Adam Smith’s Left Hand: Resilience in Economic Planning

Resilience is a new message, one demanding new audiences. A few weeks ago, I had a chance to connect with an important audience that was new to me. 

I was sitting on a raised stage on a panel in the elegant Bank of Spain — the country’s central bank. In the audience and online were some 500 financial and economic specialists from dozens of countries, all of them interested in how water was connected to national and global “financial system stability.” My question as a panelist focused on planning, which is how economists test out different scenarios: how do economic planning and resilience planning differ as we try to find and maintain financial stability?

The question cuts deeply. I’ve long felt that if we get water sharing, evaluation, and allocation arrangements inflexible or set at levels that do not match our emerging climate conditions, we’re probably going to mess up a lot of other things — how we manage our energy grid, for instance, much less how we manage tradeoffs between power generation and farms and ecosystems. Unfortunately, many examples exist for these kinds of outcomes.

With regard to the question, I have (and had in Madrid) two answers:

First, our financial system’s stability assumes climate stability, especially for water resources, which are an essential, often rate-limiting thread running through and across many sectors. If we want to have financial system stability, we need to rethink how that financial system can cope with accelerating shifts in water resources. Water is the thread that, when pulled, can weaken and unravel large parts of the larger cloth. If this happens during a major extreme event, for instance, impacts can metastasize across different parts of the financial system — an insurance/reinsurance crisis can become a banking crisis. Imagine two category 5 hurricanes hitting a major city in one year. A slow-onset crisis, like the gradual collapse of the massive Kariba Dam’s hydroelectric generation capacity on the Zambezi, can feel less like a sudden crisis but will strain the systems and economies that had reorganized themselves around it. 

We stress-test financial systems for economic crises. We might also need to stress-test them for water-climate crises.

Second, economic planning remains one of our essential tools for exploring the intersection between economic policy and potential real-life events. However, economists largely evaluate the quality of different actions and policies in terms of their economic efficiency — ideally against what economists call Pareto efficiency, which aims to eliminate all “waste” and “idle slack” to maximize current value. Pareto efficiency is about eliminating economic “deadweight.” 

Adam Smith, who launched the modern era of economics in the 1770s, would understand this way of thinking. His famous invisible hand is a silent constant economic regulator to maximize efficiency, and much economic policy in free markets is designed to strengthen the forearm and biceps of the invisible hand. I’ve not been able to find any documentation from illustrations he commissioned in his lifetime, but I choose to imagine Smith’s invisible hand being a muscular right hand.

Pareto’s deadweight, however, is exactly what constitutes resilience — it’s the space for imagining alternative states, futures, opportunities, and crises. The hand’s fingers are not pointing into the future but to an eternal now, ignoring what we know or could happen. Flexibility, redundancy, excess capacity, and intentional safety buffers clearly look like idle slack in an economically efficient planning process. A highly resilient system would clearly have terrible Pareto efficiency.

So do we give up efficiency altogether in economic planning?

That doesn’t seem like the right approach either. There are some attempts to develop new quantitative frameworks to address these issues, but they also seem fairly theoretical at this point, with a stronger focus on carbon emissions than on infrastructure development. Much less how we adjust and compensate for a shared, dynamic, and hard-to-predict resource like water. The rigid path dependencies we associate with infrastructure, governance, and allocation systems make the tension between economic efficiency and resilience that much harder. 

Until we develop better, more systemic solutions, we probably need to treat economic and resilience planning as recursive processes — comparing alternative efficiency solutions for their relative resilience. 

I am clearly biased, but I think ultimately economists will need to reconsider Pareto efficiency, so that resilience is not viewed as deadweight but a benefit, even an asset. If Adam Smith lived today on a Pacific Island or in the Himalayas, I think he would want us to add a second regulating hand — one that balances efficiency for today with resilience for tomorrow. The left hand of preparation and contingency. A hand considering the future.

I would warmly shake that hand.

John Matthews

Brasilia, Brazil