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Ch 3: Why is Economics not an Evolutionary Science? Paper

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3.5 Why is economics not an evolutionary science? The alternative of the mainstream economic vision of the economy based around equilibrium with one of continual evolution can be traced back to Marx’s Capital (1867[1938]) with his analogy of the economic system as a biological entity that is ever changing, in contrast to a chemical reaction, tending towards equilibrium. Although, Marx viewed technological change as something that capitalists reacted to, rather than drove, he has been credited with providing one of the first glimmers of the theory of competition through innovation which was developed later by Schumpeter (Kamien and Schwartz, 1982). Indeed, in delivering his graveside eulogy, Engles claimed, “Just as Darwin discovered the law of evolution in organic nature, so Marx discovered the law of evolution in human society” (quoted in Bowles, 2004:400). However, Marx was not the only late nineteenth century scholar with an interest in applying evolutionary ideas to the social sciences. Thorstein Veblen (1898) posed the question, “Why is economics not an evolutionary science?” Prescient for his time, the essence of his criticism was that economic theory centred too heavily on static equilibrium analysis and offered little insight into the mechanics of change.

As one of the forefathers of institutional economics, he remarked, “All economic change is a change in the economic community – a change in the community’s methods of turning material things into account. The change is always in the last resort a change in the habits of thought” (quoted in Coyle, 2006:182). While aside from the notable exceptions of the Austrian economists Joseph Schumpeter (1911[1982], 1942[1975] and 1954[1994]) and Freidrich Hayek (1974) and a few others others, including John Kenneth Galbraith (1958), for much of the twentieth century evolutionary theory remained very much on the edge of economic thought. More recently, the earlier doubts which had been expressed regarding the ability of the standard model to adequately explain change in the economy exploded into a full-fledged crisis during the near collapse of the financial system in 2008-2009 which was underpinned by a regulatory system based on the theoretical foundations of equilibrium and competitive markets (see conclusion). Schumpeter, for example, was adamant that not only did perfect competition not actually exist outside the world economic models, but that it was also undesirable from policy standpoint: Thus it is not sufficient to argue that because perfect competition is impossible under modern industrial conditions – or because it always has been impossible – the large scale establishment or unit of control must be accepted as a necessary evil inseparable from economic progress which it is prevented from sabotaging by the force inherent in its productive apparatus.

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What we have got to accept is that it has come to be the most powerful engine of the progress and in particular of the long- run expansion of total output not only in spite of, but also to a considerable extent through, this strategy which looks so restrictive when viewed from the individual case and from the individual point of time. In this respect, perfect competition is not only impossible, but inferior, and has no title to being set up as a model of ideal efficiency. It is hence a mistake to base the theory of government regulation of industry on the principle that big business should be made to work as the respective industry would in perfect competition (Schumpeter, 1975[1942]:106). Here Schumpeter makes the point that institutions built on the notion of perfect competition have within them sown the seeds of “sabotaging the force inherent in its [the economy’s] productive apparatus”. He argues that a degree of monopolistic competition (large-scale unit of control) is a desirable market structure in order to enable the firm to accrue the funds to invest or recoup the cost of innovative research and development.

Schumpeter’s argument is that this means that there is a logical incompatibility between entrepreneurial activity and perfect competition, as perfect competition implies the immediate elimination of excess profits through imitation. This underpins his idea that firms compete primarily through innovation, rather than through prices, because firms in most markets (which are beset with market imperfections in practice) realise the destructiveness of price competition on profits and tacitly tend to avoid it if at all possible. In this area, one of the most prominent recent notions about how the economic landscape evolves over time has been the theory of path dependence. This is the basic idea that decisions taken today or in the past influence future decisions, closing off some options and opening up others, an idea championed particularly by Paul David (1985, 1986, 1988, 1992, 1993a, 1993b, 1994) and Brian Arthur (1988, 1989,1994a, 1994b, 1994c, 1994d). Although introduced by these authors as a way of characterising the evolution of technologies and technological standards, the idea has since been adopted and applied in a wide variety of other social science disciplines as a model of social, cultural, institutional, organisational, and political, as well as economic and technological evolution (Martin, 2010).

Indeed, Martin goes so far to suggest that the spread of this concept, can be seen as part of a more general “evolutionary turn” across the social sciences reflecting a growing interest in how socio-economic systems change over time. This has involved a corresponding exploration of ideas, models, and metaphors drawn from modern evolutionary sciences, including evolutionary biology, complexity theory, and panarchy (e.g. Gunderson and Holling, 2002; Garnsey and McGlade, 2006;Wimmer and Kössler, 2006). Notions including: variety, novelty, selection, fitness retention, mutation, adaption and population dynamics thinking have been taken from evolutionary biology; the notions of far from equilibrium adaptive systems, emergence, self organisation, fitness landscapes and hysteresis have been taken from complexity theory; and adaptive cycles and resilience from panarchy (e.g. global governance systems theorists).

What these various strands of theory all have in common is that, in a non-trivial sense, history matters. Within economic geography, this evolutionary turn has had a significant influence (e.g. Boschman and Martin, 2007; Grabher, 2009; MacKinon et al., 2009) and the concept of path dependency identified as “one of the most exciting ideas in contemporary economic geography” (Walker, 2000:126). Ron Boschma and Koen Frenken (2006:280-81), major exponents in the emerging paradigm of evolutionary economic geography, see path dependency (along with generalised Darwinism and complexity theory) as a defining characteristic of their approach: … that it explains a current state of affairs from its history…. Thus the current state of affairs cannot be derived from current conditions only, since the current state of affairs has emerged from and has been constrained by previous states of affairs.

Evolutionary theory deals with path dependent processes, in which previous events affect the probability of future events to occur (Boschma and Frenken, 2006:280-81, emphasis in the original). Boshma and Martin (2007) echo the same question Veblen asked some 100 years earlier: “why is economic geography not an evolutionary science?” Here they argue for an economic geography which studies the processes and mechanisms by which the economy transforms itself from within. Three of the main criteria they list for research in this area include that firstly, there must be a focus on change rather than a static or comparative static analysis. Secondly, it must deal with irreversible processes, rather than ‘dynamic’ in the neoclassical sense where markets frictionlessly and instantaneously adjust up and down demand and supply curves. Thirdly, they argue that it should focus attention on the generation and impact of novelty as the ultimate source of self-transformation.

It is the creative capacity of economic agents and the creative function of markets that drive economic evolution and adaptation. 3.6 What is path dependency? While the notion of path dependency has had a profound effect in the social sciences, it has benefited, or suffered (as you may), from a plurality of interpretations, so, as to not to misunderstand, misuse or abuse the notion, it is important to be clear what it is we mean by it. Two main views will be contrasted – a canonical view encompassing the work of David and Arthur based around the idea of ‘lock-in’ around a stable equilibrium, and an alternative view which emphasises the change and evolution of different pathways. As set out by Harris (2004) and Page (2006) a path dependent process can be described in the following way: (3.1) Where h(t)x = {x(t), x(t-1) …. x(0), y(t+1), y(t-1)….

} is the history of past outcomes of x from some initial time (t=0), when the activity in question first emerged, up to the present time t; and any other factors, say y, that also shape the development of x over time; and Fx(t) is the “outcome function” that maps the history h(t)x into the next outcome. This outcome function is key in distinguishing path dependency theory from neoclassical theory, as it describes the extent and manner to which the history of x influences x’s future trajectory, that is, its evolution. Although David’s model differs in certain respects from that of Arthur (Table 3.1), both share three fundamental commonalities which Martin used to characterisea “canonical model”. Firstly, the ”accidental” origin of new paths: path dependence is viewed as a nonergodic stochastic process in which initial small “random” or “chance” events, or “historical accidents”, have significant long-run effects on the technological, industrial and institutional structure of the economy. This view contrasts with mainstream neoclassical theory in which the past has no influence on current outcomes and the economy converges to a unique equilibrium no matter where it started from.

Table 3.1 Processes generating lock-in in the Canonical Path Dependence Model Secondly, the notion of lock-in: once a path is “selected”, path dependency is said to occur if that path or event becomes “locked-in” through the emergence and operation of various autocatalytic network effects (David’s phrase); or through “increasing returns effects” (Arthur’s phrase); and thirdly, the canonical model appeals to exogenous shocks to unlock paths. Once a industrial location or technology has achieved “lock-in” then it is assumed to persist and remain stable until it is dislodged by an exogenous “external shock” of some kind. 3.7 Equilibrium or evolution? Arthur’s version of this model, as he has applied it to the study of industrial location is set out in Figure 3.2 Here the outcome of multiple possible equilibria is determined by the “chance” location of the initial firms. Once agglomeration effects set in due to increasing returns, the technology or industry locks-in on to one of a multiplicity of equilibrium states, or “basins of attraction” as David calls them (David, 2005:151). In their model, once this stable equilibrium state is attained, it takes a exogenous shock to dislodge it.

From here, a new equilibrium state is ‘selected’ based on how the cards have fallen in the new economic landscape. This description of economic and technological change has also been described as a punctuated equilibrium model. It strength is that it allows the application of the neoclassical equilibrium concepts while it is in a ‘stable state’, its weakness is that it offers little insight into the process of change between stable states (if such states do indeed exist outside the model). Figure 3.2 The canonical path dependence model of spatial industrial evolution As Martin (2010) points out, there is thus a curious contradiction in the model, in that path dependence seems to matter only once a new industry has emerged, but plays no part in shaping that emergence or where it takes place. This is graphically expressed in Figure 3.3 as ‘lock-in to a stable equilibrium’.

Also Martin observes that attributing “de-locking” of a pathway to some random, exogenous event, does not seem particularly enlightening. The trouble with this, is that once a stable state is achieved, it is as if history comes to an end, until an exogenous shock disturbs it onto a different path. Thus, while this literature claims to “be taking history seriously”, its weakness is that it adopts what Ulrich Witt (2003) has called the “virgin market assumption” – that the initial emergence of a technology or industrial zone takes place by chance with no reference to pre-existing technological, social, geographical or economic structures (i.e. it says nothing about the world at x(0) in the model in equation 3.1. The initial de-locking and locking-in of a particular path may arise because of the shifting preferences of markets or the entrance of new competitors and technologies, which are constant features of economic life.

For example, many technologies and industries exhibit a ‘life cycle-type trajectory’ of gestation, growth, maturity and decline. It may happen that after initial agglomeration economies have been fully developed, diseconomies begin to set in – property prices and labour costs may rise in that area, the natural resource base may become stressed or exhausted; or the profitability of the sector may fall due to increased competition and firms may diversify into other areas of business – for example, Google moving into clean energy technology; or General Motors from combustion engines to electric motors. This life-cycle conception of the rise and fall of technologies in the path dependence literature, is also connected with Raymond Vernon’s product cycle (1966), which has also informed related product life cycle theories. Here the consumption of a product goes through a process of introduction, growth, maturity, saturation and decline; and similarly, for the local production of a product. This occurs as the firm sources its parts and labour at first from the nearby area in which the innovation was invented, but then shifts production away from this ‘home’ location as the product becomes more adopted in world markets.

Ultimately, the original country of origin of the innovation may actually become an importer of the good, such as in the case of personal computers in the United States. Once off major events, such as the recent financial crisis and recession, or the collapse of communism, can produce sudden and obvious shocks that may lead to a reconfiguration of pathways. However, path disrupting change seems also to occur as an incessant process, in addition to occurring at “critical junctures” or in sudden “gales of creative destruction” (Schumpeter, 1942 [1975]:82-83): Capitalism, then, is by nature a form or method of economic change and not only never is, but never can be stationary. And this evolutionary character of the capitalist process is not merely due to the fact that economic life goes on in a social and natural environment which changes and by its change alters the data of economic action; this fact is important and these changes (wars, revolutions, and so on) often condition industrial change, but they are not its prime movers. Figure 3.3 Some stylized alternative evolutionary paths of an industry or technology Nor is this evolutionary character due to a quasi-autocratic increase in population and capital or to the vagaries of monetary systems of which exactly the same thing holds true.

The fundamental impulse that sets and keeps the capitalist engine in motion comes from the new consumers’ goods, the new methods of production or transportation, the new markets, the new forms of industrial organisation that capitalist enterprise creates. The canonical model of path dependency has also been questioned more recently by Witt (2003:124): [S]ome doubts should be raised about the plausibility of both the theoretical underpinnings of, and the empirical evidence for, technological or industrial ‘lock in’…. sooner or later there will always be new rivals who threaten the market dominance of a technology or variant. The erosion of market dominance under competitive pressure by new technologies supports Schumpeter’s empirical generalisation that an incessant process of creative destruction characterises modern industrial capitalism. However, despite his critique of the canonical model, Witt also invokes the language of multiple equilibria in his own characterisation of lock-in, albeit with the qualification “that it is by historical standards a transitory state of affairs” (Witt, 2003:125).

In contrast, Setterfield (1997:66) argues that multiple equilibria is inconsistent with “taking history seriously”: One characteristic property of an equilibrium time path is that once it has been reached, a system will display no endogenous tendency to deviate from it… Once reached then, equilibrium implies a state of extreme stasis—an “end to history”, as it were, since in the absence of shocks any subsequent evolution of the system is pre-determined by the equilibrium time path that has been achieved. Along this time path the precise sequence of events of which economic activity over time is comprised does not matter, since it will have no effect on the subsequent outcomes of the system. It appears, then that the invocation of equilibrium as a solution concept—even qualified by the caveat that any equilibrium achieved is path dependent—entails an intolerable departure from the strictures of historical time, according to which sequential patterns of activity do, in principle, matter. However, as Martin points out – Stetterfield too, ends up suggesting that for heuristic reasons, we treat equilibrium as a “temporary” outcome of path dependent processes that may yet give rise to a subsequent endogenous process of ‘innovating out’ of equilibrium” (Setterfield, 1997:67-68). This raises the awkward question of what exactly “equilibrium” means in this context, as the more “short-run” and “transitory” an equilibrium becomes, the less powerful and relevant equilibrium seems to become as an analytical or metaphorical concept.

Therefore, if the very concept of equilibrium is inconsistent with the theory and nature of an evolutionary (historical) system as Martin (2010) seems to suggest, then where does this leave the whole of neoclassical theory? If not some sort of (albeit transient) equilibrium, what is the evolutionary theorist’s governing metaphor for the economic system? While we have defined technology as being nested within the economic and social system, to properly answer these questions, we need to first more clearly explain what we mean by the “economic system” and by “change”. With the theory of path dependency we have seen how decisions in the past may influence our decisions today, but to take the next step to understand what moves the system from one pathway to another we need a framework which can draw out in greater detail the forces of change stylised in Figure 3.3, whether they be continual and incessant in nature; characterised by stability; once-off gales of creative destruction; or simply destruction, with no creation. We also need a theoretical concept which can better explain the reality of continual change in the economy which addresses the problems inherent in lock-in and punctuated equilibrium as well as agency and the scope of individuals, firms or citizens to shape the process of technological change. While several veins of research in the field of evolutionary innovation theory deal with these issues, including: technological innovations systems theory (Jacobsson and Bergek, 2004; Hekkert et al., 2007); and new path creation (Garud and Karnøe, 2001); in the next section, focus is given to Strategic Niche Management (Schot and Geels, 2008) and the related Multi-Level Perspective on systems innovation (Geels, 2002). Next Page – Ch 3: The Mechanics of Change Previous Page – Ch 3: Evolution – Path Dependency and New Path Creation in a Complex Adaptive System

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