Chapter 1: The Scarcity Paradigm

Take a look at the world we live in - the internet, AI, smartphones, airplanes, satellites, skyscrapers and the rest of the marvels of modern life. All these were completely alien to our great-great-grandparents. Yet, we do not have any more resources than they did. Come to think of it, we don’t even have more resources than our Stone Age ancestors. The amount of resources on earth simply didn’t change since the dawn of humanity. Perhaps we have a bit more meteor dust, but that’s about it.

With the same resources as our Stone Age ancestors we were able to create everything we see in the world around us today. What sets us apart from our Stone Age ancestors however is not the amount of resources we have but how we use them. We use the same resources much more efficiently.

We as humans are innately curious. We want to explore. Learn about the world around us. Tinker. Try new things. Go where no one has gone before. Leave our mark on the world. This intrinsic motivation propels us forward. A fitting name for the first economic paradigm that drove human progress could therefore be the Curiosity Paradigm.

It is easy to imagine how thousands of years ago progress was made toward where we are today through this Curiosity Paradigm. Over time we learned more about the world around us. We learned about the properties of materials, about agriculture, engineering, extraction and refining techniques, and so on and so forth. By putting this knowledge into practice we progressively used earth’s resources more effectively.

This paradigm held for countless millennia. But over time things got more complicated. And troublesome. Our knowledge increased, technology progressed, human communities grew, and so did the need for more advanced tools. But curiosity alone was not enough to produce these tools.

If you only need one person to produce a tool then not much is required for economic activity to take hold in a community. It’s really quite simple. People in such a community can just barter for goods directly. Alternatively, they can record a debt every time they provide a product or service to someone else. Later on, when the other person provides another product or service of comparable value in return, they can cancel the debt.

Personal debt recording meant that everyone in the community had to know each other in person. If people bartered that too could work. It was simple enough to practice reciprocity in a small community or village. But bartering or using personal debt couldn't work on a larger scale or in a complex economy. Doing so could grind such an economy to a halt.

The question though is how do you practice reciprocity at greater scales? Or, what happens when more people are needed in the chain of production? When you need some people extracting materials, others refining them, yet others fabricating different parts of a tool?

The more complex the tools get the better we need to coordinate people's production efforts. Intrinsic motivation just isn’t enough anymore. Bartering or recording debts also doesn’t scale.

Charismatic leaders could maybe inspire people to work together, but that too can only take you so far. Such leaders could motivate a small tightly-knit group to produce goods for their community but not much beyond that. And certainly not for prolonged time periods, that simply wouldn’t work. After all, people need to satisfy their basic needs. If their work doesn’t help satisfy those needs, they will eventually abandon it. Or worse – rebel.

Perhaps another option is to install a powerful dictator to oversee and micromanage every aspect of the chain of production. But then you'd need a centralized authority to identify every process, component and subcomponent that needs to be produced and to command their production. And since there is no effective incentive structure for people in such a system the task for the dictator would be overwhelming. You'd need people to perpetually monitor any slack throughout the network. You can hope that people are motivated to produce from their intrinsic motivation, but what if they lack such motivation? What if they don't see the benefit of producing or innovating?

Without having an economic incentive to do so you'd need the dictator to perpetually go through every part of the chain and force people to produce more, to innovate, to fill any voids in the system. And that's just for one product. Imagine the dictator having to do this for every product in the economy. That doesn’t sound like a very lucrative job.

What’s worse, the number of people needed to run such a bureaucracy would likely eclipse those who actually do the work. It would simply be impractical if not impossible.

* * * * *

Every society, in every time period, has its share of realists and of idealists. Everyone else falls somewhere on the continuum between these two extremes. Idealists focus on what is possible. On what can benefit the common good and make the world a better place. They are driven by curiosity, and less concerned about their own economic interests.

Realists on the other hand focus on what works. They want to understand how the system functions so they can make the most of it to benefit themselves and their families. They are less concerned about the world and believe that if everyone focuses on their own business other problems in society will take care of themselves.

The economy needs both types of people to move forward. Without realists nothing will work or get produced. We’d just have a society of utopian dreamers where little gets done. Without idealists society would stagnate. Nothing new or exciting would ever get created. Nothing would change. When both realists and idealists work together, society can be productive and innovative at the same time.

But what happens when the gap between what exists and what is possible is too great? When what works falls far short of what is possible, but no one knows how to get what is possible to work? When economic self-interest and the common interest diverge. That is when tension between realists and idealists starts to grow. Instead of working together they’re in conflict with each other. The way to resolve this conflict is to find a way to bridge between what works and what is possible with a new paradigm.

Through the Curiosity Paradigm society managed to produce complex tools with the same resources as their Stone Age ancestors. But the same economic paradigm that led to this social and economic growth now began to show signs of strain. To satisfy their curiosity and needs people needed more advanced tools. They had all the knowledge and resources to produce these tools. They just didn’t know how to get people to work together and produce the tools efficiently.

Just like resources were scarce, so was labor. But human wants remained unlimited. And so, a new economic paradigm was needed. A paradigm for scarce resources and scarce labor – a Scarcity Paradigm.

The historic record remains silent on how bad things got before this new paradigm emerged. Was there much societal strife? Were the realists and idealists at each other's throats? Did previously peaceful communities start to fight over resources or subjugate parts of the community? Did strongmen arise to quell the unrest? Or perhaps the transition was seamless. Maybe this new economic paradigm emerged before society turned on itself. We simply don’t know one way or another.

The historic record shows that a Scarcity Paradigm did emerge however, and it was made possible thanks to the introduction of money as a medium of exchange.

What in the world is a “medium of exchange”? A simple way to think of it would be the following: if we take any two scarce products in the economy we can determine an exchange rate between them (i.e., 3 apples for 7 potatoes, 20,000 apples for a car, and so on). We can then conceive of a common denominator that all products and services in the economy can be measured against. This denominator can be used as a unit of account throughout the economy.

What then would make a good medium of exchange? At the most basic level, it would have to be scarce so that it can correspond to the economy’s unit of account. After that it would need to have properties that allow it to facilitate exchange of value in the economy; it would have to be easy and convenient to transact with, portable, divisible, durable, and interchangeable. Obviously it should also be difficult to counterfeit.

Anything could theoretically be considered a medium of exchange – just not necessarily a very good one. But the more closely a medium of exchange follows the criteria described the better it would be in facilitating trade, and therefore the better it would be for the economy.

Money allowed us to replicate what worked in small communities and villages but much more efficiently and on a greater scale. It also allowed us to scale reciprocity beyond village relations.

In the village people reciprocated in the goods they provided to each other. But there was no general agreement on the value of any good, and therefore no easy way to tell which goods have demand in the village. Individuals could exchange goods if they mutually agreed the goods were of comparable value. Or, if people knew each other well they could record a debt for a good and be compensated at a later date.

The new economic paradigm created a dynamic where value could be assigned to goods throughout the economy. What determined the value of a good in this system? Their relative supply and demand. The more demand there was for a good the more it was valued – and vice versa. Conversely, the more scarce the good was – the smaller the supply – the more it was valued.

With money you could scale reciprocity. Instead of exchanging goods directly, you could use money as a medium of exchange. Anyone can reciprocate for a good with money, even complete strangers. Especially complete strangers.

People could exchange the products of their labor for money, which in turn gave them access to the products of other people's labor. This meant that if they wanted access to more products, they simply needed to produce more goods that other people wanted. And so, access to goods was linked to productivity. Which meant that people could be incentivized to produce based on their own economic self-interest.

The Scarcity Paradigm could also determine what people valued, at scale. Based on the demand for different goods in the community, producers could calculate their expected return from producing the goods. They could then figure out how much scarce labor and resources are needed for the production of different goods. The incentive to produce what people valued then led to more efficient allocation of scarce labor and resources.

So the new economic paradigm helped determine what people valued, and allowed complete strangers to transact. It thus drove greater economic activity than was ever possible before. But how could this paradigm solve the problem of getting large groups of people to work together and produce complex tools?

Since the paradigm created an incentive structure based on economic self-interest, people were motivated to produce whatever there was demand for in the market. But demand for a product didn’t just mean demand for a final consumer product. Any producer in such a system could now simultaneously act as a consumer. A consumer of what? Of the products from the previous stage in the production process. Then the producers of the previous stage could likewise be consumers of the products from the stage prior to that, and so on.

This meant that no matter how long or complex a chain of production got, you could always subdivide it into smaller units, and each stage of production could then be the consumer of the products of the previous stage. The laws of supply and demand applied in each stage of the production process.

In theory, such an organization structure could work as long as the process was additive; as long as the producers in each stage could sell the products of their labor for a higher price than what they paid for the inputs to their work. If the same was true in each stage of production, you could then have a well-functioning chain of production.

What’s more, this process had effective feedback loops to drive improvement and innovation. The process was self-correcting. As long as there was an opportunity to make money by improving any stage in the production process, there would be entrepreneurs who step in. On the other hand, if producers at any stage were doing a subpar job, there would be competitors wishing to replace them.

If a work post was necessary for the production process but the compensation was inadequate fewer workers would apply for the position. As the employer was willing to pay more, demand for the position increased.

Likewise, people had the economic incentive to acquire the knowledge and skills needed to be a part of this process, and to meet the demand for the skills needed in the market. The paradigm thus not only used existing scarce labor and resources effectively, it also motivated people to acquire skills, and to be productive and entrepreneurial, thus making the system more efficient as a whole.

* * * * *

The principles that applied thousands of years ago to a relatively simple chain of production involving a dozen people also apply in the modern world. The difference is that now our supply chains can involve hundreds of thousands if not millions of people.

Think about how many people are needed to produce something like a smartphone. You need people working on the software, hardware engineering, R&D, testing, quality control, procurement, assembly, manufacturing, logistics, sourcing, all the way down to raw material extraction. And that's only a fraction of the processes.

Components have subcomponents that people need to engineer and manufacture. Office buildings need to be designed and built. Factories need to be configured with manufacturing equipment, which also needs to be engineered and produced. Personnel need to be educated and trained. Manufacturing and extraction techniques need to be developed and refined. Material properties need to be researched. You also need to develop redundancies, alternative production methods and component suppliers, and so on. Because if any link in the supply chain is broken the product cannot be manufactured properly.

On top of that the production process cannot stay still. Every aspect of the network must continually improve. The process has to respond to consumer needs, to competition with other producers, to availability of materials, and to labor conditions.

While our chains of production grew exponentially over thousands of years and became vastly more complex, the underlying dynamics of the Scarcity Paradigm remained the same.

Does that mean that our economic system hasn’t changed in thousands of years? Of course not. As the Scarcity Paradigm emerged thousands of years ago we only had a vague notion of what money is and how it could be used. It took hundreds if not thousands of years of trial and error to get marginal benefits from it. But over time our understanding of the system grew and our economic outcomes improved. Though our economic system surely advanced over the years, the principles at its core remain the same today as they were thousands of years ago.

Every individual in the system is still motivated to produce, innovate, and work with others for a common economic goal. While some of the people in the network may be doing their job because of some higher purpose, many of them do so simply because the money they get lets them feed their families and gives them access to resources.

Every stage in the vast supply chain still uses as inputs the products of the previous stage. It then produces services and products to be used in the next stage of production until a final product is sold to customers. The process still needs to be additive, and the return from each stage is still determined by market forces. The system’s feedback loops work the same as before also, but now they apply to vast networks and to millions of people.

What makes this approach so powerful then is the fact that it is scalable. It creates reciprocity at scale. It can thus coordinate the actions of thousands and even millions of people. It results in a vast self-assembling network. A network that can also self-correct in response to changing conditions.

And what works in the formation of one product network similarly works for the production of any consumer good or service throughout the economy — no matter how big or small.

The mechanism therefore not only coordinates the actions of millions of people in complex networks in society today, and is responsible for all the prosperity we have today, but also promotes the efficient allocation of scarce labor and resources throughout the economy. This is what makes money the most effective coordination mechanism on the planet.