 The linear systems framework to economics that we previously discussed was developed during the industrial age. It enabled a transformation to the domain of economics from being a part of natural philosophy to becoming a much more powerful framework that could support the huge economic transformation that was the industrial evolution. It has in many ways been very successful in doing this, but today a number of major trends are having a fundamental transformative effect on our economies as we transit further into the 21st century. In this module we'll be talking about some of these major trends that are reshaping our global economy, both on the micro level and the macro level, both in the real economy and on the institutional level. These trends are taking us into a world of heightened connectivity, interdependency and in a word complexity. A world that in many ways goes beyond our traditional industrial age paradigm. What we're trying to give an overview to here is the macro scale transition of advanced economies as they're currently going from an industrial age form to a post industrial form. I've used this very open term post industrial because it's not totally clear what will be the defining factor to this next generation economy. We can identify a number of major factors that are becoming more clear. The term post industrial is in many ways a synonym for a services economy and with the huge rise in services over the past few decades, advanced economies are already fundamentally service economies. Services are very different from industrial age products and this has major implications that we'll be discussing. Given the profound effect that the information revolution is having on our economies as they become driven by information and knowledge, we'll talk about some of the implications of this for economics. Globalization is another very important transformation. Our economy of the 21st century is increasingly globally interconnected and we'll be discussing this also. And lastly, we'll talk about the rise of sustainability as it is becoming an ever more important factor in building this next generation of sustainable globally integrated economy based on services, information and knowledge. This is obviously a lot to cover in one lecture so we'll just get to touch on some of the most salient factors. The services revolution can be described with reference to very straightforward empirical data over the past number of decades services have come to dominate advanced economies and are slowly but surely coming to dominate the global economy. Having this simple observation is a very profound, subtle and complex transformation as it means the stuff that our economies produce is changing. It is changing from tangible industrial products to intangible services. These two things have fundamentally different characteristics meaning this transformation is having a very significant effect on what the economy does and is. And just to remind ourselves what all this economic activity is about, it's about the efficient use of scarce resources to achieve valued ends. Within post-industrial societies these valued ends are subtly but fundamentally changing. Advanced economies have largely completed the process of industrialization, the function of producing basic industrial products for the mass of society. And people want more than this now. They want things like experience or actual quality of life. People aren't happy to just go to the nearest beach on holiday anymore. They want a package holiday that takes them to some exotic place providing them with a full experience they can tell their friends about. They don't want just a pair of jeans, they want some designer jeans where what they're really paying for is a story than an advertising agency produced. The actual physical product is outsourced to some industrial developing economy. Advanced economies increasingly create the service experience that goes on top of the product. The nature of services is studied within service science and service design. We won't go into the technical details here but services include all sorts of things that are way outside the box of our traditional industrial age model such as attention, advice, access, experience, discussion and of course information of all kinds. These are not things that you can wrap up and put in a box to be pushed over the counter but wrapping things up and pushing them over the counter is the only real model that we have so we go on trying to use them. The whole model that was built for the mass production of standardized tangible industrial products that were pushed out to isolated and passive end users is being stretched to its limits by the rise of the services economy. Successful services are things like how happy you felt visiting a restaurant because it was a smooth, seamless service that provided you with what you expected and wanted. The focus is on people interacting with people and serving the customer rather than transforming physical goods. Service systems place people at the center of the world. They aggregate disparate technologies and subsystems in order to deliver functionality that is, importantly, measured in terms of customer satisfaction and that's a very different metric to how many products you pushed over the counter that day. Maybe the best example of this is within advertising. Previously, it was about paying some celebrity or beautiful person to tell other people that if they buy a product their lives will be better. Advertising today is increasingly focused on getting your friend to tell you that they bought an item and it actually made their lives better. The difference is subtle but profound. It's not about fancy things that have all sorts of amazing properties, it's about the actual value and experience that they deliver to a specific person, often within a specific context. Increasingly, this idea of just getting more things is not really cutting it. After many decades of prosperity, we're becoming somewhat disillusioned with this dream that was part of the industrial model. People increasingly want the real thing, happiness, health, well-being, quality of life and this is a paradigm shift because the industrial model always looks inside the economy, modelling its throughput but in the real world it's not just about what you produce, it's also about what people want and how the economy matches that. This might sound obvious but it doesn't fit into our traditional model. All we can capture is the gross output to the economy. As mentioned, serviceization is a very subtle and complex phenomena and it is in many ways the foundation to the implementation of the information revolution to our real economies. Things have to be serviceized before they can be digitalized. They are, in many ways, two sides of the same coin but the service's revolution is the infrastructure, unlike the information revolution that gets all the fame but they are totally symbiotic they enable each other. To quickly summarize, services engender a whole new economic paradigm involving co-creation, enduring service relationships, service process and life cycle, context, product service networks, personalization and extreme customization. This is very different from the industrial age, mass production of standardized one-size-fits-all discrete products that can be easily quantified. The information revolution is probably pound for pound the most profound and radical force of our time that is felt in all areas. From hooking up online to the automation of production lines it is having a structural transformation to both the technology and institutional infrastructure of our economies as they become networked, adaptive, automated and virtualized. Probably the most significant thing for us to cover here is this big idea of connectivity. What is also called hyperconnectivity which is clearly being driven by information technology as it networks our world within all domains and on all levels, hyperconnectivity is a very radical phenomena. We'll not present data or go into the details on this but just present a very high level view. Complexity theory has, in many ways, taught us that connectivity is a fundamental parameter to a system. When we have a low level of connectivity within a system, the component states can remain asynchronous for a prolonged period of time. I might totally disagree with my neighbor about what color shoes people should wear but as long as there's a big fence between us and I only see him once a month to say hi, this is not going to be a big problem and we can go on maintaining our very different philosophies about the coloring of shoes. Now let's turn up the connectivity by saying me and my neighbor getting employed by the same company to design the same pair of shoes. This connectivity means we cannot go on in our previous isolated asynchronous state, we will inevitably come into conflict and or cooperation. Because we are now, and this is the important thing, interdependent. The dynamic of independence which was our first state and interdependence which connectivity created are very different things. With interdependence the gains and losses of one are directly correlated to the gains and losses of another. Within this dynamic an individual cannot systematically get ahead by reducing the value of another one. But instead you have to make the whole pie bigger in order for you to get ahead. This fundamentally changes the dynamic towards openness and cooperation. Not because people all of a sudden become nice, virtuous individuals, we're not changing the variable of how altruistic people are. We are assuming that stays constant. What connectivity changes though is the structure of the game we're playing. Connectivity drives interdependency and non-zero sum games. Connected to this is the so-called network effect, which basically means the value of something is in its capacity to interoperate with other things. In an interconnected world value is in the network, not so much in a thing, product or organization. Almost all of the valuable knowledge your organization has is not in your organization. It is instead in the internet and your organization is going to have to have access to that network for it to maintain relevance. That means you have to be part of these networks and your value is in your differentiated function within those networks. The point for us to take away here is that information technology is driving connectivity, which leads to both greater conflict and cooperation, but ultimately greater interdependency. Because of the dynamics of interdependency it tips the balance towards open systems of organization instead of closed systems. This is going to present major problems to our traditional economic models based around closed systems and zero sum games that we discussed in the previous video. Something as profound as the information revolution has many ramifying effects across the whole structure to advanced economies and another one of these is mass automation. Information technology is commoditizing basic information processing and services. The next generation of software systems and algorithms are specifically designed to automate these functions. Whether we like it or not, whether we're ready for it or not, mass automation is upon us in the coming decades with significant economic consequences. You can take many basic services, information processing and manual tasks. There'll be some team in Silicon Valley working on automating them and major breakthroughs in the technology that supports them in doing this are happening all the time. As IT commoditizes basic economic activities, it will drive value up the value chain. It's within this context that we can talk about the burgeoning knowledge economy. As the sea of data and information grows exponentially, the amount of knowledge and intelligence becomes relatively scarce. If you've spent any time in the world of business management, you would have heard the word innovation and a relentless demand for more of it. As human capital and innovation are moving to the forefront of how organizations generate value within this emerging knowledge economy. Commoditization of basic production processes and services puts business organizations and particularly multinational corporations in a very competitive space. They have to move up the value chain to maintain differentiation. This makes the knowledge economy an ever more clear and present reality enabled by information technology and suffice to say the knowledge economy runs on very different rules to that of the industrial age economy. Another major factor to be considered here is what we might call economic virtualization. Information technology always and everywhere enables virtualization. Virtualization is the process of decoupling information from its underlying physical supporting structure. The image of a planet once only existed as an extension of a physical planet. Information technology has enabled us to decouple that information from the physical system and we can now store, manipulate and exchange this information independent from the underlining physical structure. Of course this process is nothing new, we've been doing it for thousands of years but with the information revolution it's in hyperdrive. As with almost all areas, this virtualization process is also happening to our economies. With respect to our discussion here, money can be thought about as a piece of information that represents some form of economic value. Finance is then the storage and exchange of this virtual economic value. From this perspective, finance is the information layer that sits on top of the economy. It is then possible that anything forming part of the real economy can be converted into a financial instrument and become part of the financial system. The process of doing this is called financialization and financialization is a major trend that has been taking place over the past few decades. I'll quote Wikipedia on this subject when it says, quote, financialization is the term used to describe the development over the past decades between 1980 and 2010 in which financial leverage tended to override capital equity. The financial markets tended to dominate over the traditional industrial economic activity. Financialization describes an economic system or process that attempts to reduce all value that is exchanged, whether tangible or intangible, future or present promises, etc., into financial instruments. The intent of financialization is to be able to reduce any work process or service to an exchangeable financial instrument and thus make it easier for people to trade these financial instruments. Financialization can be thought of as the virtualization of our real economy through information technology, mathematical modeling and lots of financial analysts. We take any real world asset and virtualize it into a financial instrument. They can then be processed and exchanged within the financial system. Since the liberalization of financial markets and the rise of information technology, the financial industry has been in a state of hyperdrive performing this activity. The net result of this is that it has come to dominate over the real economy. As you might imagine, this machine that we've built and are now dependent upon is very immature, fragile and we are far from understanding it, placing us in a very precarious and unstable situation, as illustrated by the 2008 financial crisis. But information technology is also transforming our capacity to quantify and define value itself. With social networking technologies and the internet of things, information technology is giving us the capacity to quantify our world like never before. Things that we thought we could never be able to quantify, like friendship or CO2 emissions, increasingly have real values associated with them, such as likes on Facebook. And as we start to embed sensors in all kinds of devices and objects, we can get real data about many aspects to our natural environment that were never possible before. What this means is that it is increasingly possible to virtualize all forms of value. Social capital, cultural capital, ecological capital, industrial capital, they are all converging onto common IP platforms. It is becoming increasingly clear that all these different forms of value are not totally independent, but increasingly interconnected. People liking your business on Facebook translates into increased revenue. People being prepared to pay extra for sustainable products means the exchange of ecological value for financial value. Fair trade and social impact bonds mean people are paying for social capital. With ethical bonds and green bonds, you are paying for cultural and ecological capital with financial capital. Different forms of value become merged within single products. All of this is only possible due to information. The more information we have, the more we can directly translate all forms of value onto a common platform and see before our eyes how they are exchanged. This means that the value of something is increasingly heterogeneous. Value is less a single thing as we increasingly recognize, quantify and correlate different forms of value. A commodity may well stop having a single homogeneous value. Its value will be a network of interacting variables and we will be able to in some way exchange these different values, which of course we already do and have always been doing, but with information technology we now have the capacity to make this explicit. Here again, we're going to get a breakdown within our traditional model that is assuming a homogeneous closed form of industrial value. Lastly, in talking about information technology, we'll note how it is enabling a new distributed structure to our economy. From manufacturing to retail to finance, information technology enables production to happen at the edge of networks and these goods can be exchanged directly peer to peer, which is in strong contrast to our traditional industrial age centralized systems of organization. As an example of this, we'll talk about what are called distributed edges. You've probably heard of Bitcoin and you probably know that it is just one of many digital currencies. In fact, it's just one of hundreds or even thousands. These digital currencies are built on top of a technology called blockchain. Blockchain is a form of distributed ledger. A ledger is a record of value exchange, typically associated with counterparties involved in that exchange. Unless you're an accountant, these ledgers won't sound like the most exciting thing in the world. What is of interest though is this, the financial industry is built on ledgers. This model of a ledger essentially captures the backbone of what finance is. And because finance is really an abstraction of the economy, it also really captures what a market is. In order to facilitate a financial transaction, you have to have two identifiable parties who wish to make that exchange. You need some impersonal system to verify their identity if needed and keep track of the transaction in some form of ledger as a record of what happened and who owes who what. These third party organizations need to be seen to be legitimate, authoritative, enduring and all those things that enable people to place their trust in them so that the transaction can be facilitated. This is largely what the financial system does. Of course, it serves other important functions, but this is in many ways the center of its functioning. Within the industrial model, this whole framework was and is still built on a centralized system. Within the industrial model, these ledgers are managed and verified by centralized organizations, such as banks. But the assets on these ledgers can be anything such as currency, pensions, contracts, mortgages or ownership of any asset. Thus, there are many different institutions, but these institutions are typically backed and regulated by the government for their ultimate centralized authority within the whole system. So this whole system looks very cozy and comfortable. Why would financial experts be so interested in these distributed ledgers? Firstly, what are distributed ledgers? We know what a ledger is. It is a list of transactions with associated identities. A distributed ledger is a ledger that keeps track of all the transactions that have ever been made within the value system. This information is encrypted and held on many different computers. Whenever two individuals wish to conduct a transaction, one of these ledgers is randomly selected in order to verify the transaction. Once it takes place, all of the other ledgers will be updated with the new information. So this is an open system in that the information is distributed out, but this information is of course encrypted. The ledger is then simply a list of all the transactions that have taken place. The process of verification is distributed out among many different computers. Distributed ledgers are essentially value exchange protocols. You can exchange any value within them. The deeds to your house, some currency, claims to a parking spot for your car, victory points in a computer game. They can all be encoded and safely exchanged without any centralized authority. This is a technical system. The faith is in the mathematics and technology, not people or institutions as it currently is. Uptake in this technology is very rapid at the moment, with somewhere around 10x growth per year. And this has major implications for the financial system. In a recent interview with the BBC, Derek White of Barclays Bank had this to say, quote, we see the power of what this blockchain can become. Venture capitalists see this, but even more exciting is the disruptive minds of entrepreneurs who see the power of this and they are building new businesses, new paradigms that are going to change the shape and face of all industries. In a World Economic Forum's report, they said this, quote, economic and monetary management will be overhauled by new systems anchored in digital currencies and the blockchain, making traditional pricing mechanisms and exchange rate systems less relevant. The World Economic Forum, notably, projected that governments would begin leveraging the blockchain sooner than the mainstream public, with this transition expected to occur in 2023. So we spend a lot of time talking about the effects of the information revolution on our economy because it's such a fundamental, powerful and disruptive force, which challenges our traditional industrial model along almost every dimension. And we'll come back to this as part of our discussion during the course, but we'll move on for now to look at two more macro-level phenomena. The abstract phenomena of globalization is one of the major processes of change in our world today. It is a social, cultural, technological and of course economic phenomena. On a theoretical level, it is a process whereby the reduction in transaction costs leads to increased connectivity between the components within the global economy. The result of this is their differentiation with respect to each other and out of that process of differentiation emerges some global pattern of organization. This is very much the same dynamic that we discussed previously, where interconnectivity drives interdependency and that changes the rules for the game. What information technology is doing for connectivity on the micro-level, globalization is in many ways doing on the macro-level, but this is a very high-level abstraction of what is really a very messy and complex process. It is a process that is only just beginning. Our world is a very big place and it is socially, culturally and economically still very heterogeneous. It is going to take a lot of globalizing before it is properly globally integrated. This process of globalization involves many deep economic and political vested interests that create many highly contentious issues. We're not dealing with obscure technicalities here. These are things that everyone cares about. Our basic premise here will be this. Economic globalization is primarily driven by global connectivity. This interconnectivity is enabled by two primary factors, one technology and the other institutional. That is the reduction in the discontinuities and boundaries between jurisdictions. Corporations have harnessed both of these to develop global networks. These global networks are the primary structure and drivers to this process of economic globalization. Starting in the late 80s, a new economic and political ideology arose, promoting the idea of the free market, both internal to the nation state through privatization, and external through the reduction in trade barriers, tariffs and other policies that were designed to reduce the discontinuities between national jurisdictions and enable a global free market. The net result of this, coupled with new information technologies, has been a massive increase in global economic exchange. Economies are at the end of the day built out of technology. Corporations are built on top of available technologies. Due to their profit motive and the competitive environment they're operating in, they are often the first to adopt new technologies and they try to exploit them towards gaining competitive advantage in their respective markets. These institutional transformations are happening on top of a new set of information and communications technologies that enable global coordination at the speed of light. Corporations have been very effective at leveraging the new possibilities of these technologies to become global networks, both in terms of their physical form as supply chains have become globally distributed throughout sourcing but also in their institutional form as networked organizations distributed out across global cities that provide them with the advanced services they need to operate competitively in a global environment. And of course we have financial institutions starting to leverage this technology and also push for deregulation and liberalization of financial markets. The net result of this is that our economies are increasingly managed and operated not by nation states within an independent national economic system but instead increasingly by these global networks run by multinational corporations. This creates both benefits and challenges because it is fundamentally changing the global economy from one that was defined and governed by discrete components to one that is essentially a set of global networks. This can and is enabling a huge restructuring to the distribution of power within the global economy because as we previously mentioned in these highly interconnected systems the wealth is largely in the network. If you can connect into the network and provide it with a differentiated function that it needs performing then you can gain access to the resources that are flowing through that network in terms of foreign direct investment, trade opportunities, expertise and so on. If you as a nation can connect into one of these networks and provide them with what they need to function whether that is commodities in frontier markets like Angola, cheap labor like in China, financial expertise like in Singapore or tax havens like in Ireland then you can attract these resources that are flowing on the network and grow your economy at an unprecedented speed. And this has proven to be one of the most effective methods for raising millions of people out of poverty. It is also having a strong redistribution effect on the macro scale as resources within the global economy that were previously highly centralized around western nations and in particular the US are becoming distributed out to anyone who can perform a differentiated function that the network needs and if you can do that with a nation that has a billion or so people like China or India then you can very rapidly change the balance of economic power which is exactly what is happening. But of course this is far from being one big success story. It has created many challenges. I'll just quote from the economist Danny Rodgerick to illustrate this when he says quote the essential problem of the post 1990 model was that we pushed for hyper globalization without the institutional infrastructure and this model created failures of legitimacy where in fact global rules went too far such as in trade with the World Trade Organization and created problems of regulation where they didn't go far enough and global finance was a key example of that. So the fundamental problem of the world economy in the years leading up to the current crisis was in balance between the reaches of markets that was increasingly global and the scope of their governance which remained by and large mostly national. The thing to remember is that this economic system is designed in such a way that it will systematically under evaluate secondary resources that is the secondary social and environmental factors that support the free market without them it can't function. This model to an economic system has systematic market failures. Those failures create externalities that work to undermine the supporting structure to the system. The result is massive environmental degradation, extreme inequality and many other problems. This form of economic system means some form of external governance to regulate these externalities. Without it the system is unsustainable not just in the long term but even in the medium and short term. To be succinct this model has systemic failures. It only really works when it has the nation state to mop up those failures. Running this model that has systemic failures without its traditional support mechanism at the scale and speed that we're currently operating at is a highly precarious situation. The end result of this is that this primary dichotomy and balancing mechanism is breaking down. This is a major unresolved issue in our world today. A constant tension creating many problems that we don't really have any solutions to. Another factor to note here is as Danny Roderick noted social governance remains by and large mostly national. We have global institutions but they are piecemeal. They don't properly integrate and coordinate in order to be effective as they need to be in order to deal with the powerful economic actors that are at play. Capabilities are still retained on the national level. There is currently no real form of democratic social regulation to the workings of our economy on the global level. There is just a significant imbalance of power towards major private actors that have the capacity to significantly influence and manipulate weak political institutions. People know this, it affects their lives and they feel disenfranchised. All of this is expressed at best in mass cynicism and resentment towards multinational corporations and at worst it is expressed through violent protests at economic summits. So why hasn't governance developed alongside the economy? There may be a number of reasons for this. One very simple fact is that coherent social governance is built on top of and requires cultural commonalities and consensus which remains a largely absence on the global level. Different nations have different cultures and from these we get different conceptions about how they want the world to be governed. There remain in many ways deeply divided and without the consensus required to formalize coherent governance. There are only really a limited number of solutions to this. Either we turn back the clock that is to say de-globalized by trying to throw out barriers to cross-border flows which might be possible or we develop some form of much stronger global social institutions to manage these externalities in the same way as we previously did on the national level. That pretty much worked on the national level whether it would work on the global level or if we could implement it is debatable. The last possibility would be to find some way of restructuring the market mechanisms to reincorporate these negative externalities that is to say fix the market failures that are creating these issues. Suffice to say globalization is another vector that takes us into the world of complexity and raises many questions that seem to be unanswerable within our traditional industrial age paradigm. The industrial model to the economy was built in a world of what appeared to be almost infinite resources. It was a world where millions of buffalo roamed across the prairies of North America and all you had to do was tame nature and the bounties were endless. This world of a struggle between man and nature is largely over. Through industrialization, we can pretty much declare victory but this victory has come at a high price. With a growing manifestation of the negative environmental externalities to the industrial age economic model coupled with a growing manifestation of the finite supply of natural resources has come the concept of sustainability a new awareness and paradigm surrounding human economic activity and its relationship to the natural environment. Sustainability is a whole new paradigm because it is truly a new way of seeing the world. Think about something like a car within the industrial paradigm cars made sense. After all the auto industry maybe 10% of our GDP because advertising agencies told us how important they were to our freedom because everyone else had one it all made sense largely because it fitted into the industrial paradigm. But with this new idea of energy efficiency we suddenly start to realize that only a few percentage points of the fuel that we put into our car is actually used to move us and this is when it's in use when on average a car is unused for 92% of the time. When we start to look at the world in this way things stop adding up in the way that they used to and we start to ask whether the industrial model is still relevant. Within the industrial model our economies looked like perfectly efficient well-oiled machines. Within the sustainability paradigm we start to see a totally different picture. We start to see how the average household power drill is used for approximately 10 minutes during its entire life cycle. How one third of the food produced in the world for human consumption every year gets lost or wasted across the supply chain. The paradigm of sustainability shifts our focus from the optimization of subsystems to the efficiency of the whole system within its environment. Linear systems theory is focused on subsystems. The industrial paradigm that is based on linear systems theory was thus focused on optimizing subsystems like individual businesses or individual production lines. In so doing it systematically depromoted the overall efficiency of the system within its full context. When we change this paradigm we start to see suboptimal solutions on the global level. As these new ideas of energy efficiency and sustainability rise we're all starting to become aware of this. Start-up businesses from Brazil to Amsterdam to Taiwan are ready to take advantage of this building new business models around tapping into this vast expanse of underutilized resources. Governments are eager to support them and people feel inspired by the opportunities. The circular economy may be a massive, macro-scale transformation to the deep structure of our economies but in many ways it's happening one recycled plastic bag at a time. With this new paradigm we're now creating value out of nothing. That is to say at zero marginal cost. We're creating value by reducing waste. Thus we don't have to actually produce anything and it may not even cost anything. Marginal cost is a central structure to our industrial age economic system. The whole thing is built around the idea that it costs something to produce value. As such, the circular economy is in strong contrast to our industrial economy that was focused on value in terms of production and consumption. There's now thought to be 62 Lego bricks for every person on the planet. We've produced a lot of Lego bricks and that created value but the vast majority of these Lego bricks are now sitting in some cupboard not being used. The value proposition today is in getting these Lego bricks to the people who want to use them and there are no shortage of startups that are focused on trying to tackle this problem through peer to peer markets. But this is not about production and throughput which is what our whole economic machinery is designed for. As such, it is creating a new form of economy, a circular economy based on the paradigm of sustainability which is only set to rise. What we've tried to outline in this brief overview to the nature of our global economy today is essentially the problem space that we face as we transit further into the 21st century. As we noted, our national industrial economic systems of organization have in many ways reached the end of their life cycle and we're challenged with building a next generation economy and it's becoming more apparent what it will look like. It needs to be sustainable. It will be globally integrated based on services, information and knowledge. As we've seen from this module, there are many challenges we face in doing this. We've tried to highlight where and how our traditional models are breaking down and hopefully at this stage, it should be apparent that these next generation systems that we see emerging such as distributed edges, network collaborative organizations, global supply chain networks and the circular economy, they all run on a very different set of principles to the ones that we discussed in the previous module based on linear systems theory. So with this very informal and quick analysis, we've set the stage to introduce you to the new paradigm of complexity economics that will hopefully provide us with some models that are better suited to this 21st century context.