In the last part of this series, we explored the implications of the first condition of value creation; irreversibility, and saw how through the production process, humans apply energy to disordered matter and through an irreversible process, create valuable items for consumption. We also saw how trade is an irreversible process. In this installment, we further lay out how the concept of entropy plays a central role in the economic process.
For the introduction to this series, see this article.
The second G-R condition, “all value-creating economic transactions reduce entropy locally within the economic system, while increasing entropy globally” enables us to explain in a deeper way a concept that Frederic Bastiat outlined over a hundred years ago; the broken window fallacy. It will enable us to distinguish the act of throwing the rock through the window from the act of repair it. Any process that creates value must be both irreversible and entropy lowering.
It is fairly obvious, and very intuitive to think about the economic processes that lower entropy. Things like cloth, lumber, crude oil, and iron ore. Even without going into the processes by which each raw material goes through to become an item of value, we understand that there is both physical and chemical energy used in it. Unfortunately, humans haven’t discovered the source of, or how to harness the theoretical “dark energy” that glues the universe together. Although, there is no shortage of people searching for perpetual-motion machines! However, aren’t there economic transactions that involve raising entropy? Like demolishing a building, or making bombs?
In the first example, demolishing a building is very often the first step in the transformation, not the complete transformation, itself. Very few people demolish buildings for absolutely no purpose…even if that purpose is to reclaim the land for building a highway or to return the land to nature. This same argument holds true for waste disposal, environmental cleanup, and recycling…which are all part of a larger transformation. Indeed, Gerogescu-Roegen advocated that production and cleanup be viewed in an integrated fashion. Before your body can create new order in order to sustain itself, it must first break down complex ordered matter (food). As they say, you can’t make an omelet without breaking some eggs!
However, this notion of order can be an ambiguous concept. For example, you spend the night painting everyone in your city’s car pink. Of course, it is very hard to say you created any value — evidenced by the fact that not everyone would pay you for painting their cars, and would likely be very upset. Furthermore, you actually have created a lower-probability configuration of the world. A world in which every car is pink is less likely than the present mix of cars (except in places like Soviet Union, where most of the cars ended up being some sort of beige…as we will see, they were creating very little value!). However, in painting every car pink, you are destroying valuable information — information about people’s preferences, their ease of finding their cars in a parking lot, etc. — and thus raising the total level of entropy in the world. So your charity, it turns out, could actually be an act of vandalism. So did you actually raise or lower entropy?
Well, the answer to that question requires an inertial frame of reference. From one perspective, you may have increased value. Say from a traffic planner — it would make identifying cars very easy. However, from the perspective of the owners of the vehicles, they have probably been made worse off.
The polish physicist Wojciech Zurek outlines this in a very clever thought experiment (von Baeyer 1998) to illustrate the principle of perspective.
A magician shows you a deck of cards; the deck is perfectly ordered by value and suit (the two of hearts is followed by the three of hearts, and so on. Likewise for each of the other suits). The magician then shuffles the deck very thoroughly, completely randomizing it. He then shows you the random deck for verification. Next, he hands you another deck of cars, also perfectly ordered by value and suit, and bets you twenty dollars that you cannot do what he just did. Thinking, “how hard can it be to shuffle a card deck?” you accept the bet and give the neatly ordered deck a really good shuffling. You hand it back to the magician with a smile and await your twenty dollars. But then, looking at the decks, he says “You lost the bet. In my shuffled deck, the order was queen of spades, ten of clubs, four of diamonds, and so on. Your deck looks nothing like mine — you owe me twenty bucks!”
The point of the parable is that any one configuration of the deck is just as likely or unlikely as any other. You have the same odds of shuffling the deck into perfect value and suit order as you do into any other order. What the magician did was pick one particular order out of all possible configurations and called it “ordered” because of arbitrary symbols printed on each card.
Coming back to the example of war, most people would agree that war is value destroying (especially the victims of war)…but are they overlooking something? Indeed, there is a fairly popular argument that a war even pulled us out of the Great Depression! Well, no, they’re not overlooking anything…they are using a different inertial reference frame. There are so many variables in the war calculation that is outside of the scope of this article.
So, low entropy may be necessary for something to have economic value, but defining what kinds of order are valuable and what kinds are not requires an inertial frame of reference — as they say, beauty is in the eye of the beholder. The second G-R condition is a necessity but not a sufficiency for value creation. We must further define preferences.
Even if we isolate this intermediate step, and forget about all others, we would see that local entropy decreases through the employment of capital, labor, and materials…and as the rubble of the building is returned to the environment, universal entropy increases. However, as Bastiat showed in “What is Seen…”, we must take into account other perspectives of value, as well as all of the possible configurations of value creation.