Tag Archives: Arbitrage

On the Diabatic Process and Standards of Living

On the Diabatic Process and Standards of Living

by Srikant Krishna (sri@srikantkrishna.com)

In thermodynamics, an adiabatic system is one that is isolated with respect to the transfer of heat. An example are two thermally sealed flasks of coffee, one warm, and one cold. This is an adiabatic system because in theory, no heat can be transferred between the two objects. The two flasks will forever maintain their own temperatures. We contrast this with the diabatic system, which as the nomenclature suggests, permits the exchange of heat between the two components. In this case, we would insert a conductive metal pipe between the two flasks. Over time, we can then expect that the temperatures of the two flasks will achieve equilibrium.

Prior to the 20th century (and in particular, the new millennium), ideas, languages, agriculture, buildings, technological implements – in other words culture and societies – were separated by vast distances, often only reachable through long and arduous voyages. This is one of the reasons why the merchant import/export trade was extremely profitable, regardless of the commodity or good being exchanged. In fact, many of the earliest corporations were formed precisely to engage in these sorts of enterprises. Historically, regions such as South Asia and East Asia contributed the lion’s share of the world’s GDP, until the development of European financial and military technology, and the concomitant colonial expansion of these nations. And thus the highly prized spices, textiles, and crafted goods of the East became available to world. In Africa, diamonds, gold, ivory and sadly even human beings were the prized exports. The gold, land, and natural resources of the Americas did not escape the machinations of European colonialists either.

The world was a very large place indeed, with an incredible diversity of culture and natural resources. Nations and cities began to become highly specialized based on the type of culture, resources, and economic activity that was transpiring at a particular locale. The first several millennia of human history were replete with a multitude of empires, and city-states with such ambtions. From the Hittites, Assyrians, Persians, Greeks, to the Romans all successfully laid claim to lands and people that extended far beyond their origins. For the purposes of this article, we begin during the Age of Colonization period during which European cities very rapidly achieved a status as a center of global import/export, and hence banking and finance advanced at an expedited pace in these regions. Other parts of the world that were colonies, rather than the centers of colonialism, specialized in resource extraction, manufacture of certain goods, and agriculture. This implicit diversity, a fundamental consequence of colonialism, created profound disparities not only in the sort of economic activity that was sited in a specific locale, but a host of ancillary institutional and organizational structures as well.

For example, the European centers of banking, finance, trade and engineering demanded that a substantial portion of the population become skilled and trained in these economic activities. Correspondingly, European universities were responsible for an astonishing array of advancements, and were the leading world-class centers of higher learning, technological innovation, and organizational and management skills. It is interesting to note how European cities displaced the previous centers of trade, learning, and technology that existed primarily in the Islamic world during the Dark Ages that also engaged in somewhat similar forms of colonialism throughout the Middle East and North Africa. A further consequence of the European domination of global economic activity was that capital formation and retention was preserved regionally and nationally within the very same European centers. For example, if a well-networked group of investors or entrepreneurs sought to raise funding for their enterprises, regardless of the particular type of activity, then the most obvious sources would be likely situated in England, Italy, the Netherlands, France, Spain, and other major economic hubs.

The heterogeneity imposed by differential economic activity produced stark sociological disparities in living standards, life expectancy, education, and population growth. For example, a diamond miner from the African continent had virtually no access to education, technology, or capital to improve his standard of living, and therefore the entire concept of social mobility was virtually absent in most of the world except for the major economic centers. This is not to say that cultural factors did not play a significant role as for example in Japan or India, but the notion of an individual from a poor or middle class background achieving education, forming networks with the priveleged, and being able to live a much more comfortable life than his or her previous generations was an exceptionally rare circumstance except in the European circles – even of which this was an improbability.

Eventually, through revolutions, warfare, and the dissemination of certain philosophical notions regarding the role of individuals, and governments, colonialism and monarchism came to an end, and engendered the formation of many modern democracies, federations, and republics throughout the entire world. The industrial revolution dramatically made the world smaller with a host of developments, including the steam engine, automobiles, the telegraph, airplanes, and electricity. Unfortunately, however, as seems to be the case with any technological innovation, whether it serves as a benefit to human civilization or a detriment is determined by the end user. Steam engines, automobiles, airplanes and electricity enabled an extraordinary leap in the devastative capabilities of militaries. The period between 1914 and 1945 was one of the most brutal and horrific eras in human civilization. It was only after the devastating power of atomic energy was unleashed on entire cities that world leaders were forced to consider ramifications of war that included the permanent destruction of a nation. In this analysis, the Mutually Assured Destruction (MAD) protocol served as a rational, game-theoretic barrier that thus far has prevented the offensive employment of highly advanced thermonuclear weapons since.

But the world became much, much smaller. Supersonic flight, rapid rail transit, highways, telephone systems, and satellites rendered travel and communication to distant places no longer an exclusive privilege that could only be afforded by the affluent. And as the world was becoming smaller, massive waves of emigration and migration became possible, that continue to this day in many regions of the world. Socially, class mobility became the norm, and no longer the exception. From 1945 onwards, it appeared that each generation’s standard of living was expected to exceed the prior’s. Coupled with the August 15th, 1971 elimination of any constraint on the creation of credit, there literally was no physical or regulatory barrier that could prevent an ordinary citizen to become educated and through success, acheive a very comfortable or luxurious life. Well, actually they could just borrow the money and pretend to live a successful life, but that is a mere aside.

Three final technological innovations reduced the size of the world to roughly that of a (navel) orange. First, the internet made it possible to communicate large amounts of data at very high rates with virtually anyone else. The data could correspond to software systems, patient record information, live video feeds, electronic mail, or digitized speech. In essence, it permitted the transmission of any type of information from one individual or organization to another in a matter of milliseconds. Simultaneously, advances in cellular technology made it possible for one individual to directly communicate through voice or messaging with anyone else on the entire planet – a truly marvelous feat that would have been difficult to predict even a few decades earlier. In fact, the most basic cellphones today far exceed the transmitter devices employed by the original Star Trek crew. And finally, today, we have mobile devices that exceed utility as cellphones, but can access the internet, and are capable to connecting hundreds of millions of people together. The result of this has been astounding collaborative human accomplishments – I point to Wikipedia as the most prominent – an dynamically evolving record of the entire human intellect.

In today’s world, the differences in learning tools, educational and informational capabilities between the rich and poor, between the developed and undeveloped parts of the world, is virtually nil. For the first time in human existence, it is possible for the individual to be limited in their ability to acquire knowledge only by the expanse of their curiosity, and of course, sadly, time. Those chidren that are being born in privilige today will have to compete directly with their counterparts in any part of the world. The notion of retention of capital in a few favored cities, regions, or even nations is rapidly evaporating.

We begain this article with the considering of an adiabatic system, in which heat cannot be exchanged by the various components of the system. This was both the colonial and 20th century models. But the world of today is a diabatic system , and fundamentally very different. If we were to regard “heat” loosely as instead the flow of information, culture, and capital, it is clear to see that the process of wage arbitrage and relative changes in the standards of living throughout the world must continue until the system reaches equilibrium.

Dear reader, please consider this momentarily, as it is the crux of this precis. No law, regulation, or policy impediment can prevent the diabatic process from forcing the system into an equilibrium state. Waking up in Manhattan or Shanghai will result in similar experiences in the very human terms of living standards: goods available for consumption, medical care, technology, transportation, and so forth. This is not to say that vast geographic differences will not strongly influence the economic activity and quality of life – as they always have. But the world has become very small indeed.

Copyright © 2013, Srikant Krishna

Srikant Krishna is a financial technologist and quantitative trader. He has a background in biophysics, software development, and the capital markets.

You can follow him on Twitter @SrikantKrishna, and on LinkedIn at http://www.linkedin.com/in/srikantkrishna/, or e-mail him at sri@srikantkrishna.com.

You can visit his blog as well.