Heterodox Economics And The Rise Of The Blockchains
Tags: Economics, Blockchain, Internet, Technology, Capitalism

a technological, legal, and monetary innovation through the lens of Perez, Jacobs, and de Soto.

photo by Tim Mossholder, via Unsplash

The fastest and most decentralized build-out of infrastructure in the history of economic development is not being covered by the mainstream financial media in the slightest. Even this is a charitable summary that allows for the interpretation that they deem other news to be more important. They don’t; they have no idea what is going on here or why it matters.

To whom then do we turn? I have in the past referenced Chris Dixon, Fred Ehrsam, Ben Thomson, and Marc Andreessen, and they certainly do know a thing or two. But I have a more fun idea. Satoshi Nakamoto invented blockchains based in part on wanting to disprove widespread economic delusions, by example rather than argument, and embedded in the Bitcoin genesis block a reference to mainstream economists having no idea how anything really works. To stay true to this strain of autodidact arrogance I do not intend to summarise contemporary commentary on blockchains. I intend instead to dig up the work of equally arrogant autodidacts from well before blockchains existed and see what they might have to say about it.

My plan is as follows: I will review three brilliant books from decidedly heterodox economists: Technological Revolutions and Financial Capital, by Carlota Perez; Cities and the Wealth of Nations, by Jane Jacobs; and, The Mystery of Capital, by Hernando de Soto. I will then briefly draw ties between the three, and finally I will attempt to extrapolate the thinking of all three authors to what I can only imagine will be some of the consequences of the rise of the blockchains.

photo by Tim Mossholder, via Unsplash

To the best of my knowledge, none of the three reference each other. But to my mind, they are kindred spirits, and their works complement one another wonderfully, not just in what they propose, but what they oppose. In all three, there is a delicious strain of contempt for the mainstream of economic thought, most of all its adoption of pseudo-mathematical reasoning rooted in physics envy. As a mathematician, I found this part of the reading experience to be particularly delightful. If physics is applied mathematics, then twentieth century economics is misapplied mathematics.

But this attitude is not just an excuse for sarcastic quips, on their part or on mine. It is precisely because these authors’ thoughts are so original, so abstract, and so removed from the blind historicism of the dominant paradigms of academia that they can be so naturally extended to the next great revolution in finance, technology, and economics. Nobel Prize winning economists call Bitcoin evil and needing to be banned, while Perez, Jacobs, and de Soto are intrigued. Stigliz, Shiller, and Krugman are moved to whine; Perez, Jacobs and de Soto are moved to think.

So think we shall.

Technological Revolutions and Financial Capital, by Carlota Perez

This book could perhaps be thought of as a sociological theory of the interplay of capital markets and technological development. Perez uses extensive historical analysis to back up axiomatic social theorizing as to which people are likely to do what, when, and why. There are no equations, no models, and no absurd idealizations of economic phenomena that leave twenty assumptions at the door; markets are not efficient and capital is not a homogenous lump of potential utility whose price reflects its risk. Capital is wielded by different people with different bases of knowledge, objectives, opportunities and access to it in the first place. It is therefore not surprising that certain patterns tend to repeat in the financing of foundational technologies; not because the solution to the differential equation of the economy is sinusoidal, but because large enough groups of people in similar enough circumstances are relatively predictable.

Perez begins by making a distinction between financial capital and production capital, which is key in setting the stage for the emergence of a new technology. “Financial capital represents the criteria and behaviour of those agents who possess wealth in the form of money or other paper assets. In that condition, they will perform those actions that, in their understanding, are most likely to increase net wealth.” By contrast, “production capital embodies the motives and behaviors of those agents who generate new wealth by producing goods or performing services.”

We might wonder from this definition whether this is not just a verbose articulation of lenders and borrowers. In a sense it is, in accurately describing the transfer of capital, but not at all in describing the roles and behaviours of those involved. It is the role of financial capital not just to save and lend, and of production capital not just to borrow and invest. It is arguably the role of both to aim to seek out the best return for the very different sources of capital they control, given the very different circumstances in which they find themselves. Perez teases out how the existence of these differing aims balance and enable mere finance to be channeled to production. Her argument in essence is that this channeling is neither a smooth nor obviously rational process, but one of experimentation, discovery, and “irrational exuberance,” and that the stages of a capital cycle can be largely captured by observing the interaction of the two groups: “the object here is to clearly distinguish between the actual process of wealth creation and the enabling mechanisms, such as finance, which influence its possibility and shape the ultimate distribution of its results.”

Perez identifies four stages interspersed with three key events. The first event is the ‘big bang’, in which the industrial potential of a new technology becomes clear. This leads to the ‘irruption phase’, in which financial capital senses the above-average returns potential of the novel production capital relative to anything else on offer and in turn gives the new technologists the means to attempt to realize the potential of their inventions.

As these above average returns become well known, we enter the ‘frenzy phase’. Nothing necessarily changes with the technological advance of the production capital, at least at first. The phase is defined by a steady decoupling of financial and production capital, that ends with financial capital run amok and a crash that forces the recoupling in the next phase. The frenzy starts from the realization that the new technology, highly returning as it is, forms only a very limited portion of the overall economy and will continue to do so for quite some time. And yet the high yields from its nonetheless rapid growth become addictive. Perez sums up with a touch of gleeful sarcasm, “in order to achieve the same high yield from all investments as from the successful new sectors, financial capital becomes highly ‘innovative’.”

This forces a decoupling. “After the growing confidence in the previous phase, financial capital becomes convinced it can live and thrive on its own. Brilliant successes in a sort of gambling world make it believe itself capable of generating wealth by its own actions, almost like having invented magic rules for a new sort of economy. Production capital, including the revolutionary industries, becomes one more object of manipulation and speculation.”

And, “the entrepreneurs of the new firms as much as the management of the old (whether modernizing or not) are forced to do whatever is necessary to attract the players in the casino and then worry as much — or more — about the performance of their stock valuations as about their actual profits. Financial capital reigns arrogant and production capital has no alternative but to adapt to the new rules; some agents with glee, others with horror.”

This may sound familiar to readers of, among many possibilities, Capital Account, by the managers of Marathon Asset Management, describing the ‘frenzy’ of the fifth technological revolution (more on what the different revolutions were shortly). “Increasingly, companies presented investors with another measure of earnings — EBITDA, or earnings before interest, tax, depreciation and amortisation — so stripped of the ordinary expenses of business that it became known jokingly as ‘earnings before bad stuff’. Chief executives justified the massive corporate takeovers of the era on the grounds that they were earnings enhancing. They also spent hundreds of billions of dollars during this period on buying back their highly priced shares. Why? Because share repurchases boosted earnings-per-share (EPS). In Enron’s last annual report to shareholders before its bankruptcy, the pioneering energy company claimed to be ‘laser-focused on earnings per share’.” Financial capital begins to treat its own numbers as a closed game, without any reference to the actual productivity of production capital. Any accounting trick to get the numbers up will do, because the numbers are no longer representations of what is important in the real world; only the numbers are important; the numbers are the real world.

Over and above simple accounting fraud, however, is the effect on production capital, which has to play to this tune whether it wants to or not. The typical example from the dot com bubble has entered folklore: add ‘dot com’ to your name and your stock price will quadruple overnight despite scarce other changes.

After some point of mindless asset price inflation and capital gains divorced from productivity gains, the bubble must pop. This is the second key event Perez identifies, ‘the crash’. It is simple enough to grasp: financial capital has, for a long time, appreciated solely on the expectation of future capital gains, thoroughly decoupled from the real gains only production capital can bring. This cannot continue forever, and, moreover, once it starts to reverse, it will likely reverse very quickly. When it is clear that there are no capital gains to be made, the gamblers will cash out, accelerating the process of decline.

The time in between the crash and Perez’s next event, ‘the recomposition’, will see a number of changes. The practices of financial capital will likely be reformed to protect investors from the scams that were inevitably willed up in the frenzy to meet its impossible demands. The potential of the technology will nonetheless be appreciated and industry standards and regulations will be drawn up to ensure sense and cooperation in its future deployment. But ultimately what each of these achieves is to embed this technological revolution in the economic, legal, and cultural fabric.

Perez argues that this sets the stage for a ‘synergy’ phase of recoupled financial and production capital and harmonious growth of both. The key to avoiding the absurdities of the frenzy, as has been established in the gap between the crash and the recomposition, is that financial capital is no longer under delusions of wealth creation. Production capital is now in control, with financial capital merely facilitating its needs. Regulation of the new industries is clear and the relevant infrastructure is understood, meaning that real long-term planning can begin. Free of the burden of ridiculous expectations for short term growth inflicted by financial capital, firms can, ironically, secure real growth in a sustainable manner. Fresh from the memory of the ruinous crash, financial capital is happy with its supporting role since the capital returns it facilitates now reflect real returns, and paper wealth is largely real wealth. Perez makes a crucial point that this phase is likely to be thought of as more harmonious than all others, since there will be a more equitable distribution of the benefits of the new technology. Its productivity enhancement will seep into more and more industries and deliver a more evenly distributed increase in real wealth, as opposed to the prior enormous fake returns to whoever happened to arrive at the frenzy first and enormous real losses to whoever happened to arrive last.

The final phase, ‘maturity’, is reached only eventually and is rather slipped into without an event marking its arrival, since the new technology can only open so many investment opportunities and, as they are exhausted, returns will fall. After the prior harmony, financial capital will once again become uneasy. Guardians of pools of capital that do not return what some still remember from earlier in the cycle, or perhaps what is simply insufficient to match real liabilities, become anxious for new opportunities. It is in direct contrast to the stagnation of returns during the maturity phase that the irruption of the next cycle seems so appealing.

Although I mentioned above that economic and legal frameworks formed around the Internet following the dotcom crash, what was arguably more important was not the misery of failed investments but the experiments the failures represented and the work that went into the experimentation. In some sense, the decoupling of financial and production capital and the magnetism of transient capital returns that financial capital represented forced an enormous industrial experiment to take place. We know now that the experiment in aggregate was a fantastic success. Not only have ‘Internet’ companies (but what isn’t these days?) created orders of magnitude more capital value than was capital wasted in irrational exuberance but, as Marc Andreessen, professional baller, is fond of pointing out, most of the ideas that lost spectacular amounts of money are now the bases of healthy, profitable, growing businesses. Price charts on a shorter than deserved timescale may appear to indicate enormous waste. But the long enough timescale must include the reconciliation, the golden age, and the maturity phase; the times in which the random-seeming results of the totality of experiments drive immense productivity gains across all industries. Perez argues none would happen in the first place without the irrational exuberance of the grand experiment.

“When the economy is shaken again by a powerful set of new opportunities with the emergence of the next technological revolution, society is still strongly wedded to the old paradigm and its institutional framework. The world of computers, flexible production, and the Internet has a different logic and different requirements from those that facilitated the spread of the automobile, synthetic materials, mass production and the highway network. Suddenly, in relation to the new technologies, the old habits and regulations becomes obstacles, the old services and infrastructures are found wanting, the old organizations and institutions are inadequate. A new context must be created; a new ‘common sense’ must emerge and propagate.”

The rewards financial capital offers in the frenzy are required for the propagation. Financial capital needs some arrogance to light the first match, but it is failing to keep this arrogance in check that eventually burns down the house.

Perez also does an excellent job of chronicling the economic history of the technological revolutions about which she simultaneously theorizes. I do not want to repeat any of this here, as any attempted simplification of this part of her work would surely reduce to an uninteresting list of events. Still, I cannot praise her enough for how well she balances the two desires. It would be both dishonest and easy to take an analysis of historical patterns, however excellent in its own right, and simply lift all and only the commonalities to form a theory that, by definition, explains everything. But she does not do this. Rather than misplaced historicism, Perez takes a philosophical approach, working from common sense definitions of financial and production capital to develop a loose theory of how they are likely to interact, within some bounds. The coupling of historical analysis is done to show that this theory seems entirely reasonable. But it is not total. Perez admits when the theory does not match history, when one cycle’s historical unfolding looks quite unlike another, and when she frankly does not know the answer to some or other question posed by the approach.

Perez seems very aware that the looseness of the theory is a natural constraint of the theory describing people, at its heart. Not ‘economies’ or ‘technologies’ or ‘nations’, but individuals with knowledge and motivations. The only major debt she perhaps owes is to Schumpeter, whom she acknowledges throughout, explicitly pointing to the ‘creative destruction’ evident as one technological revolution reshapes the legacy of its predecessors, but also in its implicit methodological individualism. As I said above, it is really a sociological theory from which economic consequences follow.

Jacobs attempts something similar, if not even more dramatic. While Perez is about equally concerned with the connections between who drives economic progress, how they do it, and why, Jacobs is solely concerned with where. In this unusual interpretation, she complements Perez well. Jacob’s answer is, in cities.

Cities and the Wealth of Nations, by Jane Jacobs

Jacobs’ book can arguably be reduced to a single theorem, which is remarkable given the breadth of the implications she teases out. The theorem is that there is no such thing as a national economy. It is a linguistic construct, existing only as a useless and confusing taxonomical tool and not in any way reflecting the functioning of the real world. The proper object of consideration, the “salient entity of economic life,” as Jacobs repeatedly refers to it, is the city.

Only in cities, Jacobs argues, does any meaningful economic activity take place, in that the economic environment anywhere else will be solely influenced by the activities of cities, and never the other way around. Cities are important because they alone engage in ‘import replacing’. This is the process of gradually developing the means to produce better versions of goods or services that were previously imported. Jacobs comments that, “any settlement that becomes good at import-replacing becomes a city. And any city that repeatedly experiences, from time to time, explosive episodes of import-replacing keeps its economy up-to-date and helps keep itself capable of casting forth streams of innovative and expert work.”

What is intriguing about Jacobs’ theory, and what perhaps provides a cute link to Perez, is that she rationalizes this theory almost entirely in social terms. It could be thought of as a sociological theory of where innovation and growth happens and why it happens there. Economic innovation happens where there is a diverse set of industrial operations active in proximity, and which export some portion of their output. Such an economic entity will still import, of course, for at least two reasons: that it is more efficient to buy the raw materials required for the specialized production than to produce them, and that the exports are ultimately exchanged for high quality specialist goods from elsewhere. But the key moments are when these imports are replaced by superior goods from within this economic unit.

It would obviously be unusual if every potential improvement to a production process was only ever discovered by precisely the people already involved in that process, and not anywhere else in the world. What happens only where there is a diversity of industrial processes is that such a discovery can immediately be put into effect; there is a ready base of potential customers given that this good is already being imported, it will be spread very quickly amongst all the different industries who could also benefit from the same innovation in their industrial processes. There are two additional sources of accelerating industrial processes that are only to be found in cities: people with experience managing this kind of enterprise and with expertise potentially relevant to it, and the availability of long-term capital commitments to scale the enterprise. The latter is particularly elusive since the savings on offer will need to come from a pool that is, in aggregate, stable and growing in order to have a suitable risk profile; in other words, they need to be sourced from a diverse and thriving economy, the likes of which are only to be found in a city.

Contrast this opportunity for innovation in a city to what would or could happen in a town with one major industry. There are no potential customers outside the industry, so there is an enormous risk of the unknown in pursuing a market for the good. There are no adjacent industries to which to spread the improvement, nor to have received it from. There are no experts in anything beyond this one industry, highly dependent on exports. And there are no pools of capital capable of long-term commitments, because the risk inherent in this economic unit are huge; if there is a wobble in the grain market, let’s say, the entire economy could collapse. Meaningful innovations are very unlikely to occur here — while they may be conceived, they will not be put to practice.

Having made the innovation, if this enterprise is truly successful it will replace its prior imports, and hence acquire the trading power to import even more specialist products that it cannot (yet) produce itself. Jacobs argues that a city may as well be defined, at least in economic terms, by its ability to replace imports:

“Whenever a city replaces imports with its own production, other settlements, mostly other cities, lose sales accordingly. However, these other settlements — either the same ones which have lost export sales or different ones — gain an equivalent value of new export work. This is because an import-replacing city does not, upon replacing former imports, import less than it otherwise would, but shifts to other purchases in lieu of what it no longer needs from outside. Economic life as a whole has expanded to the extent that the import-replacing city has everything it formerly had, plus its complement of new and different imports. Indeed, as far as I can see, city import-replacing is in this way at the root of all economic expansion. “

After dutifully, but a little drudgingly, taxonomising the variety of regional economies that exist in addition to cities and how they all interact with one another, Jacobs comes upon the concept of feedback mechanisms that mediate these interactions. One extremely important such mechanism is the valuation of the currency used to facilitate imports and exports. The problem, as throughout, is that currencies today tend to cover economic activity throughout a nation, and nations are not salient economic entities. Jacobs impudently announces that, “today we take it for granted that the elimination of multitudinous currencies in favour of fewer national or imperial currencies represents economic progress and promotes the stability of economic life. But this conventional belief is at least worth questioning. In view of the function that currencies serve as economic feedback controls. I am going to argue that national or imperial currencies give faulty and destructive feedback to city economies and that this in turn leads to profound structural economic flaws, some of which cannot be overcome no matter how hard we try.”

If a nation runs a deficit in its balance of payments, importing more than it exports, we might think of this as reflecting a larger supply of this currency in the market — it is being offered up for exchange for foreign currencies so import purchases can be made — than there is demand for it — foreigners wanting this currency to purchase the exports. This shift in supply and demand ought to make it cheaper relative to foreign currencies. This is all well understood.

However, Jacobs makes two important points that are less well understood. While the common mainstream response to such movements is to diagnose precisely which interventions are required to counterbalance the changes and achieve ‘stability’. But we know better by now than to countenance the mainstream, moreover to view ‘stability’ as at all desirable beyond in an irrelevant aesthetic sense. We want volatility and dynamism! Jacobs argues that this change in price is a valuable feedback mechanism on the state of economic activity; the depreciated currency makes imports dearer, helping local manufacturers compete, and also makes their products cheaper for foreign buyers to export; the change in value acts simultaneously as both a tariff and an export subsidy. Moreover, it will do so for exactly as long as is needed, as is dictated by the response in economic activity to the circumstances — not by a bureaucrat or a committee.

The second problem is that nations are not salient economic entities. Unlike freakish exceptions such as Singapore, which Jacobs gives high praise and seems to have proven right in backing some thirty-five years later, most nations are a mixture of numerous salient economic entities, many or none of which may be dynamic import-replacing cities. The feedback each requires to coordinate economic activity will be dramatically different. Any institutions that obscure or distort the feedback will retard economic development, since they will broadcast incessant noise over the crucial signal, and economic energy will be misused, or not used at all where it should be. Jacobs criticizes national currencies on this account in a wonderfully vivid passage that is worth quoting in full;

“National currencies, then, are potent feedback but impotent at triggering appropriate corrections. To picture how such a thing can be, imagine a group of people who are all properly equipped with diaphragms and lungs but who share only one single brain-stem breathing centre. In this goofy arrangement, the breathing centre would receive consolidated feedback on the carbon dioxide level of the whole group without discriminating among the individuals producing it. Everybody’s diaphragm would thus be triggered to contract at the same time. But suppose some of those people were sleeping, while others were playing tennis. Suppose some were reading about feedback controls, while others were chopping wood. Some would have to halt what they were doing and subside into a lower common denominator of activity. Worse yet, suppose some were swimming and diving, and for some reason, such as the breaking of the surf, had not control over the timing of their submersions. Imagine what would happen to them. In such an arrangement, feedback control would be working perfectly on its own terms but the result would be devastating because of a flaw designed right into the system.

I have had to propose a preposterous situation because systems as structurally flawed as this don’t exist in nature; they wouldn’t last. Nor do they exist in the machines we deliberately design to incorporate mechanical, chemical or electronic feedback controls; machines this badly conceived wouldn’t work. Nations, from this point of view, don’t work either.

Nations are flawed in this way because they are not discrete economic units, although intellectually we pretend that they are and compile statistics about them based on that goofy premise. Nations include, among other things in their economic grab bags, differing city economies that need different corrections at given times, and yet all share a currency that gives all of them the same information at a given time. The consolidated information is bad specific information for them even with respect to their foreign trade, and it is no information at all with respect to their trade with one another, as opposed to their international trade. Yet this wretched feedback is powerful stuff.

Because currency feedback, at bottom, all has to do with imports and exports and the balance or lack of balance between them, the appropriate responding mechanisms for such information are cities and their regions. Cities are the specific economic units that can replace imports with their own production, and the specific units that cast up streams of new kinds of exports. It is bootless to suppose that amorphous, undifferentiated statistical collections of a nation’s economies perform those functions, because they don’t.”

Jacobs acknowledges the historical reasons for this economically unfortunate development — little more than the vast expansion of centralised government in the late nineteenth century and the adoption of state monetarism as a tool of social control — but casts her eye wider than the immediate moment. She points firstly to city currencies (currencies of salient economic entities) being the norm in the early economic development of Europe at the end of the middle ages, beginning in Venice. Not only did Venice have a city currency, but it welcomed the simultaneous circulation of Byzantine coinage due to the bedrock of trade with the Eastern Empire, whose imports Venice slowly but surely began to replace. The Hanseatic League, a federation of German and Baltic cities that drove the economic development of northern Europe, following in Venice’s wake, had no league currency but allowed cities to mint their own, subject to valuable feedback from volatile intercity trade.

But Jacobs also holds out hope for the future. With incredible prescience — this being 1984 — she comments on the possibility of a future multiplication of currencies that,

“the technical difficulties and inconveniences that would entail are surmountable, increasingly so with the aid of computers, instantaneous communications systems and such devices as credit cards which — even in their current rudimentary and limited uses — are already convenient for simultaneous transactions involving diverse currencies. On my card I can order, say, books from London payable in pounds, shirts from the Boston city region payable in U.S dollars, and garden seeds payable in my own currency, Canadian dollars, all the transactions being equally convenient as far as I am concerned.”

It will not surprise the reader that this insight will be returned to below.

Since Jacobs can’t resist the occasional dig at mainstream economics, I don’t feel so bad about having this same instinct. Lest the reader think I had discarded this guilty pleasure in the introduction, I will conclude the discussion of Jacobs with the final paragraph from the first chapter, itself hardly more than 20 pages of mocking the then-state-of-the-art:

“One thing we do know by now because events have rubbed our faces in it: it would be rash to suppose that macro-economics, as it stands today, has guidance for us. Several centuries of hard, ingenious thought about supply and demand chasing each other around, tails in their mouths, have told us almost nothing about the rise and decline of wealth. We must find more realistic and fruitful lines of observation and thought than we have tried to use so far. Choosing among the existing schools of thought is bootless. We are on our own.”

I couldn’t agree more, Jane. Whatever might Hernando think?

The Mystery of Capital, by Hernando de Soto

Why capitalism triumphs in the West and fails everywhere else, the subtitle of this book, is an excellent description of its thesis. Capitalism often fails outside the West, proposes de Soto, because the framework of broadly unregulated marketplaces is necessary for economic development, but not sufficient. Also necessary, and in a sense anthropologically prior, is a well-documented and well understood institution of private property. Many countries outside the West that attempted nominally economic capitalistic reforms failed to realize anything like the expected gains in productivity because although their citizens could in theory access free markets, they were strongly incentivized to conduct their economic activity outside the law. This was because, in one form or another, it was needlessly difficult to ascertain legal ownership of assets and easier to abide by extralegal social conventions regarding asset ownership.

The book is impressive not for the complexity of its reasoning but for the lengths gone to in order to demonstrate to a desirable degree that the reasoning is on the right track. De Soto and his team of researchers gathered copious data from Cairo, Lima, Manila, Port-au-Prince, and Mexico City to try to assess both the difficulties of formal asset ownership, and the potential value of the assets pushed outside formal systems by these difficulties.

They found that in Peru, it takes 5 separate procedures to legally acquire a home, and that the first of these procedures involves 207 steps and 21 government agencies. De Soto’s team spent six hours a day on this task and completed it 289 days later. In Egypt, somebody wanting to legally register a lot on state-owned desert land would have to go through 77 steps across 31 agencies, in a process that could take between 5 and 14 years. Similar stories abound outside the West, with the obvious result that virtually none of the poor bother to opt into the legal framework for asset ownership, preferring to abide by local customs instead. De Soto elaborates that,

“… in every country we investigated, we found that it is very nearly as difficult to stay legal as it is to become legal. Inevitably, migrants do not so much break the law as the law breaks them. In 1976, two-thirds of those who worked in Venezuela were employed in legally established enterprises; today the proportion is less than half. Thirty years ago, more than two-thirds of the new housing erected in Brazil was intended for rent. Today, only about 3 percent of new construction is officially listed as rental housing. To where did that market vanish? To the extralegal areas of Brazilian cities called favelas, which operating outside the highly regulated formal economy and function according to supply and demand. There are no rent controls in the favelas; rents are paid in US dollars, and renters who do not pay are rapidly evacuated.”

The stifling conditions in the formal economy push more and more entrepreneurial energy into the extralegal sector. De Soto’s team estimated how much value was trapped in these ‘shadow economies’. Confining the search solely to real estate, they found that in Manila, for example, the extralegal sector held $133bn of value, or four times the market value of all publicly listed companies in the Philippines, and fourteen times the foreign direct investment in the preceding 25 years. In Port-au-Prince, the informal sector held 97% of all property, valued at $5bn, or over 158x all foreign direct investment in Haiti, ever.

While these figures are staggering, we might wonder why these circumstances are even so bad, if there appears, after all, to be a thriving free market outside the meddling reach of the state. To rebut this fallacy, De Soto teases at an important economic principle throughout the book. Contrary to a variety of naïve popular conceptions, the driving force of free markets is not markets, nor money, nor even assets, but capital. By which we must mean something less material than any of the former; a kind of economic potential energy stored in the transformation of materials into higher and higher forms of complex good, but always ready to be rereleased to work again the same process of transformation. Seen this way, capital is not any particular thing or even behaviour — it can exist only as an emergent property of a social system in which the exchange of shares of ownership of private assets is seamless. Clearly ‘private assets’ is a complex social construction, and even more complex still is ‘shares’ of assets, and so we quickly realize that clear representational systems matter as much to productivity under capitalism as does ‘freedom’, if not more so. Where de Soto studies, the poor lack neither assets nor free markets, but representational systems to realize the capital in these assets in markets. This is why these staggering figures represent such a tragedy: this value cannot be put back to productive work. All this capital is dead.

I will mention two further points before moving on. The first is a call to humility on the part of ‘the West’ that de Soto takes great care to make and that it would be unfair to leave out here. Though he extols ‘the West’ frequently, de Soto is careful to emphasize that this is first of all based on the economic state of affairs at the time of writing, which of course has been vastly different in the past and may well be in the future. But more importantly that his own partial theory as to why this is the case isolates the representational tools that gave rise to such circumstances as of the utmost importance and of no essential connection to those who discovered them:

“Throughout history people have confused the efficiency of the representational tools they have inherited to create surplus value with the inherent values of their culture. They forget that often what gives an edge to a particular group of people is the innovative use they make of a representational system developed by another culture. For example, Northerners had to copy the legal institutions of ancient Rome to organise themselves and learn the Greek alphabet and the Arabic number symbols and systems to convey information and calculate. And so, today, few are aware of the tremendous edge that formal property systems have given Western societies. As a result, many Westerners have been led to believe that what underpins their successful capitalism is the work ethic they have inherited or the existential anguish created by their religions — in spite of the fact that people all over the world all work hard when they can … Therefore, a great part of the research agenda needed to explain why capitalism fails outside the West remained mired in a mass of unexamined and largely untestable assumptions labelled ‘culture,’ whose main effect is to allow too many of those who live in the privileged enclaves of this world to enjoy feeling superior.”

Secondly, lest the reader think I had let up poking fun at mainstream economics, I will conclude this section with the same quote de Soto uses to begin The Mystery of Capital, from an address by the great (and heterodox) Ronald Coase:

“Economics, over the years, has become more and more abstract and divorced from events in the real world. Economists, by and large, do not study the workings of the actual economic system. They theorize about it. As Ely Devons, an English economist, once said at a meeting, “If economists wished to study the horse, they wouldn’t go and look at horses. They’d sit in their studies and say to themselves, ‘What would I do if I were a horse?’” And they would soon discover that they would maximize their utilities.”

The Threads of Heterodox Economics

Given three works, all on the same broadly defined topic, and all wonderfully original, it is surely possible to draw many more connections than I intend to here. This will be a short section, and I do not so much intend to draw parallels in economic theory as in methodology and intellectual outlook. The allure of public blockchains is that to a large extent they demand their own economic theory, which we can only hope to craft from first principles by teasing out the best of these three authors’ first principles approaches.

Firstly, none of the three ever discuss static equilibria. They are not interested in describing precisely how things are at a given moment, but rather how things change. They are interested solely in causation. They understand that economic phenomena are causal processes driven by the behaviour of individual people. People are not static. They have motivations and goals. They act. They are alive. There is no static human who can be mathematically described without reference to time.

Largely for this reason there is not a single equation across the three books. The argumentation is verbal. The reasons given for why things happen are the reasons the people doing those things acted in the way they did. Perez describes the interactions of people at the verge of financial and production capital. Jacobs describes the interactions of people with their physical environment. De Soto describes the interaction of people with agents of the law. People are messy. They can be described, but not with equations.

This basis of understanding lends itself naturally to a proper, we might say Hayekian, appreciation of what markets really are: engines of coordination of dispersed knowledge and desires. There are no static equilibria because competition is a process, not a state. We can try to grasp how markets work in the abstract, but if we lose our intellectual humility and suppose we can understand a given market entirely and in its particulars, then we must not understand markets in the first place. That twentieth century economics largely became self-indulgently enamoured with the opposite view — that every snapshot of time can be plotted on a graph and all economic data gathered and understood in its totality — explains the disdain across all three for the mainstream. Since the mainstream largely disdains public blockchains (to the extent it understands them at all) we are in a good place to continue.

Blockchains and the Tying of the Threads

There is a straightforward appeal to Perez in the context of blockchains in explaining the bubble of 2017 and the worthwhile work done since. I won’t rehash it here as I think it is pretty obvious and have nothing to add. One thought I have had, however, is that it is possible that this technology will provide an exception to Perez’s theory in some respects, but not all, insofar as it being baked into the technology itself that anybody can become financially involved without much intermediation — certainly a tiny amount relative to traditional securities. I think this goes a long way to explain the magnitude of 2017, which in some respects truly was a bubble like no other. What I wonder, though, and don’t have a good answer to, is whether this breaks the sociological thesis that relies on financial capital being institutionalized to some or other extent. This space may come to have heavy institutional involvement one day, but only by coincidence, not design, as for all other investable securities. But I really don’t know, so I’ll leave that one for now.

What I think is actually the most interesting thing to observe now is the extent to which this potentially problematic area is being addressed. You may or may not believe in the likelihood of eventual institutional involvement. But a necessary precondition, which is as a matter of fact being worked on by many brilliant people who clearly do think it is likely, is both operational infrastructure to enable it within that environment. We also clearly need a regulatory environment that treats it as clearly as it does other asset classes, given that clearly defines the opportunity cost of financial capital that may be allocated here.

What is encouraging, however, is that we have certainly had one frenzy, irruption, and crash in 2017, and it seems to have played out much as Perez would have predicted. Financial capital (with a mildly altered definition) ran amok, production was helpless to prevent it, paper gains enticed dumber and dumber money, so dumb that even outright scams became worthwhile endeavours, etc. etc., and then it all collapsed. We are now in a phase in which financial capital has been chastened and tamed, timeframes have been reset for the long term, and real wealth creation can be driven by people who know what they are doing. I certainly hope we don’t have to go through this again, but it strikes me as fantastic evidence in favour of Perez’s overall approach. This is the first technological revolution since her work, and her theory works (nearly) perfectly as an explanatory tool.

Jacobs, we recall, is primarily interested in where economic activity takes place, and what regions it is sensible to describe as salient economic entities. ‘Nations’, she argues, are rarely good examples, but cities almost always are. Not to criticize Jacobs at all, as it would be pointlessly anachronistic, but I think that the existence and proliferation of essentially digital goods throws this model into question, and that resolving this novel tension leads naturally to the best way to think about blockchains. For example, does the economic activity that happens through Google all ‘happen’ in Mountain View, California? In a pedantic sense, yes, but in a far more obvious sense, no. Google’s services are digital and very barely able to be defined in a traditional physical sense. Unlike even Amazon, which is a marvel of digital engineering but whose end product is clearly Alice in place A selling a widget to Bob in place B, it’s not entirely clear how to make such definitions for Google (which is the legal basis for its tax-scams-in-all-but-actuality).

Blockchains take this to its extreme because there isn’t even a corporation involved. In some respects, it makes a lot of sense to think of blockchains as actually being corporations; clearly not legally, but in that they are associations of individuals contributing to a common enterprise that itself is clearly acting as a discrete unit and according to a charter. This is an area of thought that is still very much developing and I don’t want to send the reader too far down the rabbit hole against her will, but it seems to make sense to a lot of people to treat blockchains as, additionally, closed economies for a single digital service with digitally native currencies, and with on-ramps to other digital assets and, at the edge of the system, to fiat currency. Where further to go with this observation is a matter of intense debate that need not concern us here, but it is however clear that they are in no way physical. It’s a bit like asking, where is BitTorrent? The only sensible answer is, on the Internet, which may or may not register with what was expected by the questioner.

Regardless of any further philosophical interpretations, it is clear that this exclusively online activity constitutes economic productivity that it makes no sense to ascribe to the US or France or Bolivia or wherever. The only sense in which it makes sense to do so for Google is that the operational backend of Google is highly centralized and has a corporation built around it in order to be allowed to be profitable and protected by law. It is a little torturous, but it is not completely nonsensical to consider Google’s economic activities as having a geographic footprint. But public blockchains ought to have no reverse engineering to tie them to a physical location — whether this is true in fact is a matter of degree and debate. But in their purest form, it arguably only makes sense to consider them as Jacobs’ salient economic entities.

This leads to probably Jacobs’ most interesting argument — that of the feedback metaphor. I don’t want to speculate on precise technical visions, lest we fall into yet more rabbit holes, but suffice it to say that it is clearly desirable that as many blockchains as possible will be capable of interoperability. We needn’t even think too hard about what this might mean beyond an analogue of using Facebook to log into Spotify and using Spotify to post on Facebook. Those two networks are ‘interoperable’ under a suitably light interpretation. So, hopefully, will be blockchains, under an interpretation that is actually more rigorous. What is potentially fascinating, however, is that this interoperability will not be on the basis of corporate agreements, but rather of automated exchange of their native currencies. Given this will be inherently digital it will ideally be fairly seamless also. Therefore, we might think, we will get exactly the kind of dynamic feedback system for these salient economies that Jacobs craved in real life, and bemoaned the structural imposition of national currencies for non-salient economic entities as preventing. Economists might even be able to observe, for the first time in hundreds of years, a genuinely free market for money spontaneously emerging, unbounded by sovereign constraints.

Finally, to de Soto. The obvious instantiation of his work in this realm is in tokenizing at the very least real estate, but ideally as much ‘property’ as possible. It doesn’t take much to realise how representational systems would be vastly improved under such a system, from which the rest of de Soto’s argument follows. This would ‘enliven’ multitudes of ‘dead capital’, and bring about enormous trade and wealth on the back of what is really little more than altering incentives. This is well researched and argued elsewhere and I have little to add but approval.

However, I think there is a more interesting line of de Soto’s thought to follow in this context. De Soto’s core thesis is sociological rather than economic; contrary to popular conception, law is an exercise in engineering, not in morality. If it is engineered poorly — immorally or otherwise — people will simply ignore it. But the law is also potentially enabling, and so effective engineering ought to be the goal, since the opportunity cost is potentially enormous. People can ‘ignore’ stupid or unjust laws regarding capital accumulation by creating shadow economies, but not by creating real economies. There is an implicit loss even in the use of the word ‘shadow’. It is less real.

The same will be true with the economic potential of blockchain. It exists. It works. It isn’t going away. And so, lawmakers have a choice. They can engineer legal frameworks that enable productivity, capital accumulation, wealth and wellbeing using this incredible technology. Or they can be stupid and unjust and create shadow economies at enormous opportunity cost.

I have never had the pleasure of any of their company or correspondence, but here is what I imagine each of my heterodox heroes would say:

Jacobs would advise to take these seriously as salient economic entities and allow their development as highly dynamic systems of information feedback. Do not force them into any previous paradigms because it almost certainly won’t work. Perez would encourage governmental leadership to facilitate a move past the crash, no less to prevent another. Let financial capital be involved but not in control. Perez, in other words, would make the case for effective integration of the technology into the mainstream. De Soto would warn of what would happen if we fail to: shadow economies will develop at enormous opportunity cost to the wellbeing of all mankind. If they would have said this, then I would agree.

But most importantly, all would be skeptical of mainstream economists. Unfortunate as it is, this is invariably a good idea. After all, so was Satoshi, one of the most heterodox economists of all time.

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