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Monday, April 13, 2015

Economics as a Hard Science

Creating wealth is reckoning with entropy

Economics — the application of scarce resources to productive ends — is generally considered a “social” science. Such classification leads many to presume that the “laws” of economics are social conventions and therefore mutable. But is economics entirely a soft science?

It’s certainly true of some branches of the discipline, such as behavioral economics. A lot of the macroeconomics that goes into setting modern fiscal and monetary policy is contrived by humans and therefore subject to the vagaries of human behavior.

But at a more fundamental level, the laws of economics rest on a foundation that underlies and defines elemental structures inherent in our universe. At that level, economics becomes a “hard” science. Its laws and principles take on the immutability of the laws derived from the observations of natural science.

Understanding the difference between those laws of economics that are “hardwired” into our universe and those that derive from human behavior is fundamental to effective social policy. The latter may be subject to legislative manipulation; the former are not. Too often, policymakers who do not understand the difference try in vain to alter the nature of our universe. And then they wonder why their policies don’t have the intended effect.

Material order

At a fundamental level, all the natural resources at our disposal have this in common: they represent material order — that is, specific arrangements of atoms and molecules. When we speak of the “scarcity” of factors of production, what is fundamentally scarce is the quantity, type, and distribution of material order around the globe and in the universe writ large.

Material order is the phenomenon termed entropy enshrined in the second law of thermodynamics, which prescribes the interaction of energy with matter to effect the dissipation of the universe. Economic scarcity is a manifestation of the second law’s observation that the amount of material disorder in the universe is continuously increasing.

If standard cosmology is true, it all started with the big bang, which saw the entire universe usher forth from a singularity. Just prior to the big bang, that singularity embodied a universe with exactly zero entropy, because in that moment, the universe was also perfectly ordered. With the big bang, a concentrated stream of energy rushed forth, forcing the expansion of space and the progression of time. The universe was no longer ordered perfectly within a single point of infinite smallness. The entropy of the universe had increased. That, in a nutshell, is the second law of thermodynamics: the total entropy of the universe is constantly increasing due to the natural dissipation of universal order, a dissipation that so far appears to be unceasing.

The math describing the second law quantifies entropy as an inverse measure of order, such that something with low entropy is more highly organized. Pure water has less entropy than contaminated water because it is pure. There is a greater degree of order in the uniform arrangement of pure water molecules that is perturbed by the introduction of even a single molecule of contaminant. As dirty water is purified, its order increases and its entropy decreases.

Water, however, does not purify itself in isolation from the rest of the universe. Rather, a universal thermodynamic “price” must be paid to reverse “localized” entropy and create order.

Wealth and the thermodynamic transaction cost

Fast forward from the big bang several billion years, until right around the time certain organizations of particles in a remote arm of the universe became sentient (read: our ancestors). Compared with the zero-entropy singularity, the universe had become decidedly more disordered. Still, until that point, the propagation of energy and matter through the still-expanding universe was unaltered by the concerted action of any particular organization of conscious particles. With human consciousness, however, our organized particles (brains) discovered meaningful ways to affect both the direction and magnitude by which the universe’s entropy would continue to increase. We did this quite selfishly,  to improve the order inherent in our own particles. We did it not only to forestall death, but to improve life. We started to become wealthy.

Human activity is all about affecting the magnitude and direction of the universe’s entropy budget — creating localized disorder or order that improves our well-being. In this sense, wealth represents our ability to manipulate material order in ways that enhance human well-being. Even self-organizing systems still operate within the constraints of universal entropic processes. In the material world, think of crystal formation; in the social world, think of Hayekian or Bejanian processes that lead us to ever-more-optimal applications of energy to the localized reversal of entropy that we term “wealth.” Both must still obey the constraints of the second law.

Consider, for instance, early man’s discovery of fire. As it burns, densely packed and highly organized molecules in wood are expelled as chaotic and highly disorganized gases. In the process, we feel heat, a form of energy. The thermodynamic phenomenon we have termed “heat” is simply the result of material order giving way to disorder, which makes heat the means by which the entropy of the universe increases. Early man used fire to generate heat, preserving and improving the human condition, and in the process began accelerating the rate at which universal entropy was increasing.

On the other hand, most modern economic activity is about the localized reversal of entropy. Consider, for instance, a modern loom. The loom more perfectly organizes the atoms and molecules in fibrous strands to produce woven fabric, useful for all sorts of products that increase human welfare. To create this local order, we harvest and combine resources — but we don’t get the increase in order for free. The total entropy of the universe must constantly increase. So we expend energy and expel heat to produce the materials that get ordered into a functional machine, which expends more heat to weave the threads into a fabric.

The key word is total. For any act, we can break this total into two parts: Stotal = Sact + Srest of the universe. By acting economically, we accumulate order and so Sact is less than zero. But, total entropy has to be greater than zero. So Srest of the universe has to be a number greater in absolute value than Sact is negative. Heat is the means by which Srest of the universe is a positive value.

And that is the key point. The expense of heat is the thermodynamic transaction cost exacted in order to accumulate material order, or wealth. Every product of man is the result of using heat to affect the overall rate at which universal entropy and therefore disorder is increasing, so that we may accumulate some lesser amount of desirable material order for our localized benefit.

Entropy and effective economic policy

The overarching implication of a thermoeconomic approach to wealth creation is that, at the level of society and social policy, the unguided evolution of norms and self-organizing institutions represents incremental societal movement in the direction of reaping maximum localized order (wealth) from minimized energy expense and disorder creation. Social orders may spontaneously evolve in the direction of improved ability to produce localized material order with minimum increases in entropy and energy expenditure. But as long as we are living in an expanding universe, the increasing well-being of humans that results from the material order that we term “wealth” must come with an entropic price tag.

For instance, in thermoeconomic terms, resource efficiency is an indication of the amount of local order accumulated relative to the heat expended for the effort. Market equilibria therefore represent the application of dispersed data to resource-allocation decisions that minimize our total entropic footprint during the pursuit of human well-being. Policies or systems that suboptimally allocate resources invariably achieve lower local order for higher levels of heat (energy) expenditure. Energy markets in particular need proper signaling mechanisms to indicate the relative abundance of useful order. Mandates and subsidies for particular types of energy corrupt these mechanisms, lowering efficiency by drawing material order away from those uses inherent in the state of minimum-entropy economic equilibrium.

Another thermoeconomic implication of entropy is that the greater the amount of localized order created (that is, the greater the quantity of goods and services produced), the greater the amount of energy needed to maintain that order against natural entropy. Bananas spoil. Wood rots. Our most durable edifices eventually crumble. When our politicians create order by dedicating available resources to build a road, they also obligate future expenditures of energy to maintain it.

Likewise, thermoeconomics limits our ability to store wealth for future consumption, as every store of wealth eventually dissipates. In that sense, all savings are ephemeral and all consumption is relatively immediate. Financial wealth merely represents a derivative claim on real wealth and the ability to exercise time preferences in our consumption. Whenever we promise the ability to consume in the future, whether the promise is made “to ourselves” (Social Security and other pension plans) or to future generations (529 college savings plans for our grandchildren), we are in fact promising some future expenditure of energy to create future order. The order we have today will be gone by then.

Or consider the eventual need to harvest material order from sources beyond our own terrestrial sphere. Without creating policies that will incentivize our species to identify nongeologic resources, we must eventually reach an equilibrium point between the cost of maintaining our existing order and the thermodynamic “revenue” that we can harvest from the sun, or from the accumulated store of capital embedded in the earth.

The Promethean fire

Modern economic activity is more complex than the fires burned by primitive man, but that activity still hinges on the thermodynamic fundamentals of heat and entropy. Economics at the foundational level of scarcity is hardwired into the universe through the second law, which requires that order accumulated during the pursuit of happiness must be offset by the generation of some greater quantity of disorder. There is, after all, no such thing as a free lunch.

  • Karl Borden is professor of financial economics at the University of Nebraska-Kearney and a serial entrepreneur with 11 successful business start-ups to his credit.

  • Dr. Jacob R. Borden is assistant professor of chemical engineering at McNeese State University.