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Finance & Investment
Beyond Supply and Demand:
The Dynamic Equilibrium Between Global Thresholds and Allocations

As a monetary adviser, I spent many years questioning bankers on the authenticity of their balances sheets. What stood out most for me in these discussions was this: the social demand for commodities is often claimed by banks as having a direct link with the ecological supply of resources which are extracted, produced and sold as commodities. But this just isn’t true. Bank reserve assets are not discounted to reflect the decline of the world’s non-renewable resources. In fact, as society’s ecological debt continues to mount, no one is actually keeping track.

As a monetary adviser, I spent many years questioning bankers on the authenticity of their balances sheets. What stood out most for me in these discussions was this: the social demand for commodities is often claimed by banks as having a direct link with the ecological supply of resources which are extracted, produced and sold as commodities. But this just isn’t true. Bank reserve assets are not discounted to reflect the decline of the world’s non-renewable resources. In fact, as society’s ecological debt continues to mount, no one is actually keeping track.

Consider how odd this is: the demand for goods is used as a proxy for the relative accessibility of non-renewable resources — yet the increasing scarcity of fossil fuels isn’t showing up in the price we pay at the gas pump. Same with water and rare minerals, which are not valued according to their declining availability. Nor does eco-value appear on the spreadsheets of most stock traders, insurance companies or other businesses.

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What’s causing such rampant misreporting and misallocation? I’ve come to see this now as more a problem of accountability than accounting. Frankly, the challenge is to admit our mistakes and reconceptualize the modern system of economic valuation, starting with the theory that it’s based on a fundamental law of equilibrium. Take, for example, Adam Smith’s idea that the efforts of individuals in pursuing their own interests naturally benefit society, or the notion that an organic circular flow exists between market prices and people’s incomes. Are these assumptions valid? And what do we mean by economic balance? Is it a principle of physics or biology?

Let’s begin by asking, is supply and demand truly able to manage the thresholds of resources which an environment can sustain, or to ensure that these resources are allocated sufficiently for the population living in that environment?

In both classical and Keynesian economics, the ratio between the supply of a quantity of a good or service and the demand for it is determined by the price of this quantity. What is tallied on the supply-side of this equation are production costs, which include labor, capital, expectations of future prices and suppliers, and the technology that’s used in production. The relative availability of materials and energy for production is also listed as a supply cost, although seldom in ecological terms. The rate at which people and their organizations may harvest or use a particular resource within its regenerative capacity is not normally registered on the supply side as an ecological yield, but as a financial outlay. Nor are the negative effects of pollution, waste, ill-health or risk typically included in production costs.

Conversely, the demand side of the market economy measures consumer income, tastes and preferences, prices of related goods and services, expectations about future prices and incomes, and the number of potential consumers. Rather than reflect actual human need, demand is a measure of individual consumption at the point of sale. It’s simply the price at which a person is willing to pay for something, signifying how much cash or credit is exchanged in the transaction. But what’s not measured by demand is the individual’s accessibility to breathable air, clean water, nutritious food, adequate shelter, or meaningful security, love, belonging and inclusion. Subjective expressions of need, beauty, volunteer labor, loss of commons or health and safety risks are simply not involved in the transmission of demand through the cash register, barcode scanner or wireless purchase.

A similar structure for market equilibrium is applied in banking and finance. Just as the supply-demand formula in microeconomics is based on a functional connection between producers and consumers, the supply-demand ledger is used in macroeconomics to express a similar type of relationship between lenders and borrowers. Here, the equilibrium between the money supply and the demand for money is adjusted through an interest rate, which represents the price that is charged for money.

Once again, this represents a certain kind of transactional balance within the marketplace, but does not reflect the broader relationship between the ecology and its population. When all that’s expressed in the standard supply-demand equation is the price of a particular commodity or good, or an interest rate which signifies the price of money, neither resource preservation and replenishment rates nor specific measures of the human need for this resource are accounted. Nor does the supply-demand equation convey the underlying costs of social harm or environmental damage that may be incurred.

This disequilibrium in value has also led to deep political biases in how the supply-demand model should be applied in society. On one hand, classical and neo-classical economists say that ‘supply creates its own demand’. They promote strong policies for investment and production through individual initiative and limited government intervention in the economy, while rationalizing endless resource extraction, production, growth and waste. In using supply-demand for their scale of balance, these analysts rarely question why the exponential values in the economy are so disjointed from the biological growth rates which occur in the natural world.

On the other hand, Keynesian economists say that boosting wages and purchasing power generates demand. They promote policies of shared investment and production through intervention by a government in its economy, while ignoring the destructive competition which this creates between available resources and the needs of a population for these resources. Here, Keynesians are little different than classical economists: both schools assume that meeting human needs is dependent on extractive production, expanding population, continuous demand, increasing personal income, rising consumption and the unintended but inevitable byproducts of manufactured pollution and disposable waste.

Neither choice is correct because the basic theory of market equilibrium ignores environmental and social costs, deeply misinterpreting the dynamic link between ecological support systems and the people who depend on them. This vital connection is seen simply as a ‘supply chain’ through which a quantity of something demanded by consumers or borrowers is delivered to them based on the quantity that firms or banks can supply. Neither the classical or Keynesian approaches to supply and demand reflect the constraints to the productive capacity of Earth’s resource base or the maximum size of a population which can be maintained indefinitely within that environment.

Our economic proxies for environmental balance are directly to blame for these fateful miscalculations. As a subsystem of a larger ecosystem, the supply-demand model does little to equalize the natural sources of productive input with the natural sinks of consumed output or waste, leading to massive market failure. Under the illusion of supply-demand equilibrium, human population is now using the basic resources of food, water, energy and minerals faster than Nature can replenish them to meet the needs of its people. To reverse this critical overshoot, we’ll have to transform our epistemology, our ideologies, our institutions and rules, as well as our methods of accounting.

All of this requires a clearer understanding of the interactions between the biosphere and human society. The ecological threshold of available resources and the allocations of those resources to meet the needs of a population are actually opposing forces which continuously counteract one another. This dynamic principle exists between every species and its environment: living organisms react to changes in their ecosystem and make adjustments to survive.

Through this constant interplay between natural and physical forces, instead of supply creating its own demand through prices or demand being dependent on income, the signaling of need by an organism routinely triggers the creation of its own supply. These self-regulating forces work in Nature and within the biology of the human body; they must also work in human societies. Measuring the replenishment of renewable and non-renewable resources will enable a society to sustain their yield relative to the offsetting needs demonstrated by the size and growth of the human population.

These divergent forces must be given an empirical basis in socioeconomic policy beyond the inept framework of supply-demand. Counterbalancing the needs of a population with its resource support systems requires a major readjustment. Here’s how this might work. What’s now included on the supply side as extraction, production and waste is redefined as the self-organization of resources within the ecological limits of the planet for their regeneration. And what’s now reported on the demand side as a measure of income is redefined as the self-sufficiency of people in meeting their daily requirements through the common use of these resources.

When supply becomes an ecological value and demand becomes the value of human need, ‘build it and they will come’ is transformed into ‘demonstrate the need and it is met’. Now, instead of a crude approximation for economic equilibrium, we have an actual measure for the cooperative activities of people managing their resources to meet their needs — a measure based on the level of regenerative output which their ecology can optimally ‘carry’ or sustain.

The term for this dynamic equilibrium between people and their environment, which points the way out of our supply-demand matrix, is biocapacity. Biocapacity expresses the intrinsic value of sustainability within an ecosystem. It is based on the thresholds of resources which can be sustained in an environment as measured against the allocations of resources sufficient to meet the needs of its population. Through this ecosystem value, biocapacity offers direct indicators and guidelines to help us organize our own sufficiency through the steadily fluctuating, self-adjusting metabolism of society as a living system.

Note: James Quilligan presented these comments at the Global Thresholds and Allocations Council (GTAC) Kickoff Meeting at the Royal Dutch Federation of Accountants in Amsterdam, convened by Reporting 3.0 on 31 January 2018, in a session on Allocation Approaches with fellow speaker Mark McElroy of the Center for Sustainable Organizations, moderated by Bill Baue of Reporting 3.0. The 35+ global experts gathered at the meeting sat in rapt attention while James spoke, and broke into spontaneous applause when he finished. Please see the GTAC Landing Page on the Reporting 3.0 website for links to the GTAC Concept Note, Meeting Presentation Deck, and Meeting Program (with abstracts by all speakers, including GRI Co-Founder Allen White, Johan Rockström of the Stockholm Resilience Centre, Doughnut Economic author Kate Raworth, Future Fit Foundation CEO Geoff Kendall, International Integrated Reporting Council Managing Director Neil Stevenson, and many others.)