Yves here. Many of you are Jamie Galbraith fans, and INET has just published a wide-ranging interview with him. Aside from discussing Galbraith’s latest book, which focuses on how flawed mainstream models ignore real resources and lead to distortions and bad policy. The talk also covers hot topics, including DOGE, Bitcoin, climate change and tariffs.
By Lynn Parramore, Senior Research Analyst at the Institute for New Economic Thinking. Originally published at the Institute for New Economic Thinking website
Economics has a dirty secret.
What if a core principle of mainstream economic theory—still taught in top universities, printed in textbooks, and shaping policy for all of us—is completely wrong? What if the iconic supply and demand chart every econ student knows by heart doesn’t actually capture the reality of how economies work?
That’s the claim of noted economist James K. Galbraith, who argues this is a “calamity.” His big problem with mainstream economics is its obsession with a 19th-century illusion: equilibrium.
Here’s the gist: general equilibrium theory—the foundation of modern economics—rests on the idea that markets naturally balance themselves over time. It assumes all economies are just a collection of independent markets, each one perfectly matching supply and demand. The theory leads to some wild assumptions: poor countries are poor because they’re “out of equilibrium,” and prosperity in developed countries is proof that free markets work—ignoring the fact that these markets sometimes crash, only to be brushed off as “unpredictable shocks.”
Galbraith thinks the real issue is that economists have been avoiding one essential truth: entropy. In physics, entropy is the force that drives the universe, and it’s fundamental to all living systems, including economies. But neoclassical economists have stubbornly stuck with equilibrium, even though entropy and equilibrium are incompatible. One is a universal law of nature; the other is just a convenient abstraction.
In his new book, Entropy Economics: The Living Basis of Value and Production (co-authored with Jing Chen), Galbraith makes the case for an economic model that embraces entropy, aligning economic theory with life processes and physical laws—something that has real implications for how we understand markets, power, and regulation. He spoke with the Institute for New Economic Thinking about the implications of entropy economics and how it helps us better understand real-world events—from the rise of crypto to climate change—by revealing them for what they truly are.
Lynn Parramore: How does entropy economics help us understand the distribution of power and control in the economy?
James K. Galbraith: The first point has to do with resources. Resources are front and center in our thinking — something which is really downplayed in mainstream economics. They tend to treat resources as being readily substitutable, one for another, and they’re not.
In order to do anything, you have to be able to extract resources and to do so with a certain degree of surplus, and that explains why it’s so difficult to move to the so-called energy transition when you’re looking at trying to replace a very efficient resource, whatever its difficulties may be, with something that’s far less efficient when the surplus is much smaller. The capacity to pull that off is really deeply questionable.
The second point has to do with the nature of the relationship between markets and government, and we make the point that all living systems and all mechanical systems are effectively regulated. That’s true of your body temperature, your blood pressure, it’s true of the pressure and the temperature in your engine, it’s true of the cooling systems on your reactors, and it’s true of the habits, regulations, laws, and constitutions that govern economic societies. These are all of the same general form, and without them, you get a meltdown or an explosion or a crash.
These are metaphors for what happens when you don’t have proper regulation in any kind of even remotely complex market system. Markets obviously exist, but they exist under the cover of governments, and as a result of that, if you try to operate a market without a government, it tends to run out of control, and it doesn’t last for very long. People will not operate in any kind of complicated market environment unless they feel that there is effective regulation.
LP: Trump has called himself the “First Crypto President.” How does what you’re saying tie into crypto, where the idea is to have money free from government control and regulation?
JG: We’re living in a very interesting experiment in which there’s a supposition that you’re going to replace state-managed monetary systems with one which is managed by the blockchain, essentially. The probable outcome is that you will see that an asset exists that people are prepared to hold as an underlying asset and mostly in the interstices of international transactions and things that people don’t want to expose to the air or don’t want to expose to regulatory authorities.
I’m not expecting Bitcoin to go away, but I think it’s implausible that it will turn into a stable exchange medium, like the very vast, very liquid, and highly reliable U.S. dollar – or, for that matter, the U.S. Treasury, a very stable core financial asset. We shall see, but I think it’s very implausible.
The price of Bitcoin goes up and down. It’s unstable and the scale is not there compared to the Treasury assets. I can see why this has a niche in the market, but it’s a different order of magnitude from the transactions on which the global economy actually relies. The interesting question there is, to what extent do the dollar and the Treasury bond and bill, the financial assets issued by a single national authority, continue to be the dominant medium for financial operations around the world? The United States has been in the business for the last few years, and not just under Trump but before, of calling into question its stability and reliability, and that is going to have, at least at the margins, the effect of reducing the hold that the U.S. has on the global financial system.
Obviously, if you’re going to say we’re going to exclude the Russians or the Iranians, and then maybe the Chinese, not to mention Venezuela and other places, then they’re obviously going to work on alternatives and workarounds. For the moment, that is not an existential threat to the prevalence of dollar-based transactions, and you can see this in the fact that the dollar’s value on exchange markets has been very stable, in fact, it’s going up relative to the euro, which is not a stable alternative. But nothing is guaranteed to last forever. There was a time not long ago when 70% of the world’s transactions were in the sterling zone. Of course, that’s not the case anymore. Now, the U.S. is not going to decline to the extent that Great Britain did, but, you know, you chip away at the credibility of your presence, the reliability of your regulatory structure, and ultimately people look for alternatives.
LP: Generally speaking, what do we miss when we adhere to general equilibrium theory, and what insight do we gain when applying the entropy economics model?
JG: In the first place, the general equilibrium theory is rooted in a view of the world that predates late 19th-century physics and biology. It predates Darwin. It predates the second law of thermodynamics. It’s a view of the world that there is some stable state to which we are tending and that we can figure out what it is.
So there may be short-term uncertainty, there may be shocks, but there’s no long-term uncertainty. Everything is going towards some stable state. And that’s a profoundly anti-scientific view. It is inconsistent with everything we know about physics, about biology, and about social societies, about human history, about everything.
The approach that we offer is not inconsistent with everything we know about everything else. And therefore, we’re sitting there in the intellectual, the scientific, the human tradition that the rest of the world has adopted well over a century ago and considers to be really the basis of human knowledge. Yes, you can anticipate things a short time into the future, but uncertainties increase as you go further out in time. They don’t diminish. So you’re always working, in making decisions, with a number of sort of basic questions that have to be resolved. For example, what’s the possibility of making a profit on a given endeavor? What are the resource costs? How much fixed investment do you have to make in advance in order to get the resources together and to apply the technologies? How much uncertainty do you face? How confident are you that things will work out? This is the kind of decision every business makes, every government makes, every household makes, in thinking about how they go from the present to the future. So we’re in line with all of that. We’re taking that as the basis for thinking about economic decisions, not something that’s just a gloss or something that can be treated as a set of, let’s say, random shocks or even chaotic motions. We’re putting in the foreground the fundamental decisions that any economic actor actually is faced with.
It’s not a complicated idea, but it’s fundamentally opposed to the notion that the world tends to a balance between the great forces of supply and demand, or however you want to characterize the textbook vision of things.
LP: How do those mistaken assumptions impact our view of tackling climate change?
JG: It tells you that if you’re going to actually do something about the challenge, you have to make decisions on a large scale, and frankly, they may not work out. I think our position on climate change tends to the pessimistic side because there are operating principles here. One of them is the Jevons Paradox, which has been around for now 160 years, that says that when you start moving to a new form of energy, it doesn’t reduce the amount that you continually use from the older sources. So when oil took over from coal for transportation, airplanes took over from the railroads, and electrical systems took over from the railroads, coal use did not diminish, it simply got concentrated in the creation of electric power. And we see that phenomenon again and again. We put together the windmills and the solar panels in order to produce renewable energy, and what crops up is that data centers and AI processors, absorb that energy, but they don’t reduce the overall use of fossil fuels for everything else.
The Germans have gone forward trying to replace not only their fossil fuels and Russian gas, but also their nuclear power with wind. They are discovering that the cost of doing so—and particularly the problem that arises when the wind dies—creates huge problems for the viability of their industry. This is something that will end up reducing living standards in Germany for a long period into the future; it’s a fundamental economic miscalculation.
So, in some sense, I think we are not being helpful by being in the cheerleading vanguard for those who think we can solve the climate change problem by making these kinds of investments. The history of experience shows that unless you have a truly dramatic shift to something much more efficient at extracting energy from resources—and nuclear power, of course, was the great example of that—you’re going to run into basic problems with the viability of the investments you’re proposing to make. We are now seeing this.
A major effect of the interest rate moves by the Federal Reserve over the last three years was to make a lot of offshore wind projects, which were extremely marginal economically when they were first proposed at a very, very low, say, 2% interest rate, no longer viable. With interest rates three times that they’re being canceled. Our view is, that you have to face the world as it actually is and not create mental bubbles.
LP: What are some of the benefits of applying entropy economics to policy over general equilibrium theory?
JG: The fact is, if you go down the road of basing policy on a fallacious body of theory, you’re going to get it wrong practically every time. Take the campaign of sanctions against the Russian Federation, which I’ve written on in another context. This is entirely based on the idea that the Russian economy consists of a set of essentially neoclassical building blocks—a capital market, a labor market—and that if you pull back and cut off those things, the Russian economy will collapse. Now, we applied a very comprehensive program of sanctions starting in 2014, which greatly accelerated in 2022.
Especially after 2022, we see the result, which was that the Russian economy didn’t collapse. In fact, it grew rather robustly. And why was that? Because we didn’t realize that by imposing these sanctions, we were creating conditions for Russian industry, Russian companies, to fill the gap in ways that were much more profitable than the conditions they faced before. We removed foreign competition. We gave them an environment where their internal resource costs were quite low. They weren’t getting the export earnings, but that’s secondary. Their internal costs were low.
Also, we forced them to develop their own internal payment system. We basically ended capital flight from Russia, so if you were a wealthy Russian oligarch, you either left altogether or you reinvested in your home country. And all of these things produced a robust and relatively balanced growth in the last few years in the Russian economy, according to really very basic business principles, but completely contrary to the neoclassical theory, which was explicitly underpinning what the Biden administration was doing and the previous administrations were thinking they were doing in trying to use this economic policy tool for a foreign policy purpose.
LP: How might this apply to what Trump has done vis-à-vis tariffs on China? Is it a continuation of neoclassical thinking?
JG: Yes, I do think so. I don’t know what they expect will happen, but what has happened already is that the Chinese have retaliated with their own tariffs, and the Chinese position is very strong. They will be able to sell their output in other markets. In fact, they’re already doing so. The U.S. share of Chinese exports has declined in recent years, and they will be able to source their raw materials, coal presumably, in other markets. So while the U.S. position with respect to Canada and Mexico is quite strong, the U.S. position with respect to China is not, and as a result, maybe they will come to some mutual agreement and back off from all of this. The idea that the U.S. has some enormous advantages over China has been tested again and again.
Another example along the same lines was the policy of denying China access to high-end NVIDIA graphics processing chips that underpin artificial intelligence. It had two consequences. One was to accelerate China’s development of its own advanced chips, which are now being incorporated into Huawei’s phones. The other was to accelerate and foster the reengineering of artificial intelligence protocols, which is why DeepSeek emerged. The idea is that there’s a combination of a neoclassical worldview—fundamentally the idea that there are, underlying production, some specific sources of technology and capital—and this is paired with a hubristic belief that we control these sources, while others don’t have access to the same resources, and that if you give others the opportunity and make it a profitable endeavor for them to exploit that opportunity, then somehow they’re not capable of doing it. And that’s effectively what’s not being considered here: What is essentially the market environment? What is the economic environment that’s being created for the other party by these policies?
That’s not a complicated thought, but somehow it doesn’t get assimilated by policymakers. And I suspect the reason is that they are absorbed with a particular worldview, which is consistent with the training and education they got when they studied economics or social studies or politics, philosophy, and economics at Oxford. They’ve got a rather basic textbook, a very superficial view of things, and they don’t really think outside of that box.
On tariffs, the first thing I would ask is, how do these measures change the decision environment facing a Chinese entrepreneur? And the first thing you have to recognize is that such things exist. This is not a country where everything’s decided by a state bureaucrat. It’s not done mechanically. It’s done by companies looking for opportunities to expand their markets, increase profitability, and net worth. So, this is an ordinary business decision. And now we’re creating an environment—particularly if we think the sanctions are going to be serious and enduring—in which, let’s say, they’re cut off from an easy source of, say, a particular technology. Again, the GPU chips are a nice example. We could probably come up with any number of them.
And of course, they say, well, we can simply close everything in this space and not do these things. Or maybe we can put some resources into fixed investments of our own that are autonomous and may be able to equal or exceed the performance of our competitor in a certain period of time. And that’s, in fact, what they did and are in the process of doing. And it’s not new. It’s what the United States did to Britain in the 19th century. It’s what Germany did in the 19th century. It’s what Japan did in the late 19th century. This is a process ongoing in the world. And again, nothing we say is out of line with very well-known history.
You have to ask: why is the policy implemented if the consequences are so clear-cut, as I think they are, when you think about it in the simple terms we offer? And the answer is they’re not thinking in those terms. They’re thinking in terms of some very mechanical notion of the production process and a strange idea that the flow of new technologies comes only from the sources that are presently—or at a given moment—providing the leading edge. Let’s say Silicon Valley and the Dutch lithography producers. That’s true at a given moment, but there’s nothing in history that suggests those things are enduring.
LP: Do you see any opportunities for entropy economics to be applied in the incoming administration?
JG: I’ve not been able to figure out what’s going on in the minds of the various people who are coming into power. I will say that a recognition that a certain part of your past investments are not profitable and should be curtailed and shut down is a good thing. I’ve long argued that the United States set out 30 years ago to dominate the world financially and militarily—particularly in the Clinton and George W. Bush period. This was a period of enormous expansion in the global ambitions of American elites, and they thought they would never face a peer competitor again, and in particular, that it wouldn’t be Russia. They didn’t anticipate and didn’t understand what was happening in the 1990s and 2000s in China. Now, we’re looking at a situation where we’re very heavily overextended. The fixed investments we made many years ago—bases, aircraft carriers, and the whole technology of American military power—have been shown to be not profitable anymore. It was once quite dominant, but technology moves on. New power centers emerge. You can get too close to someone else’s territory, and your advantage near that territory is not great, if it exists at all. That’s what we discovered in Ukraine. Trying to fight a proxy war against the Russians on the Russian border has never been a successful enterprise.
Understanding that requires making some very difficult decisions and going against large structures that have been built up but are dragging you down, and that’s a crucial, necessary step. In some sense, the Russians went through this 30 years ago. One of the things they did, and I had this explained to me once on a visit to Moscow, was they cut the military. They cut it by about 75%. The Soviet military, the Red Army, was based in a massive defensive posture in Eastern Europe and the western part of the Soviet Union. They essentially got rid of it, and then when they rebuilt their military, they rebuilt it in a different way, meeting the needs of the Russian Federation as it recovered economically.
We didn’t go through that. We simply built on what we had at the end of the Cold War, and now we’re spread out all over the world, spending a huge fraction of our national wealth on doing something that does not, in fact, assist the United States in maintaining its economic or political position. That seems to be a really basic argument. It’s not in the book, but it’s easy to see how the principles of the book apply to that.
LP: That seems to suggest that DOGE, for example, might focus on military spending if they really want to cut waste.
JG: Yeah, for sure. Military spending and the interest bill the Federal Reserve has confected for itself—paying interest on reserves to banks and paying out interest to bondholders. Why are we doing that? You want to save money? Let’s cut the interest rate. That would be another way of doing it. But yes, in terms of fixed investments—things that absorb real resources but bring a negative return—it seems to me the military budget is exactly where one should look, and so far as I can tell, they aren’t looking. There’s a cult of American power and an enormous political base for all of this spending – it’s the easiest thing to approve. And we’ll pay in terms of policy failures as we go forward into the future if they don’t come to grips with that. I understand the difficulty, but somebody has to start talking about it.
LP: Say a Harvard econ grad taught general equilibrium theory joins an AI company. How might their economic assumptions shape their approach in tech?
JG: My first reaction would be that anybody who goes on from a mainstream economics program into a real-world business environment is going to be rapidly disabused of what they were taught because the world simply doesn’t correspond to that line of instruction. They will be operating in a world that does in fact, reflect the principles of the arguments in fairly precise ways that we make in this book.
To give you a concrete example, someone goes on to work for OpenAI, let’s say six months ago, and buys in at stock value at the time, and then discovers that the Chinese come in with something that is engineered much more efficiently and which therefore deprives the incumbents of market capitalization. There you’re talking about something that can be modeled quite precisely with the tools that we place in this book, but which is not anticipated by mainstream economics.
It’s not to say that there haven’t been important economists who were fully aware of this. There’s nothing really new in the world, and this is a Schumpeterian phenomenon, if you like, but these are phenomena that are deeply downplayed by mainstream economics, according to which technology kind of floats down like the gentle rain from heaven across all of the businesses and is absorbed by them in equal measure. The world simply doesn’t work that way.
LP: Is the DeepSeek surprise a bit like what entropy economics might look like to a mainstream economics professor?
JG: Well, you raise a very nice parallel. I would be happy to argue that the approach we’re taking is the sort of DeepSeek approach to the mainstream economic theory, in that it’s simple, it’s efficient, it accounts for a great many phenomena that occur in the real world in a very clear-cut way, and so it leaves a whole mass of textbook argumentation as essentially the realization of a set of ideas ought to fall rather dramatically. The real question is whether we’ll get a fair reading. We’ll see whether DeepSeek is being banned in order to preserve the market space of much less efficient operations. Intellectually, something similar is likely to happen here. It’s up to ordinary people to see whether they wish to cut through that particular problem.
