How economies fail – More from Jane Jacobs

How do you know that an economy is healthy? The standard answer to this seemingly simple question is: It grows! While growth is an important hint at economic success, making it the only indicator would be far too simplistic. But instead of searching for the one perfect signal of economic success, I suggest a comprehensive review of the different ways for an economy to fail: acknowledging what can go wrong in an economy thus becomes the starting point for a more nuanced and realistic picture of economic health. Today, I want to frame such a picture.

A short while ago, I took a deep dive into Jane Jacob’s seminal work on the ‘Nature of Economies’, in particular her account of how an economy works and what that can tell us about innovation. In summary, three main ideas stand out:

• According to Jacobs, an economy is a complex adaptive systems that runs on three main processes: development (how it responds and adapts to change; that’s the economy’s capacity for innovation), expansion (usually referred to as growth), and self-maintenance (how the economy re-fuels and keeps itself going). All three occur in parallel in a delicate balance, depending on ever-changing circumstances.
• Implicit to Jacobs’ process descriptions is the concept of economic fuel that drives these processes: this includes not just physical energy (what we can easily measure in kilowatt-hours), but any other resource we could use, such as raw material, human skills or talents, as well as information and knowledge. The three main processes are in competition over the limited economic fuel available.
• Derived from Jacobs’ concepts is the idea of three innovation targets: the supply, the distribution, and the use of economic fuel. In particular, the distribution of economic fuel across the three main processes presents a tricky and dynamic balance, as fuel supply and fuel use are subject to constant change. To make ends meet, attention to all three of these targets is essential.

If you think about the three main processes and their competition over the limited economic fuel that is available, it seems like a miracle that an economy could prosper at all, despite the many different ways in which it can fail if it denies any of these processes the fuel they require. Understanding an economy’s potential failure modes is the first step to avoiding them:

• • Whether they are short-term or long-term: short-term success does not guarantee long-term survival, and focus on long-term sustainability may well jeopardise success in the short-term ;
  • Whether they affect only the economy itself or the wider habitat: paying attention only to the immediate needs of the economy might seem like the easy path to growth and prosperity, but ignoring the health of the habitat undermines the sustained success of the economy ;
  • Whether a shortage of economic fuel is only local or truly global: a local shortage could occur even if the global supply is sufficient; in that case, a more efficient distribution could avoid local economic failures ;
  • Whether the failure causes only a partial shrinkage or the ultimate disintegration of an economy: shrinkage of an economy is not automatically the beginning of its ultimate demise; such a reduction might occur locally and only temporarily and could actually be a strategic choice in cases when significant challenges absorb considerable energy for the development process.

Understanding these and other failure modes can serve as a sound basis for targeted innovation efforts: to solve an economy’s problems, to ensure its short-term health and to promote its long-term sustainability. I believe there’s some useful policy advice to be found in this abstract picture of economic health.

More to follow in an upcoming post.