,000,000 level. However Tom’s principal has grown to $1,644,632 after 50 years.

Brother Bill spent more than was being earned each year for more than 30 years. A graph, showing the annual withdrawals, the cumulative withdrawals and the principal over 50 years for Bill’s spending strategy is shown below.

Although Bill’s early withdrawals were significantly larger than those of his other brothers, the principal has been significantly reduced and the cumulative withdrawals soon flatten out considerably below that of his thrifty brothers. Note that after 40 years Bill has finally reacted to the diminishing principal, sharply curbed his spending, and the principal is beginning to grow once again. It would take several decades to restore the principal to the original amount at this growth rate.

Brother Ben lives in the fast lane and seems to learn in the slow lane. He spent more than was being earned each year for more than 30 years. A graph, showing the annual withdrawals, the cumulative withdrawals and the principal over 50 years for Ben’s spending strategy is shown below.

He consistently spent more than the interest income, and although at first he may have enjoyed larger income than his brothers, his cumulative withdrawals are the lowest of the four, and the principal is nearly exhausted and almost impossible to restore to the original level.

The following table summarizes key figures for each of the four brothers:

Tom Sigmund Bill Ben

Cumulative Withdrawals after 20 years





Cumulative Withdrawals after 50 years





Annual Income in Year 50





Principal after 50 years





These four brothers have illustrated each of four system behaviors of a renewable resource. Thrifty Tom ensured the outflow—his annual spending—was always less than the restorative flow—the annual interest income. This allows for continuous growth indefinitely.

Shrewd brother Sigmund was able to enjoy an interval where his annual spending exceeded the annual investment income, and because he watched signals closely and reacted quickly, he was able to adjust his spending in time to recover the full principal. The result is an S-shaped growth curve called a sigmoid.

Brother Bill went on a binge. His annual spending exceeded the annual income for an extended period of time. He was slow to react to the diminishing principal, but eventually did sharply reduce his annual spending. The principal can eventually recover, but it will take a very long time. His spending greatly overshot the income but can grow and recover, probably eventually resulting in an oscillation, repeating the overshoot pattern.

Brother  Ben was on a bender. His annual spending exceeded the annual income for an extended period of time. Because he still had money to spend he was so slow to react to the diminishing principal it is essentially exhausted. The overshoot was severe enough that the investment income has collapsed to a point where it may never recover.

System dynamic theory uses the term stock to refer to amount of a resource available at any particular instant in time, and the term flow to refer to the rate of change of the stock of resource. In this simple scenario, the principal is the stock, and it is affected by two flows. The 5% annual investment income increases the stock level and the annual spending, decided by each brother, decreases the stock level.

Tom’s renewable scenario relied on one simple rule: Ensure the consumption flow rate is less than the renewal flow rate.

Sigmund’s more dynamic strategy was successful because he watched the flow rates carefully and reacted quickly to the diminishing stock.

Brother’s Bill and Ben consumed stock in excess of the renewal rate, ignored the warning information signaled by the diminishing stock, and delayed in taking action. The annual withdrawals overshot the system’s capacity for renewal.

Tom and Sigmund both have grandchildren who are grateful for the careful stewardship and enjoy substantial inheritances preserved over so many years. Bill and Ben’s grandchildren are envious.

Pay me now or pay me later, as they say.

Note: This story was written to illustrate several system analysis concepts for the Wikiversity course "Limits to Growth".