Balance

3

July 2016
Ivan Obolensky

Profit is defined as financial gain, or the difference between the amount earned and the amount spent in buying, operating, or producing something. The term has been vilified or lauded throughout history depending on the time period and the author. It is a contentious subject, yet profit and the profit motive, when put in more abstract terms, can give us deep insights into the future, the global economy, sustainability, and even life itself.

In order to survive, an organism must expend less energy than it consumes and retain the difference. This idea is encapsulated in the Energy Balance Equation found in bioenergetics, part of the broader subject of biochemistry:

[Energy Intake (food)] = [Energy Expended (heat and work)] + [Energy Stored].1

This equation dictates not only how life operates in all its complexity and diversity, but why it functions the way it does.

If an organism expends more energy than it consumes and its reserves can supply, the organism will die. This concept is so universal, it applies at every level of life, from bacteria up through and including individuals, and more organized entities, such as packs, tribes, corporations, civilizations, and global economies.

Thus, economics, the study of finance, and even accounting are far more important subjects than they might first appear. It also follows that each is far easier to understand despite its seeming complexity because all economic and financial entities are subject to the same constraints of the equation in spite of any appearance to the contrary.

With this in mind, the Energy Balance Equation is worth examining more closely.

Much of generic system modelling is based upon the concept of stocks and flows. Energy intake and expenditure are flows. Energy stored is a stock. The actions of eating food and working are examples of flows, while fat stored in the body is an example of a stock.

The Energy Balance Equation is an example of a dynamic system. Its values are constantly changing. When we weigh ourselves, we are taking a fixed measurement at a specific moment in time. This is a measurement of a stock, our weight. It is similar to a reservoir. Flows such as Energy Intake and Energy Expended are measured over intervals of time. They are rates of change. The difficulty in working with many equations of this type is that when we assign specific numerical values to discover how the equation is behaving, we are freezing a changing process in order to calculate it. Inadvertently, we lose sight of the fact that life, as well as stock and flow models, is always in motion. This can create misperceptions.

If we decide to consume only 400 calories for lunch, we are defining a flow process, energy, intake, in terms of a fixed measure, 400 calories worth of food, a stock.

Dieting can sometimes be a hardship because dieters fail to view eating as the rate of energy intake. They may think they eat less by eating small amounts more often, but the total calorie-count consumed on a weekly or monthly basis is the same as that before the diet. This brings up an important point. Flow rates must be looked at over several time scales to get a full grasp of what is going on within a system.

Failing to observe the rates of change over many different time intervals, just like in the diet example, are also why markets, organizations, even careers, can appear to be in violation of the Energy Balance Equation. They appear to be doing great but closer inspection shows they are not. The energy stored from previous profitable activity can sustain a system even though more energy is being expended and drained than is being accumulated. Over longer time scales, this is easier to see, but humans instinctively look across much shorter periods of time.

Part of the reason for this tendency is that the mind looks for fixed patterns similar to recognizing an image embedded in a mosaic. Pattern recognition such as recalling events and noting their similarities and differences is an excellent skill and helpful in predicting the future, but it orients us to see the static over the dynamic.

It is not that our minds cannot duplicate dynamic rates of change; we can, but analytically we are not very good at it. Ask any golfer what he does exactly with his club face when he hits a drive, or a tennis player, how he connects the ball and the racket when the serve is received at over 100 mph. Instinct and training take over, and the action is done unconsciously simply because the analytical mind is too slow to deal with it.  (See Incompleteness and the Imagination).

Humans recall memories as images or short sequences of them. How many of us see the patterns around us as strands of behaviors that weave through our lives over years of time? Not many. Such abilities are rare, and this leads us to the other two parenthetical parts of the Energy Balance Equation: heat and work.

Nicholas Carnot (1796-1832), the father of thermodynamics (the study of heat, energy transfers, and energy relationships) was a French military engineer. Steam engines had been invented and perfected by James Watt, a Scottish Engineer, around 1775. Carnot worked out the upper limit for the efficiency of an engine to convert heat into mechanical work. The efficiency of this process depended on the ability of the engine to not lose heat to its surroundings.

Heat is a form of energy associated with the collisions of molecules. Hotter gases contain faster moving molecules. If the fast moving molecules are added to the same number of molecules moving at slower speeds, the faster molecules collide with the slower ones and slow down, while the slower molecules speed up. Ideally, when the system reaches equilibrium, the temperature (how we measure heat) would be halfway between the two; however, very careful and exact measurements would find this is not the case. The equilibrium temperature will be slightly less than it ought to be. Where did that missing heat energy go?

Molecules store energy in the form of internal vibrations. Molecules are formed from atoms that are held together by chemical bonds. These bonds can twist, stretch, and bend. When we mixed the cold and hot gases, some of the energy got stored in the vibrations of the molecules themselves and some in the walls of the container.

No matter the efficiency of an engine, or living organism, energy is lost and locked away into the system itself. Even a system that appears static, or dormant, has to add energy, or pull it from some form of reserve, to continue over the long term. 2

How does a system intake energy? It has to do work.

Humans formed hunter-gatherer societies in the distant past, and ‘work’ took the form of hunting game and collecting the bounty that nature provided. As humans proliferated, agriculture became the work of choice because agriculture provided a surplus. Energy, in the form of food, could be stored away until needed, allowing human populations to expand exponentially.

Profits occur when an organism, or an organization, intakes more energy than it expends. One could make the error of thinking of profits as the energy stored, or money in the bank from doing work, but once again this would be mistaking a stock for a flow. Profitability, or lack thereof, is demonstrated by comparing the rate of energy coming in to the rate of energy going out at either a specific point in time or over longer periods. A system can be profitable across a particular time scale but not profitable over another. The important point is that profitability is a comparison of rates of change.

To make this clearer, imagine having a giant reservoir of water in a desert. Is that a profit? No, it is not. It’s a stock that might be profitable, if one is able to transport it, or exchange it into something more useful, like food. Having lots of water where water is scarce is potentially hugely profitable. In an economic sense, the water is not profitable until the water starts going out, and the money starts coming in. How will the water be transported? If we are into the money game, where do we put this money? It’s a desert. There’s nobody here. Who do we sell our water to?

I have added some complexity to not only move from the more abstract to the more specific, but also to illustrate that synthetic entities, such as corporations, are simply larger variations of the Energy Balance Equation, but with more parts.

What is missing in the water in the desert analogy is infrastructure. It needs to be built, which means energy must be expended to create it and additional energy used to keep it maintained so a profit can be turned. Infrastructure could be considered a form of the heat lost in the Energy Balance Equation.

In the body, energy is stored as infrastructure (bones, cellular structures and tissue) and is usually not accessible to living organisms as a form of reserves to fall back on except under dire emergencies brought about by starvation. One of the marvels of modern finance is that economic entities can do routinely what nature only does as a desperate last resort before death; but more on that later.

The real world of economics contains many parts fitted together to make a larger whole. Each part essentially has to turn a profit on its own. Suppose, in our desert analogy, the person in charge of loading bottled water onto trucks takes the day off instead of loading. Of course, done too many times they’d be fired, but why? If we look at the Energy Balance Equation from the viewpoint of the organization, the employee’s energy intake (pay) is greater than the energy expended into the organization. To the organization, he is not profitable. The employee is escorted off the premises. But to make it interesting, we are in a desert. It’s hard to recruit people to work in the desert. People who want to do so are scarce. It’s possible that the cost of replacing him is greater than that of keeping him. It is the Energy Balance Equation that will determine the answer. Sometimes an organism must put up with other entities that take more than they give. This is called parasitism.

Parasitism is a very successful form of behavior. In nature, there are many times the number of parasites for every host. There are of course limits to how many parasites a host can endure before there is so great an imbalance between energy intake and energy leached away that the host perishes. Until that limit is reached, however, the relationship, although non-optimum for the host, or organization, is sustainable.

[As an aside, the parasite’s urge to live as long as possible is secondary to the need to acquire the energy necessary to reproduce before the host dies. To the parasite, a short life span is advantageous, which is an interesting contrast to the very human desire to live forever.]

Any process or relationship is sustainable if it ultimately leads to profitability over the long term. Life forms don’t have to be profitable all the time. Many animals hibernate or go dormant. They consume large amounts of energy to build the necessary internal reserves to sustain them through the approaching winter, or dry period. When they wake, or their reserves run out, they must turn a profit once again or die.

Human retirement from a life of work is similar. Humans build reserves or surpluses in order to use them in the future. The larger the reserve, the longer life can be sustained. Profitability (the rate of inflow to outflow) in this case no longer faces externally, but internally as life becomes all about budgeting and fine-tuning reserves to extend economic survival for as long as possible. Just as in the hibernation case, if the reserves run out, it’s back to creating profitability from external sources.

Surpluses, where they exist, are usually considered as a positive number. They can also be negative. A negative surplus is when an organism takes a surplus, not necessarily its own, from somewhere else, but is obligated to return it in the future.

In nature this is found in the parenting relationship. Parents look after their young, supplying food, skill sets, and protection with no expectation of it being returned other than to the next generation when the young grow up. This is nature’s idea of a loan.

Living entities grow their own infrastructure internally or externally in the form of future generations. Resources in nature are scarce partly because energy acquisition, when successful, is copied by other species, or consumed in an explosion of procreation. Where there is abundance, it is quickly used up before others can take advantage of it.

Nature can demonstrate largess, but only over the short term. Over longer time scales, it is frugal, and this fact makes its infrastructure expensive.

In spite of this constraint, developing infrastructure is vital to life’s development. Single-celled organisms were at the mercy of their environment. When organisms evolved to be able to move independently of the environment, whole new energy sources became available. This was an extremely profitable investment for life to undertake, but it took millions of years to acquire, with many trials and many failures. The nature we utilize and live in is the infrastructure it built. Without it, we would not exist.

Economics and finance in the modern world has not only duplicated many of nature’s methods, but has expanded upon them to a marked degree.

To most organisms, except under life-and-death circumstances, the energy locked in existing infrastructure is not available. Financial engineering has created collateralized loans that can circumvent this restraint by making once unavailable energy accessible once again. But money and energy are not exactly the same.

Money is a synthetic form of energy. It is man-made and not subject to nature’s conservation laws that dictate absolutely that energy cannot be created or destroyed. Money is more flexible, and it is this quality that is responsible for both the bounty and the headaches of modern economic existence.

When money is entered into the Energy Balance Equation as energy, the equation takes on a much more flexible format. Equalities and precise relationships that exist in the real world do not necessarily apply. Imagine a structure made out of rubber. It can be stretched and still hold its basic shape. How much deformation can a system as represented by the Energy Balance Equation withstand?

We just don’t know the answer, nor do we know what will happen to this synthetic system, the global economy, going forward. It might fail, but then again, it might not. Nature didn’t know either when organisms developed locomotion, but then it had many millions of years to find out. Economically, we are in a similar place, but without the time.

How much energy is available in the global infrastructure that can be made available through the monetizing of infrastructure? Again, we don’t know the answer. We do know that although money is an abstract representation of a physical quantity, it is still anchored to the real world. Money can be exchanged for actual goods and services. It is done every day in staggering amounts. The relationship between money and energy therefore is not just hypothetical, but what that relationship is exactly is not understood other than as vague qualitative concepts such as inflation and deflation.

Today there are trillions of dollars of loans outstanding, which means a great deal of the energy locked away in the global infrastructure has been tapped into. As a personal observation, much of this newly available energy has already been mined and channeled back into the global economy.

I see many individuals and organizations forced to cut costs and control expenditures in the face of limited profitability from competition on a global basis. This is indicative of a system whose reserves (Energy Stored) are getting close to depletion. The Energy Balance Equation is flexible, but that does not mean it can be repealed.

So what does this mean and where do we, as part of the economic system, go from here? In spite of the overwhelming complexity, we may have to confront a fundamental simplicity:

We’ll just have to get back to finding profitable work as opposed to tapping into hitherto unavailable stocks of energy (reserves).

To find profitable work3 Nature gives us a hint. Relying exclusively on surpluses is not a viable option. The answer lies in new intelligent, but nonetheless expensive, infrastructure.

For the individual, this means rethinking how to create a higher rate of Energy Intake when compared to Energy Expended as per the Energy Balance Equation.

This may be difficult but not impossible.

It was once pointed out to me by a manager in no uncertain terms that the reason he got paid so much was because no one wanted to do what he did, not because others couldn’t.

Case in point: there are thousands of job openings in all countries but the people who can do them do not exist. There is no one trained or willing to do them. For too many companies it’s like being in the desert. There is nobody there.4

 


 

  1. Frayn, K. N. (2010) Metabolic Regulation, A Human Perspective, Third Edition. Chichester, West Sussex, UK: Wiley-Blackwell
  2. Young, H. D., Freedman, R.A. (1996) University Physics Ninth Edition, Reading, MA: Addison Wesley Publishing Co.
  3. Smith, C. H. (2016) Work Won’t Be Scarce—It’s Paid Work That Will Be Scarce. Retrieved July 10, 2016 from http://charleshughsmith.blogspot.com/2016/06/work-wont-be-scarce-its-paid-work-that.html
  4. Gillespie, P. (August 15, 2015) America’s Persistent Problem: Unskilled Workers, CNN Money, retrieved July 10, 2016 from http://money.cnn.com/2015/08/07/news/economy/us-economy-job-skills-gap/

 


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© 2016 Ivan Obolensky. All rights reserved. No part of this publication can be reproduced without the written permission from the author.

  1. Georgette Blanchard
    Georgette Blanchard07-28-2016

    Profit has become a dirty word, yet is it essential to survival. We say that children, animals, plants and any other organization “profit”. If they don’t, not only will they not grow, they will not survive over the short or long term. Profit became a dirty word however when profit became the “raison d’être” of many large organizations who were not interested in “fair play” or in treating people, the environment, animals, plants, children… right. Profit for profit-sake became the motto of many of those and who cares what or who gets trampled in the process. It therefore became a dirty word for those trampled.

    • Ivan
      Ivan07-28-2016

      Hi Georgette,

      Yes, profit became associated with robbery and abuse, which it is not. That was one of the reasons I wrote the article in the first place. Work can be profitable or not and that is one of our difficulties. There is a lot of work to be done but not all of it is profitable. Part of the poor choices available in terms of work is the result of the deflationary global forces at work (technology, free trade, malinvestment due to interest rate policies that have created asymmetric asset inflation). Margins are being squeezed so profit for ANY profits sake is becoming the norm. It will change because it must, but not likely soon.

      Thank you for reading and sharing your thoughts.

      All the best,

      Ivan

  1. Letter to RL02-09-17

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