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For a while now, I’ve been dissatisfied with our shared mental models around the creative destruction being unleashed by the Internet.

On the one hand, we have coarse-grained and abstract models based on long-term historical cycles and precedents. This is the sort of thing I’ve explored quite a bit in previous posts. It involves careful analogies to previous technological revolutions. It involves debates around whether or not technological progress is stalling and whether a return to growth is possible.

On the other hand, we have detailed situational models, full of incomprehensible minutiae, that seem to develop around specific important decisions. An example is the set of mental models that drove the “fiscal cliff” farce, which just played out in the US Congress. Another is the set of mental models in evidence around the SOPA/PIPA debate last year.

The first kind of mental model is so large-scale in its concerns, it is effectively a fatalistic level of analysis. The other kind is ineffectually preoccupied with each immediate situation in turn. It quickly drives itself into a dead-end each time, and defaults to buy-more-time decisions.

I’ve thought of an allegory for understanding economic creative destruction, that I’ll call Schumpeter’s Demon. It just might be capable of informing meaningful action.

In thermodynamics, the allegory of Maxwell’s Demon is often invoked to illustrate and explore the subtleties of the second law. That sort of thing, I suspect, is the level of abstraction needed here. Especially since the operation of economic creative destruction is very similar to a thermodynamic process.

The Allegory

Imagine a town of a thousand people, with some mix of rich, middle-class and poor people. The town has been ravaged by uncertain economic times. The people live and work in a few hundred buildings: homes and workplaces. There is a general gloomy consensus that the town can only hold out for another year before nameless, inchoate horrors descend. But nobody is quite sure what those horrors are.

On this gloomy scene, a schizoid malevolent-benevolent demon appears.

The demon declares that after exactly one week, he will destroy half the buildings and kill half the people. The townsfolk can decide which buildings and people to sacrifice by marking doors and foreheads with red X’s. If they fail to do so, he will choose randomly.

But the demon also promises to leave behind a huge treasure as compensation, once he’s had his fun. He does not specify the nature of the treasure, beyond dropping a few hints about where he’s hidden it. But he promises that it will be enough to rebuild the town and its economy thrice over, put it back on the path to increasing prosperity, and raise more than enough children to replace the adults lost.

To make things more confusing, the demon throws in an exchange clause: the townsfolk can choose to trade three lives for one building, in either direction.

And to build in time pressure, he offers to trade time for either people or homes, at the exchange rate of an extra day for every additional home or every additional three people marked for sacrifice.

So what happens next?

A town meeting is convened. The rich generously supply cheap beer. Three basic conversations get underway.

The Futurists: One group ignores the immediate situation and furiously sets about debating what to do with the treasure, based on the little that is known about it through the demon’s hints, and the priorities suggested by the town’s woes.

The Situationists: The second group ignores the promise of treasure and furiously debates the question of which buildings and lives to sacrifice, based entirely on notions of fairness, values, rights and responsibilities as understood within the existing social order.

The Pragmatists: And the third group, the smallest, frantically tries to merge the conversations and talk about how to distribute the impending destruction in order to leave behind the social order best able to exploit the promised treasure.

Id-superego-ego in short.

While deliberations are in progress, a few start to despair of the the debate getting anywhere.

Some of them simply sneak off and camp outside the town limits. They pray that the demon’s random malevolence will not cross those limits, but that its promised benevolence eventually will.

These are the wannabe freeloaders looking for a heads-I-win-tails-you-lose solution.

Others bravely decide to go seek the treasure itself, based on the demon’s tantalizing hints, and steal enough for themselves outside of the bargain with the town. They meet with some success, but can never be quite sure whether they’ve found a piece of the promised treasure, or something else. Some return to town with what they’ve found, and rejoin the deliberations.

The ones who return are the entrepreneurs. The ones who never return are the anarchists.

And still others assume that the townsfolk who choose to stay will be unable to engineer anything other than a worst-case outcome. They leave, and make plans to return and rebuild after the demon is done. They find themselves waiting a lot longer than they expected to.

These are survivalists of various sorts, permanently waiting for an apocalypse that seems to be taking its time.

No conclusion is reached by the end of the week, so the townsfolk hurriedly use the time extension clause, and buy another day by sacrificing the three most drunk people, who are too drunk to notice the X being painted on their heads. When they sober up and look in the mirror, despair descends.

The cycle repeats itself, a few days at a time, depending on the number of clueless drunks around. Occasionally if there are enough drunks from the same part of town, the more sober ones mark both the drunks and their buildings with X’s, buying a lot more time at once.

And all the while, people are also being born or dying in the natural course of events. Buildings are falling down and new ones being built, implicitly changing the terms of the deal with the demon.

How will the debate end?

I have concluded that the outcome has very little to do with the relative merits of the different arguments in play. It is driven, instead, by how much of the cheap beer different people drink, and how rapidly people leave the town following each failure to make meaningful decisions.

And perhaps most interesting, the demon does not need to exist for this drama to play out as described. People merely have to believe that the demon and the deal exist, and that the situation without the demon in the picture is heading towards an unspecified disaster.

Happy New Year!