More about efficiency

On facebook, I've been getting some comments that make clear that it hasn't been exactly clear what the devil I meant by efficiency in the last post.

I'm talking about the economist's version. I studied economics, so its natural to me to think of that type of efficiency....but, I should probably have stated my unstated assumptions. They make arguments clearer.

So....what do economists mean by efficiency? I'll illustrate using something they show in first year called the "Production possibilities frontier". (PPF)

In the simplest version, you might have to two types of goods, and you could split your production between them. The wikipedia example that I linked to has two goods, food and computers. Any point on the line represents maximum efficiency.

If you're at point A, you can produce more computers, but at the cost of less food, and vice versa. This is true of any point on the line. Since you're using your resources to their maximum potential, you can only get more of one thing by getting less of another.

If you're producing at a point inside the curve, then you can get more of both, just because there is still room to be more efficient.

A couple of notes about the PPF. First, the curve is curved because of declining marginal productivity. In other words, we start producing food on the best agricultural land, with the best farmers. If we keep trying to produce more food, then eventually we have to use land not as suited for farming, and take labourers who are better at making computers and worse at making food. So we have to give up more and more computers to produce less and less food.

Second, economists generally shy away from saying how we should allocate resources between the two resources; they leave that one up to the politicians. But if you say you want 75% food and 25% computers (or vice versa), then they do say that you ought to produce those in the most efficient way possible (ie. on the frontier, the line).

In the real world, economist's say that we should strive to be somewhere on the line. They don't have an actual PPF curve for the whole economy, but the theoretical concept applies. Inefficiencies in production anywhere or anyhow mean that we're producing "inside the cuve" or "getting less production than we might have gotten for the same inputs".

This is the rationale behind most contemporary economic commentary, which is why I've chosen the PPF as an example.

Any lack of free trade means that we're producing somewhere inside the curve. We can have more food, and more computers and more stuffed teddy bears for that matter by using open global markets. We reduce inefficiencies and move closer to the frontier of maximal production.

But notice there's no temporal aspect to that curve. It's talking about maximizing efficiency in the present. This is generally what economists mean as well. If, in the future circumstances change that change our production possibilities, well, then our production possibilities will change.

Ta-da! Economists generally talk about these changing circumstances as if there is no problem, because we will find a way to adapt, somehow, and in any case under the new production constraints we can and should still produce in some maximally efficient way at the production possibilities frontier. This is the core of my disagreement of the concept.

I'll use an example to show why this is problematic. Imagine some people on an island. It's a closed system, isolated from the outside world. There is no foreign trade, which is true of our world as a whole as well (we don't import or export to Mars).

Let's say we have two production possibilities: Giant statues, and food. The inputs for both of these things are labour and wood. Labourers carve giant statues in a quarry, then wood is needed to transport them to where they will be displayed. Farmers farm food on land, but they also get lots of fish and other food from the deep ocean. To do this, they need wood from large trees with which to build ocean-going canoes.

Things are going well for the Islanders. They have become pretty efficient. The island now works as a unified whole, producing more food than ever before. This unity has not only facilitated canoe building and fishing, but also allowed improved land agricultural productivity and irrigation systems. The islanders are also able to build lots of giant statues to thank the Gods for their plenty.

The islanders have enlarged the carrying capacity of their island. Previously, it could not have supported such a high population, but now, thanks to their efficient allocation of resources, it can, which also means more skilled labourers to make better statues, and more people to take canoes out to fish the deep. The population has expanded to the extent that can be supported by the increased resources, and living standards have risen as well.

Yay!

There is just one problem: the island is running out of trees large enough to build canoes or move statues. Trees take a while to get that large. Maybe someone notices the problem, and suggests that the islanders cut down less of them. But the island is already near maximum efficiency. So to do that would mean either less statues (which offends the gods), or less food (which means people starve and get angry).

Either possibility is unacceptable. So the islanders keep cutting down the trees, until they run out. They are then unable to get food from the deep ocean, or move their statues. So, they have a new production possibilities frontier. No statues can be made, and much less food can be produced. "Since circumstances changed that changed their production possibilities, well, then then production possibilities will change".

So now, a good economist could say, all these islanders have to do is keep on producing at the edge of this new new PPF, and they will have the most efficient allocation of resources possible. They can adapt to their new circumstances.

Unfortunately for the islanders, in this case adaptation to the new PPF means starvation. They run about smashing statues, cursing the gods, fighting wars, and so on until the population has been greatly diminished to match the new PPF.

The island was Easter Island. This silly story actually happened.

They were an isolated, interconnected system, as our planet it today (we don't import much from the Moon). Population and living standards had risen to match the maximal production of the system, which was attained by producing at the production possibility frontier. In our case we've matched our expectations and needs to the expansive production enabled by our enlarged PPF.

You might contend that we wouldn't be so stupid as a bunch of isolated, primitive pacific islanders who cut down all of the trees upon which their sustenance depended. If so, you ought to pay attention to the news about climate change and the political response. Or you could note the fact that most of our transport and agricultural system are based on oil inputs (including fertilizers and pesticides). Oil is technically a renewable resource, like the trees.

But, like the Islanders, we're using it at a rate far above it's replenishment rate, and ignoring the fact that we don't seem to have any replacement that can keep our productivity similarly high. If and when production peaks and it becomes more expensive, this will reduce our PPF.

This is a problem because we have been producing things as efficiently as we can, and increased our population and living standards to match our expanded PPF. So, we have few redundancies or slack in the system to help us if we are no longer able to produce at such a high rate, much like the Islanders.