Chapter 2: The Problem with Markets

The economic paradigm that worked so well for thousands of years is now starting to fail us.

Once again we seem to be facing a familiar challenge, but this time it is on a much greater scale. Our knowledge is increasing, technology is advancing, human societies dominate the planet, and yet we don't seem to know how to coordinate our efforts at the scale we need. Nor do we use labor and resources as efficiently as we could.

The gap between what exists and what is possible is growing. We have all the resources we need to create the conditions for human flourishing, yet the results we get fall far short of our potential. Instead of creating abundance and prosperity our paradigm now creates conflicts and crises.

We have social networks with billions of users, but instead of getting more empathy and understanding between communities, society is polarized like never before. We have greater access to information than at any time in our history, but instead of having an informed populace we don't know what news sources we can trust. On top of that, science, news media and democratic institutions are facing an unprecedented crisis of trust.

Automation can potentially create incredible abundance in society, yet we’re weary that it will create mass unemployment and lead to economic collapse. AI is getting closer to providing humanity with access to superintelligence and greatly extending our capabilities, yet we fear it could subjugate or destroy human civilization.

What's worse, we can't say that these fears are unwarranted. Such scenarios are not improbable given the current dynamics in our economy.

But how did we get to this point? If the Scarcity Paradigm brought with it the most effective coordination mechanism on the planet, why are we again in a situation where we cannot coordinate scarce labor and resources at the scale we need? Is the Scarcity Paradigm nearing the point where it can no longer drive human progress? Or worse, is it starting to undermine it?

The problem lies with two fundamental and interrelated flaws of the Scarcity Paradigm. These flaws were always a part of the system. The difference is that previously their effect was marginal. In the digital age their effect is growing exponentially and becoming substantial. Maybe even overwhelming.

What are these flaws? Why are their effects so different in the digital age? The main flaw in our economic paradigm is that while there is an effective feedback loop in the market for the creation of products and services, no such effective feedback loop exists for how these affect the rest of society. There is no effective feedback loop to incentivize creating public goods or to disincentivize creating negative externalities.

What does an effective feedback loop look like? We need to look no further than the supply and demand of goods and services in the market. If you have a product that benefits customers they would buy it, and you would get money in return. You can then use that money to produce more of the product and sell more of it to customers. If on the other hand the product you’re trying to sell harms the customers, they wouldn’t want to buy it. If customers don’t want to buy your product you don’t get money for it, and then you won’t have the funds to produce more of it. Producing a good that more people want, or that people want more of, results in greater returns. So producers are always incentivized to improve their product and to make it attractive and valuable to more customers.

This is a basic feedback loop between consumers and producers that incentivizes creating the products and services that the consumers in the marketplace demand. If there is more demand for a particular product this incentivizes producers to put more resources into making more of that product. Resources and labor are then allocated throughout the economy based on the demand for various goods by the population. We’ve already seen how this mechanism is capable of producing coordination between millions of people in incredibly sophisticated supply chains.

Notice also that the feedback loop is intrinsic to the process. It doesn't require any person, organization or government agency to track how much customers like products and then reward or penalize producers accordingly (or anything of that sort). Such a process would be too cumbersome. It would also likely require an incredible amount of resources, making it extremely inefficient. But there is no need for any of that. If consumers and producers use money as a medium of exchange, the feedback loop works automatically. And so we have an effective feedback loop for products and services in the market.

The problem though is that what goes into the production function is more than just the feedback loop between consumers and producers. It also includes the feedback loop for what harms society (aka negative externalities) and the feedback loop for what benefits society (aka public goods). When a producer decides on what to produce they need to take into account all of the above.

Let's imagine then what would happen if there were an effective feedback loop for all of these. How would a producer decide what to produce?

First the producer would consider how they can maximize their impact on society. Then they would look at how to avoid harming others with the product. By taking these into account the producer would be able to get the most return for their work.

If the producer creates a good that has a greater impact on society they would get a bigger return. This would incentivize them to invest in ways to benefit society even more. Conversely, if the good has a minimal benefit to society the return will also be proportionate.

On the other hand, if a good harms society. If it results in negative externalities, the producer would suffer losses. This would incentivize the producer to do their utmost to eliminate the negative externality so that they can recover their losses. With more harm to society the producer will suffer greater losses, thus increasing the urgency to eliminate the harm.

Then, after taking into account the feedback loop for products and services in the market, and the feedback loops for impact and harm to society, the producer would come out with a good that minimizes harm to society, maximizes impact and benefits customers.

At least this would be the case if we had effective feedback loops for public goods and negative externalities. We don't.

Instead we only have an effective feedback loop for products and services in the market and no effective feedback loops for public goods or externalities.

There is no real incentive to maximize impact on society since doing so gives no economic value to the producer. Meanwhile, not only is there no benefit to not produce externalities, but there is an economic incentive at times to produce those. By offloading costs onto the public or the environment, the producer can lower their own production cost.

Does this mean that there is no benefit at all for contributing to the public good and no detriment to creating externalities? Certainly there may be some social benefits to public goods (and cost to externalities). A producer may build their brand or get public goodwill for producing public goods. Their brand may also suffer for public harm. But then this becomes a question of perception; how good the producer is at advertising their supposed virtuousness, and concealing their vice? At the end of the day the producer will have to decide if the economic benefit outweighs the social cost.

Too often it does. Especially when the producer purposely antagonizes one group of people to gain favor with another. This strategy works because a producer does not need every single person on earth to buy from them. It’s enough to have a large base of support. Antagonizing others can galvanize such support and bring more sales. This is yet another example of negative externalities; using divisive messages to polarize people for economic gain.

Of course not having effective intrinsic feedback loops doesn’t mean that there are no feedback loops at all. The main mechanism we have to incentivize public goods production and disincentivize externalities is government. Government can fund projects that are in the public interest, and can penalize companies for public harm or environmental damage.

How effective is government at doing either is questionable. What is clear however is that government is extrinsic to the process. It requires bureaucrats to track how much damage a company is doing to the environment, or analyze the expected impact for funding any given project. These things require resources and labor. The more complex the economy is, the more resources government requires to regulate it. Such a process is thus inherently inefficient.

At the same time government needs legitimacy from the public to operate effectively. Without legitimacy the public would want to curb the government’s ability to fund projects or regulate businesses. This would weaken the already fragile feedback loops that we have.

And this is without even considering that government has its own set of problems, both internally and in relation to the market; the bureaucratic process tends to be inherently inefficient and wasteful. Depending on how government is structured, and whether it has effective institutions to maintain a balance of power, it may lack legitimacy from the people, which would in turn affect people’s confidence in how government funding is allocated or how fairly industry is regulated.

Elected officials also have perverse incentives in funding distribution. Instead of considering what would be most beneficial for the people in the long term, they may favor their allies and supporters or benefit their near-term reelection prospects. For that reason, government may not be impartial when it needs to regulate cases of negative externalities in the market. Conversely, the more money and power businesses have in the economy the more influence they may exert on policymakers. It is also evident that the more involvement government has in the market — both in regulating negative externalities and in allocating funds – the more its perverse incentives are amplified.

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The dynamics we’ve described so far are not new. They’ve been with us from the very beginning of the Scarcity Paradigm. So what is different about the present moment? How did the digital age change this dynamic?

For that we have to look at what realists and idealists care about in the economy. Let's go back to our production function. The function includes the market mechanism, public goods and negative externalities. This is of course a somewhat simplistic function, but it is sufficient for the point we're illustrating.

What do the idealists in society want to measure? They want to know the overall impact of economic activity on society. The function tells us this impact by taking the benefit to customers of all the goods produced, adding to that the total benefit to the public and subtracting from it the effect of all negative externalities.

What do the realists in society want to measure? They want to know if producers will be profitable. The function gives us this information also. For that we only need to make sure the benefit to customers is positive.

For most of human history there was much overlap between the functions that realists and idealists cared about. That’s because the effect of negative externalities was always understood as inevitable, and was at least partly manageable through government regulations. Meanwhile, for most of the time, and for the vast majority of people, maximizing impact simply meant producing more goods or services.

It’s not that it was impossible to impact society in ways other than producing goods and services. It’s just that those other ways were mostly inaccessible to most of the population.

The portion of the population that could meaningfully contribute to advancing science, engineering, and so on was negligible. It is not just that people didn’t have access to books or to the latest scientific publications of the time to be able to contribute. For most of human history most of the population couldn't even read.

As long as the focus of most of society was on producing scarce goods, the effect of public goods on the production function was minimal. The gap between realists and idealists was thus small as well.

This has been the case when most people worked in agriculture. It’s also been true throughout the industrial age. But what happens when this is no longer the case? What happens when most people can have more impact on society by creating public goods than by producing scarce goods? And more importantly, what if there is no way to make money from creating such goods within the market? This is the reality that the digital age has created.

The Scarcity Paradigm worked so well because it allowed people to exchange the fruits of their labor for the fruits of other people's labor through the medium of exchange. This created a powerful coordination mechanism in the economy that could scale the production process to millions of people. It also created efficiency in the use of scarce labor and resources.

But this process only works as long as the fruits of people's labor are scarce. And as long as they are exchangeable. That’s because while resources and labor are scarce, the fruits of people's labor may or may not be. But customers don't pay for resources or labor, they pay for products and services. They don't pay for the inputs, they pay for the output. So if the output is not scarce, and if it cannot be exchanged, then it has no exchange value in the market — no matter how valuable it is to society.

The digital age created a new class of goods – abundant goods (in the form of digital content). These are goods that require limited labor to create, but are then accessible by virtually everyone. These goods also effectively don't diminish with use, since each good requires practically no resources or cost to store or distribute to billions of people.

Abundant goods still need some infrastructure and energy to maintain, so we can't claim that they are perfect public goods (goods that are by definition nonexcludable and inexhaustible). However we can say that they are nearly perfect public goods. Certainly more so than any kind of good that existed before the digital age.

What's more, as technology improves over time abundant goods can be stored and distributed even more efficiently, so such goods continually use fewer resources and are approaching perfect public goods status (though technically they may never reach it).

From a pure economic perspective this creates a massive headache. Economics is essentially about using scarce resources efficiently to benefit society. What then is a more efficient use of scarce resources than creating an abundant good? A good that requires a fixed amount of labor, is accessible to all and does not diminish with use (or at least nearly so)? Such a good would surely use scarce labor efficiently, wouldn't it?

Not exactly. Just because something is an abundant good doesn't in itself mean that it's beneficial to society. No more than being a scarce good in itself means that the good is beneficial to customers. And if something isn't beneficial to society, how can we claim that it uses resources efficiently? Perhaps the 'good' label is somewhat misleading here.

Being an abundant good only means that its effect on society can be orders of magnitude greater than traditional scarce goods. But this effect can be either positive or negative. If for example an abundant good is in the form of harmful misinformation, that can negatively affect the health or well-being of millions, or cause extreme social polarization, then it's obviously not beneficial to society.

The question then becomes what impact these goods have on the economy and on society. Obviously, the goods that create the greatest positive impact on society are the ones that use labor in the most efficient way. The ones that result in the most harm to society are the least efficient.

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Abundant goods did not alter the incentive structure of the Scarcity Paradigm. They did however amplify the effect of both public goods and negative externalities on the economy.

If before people had little incentive to create public goods, that didn't change with the introduction of abundant goods. But now the potential impact of such goods has increased exponentially. The problem though is that it mostly remains just that: an unrealized potential.

Surely people still produce such goods, but that goes back to their need to create and explore – to the Curiosity Paradigm. They just don't create them at the scale needed for our economy.

At the same time, people have just as much economic incentive to produce negative externalities. But now negative externalities have a substantial effect on society. An effect that is growing over time as technology advances.

Certainly it would be an order of magnitude more efficient to create an abundant good with a positive impact on society than using the same amount of labor to produce a scarce good that is only accessible to some people and that diminishes with use.

Yet the abundant good in this case, unlike the scarce one, would have no value in the market. Since the abundant good is accessible by everyone, it has no exchange value. Without exchange value it cannot be priced in the market.

To illustrate this point let’s imagine you have a researcher who wants to maximize her impact on the world. After years of work she discovers a cure to a particular disease that can extend the lives of millions of people. Now imagine two alternative scenarios. In the first scenario – let's call it the Scarcity Scenario – the cure is in the form of a pill, and in the second scenario (the Abundance Scenario) the cure is in the form of a combination of carefully measured ingredients that are readily available in stores. In both scenarios the effort to discover the cure was identical. In both scenarios the cure's value to society is the same (identical therapeutic results). The only difference? In the Scarcity Scenario the scientist can sell the pills. In the Abundance Scenario the product is mostly in the form of knowledge, which is much harder to exchange and therefore to profit from.

Obviously the researcher can still write a book about her discovery and make some money from that. If she includes the cure in the book however, anyone would be able to freely copy and distribute that information. And once the information is out, enforcing any kind of intellectual property restrictions would be practically impossible. This suggests that the Abundance Scenario researcher will still have drastically lower returns. It’s possible that she won’t even be able to cover the cost of the research in that case.

To drive this point home, we can modify the scenarios somewhat. What if in the Scarcity Scenario the pill could only extend the lives of thousands instead of millions in the Abundance Scenario. Maybe it is half as effective at that. Maybe the pill also has significant side effects, while the discovery in the Abundance Scenario has no side effects. Maybe the pill production process releases toxins into the environment. Regardless of such differences, the return in the Scarcity Scenario is still likely to be much higher than in the Abundance Scenario.

So it’s possible to have abundant goods that have a tremendous impact on society, and use labor extremely efficiently, yet have little to no value in the market. And at the same time have scarce goods that have relatively little value to society, or don't use labor nearly as efficiently, and yet have a lot more value in the market than abundant goods.

This means that there are economic incentives in the market to create scarce goods that don't use resources efficiently, and at the same time almost no economic incentive to create abundant goods that use resources extremely efficiently. The implication here is that the more the potential impact of the abundant good on society the more inefficient is the market at allocating resources.

Of course, the Scarcity Paradigm's inability to capture the value of public goods was always there. But as long as public goods were rare their effect on the economy was marginal. The emergence of abundant goods in the digital age completely changed this dynamic.

You can imagine the growing rift between idealists and realists that the digital age created. Realists would say that the impact of abundant goods is irrelevant and that if people want to create impact they should do so through the market; or at least they should not interfere with the market that historically worked so well.

Meanwhile, idealists see the potential that abundant goods can have on society, but realize that these cannot be monetized in the market. This leads them to be frustrated and disillusioned in the economy.

For a growing segment of the population maximizing impact no longer means greater production of physical goods. For them, impact maximization means making meaningful contributions in medicine, technology, science, engineering, journalism, software development, the arts, and so on. All areas that can have tremendous impact on society and where the contribution is an abundant good. And yet, such contributions have no comparable exchange value in the market.

When everyone has unrestricted access to the digital content there is no way for the content creator to monetize that content based on its value to society. Realists may say that you can still get revenue from advertising, but getting paid from the popularity of content is very different from getting a return on the content’s value to society. A scientific breakthrough may have incredible value to society but may only catch the attention of a few dozen people. This is especially true if the breakthrough requires advanced knowledge of the science. On the other hand, an inane tweet by a celebrity may generate millions of views. Is the inane tweet truly more valuable to society?

Content creators may also paywall their content. This can increase their returns but it will come at the expense of how much impact their content can have if it were accessible by all.

This is why our economic paradigm is starting to crack. The digital age has created a divergence between impact maximization and profit maximization in society. With automation and greater technological progress we’re only going to see this divergence grow.

So what happens when ever larger segments of the population have to choose between their economic self interest and making a meaningful impact on the world? For once, the inefficiency of labor in the Scarcity Paradigm will become more apparent. More and more people will see that our economic paradigm is not working for them. That we have all the tools to make the world a better place but are held back by our economic system. This is likely to breed dissatisfaction and resentment. And that’s before we even look in greater depth at the other major flaw of our economic paradigm – negative externalities.

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As previously mentioned, negative externalities are costs that others incur from the economic activity of market participants. A common example of a negative externality is pollution. A producer may pollute the air or water and harm nearby communities through the manufacturing process of products. While the producer gets money in exchange for the products, the nearby communities get none of the revenue. Instead they may suffer from adverse health effects, crop failure, and so on.

Now it’s possible that the nearby communities will petition the local government to intervene and demand compensation from the producer, or even to shut down the factory. It’s also possible that the producer strategically placed the factory in an area where pollution regulations are lax, where local government is less effective, or where government officials are more corrupt.

The point is that, instead of incurring costs by curbing pollution, producers can offload some of these costs onto others. They can lower their production costs through negative externalities. And so, they have an economic incentive to create negative externalities.

By offloading costs onto others market participants stand to reap greater rewards. This benefits both producers, who lower their production costs, and consumers, who get cheaper products. Those affected by the negative externalities often have no say in the exchange between consumers and producers. There is simply no effective feedback loop in our current economic paradigm to solve this problem.

While in some cases government may intervene to restrict such practices, in many cases intervention is not as simple or straightforward.

Just like with impact maximization, negative externalities are also not a new phenomenon. They’ve been with us from the dawn of the Scarcity Paradigm. So why is this a bigger issue now?

The difference is again in the magnitude of effect on society. Whatever was the effect of negative externalities before, now it is vastly greater. And growing. The Digital Age has magnified this effect in two important ways. It weakened society's ability to confront those who produce externalities, and it created a new business model that thrives on tearing society apart.

How has the Digital Age weakened our ability to confront externalities? The short answer is that, while the economy became globalized, requiring stronger institutions that act as a check on externalities, the Digital Age is making it incredibly easy to delegitimize and weaken all these institutions.

You see, in the past negative externalities could largely be geographically localized, and isolated to the production process. Which meant that they were easier to regulate and had a smaller effect on people's lives. This is no longer the case because of globalization and abundant goods.

The global economy is now deeply interconnected. We have transnational corporations with vast supply chains and markets on every continent. While these corporations have a fiduciary responsibility to their shareholders, they have virtually no responsibility to the communities where they operate. Or, for that matter, to the planet. What were once local externalities are now globalized.

But aren't there forces that can push back against corporate externalities? Governments can still regulate corporations. News media can expose destructive practices and corruption. Scientists can show the data of material harm to the public and environment caused by companies. Public sentiment can affect sales, and therefore affect the profitability of offending companies.

With all these institutions in place you’d think that there are enough elements to keep a check on those who create negative externalities in the economy. Surely. But this is where things become complicated. Institutions derive their legitimacy from public trust. Governments need public support to be effective. But what happens when institutions lose the public’s trust? What if the public is deeply polarized? Without public trust and support, government and institutions cannot act as an effective check against externalities. And if the public cannot get a clear sense of the situation, public sentiment will be muddled and won’t be effective against the offending parties.

This is exactly the dynamic that the Digital Age has created with abundant goods. We’ve already seen that abundant goods can have a positive or negative effect on society. We’ve also seen that they can amplify those effects far beyond anything a scarce good can do. What happens then when this powerful amplification tool is used to undermine the credibility and legitimacy of government and institutions? What happens when it is used to sow social discord? By undermining public trust in institutions and creating social polarization the Digital Age has made it incredibly difficult to deal with externalities.

What’s more, corporations don’t even need to bother with actively delegitimizing institutions or sowing distrust in society. The perverse incentives in the market drive people to do that work all by themselves.

Because the market cannot value abundant goods based on their impact or benefit to society, the common approach has been to monetize a scarce resource that does have exchange value: people’s attention. If digital content gets more attention, advertisers can serve their ads to more people alongside that content.

One problem with this business model is that there is no obvious relation between the quality of content and its popularity. Because quality has no value in such a system the only economic incentive is to produce attention-grabbing content.

Content that grabs the most attention tends to be emotionally charged: surprising, outrageous, divisive, or hateful content. Such content tends to generate a lot more attention than emotionally neutral or factual content. It also takes a lot less effort to generate factually-inaccurate outrageous content than well-researched quality content ,  making it easier to monetize.

So what happens when you have billions of people from all over the world connected to social media? While the platforms make billions in ad revenue, society suffers the negative externalities. Content creators always have the incentive to exaggerate, to distort, to create drama and conflict, and to sow mistrust. These are the things that grab people’s attention. And these are the things that the algorithms are designed to boost.

Meanwhile, billions of people on social media are endlessly inundated with outrage porn, misinformation and sensationalism. These are the perverse incentives that result in social polarization and a crisis of trust in media, science and institutions.

If the populace is polarized, if people can't agree on scientific facts or basic truths, and if institutions lose legitimacy, then governments have a weaker mandate to act. And when the government is ineffective against those who benefit at the expense of the public interest, it further loses public support. It's a vicious cycle of inefficacy.

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Even if we disregard for a moment how social media degrades society's ability to confront corporate externalities, the harm to society caused by social media's perverse incentives is in itself enormous.

If before corporations had the incentive to pollute the environment because it reduced production costs, in the Digital Age people have the incentive to produce divisive and outrageous content because it gets more attention. They tear society apart for clicks.

Externalities moved from mostly being in the physical realm to also being in the psychological and sociological. They now permeate every aspect of our lives. They harm everything from our children's self-esteem to our sense-making ability and our politics.

People on social media always have the incentive to present themselves as more successful, more wealthy, joyful or leading more exciting lives. At the same time, the algorithms want to push whatever content gets them more attention.

So think about the impressionable young guys and gals who are algorithmically flooded with reality-distorting images and reels. They get a compounded distortion of reality; people appear to them to be oozing with success and always having a great time, and they appear more often in their feed. Is there any wonder then that young people are feeling inadequate? That while kids are spending more time on social media, loneliness and social isolation is growing?

Because what matters is attention, not reality, there is always an incentive to diverge from the mainstream view. Not because a real controversy exists, but because that's the strategy that is likely to get the highest return. The mechanism here is quite straightforward. If a thousand people are all saying similar things, the more you diverge from these views the more likely you are to get more attention. Repeating the same claims as everyone else gets you nothing.

This works regardless of the truth of the claims. You'd get a lot more attention saying the earth is flat than if you claim that it is spherical. Trying to debunk conspiracies and misinformation requires a lot of effort. To create new ones you only need an active imagination.

Think of this concept mathematically: let’s say a certain truthful claim is repeated by a thousand people, and 95% of the population believes it. That means that each of the people has, on average, 0.095% of the total audience interested in the topic. Does it make more sense to fight in an oversaturated field for a tiny slice of 0.1% of the audience, or try to capture a 50x larger audience by being the first to adopt the opposite viewpoint? It always makes more sense to diverge and be controversial in the attention economy.

But it's not enough to push the controversy. The next step is discrediting those who disagree with you. What are they hiding? Why don't they want people to know the "truth"?!

What happens then when this dynamic plays out at scale? You get an information environment where nothing is certain. Nothing is knowable. It's not that you cannot get to the facts if you do enough research. When every fact is under attack, and people have an economic incentive to invent more controversies out of thin air, truth becomes increasingly unattainable. It's a war of attrition targeting your ability to make sense of the world. You can either spend all your time diving into rabbit holes or accept defeat.

Social media pushes the loudest, most extreme and controversial voices to the top. Not because these views are better, but because of their ability to garner the most attention. And so society is radicalized. Nuance has no value, it's boring. Instead activists and politicians compete over who can present the most extreme policies. Moderation and level-headedness is replaced by blind populism and radicalism.

* * * * *

While the incentive to create negative externalities, and the disincentive to create public goods was always there, their effects were mostly negligible on society. This has been the case for centuries. But the dynamics of the economy are now different.

Thanks to the Digital Age, it is now easier than ever to produce abundant goods. It is now also a lot easier to create negative externalities, and more difficult for society to coordinate efforts to confront them. While the impact of public goods on the economy and society can be enormous, there is still no economic incentive to produce such goods, since they have no exchange value in the market.

At the same time the effect of negative externalities has grown exponentially. Social media can be used to sow discord in society and delegitimize institutions, thus removing every effective measure society has against corporate externalities.

On top of that social media creates a perverse incentive to benefit from tearing society apart. People benefit from attacking our self-esteem and our ability to make sense of the world. It promotes radicalism and division, and poisons the minds of countless millions of people. Thus, social media makes it increasingly more difficult for people to come together and work for the common good.

Ironically, an economic paradigm that is meant to efficiently allocate scarce labor and resources is failing because it cannot value abundance. As technology improves this trend is only expected to worsen. But how bad can it possibly get? And what can we do to fix the problem?

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