The role of thermodynamics in the study of economic and ecological systems

Abstract

Economic theory has always maintained that economic value is “generated” solely within the economy where it is fully distributed among the factors of production before being “consumed”. According to this theory, the economy is an isolated system that does not need flows to pass across its boundaries in support of its steady state (“general equilibrium”). From a thermodynamic point of view this idea is unacceptable. According to thermodynamic theory, any open system, which allows flows of matter and energy to cross its boundaries, is capable of maintaining itself in steady state only because it “transport” value from its environment to restore the value that has been “consumed” within the system and dissipated. Drawing on the analogy with thermodynamics, this paper replaces the traditional systemic analog of the economy, which is the closed “circular flow” process, with the steady flow process. According to this analog, any efficient economy is an open system both physically and economically requiring a “flow” of economic value to maintain its steady state. In other words, an economically isolated system has to be inefficient and is bound to misallocate and overuse environmental resources. Whether the economy behaves as an economically isolated (inefficient) or open (efficient) system is an empirical question. However, if real economies are economically open and efficient, and environmental resources are abused due to the economy's unrestrained material growth, parts of traditional economic theory, espicially those related to benefit evaluation, will have to be modified. Policy recommendations will be affected in any case because internalization, the panacea of resource misallocations, cannot be more than a temporary solution. Instead of opening the economy, internalization encloses the harmed resource and saves it by abusing excessively other environmental resources.