Nothing has successfully updated the science underlying free market economics since Adam Smith introduced the Law of Supply and Demand in 1776. A physicist and a psychiatrist have put together their different, problem solving experiences to challenge the antiquated, economic status quo. The result is Economic Science 2.0.
Failure to predict and resolve the financial collapse of 2008 created a worldwide crisis of confidence in capitalism, and its economics. Business and economic leaders argued against government intervention, as violations of their faith in the natural protections of a free market and its ‘Invisible Hand’. Obvious signs of the incomplete recovery that resulted, combined with worries of re-collapse, must unnerve anyone in 2016 who is paying attention.
Adam Smith presented his Law of Supply-and-Demand in the spirit of Isaac Newton’s Third Law of Action-and-Reaction. Smith’s economics pictures itself as a circular-flow system of exchange resembling a Newtonian planetary system in perpetual motion, except that motivation, not gravitation drives an economy. We offer our economic “re-boot” in the light (and the heat) of 19th Century, Thermodynamic Science, as well as of 21st Century, Information Science, among other reasons to solve the motivation problem.
Our revision begins with the recognition that Smith’s economics is a theory of price not profit, in which competition among Sellers produces an equilibrium of stable pricing, as near as possible to breaking-even. Profit exists only as pricing inefficiency, because profitability requires prices higher than breaking-even. Smith’s economics thus ignores that maximum profit is the espoused and legitimate motivation of business life. Thermoeconomics resolves this illogical, price-versus-profit “inner conflict” that attacks the heart of our competitive, free enterprise system.
In contrast to perpetually repeating, Newtonian motion, thermodynamics (the science of heat and fuel) describes the irreversible, one way motion of heat across a temperature gradient. Heat flow in an engine may accomplish work, but always also dissipates a quantity of waste heat measured as “increasing entropy”. Cash flow from a hotter Buyer to a cooler Seller may similarly accomplish economic work, which if successful produces profit, which is mathematically related to increasing entropy. Supply-demand economics seeks an equilibrium state of stable prices; thermoeconomics regards equilibrium as a state of financial heat death, and an object of dread. The implication: profit is better treated as a waste product than as a magical fuel. Failure to treat profit as entropy produces thermofinancial equilibrium states, such as the crisis of 2008.
The authors offer insights, examples and solutions that are both surprising and obvious; surprising, because they uncover new information without requiring new data, and obvious, because their explanations directly match commonsensical as well as scientific understanding.
Moving from the Supply-Demand theory of price equilibrium to a Buyer-Seller theory of a profit motive explains why austerity measures obstruct recession recovery. Thermoeconomics also suggests a self-regulating Non-Value-Added Tax to mitigate bubble-bursting dangers caused by profit prestidigitation disconnected from value generation. Understanding profit’s connection to entropy will empower the management of resources to benefit all of society, without impairing innovators and entrepreneurs.