Evolutionary economics Ulrich Witt

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Although the contributions to evolutionary economics have a rather hetero dox lineage they all seem to agree on one point: the interest in, and the focus on, endogenously generated economic change, its causes and its consequences. As endogenously caused change appears on many different levels, research into evolutionary economics has been done in quite diverse fields. Pre-emi-nent topics of research have been : (1) the changes of aggregate economic activity under the influence of an incessant, yet possibly discontinuous, flow of innovations in the Schumpeterian tradition (Schumpeter, 1934); (2) the performance of industries and firms in the competitive innovative struggle and the relevance of Darwinian concepts to understanding this problem (Nelson and Winter, 1982); (3) the functioning of markets as perceived in an evolutionary perspective (Hayek, 1978); (4) the 'path dependency' of historical economic developments (Arthur, 1988); (5) the emergence and variation of societal rules and institutions that form the changing framework of economic interactions (Hayek, 1988); and (6) the individual background of the striving for change (Loasby, 1983).

Schumpeterian themes

It was Schumpeter (1934) who, for the first time, provided a consistent evolutionary interpretation of economic change. He developed a theory of entrepreneurship and submitted that cyclical patterns in aggregate economic activity can be derived from the particular time patterns of entrepreneurial activities. Being an entrepreneur is, according to Schumpeter, not an occupation or a profession, but rather a unique, and rarely found, capacity to carry out new combinations of resources; that is, innovations. The basis of this capacity is held to be a peculiar personality and motivation (Schumpeter 1934, pp. 74-94), an interpretation with obvious elitist connotations. In this respect, Schumpeter clearly contrasts with Mises and Kir/.ner who interpret the entrepreneurial element as a basic human capacity, an alertness (hill everyone possesses more or less. Likewise, Schmnpeter's view of enlrepie neurial activities as a disruption of a stationary stiite ('« in ular Mow') <>t tin economy contrasts with the Austro-American position llinl nttfihul'tin i qulli bra ting effect to entrepreneurial alertness.

It is important to note that, for Schumpeter, the inloiimitlon on iln mult il, ing inventions and discoveries is readily available li h noi iln innnmi ot novel ideas as such but their carrying out, their translation into concrete innovative ventures, that is interpreted as what entrepreneurs achieve. Given diis orientation, it is no wonder that Schumpeter tends to overemphasize the role of spectacular innovations and, by the same token, underrates small-scale innovative activities. It is often argued, however, that major innovations and small-scale innovative improvements of technologies and products systematically alternate (see, for example, Nelson and Winter, 1982, chapter 11). When Schumpeter stresses entrepreneurial will and the capacity required to turn into reality that which he assumes readily available - new knowledge -he obviously plays down the role of novelty and its creation. This does not fit well with the emphasis on the endogenous causation of economic change since, in effect, an explanation for the ultimate source of change is thus circumvented.

Later on Schumpeter (1942, pp. 132-3) himself changed his assessment of the role of the entrepreneur. He argued explicitly that the pioneering promoter loses out against the teams and trained specialists of the large corporations and trusts and becomes increasingly obsolete. Instead of being an heroic leader's achievement, innovative activities become the form of bureau and committee work. However, Schumpeter remained reluctant to address the problem of how novelty emerges in the economy. After abandoning the psychologically backed theory of the entrepreneur, his approach had therefore arrived at a point where it was open to invasion by neoclassical reinterpretations. Indeed, this was what happened in the 1970s and 1980s. Neoclassical writers were attracted by Schumpeter's provocative vision of an incessant, routine-like, industrial innovativeness which revolutionizes the economy but also embraces monopolistic practices as a necessary concomitant (Schumpeter, 1942, chapter 8). Such a view grossly deviated from the assessment derived from the static model of perfect competition. Little of Schumpeter's work has attracted as much attention as the rather isolated conjecture about the relationships between market structure and innovativeness, today discussed in innumerable contributions under the heading of Si luiinpctcrian competition'. Much of that work, empirical as well as theoreti-i id, is totally unrelated to evolutionary economics. In fact, major efforts have

I". n Ii in o'liinI the notion in the neoclassical terms of optimal innovation i hi i '.ii in and equilibrium investments into innovative activities.

1st oiioniit Miilionl i»rb i llon' and the firm

Analogies io Daiwinian concepts have always attracted economists. The economic 'natiual selection' argument refers to biological analogies in the theory of the In in thai weic discussed at the beginning of the 1950s. It is obviously inspired by Darwinian thought. The question raised was to what extent diversity in the linns' mmU and performances would be eliminated by

Bvnlutionnt v «•<«monthw ,W f competition which may be supposed to drive nil Ilium* tonus out ol tin market that are not able to operate sufficiently profitably A1, n unit« .1 «nil hi the debate, the argument tacitly presupposes much molt iliiin lis advm ni> , seem to have been aware of. In order to judge to what rxtrni nil tin p

tions on which the argument depends are fulfilled, various possible b< lm\ mini patterns must be carefully explored under diverse possible enviMiumetiiiil conditions. This is, of course, exactly what the argument hoped to avoid

The influential contribution to evolutionary economics made by Nelson and Winter (for example, 1982) is strongly informed by the debate on e« o nomic natural selection. These authors try to synthesize ideas from oigiuii/n tional and behavioral theories of the firm, in particular as suggested by the Carnegie school, on the one hand, and a loose analogy to the model of natural selection, on the other. On the basis of this synthesis, Nelson and Winter arc able to carry further an idea suggested by Schumpeter (1942), who claimed that the role of the entrepreneur as an innovator was taken over by teams and departments in corporate organizations. Where Schumpeter had no detailed conceptions as to how those corporate divisions operate, Nelson and Winter try to provide a theoretical basis. Following notions developed by the Carnegie school, they argue that organizations are based in their internal interactions on behavioral routines, rules of thumb and regular interaction patterns. Pro duction planning, calculation, price setting and even the allocation ol K<Vtl) funds thus follow rule-bound behavior.

Since there is little in the realm of the theory of firm that corresponds to 11 it-structure of reproductive processes in biology, Nelson and Wintei iiiteipret routines in only loose analogy to the theory of natural selection as 'geno types'. The firm's specific decisions thus derived, the 'phenotypes', may be more or less favorable for the firm's overall performance as ineasuied in terms of profitable growth. Assuming that routines which successfully con tribute to growth will not be changed, the actual expansion can be understood as an increase in relative frequency of those 'genes', while routines affecting deteriorations in the firm's performance are unlikely to expand. Indeed, drawing on the satisficing hypothesis it can be argued that those deteriorations trigger a search for improved routines - a kind of intentionally produced mutation. Among the results which Nelson and Winter obtain from extensive simulation experiments conducted on this basis is the conclusion that their approach supports the inverse rather than the original Schumpeter hypothesis concerning the relationship between market structure and innovativeness. According to the inverse hypothesis, the degree of concentration within an induitry, pointing to a potential for monopolistic practices, is a consequence of, lathei than a prerequisite for, a high rate of innovativeness in the industry.

New developments in biology, such as the controversy about giaduahsm \ punctualism, have recently revived the interest in analogies to hlolti}«n >d concepts. Yet, given the rather loose character of possible analogies, their pay off for the development of evolutionary economics should not be overrated. If key elements of evolutionary thought in biology are expressed in terms of the triple notion of variation, selection and replication, it seems that only the concept of selection is of direct relevance in the domain of economics. However, this concept is a very powerful tool indeed. It may help to respond to valid subjectivist reservations concerning the theoretical treatment of individual expectations and desires. Likewise, it may help to overcome the problem that, once elements of bounded rationality are admitted, this usually implies an inherent dependence of all theoretical predictions on initial conditions. If, because of limited cognitive capacities and an only subjectively rational use of information, general predictions about individual behavior can no longer be derived, competitive selection may be the only systematic inlluence which still produces regularities. Where this is the case, evolutional y economics can have recourse to a theory of competitive selection (Metcalfe, IV89).

riii* evolutionary approach to the market process

In the perspective of evolutionary economics, market processes may be theoretically approached from different angles. If, to start on the individualistic level, imperfect knowledge and uncertainty are the conditions under which economic agents act, then the question emerges as to how this state changes under the human capacity to learn. More precisely, it seems crucial to ask of what nature learning is. Consider Bayesian learning, which is assumed to start from a nucleus of truth (the prior knowledge of the true probability distribution) and implies a convergence of subjective beliefs to the true conditions. If this were the only kind of learning, all agents in the economy could well be imagined to end up in a state of general (market) equilibrium in which all Iheir knowledge-based expectations are confirmed. This is, of course, the neoclassical, general equilibrium version of the coordination story. Its disadvantage is that further change cannot be explained by this theory. After id I adaptations have been made, further change cannot come but from outside

II I'" us is on endogenously generated change, it must be assumed that lln it in still anoiltei kind of learning, which includes creation of novel ideas mil insight i, ill ,i oveiy and expansion of knowledge. Indeed, this seems to be

|a nl>lt in ol any individualistic foundation of evolutionary economics.

A close n |aiiini'-lii|> in positions held by the Austrian school and subjectivists such as Shackle m obvious Shackle rejected the standard assumption that the alternatives (limn n t lutii ally, I he slate space) which decision makers face is always already given and thai the dei ision makers only 'learn* in an adap live way about lis properties (such as associated probabilities). He held that i.volullnmirv n tmomivs 545

one of the most remarkable capacities of human do ixion innkeis is that they can create and extend what, in their subjective imagination. aie the (future) alternatives to choose from. How is the creative task, which is • «»iui|Hntaiit t<> understanding the ultimate source of change, achieved? < >n au individualistic level this question suggests enquiring, as Loasby (1983) starts to do, into what insights psychology might have to offer.

Even if progress can be made in this way, the subjectivity of knowledge still remains a problem. Whenever the sphere of the creative mind is entered, the subjectivity of newly created ideas has to be respected. Subjectivity is likely to mean diversity of individual purposes and desires out of which novel ideas emerge. The subjective particularities of each individual case are difficult to reconstruct and objectify. This obviously delimits the scope of individualistic explanations, but not necessarily that of evolutionary theorizing. What appears necessary is to extend analysis to the population level. In their interactions the agents, intentionally as well as unintentionally, impose mutually binding constraints on each other. As in a selection process, these constraints determine which actions will turn out to be tolerated or even rewarded and which will not. The constraints and their effects may often be reconstructible without knowledge of the particularities of the subjective motives and views of the involved agents.

Especially powerful forms of interactions that reveal the difference between rewarded and non-rewarded undertakings are those in the marketplace (Hayek, 1978). The competitive market process operates like a selection device, discriminating between innovative individual activities whatever the subjective state of the innovator is. Often the diversity of behavior exposed to the logic of this selection device may even be denoted in terms of observable attributes such as cost differentials, quality features, market pen etration measures, and so on. Then the effect of selection can be expressed by a diminishing variance of these attributes in the population (see Metcalfe, 1989). This amounts to a perspective similar to what is called 'population thinking' in biology, which is obviously at odds with the notion of the representative individual. In any case, the emergence of novelty and its diffusion through the markets always has allocative consequences and calls for a reconceptualization of a core element of economics - the theory of coordination. Coordination has come to be identified today almost exclusively (a notable exception being the Austrian interpretation) with the concept of general equilibrium which focuses on a state where the optimal, individual plans happen to be mutually compatible.

In this version of coordination theory there is obviously only room lot activities such as arbitrage, adaptive learning and parameter adjustments by which the coordination of individual plans in the economy is Increased Innovative activities which, in the first place, decoordinate and disrupt may occur, but they urc 'exogenous' events, that is, events outside what the theory wants to explain. In an evolutionary perspective, by contrast, coordinating and decoordinating activities are usually simultaneously present and jointly form the observable market processes (Witt, 1985). Accordingly, market processes usually perpetuate 'disequilibrium states', as neoclassical theory labels them, without offering an explanation for the regularities governing these states. Learning and adjusting, on the one hand, and the search for, and trying out of, innovations, on the other, coexist. The consequences of other agents' improved knowledge and adjustment may well be imagined to induce dissatisfaction with those who profited from having an edge in information or a possibility of arbitraging. The dissatisfaction may trigger the search for new possibilities of action and, as a consequence, may cause a state 'far from equilibrium1 to persist.

The coordination of individual economic activities in the markets may sometimes result in irreversible, self-reinforcing tendencies associated with 'network externalities', 'learning-by-using' and other instances that give rise to increasing returns to the adoption and application of one solution or standard out of several competing ones. The increasing returns may then 'lock in' (Arthur, 1988) the development in such a way that further adoption/ application decisions are bound to favor the same solution or standard, even if it turns out not to be the most effective one. The background of the phenomenon is a multiplicity of possible (technological) solutions, and the increasing returns to adoption/application are thought to induce interdependencies between the agents' decisions. This means that, instead of a unique coordination equilibrium which was supposed to exist under neoclassical assumptions, the technology here implies a multiplicity of mutually exclusive equilibria or, to denote the dynamic nature of the problem, attractors. The phenomenon is rather typical of a class of problems arising from nonlinear dynamics. It implies 'path dependency', a significant feature of evolution

'.ut lHul evolution

More i'lithai notions of socioeconomic evolution would seem to require some k111« 1 ol 'giand v iew' Unfortunately, this is still lacking, with the exception of ihi <oo poipusi-d hy Hayek (1988) which, of course, is far from providing »in ili inilnl. «plnnatlnn "i precise specification of the conjectured processes ami lit. ii o Iniiniiship'' Hayek assumes three levels of evolution. The first one is ihal ol p ii. ii. * \• ilullihi, In which primitive forms of social behavior, of preferences nml altitthli • i-Heelunling an order in social interactions have been fixed pm tn ally • I man's phylogeny. Second, there is the evolution of ihe products ol luiiinm Inn lllgent c and knowledge. Freed from the finite existence ol each individual In am by efficient forms of coding, storing and lA'oluliiminy cconamlt w 547

transmitting information, human knowledge has expanded tjnonnounly, so that today it allows the mastery of nature to an impressive rxlenl Third, and this is what Hayek considers the core of his approach, there is another level of evolution: cultural evolution as it operates 'between instinct and reason' (Hayek 1988, chapter 1). Culture, in Hayek's interpretation, is neither gencli cally conditioned nor rationally designed. It is a tradition of learnt rules of conduct whose role is often not even understood by those who follow the rules. They are passed on through cultural transmission - a 'blind' process, in the sense that it is not consciously planned or controlled.

Hayek's ideas have a certain resemblance to the more recently emerging theory of cultural transmission in sociobiology. How rules come into being, and which ones, is a question of historical accident; not so, according to Hayek, the question of which ones survive. The latter is determined by the selection process that underlies cultural evolution, a selection process operating on groups of humans sharing the same rules of conduct. Those groups succeeding in developing and passing on rules better suited to govern their social interactions are supposed to grow and feed a larger number of people. Their relative superiority may enable them to conquer and/or absorb less well equipped, competing groups and thus, unintentionally, propagate the superior sets of rules. A growing population requires increasing specialization and division of labor which, in turn, presuppose the spontaneous order to increasingly extend. The rules become ever more differentiated, abstract and difficult to understand. Over thousands of years, Hayek thus sees an 'extended order' spontaneously emerging which enabled modern societies to achieve a historically unique level of civilization and productivity. This order, the most important achievement of which, Hayek (1988, chapter 3) submits, is trade and the emergence of a system of markets, embodies an impersonal intelligence as it has been accumulated during the selection processes in the form of surviving impersonal rules of conduct.

Thus Hayek's theory of societal evolution provides a new foundation for the theory of spontaneous order which was first conceived of by the Scottish moral philosophers. The idea that regularities in social interactions may be constituted by the individual choices of all participants without anybody having intended or even understood this effect is, of course, also a core notion in Austrian economics. As Hayek repeatedly points out, it has independently been derived by Menger on the basis of such concrete examples as language, custom, moral, manners and common law. For Menger all individual actions taken together spontaneously establish a mutually coordinated behavior which helps all, and which everybody, by forming a habit, takes for granted and expects as a prevailing regularity or order. It is perhaps only today that, with the tools of game theory, the logic of the conjectured proe esses can be fully understood. Indeed, recent research on the evolution o!

economic institutions, informed by game theory, proceeds along these lines (Hirshleifcr, 1982). Models developed in this context confirm in a striking way the importance of path dependency. The multiplicity of attractors comes here in the configuration of multiple equilibria of the underlying games. Institutional evolution is accordingly characterized by more or less frequent transitions between different attractors governed once again by a frequency dependency effect which may even take such dramatic forms as revolutions.

See also:

Chapter 9: Causation and genetic causation in economic theory; Chapter 77: The 'new' institutional economics; Chapter 4: Market process; Chapter 15: Entrepreneurship; Chapter 28: Self-organizing systems

Bibliography

Arthur, W.H. (1988), 'Self-Reinforcing Mechanisms in Economics', in RW. Anderson, K.J. Arrow and D. Pines (eds), The Economy as an Evolving Complex System, Redwood City: Addison-Wesley.

Hayek, P.A. (1978), 'Competition as a Discovery Procedure', in New Studies in Philosophy,

Politics, Economics, and the History of Ideas, Chicago: Chicago University Press. Hayek, F.A. (1988), The Fatal Conceit, London: Routledge.

Ilirshleilcr, J. (1982), 'Evolutionary Models in Economics and Law', Research in Law and Economics, 4, 1-60.

Loashy, B.J. (1983), 'Knowledge, Learning, and Enterprise', in J. Wiseman (ed.), Beyond

Positive Economics?, London: Macmillan. Metcalfe, S. (1989), 'Evolution and Economic Change', in A. Silberston (ed.), Technology and

Economic Progress, London: Macmillan. Nelson, R.R. and S.G. Winter (1982), An Evolutionary Theory of Economic Change, Cambridge, Mass.: Harvard University Press. Schumpeter, J. A. (1934), The Theory of Economic Development, Cambridge, Mass.: Harvard

University Press (first German edition 1912). Schumpeter, J. A. (1942), Capitalism, Socialism, and Democracy, New York: Harper. Witt, U. (1985), 'Coordination of Individual Economic Activities as an Evolving Process of Sell-Organization', Economie Appliquée, 37, 569-95.

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